Cardinal Health 2015 Annual Report Download - page 21

MD&A Critical Accounting Policies and Sensitive Accounting Estimates
Cardinal Health | Fiscal 2015 Form 10-K 20
cost value at June 30, 2015 and 2014, respectively. We do not record
inventories in excess of replacement cost. As such, we did not record
any changes in our LIFO reserve in fiscal 2015 and 2014.
Inventories presented in the consolidated balance sheets are net of
reserves for excess and obsolete inventory which were $57 million
and $44 million at June 30, 2015 and 2014, respectively. We reserve
for inventory obsolescence using estimates based on historical
experience, sales trends, specific categories of inventory and age of
on-hand inventory. If actual conditions are less favorable than our
assumptions, additional inventory reserves may be required.
Business Combinations
The assets acquired and liabilities assumed in a business
combination, including identifiable intangible assets, are based on
their estimated fair values as of the acquisition date. The excess of
the purchase price over the estimated fair value of the identifiable
net assets acquired is recorded as goodwill. We base the fair values
of identifiable intangible assets on detailed valuations that require
management to make significant judgments, estimates and
assumptions. Critical estimates and assumptions include: expected
future cash flows for customer relationships, trademarks, trade
names, patents, developed technology and other identifiable
intangible assets; discount rates that reflect the risk factors
associated with future cash flows; and estimates of useful lives. When
an acquisition involves contingent consideration, we recognize a
liability equal to the fair value of the contingent consideration
obligation at the acquisition date. The estimate of fair value of a
contingent consideration obligation requires subjective assumptions
to be made regarding future business results, discount rates and
probabilities assigned to various potential business result scenarios.
Subsequent revisions to these assumptions could materially change
the estimate of the fair value of contingent consideration obligations
and therefore could materially affect our financial position or results
of operations. See Note 2 of the “Notes to Consolidated Financial
Statements” for additional information regarding our acquisitions.
Goodwill and Other Intangible Assets
Purchased goodwill and intangible assets with indefinite lives are not
amortized, but instead are tested for impairment annually or when
indicators of impairment exist. Intangible assets with finite lives,
primarily customer relationships, trademarks and patents, and non-
compete agreements, are amortized over their useful lives.
Goodwill impairment testing involves a comparison of the estimated
fair value of reporting units to the respective carrying amount, which
may be performed utilizing either a qualitative or quantitative
assessment. A reporting unit is defined as an operating segment or
one level below an operating segment (also known as a component).
If the estimated fair value exceeds the carrying amount, then no
impairment exists. If the carrying amount exceeds the estimated fair
value, then a second step is performed to determine the amount of
impairment, if any. An impairment charge is the amount by which the
carrying amount of goodwill exceeds the estimated implied fair value
of goodwill. We estimate the implied fair value of goodwill as the
excess of the estimated fair value of the reporting unit over the
estimated fair value of its identifiable net assets. This is the same
manner we use to recognize goodwill from a business combination.
Goodwill impairment testing involves judgment, including the
identification of reporting units, the estimation of the fair value of each
reporting unit and, if necessary, the estimation of the implied fair value
of goodwill.
We have two operating segments, which are the same as our
reportable segments: Pharmaceutical and Medical. These operating
segments are comprised of divisions (components), for which
discrete financial information is available. Components are
aggregated into reporting units for purposes of goodwill impairment
testing to the extent that they share similar economic characteristics.
Our reporting units are: Pharmaceutical operating segment
(excluding our Nuclear Pharmacy Services division and Cardinal
Health China - Pharmaceutical division); Nuclear Pharmacy Services
division; Cardinal Health China - Pharmaceutical division; Medical
operating segment (excluding our Cardinal Health at Home division);
and Cardinal Health at Home division.
Fair value can be determined using market, income or cost-based
approaches. Our determination of estimated fair value of the reporting
units is based on a combination of the income-based and market-
based approaches. Under the income-based approach, we use a
discounted cash flow model in which cash flows anticipated over
several future periods, plus a terminal value at the end of that time
horizon, are discounted to their present value using an appropriate
risk-adjusted rate of return. We use our internal forecasts to estimate
future cash flows and include an estimate of long-term growth rates
based on our most recent views of the long-term outlook for each
reporting unit. Actual results may differ materially from those used in
our forecasts. We use discount rates that are commensurate with the
risks and uncertainty inherent in the respective reporting units and
in our internally-developed forecasts. Discount rates used in our
reporting unit valuations ranged from 8.5 to 11 percent. Under the
market-based approach, we determine fair value by comparing our
reporting units to similar businesses or guideline companies whose
securities are actively traded in public markets. To further confirm fair
value, we compare the aggregate fair value of our reporting units to
our total market capitalization. Estimating the fair value of reporting
units requires the use of estimates and significant judgments that are
based on a number of factors including actual operating results. The
use of alternate estimates and assumptions or changes in the industry
or peer groups could materially affect the determination of fair value
for each reporting unit and potentially result in goodwill impairment.
We performed annual impairment testing in fiscal 2015, 2014 and
2013 and, with the exception of our Nuclear Pharmacy Services