McKesson 2006 Annual Report Download - page 41

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McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
The LIFO method was used to value approximately 85% to 90% of our inventories at March 31, 2006 and 2005. If the FIFO method, which
approximates replacement cost, had been applied, total inventories would have increased $155 million and $187 million at March 31, 2006 and
2005. In addition, we recorded LIFO reserve adjustments of benefits of $32 million and $59 million in 2006 and 2005, and an expense of
$28 million in 2004. LIFO adjustments generally represent the net effect of the amount of price increases on branded pharmaceutical products
held in inventory offset by price declines on generic pharmaceutical products, including the price decrease effect of branded pharmaceutical
products that have lost patent protection. A LIFO benefit implies that the price declines on generic pharmaceutical products, including the
effect of branded pharmaceuticals that have lost patent protection, exceeded the effect of price increases on branded pharmaceutical products
held in inventory.
In determining whether inventory valuation issues exist, we consider various factors including estimated quantities of slow-moving
inventory by reviewing on-hand quantities, outstanding purchase obligations and forecasted sales. Shifts in market trends and conditions,
changes in customer preferences due to the introduction of generic drugs or new pharmaceutical products, or the loss of one or more significant
customers are factors that could affect the value of our inventories. These factors could make our estimates of inventory valuation differ from
actual results.
Acquisitions: We account for acquired businesses using the purchase method of accounting which requires that the assets acquired and
liabilities assumed be recorded at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair
values of the net assets acquired is recorded as goodwill. Amounts allocated to acquired in-process research and development are expensed at
the date of acquisition. The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities
assumed, as well as asset lives, can materially impact our results of operations. Accordingly, for significant items, we typically obtain
assistance from third party valuation specialists. The valuations are based on information available near the acquisition date and are based on
expectations and assumptions that have been deemed reasonable by management.
There are several methods that can be used to determine the fair value of assets acquired and liabilities assumed. For intangible assets we
typically use the income method. This method starts with a forecast of all of the expected future net cash flows. These cash flows are then
adjusted to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash flow streams. Some of
the more significant estimates and assumptions inherent in the income method or other methods include: the amount and timing of projected
future cash flows; the discount rate selected to measure the risks inherent in the future cash flows; and the assessment of the asset’s life cycle
and the competitive trends impacting the asset, including consideration of any technical, legal, regulatory, or economic barriers to entry.
Determining the useful life of an intangible asset also requires judgment as different types of intangible assets will have different useful lives
and certain assets may even be considered to have indefinite useful lives.
Goodwill: We have significant goodwill assets as a result of acquiring businesses. We account for goodwill in accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” which requires us to maintain goodwill assets on
our books unless the assets are deemed to be impaired. We perform an impairment test on goodwill balances annually or when indicators of
impairment exist. Such impairment tests require that we first compare the carrying value of net assets to the estimated fair value of net assets
for the operations in which goodwill is assigned. If carrying value exceeds fair value, a second step would be performed to calculate the amount
of impairment. Fair values can be determined using market, income or cost approaches. To estimate the fair value of a business using the
market approach, we compare the business to similar businesses or guideline companies whose securities are actively traded in public markets;
or the income approach, where we use a discounted cash flow model in which cash flows anticipated over several periods, plus a terminal value
at the end of that time horizon, are discounted to their present value using an appropriate rate of return.
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