Do Chinese Costing Practices Contribute to Product Dumping

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Do Chinese Costing PracticesContribute to
Product Dumping?
Raef Lawson, PhD, CMA, CPA IMA Director of
Research rlawson_at_imanet.org
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Agenda

• Session objectives
• Background (China, economic/ accounting
  environment)
• Chinese costing practices
• IMA research study
• Background
• Initial observations
• Conclusions implications
• Challenges facing management accounting

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Question

• How many of you work for organizations that
• Have operations in China?
• Have partners in China?
• View Chinese companies as a competitive threat?

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Session Objectives

• This session discusses how the methods that
  Chinese companies use to cost their products may
  impact companies that work with or compete
  against them.
• Based on the preliminary results of IMAs Global
  Costing Study
• Whether you are competing, partnering, or looking
  to merge with a Chinese company, understanding
  the costing practices employed by these companies
  may determine the success of the venture.

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Chinese Economy Continues to Grow
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China Accounting Environment

• China adopted IAS (modified) as of January, 2007
  for all listed companies.
• Total employment 788 million (2006 estimate)
• Employment at state owned enterprises 69
  million
• CPAs in public practice 69,000
• CICPA Membership 130,000
• Government estimate of required accountants
  300,000
• severe lack of trained accountants in China
• IMA Membership 414 (China), 112 (Taiwan), 199
  (Hong Kong)
• ACCA Membership Approx 10,000

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What is Dumping / Penalties for Dumping

• 1921 Antidumping Act
• This statute authorizes compensating duties when
  imports are sold at less than normal value and
  are a cause of (or threaten) material injury to
  the U.S. industry producing products like those
  that are imported.
• The 1916 Antidumping Act
• authorizes treble damages whenever a plaintiff
  can demonstrate that imports are commonly sold in
  the United States at less than the actual
  wholesale value in the country of production

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Penalties for Dumping

• Tariff Act of 1930 (Ch. 4, Subtitle IV)
• authorizes compensating duties to offset the unit
  value of subsidies received by foreign producers.
  
• Trade Act of 1974 (Sections 201 and 406)
• allows quotas and/or higher tariffs when the
  Commission finds that aggregate imports from all
  foreign sources are a substantial cause of
  serious injury to the U.S. industry
• there is no need to show that the imports are
  "unfair," or subsidized all that matters is
  quantity.
• section 421 The ITC determines whether imports
  of a product from China are causing or
  threatening to cause market disruption to the
  domestic producers of like or directly
  competitive products. If the ITC finds market
  disruption, it recommends remedies.

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IMA / China Ministry of Commerce Costing Study

• The IMA is conducting a research project being
  sponsored by the Ministry of Commerce of the
  Peoples Republic of China
• This project involves both field research and a
  survey of Chinese companies

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Objectives of the Research Project

• Compare cost management methods in China with
  those used in other countries.
• Compare International and Chinese accounting
  policies, procedures and methods in light of the
  current anti-dumping environment.
• Examine the regulations companies follow as well
  as the actual practices they undertake.
• Evaluate to what extent Chinese cost management
  systems are influenced by open market economy
  practices versus more planned economy practices.

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Research Project Methodology

• A combination of research approaches used.
• On-site firm visits to 12 companies in China
  (completed).
• This provided data for preliminary conclusions
  and helped identify issues to be studied in the
  next phase of the study.
• A follow-up mail survey
• distributed to 400 companies by four Chinese
  Chambers of Commerce (CoC).
• The surveys were hand out to the companies and
  collect from them by the CoC. Organizations were
  asked to have the questionnaires filled out by
  the finance department and the related business
  departments.
• 209 completed surveys were received, for a 52.3
  response rate.
• This data is currently being analyzed.

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China Costing Study Field Visit Companies
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China Costing Study Field Visit Companies
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• Organizational Goals

Maximizing long term profit is an extremely
important goal
Current profit is the only real goal at our
company
My firm faces immense pressure to increase
employee headcounts
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Factors Affecting Product Pricing
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Chinese Costing Practices Issues

• Types of costing methodologies utilized
• Treatment of different types of cost
• Land use rights
• State Owned Enterprises (SOEs) vs. private
  companies
• Transfer pricing

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Reason for Product Cost Distortion
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China Costing Study Initial Observations

• Differences between Chinese and Western practices
  in the treatment of the cost of various
  function-related costs.
• The cost of Purchasing Departments for all of the
  companies visited was included in Administration
  Expense.
• The cost of factory-level supervision was often
  included in Administration Expense.
• The general Western practice would be to include
  these costs in the cost of goods produced.

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China Costing Study Initial Observations

• Differences in practices related to the costing
  of raw materials, direct labor, and overhead.
• All companies visited utilized a quota (i.e.,
  standard costing or budget) system in
  operational planning.
• However, there was typically no linkage between
  the standards and the cost accounting system
  direct materials, direct labor, and overhead were
  all allocated to a periods production based on
  the actual cost.

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Overhead Allocation Basis Used
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Treatment of Land Use Rights
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Effect of Size of Cost of Land Right on their
Accounting Treatment
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Recap

• Chinese companies operating in a complex
  environment, with multiple goals
• Costing information important in price setting
• General feeling that costing methodologies
  employed yield accurate information
• Differences between Chinese and Western costing
  methodologies identified
• Some Chinese costing practices may result in
  lower product pricing than Western companies.
• Impact of these differences now being analyzed

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Quick Break
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China Costing Study Additional Observations

• An analysis of the costing and budgeting systems
  of the companies visited would lead one to think
  that, in general, Chinese companies have outdated
  cost accounting systems
• Major Western developments in the area of cost
  management from the 1950s on have not been
  widely adopted (although the situation is
  changing)
• Ex., activity-based costing, balanced scorecard
• This conclusion would be a oversimplification of
  the situation
• During the period of isolation from the West,
  Chinese companies faced similar planning and
  control challenges
• Differences often reflect then-existing
  differences in political and economic climates in
  China and the West

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China Costing Study Parallel Development of
Costing and Control Systems
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China Costing Study Initial Observations

• Challenge going forward
• Integrating existing Chinese planning and control
  practices with Western best practices to fit the
  unique operating environment and culture of each
  (Chinese) company

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Problems with Chinese Accounting/ Management

• Procurement and Supply Chain Management - Many
  companies do not adequately control procurement,
  inventory utilization and disposal of inventory.
  Common problems include purchasing of overpriced
  raw materials (usually through a company related
  to a member of staff), discrepancies of bills of
  lading and goods received, improper storage of
  raw materials and safeguarding of inventory,
  sales of goods at/below cost to related parties,
  and illegitimate disposal of scrap materials and
  containers. 
• Sales and marketing expenses - Incorrect
  accounting for such expenses, unauthorized and
  illegitimate reimbursement expenses, "fake"
  official invoices and false transfer pricing
  agreements. 
• Corporate compliance - unauthorized and improper
  tax registration, under-reporting of tax
  liabilities, unauthorized use of company shops,
  and payment of expenses by offshore entities
  without correct accounting and taxation
  payments. 

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Problems with Chinese Accounting/ Management

• cross ownership of companies - especially when a
  local government owns the company, the land and
  many of the suppliers
• Human resources/payroll - deliberate over-accrual
  of company welfare benefits (not in line with
  government requirements), unauthorized use of
  staff benefit funds, dummy employees,
  discrepancies between contract salary and payroll
  salary payments. 
• Provisions and accruals - over-provisioning to
  create "slush" funds, lack of company policy
  and/or experience for accruals for bad debts,
  lack of company policies. 

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Management Accountants not yet Strategic Partners!

• In aiding the internal decision making process,
  the importance of planning and control in the
  finance/accounting department is not any less
  than providing accurate bookkeeping and financial
  reporting

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Challenges Faced by Management Accounting in China

• Low interest in management accounting as a field
• Possibly due to need for public accountants as
  many companies rush to go public in new
  economic environment
• Future of Chinese economic development depends on
  developing a more balanced accounting
  profession
• In global environment, only efficiently operating
  companies will survive
• Management accountants pay a key role here

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Next Steps

• Complete analysis of survey data
• Prepare final report
• Publish research study in China and USA (expected
  September 2007)

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Questions?

• Presentation will be available on the conference
  website.

rlawson_at_imanet.org