Rough Waters Essay

1912 WordsDec 22, 20128 Pages
Background Smooth Sailing is a private company that operates one cruise ship. Recently, pirate activity in the area where the cruise ship operates has increased, thus affecting the cruise ship’s potential future cash flows. The cash flow decline has directly contributed to a decline in the overall fair value of the cruise ship. Smooth Sailing has determined three possible options for its future, along with the probabilities of occurrence and estimated cash flows (ECF): 1. Continue operating the cruise ship in current area. (10% probability with $4.0 million ECF) 2. Operate cruise ship in new area with fewer pirates. (20% probability with $6.0 million ECF) 3. Operate for one more year and then return ship to lender. (70%…show more content…
If these estimated undiscounted future cash flows are less than the carrying value of the asset, an impairment charge is recognized for the excess, if any, of the asset’s carrying value over its estimated fair value. Seeing that similar companies adhere to this practice, we feel this method is a valid way to account for Smooth Sailing’s impairment of its cruise ship. Another important factor necessitating consideration is the effect the default will have on the nonrecourse debt. In our research we concluded the impact from the default does not influence the UFCF, the fair value, or the carrying value. According to FAS 144, the loss from impairment and the gain from the extinguishment of debt are two separate and distinct transactions. The Board continues to explain “the recognition of an impairment loss should be based on the measurement of the asset at its fair value and that the existence of nonrecourse debt should not influence that measurement.” Thus, the nonrecourse debt does not impact Smooth Sailing’s impairment loss calculations. US GAAP Alternative with Secondary Probabilities: Similar to the first alternative, the main issue at hand here is whether or not the asset is impaired and needs to be written down accordingly.

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