Question

TOPIC # 1: Please provide one real world example of a product cost or a period cost that a company like Raytheon or Delta Airlines will have on its income statement or balance sheet. In your own words, and drawing on your professional experience, provide a description of the cost and say why you think it is a product or period cost.

Some things to consider - how does this relate to your job? How does this relate to a business that you know about? If you don't have a job, then try to relate the topic to a business or industry that you are interested in.

Answer 1

let us first take an example of product cost with respect to Delta Airline's income statement in their 2018 10k annual filing.

Passenger service

This income statement item can be considered as a product cost since fuel is consumed by the Delta airlines fleet most exclusively when in passenger service, both in flight and on ground for terminal services for scheduled revenue earning passenger flights.

Aircraft rent

This is one of the best examples of period cost since fleet infusion and expansion is usually done by way of wet or dry leasing from aircraft leasing companies who actually owns the airplanes. Here Delta airlines is liable to pay the periodic installments on the lease regardless of the business scenario (even if the planes are not airbone and not on passenger service )

Now let us relate the topic to aviation industry in general. Aviation industry in the current day scenario is an extremely regulated one and needs high level of capital investment for infrastructure development, complying with rules and regulations by way of licenses and approvals from international regulatory bodies such as FAA. It also need to provide good return on investment to its investors. Due to the high capex requirement, capital often needs to be raised by issuing shares and trading in public. This increases capital cost and volatility. Brand expansion is only possible by way of providint exceptional service at competitive prices and a diverse choice of destinations. all these adds overheads since maintainince crew and airline hubs needs to be set up in various cities and employ thousands of people across the world for an internaltional airline such as Delta. Implementing fleet commonality, although is beneficial in largescale homogeneious market conditions, is another double edged sword since it decreases flexibility of having a diverse fleet of airplanes to serve various kinds of market (regional vs national vs international) Dry leasing airplanes is more than just a rent a car sort of commitment. The airline is expected to use the airplane during a good majority of its usable airframe life. Amending such lease terms are extremely costly and difficult and often come with penalty or comphensation obligated towards the leasing company. Airlines can increase their profitability only by reducing period costs wherever possible whilst striking a balance between capital investment requirement to make a decision between to lease/oursource or to own. These decisions will have a significant impact on the profitability of the airline based on the market conditions the particular airline finds itself in or as per the market conditons of the aviation industry in general terms.