More on GM’s Non-GAAP Earnings and $35 Billion Tax Benefit

NLPC ^ | February 15, 2013 | Mark Modica

[jazusamo]

Yesterday's earnings' report by General Motors threw up some red flags that I reviewed here. In recent quarters, the media seemed to give quite a bit of coverage on GM's earnings, but not so this time. I wanted to follow up and discuss what the financial news networks obviously will not.

The most glaring number that warrants further discussion was the $35 billion deferred tax valuation allowance. This tax credit is not allowed under GAAP (Generally Accepted Accounting Principles) but that does not stop many companies from using it as they tout non-GAAP earnings. It is the huge amount of GM's credit that makes it worthy of scrutiny. Let's look at what other sources have to say about this confusing accounting strategy that saved GM from having to explain its GAAP earnings loss of about $30 billion.

From Investopedia :

The amount of deferred income tax is based on tax rates in effect when temporary differences originate. It is an income-statement-oriented approach. It emphasizes proper matching of expenses with revenues in the period when a temporary difference originates. Finally, it is not acceptable under GAAP. ...Management can use changes in the allowance to "manipulate" NI (net income) by affecting income tax expense. Analysts should scrutinize these types of changes.

From Wikinvest :

A valuation allowance depends a great deal on management assumptions - who's to say how high a company's future profits will be, and therefore whether the company will be able to take advantage of its deferred tax assets? If management changes its assumptions about future earnings, the valuation allowance changes, and the difference is reported as earnings, today. So, management at companies with valuation allowances can directly change reported earnings today by changing assumptions about earnings tomorrow. Changing a valuation allowance is one way that management can manage or manipulate its earnings.

From Fool.com :

Keep a watchful eye on valuation allowances. Because they're based on very subjective estimates, they're an easy way for management to manipulate earnings. For example, if a company has a $100 million valuation allowance to offset $100 million in DTAs, and management realizes it's going to miss earnings by $2 million, it can make slightly more aggressive assumptions to release $2 million in its valuation allowance, which flows to net income and allows the company to meet earnings.

So, there you have it. I'll let readers come to their own conclusions on the use of tax benefits on earnings numbers, but investors should be careful investing in companies that rely on accounting methods and non-GAAP earnings figures to tout their "success." Lastly, I must add again that government-owned Ally Financial used this same exact strategy by claiming $1.3 billion of the deferred tax valuation allowance on their recent earnings, which would have been about flat under GAAP accounting. Draw your own conclusions from that, as well.

Mark Modica is an NLPC Associate Fellow.

[jazusamo]

Yesterdays thread

[jazusamo]

Working link:

http://nlpc.org/stories/2013/02/15/more-gm%E2%80%99s-non-gaap-earnings-and-35-billion-tax-benefit

[taildragger]

We need Wyatt’s Torch’s Input...

[buckalfa]

Figures lie and liars figure.

In simple terms GAAP states that you cannot book sales or other revenue to the income statement until that income is realized and deposited in the bank.

GM is cooking the books, but why shouldn't they? They know that big daddy Uncle Sam will bail them out again when the next bankruptcy threatens. It will be for the good of the nation you know. s/

[jazusamo]

I'm sure GM is confident that taxpayers would bail them out again, especially with Obama still in the WH. He wants to keep his union leader thugs happy and taxpayer money means nothing to him.

[jazusamo]

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[Wyatt's Torch]

In simple terms GAAP states that you cannot book sales or other revenue to the income statement until that income is realized and deposited in the bank.

Sorry but that's not accurate at all. You are referring to the cash based method of accounting. The vast majority of companies use accrual based accounting.

Quick difference: Accrual based accounting states that you can recognize it when it is "earned". Depending on the product the definition of "earned" differs. If you still have a "significant obligation" outstanding then you cannot recognize the revenue. However, if you ship a product, let's say a ceiling fan to Home Dept, you can recognize the revenue at the time of the shipment despite the fact that HD has not paid you the cash yet. HD might have 30 or 60 day terms to pay you so you don't collect the cash until then but you have recognized the revenue when you ship it. Same goes for cost. You recognize the cost when you "incur" the cost not when you pay out the cash. Here's a simple article outlining the differences: http://en.wikipedia.org/wiki/Comparison_of_cash_and_accrual_methods_of_accounting

You can find out a ton on how companies are doing with all of this based on their Statement of Cash Flows.

[Jim from C-Town]

Since GM is now a branch of the Federal Government WHY would they use GAAP? Not one accountant in the Federal Government uses GAAP. If the Federal Government was part of the private sector, every politician, government CPA and auditor would be serving prison time for fraud!

[Wyatt's Torch]

Let's look at what other sources have to say about this confusing accounting strategy that saved GM from having to explain its GAAP earnings loss of about $30 billion.

Yes GAAP losses, excluding the valuation allowance, were $30 billion. However, similar to the release of the valuation allowance, they are both non-cash events and don't impact the potential bankruptcy of the company one bit.

Keep a watchful eye on valuation allowances. Because they're based on very subjective estimates...

This is also true for the goodwill writeoff as well as for the original placement of the valuation reserve on the books. In both cases the accountants look at future projections for the company (in this case it was for the entire company for the valuation allowance and specifically Europe for the goodwill) to determine the prospects for suture profitability in order to determine if the reserve needs to remain on the books or if the goodwill is impaired or not. (As an FYI I've done hundreds of these model and sat through countless hours of model defense and explanation with accountants and other parties)

I'll let readers come to their own conclusions on the use of tax benefits on earnings numbers, but investors should be careful investing in companies that rely on accounting methods and non-GAAP earnings figures to tout their "success."

I don't disagree with this at all. We use language stating that in our safe harbor language and our GAAP to non-GAAP reconciliations. Just also understand that seeing a Goodwill writeoff of $35 billion also doesn't mean that one dime in cash went out the door because of it. All that tells you is that whenever they made that acquisition they overpaid.

For me, the absolute best method of understanding the value of a company is to look at their Free Cash Flow (Cash from Operations less Cap Ex) Return on Invested Capital. If you are generating increasingly more cash on a stable, well managed balance sheet it's a good company.

[Momtothe8th]

That is correct, accrual accounting is mandatory for the corporate structure and recognition of income is recorded at the moment it is earned, not necessarily when payment is made. This more accurately meets the matching principle of GAAP, which stipulates that earnings and associated expenses should be reported in the same reporting period to more accurately reflect the business ability to produce profit. I think what is not clear here and what they may be referring to as not meeting this principle would have to lie in whether or not they reported the associated expenses with those earnings. If not, they are definitely not complying with the GAAP reporting requirements and are overstating earnings for the period.

[Wyatt's Torch]

I think what is not clear here and what they may be referring to as not meeting this principle would have to lie in whether or not they reported the associated expenses with those earnings. If not, they are definitely not complying with the GAAP reporting requirements and are overstating earnings for the period.

I am not a tax guy and I know that valuation allowance stuff is extremely complex. My basic understanding of it is that when you put NOL's on the books and it appears from the outlook for the business that there is a reasonable chance ("more likely than not") that you might never use those NOL's then a reserve against them must be put up and taken against income. Now when the forecast changes and it appears that it is "more likely than not" that you will utilize the NOL's then the reserve is no longer needed and it is reversed and taken into income. Similar to say an accrual for an expected legal judgement that is a P&L hit when you post it. If you win the case later that accrual is reversed and taken back into income.