As long as recall costs are minimal, this has only a minor effect on warranty claims and accrual rates. For instance, in Toyota's fiscal year ending on March 31, 2009, its warranty claims payments were almost five times larger than its recall payments. Combining warranty and recall payments would have driven the claims rate up from 1.8% to 2.2%.

Total Cost of Quality

But what if recall payments grow and eventually exceed warranty payments? In such a case, leaving them out would present a warped picture of what Toyota calls its expenses for "quality assurances." So that's what we need to do: detail Toyota's warranty and recall expenses, both together and separately.

We don't know Toyota's recall expenses in the fiscal years 2003 to 2008. But we do know the company's warranty-only expenses for the fiscal years 2003 to 2010, and its recall-only expenses from the fiscal years 2009 to 2011. And in Figure 3, we derived figures for Toyota's warranty-only expenses in the most recent fiscal year.

With this data in hand, we're going to chart Toyota's warranty claims payments and recall payments together in Figure 4, and warranty accrual and recall provisions together in Figure 5. Note that all these figures are in billions of yen per year (at today's rates, US$1.00 = ¥80.49, so a billion yen is close to $12.4 million).

Note in Figure 4 that the recall payments in fiscal 2009 and even into fiscal 2010 weren't all that large, compared to warranty claims payments in those years. It wasn't until the most recent fiscal year that recall costs overwhelmed product warranty costs.

In terms of a percentage of revenue, warranty consumed 1.2% in the most recent fiscal year while recalls consumed a much greater 1.5%. Back in fiscal 2009 Toyota's warranty claims rate was 1.8% while its recall payments were equal to about 0.4% of product revenue. So in the past two years, by our estimates, Toyota's warranty costs fell by about a third while its recall costs quadrupled.

Accruals Equal Provisions

The flip side of warranty claims would be warranty accruals. The opposite of recall payments would be recall provisions. Back at the end of fiscal 2010, Toyota changed from a pay-as-you-go system for its recall costs to an accrual method that mirrored its warranty accounting. And then in fiscal 2011 it began to count the two together. There are slight differences in the terminology (compare Figures 2 & 3) but basically, a recall provision is the amount set aside at the time of sale to pay for anticipated future recall costs.

In Figure 5, we see a similar pattern as in Figure 4. Recall provisions start small but soon they overwhelm warranty accruals. The difference here is how fast it happens. It's a 30/70 ratio in fiscal 2009; 45/55 in fiscal 2010, and 60/40 in fiscal 2011.

And that's the big news here: at Toyota, recall costs have now overwhelmed warranty costs. Not only are recall costs now counted as part of the cost of quality -- now they're more than half the total.

Revenue hasn't changed, so it's still the same procedure to calculate the total cost of quality as a percentage of sales as to count just the cost of warranty alone. In fiscal 2009 we have product sales of ¥18,565 billion. In fiscal 2010 we have product sales of ¥17,197 billion. And in fiscal 2011, we have product sales of ¥17,337 billion. Take the annual figures for warranty and recall from Figures 4 & 5 and you have claims and accrual rates with and without recall costs included.

Claims and Accrual Rates

In Figure 6 below, the red and green lines represent the cost of warranty alone, while the orange and lime green lines represent the total cost of warranty and recalls taken together. In keeping with the format used for other companies, the data in Figure 6 represents a time series of 33 quarters, from the first quarter of calendar 2003 to the first quarter of calendar 2011.

The surprise here is how much of Toyota's revenue went towards warranty and recall costs last year. The lime green line, representing the amounts set aside for both recalls and warranty, climbed to 3.4% last year. Warranty alone was only 1.3% of that, meaning that recall costs exceeded two percent of product revenue in the fiscal year ended March 31, 2011. That represents a more than doubling of the recall provision rate in the past two years, versus a one-third decline in the accrual rate.

Comparing Apples and Oranges

It's dangerous to compare automakers precisely because of differences like these in what they do and don't include as a warranty expense. But let's make two quick comparisons. Honda Motor Co., which has historically always had warranty-only costs close to Toyota's, just turned in an annual report with claims and accrual rates both below one percent of product revenue. GM, which has always counted warranty and recalls together, just turned in a first-quarter report detailing a two percent accrual rate and a 2.6% claims rate.

We'll detail the expenses of the other automakers next week. But first we need to ask readers a question: Which set of figures should we use for Toyota from now on?

On the one hand, Toyota has chosen to emphasize the combined warranty-and-recall figures and omit the warranty-only figures. Should we follow suit? That would result in combined costs similar to GM's.

But on the other hand, warranty and recall are still separate items. Should we try to keep them separate as well? That would keep Toyota's warranty-only costs closer to Honda's.