Behavioral Implications of Airline Depreciation Accounting Policy

Case Summary:

This case examines the decision-making implications of one seemingly important accounting policy choice decision. The example is of aircraft depreciation accounting for airlines. This example was chosen because property, plant, and equipment (PP&E) comprises more than 50% of the total assets of an airline, and aircraft are a large proportion of the PP&E. Further, airlines depreciation policies vary significantly

Case Questions:

Assume that at least some rewards for the management team (and, hence, also other employees) are based on performance measured in terms of accounting income and returns on net assets. Also assume that all of these airlines are growing; that is, they are adding to their fleet of aircraft.

1. What are the behavioral implications of each of the three depreciation-related accounting policy choices:

a. Depreciation patterns (i.e., straight-line vs. accelerated);

b. estimated useful lives; and

c. residual values?

1. Consider, at a minimum, the effects of each of these choices on decisions regarding:

a. replacements of aircraft in service;

b. pricing, assuming that prices are at least somewhat dependent on costs;

c. evaluations of routes or lines of business;

d. evaluations of managers, assuming that negotiated budgets provide the primary standards of performance.

1. If the managers of a particular airline do not want to maintain a third set of books, should they tend to be conservative or liberal in their aircraft depreciation accounting?