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Part II
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS, continued
40
Critical Accounting Estimates
The company's significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements.
Management believes that the application of these policies on a consistent basis enables the company to provide the users of the
financial statements with useful and reliable information about the company's operating results and financial condition.
The preparation of the Consolidated Financial Statements in conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts, including, but not limited to, receivable and inventory valuations, impairment of
tangible and intangible assets, long-term employee benefit obligations, income taxes, restructuring liabilities, environmental
matters and litigation. Management's estimates are based on historical experience, facts and circumstances available at the time
and various other assumptions that are believed to be reasonable. The company reviews these matters and reflects changes in
estimates as appropriate. Management believes that the following represents some of the more critical judgment areas in the
application of the company's accounting policies which could have a material effect on the company's financial position, liquidity
or results of operations.
Long-term Employee Benefits
Accounting for employee benefit plans involves numerous assumptions and estimates. Discount rate and expected return on plan
assets are two critical assumptions in measuring the cost and benefit obligation of the company's pension and other long-term
employee benefit plans. Management reviews these two key assumptions annually as of December 31st. These and other
assumptions are updated periodically to reflect the actual experience and expectations on a plan specific basis as appropriate. As
permitted by GAAP, actual results that differ from the assumptions are accumulated on a plan by plan basis and to the extent that
such differences exceed 10 percent of the greater of the plan's benefit obligation or the applicable plan assets, the excess is amortized
over the average remaining service period of active employees.
About 80 percent of the company's benefit obligation for pensions and essentially all of the company's other long-term employee
benefit obligations are attributable to the benefit plans in the U.S. In the U.S. the discount rate is developed by matching the
expected cash flow of the benefit plans to a yield curve constructed from a portfolio of high quality fixed-income instruments
provided by the plan's actuary as of the measurement date. For non-U.S. benefit plans, the company utilizes prevailing long-term
high quality corporate bond indices to determine the discount rate, applicable to each country, at the measurement date.
Within the U.S., the company establishes strategic asset allocation percentage targets and appropriate benchmarks for significant
asset classes with the aim of achieving a prudent balance between return and risk. Strategic asset allocations in other countries are
selected in accordance with the laws and practices of those countries. Where appropriate, asset-liability studies are also taken into
consideration. The long-term expected return on plan assets in the U.S. is based upon historical real returns (net of inflation) for
the asset classes covered by the investment policy, expected performance, and projections of inflation and interest rates over the
long-term period during which benefits are payable to plan participants. Consistent with prior years, the long-term expected return
on plan assets in the U.S. reflects the asset allocation of the plan and the effect of the company's active management of the plans'
assets.
In determining annual expense for the principal U.S. pension plan, the company uses a market-related value of assets rather than
its fair value. The market-related value of assets is calculated by averaging market returns over 36 months. Accordingly, there
may be a lag in recognition of changes in market valuation. As a result, changes in the fair value of assets are not immediately
reflected in the company's calculation of net periodic pension cost. The following table shows the market-related value and fair
value of plan assets for the principal U.S. pension plan:
(Dollars in billions) 2015 2014 2013
Market-related value of assets $ 15.1 $ 15.9 $ 15.5
Fair value of plan assets 14.4 15.8 16.1
For plans other than the principal U.S. pension plan, pension expense is determined using the fair value of assets.