I am setting up accounting software for a flying club and seek guidance on how to do accounting for engine overhauls.
Background: The engines in small planes have an ‘expected life’ expressed in hours flown since new or Since a Major OverHaul (hours SMOH). E.g., the engine in a plane valued at $120,000 may have an engine rated for 1600 hours. (The 1600 hours is an expectation; the overhaul may be required a bit earlier or a bit later depending on wear.) When it becomes necessary to overhaul or replace the engine, in say 6-8 years, the cost may be $40,000. Airplane clubs or partnerships therefore charge themselves per hour for using the plane ($100/hr for this example), and a portion of that hourly charge goes to a reserve fund to pay for the eventual overhaul (in this case, $25 per flight-hour). For this example, it may be 6 years until the engine requires overhaul.
My thinking has been to set up some mechanism where for every flight of X hours, for which X*$100 are billed to a member, that X*$25 would increase a Liability:Engine-Overhaul account, and when the member paid his bill, X*$25 would be go to a Current Assets:Engine-Reserve-Fund. However, I’m not sure that’s right because there is not presently a true liability in that no debt is owed to a real third party, and such a promise to the overhauler will not be made until about the actual overhaul is contracted out, years from now.
So I’m not sure it’s right to think of this as a Liability account. An alternative is simply to establish a growing reserve fund, calculate external to the accounting software how much should be in the reserve fund, and move that manually. The 2 problems with this approach are:
1. It would be preferable that it all automatically fall out of the billing for flight hours, not as a separate manual process.
2. Perhaps more importantly, in 6 years as the reserve fund has grown to about $40,000, assets will appear to have grown to $120K (plane) PLUS $40K for the reserve fund, which is very misleading. To say the plane depreciated doesn't seem right, (older planes have very little decrease in market value, except for that due to hours SMOH, and once the overhaul is done the prior value is nearly restored) though I suppose it might be proper to diminish the value of the plane asset $25 for every hour flown. However, every way I can think to do this makes it a very manual ongoing process. Again, it would be preferable that it all be a natural consequence of billing for flight hours.
Finally, in terms of addressing this, cash-method accounting is generally most appropriate for small clubs like this because making cash status obvious is important. However, if the above challenge is best solved by accrual-method accounting that's worth considering.
I would greatly welcome any comments about the most appropriate chart-of-accounts items to deal with this, and how to best define the transactions.
MANY thanks in advance to anyone who can help with this.
Background: The engines in small planes have an ‘expected life’ expressed in hours flown since new or Since a Major OverHaul (hours SMOH). E.g., the engine in a plane valued at $120,000 may have an engine rated for 1600 hours. (The 1600 hours is an expectation; the overhaul may be required a bit earlier or a bit later depending on wear.) When it becomes necessary to overhaul or replace the engine, in say 6-8 years, the cost may be $40,000. Airplane clubs or partnerships therefore charge themselves per hour for using the plane ($100/hr for this example), and a portion of that hourly charge goes to a reserve fund to pay for the eventual overhaul (in this case, $25 per flight-hour). For this example, it may be 6 years until the engine requires overhaul.
My thinking has been to set up some mechanism where for every flight of X hours, for which X*$100 are billed to a member, that X*$25 would increase a Liability:Engine-Overhaul account, and when the member paid his bill, X*$25 would be go to a Current Assets:Engine-Reserve-Fund. However, I’m not sure that’s right because there is not presently a true liability in that no debt is owed to a real third party, and such a promise to the overhauler will not be made until about the actual overhaul is contracted out, years from now.
So I’m not sure it’s right to think of this as a Liability account. An alternative is simply to establish a growing reserve fund, calculate external to the accounting software how much should be in the reserve fund, and move that manually. The 2 problems with this approach are:
1. It would be preferable that it all automatically fall out of the billing for flight hours, not as a separate manual process.
2. Perhaps more importantly, in 6 years as the reserve fund has grown to about $40,000, assets will appear to have grown to $120K (plane) PLUS $40K for the reserve fund, which is very misleading. To say the plane depreciated doesn't seem right, (older planes have very little decrease in market value, except for that due to hours SMOH, and once the overhaul is done the prior value is nearly restored) though I suppose it might be proper to diminish the value of the plane asset $25 for every hour flown. However, every way I can think to do this makes it a very manual ongoing process. Again, it would be preferable that it all be a natural consequence of billing for flight hours.
Finally, in terms of addressing this, cash-method accounting is generally most appropriate for small clubs like this because making cash status obvious is important. However, if the above challenge is best solved by accrual-method accounting that's worth considering.
I would greatly welcome any comments about the most appropriate chart-of-accounts items to deal with this, and how to best define the transactions.
MANY thanks in advance to anyone who can help with this.
