Research Firm: Dell Warranty Accounting 'Troubling'

Friedman, Billings, Ramsey Research (FBR), an Arlington, Va.-based research firm, on Friday said its study of Dell's books "points to at least three troubling conclusions" in the way that the computer hardware giant has handled warranty accruals in its financial reports.

FBR said in its report that Dell's accounting for warranty accruals "has caused [earnings per share] overstatement of 2 cents to 8 cents in five of the last 12 quarters for which data is available." The study comes as Dell faces investigations by the U.S. Securities and Exchange Commission, the U.S. Attorney for the Southern District of New York and the audit committee of its board of directors.

"First, it appears that Dell regularly uses warranty accruals to materially manage margins and earnings, rendering the reported results less useful for gauging actual margin trends," FBR said in the study. "Second, as of the last quarter for which a 10-Q [report with the SEC] is available, the cost of actual claims as a percentage of products sales was rising steadily -- up 30 percent [year over year in Dell's 2006 fiscal year] and costs may be heading higher."

FBR also said Dell's way of disclosing how it manages the money it collects from product warranties, the money it sets aside in reserve for warranty expenses and how much it accrues in warranty funds, is unusual, making it difficult to identify the Round Rock, Texas-based company's warranty accruals based on public financial reports alone. The research firm said Dell could be headed for a restatement of earnings if the SEC probe includes a focus on warranties.

The FBR study isn't the first time that Dell's accounting for warranty accruals has been questioned. In a lengthy analysis last year, the publication Warranty Week estimated that because of the way Dell amortized some of its warranty reserves, as much as 38 percent of the company's operating income could be attributable to quarterly revenue that it recognized from extended warranty sales.

A Dell spokesman said the company won't comment on Warranty Week's conclusions or discuss its warranty accounting in financial results. "Our previous financial reports will have to speak for themselves," the spokesman said. "We are in a period where we are choosing not to comment beyond what we have so far regarding our financial statements. We will be choosing not to comment on this one."

In its most recent filing with the SEC, Dell shed some light on how it may be defending its accounting practices.

"As required by Statement of Financial Accounting Standards No. 5, 'Accounting for Contingencies,' the company accrues a liability when management believes that it is both probable that a liability has been incurred and the company can reasonably estimate the amount of the loss. Management believes that the company appropriately accrues for all such matters," Dell said in the filing. "However, the unfavorable resolution of one or more of these matters in a particular period could adversely affect our operating results."