Discretionary Tax Accruals to Meet the Earnings Target

Abstract

We investigate if firms discretionary tax accruals can capture managerial discretion over the potential tax increase in financial reporting to meet or beat earnings targets. We also investigate the incentives of firms that have NOL carry forwards. We consider the earnings management cases on the marginal performing groups as in Burgstahler and Dichev (1997). We propose a discretionary tax accrual as a useful metric in distinguishing the firms' incentive to increase taxable income. We find evidence regarding the trade-offs between tax benefits and non tax costs as suggested by other studies (Matsunaga et al. 1992, Dhaliwal et al. 1994, Erickson et al. 2004). Our results suggest that firms are willing to pay additional taxes. However, we find that firms don't manage taxable income to utilize loss carryforwards. Our findings suggest that we should also consider the management of taxable income in assessing earnings management to meet the earnings target. Our findings have implications for the methods in empirical earnings management research where both total accrual based approach and specific accrual based approach can be used whenever taxable income as well as book-only income is likely to be managed.