Accounting Standards Call Out Airplane Orders with Questionable Credit

By Dan Catchpole

Danieljcatchpole[at]gmail[dot]com

Nov. 6, 2018, © Leeham News: Like countless other businesses, Boeing this year adopted new accounting standards, known by the acronym ASC 606. The new rules did not significantly affect the company’s balance sheet. However, it did result in some noticeable changes to its orders and deliveries page.

Boeing added a line—dubbed ASC 606 Adjustment—to its total order table. It also moved some orders around within the order book, shifting them from the operators to Boeing Capital Corp., the aerospace giant’s financing arm.

New Lines

Now on the company’s orders page, there are three lines in its total order book table. The first line is labeled “Total Unfilled Orders.” It represents all firm orders with a financial commitment. It is the tally that the company used prior to implementing the ASC 606 changes this year.

The next row is the ASC 606 Adjustment line, which captures orders from customers that actually wind up with Boeing’s leasing arm, Boeing Capital Corp. Some customers may have less than stellar credit. The idea is that these orders pose some risk of falling through. Boeing has not disclosed how it determines which orders are considered at risk. But others, like American Airlines, chose BCC to lease the airplanes for fleet planning reasons. Twenty-two of an order by American for 47 787s will be leased from BCC. These don’t show up on the Boeing orders website under American, but rather under BCC. Boeing declined to comment on the record for this article.

The final line is labeled “Backlog.” It represents the difference between the first two lines. So, it, in theory, represents firm orders from customers with solid financing.

When the new standard was implemented, the company removed 66 orders from the backlog. By August, there were 70 ASC 606 orders. That tally is now 83. That is a tiny fraction of Boeing’s 5,932 total unfilled orders—1.4%, to be precise. The ASC 606 orders are not skewed toward any single program.

Most—60—are for 737s; five are for 777s; and 18 are for 787s. So, ASC 606 orders make up a slightly higher percentage of the 787 program’s order book—2.7%—than they do for the other programs. Still, that is a little more than one month’s work at the planned production rate of 14 airplanes per month. There is no indication how these 14 are spread through the production line. In either case, it’s hardly enough to keep Boeing CEO Dennis Muilenburg up at night.

Whose Orders?

Boeing won’t say whose orders are broken out under the ASC 606 Adjustment. The order page on the company’s public website allows visitors to generate reports using different variables. Those reports are drawn from all firm orders, including ASC 606 orders, a Boeing spokesman said.

It is possible for an order to be designated under the ASC 606 adjustment, and then later moved into the Backlog row if the customer’s credit improves, the spokesman said.

Within the backlog, some orders shifted around, as Boeing now has to report the orders by the entity that buys the airplanes, rather than the operator. So, Boeing Capital Corp. now is listed as a customer with 104 unfilled orders—75 737s, 1 777 and 28 787s, as of Nov. 2.

At least 25 of the 737s are advance sale leasebacks to the financially-struggling Jet Airways.

Embraer Scrubs Order Book

Embraer in its latest quarterly earnings report scrubbed 134 jets from its order backlog. Most of the orders—100 E175-E2s for SkyWest Airlines of the US, which were “conditional”—were stripped out due to new international accounting standards, known as IFRS 15. That standard is similar to ASC 606.

Both reforms have been several years in the making and largely deal with how and when revenue is logged. Boeing’s accountants have been working to implement the new standards for more than two years. Boeing Defense’s balance sheet was more affected than Boeing Commercial Airplanes due to how many of the defense division’s contracts are structured.

The changes make bookkeeping a lot more complicated, said David Burgstahler, an accounting professor at the University of Washington’s Foster School of Business.

Burgstahler cautioned that while he is familiar with the ASC 606 changes, he is not an expert in them.

The intent of the changes was to harmonize revenue recognition based on the principle that revenue from goods and services should be recorded when they are transferred to the customer and relative to how much has been handed over.

That is fairly straightforward for a company that makes lots of disposable widgets but becomes more complicated for really expensive durable goods like airplanes and has been much more complex for many in the digital economy.

4 Comments on “Accounting Standards Call Out Airplane Orders with Questionable Credit

  1. Accounting should simply be keeping score, unfortunately all OEMs have found that by manipulating the data they can publish better results with no pain or effort whatsoever. The problem occurs when there is the ‘big reckoning’ associated with economic turbulence or financial meltdown, the black swan event that seems to occur on a worryingly frequent basis.

    This is all about the balance between the matching concept where we endeavor to match income and expenditure in a manner that best describes the way in which the company operates against being prudent. Prudence dictates that we take a pessimistic (or realistic) view of the future where there is uncertainty.

    Regarding the future order books of the OEMs we are looking at sales running out to 5 years or more into the future and the very success of gathering those orders introduces a level of uncertainty as whether they will ever be serviced or will generate income. Common sense dictates that, assuming the world keeps spinning economically, the majority of those sales will occur but it could be argued that booking the sale should only occur when the progress payments are made and when the frame flies off on delivery.

    The same occurs with cost where Boeing looks to match some cost incurred today or in the past against future sales, the deferred income idea. This is sensible on one level but gives rise to uncertainty regarding the accounting block, future sales etc etc. Airbus are a little more robust here and simply match the cost to the aircraft being produced at the time and as such individual programmes may show losses for a considerable period (if so separated out) of time from inception but also generate ‘supernormal’ profit in later years.

    It will be interesting to see how this new standard pans out over the next few years as I suspect that the OEMs will be reticent to take the hit in one go but will eke out the pain over a number of years. What is worrying, as is so often the case, is that transparency is not possible because the application of the standard by Boeing and their auditors is shrouded in secrecy.

    As I said at the beginning accounting should simply be about keeping score in a transparent and accessible manner to the users of those accounts, unfortunately the impact of such decisions is so great that it encourages management to do their utmost to play games.

    This is the reason why seeking the FCF is so important, it is more difficult to fudge, enhance or lie about cash. As a dabbling investor as soon as I don’t understand the accounts I steer clear.

  2. I think adding some more segmentation to the order book is good. Every OE should do it. Although still a lot to manipulate, it’s a start providing better transparency.

    The financial Accounting standards are more important. Guys like Adam Levine-Weinberg are half informing their public by hiding / not mentioning Boeing’s controversial, unique financial accounting rules and resulting free cash flow. Instead suggesting other reasons supporting his apple-oranges comparison between A &B.

    https://www.fool.com/investing/2018/11/05/1-way-boeing-is-absolutely-crushing-airbus.aspx

    I think the qualification “taking your public for a ride” is real close here.

  3. I think an obstacle to the sales of the E2 that I have not seen anyone talk about is the wingspan. At a couple of airports where lots of E-jets operate, in Europe and North America, gates where created tailored towards aircraft with a wingspan of 30m. European examples for this are Pier B and all regional remote stands at Amsterdam Schiphol and 12 out of the 16 stands at London City Airport. The 30m box has become unofficial standard between the ICAO code b (24m) and code c (36m). The Embraer catered to this trend on the E1 by developing different winglets for the E170/175 and E190/195, allowing both to stay within the 30m limit. The E190-E2 and E195-E2 require regular code C stands due to their increased wingspan, and the E175-E2 is just above it as well with 31m.

    For airlines that operate out of airports like these, this is a significant problem. The existing infrastructure cannot accommodate the E2, so they cannot just replace their E1 fleet. This especially affects the E175-E2 – the one frame stretch puts it just above the scope clause, and the new wing just outside the common size for regional gates. Not considering the operational realities of their customers is coming back to haunt Embraer.

    • Wingspan of the MRJ is listed as 29.2m. Some one was thinking about that requirement

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