Question -
On 1st July, 2016, SC Airlines Ltd acquired a new aeroplane for a total cost of $10 million dollars. The following breakdown of the costs to build the aeroplane was given by the manufacturers.
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Aircraft body
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$3,000,000
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Engines (2)
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$4,000,000
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Fitting out of aircraft:
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|
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Seats
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$1,000,000
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Carpets
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$ 50,000
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Electrical equipment:
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|
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Passenger seats
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$ 200,000
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Cockpit
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$1,500,000
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Food preparation equipment
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$ 250,000
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All costs include installation and labour costs associated with the relevant part.
It is expected that the aircraft will be kept for 10 years and then sold. The main value of the aircraft at that stage will be the body and the engines. The expected selling price is $2.1 million, with the body and engines retaining the existing proportionate value.
Costs in relation to the aircraft over the next 10 years are expected to be as follows:
1) Aircraft body: This requires an inspection every 2 years for cracks and wear and tear, at a cost of $10,000.
2) Engines: Each engine has an expected life of 4 years before being sold for scrap. It is expected that the engines will be replaced in 2020 for $4.5 million and again in 2024 for $6 million. These engines are expected to incur annual maintenance costs of $300,000. The manufacturer has informed SC Airlines that a new prototype engine with an extra 10% capacity should be on the market in 2022, and that existing engines could be upgraded at a cost of $1 million.
3) Fittings: Seats are replaced every 3 years. Expected replacement costs are $1.2 million in 2019 and $1.5 million in 2025. The repair of torn seats and faulty mechanisms is expected to cost $100,000 per annum. Carpets are replaced every 5 years. They will be replaced in 2022 at an expected cost of $65,000, but will not be replaced again before the aircraft is sold in 2026. Cleaning costs amount to $10,000 per annum. The electrical equipment (such as the TV) for each seat has an annual repair cost of $15,000. It is expected that, with the improvements in technology, the equipment will be totally replaced in 2022 by substantially better equipment at a cost of $350,000. The electrical equipment in the cockpit is tested frequently at an expected annual cost of $250,000. Major upgrades to the equipment are expected every 2 years at expected costs of $250,000 (in 2015), $300,000 (in 2017), $345,000 (in 2019), and $410,000 (in 2024). The upgrades will take into effect the expected changes in technology.
4) Food preparation equipment: This incurs annual costs for repair and maintenance of $20,000. The equipment is expected to be totally replaced in 2022.
Required:
1) Start by establish the issues for your analysis by addressing the following:
a. the advantages of a components approach versus a simple depreciation of the $10 million dollars over the 10-year period.
b. Since AASB 116 requires initial recognition at cost and then provides a choice between either the cost model (impairment) or the revaluation model (increment and/or decrement) - discuss the advantages and/or disadvantages in applying either model to the aeroplane as a whole - indicating which would be the most appropriate as a result or if treated as components then which would be most applicable to the components you have identified.
c. Basis for selecting the method of depreciation according to AASB 116.
2) Discuss how the costs relating to the aircraft should be accounted for (treated) with respect to:
a. Aircraft body;
b. Engines;
c. Fittings;
d. Food preparation equipment.
e. Where relevant consider/discuss issues such as:
i. the treatment of the upgrades of cockpit equipment.
ii. accounting for inspections.
3) Determine the expenses to be recognised for the financial year 1st July 2016 to 30th June 2017.
a. Aircraft body;
b. Engines;
c. Fittings;
d. Food preparation equipment;
e. Total Expenses.