Union Pacific 2010 Annual Report Download - page 46

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Under group depreciation, the historical cost (net of salvage) of depreciable property that is retired or
replaced in the ordinary course of business is charged to accumulated depreciation and no gain or loss is
recognized. The historical cost of certain track assets is estimated using (i) inflation indices published by
the Bureau of Labor Statistics and (ii) the estimated useful lives of the assets as determined by our
depreciation studies. The indices were selected because they closely correlate with the major costs of
the properties comprising the applicable track asset classes. Because of the number of estimates
inherent in the depreciation and retirement processes and because it is impossible to precisely estimate
each of these variables until a group of property is completely retired, we continually monitor the
estimated service lives of our assets and the accumulated depreciation associated with each asset class
to ensure our depreciation rates are appropriate. In addition, we determine if the recorded amount of
accumulated depreciation is deficient (or in excess) of the amount indicated by our depreciation studies.
Any deficiency (or excess) is amortized as a component of depreciation expense over the remaining
service lives of the applicable classes of assets.
For retirements of depreciable railroad properties that do not occur in the normal course of business, a
gain or loss may be recognized if the retirement meets each of the following three conditions: (i) is
unusual, (ii) is material in amount, and (iii) varies significantly from the retirement profile identified through
our depreciation studies. During the last three fiscal years, no gains or losses were recognized due to the
retirement of depreciable railroad properties. A gain or loss is recognized in other income when we sell
land or dispose of assets that are not part of our railroad operations.
Income Taxes – We account for income taxes by recording taxes payable or refundable for the current
year and deferred tax assets and liabilities for the expected future tax consequences of events that have
been recognized in our financial statements or tax returns. These expected future tax consequences are
measured based on current tax law; the effects of future changes in tax laws are not anticipated. Future
tax law changes, such as a change in the corporate tax rate, could have a material impact on our financial
condition, results of operations, or liquidity. For example, a 1% increase in future income tax rates would
increase our deferred tax liability by approximately $300 million.
When appropriate, we record a valuation allowance against deferred tax assets to reflect that these tax
assets may not be realized. In determining whether a valuation allowance is appropriate, we consider
whether it is more likely than not that all or some portion of our deferred tax assets will not be realized,
based on management’s judgments using available evidence about future events. In 2010, there is no
valuation allowance because the deferred tax assets associated with the 2009 valuation allowance
expired unrealized. Our total valuation allowance at December 31, 2009 was $8 million.
At times, we may claim tax benefits that may be challenged by a tax authority. We recognize tax benefits
only for tax positions that are more likely than not to be sustained upon examination by tax authorities.
The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely
to be realized upon settlement. A liability for “unrecognized tax benefits” is recorded for any tax benefits
claimed in our tax returns that do not meet these recognition and measurement standards.
Pension and Other Postretirement Benefits – We use an actuarial analysis to measure the liabilities
and expenses associated with providing pension and medical and life insurance benefits (OPEB) to
eligible employees. In order to use actuarial methods to value the liabilities and expenses, we must make
several assumptions. The critical assumptions used to measure pension obligations and expenses are
the discount rate and expected rate of return on pension assets. For OPEB, the critical assumptions are
the discount rate and health care cost trend rate.
We evaluate our critical assumptions at least annually, and selected assumptions are based on the
following factors:
• Discount rate is based on a Mercer yield curve of high quality corporate bonds (rated AA by a
recognized rating agency) for which the timing and amount of cash flows matches our plans’
expected benefit payments.
• Expected return on plan assets is based on our asset allocation mix and our historical return,
taking into consideration current and expected market conditions.
• Health care cost trend rate is based on our historical rates of inflation and expected market
conditions.