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Market depreciation typically accounts around 30% of total costs,


and can reach upto 60% of total operational costs. With
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 having coexisting impacts on the bottom
line of aviation supply chain businesses. Despite being a science in
its very own right, this article piece will tap into how different
businesses across the chain handle depreciation of assets
(especially aircraft), contextualized to a macroeconomic industrywide understanding. This will allow a new spectrum and
understanding of conversation, coexistence and joint-operations
between one supply entity and another.
Depreciation is charged to the profit and loss account in order to
reflect consumption of investment in assets over the period. Tax
Depreciation is the governments procedure for expensing, or
writing off the change in an assets value over time. Tax
depreciation is an artificial depreciation based on law, not the

markets treatment of the asset. Book Depreciation is the term


commonly used to refer to the depreciation expense shown on a
companys financial statement (or the books). Book Depreciation
is tied into legal and accounting principles. Residual value is the
amount an entity could receive for the asset of age and condition it
will be in when disposed of (without inflation). Two significant
accounting estimates management uptakes to estimate
depreciation rates are useful lives and residual values of assets
(namely aircraft). Useful life is the period over which an asset is
expected to be available for use by an entity. Businesses
periodically review whether useful lives are appropriately set, and
subsequent alterations are displayed also as an implicit cost.

Market Depreciation is a widely changing variable based on the


value of the asset in the marketplace. Until the asset is sold, no one
really knows the exact market value of the asset. Once an asset is
sold, the difference between what the assets was purchased for
and the eventual selling price is referred to as Market Depreciation.
Aircraft, unlike automobiles and other equipment, tend to retain
more of their value for a longer period of time. Timing is a big factor.
The economic markets are in constant flux. Four trends as follows:

Aircraft values hold their own or even increase with strong


economic conditions.

In an economic downturn, aircraft prices call fall as quickly as


the stock market.

As a general rule, aircraft prices tend to follow the larger


business cycles. When businesses are growing and profitable,
demand for aircraft increases.

As demand increases, the available supply will decrease, and


then used prices will rise. When the business cycle declines, the
reverse is true.

Inflation helps market depreciation due to the inflated value of


money helping retain aircraft value.

The rule of thumb for depreciation is 4-6% per annum.

Factors associated to depreciation include:

economic repair lives (dictated by manufacturer and valuers in


demand for parts, maintenance requirements)

fleet deployment plans (rigorous use dictates higher cycles,


wear and tear, higher MRO requirements, lower useful life and
hence needs higher depreciation)

technological change (new technology and presence in the


market quickens replacement requirements)

overall development of aircraft asset portfolio

aircraft related fixed-asset depreciation

Legal constraints.
Depreciation methods by the book include straight line (seldom the
case but most often used) and diminishing (reducing-balance)
method. While straight line is simply original amount minus residual
value all over asset life. The reducing balance takes into account
accelerated (or decelerated) rates of depreciation over time
contingent on the differences between net book values over the
period.
For airlines, the best way to go about facilitating greater profit
margins is to depreciate the aircraft, and accumulate tax credits and
breaks. The current methodology for aircraft in the US, in fact for all
manufactured capital assets used in business today, go back to the
days of the Reagan Administration and the Economic Recovery Act
of 1984. The law effectively eliminated the old 10% Investment Tax
Credit (some of you may still remember those days) as well as the
old longer term depreciation, with a new, more attractive shorter
recovery period, referred to as the Modified Asset Cost Recovery
System (MACRS). Generally speaking, the interpretation was and
still is that aircraft owned and operated pursuant to FAR Part 91

choose the five year schedule while those aircraft operated under
FAR Part 135 and commercially operated aircraft utilized the not
quite as attractive, seven year methodology. And by the way, the
schedules are not linear. The five year schedule, as an example,
does not recover at 20% per year. Instead, the code is set for the
following methodology:

Year One 20%

Year Two 32%

Year Three 20%

Year Four 52%

Year Five 52 %

Year Six 5.76%


As we all know, depreciation under the current tax code is a tax
deduction for the benefit of the entity who has placed the asset
into service, assuming they are a current tax payer. This is
beginning to roll out across the globe to sustainably manage
domestic industries and facilitate tax cost minimization. The US also
sports The American Taxpayer Relief Act of 2012 extended the 50%
bonus depreciation allowance through the end of 2013 for qualifying
property, which may allow 50% 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). Singapore on the other hand,
has liberal rules and tax breaks on aircraft, of which is classified
under machinery and plants depreciation rates rules governing
leniency for both credits and quickened depreciation of aircraft
facilitating shorter useful life. New Zealand regulatory bodies also

allow for as little as 5 years till an aircraft can be fully depreciated


with respective tax credits. Many airlines to date, utilize depreciation
capability to sustain lower tax costs from taxable income
demonstrated.

In Australia, the Australian and International Pilots Association has


called once again for depreciation rates on new aircraft to be
accelerated to bring Australia into line with jurisdictions in which

foreign competitor airlines operate. AIPA President Captain Barry


Jackson states the concern of stringent depreciation regulations to
protect government revenue streams over the competition
competency of Australian 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
Spokeswoman Olivia Wirth making a similar call in todays press. It
currently takes 10 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 New Zealand, it would fall short of
matching the investment environment of the major international
airlines flooding our market. For example, Singapore Airlines can
depreciate its aircraft over three years. Accelerating our local
depreciation 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 taxation arrangements.
We need to think of the impact on Australias national interest if we
allow this nation to become a mere stop-over in an air transport
system provided entirely from overseas. When Qantas CEO Alan
Joyce grounded the fleet last year the effect was devastating. One
shudders to think about a situation down the track when such a
decision might be made by a CEO offshore without any redress in
Australian courts.

While book depreciation is crucial, airlines are required to preserve


their aircraft efficiently through means of operational rationalization,
balancing in-house and outsourced works, and whether to lease or
purchase (with portfolio facilitations for buy-leaseback for high
equity low-prospective carriers). Environmental inputs of the
replacement market (both through lease/purchase market), finance

capability, regulatory structures, profitability, cost-management


involvement, maintenance needs and fleet requirements drive the
write-downs of aircraft too.
Other airlines looking into the secondary and used market (typically
cash and ownership oriented airlines, or periods of high interest
rates), look to maximize book and agglomerated depreciation of
previous owners to leverage lower acquisition costs (even for
ownership of new mature late-delivery aircraft). This achieves the
greater objective of taking advantage of lower capital costs for used
planes and reaping a longer commercial lifespan for those aircraft
with its in-house maintenance crews.
An example is where Richard Anderson (CEO of Delta Airlines)
mentioned an aircraft bubble and oversupply, excess competition,
and cannibalization of aircraft within seating/payload brackets.The
aircraft market is going to be ripe for Delta over the course of the
next 12 to 36 months. Prices are going to get lower. A 9- or 10-yearold 777 on the market is for as little as $10 million. Dozens of such
wide-bodies coming off lease or retiring soon. Delta later signed a
Letter of Intent for a 10 year old 777-200 priced at $7.7M USD (or
2.95% of list price, amounting to 28% depreciation per year with
discounts). This particularly relates to the 777-200 and 777-200ER
aircraft argued to have a current market value of $10M USD, thanks
to used 777s coming onto the market (Malaysia Airlines, Transaero,
Kenya Airways and Singapore Airlines 777s), abundance/scale of
A330-300s, and new replacement aircraft programs such as the
A350-900, 787-9 and A330-900.

Meanwhile, both FedEx and UPS top up new 767 orders (old airframe optimized for cargo) from Boeing to replace their even older
DC-10, MD-11, A300 and A310 fleets (with approximately 10% lover
unit operating costs than the DC-10). This is thanks to cashorientation, maximization of current supply chain maturity in the
market, and full control of operations without strings pulled by
lessors/financiers.

The leasing market has been especially active recently, with an


influx of capital and investors becoming increasing drawn to this
lucrative sector. Lessors have a similar demand by the book, and
ensure that the aircraft are not physically depreciated as from the
book. Preservation to reduce overhaul maintenance requirements,
and extend life-span of the aircraft are predominantly done through
supply-agreements (maintenance, services, discounting, deliveryflexibility, options-flexibility, cancellation-capability and guarantees

independently negotiated) and demand-agreements (operations


outline, operational parameters, oversight-capability, de-risk
implementations, offsetting costs, rigorous price-negotiations and
guarantees with customers).Given the ludicrous competition in the
leasing market, lessors are often forced to (similar but to greater
extent for lessors) disproportionately depreciate and fluctuate rates
in which stock is written down. Typical leasing prices is 1/100th 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 developmentinvestment/trajectory)

For manufacturers, depreciation of their produced aircraft reflects


on a frames ability to remain financially efficient in the marketplace.
The rate of depletion in current market value dictates the
requirement of an airframes producer to refresh and re-strategize
the aircraft. Correlations between the current market value and
base value market correlations distinguish the trajectory of aircraft
values. Adjustments to the market value given inputs must be
recognized by an airframe manufacturer, with
competitive/environmental inputs and current business state
defining capability to refresh an aircraft model. Value retention
factors manufacturers target for is:

A sizable order backlog to adjust manufacturing operations


gradually, and dictate aircraft productions and adjustments/phaseouts.

Improve market penetration through various means. This


includes manufacturers outsourcing works and services to tap

better in the respective markets (Tianjin, USA etc.), tender for


emerging economies and growth centres, liberalization of
manufacturing works operations, improve diplomatic ties and trade
facilitations, and general marketing.

Increasing the product life-cycle of an air frame. This can be


done by utilizing the versatility of an aircraft to tap into versatile
aircraft requirements for operators. An airframe examples include
the A330 Regional (using parts availability, depreciation rates and
operator-trends to allow an aircraft for high-density short/mediumhaul services, and high wear/tear). Meanwhile for engines, powerplant manufacturers facilitate for paper de-rates, performance
improvement packages, discounting of stock, and maintenance
guarantees (complementary service provisions).

Flexibility from surplus and shortage inputs of an aircraft type.


This is done through managing troughs and crests in aircraft
demand, recognizing macroeconomic inputs, and rationalizing
outputs from the business.

Affiliations and relationships between manufacturers and


customers are crucial for retainment even after the sale, as a way
for a manufacturer to manage the second-hand and lease markets.
Recognizing behaviors customers undertake can allow
appropriation of responses to aircraft requirements. This is seen in
alignment of understandings, parameters the aircrafts operate
within, demand and supply rationalization, and even as far as joint
operations.

Closely linked to above, accommodating for financing


requirements, competitive environments and operator-needs is

crucial to retain the value and flexibly allow aircraft valuations. This
includes re-engines, re-winging, and pax-freighter conversions.

Understand when a program ends, and facilitate replacement


and retirements.

And of course, improving the aircraft specs, economics and


technology incrementally on the air-frame, while also
accommodating diversification and minimizing cannibalization of a
manufacturers product line.

Consolidation industry-wide of customers (lessors and airlines


especially) improve negotiation and discounting power of demand,
hence hinder the manufacturers capability to retain value of
aircraft, hence resulting in pushed-higher list prices.