Earnings management literature extensively explores tax regime and debt contracting as possible incentives in financial reporting. Firms engage with aggressive financial reporting to bias earnings in periods when the need for external financing increases. Contrary to this, the tax burden represents incentive for more conservative reporting. We argue that the level of firm's financial reporting aggressiveness is not constant but rather floating from period to period, directly affecting the quality of financial reports. We assume that firm's management on its own discretion determines the level of conservatism, balancing between these two incentives. The prevailing of two incentives, the need for external financing and the tax burden, determines the level of conservatism in particular reporting period. We hypothesised that the reduction in tax burden incentive overcomes the debt contracting incentive in the years of decreasing external financing need, implying more conservative accounting to balance between economic and taxable income. The total accruals are used as a measure of earnings management reflected to working capital accruals. The data analysis conducted on financial reports of 297 firms in the time-series of five years shows a significant correlation between total accruals, external financing needs and difference between economic and taxable income.
Ahmed AS. Accounting earnings and future economic rents: An empirical analysis. Journal of Accounting and Economics. 1994;17(3):377–400.
2.
R. B, Shivakumar L. Earnings quality in U.K. private firms: Comparative loss recognition timeliness. Journal of Accounting and Economics. 2005;39:83–128.
3.
Badertscher. Earnings management strategies and the trade-off between tax benefits and detection risk: to conform or not to conform? Accounting Review. 2009;84:63–97.
4.
Basu S. The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting and Economics. 1997;24:3–37.
5.
Bushman MR, Piotroski JD. Financial reporting incentives for conservative accounting: The influence of legal and political institutions. Journal of Accounting and Economics. 2006;42:107–48.
6.
Chen KP, Chu C. Internal control vs. external manipulation: A model of corporate income tax evasion. RAND Journal of Economics. 2005;36:151–64.
7.
Crocker K, Slemrod J. Corporate tax evasion with agency costs. Journal of Public Economics. 2005;89:1593–610.
8.
Dai Z. Capital Gains Taxes and Asset Prices: Capitalization or Lock-in? The Journal of Finance. 2008;63:709–42.
9.
DECHOW PM, HUTTON AP, KIM JH, SLOAN RG. Detecting Earnings Management: A New Approach. Vol. 50, Journal of Accounting Research. 2012. p. 275–334.
10.
Demirguc-Kunt A, Maksimovic V. Law, finance, and firm growth. Journal of Finance. 1998;3:2107–37.
11.
Desai M, Dyck I, Zingales L. Theft and taxes. Journal of Financial Economics. 2007;84:591–623.
12.
Devine CT. The rule of conservatism reexamined. Journal of Accounting Research. 1963;1(2):127–38.
13.
Francis J, LaFond R, Olsson PM, Schipper K. Costs of equity and earnings attributes. The Accounting Review. 2004;79(4):967–1010.
14.
Frank MM, Lynch JL, Rego SO. Are financial and tax reporting aggressiveness reflective of broader corporate policies? The Accounting Review. 2009;84(2):467–96.
15.
García Lara JM, García Osma B, Mora A. The Effect of Earnings Management on the Asymmetric Timeliness of Earnings. Vol. 32, Journal of Business Finance & Accounting. 2005. p. 691–726.
16.
Givoly D, Hayn C. The changing time-series properties of earnings, cash flows and accruals: Has financial reporting become more conservative? Vol. 29, Journal of Accounting and Economics. 2000. p. 287–320.
17.
Hanlon M, Heitzman S. A review of tax research. Journal of Accounting and Economics. 2010;50:127-178 68.
18.
Kang T, Lobo GJ, Wolfe MC. Accounting Conservatism and Firm Growth Financed by External Debt: The Role of Debt Maturity. Journal of Accounting, Auditing & Finance. 2015;
19.
Li X. Accounting conservatism and the cost of capital: An international analysis. Journal of Business Finance and Accounting. 2015;42:555–82.
20.
Muratovic-Dedic A, Serdarevic N. Financial Reporting Quality and Debt Contracting in Emerging Economy. International Journal of Academic Research in Accounting, Finance and Management Sciences. 2017;7(4):71–82.
21.
Qiang X. The Effects of Contracting, Litigation, Regulation, and Tax Costs on Conditional and Unconditional Conservatism: Cross-Sectional Evidence at the Firm Level. The Accounting Review. 2007;82:759–96.
22.
Shackelford DA, Shevlin T. Empirical tax research in accounting. Journal of Accounting and Economics. 2001;31:321–87.
23.
Slemrod J. The Economics of Corporate Tax Selfishness.
24.
Wagenhofer A. The role of revenue recognition in performance reporting. Vol. 44, Accounting and Business Research. 2014. p. 349–79.
25.
Watts RL. Conservatism in accounting part I: Explanations and implications. Accounting Horizons. 2003;17:207–21.
26.
Zhang J. The contracting benefits of accounting conservatism to lenders and borrowers. Journal of Accounting and Economics. 2008;45:27–54.
Citation
Copyright
This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
The statements, opinions and data contained in the journal are solely those of the individual authors and contributors and not of the publisher and the editor(s). We stay neutral with regard to jurisdictional claims in published maps and institutional affiliations.
