IBM 2005 Annual Report Download - page 41
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ManagementDiscussion
INTERNATIONALBUSINESSMACHINESCORPORATION ANDSUBSIDIARYCOMPANIES
40_ ManagementDiscussion
Totalcontractualpaymentsarereportedin the secondtable on
page 39 excludingtheeffectsoftimevalueandtherefore,may
notequaltheamountsreportedinthecompany’sConsolidated
StatementofFinancialPosition.
Purchaseobligationsincludeallcommitmentstopurchase
goodsorservicesofeitherafixedorminimumquantitythatmeet
anyofthefollowingcriteria:(1)theyarenoncancelable,(2)the
companywouldincurapenaltyiftheagreementwascanceled,
or (3) the company must make specified minimum payments
even if it does not take delivery of the contracted products or
services(“take-or-pay”).Iftheobligationtopurchasegoodsor
services is noncancelable, the entire value of the contract is
included in the second table on page 39. If the obligation is
cancelable,butthecompanywouldincurapenaltyifcanceled,
thedollaramountofthepenaltyisincludedasapurchaseobli-
gation. Contracted minimum amounts specified in take-or-pay
contracts are also included in the table as they represent the
portionofeachcontractthatisafirmcommitment.
Intheordinarycourseofbusiness,thecompanyentersinto
contracts that specify that the company will purchase all or a
portionofitsrequirementsofaspecificproduct,commodity,or
servicefromasupplierorvendor.Thesecontractsaregenerally
enteredintoinordertosecurepricingorothernegotiatedterms.
They do not specify fixed or minimum quantities to be pur-
chasedand,therefore,thecompanydoesnotconsiderthemto
bepurchaseobligations.
CriticalAccountingEstimates
TheapplicationofGAAPinvolvestheexerciseofvaryingdegrees
ofjudgment.Whiletheresultingaccountingestimateswill,bydef-
inition,notalwayspreciselyequaltherelatedactualresults, certain
estimates involve more judgment than others. Those estimates
aredescribedbelowandonpage 47 forGlobalFinancing.
Thesensitivityanalysesused below arenotmeantto pro-
videareaderwithmanagement’spredictionsofthevariabilityof
theestimatesused.Rather,thesensitivitylevelsselected(e.g.,
5 percent,10 percent, etc.) are included to allow users of the
Annual Report to understand a general-direction cause and
effectofchangesintheestimates.
USEFUL LIVES OF MICROELECTRONICS
PLANTS AND EQUIPMENT
Thecompanydeterminestheestimatedusefullivesandrelated
depreciation charges for its plants and equipment. For Micro-
electronics, this estimate is based on projected technology,
processandproductlifecyclesthatcouldchangesignificantly
duetotechnicalinnovationsandcompetitoractionsinresponse
torelatively volatile industry cycles. To theextentactualuseful
livesarelessthanpreviouslyestimatedlives,thecompanywill
increase its depreciation charge or will writeoff or writedown
technicallyobsoleteornon-strategicassets.
ThecompanyestimatesusefullivesofitsMicroelectronics
equipmentbyreferencetothecurrentandprojecteddynamics
inthe semiconductorindustry,product/processlifecyclesand
anticipatedcompetitoractions.
TotheextentthatMicroelectronics’ actualusefullivesdiffer
frommanagement’s estimates by10percent,consolidatednet
income in 2005 would have been an estimated $48 million
higher if theactualliveswerelonger thantheestimates andan
estimated$59millionloweriftheactualliveswereshorterthan
theestimates(basedupon2005results).
PENSION ASSUMPTIONS
Theexpectedlong-termreturnonplanassetsisusedincalculat-
ingthenetperiodicpension(income)/cost.Seepage 92 forinfor-
mationregardingtheexpectedlong-termreturnonplanassets
assumption.The differencesbetween the actual returnonplan
assetsandexpectedlong-termreturnonplanassets,acompo-
nentofunrecognizedgains/losses, arerecognized overtheserv-
ice lives of the employees in the plan, provided such amounts
exceed thresholds which are based upon the obligation or the
valueofplanassets,asprovidedbyaccountingstandards.
As described on page 87, if the fair value of the pension
plan’s assets is below the plan’s ABO, the company will be
requiredtorecordaminimumliability and achargetostockhold-
ers’ equity.Thecompanymayvoluntarilymakecontributionsorbe
required, by law, to make contributions to the pension plans.
Actualresultsthatdifferfromtheestimatesmayresultinmoreor
less future company funding into the pension plans than is
plannedbymanagement.Seepage 39 foradditionalinformation
andnear-termsensitivitiesofactualreturnsonfundingdecisions.
Totheextenttheoutlookforlong-termreturnschangessuch
thatmanagementchangesitsexpectedlong-termreturnonplan
assetsassumption,each50basispointincreaseordecreasein
the expected long-term return on PPP plan assets assumption
will have an estimated increase or decrease, respectively, of
$225 milliononthefollowingyear’spre-taxnetperiodicpension
income(baseduponthePPP’splanassetsatDecember31,2005
andassumingnocontributionsaremadein2006).
Anotherkeymanagementassumptionisthediscountrate.
See page 91 for information regarding the discount rate
assumption. Changes in the discount rate assumptions will
impacttheinterestcostcomponentofthenetperiodicpension
income calculation and due to the fact that the ABO is calcu-
latedonanetpresentvaluebasis,changesinthediscountrate
assumptionwillalsoimpactthecurrentABO.Anincreaseinthe
ABOcausedbyadecreaseinthediscountratemayresultina
voluntarycontributiontoapensionplan.
As discussed on page 91, the company reduced the dis-
countrateassumptionforthePPPby25basispointsto5.5per-
centonDecember 31,2005.This change will increasepre-tax
costandexpensein2006 by$94 million.Hadthediscountrate
assumption for the PPP increased by 25 basis points on
December31,2005,pre-taxcostandexpensewould decrease
by$96 millionin2006.Asmentionedabove,changesinthedis-
countrateassumptionwillimpacttheABOwhich, inturn,may
impact the company’s funding decisions if the ABO exceeds
planassets.Inordertoanalyzethesensitivityofdiscountrate
movements, each 25 basis point increase or decrease in the
interestrate will causea correspondingdecreaseorincrease,
respectively,inthePPP’sABOofanestimated$1.2 billionbased
uponDecember31,2005 data.Page 90 presentsthePPP’sABO