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.
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.
Investment dictionary. Academic. 2012.
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