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Comment
1.
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We
note your response to our prior comment number 3. The fact that
you have begun labeling these costs as Planned Major Maintenance
Activities (or “PMMA”) in response to our comments does not change the
underlying nature of the large majority of the costs that you have
capitalized as drydocking; they are expenditures incurred for repair
and
maintenance that do not appreciably extend the useful life, increase
the
earning capacity, or improve the efficiency of vessels, but rather
allow
vessels to continue to be operated in their current
capacity. With respect to your reference to FSP AUGAIR-1, we
believe the guidance was intended solely to eliminate use of the
accrue-in-advance method. While we understand your effort to
analogize to the AICPA Airline Guide and its reference to the deferral
method, it is important to note that the deferral method is rarely
used in
practice by airlines. In fact, the largest airlines expense
maintenance as incurred and do not use the deferral
method. Because direct expensing, rather than deferral, is the
predominant method used in practice in the airline industry, we do
not
find your analogy to the Airline Guide’s deferral method to be a
compelling reason to allow you to capitalize non-betterment repair
and
maintenance costs incurred during drydocking. In addition, your
practice of capitalizing these repair and maintenance costs is problematic
because it implies that estimated useful lives assigned to a portion
of
your vessels’ initial costs were greater than they should have been
(built-in overhaul method). It is also problematic because it
results in inconsistent treatment by you of repair and maintenance
costs
with some being capitalized and some being expensed depending solely
on
whether the costs were performed before or after being noted as necessary
by a drydocking inspection. We do not object to you
capitalizing the actual costs of the regulatory inspection and the
drydocking itself (i.e., the cost to put the ship in the dry dock
and have
it stored there temporarily). However, we continue to believe
repair and maintenance costs that are not betterments do not qualify
for
deferral but rather should be expensed as incurred in accordance
with your
accounting policy for repair and maintenance costs, which states
that all
repair and maintenance costs are expensed as incurred. We
believe you should amend your Form 20-F for the year ended December
31,
2006 and subsequent filings, as appropriate, to restate your financial
statements to expense, rather than defer and amortize, repair and
maintenance costs incurred during drydockings in conformity with
your
repair and maintenance costs accounting
policy.
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Response:
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As
discussed in our Second Response Letter, we have historically accounted
for costs incurred with PMMA we deemed directly related to drydocking
using the deferral method and costs we deemed to be repair and maintenance
using the direct expense method. We continue to believe that
the deferral method is one of three generally accepted methods of
accounting for costs incurred with PMMA for the reasons indicated
in our
Second Response Letter. We believe our analogy to FSP AUGAIR-1
(“FSP AIR”) is relevant to our industry as the Financial Accounting
Standards Board (“FASB”) staff noted during the deliberation of the FSP
AIR that the primary guidance on accounting for PMMA is the AICPA
Industry
Audit Guide, Audits of Airlines (the “Guide”). The FASB
staff also noted during the FSP AIR deliberations that there is
significant diversity in the way companies define PMMA and specifically
noted that entities in the shipping industry typically account for
PMMA
using the deferral method. Section 3.64 of the Guide notes the
following regarding PMMA:
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“For
accounting purposes, airframe and aircraft engine overhauls
encompass all inspections or replacements of major components,
which the civil air regulations require at specific maximum periodic
intervals to recertify that the frame or engine is completely
airworthy. An overhaul does not include, however, the cost of
routine replacement of minor parts and servicing or inspection
of
airframes and aircraft engines.” [Emphasis
added]
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Section
3.69 of the Guide notes the following regarding the accounting
methods:
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“Air
carriers should adopt an accounting method that recognizes overhaul
expenses in the appropriate period…The following methods are most often
employed:…Deferral method.”
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Section
3.72 of the Guide notes the following regarding the deferral
method:
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“Deferral
Method. Under the deferral method, the actual cost of each
overhaul is capitalized and amortized to the next
overhaul.”
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While
PMMA are not well defined in the Guide, an overhaul as described
in the
Guide includes the cost of all inspections required by civil air
regulations. The Guide further supports the capitalization of
overhaul costs following the deferral method. We believe the
costs we incur in connection with drydocking are directly analogous
to
overhaul costs required by civil air regulations as drydocking is
a
mandatory step that must be undertaken in order to satisfy statutory
requirements by the International Maritime Organization (“IMO”) and to
obtain or continue a vessel’s class certification. As noted in
our Second Response Letter, we have policies and procedures in place
to
distinguish normal repairs and maintenance costs from PMMA that are
incurred in connection with drydocking. As noted above, we
expense as incurred repairs and maintenance cost regardless if those
costs
are incurred before, during or after the drydocking
process.
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Based
on the above, we believe our current accounting policy for PMMA is
not an
error and is in accordance with U.S. Generally Accepted Accounting
Principles and shipping industry practice. Notwithstanding the
foregoing, we understand that the SEC Division of Corporation Finance's
staff believes that the direct expense method is the preferable method
of
accounting for costs incurred in connection with
PMMA. Accordingly, after reviewing the alternative PMMA
accounting methods and their impact on our results of operations
and
administrative requirements of the different accounting methods, we
have decided to change our method of accounting for PMMA from the
deferral
method to the direct expense method. We will reflect this change
as a
change in accounting principle from an accepted accounting principle
to a
preferable accounting principle in accordance with Statement of Financial
Accounting Standards No. 154 “Accounting Changes and Error Corrections”
commencing with the first quarter of 2008.1
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Very
truly yours,
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SEWARD
& KISSEL LLP
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By:
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/s/
Gary J. Wolfe
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Gary
J. Wolfe
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Cc:
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Doug
Jones, SEC
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Lyn
Shenk, SEC
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