SkyWest Airlines 2002 Annual Report Download - page 40

uses the deferral method of accounting for Brasilia engines and was using the accrual method for
Canadair Regional Jet (CRJ) engines through December 31, 2001. As discussed below, during the
quarter ended March 31, 2002, the Company elected to change its method of accounting for CRJ
engine overhauls to expensing overhaul maintenance events as incurred (the direct-expense method).
The costs of maintenance for airframe and avionics components, landing gear and normal recurring
maintenance are expensed as incurred. For leased aircraft, the Company is subject to lease return
provisions that require a minimum portion of the ‘‘life’’ of an overhaul be remaining on the engine at
the lease return date. For Brasilia engine overhauls related to leased aircraft to be returned, the
Company adjusts the estimated useful lives of the final engine overhauls based on the respective lease
return dates.
Effective August 1, 2001, the Company and GE Engine Services, Inc. (GE) executed a sixteen-year
engine services agreement (the ‘‘Services Agreement’’) covering the scheduled and unscheduled repair
of CRJ engines. Under the terms of the Services Agreement, the Company agreed to pay GE a fixed
rate per-engine-hour, payable monthly, and GE assumed the responsibility to overhaul the Company’s
CRJ engines as required during the term of the Services Agreement, subject to certain exclusions. The
Company accounted for all CRJ engine overhaul costs through December 31, 2001 under the accrual
method using an estimated hourly accrual rate through August 1, 2001, and then for the period from
August 1, 2001 through December 31, 2001, using the fixed rate per-engine-hour pursuant to the
Services Agreement.
In response to changing market conditions, the Company and one of its major partners agreed to
modify the method of reimbursement for CRJ engine overhaul costs under their contract flying
arrangement beginning in 2002 from reimbursement based on engine flight hours to reimbursement
based on actual engine overhaul costs at the maintenance event. In April 2002, the Company and GE
signed a letter agreement (the Letter Agreement) amending the Services Agreement in response to the
change with the Company’s major partner. Pursuant to the Letter Agreement, payments under the
Services Agreement were modified from the per-engine-hour basis, payable monthly, to a time and
materials basis, payable at the maintenance event. The revised payment schedule extended through
December 31, 2002, at which time monthly payments were to resume on the fixed rate per-engine-hour,
as adjusted for the difference in the actual payments made under the Letter Agreement during 2002 as
compared to the payments that would have been made under the Services Agreement during 2002. As
discussed below, on March 14, 2003, the Services Agreement was further amended.
Due to the change in the Company’s contractual arrangement with one of its major partners and
based on the Letter Agreement, the Company elected to change from the accrual method to the direct-
expense method for CRJ engine overhaul costs effective January 1, 2002. The Company believes the
direct-expense method is preferable in the circumstances because the maintenance liability is not
recorded until the maintenance services are performed, the direct-expense method eliminates significant
estimates and judgments inherent under the accrual method, and it is the predominant method used in
the airline industry. Accordingly, effective January 1, 2002, the Company reversed its engine overhaul
accrual that totaled $14,081,000 by recording a cumulative effect of change in accounting principle of
$8,589,000 (net of income taxes of $5,492,000).
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