Some of the methods by which companies can smooth earnings can certainly be plugged, by a tightening of accounting standards.

In the US, the Financial Accounting Standards Board has issued a string of new guidelines pertaining to areas such as mergers, restructuring costs, and accounting for goodwill, which are most prone to smoothing.

In India, the Institute of Chartered Accountants of India too has promulgated a few new accounting standards that reduce the scope for smoothing.

The new Accounting Standard 25 on Interim Financial Reporting, for instance, prevents companies from allocating expenses to the quarterly accounts on the basis of an estimated proportion of the full year's charges.

This has had far-reaching implications for the quarterly financial announcements, forcing HLL to take restructuring charges, and MICO depreciation charges, to their quarterly accounts on the basis of actuals rather than discretionary estimates.

But despite a more stringent accounting framework, it would be quite difficult to deter companies that are completely determined to smooth their earnings performance.

Therefore, investors need to be armed with knowledge — of the prevalent methods of smoothing and of how to see beyond them — in order to make better investment decisions. Investors may bear the following pointers in mind while evaluating earnings performance:

True, companies have been known to resort to bill-and-hold transactions (where sales are invoiced but not actually shipped) or to push sales to dealers at the end of an accounting period, to present a better sales performance. But such adjustments can only be temporary and are bound to show up in the next accounting period. Further, they can make only a marginal difference to the overall picture.

A sharp dip in "other expenditure" as a proportion of sales could indicate cost savings, or some unusual income, which has been tucked under the `other expenditure' figure.

A sharp drop in raw material costs as a proportion of sales could indicate lower input prices, or the fact that the company has produced less and is liquidating stocks built up in the previous period.

For instance, a company's decision to write off a large chunk of deferred marketing expenses in a single year could mean that it does not expect any future benefits to materialise from that expense.

A large "asset impairment charge" could mean that a company is scrapping a key division. Finally, do not read too much into the sketchy financial information provided in the quarterly results announcements. The cash flow statement, the balance sheet and the schedules to the profit and loss account are crucial for evaluating a company's true financial position in its entirety.

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