FINANCIAL REPORTING INCENTIVES: TAXATION AND EXTERNAL FINANCING NEED

Earnings management literature extensively explores tax regime and debt contracting as possible incentives in financial reporting. Firms engage with aggressive financial reporting to bias earnings in periods when the need for external financing increases. Contrary to this, the tax burden represents incentive for more conservative reporting.   We argue that the level of firm’s financial reporting aggressiveness is not constant but rather floating from period to period, directly effecting quality of financial reports. We assume that firm’s management on its own discretion determines level of conservatism balancing between these two incentives. The prevailing of two incentives, the need for external financing and the tax burden, determines level of conservatism in particular reporting period.   We hypothesised that the reduction in tax burden incentive overcomes the debt contracting incentive in years of decreasing external financing need, implying more conservative accounting to balance between economic and taxable income. The total accruals are used as a measure of earnings management reflected to working capital accruals.   The data analysis conducted on financial reports of 297 firms in the time-series of five years shows significant correlation between total accruals, external financing needs and the difference between economic and taxable income

CONSTRUCTING ACCOUNTING UNCERTAINITY ESTIMATES VARIABLE

This paper presents research results on the BIH firms’ financial reporting quality, utilizing empirical relation between accounting conservatism, generated in created critical accounting policy choices, and management abilities in estimates and prediction power of domicile private sector accounting. Primary research is conducted based on firms’ financial statements, constructing CAPCBIH (Critical Accounting Policy Choices relevant in B&H) variable that presents particular internal control system and risk assessment; and that influences financial reporting positions in accordance with specific business environment. I argue that firms’ management possesses no relevant capacity to determine risks and true consumption of economic benefits, leading to creation of hidden reserves in inventories and accounts payable; and latent losses for bad debt and assets revaluations. I draw special attention to recent IFRS convergences to US GAAP, especially in harmonizing with FAS 130 Reporting comprehensive income (in revised IAS 1) and FAS 157 Fair value measurement. CAPCBIH variable, resulted in very poor performance, presents considerable lack of recognizing environment specifics. Furthermore, I underline the importance of revised ISAE and re-enforced role of auditors in assessing relevance of management estimates