Is Earnings Fraud Associated with High Deferred Tax and/or Book Minus Tax Levels?

56 Pages Posted: 31 Oct 2005 Last revised: 4 Sep 2019

See all articles by Michael Ettredge

Michael Ettredge

University of Kansas - Accounting and Information Systems Area

Lili Sun

University of North Texas - Department of Accounting

Picheng Lee

Pace University - Department of Accounting

Asokan Anandarajan

New Jersey Institute of Technology

Abstract

The objective of this paper is to provide preliminary evidence whether SFAS No. 109 tax data might be useful in distinguishing between firms that do versus do not engage in earnings overstatement fraud (hereafter fraud). We examine the associations of various versions of deferred tax expense (DTE) variables and book income minus taxable income (BMT) variables with fraud, in the year of fraud onset and the year prior to fraud. The analysis is based upon a sample of 65 firms with positive pretax income, sanctioned by the Securities and Exchange Commission (SEC), in Accounting and Auditing Enforcement Releases (AAERs). A set of control firms are matched by asset size, two-digit SIC code, year, and nature of income (positive versus negative pretax income). We also perform analyses using a larger, non-matched control sample. Our results indicate that, for firms with positive pretax income, DTE-based variables have strong incremental associations with fraud occurrence, beyond discretionary accruals and selected other explanatory variables, in the year of fraud onset. DTE-based variables have modest incremental power to explain future (next-year) fraud occurrence (but only when using matched samples). BMT-based variables generally lack explanatory power. In summary, this study provides new information about managers' tax reporting behavior in the presence of fraud, and suggests that DTE-based variables are likely to be useful in detecting fraud.

Keywords: earnings overstatement, earnings quality, financial statement fraud, book income, taxable income, deferred tax expenses, SFAS No. 109

JEL Classification: M41, M43, M49, G38, H25

Suggested Citation

Ettredge, Michael L. and Sun, Lili and Lee, Picheng and Anandarajan, Asokan, Is Earnings Fraud Associated with High Deferred Tax and/or Book Minus Tax Levels?. Auditing: A Journal of Practice & Theory, Vol. 27, May 2008; Pace University Accounting Research Paper No. 2005/05. Available at SSRN: https://ssrn.com/abstract=826587

Michael L. Ettredge (Contact Author)

University of Kansas - Accounting and Information Systems Area ( email )

1300 Sunnyside Avenue
Lawrence, KS 66045
United States
785-864-7537 (Phone)
785-864-5328 (Fax)

Lili Sun

University of North Texas - Department of Accounting ( email )

1155 Union Circle #305219
Denton, TX 76203-5017
United States
940-565-3077 (Phone)

Picheng Lee

Pace University - Department of Accounting ( email )

1 Pace Plaza
New York, NY 10038-1502
United States

Asokan Anandarajan

New Jersey Institute of Technology ( email )

University Heights
School of Management
Newark, NJ 07102

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