Harvard Case - Depreciation at Delta and Pan Am
"Depreciation at Delta and Pan Am" Harvard business case study is written by William J. Bruns Jr., Eric J. Petro. It deals with the challenges in the field of Accounting. The case study is 10 page(s) long and it was first published on : Sep 8, 1989
At Fern Fort University, we recommend that Delta Air Lines adopt a more comprehensive and transparent approach to depreciation accounting, aligning its practices with industry best practices and regulatory requirements. This involves a thorough review of its current depreciation methods, considering factors like asset life, usage patterns, and technological advancements. Delta should also explore the potential benefits of adopting activity-based costing (ABC) to better allocate depreciation expenses across its diverse operations.
2. Background
This case study examines the contrasting depreciation accounting practices of Delta Air Lines and Pan American World Airways (Pan Am) during the 1980s. Delta, known for its conservative approach, used a straight-line depreciation method, while Pan Am employed accelerated depreciation methods, aiming to maximize tax benefits. This difference in accounting practices significantly impacted their financial statements and ultimately contributed to Pan Am's financial struggles and eventual bankruptcy.
The main protagonists of the case are:
- Delta Air Lines: A successful airline known for its conservative financial management and focus on long-term profitability.
- Pan American World Airways: A once-dominant airline that faced financial difficulties due to aggressive expansion, fluctuating fuel prices, and competition.
- The accounting profession: The case highlights the role of accounting practices in shaping corporate performance and the importance of transparency and consistency in financial reporting.
3. Analysis of the Case Study
This case study can be analyzed through the lens of financial accounting and management accounting.
Financial Accounting:
- Depreciation Methods: Delta's use of straight-line depreciation, while conservative, provided a more accurate reflection of the true economic decline in asset value. Pan Am's accelerated depreciation methods, while beneficial for tax purposes, overstated earnings in the short term and ultimately contributed to a distorted view of its financial health.
- Financial Statement Analysis: The contrasting depreciation methods significantly impacted the two airlines' financial statements, particularly their income statements and balance sheets. Pan Am's accelerated depreciation led to higher reported profits in the early years, which could have misled investors and creditors.
- Accounting Standards: The case highlights the importance of adhering to Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) to ensure consistent and transparent financial reporting.
Management Accounting:
- Cost Accounting: The case demonstrates the importance of accurate cost accounting in decision-making. Delta's conservative approach to depreciation allowed for more accurate cost allocation and better informed investment decisions.
- Activity-Based Costing (ABC): Delta could explore ABC to allocate depreciation expenses more accurately across its various operations, including maintenance, flight operations, and customer service.
- Performance Indicators: The case highlights the need for robust performance indicators beyond financial metrics. Delta's focus on long-term profitability and operational efficiency, as evidenced by its conservative accounting practices, ultimately contributed to its success.
4. Recommendations
- Review and Update Depreciation Methods: Delta should conduct a comprehensive review of its current depreciation methods, considering factors such as:
- Asset Life: Evaluate the actual useful life of its assets, considering technological advancements, maintenance practices, and industry standards.
- Usage Patterns: Analyze the intensity of asset usage across different operational segments and adjust depreciation accordingly.
- Technological Advancements: Consider the impact of technological advancements on asset obsolescence and adjust depreciation schedules accordingly.
- Implement Activity-Based Costing (ABC): Delta should explore the implementation of ABC to allocate depreciation expenses more accurately across its diverse operations. ABC can provide a more granular view of cost drivers and improve decision-making regarding asset utilization and resource allocation.
- Enhance Financial Reporting Transparency: Delta should strive for greater transparency in its financial reporting, clearly disclosing its depreciation methods and the rationale behind them. This will enhance investor confidence and facilitate more informed decision-making.
- Develop a Robust Asset Management Strategy: Delta should develop a comprehensive asset management strategy that includes:
- Regular Asset Reviews: Periodically assess the condition and performance of its assets to identify potential issues and optimize their usage.
- Asset Disposal Policies: Establish clear policies for asset disposal, considering factors such as age, condition, and market value.
- Investment in New Assets: Develop a strategic approach to investing in new assets, balancing the need for modernization with cost-effectiveness.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies and Consistency with Mission: Delta's core competency lies in its operational efficiency and commitment to long-term profitability. Implementing these recommendations aligns with this mission by promoting accurate cost allocation, informed decision-making, and enhanced financial transparency.
- External Customers and Internal Clients: Transparent and accurate financial reporting builds trust with investors, creditors, and other stakeholders. ABC can also help Delta better understand its cost structure and allocate resources more effectively, ultimately benefiting customers through improved service and competitive pricing.
- Competitors: By adopting a more comprehensive approach to depreciation, Delta can position itself favorably compared to competitors who may be using less accurate or transparent methods. This can enhance its financial standing and attract investors.
- Attractiveness ' Quantitative Measures: While the specific financial impact of these recommendations may vary, the potential benefits include:
- Improved Accuracy of Financial Statements: More accurate depreciation accounting will lead to a more realistic representation of Delta's financial performance.
- Enhanced Decision-Making: Better cost allocation and performance analysis will lead to more informed investment decisions and operational improvements.
- Increased Investor Confidence: Greater transparency and consistency in financial reporting will build trust with investors and enhance Delta's overall attractiveness.
6. Conclusion
Delta Air Lines has a strong foundation for continued success. By adopting a more comprehensive and transparent approach to depreciation accounting, Delta can further strengthen its financial position, enhance its competitive advantage, and solidify its reputation as a financially sound and responsible organization.
7. Discussion
Other alternatives not selected include:
- Maintaining the status quo: This option would continue Delta's current approach to depreciation but may not be optimal in the long run.
- Adopting a more aggressive depreciation method: This option could potentially increase short-term profits but could also lead to a distorted view of the company's financial health.
Key risks and assumptions associated with the recommendations include:
- Implementation Costs: Implementing ABC and updating depreciation methods may require significant upfront investment in resources and technology.
- Resistance to Change: Some employees may resist changes to existing accounting practices, requiring effective communication and change management strategies.
- Market Volatility: External factors such as fuel price fluctuations and economic downturns could impact the effectiveness of these recommendations.
8. Next Steps
- Form a Task Force: Establish a task force composed of finance, accounting, and operations professionals to oversee the implementation of these recommendations.
- Conduct a Comprehensive Review: Conduct a thorough review of Delta's current depreciation methods and identify areas for improvement.
- Pilot ABC Implementation: Pilot ABC in a specific operational segment to assess its effectiveness and identify potential challenges.
- Develop Communication Plan: Develop a comprehensive communication plan to inform stakeholders about the changes to depreciation accounting and their rationale.
- Monitor and Evaluate: Continuously monitor the impact of these recommendations on Delta's financial performance and make adjustments as needed.
By taking these steps, Delta can effectively implement a more comprehensive and transparent approach to depreciation accounting, positioning itself for continued success in the competitive airline industry.
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Case Description
Depreciation policies of Delta Air Lines and Pan Am Corp. are compared and contrasted against a summary of operating data from each airline. Questions with the case require projection of future depreciation on a new aircraft using the policies of each company.
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