The accounting scandal at Delphi Corp. shows again just how much pressure the U.S. auto industry is under to deliver a profit to Wall Street in an era of price cuts and ruthless global competition.
According to Securities and Exchange Commission filings, Delphi counted income and expenses in a way that inflated its performance, in one case adding $61 million to pretax income.
The filings shed light on an increasingly common and controversial practice in the auto industry: "rebates" given by a supplier to the buyer of auto parts or services. The "rebates" theoretically reflect future price cuts promised over the years of a contract.
Delphi, the world's largest auto supplier, is not in trouble because it engaged in the so-called "pay-to-play" rebate game. But Delphi accounted for rebates paid by its own suppliers as current income rather than accounting for them over the life of the contract. Such a practice can give investors and analysts the impression that income is greater than it really is.
The SEC filings come at a bad time for Delphi and other suppliers that are struggling with Big 3 production cuts in the wake of lower U.S. car sales. In January, Delphi said it expects a tough first quarter because of lower production and high raw-material prices.
Automakers and other suppliers are sure to come under scrutiny for the way they have accounted for rebates. Under Chairman J.T. Battenberg III, Delphi prided itself on its independent board of directors - and those directors now are investigating the mess.
The period under study dates back to 1999, when the company was spun off from General Motors.
Rebates are just one of the things that led to the resignation of CFO Alan Dawes on March 4. Separate investigations by the SEC and Delphi's independent audit committee so far have identified three questionable areas:
1. The misreported rebates. In some cases, Delphi claimed as pretax net income the rebates it received from computer vendor EDS Corp. and other suppliers.
Rebating is a murky business practice. Under accounting rules, Delphi is required to spread the rebates over the life of the contract. Instead, according to SEC documents, Delphi counted one $20 million rebate from EDS as income in the fourth quarter of 2001.
It counted $18 million of another EDS rebate as a "reduction of expense" in the third quarter of 2001. The company told the SEC that there could be many more such accounting errors.
2. Round-trip trades. Delphi counted some asset sales as accounts receivable, even though it agreed to repurchase the assets at a later date. In one case Delphi sold $70 million of precious metals for a $6 million profit. Under generally accepted accounting principles, this should have been treated as a "financing transaction" - that is, it turned hard assets into cash, but with an equal liability. It should not have been treated as a "disposition of assets."
3. Deferred expenses. Rather than recording $23 million in costs for computer services contracts with EDS and other vendors in 2002 and 2003, it deferred them until a later period.
Investigators also have raised questions about the way Delphi booked $237 million in cash payments it made to GM in 2000 as part of the settlement in which GM spun off Delphi as an independent company.