9-198-001 REV: SEPTEMBER 16, 2004 WILLIAM J. BRUNS, JR. Depreciation at Delta Air Lines and Singapore Airlines (A) Property, plant, and equipment (PP&E) is a significant asset category of most airline companies. PP&E usually constitutes more than 50% of the total assets of an airline, and depreciation of these assets is a major operating expense.
However, unlike many expenses—for example, salaries, the cost of aircraft fuel, the cost of meals and beverages, all of which are significant operating expenses for airlines—depreciation of PP&E is different in that the methods and estimates used to determine the amount of this expense can vary widely among companies. Moreover, the methods and estimates used can have a significant impact on companies’ reported earnings. Thus, unless the user of financial statements sifts through the footnotes to sort out the details, comparability among companies within an industry can be problematic.
Consider, for example, the depreciation practices of two major airlines—Delta Air Lines and Singapore Airlines—in 1993. Delta Air Lines Delta Air Lines was one of the major passenger airlines in the United States, with almost $12 billion in annual revenues. It served 161 cities in 44 states in the United States, and it also operated flights to 33 foreign countries. In terms of operating revenues and revenue passenger miles flown, 1 it was, in 1993, the third-largest U. S. airline. (American Airlines and United Airlines were the largest. ) Delta had been expanding its international operations.
In fiscal year 1990 it entered a partnership with Singapore Airlines that was meant to coordinate some of their scheduling and marketing efforts. In November 1991, Delta purchased most of the transatlantic route authorities of Pan Am, which had gone bankrupt. Thus in fiscal year 1993, revenues from international flights represented 21% of total operating revenues. This represented a large increase from earlier years, but it was still a smaller 1 “Revenue passenger miles” is a widely used measurement of traffic volume in the airline industry. It represents the number of miles flown by all revenue-paying passengers. ___________________________________________________________ ____________________________________________________ Resarch Associate Jeremy Cott prepared this case under the supervision of Professor William J. Bruns, Jr. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 1997 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www. bsp. harvard. edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. 198-001 Depreciation at Delta Air Lines and Singapore Airlines (A) proportion of total revenues than what was the case for some other major carriers. (For example, in 1993, 38% of United’s revenues, and 26% of American’s, came from international flights. Although Delta was the third-largest U. S. airline in terms of operating revenues and revenue passenger miles flown, it was the largest in terms of the number of airline departures and the number of passengers carried. Exhibit 1 shows key financial and operational data for Delta for the years 1989 through 1993. Delta was in the throes of difficulties affecting most American airlines. Deregulation of the industry in 1978 had led to increasing price competition; in the 1980s and early 1990s, airline fares didn’t even remotely keep pace with inflation.
Major carriers like Delta—with high cost structures left over from an earlier, regulated environment—were hit hard by competition from low-cost, nofrills airlines like Southwest and People’s Express. In the late 1980s and early 1990s, the difficulties mounted: Iraq’s invasion of Kuwait discouraged passenger travel and caused fuel prices to skyrocket; the American economy went into a recession; and fare wars intensified. In four years, 1990-1993, the American airline industry as a whole lost $12. 8 billion. Delta went about reassessing its marketing programs and cutting back on staff in an effort to control costs. The work we are doing to cut costs and raise revenues,” the 1993 Annual Report stated, “fits within a comprehensive effort to transform our Company into a high performing organization. ” Delta’s property and equipment totaled $7. 1 billion on its 1993 balance sheet. The largest part of this ($5. 5 billion) consisted of aircraft and other flight equipment. (See Exhibits 2 and 3, which show the dollar values of Delta’s fixed assets and the composition of its aircraft fleet. ) The average age of Delta’s aircraft was 8. 8 years, which was relatively young by industry standards.
Among other major airlines, the average age of aircraft varied a good deal. At American and United, the two largest passenger airlines in the United States, the average age of aircraft was 8. 9 and 10. 8 years, respectively. At Continental, the fifth-largest airline, it was 15. 3. At TWA, the seventh largest, it was 18. 7. (There was no necessary connection, however, between the average age of an airline’s fleet and the assumption it made regarding the fleet’s depreciable life. ) In April 1993 Delta announced a change in its depreciation assumptions regarding flight equipment.
The last time Delta had made such a change had been in July 1986. (See the excerpts from the footnotes to Delta’s financial statements, regarding this, in Exhibit 4. )2 Singapore Airlines Singapore Airlines was the largest private-sector employer in Singapore’s booming economy. At the end of fiscal year 1993, its route network covered 70 cities in 40 countries. Singapore was a transit point for a good deal of travel in Asia, but the airline also handled a lot of traffic to other continents: for example, it flew regularly to the United States across both the Atlantic and Pacific Oceans, and flew nonstop to and from London nine imes a week. Of its total operating revenues, about 44% came from flights to Asia, 23% from flights to Europe, 22% from flights to North and South America, and 11% from flights to the Southwest Pacific. In fiscal year 1993 its total operating revenues ($5. 1 2 During fiscal year 1993 Delta also changed one of its assumptions regarding pension accounting. “Effective April 1, 1993, Delta increased from 9% to 10% its assumption regarding the expected return on plan assets associated with defined benefit pension plans. This change in accounting estimate resulted in a decrease in pension expense of $12. million in fiscal 1993, and is expected to reduce pension expense by an estimated $56 million in fiscal 1994. ” (1993 Annual Report) 2 Depreciation at Delta Air Lines and Singapore Airlines (A) 198-001 billion in Singapore dollars, $3. 1 billion in U. S. dollars) would have made it the seventh-largest airline in the United States—larger, for example, than Trans World Airlines and Southwest. 3 Exhibit 5 shows key financial and operational data for Singapore for the years 1989 through 1993. The airline was renowned for its high level of customer service, geared largely to business travelers.
Year after year, it won awards from various trade associations and travel magazines for the quality of its service. The average age of its aircraft was 5. 1 years, which was the youngest of any major airline in the world. (See Exhibits 6 and 7, which show the dollar values of Singapore’s fixed assets and the composition of its aircraft fleet. ) According to an industry publication, Singapore’s exclusive MEGATOP 747-400, which it bought from Boeing, was “the largest, fastest long-haul aircraft in the world, offering state-of-the-art technology and comfort. 4 Much of the Asian airline market was regulated. Moreover, slightly more than half of Singapore Airlines’ common stock was owned by the Singapore government. However, the company received no government subsidy and operated under most of the usual pressures from international competition and the investment community. Its stock was followed by more than 20 investment analysts. Asian airlines at this time were generally more profitable than American airlines, but they definitely did not feel immune to the problems in the industry.
In 1993, Singapore Airlines’ net profit dropped (in Singapore dollars) from $922 million to $741 million—or (in American dollars) from $555 million to $452 million. In its Annual Report for the year, the company said that the year had been “a difficult one for most airlines. The industry continued to be saddled with huge financial losses…. Singapore Airlines was not spared. ” As a result, the company’s briefing for reporters was held at a much more modest hotel than usual, and staff bonuses were reduced from the 3. 4 months of the previous year to a half-month.
The company said that it was continuing with its expansion plans, expecting an eventual recovery in the business cycle. Its capital expenditures, however, were running about $2 billion a year (Singapore dollars), and, as a result, the company’s Annual Report said, “it is possible that, in a few years’ time, we shall have to incur debt. ”5 During fiscal year 1993, the company’s assumptions regarding its depreciation of flight equipment remained unchanged. The last time Singapore had changed its depreciation policy regarding flight equipment had been in April 1989. See the excerpts from the footnotes to Singapore’s financial statements, regarding this, in Exhibit 8. ) 3 Singapore Airlines was actually a wholly owned subsidiary of a holding company named SIA, 90% of whose revenues came from the airline operation. All of the financial and operating data cited in this case regarding Singapore Airlines, however, pertains solely to Singapore Airlines, not the holding company. (The holding company’s other investments were in engineering and airport terminal services, a regional airline, and various hotel properties. ) 4 Business Wire, November 29, 1996. Business Times in Singapore reported on May 20, 1993, that “even with the lower earnings” in fiscal year 1993, Singapore Airlines “retained its position as the world’s most profitable airline. ” The company’s director of corporate affairs reported a conversation he had with an industry analyst in which “the analyst said that if an American airline had reported such figures, the market would have rejoiced at the news. ” In response, the company’s director of corporate affairs said to the analyst, “You must forgive the local press because it is influenced by the performance of other Singapore companies. ” 3 198-001
Depreciation at Delta Air Lines and Singapore Airlines (A) Questions 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? (b) For Singapore, what was its annual depreciation expense (per $100 of gross aircraft value) prior to April 1, 1989; and from April 1, 1989 on? 2. Are the differences in the ways that the two airlines account for depreciation expense significant?
Why would companies depreciate aircraft using different depreciable lives and salvage values? What reasons could be given to support these differences? Is different treatment proper? 3. Assuming the average value of flight equipment that Delta had in 1993, how much of a difference do the depreciation assumptions it adopted on April 1, 1993 make? How much more or less will its annual depreciation expense be compared to what it would be were it using Singapore’s depreciation assumptions? 4. Singapore Airlines maintains depreciation assumptions that are very different from Delta’s.
What does it gain or lose by doing so? How does this relate to the company’s overall strategy? 5. Does the difference in the average age of Delta’s and Singapore’s aircraft fleets have any impact on the amount of depreciation expense that they record? If so, how much? 4 Depreciation at Delta Air Lines and Singapore Airlines (A) 198-001 Exhibit 1 Delta Air Lines: Key Financial and Operational Data ($ millions) Exhibit 1 Delta Air Lines: Key Financial and Operational Data ($ millions) For the fiscal years ending June 30 1992 1991 1990 10,162 7,093 69. % 8,411 5,641 67. 1% 7,227 5,399 74. 7% 1993 Total assets Fixed assets Fixed assets/Total assets Long-term debt (including capital leases) Total debt/Total assets 11,871 7,141 60. 2% 1989 6,484 4,478 69. 1% 3,717 31. 3% 2,833 27. 9% 2,058 24. 5% 1,315 18. 2% 703 10. 8% Total operating revenues Total operating expenses Depreciation expense for fixed assets Depreciation expense/ Total operating expense Operating profit Operating profit/Revenues Gain on sale of flight equipment (pretax) Net profit (excluding cumulative effect of accounting change) Net profit/Revenues 1,997 12,572 679 5. 4% (575) -4. 8% 65 10,837 11,512 585 5. 1% (674) -6. 2% 35 9,170 9,621 512 5. 3% (450) -4. 9% 17 8,582 8,163 453 5. 5% 420 4. 9% 18 8,089 7,411 378 5. 1% 678 8. 4% 17 (415) -3. 5% (506) -4. 7% (324) -3. 5% 303 3. 5% 461 5. 7% Revenue passenger miles (millions) Number of revenue passengers carried (millions) Average passenger trip length (miles) Available passenger miles (millions) Capacity utilization 82,406 85 969 132,282 62. 3% 72,693 77 944 123,102 59. 1% 62,086 69 900 104,328 59. 5% 58,987 67 880 96,463 61. 1% 55,904 64 874 90,742 61. 6%
Source: Company Annual Reports and 10-Ks; ratios calculated by casewriter. 5 198-001 Depreciation at Delta Air Lines and Singapore Airlines (A) Exhibit 2 Delta Air Lines: Property and Equipment ($ millions) June 30 1993 1992 8,354 (3,213) 5,141 173 (112) 61 2,211 (983) 1,228 663 7,093 Flight equipment owned Less: Accumulated depreciation 9,043 (3,559) 5,484 173 (128) 45 2,373 (1,143) 1,230 383 7,142 Flight equipment under capital leases Less: Accumulated depreciation Ground property and equipment Less: Accumulated depreciation Advance payments for equipment Total Source: Exhibit 3
Company Annual Reports. Delta Air Lines: Aircraft Fleet as of June 30, 1993 Average Seats per Aircraft 177 178 148 107 127 182 204 254 218 302 300 266 223 253 142 150 Type of Aircraft A310-200 A310-300 B727-200 B737-200 B737-300 B757-200 B767-200 B767-300 B767-300ER L1011-1 L1011-200 L-1011-250 L1011-500 MD-11 MD-88 MD-90 Total Owned 3 106 1 3 43 15 2 7 32 1 6 17 1 59 296 Leased 4 15 43 57 13 41 23 7 8 57 268 Total 7 15 149 58 16 84 15 25 14 32 1 6 17 9 116 0 564 Source: Note: Company Annual Reports. All of the aircraft shown above as “leased” were being operated under “operating” leases. 6
Depreciation at Delta Air Lines and Singapore Airlines (A) 198-001 Exhibit 4 Delta Air Lines’ Depreciation Policy Excerpt from Delta Air Lines’ “Notes to Consolidated Financial Statements” (for fiscal year 1993) Depreciation and Amortization—Prior to April 1, 1993, substantially all of the Company’s flight equipment was being depreciated on a straight-line basis to residual values (10% of cost) over a 15year period from the dates placed in service. As a result of a review of its fleet plan, effective April 1, 1993, the Company increased the estimated useful lives of substantially all of its flight equipment.
Flight equipment that was not already fully depreciated is being depreciated on a straight-line basis to residual values (5% of cost) over a 20-year period from the dates placed in service. Excerpt from Delta Air Lines’ “Notes to Consolidated Financial Statements” (for fiscal year 1987) Depreciation and Amortization—Prior to July 1, 1986, substantially all of the Company’s flight equipment was being depreciated on a straight-line basis to residual values (10% of cost) over a 10year period from dates placed in service.
As a result of a comprehensive review of its fleet plan, effective July 1, 1986, the Company increased the estimated useful lives of substantially all of its flight equipment. Flight equipment that was not already fully depreciated is now being depreciated on a straight-line basis to residual values (10% of cost) over a 15-year period from dates placed in service. The effect of this change was a $130 million decrease in depreciation . . . for the year ended June 30, 1987. Note:
Delta’s assumptions regarding the depreciable life and salvage value of fixed assets other than flight equipment were quite different and were, in any case, unchanged in 1993. 7 198-001 Depreciation at Delta Air Lines and Singapore Airlines (A) Exhibit 5 Singapore Airlines: Key Financial and Operational Data ($ millions, Singapore dollars) 1993 Total assets Fixed assets Fixed assets/Total assets Long-term debt (including capital leases) Total debt/Total assets 9,417 6,729 For the fiscal years ending March 31 1992 1991 1990 9,366 5,876 62. 7% 421 4. 5% 8,516 4,960 58. 2% 450 5. 3% 7,708 4,515 58. % 518 6. 7% 1989 6,365 3,926 61. 7% 624 9. 8% 71. 5% 0 0. 0% Total operating revenues Total operating expenses Depreciation expense for fixed assets Depreciation expense/ Total operating expense Operating profit Operating profit/Revenues Gain on sale of flight equipment (pretax) Net profit (excluding cumulative effect of accounting change) Net profit/Revenues 5,135 4,480 708 15. 8% 655 12. 8% 42 5,013 4,149 614 14. 8% 863 17. 2% 129 4,602 3,760 513 13. 6% 842 18. 3% 208 4,730 3,601 439 12. 2% 1,129 23. 9% 195 4,272 3,407 550 16. 1% 865 20. 2% 96 741 14. 4% 922 18. 4% 887 19. 3% 1,177 24. 9% 28 21. 7% Revenue passenger miles (millions) Number of revenue passengers carried (millions) Average passenger trip length (miles) Available passenger miles (millions) Capacity utilization Note: March 31 exchange rate for conversion of Singapore dollars to U. S. dollars 23,663 8. 7 2,720 33,174 71. 3% 21,808 8. 1 2,692 29,659 73. 5% 19,582 7. 1 2,758 26,063 75. 1% 19,210 6. 8 2,825 24,523 78. 3% 17,991 6. 2 2,902 22,789 78. 9% $1. 64 $1. 66 $1. 80 $1. 89 $1. 96 Source: Company Annual Reports and 10-Ks; ratios calculated by casewriter. 8 Depreciation at Delta Air Lines and Singapore Airlines (A) 98-001 Exhibit 6 Singapore Airlines: Singapore dollars) Fixed Assets ($ millions, March 31 1993 1992 Flight equipment Less: Accumulated depreciation 9,224 (3,914) 5,310 1,020 (549) 471 947 6,728 7,814 (3,330) 4,484 1,018 (589) 429 962 5,875 Ground property and equipment Less: Accumulated depreciation Advance and progress payments Total Source: Company Annual Reports. Exhibit 7 Singapore Airlines: March 31, 1993 Type of aircraft B747-400 (MEGATOP) B747-300 (BIG TOP) B747-300 (COMBI) B747-200 B747-200 Freighter B737-200 Freighter B737-300 Freighter A310-300 A310-200 Total
Aircraft Fleet as of In operation 18 11 3 3 1 2 1 12 6 57 Source: Note: Company Annual Reports. Singapore owned all of its aircraft; it did not operate any under “operating leases. ” (Confirmed by company in June 6, 1997 phone conversation. ) 9 198-001 Depreciation at Delta Air Lines and Singapore Airlines (A) Exhibit 8 Singapore Airlines’ Depreciation Policy Excerpt from Singapore Airlines’ “Notes to the Accounts” (for fiscal year 1993) Depreciation of Fixed Assets—The Company depreciates its new aircraft, spares and spare engines over 10 years to 20% residual values. . . For used aircraft less than 5 years old, the Company depreciates them over the remaining life (10 years less age of aircraft) to 20% residual value. In the case of used aircraft more than 5 years old, they are depreciated over 5 years to 20% residual value. Excerpt from Singapore Airlines’ “Notes to the Accounts” (for fiscal year 1990) Depreciation of Fixed Assets—[Prior to April 1, 1989], the operational lives of the aircraft fleet were estimated to be 8 years with 10% residual values. . . [Effective] April 1, 1989, the Company depreciated its aircraft, spares and spare engines over 10 years to 20% residual values. . . . This arises from a review of the operational lives and residual values of the aircraft fleet. Note: Singapore’s assumptions regarding the depreciable life and salvage value of fixed assets other than flight equipment were quite different and were, in any case, unchanged in 1993. 10