Testing for This to Work

Depreciation at Detta end Pan Am

Net property and equipment at Pan Am Corporation represented approximately 52 % of total assets at December 31, 1988. This was down from about 54% at the end of 1987. Pan Am's fleet

at year end increased to 140 aU=ft. up were depreciated over periods ranging fro (See excerpts from Pan Am Corporation's"

year (see ExIu"bit3.)_~. aircraft

.

0 Consolidated Financial Statements" in Exhibit

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4.) Required'

(A)

(B) (C) 1.

2.

3.

4.

.

l~~OUS

18 0 25

The followingare hypothetical events:

, and a residual value

~as used.

On January 1, 1989, the company purchases and takes delivery of a new Boeing 747 aircraft. The cost is $50 million.

. On January 1, 1993, the company extends the life of the aircr~_ by five years. On December 31, 1999. the plane is sold for $20 million.

(a) Estimate how Delta and Pan Am would account for the above events. Compute depreciation expense for each year through 1999. Ignore the effect of income

taxes.

.

(b) Repeat (a) above assuming that both airlines use the double declining balance method of depreciation.

Are the differences between the way each airline accounts for depreciation significant? Why would companies depreciate the same aircraft using different lives and residual values? What reasons could be given to support these differences? Is different treatment proper?

Both Delta and Pan Am extended the lives of certain aircraft in fiscal 1987. Under what circumstances do you believe that the extension of service Jives is proper?

How would your answer to Question 1 change if the aircraft were leased instead of . purchased, and if the transaction qualified as a capital lease? Assume that the PI:eSent value of future minimum lease payments is $50 million and that the implicit interest rate is 12%. Further assume that the length of the lease for each company is the same as the csrim",ed useful life of the aircraft. (For this question ignore events (B) and (C).)