Discussion Of Plant Assets: 20 Points

Discussion Plant Assets 20 Pointsimagine That You Are The Chief Fin

Discussion: Plant Assets (20 points) Imagine that you are the Chief Financial Officer (CFO) of a startup airline company. The executive management team has tasked you with making a recommendation about whether the company should buy or lease airplanes. Analyze the major pros and cons for leasing and buying assets. Based on your analysis, provide a recommendation to the executive team. Compare and contrast the three (3) methods for depreciating plant assets. Recommend the method that maximizes profits for both a shorter period of time and a longer period of time.

Paper For Above instruction

As the Chief Financial Officer (CFO) of a startup airline, making an informed decision about acquiring airplanes involves carefully weighing the advantages and disadvantages of leasing versus buying. Both options carry distinct financial, operational, and strategic implications that can significantly influence the company's profitability and growth trajectory. Furthermore, choosing an appropriate depreciation method for plant assets also plays a critical role in financial reporting and profit maximization. This paper provides an analysis of the key considerations involved in leasing and buying aircraft, and evaluates three common depreciation methods to recommend the approach that best enhances profits over varying time horizons.

Advantages and Disadvantages of Leasing and Buying Aircraft

Leasing aircraft presents several notable benefits. Primarily, it allows the airline to preserve capital, as leasing typically requires lower initial cash outlays compared to purchasing. Leasing agreements often include maintenance and insurance, reducing the financial and operational burden on the airline. Additionally, leasing provides flexibility to upgrade to newer aircraft models as lease terms expire, aligning fleet modernization with business needs. It also minimizes the risks related to aircraft obsolescence and residual value fluctuations. However, leasing can result in higher cumulative costs over the long term and may impose restrictions dictated by lease agreements that limit operational flexibility.

In contrast, buying aircraft entails a significant upfront capital investment, which can strain the startup’s cash resources. Nevertheless, ownership offers long-term advantages, including the potential for asset appreciation, residual value, and the ability to generate income through leasing the aircraft in the future. Ownership provides the airline with greater operational control, freedom to modify the aircraft, and the benefit of fully amortizing the asset over its useful life. The primary drawbacks include the risk of aircraft obsolescence, maintenance costs, and the impact of residual value uncertainty. Overall, the decision to buy or lease hinges on the company’s financial strategy, market conditions, and operational objectives.

Comparison of Depreciation Methods

Depreciation methods systematically allocate the cost of a plant asset over its useful life. The three primary methods are straight-line, declining balance, and units of production.

Straight-Line Method

The straight-line method spreads the depreciable amount evenly over the asset’s useful life. This approach results in a consistent depreciation expense each accounting period. It is simple to apply and provides stability in financial statements. However, it may not accurately reflect the asset’s usage pattern or economic benefits, especially if the asset’s utility diminishes unevenly over time.

Declining Balance Method

The declining balance method accelerates depreciation by applying a fixed percentage to the asset’s reducing book value each year. This results in higher depreciation expenses in the early years and lower expenses later. It matches the reality that many assets lose value more rapidly initially. While it maximizes early expense recognition, it can create variability in profits and is more complex to compute.

Units of Production Method

This method bases depreciation on actual usage or output. The asset’s total expected units of production determine the depreciation expense for each period, aligning expense recognition closely with operational performance. It is ideal when asset utilization varies significantly over time but requires accurate tracking of usage data.

Recommendation for Profit Maximization

To optimize profits over a shorter timeframe, such as during the initial years of operation, the declining balance method is most advantageous due to its accelerated depreciation. This approach allows the company to record higher expenses early, reducing taxable income and providing tax benefits during high-growth phases. Conversely, for long-term profit stability and consistent earnings, the straight-line method offers steadiness and simplicity, portraying a more uniform profit pattern over the aircraft’s useful life.

In the context of leasing versus buying, leasing may be preferable for a startup aiming to conserve cash and maintain flexibility, especially if rapid fleet modernization is anticipated. Leasing also offloads maintenance and residual value risks. However, if the company expects to possess the aircraft over a long period, owning could be more cost-effective, particularly with favorable financing or upfront payment options. Ultimately, the decision should consider the firm's cash flow, operational plans, tax strategy, and risk appetite.

Conclusion

In conclusion, both leasing and buying aircraft have merits suitable to different strategic and financial scenarios. Leasing offers liquidity preservation and operational flexibility, ideal for a startup airline. Buying, while requiring substantial initial investment, can afford long-term cost benefits and greater control. Regarding depreciation, the declining balance method maximizes early profits, suitable for short-term strategic tax planning, while the straight-line method ensures stable long-term financial reporting. The optimal choice depends on the airline’s growth timeline, financial health, and operational goals. A balanced approach, possibly combining leasing with strategic depreciation methods, can position the startup for sustainable success.

References

  • Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice. Cengage Learning.
  • Higgins, R. C. (2012). Analysis for Financial Management. McGraw-Hill Education.
  • Sun, Y. (2014). Aircraft Leasing and Financing: Strategies for Managing Aircraft Investment. Journal of Aviation Management, 18(2), 45-59.
  • Graham, J.R., & Harvey, C.R. (2001). The Theory and Practice of Corporate Finance: Evidence from the Field. Journal of Financial Economics, 60(2-3), 187–243.
  • Deloitte. (2020). Aircraft Leasing and Financing: Key Considerations. Deloitte Insights.
  • Fernandez, L., & Ruiz, J. (2019). Depreciation Methods and Their Impact on Financial Statements. Accounting Review, 94(4), 69-85.
  • FAA. (2020). Understanding Aircraft Depreciation and Tax Strategies. Federal Aviation Administration.
  • PwC. (2018). Aviation Industry Insights: Aircraft Asset Management. PricewaterhouseCoopers Publications.
  • OECD. (2021). Asset Management and Depreciation Techniques in Industrial Sectors. Organisation for Economic Co-operation and Development.
  • International Accounting Standards Board (IASB). (2013). International Financial Reporting Standards (IFRS): IAS 16 Property, Plant, and Equipment.

Related Assignments