Explain the Income Smoothing Hypothesis

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The Answer is There has been considerable speculation about the reasons why a particular accounting policy is preferred in some circumstances while another accounting policy is preferred in other circumstances.Some of the earliest speculation began with an article by Gordon in 19646 in which he suggested that managers' incentives to smooth reported proﬁt explained the choice of accounting policies.Gordon referred to this as the income-smoothing hypothesis.However,more recent survey research by Graham,Harvey and Rajgopal has found that,while an overwhelming majority of the chief financial ofﬁcers (CFOs)they surveyed prefer smooth earnings,they are reluctant to achieve this by means of accounting policy choices - perhaps because of the stigma attached to accounting fraud in the post-Enron environment.10 Instead,the executives surveyed are willing to make small or moderate sacriﬁces in economic value - for example,by delaying maintenance or advertising expenditure - in order to achieve smooth earnings.

Explain the Income Smoothing Hypothesis

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