5-100 GENERAL MOTORS In March 2006, General Motors (GM) announced that it needed to restate its

prior years 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 cant 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 pretax 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 pretax gain from disposing of preciousmetals 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 judgment were intentional or

unintentional, discuss how the nature of the errors affects the auditors 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 companys CFO and CEO? How would those judgments affect
the auditors assessment of the control environment?
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.
b. 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?
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 companys 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.
c.
Explain the rebates, or up-front rebates, from the companys 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?
A rebate is an amount paid by way of reduction, return, or refund on what has already
been paid or contributed. It is a type of sales promotion that marketers use primarily
as incentives or supplements to product sales. Rebate offers attract consumers because the
offer makes the price seem much lower than normal. In fact, companies would rather use a
rebate in place of a sale to increase the attractiveness of their products, because they know so
many buyers will not redeem the rebate. Its an effective way for the company to achieve
market segmentation by getting the benefit of finding out additional information about the
customers. The auditors can perhaps trace and check the entries of the company as to whether
it was able to record it in the books properly.