Chevron 2004 Annual Report Download - page 45

CHEVRONTEXACO CORPORATION 2004 ANNUAL REPORT 43

Management฀makes฀many฀estimates฀and฀assumptions฀in฀the฀
application฀of฀generally฀accepted฀accounting฀principles฀(GAAP)฀
that฀may฀have฀a฀material฀impact฀on฀the฀company’s฀consolidated฀
financial฀statements฀and฀related฀disclosures฀and฀on฀the฀compa-
rability฀of฀such฀information฀over฀different฀reporting฀periods.฀
All฀such฀estimates฀and฀assumptions฀affect฀reported฀amounts฀of฀
assets,฀liabilities,฀revenues฀and฀expenses,฀as฀well฀as฀disclosures฀of฀
contingent฀assets฀and฀liabilities.฀Estimates฀and฀assumptions฀are฀
based฀on฀management’s฀experience฀and฀other฀information฀avail-
able฀prior฀to฀the฀issuance฀of฀the฀financial฀statements.฀Materially฀
different฀results฀can฀occur฀as฀circumstances฀change฀and฀addi-
tional฀information฀becomes฀known.
The฀discussion฀in฀this฀section฀of฀“critical”฀accounting฀esti-
mates฀or฀assumptions฀is฀according฀to฀the฀disclosure฀guidelines฀
of฀the฀Securities฀and฀Exchange฀Commission฀(SEC),฀wherein:
1.฀ ฀the฀nature฀of฀the฀estimates฀or฀assumptions฀is฀material฀due฀to฀
the฀levels฀of฀subjectivity฀and฀judgment฀necessary฀to฀account฀
for฀highly฀uncertain฀matters฀or฀the฀susceptibility฀of฀such฀
matters฀to฀change;
2.฀ ฀the฀impact฀of฀the฀estimates฀and฀assumptions฀on฀the฀
company’s฀financial฀condition฀or฀operating฀performance฀
is฀material.
Besides฀those฀meeting฀these฀“critical”฀criteria,฀the฀company฀
makes฀many฀other฀accounting฀estimates฀and฀assumptions฀in฀pre-
paring฀its฀financial฀statements฀and฀related฀disclosures.฀Although฀
not฀associated฀with฀“highly฀uncertain฀matters,”฀these฀estimates฀
and฀assumptions฀are฀also฀subject฀to฀revision฀as฀circumstances฀
warrant,฀and฀materially฀different฀results฀may฀sometimes฀occur.฀
For฀example,฀the฀recording฀of฀deferred฀tax฀assets฀requires฀an฀
assessment฀under฀the฀accounting฀rules฀that฀the฀future฀realization฀
of฀the฀associated฀tax฀benefits฀be฀“more฀likely฀than฀not.”฀Another฀
example฀is฀the฀estimation฀of฀oil฀and฀gas฀reserves฀under฀SEC฀rules฀
that฀require฀“...฀geological฀and฀engineering฀data฀(that)฀demon-
strate฀with฀reasonable฀certainty฀(reserves)฀to฀be฀recoverable฀in฀
future฀years฀from฀known฀reservoirs฀under฀existing฀economic฀
and฀operating฀conditions,฀i.e.,฀prices฀and฀costs฀as฀of฀the฀date฀the฀
estimate฀is฀made.”฀Refer฀to฀Table฀V,฀“Reserve฀Quantity฀Informa-
tion,”฀beginning฀on฀page฀87฀for฀the฀changes฀in฀these฀estimates฀
for฀the฀three฀years฀ending฀December฀31,฀2004,฀and฀to฀Table฀VII,฀
“Changes฀in฀the฀Standardized฀Measure฀of฀Discounted฀Future฀
Net฀Cash฀Flows฀From฀Proved฀Reserves,”฀on฀page฀92฀for฀estimates฀
of฀proved-reserve฀values฀for฀each฀year-end฀2002฀through฀2004,฀
which฀were฀based฀on฀year-end฀prices฀at฀the฀time.฀Note฀1฀to฀the฀
Consolidated฀Financial฀Statements฀includes฀a฀description฀of฀the฀
“successful฀efforts”฀method฀of฀accounting฀for฀oil฀and฀gas฀explo-
ration฀and฀production฀activities.฀The฀estimates฀of฀crude฀oil฀and฀
natural฀gas฀reserves฀are฀important฀to฀the฀timing฀of฀expense฀rec-
ognition฀for฀costs฀incurred.
The฀discussion฀of฀the฀critical฀accounting฀policy฀for฀“Impair-
ment฀of฀Property,฀Plant฀and฀Equipment฀and฀Investments฀in฀
Affiliates”฀on฀page฀44฀includes฀reference฀to฀conditions฀under฀
which฀downward฀revisions฀of฀proved฀reserve฀quantities฀could฀
result฀in฀impairments฀of฀oil฀and฀gas฀properties.฀This฀commen-
tary฀should฀be฀read฀in฀conjunction฀with฀disclosures฀elsewhere฀in฀
this฀discussion฀and฀in฀the฀Notes฀to฀the฀Consolidated฀Financial฀
Statements฀related฀to฀estimates,฀uncertainties,฀contingencies฀and฀
new฀accounting฀standards.฀Significant฀accounting฀policies฀are฀
discussed฀in฀Note฀1฀to฀the฀Consolidated฀Financial฀Statements฀on฀
page฀54.฀The฀development฀and฀selection฀of฀accounting฀estimates฀
and฀assumptions,฀including฀those฀deemed฀“critical,”฀and฀the฀
associated฀disclosures฀in฀this฀discussion฀have฀been฀discussed฀by฀
management฀with฀the฀audit฀committee฀of฀the฀Board฀of฀Directors.
The฀areas฀of฀accounting฀and฀the฀associated฀“critical”฀esti-
mates฀and฀assumptions฀made฀by฀the฀company฀are฀as฀follows:
Pension฀and฀Other฀Postretirement฀Benefit฀Plans฀ The฀determi-
nation฀of฀pension฀plan฀expense฀is฀based฀on฀a฀number฀of฀actuarial฀
assumptions.฀Two฀critical฀assumptions฀are฀the฀expected฀long-
term฀rate฀of฀return฀on฀plan฀assets฀and฀the฀discount฀rate฀applied฀
to฀pension฀plan฀obligations.฀For฀other฀postretirement฀employee฀
benefit฀(OPEB)฀plans,฀which฀provide฀for฀certain฀health฀care฀
and฀life฀insurance฀benefits฀for฀qualifying฀retired฀employees฀and฀
which฀are฀not฀funded,฀critical฀assumptions฀in฀determining฀OPEB฀
expense฀are฀the฀discount฀rate฀applied฀to฀benefit฀obligations฀and฀
the฀assumed฀health฀care฀cost-trend฀rates฀used฀in฀the฀calculation฀
of฀benefit฀obligations.
Note฀22฀to฀the฀Consolidated฀Financial฀Statements,฀beginning฀
on฀page฀70,฀includes฀information฀for฀the฀three฀years฀ending฀Decem-
ber฀31,฀2004,฀on฀the฀components฀of฀pension฀and฀OPEB฀expense฀and฀
the฀underlying฀assumptions฀as฀well฀as฀on฀the฀funded฀status฀for฀the฀
company’s฀pension฀plans฀at฀the฀end฀of฀2004฀and฀2003.฀
To฀estimate฀the฀long-term฀rate฀of฀return฀on฀pension฀assets,฀
the฀company฀employs฀a฀rigorous฀process฀that฀incorporates฀actual฀
historical฀asset-class฀returns฀and฀an฀assessment฀of฀expected฀
future฀performance฀and฀takes฀into฀consideration฀external฀actu-
arial฀advice฀and฀asset-class฀factors.฀Asset฀allocations฀are฀regularly฀
updated฀using฀pension฀plan฀asset/liability฀studies,฀and฀the฀deter-
mination฀of฀the฀company’s฀estimates฀of฀long-term฀rates฀of฀return฀
are฀consistent฀with฀these฀studies.฀For฀example,฀the฀expected฀long-
term฀rate฀of฀return฀on฀United฀States฀pension฀plan฀assets,฀which฀
account฀for฀about฀70฀percent฀of฀the฀company’s฀pension฀plan฀
assets,฀has฀remained฀at฀7.8฀percent฀since฀2002.฀฀
The฀year-end฀market-related฀value฀of฀U.S.฀pension฀plan฀assets฀
used฀in฀the฀determination฀of฀pension฀expense฀was฀based฀on฀the฀
market฀value฀in฀the฀preceding฀three฀months฀as฀opposed฀to฀the฀
maximum฀allowable฀period฀of฀five฀years฀under฀U.S.฀accounting฀
rules.฀Management฀considers฀the฀three-month฀period฀long฀enough฀
to฀minimize฀the฀effects฀of฀distortions฀from฀day-to-day฀market฀
volatility฀and฀still฀be฀contemporaneous฀to฀the฀end฀of฀the฀year.฀For฀
plans฀outside฀the฀United฀States,฀market฀value฀of฀assets฀as฀of฀the฀
measurement฀date฀is฀used฀in฀calculating฀the฀pension฀expense.
The฀discount฀rate฀assumptions฀used฀to฀determine฀pension฀
and฀postretirement฀benefit฀plan฀obligations฀and฀expense฀reflect฀
the฀prevailing฀rates฀available฀on฀high-quality,฀fixed-income฀debt฀
instruments.฀At฀December฀31,฀2004,฀the฀company฀calculated฀the฀
U.S.฀pension฀obligation฀using฀a฀5.8฀percent฀discount฀rate.฀The฀
discount฀rates฀used฀at฀the฀end฀of฀2003฀and฀2002฀were฀6฀percent฀
and฀6.8฀percent,฀respectively.฀
An฀increase฀in฀the฀expected฀long-term฀return฀on฀plan฀assets฀
or฀the฀discount฀rate฀would฀reduce฀pension฀plan฀expense,฀and฀vice฀
versa.฀Total฀pension฀expense฀for฀2004฀was฀$564฀million.฀As฀an฀
indication฀of฀the฀sensitivity฀of฀pension฀expense฀to฀the฀long-term฀
rate฀of฀return฀assumption,฀a฀1฀percent฀increase฀in฀the฀expected฀
rate฀of฀return฀on฀assets฀of฀the฀company’s฀primary฀U.S.฀pension฀
plan,฀which฀accounted฀for฀about฀60฀percent฀of฀the฀company-
wide฀pension฀obligation,฀would฀have฀reduced฀total฀pension฀plan฀
expense฀for฀2004฀by฀approximately฀$45฀million.฀A฀1฀percent฀
increase฀in฀the฀discount฀rate฀for฀this฀same฀plan฀would฀have฀
reduced฀total฀benefit฀plan฀expense฀for฀2004฀by฀approximately฀
$115฀million.฀The฀actual฀rates฀of฀return฀on฀plan฀assets฀and฀dis-
count฀rates฀may฀vary฀significantly฀from฀estimates฀because฀of฀
unanticipated฀changes฀in฀the฀world’s฀financial฀markets.
In฀2004,฀the฀company’s฀pension฀plan฀contributions฀totaled฀
$1.6฀billion฀(approximately฀$1.3฀billion฀to฀the฀U.S.฀plans).฀In฀