Recently, more than three million cars were recalled because of potential problems with passenger airbags. Almost all global car manufacturers have faced significant recalls over the past two years. The number of recalls has been increasing — with an exception during the economic crisis 2009-2010 — due to time, cost and market pressure.

In a year, global automotive warranties are estimated at $40 billion, 3–5 per cent loss in sales. Low-cost production often leads to poor quality, and outsourcing leads to transfer of knowhow, including techniques and processes. A recent survey by Deloitte showed that vehicle trustworthiness is an important factor for consumers. Roughly 67 per cent of the respondents said recent product recalls were of concern, but more than 67 per cent said they would still consider buying a brand despite a recall.

Companies that issue a product recall often face grave financial consequences — especially related to their stock price.

A correlation of recall data and stock prices over multiple industries showed that a company’s stock tends to underperform the sector index by an average of 2.3 per cent the day after a recall. After two weeks, a poorly-managed recall execution can cause stock declines up to 22 per cent

In developed countries, product recall is handled systematically. A survey in the US showed that companies that are prepared to deal with the near-inevitable prospect of a product recall tend to fare better — especially in terms of stock price — than those that are not.

Handling recalls in india

In India, the systems are not sufficiently mature. Indian manufacturers generally do not make a recall public — whereas, in other countries it is made public through a press conference, before the other recall procedures follow.

Accounting aspect

Generally, the replacement of failed or non-working parts is accounted through warranty provisions. The provision for warranty under Indian generally accepted accounting principles (GAAP) is governed by AS-29 — Provisions, Contingent Liabilities and Contingent Assets — as warranty is a current obligation arising out of a past obligation.

The quantum of warranty provision is always a matter of debate. Past numbers and the pattern of warranty claims constitute the primary basis for a warranty provision. Other factors such as technology improvement, implementing a system to identify the source of faults (own/ supplier’s) can also be considered when making/ reversing the existing warranty provision. Auditing warranty provision is a matter of judgement and requires experience and thorough knowledge of the industry.

If the recall quantum is insignificant to the total warranty claims made by customers/ dealers, then the product recall costs can be adjusted through the existing warranty provision appearing in the books of account. However, there is the alternative of directly recording product recalls as an expense if these are significant — here it is necessary to analyse the impact on warranty provision, especially the basis for it.

On the risk-mitigation side, insurance policies are available to minimise the impact of recalls. They generally cover exposures against media announcements and public relations costs, shipping costs, additional labour and warehousing costs, product repair or replacement costs, loss of profits, and brand rehabilitation.

Given the tough economic climate, manufacturers face a challenge in managing product recalls and their accounting; they will have to enhance their quality and claim-processing systems to minimise the impact on the brand.

Hemant Joshi is Partner and Nikhil Kenjale is Manager, Deloitte Haskins & Sells

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