ABSTRACT AN EMPIRICAL EXAMINATION OF FINANCIAL STATEMENT PRESENTATION OF THE CORPORATE INCOME TAX EXPENSE By James Robert Hasselback This research examines the extent to which the fin- ancial reporting of corporate income taxes is in accordance with certain disclosure requirements of the Accounting Principles Board and whether the extent of adherence to these requirements is related to (1) corporate Federal income tax rate incurred, (2) corporate size, and (3) independent auditor. There have been several APB Opinions issued since 1962 concerning the financial reporting of income taxes in fin- ancial statments to shareholders. Four income tax dis— closure requirements and the placement of the income tax expense in the income statement are selected for analysis, as follows: 1. Disclosure of the method of accounting for invest- ment credits and amounts included in income for the year. 2. Disclosure of the current and deferred income tax figures in the income statement. 3. Disclosure of the income tax effect of extraordinary items. u. Disclosure of the amounts of tax loss carryforwards not included in the income for the loss year with expiration dates. 5. Placement of income tax expense (relating to income before extraordinary items) in the income statement. A random sample of 300 corporations is taken from com- panies listed on the New York and American Stock Exchanges. James Robert Hasselback The sample is classified two ways by tax rate (high and low), two ways by size (large and small), and nine ways by inde- pendent auditor, representing each of the "Big-8" with all others comprising the ninth group. The study analyses variables that make up the financial reporting of income taxes in annual reports to shareholders and tests for sig- nificant differences to these particular classifications. The statistical test applied is a three-factor analysis of variance applied to log transformations of cell propor- tions. Using a 30-cell table, various hypotheses were tested to determine the existence of any relationships between each of the three main factos and the four APB Opinion income tax reporting requirements and the placement of the income tax expense. The analysis of the location of the income tax expense resulted in the most important finding of significance in the study. The relationship of corporate size (when measured by assets but not revenues) and the location of the income tax expense in the income statement is statis- tically significant at the .05 level. Large corporations are more likely to include the income tax expense as an element among the operating expenses than are small cor- porations. The Federal income tax rate when measured either by the flow-through method or by the normalized method also shows a relation with its placement. Low Federal income tax rate corporations are more likely to include the tax James Robert Hasselback among the operating expenses than are high Federal income tax rate corporations. The results were significant at the .05 level when Federal income tax rates were measured either by the flow—through or the normalized methods. AN EMPIRICAL EXAMINATION OF FINANCIAL STATEMENT PRESENTATION OF THE CORPORATE INCOME TAX EXPENSE By JAMES ROBERT HASSELBACK A DISSERTATION Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Accounting and Financial Administration 1976 © COPYRIGHT BY JAMES ROBERT HASSELBACK 1976 ii ACKNOWLEDGEMENTS There are many who deserve recognition for their con- tribution and assistance during the Ph. D. program. This dissertation could never have been completed without the assistance, counsel, and guidance of faculty, friends, and fellow graduate students at Michigan State University. To my dissertation committee I express my sincere appreciation. Professor Hugo Nurnberg, as Chairman, devoted considerable time to improve the study. Professor Steven Dilley assisted with the tax aspects of the research and Professor Dennis Gilliland assisted with the statistical design. Great appreciation is due the Haskins and Sells Foun— dation for its financial assistance during my dissertation endeavor. iii TABLE OF CONTENTS ACKNOWLEDGMENTS ...................................... LIST OF Chapter I II TABLES ....................................... PURPOSE OF STUDY AND LITERATURE REVIEW ....... APB Opinion Income Tax Disclosure Requirements .............................. Purpose and Motivation of the Study ....... ... Increased Disclosure for Predictive Purposes ................................. A. Introduction ........... ................ B. Tax Laws Pertaining to Period Studied .. 1. Income taxes at the "normal" rate .. 2. Capital gains tax ......... .......... 3. Partial and complete exemptions ..... u. Other tax-reducing provisions ...... Social Responsibility Accounting ............. "Fair Share" ............................... Inadequate Disclosure of Taxes ............. Follow-up on Related Studies .... ............. Independent Auditor Influence ....... ....... Corporate Size Influence ................... Approach and Organization of the Study ....... Footnotes .................................... RESEARCH QUESTIONS, DESCRIPTION OF THE RESEARCH DESIGN, AND APPLICATION ........... Selection of the Sample ...................... Reasons for Selection ........................ Data Source .................................. Tax Rate Influence ........................... Research Problem ........................... Methodology ................................ Corporate Size Influence ..................... Research Problem ........................... iv 11 12 12 13 1” 15 16 17 22 22 2M 26 27 29 30 32 III IV TABLE OF CONTENTS--Continued Page Methodology ................ . ............... H5 Independent Auditor .......................... #5 Research Problem ................... . ...... . #5 MethOdOlOgy O O O O O O O O O O O O O O 0 O I O ...... O ....... 1‘6 Statistical Tests ............................ H6 Footnotes . ................................... 51 RESULTS OF THE STUDY ........................ . 52 Data Gathering Procedure ..................... 52 Flow-Through Federal Income Tax Rate Computation ................................ 53 Normalized Federal Income Tax Rate Computation ............................. ... 5h Classifying Corporations by Size According to Revenues ................................ 55 Classifying Corporations by Size According to Assets ........ ..... ... ..... .... ...... . 55 Classifying Corporations by Auditor .......... 55 ANOVA Procedure .............................. 56 Investment Credit Disclosure Requirement Analysis .............. . .................... 59 Timing Difference Disclosure Requirement Analysis ... ..... . ..... ..................... 69 Extraordinary Items Disclosure Requirement Analysis ....................... .. ......... 79 Tax Carryforward Disclosure Requirement Analysis .......................... . . ...... 80 Location of Income Tax Expense Analysis ...... 85 Results of the Hypotheses Testing ............ 100 Federal Income Tax Rate-Corporate Size Relationship ............................... 103 Footnotes . ................................... 106 SUMMARY, IMPLICATIONS, AND LIMITATIONS ..... .. 107 Summary ..................................... 107 Summary of Research Findings ................. 110 Implications of the Study .................... 111 Limitations of the Research .................. 113 Suggestions for Further Research ............. 116 Footnotes . ......... . ......................... 119 II III IV TABLE OF CONTENTS--Continued Page APPENDICES Corporations Included in Sample .............. 120 Corporations Eliminated in Selection Process and Reason ................................. 126 Computation Procedures for Federal Income Tax Rates ...................................... 128 Questionnaire ................................ 132 SELECTED BIBLIOGRAPHY oooooooooooooooooooooooo 133 vi Table 1-1 3-1 3-la 3-2 3-2a LIST OF TABLES TAXABLE PROFIT AND EFFECTIVE TAX RATES ....... 13 ANALYSIS OF INVESTMENT CREDIT DISCLOSURE REQUIREMENT Size by Revenue, Flow-Through Federal Income Rax Rate, Auditor ...... .................... 61 ANOVA RESULTS OF INVESTMENT CREDIT ANALYSIS Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor .... ...................... 62 ANALYSIS OF INVESTMENT CREDIT DISCLOSURE REQUIREMENT Size by Assets, Flow-Through Federal Income Tax Rate, Auditor .......................... 63 ANOVA RESULTS OF INVESTMENT CREDIT ANALYSIS Size by Assets, Flow-Through Federal Income Tax Rate, Auditor ............. . ............ 6” ANALYSIS OF INVESTMENT CREDIT DISCLOSURE REQUIREMENT Size by Revenue, Normalized Federal Income Tax Rate, Auditor ..... ....... ...... . ....... 65 ANOVA RESULTS OF INVESTMENT CREDIT ANALYSIS Size by Revenue, Normalized Federal Income Tax Rate, Auditor ..................... ..... 66 ANALYSIS OF INVESTMENT CREDIT DISCLOSURE REQUIREMENT Size by Assets, Normalized Federal Income Tax Rate, Auditor .. ......... ..... .......... 57 ANOVA RESULTS OF INVESTMENT CREDIT ANALYSIS Size by Assets, Normalized Federal Income Tax Rate, Auditor .......................... 68 vii Table 3-5 3—6 3-7 3-7a 3-8 3-8a 3-9 3-10 LIST OF TABLES con't Page ANALYSIS OF INCOME TAX COMPONENT DISCLOSURE REQUIREMENT Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor .......................... 71 ANOVA RESULTS OF INCOME TAX COMPONENT ANALYSIS Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor ................ . ......... 72 ANALYSIS OF INCOME TAX COMPONENT DISCLOSURE REQUIREMENT Size by Assets, Flow—Through Federal Income Tax Rate, Auditor 0.0.0.0.... ..... I. ....... O 73 ANOVA RESULTS OF INCOME TAX COMPONENT ANALYSIS Size by Assets, Flow-Through Federal Income Tax Rate, Auditor .......................... 7% ANALYSIS OF INCOME TAX COMPONENT DISCLOSURE REQUIREMENT Size by Revenue, Normalized Federal Income Tax Rate, Auditor .......................... 75 ANOVA RESULTS OF INCOME TAX COMPONENT ANALYSIS Size by Revenue, Normalized Federal Income Tax Rate, Auditor ......... ...... ........... 76 ANALYSIS OF INCOME TAX COMPONENT DISCLOSURE REQUIREMENT Size by Assets, Normalized Federal Income Tax Rate, Auditor ............. ...... ....... 77 ANOVA RESULTS OF INCOME TAX COMPONENT ANALYSIS Size by Assets, Normalized Federal Income Tax Rate, Auditor ..................... ..... 78 ANALYSIS OF EXTRAORDINARY ITEMS DISCLOSURE REQUIREMENT Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor ..... ..... ........ ........ 81 ANALYSIS OF EXTRAORDINARY ITEMS DISCLOSURE REQUIREMENT Size by Assets, Flow-Through Federal Income Tax Rate, Auditor ........ .................. 82 viii Table 3-11 3-12 3-13 3-1” 3-15 3-15 3-17 3-l7a LIST OF TABLES con't Page ANALYSIS OF EXTRAORDINARY ITEMS DISCLOSURE REQUIREMENT Size by Revenue, Normalized Federal Income Tax Rate, Auditor .......................... 83 ANALYSIS OF EXTRAORDINARY ITEMS DISCLOSURE REQUIREMENT Size by Assets, Normalized Federal Income Tax Rate, Auditor ........... ... ...... ...... 3” ANALYSIS OF TAX CARRYFORWARD DISCLOSURE REQUIREMENT Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor ..... . ...... ....... ..... .. 85 ANALYSIS OF TAX CARRYFORWARD DISCLOSURE REQUIREMENT Size by Assets, Flow-Through Federal Income Tax Rate, Auditor .......................... 87 ANALYSIS OF TAX CARRYFOWARD DISCLOSURE REQUIREMENT Size by Revenue, Normalized Federal Income Tax Rate, Auditor . ........ .... ...... . ...... 88 ANALYSIS OF TAX CARRYFORWARD DISCLOSURE REQUIREMENT Size by Assets, Normalized Federal Income Tax Rate, Auditor .......................... 89 ANALYSIS OF LOCATION OF THE INCOME TAX EXPENSE Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor .......................... 90 ANOVA RESULTS OF INCOME TAX LOCATION ANALYSIS Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor .......................... 91 ANALYSIS OF LOCATION OF THE INCOME TAX EXPENSE Size by Assets, Flow-Through Federal Income Tax Rate, Auditor .......................... 92 ix Table 3-18a 3-19a 3-20a LIST OF TABLES con't Page ANOVA RESULTS OF INCOME TAX LOCATION ' ANALYSIS Size by Assets, Flow-Through Federal Income Tax Rate, Auditor .... ............... . ...... 93 ANALYSIS OF LOCATION OF THE INCOME TAX EXPENSE Size by Revenue, Normalized Federal Income Tax Rate, Auditor ...... ..... . ............ .. 9” ANOVA RESULTS OF INCOME TAX LOCATION ANALYSIS Size by Revenue, Normalized Federal Income Tax Rate, Auditor ... ....................... 95 ANALYSIS OF LOCATION OF THE INCOME TAX EXPENSE Size by Assets, Normalized Federal Income Tax Rate, Auditor . ................ . ........ 95 ANOVA RESULTS OF INCOME TAX LOCATION ANALYSIS Size by Assets, Normalized Federal Income Tax Rate, Auditor .. ..... . ........... ....... 97 LOCATION OF INCOME TAX EXPENSE AND CORPORATE SIZE MEASURED BY ASSETS ............ 98 FLOW-THROUGH FEDERAL INCOME TAX RATE AND SIZE MEASURED BY REVENUES OR ASSETS .......... 99 NORMALIZED FEDERAL INCOME TAX RATE AND SIZE MEASURED BY REVENUES OR ASSETS .......... 99 CHAPTER I PURPOSE OF STUDY AND LITERATURE REVIEW This study examines the financial reporting of corpor- ate income tax expense in both annual reports to shareholders and IO-K reports to the Securities and Exchange Commission (SEC). Specifically, the study examines the extent to which the financial reporting of corporate income taxes is in ac- cordance with pronouncements of the Accounting Principles Board (APB); and whether the extent of adherence to these pronouncements as well as the location of tax expense in the income statement are related to (1) effective corporate Federal income tax rate, (2) corporate size, and (3) independent auditor. A random sample of 300 corporations is taken from com- panies listed on the New York and American Stock Exchanges. The sample is classified two ways by tax rate incurred (high and low), two ways by size (large and small), and nine ways by independent auditor. The study analyzes dependent var- iables that make up the financial reporting of income taxes in annual reports to shareholders and tests for significant differences relating to these particular classifications, which are the independent variables. 2 The main thrust of this study is to examine the extent to which corporate annual reports to shareholders adhere to the disclosure requirements of APB Opinion Nos. 2, u, 11, 23, and 2&1 insofar as these pronouncements pertain to the fin- ancial reporting of income taxes. It should be noted that corporate annual reports to shareholders are usually less detailed than lO-K reports to the SEC. The latter are pre- pared in accordance with reporting requirements of the SEC whereas the former are prepared in accordance with somewhat different reporting requirements of the Financial Accounting Standards Board (FASB) and its predecessor, the Accounting Principles Board. (The study examines adherence to income tax disclosure requirements of APB Opinions only; the FASB has not as yet issued any pronouncement on the financial reporting of income taxes although a pronouncement on the financial reporting of income taxes by oil and gas producing firms is about to be issued.2) The lO-K reports are used, together with a questionnaire, to determine the extent of adherence of corporate annual reports to APB Opinions. APB INCOME TAX DISCLOSURE REQUIREMENTS There have been several APB Opinions issued since 1962 concerning the financial reporting of income taxes in fin- ancial statements to shareholders. In the following dis- cussion, these pronouncements are examined along with the reasons for selecting for study only some of the financial reporting disclosure requirements within these pronouncements. 3 The financial reporting of income taxes as specified in APB Opinions can be broken down into two distinct areas: (1) the computation of income tax expense, and (2) disclosure requirements.3 The computation of income tax expense involves such matters as interperiod tax allocation and the method of accounting for investment credits; such matters affect the computation of net income before extraordinary items and the final net income figure. Disclosure requirements involve the presentation of other income tax information in the annual report, either parenthetically or in footnotes. It could be argued that nonadherence to computational require- ments is a more serious departure from generally accepted accounting principles than nonadherence to disclosure re- quirements; that the former requires the issuance of an adverse opinion by the independent auditor whereas the latter may not;u and that since this researcher is unaware of the issuance of any adverse opinion in conjunction with the financial statements of NYSE and AMEX companies, complete adherence to these computational requirements can be assumed. In any event, the present study is limited to examining ex— tent of adherence to APB Opinion income tax expense dis- closure requirements; extent of adherence to APB Opinion income tax expense computation requirements is not examined in this study. APB Opinion No. 2 "Accounting for the 'Investment Credit'" is an early APB pronouncement on the financial u reporting of income taxes that still remains partially in effect.5 The Opinion requires the deferral method, whereby the effect of the investment credit is included in income over the productive life of the related asset and not only in the year in which the asset is placed into service.6 Shortly after the issuance of APB Opinion No. 2, the SEC issued Accounting Series Release No. 96 in which it sanctioned the flow-through method, whereby the effect of the invest- ment credit is included in income of the particular years in which the credit is taken, as an alternative to the de- 7 ferral method. This was followed by the issuance of APB Opinion No. u, also entitled "Accounting for the 'Investment Credit'," which sanctions the flow-through method as a less desirable but acceptable alternative to the deferred method.8 Neither APB pronouncammfi:sanctioned reporting an investment credit as a subsidy by way of contribution of capital by the government to the taxpayer-corporation. Both the deferral and flow-through methods of accounting for investment credits represent computational aspects of the financial reporting of income tax expense. Paragraph 11 of APB Opinion No. u requires "that which- ever method of accounting for the investment credit is adopted, it is essential that full disclosure be made of the method followed and amounts involved, when material."9 The amount of investment credit taken into income by a cor- poration in any particular year can have a significant 5 bearing on net income after taxes and therefore is important from both predictive and social responsibility vieWpoints (as discussed on pages 22-26). Therefore, an examination will be made of the extent to which corporations adhere to these disclosure requirements. APB Opinion No. 11 "Accounting for Income Taxes"10 is the heart of the income tax disclosure requirements of the APB. This Opinion requires the comprehensive use of the deferred method of interperiod income tax allocation.11 The requirement is of a computational nature and, according- ly, adherence to it is not examined in this study. Paragraph 60 of APB Opinion No. 11 requires the follow- ing presentation of corporate income Bx expense in the income statement: In reporting the results of operations the com- ponents of income tax expense for the period should be disclosed, for example: a. Taxes estimated to be payable b. Tax effects of timing differences c. Tax effects of operating losses. These amounts should be allocated to (a) income before extraordinary items and (b) extraordinary items and may be presented as separate items in the income statement or, alternatively, as combined amounts with disclosure of the components parenthetically or in a note to the financial statements. Cursory reading of annual reports has shown that many corporations have not adhered to these requirements. As discussed later, these required disclosures are important for both predictive and social responsibility goals. There- fore, annual reports are examined to determine the extent 6 of adherence to requirements (a) and (b) of paragraph 60. Corporations reporting losses for the period studied are eliminated from the study for reasons discussed later (see Chapter II, page 37); therefore, adherence to disclosure requirements of (c) is not examined in this study. Allocation of income taxes between income before extra- ordinary items and extraordinay items is viewed as a com- putational requirement. Accordingly, adherence to this re- quirement is assumed, for reasons elaborated upon previously. But disclosure of the tax effects of extraordinary items is another matter. This study examines the extent to which corporations disclose the tax effects of extraordinary items consistent with the second sentence of paragraph 60. Such disclosures are important in determining the effective tax rate incurred by a corporation. APB Opinion No. 11 also requires disclosure of the amounts of any operating carryforwards not included in income for the loss period, together with expiration dates.13 Adherence to this disclosure requirement is studied because a cursory reading of annual reports suggests that some cor- porations are not adhering to it although this information is useful for predictive purposes. APB Opinion No. 11 requires that "when the tax benefits of loss carryforwards are not recognized until realized in full or in part in subsequent periods, the tax benefits should be reported in the results of operations of those periods as extraordinary items."11+ Accordingly, the finan- cial reporting of the tax benefits of carryforward losses is viewed as a computational requirement and adherence to it is assumed, for reasons mentioned previously. Paragraph 63b of APB Opinion No. 11 requires that dis- closure be made of significant amounts of any other unused deduction or credits, such items as capital losses, contri— bution carryovers, and foreign tax credits, together with expiration dates.15 Few corporations have these items and fewer still could be shown to fail to disclose them. There- fore, no analysis is made of this disclosure requirement. Another important provision of APB Opinion No. 11 re— quires disclosure of the "reasons for significant variations in the customary relationship between income tax expense and "16 pre-tax accounting income . . However, the teeth of this requirement are removed by the remainder of the statement: "if they are not otherwise apparent from the financial state- ul7 In ments or from the nature of the entity's business. view of the wording of this disclosure requirement, it is virtually impossible to determine whether a corporation is or is not in violation of it. Balance sheet deferred tax debits and credits must be classified as current and noncurrent consistent with APB 18 Opinion No. 11. These current and deferred debits and credits are often buried among other current assets and liabilities; hence it is again virtually impossible to 8 determine the extent of adherence to this classification requirement. Therefore, an analysis is not made to the extent of adherence to this disclosure requirement. APB Opinion Nos. _3 and 21 require interperiod alloca- tion of income taxes for undistributed earnings of subsid- iaries or, for subsidiaries with specified circumstances, the disclosure of amounts on which taxes have not been 19 allocated; in this respect APB Opinion Nos. 3 and 2 take a partial approach to interperiod tax allocation whereas APB Opinion No. 11 takes a comprehensive approach. The Accounting Principles Board, in Opinion No. 23, concluded that "it should be presumed that all undistributed earnings of a subsidiary will be transferred to the parent company," thereby necessitating interperiod tax allocations. However, the Opinion further states that "no income taxes should be accrued by the parent company, if sufficient evi- dence shows that the subsidiary has invested or will invest the undistributed earnings indefinitely or that the earnings will be remitted in a tax-free liquidation." Under these circumstances, a permanent difference arises. APB Opinion No. 2n requires the accrual of deferred income taxes on undistributed earnings of investments in common stock accounted for by the equity method (other than subsidiaries and corporate joint ventures). The Opinion states in part: 9 If evidence indicates that an investor's equity in undistributed earnings of an investee will be realized in the form of dividends, an investor should recognize income taxes attributable to the timing difference as if the equity in earnings of the investee that the investor included in income were remitted as a dividend during the period, recognizing available dividend-received deductions and foreign tax credits. Income taxes of the investor company should also include taxes that would have been withheld if the undistributed earnings had been remitted as dividends. If ev- idence indicates that an investor's equity in undistributed earnings of an investee will be realized by ultimate dispositon of the invest- ment, an investor should accrue income taxes attributable to the timing difference at capital gains or other appropriate rates, recognizing all available deductions and credits. Nonadherence to these disclosure requirements conceiv- ably can be determined by examining the annual report for the following year or the lO-K reports or by a question- naire. It is likely, however, that a corporation either discloses these undistributed earnings on which taxes have not been allocated or allocates taxes on these and other timing differences without breaking down the component deferred taxes. Accordingly, because the subsidiary must be under specified circumstances for this disclosure re- quirement to pertain, adherence to it is not examined in this study. Adherence to these four disclosure requirements is determined individually in the following manner, A corpor- ation that makes each disclosure in its annual report is considered to adhere to each disclosure requirement. 10 On the other hand, a corporation that does not make each disclosure is still adhering to the particular disclosure requirement if it does not have the particular item that requires disclosure; a corporation is not adhering to the particular disclosure requirement if it has the particular item but does not disclose it. Unfortunately, the latter can be determined objectively only if the corporation makes such a disclosure in either its annual report for the following year, its lO-K report for the same or the follow- ing year, or in response to a questionnaire. A corpor- ation that neither discloses the particular item in one of these places nor explicitly states that it does not have such an item will be classified as indeterminate with respect to its adherence to the particular disclosure requirement. In addition to the four APB Opinion disclosure require- ments that are studied, an additional analysis is made of the location in the income statement of income tax expense relating to income before extraordinary items. Income tax expense is deducted separately from net income before income taxes to determine net income after income taxes, or is included among the operating expenses. Whereas the SEC requires the use of the former presentation in lO—K re- ports,20 both presentations are acceptable in annual reports to shareholders. The former presentation reflects in part the continuing controversy over the nature of the income ll tax--specifically, whether it is an expense or a distribution of income.21 An analysis of the placement of income tax expense is related to the question of whether some corpor- ations are attempting to obscure the amount of their income taxes (see pages 2H-26). To summarize, four income tax disclosure requirements and the location of the income tax expense in the income statement are selected for analysis, as follows: 1. Disclosure of method of accounting for investment credits and amounts included in income for the year. 2. Disclosure of the current and deferred income tax figures in the income statement. 3. Disclosure of the income tax effect of extraordinary items. u. Disclosure of the amounts of tax loss carryforwards not included in income for the loss year with expiration dates. 5. Location of income tax expense (relating to income before extraordinary items) in the income state- ment. In the remainder of this study, all five items selected for analysis are occasionally referred to as the "APB Opinion income tax disclosure requirements." This terminology is used for simplicity even though the last item--income tax location in the income statement——is not an APB Opinion disclosure requirement. PURPOSE AND MOTIVATION OF THE STUDY There are three major reasons for research into the financial reporting of corporate income taxes in financial statements, pertaining to (1) increased disclosure for pre- dictive purposes; (2) social responsibility reporting; and 12 (3) follow-up on related studies. Increased Disclosure for Predictive Purposes A. Introduction Analysts and other readers of published income state- ments are sometimes puzzled by the low percentage relation- ships they observe between Federal income taxes and pre-tax accounting income. This section analyzes the underlying tax-law provisions and financial reporting practices which can create this condition. As an example, consider the following data from the 1972 Annual Report of Xtra Incorporated: XTRA INCORPORATED Income before Provision for Federal Income Tax $5,”13,235 Provision for Federal Income Taxes 1,588,000 Net Income $u,825,235 Federal income taxes amount to only 2u.8 percent of pretax accounting income. However, the corporate tax rates in 1972 and 1973 were: 1. 22 percent of the first $25,000 of taxable income-- the "normal tax." 2. 26 percent additional on the taxable income in excess of $25,000--the "surtax." For firms with taxable incomes in excess of $1,000,000, the overall Federal income tax rate in 1972 and 1973 ap— proaches ”8.0 percent. Table 1-1 illustrates the behavior 13 of the overall Federal income tax rate for taxable incomes from $25,000 to $2,000,000. If the entire Xtra Incorporated pretax accounting income of $6,”l3,235 were taxable at the 1972 rates, its effective tax rate would have been approx- imately ”7.9 percent. Clearly, the financial statement user must determine the reasons for any unusual relationships between income and income taxes if he is to accurately forecast future levels of pep income after income taxes.22 The underlying conditions that give rise to an unusually low income tax rate must be studied to determine whether, and to what ex- tent, they will persist into the future. TABLE 1-1 TAXABLE PROFIT AND EFFECTIVE TAX RATES Taxable Profit Effective Tax Rate $ 25,000 22.0% 50,000 35.0 100,000 ”1.5 300,000 ”5.8 500,000 ”6.7 700,000 ”7.1 1,000,000 ”7.” 2,000,000 ”7.9 23 B. Tax Laws Pertaining to Period Studied The tax laws contain a number of features which, when combined with current financial reporting practices, result in reporting of income tax expense that is a smaller 1” percentage of pretax accounting income than the statutory rates: 1. Taxation of more than $25,000 of income at the "normal-tax" rate of only 22 percent. 2. Taxation of portions of pretax accounting income at the 30 percent capital gains rate. 3. Partial or complete exemption of some income from taxation. ”. Other special tax-reducing features (statutory depletion, investment credits, etc.). 1. Income taxes at the "normal" rate The first $25,000 of a corporation's taxable income is taxed at 22 percent, the "normal" rate. Taxable income over $25,000 is taxed at ”8 percent--the 22 percent normal rate plus the 26 percent "surtax." However, the income state- ments in some corporate annual reports cover a number of legally separate corporate entities—-they are consolidated financial statements. If these legally separate corporate entities file individually, more than $25,000 of the pretax accounting income of the consolidated group may be exempted from the surtax, resulting in a low effective tax rate on consolidated pretax accounting income. Table 1-1 in- dicates an effective tax rate of ”1.5 percent on $100,000 of taxable income. If this income represented the consoli- dated income of four separate corporations, each of which filesits own tax return, the effective tax rate would be as low as 22 percent if the $100,000 of income were divided equally among the four corporations. 15 Since the first $25,000 of taxable income is not subject to the 26 percent surtax, this amount is sometimes referred to as the "surtax exemption". The election to take a surtax exemption for each corporation of a controlled group carries with it an additional tax of six percent on the first $25,000 of taxable income. With the passage of the Tax Reform Act of 1969, the multiple surtax exemptions available to members of a controlled group are being phased out over a six-year period.2u Thus, for calendar year 1972, the original surtax exemption has been reduced to $12,500 with further reductions until the end of 197”.25 2. Capital gains tax Beginning with 1971, a maximum tax of 30 percent is applicable to capital gains of corporations; previously the rate was 25 percent. If capital gains are included in pre- tax accounting income, they reduce the overall effective tax rate. For example, assume that XYZ Corporation has pretax accounting income of $100,000, including a $30,000 capital gain. The capital gains provision reduces the over- all effective Federal income tax rate to 37.1 percent from ”1.5 percent if no part of the taxable income was a capital gain. If the capital gain is material in amount and meets the criteria under APB Opinion No. 30 for extraordinary items,26 it must be excluded from pretax accounting income 27 before extraordinary items. The associated tax effect is 16 then deducted directly from the separately reported capital gain and therefore does not influence the normal relation- ship between pretax accounting income and income tax expense. This type of presentation is illustrated by the "net-of-tax" treatment of a material gain reported as an extraordinay item in the 1972 Lykes-Youngstown Corporation annual report. LYKES-YOUNGSTOWN CORPORATION Income before extraordinary items $17,580,000 Gain on sale of investment, less income tax of $2,””7,000 8,018,000 Net income for the year $25,598,000 The gross gain would be $10,”65,000 ($8,018,000 plus $2,””7,000). The tax of $2,””7,000 amounts to approx- imately 23.”% of the gain. APB Opinion No. 30, issued in 1973, narrowed drastically the definition of extraordinary items; many items that were formerly classified as extraordinary are now reported with normal operations. This Opinion has the effect of increasing the number of corporations that report income tax expense which, as a percentage of pretax accounting income, is below the statutory rates. 3. Partial and complete exemptions Certain items are included in pretax accounting income which are either wholly or partially excluded from taxable income. For example, interest revenue on state or municipal obligations is wholly exempt from taxation, although it is included in pretax accounting income. If the nontaxable 17 income is material in amount, it produces a low effective tax rate. This is revealed in the data below from the 1972 annual report of Chase Manhattan Corporation: CHASE MANHATTAN CORPORATION Profit before income taxes $210,221,111 Income tax 61,908,128 Income tax as a % of profit before income taxes 29.”% A breakdown of Chase Manhattan's gross revenues for 1972 reveals $85,6”8,570 of interest on state and municipal secu- rities. This item alone largely explains the low tax per— centage of 29.” percent. If this revenue is excluded, the ratio of tax to profit is approximately ”9.7 percent. Other items often included in pretax accounting income but partially or wholly exempt from taxation include: 1. Dividends received. In general, 85 percent of such dividends are not subject to taxation. This "div- idends received deduction" will be raised to 100 percent over a six-year period for members of a controlled group. 2. Equity in undistributed profits of unconsolidated subsidiaries. This item is not considered income under the current law. ”. Other tax-reducing provisions For most of a 12-year period, beginning with the Revenue Act of 1962, taxpayers could reduce Federal income taxes by acquiring certain qualified assets.29 This investment tax credit amounted to as much as 7 percent of the cost of qual- ified assets. The investment tax credits taken in a given 18 year are typically used, in whole or in part, to reduce the income tax provision (expense) for the year. This treatment explains a large part of the low effective tax rates in many published income statements. To illustrate, consider the following data from the 1972 Annual Report of Trans World Airlines: TRANS WORLD AIRLINES Profit before income taxes $”3,697,000 Income tax 9,893,000 Tax percentage 22.6% In the footnotes to its 1972 Annual Report, Trans World Airlines reported that the 1972 tax expense was reduced by investment tax credits of $10,129,000. If these tax credits are added to the reported income tax of $9,893,000, the tax percentage would be approximately ”5.8 percent. In this case the tax credits largely explain the unusually low effec- tive tax rate. Another tax-reducing feature is the percentage depletion deduction granted companies that extract natural resources. The best known is the oil depletion allowance which is 22.0 percent of the revenue from the property, subject to certain overall limitations. Percentage depletion deductions for tax purposes usually exceed depletion expense for financial reporting purposes, since the latter is based upon the cost of the property rather than upon the revenues from the property. Accordingly, taxable income is usually less than pretax accounting income, producing a lower than normal 19 relationship between income tax expense and pretax account- ing income.30 Other special features affecting the income tax and pre- tax accounting relationship include (1) the inclusion of foreign subsidiary profits in consolidated reports which may not be subject to U.S. income taxes; (2) the effects of operating loss carryovers; and (3) the use by some reg- ulated industries of flow-through tax accounting for depreci- ation timing differences. A major objective of financial accounting is to provide financial information that is useful for decision making. The recent report of the American Institute of Certified Public Accountants (AICPA) study group on the objectives of financial statements states that "an objective of finan- cial statements is to provide users with information for predicting, comparing, and evaluating earning power." 31 Toward this end, accounting attempts to disclose those as- pects of an economic entity's experience which are relevant to make judgments about its future. To improve (not nec- essarily increase) accounting disclosure means to increase its usefullness. The Securities Acts have the same perspective of user information. A typical description of the goals of the Securities Act of 1933 and the Securities Exchange Act of 193” is notes by Mundheim: The theory of the Securities Act is that if investors are provided with sufficient information to permit them 20 to make a reasoned decision concerning the investment merits of securities offered to them, investor interest can be adequately protected without unduly restricting the ability of business ventures to raise capital. As already noted, APB Opinion No. 11 requires disclosure of the "reasons for significant variations in the customary relationships between income tax expense and pretax account- ing income if they are not otherwise apparent from the fin- ancial statements or from the nature of the entity's bus— iness." 33 3” But few corporations make such disclosures; presumably, it is maintained that the reasons for any sig- nificant variations are in fact apparent. This study recommends additional disclosures of income tax data in annual reports to shareholders. These addi- thmfl.disclosures should enable users of financial statements to better understand the reasons underlying any differences between the Federal income tax rate incurred and the stat- utory rate, and therefore enable them to distinguish between one-time and continuing tax advantages and to appraise the significance of changing tax rates. Such disclosures should contribute to more efficient capital markets. The weight of recent empirical studies convincingly suggests that security markets are relatively efficient--specifically, that indiv- idual company stock prices fully reflect all publicly avail- able information about the companies; and that efforts to analyze this information cannot be expected to produce su- perior investment returns for the given risks. For example, one cannot expect to earn superior rates of return by 21 analyzing annual reports or announcements of dividends or stock splits. But as Lorie and Hamilton note, there is a curious paradox.... That is, market prices will promptly and fully reflect what is knowable about the companies whose shares are traded only if investors seek to earn superior returns, make conscientious and competent efforts to learn about the companies whose securities are traded, and analyze relevant information promptly and perceptively. If that effort were aban- doned the efficiency of the market would diminish rapidly.35 Although the empirical studies do not as convincingly demonstrate the efficiency of securities markets to com- pound all information (whether publicly available or unavail- able) into stock market prices, it is clear that fuller dis- closure of income tax information in annual reports should increase market efficiency by making publicly available what may not have been publicly available. For reporting purposes the question is often raised regarding how much information is necessary. If the ques- tion is asked "would you prefer more disclosure or less?" most people would say, "why more, of course!" Certainly, surveys made of financial analysts reveal their desire for more information.36 But then we ask, (or should ask), "more disclosure at what price?", for disclosure is not a free good. Like most goods, its production entails costs. Nevertheless, the value of information disclosed in financial statements may exceed its cost. This research study assumes that presentation of additional income tax information is of value for predictive purposes and that 22 the benefits exceed the costs. The immediate out-of-pocket costs of presenting additional Federal income tax informa- tion in annual reports to shareholders should be negligible since corporations are required to present the same infor- mation in 10-K reports to the SEC. Social Responsibility Accounting Bedford, in writing about the expansion of corporate financial disclosure to meet the public's right to know, states the following: Accounting theory seems to have increasingly assumed that the public does have a right to know much more than had previously seemed appropriate. There appears to be a close relationship between the increasing social and legal emphasis on the public right to know and the increasing emphasis of theoretical proposals for the expansion of accounting disclosures. As the social right to know becomes increasingly taken for granted, accounting-theory proposals seem to emphasize expanded disclosures even though the effect may not be in the immediate best interest of the company. Thus the rights of the public appear to be viewed as more important than the right of the company in several theoretical account- ing-disclosure proposals. From a social responsibility point of view, there are at least two reasons for requiring a corporation to more fully disclose those factors that affect its Federal income tax: (1) to provide the means of determining whether or not it is paying its "fair share" of Federal income taxes and (2) to prevent a corporation from implying that its Federal income tax is a greater percentage of its net income before taxes than is the true case. "Fair Share"--A1though the statutory corporate income tax rate is ”8 percent on taxable income in excess of $25,000, 23 the effective Federal income tax rate incurred by many cor- porations is considerably less. This difference arises because the computation of taxable income includes numerous provisions considered perfectly reasonable by some but con- sidered unreasonable tax expenditures or subsidies by others. Charles A. Vanik of the the United States House of Representatives noted that, ignoring accounting deferrals, the effective Federal corporate income tax rate for 1972 was 29 percent, a figure well below the statutory rate of 38 ”8 percent. On the basis of a study of l”5 companies selected from Fortune's list of large corporations39 and other data taken from public sources (such as reports to regulatory agencies and annual reports to shareholders), he argued that large corporations actually have been reducing their tax rates in recent years. Vanik showed that in the tax year 1972 there were 11 profitable corporations of 90 studied that paid no Federal income tax; in addition to three industrials that paid no tax, 1” of the remaining 58 industrials paid less than 10 percent.”0 These corporations apparently avoid Federal taxes through legal write-offs, investment tax credits, and loss carryovers from prior years. Vanik stated that small businesses do not have the ability to fully utilize the tax benefits available to large businesses. He further notes that the tax subsidy system of the Internal Revenue Code encourages the rich to get richer, the big to become bigger, and the small to lose out.ul It should be stressed 21+ that these corporations have done nothing illegal in lower- ing their effective tax rates; they have simply taken ad- vantage of the many provisions of the tax laws. Other commentators also claimed that individuals and corporations are not paying their "fair share" of Federal . ”2 1ncome taxes. In recent years, public attention has been focused on individuals and corporations that pay little or no Federal income taxes while earning substantial income. For example, Walter F. Mondale, a member of the tax-writing Senate Finance Committee, stated that it is long past time to enact reform to end this growing tax avoidance by the rich. Everyone, from the president on down, should pay their fair share in taxes. The average working American has already seen more than enough of this kind of artful tax- dodging. He is fed up--and rightly so--with a system that forces him to pay more so the rich can pay less. It is not the intent of this thesis to define what amount of taxes should be paid in order for a company to be paying its "fair share." But with fuller disclosure of income tax data by corporations in their published fin- ancial statements, society is better able to evaluate the equity by which income taxes are assessed and decide if there is a need for changes in the tax laws. Inadequate Disclosure of Taxes--Complex financial re- porting procedures used by corporations and especially con- glomerates have made it difficult to accurately estimate the actual Federal income tax paid or incurred for a particular year. The following quotation from Philip M. Stern's The ”3 25 Rape of the Taxpayer aptly notes this problem: At times, corporate chieftains have exhibited an acute tenderness to the charge that their companies pay less than their share of taxes. One such, whose response was astounding, if only for its gall, was Stewart 8. Cort, Board Chairman of the Bethlehem Steel Corporation. In September, 1972, Mr. Cort felt moved to have his company take out a full-page advertisement (tax-deductible, of course) in Forbes magazine. It featured a personal message from Chairman Cort which sought, in part, to rebut the contention, made in the 1972 Presidential campaign, that his company and other corporations "aren't . . . paying our 'fair share'" of taxes. How can that be, Mr. Cort wondered, when "our total tax expense was . . . $155 million in 1970"? An Odd phrase, "total tax expense." What did it mean? Close scrutiny of company reports discloses that his "tax expense" is made up of Social Security taxes, property taxes, and state and foreign taxes. The phrase omits any mention of Federal income tax-- perhaps because Bethlehem Steel paid none in either 1969 or 1970 (when it received refunds from Uncle Sam of $53 million and $1” million, respectively, despite before-tax profits of nearly $300 million in those two years). Yet Mr. Cort's tax-deductible message asks the reader to "think twice before swallowing all this balony about large corporations not carrying their fair share of the tax burden." All of this might have been less objectionable had it not been part of an ad headlined I SAY LET'S KEEP THE CAMPAIGN HONEST and urging the reader to beware of candidates' statements tflgt may be "faulty, ill-founded, or misleading." It is often impossible to determine the Federal income tax expense for the year from an examination of the annual report to shareholders because it may be combined with local, state, and foreign income taxes. Specifically, a recent survey of 136 corporate annual reports revealed that in the provision for income taxes, the Federal income tax was combined with other income taxes in 116 reports whereas ”6 it was disclosed separately in only 20 reports. This suggests that some corporations may be attempting to appear 26 to be incurring a higher Federal income tax rate than is actually the case. A corporation's income tax rate is often computed by dividing the tax figure in the income statement by "Before Tax Income." If the resulting percen- tage approaches ”8 percent, it may appear that the corporation is paying its "fair share." Annual report users may not understand that the income tax figure often includes state, local, and foreign income taxes as well as Federal income taxes. Added disclosure may be needed to inform rather than mislead. Because the Federal tax system is based on self— assessment and voluntary compliance, it is essential that the public be confident in its fairness and integrity. A major aim of this study is to determine if the extent of disclosure of income taxes in annual reports to share- holders is related to the Federal income tax rate incurred. Extent of adherence to relevant disclosure requirements of APB Opinions is used as a surrogate for the extent of Federal income tax disclosure in annual reports to share- holders. The reason for using this surrogate is that the disclosure requirements of APB Opinions repreSent the only disclosure requirements pertaining to the financial report- ing of income taxes in annual reports to shareholders; they are the only disclosures that can be tested empirically. Follow-up on Related Studies This study also represents a logical extension of pre- vious studies, as the following review of the literature 27 makes apparent. Independent Auditor Influence-~One of the generally accepted auditing standards is that "informative disclosures in the financial statements are to be regarded as reason- ably adequate unless otherwise stated in the [auditor's] report."u7 What this "reasonably adequate standard of in- formative disclosure" really represents is, for practical purposes,1£fi%:to the judgment of the independent auditor. Different auditors may have different interpretations of the disclosure requirements of APB Opinions. Accordingly, an independent auditor may influence the extent of disclosure in financial statements on which he reports; the degree of influence may differ from one auditor to another.’48 Several researchers have attempted to determine if relationships exist between particular independent auditing firms and particular reporting practices. The results of these studies are mixed. In a study of changes in the financial reporting of the investment credit by 300 companies between 1963 and 196”, Neumann found that the likelihood of a consistency qualification for an accounting change was pp: related to the particular auditing firm.”g However, as part of a study of firms receiving an auditor's consistency qualification during the 1959-68 period, Gosman concluded that sample companies audited by Price Waterhouse and Co. were more likely to receive a con- sistency qualification than sample companies audited by 28 other CPA firms; Coopers 8 Lybrand's (formerly Lybrand, Ross Bros., 8 Montgomery) clients were less likely to receive such qualifications.50 The study consisted of 100 firms randomly selected from those listed in the 1969 Fortune 500. Frishkoff51 used multiple discriminant analysis to test for relationships among the materiality of changes in accounting principles, the size of the auditing firm, and whether audit opinions were qualified or unqualified as to consistency in the application of accounting prin- ciples. The size of the auditing firm performing the audit was not found to be a significant discriminatory variable. Smith and Smith52 utilized communication theory as the basis for measuring the performance of communication of financial reporting. Two readability formulas were applied to financial statement notes of the first fifty of Fortune's list of 500 largest industrial corporations for 1969 to measure the adequacy of communication. They found that a relationship does pp: exist between the identity of ex- ternal auditors and the comprehension ease level of finan- cial statement notes. 53 found that a difference exists Singhvi and Desai in the quality of disclosure in financial statements of firms audited by large and small CPA firms. In their study, the "Big-8" were classified as large and the remaining CPA firms were small. The empirical work in their study was limited to shareholder annual reports of 100 listed and 55 29 unlisted corporations for fiscal years ending between April 1, 1965, and March 31, 1966. As a logical extension of these previous research ef- forts, the present study tests for a relationship between the independent auditor and both extent and adherence to APB Opinion income tax disclosure requirements and location of income tax expense in the income statement. Corporate Size Influence-—The Singhvi and Desai studysu also found a positive relationship between the asset size of a corporation and the quality of disclosure. They used an index of disclosure including 3” items. Breaking cor- porations into eight size classifications, they found that the quality of disclosure in annual reports of each succes- sive group was greater on average than the preceding smaller group. By holding the percentage change in income relatively constant, Frishkoff found that larger firms were less likely than smaller firms to receive qualified audit opinions for changes in accounting principles.55 However, Stringer took issue with Frishkoff, especially the 25 percent of income cut-off that Frishkoff employed to distinguish be— tween material and immaterial changes. Stringer held that the proper cut-off should be 5 percent and, using this cut- off, that Frishkoff's data do not provide significant evi- dence of discrimination between small and large companies. This study also tests for a relationship between cor- porate size and adherence to APB Opinion disclosure require— ments. 30 Congressman Vanik, in a 1972 study, stated: The average effective [cash paid] tax rate of all American corporations in 1969 was 37 percent. But the average tax rate for the top 100 industrial corporations was 26.9 percent. This means that the smaller corporations appear to be paying a rate above the average. It is my estimate that the smaller corporations--those under the top 100-- pay, on the average, a rate of ”” percent. This appears to be a reversal of the "ability to pay" principle on which the individual income tax is supposedly based. Do small businesses have the same ability to fully utilize the tax benefits available to large businesses? The Vanik study encompassed only the largest 100 industrial corporations. This study expands upon the Vanik study to test his contention that large corporations pay lower Federal income tax rates than small corporations. APPROACH AND ORGANIZATION OF THE STUDY This study is an effort to identify some of the char— acteristics of the financial reporting of income taxes in the hope that the knowledge of such characteristics may shed light on the motives behind such financial reporting practices. A plan for the remaining three chapters follows. Chapter II includes a statement of the hypotheses to be tested. The research methodology and the data collection techniques are described. Chapter III contains the raw data collected and reports the results of the hypotheses subject to statistical analysis. Finally, Chapter IV provides a summary of the findings as well as the conclusions and implications drawn therefrom. 31 The limitations of the present study and suggestions for further research are also discussed. 10. 32 FOOTNOTES The American Institute of Certified Public Accountants through its Accounting Principles Board issued 31 Opinions between November, 1962, and June, 1973, con- cerning various generally accepted accounting principles. The proposed Statement would require interperiod income tax allocation with respect to intangible drilling and development costs and some other costs associated with oil and gas properties. Financial Accounting Standards Board, "Accounting for Income Taxes--Oil and Gas Producing Companies" (Stamford, Connecticut: April 1975). John C. Burton, Chief Accountant for the SEC, stated the following regarding the SEC's role in accounting: 'Tlthink that we now have an active role in the broad reporting areas of disclosure and financial reporting and it comes into accounting in a number of respects, but I see no reason to think that the SEC is going to become the center of accounting principles in the fore- seeable futureJ' "An Interview with John C. Burton," Management Accounting (May 1975). p. 22. The AICPA's first Standard of Reporting states: "The report shall state whether the financial statements are presented in accordance with generally accepted principles of accounting." American Institute of Certi- fied Public Accountants, AuditingpStandards and Pro- cedures (New York: AICPA, 1963), p. 16. American Institute of Certified Public Accountants, Accounting Principles Board, Opinion No. 2, "Accounting for the 'Investment Credit'" (New York: AICPA, 1962). APB Opinion No. 2, paragraph 13. Securities and Exchange Commission, Accounting Series Release No. 96, "Accounting for the TInvestment Credit'" (January 10, 1963). American Institute of Certified Public Accountants, Accounting Principles Board, Opinion No. ” (Amending No. 2), "Accounting for the 'Investment Credit'" (New York: AICPA, 196”), paragraph 9. APB Opinion No. ”, paragraph 11. American Institute of Certified Public Accountants, Accounting Principles Board, Opinion No. 11, "Accounting ll. 12. 13. 1”. 15. 16. 17. 18. 19. 20. 21. 22. 23. 33 for Income Taxes" (New York: AICPA, 1967). 1212', paragraph 3”. 1219', paragraph 60. 1219', paragraph 63a. £219., paragraph ”5. (Italics in original.) 1219'; paragraph 63b. Ibid., paragraph 63c. Ibid. Ibid., paragraph 57. American Institute of Certified Public Accountants, Accounting Principles Board, Opinion No. 23, "Accounting for Income Taxes--Special Areas" (New York: AICPA, 1972), paragraphs 9 and 1”; Accounting Principles Board, Opinion No. 2”, "Accounting for Income Taxes--Invest- ments in Common Stocks Accounted for by the Equity Method (Other than Subsidiaries and Corporate Joint Ventures)" (New York: AICPA, 1972), paragraph 7. Sbcuritiesand Exchange Commission, Regulation S-X, Rule 5-03(15). See Hugo Nurnberg, Cash Movements Analysis of the Account- ing for Corporate Income’Taxes (East’Lansing, Michigan: Division of Research, Graduate School of Business Admin- istration, Michigan State University, 1971), pp. 8-1”. "An Interview with John C. Burton," p. 21. "We think by giving them better data we can encourage them in the direction of doing a better job, thus leading, we hope, to more efficient capital markets." Since the time (July 1, 1972 and June 30, 1973) encom- passed by this study, there have been several changes in the Internal Revenue Code: The present $25,000 exemption from the corporate surtax has been increased to $50,000. Further, the tax rate on the first $25,000 of taxable income was cut to 20%, while the rate for the second $25,000 remains at 22%, the same rate previously applied to corporate taxable income not subject to the corporate surtax. For corpor— ations with at least $50,000 in taxable income, the 2”. 25. 26. 27. 28. 29. 30. 31. 3” savings will come to $7,000 over the old rates. The increase in the surtax exemption applies only to 1975; after that, the rates revert to the rates discussed. The percentage depletion deduction for oil and gas wells for most large firms has been eliminated but the new law permits a so-called small producer exception that permits many oil and gas producers to continue to claim percentage depletion although at a lesser rate than was previously available. The 22% rate begins to drop gradually after 1980 to 15%. The investment credit has been temporarily increased to 10% on property placed in service during the period starting January 22, 1975 and ending December 31, 1976. An additional 1% credit is available for certain employee stock ownership plans. The provisions of the Code that are discussed in the text are the provisions pertaining over the period encompassed by this study. See Sec. 156”(a) for details. Reg. 156”-l. American Institute of Certified Public Accountants, Accounting Principles Board, Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of disposal of a segment of a business, and extraordinary, unusual and infrequently occurring events and trans- actions" (New York: AICPA, 1973). APB Opinion No. 9 recommends that material extraordinary items "be segregated from the results of ordinary op- erations and shown separately in the income statement...‘ (page 113). The extraordinary items would be reported net—of-tax. See American Institute of Certified Public Accountants, Accounting Principles Board, Opinion No. 9, "Reporting the Results of Operations" (New York: AICPA, 1966). See Sec. 156”(b) for details. The investment credit was suspended from October 10, 1966 to March 9, 1967. It was terminated from April 19, 1969 until March 31, 1971. See Footnote 2 above. Stxthroup on the Objectives of Financial Statements, 32. 33. 3”. 35. 36. 37. 38. 39. ”0. ”1. ”2. ”3. u”. 35 Objectives of Financial Statements (New York: AICPA, 1973), p. 62. Robert Mundheim, "Forward, Symposium on Securities Regulation," Law and Contemporary Problems (Summer 196”), p. 6”8. APB Opinion No. 11, paragraph 63c. Eugene E. Comiskey and James R. Hasselback, "Analyzing the Profit-Tax Relationship," Financial Management (Winter 1973), pp. 57-62. James H. Lorie and Mary T. Hamilton, The Stock Market: Theories and Evidence (Homewood, Illinois: RiChard D. Irwin, Inc., 1973), p. 98. R. K. Mautz, Financial Reporting by Diversified Companies (New York: Financial Executives Research Foundation, 1968), p. 12”. Norton Bedford, Extensions in Accounting Disclosure (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1973), p. 1”5. "House Democrat Says 11 Big Firms Avoided Paying Any Federal Income Tax Last Year," The Wall Street Journal (August 2, 1973), p. 5. These include the top 100 industrial corporations; 20 airlines, railroad, and trucking corporations; 10 tele- phone, electric power, and gas transmission corporations; the six largest retailing corporations; and the nine largest commercial banks. The Wall Street Journal (August 2, 1973), p. 5} Charles A. Vanik, "Corporate Federal Tax Payments and Federal Subsidies to Corporations," Congressional Record- House (1972), p. H6709. Philip M. Stern, The Rape of the Taxpayer (New York: Random House, 1973), pp. 209-210; Charles A. Vanik, "Corporate Federal Tax Payments and Federal Subsidies to Corporations for 1972," Congressional Record-House (August 1, 1973), p. H7180. Joseph A. Pechman, "Distribution of Federal and State Income Taxes by Income Classes," The Journal of Finance (May 1972), p. 180. "”02 Americans Earning $100,000 Charged With Artful ”5. ”6. ”7. ”8. ”9. 50. 51. 52. 53. 5”. 55. 56. 57. 36 Tax-Dodging," LansinggState Journal (March 1”, 1973), p. F-2. Stern, pp. 209-210. Accounting Trends 8 Techniques, 26th Edition (New York: AICPA, 1972). American Institute of Certified Public Accountants, Auditing Standards and Procedures (New York: AICPA, 1963), p. 16. See John L. Carey, The CPA Plans for the Future (New York: AICPA, 1965), pp. 128-133. Frederick L. Neumann, "The Auditing Standard of Con- sistency," Empirical Research in Accounting: Selected Studies 1968, pp. 8-16. Martin L. Gosman, "Characteristics of Firms Making Accounting Changes," The Accopnting Review (January 1973), pp. 1-11. Paul Frishkoff, "An Empirical Investigation of the Concept of Materiality in Accounting," Empirical Re- search in Accounting; Selected Studies 1970, p. 128. James E. Smith and Nora P. Smith, "Readability: A Measure of the Performance of the Communication Function of Financial Reporting," The Accounting Review (July 1971), p. 560. Surendra S. Singhvi and Harsha B. Desai, "An Empirical Analysis of the Quality of Corporate Financial Disclo- sure," The Accounting Review (January 1971), p. 129- 138. Singhvi and Desai. Frishkoff. Kenneth W. Stringer, "Discussion of an Empirical In- vestigation of the Concept of Materiality in Account- ing," Empirical Research in Accounting: Selected Studies 1970, p. 133-137. Vanik (1972), p. H6707 (emphasis added). CHAPTER II RESEARCH QUESTIONS, DESCRIPTION OF THE RESEARCH DESIGN, AND APPLICATION SELECTION OF THE SAMPLE The data for this study are gathered from a random sample of 300 corporations listed on the New York and Amer- ican Stock Exchanges. Because of the difference in the num- ber of corporations listed on each exchange, the sample of 300 consists of 167 New York Stock Exchange and 133 American Stock Exchange listed corporations (from among 1,52” NYSE and 1,215 AMEX listed corporations). The sample, therefore, is of corporations that investors are quite interested in-- publicly held corporations whose shares are traded on the two largest stock exchanges in the United States. Rather than one overall simple random sample, a pro- portional stratified random sample is used in the study. As discussed on the next page, some corporations are eli- minated in the selection process. It was expected that more AMEX corporations would be eliminated than NYSE corporations. Therefore, stratification is used to insure that AMEX cor— porations are represented in the final sample of 300 cor- porations. 37 38 Each corporation on each exchange is assigned a number and the selection of corporations from each exchange is made through the use of a random number table. During the se- lecthn1process, a company is eliminated if it incurred a loss for the year of study or is either a real estate investment trust (REIT), a foreign corporation, or an investment trust. The latter corporations are eliminated because they would pay little or no Federal income taxes because of their tax status. Corporations with losses are eliminated because of the problem of computing meaningful tax rates. The random selection continues until the requisite 300 corporations are obtained. A total of 26 NYSE listed corporations and ”2 AMEX listed corporations are eliminated in this way. Appendix I indicates the 300 corporations finally se- lected for the sample; Appendix II indicates those corpor- ations eliminated and the reasons for the elimination. REASONS FOR SELECTION A substantial portion of these 300 corporations are quite large. Accordingly, assuming that Stempf's assertion that "what is good accounting practice for the large [cor- poration] sets a standard for all"1 is valid, this study should reveal the standards which have been established for reporting corporate income taxes. Similarly, since most of the large certified public accounting firms are represented in this sample, this re- search should disclose any auditor effect on the financial 39 reporting of income taxes by the most prominent section of the public accounting profession. Finally, the published annual reports and lO-K reports of these corporations are readily available. DATA SOURCE For each corporation, extent of adherence to APB Opinion disclosure requirements is determined by examining the annual report to shareholders for the fiscal year ending between July 1, 1972 and June 30, 1973, the year of study. This study is limited to the annual report for one year because of the near-impossibility of obtaining adequate Federal income tax data before July 1, 1972. The SEC explicitly requires disclosure in 10-K reports for years ending after June 30, 1972 of both the current and deferred Federal income tax figures;2 thus lO-K reports can be used to test for extent of adherence to APB Opinions in annual reports to shareholders only for fiscal years ending after July 1, 1972. Most of the Federal income tax information is gathered from the lO-K report for the year of study. However, the following year's annual report to shareholders or lO-K report is also utilized if tax information for the year of study is presented therein. A questionnaire is mailed to each corporation that does not disclose the necessary informa- thn1in either its annual reports to shareholders or lO-K reports for either the year of study or the follow-up year. The following data are taken from the financial ”O statements and footnotes thereto: 1. location of income tax expense in the income statement 2. amount of income taxes--both current and deferred-- in the annual report 3. amount of Federal income taxes-—both current and deferred--in the lO-K report ”. disclosure of income tax effect of extraordinary items 5. amount of tax loss carryforward with expiration dates 6. method of accounting for and amounts of investment credit (included in income, deferred in the accounts, and any carryforward) 7. amount of net income after income taxes 8. net amount of extraordinary items 9. total assets 10. net sales or revenues 11. independent auditor TAX RATE INFLUENCE Research Problem The major goal of this portion of the study is to de- termine if a relationship exists between corporate Federal income tax rates and adherence to APB Opinion income tax disclosure requirements or location of income tax expense in the incOme statement. The statutory Federal income tax rate for the year of study is 22 percent on the first $25,000 of taxable income and ”8 percent on any excess over $25,000. However, the effective rates incurred by corporations may differ signif- icantly from ”8 percent because of the various provisions of the tax law discussed in Chapter I and various financial reporting practices discussed below. Corporate income tax rates may be measured by users in different ways and this study selects two measures of the effective Federal income ”1 tax rate for use in the analysis. The rationale underlying this part of the study is the hypothesis that corporations with low Federal income tax rates are attempting to obscure this fact; indeed, that they are attempting to create the impression that a greater percentage of their income is paid as Federal income taxes than is actually the case. For example, by not disclosing the tax effects of extraordinary items, although such dis- closures are required by APB Opinion No. 11, it is impossible to compute an effective income tax rate for the corporation. In some instances, the rate incurred on extraordinary items may be significantly lower than the rates incurred on income before extraordinary items because of lower capital gains rates or other tax-reducing provisions. These lower rates would have the effect of reducing the overall tax rate; by not reporting the tax on extraordinary items, these lower rates cannot be as readily determined. As pointed out in Chapter I, this portion of the re- search is justified because income tax disclosures are im- portant for predictive purposes and because of the claims of an increasing number of commentators that many corpor- ations are not paying their "fair share."3 Methodology The accounting followed in income tax returns may differ in material respects from the accounting employed in the preparation of financial statements included in annual re- ports to shareholders and lO—K reports to the SEC. For ”2 example, companies may use the sum—of-the-year's-digits depreciation method in their income tax returns even though they use the straight-line depreciation method in their financial statements. Comprehensive income tax allocation for these resulting timing differences is required under generally accepted accounting principles.u Comprehensive income tax allocation is based on the theory that income tax expense should be recognized in the published financial statements in the period in which the taxable revenue or tax deductible ex- pense is included in pre-tax income; if there is a timing difference in the recognition of the revenue or expense for tax and financial accounting purposes, its tax effect should be deferred until the timing difference reverses. The de- ferral of the tax effect is accomplished by reporting an adjustment to income tax expense in the income statement together with a deferred tax debit or credit in the balance sheet. Because a Federal income tax rate based on the income tax expense reported in the income statement (the normalized rate) may differ from a rate based on the actual tax paid to the government (the flow-through rate), both rates are computed. The use of the two methods of computing Federal income tax rates facilitates a comparison of the methods and raises questions as to why any differences in results may exist. By measuring the tax rate both ways, any problem of ”3 definition is highlighted. A researcher may be accused of using the incorrect measure of the Federal income tax rate when one or the other measure is used. By performing the statistical tests using both methods to compute rates, this problem is avoided. For each corporation, the computation of its Federal income tax rate is calculated by dividing its total Federal income taxes by its total net income before Federal income taxes. The numerator used in computing the normalized Fed- eral income tax rate is total Federal income taxes pertaining to net income before extraordinary items, extraordinary items, and prior period adjustments; the denominator is the sumcfi net income after taxes, extraordinary items net of taxes, prior period adjustments net of taxes, and total Federal income taxes computed for the numerator. The nu- merator used in computing the flow-through tax rate is the current Federal taxes pertaining to net income before extra- ordinary items, extraordinary items, and prior period ad- justments; the denominator is the denominator derived above for the normalized rate. A possible bias may arise in com- puting the flow-through rate. Specifically, if a corpor- ation does not show a current and deferred breakdown of the tax effect of an extraordinary item, it is assumed that the entire amount is current. The amount of this tax in relation to the total tax and the validity of this assumption com- prise the potential bias. For those corporations that fail to break down income ”u into the Federal, state, local, and foreign components in the annual report to shareholders or lO-K report for the year of study, an estimate is made of the Federal income taxes alone whenever the annual report to shareholders or 10-K report for the following year shows such a breakdown; the proportion of total income taxes that are Federal income taxes for the year of study is assumed to be equal to the preportion in the following year. A questionnaire is sent to those companies where reasonable estimates cannot be made. (Appendix III illustrates the procedures used to compute Federal income tax rates; Appendix IV contains the questionnaire.) Corporations for which the Federal income tax rate cannot be determined from the available data (annual reports, lO—K reports) or the questionnaire are classified as inde- terminate. The remaining corporations are ranked by their Federal income tax rates in descending order; the first half of these corporations are classified as high income tax rate corporations and the other half are classified as low income tax rate corporations. CORPORATE SIZE INFLUENCE Research Problem The major goal here is to determine if a relationship exists between corporate size and adherence to APB Opinion income tax disclosure requirements or location of income tax expense in the income statement. ”5 A positive relationship between the size of a corpor- ation and the quality of disclosure might exist for several reasons. Perhaps small corporations are more fearful than large corporations that full disclosure would endanger their competitive positions. Or perhaps large corporations are more in the public eye and therefore more subject to share- holders' and analysts' pressure for fuller disclosure than small corporations. Alternatively, perhaps large corpor- ations disclose more information than small corporations in order to minimize pressure from anti-trust regulatory agencies. Finally, perhaps large corporations disclose more information than small corporations because they are more conscious of their social responsibility. Methodology The same random sample of 300 corporations is used. The 300 corporations are ranked in descending order by size, using total assets for a first ranking and total net revenues for a second ranking. The top 150 corporations are clas- sified as large corporations and the bottom 150 are clas- sified as small corporations. INDEPENDENT AUDITOR Research Problem The major goal is to determine the relationship between the independent auditor and adherence to APB Opinion income tax disclosure requirements or location of income tax expense in the income statement. ”6 Methodology The same random sample of 300 corporations is used, divided into nine groups by auditors--eight groups for cor- porations audited by each of the "Big-8" accounting firms and a ninth group for corporations audited by all other accounting firms. STATISTICAL TESTS The statistical test appliedis a three-factor analysis of variance. As the name implies, the analysis-of-variance procedure attempts to analyze the variation in a dependent variable and assign portions of this variation to each of a set of independent variables. The reasoning is that de- pendent variables vary only because of variation in a set of unknown independent variables. The objective of the analysis of variance is to locate important independent variables in a study and to determine how they interact and affect the dependent variables. The three factors are corporate Federal income tax rate, corporate size, and corporate independent auditor. Factor A, corporate Federal income tax rate, has two levels representing high and low Federal income tax rate corpor- ations.‘ Factor B, corporate size, has two levels represent- ing large and small corporations. Factor C, independent auditor, has nine levels representing each of the "Big-8" accounting firms and a ninth level for accounting firms other than the "Big-8." The dependent variables are ”7 classificatory--adherence, nonadherence, and indeterminacy to APB Opinion disclosure requirements, and the location of income tax expense in the income statement, as discussed more fully in Chapter I. In addition to being interested solely in the effect one variable (independent) has on another variable (depend- ent), investigators frequently ask whether this effect is the same for all levels of a second, independent variable. If this effect is not the same, an interaction between the two independent variables is said to exist. Because of the possibility of accepting relationships that may be caused by other factors, the interrelationships of the three main factors--Federal income tax rate, corporate size, and in- dependent auditor--are also tested. In this analysis one must consider: Three main effects Federal income tax rate Corporate size Independent auditor Three two-factor interactions Federal income tax rate x Corporate size Federal income tax rate x Independent auditor Corporate size x Independent auditor One three-factor interaction Federal income tax rate x Corporate size x Independent auditor Twenty 36-cell tables, similar to the one on the follow- ing page, are used to compile the data on the five dependent variables. That is, with the Federal income tax rate mea— sured two ways (flow-through and normalized) and corporate size measured two ways (sales and assets), each of the five ”8 dependent variables requires four tables, or a total of twenty tables. THREE-WAY ANALYSIS OF VARIANCE Corporate Size Large Small Federal Income Tax Rate High Low High Low Independent Auditor AA AY CL EE HS PM PW TR Other The information contained in each of the 36 cells with respect to each of the four disclosure requirement variables consists of the number of corporations in that cell that (l) adhere to the disclosure requirement, (2) do not adhere to the disclosure requirement, and (3) for which adherence or nonadherence to the requirement cannot be determined. The information in each cell for the income tax location variable consists of the number of corporations that report income tax expense separately and the number of corporations that include it among operating expenses. The cell information is then computed as frequencies and a logit transformation used in order to perform the three-way analysis of variance. From the viewpoint of theory, ”9 the analysis of proportions presents more difficulties than the analysis of normally distributed continuous variables. Few exact results are available. The logit transformation is one of the approximate methods used in practice. If the proportions in the cells cover a wide range from close to zero up to 50 percent or beyond, it is reasonable to expect that row and column effects are more likely to be additive on a logit scale than on the original proportion scale. In the scale of proportions, row and column effects cannot be strictly additive over the whole range. The logit trans— formation pulls out the scale near 1 and 100%, so that the scale extends from -00 to +§ . In the logit analysis row and column effects may be additive, whereas in the proportion scale for the same data, there might be interactions that are entirely a consequence of the scale.5 The hypotheses to be tested include: HO : there is no difference in adherence to APB Opinion 1 income tax disclosure requirements among auditors H : there is a difference in adherence to APB Opinion 1 income tax disclosure requirements among auditors H : uAA = uAY = uCL = u = u = u = u EE HS PM PW = uTR = u0 H : H0 is not true 1 1 The proportions of the nine rows are relevant to this ques- tion. Stated differently, the null hypothesis becomes: The row proportions do not differ. H : there is no difference in adherence to APB Opinion 0 . . . 2 income tax disclosure requ1rements among large and small corporations 50 H : there is a difference in adherence to APB Opinion a2 income tax disclosure requirements among large and small corporations The proportions of the two columns bear upon this question and the null hypothesis can be stated: The column propor- tions do not differ. HO : there is no difference in adherence to APB Opinion 3 income tax disclosure requirements among high and low Federal income tax rate corporations H : there is a difference in adherence to APB Opinion income tax disclosure requirements among high and low Federal income tax rate corporations H : u = u H : u i u 3 H L a3 H L The proportions of the two arrays relate to this question. Alternatively, the null hypothesis can be stated: The pro- portions of the arrays do not differ. H : there are no interaction effects among the three ” main factors (Federal income tax rate, corporate size, and independent auditor) H : there is an interaction effect among the three ” main factors 51 ~ FOOTNOTES Victor H. Stempf, "Trends in Accounting Procedure," The Journal of Accountancy (June l9”0), p. ”5”. "SEC Adoption of Amendments to Regulation S-X," Fed- eral Securities Law Reports, Number ”29 (June 26, 1972), p. l”. Philip M. Stern, The Rape of the Taxpayer (New York: Random House, 1973), pp. 209-210; Charles A. Vanik, "Corporate Federal Tax Payments and Federal Subsidies to Corporations for 1972," Congressional Record-House (August 1, 1973), p. H7180. American Institute of Certified Public Accountants, Accounting Principles Board, Opinion No. 11, "Accounting for Income Taxes" (New York: AICPA, 1967), paragraph 3”. George W. Snedecor and William G. Cochran, Statistical Methods (6th edition; Ames, Iowa: Iowa State University Press, 1967), p. ”9”. CHAPTER III RESULTS OF THE STUDY DATA GATHERING PROCEDURE After the sample of 300 corporations was selected, the annual report of each corporation for the year of study was analyzed to determine corporate revenues, corporate assets, independent auditor, flow-through and normalized Federal income tax rates, adherence or nonadherence to each of the four APB Opinion disclosure requirements, and the placement of income tax expense in the income statement. Where any of the preceding information was missing, the following year's annual report and the two years' lO-Ks were also analyzed. Questionnaires were sent to the 88 corporations that did not disclose this information in any of these sources. Fifty-seven corporations provided the information requested in the questionnaire or a follow-up letter, for a response rate of 65 percent. Fifty-six corporations were queried on current-deferred Federal income tax information, ”8 on the investment credit, eight on extraordinary items, and five on loss carryforwards;' several corporations were queried on more than one item. 52 53 FLOW—THROUGH FEDERAL INCOME TAX RATE COMPUTATION The flow-through Federal income tax rate for each cor- poration was determined in the manner discussed in Chapter II. Because of the lack of complete information, the flow- through Federal income tax rate of 25 corporations could not be determined precisely. A flow-through tax rate figure was available for most of these 25 corporations, but it included taxes other than just Federal income taxes. Nine of the 25 corporations were classified as low flow-through Federal income tax rate corporations; each of these corporations had a flow-through rate of less than 27.3 per- cent, even when the rate included other than Federal income taxes. (It was assumed that these nine corporations did not have combinations of positive Federal income taxes and negative other income taxes for the same year.) Sixteen corporations could not be classified into either the high or low tax rate groups and were deleted. The remaining 28” corporations were then classified into two equal groups representing the two levels of flow— through Federal income tax rates. The l”2 corporations above 31.5 percent were classified as high flow-through Federal income tax rate corporations and the l”2 below 31.5 percent were classified as low flow-through Federal income tax rate corporations. 5” NORMALIZED FEDERAL INCOME TAX RATE COMPUTATION The normalized Federal income tax rate for each cor- poration was determined in the manner discussed in Chapter II. For 15 of the 300 corporations a normalized Federal income tax rate could not be determined precisely because of a lack of complete information. An income tax rate could be computed for each of these 15 corporations, but it in- cluded local, state, or foreign income taxes. Seven of the 15 corporations were classified as low normalized Federal income tax rate corporations; each of these corpor- ations had a normalized rate of less than 39.3 percent even when the rate included other than Federal income taxes. (It was assumed that these seven corporations did not have combinations of positive Federal income taxes and negative other income taxes for the same year.) Eight corporations could not be classified into the high and low tax rate groups and were deleted. The remaining 292 corporations were then classified into two equal groups representing the two levels of nor- malized Federal income tax rates. The 1”6 corporations above ”0.2 percent were classified as high normalized Fed- eral income tax rate corporations and the 1”6 below ”0.2 percent were classified as low normalized Federal income tax rate corporations. 55 CLASSIFYING CORPORATIONS BY SIZE ACCORDING TO REVENUES The ranking of the 300 corporations by reported rev- enues resulted in a range from $20,19”,000,000 to $1,073,000, with a median of $99,000,000. The 150 corporations above the median were classified as large corporations and the 150 below it were classified as small corporations. Net revenues was used as the basis of classification; this amount generally represents what is considered in the particular instance to be gross revenues less returns, allow- ances, and trade discounts. For this classification, it is assumed that all 300 corporations report revenues on a comparable basis, notwithstanding well-known variations in practice.1 CLASSIFYING CORPORATIONS BY SIZE ACCORDING TO ASSETS A ranking of the corporations by total assets resulted in a range from $51,171,600,000 to $1”9,000, with a median of $86,500,000. The 150 corporations above the median were classified as large corporations and the 150 below it were classified as small corporations. CLASSIFYING CORPORATIONS BY AUDITOR The random sample of 300 corporations taken from the New York and American Stock Exchanges revealed the following classification by auditor: 56 Arthur Andersen ”9 Arthur Young 27 Coopers 8 Lybrand 26 Ernst E Ernst 23 Haskins 8 Sells 31 Peat Marwick ”1 Price Waterhouse 37 Touche Ross 28 Others _38 300 The above breakdown of the 300 sampled corporations may not be in the same proportion as the population of all cor- porations listed on the NYSE and AMEX. Certain auditing firms may audit particular classes of corporations that are not included in the sample, such as real estate invest- ment trusts. This classification was then used in the analysis in- volving the nine-way classification by auditor. ANOVA PROCEDURE Tables 3-1 through 3-20 give the frequency counts for the twenty three-way classifications. In Tables 3-1 through 3-16, each cell lists the frequencies of adherence, nonad- herence, and indeterminacy, in that order. In Tables 3-9 through 3-16, the number of corporations for which the dis- closure requirement is not applicable is given in the right- hand corner of each cell. Tables 3-17 through 3-20 pertain to the dependent variable location of income tax expense in the income statement. The first number listed in each cell is the frequency of corporations that report income tax expense as a separate deduction from net income and the second number is the frequency of corporations that 57 include income tax expense among operating expenses. An analysis of variance procedure was applied to the binary data resulting after deleting the indeterminates. A logit transformation was first performed. The logit for each cell was calculated as follows: Y = ln((A + .5)/(N + .5)) where 1n denotes the log to base e, A denotes the frequency of adherence (or frequency of tax expense reported separately in the case of the location variable), and N denotes the frequency of nonadherence (or frequency of tax expense in- cluded among operating expenses in the case of the location variable).2 An estimate of the variance of Y is provided by 5‘2 = (A+N+l)/[(A+.5)(N+.5)]. A weighted least squares analysis of variance with cell weights $31 was performed on each of the Y variables for Tables 3—1 through 3-8 and 3-17 through 3-20; the results are reported in corresponding Tables 3-1a through 3-8a and 3-l7a through 3-20a. The an- alysis of variance was not performed for Tables 3-9 through 3-16. Inspection of the cell frequencies in these tables reveals that the disclosure requirements were applicable to few corporations, that nonadherence was minimal for those to which it did apply, and that an analysis of variance would therefore reveal no significant sources of variation. The three-way analysis of variance for each of the indicated tables was computed using the Statistical Analysis System (SAS) package program designed and implemented by Barr and Goodnight,3 and on file at the Northeast Regional 58 Data Center of the University of Florida. For each dependent variable, an analysis of variance table is produced. Listed as sources of variation are all the effects specified in the governing model, any relevant pooled effects, a RESIDUAL term (if appropriate), and the corrected total. Degrees of freedom, sum of squares, and mean squares are tabulated. The RESIDUAL sum of squares is the CORRECTED TOTAL sum of squares less all the sums of squares computed for effects. The variations attributed to each source and degrees of freedom are given in the ANOVA tables. The levels of significance were determined in regard to Chi-Square dis- tributions, the large sample null distributions. The Chi- Square distribution was used because each cell was converted into a proportion. This conversion results in a single observation for each cell and thus a replication factor necessary for the F statistic is lacking. Because the sample sizes are not very large, these levels should not be inter- preted as exact measures of significance. In the analysis of adherence to each of the APB Opinion disclosure requirements studied, any indeterminate responses were deleted from the analysis and the remaining yes-no dichotomy analyzed by the three factors. Such deletion assumes that the true state of indeterminate firms (either adhering or not adhering) is in the same proportion as de- terminate firms. Deletion of these indeterminate responses is necessitated because of the lack of data, but may result 59 in a confounding error. Unfortunately, no other procedure seems reasonable, since the ANOVA tests are designed to test for significant differences in cell proportions and are unconcerned with the population proportions per se. More- over, the ANOVA procedure is unable to handle a three-way response for each cell, so the indeterminate responses. cannot be analyzed separately. INVESTMENT CREDIT DISCLOSURE REQUIREMENT ANALYSIS The first disclosurerequirement investigated concerned the investment credit. As discussed in Chapter I, corpor- ations are required to disclose the amount and method of accounting for investment credits, when material. Among the 300 corporations, it was found at the outset that 213 corporations provided information concerning the investment credit in their annual report for the year of study. Of the remaining 87 corporations, further analysis determined that ”9 corporations either had no investment credit to report or an amount determined to be insignificant; 18 corporations were found to have an investment credit exceeding five percent of their normalized Federal income tax and thus in violation of the investment credit disclosure requirement. No determination could be made for the remain- ing 20 corporations. One corporation did disclose the dollar amount of the investment credit but was classified as a nonadherer because it did not disclose the method used to account for the 60 investment credit. The raw data for the investment credit disclosure re- quirement are presented in Tables 3-1 through 3-”; the num- bers in the cells represent, from top to bottom, adherers, nonadherers, and indeterminates. The SAS ANOVA computer program was then applied to the logit transformation of the data presented in Tables 3-1 through 3-”, after deleting the 20 indeterminate corporations. Two hundred seventy corporations remained in the analysis using the flow-through Federal income tax rate, since six of the indeterminate investment credit corporations were also indeterminate flow-through Federal income tax rate corporations (300-16-20+6=270). Using the normalized Federal income tax rate, 27” corporations remained after eliminating the 20 indeterminate investment credit corporations. Two of the indeterminate normalized Federal income tax rate corporations were also indeterminate investment credit cor- porations (300-8-20+2=27”). Tables 3-1a through 3—”a present the results of the ANOVA analysis, indicating the dependent variable, the Chi- Square result, and the level of significance for each main effect and interaction. Level of significance is indicated only when it is less than .”. An analysis of the results from the ANOVA reveals no relationship between any of the three main effects (corpor- ate size, corporate tax rate, and independent auditor) and adherence or nonadherence to the APB Opinion investment credit Table 3-1 61 ANALYSIS OF INVESTMENT CREDIT DISCLOSURE REQUIREMENT Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor Corporate Size Federal Income Tax Rate La* 2e Sm 11 High High Low .TQtals Independent Auditor AA . H H F'r N00 2 too AY CL l—' EE ...! HS PM (DODCDOI—‘HOHOOl-‘CDH H [...-I PW H TR #aocohusauacam1Ak4mcmoxroc3u>o+4;n:h4m Other N:ocauJOCDUHDOJOIdkdxuacn4FJocnc>own ...—l Total HNN OOO')i—‘OCDOOQOOO’OOU‘IOOCDOOO’OOLOON CD Q MmN OOCDOOUlHH-tow 'q boom: 0+4 .C' mcpa>h4c3m 252 18 1” Lar e Size 13” 10 Sma 1 118 Tax Rate Hi h 132 7 3 Low 120 11 ll 62 TABLE 3-1a ANOVA RESULTS OF INVESTMENT CREDIT ANALYSIS Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT FREEDOM SIGNIFICANCE Main Effects Size .0090 l -- Tax Rate .5927 1 —— Auditor 3.”357 8 -- 2-Way Interactions Size x Tax Rate .3779 l -- Size x Auditor 3.3870 8 -- Tax Rate x Auditor 2.5937 8 -- 3-Way Interaction Size x Tax Rate x 1.6””9 8 -- Auditor Table 3-2 63 ANALYSIS OF INVESTMENT CREDIT DISCLOSURE REQUIREMENT Size by Assets, Flow-Through Federal Income Tax Rate, Auditor Corporate Size La‘ 28 Sm 11 Federal Income Tax Rate High Low H. i—J F0 :3” Low Totals H [—1 Independent Auditor AA 1*" C) 35 5 5 AY 2” 2 0 CL [—1 2” 1 1 EE LocafilACerDCDUIocam 22 1 0 HS H 26 2 2 PM H ...: HIJFJQ 35 5 0 PW MOMOOOOOOHOI—JOOl—‘ml—‘N I-l 32 1 2 TR fiOOCDOCO 23 0 .3 Othe H H 31 1 l 01 OM; OOMOO-C'OOCDOOU'IOOU‘IOOOOOUWOOLOON Total \l U‘I\]£D HOWNOO’I—‘H \) (D OHU‘IHO pcn 4: EDI-'l-J OOOOONI—‘OU‘IOOOOHH-POH-roowOHM-FHCD 252 18 l” Size Lar e 133 Small 119 Tax Rate High 132 7 ‘ 3 Low 120 11 ll 6” TABLE 3—2a ANOVA RESULTS OF INVESTMENT CREDIT ANALYSIS Size by Assets, Flow-Through Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT FREEDOM SIGNIFICANCE Main Effects Size .3399 l -- Tax Rate .8360 1 -- Auditor 3.0763 8 -- 2-Way Interactions Size x Tax Rate .1351 1 -- Size x Auditor 3.2H07 8 -- Tax Rate x Auditor 2.6167 8 -- 3-Way Interaction Size x Tax Rate x 1.1125 8 -- Auditor Table 3-3 ANALYSIS OF INVESTMENT CREDIT DISCLOSURE REQUIREMENT Size by Revenue, Normalized Federal Income Tax Rate, Auditor Corporate Size Federal Income Tax Rate 2e Sm ll High Low High t" O 2 Totals Independent Auditor AA hoFJm AY ...: 00 LN» 10 36 5 6 2H 2 l CL H 2n 1 1 EB 22 l 0 HS 27 2 l PM MOOLOOI—‘MOI—‘OOOCD H 35 5 l PW H H 33 1 2 TR H 23 0 u Other H 32 l 2 Total (JON; OOCDP—‘O-C'OOOOOFOOFOOU'IOOCDOl—‘Q (fl CI) mono OO-F-‘OOQI—‘i—‘MON at (00001 MOO)HOOl—‘OQHI—‘QI—‘MQOOCOI—‘OUTl-‘OWl—‘O .L' 4701\1 Ol—‘CDNONOOSONQOOQOOWOOWOHle—‘(fl 256 18 18 Size Lar e 13” 10 Small 122 13 Tax Rate N High Low 129 5 l2 127 13 6 66 TABLE 3-3a ANOVA RESULTS OF INVESTMENT CREDIT ANALYSIS Size by Revenue, Normalized Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT - FREEDOM SIGNIFICANCE Main Effects Size .0453 l -- Tax Rate 1.2230 1 .270 Auditor 2.628u 8 -- 2-Way Interactions Size x Tax Rate .OSHH l -- Size x Auditor 3.1203 8 -- Tax Rate x Auditor 3.u722 8 -- 3-Way Interactions Size x Tax Rate x 1.85u2 8 -- Auditor Table 3-u 67 ANALYSIS OF INVESTMENT CREDIT DISCLOSURE REQUIREMENT Size by Assets, Normalized Federal Income Tax Rate, Auditor Corporate Size Federal Income Tax Rate La” 2e Sm ll High Low High Low Totals Independent Auditor AA AY taPco 12 3 |-’ Ol-J OOI-J 36 5 6 2H 2 l CL 5 [.4 2n 1 1 BE 22 'l HS EOONOH Tdnaqcacam+4c>m+4kaL4c3o PM P [.1 PW H TR Other N J: Total FHQ HOMI—‘O-F’OOLOOOMOO-F’OOUWOOU‘IOOQ (I) LOCDCD oowHomI—IHwommoo [—1 M l-‘OOHOOI—‘OCDI—‘i—‘O oo 3:: J: pcno1 OF4~flHCDu>OCDQJOP0¥70CDU1OF403OCDQHDCDSWOFJG 256 18 13 Size Lar e 133 Small 123 11 Tax High Rate Low 129 5 12 127 13 6 68 TABLE B-Qa ANOVA RESULTS OF INVESTMENT CREDIT ANALYSIS Size By Assets, Normalized Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT FREEDOM SIGNIFICANCE Main Effects Size .4679 1 -- Tax Rate 1.0635 1 .301 Auditor 2.8269 8 -- 2-Way Interactions Size x Tax Rate .0955 l -- Size x Auditor 3.u30u 8 -- Tax Rate x Auditor 2.9H76 8 -- 3-Way Interaction Size x Tax Rate x 2.2988 8 ~- Auditor 69 disclosure requirement, and no significant interactions. Indeed, the lowest level of significance was .27. The one major point to be made from the investment credit research is that in the sample of 300 corporations, 18 were found to be in violation of the APB Opinion disclos- ure requirements and another 20 may also be in violation. TIMING DIFFERENCE DISCLOSURE REQUIREMENT ANALYSIS Under APB Opinion No. 11, corporations are required to disclose the components of income tax expense for the period that represent taxes estimated to be payable currently and the tax effects of timing difference. These amounts may be presented as separate items in the income statement or combined in the income statement with disclosure of the components parenthetically or in a note to the financial statements. From an analysis of the 300 corporations, it was de- termined that 69 corporations did not present sufficient information for the computation of both the flow—through and normalized income tax figures. A further search was made of the following year's annual report, the two years' lO-K reports, and a follow-up questionnaire sent where a determination still could not be made. Forty-one of these corporations were in violation of the disclosure requirement; 19 of the corporations were not in violation, and adequate information was not available on the remaining nine corporations to classify them as either adhering or 70 -not adhering to these disclosure requirements. To be classified as a nonadherer of the timing dif- ference disclosure requirement, it was necessary that the undisclosed difference between the normalized and the flow- through tax expense be at least five percent of the nor- malized figure. There were 28% corporations remaining in the analysis using the flow-through Federal income tax rate and 283 in the analysis using the normalized Federal income tax rate. The nine corporations that were indeterminate as to timing difference were also indeterminate as to the flow-through Federal income tax rate, thus no further eliminations were necessary (300-16-9+9=28u). Nine additional indeterminate timing difference corporations were eliminated for normal- ized purposes (300-8-9+0=283). Two of the nonadherers when measured by the flow-through rate and three nonadherers when measured by the normalized rate were eliminated in Tables 3-5 through 3-8 because of indeterminate Federal income tax rates. The raw data for the timing difference disclosure re- quirement are presented in Tables 3-5 through 3-8; the numbers in the cells represent, from top to bottom, adherers, non- adherers, and indeterminates. The SAS ANOVA computer program was applied to the logit transformation of the data in Tables 3—5 through 3—8; the results are presented in Tables 3-5a through 3-8a. Table 3—5 7 1 ANALYSIS OF INCOME TAX COMPONENT DISCLOSURE REQUIREMENT Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor Corporate Size Federal Income Tax Rate La ge JSm ll High High Low Totals Independent Auditor AA 12 t‘r l—‘MO z 36 9 0 AY 21 5 0 CL 23 3 ‘0 EE ....I 23 0 0 HS 2% 6 0 PM H 37 3 0 PW H 32 3 0 TR 21 5 0 Other H 28 5 0 Total m . c>m~q CHAU10+4010+4overdowocaowocao>ocaoiocboquA \1 C(00) COUTOCDNOHCHOHFOI—‘QOONOMLDOOQO \l I-' DU‘IN OHMOOLOOOU‘IOOOJOMQOOHOOWOOU’IOM; F4: ONO.) owmoHsonOHmowmpo-cot—‘wowwomoo zus 39 0 Size Lar e 130 17 Sma l 115 22 Tax Rate Hi h 129 13 0 Low 116 26 0 72 TABLE 3-5a ANOVA RESULTS OF INCOME TAX COMPONENT ANALYSIS Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT FREEDOM SIGNIFICANCE Main Effects Size 1.8912 1 .169 Tax Rate 1.9807 1 .160 Auditor 6.2836 8 -- 2-Way Interactions Size x Tax Rate 3.7769 1 .053 Size x Auditor 6.9H82 8 -- Tax Rate x Auditor n.1356 8 -- 3-Way Interactions Size x Tax Rate x u.1288 8 -- Auditor Table 3-6 73 ANALYSIS OF INCOME TAX COMPONENT DISCLOSURE REQUIREMENT Size By Assets, Flow-Through Federal Income Tax Rate, Auditor Corporate Size La ge Sm 11 Federal Income Tax Rate High Low High Low .Totals 12 12 u 8 36 l l 2 5 9 Independent Auditor AA 0 0 0 0 10 6 8 5 2 21 3 1 0 l 5 AY L 0 o n J 5 9 7 2 23 0 2 0 l 3 __Q§:~ 0 0 0 0 0 6 1 ll 5 23 0 0 0 0 0 EE 0 1D 0 0 0 5 8 7 u 2“ 0 2 2 2 6 HS 0 0 0 0 0 u l7 1” 2 37 l 1 0 1 3 PM 0 Q, 0 0 0 5 16' 6 5 32 l 1 0 l 3 PW 0 0 0 0 0 u 5 11 l 21 0 3 1 l 5 TR 0 0 0 0 Q 2 u 15 7 28 l 0 l 3 5 Othe 0 0 0 0 10 M9 80 80 36 2H5 7 11 6 15 39 Total 0 0 0 0 0 Size Tax Rate La e Small High Low 129 116 129 116 18 21 13 26 0 0 0 0 _ 7H TABLE 3-6a ANOVA RESULTS OF INCOME TAX COMPONENT ANALYSIS Size by Assets, Flow-Through Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT FREEDOM SIGNIFICANCE Main Effects Size 1.1H23 l .287 Tax Rate 2.u266 l .120 Auditor 6.1086 8 -- 2-Way Interactions Size x Tax Rate H.6653 l .031 Size x Auditor 4.7398 8 -- Tax Rate x Auditor 3.5808 8 -- 3-Way Interaction Size x Tax Rate x 5.7129 8 -- Auditor Table 3-7 75 ANALYSIS OF INCOME TAX COMPONENT DISCLOSURE REQUIREMENT Size by Revenue, Normalized Federal Income Tax Rate, Auditor Corporate Size Federal Income Tangate La‘ 2e Sm ll High Low High Low .Totals Independent Auditor AA 8 his 36 8 3 AY 21 6 0 CL H 23 3 10 EB 23 0 0 HS 21+ 5 1 PM H 37 3 l PW l—' i— I 33 3 0 TR H 21 5 1 Othen oiorouJOFAuaorduJorduaocauushqunoamhoH [.4 27 5 3 Total F4; \JOQ OD (1) Duo; OHWONU’VOHWOHO’OOLDOOCDOl—‘OOOCD OH wNwOHOOI—‘QI—‘OCOT—‘MQOOLOOOCDOI—‘COI—‘wfi bl-‘Q #4: 1HFJ¥ <3n3m+4c>wc3c>ccakJmcaNHmcaocncHAnJDroowooam 2H5 38 o Size Lar e 130 17 Small 115 21 v Tax Rate High Low l 118 20 8 127 18 l 76 TABLE 3-7a ANOVA RESULTS OF INCOME TAX COMPONENT ANALYSIS Size by Revenue, Normalized Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT FREEDOM SIGNIFICANCE Main Effects Size .558” l -- Tax Rate .1011 l -- Auditor 5.138” 8 -— 2-Way Interactions Size x Tax Rate 3.7337 1 .05” Size x Auditor 6.3916 8 -- Tax Rate x Auditor 2.7659 8 -- 3-Way Interaction Size x Tax Rate 3.5”19 8 -- Auditor Table 3-8 77 ANALYSIS OF INCOME TAX COMPONENT DISCLOSURE REQUIREMENT Size by Assets, Normalized Federal Income Tax Rate, Auditor Corporate Size Federal Income Tax Rate La' ge Sm 11 High Low High Low glotals Independent Auditor AA H 01 AY CL 7 H H OKDFHDtDF' EE HS |-' -PM OOHODOMDH N L‘OthHO~JDCDGDOCD~JDFJ$WJQJO PW H TR Other H Total 4: . NLOH OOOOOH-KOHmOHI—‘Ol—‘wDOMOl—‘Fow-PNl—‘LO CDOHMommOHIOH 00 be \l wmmowcool—Ioo oar—7“ (A) HLDLO ONmHOwDOWOHmDH-FDOQDI—‘NDI-‘(DDCDO’ 2”5 38 Size _Large Small, F 29 18 116 20 Tax Rate High Low 118 20 8 127 18 1 TABLE 3-8a ANOVA RESULTS OF INCOME TAX COMPONENT ANALYSIS Size by Assets, Normalized Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE RESULT Main Effects Size .3082 Tax Rate .1855 Auditor 5.8205 2-Way Interactions Size x Tax Rate 3.3563 Size x Auditor 5.1237 Tax Rate x Auditor 2.5918 3-Way Interaction Size x Tax Rate x 5.3351 Auditor DEGREES OF FREEDOM LEVEL OF SIGNIFICANCE 067 79 The ANOVA Tables 3-5a through 3—8a reveal no signif- icant main effects but significant (or at least marginally significant) two-way interaction between corporate size and tax rate. The column totals of Tables 3-5 through 3-8 show that in each case there is a slight to moderate increase in adherence rate in going from a high to a low tax rate for large corporations and a moderate to large decrease in adherence rate in going from a high to a low tax rate for small corporations. A priori, it might be expected that large corporations with low tax rates are least likely to adhere to the timing difference disclosure requirement, but this expectation is not supported by the data. Although other explanations for the significance of this interaction are conceivable, they are largely conjectural and therefore will not be offered here. Although the adherence-nonadherence is at best only weakly related to any of the three factors studied, it is significant that at least 13 percent of the sampled corpor- ations are in violation of this particular disclosure re- quirement. EXTRAORDINARY ITEMS DISCLOSURE REQUIREMENT ANALYSIS Several APB Opinions call for disclosure of income taxes pertaining to income before extraordinary items and the income tax effects of extraordinary items themselves. Of the 300 corporations, it was found that 208 reported no extraordinary items in their income statement. 0f the 80 remaining 92 corporations, 82 were found to be adhering to the disclosure requirement, four were not adhering, and there was insufficient information for such a determination for six corporations. To be classified as not adhering to this disclosure requirement, the undisclosed income tax effect of the extraordinary item had to be at least five percent of the total normalized income tax. Because only four corporations were found in violation of this disclosure requirement, the ANOVA was not performed on the data. In the presentation of the raw data in Tables 3-9 through 3-12, the numbers in the cells to the left represent, from top to bottom, adherers, nonadherers, and indeterminates, whereas the numbers in the cells at the right represent firms that do not report extraordinary items. Two of the indeterminate extraordinary item corporations were among the eight eliminated. TAX CARRYFORWARD DISCLOSURE REQUIREMENT ANALYSIS APB Opinion No. 11 requires disclosure of the amounts of any operating loss carryforwards not included in net income for the loss period, together with expiration dates. This disclosure requirement was found to apply poten- tially to only 35 of the 300 corporations. Thirty of these 35 corporations adhered to the disclosure requirement, three did not, and information was not available to make a deter- mination for two corporations. Nonadherence was considered 81 Table 3-9 ANALYSIS OF EXTRAORDINARY ITEMS DISCLOSURE REQUIREMENT Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor Corporate Size Lagge Sm 11 Federal Income Tax Rate High Low High Low Totals ' 2 3 l 3 9 ‘0 l 0 0 1 Independent Auditor AA 0 11 40 9 n j; {110 n 35 2 2 3 3 10 0 0 0 0 0 AY 0 8 0 £4 a 7 r1 2 IL 1 l l 0 1 3 0 0 0 0 0 CL 0 5 (J 10 C) 6 l J; IL 22 2 l 2 l 6 0 0 0 0 0 EB D at; J] '1 n 9 fl 3 fl 1] 2 2 2 3 9 0 0 0 0 0 HS 0 3 Q 0 7 1 '4 1 20 0 5 5 a 1n 0 1 0 0 1 PM 0 6 O, C) 8 0 IL 25 l 5 0 5 11 l 0 0 0 1 PW 0 5 0 lfl_ 0 1121 IL 79 2 3 l 2 8 0 0 0 0 0 TR 0 5 1 20 1. 2 2 15 3 1 0 3 7 0 0 1 0 1 Othe 0 3 1 1 01 0 1 1 9 15 23 1M 25 77 l 2 l 0 H Total 0 50 2 ELLE? IL 1+ 3 6 19 Size Tax Rate Lar e Small Hi h Low 38 39 29 H8 3 l 2 2 2 10” H 93 OIJJJ 6 86 82 Table 3-10 ANALYSIS OF EXTRAORDINARY ITEMS DISCLOSURE REQUIREMENT Size by Assets, Flow-Through Federal Income Tax Rate, Auditor Corporate Size ____LgFgg___ Sm.11, Federal Income Tax Rate High Low High Low Totals 2 2 1 l4 9 '0 1 0 0 1 Independent Auditor AA 0 ll 0 10 0 5 0 9 0 35 2 5 3 0 10 ‘ 0 0 0 0 0 AY . 0 8 t) 3 0 2 r1 3 n 16 0 1 1 1 3 . 0 0 0 0 0 CL. 0 5 t) 10 0 6 .1111 jL 22 2 l 2 1 6 0 0 0 0 0 EE 0 u n 0 9 0 '1 D 1] 2 3 2 2 9 0 0 0 0 0 HS E) 3 0 7 0 '7 1 £1 IL 20 l 7 H 2 1n 0 l 0 0 1 PM 0 Iat 0 1 010+ 0 l 0 25 0 5 1 5 ll 1 0 0 0 1 PW 0 5 0 I; 0 5 1. 0 IL 22 l 3 2 2 8 0 0 0 0 0 TR 0 3 2 (110 0 0 2 15 2 0 1 u 7 0 0 l 0 1 Other 0 1 1 ‘ L14 0 7 1 24 12 27 17 21 77 l 2 1 J 0 u Tkytal 0 an 3 5 0,67_ 23,28 6 197 Size Tax Rate High Low 29 ua 2 2 _ 0111 6 86 83 Table 3-11 ANALYSIS OF EXTRAORDINARY ITEMS DISCLOSURE REQUIREMENT Size by Revenue, Normalized Federal Income Tax Rate, Auditor Corporate Size La ge Sm 11 Federal Income Tax Rate High Low High Low Totals 1 H 3 l 9 0 1 0 0 1 Independent Auditor AA 0 10 0.12 0 3 r) 7 Q22] 2 2 3 H 11 0 0 0 0 0 AY . 0 6 0 6 0 ]_ r1 3 An 15 l 1 0 1 3 0 0 0 0 0 CL 0 5 t) 10 1. 5 0 11 IL 22 1 2 1 2 6 0 0 0 0 0 BE n 5 J] 'l n 8 fl 1; 0 J7 l 3 2 3 9 0 0 0 0 0 HS 0 3 0 5 0 8 (1 u n 21 0 5 2 7 1n 0 1 0 0 1 PM o 1L n 11 o 3 n 3 IL 25 2 4 2 3 ll 1 0 0 0 1 PW 0 7 0 10 1 5 0 1 L 23 2 3 2 1 8 0 0 0 0 0 TR 0 3 J. 3 0 9 1 2 2 12 2 2 3 1 8 0 0 0 1 1 Other 0 I+ 0 (115 0 5 0 2s 12 26 18 23 79 1 2 0 l 4 Ikytal 0 us 1 El 2 57 1 31 612 Size Tax Rate Lar e Sma 1 High Low 38 H1 30 H9 3 1 l 3 1 107 3 98 2 113 2 92 Table 3-12 8M ANALYSIS OF EXTRAORDINARY ITEMS DISCLOSURE REQUIREMENT Size by Assets, Normalized Federal Income Tax Rate, Auditor Corporate Size La ge Sm 11 Federal Income Tax Rate High Low High Low Totals 1 3 3 2 9 0 1 0 0 1 Independent Auditor AA (1 11 0 12 0 7 0 TL, 0 37 2 5 3 1 11 0 0 0 0 0 AY 0 5 (1 6 () 2 0 3 0 16 0 1 1 l 3 0 0 0 0 0 CL. 0 5 0 10 1 5 0 2 l 22 l 2 l 2 6 0 0 0 0 0 EE 0 H (1 0 0 8 0 5 0 jfl 1 H 2 2 9 0 0 0 0 0 HS (1 3 0 7 0 8 E) 3 0 21 0 8 2 M 1“ 0 1 0 0 1 .PM 0 __2_ 0 12 0 10 0 ’2 3 0 26 l u 3 3 ll 1 0 0 0 1 PW 0 '7 0 11 1. 5 0 0 1. 23 2 2 2 2 8 0 0 0 0 0 TR 0 3 2 3 0 9 0 2__ 2 17 1 1 H 2 8 0 0 0 l l Othe 0 2 0 2 0 l7 0 5 0 2 9 30 21 19 79 l 2 0 l M Totalé o u2 2 6 2 7 o 29 u 205 Size Tax Rate Lar-e Sma 1 Hi.h Low 9 H9 3 l 1 3 2 105 2 100 2 113 2 92 85 to exist if the amount of carryforward was not disclosed in the annual report, regardless of magnitude. In the presentation of the raw data in Tables 3-13 through 3-16, the numbers in the cells to the left represent, from top to bottom, adherers, nonadherers, and indeterminates, whereas the numbers in the cells at the right represent firms that do not report operating loss carryforwards; one nonadherer and one indeterminate were among the 16 corpor— ations eliminated in Tables 3-13 and 3-1”, and one nonadherer and two indeterminates were among the eight corporations eliminated in Tables 3-15 and 3-16. Since the number of nonadherers was small, the ANOVA was not performed on the data. LOCATION OF INCOME TAX EXPENSE ANALYSIS Income tax expense is either reported separately or included among the operating expenses in the income state- ment. Two hundred fifty-nine corporations reported income tax expense separately and H1 corporations included it among operating expenses. After eliminating the indeterminate Federal income tax rate corporations, the totals became ZHH and 40 for the flow-through analysis, and 252 and no for the normalized analysis presented in Tables 3-17 through 3-20; the numbers in the cells represent, from top to bottom, firms that deduct tax expense separately and firms that include it among the operating expenses. Tables 3~l7a through 3-20a present the results of the ANOVA analysis. 86 TABLE 3-13 ANALYSIS OF TAX CARRYFORWARD DISCLOSURE REQUIREMENT Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor Corporate Size La ge Sm 11 Federal Income Tax Rate High Low High Low Totals 0 0 0 3 3 0 0 0 0 0 Independent Auditor AA 0 l3 0 13 O 6 [110 43.52 0 2 0 l 3 0 0 0 0 0 AY’ . 0 9 1. ,1 o s n 1 99 0 l 0 0 l 0 0 0 0 0 __QL, 0 6, 0 LU) 0_6 () 3 EL 25 0 l 0 0 l 0 0 0 0 0 EE 0 6 0 1. [111 0 ll (1 22 0 0 1 l 2 0 1 0 0 1 HS 0 5 0 7 0 8 0 '7 (1 21 0 3 2 2 7 0 0 0 1 1 PM. 0 6, 0 12 0 11 0 .3 0 32 0 5 0 2 7 0 0 0 0 0 PW 0 7 C) II 0 5 C) 5 0 28 0 2 0 2 u 0 0 0 0 0 TR 0 7 0 3 0 9 0 13 0 22 0 0 0 2 2 0 0 0 0 0 Other 0 6 0 5 0 13 0 7 0 0 1n 3 13 30 0 1 0 l 2 Total 0 65 1 6 11 7n Lug 1 2 Size Tax Rate Lar e Small High Low 1 1 0 2 1 131 o 12 f _ o 139 1 112 11 15 3 27 1 87 TABLE 3-1u ANALYSIS OF TAX CARRYFORWARD DISCLOSURE REQUIREMENT Size by Assets, Flow-Through Federal Income Tax Rate, Auditor Corporate Size La‘ge _Sm 11 Federal Income Tax Rate High __ng High Low Totals 0 0 0 3 3 , '0 0 0 0 0 Independent Auditor AA 9 13 g 33 9 5_ £119. gth; 0 3 0 0 3 0 0 0 0 0 AY .0 9 1 5 0 5 n 1 22 0 l 0 0 l . 0 0 0 0 0 __QE:, 0 .6 [1 10 0 J (1 3 0 c 0 l 0 0 l 0 0 0 0 0 EB n j n n 11 fl 5 [l 22 0 0 l l 2 0 l 0 0 1 HS 0 5 0 0 6 0 5 0 27 0 u 2 1 7 0 0 0 l 1 PM 0 5 0 1:4 0 12 0 1 0 3 0 5 0 2 7 0 0 0 0 0 PW 0 6 (J l%_ 0 6 O 1+ 0 2B 0 2 0 2 M 0 0 0 0 0 TR 0 u 0 .4112 0 E) (J 22 0 0 0 2 2 0 0 0 0 0 Other 0 3 0 A 016 0 8 0 0 16 3 ll 30 0 l 0 1 2 Total 0 56 1 7i 0 83 0 391 1 251 Size Tax Rate _Large Small, Hi h Low 16 1” 1 1 0 2 1 129 0 122 O 139 1 112 88 TABLE 3-15 ANALYSIS OF TAX CARRYFORWARD DISCLOSURE REQUIREMENT Size By Revenue, Normalized Federal Income Tax Rate, Auditor Corporate Size La ge Sm 11 Federal Income Tax Rate High Low High Low .Totals 0 0 l l 2 . 0 0 0 0 0 Independent Auditor AA 0 11 4D 11 0 H1 [1 1 n as 1 l 0 l 3 0 0 0 0 0 AY . 0 J 1. 6 r) 5 n1 1 21 0 1 0 0 1 0 0 0 0 0 __Q§1 (J 6 0 10 0 6 0 :1 11 25 0 l 0 0 1 0 0 0 0 0 EB n 4-1 11 7 n n 6 fl 7? 0 0 2 0 2 0 1 0 0 1 HS 0 _& 0 0 8 C) 7 0 27 0 3 l 3 7 0 0 l 0 1 PM 0 9 O 13 C) 8 0 7 I) 39 1 u 1 1 7 0 0 0 0 0 PW 0 9 0 l 0 7 CL,3 0 29 0 2 2 0 u 0 0 0 0 0 TR 0 5 0 J) 9 0 1+ 0.23 0 0 2 0 2 0 0 0 0 0 Othe 0 6 1) 0 16 (1 2 0 2 12 9 6 29 0 l l. 4 0 2 Total 0 57 1 76L 0 7 11 SQL .1360; Size Tax Rate , High Low 11 18 f 1 1 0 13a 1 126 89 TABLE 3-16 ANALYSIS OF TAX CARRYFORWARD DISCLOSURE REQUIREMENT Size by Assets, Normalized Federal Income Tax Rate, Auditor Corporate Size La ge Sm 11 Federal Income Tax Rate High Low High 1Low .Totals 0 0 1 1 2 '0 0 0 0 0 Independent Auditor AA 0 12. 0 15 0111 [1 3 10105 1 2 0 0 3 0 0 0 0 0 AY . 0 6 1 8 f) 5 n 1 22 0 l 0 0 l . 0 0 0 0 0 CL- 0 11 c1 10 0 7 0 11 n 25 0 l 0 0 1 0 0 0 0 0 EE 0 j n 'I I] Q n 7 D 92 0 0 2 0 2 0 l 0 0 1 HS 0 U (1 1 0 8 t) 5 0 ;fl_ 0 H ' l 2 7 0 0 ‘ 1 0 1 PM 0 2 0 17' 0110 0 M 0 33 1 u l 1 7 0 0 0 0 0 PW 0 8 0 ll 0 8 (J 2 0 29 0 '2 2 0 M 0 0 0 0 0 TR 0 5 0 5 C) 9 0 4 t) 23 0’ 0 2 0 2 0 0 0 0 0 Other 0 3 0 3 019 0 8 0 33 2 19 9 H 29 0 1 111le 0 2 mu Total 0 50 1 8 fl [1 LL- 1 9 Size Tax Rate Lar Sma l . High Low 16 13 ll 18 l l 1 1 l 131 0 129 0 139 1 126 90 TABLE 3-17 ANALYSIS OF LOCATION OF THE INCOME TAX EXPENSE Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor Corporate Size La1ge Sm 11 Federal Income Tax Rate High Low High Low .Totals 13 9 6 ll 39 . ‘0 H 0 2 6 Independent Auditor AA 9 6 5 H 29 0 l 0 l 2 AY 5 5 6 3 19 l 6 0 0 7 CL 6 l 10 H 21 0 l 1 0 2 EE 5 6 7 6 24 0 2 2 2 6 HS 6 19 12 u 36 PM 0 1 1 2 u 6 11 n u 25 l 5 1 3 10 PW 7 5 8 5 25 0 0 1 0 1 TR 5 5 l2 9 31 l 0 l 0 Othe 2 62 62 70 50 299 3 20 7 10 90 Total Size Tax Rate Lar e Small High Low 12” 120 132 112 23 17 10 30 91 TABLE 3-l7a ANOVA RESULTS OF INCOME TAX LOCATION ANALYSIS Size by Revenue, Flow-Through Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT FREEDOM SIGNIFICANCE Main Effects Size .8539 l .356 Tax Rate 7.2678 1 .008 Auditor 7.0843 8 -- 2-Way Interactions Size x Tax Rate .5698 1 -_ Size x Auditor 6.8999 8 _- Tax Rate x Auditor 9.1160 8 -- 3-Way Interaction Size x Tax Rate x 2.3300 8 -- Auditor 92 TABLE 3-18 ANALYSIS OF LOCATION OF THE INCOME TAX EXPENSE Size by Assets, Flow-Through Federal Income Tax Rate, Auditor Corporate Size La ge Sm 11 Federal Income Tax Rate High Low High Low Totals 13 8 6 12 39 Independent Auditor AA 0 5 0 1 6 9 7 5 3 29 AY ' 0 2 0 0 2 u 5 7 3 19 CL 1 6 0 0 7 6 1 10 H 21 EE 0 0 1 l 2 5 7 7 5 2” HS 0 3 2 l 6 5 15 13 3 36 PM 0 3 1 0 u 5 l2 5 3 25 PW l 5 l 3 10 u 8 ll 2 25 TR 0 0 1 0 l 2 H 15 10 31 Other 1 0 1 0 2 74 53 67 79 us 2uu 3 29 7 6 90 Total Size Tax Rate L e Sma High Low 120 12a 132 112 A 27 13 10 30 93 TABLE 3-18a ANOVA RESULTS OF INCOME TAX LOCATION ANALYSIS Size by Assets, Flow-Through Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT FREEDOM SIGNIFICANCE Main Effects Size 3.8891 1 .099 Tax Rate 5.0156 1 .025 Auditor 7.9796 8 -- 2-Way Interactions Size x Tax Rate .3760 1 -- Size x Auditor 7.0229 8 -- Tax Rate x Auditor 3.8361 8 -- 3-Way Interaction Size x Tax Rate x 2.6306 8 -- Auditor 99 TABLE 3-19 ANALYSIS OF LOCATION OF THE INCOME TAX EXPENSE Size by Revenue, Normalized Federal Income Tax Rate, Auditor Corporate Size La ge Sm 11 Federal Income Tax Rate High Low High Low .Totals 11 13 9 8 91 Independent Auditor AA 0 9 2 0 6 8 7 9 6 25 AY . 0 l 0 1 2 6 9 6 3 l9 -_2£:1 0 7 0 0 7 5 2 8 6 21 EE 0 l 1 0 2 9 7 8 5 29 HS 0 2 2 2 6 9 16 10 7 37 PM 0 l 0 3 9 9 9 5 3 26 PW 1 5 3 l 10 5 7 10 9 26 TR 0 0 l 0 1 6 3 l7 7 33 Othe 0 1 l 0 2 58 68 77 99 252 l 22 10 7 90 Total Size Tax Rate Lar e Small . High Low 126 126 135 117 1 23 17 11 29 TABLE 3-19a ANOVA RESULTS OF INCOME TAX LOCATION ANALYSIS Size by Revenue, Normalized Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE RESULT Main Effects Size Tax Rate Auditor 2-Way Interactions Size x Tax Rate Size x Auditor Tax Rate x Auditor 3-Way Interaction Size x Tax Rate x Auditor .6813 5.9812 9.3213 3.5200 7.0695 1.9706 9.7379 DEGREES OF FREEDOM LEVEL OF SIGNIFICANCE 012 327 059 96 TABLE 3-20 ANALYSIS OF LOCATION OF THE INCOME TAX EXPENSE Size by Assets, Normalized Federal Income Tax Rate, Auditor Corporate Size La ge Sm 11 Federal Income Tax Rate High Low High Low Totals 11 12 9 9 91 Independent Auditor AA 1 9 1 0 6 7 9 5 9 25 AY 0 2 0 0 2 5 9 7 3 19 CL.' 0 7 0 0 7 5 2 8 6 21 EE, 0 0 l l 2 9 8 8 9 29 HS 0 3 2 l 6 2 18 12 5 37 PM 0 3 0 1 9 8 10 6 2 26 PW 1 5 3 1 10 5 7 10 9 26 TR 0 0 1 0 1 3 2 20 8 33 Other 0 l l 0 2 50 72 85 95 252 2 25 9 9 90 Total Size Tax Rate Lar e Small 1 High Low 122 130 135 117 27 13 11 29 97 TABLE 3-20a ANOVA RESULTS OF INCOME TAX LOCATION ANALYSIS Size by Assets, Normalized Federal Income Tax Rate, Auditor FACTOR CHI-SQUARE DEGREES OF LEVEL OF RESULT FEEEDOM SIGNIFICANCE Main Effects Size 2.5605 1 .109 Tax Rate 9.0601 1 .099 Auditor 9.6292 8 .293 2-Way Interactions Size x Tax Rate 2.5537 1 .110 Size x Auditor 6.3026 8 -- Tax Rate Auditor 1.8201 8 -- 3-Way Interactions Size x Tax Rate x 2.3292 8 -- Auditor 98 The relationship of corporate size (measured by assets but not revenues) and the location of income tax expense in the income statement are statistically significant. As can be seen more clearly in Table 3-21, large corporations are more likely than small corporations to report income tax expense among the operating expenses. All 300 corpor- ations are used in this test since size and location of income tax expense are known. Using a Chi-Square test of independence, the computed Chi-Square is 9.77 for Table 3-21, significant at the .029 alpha level.u TABLE 3-21 LOCATION OF INCOME TAX EXPENSE AND CORPORATE SIZE MEASURED BY ASSETS Corporate Size Placement of Income Tax Large Small Deducted Separately 123 136 Among Operating Expenses 27 19 There is also a statistically significant relationship between Federal income tax rate (either flow-through or normalized) and the location of income tax expense in the income statement. As can be seen more clearly from Tables 3-22 and 3-23 (abstracted from Tables 3-16 through 3-20), low Federal income tax rate corporations are more likely than high Federal income tax rate corporations to report income tax expense among the operating expenses. Here, the computed Chi-Square is 11.69 for Table 3-22 (revenue or asset size and flow-through rate), significant at the 99 .001 alpha level; and 9.39 for Table 3-23 (revenue or asset size and normalized rate), significant at the .001 alpha level. TABLE 3-22 FLOW-THROUGH FEDERAL INCOME TAX RATE AND SIZE MEASURED BY REVENUES OR ASSETS Flow-Through Rate Placement of Income Tax High Low Deducted Separately 132 112 Among Operating Expenses 10 30 TABLE 3-23 NORMALIZED FEDERAL INCOME TAX RATE AND SIZE MEASURED BY REVENUES OR ASSETS Normalized Rate Placement of Income Tax High Low Deducted Separately 135 117 Among Operating Expenses 11 29 The ANOVA analysis in Tables 3-l9a and 3-20a also in- dicate statistically significant interactions between the tax rate main effect, measured by the normalized rate, and the size main effect, measured either by revenues (d = .059) or assets (1 = .110). This comes about because 22 of 29 and 25 of 29 low normalized Federal income tax rate corpor- ations that reported income taxes among operating expenses were also large revenue or asset corporations, respectively. 100 RESULTS OF THE HYPOTHESES TESTING Four individual hypotheses were presented in Chapter II to be tested with respect to adherence or nonadherence to four APB Opinion disclosure requirements along with the income statement classification of income taxes, the last loosely referred to below as an APB Opionion disclosure re- quirement: H : there is no difference in adherence to APB Opinion income tax disclosure requirements among auditors there is a difference in adherence to APB Opinion 1ncome tax disclosure requirements among auditors there is no difference in adherence to APB Opinion income tax disclosure requirements between large and small corporations there is a difference in adherence to APB Opinion income tax disclosure requirements between large and small corporations there is no difference in adherence to APB Opinion income tax disclosure requirements between high and low Federal income tax rate corporations there is a difference in adherence to APB Opinion income tax disclosure requirements between high and low Federal income tax rate corporations there are no interaction effects among the three main factors (Federal income tax rate, corporate size, and independent auditor) there is an interaction effect among the three main factors Since the location of the income tax expense in the income statement does not fall within the technical clas- sification of an APB Opinion disclosure requirement, the following discussion separates the four APB Opinion 101 disclosure requirements from the income tax location analysis. Each of the four APB Opinion disclosure requirements must be judged individually to determine an acceptance or rejection of the first null hypothesis. Differences in ad- herence to the four APB Opinion disclosure requirements were not significant among corporations audited by the nine groups of independent auditors. Therefore, the first null hypoth- esis cannot be rejected. The second null hypothesis of no difference in adherence to APB Opinion disclosure requirements between large and small corporations also cannot be rejected. Differences in adherence to the four individual APB Opinion disclosure requirements were not significant between large and small corporations. The third null hypothesis of no difference in adherence to APB Opinion disclosure requirements between high and low Federal income tax rate corporations also cannot be rejected. Differences in adherence to the four individual APB Opinion disclosure requirements were not significant between high tax rate and low tax rate corporations. The fourth null hypothesis of no interactions in ad- herence to APB Opinion disclosure requirements among the three main variables (auditor, size, tax rate) can be re- jected in one instance--the size-tax rate interaction for the timing difference disclosure requirement. Any interpre- tation of this interaction is conjectural, however, for its 102 direction is not as anticipated. The income tax location comparison with the three main effects did result in some statistically significant differ- ences. No relationship was found between the independent auditor and the location of the income tax expense in the income statement. However, when size was measured by assets, large corporations were found to be more likely than small corporations to report income tax expense among Operating expenses,and thus the null hypothesis of no differences can be rejected. No significance was found to exist when size was measured by revenues. A significant relationship was found between the tax rate and the location of income tax expense in the income state- ment, whether a flow-through or normalized Federal income tax rate is used. Low tax rate corporations tend to report income taxes among Operating expenses rather than as a sep- arate deduction. Thus, the null hypothesis of no differences among high and low Federal income tax rate corporations can be rejected. Two interactions of marginal significance were found in the analysis of the position of income tax expense in the income statement. Specifically, both relate to inter- actions between firm size and tax rate, where the tax rate is normalized and firm size is measured either by revenues or assets. 103 FEDERAL INCOME TAX RATEACORPORATE SIZE RELATIONSHIP Vanik's contention that small businesses do not have the ability to fully utilize the tax benefits available to large businesses is supported by this study. The classifi- cation of large and small was used for corporate size together with the actual Federal income tax rates. The null hypothesis that large corporations do not incur lower Federal income tax rates than small corporations was tested with the test statistic: X - X z = 2 ‘ 2 2 EL S_2_ n1 n2 where: X1 = average Federal income tax rate of large cor- porations X2 = average Federal income tax rate of small cor- porations 812: variance of large corporation's Federal income tax rates 822: variance of small corporation's Federal income tax rates nl = number of large corporations n2 = number of small corporations Twenty-five indeterminate flow-through Federal income tax rate corporations and 15 indeterminate normalized Federal income tax rate corporations are eliminated in the respective tests. This leaves 199 large corporations and 109 133 small corporations in the flow—through test and 196 large and 139 small corporations in the normalized test. Using the flow-through Federal income tax rate and revenues as the size criterion results in a Z of 1.589; the null hypothesis can be rejected at the .057 level of signi- ficance. Thus the average flow-through Federal income tax rates of 29.6% for large corporations and 28.9% for small corporations are significantly different; large corporations have lower tax rates than small corporations, which is con- sistent with Vanik's contention. Using the flow-through Federal income tax rate and assets as the size criterion results in an even more signif- icant Z of 2.797; the null hypothesis can be rejected at the .003 level of significance. The average flow-through Federal income tax rate is 23.1% for large corporations and 30.5% for small corporations. Although Vanik's assertion pertained only to the flow- through Federal income tax rate, similiar analyses were performed using normalized Federal income tax rates. The results were even more significant than with the flow-through Federal income tax rate. Using revenues as the size criterion results in a Z of 2.007, significant at the .022 level; the average normalized Federal income tax rate was 33.9% for large corporations and 37.7% for small corporations. Using assets as the size criterion results in a Z of 3.290, signif— icant at the .001 level; the average normalized Federal income 105 tax rate was 32.8% for large corporations and 38.9% for small corporations. 106 FOOTNOTES See Accounting and Reporting Problems of the Accounting Profession *(Chicago: The Firm, 1962), pp. 97-101. George W. Snedecor and William G. Cochran, Statistical Methods (6th edition; Iowa State University Press, Ames, Iowa, 1967), p. 999. Anthony James Barr and James Howard Goodnight, A User's Guide to the Statistical Analysis System, (Raleigh, North Carolina, August 1972), p. 138-152. The Chi-Square results from Tables 3-21 through 3-29 were derived from the 2x2 contingency tables provided rather than the results of the 3-way ANOVA. The re- sults may differ slightly from the ANOVA because the cells in the ANOVA are converted to proportions with a transformation applied. The following Chi-Square test statistic is used: 2 ‘7‘? = N(011022-012021) nln2(011+021)(012+022) where N total number of corporations in test nl number of corporations in upper group n2 number of corporations in lower group CHAPTER IV SUMMARY, IMPLICATIONS, AND LIMITATIONS SUMMARY This study examines the extent to which corporate annual reports to shareholders are in accordance with the income tax disclosure requirements of APB Opinions Nos. 2, 9, 11, 22, 23, and 29 It also considers the validity of contentions that the burden of corporate income taxes is not equal for large and small corporations. Consistent with these APB Opinions, the following in- come tax disclosures should be made either in the income statement, in the balance sheet, or in the footnotes: l. 2. 3. u. 5 Taxes estimated to paid currently. Tax effects of timing differences, both currently and cumulatively. Tax effects of investment credits. Tax effects of operating losses Tax effects of extraordinary items. Also, the balance sheet or footnotes should disclose: Refundable taxes arising from the utilization of carrybacks of losses and credits. Future tax benefits anticipated from the use of net operating loss carryforwards. Deferred investment credits that may be reflected as reductions of accounting tax provisions in future years. Amounts of any loss carryforwards not recognized in the loss period, together with expiration dates. Significant amounts of any other unused deductions 107 108 or credits, together with expiration dates. 11. Reasons for significant variations in the customary relationships between income tax expense and pretax accounting income, if they are not otherwise appar- ent. Four income tax disclosure requirements and the location of the income tax expense in the income statement were se- lected for analysis, as follows: 1. Disclosure of the method of accounting for invest- ment credits and amounts included in income for the year. 2. Disclosure of current and deferred income tax figures in the income statement. 3. Disclosure of the income tax effect of extraordinary items. 9. Disclosure of the amounts of tax loss carryforwards not included in income for the loss year with ex- piration dates. 5. Placement of income tax expense (relating to income before extraordinary items) in the income statement. A random sample of 300 corporations was taken from the New York and American Stock Exchanges. Corporations that were real estate investment trusts, investment trusts, foreign corporations, or incurred a loss for the year of study were eliminated from consideration. Annual reports to shareholders for the fiscal year ending between July 1, 1972 and June 30, 1973 were used for the year of study. Adherence or nonad- herence to each of the four disclosure requirements studied and the location of income tax expense in the income state- ment was determined by analyzing the annual reports for the year of study and the following year, the lO-K reports of the two years, and a follow-up questionnaire sent where a determination still could not be made. Adherence or nonadherence to the selected disclosure requirements was analyzed by corporate Federal income tax 109 rate, corporate size, and independent auditor through a three-way analysis of variance. Corporate income tax rate was measured two ways, flow-through and normalized; cor- porate size was also measured two ways, by revenues and by assets. Corporations were classified into two groups of 192 corporations each, representing high and low flow-through Federal income tax rates; and two groups of 196 corporations each, representing high and low normalized Federal income tax rates. The 300 corporations were also broken into two equal groups representing large and small corporations. These two factors plus a nine-way classification by auditor resulted in a 36-cell breakdown for each of the four income tax APB Opinion disclosure requirements and income tax location. A total of 20 individual 36-cell tables resulted since the Federal income tax rate and the corporate size were each measured two ways. For the four income tax APB Opinion disclosure require— ments, each cell of each table included the number of cor- porations adhering to the particular disclosure requirement, not adhering to the requirement, and an indeterminate class- ification, where appropriate. For the income tax location in the income statement each cell of each table included the number of corporations including the expense among the operating expenses and the number reporting it as a separate deduction. The 12 tables relating to the APB disclosure 110 requirements for investment credits and current versus de— ferred income taxes as well as the income tax location in the income statement were analyzed by an SAS ANOVA com- puter program. The indeterminates of each disclosure re- quirement were deleted before the computer program was applied. The eight tables relating to the APB disclosure requirements for the tax effects of extraordinary items and the tax effects of loss carryforwards were not analyzed by the SAS ANOVA computer program, since these requirements were applicable to only a small number of corporations and an even smaller number were found in violation. SUMMARY OF RESEARCH FINDINGS Although not statistically significant in relation to corporate size, tax rate, or auditor alone, nonadherence to each of the four APB Opinion income tax disclosure require- ments was found in this study. More interesting, the study found a statistically significant difference in the location of income tax expense, depending on corporate size (measured by assets but not revenues) and tax rate (either flow-through or normalized). Large corporations were more likely than small corporations to include income tax expense among op- erating expenses; low Federal income tax rate corporations were more likely than high Federal income tax rate corpor— ations to report income tax expense among operating expenses. No relationship was found among corporations by auditors and the location of income tax expense. There was 111 also a significant relationship in effective Federal income tax rates between large and small corporations, regardless of how tax rate and size are measured. Large corporations incur lower effective tax rates than small corporations. IMPLICATIONS OF THE STUDY The implications of this study are many. First, a sig- nificant number of corporations did not adhere to selected APB Opinion income tax expense disclosure requirements. Since the sample is random, this finding of nonadherence can be projected to the population comprising the New York and American Stock Exchanges. If Stempf is correct in con- tending that the accounting practice for the large corpor- ation sets the standard for all, one wonders about the cred- ibility of accounting disclosure practices of other corpor- ations. A further question can be raised concerning the causes of these violations. If corporations are required to disclose these selected items, what is the basis for non- adherence? Is the independent auditor remiss in granting a clean opinion in the face of nonadherence to these APB Opinion disclosure requirements? Who is the policeman to see that the APB Opinion disclosure requirements are enforced? The nonadherence to presently required APB Opinion income tax disclosure requirements makes prediction of future net income more difficult. Without the "required" infor- mation, let alone additional information, the prediction of future income tax rates is difficult. The required 112 disclosures may help to explain the existing variations in tax rates and facilitate the prediction process. This study found that 13 percent of the corporations were not adhering to the timing difference disclosure re— quirement. Nonadherence to this requirement makes it im- possible to determine the flow—through income tax rate. However, this is only the tip of the iceberg as far as "social responsibility" accounting is concerned. The APB Opinions require only that the components of income taxes be disclosed; they do not require disclosure of Federal income tax current and deferred components. In most cases, it was necessary to consult sources other than annual reports to shareholders to compute the Federal income tax rates; even with these other sources, the rates for several corporation could not be computed. It is nearly impossible to determine whether or not cor- porations are incurring their "fair share" of Federal income taxes when the information is not readily available in their annual reports. Outside report users may equate income tax expense with Federal income taxes, whereupon some corporations will appear to be incurring higher Federal tax rates than is the true situation. Even if outside report users do not equate the two, they are still unable to compute the Federal income tax rates because of a lack of information. The finding that low Federal income tax rate corpor- ations tend to report income tax expense among operating 113 expenses rather than as a separate deduction tends to support the hypothesis that low Federal income tax rate corporations attempt to obscure their favorable Federal income tax rate status. This hypothesis is further supported by the fact that most corporations do not fully disclosue the Federal income tax components of income tax expense in their annual reports to shareholders, although it should be noted that such disclosures are not presently required. Thus, the contentions of Vanik and Stern (cited in Chapter I) tend to be supported. Note, however, that any conclusions con- cerning the motivations for these disclosure practices are necessarily conjectural; this study has not examined the minds of corporate managers. Increased disclosure of Federal income tax information is necessary if society is to effectively evaluate the equity by which income taxes are assessed and decide whether there is a need for changes in the tax laws. LIMITATIONS OF THE RESEARCH A major limitation of this study is the availability of flow-through and normalized Federal income tax rate fig— ures. For a few corporations the researcher made a judgment as to whether the corporation was a high or low Federal income tax rate corporation; several other corporations were deleted in the analysis for lack of Federal income tax rates. The sample is not a random sample of all corporations, 119 but only of those corporations listed on the New York and American Stock Exchanges. Therefore, statistical infer— ences are limited to corporations listed on these two ex— changes. However, the corporations listed on these exchanges comprise the vast majority of the country's sales and assets, and statistical inferences concerning their financial re- porting practices should be of interest in their own right. The sample also may not be representative of all cor- porations listed on the New York and American Stock Exchanges because certain corporations were eliminated. Specifically, loss corporations as well as REITs, investment trusts, and foreign corporations were excluded. Additionally, it is questionable whether small corporations are included in the sample, since the sample is selected from the two largest stock exchanges. However, the availability of information limits the sample to these two groups. Perhaps the compar— ison is better explained in terms of large and "smaller" corporations. The accounting literature is concerned almost exclus- ively with listed corporations; in fact, many recent em- pirical studies sample only Fortune 500 or New York Stock Exchange corporations. Accordingly, the sample underlying this study is less restrictive than those of many other studies. Once again, the results should be of interest per se, notwithstanding the limited population from which the sample is drawn. The sample is limited to profitable corporations, as 115 discussed in Chapter II. This feature was necessary for tax rate computation purposes and should have had no effect on the relationship of corporate size and auditor with dis- closure practices. The original stratification of the sample into two parts representing the New York and American Stock Exchanges was based on the‘uynilnumber of corporations listed on each exchange. The requisite number of corporations was then selected for each. A larger number of corporations were deleted during the selection process from the American Stock Exchange than from the New York Stock Exchange. This resulted in the remaining firms listed on the American Stock Exchange having a slightly larger probability of being in- cluded among the final 300 corporations studied than is indicated from the relative number of firms listed on each exchange. Perhaps a better procedure would be to eliminate ineligible corporations before beginning the sampling pro- cedure and then stratify according to the number of firms remaining. Of course, this would involve determining the status of over 2,700 corporations according to the selection criteria, a task avoided under the sampling plan employed. Some significance may have been lost because the sample of 300 corporations was spread over 36 cells, resulting in only a few responses in some of the cells. With a larger sample size, it might have been possible to find some more definite relationships, especially among the auditors. 116 Because of the cell sizes, a logit transformation was applied to the data. Transforming the data may cause some differences in results. However, the transformation was necessary to avoid interactions that may be a consequence of the scale. Some corporations were deleted from the study for lack of sufficient data to determine Federal income tax rates and adherence or nonadherence to individual APB Opinion disclosure requirements. Deletion implicitly assumes that such corporations adhere or do not adhere to disclosure re- quirements in the same proportions as the corporations re- maining in the sample. Although some confounding of var— iables may result, this is inevitable given the nature of the subject. There may also be a possible confounding due to the unknown materiality criteria applied by the individual firms and their auditors in deciding just what constitutes adherence to APB Opinion income tax expense disclosure re- quirements. For this reason, some firms that where found to be not adhering to these disclosure requirements might have concluded that the amounts involved were immaterial and hence that disclosure was unnecessary. Accordingly, all of the previous findings must be tempered by this unknown materiality factor. SUGGESTIONS FOR FURTHER RESEARCH A follow-up study of the reasons for nonadherence to APB Opinion income tax disclosure requirements readily sug- 117 gests itself. Such a study could proceed by requesting ex- planations from the managements and the independent auditors for the nonadherence to the disclosure requirements. Another logical extension of the present study is a study of the extent to which income tax figures reported in annual reports to shareholders are broken down by jurisdiction. The present study only analyzed the extent to which corpor- ations adhered to particular APB Opinion disclosure require- ments. Corporations may meet these disclosure requirements by presenting overall income tax figures without indicating the Federal, state, local and foreign components. It was often impossible to determine the Federal income tax rates from the annual reports to shareholders, resulting in corporations knowingly or unknowingly obscuring their effective Federal income tax rates. Still another logical extension of the present study is a study of the extent of adherence to SEC lO-K income tax disclosure requirements. This follow-up study would be quite appropriate in light of the new SEC income tax disclosure requirements.1 The present study could also be extended by expanding the sample size to include all NYSE and AMEX firms. This would alleviate the cell size problem of this study and increase the power of the statistical tests. Finally, the present methodology suggests itself for studies of other financial reporting disclosure requirements, 118 as specified in APB Opinions, FASB Statements, or SEC re- leases. Of course, the "fair share" and social account- ability rationales would not be adequate for such studies; other rationales would have to be developed. 119 FOOTNOTES U.S., Securities and Exchange Commission, Regulation §:X, Rule 3-16(o), "General Notes to Financial State- ments." Effective for fiscal years ending on or after December 28, 1973. APPENDICES 120 APPENDIX I CORPORATIONS INCLUDED IN SAMPLE ACF Industries ADM Industries A. J. Industries Abbott Labs Aberdeen Manufacturing Admiral Airborne Freight Airpax Electronics Inc. Airwick Industries Inc. Allied Control Co. Inc. Alpha Portland Industries Aluminum Company of America American Brands American Business Products American Chain 8 Cable Co. American Medicorp American Standard Ampex Corporation Apache Corporation Apco Oil Corporation Arkansas Louisiana Gas Company Armin Corporation Ashland Oil ASPRO, Inc. Associated Food Stores Inc. New York Automatic Service Company Automation Industries Avon Products Babcock 8 Wilcox Bartons Candy Beneficial Corporation Bertea Corporation Beverly Enterprise Bio-Dynamics Brad Ragan Inc. Bradford Computer Briggs 8 Stratton B. Brody Seating Company Brunswick Budget Industries Inc. Bulova Watch Company Inc. Burns International Security California Financial Campbell Soup Canoga Industries Capital Reserve Carnation Company 121 APPENDIX I con't Caterpillar Certron Corporation Charter Company Chase Manhattan Chesebough Ponds Inc. Chock Full O'Nuts Cincinnati Gas 8 Electric Cincinnati Milacron Inc. Circle K Corporation City Gas Company of Florida Clark Consolidated Industries Clarkson Industries Coleman Company Inc. Colonial Sand 8 Stone Commercial Metals Condec Corporation Connelly Containers Continental Copper 8 Steel Contintental Investment Crouse Hinds Company Cummins Engine Cutler-Hammer Cyprus Mines Corporation Dan River Data Documents Dean Whitter Deltona Corporation Den-Tal-Ez Dillingham _R. R. Donnelley du Pont ESB Inc. Easco Corporation Eason Oil Company Eastern Airlines Electronic Data Systems Corporation Essex Chemical Corporation Fairchild Camera Federal Sign 8 Signal Corporation Financial Corporation of Santa Barbara Financial Federation Inc. Financial General Bankshares Firestone Tire 8 Rubber Food Fair Stores Ford Motor Company Frank's Nursery Sales Inc. Freeport Minerals A. L. Garber, Inc. Gaynor-Stafford Industries General American Oil 122 APPENDIX I con't General Cigar General Development General Portland Inc. General Telephone 8 Electronics Genuine Parts Company Getty Oil Gillette Company Gimbel Brothers Gino's Inc. Gladding Corporation Glover Inc. Goldblatt Bros. Inc. Gorin Stores Gulton Industries Inc. NMW ' Hallcraft Homes Hamilton Cosco Inc. Hampshire Designers Handy 8 Harman John H. Harland Company Harte Hanks Newspapers Harvey Group Inc. Walter E. Heller International Hercules Hi Shear High Voltage Engineering Hofmann Industries Honeywell Geo. A. Hormel House of Fabrics House of Ronnie, Inc. Howell Industries Huffman Manufacturing Company Huntington Health ICN Pharmaceuticals IMC Magnetics Illinois Central Industries International General Industries International Harvester International Multifoods Interpace Investors Diversified Services Iowa Electric Light 8 Power Company Iroquois Brands Irvin Industries Inc. Johnson 8 Johnson Jupiter Industries K-Tel International Kaiser Cement Kansas-Nebraska Natural Gas 123 APPENDIX I con't Kay Corporation Kelsey Hayes Key Company Killearn Properties Kit Manufacturing S. S. Kresge LFE Corporation Leath 8 Company Leisure Technology Lenox Incorporated Libby McNeill 8 Libby Lloyds Electronics Inc. Long Island Lighting Lowenstein 8 Sons LVO Corporation Lykes-Youngstown MCA MEM Company, Inc. Madison Square Garden Corporation Mangel Stores Corporation Mark Controls Corporation Marlene Industries Masonite Corporation Maul Brothers Arthur G. McKee Medalist Industries Inc. Microdot Milton Roy Company Moog Inc. Morrison-Knudsen Mount Vernon Mills Munford Inc. Munsingwear NVF Company National City Lines National Distributing National Industries National Paragon Corporation National Presto Industries National Semiconductor National Service Industries Inc. National Standard National Steel New Idria Mining 8 Chemical Newcor Inc. Northern Natural Gas OKC Corporation Offshore Company Ogden Ohio Art Ohio Brass Olla Industries 129 APPENDIX I Con't Onan Corporation Oriole Homes Corporation Outboard Marine Overhead Door Corporation Owens Corning Oxford First PPG Industries PSA Pacific Savings 8 Loan Pargas, Inc. Park Electrochemical Parkway Distributors Penn Engineering Perkin Elmer Permaneer Corporation Potlatch Corporation Pratt 8 Lambert Inc. Public Services of New Hampshire Puget Sound Public and Lighting Pullman Incorporated Quaker Oats Company Raymond Precision Reserve Oil 8 Gas Company Resistoflex Corporation Revlon Inc. Rio Grande Industries Rogers Corporation Royal Industries Rust Craft Ryerson 8 Haynes Inc. SCA Services SOS Consolidated Safeway Stores Inc. Sambo's Restaurant San Jose Water Works Santa Fe Industries Sav-on-Drugs Schering Plough Corporation Scot Lad Foods Security Plastics Seligman 8 Associates Shell Oil Company Shenandoah Oil Corporation Sherwood Medical Industries. Henry I. Siegel Company, Inc. Sifco Industries Sigma Instruments Signode Corporation Simplicity Pattern 125 APPENDIX I con't Singer Company Skaggs Companies Smith International Solitron Devices Inc. Soundesign Corporation Southdown Inc. Southern Pacific Southland Corporation Spring Mills Inc. Standard Motor Products Stardust Inc. Stelbar Industries Inc. Stevcoknit Inc. Superior Surgical Manufacturing Synalloy Corporation Taft Broadcasting Tampa Electric Tandy Corporation Teleflex Inc. Texas Instruments Texas Utilities Textron Thiokol Chemical Trans World Airlines Traingle Industries UMC Industries Union Carbide United Dollar Stores U. S. Home Corporation United States Radium Corporation United States Tobacco Valle's Steak House Varo Inc. Veeco Instruments Inc. Viacom International Victor Comptometer Voplex Corporation WUI, Inc. Watsco Inc. Weatherhead Company West Point Pepperell Weyerhaeuser Whiting Corporation Wieboldt Stores Wilshire Oil Company of Texas Wilson Brothers Winn Dixie Stores Inc. Wrather Corporation Xerox Corporation Xtra, Inc. Zero Manufacturing Company Zimmer Homes 126 APPENDIX II CORPORATIONS ELIMINATED IN SELECTION PROCESS AND REASON NEW YORK STOCK EXCHANGE Alcan Aluminum American Century Mortgage Arcata National Corp. Barlett Mortgage Chicago Milwaukee Corp. Contintental Can Distillers Corp. Dome Mines Limited Duplan Corp. First National Stores First Real Estate Equity Mortgage Greater Washington Investors INA Investment Securities Institutional Investors Trust Japan Fund National Union Electric Co. Newhall Land and Farming Niagara Share North America Mortgage Investment Pacific Petroleums Petroleum Corporation of America Pueblo International F 8 M Schaefer Shell Transport Unilever Ltd. Wachovia Realty Investments Canadian REIT Loss REIT Loss Loss Canadian Canadian Loss Loss REIT Loss Investment Fund REIT Investment Fund Loss Loss Investment Fund REIT Canadian REIT Loss Loss British British REIT 127 APPENDIX II con't AMERICAN STOCK EXCHANGE Aerodex Inc. Loss All American Industries Loss Alliance Tire Israeli American Israeli Paper Israeli Aquitaine Co. of Canada Ltd. Canadian Arwood Corporation Loss Atlas Consolidated Filipino BT Mortgage Investors REIT Beneficial Standard Mortgage REIT Bow Valley Industries Canadian Canadian Homestead Oils Ltd. Canadian Canadian Hydrocarbons Canadian Domtar Ltd. Canadian Euthenics Systems Loss Family Record Plan Inc. Loss Federal Resources Corporation Loss Fidelco Growth Investors REIT Fields Plastics and Chemicals Loss M. H. Fishman Co. Inc. Loss Foodarama Supermarkets Loss Giant Yellowknife Mines Canadian — Hayden Stone Inc. Loss Hudson's Bay Oil and Gas Co. Canadian Hycel, Inc. Loss Interphoto Corp. Loss Larwin Realty REIT LIBCO Corp. Loss Marinduque Mining Filipino Mego International Loss Mortgage Growth Investors REIT Movielab Inc. Loss NJB Prime Investors REIT O'okiep Copper South African Penobscot Shoe Co. Loss Prarie Oil Royalties Canadian Realty Equities Loss Supercrete Ltd. Canadian Unionamerican Mortgage and Equity Trust REIT United National Corp. Loss Wichita Industries Loss Wilson Pharmaceutical and Chemical Loss Zion Foods Loss 128 APPENDIX III COMPUTATION PROCEDURES FOR FEDERAL INCOME TAX RATES In computing the Federal income tax rates (flow-through and normalized), each corporation's income statement was recast as follows if not already in this format: Net income before Federal income taxes xx Federal income taxes: Current xx Deferred xx Total Federal income taxes __ xx Net income i; The "current Federal income taxes: represents the flow- through figure for computational purposes and the "Total Federal income taxes" represents the normalized figure. Each of these figures was divided by "Net income before Federal income taxes" to derive the flow-through and nor- malized Federal income tax rates. This recasting was necessary whenever Federal income taxes were included among the operating expenses or when- ever the income tax section included other taxes in addition to Federal income taxes. Thus, all taxes other than Federal income taxes were considered operating expenses Of the corporation. A good example (though not part of the present study) is Gulf Oil Corporation. Its 1979 income statement includes a $9,723,000,000 item among the Operating expenses entitled "Taxes on income and general taxes." Note 8 to the statements shows the following (all figures in millions of dollars: 129 United States taxes Current income $291 Investment tax credits (51) Deferred income (129) Consumer excise 802 Sales, use, ad valoren and other' ‘212 Total United States taxes 1075 Foreign taxes Current income 2691 Deferred income 98 Consumer excise 692 Sales, use, ad valoren and other 267 Total foreign taxes 3698 $7239 Only the first three items are included in the compu- tation of flow-through and normalized Federal income tax rates; the remaining items are included as operating expenses. Thus, the flow-through Federal income tax is $190,000,000 ($291,000,000 - 51,000,000) and the normalized Federal tax is $61,000,000 ($291,000,000 - 51,000,000 - 129,000,000). The $61,000,000 normalized Federal income tax is then added to the net income figure of $1,065,000,000 to arrive at a net income before Federal income taxes of $1,126,000,000. Recast income statements were also necessary for cor- porations reporting extraordinary items, gains and losses from discontinued operations net of taxes, and prior period adjustments. Items of this nature were restated in the form above and combined in the respective classifications. The major difficulty in recasting these statements involved corporations that reported extraordinary items. Quite often the statements disclosed the income tax effect 130 of the extraordinary items but did not break the figure into its current and deferred components. In such situations, the total tax effect was considered current. The income statement of Dan River Inc. for 1972 illustrates this pro- cedure: Earnings before income taxes $6596 Provision for income taxes 2565 Earnings before extraordinary gain 3981 Extraordinary gain net of $890 income taxes 1160 Net earnings 'l9l The current and deferred Federal income taxes were $1020 and $1087, respectively. Therefore, the flow-through figure became $1860 (1020 + 890); the normalized figure, $2997 (1020 + 890 + 1087); with the denominator at $8088 (5191 + 2997). Federal income tax rates could not be computed for cor- porations that did not disclose Federal and other income taxes. However, if such a breakdown was disclosed the following year, the ammaproportions were assumed to apply to the year of study. For example, Aberdeen Manufacturing Company did not disclose a breakdown between Federal and state income taxes for 1972; for 1973, the provisions for current and deferred state income taxes comprised one-sixth of the provisions for total current and deferred income taxes. Therefore, both the total flow-through and normalized income tax rates were reduced by one-sixth to arrive at the Federal tax rates for 1972, the year of study. Federal income tax rates could not be computed for 131 corporations that did not disclose any of the following items: Federal income taxes per se; a breakdown of Federal income taxes into current and deferred components; or income tax effects of gains or losses from discontinued Operations, extraordinary items, or prior period adjustments. 132 APPENDIX IV QUESTIONNAIRE COLLEGE OF BUSINESS ADMINISTRATION ' UNIVERSITY OF FLORIDA ° GAINESVILLE 326” Accounting Department 904-392-0155 November 1979 Dear Sir: As part of a research project on the financial reporting of corporate income taxes, I need to obtain certain tax information regarding your corporation's 1972 annual report. I was able to obtain most of the data needed on your corporation from published reports with the exception of current and deferred Federal income taxes and the investment credit. Will you please provide the information pertaining to the current and deferred Federal income taxes and the investment credit requested below. You may use the bottom of this sheet and enclose it in the return envelope provided. ‘ This information is required in lO—K reporting to the Securities and Exchange Commission. Thank you for your cooPeration. Sincerely, James R. Hasselback Assistant Professor For the 1972 annual report: Amount of current Federal income tax Amount of deferred Federal income tax Method used in accounting for the investment credit: Flow-through Deferral Amount of investment credit written off in the annual report "EQUAL EMPLOYMENT OPPORTUNITY/AFFIRMATIVE ACTION EMPLOYER" SELECTED BIBLIOGRAPHY SELECTED BIBLIOGRAPHY BOOKS Barr, Anthony James, and Goodnight, James Howard. A User's Guide to the Statistical Analysis System. Raleigh, North Carolina: Student Supply Stores, North Carolina State University, August 1972. Bedford, Norton M. Extension in Accounting Disclosure. Englewood Cliffs, New Jersey: Prentice-Hall., 1973. Carey, John L. The CPA Plans for the Future. New York: AICPA, 1965. Glass, Gene V., and Stanley, Julian C. Statistical Methods in Education and Psychology. Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1970. Goodman, Hortense, and Lorensen, Leonard. Illustrations of Interperiod Tax Allocation. New York; AICPA, 1979. Janson, Ernest C., MacLean, John A., and Wright, David T. Financial Reporting and Tax Practices in Nonferrous Mining, 3rd Edition. New York: Coopers 8 Lybrand, 1979. Lorie, James H., and Hamilton, Mary T. The Stock Market: Theories and Evidence. Homewood, Illinois: Richard D. Irwin, Inc., 1973. Mautz, R. K. Financial Reporting by Diversified Companies. New York: Financial Executives Research Foundation, 1968. Nurnberg, Hugo. Cash Movements Analysis of the Accounting for Corporate Income Taxes. East Lansing, Michigan: Division of Research, Graduate School of Business Administration, Michigan State University, 1971. Siegel, Sidney. Nonparametric Statistics for the Behaviorial Sciences. New York: McGraw-Hill, 1956. Snedecor, George W., and Cochran, William G. Statistical Methods, 6th Edition. Ames, Iowa: Iowa State Univer- Slty Press, 1967. 133 139 Stern, Philip M. The Rape of the Taxpayer. New York: Random House, 1973} ARTICLES AND PERIODICALS Adlman, Monroe. "Accounting for Income Taxes-~Effect on Corporate Earnings." The Tax Executive (October, 1968), 1-7. Beaver, William H., Kennelly, John W., and Voss, William M. "Predictive Ability as a Criterion for the Evaluation Of Accounting Data." The Accounting Review (October, 1968), 675—683. Benston, George J. "The Value of the SEC's Accounting Dis- closure Requirements." The Accounting Review (July, 1969), 515—532. Cochran, W. G. "The Chi-Square Test of Goodness of Fit." Annuals of Mathematical Statistics (Volume XXIII, 1952), 315-395. Coleman, Almand R. "Controversial Areas of Corporate Re- porting Practices." Financial Executive (October, 1969), 36-91. Comiskey, Eugene E., and Hasselback, James R. "Analyzing the Profit Tax Relationship." Financial Management (Winter, 1973), 57-62. Corcoran, W. Waune, and Leininger, Wayne E., Jr. "Finan- cial Statements--Who Needs Them?" Financial Executive Cushing, Barry E., and Deakin, Edward B. "Firms Making Accounting Changes: A Comment." The Accounting Review (January, 1979), 109-111. Dasher, Paul E., and Copeland, Ronald M. "Some Further Evidence on 'Criteria for Judging Disclosure Improve- ment'." Journal of Accounting Research (Spring, 1971), 32-37. Davidson, Sidney. "Accounting and Financial Reporting in the Seventies." The Journal of Accountancy(December, 1969), 29-37. Frishkoff, Paul. "An Empirical Investigation of the Concept of Materiality in Accounting." 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AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS Accounting Principles Board, Opinion No. 2, "Accounting for the Investment Credit," New York, November, 1962. _, Opinion No. 9, "Accounting for the Investment Credit,: New York, March, 1969. , Opinion NO. 11, "Accounting for Income Taxes," New York, March, 1969. , Opinion No. 23, "Accounting for Income Taxes-- Special Areas," New York, April, 1972. , Opinion No. 29, "Accounting for Income Taxes-- Investments in Common Stock Accounted for by the Equity Method (Other than Subsidiaries and Corporate Joint Ventures)," New York, April, 1972. , Opinion NO. 30, "Reporting the Results of Operations --Reporting the effects of disposal of a segment of a business, and extraordinary, unusual and infrequently occurring events and transactions," New York, June, 1973. Auditing Standards and Procedures, New York, 1963. 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