Tax numbers aid analysts more than narratives, study finds

When it comes to tax disclosures, financial executives are under increasing pressure. They must walk a fine line between meeting the letter of the law with regards to disclosure compliance and opening up their books too wide — potentially drawing the unintended consequences of arming competitors or drawing the scrutiny of regulators. 

Tax disclosure requirements are also a growing challenge for many companies. For example, rules issued by the Financial Accounting Standards Board have drawn significant pushback. They require companies to break out much more information in their reports on the income taxes they pay, such as identifying a country or state that receives more than 5% of their total tax payments.    

Yet part of the job for many finance leaders at public companies is to inform and communicate with analysts so that they in turn can explain the company’s business models to investors and the lending community. Done well, that can open the doors to financing deals and, well, more investors.

With that in mind, CFOs would do well to thoughtfully share at least some specific numbers in their financial reports in order to paint the clearest picture possible of their organization’s tax situation, according to a recent study by Carly Burd, an assistant accounting professor at North Carolina State University’s Poole College of Management.

Burd found that providing more detailed numeric data, as compared to relying more on narrative stories, does a better job informing analysts, according to the study published earlier this month. 

“Analysts are better enabled to implicitly forecast tax outcomes when firms report more granular numeric tax detail, especially in the footnotes, which is most valuable for firms with complex tax positions,” Burd told CFO Dive in an email Friday. “Narrative disclosure helps, but not in the way numeric does.”  

The findings underscore an exception to previous studies that found number-heavy financial statements can create a “muddled picture for investors,” according to a release on Newswise, a research distribution platform. 

“Previous work found that when a company includes more numbers in its annual report financial statement it becomes so complex that investors find it difficult to process,” Burd said in a statement in the release. “I wanted to focus specifically on numbers related to the wide variety of transactions a company engages in that can affect tax outcomes. And when I looked solely at those tax numbers, I found that the numbers actually contribute to clarity for investors.” 

For her study, Burd used eXtensible Business Reporting Language, a machine-readable language that can tag numeric items in financial statements, to analyze tax numbers in 7,944 annual reports of 2,099 companies from 2012 to 2019. 

The study also found that the transparency does come with a risk: The statements containing more tax numbers were more likely to be downloaded by employees of the Internal Revenue Service, according to the release. 

However, the study asserts that closer scrutiny by the IRS may have prompted the companies to provide the additional data, and potentially have preceded their more transparent approach. 

“Firms with greater IRS scrutiny may be compelled to provide more complete numeric tax detail…As such, the results should be interpreted as associational rather than causal,” the report states.