Applying ASC 606 to the Airbus Order Book

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By Vincent Valery

Introduction  

July 27, 2020, © Leeham News: Since the first quarter of 2018, Boeing applies a new revenue recognition accounting standard, ASC 606, to its aircraft order book.

As a result, the OEM needs to remove orders from the backlog when a customer deviates materially from its contractual obligations.

ASC 606 adjustments affect all Boeing commercial aircraft programs apart from the 767. Orders removed from the 737 backlogs increased from 183 to 622 between the end of 2019 and June 2020. The figure should rise further as more airlines have strained finances due to the COVID-19 outbreak.

Other aircraft OEMs, notably Airbus, do not apply such standard. As a result, the firm backlogs of Airbus and Boeing aren’t apples-to-apples comparisons.

With Airbus reporting earnings Thursday, LNA adjusts the OEM’s order book for orders at material risk of cancellation. The goal is to obtain a more representative market share picture.

Summary
  • ASC 606 Course 101;
  • Identifying Boeing ASC 606 customers;
  • Applying adjustments to Airbus’ order book;
  • Estimation of adjusted market shares.

ASC 606 in a nutshell

The Financial Accounting Standards Board defines the ASC (Accounting Standards Codification) 606 principle in the following way:

The core principle of Topic 606 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

FASB ASC 606-10-05-3 through 05-4 and 606-10-10-2 through 10-4

For Boeing, it means the OEM needs to assess customer’s willingness and ability to take delivery of firm aircraft orders. As part of an aircraft purchase agreement, airlines need to pay a deposit to book a delivery slot. Airlines then must make pre-delivery payments as the aircraft goes through the assembly line. The final payment occurs at delivery.

If a customer falls behind on pre-delivery payments and Boeing assesses there is a significant chance the airline won’t be able to catch up, it must remove the order from the backlog. If an airline decides to renege on its purchase agreement and cannot agree on penalty terms, Boeing will also have to remove the order from the backlog while going through litigation.

Identifying ASC 606 orders in Boeing’s backlog

While Boeing discloses the number of aircraft it removed from its backlog under ASC 606, the OEM does not disclose the breakdown by customer. Below is a table showing the order tally with ASC 606 adjustments as of June 30th:

Airlines that ceased operations, such as Jet Airways, are easily identifiable. So are airlines that entered administration or Chapter 11 bankruptcy. However, numerous customers did not declare bankruptcy, so it requires a fair bit of judgment to identify them.

Easier to identify twin-aisle than single-aisle customers

Due to the smaller number of airlines operating and ordering widebody aircraft, it is easier to identify ASC 606 orders. LNA believes it identified all twin-aisle Boeing customers with ASC 606 adjustments.

The large number of 737 customers makes it harder to identify affected orders. On top of airlines that went into administration, some decided that they did not want to meet the sales contract requirements. LNA does not have insight into contract details and potential breaches.

The 737 MAX program has 785 orders with unidentified customers. A large but unknown portion is with Chinese airlines. LNA assigned a fraction of ASC 606 orders to those customers.

Accounting for new airlines going into administration since the end of June, we see an updated ASC 606 count at 626, 3, 18, and 34 for the 737, 747, 777, and 787 programs, respectively.

We now turn our attention to Airbus’ order book.

Identifying Airbus customers subject to ASC 606

Some airlines that are subject to ASC 606 adjustments at Boeing are also Airbus customers. We consider that those orders are also subject to ASC 606 adjustments if European accounting had such a standard.

Airbus’ A320ceo order book still has outstanding orders for airlines that have now ceased operations for 10 years: Hamburg International Airlines and Mexicana.

Airbus also lists firm orders for Iran Air. Since Boeing never added those to its order book and deliveries will not happen for the foreseeable future, we added those to the ASC 606 tally.

As LNA does not have insight into potential contract breaches, our methodology will not account for Airbus customers that did not go into administration but are significantly breaching sales contracts.

Adjusted order books for Airbus and Boeing

Below are the adjusted order books in the single-aisle market:

A significant portion of the outstanding A320ceo family orders is with shaky customers, including the three listed in the above section. So far, the 737MAX order book has received more ASC 606 adjustments than the A320neo one.

Below is the tally in the twin-aisle market, including freighters:

Both A330 programs have a significant portion of their order book that would be with ASC 606 customers. We did not add to the A330neo tally a customer in substantial financial difficulties. Should that customer enter administration or renege on orders, it would materially affect the A330neo order book.

Most 777 Classic adjustments are with freighter customers. ASC 606 orders represent similar proportions of the backlogs on the A350 (8%) and 787 (6%), all with passenger airlines.

Adjusted market shares

Since the 737 MAX backlog has more ASC 606 orders, for now, the 737 adjusted market share is lower against the A220 and A320 (37% post-adjustments vs. 39% pre):

In the twin-aisle market, adjustments are in Boeing’s favor (56% post-adjustments vs. 53% pre):

Conclusion

As the COVID-19 is bruising airline’s finances, an increasing portion of Airbus’ and Boeing’s order books are at risk. This analysis attempts to quantify the fraction of Airbus’ order book that would be eligible for ASC 606 adjustments.

At the level of the single or twin-aisle market, the adjustments do not materially alter the market share picture. Those adjustments marginally improve the position of the dominant OEM in that market segment: Airbus on single-aisle, Boeing on twin-aisle.

ASC 606 adjustments affect some programs more than others. The A330neo program appears particularly vulnerable. Airbus needs to clean-up its A320ceo and A330neo backlog.

Boeing has been more affected than Airbus by adjustments on its major single-aisle program. However, the balance could quickly change should a major customer enter administration. Several customers placed substantial single-aisle orders.

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