（2007）Material Weaknesses in Tax-Related Internal Controls and Earnings Management.pdfVIP

Material Weaknesses in Tax-Related Internal Controls and Earnings Management Cristi Gleason Tippie School of Business University of Iowa Morton Pincus Merage School of Business University of California, Irvine and Sonja Olhoft Rego Tippie School of Business University of Iowa September 6, 2007 Preliminary and incomplete. Please do not quote without permission from authors. Material Weaknesses in Tax-Related Internal Controls and Earnings Management I. Introduction As mandated by the Sarbanes-Oxley Act (SOX) of 2002, publicly traded companies must disclose material weaknesses in their internal controls for financial reporting. Initial disclosures indicate that one of the most common areas reflecting material internal control weaknesses is that of income tax reporting (Audit Analytics database; KPMG 2006, 23-24). Prior to SOX, corporate tax departments primarily focused on minimizing effective tax rates and tax liabilities, and companies often lacked meaningful internal controls over their tax function. This changed with the enactment of SOX. Firms have expanded the scope and documentation of their internal controls in the tax area (KPMG 2006, 15), and the presumption is that such actions will lead to more accurate and reliable financial reporting.1 In this study, we examine the impact of material weaknesses in tax-related internal controls on financial reporting. First, we investigate whether earnings management using the income tax accrual is more prevalent for firms