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Marshall School of Business
University of Southern California
Behavioral Implications of Airline Depreciation
Accounting Policy Choices
Teaching Note
Purpose of Case
It seems obvious that firms choices of accounting policies will affect managers decision-
making. But somehow when accounting choices are being considered, the financial reporting
implications of the choices seem to dominate.
This case was written to force students to consider the decision-making implications of one
Suggested Assignment Questions
This case was used successfully as part of a final exam. The exam questions, which are shown
below (importance weightings in parentheses), can be adapted for use in a classroom setting.
(50%) 1. Assume that at least some rewards for the management team (and, hence, also
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
274
a. replacements of aircraft in service;
b. pricing, assuming that prices are at least somewhat dependent on costs;
c. evaluations of routes or lines of business;
d. evaluations of managers, assuming that negotiated budgets provide the primary
standards of performance.
(20%) 2. Assume that in a particular US airline company, there is a conflict between the
benefits of conservatism vs. liberalism in depreciation accounting. That is, for this
Case Analysis
One question that can be usefully posed is: why do airline companies choose different
depreciation policies? These decisions seem to be driven by financial reporting concerns. More
liberal depreciation policies can be used to hide losses. More conservative policies can be used
to create hidden reserves that facilitate managers management of earnings.
To a lesser extent, the economic realities are different. Some aircraft depreciate faster than
others. These effects are generally smaller than most people assume, however. Virtually every
aircraft can fly almost indefinitely with proper maintenance.
Question 1
What are the effects of this accounting policy choice on managerial decisions? More rapid
depreciation causes higher expense on the income statement but reduces aircraft book values on
the balance sheet more quickly. But, interestingly, the reality does not change at all! In the US,
there are no tax effects and no cash flow effects, and the economic value of the company does
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
275
not change. Academic studies have shown that the stock market is very good at seeing through
fully disclosed differences such as these.
Some students get confused about this issue because they do not realize that in the books that
US firms keep for tax purposes firms will depreciate their aircraft as quickly as possible,
While there are no direct effects of this accounting policy choice on real firm value, value can
be affected because managers decisions can be affected. Managers do make decisions based on
accounting numbers. One of the clearest behavioral implications of depreciation accounting
policies is in the replacement-of-aircraft decision. Managers in firms that depreciate aircraft
slowly tend to be slow to replace their aircraft because they have to absorb the write-off of the
remaining book value. This is a known empirical regularity. For example, Singapore Airlines
In theory, management decision-making should be improved if the accounting records reflect
the economic reality. We know, for example, that the early US railroad companies did not
depreciate their fixed assets. As a consequence, the railroads overstated their income and assets,
and the railroad managers were misled by their own financial statements. Ultimately about 50%
of the track put in place before 1900 was placed in receivership.
But what is the real economic depreciation of aircraft? The reality will vary somewhat with
Question 2
This question requires students to consider the benefits and costs of having, potentially, a third
set of books. In theory, at least, keeping a set of books that better reflects the economic reality
of the declining value of the aircraft assets should lead to better decision-making. Some
Merchant & Van der Stede, Management Control Systems, 3rd edition, Instructors Manual
276
Question 3
This question was posed to force students to reach a conclusion as to what one single accounting
policy choice might be best. They might usefully make observations about each of four
Pedagogy
This case should only be used with students who have studied the mechanics of depreciation
accounting. Generally, this is not a constraint because the depreciation topic seems to be
