The use of Accruals for Tax and Financial Reporting Purposes and Stock Market Response

This study investigates the effect of book tax conformity in Korea on the use of accruals. Specifically, we use a sample of 4,331 Korean firms and decompose their total accruals into book tax accruals and book only accruals. Book tax accruals are defined as accruals that affect both taxable income and reported earnings. Book only accruals are defined as accruals that affect solely reported earnings and have no effect on a firm’s taxable income. We anticipate that managers will decrease taxable income by recording book tax accruals that have relatively high book tax conformity to reduce their tax liability. Managers are expected to attempt to increase book income through book only accruals. We also examine the market response to the firms using these accruals in different directions. Our evidence demonstrates that firms are increasingly using income decreasing book tax accruals to decrease taxable income, and using book only accruals to increase financial income and compensate potential non tax cost such as financial reporting costs. In addition, our results show that the market correctly assess the management of accruals even when the uses of two accruals offset each other.