IBM 2012 Annual Report Download - page 60

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Management Discussion
International Business Machines Corporation and Subsidiary Companies
Critical Accounting Estimates
The application of GAAP requires the company to make estimates
and assumptions about certain items and future events that directly
affect its reported financial condition. The accounting estimates and
assumptions discussed in this section are those that the company
considers to be the most critical to its financial statements. An
accounting estimate is considered critical if both (a) the nature of
the estimate or assumption is material due to the levels of subjectiv-
ity and judgment involved, and (b) the impact within a reasonable
range of outcomes of the estimate and assumption is material to the
company’s financial condition. Senior management has discussed
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 informa-
tion is reasonably available, can be reliably estimated and provides
material information to investors. The amounts used to assess sen-
sitivity (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 manage-
ment’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 company’s benefit obligation to employees and net periodic
pension (income)/cost 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 (income)/cost calculation (see page 126 for information
regarding the discount rate assumptions) and the projected benefit
obligation (PBO). The company decreased the discount rate
assumption for the IBM Personal Pension Plan (PPP), a U.S.-based
defined benefit plan, by 60 basis points to 3.60 percent on Decem-
ber 31, 2012. This change will increase pre-tax cost and expense
recognized in 2013 by an estimated $156 million. If the discount rate
assumption for the PPP increased by 60 basis points on December
31, 2012, pre-tax cost and expense recognized in 2013 would have
decreased by an estimated $200 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, 2012 data.
The expected long-term return on plan assets assumption is
used in calculating the net periodic pension (income)/cost (see page
126 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
pension (income)/cost. The differences between the actual return
on plan assets and the expected long-term return on plan assets
are recognized over five years in the expected return on plan assets
line in net periodic pension (income)/cost and also as a component
of actuarial gains/losses, which are recognized over the service lives
of the employees in the plan, provided such amounts exceed thresh-
olds which are 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 $249 million on
the following year’s pre-tax net periodic pension (income)/cost
(based upon the PPP’s plan assets at December 31, 2012 and
assuming no contributions are made in 2013).
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 arrange-
ments 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 experi-
ence 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 2012, net income would have been
impacted by $79 million (excluding Global Financing receivables
discussed on page 65).