Depreciation Accounting Method of Airjet Airways Ltd and the Lion Airlines Ltd - Case Study Example

RРОRАTЕ АССОUNTING АSSIGNMЕNT: САSЕ STUDY By Student’s Name Code + Course Name Professor University City/State Date Соrроrаtе Ассоunting Аssignmеnt: Саsе study Requirement 1 According to Horngren, Datar, and Rajan (2012), depreciation is the allocation of a portion of a fixed asset to the income statement to show the portion of the fixed asset that has been used up in generating the revenue for the company. There are various accounting methods for depreciation that are allowed by the international financial reporting standards, IFRS. Both Airjet Airways Ltd and the Lion Airlines Ltd have adopted the same depreciation accounting method which is the straight line method. Lucas & Rafferty (2008) observe that under the straight line method of depreciation, the company allocates the same amount of depreciation per year. This amount is arrived at by dividing the depreciable amount by the useful life of the asset being depreciated (Spiceland and Sepe 2001). The depreciable amount as, explained by Atrill and McLaney (2012), is the difference between the cost of the asset and the value of the same asset after its useful life, residual value. The useful life of the asset will usually vary depending on type of the asset and the activity level of the asset. The management usually determines this. For the year ending 30th June, 2013 for Airjet Airways Ltd and 31st March 2013 for Lion Airlines Ltd both companies have Aircraft, spares and spare engines as the major assets that are subject to depreciation. However, the two companies vary in the way they determine the useful lives of the fixed assets. Note that the useful life of an asset is very critical in determining the amount of depreciation to be recognized in that year with respect to that asset (Horngren & Harrison 2009). This brings about the differences in the amounts reported in the two companies. As noted in Steven, Roby, and Gregory (2008) a company with short life spans of the asset will always have a large depreciation amount than a company with long assets’ life spans. For instance, the useful life (in years) for aircraft and engines in the case of Airjet Airways Ltd is 20 years whereas the same asset in the case of Lion Airlines Ltd is 15 years. This means an asset costing the same amount under the two companies will report varying amount of depreciation in their financial statements. As noted earlier, various factors determine the residual value of an asset one of which is leaving the decision to the discretion of the management. According to Nickerson and Silverman (2003) and in Bazerman and Moore (2009), the management may be subjective in determining the residual value of the fixed assets. Since the two companies have different management hence decision made is different, there arises differences in determination of the residual values of the fixed assets, which in turn affects the amount of depreciation computed under the straight-line method of depreciation (Godfrey, Hodgson & Holmes 2006). For instance, the residual value for aircraft and engines in the case of Airjet Airways Ltd is 20% of the cost of aircraft and engines whereas the same asset in the case of Lion Airlines Ltd has a residual value equivalent to 10% of the cost of the asset. This means that the same asset will have different amounts of depreciation under the two companies. From the aforementioned, it is evident that Airjet Airways Ltd will report a lower amount of depreciation than Lion Airlines Ltd in its financial statements owing to the differences in the residual value of the fixed asset (Elliott & Elliott 2011). Requirement 2 Computation of depreciation expense using straight-line method Depreciation expense for AirJet Airways Ltd for the 2013 financial year with respect to ‘aircraft and engines’ Cost of aircraft and engines = $13,358,900,000 Therefore, residual value = 20%*$13,358,900,000 = $2,671,780,000 since the policy of the company is to set residual value at 20% of the cost of the asset. Depreciable amount = cost of aircraft and engines – residual value of aircraft and engines = $13,358,900,000 - $2,671,780,000 = $10,687,120,000 The useful life for aircraft and engines is 20 years hence the depreciation expense is as computed below $10,687,120,000/20 = $534,356,000 Therefore, depreciation expense for AirJet Airways Ltd for the 2013 financial year with respect to ‘aircraft and engines is estimated at $534,356,000. Depreciation expense for AirJet Airways Ltd for the 2013 financial year with respect to spare parts Cost of spare parts = $750,700,000 Therefore, residual value = 20%*$750,700,000= $150,140,000 since the policy of the company is to set residual value at 20% of the cost of spare parts. Depreciable amount = cost of spare parts – residual value of spare parts = $750,700,000 - $150,140,000 = $600,560,000 The useful life for spare parts is 20 years (the highest life span that results to the minimum depreciation charge) hence the depreciation expense is as computed below $600,560,000/20 = $30,028,000 Therefore, depreciation expense for AirJet Airways Ltd for the 2013 financial year with respect to spare parts is estimated at $30,028,000. Total depreciation expense for aircraft and engines and spare parts = $534,356,000 + $30,028,000 = $564,384,000 Depreciation expense for Lion Airlines Ltd for the 2013 financial year with respect to ‘aircraft and engines’ Cost of aircraft and engines = $17,718,100,000 Therefore, residual value = 10%*$17,718,100,000 = $1,771,810,000 since the policy of the company is to set residual value at 10% of the cost of the asset. It has been assumed that the aircraft and engines were new when acquired. Depreciable amount = cost of aircraft and engines – residual value of aircraft and engines = $17,718,100,000 - $1,771,810,000 = $15,946,290,000 The useful life for aircraft and engines is 15 years since it has it has been assumed that the aircraft and engines were new when acquired hence the depreciation expense is as computed below $15,946,290,000/15 = $1,063,086,000 Therefore, depreciation expense for Lion Airlines Ltd for the 2013 financial year with respect to ‘aircraft and engines is estimated at $1,063,086,000. Depreciation expense for Lion Airlines Ltd for the 2013 financial year with respect to spare parts Cost of spare parts = $1,306,100,000 Therefore, residual value = 10%*$1,306,100,000 = $130,610,000 since the policy of the company is to set residual value at 10% of the cost of the asset. It has been assumed that the spare parts were new when acquired. Depreciable amount = cost of spare parts – residual value of spare parts = $1,306,100,000 - $130,610,000 = $956,777,400 The useful life for spare parts is 15 years since it has it has been assumed that the spare parts were new when acquired hence the depreciation expense is as computed below $956,777,400/15 = $63,785,160 Therefore, depreciation expense for Lion Airlines Ltd for the 2013 financial year with respect to spare parts is estimated at $63,785,160. Total depreciation expense for aircraft and engines and spare parts = $1,063,086,000 + $63,785,160 = $1,126,871,160 Estimating the depreciation expense by exchanging the useful lives and residual values for the two companies Depreciation expense for AirJet Airways Ltd for the 2013 financial year with respect to ‘aircraft and engines’ Cost of aircraft and engines = $13,358,900,000 Therefore, residual value = 10%*$13,358,900,000 = $1,335,890,000 using the residual value policy of the Lion Airlines Ltd. Depreciable amount = cost of aircraft and engines – residual value of aircraft and engines = $13,358,900,000 - $1,335,890,000 = $12,023,010,000 The useful life for aircraft and engines is 15 years hence the depreciation expense is as computed below $12,023,010,000/15 = $801,534,000 since the useful life for aircraft and engines in the case of Lion Airlines Ltd is 15 years. Therefore, depreciation expense for AirJet Airways Ltd for the 2013 financial year with respect to ‘aircraft and engines is estimated at $801,534,000. Depreciation expense for AirJet Airways Ltd for the 2013 financial year with respect to spare parts Cost of spare parts = $750,700,000 Therefore, residual value = 10%*$750,700,000= $75,070,000 using the residual value policy of the Lion Airlines Ltd. Depreciable amount = cost of spare parts – residual value of spare parts = $750,700,000- $75,070,000 = $675,630,000 The useful life for spare parts is 15 years since the useful life for spare in the case of Lion Airlines Ltd is 15 years hence the depreciation expense is as computed below $675,630,000/15 = $45,042,000 Therefore, depreciation expense for AirJet Airways Ltd for the 2013 financial year with respect to spare parts is estimated at $45,042,000. Total depreciation expense for aircraft and engines and spare parts = $801,534,000 + $45,042,000 = $846,576,000 Depreciation expense for Lion Airlines Ltd for the 2013 financial year with respect to ‘aircraft and engines’ Cost of aircraft and engines = $17,718,100,000 Therefore, residual value = 20%*$17,718,100,000 = $3,543,620,000 using the residual value policy of the AirJet Airways Ltd. Depreciable amount = cost of aircraft and engines – residual value of aircraft and engines = $17,718,100,000 - $3,543,620,000 = $14,174,480,000. The useful life for aircraft and engines is 20 years since the useful life for spare in the case of AirJet Airways Ltd is 20 years hence the depreciation expense is as computed below $14,174,480,000/20 = $708,724,000 Therefore, depreciation expense for Lion Airlines Ltd for the 2013 financial year with respect to ‘aircraft and engines is estimated at $708,724,000. Depreciation expense for Lion Airlines Ltd for the 2013 financial year with respect to spare parts Cost of spare parts = $1,306,100,000 Therefore, residual value = 20%*$1,306,100,000 = $261,220,000 using the residual value policy of the AirJet Airways Ltd. Depreciable amount = cost of spare parts – residual value of spare parts = $1,306,100,000 - $261,220,000 = $1,044,880,000 The useful life for aircraft and engines is 20 years since the useful life for spare in the case of AirJet Airways Ltd is 20 years hence the depreciation expense is as computed below $1,044,880,000/20 = $52,244,000 Therefore, depreciation expense for Lion Airlines Ltd for the 2013 financial year with respect to spare parts is estimated at $52,244,000. Total depreciation expense for aircraft and engines and spare parts = $708,724,000 + $52,244,000 = $760,968,000 The table below is a summary and comparative analysis of the findings above Without exchanging useful lives and residual values Exchanging useful lives and residual values company Total asset Cost Total Depreciation expense Portion depreciated (%) Total Depreciation expense Portion depreciated (%) AirJet Airways Ltd 14,109,600,000 $564,384,000 4% $846,576,000 6% Lion Airlines Ltd 19,024,200,000 $1,126,871,160 6% $760,968,000 4% Absolute Difference $562,487,160 $85,608,000 The comparative analysis carried above shows that the depreciation policies for Lion Airlines Ltd yield higher depreciation than the depreciation policies at AirJet Airways Ltd. This is because the portion of the asset depreciated in financial year 2013 using depreciation policies for Lion Airlines Ltd is equivalent to 6% of the asset whereas when using depreciation policies for AirJet Airways Ltd is equivalent to 4% of the asset. Watts and Zimmerman (1986) and CCH Editors (2008) explain that such a discrepancy will result to overstatement or understatement of profit of one company in comparison with the other. Requirement 3 The company reviewed in this section is Qantas Airways Ltd. Its financial year ends 30th June of every year. It is listed in the Australian stock exchanges, ASX and its ticker symbol is QAN. The company was established in 1920 in Queensland and it is currently the largest domestic and international airline in Australia. In addition, the airline is the leader in long distance worldwide and the strongest brand in Australia. The group has two airline brands namely; Qantas and Jetstar, which operates in domestic market, regionally and internationally. The company is an employer of over 30,000 people with majority being based in Australia. The policy adopted by the Qantas group in relation to accounting method for depreciation is the straight-line method. The company uses the straight-line method to depreciate all property, plant, and equipment but does not depreciate freehold land. Qantas group calculates depreciation rates of owned assets in order to allocate the asset cost over the estimated life span of the asset. Acquired assets are depreciated from the date of acquisition but internally developed assets are depreciated from the date they are completed or are made available for use in the company. Any improvement cost in assets is depreciated over the estimated useful lives of the improvements or the useful life of the asset that is remaining as at that time whichever is the shorter period. The term of then relevant lease is used in depreciating the fixed assets under the finance lease. However, if the company is probable to gain ownership of the asset, then the life of the asset is used for depreciation. The policy of the company is to review and reassess the useful lives and residual values of its assets annually while taking into consideration the estimated life span of the asset, long term fleet plan and commercial and technological developments. Requirement 4 According to Black (2003), the amount depreciated for an asset is recognized as an expense in the income statement of the company. This helps to show the portion of the asset that was utilized in the generation of revenue for the company hence the reason for charging it against the income (Fess and Warren 2004). Varying depreciation policies result in different amounts of depreciation charged against the income of the companies as has been discussed above. The major differences arise from the use of different approaches in determining the useful lives and the residual values of the assets (Greuning 2005). A company using a lower residual value will usually produce a higher depreciation expense than a company using a higher residual value for the assets when using the straight-line method of depreciation. Similarly, a company using a lower useful life will usually produce a higher depreciation expense than a company using a higher useful life for the assets when using the straight line method of depreciation. Since depreciation expense is an item appearing in the income statement of the reporting company, a company with a lower depreciation expense will have a higher net income than a company with a higher depreciation expense (Hilton 2004). By extension, this will affect a number of financial ratios of the respective companies. For instance, the net profit margin of the company with a lower depreciation expense will be lower than the net profit margin of the company with a lower depreciation expense (Soffer & Soffer 2003). The return on equity ratio will also be affected since the net profit is an addition to the equity capital of the company (Picker 2009). References AASB (Australian Accounting Standards Board) 2004, Framework for the Preparation and Presentation of Financial Statements, Australian Accounting Standards Board, Melbourne Atrill, P & McLaney, E 2012, Management accounting for decision makers, 7th ed., Pearson education ltd, Harlow, England. Bazerman, M. H & Moore, D. A 2009, Judgment in managerial decision making (7th ed.), Wiley, Hoboken, NJ Black, G 2003, Students' Guide To Accounting and Financial Reporting Standards, Financial Times Prentice Hall, London CCH Editors 2008, Australian Master Accountants Guide, CCH Australia Limited, Sydney Elliott, B & Elliott, J 2011, Financial Accounting and Reporting (15th ed.), FT Prentice Hall, Harlow, England. Fess, E & Warren, C 2004, Accounting principles, Southwestern Company, Canada. Godfrey, J, Hodgson, A & Holmes, S 2006, Accounting theory, 6th edn, John Wiley & Sons Australia, Brisbane Greuning, H. V 2005, International financial reporting standards: A practical guide, Routledge, New York. Hilton, R. W 2004, Managerial Accounting: Creating Value in a Dynamic Business Environment, McGraw-Hill Publisher, New Delhi Horngren, C. T & Harrison, W. T 2009, Accounting (7th ed.), Pearson Prentice Hall, Upper Saddle River, NJ Horngren, C. T, Datar, S. M & Rajan, M. V 2012, Cost Accounting: A Managerial Emphasis, (14th ed.), Pearson Prentice Hall, Upper Saddle River, New Jersey Lewis, R & Pendrill, D 2004, Advanced Financial Accounting (7th ed.), FT Prentice Hall, Harlow, England. Lucas, M & Rafferty, J 2008, ‘Cost analysis for pricing: exploring the gap between theory and practice’, The British Accounting Review, vol. 40, no.2, pp.148-160. Nickerson, J & Silverman, B 2003, ‘Why firms want to organize efficiently and what keeps them from doing so: Inappropriate governance, performance, and adaptation in a deregulated industry’, Administrative Science Quarterly, vol. 48, no. 3, pp. 433–465. Picker, R 2009, Australian accounting standards, John Wiley & Sons Australia Limited, Australia Soffer, L & Soffer, R 2003, Financial statement analysis, Prentice Hall, Upper Saddle River, NJ Spiceland, J. D & Sepe, J.F 2001, Intermediate Accounting, McGraw-Hill Publisher, New Delhi. Steven R. J, Roby, B. S & Gregory, J 2008, Managerial Accounting: A Focus on Ethical Decision Making, Cengage Learning, New Jersey Watts, R & Zimmerman, J 1986, Positive accounting theory, Prentice Hall, Englewood Cliffs, NJ Read More