Problem-Solution Proposal
A PROPOSAL FOR
Increased Profitability by
Resolving Unclear Accounting Methods
Prepared for Dennis Muilenburg
Chief Executive Officer, The Boeing Company
By Roshani Dabadi
Business Major at San Francisco University -- Concentration in Accounting
March 30, 2017
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Transmittal Letter Roshani Dabadi 1728 Liberty St. El Cerrito, CA 94530 Dennis Muilenburg Chief Executive Officer Boeing Capital Corporation 100 N. Riverside Plaza Chicago, Illinois 60606 Dear Mr. Muilenburg, I hold Boeing in a very high regard since it is a unique company with high market potentials and source of pride for our national economy. Through my thorough research of Boeing’s stock market history, I have created this proposal to solve the problem of program accounting causing unpredictable drops in the company’s market prices and driving away its potential investors. While middle-income investors have the highest stake in this problem, program accounting also impedes Boeing’s capital growth and market standing. Boeing’s share value has dropped to its lowest in the stock market due to the multiple probes by the U.S. Securities and Commission for program accounting’s overestimated income projections and sudden bookings of loss. To protect the company from losing its name and to re-establish the company’s market position, Boeing should restore unquestionable clarity in its financial statements by changing the method to unit-cost accounting. The benefits of unit-cost accounting far outweigh the current accounting method. They include a stable market standing, more investors’ returns, increased capital with higher revenues, better understanding of the company’s financial transactions, better control over the company’s expenses and last but not the least, higher esteem among the public for up-keeping transparency. Thank you for your consideration and I hope that we can meet to discuss the benefits of changing Boeing’s accounting to unit-cost method and the increased market opportunities it will bring to the company. Sincerely, Roshani Dabadi
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Table of Contents Executive Summary 4
Introduction 5
Problem/Need Statement Analysis 6
Solution Analysis 10
Work Plan 12
Budget/Cost Analysis 13
Evaluation 14
Conclusion 15
References 16
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Executive Summary
Boeing is losing investors because the method Boeing uses to record its profits and costs is inaccurate and, at times, dishonest. To solve this problem, Boeing should switch back to the conventional method, unit-cost accounting for an improved and clear financial disclosure. The proposed work plan will take about seven months starting June 2017, when the company finishes its second quarterly report for this year. The estimated cost of the project from beginning to the end while keeping the costs at their minimum is roughly $822,400. It will prove to be a worthy investment for the company’s betterment in the long run and the market potentials the change will bring.
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Introduction
Boeing is losing out on investors and its market share prices due to its current accounting method. To alleviate market volatility and uncertainty among investors, Boeing should adopt a clear accounting method, unit-cost accounting. By adopting unit-cost accounting, Boeing can maintain transparency, restore people’s faith in the company, grow the company’s capital and reclaim its position in the market as the strongest and most reliable aerospace company.
Contact Information: Roshani Dabadi rdabadi@sfsu.edu 1728 Liberty St El Cerrito, CA 94530 (510) 407-7149 Written for: Dennis Muilenburg Chief Executive Officer Boeing Capital Corporation 100 N. Riverside Plaza Chicago, Illinois 60606 Written on: March 30, 2017 Effective Start Date for Work Plan: June 01, 2017
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Problem/Need Statement and Analysis
The Problem: Program accounting has driven Boeing into accounting practices that obscure the actual productions costs of their projects and mislead the investors. For instance, the loss incurred on each plane the company makes does not show up on the quarterly balance sheets at all (Ausick 2016). It is tough to make reasonable judgment calls for the investors of Boeing when the company only makes estimates of their production costs instead of booking its costs as they occur. When the company makes a cost estimate of the entire project and then divides the cost evenly throughout all the planes assigned to that time frame, the result is an exaggerated amount of company profits. That misrepresents the company’s financial handlings and causes inaccurate economic forecasts. As per Ausick (2016), earnings from operations in 2015 under the program accounting method totaled $5.157 billion. Under the unit cost method, earnings from operations would have totaled $2.669 billion. The earnings are nearly doubled by the program accounting method even though the actual earnings are half of that amount. For investors, that appears deceptive, making it impossible for anyone to gauge the business accurately with such inconsistencies. Boeing’s 787 Dreamliner project had significant delays due to raw materials, electric systems and complex supply chain. Even though the company had to bear heavy losses, Boeing reported a small profit on each plane sold. The company records a loss only when the program reaches a point where earnings would not cover the losses incurred. When the sunk costs exceed the estimated profits before the completion of the project, the company will have to file for a loss. The sudden drop in stock values causes turmoil in the stock market and investors to lose their hard-earned money, thus, risking the company’s credibility as well. As Bryant (2016) states in Chicago Business, Boeing has accrued $28.5 billion in "deferred production costs" on the 787, plus $3.9 billion in unamortized tooling and other costs, bringing the total to more than $32 billion. To make it worse, the number actually underestimates Boeing's total losses on the 787 program because the company also spent billions of dollars on R&D prior to the plane's launch. When the company spreads out its profits on a plane-by-plane basis and estimates the profits they would accrue in years to come, it renders the total estimated profits deceptive of the current status of the company. This kind of confusing accounting causes unnatural market volatility that puts investors at a high risk of losing money, which will eventually result in the company losing its standing in the market.
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The misrepresentation of profits and losses has caused the U.S. Securities and Exchange Commission to scrutinize Boeing’s accounting method as well. Every the S.E.C. probes a company, it hurts the company’s stock values and market reputation. If Boeing continues using program accounting to make its financial estimates, the company will face many such investigations in future and that makes the company’s market standing even more uncertain.
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Who/What the Problem Affects: Professionals and laypersons dabbling in stock investments are both affected adversely by market volatility caused by program accounting. According to Markman (2014), middle class households have the highest contribution in the stock market. Losing confidence in the stock market can drive the middle- income families completely out of the market because they are already more risk averse and the market volatility shakes their faith in the system even more. (Kurtzleben, 2012) People buy shares or invest because they find the company doing well as per its profit reports. A sudden report of a financial loss by the company or sudden fluctuations in the share prices negatively affect many investors’ lives. Given that Boeing is a top producer of commercial aircraft and deals with a wide variety of jetliners designed to meet the needs of millions of passengers worldwide, the company’s accounting choices undoubtedly have many repercussions on people’s lives apart from the investment side of it. Its market success plays an important role in supporting aerospace jobs across its supply chain and across the United States. In 2015 alone, Boeing paid nearly $50 billion to more than 13,600 businesses, supporting an additional 1.5 million supplier-related jobs in the United States. (Boeing, 2015) If Boeing does not do well as a company, that eventually means less market for its suppliers and for the workers at Boeing as well. In addition to that, Boeing itself has a high stake in the problem because through the stock market, publicly traded companies raise money for its growth and development. Since Boeing has been publicly traded for years now, it must maintain a positive trend in its share values. Increasing the company’s capital is only possible through proper planning for costs and budgeting that builds a clear understanding of its future and attracts investors. When program accounting keeps leaving the investors in the lurch, it will impede the growth of capital. Program accounting is subject to frequent SEC probes. Boeing comes under SEC’s radar due to its vague and highly uncertain cost estimates that are nearly immaterial for the readers of its financial statements. (Bomey, 2016) When Boeing keeps stirring up controversial investigations, it turns into national news, which puts the company’s credibility and reputation at risk. A company bears a heavy cost when a government branch fact-checks its financial disclosure because it indicates serious wrongdoing. That leads to analysts and rating agencies to rate the company down as well.
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Why a Solution is Necessary: Foggy financial reports are misleading investors and jeopardizing their hard- earned money that they invest hoping for a fair payback. When stock prices keep fluctuating unpredictably, investing money in company stocks becomes mere unpredictable betting. Investing in Boeing stocks should not be akin to making a bet in a casino. Misleading financial reports jeopardize the credibility of well-established investment logics and strategies of risk management and maximizing profits. Program accounting leaves a lot of room for forward-looking statements. The Form 10-K of Boeing (Boeing, 2016) states that forward-looking statements are based on expectations and assumptions that we believe to be reasonable when made, but that may not prove to be accurate. These statements are not guarantees and are subject to risks, uncertainties and changes in circumstances that are difficult to predict. While there is always an allowance for financial adjustments, Boeing relies on distant and uncertain estimates instead of selecting an accounting method that best communicates the critical details and economics of transactions. Boeing must get rid of the discrepancies between estimated and real income to ensure credibility of the financial reports. Boeing rivals, Bombardier and Airbus Group, use a different accounting system and report losses on new aircraft programs as they accrue. There are plenty of evidences that the rival European aerospace company, Airbus, is marching towards market domination as well. As per Topham (2016), Airbus now has 57% of the market overall by units ordered, with the 1,036 orders in 2015 making its cumulative order book total more than $1tn (£693bn), securing production for a decade to come. If Airbus continues to secure more orders over the coming years, it will leave Boeing far behind. If Boeing does not adopt financial clarity, there are only more SEC investigations and further drop in the company’s market shares in future. Boeing must rebuild the company’s competitive advantage by adopting a straightforward accounting method and thus, reclaim its strong foothold in the market and restore people’s faith in it.
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Solution Analysis Solution Description: Through the conventional unit accounting route, Boeing can reestablish trust in investors because it reflects honesty and ethical practice. The discrepancies between actual costs/profits and the estimated amounts caused by program accounting can only be closed by changing the way the company accounts for its costs and profits. The best solution for that is unit-cost accounting. It is much more convenient to record the company’s actual transactions instead of having two parallel budgets, the estimated budget and the actual budget. While functioning through unit-cost accounting, even if Boeing would take a hit in its profit margin during the initial setup of massive projects such as the Dreamliner or the 787 project, the company’s cash flow statements and the supplemental information it provides to investors on unit-cost method can deflect that issue. (Bryant, 2016) Boeing would also be able to track and control its costs instead of filing for a loss only after the costs have surpassed the earnings. Once Boeing adopts a clear way of presenting its financial transactions, the SEC will stop scrutinizing the company for possible foul play and deceptive practices. (Harris, 2016) All the information on the underlying financial transactions will be out there as they are happening. Once these SEC probes stop, the analysts and rating agencies will once again raise the company’s market position with positive ratings. A good reputation will earn investors’ faith in the company and raise its financial capital. Strategies to Accomplish the Desired Goals: The proposed solution would require starting the next year on a unit-by-unit basis after closing the last financial statement as it is. After careful research to identify corporate strengths and weaknesses, the following steps should be taken to carry out the solution successfully:
x Prepare detailed cash-flow statements to provide more clarity in financial disclosure for the current period.
x Hold company meetings to inform all the Boeing locations about initiating a change in the accounting method.
x Notify the IRS commissioners of the intent to change the accounting method.
x Strategic planning session in the beginning of the new fiscal year. x Prepare for a new accounting method by installing new software and
training the accountants/auditors to adjust to the new system. x Provide supplementary information with both short-term and long-term
financial goals of the company to investors and employees to clarify the confusions caused by program accounting’s vague reports.
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Foreseen Changes after Solution Is Accomplished: The change will be vital in re-establishing the company’s reputation. The SEC will stop placing the company under a scrutiny due to financial confusions. Making sure that nothing warrants such investigations will help to ensure stable share prices. After applying unit-cost accounting, the company will stay consistent in the stock market because there will be no reason for the SEC to fact-check the company for puzzling financial reports. Thus, Boeing will not be subject to sudden price drops in the stock market caused by investigations. As the company proves to be more bankable in the market, it will lead to more people wanting to buy company shares hoping for a positive return. An increase in the number of investors will help the company grow its capital, which will lead to an overall enhancement of the company. That capital can go towards improved amenities for employees or to any other facility that enriches the company. More revenues are always a desired outcome through various means and if it comes with better business ethics and agendas, it would shoot two goals at the same time. The transition to unit-cost accounting will also hone the competitive edge Boeing already has over the French-European company, Airbus. Since Airbus currently operates under unit-cost accounting, they have the advantage of financial clarity that Boeing does not. The competitive pressure Airbus causes to Boeing has compelled the company into cutting costs and laying off its employees in the process. Such measures to cut costs that hurt employees’ goodwill will not be necessary once Boeing switches to unit-cost accounting. The market ratings will also increase and the company will have more financial and human capital.
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Work Plan
DATE TASK RESOURCES PEOPLE
June 1, 2017
Hold company meetings in all the locations to inform the staff
about the implementation of the unit cost
accounting method
Multi-media sources, conference rooms, presenters, wages
Chief Executive Officer – 1 Executive Council of Commercial Airplanes – 17 President of Boeing Capital Corporation -1
July 1, 2017
Remove the existing software and install new
accounting software in the
company’s computing
devices
Software engineers, new devices to install
Software engineers - 10 Laborers/technicians to
install upgraded devices – 50
Chief Technology Officer - 1
August 1, 2017
Organize workshops in all the locations to
train the employees to use the new system
Handbooks/Guidelines, Wages
Executive Council of Commercial Airplanes – 17 Chief Technology Officer –
1
September 1, 2017
Hold collective meetings to educate the
employees more about the new method and its
benefits
Wages, Presenters Chief Financial Officer – 1
Executive Leaders - 10
December 1, 2017
Close the financial
statement of 2017 with clear reflections of
income/profits under unit-cost
accounting
Accountants, CFO, Computer programs
Certified Accountants – 10 Auditors – 10 Chief Financial Officer - 1
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Budget/Cost Analysis
Wages: (Bureau of Labor Statistics)
Title Average Wages Total Number of
Employees Estimated Total
Expense
Computer Technicians (IT
Staff) $ 50 per hour 50
$ 250,000 (estimated hours
for each technician =
100) Executive Council
of Commercial Airplanes
including the CFO
$ 2,000,000 per year
17 $ 34,000,000
Accountants $ 68,150 20 $ 1,363,000 Design: (Bureau of Labor Statistics)
Source of Funds: Boeing’s operating account will bear the expenses of technicians who will install the new programming software. It will also provide compensation to the software engineer who will design the new accounting program for all the Boeing computing devices. No extra funds will be required from the company’s operating account to compensate the executive council because they are already a part of Boeing. Cost benefit analysis for implementing the objectives (Balakrishnan, 2016):
Total Estimated Cost $ 1,721,000 Total Expected Revenue (First Quarter) $ 25 Billion
Total Expected Revenue (Second Quarter) $ 31 Billion The revenues generated from investments will surpass the current amount and that will show in the first quarter itself. The revenues will continue increasing marginally as the company keeps building a record of investors’ goodwill with financial clarity.
Title Average Wages Total Number of
Employees Estimated Total
Expense
Software Engineer
$ 108,000 per year
A software engineer to design
the unit-cost accounting program for
Boeing
$ 108,000
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Evaluation Strengths:
x Increased goodwill and faith towards the company.
x Clarity in financial handlings and better market predictions.
x Strong market ratings from analysts.
Weaknesses:
x Confusions regarding the new fiscal year policy changes can crop up since the planes were ordered during the program accounting method.
x Cannot ascertain positive reactions from middle-income investors but it is anticipated.
Opportunities:
x Establishment of undeniable business ethics.
x Business dealings will be easier internationally since Europe is already accounting for its profits/costs in unit-cost method.
Threats:
x Large scale costs would look bigger on the financial statements.
x The market shares might not go up as predicted due to other circumstances beyond the company’s control.
Issues: If Boeing drops program accounting and takes up unit-cost method, executives are concerned that it would be competitively harmful for the company. (Ostrower, 2016) Also that the sudden change in the accounting method can throw off the budgeting that was created on the basis of program accounting. Since program accounting extends throughout the time frame assigned to a project, it would be challenging to reassign the total costs on a unit-by-unit basis. Contingency Plans: During the initial drop in the company’s profit margin while setting up the Dreamliner or the 787 project, the impact on the cash flow is anticipated to be small. The future earnings from the planes would also make up for the initial loss. (Ostrower, 2016) Some investors might get deterred by the initial hefty loss that shows in the records of unit-cost accounting system during the inception of projects. To assuage their investment anxieties, Boeing can organize conferences and group meetings by the executive council to supplement investors with Boeing’s financial information. Presenting the long- term potentials of Boeing projects and the lucrative investment paybacks can control that issue.
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Conclusion In conclusion, Boeing needs to change its accounting method because program accounting has been a liability to both the company and its investors. Unit-cost accounting will get rid of the inconsistencies caused by program accounting and rebuild Boeing’s financial and public standing.
As Boeing starts its accounting functions in a traditional unit-cost method, investors would grow curious because they would be able to zero down on the exact costs that the company bears for its projects. Middle-income investors would re-enter the market as they would not be feel hoodwinked by far-flung and distant forecasting of revenues by the company. Last but not the least, the traditional method will stop the U.S. Securities and Commissions’ enquiries.
Other benefits of switching to unit-cost method are a stable market standing, increased investors’ paybacks, increased capital for the company with higher revenues, ability to oversee and control the company’s expenses easily and last but not the least, respect among the public for unquestionably ethical business practice.
I am very much hopeful that you will consider my proposal to alleviate market instability by switching to unit-cost accounting. My proposal aims to enlarge the company’s capital through an optimistic outlook among investors and average Americans in general. The sooner we can transform the accounting method, the better it would be for the company and our economy that largely relies on middle-income households.
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References Ausick, P. (2016, Feb 11) SEC said to question Boeing accounting method,
shares dive 10%; Chatham: Newstex. Retrieved March 20, 2017 from https://www.search.proquest.com
Balakrishnan, A. (2016, April 27). Boeing misses earnings estimates; beats on
revenues. Retrieved March 29, 2017, from http://www.cnbc.com Boeing. (n.d.). Retrieved March 12, 2017, from http://www.boeing.com Bomey, N. (2016, February 11). Boeing stock plunges on report of SEC probe.
Retrieved March 29, 2017, from http://www.usatoday.com Bryant, C. (2016, April 14). “Boeing's $32 billion accounting question”. Chicago
Business. Retrieved March 29, 2017, from http://www.chicagobusiness.com Bureau of Labor Statistics. (2016, May). Retrieved March 25, 2017, from
United States Department of Labor website: http://www.bls.gov Forbes (2016, May). Market Cap as of May 2016. Retrieved March 29, 2017, from
https://www.forbes.com Harris, R. (2016, Feb 12). Boeing stock plunges on report of SEC accounting
probe. University Wire Retrieved March 08, 2017, from https://www.search.proquest.com
Jr. M. (2016, October 12). Boeing's Move into Program Accounting. Retrieved
March 06, 2017, from http://www.theconservativeincomeinvestor.com Kurtzleben, Danielle. (2012) "Study: Middle Class Is Risk-Averse When It Comes
to Investing". Retrived March 30, 2017, from https://www.usnews.com Markman, J. (2014). In stock ownership, middle class has upper hand. Oil and
Gas Investor This Week, 22(44), 1. Ostrower, J., & Cameron, D. (2016, Feb 12). Boeing shares drop on accounting
focus. Wall Street Journal Retrieved March 08, 2017, from https://www.search.proquest.com
Topham, G. (2016, January 12). Airbus Flies Past Boeing in Aircraft Orders. The
Guardian. Retrieved March 10, 2017 from https://www.theguardian.com