Depreciation at Delta Air Lines and Singapore Airlines UAA – ACCT 650 - Seminar in Executive Uses...
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Transcript of Depreciation at Delta Air Lines and Singapore Airlines UAA – ACCT 650 - Seminar in Executive Uses...
Depreciation at Delta Air Lines and Singapore Airlines
UAA – ACCT 650 - Seminar in Executive Uses of Accounting Dr. Fred Barbee
5
Why study this case?
To “compare and contrast” depreciation assumptions from two airlines that . . .
Are in some ways alike, and
In other ways vastly different
6
Why Look at an Airline?
PP&E for airlines usually comprise greater than 50% of total assets.
Aircraft of one airline are substantially similar to aircraft of another airline (at least to the lay person).
Depreciation is not an attempt to establish the value of an asset.
Depreciation is not a measure of the decline in value of an asset.
11
Depreciation Defined
The process of allocating the cost of property, plant, and equipment as an expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.
DepreciationBEGINNING
ENDING
Life of the Asset
96 97 98 99 00 01 02 03 04 05
Depreciation is a process of allocation,
not valuation.
13
Cost
Allocation
AcquisitionCost
Balance Sheet Income Statement
Expense
Depreciation
Unused Used
An application of the matching principle.
14
Income
StatementDepreciation
Expense Depreciation for
the current year
Balance
SheetAccumulatedDepreciation Total depreciation to
date of balance sheet
Depreciation
16
Long-Term Assets
Have a useful life of more than one year.
Are acquired for use in the business.
Are not intended for resale to customers.
Are reported at carrying (book) value.
18
Management Issues
The cost of the asset must be measured.
The depreciable life of the asset must be estimated.
19
Management Issues
The salvage value of the asset at the end of its life must be estimated
A pattern for recognizing depreciation over the depreciable life of the asset must be selected.
Issues Related to Long-Lived Assets
Asset Service Potential
Acquisition DisposalUse in business operations
Time
Decline in future service benefits.
Book Value
Accounting Issues
Measuring Cost
Recording Disposals
Allocation of costAccounting For post
acquisition expenses.
Issues Related to Long-Lived Assets
Asset Service Potential
Acquisition DisposalUse in business operations
Time
Decline in future service benefits.
Book Value
Accounting Issues
Measuring Cost
Recording Disposals
Allocation of costAccounting For post
acquisition expenses.
Acquisition cost of Property, Plant, and Equipment
Fundamental Issue #1: What is the value of the asset?
24
Expected Benefit Approach
Recognizes that assets are valuable because of the future cash inflows they are expected to generate.
25
Focuses on the amount of resource expenditures required to acquire an asset.
Economic Sacrifices Approach
26
Measuring the Carrying Value of Long-Lived Assets
Expected Benefit Approaches
Discounted present value.
Net realizable value.
Economic Sacrifice Approaches
Historical cost less accumulated depreciation.
Replacement cost.
28
Hypothetical Case – A Truck
Original cost $100,000
Two years old, has remaining useful life of 8 years
No salvage value
Depreciated using straight-line
30
Discounted Present Value
Expected net operating cash inflows = $18,000 per year (assumed) for eight remaining years, discounted at a 10% (assumed) rate.
5.33493 x $18,000 = $96,029
31
Net Realizable Value
Current resale price from an over-the-road equipment listing (Purple Book) for the specific vehicle model.
$85,000 (Assumed)
33
Historical Cost
Historical Cost less Accumulated Depreciation
$100,000 – [(100,000/10 years) x 2 years] = $80,000
34
Replacement Cost
Replacement cost of a two-year-old vehicle in equivalent condition
$90,000 (assumed)
35
Possibilities
Discounted PV Approach $96,029
Net Realizable Value 85,000
Historical Cost (Less A/D) 80,000
Replacement Cost 90,000
36
Possibilities
Discounted PV Approach $96,029
Net Realizable Value 85,000
Historical Cost (Less A/D) 80,000
Replacement Cost 90,000
37
“Value” of Asset
“Cost” includes all reasonable and necessary expenditures incurred in:
Acquiring an operational asset;
Placing it in its operational setting; and
Preparing it for use;
Less any cash discounts allowed.
Acquisition cost of Property, Plant, and Equipment
Fundamental Issue #2: Allocating the Cost of an Asset?
39
Theoretical Justification
The matching principle requires the cost of an asset be charged to expense in the periods benefited.
The allocation process is called depreciation.
40
Revenue-Expense AssociationThe Matching Principle
Three principles govern the inclusion of an expense in the matching process:
Association of cause and effect
Systematic and rational allocation
Cost Flows in a Manufacturing FirmCost Flows in a Manufacturing Firm
DMDM
DLDL
MOHMOH
DM Inv.DM Inv.
WIP Inv.WIP Inv.
FG Inv.FG Inv.
WIPWIP
Manufacturing Costs
COGSCOGS
S&AS&A
Sales
-= Gross Margin
-Net Income=
Balance Sheet
Period Period CostsCosts
Income Statement
Pro
du
ct C
ost
sP
rod
uct
Co
sts
Unfinished
Finished
Sold
UsedUsed
Applied
Unused
Sale
42
Revenue-Expense AssociationThe Matching Principle
Three principles govern the inclusion of an expense in the matching process:
Association of cause and effect
Systematic and rational allocation
Immediate recognition
45
Factors in Computing Depreciation
The calculation of depreciation requires three amounts for each asset:
Cost
Useful life
Salvage value
46
Depreciation Methods Based on Time
Straight-Line
Accelerated
Sum-of-the-years’-digits
Declining Balance
48
Depreciation
If an asset is expected to benefit all periods equally,
a straight-line method of depreciation would be appropriate.
49
Depreciation
If more benefits are expected early in the life of an asset . . .
an accelerated method of depreciation would be appropriate.
50
Depreciation
If benefits are related to the output of an asset . . .
the units-of-production method of depreciation would be appropriate.
52
Types of Accounting Changes
Change in Accounting Principle
Change in Accounting Estimate
Change in Reporting Entity
Errors in Financial Statements
53
What Can Change?
Estimated Life
Estimated Salvage Value
Pattern of Depreciation
These are set at
acquisition
A change can be made if another method is
preferable.
55
Straight-Line Depreciation –The Rationale
Decline in service potential relates primarily to the passage of time.
Level of activity is important but use of asset is relatively constant.
Cost - Salvage Value
Useful life in years
Depreciation
Expense per Year=
Straight-Line Method
Appropriate if an asset is expected to benefit all periods equally.
Known Estimated
Estimated
On December 31, 2001, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated salvage value of $5,000.
Straight-Line Method
Depreciation Expense Per Year
=$50,000 - $5,000
5 Years
= $9,000
Depreciation Accumulated Accumulated UndepreciatedExpense Depreciation Depreciation Balance
Year (debit) (credit) Balance (book value)2001 50,000$ 2002 9,000$ 9,000$ 9,000$ 41,000 2003 9,000 9,000 18,000 32,000 2004 9,000 9,000 27,000 23,000 2005 9,000 9,000 36,000 14,000 2006 9,000 9,000 45,000 5,000
45,000$ 45,000$
Salvage Value
Depreciation Schedule
Straight-Line Method
Dep
reci
atio
n
Exp
ense
Depreciation Expense is
reported on the Income
Statement.
Book Value is reported on the Balance
Sheet.
Step 2:Double-declining-
balance rate= 2 ×
Straight-linedepreciation rate
Double-Declining-Balance Method
Step 1:Straight-line
depreciation rate=
100 % Useful life in periods
Step 3:Depreciation
expense=
Double-declining-balance rate
×Beginning period
book value
Double-Declining-Balance Method
Ignores salvage value.
A Constant Rate
A Declining Balance
65
Double-Declining-Balance Method
On December 31, 2001, equipment was purchased for $50,000 cash.
The equipment has an estimated useful life of 5 years and an estimated residual value of $5,000.
Calculate the depreciation expense for 2002 and 2003
Step 2:Double-declining-
balance rate= 2 × 20% = 40%
Step 3:Depreciation
expense= 40% × $50,000 = $20,000 (2002)
Step 1:Straight-line
depreciation rate=
100 % 5 years
= 20%
Double-Declining-Balance Method
67
2002 Depreciation: 40% × $50,000 = $20,000
2003 Depreciation: 40% × ($50,000 - $20,000) = $12,000
Double-Declining-Balance Method
Depreciation Accumulated UndepreciatedExpense Depreciation Balance
Year (debit) Balance (book value)2001 50,000$ 2002 20,000$ 20,000$ 30,000 2003 12,000 32,000 18,000 2004 7,200 39,200 10,800 2005 4,320 43,520 6,480 2006 2,592 46,112 3,888
46,112$
($50,000 – $43,520) × 40% = $2,592
Below salvage value
Double-Declining-Balance Method
Depreciation Accumulated UndepreciatedExpense Depreciation Balance
Year (debit) Balance (book value)2001 50,000$ 2002 20,000$ 20,000$ 30,000 2003 12,000 32,000 18,000 2004 7,200 39,200 10,800 2005 4,320 43,520 6,480 2006 1,480 45,000 5,000
45,000$
We usually have to force depreciation expense in thelatter years to an amount that brings BV to salvage value.
Double-Declining-Balance Method
Life in Years
An
nu
alD
epre
ciat
ion
$0
$5,000
$10,000
$15,000
$20,000
1 2 3 4 5
Double-Declining-Balance
Comparing Depreciation Methods
Life in Years
$0
$2,000
$4,000
$6,000
$8,000
$10,000
1 2 3 4 5
An
nu
alD
epre
ciat
ion
Straight-Line
Net property, plant, and equipment is the undepreciated cost (book value) of the plant assets.
Book value Market value
Reporting Depreciation
Property, plant, and equipment: Land and buildings 150,000$ Machinery and equipment 200,000 Office furniture and equipment 175,000 Land improvements 50,000 Total 575,000$ Less Accumulated depreciation (122,000) Net property, plant, and equipment 453,000$
Selecting an Appropriate Depreciation Method
What are the factors that should be considered in
selecting a depreciation
method?
76
Delta Air Lines
Third largest U.S. airline in 1993
$12 billion in annual revenues (almost $15 billion in 1999)
Served 161 cities in 44 states
Operated flights to 33 foreign countries.
77
Delta Air Lines
Losing money
Average age of aircraft 8.8 years (9.6 in 2000)
Changed depreciation assumptions in 1993
78
Delta Air Lines
Average passenger trip length was 969 miles in 1993.
Capacity utilization 62.3%
Long term debt was $3,717
80
Singapore Airlines
Largest private-sector employer in Singapore
Route network covered 70 cities in 40 countries
Total operating revenues in 1993 $5.1 billion (Singapore $)
81
Singapore Airlines
Average age of aircraft was 5.1 years
Profitable
Capacity utilization 71.3%
Average trip length 2,720 miles
No long-term debt
83
Comparison . . .
Calculate the annual depreciation expense that Delta and Singapore would record for each $100 gross value of aircraft.
Life (in Years)
Salvage Value
Depr. Exp Per $100
Singapore Airlines< 4/01/89 8 10% $11.25
> 4/01/89 10 20% 8.00
Delta Air Lines< 7/01/8610 10 10% $9.00
7/86 to 3/93 15 10% 6.00
> 4/01/93 20 5% 4.75
Life (in Years)
Salvage Value
Depr. Exp Per $100
Singapore Airlines< 4/01/89 8 10% $11.25
> 4/01/89 10 20% 8.00
Delta Air Lines< 7/01/8610 10 10% $9.00
7/86 to 3/93 15 10% 6.00
> 4/01/93 20 5% 4.75
88
Comparison . . .
Are the differences in the ways the two airlines account for depreciation expense significant?
Why would companies depreciate aircraft using different depreciable lives and salvage?
90
Comparison . . .
Why would companies depreciate aircraft using different depreciable lives and salvage values?
What reasons could be given to support these differences?
Is different treatment proper?
92
Useful Life - Factors
Technology
Singapore has newer aircraft
Aircraft Use
Frequent takeoffs and landings
Maintenance
Remember Valuejet?
95
Delta Air Lines
Assuming the average value of flight equipment that Delta had in 1993, how much of a difference do the depreciation assumptions it adopted on April 1, 1993 make?
96
Delta Air Lines
How much more or less will its annual depreciation expense be compared to what it would be were it using Singapore’s depreciation assumptions?
97
Look at Exhibit 2
1993 1992
Owned Aircraft $9,043 $8,354
Leased Aircraft 173 173
Gross Value of Aircraft $9,216 $8,527
Average Gross Value $8,872
Life (in Years)
Salvage Value
Depr. Exp Per $100
Singapore Airlines< 4/01/89 8 10% $11.25
> 4/01/89 10 20% 8.00
Delta Air Lines< 7/01/8610 10 10% $9.00
7/86 to 3/93 15 19% 6.00
> 4/01/93 20 5% 4.75
Look at Previous Delta Policies
Delta’s Previous
Policy
Delta’s Current Policy
Average Gross Value
Difference in Depreciation
101
Delta Vs. Singapore
There is yet another difference in the two airlines leading to a savings of Delta over Singapore on depreciation expense.
Historical cost basis; and
Age of the aircraft
102
Delta Vs. Singapore
Does the difference in the average age of Delta’s and Singapore’s aircraft fleets have any impact on the amount of depreciation expense they record?
If so, how much?
103
Look at the age of the aircraft
Age
Delta 8.8
Singapore 5.1
Difference in age 3.7
Assume a 3% - 4% annual inflation in the mid to late 80s.
Average Gross Value $8,872
3.5% Inflation x 3.7 Years 12.95%
Increased Value $1,150
Adjusted Gross Value $10,022
Increased Value
Singapore’s Rate
Additional Depreciation
105
Savings in depreciation expense due to more liberal assumptions
$288
Savings in depreciation due to older aircraft
92
Total savings Delta over Singapore
$380
Delta Vs. Singapore
106
Delta Vs. Singapore
Singapore Airlines maintains depreciation assumptions that are very different from Delta’s
What does it gain or lose by doing so?
How does this relate to the company’s overall strategy?
Compare Strategies
107
Singapore Airlines
1. Renowned for customer service
State-of-the-art aircraft
Capacity utilization = 71.3%
1993 Annual Report: “A superior product will probably enable us to sustain relatively high load factors.
108
Singapore Airlines
2. Long-haul Airline
Average passenger trip length in 1993 was 2,720 miles (Delta = 969)
Less wear and tear on aircraft – long trips are less stressful than frequent landings and takeoffs
109
Singapore Airlines
3. Gain on sale of aircraft
Average gain $134 million
Direct result of depreciation policies?
Result of corporate strategy
Depreciate fast resulting in low book values on disposal
110
Singapore Airlines
4. Owned Vs. Leased Aircraft
Singapore operates none of their aircraft under operating leases
Delta operates close to 50% of their aircraft under non-cancelable operating leases.