Carnival Cruises 2007 Annual Report Download - page 37

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
34 | CARNIVAL CORPORATION & PLC
maintenance and minor improvement costs as they are
incurred. Finally, when we record the retirement of a ship
component that is included within the ship’s cost basis, we
may have to estimate its net book value to determine the
amount of ship component retired.
We determine the average useful life of our ships and
their residual values based primarily on our estimates of the
weighted-average useful lives and residual values of the ships’
major component systems, such as cabins, main diesels, main
electric, superstructure and hull. In addition, we consider,
among other things, long-term vacation market conditions and
competition and historical useful lives of similarly-built ships.
We have estimated our new ships’ average useful lives at 30
years and their average residual values at 15% of our original
ship cost.
Given the very large and complex nature of our ships, ship
accounting estimates require considerable judgment and are
inherently uncertain. We do not have cost segregation studies
performed to specifically componentize our ships. In addition,
since we do not separately componentize our ships, we do
not identify and track depreciation of specific original ship
components. Therefore, we have to estimate the net book
value of components that are replaced or refurbished, based
primarily upon their replacement or refurbishment cost and
their age.
If materially different conditions existed, or if we materially
changed our assumptions of ship lives and residual values, our
depreciation expense or loss on replacement or refurbishment
of ship assets and net book value of our ships would be mate-
rially different. In addition, if we change our assumptions in
making our determinations as to whether improvements to a
ship add value, the amounts we expense each year as repair
and maintenance costs could increase, partially offset by a
decrease in depreciation expense, as less costs would have
been initially capitalized to our ships. Our fiscal 2007 ship
depreciation expense would have increased by approximately
$26 million for every year we reduced our estimated average
30 year ship useful life. In addition, if our ships were estimated
to have no residual value, our fiscal 2007 depreciation expense
would have increased by approximately $133 million.
We believe that the estimates we made for ship account-
ing purposes are reasonable and our methods are consistently
applied in all material respects and, accordingly, result in
depreciation expense that is based on a rational and systematic
method to equitably allocate the costs of our ships to the
periods during which services are obtained from their use.
In addition, we believe that the estimates we made are rea-
sonable and our methods consistently applied in all material
respects (1) in determining the average useful life and average
residual values of our ships; (2) in determining which ship
improvement costs add value to our ships; and (3) in deter-
mining the net book value of ship component assets being
replaced or refurbished. Finally, we believe our critical ship
accounting estimates are generally comparable with those of
other major cruise companies.
Asset Impairment
The impairment reviews of our ships, goodwill and trade-
marks, which has been allocated to our cruise line reporting
units, require us to make significant estimates to determine
the fair values of these assets or reporting units.
The determination of fair value includes numerous uncer-
tainties, unless a viable actively traded market exists for the
asset or for a comparable reporting unit, which is usually
not the case for cruise ships, cruise lines and trademarks.
For example, in determining fair values of ships utilizing dis-
counted forecasted cash flows, significant judgments are made
concerning, among other things, future net revenue yields,
net cruise costs per ALBD, interest and discount rates, cruise
itineraries, technological changes, consumer demand, govern-
mental regulations and the effects of competition. In addition,
third party appraisers are sometimes used to determine fair
values of ships and cruise lines and some of their valuation
methodologies are also subject to similar types of uncertain-
ties. Also, the determination of fair values of cruise line report-
ing units using a price earnings multiple approach also requires
significant judgments, such as determining reasonable multi-
ples. Finally, determining trademark fair values also requires
significant judgments in determining both the estimated
trademark cash flows, and the appropriate royalty rates to
be applied to those cash flows to determine their fair value.
We believe that we have made reasonable estimates and
judgments in determining whether our ships, goodwill and
trademarks have been impaired. However, if there is a mate-
rial change in the assumptions used in our determination of
fair value or if there is a material change in the conditions or
circumstances influencing fair value, we could be required
to recognize a material impairment charge.