IBM 2009 Annual Report Download - page 78

Notes to Consolidated Financial Statements
INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES
Stock-Based Compensation
Stock-based compensation represents the cost related to stock-
based awards granted to employees. The company measures
stock-based compensation cost at grant date, based on the
estimated fair value of the award and recognizes the cost on a
straight-line basis (net of estimated forfeitures) over the employee
requisite service period. The company estimates the fair value of
stock options using a Black-Scholes valuation model. The cost
is recorded in cost, SG&A, and RD&E in the Consolidated State-
ment of Earnings based on the employees’ respective function.
The company records deferred tax assets for awards that
result in deductions on the company’s income tax returns, based
on the amount of compensation cost recognized and the statu-
tory tax rate in the jurisdiction in which it will receive a deduction.
Differences between the deferred tax assets recognized for finan-
cial reporting purposes and the actual tax deduction reported on
the income tax return are recorded in additional paid-in capital
(if the tax deduction exceeds the deferred tax asset) or in the
Consolidated Statement of Earnings (if the deferred tax asset
exceeds the tax deduction and no additional paid-in capital
exists from previous awards).
See note T, “Stock-Based Compensation,” on pages 105 to
109 for additional information.
Income Taxes
Income tax expense is based on reported income before income
taxes. Deferred income taxes reflect the tax effect of temporary
differences between asset and liability amounts that are rec-
ognized for financial reporting purposes and the amounts that
are recognized for income tax purposes. These deferred taxes
are measured by applying currently enacted tax laws. Valuation
allowances are recognized to reduce deferred tax assets to the
amount that will more likely than not be realized. In assessing
the need for a valuation allowance, management considers all
available evidence for each jurisdiction including past operating
results, estimates of future taxable income and the feasibility of
ongoing tax planning strategies. When the company changes
its determination as to the amount of deferred tax assets that
can be realized, the valuation allowance is adjusted with a cor-
responding impact to income tax expense in the period in which
such determination is made.
The company recognizes tax liabilities when, despite the
company’s belief that its tax return positions are supportable,
the company believes that certain positions may not be fully
sustained upon review by tax authorities. Benefits from tax
positions are measured at the largest amount of benefit that is
greater than 50 percent likely of being realized upon settlement.
The current portion of tax liabilities is included in taxes and the
noncurrent portion of tax liabilities is included in other liabilities in
the Consolidated Statement of Financial Position. To the extent
that new information becomes available which causes the com-
pany to change its judgment regarding the adequacy of existing
tax liabilities, such changes to tax liabilities will impact income
tax expense in the period in which such determination is made.
Interest and penalties, if any, related to accrued liabilities for
potential tax assessments are included in income tax expense.
Translation of Non-U.S. Currency Amounts
Assets and liabilities of non-U.S. subsidiaries that have a local
functional currency are translated to United States (U.S.) dol-
lars at year-end exchange rates. Translation adjustments are
recorded in accumulated other comprehensive income/(loss)
in the Consolidated Statement of Changes in Equity. Income
and expense items are translated at weighted-average rates of
exchange prevailing during the year.
Inventories, plant, rental machines and other property—net
and other non-monetary assets and liabilities of non-U.S. subsid-
iaries and branches that operate in U.S. dollars are translated at
the approximate exchange rates prevailing when the company
acquired the assets or liabilities. All other assets and liabilities
denominated in a currency other than U.S. dollars are trans-
lated at year-end exchange rates with the transaction gain or
loss recognized in other (income) and expense. Cost of sales
and depreciation are translated at historical exchange rates. All
other income and expense items are translated at the weighted-
average rates of exchange prevailing during the year. These
translation gains and losses are included in net income for the
period in which exchange rates change.
Derivatives
All derivatives are recognized in the Consolidated Statement
of Finan cial Position at fair value and are reported in prepaid
expenses and other current assets, investments and sundry
assets, other accrued expenses and liabilities or other liabilities.
Classification of each derivative as current or noncurrent is based
upon whether the maturity of the instrument is less than or greater
than 12 months. To qualify for hedge accounting, the company
requires that the instruments be effective in reducing the risk
exposure that they are designated to hedge. For instruments that
hedge cash flows, hedge effectiveness criteria also require that it
be probable that the underlying transaction will occur. Instruments
that meet established accounting criteria are formally designated
as hedges. These criteria demonstrate that the derivative is
expected to be highly effective at offsetting changes in fair value
or cash flows of the underlying exposure both at inception of the
hedging relationship and on an ongoing basis. The method of
assessing hedge effectiveness and measuring hedge ineffective-
ness is formally documented at hedge inception. The company
assesses hedge effectiveness and measures hedge ineffective-
ness at least quarterly throughout the designated hedge period.
Where the company applies hedge accounting, the company
designates each derivative as a hedge of: (1) the fair value of a
recognized financial asset or liability or of an unrecognized firm
commitment (fair value hedge); (2) the variability of anticipated
cash flows of a forecasted transaction or the cash flows to be
received or paid related to a recognized financial asset or liability
(cash flow hedge); or (3) a hedge of a long-term investment
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