Do Auditor-Provided Tax Services Impair Independence or Generate Knowledge Spillover? Evidence from Assessing Tax Accrual Quality

Abstract

This paper tests whether auditor-provided tax services (APTS) affect estimation error in income tax expense. A decrease (increase) in tax expense estimation error is consistent with knowledge spillover (reduced professional skepticism) from one accounting firm providing both audit and tax services. We find that estimation error in the tax account is nearly 10 percent greater for firms that purchase a material amount of APTS, consistent with reduced professional skepticism. These results are robust to a variety of methods to address endogeneity concerns. We examine two alternative explanations for reduced professional skepticism and find evidence consistent with in-group identification, not economic bonding. In-group identification is a cognitive bias that leads one to establish a higher threshold for questioning work performed by people from one’s group relative to work performed by outsiders. In an APTS setting, in-group identification leads auditors to view tax work performed by professionals from their accounting firm with less skepticism than tax work performed by professionals outside their firm. Our findings provide new evidence of how APTS affects income tax expense estimation error and informs recent US and EU legislative initiatives that question whether APTS should continue to be permitted.