A taxing audit—On the association between auditor workload compression and tax avoidance

• Published date: 01 October 2022
• Author: Dennis M. Lopez,S. Mark Greenwald
• Date: 01 October 2022
• DOI: http://doi.org/10.1111/ijau.12289

ORIGINAL ARTICLE

A taxing audit—On the association between auditor workload

compression and tax avoidance

Dennis M. Lopez | S. Mark Greenwald

University of Texas at San Antonio, San

Antonio, Texas, USA

Correspondence

Dennis M. Lopez, University of Texas at San

Antonio, One UTSA Circle, San Antonio, TX

78249 USA.

Email: dennis.lopez@utsa.edu

Funding information

The authors did not receive external funding

for the completion of this study.

This study investigates the association between auditor workload compression and

tax avoidance. Heavy auditor workloads can limit the extent to which auditors are

able to examine the determination of the income tax provision, creating opportunities

for companies to maintain their tax avoidance strategies unimpeded. We find evi-

dence indicating that audits performed by auditors with greater levels of workload

compression are associated with greater levels of tax avoidance, as proxied by the

cash effective tax rate, the Generally Accepted Accounting Principles (GAAP) effec-

tive tax rate and book-tax differences. We also investigate the role of auditor-

provided tax services (APTS) on the said associations and find evidence generally

consistent with knowledge spillover; however, we do not find evidence of a moderat-

ing effect from APTS on the association between auditor workload compression and

tax avoidance. This study contributes to the auditing and tax literatures by being

among the first to investigate whether audit-related constraints due to workload

compression affect the outcomes of management's determination of the tax

provision.

KEYWORDS

audit quality, auditor performance, busy season, cash effective tax rate, GAAP effective tax

rate, tax aggressiveness, tax avoidance, workload compression

1|INTRODUCTION

The discretion and complexity associated with the calculation of a

company's tax expense and its related provisions, whether via the

Generally Accepted Accounting Principles (GAAP) in the

United States or the International Financial Reporting Standards

(IFRS), create information asymmetry among managers, shareholders

and auditors. These circumstances lead to opportunities for tax avoid-

ance, which can greatly increase the risks associated with completing

a financial statement audit (Bird & Davis-Nozemack, 2018; Cazier

et al., 2015; Dhaliwal et al., 2004; Graham et al., 2012; Gupta

et al., 2016; Hanlon et al., 2012; Payne & Raiborn, 2018;

Weisbach, 2002). Given that audit risk is a primary concern of auditors

and that the PCAOB has expressed reservations over the tax compo-

nents of the audit (PCAOB, 2015,2017), the purpose of this study is

to investigate if there is a link between financial statement auditors

and management's tax reporting decisions. In particular, we

investigate whether a factor known to have a negative impact on

auditor performance, namely, auditor workload compression, is associ-

ated with greater levels of tax avoidance. Our study helps shed light

on a little-investigated aspect of financial statement audits and

advances our understanding of factors associated with tax avoidance.

Prior research has examined the link between auditor workload

compression and audit quality, finding that greater levels of workload

compression are associated with lower audit quality (e.g., Christensen

et al., 2021; Lopez & Peters, 2012). Heavy auditor workloads can limit

the extent to which auditors are able to examine the determination of

the income tax provision, creating opportunities for companies to

maintain their tax avoidance strategies unimpeded. Therefore, we

investigate whether audits performed under time pressures that

inherently limit the extent to which auditors are able to examine items

such as tax estimates and strategies are associated with lower taxes.

This study finds ground in prior research indicating that financial

reporting elements such as the tax provision may offer managers an

Received: 2 August 2020 Revised: 22 April 2022 Accepted: 22 June 2022

DOI: 10.1111/ijau.12289

420 © 2022 John Wiley & Sons Ltd. Int J Audit. 2022;26:420–445.wileyonlinelibrary.com/journal/ijau

opportunity for manipulation, even after the enactment of FASB

Interpretation 48 (FASB, 2006) (e.g., Cazier et al., 2015; Dhaliwal

et al., 2004; Frank & Rego, 2006; Gleason et al., 2018; Gleason &

Mills, 2008; Gupta et al., 2016).

1,2

Similar to that line of research, this

study is based on the assumption that risk-neutral shareholders

expect managers and companies to maximize their profits, which

includes pursuing tax avoidance to the extent that the incremental

benefits exceed the incremental costs (Hanlon & Heitzman, 2010).

Earlier studies have documented an association between audit fees

and book-tax differences (Hanlon et al., 2012) and between audit fees

and tax-aggressive companies (Donohoe & Knechel, 2014).

Kanagaretnam et al. (2016) document that audit quality is negatively

associated with tax aggressiveness. However, to the best of our

knowledge, prior studies have not specifically considered the role of

heavy auditor workloads on the external examination of the tax provi-

sion and tax avoidance.

While financial statement auditors are not responsible for the tax

affairs of their clients, the reputational and monetary costs associated

with financial reporting issues can be significant.

3

For instance, errors

and omissions on a tax return can translate into misstatements on the

tax provision, which can increase the likelihood of a financial

statement restatement. In addition, aggressive tax avoidance can

sometimes carry significant financial and ethical implications for those

involved in the financial reporting process (Bird & Davis-

Nozemack, 2018; Payne & Raiborn, 2018; West, 2018). Auditors are

engaged to attest to the fair representation of the accounting

information in the financial statements, including tax-related

disclosures. Accordingly, auditors serve as an important intermediary

between financial statement issuers and society in general. While

investors' main concern is usually wealth creation and most forms of

tax avoidance are in fact legal, companies that engage in legally

suspect forms of tax avoidance may face fines, bad press and loss of

business (Boone et al., 2015; Hanlon & Slemrod, 2009; Kanagaretnam

et al., 2018).

Prior research has shown that investors consider a company's tax

strategies as part of their overall business valuation, and tax avoidance

is generally factored in as a value-enhancing element in their assess-

ments (Drake et al., 2019; Goh et al., 2016; Inger, 2014). However,

consumer watchdog agencies, journalists and government taxing

authorities generally deem tax avoidance as a social negative (Dyreng

et al., 2016). Given that accounting firms are concerned about their

liability and reputation, more determined auditors may seek to

influence the tax avoidance decisions of their clients through

increased fees or scrutiny as a means to offset litigation risk and lower

the possibility of reputational damage (Donohoe & Knechel, 2014).

These dynamics underscore the importance of obtaining a better

understanding of the role of auditor workload compression in tax-

related matters.

Our proxy for auditor workload compression comes from Lopez

and Peters (2012) and is based on the relative amount of audit fees

generated by an auditor during the fiscal year-end month of a client.

Following the lead of prior related research, we investigate three

alternative proxies of tax avoidance: the cash effective tax rate, GAAP

effective tax rate and book-tax differences. These measures, in combi-

nation, allow for a wider understanding of the impact of workload

compression on tax reporting, as each indicates a different aspect of

tax avoidance (Hanlon & Heitzman, 2010). In addition, these measures

are easy to understand and have been widely tested in the extant tax

literature (Chyz & Gaertner, 2018; Dyreng et al., 2010).

We find that audits performed by auditors with greater levels of

workload compression are associated with greater levels of tax avoid-

ance, as evidenced by lower tax rates (i.e., cash ETR and GAAP ETR)

and greater tax complexity (via larger book-tax differences). This can

be interpreted as evidence that audits performed by overworked audi-

tors inadvertently allow more room for managerial discretion or error.

Furthermore, we find that these effects are not observable among

non-December year-end companies (i.e., non-busy season), which fur-

ther emphasizes the differential impact of workload compression on

tax avoidance. We supplement our tests by investigating the role of

auditor-provided tax services (APTS) in the association between

auditor workload compression on tax avoidance. Prior studies suggest

that tax-related services can improve audit quality through knowledge

spillover (e.g., Gleason et al., 2018), but there is evidence that auditor

independence may be at risk (e.g., Aschauer & Quick, 2018; Choi,

Kim, & Zang, 2010; Quick & Warming-Rasmussen, 2009). We find

evidence of lower tax avoidance among companies that engage their

auditors in the provision of APTS, which is consistent with the

knowledge spillover effect previously documented in the literature.

However, our tests fail to find statistically significant results when

we explore the possibility of a moderating effect from APTS on

the association between auditor workload compression and tax

avoidance.

This study makes several important contributions to the audit and

tax literatures. First, we build on the findings from studies such as

Lopez and Peters (2012) and Christensen et al. (2021) regarding the

detrimental effects of workload pressures by evaluating the tax ramifi-

cations of the issue. To the best of our knowledge, this study is among

the first to investigate the audit examination of the tax provision in

connection to auditor busyness. As a result, this study sheds light into

a previously under-researched but essential component of every

audit. Second, we contribute to prior research on APTS, a subset of

non-audit services provided by audit firms. Our tests do not find evi-

dence of a significant interaction between workload compression and

APTS. This is unsurprising given that there are mixed results in the

prior literature; in addition, stakeholder groups present conflicting

views regarding the ultimate impact of auditors' involvement in tax-

related matters. However, we find evidence consistent with a main

effect of knowledge spillover on tax avoidance after considering the

impact of auditor workload compression. This evidence is important,

as most related studies focus on APTS as a proxy for auditor influence

on the tax provision (via either knowledge spillover or economic

bonding) but largely ignore the role of nonmonetary forces such as

workload compression. Third, this study focuses on audit-related con-

straints and their impact on management's determination of the tax

provision using a novel method that allows us to investigate the possi-

bility of a link between financial statement audits and tax avoidance.

LOPEZ AND GREENWALD 421