This paper presents a forensic financial analysis and corporate governance assessment of Delta Air Lines, Inc., drawing primarily on the company's 2020 Form 10-K Annual Report. The analysis identifies three key financial vulnerabilities — a high debt-to-equity ratio, risk of asset fraud, and questionable PPE valuations — and evaluates their potential to invite SEC enforcement action. The corporate governance section examines the integrity and rigor of Delta's board structure, audit committee effectiveness, whistleblowing policy, and risk management framework using a five-factor model (composition, compensation, competency, clarity, and consistency). Both sections conclude with targeted recommendations, including strengthened internal controls, audit trails, a formal whistleblower protection program, and the establishment of a dedicated risk management committee.
Delta is an established leader in the aviation industry, supported by a strong brand image complemented by numerous prestigious awards. The airline's commitment to innovation has played a critical role in its success since emerging from bankruptcy in 2007 (Anderson, 2014). Over the past few decades, Delta has adopted an innovative business model and corporate culture that include an employee profit-sharing program and global expansion. In 2019, Delta Air Lines served nearly 200 million customers and was ranked the largest airline in the world by total revenues. Additionally, the airline was the most profitable, recording five consecutive years of $5 billion or more in pre-tax income (Delta Air Lines, 2020). This report provides a forensic financial analysis and corporate governance assessment of Delta Air Lines, Inc. at a time when the airline was experiencing tremendous growth and profitability.
Delta Air Lines is currently the most profitable airline given its pre-tax profits of at least $5 billion for the last five years. As an exceptional and trusted customer brand, Delta has an expansive global network through which it connects more than 200 million customers to over 300 destinations in over 50 countries (Delta Air Lines, 2020). The growth and profitability of the airline in recent years is attributable to its global standard in customer experience, service, and reliability. The airline was named one of Fortune's most admired companies in 2020 due to its consistent delivery of industry-leading results with unrivaled empathy and commitment to innovation. Delta has capitalized on its strong brand image to maintain strong financial performance and position over the last five years.
As evident in the company's 2020 Form 10-K Financial Statement, Delta Air Lines has two major business and operating segments: Airlines and Refinery. The Airline segment focuses on passenger and cargo services offered domestically and internationally, and also covers the maintenance and repair of third-party aircraft (Bush, 2016). The Refinery segment covers the refining and production of jet fuel; it is operated by Delta's subsidiaries Monroe Energy LLC and MIPC, LLC, and produces jet fuel, diesel, and gasoline. This segment also supplies jet fuel to Delta's aircraft at a lower cost compared to outsourcing, with the primary objective of supporting the Airline segment as a means of increasing the airline's overall profitability. The table below shows the financial information by segment for the year ending December 31, 2020.
Table 1: Segmented Data for Delta Air Lines for the Year Ended December 31, 2020 (in millions)
Airline: Operating revenue $15,945 | Refinery: $3,143 | Intersegment Sales/Other: ($214) (1), ($1,472) (2), ($307) (3) | Consolidated: $17,095
Operating loss: Airline ($12,253) | Refinery ($216) | Consolidated ($12,469)
Interest expense, net: Airline $928 | Refinery $1 | Consolidated $929
Depreciation and amortization: Airline $2,312 | Refinery $99 | Intersegment ($99) | Consolidated $2,312
Restructuring charges: Consolidated $8,219
Total assets, end of period: Airline $70,548 | Refinery $1,448 | Consolidated $71,996
Capital expenditures: Airline $1,879 | Refinery $20 | Consolidated $1,899
Source: Delta Air Lines 2020 Annual Report (NYSE: DAL)
Delta Air Lines has transformed its business strategy and approach over the last decade. During this period, the company has established a customer-focused operation with industry-leading products, service, reliability, and a strong financial position. However, certain factors in the firm's financial statements and risk management policies show vulnerability to SEC action — whether fraudulent or otherwise. Similarly, there are factors in corporate governance that represent potential weaknesses requiring mitigation through stronger governance policy.
As shown in the 2020 Form 10-K Financial Statement, Delta Air Lines holds a strong financial position in the market, evident in its consistent pre-tax income of $5 billion or more over the past five years. However, the onset of the COVID-19 pandemic had significant impacts on the aviation industry. Following the pandemic, the airline made substantial adjustments to its network and operations in response to travel restrictions and declining demand. These measures were initiated to safeguard both customers and the company's financial position. As the firm continues to make significant operational adjustments due to the pandemic and other market factors, it is important to ensure that its financial reporting standards and practices are not vulnerable to Securities and Exchange Commission (SEC) action.
DiPiazza and Eccles (2002) note that businesses face the need to develop an effective business-reporting model in order to build public trust. Financial reporting should embrace the spirit of transparency and performance auditing. This forensic financial analysis examines factors in the financial statements provided by Delta Air Lines and their potential vulnerability to SEC action. The assessment primarily focuses on identifying issues that could be buried in the airline's statements and associated notes, as well as information disclosed to the public. This information is provided as a preemptive risk mitigation action and includes recommendations.
As shown in the consolidated balance sheets for the year ending December 31, 2020, Delta Air Lines had total assets of $71,996 million — a $7,464 million increase from the prior fiscal year (Delta Air Lines, 2020). These assets can be divided into three major categories: Current Assets, Property, Plant and Equipment (PPE), and Other Assets. Similar to its main competitors, Delta's PPE accounts for a significant portion of total assets, followed by Other Assets and Current Assets. According to Bush (2016), current assets are typically low for airlines because of significant investments in PPE, which is an essential function of an airline. PPE accounts for the largest asset group because the aircraft and airport gates required to provide service are classified under this category.
Computing Delta Air Lines' financing requires an adjustment when comparing total liabilities with total equity. Bush (2016) notes that Total Stockholders' Equity would not be suitable for use in this scenario because of the firm's deficit in Retained Earnings. While Delta had no deficit in Retained Earnings for the year ending December 31, 2019, the deficit for the year ending December 31, 2020 implies the company had no income from stock in that fiscal year. Therefore, Paid-in Capital was compared with total liabilities to determine whether total liabilities or total equity handles the airline's financing.
As shown in the financial statements for the year ending December 31, 2020, Delta Air Lines carried higher amounts of liabilities compared to stock income — a trend evident in its financial performance over the past five years. Despite maintaining a strong financial position relative to industry rivals, the higher amounts of liabilities than stock income imply that Delta heavily relies on debt and loans to fund expenditures. This is a major risk, as it can put the company in debt and negatively impact its solvency ratios. Generally, organizations with a higher debt-to-equity ratio are at greater risk of compounding loan obligations and deteriorating solvency.
The company's vulnerability to negative solvency ratios — due to heavy reliance on debt and loans — could be a source of fraudulent financial reporting activity. Delta Air Lines faces the need to ensure that its financial reports accurately reflect this heavy reliance on debt. Failure to do so would constitute a material misstatement. Murphy (2020) states that companies need to acknowledge what they do not know and seek help to understand and mitigate fraud risks in financial reporting. For Delta, recognizing the reliance on debt and loans to finance expenditures is critical to providing an accurate picture of its financial position. By acknowledging this reliance, Delta would accurately demonstrate its vulnerability to negative solvency ratios — a major business risk. The current financial statements for the year ending December 31, 2020 do not provide a fully accurate picture of solvency ratios in relation to the firm's higher debt-to-equity ratio.
The second risk related to Delta Air Lines' asset composition and financing concerns potential asset fraud. According to Bush (2016), audit risks that are likely to occur in financial reporting and auditing are linked to three areas of the fraud triangle: pressure, opportunity, and rationalization. For Delta, assets represent a major audit risk because all three elements of the fraud triangle are present. Management may face pressure to inflate asset values in order to improve financial analysis data and increase shareholder value. This pressure stems from the company's current asset composition and its heavy reliance on debt and loans to finance expenditures.
As previously noted, PPE accounts for a significant portion of the company's total assets. Compared to the prior fiscal year, PPE values for the year ending December 31, 2020 decreased while Current Assets increased. Management could face pressure to inflate Current Assets — which include cash, short-term investments, cash equivalents, accounts receivable, and deferred income assets — in order to enhance solvency ratios. Similarly, PPE is vulnerable to audit risks or asset fraud because of its size and the estimation methods used in its computation.
The pressure to inflate asset amounts could be reinforced by the realization that asset values can be more easily manipulated than other line items. This is partly because Delta Air Lines values assets using predicted amounts rather than pre-determined values such as liabilities due (Bush, 2016). The airline does not employ absolute valuation methods but instead relies on relative valuation and comparable transactions. This creates an opening for the manipulation of asset values to artificially higher amounts — which could, in turn, constitute fraudulent activity warranting SEC action.
Assets also present a concrete opportunity for fraud because they are directly accessible to management. Since assets are the property of the firm, they can be misrepresented without obligating the company to serve another entity or make a payment to a third party. The absence of another party's involvement means Delta could act alone in committing asset fraud, reducing the likelihood of detection.
While there is no evidence of asset fraud in Delta's financial statements for the year ending December 31, 2020, assets remain vulnerable to audit risks. This vulnerability stems in part from a lack of clarity in inventory controls. The airline manages inventory on an origin-and-destination basis (Delta Air Lines, 2016) and has established a policy focused on preventing circumvention of inventory management controls, including disciplinary actions for agents who do so. However, the existing inventory controls lack clarity regarding measures specifically aimed at preventing asset fraud or audit risks. Therefore, the firm's risk management policies do not adequately address asset fraud in relation to existing inventory controls. Even though the firm has established an Inventory Circumvention Policy, the lack of clarity in inventory controls allows for audit risks — particularly asset fraud.
The third potential risk in Delta Air Lines' financial statements concerns the valuation of PPE, which accounts for over 40% of total assets. The financial values presented under this category may not accurately reflect what actually exists. There is no information in the financial statements or other reports issued by Delta Air Lines regarding the physical count of aircraft or the fair market value of each aircraft. Determination of fair market value should be made using current average sales prices, and the absence of such information means the financial values presented under PPE may not accurately reflect the company's holdings.
In addition to using current average sales prices, PPE estimation at Delta Air Lines involves calculating depreciation expense. The airline employs straight-line depreciation, which implies that the depreciation expense for each asset should be equal in each period (Bush, 2016). It is not clear to what extent Delta examines the historical useful life of all its assets, particularly within this asset group.
The likelihood of reporting figures that do not represent accurate financial valuations for PPE increases Delta's exposure to improper revenue recognition. Murphy (2020) identifies improper revenue recognition as one of the most common fraud areas in financial reporting, attributable to fictitious revenues, poor valuation, timing issues, and use of the percentage-of-completion method. For Delta, vulnerability to improper revenue recognition is directly tied to valuation issues related to PPE. The firm must ensure that financial valuations in this category reflect what actually exists and are grounded in accurate valuation measures.
"Internal controls and audit trails to address risks"
"Audit quality, whistleblowing, and risk management gaps"
"Proposed governance improvements and new committee"
Delta Air Lines is the most profitable airline with revenues of at least $5 billion in the past five years. The company's profitability and rise from the 2007 bankruptcy is attributable to sound business strategies and practices. Through its financial statements and other reports, Delta has demonstrated the measures it undertakes to continue promoting business success and profitability. However, forensic financial analysis reveals that the company could be vulnerable to SEC action due to a higher debt-to-equity ratio, the likelihood of asset fraud, and poor valuations of PPE. These issues can be addressed through a review of internal controls for financial reporting and the use of audit trails. With regard to corporate governance, Delta has weaknesses in the areas of whistleblowing policy, risk management, and audit quality. These weaknesses can be addressed through the creation of a whistleblower protection program, the establishment of a risk management committee, and a strengthened audit process.
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