Depreciation: alternative methods and change in estimated useful life
Early in January x1, Ionian Airlines purchases a new wide-bodied aircraft for its short- and mediumhaul routes in Europe. The aircraft cost 30 million. It has an expected useful life of 15 years and an estimated residual value of 3 million (in x1 values).
Ionian is pleased with its purchase. The aircraft proves to be more reliable and have lower operat- ing costs than expected. At the start of x5, Ionian extends the estimated life by three years. However, it does not change its estimate of the aircraft's residual value.
Ionian encounters financial difficulties in x6 as a result of increased competition following the entry of low-cost airlines into its markets. It sells the aircraft for 18 million in late December x6. Ionian's financial year ends on 31 December.
Required
(a) Assume Ionian uses the SL method of depreciation. Calculate the depreciation that Ionian charges each year on this aircraft between x1 and x6. What is the gain or loss on disposal it recognises in its x6 accounts?
(b) Assume Ionian uses the DB method of depreciation. It sets the DB rate at 150% of the SL rate but ignores estimated residual values in determining the annual DB charge. Recalculate the annual depreciation Ionian charges on this aircraft between x1 and x6 and the gain or loss on disposal at the end of x6.
Some companies switch to SL depreciation when the SL charge, calculated on the basis of the remaining depreciable amount, exceeds the DB charge. If Ionian follows this practice, will it switch over to SL depreciation before it sells the aircraft in x6 and, if so, when?
(c) While reviewing the published accounts of Alpair, another European regional airline, you notice that it owns aircraft of a similar type but depreciates them over 12 years. Suggest reasons why the two airlines assume a different useful life for the same class of aircraft.