In March 2006, General Motors (GM) announced that it needed to restate its previ

Question

In March 2006, General Motors (GM) announced that it needed to restate its previous year's financial statement. Excerpts from the Wall Street Journal describing the restatements include:

GM, which already faces an SEC probe into its accounting practices, also disclosed that its 10-K report, when filed will outline a series of accounting mistakes that will force the car maker to restate its earnings from 2000 to the first quarter of 2005. GM also said it was widening by $2 billion the loss it reported for 2005.

Many of the other GM problems relate to rebates, or credits, from suppliers. Typically, suppliers offer an upfront payment in exchange for a promise by the customer to buy certain quantities of products over time. Under accounting rules, such rebates can't be recorded until after the promised purchases are made.

GM said it concluded it had mistakenly recorded some of these payments prematurely. The biggest impact was in 2001, when the company said it overstated pre-tax income by $405 million as a result of prematurely recording supplier credits. Because the credits are being moved to later years, the impact in those years was less, and GM said it would have a deferred credit of $548 million that will help reduce costs in future periods. The issue of how to book rebates and other credits from suppliers is a thorny one that has tripped up other companies, ranging from the international supermarket chain Royal Ahold, N.V. to the U.S.-based Kmart Corporation.

GM also said it had wrongly recorded a $27 million pre-tax gain from disposing of precious-metals inventory in 2000, which it was obliged to buy back the following year.

Gm told investors not to rely on its previously reported results for the first quarter of 2005, saying it had underreported its loss by $149 million. GM said it had prematurely boosted the value it ascribed to cars it was leasing to rental car companies, assuming they would be worth more after the car rental companies were done with them. GM previously had reported a loss of $1.1 billion, or $1.95 a share, for the first quarter. (March 18, 2006)

You may assume the amounts are material.

b. Describe the nature of the accounting judgement made by the company regarding the residual value of the cars it leases. What information and communication system should exist regarding the residual value of the cars returned from leasing? What controls should be in place? What evidence would the auditor need to evaluate the reasonableness of the change made by the company?

Explanation / Answer

Answer

The accounting judgment made by the company with regards to the residual value of the cars it leases was not reliable because it lacked evidences and information of current market conditions. Perhaps, the auditor can obtain information about the company’s information and communication system with regards to the cars returned from leasing. The auditor can ask for substantive evidences such as documents about the car leasing, authorization, inquiries, invoices, receipts and others for control purposes.

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