BUS - 344
CRN- 50606
CASE STUDY – TESLA WARRANTY EXPENSE: A
CASE OF GOODWILL BY THE AUDITORS
Submitted to- Mrs. Diksha Kakkar
Date Submitted -2nd July,2020
Date Due -2nd July,2020
Submitted by- Simran Kaur Batra
(300165731)
Email- SimranKaur.Batra@student.ufv.ca
“Is Tesla engaging in accounting fraud? The Securities and Exchange Commission
charged Mr. Musk with fraud in 2018, but that was related to his infamous $420
"funding secured" tweet. If Tesla is cooking the books, it would be the financial
scandal of the decade.”
INTRODUCTION
History has shown that inventors of new innovations often aren't the ones that
make the real money from their evolving world ideas. Nikola Tesla, namesake for
the Musk company, died broke. Ironically, Westinghouse and GE, not Thomas
Edison, made money off the light bulb and electrified America. And Howard
Hughes, though incredibly wealthy from the tool business of his family, became
insane as he created a series of misadventures in aviation, Las Vegas and
Hollywood.
In almost two decades of life, Tesla has never made an annual income, but her
shares are worth more than Ford, Chrysler and General Motors combined. This
valuation makes Musk 's stake in Tesla worth almost $30bn despite the company
selling only a fraction of the cars sold by its American competitors. Having a high
net worth has not reduced Musk's determination, as he is notorious for sleeping on
production lines and making his employees' tyrant-like demands. Musk is under
relentless pressure to meet quarterly expectations of Wall Street, when on the front
of the electric vehicle Audi, Porsche and other rivals catch up with Tesla.
According to Musk himself, an much greater cause of tension have been shortsellers — investors who bet Tesla's stock will lose interest.
TESLA’S ACCOUNTING POLICIE’S CONTROVERSY
The SEC (Securities and Exchange Commission) and analysts have repeatedly
reviewed Tesla's (TSLA) accounting policy. The SEC asked Tesla in September to
comment on its sales, facilities, guarantees and its direct car leasing system.
Following Tesla's reply the SEC closed the review in October.
Yet the issue resurfaced again in the third quarter after Tesla's surprise profit.
Many observers have predicted a defeat. Tesla stock rose 17.7 per cent the day
after earnings were posted. Barron's and Wccftech found out that the firm lowered
its obligations and responsibilities relevant to warranties, which boosted its
earnings. Although critics, media and regulators have challenged Tesla's
accounting practices on different grounds, its warranty expenditures have been one
area of contention. Two big warranty related issues have slipped under the radar.
A number of bears dug into the 10-Q after the previous earnings call and decided
that Tesla had played with warranty numbers to try and show a profit. I ended up
not publishing it because by the time I had completed all the work to feel pretty
confident about my conclusion, it felt that no one was calling for Tesla to play with
her warranty accrual numbers improperly any more. In the bear and bull dispute
over the warranty Johnson takes up the same point. His quote: “you take those [one
time adjustments in Q3] out, you adjust their warranty accounting to actually
account for the amount of warranty they need, and they’re losing money.”
TESLA’S ACCOUNTING: WARRANTY EXPENSES ON LEASED PRODUCTS
The SEC has challenged Tesla's accounting of rented car and solar energy
guarantees under leasing arrangements. The regulator directly told Tesla if it
understood warranty payments on those devices.
Tesla clarified in her reaction the leasing customers do not own the properties. As
for other properties owned by Tesla, improvements and maintenance are therefore
remembered when they occur. The company noted, "Leasing customers are getting
the benefit of productive assets owned by Tesla. Repairs and maintenance are
incurred on such owned assets over the term of use of the assets, rather than as an
upfront cost. Therefore, no warranty requirements are placed on consumers, and
we pay the costs to repair as incurred.”
WARRANTY ACCOUNTING & RESERVES
After the claims about the Q3 warranty adjustments came out, it was thought worth
trying to dig into where Tesla's warranty reserves ranked in comparison with other
car manufacturers, and whether or not its adjustment was appropriate. At the top,
that was a bear statement that appeared to me to have validity — it was said before
that there are certain accounts that you can legitimately play with to exploit your
income, and warranty is one of those accounts. Whether you pay for events each
quarter may have a small but important impact on results each quarter.
After a lot of analysis, I landed on a website called "warrantyweek.com," which I
wish I had only discovered at the outset of my study, because the work on the website
validated mine and digged even further than I did. Unless you just want to know how
the accounting for the warranty works, enjoy the rabbit hole that I just led to. We
still don't post posts because they're full of the wonky things I enjoy reading and I
can truly appreciate what I'm looking at. I'll cover that in a moment if you're just
here for the Tesla stuff.
The first big idea to get out of this is that an external observer can not check the
warranty expenses to determine their maths. However, because you don't know
whether a business paid the right amount of money on warranties until after time,
arguing that a business using its warranty accrual system to either cover or raise
earnings becomes an convenient goal to blame on analysts that made the wrong call
about a stock, since it the take months or years until the company reveals whether
its accrual rate was accurate, In other words, paying for promises is a very good
scapegoat for your not-so-big calls.
Additionally, warranty accruals are very wonky, as in the same cost center you make
corrections for past quarters because of the new goods delivered, and it is a
nightmare for others to be able to figure them out. Internally, Tesla may have decided
to change the amount she holds for warranties, but she doesn't need to show us what
the change was or why. Just for the record, this is not just a Tesla phenomenon, it's
representative of the industry as a whole.
MISSCLASSIFICATION OF “GOODWILL”
This is even more confusing later, as some businesses do not provide notices in their
warranty maintenance board, and some do. Over the last few months, there's been a
bit of a dispute over whether or not Tesla classifies so many improvements as
"goodwill." If it does this, at the expense of current profits, it ends up with much
larger accrued warranty repairs, which would seem to be a strange outcome for them
to want based on some more data I'm about to get into. Also interesting is that if a
fix is officially categorized as "goodwill," "warranty," or otherwise, individual
classifications mean little with lemon regulation, and Tesla will not mark repairs as
"goodwill" to mitigate this.
Nonetheless, returning to the subject at hand, one of the things investors did not
point out in the whole warranty controversy was that Tesla contributed $37.75
million to their Q1 2019 guarantee contingency pool. Although we can't be sure of
the explanation for the move, it's almost as possible that Tesla thought it was
bigger than expected, and the firm took back more of it to its declaration of profits.
WHY DID TESLA REPORT A SURPRISE PROFIT?
Tesla's profit news that triggered a two-day gain of almost 29% for the stock this
month was not as good as it looked, a securities filing indicates. Tesla recognized
$153 million in warranty expense for the second quarter of 2019. If the warrantyexpense rate had not changed, Tesla's pretax income would have been about $12
million lower. Tesla reported a pretax profit of $176 million during the second
quarter. It added another $37 million in third-quarter pretax income, bringing the
total warranty-related boost to almost $50 million. It's a substantial figure,
compared with the $176 million profit Tesla reported. Still, investors expected
Tesla to lose money in the third quarter. The warranty changes are not enough to
account for the entire unexpected profit. It's impossible to know exactly why the
warranty rate and accrual changed. Tesla, for instance, only paid out $59 million in
warranty cash during the third quarter.
In 2018, Musk told The New York Times that "from a personal pain standpoint, the
worst is yet to come." As expectations for Tesla crank up over the coming quarters
along with increased accounting scrutiny, one wonders if Musk's words were
prophetic.
CONCLUSION
My first point is that the warranty stuff is much more interesting than I should have
imagined.
My second and more important conclusion is that Tesla's accounting for the warranty
is based on industry guidelines and appears to be higher than required. It is also
worth pointing out that it has had the lowest warranty claims rate of any maker since
Tesla was formed in 9 out of 10 years, with the outlier being 2010, when the only
product was the original Roadster.
That's incredible to me because there have been issues with early electric motors,
again.
However, as it comes out, Tesla wants to list its warranty accruals on its 10-Q, it's
nice to be armed with the details again now, because I think we'll see many more
highly ranked analysts refer to it as evidence that their bear calls were right and
Tesla's just cooking the books. It's too bad they don't have the same resources to
look up real warranty details for unranked amateurs like me.
And, maybe it just seems like they know what they're thinking about with people
who don't know how all of this works. Perhaps it's just a polite way to try to save
skin.
REFERENCES
Cherney, M. (2020). The Facebook Ad Boycott Gains Steam. Analysts Say
Buy on the Weakness. Retrieved 2 July 2020, from
https://www.barrons.com/articles/facebook-stock-ad-boycott-civil-rightssocial-media-51593463696
Tesla’s Accounting Policies: Another Controversy for TSLA - Market
Realist. (2019). Retrieved 2 July 2020, from
https://marketrealist.com/2019/11/teslas-accounting-policies-anothercontroversy-for-tsla/
Warranty Week Industry Headlines. (2020). Retrieved 2 July 2020, from
https://warrantyweek.com/newsroom/
Moogal, F., & Moogal, F. (2020). Tesla [TSLA] FUD: Warranty Claims.
Retrieved 2 July 2020, from https://cleantechnica.com/2020/01/30/teslatsla-fud-warranty-claims/