Warwick Merchants Fleet: An Integrative Case

WARWICK MERCHANTS FLEET 2013Diane Crump, CPA and audit partner with Gayle & Fisher (a regional northeastern CPA firm) sits at a table in the Crow's Nest, a commercial fishing and merchant marine hang-out in the coastal town of Closter, Massachusetts. It is late November and there is a definite chill in the air. Across the table is Michael Still, Chief Financial Officer of WM Fleet division of World Ocean Logistics (WOL). Diane is continuing a discussion with Michael that began a few weeks ago as part of the initial planning for the audit of WOL for 2013. WOL owns and operates a fleet of seven large ocean-going freighters, which they refer to as the Warwick Merchants Fleet (WM). The seven freighters were purchased in early 2010 for $66 million each from HH Heavy Industries and represent the latest in freighter technology. The fleet has an expected useful life of thirty years, and each ship can be salvaged for an estimated $1.2 million. The WM fleet is a class of freighters called container ships which are designed in such a manner that no space is wasted. Their capacity is measured in TEUs (Twenty-foot equivalent units). This is the number of 20-foot containers that a vessel can carry. Informally known as "box boats," boats like the WM fleet carry the majority of the world's dry cargo, meaning manufactured goods. Each vessel in the WM fleet is propelled by a single MAN B&W K108ME-C diesel engine and has crews of 30 to 40 people. They have large accommodation blocks at their stems, directly above the engine rooms. The WM ships carry up to 12,000 containers on a voyage. The total value of their cargo can reach $250 million. Each boat is nearly 430 yards long, 54 yards wide and has a top speed of 25 knots, driven by a 10-meter in diameter, 130-ton propeller.Diane and Michael are involved in a discussion of the accounting treatment of the WM fleet's maintenance costs, a discussion which has become something of a disagreement. Diane senses Michael's growing frustration and is anxious to make peace."Look Michael, if WOL management is dead set on allocating a part of the painting costs to each and every accounting period, I'll do what I can. But I'm going to have to find some support. The senior partners are pretty serious about representational faithfulness, and, well, in my discussions, they just don't think, well, they just don't think allocating is a correct way to measure periodic performance. Besides, why has this all of a sudden become such an issue? You have always just expensed the maintenance costs as incurred."Michael's blood pressure seemed to rise. The peace offering, if it was one, was not successful. Michael's voice seemed more agitated. "Diane, the matching principle is one of the most pervasive and respected postulates in accounting. We are only trying to match the costs of painting to the revenues earned each accounting period. Everyone agrees, you included, that each and every accounting period benefits from the painting. Why then, is it not proper to allocate these costs to each accounting period?"The painting costs being discussed are a major operating expense of the WM fleet. With hulls constructed of a newly developed alloy that includes an increased mix of metals subject to oxidation, a special paint/sealer is required to be applied every four years. Painting each freighter requires approximately 180,000 gallons of the paint/sealer at a current cost of $18 per gallon, plus the labor costs of the sub-contracted painters, which is currently estimated to be $800,000 per freighter, bringing total painting costs to about $4 million per freighter. This means once every four years, currently scheduled for January 2014, WOL must spend $28 million to paint the fleet. These costs are considered material to the cost of the freighters and to the historical annual fleet gross revenues of approximately $600 million.Diane responded to Michael's question. "Michael, maybe it is proper. …