Vessel components and depreciation

Why are vessels split into components?

IAS 16 requires each significant part of an asset with a different useful life to be depreciated separately. For a ship, the obvious parts are the hull and main machinery, which last as long as the vessel trades; the value of the vessel's survey and coating condition, which is used up by the next dry-dock; and major equipment fitted later, such as exhaust gas scrubbers, ballast water treatment systems or energy-saving devices. Without componentisation, dry-docking costs and retrofits would have no consistent place in the accounts. See component depreciation.

Vessel components: a new bulk carrier

An owner takes delivery of a new bulk carrier costing US$ 35 million. It has a lightweight tonnage, the weight of the ship itself, of 12,000 tonnes, and the current scrap price is US$ 400 per tonne, so its residual value is 4.8 million. The owner expects to trade it for 25 years and identifies 1.5 million of the cost as the dry-docking component, used up by the first special survey in year 5.

Componentisation adds 0.240 million a year of depreciation in the first five years. At the first special survey, the cost of the dry-dock is capitalised as the new component and depreciated until the next one, so the pattern repeats; for vessels older than 15 years, surveys and dry-docks come more often. See dry-docking costs.

How is the residual value set?

IAS 16 defines residual value as the amount the owner would get today for the asset if it were already of the age and condition expected at the end of its life. For most vessels, that is the scrap value: the lightweight tonnage multiplied by the scrap steel price, less costs of delivering the vessel to the recycling yard. If the scrap price fell from US$ 400 to 300 per tonne, the residual value would drop to 3.6 million and depreciation of the hull would rise by 0.048 million a year if the change applied from the start; in practice, the change is applied prospectively over the remaining life. Some owners use an average scrap price over several years to avoid volatility, and they need to show this is a reasonable estimate of current prices. Vessels expected to be sold in the second-hand market well before scrapping need a residual value based on expected resale value instead.

How is the useful life set?

Common useful lives are about 25 years for bulk carriers, tankers and container ships and longer for gas carriers, but the estimate is entity-specific. Charterers' preference for younger ships, tightening efficiency rules such as the IMO's carbon intensity indicator, and the EU Emissions Trading System can shorten the economic life of older, less efficient vessels, and owners review lives every year. A change in useful life is a change in estimate, applied prospectively.

How are scrubbers and other retrofits treated?

An exhaust gas scrubber fitted for US$ 2.5 million is capitalised as a separate component and depreciated over the shorter of its own useful life, say 15 years, and the vessel's remaining life, giving 0.167 million a year. Ballast water treatment systems are required by international rules for the vessel to keep trading; IAS 16 allows equipment acquired for safety or environmental reasons to be capitalised even though it does not increase the vessel's earnings directly, because without it the vessel could not earn anything. Energy-saving devices and engine modifications follow the same component logic.

How are newbuildings and second-hand vessels accounted for?

Instalments paid to a shipyard during construction are recognised as vessels under construction, together with supervision costs, and borrowing costs on financing for the newbuilding are capitalised under IAS 23, because a vessel is a qualifying asset. Depreciation starts on delivery. For a second-hand vessel, the owner identifies a dry-docking component based on the time to the vessel's next scheduled survey, and depreciates the hull over the remaining expected life to its residual value. Vessels bought with a charter attached may also need part of the price allocated to the charter's favourable or unfavourable terms.

How does US GAAP differ?

US GAAP permits but does not require component depreciation. Many shipping companies reporting under US GAAP depreciate vessels as a whole to a scrap-based residual value and account for dry-docking separately, typically by deferring the cost and amortising it to the next dry-dock. See shipping accounting and aircraft components, which follow the same logic for airlines.

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