Accounting for Maintenance Costs

In Airline Industry By: Group 5 MBA –AvM (2011-13)

Team Members

Akanksha Sood Ankita Jadon Kuldeep Yadav Mohith Krishna Niriha Khazanchi Samrendra Nath Rai Supreet Bhattacharya Vanket Ambuj

OBJECTIVES

 Understand the concepts and issues involved in Accounting for Maintenance  Elaborate on the methodologies employed  Describe and explain other issues related to accounting for maintenance  List various recommendations

Background

 Depending on the age and type of their aircraft and the route structure over which they operate  Technical changes have led to different generations of aircraft being employed with maintenance requirements which differ in both timing and nature.

Cont….

 Fleet maintenance requirements typically involve   short cycle engineering checks, component checks “A” monthly checks, annual airframe and “D” checks) and engine checks checks, periodic heavy maintenance (notably “C” checks  Does not include activities which would result in life extension programmes, improvements or betterment of the aircraft.

Cont….

 The contracts of some aircraft held under operating leases require that the lessee makes maintenance payments to the lessor  Such payments will usually be made on the basis of a flight hour rate often broken down into its engine and airframe component  may also include an initial maintenance deposit.

Current Accounting Standards Framework

 In preparing this Airline Accounting Guideline  the Accounting Policy Task force has considered the conceptual framework of both  what is and what is not commonly permitted by major accounting standard setting bodies in relation to accounting for provisions and fixed assets.

 Paragraph 95 of the International Accounting Standards Committee’s Statements” states that (“IASC”) “Framework for the Preparation of Financial  expenses should be recognized in income statement  This is the “matching concept” which is well established within the conceptual framework of all of the major accounting standard setting bodies.



The IASC’s recent standard, IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’

 marks a change in approach to the issue of accounting for provisions in general and maintenance costs in particular.

 The UK has introduced a standard, FRS 12,  which is almost identical to IAS 37.

 The application of IAS 37 to airline maintenance accounting maintenance provision.

therefore introduces additional concepts/tests which have a bearing on whether it is possible for an airline to set up a

METHODOLOGIES

 Airlines adopt one of the following three costs:    Capitalise amortise) methodologies Expense as incurred Provide on the accruals basis and when accounting for these maintenance depreciate (alternatively referred to as defer and

1. Expense as Incurred

 Such an approach is self explanatory  All maintenance costs, including heavy maintenance costs, are written off as incurred.

For such purposes “incurred” is typically taken as being when the maintenance work has been performed.

 Such an approach is well established and is permitted in principle under IAS 37, US GAAP and indeed all other widely recognized accounting standards.

2. Accruals Basis

 This involves progressively building up an accrual for maintenance liabilities in advance of the maintenance event, with a view to ensuring an even charge for maintenance expense in line with the use of the equipment.

 Once maintenance is performed, the accrual is used, and a new accrual is then built up prior to the next maintenance point.

Cont….

 With respect to engine checks, it is most usual to accrue on a flight hour basis  For heavy methods, such maintenance, as accruing expected cost evenly over the period between checks, may also be used other the

3. Capitalise and Depreciate

(Alternatively Referred to as Defer and Amortise)  IAS 37 has defined the capitalise and depreciate method with a view to producing a profit and loss charge broadly similar to the accruals basis.

For example

 If the first airline maintenance of a new aircraft costing $100 million is expected to cost $5 million after five years    the depreciation policy should ensure that of the overall asset cost $5 million is depreciated over five years and only $95 million over the full expected service life, say fifteen years.

Once the first heavy maintenance point is reached, a capitalize and depreciate policy can satisfactorily be employed. A similar approach may be employed for engine maintenance.

Other Issues

 Payments to lessors  generally based on a flight hour rate  Return to lessor costs  Additional maintenance costs are frequently incurred in order to satisfy the return to lessor criteria of leased aircraft  Second Hand aircraft  If heavy maintenance expenditure is incurred as part of the acquisition of the second hand aircraft such expenditure should be dealt with as part of the asset cost and depreciated to the next heavy maintenance point.

Recommendations

 The Accounting Policy Task Force considers that an airline should employ an accounting policy for maintenance expenditure which ensures that costs are expensed to the profit and loss account in a manner which fulfills the matching concept. It recommends:

Cont….

 The accounting treatment of all maintenance expenditure  The nature of heavy maintenance expenditure  The accounting basis used for different types of heavy maintenance  The accounting treatment of maintenance liabilities arising on the acquisition of second hand aircraft  The rates used in amortizing the capitalized maintenance costs

Transitional Arrangements

 A change in an airline’s accounting treatment of maintenance expenditure will be a change in accounting policy.

 IAS37 requires that the airline’s opening reserves be adjusted to reflect the position as if the airline had always adopted the new policy.

 Airlines are encouraged, but not required, to adjust the opening balance of retained earnings for the earliest period presented and to restate comparative information  If comparative information is not restated, this fact should be disclosed.