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Posted on Jun 28, 2024

Impairment analysis: Comparison of impairment of long-lived assets between US GAAP and IFRS Introduction Genco Shipping & Trading has been a public company since 2005

Impairment analysis: Comparison of impairment of long-lived assets between US GAAP and IFRS Introduction Genco Shipping & Trading has been a public company since 2005 and currently trades on the New York Stock Exchange under the ticker symbol GNK. As a US public company GNK, files its financial statements with the Securities and Exchange Commission (SEC) using US Generally Accepted Accounting Principles (US GAAP). They are a transporter of dry bulk materials, including iron ore, coal, grain, and many other raw materials on large vessels among international shipping routes. Genco Shipping & Trading went public with 17 vessels and has expanded operations through the acquisition of additional vessels to bring the total number of ships up to 53 as of December 31, 2012. Genco's largest acquisition of vessels occurred in June of 2007 when they purchased 9 capesize vessels for approximately $1.1 billion. These vessels were delivered to Genco between the third quarter of 2007 and the first quarter of 2010 when the last vessel was built. The dry bulk shipping industry has experienced a significant boom and bust cycle over the last decade. The Baltic Dry Index (BDI), a shipping and trade index for 4 classes of ships (capesize, panamax, supramax, and handysize), measures the daily average rental rate to ship raw materials across a variety of international shipping routes. The higher the BDI, the more a company can rent its vessels for. As seen in figure 1, the BDI has fluctuated from over 11,000 to below 1,000 since GNK went public. The daily rental rates for capesize dry bulk vessels has ranged from over $150,000 per day to under $5,000 (Platou, 2011). Following the leasing rates, the fair market value of all classes of ships has varied significantly over the last decade, with the capesize asset prices ranging from $150 million in early 2008 to under $40 million (Platou, 2011). The Securities and Exchange Commission has raised questions about the estimates used by the company for the impairment of long lived assets. Item 6 in the SEC comment letter to Genco dated March 16, 2011 addressed this concern and is listed below, the entire letter can be found at the SEC website at http://www.sec.gov/Archives/edgar/data/1326200/000000000011016598/filename1.pdf Impairment of long-lived assets, page 67 6. In the fifth paragraph of this section, you state that assumptions used to develop estimates of future undiscounted cash flows are based on historical trends. Please expand this disclosure to discuss the time periods involved in your use of historical trends, and how current charter rates compare to the rates you used in your analysis. This case study will require you to create an estimate of the calculation for impairment of long-lived assets using shipbroker analyst reports and information contained in the 10-K. For this assignment, you will only be concerned with the 9 capesize vessels purchased at the height of the market in 2007. A listing of the vessels is included in table 1 and includes; the year they were built, the size of the vessel, the name of the vessel, the purchase price, and the carrying value as of December 31, 2011. Additional information is presented after the assigned questions to help in creating the estimates needed for the impairment calculation. Assignment Requirements 1. Prepare a memorandum of the accounting requirements for the impairment of longlived assets under US GAAP and IFRS including a comparison of the two methods. You must provide citations to the Accounting Standards Codification (ASC) and the International Accounting Standards (IAS) in your report. 2. In an excel spreadsheet, create an estimate of the impairment calculation prepared by the company or the auditors for the nine capesize vessels listed in table 1 using US GAAP. For each of the estimates used, provide support as to why you used that estimate. Support for your estimates should come from the shipbroker reports, the company's filings with the SEC, or other reliable information. Treat these estimates as if you were an audit staff person creating workpapers for partner review (your support for the estimates can either be provided in the spreadsheet or in the memo). 3. In an excel spreadsheet, create an estimate of the impairment calculation prepared by the company for the nine capesize vessels listed in table 1 using IFRS. Again support all of your estimates. 4. In the memo prepared in step one, answer the following additional questions. a. Which estimates have the greatest impact on the company's impairment calculation? b. If the company filed using IFRS, does that change your calculation and estimate of impairment? c. Do you agree with the company's estimate in which they have not impaired the vessels? d. Which accounting standard do you think provides more reliable financial statements in regards to asset impairment, US GAAP or IFRS? e. Calculate the book value per share and compare this to the stock price. Do you think the stock should be trading at the book value per share? Additional information Vessel Depreciation When leasing a ship, Genco is still required to pay operating expenses including employee wages, insurance, spare parts, etc. The company estimated this cost to be approximately $5,500 per ship per day for 2012 for a capesize vessel (2012). Dry bulk vessels are required to have significant inspections every 5 years after being built with the fifth inspection being expensive and very time consuming. As a result, most companies elect to depreciate vessels on a 25 year useful life. The scrap value of the vessels is roughly equal to the weight of steel in the ship times the price per ton of steel. Genco follows industry practice and depreciates their vessels over the estimated useful life 25 years. However, the decision to pay for the fifth special survey and continue operating a vessel or scrap it comes down to a choice, daily income from the ship and the scrap value sometime in the future, or the scrap value today. In periods of high shipping rates, the amount of ships sold for scrap decreases significantly, for instance during 2007 only 26 ships were scrapped (Platou, 2008). This compares to over 540 ships scrapped during 2012 (Platou, 2013) which yielded extremely low lease rates for the dry bulk market. Revenue Rates In prior years, Genco has maintained a utilization rate across all of their ships in excess of 99%, meaning the ship is earning revenue more than 360 days a year. The amount of revenue earned by a vessel follows the laws of supply and demand. If there are 4 lessee's wanting to lease a capesize vessels and only 3 vessels available, the price will increase until one of the lessee's is priced out of the market. This is what happened during 2007 and 2008, the Chinese economy was booming and the need for additional raw materials soared. As a result of this rapid expansion, there were not enough vessels to fill demand and the price to lease a ship increased to extraordinary levels. Following the sky high leasing rates, owners placed orders to build thousands of new ships hoping to take advantage of extremely high rental rates. However, during the last few years, the supply of ships has significantly outpaced the growth in demand for new ships. The total fleet growth was approximately 14% in 2011 and 12% in 2010, during those years the demand for ships only increased by approximately 6%. As a result, the dry bulk industry now has idle ships which are not collecting any revenue at all and forcing the revenue rates down (Platou, 2011). Reading Shipbroker Reports The shipping industry is followed closely by numerous shipbrokers that provide estimates of asset values, revenue rates, fleet growth, fleet demand and many other data points1. Many of these shipbrokers provide their analyst reports for free on their websites; a few of the larger brokers include Shiptrade Services SA, Intermodal, Lion Shipbrokers, R.S. Platou, Athenian Shipbrokers. The reports are often very detailed and can include acronyms and shipping jargon. First, as Genco only operates within the dry bulk industry we will want to ignore all references to tankers (wet) in the analyst reports. Industry - Genco Shipping & Trading only operates within the dry bulk segment. The dry bulk segment is broken down into 4 classes of ships, capesize, pananax, supramax, and 1 While the numbers in each analyst report may differ slightly, the estimates from any report provide a reasonable basis for our estimations. handysize. The capesize vessels are the largest and can carry approximately 180,000 tons of material. The capesize vessels got their name as they are too large to go through the Panama Canal or the Suez Canal and must go around the Cape of Good Hope (southern tip of Africa) and Cape Horn (southern tip of South America). This project will only examine the capesize vessels in the drybulk segment. Fair Market Value of Assets - The shipbroker reports will not list out the exact value of a particular vessel, instead we will have to create an estimate with the information that is given. First, the size or class of the vessel is required to determine the fair market value. For Genco, we are examining their nine capesize vessels for impairment. Next, the age of the vessel will significantly impact the fair market value of the vessel, however the shipbroker reports will not list each year individually. For instance if you have a 7 year old vessel, a reasonable estimate would be to average the value of a 5 and 10 year old vessel. Estimated Revenue Rates - The shipbroker reports will report the revenue earned by ships under various leasing arrangements. The spot market provides the estimated revenue earned by a ship per day for a single voyage at this time (i.e. carrying iron ore from Brazil to China). The time charter (TC) market provides the estimated revenue per day for a set period of time (i.e. a 1 year time charter in which the lessor can decide how they wish to utilize the ship for the 1 year). Again, similar to determining the value of a ship, the class or size of the ship will significantly impact the revenue earned by the vessel. The age of a vessel has a minimal impact on the daily rental rates. These reports provide a history of what lease rates have been, it is necessary to create an estimate of future revenue rates based on the past information. In addition to using historical data, an active futures market is traded providing another estimate for future revenue rates for each of the classes of vessels. These future markets are designated as Forward Freight Arrangements (FFA's). Operating Expenses - Operating expenses vary by company, by class of vessel, and by the age of the vessel. Genco has estimated the operating expenses for the nine capesize vessels to be approximately $5,500 per day per vessel (2012). Table 1 - Carrying Value of nine Capesize vessels purchased in 2007 Name of Vessel Year Built Size in Tons Purchase Carrying Value at Price 12-31-2011 in 000's Genco Augustus 2007 108,286 180,000 125,000 Genco Tiberius 2007 108,471 175,000 125,000 Genco London 109,689 2007 177,000 125,000 Genco Titus 110,188 2007 177,000 125,000 Genco Constantine 2008 115,556 180,000 129,000 Genco Hadrian 2008 113,264 170,500 121,000 Genco Commodus 115,690 2009 170,500 121,000 Genco Maximus 115,634 2009 170,500 120,000 Genco Claudius 117,359 2010 170,500 120.000 Totals 1,014,137 1,571,000 1,111,000 Figure 1 - Baltic Dry Index Note: This table presents the fair market value of newly built ships straight from the shipyard for the four classes of vessels. This data is from RS Platou, an internationally recognized ship broker. Note: This table presents the fair market value of 5 year old ships bought on the open market for the four classes of vessels. This data is from RS Platou, an internationally recognized ship broker. Note: This table presents the fair market value of 10 year old ships bought on the open market for the four classes of vessels. This data is from RS Platou, an internationally recognized ship broker. Note: This table provides the revenue rate per day to lease a ship for a single voyage for the four classes of dry bulk vessels. This data is from RS Platou, an internationally recognized ship broker. Note: This table provides the revenue rate per day to lease a ship for 12 months for the four classes of dry bulk vessels. This data is from RS Platou, an internationally recognized ship broker. References: 2012. Genco Shipping and Trading December 31, 2011 10K. Genco Shipping and Trading. PLATOU, R. 2008. The Platou Report 2007. PLATOU, R. 2011. RS Platou Monthly. PLATOU, R. 2013. The Platou Report 2012