Is the balance sheet method of deferred tax informative?

Abstract

Purpose This study aims to compare the value relevance of the recognised deferred tax elements under International Accounting Standard 12 (IAS 12): Income Taxes (balance sheet method) relative to the taxes payable (flow through) method. It also investigates the value relevance of the IAS 12 deferred tax disclosures. Design/methodology/approach This study used standard valuation models to examine the association between share price and the recognised amounts and footnote disclosures of IAS 12. The Vuong (1989) test is then used to assess which information set is more value relevant. The sample includes 440 firm years over the period 2008-2012. Findings The results show that deferred tax amounts recognised under the balance sheet method provide no more information to investors than the taxes payable method (TPM). Deferred tax footnote disclosures, however, are more relevant than the amounts recognised under the balance sheet method. This study investigates potential reasons for the relevance of footnote disclosures. Research limitations/implications This study has not addressed whether the deferral method of deferred tax is relevant. In addition, while footnote disclosures look promising, further research is necessary. Practical implications The results suggest, given the complexity and cost of compliance with IAS 12, that the International Accounting Standards Board (IASB) should undertake a comprehensive re-think on the relevance of the balance sheet method in IAS 12 and revert to the TPM. Originality/value The IASB and the European Financial Reporting Advisory Group have expressed concerns over the balance sheet method under IAS 12. The IASB and the Financial Accounting Standards Board also have concerns over the cost and complexity of the deferred tax disclosures. The study’s results offer a perspective by examining whether the balance sheet method is value relevant. Prior research has addressed this issue using local data (i.e. pre-International Financial Reporting Standards). This study also provides suggestions for future research into deferred tax footnote disclosures.