Entifying Different Costs And Relevant Time Frames Accounting Essay

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This report is to assist Clearday Guides to analyse using the management accounting method to decide whether the company should buy or rent an aircraft for their aerial photography.

entifying different costs and relevant time frames

The relevant costs in this situation are spilt into fixed costs and variable costs. The fixed costs are the yearly cost of the aircraft over a period of five years which is $3,600 per annum, this is calculated based on the initial outlay of $36,000 deducting the gain on disposal based on today's realisable rate $18,000 which is equal to $18,000 spread over a period of five years.

As shown below the table for the classification of the costs:

Fixed cost

Cost of the aircraft

$3,600

Hangarage

$3,900

Pilot's salary

$36,000

Salary on cost

$5,700

Subtotal

$49,200

Variable cost

Maintenance

$5,400

Insurance

$4,500

Landing fee

$130 per landing

Fuel

$54 per litre

The variable costs consists of the maintenance and repairs; insurance and certification; fuel costs, landing fees and handling fees which varies accordingly to the number of hours the aircraft is being flown.

Analysis

The company currently estimates a total flying period of about 400 hours and committed rental hours of 120 hours from the local flying club.

The company is currently considering whether should it buy or rent an aircraft due to the increasing rental rate charged by Plummet.

There is an opportunity for the company currently to purchase an aircraft which would cost the company $36,000 in initial outlay and with a today's disposal gain of $18,000 after a period of five years.

Therefore a feasibility study is conducted to see the viability of this option or should the company continue to rent the aircraft.

Assumptions and information needed

As per the comparison table shown in Appendix A, the assumptions make are as follows :-

The pilot and plane can be rented out;

Assuming that the pilot and plane can be rent out, we need information on the regulation from the relevant authorities if a private plane can be sub-let? Is the company able to sub-let the aircraft together with the pilot? We would also need to do a market research on the rate the industry is charging for example, in this memo, it is indicated that we will be charging the flying school a rate of $105 per hour since the guaranteed minimum flying hours are 120 hours. Is there any demand for sub-letting the aircraft and pilot? For customers' requiring fewer hours, what is the rate the industry is charging and is it profitable to sub-let?

The rental flying hours of the local flying club is assumed to be guaranteed for five years;

We assumed that the local flying club's flying hours of 120 hours is guaranteed for five years. We would need to ensure that this is a minimum guaranteed hours and these conditions would be specified in the rental agreement with the flying club.

The cash flow is regular;

Assuming that cash flow is regular, we have not taken into the account annual inflation and we are also assuming all the fixed costs are fixed within the relevant range over the period of five years.

The additional salary on cost is a fixed cost;

We are assuming that the additional salary on cost is fixed every year regardless of the number of flying hours therefore additional information is needed to substantiate that this assumption is made correctly or alternatively is the additional salary on cost to vary with the flying hours of the aircraft?

The increase in the insurance and maintenance costs are proportionate to the number of flying hours;

In the calculation, the insurance and maintenance costs linear to the number of flying hours. The basis gathered from the memo to make this assumption is that for the additional 120 hours, the insurance and maintenance costs gone up by 20%. Will there be a cap to the insurance and maintenance costs when the aircraft flies to a limit of a certain flying hours or the insurance and maintenance costs are just linear to the additional flying hours or the costs are staggered?

The rental rate that Plummet is charging is constant at the rate of $70 per hour for the next five years;

We are on the assumption that the rental rate charged by Plummet would be constant during the relevant range of five years, the past historical rental rates are also useful as this would allow to make an analysis on the incremental rate change throughout the past renting period and this would thus further give additional information to the management to decide under what situation the company should really considered buying an aircraft rather than renting?

Considerations of other factors

Renting an aircraft gives the company significantly more freedom to change the rental company at a moment's notice. The financial consequences are minimal and can be addressed by simply writing a notification to the rental company. Aircraft owners wanting to dispose the aircraft tend to face a much more complicated process of selling their aircraft. The loan still needs to be service while the company is waiting to find a buyer. Unless money is not an issue, but the risk of losing the portion of the money as compared to putting the money into fixed deposits might be substantial.   On the other hand, with the flexibility of renting comes also some instability. The rental company may raise the rent. If you own the aircraft, you are able to plan your schedule to your needs and requirements as you desire. It would also have the capability to accept more jobs as the opportunity arise.

By having an aircraft, the company's image could be raised as owning an aircraft is prestigious and more customers would have faith to give their jobs to Clearday as they trust that the quality of their job will be better than those companies who need to rent an aircraft to assist them to take the photographs and also the cost of the job might be cheaper than their competitors.

The aircraft rental which is considered as opportunity cost might be another source of other income even though that is not the company main income and it might come in handy during a time of need.

The risks in such a recommendation could be for example, during bad times where we are unable to fully utilise the aircraft, the company will still have to bear all the costs on their own account and also the staffs employed due to the purchase of the aircraft thus becoming a liability to the company. In this event the company might not have enough flying hours to justify the investment of the aircraft.

The cashflow of the company should also be considered because by investing $36,000 upfront into the aircraft, the company may miss out the opportunity cost of putting the money into banks as fixed deposit which can earn interest for the period of 5 years or in other opportunities which may present itself over the period.

Conclusion

Summary

Buy

Rent

Conclusion

400 hrs

203,859

140,000

Rent

600 hrs

259,539

210,000

Rent

800 hrs

297,218

280,000

Rent

1000 hrs

324,310

350,000

Buy

1200 hrs

332,562

420,000

Buy

Based on the information provided and the summary shown above, my recommendation would be for the company to buy the aircraft if the flying hours are above 950 hours else the company should continue to rent.

Appendix A

400 hrs

600 hrs

800 hrs

900 hrs

950 hrs

1000 hrs

Fixed Cost

Rent

 

 

28,000

 

42,000

 

56,000

 

63,000

 

66,500

 

70,000

Cost

(36,000-18,000)/5

3,600

 

3,600

 

3,600

 

3,600

 

3,600

 

3,600

 

Garage

 

3,900

 

3,900

 

3,900

 

3,900

 

3,900

 

3,900

 

Pilot's salary

 

36,000

 

36,000

 

36,000

 

36,000

 

36,000

 

36,000

 

Salary on cost

 

5,700

 

5,700

 

5,700

 

5,700

 

5,700

 

5,700

 

Fixed Cost

Sub-total

49,200

28,000

49,200

42,000

49,200

56,000

49,200

63,000

49,200

66,500

49,200

70,000

Variable Costs

Maintenance

 

5,400

 

7,200

 

9,001

 

9,901

 

10,351

 

10,801

 

Insurance

 

4,500

 

6,000

 

7,501

 

8,251

 

8,626

 

9,001

 

Landing

 

-

 

-

 

-

 

-

 

-

 

-

 

Fuel

 

-

 

-

 

-

 

-

 

-

 

-

 

Total cost

 

59,100

28,000

62,401

42,000

65,701

56,000

67,352

63,000

68,177

66,500

69,002

70,000

Less

Local flying club

 

(4,140)

 

(4,140)

 

(4,140)

 

(4,140)

 

(4,140)

 

(4,140)

 

Part timer / out sourced

 

(10,588)

 

(6,353)

 

(2,118)

 

-

 

-

 

-

 

 

 

44,372

28,000

51,908

42,000

59,444

56,000

63,212

63,000

64,037

66,500

64,862

70,000

 

Total for 5 years

221,859

140,000

259,539

210,000

297,218

280,000

316,058

315,000

320,184

332,500

324,310

350,000

Less

Initial outlay on buying the aircraft

(36,000)

 

(36,000)

 

(36,000)

 

(36,000)

 

(36,000)

 

(36,000)

 

Add

Gain on disposal of aircraft 

18,000

 

18,000

 

18,000

 

18,000

 

18,000

 

18,000

 

 

Grand total for 5 years

203,859

140,000

241,539

210,000

279,218

280,000

298,058

315,000

302,184

332,500

306,310

350,000

Opportunity Cost

 

 

a)

Local flying club

120 hrs x $105/hr

12,600

Petrol

120 hrs x $54/hr

(6,480)

Insurance

$4,500 x 20%

(900)

Maintenance

$5,400 x 20%

(1,080)

 

 

 

4,140

 

 

 

 

 

 

500 hours

300 hours

200 hours

b)

Part timer / out sourced

 $21.78/hr

10,588

6,353

2,118

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