Columbus Business Daily

Define income smoothing and explain how it is implemented.?

Research has shown that numerous companies manage their earnings. A variety of earnings management techniques are available ranging from income smoothing to outright fraud.

Public Comments

1. My understanding of "income smoothing" is that companies deliberately time their income and expenses in a way that allows them to match the analysts' expected earnings for a particular quarter. For example, if it looks like they have greater than expected sales and earnings in the second quarter, but are concerned that the third quarter might not be as good, they might defer shipping some items scheduled for shipping on June 29th and 30th to July 1st so that they count as sales in the third quarter rather than the second. They might also purchase some things that could have waited until July in late June so that the expenses count in the second quarter instead of the third quarter. That way they've reduced the earnings for second quarter (which would have been better than expected if they just let things go normally) and increased the earnings in the third quarter (which would have been worse than expected if they just let things go normally). Why do this if they still make the same amount of money over the course of the year? Because stock analysts (and many investors) prefer companies with "predictable" earnings, so they'll value a stock higher if it meets expectations every quarter than if it's better than expected some quarters and worse than expected other quarters - even if the end result for the year is exactly the same! Crazy in my opinion...and it leads companies to do some crazy stuff (e.g. drastic expense cuts late in a quarter) which I think in the long run is a negative because it can impact productivity.