Federal Express 2005 Annual Report Download - page 56

FEDEX CORPORATION
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The depreciation or amortization of our capital assets over their
estimated useful lives, and the determination of any salvage val-
ues, requires management to make judgments about future events.
Because we utilize many of our capital assets over relatively long
periods (the majority of aircraft costs are depreciated over 15 to 18
years), we periodically evaluate whether adjustments to our esti-
mated service lives or salvage values are necessary to ensure
these estimates properly match the economic use of the asset.
This evaluation may result in changes in the estimated lives and
residual values used to depreciate our aircraft and other equip-
ment. These estimates affect the amount of depreciation expense
recognized in a period and, ultimately, the gain or loss on the dis-
posal of the asset. Historically, gains and losses on operating
equipment have not been material (typically less than $10 million
annually). However, such amounts may differ materially in the
future due to technological obsolescence, accident frequency,
regulatory changes and other factors beyond our control.
Because of the lengthy lead times for aircraft manufacture and
modifications, we must anticipate volume levels and plan our
fleet requirements years in advance and make commitments for
aircraft based on those projections. These activities create risks
that asset capacity may exceed demand and that an impairment
of our assets may occur. In addition, opportunistic aircraft pur-
chases (primarily aircraft in passenger configuration) that have
not been placed in service totaled $348 million and $106 million at
May 31, 2005 and 2004, respectively. We plan to modify these
assets in the future to place them into operation.
The accounting test for whether an asset held for use is
impaired involves first comparing the carrying value of the asset
with its estimated future undiscounted cash flows. If the cash
flows do not exceed the carrying value, the asset must be
adjusted to its current fair value. Because the cash flows of our
transportation networks cannot be identified to individual assets,
and based on the ongoing profitability of our operations, we have
not experienced any significant impairment of assets to be held
and used. However, from time to time we make decisions
to remove certain long-lived assets from service based on pro-
jections of reduced capacity needs and those decisions may
result in an impairment charge. Assets held for disposal must be
adjusted to their estimated fair values when the decision is made
to dispose of the asset and certain other criteria are met. There
were no material asset impairment charges recognized in 2005,
2004 or 2003.
Leases. We utilize operating leases to finance certain of our
aircraft and facilities. Such arrangements typically shift the risk
of loss on the residual value of the assets at the end of the
lease period to the lessor. As disclosed in “Contractual Cash
Obligations” and Note 8 to the accompanying consolidated
financial statements, at May 31, 2005 we had approximately $14
billion (on an undiscounted basis) of future commitments for pay-
ments under operating leases. The weighted average remaining
lease term of all operating leases outstanding at May 31, 2005
was approximately six years.
The future commitments for operating leases are not reflected as
a liability in our balance sheet because these leases do not meet
the accounting definition of capital leases. The determination of
whether a lease is accounted for as a capital lease or an operat-
ing lease requires management to make estimates primarily
about the fair value of the asset and its estimated economic
useful life. We believe we have well-defined and controlled
processes for making this evaluation, including obtaining third-
party appraisals for material transactions.
On February 7, 2005, the SEC posted to its Web site a letter from
the Chief Accountant of the SEC to the AICPA Center for Public
Company Audit Firms discussing three lease accounting issues
that have been the cause of several recent public company
restatements. Of specific concern is the appropriate accounting
for: (1) the amortization of leasehold improvements by a lessee in
an operating lease with lease renewals; (2) the pattern of recog-
nition of rent when the lease term in an operating lease contains a
period where there are free or reduced rents (commonly referred
to as “rent holidays”); and (3) incentives related to leasehold
improvements provided by a landlord/lessor to a tenant/lessee in
an operating lease. We evaluated our accounting for the three
lease accounting issues identified by the SEC and believe that we
are in compliance with the SEC’s guidance.
Goodwill. We have approximately $2.8 billion of goodwill on our
balance sheet resulting from the acquisition of businesses, which
includes approximately $1.7 billion from our acquisition of FedEx
Kinko’s in 2004. Accounting standards require that we do not
amortize goodwill but review it for impairment on at least
an annual basis.
The annual evaluation of goodwill impairment requires the use of
estimates and assumptions to determine the fair value of our
reporting units using a discounted cash flow methodology. In par-
ticular, the following estimates used by management can
significantly affect the outcome of the impairment test: revenue
growth rates; operating margins; discount rates and expected
capital expenditures. Each year, independent of our goodwill
impairment test, we update our weighted-average cost of capital
calculation and perform a long-range planning analysis to pro-
ject expected results of operations. Using this data, we complete
a separate fair-value analysis for each of our reporting units.
Changes in forecasted operations and other assumptions could
materially affect these estimates. We compare the fair value of
our reporting units to the carrying value, including goodwill, of
each of those units. We performed our annual impairment tests in
the fourth quarter of 2005. Because the fair value of each of our
reporting units exceeded its carrying value, including goodwill,
no impairment charge was necessary.