Critical Accounting Estimates

The preparation of financial statements in accordance with U.S. Generally Accepted Accounting Principles (GAAP) requires management to make significant judgments and estimates to develop certain amounts reflected and disclosed in the financial statements. In many cases, there are alternative policies or estimation techniques that could be used. We maintain a thorough process to review the application of accounting policies and to evaluate the appropriateness of the many estimates that are required to prepare the financial statements of a large organization. Management discusses the development and selection of these accounting policies and estimates with the Audit and Finance Committee of the Board. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and new or better information.

The critical accounting policies that are considered either the most judgmental, or involve the selection or application of alternative accounting policies, and are material to financial statements, are those relating to workers’ compensation costs, deferred revenue for prepaid postage, and contingent liabilities.

Workers’ Compensation Costs are highly sensitive to discount and inflation rates and the length of time recipients stay on the compensation rolls. However, the total annual cash payment for claims is relatively stable and predictable. The workers’ compensation costs reflected on our Statement of Operations are subject to actuarial estimates of future pay-outs, based upon prior claims data. Changes in the actuarial estimates and estimates of discount and inflation rates can significantly impact reported results from period to period. In the third quarter of 2009, we instituted a policy of updating inflation and discount rates on a quarterly basis.

The discount rate reflects the current rate at which the workers’ compensation liabilities could be effectively settled at the measurement date (e.g., the end of the accounting period). In setting the discount rates, we use the current yield, as of the measurement date, on a basket of Treasury securities that is matched to the expected duration of both the medical and compensation claims.

For changes due to inflation in compensation claim obligations, we use the CPI-U as forecasted by IHS Global Insight in their quarterly report. For medical claims, we use the average rate of medical cost increases experienced by our workers’ compensation claimants over the past five years as an estimate for future medical inflation. This was a change beginning in 2010. Previously, we had used forecasted medical inflation rates published by an independent source. During 2010, we determined that our own history served as a better indicator of future costs and revised the estimation accordingly.

Deferred revenue Prepaid Postage is an estimate of postage that has been sold but has not yet been used by customers. Revenue is recognized only when services are rendered. Because payments for postage are collected in advance of services being performed, revenue is deferred and reflected in the Balance Sheets as “Deferred revenue — prepaid postage”. Two categories of postage sales account for the bulk of deferred revenue — prepaid postage: stamp sales and postage meters. Stamp sales in 2010 totaled $8.8 billion. Deferred revenue on stamp sales is estimated using statistical samples of stamped mail exiting our system across the country. The estimated stamp usage is subtracted from stamp sales, with the difference representing our obligation to perform future services. We also include a provision for stamps sold that may never be used, either through loss, damage, or collecting activity. Changes in consumer stamp usage patterns can significantly impact the estimated liability related to stamp sales.

In contrast to postage paid for by purchasing stamps, metered postage is primarily used by businesses. Accordingly, the deferral amount is much smaller as a percentage of annual sales than for stamps, because business customers generally manage their cash flow much more closely and purchase postage as needed. Metered postage receipts in 2010 totaled $16.3 billion. Deferred revenue related to meters is estimated by monitoring the actual usage of all postage meters that had postage added during the month preceding the financial measurement date. The information from the two most recent meter readings allows us to derive a deferral percentage, which is applied to all postage meters.

We also include in our estimate of deferred revenue – prepaid postage, an estimate for mail that is in-transit within the postal system. We do this because the earnings process is not considered complete until mail is delivered to the customer.

In 2009, we refined our estimation methodology for deferred revenue on stamp sales to reflect changes in customer usage patterns of both Forever and denominated stamps demonstrated during 2009. In Quarter III, 2010, the estimation methodology was further refined to reflect new information concerning the amount of purchased Forever stamps that will never be used. The changes in 2009 and 2010 to the estimation model are considered changes in accounting estimates under GAAP and, accordingly, the impact of the change is reflected in the quarter that the change in estimate is made.

Contingent Liabilities require significant judgment in estimating potential losses for legal and other claims. Each quarter, significant new claims and litigation are evaluated for the probability of an adverse outcome. In addition, each quarter any prior claims and litigation are reviewed and, when necessary, the liability balance adjusted for resolutions or revisions to prior estimates. Estimates of loss can therefore change as individual claims develop and additional information becomes available.

Retirement and health benefit costs for employees and retirees represent a significant portion of expenses. Any change in laws or regulations affecting the amounts, timing, or administration of these benefits could have a material effect on our financial position and results of operations. We participate in the federal government pension and retiree health benefits programs, and accordingly account for these using multi-employer plans accounting rules. As such the expense is the amount we are required to fund.

In addition, the depreciation and amortization of capital assets over their estimated useful lives, and the determination of salvage value, requires us to make judgments about future events. Because capital assets are utilized over relatively long periods of time, we make periodic evaluations as to whether the estimated service lives or salvage values remain appropriate. Changes to estimated lives and residual values may affect the amount of depreciation expense recognized in a period and, ultimately, the gain or loss on disposal of the asset.

For further information, see Note 3, Summary of Significant Accounting Policies, Note 6, Contingencies, and Note 9, Workers’ Compensation, in the Notes to the Financial Statements.