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Dana In The Dumps

Oct 10

Written by: Jack Ciesielski
10/10/2005 8:24 AM

Dana Corporation announced this morning that it will pull its 2004 financials and those for the first two quarters of 2005, with restatements to follow. It's also postponing its third quarter earnings release until it's completed an investigation of its accounting.

The problems, from the news release: "The primary purpose for the restatements is to correct issues involving customer pricing and transactions with suppliers in Dana's Commercial Vehicle business...In connection with the restatements, the company believes that there are material weaknesses in its internal control over financial reporting."

In mid-September, the company had warned that it was evaluating the carrying value of its $740 million worth of deferred tax assets. (In essence, that's the benefit the company would receive in terms of taxes saved for deductions and credits that it has been unable to use on tax returns so far. At the end of 2004, much of Dana's deferred tax assets related to other postemployment benefits, net operating losses, and capital loss carryforwards.) Dana's estimate of their value now: zilch. From the release:

"The company now believes that it will be unable to maintain its U.S. deferred tax assets or to record similar tax benefits in the future..."

That's a pretty gloomy implied forecast: it says that the company won't generate enough taxable income to justify carrying those deferred tax assets - or record new ones for more losses that could be stacked up. Back in May, Delphi went through the same forecasting exercise and wrote down its deferred tax assets, too.

The writedown of the deferred tax assets is sobering, but probably not that much of a surprise to watchers of the auto industry. Forecasting is hard stuff, especially when it's about the future; as visibility about an industry's prospects become clearer, and optimism gets the boot, writedowns follow. (Another example: see GM and its Fuji investment last week.)

What's more curious about Dana's predicament is that the firm suspects internal control problems - and its financial internal controls passed muster at the end of 2004. The only change in the internal controls noted in 2005 was in the second quarter 10-Q: "On June 1, 2005, we outsourced certain of our human resources services to IBM. We have not yet fully tested internal controls applicable to this change. This change is part of our cost reduction initiative for administrative costs. During 2005, we will perform appropriate testing to ensure the effectiveness of internal controls as they relate to the reliability of financial reporting and the preparation and fair presentation of our published consolidated financial statements." Not exactly the same stuff they fingered in the press release.

Details as they occur. And they probably will.

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Unexplored Obligations: Other Postretirement Benefits

Defined benefit pension plans take center stage in the pantheon of investors’ fears when it comes to worrying about liquidity effects or earnings distortions. Yet they rarely consider the cash demands and earnings distortions resulting from other postretirement benefit plans.

Since they’ve been required to measure - and display - a figure expressing the value of the promises made for providing employee health care benefits, managers have dealt vigorously with the obligations. Their growth has been held in check while pension obligations have grown ever higher. Yet even as they’ve become more controlled, other postretirement benefit plans are worth investor attention. As the benefit plans become less fearsome, the accounting principles involved have helped an increasing number of companies recognize phantom earnings - negative benefit costs - even while they’re putting cash into benefit payments under these plans. It’s better to be alert to such a trend early: firms may not always bring it to the attention of investors.

A recent edition of The Analyst’s Accounting Observer looks at the problematic reporting, with an eye focused on the "phantom income" results shown by 42 companies having negative OPEB costs. While the report is available only to paid subscribers, a condensed version is available for free upon request. To receive it, send an e-mail to Brenda Rappold at brappold@accountingobserver.com, with “OPEB Costs” in the subject line.

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