Terry H Jackson and Dr. Ted Christensen, Accounting and Information Systems
September 11, 2001 will be a day long remembered by Americans and for people around the world. The destruction to the World Trade Center and the Pentagon not only led to the loss of many lives, but these events also affected our economy in a dramatic way. Many industries have been affected by the terrorist attacks, but the industry that has been most directly affected is the airline industry. On the balance sheet, American Airlines and United Airlines only lost two used airplanes each. However, cancelled flights, a decrease in demand for flights, lawsuits, and increased security costs have lead to a substantial decrease in earnings across the industry.
Accounting standards dictate that events of this nature should be reported in companies’ income statements as an “extraordinary item.” This means that the costs associated with the attack should be reported after income from continuing operations or, in other words, as a “below the line” item. These below the line items tend to be ignored by investors and creditors because they do not reflect a company’s on-going performance. Since they are generally viewed as “onetime” events, interested parties generally focus on line items on an income statement that are “above the line” or relate to the continuing operations of the company.
Even though hijacked airplanes crashing into the World Trade Center or the Pentagon clearly meets the basic criteria of an extraordinary item, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (a private-sector group that determines Generally Accepted Accounting Principles in the US) decided to prohibit airlines from using extraordinary line item treatment for losses incurred in connection with the September 11 terrorist attacks.
In commenting on this decision, EITF Chairman Tim Lucas stated, “Because of the far-reaching effects of the September 11 events, coupled with a weakening economy that predated those events, it would be difficult to capture the resulting economic effects in companies’ financial statements. As one example, the events impacted airlines in multiple ways. Air carriers were unable to fly for two days, suffered the effects of rerouting and initiated layoffs in anticipation of lower passenger demand. No single line item can capture all of those effects. Other companies representing a broad range of industries are experiencing similar impacts” (FASB, 2001).
With the EITF’s decision regarding treatment of extraordinary line items, United and American were due to take a major hit in their third quarter financial statements. In addition, the decreased revenues of all airlines created a liquidity concern regarding air carrier’s ability to meet current financial obligations. To prevent a meltdown of the airline industry, President Bush signed into law the Air Transportation Safety and System Stabilization Act. The major purpose of this act was to provide $5 billion in government grants for direct and incremental costs resulting from the terrorist attacks, including lost revenues, recognized by airlines in the third quarter of 2001. American Airlines’ third quarter financial statements indicate that they suffered substantial losses. Passenger Revenues were $441 million lower than the five-year average for the third quarter and American suffered a $414 million quarterly loss. Also, American Airlines reported special charges totaling $632 million. Those special charges included a $496 million provision for aircraft impairments and groundings, a $61 million facility exit cost, employee charges of $55 million, and $20 million of other charges. One interesting fact is that American Airlines received $809 million from the stabilization act, $177 million more than their special charges related to the tragic event of September 11.
According to their financial statements, United Airlines suffered a $1.15 billion loss for the third quarter! Their operating revenues and net earnings were down $625 million and $1.476 billion respectively. United reported an even larger special charge under their operating expenses than American Airlines. Their $1.31 billion special charge was made up of many parts. This charge included $788 million allocated to aircraft groundings and impairments, $217 million to reduction of work force, $181 million to early termination fees, $107 million to discontinued capital projects, and $20 million to miscellaneous. Also, United reported an additional $49 million non-operating special charge from write-downs on certain non-operating equipment. Even though United had a larger special charge than American, United only received $391 million from the government. Differing from American Airlines, United recorded the $391 million stabilization grant as an “other income” line item.
During my research, I also examined the financial statements of other major airlines in the United States. Even though they lost no aircraft, other airlines suffered lost revenues from the decline in air traffic and from closed airports. Southwest Airlines was the only airline that was able to achieve a profit without receiving funds from the government grant. Southwest had a 10.1% increase in earnings compared to their five-year average.
What I have found very interesting from conducting this research is the magnitude of the impairments that these airlines are taking during this quarter. As mentioned above, the impairments from United and American total more than $1 billion in write-downs. I believe that the reason these impairments are so large is because of the government’s willingness to reimburse these impairment charges. This incentive motivated American Airlines to accelerate the retirement of its remaining 50 Boeing 727s (which it had scheduled to retire in January 2003), ground all McDonnell Douglas DC-9 aircraft by the end of October 2001, and immediately ground eight McDonnell Douglas MD-80 aircraft.
The motivation for these airlines to report large losses could also be attributed to the low earnings expectations of the public. The public expected each airline to have a miserable quarter. Expecting this reaction, made it easier for the airlines to choose to take such large special charges. An excellent example of this is Southwest Airlines. Totaling more than $150 million, Southwest Airlines reported the largest profit for the third quarter of 2001. However, Southwest reported a non-operating loss of $152 million from hedging fuel. Did Southwest choose to recognize this hedging loss in the third quarter on purpose? With such large profits compared to the rest of the airline industry, it appears that they were motivated to do so.
References
- FASB, 2001. FASB’s EITF Against Extraordinary Treatment for Terrorist Attack Costs. www.fasb.org/eitf/eitf91101.shtml. (Updated October 1, 2001)