October 20, 2018

Fuel for thought?

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It’s been called many things so far, but ‘Diesel Dupe’ and ‘Dieselgate’ are among the more common monikers given to the Volkswagen (VW) emissions scandal.

Germany’s VW is the second largest car maker in the world, behind Toyota. It owns Audi, Seat and Skoda and luxury brands such as Bentley and Porsche.

The essence of the story is that the US Environmental Protection Agency (EPA) recently discovered that VW diesel cars being sold in America appear to have had a piece of software (dubbed by the press as a ‘defeat device’) installed in their engines. Although details of exactly how the software works are hazy, it appears that it detects when the car’s engine is being put through a laboratory-based nitrogen oxide (NOx) emissions test and makes the engine switch into a low-emissions mode, allowing it to pass the test. Once the car is on the road, the software appears to switch the engine out of test mode. According to various press reports, the engines then actually emit NOx pollutants at levels of up to 40 times above the US legal limit.

VW has admitted cheating tests in the US and subsequently said that around 11 million cars worldwide are fitted with the ‘defeat device’.

What does this mean for VW? Will it collapse, survive by the skin of its teeth or emerge stronger?  One thing seems certain: it will cost the company a lot of money. But it’s not at all clear how much.

Depending on which source you read, VW has already made a provision of anywhere between €6bn and €7bn to cover the costs resulting from the scandal. That resulted in VW reporting, in late October, its first quarterly loss in 15 years.

What costs are involved? 

There are many potential costs: some quantifiable, others not. VW will need to account for them in its annual accounts to shareholders in order to give a ‘true and fair view’ of its position. An accounting provision will be necessary. But of what magnitude?

Quantifiable costs (mainly)

  • Fines by regulatory bodies. There is talk that, at least in the US, VW could be fined an amount per vehicle by the EPA. If we assume that the maximum fine is €35,000 and there are 0.5 million vehicles involved in the US, the potential fine could be €17.5bn. And that is just the potential US fine! To give an idea of what this means, VW’s 2014 global operating profit was around €12.5bn.
  • Hardware and software repair costs. With VW set to recall cars worldwide from early next year, direct costs will be incurred on every repair. Even if the repair costs are as little as €100, the cost would be over €1bn globally.
  • Refunds. Customers who paid extra for their VW thinking it was better for the environment might claim a refund. This cost could be calculated fairly accurately because the amounts paid for each vehicle when purchased will be on record somewhere.
  • Set amount compensation. Will drivers get any compensation? If each driver were to receive a set payout, of, say €1,000, VW could be looking at a cost of some €11bn.

Unquantifiable costs

  • Opportunity costs. If time is spent fixing repairs with no revenue, potential revenue/profit generating work cannot be undertaken.
  • Driver compensation. In today’s litigious society, it is likely that claims are already being prepared, with lawyers perhaps claiming that drivers have been misled or that their cars are devalued as a result of the scandal. These claims will be almost impossible to quantify with any degree of objectivity.
  • Class action lawsuits. There may be class action lawsuits to enable VW owners to sue the company en masse.
  • Dealership compensation. In the UK, there are suggestions that dealerships might be able to claim for compensation. It’s too early to say what this might involve.
  • Lost future sales. Damage to VW’s reputation and brand image will result in some potential customers buying an alternative brand. This is impossible to quantify.
  • Share price movement litigation. It’s difficult to prove any downward movement is a direct result of the scandal, but there may be legal action by shareholders who saw their investment plummet following the revelations. Is this quantifiable? Probably not.

The audit opinion

How will auditors be able to sign off the accounts as a true and fair view for the next set of statutory accounts given that the extent and amount of potential liability are unknown at this stage? What about other peripheral but critically important effects of the scandal that could come into play financially for VW?

The city of Wolfsburg

VW is everything in Wolfsburg. The citizens know that anything that affects VW also affects them. If VW has to cut costs, local suppliers could lose contracts and workers might be laid off, with serious local economic impact. The local football team, VfL Wolfsburg, is wholly owned by VW and could be a target for cuts, forcing it to sell star players. Would the suppliers, the ex-employees, the citizens of Wolfsburg or even the footballers of VfL Wolfsburg make a claim against VW for lost earnings? They might.


If VW is found to have cheated, could some governments in Europe whose car and road taxes are based on emission levels (the higher levels paying more taxation) sue VW for loss of tax revenues? They might. In the UK, for example, could individuals who bought a VW, believing it to be a lower taxable benefit-in-kind because of its low emissions, and whose taxable income now rises due to increased emissions, also sue VW if they end up having to pay more tax? They might.

Companies that have invested in diesel technology

If diesel cars suddenly lose their appeal because of the emissions revelations, this could make buyers go back to petrol, rendering R&D of diesel technology redundant. If this happens, will these companies sue VW? They might.

Public health

NOx emissions have been linked to respiratory illnesses. Could people sue VW blaming it for their illnesses? They might.

It is, however, not all negative for VW…

Toyota has suffered from well-publicised recall problems in recent years and responded with an extensive campaign to address its failings and rebuild consumer trust. Its sales recovered following a short-term fall, and it remains the biggest manufacturer, so perhaps VW can ride the scandal out and make a full recovery.

But here’s an afterthought…

Are these fraudulent practices limited to VW, or are other car companies engaged in similar skullduggery? No doubt various regulatory and government inquiries will determine this. What would the consequences be for the car industry if VW were found not to be alone?

In summary

This is unlikely to be the full story or the end of the financial impact. VW has already set aside between €6bn and €7bn to address the scandal. In light of the continuing developments, this provision seems unlikely to be sufficient. Quite how one could go about calculating an acceptable provision to satisfy the auditors, VW shareholders and others is, however, unclear!

Colin Garvie, Teaching Fellow About Colin Garvie, Teaching Fellow

Teaching Fellow and Chartered Accountant, delivers Accounting to on-campus students in Edinburgh, Malaysia and Dubai.