Managers’ Use of Tax Settlements in Future Uncertain Tax Benefit Accruals

48 Pages Posted: 20 Jun 2019

See all articles by Andrew M. Bauer

Andrew M. Bauer

University of Waterloo - School of Accounting and Finance

Kenneth J. Klassen

University of Waterloo - School of Accounting and Finance

Date Written: June 13, 2019

Abstract

We examine the financial statement disclosures that accompany settlements of uncertain tax benefits (UTB) to explore how managers reflect this information into their underlying probability assessments and thus future estimates of UTB reserves. We use textual analysis to develop a measure of the similarity between tax footnotes and a tax settlement-specific list of terms capturing unfavorable and favorable outcomes. After demonstrating that this proxy is associated with a subset of manually verified settlements, we examine whether these disclosures predict future UTBs. We find that managers revise upwards future UTBs following unfavorable tax settlements, but do not revise future UTBs following favorable tax settlements. These findings are consistent with extant theory and literature that suggests subsequent judgments respond more to unfavorable information and that UTB balances tend to be over-stated. Our research fills a gap in extant literature by providing evidence on how managers incorporate new information into their judgments. Our research also provides a method to classify routine but ambiguous tabulated financial statement disclosures, and demonstrates specifically the usefulness of certain qualitative UTB information.

Keywords: disclosure, tax settlement, textual analysis, uncertain tax benefit

JEL Classification: C89, D81, H25, M48

Suggested Citation

Bauer, Andrew M. and Klassen, Kenneth, Managers’ Use of Tax Settlements in Future Uncertain Tax Benefit Accruals (June 13, 2019). Available at SSRN: https://ssrn.com/abstract=3403836 or http://dx.doi.org/10.2139/ssrn.3403836

Andrew M. Bauer

University of Waterloo - School of Accounting and Finance ( email )

200 University Ave W
Waterloo, Ontario N2L 3G1
Canada

Kenneth Klassen (Contact Author)

University of Waterloo - School of Accounting and Finance ( email )

Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x38550 (Phone)
519-888-7562 (Fax)

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