Hewlett-Packard makes this list three times, because within each fiscal year it's been removing funds from its warranty reserve. In fiscal 2009, it removed $223 million. In fiscal 2010, it removed $53 million. And so far in fiscal 2011, it's removed $38 million. As of the end of April 2011, its warranty reserve balance was $2.43 billion.

That's a good thing, if it turns out that product quality is higher than was forecast, or repair costs are lower than was forecast. But it's not all good. It's a bit like predicting rain and getting a dry spell instead. Everyone's happy, but they're also carrying around umbrellas, and doubting your prescience. It would be better if accruals were always exactly enough to pay claims -- no more, no less.

The other repeat in Figure 1 is Motorola. Although the two separate companies Motorola Mobility Holdings Inc. and Motorola Solutions Inc. didn't formally exist until 2010, both restated their warranty accounts late last year as if they had been in business independently in 2009. And in that theoretical year apart, Motorola Mobility withdrew $49 million while Motorola Solutions withdrew $47 million from their reserve funds.

Sizeable Withdrawals

Seagate Technology plc, Terex Corp., and United Technologies Corp. were also among the companies making sizeable withdrawals from their warranty reserves since 2009. Understandably, they don't want to draw any attention to these transactions, for two reasons. First, they're correcting mistakes, where past estimates proved to be too high. And second, the suspicion is always there, that the company is somehow manipulating forecasts to provide magical boosts to earnings, just when they're needed.

We found little evidence of that. But we did look for ways to quantify these favorable changes of estimates in units other than dollars. For while GM and HP have hundreds of millions to move around, smaller companies don't. But proportionately, their changes of estimate can be even more beneficial.

In Figure 1, the final column lists the closing balance in the warranty reserve funds, after claims have been paid, after accruals have been made, and after these changes of estimate have been processed. For companies like GM and HP, the changes of estimate represented between 2/100ths and 9/100ths of their ending balance. In other words, even though the amounts taken out were large, the amounts left behind were even larger.

That's not so for all of them, however. Look again at Garmin Ltd. After removing $42.8 million from its reserves in 2010, the company had only $49.9 million left behind. More ominously, that amount was equal to what the company was paying in claims in only 4-1/2 months. But the company had also managed to reduce its claims rate significantly from where it was in 2008-2009.

Withdrawals Exceed Reserves?

Most shockingly, we found that a 1:1 ratio between the adjustment and the ending balance wasn't all that rare. In fact, of the 914 adjustments we found, 32 of them were greater than or equal to the ending balance. Garmin's adjustment was 41st on that list, the top ten of which are in Figure 2.

For instance, International Lottery & Totalizator Systems Inc., which as its name implies is a maker of lottery systems and gambling machinery, reported in the quarter ending in January 2009 that it withdrew $382,000 from its warranty reserve. That's no big deal until you notice that it left only $26,000 in its warranty reserve after that adjustment. And that means there is almost a 15:1 ratio between the size of the adjustment and the ending balance in the reserve.

  Source: Warranty Week