WSJ: Boeing Shares Fall on Accounting Probe Report

The SEC is said to be investigating accounting methods on two jetliner programs

By: Jon Ostrower and Doug Cameron; Updated Feb. 11, 2016 7:34 p.m. ET

Boeing Co. shares fell sharply Thursday as fresh concerns about the company’s accounting
method for its jetliners added to investor anxiety about the outlook for the commercial-aircraft
market. The world’s largest aerospace company long has employed a system called program
accounting that averages out expected costs and revenue on airplane programs over years of
production, enabling it to book anticipated future profits as part of current earnings. The
system is compliant with Generally Accepted Accounting Principles but rarely used by other
companies, and some investors and shareholders have raised concerns that it builds long-term
assumptions into Boeing’s financial reporting about factors that are too uncertain.

Attention to the accounting method renewed on Thursday after a report that the Securities and
Exchange Commission is investigating whether Boeing properly accounted for the long-term
costs and expected sales of two of its most prominent jet programs—the 787 Dreamliner and
the 747 aircraft. The report, by Bloomberg News, which cited people with knowledge of the
matter, said SEC enforcement officials hadn’t reached conclusions and could decide against
bringing a case. Boeing and the SEC declined to comment. “We typically do not comment on
media inquiries of this nature,” said John Dern, a Boeing spokesman.

Boeing shares ended down 6.8% in Thursday trading—after recovering from much steeper
declines—to their lowest closing price since September 2013. The stock is down 25% this year
on concerns that years of record jet deliveries may be petering out due to strong competition
and global economic weakness. Boeing declined Thursday to comment on its accounting
methods. In the past, Boeing has said that program accounting, which it has used for decades, is
critical to avoiding big swings in earnings that could make it difficult to pursue projects that can
stretch over years but require huge outlays up front. Several analysts on Thursday called the
stock selloff overblown, saying that even if Boeing had to change its accounting practices the
likely impact on its cash flow would be small. However, accounting method aside, if Boeing’s
cost-saving projections fall short, then it won’t meet cash-generation goals, eagerly awaited by
investors.

Program accounting requires Boeing to estimate cost levels, sales volumes, and anticipated
productivity improvements and pricing for jets that might be made years in the future. Some
analysts and investors have said that the difficulty of predicting such long-term factors could
make such accounting conclusions arbitrary.

From the Dreamliner’s start, Boeing has had to spend more producing each of the
technologically advanced, fuel-efficient jets than it gets selling them. Boeing tallies the
accumulated shortfall as “deferred production costs.” For the Dreamliner, that tally grew to
$28.5 billion as of the fourth quarter after delivery of more than 350 of the aircraft since 2011.

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Boeing expects to erase that deficit over time because costs for making jets generally drop as
manufacturers scale up output and learn to produce more efficiently. The company said last
month that it expects to start making money on a unit basis on each 787 delivery later this year.
Those record costs mean Boeing must average $30.4 million in profit per plane on its
outstanding order backlog, all before it expects to recover another $8.7 billion on 158 jets it
hasn’t yet sold, according to its SEC filings. Some analysts are concerned that the pace of cost
reduction has fallen short. Boeing’s cost-cutting to date is more in line with its recent jetliner
programs, such as its 777, not a more aggressive decline required to recover its costs, said UBS
analyst David Strauss.

Credit Suisse analyst Rob Spingarn in a December investor note wrote that Boeing “may be
overly optimistic” about its ability to recover all of its deferred costs, potentially falling short by
an estimated $7.5 billion over its next nearly 1,000 deliveries. Boeing in 2002 paid $92.5 million
to settle a class-action suit alleging it manipulated program accounting on the 777 jet to shield
the timing of cost overruns and production problems five years earlier, according to court
documents. The company didn’t admit wrongdoing.

Jeff Wilks, director of the School of Accountancy at Brigham Young University, said program
accounting “was trying to recognize how perverse that reporting would be” if the huge initial
costs of production were reflected in a company’s earnings. The risk, he said, could come if a
company “didn’t foreshadow or give a good sense of its expectations” for what it costs and
revenues would be.

Few other companies use program accounting. Rival Airbus accounts for its jet programs
differently, using International Financial Reporting Standards, booking cost overruns as they
occur rather than trying to amortize them over the life of future aircraft production. Airbus took
repeated hits to earnings during the development of the A380 superjumbo as the plane’s
development and production costs grew. Airbus last year began delivering the first A380 jets
that no longer lose money.

Boeing has adjusted its expectations for the Dreamliner several times. It initially set the
accounting block—the number of planes over which it averages costs and revenue—at 1,100
aircraft, already far larger than it has for earlier programs. It raised that in 2013 to 1,300 aircraft
when it announced plans to boost output, amounting to about a decade of planned production.
Boeing said those estimates were driven by forecast demand for the jet.

The gap between accounting methods can be sizable. Boeing says that earnings from
operations in its commercial airplanes segment last year would have been $2.67 billion on a
unit-cost accounting basis, compared with the $5.16 billion it reported using program
accounting. In 2014, unit accounting would have created a $122 million loss, compared with the
$6.41 billion operating profit Boeing reported.
—Robert Wall and Aruna Viswanatha contributed to this article.
Write to Doug Cameron at doug.cameron@wsj.com and Jon Ostrower at jon.ostrower@wsj.com

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