General Electric (GE.N), the United States’ largest industrial conglomerate, will restate its earnings for 2016 and 2017 as it adopts a new accounting standard, according to a regulatory filing on Friday.
The updated accounting standard, which will take into account revenue from long-term contracts, will result in a 13 cent cut in reported earnings per share for 2016 and a cut of 16 cents per share for 2017, according to the company’s 10-K filing.
GE is adopting the new accounting standards as the Securities and Exchange Commission investigates the company over its accounting for long-term service contracts.
The news comes as new CEO John Flannery has been at the helm for less than six months and the company is reeling from a downturn its its core Power Systems business. I had the following takeaways on the recent announcement.
Can You Trust Management?
GE was once known for having best-in-class internal controls and business metrics in which to analyze its operations. Six Sigma, the company’s former mantra, was designed to bring a manufacturing approach to all of GE’s operations and was used as a tool to reduce mistakes. Cracks in its internal controls materialized after former CEO Jeffrey Immelt revealed GE had a spare business jet Immelt employed for his personal use. The problem was that GE’s board was totally unaware of the extra jet and the news materialized as the company revenue and earnings were in a tailspin. The case of the “unknown business jet” might have been the canary in the coal mine.
The question I have over the SEC action is, “What did GE’s management know and when did it know it? Was management aware that its revenue recognition practices were favorable to GE and not in accordance with SEC standards? If so then what else is management hiding?” That said, GE’s shoddy accounting for long-term service contracts might not be a one-off event. I understand the SEC is also investigating the company’s internal controls and bookkeeping pursuant to certain insurance reserves:
Around the insurance industry, long-term care policies have been hurt by soaring healthcare costs and longer life expectancies. Other insurance companies have been forced to book losses in recent years.
But it wasn’t until last week that GE announced a $6.2 billion hit and warned it will devote $15 billion to boost insurance reserves.
GE said the SEC is probing “the process leading to the insurance reserve increase” as well as the fourth quarter loss.
Lynn Turner, former chief accountant at the SEC, said the insurance problems raise questions about GE’s controls and bookkeeping.
“GE seems to be way behind the 8-ball on this. Others have been boosting reserves and GE hasn’t,” Turner said.
Market chatter suggests rising payouts for long-term care providers have been known throughout the industry. GE’s delay in increasing reserves for such contracts might have made financial results in prior years more attractive than they otherwise would have been. This may not simply speak to a lack of internal controls. These major accounting issues could also raise questions as to whether investors can still trust management to provide financial results that accurately reflect the state of the company.