Relationship between earnings management and abnormal book-tax differences in Brazil

Abstract

The aim of this study was to verify whether the discretionary actions of managers to manage earnings can be captured by abnormal book-tax differences (ABTD). In Brazil, there are no studies with the disaggregated use of earnings management (EM) through operational choices as a proxy for discretionary decisions to be captured by ABTD. Moreover, the previous studies focus on the period before the International Financial Reporting Standards (IFRS) were required in Brazil or when they were still being implemented, which may change the context of earnings management in the country and, consequently, the relationship with ABTD. This study is relevant for accounting information users, such as investors, creditors, the tax authorities, and regulatory bodies, as the findings may help them to identify manager opportunism through earnings management. The identification that tax management can be affected by EM through accounting and operational decisions reveals that investors, creditors, the tax authorities, regulators, and auditors should remain vigilant against deteriorations in accounting information quality and, consequently, in the utility of that information. An analysis of 201 non-financial companies was carried out, covering 2012 to 2016, thus totaling 1,005 observations. Five panel data regression models were used: three to capture EM, one to identify ABTD, and one to relate these variables. A significant and positive relationship was revealed between accounting and operational EM and ABTD, indicating that companies that manage earnings upward have positive ABTD, and companies that manage earnings downward have negative ABTD. This research therefore contributes to identifying that ABTD captures the discretionary actions of managers related to EM through accounting and operational decisions.

Earnings Management and Tax Minimization: Comprehensive Analysis of Book-Tax Differences in Indonesia

“…This implies that companies implementing AEM practices tend to engage in higher levels of tax avoidance. These results are consistent with previous studies conducted by Frank et al (2009), Ginting & Martani (2017), Surahman & Firmansyah (2017), Morais &Macedo (2021), andMasri (2022). Moving on to REM, as shown in Tables 5 and 7, different REM methods shows varying results.…”

“…On the other hand, REM_EXP (Real Earnings Management through Discretionary Expenses) is negatively related to ABTD, suggesting that companies employing discretionary expenses for earnings management tend to have lower levels of tax avoidance. The negative relationship between REM_EXP and ABTD findings align with previous studies by Geraldina (2013), Morais &Macedo (2021), andMasri (2022).…”

“…This disparity is often due to Accrual Earnings Management (AEM) strategies, where companies manipulate accruals in their accounting practices (Hanlon & Heitzman, 2010). Further supporting this theory, Morais and Macedo (2021) suggest that companies engaging in AEM activities are likely to have a larger disparity between their reported book earnings and tax earnings, resulting in a higher Abnormal Book-Tax Difference (ABTD). Ginting & Martani (2017) Earnings management theory discusses how managers use judgement in financial reporting and in structuring transactions to influence contractual outcomes that depend on reported accounting numbers.…”

“…This practice allows them to show higher earnings to shareholders while potentially paying less in taxes to the government. Morais & Macedo (2021) suggest that managing the cash flow from day-to-day business operations can cause differences in the earnings they report for accounting and tax purposes. By intentionally generating abnormal cash flow patterns, companies can make their reported earnings appear bigger than they actually are, leading to a larger ABTD.…”

The effect on the BTD of IFRS adoption and the end of the Transitional Tax Regime (RTT) in Brazil

“…These differences between book and taxable income are called book-tax differences (BTDs) in the literature. Morais and Macedo (2021) recently showed that, in Brazil, the BTD captures the discretionary actions of managers related to earnings management via accounting decisions.…”