Proctor and Gamble 2006 Annual Report Download - page 40

The Procter &Gamble Company and Subsidiaries
38 Management’s Discussion and Analysis
changing facts and circumstances, such as the progress of tax audits,
and adjust them when significant changes in risk warrant it. We have
a number of audits in process in various jurisdictions. Although the
resolution of these tax uncertainties is uncertain, based on currently
available information, we believe that the ultimate outcomes will not
have a material adverse effect on our results of operations, financial
condition or cash flows.
Our accounting represents management’s best estimate of future
events that can be appropriately reflected in the accounting estimates.
Certain changes or future events, such as changes in tax legislation,
geographic mix of earnings, completion of tax audits or earnings
repatriation plans could have an impact on our estimates and
effective tax rate.
Employee Benefits
We sponsor various post-employment benefits throughout the world.
These include pension plans, both defined contribution plans and
defined benefit plans, and other post-employment benefit (OPEB)
plans, consisting primarily of health care and life insurance for retirees.
For accounting purposes, the defined benefit and OPEB plans require
assumptions to estimate the projected and accumulated benefit
obligations, including the following: discount rate; expected salary
increases; certain employee-related factors, such as turnover,
retirement age and mortality; expected return on assets and health
care cost trend rates. These and other assumptions affect the annual
expense recognized for these plans. Our assumptions reflect our
historical experiences and management’s best judgment regarding
future expectations. In accordance with U.S. GAAP, the net amount
by which actual results differ from our assumptions is deferred. If this
net deferred amount exceeds 10% of the greater of plan assets or
liabilities, a portion of the deferred amount is included in expense for
the following year. The cost or benefit of plan changes, such as
increasing or decreasing benefits for prior employee service (prior service
cost), is deferred and included in expense on a straight-line basis over
the average remaining service period of the employees expected to
receive benefits.
Theexpectedreturnonplanassetsassumptionisimportant,sincemany
of our defined benefit plans and our primary OPEB plan are funded.
The process for setting the expected rates of return is described in
Note 9 to the Consolidated Financial Statements. For 2006, the average
return on assets assumption for pension plan assets and OPEB assets
was 7.3% and 9.2% respectively. A change in the rate of return of
0.5% for both pension and OPEB assets would impact annual benefit
expense by less than $40 million after tax.
Since pension and OPEB liabilities are measured on a discounted basis,
the discount rate is a significant assumption. Discount rates used for
our U.S. defined benefit and OPEB plans are based on a yield curve
constructed from a portfolio of high quality bonds for which the timing
and amount of cash outflows approximate the estimated payouts of
the plan. For our international plans, the discount rates are set by
benchmarking against investment grade corporate bonds rated AA or
better. The average discount rate on the defined benefit pension plans
of 5.2% represents a weighted average of local rates in countries
where such plans exist. A 0.5% change in the discount rate would
impact annual after-tax benefit expense by less than $45 million.
The rate on the OPEB plan of 6.3% reflects the higher interest rates
generally available in the U.S., which is where a majority of the plan
participants receive benefits. A 0.5% change in the discount rate
would impact annual after-tax OPEB expense by less than $10 million.
Certain defined contribution pension and OPEB benefits in the U.S. are
funded by the Employee Stock Ownership Plan (ESOP), as discussed in
Note 9 to the Consolidated Financial Statements.
Acquisitions
We account for acquired businesses using the purchase method of
accounting. Under the purchase method, our consolidated financial
statements reflect an acquired business starting from the completion
of the acquisition. In addition, the assets acquired and liabilities assumed
must be recorded at the date of acquisition at their respective estimated
fair values, with any excess of the purchase price over the estimated fair
values of the net assets acquired recorded as goodwill.
Significant judgment is required in estimating the fair value of intangible
assets and in assigning their respective useful lives. Accordingly, we
typically obtain the assistance of third-party valuation specialists for
significant items. The fair value estimates are based on available historical
information and on future expectations and assumptions deemed
reasonable by management, but are inherently uncertain.
We typically use an income method to estimate the fair value of
intangible assets, which is based on forecasts of the expected future
cash flows attributable to the respective assets. Significant estimates
and assumptions inherent in the valuations include the amount and
timing of future cash flows (including expected growth rates and
profitability), the underlying product life cycles, economic barriers to
entry, a brand’s relative market position and the discount rate applied
to the cash flows. Unanticipated market or macroeconomic events
and circumstances may occur, which could affect the accuracy or
validity of the estimates and assumptions.
Determining the useful life of an intangible asset also requires
judgment. Certain brand intangibles are expected to have indefinite
lives based on their history and our plans to continue to support and
build the acquired brands. Other acquired brands are expected to
have determinable useful lives. Our assessment as to brands that have
an indefinite life and those that have a determinable life is based on a
number of factors including competitive environment, market share,
brand history, underlying product life cycles, operating plans and the
macroeconomic environment of the countries in which the brands are
sold. Our estimates of the useful lives of determinable-lived intangibles,
primarily including brands, technologies and customer relationships,
are primarily based on these same factors. All of our acquired
technology and customer-related intangibles are expected to have
determinable useful lives.
Other significant estimates associated with the accounting for
acquisitions include exit costs. Provided certain criteria are met, exit
costs related to acquired operations are treated as acquired liabilities.