An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Tanya Y.H. Tang
The Australian National University

Abstract: This paper constructs a theoretical framework in which book-tax differences (BTD) is interpreted as a function of accounting-tax misalignment, earnings management(EM) and tax management(TM). The paper develops a cross-sectional model to identify normal and abnormal components in total BTD. Normal BTD reflects the mechanical differences due to the divergent reporting rules for book and tax purposes, signalling the extent of accounting-tax misalignment. Abnormal BTD (ABTD) is attributed to the opportunistic differences due to the managerial choices in accounting and tax reporting, quantifying the level of management manipulations. Using financial-based data of B-shares listed firms, this paper tests the association between ABTD and the incentives for EM and TM in China. The evidence shows that firms with strong incentives and likelihood for EM and TM have high levels of ABTD, suggesting that BTD is a useful proxy for EM and TM after controlling for accounting-tax misalignment.

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