Effects of Income Smoothing
Today, earnings management methods, such as income smoothing, are becoming more and more ubiquitous ways of improving earnings quality and attractiveness to investors. Because investors pay such close attention to income levels and firm stability, such methods are coming under heavy scrutiny, and are receiving more attention in the way of research and studies. The scrutiny is an attempt to explain the effects, and whether or not, in the long-run, these methods of earnings management are, in fact, effectual.
The actual effects of earnings management, particularly income smoothing, are far-reaching, and many. Most in the accounting field would agree that the prevalence of income smoothing, which is a technique used by management to reduce the variability of income, through the use of accounting entries, like accruals, thereby producing a more desirable income level, has reached an unprecedented level. Up for argument, however, are the actual effects of smoothing; positive or negative; ethical or morally bankrupt? Some researchers have suggested that, from an ethics stand point, the effects are cultural. For example, in the article ‘A cross-country study on the effects of national culture on earnings management’, the authors posited that the relationship between the dimension of individualism of national culture and the magnitude of earnings management is positive (income-increasing or income-decreasing) (Han, Kang and Salter). What this means is that the effects and uses of earnings management is subject to cultural context – that is, the degree to which company management make use of discretionary entries to manage earnings is different in a country like the United States, in comparison to a country like Saudi Arabia.
The relevant arguments surrounding the effects of earnings management and income smoothing are driven by the premise of earnings quality. The quality of earnings, while being relatively new as a research topic, seems to be at the heart of
The actual effects of earnings management, particularly income smoothing, are far-reaching, and many. Most in the accounting field would agree that the prevalence of income smoothing, which is a technique used by management to reduce the variability of income, through the use of accounting entries, like accruals, thereby producing a more desirable income level, has reached an unprecedented level. Up for argument, however, are the actual effects of smoothing; positive or negative; ethical or morally bankrupt? Some researchers have suggested that, from an ethics stand point, the effects are cultural. For example, in the article ‘A cross-country study on the effects of national culture on earnings management’, the authors posited that the relationship between the dimension of individualism of national culture and the magnitude of earnings management is positive (income-increasing or income-decreasing) (Han, Kang and Salter). What this means is that the effects and uses of earnings management is subject to cultural context – that is, the degree to which company management make use of discretionary entries to manage earnings is different in a country like the United States, in comparison to a country like Saudi Arabia.
The relevant arguments surrounding the effects of earnings management and income smoothing are driven by the premise of earnings quality. The quality of earnings, while being relatively new as a research topic, seems to be at the heart of
Cited: Gosalia, Kamalesh. Earnings Quality Differential Between Canadian and U.S. Public Companies. Research Report. Burnaby: Certified General Accountants Association of Canada, 2010. Online Document. Han, Sam, et al. "A cross-country study on the effects of national culture on earnings management." Journal of International Business Studies (2010): 123-141. JSTOR Online Database. 26 02 2013.