provisions of balance sheet account 2131 Accrued Federal Income Taxes.

[ER-327, 26 F.R. 4222, May 16, 1961 as amended by ER-425, 30 F.R. 745, Jan. 23, 1965]

Sec. 2-7 Delayed items.

(a) All items affecting net income, including revenue and expense adjustments, shall be recorded in the appropriate profit and loss accounts shown on the income statement, and shall not be entered directly to retained earnings.

(b) Items applicable to operations occurring prior to the current accounting year shall be included in the same accounts which would have been charged or credited if the items had not been delayed; Provided, That any item of extraordinary nature which is so large in amount that inclusion in the accounts for a single year would materially distort the total operating expenses or total operating revenues, as applicable, shall be included in Profit and Loss classification 9700 Special Items. Ordinary adjustments of a recurring nature shall not be considered extraordinary and shall be included in the accounts to which ordinarily applicable. For purposes of this regulation, debits or credits included in classification 9700 Special Items shall be limited to items which (1) have no particular time incidence; (2) represent revenue or expense elements being retroactively introduced into the basis used for income computation; (3) represent revenue or expense elements being retroactively eliminated from the basis used for income computation; or (4) are retroactive adjustments of Federal subsidy due to revisions of subsidy mail rates of prior periods. Examples of extraordinary items to be included in this classification, when of sufficient materiality, are: catastrophic losses which are not a recurrent business hazard, such as from floods; the retroactive establishment or elimination of previously established reserves; and extraordinary writeoffs of intangible assets which through unusual circumstances have become worthless, and adjustments resulting from refunding or premature retirement of debt. As a standard practice, an extraordinary item to be classified as special must exceed one-half of one per

cent of the twelve-months-to-date total operating revenues or total operating expenses depending on the nature of the item. When an item (or items) recorded in the objective accounts of a given function and relating to a single transaction does not exceed this amount but does exceed one percent of the total functional classification of which it is a part, it shall be included in the account to which ordinarily applicable and footnoted on Form 41.

(c) Items applicable to operations occurring in prior quarters of the current accounting year shall be included in the same accounts that would have been charged or credited if the items had not been delayed: Provided, That, when the total amount of an adjustment recorded in one or more of the regular objective accounts of a given function relating to a single transaction exceeds one percent of the twelve-months-to-date total in the applicable functional account, it shall be identified in amount and nature by quarters to which applicable, as a footnote to the CAB Form 41 income statement for the quarter in which included.

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 not required 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 for such funds and that it may include interest on funds set aside and carried in balance sheet account 1550 Special Funds-Other 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, 1689, or 1830) and credited to profit and loss subaccount 87.2 Interest Capitalized-Credit or, if imputed interest, to profit and loss subaccount 80.1 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 debiting profit and loss subaccount 80.2 Imputed Interest Deferred-Debit and crediting balance sheet account 2390 Other Deferred Credits which shall be cleared to profit and loss subaccount 80.3 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 development project is not brought to fruition, any related capitalized interest shall be eliminated from the accounts by reversal of the capitalizing entries.

(80 Stat. 383, 5 U.S.C. 552) [ER-484, 32 F.R. 5367, Mar. 30, 1967]

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 reserves 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.

(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 subsidiary 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 or other companies in which the air carrier holds 50 percent or less of the voting capital stock 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 reserves for loss in value may not be feasible, which have been expended 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.

(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-327, 26 F.R. 4222, May 16, 1961, as amended by ER-546, 33 F.R. 18696, Dec. 18, 1968]

Sec. 2-13 Establishment of reserves.

(a) Provisions for reserves covering transactions or conditions which do not diminish assets or result in demonstrable liability to the air carrier, with corresponding diminution in stockholder equity during the period over which accrued, shall not be charged against income but shall be charged directly against balance sheet account 2940 Unappropriated Retained Earnings.

(b) All reserves 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) Provisions for self-insurance against damage to property, or other risks, may be charged against income as recurring operating expense, and credited to balance sheet account 2350 Reserve for Self-Insurance, in accordance with a plan which reflects actuarial or other reasonable measurement of risk: Provided, The air carrier demonstrates that the accrual rate is reasonable in terms of resulting cost level and will

not, in any accounting period, inflate the operating costs above those which would result from equivalent coverage through purchased insurance. Such provisions shall be made in accordance with the instructions for balance sheet account 2350 Reserve for Self-Insurance. No provision shall be made through income charges for a retroactive initiation or adjustment of self-insurance reserves. Such reserves shall be accumulated on a forward basis only. However, the air carrier may effect an interim segregation of retained earnings through balance sheet account 2930 Appropriations of Retained Earnings. The balance of such segregation of retained earnings is to be returned to unappropriated retained earnings upon attainment of the planned level of the self-insurance reserve, accumulated through income charges. Where risks to be borne by the air carrier are reduced or eliminated, due to substitution of purchased insurance, or otherwise, the self-insurance reserve requirements shall be redetermined. Excesses in existing reserves, of material amount, over those required to cover current risks borne by the air carrier shall be accounted for as provided in balance sheet account 2350 Reserve for Self-Insurance. Material effects upon income taxes resulting from differences as between income recognized for tax and book purposes, associated with provisions for self-insurance, shall be accounted for in accordance with the instructions for balance sheet account 2340 Deferred Federal Income Taxes. Each air carrier shall file with the Civil Aeronautics Board a statement of accounting procedures when a policy with respect to self-insurance is established. This statement shall set forth: (1) The amount of self-borne and purchased coverage, respectively, for each type of risk involving self-insurance; (2) the rates of accrual to the self-insurance reserves; (3) such other detail as may be pertinent to the plan; and (4) information necessary to establish the reasonableness of the plan in conformance with the standards prescribed by this system of accounts and reports. The rates and practices set forth in such statements shall thence forth be used by the air carrier unless notified by the Civil Aeronautics Board, in accordance with section 22(d) or 32

(d) as applicable, that they do not meet the requirements set forth in this section.

(d) Additional reserves over those prescribed in this system of accounts may be established for the purpose of equalizing or distributing 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 expended directly. Each air carrier shall submit, for approval by the Civil Aeronautics Board, a plan for each such equalization reserve which shall set forth the proposed accounting and rates of accrual. Such plans shall provide for the liquidation of each expense equalization reserve at the close of each accounting year. Equalization reserves shall not be used in respect to expenditures, the distortionary fluctuations of which spread over a cycle of longer than one year. (See section 22(d) or 32(d), as applicable.)

[ER-327, 26 F.R. 4222, May 16, 1961, as amended by ER-369, 27 F.R. 12818, Dec. 28, 1962; ER-483, 32 F.R. 2809, Feb. 11, 1967] Sec. 2-14 Depreciation and amortization.

(a) Depreciation shall be calculated by the air carrier in such manner as will prevent the charging of either excessive or inadequate expense or the accumulation of excessive or inadequate reserves, 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 retire

ment 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 inIclude 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-327, 26 F.R. 4222, May 16, 1961, as amended by ER-483, 32 F.R. 2810, Feb. 11, 1967]

Sec. 2-15 Contingent assets and con

tingent liabilities.

Contingent assets and contingent liabilities, except as permitted by account 2930 Appropriations of Retained Earnings, shall not be included in the body of the balance sheet but shall be explained in footnotes.

Sec. 2-16 Notes to financial statements.

All matters which are not clearly identified in the body of the financial statements but which may influence materially interpretations or conclusions which may reasonably be drawn in regard to financial condition or earnings position shall be clearly and completely stated as footnotes to the financial statements.

Sec. 2-17

Revenue accounting practices.

(a) Revenue accounting practices shall conform to the provisions of account 2160 Unearned Transportation Revenue.

(b) Physical verification of the reliability of passenger revenue accounting practices shall be made at least once each accounting year, and an analysis showing the results of such verification shall be submitted to the Board within 30 days following its completion. The analysis supporting the verification shall include:

(1) The cutoff date for the liability to be verified;

(2) The number of months after the cutoff date during which documents were examined to verify the liability;

(3) The nature of the documents which were examined for purposes of the verification;

(4) The totals for each of the various types of documents examined, on actual or sampling basis;

(5) A description of the sampling technique and conversion to totals, if sampling was employed;

(6) The amount and basis for all estimates employed in the verification; and

(7) The amount of resulting adjustments and the quarter in which such adjustments were, or are to be, made in the accounts.

(c) The amount of any adjustment shall be reported on schedule B-2 or B2.1, as applicable, in the quarter booked in accordance with the instructions for these schedules contained in sections 23 and 33.

[ER-606, 35 F.R. 4614, Mar. 17, 1970]

Sec. 2-18 Transactions between members of an affiliated group.

(a) Unless otherwise approved by the Board's Director, Bureau of Accounts and Statistics, transactions between the regulated activity of an air carrier and activities conducted by nontransport divisions or other corporate members of an affiliated group shall be recorded by the air carrier as provided in paragraphs (b) through (e) of this section 2-18.

(b) Charges for services and assets purchased by or transferred to a regulated activity of an air carrier from other activities of an affiliated group shall be recorded initially in the accounts of the regulated air carrier activity at their