Meritor Acquisition and 2022 Financial Results
Table of Contents
Accounting for Income Taxes
We determine our income tax expense using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax effects of
temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Future tax benefits of net operating loss
and credit carryforwards are also recognized as deferred tax assets. We evaluate the recoverability of our deferred tax assets each quarter by assessing the likelihood of future
profitability and available tax planning strategies that could be implemented to realize our net deferred tax assets. At December 31, 2022, we recorded a net deferred tax
liability of $24 million. The net deferred tax assets included $799 million for the value of net operating loss and credit carryforwards. A valuation allowance of $704 million was
recorded to reduce the tax assets to the net value management believed was more likely than not to be realized. In the event our operating performance deteriorates, future
assessments could conclude that a larger valuation allowance will be needed to further reduce the deferred tax assets.
In addition, we operate within multiple taxing jurisdictions and are subject to tax audits in these jurisdictions. These audits can involve complex issues, which may require an
extended period of time to resolve. We accrue for the estimated additional tax and interest that may result from tax authorities disputing uncertain tax positions. We believe we
made adequate provisions for income taxes for all years that are subject to audit based upon the latest information available. A more complete description of our income taxes
and the future benefits of our net operating loss and credit carryforwards is disclosed in NOTE 5, "INCOME TAXES," to our Consolidated Financial Statements.
Pension Benefits
We sponsor a number of pension plans globally, with the majority of assets in the U.S. and the U.K. In the U.S. and the U.K., we have major defined benefit plans that are
separately funded. We account for our pension programs in accordance with employers' accounting for defined benefit pension plans, which requires that amounts recognized in
financial statements be determined using an actuarial basis. As a result, our pension benefit programs are based on a number of statistical and judgmental assumptions that
attempt to anticipate future events and are used in calculating the expense and liability related to our plans each year at December 31. These assumptions include discount rates
used to value liabilities, assumed rates of return on plan assets, future compensation increases, inflation, employee turnover rates, actuarial assumptions relating to retirement
age, mortality rates and participant withdrawals. The actuarial assumptions we use may differ significantly from actual results due to changing economic conditions, participant
life span and withdrawal rates. These differences may result in a material impact to the amount of net periodic pension cost to be recorded in our Consolidated Financial
Statements in the future.
The expected long-term return on plan assets is used in calculating the net periodic pension cost. We considered several factors in developing our expected rate of return on plan
assets. The long-term rate of return considers historical returns and expected returns on current and projected asset allocations. Projected returns are based primarily on broad,
publicly traded passive fixed income and equity indices and forward-looking estimates of the value added by active investment management. At December 31, 2022, based
upon our target asset allocations, it is anticipated that our U.S. investment policy will generate an average annual return over the 30-year projection period equal to or in excess
of 6.50 percent, including the additional positive returns expected from active investment management.
The one-year return for our U.S. plans was a 5.7 percent loss for 2022. Our U.S. plan assets averaged annualized returns of 6.58 percent over the prior ten years and resulted in
approximately $166 million of actuarial losses in accumulated other comprehensive loss (AOCL) in the same period. Based on the historical returns and forward-looking return
expectations for capital markets, as plan assets continue to be de-risked, consistent with our investment policy, we believe our investment return assumption of 7.00 percent in
2023 for U.S. pension assets is reasonable and attainable.
The methodology used to determine the rate of return on pension plan assets in the U.K. was based on establishing an equity-risk premium over current long-term bond yields
adjusted based on target asset allocations. At December 31, 2022, based upon our target asset allocations, it is anticipated that our U.K. investment policy will generate an
average annual return over the 20-year projection period equal to or in excess of 4.01 percent. The one-year return for our U.K. plans was a 41.3 percent loss for 2022. The
majority of the Cummins U.K. plan's assets and certain Meritor U.K. plan's assets are linked to the price of U.K. government gilts in order to hedge movements in the
liabilities. U.K. government gilts fell approximately 40 percent during 2022 while our total U.K. pension assets fell by 41.3 percent as a result of the asset price declines over
the same period. We generated average annualized returns of 2.76 percent over ten years, resulting in approximately $310 million of actuarial losses in AOCL. Our strategy with
respect to our investments in pension plan assets is to be invested with a long-term outlook. Based on the historical returns and forward-looking
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