Earnings Management During Import Relief Investigations” was written by Jennifer J. Jones. It illustrates her study and examination of the effects of managing reported earnings to alleviate the costs of tariffs and quota increases on import businesses. The ITC or (United States International Trade Commission) conducts relief investigations on companies that import goods so they can make a determination on the import relief rate. The ITC sets the import relief after reviewing a plethora of factors.
Some factors include the profitability of the industry and the trends in profitability. Import relief is described as a set of federally imposed regulations which are designated to suspend or restrict the importation of goods into the country in order to protect American manufacturers. The measures often include subsidies, restriction, and assistance to domestic companies. The author describes the reasoning behind the import relief, as well as the effects of the import relief on the affected parties.
Because consumers have diverse interests the effects of the import relief has not been studied in great detail. Often contractors who share a relation to the import business carefully monitor and adjust the accounting numbers to influence the policy makers into not raising the import relief rate. The author says that import relief is basically a wealth transfer from the consumer to the domestic producers because the importers will simply raise prices as the import relief gets higher, and domestic producers will make money because their prices can be highly competitive with the importers.
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In this exchange the ultimate losers are the consumers who will either pay a higher price for imported goods or buy domestic products which generally cost more. Because consumers do not monitor the earnings of import companies the import companies are able to manipulate earnings nearly unhindered. This manipulation of accounting numbers to influence import relief benefits importers and costs the consumers. Because the ITC is looking out for the domestic producers, importers are in a way forced to manipulate their reported earnings to maintain profits.
The import companies really don’t lose much when the import relief goes up. The cost of importing goods to the United States and paying the import relief is most often cheaper than manufacturing goods in the United States. The ITC looks at a company’s earnings before taxes. To circumvent the ITC the managers of import companies often use multiple accrual accounts. By playing somewhat of a shell game with the ITC the import companies are able to hide assets or shift them to the next quarter to show a lower profit margin. The author conducted a cross sectional investigation of the accrual accounts of import companies.
Her investigation revealed that the import companies suddenly report lower earnings and income just before the investigation period. The obvious concern of the import industry is illustrated by the drastic counter measures put in place by the managers of import companies. The methodology of the ITC is effective at protecting domestic producers and the American economy but it puts import companies in a difficult situation. When presented by the moral dilemma of altering reported income import companies must make a decision which in the minds of many theorists is not a decision at all.
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Because businesses are driven by profits and managers are paid by the shareholders to protect the best interest of the company they are forced to alter reported earnings. Because the import companies show lower earnings just before the reporting period that is disproportionate to their earnings through the year it is clear that the import companies are circumventing larger import relief rates by manipulating earnings just before the ITC investigation period. The managers of the import companies are responsible for the manipulation of accounting numbers.
It is only natural for managers to protect the interest of the company. However, many consider the manipulation of accounting numbers to influence the import relief to be unethical. On the other hand many theorists believe that the import relief is an unfair tariff on import companies. Politics play a major role in the creation of the import relief. Some theorist claim that politicians who are influenced by large companies can affect the decision making process of the ITC investigation. Because the import relief is based on many different factors the manipulation of reported income could possibly be an unnecessary.
In addition, accountants who engage in the manipulation of earnings can face legal penalties for falsifying accounting numbers. The SEC should investigate the accounting books of import companies to discover falsifications before they can affect ITC’s investigation and decision. It is not addressed why auditors do not report earnings manipulations. It is possible that because of the adverse relationship by companies and their audit firms it is possible that the manipulations are discovered and hidden.
The author conducted her study of five import industries. She studied the auto industry, carbon steel industry, stainless steel industry, copper industry, and footwear industry. Based on her calculations the reported earnings of the different industries would remain constant with the earnings trend of the rest of the year. The author also studied the earnings of 459 other firms who were excluded from the ITC’s investigation to determine if in the period of the investigation their reported earnings decreased also.
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Her empirical testing of the firms accruals showed that the firms that were excluded from the investigation showed statistically consistent reported earnings during the investigation period. The author’s theory of earnings management during import relief investigations shows parallels to the political cost hypothesis. Although her study was sufficient in proving her point the author acknowledges that her study was not conducted on a broad enough sample. However, Jones’s study of earnings management during import relief investigations is a valuable example for future reference regarding ITC financial investigations.
The author created an equation to discover the trend of reported earnings and what the reported earnings should be for the investigation period. The purpose of import relief is to protect domestic companies because foreign manufacturing is dramatically cheaper than domestic manufacturing companies. To maintain competitiveness between domestic and foreign producers and protect American businesses the ITC regulates the import relief. Because the import relief is decided by the ITC based on many different factors so manipulating reported earnings will not be enough to completely skew the ITC’s decision.
The plethora of factors that the ITC uses to create the import relief are used because the ITC is afraid of making the import relief unfair to any party so it uses multiple methods of determination. The ITC utilizes policies to ensure fair trade and importing. The ITC protects from imports being sold at less than fair value which the ITC calls dumping. The ITC uses investigations and statutes to regulate dumping; they call these policies anti- dumping. The ITC also protects against companies benefitting from foreign subsidiaries by conducting countervailing duties.
The author states that the import relief can be simplified as a transfer of wealth from the consumers “losers” to the domestic producers “winners”. It is often considered to be unfair. The import relief protects the American economy by protecting the market from being flooded with cheap imported products. If the market is flooded by cheap imported products many domestic companies will be put out of business due to a rapid drop in sales. The ITC tries to level the playing field with the import relief.
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American businesses fail to remain cheap and competitive with the foreign producers because in foreign countries there are no federal regulatory powers making regulations that cost business time and money. In addition, foreign countries usually don’t contend with labor unions that demand higher employee salaries and limits on performance demands. In conclusion, “Earnings Management During Import Relief Investigations” by Jennifer J. Jones is a valuable reference to the import industries reaction to ITC investigations.
It presents her study into import relief investigations which should be a read by all individuals seeking knowledge about accounting, finances, and the import industry. Many theorists believe import relief to be controversial. The import relief must be beneficial to American business as it forces importers to manipulate reported earnings just to circumvent higher import relief. Import relief is a factor that weighs into international business and will remain an issue of concern for accountants and business practitioners alike.
