Bias in Quarterly Estimates of Annual Effective Tax Rates and Earnings Management

Comprix, Joseph; Mills, Lillian F.; Schmidt, Andrew

doi:10.2308/atax-10152

Cited by 47 publications

(34 citation statements)

References 52 publications

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“…We include UTB_change, which is the difference between the UTB ending and beginning balances scaled by lagged market value of equity, and IntPenMagn, which (as described previously) is the absolute value of UTB interest and penalty expense scaled by pre-tax income. Consistent with the arguments in Comprix, Mills, and Schmidt (2012), we expect tax expense to be more difficult to forecast when there are larger levels of UTBs and when the penalties and interest associated with UTBs are larger. We also include ETR_STD (ETR_change), which is the standard deviation of the previous four years of effective tax rates (absolute value of the prior year change in effective tax rates) as determined by the implied ETR based on actual pre-tax income and net income reported in I/B/E/S, and the absolute value of the difference between the firm's prior year GAAP ETR and 35 percent (absPermDiff ).…”

Section: Implications For Financial Statement Userssupporting

confidence: 60%

“…We also include ETR_STD (ETR_change), which is the standard deviation of the previous four years of effective tax rates (absolute value of the prior year change in effective tax rates) as determined by the implied ETR based on actual pre-tax income and net income reported in I/B/E/S, and the absolute value of the difference between the firm's prior year GAAP ETR and 35 percent (absPermDiff ). We expect tax expense to be more difficult to forecast when ETRs are less stable over time, and when a firm has permanent differences (Comprix et al 2012;Dhaliwal et al 2004). …”

Section: Implications For Financial Statement Usersmentioning

confidence: 99%

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Income Statement Reporting Discretion Allowed by FIN 48: Interest and Penalty Expense Classification

Abernathy

Beyer

Gross

et al. 2017

The Journal of the American Taxation Association

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Financial Accounting Standards Board Interpretation No. 48 (FIN 48, FASB 2006) allows discretion regarding the income statement classification of interest and penalty expenses for unrecognized tax benefits (UTBs). We investigate whether tax avoidance, management compensation, and debt agreements affect the expense classification election and whether this discretion has implications for financial statement users. We find firms that engage in tax avoidance activities, measured by effective tax rates (ETRs) and involvement in tax disputes, are more likely to include interest and penalties in tax expense. We also find that interest and penalties are more likely to be classified as tax expense when CEO compensation is more sensitive to pre-tax income. Finally, we find that UTB interest and penalty expense classification is associated with analysts' ETR forecast accuracy, which suggests there is a potential unintended consequence related to decision usefulness of FIN 48 reporting due to expense classification discretion.

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Section: Implications For Financial Statement Userssupporting

confidence: 60%

Section: Implications For Financial Statement Usersmentioning

confidence: 99%

Income Statement Reporting Discretion Allowed by FIN 48: Interest and Penalty Expense Classification

Abernathy

Beyer

Gross

et al. 2017

The Journal of the American Taxation Association

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“…Identification of expected tax avoidance is difficult because quarterly estimates of annual effective tax rates disclosed in firms' 10-Q's contain upward bias (Comprix, Mills and Schmidt 2011) and sophisticated users of financial statements have difficulty interpreting effective tax rate changes (Bauman and Shaw 2005). In addition, the variability of annual tax rates due to refunds, settlements and other tax irregularities limits the use of an annual rate as an expectation for a future year's rate.…”

Section: Relative Valuation Of Tax Avoidancementioning

confidence: 99%

Relative Valuation of Alternative Methods of Tax Avoidance

Inger

2013

The Journal of the American Taxation Association

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This paper examines the relative valuation of alternative methods of tax avoidance. Prior studies find that firm value is positively associated with overall measures of tax avoidance; I extend this research by providing evidence that investors distinguish between methods of tax reduction in their valuation of tax avoidance. The impact of tax avoidance on firm value is a function of tax risk, permanence of tax savings, tax planning costs, implicit taxes and contrasts in disclosures of tax reduction in the financial statements. My empirical results suggest that tax avoidance resulting from stock option tax benefits is positively associated with firm value, accelerated depreciation is not associated with firm value and deferral of residual tax on foreign earnings is negatively associated with firm value. Prior studies that find the positive association between firm value and tax avoidance is attenuated in poorly governed firms suggest the discount results from investor concern of managerial opportunism. Self-serving managers conceal diversion of tax savings from investors under the pretext that aggressive tax positions must be hidden from tax authorities in the financial statements. Under this theory transparent tax reduction methods that are clearly supported by the law should not be discounted by investors of poorly governed firms. However, I find that tax avoidance resulting from transparent stock option tax deductions is discounted in poorly governed firms, while tax avoidance derived from opaque deferral of the residual tax on foreign earnings is not, inconsistent with investors believing that managers are exploiting the compromised information environment associated with complex tax transactions.iii Dedication I dedicate this dissertation to my family. Matt, thanks for the support, sacrifice and understanding along the way. Marlowe, thanks for the perspective and smiles when I needed it most. Mom, Dad, Chris and Steve, thanks for the encouragement and support, both emotionally and financially.iv Acknowledgements First, I thank Dr. Bryan Cloyd, my dissertation chair, for his direction throughout the doctoral program. Thank you for your time and energy over the past four years to get me to this point. I appreciate that you always are able to help me see things in new ways, both from an academic and life standpoint. It was an honor to work with you.

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“…Conversely, the Compustat Unrestated U.S. Quarterly file identifies the net income effect for each quarter of each fiscal year for each firm. Studies that use the Compustat Unrestated Quarterly file to obtain originally released accounting data include Bronson et al (2011), Price et al (2011), andComprix et al (2012), among others.…”

Section: Research Design and Descriptive Statistics Samplementioning

confidence: 99%

The Contagion Effect of Low-Quality Audits

Francis

Michas

2012

The Accounting Review

258

103

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We investigate if the existence of low-quality audits in an auditor office indicates the presence of a ''contagion effect'' on the quality of other (concurrent) audits conducted by the office. A low-quality audit is defined as the presence of one or more clients with overstated earnings that were subsequently corrected by a downward restatement. We document that the quality of audited earnings (abnormal accruals) is lower for clients in these office-years (when the misreporting occurred) compared to a control sample of officeyears with no restatements. This effect lasts for up to five subsequent years, indicating that audit firms do not immediately rectify the problems that caused contagion. We also find that an office-year with client misreporting is likely to have subsequent (new) client restatements over the next five fiscal years. Overall, the evidence suggests that certain auditor offices have systematic audit-quality problems and that these problems persist over time.

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Bias in Quarterly Estimates of Annual Effective Tax Rates and Earnings Management

Cited by 47 publications

References 52 publications

Income Statement Reporting Discretion Allowed by FIN 48: Interest and Penalty Expense Classification

Income Statement Reporting Discretion Allowed by FIN 48: Interest and Penalty Expense Classification

Relative Valuation of Alternative Methods of Tax Avoidance

The Contagion Effect of Low-Quality Audits

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