delta singapore

Depreciation at Delta Air Lines and Singapore Airlines

Kendra Yates

ACCT 5401.001

September 19, 2006

Overview

Understanding Terms

Methods of Depreciation

Depreciation Process

Depreciation Effect

Asset Disposal

Case Background

Case Questions

Understanding Terms

For a fixed asset: Depreciation:

“the process by which a company allocates an asset’s cost over the duration of its useful life” … investopedia.com

basically: initial cost is spread over its useful life

“the amount of expense matched with revenues”4

Understanding Terms

For a natural resource: Depletion

For an intangible asset: Amortization

Understanding Terms

Fixed Asset: “asset that provide benefits over several

periods” 4

“tangible assets that are long-term or relatively permanent assets” 5

Example: Property, Plant and Equipment or PP&E

Understanding Terms

Need to know before depreciation calculated for fixed asset: 1

acquisition cost salvage value expected useful life depreciation method

Understanding Terms

Acquisition cost: Acquisition Cost = Purchase Price + Cost to Prepare for Use

Salvage value (or residual value): estimated when begin use of asset 5

estimated worth at end of useful life 6

Salvage value = Expected Selling Price – Any Removal Costs

Expected useful life: “period over which services are expected to be

rendered by an asset” 3

Understanding Terms

Depreciable cost: 4

matched to periods when asset generates revenue

should resemble asset value decline based on historical cost

Depreciable Cost = Acquisition Cost – Salvage Value

Methods of Depreciation

Most commonly used: Straight Line

Others: Declining Balance (or accelerated) Sum-Of-Years’ Digits

Methods of Depreciation

Straight Line: used by most US businesses

cost equally divided over useful life

Annual Depreciation Expense = (Acquisition Cost – Salvage Value)/ Expected Useful Life

Straight Line Depreciation

[Cost] [Salvage Value]

$2000 $50

5 years

Annual Depreciation Expense = ($2000-$50) 5 years

= $390/yearTotal Depreciation Expense = $1500

Methods of Depreciation

Declining Balance: 7

large amount of depreciation expense recognized in early years

theory: asset most productive early on

constant depreciation rate per year, not depreciation value

salvage value not considered in depreciation rate 5

Annual Depreciation Expense = Value of Asset * Rate

Declining Balance Depreciation

3 Types: 7

Double Declining Balance: depreciation rate = (200/N)%

Depreciation Rate = (150/N)%

Single Declining Balance: Depreciation rate = (100/N)%

Double Declining Balance

Cost = $200 0

Useful Life = 5 years

Depreciation Rate = (200/N)% = 40%

Year Beginning value Depreciation Expense Ending Value1 $2,000 $800 $1,2002 $1,200 480 7203 $720 288 4324 $432 173 2595 $259 104 156

Total $1,844

Declining Balance

Cost = $2000

Useful Life = 5 years

Depreciation Rate = (150/N)% = 30%

Single Declining Balance

Cost = $200

Useful Life = 5 years

Depreciation Rate = (100/N)% = 20%

Year Beginning value Depreciation Expense Ending Value1 $2,000 $400 $1,6002 $1,600 $320 1,2803 $1,280 $256 1,0244 $1,024 $205 8195 $819 $164 655

Total $1,345

Sum-Of-Years’ Digits

does not have constant depreciation expense or rate 5

similar to declining balance

Depreciation rate = # of remaining useful life years

sum of digits of useful life years

Sum-Of-Years’ Digits

Cost = $200

Useful Life = 5 years

Depreciation rate = # of remaining useful life years

5 + 4 + 3 + 2 + 1 (or 15)

Year Beginning value Depreciation Rate Depreciation Expense Ending Value1 $2,000 [5/15] $667 $1,3332 $1,333 [4/15] $356 9783 $978 [3/15] $196 7824 $782 [2/15] $104 6785 $678 [1/15] $45 633

Total $1,367

Depreciation Process

Asset purchased & used over useful life

Acquisition cost appears as use of cash on cash flow statement

Value of asset seen on balance sheet

Expense not initially seen on income statement

Each year of useful life, depreciation expense seen on income statement 2

Depreciation Effect

Simplicity of application

Expense

Net Income on income statement

Taxes

Company’s reported earnings

Investment interest

DOESN’T EFFECT CASH FLOW

Asset Disposal

Disposal: can occur before or after the end of

expected useful life

Reasons for disposal: asset no longer useful technology has made asset outdated maintenance & repair costs high

Asset Disposal

Book value: 3

value to replace the asset in current condition

represents what person is willing to pay for asset

Book Value = (Acquisition Cost – Salvage Value) – (Annual Depreciation * age)

Asset Disposal

Gain: Sales Price > Book Value example:

sold truck for $12,000, book value = $10,000$12,000 – 10,000 = $2,000 gain

Loss: Sale Price < Book Value example:

sold truck for $12,000, book value = $14,000$12,000 - $14,000 = $2,000 loss

Case Background

PP&E of airlines: more than 50% of total assets

Depreciation: major operating expense

Depreciation of PP&E: methods & estimates can vary significantly

flights to 161 cities + 33 foreign countries 3rd largest US airline [operating revenue] largest [# of airline departures & passengers carried]

Expanding international operations: 1990: partnership w/ Singapore 1991: purchased Pan am transatlantic route 1993: large ↑ in international flight revenue

Delta Air Lines

History effects: 1978: deregulation ↑ price competition 1980-1990:

fares didn’t keep up w/ inflation Kuwait invasion: ↓ in travel & ↑ fuel prices Economy recession Intense price competition

1990-1993: American airline industry lost $12.8 billion

flights to 70 cities in 40 countries largest private-sector employer in

Singapore 7th largest ranked among US airlines

International operations: large travel in Asia nonstop flights to London transatlantic & pacific flights to US

Singapore Airlines

more profitable then American airlines at the time

½ of common stock owned by government pressure from international competition &

investors

History effects: 1993:

net profit dropped $103 million [US $] staff bonuses reduced expansion continued

Property, Plant, & Equipment

Average Age of Aircraft:

* no connection b/w age & depreciable life assumption

Airline Age [years]Singapore 5.1Delta 8.8American 8.9United 10.8Continental 15.3TWA 18.7

Property, Plant, & Equipment

Number of Aircraft:

Delta SingaporeOwned 296 57Leased 268 0Total 564 57

Case Question #1(A)

Delta Air Lines: Straight line

Example:Annual Depreciation = ($100 - $10)/10 = $9/yr

Acquisition Cost Salvage Value Useful Life Annual DepreciationPrior to 7/1/86 $100 $10 10 $9/year7/1/86 - 4/1/93 $100 $10 15 $6/yearfollowing 4/1/93 $100 $5 20 $4.75/year

Case Question #1(B)

Singapore Airlines: Straight line

Acquisition Cost Salvage Value Useful Life Annual DepreciationPrior to 4/1/89 $100 $10 8 $11.25/yearfollowing 4/1/89 $100 $20 10 $8/year

Case Question #1(B)

Singapore Airlines: Used aircraft < 5 years old

Used aircraft > 5 years old

Annual Depr. = (100 – 20)/ 5 = $16/year

Years Old Acquisition Cost Salvage Value Useful Life (10 - Age) Annual Depreciation (per yr.)1 $100 $20 10 9 $8.892 $100 $20 10 8 $10.003 $100 $20 10 7 $11.434 $100 $20 10 6 $13.33

Case Question #2

Differences in finding annual depreciation: Differences in assumption of:

useful life salvage values

1993 Annual Depreciation: Singapore almost 2X that of Delta

* Significant b/w Delta & Singapore *

Case Question #2

Use of different depreciable lives & salvage values:

↑ Useful Life or ↑ Salvage Value:

= ↓ Expense/year = ↑ Net Income = ↑ Taxes

What is effect on gain or loss at disposal time?

Case Question #2

Reasons to support these differences ↑ Net Income: attracts new investors

↓ Net Income: decreases taxes, pleases smarter investors

Is different treatment proper: IT DEPENDS Legal to change methods How you want the books to look?

Case Question #3

Average flight equipment value: Delta Air Lines:

owned = $9043/296 = $30.6 million

Acquisition Cost Salvage Value Useful Life Annual Depreciation(million) (million/year)

prior to 4/1/93 $31 $3 15 $1.83following 4/1/93 $31 $2 20 $1.45Singapore $31 $6.11 10 $2.44

0.38

0.99WHY IS THIS IMPORTANT?

Case Question #4

Singapore maintains different depreciation assumptions from Delta

By doing this: ↑ Depreciation Expense = ↓ Net Income = ↓ Taxes Gains: smarter investors (followed by 20 analysts) Loses: uninformed investors

Company’s overall strategy: Doesn’t attract spur-of-the-moment investors Targets more knowledgeable investors

Case Question #5

Impact of average age of aircraft on amount of depreciation recorded: Delta:

NO doesn’t effect annual expense will effect gain/loss at disposal

Singapore: YES, calculates annual depreciation slightly

different for old & new planes will not greatly effect gain/loss at disposal (more

accurate)

Conclusion

Who is more correct? No right or wrong method

Does it matter in the end? Not really

Do you have any questions?

Sources

1. http://ocw.mit.edu/NR/rdonlyres/Sloan-School-of-Management/15- 515Fall2003/72DC3EDE-358F-44CA-A706-0F2AD5D22E8B/0/lec7.pdf#search=%22how%20does%20depreciation%20effect%20net%20income%22

2. http://www.oreillynet.com/pub/a/network/2004/07/23/onlineinvestinghacks.html?page=2

3. http://www.uh.edu/mapp/03/030305.htm

4. “Accounting for Managers” by William J. Bruns, Jr.

5. “Accounting” 12th Edition by Warren Reeve Fess

6. www.investopedia.com

7.http://support.sas.com/rnd/app/da/new/801ce/ets/chap11/sect9.htm

8. http://www.aicpa.org/PUBS/jofa/mar2002/meeting.htm