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.

C. Explain the rebates, or upfront rebates, from the companies supplies. Why would the supplies pay the up front credit? What is the proper accounting for the upfront credits? What controls should be in place to account for that upfront credits? How would the auditor test 1.) The controls over the accounting for the upfront credit and 2.) The expenses of certain accounts, are the liability accounts?

D.)Do you believe that the material and the statements were the result of errors or fried? Discuss the reason for your opinion.

Answer 1

C.

• Rebates or upfront rebates are advance payment received by the supplier in lieu of a car or other product to be purchased by the customer over a period of time which should not be recognized in the until the promised purchase are not made.
• The supplier would pay up-front credit to get orders from the company because of its reputation and amount involved will enhance the supplier’s turnover and improve its credentials.
• The up-front credit should be recognized in the books only once the customer buys a certain quantity over the period of time till then it should be treated as a deferred asset and not recognized as part of revenue.
• There should be in-built control in the system which should recognize the up-front credit from the supplier and if any amount of transfers from advance account to revenue there should be shown error unless the same is duly. Authorized which can only happen after the customer buys a certain quantity.
• The auditor should randomly. Select up-front creditor and feed the same data to both advance account the auditor should check the bank account payment details and correspondingly check the liability account to see if there is under or overpayment and sometimes inquire with the vendors casually.

D.

From the given facts it can be assumed that the misstatements are results of fraud rather than an error. An organization such as GM has an inbuilt internal control system, which is the responsibility of the management to implement and follow, to tackle any sort of frauds. Misstatement to such a large extent is not possible without the consent and collision of the top management. Further, there is not a single event of misstatement but a series of them are there in different years to jack-up the profit, which is evident from the information available.

Hence we believe that the misstatement is due to fraud.