Recall provisions

When does a recall create an obligation?

The past event is the sale of vehicles with the defect. Whether that creates a present obligation depends on whether the carmaker has no realistic alternative but to fix them. A recall ordered by a regulator is a legal obligation. A voluntary recall becomes a constructive obligation when the carmaker announces it to regulators or customers, creating a valid expectation that it will act. Before that, if the carmaker has identified a safety defect that rules require it to remedy, it may already have no realistic alternative, and a provision is needed even though the recall has not been launched. While the defect is still being investigated and a recall is possible but not probable, the carmaker discloses a contingent liability if the outflow is not remote. See contingent liabilities.

Recall provisions: measuring the cost

A carmaker recalls 200,000 vehicles to replace a faulty part. Each repair costs US$ 450 in parts, dealer labour and handling. Experience with similar recalls shows that about 75% of owners bring their vehicles in, even after reminders. Notifying owners, running the campaign and supporting dealers will cost 2.5 million.

The completion rate is an estimate of the obligation that will actually be settled, based on evidence from past campaigns, the vehicles' age and the severity of the defect; it is revisited as the campaign runs, and the provision is used as repairs are made. Because most recalls are completed within a year or two, discounting is often immaterial. Recalls fixed by over-the-air software updates cost far less per vehicle, but still need a provision for the update and any vehicles that cannot receive it.

How are supplier recoveries treated?

Where a supplier's part caused the defect, the carmaker may recover part of the cost. If the supplier has agreed to bear 40%, the carmaker recognises a reimbursement asset of 28.0 million, separately from the provision, only once recovery is virtually certain, typically when the supplier accepts the claim. Until then, the full provision stands. In profit or loss, the expense can be shown net of the reimbursement once it is recognised.

What about vehicles in stock and other costs?

Affected vehicles still in the carmaker's or its dealers' stock are fixed before sale. For the carmaker's own inventory, the cost of rework is part of the cost of the inventory or reduces its net realisable value; for vehicles already sold to dealers, it is part of the recall provision. Fines from regulators and claims from customers or class actions are separate obligations, each assessed under IAS 37; lawsuits are often contingent liabilities until a settlement is probable. Goodwill gestures, such as extended warranties offered to affected owners, are accounted for when the carmaker commits to them. See vehicle warranties and EV battery warranties.

How is a range of outcomes measured?

Recalls of new defects can have wide ranges of possible cost. Under IAS 37, a large population is measured at the expected value, and where a continuous range of outcomes is equally likely, the midpoint of the range is used: if the cost could be anywhere from US$ 50 million to 90 million, the provision would be 70 million. Carmakers disclose the uncertainty and, where significant, the assumptions behind the estimate. See IAS 37 provisions.

How does US GAAP differ?

Under ASC 450, a loss contingency is accrued when it is probable and reasonably estimable, similar to IAS 37's test, but when a range has no best estimate within it, the minimum of the range is accrued: 50 million in the example rather than 70 million, with the possible additional loss disclosed. US GAAP also does not usually discount these liabilities. See IAS 37 vs ASC 450 and automotive accounting.

This guide is general information. It is not tax or legal advice for your situation.