1. Calculate the annual depreciation expense that Delta and Singapore would record for each $100 gross value of aircraft. (a) For Delta, what was its annual depreciation expense (per $100 of gross aircraft value) prior to July 1, 1986; from July 1, 1986 through March 31, 1993; and from April 1, 1993 on? Prior to July 1: (100-10)/10 = $9 annual depreciation
From July 1, 1986 through March 31, 1993: (100-10)/15 = $6 annual depreciation From April 1, 1993 on: (100-5)/20 = $4.75 annual depreciation (b) For Singapore, what was its annual depreciation expense (per $100 of gross aircraft value) prior to April 1, 1989; and from April 1, 1989 on? Prior to April 1, 1989: (100-10)/8 = $11.25 annual depreciation From April 1, 1989 on: (100-20)/10 = $8 annual depreciation
2. Are the differences in the ways that the two airlines account for depreciation expense 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? Delta Airlines and Singapore Airlines both adopted straight-line method for depreciation. The difference between the two lied in their estimates of residual value and useful life of the aircraft. Singapore Airlines assumed a much shorter useful life and higher residual value of the aircraft. We view the differences as significant since Singapore Airlines depreciated the value of its aircraft almost twice as fast as Delta Airlines did.
The main reason why companies would depreciate aircraft using different depreciable lives and salvage values is that the management of the companies wanted to achieve certain earnings result. Delta Airlines kept showing loss since 1991 and therefore the management had the incentive to reduce operating expenses and make financial statements look better. Singapore Airlines took higher annual depreciation because they performed well and higher depreciation expense can reduce the company’s tax liability. However, as the company started to be influenced and harmed by the problems in the whole industry, Singapore Airlines also felt the pressure and therefore changed their depreciation estimates. Companies have many reasons to support these different estimates of residual value and useful life.
First, companies have different types of aircraft and each type has its own residual value and useful life, leading to the big difference in depreciation speed between the two airlines. Second, the different percentages of international flights (21% for Delta; 56% for Singapore) may lead to different depreciation speed since longer flights may shorten the useful life the aircraft. Third, different business objectives may also justify the different ways of depreciation. Singapore Airlines is well known for its high level of customer service and the company aims to provide the best for its passengers. As a result, Singapore Airlines would tend to dispose aircraft at an earlier age. We believe the different treatment is proper as long as the companies can offer reasonable explanation for its depreciation methods. Companies should not change its depreciation method for the sole purpose of distorting earnings without reasons to support.
