form of income management that reflects economic results, not as they are, but rather as management wishes them to look. This results in lower earnings quality since net income does not representatively portray the economic performance of the business entity for the period. Income smoothing relies not on falsehoods and distortions but on the wide leeway existing in alternatively accepted accounting principles and their interpretations. It is conducted within the structure of gaap. In effect, it redistributes income statement credits and charges among periods. The prime objective is to moderate income variability over the years by shifting income from good years to bad years. Future income may be shifted to the present year or vice versa. In a similar vein, income variability can be modified by shifting expenses or losses from period to period. An example is reducing a discretionary cost (e.g., advertising expense, research and development expense) in the current year to improve current period earnings. In the next year, the discretionary cost will be increased.
For analytical purposes, the analyst should restate net income for profit increases or decreases due to income smoothing attempts.
