Royal Caribbean Cruise Lines 2014 Annual Report Download - page 42

Royal Caribbean Cruises Ltd. 41
PART II
and our knowledge of the cruise vacation industry.
We do not identify and track depreciation by ship
component systems, but instead utilize these esti-
mates to determine the net cost basis of assets
replaced or refurbished. Improvement costs that we
believe add value to our ships are capitalized as addi-
tions to the ship and depreciated over the shorter of
the improvements’ estimated useful lives or that of
the associated ship. The estimated cost and accumu-
lated depreciation of replaced or refurbished ship
components are written off and any resulting losses
are recognized in cruise operating expenses.
We use the deferral method to account for drydock-
ing costs. Under the deferral method, drydocking
costs incurred are deferred and charged to expense
on a straight-line basis over the period to the next
scheduled drydock, which we estimate to be a period
of thirty to sixty months based on the vessel’s age
as required by Class. Deferred drydock costs consist
of the costs to drydock the vessel and other costs
incurred in connection with the drydock which are
necessary to maintain the vessel’s Class certification.
Class certification is necessary in order for our cruise
ships to be flagged in a specific country, obtain lia-
bility insurance and legally operate as passenger
cruise ships. The activities associated with those dry-
docking costs cannot be performed while the vessel
is in service and, as such, are done during a drydock
as a planned major maintenance activity. The signifi-
cant deferred drydock costs consist of hauling and
wharfage services provided by the drydock facility,
hull inspection and related activities (e.g., scraping,
pressure cleaning, bottom painting), maintenance to
steering propulsion, thruster equipment and ballast
tanks, port services such as tugs, pilotage and line
handling, and freight associated with these items. We
perform a detailed analysis of the various activities
performed for each drydock and only defer those
costs that are directly related to planned major main-
tenance activities necessary to maintain Class. The
costs deferred are related to activities not otherwise
routinely periodically performed to maintain a vessel’s
designed and intended operating capability. Repairs
and maintenance activities are charged to expense
as incurred.
We use judgment when estimating the period between
drydocks, which can result in adjustments to the esti-
mated amortization of drydock costs. If the vessel is
disposed of before the next drydock, the remaining
balance in deferred drydock is written-off to the gain
or loss upon disposal of vessel in the period in which
the sale takes place. We also use judgment when
identifying costs incurred during a drydock which are
necessary to maintain the vessel’s Class certification
as compared to those costs attributable to repairs
and maintenance which are expensed as incurred.
We believe we have made reasonable estimates for
ship accounting purposes. However, should certain
factors or circumstances cause us to revise our esti-
mates of ship useful lives or projected residual values,
depreciation expense could be materially higher or
lower. If circumstances cause us to change our assump-
tions in making determinations as to whether ship
improvements should be capitalized, the amounts we
expense each year as repairs and maintenance costs
could increase, partially offset by a decrease in depre-
ciation expense. If we had reduced our estimated
average 30-year ship useful life by one year, depre-
ciation expense for 2014 would have increased by
approximately $24.3 million. If our ships were esti-
mated to have no residual value, depreciation expense
for 2014 would have increased by approximately
$159.1 million.
Valuation of Goodwill, Indefinite-Lived Intangible
Assets and Long-Lived Assets
We review goodwill, trademarks and trade names,
which are our most significant indefinite-lived intangi-
ble assets, for impairment at the reporting unit level
annually or, when events or circumstances dictate,
more frequently. The impairment review for goodwill
consists of a qualitative assessment of whether it is
more-likely-than-not that a reporting unit’s fair value
is less than its carrying amount, and if necessary, a
two-step goodwill impairment test. Factors to con-
sider when performing the qualitative assessment
include general economic conditions, limitations on
accessing capital, changes in forecasted operating
results, changes in fuel prices and fluctuations in for-
eign exchange rates. If the qualitative assessment
demonstrates that it is more-likely-than-not that the
estimated fair value of the reporting unit exceeds
its carrying value, it is not necessary to perform the
two-step goodwill impairment test. We may elect
to bypass the qualitative assessment and proceed
directly to step one, for any reporting unit, in any
period. We can resume the qualitative assessment
for any reporting unit in any subsequent period.
When performing the two-step goodwill impairment
test, the fair value of the reporting unit is determined
and compared to the carrying value of the net assets
allocated to the reporting unit. We estimate the fair
value of our reporting units using a probability-
weighted discounted cash flow model. The estimation
of fair value utilizing discounted expected future cash
flows includes numerous uncertainties which require
our significant judgment when making assumptions
of expected revenues, operating costs, marketing,
selling and administrative expenses, interest rates,
ship additions and retirements as well as assumptions
regarding the cruise vacation industry’s competitive
environment and general economic and business con-
ditions, among other factors. The principal assump-
tions used in the discounted cash flow model are