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Using Financial Ratios to Select Companies for Tax Auditing: And Exploratory Analysis

Dorina Marghescu, Minna Kallio, Barbro Back, Using Financial Ratios to Select Companies for Tax Auditing: And Exploratory Analysis. TUCS Technical Reports 996, Turku Centre for Computer Science, 2010.

Abstract:

Tax auditing procedures include an investigation of the accounting records of a company and of other sources of information in order to assess whether the taxation has been based on correct and complete information. When there are found discrepancies between the accounting information and the real situation, the taxation should be corrected so that the eventual tax defaults are assessed and debited. The paper analyzes to what extent the financial performance of a company can be used as an indicator of tax defaults. We focus on one type of tax, namely employer’s contribution or payroll tax, and four financial ratios. We evaluate different models built on a set of Finnish companies by using a binomial logistic regression analysis. The study is exploratory, meaning that it aims at understanding the characteristics of the companies with tax defaults, rather than confirming a hypothesis or predicting the likelihood that the company is in the high-risk group. In addition, the analysis is at a preliminary stage in the sense that it does not include all relevant characteristics of the companies, but only a limited amount, namely four ratios representing financial performance. However, the study is useful because it provides evidence that a certain group of companies that have employer’s contribution defaults presents particular characteristics and that more variables are needed to fully capture the particularities of the companies of interest. Methodologically, the study shows that the logistic regression is useful for modeling the differences between the companies with tax defaults and the companies without tax defaults, and that the pre-processing of the data in terms of filtering out the companies into meaningful groups is as important in modeling as the selection of appropriate variables.

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BibTeX entry:

@TECHREPORT{tMaKaBa10a,
  title = {Using Financial Ratios to Select Companies for Tax Auditing: And Exploratory Analysis},
  author = {Marghescu, Dorina and Kallio, Minna and Back, Barbro},
  number = {996},
  series = {TUCS Technical Reports},
  publisher = {Turku Centre for Computer Science},
  year = {2010},
  keywords = {tax auditing, financial performance, financial ratios, binomial logistic regression},
  ISBN = {978-952-12-2537-6},
}

Belongs to TUCS Research Unit(s): Data Mining and Knowledge Management Laboratory

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