Acct 531 – Intermediate Finance Acct 1 SECTION 1 – 13WQ
Instructor: John V. Merle, MBA
February 27, 2013
Depreciation expense is the way that the use of an asset is matched with the revenue that is generated from the asset on the income statement during the time period being reported. Each asset used in a business has a useful life as disclosed by the company’s depreciation policies for each category of asset. The other piece of calculating depreciation is the assumed salvage or “residual” value. There are several different methods of depreciating an asset:
1) Straight-line = [pic]
2) Double-declining balance =
Delta and Singapore both use “straight-line” but they assume different salvage values for their fleet as well as different useful life assumptions. This case study will evaluate the differences in their rates of depreciation and the impact on their operating income and profitability before and after they changed their methodology and depreciation assumptions in their policy.
Question One – Calculate the annual depreciation expenses that Delta and Singapore would record for each $100 gross value of aircraft:
• deprec. exp. prior to July 1, 1986: $9.00 [(100-(10%*100))/10] • deprec. exp. from July 1, 1986-March 31, 1993: $6.00 [(100-(10%*100))/15] • deprec. exp. from April 1, 1993 to today: $4.75 [(100-(5%*100))/20]
• deprec. exp. prior to April 1, 1989: $11.25 [(100-(10%*100))/8] • deprec. exp. from April 1, 1989 on: $8.00 [(100-(20%*100))/10] • deprec. exp for used aircraft more than 5 years old at the fiscal year 1993: $16.00 [(100-(20%*100))/5]
Question Two -- Are the differences in the ways that the two airlines account for depreciation significant? Why would companies depreciate aircraft using different depreciable lives and salvage values? What reasons could be given to support these differences? Is different treatment proper?
Both Delta and Singapore airlines use the same straight-line depreciation method to account for their depreciation expense. However, the assumptions they use for the depreciation lives and salvage values are different. Oftentimes companies prefer to use different salvage values and depreciation lives when recording their depreciation expense because of the policies of their airlines or due to managerial decision-making.
Singapore prefers to pay less in taxes so they can decrease their profit by recording their depreciation expense within a short period. They benefit from following this policy, especially since their net profit is sufficient. Since there are no explicit or mandatory rules governing the treatment of depreciation, each company can decide which method they prefer for their company. Therefore, different treatment is proper as long as they follow the policy in place by their company.
Question Three -- Assuming 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? How much more or less will its annual depreciation expense be compared to what it would be were it using Singapore’s depreciation assumption?
By changing their rules for depreciation on April 1, 1993, Delta began to record $4.75 per year instead of the $6 per year depreciation expense they used to record per $100 of gross aircraft value. That results in a 21% decrease in their depreciation expense.
Had Delta been using Singapore’s depreciation assumptions, the depreciation expense would have increased from the $6 per year to $8 per year of depreciation expense per $100 gross aircraft value. That would result in a 33% increase in their depreciation expense from $679 million to $905 million or $226 million more in...