United Technologies 2011 Annual Report Download - page 50

MANAGEMENT’S DISCUSSION AND ANALYSIS
Product Performance. We extend performance and operating
cost guarantees beyond our normal service and warranty
policies for extended periods on some of our products,
particularly commercial aircraft engines. Liability under such
guarantees is based upon future product performance and
durability. In addition, we incur discretionary costs to service
our products in connection with product performance issues.
We accrue for such costs that are probable and can be
reasonably estimated. The costs associated with these
product performance and operating cost guarantees require
estimates over the full terms of the 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 15 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, have settled some allegations and
continue to litigate certain cases. 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 17
to the Consolidated Financial Statements for further
discussion. We recorded sales to the U.S. government of $9.8
billion in 2011, $9.9 billion in 2010, and $9.3 billion in 2009.
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
annual periodic cost to a 25 basis point change in the
discount rate as of December 31, 2011.
(Dollars in millions)
Increase in
Discount Rate
of 25 bps
Decrease in
Discount Rate
of 25 bps
Pension plans
Projected benefit obligation $(776) $812
Net periodic pension cost (65) 66
Other postretirement benefit plans
Accumulated postretirement benefit
obligation (13) 13
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 2011 pension expense by
approximately $58 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 is
then compared to high-quality bond indices for
reasonableness. Global market interest rates have decreased
in 2011 as compared with 2010 and, as a result, the weighted-
average discount rate used to measure pension liabilities
decreased from 5.4% in 2010 to 4.7% in 2011. In December
2009, we amended the salaried retirement plans (qualified
and non-qualified) to change the retirement formula effective
January 1, 2015. At that time, final average earnings (FAE)
and credited service will stop under the formula applicable
for hires before July 1, 2002. Employees hired after 2009 are
not eligible for any defined benefit pension plan and will
instead receive an enhanced benefit under the UTC Savings
Plan. The continued recognition of prior pension losses and
the impact of a lower discount rate, partially offset by
additional funding and the positive returns experienced
during 2011, are expected to increase pension expense in 2012
by approximately $250 million as compared to 2011. See Note
11 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 the adequacy of 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, 2011 and 2010, we had $884 million and
$799 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.
48 UNITED TECHNOLOGIES CORPORATION