Impact Of Ifrs Shipping

TRANSPORT

Impact of IFRS:
Shipping

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CONTENTS
Introduction 1
1. Cost capitalisation 2
2 Depreciation and residual value 5
3. Impairment of non-financial assets 8
4. Leasing 13
5. Consolidation and joint arrangements 18
6. Revenue and costs 22
7. Financial instruments 27
8. Segment reporting 30
9. First-time adoption 32

Impact of IFRS: Shipping | 1

Introduction
In 2011 we reported that it was difficult The key areas In doing this, we have referred to our
to obtain comparable financial reports survey of publically available financial
Based upon the frequent conversations
for the biggest shipping companies in information of the world’s largest
we have with shipping companies and
the world. We struggled to find any shipping companies. This sample was
KPMG member firms’ experience of
relevant reporting for about a third of first selected from the 2010/11 reporting
undertaking GAAP conversions to IFRS,
those we looked for, and beyond this, season to support our analysis for our
the following topics are the key areas
we found comparability difficult with recent Shipping Insights 4 publication,
to consider:
ten different accounting bases used amended to focus on only those
for the remaining two thirds. 1. Cost capitalisation companies using IFRS. A list of these
companies is provided in the Appendix.
But the picture is getting better. Our 2011 2. Depreciation and residual value We have not updated our analysis to
findings, published in Shipping Insights 4: consider more recent financial
Keeping Ahead, recognised that many 3. Impairment of non-financial assets
announcements and reports.
countries are swiftly adopting
4. Leasing
International Financial Reporting The International Accounting Standards
Standards (“IFRS”) and that local GAAPs 5. Consolidation and joint arrangements Board (“IASB”) – the organisation that
were likely to be superseded in the next develops new IFRSs – is incredibly busy
couple of years. Compared with a similar 6. Revenue and costs at the moment. At the time of issuing
KPMG survey in 2008, more accounts this publication there are fundamental
were publically available and less 7 Financial instruments
. changes proposed to leasing and revenue
accounting GAAPs were being used. 8. Segment reporting recognition and we expect further clarity
Other than the US, we can expect around financial instruments. As we
companies based in all the major 9. First-time adoption consider each key topic, we have looked
shipping countries to be reporting on a forward to how new proposals may
consistent basis as IFRS adoption In our experience, these areas are most affect the balance sheets and income
continues at a pace. sensitive to the operational reality of the statements of shipping companies in
shipping industry – be it the nature of the the future.
The challenge remains for preparers assets and liabilities or the contractual
and users alike, as to how to adopt the arrangements most commonly entered We hope both current users of IFRS and
principles of IFRS in the world of shipping into. This publication sheds light on these those planning a conversion in the near
– where choices exist, or judgment is issues by considering how shipping term find this publication helpful and
required, differences in interpretation companies are dealing with the informative. KPMG’s global shipping
or application are inevitable. complexity in practice and by providing network has the breadth and depth of
specific examples to illustrate the resource to provide clients with support
In this publication, we assess the application of IFRS. and advice on all aspects of current and
impact of IFRS on the shipping industry future international financial reporting
– looking in some detail at the key areas issues. I would encourage you to keep in
that company Boards and their finance touch with your normal KPMG contact,
teams have to grapple with. or link up with our network.

John Luke
KPMG, Global Head of Shipping

2 | Impact of IFRS: Shipping

1. Cost capitalisation
Vessels are recognised at cost, being the directly attributable costs incurred
by a company in bringing the asset to the location and condition necessary
for its intended use.

Cost typically equates to the contract Borrowing and hedging costs Recognition and Measurement. In that
price agreed with the shipyard and case the company may designate certain
Borrowing costs that are directly
includes: vessel construction contracts as hedged
attributable to the construction are
items. For cash flow hedges, the effective
• cost of any option purchased to secure capitalised, as it generally takes a
portion of the exchange gains or losses is
a future slot in the yard (but see later); substantial period of time to build a
initially recognised in other comprehensive
vessel. Borrowing costs may include
income, rather than in the income
• stage payments to the yard over certain finance charges and foreign
statement. IAS 39 permits an accounting
the build phase (which may include exchange differences that are regarded
policy choice to either capitalise these
incremental or variation costs as an adjustment to interest costs.
amounts within the initial cost of the
associated with design changes, In our view, borrowing costs also may
investment or to recycle them to profit
price escalation etc. during the include payments and accruals made
or loss in the same period during which
construction); under interest rate swaps used for
the vessel affects profit or loss over the
hedging of eligible borrowing costs (but
• borrowing costs eligible for depreciation period or when the vessel is
not the mark-to-market change in the fair
capitalisation and costs associated impaired or sold.
value of the interest rate swap).
with hedging future stage payments;
Identifying borrowing costs on general Repositioning costs
• initial inspection and certification costs; (as opposed to specific) borrowings Generally start-up and pre-operating
and can be challenging. A weighted average costs are not eligible for capitalisation
interest cost approach is applied, making unless those costs are necessary to
• potentially some repositioning costs
sure to exclude any interest on specific bring the asset to its working condition.
(including first fill of lube-oil and
borrowings. The objective is to capitalise Therefore, costs incurred up to the
bunker fuel).
borrowing costs that would have been moment when the vessel is capable
In KPMG firms experience, owners rarely avoided had the asset not been of operating in the intended manner
incur significant internal direct costs constructed. The amount capitalised may (including moving it to a required location)
associated with the build; however some not exceed the actual interest incurred by do meet the definition of an eligible cost.
internal costs associated with an in-house the company. The period during which
team managing the build contract may be interest is capitalised should broadly In our experience, companies seeking
eligible for capitalisation if they are match the period over which other costs to capitalise costs in this area generally
directly attributable to the project. are eligible for capitalisation. consider repositioning costs from the yard
to the nearest major port, rather than the
Non-specific or operating costs are Some vessel construction contracts may actual costs incurred in moving the vessel
expensed as incurred, including costs be in currencies other than the functional to a port of choice (or port determined
associated with crew training. currency of the company. To mitigate its under a charter agreement). In some
exposure to fluctuations in exchange instances, the vessel generates an
rates a company may use hedging. operating loss in its first days at sea, as it
If certain conditions are met, the moves from the yard to the commencement
company may apply hedge accounting of its first laden voyage. The operating loss
under IAS 39 Financial Instruments: is expensed as incurred.


Subsequent expenditure and In most cases a company acquires a IFRS is silent with regards to the specific
dry-docking vessel (either new or second-hand) for costs that should be included in
a fixed sum without necessarily knowing measuring the component attributable
When an item of property, plant and
the cost of the individual components, to major inspection or overhaul costs
equipment (“PPE”) comprises individual
and accordingly these should be (i.e. whether they should be incremental
components for which different
estimated either by reference to current and/or external costs). Expanding the
depreciation methods or rates are
market prices, in consultation with the example above where the owner’s
appropriate, each component is
contractor or by some other reasonable in-house ship management team carry
depreciated separately. A separate
method of approximation such as out most of the dry-dock work and the
component may be either a physical
relative values. external costs incurred is only 30. In our
component or a non-physical component
view, the company should attribute the
that represents a major inspection or Dry-docking (as the major overhaul) is entire 80 to the component on the basis
overhaul. PPE is separated into parts identified and accounted for as a separate that the cost of an item of PPE includes
(components) when those parts are component. For example, an owner internal as well as external costs, and
significant in relation to the total cost acquires a new vessel for 400 and the there is no requirement for the costs to
of the item. useful life of the ship is 20 years and the be incremental.
next dry-docking is due in three years. At
Component accounting is compulsory,
the acquisition date the dry-docking costs In our view, borrowing costs associated
but this does not mean that a company
for similar ships that are three years old with a dry-docking need not be
should necessarily split its assets into
are approximately 80. Therefore, the cost capitalised, assuming the dry-docking
an infinite number of components if the
of the dry-docking component for periods are relatively short.
effect on the financial statements would
accounting purposes is 80 and this
be immaterial. Owners may also incur subsequent
amount would be depreciated over the
three years to the next dry-docking. The expenditure to enhance the operating
Broadly vessels comprise a hull, engine,
remaining carrying amount, which may capability of the vessel or extend its life
superstructure, navigation system and
need to be split into further components, (such as raising the bridge or significantly
other fit-out assets. In our experience,
is 320. Component accounting for replacing the hull). Such costs are eligible
companies are pragmatic in the approach
inspection or overhaul costs is intended for capitalisation provided future
to componentisation with the base
to be used only for major expenditure economic benefits are associated with
assumption that these elements have
that occurs at regular intervals over the them. Finally costs incurred in meeting
approximately the same engineering
life of an asset. Costs associated with new or changing regulation may be
lives and therefore depreciable lives.
routine repairs and maintenance are eligible for capitalisation even though the
Companies only move away from this
expensed as incurred including routine expenditure itself does not give rise
assertion if persuasive evidence exists to
maintenance performed whilst the vessel directly to future economic benefits.
the contrary which would result in a
material impact. One area of challenge is is in dry dock.
around navigation equipment, where the
operational service life may be longer
than the period up to which the
technology becomes obsolete.


Assets leased under an operating Purchase of second hand vessels Additional footnote disclosure is
lease required for the:
Second hand vessel sales are usually
Accounting for dry dock and other arranged by a ship broker. The purchaser • existence and amounts of restriction
subsequent asset expenditure is more recognises the vessel as PPE at the on title and PPE pledged as security
complex for an asset leased under an contract price (which includes an element for liabilities;
operating lease because the asset and of broker fees and transaction costs such
future obligations under the lease are as legal and inspection). • amount of borrowing costs capitalised
not reflected in the lessee’s statement of in the period;
financial position. There is no guidance in Sale and purchase contracts typically
IFRS on whether component accounting specify at which port ownership transfers. • amount of expenditure recognised
is appropriate when the principal asset is Costs associated with moving the vessel in the carrying amount of an item of
not recognised in the financial statements. after the sale are unlikely to be eligible for PPE that is in the course of
capitalisation and therefore would be an construction; and
Regular dry-docking is essential for the operating cost of the purchaser.
owner or operators to maintain the vessel • amount of contractual commitments
classification and insurance. Accordingly, Disclosure for the acquisition of PPE.
certain lease arrangements may require IFRS financial statements are required to The last point is relevant for investors
the lessee to incur the dry-dock cost. In disclose the gross carrying amount of to understand the entity’s exposure to
our view, the nature of the transaction will PPE, the accumulated depreciation and new tonnage.
determine the accounting treatment and the impairment losses at the end of the
it may be appropriate for the lessee to: period and a reconciliation from the
opening balance sheet (and comparative).
• apply the component approach and
Experience in practice?
recognise major repair or overhaul A distinction is made between assets
costs as a leasehold improvement; or purchased and those acquired through
Companies in our survey provided
a business combination. Assets classified
• apply the liability approach and build little insight into the types of costs
as held for sale in accordance with
up a provision for the dry-docking being capitalised. Some policies
IFRS 5 Non-current Assets Held for Sale
cost over the period of the lease. included “costs of bringing the asset
and Discontinued Operations are
The provision would be measured at into use” but the narrative was
disclosed separately.
the expected cost of the dry-docking unclear as to the specific approach
based on the condition of the vessel at Disclosures are made by separate asset being adopted to issues such as
each reporting date. classes. This does not mean an analysis repositioning.
by asset component, but rather groupings
If a vessel could be handed back part-way Almost all companies stated that
of assets that are similar in nature. IAS 16
through its dry-dock cycle (rather than they were capitalising interest or
Property, Plant and Equipment provides
being handed back only after a full dry borrowing costs. In instances where
“ships” as an example of an asset class.
dock had been undertaken), then the non-specific funding was being used
We would encourage companies that are
component approach may be appropriate. to build new ships, some companies
engaged in different types of shipping
provided guidance on the rate at
Alternatively, a liability approach may activity (e.g. dry-bulk, container and
which interest was capitalised.
be appropriate if the lease agreement tanker) to provide disclosure at this level,
specifies that the lessee should return as this provides users of accounts with The majority of the sample
the vessel in its original condition or more insightful information, particularly categorised all ship sub-classes
compensate for costs required to restore when considering impairment risks, (e.g. dry-bulk, container and tanker)
the vessel to its original condition. and may better align with segmental as one class of PPE.
disclosures.


2. Depreciation and residual value
Subsequent to initial recognition, items of PPE are depreciated on a
systematic basis to the income statement over their useful economic
lives to a residual value.

IFRS requires companies to reassess Depreciation of the major components of In our experience, owners typically adopt
the useful economic lives and residual the vessel could be suspended, e.g. whilst a prudent approach and consider the
values of assets at each reporting date, in dry dock, but this practice does not most likely utility of the asset. This is
with a change in either being appear commonplace, presumably on frequently shorter than the theoretical
accounted for prospectively as a the grounds of materiality. engineering life of the hull and engine.
change in accounting estimate.
Useful economic lives Residual value
Commencement of depreciation The useful economic life of a vessel Residual value is the amount that a
Depreciation commences once the component is judgmental, and can be company could receive for the asset at
asset is complete and in a condition and complicated by: the reporting date if the asset were
location ready for use. In the shipping already of the age and in the condition
industry, there is perhaps less ambiguity • the long engineering lives of vessels; that it will be in when the company
regarding this judgment than in other • the uncertainty over the future market expects to dispose of it. Residual value
sectors and given our comments in the conditions in which the vessel will does not include expected future
previous section depreciation usually operate; inflation. The estimated residual value is
commences when the vessel is delivered. based on similar assets that have reached
• fleet deployment and operating cycles; the end of their useful lives at the date
IAS 16 outlines different methods of that the estimate is made.
depreciation, encouraging companies • future technological changes, including
to adopt a policy that best reflects the the impact of regulations and
consumption of economic benefits. In our constraints and new engine design;
experience, the straight-line method is and
almost exclusively used within the • the repairs and maintenance policies.
shipping industry.


In the shipping industry, the residual Disclosure
value can be relatively material because
IAS 16 requires companies to disclose:
of the scrap value of steel and the
considerable scrapping market that • the depreciation charge and
exists. Accordingly, today’s market price accumulated depreciation;
for scrap steel can be used as a basis for
determining a vessel’s residual value. • the basis for estimating residual
values;
Depending on the market conditions, the
residual value of a vessel can potentially • the useful economic lives; and
be higher than its net book value. At this
• depreciation method.
point, the company suspends
depreciation until such time as the If a company changes its assessment of
residual value falls again. useful economic lives or residual value
during the year, the effect to net income
Using steel price to determine a residual
is also disclosed.
value is not without challenges. Given the
volatility of the steel price over the past In our experience, shipping companies
five years. We do not suspect that the tend to disclose broad ranges rather than
standard setters envisaged companies specific rates, which makes it difficult to
having to mark residual values to market assess the quality of the fleet in
each year. However, when a change in operation. This contrasts with companies
market conditions is material, we would in the airline industry, which often
expect owners to update the estimates. describe in more detail the nature and
age of the aircraft fleet they are operating.


Experience in practice?

Overall, there was consistency in the Figure 1: UEL disclosed by shipping companies
’s
selection of useful economic lives.
Percentage of companies with UEL in specified range
One or two companies provided very
broad ranges of lives (for example, 60
one quoted 10-25 years), which
presented a challenge in assessing 50
the age and long run depreciation
charge of the company. Outliers in
40
the analysis above were likely to have
asset-specific reasons for shorter or
longer lives. In particular, for FPSOs 30
this judgment is likely to be driven by
the remaining reserves associated with 20
the oil field. It did however appear that
companies were being prudent in their 10
estimates, as the engineering lives of
vessels were, generally, longer than 0
20-25 years. This appears to indicate 1-7 8-13 14-19 20-25 26-31 32+
that companies expect vessels to Source: KPMG LLP (UK) 2012
become economically impaired before
the end of their engineering lives due further and stated that three year impact of such change in estimate to be
to technological evolutions or average scrap steel prices were used disclosed if material.
regulatory requirements. – obviously to address the volatility point
identified above. The level of detail in disclosures made
Just less than one third of our sample it difficult to identify the impact of
did not provide information on how Of our sample, we did not identify any different depreciation rates on the net
residual values were determined. company that disclosed a change in profit of companies in the industry.
Several used a percentage of the estimate of either useful economic life However, it was possible to identify
original cost price as a proxy (with a or residual value in the latest financial those that were more prudent (and
range of 5% to 20%) and others used year. Accounting standards require the charged higher depreciation) year
average steel prices (lightweight on year.
tonnes – LWT). Of these, some went


Impairment of
3. non-financial assets
Impairment is one of the most critical judgments in considering the strength
of the balance sheet and something that debt holders, equity owners and
the supply chain are intently focussed on.

Notwithstanding the cyclical nature of have independent cash inflows, and are • evidence being available from internal
the shipping industry, the level of not alternative tests. reporting that indicates economic
impairments recognised historically performance of an asset is worse
has been relatively low – in our 2011 In identifying groups of assets that have than expected.
Shipping Insights publication we independent cash inflows, in our view
noted that less than a half of one two considerations, neither of which is Practical triggers therefore include:
percent of our sample’s aggregate net likely to be determinative in isolation,
are particularly useful in the analysis: • general downturn in global economy
book value of vessels had been
(which drives demand for vessel
impaired during the 2010 reporting
• Revenue separation – are the streams movements);
cycle – and there are a number of
of revenue derived from these groups of
factors which may be underpinning • depressed freight rates;
assets independent of one another; and
this, which we consider below.
• Asset separation – are the assets • depressed new build prices or
Cash generating units operated together to such an extent resale prices;
Wherever possible, the assessment of that they do not generate independent
• vessels being laid up;
impairment is performed on an individual revenue streams?
asset basis. However, this is not possible • higher than normal scrapping rates;
Liner companies, in particular, usually
if an asset generates cash flows only in
find that inter-relationships between • substantial physical damage to
combination with other assets as part of
operating assets make specific allocation the vessel;
a larger cash-generating unit (“CGU”)
of all cash flows to individual vessels
which cannot be larger than an operating • technological obsolescence
challenging if not impossible. Some
segment as defined by IFRS 8 Operating (e.g. driven by regulatory change); and
companies may group assets by a
Segments. In our experience, many
particular trade that they operate, but
single assets in the shipping industry do • operating losses.
even that can sometimes be difficult
not qualify for independent impairment
given the ability of operators to switch
testing, because they are operated as Impairment model
vessels between trades.
part of an integrated fleet.
Where an impairment test is performed,
Individual asset testing is more the carrying amount of an asset or group
Accordingly assets need to be grouped in
commonplace where specific or of assets is compared to its recoverable
the smallest asset pool, which generates
specialist vessels are in operation or are amount, which is the higher of:
independent cash flows. The identification
chartered to an individual counterparty on
of CGUs requires judgment and can be
specific terms. • Fair value less costs to sell (generally
one of the most difficult areas of
based on the market price); or
impairment testing. Whilst the key test is
Impairment triggers
the identification of independent cash • The value expected to be generated
inflows, IAS 36 Impairment of Assets IAS 36 provides a number of example from the continuing use of the asset
also refers to other factors such as the indicators of possible impairment, – its value in use.
manner in which management monitors such as:
If the carrying value is greater than the
operations and makes decisions about recoverable amount then the asset is
• a significant adverse change in the
continuing or disposing of assets and/or written down.
market and economic environment in
operations. In our view, these additional
which a company operates or to which
factors are intended to assist
an asset is dedicated; and
in identifying parts of the business that


Identifying fair value
The best evidence of fair value is a
binding sale agreement in an arm’s length
transaction. In the absence of liquid
markets, entities use the best information
available to estimate the amount that
could be obtained through the disposal of
the asset at the reporting date. The use of
one or more independent brokers may be
appropriate and the recently introduced
on-line valuation tools can also provide
supporting evidence.

Assessing value in use
The value in use of an asset (or group of
assets) is defined as the present value of
the future cash flows expected to be
derived from the asset or CGU. The key
factors in assessing a value in use are
therefore the composition of cash flows
and the discount rate applied.

Cash flow composition
The cash flow projections are required to
be based on reasonable and supportable
assumptions and are built up by
considering:

• spot or chartered rates for vessels;

• utilisation;

• operating costs of the vessels; and

• the estimated useful economic life.

Cash flows for dry-docking are also
included as they are necessary to
maintain the performance of a vessel
in its current condition; however,
discretionary capital expenditure
that could enhance or improve the
vessel’s performance or life is
excluded from the calculation.


IAS 36 states that a maximum of a A further complication is that WACC is a • the amount necessary to restore
five-year horizon is appropriate for the post-tax discount rate, whilst IAS 36 the assets of the CGU to their pre-
cash flows to be based upon company’s requires using a pre-tax discount rate for impairment carrying value less
budgets and forecasts, and thereafter a impairment testing purposes. However, subsequent depreciation that would
growth rate is applied. Long-term charter this may not cause an issue for a shipping have been recognised.
agreements could be a reason to rebut company operating in a tonnage tax
this time horizon (especially for bare regime. The tonnage tax is not based on Reversals are recognised in the income
boat arrangements). Absent such taxable profits and is not considered to statement (unless the assets were
arrangements a terminal growth rate is be an income tax under IAS 12 Income revalued).
usually applied. Taxes. Therefore, in our view the cash
A reversal does not arise due to the
flows in a value in use calculation should
Complexity arises in the shipping industry impact of the unwinding of the discount
be determined net of the tonnage tax
because of the cyclical nature of its used in determining value in use.
cash outflows.
operations. This also may be a factor
for lowering a long-term growth rate. Part-completed new builds
Differences between fair value and
value in use Some vessels under construction may be
Discount rate subject to impairment if the agreed costs
In principle, and in a perfect market, there
The discount rate to be applied to the to build a vessel become higher than its
should be very few differences between
projected cash flows reflects the current estimated value in use or fair value. This
a fair value and value in use, as both are
market assessment of the risks specific issue has been especially relevant in the
calculating the long-term earnings
to the asset or CGU and the time value of past couple of years as new build prices
potential of the vessel. However, in
money. The key point to highlight is that have dropped by up to 40% from the
practice, value in use may be higher as it
the discount rate for impairment purpose 2007/8 peak.
takes into account entity specific factors
is unlikely to equal the weighted average
and information that may not be readily If this is the case and the contract with
cost of capital (“WACC”) of the asset
available to market participants. the shipyard cannot be cancelled without
holder, because it may not represent the
Example factors include: a penalty, then it is necessary to consider
rate of return that a market participant
would require if it were to choose to whether the contract is onerous under
• charter arrangements for the individual
invest in the vessel(s) in question. IAS 37 Provisions, Contingent Liabilities
assets, which could have more
and Contingent Assets. In assessing
favourable terms than current
It is generally rare that a discount rate is whether a contract is onerous, a shipping
market rates;
observable directly from the market, and company compares the expected
therefore one needs to be derived. The • a more optimistic view of daily benefits from the vessel with the lower
most common method in practice is to running costs; of the cost to fulfil the contract and any
start with a company’s WACC which is compensation or penalty to cancel the
then adjusted to build up a market • high residual values and different views contract. If the expected costs to fulfil or
participant discount rate. on useful economic lives; cancel the contract are higher than the
expected benefits from the vessel, then
Factors to consider to arrive at an • different views on discount rates; the contract is onerous. Before a separate
appropriate rate include the: provision for an onerous contract is
• a more bullish view of market
established, the shipping company
• nature of the chartering arrangement sentiment; and
recognises an impairment loss on the
– in the case of spot and time charters
• the level of liquidity in the market vessel under construction.
the owner is exposed to both
operational and credit risk, whilst for (a discount may be applied when
there is a lack of liquidity). Parent and subsidiary considerations
bareboat charters only credit risk may
be relevant; It is not uncommon for a parent to charter
Reversal of past impairments a vessel from its subsidiary and then
• terminal value – risks associated with If there is an indication at a reporting onward charter (either for a long or a
vessel scrapping are likely to be date that the recoverable amount of the short- term) to its customers. In such
different to re-sale and/or a purchase impaired vessel or CGU increases, the instances, different assessments of
option; and the impairment of the vessel or CGU is CGU’s and different estimates of cash
reversed. The amount of the reversal flows may be used for impairment testing
• nature of the asset(s) – forecasting and
is the lower of: purposes at the Group (consolidated)
liquidity risk associated with the
level compared to the subsidiary level.
different types (dry-bulk, container, • the amount necessary to bring the For example; in a one-ship vessel owning
tanker etc) and different sizes (cape, carrying value of the asset to its company, cash inflows from the parent’s
panamax, handy etc) of vessels. recoverable amount; and charter and the daily running costs may
be easily determinable, whereas at a


consolidated level, such transactions
are eliminated and replaced by external Experience in practice?
exposures. Accordingly the impairment
test at the group and subsidiary could
yield a different outcome. A market participant discount rate is applying an inflation increase of 1.8%
difficult to calculate and therefore and the highest rate being 13.4%.
High-level “sense” checks the divergence of disclosed rates is About half of these disclosures
perhaps not surprising. were based upon market measures
When the recoverable amount of a CGU
(seaborne container indices, Baltic
is determined on the basis of value in use About half the sample clearly disclosed indices, etc) and others were based
and substantial parts of the company are discount rates, with the lowest at upon internal management business
being tested for impairment, a high-level 5% and the highest at 13% (post tax). plans. The extent of this spread is
comparison between market Only one indicated a significant perhaps surprising, but we would
capitalisation, adjusted for the market difference between pre and post-tax expect different vessels operating in
value of debt and any surplus (or specific) rates presumably because this certain geographies to have specific
assets, and the total value in use for all company was operating outside growth rates.
CGUs provides some support that the tonnage tax.
assumptions and discount rate used About a quarter of our sample identified
are appropriate for the cash flows. Only three companies disclosed a cash-generating units, and these were
range of rates being used – presumably generally on a fleet basis.
Disclosure reflecting their belief that the market
IAS 36 requires a number of specific rates for separate asset classes were Very few in the sample provided
disclosures, but perhaps most importantly: different. sensitivity analysis in sufficient detail
that aid users of accounts to assess
• a description of the cash-generating Just under a half of our sample the strength of long-term forecasts.
units; disclosed indicative growth rates used
for impairment calculations. Here the
• whether the recoverable amount is
range was even wider, with one
based on fair value or value in use; and

• the assumptions underpinning
the recoverable amount (such as
discount rates).


4. Leasing
Leases are commonplace in the shipping industry – both as a source of capital
to fund new build programmes and second-hand purchases and also as a
regular way to do business through bare-boat and time-charter arrangements.

Lease accounting issues have focussed • Purchase options – the existence IFRS requires companies to assess the
on the judgment of whether of a purchase option that is expected relative weight of evidence given the
arrangements are “on” or “off” balance (at the start of the lease term) to be above factors, and KPMG believe an
sheet. As we will see later in this exercised means that legal title is overall assessment of the transfer of
section, new accounting proposals expected to transfer. If the option risk and reward should be made.
mean that this distinction is likely to price is expected to be below market,
be removed, and perhaps accounting this may indicate that the lessee will Economic vs useful life
for both lessors and lessees is about to exercise it; An asset’s economic life may be longer
get far more complex. than its useful life. The economic life is
• Major part of economic life – if the the period over which the asset is
Operating vs finance leases lease term is for the major part of the expected to be usable. The useful life is
asset’s economic life, then the the period over which the economic
Under existing accounting standards
agreement would normally be benefits of the asset are expected to be
(IAS 17 Leases) the assessment of
classified as a finance lease; consumed by the lessee.
whether a lease is a finance or operating
lease depends on whether substantially • Present value test – if at the start of
all of the risks and rewards incidental to Present value test and minimum
the lease the present value of the
ownership of the leased asset have been lease payments
minimum lease payments amounts to
transferred from the lessor to the lessee. substantially all of the fair value of the Minimum lease payments are those
leased asset, then the agreement is payments that the lessee is, or can be,
Under a finance lease, the lessor required to make to the lessor over the
normally classified as a finance lease;
recognises a finance lease receivable lease term and include:
and
and the lessee a finance lease liability
for future lease payments. Under an • Specialised nature of the asset • Residual value payments – from the
operating lease both parties treat the – if the asset is customised in such a lessee’s perspective, this includes any
lease as an executory contract with way that only the lessee can use it amount guaranteed by the lessee or a
rentals being recognised in the income without major modification, then this is party related to it and from the lessor’s
statement over the term of the lease on a a factor in concluding on a finance perspective this includes any residual
straight line basis. Under a finance lease lease arrangement. guarantees of an unrelated third party;
of a vessel the lessee recognises an and
asset on its balance sheet, and under an Supplemental indicators that suggest a
finance lease include: • The exercise price of a purchase
operating lease, the asset remains on the
option – to the extent it is reasonably
balance sheet of the lessor.
• the lessee can cancel the lease but the certain at the inception of the lease
Distinguishing between a finance and lessor’s losses are borne by the lessee; that it will be exercised (and would also
operating lease can be challenging in include a put option under which the
• gains and losses on the residual value lessor can require the lessee to
some circumstances. The following are
fall to the lessee; and purchase the asset at the end of the
key indicators of a finance lease:
lease as this functions economically
• the lessee can extend the lease at
• Transfer of ownership – if legal as a residual value guarantee).
below market rent.
ownership of the asset transfers to the
lessee either during or at the end of the
lease, then the agreement usually will
be classified as a finance lease;


Contingent rents are excluded from the When modifying terms, a company is Tax variation clauses
minimum lease payments. Costs for required to test whether the lease would
Some leases outside a tonnage tax
services and taxes to be paid by and have been classified differently if the
regime allow the lessor to obtain
reimbursed to the lessor (including modification had been in effect at the
a tax benefit that is passed to the lessee
amounts for repairs and maintenance) inception of the lease. If the modified
in the form of reduced rentals. Most of
are also excluded. If payments due terms would have resulted in a different
these arrangements contain a variation
under a lease include charges that are classification based on the original
clause so that any tax disadvantage
reimbursements for expenditures paid estimates and circumstances, then the
suffered by the lessor as a result of
by the lessor on behalf of the lease, then modified agreement is regarded as a
changes in tax law or rates will be
such elements are separated from the new lease, and is classified in accordance
compensated by an increase in future
minimum lease payments based on the with the modified terms, based on
lease payments. IFRS does not contain
relative fair values of the components estimates at the modification date.
specific guidance on whether to account
of the arrangement.
In the scenario where the lessee gives for amendments retrospectively or
IFRS has no bright line for its present notice of its intention to exercise a prospectively and in our view, the method
value test (unlike US GAAP which uses renewal option (which it did not anticipate applied should reflect the nature of the
a threshold of 90% or more of the fair making at the inception of the lease), clause and whether the effect of the tax
value of the leased asset). it may be acceptable to account for the change is retrospective or prospective.
secondary lease period as a new lease
Residual value guarantees either from the date of notice or the first
The definition of minimum lease payments day of the new lease. The classification
for a lessor also includes any residual of the new lease may be different from
value guaranteed by a financially capable the original lease classification. In certain
independent party, whereas the lessee circumstances, a secondary lease period
includes only amounts guaranteed by or option may be added to the original
the lessee and the parties related to lease part way through the initial lease
the lessee. term. In such cases, it may be acceptable
to reconsider the classification of the
Initially the lessor records a finance lease based on the new provisions,
lease receivable at the amount of its either at inception of the original lease
net investment, which comprises the or at the date the change is made.
present value of the minimum lease
payments and any unguaranteed residual Renewing the lease does not, in itself,
value accruing to the lessor. The present result in a modification. But care is
value is calculated by discounting the needed when the renewal does result
minimum lease payments due and any in changes to some of the original lease
unguaranteed residual value, at the terms (which could include the basis
interest rate implicit in the lease. Initial of rental payments) as this could result
direct costs are included in the calculation in a modification. The area of
of the finance lease receivable, because modifications is complex and there is
the interest rate implicit in the lease, little specific guidance available.
used for discounting the minimum
lease payments, takes initial direct Profit share arrangements
costs incurred into consideration. Certain charter agreements provide
for the parties to share the “profit”
Subsequent changes to leases between the charter and spot rate.
Leases are not reclassified for changes This is to compensate the parties
in estimate (e.g. of the economic life for locking in longer-term arrangements.
or residual value) or changes in Where such contingent clauses exist,
circumstance (e.g. default of the lessee these may be recognised when
or the likelihood that the lessee will certain and in the period to which
renew a lease), but modification of key they relate.
terms may result in the company having
to account for a new lease.


Sale and leaseback transactions Special purposes entities defined by reference to control of the
infrastructure. An agreement between
When a sale and leaseback results in a Under some lease arrangements vessels
“Grantor” (typically a government
finance lease, any gain on the sale is can be transferred to special purpose
authority or agency) and “Operator” (the
deferred and recognised as income over entities (“SPEs”), and then leased back.
private-sector entity using the
the lease term. These SPEs usually have limited activity
infrastructure) is within the scope of
other than the lease of the vessel and the
If the leaseback is classified as an IFRIC 12 if:
servicing of debt finance, and therefore
operating lease then any gain or loss is may be operating on “auto-pilot” .
recognised immediately if the agreement Determining whether such SPEs are 1. The Grantor controls what services
terms are clearly at fair value. If the sale subject to consolidation requires the operator must provide with the
price is above fair value, then any gain is judgments that take into account specific infrastructure;
deferred and amortised. If the sale price facts and circumstances (see section 5).
is below fair value then the gain or loss is 2. The Grantor controls to whom it
recognised immediately, unless it is Service concession arrangements or must provide the services;
compensated by below-market future arrangements that contain a lease
rentals. In these scenarios, gains are 3. The Grantor controls (or regulates) at
In our experience certain port operating what price services are charged; and
deferred and amortised.
agreements fall within the scope of IFRIC
12 Service Concession Arrangements. 4. The Grantor controls through
IFRIC 12 does not define public-to-private ownership, beneficial entitlement or
service concession arrangements, but it otherwise, any significant residual
describes typical “features” of such interest in the infrastructure at the
arrangements. The scope of IFRIC 12 is end of the concession term.


Certain arrangements may contain some Disclosure
of the characteristics of a public-to-private Experience in practice?
IAS 17 requires that lessors and lessees
service concession arrangement but be
disclose the following for operating
outside of the scope of IFRIC 12. For
leases: Four companies mentioned service
example, this may be a case if the Grantor
does not control prices charged by the • The future minimum lease payments concession arrangements (or similar)
Operator or any significant residual (or receipts) under non-cancellable and noted that these may give rise to
interest in the infrastructure. operating leases in aggregate for each financial assets (i.e. the companies
of the following periods: recognised financial assets rather
For the purposes of IFRIC 12, it is than PPE). No company in our
sufficient for the price to be regulated by – not later than one year; sample specifically referred to IFRIC
the Grantor – either through a capping 4 within accounting policy sections
mechanism or an approval process. – later than one year and not later as policy issue.
We find that price control is often than five years;
retained by the Grantor where it is Some basic disclosure around the
– later than five years; companies as lessors was available,
exposed to volume risk (i.e. is taking a
variable fee). however it was not possible to
• Total contingent rents recognised as an
assess the consequential impact
expense (or income) in the period; and
Accounting under IFRIC 12 is complex, of any adoption of the new leasing
and may result in the recognition of • A general description of the company’s proposals.
intangible assets (being the “right to leasing arrangements.
use”) and a liability for the payments to
the Grantor. Port concession rights may
also relate to certain items of PPE which
are classified as intangible assets.

Where an arrangement is outside the
scope of IFRIC 12, companies need to
consider the requirements of IFRIC 4
Determining whether an Arrangement
contains a Lease and IAS 17.


On the horizon
But all of this is about to change... The key proposals at the time of issuing
this publication are outlined below. The
The IASB and the US FASB (the Boards) broad principles are likely to remain and
continue their deliberations over a new will have significant ramifications for
accounting model for lease accounting. shipping companies in the future.
The Boards remain committed to bringing
all leases on balance sheet, but the finer
points of the proposals are still being
fleshed out, with another comment
period expected sometime in late 2012.

Area Consequence

Identifying leases and embedded leases… All leases (operating and financing) would be brought on balance sheet for lessees.
being a contract that: Short leases (less than 12 months) are likely to be scoped out, but longer term arrangements and bare-boat
• Conveys the right to use a specified asset; charters are likely to be within scope.
and Distinguishing between a lease and a service and the interchangeability of assets to fulfil contracts would
• Conveys the right to control the use of the become key judgments. Contracts of affreightment may continue to be off-balance sheet.
underlying asset

Lease classification test The proposed test is based upon the extent of consumption of the underlying asset (ie whether the lessee
acquires more than an insignificant portion of the utility of the underlying asset). For assets other than
investment property, the lessee will apply the accelerated model and the lessor will apply the receivable and
residual model, unless consumption is insignificant. If consumption is insignificant, then the lessee will apply a
straight-line model and the lessor will apply an approach similar to current operating lease accounting.

Accounting for lessees A lessee would recognise a right of use (“ROU”) asset and a lease liability.
For the straight-line model, lessees would measure the lease liability at amortised cost, recognise the
total lease expense on a straight line basis as a single-line income statement item and adjust the carrying
amount of the ROU asset by the difference between the total lease expense and the interest expense on
the lease liability.
Those applying the accelerated model would measure the lease liability at amortised cost, recognising
interest expense in the income statement, amortise the ROU asset generally on a straight-line basis,
recognising amortisation expense in the income statement, and thereby recognise the total lease expense
on an accelerated basis.

Accounting for lessors Under the receivable and residual model, the lessor would recognise a lease receivable and a residual asset on
lease commencement, measure the lease receivable initially at the present value of the lease payments,
measure the residual asset as an allocation of the carrying amount of the underlying asset,
and recognise interest income over the lease term, resulting in an accelerated income recognition.
Under the operating lease model, the lessor would continue to recognise the underlying asset and recognise
lease payments on a straight line basis.

Determining the discount rate The rate would be that implicit in the contract, which would result in a contract specific
(rather than portfolio) approach.

Variable lease payments Variable lease payments based upon indices would be calculated at the spot rate on commencement of the
lease.
Actual variable lease payments arising in the year but not included in the initial assessment would be recognised
as an expense as incurred and the lease liability would be reassessed to reflect the closing spot rate.

Initial direct costs These would be included in the carrying amount of the ROU asset.

Transition Companies would need to decide whether to apply the requirements fully retrospectively or prospectively from
adoption date.


Consolidation and
5. joint arrangements
A new suite of standards issued in 2011 may have a significant impact
on shipping companies. IFRS 10 Consolidated Financial Statements, IFRS 11
Joint Arrangements and IFRS 12 Disclosure of Interests in Other Entities set out
requirements for consolidation, joint arrangements and relevant disclosures.

These standards are effective for The concept of control under IFRS 10 is savings. The investor needs to have
periods beginning on or after not identical to the definition of control exposure or rights to variable returns
1 January 2013, with early adoption under current standards. An investor from its involvement. Power considers
possible. The effective date for controls an investee when it is exposed, the existing rights that give the ability
companies applying IFRSs as adopted or has rights, to variable returns from its to direct relevant activities, i.e. those
in the EU may be on or after 1 January involvement with the investee and has that significantly impact the investee’s
2014, subject to finalisation of the the ability to affect those returns through returns. IFRS 10 explicitly includes the
endorsement process. Rather than its power over the investee. concept of de facto control which can
looking backwards this section result in consolidation of entities with
focusses solely on the new Returns are defined broadly and include less than majority of voting rights.
requirements. not just the ownership benefits such as An investor needs to have the ability
dividends but also fees, remuneration, to use its power over the investee to
tax benefits, economies of scale and cost affect its returns.


Figure 2: Control model

Identify the investee (legal entity or silo)

Identify the relevant activities of the investee

Identify how decisions about the relevant activities are made

Voting rights Other rights

Consider
Majority of Less than a majority
voting rights of voting rights
Purpose and design
Link
Consider Consider between
Evidence of practical
power and
ability to direct
Rights held Agreements with returns?
by others other vote holders
Special relationships
Other contractual
agreements
Large exposure to
variability in returns
Potential voting rights/
“de facto” power

Exposure to variability in returns?

Source: First Impressions: Consolidated financial statements, May 2011, KPMG IFRG Limited.


Voting and other rights When holder of voting rights as a group Joint arrangements
do not have the ability to significantly
There is a gating question in the control Under IFRS 11, joint arrangements are
affect the investee’s returns, the investor
model, which is to consider whether essentially defined in the same way as
considers the purpose and design of the
voting rights or rights other than voting under IAS 31 Interests in Joint Ventures;
investee as well as the following factors:
rights are relevant when assessing however, the classification of joint
whether the investor has power over • evidence that the investor has the arrangements, which affects the
the investee. This judgment needs to practical ability to direct the relevant accounting, has changed to:
consider the substantive rights activities unilaterally (this being the
exercisable when decisions about the • Joint operations, whereby the parties
factor with the greatest weight);
relevant activities need to be made and with joint control have rights to the
whether the holder has the practical • indications that the investor has a assets and obligations for the liabilities,
ability to exercise the rights. special relationship with the investee; relating to the arrangement; and
and
An investor can have power over an • Joint ventures, whereby the parties
investee when the relevant activities • whether the investor has a large with joint control have rights to the net
are directed through voting rights in exposure to variability in returns. assets of the arrangement.
the following circumstances:
In considering special relationships, The key to determining the type of the
• the investor holds the majority of IFRS 10 requires companies to consider arrangements, and therefore the
the voting rights and these are (amongst other factors) whether the subsequent accounting, is the rights and
substantive; or investee’s operations are dependent obligations of the parties arising from the
upon the investor and a significant arrangements in the normal course of
• the investor holds less than half the proportion of the investee’s operations business. If a joint arrangement is
voting rights but has arrangements are conducted on behalf of determined to be a joint operation,
which allow unilateral direction of the the investor. then the joint operator accounts for its
relevant activities of the investee. own assets, liabilities and transactions,
These considerations are likely to touch including its share of those incurred
on a number of industry issues, including jointly. If a joint arrangement is determined
terminal activities that are conducted to be a joint venture, then the joint venture
through a joint venture whilst one of accounts for its investment using the
the investor is responsible for a equity method; the free choice between
considerable amount of the terminal using the equity method or proportionate
traffic. Any analysis will be specific to the consolidation has been eliminated.
facts and circumstances of the
agreements and activities of the investee.

Figure 3:The decision tree for classifying a joint arrangement

Is the arrangement structured through a vehicle that is separate from the parties?
Structure No

Yes

Legal Does the legal form of the separate vehicle give the parties rights to the assets
Yes
form and obligations for the liabilities of the arrangement?

No Joint
operation

Contractual Do the contractual arrangements give the parties rights to the assets and
Yes
arrangement obligations for the liabilities of the arrangement?

No

Do the parties have rights to substantially all of the economic benefits of the
Other facts and
assets relating to the arrangement; and does the arrangement depend on the Yes
circumstances
parties on a continuous basis for settling its liabilities?

No

Joint venture

Source: First Impressions: Joint arrangements, May 2011, KPMG IFRG Limited.


Pool arrangements Disclosure The disclosures may be aggregated for
interests in similar entities with the
Pool arrangements are commonplace in The increased level of disclosures
method of aggregation being disclosed.
the shipping industry – they provide a required by IFRS 12 (as compared to
Suitable characteristics for aggregation
mechanism for sharing risk, by operating current practice) has been driven, in part,
may include nature or geography.
contributed assets as a cohesive fleet and by the IASB’s review of the impact of the
However, joint arrangements cannot be
collecting and distributing earnings under 2008 financial crisis. Stakeholders were
aggregated with associates.
a pre-arranged points-weighting system. concerned about off-balance sheet SPEs
and a lack of transparency over critical
Typically there are three types of pool accounting judgements. The objective
structure that are accounted for of IFRS 12 is to help users of accounts Experience in practice?
differently. The company: evaluate the nature of, and risks
associated with, an entity’s interests
• controls the pool – the pool is Nearly one half of our sample had
in other entities and the effects of
consolidated; some involvement in pool
those interests on financial position,
arrangements and the majority of
• is a joint operator of the pool – the performance and cash flow.
these were treated as joint
company’s share of revenue, costs,
IFRS 12 requires: arrangements.
assets and liabilities is recognised; or
• disclosures about significant
• is chartering the vessel into a pool
judgments and assumptions made in
operation, and recognises the net
determining control, significant
income from this charter arrangement.
influence or joint control, in particular
Different pool arrangements require where a company holds more than half
a careful consideration of all specific the voting shares of another and does
terms, facts and circumstances, as their not consolidate, it needs to explain
classification would affect the accounting why;
outcome.
• disclosures about interests in
Most pools in the shipping industry are subsidiaries, joint ventures, joint
not structured through a separate legal arrangements and associates such as
entity (or an entity recognised by some name, nature of interest, dividends and
other form of statute) and therefore summarised financial information;
would more likely be classified as joint
• nature and extent of significant
operations rather than joint ventures.
restrictions on investor’s ability to
The accounting outcome will reflect
access or use assets and settle
the aim of pooling – revenue and cost
liabilities; and
sharing that protects the return on the
company’s asset. • specific disclosures for structured
entities (whether consolidated or
Frequently, the pool participants appoint
unconsolidated).
a pool manager. Power to control arises
from rights – these include current and
potential voting rights and decision-
making rights arising from a management
contract. Here, the critical aspect is
whether the manager is permitted to use
these additional rights to its own benefit.
If the manager is merely as an agent
(i.e. is using the delegated powers for
the benefit of all), its remuneration is
“at market” (i.e. is commensurate with
services provided) and has no unusual
decision-making authorities it is unlikely
that being the pool manager will affect
the accounting outcome.


6. Revenue and costs
Revenue is recognised only if it is probable that future economic benefits will
flow to the entity and these benefits can be measured reliably.

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