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…
FASB 360-10-35-17 states that a “loss shall be recognized only if the carrying amount...exceeds its fair value.” Using the new probabilities, the UFCF is exactly equal to the current carrying value and by definition does not qualify as impaired.

Greater examination of factors, both qualitative and quantitative, that affect the future cash flows and the fair value is necessary in order to more clearly determine whether or not the assets will be recoverable under these secondary probabilities. As mentioned above in the background, the effect of the impairment loss on the financial statements may impact the decisions made by its users, so Smooth Sailing must become more certain about the probabilities that each indicated cash flow will occur.

For both above-mentioned probability alternatives, it is important to also consider when to check for impairment. According to FASB 360-10-35-21, an asset should be “tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable.” For example, if Smooth Sailing’s estimates change due to changes in pirate circumstances, a re-evaluation of impairment will be necessary.

Other GAAP Alternatives: In the preliminary brainstorming process, we considered many other accounting alternatives. However, during the researching phase, we did not find any supporting