Rough Waters Ahead

Topics: Asset, Goodwill, Generally Accepted Accounting Principles Pages: 5 (1926 words) Published: May 1, 2014
TrueBlood Case – Rough Waters Ahead
1. How should Smooth Sailings’ management perform the recoverability test for the cruise ship as of December 31, 2010? In addressing this question, consider: The following are the required steps to identify, recognize and measure the impairment of a long-lived asset (group) to be held and used: 

Step 1: Indicators of impairment — FASB ASC 360-10-35-21
“A long-lived asset (asset group) shall be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable.”

In this case, there is a possibility of impairment because of an increased presence of pirates in the area in which Smooth Sailing cruises, the cruise ship’s operating performance has significantly declined, which has directly contributed to a decline in its overall fair value.

Step 2: Test for recoverability
“If indicators are present, perform a recoverability test by comparing the sum of the estimated undiscounted future cash flows attributable to the asset (group) in question to their carrying amounts “

In this case, $2.3million < $4.0million

Step 3: Measurement of an impairment
“If the undiscounted cash flows used in the test for recoverability are less than the long-lived asset’s (group’s) carrying amount, determine the fair value of the long-lived asset (group) and recognize an impairment loss if the carrying amount of the long-lived asset (group) exceeds its fair value.”

• What assets and liabilities should be included in the “asset group” as defined by ASC 360-10 for purposes of performing the recoverability test? FASB ASC 360-10-35-23
“For purposes of recognition and measurement of an impairment loss, a long-lived asset or assets shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. However, an impairment loss, if any, that results from applying this Subtopic shall reduce only the carrying amount of a long-lived asset or assets of the group in accordance with paragraph 360-10-35-28. ASC paragraph 360-10-35-27 states that long-term debt should be adjusted before testing the asset for recoverability” Therefore; - The cruise ship (Net Book Value)$4.6 million Plus Net working capital $0.1 million

Total $4.7 million
(NB: Nonrecourse Debt of $4.0mm is not included)
• How should the multiple operating scenarios impact the recoverability test? FASB ASC 360-10-35-30
“…. However, if alternative courses of action to recover the carrying amount of a long-lived asset (asset group) are under consideration or if a range is estimated for the amount of possible future cash flows associated with the likely course of action, the likelihood of those possible outcomes shall be considered. A probability-weighted approach may be useful in considering the likelihood of those possible outcomes.”

Option A: 4.0 mm x 10% =0.4 million
Option B: 6.0 mm x 20%=1.2 million
Option C: 1.0mm x 70%=0.7 million
Total=2.3 million
In this case, $2.3million < $4.0million. There will be an Impairment Loss. • What impact should the potential foreclosure and extinguishment of debt have on the cash flows used to perform the recoverability test? Section 2.3.1.1

However, in rare instances, if the lowest level of identifiable cash flows includes cash flows associated with debt principal payments and it is not practical to eliminate those cash flows (which would be more likely to occur when the asset group is a business or reporting unit), then the debt should be included in the asset group (i.e., netted with the carrying amounts of the assets of the group) so as to maintain an appropriate comparison. This basis adjustment provides the same result as if the debt principal payments have been excluded (e.g., debt with a carrying value of $100 would have undiscounted cash flows of $100). Option C which suggests...
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