Title

Income Statement Reporting Discretion Allowed by FIN 48: Interest and Penalty Expense Classification

Department

School of Accountancy

Document Type

Article

Publication Date

Spring 2017

Embargo Period

7-18-2018

Abstract

Financial Accounting Standards Board Interpretation No. 48 (FIN 48, FASB 2006) allows discretion regarding the income statement classification of interest and penalty expenses for unrecognized tax benefits (UTBs). We investigate whether tax avoidance, management compensation, and debt agreements affect the expense classification election and whether this discretion has implications for financial statement users. We find firms that engage in tax avoidance activities, measured by effective tax rates (ETRs) and involvement in tax disputes, are more likely to include interest and penalties in tax expense. We also find that interest and penalties are more likely to be classified as tax expense when CEO compensation is more sensitive to pre-tax income. Finally, we find that UTB interest and penalty expense classification is associated with analysts' ETR forecast accuracy, which suggests there is a potential unintended consequence related to decision usefulness of FIN 48 reporting due to expense classification discretion.

Journal Title

The Journal of the American Taxation Association

Journal ISSN

0198-9073

Volume

39

Issue

1

First Page

45

Last Page

66

Digital Object Identifier (DOI)

10.2308/atax-51542

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