Depreciation at Delta Air Lines and Singapore Airlines UAA – ACCT 650 - Seminar in Executive Uses of Accounting Dr. Fred Barbee
Financial Reporting n o i t a i c e r p Up Close and e D Personal
Yeah! MBA We want to go . . . Beyond ACCT 201!
MBA We want to ask WHY?
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
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).
Accrual-Basis Accounting The Accounting System Revenue Recognition Matching Principle
A Theoretical View of Depreciation Salvage Value $1 $5 $4 $3 $2 Book Value of the Asset Time $1 $1 $1 $1 Consumed as Depreciation Expense An application of the Matching Principle
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.
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.
BEGINNING ENDING 96 97 98 99 00 01 02 03 04 05 Life of the Asset Depreciation Depreciation is a process of allocation, not valuation.
Depreciation Balance Sheet Income Statement Cost AcquisitionCost Expense Allocation Unused Used An application of the matching principle.
Depreciation IncomeStatement DepreciationExpense Depreciation forthe current year BalanceSheet AccumulatedDepreciation Total depreciation todate of balance sheet
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.
Management Issues • The cost of the asset must be measured. • The depreciable life of the asset must be estimated.
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 Use in business operations Acquisition Disposal Decline in future service benefits. Book Value Time Accounting Issues Measuring Cost Allocation of cost Accounting For post acquisition expenses. Recording Disposals
Issues Related to Long-Lived Assets Asset Service Potential Use in business operations Acquisition Disposal Gain or Loss Cost Principle Matching Principle Decline in future service benefits. Book Value Time Accounting Issues Measuring Cost Allocation of cost Accounting For post acquisition expenses. Recording Disposals
Acquisition cost of Property, Plant, and Equipment Fundamental Issue #1: What is the value of the asset?
Expected Benefit Approach • Recognizes that assets are valuable because of the future cash inflows they are expected to generate.
Economic Sacrifices Approach • Focuses on the amount of resource expenditures required to acquire an asset.
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.
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
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
Net Realizable Value • Current resale price from an over-the-road equipment listing (Purple Book) for the specific vehicle model. • $85,000 (Assumed)
Historical Cost • Historical Cost less Accumulated Depreciation • $100,000 – [(100,000/10 years) x 2 years] = $80,000
Replacement Cost • Replacement cost of a two-year-old vehicle in equivalent condition • $90,000 (assumed)
“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?
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.
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 Firm Manufacturing Costs Balance Sheet Unused DM DM Inv. Used Used Unfinished DL WIP WIP Inv. Product Costs Applied Finished MOH FG Inv. Sale Sales - Sold COGS = Income Statement Gross Margin - Period Costs S&A = Net Income
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
Factors in Computing Depreciation • The calculation of depreciation requires three amounts for each asset: • Cost • Useful life • Salvage value
Depreciation Methods Based on Time • Straight-Line • Accelerated • Sum-of-the-years’-digits • Declining Balance
Depreciation Methods Based on Activity Level • Productive output • Service quantity
Depreciation • If an asset is expected to benefit all periods equally, • a straight-line method of depreciation would be appropriate.
Depreciation • If more benefits are expected early in the life of an asset . . . • an accelerated method of depreciation would be appropriate.
Depreciation • If benefits are related to the output of an asset . . . • the units-of-production method of depreciation would be appropriate.