Income Smoothing
Introduction
The income smoothing literature has been the centre of attention in the accounting world for the past few decades. When companies experience economic turbulence due to a poor performance year, they turn to the accounting management department to resolve the bottom line. A strategy that managers can approach is changing the true information content of the company. As a result this has led managers to resort to smoothing their income. Many questions have been raised whether or not it is common for companies to smooth their reported income, which many have argued whether if income smoothing is appropriate or ethical.
Income smoothing is defined as a technique to remove volatility in earnings by leveling off the peaks and valleys of earnings over a number of years. Its primary objective is to moderate income variability by reducing income during good successful years and as a result defer them for use during the bad years. (Beidleman, C.R. 1973) It is a process that is common in the accounting practice in which it can stretch over many periods. The application of income smoothing is often referred to earnings management. Earnings management is perceived as a strategy tool that is applied in companies in order for managers to manipulate accounting information. It is defined as, “a purposeful intervention by management in the earnings determination process, usually to satisfy self objectives.” (Wild, J. et al, 2001, p.1052)
It has been proven in studies that it is common for company managers to manipulate reported profits for their company’s interests. Managers can accomplish this by simply selecting certain accounting policies, changing accounting estimates, and manipulating accruals. (Yoon, S.S. & Miller, G. 2002). However, when profits are manipulated for self-interests or incentive schemes, their integrity is at risk. To prevent managers from misrepresenting their company’s prospects, regulators have advocated a reduction in accounting
The income smoothing literature has been the centre of attention in the accounting world for the past few decades. When companies experience economic turbulence due to a poor performance year, they turn to the accounting management department to resolve the bottom line. A strategy that managers can approach is changing the true information content of the company. As a result this has led managers to resort to smoothing their income. Many questions have been raised whether or not it is common for companies to smooth their reported income, which many have argued whether if income smoothing is appropriate or ethical.
Income smoothing is defined as a technique to remove volatility in earnings by leveling off the peaks and valleys of earnings over a number of years. Its primary objective is to moderate income variability by reducing income during good successful years and as a result defer them for use during the bad years. (Beidleman, C.R. 1973) It is a process that is common in the accounting practice in which it can stretch over many periods. The application of income smoothing is often referred to earnings management. Earnings management is perceived as a strategy tool that is applied in companies in order for managers to manipulate accounting information. It is defined as, “a purposeful intervention by management in the earnings determination process, usually to satisfy self objectives.” (Wild, J. et al, 2001, p.1052)
It has been proven in studies that it is common for company managers to manipulate reported profits for their company’s interests. Managers can accomplish this by simply selecting certain accounting policies, changing accounting estimates, and manipulating accruals. (Yoon, S.S. & Miller, G. 2002). However, when profits are manipulated for self-interests or incentive schemes, their integrity is at risk. To prevent managers from misrepresenting their company’s prospects, regulators have advocated a reduction in accounting
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