Professional Documents
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Learning Objectives
How to understand the component of a depreciation policy--cost, life, residual value, and pattern for reporting depreciation How to do the compare and contrast when the two airlines adopt significantly different accounting policy for depreciation of aircraft. How to do analysis in the economic context where each airline operates. Doing analysis should link accounting choices to financial reporting and business strategy.
Annual Depreciation Salvage Value for Expense Per $100 Gross Aircraft(% of cost) Value of Air Craft 10%
20%
8
10
$11.25(a)
$8.00(b)
10 15
10% 10%
$9.00(c) $6.00(d)
$4.75(e)
Financial Considerations
The recent financial performances of these two airlines are dramatically different. Delta lost $1.2 billion from 1991 to 1993. Meanwhile Singapore remains profitable in the same period and made $1.6 billion. We can imagine that Delta want to reduce its reported expenses,if at all possible, while Singapore can afford to take a larger hit from depreciation expense,if just as insurance against a possible downturn in the future.
Financial Considerations(cont.)
(1) (2) How much of a different amount in depreciation expense. The average gross value of Deltas flight equipment in 1993 (9043+173+8354+173)/2=8872 million Compared to Singapores depreciation assumptions, Delta can save about $288 million a year in depreciation expense. 8827*(0.08-0.0475)=$288 million Compared to Deltas own depreciation assumptions prior to April 1, 1993, Delta can save about $111 million on an annual base. 8872*(0.06-0.0475)=$111 million We can do a couple of reality checks on this Delta disclosed in its annual report that it reduced depreciation expense by $34.3 million from April 1,1993. When Delta changed its depreciation assumptions in 1986, it reduced annual depreciation expense by $130 million.
(3)
(1) (2)
Singapores Strategy
Why would Singapore employ depreciation assumptions that are so much more conservative than Deltas? The answer is that Singapore will get all of the difference in depreciation expense back (1) One way Singapore could get it back is by having much less depreciation expense in the future ; (2) In the book gains on the sale of flight equipment. Exhibit 1 and 5 of the case indicate that Deltas annual book gain on the sale of flight equipment during 19891993 was about $30 million, whereas Singapores average annual book gain on the sale of flight equipment was $134 million in Singapore dollars, $74 million in U.S. dollar
Singapores Strategy(cont.)
How Singapores accounting practice relates to its overall business strategy. Singapore airline is renowned for its customer service and it gets the aircrafts market price above book value Singapore intends to sell its aircrafts from the very start when they are not so much used. Singapore can afford to take a large hit in its depreciation expense because it knows that it can record large gains on their sale Singapore can maintain its differentiation in the marketplace with a regular supply of new aircraft. We can see a likely consequence of this strategy from Singapore airlines capacity utilizationover 70%.