A Hidden Financial Risk for Auto Suppliers

WARRANTY
CLAIMS:
A Hidden
Financial Risk for
Auto Suppliers
Product recalls by Toyota and GM for vehicle safety issues have
dominated recent news headlines. Underlying these (and all) recalls is
the burden of a continuing vehicle problem, which can present itself in
warranty claims to the OEM and component suppliers of the vehicle.
While warranty claims haven’t traditionally been the “hot” topic for
discussion in the automotive industry, they’ll garner much more attention in the future. On top of the current recalls, the automotive industry
is scrambling to handle a record number of new vehicle launches over
the next five years, with increasing risks of future product problems
emerging in recalls and warranty claims. For any supplier, these risks
have the potential to result in significant financial liabilities that were
unforeseen when the part was originally designed, produced, and sold.
QUICK REFERENCE GUIDE
Common warranty terms you need to know:
•
MIS: Months In Service
•
NTF: No Trouble Found
•
WRP: Warranty Reduction Program (Ford)
•
GWC: Global Warranty Chargeback (Ford)
•
SAWRP: Supplier Associated Warranty
Reduction Program (Chrysler)
•
PRAS: Parts Return Analysis System
(Chrysler)
•
C/1000: Warranty Conditions per
1,000 Vehicles
•
IPTV: Incidents Per Thousand Vehicles
UNDERSTANDING THE FINANCIAL COMPLEXITIES
OF WARRANTY DATA
Calculating the financial liabilities of recalls or warranties may involve
thousands, even millions, of parts, sometimes from years earlier.
Supplier financial responsibilities for each component affected become
difficult to track to the root cause of the problem and, many times,
accurate product data just isn’t available. This difficulty in analyzing
historical product information has resulted in many OEMs simplifying
warranty cost and sharing as 50/50 — even when it’s not clear that the
supplier has any responsibility for the problem!
When assessing costs resulting from recalls and warranty claims, there
are a multitude of charges that can result. Suppliers need to be aware of
the potential “flow down” impact of OEM cost claims that may include:
•
Repair costs incurred for noneligible parts, as part of a “goodwill”
response by the OEM or dealer to their customers.
•
Conditional parts from other suppliers that are necessary
to adequately complete repairs for the components under
recall or warranty.
•
Excessive labor and use of parts incurred in the repair, which
may occur due to increased time or higher labor rates used
for the recall or warranty repair (versus standard measures).
•
Duplicate repairs for recall or warranties showing up in costs
claimed by the OEM. These have typically been found in
warranty and recall data due to duplicate data being entered
in databases or when multiple repairs occur on multiple parts,
creating confusion in the data being entered.
When cost inaccuracies show up in the recall or warranty claims, the
simplifying cost-sharing agreements can become much more expensive
than expected. Compounding the difficulties in identifying accurate
information on recalls and warranties is the inconsistency among
OEMs in their procedures for tracking product information as well as
inconsistencies in their supplier procedures and agreements.
GUIDANCE FOR ACCOUNTING AND
FINANCIAL REPORTING
There’s significant debate among suppliers regarding the requirements
for reporting potential costs of recalls and warranties. At the time of
production and sale, it may be recognized as a cost that may occur in
the future. Consequently, the following accounting standards apply to
recall and warranty claims:
•
For U.S. GAAP (generally accepted accounting principles),
ASC 450 and ASC 460
•
For IFRS (international financial reporting standards), Standard #37
WARRANTY CLAIMS: A
When it comes to financial statement recognition, suppliers should record
a warranty loss when (1) it’s probable a claim has been incurred as of the
reporting date and (2) the amount of loss can be reasonably estimated.
These costs are generally recorded at the time of sale based on historical
defect rates; changes in estimates are recognized prospectively in future
period results.
All OEMs have established policies for warranty reserves based on the
estimated future financial liability of the sale of current vehicles, typically
based on statistical analysis of historical vehicle performance. Because
of the potential financial impact from an OEM recall or warranty, many
suppliers have also begun to establish warranty reserves in current-year
financial statements with the expressed concern about the risks from an
OEM recall or warranty claim.
WARRANTY OBLIGATIONS OF SUPPLIERS
When estimating your warranty obligations, the specific costs to be considered should include the replacement part or parts, shipping and handling,
labor, testing, sorting and containment services, data analysis and tracking,
and potentially other incremental costs. It’s important to recognize the
“landscape” of your warranty obligations to cost effectively work through
the recall or warranty, especially in the areas of:
•
Understanding OEM (or supplier) contract terms and business practices.
•
Accessing relevant product data, including the histories of vehicle and
component performance, industrywide data and trends (including
National Highway Traffic Safety Administration information as needed),
internal product information, and the results of preproduction tests
(OEM and supplier).
•
Using information systems capabilities (especially for data segmentation). The information required includes tracking frequency
and severity (cost) by product time in field, estimated time lag
in occurrence, statistical analysis of product data, and actuarial
(or arithmetic) calculations of future costs.
•
Communicating frequently and effectively with your customer, whether
OEM or supplier.
Evaluating your capabilities for capturing the required product and
financial information to manage your warranty obligations is a critical
internal work activity. In working with suppliers, we’ve recognized
warranty information management practices in three broad categories:
BASIC
BETTER
BEST
Total accumulated
losses by product
type, in-service date,
and warranty term.
Cost per unit by
product type,
in-service date,
and warranty term.
Frequency of occurrence
and cost by product
type, in-service date,
and warranty term.
Hidden Financial Risk for Auto Suppliers
SERVING AUTOMOTIVE
SUPPLIERS
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and creative business and financial advice
has propelled Plante Moran to the position
of one of the largest, market-leading
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and deep industry expertise from working
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manufacturing process technology.
Every day our grounded, practical, and
collaborative professionals are working
with companies like yours, adapting best
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When it comes to solving these problems,
sharp minds, passion, and hard work add to
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delivering “a higher return on experience.”
For more insights from our automotive team,
visit us at automotive.plantemoran.com.
WARRANTY CLAIMS: A
Hidden Financial Risk for Auto Suppliers
THE FINANCIAL AUDITOR PERSPECTIVE
There are a number of financial reporting items
to consider when accounting for warranty claims
including the timing of recognition, current versus
noncurrent balance sheet classification, income
statement classification, and accounting and
presentation of cost recoveries from suppliers and
insurance policies. From an auditor’s perspective,
it’s important for the company to:
•
Know its information system capabilities, including product, business, and financial reporting.
•
Communicate frequently and consistently with
customers, especially to establish processes,
procedures, and expectations before issues may
arise (i.e., coordination with quality, engineering,
customer support, accounting, etc.).
•
Document the process and data used to
ensure warranty obligations have been properly
identified and quantified.
The extra effort expended by suppliers to be more
disciplined in gathering and analyzing data regarding
product issues will serve well in protecting the
company’s financial interests during a recall or
warranty claims process. Generally, it will lead to
fewer surprises in reported results.
IN CONCLUSION
Lack of accurate information is one of the biggest
challenges in figuring out the “real” cost of product
recalls and warranty claims. They can be difficult to
track, and it’s challenging to estimate the potential
financial exposure. There are so many complexities
in the various company and product responsibilities,
and such a large volume of information through
which to sift, that suppliers often feel overwhelmed
by the task. Hence the widespread use of broad-cost
sharing agreements that aren’t based on detailed
claims analysis.
However, in today’s safety-conscious environment,
the cost of warranties to suppliers is growing
dramatically. For more information on the financial
considerations inherent in warranty claims and
opportunities to improve the process, give us a call.
AUTHORS
Daron Gifford
Partner, Strategy Consulting
Practice Leader
248.223.3709
daron.gifford@plantemoran.com
Jason Carano
Partner, Assurance
312.602.3519
jason.carano@plantemoran.com