Income Smoothing Methods
Introduction
“How do you explain to an intelligent public that it is possible for two companies in the same industry to follow entirely different accounting principles and both get a true and fair audit report?” - M. Lafferty
Nowadays, as our economy is facing possible everyday crises, managers undergo an increasing pressure in order to keep their company 's earnings stable. Shareholders and analysts expect companies to meet forecasted goals and not to deviate from these. Especially, reliable companies are to report positive results and shall not present any 'surprises '. Managers therefore often turn to their accounting departments for help, whose job it then is to improve the bottom line by changing the information shown in financial statements and hence improve investor confidence. This process is also called earnings management. Earnings management may be utilised in several different ways – facilitated by the flexibility of the US GAAP and the IFRS. These can be stated and interpreted in numerous ways whilst accountants work in the 'gray zones ' of accounting principles. Profits can be changed easily by using certain accounting methods or manipulating accruals. When discovered, this information will have a negative effect on a company 's share price and its reputation in general.
Methods of Income Smoothing
In order to present a more positive result to shareholders and a more favorable view of company’s results, numerous methods exist that can be used by accountants. Most methods are achieved by using book entries.
The Depreciation Method
The Depreciation Method is one of the most popular methods applied. Hereby a company may change their method of depreciation from straight line to declining balance method or vice versa. Additionally a popular option exists to increase the useful life of an asset. (see Appendix A.1)
The Allowance Method
Within the Allowance Method a company sets aside a certain percentage of their outstanding accounts
“How do you explain to an intelligent public that it is possible for two companies in the same industry to follow entirely different accounting principles and both get a true and fair audit report?” - M. Lafferty
Nowadays, as our economy is facing possible everyday crises, managers undergo an increasing pressure in order to keep their company 's earnings stable. Shareholders and analysts expect companies to meet forecasted goals and not to deviate from these. Especially, reliable companies are to report positive results and shall not present any 'surprises '. Managers therefore often turn to their accounting departments for help, whose job it then is to improve the bottom line by changing the information shown in financial statements and hence improve investor confidence. This process is also called earnings management. Earnings management may be utilised in several different ways – facilitated by the flexibility of the US GAAP and the IFRS. These can be stated and interpreted in numerous ways whilst accountants work in the 'gray zones ' of accounting principles. Profits can be changed easily by using certain accounting methods or manipulating accruals. When discovered, this information will have a negative effect on a company 's share price and its reputation in general.
Methods of Income Smoothing
In order to present a more positive result to shareholders and a more favorable view of company’s results, numerous methods exist that can be used by accountants. Most methods are achieved by using book entries.
The Depreciation Method
The Depreciation Method is one of the most popular methods applied. Hereby a company may change their method of depreciation from straight line to declining balance method or vice versa. Additionally a popular option exists to increase the useful life of an asset. (see Appendix A.1)
The Allowance Method
Within the Allowance Method a company sets aside a certain percentage of their outstanding accounts