Knowledge Brief – Warranty Reserves and Accrual Rates Management

In the aftermarket business, the warranty reserves determine how serious a manufacturer is about their after-sales strategy.

According to reports from Harvard Business Review, businesses are focusing on their after-sales strategy to generate additional business and improve customer satisfaction.

Here are the top 3 things that give a better perspective about warranty reserve:

 1. Basics of Warranty Reserve and Accrual Rates:

Warranty Reserve is a fund maintained by the manufacturer to meet warranty expenses. The warranty reserve balance is the balance left after deductions of claim expenses for the year.

The accrual rate is usually a fixed percentage of sales and is managed by the finance department of the company. The finance department can adjust the accrual rate to manage company earnings.

Hence, management of warranty reserve and its accrual rates becomes crucial for a company.

The finance department of a manufacturing company should ask these five basic questions to manage and analyze warranty reserve information:

1. What is the opening balance of the warranty reserve?
2. What is the current additional reserve including this year?
3. What is the status of warranty expense?
4. Are there any cost adjustments to the reserve?
5. Are there any external factors, such as currency fluctuations, that impact the warranty reserve?

2. Influencers of Warranty Accrual

Influencer 1: Manufacturing Quality

The manufacturing quality of a product dictates the future course of a company. Companies have paid huge penalties and suffered declining market share due to poor product quality.

Quality manufacturers invest in a robust Product Quality Management System that streamlines complex quality management processes and integrate efficiencies into the system.

An efficient product quality management system helps identify and fix issues faster-providing insights into current manufacturing processes. These systems have a positive impact on warranty reserves by reducing warranty expenses.

Influencer 2: Product Mix

Every new product launched by the manufacturer could have newer product-related issues.

These issues need to be analyzed and documented by the warranty teams to determine corrective and preventive actions and may see a surge in warranty expenses during this period of product stabilization.

This influences the warranty reserve. If these scenarios occur for a series of products, the warranty reserves suffer substantially.

The new product launch is probably the most precarious activity and can also be a challenge sometimes. There is no historical evidence of selling a product or offering warranty, upon which a manufacturer can rely to avoid the warranty impact.

Influencer 3: Changes in Warranty Coverage Period

Marketing initiatives can improve product sales by providing extra warranty coverage. The extra warranty coverage requires loading the company’s existing warranty reserves. This, in turn, increases the average repair cost per unit.

3. Disclosing Accrual Information:

Some U.S. regulations, such as FASB interpretation 452, require a manufacturer to disclose the warranty terms, accounting policies and sources of funding of the warranty accruals.

U.S. regulations suggest that the Extended Warranty Cost reserve be handled differently than standard warranties, the costs of which are recognized at the inception of warranty.

There are many accounting methodologies to manage accrual information; some of the popular ones are:

1. Bornhuetter-Ferguson Test A Priority
2. Average Age of Warranty Claim Times Annual Spend
3. Active Life Approach
4. Calendar Year Payments to Revenue Approach

A good Warranty Management System must have reporting capability on metrics, such as:

1. Average warranty cost per vehicle
2. Breakup of costs by Parts, Labor and other Services
3.  Relation between product failures and warranties
4. Top product models causing major warranty expenses

These metrics will give an in-depth understanding of failure information and expenses incurred against each failure and help connect the dots between reserves vs. expenses.

Tavant Warranty is a flexible, user-friendly, and effective warranty management solution for the complete warranty lifecycle of original equipment manufacturers and aftermarket industries.

Its unique cross-functional integrations structure connects business departments and leads to a rapid reduction in warranty costs and reserves, increased supplier recovery, and enhanced reserves forecasting accuracy. The system backed by Artificial Intelligence (AI) results in better workflows for manufacturers, which in turn improves cash flow, thereby improving financial health and profitability for the organization.

“Tavant Warranty is a one-of-a-kind, AI-powered solution that helps organizations maximize their aftermarket revenues by over 2%, reduce claim processing time by 30%, increase supplier recovery by 50%, eliminate fraudulent claims, improve product-return cycle time by 25%, and helps you improve your warranty reserves” Information.