Baker Hughes 2007 Annual Report Download - page 116

2007 Form 10-K 33
of taxable income in any jurisdiction requires the interpretation
of the related tax laws and regulations and the use of estimates
and assumptions regarding significant future events such as
the amount, timing and character of deductions, permissible
revenue recognition methods under the tax law and the sources
and character of income and tax credits. Changes in tax laws,
regulations, agreements and treaties, foreign currency exchange
restrictions or our level of operations or profitability in each
taxing jurisdiction could have an impact on the amount of
income taxes that we provide during any given year.
Our tax filings for various periods are subjected to audit
by the tax authorities in most jurisdictions where we conduct
business. These audits may result in assessments of additional
taxes that are resolved with the authorities or through the
courts. We believe these assessments may occasionally be
based on erroneous and even arbitrary interpretations of
local tax law. Resolution of these situations inevitably includes
some degree of uncertainty; accordingly, we provide taxes only
for the amounts we believe will ultimately result from these
proceedings consistent with the requirements of FIN 48,
Accounting for Uncertainty in Income Taxes – an interpretation
of FASB Statement No. 109 (“FIN 48”). The resulting change
to our tax liability, if any, is dependent on numerous factors
that are difficult to estimate. These include, among others, the
amount and nature of additional taxes potentially asserted by
local tax authorities; the willingness of local tax authorities to
negotiate a fair settlement through an administrative process;
the impartiality of the local courts; the sheer number of coun-
tries in which we do business; and the potential for changes
in the tax paid to one country to either produce, or fail to pro-
duce, an offsetting tax change in other countries. Our experi-
ence has been that the estimates and assumptions we have
used to provide for future tax assessments have proven to be
appropriate. However, past experience is only a guide, and the
potential exists, however limited, that the tax resulting from
the resolution of current and potential future tax controversies
may differ materially from the amount accrued.
In addition to the aforementioned assessments that have
been received from various tax authorities, we provide for
taxes for uncertain tax positions where assessments have not
been received in accordance with FIN 48. We believe such tax
reserves are adequate in relation to the potential for additional
assessments. Once established, we adjust these amounts only
when more information is available or when an event occurs
necessitating a change to the reserves. Future events such as
changes in the facts or law, judicial decisions regarding the
application of existing law or a favorable audit outcome will
result in changes to the amounts provided. We believe that
the resolution of tax matters will not have a material effect on
the consolidated financial condition of the Company, although
a resolution could have a material impact on our consolidated
statement of operations for a particular period and on our
effective tax rate for any period in which such resolution occurs.
Pensions and Postretirement Benefit Obligations
Pensions and postretirement benefit obligations and the
related plan expenses are calculated using actuarial models
and methods. This involves the use of two critical assumptions,
the discount rate and the expected rate of return on assets,
both of which are important elements in determining plan
expenses and in measuring plan assets and liabilities. We eval-
uate these critical assumptions at least annually. Although con-
sidered less critical, other assumptions used in determining
benefit obligations and plan expenses, such as demographic
factors like retirement age, mortality and turnover, are also
evaluated periodically and are updated to reflect our actual
and expected experience.
The discount rate enables us to state expected future cash
flows at a present value on the measurement date. The devel-
opment of the discount rate for our U.S. plans was based on
a bond matching model whereby a hypothetical bond portfo-
lio of high-quality, fixed-income securities is selected that will
match the cash flows underlying the projected benefit obli-
gation. The discount rate assumption for our non-U.S. plans
reflects the market rate for high-quality, fixed-income securities.
A lower discount rate increases the present value of benefit
obligations and increases plan expenses. We used a discount
rate of 6.0% in 2007, 5.5% in 2006 and 6.0% in 2005 to
determine plan expenses. A 50 basis point reduction in the
discount rate would have decreased income from continuing
operations before income taxes by approximately $3.3 million
in 2007.
To determine the expected rate of return on plan assets,
we consider the current and expected asset allocations, as
well as historical and expected returns on various categories
of plan assets. A lower rate of return increases plan expenses.
We assumed rates of return on our plan investments were
8.5% in 2007, 2006 and 2005. A 50 basis point reduction
in the expected rate of return on assets of our principal plans
would have decreased income from continuing operations
before income taxes by approximately $3.4 million in 2007.
DISCONTINUED OPERATIONS
In the fourth quarter of 2005, our management initiated
and our Board of Directors approved a plan to sell the Baker
Supply Products Division (“Baker SPD”), a product line group
within the Completion and Production segment, which dis-
tributes basic supplies, products and small tools to the drilling
industry. In March 2006, we completed the sale of Baker SPD
and received cash proceeds of $42.5 million. We recorded a
gain on the sale of $19.2 million, net of tax of $11.0 million,
which consisted of an after-tax gain on the disposal of $16.9 mil-
lion and $2.3 million related to the recognition of the cumula-
tive foreign currency translation adjustments into earnings.
We have reclassified the consolidated financial statements
for all prior periods presented to reflect this operation as dis-
continued. See Note 2 of the Notes to Consolidated Financial
Statements in Item 8 herein for additional information regard-
ing discontinued operations.
NEW ACCOUNTING STANDARDS
In February 2006, the Financial Accounting Standards Board
(“FASB”) issued Statement of Financial Accounting Standards
(“SFAS”) SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments – an amendment of FASB Statements No. 133
and No. 140 (“SFAS 155”). SFAS 155 amends SFAS 133, which