How Much Do Financial Statement Auditors Affect Income Tax Reporting?

• In Event: Auditing Complex Estimates

Abstract

This paper examines the influence of financial statement auditors on their clients’ discretionary financial reporting choices. We use an econometric technique from the labor economics literature that captures the magnitude of individual parties’ influence on an outcome of interest. Focusing on discretion over income tax reporting, we estimate that audit offices explain eleven percent of the variation in tax contingency reserves (a highly subjective tax account), after controlling for time-varying company characteristics and year, industry, and manager fixed effects. In contrast, audit offices explain less than four percent of the variation in taxes paid (a less subjective tax account). This econometric technique permits the extraction of estimated audit office fixed effects, which allows us to document the magnitude of each audit office’s fixed effect and to explore factors associated with these amounts. We find some evidence that audit offices that provide more tax non-audit services to their clients are associated with relatively larger client tax reserves, whereas audit offices that are industry experts for more of their clients are associated with relatively smaller client tax reserves. As the number of complex and subjective estimates in financial statements grows over time, our study provides important evidence on the magnitude of the auditor’s role in determining reported financial statement amounts.

Authors

• Allison Koester, Georgetown University

• Bridget Stomberg, Indiana University - Bloomington

• Brian Matthew Williams, Indiana University - Bloomington

• Junwei Xia, Indiana University - Bloomington