Classificatory smoothing of Income with Extraordinary Items - Summary
Within this paper they talk about whether extraordinary items are used to smooth ordinary or operating income over time. The role of extraordinary items was never really looked at become separately and that is what they wanted to look at. They talk about how previously the focus was on net income after extraordinary items but that it is important to look at net income before extraordinary items also. The use of the smoothing of income with extraordinary items could be used to predict future earnings. They also state that ordinary income is superior to net income to predict future earnings. (reference). “Income smoothing is the deliberate dampening of fluctuations about some level of earnings considere to be normal to a firm”. (reference) This can be achieved through several smoothing dimensions which are; smoothing through events occurrence and/or recognition, smoothing through allocation over time, smoothing through classification. In this paper the focus is on the last one, which is the degree that revenues and expenses are used alone or incrementally for smoothing of income statistics other than net income. (reference) Nonrecurring items be classified within the category of extraordinary items, for income smoothing. A couple of examples of these would be write-off of goodwill or the sale of a large segment of a company. Reclassifying these items could help a company show a favorable ordinary income. A test was conducted for classificatory smoothing with extraordinary items to observe whether these items could be classified as ordinary or extraordinary to smooth income. Assumptions were made with respect to; management’s expectations for future earnings, what is perceived by management as a favourable distribution of ordinary income over time, management’s anticipation as to future significance of variables with the potential of smoothing, managements...
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