Download - 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