Expert answer:Financial Accounting: Income Concepts and Working
Solved by verified expert:One reason accounting earnings
may not be a realistic measure of economic income is the incentive and
ability of business managers to manipulate reported profits for their
own benefit. This may be particularly true when their company has an
incentive compensation plan that is linked to reported net income. The
manipulation of earnings known as earnings management frequently involves income smoothing. Income smoothing
has been defined as the dampening of fluctuations about some level of
earnings that is considered normal for the company. Research has
indicated that income smoothing occurs because investors prefer a
stable rather than a volatile earnings trend. Discuss why investors prefer stable and consistent earnings trends.
Identify ways and methods that business managers might use to smooth
earnings.
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