Estee Lauder 2004 Annual Report Download - page 42

THE EST{E LAUDER COMPANIES INC.
The amounts necessary to fund future payouts under
these plans are subject to numerous assumptions and
variables. Certain significant variables require us to make
assumptions that are within our control such as an antici-
pated discount rate, expected rate of return on plan assets
and future compensation levels. We evaluate these
assumptions with our actuarial advisors and we believe
they are within accepted industry ranges, although an
increase or decrease in the assumptions or economic
events outside our control could have a direct impact on
reported net earnings.
The pre-retirement discount rate for each plan used for
determining future net periodic benefit cost is based on a
review of highly rated long-term bonds. For fiscal 2004,
we used a pre-retirement discount rate for our U.S. Plan
of 5.75% and varying rates on our international plans of
between 2.25% and 6.00%. For fiscal 2004, we used an
expected return on plan assets of 8.00% for our U.S. Plan
and varying rates of between 3.25% and 7.50% for our
international plans. In determining the long-term rate of
return for a plan, we consider the historical rates of return,
the nature of the plan’s investments and an expectation
for the plan’s investment strategies. The U.S. Plan asset
allocation as of June 30, 2004 was approximately 63%
equity investments, 32% fixed income investments, and
5% other investments.
For fiscal 2005, we will use a pre-retirement discount
rate for the U.S. Plan of 6.00% and anticipate using an
expected return on plan assets of 7.75%. The net change
in these assumptions from those used in fiscal 2004 will
cause a de minimis decrease in pension expense in fiscal
2005. We will continue to monitor the market conditions
relative to these assumptions and adjust them accordingly.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill is calculated as the excess of the cost of
purchased businesses over the value of their underlying
net assets. Other intangible assets principally consist
of purchased royalty rights and trademarks. Goodwill
and other intangible assets that have an indefinite life are
not amortized.
On an annual basis, we test goodwill and other
intangible assets for impairment. To determine the fair
value of these intangible assets, there are many assump-
tions and estimates used that directly impact the results
of the testing. We have the ability to influence the
outcome and ultimate results based on the assumptions
and estimates we choose. To mitigate undue influence,
we use industry accepted valuation models and set
criteria that are reviewed and approved by various levels
of management.
INCOME TAXES
We account for income taxes in accordance with State-
ment of Financial Accounting Standards (“SFAS”) No. 109,
“Accounting for Income Taxes.” This Statement establishes
financial accounting and reporting standards for the
effects of income taxes that result from an enterprise’s
activities during the current and preceding years.
It requires an asset and liability approach for financial
accounting and reporting of income taxes.
As of June 30, 2004, we have current net deferred tax
assets of $145.9 million and non-current net deferred tax
liabilities of $26.8 million. The net deferred tax assets
assume sufficient future earnings for their realization, as
well as the continued application of currently anticipated
tax rates. Included in net deferred tax assets is a valuation
allowance of approximately $4.2 million for deferred tax
assets, which relates to foreign tax loss carryforwards not
utilized to date, where management believes it is more
likely than not that the deferred tax assets will not be real-
ized in the relevant jurisdiction. Based on our assess-
ments, no additional valuation allowance is required. If we
determine that a deferred tax asset will not be realizable,
an adjustment to the deferred tax asset will result in a
reduction of earnings at that time.
Furthermore, we provide tax reserves for Federal, state
and international exposures relating to audit results,
planning initiatives and compliance responsibilities. The
development of these reserves requires judgments about
tax issues, potential outcomes and timing, and is a sub-
jective critical estimate.
DERIVATIVES
We account for derivative financial instruments in accor-
dance with SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities,” as amended, which
establishes accounting and reporting standards for deriv-
ative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities.
This Statement also requires the recognition of all deriva-
tive instruments as either assets or liabilities on the
balance sheet and that they be measured at fair value.
We currently use derivative financial instruments to
hedge certain anticipated transactions and interest rates,
as well as receivables and payables denominated in for-
eign currencies. We do not utilize derivatives for trading
or speculative purposes. Hedge effectiveness is docu-
mented, assessed and monitored by employees who are
qualified to make such assessments and monitor the
instruments. Variables that are external to us such as
social, political and economic risks may have an impact
on our hedging program and the results thereof.
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