Earnings Management Using the Valuation Allowance for Deferred Tax Assets Under SFAS 109

Posted: 22 Jul 2003

See all articles by Catherine M. Schrand

Catherine M. Schrand

University of Pennsylvania - Accounting Department

M.H. Franco Wong

University of Toronto - Rotman School of Management

Abstract

SFAS 109 allows firms to use their discretion to set arbitrarily high valuation allowances against deferred tax assets. Firms can then later use these "hidden reserves" to manage earnings. Our evidence indicates that most banks do not record a valuation allowance to manage earnings, but rather to follow the guidelines of SFAS 109. However, if the bank is sufficiently well capitalized to absorb the current-period impact on capital, the amount of the valuation allowance increases with a bank's capital. In later years, bank managers adjust the valuation allowance to smooth earnings. The magnitude of the discretionary adjustment increases with the deviation of unadjusted earnings from the forecast or historical earnings.

Keywords: Earnings management, deferred taxes, discretion, banks

JEL Classification: M41, M43, G21, H25

Suggested Citation

Schrand, Catherine M. and Wong, M.H. Franco, Earnings Management Using the Valuation Allowance for Deferred Tax Assets Under SFAS 109. Contemporary Accounting Research, Vol. 20, No. 3, Fall 2003 . Available at SSRN: https://ssrn.com/abstract=410660

Catherine M. Schrand (Contact Author)

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6798 (Phone)
215-573-2054 (Fax)

M.H. Franco Wong

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6
Canada
416-946-0729 (Phone)

HOME PAGE: http://www.rotman.utoronto.ca/FacultyAndResearch/Faculty/FacultyBios/Wong.aspx

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