On November 5, 2003, Eli Colby was looking over his company’s financial statements for the year ending October 31, 2003. Belle Air Charter, a small airline charter service company based in Vancouver, British Columbia, incurred another net loss in fiscal 2003. Colby needed to know the profitability (or lack thereof) of Belle Air’s three airplanes; hence, he decided to produce an income statement reflecting the profits generated or the losses incurred by each plane so that a decision could be made about the fleet mix for subsequent years.

COMPANY BACKGROUND

Belle Air Charter was established in 1992 by Eli Colby. Colby, who had accumulated substantial personal wealth from real estate investments in western Canada, had a long love affair with flying and yearned to operate his own flight business. Realizing the relative lack of charter services in his home town of Vancouver, Colby decided to make an investment and devote his full time efforts to building Belle Air. While the company was formed more because of Colby’s interest than its potentially lucrative earnings potential, Colby hoped to earn a return that was, at the least, comparable to what he could have earned from a chartered bank. Unfortunately, profitability had never been very strong, and Colby found himself investing more and more money to keep the operation afloat. This is reflected in the company’s financial statements (see Exhibits 1 and 2).

Chartered airlines differed from traditional scheduled airlines insomuch as the smaller chartered companies ran their flights on demand. An order would be taken from a customer indicating desired flight time, location, date, and perhaps even plane type, and the company would try to schedule the customer accordingly. While the larger airlines offered a service much like a flying “bus” with large passenger capacity and scheduled stops, charter airlines acted more like an “air taxi” with small passenger capacities and user-dictated stops and schedules.

Belle Air’s sales came from two basic markets: business executive travel and medical emergency flights. The business sector accounted for 70 per cent of Belle Air’s revenue, with most of the private business coming from Vancouver’s dominant banking sector. The British Columbia government, which ran the province’s socialized Medicare program, accounted for 25 per cent of Belle Air’s revenue. Medical

emergencies that required the immediate, expedient transport of a patient or a human organ to a hospital often required the speed of air transportation. The government subcontracted much of the emergency flight service to small air charter companies, such as Belle Air. The remaining five per cent of sales came from individuals seeking charter flights for pleasure, or from businesses needing emergency freight shipments.

Price was one of Belle Air’s key competitive factors. The scheduled air lines operating out of Vancouver and nearby Seattle often offered businesses convenient flight schedules and frequent seat sales. Despite the customized nature of the business, Belle Air could not charge too large a premium over the commercial airlines for fear of losing many budget-conscious customers.

The business attempted to control costs as closely as possible, given the competitive nature of the industry. For example, pilots were instructed to try to purchase fuel in the cheapest of locations. However, Belle Air management also realized the need to provide top-notch service to their elite group of clients, and felt that certain costs could not be reduced without affecting service. For instance, pilots were paid a generous wage to help promote company loyalty and strong customer relations. In return, Belle Air expected its pilots to be well-versed in the company’s operations, to be able to fly more than one type of plane, and to be willing to be on-call at any time for emergency medical flights.

THE FLEET MIX

Belle Air attempted to keep a well-rounded fleet mix to help ensure maximum market accessibility. The fleet consisted of a small five-seat propeller-equipped plane (listed on the companies records as PN5), one seven-seat pressurized, jet-propelled plane (known as PC37), and one small jet (J50). The business owned the two propeller planes, but leased the jet.

The three planes each served a slightly different niche in the market. The smaller PN5 was used by cost- conscious customers for smaller flights. The PN5 was the slowest and most uncomfortable of the three planes. The PC37 provided more comfort due to its pressurized cabin, and travelled slightly faster than the PN5. The J50 jet was the fastest of the aircraft and was used for the longest flights. This additional speed was offset by a higher price. Business travellers preferred the jet or the PC37 to the PN5. The government usually chose the cheapest plane available for medical emergency flights.

Scheduling flexibility and plane availability were very important success factors for the business. If Belle Air could not meet a demand for a certain aircraft type for a certain time, the requesting company would likely go to a competitor. If Belle Air’s cheaper plane was unavailable for a medical emergency, the government would quickly look for an alternate source; they would only accept one of Belle Air’s higher priced planes if it was the cheapest available alternative in the nearby area. Thus, it was not uncommon for small charter companies to be operating well under full capacity due to these competitive forces.

Customers were charged a basic rate for each kilometre flown by the plane, plus a per-kilometre fuel charge. In addition, airport landing fees (minimum of two per flight) and any overnight fees were charged directly to customers. The rates for the assorted aircraft varied based on Belle Air’s cost, the plane’s flight speed and market conditions. These revenues are summarized with other plane information in Exhibit 3.

STATEMENT DEVELOPMENT

Colby wanted to get an income statement for each of the three planes. He wanted these three statements to reflect all of Belle Air’s costs. Despite the fact that the company was primarily a fixed-cost operation, many of the costs could be directly attributed to each plane. Other expenses related to the operation as a whole; hence, they needed to be allocated on some logical basis.

Records regarding fuel costs, maintenance parts, plane insurance and landing/ overnight charges were kept for each plane and were as follows for fiscal 2003:

	PN5	PC37	J50
Fuel Expenses	$ 40,479	$130,570	$121,259
Maintenance: Parts	27,166	71,990	36,674
Flight Insurance	8,025	13,132	13,160
Airport Landing Fees Incurred	20,570	33,170	26,288
Overnight Charges Paid	6,542	18,704	9,342
	$102,782	$267,566	$206,723

The lease payment related solely to the J50 jet. Amortization was calculated for the two business-owned planes based on a double-declining-balance method.

Selling expenses listed on the income statement included advertising and promotion costs, bad debt expense, telephone and answering service expenses, and travel and automobile costs. Colby felt that these should be allocated on the basis of revenue earned per plane.

The maintenance crew worked on both the owned planes, and the leased jet. Hourly records of time spent on each plane were not kept. Thus, Colby felt that the labor costs should be allocated based on the cost of plane maintenance parts used on each aircraft.

The pilots were paid an hourly wage for hours flown plus a base salary and benefits. This process allowed Belle Air to maintain maximum flexibility, while providing fair compensation to the pilots. Pilots also helped with some other administrative duties; hence, their wages could not be considered a “direct cost.” Initially, Colby felt that this cost would be allocated solely on plane hours logged; however, upon further thought, he realized that only one of the pilots was qualified to fly the leased jet. The senior aviator able to pilot the jet was paid 25 per cent more than the average pilot due to his additional seniority and experience. Colby felt it would be reasonable to account for the difference in pilot compensation when allocating their wages across the three planes. Thus, a premium would be calculated and added to the actual jet hours flown in order to get “equivalent jet hours.” The equivalent jet hours would be treated the same as the actual hours flown for the other two planes.

Interest was paid on the debt needed to finance the company. Since much of the debt was used to finance the purchase of the planes, Colby believed that more of the interest should be allocated to the two planes that were owned. He deduced that roughly 35 per cent of the interest would be attributed to the PN5, 50 per cent to the PC37 and the remainder to the leased jet.

General and administrative costs included all costs related to the office building (e.g., amortization, cleaning expenses, office supplies, office utilities), all costs related to the hangar (which housed the planes when they were not in use), and all other administrative costs (such as membership dues, government regulation manuals and subscriptions, licenses, administrative personnel and land rental fees). Due to the nature of the operation, Colby inferred that unless a clear cause and effect relationship existed for an indirect expense, the best allocation basis would be kilometres flown.

CONCLUSION

Colby knew that his task would be relatively straightforward given the information before him. He was suspicious that one or two of the planes were not “carrying their weight” and was anxious to see the results so that further decisions could be made.

Exhibit 1 BALANCE SHEET

As At October 31, 2003

	2003			2002
ASSETS
Current Assets:
Accounts Receivable	$ 165,132			$ 181,325
Aircraft Parts	60,627			42,530
Prepaid Expenses	7,212			15,332
	$ 232,971			$ 239,187
Fixed Assets:
PN5 Aircraft	$ 298,450		$ 298,450
Less: Accumulated Amortization	(98,512)	$ 199,938	(69,949)		$ 228,501
PC37 Aircraft	$ 731,259		$ 731,259
Less: Accumulated Amortization	(171,388)	559,871	(91,407)		639,852
Property, Building and Hangar (net)		652,964			574,323
Total Assets		$ 1,645,744			$ 1,681,863
LIABILITIES & OWNER’S EQUITY
Current Liabilities:
Bank Indebtedness		$ 156,181			$ 102,714
Accounts Payable		50,077			95,228
Current Portion of Long-term Debt		14,400			20,800
		$ 220,658			$ 218,742
Long-Term Debt		$ 174,872			$ 163,131
Shareholders’ Equity:
Common Stock		$ 500,000			$ 500,000
Contributed Capital		1,070,000			1,010,000
Deficit		(319,786)			(260,010)
Total Liabilities & Owner’s Equity		$ 1,645,744			$ 1,681,863

Exhibit 2 INCOME STATEMENT

For the Year Ending October 31, 2003

Mileage Revenue	$ 822,697
Fuel Charged to Customers	341,453
Landing and Overnight Charges to Customers	114,450
Total Revenue		$ 1,278,600
Operating Expenses:
Aircraft Fuel	$ 292,308
Airport Landing Fees and Overnight Charges	114,616
Amortization — Aircraft	108,544
Flight Insurance	34,317
Leased Aircraft	141,205
Maintenance — Parts	135,830
Wages — Maintenance Crew	97,100
Wages — Pilots	196,300
Total Operating Expenses		$ 1,120,220
Selling and Service Expenses		52,100
General and Administrative		134,076
Interest		31,980
Net Loss		$ (59,776)

Revenues from Flying:

Exhibit 3

AIRCRAFT DATA FROM FISCAL 2003

Revenues Earned from Fiscal 2003:	PN5	PC37	J50
Mileage Charges Earned	$ 149,811	$ 396,416	$ 276,470
Fuel Charges Earned	53,504	165,376	122,573
Landing Charges Recovered	20,570	33,170	26,288
Overnight Charges Recovered	6,263

Answer rating: 100% (QA)

1Introduction Belle Air Charter The company provides Chartered Airline services to its customers The services are customized with high flexibility to meet customers needs Price is one the most importa... View the full answer