Assessing Financial Reporting Risk in the Income Tax Accrual
Terry J. Shevlin
University of California-Irvine
June 9, 2014
Georgetown McDonough School of Business Research Paper
We develop a new measure of tax-related financial reporting risk. Our measure, which we refer to as tax accrual quality, is based on variation in the extent to which the income tax accrual maps into income tax-related cash flows. We interpret a lack of mapping as estimation error and thus higher tax-related financial reporting risk. We show that poor tax accrual quality is associated with proxies that capture greater judgment and complexity in applying GAAP which increase estimation error in the tax accrual. We document that poor tax accrual quality is associated with future tax-related financial statement restatements and tax-related internal control material weaknesses. Finally, we demonstrate that earnings better capture a firm’s economic performance (as reflected in contemporaneous stock returns) when tax accrual quality is better. All of our empirical results related to tax accrual quality are incremental to working capital accruals quality. We conclude by suggesting how researchers could use our tax accrual quality measure to address research questions related to financial reporting risk in the income tax accrual.
Number of Pages in PDF File: 62
Keywords: financial reporting risk; accrual quality; accounting for income taxes
JEL Classification: M41
Date posted: September 6, 2013 ; Last revised: June 12, 2014
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