Depreciation at Delta Airlines – the Fresh Start
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I. Summary of the text
Before we start talking in particular about the case of Delta Airlines, we must make clear the importance of depreciation and how to carry it out because, within an airline company, the vast majority of company assets (aircraft, flight crew and ground assets) have to be depreciate, representing a significant operating expense for the company.
Once this review, we will focus on the company in question, Delta Airlines, which filed for bankruptcy in 2005, leaving it as a new company in 2007, becoming in 2008 the airline with more international destinations in the world and, following its merger with Northwest Delta Airlines, the largest airline in the world.
As for depreciation, Delta Airlines has changed several times the life of their aircraft, primarily motivated by reasons of competition with other companies during these periods.
However, the change of the lifetime of the relevant aircraft change was caused by the engine therein, from a piston engine used to power jet engine with which deterioration reduced in the plane of considerably, thereby extending the useful life of the aircraft.
However, different circumstances have led to Delta Airlines will not take the same choices as other American companies in terms of life extension we mean by behaving in a more conservative or aggressive according to their circumstances.
II. Long term assets
(1) CURRENT ASSETS VERSUS LONG TERM ASSETS
The difference between current and long term assets is that current assets are converted/used within a single operating cycle (inventory, work in progress, accounts receivable, etc), whereas long term assets are used for multiple operating cycles (machines, buildings, etc).
There are three types of long term assets: long term tangible assets, such as machines and buildings, long term intangible assets such as patents and trademarks and long term financial assets such as shares held in other companies. We focus on long term tangible assets.
However, many of the principles discussed here can be applied to intangible assets. Accounting for financial assets however, has some distinct features.
Key points:
-Current assets are converted or used within a single operating cycle.
– Long term assets are used multiple operating cycles.
(2) PURCHASE (OR DEVELOPMENT) OF LONG TERM ASSETS
First, it needs to be determined if accounting principles allow for the asset to be recognized. The accounting treatment under IFRS (and also under US GAAP) differs for tangible and intangible assets. The requirements for capitalizing self developed (as opposed to purchased) intangible assets are most restrictive. The rationale behind this is that the valuation for these assets is most uncertain.
If accounting principles allow recognition of an asset, the next issue is which items can be included, and which items need to be expensed. The basic rule here is that – when recognizing the asset is allowed – all money that is spent to get the asset up and running is capitalized as part as the cost of the asset.
III. Depreciation: concept and methods.
IAS16 defines depreciation as “the systematic allocation of the depreciable amount of an asset over its useful life”. This definition makes it clear that the purpose of depreciation is simply to allocate an expense between accounting periods. The depreciation process makes no attempt to show assets at their current values. Not does it guarantee that there will be funds available to replace those assets when they come to the end of their useful lives. Depreciation charges reduce profits but have no direct effect on an entitys cash resources and do not ensure that cash is “saved up” to buy replacement asstes.
IAS16 also defines a number of key terms which are used in the section of the standard which deals with depreciation.
These are as follows:
1) DEPRECIABLE AMOUNT: “the cost of an asset, or other amount substituted for cost, less its residual value”.
2) USEFUL LIFE: “period over which an asset is expected to be available for use by an entityor the number of production or similar units expected to be obtained from the asset by an entity”.
3) RESIDUAL VALUE: “the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.”
4) COST: “monetary value of the expenditure of raw materials, equipment, services”
The definition of depreciable amount makes it clear that depreciation does not cease if an asset is revalued. All that happens is that a valuation is substituted for the assets carrying amount, resulting in a revaluation gain or loss.
Depreciable amount is now equal to the amount of the valuation less the assets residual value. Subsequent depreciation charges will be based upon this revised depreciable amount and will continue for the remainder of the assets useful life.
If an item of property, plant and equipment is revalued upwards and a revaluation gain in relation to that item is credited to revaluation reserve, subsequent depreciation charges will exceed depreciation based on the items original cost. In these circumstances, the amount of excess depreciation in each accounting period may be transferred from revaluation reserve to retained earnings. This transfer takes place in the statement of changes in equity and does not affect the statement of comprehensive income.
(1) IAS16 REQUIREMENTS WITH REGARD TO DEPRECIATION
IAS16 establishes a number of general requirements with regard to the depreciation of property, plant and equipment and then deals with depreciation methods. The main general requirements are as follows:
Each part of an item of property, plant and equipment with a cost that is significant in relation to the items total cost should be depreciated separately. However, parts of an item may be grouped for depreciation purposes if they have the same useful life and if the same depreciation method is applicable to each part.
The depreciation charge for an accounting period should