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Does Tax Avoidance, Deferred Tax Expenses and Deferred Tax Liabilities Affect Real Earnings Management? Evidence From Indonesia
Does Tax Avoidance, Deferred Tax Expenses and Deferred Tax Liabilities Affect Real Earnings Management? Evidence From Indonesia
Does Tax Avoidance, Deferred Tax Expenses and Deferred Tax Liabilities Affect Real Earnings Management? Evidence From Indonesia
and Economies
Tax Avoidance, Deferred Tax Expenses and Deferred Tax Liabilities 117
Vol.
14, No. 2, April 2022, pp. 117-148 https://doi.org/10.22452/IJIE.vol14no2.5
Does Tax Avoidance, Deferred Tax
Expenses and Deferred Tax Liabilities
Affect Real Earnings Management?
Evidence from Indonesia
Nera Marinda Machdara
Abstract: The study analyses the effect of tax avoidance, deferred tax expenses and
deferred tax liabilities on real earnings management. The samples consist of 152
manufacturing companies listed on the Indonesian Stock Exchange (IDX). The study
examines the financial statements from 2011 to 2019, ending up with 1,368 observations.
The empirical results of this study are as follows. First, tax avoidance affects positively
the abnormal discretionary operating cash flows and the abnormal discretionary
expenses. However, tax avoidance does not affect the abnormal discretionary production
costs. Second, deferred tax expenses affect real earnings management positively, either
through abnormal discretionary operating cash flows, abnormal discretionary expenses,
or abnormal discretionary production costs. Third, deferred tax liabilities affect real
earnings management positively, either by using abnormal discretionary operating cash
flows, abnormal discretionary expenses, or abnormal discretionary production costs.
The findings of this study may be of interest to regulators and tax authorities, as they
highlight how to increase the actual amount of tax payments by reducing the occurrence
of real earnings management activities. Regulators need to consider tax audits on
companies that have suffered losses but are still operating.
Keywords: Tax avoidance; Deferred tax expenses; Deferred tax liabilities; Real
earnings management.
JEL Classification: H21, H32, M41
a Universitas Bhayangkara Jakarta Raya, 7, Jl. Harsono RM No.67, RT.7/RW.4, Ragunan, Pasar
Minggu, South Jakarta City, Jakarta 12550, Indonesia. Email: nera.marinda@dsn.ubharajaya.
ac.id
118 Nera Marinda Machdar
1. Introduction
Corporate taxation is one of the most important sources of revenue for the
Indonesian government and also a policy tool to regulate the course of a
country’s economy in support of national priority development. Sri Mulyani,
the Minister of Finance of the Republic of Indonesia, announced that tax
revenues in Indonesia have fallen short of the target (shortfall) over the last
five years (Rengganis, 2020). Tax revenue realisation in 2020 was only Rp.
1,070 trillion, or 89.3% of the target of Rp. 1,198.8 trillion. Realisation of
tax revenue in 2019 was recorded at Rp. 1,332.1 trillion or 84.4% of the
target of Rp. 1,577.6 trillion. In percentage terms, this realisation is lower
than 2017 and 2018 which respectively reached 89.7% and 92.4% of the
APBN target. However, the realisation in 2017 and 2018 was still higher
than the achievement in 2015 and 2016, which were 82% and 81.6% of
the National Budget (Anggaran Pendapatan dan Belanja Negara or APBN)
target, respectively. The APBN outlines revenue and expenditure targets for
one fiscal year.
According to Rengganis (2020), the cause of the failure to achieve the
tax revenue target was due to various factors. First, declining commodity
prices caused the performance of tax revenues in the plantation, oil and
gas and mining sectors to decline. Second, international trade fell and had
an impact on the realisation of Value Added Tax (VAT) or import VAT
revenues, which only reached 81.3%. Third, the government has issued
many tax incentives, such as tax holidays, tax allowances, increasing the
threshold for luxury residences, and efforts to accelerate tax refunds. Fourth,
the utilisation of data and information is not optimal. Fifth, delays in tax
collection in several sectors, such as e-commerce. The Directorate General
of Taxes (DJP) is now facing a condition where on the one hand it has to
collect tax revenues, on the other hand, it also provides support and even
helps taxpayers to get tax incentives.
Despite the fact that taxes are compulsory levies for Indonesians, tax
collection is frequently hampered, particularly by tax resistance, which
typically arises when there are opportunities from tax legislation gaps
(Damayanti & Wulandari, 2021). Direct action is used to indicate resistance
to tax officials with the goal of lowering taxes, it can also be referred to as
active resistance.
Almashaqbeh et al. (2018) revealed that managers have substantial
Tax Avoidance, Deferred Tax Expenses and Deferred Tax Liabilities 119
motivations to engage in tax and earnings management. According to Scott
and O’Brien (2019), earnings management is a management alternative
for defining accounting policies, or actions, that may affect the reporting
income. Earnings management can be defined as management’s involvement
in financial statement engineering in order to benefit themselves. Tax
motivation is one means of earnings management to reduce the amount of
tax burden payments through income reduction (Scott & O’Brien, 2019).
Management has different ways to report pre-tax income and taxable
income (Kałdoński & Jewartowski, 2020). In the company’s efforts to
minimise tax payments, management tends to report higher profits for
financial reporting purposes, and lower profits for tax purposes. Management
is motivated differently to report taxable income and accounting income.
Each of these had a distinct performance metric based on measurement units.
Furthermore, neither pre-tax income nor taxable income contain information
that is useful to tax authorities or users of financial statements.
Accounting standards allow management policies to be used in
selecting alternative accounting methods. It has the potential to result in
actual earnings management practices (Kadoski & Jewartowski, 2020).
The practices of real earnings management have a direct impact on cash
flow (Cohen & Zarowin, 2010). As an operational decision, it is also more
difficult to control (Dichev et al., 2013). Tax avoidance is the transfer of
profits that should belong to the state to shareholders through transactions
that can be combined with earnings management (Pipatnarapong et al.,
2020). Income tax is a significant element of a company’s expense, as well
as a reduction in cash flow accessible to the company and its shareholders.
Tax avoidance provides alternatives for businesses to decrease their tax
burden (Cheong & Woo, 2016). Deferred tax expenses and deferred tax
liabilities, in addition to tax avoidance, provide a chance to reduce tax
burdens. Earnings management can be predicted using deferred tax expenses
by a company to avoid a decline in profits, and to prevent losses (Rafay &
Ajmal, 2014). Companies’ earnings management strategies to reduce losses
are heavily influenced by deferred tax liabilities (Lee et al., 2015). Deferred
tax liabilites causes the level of earnings earned to decrease, so that it has
a greater chance of getting bigger earnings in the future and reduces the
amount of tax paid.
The number of studies that include tax avoidance in the context of
real earnings management is still quite small (Pipatnarapong et al., 2020;
120 Nera Marinda Machdar
Damayanti & Wulandari, 2021). The use of tax avoidance, deferred tax
expenses, and deferred tax liabilities to identify real earnings management
by abnormal discretionary operating cash flows, abnormal discretionary
expenses, and abnormal discretionary production costs, is proposed and
evaluated in this study. There has been no prior research on the relationship
between deferred tax expenses and deferred tax liabilities with real earnings
management. This study aims to close that gap. The ability to detect real
earnings management reliably is crucial to assess the reported income’s
quality (Kałdoński & Jewartowski, 2020). The purpose of this research is
to first examine the impact of tax avoidance on real earnings management.
Second, the impact of deferred tax expenses on real earnings management
will be examined. Third, to research the impact of deferred tax liabilities on
real earnings management.
This research will help to advance accounting sciences by examining
the impact of tax avoidance, deferred tax expenses, and deferred tax
liabilities on real earnings management. Furthermore, as part of real earnings
management, this study is predicted to construct tax avoidance, deferred tax
expenses, and deferred tax liabilities. This study is also expected to inform
tax authorities that pre-tax income can be managed in such a way that it does
not affect taxable income using real earnings management. This research
will also assist policymakers in the future in designing tax systems and
accounting standards to close the gap between pre-tax and taxable income.
This study is organised in the following way. The review of the literature
and hypotheses are explained in Section 2. The methodology is provided in
Section 3. The empirical data and debate are contained in Section 4. The
study is concluded in Section 5.
Deferred tax expenses are the difference between corporate tax expenses
and current tax expenses that result from transitory tax discrepancies (Rafay
& Ajmal, 2014). Deferred tax expenses are a component of total corporate
income tax expense that reflect the impact of tax through temporary
differences between pre-tax and taxable income. Real earnings management
has a greater opportunity to avoid reporting losses due to an increase in
deferred tax expenses.
Companies are not required to submit financial statements for two
purposes of reporting income because they are required to reconcile fiscal
accounts at the end of the period (Waluyo, 2020). They determine the
amount of taxable income by doing adjustments or corrections to fiscal
accounts that are both positive and negative. Deferred tax liabilities result
from the negative fiscal correction. Deferred tax liabilities are multiplied
by the applicable tax rate, and the results are recognised as deferred tax
expenses to be added (subtracted) from the current tax expense (benefit)
(Waluyo, 2020). If the amount of tax expense exceeds the amount of current
tax, deferred tax expenses are generated. When there is a positive correction,
it means that the company recognises deferred tax assets. Such deferred tax
assets are multiplied by the applicable tax rate, and the results are recognised
as deferred tax benefits, that must be subtracted (added) from current tax
expenses (benefit) (Waluyo, 2020).
124 Nera Marinda Machdar
expenses (Rafay & Ajmal, 2014). The difference between accounting income
and the book-tax gap caused by temporal differences provides information
about earnings quality (Penman, 2012). According to Penman (2012), the
information contained in the book-tax gap influences the company's future
earnings, thereby increasing the quality of earnings and firm value.
Earnings engineering is the practice of increasing or decreasing the
quantity of deferred tax expenses recorded in the comprehensive profit and
loss statement. Management may minimise deferred tax expenses to reduce
the tax payment. Management, on the other hand, employs real earnings
management to increase reported earnings. Deferred tax expenses reflect the
amount of income tax that will be paid in future periods. According to Dridi
and Boubaker (2015), companies use deferred tax expenses to avoid losses
by delaying income and accelerating tax savings. As a result, through real
earnings management, the company engineered the deferred tax expenses
related to accruals.
Several earlier studies on the impact of deferred tax expenses on real
earnings management have been done, but the findings were inconsistent
(Juliati & Tjaraka, 2014; Trisnawati et al., 2015; Baradja et al., 2017;
Purnamasari, 2019; Machdar & Nurdiniah, 2021). Deferred tax expenses
help with real earnings management (Machdar & Nurdiniah, 2021). Real
earnings management increases in tandem with the increase in deferred tax
expenses. The greater the deferred tax expenses, the greater the likelihood
that the corporation is managing its earnings. The greater the difference
between pre-tax and taxable income, the more the corporation attempts to
control earnings in order to reduce tax obligations for the period. Juliati and
Tjaraka (2014) discovered that deferred tax expenses and current tax expenses
can detect earnings management in response to changes in corporate income
tax rates. Baradja et al. (2017) examined 46 manufacturing companies to
determine the impact of deferred tax expenses on real earnings management.
The results showed that deferred tax expenses had a positive effect on real
earning management. This means that when deferred tax expenses rise, the
likelihood of the corporation engaging in profits management rises as well.
On the other hand, Trisnawati et al. (2015) found that deferred tax expenses
do not have an impact on the probability of companies doing real earnings
management to avoid reporting losses, while Purnamasari (2019) claimed that
deferred tax expenses have a positive but insignificant impact on the likelihood
of corporations managing their earnings.
Tax Avoidance, Deferred Tax Expenses and Deferred Tax Liabilities 129
Based on the above explanation, the following hypotheses are proposed
in this study:
income and cash flow in the short term, it also runs the risk of diminishing
cash flow in the long term.
Based on the foregoing explanation, the following hypotheses are
proposed in this study:
3. Methodology
In equation (1), OCFit is operating cash flows of firm i in year t; TAit-1 is total
assets of firm i in year t-1; Sit is sales of firm i in year t; ΔSit is the changes
in sales (Sit - Sit-1); δ0, δ1, δ2, δ3 are all constants; and Єit represents the
error residual of firm i in the year t.
132 Nera Marinda Machdar
Abnormal discretionary expenses (ABEXPSit) are the actual expenses less the
normal expenses, as calculated by using the estimated residual value from
equation (2). If the value of abnormal discretionary expenses is less than
zero, the company is suspected of having them (negative).
Abnormal discretionary production costs (ABPRODTit) is the sum of
the cost of goods sold (COGSit) and inventory changes (ΔINVTit) over the
course of the year. (Abnormal discretionary production costs replicate the
measurement of Kothari et al. (2016) as follows:
Total accruals are defined as net income after taxes minus operational cash
flows in equation (6), ΔARit is the change in account receivable of firm i in
year t, PPEit is the property, plant, and equipment of firm i in year t, and Єit
represents the error residual of firm i in the year t.
Second, it finds an aspect of tax avoidance by isolating the book-tax
discrepancies components that are not attributable to income manipulation.
This study measures tax avoidance, deferred tax expenses and deferred tax
liabilities in three ways. The first model (1) is used to analyse the variables
of tax avoidance, deferred tax expenses and deferred tax liabilities that affect
abnormal discretionary operating cash flows.
Model 1:
Model 2:
Model 3:
Models (1), (2), and (3) now have all of their variables defined. The
SPSS statistical software is used in all of the regression models.
Notes: ABOCF = Abnormal discretionary operating cash flows, ABEXPS = Abnormal discretionary
expenses, ABPRODT = Abnormal discretionary production costs, TXAVOID = Tax avoidance,
DFTE = Deferred tax expenses, DFTL = Deferred tax liabilities, MTB = Market to book value,
SIZES = Company size.
Source: Data is processed.
Notes: ABOCF = Abnormal discretionary operating cash flows, ABEXPS = Abnormal discretionary
expenses, ABPRODT = Abnormal discretionary production costs, TXAVOID = Tax avoidance,
DFTE = Deferred tax expenses, DFTL = Deferred tax liabilities, MTB = Market to book value,
SIZES = Company size.
***Significant at 1% level, **Significant at 5% level, * Significant at 10% level.
Source: Data is processed.
138 Nera Marinda Machdar
Notes: ABOCF = Abnormal discretionary operating cash flows, ABEXPS = Abnormal discretionary
expenses, ABPRODT = Abnormal discretionary production costs, TXAVOID = Tax avoidance,
DFTE = Deferred tax expenses, DFTL = Deferred tax liabilities, MTB = Market to book value,
SIZES = Company size.
***Significant at 1% level, **Significant at 5% level, * Significant at 10% level.
Source: Data is processed.
that TXAVOID, DFTE, DFTL, MTB, and SIZES simultaneously affect the
abnormal discretionary production costs.
Notes: ABOCF = Abnormal discretionary operating cash flows, ABEXPS = Abnormal discretionary
expenses, ABPRODT = Abnormal discretionary production costs, TXAVOID = Tax avoidance,
DFTE = Deferred tax expenses, DFTL = Deferred tax liabilities, MTB = Market to book value,
SIZES = Company size.
***Significant at 1% level, **Significant at 5% level, * Significant at 10% level.
Source: Data is processed.
5. Conclusion
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