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Time for a break from the drone of SAB 108 adjustments…

I’ll drone instead about the internal controls report in the General Motors (GM) 10-K filed last week. The media has jumped on this one because of the sensationalism of the disclosures: the lack of controls over internal reporting and the government investigation of GM’s accounting actually made it into the “Risk Factors” section of the 10-K. Maybe you’d expect that from a start-up - but not from a storied company the size of GM.

Go to section 9A, “Controls and Procedures,” and you’ll see the whole management report on the internal controls. A couple bars go like this:

“1. The Corporation lacked the technical expertise and processes to ensure compliance with SFAS No. 109, Accounting for Income Taxes, and did not maintain adequate controls with respect to (a) timely tax account reconciliations and analyses, (b) coordination and communication between Corporate Accounting and Tax Staffs, and (c) timely review and analysis of corporate journals recorded in the consolidation process…

2. The Corporation in certain instances lacked the technical expertise and did not maintain adequate procedures to ensure that the accounting for derivative financial instruments under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, was appropriate. Procedures relating to hedging transactions in certain instances did not operate effectively to (a) properly evaluate hedge accounting treatment (b) meet the documentation requirements of SFAS No. 133, (c) adequately assess and measure hedge effectiveness on a quarterly basis, and (d) establish the appropriate communication and coordination between relevant GM departments involved in complex financial transactions…

3. The Corporation did not maintain a sufficient complement of personnel with an appropriate level of technical accounting knowledge, experience, and training in the application of generally accepted accounting principles commensurate with the Corporation’s complex financial accounting and reporting requirements and low materiality thresholds…

4. Due to the previously reported material weaknesses, as evidenced by the significant number and magnitude of out-of-period adjustments identified during the year-end closing process and the resulting restatements related to deferred taxes and hedging activities, management has concluded that the controls over the period-end financial reporting process were not operating effectively. Specifically, controls were not effective to ensure that significant non-routine transactions, accounting estimates, and other adjustments were appropriately reviewed, analyzed, and monitored on a timely basis…”

A handful of observations:

Anyone still in college and reading this blog, take note (all three of you): General Motors doesn’t seem to have a lot of technical expertise on hand when it comes to complex accounting matters. The first three weaknesses discussed above all had a common thread - a lack of technically competent personnel. It’s not just in Detroit, folks. This is one of the most common weaknesses you can observe if you spend time reading these control reports. That’s a great thing for people looking for a career in accounting.

(Of course, finance is sexier and sounds cooler to the opposite sex than accounting, especially in your college years. Who needs accountants? Why, the world simply cries out for more investment bankers! Sober up, finance students. If you really want to go where your talents are needed, and the future looks bright, think about accounting.)

Don’t blame GM’s problems on “complexity.” General Motors is a great big consenting adult of a corporation. It engages in business in many taxing locales, and it voluntarily chose to use derivatives. If you’re going to do things that involve complex transactions that are hard to communicate to your shareholders, be prepared to account for them the right way.

Underinvestment in accounting and finance staff saves dollars in the short run - but costs the firm’s reputation dearly in the long run. In this regard, General Motors is no different than so many other companies who’ve come up short in the controls-over-reporting department. Financial reporting is a cost center, for crying out loud: the natural managerial instinct is to starve it. Managers do not lay awake at night worrying about the configuration of accounting and finance departments the same way they’d fret over the layout of the marketing function or the advertising budget. Those functions make money for the company, whereas accounting and finance are often viewed as a drain - until it’s time to do the work over again (see “Restatement Zoo” link). Then the new accounting and finance people are pretty important. For a while.

Corollary and conclusion: it’s a management problem. But it’s so much easier to just blame accounting for being too demanding. Again, this is not to single out GM as particularly inept. It’s just that it happens to be one of our country’s biggest firms and employers, and this scenario has played out in so many other instances over the past few years. This is a sprawling giant of a company, a management challenge all its own in every department. It’s apparent from these weaknesses that insufficient managerial attention was given to managing the accounting and finance function.

General Motors has taken some big strides towards pulling its finance staff out of the muck and onto the track; it discusses them in Section 9 as well.

It would be great to see other companies face up to their underinvestment in controls and accounting personnel. After all - what’s good for GM is good for the United States too.

GM 1-yr chart

Source: General Motors Disclosures: Lessons From a Floundering Giant