Journal
Name and citation:
ABACUS, Vol. 43, No. 2,
2007
Title: Optimal Smoothing of Profit Via Overhead Allocation
Author: Steve Su
Abstract: Income smoothing, as defined in Statistical Activity Cost
Theory (SACT), is the rational statistical adjustment of periodic accounting
earnings to reduce their time volatility around average long-term profit per
period. This article demonstrates how overhead cost allocations can be applied
to smooth accounting earnings optimally in accordance with this definition.Such
an approach parallels earlier work, such as that by Lane and Willett (1997,
1999), in which a depreciation formula
was derived and applied for this purpose. In particular, it is shown that, to
realize an income smoothing effect in profit making firms, the usual optimal
strategy is to over-allocate costs, giving support to the accounting principle
of conservatism.
Keywords: Accounting; Allocation; Conservatism; Measurement; Overhead; Theory.
