Vessel impairment

What is the cash-generating unit for a vessel?

A vessel on a charter earns cash inflows that are largely independent of the owner's other vessels, so each vessel is normally its own cash-generating unit. Vessels may be grouped when their cash flows are genuinely interdependent: in a shipping pool, where earnings are shared, or under a contract of affreightment served by several vessels interchangeably. Owners do not group vessels simply because they are the same type. See cash-generating units.

What triggers a vessel impairment test?

The most common indicator is a fall in broker valuations below the vessel's carrying amount. Others include sustained falls in charter rates, a glut of newbuildings, the loss of a charter, damage or long off-hire, new environmental rules that make a vessel uncompetitive, and the company's market value falling below its net assets. Many owners obtain broker valuations for every vessel at each reporting date, partly because loan covenants require them, so the indicator is easy to see.

How is fair value less costs of disposal measured?

Usually from valuations by independent ship brokers, who estimate the price a willing buyer would pay for the vessel charter-free, based on recent sales of similar vessels adjusted for age, size, yard and specification. A vessel on a long charter at rates above or below the market is worth more or less than its charter-free value, and brokers or owners adjust for that. Costs of disposal, such as broker commissions, are deducted. In the example, a broker value of US$ 20 million less 1% costs gives 19.8 million.

Vessel impairment: a value in use calculation

A bulk carrier is carried at US$ 28 million and has 15 years of life left. It is on a time charter at 15,000 a day for 2 more years; after that, the owner assumes 14,500 a day, its estimate of rates over the cycle based on a long-term historical average for the vessel class. It expects 355 earning days a year, operating costs of 6,500 a day, dry-docks costing 1.5 million in years 5 and 10, and a scrap value of 4.8 million at the end. The pre-tax discount rate is 8%.

Value in use is higher than the broker value, as is common when the owner expects rates to recover from a weak market, so the vessel is written down to 23.9 million and depreciated from that amount over its remaining life. The impairment is recognised in profit or loss and disclosed with the key assumptions.

How sensitive is value in use?

Very. In the example, each US$ 1,000 a day lower in the assumed rate for unfixed days reduces value in use by about 2.4 million. Because the unfixed period is long, the rate assumption dominates the result, and IAS 36 requires it to reflect reasonable and supportable assumptions that give greater weight to external evidence. Using a ten-year average when recent rates are far lower, or ignoring the effect of environmental rules on older ships, are common challenges. Owners disclose the assumed rates and the change that would cause an impairment.

What about vessels to be sold and newbuildings?

When an owner decides to sell a vessel and the sale is highly probable within a year, the vessel is classified as held for sale under IFRS 5 and measured at the lower of carrying amount and fair value less costs to sell, so an agreed sale price below carrying amount causes an immediate write-down. Newbuilding contracts signed at prices above current market values are tested too: instalments already paid are part of vessels under construction, tested with the expected cash flows of the finished vessel, and a contract the owner cannot cancel may be onerous under IAS 37 if the cost to complete exceeds the benefits expected. See vessel components and depreciation.

Can a vessel impairment be reversed?

Yes. If the estimates used to determine recoverable amount improve, for example because charter rates and vessel values recover, the impairment is reversed, but only up to the carrying amount the vessel would have had after depreciation if no impairment had been recognised. Owners assess at each reporting date whether there is an indication that an earlier impairment no longer exists. See impairment reversals.

How does US GAAP differ?

Under ASC 360, a vessel is impaired only if its undiscounted cash flows are below its carrying amount, and then it is written down to fair value. Because undiscounted cash flows over a long remaining life usually exceed carrying amount, US GAAP owners record impairments less often, and they cannot reverse them. See IAS 36 vs US GAAP and shipping accounting.

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