IBM 2010 Annual Report Download - page 54

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Management Discussion
International Business Machines Corporation and Subsidiary Companies
Valuation of Assets
The application of business combination and impairment account-
ing requires the use of significant estimates and assumptions. The
acquisition method of accounting for business combinations
requires the company to estimate the fair value of assets acquired,
liabilities assumed, and any noncontrolling interest in the acquiree
to properly allocate purchase price consideration between assets
that are depreciated and amortized from goodwill. Impairment
testing for assets, other than goodwill, requires the allocation
of cash flows to those assets or group of assets and if required,
an estimate of fair value for the assets or group of assets. The
company’s estimates are based upon assumptions believed to be
reasonable, but which are inherently uncertain and unpredictable.
These valuations require the use of management’s assumptions,
which would not reflect unanticipated events and circumstances
that may occur.
Valuation of Goodwill
The company reviews goodwill for impairment annually and when-
ever events or changes in circumstances indicate the carrying
value of goodwill may not be recoverable. The guidance on good-
will impairment requires the company to perform a two-step
impairment test. In the first step, the company compares the fair
value of each reporting unit to its carrying value. The company
determines the fair value of its reporting units based on the
income approach. Under the income approach, the company
calculates the fair value of a reporting unit based on the present
value of estimated future cash flows. If the fair value of the reporting
unit exceeds the carrying value of the net assets assigned to that
unit, goodwill is not impaired. If the carrying value of the net assets
assigned to the reporting unit exceeds the fair value of the reporting
unit, then the second step of the impairment test is performed in
order to determine the implied fair value of the reporting unit’s
goodwill. If the carrying value of a reporting unit’s goodwill
exceeds its implied fair value, then the company records an
impairment loss equal to the difference.
Determining the fair value of a reporting unit is judgmental in
nature and involves the use of significant estimates and assump-
tions. These estimates and assumptions include revenue growth
rates and operating margins used to calculate projected future
cash flows, discount rates and future economic and market con-
ditions. The company’s estimates are based upon assumptions
believed to be reasonable, but which are inherently uncertain and
unpredictable. These valuations require the use of management’s
assumptions, which would not reflect unanticipated events and
circumstances that may occur.
The annual goodwill impairment analysis, which the company
performed during the fourth quarter of 2010, did not result in an
impairment charge. Utilizing the balances as of September 30,
2010, the excess of fair value over carrying value for each of the
company’s reporting units ranged from approximately $0.3 billion
to approximately $75.7 billion. In order to evaluate the sensitivity of
the fair value calculations on the goodwill impairment test, the
company applied a hypothetical 10 percent decrease to the fair
values of each reporting unit. This hypothetical 10 percent
decrease would result in excess fair value over carrying value rang-
ing from approximately $0.2 billion to approximately $67.1 billion
for each of the company’s reporting units.
Loss Contingencies
The company is currently involved in various claims and legal
proceedings. Quarterly, the company reviews the status of each
significant matter and assesses its potential financial exposure. If
the potential loss from any claim or legal proceeding is considered
probable and the amount can be reasonably estimated, the
company accrues a liability for the estimated loss. Significant
judgment is required in both the determination of probability and
the determination as to whether an exposure is reasonably
estimable. Because of uncertainties related to these matters,
accruals are based only on the best information available at the
time. As additional information becomes available, the company
reassesses the potential liability related to its pending claims and
litigation and may revise its estimates. These revisions in the
estimates of the potential liabilities could have a material impact
on the company’s results of operations and financial position.
Global Financing Receivables Allowance for Credit Losses
The Global Financing business reviews its financing receivables
port folio at least quarterly in order to assess collectibility.
A description of the methods used by management to estimate
the amount of uncollectible receivables is included on pages 77
and 78. Factors that could result in actual receivable losses that
are materially different from the estim ated reserve include sharp
changes in the economy, or a significant change in the economic
health of a particular client that represents a concentration in
Global Financing’s receivables portfolio.
To the extent that actual collectibility differs from management’s
estimates currently provided for by 10 percent, Global Financing’s
segment pre-tax income and the company’s consolidated income
before income taxes would be higher or lower by an estimated
$40 million (using 2010 data), depending upon whether the actual
collectibility was better or worse, respectively, than the estimates.
Residual Value
Residual value represents the estimated fair value of equipment
under lease as of the end of the lease. Residual value estimates
impact the determination of whether a lease is classified as
operating or capital. Global Financing estimates the future fair value
of leased equipment by using historical models, analyzing the
current market for new and used equipment and obtaining