General (non)Communication Chooses Earnings Adjustment Over Restatement

Another SAB 108 adjustment regarding interest capitalization pops up in the 10-K filing of General Communication Inc. (The other one noted recently was in the 10-K filing of Deltic Lumber.) Like the Deltic Lumber correction, this one had a favorable effect on retained earnings.

Check this explanation:

Prior to January 1, 2006, only the interest costs incurred during the construction period of significant capital projects, such as construction of an undersea fiber optic cable system, were capitalized. Beginning January 1, 2006, we modified our interest capitalization policy resulting in the capitalization of material interest costs incurred during the construction period of non-software capital projects and the capitalization of interest costs incurred during the development period of a software capital project.

These misstatements accumulated over several years and were immaterial when quantifying the misstatements using the statement of operations method. Upon adoption of SAB No. 108 on January 1, 2006, we recorded a $3.5 million increase to property and equipment in service and $1.6 million increase to accumulated depreciation for the cumulative misstatement as of December 31, 2005. Accordingly, we increased retained earnings by $1.1 million and recorded $772,000 as a long-term deferred tax liability.

It’s a pretty minor amount - less than 1% of beginning retained earnings, and the adjustment to PP&E is less than 1%, too. It sounds as if the firm made a policy change as of 1/1/2006, then looked back to see what the effect would have been had the proper policy been in place all along. It’s not clear that they were examining the differences between policies until the time they changed it. And when they did, the change still didn’t come up to a material amount.

General Communication appears to have defaulted to the retained earnings adjustment approach - something that seems pretty common. But check this excerpt from SAB 108:

The staff will not object if a registrant does not restate financial statements for fiscal years ending on or before November 15, 2006, if management properly applied its previous approach, either iron curtain or rollover, so long as all relevant qualitative factors were considered.

If a firm was quantifying its errors all along and waiving them, and application of SAB 108’s dual approach results in a correction, then the retained earnings adjustment is just fine. But if a firm makes a correction to its policy in 2006 and hadn’t been quantifying it all along prior to that change, it could be argued that the retained earnings adjustment is not the right way to go. But it seems like pretty much all companies have taken the retained earnings route, ignoring the fact that restatement is preferable and that immaterial items should simply pass through earnings.

GNCMA 1-yr chart