McKesson 2006 Annual Report Download - page 44

McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
For disclosure purposes only, we estimate the fair value of employee stock options using the Black-Scholes option-pricing model. We
believe that it is difficult to accurately measure the value of an employee stock option. Our estimates of employee stock option values rely on
estimates of factors we input into the model. The key factors involve an estimate of future uncertain events. The key factors influencing the
estimation process, among others, are the expected term of the option, the expected stock price volatility factor and the expected dividend yield.
We continue to use historical exercise patterns as our best estimate of future exercise patterns in determining our expected term of the option.
In 2006, we began using a combination of historical and quoted implied volatility to determine the expected stock price volatility factor. We
believe that this market-based input provides a better estimate of our future stock price movements and is consistent with emerging employee
stock option valuation considerations. Our expected stock price volatility assumption continues to reflect a constant dividend yield during the
expected term of the option. Once employee stock option values are determined, current accounting practices do not permit them to be
changed, even if the estimates used are different from actual.
The pro forma effect on net income (loss) and diluted earnings (loss) per common share for the years ended March 31, 2006, 2005 and 2004
is set forth in Financial Note 1, “Significant Accounting Policies,” to the accompanying consolidated financial statements, under the caption
“Share-Based Payment.” In addition, beginning in 2007, we will report the value of stock options in our income statement. See our discussion
in the “Recently Issued Accounting Standards” section of this Financial Review.
Pension and Other Postretirement Benefits: We provide defined benefit pension plans or defined contribution plans for the majority of our
employees worldwide. In the U.S., we have both qualified and supplemental (non-qualified) defined benefit plans and defined contribution
plans, as well as other postretirement benefit plans, consisting primarily of healthcare and life insurance for retirees. Our non-qualified U.S.
retirement plans and our other postretirement benefit plans, which are provided to certain employees, are unfunded obligations.
In 2006 and 2005, we made contributions of $7 million and $46 million to our U.S. non-qualified pension plans. In the aggregate, our U.S.
qualified pension plans are overfunded on an accumulated benefit obligation measurement basis as of March 31, 2006 and 2005. Outside the
U.S., in general, we fund our defined benefit plans to the extent that tax or other incentives exist and similar to our U.S. non-qualified pension
plans, we have accrued liabilities on our consolidated balance sheets to reflect those plans that are not fully funded.
The accounting for benefit plans is highly dependent on actuarial estimates, assumptions and calculations which result from a complex
series of judgments about future events and uncertainties. The assumptions and actuarial estimates required to estimate the employee benefit
obligations for the defined benefit and postretirement plans, include discount rate, expected salary increases, certain employee-related factors,
such as turnover, retirement age and mortality (life expectancy), expected return on assets and healthcare cost trend rates. We evaluate these
critical assumptions at least annually. Our assumptions reflect our historical experiences and our best judgment regarding future expectations
that have been deemed reasonable by management. The judgments made in determining the costs of our benefit plans can materially impact our
results of operations. As such, we obtain assistance from actuarial experts to aid in developing reasonable assumptions and cost estimates.
Actual results in any given year will often differ from actuarial assumptions because of economic and other factors. The effects of actual results
differing from our assumptions are included in unamortized net gain and loss, which is amortized over future periods.
Our weighted-average assumption for the expected long-term rate of return on assets in our pension plans, which determines net periodic
benefit cost, was 8.2% and 8.2% for 2006 and 2005. The weighted-average assumption for the expected return on assets for our plans reflects
our actual historical return experience and our long-term assessment of forward-looking return expectations by asset class, which is used to
develop a weighted-average expected return based on the implementation of our targeted asset allocation in our respective plans. Our target
asset allocation is determined based on the risk tolerance characteristics of the plan and, at times, may be adjusted to achieve our overall
investment objective. The weighted average discount rate used in calculating our pension benefit obligations at March 31, 2006, is 5.6%, which
represents a 20 bp decline from our March 31, 2005 rate of 5.8%. A lower discount rate increases the present value of benefit obligations and
increases pension expense. The discount rate for our defined benefit and postretirement plans is based on a yield curve constructed from a
portfolio of high quality corporate bonds rated AA or better for which the timing and amount of cash flows approximate the estimated payouts
of the plans.
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