Earnings Management: New Evidence Based on Deferred Tax Expense

We assess the usefulness of deferred tax expense in detecting earnings management. Assuming greater discretion under GAAP than under tax rules, and assuming managers exploit such discretion to manage income upward primarily in ways that do not affect current taxable income, then such earnings management will generate book-tax differences that increase deferred tax expense. Our results provide evidence consistent with deferred tax expense generally being incrementally useful beyond total accruals and abnormal accruals derived from two Jones-type models in detecting earnings management to avoid an earnings decline and to avoid a loss. Only total accruals is incrementally useful in detecting earnings management…