Southwest Airlines. What types of budgets would you recommend for the company? Why?
Currently, the type of accounting standard that is being utilized by Southwest Airlines is Generally Accepted Accounting Principals (GAAP). This is the basic benchmark that has been implemented by many U.S. companies to more accurately account for: their budgets, expenses, assets and liabilities. Over the years, it has become common for most corporations to follow these different standards. ("2010 Annual Report," 2010) ("Generally Accepted Accounting Principles," 2011)
However, Southwest takes this process one step further by also including Pro Forma accounting standards as an alternate way of evaluating the company. This is when you are anticipating that certain events have occurred in the future and are listing them as revenues in the current quarter (such as: future earnings on a large contract that was signed). The idea with using this approach is to see how these revenues could have an impact on the company's overall bottom line. Once this occurs, it will provide investors with a more complete picture of the financial strength of the company. ("2010 Annual Report," 2010) ("Pro Forma," 2011)
That being said, there is room in both of these accounting standards for auditors to be able to manipulate numerous figures. In the airline industry this can be problematic, as it will have an impact on the ability of the company to adjust to changes that are taking place in the industry and with demand from customers. Over the course of time, this can force some of the strongest carriers to face financial challenges. ("Generally Accepted Accounting Principles," 2011) (Thomasette, 2007, pp. 48 -- 50)
A good example of this can be seen by looking no further than United Airlines. During the 1990's, the company was considered to be at the forefront of innovation and customer service. This is because, fuel prices were low and passenger traffic was strong. These factors helped the company to dramatically increase their earnings. However, beneath the surface accountants were engaging in practices to increase the company's revenues most notably: postponing future pension payments. The idea was that this would help the company to realize rising revenues, which will have a positive effect on the price of the stock. The problems began when the economy suddenly slowed in early 2000. Then, the airline was hit by rising fuel costs and the aftermath of the September 11th attacks. These elements made it difficult for United to fund their pension plan and keep up with the new realities in the industry (rising security costs). At which point, they would be forced into bankruptcy in order to: restructure their business model, balance sheets and labor agreements. This is significant because, it is showing how GAAP-based standards have a major drawback that are making it difficult to accurately value the company. (Thomasette, 2007, pp. 48 -- 50)
As a result, Southwest needs to begin utilizing a strategy that will embrace accounting principles that are more reflective of the changes that are taking place in the industry. Once this occurs, it will provide the greatest insights as to what budgetary practices should be utilized by the company. This will help them to more effectively adjust to changes inside the industry and to provide investors with more accurate information.
A New Strategy
The challenges that are being faced under GAAP principals have been an ongoing concern for sometime among a number of multinational corporations. This is because of: the different issues of possible irregularities and the dissimilarities of methodologies utilized in the United States. Over the course of time, this has led to efforts to create some kind of international standard called the International Financial Reporting Standards (IFRS). As, many of the European companies were following a different set of criterion known as: International Accounting Standards (IAS). This was a set of benchmarks for accounting that were first embraced by the EU in 1973. As technology / globalization began to improve, this had an effect on communication and collaboration among businesses around the world. This led to the development of IFRS standards (starting in 2001). As a part of an effort, to address shortfalls in GAAP and to provide accepted practices that is embraced around the world. ("U.S. GAAP vs. IFRS," 2009)
Similarities between GAAP and IFRS Standards
Over the last several years, the two standards are being integrated into one that is under IFRS guidelines. The reason why is because this methodology has a number of similarities to GAAP including: the balance sheet, income statement, the recognition of income / expenses, notes on the financial statement and both are prepared on accrual basis. These different elements are important, as they are illustrating how the two could easily be integrated into one another. ("U.S. GAAP vs. IFRS," 2009)
Differences between the Two Standards
The differences between the two standards are within the levels of specific guidance that is being provided with each. Some of the most notable include: dissimilarities in the required financial reporting periods and the classification of debt. ("U.S. GAAP vs. IFRS," 2009)
The required financial reporting period is the length of time that is used to report the various figures of the company. Under GAAP provisions, corporations are required to report transactions from their balance sheet for the last two years. However, with all other information, this can be provided at the end of a three-year time period. This is different from IFRS standards, which requires that all information must follow the same time frame. The dissimilarities between the two standards are significant, because it is illustrating some of the obvious disparities in the GAAP methodology. ("U.S. GAAP vs. IFRS," 2009)
The classification of debt is different between the two standards. With GAAP allowing for certain agreements to be waived, in the event that the lender agrees to: extend or modify the terms of loan. This would have to take place at least one year prior to any kind of exemptions on the financial statements that are being reported to the company. While, IFRS standards require that all of the information presented on the balance sheet is listed as current. This is important, because it is showing how the different benchmarks between the two can allow for disparities in the accuracy of information that is being reported. ("U.S. GAAP vs. IFRS," 2009)
If this standard could be utilized by Southwest, it will help to provide additional information about the underlying strengths and weaknesses facing the company. This will help the airline to supply more accurate earnings projections to shareholders. While at the same time, it will allow the company to adapt more effectively adapt to the challenges that are facing the industry. ("U.S. GAAP vs. IFRS," 2009)
As a result, the budgetary standard that is recommended for the airline is to begin following IFRS guidelines. The reason why, is because it can provide increased amounts of transparency. In the sector one of the biggest challenges that are facing a wide variety of carriers is the number changes that are occurring. This can happen, based on one single factor such as rising fuel prices or a variety of elements. To include: a combination of high fuel prices, slumping consumer demand and increased security costs. This is problematic for many companies, because it means that there is the possibility that their financial controls could prove to be ineffective. Over the course of time, this can cause managers to underestimate the risks facing the business until it is too late.
This is the point that they will want to make adjustments to their strategy, but are unable to do so. The reason why is due to the fact that GAAP principals allowed for earnings to be inflated (which will lead to downward revisions). Then, it makes it difficult to understand how certain events…