The Aggregation and Valuation of Deferred Taxes

Posted: 24 Jun 2002

See all articles by Eli Amir

Eli Amir

Tel Aviv University

Michael Kirschenheiter

College of Business Administration University of Illinois at Chicago

Kristen Willard

affiliation not provided to SSRN


This paper clarifies some of the conflicting arguments about the value relevance of deferred taxes. We address two questions. First, does accounting aggregation hold, or in other words, are deferred tax expense and liability balances valued the same as operating earnings and asset balances, respectively? Second, what accounting method for deferred taxes preserves classical accounting relations, or should deferred taxes be recorded as equity, as debt, or as some combination of these categories? We answer these questions using a model of depreciable assets and cashflow dynamics identical to Feltham and Ohlson (1996). In this setting, we find that aggregation does not hold; rather deferred taxes are valued less than earnings and book value. Deferred taxes add value because they represent the deferral of tax payments, so their value is the net present value of the tax benefits. We interpret this result to mean that the timing of the reversal of temporary differences does matter, consistent with recent empirical work. Our analysis shows that the deferred tax liability, as currently recorded in accordance with US GAAP, overstates the liability. In answer to the second question, we find that the classical accounting relations hold only when deferred taxes are adjusted to their net present value. Further, the extent of this adjustment depends on whether or not the tax benefits are capitalized into the cost of the operating asset. If the benefits are reflected in the assets cost, deferred taxes should be adjusted down based on the ratio of the discount rate over the sum of the tax depreciation and discount rates. Otherwise, the entire balance should be treated as equity.

JEL Classification: H25, G12, M41, M44

Suggested Citation

Amir, Eli and Kirschenheiter, Michael and Willard Barry, Kristen L., The Aggregation and Valuation of Deferred Taxes. Review of Accounting Studies, Vol. 6, No. 2/3, June/September 2001, pp. 275-297, Available at SSRN:

Eli Amir

Tel Aviv University ( email )

312 Recanati Bldg.
69978 Tel Aviv
+972 3 640-8510 (Phone)
+972 3 640-7738 (Fax)

Michael Kirschenheiter (Contact Author)

College of Business Administration University of Illinois at Chicago ( email )

601 South Morgan Street
11th Floor
Chicago, IL 60607
United States
312.996-2284 (Phone)
312.996-4520 (Fax)

Kristen L. Willard Barry

affiliation not provided to SSRN

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