(a) All income taxes shall be accrued by proportionate charges or credits to income in each calendar quarter and shall reflect the application of the effective tax rate expected to be applicable for the full year exclusive of tax related to significant unusual or extraordinary items that are separately disclosed or included net of tax in the reporting period. The interperiod tax allocation method shall be applied for all material timing differences between pretax accounting income and taxable income.

(b) The tax effect of timing differences which increase or decrease taxes currently payable shall be recognized in balance sheet account 2340, Deferred Income Taxes. Any resulting net debit balance in this account shall be treated for statement purposes as a special subaccount in balance sheet account 1890, Other Assets. In effecting these accruals, records with respect to deferred taxes (including foreign, state, and local taxes based upon income) shall be maintained in accordance with the provisions of balance sheet account 2340, Deferred Income Taxes.

(c) The tax effects of any realizable tax carrybacks shall be recognized in the determination of net income (loss) of the loss periods; appropriate adjustments of existing deferred income taxes may be necessary.

(d) The benefits of loss carryforwards shall normally be recognized in the year in which such loss is applied to reduce income taxes. However, in unusual circumstances when realization is assured beyond a reasonable doubt, the future benefits may be recognized in the year of loss. In cases where deferred taxes attributable to prior timing differences exist to recognize all or a portion of the loss carryforward, an appropriate amount of the benefit may be offset against deferred taxes. However, net deferred taxes attributable to prior timing differences which would not be amortized until after the expiration of the carryforward period, shall not be offset by loss carryforwards.

(e) At the option of the air carrier, investment tax credits may be treated as a reduction of income tax expense in the year they are actually realized (flowthrough method) or they may be deferred and amortized over the useful life of the property to which it relates and they shall be accounted for in accord

ance with the provisions of balance sheet accounts 2130, Accrued Taxes, 2340, Deferred Income Taxes, and 2345, Deferred Investment Tax Credits. [ER-948, 41 FR 12289, Mar. 25, 1976, as amended by ER-980, 42 FR 24, Jan. 3, 1977] Sec. 2-7 Extraordinary items, discontinued operations, prior period adjustments, and accounting changes.

(a) All items affecting net income, including revenue and expense adjustments, shall be reported in the profit and loss accounts to which they relate unless evidence clearly supports their treatment as an extraordinary item, as a discontinued operation, a prior period adjustment, or a change in accounting principle.

(b) Extraordinary items recorded in Section 9700 shall be characterized by their unusual nature and infrequent occurrence, taking into account the environment in which the air carrier operates. They must also be material. In this context, unusual means that the underlying event or transaction is abnormal and significantly different from the ordinary and typical activities of the air carrier, and infrequently occurring means that the event or transaction is not reasonably expected to recur in the foreseeable future.

(c) The materiality of an unusual and infrequently occurring event or transaction should be measured in relation to its impact on net income (loss) before extraordinary items or to the trend of earnings. As a standard practice, an unusual and infrequently occurring event or transaction shall be deemed to have a material impact on income (loss) before extraordinary items if it would be considered material for the purposes of filing the Securities and Exchange Commission's Form 10-K or if it exceeds one-half of one percent of the twelvemonths-to-date total operating revenues or total operating expenses, depending on the nature of the item. When an item is not material but does exceed one percent of the total functional classification of which it is a part, it shall be included in the ordinary account to which applicable, and footnoted on CAB Form 41 schedule P-2. As a general rule, items shall be considered separately rather than in the aggregate. However, the effects of a series of related transactions arising from a single specific and separately identifiable event or plan of action shall be aggregated for the purpose of determining materiality.

(d) Events or transactions which are material as determined in conjunction with the criteria set forth in paragraph (c) above and are either unusual or nonrecurring, but not both, should be disclosed on CAB Form 41 schedule P-2. The events or transactions should be identified both as to their nature and their financial effects.

(e) The earnings (losses) of discontinued nontransport operations shall be reported separately from transport, transport-related and continuing nontransport operations and separately from extraordinary items. In addition, any gain or loss from the disposal of a nontransport operation shall be reported in conjunction with the related results of discontinued nontransport operations in functional classification 9600 and not as an extraordinary item. For the purposes of this system of accounts and reports, discontinued nontransport operations shall refer to the disposal of investor controlled companies and the cessation of nontransport operations, the results of which are accounted for through profit and loss objective accounts 86, 87, and 88.2.

(f) All material adjustments which can be specifically identified with and directly related to business activities of particular prior periods shall be reflected as adjustments of the opening balance of retained earnings. In order to qualify for such treatment the adjustment must not be attributable to economic events occurring subsequent to the date of financial statements for the prior period; it must depend primarily on determinations by persons other than management; and not be susceptible of reasonable estimation prior to such determination. Corrections of errors in financial statements of a prior period should be disclosed as a prior period adjustment in the period in which the error was discovered and corrected. Materiality should be determined using the criteria set forth in paragraph (c) above.

(g) The cumulative effect of changes in accounting principle shall be reflected in the account provided for in the determination of net income and clearly and completely described in notes to the income statement (see section 18). The amount of the cumulative effect of a change in accounting principles shall represent the difference between (a) the amount of retained earnings at the beginning of the period of the change and

(b) the amount of retained earnings that would have been reported at that date if the new accounting principle had been applied retroactively for all prior periods which would have been affected by recognizing only the direct effects of a change and the related income tax effect. Financial statements of prior periods shall not be restated without the prior approval of the Director, Bureau of Accounts and Statistics. Changes in accounting estimates shall be accounted for in (a) the period of change if the change affects that period only or (b) the period of change and future periods if the change affects both. Materiality should be measured both in relation to the effects of each change separately and the combined effect of all changes. [ER-948, 41 FR 12290, Mar. 25, 1976, as amended by ER-980, 42 FR 24, Jan. 3, 1977] Sec. 2-8

Unaudited items.

If a transaction has occurred but the amount involved is not precisely determinable, the amount shall be estimated, included in the proper accounts and where significant noted for financial statement purposes. The carrier is notrequired to anticipate or disclose minor items which would not appreciably affect the results of its operations or financial position.

Sec. 2-9 Improvements, additions and betterments.

(a) As a general rule, expenditures for additions, betterments or improvements, which increase the productive capacity of units of land, property or equipment, shall be capitalized rather than charged directly against income of the period in. which incurred. Expenditures of insignificant amount related to individual projects may be expensed as incurred, rather than capitalized, provided their inclusion as individual items or when aggregated for like items encompassed by a particular program, will not distort current operating results.

(b) The costs to be capitalized shall include all costs directly incurred by reason of the program together with an allocated portion of overhead costs to the full extent overhead expenses have been responsive to the volume of capitalizable projects currently or periodically in process.

(c) When superior parts are substituted for old parts in existing units of property and equipment as an incident to normal maintenance operations where normal retirement procedures are not

practicable, the excess cost of the new parts over the estimated current cost of new parts of the kind replaced shall be charged to the related property and equipment account.

Sec. 2-10

Capitalization of interest.

(a) Interest may be capitalized on funds actually committed as equipment purchase deposits or actually used to finance the construction or acquisition of operating property from the date the funds are first so employed to the date the property is ready for use: Provided, That the capitalization will be limited in both time and amount to the reasonable requirements of such funds and that it may include interest on funds set aside and carried in balance sheet account 1550 Special Funds-Other and account 1685 Equipment Purchase Deposits and Advance Payments for a period not to exceed 6 months in advance of the date they are scheduled under a legally binding contract to be committed for payment to the manufacturer or contractor.

(b) Interest may be capitalized on funds actually employed in developmental and preoperating projects other than property acquistion and construction up to the date the related operations are initiated.

(c) In determining the amount of interest to be capitalized under the provisions of paragraphs (a) and (b) of this section 2-10, the effective interest rate shall be representative of the current rate for long-term debt of the carrier. Imputed interest at the same rate may be capitalized on equity funds whenever commitments under paragraph (a) or (b) of this section 2-10 exceed the balance of long-term debt. The amount of interest so computed shall be reduced by any interest or other earnings from such funds on deposit with or for the account of the manufacturer or contractor. With respect to funds set aside pending actual commitment, the earnings shall be computed on the basis of the average rate earned on the carrier's current or longterm investment of special funds in interest-bearing securities but not to exceed the total amount of such interest actually earned.

(d) Interest capitalized under paragraph (a) or (b) of this section 2-10 shall be charged to the balance sheet account in which the funds are carried (1550, 1685, 1689, or 1830) and credited to profit and loss subaccount 83.4-Interest Capitalized-Credit or, imputed interest,

to profit and loss subaccount 83.1-Imputed Interest Capitalized-Credit. Interest capitalized under paragraph (a) of this section shall be recorded in such a manner as to facilitate audit and, upon completion of the project, shall be transferred to subaccounts of the appropriate property balance sheet accounts as a cost of the related asset. When imputed interest is capitalized, a concurrent entry shall be recorded by debiting profit and loss subaccount 83.2-Imputed Interest Deferred-Debit and crediting balance sheet account 2390 Other Deferred Credits which shall be cleared to profit and loss subaccount 83.3-Imputed Interest Deferred Credit periodically as the amount of such interest in the asset accounts is written off.

(e) The capitalization of interest will be permitted only to the extent it is reflected in the accounts on a current basis. Furthermore, in the event that a construction project is not completed or a developmental project is not brought to fruition, any related capitalized interest shall be eliminated from the accounts by reversal of the capitalizing entries.

[ER-755, 37 FR 19726, Sept. 21, 1972, as amended by ER-980, 42 FR 24, Jan. 3, 1977] Sec. 2-11 Accounting for transactions in gross amounts.

(a) All assets and liabilities shall be stated in balance sheet presentations in gross values, provided that all depreciation, provisions for uncollectible accounts and other valuation allowances shall be offset against the class of asset to which related. Amounts receivable from, and amounts payable to, associated companies and other air carriers, which are normally settled on a current basis shall be stated in gross amounts receivable and gross amounts payable. Amounts receivable from, and amounts payable to, individual associated companies which are not settled on a current basis, and are not includible in current assets or current liabilities, shall be stated in net amounts receivable or payable. Receivables from particular associated companies shall not be offset against payables to other associated companies.

(b) The cost of Treasury Certificates or other tax notes, which are to be surrendered to the United States Treasury, rather than independently sold, in satisfying Federal income tax liabilities may be offset against accrued Federal income

tax liabilities provided both the gross income tax liability and the value of the tax notes are reflected on the face of the balance sheet. The offset of other government securities or other assets against Federal income tax liabilities is prohibited.

[ER-755, 37 FR 19726, Sept. 21, 1972, as amended by ER-980, 42 FR 24, Jan. 3, 1977] Sec. 2-12 Acquisition and valuation of

assets.

(a) As a general rule, all assets shall be recorded at cost to the air carrier and shall not be adjusted to reflect changes in market value. Exceptions to this rule shall be limited to the following items:

(1) Investments in investor controlled companies (as that term is defined in section 03) shall be recorded at cost (except as provided in section 5-2(c)) plus the equity in the undistributed earnings or losses of such companies since acquisition. (Investments in associated companies, other than investor controlled companies, and other companies shall be recorded at cost, except as provided in section 5-2(c).)

(2) Spare parts and materials of a class for which the accrual of allowances for loss in value may not be feasible, which have been expensed from current inventories and are recovered, may be returned to inventory at estimated value with contra credit to the expense accounts initially charged. The cost (as defined in section 03, "Cost") to be recorded shall represent the cash price of the asset acquired unless otherwise specifically provided in paragraphs (b) and (c) of this section. When the consideration given for property is other than cash. the value of such consideration shall be determined on a cash basis, in accordance with the following provisions.

(3) The carrying amount of a marketable equity securities portfolio shall be the lower of its aggregate cost or market value, determined at the balance sheet date. The amount by which aggregate cost of the portfolio exceeds market value shall be accounted for as a valuation allowance. (See paragraph (a) (6) of this section.)

(4) Marketable equity securities owned by a carrier shall be grouped into separate portfolios according to the current or noncurrent classification of the securities for the purpose of comparing aggregate cost and market value to determine carrying amount.

(5) If there is a change in the classification of a marketable equity security between current and noncurrent (accounts 1100 and 1530, respectively), the security shall be transferred between the corresponding portfolios at the lower of its cost or market value at the date of transfer. If market value is less than cost, the market value becomes the new cost basis, and the difference shall be accounted for as if it were a realized loss and included in the determination of net income by charging account 8188 4

(6) Changes in the valuation allowance for a marketable equity securities portfolio included in current assets shall be included in the determination of net income of the period in which they occur by charging account 8188.3. Accumulated changes in the valuation allowance for a marketable equity securities portfolio included in noncurrent assets shall be included in the equity section of the balance sheet and shown separately in account 2950.

(7) For those marketable securities for which the effect of a change in carrying amount is included in stockholders' equity rather than in net income, a determination must be made as to whether a decline in market value below cost as of the balance sheet date of an individual security is other than temporary. If the decline is judged to be other than temporary, the cost basis of the individual security shall be written down to a new cost basis and the amount of the write-down shall be accounted for as a realized loss by charging account 8188.4. The new cost basis shall not be changed for subsequent recoveries in market value.

(b) Costs of assets charged against income by an air carrier shall not be reinstated through property exchanges, and again charged against income by another air carrier but shall be recorded by each successive user at the unrecovered cost of property given in exchange, adjusted by the amount of any additional cash or other consideration given or received. For purposes of this system of accounts, an exchange is defined as a transaction in which tangible property represents more than 75 percent of the fair market value of the total consideration. Capital gains or losses, as a matter of policy, will not be recognized in property exchanges. (See also section 5-3 (e) (8).)

(c) The cost of properties obtained under a conditional sales contract shall

be recorded as assets as at the date upon which delivery has been completed even though legal title remains in the vendor unless there is material uncertainty as to the complete consummation of the transaction.

[ER-755, 37 FR 19726, Sept. 21, 1972, as amended by ER-948, 41 FR 12290, Mar. 25, 1976; ER-980, 42 FR 24, Jan. 3, 1977]

Sec. 2-13 Establishment of allowances.

(a) Provisions for allowances covering loss contingencies, which are not accruable because it is less than probable that an asset has been impaired or a liability has been incurred as of the report date and/or the amount of the loss cannot be reasonably estimated, are permitted as an appropriation of retained earnings and shall be maintained as a subaccount of 2900 Retained Earnings. When accrued losses and related costs are incurred, they shall not be charged to the appropriation and at no time shall the appropriation be transferred in whole or in part to income.

(b) All allowances shall be classified in balance sheet presentations in terms of their inherent impact upon the air carrier's financial condition as either valuation of assets (offsetting the assets to which related), accrued liabilities, or appropriations of retained earnings.

(c) [Reserved]

(d) Additional allowances over those prescribed in this system of accounts may be established for the purpose of allocating expense charges between calendar quarters of each accounting year in accordance with operations performed, in the event such expenditures are part of a specific program to which the air carrier is demonstrably committed and are of sufficient magnitude to significantly distort the financial results of the current quarter if expensed directly. Each air carrier shall submit, for approval by the Civil Aeronautics Board, a plan for each such equalization allowance which shall set forth the proposed accounting and rates of accrual. Such plans shall provide for the liquidation of each expense allocation allowance at the close of each accounting year. Allocation allowances shall not be used in respect to tions of which spread over a cycle of longer than one year. (See section 22(d) or 32(d), as applicable.)

[ER-755, 37 FR 19726, Sept. 21, 1972, as amended by ER-948, 41 FR 12290, Mar. 25, 1976; ER-980, 41 FR 25, Jan. 3, 1977]

Sec. 2-14 Depreciation and amortization.

(a) Depreciation shall be calculated by the air carrier in such a manner as will prevent the charging of either excessive or inadequate expense or the accumulation of excessive or inadequate allowances, and shall be based upon a study of the air carrier's history and experience or such engineering or other information as may be available with respect to prospective future conditions and without regard to depreciation accounting practices adopted for tax purposes. Undepreciable residual values shall be established for each class of property and equipment and shall represent the fair and reasonable estimate of the recoverable value as of the end of the service life over which the property is depreciated. Depreciation chargeable against operations shall be limited to the actual costs incurred in the acquisition of the properties to which related. The cost of properties which are generally repaired and reused shall not upon retirement be charged against current operating expenses but, to the extent not written off in the form of depreciation, shall be treated as part of the capital gain or loss. The cost of properties of a type which are recurrently expended and replaced shall be charged to operating expenses as issued for use. However, the net charge to operating expense for any asset, used, consumed or abandoned shall be limited to the difference between the cost incurred in acquisition and any related accrued depreciation.

(b) In accordance with the provisions of section 22(d) or 32(d), as applicable, each air carrier shall file with the Civil Aeronautics Board a statement which shall clearly and completely describe for each classification of property and equipment the methods, service lives, and residual values used for computing depreciation on the different subcategories of property or equipment included therein. This statement shall be sufficiently descriptive to permit a pro forma construction of the depreciation calculation of each accounting period and shall include identification of those categories depreciated on a unit basis and those categories depreciated on a group basis, as well as the mathematical bases employed for allocating applicable costs to the different accounting periods.

[ER-755, 37 FR 19726, Sept. 21, 1972, as amended by ER-980, 42 FR 25, Jan. 3, 1977]