Shipping-Accounting for Owned Vessels by Shipping Companies

8/11/2019 Shipping-Accounting for Owned Vessels by Shipping Companies

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1 IFRS for Shipping | Accounting for owned vessels by shipping companies

IFRS for Shipping

Accounting for owned vessels by

shipping companies

April 2011

Global Shipping & Ports Group




DeloitteAccounting for owned vessels by shipping companies

Contents Page

Forward 3

1. Introduction and Objective 4

2. Accounting Guidance 5

2.1 Vessel orders and options 5

2.2 Pre-delivery instalments ("PDIs") 6

2.3 Treatment of borrowing costs on PDI’s 8

2.4 Elements of the price calculation for a new vessel 9

2.5 Cost allocation and componentisation 10

2.6 Useful life, depreciation basis and residual value 11

2.7 Subsequent maintenance costs 13

2.8 Impairment 14

2.9 Assets held for disposal 16

2.10 Acquisition of vessels in the secondary market 17

3. Practical Examples 18

4. Differences from US GAAP and UK GAAP 23

5. Deloitte Shipping Team 25




Forward

I welcome you to our first of a series of publication focussing on accounting issues for the shipping

industry. This continues our focus at Deloitte to find ways to providing in-depth insights to financialaccountants working across the shipping industry. Vessel fixed asset accounting is a complex areafor all account preparers whether you are working under International Financial Reporting Standards(IFRS) or other generally accepted accounting principles.

This publication in our series seeks to provide details of the accounting principles involved withacquiring vessels. It also seeks to be a practical and pragmatic guide on how all of the complexrelated accounting rules need to be applied. The manual covers numerous examples, drawing onreal life examples of situations and circumstances that we have encountered over recent years underIFRS. We would be interested to hear from you if there are other commonly encountered issues thatyou believe we should consider in the future.

This publication is based on accounting standards currently on issue and effective under IFRS.There are currently a number of IFRS new standards and exposure drafts which are likely to changethe accounting over the coming five years; these are not within the scope of this publication.

I would like to take this opportunity of thanking Dina Karsas and Athena Kartsaklis who as part of ourshipping team have contributed significantly to the development of this publication.

So please enjoy and hope you find it useful.

George D. CambanisGlobal Shipping & Ports Leader




1. Introduction and ObjectiveThis publication addresses the accounting for owned vessels through their life cycle from purchase todisposal or scraping. It is primarily intended as a practical source of guidance for the industry. Itassumes a competent knowledge of IFRS, and some familiarity with the accounting aspects ofvessels.

The shipping industry has made substantial long-term capital investments in new ships. There aresignificant risks in these investments and the extent to which they are successfully managed has asubstantial impact on the long-term profitability of both owners and lessors. As a result it is importantto ensure that the exposure of entities to these risks, and their relative success in managing them, isproperly reflected in financial statements.

The purchase of vessels is not a simple matter, even when financing is available. Orders have to beplaced with the major shipyards well ahead of actual delivery. Significant time is put into negotiatingpricing, delivery conditions and on board equipment. As a result it is often difficult to determine howthe contract price compares with the deals obtained by others.

During their lives vessels require major maintenance and the replacement of key components.Owners spend substantial time managing these maintenance requirements to ensure the optimal

balance of operational efficiency while incurring the lowest possible dry-dock and special surveycosts. The extent to which they are effective in doing this will have a substantial impact on theirreported results.

Within the ship leasing market there is a significant divergence in the extent to which the lessor bearsthe risk of the vessel maintenance cost. Given the substantial sums involved, understanding themaintenance costs and the potential exposure of the lessor to them, is key to maximising value fromship leases and ultimately in the profitability of both the lessor and the owner involved.

Many ship owners do not intend to retain their vessels until they are scrapped. Depending on theirfleet policies the owners of ships, both lessors and owners, often take substantial risks on the marketvalue of their ships. A number of factors impact the value of an ship in the secondary market: themaintenance status of its key components, vessel prices in the secondary market and currencyfluctuations. There are also a number of ways in which exposure to vessel value risk can bemanaged and mitigated and there is a wide variation in the approaches adopted and theireffectiveness.

Accounting for ships is a complex area and we have therefore sought in this publication to providesome practical guidance. The guidance is written from an IFRS perspective. In section 4 we have setout the key differences between the IFRS treatment outlined in this manual and that under USGenerally Accepted Accounting Principles (US GAAP) or UK Generally Accepted AccountingPrinciples (UK GAAP).

When applying the suggested accounting treatments in this manual, the preparer of financialstatements must reflect on three issues:- materiality;- ensuring a full understanding of any related legal agreement, including all terms and conditions, of

the transaction; and- timing of recognition.

This publication is prepared based on our understanding of International Financial ReportingStandards (“IFRSs”) effective at the date of publication. The International Accounting StandardsBoard (“IASB”) has released a number of new standards and exposure drafts which will most likelychange the accounting over the coming five years; these are not within the scope of this manual.

This publication covers topics only in general terms and is intended to give a wide audience anoutline understanding of the issues in subject, and therefore cannot be relied on to cover specificsituations. Applications of the principles set out herein will depend on the particular circumstancesinvolved and do not form an appropriate substitute for considered specific advice tailored to yourcircumstances. We recommend that you obtain professional advice before acting or refraining fromacting on any of its contents. We would be pleased to advise you on the application of the principles

discussed in this publication and other matters tailored to your specific circumstances.




2. Accounting Guidance

2.1 Vessel orders and options

2.1.1 Background

Purchasers generally place orders for new vessels well ahead of delivery of the vessel itself. Theseorders are typically for a fixed price and provide a guaranteed slot in the delivery or productionqueue. These queues can stretch out over a number of years for many vessel types.

These purchase orders often have significant value for several reasons:

• The purchaser has obtained volume or other discounts from the shipyard which another shippingcompany cannot obtain.

• There is a shortage of available vessels in the secondary market.• There is a shortage of available construction slots for the desired delivery dates.

Purchasers often also obtain options for additional vessels when they place orders. These optionsalso guarantee the purchaser a fixed price and delivery slot for these additional vessels.Consequently, the options can have significant value.

2.1.2 Determination of accounting treatment

Orders for vessels are purchase commitments for non-financial assets and the amount payable isrequired to be disclosed in the financial statements under IFRSs.

Options over vessel are derivatives over non-financial assets and are therefore generally outside ofthe scope of IAS 39 Financial Instruments: Recognition and Measurement.

2.1.3 Application of accounting treatment

Typically, a purchaser would place an order or option with the shipyard and so there would not be anadditional cost to them outside the purchase cost of the vessel itself and any related commissions.

However, if the order or option has been purchased in the secondary market, the amount paid toacquire it should be held on balance sheet and treated as part of the purchase cost of the vesselitself. The purchased order or option would typically be classified as a prepayment and thereforewould not qualify to be held at fair value. It would normally be classified as a non-monetary item andtherefore not retranslated at each reporting date.





2.2 Pre-delivery instalments (“PDIs”)

2.2.1 Background

The purpose of pre-delivery instalments (“PDIs”) is to secure the purchaser’s place in the deliverytimetable for the vessel and to provide part of the finance for the construction of that vessel to theshipyard. They form part of the standard contractual terms of most major shipyards.

Under IFRS, it is necessary to consider what type of asset the PDI represents. Historically industrypractice has been to treat PDIs as property, plant and equipment, representing the cost of an assetunder construction for the purchaser specifically.


There are normally two possible ways of accounting for PDIs, which is accounting as part of the

vessel under construction or accounting as a prepayment for a future vessel acquisition. Theappropriate accounting treatment is likely to depend on the specific details of the arrangemententered into by the purchaser and shipyard and we have seen both approaches being adopted byshipping companies. However, under the terms of most current vessel delivery contracts with themajor shipyards the second of these options is likely to be the most appropriate. This is because it isdifficult to see why the item should be classified as a fixed asset when the ship owning entity has norights of ownership over the vessel at the time the PDI is paid.

1. Accounting as an asset representing the vessel itself which is under construction

In order for an asset to be included within property, plant and equipment, it must meet the definitionof property, plant and equipment under IAS 16 Property, Plant and Equipment. Property, plant andequipment are tangible items that:

(a) are held for use in the production or supply of goods or services, for rental to others, or foradministrative purposes; and

(b) are expected to be used during more than one period. [IAS 16.6]

PDIs may meet the definition of property, plant and equipment if the payments made represent thepart payment towards an asset in the course of construction by the shipyard for the purchaser: inother words, if in substance ownership of the underlying asset already rests with the purchaser and itis being constructed by another party on the purchaser’s behalf.

There is no specific guidance in IFRSs on when it is appropriate to regard a vessel that is beingconstructed as an asset of the purchaser, rather than an asset of the seller. However, we considerthat the principles in IFRIC 15 Agreements for the Construction of Real Estate could be considered

relevant on this point. IFRIC 15 provides guidance on when revenue should be recognised bycompanies engaged in the construction of real estate and we believe its principles are inherentlyrelevant for PDI accounting. Applying this guidance to vessels it would be necessary to considerwhether the buyer is able to specify the major elements of the design of the vessel to such a degreethat the asset is specific to that customer rather than being a generic product that could be sold to anumber of customers.

We do not believe that the terms of many PDI payments would meet these criteria for the ownershipof a portion of the underlying asset to have been transferred to the purchaser on payment of the PDI.We note that the financing of PDIs is a continued area of difficulty for the industry, partially due to thefact they do not provide security over the underlying asset in the event of a default by the shippingcompany. IFRIC 15 is relatively new guidance that does not directly apply to the shipping industry,and therefore we believe that it remains acceptable for the industry to continue to adopt the approachof capitalising PDIs as assets under construction. However this approach may need furtherconsideration in light of ongoing changes in IFRSs in this area.





2.2 Pre-delivery instalments (PDIs)

2. Accounting as a prepayment in respect of the future acquisition of the vessel

As discussed in 1. above, the ownership of the vessel is unlikely to transfer to the purchaser until thepoint of delivery. If this is the case, then the pre-delivery payments could be recorded asprepayments towards the future purchase of an asset. Because of the inherent difficulties outlinedabove under the above option 1., it is likely that this accounting treatment is the most appropriatebased on the terms of the various PDI arrangements we have seen.


1. Treatment as an asset representing the vessel itself which is under construction

As the vessel is constructed the cost of the work undertaken should be accrued for by the entity it isbeing constructed for using appropriate exchange rates as the work is accrued. Alternatively, wherethe timing of the PDIs materially matches the timing and value of the work undertaken, it may beappropriate simply to capitalise these. However, both these approaches will require a detailedunderstanding of what work is being done and the value of this. Such information is normallyavailable to parties purchasing vessels via the on site supervision of the construction of the vessel byrepresentatives of the shipping company.

As assets in the course of construction are non-monetary in nature they should not be retranslated ateach year end. [IAS 21.23]

No depreciation should be provided on the PDIs until the vessel is ready for use, i.e. until it isdelivered. [IAS 16.55]

The payment should be recorded within property, plant and equipment. Where the aggregate amountof PDIs is material they should be shown separately under a heading such as “Vessels underconstruction”, or “Advances for vessel constructions” rather than in one of the other classes ofProperty, Plant and Equipment. [IAS 16.74b]

2. Treatment as a prepayment in respect of the future acquisition of the vessel

PDIs made in a foreign currency should be recorded on initial recognition in the entity’s functionalcurrency, translated from the foreign currency at the actual exchange rate on the date that thepayment is made, assuming no hedging is in place. [IAS 21.21]

As prepayments are a non-monetary asset they should not be retranslated at each year end date.

[IAS 21.23]

As discussed above, there will often be a significant financing element affecting the amount of such aprepayment. In such cases, even though a prepayment is not a financial asset, we believe it will beappropriate to reflect the implicit financing by unwinding the financing discount over time (if material),using the discount rate implicit in the original transaction.

The amount paid will be recorded as a prepayment within non-current assets. Upon delivery of thevessel the balance should be included as part of the cost of the asset within Property, Plant andEquipment.





2.3 Treatment of borrowing costs on PDIs

2.3.1 Background

From periods beginning on or after 1 January 2009, a revised version of IAS 23 Borrowing Costs hasbeen effective. This revision stipulates that it is mandatory to capitalise borrowing costs that aredirectly attributable to the acquisition, construction or production of a “qualifying asset”. A qualifyingasset is one that necessarily takes a substantial period to get ready for its intended use or sale. Otherborrowing costs continue to be recognised as an expense. Under the previous standard thisapproach was one of the allowed alternative treatments for borrowing costs related to a qualifyingasset.


This accounting treatment can only be applied where the company has a qualifying asset in which tocapitalise borrowing costs. This will be the case where the PDI is accounted for as an asset in thecourse of construction as discussed in section 2.2. Where an entity is accounting for the PDI as a

prepayment, this would not be considered a qualifying asset under IAS 23. However, there may bean inherent financing element to the prepayment, and in which case the unwinding of the financingelement would cause the underlying prepayment asset to be increased over time, as described insection 2.2.and that would likely have the same effect as the capitalisation of the interest expense.

2.3.3 Application of accounting treatment under the revised IAS 23

The borrowing costs may include:

• Interest expense calculated using the effective interest method;• Finance charges in respect of finance leases; and• Exchange differences arising from foreign currency borrowings to the extent that they are

regarded as an adjustment to interest costs. [IAS23.6]

The capitalisation of borrowing costs should commence when the PDI is made, providing thefollowing criteria are being met:

• Expenditure for the asset is being incurred;• Borrowing costs are being incurred; and• Activities that are necessary to prepare the asset for its intended use or sale are in progress. [IAS

23.17]

Capitalisation should cease when the vessel is substantially complete. [IAS 23.20] Note that if thereare prolonged periods of suspension of active development of the vessel, capitalisation of theborrowing costs should be suspended for that period. [IAS 23.21]

To the extent that the purchaser borrows funds specifically for the purpose of obtaining a qualifying

asset (i.e. the vessel), the purchaser should determine the amount of borrowing costs eligible forcapitalisation. These will be the actual borrowing costs incurred on that borrowing during the periodless any investment income on the temporary investment of those borrowings. [IAS 23.12]

To the extent that the purchaser borrows funds generally and uses them for the purpose of obtaininga qualifying asset (i.e. PDIs), the purchaser should determine the amount of borrowing costs eligiblefor capitalisation by applying a capitalisation rate to the expenditures on that asset. The capitalisationrate should be the weighted average of the borrowing costs applicable to the borrowings of thepurchaser that are outstanding during the period, other than borrowings made specifically for thepurpose of obtaining a qualifying asset. The amount of borrowing costs that the purchasercapitalises during a period should not exceed the amount of borrowing costs it incurred during thatperiod. [IAS 23.14]

With respect to disclosure, the purchaser should disclose the amount of borrowing costs capitalisedin the period and the capitalisation rate used to determine the amount of borrowing costs eligible forcapitalisation. [IAS 23.26]





2.4 Elements of the price calculation for a new vessel

2.4.1 Background

A vessel price is agreed via contractual terms often years in advance. There are generally differentarrangements where the vessel is delivered either early or late. Consequently, it is important for thepreparer of financial statements to understand the precise terms of the contract.


IAS 16 requires the total cost of each asset being acquired to be determined. Once this has beencalculated this total value can then be used as the starting point from which to determine individualcomponent values. The determination of component values is set out in section 2.5 below.

2.4.3 Application of this accounting treatment

The total cost of the newly constructed vessel should therefore be determined by aggregating all ofthe following items where they have been incurred and are material:

• The total net cash paid to the shipyard in respect of all items. [IAS 16.6];• Any capitalised borrowing costs or finance charges accrued as a result of making PDIs to the

shipyard;• Vessel registration and certifications;• Seaworthiness certificates;• Legal costs and other related professional fees which are directly associated with the purchase of

the vessel;• Amounts paid to acquire purchase options in respect of the vessel; and• Any other costs directly attributable to bringing the vessel to the location and condition necessary

for it to be capable of operating in the manner intended by management. For instance, this mayinclude the costs of lubricants and bunkers consumed prior to delivery for example during the seatrials, supervision costs incurred during the construction period.

The net cash paid for the vessel will be the aggregate of the PDIs and the balancing payment made.Where the PDIs are denominated in a foreign currency and as they are non-monetary items (seesection 2.2) each of these payments will be held on balance sheet at the historic rate on the date thepayment was made. The net cash paid for the vessel will therefore consist of a weighted averageblend of the exchange rates prevailing at the date of payments.





2.5 Cost allocation and componentisation

2.5.1 Background

Vessels may have a number of components which require either replacement or major overhaul atintervals during the vessel’s operational life cycle. The frequency of the work is usually determined inaccordance with the rules and regulations of the vessel’s classification society on the basis of thetime period since the last work was undertaken. Unplanned events can arise when vessel experiencetechnical problems and as a result major overhauls and repairs arise on an unplanned basis.


IAS 16 requires that “Each part of an item of property, plant and equipment with a cost that issignificant in relation to the total cost of the item shall be depreciated separately”. [IAS 16.43]

However, the standard also allows that if the useful life and depreciation method of two componentsare materially the same they may be grouped together. [IAS 16.45]

Components of vessel that should be separately identified include not only the physical items that willrequire replacement during the life of the vessel, but also the notional overhaul element for items thatrequire major overhaul in the future, , during the life of the vessel.


Example 1 in section 3 illustrates the depreciation of separate components of a vessel.

We have seen most dry-bulk, tanker and container companies identify two groups of components.

• Cost of major overhaul or dry-docking.• Cost of the vessel excluding projected dry-docking.

The fair value of each of these components should be identified at the date of acquisition of thevessel. Prices for each of these individual components are often not specified in the purchaseagreement for the vessel. It will therefore be necessary to estimate the fair value of the dry-dockingcomponent taking into account the vessel’s last and next scheduled dry-docking. The fair value couldbe estimated by obtaining values from other sources such as the shipyard(s), in-house specialists,the maintenance providers or independent vessel appraisers. The fair value will be the actual value atwhich the entity is able to obtain these components, including any discounts from list price it receivesfrom the component or service provider. Other vessel types, such as cruise ships or ferries, willgenerally also have hotel type components which are expected to be replaced at regular intervals.

A vessel will require seaworthiness checks, under water inspections, intermediate surveys as well asspecial surveys throughout its useful economic life. An asset should be carved out from the mainvessel asset for each type of these checks. In practice, only the dry-docking and special surveychecks will be sufficiently material to warrant separate capitalisation. For instance, a tanker mayrequire a special survey every 5 years and an intermediate survey in between. Separate assets foreach of these should be created when the initial componentisation of the vessel is done, if expectedto be material.

Typically a new vessel will be assumed to be supplied with each of these components “brand new”.In other words the vessel will be assumed to be in the condition that it would be had it just beenthrough each of the checks and overhauls required so that the full cost of each of these will be carvedout as separate components in the initial allocation.

Depending on whether there are any PDIs and how the cost of the vessel is recorded in the books,as described in sections 2.2 and 2.4, the elements of the cost may be recorded at different exchangerates. For the purposes of the componentisation it would be appropriate to translate all thecomponents at the same rate on initial recognition based on the blended average rates used for the

amounts paid for the vessel. Subsequent expenditure on maintenance which is capitalised should betranslated at the appropriate rate when it is incurred.





2.6 Useful life, depreciation basis and residual value

2.6.1 Background

Vessel owners will all have different intentions about how they intend to use their vessel, how longthey intend to keep them and how they intend to dispose of them. These choices will have asignificant impact on the value which they are able to obtain from each vessel over its lifetime. Howthe depreciation charge is determined needs to reflect these choices in order to reflect the differencesin the way vessels are managed between businesses.


Useful life

Useful life is the period over which an asset is expected to be available for use by an entity.

Vessel hull and engine

The vessel hull and engine component will be depreciated over their useful life to their residual value.Because it is often not possible to replace the engines prior to disposal of the vessel the engine willhave the same useful life as the hull. The useful life will not change unless there is a change in theintended period of ownership of the vessel. Maintenance of the vessel should have no impact on thedepreciation of the vessel hull and engine component.

Some examples of estimated useful lives we have typically seen in practice are:

- container vessels: 25 - 30 years- dry-bulk vessels: 25 - 28 years

- tanker vessels: 25 years

Dry-docking component

The dry-docking component of a vessel will be amortized to the date of the next expected dry-docking. If the new dry-docking is performed prior to the initial expected dry-docking date, the usefullife should be adjusted prospectively as a change in estimate.

Depreciation basis

IAS 16 does not specify which approach should be used to allocate depreciation between periods.The approach of using a straight line basis has the benefit of simplicity and is used by many vesselowners.

Residual value

The residual value of an asset is the estimated amount that an entity would currently obtain fromdisposal of the asset, after deducting the estimated costs of disposal, if the asset were already of theage and in the condition expected at the end of its useful life. [IAS 16.6]





2.6 Useful life, depreciation basis and residual value

2.6.2 Determination of accounting treatment - Continued

Changes to estimates

The judgements made for useful lives and residual values should be revisited at each reporting dateor at least annually. Material changes in the policy covering ownership of vessel will need to bereflected in such judgements.

Where the estimated useful life or estimated residual value for a vessel change for any reason, thischange should be accounted for prospectively. [IAS 16.51] In other words if the estimated residualvalue of a vessel falls, the additional depreciation charge should be spread over the remaining usefullife of the vessel, without any catch up charge for the vessel’s life to date.


Depreciation basis

Finance teams require access to special survey and dry-docking data including the next expecteddry- docking date, in order to calculate the depreciation charge for the dry-docking component.

Residual value

The residual value of the dry-docking component is typically assumed to be zero as they will be fullyreplaced when the next relevant overhaul is undertaken. It is not usually possible to determine theresidual value of a maintenance component part way through its life. A common approach istherefore to assume that the residual value is determined by reference to the original cost and

reduces over time in line with the chosen depreciation method, assuming there is no evidence to thecontrary. The net book value on the date of disposal is assumed to be its residual value.

To determine the residual value of a vessel it is normally necessary to obtain the light weight tons ofthe steel within the vessel and an appropriate rate for the steel scrapping value. In practice, anaverage market steel value is often used to compute the scrap value.

The residual value should be stated net of anticipated costs to scrap the vessel. This will be unique toeach owner and will depend on factors such as where the owner intends to scrap the vessel. Inaddition to the steel scrap value, there may be other costs to consider such as costs to arrive at thescrap yard or commissions.

By choosing to dispose of a vessel significantly before the end of its life an owner is taking a

substantial economic risk on the residual value of the vessel and this is reflected in the potentialvolatility in the depreciation charge. The commercial rationale for such accounting is limited to thefact that owning the vessel will always give the shipping company or lessor a valuation riskconcerning the value of the vessel at the date of disposal. The accounting principles require that thisrisk is effectively re-measured at each balance sheet date based on the latest market value data. IAS16 is very clear in its definition of residual value that preparers of accounts should not take the ‘long-term’ view of value but specifically reflect the change in value through the depreciation charge ateach reporting date.





2.7 Subsequent maintenance costs

2.7.1 Background

During a vessel’s useful life three types of maintenance work will be undertaken:

- Planned major maintenance work;- Unplanned or emergency major maintenance work; and- Day to day maintenance work.


An entity does not recognise in the carrying amount of an item of property, plant and equipment thecosts of the day-to-day servicing of the item. [IAS 16.12]

An entity recognises in the carrying amount of an item of property, plant and equipment the cost ofreplacing parts of such an item when that cost is incurred if the recognition criteria are met, [IAS16.13] and the amount in itself is deemed to be material.

The accounting treatment for unplanned maintenance work depends upon the work undertaken. If itreplaces a component which has been separately identified for depreciation purposes and thereforefully restores this previously partially depreciated component then it will be accounted for as areplacement of that component.

If the unplanned maintenance work replaces a component which has not previously been depreciatedseparately, then it should accounted for the disposal of the existing component anyway.

All day to day maintenance work which does not materially enhance the asset will be expensed as

incurred.


It is likely that the cost of major planned maintenance will increase over the life of a vessel due toinflation and the age of the vessel. This additional cost will be capitalised when incurred and thereforethe depreciation charge on these components will be greater in the later stages of a vessel’s life.

When major planned maintenance work is undertaken the cost should be capitalised. For instancewhen an engine overhaul is undertaken the cost of the overhaul will be capitalised as a new assetthat will then be depreciated over the period to the next overhaul. The depreciation of the previousoverhaul will typically have been calculated such that it had a net book value of nil when the currentoverhaul was undertaken. If this was not the case, e.g. because the work was required earlier than

expected, then any remaining net book value of the old component should be expensed immediately.[IAS 16.14]

The initial carve out of components should include all major maintenance events which are likely tooccur over the currently adopted useful life of the vessel. Sometimes, it may subsequently be foundthat the initial allocation was insufficiently detailed, in that not all components were identified. In thissituation it is necessary to determine what the net book value of the component would currently behad it been initially identified. This will sometimes require the initial cost to be determined byreference to the replacement cost and the associated accumulated depreciation charge determinedusing the rate used for the residual hull. This is likely to leave a significant net book value in thecomponent being replaced which will need to be written off at the time the replacement is capitalised.[IAS 16.14]





2.8 Impairment

2.8.1 Background

Vessels often have volatile values. These vessels values depend on numerous macro economicfactors such as world trade requirements, demand for raw materials and finished goods by industrialsocieties and the supply of vessels available to meet the demand.


If, and only if, the recoverable amount of an asset is less than its carrying amount, the carryingamount of the asset shall be reduced to its recoverable amount. [IAS 36.59]

The recoverable amount of an asset or a cash-generating unit is the higher of its fair value less coststo sell and its value in use. [IAS 36.6]

If there is any indication that an asset may be impaired, a recoverable amount shall be determined forthe individual asset. If it is not possible to estimate the recoverable amount of the individual asset, anentity shall determine the recoverable amount of the cash-generating unit to which the asset belongs(the asset's cash-generating unit). [IAS 36.66]


For accounting purposes it is not normally possible to determine impairment of a particular vesselcomponent separately from that of the other components of that vessel unless there has beenspecific physical damage to that component. An individual vessel may be considered as an individualcash generating unit which can be assessed for impairment. However, where vessels are operatedas a fleet, for instance with individual vessels being inter-changeable in accordance with the charter

party or contract of affreightment, it may be more appropriate to consider each fleet as a cashgenerating unit.

Determination of fair value

There is significant volatility in market prices for vessels generally. While it is relatively easy toforecast vessel supply, based on production rates of the major shipyards, demand is directly linked towider economic conditions. There is therefore cyclicality in vessel prices.

There is also significant volatility in demand for particular vessel types. This will depend upon factorssuch as the availability of substitutes or the development of new vessels in that class, the liquidity ofthe market in that type of vessel and the fortunes of particular market segments. Brokers can providevessel values by reference to transactions of which they are aware and where there are no

transactions for a particular model of vessel they will normally extrapolate a value from transactionsfor similar types of vessel. In such situations it is important to understand the judgements involvedand, if necessary, obtain a second independent valuation.

Unless they have undertaken a physical inspection of the vessel, brokers normally provide a valuebased on historical sales and purchase data of similar vessels. Where this is used to determine thefair value for accounting purposes it will be necessary to take into account the actual maintenancecondition of the vessel and adjust the brokers’ value accordingly. Where this is considered to bematerial it may be necessary to arrange a physical inspection of the vessel. The maintenanceadjusted market value should then be used in the impairment review of the entire vessel, includingthe separately capitalised and depreciated components.





2.8 Impairment

Finally, for entities whose functional currency is not US Dollars there is also exposure to exchange

rates as the large majority of vessel transactions are conducted in US Dollars. The spot exchangerate on the date of the impairment assessment should be used for the purposes of determining thecurrent resale price.

Determination of costs to sell

If a ship-owner decides to sell a vessel, the vessel may require substantial marketing. This can beundertaken either in house, if there is the appropriate expertise, or outsourced to a broker.

Determination of value in use

Shipping companies typically have robust estimates of the daily costs of operating a particular vesselwhich can be used as the basis for a cash flow projection for a value in use calculation. However,allowances should be made in the model for volatile costs, with reasonable estimates made of likelyprice increases and a sensitivity analysis undertaken.

In addition revenue estimates, have significant potential volatility, with significant exposure to bothgeneral economic conditions and unforeseen events. Reasonable revenue estimates shouldtherefore be made and sensitivities considered.

For lessors future cash flows are normally more predictable, although estimates will need to be madewhere future cash flows are dependent upon extending an existing charter or entering into newcharter agreements. These estimates should be based on what management consider to be the mostprobable likely outcome.

A suitable discount rate should also be determined, which takes into account the significant risks towhich the shipping industry in general is exposed and those affecting the particular vessel.





2.9 Assets held for disposal

2.9.1 Background

When vessels are to be sold, and the criteria in IFRS 5, Non-current assets held for sale anddiscontinued operations, are met, the vessels are reclassified on the balance sheet as held for saleassets. The vessel may still be operated while in this category, as long as they are available forimmediate sale and being actively marketed, resulting in revenues with no associated depreciationcharge on the vessel.


Classification to and from held for sale assets

Where a decision is made to dispose of a vessel currently held, the shipping company will need to be

reasonably certain of being able to dispose of them within the coming year, in the current marketconditions, for them to be classified as held for sale assets.

Where vessels have previously been classified as held for sale but have not been sold within oneyear of the classification, IFRS 5.B1 (c) contains specific requirements if the vessels are to continueto be classified as held for sale. We note that the used vessel market has been volatile in recentyears and the decision to dispose of vessels will need to take account of short term liquidityconsiderations as well as the current market prices of vessels. Furthermore, in the current marketconditions potential purchasers of the vessel may not be able to find the necessary finance.

Whilst it is permitted for vessels to be included in the category of assets held for sale while thevessels are being used, in the event that they cease to qualify as held for sale a reclassification tofixed assets would be required, with an adjustment to the net book value to account for the

depreciation that would have been charged on the assets, had they not been reclassified to held forsale assets.

Accounting treatment upon classification to held for sale

Once an asset is classified as held for sale, depreciation should cease on the asset and it should bereclassified to held for sale assets (in current assets) at the lower of the carrying amount and fairvalue less costs to sell. Subsequently, the held for sale asset should be re-measured to the lower ofthese amounts at each period end, by comparing the carrying amount to the fair value less costs tosell. The fair value less costs to sell should be measured in the sale currency of the likely disposalcontract (usually US$), taking account of the period end exchange rate.

Accounting treatment for subsequent expenditure

Where subsequent expenditure on a vessel improves its marketability or sale price this should becapitalised into the carrying value of the held for sale asset. The new carrying value of the vesselshould be compared with the new fair value less costs to sell, and written down to the latter if lower,with any reduction in the carrying value being taken to the income statement. In addition, ifsubsequent expenditure does not meet the definition of an asset it should be expensed.


Note that where a vessel classified as held for sale is still being used, there is an effectivedepreciation “saving” on the vessel compared with the vessels which remain in fixed assets.





2.10 Acquisition of vessels in the secondary market

2.10.1 Background

Many shipping company and lessors buy vessels in the secondary market. This raises a different setof accounting issues from buying a new vessel. The purchaser must consider how to account forrelated professional costs, and certain ongoing lease conditions when they arise, such as afavourable or unfavourable attached time charter.


Professional costs

IAS 16 stipulates that directly attributable costs should be included in the recorded cost of the vessel[IAS 16.16]. These may include related professional fees incurred on an incremental basis. These

are often more significant for the purchaser of a vessel in the secondary market as they are borneprimarily by the shipyard when buying a new vessel. It should be noted however that those feesincurred whilst searching for a suitable vessel are not directly attributable to a specific asset andshould therefore be expensed as incurred.

Lease conditions

IFRS does not specifically address how to account for favourable or unfavourable attached timecharters acquired with the vessel. However, IAS 16.44 provides some guidance indicating that if anentity that acquires property, plant and equipment subject to an operating lease in which it is thelessor, it may be appropriate to depreciate separately amounts reflected in the cost of that item thatare attributable to favourable or unfavourable lease terms relative to market terms [IAS 16.44]. Byapplying this guidance, if the purchaser obtains a vessel with a favourable attached time charter, the

element of the purchase price that relates to the time charter would be capitalised separately anddepreciated over the period that the shipping company will benefit from these favourable charter hirerates. Conversely, if there are unfavourable attached charter hire terms, this accounting will have theeffect of reducing the purchase price of the vessel. However, in the absence of explicit guidanceunder IFRS, practice may be mixed on the accounting for favourable or unfavourable attached timecharters acquired with the vessel, and we have seen companies present the element of the purchaseprice that relates to favourable or unfavourable attached time charter as an intangible or a liability,respectively, which is amortised over the remaining period of the charter agreement into revenue.


The application of the above accounting policies will mean that the vessel is recorded at its cost in

accordance with IAS 16.




3. Practical Examples

Example 1 – Component depreciation

In the example below for simplicity we have assumed a vessel which has only two components

identified which it has purchased – a vessel excluding the dry-dock component and a dry-dockoverhaul component. As described in section 2.5.3 depending on the vessel type there could be anumber of other major components to be separately identified and depreciated.

An entity purchases a ship for CU40 million. This ship will be required to undergo a dry-dock (“DD”)overhaul every five years to restore its service potential. At the time of purchase, the service potentialthat will be required to be restored by the overhaul can be measured based on the cost of the dry-docking if it had been performed at the time of the purchase of the ship, e.g. CU4 million.

The following shows the calculation of the depreciation of the ship for Years 1 to 5, using the straight-line method.

Amount $ ‘000 Useful li fe (years )

Cost of vessel 40,000

Comprising:

- the vessel, excluding the DD 36,000 30

- the projected dry-docking 4,000 5

For years 1-5 depreciation charges p.a. are:

- the vessel, excluding the DD 1,200

- the projected dry-docking 800

By the end of Year 5, the service potential would be fully depreciated. When a dry-docking is carriedout in Year 6, the expenditure is capitalised to reflect the restoration of service potential, which is thendepreciated over the period to the next overhaul in Years 6 to 10.

The process in Years 6 to 10 repeats every five years from Year 11 onwards until Year 30, when bothship and the cost of dry-docking are fully depreciated and a new ship is acquired.

Note that the entity is required to use its best efforts to identify separately components such as theDD component when the asset is first acquired or constructed. That separate identification, and thesubsequent separate depreciation of the DDl component, is not, however, a necessary condition forthe capitalisation of the subsequent expenditure on the overhaul as part of the cost of the asset.

If, in the example above, the entity had failed to identify the DD component at the date of acquisitionbecause it was not considered significant, and had not depreciated that component separately duringYears 1 to 5, the expenditure on the overhaul in Year 6 would still be capitalised as part of the cost ofthe asset, provided that the general recognition criteria were met. In this circumstance, the entitywould be required to estimate the remaining carrying amount of the DD component at the date of thefirst overhaul (which would be approximately CU3.33 million, i.e. CU4 million depreciated for 5 yearsout of 30), and to derecognise that carrying amount at the same time as the expenditure on theoverhaul is capitalised.





Example 2 – Vessel held for sale

During October 2010 Poseidonos Shipping Company decided to sell one of its vessels. The

Company obtained approval from its directors during October 2010, and started looking for a buyer.Also during October 2010, the Company started to actively market the vessel – contacting brokers,started negotiating sales price, etc.

During December 2010, the Company entered into a Memorandum of Agreement (MOA) with anunrelated party to sell vessel A, with a NBV of $60 million, for $41 million (including approximately $1million of costs to sell), which will approximate to a $20 million loss.

Also consider the following two different scenarios:

A. Vessel A is on a time charter (TC) with Charterer X until July 2013. The charter partyagreement prohibits that vessel A, then on a time charter with Charterer X would not be solduntil January 20, 2011, or later until completion of the trip that had already been arranged by

the Charterer.

B. During October 2010 vessel A was on a TC with Charterer X. The Charter Party allows theowners of the vessel to sell the vessel to a third party and the Charterers cannotunreasonably refuse this sale.

Criteria Action taken Case A Case B

Available for immediate sale inits present condition

Case A: the sale restriction in theCP agreement means the vessel isnot available for immediate sale.

Case B: the vessel is available for

immediate sale as the transfer ofownership is not restricted. This iscustomary in the shipping industry.

× √

The sale must be highlyprobable.

Commitment to sell the vesselThe Company obtained approvalfrom its directors to sell the vessel.

√ √

Actively seeking to locate buyerDuring October 2010, the Companystarted to actively market thevessel.

√ √

Sale probable within 1 year

During December 2010 theCompany signed an MOA with anunrelated party for a price of $40million.

√ √

Reasonable price Refer above. √ √

Case A Case B

Vessel will be classified as asset held andused as of December 31, 2010.

Vessel will be classified as asset held for sale asof December 31, 2010.





Example 3 – Borrowing Costs

Poseidon Shipping Company entered into a contract with a shipyard on July 1, 2010 for the

construction and purchase of two Panamax vessels. The contract price was $50 million per vessel,with a scheduled delivery date of December 1, 2011. The payment terms are as follows:

Timing Date Percentage Amount

Upon entering into agreement July 1, 2010 10% contract $10 million

Steel cutting December 1, 2010 40% contract $40 million

Keel laying-Launching February 1, 2011 15% contract $15 million

Delivery December 1, 2011 35% contract $35 million

Total $100 mill ion

We assume that construction activities commence upon payment of 1st installment.

Poseidon Shipping has the following outstanding debt:

- Directly related to the vessels: bank loan at variable rate (Libor+margin) to cover 70% of thecost of the vessels. Interest due quarterly, beginning on date of first draw. For 2010, weassume that the variable loan rate was 5% throughout the year.

General corporate debt: weighted average interest rate of 4.5%

Poseidon also incurred the following other costs in 2010:

Description Amount

Construction related costs, supervision, travel, vessel inspection, site team $50,000

Broker’s commission (4% of construction value due up front) $4,000,000

Legal fees to establish the title of vessel owning companies $5,000

Office overhead (general and administrative) and other expenses $4,000

Total $4,059,000





Example 3 – Borrowing Costs - Continued

Step 1: Identifying vessel acquisition costs to capitalize for year ended December 31,2 010

• Installment payments to shipyards.• Indirect costs related to construction (supervision costs etc).• Broker’s commissions.• Legal fees.• Direct interest expenses.• Indirect interest expenses.

Description Amount tocapitalize

Construction related costs, supervision, travel, vessel inspection, site team $50,000

Broker’s commission (4% of construction value due up front) $4,000,000

Legal fees to establish the title of vessel owning companies $5,000

Office overhead (general and administrative) and other expenses -

Total capitalizable expenses $4,055,000

Step 2: Identify expenditures eligible for interest capitalization IAS 23

Eligible expenditures include capitalized expenditures (net of progress payment collections) for thequalifying asset that have required the payment of cash, the transfer of other assets, or the incurringof a liability on which interest is recognized.

Description Amount

Installment payment, financed through bank loans (70%) $70,000,000

Installment payments, financed from equity (30%) $30,000,000

Other capitalized costs (initial expenses), financed from equity $4,055,000

Total $104,055,000

Step 3: Calculate the appropriate capitalization rate

The most appropriate rate to use as the capitalization rate is the rate applicable to specific new debtresulting from the need to finance the acquired assets.

• Specific borrowings: Average eligible capitalized expenditures x interest rate on specificborrowings.

• If there is no specific new debt, the capitalization rate is a weighted-average of the rates ofthe other borrowings of the entity

• Other borrowings: Average eligible capitalized expenditures x weighted average rates ofborrowings.





Example 3 – Borrowing Costs - Continued

Step 4: Calculate capitalized interest as of December 31, 2010

Description Calculation Amount

Interest on 1s

$ 7,000,000*5%*6/12installment payment, financed

through bank loans$175,000

Interest on 2nd

$28,000,000*5%*1/12installment payment, financed

through bank loans$116,667

Interest on 1s

$ 3,000,000*4.5%*6/12installment payment, financed

from equity$67,500

Interest on 2n

$12,000,000*4.5%*1/12installment payment, financed

from equity$45,000

Interest on indirect costs (*) $ 4,055,000*4.5%*6/12 $91,238

Total $495,405

(*) Indirect costs were assumed to be incurred on July 1, 2010, as they related to the brokers’commissions and other costs due up-front.

Step 5: Calculate total capitalized costs as of December 31, 2010

Description Amount

Installment payments $50,000,000

Capitalized expenses $4,055,000

Capitalized interest $495,405

Total $54,550,405




4 Differences from US GAAP and UK GAAP

Many of the key principles outlined in this manual are also applicable under UK GAAP. However,there are some key areas of difference which we have outlined below. These differences are notintended to be exhaustive and individual circumstances should be considered carefully.

Area IFRStreatment

UK GAAPtreatment

US GAAPTreatment

VesselRecognition Basis

Cost or revaluationbasis permitted.

Cost or revaluationbasis permitted.

Cost basis must beused. Revaluationbasis is prohibited.

AssetDepreciation

IFRS requires acomponent approachfor depreciation whereassets must beseparated into

significant individualcomponents anddepreciated over theiruseful lives.

UK GAAP requires acomponent approachfor depreciation whereassets must beseparated into

significant individualcomponents anddepreciated over theiruseful lives.

Component accountingis permitted, but notrequired.

Major Maintenance/ Overhaul Costs(Dry-docking andSpecial SurveyCosts)

Costs are generallycapitalized in assetcosts and depreciatedaccording to thecomponent approach.

Costs are generallycapitalized in assetcosts and depreciatedaccording to thecomponent approach.

Costs are eitherexpensed as incurred,deferred and amortizeduntil the next overhaul,or accounted for as apart of the cost of theasset.

Acquired TimeCharters withVesselAcquisition

Diversity in practicemay exist. IAS 16indicates that theelement of thepurchase price thatrelates to favourable orunfavourable attachedtime charter be treatedas a separatecomponent of thevessel cost anddepreciated over theremaining charter

period

The element of thepurchase price thatrelates to favourableor unfavourableattached time charterwill be a separatecomponent of thevessel cost anddepreciated over theremaining charterperiod.

The element of thepurchase price thatrelates to favourableor unfavourableattached time charterwill be presented as anintangible or a liabilityrespectively and will beamortized over theremaining period of thecharter agreement intorevenue.

BorrowingCosts

Borrowing costs inrelation to qualifyingassets must becapitalised as part ofthe cost of that asset.

Preparers have anaccounting policychoice on whether tocapitalise borrowingcosts. The policy mustbe applied consistentlyto all tangible fixedassets.

Borrowing costs inrelation to qualifyingassets must becapitalised as part ofthe cost of that asset.



Deloitte Shipping Team

For further assistance in any of the areas raised in this manual please do not hesitate to contact the Deloitteshipping team:

Global leadership Cyprus

Costas Georghadjis

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Torben Okkels

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George D. Cambanis+30 210 6781101

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Nicola Zerega

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Ruwayda Ebrahim

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Chris Jones

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Anis Sadek

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United Kingdom

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Jack Azose

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Greg Koslow+1 212 436 2327

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Peter Bommel

Global Industry Leader

Energy & ResourcesDeloitte Touche Tohmatsu Limited

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George D. Cambanis

Global Shipping & Ports Leader

Energy & Resources

Deloitte Touche Tohmatsu Limited

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Shipping-Accounting for Owned Vessels by Shipping Companies

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