5-92. General Motors

FRAUD In March 2006, General

Motors (GM) announced that it needed to restate its previous year's financial

statements. Excerpts from the Wall Street Journal describing the restatements

include the following:

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 cannot

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.

Without determining whether

the errors in accounting judgment 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 aggressive by the company's CFO and CEO?

How would those judgments affect the auditor's assessment of the control

environment?

Describe the nature of the

accounting judgment 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?

Explain the rebates, or

up-front rebates, from the company's suppliers. Why would the suppliers pay the

up-front credits? What is the proper accounting for the up-front credits? What

controls should be in place to account for the up-front credits? How would the

auditor test?

(1)

the controls over the

accounting for the up-front credits and

(2)

the expense-offset account,

or the liability account?

Do you believe that the

material misstatements were the result of errors or fraud? Discuss the reasons

for your opinion.