Journal of Business Finance & Accounting, 32(5) & (6), June/July 2005, 0306-686X

Determinants of the Accounting

Change for Income Tax

NORMAN WONG*

Abstract: This study examines determinants of the decision of New Zealand

firms to change their income tax accounting method from comprehensive to
partial allocation. New Zealand provides a unique setting to investigate this
issue because it allows firms the choice to use either the comprehensive or
partial allocation procedures to account for income tax. I find that efficient
contracting and debt-related opportunistic factors are both important deter-
minants that influence firms decisions to change to partial. Specifically, the
results indicate that the change is related to the extent of investment in
depreciable assets and the closeness of firms to their debt covenant
restrictions.
Keywords: accounting changes, income tax, efficient contracting, opportun-
ism, regulation

* The author is from the University of Aukland. This study is based on his PhD thesis at
the University of Auckland. He would especially like to thank the anonymous referee
and the following people for their helpful comments: Jilnaught Wong and David
Emanuel (supervisors), Henk Berkman, Jerry Bowman, Mike Bradbury, Philip
Brown, Dan Dhaliwal, Jayne Godfrey, Alister Hunt, Michael Keenan, Paul Koch,
Richard Morris, Steve Rock, Paul Rouse, Greg Schwann, Phil Shane, Baljit Sidhu,
Barry Spicer, Stephen Taylor, Robert Wilton, Ian Zimmer, and seminar participants
at the University of Auckland, the AAANZ Doctoral Colloquium in Tasmania, and the
Annual Summer Research School in Financial Reporting and Corporate Governance,
jointly sponsored by the University of Sydney and the University of Technology,
Sydney. He would also like to thank Margaret Tibbles for her assistance in locating a
number of annual reports that were needed in the study. (Paper received September
2003, revised and accepted June 2004)
Address for correspondence: Norman Wong, Department of Accounting and Finance,
Faculty of Business and Economics, The University of Auckland, Private Bag 92019,
Auckland, New Zealand.
e-mail: n.wong@auckland.ac.nz

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1. INTRODUCTION

In this study, I examine determinants of the decision of New

Zealand firms to change their income tax accounting method
from comprehensive to partial allocation, which generally has
the effect of reducing income tax expense, increasing earnings
after tax, and reducing the deferred tax liability.1 The New
Zealand institutional setting provides a unique setting to inves-
tigate this issue because it allows firms the choice to account for
income tax using either the comprehensive or partial allocation
procedures (respectively, to be referred to as comprehensive
and partial from here onwards). Other major accounting
jurisdictions, including the US, Canada and Australia, mandate the
use of comprehensive only (with very few exceptions), a position
required currently by the International Accounting Standards
Board in International Accounting Standard (IAS) 12.
I hypothesize that efficient contracting and opportunistic
factors influence firms decisions to change their income tax
policy from comprehensive to partial. The efficient contracting
perspective contends that policy decisions made by firms, includ-
ing accounting choices, maximize firm value (Watts, 1977; Ball,
1989; and Watts and Zimmerman, 1990). With respect to account-
ing policy choices, this perspective argues that companies change
to new procedures if the existing procedures provide inefficient
measures of financial performance and financial position for
accounting and contracting purposes. On the other hand, the
opportunistic view suggests that firms choose their accounting
policies so as to exploit wealth transfers between claimants of
the firm (Watts and Zimmerman, 1986 and 1990). When this
happens, firm value is not maximised because there is intent to
distort, manipulate, or misrepresent accounting information.
Overall, I find that efficient contracting and debt-related
opportunistic factors are both important determinants in the
decision of New Zealand firms to change their income tax
method from comprehensive to partial. In particular, the

1 This occurs because partial tax allocation only recognizes timing differences, the items
that give rise to the deferred tax liability, that are expected to reverse in the foreseeable
future in the calculation of income tax (i.e., deferred tax liabilities that are unlikely to be
paid are not recognized). In comprehensive tax allocation, all timing differences are
recognized no matter if they reverse or not.

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 DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX 1173

results indicate that firms decisions to change to partial is

related to the extent of investment in depreciable assets and
the closeness of firms to their debt covenant restrictions.
This study contributes to the accounting literature in two
ways. First, the study provides improvements to the design of
this type of research. In particular, by concentrating on firms
that change accounting policy over time, the study provides a
research methodology to investigate more compellingly the
explanations for any effects that are observed, rather than just
documenting the existence of an effect (if it exists) (Ball and
Foster, 1982, p. 209). Second, the studys empirical results
provide important implications for standard setting.
Specifically, if policy makers restrict accounting method choices
that are efficient from the accepted set of accounting pro-
cedures because they believe these to be opportunistic, then
promulgation of these regulations would be counter-productive
to firm value maximization (Zimmer, 1989; Mian and Smith,
1990; Christie, 1992; Wong, 1992; and Swieringa, 1998). New
Zealand provides an ideal setting to consider this, because sug-
gestions have been made to mandate comprehensive as the only
method for accounting for income tax (Institute of Chartered
Accountants, 1996). While the evidence in this study suggests
that the decision to change to partial is due partly to opportun-
istic factors, the results indicate that efficiency considerations
are also important. Consequently, if these suggested regulations
take place in New Zealand, then an efficient accounting policy
choice (i.e., partial) for firms to use to report accurately their
deferred tax liabilities will have been removed.
In the next section, a brief discussion of the institutional setting
and the accounting policy choice research on income tax is provided.
Section 3 presents the hypotheses. Section 4 examines the research
methodology issues used to test the hypotheses and Section 5
presents the results of these tests. The study concludes in Section 6.

2. INSTITUTIONAL SETTING AND PRIOR RESEARCH

(i) Accounting for Income Tax in New Zealand

Prior to 1980, accounting for income tax was unregulated in New
Zealand. Despite this, a number of firms practiced tax effect

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accounting (see Ryan, Heazlewood, Wong and Chye, 1984). In

1980, the first accounting standard on interperiod tax allocation,
known as Statement of Standard Accounting Practice (SSAP) 12:
Accounting for Interperiod Allocation of Income Tax, was promulgated
in New Zealand. It required firms to use interperiod tax allocation
procedures, giving them the choice to allocate timing differences
using either the comprehensive or partial procedures.2 Firms can
use the partial basis if there is a reasonable probability that the tax
effects of the timing differences are not likely to reverse in the future.
In 1991, SSAP-12 was replaced with SSAP-12 (Revised): Accounting
for Income Tax, but still gave firms the choice to use either com-
prehensive or partial in applying interperiod tax allocation.3
In April 1996, the Institute of Chartered Accountants of New
Zealand issued a discussion document on accounting for income
tax, Invitation to Comment: Accounting for Income Tax by Taxpayers.
This document asked for comments on whether comprehensive
should be the only method adopted in New Zealand to account
for interperiod tax allocation, a view favoured by the
International Accounting Standards Board in International
Accounting Standard (IAS) 12: Accounting for Taxes on Income and
practiced in other accounting jurisdictions, such as the US,
Canada and Australia. To date, the responses from the discus-
sion document have yet to be addressed publicly, and the
requirements in SSAP-12 (Revised) continue to govern in New
Zealand. However, New Zealand has recently made the decision
to adopt international financial reporting standards. Entities

2 The terms comprehensive and partial are not actually used in SSAP-12, but are
implied. The choice to allow comprehensive or partial arose primarily as a result of
the empirical evidence suggesting the non-reversal of deferred tax liabilities under the
comprehensive basis.
3 Statistics on the number of companies that use comprehensive versus partial to
account for income tax in New Zealand for the time period examined in this study are
not well documented. However, surveys by Alley (1990 and 1994) of the top 100 listed
companies in New Zealand for the years 1988 to 1992 show the following: in 1988, 50
used comprehensive, while 36 used partial; in 1989, 37 used comprehensive, while 42
used partial; in 1990, 36 used comprehensive, while 18 used partial; in 1991, 26 used
comprehensive, while 21 used partial; and in 1992, 30 used comprehensive, while 21
used partial (the number of companies surveyed each year varies because the necessary
data for each company were not always disclosed or available). Alley also reports that
one of the major items in New Zealand that creates a timing difference is from the
application of different depreciation rates for calculating income for taxation and
accounting purposes. Further, companies in New Zealand typically use the straight
line method, as opposed to accelerated methods, to depreciate fixed assets for account-
ing purposes (see Ritchie, 1990 and 1994).

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 DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX 1175

have an option to convert early to the international financial

reporting standards in 2005, or by 2007, when all entities must
comply with these. Presumably, this means that the require-
ments of IAS 12 to account for income tax using comprehensive
will ultimately apply in New Zealand.

(ii) Accounting Policy Choice Research on Income Tax

In general, the accounting literature shows that a firms
deferred tax accounting choice supports opportunistic behav-
iour, such as avoiding debt covenant violation, masking poor
performance, and reducing the effects of political costs (e.g.,
Wong, 1986; and Gupta, 1995). However, while opportunism
is an important factor to consider, other issues may also be
significant in the deferred tax accounting decision. For example,
Gordon and Joos (2004) examine the effect of the recent
elimination of the partial method to account for income tax
in the UK. While Gordon and Joos find that the flexibility
provided under partial can be used to measure unrecognised
deferred taxes opportunistically, they also find that this does
not nullify the predictive power of (unrecognised) deferred
taxes for future deferred tax reversals and for profitability
measures (p. 99). Hence, overall based on their evidence,
Gordon and Joos conclude that eliminating the partial method
for deferred taxes in the UK reduces the usefulness of deferred
tax disclosures.
Besides examining firms choice of deferred tax accounting
policy, there also exists in the accounting literature a large body
of capital markets research that studies the value relevance
of interperiod tax allocation. This research suggests that: (1) inter-
period tax allocation is an important factor in investors decisions
and investors are more likely to value a firms shareprice down-
wards when there is an increase in the amount of the deferred tax
liability (Beaver and Dukes, 1972; and Rayburn, 1986); and (2)
the negative association is weaker or does not exist if the timing
differences that give rise to the change in deferred tax liability are
(i) recurring in nature (Chaney and Jeter, 1994), (ii) generated by
certain types of companies (e.g., utilities) (Daley, 1995), and (iii)
accounted for using the comprehensive, rather than the partial,
tax allocation method (Citron, 2001).

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3. HYPOTHESES

(i) Determinants Based on the Efficient Contracting Perspective

If a firm has chosen to use comprehensive and circumstances are
such that the firm makes from year to year large continually
increasing investments in depreciable assets, which can produce
significant amounts of depreciation timing differences, then
adherence to comprehensive may be inefficient for determining
accurately the deferred tax liability that is reported on the bal-
ance sheet.4 This is because the increasing investments in depre-
ciable assets generate ever growing tax deductions in the current
period, giving rise to a corresponding growth in the deferred tax
liability, but which may not result in future tax payments thereby
questioning the need to have that liability (Davidson, 1958) (see
also Price Waterhouse and Co., 1967, for US evidence; Beechy,
1983, for Canadian evidence; and Wise, 1980 and 1986, for New
Zealand evidence of this).5 Hence, the deferred tax liability is
overstated on the balance sheet, and if this occurs, could result in
unintentional adverse economic consequences. For example, it
can constrain the firm from further borrowing for profitable
investment projects, because it pushes the firm closer to its debt
covenant restrictions (such as debt to total tangible assets) in their
existing debt contracts. This can be costly, since the firm would
have to forgo the value increase from investing in the project or
risk default on the debt contract, or it must use equity to fund
the projects, which is a more expensive form of financing. But
the unintentional overstatement of the deferred tax liability can
also cause an inadvertent breach of the debt covenant, which is
detrimental to the firm, since unnecessary renegotiation costs
are incurred. Furthermore, the reputation of the firms credit
standing may be seriously damaged.
To avoid these firm value-reducing consequences, a firm can
opt to change its accounting policy for income tax to the partial

4 A maintained assumption in the arguments presented in this section is that compre-

hensive is the efficient technique for measuring the firms deferred tax liability initially.
The rationale for making this assumption is taken from Economic Darwinism, which
suggests that the economic structures we observe in firms exist and survive because they
are cost efficient (Alchian, 1950; Fama and Jensen, 1983a and 1983b; and Jensen, 1983).
5 It is worth mentioning as well that Wise (1986) finds in New Zealand that decreases in
deferred tax liabilities are not necessarily associated with decreases in depreciable assets.

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 DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX 1177

tax allocation procedure. This procedure is preferred because if

the additional tax deductions from the asset acquisitions do not
result in future tax payments, the tax effect of these deductions
should be excluded from the calculation of the deferred tax
liability. Hence, the efficient contracting perspective gives rise
to the following hypothesis:

H1: Firms that change to partial are more likely to have

investments in depreciable assets that are greater than
those of firms that remain using comprehensive.

(ii) Determinants Based on the Opportunistic Perspective

A firm may have opportunistic incentives to change their
accounting policy for income tax from comprehensive to partial.
To the extent that partial, relative to comprehensive, increases
earnings after tax and reduces the deferred tax liability, two
opportunistic situations can arise with regard to the deferred
tax accounting choice (as discussed variously in Wong, 1986;
and Gupta, 1995).
First, if a firm has a debt contract that limits the ratio of
reported debt to total tangible assets and it is close to breaching
that limit, the firm has an incentive to change to partial so as to
make that restriction less binding. Second, the firm may have an
incentive to change to partial, the income increasing technique,
to mask poor earnings performance.6 Given these situations,
the opportunistic perspective gives rise to the following
hypotheses:7

6 Firms may also have an incentive not to change to partial, but remain on compre-
hensive, because of political costs that may be associated with the reporting of low tax
rates in the income statement when using partial (Wong, 1986; and Gupta, 1995).
However, I do not investigate this incentive because Wong (1986) and Gupta (1995)
find that New Zealand and US firms, respectively, are unlikely to mitigate these political
costs through the choice of interperiod tax allocation method.
7 Two further opportunistic situations can also arise. First, a firm rewarding its man-
agers on the basis of an earnings-based bonus scheme has an incentive to change to
partial to increase the bonus that managers receive. And second, a firm that is large in
size has an incentive to change to partial to reduce the political costs of reporting a large
deferred tax liability figure in the balance sheet. These two opportunistic situations,
respectively, are not tested in this study because (1) bonus scheme information is not
disclosed publicly in New Zealand (Wong, 1986), and (2) there is difficulty in attributing
the size effect that may be observed solely to the political cost phenomenon (Ball and
Foster, 1982).

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1178 WONG

H2: Firms that change to partial are more likely to have debt
to total tangible assets ratios that are greater than those
of firms that remain using comprehensive.
H3: Firms that change to partial are more likely to have
earnings performance that is lower than those of firms
that remain using comprehensive.

4. RESEARCH METHODOLOGY

(i) Sample Selection

To test hypotheses H1 to H3, a sample of firms that change from
comprehensive to partial is selected. This is done by examining
the financial statements of firms that are publicly listed on the
New Zealand Stock Exchange between 1981 and 1994 for
changes in their deferred tax policy. This process gave 33
firms that switched accounting method. A control sample is
also selected by matching each firm that changes to partial
with a firm that did not switch (i.e., continued using
comprehensive) on size (as measured by total assets) in the
year of the change. Size is chosen as a criterion to match on
because it appears to be an important variable in many account-
ing policy choice studies (Christie, 1990). Hence, it is important
to control for size in the statistical tests that follow in this study
so that it does not confound the interpretation of the other
hypothesized variables of interest.8 The sample selection
procedure yields an experimental and control sample of 33
firms each that are suitable for the analysis.

(ii) Research Design

Data for the tests are collected for the year in which the change
takes place, the three years prior to the change, and the two
years following the change for each firm. The data are then

8 Initially, industry was also chosen as a matching variable. However, matching the
change sample on the basis of these three criteria (i.e., size, time period, and industry)
was difficult because of the inability to find a control firm with an approximately equal
size in the same industry as the change firm in the year of the change. I decided that the
more important variable to match on was size and hence industry was excluded as a
matching criterion. See Panel B of Table 2 and the discussion later, which show that in
any event there does not appear be an industry effect in the data.

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 DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX 1179

analyzed by aligning the sample by event time. The year the

change takes place is event year 0 in the analysis. The event time
methodology is important because it allows an in depth examin-
ation of the circumstances that could have lead to the change to
partial and whether the hypothesized variables operate only at
event year 0 or also in other years. All data are hand collected
from the firms financial statements.
The number of observations in each event year varies (see
Table 3) because data are not always available for some firms
since: (1) the firm may have delisted in a year after the change
in tax accounting policy or only listed one or two years before
the change, and hence its financial statements are not publicly
available; or (2) the firm was substantially restructured (e.g.,
through merger or takeover) and the financial statements no
longer reflect the financial position of the firm that was chosen
initially; or (3) the firms financial statements simply could not
be located for a particular year. The most affected period is
event year 2, where only 24 observations of the total 33
change firms remain.9
To test hypotheses H1 to H3, the following variables are
defined for each firm i in event time t:
CIi,t gross depreciable assetsi,t/total assetsi,t,
where gross depreciable assets is the gross fixed
assets excluding land and buildings minus the
book value of other non-depreciable fixed assets;
PROGDAi,t gross depreciable assetsi,t/gross fixed assetsi,t;
CGDAi,t (gross depreciable assetsi,t gross depreciable
assetsi,t
1)/gross depreciable assetsi,t
1;
LEVi,t (total liabilities including deferred tax liability
adjusted for the accounting method adopted)i,t/
(total assets intangible assets and any future
tax benefits)i,t;10

9 Additional investigation shows little indication that the loss of observations in event
year 2 is due to financial distress (eight of the missing observations are due to the firm
being taken over, while one is due to the firm being in financial distress and delisted).
Despite this, caution should still be used in interpreting the results of the study as the
sample size is small and there may exist a mortality threat to internal validity.
10 In New Zealand, firms only show the net effect of their deferred tax liabilities and
future tax benefits. They are less likely to disclose these items separately in the balance
sheet.

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1180 WONG

ROAi,t net profit before taxi,t/(market capitalization of

equity book value of preference shares, min-
ority interest and long term and current liabil-
ities but excluding deferred taxes)i,t.

CI, PROGDA and CGDA measure the extent of firms invest-

ment in depreciable assets and are used to test hypothesis H1.
These variables modify the gross depreciable assets figure used
in the calculations to exclude fixed assets that: (1) are not
depreciated (e.g., land) and therefore do not give rise to timing
differences;11 or (2) do not generate large amounts of deprecia-
tion timing differences and are subject to substantial revaluation
(e.g., buildings).12 LEV is a leverage calculation that measures
the closeness of firms to their debt covenant restrictions and is
used to test hypothesis H2. The LEV variable calculation
includes firms deferred tax liability, but is adjusted for the
accounting method adopted that is, change sample firms for
event years 0, 1 and 2 respectively, are restated as if they are
still using the comprehensive basis. This adjustment is possible
because New Zealand firms that use partial are required to also
disclose the amount of any unrecognised deferred tax liabilities
in the notes to their accounts. The ROA variable (return on
assets) is a measure of earnings performance and is used to test
hypothesis H3.
To test the hypotheses, univariate and multivariate analyses are
used. The univariate analysis employs an experimental group-
control group, before-after research design to test whether the
paired difference between the firms in the change and control
samples for each hypothesized variable in each event year (i.e.,
change firm i in event year t less control firm i in event year t) is
different from zero. The statistical tests in the univariate analysis
involve the paired t-test and the Wilcoxon test.

11 Intangible assets (e.g., goodwill) are also included in this item, and hence, are
excluded in these variable calculations, because in general the amortization of intangible
assets is never an allowable deduction in New Zealand (i.e., amortization of intangible
assets are treated as permanent differences).
12 In general, when depreciable assets are revalued, depreciation is calculated on the
revalued amount for accounting purposes but only on the historical cost amount for tax
purposes. Therefore, a permanent difference, rather than a timing difference, is created
because the part of depreciation that relates to the revaluation increment is never an
allowable deduction for tax purposes.

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The multivariate analysis examines simultaneously the joint and

partial effects that the hypothesized variables have on firms that
change to partial. To do this, the following pooled cross-section time
series logit regression model is estimated (expected sign of the coeffi-
cients in parentheses, except for the size and time dummy variables):

CHANGEi;t
1INVESTMENTi;t 2LEVi;t 3LOGTA i;t

4DCOVi;t 5ROA i;t


6D
2i;t 7D
1i;t 8D0i;t 9D 1i;t
10D 2i;t "i;t

where CHANGE is a binary variable equal to 1 if the firm comes

from the change sample, otherwise 0, for each firm i in event time t;
INVESTMENT is the variable that measures the extent of invest-
ment in depreciable assets (i.e., defined previously as CI, PROGDA,
or CGDA, respectively) for each firm i in event time t; LEV is defined
as previously; LOGTA is the size variable for each firm i in event
time t, defined as the natural logarithm of total assets; DCOV is a
dummy variable equal to 1 if the firm has accounting-based debt
covenants, otherwise 0, for each firm i in event time t; ROA is
defined as previously; D
2 is a dummy variable equal to 1 if
event time is
2, otherwise 0, for each firm i in event time t; D
1
is a dummy variable equal to 1 if event time is
1, otherwise 0, for
each firm i in event time t; D0 is a dummy variable equal to 1 if event
time is 0, otherwise 0, for each firm i in event time t; D 1 is a
dummy variable equal to 1 if event time is 1, otherwise 0, for each
firm i in event time t; D 2 is a dummy variable equal to 1 if event
time is 2, otherwise 0, for each firm i in event time t;
, 1, 2, 3,
4, 5, 6, 7, 8, 9, and 10 are the parameters of the model; and
" is the error term for each firm i in event time t.
The DCOV variable captures the effect that firms with account-
ing-based debt covenants are more likely to make accounting
decisions that are opportunistic compared to those that do not
have such covenants. Following Skinner (1993) and Wong and
Wong (2001), the DCOV variable is included in the model
because leverages ability to measure the closeness to debt

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1182 WONG

covenant breach may be low, since prior research also suggests

that leverage may proxy for the effect of a firms investment
opportunity set (Watts and Zimmerman, 1986; Press and
Weintrop, 1990; and Smith, 1993).13 The existence of account-
ing-based debt covenants is determined by reviewing the firms
financial statements (including the Directors Report, the
Statement of Accounting Policies, and the Notes to the Financial
Statements related to the disclosure of non-current liabilities) and
actual debt contracts if these are publicly available.14
The main advantages of using the pooled regression model in
this study is that: (1) the sample size is increased; and (2) it allows
us to better analyse the effects that result from the dynamics of
change in the units of analysis (i.e., the companies that change to
partial), as suggested by Baltagi (1995) (cited in Gujarati, 2003,
p. 637). However, we must also be cautious in interpreting the
results of the pooled regression model, because the model
assumes that the regression parameters are constant across firms
and across time, which may not always be the case (Judge, Hill,
Griffiths, Lutkepohl and Lee, 1988). To partly overcome this
concern, the inclusion of time dummy variables attempts to
control for any cross-sectional variation that may occur in any
particular event year. In addition, although not reported, I esti-
mate cross-sectional regressions by each event year because obser-
vations in the pooled regression may not be independent and may
overstate the significance tests. In general, the results of these
regressions are weaker but do not alter the interpretation of the
pooled regression findings presented in this study. The t-statistics
reported in the multivariate analyses are based on the covariance
matrix White (1982) suggests when models estimated by maxi-
mum likelihood (such as the logit regression) are misspecified.15

13 An alternative, and perhaps better, measure to proxy for the closeness of debt
covenant breach may also be to use the ratio of the firms leverage to the industry
average leverage (I would like to thank the referee for making this suggestion).
However, I am unable to calculate this measure in this study because data for industry
average leverage are not available.
14 In New Zealand, there is no regulatory requirement for firms to disclose their
accounting-based debt covenants in their financial reports.
15 I also test the coefficient estimates using the uncorrected covariance matrix. The
results of these tests do not alter the regression findings reported in this study. The
Pearson and Spearman correlations between the variables in each model are also
calculated. In general, these correlations exhibit low association. Hence, multicollinear-
ity does not appear to be a major concern.

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 DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX 1183

(iii) Preliminary Analysis

If the matching procedure is effective, there should be little
difference in the size variable (as proxied by total assets)
between the change and control samples. The results in Table 1
show this. Paired t-tests and Wilcoxon tests using a two-tailed
level of significance show the mean difference in the total assets
variable between the change and control samples (i.e., the total
assets of change firm i in event year t less the total assets of
control firm i in event year t) is not significantly different from
zero in each of the event years.
Table 2 provides summary details of the composition of the
change and control samples by year of change (Panel A) and by
industry classification (Panel B).16 Panel A shows that 58 percent
of the changes to partial take place in the years prior to 1987.
Most changes occur in 1986, and in the years after 1987, the
number of changes is fewer. However, there does not appear to
be any particular year in which the change to partial is more
prevalent (2 9.000, probability value 0.773, for a one-sample
1  c contingency table test). Panel B shows little sign that the
change or control firms come from any particular industry,
although nine change firms come from the Agriculture and
Property sectors (2 15.476, probability value 0.692, for a
two-sample 2  c contingency table test).

5. RESULTS

(i) Univariate Analyses

Table 3 presents descriptive statistics and results of the univari-
ate between group tests for the hypothesized variables. Panel A
shows the results of testing hypothesis H1 (i.e., firms that change
to partial are more likely to have investments in depreciable
assets that are greater than those of firms that remain using
comprehensive) with the CI variable. For each event year, the
mean CI for the change sample is greater than the mean CI for
the control sample, as expected. However, paired t-tests and

16 In the two chi-square tests that follow, caution should be used in interpreting the
results because of the small number of observations in some cells which may make the
tests suspect.

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 Table 1
1184

Univariate Tests for Total Assets for Experimental Firms Changing to the Partial Basis and Control Firms that
Remained on Comprehensive (levels in thousand of dollars)
Event Timea
3
2
1 0 1 2

Change Sample
Mean 63,317 76,041 92,314 118,263 117,853 116,533
Median 32,793 41,551 51,170 59,598 73,361 72,145
Min. 2,679 3,530 3,815 4,430 5,665 6,432
Max. 380,728 386,854 483,029 587,994 514,910 431,439
SD 83,329 97,660 112,277 137,504 132,469 122,093
Control Sample
Mean 73,947 81,893 95,608 111,232 139,565 136,951
Median 47,020 51,171 52,972 55,102 64,035 66,318
Min. 1,920 2,839 2,429 2,015 2,472 4,530
WONG

Max. 353,671 335,231 445,408 620,500 844,685 634,530

SD 86,968 78,029 101,253 131,653 188,606 159,032
Test of Paired Differences

#
(two tailed probabilities):
Paired t-test 0.254 0.517 0.689 0.112 0.240 0.357
Wilcoxon 0.118 0.183 0.386 0.280 0.564 0.511
N pairs 27 31 33 33 27 24
Note:
a
Event time is the year relative to the year of change to the partial tax allocation basis for firms in the experimental sample. That is: event time
3
is the year three years prior to the change; event time
2 is the year two years prior to the change; event time
1 is the year prior to the change;
event time 0 is the year of the change; event time 1 is the year subsequent to the change; and event time 2 is the year two years subsequent to
the change.

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 DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX 1185

Table 2
Distribution of Experimental and Control Sample Firms on Event
Dates (i.e., year experimental firms change to partial basis) and
Industry Membership
Panel A
Year Change Sample Control Sample

1981 2 2
1982 3 3
1983 4 4
1984 4 4
1985 1 1
1986 5 5
1987 1 1
1988 3 3
1989 2 2
1990 2 2
1991 2 2
1992 1 1
1993 2 2
1994 1 1

Total 33 33

Panel B
Industry Classification Change Sample Control Sample

Agriculture 5 1
Automotive 1 2
Chemicals 1 3
Construction 2 1
Electrical 1 1
Energy and fuel 1 0
Engineering 2 2
Food 2 2
Forestry and forest products 1 2
Liquor and tobacco 0 2
Meat and by-products 1 1
Media and communications 2 3
Medical supplies 0 1
Mining 1 0
Miscellaneous 3 4
Printing and publishing 0 1
Property 4 1
Retail merchants 2 4
Textiles and apparel 2 2
Transport and tourism 2 0

Total 33 33

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1186 WONG

Table 3
Descriptive Statistics and Univariate Tests of Hypothesized Variablesb
Using the Experimental Group-control Group, Before After (Pretest-
posttest) Research Design
Event Timea
3
2
1 0 1 2

Panel A: CI (+)
Change Sample:
Mean 0.308 0.284 0.252 0.263 0.289 0.299
Median 0.259 0.228 0.218 0.238 0.273 0.282
SD 0.205 0.199 0.181 0.173 0.197 0.190
Control Sample:
Mean 0.217 0.226 0.246 0.253 0.247 0.250
Median 0.226 0.223 0.228 0.213 0.237 0.238
SD 0.099 0.124 0.142 0.149 0.143 0.147
Test of Paired Differences (one tailed probabilities):
Paired t-test 0.026 0.118 0.449 0.415 0.218 0.203
Wilcoxon 0.029 0.092 0.378 0.344 0.200 0.200
N pairs 27 31 33 33 27 24

Panel B: PROGDA (+)

Change Sample:
Mean 0.674 0.696 0.694 0.698 0.692 0.702
Median 0.684 0.762 0.764 0.740 0.679 0.680
SD 0.207 0.252 0.247 0.248 0.268 0.257
Control Sample:
Mean 0.495 0.540 0.551 0.553 0.573 0.556
Median 0.496 0.569 0.559 0.544 0.577 0.574
SD 0.223 0.233 0.243 0.243 0.226 0.197
Test of Paired Differences (one tailed probabilities):
Paired t-test 0.005 0.011 0.015 0.016 0.053 0.030
Wilcoxon 0.005 0.006 0.013 0.014 0.043 0.020
N pairs 26 31 33 33 27 24

Panel C: CGDA (+)

Change Sample:
Mean n.a. 0.335 0.347 0.372 0.255 0.175
Median n.a. 0.128 0.183 0.218 0.137 0.124
SD n.a. 0.730 0.706 0.489 0.445 0.451
Control Sample:
Mean n.a. 0.183 0.172 0.196 0.126 0.243
Median n.a. 0.094 0.163 0.083 0.081 0.131
SD n.a. 0.360 0.233 0.451 0.329 0.330
Test of Paired Differences (one tailed probabilities):
Paired t-test n.a. 0.180 0.098 0.048 0.132 0.273
Wilcoxon n.a. 0.135 0.228 0.027 0.115 0.034
N pairs n.a. 26 31 33 27 24

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 DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX 1187

Table 3 (Continued)
Event Timea
3
2
1 0 1 2

Panel D: LEV (+)

Change Sample:
Mean 0.497 0.456 0.507 0.544 0.776 0.526
Median 0.491 0.490 0.536 0.537 0.517 0.513
SD 0.157 0.160 0.144 0.180 1.404 0.158
Control Sample:
Mean 0.471 0.480 0.502 0.478 0.484 0.484
Median 0.485 0.476 0.488 0.443 0.437 0.508
SD 0.112 0.142 0.148 0.146 0.156 0.132
Test of Paired Differences (one tailed probabilities):
Paired t-test 0.225 0.264 0.448 0.016 0.129 0.166
Wilcoxon 0.387 0.407 0.287 0.017 0.125 0.265
N pairs 27 31 33 33 27 24

Panel E: ROA ({)

Change Sample
Mean 0.082 0.090 0.111 0.064 0.071 0.073
Median 0.081 0.079 0.093 0.065 0.067 0.083
SD 0.067 0.051 0.065 0.088 0.079 0.090
Control Sample:
Mean 0.108 0.097 0.068 0.066 0.084 0.086
Median 0.100 0.084 0.066 0.072 0.078 0.084
SD 0.081 0.079 0.099 0.090 0.076 0.056
Test of Paired Differences (one tailed probabilities):
Paired t-test 0.079 0.333 0.021 0.458 0.204 0.276
Wilcoxon 0.098 0.292 0.041 0.447 0.360 0.489
N pairs 27 31 33 33 27 24
Notes:
a
Event time is the year relative to the year of change to the partial tax allocation basis for
firms in the experimental sample. That is: event time
3 is the year three years prior to the
change; event time
2 is the year two years prior to the change; event time
1 is the year
prior to the change; event time 0 is the year of the change; event time 1 is the year
subsequent to the change; and event time 2 is the year two years subsequent to the change.
b
CI is gross depreciable assets divided by total assets for each firm i in event time t;
PROGDA is gross depreciable assets divided by gross fixed assets for each firm i in event
time t; CGDA is the percentage change in gross depreciable assets for each firm i from
event time t-1 to event time t; LEV is total liabilities including the deferred tax liability
divided by total assets but excluding intangible assets and any future tax benefit for each
firm i in event time t; ROA is net profit before tax divided by the market capitalization of
equity plus the book value of preference shares, minority interest, and long term and
current liabilities but excluding deferred taxes for each firm i in event time t.

Wilcoxon tests on the paired observations by event time gen-

erally do not support hypothesis H1.
Panel B presents the results of testing hypothesis H1 using
the PROGDA variable. The results show that the mean

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1188 WONG

difference is positive and significant (using paired t-tests and

Wilcoxon tests) in every event year. While these results sup-
port hypothesis H1, they also raise the following question:
Why didnt change firms switch to partial before year 0? A
plausible reason is that the friction to firm value maximization
is largest in event year 0, but it is difficult to see this in the
tests on PROGDA. The tests on CGDA shed more light on
this.
The results in Panel C show that the mean difference in
CGDA is positive and significant in event year
1 at the ten
percent level using a paired t-test only, and in event year 0 at
the five percent level using both the paired t-test and
Wilcoxon test. However, the results also show an unexpected
negative and significant mean difference in CGDA in event
year 2 for a Wilcoxon test at the five percent level. Despite
this, the results in Panel C indicate overall that in the years
leading up to the change, the change firms on average have
substantially larger rates of increase in depreciable assets than
the control firms (i.e., the friction is largest around the year of
the change). This evidence provides support for hypothesis
H1.
Panel D presents the results of testing hypothesis H2 (i.e.,
firms that change to partial are more likely to have debt to total
tangible assets ratios that are greater than those of firms that
remain using comprehensive) using the LEV variable. The
results show that leverage in general tends to be higher in the
change sample than in the control sample in each event year.
However, only in event year 0 is the mean difference significant
(at the five percent level using both the paired t-test and
Wilcoxon test). Hence, there is limited support for hypothesis
H2.17
Panel E exhibits the results of testing hypothesis H3 (i.e., firms
that change to partial are more likely to have earnings

17 A similar result is found when testing hypothesis H2 using the DCOV variable. In
particular, the percentage of firms with accounting-based debt covenants (i.e., DCOV) is
generally higher for the change sample in each event year (the mean DCOV in event
years
3,
2,
1, 0, 1 and 2, respectively, for the change sample is 0.481, 0.355,
0.364, 0.394, 0.407 and 0.333; while for the control sample, it is 0.333, 0.355, 0.303,
0.242, 0.296 and 0.292), but only in event year 0 is the mean difference significant (the
one tailed probability value using the paired t-test and Wilcoxon test, respectively, is
0.067 and 0.066).

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 DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX 1189

performance that is lower than those of firms that remain using

comprehensive) with the ROA variable. In general, earnings
performance is slightly better in the control sample than in the
change sample. However, the only significant results are in
event years
3 and
1. In event year
3, the mean ROA for
the change sample is significantly less than that of the control
sample at the ten percent level using both the paired t-test and
Wilcoxon test, as expected. However, in event year
1, the
mean ROA for the change sample is significantly greater than
the mean ROA for the control sample at the five percent level
for both the paired t-test and Wilcoxon test. This result is
inconsistent with hypothesis H3 and perhaps suggests that earn-
ings-related opportunistic incentives to change to partial are
unlikely.18
In summary, the univariate analysis results in Table 3 show in
general that tests: (1) on CI do not support hypothesis H1; (2)
on PROGDA are consistent with hypothesis H1; (3) on CGDA
are consistent with hypothesis H1; (4) on LEV provide limited
support for hypothesis H2; and (5) on ROA do not support
hypothesis H3.

(ii) Multivariate Analyses

Table 4 shows the results of estimating the pooled regression
model. The estimates show that CI (at the one percent level),
PROGDA (at the one percent level), and CGDA (at the five
percent level), respectively, have a significant positive effect on
the change in deferred tax accounting policy. The strongest
results are for the regression with PROGDA, where the
McFaddens rho-squared is 9.1 percent. However, DCOV is
also positive and significant in each model estimated (at the
five percent level in Model 1, at the one percent level in
Model 2, and at the ten percent level in Model 3), while LEV
is positive and significant in only Models 1 (at the ten percent

18 Although not reported, I also test hypothesis H3 using Return on Equity (ROE),
which is defined as the net profit before tax divided by shareholders funds for each firm
i in event time t. The ROE results do not alter the ROA findings reported in this study
and are not discussed further.

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 Table 4
1190

Logit Analysis of the Relation Between the Decision to Change to the Partial Basis and the Hypothesized Variablesb
Modela (coefficient, t-statistic in parentheses) 1 2 3

Intercept 0.459
0.719 0.153

(0.272) (
0.427) (0.085)
CI 1.733*
(2.469)
PROGDA 3.000*
(4.584)
CGDA 0.509**
(1.812)
LEV 1.220*** 0.405 1.699**
(1.397) (0.746) (1.856)
LOGTA
0.225
0.203
0.180
WONG

(
1.092) (
0.995) (
0.806)

DCOV 0.508** 0.816* 0.391***
(2.142) (3.095) (1.472)
ROA

0.253
0.735 1.146

#
(
0.165) (
0.469) (0.700)
D
2 0.077
0.027
(0.204) (
0.069)
D
1 0.072
0.023 0.016
(0.193) (
0.061) (0.042)
D0 0.067
0.018 0.038
(0.182) (
0.047) (0.100)
D1 0.016
0.061 0.053
(0.041) (
0.150) (0.131)

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 #
D2 0.069 0.012 0.085
(0.172) (0.029) (0.200)
McFaddens rho-squaredc 0.030 0.091 0.031
Likelihood ratiod 14.784 43.958 11.943
P-value 0.140 0.000 0.217
N 350 348 282
Notes:
a
Model refers to each regression that is estimated using each of the three variables to measure the extent of investment in depreciable assets. In

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particular, Model 1 is the regression when CI is used to measure the investment in depreciable assets; Model 2 is the regression when PROGDA is
used to measure the investment in depreciable assets; and Model 3 is the regression when CGDA is used to measure the investment in depreciable
assets (variable definitions below).
b
Dependent variable is a binary variable equal to 1 if the firm comes from the change sample, otherwise 0 for each firm i in event time t; CI is
gross depreciable assets divided by total assets for each firm i in event time t; PROGDA is gross depreciable assets divided by gross fixed assets for
each firm i in event time t; CGDA is the percentage change in gross depreciable assets for each firm i from event time t-1 to event time t; LEV is
total liabilities including the deferred tax liability divided by total assets but excluding intangible assets and any future tax benefit for each firm i in
event time t; DCOV is a dummy variable equal to 1 if the firm has accounting-based debt covenants, 0 otherwise for each firm i in event time t;
LOGTA is the log of total assets for each firm i in event time t; ROA is net profit before tax divided by market capitalization of equity plus the book
value of preference shares, minority interest, and long term and current liabilities but excluding deferred taxes for each firm i in event time t; D

2 is a dummy variable equal to 1 if event time is
2, otherwise 0 for each firm i in event time t; D
1 is a dummy variable equal to 1 if event
time is
1, otherwise 0 for each firm i in event time t; D0 is a dummy variable equal to 1 if event time is 0, otherwise 0 for each firm i in event time
t; D 1 is a dummy variable equal to 1 if event time is 1, otherwise 0 for each firm i in event time t; D 2 is a dummy variable equal to 1 if event
time is 2, otherwise 0 for each firm i in event time t.
c
McFaddens rho squared is a measure of the explanatory power of the variables collectively in the logit regression model. It is calculated as 1
minus the log of L divided by the log of L0, where log of L is the log-likelihood of the fitted model and log of L0 is the log-likelihood of the model
containing the intercept only.
d
The likelihood ratio is computed to test the null hypothesis that all the parameters in the logit regression model are simultaneously equal to
zero. It is calculated as
2 multiplied by the difference between the log of L and the log of L0 (where log of L and log of L0 are defined as above),
and has an asymptotic distribution that is a chi-square with (m
1) degrees of freedom, where m equals the number of parameters in the model.
DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX

* Significant at the 1% level (one tail test).

** Significant at the 5% level (one tail test).
*** Significant at the 10% level (one tail test).
1191
1192 WONG

level) and 3 (at the five percent level). ROA, LOGTA and the
time dummies are insignificant in all the models.19
Subject to concerns over the use of the pooled model, as
discussed in the research design section, overall the regression
results suggest that the variables representing efficiency (CI,
PROGDA and CGDA) and debt-related opportunistic variables
(LEV and DCOV) are significant factors that influence the
accounting decision to change income tax accounting method
from comprehensive to partial. This finding is inconsistent with
Gupta (1995), who finds little evidence to suggest that efficiency
is related to the interperiod tax allocation choice he concludes
that opportunism is more likely. However, the regression
results are generally consistent with the findings in Skinner
(1993), who concludes that opportunism or efficiency cannot
be separated from each other as explanations for accounting
choice, and with Holthausens (1990, p. 209) comment that
opportunistic and efficient contracting incentives may be partial
explanations of firms accounting choice decisions.

6. CONCLUSION

In this study, I examine determinants of the decision of New

Zealand firms to change their income tax accounting method
from comprehensive to partial allocation. I hypothesize that
efficient contracting and opportunistic factors influence this
accounting policy decision. After carrying out univariate and
multivariate analyses, the results suggest in general that efficient

19 I also investigate whether firms that change to partial are more likely to have
increases in leverage and decreases in earnings performance, respectively, that are greater
than those of firms that remain on comprehensive from event year
1 to event year 0.
This analysis examines if the change to partial is motivated by changes in the financial
performance and/or financial position of the firm. To do the analysis, I estimate for each
model a cross-sectional regression for event year 0 only by replacing the LEV and ROA
variables with the change in leverage (CLEV) and the change in return on assets
(CROA), respectively, from event year
1 to event year 0. I find that the results of
this analysis do not alter the tenor of the findings in the pooled regressions. Specifically,
the results are as follows: (1) for Model 1, where CI measures the investment in
depreciable assets, only the estimates of DCOV (at the one percent level) and CLEV
(at the five percent level) have a significant and positive effect; (2) for Model 2, where
PROGDA measures the investment in depreciable assets, only the estimates of DCOV (at
the five percent level), CLEV (at the five percent level) and PROGDA (at the one percent
level) have a positive and significant effect; and (3) for Model 3, where CGDA measures
the investment in depreciable assets, only the estimates of CLEV and CGDA (both at the
ten percent level) have a significant and positive effect.

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 DETERMINANTS OF THE ACCOUNTING CHANGE FOR INCOME TAX 1193

contracting and debt-related opportunistic factors are both

important determinants that influence firms decisions to
change their income tax policy from comprehensive to partial.
In particular, the results indicate that the change to partial is
related to the extent of investment in depreciable assets and the
closeness of firms to their debt covenant restrictions.20
However, caution must be used in interpreting the evidence
because of three research limitations that potentially weaken the
results. First, the small sample size reduces the power of the
statistical tests, despite the use of non-parametric statistical
procedures. It also makes it difficult to generalize the results
to a wider population. While this is a concern, Fields, Lys and
Vincent (2001, p. 301) suggest that small sample studies can also
be beneficial in accounting choice research because they com-
plement existing large sample studies and provide greater
insight into the underlying causes of the empirically observed
effects. Second, some companies in the change group drop out
of the analysis in event year 2. This suggests that the account-
ing changes may be related to firm mortality, although
additional investigation shows little indication that the firms
drop out because of reasons of financial distress. And third,
the explanatory power of the regression models is low and
suggests there are other variables that are important in the
decision to change to partial.
Despite these limitations, the study has contributed to the
accounting literature in two ways. First, the analysis focuses in
detail on a single accounting choice, interperiod tax allocation,
and explores the institutional and contracting setting in more
depth than other studies by focusing over time on the deferred

20 Six case studies (three firms each from the change and control samples, respectively)
were also conducted to complement the statistical analyses and to provide a more
detailed contextual analysis of the circumstances of the firms. Using financial and non-
financial evidence that was collected, the results of the case study analyses suggest the
following: (1) all case companies are profitable and there does not appear to be any sign
of financial distress; (2) all case companies are not close to breaching their leverage ratio
defined debt covenant limits, which state that debt should not exceed an amount that is
equal to 60 (or sometimes 65 percent in some cases) of total tangible assets; and (3) case
companies from the change sample appear to be more involved in increasing their
investments in depreciable assets than cases from the control sample and they state that
the change to partial is because their timing differences are growing and are unlikely to
reverse in the foreseeable future. Overall, these results indicate that the accounting and
debt contracting decisions of the case study firms that relate to income tax are influ-
enced more by efficient contracting, rather than opportunistic, factors.

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1194 WONG

tax accounting policy decision. Second, similar to Gordon and

Joos (2004), the study provides important insights that will assist
regulators, especially in New Zealand, in determining the
economic consequences of regulation on firms before they
prescribe policy.
In New Zealand, regulators have been considering whether
comprehensive should be the only method adopted to account
for interperiod tax allocation. This is a view favoured by the
International Accounting Standards Board and other major
accounting jurisdictions in the world, including the US,
Canada and Australia. Besides showing an opportunistic rela-
tion, the empirical results in this study also suggest that New
Zealand firms view partial as an efficient accounting policy in
accounting for income tax when certain circumstances arise
(i.e., when the extent of investment in depreciable assets
increases). Mandating comprehensive to be the only accounting
practice for income tax in New Zealand will remove an efficient
accounting policy. This may be counter-productive because it
potentially reduces firm value and ignores firm specific factors,
which affect decisions that maximize firm value. Therefore, this
study concludes by warning policy makers that they must con-
sider carefully the economic consequences of their actions
before promulgating accounting regulations.

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