Deferred Tax Asset Valuation Allowances and Auditors' Going Concern Evaluations

The valuation allowance for deferred tax assets is an audited disclosure that reflects management’s expectations regarding the future profitability of a company. Building on prior literature that establishes this disclosure as an indicator of future distress, we examine whether the valuation allowance is associated with auditors’ going concern evaluations. We find evidence that the existence and magnitude of the valuation allowance, as well as changes in the allowance, are positively associated with the likelihood that a company receives a first-time going concern opinion. We also find some evidence that valuation allowances are associated with reduced Type I and Type II going concern opinion misclassifications. Our results suggest that the information related to management’s plans and expectations that is reflected in the valuation allowance is incrementally relevant to auditors in their assessment of a company’s likelihood of failure.