1. Michelle Hanlon Presented by: IRA GERALDINA
The Persistence and Pricing of Earnings, Accruals, and Cash Flows When Firms Have Large Book Tax Differences
Michelle Hanlon
Presented by:
IRA GERALDINA

2. Outline Research Background Research Questions
Theory & Hypothesis Development
Methodology
Results
Conclusions

3. Earning , Accrual, and Cash Flow
Persistence
BTD
Market Assessment
Overview

4. Backgrounds
The difference between pre-tax financial reporting and taxable income can provide information about current earning
Book tax differences can be informative about management discretion in the accrual process
- Revsine et al. (1999); Palepu et al. (2000); Penman 2001
Large differences between book and taxable income an indicator as low quality of financial reporting earning
Book tax differences as an indicator of earnings management (Mills dan Newberry, 2001; Philips et al. 2003; Joos et al. 2000; dan Lev dan Nissin, 2004)
Extend litelatur on book tax differences

5. Research Questions Q1 Q2
How is the role of book tax differences in indicating in persistence of earnings, accruals, and cash flows?
How is the role of book tax differences in indicating in influencing investors’ assessments of persistence of earnings and earnings components?

6. Theory Accounting earnings Vs Taxable income
Permanent and temporary differences
SFAS No. 109 uses balance sheet approach in reporting temporary differences
Future taxable Vs future deductible amounts
Future taxable amounts increase deferred tax liability & recognize deferred tax expense
Future deductible amounts increase deferred tax asset & recognize deferred tax benefit

7. Hypotheses Development
FASB’s Concept Statements No. 2 Qualitative Characteristics of Accounting Information:
- predictive value (part of relevance)
Earning persistence as determinant of earning quality (Jonas and Blanchet, 2000)
Earning persistence as a relevant-value characteristics of earnings (Ohlson, 1995)
Book tax differences reflecting information about current earnings persistence.

8. Hypotheses Development
Increase in deferred tax liability might be an
indication of deteriorating of earnings quality
Deferred tax assets as a way to artificially
increasing earnings (Revsine et al., 1999)
The objectives of financial reporting and tax reporting are differences
- financial income as
signal of management
performance (Dechow,
1994)
- IRC provides frameworks
in determining tax liability
(Scholes et al. 2002
Manzon dan Plesko 2002)

9. Hypotheses Development
Book tax differences can be generated as tax planning strategies
- larger book tax
differences the
greater the likelihood
of IRS audit and
adjustment (Mills, 1998)
Firms with large book tax differences are suspected having lower earnings quality
(Jones et.al., 2000)

10. Pre-tax earning persistence for firm years with large negative or positive book tax differences is lower than earning persistence for firms with small book tax differences
HYPOTHESES 1

11. subjectivity in financial reporting accrual process
HYPOTHESES 2
The persistence of the accruals component of earnings is lower for firms with years with large negative or positive book tax differences relative to firm years with small book tax differences
Large book tax
differences indicate
low earnings quality
book tax differences
are indicative of
subjectivity in financial
reporting accrual
process

12. HYPOTHESES 3
The expectation of pre-tax earnings persistence reflected in stock prices for the accrual component of pre-tax earnings is consistent with observed persistence of accruals for firm years with relatively large boob tax differences
Lower ERC for firm-
years with large book
tax differences introducing
possibility of manager’s
opportunistic on discretion
(Jones et at.,2000)
If investor use book tax
differences as information
about persistence of
accruals, they may not
misprice (Sloan, 1996)

13. Methodology CSRP and Compustat (1994-2000)
Final sample: 14,106 data-4,048 firms
observations (non financial industries)
22,242 missing variables data excluded
(pre-tax financial loss)
6,447 excluded
(negative current tax expense)
1,518 excluded
3,194 excluded (NOL)

14. Methodology
Model
Prediction
γ4 < 0 (γ5 < 0)
Consistent with H1

15. Methodology Model Prediction
γ7 < 0 and γ8 < 0, Consistent with H2
γ6 < γ3, accrual persistence less than cash flows persistence

16. Methodology
Model
Prediction
γ1* closed to γ1
γ2* closed to γ2

17. Methodology
Model
Prediction
β1 < 0
β1 is not significant for LBTD

18. RESULTS Descriptive Statistics Panel A
Mean & Median of PTACC is negative

19. RESULTS Descriptive Statistics Table 1 Panel B
PTACC is correlated with DTE only -0,008

20. RESULTS
LNBTD: AVETA, BM, Sales, Sales Growth
LPBTD : BTD

21. RESULTS
γ4 = and γ5 =
Consistent with H1

22. RESULTS
γ7 = and γ8 = & γ6 < γ3 consistent with H2
γ2 < γ31

23. See LPBTD Pre-tax earning performance
RESULTS
See LPBTD Pre-tax earning performance

24. See LPBTD Pre-tax accrual performance
RESULTS
See LPBTD Pre-tax accrual performance

25. RESULTS See LNBTD Subsample , γ1* closed to γ1
See LPBTD Subsample, ((γ1* /γ1 )) <1
See LNBTD Subsample , γ1* closed to γ1
See SmallBTD subsample, underestimate

26. RESULTS LPBTD, consistent with H3 LNBTD inconsistent with H3
Full sample and SmallBTD : γ2* > γ2 and γ1* < γ1
LPBTD, consistent with H3
LNBTD inconsistent with H3

27. RESULTS LNBTD, insignificant
PTACC abnormal return= 4%
LNBTD, insignificant
LPBTD, significant : Rationally perception

28. Additional Analysis The effect of special items:
Firm years with large book tax differences having lower persistence in earnings, accruals, and cash flows
Firm years with large positive (negative) book tax differences having lower persistence in accruals relative to firm years small book tax differences having lower
Firm years with large positive (negative) book tax differences having lower persistence in cash flows, somewhat weaker.

29. Additional Analysis
Examination of the disclosure of changes in DTA and DTL:
Only 27 out of the 60 firms does the DTE tie out to the change of DTA and DTL
Change of in DTA and DTL of Firm years with large positive book tax differences is from the depreciation, bad debt reserved, pensions, postretirement benefits and others.
The largest categories for LNBTD from reserves and accruals
Consistent with subsample’s accruals having a lower persistence for future earnings as compared to accruals for SmallBTD.

30. Additional Analysis Scaler
Coefficient on the accrual interaction term for LPBTD group continues to be negative and significant.
Firms years with large positive (negative) book tax differences have lower persistence in earnings and accruals

31. Additional Analysis ROE on Equity as a correlated omitted variables
The coefficient for interaction term is significantly negative (-0, 428)
Consistent with higher ROE firms having more mean reverting income.

32. Additional Analysis Book-tax differences as a proxy for
discretionary accruals:
Coefficient on cash flows is 0.747, the coefficient on accruals excluding the book-tax differences is (significantly differences)
Coefficients on the book tax differences is (significantly different than the coefficient on accruals excluding book tax differences )
Consistence with book tax differences proxying for for discretion.

33. Conclusions
Firm years with large positive book tax differences have lower persistence in earnings than firm years with small book tax differences.
Firm years with large negative book tax differences have significantly less persistent in earnings, accruals, and cash flows.
Market asses a lower expectation of earning persistence for the firm years with large positive book tax differences, but underestimate the persistence of cash flows
Firm years with large negative and small book tax differences, investor overestimate the persistence of the accrual component

34. Limitations
Sample size and time period
Sample partition