Pong, Airline Computers, and Depreciation Expense
I traveling to Italy last summer, when flying was generally a mess for overseas travelers.
Late flights, hundreds of cancellations, unclear guidance from airlines. My flights to Italy were fine, but my Rome to NYC flight was 4 hours late, and I missed my connection. A hassle, to be sure, but here’s what really stood out to me:
The age of the airline’s computer equipment.
I flew American, and I glanced over the counter several times to look at the computers. The keyboards were ancient, and the screen looked like someone was playing Pong in a 70’s arcade.
So many people were traveling in the summer of ’22 that the volume overwhelmed the IT hardware and software. Travel agents and baggage handlers couldn’t get online, or the system was running too slow to serve customers.
What about the airline regulators? Similar story.
“Failing Vintage Hardware”
The Wall Street Journal reported in 2022 that: “The Federal Aviation Administration halted flights across America in early January, paralyzing air traffic for nearly two hours. It was the first nationwide ground stop since the Sept. 11 terrorist attacks and shook an industry struggling to cope with a post-pandemic surge in travel.”
The FAA blamed a contractor for unintentionally deleting computer files in an alert system, which tells pilots about restrictions and hazards along their routes.
A contractor- not an employee- can delete FAA computer files?
The biggest issue is the age of the IT equipment.
“A closer look at the system suggests that its problems run much deeper. Despite repeated warnings about its vulnerability, the system hasn’t been overhauled in years. Phasing out aging equipment has been put off since at least 2016. It is so fragile that flooding from heavy rain at an Oklahoma City facility in 2021 knocked out the system.”
Former FAA officials and industry representatives said it is antiquated and urgently needs to be fixed. The Transportation Department, the FAA’s parent agency, said in budget documents for the 2023 fiscal year that the system relies on “failing vintage hardware.”
You can’t run a government agency, a non-profit, or a commercially viable business without investing in assets. If your equipment is out of date, the business can’t serve customers effectively, and some clients won’t come back.
The good news? You can expense the investment over time.
How Depreciation Expense Works
An asset is a resource used to generate revenue for a business, and depreciation is posted when an asset is used to produce revenue and profits. Tangible (physical) assets are depreciated, while intangible assets are expensed using amortization. Depreciation expense does not impact cash.
Depreciation method: factors
When a company purchases an asset, management must make some decisions before calculating depreciation. Assume, for example, that a landscaping company purchases a truck for $25,000.
The matching principle of accounting states that the revenue earned from using the truck should be matched with the depreciation expense- the expense that occurs when the asset is gradually “used up”.
Here are some factors used to determine depreciation expense:
Useful life: This is the number of years that the company will use the asset in the business. Assume that the truck’s useful life is five years.
Salvage value: The dollar amount that the asset can be sold for at the end of the useful life. In many cases, the salvage value is zero, but assume a salvage value of $3,000 for this example.
Depreciation method: There are a variety of depreciation methods, and the method chosen should relate to how the asset is used in the business. If, for example, the asset is used heavily in the early years, a company should choose a depreciation method that posts more expense in the early years. Assume a straight-line method for the truck, because the firm expects to drive the same number of miles each year over the useful life.
Each of these variables impacts the dollar amount of depreciation expense posted each year.
Using the straight-line depreciation method
The landscaping company must calculate the depreciable base for the truck, which is the asset value used in the calculation. The straight-line method subtracts any salvage value from the purchase price of the asset, so the depreciable base is:
($25,000 - $3,000 = $22,000)
Annual depreciation is ($22,000 depreciable base) / (5 year useful life), or $4,400.
Considering an accelerated depreciation method
If the company plans to use an asset far more often in the first few years and less in later years, the business may use an accelerated depreciation method. Accelerated means more expense in early years, and less in later years.
It’s important to remember: the total amount depreciated is the same, regardless of the depreciation method chosen. The truck’s depreciation cannot be more than the ($22,000 depreciable base. The only difference between depreciation methods is the timing from one year to the next.
The Lesson
No business can operate long-term without an investment in assets, and depreciation expense tracks the use of company assets to generate revenue.