GM Will Book $39 Billion Charge [Q]

Write-Down of Tax Credits Indicates That Profits Won't Come in Near Term

By JOHN D. STOLL November 7, 2007; Page A3

General Motors Corp. will take a $39 billion, noncash charge to write down deferred-tax credits, a signal that it expects to continue to struggle financially despite significant restructuring and cost cutting in the past two years.

The deferred-tax assets stem from losses and could be used to offset taxes on current or future profits for a certain number of years.

• The News: GM will take a $39 billion charge from writing down the value of net deferred-tax credits it could have used if it had been profitable. • The Signal: The write-down is an acknowledgment that GM will struggle financially in the near-term, despite restructuring moves and signs of progress. • Challenges Ahead: GM and other auto makers face the effects of rising prices at the pump, an expected continued slowdown in U.S. auto sales and tough competition.In after-hours trading, GM fell 2.9% to $35.14. Before the disclosure, its shares finished at $36.16, up 16 cents, or less than 1%, in New York Stock Exchange composite trading.

GM, the world's largest auto maker in vehicle sales, was to report third-quarter financial results today. The company, which was stung by big losses in 2005 and 2006, said the write-down was triggered by three main issues: a string of adjusted losses in core North American operations and Germany over the past three years, weakness at its GMAC Financial Services unit, and the long duration of tax-deferred assets.

GM had appeared to be making progress in stemming its losses. Its global automotive operations were profitable in the first half of the year. It recently signed a labor deal with the United Auto Workers that allows it to establish an independent trust to absorb its approximately $50 billion in hourly retiree health-care liabilities. The move promises to significantly reduce GM's cash health-care expenses and combine with other labor-cost cuts in creating a more profitable North American arm.

If it returns to steady profits, GM could remove the valuation allowance and reclaim some or all of the $39 billion in deferred credits.

For now, the massive charge promises to devastate GM's headline financial results for the third quarter, and for the year, likely leading to the worst annual loss in its 99-year history. Although the charge is an accounting loss that doesn't involve cash, it is still a staggering sum. By comparison, the company reported a total of $34 billion in net income from 1996 to 2004.

GM will partially offset the charge with a gain of more than $5 billion related to the sale of its Allison Transmission unit.

The charge follows more than $12 billion in losses since the beginning of 2005. GM has been scrambling to cut the size of its U.S. operation amid shrinking market share, rising costs and a rapidly globalizing auto industry. Its restructuring has been complicated by a slowdown in U.S. demand for automobiles and losses at GMAC.

The lending giant lost $1.6 billion in the third quarter, the biggest quarterly setback since at least the 1960s. It made money on auto lending and insurance but was dragged down by a $1.8 billion setback at ResCap, its residential-mortgage business and a big player in subprime loans. GM's exposure is limited because it sold 51% of GMAC to Cerberus Capital Management LP last year. In the past, GMAC delivered dividends to GM, including more than $9 billion in the decade before the GMAC sale.

The write-down isn't expected to affect GM's liquidity position, which stood at $27.2 billion as of June 30. GM has been selling noncore assets in recent years to pad its bank account. In addition, GM Chief Financial Officer Frederick "Fritz" Henderson said the write-down won't preclude it from using loss carry-forwards or other deferred-tax assets in the future. It is unclear whether GM's plunge deeper into negative shareholder-equity status will affect it's borrowing capabilities or credit rating.

The latest disclosure underscores the challenge Chief Executive Officer Richard Wagoner faces in seeking a full-scale turnaround as GM hangs on to its No. 1 global-sales ranking over Toyota Motor Corp. by a thread. Delphi Corp., GM's top supplier, has failed in attempts to emerge from bankruptcy protection, so GM must wait indefinitely on cost savings it hopes to gain from a reorganized Delphi. Also, U.S. automobile demand has withered to the lowest point in a decade, and, as oil futures continue to escalate, pressure on high-profit trucks and SUVs remains firm.

Write to John D. Stoll at john.stoll@dowjones.com1

URL for this article: http://online.wsj.com/article/SB119438884709884385.html

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QUESTIONS:
1.) Define the terms deferred tax assets, deferred tax liabilities, net operating loss carryforwards, and deferred tax credits.

2.) Which of the above three items has General Motors recorded for a total of $39 billion? In your answer, comment on the opening statement in the article that GM will write-down its "deferred tax credits."

3.) What is a valuation allowance against deferred tax assets? When must such an allowance be recorded under generally accepted accounting standards? Use GM's situation as an example in your answer.

4.) GM states that its $39 billion write down was impacted by three factors. Explain how each of these factors bears on the determination of a valuation allowance against deferred tax assets. Be specific.

5.) The author writes, "If it returns to steady profits, GM could remove the valuation allowance and reclaim some or all of the $39 billion in deferred credits," and that the write-down does not preclude GM from future use of its net operating loss carryforwards and deferred tax assets. Explain these statements, including the entries that will be recorded if the deferred tax assets are used in the future