United Technologies 2008 Annual Report Download - page 59

agreements, and require management to consider factors such as the extent of future
maintenance requirements and the future cost of material and labor to perform the services.
These cost estimates are largely based upon historical experience. See Note 13 to the
Consolidated Financial Statements for further discussion.
Contracting with the U.S. Government. Our contracts with the U.S. government are subject to
government oversight and audit. Like many defense contractors, we have received audit
reports, which recommend that certain contract prices should be reduced to comply with
various government regulations. Some of these audit reports have involved substantial
amounts. We have made voluntary refunds in those cases we believe appropriate. In addition,
we accrue for liabilities associated with those government contracting matters that are
probable and can be reasonably estimated. The inherent uncertainty related to the outcome of
these matters can result in amounts materially different from any provisions made with respect
to their resolution. See Note 15 to the Consolidated Financial Statements for further
discussion. We recorded sales to the U.S. government of $7.7 billion, $7.3 billion, and $6.4
billion in 2008, 2007, and 2006, respectively.
Employee Benefit Plans. We sponsor domestic and foreign defined benefit pension and other
postretirement plans. Major assumptions used in the accounting for these employee benefit
plans include the discount rate, expected return on plan assets, rate of increase in employee
compensation levels, and health care cost increase projections. Assumptions are determined
based on company data and appropriate market indicators, and are evaluated each year at
December 31. A change in any of these assumptions would have an effect on net periodic
pension and postretirement benefit costs reported in the Consolidated Financial Statements.
In the following table, we show the sensitivity of our pension and other postretirement benefit
plan liabilities and net periodic cost to a 25 basis point change in the discount rate as of
December 31, 2008.
(in millions of dollars)
Change in
Discount Rate
Increase in 25 bps
Change in
Discount Rate
Decrease in 25 bps
Pension plans
Projected benefit obligation $(625) $647
Net periodic pension cost (67) 66
Other postretirement benefit plans
Accumulated postretirement benefit
obligation (14) 14
Net periodic postretirement benefit cost — —
Pension expense is also sensitive to changes in the expected long-term rate of asset return. An
increase or decrease of 25 basis points in the expected long-term rate of asset return would
have decreased or increased 2008 pension expense by approximately $48 million.
The weighted-average discount rate used to measure pension liabilities and costs is set by
reference to UTC specific analysis using each plan’s specific cash flows and compared to high-
quality bond indices for reasonableness. Global market interest rates have increased in 2008 as
compared with 2007 and, as a result, the weighted-average discount rate used to measure
pension liabilities increased from 6.0% in 2007 to 6.1% in 2008. Pension expense in 2009 is
expected to increase approximately $225 million primarily as a result of negative asset return
incurred in 2008 that resulted from the deterioration in the global equity markets. See Note 10
to the Consolidated Financial Statements for further discussion.
Inventory Valuation Reserves. Inventory valuation reserves are established in order to report
inventories at the lower of cost or market value on our Consolidated Balance Sheet. The
determination of inventory valuation reserves requires management to make estimates and
judgments on the future salability of inventories. Valuation reserves for excess, obsolete, and
slow-moving inventory are estimated by comparing the inventory levels of individual parts to
both future sales forecasts or production requirements and historical usage rates in order to
identify inventory where the resale value or replacement value is less than inventoriable cost.
Other factors that management considers in determining these reserves include whether
individual inventory parts meet current specifications and cannot be substituted for a part
currently being sold or used as a service part, overall market conditions, and other inventory
management initiatives.
As of December 31, 2008, and 2007 we had $497 million and $471 million, respectively, of
inventory valuation reserves recorded. Although management believes these reserves are
adequate, any abrupt changes in market conditions may require us to record additional
inventory valuation reserves.
Off-Balance Sheet Arrangements and Contractual Obligations
We extend a variety of financial guarantees to third parties in support of unconsolidated
affiliates and for potential financing requirements of commercial aerospace customers. We also
have obligations arising from sales of certain businesses and assets, including representations
and warranties and related indemnities for environmental, health and safety, tax and
employment matters. Circumstances that could cause the contingent obligations and liabilities
arising from these arrangements to come to fruition are changes in an underlying transaction
(e.g., hazardous waste discoveries, etc.), nonperformance under a contract, customer requests
for financing, or deterioration in the financial condition of the guaranteed party.
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