The SEC recently sent a request to General Motors, Ford, Delphi and others to understand their actuarial assumptions for pension accounting to determine if changes were made to impact reported profits and not warranted by reality. Pension accounting, especially of plans that are as deeply under-funded as those of the auto companies, is a legitimate area of inquiry for the agency, especially at " />

Issue: Nov 2004


Keller



Do We Actually Know What the Auto Companies Earn or Lose?

by Maryann Keller

The SEC recently sent a request to General Motors, Ford, Delphi and others to understand their actuarial assumptions for pension accounting to determine if changes were made to impact reported profits and not warranted by reality. Pension accounting, especially of plans that are as deeply under-funded as those of the auto companies, is a legitimate area of inquiry for the agency, especially at a time when the Pension Benefit Guaranty Corporation is facing massive liabilities.

It seems that the regulators have now set their sights on management behavior that aims to smooth or present in inaccurate picture of corporate profits through the use of accounting changes or purely financial contrivances.

Accounting practices are supposed to ensure that costs and revenues match up in each reporting period and what is leftover is what the company earned. While no one argues that this isnt being done at the auto companies, the SEC inquiry goes to the question of what is the actual expense and when should it be recognized. Changes in accounting policies, as everyone knows, can have an immediate and dramatic impact on reported profits usually with consequences to the companys operations or balance sheet over a period of time.

There was a time in the 1970s when GM was simply the most conservative and financially powerful company on the planet. At that time we spoke about the high quality of GMs earnings vis-?-vis Ford which would have given it another $1 a share in profits using Fords perfectly legitimate accounting standards on depreciation, taxes, reserves and pensions, to name just a few areas. The legacy of Alfred Sloan and Donaldson Brown was a company that made returns on investment the driving force in decision making. Brown also instilled a discipline in the accounting policies that rapidly eroded in the 1980s as GM got into competitive trouble.

As GMs market share fell, its costs rose and it threw away billions on an ill-conceived notion that technology would vault the company again into a global leadership position. GMs management never dealt with the competitive problems or the fact that it wasted billions on non-productive assets. But it was adroit in boosting profits by replacing conservative accounting policies with liberalized, though perfectly legal, standards. While it may have made some executives feel better to think that things really werent so bad, it disguised the ongoing deterioration of the business. It was easy to add profits to the bottom line by assuming that tools, plants and equipment should be written off in 10 or 20 years instead a three to 10 to reverse reserves or change actuarial assumptions on pensions. Of course nothing had changed operationally but it just didnt seem as bad when the quarterly profits were reported. And of course, executive compensation reflected earnings as reported and not adjusted for accounting changes. After a couple of quarters everyone forgot that on the old accounting policies GMs earnings would have been significantly lower. I cant even contemplate how large the losses in North America would be now if the 1974 accounting policies were in effect.

For an analyst or investor in GM, the 1990s were equally frustrating because of the almost annual write-offs taken for various reorganizations and adjustments. Just what the company earned in any period compared to a previous period was nearly impossible to figure out, especially when a write-off taken a year or more earlier was partially reversed.

The accounting changes of the past 20 years enabled GM management to avoid making tough decisions that might have turned the ship around faster. Perhaps labor contracts would have reflected a different reality. Perhaps incompetent executives would have been tossed out before they retired gracefully to a semi-tropical haven.

Creating profits with the stroke of a pen instead of in the factory or dealership has been all too common in many companies and the longterm consequences are never good for the financial and operational health of a business.

Maryann Keller is a veteran auto industry analyst and author of the books Rude Awakening: The Rise, Fall and Struggle to Recover at General Motors and Collision: GM, Toyota and Volkswagen and the Race to Own the 21st Century.

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