Rachele it plans to sell or its costs are

Rachele Armand

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13 December 2017

 

Boeing’s
Accounting Practices

In 2016,
Boeing faced scrutiny from the SEC regarding whether or not the company properly accounted for costs
and expected sales related to its 787 Dreamliner and 747 jumbo jet. Boeing uses
the program accounting method, which allows companies to spread out the costs of
producing jetliners over various airplanes while deferring costs throughout the
project’s expected life (Schmidt,
2016). In other
words, the firm avoids recording a large cost up front. The investigation primarily began due to
concerns about projections that Boeing made about the long-term profitability
for its largest jets, the 787 Dreamliner and the 747 (Bryant, 2016). The main areas under examination were
how Boeing calculates the development costs on its 787 Dreamliner and 747-8
jumbo jet, how Boeing applies those costs to the revenues it receives for
selling the planes over time, and how it comes up with a resulting number for
the profit it earns on each airplane (Smith, 2016). In other words, the accounting method Boeing used is complex and
relies too much of the subject nature of future estimations.

The two main jetliners under investigation are
the 787 Dreamliner and the 747 jumbo jet.
The company has reported receiving repeat orders for the 787, while the 747 has
collected only two sales over two years. As a result, Boeing could face up to about $9.7 billion in charges for the 787 and
747 programs, if it is unable sell more of both aircrafts (Reuters, 2016) As Boeing is experiencing, in program
accounting, the method could go wrong if a company either initially
overestimates the number of airplanes it plans to sell or its costs are
significantly higher than planned. In Boeing’s case, both scenarios look
possible. The company has already overshot its budget for the 787 and has
incurred $28.5 billion in expenses for building it. Thus, if it fails to sell
1,300 787s or if it reduces its expenses, it could incur a hefty loss. (Schmidt,
2016) The
so-called deferred production cost balance on the 787 Dreamliner now tops $30
billion. But because the 787 aircraft continues to attract sales, Boeing has
said it doesn’t need to take an accounting charge to write off any of that total
(Bryant, 2016). The most negative outcome would, of course,
be that BA’s projections are proved wrong and it has to write off
a significant amount of investments, thus incurring hefty losses. In this
case, analysts would also end up revising their future cash flow estimates. Regardless
of the outcome, this means that Boeing stock could be headed for high
volatility (Schmidt, 2016).

A
corporation’s projected profit plays a vital role in an investor’s decision-making
process. Boeing uses program accounting, which is
accepted by the SEC allowed as long as specific companies meet a specific list
of criteria. The theory
behind program accounting asserts that with each program or model, production
cost per unit will be reduced over time due to volume efficiencies and learning
effects. However,
many companies have left this accounting behind, which has created a major
discrepancy in the comparison between Boeing’s and other company’s reported
earnings. While other companies are incurring huge initial costs, Boeing is
experiencing sales growth efficient manufacturing over time, which causes the
costs fall, and profitability rises (Schmidt,
2016). As a result, Boeing is
reporting lower costs and higher profits than the other companies. Not to
mention, the projections being computed are severely subjective, which means
the predicted profits can be materially incorrect. The ambitious earnings
estimates will then be misleading for investor’s when evaluation Boeing and
comparing it to other companies.

The program method might be
recognized under GAAP right now, but companies should no longer be able to use the
program accounting method. This method is preventing investors from trading efficiently.
It widens the information gap
between management and investors. It creates more information asymmetry, which in
turn creates a more inefficient market. It is
heavily reliant on estimates regarding what its
revenues and costs will look like over the lifetime of an aircraft program. Simply
put, these estimates are relevant but not reliable. Luckily, investors can turn
to the cash flow statement to avoid being completely in the dark. Moreover, its rules are “complex and there are
few black-and-white rules governing how companies apply program accounting” (Smith,
2016). Therefore, it is very subjective in nature, which makes it difficult to
enforce. It will be difficult for the SEC to show Boeing did anything wrong —
potentially tough enough that after making a few inquiries, the SEC won’t even
try, and will drop the investigation without filing charges. Furthermore, there
are issues can arise with internal controls as well. Program accounting’s subjective
nature poses an issue when auditing, in theory, is an objective process. It
becomes an issue of how close your subjectivity is to objectivity (Hamilton, 2016). Due to the lack of control internally…

Overall, the program accounting that Boeing
is using should no longer be recognized under GAAP. Program accounting is a
complex method with many grey areas that involves many projections for long
time periods. The earnings projections made under this method can go wrong,
even when calculated by honest, skilled managers, with projections that can be
justified using many historical events and explanations. Thus, there are more negative
consequences that can arise than positive results. An unfair competitive
advantage can be given to companies that use the program method over those that
do not. The companies that do engage in it can report higher earnings than they
should have if they had not used this accounting method. Moreover, it could be
difficult for the SEC to prove that Boeing engaged in any wrongdoing. Lastly,
the market is negatively impacted because investors will decide to put their
money in the company because the financial statements show the company doing
better than it actually is. Overall, program accounting has run its course and
should no longer be used.

 

 

 

 

 

 

 

 

 

 

Reference

Bryant, C. (2016, April 14). Boeing’s $32
Billion Accounting Question. Retrieved December 11, 2017, from
https://www.bloomberg.com/gadfly/articles/2016-04-14/boeing-s-32-billion-accounting-question

Hamilton, S. (2016, April 19). Pontifications:
Boeing sued over program accounting. Retrieved December 11, 2017, from

Pontifications: Boeing sued over program accounting

Reuters. (2016, February 11). SEC probes
Boeing’s accounting of Dreamliner, 747: Bloomberg. Retrieved December 11, 2017,
from
http://www.businessinsider.com/r-sec-probes-boeings-accounting-of-dreamliner-747-bloomberg-2016-2

Schmidt, A. (2016, February 18). How Could
the SEC Probe Impact the Boeing Company? . Retrieved December 11, 2017, from https://beta.marketrealist.com/2016/02/what-is-boeings-program-accounting-issue-about?utm_source=redirect5&utm_medium=auto

Smith, R. (2016, February 15). The SEC Is
Probing Boeing. Is It Time to Panic Yet? Retrieved December 11, 2017, from
https://www.fool.com/investing/general/2016/02/15/the-sec-is-probing-boeing-is-it-time-to-panic-yet.aspx

 

 

 

 

 

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