Shipping Note Spring 2012 (1)

Shipping Note

“ Understanding the GAAP between value and net assets.”

Page 2

“ Plus ça change on revenue recognition.”

Page 2

“Confidence up but new investment appetite wanes.” Page 3

“The devil’s dictionary.” Pages 3 & 4

Shipping must adopt model guidelines

Inside

Businesses must be able to produce

properly documented and timely financial

information for their stakeholders, which

should include a view of the future. In

good times, when charter rates exceeded

operating expenses, little attention needed

to be paid to future cash flows and debt

service. But today, it is essential to be able

to anticipate, to the extent it is possible,

future cash flows and pinch points.

Dawn Webb, a Partner of Moore Stephens

Chartered Accountants says, “It is

essential to provide banks with detailed

information in the event that it becomes

clear that a company may default on the

terms of a loan. It is better still if this can

be done before any covenants are

breached or payments missed. In these

difficult times, the key is for businesses to

help banks to help them, by anticipating

defaults or breaches and presenting a

solution, rather than waiting for the

default. This cannot be achieved without

a proper financial model.

“Clearly a model is not a panacea for

difficult trading conditions but working

with a bank to present its credit

committee with a potential solution,

rather than with a problem, is more

likely to engender a positive attitude

to any restructuring.”

Spring 2012

PREC ISE . PROVEN. PERFORMANCE .

Shipping is experiencing tough times. An increasing number of companies are unable to repay, or in some cases, even service their debts. That could mean an uncomfortable meeting with the bank. But too many companies are not properly prepared for such an encounter.

Financial modelling is a key component

of any renegotiation of facilities. A viable

model, typically including integrated

balance sheet, profit and loss account

and cash flow statement, can help to

support a restructuring proposal, by

demonstrating the impact of changes on

future cash flow.

Financial modelling doesn’t change the

economic fundamentals of a business.

But it is a tool with which to identify

ways to manage the impact of a volatile

market. A good quality financial model is

also an invaluable, ongoing management

tool. It can be used to make longer-term

strategic decisions and to determine the

nature and structure of future investments

and the potential returns on investment.

Experienced, external advice can help

reduce the time and money spent on

resolving problems. Moore Stephens has

worked with companies in the shipping

industry and with their stakeholders, both

prior to and following bank intervention.

We have concluded a number of

successful independent business reviews.

Our combined corporate finance and

shipping industry expertise could make all

the difference in today’s difficult market.

[email protected]

Moore Stephens Isle of ManAudit and Consulting

Follow us on Twitter @MSIOM

Under IFRS, this does not apply, with the result that impairments

are less likely to be recorded under US GAAP than under IFRS.

One thing is for sure. If directors are going to report net assets

at substantially more than the company’s market capitalisation,

they need to be ready to explain why. While Nelson may have

seen no ships, some directors might be accused of seeing the

ships, but not the problems associated with them.

Comparing the market capitalisation of many listed shipping

companies with their reported net assets, the equity markets

seem to have decided that a number of shipping companies are

not worth the values they have been reporting in their balance

sheets. We saw a plethora of bad news affecting shipping in

late 2011, little of which will have been reflected by companies

which reported third-quarter results, and none by companies

listed on exchanges which only require six-monthly figures to

be published. This raises the question of whether the values

reported in the balance sheet can continue to be appropriate.

It matters which accounting standards are being applied. Under

US GAAP, for example, one dollar of expected profit in fifteen

years’ time is given the same weighting as a dollar of expected

profit tomorrow in deciding whether or not assets are impaired.

Understanding the GAAP between value and net assetsThe difference between a company’s value and its reported net assets can be substantial. The general rule is that companies are worth, at least, their net assets, and often substantially more. Today, that rule is being broken frequently, in shipping as much as anywhere else.

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Plus ça change on revenue recognitionThe project on accounting for revenue

had been put back, with the next

documents issued being more proposals

rather than a final standard. The revised

proposals have now been published.

The original proposals would have

changed the way in which shipping

companies recognise income, primarily

on voyage charters. This would often

have meant recognising revenue - and

profit – as voyages completed. Despite

this, they were seen as fairly small beer

since the changes were likely to be minor.

They would have led to a slight deferral

of accumulated profit over current

practice, but would have had little impact

on the results reported for each year.

The larger the fleet, the smaller the

impact would probably have been, as

voyages completed shortly before and

shortly after the end of the year would

be likely to balance out.

Even this minor change now seems

unlikely. The new proposals would

normally lead to continuation of current

accounting treatments, as the standard-

setters have reconsidered how to deal

with the provision of services, such as

shipping services. In many cases, services

will continue to be accounted for on a

time basis, and profits on voyage charters

will therefore be recognised over the

duration of the voyage.

So it looks as though accounting for

revenue is not likely to change very much

in the next few years. Now, when it comes

to leasing…

[email protected]

Moore Stephens Isle of ManAudit and Consulting

According to our latest shipping confidence survey, the average

confidence level expressed by respondents in the markets in

which they operate was 5.5 on a scale of 1 (low) to 10 (high),

marginally up on the figure of 5.4 recorded in November 2011.

The overall number of respondents expecting to make a major

investment or significant development over the next twelve

months fell, on a scale of 1 to 10, from 5.2 to 4.9 – the lowest

figure for three years.

Demand trends, competition and finance costs continued to

dominate the top three factors cited by respondents as those

likely to influence performance most significantly over the next

year. There was an 8 percentage point drop in the number of

respondents overall who expected finance costs to increase over

the next twelve months, and a 2 percentage point increase in

the number of respondents who thought that finance costs

would come down.

Respondents across all tonnage types were more confident of

rate increases than they were three months previously. In the

tanker sector, the number of respondents expecting rates to

Confidence up but new investment appetite wanes

increase over the coming year rose from 30% to 35%. In the dry

bulk sector, there was a 15 percentage point increase, to 38%, in

the overall number of respondents who thought that rates would

rise. And in the container ship market, 31% of respondents

expected rates to go up, as opposed to 23% last time.

Read the full survey report at

www.moorestephens.co.uk/shippingconfidence

Average confidence over time

Overall confidence levels in the shipping industry increased slightly in the three months ended February 2012. This is the third successive quarter in which there has been a small uptick in confidence.

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The ninth in a series looking at classic and alternative definitions

of shipping and accountancy terms.

Textbook definitionImpairment is a reduction in the value of an asset as a result of

the asset no longer generating the benefits expected earlier as

determined by a company through periodic assessments.

The alternative definition If your market capitalisation falls below net assets, you are

impaired. This is bad luck. The other possibility is that you are

lying through your teeth. But it is not the end of the world. If

you are using US GAAP, you are less likely to be impaired than

you would be if you were using IFRS, or almost any other

acronym. That’s a relief.

Shipowners are particularly susceptible to impairment. This may

be because they buy at the top of the market, sell at the

bottom, and operate at a loss for twelve months of the year.

This is called entrepreneurialism. Once shipowners have decided

that an asset is impaired, however, they can write it down.

This is better than simply trying to remember it. As long as it

is written down, they can carry on using the asset. How fair

is that?

Shipping has suffered from impairment since the Battle of

Copenhagen. Here, Nelson saw no ships and always wore a hat.

Some shipowners see the ships but don’t wear a hat at all. In

this way, they lose 90% of their body heat, according to their

mums. The remaining 10% is written down.

What the eye doesn’t see, the heart doesn’t grieve over.

The devil’s dictionary: I is for impairment

Moore Stephens Isle of ManAudit and Consulting

The tenth in a series looking at classic and alternative definitions

of shipping and accountancy terms.

Textbook definitionThe Jones Act, or Merchant Marine Act 1920, requires that

cargo moving between US ports must be carried in US-built

and registered ships owned by US citizens.

The alternative definition The Jones Act has always been a hot potato. In 1954, the Mills

Brothers had a hit single with ‘The Whole Town’s Talking About

the Jones Act’ which was only prevented from reaching number

one by the Stargazers’ version of ‘I See the Moon (the Moon

Sees Me)’. Today, Jones is a cold potato because people have

more important things to worry about.

Under the Jones Act, cabotage is all one-way, unlike in Europe.

The Americans have a better currency and nicer weather,

however. Jones also provides welfare benefits for US seafarers,

who are allowed to claim damages if they spend at least 30%

of their time working on US ships. If they are injured, they can

claim more. A whole community of Jones Act lawyers has

grown up over the years, with one leading attorney exhorting

seafarers via his website, “Don’t try to hide prior injuries or fudge.”

Critics claim that it prices US shipbuilders out of the international

market and that it hinders free trade and is particularly hard on

Hawaii. It is the only US state made up of a mixture of islands

and vowels which does not observe daylight saving, the other

being Arizona.

More is less.

The devil’s dictionary: J is for Jones Act

For more information please go to:

www.msiom.im

Follow us on Twitter: @MSIOM

Follow us on Twitter @MSIOM

Dawn Webb

[email protected]

S dawn.webb.msiom

Andrew Dixon

[email protected]

S andrew.dixon.msiom

Moore Stephens Chartered Accountants and Consulting

Limited

PO Box 25, 26-28 Athol Street

Douglas, Isle of Man, IM99 1BD British Isles

T +44 (0)1624 662020

www.msca.im

www.mscl.im

This bulletin is prepared by Moore Stephens Chartered Accountants and Moore Stephens Consulting Limited. Shipping Note is designed to keep readers abreast of current developments and trends. It is a general guide only and is not intended to be comprehensive. No liability is accepted for the opinions it contains, or for any errors or omissions. In all cases you should seek professional advice specific to your circumstances. Printed and published by © Moore Stephens Isle of Man a member firm of Moore Stephens International Limited. Moore Stephens International Limited is regarded as one of the world’s leading accounting and consulting networks with 636 member and correspondent offices in some 100 countries. April2012FA406.1

Moore Stephens Isle of ManAudit and Consulting