1.

What are some of the possible reasons why Delta may have extended the lives of flight
equipment and changed residual values four times since 1986?

It is understood that the there are a multitude of factors that affect the useful life of flight
equipment. These factors include unexpected dynamics such as technological improvements.
Therefore, it might be reasonable to suppose that the estimates of the useful might change
with changes in these factors. For instance, ten year was the standard useful life of the
airplane in the starting years of commercial operations. However, with the advent of more
sophisticated technology, the useful life for airplanes started to increase. Thus, it is not
surprising that delta used a useful life of ten years prior to mid 1980s, but increased the useful
life thereafter. Similarly, it is normal for Delta to reassess its assets after the reorganization in
2007. As part of the revaluations, it makes sense that the company also adjusts the useful life
and salvage value of the equipment. However, these were not the only occasions on which
the company changed its depreciation policy. In fact, there were two other occasions,
between 1985 and 2007, when the company extended the lives of its equipment.

It is hard to believe that the revisions in useful life were due to a factor such as technological
improvements. Technology might improve the useful life of new equipments, but the existing
(old) airplanes should not yield a longer useful life. It is a common practice for companies to
manipulate their earnings by changing their accounting policies without substantial economic
reason behind the change. A longer useful life results in lower depreciation expense for each
year. A lower expense results in higher earnings. Moreover, the practice might not even result
in additional taxation on higher earnings because the calculation of depreciation for tax
purposes is different from the calculation of accounting depreciation. Such earnings
manipulation can be expected in the airlines industry where tough competitive environment
in recent years has lead to lower earnings for established airlines. Therefore, there is
sufficient rationale to believe that Delta might have extended the life of flight equipment to
boost its earnings. However, such practices reduce the quality of earnings because the
increase in earnings is not backed by the core operations of the airlines and is not sustainable.

2. Assume Delta purchased the following six aircrafts:

Yea Price ($ Aircraft

What would have been the assumed residual value of each aircraft and the first-year
depreciation for each aircraft? (Use 25 and 30 years for estimated lives after 1998 and
residual values of 5% for 1993 through 2006 and 10% of cost for 2007)

The aircrafts were purchased at various points in time where the company had different
depreciation policy. It is important to note that the company has revalued all of its equipment
following the recent reorganization and all the current equipment is subject to a similar
depreciation policy. However, the depreciation policy at the time of the purchase of many of
the afore-mentioned aircrafts was inconsistent. Therefore, the company’s estimate of salvage
value and useful life at the time of the purchase of the aircrafts may differ. The following
table states the applicable depreciation policy (salvage value and useful life) at the time of the
purchase of each aircraft, and then calculates the estimated residual value and initial
depreciation after the purchase:

Estimated
Price Applicable Applicable Initial
Yea Residual
Aircraft ($ Salvage Value Useful Life Depreciation
r Value ($
millions) (% of cost) (years) ($ millions)
millions)
1985 MD88 33 10% 3.30 10 3.30
1988 MD88 39 10% 3.90 15 2.60
1992 B-757-200 66 10% 6.60 15 4.40
1993 B-757-200 68 5% 3.40 20 3.40
B-777-
2006 210 5% 10.50 25 8.40
200ER
B-777-
2007 220 10% 22.00 30 7.33
200ER

The results highlight that, with the passage of time, the initial depreciation following the
purchase of aircraft has decreased in proportion to cost of the equipment. This observation
can be clearly authenticated by looking at the initial depreciation and price (cost) of the last
two aircrafts. Although the aircraft purchased in 2007 costs more the aircraft purchased in
2006, the initial depreciation on the newer aircraft is lower because of the changes in
depreciation policy.

3. Assume each aircraft in question 2 is still in Delta’s fleet in 2007. How would you
estimate the net book value of aircraft before application of “fresh start” accounting in
2007? How would this compare to the “fresh start” value that Delta estimated in 2007 as
described in the notes from consolidated financial statements included in the Form 10-K
and the case?

The net book value of each aircraft can be calculated by sub

Assume that each aircraft in Question 2 is still in Delta's fleet in 2007. How would you
estimate the net book value of aircraft before application of "fresh start" accounting in 2007?
See attached spreadsheet How would this compare to the "fresh start" value that Delta
estimated in 2007 as described in the notes from the consolidated financial statements
included in the Form 10-K and the case? The NBV’s prior to the fresh start values are higher
than the fresh start values. The fact that Delta as part of the fresh start values, reduced by $1
Billion the property and equipment to fair value confirms this. It would be logical that the
older planes were reduced substantially below the NBV values to fair value due to their age.
The more recent planes from 2006 forward most likely did not have a fair market revaluation
as substantial (as a % from NBV to fresh start value) as the older planes. In addition, as part
of the fresh start process, Delta adjusted the depreciable lives of flight equipment to reflect
revised estimated useful lives. As a result, depreciation expense decreased by $127 million in
2007. As a result of all of these changes (as seen in exhibit 4 in the property and equipment
section of the balance sheet) accumulated depreciation was reduced from $6.8 billion in 2006
to $299 million in 2007 4. How should the net book value of each aircraft have been
established for the "fresh start" balance sheet for December 31, 2007? For each aircraft how
would you have established the depreciation for 2007? The NBV on December 31, 2007
would be established by first taking the revised fair value as determined in SFAS No.157,”
Fair Value Measurements” (SFAS 157). You would then reduce this new fair value by 8
months of depreciation from May 1, 2007 to December 31, 2007. The depreciation for the
first 4 months would have been established based on the useful livespriorto SFAS No.157,”
Fair Value Measurements” (SFAS 157). The depreciation for the last 8 months would have
been established based on the useful lives afterSFAS No.157,” Fair Value Measurements”
(SFAS 157)

PEP ACCT652 Delta Assignment Hi guys. I just want to give you a few clarifications for the
Delta Airlines assignment. For Question 2—sorry about the confusion. If you look at the
Exhibit 1 in the case study you’ll realize that for planes between 1998 and 2006 they have
two residual values: 5% and 10%. And then you have the same range of numbers for
estimated useful life of planes bought in 2007: 21-30 years. In the write-up of the assignment
I put in a typo. It should say “use 25 years and residual values of 5% for planes between 1998
through 2006.” That’s where my typo was. I wrote “1993.” So 1998 to 2006, and then use 30
years and 10% for planes acquired in 2007. And then what you should do is set it up like that:
what is useful life of the planes, what is the residual value, what’s the first year depreciation?
Now, for Question 3, what I want you to do is what would be the netbook value of those
planes if I would have just continued with the same
form of depreciation, if nothing would have changed—if Delta would have never filed for
bankruptcy. Now, be careful: if a plane is written down or depreciated to its residual value,
then there is no further depreciation, so that’s probably going to be the case for the planes
purchased earlier on, in ’85 for example. If it depreciated for its useful life, and you reached
the residual value, then there’s no more depreciation. For other planes that may not be the
case. And then what I want you to do for Question 3 is also compare this to the fresh-start
accounting. So, now, the fresh-start accounting—there’s different ways you can think about
it. So, for Question 3, what I want you to do is just do you expect the netbook value to be
higher or lower based on the fresh-start accounting. So, I want this to be somewhat more
descriptive. Then for Question 4, I want you guys to go into more detail. So I want you to
look at Exhibits 2-5 in the case study. I also want you to look at what does Delta say in their
10-K. They talk about fresh-start on page 24, and then on page F-20. And also provide a brief
write-up. Now, here I also want you to do calculations. And I know 3 and 4 somewhat go
hand-in-hand, but for 4 specifically I want you to look at how many planes would they still
have based on—how many planes do they still have in the fleet. And then, in Exhibit 3 they
tell you what a price of such a plane would be—what the current market price of such a plane
would be. So you can calculate how many planes do they have, what would the current
market price be, and then while we sort of have to estimate depreciation. If that’s the useful
life, by how much would it have depreciated in the first year? And then what you can do is
compare this to Exhibit 4. What was actually the depreciation they calculated? And then
Exhibit 5, what are they actually valuing their aircrafts at in their 2007 financial statements.
And hopefully you will be able to draw a conclusion based on what it looked like originally,
what it should look like using market prices coming out of Exhibit 2 and Exhibit 3, and then,
what did they actually report. Hopefully that made this a little clearer. If you have any
additional questions please send me an email. Thanks