Question: General Electric Company GE is a large U S based

General Electric Company (GE) is a large U. S.- based conglomerate, with operations that included industrial equipment and services, healthcare, TV and entertainment, and commercial finance. The sheer complexity and industry diversity of GE made it particularly difficult for even financial analysts to fully understand the company, since it is unlikely, if not impossible, for anyone to be an expert in all the industries in which the company operated. As a result, it was very difficult for investors to predict GE’s future performance. This put a strong onus on GE management to assist investors in this regard. Table 11.3 shows reported earnings for GE for the years indicated. What is striking is the steady increase in reported earnings until 2008. Only in 2005, when net income was pulled down by a large loss on discontinued operations, was there a small break in this impressive pattern of earnings growth. Some of the techniques that GE is reported to have used to generate these smooth earnings are
Changes to the expected rate of return on pension plan assets.
Sales of divisions. Such sales generally lead to large special item gains.
Restructuring charges. These are charges to current earnings to provide for expected costs of restructuring the operations of one or more of its many divisions. It is claimed that GE managed the amounts and timing of these charges so as to offset large special item gains, such as from sales of divisions. The objective was to avoid reporting higher earnings than could be sustained in future years.
Buying profitable businesses. GE was constantly acquiring new subsidiary companies. If needed to prevent reporting an earnings decrease, managing the timing and identity of such acquisitions can achieve an immediate contribution to consolidated reported earnings in the year of acquisition.
Conservative accounting. Rapid amortization of, for example, leased aircraft by GE’s commercial finance division enables large profits to be recorded when the aircraft are eventually sold. The timing of such sales can be managed by GE.
Allocation of purchased goodwill upon acquisition of subsidiary companies. When GE acquires a subsidiary, it may decide, or be required, to dispose of segments of the acquired business. The flexibility under GAAP of allocation of the excess of amount paid for a subsidiary company over the fair value of assets acquired (i. e., purchased goodwill) enabled GE to record a gain on such dispositions, by allocating a relatively small amount of the excess amount paid to any subsidiary segments that it intended to dispose of. The important point about the array of earnings management techniques available to GE is that they can be used in concert to report a smooth earnings sequence. Table 11.3 suggests that, until 2008, GE was quite successful in this regard.

a. Evaluate restructuring charges as an earnings management device.
b. Under securities markets efficiency, share prices always fully reflect all public information about a firm’s securities. In the absence of earnings management, would the share price of a complex firm like GE always have reflected all public information about GE? Explain why or why not. Given its earnings management during that time, would GE’s share price have fully reflected all public information? Explain.
c. Was earnings management by GE during the period 1993– 2007 good or bad? Explain.

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