Legend has it that companies like to release bad news after the markets close on Fridays so that it either goes unnoticed (unlikely) or investors have more time to calm down before reacting negatively.
True or not, there was an interesting bunch of post-close releases of non-reliance 8-Ks issued this past Friday. A look at a few of them:
Yellow Pages publisher R.H. Donnelley recalled its 2004 10-K due to an accounting error in a publishing partnership investment. The error involved an over private investment trust of deferred costs that were to be matched against advertising revenue received; correcting the over amortization was worth at least $3 million in decreased loss in the investment.
Supermarket operator Great Atlantic & Pacific Tea Co. (GAAP Tea Co.?) disclaimed its 2004 annual report, due to lease accounting issues. Its 2005 report, to be filed tomorrow, will contain corrected lease accounting.
Mark West Energy Partners LP pulled its financials from 2003 and 2004 because of an issue with sales of subordinated Partnership units and interests in the General Partner to directors and officers of Mark West Hydrocarbon (the LP’s parent company). Originally, the transactions had been treated as outright sales of assets; on closer examination, they were more properly classified as compensation to the officers and directors.
SEMCO Energy restated its 2004 annual report and interim financial statements due to errors in computing basic and diluted earnings per share.
The first thing you think of when you hear that Bright point faces an accounting issue is “AIG.” Wrong. Bright point is pulling its recent 2004 10-K because of overstated receivables and revenues in France and improperly recorded vendor rebates in Australia. The really interesting thing: in the 10-K, management had “concluded that the Company’s internal control over financial reporting was effective as of December 31, 2004, notwithstanding the existence of significant deficiencies.” Auditors Ernst & Young agreed. The errors were discovered later.
Get Me Rewrite: GE’s Derivatives Corrections
This morning GE issued a non-reliance 8-K on its 2004 financial statements. The culprit: incorrect application of the notoriously complicated Statement 133, “Accounting for Derivative Instruments and Hedging Activities.”
There were three chief errors that GE’s internal audit staff uncovered “in the course of a regularly scheduled audit.”
– There were interest rate and currency swaps at General Electric Credit Corporation that included up-front fees paid or received – and the swaps amounted to about 14% of total borrowings at January 1, 2001, when Statement 133 became effective. At the end of 2004, they were about 6% of total borrowings.
On the first pass, GE treated the fees as immaterial. (The 8-K doesn’t disclose the amount of the fees alone.) Auditors KPMG agreed with the treatment in their 2001 audit. By 2003, these kinds of swaps were mostly discontinued, but existing swaps retained the accounting treatment. The problem: because of the up-front fees, the fair value of the swaps was not zero at the initiation of the transaction – and 133 requires ongoing “effectiveness testing” of the hedge (to determine if it really is a hedge.)
GE didn’t perform effectiveness testing. The filing doesn’t specify the consequences of ultimately completing the testing, but if they’re doing a restatement, you’d think that the testing showed that the swaps were not effective hedges. The consequences of ineffective hedges is that the changes in fair value of the hedging instruments should pass through earnings as they are revalue each period.
– Second issue: there was a a hedge accounting position linked to a portfolio of assets consolidated by General Electric Credit Corporation in July 2003 when FIN 46 (Consolidation of Variable Interest Entities) was implemented. The portfolio’s assets amounted to 2% and 1% of GE’s total assets at consolidation and at year end 2004, respectively. Not an insignificant-sized portfolio, when you consider the size of GE’s asset base.
GE engaged in “interest rate swaps in 2003 to adjust the economic yield on these newly-consolidated fixed-rate assets from a fixed to a floating rate.” Once again, the firm did not perform subsequent effectiveness testing. The internal auditors found something that the initial recorders and auditors missed on the first go-round: the prepayment penalties in the underlying assets were not properly factored into the associated swaps. If they had been, effectiveness testing wouldn’t have been required. Because they didn’t reflect the penalties, the testing was required; it wasn’t executed. And here we are.
– GE is less descriptive about the other errors, saying only that the internal audit “identified other errors under SFAS 133 with respect to other aspects of certain swaps and other derivative instruments. Adjustments to correct the accounting for these transactions also are included in our restated results of operations. We do not believe these other adjustments are material, individually or in the aggregate, to our financial position or our results of operations for any reported period.”
Toting up the restatement, GE figures that “the cumulative effect of these changes is a non-cash earnings increase of $381 million from 2001 through the first quarter of 2005, less than six-tenths of one percent of GE’s earnings over this period.” It mentions that the restatement mattered little on an annual basis, but on a quarterly basis, restatement became necessary.