Income Smoothing Methods

1100 Words May 24th, 2011 5 Pages
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
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However, many companies also amortize so-called ‘one-time expenses’ by listing them as a capital expense (on C/F) and paying the cost by amortization, hence improving the company’s net income.
The Classification Method
This method defines whether or not a transaction is classified as operating income or non-operating income.

The Matching Book Method
The Matching Book Method allows managers to decide in which period transactions are to be recorded. Thus, this method is the most powerful method in income smoothing.

The Channel Stuffing Method
The Channel Stuffing Method is a tool used to inflate sales within a company by selling goods to customers that did not order them in first place. This leads to more positive sales figures at first (which can then be stated) but has several disadvantages in the long-run.
Conclusion
Smoothing of income is an undeniable practice used by accountants to favour the companies' current needs, therefore it can be showing rather higher or lower earnings than the actual latter. There are several methods through which this practice is applied depending on the preferences as well as on the requirements of the people interested in the financial statements.
Approaching income smoothing from the legality perspective, one would surely come by - not only - examples of both legal and illegal aspects, but also by a gray area, where it is mostly unclear whether the act is a