Principles of Accounting and Depreciation Methods
As commented by Bragg (2017), depreciation could be defined as the systematic distribution of the cost of an asset over its useful life in order to match the systematic allocation with the revenue generated from the asset. Few examples include building, equipment, furniture along with plant and machinery, as these are depreciable assets. However, the only exception is land, since its value appreciates with the passage of time.
The current reporting of depreciation is dependent on two principles of accounting, which are described briefly as follows:
Cost principle:
According to this principle, the amount of depreciation disclosed in the income statement and the amount of asset disclosed in the balance sheet statement needs to be dependent on the original asset cost.
Matching principle:
According to this principle, the cost of an asset could be distributed to depreciation over the asset life. As a result, the asset cost is segregated with some cost disclosed in the income statements issued at the time of asset life. By distributing a part of the cost of the asset to the income statement, a part of the asset cost with each year where the asset is used is matched (Cooper 2017).
The two prevalent depreciation methods used in accounting mainly comprise of the following:
Straight-line depreciation method:
This is the most widely used and simplest method, which is computed by taking the acquisition or purchase price of an asset from which the salvage value is deducted. The result is divided by the economic life of the asset for which the years could be expected reasonably in order to benefit the organisation.
Reducing balance method:
In case of the above-stated method, a certain percentage is written off from the asset value every year. As a result, it leads to reduced value, which is the result of the asset cost less depreciation until date (DiTommaso, Warren and Richard 2017).
Qantas Airways Limited is an Australian flag carrier and it is the biggest airline in terms of fleet size, global flights and global destinations. The main services of the airline include passenger and freight air transportation services in Australia and global nations. As of 30 June 2017, the number of fleets has increased to 309, which was 303 in 2016 (Investor.qantas.com 2018).
Virgin Australia Limited is a major player in the Australian aviation industry involved in the operations of domestic and global airline business. As of 30th June 2017, the fleet of Virgin Australia Limited comprises of the following aircraft:
Comparison of Qantas Airways and Virgin Australia Limited
It has been observed from “Page 69 of the Annual Report of Qantas” under the notes to financial statements; accumulated depreciation and impairment are recorded in the section of property, plant and equipment. These values are deducted from the purchase price at the date of acquisition to arrive at the net book value (Dvo?ák and Lukáš 2017). Virgin Australia Limited follows the similar procedure in recording its accumulated depreciation and impairment, as evident from its “Page 70 of the Annual Report”. In addition, both the organisations use the straight-line method of depreciation for arriving at the book values of their assets.
It has been identified that the different classes of assets have different rates of depreciation; however, Virgin Australia Limited has not disclosed the salvage values in its annual report that Qantas has disclosed in its annual report. The impact of the straight-line method is a stable and uniform minimisation in revenues and values of assets in each accounting period of the useful life of the asset (Fekiri and Ezzeddine 2018). Since both the organisations are involved in using the straight-line method of depreciation, the same depreciation expense is charged in all the accounting years across the useful life of the assets.
For instance, it is assumed that Qantas has purchased aircraft spare parts worth $50,000 with a useful life of five years, while Virgin has bought aeronautic-related asset worth $63,000 having a useful life of seven years. It is further assumed that both the assets have no residual values. The depreciation expense for the first year in case of Qantas is $10,000; while in case of Virgin, it would be $7,000. In both situations, depreciation expense would be debited and accumulated depreciation would be credited. The depreciation expense is recorded in the income statement in the form of minimisation to revenues, while accumulated depreciation is recorded in the form of contra account to the related assets. Hence, the asset costs are minimised to their book values, while the net income is reduced as well.
The useful lives of Qantas and Virgin for various classes of assets are depicted as follows:
As observed from the above two tables, it could be stated that the useful life of an asset is different in Qantas in contrast to Virgin. The primary reasons behind such variation are described briefly as follows:
The physical factors are significant especially to project the useful life of buildings, which include decay, casualty like flood and fire along with wear and tear (Karwowski 2016). These factors would lead to retirement of the building. Thus, maintenance plays a significant role in extending or shortening the useful life of an asset. In case of both Virgin and Qantas, the useful life of buildings is estimated between 30 years and 40 years.
Reporting Requirements for Asset Impairment
These factors would have impact on equipment, machinery and aircraft maintenance parts. Equipment could be obsolete even before its technical life (Maffei 2016). In addition, such factors have effect on the residual values as well. In case of Virgin, there are no residual values for assets, while for Qantas; residual values are estimated for all depreciable rates. Thus, this factor could be a primary reason behind the different useful lives for different entities.
It is necessary for the organisations to take into account whether they would use assets with identical amounts every year across their useful lives. In such situation, the organisations need to have the discretion of using the straight-line depreciation method. On the other hand, Qantas Airways Limited and Virgin Australia Limited could select the reducing balance method, if it apportions higher amount of depreciation expense to the initial years of lives of their assets rather than the later years.
The factors that would have direct impact on the useful lives of assets like aircrafts comprise of the following:
- The estimated asset usage and whether any other management team could manage aircrafts in an effective fashion, which could have adverse repercussions on the overall lives of the assets
- Technological, technical and other kinds of obsolescence for ascertaining the rates of depreciation and impairment to be realised, if any (Shaari, Tongyu and Ray 2017)
- If the rivals come up with better aircrafts having greater performance, the life of the existing tangible asset might decline
- If aircrafts are not maintained adequately, there would be drastic minimisation in the useful lives of the aircrafts and sometimes maintenance needs considerable amount of resources
An asset of an organisation is said to be impaired, which has a market value lower than the price listed on the balance sheet statement of the organisation. Hence, the recording of impairment is to be made, if the estimated future cash flows could not be recovered (Small, Lucinda and Achmad 2017). For both Qantas and Virgin, the reporting requirements of asset impairment are discussed as follows:
- In case, there is indication of impairment, the recoverable amount related to the asset needs to be ascertained.
- The asset is said to be impaired, if it’s recoverable amount is lower in contrast to the carrying value.
- Extensive revelation is needed for the impairment test and any realisation of impairment loss (Souissi 2017).
- Impairment loss realised in previous periods for an asset needs to be reversed, if there is variation in estimates used in ascertaining the recoverable amount of the asset.
References:
” Investor.qantas.com.”. 2018. https://investor.qantas.com/annual-report-2017/.
“Virginaustralia.com.”. 2018. https://www.virginaustralia.com/cs/groups/internetcontent/@wc/documents/webcontent/~edisp/2017-annual-report.pdf.
Bragg, Steven M. Fixed Asset Accounting. AccountingTools LLC, 2017.
Cooper, Steve. “Taking a measured approach.” Investor perspectives (2015): 1-7.
DiTommaso, Marie, Warren Ruppel, and Richard F. Larkin. “LONG?LIVED ASSETS, DEPRECIATION, AND IMPAIRMENT.” Wiley Not?for?Profit GAAP 2017: Interpretation and Application of Generally Accepted Accounting Principles (2017): 335-346.
Dvo?ák, Martin, and Lukáš Poutník. “The Comparative Analysis of CAS and IPSAS Requirements on Tangible Fixed Assets.” In New Trends in Finance and Accounting, pp. 497-510. Springer, Cham, 2017.
Fekiri, Kamel, and Ezzeddine Abaoub. “Relationship between Specific Accruals and Disclosed Accounting results of companies in financial failure.” Global Journal of Management And Business Research (2018).
Karwowski, Mariusz. “The risk in using financial reports in the study of airline business models.” Journal of Air Transport Management 55 (2016): 185-192.
Maffei, Marco. “Amortization and Depreciation.” Global Encyclopedia of Public Administration, Public Policy, and Governance (2016): 1-7.
Shaari, Hasnah, Tongyu Cao, and Ray Donnelly. “Reversals of impairment charges under IAS 36: evidence from Malaysia.” International Journal of Disclosure and Governance 14, no. 3 (2017): 224-240.
Small, Rashied, Lucinda Smidt, and Achmad Joseph. “Impairment of assets-does it actually matter?.” Professional Accountant 2017, no. 30 (2017): 20-21.
Souissi, Mohsen. “Fair Value or Cost Method: Analytical Hierarchy Process to Multiple Criteria Problem.” (2017).
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