We are writing to you regarding the inquiry we received over the possible impairment of your cruise ship. Our response was formulated using our extensive knowledge of the U.S. Generally Accepted Accounting Principles and referring to ASC 360-10 over the testing of impairment. After preforming recoverability tests, we have concluded that your cruise ship is impaired, and an impairment loss of $1.6 million should be recorded on December 31, 2010. In the second scenario, the asset is recoverable because the expected future cash flows are greater than the carrying value; therefore, the cruise ship is not impaired. The rest of this memo will describe how we calculated the impairment on your cruise ship. In order to test for impairment of an asset, we must first determine if there is an indicator that may indicate that the carrying amount of the asset may not be recoverable. According to ASC 360-10-35-21, an indicator is present when there is an adverse change in the extent or manner in which a long-lived asset is used or there is an adverse change in the business climate that could affect the value of a long-lived asset. Based on the information you provided us regarding the possible change in cruise ship route and economic climate due to pirates, we have concluded that there is an impairment indicator present. Due to the nature of the tourism industry, we determined that the presence of pirates is dangerous and unattractive to tourists and caused a decrease in cash flows.
Operating in new areas would also cause a decrease in cash flows because of the costs of relocating and lack of experience in the new area. After identifying the presence of an indicator of impairment, we must test the recoverability of the asset group. The cruise ship is the primary asset in the asset group, which includes your $0.1 million of working capital. Your working capital is included in the asset group for the following two reasons: it does not have cash flows that are independent of the cruise ship because the working capital is key to running the cruise ship’s operations, and it is independent of the cash flows of other assets and liabilities. The nonrecourse debt was not included in the asset group because the debt obligation does not have to be repaid using the cash flows of the cruise ship. In accordance with ASC 360-10-35-30, we calculated the estimated un-discounted future cash flows based on your assumptions of the asset group’s profitability and compared it to the asset group’s carrying value.
Because of the three possible scenarios, we used a probability weighted-average approach for our calculations. To perform these calculations, we added the cash flow for each option for the years 2011-2015. In 2012, we included $3 million for the estimated fair value of the ship. These calculations are displayed in Table 1. To calculate the asset group’s carrying value we added $4.6 million of ship’s net book value to the $0.1 million of net working capital, which resulted in a net carrying value of $4.7 million. After performing the calculations, we concluded that the asset group was not recoverable because the estimated future cash flows of $4.6 million were less that the net carrying value of $4.7 million.
To calculate the asset group’s carrying value, we added $4.6 million of the ship’s net book value to the $0.1 million of net working capital, which resulted in a net carrying value of $4.7 million. After performing the calculations, we concluded that the asset group was not recoverable because the estimated future cash flows of $4.6 million were less that the net carrying value of $4.7 million. Because we determined that the asset group was not recoverable, we proceeded to measure the impairment loss. The impairment loss is the excess of the asset group’s carrying value over the asset group’s fair value. ASC 820 states that fair value is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.” The fair value of the asset group consists of the cruise ship, which has a fair value of $3 million, and the net working capital of $.1 million.
The difference between the asset group’s fair value of $3.1 million and the carrying value of $4.7 million is an impairment loss $1.6 million, which should be recorded at the end of the current period, December 31, 2010. Per your request, we have also calculated probability weighted-average if of the second scenario. The calculations for the recovery test for this circumstance are displayed in Table 2. After performing the calculations, we concluded that the asset group is recoverable because the future cash flows of $4.8 million are greater than the net carrying value of $4.7 million. The results of the second scenario indicate that the asset is not impaired.
With our knowledge of U.S. Generally Accepted Accounting Principles and the guidance of ASC 360-10 over the testing of impairment, we have provided you an analysis regarding the impairment of your cruise ship. Based on the information we were given, we have concluded that the asset group in the scenario is impaired and requires an impairment loss of $1.6 million. In the second scenario, the asset group proved to be recoverable, and therefore no impairment loss has occurred. If you have any further questions, please feel free to contact us, and we will be happy to assist you.