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Earnings Management through Deferred Taxes recognized under IAS 12 - Evidence from Pakistan

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Abdul Rafay, FCA
Mobeen Ajmal, University of Management Technology

The paper is aimed at examining the earnings management through deferred taxes calculated under IAS 12. Atwood et. al. (2010) found that the book-tax nonconformity leads to better earning quality and higher association of earnings and future expected cash flows. Different components of deferred tax line items reverse the tax effects at different times. As per Wong et. al. (2011) such component wise partial allocation is more value relevant than the comprehensive figure of deferred tax. Pakistan is one of the pioneer implementers of IFRS. Our hypothesis is that in Pakistan components of deferred tax disclosed under IAS 12 provide value relevant information to equity investors. We have divided the deferred tax components in three categories, those arising from operational activities, investing activities and financing activities. These activities are further sub-divided to ensure that no value relevant component was aggregated with a non-value relevant component that leads to information slacks. Our sample includes data from 2009 to 2013 of Shariah compliant companies indexed in KMI-30. We find that deferred tax line items in Balance Sheet are reflected in market prices. Also investors treat differently deferred tax line items arising from operating, financing and investing activities. Furthermore the value relevance is dissimilar for different components of deferred tax. Some, like unabsorbed losses, are negatively associated while others like depreciation/amortization are almost value irrelevant. The paper would help understand the significance of deferred taxes in equity valuation and the possibility of earnings management with respect to deferred taxes. There is a significant need for such a paper as no work has been done regarding this in Pakistan or even in any other country that has adopted IFRS.

Abdul Rafay is a Fellow member of Institute of Chartered Accountants of Pakistan. Since 2001, he is a life time member of Lahore Tax Bar Association. He served as Co-regional Director (Founding) of Lahore/Islamabad Chapter of Professional Risk Managers International Association (PRMIA), Washington, USA (2011-2013). In 2012, he was nominated as Member: Education & Training Committee (ETCOM) of The Institute of Chartered Accountants of Pakistan (ICAP). He is REDC Alumni of Lahore University of Management Sciences (LUMS). Recently his name is included in the list of "Certified Directors" as per Clause (xi) of The Code of Corporate Governance 2012 issued by Securities and Exchange Commission of Pakistan (SECP).

Mobeen Ajmal is a lecturer in School of Business and Economics at University of Management and Technology, Lahore. He received his MBA degree at Lahore University of Management Sciences with distinction. His research interests include Risk Management, Taxation and Financial Modeling.

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posted by S A J Shirazi @ 5/30/2014 04:40:00 PM,

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