The Aircraft Depreciation Dilemma

7/24/2019 The Aircraft Depreciation Dilemma

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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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The Aircraft Depreciation Dilemma