The Valuation Allowance for Deferred Tax Assets－Information Content and Earnings Management－

The valuation allowance for deferred tax assets is an estimate of the portion of deferred tax assets that is not realizable because of insufficient future taxable income. Changes in the valuation allowance contain incremental information content, in addition to publicly available information, in predicting future income. However, changes in the valuation allowance for firms that likely manage earnings through their valuation allowance accounts are less associated with future income than for non－earnings management firms, implying that managers manipulate the valuation allowance to manage earnings. These findings of this study have mixed implications for accounting standard setters and regulators. Incremental information content of the valuation allowance found here suggests that mandating recognition of forward－looking information in financial statements has the potential to make these statements more informative. On the other hand, earnings management implication of the valuation allowance, which is also found here, implies managers’ ability to fool investors through opportunistic manipulation and a potential to make the financial statements less informative. Korean GAAP does not require firms to report the valuation allowance for deferred tax assets. Considering the properties of deferred tax assets, information contents and earnings management, the disclosure of the valuation allowance for deferred tax assets is expected to improve the usefulness of financial information.