E-Z-GO 2010 Annual Report Download - page 46

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includes estimates of recoveries asserted against the customer for changes in specifications. Due to the size, length of time and
nature of many of our contracts, the estimation of total contract costs and revenues through completion is complicated and subject to
many variables relative to the outcome of future events over a period of several years. We are required to make numerous
assumptions and estimates relating to items such as expected engineering requirements, complexity of design and related
development costs, performance of subcontractors, availability and cost of materials, labor productivity and cost, overhead and
capital costs, manufacturing efficiencies and the achievement of contract milestones, including product deliveries.
Our cost estimation process is based on the professional knowledge and experience of engineers and program managers along with
finance professionals. We update our projections of costs at least semiannually or when circumstances significantly change.
Adjustments to projected costs are recognized in earnings when determinable. Anticipated losses on contracts are recognized in full in
the period in which the losses become probable and estimable. Due to the significance of judgment in the estimation process
described above, it is likely that materially different revenues and/or cost of sales amounts could be recorded if we used different
assumptions or if the underlying circumstances were to change. Our earnings could be reduced by a material amount resulting in a
charge to earnings if (a) total estimated contract costs are significantly higher than expected due to changes in customer specifications
prior to contract amendment, (b) total estimated contract costs are significantly higher than previously estimated due to cost overruns
or inflation, (c) there is a change in engineering efforts required during the development stage of the contract or (d) we are unable to
meet contract milestones.
Goodwill
We evaluate the recoverability of goodwill annually in the fourth quarter or more frequently if events or changes in circumstances,
such as declines in sales, earnings or cash flows, or material adverse changes in the business climate, indicate that the carrying value
of a reporting unit might be impaired. Goodwill is reviewed for potential impairment using a two-step process. In Step 1, companies
are required to estimate fair value of their reporting units, which may be done using various methodologies, including the income
method using discounted cash flows. If its estimated fair value exceeds its carrying value, the reporting unit is not impaired, and no
further analysis is performed. Otherwise, the amount of the impairment must be determined in Step 2 of the goodwill impairment test.
In Step 2, the implied fair value of goodwill is determined by assigning a fair value to all of the reporting unit’s assets and liabilities,
including any unrecognized intangible assets, as if the reporting unit had been acquired in a business combination at fair value. If the
carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss would be
recognized in an amount equal to that excess.
Fair values are established primarily using discounted cash flows that incorporate assumptions for the unit’s short- and long-term
revenue growth rates, operating margins and discount rates, which represent our best estimates of current and forecasted market
conditions, current cost structure, anticipated net cost reductions, and the implied rate of return that we believe a market participant
would require for an investment in a company having similar risks and business characteristics to the reporting unit being assessed.
The revenue growth rates and operating margins used in our discounted cash flow analysis are based on our businesses’ strategic plans
and long-range planning forecasts. The long-term growth rate we use to determine the terminal value of the business is based on our
assessment of its minimum expected terminal growth rate, as well as its past historical growth and broader economic considerations
such as gross domestic product, inflation and the maturity of the markets we serve. We utilize a weighted-average cost of capital in
our impairment analysis that makes assumptions about the capital structure that we believe a market participant would make and
include a risk premium based on an assessment of risks related to the projected cash flows of each reporting unit. We believe this
approach yields a discount rate that is consistent with an implied rate of return that an independent investor or market participant
would require for an investment in a company having similar risks and business characteristics to the reporting unit being assessed.
Based on our annual review, the fair value of all of our reporting units exceeded their carrying values, and we do not believe that there
is a reasonable possibility that any units might fail the Step 1 impairment test in the foreseeable future.
Retirement Benefits
We maintain various pension and postretirement plans for our employees globally. These plans include significant pension and
postretirement benefit obligations, which are calculated based on actuarial valuations. Key assumptions used in determining these
obligations and related expenses include expected long-term rates of return on plan assets, discount rates and healthcare cost
projections. We also make assumptions regarding employee demographic factors such as retirement patterns, mortality, turnover and
rate of compensation increases. We evaluate and update these assumptions annually.
To determine the weighted-average expected long-term rate of return on plan assets, we consider the current and expected asset
allocation, as well as historical and expected returns on each plan asset class. A lower expected rate of return on plan assets will
increase pension expense. For 2010, the assumed expected long-term rate of return on plan assets used in calculating pension
expense was 8.26%, compared with 8.58% in 2009. In 2010 and 2009, the assumed rate of return for our domestic plans, which
represent approximately 90% of our total pension assets, was 8.50% and 8.75%, respectively. A 50-basis-point decrease in this long-
term rate of return in 2010 would have resulted in approximately a $22 million increase in pension expense for our domestic plans.
The discount rate enables us to state expected future benefit payments as a present value on the measurement date, reflecting the
current rate at which the pension liabilities could be effectively settled. This rate should be in line with rates for high-quality fixed