McKesson 2012 Annual Report Download - page 45

McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
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Inventories: We report inventories at the lower of cost or market (“LCM”). Inventories for our Distribution
Solutions segment consist of merchandise held for resale. For our Distribution Solutions segment, the majority of
the cost of domestic inventories is determined using the LIFO method and the cost of Canadian inventories is
determined using the first-in, first-out (“FIFO”) method. Technology Solutions segment inventories consist of
computer hardware with cost generally determined by the standard cost method, which approximates average cost.
Rebates, fees, cash discounts, allowances, chargebacks and other incentives received from vendors are generally
accounted for as a reduction in the cost of inventory and are recognized when the inventory is sold. Total
inventories were $10.1 billion and $9.2 billion at March 31, 2012 and 2011.
The LIFO method was used to value approximately 88% and 87% of our inventories at March 31, 2012 and
2011. At March 31, 2012 and 2011, our LIFO reserves, net of LCM adjustments, were $107 million and
$96 million. LIFO reserves include both pharmaceutical and non-pharmaceutical products. In 2012, 2011 and
2010, we recognized net LIFO expense of $11 million, $3 million and $8 million within our consolidated statements
of operations, which related to our non-pharmaceutical products. A LIFO expense is recognized when the net effect
of price increases on branded pharmaceuticals and non-pharmaceutical products held in inventory exceeds the
impact of price declines and shifts towards generic pharmaceuticals, including the effect of branded pharmaceutical
products that have lost market exclusivity. A LIFO credit is recognized when the net effect of price declines and
shifts towards generic pharmaceuticals exceeds the impact of price increases on branded pharmaceuticals and non-
pharmaceutical products held in inventory.
We believe that the average cost or FIFO inventory costing method provides a reasonable estimation of the
current cost of replacing inventory (i.e., “market”). As such, our LIFO inventory is valued at the lower of LIFO or
market. Primarily due to continued net deflation in generic pharmaceutical inventories, pharmaceutical inventories
at LIFO were $76 million and $156 million higher than market as of March 31, 2012 and 2011. As a result, we
recorded a LCM credit of $80 million in 2012 and a LCM charge of $44 million in 2011 within our consolidated
statements of operations to adjust our LIFO inventories to market. During 2012, we experienced a decline in
deflationary trends in generic pharmaceuticals as a result of a reduction in generic product launches as compared to
the prior year.
In determining whether inventory valuation issues exist, we consider various factors including estimated
quantities of slow-moving inventory by reviewing on-hand quantities, outstanding purchase obligations and
forecasted sales. Shifts in market trends and conditions, changes in customer preferences due to the introduction of
generic drugs or new pharmaceutical products or the loss of one or more significant customers are factors that could
affect the value of our inventories. We write down inventories, which are considered excess and obsolete, as a result
of these reviews. These factors could make our estimates of inventory valuation differ from actual results.
Business Combinations: We account for acquired businesses using the acquisition method of accounting, which
requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair
values. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as
goodwill. Acquisition-related expenses and related restructuring costs are expensed as incurred.
Several methods may be used to determine the fair value of assets acquired and liabilities assumed. For
intangible assets, we typically use the income method. This method starts with a forecast of all of the expected
future net cash flows for each asset. These cash flows are then adjusted to present value by applying an appropriate
discount rate that reflects the risk factors associated with the cash flow streams. Some of the more significant
estimates and assumptions inherent in the income method or other methods include the amount and timing of
projected future cash flows, the discount rate selected to measure the risks inherent in the future cash flows and the
assessment of the asset’s life cycle and the competitive trends impacting the asset, including consideration of any
technical, legal, regulatory, or economic barriers to entry. Determining the useful life of an intangible asset also
requires judgment as different types of intangible assets will have different useful lives and certain assets may even
be considered to have indefinite useful lives. Refer to Financial Note 2, “Business Combinations,” to the
consolidated financial statements appearing in this Annual Report on Form 10-K for additional information
regarding our acquisitions.