While most of the major US-based manufacturers now include the warranty tables mandated by FASB FIN 45, at least one-in-five have chosen non-compliance. What happens to them? FASB says they can be called non-GAAP companies, but the SEC says little about enforcement plans.
There must be more than 750 US-based manufacturers providing warranties with the products they sell. To date, however, only that number of companies have followed the warranty disclosure procedures outlined in the Financial Accounting Standards Board's Interpretation No. 45, published in Nov. 2002 and effective for all interim and annual financial statements covering periods ending after Dec. 15 of last year.
The first question to ask is whether compliance with FASB's FIN 45 is optional or mandatory. Is it merely a suggested accounting standard or is it required of all public companies providing guarantees such as product warranties?
The second question is what happens to all the companies that either partially or completely ignore the disclosure requirements. Does FASB have an enforcement mechanism, or is enforcement left up to the U.S. Securities and Exchange Commission?
Not an Option
To answer the first question, we asked Sheryl Thompson, FASB's manager of public relations, specifically whether FIN 45 disclosures were required or voluntary. "Well, it's GAAP -- Generally Accepted Accounting Principle," she said. "And the SEC recognizes the FASB standards or accounting guidance as being authoritative."
Thompson was told that there are at least 175 companies known to Warranty Week as providers of product warranties which have not made the expected disclosures in any of the last four financial statements they filed with the SEC, but that at least 684 have included the warranty tables described in paragraph 14(b) of FIN 45.
"Most companies want to file statements in accordance with GAAP," she said. "Why they would veer away from that, they must have a good reason. If a company does not prepare its financial statements in accordance with GAAP, there must be a reason why they don't believe that the accounting is required."
Thompson, however, declined to comment on any of the companies named. "If that's what the [FIN 45] standard says, then that would be the requirement. But in terms of commenting on another company's accounting, we would never do that."
As for the second question, Thompson said it wouldn't be FASB's job to enforce the standards it sets. " We're not involved with enforcement. We just set the accounting standards," she said. "It's the SEC that would be involved in terms of companies that don't follow GAAP. We're an accounting standards-setter. We have nothing to do with enforcement. That's SEC."
John Nester of the SEC Office of Public Affairs agreed completely with that analysis. "On any FASB rule, they write them and we enforce them, to the extent that they're used by publicly-traded companies in their financial statements that are reported to the SEC," he said.
The problem is that the SEC has not yet determined whether the warranty disclosures included in FIN 45 meet what he called a "materiality standard." The full title of the standard is "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others." Most of the document concerns itself with guarantees of property leases, loans, share prices, and other items. In its 42 pages of explanation, warranty occupies about half of page 9. That's it. In its entirety, that section reads as follows:
- 14. For product warranties and other guarantee contracts that are excluded from the initial recognition and initial measurement requirements of this Interpretation pursuant to paragraph 7(b) (collectively referred to as product warranties), a guarantor is not required to disclose the maximum potential amount of future payments specified in paragraph 13(d) above. Instead, the guarantor is required to disclose for those product warranties the following information:
- a. The guarantor's accounting policy and methodology used in determining its liability for product warranties (including any liability [such as deferred revenue] associated with extended warranties).
b. A tabular reconciliation of the charges in the guarantor's aggregate product warranty liability for the reporting period. That reconciliation should present the beginning balance of the aggregate product warranty liability, the aggregate reductions in that liability for payments made (in cash or in kind) under the warranty, the aggregate changes in the liability for accruals related to product warranties issued during the reporting period, the aggregate changes in the liability for accruals related to preexisting warranties (including adjustments related to changes in estimates), and the ending balance of the aggregate product warranty liability.
Regarding materiality, Nester was told that more than 30 of the companies ignoring FIN 45 were spending $10 million or more on product warranties each year, and that more than a dozen non-complying companies were likely spending $100 million or more per year. He responded that it isn't a dollar amount. Materiality is more of a question of proportionality.
"Everything always comes down to a materiality standard," Nester said. "The materiality standard infers whether a reasonable investor would want to know it before making a decision to buy, sell, or hold. And then there's also consideration that can be given to whether it's consolidated with other disclosures."
There also are issues concerning whether the three paragraphs quoted above sufficiently explain what is expected of manufacturers that issue product warranties, Nester said. It's not so much an issue with the format of the 14(b) warranty table or its contents as it is an issue having to do with what should and shouldn't be included under each of the six headings. Should the figure for "payments made" include the shipping cost of returned parts? Should it include the price differential of components purchased under warranty versus somewhat lower "as-is" prices? FIN 45 is far from detailed on matters such as these.
Warranty Week outlined some of these questions for Nester, along with some of the amounts a few of the top non-complying companies were spending, in hopes he could elicit a comment from the Office of the Chief Accountant. In hindsight, it appears that was the wrong approach.
"The Commission is clearly aware of those issues," Nester said. "But we never comment on individual companies unless we've brought some sort of an action in a court or before an administrative law judge." And to date, the SEC has not brought any actions against companies for non-compliance with paragraph 14(b) of FASB FIN 45. So there was no comment.
What follows is Warranty Week's estimate of the amounts involved. So far this year, the 750 complying manufacturers have reported warranty claims of $17.5 billion. It's our estimate that the 175 non-complying companies that we know about have registered an additional $3.2 billion in claims over the same period of time, which they have either not disclosed or have only partially disclosed (for instance, by disclosing just the beginning and ending balances of their reserve funds).
Non-GAAP Warranty Providers
Estimated Warranty Claims,
Third Quarter, 2003
(all figures in US $ millions)
|General Electric Co.||$4,199m||$187m|
|Lockheed Martin Corp.||$8,078m||$78m|
|Northrop Grumman Corp.||$6,619m||$64m|
|Emerson Electric Co. (10-K)||$14,270m||$46m|
|Sanmina-SCI Corp. (10-K)||$10,037m||$36m|
|Black & Decker Corp.||$1,144m||$21m|
|American Axle & Mfg.||$868m||$17m|
|Jabil Circuit Inc. (10-K)||$4,729m||$17m|
|Pitney Bowes Inc.||$322m||$5.7m|
|Monaco Coach Corp. (9 mo.)||$845m||$5.3m|
|Surge Technologies Corp.||$386m||$4.9m|
|Sauer-Danfoss Inc. (9 mo.)||$864m||$1.7m|
|Other (150 companies)||$9,789m||$95m|
|Total Non-GAAP Manufacturers||$109,339m||$1,066m|
Sources: Revenue from SEC Form 10-Q & Form 10-K
Claims estimates by Warranty Week
(10-K) -- Product sales are for the full fiscal year; claims estimate for third quarter.
(9 mo.) -- Product sales reported for nine months; claims estimate for third quarter.
Undoubtedly, there are numerous additional companies not on this list. To get on the list, a company had to make some kind of statement along the lines of "we accrue for product warranties at the time a product is sold." Alternatively, they had to sell a product and state somewhere in the product literature that it was covered by a product warranty. Granted, some companies may immediately expense their warranty claims and therefore may not maintain a reportable warranty reserve fund. Others may experience claims rates so low that they may not feel it's necessary to break them out separately from other accrued liabilities. However, only a handful of the non-complying companies even acknowledged that FIN 45 existed, and very few detailed their excuse for non-compliance.
The surprise is that while at least 175 US-based companies have chosen not to comply with FIN 45, numerous internationally-based companies have chosen to make the disclosures. This is completely optional on their part. By doing so, they can claim their financial statements follow US GAAP. But for them, compliance is completely optional.
International Warranty Providers
What follows is a list of the top 25 internationally-based companies that have made disclosures of their product warranty accounting. We would include the dollar amounts involved, if not for two problems. First, many of these companies, especially the Japanese manufacturers, were reporting on fiscal years that ended on March 31. Several others reported on half-years ended in September or October. None reported quarterly amounts. Second, the companies on this list report not only in dollars, but also in yen, euro, pounds, and Swedish kroner. With exchange rates in rapid fluctuation, translating them all back into dollars would be highly dependent on the date chosen and the exchange rate in effect that day.
Instead, we will report upon two key metrics: the claims rate and the accrual rate. Though both rates change over time, the US experience suggests they do so slowly, with half-point changes uncommon and full-point changes exceedingly rare. And while exchange rate fluctuations matter a great deal to all of these international companies, each of these rates was computed in the manufacturer's native currency.
Top International Warranty Providers
Warranty Claims & Accrual Rates
(as percentages of product sales)
|Royal Appliance Mfg. Co.||4.6%||4.4%|
|Marconi Corp. plc||2.9%||2.3%|
|CNH Global N.V.||2.5%||2.3%|
|Ericsson LM Telephone Co.||2.4%||1.9%|
|Toyota Motor Corp.||1.2%||1.4%|
|Honda Motor Co. Ltd.||1.1%||1.7%|
|Embraer Brazilian Aviation Co.||0.9%||1.7%|
|Infineon Technologies AG||0.5%||1.2%|
|Matsushita Electric Industrial Co. Ltd.||0.4%||0.5%|
Source: SEC Filings
When the claims rate exceeds the accrual rate, a company's warranty reserve will usually shrink. When the opposite is true, the reserves will usually increase. We don't want to make too much of this, but look at the rate difference at Alstom, and then look at the difference at Nokia. Clearly, one is allowing its reserves to contract while the other is letting them expand.
Not on the chart is any mention of warranty reserve capacity. However, if one accepts that the US median is around 15 warranty-months -- that is, reserve balances equal roughly 15 months of claims, then it appears the international median is higher.
Of the 25 companies listed here, half were above 20 warranty-months and half were below. Among those on the high side were electrical power equipment companies ABB Ltd. and Siemens AG; carmakers DaimlerChrysler, Honda, and Fiat; telecom and consumer electronics makers Hitachi, Alcatel, and Marconi; and appliance maker Electrolux. Among those on the low side were consumer electronics titans Sony, Canon, Matsushita, and Thomson; construction equipment makers CNH and Komatsu; and carmaker Toyota.
In terms of hard numbers, ABB is at 92 warranty-months; Siemens is at 47; DaimlerChrysler is at 25; Toyota is at 16; and Sony is at 13. Four companies -- Matsushita, CNH, Kubota, and Royal -- are below 10 warranty-months. For the sake of comparison, General Motors and Ford have claims and accrual rates between 2.6% and 3% and reserves of 18 to 21 warranty-months. Caterpillar is at 2.3%, 2.0%, and 16 warranty-months. IBM is at 3.3% and 8.3 warranty-months. Hewlett-Packard is around 4% and 10 warranty-months. Cisco is at 1.8% and 9.4 warranty-months.
Happy New Year
This is the final column of a four-part series covering the warranty disclosures of major manufacturers. It also is the last issue of the year for Warranty Week. Although many readers no doubt are away from their desks during this holiday week, we wanted to publish this material as soon as possible so we can get back to our usual topics in the new year.
As some of our early subscribers already know, this is the end of Warranty Week's first complete year. We celebrated our first birthday on Dec. 18, but also marked some other important milestones in the past few weeks. On Nov. 4, the Web site logged its millionth page request, and on Dec. 9 we signed our thousandth email subscriber.
Thanks to all of you for your continued support, and thanks also to our sponsors for your continued patronage. And whether you read this column in late 2003 or early 2004, our hope for all of you is for not only a happy, but also a safe and a prosperous new year.
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