Connecting earnings management to the real World:What happens in the black box of the boardroom?

income smoothing describes the concept that

Both models assume that stock prices are a linear function of earnings and the book value of equity. Literature questions the assumption of a linear function in value relevance studies (Barth et al. 2001b; Holthausen and Watts 2001). Thus, alternative models to examine the value relevance of deferred taxes will be warranted. Alternatives include, e.g., ordered logit models with additional control variables , and non-linear residual income models that explicitly consider growth opportunities (Biddle et al. 2001). Valuation relevance studies assess how the information provided by deferred taxes is implemented in the decision-making processes of various financial statement users (Barth et al. 2001b; Beaver 2002).

Financial accounting literature indicates that managerial judgment is a double-edged sword the use of which depends on managerial incentives (Feltham and Pae 2000; Sankar and Subrahmanyam 2001). That is, management can exercise judgment for information communication or opportunistic purposes. At December 31, 20X7, FSP Corp has an AFS debt security with a $100 amortized cost basis and a fair value of $60. It determines that it does not intend to sell the security and it is not more likely than not that it will be required to sell the security. This impairment is considered other-than-temporary and comprises a $10 credit-related impairment and a $30 non-credit-related component. After the recognition of the OTTI, the debt security’s adjusted amortized cost basis is $880 (i.e., the previous cost basis less the credit loss recognized in net income) and its carrying value is $700 (i.e., fair value).

cash flow from operating activities?

As a result, depreciation-related deferred tax liabilities, which represent one of the largest items of deferred tax liabilities, are not forecast relevant, as assumed by ASC 740 . This finding can, inter alia, explain the limited forecast relevance of deferred tax liabilities. Mear et al. criticize the low predictive ability of deferred taxes on future income tax payments. The authors find a forecast relevance of deferred taxes for future income taxes only if they exclude firm-year observations with losses.

income smoothing describes the concept that

Thus, managers of large firms are expected to have greater incentives to make accounting choices that reduce the likelihood of these political costs being incurred. It found that firms use income-decreasing discretionary accruals in industries applying to the United States International Trade Commission for import relief, and in firms under investigation for anti-trust dealings during the year of the investigation. Similar income smoothing describes the concept that results are found in the cable television industry and in chemical firms exposed to the Superfund laws . Our literature review has a number of implications for future research on financial accounting for deferred taxes, which we deem to be a fertile field for empirical research. In this section, we discuss three methodological implications and six content-driven implications, thereby suggesting avenues for future research.

Blank 2: comprehensive

Corporations prefer regular patterns in presenting their results over inconsistent “plot twists” because accounting decisions are usually never black-and-white and because of the analyst backlash when companies declare a financial surprise. Most publicly traded corporations, at least in the United States, favor consistency over inconsistency when presenting financial results. They prefer it because the community of financial professionals who review their findings acts as investors’ regulators. Both income smoothing and being ethical have ambiguous definitions, which might be problematic in particular instances. If each quarter yields unpredictable earnings or losses, justifying the purchase of new machinery or hiring more workers becomes considerably more difficult. It is more helpful to create consistent revenues for company planning objectives, such as budgeting so that management may plan for growth.

income smoothing describes the concept that

To classify a firm as an earnings manager to avoid earnings decline, Phillips et al. calculate the change in a firm’s net income divided by the market value of equity. If this ratio is greater than zero but smaller than 0.1, a firm is classified as an earnings manager. The authors find that deferred tax expenses are more appropriate than accruals for identifying upward earnings management. Phillips et al. find no evidence that deferred tax expenses can identify earnings management to meet analyst forecasts. In a subsequent study using a subsample of Phillips et al. decompose the total deferred tax amount into several components—e.g., revenue and expense accruals and reserves, depreciation- or compensation-related deferred taxes, and the valuation allowance. They analyze which of these components is incrementally useful in identifying upward earnings management and find that the previously identified relation between deferred tax expenses and upward earnings management still hold for all components.

Analyzing earnings quality requires an analyst to

The final sample contains 76 articles published between 1972 and 2019 in high-quality academic journals. It is a generally accepted objective of financial statements to provide relevant information that is useful to take economic decisions (Barth et al. 2001b; Brouwer and Naarding 2018). According to the US FASB, financial statements shall “provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions” (SFAC No. 1 para 34).

Banks and investors look at liquidity when deciding whether to loan or invest money in a business. Kraft A, Lopatta K. Auditor fees, discretionary book-tax differences, and tax avoidance. Feltham GA, Pae J. Analysis of the impact of accounting accruals on earnings uncertainty and response coefficients.

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