Income Smoothing

AAA

DEFINITION of 'Income Smoothing'

The use of accounting techniques to level out net income fluctuations from one period to the next. Companies indulge in this practice because investors are generally willing to pay a premium for stocks with steady and predictable earnings streams, compared with stocks whose earnings are subject to wild fluctuations.


Examples of income smoothing techniques include deferring revenue during a good year if the following year is expected to be a challenging one, or delaying the recognition of expenses in a difficult year because performance is expected to improve in the near future.

INVESTOPEDIA EXPLAINS 'Income Smoothing'

Income smoothing does not rely on "creative" accounting or misstatements - which would constitute outright fraud - but rather on the latitude provided in the interpretation of GAAP.


An often-cited example of income smoothing is that of loan-loss provisions by banks, since they have considerable leeway in determining this provision. Banks may be tempted to understate annual loan-loss provisions in years of low profitability, and may be inclined to overstate them during highly profitable periods.

RELATED TERMS
  1. Cookie Jar Accounting

    A disingenuous accounting practice in which periods of good financial ...
  2. Non-GAAP Earnings

    An alternative earnings measure of the performance of a company. ...
  3. Accounting Cushion

    The overstatement of a company's expense provision, in order ...
  4. Accounting Noise

    The distortion that is caused in a company's financial statements ...
  5. Generally Accepted Accounting Principles ...

    The common set of accounting principles, standards and procedures ...
  6. Wealth Management

    A high-level professional service that combines financial/investment ...
RELATED FAQS
  1. What is earnings management?

    Before diving into what earnings management is, it is important to have a solid understanding of what we mean when we refer ... Read Full Answer >>
  2. What are some examples of general and administrative expenses?

    In accounting, general and administrative expenses represent the necessary costs to maintain a company's daily operations ... Read Full Answer >>
  3. How do dividend distributions affect additional paid in capital?

    Whether a dividend distribution has any effect on additional paid-in capital depends solely on what type of dividend is issued: ... Read Full Answer >>
  4. Why can additional paid in capital never have a negative balance?

    The additional paid-in capital figure on a company's balance sheet can never be negative because companies do not pay investors ... Read Full Answer >>
  5. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    The One-Time Expense Warning

    These income statement red flags may not spell a company's downfall. Learn why here.
  2. Economics

    Understanding the Top Line

    Top line refers to a company’s gross sales without any reductions for discounts or returns.
  3. Economics

    What's an Allowance for Doubtful Accounts?

    The allowance for doubtful accounts represents the percentage of the accounts receivable the company expects to write-off as uncollectible.
  4. Fundamental Analysis

    Understanding Activity Ratios

    Activity ratios measure how effectively a business uses its assets.
  5. Investing Basics

    What is Accrued Income?

    In a mutual fund, accrued income is earnings that have accumulated over the year, but have not yet been paid out to shareholders.
  6. Fundamental Analysis

    Explaining the Common Size Income Statement

    A common size income statement expresses each account as a percentage of net sales.
  7. Professionals

    What Does an Auditor Do?

    An auditor ensures that organizations maintain accurate and honest financial records.
  8. Fundamental Analysis

    Calculating the Net Debt to EBITDA Ratio

    Financial analysts typically use the net debt to EBITDA ratio to determine a company’s ability to pay its debt.
  9. Economics

    How Does an Operating Lease Work?

    Operating lease is a term used mostly in accounting to denote a lease that gives the lessee rights to use and operate an asset without ownership.
  10. Economics

    Understanding Historical Cost

    Historical cost equals the original purchase price of an asset recorded on a company’s balance sheet.

You May Also Like

Hot Definitions
  1. Hedging Transaction

    A type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging ...
  2. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  3. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
  4. Nuncupative Will

    A verbal will that must have two witnesses and can only deal with the distribution of personal property. A nuncupative will ...
  5. OsMA

    An abbreviation for Oscillator - Moving Average. OsMA is used in technical analysis to represent the variance between an ...
  6. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!