IBM 2005 Annual Report Download - page 42
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ManagementDiscussion
INTERNATIONALBUSINESSMACHINESCORPORATION ANDSUBSIDIARYCOMPANIES
_41
(afterthereductionindiscountratediscussed onpage40)and
planassetsasofDecember31,2005.
Impactsofthesetypesofchangesonthepensionplansin
other countries will vary depending upon the status of each
respectiveplan.
COSTS TO COMPLETE SERVICE CONTRACTS
The company enters into numerous service contracts through
its SO and BCS businesses. SO contracts range for periods
up to ten years and BCS contracts can be for several years.
Duringthecontractualperiod,revenue,costandprofitsmaybe
impacted by estimates of the ultimate profitability of each
contract,especiallycontracts forwhichthecompanyusesthe
percentage-of-completionmethodofaccounting.Seepage 55
forthecompany’sservicesrevenuerecognitionaccountingpoli-
cies.Ifatanytime theseestimatesindicatethecontractwillbe
unprofitable,the entireestimated lossfor the remainderof the
contractisrecordedimmediately.
Thecompanyperformsongoingprofitabilityanalysesofits
servicescontractsinordertodeterminewhetherthelatestesti-
matesrequireupdating.Keyfactorsreviewedbythecompany
toestimatethefuturecoststocompleteeachcontractarefuture
laborcostsandproductivityefficiencies.
Totheextentactualestimatedcompletedcontractmargins
onpercentageofcompletionservicescontractsdifferfromman-
agement’squarterlyestimatesby1 percentagepoint,thecom-
pany’sconsolidatednetincomewouldhaveimproved/declined
byanestimated$45 millionusing2005 results,dependingupon
whethertheactualresultswerehigher/lower,respectively,than
theestimates.Thisamountexcludesanyaccrualresultingfrom
contractsinlosspositions.Foralllong-termservicescontracts
that have an estimated completed contract profit margin of 5
percentor less, ifactualprofitswere5percentagepoints less
thanexpected, consolidatednetincomewouldbereducedby
anestimated$135 million.
INVENTORY
The company reviews the market value of and demand for its
inventory on a quarterly basis to ensure recorded inventory is
statedatthelowerofcostor market.Inventoriesathigherriskfor
writedownsorwriteoffsarethoseintheindustriesthathavelower
relativegrossmarginsandthataresubjecttoahigherlikelihood
of changes in industry cycles. The semiconductor business is
onesuch industry.
Factors that could impact estimated demand and selling
pricesarethetimingandsuccessoffuturetechnologicalinnova-
tions,competitoractions,supplierpricesandeconomictrends.
Totheextentthat total inventory lossesdifferfrommanage-
ment estimates by 5 percent, the company’s consolidated net
incomein2005 wouldhaveimproved/declinedbyanestimated
$22 million using 2005 results, depending upon whether the
actualresultswerebetter/worse,respectively,thanexpected.
WARRANTY CLAIMS
Thecompany offers warrantiesonmostofits products.Thecom-
panyestimatesthe costoffuturewarrantyclaimsforitscurrent
period sales and records accrued warranty costs for these
sales.Thecompanyuseshistoricalwarrantyclaiminformation,
aswellasrecenttrendsthatmightsuggestthatpastcostinfor-
mationmaydifferfromfutureclaims.
Factors that could impact the estimated claim information
includethe success ofthe company’sproductivityand quality
initiatives,aswellaspartsandlaborcosts.
Totheextentthatactualfutureclaimscostsdifferfromman-
agement’s estimates by 5 percent, consolidated net income
would have improved/declined by an estimated $26 million in
2005, depending upon whether the actual claims costs were
lower/higher,respectively,thantheestimates.
INCOME TAXES
The company is subject to income taxes in both the U.S. and
numerousforeignjurisdictions.Significantjudgments are required
indeterminingthe consolidated provisionforincometaxes.
During the ordinary course of business, there are many
transactionsandcalculationsforwhichtheultimatetaxdeter-
minationisuncertain.Asaresult,thecompanyrecognizestax
liabilitiesbased on estimatesof whether additionaltaxes and
interestwillbedue. Thesetaxliabilitiesarerecognizedwhen,
despite the company’s belief that its tax return positions are
supportable, the company believes that certain positions are
likely to be challenged and may not be fully sustained upon
reviewbytaxauthorities. Thecompanybelievesthatitsaccru-
alsfortaxliabilitiesareadequateforallopen audit yearsbased
on its assessment of many factors including past experience
and interpretations of tax law. This assessment relies on esti-
mates and assumptions and may involve a series of complex
judgments about future events. To the extent that the final tax
outcome of these matters is different than the amounts
recorded, such differences will impact income tax expense in
theperiodinwhichsuchdeterminationismade.
Significant judgment is also required in determining any
valuation allowance recorded against deferred tax assets. In
assessingtheneedforavaluationallowance,managementcon-
siders all available evidence including past operating results,
estimatesoffuturetaxableincomeandthefeasibility of ongoing
taxplanningstrategies.Intheeventthatthecompanychanges
itsdeterminationastothe amount ofdeferredtaxassetsthatcan
berealized,thecompanywilladjustitsvaluationallowancewith
acorrespondingimpacttoincometaxexpenseintheperiodin
whichsuchdeterminationismade.
Totheextentthattheprovisionforincometaxesincreases/
decreases by 1 percent of Income from continuing operations
beforeincometaxes,consolidatedincomefromcontinuingoper-
ationswouldhavedeclined/improvedby$122 millionin2005.
RESTRUCTURING ACTIONS
The company has executed, and may continue to execute,
restructuringactions whichrequiremanagementtoutilizesignif-
icant estimates related to expenses for severance and other
employee separation costs, realizable values of assets made
redundantorobsolete,leasecancellationandotherexitcosts.If
the actual amounts differ from the company’s estimates, the