McKesson 2011 Annual Report Download - page 47

McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
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Inventories: We report inventories at the lower of cost or market (“LCM”). Inventories for our Distribution
Solutions segment consist of merchandise held for resale. For our Distribution Solutions segment, the majority of
the cost of domestic inventories is determined using the LIFO method and the cost of Canadian inventories is
determined using the first-in, first-out (“FIFO”) method. Technology Solutions segment inventories consist of
computer hardware with cost determined by the standard cost method. Rebates, fees, cash discounts, allowances,
chargebacks and other incentives received from vendors are generally accounted for as a reduction in the cost of
inventory and are recognized when the inventory is sold. Total inventories were $9.2 billion and $9.4 billion at
March 31, 2011 and 2010.
The LIFO method was used to value approximately 87% of our inventories at March 31, 2011 and 2010. At
March 31, 2011 and 2010, our LIFO reserves, net of LCM adjustments, were $96 million and $93 million. LIFO
reserves include both pharmaceutical and non-pharmaceutical products. In 2011, 2010, and 2009, we recognized net
LIFO expense of $3 million, $8 million and $8 million within our consolidated statements of operations. In 2011,
our $3 million net LIFO expense related to our non-pharmaceutical products. A LIFO expense is recognized when
the net effect of price increases on branded pharmaceuticals and non-pharmaceutical products held in inventory
exceeds the impact of price declines and shifts towards generic pharmaceuticals, including the effect of branded
pharmaceutical products that have lost market exclusivity. A LIFO credit is recognized when the net effect of price
declines and shifts towards generic pharmaceuticals exceeds the impact of price increases on branded
pharmaceuticals and non-pharmaceutical products held in inventory.
We believe that the FIFO inventory costing method provides a reasonable estimation of the current cost of
replacing inventory (i.e., “market”). As such, our LIFO inventory is valued at the lower of LIFO or inventory as
valued under FIFO. Primarily due to continued net deflation in generic pharmaceutical inventories, pharmaceutical
inventories at LIFO were $156 million and $112 million higher than FIFO as of March 31, 2011 and 2010. As a
result, in 2011 and 2010, we recorded LCM charges of $44 million and $5 million within our consolidated
statements of operations to adjust our LIFO inventories to market. As deflation in generic pharmaceuticals
continues, we anticipate that LIFO credits from the valuation of our pharmaceutical products will be fully offset by
LCM reserves.
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. We provide reserves for excess and obsolete inventory, if indicated, as a result of
these reviews. These factors could make our estimates of inventory valuation differ from actual results.
Business Combinations: We account for acquired businesses using the acquisition 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. Effective April 1, 2009, acquisition-related expenses and restructuring costs are recognized separately
from the business combinations and are expensed as incurred. Acquisition-related expenses totaled $52 million in
2011 and were not material in 2010.
Several methods may 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 for each asset or liability acquired. 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. Refer to Financial Note 2, “Business
Combinations,” to the consolidated financial statements appearing in this Annual Report on Form 10-K for
additional information regarding our acquisitions.