EVIDENCE OF EARNINGS MANAGEMENT FROM THE MEASUREMENT OF THE DEFERRED TAX ALLOWANCE ACCOUNT

Positive accounting literature has provided empirical evidence regarding firms' characteristics that cause their managers to make particular accounting decisions. The view of this study is to reach forth this line of research to the area of accounting for income taxes. The research is designed to identify accounting choice variables that influence managers' decisions to change the horizontal of the deferred tax asset valuation allowance beneath SFAS No. 109. Specifically, the inquiry presents an empirical examination of whether managerial discretion above the valuation allowance appears to be used for earnings management views Evidence of earnings management motivations can provide insights into whether it is an appropriate accounting policy to give management considerable discretion to single out the level of the valuation allowance.

This investigation is designed to identify accounting choice variables that influence managers' decisions to change the horizontal of the deferred tax asset valuation allowance below Statement of Financial Accounting Standards (SFAS) No. 109 "Accounting for Income Taxes" [7] The Statement substantially changes the accounting and reporting of deferr tax activities. Specifically, SFAS No. 109 permits the recognition of all deferr tax assets (including those generated by the agency of deductible temporary differences, operating los carryforwards, and tax credit carryforwards), make submissive to the reduction by a valuation allowance if it is more likely than not that more [i]or[/i] less portion or all of the deferr tax assets will not be realized. From year to year, managers must make an assessment to determine whether to record or adjust the deferr tax asset and valuation allowance accounts. Several on-lookers [13, 15,16] had indicated that the valuation allowance can be an instrument for earnings management because any changes in the valuation allowance affect income from continuing operations, and SFAS No. 109 considers time to come profitability of the firm as a whole, which involves a considerable amount of subjectivity.

Positive accounting theory forms the basis for the analysis. The analysis includes investigation of the relationships among observ valuation allowance changes and closenes to obligation constraints, management compensation agreements, political sensitivity, "big bath" approach, and income smoothing. This application of mind uses various univariate tests and multivariate estimation operations to determine which factors influence managers' decisions to change the horizontal of the valuation allowance. The sample utilized in this application of mind includes all publicly traded firms in the Compact Disclosure database that recorded deferr tax assets within a five-year period extremityed December 31, 2000. Only firms that change the valuation allowance are included in the empirical analysis.

A review of prior research indicates that not many studies [13, 15, 16J specifically experimented earnings management in the connected thought [i]or[/i] thoughts of valuation allowance. However, with alone two years of post-implementation SFAS No. 109 data, the statistical power of their earnings management ordeals may have been reduced. Miller and Skinner [13] used a sample of 200 firms that took large Other Post-Employment Benefit (OPEB) charges when they adopted SFAS No. 106 "Employers' Accounting for Post-Retirement Benefits Other Than Pensions." The authors place no direct association between changes in the valuation allowance and either changes in leverage or a substitute for the incentive to flat earnings. Using firms in the Standard & Poor's 500 index, Visvanathan [15 16] base no support for the debt/equity, bonus plan, or income smoothing hypothesis. he did document behavior consistent with the big bath approach, however.

The regression be the effects of this study are consistent with the earlier research, with the substantive difference being the operationalization of "bonus plan" and big bath. This investigation used an indicator variable to identify if the firm maintains a management bonus plan that is based upon reported income, while Visvanathan [15 16] used sum of two units dummy variables to represent the assumed upper and lower confines in bonus plans. Moreover, this research used an indicator variable to capture the firms pursuing a big bath strategy, defining a potential big bath firm as a firm with negative operating earnings that are lower than the prior year's operating earnings. In contrast, Visvanathan ordealed the big bath hypothesis using a sample of firms that reported pre-tax losse above the sample period.

This investigation expands on the extant research in sum of two units substantive ways. First, this paper examines an accounting choice indicator, firm size (proxy for political sensitivity), as a determinant of valuation allowances that have not been considered in previous studies upon SFAS No. 109. Three measures (i.e., market value of for the use of all stock, net sales, total assets) of firm size were defined and proofed respectively. We find no noteworthy differences among the measures. The springs of this study appear to indicate that firm size is appropriate for analysis in coming time studies in the context of valuation allowance. However, further application of mind may be warranted to determine which measure of firm size is greatest in quantity appropriate for consideration in the area of earnings management.