The Effect of the Adoption of International Accounting Standards No. 12 (IAS No. 12) for Firms Reporting Losses: Evidence from Korea

Abstract

This study examines the effects of the adoption of International Accounting Standards No. 12, Income Taxes (IAS No. 12) on the incremental information about future profitability for firms reporting losses compared to Korean Generally Accepted Accounting No. 16, Accounting for Income Taxes (K-GAAP No. 16). Specifically, this paper shows that whether the IAS No. 12 affects the information of deferred tax assets (DTAs) regarding loss persistence which implies the ability to predict earnings sustainability. Using a sample of 2,905 observations from Korean listed firms that reported a loss between 2007 and 2014, we divide loss firm-years into categories of ‘good news’ (GN) or ‘bad news’ (BN) based on whether management appears to report an increase in DTAs. We find that our tax categories have incremental information about the probability of loss reversal under K-GAAP No. 16, but under IAS No. 12 the incremental effects of a deferred tax balance disappear. Also, we find that investors underweight the informativeness of DTAs under K-GAAP, and after the adoption of IAS No. 12, investors cannot obtain buy-and-hold returns by buying GN firm-years and selling BN firms-years. However, this is not because investors understand the information of DTAs, but because the informativeness of DTAs deteriorates after the relaxation in the recognition threshold of DTAs.