Q3b – December 2014

Extract from question:
‘Kayte keeps some of the vessels for the whole 30 years and these vessels are required to undergo an engine overhaul in dry dock every 10 years to restore their service potential, hence the reason why some of the vessels are sold. The residual value of the vessels kept for 30 years is based upon the steel value of the vessel at the end of its economic life. At the time of purchase, the service potential which will be required to be restored by the engine overhaul is measured based on the cost as if it had been performed at the time of the purchase of the vessel.

In the current period, one of the vessels had to have its engine totally replaced after only eight years. Normally, engines last for the 30-year economic life if overhauled every 10 years. Additionally, one type of vessel was having its funnels replaced after 15 years but the funnels had not been depreciated separately”

The question asks for the accounting treatment of the above and the answer mentions:

“As regards the vessels which are kept for the whole of their economic life, a residual value based upon the scrap value of steel is acceptable. Therefore the vessels should be depreciated based upon the cost less the scrap value of steel over the 30-year period. The engine need not be componentised as it will have the same 30-year life if maintained every 10 years. It is likely that the cost of major planned maintenance will increase over the life of a vessel due to inflation and the age of the vessel. This additional cost will be capitalised when incurred and therefore the depreciation charge on these components may be greater in the later stages of a vessel’s life.

When major planned maintenance work is to be undertaken, the cost should be capitalised. The engine overhaul will be capitalised as a new asset which will then be depreciated over the 10-year period to the next overhaul. The depreciation of the original capitalised amount will typically be calculated such that it had a net book value of nil when the overhaul is undertaken.

This is not the case with one vessel, because work was required earlier than expected. In this case, any remaining net book value of the old engine and overhaul cost should be expensed immediately.”

My queries:
1. why would the nbv considered nil when the overhaul is undertaken since the vessel can be sold for scrap metal (as mentioned in another part of the answer)

2. the answer mentions that because work was required earlier than expected that cost should be expensed, however that work would add economic value so then why is it not capitalised?

3. from what i have read in study texts, etc i thought this would be similar to the airplane example where componentization takes place , however the vessel was depreciated as a whole unit. My question is how would you know when to componentize and depreciate?