T R A N S P O RT
KPMG’s Disclosures Handbook: Accounting and Financial Reporting in the Global Airline Industry
K P M G I NT E R N AT I O N A L
KPMG’s Global Airline practice KPMG International is the coordinating entity for a global network of professional service firms that provide audit, tax and advisory services with an industry focus. The aim of KPMG member firms is to turn knowledge into value for the benefit of their clients, people and the capital markets. With nearly 100,000 people worldwide, member firms provide audit, tax and advisory services to 731 cities in 144 countries. Through its member firms, KPMG has invested extensively in developing a high-quality airline team. KPMG’s understanding of the industry is both current and forward looking, thanks to KPMG’s member firms’ global experience, knowledge sharing, industry training and the use of professionals with direct experience in the airline industry. KPMG member firms serve the market leaders within the airline sector. They provide external audit services to 26 percent of passenger airlines in the top 50 airline companies ranked by revenue. They also provide other services to over 60 percent of these airlines. KPMG’s strength lies in its professionals and their knowledge and experience gathered from working with a large and diverse client base. KPMG’s industry experience helps the team understand both your business priorities and the strategic issues facing your company. KPMG’s Global Airline practice’s presence in many major international markets, combined with industry knowledge, positions KPMG well to assist you in recognizing and making the most of opportunities, as well as implementing changes necessitated by industry developments. For more information on KPMG’s Global Airline practice, please contact:
Martin Sheppard Head of Aviation +61 2 9335 8221 msheppard@kpmg.com.au
Dr. Ashley Steel Global Chair – Transport +44 20 7311 6633 ashley.steel@kpmg.co.uk Alternatively, visit KPMG’s website at kpmg.com With thanks to KPMG’s Transport practice in Australia. Authors Julian McPherson Malcolm Ramsay Special thanks to Rachel Gadiel Charmaine Hopkins Rachel Riley Sharon Smith
Introduction In this, the first volume of KPMG’s Airline Accounting and Financial Reporting Handbook, KPMG has focused on airlines reporting under U.S. reporting standards and airlines that are transitioning to reporting under International Financial Reporting Standards (IFRS). This handbook looks at some of the key accounting and reporting issues in the passenger airline industry. For companies listed on the main
IFRS and legacy GAAPs of a selection of
European, and a number of Asia-Pacific
major airlines. There are signs of
exchanges, there has been a
convergence between IFRS and U.S.
fundamental change in the basis of
reporters in areas such as accounting for
financial reporting in 2005. Since
frequent-flyer schemes, however differing
September 1, 2005 these companies’
fact patterns and interpretations of the
financial statements have been prepared
requirements in IFRS and U.S. GAAP
under IFRS. Management has been
continue to result in differences in the
working through the impact of adopting
application of these standards. The
IFRS and disclosing changes to
upcoming and proposed guidance issued
stakeholders through 2005. CFOs face
by the International Accounting Standards
the challenge of explaining company
Board (IASB) indicates that IFRS, like
performance on a new basis – with
existing U.S. regulations, will require
greater emphasis on measurement of
enhanced disclosures about the key
items at fair values rather than historic
sources of estimation and uncertainty at
cost – giving rise to greater volatility and
the balance-sheet date that may impact
less certainty in financial results. In our
the carrying amounts of assets and
experience, items not required to be
liabilities over the next reporting period.
recognized in the financial statements under legacy Generally Accepted
Risks and cautionary factors have been
Accounting Principles (GAAP) are now
disclosed by airlines reporting in the U.S.
required to be recognized under IFRS.
for a number of years. This handbook
Such items include derivatives, share-
analyzes and compares the risk factors
based payment plans and the recognition
disclosed in a sample of the Securities
of the surplus or deficit position of
and Exchange Commission (SEC) filings
defined benefit post-employment plans.
of passenger airlines listed on the U.S. exchanges.
KPMG’s Global Airline practice provides an analysis of the disclosures of critical
In order to highlight key financial
accounting policies by airlines. Not
reporting trends and issues impacting
surprisingly, the financial reports
airlines, KPMG’s Global Airline practice
surveyed highlight that revenue
has surveyed the 2005 public financial
recognition is a key area of disclosure.
regulatory filings (annual and interim
This handbook looks at example
reports, 10-Ks, 20Fs and IFRS conversion
accounting policies across U.S. GAAP,
releases) of 23 of the world’s airlines that
currently, or will in the near future, report
(1) critical accounting policies (2)
(3) disclosure of risk factors. KPMG
under either U.S. GAAP or IFRS. The
disclosures around transition from
reviewed samples of disclosures made
focus of KPMG’s disclosure survey was:
previous GAAP to IFRS; and
by the following airlines.
Airline
Regulatory filing surveyed and reporting GAAP
GAAP under which 2006 financial regulatory filing will be prepared
Air France – KLM Group
Annual report and 20F – March 31, 2005 French GAAP, U.S. GAAP1 and September 30, 2005 half year under IFRS as adopted by the European Union
IFRS as adopted by the European Union, U.S. GAAP1
Alitalia – Linee Aeree Italiane S.p.A
Annual report – December 31, 2005 IFRS as adopted by the European Union
IFRS as adopted by the European Union
AMR Corp/American Airlines Inc
10k – December 31, 2005 U.S. GAAP
U.S. GAAP
British Airways plc
Annual report and 20F – March 31, 2005 UK GAAP, U.S. GAAP1 and IFRS as adopted by the European Union financial information release for year ended March 31, 2005 (issued July 2005)
IFRS as adopted by the European Union, U.S. GAAP1
Cathay Pacific Airways Ltd
Annual report – December 31, 2005 Hong Kong Accounting and Financial Reporting Standards
Hong Kong Accounting and Financial Reporting Standards (IFRS based)
Continental Airlines Inc
10k – December 31, 2005 U.S. GAAP
U.S. GAAP
Delta Air Lines Inc
10k – December 31, 2005 U.S. GAAP
U.S. GAAP
Deutsche Lufthansa AG
Annual report – December 31, 2005 IFRS as adopted by the European Union
IFRS as adopted by the European Union
easyJet plc
Annual report – September 30, 2005 UK GAAP and IFRS as adopted by the European Union financial information release for the year ended September 30, 2005 (issued January 2006)
IFRS as adopted by the European Union
Iberia Lineas Aereas de Espara, S.A
Annual report – December 31, 2004
IFRS as adopted by the European Union
Japan Airlines Corporation
Annual report – March 31, 2005 Japanese GAAP
Japanese GAAP
JetBlue Airways Corporation
10k – December 31, 2005 U.S. GAAP
U.S. GAAP
Airline
1
Regulatory filing surveyed and reporting GAAP
GAAP under which 2006 financial regulatory filing will be prepared
Northwest Airlines Corporation
10k – December 31, 2005 U.S. GAAP
U.S. GAAP
Qantas Airways Limited
December 31, 2005 half year, IFRS
IFRS
Ryanair Holdings plc
Annual report and 20F– March 31, 2005 Irish, UK GAAP and U.S. GAAP1 and IFRS as adopted by the European Union explanation of the financial impact for the year ended March 31, 2005 (issued August 2005)
IFRS as adopted by the European Union, U.S. GAAP1
SAS Group
Annual report – December 31, 2005 IFRS as adopted by the European Union
IFRS as adopted by the European Union
Singapore Airlines Limited
Annual report – March 31, 2005 Singapore Financial Reporting Standards
Singapore Financial Reporting Standards (IFRS based)
South African Airways
Annual report – March 31, 2005 South African GAAP
South African GAAP (IFRS based)
Southwest Airlines Co.
10k – December 31, 2005 U.S. GAAP
U.S. GAAP
Swiss International Airlines (Group)
Half-year report – June 30, 2005 IFRS
IFRS
United Airlines – UAL Corporation
10k – December 31, 2005 U.S. GAAP
U.S. GAAP
U.S. Airways – America West Holdings Corporation
10k – December 31, 2005 U.S. GAAP
U.S. GAAP
Virgin Blue Holdings Limited
Annual report – September 30, 2005, Australian GAAP
Australian equivalents to IFRS
Securities and Exchange Commission (SEC) Foreign Private Issuer in the U.S.
KPMG’s Global Airline practice has taken
otherwise of these policies, rather the
This handbook is not a comparison of
direct extracts from various airline
examples used are to demonstrate
U.S. GAAP and IFRS but rather a
accounting policies. These extracts have
current accounting disclosure practice
comparison of financial accounting
been taken from the relevant publicly
and to facilitate discussion on key airline
policies and reporting disclosures made
available regulatory report noted above.
accounting issues as identified by
by airlines reporting under U.S. GAAP
No comment is made by KPMG’s Airline
airlines.
and those transitioning to reporting
practice in regard to the adequacy or
under IFRS.
v i K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Forewords We are pleased to present KPMG’s first Disclosures Handbook for the global airline industry. With the current industry focus on reducing costs in times of record oil prices and continued global conflict, at no time has it been more important to have transparency in the reporting practices of airlines. ]There has been a fundamental shift in the basis of reporting in the past 18 months with many global airlines converting to IFRS. The next move forward is no doubt the continued harmonization of IFRS and U.S. GAAP. This handbook takes a first look at how IFRS and U.S. GAAP disclosures and accounting policies line up. Whilst the result of convergence to date is encouraging in some areas, divergence still remains in other areas such as maintenance accounting and in some aspects of derivatives accounting. It is interesting to note the extensive critical accounting policy disclosures that U.S. regulators require. This is an area that until now has had little focus in annual reports elsewhere in the world. Future IFRS requirements may see expanded disclosures from airlines in this area and these disclosures will be worthy of review. The impact of the transition to IFRS has varied considerably between airlines, with approximately U.S.$3.5 billion of net assets being wiped off the opening balance sheets of the airlines surveyed. Almost more importantly, the assets and liabilities recognized under IFRS are often subject to volatile fair value movements, which we expect will impact the balance sheet and income statement of these airlines on an ongoing basis. It is still early days in the accounting standard convergence process. We expect a clearer picture will emerge as airlines complete their first full sets of IFRS financial statements during 2006. However, more direct dialogue is required with standard-setting bodies to ensure that the airline industry perspective is understood. Airlines are truly global businesses and on the ‘front line’ in terms of the impact of changes to global regulations. Hence it is essential that their circumstances are taken into account. We hope you find this handbook a useful reference point when contemplating airline specific accounting treatments. Martin Sheppard Head of Aviation KPMG in Australia Dr. Ashley Steel Global Chair, Transport KPMG LLP UK This publication provides an excellent and timely point of reference as many airlines are reviewing their disclosures. IFRS has moved on from determining and reporting transition impacts to ‘live’ business as usual reporting under the new GAAP, which will provide a challenge to CFOs reporting to stakeholders. KPMG’s Airline Practice has worked with the IATA Accounting Working Group to assist airlines with accounting and reporting issues through a series of Airline Accounting Guidelines (AAG) over the last 10 years, with the most recent AAG issued in June 2005 covering foreign currency translation and hedging. This continued relationship has enhanced accounting and reporting in the airline industry. John Vierdag Chairman – IATA Accounting Working Group International Air Transport Association
Executive summary 1 Critical accounting policies 1.1 Revenue recognition
1 3 3
1.1.1 Passenger and freight revenue
3
1.1.2 Frequent flyer accounting
6
1.2 Property, plant and equipment
11
1.2.1 Aircraft cost
11
1.2.2 Maintenance accounting
15
1.2.3 Airport landing and gate slots
18
1.2.4 Depreciation and residual values
20
1.2.5 Impairment testing
23
1.3 Aircraft leasing 1.3.1 Sale and leaseback transactions
1.4 Financial instruments
27 27
29
1.4.1 Hedge accounting
29
1.4.2 Embedded derivatives
34
2 Airline risk factors 3 Analysis of transition to IFRS in 2005 Appendix – Aircraft useful lives, depreciation rates and residual values KPMG’s Global Airline practice contacts
35 47 50 54
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 1
Executive summary The airline industry has faced increasingly complex accounting requirements with transition to IFRS and changes in U.S. GAAP reporting over the past few years.
The U.S. has experienced significant
airlines. Typically, airlines are exposed to
changes with the introduction of the
changes in fuel price, foreign exchange
Sarbanes-Oxley legislation and reporting
rates and interest rates. Accounting for
under Section 404, with many U.S.
hedging activities is burdensome and will
foreign private issuers reporting under
usually lead to some volatility in the profit
this framework for the first time this
and loss, particularly when hedge
coming year. The risk of ‘getting it wrong’
accounting requirements are not met and
from an accounting or internal control
therefore the fair value of the derivative
perspective has never been higher and
is marked to market through the profit or
regulators in many countries have been
loss. Companies in the airline industry
more active and willing to challenge
generally have higher cashflow volatilities
accounting treatments.
and higher asset bases compared to many other industries, which leave them
The transition to IFRS by European and
vulnerable to asset impairment if there
certain Asia-Pacific carriers has set
are sudden demand shocks. The range
airlines on a path toward harmonization
and impact of the risk factors KPMG has
of financial reporting. The reporting
reviewed highlights the potential for
KPMG has surveyed, demonstrates that
volatility in results.
global airlines transitioning to IFRS have made similar adjustments in their
The nature of IFRS transition adjustments
financial statements. KPMG’s survey also
KPMG has reviewed illustrates a trend
highlights that IFRS transition
toward harmonization of accounting
adjustments have been significant in
policies between airlines, which should
terms of their size and nature on the
enable greater comparability for
balance sheet and the income statement
stakeholders when reviewing the
in the areas of recognition and
reporting of different airlines. However,
measurement of financial instruments,
KPMG’s survey also shows that differing
property, plant and equipment, revenue
accounting policy choices remain under
recognition and accounting for post-
IFRS, both on transition and on an
employment benefits.
ongoing basis, which suggests some differences in the basis of accounting will
Looking ahead, KPMG’s Global Airline
continue. Divergent interpretations of
practice believes that the ongoing
accounting standards, along with
transition to IFRS, and the increasing
different airline fact patterns, will often
trend to a fair value measurement basis,
result in differences in the application
is likely to lead to greater volatility for
of IFRS.
2 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
The goal of one set of harmonized accounting standards is moving forward slowly with the increasing collaboration of the U.S. Financial Accounting Standard Board (FASB) and IASB with a view to convergence of IFRS and U.S. GAAP. The ‘roadmap’ set out in the agreement between these standard-setters includes a series of steps that require completion prior to the SEC agreeing to eliminate its reconciliation requirement for SEC foreign private issuers that report under IFRS. Convergence topics on the FASB/IASB agenda include; accounting for revenue, intangible assets, leasing and financial instruments. It is no coincidence that these topics are the critical accounting policies highlighted by airlines in their reporting and discussed in this survey. As a result of the work of the IASB and FASB, divergence in significant airline accounting policies is likely to be reduced gradually. For example, the IASB is reviewing the choices for the capitalization of borrowing costs which may more closely align IFRS with U.S. GAAP, whilst the FASB is reviewing maintenance accounting which may reduce some, if not all, of the discrepancies with IFRS. The overall message it would seem is that in this phase of almost continual transition and convergence of U.S. GAAP and IFRS, the need for engagement and communication between airlines and standard-setters has never been greater.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 3
1 Critical accounting policies 1.1 Revenue recognition
The general accounting practice
when to recognize unavailed revenue
1.1.1 Passenger and freight revenue
for passenger and freight revenue
which occurs where tickets are not used
recognition is that revenue received is
(also known as ’breakage’). Judgements
Perhaps the most critical accounting
deferred and classified as a liability on
and assumptions underpinning estimates
policy for all airlines is revenue
the balance sheet until the passenger
of when to recognize unavailed revenue
recognition, with the industry generally
or freight is actually uplifted at which
can have a significant impact on results.
generating thin profit margins. Airline
time the revenue is recognized in profit
For this reason, the majority of U.S.
revenue recognition extends from core
and loss.
airlines surveyed highlight this as an area
passenger and freight revenue to
of significant judgement in their financial
accounting for complex loyalty or
This recognition principle results in
frequent flyer programs.
estimation being required to determine
statements.
4 K P M G ’s A i r l i n e R i s k a n d Ac c o u n t i n g Po l i c i e s a n d D i s c l o s u r e s H a n d b o o k
Sample of accounting policies British
Passenger ticket and cargo waybill sales, net of discounts, are recorded as current liabilities in the ’sale in
Airways
advance of carriage’ account until recognised as revenue when the transportation service is provided. Commission costs are recognised at the same time as the revenue to which they relate and are charged to cost of sales. Unused tickets are recognised as revenue using estimates regarding the timing of recognition based on the terms and conditions of the ticket and historical trends. Other revenue is recognised at the time the service is provided.
Reporting GAAP:
IFRS as adopted by the European Union
Singapore
Passenger and cargo sales are recognised as operating revenue when the transportation is provided. The
Airlines
value of unused tickets and air waybills is included in current liabilities as sales in advance of carriage and recognised as revenue if unused after two years and one year respectively.
Reporting GAAP:
Singapore Financial Reporting Standards
Southwest
…Tickets sold for passenger air travel are initially referred to as “Air traffic liability”. Passenger revenue is
Airlines
recognized and air traffic liability is reduced when the service is provided (i.e., when the flight takes place). “Air traffic liability” represents tickets sold for future travel dates and estimated future refunds and exchanges of tickets sold for past travel dates. The balance in “Air traffic liability” fluctuates throughout the year based on seasonal travel patterns and fare sale activity. The Company's “Air travel liability” balance at December 31, 2005 was $649 million, compared to $529 million as of December 31, 2004… Events and circumstances outside of historical fare sale activity or historical Customer travel patterns, as noted, can result in actual refunds, exchanges, or forfeited tickets differing significantly from estimates. The company evaluates its estimates within a narrow range of acceptable amounts. If actual refunds, exchanges or forfeiture experience results in an amount outside of this range, estimates and assumptions are reviewed and adjustments to “Air traffic liability” and to “Passenger revenue” are recorded, as necessary. Additional factors that may affect estimated refunds and exchanges include, but may not be limited to, the Company's refund and exchange policy, the mix of refundable and non-refundable fares, and promotional fare activity. The company's estimation techniques have been consistently applied from year to year; however, as with any estimates, actual refund, exchange, and forfeiture activity may vary from estimated amounts…
Reporting GAAP:
U.S. GAAP (currency quoted in U.S. dollars)
K P M G ’s A i r l i n e R i s k a n d Ac c o u n t i n g Po l i c i e s a n d D i s c l o s u r e s H a n d b o o k 5
Key considerations in applying the sample accounting policies
expenses incurred in generating revenue,
The financial reports surveyed highlight
such as commissions, taxes and other
key assumptions and judgements which
levies, does not impact net profit or loss,
impact passenger and freight revenue
it impacts non-GAAP financial performance
recognition. These include determining:
measures such as unit cost per seat mile
• when and how unavailed revenue
ratios that receive close attention from
recognized on the balance sheet
Whilst an accounting policy of offsetting
analysts and finance providers.
should be released to profit and loss • the amount of expenses to be netted
The disclosure of one-off changes to
against revenues rather than being
estimates is guided by the relevant
recognised as a cost of sale; and
reporting GAAP. A number of airlines in
• the disclosure of changes in customer
the survey have reported these changes
behaviour or ticket conditions between
as they occur. The materiality of the
reporting periods which result in
change in estimate is likely to guide the
one-off amounts of revenue being
extent of the disclosure.
recognized.
Survey findings In practical terms, implementation of
All airlines surveyed defer passenger and
an appropriate revenue recognition
freight revenue until the customer or
accounting policy and underlying
cargo is uplifted. There are a variety of
methodology will be dependent on
disclosures dealing with accounting for
available historical data, sophistication of
unavailed revenue. The U.S. airlines
revenue accounting systems and the
surveyed state that they recognize
availability of data to determine breakage
unavailed revenue based on estimates
rates. For example, whether breakage
that are underpinned by historic trends,
data is available by ticket type, route
adjusting for ticket usage patterns,
(leisure routes may have different
refunds, exchanges and inter-line
breakage rates than business routes) and
adjustments. Generally, other airlines
inter-line tickets (where a passenger
state only that unavailed revenue is
ticket is sold by one airline but the
recognized on a ’systematic basis’.
passenger is flown by another airline).
Singapore Airlines is the only airline that
The sample accounting policies show
states specifically that passenger
that methods vary from detailed
unavailed revenue is recognized on a
statistical and historical trend analysis to
time expiry basis if the ticket remains
time based recognition. In either
unused for more than two years.
instance, the underlying ticket terms and conditions are key in determining an appropriate accounting policy.
6 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
1.1.2 Frequent flyer accounting
• ’Deferred revenue’ method. Revenue from sold points is deferred on the
Customer loyalty programs or ’frequent
balance sheet and recognized in the
flyer’ programs are now a core product
profit or loss when the award points
offering for most multiple-class airlines
are redeemed. For earned points, a
and a growing number of low cost
portion of the passenger revenue is
carriers to differentiate from competitors
deferred as a liability in the balance
and capture higher yielding business
sheet and only recognised as revenue
customers. Frequent flyer programs offer
when the points are redeemed. No
passengers the opportunity to earn
associated provisions are required.
points or ’miles’, which can be redeemed in exchange for free flights or other
Revenue and cost recognition profiles are
products. Points or miles are principally
profoundly different under the two
earned in two ways:
methodologies. Airlines reporting under
• Earned points – points earned through
U.S. GAAP and many airlines that have
travel on an airline or an airline’s
transitioned to IFRS apply the ‘deferred
partners’ qualifying flights.
revenue’ method for sold points. The
• Sold points – points sold to third
majority of airlines continue to account
parties such as credit card providers,
for earned points using the ‘incremental
hotels and car rental companies. These
cost’ method. Most U.S. airlines discuss
third parties reward their customers
accounting under both methodologies
with points when they purchase or
and provide a summary of both
use their products. Cash is received
methodologies. The Qantas disclosure
by the airline from the third party upon
summarizes the accounting position
issue of the points by the airline.
under IFRS. The International Financial Reporting Interpretations Committee
There are two principle methods of
(IFRIC), the interpretation body for IFRS,
accounting for frequent flyer programs in
is currently looking at loyalty program
the airline industry:
accounting and the appropriate revenue
• ’Incremental cost’ method. Revenue
recognition. As IFRS converges with U.S.
from sold points is recognized
GAAP, it will be interesting to see the
immediately and passenger revenue
outcome of the IFRIC’s review.
for flights on which passengers earn points is recognised in accordance with the airline’s revenue recognition policy (see 1.1.1). A provision is then recognized based on the marginal or incremental cost per point (i.e. the cost of fuel, meals, insurance and ticketing costs) to the airline of point redemption. The provision is extinguished when the passenger utilizes or ’burns’ the points.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 7
Sample of accounting policies United Airlines
Frequent Flyer Accounting. United’s Mileage Plus frequent flyer program awards mileage credits to passengers who fly on United, Ted, United Express, the Star Alliance carriers and certain other airlines that participate in the program. Additionally, United sells mileage credits to participating airline partners in the Mileage Plus program and ULS sells mileage credits to non-airline business partners. In any case, the outstanding miles may be redeemed for travel on United, or any airline that participates in the program (in which case, United pays a designated amount to reimburse the transporting carrier). The Company has an obligation to provide this future travel; therefore, we recognize a liability and corresponding expense for mileage earned by passengers who flew on United, Ted, United Express, Star Alliance partners, or one of the Mileage Plus airline partners. For miles earned by members through non-airline business partners, a portion of revenue from the sale of mileage is deferred and recognized when the transportation is provided. At December 31, 2005, our estimated outstanding number of awards to be issued against earned and outstanding mileage credits was approximately 10.1 million, compared to 10.2 million for December 31, 2004. We currently estimate that approximately 8.3 million of these awards will ultimately be redeemed and, accordingly, have recorded a liability of $923 million, which includes the deferred revenue from the sale of miles to non-airline business partners. We utilize a number of estimates in accounting for the Mileage Plus program that require management judgment as discussed below. Members may not reach the threshold necessary for a free ticket award and outstanding miles may not always be redeemed for free travel. Therefore, based on historical data and other information, we estimate how many miles will never be used for an award and exclude those miles from our estimate of the Company’s liability. We also estimate the average number of miles that will be used to redeem an award, which can vary depending upon member choices from alternative award categories. If average actual miles used per award redeemed are more or less than previously estimated, we must subsequently adjust the liability and corresponding expense. A hypothetical 1% change in our estimate of breakage, currently estimated at 18%, has approximately a U.S. $3.5 million effect on the liability.
8 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Sample of accounting policies When a travel award level is attained by a Mileage Plus member, we record a liability for the estimated incremental cost to United of providing the related future travel, based on expected redemption. For award redemptions expected to occur on United, United’s incremental costs are estimated to include variable items such as fuel, meals, insurance and ticketing costs, for what would otherwise be a vacant seat. The estimate of incremental costs does not include any indirect costs or contribution to overhead or profit. A change to these cost estimates, such as a significant change in jet fuel prices, could have a significant impact on our liability in the year of change as well as in future years, since underlying variable cost factors can differ significantly from period to period. A hypothetical 1% change in the cost of jet fuel has approximately a U.S. $783 thousand effect on the liability. In 2005, 1.9 million Mileage Plus travel awards were used on United, as compared to 1.7 million awards used in 2004, and 2.0 million in 2003. This number represents the number of awards for which travel was actually provided and not the number of available seats that were allocated to award travel. These awards represented 6.6 percent of United’s total revenue passenger miles in 2005, 7.4% in 2004 and 9.0% in 2003. Passenger preference for Saver awards, which have stringent seat inventory level limitations but require the use of fewer miles to redeem the award, keeps the potential displacement of revenue passengers on United by award travel at a lower level than would be the case for less restrictive awards. Total miles redeemed for travel on United in 2005, including travel awards and class-of-service upgrades, represented U.S. 79% of the total miles redeemed, of which 70% were used for travel within the US and Canada… Reporting GAAP:
U.S. GAAP (currency quoted in U.S. dollars)
Qantas
The Qantas Group receives revenue from the sale to third parties of rights to have Qantas award points allocated to members of the Qantas Frequent Flyer Program. This revenue is deferred and recognised in the Income Statement when the points are redeemed and passengers uplifted. Members of the Qantas Frequent Flyer Program also accumulate points by travelling on qualifying Qantas and partner airline services. The obligation to provide travel rewards to members arising from these points is provided for as points are accumulated, net of estimated points that will not be redeemed. The provision is based on the incremental cost (being the cost of meals, fuel and passenger expenses) of providing the travel rewards. The provision is reduced as members redeem awards or if their entitlements expire.
Reporting GAAP:
IFRS
Key considerations in applying the sample accounting policies
Application of the ’incremental cost’
when a ticket is sold, versus deferring
method
a portion of a ticket value attributable
The financial reports surveyed emphasise
• Displacement of fare-paying
to the points. Most of the U.S. airlines
that frequent flyer accounting involves a
passengers – to support use of the
surveyed note that displacement of
high level of estimation and judgement.
‘incremental cost’ method, it is
revenue passengers is kept to a
The reports surveyed make reference to
important for airlines to analyse the
minimal level through management of
a number of estimates that form the
level of displacement of fare-paying
load factors, frequent flyer inventory,
basis of accounting for these schemes,
passengers to demonstrate that
frequent flyer travel ’black out’ periods
as outlined below.
frequent flyers are utilising a seat that
and this is illustrated through the the
would otherwise be vacant. This is a
low ratio of points usage to revenue
key assumption in enabling the airline
passenger miles (see table on page 9).
to raise a provision for the points
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 9
• Estimation of the incremental cost of
This portion of revenue is then
inactive accounts, mileage related to
fulfilling the award. Airlines estimate
deferred in the balance sheet and
accounts that have not yet reached the
the marginal or incremental cost of a
recognised as revenue when the
lowest level of free travel award, and
point. The incremental cost may differ
points are utilised.
mileage in active accounts that have
depending on whether the points are expected to be redeemed on its own
reached the lowest level of free travel • Proportion of cash earned on sold
award but which are not expected to ever
airline or other airlines or providers of
points – where cash is received from
services. When points are purchased
third parties on the sale of points, how
from other airlines or providers of
much revenue (if any) can be
A number of U.S. airlines and U.S. GAAP
services to satisfy redemptions, they
recognized on sale with the remainder
filers disclose the portion of ‘Revenue
are accrued at the contractual rate of
(usually the whole or vast majority of
Passenger Miles’ relating to frequent
expected redemption on those carriers
value) recognized on uplift.
flyer award flights as part of their
be redeemed for free travel …”
rationale that there is minimal passenger
and service providers. When the points are redeemed by flying on that
Survey findings
displacement from award flights. These
airline or a partner airline the liability is
One of the distinct trends the survey
disclosures are summarised on page 9.
utilized.
highlights is the move towards adoption of the ‘deferred revenue’ method for sold
Application of both ’incremental cost’ and
points for non-U.S. airlines. Cathay
’deferred’ method
Pacific, British Airways and Qantas have
• Estimation of breakage rates (i.e.
transitioned from ‘incremental cost’ to
points awarded which will not be
‘deferred revenue’ accounting for sold
utilised) will depend on point expiry
points in the 2005 reporting period, the
time limits and are usually determined
latter two on adoption of IFRS in 2005.
by reference to historical rates of point
All airlines surveyed that report under
utilisation.
U.S. GAAP adopt a ‘deferred revenue’
• Assessment of the threshold at which
approach for sold points and the
an accrual for points is recognized.
‘incremental cost’ method for earned
Some airlines such as American, Delta
points. All other airlines surveyed adopt
and United Airlines do not accrue a
the ‘incremental cost’ method for earned
liability until a frequent flyer member
points.
reaches the minimum threshold mileage to claim a free flight.
The level of disclosures in relation to the measurement of provisions under the
Application of the ’deferred revenue’
‘incremental cost’ method varies. JetBlue
method
state that in estimating their provision for
• Estimation of the revenue per point –
such incremental costs ‘we currently
this is relevant where airlines have
assume that 90 percent of earned
adopted ‘deferred revenue’ accounting
awards will be redeemed and that 30
for earned points. When applying this
percent of our outstanding points will
methodology to earned points, an
ultimately result in awards’.
airline must estimate the portion of revenue paid for a ticket that relates to
American Airlines’ 10k states, “in making
the frequent flyer points earned when
the estimate of free travel awards,
the ticket is purchased.
American has excluded mileage in
1 0 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Airline 2005
2004
2003
2002
American Airlines1
7.2%
7.5%
7.8%
N/D
America West2
1.7%
1.7%
1.7%
N/D
British Airways
3.2%
4.0%
4.4%
N/D
Continental Airlines4
7.0%
5.6%
N/D
N/D
Delta Airlines4
9.0%
8.0%
9.0%
9.0%
Northwest Airlines4
7.3%
6.9%
7.5%
7.8%
Southwest Airlines5
6.6%
7.1%
7.5%
6.8%
United Airlines4
6.4%
7.4%
9.0%
7.8%
N/D = Not disclosed 1 = of passengers boarded 2 = Average awards redeemed as a percentage of revenue passenger miles in each year 3 = Frequent flyer revenue passenger kilometres (RPK) as a percentage of total RPKs) 4 = Award flights as a percentage of revenue passenger miles in each year 5 = of revenue passengers carried
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 1 1
1.2 Property, plant and equipment
IFRS requires major component parts of
1.2.1 Aircraft cost
depreciation policies applied to each
The airline industry has contended with
identified component. Typically, this might
several significant events in recent times
involve separately identifying and
that have led to major losses, bankruptcy
depreciating components such as
or bankruptcy protection of a number of
airframes, engines, cost of major
major airlines. This has included the
inspections, modifications, seats, in-flight
terrorist attacks in New York and London,
entertainment, landing gear, rotables
SARS, the Iraq war, Bali bombings and
and repairables.
assets to be capitalized and appropriate
avian flu. These events have impacted the secondary aircraft market and
A common feature of aircraft purchase
consequently the valuation of aircraft
contracts are the offering of manufacturer
assets in financial statements.
or engine ’credits’ to airlines as an incentive to purchase a manufacturer’s
Aircraft and aircraft-related assets are
aircraft or engine. These credits are in-
high-cost assets. The list price of a new
substance rebates or discounts from the
wide-bodied aircraft may be in the
purchase price of the asset and are
hundreds of millions of dollars.
typically deducted from the acquisition
Accounting for such high value and
cost of the asset capitalized on the
complex assets involves consideration of
balance sheet.
several factors. Foremost of these is the determination of what costs are capitalized as part of the cost of the aircraft. Generally all costs incurred in bringing the aircraft into working condition should be capitalized. This will include purchase-right payments and may also include capitalized borrowing costs where the funds are borrowed specifically (or a notional allocation of general indebtness) for an aircraft that is deemed to be a ‘qualifying’ asset. Under IFRS there is a choice as to whether borrowing costs relating to a ‘qualifying’ asset are expensed, whereas U.S. GAAP requires such borrowing costs to be capitalized. (This principle is the subject of review by the IASB with the potential for the option to expense borrowing costs being eliminated).
1 2 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Sample of accounting policies easyJet
Tangible fixed assets are stated at cost less accumulated depreciation… … An element of the cost of a new aircraft is attributed to prepaid maintenance of its engines and airframe… The cost of new Airbus aircraft comprises the invoiced price of the aircraft from the supplier less the estimated value of other assets received by easyJet for no consideration in connection with the transaction to purchase aircraft. Principal assets received for no consideration in connection with the acquisition of aircraft include the following: • Cash – The cash received is recognised as an asset in the balance sheet. The corresponding credits are treated as a discount and are spread equally across each of the 120 Airbus aircraft to be delivered. • Aircraft spares – These are capitalised in the balance sheet at their list price and are then depreciated according to easyJet’s stated accounting policies for spares. The corresponding credits are then spread equally across the cost of each of the 120 Airbus aircraft to be delivered. Advance payments and option payments made in respect of aircraft purchase commitments and options to acquire aircraft where the balance is expected to be funded by mortgage financing are recorded at cost. On acquisition of the related aircraft, these payments are included as part of the cost of aircraft and are depreciated from that date…
Reporting GAAP:
easyJet’s disclosure of anticipated accounting policies under IFRS as adopted by the European Union released in January 2006
Qantas
Items of property, plant and equipment are initially recorded at cost, being the fair value of the consideration provided plus incidental costs directly attributable to the acquisition… Major modifications to aircraft and the costs associated with placing the aircraft into service are capitalised as part of the cost of the asset to which they relate. The cost of major inspections of aircraft and engines is capitalised and depreciated over the scheduled usage period to the next major inspection event. All other aircraft maintenance costs are expensed as incurred. Manpower costs in relation to employees that are dedicated to major modifications to aircraft are capitalised as part of the cost of the modification to which they relate. Borrowing costs associated with the acquisition of qualifying assets such as aircraft and the acquisition, construction or production of significant items of other property, plant and equipment are capitalised as part of the cost of the asset to which they relate.
Reporting GAAP:
IFRS
Air France–KLM
Special rule for the opening balance sheet In the context of the initial application of the IFRS and in accordance with the option offered by IFRS 1, the Group valued the fair value of its fleet at April 1, 2004 and used this valuation as the “assumed cost”. This treatment thus allows the Group to have all of its fleet accounted for at fair value, given that market value was used when valuing the acquisition balance sheet for the acquisition of the KLM group in the same period (May 1, 2004). The valuations were conducted by independent experts.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 1 3
Sample of accounting policies Principles applicable since April 1, 2004 Property, plant and equipment are recorded at the historical acquisition or manufacturing cost, less total amortizations and any depreciation for loss of value. The financial interest on the capital used to finance the investments during the period prior to operation are an integral part of the historical cost. Insofar as investment installments are not financed by specific loans, the Group uses the average interest rate on the current unallocated loans at the end of the period in question. Maintenance costs are booked as expenses for the period, with the exception of programs that extend the useful life of the asset or increase its value, which are then capitalized (maintenance on airframes and engines excluding parts with limited useful lives). Flight equipment The acquisition price of aircraft equipment is denominated in foreign currencies. It is converted at the payment price or, if applicable, at the hedging price assigned to it. Manufacturers’ discounts if any are deducted from the value of the asset in question. Aircraft are depreciated using the straight-line method over their average estimated useful life. Since April 1, 2004, this period has been set at 20 years without residual value except in special cases. Given a market in which transactions are denominated in U.S. dollars, and the useful life set on average at 20 years, no residual value on the date of entry into service is determined on the acquisition date. The accounting standard recommends an annual review of the residual value and the amortization schedule. During the operating cycle, in developing fleet replacement plans, the Group reviews whether the amortizable base or the useful life should be adapted and, if necessary, determines whether a residual value should be recognized. Any airframes and engines (excluding parts with a limited useful life) are isolated from the aircraft acquisition price and amortized over the current duration until the next scheduled major maintenance event. Aircraft parts are recorded in the consolidated balance sheet as fixed assets. The amortization period varies from 3 to 20 years depending on the technical properties of each item. Reporting GAAP:
IFRS as adopted by the European Union
1 4 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Key considerations in applying the sample accounting policies
• Accounting for modifications to aircraft. Modifications may require
Outlined below are the key factors that
capitalization depending on their
impact the accounting for aircraft cost:
nature.
• The level of component parts which are identified and capitalized and the
• Accounting for maintenance
useful lives and residual values of
expenditure. Airlines must distinguish
these components. (Useful lives,
between one-off maintenance repairs
depreciation rates and residual values
which restore an asset to its normal
are considered in further detail in
condition, for example, repairs arising
section 1.2.4.)
from birdstrike damage which should be expensed, as opposed to major
• The elements of costs to be
maintenance expenditure or
capitalized into the aircraft. Costs
expenditure which replaces
capitalized under IFRS are not always
components of an aircraft. For
the same as those permitted under
example, a new type of business class
U.S. GAAP, for example, under IFRS
seat or more efficient fuel delivery
interest costs are either capitalised or
system which would be capitalizable
expensed whereas under U.S. GAAP
as an asset. (This is discussed in more
interest costs must be capitalised
detail in section 1.2.2.)
where the company has deemed an aircraft to be a qualifying asset. Also,
Survey findings
hedging gains or losses on progress
The nature of costs disclosed by airlines
payments are generally included in the
as capitalized as part of the cost of the
determination of the cost of the
aircraft were generally consistent.
aircraft and where IFRS and U.S. GAAP differ on accounting for
The accounting for manufacturers’
derivatives, it may impact the costs
credits/discounts were not disclosed by
that can be capitalized.
most airlines surveyed, however when the accounting policy was disclosed such
The treatment of credits received from
as by easyJet, they were deducted from
aircraft or engine suppliers to incentivise
the initial cost of the asset.
the purchase of aircraft. These credits come in various forms including
Where aircraft were purchased through a
guaranteed trade-in values, spare parts
series of progress payments, the interest
support, marketing support, training
attributed to these payments was
support or introduction cost support. The
generally capitalized as a cost of the
financial statements of airlines surveyed
underlying aircraft asset.
indicates that the vast majority of these rebates are offset against the cost
The level of disclosure in respect of
capitalized in respect of the aircraft and
accounting for component parts of an
not recognized as revenue in the profit
aircraft and associated depreciation
or loss.
policies is summarized in section 1.2.4.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 1 5
1.2.2 Maintenance accounting
The survey highlighted that airlines adopt
aircraft. Instead (using aircraft as an
varying accounting policies for
example) IFRS requires that major
Airlines are required to conduct varying
maintenance. Routine ’day-to-day’
inspection costs are recognized as a
levels of aircraft maintenance which
maintenance is usually expensed. Heavy
component of the cost of aircraft asset
involve significantly different labor and
or major cyclical maintenance is
and depreciated over the period to the
materials inputs.
accounted for in three different ways
next heavy maintenance ‘event.’
(depending on the reporting GAAP): Maintenance requirements depend on
expensed as incurred; capitalized as a
U.S. GAAP allows any of the three
the age and type of aircraft and the route
component part of the aircraft’s cost and
options of expensing major maintenance:
network over which they operate.
depreciated over the period to the next
expensing as incurred, capitalization as a
Technological changes mean that ‘new
major maintenance ’event’; or provided
component part of the aircraft or creation
generation’ aircraft have maintenance
for in advance based on the expected
of provisions for expected costs in
profiles different to older aircraft.
cost of maintenance. Power-by-the-hour
advance. However, the FASB is currently
maintenance agreements are becoming
reviewing the option to create a provision
Fleet maintenance requirements may
more prevalent, with the accounting for
in advance for expected maintenance
involve short cycle engineering checks,
these depending on the substance of the
costs, with the current preferred option
for example, component checks, monthly
agreement and whether the aircraft is
to expense as incurred. Under both IFRS
checks, annual airframe checks, periodic
owned or leased.
and U.S. GAAP routine servicing and
heavy maintenance (eg. ’C’ checks and
maintenance costs must be expensed
’D’ checks) and engine checks. With ‘new
The accounting policy adopted is
generation’ aircraft changing historic
somewhat dependent on the GAAP
maintenance profiles, the fact pattern of
under which the airline reports. IFRS
the airline’s actual system of
prohibits creating a provision for major
maintenance is crucial.
maintenance in advance for owned
as incurred.
1 6 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Sample of accounting policies British Airways
Major overhaul expenditure, including replacement spares and labour costs, is capitalised and amortised over the average expected life between major overhauls. All other replacement spares and other costs relating to maintenance of fleet assets are charged to the income statement on consumption or as incurred respectively.
Reporting GAAP:
IFRS as adopted by the European Union
Northwest
Routine maintenance, airframe and engine overhauls are charged to expense as incurred or when the asset is
Airlines
inducted at the vendor for service, except engine overhaul costs covered by power-by-the-hour type agreements, which are accrued on the basis of hours flown. Modification that enhance the operating performance or extend the useful lives of airframes or engines are capitalized and amortized over the remaining estimated useful life of the asset.
Reporting GAAP: Ryanair
U.S. GAAP With respect to the group’s operating lease agreements, where the group has a commitment to maintain the aircraft, provision is made during the lease term for the obligation based on estimated future costs of major airframe and certain engine maintenance checks by making appropriate charges to the profit and loss account calculated by reference to the number of hours or cycles operated during the year. All other maintenance costs are expensed as incurred.
Reporting GAAP:
Irish and UK GAAP with no difference noted in the subsequent IFRS release in August 2005
United Airlines
Maintenance and repairs, including the cost of minor replacements, are charged to maintenance expense as incurred, except for costs incurred under our power by the hour engine maintenance agreements, which are expensed based upon the number of hours flown‌
Reporting GAAP:
U.S. GAAP
U.S. Airways
Maintenance and repair costs for owned and leased flight equipment are charged to operating expense as incurred. AWA historically recorded the cost of major scheduled airframe, engine and certain component overhauls as capitalized assets that were subsequently amortized over the periods benefited, (referred to as the deferral method). U.S. Airways Group charges maintenance and repair costs for owned and leased flight equipment to operating expense as incurred. In 2005, AWA changed its accounting policy from the deferral method to the direct expense method. While the deferral method is permitted under accounting principles generally accepted in the United States of America, U.S. Airway Group and AWA believe that the direct expense method is preferable and the predominant method used in the airline industry. The effect of this change in accounting for aircraft maintenance and repairs is recorded as a cumulative effect of a change in accounting principle.
Reporting GAAP:
U.S. GAAP
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 1 7
Key considerations in applying the sample accounting policies
• How is the useful life for capitalized maintenance determined? It may be
The financial reports surveyed show that
difficult to establish accurate periods
capitalization of heavy maintenance or
for maintenance depreciation given
providing for maintenance in advance
different aircraft utilization/cycles.
requires significant levels of judgment on the part of management due to the
Survey findings
estimation involved. Where maintenance
Airlines reporting under IFRS, or
is capitalized, in our experience
transitioning to IFRS account for major
management typically consider:
maintenance as a component of the
• What maintenance events are
aircraft and capitalize and depreciate the
capitalized? What defines ’major
maintenance cost over the period until
maintenance’ – is it by type of check
the next maintenance ‘event’. Almost all
or measured by a quantitative
airlines surveyed that have transitioned to
threshold? What constitutes major
IFRS including British Airways, Air France
maintenance for airframes and for
– KLM and Qantas have moved from a
engines?
policy of expensing all maintenance to
• What constitutes a major cyclical
capitalizing heavy maintenance.
maintenance expense versus ’abnormal’ maintenance? • How are costs measured? The
Of the airlines surveyed, accounting for maintenance and repairs under ’power-by-
measurement of costs may be clear
the-hour’ contracts generally were
if it is based on an actual invoices
accrued and expensed on the basis of
provided by a third party, but how are
hours flown.
costs attributed if an airline undertakes its own maintenance? • How are power-by-the-hour contracts
Airlines surveyed that report under U.S. GAAP either capitalized or expensed
accounted for? Straight forward
maintenance costs. A limited sample of
power-by-the-hour costs are expensed
the airlines surveyed disclosed the
but often top-up or refund
treatment of maintenance costs on
arrangements embedded in the
different fleet types.
contracts may mean that by-the-hour arrangements are in substance maintenance prepayments and therefore require different accounting. • How are maintenance costs for aircraft subject to an operating lease accounted for? Typically aircraft operating leases include requirements to undertake maintenance in line with manufacturers’ recommendations and some airlines provide for maintenance on a flying hour basis.
1 8 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
1.2.3 Airport landing and gate slots
resulted in airlines trading airport landing
operating rights is generally capitalized as
and gate slots in an informal ’secondary
an intangible asset by airlines reporting
As global air traffic continues to grow,
market’, particularly at key international
under IFRS and U.S. GAAP.
space at airports is becoming
hubs such as London Heathrow. The cost
increasingly constrained. This has
of acquiring landing slots or airport
Sample of accounting policies American
Route acquisition costs and airport operating and gate lease rights represent the purchase price attributable
Airlines
to route authorities (including international airport take-off and landing slots), domestic airport take-off and landing slots and airport gate leasehold rights acquired. Indefinite-lived intangible assets (route acquisition costs) are tested for impairment annually on December 31, rather than amortized, in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). Airport operating and gate lease rights are being amortized on a straight-line basis over 25 years to a zero residual value.
Reporting GAAP:
U.S. GAAP
British Airways
Landing rights acquired from other airlines either directly or as a result of a business combination are capitalised at cost (or at fair value if acquired through a business combination) and amortised over a period not exceeding 20 years. The carrying value is reviewed for impairment if events or changes in circumstances indicate the carrying value may not be recoverable.
Reporting GAAP:
IFRS as adopted by the European Union
Continental
Routes represent the right to fly between cities in different countries. Routes are indefinite – lived intangible assets and are not amortized. We perform a test for impairment of our routes in the fourth quarter of each year. Airport operating rights represent gate space and slots (the right to schedule an arrival or departure within designated hours at a particular airport). Airport operating rights are amortized over the stated term of the related lease or 20 years…
Reporting GAAP:
U.S. GAAP
Qantas
Airport landing slots are stated at cost less any accumulated impairment losses. Airport landing slots are allocated to cash generating units and are not amortised as they are considered to have an indefinite useful life and are tested annually for impairment.
Reporting GAAP:
IFRS
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 1 9
Key considerations in applying the sample accounting policies
for impairment annually and when there
Several airlines surveyed had capitalized
are indicators of impairment at reporting
acquired landing slots as indefinite life
The financial reports surveyed highlight
date.
intangible assets. A number of the U.S.
that accounting for landing slots or
airlines surveyed had capitalized airport-
operating rights is dependent on the
Survey findings
operating rights and amortized them over
underlying rights and length of access
The accounting policies of the airlines
a period of 20-25 years.
that the slots or rights provide. Under
surveyed were mixed. The majority of
both U.S. GAAP and IFRS intangible
non-U.S. airlines surveyed made no
The impairment testing of intangible
assets with an indefinite useful life are
specific disclosures in relation to aircraft
assets is considered in section 1.2.5.
not amortized, but rather are assessed
landing slots.
2 0 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
1.2.4 Depreciation and residual values
aircraft. These aircraft have reduced
vary across airlines. This may cause
operating costs and are adversely
significant differences in periodical
Two of the most basic but important
impacting the values of older aircraft in
profitability and impact the comparability
accounting estimates airline management
the secondary market. When decisions
of businesses within the industry.
make is the useful lives and residual
are made to retire aircraft earlier than
values of aircraft. These estimates
anticipated, accelerated depreciation may
determine effective depreciation rates.
need to be applied prospectively to reduce the carrying value of aircraft.
Useful lives and residual values of existing aircraft fleets are increasingly
Aircraft-related, asset depreciation
being impacted by ‘new generation’
policies and residual value assumptions
Sample of accounting policies Alitalia
Tangible assets are depreciated on a straight line basis every year using depreciation rates intended to reflect the remaining useful life of the assets. More specifically, the following rates of depreciation are charged on the fleet – depreciation is in line with normal practice in the air transport industry: Long haul aircraft (B777, B767, MD11)
20 years
Short-medium haul aircraft (A321, A320, A319, MD80, ERJ145)
18 years
5% 5.5%
Turboprop aircraft (ATR 72)
14 years
7.14%
The recoverability of the value of tangible assets is checked using the method laid down by IAS 36 as described under “Impairment of assets”. The depreciable amount of a tangible asset consists of its initial book value net of its residual value. IAS 16 defines residual value as an estimate of the amount the business expects to recover through the sale of the asset, net of disposal costs, assuming the asset is already in the condition expected for it at the end of its useful life. The Alitalia Group has adopted a certain percentage of the initial historic cost of its aircraft as their residual value as follows: 10%
For B777, B767, MD11, A321, A320, A319, ERJ145
5%
For MD80, ATR72
0
For ATR42
Useful life is intended as the period of time during which an asset is expected to be available for use by the business. The Alitalia Group extends the useful life of those aircraft which, having undergone their third heavy maintenance, show a lag between the depreciation period of the aircraft and the period of the cyclical maintenance…
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 2 1
Sample of accounting policies …Where the individual components of a complex tangible asset have different useful lives, they are recorded separately so that they can be depreciated over their useful lives using a component approach. In particular, aircraft have been broken down into the following components: • heavy maintenance (i.e. D-check, IL inspection); • airframe; • engine. The component approach is also used to separate the value of land and buildings. Only buildings are depreciated. Assets held under finance leases are depreciated based on their estimated useful lives in the same manner as owned assets… Reporting GAAP:
IFRS as adopted by the European Union
American
The provision for depreciation of operating equipment and property is computed on the straight-line method
Airlines
applied to each unit of property, except that major rotable parts, avionics and assemblies are depreciated on a group basis. The depreciable lives used for the principal depreciable asset classifications are: Depreciable Life American jet aircraft and engines
20-30 years
Major rotable parts, avionics and assemblies
Life of equipment to which applicable
Improvements to leased flight equipment
Term of lease
Buildings and improvements (principally on leased land)
5-30 years or term of lease, including estimated renewal options when renewal is economically compelled at key airports
Furniture, fixtures and other equipment
3-10 years
Capitalized software
3-10 years
Effective January 1, 2005, in order to more accurately reflect the expected useful life of its aircraft, the Company changed its estimate of the depreciable lives of its Boeing 737-800, Boeing 757-200 and McDonnell Douglas MD-80 aircraft from 25 to 30 years. As a result of this change, Depreciation and amortization expense was reduced by approximately U.S. $108 million for the year ended December 31, 2005. Residual values for aircraft, engines, major rotable parts, avionics and assemblies are generally five to ten percent, except when guaranteed by a third party for a different amount. Equipment and property under capital leases are amortized over the term of the leases or, in the case of certain aircraft, over their expected useful lives. Lease terms vary but are generally ten to 25 years for aircraft and seven to 40 years for other leased equipment and property. Reporting GAAP:
U.S. GAAP (currency quoted in U.S. dollars)
2 2 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Key considerations in applying the sample accounting policies
Survey findings
Determining an appropriate depreciation
policy assumptions are mixed. Generally
rate and associated aircraft residual value
aircraft assets are depreciated over 15 to
is dependent on a number of factors
25 years to residual values of between
including:
0 to 20 percent. The straight-line method
• intended life of the fleet type being
of depreciation is the most commonly
operated by the airline • estimate of the economic life from the manufacturer
Depreciation and residual value accounting
used. Airline disclosures demonstrate that a small change in estimate can have a large impact on profit or loss. Appendix 1
• fleet deployment plans including
shows that there is significant divergence
timing of fleet replacements
depreciation assumptions. In our experience
• changes in technology
this is likely to reflect the different flying
• repairs and maintenance policies
patterns of each airline as well as differing
• aircraft operating cycles (long-haul
management views on this matter.
aircraft may have a different
Appendix 1 summarizes the individual
depreciation profile to high cycle short
asset type, useful lives, depreciation rates
haul aircraft)
and residual values of the airlines surveyed.
• prevailing market prices and the trend in price of second hand and replacement aircraft • legal constraints on registration • aircraft-related fixed asset depreciation rates, for example, rotables and repairables may reflect the airline’s ability to use common components across different aircraft types.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 2 3
1.2.5 Impairment testing
fuel prices. The industry, in particular the
The airline industry is highly capital
U.S., has lost billions of dollars over the
intensive. The majority of airlines have
past five years. Achieving an acceptable
hundreds of millions to billions of U.S.
return on capital is a constant challenge.
dollars of tangible assets capitalized on their balance sheet representing aircraft
The directors and management of airlines
and related infrastructure and support
not meeting required returns on capital or
assets.
sufficient levels of profitability are likely to be regularly reviewing the carrying
Whilst capital investment is high,
value of aircraft assets. Both IFRS and
earnings have historically been volatile.
U.S. GAAP require that a review for
The airline industry is vulnerable to
impairment be undertaken if events
economic recession and external demand
indicate that asset-carrying amounts may
shocks such as those caused by terrorist
not be recoverable, and this be done at
acts, pandemics or overseas conflicts.
least annually.
The latest challenge being record high
2 4 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Sample of accounting policies Air France –
Pursuant to IAS 36 "Impairment of Assets", the Group reviews annually the book values of tangible and
KLM
intangible assets in order to assess whether there is any indication showing that the value of these assets could change. If such an indication exists, the recoverable value of the assets is estimated in order to determine the amount, if any, of the loss of value. The recoverable value is the higher of two values: the fair value minus selling costs and its useful value. When it is not possible to estimate the recoverable value of an asset considered separately, it is attached to other assets. The Group determined that the smallest level at which assets could be tested were the cash-generating units (CGU) corresponding to the Group’s business sectors. When the recoverable value of a CGU is less than its book value, a depreciation is recognized. This depreciation is allocated first to the balance sheet value of the goodwill. The remainder is allocated to the other assets composing the CGU prorated on the basis of their book value. The recoverable value of the CGUs is determined by using a discount rate corresponding to the weighted average cost of the Group’s capital, which was 7.5% for fiscal 2004/05.
Reporting GAAP:
IFRS as adopted by the European Union
Continental
We record impairment losses on long-lived assets used in operations, primarily property and equipment and airport operating rights, when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those items. Our cash flow estimates are based on historical results adjusted to reflect our best estimate of future market and operating conditions. The net carrying value of assets not recoverable is reduced to fair value. Our estimates of fair value represent our best estimate based on industry trends and reference to market rates and transactions. We recognized fleet impairment losses in 2003 which were partially the result of the September 11, 2001 terrorist attacks and the related aftermath. These events resulted in a re-evaluation of our operating and fleet plans, resulting in the grounding of certain older aircraft types or acceleration of the dates on which the related aircraft were to be removed from service. The grounding or acceleration of aircraft retirement dates resulted in reduced estimates of future cash flows. We recorded an impairment charge of $65 million to reflect decreases in the fair value of our owned MD-80s and spare parts inventory for permanently grounded fleets. We estimated the fair value of these aircraft and related inventory based on industry trends and, where available, reference to market rates and transactions. All other long-lived assets, principally our other fleet types and airport operating rights, were determined to be recoverable based on our estimates of future cash flows. There were no impairment losses recorded during 2004 and 2005. We also perform annual impairment tests on our routes, which are indefinite life intangible assets. These tests are based on estimates of discounted future cash flows, using assumptions consistent with those used for aircraft and airport operating rights impairment tests. We determined that we did not have any impairment of our routes at December 31, 2005.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 2 5
Sample of accounting policies We provide an allowance for spare parts inventory obsolescence over the remaining useful life of the related aircraft, plus allowances for spare parts currently identified as excess. These allowances are based on our estimates and industry trends, which are subject to change and, where available, reference to market rates and transactions. The estimates are more sensitive when we near the end of a fleet life or when we remove entire fleets from service sooner than originally planned. We regularly review the estimated useful lives and salvage values for our aircraft and spare parts. Reporting GAAP:
U.S. GAAP (currency quoted in U.S. dollars)
Lufthansa
…All goodwill was for the first time subjected to a regular recoverability test under IAS 36 in financial year 2005. The tests have been performed at the level of the smallest cash generating unit (‘CGU’) on the basis of the value in use. The goodwill originating from the acquisition of Air Dolomiti S.p.A and of the Eurowings group has in this connection been tested as the smallest independent cash generating unit at the level of Lufthansa AG and it regional partners. The following table provides an overview of the goodwill tested and the assumptions included in the respective recoverability tests. CGU
Segment Carrying amount of goodwill Impairment Revenue growth p.a. planning period EBITDA margin planning period Rate of investment planning period Planning period Revenue growth p.a. after the end of the planning period EBITDA margin after the end of the planning period Rate of investment after the end of the planning period Discount rate
Lufthansa
BizJet
LSG Sky
LSG Sky
AG and
International
Chefs USA
Chefs Korea
regional partners Passenger business
Maintenance
Group Catering
Catering
€249m –
€20m €20m
€557m €280m
€65m –
2.5% to 6.4% 8.1% to 9.9%
2.5% to 4.6% 9.2% to 9.4%
-8.5% to 0.2% 4.7% to 5.1% -2.8% to 8.6% 4.7% to 5.1%
3.5% to 5.7% 3 years
0.6% to 1.3% 3 years
2% 4 years
1.0% to 1.9% 3 years
2.5%
2.5%
2%
5%
9.9%
9.1%
9.6%
25.3%
5.7% 9.8%
0.9% 9.5%
2% 9.8%
1% 9.8%
The assumptions used for the recoverability tests are based on external sources in the planning period. In some cases, risk reductions have been effected in order to allow for special regional features and market share trends specific to the respective company. In case revenue growth of the LSG Sky Chefs USA group should stagnate at 0 percent at the end of the planning period, this would result in an additional impairment of €78m under ceteris-paribus conditions. Reporting GAAP:
IFRS as adopted by the European Union (currency quoted in Euros)
2 6 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Sample of accounting policies U.S. Airways
We assess the impairment of long-lived assets and intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors which could trigger an impairment review include the following: significant changes in the matter of use of the assets; significant underperformance relative to historical or projected future operating results; or significant negative industry or economic trends. An impairment has occurred when the future undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those items. Cash flow estimates are based on historical results adjusted to reflect management’s best estimate of future market and operating conditions. The net carrying value of assets not recoverable is reduced to fair value. Estimates of fair value represent management’s best estimate based on appraisals, industry trends and reference to market rates and transactions. Changes in industry capacity and demand for air transportation can significantly impact the fair value of aircraft and related assets.
Reporting GAAP:
U.S. GAAP
Key considerations in applying the sample accounting policies • Both IFRS and U.S. GAAP embody the
on a number of different bases including: • Assessing that all aircraft assets should be grouped for impairment
concept that impairment testing
testing (based on economic
should be performed on the smallest
interdependencies).
group of assets that work together to generate independent cash flows, ie (CGUs). • Determining the appropriate asset group to use as a basis for impairment testing requires significant judgment.
• Grouping assets on an aircraft fleet type basis.
Survey findings Many U.S. airlines have booked impairment charges in relation to aircraft assets. U.S. airlines generally disclose that asset impairment is undertaken on an aircraft type basis.
• Considering impairment on an individual aircraft asset basis. • Allocating aircraft assets to individual routes or route groups.
The disclosure of asset groups is
The majority of non-U.S. airlines surveyed were silent as to the basis on which impairment testing is undertaken, including the assets grouped for
limited in the reports surveyed, with
Different airlines’ circumstances will be
impairment testing. No non-U.S. airlines
only Lufthansa identifying the actual
the critical factor in applying this in
reported any impairment charges, other
CGU’s tested. It appears that airlines
practice.
than Lufthansa (see sample accounting
have assessed asset groups
policy on page 25).
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 2 7
1.3 Aircraft leasing
financing is structured as a sale and
over the life of the lease), whether the
1.3.1 Sale and leaseback transactions
leaseback, then the lease arrangement
aircraft and/or related deposits and
may be classified as a finance or
capitalized costs can be derecognized
Varying financing structures (some of
operating lease. However, the key
from the balance sheet; whether there is
which are tax driven) are put in place to
accounting considerations generally
a requirement to consolidate any special
help enable airlines to finance aircraft
remain the same irrespective of the
purpose leasing entities and the cashflow
orders from manufacturers and refinance
classification of the lease. They include:
disclosures required.
existing aircraft. These transactions may
timing of recognition of gain or loss on
occur prior to or post delivery. If the
sale (ie at the point of sale or deferred
Sample of accounting policies easyJet
…easyJet enters into sale and leaseback transactions whereby it sells to a third party rights to acquire aircraft. On delivery of the aircraft, easyJet subsequently leases the aircraft back, by way of operating lease. Any profit on the disposal, where the price that the aircraft is sold for is not considered to be fair value, is deferred and amortised over the lease term of the asset. Purchase rights (being the amount of pre delivery deposits paid) for aircraft that are expected to be sold and leased back to lessors are considered to be monetary assets. These are disclosed separately from fixed assets…
Reporting GAAP:
IFRS as adopted by the European Union
JetBlue
…During 2005, we entered into sale and leaseback transactions for six EMBRAER 190 aircraft acquired during the year. Gains associated with sale and leaseback operating leases have been deferred and are being recognized on a straight-line basis over the lease term as a reduction to aircraft rent expense…
Reporting GAAP:
U.S. GAAP
Singapore
Leases where the lessor effectively retains substantially all the risks and benefits of ownership of the
Airlines
leased assets are classified as operating leases. Operating lease payments are recognised as an expense in the profit and loss accounts on a straight-line basis over the lease term. Gains or losses arising from sale and operating leaseback of aircraft are determined based on fair values. Differences between sale proceeds and fair values are deferred and amortized over the minimum lease terms…
Reporting GAAP:
Singapore Financial Reporting Standards
Key considerations in applying the sample accounting policies In KPMG’s experience there are a number of issues in analyzing and accounting for
lessor is required. One of the primary
remove the final delivery payment to
risks of aircraft financing is who bears
the aircraft manufacturer from an
the residual aircraft value risk.
airline’s cash flow statement as it is
• At what date was there a sale? This
made by the lessor. If there is an
lease transactions. These include:
impacts not only the timing of any
intention to sell the aircraft prior to
• Has there been a sale of the aircraft?
profit recognition and balance sheet
delivery the classification of the
An analysis of whether the risks and
impact but also cashflow statement
security deposits also requires
benefits have been transferred to the
disclosures as a sale pre-delivery may
consideration.
2 8 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
• Are the sale proceeds at fair value?
Survey findings
Aircraft fair values are often difficult to
The method of determining fair values is
determine owing to the significant
not disclosed by airlines so it is difficult to
discounts to list prices given to large
determine how this is analyzed, particularly
aircraft orders. Assessments of fair
for newer aircraft types, that do not have
values are often complicated by the
a track record of open market sales.
capitalization of interest costs, hedging gains or losses and other costs into
The treatment of leaseback transactions
the cost of the aircraft by airlines.
in the cashflow statement is clear.
When these costs are totaled do they
However some airlines have made
represent an appropriate fair value to
disclosures where non cash financing
be analyzed against the lessor’s upfront
transactions have taken place – a
payment in a sale and leaseback?
requirement under IFRS and U.S. GAAP.
When the transaction involves older aircraft this determination of appropriate
There may be further disclosures around
fair values is more complex as these
aircraft financing as the first annual
may lack recent relevant sales
reports prepared under IFRS are
information.
published.
Whilst third party ’desktop’ valuations are a useful starting point to assess the fair value of an aircraft, other important factors to be considered include: analysis of the nature of costs capitalized into the aircraft value; benchmarking of lease rates; and understanding the economic rationale for any gain or loss on disposal. Under IFRS gains or losses on sale and operating leasebacks, if deemed at fair value, are recognized in the profit and loss account immediately whereas they are generally amortized over the life of the lease under U.S. GAAP where there is on-going involvement in the asset.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 2 9
1.4 Financial instruments
certainty over the future price or rate that
and Measurement’, is being applied by
will be paid for an existing or forecast
airlines reporting under IFRS for the first
1.4.1 Hedge accounting
transaction. Whilst principles for accounting
time from January 1, 2005 onwards.
Airlines, in common with other entities,
for financial instruments are broadly similar
are exposed to fluctuations in foreign
under both IFRS and U.S. GAAP, differences
The financial report disclosures relating to
exchange rates, interest rates and
in detail result in disparities in accounting.
hedge accounting vary according to the hedging activities airlines undertake. Two
commodity prices. The U.S. GAAP standard on the recognition
extracts of hedge activities accounting
In order to manage or limit exposure to
and measurement of financial instruments
policies are set out below; one airline
changes in rates or prices, many airlines
and hedge accounting (FAS 133) has
reporting under U.S. GAAP and one
undertake hedging activities. These
been effective for several years. The IFRS
under IFRS.
activities typically involve the use of
standard providing similar guidance, IAS
derivative financial instruments to provide
39 ‘Financial Instruments: Recognition
Sample of accounting policies Southwest
The Company utilizes financial derivative instruments primarily to manage its risk associated with changing
Airlines
jet fuel prices, and accounts for them under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended (SFAS 133). See “Qualitative and Quantitative Disclosures about Market Risk” for more information on these risk management activities and see Note 10 to the Consolidated Financial Statements for more information on SFAS 133, the Company’s fuel hedging program, and financial derivative instruments. SFAS 133 requires that all derivatives be marked to market (fair value) and recorded on the Consolidated Balance Sheet. At December 31, 2005, the Company was a party to over 400 financial derivative instruments, related to fuel hedging, for year 2006 and beyond. The fair value of the Company’s fuel hedging financial derivative instruments recorded on the Company’s Consolidated Balance Sheet as of December 31, 2005, was $1.7 billion, compared to $796 million at December 31, 2004. The large increase in fair value primarily was due to the dramatic increase in energy prices throughout 2005, and the Company’s addition of derivative instruments to increase its hedge positions in future years. Changes in the fair values of these instruments can vary dramatically, as was evident during 2005, based on changes in the underlying commodity prices. Market price changes can be driven by factors such as supply and demand, inventory levels, weather events, refinery capacity, political agendas, and general economic conditions, among other items. The financial derivative instruments utilized by the Company primarily are a combination of collars, purchased call options, and fixed price swap agreements. The Company does not purchase or hold any derivative instruments for trading purposes. The Company enters into financial derivative instruments with third party institutions in “over-the-counter” markets. Since the majority of the Company’s financial derivative instruments are not traded on a market exchange, the Company estimates their fair values. Depending on the type of instrument, the values are determined by the use of present value methods or standard option value models with assumptions about commodity prices based on those observed in underlying markets. Also, since there is not a reliable forward market for jet fuel, the Company must estimate the future prices of jet fuel in order to measure
3 0 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Sample of accounting policies the effectiveness of the hedging instruments in offsetting changes to those prices, as require by SFAS 133. Forward jet fuel prices are estimated through the observation of similar commodity futures prices (such as crude oil, heating oil, and unleaded gasoline) and adjusted based on historical variations to those like commodities. Fair values for financial derivative instruments and forward jet fuel prices are both estimated prior to the time that the financial derivative instruments settle, and the time that jet fuel is purchased and consumed, respectively. However, once settlement of the financial derivative instruments occurs and the hedged jet fuel is purchased and consumed, all values and prices are known and are recognized in the financial statements. Based on these actual results once all values and prices become known, the Company’s estimates have proved to be materially accurate. Estimating the fair value of these fuel hedging derivatives and forward prices for jet fuel will also result in changes in their values from period to period and thus determine how they are accounted for under SFAS 133. To the extent that the total change in the estimated fair value of a fuel hedging instrument differs from the change in the estimated price of the associated jet fuel to be purchased, both on a cumulative and period-to-period basis, ineffectiveness of the fuel hedge can result, as defined by SFAS 133. This could result in the immediate recording of noncash charges or income, even though the derivative instrument may not expire until a future period. Likewise, if a cash flow hedge ceases to qualify for hedge accounting, those periodic changes in the fair value of derivative instruments are recorded to “Other gains and losses” in the income statement in the period of the change. Ineffectiveness is inherent in hedging jet fuel with derivative positions based in other crude oil-related commodities, especially considering the recent volatility in the prices of refined products. In addition, given the magnitude of the Company’s fuel hedge portfolio total market value, ineffectiveness can be highly material to financial results. Due to the volatility in markets for crude oil and related products, the Company is unable to predict the amount of ineffectiveness each period, including the loss of hedge accounting, which could be determined on a derivative by derivative basis or in the aggregate. This may result in increased volatility in the Company’s results. Prior to 2005, the Company had not experienced significant ineffectiveness in its fuel hedges accounted for under SFAS 133, in relation to the fair value of the underlying financial derivative instruments. The significant increase in the amount of hedge ineffectiveness and unrealized gains on derivative contracts settling in future periods recorded during 2005 was due to a number of factors. These factors included: the recent significant increase in energy prices, the number of derivative positions the Company holds, significant weather events that have affected refinery capacity and the production of refined products, and the volatility of the different types of products the Company uses in hedging. The number of instances in which the Company has discontinued hedge accounting for specific hedges had increased recently, primarily due to the foregoing reasons. In these cases, the Company had determined that the hedges will not regain effectiveness in the time period remaining until settlement and therefore must discontinue special hedge accounting, as defined by SFAS 133. When this happens, any changes in fair value of the derivative instruments are marked to market through earnings in the period of change.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 3 1
Sample of accounting policies As the fair value of the Company’s hedge positions increases in amount, there is a higher degree of probability that there will be continued and correspondingly higher variability recorded in the income statement and that the amount of hedge ineffectiveness and unrealized gains or losses recorded in future periods will be material. This is primarily due to the fact that small differences in the correlation of crude oil-related products are leveraged over large dollar volumes. SFAS 133 is a complex accounting standard with stringent requirements, including the documentation of a Company hedging strategy, statistical analysis to qualify a commodity for hedge accounting both on a historical and a prospective basis, and strict contemporaneous documentation that is required at the time each hedge is executed by the Company. As required by SFAS 133, the Company assesses the effectiveness of each of its individual hedges on a quarterly basis. The Company also examines the effectiveness of its entire hedging program on a quarterly basis utilizing statistical analysis. This analysis involves utilizing regression and other statistical analyses that compare changes in the price of jet fuel to changes in the prices of the commodities used for hedging purposes (crude oil, heating oil, and unleaded gasoline). The Company continually looks for better and more accurate methodologies in forecasting future cash flows relating to its jet fuel hedging program. These estimates are used in the measurement of effectiveness for the Company’s fuel hedges, as required by SFAS 133. Any changes to the Company’s methodology for estimating future cash flows (i.e, jet fuel prices) will be applied prospectively, in accordance with SFAS 133. While the Company would expect that a change in the methodology for estimating future cash flows would result in more effective hedges over the long-term, such a change could result in more ineffectiveness, as defined, in the short-term, due to the prospective nature of enacting the change… Reporting GAAP:
U.S. GAAP (currency quoted in U.S. dollars)
Qantas
Qantas is subject to foreign currency, interest rate, fuel price and credit risks. Derivative financial instruments are used to hedge these risks. Qantas policy is not to enter, issue or hold derivative financial instruments for speculative trading purposes. Derivative financial instruments are recognised at fair value both initially and on an ongoing basis. The method of recognising gains and losses resulting from movements in market prices depends on whether the derivative is a designated hedging instrument, and if so, the nature of the item being hedged. The Qantas Group designates certain derivatives as either; (1) hedges of the fair value of recognised assets or liabilities or a firm commitment (fair value hedge); or (2) hedges of highly probable forecast transactions (cash flow hedges). Gains and losses on derivative financial instruments qualifying for hedge accounting are recognised in the same income statement category as the underlying hedged instrument. Qantas documents at the inception of the transaction the relationship between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking each transaction. Qantas also documents its assessment, both at hedge inception and on an ongoing basis, of whether the hedging instruments that are used in hedge transactions have been and will continue to be highly effective.
3 2 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Sample of accounting policies Fair Value Hedge Changes in the fair value of derivative financial instruments that are designated and qualify as fair value hedges are recorded in the Income Statement, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. Cash Flow Hedge The effective portion of changes in the fair value of derivative financial instruments that are designated and qualify as cash flow hedges is recognised in Equity in the Hedge Reserve. Amounts accumulated in the Hedge Reserve are recognised in the Income Statement in the periods when the hedged item will affect profit or loss (ie. when the underlying income or expense is recognised). Where the hedged item is of a capital nature, amounts accumulated in the hedge reserve are transferred from equity and included in the measurement of the initial cost or carrying amount of the asset or liability. When a hedging instrument expires or is sold, terminated or exercised, or the entity revokes designation of the hedge relationship but the hedged forecast transaction is still expected to occur, the cumulative gain or loss at that point remains in equity and is recognised in accordance with the above policy when the transaction occurs. If the underlying hedged transaction is no longer expected to take place, the cumulative unrealized gain or loss recognised in equity in respect of the hedging instrument is recognised immediately in the Income Statement. Derivatives That Do Not Qualify For Hedge Accounting From time to time certain derivative financial instruments do not qualify for hedge accounting. Changes in the fair value of any derivative instrument, or part of a derivative instrument, that does not qualify for hedge accounting are recognised immediately in the income statement in Other Expenses ($18.8 million net gain in the six months to 31 December 2005). Fair Value Calculations The fair value of financial instruments traded in active markets is based on quoted market prices at the balance sheet date. The fair value of financial instruments that are not traded in an active market are determined using valuation techniques consistent with accepted market practice. The Qantas Group uses a variety of methods and input assumptions that are based on market conditions existing at balance date. The fair value of derivative financial instruments includes the present value of estimated future cash flows. Reporting GAAP:
IFRS (currency quoted in Australian dollars)
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 3 3
Key considerations in applying the sample accounting policies
Survey findings
The financial reports surveyed show the
along with foreign exchange and interest
high level of complexity associated with
rates. Airlines communicate the impact of
meeting onerous hedge accounting
hedge accounting in various ways. British
requirements, particularly jet fuel
Airways, for example, discloses the
hedging. Both IFRS and U.S. GAAP
impact of fuel hedge ineffectiveness as a
require detailed documentation and
separate line item in its income statement.
hedge effectiveness testing requirements
Many of the U.S. carriers provide detailed
to be met before hedge accounting can
reconciliations of the impact of hedge
be applied. Key requirements include:
accounting on, for example, fuel costs.
Most airlines surveyed hedge jet fuel
• Ensuring hedge documentation is in place for all hedges at inception and
In the key area of hedge effectiveness
throughout the life of the hedge.
testing, few airlines provide disclosure of
• Ensuring that hedge documentation
the details of the methodology used
clearly sets out the hedged item,
other than the type, for example,
hedging instrument, risk management
regression testing. There is little
objective, strategy and how the entity
disclosure of the key assumptions used
will test for effectiveness both
in testing effectiveness.
prospectively and retrospectively. • As a result of the requirement to
Some airlines in the U.S. have noted that
hedge commodity price risk in its
in 2005, for the first time they are
entirety, it is not possible to designate
experiencing significant hedge
a component of jet fuel hedge (eg
ineffectiveness. This is primarily based on
crude oil) as a hedged risk. Neither
the record high, and highly volatile fuel
U.S. GAAP nor IFRS mandate an
prices experienced. This has continued
approach to determining hedge
well into 2006 and is likely to be a key
effectiveness on a prospective or
consideration for airlines when reporting.
retrospective basis. Typically the methods used to assess hedge
At the time of publication, many European
effectiveness on a prospective and
and Asia-Pacific airlines had not finalized
retrospective basis are: regression
and issued their first annual reports under
analysis, variance reduction or dollar
IFRS. It remains to be seen how the level
offset hedge tests (which under both
of disclosure around hedge accounting
GAAP’s needs to be in the 80-125
under IAS 39 compares with the detailed
percent effectiveness range). When
disclosures in the financial reports shown
using statistical tests, key estimates
under FAS 133.
such as length of data sets, prices and hedge ratios require consideration.
3 4 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
1.4.2 Embedded derivatives
maintenance and parts suppliers and in
Airlines enter into numerous complex
certain circumstances these contracts
contracts with aircraft manufacturers,
may contain embedded derivatives.
Sample of accounting policies No separate airline accounting policies were noted in the surveyed airlines.
Key considerations
when the contract currency is routinely
Survey findings
A key factor in determining the need to
denominated or the currency commonly
None of the airlines reporting under IFRS,
separate an embedded derivative is how
used in the economic environment in
or transitioning to IFRS, made any
closely related a derivative is to the host
which the transaction takes place.
disclosure about the impact of, or
contract. One of the likely areas where
accounting for, embedded derivatives.
embedded derivatives may occur is
In the airline industry it is common place
There were no separate disclosures by
where contracts are denominated in a
for contracts to be denominated in U.S.
the U.S. GAAP reporters surveyed.
currency that is not the functional
dollars even where the dollar is not the
currency of either the airline or of the
functional currency of any of the
other party to the contract. In such cases,
contracting parties. Common examples
the embedded derivative would
include fuel purchases, jet aircraft and
potentially require separation and
aircraft spares purchases, inter-airline
measurement at fair value. No separation
settlements and elements of airframe
of an embedded derivative is required
and engine maintenance.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 3 5
Airline risk factors Risk factors
of risk factors on a company’s financial
This section of the handbook highlights
development. KPMG surveyed the most
the significant business risk factors
recent relevant SEC regulatory filings of
disclosed by airlines in SEC filings. These
11 SEC airlines and considered their
risks are described in domestic and
quantitative and qualitative disclosures
foreign SEC registrants’ annual financial
about risks.
reports. Risks include increasing competition, economic, political, security
The table on page 36 summarizes the
and business specific risks as well as
principle risks disclosed by each airline.
financial exposures. These risks or
Our commentary and a sample of
cautionary factors are included in order to
disclosures related to these risks are
alert stakeholders to the possible impact
set out after the table.
✓
✓
✓
✓
✓
✓
Geopolitical risk
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
Competition
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
Regulation
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
Economic conditions
✓
✓
✓
✓
✓
✓
✓
✓
High levels of debt
✓
✓
✓
✓
✓
Labor costs and employee retirement obligations
✓
✓
✓
✓
Insurance costs
✓
British Airways
✓
Ryanair
✓
Air France – KLM
✓
Southwest Airlines
American Airlines
✓
Delta
Continental Airlines
✓
North West Airlines
JetBlue Airways
Increasing cost of jet fuel
Airlines
United Airlines
U.S. Airways
3 6 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Risk factors
✓
Security costs
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
Risk in international operations Changes in interest rates
✓
Failure of technology
✓
Significant operating losses
✓
Airline bankruptcies
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
Early retirements
✓
✓
✓
✓
✓
✓
✓
Service interruptions at major hubs
✓
✓
Safety
✓
✓
✓
✓
Reliance on suppliers
✓
✓
✓
Dependence on key personnel
✓
✓
Liquidity risks
Aircraft utilization
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
✓
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 3 7
KPMG comment Increasing costs of jet fuel
Sample risk disclosures “Our business is dependent on the price and availability of aircraft fuel. Continued periods of historically high fuel costs, significant disruptions in the
Jet fuel is one of the largest and most
supply of aircraft fuel or significant further increases in fuel costs could have a
volatile expenses that all airlines are
significant negative impact on our operating results.
exposed to. The rise in global oil prices has led to jet fuel cost increases of up
Our operating results are significantly impacted by changes in the availability or price
to 30 percent of total airline costs and
of aircraft fuel. Fuel prices increased substantially in 2004 compared with 2003 and
is now expected by many airlines to be
continued to increase through 2005 and into 2006. Due to the competitive nature of
the largest single cost in 2006 where
the airline industry, we generally have not been able to increase our fares or
historically this has been labor. Airline’s
otherwise increase revenues sufficiently to offset the rise of fuel prices in the past
exposure to volatile fuel prices can be
and we may not be able to do so in the future. Although we are currently able to
managed to some extent by hedging,
obtain adequate supplies of aircraft fuel, it is impossible to predict the future
supply agreements and passing on
availability or price of aircraft fuel. In addition, from time to time we enter into
increased costs through passenger fuel
hedging arrangements to protect against rising fuel costs. Our ability to hedge in
surcharges.
future, however, may be limited.” – U.S. Airways
Geopolitical risks
“Risk Factors Relating to Terrorist Attacks and International Hostilities.
Geopolitical risks are outside the
Reservations of Ryanair’s flights to London dropped materially for a number of days
control of airlines. The mitigation
in the immediate aftermath of the terrorist attacks in London on July 7, 2005 and
strategy of most airlines has been to
failed attacks on July 21, 2005. In fiscal 2005, flights into and out of London accounted
significantly increase mandatory and
for 15.4 million, or 56%, of passengers travelling on the Company’s network. As in
voluntary airline security spending and
the past, the Company reacted to these acts of terrorism by initiating system-wide
obtaining insurance from the
fare sales to stimulate demand for air travel. Future acts of terrorism, particularly in
commercial market and in some
London, or other markets that are significant to Ryanair, could have a material
jurisdictions, governments. In some
adverse effect on the Company’s profitability or financial condition should the
markets, insurers are looking to limit
public’s willingness to travel to and from those markets be reduced as a result.”
coverage to certain types of attacks.
– Ryanair
Competition
”The airline industry is fiercely competitive and fares are at historically low levels.
Legacy airlines in virtually all major
Service over almost all of our routes is highly competitive and fares remain at historically
regions have been increasingly
low levels. We face vigorous, and in some cases, increasing competition from major
impacted by competition from low cost
domestic airlines, national, regional, all-cargo and charter carriers, foreign air carriers,
carriers (LCCs). LCCs typically have
LCCs, and, particularly on shorter segments, ground and rail transportation. We also face
substantially lower cost bases than
increasing and significant competition from marketing/operational alliances formed by our
legacy airlines through lower labour
competitors. In addition, the competitive landscape we face would be altered
costs, simplified operations and lower
substantially by industry consolidation, including merger, equity investment and joint
infrastructure costs. Competition from
venture transactions. The percentage of routes on which we compete with carriers
LCCs has driven passenger fares down
having substantially lower operating costs than ours has grown significantly over the past
and LCC’s have taken market share,
decade, and we now compete with LCCs on 75 percent of our domestic network.
focusing on high frequency point to point operations versus the more traditional hub model.
3 8 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
KPMG comment
Sample risk disclosures Certain alliances have been granted immunity from anti-trust regulations by governmental authorities for specific areas of cooperation, such as joint pricing decisions. To the extent alliances formed by our competitors can undertake activities that are not available to us, our ability to effectively compete may be hindered. Pricing decisions are significantly affected by competition from other airlines. Fare discounting by competitors has historically had a negative effect on our financial results because we must generally match competitors’ fares, since failing to match would result in even less revenue. More recently, we have faced increased competition from carriers with simplified fare structures, which are generally preferred by travelers. Any fare reduction or fare simplification initiative may not be offset by increases in passenger traffic, a reduction in costs or changes in the mix of traffic that would improve yields. Moreover, decisions by our competitors that increase – or reduce – overall industry capacity, or capacity dedicated to a particular domestic or foreign region, market or route, can have a material impact on related fare levels.” – American Airlines
Regulation
“Changes in international, regional and local regulation and legislation could significantly increase our costs of operations or reduce our revenue.
The airline industry is highly regulated in terms of rights of access to markets
Our operations are subject to a high degree of international, European and national
and the ‘freedoms’ an airline may have.
regulation covering most aspects of our operation, including traffic rights, fare
Bilateral agreements, based on the
setting, operating standards (the most important of which relate to safety, security
domocile of carriers, currently
and aircraft noise), airport access and slot availability.
dominate however, new ’open skies’ agreements are in place in some
Additional laws and regulations and additional or increased taxes, airport and
markets and are on the way in others.
navigation rates and charges have been proposed from time to time that could
Also, airlines often operate out of near
significantly increase our cost of operations or reduce our revenues. The ability of
monopoly airports which can over short
European carriers to operate international routes is subject to change because the
periods significantly increase the
applicable arrangements between European and foreign governments may be
charges airlines face. This combined
amended from time to time, or because appropriate slots are not available. Laws or
with other aeronautical charges, which
regulations enacted in the future may adversely affect our business.”
airlines have limited ability to negotiate,
– Air France – KLM
result in this area being of risk to airlines. Economic conditions
”Our business is affected by many changing economic and other conditions beyond our control and our results of operations tend to be volatile.
The demand for passenger airlines is often linked directly to GDP growth.
Our business, and that of the rest of the airline industry is affected by many changing
Macro economic changes appear to
conditions largely outside of our control, including among others:
correlate to passenger numbers.
• actual or potential changes in international, national, regional and local economic,
Therefore this is a key airline risk area.
business and financial conditions, including recession, inflation and higher interest rates, war, terrorist attacks or political instability; • changes in consumer preferences perceptions, spending patterns or demographic trends; • actual or potential disruptions to the air traffic control system;
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 3 9
KPMG comment
Sample risk disclosures • increases in, costs of safety, security and environmental measures; • outbreaks of diseases that affect travel behavior or • weather and natural disasters…”– American Airlines
High levels of debt
“We have a significant amount of fixed obligations and we will incur significantly more fixed obligations, which could harm our ability to meet our growth strategy
The airline industry is characterized by
and impair our ability to service our fixed obligations.
high fixed costs or obligations that leave airlines vulnerable to changes in
As of December 31, 2005, our debt of $2.33 billion accounted for 71.9% of our total
demand, such as occurred post the
capitalization. Most of our long-term and short-term debt has floating interest rates.
terrorist attacks of September, 2001
In addition to long-term debt, we have a significant amount of other fixed obligations
and pandemics such as SARS in Asia.
under lease related to our aircraft, airport terminal space, other airport facilities and
Other issues may cause significant
office space. As of December 31, 2005, future minimum lease payments under
increases in costs over short periods,
noncancelable leases and other financing obligations were approximately $786
including jet fuel, and the ability of
million for 2006 through 2010 and an aggregate of $1.95 billion for the years thereafter.
airlines to service fixed costs and
We have commenced construction of a new terminal at JFK with PANYNJ. The
attract and service capital.
minimum payments under this lease will be accounted for as a financing obligation and have been included above. As of December 31, 2005, we had commitments of approximately $6.44 billion to purchase 192 additional aircraft and other flight equipment over the next seven years, including estimated amounts for contractual price escalations. We will incur additional debt and other fixed obligations as we take delivery of new aircraft and other equipment and continue to expand into new markets. We typically finance our aircraft through either secured debt or lease financing. Although we believe that debt and/or lease financing should be available for our aircraft deliveries, we cannot assure you that we will be able to secure such financing on terms acceptable to us or at all. Our high level of debt and other fixed obligations could: • impact our ability to obtain additional financing to support capital expansion plans and for working capital and other purposes on acceptable terms or at all; • divert substantial cash flows from our operations and expansion plans in order to service our fixed obligations; • require us to incur significantly more interest or rent expense than we currently do, since most of our debt has floating interest rates and five of our aircraft leases have variable-rate rent; and • place us at a possible competitive disadvantage compared to less leveraged competitors and competitors that have better access to capital resources. Our ability to make scheduled payments on our debt and other fixed obligations will depend on our future operating performance and cash flow, which in turn will depend on prevailing economic and political conditions and financial, competitive, regulatory, business and other factors, many of which are beyond our control. We have no lines of credit, other than two short-term borrowing facilities for certain aircraft predelivery deposits. We are dependent upon our operating cash flows to fund our operation and to make scheduled payments on our debt and other fixed obligations. We cannot
4 0 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
KPMG comment
Sample risk disclosures assure you that we will be able to generate sufficient cash flow from our operations to pay our debt and other fixed obligations as they become due, and if we fail to do so our business could be harmed. If we are unable to make payments on our debt and other fixed obligations, we could be forced to renegotiate those obligations or obtain additional equity or debt financing. To the extent we finance our activities with additional debt, we may become subject to financial and other covenants that may restrict our ability to pursue our growth strategy. We cannot assure you that our renegotiation efforts would be successful or timely or that we could refinance our obligations on acceptable terms, if at all.” – JetBlue (currency quoted in U.S. dollars)
Labor disputes and employee
“Union disputes, employee strikes and other labor-related disruptions may
retirement obligations
adversely affect our operations.
A significant cost issues for many
Our business plan includes assumptions about labor costs going forward. Currently,
legacy airlines is the funding of post
the labor costs of both AWA and U.S. Airways are very competitive and very similar;
employment plans and labour
however, we cannot assure that labor costs going forward will remain competitive,
agreements. A number of airlines have
either because our agreements may become amendable or because competitors may
significant post employment plan
significantly reduce their labor costs. Approximately 80% of the employees within
liabilities. Major U.S., European and
U.S. Airways Group are represented for collective bargaining purposes by labor unions.
Asian airlines are seeking to reduce
In the United States, prior to the merger these employees were organized into nine
costs through restructuring labour or
labor groups represented by five different unions at U.S. Airways, seven labor groups
post employment plans. This is either
represented by four different unions at AWA, four labor groups represented by
through Chapter 11 proceedings in the
four different unions at Piedmont, and four labor groups represented by four
U.S. or other restructuring. The risk of
different unions at PSA. There are additional unionized groups of U.S. Airways
industrial unrest or financial stress of
employees abroad.
funding these agreements is common. Relations between air carriers and labour unions in the United States are governed by the Railway Labor Act (the “RLA”). Under the RLA, collective bargaining agreements generally contain “amendable dates” rather than expirations dates, and the RLA requires that a carrier maintain the existing terms and conditions of employment following the amendable date through a multi-stage and usually lengthy series of bargaining processes overseen by the National Mediation Board. This process continues until either the parties have reached agreement on a new collective bargaining agreement, or the parties have been released to “self-help” by the National Mediation Board. Although in most circumstances the RLA prohibits strikes, after release by the National Mediation Board carriers and unions are free to engage in self-help measures such as strikes and lock-outs. None of the U.S. Airways labor agreements becomes amendable until December 31, 2009. Of the AWA labor agreements, three are currently amendable, and a fourth becomes amendable in 2006. There is the potential for litigation to arise in the context of the labor integration process. Unions may bring court actions or grievance arbitrations, and may seek to compel airlines to engage in the bargaining processes where the airline believes it has no such obligation. There is a risk that one or more unions may pursue such
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 4 1
KPMG comment
Sample risk disclosures judicial or arbitral avenues in the context of the merger, and, if successful, could create additional costs that we did not anticipate. There is also a risk that disgruntled employees, either with or without union involvement, could engage in illegal slowdowns, work stoppages, partial work stoppages, sick-outs or other action short of a full strike that could individually or collectively harm the operation of the airline and impair its financial performance.” – U.S. Airways
Insurance costs
“Insurance costs increased significantly after September 11, 2001, and may increase in the future, and the amount of available insurance coverage may be
Whilst insurance costs have receded
further limited as a result of similar events.
from post September 11 highs, the availability of appropriate insurance at
Following the terrorist attacks on September 11, 2001, insurance premiums for
an acceptable premium remains a key
airlines increased significantly, especially for risks relating to terrorism. In addition, in
risk.
the immediate aftermath of September 11, 2001, insurance companies renegotiated insurance coverage for certain risks relating to war and other hostilities, charging substantially higher rates and limiting coverage to a uniform amount of $50 million. As a result, the European Commission authorized European governments to offer coverage to airlines, at a charge, for loss amounts that exceeded the insurance coverage available in the market for war and other hostilities. In the event of further terrorist attacks or acts of war, government support similar or comparable to the coverage that was made available in the immediate aftermath of September 11, 2001 may not be made available, insurance premiums may be increased further or insurance may be made available only with additional limitations on coverage. Any failure to obtain adequate insurance coverage or insurance coverage at financially acceptable terms in the future would materially adversely affect our business, financial condition and results of operations.” – Air France – KLM (currency quoted in Euros)
Security costs
“Additional security requirements may increase our costs and decrease our traffic.
In response to new regulation and
Since September 11, 2001, the Department of Homeland Security (“DHS”) and TSA
passenger concerns, many major
have implemented numerous security measures that affect airline operations and
airlines have spent hundreds of millions
costs, and are likely to implement additional measures in the future. Most recently,
on additional security costs over the
DHS has begun to implement the U.S.-VISIT program (a program of fingerprinting
last 5 years. With every new regulation,
and photographing foreign visa holders), announced that it will implement greater
comes a cost implication. Even if these
use of passenger data for evaluating security measures to be taken with respect to
costs are recovered, they increase
individual passengers, expanded the use of federal air marshals on our flights (thus
costs which the passenger ultimately
displacing additional revenue passengers and causing increased customer
pays for. Only three airlines highlighted
complaints from displaced passengers), begun investigating a requirement to install
this risk, which may indicate that
aircraft security systems (such as active devices on commercial aircraft as
airlines believe that the financial burden
countermeasures against portable surface to air missiles) and expanded cargo and
of security may have peaked and that it
baggage screening. DHS has also required certain flights to be cancelled on short
is a cost that passengers are willing to
notice for security reasons, and has required certain airports to remain at higher
pay for.
security levels than other locations.
4 2 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
KPMG comment
Sample risk disclosures In addition, foreign governments also have begun to institute additional security measures at foreign airports we serve, out of their own security concerns or in response to security measures imposed by the U.S. A large part of the costs of these security measures is borne by the airlines and their passengers, and we believe that these and other security measures have the effect of decreasing the demand for air travel and the attractiveness of air transportation as compared to other modes of transportation in general. Security measures imposed by the U.S. and foreign governments after September 11, 2001 have increased our costs and therefore adversely affected our financial results, and additional measures taken in the future may result in similar adverse effects… ” – Continental
Risk in international operations
“Our international operations could be adversely affected by numerous events, circumstances or government actions beyond our control.
This risk is similar in nature to other regulatory risks noted, however it is
Our current international activities and prospects could be adversely affected by
wider in terms of non airline specific
factors such as reversals or delays in the opening of foreign markets, exchange
risks, for example highlighting foreign
controls, currency and political risks, taxation and changes in international
exchange risk.
government regulation of our operations, including the inability to obtain or retain needed route authorities and/or slots.” – American Airlines
Changes in interest rates
“We are exposed to changes in interest rates.
As airlines are generally significant
We had $6.4 billion of debt and capital lease obligations that were accruing interest
users of debt financing, interest rate
as of December 31, 2005 and $1.9 billion of total balance sheet cash, cash
risk is an important management issue.
equivalents, and short term investments as of December 31, 2005. Of this
The risk of exposure to both fixed and
indebtedness, 66% bears interest at floating rates. An increase in interest rates
floating rates can be managed to some
would have an overall negative impact on our earnings as increased interest expense
extent by hedging activities.
would only be partially offset by increased interest income.”– North West (currency quoted in U.S. dollars)
Failure of technology
“We could be adversely affected by a failure or disruption of our computer, communications or other technology systems.
Legacy airlines have traditionally built proprietary systems to meet
We are increasingly dependent on technology to operate our business. The
organisational IT needs. Over the last
computer and communications systems on which we rely could be disrupted due to
ten years third party software providers
events beyond our control including natural disasters, power failures, terrorist
have provided IT solutions for the
attacks, equipment failures, software failures and computer viruses and hackers. We
airline industry and there has been
have taken certain steps to help reduce the risk of some (but not all) of these
significant outsourcing activity. The
potential disruptions. There can be no assurance however, that the measures we
importance of the internet in providing
have taken are adequate to prevent or remedy disruptions or failures of these
the distribution channel for low cost
systems. Any substantial or repeated failures of these systems could impact our
carriers and now legacy airlines make
operations and customer service, result in the loss of important data, loss of
these systems key.
revenues, increased costs, and generally harm our business.
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 4 3
KPMG comment
Sample risk disclosures Moreover, a catastrophic failure of certain of our vital systems (which we believe is a remote possibility) could limit our ability to operate our flights for an indefinite period of time, which would have a material adverse impact on our operations and our business.” – American Airlines
Significant operating losses
“We continue to experience significant losses.
A key risk identified by some U.S.
Since September 11, 2001, we have incurred significant losses. We reported a net
airlines which have consistently posted
loss of $68 million in 2005 and expect to incur a significant loss for the first quarter
losses in recent years.
of 2006 under current market conditions. Losses of the magnitude incurred by us since September 11, 2001 are not sustainable if they continue. These losses are primarily attributable to decreased yields on passenger revenue since September 11, 2001 and record high fuel prices. Passenger revenue per available seat mile for our mainline operations was 5.8% lower for the year ended December 31, 2005 versus 2000 (the last full year before the September 11, 2001 terrorist attacks). We have been able to implement some fare increases on certain domestic and international routes during 2005, but these increases have not fully offset the substantial increase in fuel prices. Our ability to raise our fares is limited due to the substantial price competition in the airline industry, especially in U.S. domestic markets. We cannot predict when or if yields will increase. Further, we cannot predict the long-term impact of any changes in fare structures, most importantly in relation to business fares, booking patterns, low-cost competitor growth, increased usage of regional jets, customers’ directly booking on the internet, competitor bankruptcies and other changes in industry structure and conduct, but any of these factors could have a material adverse effect on our results of operations, financial condition or liquidity.” – Continental Airlines (currency quoted in U.S. dollars)
Airline bankruptcies
“The airline industry has incurred significant losses resulting in airline restructurings and bankruptcies, which could result in changes in our industry.
Several of the largest U.S. airlines have spent time, or are currently in, Chapter
In 2005, the domestic airline industry reported its fifth consecutive year of losses,
11. The ability of these carriers to
which is causing fundamental and permanent changes in the industry. These losses
restructure and reduce costs to better
have resulted in airlines renegotiating or attempting to renegotiate labor contracts,
complete with competitors has been
reconfiguring flight schedules, furloughing or terminating employees, as well as
highlighted as a key risk.
consideration of other efficiency and cost-cutting measures. Despite these actions, several airlines, including Delta Air Lines and Northwest Airlines in September 2005, have sought reorganization under Chapter 11 of the U.S. Bankruptcy Code permitting them to reduce labor rates, restructure debt, terminate pension plans and generally reduce their cost structure. In the fall of 2005, U.S. Airways, which had been in bankruptcy, and American West completed a merger, which may enable the combined entity to have lower costs and a more rationalized route structure and therefore be better able to compete. It is foreseeable that further airline reorganizations,
4 4 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
KPMG comment
Sample risk disclosures bankruptcies or consolidations may occur, the effects of which we are unable to predict. We cannot assure you that the occurrence of these events, or potential changes resulting from these events, will not harm our business or the industry. – JetBlue
Liquidity issues
“We have substantial liquidity needs and face significant liquidity pressure.
Substantial indebtedness, either pre
At December 31, 2005, our cash and cash equivalents and short-term investments
Chapter 11 or as a consequence of
were $2.0 billion. This amount reflects the net proceeds from our sale of ASA to
Chapter 11 is a significant issue in
SkyWest and the net proceeds from our borrowings under our post-petition
terms of an airlines’ ability to raise
financing agreements (“Post-Petition Financing Agreements”), which consist of a
further capital. Many U.S. carriers have
Secured Super-Priority Debtor-in-Possession Credit Facility from a syndicate of
restrictions due to substantially all
lenders (the “DIP Credit Facility”) and a modification agreement with American
remaining assets being encumbered.
Express Travel Related Services Company, Inc (“Amex”) and American Express Bank,
This issue is not restricted to the U.S.,
F.S.B that modified existing agreements with Amex under which Amex purchases
with it being flagged by European
SkyMiles from us (the “Amex Post-Petition Facility”).
carriers as well. We have substantial liquidity needs in the operation of our business and face significant liquidity challenges due to historically high aircraft fuel prices, low passenger mile yields, credit card processor holdbacks and cash reserves and other cost pressures. Accordingly, we believe that our cash and cash equivalents and short-term investments will remain under pressure during 2006 and thereafter. Because substantially all of our assets are encumbered and our Post-Petition Financing Agreements contain restrictions against additional borrowing, we believe we will not be able to obtain any material amount of additional debt financing during our Chapter 11 proceedings.” – Delta Airlines (currency quoted in U.S. dollars) Safety
“We are at risk of losses and adverse publicity stemming from any accident involving our aircraft.
Airline safety has always been a key industry issue. Risk disclosures are
If one of our aircraft were to crash or be involved in an accident, we could be
limited to a minority of airlines
exposed to significant tort liability. The insurance we carry to cover damages arising
surveyed.
from any future accidents may be inadequate. In the event that our insurance is not adequate, we may be forced to bear substantial losses from an accident. In addition, any accident involving an aircraft that we operate or is operated by an airline that is one of our codeshare partners could create a public perception that our aircraft are not safe or reliable, which could harm our reputation, result in air travelers being reluctant to fly on our aircraft and harm our business.” – Delta Airlines
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 4 5
KPMG comment
Sample risk disclosures
Dependence on key personnel
“Dependence on key personnel.
This risk factor is not a specific airline
The Company’s success depends to a significant extent upon the efforts and abilities
issue. The value of a capable senior
of its senior management team, including Michael O’Leary, the Chief Executive of
management team is an intangible that
Ryanair, and key financial, commercial, operating and maintenance personnel. Mr
is difficult to quantify. It is interesting to
O’Leary’s current contract may be terminated by either party upon 12 months’ notice.
note that labor cost percentages are
See “Item 6. Directors, Senior Management and Employees – Compensation of
now debt covenants for some airlines.
Directors and Senior management – Employment Agreements”. The Company’s success also depends on the ability of its executive officers and other members of senior management to operate and manage effectively both independently and as a group. Although the Company’s employment agreements with Mr. O’Leary and its other senior executives contain non-competition and non-disclosure provisions, there can be no assurance that these provisions will be enforceable in whole or in part. Competition for highly qualified personnel is intense, and the loss of any executive officer, senior manager or other key employee could have a material adverse effect upon the Company’s business, operating results and financial condition.” – Ryanair
Reliance on suppliers
“Supplier failure.
Airlines, like all businesses, are
The Group is dependent on third parties, e.g. fuel suppliers, caterers, IT, for important
dependent on their suppliers to enable
aspects of its operation. It is essential that critical supplies should be maintained; if
delivery of their own services. Failure
this were not so, operations would be disrupted and the business and results would
of suppliers can cause major disruptions
suffer.” – British Airways
and financial loss. Services interuptions at hubs
“Interruptions or disruptions in service at one of our hub airports cold have a material adverse impact on our operations.
Virtually all airlines operate from a small
We operate principally through primary hubs in Charlotte, Philadelphia and Phoenix
number of key airports or hubs through
and secondary hubs/focus cities in Pittsburgh, Las Vegas, New York, Washington, D.C.
which their flights originate. Disruptions
and Boston. A majority of our flights either originate or fly into one of these locations.
at these hubs may have a major impact
A significant interruption or disruption in service at one of our hubs could result in
on those airlines operations.
the cancellation or delay of a significant portion of our flights and, as a result, could have a severe impact on our business, operations and financial performance.” – U.S. Airways
Early retirements
“The retirement of a significant number of our pilots prior to their normal retirement age of 60 could require significant contributions to our defined
Early retirement of employees is an
benefit pension plan for pilots, significantly disrupt our operations and
increasingly common feature where
negatively impact our revenue.
airlines are in financial distress. Employees take early retirement in
Under our defined benefit pension plan for pilots (“Pilot Plan”), Delta pilots who
order to crystallise the benefits they
retire can elect to receive 50% of the present value of their accrued pension benefit
have accrued under post employment
in a lump sum in connection with their retirement and the remaining 50% of their
plans and avoid the risk of a potential
accrued pension benefit as an annuity after retirement. In recent years, our pilots
reduction in benefits in the event of the
have retired prior to their normal retirement age of 60 at greater than historical levels
airlines bankruptcy.
due to (1) a perceived risk of rising interest rates, which could reduce the amount of
4 6 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Sample risk disclosures their lump sum pension benefit; and/or (2) concerns about their ability to receive a lump sum pension benefit if a notice of intent to terminate the Pilot Plan is issued during a restructuring under Chapter 11 of the Bankruptcy Code. While the Pilot Plan is currently prohibited from making the lump sum payments, it is currently projected that the lump sum feature would become available in October 2006 if the Pilot Plan is not subject to termination proceedings prior to that date. If a significant number of pilot early retirements occurs in the near future, the resulting lump sum payments, combined with other factors, could trigger a requirement to make contributions to the Pilot Plan in excess of amounts currently estimated. The amount of any additional contribution depends on factors that are not currently known and, therefore, cannot be reasonably estimated at this time. An additional contribution could have a material adverse impact on our liquidity. A significant number of pilot early retirements in the near future could also disrupt our operations and have a material adverse impact on our revenues because there may not be enough pilots to operate certain aircraft types for a period of time, the duration of which cannot be determined. We and ALPA had agreed to certain provisions that helped mitigate the effect of pilot early retirements on our operations over the past eighteen months, but these provisions expired on December 31, 2005. As of January 31, 2006, approximately 1,700 of our 5,900 pilots on the active roster are at or over age 50 and thus were eligible to retire at the beginning of February 2006.”– Delta Airlines Aircraft utilization
“We rely on maintaining a high daily aircraft utilization rate to keep our costs low, which makes us especially vulnerable to delays.
A dependence on high aircraft utilization as a risk factor has only been
One of our key competitive strengths is to maintain a high daily aircraft utilization
recognized by one low-cost carrier and
rate, which is the amount of time that our aircraft spend in the air carrying passengers.
highlights the importance of high asset
High daily aircraft utilization allows us to generate more revenue from our aircraft
utilization to the business model and
and is achieved in part by reducing turnaround times at airports so we can fly more
future profitability.
hours on average in a day. The expansion of our business to include a new fleet type, new destinations, more frequent flights on current routes and expanded facilities could increase the risk of delays. Aircraft utilization is reduced by delays and cancellations from various factors, many of which are beyond our control, including adverse weather conditions, security requirements, air traffic congestion and unscheduled maintenance. Reduced aircraft utilization may limit our ability to achieve and maintain profitability as well as lead to customer dissatisfaction.” – JetBlue
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 4 7
Analysis of transition to IFRS in 2005 Introduction
Since January 1, 2005, depending on the
handbook is an analysis of the impact of
For companies listed on the main
jurisdiction within which the airlines
the transition to IFRS of the surveyed
European and a number of Asia-Pacific
operate, certain airlines have been
airlines based on public filings. At the
stock exchanges, there has been a
required to prepare their financial
time of writing this handbook, airlines
fundamental change in the basis of
statements under IFRS or equivalents
with March 31, 2006 financial year ends
financial reporting for the 2005 year.
thereof. Set out in this section of the
had not yet issued their annual report.
Impact of transition to IFRS on total equity Airline 2
Air France
Alitalia1
– KLM Transition date
Shareholder’s equity (pre-IFRS)
British
Cathay
Airways
Pacific2 U.S.$m1
U.S.$m1
U.S.$m1
U.S.$m1
April 1 04
Jan 1 04
April 1 04
4,998.3
1,590.9
4,031.7
(2,188.2)
3,999.5
easyJet
Qantas
Ryanair
Virgin Blue
U.S.$m1
U.S.$m1
U.S.$m1
U.S.$m1
Oct 1 04
July 1 04
April 1 04
April 1 04
1,430.6
4,074.4
1,790.7
460.6
(37.4)
(5.3)
IFRS/IAS standard IAS 19
Employee benefits
(24.6)
26.0
IFRS 1
First-time adoption
(910.6)
(5.5)
(0.7)
38.8
of IFRSs IAS 18
Revenue
IAS 16
Property, plant
IAS 21
Changes in foreign
(307.9) 137.5
(32.2)
(467.9)
(49.8)
(28.2)
and equipment 280.2
13.4
(173.3)
(7.8)
exchange rates IAS 12
Income taxes
(103.4)
IAS 27/28
Scope of consolidation
(100.9)
IAS 17
Leases
IFRS 2
Share-based payments
IFRS 3
Goodwill arising on
83.9
(7.2)
5.5
(36.5) (11.1)
2.8
business combinations IFRS 5
Assets held for resale
(5.5)
IAS 28
Associates
(106.9)
IAS 20
Government grants
IAS 38
Intangible assets
(3.8) (21.6)
Deferred tax on IFRS adjustments
301.5
Other
(2.5)
(9.8) (0.6)
Total impact on transition
(840.5)
210.5
(2,562.5)
(32.2)
4.9
(539.0)
(2.5)
1.7
IAS 39/32
883.1
100.1
515.9
13.7
4
245.9
166.1
4
Financial instruments3
$U.S.D impact has been calculated by applying a KPMG sourced rate at transition date to the figures stated in the airline financial report. A number of airlines, such as Singapore Airlines, Cathay Pacific and South African Airways have GAAPs which are progressively adopting equivalents to IFRS. Whilst these changes are not all reflected in the table above, they are included in the commentary below. Iberia has not been included in the table as the full opening balance sheet information was not available, and they are not included in the commentary below. 3 IAS 39 Financial Instruments: Recognition and Measurement and IAS 32 Financial Instruments: Disclosure and Presentation have been adopted in the financial year following transition in accordance with the transition exemptions of IFRS 1 “First-time adoption of International Financial Reporting Standards”. 4 Information not available at time of publication. 1 The 2
4 8 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
IAS 19 – Employee benefits
IAS 18 – Revenue
Singapore Airlines (on a prospective
IFRS requires post-retirement employment
Airlines receive revenue from the sale of
basis), South African Airways and SAS
defined benefits such as pension plans to
frequent flyer points or miles to third
Group. Other airlines such as Air France –
be recognised on the balance sheet. One
parties under frequent flyer programs.
KLM and Ryanair had already adopted
area of IAS 19 that had, and we anticipate
Under many legacy GAAPs, revenue
this accounting treatment historically. Air
will continue to have, a significant impact
received from the sale of these points to
France – KLM has made an adjustment
on airlines financial statements has been
third parties was recognized when the
for rebates on fixed assets which were
the recognition of the ‘funded status’ of
sale was made. Cathay Pacific, British
recognized as income under French
post-employment defined benefit plans.
Airways and Qantas have transitioned
GAAP. This reduced assets and equity by
On transition to IFRS, airlines were
from immediate revenue recognition on
U.S.$30.8 million.
required to determine whether defined
sale of points, to deferred revenue
benefit plans were in a deficit or surplus
accounting, the latter two on adoption of
position by measuring the present value
IFRS in 2005. See handbook section 1.1.2
IAS 21 – The effects of changes in foreign exchange rates
of defined benefit obligation
for analysis of this accounting policy. Air
Under UK GAAP certain U.S. dollar
(incorporating all cumulative actuarial
France – KLM generated a gain on
denominated assets and liabilities had
gains and losses to the extent recognised
exchange of summer and winter landing
been treated as a foreign operation
by the entity) and the fair value of the
slots. Under French GAAP the group
(branch) by British Airways and easyJet
associated plan assets. The net position
recognised the gain as revenue
with the U.S. dollar as their functional
(surplus or deficit) was then recognized
immediately whereas under IFRS, the
currency. As a result exchange
on the balance sheet as an asset or a
group considered that the transfer of the
movements on re-translation of assets
liability, depending on the funding status
risks and benefits inherent in ownership
and liabilities had been taken to reserves
of the plan. While not an airline specific
of the slots was not yet complete.
rather than through the Income
issue, many legacy airlines have
Therefore the recognition of the gain on
Statement. IAS 21 provides additional
significant defined benefit and other post
the exchange was deferred as a liability
criteria to allow the functional currency to
employment programs. Air France – KLM,
on balance sheet.
be determined and therefore certain aircraft owing companies have ceased to
Qantas Airways, British Airways, Ryanair
be U.S. dollar branches under IAS 21 and
adjustments on transition to IFRS.
IAS 16 – Property, plant and equipment
British Airways and easyJet have also
When an asset is made up of several
Sterling functional currencies. Exchange
recognized an annual leave provision on
components which have a cost that is
movements on monetary items are now
transition to IFRS. Alitalia recognized a
significant in relation to the overall cost of
taken to the profit and loss.
provision for staff airline tickets as a long-
the item IAS 16 requires that these
term benefit. It was the only airline to
components be capitalised and depreciated.
IAS 12 – Income taxes
disclose this provision as an IFRS
Components which may be separately
Adjustments have been made by airlines
adjustment.
identified include airframes, engines,
including British Airways, easyJet,
and Alitalia have all recognized
have been reassessed as having UK
modifications, heavy maintenance, seats,
Qantas and Virgin Blue to tax effect their
IFRS 1 – First time adoption of IFRS
landing gear etc. One of the frequent
IFRS adjustments. Air France – KLM has
Air France – KLM opted to revalue the Air
adjustments made on transition to IFRS
recognized a deferred tax liability for the
France portion of its aircraft fleet to fair
has been to capitalize major aircraft
realisable gain that will arise when its
value on transition to IFRS. This resulted
maintenance and engine overhaul costs
perpetual subordinated loan securities
in a U.S.$588.2 million adjustment to reduce
and depreciate them over the period to
are redeemed. There is also a small
equity on transition. Similarly, Alitalia has
the next inspection or overhaul. Airlines
adjustment for the deferred tax on the
chosen to adopt the fair value method for
that have changed their accounting for
undistributed reserves of equity affiliates.
its ATR42 aircraft (the amount of the
heavy maintenance on transition to IFRS
adjustment has not been specified).
include Qantas, British Airways, Alitalia,
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 4 9
Deferred tax on IFRS adjustments
was taken by most airlines, with goodwill
Air France, Alitalia and the SAS Group
balances effectively frozen at transition
have separately disclosed the tax effect of
date with amortization of goodwill no
IFRS transition adjustments. Other
longer recognized as an expense in the
airlines have disclosed the impact of IFRS
profit or loss.
adjustments net of tax.
IAS 23 – Borrowing costs IAS 27 – Consolidated and separate financial statements
Air France – KLM has retrospectively
Air France – KLM has consolidated
borrowing costs relating to qualifying
entities under IFRS which had not been
assets.
applied an adjustment to capitalise
consolidated under French GAAP. IAS 27 requires an entity be consolidated when
IAS 38 – Intangible assets
the power to control the entity is
Adjustments made by Alitalia relate to
demonstrated. Accordingly, Air France
deferred start-up, expansion and training
Parthairs Leasing (AFPL) has been fully
costs as well as the cessation of
consolidated on transition to IFRS.
amortization of goodwill.
IAS 17 – Leases
finance leases to operating leases.
IAS 39 – Financial instruments: Recognition and Measurement and IAS 32 Financial Instruments: Disclosure and Presentation
Qantas have reclassified a number of
Common measurement differences
aircraft from operating leases to finance
related to:
leases on transition. Air France – KLM
• recognition of all derivative financial
The application of the lease classification criteria in IAS 17 resulted in Alitalia reclassifying 20 of its MD80 aircraft from
also reclassified 13 aircraft from operating
instruments at fair value on balance
lease to finance leases. Qantas made
sheet (all airlines where relevant)
an additional adjustment to recognize
• recognition of finance charges based
contracted rental escalations on a
on the effective interest method
straight-line basis.
(Alitalia, Qantas, Ryanair, SAS Group) • reclassification of convertible
IFRS 2 – Share-based payment The fair value of share based entitlements granted to employees is
instruments between debt and equity (Alitalia) • creation of hedge accounting reserves
recognized as an expense spread over
in equity in relation to cashflow
the period during which employees
hedges (Alitalia, Ryanair, Qantas,
become entitled to the equity instrument.
Singapore Airlines, SAS Group) • adjustments to investments classified
IFRS 3 – Business combinations
as available-for-sale (Alitalia, Qantas,
easyJet elected not to restate business
Singapore Airlines, SAS Group)
combinations and as a result ceased
• the movement in the intrinsic value of
amortisation of U.S.$561.1 million of
zero cost option collars are taken to
goodwill. The goodwill will be subject to
equity reserves and the time value to
annual impairment testing. This election
the profit or loss (easyJet, Qantas).
5 0 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Appendix Useful lives, depreciation rates and residual values disclosed by airlines
Set out in this Appendix are the useful
Unless otherwise noted, the method of
aircraft and note that the useful life may
lives, depreciation rates and residual
depreciation used is on a straight line
change if the cycle assumptions are
values in relation to aircraft and aircraft
basis. Some airlines have used estimated
revised.
related assets.
cycles to determine the useful life of the
Asset category
Aircraft
Airline
Air France – KLM Alitalia Alitalia Alitalia Alitalia American Airlines British Airways British Airways British Airways British Airways Cathay Pacific Cathay Pacific Continental Airlines Delta easyJet easyJet easyJet Iberia Airlines Iberia Airlines Japan Airlines
Asset category
Aircraft Long haul (B777, B767, MD11) Short-medium haul aircraft (A321, A320, A319, MD80, ERJ145) Turboprop aircraft (ATR 72) Heavy maintenance Jet aircraft and engines Boeing 747 - 400 and 777 - 200 Boeing 767 - 300 and 757 - 200 Airbus 321, A320, A319, Boeing 737 - 400 Embraer RJ145, British Aerospace 146 Passenger aircraft Freighter aircraft Jet aircraft and simulators Owned flight equipment Aircraft Aircraft improvements Aircraft pre-paid maintenance Aircraft cells Aircraft components Aircraft
Useful life (years)
Annual depreciation rate
Residual value
20 20
* 5%
nil 10%a
18 14 5.5 to 8 20 to 30 * * * * * 20 20 to 27 10 to 25 7 3 to 7 3 to 7 22 4 to 7 Useful life of aircraft type2
5.5% 7.14% * * 3.7%1 4.7%1 4.9%1 4.8%1 * * * * * * * * * *
5 - 10% 0% * 5 - 10% * * * * 0 - 10% 0 - 20% 15% 5 - 40% * * * * * *
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 5 1
Asset category
Airline
Asset category
Useful life (years)
Annual depreciation rate
Residual value
25 fleet life 12 20 10 to 20 Inspection life 20 23 Period to next check (8-12 B737-800) 20 15 15 5 15 less age of aircraft 15 years less age of aircraft * 23 to 25 25 to 30 * 10 to 15 3 to 5 Term of lease up to 10 years 5 to 25 5 to 20 20 8 15 10 to 15
* * * * * * * *
20% 10% 15% 0 - 20% 0 - 20% * â‚Ź500,000 15%
* * * * *
nil 10% 10% 20% 20%
*
20%
* 4% * * 10-25% * *
10% * 15% * * 5% - 20% *
* * * * * * *
* * * 10% * 10% *
Aircraft
Engines
Jetblue Airways Jetblue Airways Lufthansa Qantas Qantas Qantas Ryanair Ryanair Ryanair
Aircraft Aircraft parts New aircraft Jet aircraft and engines Non-jet aircraft and engines Major aircraft inspections Boeing 737 - 200 Boeing 737 - 800 Embedded maintenance
SAS Group Singapore Airlines Singapore Airlines Singapore Airlines Singapore Airlines
Aircraft New passenger aircraft New freighter aircraft Training aircraft Used freighter aircraft
Singapore Airlines
Used passenger aircraft
South African Southwest Airlines United Airlines Virgin Blue Swiss Airlines
Passenger aircraft Aircraft and engines Aircraft Airframe, engines and landing gear Aircraft Heavy maintenance Improvements to leased aircraft
U.S. Airways Lufthansa SAS Group SAS Group Singapore Airlines Swiss Airlines
Passenger aircraft Spare engines Reserve engines Engine components Spare engines Spare engines
5 2 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Useful lives, depreciation rates and residual values disclosed by airlines continued
Asset category
Airline
Asset category
Useful life (years)
Annual depreciation rate
Residual value
Air France – KLM American Airlines
Spare parts Major rotable parts, avionics and assemblies
3 to 20 life of equipment to which applicable 5 to 25 25 to 30 10 8 to 10 18 8 to 273 15 to 20 15 Fleet life N/D 5 10 to 20 12 to 14 10 10 3 to 12 Term or useful life (6 years) 6 to 10 6 3 to 10 2 to 65 8 to 27 12 3 to 10 Lease term 4 to 25
* * *
*
Rotables, repairables and spare parts
Flight simulators
Flight and ground equipment
U.S. Airways Continental easyJet Iberia Airlines Iberia Airlines Japan Airlines Qantas Singapore Airlines Southwest Airlines Virgin Blue Alitalia Air France - KLM Iberia Airlines Singapore Airlines Swiss Airlines U.S. Airways
Rotables and repairables Rotable spare parts Aircraft spares Spare parts - repairable Spare parts - rotating Spare parts Aircraft spare parts Spare parts Aircraft parts Rotables and maintenance parts (used) Flight simulators and electronic equipment Flight simulators Flight simulators Flight simulators Simulators Property and equipment - ground
Continental Airlines Continental Airlines Continental Airlines Delta Airlines Japan Airlines Japan Airlines Jetblue Airways Jetblue Airways Jetblue Airways Northwest Airlines SAS Group
Flight and ground equipment Food service equipment Surface transportation/ground equipment Ground property and equipment Ground property and equipment Flight equipment In-flight entertainment systems Property and equipment - ground Flight equipment leasehold improvement Flight equipment Workshop and aircraft servicing equipment
5
* * * * * * * * * * 20% 20% * * * *
5-10%
* 10% nil 10 10-20% 0-20% nil 4% 4% * * * * * *
* * * * * * * * * *
nil nil * * * nil nil nil *
*
*
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 5 3
Asset category
Fixtures, fittings and other equipment
Computer equipment
Plant and equipment
Airline
Air France - KLM American Airlines British Airways Cathay Pacific easyJet Iberia Airlines Iberia Airlines Iberia Airlines Lufthansa Northwest Airlines SAS Group Singapore Airlines South African Virgin Blue Air France - KLM American Airlines Cathay Continental Airlines easyJet Iberia Airlines Japan Airlines Virgin Blue Alitalia Continental Airlines Lufthansa United Airlines Virgin Blue
Asset category
Fixtures and fittings Fixtures, fittings and other equipment Equipment Other equipment Furniture, fittings and equipment Furniture and fittings Land transport items Machinery, fixtures and tools Office and factory equipment Other property and equipment Other equipment and vehicles Other Containers Leasehold improvements Equipment and tooling Capitalized software Software development Computer software Hardware and software Data processing equipment Software Computer equipment Plant, machinery, equipment and fittings Maintenance and engineering equipment Plant and machinery Property, plant and equipment Plant and equipment
Useful life (years)
8 to 15 3 to 10 3 to 25 3 to 7 3 10 7 to 10 10 to 15 3 to 10 3 to 32 3 to 5 1 to 12 * * 5 to 15 3 to 10 < 4 years 3 to 10 3 4 to 7 5 to 7 * 10 8 10 3 to 15 *
Effective annual depreciation rate. Straight-line method used for all categories except Boeing 747 and DC 10's, where declining-balance method is used. 3 Declining balance method is used. * Not disclosed. 1 2
Annual depreciation rate
* * * * * * * * * * * * 5% 20-40% * * * * * * * 33.30% 10% * * * 20%
Residual value
* * * nil * * * * * * * nil * * * * * * * * * * * * * * *
5 4 K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
KPMG’s Global Airline practice contacts Martin Sheppard Australia Head of Aviation +61 2 9335 8221 msheppard@kpmg.com.au Dr Ashley Steel United Kingdom Global Chair – Transport +44 20 7311 6633 ashley.steel@kpmg.co.uk Argentina Norbeto Cors +54 11 4316 5806 ncors@kpmg.com Belgium Patrick de Poorter +32 9 241 8810 pdepoorter@kpmg.com Brazil Manuel Fernandes +55 21 3231 9412 mfernandes@kpmg.com Canada Steve Beatty +1 416 777 3569 sbeatty@kpmg.ca Czech Republic Stanislav Cervenan +420 222 123 944 stanislavcervenan@kpmg.cz Denmark Soeren Thorup Soerensen +45 3818 3594 stsoerensen@kpmg.dk Egypt Hossam Fahmy +20 2 536 1581 hfahmy@kpmg.com Finland Solveig Tornroos-Huhtamaki +358 9 6939 3733 solveig.tornroos-huhtamaki@kpmg.fi France Philippe Arnaud +33 1 5377 3809 parnaud@kpmg.com
Germany Ulrich Maas +49 30 2068 4888 umaas@kpmg.com
Peru Jessica Oblitas +51 1 9792 2440 joblitas@kpmg.com
Hong Kong Andrew Weir +852 2826 7243 andrew.weir@kpmg.com.hk
Portugal Sattar Sikander +351 210 110 090 ssattar@kpmg.com
Hungary Andrea Sartori +36 1 887 7215 andreasartori@kpmg.com
Russia Richard Glasspool +7 095 937 4470 richardglasspool@kpmg.com
Ireland Sean O’Keefe +353 1 410 1241 sean.okeefe@kpmg.ie
Singapore Wah Yeow Tan +65 6213 2503 wahyeowtan@kpmg.com.sg
Italy Marco Giordano +39 06 80 96 13 47 mgiordano@kpmg.it
South Africa Tshidi Mokgabudi +27 11 647 6735 tshidi.mokgabudi@kpmg.com.za
India Manish Mohnot +91 22 2491 3030 mmohnot@kpmg.com
Spain Miguel Angel Ibanez +34 91 5550 132 maibanez@kpmg.es
Japan Toshio Ikeda +81 3 3266 1142 toshio.ikeda@jp.kpmg.com
Sweden Roland Nilsson +46 8 723 9309 roland.nilsson@kpmg.se
Korea Peter C Kim +82 2 2112 0880 pckim@kpmg.com
Switzerland Roger Neininger +41 1 249 21 25 rneininger@kpmg.com
Mexico Hector A Ramirez +52 55 5246 8545 hramirez@kpmg.com
Taiwan Beryl Lin +886 2 2715 9760 beryllin@kpmg.com.tw
Netherlands Herman van Meel +31 20 656 7222 vanmeel.herman@kpmg.nl
Thailand John Sim +66 2 677 2288 Jsim3@kpmg.com
New Zealand Paul Herrod +64 9 3675 323 pherrod@kpmg.com
United States Chris Xystros +1 757 616 7009 cmxystros@kpmg.com
Norway Aage Seldal +47 5157 8219 aage.seldal@kpmg.no
K P M G â&#x20AC;&#x2122;s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 5 5
Notes
5 6 K P M G â&#x20AC;&#x2122;s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y
Notes
K P M G ’s D i s c l o s u r e s H a n d b o o k : Ac c o u n t i n g a n d F i n a n c i a l Re p o r t i n g i n t h e G l o b a l A i r l i n e I n d u s t r y 5 7
kpmg.com
The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG International provides no audit or other client services. Such services are provided solely by member firms of KPMG International (including sublicensees and subsidiaries) in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any other member firm, nor does KPMG International have any such authority to obligate or bind any member firm, in any manner whatsoever.
Š 2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. Printed in Australia. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. May 2006. VIC9838IM. Liability limited by a scheme approved under Professional Standards Legislation.