Delta and singapore analysis

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Delta and singapore analysis

  1. 1. Case Study Depreciation at Delta Airline and Singapore Airlines. Submission Date 16-Sep-2009 Class EPGP– 09-10 Subject Financial Reporting and Analysis Submitted by  Abhishek Pangaria  Mandeepak Singh  Rajendra Inani  Saravanan Logu  Tarandeep Singh  Vivek Edlabadkar Table of contents Objectives............................................................................................................................2 Depreciation in airline industry...........................................................................................2 Case Background.................................................................................................................2 Test Case Question 1..........................................................................................................3 Test Case Question 2...........................................................................................................4 Test Case Question 3...........................................................................................................6 Test Case Question 4...........................................................................................................7 Test Case Question 5...........................................................................................................7
  2. 2. Case Study – Depreciation at Delta Airlines and Singapore Airlines Objectives To understand the different depreciation methods used by Delta Airlines and Singapore Airlines during the period of 1989-1993. Depreciation in airline industry Typically, an airline’s aircraft depreciation expense is derived by initially estimating both the useful life and the residual value or the perceived fair market value of the aircraft at the end of its estimated useful life. To determine the periodic depreciation expense that reduces the value of the aircraft on the company’s balance sheet while increasing operating expenses the total cost of the aircraft is reduced by the estimated residual value and that sum is divided by the estimated useful life. By increasing the estimated residual value and extending the estimated useful life of its aircraft, an airline company would prospectively record a lower depreciation expense on its income statement and a higher value for each aircraft on its balance sheet. Consequently, the airline would receive a boost to earnings in all future periods and a boost to earnings growth during the four quarters following the change, as prior financial Statements are not restated. While near term earnings would be boosted by the reduced depreciation expense, future earnings may be adversely impacted from this change as the reduced depreciation expense leads to higher reported aircraft values and, if upon disposition of the aircraft the book value is in excess of the realizable value, losses will be incurred. Case Background Delta Airline is one of the major passenger airlines in US, with almost $12 billion in annual revenues. It changed its depreciation method in financial statement twice between 1989 and 1993. In both times it increased the useful life of aircraft and once decreased the residual value. Singapore Airlines a major passenger airline in Asia. It changed its depreciation calculation method in 1989. It increases its aircrafts usage life and increased the residual value. In this case study we are going to analyze there financial statements and figure out the rational behind these changes. Page 2 of 7
  3. 3. Case Study – Depreciation at Delta Airlines and Singapore Airlines Test Case Question 1 Calculate the annual depreciation expense that Delta and Singapore would record for each $100 gross value of aircraft. Depreciation = (Asset value – Residual Value) / Asset life Fixed Asset Price $100 Delta Airlines Prior to Between April 1, 1993 July 1,1986 July 1,1986 and Onward March31, 1993 Residual Value 10% 10% 5% Asset Life 10 15 20 Depreciation $9 $6 $4.75 Singapore Airlines Prior to After April 1, 1989 April 1, 1989 Residual Value 10% 20% Asset Life 8 10 Depreciation $11.25 $8 Page 3 of 7
  4. 4. Case Study – Depreciation at Delta Airlines and Singapore Airlines Test Case Question 2 Are the differences in the ways that two airlines account for depreciation expense significant? Both of the Airlines use Straight Line Method of Depreciation. The Salvage value and Asset Life of both Delta and Singapore Airlines is different at different point of times. On occasions and data provided in the case we can conclude that Delta had much higher average asset life compared to Singapore Airlines. On the other hand the residual value of Delta was much less than Singapore airlines. Why would the companies depreciate aircraft using different depreciable lives and salvage values? What reasons could be given to support their differences? 1. Various airlines have different depreciation methods based on type of fleet and business objectives 2. Type of fleet – There has been several technological advancements in airline industry. Airbus and Boeing introduced aircrafts that they claimed to have higher periods of operation compared to previous ones. The newer aircrafts added to fleet of any airline can give them an option to depreciate the fleet over longer period of time. 3. Usage and Maintenance - Based on the lesser usage and higher maintenance of an aircraft, the company may decide to increase its average usage period and so lower depreciation rate. 4. Another important reason prima facie is to show more profits due to less depreciation. It needs to be noted that there has been more depreciation assumption changes by airlines during rough or loss making times of airline industry. (e.g. 1992-1993) Page 4 of 7
  5. 5. Case Study – Depreciation at Delta Airlines and Singapore Airlines Is the different treatment proper? Yes, Based on company's objective the treatment is proper. Every company may have its own reasons to calculate depreciation on its own premises and rationales. Example of recent changes Continental Air Lines, Inc. increased its estimated useful life on certain new generation aircraft and increased the residual value on all aircraft on January 1, 1998. It changed to an estimated useful life of 30 years from 25 years on newer model planes the Company has recently purchased. Southwest Airlines Company: Effective January 1, 1999 extended the depreciable lives of its 737-300/500 airplanes to 23 years from 20 years. Some haven’t changed Alaska Airgroup Inc. has maintained constant its depreciation policy at eight to 20 years for aircraft, which ranks as one of the most conservative in the industry. Page 5 of 7
  6. 6. Case Study – Depreciation at Delta Airlines and Singapore Airlines Test Case Question 3 Assuming the average value of flight equipment that Delta had in 1993, how much difference do the depreciation assumptions it adopted on April 1, 1993 make ? Depreciation value difference is of (6 – 4.75) at $100 value. So for 9216 it will be 1.25/100 * 9216 = 115.2 Year 1993 Value of Flight equipment owned 9043 Flight equipment under capital leases 173 Total Equipment 9216 Diff in depreciation value 0.0125 Total change 115.2 How much more or less will its annual depreciation expense be compared to what it would be were it using Singapore’s depreciation assumption? Year 1993 Flight equipment owned 9043 Flight equipment under capital leases 173 Total Equipment 9216 Diff in depreciation value 0.0325 Total change 299.52 Page 6 of 7
  7. 7. Case Study – Depreciation at Delta Airlines and Singapore Airlines Test Case Question 4 Singapore Airlines maintains depreciation assumptions that are very different from Delta’s. What does it gain or lose by doing so? How does this relate to company’s overall strategy? 1. There will be low net income as the depreciation amount is higher. Besides this, there will be less tax because of low income. So savings on tax can be a gain. 2. They target to sell the aircraft at fair market value which will be obviously much higher than 20% residual cost after 10 year. How does this relate to company’s overall strategy? The above strategy of reselling the aircraft relates to the company's overall strategy of maintaining newer aircraft in their feet. They sell a significant aircraft as can be seen from Exhibit 1. We can see that relative proportion of sale of flight equipments is higher for Singapore Airlines as compared with Delta Airlines. Test Case Question 5 Does the difference in the average age of Delta’s and Singapore’s aircraft fleets have any impact on the amount of depreciation expense? No there is no direct relation of average age of Delta’s and Singapore’s aircraft fleets and amount of depreciation expense. Page 7 of 7

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