Estee Lauder 2012 Annual Report Download - page 105

THE EST{E LAUDER COMPANIES INC. 103
for which a decrease of 75 basis points in our terminal
growth rate would still result in a fair value calculation
exceeding its book value. Changes in the valuation
assumptions from those used in the prior year primarily
reflect the impact of the current economic environment
on the reporting units and their projected future results
of operations.
To determine fair value of other indefinite-lived intan-
gible assets, we use an income approach, the relief-from-
royalty method. This method assumes that, in lieu of
ownership, a third party would be willing to pay a royalty
in order to obtain the rights to use the comparable asset.
Other indefinite-lived intangible assets’ fair values require
significant judgments in determining both the assets’
estimated cash flows as well as the appropriate discount
and royalty rates applied to those cash flows to determine
fair value. Changes in such estimates or the application of
alternative assumptions could produce significantly
different results. The fiscal 2012 and 2011 terminal growth
rate applied to future cash flows was 3% and the fiscal
2012 and 2011 discount rates ranged from 10% to 18%.
The fiscal 2012 and 2011 royalty rates ranged from
0.5% to 12%.
We review long-lived assets for impairment whenever
events or changes in circumstances indicate that the car-
rying amount may not be recoverable. When such events
or changes in circumstances occur, a recoverability test is
performed comparing projected undiscounted cash flows
from the use and eventual disposition of an asset or asset
group to its carrying value. If the projected undiscounted
cash flows are less than the carrying value, an impairment
would be recorded for the excess of the carrying value
over the fair value, which is determined by discounting
future cash flows.
INCOME TAXES
We account for income taxes using an asset and liability
approach that requires the recognition of deferred tax
assets and liabilities for the expected future tax conse-
quences of events that have been recognized in our con-
solidated financial statements or tax returns. As of June
30, 2012, we have current net deferred tax assets of
$247.8 million and non-current net deferred tax assets of
$103.1 million. The net deferred tax assets assume suffi-
cient future earnings for their realization, as well as the
continued application of currently anticipated tax rates.
Included in net deferred tax assets is a valuation allow-
ance of $73.2 million for deferred tax assets, where man-
agement believes it is more-likely-than-not that the
deferred tax assets will not be realized in the relevant
jurisdiction. Based on our assessments, no additional
valuation allowance is required. If we determine that a
deferred tax asset will not be realizable, an adjustment to
the deferred tax asset will result in a reduction of net earn-
ings at that time.
We provide tax reserves for U.S. federal, state, local
and foreign exposures relating to periods subject to audit.
The development of reserves for these exposures requires
judgments about tax issues, potential outcomes and tim-
ing, and is a subjective critical estimate. We assess our tax
positions and record tax benefits for all years subject to
examination based upon management’s evaluation of
the facts, circumstances, and information available at the
reporting dates. For those tax positions where it is more-
likely-than-not that a tax benefit will be sustained, we have
recorded the largest amount of tax benefit with a greater
than 50% likelihood of being realized upon settlement
with a tax authority that has full knowledge of all relevant
information. For those tax positions where it is not more-
likely-than-not that a tax benefit will be sustained, no tax
benefit has been recognized in the consolidated financial
statements. We classify applicable interest and penalties
as a component of the provision for income taxes.
Although the outcome relating to these exposures is
uncertain, in management’s opinion adequate provisions
for income taxes have been made for estimable potential
liabilities emanating from these exposures. If actual out-
comes differ materially from these estimates, they could
have a material impact on our consolidated results
of operations.
DERIVATIVES
We address certain financial exposures through a con-
trolled program of risk management that includes the use
of derivative financial instruments. We enter into foreign
currency forward contracts and may enter into option
contracts to reduce the effects of fluctuating foreign cur-
rency exchange rates and interest rate derivatives to man-
age the effects of interest rate movements on our
aggregate liability portfolio. We also enter into foreign
currency forward contracts and may use option contracts,
not designated as hedging instruments, to mitigate the
change in fair value of specific assets and liabilities on
the balance sheet. We do not utilize derivative financial
instruments for trading or speculative purposes. Hedge
effectiveness is documented, assessed and monitored
by employees who are qualified to make such assess-
ments and monitor the instruments. Variables that are
external to us such as social, political and economic risks
may have an impact on our hedging program and the
results thereof.