The Aircraft Depreciation Dilemma

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    Independent research done, with unique instruments of aircraft

    efficiency to display how each aircraft plays in the lease rates and

    values within the market, can be requested by:

    -email ([email protected])

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    -private inbo on linked social media pa!es.

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    #arket depreciation typically accounts around $%& of total costs,

    and can reach upto '%& of total operational costs. ith

    depreciation defined as an implicit cost measure of decline in value

    of a particular asset over periods of its lifespan, it is ever so relevant

    to the aviation industry namely aircraft assets (diverse catalysts),currency, and capital stock havin! coeistin! impacts on the bottom

    line of aviation supply chain businesses. *espite bein! a science in

    its very own ri!ht, this article piece will tap into how different

    businesses across the chain handle depreciation of assets

    (especially aircraft), contetuali+ed to a macroeconomic industry-

    wide understandin!. his will allow a new spectrum and

    understandin! of conversation, coeistence and oint-operations

    between one supply entity and another.

    *epreciation is char!ed to the profit and loss account in order to

    reflect consumption of investment in assets over the period. a

    *epreciation is the !overnments procedure for epensin!, or

    /writin! off0 the chan!e in an assets value over time. adepreciation is an artificial depreciation based on law, not the

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    markets treatment of the asset. 1ook *epreciation is the term

    commonly used to refer to the depreciation epense shown on a

    companys financial statement (or the /books0). 1ook *epreciation

    is tied into le!al and accountin! principles. 2esidual value is the

    amount an entity could receive for the asset of a!e and condition it

    will be in when disposed of (without inflation). wo si!nificant

    accountin! estimates mana!ement uptakes to estimate

    depreciation rates are useful lives and residual values of assets

    (namely aircraft). 3seful life is the period over which an asset is

    epected to be available for use by an entity. 1usinesses

    periodically review whether useful lives are appropriately set, and

    subsequent alterations are displayed also as an implicit cost.

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    #arket *epreciation is a widely chan!in! variable based on thevalue of the asset in the marketplace. 3ntil the asset is sold, no one

    really knows the eact market value of the asset. 4nce an asset is

    sold, the difference between what the assets was purchased for

    and the eventual sellin! price is referred to as #arket *epreciation.

    5ircraft, unlike automobiles and other equipment, tend to retain

    more of their value for a lon!er period of time. imin! is a bi! factor.

    he economic markets are in constant flu. 6our trends as follows:

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    5ircraft values hold their own or even increase with stron!

    economic conditions.

    In an economic downturn, aircraft prices call fall as quickly asthe stock market.

    5s a !eneral rule, aircraft prices tend to follow the lar!er

    business cycles. hen businesses are !rowin! and profitable,

    demand for aircraft increases.

    5s demand increases, the available supply will decrease, and

    then used prices will rise. hen the business cycle declines, the

    reverse is true.

    Inflation helps market depreciation due to the inflated value of

    money helpin! retain aircraft value.

    he rule of thumb for depreciation is 7-'& per annum.

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    6actors associated to depreciation include:

    economic repair lives (dictated by manufacturer and valuers in

    demand for parts, maintenance requirements)

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    fleet deployment plans (ri!orous use dictates hi!her cycles,

    wear and tear, hi!her #24 requirements, lower useful life and

    hence needs hi!her depreciation)

    technolo!ical chan!e (new technolo!y and presence in the

    market quickens replacement requirements)

    overall development of aircraft asset portfolio

    aircraft related fied-asset depreciation

    8e!al constraints.

    *epreciation methods by the book include strai!ht line (seldom the

    case but most often used) and diminishin! (reducin!-balance)

    method. hile strai!ht line is simply ori!inal amount minus residual

    value all over asset life. he reducin! balance takes into account

    accelerated (or decelerated) rates of depreciation over time

    contin!ent on the differences between net book values over the

    period.

    6or airlines, the best way to !o about facilitatin! !reater profit

    mar!ins is to depreciate the aircraft, and accumulate ta credits and

    breaks. he current methodolo!y for aircraft in the 39, in fact for all

    manufactured capital assets used in business today, !o back to the

    days of the 2ea!an 5dministration and the conomic 2ecovery 5ct

    of ;redit (some of you may still remember those days) as well as the

    old lon!er term depreciation, with a new, more attractive shorter

    recovery period, referred to as the #odified 5sset >ost 2ecovery

    9ystem (#5>29). ?enerally speakin!, the interpretation was and

    still is that aircraft owned and operated pursuant to 652 art

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    choose the five year schedule while those aircraft operated under

    652 art ;$A and commercially operated aircraft utili+ed the not

    quite as attractive, seven year methodolo!y. 5nd by the way, the

    schedules are not linear. he five year schedule, as an eample,

    does not recover at B%& per year. Instead, the code is set for the

    followin! methodolo!y:

    Cear 4ne D B%&

    Cear wo D $B&

    Cear hree D B%&

    Cear 6our D AB&

    Cear 6ive D AB &

    Cear 9i D A.E'&

    5s we all know, depreciation under the current ta code is a ta

    /deduction0 for the benefit of the entity who has placed the asset

    into service, assumin! they are a current ta payer. his is

    be!innin! to roll out across the !lobe to sustainably mana!e

    domestic industries and facilitate ta cost minimi+ation. he 39 also

    sports he 5merican apayer 2elief 5ct of B%;B etended the A%&

    bonus depreciation allowance throu!h the end of B%;$ for qualifyin!

    property, which may allow A%& of the cost of the aircraft to be

    deductible in the first year of purchase ( a credit rather than an

    actual sped devaluation in assets). 9in!apore on the other hand,

    has liberal rules and ta breaks on aircraft, of which is classified

    under machinery and plants depreciation rates rules !overnin!

    leniency for both credits and quickened depreciation of aircraft

    facilitatin! shorter useful life. Few Gealand re!ulatory bodies also

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    allow for as little as A years till an aircraft can be fully depreciated

    with respective ta credits. #any airlines to date, utili+e depreciation

    capability to sustain lower ta costs from taable income

    demonstrated.

    In 5ustralia, the 5ustralian and International ilots 5ssociation has

    called once a!ain for depreciation rates on new aircraft to be

    accelerated to brin! 5ustralia into line with urisdictions in which

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    forei!n competitor airlines operate. 5I5 resident >aptain 1arry

    Hackson states the concern of strin!ent depreciation re!ulations to

    protect !overnment revenue streams over the competition

    competency of 5ustralian airlines, as follows:

    Qantas pilots have been pushing for accelerated depreciation

    rates as part of a package of measures to redress the imbalance in

    the international airline investment environment for two years. We

    have conducted this push without the support of Qantas

    management, however I was glad to see Corporate Affairs

    pokeswoman !livia Wirth making a similar call in today"s press. It

    currently takes #$ years for Australian airlines to write%off a new

    aircraft. While a reduction to a five%year write%off would at least

    match the rate available to Air &ew 'ealand, it would fall short of

    matching the investment environment of the ma(or international

    airlines flooding our market. )or e*ample, ingapore Airlines can

    depreciate its aircraft over three years. Accelerating our localdepreciation rate would help Qantas + and indeed all other

    Australian international airlines + to compete against advantaged

    foreign competitors. After opening our skies to foreign airlines

    Australia should not make it even more difficult for our international

    airlines to compete through uncompetitive ta*ation arrangements.

    We need to think of the impact on Australia"s national interest if we

    allow this nation to become a mere stop%over in an air transport

    system provided entirely from overseas. When Qantas C! Alan

    -oyce grounded the fleet last year the effect was devastating. !ne

    shudders to think about a situation down the track when such a

    decision might be made by a C! offshore without any redress in

    Australian courts.

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    hile book depreciation is crucial, airlines are required to preserve

    their aircraft efficiently throu!h means of operational rationali+ation,

    balancin! in-house and outsourced works, and whether to lease or

    purchase (with portfolio facilitations for buy-leaseback for hi!h

    equity low-prospective carriers). nvironmental inputs of the

    replacement market (both throu!h leasepurchase market), finance

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    capability, re!ulatory structures, profitability, cost-mana!ement

    involvement, maintenance needs and fleet requirements drive the

    write-downs of aircraft too.

    4ther airlines lookin! into the secondary and used market (typically

    cash and ownership oriented airlines, or periods of hi!h interest

    rates), look to maimi+e book and a!!lomerated depreciation of

    previous owners to levera!e lower acquisition costs (even for

    ownership of new mature late-delivery aircraft). his achieves the

    !reater obective of takin! advanta!e of lower capital costs for used

    planes and reapin! a lon!er commercial lifespan for those aircraft

    with its in-house maintenance crews.

    5n eample is where 2ichard 5nderson (>4 of *elta 5irlines)

    mentioned an /aircraft bubble0 and oversupply, ecess competition,

    and cannibali+ation of aircraft within seatin!payload brackets./he

    aircraft market is !oin! to be ripe for *elta over the course of thenet ;B to $' months. rices are !oin! to !et lower. 5

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    #eanwhile, both 6ed and 39 top up new E'E orders (old air-frame optimi+ed for car!o) from 1oein! to replace their even older

    *>-;%, #*-;;, 5$%% and 5$;% fleets (with approimately ;%& lover

    unit operatin! costs than the *>-;%). his is thanks to cash-

    orientation, maimi+ation of current supply chain maturity in the

    market, and full control of operations without strin!s pulled by

    lessorsfinanciers.

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    he leasin! market has been especially active recently, with an

    influ of capital and investors becomin! increasin! drawn to this

    lucrative sector. 8essors have a similar demand by the book, and

    ensure that the aircraft are not physically depreciated as from the

    book. reservation to reduce overhaul maintenance requirements,

    and etend life-span of the aircraft are predominantly done throu!h

    supply-a!reements (maintenance, services, discountin!, delivery-

    fleibility, options-fleibility, cancellation-capability and !uarantees

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    independently ne!otiated) and demand-a!reements (operations

    outline, operational parameters, oversi!ht-capability, de-risk

    implementations, offsettin! costs, ri!orous price-ne!otiations and

    !uarantees with customers).?iven the ludicrous competition in the

    leasin! market, lessors are often forced to (similar but to !reater

    etent for lessors) disproportionately depreciate and fluctuate rates

    in which stock is written down. ypical leasin! prices is ;;%%th of

    aircraft value per month, and strive to ensure balance is made

    between the market value and base value for any type of aircraft

    (transferable niche facilitation and development-

    investmenttraectory)

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    6or manufacturers, depreciation of their produced aircraft reflects

    on a frames ability to remain financially efficient in the marketplace.

    he rate of depletion in current market value dictates the

    requirement of an airframes producer to refresh and re-strate!i+e

    the aircraft. >orrelations between the current market value and

    base value market correlations distin!uish the traectory of aircraft

    values. 5dustments to the market value !iven inputs must be

    reco!ni+ed by an airframe manufacturer, with

    competitiveenvironmental inputs and current business state

    definin! capability to refresh an aircraft model. Lalue retention

    factors manufacturers tar!et for is:

    5 si+able order backlo! to adust manufacturin! operations

    !radually, and dictate aircraft productions and adustmentsphase-

    outs.

    Improve market penetration throu!h various means. his

    includes manufacturers outsourcin! works and services to tap

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    better in the respective markets (ianin, 395 etc.), tender for

    emer!in! economies and !rowth centres, liberali+ation of

    manufacturin! works operations, improve diplomatic ties and trade

    facilitations, and !eneral marketin!.

    Increasin! the product life-cycle of an air frame. his can be

    done by utili+in! the versatility of an aircraft to tap into versatile

    aircraft requirements for operators. 5n airframe eamples include

    the 5$$% 2e!ional (usin! parts availability, depreciation rates and

    operator-trends to allow an aircraft for hi!h-density shortmedium-

    haul services, and hi!h weartear). #eanwhile for en!ines, power-

    plant manufacturers facilitate for paper de-rates, performance

    improvement packa!es, discountin! of stock, and maintenance

    !uarantees (complementary service provisions).

    6leibility from surplus and shorta!e inputs of an aircraft type.

    his is done throu!h mana!in! trou!hs and crests in aircraft

    demand, reco!ni+in! macroeconomic inputs, and rationali+in!

    outputs from the business.

    5ffiliations and relationships between manufacturers and

    customers are crucial for retainment even after the sale, as a way

    for a manufacturer to mana!e the second-hand and lease markets.

    2eco!ni+in! behaviors customers undertake can allow

    appropriation of responses to aircraft requirements. his is seen in

    ali!nment of understandin!s, parameters the aircrafts operate

    within, demand and supply rationali+ation, and even as far as oint

    operations.

    >losely linked to above, accommodatin! for financin!

    requirements, competitive environments and operator-needs is

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    crucial to retain the value and fleibly allow aircraft valuations. his

    includes re-en!ines, re-win!in!, and pa-frei!hter conversions.

    3nderstand when a pro!ram ends, and facilitate replacementand retirements.

    5nd of course, improvin! the aircraft specs, economics and

    technolo!y incrementally on the air-frame, while also

    accommodatin! diversification and minimi+in! cannibali+ation of a

    manufacturers product line.

    >onsolidation industry-wide of customers (lessors and airlines

    especially) improve ne!otiation and discountin! power of demand,

    hence hinder the manufacturers capability to retain value of

    aircraft, hence resultin! in pushed-hi!her list prices.

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