Maintenance reserves and checks

How do maintenance reserves work?

Under many aircraft leases, the airline pays the lessor a monthly amount for each major maintenance event: so much per flight hour for each engine, per cycle for landing gear and per month for airframe heavy checks. When the airline performs qualifying maintenance, it claims reimbursement from the reserves it has paid for that event, usually capped at the amount paid. Reserves left unused at the end of the lease are normally kept by the lessor, often in place of compensation the airline would otherwise owe under the return conditions. Some leases have no reserves and rely on return conditions alone; airlines with strong credit ratings often negotiate this.

How are maintenance reserves accounted for under IFRS?

Maintenance reserves depend on flight hours or cycles, so they are not fixed lease payments and are left out of the IFRS 16 lease liability. The question is what each payment buys. To the extent the airline expects to perform the maintenance during the lease and recover the payment, it is in substance a prepayment of maintenance held by the lessor, recognised as an asset. To the extent it does not expect to recover it, for example because the next event falls after the lease ends or the expected cost is below the reserves, the payment is a cost of using the aircraft, recognised as a variable lease expense. The assessment is made for each maintenance event and updated as flying patterns, costs and fleet plans change. See aircraft leases under IFRS 16.

Maintenance reserves: an engine over an eight-year lease

An airline leases an aircraft for 8 years and pays engine reserves of US$ 300 per flight hour. The engine flies 3,000 hours a year, so the airline pays US$ 0.9 million a year. The next shop visit is expected in year 6 and to cost 6.0 million; the lessor reimburses up to the reserves paid. By year 6, the airline has paid 5.4 million, all expected to be reimbursed, so each payment is recognised as a receivable from the lessor.

The airline's own share of the shop visit, 0.6 million, is capitalised as a component of the right-of-use asset, or as a leasehold improvement, and depreciated over the period it benefits the airline, here the 2 years left on the lease. The reserves paid after the shop visit cannot be recovered, because the engine's next shop visit falls after the aircraft is returned, so they are expensed as paid. In this lease, those retained reserves stand in for return compensation, so the expense is part of the cost of meeting the return conditions.

What if reserves exceed the expected cost?

If the shop visit were expected to cost only 4.5 million, the airline could recover only 4.5 of the 5.4 million it will have paid. The non-recoverable part, 17% of each payment, is expensed as it is paid, and only the rest is recognised as a receivable. Estimates change as engines age and as shop visit costs rise, and changes are applied prospectively, with any receivable no longer expected to be recovered written off. Lessors also cap reimbursements per event and may exclude some costs, such as life-limited parts or damage, which the airline bears itself.

How are heavy checks on owned aircraft treated?

IAS 16 treats major inspections and overhauls as components. When an aircraft is bought, part of its cost is identified as the maintenance condition at that date and depreciated until the first check or shop visit. Each later check is capitalised when performed and depreciated until the next one, with any remaining carrying amount of the previous check derecognised. Routine line maintenance and minor checks are expensed. An airline cannot provide in advance for future overhauls of its own aircraft: it has no present obligation, because it could sell or retire the aircraft instead, a point IAS 37 illustrates with an aircraft overhaul example. Ship owners treat dry-docks the same way; see dry-docking costs. See aircraft components and depreciation and IAS 37 provisions.

What about power-by-the-hour contracts?

Many airlines pay engine manufacturers or maintenance providers a rate per flight hour for comprehensive engine maintenance. If the provider takes on the risk of the actual cost of future shop visits, the payments are an expense as the engine is flown. If the payments are later reconciled to the actual cost of the work, they are closer to a prepayment, recognised as an asset and expensed or capitalised when the work is done. The contract terms decide which, and contracts often combine both.

How do lessors account for reserves received?

A lessor records maintenance reserves received as a liability while it expects to reimburse them. Amounts it expects to keep, because the airline will return the aircraft before the related maintenance, are recognised as lease income, and unused reserves are released at the end of the lease. When an aircraft moves to a new lessee, any reserves the lessor contributes to the new airline's maintenance are a cost of the new lease. See lessor accounting.

How does US GAAP differ?

For leased aircraft, US airlines apply a similar test: reserves that are probable of being reimbursed are deposits, and the rest is expensed as supplemental rent. For owned aircraft, US GAAP allows a choice of methods for planned major maintenance: expensing it as incurred, the deferral method, which capitalises each event and amortises it until the next, or the built-in overhaul method, which is close to the IFRS component approach. Accruing for future overhauls in advance is not allowed under either framework. See airline accounting.

This guide is general information. It is not tax or legal advice for your situation.