Depreciation At Delta Essay

1521 words - 7 pages

Depreciation at Delta Air Lines and Singapore Airlines (A)
In the early 1990s, the American airline industry experienced a $12.8 billion loss. During this fragile economic state, airline companies reconsidered accounting policies and the long-term effect of each policy on a company’s bottom line. Accounting for such a large part of Total Assets (approximately 50%), the PPE account and its contra account, Accumulated Depreciation, affect both the Balance Sheet and the Income Statement of airline companies. Therefore, the method and assumptions a company implements relating to the calculation of depreciation can significantly alter the company’s financial appearance.
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The smaller depreciable base significantly decreases the amount of total depreciation taken. Based on every $100 of gross equipment, Singapore recognized $8 of depreciation expense in years subsequent to 1989, the year of change in their depreciation assumptions (see Exhibit 1). Prior to the change, Singapore recognized $11.25 depreciation expense on every $100 (see Exhibit 1). Singapore recognized less depreciation expense after the change, resulting in a slightly increased Net Income in years subsequent to 1989.
A company can use depreciation to manipulate Net Income and Total Assets. By decreasing (increasing) depreciation expense, Net Income is increased (decreased) and Total Assets are increased (decreased). When a company’s depreciation expense (book) is lower than MACRS depreciation (tax), the result is a Deferred Tax Asset. The DTA created can be used to prepay taxes in the current period for income expected in subsequent periods. This is useful when a company has the bottom line and cash to do so, thus decreasing Net Income in the current period, while increasing Net Income in subsequent periods. When a company recognizes depreciation expense (book) greater than MACRS depreciation (tax), the company can use the created Deferred Tax Liability to defer taxes to a later period, which is beneficial when a company expects to have lower net income in subsequent tax years.
In 1991 and 1992, Delta’s profits were plummeting, showing a Net Loss of $324M and $506M, respectively. Depreciation expense accounted for 5.3% and 5.1% of total Operating Expenses in 1991 and 1992, almost 75% less than depreciation expense accounted for on Singapore’s books (13.6% and 14.8%). Delta lowered depreciation expense in 1993 in order to achieve a better bottom line in future years, to compensate for their NOL. The average salvage value of Delta’s fleet was too generous, considering Delta had the largest number of airline departures of all US airlines, as of 1993. It was appropriate for Delta to increase the depreciable base by decreasing the residual value of PPE. Delta used an increased useful life assumption to decrease expense taken in order to improve their reported income.
Singapore’s business strategy is the main driver for changing their depreciation assumptions. Singapore provides luxury flights in Eurasia to business travelers. It is important for Singapore’s fleet to have the newest, most technologically advanced planes on the market. Because their planes are of better quality and are newer, it was appropriate for Singapore to double the salvage value of their fleet from 10% to 20%, due to higher turnover caused by buying new planes. Due to advancements in plane engineering and less usage, it was also acceptable for Singapore to extend the average useful life of their fleet from 8 years to 10 years.
The average value of Delta’s flight equipment in 1993, including Capital Leases, totaled $8,872M. This was determined by...

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