Back on January 16, 2003, after more than 23 years, General Electric (GE) Co. decided to dump its well-recognized slogan, "We Bring Good Things to Life," and decided to spend more than $100 million to launch a new campaign with the tagline, "Imagination at Work." A reasonable question is whether GE took its new slogan too seriously because the transactions it engaged in certainly relied on imagining the results of operations it desired and developing the techniques to accomplish that goal.
On August 9, 2009, GE came clean and settled accounting fraud charges with the SEC for allegedly misleading investors with improper hedge accounting and revenue recognition schemes. Specifically, GE was charged with violating accounting rules when it changed its original hedge documentation to avoid recording fluctuations in the fair value of interest rates swaps, which would have dragged down the company's reported earnings-per-share estimates.
In addition, the SEC charged GE with making up schemes to accelerate the recognition of revenue from its locomotive and aircraft spare parts business, to make the company's financial results appear healthier than they actually were.
Without admitting or denying guilt, GE paid a fine of $50 million, and agreed to remedial action related to internal control enhancements. "GE bent the accounting rules beyond the breaking point," noted Robert Khuzami, director of the SEC's Division of Enforcement, in a statement. The facts of the case are taken from the complaint filed by the SEC against GE.
The SEC uncovered the violations after conducting "risk-based" investigations at GE, in which the government staffers identify a potential risk in an industry or at a particular company and develop a plan to test whether the problem actually exists. In the case of GE, the SEC identified potential misuse of hedge accounting as a possible risk area.
The SEC filed its complaint in the U.S. District Court for the District of Connecticut pointing out that GE met or exceeded analysts' consensus earnings-per-share expectations every quarter from 1995 through filing of its 2004 annual report. However, the SEC charged that during 2002 and 2003, high-level GE accounting executives or other finance personnel approved accounting that did not comply with GAAP in order to hit the EPS estimates.
The complaint filed by the SEC provides details of the accounting treatments GE tried to pass off as GAAP compliant. For instance, during the periods under investigation, GE issued commercial paper to fund assets that had fixed, long-term interest rates. Because the rolling commercial paper program exposed GE to fluctuations in variable, short-term interest rates, the company sought to hedge its exposure with interest rate swaps. GE was intent on qualifying for hedge accounting, which is considered advantageous because gains and losses on derivatives—in this case the swaps—can be deferred until they mature.
But in early 2003, GE changed its hedge accounting to accomplish two goals: to avoid reporting a disclosure that might have led to the loss of hedge accounting for its entire commercial paper program, and avoid recording what................................................
1. Review the SEC's complaint against GE (see Note 1) and explain the specifics of the company's hedging transactions and why they violated GAAP.
2. Did GE violate the rules for revenue recognition (pre-2016-change) on the "sale" of its locomotives? Explain.
3. Did GE engage in earnings management? How would you make that determination given the facts of the case?

Answer rating: 100% (QA)

The specific hed ging transactions that GE engaged in violated GA AP because the company changed its ... View the full answer