General Motors Co. had a pretty good quarter in the last months of 2017.
Sales of its SUVs surged, surpassing those of competitors like the Ford Escape and fueling fat gross margins. Looking ahead to 2018, the company forecasts strong earnings. And of course it’s staring at a healthy tax cut, courtesy of the administration of President Donald Trump and Republicans in Congress.
Naturally, when the time came to do its earnings call, the company reported a $5.15 billion loss for the quarter.
Actually, if you know a bit about accounting, this is entirely natural. In lowering the company’s corporate taxes, the government suddenly made the ability to avoid those taxes less valuable.
Between 2005 and 2008 (when the government stepped in to bail it out), GM lost roughly $80 billion. These are gruesome numbers. But that grim cloud had a silver lining: Those staggering losses created something called an “NOL carryforward.”
And what is an NOL carryforward, you ask? NOL stands for “Net Operating Loss,” and NOL carryforwards are a tax asset arising from those sorts of losses. Accounting mavens may remember the mini-scandal that NOLs created for Trump during the 2016 election, because he had used them to offset his profits and pay very little income tax.
Here’s how I explained the NOL when the Trump story broke:
At issue is the “net operating loss,” an accounting term that means basically what it sounds like: When you net out your expenses against the money you took in, it turns out that you lost a bunch of money. However, in tax law, this has a special meaning, because these NOLs can be offset against money earned in other years. You can use a “carryforward” to offset the losses against income made in future years (as many as 15 future years, under the federal tax law of 1995). You can also use a “carryback” to offset those losses against income you made in past years.
GM’s enormous losses generated an enormous future benefit, allowing the company to earn income without paying taxes on it. Quite properly, accounting requires them to carry that future benefit as an asset on the company’s books. But when the tax rate goes down, that benefit is no longer so beneficial. A “get out of taxes free card” is obviously more valuable when your tax rate is 35 percent than when it is 21 percent. The asset has to be written down -- which in turn shows up as a charge against net income.
Welcome to the wonderful, weird world of accounting, where something positive, like lower taxes, can show up as a negative on your books. Luckily for GM, the market wasn’t fooled; although the company has suffered somewhat from the market’s general decline, it got a nice bounce off the earnings call where it announced that multi-billion-dollar loss.
My hometown of Washington could take a lesson from this very sensible reaction: Accounting is useful, but it isn’t real.
Generally Accepted Accounting Principles do not aim to give us a real, true, complete, unerringly accurate picture of a company’s net worth and its earnings prospects, because that is an impossible task. (To offer just one example, say that you are a vineyard owner operating next to a tannery whose by-products are, unbeknownst to you, slowly poisoning your land and vines. You may try to be scrupulously fair in representing the worth of your winery -- but you will still be wrong.)
And that’s just one of the fascinating quandaries that beset accountants:
Should you account for revenue and expenses when the cash moves in or out the door, or at the moment when you know that you owe (or are owed)?
When you have a big pile of inventory that has been acquired over a long period of time, how do you record the cost of the goods you’ve sold -- is it the price of the first shipment you got, or the most recent, or some average of your cost over time?
Should real estate be valued at what you paid for it, or what you could sell it for today?
There is no obvious answer to any of these questions (or the many more complicated ones I’ve left unexplored). But before we can issue a financial statement, we have to try to come up with some. So accountants do their best to stick to reasonable, “conservative” principles -- conservative not in the political sense, but because they give managers the least leeway to make up numbers that please them.
Those numbers are not necessarily more accurate than we could get in any other way -- some Platonic ideal accounting standard would probably have reflected GM’s improved expectations, not the diminishing value of its past losses. Yet these numbers are consistent, allowing investors to compare companies, and shareholders to feel reasonably secure that corporate managers aren’t cooking the books.
Washington has its own form of these dilemmas. Yet unlike the markets who reacted positively to GM, we often don’t recognize them. Take the way Democrats gamed the Congressional Budget Office’s scoring process to get Obamacare rated as reducing the deficit -- and then journalists treated those numbers as if they were a likely prediction about the future, rather than the product of a particular set of scoring rules. (That phenomenon recurred during the Republican attempt to repeal Obamacare.) Or the somewhat bizarre way that the government accounts for student loans, making them appear to be a profitable arbitrage opportunity rather than a substantial risk. Or the perennial arguments over the Social Security Trust Fund.
Discussions of these issues are frequently marred by the belief -- or at least the assertion -- that these government numbers reflect the best and truest guess analysts can make at a system’s future revenues and outlays. And of course, government analysts would like their numbers to be right and true. But just as in the private sector, they frequently publish numbers that more accurately reflect the standards they have adopted to calculate the numbers than the true state of the world.
If those standards routinely depart from reality, then they should be adapted (something that the CBO and other branches of government regularly do, within the limits set by law and considerations such as keeping continuity so that you can compare one set of figures with a previously published set). But the process of adaptation is slow, and in the meantime, we will regularly get some odd results. Just like traders, we therefore have to be alert to those oddities -- and do our best to figure out what the numbers really tell us, rather than what they might suggest from a casual glance.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of “The Up Side of Down: Why Failing Well Is the Key to Success.”
© Copyright 2021 Bloomberg L.P. All Rights Reserved.