Pepsi 2006 Annual Report Download - page 44

Our pension plans cover full-time
employees in the U.S. and certain inter-
national employees. Benefits are
determined based on either years of
service or a combination of years of ser-
vice and earnings. U.S. and Canada
retirees are also eligible for medical and
life insurance benefits (retiree medical)
if they meet age and service
requirements. Generally, our share of
retiree medical costs is capped at speci-
fied dollar amounts that vary based
upon years of service, with retirees con-
tributing the remainder of the cost.
On December 30, 2006, we adopted
SFAS 158, Employers’ Accounting for
Defined Benefit Pension and Other
Postretirement Plans — an amendment
of FASB Statements No. 87, 88, 106, and
132(R) (SFAS 158). SFAS 158 requires
that we recognize the overfunded or
underfunded status of our pension and
retiree medical plans (our Plans) as an
asset or liability on our December 30,
2006 balance sheet. Subsequent
changes in the funded status will be
recognized in comprehensive income in
the year in which they occur. SFAS 158
also requires that, beginning in 2008,
our assumptions used to measure our
annual pension and retiree medical
expenses be determined as of the bal-
ance sheet date, and all plan assets and
liabilities be reported as of that date.
Currently, the assumptions used to mea-
sure our annual
pension and retiree
medical expenses are
determined as of
September 30 (mea-
surement date) and
all plan assets and
liabilities are gener-
ally reported as of that date. In
accordance with SFAS 158, prior year
amounts have not been adjusted. For
further information regarding the impact
of our adoption of SFAS 158, see Note 7.
Our Assumptions
The determination of pension and
retiree medical plan obligations and
related expenses requires the use of
assumptions to estimate the amount of
the benefits that employees earn while
working, as well as the present value of
those benefits. Annual pension and
retiree medical expense amounts are
principally based on four components:
1) the value of benefits earned by
employees for working during the year
(service cost), 2) increase in the liability
due to the passage of time (interest
cost), and 3) other gains and losses as
discussed below, reduced by 4) expect-
ed return on plan assets for our
funded plans.
Significant assumptions used to mea-
sure our annual pension and retiree
medical expenses include:
• the interest rate used to determine
the present value of liabilities
(discount rate);
• certain employee-related factors,
such as turnover, retirement age
and mortality;
• for pension expense, the expected
return on assets in our funded plans
and the rate of salary increases for
plans where benefits are based on
earnings; and
• for retiree medical expense, health
care cost trend rates.
Our assumptions reflect our historical
experience and management’s best
judgment regarding future expectations.
Due to the significant management
judgment involved, our assumptions
could have a material impact on the
measurement of our pension and
retiree medical benefit expenses
and obligations.
At each measurement date, the dis-
count rate is based on interest rates for
high-quality, long-term corporate debt
securities with maturities comparable to
those of our liabilities. In the U.S., we
use the Moody’s Aa Corporate Index
yield and adjust for differences
between the average duration of the
bonds in this Index and the average
duration of our benefit liabilities, based
upon a published index.
The expected return on pension plan
assets is based on our historical experi-
ence, our pension plan investment
strategy and our expectations for long-
term rates of return. Our pension plan
investment strategy is reviewed annu-
ally and is established based upon plan
liabilities, an evaluation of market con-
ditions, tolerance for risk, and cash
requirements for benefit payments. We
use a third-party advisor to assist us in
determining our investment allocation
and modeling our long-term rate of
return assumptions. Our current invest-
ment allocation target for our U.S.
plans is 60% in equity securities, with
the balance in fixed income securities.
Our expected long-term rate of return
on U.S. plan assets is 7.8%, reflecting
estimated long-term rates of return of
9.3% from equity securities and 5.8%
from fixed income securities. We use a
market-related value method that rec-
ognizes each year’s asset gain or loss
over a five-year period. Therefore, it
takes five years for the gain or loss from
any one year to be fully included in the
other gains and losses calculation
described below.
Other gains and losses resulting from
actual experience differing from our
assumptions and from changes in our
assumptions are also determined at
each measurement date. If this net
accumulated gain or loss exceeds 10%
of the greater of plan assets or liabili-
ties, a portion of the net gain or loss is
included in expense for the following
year. The cost or benefit of plan
changes that increase or decrease bene-
fits for prior employee service (prior
service cost/(credit)) is included in earn-
ings on a straight-line basis over the
average remaining service period of
those employees expected to benefit,
which is approximately 11 years for
pension expense and approximately
13 years for retiree medical.
Pension and Retiree Medical Plans
42
SFAS 158 requires that we recognize the
overfunded or underfunded status of our pension
and retiree medical plans as an asset or liability
on our December 30, 2006 balance sheet.
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