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. Generally Accepted Accounting Principles ...

    The common set of accounting principles, standards and procedures ...
  4. Accounting Noise

    The distortion that is caused in a company's financial statements ...
  5. Accounting Cushion

    The overstatement of a company's expense provision, in order ...
  6. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...
Related Articles
  1. The One-Time Expense Warning
    Fundamental Analysis

    The One-Time Expense Warning

  2. What is earnings management?
    Options & Futures

    What is earnings management?

  3. How The Patriot Act Works & Why Is It ...
    Investing News

    How The Patriot Act Works & Why Is It ...

  4. Material Adverse Effect A Warning Sign ...
    Markets

    Material Adverse Effect A Warning Sign ...

comments powered by Disqus
Hot Definitions
  1. Accounts Payable - AP

    An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable ...
  2. Ratio Analysis

    Quantitative analysis of information contained in a company’s financial statements. Ratio analysis is based on line items ...
  3. Days Payable Outstanding - DPO

    A company's average payable period. Calculated as: ending accounts payable / (cost of sales/number of days).
  4. Net Sales

    The amount of sales generated by a company after the deduction of returns, allowances for damaged or missing goods and any ...
  5. Over The Counter

    A security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, etc. The phrase "over-the-counter" ...
  6. Earnings Before Interest After Taxes - EBIAT

    A financial measure that is an indicator of a company's operating performance. EBIAT, which is equivalent to after-tax EBIT ...
Trading Center