Application Exercise 5

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Application Exercise 5

Solve the following accounting problems.

  1. Refer to the Delta Air Lines financial statement, page 34. How much did the operating revenue change from 2019 to 2020? Explain why.
  1. Fuel cost is usually the first or second largest operating expense for an airline. Refer to the Delta Air Lines financial statement, page 37. In 2020, by what percentage did the cost of fuel as an operating expense change? Explain why.
  1. Explain the steps Delta took to reduce the largest operating expense on the statement. Refer to Delta Air Lines annual report in the Study Materials.
  1. Identify and explain the four points of the ticket pricing timeline. Refer to the Ticket Pricing Timeline in Lesson 9 in the Study Materials.
  1. Explain the cost cutting steps outlined in the IATA Economics’ Chart of the Week (21 August 2020) and describe their intent. Describe in what areas of the balance sheet the cost cutting steps would appear and how their effectiveness would be measured.

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Application Exercise 5

  1. Refer to the Delta Air Lines financial statement, page 34. How much did the operating revenue change from 2019 to 2020? Explain why.

The operating revenue was $47,007 million in 2019 and reduced to $17,095 million in 2020 – a decrease of 64% (DELTA AIRLINES, INC., 2020). The decrease is largely attributed to the impact of the COVID-19 that affected the bigger part of 2020. Countries closed their borders and imposed travel restrictions and lockdowns as containment measures that could mitigate the spread of the novel virus. With such measures, there were no flight travels within countries and across borders bringing air travels to a standstill (IATA, 2020). With the sharp decline in air travel demand, there was a considerable cash burn and a deterioration in the financial outlook of the airline industry.

  1. Fuel cost is usually the first or second-largest operating expense for an airline. Refer to the Delta Air Lines financial statement, page 37. In 2020, by what percentage did the cost of fuel as an operating expense change? Explain why.

The cost of aircraft fuel and related taxes were $8,519 in 2019 and reduced $3,176 in 2020 – a 63% decrease (DELTA AIRLINES, INC., 2020). This is a huge decrease that would be much profiting if normal operations were ongoing. However, this decrease is attributed to the halt of operations as occasioned by the COVID-19 pandemic. With border closures, travel restrictions, and lockdowns that followed the pandemic, the airline industry suffered the biggest hit since their operations were brought to a standstill (IATA, 2020). This, in turn, impacted the jet fuel industry because airplanes are the largest consumer of oil and fuel. According to International Energy Agency (IEA) data, airlines consumed about 10% of total oil demand in OECD countries in 2019 and dropped to 6% in 2020 (Sharafedin, B., Samanta, K., and Kelly, 2021). On the other hand, gasoline demand remained constant at 30% both years. These statistics attest to the drastic drop in fuel consumption recorded by Delta Air Lines in 2020. Besides, there were no flight passengers to use their services since they were in lockdown.

  1. Explain the steps Delta took to reduce the largest operating expense on the statement. Refer to Delta Air Lines’ annual report in the Study Materials.

Following the entry of the COVID-19 pandemic and its impending impacts on the airline industry, Delta Air Lines took quick steps to cushion itself against the situation. Various cost-cutting measures were taken to preserve cash. Liquidity sources such as accessing credit lines, government support, and bond issuance were taken (IATA, 2020). Additionally, the company applied other strategies to differ and spread the cost over time for liquidity maintenance. For instance, “Delta paid $62 million to terminate an aircraft purchase agreement with LATAM, under which they were to purchase four A350s” (Soni, 2020, para. 5). As a result, the company does not pay for anything, including the cost associated with reconfiguring the aircraft and the full purchase price. Other options, such as capital market transactions are also available for the company. These include options, such as reducing dividends, capital reductions, issuing new shares, and sharing buybacks.

  1. Identify and explain the four points of the ticket pricing timeline. Refer to the Ticket Pricing Timeline in Lesson 9 in the Study Materials.

Airline ticket prices vary depending on the amount of time between the purchase and the day of flight and seasonality. Since flights to Hawaii have a unique booking style, this is also a factor to consider. Regarding the number of days before departure, airfares are subdivided into six booking zones (Dhir, Smith, and Overcast, 2021).

  1. The most advanced zone is First Dibs in which booking is done 203-315 days in advance. In this state, each ticket costs $50 more on top of the lowest airfare. There are many and better choices of seats and itineraries that can be made at this stage (Dhir, Smith, and Overcast, 2021).
  2. Peace of Mind is the next level in which booking occurs 116-202 days in advance. Each ticket costs $20 on top of the base price. It is also associated with many good choices in terms of flights and seats (Dhir, Smith, and Overcast, 2021).
  • Prime Booking Window is the third stage where booking occurs 21-115 days in advance. Within this period, Airfares average within 5% of their lowest prices. It’s the most preferred time to book flights and hunt for bargains (Dhir, Smith, and Overcast, 2021).
  1. The fourth stage is the Push Your Luck in which booking occurs 14-20 days in advance. This state is associated with the rising fare and reduced options since most of the best options in terms of seats and itinerary have already been sold out. However, with luck, one can still get lower fares at this stage (Dhir, Smith, and Overcast, 2021).
  2. Explain the cost-cutting steps outlined in the IATA Economics’ Chart of the Week (21 August 2020) and describe their intent. Describe in what areas of the balance sheet the cost-cutting steps would appear and how their effectiveness would be measured.

Airline resorted to other liquidity sources such as government support, accessing credit lines, and bond issuance. Government support aims to ensure essential connectivity amidst the pandemic and protect millions of jobs supported by the industry (Abate, Christidis, & Purwanto, 2020). For instance, the US provided a Loan of US$58 billion bailouts for US airlines (US$61 billion including grants for contractors), which was signed into law on March 27, 2020, as part of the CARES Act” (Abate, Christidis, & Purwanto, 2020, p. 5). Most airline companies could not generate revenue during the pandemic but had to sustain the cost of maintaining their organization and employees. The only viable way to do this was to increase access to credit. For instance, according to Arnold (2020), the four largest U.S. airlines — American, Delta, United, and Southwest have borrowed loans to cover cash burn of between $30 million to $70 million daily. Bond issuance also gave airlines a viable option to maintain employees and investments. In the end, the industry accumulated about $204 billion of new debt (IATA, 2020).

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References

Arnold, M. K. (2020). Airlines are racking up billions in debt to get through COVID-19. Can they survive? Chicago Tribune. https://www.chicagotribune.com/coronavirus/ct-nw-coronavirus-united-american-southwest-airlines-20200512-6wn44pjd5bgmdpqdx4vibur6sq-story.html

Abate, M., Christidis, P., & Purwanto, A. J. (2020). Government support to airlines in the aftermath of the COVID-19 pandemic. Journal of air transport management, 89, 101931. https://doi.org/10.1016/j.jairtraman.2020.101931

DELTA AIR LINES, INC. (2020). DELTA. https://www.annualreports.com/HostedData/AnnualReports/PDF/NYSE_DAL_2020.pdf

Dhir, R., Smith, A., and Overcast, K. (2021). What Is the Cheapest Time to Book a Flight? Investopedia. https://www.investopedia.com/ask/answers/113015/do-plane-tickets-get-cheaper-closer-date-departure.asp

IATA. (2020). IATA Economics’ Chart of the Week. COVID-19 lowers airline credit ratings and raises the cost of debt. https://www.iata.org/en/iata-repository/publications/economic-reports/covid-19-lowers-airline-credit-ratings-and-raises-the-cost-of-debt/

Soni, R. (2020). Staying afloat: managing liquidity in the COVID-19 fallout. ReedSmith. https://www.assetfinanceinbrief.com/2020/06/staying-afloat-managing-liquidity-in-the-covid-19-fallout/

Sharafedin, B., Samanta, K., and Kelly, S. (2021). Cloudy outlook for stalled jet fuel demand recovery. REUTERS. https://www.reuters.com/article/us-global-oil-jet-fuel-idUSKBN2AI0BU

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