One reason accounting earnings might not be a realistic measure of economic income is the incentive and ability of business managers to manipulate reported pro?ts for their own bene?t. 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 , commonly involves income smoothing. Income smoothing has been de?ned as the dampening of ?uc-tuations about some level of earnings that is considered normal for the company. Research has indicated that income smoothing occurs because business managers prefer a stable rather than a volatile earnings trend.
Required: a. Why do business managers prefer stable earnings trends?
b. Discuss several methods business managers might use to smooth earnings.