IBM 2011 Annual Report Download - page 61

59
Management Discussion
International Business Machines Corporation and Subsidiary Companies
the development, selection and disclosure of these estimates with
the Audit Committee of the company’s Board of Directors. The
company’s significant accounting policies are described in note A,
“Significant Accounting Policies,” on pages 76 to 86.
A quantitative sensitivity analysis is provided where that information
is reasonably available, can be reliably estimated and provides material
information to investors. The amounts used to assess sensitivity
(e.g., 1 percent, 10 percent, etc.) are included to allow users of the
Annual Report to understand a general direction cause and effect
of changes in the estimates and do not represent management’s
predictions of variability. For all of these estimates, it should be noted
that future events rarely develop exactly as forecasted, and estimates
require regular review and adjustment.
Pension Assumptions
For the company’s defined benefit pension plans, the measurement
of the benefit obligation to employees and net periodic pension
(cost/income) requires the use of certain assumptions, including,
among others, estimates of discount rates and expected return
on plan assets.
Changes in the discount rate assumptions will impact the (gain)/
loss amortization and interest cost components of the net periodic
pension cost/(income) calculation (see page 127 for information
regarding the discount rate assumptions) and the projected benefit
obligation (PBO). As presented on page 127, the company decreased
the discount rate assumption for the IBM Personal Pension Plan
(PPP), a U.S.-based defined benefit plan, by 80 basis points to
4.20 percent on December 31, 2011. This change will increase pre-
tax cost and expense recognized in 2012 by an estimated $250 million.
If the discount rate assumption for the PPP increased by 80 basis
points on December 31, 2011, pre-tax cost and expense recognized
in 2012 would have decreased by an estimated $265 million. Changes
in the discount rate assumptions will impact the PBO which, in turn,
may impact the company’s funding decisions if the PBO exceeds
plan assets. Each 25 basis point increase or decrease in the
discount rate will cause a corresponding decrease or increase,
respectively, in the PPP’s PBO of an estimated $1.4 billion based
upon December 31, 2011 data. The PPP’s PBO (after the decrease
in discount rate presented on page 127) and plan assets as of
December 31, 2011 are presented on page 125.
The expected long-term return on plan assets is used in
calculating the net periodic pension (income)/cost. See page 128
for information regarding the expected long-term return on plan
assets assumption. Expected returns on plan assets are calculated
based on the market-related value of plan assets, which recognizes
changes in the fair value of plan assets systematically over a five-year
period in the expected return on plan assets line in net periodic
(income)/cost. The differences between the actual return on plan
assets and expected return on plan assets are recognized as
a component of actuarial gains/losses, which are recognized in
net periodic (income)/cost over the service lives of the employees
in the plan, provided such amounts exceed thresholds based
upon the obligation or the value of plan assets, as provided by
accounting standards.
To the extent the outlook for long-term returns changes such
that management changes its expected long-term return on plan
assets assumption, each 50 basis point increase or decrease in the
expected long-term return on PPP plan assets assumption will have
an estimated increase or decrease, respectively, of $253 million
on the following year’s pre-tax net periodic pension (income)/
cost (based upon the PPP’s plan assets at December 31, 2011
and assuming no contributions are made in 2012).
The company may voluntarily make contributions or be required,
by law, to make contributions to its pension plans. Actual results that
differ from the estimates may result in more or less future company
funding into the pension plans than is planned by management.
Impacts of these types of changes on the company’s pension plans
in other countries worldwide will vary depending upon the status of
each respective plan.
Revenue Recognition
Application of the various accounting principles in GAAP related to
the measurement and recognition of revenue requires the company
to make judgments and estimates. Specifically, complex arrangements
with nonstandard terms and conditions may require significant
contract interpretation to determine the appropriate accounting,
including whether the deliverables specified in a multiple element
arrangement should be treated as separate units of accounting.
Other significant judgments include determining whether IBM or a
reseller is acting as the principal in a transaction and whether
separate contracts are considered part of one arrangement.
Revenue recognition is also impacted by the company’s ability
to estimate sales incentives, expected returns and collectibility. The
company considers various factors, including a review of specific
transactions, the creditworthiness of the customers, historical
experience and market and economic conditions when calculating
these provisions and allowances. Evaluations are conducted each
quarter to assess the adequacy of the estimates. If these estimates
were changed by 10 percent in 2011, net income would have been
impacted by $85 million (excluding Global Financing receivables
reserves discussed on page 65).
Costs to Complete Service Contracts
The company enters into numerous service contracts through its
GTS and GBS businesses. During the contractual period, revenue,
cost and profits may be impacted by estimates of the ultimate
profitability of each contract, especially contracts for which the
company uses the percentage-of-completion (POC) method of
accounting. If at any time these estimates indicate the POC contract
will be unprofitable, the entire estimated loss for the remainder of
the contract is recorded immediately in cost. The company performs
ongoing profitability analyses of its services contracts in order to
determine whether the latest estimates require updating. Key factors
reviewed by the company to estimate the future costs to complete
each contract are future labor costs, future product costs and
expected productivity efficiencies. Contract loss provisions recorded
as a component of other accrued expenses and liabilities were
approximately $52 million and $23 million at December 31, 2011 and
2010, respectively.