Tax, Profit and Assets

[Aahz the Pervect]

Disclaimer - I did a search and couldn't find this question asked - but there was at least one thread that said something along the lines of 'you don't have access' when I tried to read it. No clue what that is about.


As I understand Acct practices, the purchase of permanent equipment for your business is not an 'expense' to be subtracted from your profits (taxable $$). They are assets that add to the value of your company, while expenses are generally understood to be pure costs associated with running your business that (in themselves) add zero value (in real $$) to your company.  Is there an exception to this in the airline industry for Aircraft?

You can depreciate the asset over time and use the depreciation as an expense to lower your taxable income, but in the case of something as long lived as an AC, I imagine that would be a 10+ year process.

My question - Is the location of the 'Purchased Aircraft' line on the income statement relevant? It is sandwiched between 'Aircraft Leases' and 'Alliance Fees' seeming to indicate it is treated as a pure expense. Is it treated as a 100% expense immediately as a way of avoiding the Pain In the Ass depreciation formulas?

Or am I just totally misreading it?

[Kontio]

The income statement currently lists how much cash is coming in and going out. It does not consider whether cash going out is actually an investment or a true expense. Actual accounting practices you write about are yet to be implemented.

[Aahz the Pervect]

Cool - Knowing the ground rules is 1/2 the battle - Many thanks for the heads up!

Gonna stop calling my planes AC (Aircraft) and start referring to them as FTS (Flying Tax Shelter) - Woohooo!!!

[Sami]

(hoping to make some changes to this in the future...)

[swiftus27]

Aahz, I have already sent the information to Sami about what would be considered to be more or less GAAP. 

When you buy a plane, you can depreciate it over so many years (probably 20-30, but I wouldn't know for sure without looking it up).  The depreciated amount would go against your taxable income.  Right now, the purchase itself goes against the taxes.   Because Cash and the airplanes themselves would both be ASSET accounts, your net value would not change ON THE BOOKS.  Sure, the plane may have appreciated or depreciated but irl you always depreciate the asset in this instance. 
For example, if you buy a plane for 30 million, each year you could write 1 million off as Depreciation (an expense).  You can't depreciate anything past 0.  Your airline's value should be: ((net book value of planes)+(cash))-(liabilities).
If you sold a plane that you had depreciated for tax purposes for more than what is left on the books, it would be a Gain on Sale.   So, if you sold a plane for 1 million that had a BOOK value of 500k, you'd have to pay taxes on the 500k profit.   

Lease payments should count 1:1 against taxes as it does in the game.

[Aahz the Pervect]

yeah - I get how tax is computed on Capital Gains from sales of depreciated assets in RL and began to suspect that wasn't modeled here (yet - I have faith Sami!) when it appeared that I able to shelter 100% of the AC cost at the time of the 2 payments. Interesting that I can shelter the entire down payment a year'ish before the plane shows up - opens up a few cool ways to play with the books (something I can't do in RL) so kinda looking forward to maximizing that while I can, now that I know I'm not just misinterpreting the data


Just to be clear - Wasn't intended as a whine or complaint, just a request as to how the system here works. I have absol no problem playing by the set rules (since it's an even playing field for everyone) as Sami works his magic on future versions. If anything, was my fault for assuming I knew how it worked for the last couple (game) years w/out verifying my assumptions long ago heh.

And yeah - I get how Leases (and the Alliance Fee's I mentioned) would normally be considered a pure operating expense and deduct from income right off the top - which was why I was initially confused as to the 'Purchases' line being between them. All good now - thanks again everyone for the prompt replies and explanations of how it works here!

EDIT - As an aside, if the RL method is implemented here it will help narrow the gap between huge companies and the smaller ones (imho). The bigger the Airline's income, the more the current method benefits them.

[alexgv1]

Amortisation and Depreciation

Amortization is writing off aircraft value (or other asset) over its estimated lifetime and is a fixed rate over time.

This reduces balance sheet valuation so cost can be charged to operating expense.

This expense is called depreciation. Depreciation may be affected by other factors, such as a poor safety record

Typically:
14-16 years to 10% of purchase value for wide-body jet
8-10 years for short-haul aircraft

(Source: University of Southampton School of Engineering Sciences)

Here is an equation for depreciation I found in my course notes for my degree:

Annual depreciation = (Purchase Price - Residual Value) / Depreciation Period.

e.g. An aircraft costing $100m depreciates 10% annually over its 15 year life cycle.

Annual depreciation = ($100m - (0.1*$100m)) / 15years = $6m/year

Hourly depreciation can be calculated by annual utilisation, i.e. number of block hours flown.

Hope this helps you if you were thinking of implementing this. Have no idea about the tax unfortunately.

[swiftus27]

Taxes are easy once you have net income.  Since we don't have to worry about alot of the other income statement stuff, it shouldn't be too hard.   We dont have any fixed asset other than planes.   The gates/slots themselves aren't considered assets at all (maybe they should?)

[Aahz the Pervect]

nods - I've played games before where Slots were 'owned' and assets avail for resale etc. Hard to justify in the current game model since there are no auctions etc. May lead to even more hassles concerning slot hoarding. (In my head, I considered them a 'rental' fee in this sim)

If Sami had unlimited time, working up part of the Maintenance costs as asset purchases (hangers, heavy equipment, tools) would be more in line with RL too.

But that could be a whole 'nother expansion-version of the game where one has to buy a Maintenance Facility with multiple choices avail concerning size, potential size (expansion capability), % =/- to maintenance results based on funding levels/equipment on hand etc etc.

I understand that's already currently built into the exponential commonality costs, just saying, if we want to get technical and explore this train of thought further....Slots and some Maintenance costs could both be assets I think.

[schro]

Sami - I know this has been in and out of the feature request forum for a while.  Would it be helpful if I were to writeup requirements in a business/systems analyst style to make it easier for you to code?

[Sami]

Sure. I'm no accountant (although I do know some basics..). I've also got some reference material etc but of course a summary in layman's terms would be always helpful.

[theguv316]

its only a game lads you lost me at Amortisation ! ! ! !


some of us are lonely little Civil Servants

[RushmoreAir]

Amortization is technically depreciation on expenses, so you would "amortize" certain expenses over time, so you would amortize leasing expense
Depreciation is on owned aircraft.

[yyebo]

its only a game lads you lost me at Amortisation ! ! ! !


some of us are lonely little Civil Servants

Amortization actually is essential to most management games.

Without proper amortization/depreciation, we don't know the true expense therefore the profit amount you get is false and relatively useless.

For example, in this game,

if a company had a net profit of $20m at the end of year. Normally there will be $6M tax (if the tax rate is 30%)
Then the CEO purchased planes for $20m (cash on hand + loan) from used market before the year ends, which made net profit become zero
Because the cost of purchases have been recognised as expense rather than capital.

Therefore this company does not have to pay a cent for tax,
In the beginning of next year the $20m worth of plane can be sold on the market for $18-20m quite easily, which will make at most $2m loss

Overall we can see this company voided at least $4m of tax!

Hopefully this will help you to understand how important the proper financial statements are

Pai
Lunar Airways

[EYguy]

I think that the main problem with that cash flow chart are the difference between fiscal laws in all the countries around the world. If you have an a/c which is leased, that chart is okay: you do not have any asset in your balance sheet and your moving all your company on "cash", not with assets and accounting standards.
The point is: we have company values growing each year even when the a/c are getting older because the income statement doesn't reflect the actual fiscal laws of the world: if I' amortizating my a/c in 5 years (as it is tipical here in Italy) instead of 3 years (which is the "quick amortization" in Italy") I could save more money but decrease my company value. This happens because I am amortizating my a/c faster than other companies, mainly because I could demonstrate to the revenue agency that I am using them above the average.
So the main issue with the income statement (and hence with the company value) is that it doesnt reflect the differences and influences of fiscal laws...

[Aahz the Pervect]

I think that the main problem with that cash flow chart are the difference between fiscal laws in all the countries around the world. If you have an a/c which is leased, that chart is okay: you do not have any asset in your balance sheet and your moving all your company on "cash", not with assets and accounting standards.
The point is: we have company values growing each year even when the a/c are getting older because the income statement doesn't reflect the actual fiscal laws of the world: if I' amortizating my a/c in 5 years (as it is tipical here in Italy) instead of 3 years (which is the "quick amortization" in Italy") I could save more money but decrease my company value. This happens because I am amortizating my a/c faster than other companies, mainly because I could demonstrate to the revenue agency that I am using them above the average.
So the main issue with the income statement (and hence with the company value) is that it doesnt reflect the differences and influences of fiscal laws...

Actually, like much of the financial aspect of the sim, for ease of gameplay, a set standard for all airlines is sufficient at the moment I think. We use a single currency to avoid the hassles of exchange rates etc. We use one set standard for number of 'Pilots in the Cockpit' despite there being different regulations for smaller planes on different continents. Instead of exponentially making this fix harder on Sami by asking for a dozen different sets of financial laws to code, I'm perfectly fine with everyone using one set, regardless of location.

But we can agree on some basic principles that could be better I think. As already discussed here, separating asset purchases out of the expense column is something I think everyone can agree is proper, regardless of the exact financial system in any particular country. As to how in-depth they want to get coding depreciation (whether it's a simple straight % every year or we have choices for 'fast' or normal or whatever) - I'm good with whatever, as long as it fits in the General Acct Principles.

As to the specific example, I'm a little confused.

"if I' amortizating my a/c in 5 years (as it is tipical here in Italy) instead of 3 years (which is the "quick amortization" in Italy") I could save more money but decrease my company value."

- Actually, if you use the 5 yr, doesn't your company retain it's 'value' in hard assets longer? (all other things being equal)

As to whether the 3 yr or 5 yr method saves more money - It is entirely dependent upon your profit. (I think...Schro or Swiftus?)  If you have a great profit margin right away, the 3 yr write off makes more sense. But if you are making money on more of a curve, where your profit in years 1-3 aren't real great yet but you see big money coming in later in years 4-5, then the 5 yr depreciation would be better probably. Alternatively, you have the opportunity cost of being able to use more of your money faster with the 3 yr plan. The obvious factor would be if you even have a decent profit margin in years 1-3 to be taxed on. If you are already at/near the break even point on income, a bigger write-off for depreciation gets you nothing. (imho - been a few years since I've had to personally handle depreciation stuff, so I could be mistaken or out of date)

[Sami]

For depreciation there will be one standard model, or max 2-3 different models based on aircraft size for example, on which it is counted. Not a chance to make it realworld like for all countries.

[EYguy]

For me it is ok to have one set of rules which separate investments from expenses in the income statement, as Aahz suggested. Even the use of single currency is not a problem, even because in real life both Airbus and Boeing quote their prices in USD for ease of use with their customers and most of the world economies are still linked to the USD.
What I wanted to say about "quick amortisation" is something that reflect reality, at least with some revenue services in Europe.

The point is: if I am using an a/c (or could be a bus, a car, a train, whatever you want to use) above the average use, I could have a higher amortisation cost in my income statement. If you think carefully about this rule, you'll see that it is a wise decision.
Airlines keep their a/c airborn for an average of about 12 hrs/day: as you know, the economy of today's aviation industry mandates that to wring out the more profit you can have from an a/c, you have to keep it airborne for as much time as possible. Of course, Emirates has an average airborne time of a lil less than 18hrs/day per a/c. This means that its a/c are being exploited MORE THAN AVERAGE, so their value is decreasing faster than average and they will be phased out earlier than the a/c of other airlines.
This "quick amortisation" allows you to get more cash flow from your normal activity because you can assign this higher "figured cost" to yur income statement. Thus, this higher cost will lower your accounting profit (I hope that everyone here know the difference between accounting profit and cash flow!) and give you more cash flow (in short, cash in your bank account). This high amount of cash you have, will be used to buy a new a/c, car, bus, whatever... I think that getting the value of "airborne time" should not be that difficult if anyone will ever want to implement this feature...

So, when talking about the choice of 3 yrs or 5/8 years, it is mainly a matter of how you want to set up your revenue rules. If I can get the 3 yrs rule, this will reflect that fact that I am using my a/c above the average and so my a/c is getting old "faster" than its counterparts. Of course, with this rule I have more cash flow, because the more time my a/c is airborne, the more money it makes and the less taxes I'm going to pay! If I use the 5 or 8 years rule, I can always make lot of money if I keep my a/c airborne as much time as possible, but I'll pay more taxes because the government allows me to "write off" only one 5th of the value of the a/c per year...

[Aahz the Pervect]

This is a side topic really to the general 'making the acct stuff better' topic, but thanks to those whose patience allows us to discuss!! I work in an acct department of 1 - so I don't get a lot of chances to pick the brains of other beancounters on stuff that doesn't directly effect my industry.

EYguy- Just to get clarification, While I agree that the 'fast' depreciation is often useful for a company, would you agree it is a case-by-case basis? Not every company will need the larger expenses in the first few years of operation. In fact, for those trying to establish good credit to gain larger loans, faster depreciation of their company's hard assets may hurt them. Since the 'real' gain of depreciation expense is actually 30% (the current Airway sim tax rate) of the depreciated amount and only useful if your Profit (after all other expenses) is larger then the amount you are writing off. While you gain 30% of the depreciated amount in cash, overall your company loses 70% of that depreciated amount in value. In years 1-3 (admittedly I am a noob here) I find myself working hard to increase my company value so I can get larger loan amounts faster and get the Big Money AC up and running sooner rather then later. (Again, this is my understanding - looking for help on where I'm going wrong if I'm just not getting it)

New Thought - With Secured Loans being tied directly to particular assets, will the loan system need to be reworked a bit so that Loans don't end up being top heavy compared to the depreciated value of the asset (that is 'securing' the loan) over time?

[EYguy]

Aahz, I agree with you! It is something that could work on a case by case basis but it is actually the way that allows Ryanair to make so much profit and have so much money to invest in new a/c while keeping its debt low!
Anyway, talking about you idea of how to tie the loans to a/c and the value of loans, I would like to propose the following idea: why don't allow a player to tie the loan to a smaller a/c as soon as the value of the loan allows such change? I have often found myself with big wide body a/c tied up in loans that had an amount with the size of a medium-large a/c... If everybody starts doing the right maths, anyone will see that this idea is a "zero cost" change but with lot of freedom of action for the players...