Proctor and Gamble 2010 Annual Report Download - page 49

Management’s Discussion and Analysis The Procter & Gamble Company 47
audits, and adjust them accordingly. We have a number of audits in
process in various jurisdictions. Although the resolution of these tax
positions is uncertain, based on currently available information, we
believe that the ultimate outcomes will not have a material adverse
effect on our financial position, results of operations or cash flows.
Because there are a number of estimates and assumptions inherent
in calculating the various components of our tax provision, certain
changes or future events such as changes in tax legislation, geographic
mix of earnings, completion of tax audits or earnings repatriation plans
could have an impact on those estimates and our effective tax rate.
Employee Benefits
We sponsor various post-employment benefits throughout the world.
These include pension plans, both defined contribution plans and
defined benefit plans, and other post-employment benefit (OPEB) plans,
consisting primarily of health care and life insurance for retirees. For
accounting purposes, the defined benefit pension and OPEB plans
require assumptions to estimate the projected and accumulated
benefit obligations, including the following variables: discount rate;
expected salary increases; certain employee-related factors, such as
turnover, retirement age and mortality; expected return on assets
and health care cost trend rates. These and other assumptions affect
the annual expense and obligations recognized for the underlying
plans. Our assumptions reflect our historical experiences and manage-
ment’s best judgment regarding future expectations. In accordance
with U.S. GAAP, the net amount by which actual results differ from
our assumptions is deferred. If this net deferred amount exceeds 10%
of the greater of plan assets or liabilities, a portion of the deferred
amount is included in expense for the following year. The cost or
benefit of plan changes, such as increasing or decreasing benefits for
prior employee service (prior service cost), is deferred and included in
expense on a straight-line basis over the average remaining service
period of the employees expected to receive benefits.
The expected return on plan assets assumption is important, since
many of our defined benefit pension plans and our primary OPEB plan
are funded. The process for setting the expected rates of return is
described in Note8 to the Consolidated Financial Statements. For
2010, the average return on assets assumptions for pension plan
assets and OPEB assets were 7.1% and 9.1%, respectively. A change
in the rate of return of 0.5% for both pension and OPEB assets would
impact annual after-tax benefit expense by less than $45million.
Since pension and OPEB liabilities are measured on a discounted basis,
the discount rate is a significant assumption. Discount rates used for
our U.S. defined benefit pension and OPEB plans are based on a yield
curve constructed from a portfolio of high quality bonds for which the
timing and amount of cash outflows approximate the estimated
payouts of the plan. For our international plans, the discount rates
are set by benchmarking against investment grade corporate bonds
rated AA or better. The average discount rate on the defined benefit
pension plans of 5.0% represents a weighted average of local rates in
countries where such plans exist. A 0.5% change in the discount rate
would impact annual after-tax defined benefit pension expense by
less than $65million. The average discount rate on the OPEB plan of
5.4% reflects the higher interest rates generally applicable in the U.S.,
which is where a majority of the plan participants receive benefits.
A 0.5% change in the discount rate would impact annual after-tax
OPEB expense by less than $30million.
Certain defined contribution pension and OPEB benefits in the U.S. are
funded by the Employee Stock Ownership Plan (ESOP), as discussed in
Note8 to the Consolidated Financial Statements.
Acquisitions, Goodwill and Intangible Assets
We account for acquired businesses using the purchase method of
accounting. Under the purchase method, our Consolidated Financial
Statements reflect the operations of an acquired business starting
from the completion of the acquisition. In addition, the assets acquired
and liabilities assumed must be recorded at the date of acquisition at
their respective estimated fair values, with any excess of the purchase
price over the estimated fair values of the net assets acquired
recorded as goodwill.
Significant judgment is required in estimating the fair value of intan-
gible assets and in assigning their respective useful lives. Accordingly,
we typically obtain the assistance of third-party valuation specialists
for significant items. The fair value estimates are based on available
historical information and on future expectations and assumptions
deemed reasonable by management, but are inherently uncertain.
We typically use an income method to estimate the fair value of
intangible assets, which is based on forecasts of the expected future
cash flows attributable to the respective assets. Significant estimates
and assumptions inherent in the valuations reflect a consideration of
other marketplace participants, and include the amount and timing
of future cash flows (including expected growth rates and profitability),
the underlying product or technology life cycles, economic barriers to
entry, a brand’s relative market position and the discount rate applied
to the cash flows. Unanticipated market or macroeconomic events and
circumstances may occur, which could affect the accuracy or validity
of the estimates and assumptions.
Determining the useful life of an intangible asset also requires judg-
ment. Certain brand intangibles are expected to have indefinite lives
based on their history and our plans to continue to support and build
the acquired brands. Other acquired intangible assets (e.g., certain
trademarks or brands, customer relationships, patents and technologies)
are expected to have determinable useful lives. Our assessment as to
brands that have an indefinite life and those that have a determinable
life is based on a number of factors including competitive environment,
market share, brand history, underlying product life cycles, operating
plans and the macroeconomic environment of the countries in which
the brands are sold. Our estimates of the useful lives of determinable-
lived intangibles are primarily based on these same factors. All of our
acquired technology and customer-related intangibles are expected
to have determinable useful lives.