Updated from 8:21 a.m. EDT
will restate three years of earnings to fix the way it applies an accounting standard governing the use of derivatives to hedge interest-rate risk.
The accounting has been the subject of an informal
Securities and Exchange Commission
probe since January, the company disclosed in a government filing Friday.
In an early morning press release, GE also raised second-quarter guidance. In a subsequent conference call, the company said the raised guidance reflected a gain from an asset sale.
The restatement, which GE said is "immaterial" on an annual basis and will result in higher, not lower, earnings, involves the same accounting rule that has led to
massive bookkeeping overhaul.
The standard, known as SFAS 133, governs the circumstances in which a derivative contract, typically an interest rate swap, can be considered purely a hedge and not a speculative bet on future rates.
"We implemented SFAS 133 with diligence in 2001, and our technical accountants and KPMG reviewed that implementation. However, under SFAS 133, it's clear some of our derivatives do not qualify for hedge accounting," GE said in a statement.
The most immediate impact of the correction will be the downward restatement of GE's previously reported first-quarter earnings by a penny. The company now says it earned 37 cents a share in the first quarter instead of its previously reported 38 cents a share.
The company was told on Jan. 20 that the Boston office of the SEC was conducting an informal investigation of the hedge accounting and wanted the company to hand over certain documents and information. The company said it complied with the request and continues to cooperate with the ongoing probe.
GE shed more light on the nature of the restatement in its SEC filing. According to the company, the mistakes were in two areas: a slug of interest rate and currency swaps carried by General Electric Capital that related to about 14% of the company's borrowing in January 2001, and hedges on a portfolio of previously off-balance-sheet assets that were consolidated into GE's results under a post-Enron accounting rule known as Fin 46.
The errors in the first group of derivatives pertained to SEC requirements that their fair value be zero when they arrive on a company's balance sheet. GE said the company's portfolio included "fees paid or received at inception" that were initially viewed as immaterial but were later determined to mean the zero-fair-value standard wasn't met. GE said it stopped using such swaps in 2003 but had continued the previous accounting for contracts already in place.
In the second group, the accounting errors pertained to hedges for a portfolio of assets that was consolidated by General Electric Capital under Fin 46 in July 2003. The swaps were designed to switch the yield of fixed-rate assets into a floating rate. GE's mistake was not to subject the derivatives to "periodic testing" to make sure they still qualified as hedges.
"We determined as a result of the internal audit that the prepayment penalties in the underlying assets, which ... had not been identified by us or KPMG LLP at implementation, were not appropriately mirrored in the associated swaps, as required in order to avoid periodic testing of effectiveness under SFAS 133," the company said.
For the second quarter, GE now sees earnings of 43 cents to 45 cents, instead of 42 cents to 44 cents. The upside reflects the profit of a separate asset sale that GE announced before the bell Friday.
The company reaffirmed full-year earnings guidance of $1.78 to $1.83 a share. Overall, GE said, the cumulative impact of the accounting correction will be to increase earnings by $381 million from 2001 through last quarter. The amount is less than six-tenths of 1% of GE's earnings over the period, the company said.
"The company is in great shape," CEO Jeff Immelt said in a release. "Our April orders are strong, and we have increased guidance for second quarter and maintained guidance for the year. We remain committed to meeting or exceeding our expectations and those of investors."
Shares gained 3 cents to $35.88.