Do Auditor-Provided Tax Services Improve the Estimate of Tax Expense?

Abstract:     
Concerns about auditor independence prompted regulators to restrict auditor-provided nonaudit services. Despite the failure of researchers to document a decrease in financial reporting quality associated with nonaudit services, there has been a significant decline in permissible auditor-provided tax services. Audit committees are unlikely to approve such services unless they perceive that the benefits of knowledge spillover exceed the risks of independence failure. We investigate tax expense, a setting where tax services could directly generate either effect. We use Internal Revenue Service, financial statement and auditor fee data to test whether auditor-provided tax services improve financial reporting from 2000 to 2002. We find that corporations that purchase auditor-provided tax services are fully reserved for IRS disputes. Other corporations must record additional expense in the year the IRS concludes its examination and in the year it settles the dispute. We conclude that auditor-provided tax services are associated with more accurate estimates of tax expense, consistent with knowledge spillover and contrary to concerns about independence failure.

Number of Pages in PDF File: 48

Keywords: Auditor fees, auditor independence, tax reserves, tax contingencies

JEL Classification: H25, M41, M49

working papers series