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. Accident Year Experience

    Premiums earned and losses incurred during a specific period ...
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 >>
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. Investing

    What's a Debit Note?

    A debit note is a document used by a seller to inform a purchaser of a dollar amount owed. As the name indicates, it is a note from the seller that a debit has been made to the purchaser’s account. ...
  3. Investing

    What's Capitalization?

    Capitalization has different meanings depending on the context.
  4. Fundamental Analysis

    The Best 5 Online Accounting Systems For Small Business

    Running a small business can be difficult, but thanks to these online accounting services, taking care of payroll doesn't have to be.
  5. Investing

    Understanding Cost Accounting

    Cost accounting is the method of financially allocating expenses to goods that are manufactured for resale. Cost accounting is also referred to as managerial accounting, because managers use ...
  6. Investing

    What are Prepaid Expenses?

    A prepaid expense is an asset on the balance sheet. Due to accounting principles, expenses are often accrued on the balance sheet and expensed in a later period.
  7. Investing

    What's a Sunk Cost?

    A sunk cost was incurred in the past, is independent of future events and cannot be recouped. Economists teach that sunk costs should not be considered when making a financial decision. Rather, ...
  8. Investing

    What are Fixed Costs?

    Fixed costs are business expenses that do not change as the level of production goes up or down. They are one of two types of business expense, the other being variable costs. Variable costs ...
  9. Fundamental Analysis

    What's the FCCR?

    The fixed charge coverage ratio (FCCR) is an accounting calculation that shows a company’s ability to pay its fixed costs – expenses that generally do not vary with production level. This may ...
  10. Investing

    What's an Average Collection Period?

    Average collection period is an accounting term referring to the average number of days between a sale made on credit, and receipt of the payment. Businesses monitor this number to make sure ...

You May Also Like

Hot Definitions
  1. Fixed Cost

    A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses ...
  2. Subsidy

    A benefit given by the government to groups or individuals usually in the form of a cash payment or tax reduction. The subsidy ...
  3. Sunk Cost

    A cost that has already been incurred and thus cannot be recovered. A sunk cost differs from other, future costs that a business ...
  4. Technical Skills

    1. The knowledge and abilities needed to accomplish mathematical, engineering, scientific or computer-related duties, as ...
  5. Prepaid Expense

    A type of asset that arises on a balance sheet as a result of business making payments for goods and services to be received ...
  6. Gordon Growth Model

    A model for determining the intrinsic value of a stock, based on a future series of dividends that grow at a constant rate. ...
Trading Center