Premium Essay

Rough Waters Ahead Case Study

In: Business and Management

Submitted By PennyXu
Words 2420
Pages 10
February 18, 2016
Research File Memorandum

Prepared by: Certified Public Accountants

Client: Smooth Sailing
Subject: Fair Value Accounting – Asset Impairment

Background: Smooth Sailing is a privately-held cruise operator. The company operates a sole cruise ship that was purchased using non-recourse debt from a bank. Nonrecourse debt is secured by the collateral. In the event of default, the lender can only seize the collateral and no further action can be taken against smooth sailing. Smooth Sailing believes their ship is independent of all of their other asset groups. The ship generates its own cash flows.

In the current operating year, pirates have entered the area where the cruise ship operates. As a result of this incursion, the ship experienced thirty percent lower cash flows of $1.0 million in the current year. The company does not anticipate this will change in the near-term. This change may require the company to consider an impairment loss on the asset since the fair value (future cash flows) does not exceed the carrying cost of the boat.

The boat currently carrying value is $4.6 million while the initial estimate of the fair value is $3.0 million. The debt also carries a value of $4.0 million. This initial estimate leads me to believe that this asset needs to be tested for impairment. The future cash flows should be used from the probability table (Exhibit A) in order to determine the value of the asset.

Statement of research problem or question:

What does US GAAP say about:

1. How does management perform asset impairment testing?
2. What categories of assets and liabilities should be included in the test?
3. Should an asset impairment loss be recognized?

Plausible Alternatives:

Question 1
• Compare the fair value to the book value based on market prices
• Compare recoverable discounted future cash flows to book value
•…...

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