Profit Smoothing....

08 April 2007 |

It is now the year end for many companies and the accountants will very busy finalising their company's accounts. You may be very busy to read all of it but I would write in this article... you may find it informative.

Creative Accounting is a dirty word in accounting .... but the world 'creative' is good in the real world. So year end... and companies want to present a very good picture of state of affairs of the company to their shareholders... and the directors would expect that their accountant workout their creative minds in this definitive purpose.... This practise is know as 'Profit Smoothing'

Some of the common methods:

  • Setting up a provision for possible future expenditure. This was then taken to the profit and loss account artificially to enhance profits in the subsequent periods.
  • Recognising profits on long term contracts before they are completed provides opportunities for profit smoothing.
  • Extraordinary items are large unusal items from items from events or transactions that fall outside the scope of ordinary activities of the business and not expected to recur.
  • A company that has large changes in revenue will usually use profit smoothing. This involves moving current income to the future. For example, suppose the company is a video game company, and they get massive revenue "spikes" when a game is released, but relatively low sales the rest of the time. The company will spread the money from the "spikes" out over the year, so that their revenue shows a steady increase from year to year. Using profit smoothing is legal, but can be abused.
  • Accounting Scandals: Click here
  • Fraud Basic: Click here
Share some of the profit smoothing practises you have come across by commenting on the blog, so other fellow accountants would also know and share their thoughts.

Profit Smoothing practices are not recommended as you will comprise your Code of Ethics. I would recommend you read on Financial Reporting


Regards,

Santosh Puthran


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