On which side the aisle are you? I found an academic paper "EARNINGS SMOOTHING: FOR GOOD OR EVIL?*" by Peter Demerjian, et.al. that in their abstract, once you cut away for double-talk, they state good managers, smoothing is good. bad managers, well its bad. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2426313 (footnote: reading one article is not a proper research technique) So, if you do use earning smothing are you a good or bad manager? Is it good for the company/shareholders? Or is it bad for the company/shareholders?
Earnings Smoothing
Answers
I am on the side of letting chips fall as they may. Earnings guidance should take care of any questions/apprehensions about peaks and valleys. I believe that earnings smoothing is a slippery slope that encourages us finance/
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Agree. When the principles are not clear and may vary from the financial manager's individual capability, integrity and interpretation, the
Earning smoothing in construction is often needed and is something good financial managers do. For instance, if a project manager tells you the margin on a job is 12%, but based on historical research and past job performance, it is likely the job will land at 9%, then go ahead and drop off the 3% to what is realistic based on research. This way at the end of the job if it comes in higher than the historical 9% you, as the financial manager, and the construction manager, will both look like heros for gaining margin. Bonding companies hate to see underbillings because it often times means margin on a job is slipping. Reducing the margin to a realistic number will hopefully decrease the likelihood of underbillings.
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Is this a
Even with % of completion billing, you'd recognize expenses when incurred and still bill the agreed upon sales figures (plus / minus change orders).
Under Percentage of Completion Accounting, invoicing does not equal sales.
"Earnings Smoothing" is often code for "Accounting Fraud". You can put all the flowery language you want to around it, but it doesn't change what it really is.
Financial reporting function, which are given to management, as well as various state contracting boards.
With percent of completion you recognize revenue based on expenses, but the revenue is billed revenue plus underbillings or less overbillings depending on the margin for the job.
So on a job that has total job cost of $1,000,000 at a 12% margin, the recognized revenue would be $1,136,000 (rounded). If $1,500,000 was billed to the customer, the you would deduct from recognized revenue (not billed) $364,000 which is considered overbilled. On the balance sheet the offsetting is recorded as a liability.
Take the same job cost of $1M with the 12% margin, if only $1,005,000 was billed, then the job would have to have an additional revenue recorded of $131,000, which wouldn't necessarily be billed, but included at the end of the month for accrued revenue.
Expenses are recognized as incurred and the job is billed as agreed upon by the customer and architect, however the recognized revenue has to have the underbillings and overbillings taken into account.
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