Aggressive Tax Spending Leads to Fewer Restatements

Companies that engage their audit firm for significant tax consulting services are less prone to revising their financial statements, an American Accounting Association study has found.

"Companies that spend a large amount on tax services from their audit firm typically had fewer restatements than those who spent small amounts or zero," the study said.

Tax services were spared in the Sarbanes-Oxley Act and subsequent Securities and Exchange Commission interpretations of the law, which sought to eliminate conflicts of interest between accounting firms’ consulting and auditing arms. Members of Congress and other groups argued that providing tax services would put consultants in the position of auditing their own work or being an advocate for their client during the audit.

During the development of Sarbanes-Oxley and the SEC rules, the Big 4 accounting firms lobbied heavily to keep their tax practices, which account for about one-fifth of their revenue. The SEC’s rule allows audit firms to offer tax compliance, tax planning and tax advice as long as the client’s board pre-approves the arrangement.

The AAA study suggests that the practice of auditing tax services may actually improve a company’s audit results.

"Our tax services results do not support that substantial tax services fees to the auditor's firm create an economic dependence on the client that necessarily leads to lax GAAP (generally accepted accounting principles) enforcement by the auditor," the study stated.

The study, "In Auditor Independence and Non-Audit Services: What Do Restatements Suggest," looked at the audit fee data from 944 firms, spanning 1995 to 2000, before Enron, WorldCom and Global Crossing bankruptcies resulted in new bans on the kind of consulting work auditors could do.

The study group was comprised of 432 companies that announced restatements, which was compared against 512 companies that had the same auditor and similar revenue, but didn't restate earnings.

The seven largest U.S. accounting firms provided the data on a confidential agreement. The data comes from a 2001 ruling that required public companies to disclose what they spent on auditors and non-audit fees each year.

The study’s authors are William Kinney, University of Texas, Zoe-Vonnna Palmrose, University of Southern California, and Susan Scholz, University of Kansas.

The American Accounting Association, an academic research and education-based group in Sarasota, FL funded the study.