A few years ago, a Delta Air Lines 727 crashed in Dallas. The crash resulted in a gain of $.11 per share for Delta. How could this happen? Consider the accounting for airplanes. Airlines insure their craft at market value, $6.5 million for Delta’s 727. However, the planes’ book values are often much less because of large accumulated depreciation amounts. The book value of Delta’s 727 was only $962,000.
1. Suppose Delta received the insurance payment and immediately purchased another 727 for $6.5 million. Compute the effect of the insurance payment on pretax income. Also compute the effect on Delta’s total assets.
2. Do you think a casualty should generate a reported gain? Why?