Weighing the accounting implications of IMO 2020
The market is expecting that some 3,000 vessels in service will have scrubbers installed by the time the IMO 2020 regulation comes into effect from 1 January 2020. The alternative course will be to operate vessels without scrubbers and consume low-sulphur bunkers, or other compliant fuels, which are expected to be more expensive. As well as the commercial implications of the need to comply with IMO 2020, ship-owners and operators need to consider the accounting implications.
From a ship-owner’s perspective, where a decision is taken to retrofit scrubbers any directly attributable costs can only be capitalised if it is probable that future economic benefits associated with the retrofit will flow to the entity. So before capitalising, the ship-owner would need to perform an assessment that there will be a net benefit from installing the scrubbers in the form of expected fuel costs savings or higher freight rates. General expectation is that such costs are expected to be capitalised and depreciated over the remaining life of the vessel in accordance with IAS 16 Property, Plant and Equipment. This depreciation period assumes that the scrubbers will last for the same period of time as the vessel to which they are fitted.
The availability and pricing of low-sulphur bunkers in the future, together with the uncertainty of whether freight rates or time charter rates will increase to offset the more expensive low-sulphur bunkers or the cost of scrubbers, are factors that ship-owners will need to consider when performing annual impairment review and useful life assessments
BDO’s latest shipping confidence survey results showed that 26% of respondents expected the price differential between high-sulphur fuel oil and IMO-compliant low-sulphur fuel oil at 1 January 2020 to be between $175 and $249 per metric tonne. This compares to the 23% who thought likewise in November 2018. Meanwhile 24% put the figure at between $100 and $174, compared to 12% previously, while 17% estimated the differential at between $250 and $324 compared to 24% last time. These results are consistent with the current price spread between high-sulphur fuel oil and low-sulphur fuel oil estimated to be around $200 per metric tonne, according to Clarksons Platou Futures. The surge in demand for low-sulphur fuel, coupled with concerns about refinery capacity, is likely to result in price spikes and volatility while the market settles out. Therefore, the current market trends and expectations of the bunker price differential, between the cost of low-sulphur fuel and high-sulphur fuel, seem to be commercially supportive of investment in scrubbers.
Where the costs to install scrubbers have been incurred and capitalised, should indicators of impairment arise resulting in the need to perform an impairment review based on a value-in-use assessment, the discounted future cash flow projections will need to include estimates for the expected freight and charter rates.
Many major carriers have announced their decision to implement fuel surcharges, bunker adjustment factors or other ways to pass on the higher cost of lower sulphur fuel to their customers. This means that currently owners operating their vessels under voyage charter arrangements, with a responsibility to bear the fuel costs, are expecting freight rates to rise which is likely to increase the margins earned by scrubber fitted vessels due to their lower fuel costs. In time charter arrangements, where the charterer bears the costs of fuel, the owners of scrubber fitted vessels are expecting an increase in the charter rates as these vessels will have lower fuel costs for the charterers. However, the ability of the owners to increase the freight or charter rates is yet to be seen and the actual impact on markets post 1 January 2020 will provide the final verdict on impairment review assessments.
Management will need to consider if such estimation uncertainties are material and will need to provide additional disclosures in the financial statements as to how estimates and judgments are formed about the impact of IMO 2020 on future cash flows projections.