Windfall for Warranty Managers:

While the interpretation was supposed to be implemented for all interim and annual reports covering periods ending after Dec. 15, 2002, in reality most companies didn't get around to inserting a paragraph 14(b) warranty table into their 10-Q or 10-K filings until April or May 2003 (most of them were for quarters or fiscal years ending on March 31). At least 40 manufacturing companies have still not gotten around to it, filing 2002 annual reports and 2003 first quarter reports with the SEC that continue the old ways of saying little or nothing about warranties.

Although the battle over disclosures of warranty costs doesn't make the headlines as often as the accounting controversies surrounding employee stock options, it nevertheless remains a somewhat sensitive topic. However, if we're not mistaken in counting the 675 companies who have and the 40 who haven't published 14(b) tables, we can conclude that more than 90% of manufacturing companies are in compliance on the first go-round.

The Product Warranty Table

Here's an example of a 14(b) product warranty liability table, taken from Note 4 in the SEC Form 10-Q filed for the first quarter by General Motors:

All figures for GM's 14(b) warranty table are in $ millions. As mentioned, at least 675 manufacturing companies have included these brand new FASB FIN 45 14(b) warranty tables in their latest filings. Together, these companies increased their warranty reserves from approximately $32.2 billion on Dec. 31, 2002, to more than $32.9 billion on March 31, 2003 -- the first quarter of 2003. During that period they spent around $5.52 billion honoring warranty claims (payments), and replenished their warranty reserves with around $5.93 billion (increases in liability). Add to that a net +$193 million increase in adjustments of estimate and a positive effect of currency translations of around $103 million, and you have the ingredients needed to assemble a 14(b) table of total U.S. warranty claims management spending during the first quarter of 2003.

Companies are most certainly missing from version 1.0 of the list. Readers are encouraged to send in names, which we will add to the list. We need help identifying all the publicly-traded companies that issue product warranties, especially the smaller manufacturers. As newly-found companies are added, these totals will be revised and amended in the online copies of this report. We also expect that later in the year, currently non-compliant companies will make FASB FIN 45-compliant disclosures that are retroactive to Dec. 15, 2002. As they do so, the totals in these charts will be revised as required.

The major problem encountered when trying to find the missing companies is that not all companies issue warranties. If they're a bank, a restaurant chain, an electrical company, a phone company, a brokerage house, or an insurance company, they most probably have no warranty matters to disclose (although they most likely have made other types of guarantees covered by FASB FIN 45). Therefore, the absence of a warranty disclosure in a financial statement does not in and of itself mean a company is flouting FASB FIN 45 requirements. They simply might have no warranties to disclose. And telling the difference between a company that doesn't provide product warranties and a company that issues them but doesn't talk about it is not so simple. Because warranty disclosures didn't begin in earnest until first quarter 10-Q statements were filed in early May 2003, there is as yet no master list -- no Fortune 500 of warranted product manufacturers -- to use as a reference.

In addition, these are net figures -- payments minus reimbursements -- so one warranty claim could involve money passed between, say, an axle manufacturer, an auto manufacturer, and a dealer. If the company is a retailer or a wholesaler, they might very well deal with warranties somewhere in their supply chains on a pass-through basis, but they would not typically issue those warranties themselves. Merely selling or distributing a product covered by a manufacturer's warranty does not invoke the disclosure requirements of the interpretation. It remains unclear whether overhead -- the paper-shuffling costs incurred by a retailer or a dealer in their handling of claims -- is in and of itself a disclosure required by FASB FIN 45.

Then again, some retailers also sell their own extended warranty plans, and some businesses such as automobile service stations might also warrant the repairs they make, using not only the warranted parts of a manufacturer but also their own warranted labor. Retailers, wholesalers, and OEM manufacturers could report just the net amount they pay in overhead as they pass warranty matters through to their suppliers and subcontractors. Others might elevate the warranty of the parts and components they sell above and beyond what the supplier itself offers, for instance issuing a one-year warranty for an item covered by only a 90-day manufacturer's warranty (or no warranty at all).

International Laissez Faire?

If the manufacturer is a subsidiary of a company based in another country, however, they can continue making little or no warranty disclosures. For instance, Electrolux on the appliance side, Chrysler in the automotive segment, and virtually the entire consumer electronics industry are ultimately owned by entities based in Europe or Japan. Warranty Week found a handful of Canadian companies following the FASB warranty disclosure rules in their filings, but for the most part the non-American manufacturers took full advantage of their immunity from persecution (see Part Four for a list of the top 50 foreign warranty issuers).

This puts U.S.-based manufacturers at somewhat of a disadvantage. For while it can now be said with certainty that warranty costs during the first quarter equaled 2.83% of auto sales at General Motors and 2.44% at Ford, there is no comparable public information for Chrysler, or for all the other automobile manufacturers based outside the 50 states -- even those that operate "transplant" factories within the U.S. This makes it almost impossible to analyze industries such as consumer electronics, where it seems like all but a handful of speaker and jukebox manufacturers are ultimately based abroad.

Even among U.S.-based manufacturing companies, however, product warranties are not a requirement. In many states it is perfectly acceptable to sell a manufactured product "as is" and without a warranty. In manufacturing industries such as petroleum, chemicals and paper, for instance, product warranties are virtually unknown. However, there is always the implied warranty of fitness for a particular purpose, meaning an oil company cannot sell kerosene and call it diesel. And there is the implied warranty of merchantability, meaning a paper company cannot sell drinking cups with holes in the bottom. But implied warranties are not covered by FASB disclosure requirements.

Satisfaction Not Guaranteed

Intellectual properties such as books, compact discs, and motion pictures are typically not covered by product warranties, although some might be subject to satisfaction guarantees or some other type of return policy. Of course, they're all subject to the implied warranties listed above, but the bottom line is that the companies which manufacture those products do not have to make any FASB-mandated warranty disclosures. Simply put, the FASB rule is if you provide a warranty, you must disclose its finances.

For the most part, shrink-wrapped computer software makers are not issuers of warranties, and what little software is warranted is usually covered for 90 days or less, and only for the replacement of defective software. Monetarily, claims are insignificant, typically involving nothing more than the mailing of a replacement CD and perhaps some labor costs for online or on-the-phone support. Therefore, most software makers generally don't keep a warranty reserve fund, and don't report upon their warranty activities. However, some computer vendors sell a mixture of software, hardware, and consulting services, so a portion of their revenue is covered by a warranty. Depending on the size of that hardware product business, they may or may not decide to keep a warranty reserve fund on the books. They can always expense it as the need arises, taking the chance that a major mess-up could bankrupt the company.

Interestingly, Microsoft Corp. did make a warranty disclosure in its latest 10-Q, but it came in reference to its new line of Xbox game consoles, not its core Windows or Office product lines. Having launched the warranted Xbox, Microsoft has become a hardware manufacturer required to make FASB 45 disclosures. Even more interestingly, Microsoft reported spending exactly $0 servicing the warranty claims of its Xbox customers over the past nine months, although the company nevertheless increased the reserve from $8 million to $18 million. While that's insignificant compared to Microsoft's quarterly revenue, it's a good percentage of its $2.28 billion in game box revenue.

Common sense would suggest that companies such as Motorola Inc., General Electric Co., and Masco Corp. are manufacturers that sell at least some products covered by warranty, be they pagers, plane engines, or plumbing fixtures. However, they and at least a hundred other large manufacturing companies continue to make little or no warranty disclosures in their most recent financial reports filed through May 2003. Some simply state that their warranty costs are within expectations, without providing additional details. Others describe their products and associated warranty programs in detail, and then forget to include a 14(b) table. See Part Four for a list of the top 15 manufacturers missing from the ranks of FASB-compliant companies.

Under the heading of "new accounting pronouncements," a few manufacturing companies stated that they have fully implemented FASB Interpretation No. 45, despite the absence of 14(b) warranty tables elsewhere in their filings. Some continue to provide only beginning and ending fund balances for their warranty reserves within the accrued liabilities section of their balance sheets, without providing any figures at all for the inputs and outputs to the fund over the course of the quarter. Others say their warranty costs are very slight, or in legal wording, "immaterial," and therefore they do not require disclosure. We're not lawyers or accountants, but we read FASB Interpretation No. 45 in its entirety, and nowhere does it provide such a loophole based upon dollar amount or percentage.

In fact, companies that sell products whose warranty costs are "immaterial" should be proud to disclose such facts. If warranty costs eat up only 0.1% of sales or even 0.01% of sales, such a disclosure would suggest that a manufacturer's products are made very well (or their warranty policies are extremely restrictive). The smallest quarterly claims total yet reported was for $392 by a homebuilder, for whom that amount represented 0.01% of product sales. However, one company with no claims and no warranty reserve fund at all noted that management had concluded it didn't need one -- because the company had yet to sell any products. Also, companies remain free to expose themselves to risk by expensing warranty claims as they arise, without the buffer of a reserve fund. They still, however, must disclose the amount of the expense and how warranty claims are financed. It's not the presence of a reserve fund that triggers FASB FIN 45; it's the presence of a guarantee.

Naming Names

But before we get too deep into naming names, we are asking for all readers to help us make the Warranty Week 500 list as complete as possible. We've already included the companies of all registered Warranty Week subscribers on the list, so there's no need to send in your own company's name. You're included. But who are your competitors? Give us their names and we'll give you their warranty costs, compared to your own.

In the June 9 issue we will attempt to provide meaningful industry averages as well as high/low ranges, as soon as we're confident that the list of warranty-issuing companies is as complete as possible. For while in this edition we're providing a short list just of the 25 companies at the top, in reality it makes little sense to compare the warranty costs of a golf club to a jet plane, even if they're both made out of steel (or titanium).

Please take a moment to send us an email, listing a few of the companies you are certain are business units of U.S.-based manufacturers selling products covered by warranties. No company is too small -- the smallest company on the list so far reported sales of just $390,000 during the first quarter. And no warranty reserve is too small -- 20 companies reported reserve funds smaller than $100,000 as of March 31.

And once again, thank you Enron, thank you Bernie Ebbers, and thank you to all the book-cooking chefs who've ever listed the proceeds from a bank loan as revenue from a product sale, and to those who've ever called a secretly-owned offshore subsidiary an unrelated third party. Without your efforts, and the accounting reforms they inspired, warranty costs and warranty reserve fund balances might not have become public information.