Section 404 requirements were implemented by the Sarbanes-Oxley Act in 2004. Section 404 reporting on internal controls required many large filers to restate financial statements in order to correct misstatements. This report will focus on Ford Motor Company, and how they were affected by the new accounting rules. More specifically, it will discuss why restatements of Ford’s financials were necessary, and who prompted the change. Then, it will discuss the audit opinion on Ford prior to and after the restatements.
Finally, it will explain the impact of the restatements on the financials, and ultimately who was to blame for the improper accounting treatment of certain transaction that caused a need for restatements. There were many accounting issues that were affected by Section 404, but one that pertains to Ford in particular. SFAS 133, titled Accounting for Derivative Instruments and Hedging Activities, was the main subject of Ford’s restatements.
Ford put out a press release related to this matter in 2006, which claimed “Ford Motor Company uses transactions involving derivatives, including swaps, forwards and options, to reduce economic risk and volatility in a disciplined and defensive manner” (Ford, 2006). Simply put, Ford found that they were able to minimize the risk of long-term debt issuances through interest rate swaps. Ultimately, it was determined that some of the interest rate swaps were not accounted for properly because they were not exempt from SFAS 133.
Because these swaps were subject to SFAS 133, Ford would need to restate its financial statements in accordance with those accounting rules. The derivative transactions briefly described above were not prevented or changed as a result of SFAS 133. Rather, it was necessary that Ford restate their financials as a result of improper accounting treatment for some transactions involving interest rate swaps. Ford was improperly accounting for some interest rate swaps based on their belief that the swaps were exempt from Paragraph 68 of SFAS 133 (Moeller, 2006).
Paragraph 68 has certain requirements that if met, will exempt transactions from periodic assessments of their effectiveness. While Ford’s interest rate swaps were and still are very effective methods for hedging, it turned out that they did not meet the exemption requirements of Paragraph 68. Therefore, it was necessary that Ford restate their financials in accordance to SFAS 133. There were many changes that resulted in Ford’s restatements. Instead of offsetting the debt they were hedging, the change in the fair value of the hedging instruments (interest rate swaps) needed to be recorded as derivative gains or losses (Moeller, 2006).
How the instruments work is that their fair value is inversely related to actual interest rates. When interest rates increase, the instruments decline in value. Vice versa goes for when the interest rates decrease. This can substantially affect earnings because of how volatile interest rates can be, especially with how the economy has been over the past decade (Meoller, 2006). Exhibit A displays how the change in accounting of the instruments affected Ford’s net income. Ford’s restatements described above were issues that were existent in prior years.
For this reason, Exhibit A shows how the accounting changes affected Ford’s net income from 2001 through 2005. Ford named all of the financial statements which needed to be restated in an amended Form 10-K, which read, “we are restating herein our historical balance sheets as of December 31, 2005 and 2004; our statements of income, cash flows and stockholders’ equity for the years ending 2005, 2004, and 2003; and selected financial data as of and for the years ended December 31, 2005, 2004, 2003, 2002 and 2001” (Ford 10-K/A, 65).
While no further detail will be provided as to how these statements were affected, it is important to note how significant the account changes were. The market reaction to Ford’s restatements is difficult to read. Normally, restatements would lead one to think that the change would be for the worse. In Ford’s case, that does not hold true. Taking into account the total change in net income caused by the accounting changes from 2001 through 2005 (based on Exhibit A), Ford’s net income increased 825 million.
There are so many factors which affect Ford’s market position that it is mere speculation to judge the impact of the restatements on the market. However, competitor General Motors’s shares did jump nearly 5. 6% following the news, so it is possible that that was at least partially caused by the restatements (Langlois, 2006). After the discovery of violations of Paragraph 68 of SFAS 133, Ford Motor Company filed an amended 2005 10-K Report to restate previously reported financial results from 2001 through 2005 and also for the first two quarters of the year 2006, to correct accountings concerning interest rate swaps.
Ford Motor Company asserted did not affect the economics of the derivative transactions involved, nor did it have any effect on Ford Motor Credit's cash. * | * | * Transactions that we designated as fair value hedges involved interest rate swaps hedging the back-end of debt instruments or involved longer-than-normal settlement periods. | * | | * We paid or received fees when entering into a derivative contract or upon changing counterparties. | * | | * Interest rate swaps included terms that did not exactly match the terms of the debt, including prepayment optionality.
| Moreover, they also identified material weakness in our internal control over disclosure controls and ineffective procedures as of December 31, 2005. Don Leclair, Ford Motor’s Chief Financial Offer and Executive Vice President, believes that the mistakes were unintentional. He said that due to the complexity nature of SFAS 133 and the continuing evolvement of the interpretation of its proper application, implementation and accounting for hedge accounting have always been ambiguous. Mr. Leclair stated that Ford’s overall hedging strategy is sound and will correct accounting for these types of derivative instruments.
The company also said the correction to the accounting does not affect the economics of the derivative transactions, nor have any impact on the company's cash. Company official believe that the results in 2002 “will improve materially. ” The explanations provided by Ford Motor Company are convincing. SFAS 133 is one of the most complex accounting standards ever introduced, running over 200 pages. This has led to some major companies to restate their financial statements over the years. In fact, statistics show that 1 in 10 public companies had to file restatements
due to SFAS 133. Although FAS offer detail directions on hedge accounting, the rules managed to be overly complex and vague. Due to the criticism, SFAS 133 was modified in 2008 to reduce the complexity. In addition, Ford posted massive loss during 2006 when they decided to restate its financial statements and it did not make things look better than before. It seems like Ford Motor Company made an honest mistake and the cause of restatement was due to the difficulty of complying with SFAS 133.