In March 2006, General Motors (GM) announced that it needed to restate its prior year's financial statements.

Excerpts from the Wall Street Journal describing the restatements include the following:

● GM, which already faces an SEC probe into its accounting practices, also disclosed that its 10-K report, when filed, will outline a series of accounting mistakes that will force the car maker to restate its earnings from 2000 to the first quarter of 2005. GM also said it was widening by $2 billion the loss it reported for 2005.

● Many of the other GM problems relate to rebates, or credits, from suppliers. Typically, suppliers offer an upfront payment in exchange for a promise by the customer to buy certain quantities of products over time. Under accounting rules, such rebates can't be recorded until after the promised purchases are made.

● GM said it concluded it had mistakenly recorded some of these payments prematurely. The biggest impact was in 2001, when the company said it overstated pretax income by $405 million as a result of prematurely recording supplier credits. Because the credits are being moved to later years, the impact in those years was less, and GM said it would have a deferred credit of $548 million that will help reduce costs in future periods. The issue of how to book rebates and other credits from suppliers is a thorny one that has tripped up other companies, ranging from the international supermarket chain Royal Ahold, N.V. to the U.S.-based Kmart Corporation.

● GM also said it had wrongly recorded a $27 million pretax gain from disposing of precious-metals inventory in 2000, which it was obliged to buy back the following year.

● GM told investors not to rely on its previously reported results for the first quarter of 2005, saying it had underreported its loss by $149 million. GM said it had prematurely boosted the value it ascribed to cars it was leasing to rental-car companies, assuming they would be worth more after the car-rental companies were done with them. GM previously had reported a loss of $1.1 billion, or $1.95 a share, for the first quarter. (March 18, 2006) You may assume the amounts are material.

a. Without determining whether the errors in accounting judgment were intentional or unintentional, discuss how the nature of the errors affects the auditor's judgment of the control environment and whether the auditor should conclude there are material weaknesses in internal control. What would your judgment be if the accounting treatment were deemed acceptable, but aggressive by the company's CFO and CEO? How would those judgments affect the auditor's assessment of the control environment?

b. Describe the nature of the accounting judgment made by the company regarding the residual value of the cars it leases. What information and communication system should exist regarding the residual value of the cars returned from leasing? What controls should be in place? What evidence would the auditor need to evaluate the reasonableness of the change made by the company?

c. Explain the rebates, or up-front rebates, from the company's suppliers. Why would the suppliers pay the up-front credits? What is the proper accounting for the up-front credits? What controls should be in place to account for the up-front credits? How would the auditor test (1) the controls over the accounting for the up-front credits and (2) the expense-offset account, or the liability account?