The Aggregation and Valuation of Deferred Taxes

Eli Amir, Michael Kirschenheiter () and Kristen Willard
Additional contact information
Eli Amir: Tel Aviv University
Michael Kirschenheiter: Columbia University
Kristen Willard: Columbia University

Review of Accounting Studies, 2001, vol. 6, issue 2, No 8, 275-297

Abstract: Abstract This paper clarifies some of the conflicting arguments about the value relevance of deferred taxes. We address two questions. First, does accounting aggregation hold, or in other words, are deferred tax expense and liability balances valued the same as operating earnings and asset balances, respectively? Second, what accounting method for deferred taxes preserves classical accounting relations, or should deferred taxes be recorded as equity, as debt, or as some combination of these categories? We answer these questions using a model of depreciable assets and cashflow dynamics identical to Feltham and Ohlson (1996). We find that aggregation does not hold; rather deferred taxes are valued less than earnings and book value. Deferred taxes add value because they represent the deferral of tax payments, so their value is the net present value of the tax benefits. We interpret this result to mean that the timing of the reversal of temporary differences does matter, consistent with recent empirical work. Our analysis shows that the deferred tax liability, as currently recorded in accordance with US GAAP, overstates the liability. Also, we find that the classical accounting relations hold only when deferred taxes are adjusted to their net present value. Further, the extent of this adjustment depends on whether or not the tax benefits are capitalized into the cost of the operating asset. If the benefits are reflected in the asset's cost, deferred taxes should be adjusted down based on the ratio of the discount rate over the sum of the tax depreciation and discount rates. Otherwise, the entire balance should be treated as equity.

Keywords: deferred taxes; proper accounting; valuation (search for similar items in EconPapers)
Date: 2001
References: Add references at CitEc
Citations:

Downloads: (external link)
http://link.springer.com/10.1023/A:1011619010143 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:reaccs:v:6:y:2001:i:2:d:10.1023_a:1011619010143

Ordering information: This journal article can be ordered from
http://www.springer.com/accounting/journal/11142

DOI: 10.1023/A:1011619010143

Access Statistics for this article

Review of Accounting Studies is currently edited by Paul Fischer

More articles in Review of Accounting Studies from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().