Federal Express 2011 Annual Report Download - page 33

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MANAGEMENT’S DISCUSSION AND ANALYSIS
Our self–insurance accruals are primarily based on the actuarially
estimated, undiscounted cost of claims to provide us with estimates
of future claim costs based on claims incurred as of the balance
sheet date. These estimates include consideration of factors such as
severity of claims, frequency of claims and future healthcare costs.
Cost trends on material accruals are updated each quarter. We self–
insure up to certain limits that vary by operating company and type
of risk. Periodically, we evaluate the level of insurance coverage and
adjust insurance levels based on risk tolerance and premium expense.
Historically, it has been infrequent that incurred claims exceeded our
self–insured limits. Other acceptable methods of accounting for these
accruals include measurement of claims outstanding and projected
payments based on historical development factors.
We believe the use of actuarial methods to account for these liabilities
provides a consistent and effective way to measure these highly
judgmental accruals. However, the use of any estimation technique in
this area is inherently sensitive given the magnitude of claims involved
and the length of time until the ultimate cost is known. We believe
our recorded obligations for these expenses are consistently measured
on a conservative basis. Nevertheless, changes in healthcare costs,
accident frequency and severity, insurance retention levels and other
factors can materially affect the estimates for these liabilities.
LONG–LIVED ASSETS
PROPERTY AND EQUIPMENT. Our key businesses are capital intensive,
with approximately 57% of our total assets invested in our transporta-
tion and information systems infrastructures. We capitalize only those
costs that meet the definition of capital assets under accounting stan-
dards. Accordingly, repair and maintenance costs that do not extend
the useful life of an asset or are not part of the cost of acquiring the
asset are expensed as incurred.
The depreciation or amortization of our capital assets over their
estimated useful lives, and the determination of any salvage val-
ues, requires management to make judgments about future events.
Because we utilize many of our capital assets over relatively long
periods (the majority of aircraft costs are depreciated over 15 to 18
years), we periodically evaluate whether adjustments to our estimated
service lives or salvage values are necessary to ensure these esti-
mates properly match the economic use of the asset. This evaluation
may result in changes in the estimated lives and residual values used
to depreciate our aircraft and other equipment. For our aircraft, we
typically assign no residual value due to the utilization of these assets
in cargo configuration, which results in little to no value at the end of
their useful life. These estimates affect the amount of depreciation
expense recognized in a period and, ultimately, the gain or loss on
the disposal of the asset. Changes in the estimated lives of assets
will result in an increase or decrease in the amount of depreciation
recognized in future periods and could have a material impact on
our results of operations. Historically, gains and losses on operating
equipment have not been material (typically aggregating less than $10
million annually). However, such amounts may differ materially in the
future due to changes in business levels, technological obsolescence,
accident frequency, regulatory changes and other factors beyond our
control.
Because of the lengthy lead times for aircraft manufacture and
modifications, we must anticipate volume levels and plan our fleet
requirements years in advance, and make commitments for aircraft
based on those projections. Furthermore, the timing and availabil-
ity of certain used aircraft types (particularly those with better fuel
efficiency) may create limited opportunities to acquire these aircraft
at favorable prices in advance of our capacity needs. These activi-
ties create risks that asset capacity may exceed demand and that
an impairment of our assets may occur. Aircraft purchases (primar-
ily aircraft in passenger configuration) that have not been placed in
service totaled $173 million at May 31, 2011 and $101 million at May
31, 2010. We plan to modify these assets in the future and place them
into operations.
The accounting test for whether an asset held for use is impaired
involves first comparing the carrying value of the asset with its esti-
mated future undiscounted cash flows. If the cash flows do not exceed
the carrying value, the asset must be adjusted to its current fair value.
We operate integrated transportation networks and, accordingly, cash
flows for most of our operating assets are assessed at a network level,
not at an individual asset level for our analysis of impairment. Further,
decisions about capital investments are evaluated based on the impact
to the overall network rather than the return on an individual asset.
We make decisions to remove certain long–lived assets from service
based on projections of reduced capacity needs or lower operating
costs of newer aircraft types, and those decisions may result in an
impairment charge. Assets held for disposal must be adjusted to their
estimated fair values less costs to sell when the decision is made to
dispose of the asset and certain other criteria are met. The fair value
determinations for such aircraft may require management estimates,
as there may not be active markets for some of these aircraft. Such
estimates are subject to revision from period to period.
There were no material property and equipment impairment charges
recognized in 2011 (see “Overview” for additional information on
certain asset impairments in our FedEx Freight segment in 2011) or
2010. However, during 2009, we recorded $202 million in property and
equipment impairment charges. These charges were primarily related
to our decision to permanently remove from service certain aircraft,
along with certain excess aircraft engines, at FedEx Express.
LEASES. We utilize operating leases to finance certain of our aircraft,
facilities and equipment. Such arrangements typically shift the risk
of loss on the residual value of the assets at the end of the lease
period to the lessor. As disclosed in “Contractual Cash Obligations”
and Note 7 of the accompanying consolidated financial statements, at
May 31, 2011 we had approximately $14 billion (on an undiscounted
basis) of future commitments for payments under operating leases.
The weighted–average remaining lease term of all operating leases
outstanding at May 31, 2011 was approximately six years. The future
commitments for operating leases are not reflected as a liability in our
balance sheet under current U.S. accounting rules.