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ACCA Applied Skills · Financial Reporting · Limitations of financial statements

Which of the following is an example of income smoothing through creative accounting?

Recognising an excessive provision in a high-profit year and releasing it in a low-profit year is income smoothing. It moves profit between periods to show a steadier trend, and it breaches IAS 37 because provisions must reflect a genuine present obligation measured at the best estimate.

  1. ARecognising an excessive provision in a high-profit year and releasing it in a low-profit yearCorrect
  2. BDisclosing a contingent liability in the notes to the financial statements
  3. CReporting a non-adjusting event after the reporting period in the notes
  4. DApplying a new IFRS Accounting Standard retrospectively as required

Explanation

Creating an excessive provision when profits are high reduces profit, and releasing it later boosts profit, giving a smoother trend. The other options are compliant disclosure or required application of standards. Such provisions would not meet the IAS 37 recognition criteria.

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