What is the difference between straight-line and accelerated depreciation for aircraft leasing?

1 Straight-line depreciation

Straight-line depreciation is the simplest and most common method of depreciation. It assumes that the asset loses value at a constant rate over its useful life. To calculate the annual depreciation expense, you divide the cost of the asset minus the salvage value by the number of years of useful life. For example, if you lease an aircraft that costs $10 million, has a salvage value of $2 million, and a useful life of 20 years, you would depreciate it by $400,000 per year ($10 million - $2 million / 20 years). The advantage of this method is that it is easy to apply and consistent. The disadvantage is that it may not reflect the actual pattern of wear and tear or obsolescence of the asset.

2 Accelerated depreciation

Accelerated depreciation is a method of depreciation that allocates more of the cost of the asset to the earlier years of its useful life and less to the later years. This reflects the assumption that the asset loses value faster in the beginning and slower in the end. There are different formulas for accelerated depreciation, such as double declining balance or sum of the years' digits. For example, using the double declining balance method, you would multiply the cost of the asset by 2 divided by the number of years of useful life, and then subtract the accumulated depreciation from the previous years. For the same aircraft in the previous example, you would depreciate it by $1 million in the first year ($10 million x 2 / 20 years), by $800,000 in the second year ($10 million - $1 million x 2 / 20 years), and so on. The advantage of this method is that it matches the depreciation expense with the revenue generated by the asset, and it provides higher tax deductions in the early years. The disadvantage is that it is more complex and variable.

3 Lease types and depreciation methods

The type of lease you choose can affect the depreciation method you use and the tax implications you face. There are two main types of leases: operating leases and capital leases. Operating leases are short-term leases that do not transfer the ownership or risks of the asset to the lessee. The lessor retains the ownership and depreciation rights of the asset, and charges the lessee a fixed rental fee. Operating leases are treated as operating expenses, and do not affect the balance sheet of the lessee. Capital leases are long-term leases that transfer the ownership or risks of the asset to the lessee. The lessee records the asset and the lease liability on its balance sheet, and claims the depreciation and interest expenses on its income statement. Capital leases are treated as financing arrangements, and affect the debt-to-equity ratio and return on assets of the lessee.

4 Tax benefits and depreciation methods

The depreciation method you use can have a significant impact on your tax benefits as a lessee or a lessor. Depreciation is a non-cash expense that reduces your taxable income and increases your cash flow. The higher the depreciation expense, the lower the tax liability. Therefore, using an accelerated depreciation method can provide more tax benefits in the early years of the lease than using a straight-line depreciation method. However, this also means that you will have less depreciation expense and more tax liability in the later years of the lease. Depending on your tax situation and cash flow needs, you may prefer one method over the other.

5 Aircraft valuation and depreciation methods

The depreciation method you use can also affect the value of the aircraft at the end of the lease term. The value of the aircraft is determined by its market price, which depends on factors such as supply and demand, age, condition, maintenance, and technology. The depreciation method you use does not change the market price of the aircraft, but it changes the book value of the aircraft, which is the cost of the asset minus the accumulated depreciation. The difference between the market value and the book value of the aircraft is called the residual value. The residual value can be positive or negative, depending on whether the market value is higher or lower than the book value. Using an accelerated depreciation method can result in a lower book value and a higher residual value than using a straight-line depreciation method. This can affect the lease payments, the buyout options, and the capital gains or losses of the lessee or the lessor.

6 Here’s what else to consider

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