Does the Initial Disclosure of Tax-related Critical Audit Matters Constrain Tax-related Earnings Management?

57 Pages Posted: 2 Jun 2020 Last revised: 26 Aug 2021

See all articles by Katharine D. Drake

Katharine D. Drake

University of Arizona - Department of Accounting

Nathan C. Goldman

North Carolina State University - Department of Accounting

Stephen J. Lusch

Texas Christian University - Department of Accounting

Jaime J. Schmidt

University of Texas at Austin

Date Written: August 25, 2021

Abstract

Does the initial disclosure of tax-related critical audit matters (CAMs) constrain tax-related earnings management? If so, it would support the PCOAB’s expectation that investors indirectly benefit from CAMs through the increased attention given to the matters underlying the CAMs. We examine auditors’ initial CAM disclosures of large U.S. accelerated filers and find that tax-related CAM disclosures are associated with a lower likelihood that the audited company uses tax expense to meet analysts’ after-tax consensus forecasts. We find that tax-related CAM disclosures are associated with subsequent increases in the length of and use of uncertain language in tax footnotes. However, we do not find tax-related CAMs are associated with increased audit fees or tax-related non-audit service fees. Our results indicate that the disciplinary benefit of CAMs appears primarily driven by management’s response to CAM disclosures.

Keywords: Critical audit matter disclosures, Earnings management, Tax expense, Unrecognized tax benefits

Suggested Citation

Drake, Katharine D. and Goldman, Nathan C. and Lusch, Stephen J. and Schmidt, Jaime J., Does the Initial Disclosure of Tax-related Critical Audit Matters Constrain Tax-related Earnings Management? (August 25, 2021). Available at SSRN: https://ssrn.com/abstract=3606701 or http://dx.doi.org/10.2139/ssrn.3606701

Katharine D. Drake (Contact Author)

University of Arizona - Department of Accounting ( email )

Tucson, AZ 85721
United States

Nathan C. Goldman

North Carolina State University - Department of Accounting ( email )

Raleigh, NC 27695-8113
United States

Stephen J. Lusch

Texas Christian University - Department of Accounting ( email )

M.J. Neeley School of Business
TCU Box 298530
Fort Worth, TX 76129
United States

Jaime J. Schmidt

University of Texas at Austin ( email )

Austin, TX 78712
United States

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