McKesson 2012 Annual Report Download - page 47

McKESSON CORPORATION
FINANCIAL REVIEW (Continued)
43
Supplier Reserves: We establish reserves against amounts due from suppliers relating to various price and
rebate incentives, including deductions or billings taken against payments otherwise due to them. These reserve
estimates are established based on judgment after considering the status of current outstanding claims, historical
experience with the suppliers, the specific incentive programs and any other pertinent information available. We
evaluate the amounts due from suppliers on a continual basis and adjust the reserve estimates when appropriate
based on changes in factual circumstances. As of March 31, 2012 and 2011, supplier reserves were $115 million
and $102 million. The ultimate outcome of any outstanding claims may be different from our estimate. All of the
supplier reserves at March 31, 2012 and 2011 pertain to our Distribution Solutions segment. An increase or
decrease in the supplier reserve as a hypothetical 0.1% of trade payables at March 31, 2012 would result in an
increase or decrease in the cost of sales of approximately $16 million in 2012. The selected 0.1% hypothetical
change does not reflect what could be considered the best or worst case scenarios.
Income Taxes: Our income tax expense and deferred tax assets and liabilities reflect management’s best
assessment of estimated current and future taxes to be paid. We are subject to income taxes in the U.S. and
numerous foreign jurisdictions. Significant judgments and estimates are required in determining the consolidated
income tax provision and in evaluating income tax uncertainties. We review our tax positions at the end of each
quarter and adjust the balances as new information becomes available.
Deferred income taxes arise from temporary differences between the tax and financial statement recognition of
revenue and expense. In evaluating our ability to recover our deferred tax assets, we consider all available positive
and negative evidence including our past operating results, the existence of cumulative net operating losses in the
most recent years and our forecast of future taxable income. In estimating future taxable income, we develop
assumptions including the amount of future federal, state and foreign pre-tax operating income, the reversal of
temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions
require significant judgment about the forecasts of future taxable income and are consistent with the plans and
estimates we use to manage the underlying businesses. We had deferred income tax assets (net of valuation
allowances) of $1,335 million and $1,297 million at March 31, 2012 and 2011 and deferred tax liabilities of
$2,495 million and $2,261 million. Deferred tax assets primarily consist of net loss and credit carryforwards and
timing differences on our compensation and benefit related accruals. Deferred tax liabilities primarily consist of
basis differences for inventory valuation (including inventory valued at LIFO) and other assets. We established
valuation allowances of $101 million and $99 million for 2012 and 2011 against certain deferred tax assets, which
primarily relate to federal, state and foreign loss carryforwards for which the ultimate realization of future benefits is
uncertain. Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future.
Should tax laws change, including those laws pertaining to LIFO, our cash flows could be materially impacted.
If our assumptions and estimates described above were to change, an increase/decrease of 1% in our effective
tax rate as applied to income from continuing operations would have increased/decreased tax expense by
approximately $19 million, or $0.08 per diluted share, for 2012.
Share-Based Compensation: Our compensation programs include share-based compensation. We account for
all share-based compensation transactions using a fair-value based measurement method. The share-based
compensation expense, for the portion of the awards that is ultimately expected to vest, is recognized on a straight-
line basis over the requisite service period for those awards with graded vesting and service conditions. For awards
with performance conditions and multiple vest dates, we recognize the expense on a graded vesting basis. For
awards with performance conditions and a single vest date, we recognize the expense on a straight-line basis.
We estimate the grant-date fair value of employee stock options using the Black-Scholes options-pricing model.
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 life of the option, the expected stock price volatility and the expected dividend yield. In
determining the expected life of the option, we primarily use historical experience as our best estimate of future
exercise patterns. We use a combination of historical and implied market 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 employee stock option valuation considerations. Once the fair values of employee
stock options are determined, current accounting practices do not permit them to be changed, even if the estimates
used are different from actual experience.