Did FIN 48 Limit the Use of Tax Reserves as a Tool for Earnings Management?

49 Pages Posted: 9 Aug 2010 Last revised: 14 May 2014

See all articles by Richard A. Cazier

Richard A. Cazier

University of North Texas

Sonja O. Rego

Indiana University - Kelley School of Business - Department of Accounting

Xiaoli (Shaolee) Tian

Georgetown University - McDonough School of Business

Ryan J. Wilson

University of Iowa - Henry B. Tippie College of Business

Date Written: August 8, 2011

Abstract

We utilize new income tax reserve disclosures required under FIN 48 to examine whether managers use discretion over this accrual to manage earnings to meet the consensus analyst forecast. We find that firms with pre-managed earnings (i.e., earnings before the change in the tax reserve) that are below the consensus analyst forecast are far more likely to reduce their tax reserves and thus report higher net income. In fact, we find that 37 percent of firm-years with pre-managed earnings below the consensus forecast meet the forecast when the change in the tax reserve is included in earnings. In contrast, only 9.8 percent of firm-years with pre-managed earnings above the consensus forecast increased their tax reserves to the extent that it caused them to miss the consensus forecast. This asymmetric result is consistent with managers using their discretion over tax reserves to meet consensus analyst forecasts. Using a proxy for changes in tax reserves developed by Blouin and Tuna (2007), we also document a decline in the use of tax reserves to meet the consensus analyst forecast following the adoption of FIN 48. Nonetheless, our results using both estimated and actual changes in tax reserves clearly suggest that managers continue to use their discretion over this account to meet the consensus analyst forecast, although at a lower rate of recurrence than during the pre-FIN 48 time period.

Keywords: Tax reserves, unrecognized tax benefits, FIN 48, earnings management, analyst forecasts

JEL Classification: M40, M41, M49

Suggested Citation

Cazier, Richard A. and Rego, Sonja O. and Tian, Xiaoli (Shaolee) and Wilson, Ryan J., Did FIN 48 Limit the Use of Tax Reserves as a Tool for Earnings Management? (August 8, 2011). Available at SSRN: https://ssrn.com/abstract=1656012 or http://dx.doi.org/10.2139/ssrn.1656012

Richard A. Cazier

University of North Texas ( email )

College of Business Administration
P.O. Box 305219
Denton, TX 76203
United States
940-369-8612 (Phone)

Sonja O. Rego (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812 855-6356 (Phone)

HOME PAGE: http://kelley.iu.edu/Accounting/faculty/page12887.cfm?ID=33017

Xiaoli (Shaolee) Tian

Georgetown University - McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States

Ryan J. Wilson

University of Iowa - Henry B. Tippie College of Business ( email )

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Iowa City, IA 52242-1000
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