Financial Accounting Depreciation at Delta Airlines & Singapore Airlines (Solution to Case #2) 24th November, 2009 1. Calculate the annual depreciation expense that Delta and Singapore would record for each $100 gross value of aircraft. a. Delta: i. Prior to July 1, 1986 the Delta airline assets were depreciated using Straight Line Method at 10% for 10 years for a salvage value of 10%. Depreciation Expense = (Cost of Asset – Salvage Value) / number of year Depreciation Expense = (100. 00 – 10. 00) / 10 = 9 dollars for every 100 dollars of airline equipment i. From July 1, 1986 to March 31, 1993 the depreciation was Straight line at 10% for 15 years for a salvage value of 10%. Therefore Depreciation Expense = (Cost of Asset – Salvage Value) / number of year Depreciation Expense = (100. 00 – 10. 00) / 15= 6 dollars for every 100 dollars of airline equipment iii. After April 1, 1993 depreciation was at 5% salvage value for 20 years Depreciation Expense = (Cost of Asset – Salvage Value) / number of year Depreciation Expense = (100. 00 – 5. 00) / 20 = 4. 5 dollars for every 100 dollars of airline equipment b. Singapore: i. Prior to April1, 1989 – Depreciation was at 10% salvage value for 8 years Depreciation Expense = (Cost of Asset – Salvage Value) / number of year Depreciation Expense = (100. 00 – 10. 00) / 8 = 11. 25 dollars for every 100 dollars of airline equipment ii. After to April1, 1989 – Depreciation was at 20% residual value for 10 years Depreciation Expense = (Cost of Asset – Salvage Value) / number of year Depreciation Expense = (100. 0 – 20. 00) / 10 = 8 dollars for every 100 dollars of airline equipment [pic] 2. Are the differences in the ways the two airlines account for depreciation expense significant? Why would the companies depreciate aircraft using different depreciable lives and salvage values? What reasons could be given to support these differences? Is different treatment proper? We can create an analytical model looking at the above assumptions and calculations. The range between the depreciation of Delta and Singapore airlines is 4. 5 – 11. 25, which is a vast difference even though both are using a similar method of depreciation, that of straight line method. Keeping in mind the airline industry the way of depreciation is very important as the value may rise to billions of dollars. We can see in this case that both the airlines have a very different approach to depreciation. The average life calculated by Delta for its airline equipment 15-20 yrs with a low salvage value whereas for Singapore Airline is 8-10 years with a high salvage value.
While delta over the years increases the useful life and decreases the salvage value of its assets and thereby reducing the depreciation expense, Singapore airlines charges a very high depreciation and over a period of time increases the salvage value and the useful life estimates. As a result of these, the Depreciation expense to total operating expense ratio for Delta (average depreciation expense from 1989 to 1993 is 5. 3%) is much lower than Singapore airlines (average depreciation expense from 1989 to 1993 is 14. %) Companies would depreciate aircraft values depending on the following factors 1. The nature of the technology employed: – Technologically newer aircraft probably last longer than earlier, technologically less advanced aircraft. According to the exhibit3 and exhibit7, we can see that Singapore has more of the Boeing 747-400, but Delta doesn’t have any 747-400s. 2. The specific use that aircraft is given: – The case indicates that Singapore is a much longer-haul carrier than Delta.
The average passenger trip length for Delta is about 900 miles, whereas the average passenger trip length for Singapore is about 2700 miles. 3. Maintenance: – The better maintained aircraft are, the longer they are likely to last. Due to the existing maintenance standards for aircrafts we can assume that major airlines like Delta and Singapore both have good maintenance programs. Every company has their own way to depreciate fixed assets based on their requirements and situations. The main reason for such a difference in strategies is showing the amount of profit in a particular period.
In case of Delta they have increased the life of an asset showing low depreciation which leads to low operating expense resulting in higher profits. However for Singapore airline the operating profit is good and there is not much need to show lower depreciation, moreover it adds on to their value by showing a higher salvage value for the equipments they carry. The difference is policies if proper as the useful life of the asset and the salvage value largely depend the experience that the organization has in the field and usage of the equipment.
In this case we can clearly see that Singapore airlines have a much smaller operation level than delta. 3. 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? How much more or less will its annual depreciation expense be compared to what it would be were it using Singapore’s depreciation assumptions? |Delta Airlines |1993 | |Value of Owned Aircraft $9,043. 00 | |Value of Leased Aircraft |$ 173. 00 | |Total Value of Aircraft |$9,216. 00 | Looking at the equation we did in question 1. We worked out that the depreciation per $ 100 prior to 1993 was $ 6. 00. After the change in policy the depreciation per $ 100 changed to $4. 75. Looking at this we can we can say that there has been a difference of 20% on the depreciation expense.
Hence the depreciation after changing the policy will be as follows: – = Accumulated Depreciation of 1993 – 20%(Accumulated depreciation of 1993) = $ 3559. 00 – $ 711. 80 = $ 2847. 20mn We also worked out that the depreciation expense of Singapore airlines per $100 during 1993 was $ 8. 00. This shows that there is an increase of 33. 33% to the accumulated depreciation. Hence if the policy of Singapore Airlines is followed the accumulated depreciation will be = Accumulated Depreciation of 1993 + 33. 33%(Accumulated depreciation of 1993) = $ 3559. 0 – $ 1186. 20 = $ 4745. 20mn Assuming Delta airlines calculates depreciation like Singapore Airlines; it will be accumulating higher depreciation on the flight equipment. 4. 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? The operation expenses of Singapore Airlines are less compared to Delta Airlines. Hence there is less need for Singapore to have a small rate of depreciation.
Moreover there is always a possibility that Singapore Air can cover the high amount of depreciation in future. By recording a high amount of depreciation and for lower years can mean that the asset can be sold at a price higher than the salvage value. It is evident in case Singapore airlines has done that and has made a significant amount of gain by sales of flight equipment. Moreover if Singapore airlines decide to continue with the fleet and not sell it, they will have to keep a very less provision for depreciation for the asset in the future.
This can be a very useful strategy for Singapore airline, enabling to upgrade their assets a smaller cycle. This will help them in marketing, lower maintenance and better customer satisfaction. 5. 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? The average age Delta is 8. 8 yrs and Singapore is 5. 1 yrs Assuming Delta and Singapore airlines buy aircraft at the same price and at the same time. Price of Aircraft $100000 Depreciation for Delta Airlines with their policy post 1993
Depreciation= (100000-5000) / 20 Depreciation / yr= $4750 / yr Avg. Total life of aircraft = 8. 8 yrs Hence total depreciation recorded by Delta air is $4750*8. 8 =$41800 Depreciation for Singapore Airlines with their policy post 1993 Depreciation= (100000-20000) / 10 Depreciation / yr= $8000 / yr Avg. Total life of aircraft = 5. 1 yrs Hence total depreciation recorded by Singapore air is $8000*5. 1 =$40800. We can conclude by saying that Delta Airlines accounts for a higher depreciation as the average life of their aircrafts is longer.