Earnings Management through Tax Reserves and Auditor-Provided Tax Services

• In Event: Dialogue Session 2
  In Dialogue Session: Dialog Session II

Abstract

This study investigates whether firms continue to use tax reserves to achieve financial reporting objectives in the post-FIN 48 period and the effect of auditor-provided tax services on earnings management through tax reserves. I consider three type of earnings management incentives in my analyses: meeting or beating the consensus forecasts, income smoothing, and taking an “earnings bath”. My analyses yield evidence that only non-large firms manipulate tax reserves to meet/beat earnings forecast in the post-FIN 48 period. But in the post-FIN 48 period, tax reserves are still utilized by both large and non-large firms to smooth earnings. Moreover, I find evidence that the auditor who provides more tax services facilitates large firms’ earnings smoothing in the post-FIN 48 period, providing clear evidence of independence impairment. This behavior does not exist within non-large firms, arguably because the auditor does not compromise independence for less important clients.

Author

• Chunlai Ye, Texas A&M International University