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The Financial Accounting Standards Board recently issued Accounting Standards Update 2015–17, which will require firms to classify all deferred tax assets and liabilities as noncurrent in classified balance sheets instead of separating them into current and noncurrent amounts. This change is designed to simplify the reporting of deferred taxes and align with International Financial Reporting Standards. This study conducts empirical analyses on a broad cross-section of publicly traded U.S. firms in order to examine the stock market's valuation of current and noncurrent deferred tax assets and liabilities. The results suggest that classifying all deferred taxes as noncurrent may adversely affect the usefulness of financial statements for equity investors.

With IAS19R, Employee Benefits , the IASB simplified the accounting for defined-benefit pension plans by eliminating the use of an expected pension asset return assumption and by eliminating several of the income smoothing techniques included in the previous standard. To provide prospective evidence useful to the FASB's ongoing attempts to simplify and improve accounting standards, this study applies the revised pension accounting rules under IAS19R to a sample of U.S. firms with defined-benefit pension plans. Overall, there is no significant change in total pension expense from applying IAS19R versus current U.S. GAAP for a sample of S&P 500 firms over 2010–2012. This is due to the effects of eliminating the expected pension asset return and the “corridor” approach to smoothing unrealized gains or losses essentially offsetting each other. However, it is shown that IAS19R would significantly increase pension expense for subsamples of firms with high expected pension asset return assumptions, firms with low levels of amortized net pension losses or gains, and firms with better-funded pension plans.

This study examines the impact of FASB Interpretation No. 48 (FIN48), Accounting for Uncertainty in Income Taxes, on earnings management (EM) activity, by focusing on changes in the deferred tax asset valuation allowance (DTVA). FIN48 was adopted, in part, over concerns that firms were using the reserve for uncertain tax positions (cushion) to manage earnings. However, there are reasons to believe that the adoption of FIN48 may have impacted the extent to which firms utilize DTVA changes as a strategic accounting choice. As the provision for income taxes is one of the final accounts closed prior to an earnings announcement, income tax accounting is generally regarded as a final opportunity to strategically meet earnings goals. To the extent that FIN48 reduced cushion-based EM, firms may have increasingly used DTVA changes as a substitute. Alternatively, the attention that FIN48 brought to firms’ income tax footnotes may have curbed the strategic use of income tax accounting, in general. This study employs a sample of publicly traded US firms over the period of 2003–2010. A regression model and an analysis of the frequency of DTVA-based EM reveal no evidence of a systematic change in behavior attributable to FIN48. However, further analysis reveals that firms identified as managing earnings to meet analyst forecasts increasingly used discretionary DTVA changes relative to changes in tax cushion in the post-FIN48 period. The results have implications for existing research on income tax-based EM.

Purpose – The purpose of this study is to re-examine the relation between changes in profit margin (ΔPM) and changes in return on net operating assets (ΔRNOA) by partitioning on the direction of the change in PM. DuPont analysis provides a means of disaggregating a firm’s return on net operating assets (RNOA) into asset turnover (ATO) and profit margin (PM) components to gain insights into the underlying drivers of operating profitability. Prior research finds that changes in ATO are informative about one-year-ahead changes in RNOA, while changes in PM are not. Design/methodology/approach – Consistent with prior research, regression analysis is used to develop a predictive model for one-year-ahead changes in RNOA. Results based on in-sample parameter estimates are used to examine the out-of-sample forecasting accuracy of alternative model specifications. Findings – The results are consistent with significant forecast improvement resulting from considering the impact on future RNOA of the direction of the ΔPM. Originality/value – The study contributes to the literature on the determinants of profitability ratios by providing further guidance on how financial statement information can be utilized to improve forecasts of firm performance.

SYNOPSIS Accounting for defined-benefit pension plans is complex, and reported financial statement amounts are significantly impacted by a myriad of assumptions. In its interpretative release FR-72 (SEC 2003), the SEC called for more informative and transparent Management Discussion and Analysis (MD&A) disclosure of critical accounting estimates (CAE), including those regarding pension plans. This paper uses a random sample of 147 firms with relatively large defined-benefit pension plans to analyze firms' MD&A pension-related critical accounting estimate disclosures. We find that 60 (61) percent of our sample firms quantify the effect on pension measurements—primarily pension expense—of a given change in discount rates (expected asset returns). The median effect on earnings per share of these CAE-disclosing firms is between two and three cents. Firms rarely disclose the effects of potential changes in future salary assumptions or other estimates on pension measurements. While FR-72 encourages MD&A disclosure of information to assess the past accuracy of or predict future changes in critical accounting estimates, few firms provide such information with respect to their pension plans, suggesting avenues for improvement in disclosures. Finally, we use logistic regression to analyze the determinants of firms' decisions to disclose the sensitivity of pension expense to pension discount rate or expected asset return assumptions. Results indicate that the likelihood of providing a discount rate or expected asset return CAE is positively related to firm size, having a Big 4 auditor, and the variability of pension plan funded status, and is lower for firms operating in regulated industries and for firms with better-funded pension plans.

Prior to 1995, the U.S. Securities and Exchange Commission (SEC) required publicly-traded, capital-intensive registrants to prepare detailed supplemental schedules summarizing the activity in fixed asset-related accounts. This study examines these previously-mandated schedules and illustrates how current aggregated reporting requirements potentially conceal insights that could be gained with finer information. This is a significant issue, as current disclosures under International Financial Reporting Standards (IFRS) are similar to the former SEC requirements. The analysis supports the conclusion that stakeholders in capital-intensive U.S. firms are at an informational disadvantage relative to stakeholders in similar firms reporting under IFRS.

This study compares the valuation of advertising barter sales recognized under APB Opinion No. 29, relative to transactions recorded under EITF Issue No. 99-17. EITF 99-17 was the FASB's response to the perception that Internet-related firms were overstating revenue. The results indicate an inverse relation between price-to-sales ratios and the amount of advertising barter recorded under APB 29 by e-tailing firms. In contrast, we find no evidence of a discount for similar transactions recognized under EITF 99-17. This change in value relevance is consistent with increased credibility of recorded revenue. These results have implications for revenue recognition practices and accounting regulation.

Under current accounting rules, U.S. multinationals are not required to record liabilities for future taxes on earnings of foreign subsidiaries, as long as those earnings are deemed to be indefinitely reinvested in those subsidiaries. These rules allow considerable flexibility in the designation of earnings deemed permanently reinvested and the reporting of expected repatriation taxes thereon. Some firms disclose amounts for unrecorded taxes on permanently reinvested earnings, but most do not. We show that while estimated repatriation taxes are relevant in explaining share prices of non-disclosing firms, they are less relevant than firm-disclosed amounts are in explaining share prices of disclosing firms. This result is due to estimated repatriation tax amounts exhibiting downward bias, and less accuracy for actual repatriation tax effects, relative to firm-disclosed repatriation tax amounts. We propose new disclosures designed to improve the relevance of estimated repatriation tax amounts.

Under U.S. GAAP, development stage enterprises are required to report cumulative (i.e., inception-to-date) totals for each line item in the statements of income, cash flow, and stockholders’ equity. The purpose of this study is to investigate whether additional income statement disclosures provide value-relevant information to investors. Based on an empirical analysis of a sample of publicly traded development stage enterprises, we find that historical income statement components do not exhibit a significant association with equity values after controlling for the effects of non-financial information and current accounting data. In terms of current accounting data, book value of equity (primarily contributed capital), cash holdings, and R&D expense appear to be most useful for valuation purposes. These results imply that supplemental disclosure requirements geared toward providing qualitative information about development stage firms may prove more informative than providing cumulative financial statement data.

From a financial analysis perspective, proportionate consolidation of significant influence equity investments is often presumed to provide more useful information than equity method accounting. Surprisingly, Kothavala [Kothavala, K., 2003, Proportional consolidation versus the equity method: A risk measurement perspective on reporting interests in joint ventures, Journal of Accounting and Public Policy 22, 517–538.] finds that financial statement measures based on the equity method are more relevant for bond ratings than are similar measures based on proportionate consolidation. This study provides additional evidence regarding this issue. Using a sample of manufacturing firms with significant influence equity investments accounted for under U.S. GAAP, the results indicate that pro forma proportionately consolidated financial statements have greater relevance than equity method statements for explaining bond ratings.

SYNOPSIS In July 2006, the International Accounting Standards Board and the Financial Accounting Standards Board (the “Boards”) added a leasing project to their agenda. In August 2010, the Boards jointly released an exposure draft proposing a “right-of-use” model for the recognition of lease-related assets and liabilities. In their deliberations, the Boards noted numerous studies focusing on lessee accounting, but very little research examining lessor-related topics. To address this gap in the literature, this paper identifies key reporting and disclosure issues associated with lessors, and suggests improvements that could be incorporated into lease accounting guidance. This study is based on an analysis of the financial statement disclosures of 57 of the 100 largest equipment lessors in the U.S. market. Disclosure quality, residual values, and the balance sheet impact of the proposal are examined, and numerous suggestions are offered to enhance the usefulness of lessor financial statement disclosures for decision makers.

One role of stock options in executive compensation packages is to counterbalance the inherently short-term orientation of base salary and annual bonuses. Managerial compensation plans frequently include stock options in order to better align the interests of managers and outside shareholders and reduce agency problems. However, since option values are sensitive to fluctuations in stock prices, and investors reward firms that meet or exceed earnings expectations, executives of firms with sizable option components in their compensation plans have increased incentives to report earnings that meet or exceed analysts' forecasts. We show that the propensity to meet or exceed analysts' quarterly earnings forecasts is positively related to the use of options in top executives' compensation plans. Further, firms that employ relatively more options in their compensation plans more frequently report earnings surprises that exceed analysts' forecast by small amounts (between 0 and 1 cent per share). These results suggest that the use of stock-based compensation intensifies top executives' focus on financial analysts' short-term earnings forecasts.

This study examines whether managerial forecasts of annual effective tax rates, disclosed in interim financial statements, are useful in predicting future quarterly earnings, are incorporated in financial analysts' forecasts of quarterly earnings, or are impounded in stock prices. The integral view of interim financial reporting requires managers to make their best estimate of the effective income tax rate (ETR) to be in effect for the full fiscal year. Thus, the ETR reflected in interim financial statements represents the disclosure of certain private information regarding management's expectations for forthcoming earnings. Auditors review the income tax provision in conjunction with the release of interim financial statements, arguably lending credibility to management's ETR forecast. Our empirical analyses show that interim effective tax rate disclosures are useful in predicting next-quarter earnings. However, financial analysts generally under-utilize this information when firms report large decreases in ETR. Surprisingly, small ETR increases are related to higher future earnings, and a zeroinvestment strategy based on small ETR increases yields significant abnormal returns. In sum, although interim ETRs are useful in predicting future earnings, both financial analysts and stock market investors fail to fully impound the earnings implications of interim effective tax rate changes in their decisions.

This study examines the market valuation of the unearned revenue liability reported by a sample of newspaper and magazine publishers. The evidence indicates that stock prices behave as if the unearned revenue liability represents an economic asset overall. It is further shown that the market valuation of the unearned revenue “asset” is increasing in the magnitude of advertising relative to circulation revenue. After controlling for advertising revenue inflows, reported unearned revenue is negatively related to stock price, indicating that the economic asset is valued in part on its liability characteristics. These results have direct implications for the FASB's current deliberations on revenue and liability recognition.

Existing research documents that firms employing relatively high levels of stock option-based compensation more frequently report quarterly earnings that meet or exceed analysts’ forecasts. This paper examines the roles of income-increasing accounting choices and management guidance to analysts in this “numbers game.” Our analysis is motivated by increased capital market and Securities and Exchange Commission (SEC) scrutiny of the effects of both stock option-based compensation and financial analysts in capital markets. Using a sample of S&P 1500 firms over 1992–2002, we find that firms that compensate top managers more heavily with stock options employ expectations-reducing guidance to financial analysts, not income-increasing abnormal accounting accruals, to enable them to more frequently meet analysts’ earnings targets. The results suggest that rule-making and enforcement aimed at curbing managements’ guidance to analysts, rather than narrowing accounting flexibility, might be more effective in tempering the “numbers game.”

We use the provisions of SFAS No. 109, Accounting for Income Taxes, to examine the extent to which stock prices of Internet firms were associated with expectations of future profitability before versus after the ‘market correction’ in early 2000. We find that the valuation of deferred tax assets of firms with business models reliant on the level of web site traffic was significantly greater after the market correction. In our view, this evidence is consistent with pre-correction mispricing.

This paper reports the results of a study of the financial reporting effects of off-balance-sheet activities concealed by the equity method of accounting. The study examines footnote disclosures relating to equity method investees, offers suggestions for improving the usefulness of those disclosures, and estimates the valuation effects of information in the disclosures. An important empirical finding is that the market places significant negative values on investor-guaranteed off-balance-sheet obligations.

Extant research examining the determinants of deferred tax asset valuation allowances finds that the evidence provisions outlined in SFAS 109 explain a significant portion of both levels of and changes in recorded valuation allowances. In addition, there is evidence of a stock price reaction around the time of announcements of valuation allowance information. The present study extends existing research in two ways. First, extant research on determinants of valuation allowance changes does not incorporate the asymmetry in the evidence provisions of SFAS 109. Accordingly, we separately examine the determinants of increases versus decreases in valuation allowances and find that the evidence provisions of SFAS 109 explain a much greater portion of valuation allowance increases than decreases. Second, we examine the association between annual stock returns and reported earnings resulting from valuation allowance changes. While the earnings effect of valuation allowance changes is found to be significant in the expected direction, the stock price reactions do not occur in the period the earnings effect is reported. This is consistent with low earnings “quality” under SFAS 109.

This study utilizes a sample comprised of Fortune 500 firms to examine earnings management via changes in the deferred tax asset valuation allowance. The study extends existing research in three ways. First, we document that the earnings effect of a valuation allowance change often cannot be determined from financial statement disclosures. Based on an analysis of sample firms' income tax footnotes, we offer suggestions to improve disclosure policy. Second, prior research uses the net change in the valuation allowance account as a proxy for the earnings effect of valuation allowance changes. We argue that the amount reported in the effective tax rate reconciliation is a better measure of the income statement effect and document certain significant differences between the measures. Third, prior research employs cross-sectional regression models in an effort to make generalizations about earnings management behavior. In contrast, we use a contextual approach to assess whether observed valuation allowance changes are consistent with different motivations for earnings manipulation. The contextual analyses are based on identifying firms in the position to engage in various forms of earnings management and examining the earnings effect of valuation allowance changes made by firm managers. Cross-sectional tests find virtually no evidence in support of earnings management. Of particular note, we find that the incidence of “big bath” behavior may be exaggerated. In contrast, a contextual approach identifies specific instances in which earnings management may exist. Thus, the analysis of valuation allowance changes is contextual and requires careful consideration of activity in the allowance account. This point underscores the deficiency in income tax reporting and the need for increased disclosure in this area.

Outlines the role of the conservatism inherent in generally accepted accounting principles in Ohlson’s (1995) and Feltham and Ohlson’s (1995) valuation models and compares it with other research findings. Identifies potential sources of conservatism (e.g. expensing advertising costs, providing for deferred tax etc.), develops a mathematical model and applies it to 1980‐1994 US data to examine their relative importance. Finds that intensity of R&D and age of fixed assets are the most significant and goes on to compare the effectiveness of the Feltham/Ohlson conservatism parameter in capturing this information. Shows that their linear information models seems to capture different aspects of the relationship between book and market values and calls for further research.

This study examines the usefulness of interim income tax disclosures in predicting future earnings and analysts' forecast errors. The integral view of interim financial reporting requires managers to make their best estimate of the effective income tax rate expected to be in effect for the year. Thus, the effective tax rate disclosed in the first quarter's Form 10-Q potentially provides some private information regarding management's expectations for forthcoming earnings. Our analyses show that these interim tax rate disclosures are useful in predicting future earnings and, in addition, are positively related to analysts' forecast errors. The results suggest analysts underutilize effective tax rate information in interim disclosures that could be used to improve the accuracy of their earnings forecasts.

When customers prepay for goods or services, accounting practice requires that the cash inflow to the firm be classified as a liability ("unearned revenue liability") until delivery to the customer. While there are eventual cash outflows associated with customer prepayments (equal to the marginal cost of producing the good or service), an argument can be made that the book liability actually represents an economic asset. As long as the firm is selling its product above cost, the cash outflows associated with future delivery are less than the cash advance received currently. Therefore, a net economic asset exists, equal to the difference between the cash received and the cost of the goods to be delivered. This paper utilizes a sample of firms from the magazine and periodicals publishing industry to examine the relation between the book liability for unearned revenue and firm equity value. The empirical tests provide strong evidence that stock prices behave as if the unearned revenue liability represents an economic asset. Further, the valuation of the asset is negatively related to the variable costs of production. The study also examines the association between the unearned revenue liability, current sales, and future sales. The empirical analysis provides evidence that the change in next-year sales is related to the change in current year sales conditioned on the change in the unearned revenue liability. In other words, sales increases in the current year do not persist into the future unless accompanied by an increase in the unearned revenue liability.