Question

You are the current "up-and-coming" corporate controller for a publicly traded company called Spartan Cruises, Inc. and as such, report to the CFO Tom Harris who in turn reports to the CEO Michele Lowry.

Spartan Cruises, headquartered in Miami, offers upscale cruises primarily to US citizens out of three ports as follows:

1.      15 ships operating out of Miami with Caribbean itineraries that are very profitable.

2.      10 ships operating out of Barcelona Spain with Mediterranean itineraries that are modestly profitable.

3.      5 ships operating out of Sydney Australia with Australian coast and New Zealand itineraries that are effectively break even from a financial perspective.

All 30 ships cost approximately $150.00 million/ship and are depreciated on a straight line basis over 10 years (with no residual or salvage value) - the 15 operating out of Miami are relatively new, the 10 operating out of Barcelona are 5 years old, and the 5 ships operating out of Sydney are much older and fully depreciated.

In addition, Spartan Cruises had previously signed contracts to purchase 3 additional ships at $150.0 million/ship that were scheduled to be delivered to Miami in mid-2022 but as of today, construction has not commenced. As part of the contract signing process for each ship, Spartan Cruises made a good-faith non-refundable deposit of $20.0 million/ship and recorded a combined asset of $60 million on their balance sheet.

Late last week, CFO Tom and CEO Michele attended a high-level economic summit in New York City and during the conference, credible market experts predicted that the cruise industry is about to go through permanent economic contraction and as such, will no longer enjoy the demand and revenue levels it enjoyed in recent years. Specifically, the experts predict that cruise industry revenues will be 70% lower than what the industry was otherwise anticipating over the next five years due primarily to the pandemic vulnerability passengers are exposed to as evidenced by the recent well-publicized coronavirus (something Spartan Cruises was fortunate to totally avoid).

On the private plane ride back from New York, Tom and Michele discussed how Spartan Cruises was going to adapt to this new reality given that the Barcelona & Sydney operations will probably become very unprofitable as incoming cash flow from cruise sales is expected to effectively evaporate.

Tom and Michele are considering discontinuing the Barcelona and Sydney operations, and cancelling the orders for the 3 new ships, and have asked you to quantify on a macro perspective what the financial impact would be if the Spartan Cruises Board of Directors decided to move in that direction and announce these discontinued operations before the end of the March 31 first quarter.

Q1.

what the effect might be for reflecting these "impairment issues" into the March 31, 2020 first quarter income statement

Q2.

other financial considerations that management might take into account when deciding on this potential action.

Answer 1

Q1. Due to these developments, cancelling the contract for the new ships would result in an expense of $60 million due to non-refundable deposit in the march ended quarter. Also the boats in Barcelona with a remaining life of 5 years with and combined WDV of $750 million($75 million * 10 ships) would have to be revalued at a fair market price if they are no longer to be used for generating income unless they are transferred to the Miami operations where they will be used for further economic activity.

Q2. Other considerations:

-Future demand estimate. Is demand in the future after the coronavirus crisis estimated to return to pre-virus levels, if so the company can hold out on cancelling new boat purchases and avoid losing 60 million if the new ships will be required in the future.

-Profit from Barcelona operations. If the ships in Barcelona still have half their lives left and that operation is modestly profitable, the operations should be temporarily halted due to the coronavirus crisis instead of permanently discontinuing operations so that income can be earned in the future and remaining life of the ships can be utilised.