The impact of tax optimization and temporary differences on earnings management: The case of Vietnam

This study also aims at illustrating that other indicators relating to differences between accounting and taxable profit do not leave any remarkable impacts on the model. This means that enterprises operating in the industrial sector do not use or rarely use those indicators to implement EM Sapo. Đề tài Hoàn thiện công tác quản trị nhân sự tại Công ty TNHH Mộc Khải Tuyên được nghiên cứu nhằm giúp công ty TNHH Mộc Khải Tuyên làm rõ được thực trạng công tác quản trị nhân sự trong công ty như thế nào từ đó đề ra các giải pháp giúp công ty hoàn thiện công tác quản trị nhân sự tốt hơn trong thời gian tới.

The impact of tax optimization and temporary differences

on earnings management: The case of Vietnam

Nguyen, Dieu Linh 1 , Hoang, Thi Thu 2

1, 2 Banking Academy of Vietnam

* Corresponding author.

E-mail address: linhnd@hvnh.edu.vn (Nguyen, D.L.), hoangthu2k1tn@gmail.com (Hoang, T.T.)

1 Introduction

Earning management is one of the topics

that many economists are interested in when they assess the transparency of information published in a business’s annual

report, especially in the context of economic

instability such as natural disasters,

epidem-ics, etc and through the strong development

the tech sector Many businesses are willing to

adjust business results to achieve profit

tar-gets and desired debt ratios, thereby indirectly

influencing the decisions of shareholders and

investors

A company’s goal is to maximize its

share-holders’ profit, while the state’s goal is to

maximize taxation income So, a company will take necessary steps to minimize their taxes through legal means, this process is called tax planning (Dewi, Nuraina and Amah, 2017)

Previously local and international researchers have produced literature analyzing the motives behind earning management practices Jensen and Meckling (1976) attempted to illustrate the motive of agents (management) making decisions to maximize their personal benefits

The principal is the owner of the business who delegates responsibilities to the agents to who would run it This theory explains the conflict

of interest between the two parties, where the principal prioritizes the long-term wellbeing

of the firm while the agent prioritizes personal

strat-egies used by Vietnamese companies for earning management through the use of temporary difference between accounting and taxable profit

Following the model of Cindy (2021), we leverage quantitative methods, built models and tested the impact of 08 factors on earning management (EM), tax optimization (ETR), deferred tax asset (DTA), deferred tax liability (DTL), deferred tax expense (DTE), company size (SIZE), financial leverage (LEV), return on assets (ROA), cash flow from operating activities (CFO)

The sample we selected were 113 industrial enterprises operating in mul-tiple sectors listed on the Vietnam Stock Exchange in the period between 2016-2020 Empirical results our sample have shown that earning manage-ment (EM) may be affected by DTA, ROA, cash flow from operating activi-ties, and financial leverage under various motives This study also aims at illustrating that other indicators relating to differences between account-ing and taxable profit do not leave any remarkable impacts on the model

This means that enterprises operating in the industrial sector do not use or rarely use those indicators to implement EM Sapo.

Received

Revised

Accepted

19 th Apr 2023

28 th Nov 2023

28 th Nov 2023

Keywords

deferred income tax

deferred tax assets

earning management

difference between

accounting and

taxable profit

tax optimization

DOI:

10.59276/JEBS.2023.12.2531

benefits The agents are incentivized to

maxi-mize firm performance to earn higher bonuses

Watts and Zimmerman derived positive

ac-counting theory in 1978 based on Jensen and

Mecsskling’s agency theory This theory tries

to predict accounting policies taken by the

agents in different scenarios The agents will

maximize profits to get bonuses or when they

must fulfill agreements such as debt covenants

The agent will minimize profits to minimize

compliance costs, which include taxes

In accounting and taxation rules, there are

grey areas that allow agents to have subjective

freedom such as using judgment which has

no other basis other than the agents’ opinion

Deferred tax accounts show up because of the

differences between accounting and taxation

rules, these differences are called temporary

differences A larger temporary difference

can indicate more liberal accounting policies

(Hawkins, 1998 within Yulianti, 2005)

Com-pany tax subjects are required to make fiscal

financial income statement Filing taxes based

on the fiscal income statement requires

adjust-ments as there are differences in accounting

rules as compared to tax laws, particularly in

income and expense recognition, as well as

tax laws attempting to incentivizing certain

behaviors and discouraging others The gains/

loss in fiscal income statement is the basis

that the government relies on to impose tax on

these firms The differences between fiscal and

accounting gains/losses are reported in three

temporary differences accounts which are:

de-ferred tax asset, dede-ferred tax liability, dede-ferred

tax expense Deferred tax assets show up when

accounting gains is lower than fiscal gains, so

the current tax expense is higher than

account-ing tax expense The rule requires companies

to evaluate the amount of this account at the

end of every period Deferred tax liability

shows up when accounting gains is higher than

fiscal gains, making the current tax expense

lower than accounting tax expense Deferred

tax expense shows up when accounting gains

is higher than fiscal gains, making the current

tax expense lower than accounting tax expense

PSAK 46 also gives freedom to the company

to defer their taxes (Yulianti, 2005)

The different characteristics in each temporary difference account can potentially be used to indicate the direction of earning management that was performed The different character-istics of each temporary differences account have the potential to indicate the direction

in which earning management is moving

Because of their characteristics, deferred tax assets have the potential to indicate down-wards earning management while deferred tax liability has the potential to indicate upwards earning management Though it is possible that these temporary differences arise purely due to the different policies used for accounting and for fiscal purposes As explained by the agency theory, the company is motivated to maximize its profits, one of the ways to achieve that is

by minimizing tax expenses This is when the company uses the rules and facilities that are available (such as loss compensations and free zones) to minimize the taxes they need to pay

With those facilities and rules, a company can manipulate its financial statement to achieve minimization in taxes they are obligated to pay

Previous researchers found that tax planning has a significant effect to earning management

as one of the ways to lessen taxes using the facilities and rules is by earning management (Baraja, Basri, Sasmi, 2017; Dewi et al, 2017;

Hapsari and Manzilah, 2016; Lubis and Sury-ani, 2018; Santana and Wirakusuma, 2016)

Other researchers found that tax planning has

no significant effect to earning management due

to companies evading tax using illegal means, which are harder to detect (Aditama and Pur-waningsih, 2014; Ifada and Wulandari, 2015)

Previous research about the effect of temporary difference towards earning management also found differing results Some found temporary difference accounts have significant effect to temporary difference and can be used to detect earning management done by a firm due to some subjectivityin deferring taxes (Astutik and Mildawati, 2016; Baraja et al, 2019; Fajri and Mayangsari, 2012; Sutadipraja, Ningsih and Mardianac, 2020; Yulianti, 2005) Lu (2002) found deferred tax assets can be used by firms to

perform big bath earning management Philips,

Pincus and Rego (2003) found earning

manage-ment can be detected using deferred tax expense

when firms are avoiding loss While other

re-search found temporary difference, accounts are

not able to do so as there are risks to reporting

high temporary difference such as users of the

financial report questioning the credibility of the

report (Sibarani, Hidayat and Surtikanti, 2015;

Suranggane, 2007; Utami and Malik, 2015)

Using quantitative methods, the purpose of this

study is to analyze the relationship between tax

optimization and temporary differences

affect-ing profit management at Vietnamese industrial

enterprises The article consists of 5 parts,

structured as follows: Introduction; Theoretical

framework; Research methodology; Results

and discussion; Conclusion

2 Theoretical framework

2.1 Related Concepts

Earning management is when a firm uses the

grey area in accounting rules to alter the

con-tent of financial report so it better reflects what

the company wants to portray, rather than the

objective truth It is “a deliberate intervention

in the financial disclosure process to achieve

personal goals” (Schipper, 1989)

Healy and Wahlen (1999) argue that earning

management will occur when managers take

advantage of accounting rules or internal

trans-actions to influence financial statements to make

the users of financial statements misunderstand

the operation situation of the company

Earning management reflects the actions of

managers in choosing accounting policies to

benefit or increase the market value of the

company (Scott, 1997)

A temporary difference is the difference between

the carrying amount of an asset or liability in

the Balance Sheet and the tax base of that

as-set or liability (based on paragraph No 3, 4 in

Vietnamese Accounting Standard No 17 (VAS

17)) In which, the income tax base of an asset

or liability is the value calculated for the asset or

liability to determine corporate income tax

Tax optimization is an action to minimize tax liability by preparing technical financial statements so that the amount of tax payable

is as low as possible Tax planning variables are measured using the tax withholding ratio formula, which is a measure of tax manage-ment efficiency in the current year’s financial statements (Aditama & Purwaningsih, 2014)

Tax planning is part of tax administration and is the first step in tax administration (Aditama and Purwaningsih, 2014) Tax planning is to be able

to select all types of tax savings measures taken

by the company and ensure that its implementa-tion has met the applicable tax regulaimplementa-tions That

is the ultimate goal of the tax filing process

Tax planning is about creating minimal tax debt

by not violating applicable tax regulations In this concept, tax planning variables measured using tax retention rates are used to measure the effectiveness of corporate tax planning This measure of variability refers to the study that was done by Widiatmoko and Ika (2016)

According to Erly Suandy (2014), in his book titled “Tax planning”, said that tax planning is the first step in tax management At this stage, the collections and studies of tax regulations that can be selected for the type of tax savings measure will be carried out In general, the em-phasis of tax planning to minimize tax liability

Cindy Lysta Tartono (2021) found that only deferred tax liabilities have significant im-pact on earning management It can be used

to detect earning management upwards Tax planning affects absolute earning management without specific direction Deferred tax assets

do not have a significant impact to detect earn-ing management downwards and deferred tax expense has no significant impact to earning management but can potentially detect earning management upwards in extreme cases

In Vietnam, researches by Khanh and Thu (2019) on the relationship between financial leverage and profit management has demon-strated a positive relationship between them

Enterprises with high financial leverage tend

to reduce their profit management through accruals In addition, the study also shows the impact of other factors such as cash flow from

operating activities (CFO), revenue growth,

and fixed assets of the enterprise

Nguyen Cong Phuong and Pham Dinh Tuan

(2019) pointed out that when debt pressure

increases, profit management also increases

Specifically, with 1,349 enterprises listed on

the stock market between 2010 and 2018, the

adjusted profit increased when enterprises had

large short-term debts or increased debt

bal-ance compared to last year On the contrary,

adjusted profit is reduced when enterprises

have high long-term debt

The positive effect of the debt ratio on the

ac-crual variable is also pointed out by Nguyen

Ha Linh (2017) with 2,132 observations from

non-financial enterprises on the Vietnam Stock

Exchange Tran Thi Hong Diem (2021) also

studies the impact of financial leverage on

profit management, the results show a

nega-tive relationship between debt ratio and accrual

accounts In 131 enterprises (393 observations)

in the period 2017-2019, when the debt ratio

increases, enterprises tend to reduce their profit

management actions The study also shows the

positive impact between return on asset (ROA)

on earning management and the opposite

direc-tion between cash flow from operating

activi-ties (CFO) to profit management

A synthesis of studies in Vietnam shows that

new studies address and focus on analyzing the

impact on earning management through debt

ra-tio and financial leverage We expand and delve

into 08 factors (Tax Optimization (ETR);

De-ferred Tax Asset (DTA), DeDe-ferred Tax Liability

(DTL), Deferred Tax Expense (DTE), Company

size (SIZE), Financial Leverage (LEV), Return

on Assets (ROA), Cash flow from operating

activities (CFO) to earning management (EM))

to find out the maximum impact Tax

optimiza-tion and temporary difference between

account-ing and tax on profit management in enterprises

listed on Vietnam stock exchange

2.2 Theory explains the relationship between

shareholders and managers

Jensen Mackling (1976) formulated this theory

intending to explain the relationship between

investors and executives in a business Share-holders will appoint administrators to run the business and delegate decisions to managers in business matters of the enterprise The problem concerning the disparity of interests has risen when business executives tend to make deci-sions that do not guarantee the benefit of the company as a whole, but instead for their own personal benefit Information asymmetry occurs because executives know more about the inter-nal business of the business than those outside the company such as shareholders (Morris, 1987) The consequences of this asymmetric in-formation allow managers to perform behaviors that affect the profitability of enterprises so that financial information on financial statements benefits individual managers

2.3 Positive Economic Theory

Watts and Zimmerman (1978) constructed and developed Positive Economic Theory intend-ing to predict how accountintend-ing rules would be adopted by enterprises Administrators can implement earning-increasing management to diversify the financial position of the business

so that they can earn more bonuses through ad-justments to increase deferred tax expenses in the current period, to create temporary differ-ences between accounting and withholding

tax-es that form deferred tax assets and enterpristax-es will earn in the future, showing that in the future enterprises will report lower deferred tax expense, ostensibly showing the governance

of good managers through reducing costs for enterprises, the qualifications of managers will

be recognized thereby improving their bonus amount from the company

With the impulse of minimizing state budget payable expenses, companies will implement tax optimization using existing principles and regulations to adjust so that the company will only have to pay as little amount of tax as pos-sible while still satisfying the regulations of the enterprise The implementation of EMs with the aim of optimizing taxes for enterprises benefits not only managers but also shareholders be-cause if the expense for tax is high, the dividend

distributed to shareholders will be reduced.

2.4 Theory of deferred tax (including

de-ferred tax expenses, dede-ferred tax liability,

deferred tax asset) and provisions in Vietnam

Because of the difference in the recognition of

expenses and revenues between accounting and

taxes, as well as taxable income and

account-ing income differs, resultaccount-ing in differences

between the amount of taxes payable and taxes

in the accounting books Accounting standards

have more detailed guidelines on expenses and

income than tax authorities’ regulations The

differences that make up the temporary deviance

will be reported in the financial statements in the

deferred tax assets, tax liability and deferred tax

expenses, as shown in Figure 1

A company may report deferred tax assets

or deferred tax liability or both Deferred tax

expenses are different from deferred tax assets

or deferred tax liability because the other two

accounts are cumulative, while deferred tax

expense accounts are reflective of the tax

ex-penses of the current accounting period When

deferred tax expense is negative, it means

that the company reports deferred tax assets

Deferred tax assets represent taxable income

higher than accounting earning at the current period, therefore in the future, the company will have a deferred tax assets deduction to reduce future taxes or reduce the amount of defered tax liability

2.5 Theory of tax-optimized activity

Tax optimization is when a business minimizes the amount of tax payable by using available tools and regulations A company will review all current principles and regulations and choose one that reduces most of the taxes it has

to pay (Astutik and Mildawati (2016)) Slem-rod (2004) found that it is difficult to determine the amount of tax optimized by a company that performs tax optimization according to legal

or illegal behavior (tax evasion) However, this study will not focus on the differences between the two methods of implementing tax opti-mization and ways to detect how to optimize taxes because that requires a broader scope of research

2.6 Theory of earning management behavior

in enterprises

Earning management is when a business exploit

Source: Cindy (2021)

Figure 1 Temporary spreads

the vulnerability in accounting standards to

mold the indicators in the financial statements

so that it reflects what the company want rather

than the truth Opportunistic earning

manage-ment is a type of earning managemanage-ment that has

the potential to mislead shareholders about the

financial position of a business (Holthausen and

Leftwich, 1983 and Beneish, 2001) Meanwhile,

efficient earning management is when earning

management maximizes the information on

financial statements for those who use relevant

information (Siregar and Utama, 2008) There

are two types of earning management: actual

earning management and cumulative

earn-ing management Actual earnearn-ing management

is harder to detect and also more expensive

(Cohen, Dey and Lys, 2008) Cumulative

earn-ing management is when a business manager

chooses accounting principles to manage

earn-ing (Braam et al, 2015)

An administrator can prepare one financial

statement with different motives According to

Scott (2003, 2017) here are 4 types of earning

management:

+ Manipulating financial statements: When

there is pressure such as changing board

mem-bers, new board members will tend to lower

the profitability of the first year of their tenure

to act as if the financial situation is progressing

well during their tenure

+ Minimum earning: Minimize earnings

because of the state’s expenses payable such

as taxes This type is usually implemented by

companies with a good financial situation as

well as the administrator who retains the profits

of the enterprise during the highly profitable

years and then gradually allocates to the years

when the business is losing money to avoid

having to pay state payables

+ Earning maximization: Earning maximization

is driven by managers who want more bonuses

from the company’s performance or when the

company wants to borrow capital to operate

+ Recognizing expenses and income period:

Both are used to maximize or minimize

earn-ings Minimizing earnings is enacted by

delay-ing revenue recognition and early expense

recognition, and vice versa

3 Research methodology

3.1 Research model

Based on the above theories, we have built 08 in-dependent variables (Tax optimization, Deferred tax asset, Deferred tax liability, Deferred tax ex-pense, Company size, Financial leverage, Return

on asset, Cash flow from operating activities and

01 dependent variable (Earning Management)

in the model that to research the impact of tax optimization and temporary disparity on income management in Vietnamese firms

The research’s quantitative model and vari-ables’ scales are based on the model of Cindy Lystia Tartono (2021)

EM = α + β1ETR + β2DTA + β3DTLit + β4DTEit + β5SIZEit + β6LEVit + β7ROAit + β8CFOit + Eit (1)

3.2 Measure variables

The study used the Modified Jones (1995)’s model to detect the EM levels of each enter-prise The EM level is measured by the discre-sionary accrual variable of the enterprises The model is presented and implemented as follows:

DAt(At-1)-1 = TAt (At-1)-1 − NDAt(At-1)-1 (2) Inside:

DAt: Discresionary accrual of enterprises in year t

NDAt: Non-discresionary accrual of enteprises year t

TAt: Total accrual of enterprises

TAt = Net revenue from sales of goods and provision of services − Net cash flow from

At-1: Total assets of enterprise in year t-1 Thus, to detect the level of EM, the study uses the following equation to determine the non-self-defined accrual accounting variable of the enterprise according to the model:

NDAt (At-1)-1 = α1 (At-1)-1 + α2 (∆REVt − ∆RECt) (At-1)-1 + α3PPEt(At-1)-1 (4) Inside:

∆RECt = Annual customer receivables year t – Annual customer receivables year (t−1)

∆REVt = Revenue from the yearly contract t−

Revenue from the yearly contract (t−1)

PPEt: Fluctuations in tangible fixed assets of

enterprises in the year t

To determine the variable “discresionary

ac-crual”, the study uses model (4) to perform

parameter estimates a1, a2, a3 After that, the

au-thors put the estimated parameters into model

(3) for each enterprise to determine the

non-discresionary accrual variable NDAt(At-1)-1

TAt(At-1)-1 = a1(At-1)-1 + a2 (∆REVt − ∆RECt)

(At-1)-1 + a3PPEt(At-1)-1 (5)

Finally, we determine the discresionary accrual

variable DAt(At-1)-1 based on the formula (1)

Depending on the results of the calculations, it

is possible to conclude for EM in some cases

as follows:

DAt(At-1)-1 < 0: The enterprise adjusts to

re-duce earning

DAt(At-1)-1 > 0: The enterprise adjusts to

in-crease earning

DAt(At-1)-1 = 0: The enterprises does not adjust

earning

3.3 Research hypotheses

The hypotheticals and impact dimensions of factors relating to the temporary difference between accounting and taxation, tax optimiza-tion and EM are shown in Figure 2

H1: Tax optimization affects positively earning management

H2: Deferred tax assets have a countervailing effect on earning management

H3: Deferred tax liability affects positively earning management

H4: Deferred tax expense has a positive impact

on earning management

H5: Financial leverage affects positively earn-ing management

H6: Cash flow from operating activities affects negatively earning management

H7: The size of the business affects positively earning management

H8: Return on asset affects positively to earn-ing management

3.4 Data collection

Secondary data is collected from individual financial statements of industrial enterprises

Table 1 Research scale of variables

Dependent variable

Independent variables

Yourke et al (2016)

(2019)

Ekawati (2016)

Hanna (2014)

Source: Cindy (2021)

listed firms on the Vietnam Stock Exchange in

the period from 2015 to 2020 with the sources

from FiinPro and CafeF Using secondary data

collected during data collection, the research

team coded it in excel, and then put it into

Sta-ta software for processing Content includes:

Step 1: Descriptive statistics Describe the

basic characteristics of the collected data or the research sample of the model

Step 2: On Stata software, perform linear re-gression for 8 independent variables; consider the criteria from the research results including R-square, P-value to remove variables that are not statistically significant

Table 2 Sample description

Manufacturing enterprises listed on the

Vietnam Stock Exchange in the period

Enterprises without enough information in

Uncontinuously operating enterprises in

Source: Self-syntheses from FiinPro and CafeF Source: Self-syntheses based on literature review

Figure 2 Research hypotheses

Step 3: Conduct the test and fix the defects

after removing the independent variables that

are not statistically significant

Step 4: Analyze the regression results;

build-ing equations representbuild-ing the relationship

between independent and dependent variables,

considering research hypotheses

The number of qualified samples is 113

enter-prises in the industrial sector with 94

observa-tions (Table 2) Once the data was collected,

the team filtered and encoded the variables and

processed the data on Stata 16

4 Results and discussion

4.1 Statistical results describing variables

We use statistical methods in order to

con-veniently compare and summarize data The

descriptive statictical data is represented as

follow Table 3

The EM index of enterprises listed on the

Vietnam Stock Exchange in the period of

2015-2020 has the mean value of 0.79% with

the maximum of 159.8% and the minimum of

-68.98% It can be seen that there’s a

signifi-cant difference among enterprises operating in

the industrial sector referring to the situation

of earning management through discrestionary

variables

The result shows that there are significant

ef-fects of deferred tax assets, Return on asset,

cash flow from business activities and financial leverage on EM, as:

The deferred tax assets (DTA) has a mean value of 3.57 ranging from -1 to 210.1141

This is a large range with a standard deviation

of 22.91 It means that the deferred tax assets

of enterprises operating in the industrial sector has an increase rate from -100% to 210114.1%

The enterprises has an increase of 35.7% on average This shows that there is a momentus difference in the rate of increase in deferred tax assets over the years of research between enterprises operating in the industrial sector

On the other hand, defered tax asset has the op-posite effect on the EM activities of enterprises operating in the industrial sector

Cash flow from operating activities has a nega-tive impact on the EMs of enterprises operat-ing in the industrial sector in Vietnam The ratio of cash flow from operating activities to assets among enterprises reached an average

of 0.082 with a standard deviation of 0.15 The highest value achieved is 1.45 and the lowest

is -1.02, showing the efficiency of conversing assets into generating cash flow for enterprises operating in the industrial sector is not high, however, these figures do not pose much differ-ence among enterprises

The return on asset of industrial enterprises has

a favorable effect on earning management The control variable ROA reached a mean of 12%

with a standard deviation of 1.28, the lowest

Table 3 Descriptive statistical results

Source: Results from Stata 16 software

value achieved was 0.38% and the highest at

1655.4% showed that the difference in the ratio

of earning after tax and average total assets

among enterprises is significant The reason

may be due to the growth rate of total assets,

the operating performance and the

manage-ment efficiency among enterprises contribute

to a major difference However, the majority of

enterprises operating in the field have low asset

management efficiency at around 12%

Financial leverage has a negative impact on

earning management at enterprises

operat-ing in the industrial sector in Vietnam The

lowest and highest financial leverage value

is 0.000063 and 6.78, respectively, which

indicates that there is a substantial difference

among enterprises This also represent that the

proportion of liabilities to total assets in the

indusstrial enterprises ranges from 0.0063%

to 67.8%, mainly around 44.6%, which means

that the majority of industrial enterprises apply

financial leverage to increase production and

business motivation

Based on the primary result of OLS model,

though Significance-F coefficient is equal to

0.0000 (less than 0.05), the DTL variable is

ignored due to the presence of collinearity in

the data Thus, it can be concluded that the three

independent variables DTE, SIZE, ETR have

no significance or that the level of significance

is not enough for the model To overcome and build a regression model, we proceeded to remove variables that were invalid and variables that were ignored due to collinearity in the data

From the results of the above linear regression, the study proceeded to remove 04 variables that are not significant for the study model as DTL; ETR; SIZE; DTE and conduct linear regression tests for the remaining 4 variables:

DTA; ROA; LEV; CFO

4.2 Analysis of regression results

The OLS model results (ordinary least squares)- Table 4 shows that the Significance-F coefficient is equal to 0.0000 (less than 0.05), which explains the meaningful study modeling

The R-squared value of 0.3758 represents 37.58% of the change in the dependent vari-able which happened due to the independent variables and control variables in the model

The results from the OLS test also show, with

a significance level of 5%, that the 4 variables selected by the study all satisfy the significance level of P-value

Considering the Coef value from the regression results, the DTA and CFO may have the oppo-site effect on EM with regression coefficients

of -0.0014 and -0.578, respectively Therefore, when the DTA variable and CFO increase by

Table 4 Regression result for 4 variables: DTA, ROA, LEV, CFO

Source: Results from Stata 16 software