What is profit smoothing and how is it done?

Answer 1

Profit smoothing is a creative accounting method used to 'smooth' profit from one period to the next. It is used to maintain shareholders' profit expectations as profit from one period to the next can change significantly.For example, a mining company may earn profit of $1billion in one period and forecast profit for the next period indicate $1million. If the company were to announce profit of $1billion, shareholder expectation would be similar in the next period. Smoothing this profit to recognise $500million in the first period and $500million in the next period would promote investor confidence and presumably maintain a more consistence market price.

Answer 2

Profit smoothing is the use of accounting techniques to level out net income fluctuations from one period to the next. 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.