Is information in deferred tax valuation allowance useful in predicting the firm’s ability to continue as a going concern incremental to MD&A disclosures and auditor’s going concern opinions?

Abstract

This study explores the role of deferred tax valuation allowances, management’s discussion of ability to continue as a going concern, and auditor going concern opinions in predicting the financial distress of a firm. Mayew et al. (Account Rev 90(4):1621–1651, 2015) show that textual disclosures in the Management, Discussion, and Analysis (MD&A) section of a firm’s SEC 10-K filing predict a firm’s ability to continue as a going concern. This study advances their analysis by including deferred tax valuation allowances in their framework. To the extent valuation allowances incorporate managers’ private information about future profitability, valuation allowances are useful in identifying the transitory nature of losses and thus the going concern status of the firm. Using a sample of firms that filed for bankruptcy over the period 2002–2018, the study shows that increases to valuation allowances are incrementally informative in predicting a firm’s ability to continue as a going concern after considering management’s textual disclosures, linguistic tone of the MD&A, auditor’s going concern opinions, financial statement ratios, and market-based variables. These results extend to three years prior to bankruptcy. The results also speak to the evolving roles of MD&A disclosures and auditor opinions on going concern.