How Firms Avoid Losses: Evidence of Use of the Net Deferred Tax Asset Account
University of Washington Working Paper
41 Pages Posted: 17 Feb 2003
Date Written: November 26, 2002
This paper investigates whether firms use discretion in accounting for deferred taxes to increase earnings and avoid reporting a loss. We find that firm-years with small scaled profits reduce (relative to the prior year) the proportion of the gross deferred tax asset reserved by the valuation allowance more than firm-years with small scaled losses. We find no evidence that the firm-years that have seemingly moved from having a small scaled loss to a small scaled profit using changes in the net deferred tax asset have greater expected future taxable income to support this change under SFAS 109. Our results also suggest that firms that increase earnings through the net deferred tax asset have relatively lower costs to managing earnings to avoid a loss, that is, these firms have a smaller pre-managed loss.
Keywords: deferred taxes, valuation allowance, net deferred tax asset
JEL Classification: M41, M43
Suggested Citation: Suggested Citation