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.

a. Without determining whether the errors in accounting judgement were intentional or unintentional, discuss how the nature of the errors affects the auditor's judgment of the control environment and whether the auditor should conclude there are material weaknesses in internal control. What would your judgment be if the accounting treatment were deemed acceptable, but agressive by the company's CFO and CEO? How would those judgments affect the auditor's assessment of the control environment?

Explanation / Answer

Answer

The control environment of the company serves as part of the evidence of the reasonableness of account balances and disclosures of the financial statements. Thus, knowing that errors were committed in the account balances of the financial statements of the company, the auditor can perhaps conclude that its internal control are not operating effectively. In my opinion, even if the accounting treatment were deemed acceptable, the fact that errors were committed means that something lacked in its internal control procedures. The auditor can conclude that there is an unacceptable level of risk and can decide to expand substantive audit procedures of the recorded transactions

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