The Effect Of Book-Tax Conformity On The Use Of Accruals: Evidence From Korea

Abstract

This study in the Korean context investigates the effect of book-tax conformity on the use of accruals. In a sample of 4,331 Korean firms, we divide total accruals into book-tax accruals and book-only accruals. Book-tax accruals are defined as those that affect both taxable income and reported earnings. Book-only accruals are defined as those that affect only reported earnings and are unrelated to taxable income. We anticipate that managers will decrease taxable income by recording book-tax accruals that conform relatively closely to taxable income in order to reduce their tax liability. They are expected to attempt to increase book income through book-only accruals. We also examine the market response to firms that use these two types of accruals in different ways. Our evidence demonstrates increased use of income-decreasing book-tax accruals to decrease taxable income and increased use of book-only accruals to increase financial income. Use of book-only accruals also compensates for potential costs unrelated to tax, such as financial reporting costs. In addition, our results show that the market correctly assesses the management of accruals even when the uses of book-tax and book-only accruals offset each other.