Academic journal article Issues in Accounting Education

Interstate Transport, Inc.: A Case Study in Earnings Management

Academic journal article Issues in Accounting Education

Interstate Transport, Inc.: A Case Study in Earnings Management

Article excerpt


This case asks student teams to make a number of accounting decisions in the context of a single company. The decisions address the allowance for bad debts, inventory valuation, depreciation lives and methods, contingency provisions, and accounting for off-book entities. The case selling requires you to address those issues in an integrated way, and establish a rationale for the decisions required. The teamwork required illustrates the way differing personal judgments, regarding both facts and principles, enter into the determination of net income. Whether you mean to or not, your teams will be practicing "earnings management."


The Executive Committee of Interstate Transport, Inc. has been called to a meeting to consider some open issues regarding the company's financial statements for the year ended December 31, 20X4. The industry is on the edge of one of its down cycles, and some members of the management team have adopted a "hunker-down" attitude with regard to the business and the financials. Others, however, are sure that things are going to come back quickly, and argue that the company needs to maintain (and project) a more positive perspective. Because of those differing views, the CEO concluded that everyone deserved a chance to have a say concerning the judgments required in the preparation of this year's financial statements. In anticipation of the Executive Committee meeting, the financial staff pulled together a packet of information outlining the open issues, and drew up a set of projected financial statements for 20X4 before considering of any of those open issues. The meeting will be interesting.

The Company and Its Industry

Interstate Transport, Inc. (ITI) manufactures and services a wide variety of specialty trailers for both over-the-road and off-road transport of liquid and solid commodities. The company has been tempted to jump into the larger market for general merchandise trailers, but it is a very competitive, low margin business. ITI's strategy--at least for the present--has been to focus on its relatively narrow niche and use reconditioning and parts sales to smooth the inevitable peaks and valleys in new trailer sales.

In slack economic times, when ITI's customers were forced to cut back on their purchases of new trailers, many could be convinced to cycle their existing fleet back to ITI shops for reconditioning. Some of the larger trucking companies did their own reconditioning, but even they purchased parts from ITI, as did the independent repair shops. In good years, trailer sales were 60 percent of ITI's business, while parts sales were 20 percent and reconditioning services were 20 percent. In leaner years, trailer sales might fall to 35 percent; trailer sales carried the highest margins, but parts sales and reconditioning services provided enough profit in the leaner years to keep the company together.

ITI's product line consists of variations on a basic tanker model and on an open-top hopper model. Sales prices for the tankers range from $150,000 for the 40-foot painted steel version to $250,000 for the 50-foot stainless steel model, which has its own pumping unit. The hopper trailers are either made of sheet steel or aluminum sheets, and the prices are $100,000 and up, depending on the length of the trailer and the gauge of the sidewall sheets. Specialty hopper trailers could be as expensive as a top-of-the-line tanker, depending on unique features required by the customer. Most trailers are built to order, with a wide variety of customization options available.

Most of the 60 firms in the industry have assets of less than $10 million, although there are four large firms with assets over $250 million. ITI is a distant fourth in that major-player group. The other three major firms focus mostly on general transport and the trailer/train/ship container business. …

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