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for airlines usually comprise greater than 50% of total assets. of one airline are substantially similar to aircraft of another airline (at least to the lay person).
Aircraft
Depreciation
is not
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.
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B E G I N N I N G
Depreciation
96 97 98 99 00 01 02 03 04 05
E N D I N G
Depreciation
Balance Sheet Acquisition Cost Cost Allocation Income Statement Expense
Used
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Depreciation
Depreciation Expense Income Depreciation for the current year Statement
Balance Sheet
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Long-Term Assets
Long-Term Assets
Have Are Are Are
acquired for use in the business. not intended for resale to customers. reported at carrying (book) value.
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Management Issues
The The
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Management Issues
The
salvage value of the asset at the end of its life must be estimated pattern for recognizing depreciation over the depreciable life of the asset must be selected.
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Disposal
Book Value
Time
Accounting Issues
Measuring Cost Allocation of cost Accounting For post acquisition expenses. Recording Disposals
Disposal
Book Value
Time
Accounting Issues
Measuring Cost Allocation of cost Accounting For post acquisition expenses. Recording Disposals
that assets are valuable because of the future cash inflows they are expected to generate.
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Benefit Approaches
present value.
Discounted Net
realizable value.
Economic
Historical
Sacrifice Approaches
Replacement
cost $100,000
years old, has remaining useful life of 8 years salvage value using straight-line
Depreciated
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net operating cash inflows = $18,000 per year (assumed) for eight remaining years, discounted at a 10% (assumed) rate. x $18,000 = $96,029
5.33493
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resale price from an over-theroad equipment listing (Purple Book) for the specific vehicle model. (Assumed)
$85,000
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Historical Cost
Historical
$100,000
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Replacement Cost
Replacement $90,000
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Possibilities
Discounted PV Approach Net Realizable Value Historical Cost (Less A/D) Replacement Cost $96,029 85,000 80,000 90,000
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Possibilities
Discounted PV Approach Net Realizable Value Historical Cost (Less A/D) Replacement Cost $96,029 85,000 80,000 90,000
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Value of Asset
Cost
an operational asset;
Preparing Less
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Theoretical Justification
The
matching principle requires the cost of an asset be charged to expense in the periods benefited. allocation process is called depreciation.
The
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Produ ct Costs
DM DM DL DL MOH MOH
DM Inv. DM Inv.
Unfinished
Fini sh e d
Sale Sold
WIP WIP
Sales
Income Statement
= =
Period Costs
recognition
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The
salvage value of the asset at the end of its life must be estimated.
life value
Salvage
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Straight-Line Accelerated
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Depreciation
48
Depreciation
49
Depreciation
50
in Financial Statements
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of Depreciation
Methods of Depreciation
Straight-Line Method
Decline in service potential relates primarily to the passage of time. Level of activity is important but use of asset is relatively constant.
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Estimated
Cost - Salvage Value Useful life in years
Estimated
Straight-Line Method
On December 31, 2001, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated salvage value of $5,000.
$50,000 - $5,000 5 Years $9,000
Depreciation Schedule
Depreciation Expense (debit) $ 9,000 9,000 9,000 9,000 9,000 45,000 Accumulated Depreciation (credit) $ 9,000 9,000 9,000 9,000 9,000 45,000 Accumulated Depreciation Balance $ 9,000 18,000 27,000 36,000 45,000 Undepreciated Balance (book value) $ 50,000 41,000 32,000 23,000 14,000 5,000
Salvage Value
Straight-Line Method
Depreciation Expense
Methods of Depreciation
Declining-Balance
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Accelerated Depreciation
Repair Costs
Depreciation
Double-Declining-Balance Method
Step 1:
Straight-line = depreciation rate 100 % Useful life in periods
Step 2:
Double-decliningbalance rate = 2 Straight-line depreciation rate
Double-Declining-Balance Method
A Constant Rate Step 3:
Depreciation Double-decliningBeginning period = expense balance rate book value
A Declining Balance
Double-Declining-Balance Method
On December 31, 2001, equipment was purchased for $50,000 cash. The equipment has an estimated useful life of 5 years and an estimated residual value of $5,000. Calculate the depreciation expense for 2002 and 2003
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Double-Declining-Balance Method
Step 1:
Straight-line = depreciation rate 100 % 5 years = 20%
Step 2:
Double-declining= 2 20% = 40% balance rate
Step 3:
Depreciation = 40% $50,000 = $20,000 (2002) expense
Double-Declining-Balance Method
2002 Depreciation: 40% $50,000 = $20,000
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Double-Declining-Balance Method
Depreciation Accumulated Undepreciated Expense Depreciation Balance (debit) Balance (book value) $ 50,000 $ 20,000 $ 20,000 30,000 12,000 32,000 18,000 7,200 39,200 10,800 4,320 43,520 6,480 2,592 46,112 3,888 Below salvage value $ 46,112
Double-Declining-Balance Method
Depreciation Expense (debit) $ 20,000 12,000 7,200 4,320 1,480 45,000 Accumulated Depreciation Balance $ 20,000 32,000 39,200 43,520 45,000 Undepreciated Balance (book value) $ 50,000 30,000 18,000 10,800 6,480 5,000
We usually have to force depreciation expense in the latter years to an amount that brings BV to salvage value.
Straight-Line
Annual Depreciation
Life in Years
$20,000 $15,000
Double-Declining-Balance
Annual Depreciation
$10,000 $5,000 $0
Life in Years
Reporting Depreciation
Property, plant, and equipment: Land and buildings Machinery and equipment Office furniture and equipment Land improvements Total Less Accumulated depreciation Net property, plant, and equipment $ 150,000 200,000 175,000 50,000 $ 575,000 (122,000) $ 453,000
Net property, plant, and equipment is the undepreciated cost (book value) of the plant assets.
Book value
Market value
Delta
Singapore
Lets Compare
billion in annual revenues (almost $15 billion in 1999) 161 cities in 44 states flights to 33 foreign countries.
Served
Operated
76
Average
2000)
Changed
1993
77
Capacity Long
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Singapore Airlines
Singapore Airlines
Largest
private-sector employer in Singapore network covered 70 cities in 40 countries operating revenues in 1993 $5.1 billion (Singapore $)
Route
Total
80
Singapore Airlines
Average
long-term debt
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Delta
Singapore
Comparison . . .
Calculate
the annual depreciation expense that Delta and Singapore would record for each $100 gross value of aircraft.
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84
Singapore Airlines . . .
10-year Salvage
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Singapore Airlines
Singapore Airlines
Comparison . . .
Are
the differences in the ways the two airlines account for depreciation expense significant? would companies depreciate aircraft using different depreciable lives and salvage?
Why
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Useful Life
Comparison . . .
Why
would companies depreciate aircraft using different depreciable lives and salvage values? reasons could be given to support these differences? different treatment proper?
What
Is
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Useful Life
Singapore Air
Delta Air
Aircraft
Use
takeoffs and landings
Frequent
Maintenance
Remember
Valuejet?
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Financial Considerations
Singapore Air
For three year period 1990 - 1993
Delta Air
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?
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much more or less will its annual depreciation expense be compared to what it would be were it using Singapores depreciation assumptions?
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Look at Exhibit 2
1993 Owned Aircraft Leased Aircraft Gross Value of Aircraft Average Gross Value 1992
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Singapore Airlines
Look
at Current Policies
Delta Air
Singapore Air
Difference in Depreciation
Look
Difference in Depreciation
is yet another difference in the two airlines leading to a savings of Delta over Singapore on depreciation expense.
Historical Age
of the aircraft
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the difference in the average age of Deltas and Singapores aircraft fleets have any impact on the amount of depreciation expense they record? so, how much?
If
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Average Gross Value 3.5% Inflation x 3.7 Years Increased Value Adjusted Gross Value Increased Value Singapores Rate
Additional Depreciation
92 $380
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Airlines maintains depreciation assumptions that are very different from Deltas does it gain or lose by doing so?
What How
Compare
Singapore Airlines
1. Renowned for customer service
State-of-the-art aircraft Capacity utilization = 71.3% 1993 Annual Report: A superior product will probably enable us to sustain relatively high load factors.
107
Singapore Airlines
2. Long-haul Airline
Average passenger trip length in 1993 was 2,720 miles (Delta = 969) Less wear and tear on aircraft long trips are less stressful than frequent landings and takeoffs
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Singapore Airlines
3. Gain on sale of aircraft
Average gain $134 million Direct result of depreciation policies? Result of corporate strategy
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Singapore Airlines
4. Owned Vs. Leased Aircraft
Singapore operates none of their aircraft under operating leases Delta operates close to 50% of their aircraft under non-cancelable operating leases.
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Singapore operates none of their aircraft under operating leases Delta operates close to 50% of their aircraft under non-cancelable operating leases.
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