Note: Tesla is a fascinating case in fraud and of the “wizard” behind the fraud, who has managed to pull the wool over a large population of stock gamblers. Tesla is a saga for the ages and likely the biggest Ponzi scheme in U.S. history. The Company and its CEO are truly emblematic of the fraud and corruption that has engulfed the entire U.S. economic, financial and legal/political system. If this country survives what’s coming, there will be semester long classes in top-10 business schools and psychology masters programs devoted to the case study of Tesla.
A long-time Tesla critic published an article in Seeking Alpha outlining the fraudulent nature of Tesla’s accounting for “warranty expense.” I did not read the article beyond the summary because it was placed behind Seeking Alpha’s subscription firewall. But I’ve detailed this aspect of Tesla’s accounting fraud in previous issues of the Short Seller’s Journal . Tesla has been reducing its provision for warranty expenses relative to the number of vehicles it sells for several quarters. While the warranty provision should rise in correlation with the rising number of vehicles delivered, Tesla and its auditor have decided an inverse relationship between these two variables makes more sense.
In addition, as it turns out Tesla in many instances allocates warranty expenditures incurred to “goodwill” and other non-warranty expense categories, which enables it to move the expense – a cash expense incurred – off its income statement and on to the balance sheet or to the “operating expenses” section of the income statement.
GAAP accounting no longer requires a company to amortize goodwill evenly over time as an expense on the income statement. Those of you who might know GAAP warranty accounting rules might say that the warranty expenses as they incur only affect the income statement to the extent they exceed the “provision for warranty expenses” that accumulates on the balance sheet.
However, in all likelihood Tesla is playing these games with its warranty expenditures because it has already exceeded the amount it has previously reserved for warranty expenses. OR over time if Tesla reports – fraudulently – less on actual warranty expenditures than it has reserved for them, it can “release” the warranty expense reserve into the GAAP income statement as a contra expense to boost gross margin and operating margin. This in turn contributes to the accounting manipulations used in any attempt to generate positive net income.
Furthermore, understating current warranty expenditures enables Tesla to understate future provisions for warranty expense, which should be expensed every quarter as part of the cost of goods sold. In other words, moving warranty expenditures into other expense categories or into goodwill reduces the cost of goods sold thereby artificially and fraudulently boosting the reported GAAP gross margin.
Moreover, the amount of warranty expenditures tossed fraudulently into goodwill never hits the income statement. It sits in the goodwill asset account on the balance sheet which no longer has to be amortized into operating expenses, thereby boosting operating and operating margin OR reducing operating losses. Yes, there is an accounting rule that applies to the revaluation of goodwill but don’t hold your breath waiting for Musk to adhere to any accounting regulations.
This is crucial to understanding the breadth and scale of Tesla’s accounting fraud. Tesla has made it a point of emphasis to boast about its gross margin, which is much larger than the gross margin for the legacy auto OEMs. Also, Wall Street analysts focus on Tesla’s gross margin. When the gross margin reported is higher than expected, the stock price jumps. This accounting scheme also fraudulently boosts Tesla’s operating and net incomes. In fact, if Tesla adhered to strict GAAP accounting, its gross margin would be substantially lower and in all likelihood the Company would have never been able to report positive earnings per share in Q3.
But wait, there’s evidence that backs my assertion above that Tesla fraudulently misclassifies warranty repair expenditures. Tesla owners who have taken their car in for warranty-related repairs have been reporting that on the final invoice the warranty service repair is classified as “Goodwill – service.” You can see a photocopy of one such example in an article published by InsideEvs.com. There are also several lawsuits filed against Tesla with documentation showing that Tesla’s misclassification of warranty service expenditures is standard operating procedure at the service centers.
As it turns out, Tesla labels warranty service expenditures for two more fraudulent reasons. First, under California’s Lemon Law, in many instances Tesla would be required either to buy back for full price the tarnished vehicle from the owner or replace it with a brand new vehicle. Likely this law is similar in most States. Second, repeated warranty repairs for the same problem would require per NHTSA regulations for a recall of the defective parts involved. But labeling these repairs as “goodwill” enables Tesla to fraudulently avoid both of these costs of adhering to the law.
Musk’s business per se is not to be sell cars but sell stock in a company that sells cars. Musk’s accounting schemes are aimed directly at pushing the stock price higher. The primary motive behind this effort is Tesla’s insane CEO compensation plan, which would award Musk with $364 million in stock/options if the market cap hits $100 billion (which is more than Ford and GM combined).
Though I can’t prove it without access to the actual records, I suspect that Goldman Sachs and Morgan Stanley have a lucrative fee-generating business lending money to Musk against the value of his Tesla shares. In other words, Musk – along with Gold man and Morgan Stanley, will do and say anything to try and force the stock higher in order to achieve that compensation milestone level and to protect the value of the collateral used secure loans to Musk.