Income smoothing is the process of manipulating accounting methods to reduce fluctuations in net income from one reporting period to the next. It is the act of balancing gains and losses over time to offer a more consistent look at a company's financial health. Accounting experts make use of various accounting techniques to achieve this level of consistency. Examples of income smoothing can include changing the way a company transacts business, such as extending payment discounts or intentionally shortening return timeliness, and through the use of lower-valued assets.

Income smoothing is generally seen as an honest way for companies to manage their finances over time, when performed according to the rules and regulations put forth by the Generally Accepted Accounting Principles (GAAP). It is mainly used to reduce reported income in years of significant earnings and increase reported income in years of low earnings, and can include having a company use one-time receivables and one-time payables. This process involves the company recognizing income in one period and then deferring it to the next period in order to compensate for annual swings in income.

Though legal if done properly within the guidelines of GAAP, income smoothing can also sometimes be used to create misleading financial reports, to minimize taxes, and to attract investors. Companies may engage in income smoothing tactics to provide a steady, more attractive look to investors, shareholders, and other parties reviewing the company's financial records. This practice carries yet another risk, however. If an honest accountant sets up the company and performs income smoothing ethically, the pattern of profits and losses may be too consistent to appear realistic. This can in turn raise suspicions over the accuracy of financial records.

Overall, income smoothing is a powerful tool for interpreting or manipulating the results of financial reporting. It holds benefits for companies looking to create the most attractive financials possible, but companies must perform it ethically and within the limits of the GAAP. Businesses doing such manipulation should always be aware of the risks associated with income smoothing and be sure to utilize all available resources and take any necessary precautions when engaging in this practice.