Cummins Inc. Equity Valuation and Analysis

accounting policy than amortization, this lends itself to accounting distortions due
to management’s evaluation of the fair value. However, because goodwill
comprises .032% of Cummins total revenues, a relatively small amount,
management discretion on fair value estimates will not materially impact the
company’s state of operations.
Warranty provisions are another key factor in accounting policies. Cummins Inc.
includes warranties on its products to improve the quality of its brand image.
Cummins Inc. Inc. charges estimated warranty costs to earnings at the time
products are delivered to the customer and estimates liabilities associated with
warranty cost using a historical experience of warranty programs. However,
warranty liability estimates can result in higher or lower expenses depending on
management estimates. Revenue is recognized on a straight-line basis over the
contract period. If warranty expense estimates are lower than the actual future
warranty claims, earnings are overstated. Overall during the period of 2002-
2005, Cummins Inc. was relatively consistent in provisions for warranties issued.
Provisions increased at a rate consistent with sales over the same time period.
Cummins Inc.’ estimation of warranty liabilities appears to be more conservative
because of their consistent overstatement of provisions for warranty liability.
Actual warranty payments as a percentage of provisions for warranties were
72.22% in 2004 and 80.27% in 2005. Because of the conservative reporting of
provisions for warranties, net income is understated.
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