IBM 2011 Annual Report Download - page 62

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Management Discussion
International Business Machines Corporation and Subsidiary Companies
Income Taxes
The company is subject to income taxes in the U.S. and numerous
foreign jurisdictions. Significant judgments are required in determining
the consolidated provision for income taxes.
During the ordinary course of business, there are many
transactions and calculations for which the ultimate tax determination
is uncertain. As a result, the company recognizes tax liabilities based
on estimates of whether additional taxes and interest will be due.
These tax liabilities are recognized 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. The company believes that its accruals for tax
liabilities are adequate for all open audit years based on its assessment
of many factors, including past experience and interpretations of tax
law. This assessment relies on estimates and assumptions and may
involve a series of complex judgments about future events. To the
extent that new information becomes available which causes the
company 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.
Significant judgment is also required in determining any valuation
allowance recorded against deferred tax assets. 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. In the event that the company changes its
determination as to the amount of deferred tax assets that can be
realized, the company will adjust its valuation allowance with a
corresponding impact to income tax expense in the period in which
such determination is made.
The consolidated provision for income taxes will change period-
to-period based on nonrecurring events, such as the settlement of
income tax audits and changes in tax laws, as well as recurring
factors including the geographic mix of income before taxes, the
timing and amount of foreign dividend repatriation, state and local
taxes and the effects of various global income tax strategies.
To the extent that the provision for income taxes increases/
decreases by 1 percent of income before income taxes, consolidated
net income would have improved/decreased by $210 million in 2011.
Valuation of Assets
The application of business combination and impairment accounting
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 non-controlling 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 whenever
events or changes in circumstances indicate the carrying value of
goodwill may not be recoverable. In the fourth quarter of 2011, the
company early adopted new Financial Accounting Standards Board
guidance that simplifies how an entity tests goodwill for impairment.
It provides an option to first assess qualitative factors to determine
whether it is more likely than not that the fair value of a reporting unit
is less than its carrying amount.
The company assesses qualitative factors in each of its
reporting units that carry goodwill. Among other relevant events
and circumstances that affect the fair value of reporting units,
the company assesses individual factors such as:
• A significant adverse change in legal factors
or the business climate
• An adverse action or assessment by a regulator
• Unanticipated competition
• A loss of key personnel
• A more-likely-than-not expectation that a reporting
unit or a significant portion of a reporting unit will be sold
or otherwise disposed of
The company assesses these qualitative factors to determine
whether it is necessary to perform the two-step quantitative goodwill
impairment test. Under the new guidance, this quantitative test
is required only if the company concludes that it is more likely than
not that a reporting unit’s fair value is less than its carrying amount.
After performing the annual goodwill impairment qualitative analysis
during the fourth quarter of 2011, the company determined it was
not necessary to perform the two-step goodwill impairment test.
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 in note A, “Significant
Accounting Policies,” on pages 85 and 86. Factors that could result