Decomposing Changes in Deferred Tax Assets and Liabilities to Isolate Earnings Management Activities

45 Pages Posted: 21 Oct 2003

See all articles by John D. Phillips

John D. Phillips

University of Connecticut - Department of Accounting

Morton Pincus

University of California, Irvine

Sonja O. Rego

Indiana University - Kelley School of Business - Department of Accounting

Huishan Wan

University of Iowa - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: September 30, 2003

Abstract

This paper provides evidence on the types of accounts that reveal earnings management activities. We build on Burgstahler and Dichev's (1997) evidence of earnings management to avoid an earnings decline and Phillips et al.'s (2003) findings that deferred tax expense can be used to detect such earnings management. In particular, we investigate the relation between changes in annual earnings and changes in deferred tax asset and liability components using firms' income tax footnote disclosures. We establish the incremental usefulness of the change in net deferred tax liabilities (DTLs) in detecting earnings management to avoid an earnings decline, and then decompose the total change in net DTLs into eight components to determine which types of accounts are associated with earnings management activities. Our evidence indicates that firms use revenue and expense accruals and reserves and other asset valuation accruals to manage earnings upwards.

In addition, we build on Joos et al.'s (2003) results and partition our sample into firm-years with positive and negative changes in net DTLs and repeat our analyses. We find that both sub-samples manage revenue and expense accruals and reserves to report earnings increases; however, only firm-years with a positive change in net DTL also reflect the use of the deferred tax asset valuation allowance account to manage earnings upward, and only firm-years with a negative change in net DTL also manage earnings upward using other asset valuation accruals.

Keywords: earnings management, deferred taxes, valuation allowance account

JEL Classification: M41, M43, H25, M49

Suggested Citation

Phillips, John D. and Pincus, Morton P.K. and Rego, Sonja O. and Wan, Huishan, Decomposing Changes in Deferred Tax Assets and Liabilities to Isolate Earnings Management Activities (September 30, 2003). Available at SSRN: https://ssrn.com/abstract=452980 or http://dx.doi.org/10.2139/ssrn.452980

John D. Phillips

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States
860-486-2789 (Phone)
860-486-4838 (Fax)

Morton P.K. Pincus

University of California, Irvine ( email )

Irvine, CA 92697-3125
United States
949-824-4062 (Phone)
949-725-2812 (Fax)

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

Huishan Wan

University of Iowa - Department of Accounting ( email )

108 Pappajohn Business Building
Iowa City, IA 52242-1000
United States

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