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Fraud and the lure of corporate estimates

What if a company could significantly improve its financial results, regardless of reality? That opportunity exists today. The fallout from the COVID pandemic has made financial estimates increasingly difficult to calculate and open to manipulation and fraud. Here’s why.

In 2020, American Airlines (AA) grounded hundreds of planes and relegated them to long-term storage in the Arizona desert as the largest airline in the U.S. responded to sinking demand in the wake of the COVID-19 pandemic. By the end of March 2021, the planes were still in storage and hadn’t earned revenue for over 12 months, which meant they’d need to be “impaired” (written down to their current value) as defined by the accounting standards.

At the end of 2020, AA impaired five asset groups — Airbus A330-200s and 300s, Boeing 757-200s and 767-300ERs, and Embraer E190s — totaling 150 planes and $1.5 billion in impairment. Many of those planes were in excellent condition and had several years of useful life before they’d normally be retired, but impairing the entire asset group satisfied accounting standards. AA planes in storage, in other asset groups (i.e., 737s), didn’t need to be impaired because under “group asset” accounting rules, the asset group they belonged to was still earning revenue that exceeded the total value of the asset group. While the “group” is earning revenue, there can be individual assets within the group that aren’t. The challenge is knowing where the tipping point lies, and for AA that involved assumptions about when planes would start transporting passengers again.

AA executives had estimated in the company’s 2020 annual report that they’d have all planes that weren’t impaired back in the air by summer of 2021. (See “American Airlines, 10K, for fiscal year ended December 31, 2020.”) But that didn’t happen. Another COVID variant hit, and staff refused to come back to work. Pilots “timed out” and couldn’t fly until they retrained. AA didn’t have enough flight crews to man the scheduled flights, resulting in thousands of canceled flights in 2021. (See “American Airlines Says Scheduling Problems Are Summer-Only Issue. Philly Pilots Say They Could Linger,” by Ted Reed, Forbes, June 26, 2021; “American Airlines cancels hundreds of flights amid staffing, maintenance issues,” by Mina Kaji and Sam Sweeney, ABC News, June 20, 2021; and “Airlines cancel more than 800 U.S. flights as Covid hits crews,” by Leslie Josephs, CNBC, updated Dec. 25, 2021.) Storing the planes caused other challenges. It turns out that it takes roughly 1,000 hours of maintenance to get a plane back into service. And planes in storage require significantly more maintenance than planes routinely flying. (See “How American Airlines pulls planes from pandemic storage,” by Gregory Wallace and Pete Muntean, CNN travel, April 12, 2021.)

Storage and maintenance cost increases, combined with revenue shortages, were only some of the challenges AA was facing that impacted its financials. AA also waived change fees for customers, reduced flights and flight plans and received a $4.75 billion cash infusion from the U.S. Treasury to help them stay afloat. (See “American Airlines Takes Strategic Action in Second Quarter to Prioritize Safety, Flexibility and Efficiency in Response to COVID‑19,” AA, July 23, 2020.)

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