form6k.htm
FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Report of Foreign Issuer
 
Pursuant to Rule 13a-16 or 15d-16
of the Securities Exchange Act of 1934
 
For the month of February 2014
 
Commission File Number: 001-02413
 
Canadian National Railway Company
(Translation of registrant’s name into English)
 
935 de la Gauchetiere Street West
Montreal, Quebec
Canada H3B 2M9
(Address of principal executive offices)

Indicate by check mark whether the registrant files or will file annual reports under
cover of Form 20-F or Form 40-F:

Form 20-F ____                                                      Form 40-F    X                                

Indicate by check mark if the registrant is submitting the Form 6-K in paper as
permitted by Regulation S-T Rule 101(b)(1):

Yes ____                                           No   X

Indicate by check mark if the registrant is submitting the Form 6-K in paper as
permitted by Regulation S-T Rule 101(b)(7):

Yes ____                                           No   X

Indicate by check mark whether by furnishing the information contained in this
Form, the Registrant is also thereby furnishing the information to the Commission
pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934:

Yes ____                                           No   X

If “Yes” is marked, indicate below the file number assigned to the registrant in
connection with Rule 12g3-2(b): N/A
 

 
 

 
 

 
 

             CN Logo
Canadian National Railway Company

                Table of Contents
 
Item
 

 
 
 

 
Management’s Report on Internal Control over Financial Reporting
 
 
Item 1

 
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Management has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (1992). Based on this assessment, management has determined that the Company’s internal control over financial reporting was effective as of December 31, 2013.
KPMG LLP, an independent registered public accounting firm, has issued an unqualified audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013 and has also expressed an unqualified audit opinion on the Company’s 2013 consolidated financial statements as stated in their Reports of Independent Registered Public Accounting Firm dated February 3, 2014.





(s) Claude Mongeau
President and Chief Executive Officer

February 3, 2014





(s) Luc Jobin
Executive Vice-President and Chief Financial Officer

February 3, 2014




 
1

 
Report of Independent Registered Public Accounting Firm
 
 
Item 2
 
To the Shareholders and Board of Directors of the Canadian National Railway Company

We have audited the accompanying consolidated balance sheets of the Canadian National Railway Company (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2013 and 2012, and its consolidated results of operations and its consolidated cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with United States generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 3, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.



 
 
 
(s) KPMG LLP*

Montreal, Canada
February 3, 2014


* FCPA auditor, FCA, public accountancy permit No. A106087
KPMG LLP is a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.
 
                  KPMG Canada provides services to KPMG LLP.

 
2

 
Report of Independent Registered Public Accounting Firm
 
 
To the Shareholders and Board of Directors of the Canadian National Railway Company

We have audited the Canadian National Railway Company’s (the “Company”) internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the COSO.
We also have audited, in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2013, and our report dated February 3, 2014 expressed an unqualified opinion on those consolidated financial statements.





(s) KPMG LLP*

 
Montreal, Canada
February 3, 2014
 
 
*FCPA auditor, FCA, public accountancy permit No. A106087
 
 
 
 
KPMG LLP is a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.
 
KPMG Canada provides services to KPMG LLP.

 
3

 
Consolidated Statement of Income                                                                                                                                U.S. GAAP
   
 
 
Item 3

 
In millions, except per share data
Year ended December 31,
   
2013 
   
2012 
   
2011 
                     
Revenues
   
$
10,575 
 
$
9,920 
 
$
9,028 
                     
Operating expenses
                   
 
Labor and fringe benefits
     
2,182 
   
1,952 
   
1,812 
 
Purchased services and material
     
1,351 
   
1,248 
   
1,120 
 
Fuel
     
1,619 
   
1,524 
   
1,412 
 
Depreciation and amortization
     
980 
   
924 
   
884 
 
Equipment rents
     
275 
   
249 
   
228 
 
Casualty and other
     
295 
   
338 
   
276 
Total operating expenses
     
6,702 
   
6,235 
   
5,732 
Operating income
     
3,873 
   
3,685 
   
3,296 
Interest expense
     
(357)
   
(342)
   
(341)
Other income (Note 12)
     
73 
   
315 
   
401 
Income before income taxes
     
3,589 
   
3,658 
   
3,356 
Income tax expense (Note 13)
     
(977)
   
(978)
   
(899)
Net income
   
$
2,612 
 
$
2,680 
 
$
2,457 
Earnings per share (Note 15)
                   
 
Basic
   
$
3.10 
 
$
3.08 
 
$
2.72 
 
Diluted
   
$
3.09 
 
$
3.06 
 
$
2.70 
Weighted-average number of shares (Note 15)
                 
 
Basic
     
843.1 
   
871.1 
   
902.2 
 
Diluted
     
846.1 
   
875.4 
   
908.9 
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
                       
See accompanying notes to consolidated financial statements.
             

 
4

 
Consolidated Statement of Comprehensive Income                                                                                                       U.S. GAAP
 
 

In millions
Year ended December 31,
 
2013 
 
2012 
 
2011 
                   
Net income
$
2,612 
$
2,680 
$
2,457 
                   
Other comprehensive income (loss) (Note 18)
           
 
Foreign exchange gain (loss) on:
           
   
Translation of the net investment in foreign operations
 
440 
 
(128)
 
130 
   
Translation of US dollar-denominated long-term debt designated as
           
     
a hedge of the net investment in U.S. subsidiaries
 
(394)
 
123 
 
(122)
 
Pension and other postretirement benefit plans (Note 11):
           
   
Net actuarial gain (loss) arising during the year
 
1,544 
 
(660)
 
(1,541)
   
Prior service cost arising during the year
 
 
(6)
 
(28)
   
Amortization of net actuarial loss included in net periodic benefit cost (income)
226 
 
119 
 
   
Amortization of prior service cost included in net periodic benefit cost (income)
 
 
 
 
Derivative instruments (Note 17)
 
 
 
(2)
                   
Other comprehensive income (loss) before income taxes
 
1,821 
 
(545)
 
(1,551)
Income tax recovery (expense)
 
(414)
 
127 
 
421 
Other comprehensive income (loss)
 
1,407 
 
(418)
 
(1,130)
Comprehensive income
$
4,019 
$
2,262 
$
1,327 
             
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
                   
See accompanying notes to consolidated financial statements.
           

 
5

 
Consolidated Balance Sheet                                                                                                                                           U.S. GAAP
   
 

In millions
December 31,
 
2013 
   
2012 
             
Assets
           
             
Current assets
           
     Cash and cash equivalents
 
$
214 
 
$
155 
     Restricted cash and cash equivalents (Note 8)
   
448 
   
521 
     Accounts receivable (Note 3)
   
815 
   
831 
     Material and supplies
   
274 
   
230 
     Deferred and receivable income taxes (Note 13)
   
137 
   
43 
     Other
   
89 
   
89 
Total current assets
   
1,977 
   
1,869 
             
Properties (Note 4)
   
26,227 
   
24,541 
Intangible and other assets (Note 5)
   
1,959 
   
249 
Total assets
 
$
30,163 
 
$
26,659 
             
Liabilities and shareholders’ equity
           
             
Current liabilities
           
     Accounts payable and other (Note 6)
 
$
1,477 
 
$
1,626 
     Current portion of long-term debt (Note 8)
   
1,021 
   
577 
Total current liabilities
   
2,498 
   
2,203 
             
Deferred income taxes (Note 13)
   
6,537 
   
5,555 
Pension and other postretirement benefits, net of current portion (Note 11)
   
541 
   
784 
Other liabilities and deferred credits (Note 7)
   
815 
   
776 
Long-term debt (Note 8)
   
6,819 
   
6,323 
             
Shareholders’ equity
           
     Common shares (Note 9)
   
4,015 
   
4,108 
     Accumulated other comprehensive loss (Note 18)
   
(1,850)
   
(3,257)
     Retained earnings
   
10,788 
   
10,167 
Total shareholders’ equity
   
12,953 
   
11,018 
Total liabilities and shareholders’ equity
 
$
30,163 
 
$
26,659 
             
             
             
On behalf of the Board:
           
             
             
             
David G. A. McLean
Claude Mongeau
         
Director
Director
         
             
             
             
See accompanying notes to consolidated financial statements.
           

 
6

 
Consolidated Statement of Changes in Shareholders’ Equity                                                                                       U.S. GAAP
 
 


 
Issued and
     
Accumulated
           
 
outstanding
     
other
       
Total
 
common
 
Common
comprehensive
 
Retained
 
shareholders’
In millions
shares (Note 9)
 
shares
loss
 
earnings
 
equity
                           
Balances at December 31, 2010
918.7 
 
 $
4,252 
 
 $
(1,709)
 
 $
8,741 
 
 $
11,284 
                           
Net income
   
-  
   
-  
   
2,457 
   
2,457 
Stock options exercised and other (Notes 9, 10)
5.3 
   
74 
   
-  
   
-  
   
74 
Share repurchase programs (Note 9)
(39.8)
   
(185)
   
-  
   
(1,235)
   
(1,420)
Other comprehensive loss (Note 18)
   
-  
   
(1,130)
   
-  
   
(1,130)
Dividends ($0.65 per share)
   
-  
   
-  
   
(585)
   
(585)
                           
Balances at December 31, 2011
884.2 
   
4,141 
   
(2,839)
   
9,378 
   
10,680 
                           
Net income
   
-  
   
-  
   
2,680 
   
2,680 
Stock options exercised and other (Notes 9, 10)
6.4 
   
128 
   
-  
   
-  
   
128 
Share repurchase programs (Note 9)
(33.8)
   
(161)
   
-  
   
(1,239)
   
(1,400)
Other comprehensive loss (Note 18)
   
-  
   
(418)
   
-  
   
(418)
Dividends ($0.75 per share)
   
-  
   
-  
   
(652)
   
(652)
                           
Balances at December 31, 2012
856.8 
   
4,108 
   
(3,257)
   
10,167 
   
11,018 
                           
Net income
   
-  
   
-  
   
2,612 
   
2,612 
Stock options exercised and other (Notes 9, 10)
1.4 
   
40 
   
-  
   
-  
   
40 
Share repurchase programs (Note 9)
(27.6)
   
(133)
   
-  
   
(1,267)
   
(1,400)
Other comprehensive income (Note 18)
   
-  
   
1,407 
   
-  
   
1,407 
Dividends ($0.86 per share)
   
-  
   
-  
   
(724)
   
(724)
Balances at December 31, 2013
830.6 
 
$
4,015 
 
$
(1,850)
 
$
10,788 
 
$
12,953 
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
                           
See accompanying notes to consolidated financial statements.
                         

 
7

 
Consolidated Statement of Cash Flows                                                                                                                          U.S. GAAP
 
 

In millions                                                                        Year ended December 31,
 
2013 
   
2012 
   
2011 
                 
Operating activities
               
Net income
$
2,612 
 
$
2,680 
 
$
2,457 
Adjustments to reconcile net income to net cash provided by operating activities:
               
     Depreciation and amortization
 
980 
   
924 
   
884 
     Deferred income taxes (Note 13)
 
331 
   
451 
   
531 
     Gain on disposal of property (Notes 4, 12)
 
(69)
   
(281)
   
(348)
Changes in operating assets and liabilities:
               
     Accounts receivable
 
32 
   
(20)
   
(51)
     Material and supplies
 
(38)
   
(30)
   
11 
     Accounts payable and other
 
(245)
   
129 
   
34 
     Other current assets
 
13 
   
(13)
   
(2)
Pensions and other, net
 
(68)
   
(780)
   
(540)
Net cash provided by operating activities
 
3,548 
   
3,060 
   
2,976 
                 
Investing activities
               
Property additions
 
(1,973)
   
(1,731)
   
(1,625)
Disposal of property (Note 4)
 
52 
   
311 
   
369 
Change in restricted cash and cash equivalents
 
73 
   
(22)
   
(499)
Other, net
 
(4)
   
21 
   
26 
Net cash used in investing activities
 
(1,852)
   
(1,421)
   
(1,729)
                 
Financing activities
               
Issuance of debt (Note 8)
 
1,850
   
493
   
787 
Repayment of debt (Note 8)
 
(1,413)
   
(140)
   
(509)
Issuance of common shares due to exercise of stock options and
               
   related excess tax benefits realized (Note 10)
 
31 
   
117 
   
77 
Repurchase of common shares (Note 9)
 
(1,400)
   
(1,400)
   
(1,420)
Dividends paid
 
(724)
   
(652)
   
(585)
Net cash used in financing activities
 
(1,656)
   
(1,582)
   
(1,650)
                 
Effect of foreign exchange fluctuations on US dollar-denominated cash and cash equivalents
 
19 
   
(3)
   
14 
                 
Net increase (decrease) in cash and cash equivalents
 
59 
   
54 
   
(389)
                 
Cash and cash equivalents, beginning of year
 
155 
   
101 
   
490 
                 
Cash and cash equivalents, end of year
$
214 
 
$
155 
 
$
101 
                 
Supplemental cash flow information
               
Net cash receipts from customers and other
$
10,640 
 
$
9,877 
 
$
8,995 
Net cash payments for:
               
     Employee services, suppliers and other expenses
 
(5,558)
   
(5,241)
   
(4,643)
     Interest
 
(344)
   
(364)
   
(329)
     Personal injury and other claims (Note 16)
 
(61)
   
(79)
   
(97)
     Pensions (Note 11)
 
(239)
   
(844)
   
(468)
     Income taxes (Note 13)
 
(890)
   
(289)
   
(482)
Net cash provided by operating activities
$
3,548 
 
$
3,060 
 
$
2,976 
                 
                 
                 
                 
                 
                 
See accompanying notes to consolidated financial statements.
               

 
8

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   
 

Canadian National Railway Company, together with its wholly-owned subsidiaries, collectively “CN” or “the Company,” is engaged in the rail and related transportation business. CN spans Canada and mid-America, from the Atlantic and Pacific oceans to the Gulf of Mexico, serving the ports of Vancouver, Prince Rupert, B.C., Montreal, Halifax, New Orleans and Mobile, Alabama, and the key cities of Toronto, Buffalo, Chicago, Detroit, Duluth, Minnesota/Superior, Wisconsin, Green Bay, Wisconsin, Minneapolis/St. Paul, Memphis, St. Louis, and Jackson, Mississippi, with connections to all points in North America. CN’s freight revenues are derived from the movement of a diversified and balanced portfolio of goods, including petroleum and chemicals, grain and fertilizers, coal, metals and minerals, forest products, intermodal and automotive.


1 – Summary of significant accounting policies

These consolidated financial statements are expressed in Canadian dollars, except where otherwise indicated, and have been prepared in accordance with United States generally accepted accounting principles (U.S. GAAP). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of revenues and expenses during the period, the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements. On an ongoing basis, management reviews its estimates, including those related to personal injury and other claims, environmental matters, depreciation, pensions and other postretirement benefits, and income taxes, based upon currently available information. Actual results could differ from these estimates.

On October 22, 2013, the Board of Directors of the Company approved a two-for-one common stock split in the form of a stock dividend of one additional common share of CN for each share outstanding, which was paid on November 29, 2013, to shareholders of record on November 15, 2013. All share and per share data presented herein reflect the impact of the stock split.

A. Principles of consolidation
These consolidated financial statements include the accounts of all subsidiaries. The Company’s investments in which it has significant influence are accounted for using the equity method and all other investments are accounted for using the cost method.

B. Revenues
Freight revenues are recognized using the percentage of completed service method based on the transit time of freight as it moves from origin to destination. The allocation of revenues between reporting periods is based on the relative transit time in each period with expenses being recorded as incurred. Revenues related to non-rail transportation services are recognized as service is performed or as contractual obligations are met. Revenues are presented net of taxes collected from customers and remitted to governmental authorities.

C. Foreign currency
All of the Company’s operations in the United States (U.S.) are self-contained foreign entities with the US dollar as their functional currency. Accordingly, the U.S. operations’ assets and liabilities are translated into Canadian dollars at the rate in effect at the balance sheet date and the revenues and expenses are translated at average exchange rates during the year. All adjustments resulting from the translation of the foreign operations are recorded in Other comprehensive income (loss) (see Note 18 – Accumulated other comprehensive loss).
The Company designates the US dollar-denominated long-term debt of the parent company as a foreign currency hedge of its net investment in U.S. subsidiaries. Accordingly, foreign exchange gains and losses, from the dates of designation, on the translation of the US dollar-denominated long-term debt are also included in Other comprehensive income (loss).

D. Cash and cash equivalents
Cash and cash equivalents include highly liquid investments purchased three months or less from maturity and are stated at cost, which approximates market value.

E. Restricted cash and cash equivalents
The Company has the option, under its bilateral letter of credit facility agreements with various banks, to pledge collateral in the form of cash and cash equivalents for a minimum term of one month, equal to at least the face value of the letters of credit issued. Restricted cash and cash equivalents are shown separately on the balance sheet and include highly liquid investments purchased three months or less from maturity and are stated at cost, which approximates market value.

 
9

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

F. Accounts receivable
Accounts receivable are recorded at cost net of billing adjustments and an allowance for doubtful accounts. The allowance for doubtful accounts is based on expected collectability and considers historical experience as well as known trends or uncertainties related to account collectability. When a receivable is deemed uncollectible, it is written off against the allowance for doubtful accounts. Subsequent recoveries of amounts previously written off are credited to the bad debt expense in Casualty and other in the Consolidated Statement of Income.

G. Material and supplies
Material and supplies, which consist mainly of rail, ties, and other items for construction and maintenance of property and equipment, as well as diesel fuel, are valued at weighted-average cost.

H. Properties
Railroad properties are carried at cost less accumulated depreciation including asset impairment write-downs. Labor, materials and other costs associated with the installation of rail, ties, ballast and other structures are capitalized to the extent they meet the Company’s capitalization criteria. Major overhauls and large refurbishments of equipment are also capitalized when they result in an extension to the service life or increase the functionality of the asset. Repair and maintenance costs are expensed as incurred.
The cost of properties, including those under capital leases, net of asset impairment write-downs, is depreciated on a straight-line basis over their estimated service lives, measured in years, except for rail which is measured in millions of gross tons per mile. The Company follows the group method of depreciation whereby a single composite depreciation rate is applied to the gross investment in a class of similar assets, despite small differences in the service life or salvage value of individual property units within the same asset class.
In accordance with the group method of depreciation, upon sale or retirement of properties in the normal course of business, cost less net salvage value is charged to accumulated depreciation. As a result, no gain or loss is recognized in income under the group method as it is assumed that the assets within the group on average have the same life and characteristics and therefore that gains or losses offset over time. For retirements of depreciable properties that do not occur in the normal course of business, a gain or loss may be recognized if the retirement varies significantly from the retirement pattern identified through depreciation studies. A gain or loss is recognized in Other income for the sale of land or disposal of assets that are not part of railroad operations.
Assets held for sale are measured at the lower of their carrying amount or fair value, less cost to sell. Losses resulting from significant rail line sales are recognized in income when the asset meets the criteria for classification as held for sale, whereas losses resulting from significant rail line abandonments are recognized in the Consolidated Statement of Income when the asset ceases to be used. Gains are recognized in income when they are realized.
The Company reviews the carrying amounts of properties held and used whenever events or changes in circumstances indicate that such carrying amounts may not be recoverable based on future undiscounted cash flows. Assets that are deemed impaired as a result of such review are recorded at the lower of carrying amount or fair value.

I. Intangible assets
Intangible assets consist mainly of customer contracts and relationships assumed through past acquisitions and are being amortized on a straight-line basis over 40 to 50 years.
The Company reviews the carrying amounts of intangible assets held and used whenever events or changes in circumstances indicate that such carrying amounts may not be recoverable based on future undiscounted cash flows. Assets that are deemed impaired as a result of such review are recorded at the lower of carrying amount or fair value.

J. Pensions
Pension costs are determined using actuarial methods. Net periodic benefit cost is charged to income and includes:
  (i)
the cost of pension benefits provided in exchange for employees’ services rendered during the year;
 
(ii)
the interest cost of pension obligations;
 (iii)
the expected long-term return on pension fund assets;
 (iv)
the amortization of prior service costs and amendments over the expected average remaining service life of the employee group covered by the plans; and
 
(v)
the amortization of cumulative net actuarial gains and losses in excess of 10% of the greater of the beginning of year balances of the projected benefit obligation or market-related value of plan assets, over the expected average remaining service life of the employee group covered by the plans.

The pension plans are funded through contributions determined in accordance with the projected unit credit actuarial cost method.


 
10

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

K. Postretirement benefits other than pensions
The Company accrues the cost of postretirement benefits other than pensions using actuarial methods. These benefits, which are funded as they become due, include life insurance programs, medical benefits and, for a closed group of employees, free rail travel benefits.
The Company amortizes the cumulative net actuarial gains and losses in excess of 10% of the projected benefit obligation at the beginning of the year, over the expected average remaining service life of the employee group covered by the plan.

L. Personal injury and other claims
In Canada, the Company accounts for costs related to employee work-related injuries based on actuarially developed estimates of the ultimate cost associated with such injuries, including compensation, health care and third-party administration costs.
In the U.S., the Company accrues the expected cost for personal injury, property damage and occupational disease claims, based on actuarial estimates of their ultimate cost.

For all other legal actions in Canada and the U.S., the Company maintains, and regularly updates on a case-by-case basis, provisions for such items when the expected loss is both probable and can be reasonably estimated based on currently available information.

M. Environmental expenditures
Environmental expenditures that relate to current operations, or to an existing condition caused by past operations, are expensed unless they can contribute to current or future operations. Environmental liabilities are recorded when environmental assessments occur, remedial efforts are probable, and when the costs, based on a specific plan of action in terms of the technology to be used and the extent of the corrective action required, can be reasonably estimated. The Company accrues its allocable share of liability taking into account the Company’s alleged responsibility, the number of potentially responsible parties and their ability to pay their respective shares of the liability. Recoveries of environmental remediation costs from other parties are recorded as assets when their receipt is deemed probable and collectability is reasonably assured.

N. Income taxes
The Company follows the asset and liability method of accounting for income taxes. Under the asset and liability method, the change in the net deferred income tax asset or liability is included in the computation of Net income or Other comprehensive income (loss). Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled.

O. Derivative financial instruments
The Company uses derivative financial instruments from time to time in the management of its interest rate and foreign currency exposures. Derivative instruments are recorded on the balance sheet at fair value and the changes in fair value are recorded in Net income or Other comprehensive income (loss) depending on the nature and effectiveness of the hedge transaction. Income and expense related to hedged derivative financial instruments are recorded in the same category as that generated by the underlying asset or liability.

P. Stock-based compensation
The Company follows the fair value based approach for stock option awards based on the grant-date fair value using the Black-Scholes option-pricing model. The Company expenses the fair value of its stock option awards on a straight-line basis, over the period during which an employee is required to provide service (requisite service period) or until retirement eligibility is attained, whichever is shorter. The Company also follows the fair value based approach for cash settled awards using a lattice-based valuation model. Compensation cost for cash settled awards is based on the fair value of the awards at period-end and is recognized over the period during which an employee is required to provide service (requisite service period) or until retirement eligibility is attained, whichever is shorter. See Note 10 - Stock plans, for the assumptions used to determine fair value and for other required disclosures.

 
11

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

2 – Accounting changes

The Company adopts accounting standards that are issued by the Financial Accounting Standards Board (FASB), if applicable. For the years 2013, 2012 and 2011, there were no accounting standard updates issued by FASB that had a significant impact on the Company’s consolidated financial statements, except as noted below.

In February 2013, the FASB issued Accounting Standards Update (ASU) 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-02 added new disclosure requirements to Accounting Standards Codification (ASC) 220, Comprehensive Income, for items reclassified out of accumulated other comprehensive income (AOCI) effective for reporting periods beginning after December 15, 2012. It requires entities to disclose additional information about amounts reclassified out of AOCI by component including changes in AOCI balances and significant items reclassified out of AOCI by the respective line items of net income. The Company has adopted ASU 2013-02 for the reporting period beginning January 1, 2013 and the prescribed disclosures are presented in Note 18 – Accumulated other comprehensive loss to the Company’s consolidated financial statements.


3 – Accounts receivable

In millions
 
December 31,
2013 
2012 
Freight
   
$
675 
$
674 
Non-freight
     
147 
 
167 
Gross accounts receivable
     
822 
 
841 
Allowance for doubtful accounts
     
(7)
 
(10)
Net accounts receivable
   
$
815 
$
831 


4 – Properties

                                       
In millions
   
December 31, 2013
   
December 31, 2012
   
Depreciation
     
Accumulated
             
Accumulated
     
   
rate
 
Cost
 
depreciation
   
Net
   
Cost
 
depreciation
   
Net
Track and roadway (1)
2%
$
27,833 
 
$
7,103 
 
$
20,730 
 
$
26,209 
 
$
6,948 
 
$
19,261 
Rolling stock
4%
 
5,193 
   
1,894 
   
3,299 
   
4,989 
   
1,785 
   
3,204 
Buildings
2%
 
1,392 
   
521 
   
871 
   
1,275 
   
492 
   
783 
Information technology (2)
12%
 
1,000 
   
455 
   
545 
   
976 
   
427 
   
549 
Other
6%
 
1,388 
   
606 
   
782 
   
1,273 
   
529 
   
744 
Total properties including capital leases
$
36,806 
 
$
10,579 
 
$
26,227 
 
$
34,722 
 
$
10,181 
 
$
24,541 
                                       
                                       
Capital leases included in properties
                                 
Track and roadway (3)
 
$
417 
 
$
58 
 
$
359 
 
$
417 
 
$
53 
 
$
364 
Rolling stock
   
982 
   
358 
   
624 
   
1,222 
   
353 
   
869 
Buildings
   
109 
   
21 
   
88 
   
109 
   
18 
   
91 
Other
   
102 
   
22 
   
80 
   
91 
   
17 
   
74 
Total capital leases included in properties
$
1,610 
 
$
459 
 
$
1,151 
 
$
1,839 
 
$
441 
 
$
1,398 
                                       
(1)
Includes the cost of land of $1,911 million and $1,766 million as at December 31, 2013 and December 31, 2012, respectively.
(2)
The Company capitalized $85 million in 2013 and $93 million in 2012 of internally developed software costs pursuant to FASB ASC 350-40, “Intangibles – Goodwill and Other, Internal – Use Software.”
(3)
Includes $108 million of right-of-way access in both years.



 
12

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

Accounting policy for capitalization of costs
The Company’s railroad operations are highly capital intensive. The Company’s properties consist mainly of a large base of homogeneous or network-type assets such as rail, ties, ballast and other structures, which form the Company’s Track and roadway properties, and Rolling stock. The Company’s capital expenditures are for the replacement of assets and for the purchase or construction of assets to enhance operations or provide new service offerings to customers. A large portion of the Company’s capital expenditures are for self-constructed properties including the replacement of existing track and roadway assets and track line expansion, as well as major overhauls and large refurbishments of rolling stock.
Expenditures are generally capitalized if they extend the life of the asset or provide future benefits such as increased revenue-generating capacity, functionality, or physical or service capacity. The Company has a process in place to determine whether its capital programs qualify for capitalization. For Track and roadway properties, the Company establishes basic capital programs to replace or upgrade the track infrastructure assets which are capitalized if they meet the capitalization criteria. These basic capital programs are planned in advance and carried out by the Company’s engineering workforce.
In addition, for Track and roadway properties, expenditures that meet the minimum level of activity as defined by the Company are also capitalized as detailed below:
·  
Land: all purchases of land;
·  
Grading: installation of road bed, retaining walls, drainage structures;
·  
Rail and related track material: installation of 39 or more continuous feet of rail;
·  
Ties: installation of 5 or more ties per 39 feet;
·  
Ballast: installation of 171 cubic yards of ballast per mile.

Expenditures relating to the Company’s properties that do not meet the Company’s capitalization criteria are considered normal repairs and maintenance and are expensed. For Track and roadway properties, such expenditures include but are not limited to spot tie replacement, spot or broken rail replacement, physical track inspection for detection of rail defects and minor track corrections, and other general maintenance of track infrastructure.
For the ballast asset, the Company also engages in “shoulder ballast undercutting” that consists of removing some or all of the ballast, which has deteriorated over its service life, and replacing it with new ballast. When ballast is installed as part of a shoulder ballast undercutting project, it represents the addition of a new asset and not the repair or maintenance of an existing asset. As such, the Company capitalizes expenditures related to shoulder ballast undercutting given that an existing asset is retired and replaced with a new asset. Under the group method of accounting for properties, the deteriorated ballast is retired at its average cost measured using the quantities of new ballast added.
For purchased assets, the Company capitalizes all costs necessary to make the asset ready for its intended use. Expenditures that are capitalized as part of self-constructed properties include direct material, labor, and contracted services, as well as other allocated costs which are not charged directly to capital projects. These allocated costs include, but are not limited to, fringe benefits, small tools and supplies, machinery used on projects and project supervision. The Company reviews and adjusts its allocations, as required, to reflect the actual costs incurred each year.
Costs of deconstruction and removal of replaced assets, referred to herein as dismantling costs, are distinguished from installation costs for self-constructed properties based on the nature of the related activity. For Track and roadway properties, employees concurrently perform dismantling and installation of new track and roadway assets and, as such, the Company estimates the amount of labor and other costs that are related to dismantling. The Company determines dismantling costs based on an analysis of the track and roadway installation process.

Accounting policy for depreciation
Properties are carried at cost less accumulated depreciation including asset impairment write-downs. The cost of properties, including those under capital leases, net of asset impairment write-downs, is depreciated on a straight-line basis over their estimated service lives, measured in years, except for rail which is measured in millions of gross tons per mile. The Company follows the group method of depreciation whereby a single composite depreciation rate is applied to the gross investment in a class of similar assets, despite small differences in the service life or salvage value of individual property units within the same asset class. The Company uses approximately 40 different depreciable asset classes.
 
13

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

  For all depreciable assets, the depreciation rate is based on the estimated service lives of the assets. Assessing the reasonableness of the estimated service lives of properties requires judgment and is based on currently available information, including periodic depreciation studies conducted by the Company. The Company’s U.S. properties are subject to comprehensive depreciation studies as required by the Surface Transportation Board (STB) and are conducted by external experts. Depreciation studies for Canadian properties are not required by regulation and are conducted internally. Studies are performed on specific asset groups on a periodic basis. Changes in the estimated service lives of the assets and their related composite depreciation rates are implemented prospectively.
For the rail asset, the estimated service life is measured in millions of gross tons per mile and varies based on rail characteristics such as weight, curvature and metallurgy. The annual composite depreciation rate for rail assets is determined by dividing the estimated annual number of gross tons carried over the rail by the estimated service life of the rail measured in millions of gross tons per mile. For the rail asset, the Company capitalizes the costs of rail grinding which consists of restoring and improving the rail profile and removing irregularities from worn rail to extend the service life. The service life of the rail asset is based on expected future usage of the rail in its existing condition, determined using railroad industry research and testing, less the rail asset’s usage to date. The service life of the rail asset is increased incrementally as rail grinding is performed thereon. As such, the costs incurred for rail grinding are capitalized given that the activity extends the service life of the rail asset beyond its original or current condition as additional gross tons can be carried over the rail for its remaining service life. The Company amortizes the cost of rail grinding over the remaining life of the rail asset, which includes the incremental life extension generated by the rail grinding.

Disposal of property
2013
Exchange of easements
On June 8, 2013, the Company entered into an agreement with another Class I railroad to exchange perpetual railroad operating easements including the track and roadway assets on specific rail lines (collectively the “exchange of easements”) without monetary consideration. The Company has accounted for the exchange of easements at fair value pursuant to FASB ASC 845, Nonmonetary Transactions. The transaction resulted in a gain on exchange of easements of $29 million ($18 million after-tax) that was recorded in Other income.

Lakeshore West
On March 19, 2013, the Company entered into an agreement with Metrolinx to sell a segment of the Oakville subdivision in Oakville and Burlington, Ontario, together with the rail fixtures and certain passenger agreements (collectively the “Lakeshore West”), for cash proceeds of $52 million before transaction costs. Under the agreement, the Company obtained the perpetual right to operate freight trains over the Lakeshore West at its then current level of operating activity, with the possibility of increasing its operating activity for additional consideration. The transaction resulted in a gain on disposal of $40 million ($36 million after-tax) that was recorded in Other income under the full accrual method of accounting for real estate transactions

2012
Bala-Oakville
On March 23, 2012, the Company entered into an agreement with Metrolinx to sell a segment of the Bala and a segment of the Oakville subdivisions in Toronto, Ontario, together with the rail fixtures and certain passenger agreements (collectively the “Bala-Oakville”), for cash proceeds of $311 million before transaction costs. Under the agreement, the Company obtained the perpetual right to operate freight trains over the Bala-Oakville at its then current level of operating activity, with the possibility of increasing its operating activity for additional consideration. The transaction resulted in a gain on disposal of $281 million ($252 million after-tax) that was recorded in Other income under the full accrual method of accounting for real estate transactions.

2011
IC RailMarine
On August 1, 2011, the Company sold substantially all of the assets of IC RailMarine Terminal Company (“IC RailMarine”), an indirect subsidiary of the Company, to Raven Energy, LLC, an affiliate of Foresight Energy, LLC (“Foresight”) and the Cline Group (“Cline”), for cash proceeds of $70 million (US$73 million) before transaction costs. IC RailMarine is located on the east bank of the Mississippi River and stores and transfers bulk commodities and liquids between rail, ship and barge, serving customers in North American and global markets. Under the sale agreement, the Company will benefit from a 10-year rail transportation agreement with Savatran LLC, an affiliate of Foresight and Cline, to haul a minimum annual volume of coal from four Illinois mines to the IC RailMarine transfer facility. The transaction resulted in a gain on disposal of $60 million ($38 million after-tax) that was recorded in Other income.


 
14

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

Lakeshore East
On March 24, 2011, the Company entered into an agreement with Metrolinx to sell a segment of the Kingston subdivision known as the Lakeshore East in Pickering and Toronto, Ontario, together with the rail fixtures and certain passenger agreements (collectively the “Lakeshore East”), for cash proceeds of $299 million before transaction costs. Under the agreement, the Company obtained the perpetual right to operate freight trains over the Lakeshore East at its then current level of operating activity, with the possibility of increasing its operating activity for additional consideration. The transaction resulted in a gain on disposal of $288 million ($254 million after-tax) that was recorded in Other income under the full accrual method of accounting for real estate transactions.


5 – Intangible and other assets

In millions
December 31,
 
2013 
   
2012 
Pension asset (Note 11)
 
$
1,662 
 
$
Deferred and long-term receivables
   
109 
   
87 
Intangible assets (A)
   
59 
   
57 
Investments (B)
   
57 
   
30 
Other
   
72 
   
75 
Total intangible and other assets
 
$
1,959 
 
$
249 

A. Intangible assets
Intangible assets consist mainly of customer contracts and relationships assumed through past acquisitions.

B. Investments
As at December 31, 2013, the Company had $46 million ($20 million as at December 31, 2012) of investments accounted for under the equity method and $11 million ($10 million as at December 31, 2012) of investments accounted for under the cost method.


6 – Accounts payable and other

In millions
December 31,
 
2013 
   
2012 
             
Trade payables
 
$
408 
 
$
386 
Payroll-related accruals
   
351 
   
340 
Accrued charges
   
156 
   
135 
Accrued interest
   
125 
   
105 
Income and other taxes
   
96 
   
294 
Stock-based incentives liability (Note 10)
   
80 
   
88 
Personal injury and other claims provisions (Note 16)
   
45 
   
82 
Environmental provisions (Note 16)
   
41 
   
31 
Other postretirement benefits liability (Note 11)
   
18 
   
17 
Other
   
157 
   
148 
Total accounts payable and other
 
$
1,477 
 
$
1,626 


7 – Other liabilities and deferred credits

In millions
December 31,
 
 2013 
   
 2012 
Personal injury and other claims provisions, net of current portion (Note 16)
 
$
271 
 
$
232 
Stock-based incentives liability, net of current portion (Note 10)
   
240 
   
203 
Environmental provisions, net of current portion (Note 16)
   
78 
   
92 
Deferred credits and other
   
226 
   
249 
Total other liabilities and deferred credits
 
$
 815 
 
$
 776 



 
15

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

8 – Long-term debt
         
Outstanding
US dollar-
denominated
amount
           
             
                December 31,
In millions
Maturity
     
2013 
   
2012 
Debentures and notes: (A)
                   
                         
Canadian National series:
                   
 
4.40%
10-year notes (B)
Mar. 15, 2013
 
$
-   
 
$
-   
 
$
398 
 
4.95%
6-year notes  (B)
Jan. 15, 2014
   
325 
   
346 
   
323 
 
    -
2-year floating rate notes (C)
Nov. 6, 2015
   
350 
   
372 
   
-   
 
5.80%
10-year notes  (B)
June 1, 2016
   
250 
   
266 
   
249 
 
1.45%
5-year notes  (B)
Dec. 15, 2016
   
300 
   
319 
   
298 
 
5.85%
10-year notes  (B)
Nov. 15, 2017
   
250 
   
266 
   
249 
 
5.55%
10-year notes  (B)
May 15, 2018
   
325 
   
346 
   
323 
 
6.80%
20-year notes  (B)
July 15, 2018
   
200 
   
213 
   
199 
 
5.55%
10-year notes  (B)
Mar. 1, 2019
   
550 
   
585 
   
547 
 
2.85%
10-year notes  (B)
Dec. 15, 2021
   
400 
   
425 
   
398 
 
2.25%
10-year notes  (B)
Nov. 15, 2022
   
250 
   
266 
   
249 
 
7.63%
30-year debentures
May 15, 2023
   
150 
   
159 
   
149 
 
6.90%
30-year notes  (B)
July 15, 2028
   
475 
   
505 
   
473 
 
7.38%
30-year debentures  (B)
Oct. 15, 2031
   
200 
   
213 
   
199 
 
6.25%
30-year notes  (B)
Aug. 1, 2034
   
500 
   
532 
   
498 
 
6.20%
30-year notes  (B)
June 1, 2036
   
450 
   
479 
   
448 
 
6.71%
Puttable Reset Securities PURSSM (B)
July 15, 2036
   
250 
   
266 
   
249 
 
6.38%
30-year debentures  (B)
Nov. 15, 2037
   
300 
   
319 
   
298 
 
3.50%
30-year notes  (B)
Nov. 15, 2042
   
250 
   
266 
   
249 
 
4.50%
30-year notes  (B)
Nov. 7, 2043
   
250 
   
266 
   
-   
                         
Illinois Central series:
                   
 
5.00%
99-year income debentures
Dec. 1, 2056
   
   
   
 
7.70%
100-year debentures
Sep. 15, 2096
   
125 
   
133 
   
124 
Total US dollar-denominated debentures and notes
   
$
6,157 
   
6,549 
   
5,927 
BC Rail series:
                   
 
Non-interest bearing 90-year subordinated notes  (D)
July 14, 2094
         
842 
   
842 
Total debentures and notes
           
7,391 
   
6,769 
Other:
                     
 
Commercial paper  (E) (F)
           
273 
   
-   
 
Accounts receivable securitization  (G)
           
250 
   
-   
 
Capital lease obligations and other  (H)
           
783 
   
985 
Total debt, gross
           
8,697 
   
7,754 
Less:
                     
 
Net unamortized discount
           
857 
   
854 
Total debt (I) (1)
           
7,840 
   
6,900 
Less:
                     
 
Current portion of long-term debt  (I)
           
1,021 
   
577 
Total long-term debt
         
$
6,819 
 
$
6,323 
(1)
See Note 17 - Financial instruments, for the fair value of debt.
     
       
Footnotes to the table follow on the next page.










 
16

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

A. The Company’s debentures, notes and revolving credit facility are unsecured.

B. These debt securities are redeemable, in whole or in part, at the option of the Company, at any time, at the greater of par and a formula price based on interest rates prevailing at the time of redemption.

C. These floating rate notes bear interest at the three-month London Interbank Offered Rate (LIBOR) plus 0.20%. The interest rate as at December 31, 2013 was 0.44%.

D. The Company records these notes as a discounted debt of $9 million, using an imputed interest rate of 5.75%. The discount of $833 million is included in the net unamortized discount.

E. The Company has an $800 million revolving credit facility agreement with a consortium of lenders. On March 22, 2013, the agreement was amended to extend the term to May 5, 2018. The agreement allows for an increase in the facility amount, up to a maximum of $1.3 billion, as well as the option to extend the term by an additional year at each anniversary date, subject to the consent of individual lenders. The credit facility, containing customary terms and conditions, is available for general corporate purposes, including back-stopping the Company’s commercial paper program, and provides for borrowings at various interest rates, including the Canadian prime rate, bankers’ acceptance rates, the U.S. federal funds effective rate and the LIBOR, plus applicable margins. The credit facility agreement has one financial covenant, which limits debt as a percentage of total capitalization, and with which the Company is in compliance. As at December 31, 2013 and December 31, 2012, the Company had no outstanding borrowings under its revolving credit facility and there were no draws during the years ended December 31, 2013 and 2012.

F. The Company has a commercial paper program, which is backed by its revolving credit facility, enabling it to issue commercial paper up to a maximum aggregate principal amount of $800 million, or the US dollar equivalent. As at December 31, 2013, the Company had total borrowings of $273 million presented in Current portion of long-term debt on the Consolidated Balance Sheet (nil as at December 31, 2012). The weighted-average interest rate on these borrowings was 1.14%.
The Company presents issuances and repayments of commercial paper in the Consolidated Statement of Cash Flows, all of which have a maturity less than 90 days, on a net basis. The following table presents the gross issuances and repayments of commercial paper:

In millions
 
2013
 
2012
 
2011
Issuances of commercial paper
$
3,255 
$
1,861 
$
659 
Repayments of commercial paper
$
(2,987)
$
 (1,943)
$
 (575)

The Company has revised the Consolidated Statement of Cash Flows for 2012 and 2011 to present the cash flows from the issuances and repayments of commercial paper on a net basis, consistent with the presentation adopted for 2013.  The Company chose to present such cash flows on a net basis since the issuance and repayments of commercial paper are part of the Company’s cash management activities and this debt matures in less than 90 days.

G. On December 20, 2012, the Company entered into a three-year agreement, commencing on February 1, 2013, to sell an undivided co-ownership interest in a revolving pool of accounts receivable to unrelated trusts for maximum cash proceeds of $450 million. The trusts are multi-seller trusts and the Company is not the primary beneficiary. Funding for the acquisition of these assets is customarily through the issuance of asset-backed commercial paper notes by the unrelated trusts.
The Company has retained the responsibility for servicing, administering and collecting the receivables sold. The average servicing period is approximately one month. Subject to customary indemnifications, each trust’s recourse is limited to the accounts receivable transferred.
The Company is subject to customary reporting requirements for which failure to perform could result in termination of the program. In addition, the program is subject to customary credit rating requirements, which if not met, could also result in termination of the program. The Company monitors the reporting requirements and is currently not aware of any trends, events or conditions that could cause such termination.
The accounts receivable securitization program provides the Company with readily available short-term financing for general corporate use. In the event the program is terminated before its scheduled maturity, the Company expects to meet its future payment obligations through its various sources of financing including its revolving credit facility and commercial paper program, and/or access to capital markets.



 
17

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

  The Company accounts for its accounts receivable securitization program under ASC 860, Transfers and Servicing. Based on the structure of the program, the Company accounts for the proceeds as a secured borrowing. As such, as at December 31, 2013, the Company recorded $250 million of proceeds received under the accounts receivable securitization program in the Current portion of long-term debt on the Consolidated Balance Sheet at a weighted-average interest rate of 1.18% which is secured by and limited to $281 million of accounts receivable.
 
 H. During 2013, the Company recorded $44 million in assets it acquired through equipment leases ($94 million in 2012), for which an equivalent amount was recorded in debt.
Interest rates for capital lease obligations range from approximately 0.7% to 8.5% with maturity dates in the years 2014 through 2037. The imputed interest on these leases amounted to $209 million as at December 31, 2013 and $249 million as at December 31, 2012.
The capital lease obligations are secured by properties with a net carrying amount of $779 million as at December 31, 2013 and $1,021 million as at December 31, 2012.

I. Long-term debt maturities, including repurchase arrangements and capital lease repayments on debt outstanding as at December 31, 2013, for the next five years and thereafter, are as follows:

In millions
 
Capital leases
 
Debt
 
Total
2014 
(1)
 
$
153 
$
 868 
$
1,021 
2015 
     
83 
 
 369 
 
452 
2016 
     
287 
 
 582 
 
869 
2017 
     
143 
 
 263 
 
406 
2018 
     
 
 556 
 
563 
2019 and thereafter
 
109 
 
 4,420 
 
4,529 
     
$
782 
$
7,058 
$
7,840 
(1)  Current portion of long-term debt.
           

J. The aggregate amount of debt payable in US currency as at December 31, 2013 was US$6,730 million (C$7,158 million), including US$573 million relating to capital leases and other; and US$6,690 million (C$6,656 million), including US$733 million relating to capital leases and other, as at December 31, 2012.

K. The Company has a series of bilateral letter of credit facility agreements with various banks to support its requirements to post letters of credit in the ordinary course of business. On March 22, 2013, the expiry date of these agreements was extended by one year to April 28, 2016. Under these agreements, the Company has the option from time to time to pledge collateral in the form of cash or cash equivalents, for a minimum term of one month, equal to at least the face value of the letters of credit issued. As at December 31, 2013, the Company had letters of credit drawn of $481 million ($551 million as at December 31, 2012) from a total committed amount of $503 million ($562 million as at December 31, 2012) by the various banks. As at December 31, 2013, cash and cash equivalents of $448 million ($521 million as at December 31, 2012) were pledged as collateral and recorded as Restricted cash and cash equivalents on the Consolidated Balance Sheet.


 
18

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

9 – Capital stock

A. Authorized capital stock
The authorized capital stock of the Company is as follows:
·  
Unlimited number of Common Shares, without par value
·  
Unlimited number of Class A Preferred Shares, without par value, issuable in series
·  
Unlimited number of Class B Preferred Shares, without par value, issuable in series

B. Issued and outstanding common shares
Common stock split
On October 22, 2013, the Board of Directors of the Company approved a two-for-one common stock split in the form of a stock dividend of one additional common share of CN for each share outstanding, which was paid on November 29, 2013, to shareholders of record on November 15, 2013. All share and per share data presented herein reflect the impact of the stock split.

The following table provides the activity of the issued and outstanding common shares of the Company for the years ended December 31, 2013, 2012 and 2011:

In millions
Year ended December 31,
 
2013 
 
2012 
 
2011 
Issued and outstanding common shares at beginning of year
     
856.8 
 
884.2 
 
918.7 
Number of shares repurchased through buyback programs
     
(27.6)
 
(33.8)
 
(39.8)
Stock options exercised
     
1.4 
 
6.4 
 
5.3 
Issued and outstanding common shares at end of year
     
830.6 
 
856.8 
 
884.2 

Share repurchase programs
On October 22, 2012, the Board of Directors of the Company approved a share repurchase program which allowed for the repurchase of up to $1.4 billion in common shares, not to exceed 36.0 million common shares, between October 29, 2012 and October 28, 2013 pursuant to a normal course issuer bid at prevailing market prices plus brokerage fees, or such other prices as may be permitted by the Toronto Stock Exchange. The Company repurchased a total of 29.4 million common shares for $1.4 billion under this share repurchase program.
On October 22, 2013, the Board of Directors of the Company approved a new share repurchase program which allows for the repurchase of up to 30.0 million common shares, between October 29, 2013 and October 23, 2014 pursuant to a normal course issuer bid at prevailing market prices plus brokerage fees, or such other prices as may be permitted by the Toronto Stock Exchange.
The following table provides the information related to the share repurchase programs for the years ended December 31, 2013, 2012 and 2011:

In millions, except per share data
Year ended December 31,
 
2013 
 
2012 
 
2011 
Number of common shares (1)
   
 27.6 
 
 33.8 
 
 39.8 
Weighted-average price per share (2)
 
$
 50.65 
$
 41.36 
$
 35.67 
Amount of repurchase
 
$
 1,400 
$
 1,400 
$
 1,420 
(1)
Includes common shares purchased in the first and fourth quarters of 2013, 2012 and 2011 pursuant to private agreements between the Company and arm’s-length third-party sellers.
(2)
Includes brokerage fees.
             



 
19

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

10 – Stock plans

The Company has various stock-based incentive plans for eligible employees. All share and per share data for such plans reflect the impact of the stock split (see Note 9 – Capital stock).  A description of the Company’s major plans is provided below:

A.     Employee Share Investment Plan
The Company has an Employee Share Investment Plan (ESIP) giving eligible employees the opportunity to subscribe for up to 10% of their gross salaries to purchase shares of the Company’s common stock on the open market and to have the Company invest, on the employees’ behalf, a further 35% of the amount invested by the employees, up to 6% of their gross salaries.
The following table provides the number of participants holding shares, the total number of ESIP shares purchased on behalf of employees, including the Company’s contributions, as well as the resulting expense recorded for the years ended December 31, 2013, 2012 and 2011:

Year ended December 31,
 
2013 
 
2012 
 
2011 
Number of participants holding shares
 
 18,488 
 
 17,423 
 
 16,218 
Total number of ESIP shares purchased on behalf of employees (millions)
 
 2.3 
 
 2.5 
 
 2.6 
Expense for Company contribution (millions)
$
 30 
$
 24 
$
 21 

B.     Stock-based compensation plans
The following table provides the total stock-based compensation expense for awards under all plans, as well as the related tax benefit recognized in income, for the years ended December 31, 2013, 2012 and 2011:

In millions
Year ended December 31,
 
2013 
 
2012 
 
2011 
Cash settled awards
             
Share Unit Plan
 
$
 92 
$
 76 
$
 81 
Voluntary Incentive Deferral Plan
   
 35 
 
 19 
 
 21 
     
 127 
 
 95 
 
 102 
               
Stock option awards
   
 9 
 
 10 
 
 10 
Total stock-based compensation expense
 
$
 136 
$
 105 
$
 112 
               
Tax benefit recognized in income
 
$
 35 
$
 25 
$
 24 
(i)     Cash settled awards
 
Share Unit Plan
In 2013, the Company granted 0.8 million performance share units (PSUs), previously known as restricted share units (RSUs), (0.9 million in both 2012 and 2011) to designated management employees entitling them to receive payout in cash based on the Company’s share price. The PSUs granted are generally scheduled for payout after three years (“plan period”) and vest conditionally upon the attainment of a target relating to return on invested capital (ROIC) over the plan period. Such performance vesting criteria results in a performance vesting factor that ranges from 0% to 150% depending on the level of ROIC attained.
Payout is conditional upon the attainment of a minimum share price, calculated using the average of the last three months of the plan period. In addition, commencing at various dates, for senior and executive management employees (“executive employees”), payout for PSUs is also conditional on compliance with the conditions of their benefit plans, award or employment agreements, including but not limited to non-compete, non-solicitation and non-disclosure of confidential information conditions. Current or former executive employees who breach such conditions of their benefit plans, award or employment agreements will forfeit the PSU payout. Should the Company reasonably determine that a current or former executive employee may have violated the conditions of their benefit plans, award or employment agreement, the Company may at its discretion change the manner of vesting of the PSUs to suspend payout on any PSUs pending resolution of such matter.
The value of the payout is equal to the number of PSUs awarded multiplied by the performance vesting factor and by the 20-day average closing share price ending on January 31 of the following year. On December 31, 2013, for the 2011 grant, the level of ROIC attained resulted in a performance vesting factor of 150%. As the minimum share price condition was met, payout under the plan of approximately $80 million, calculated using the Company’s average share price during the 20-day period ending on January 31, 2014, will be paid to employees meeting the conditions of their benefit plans, award or employment agreements in the first quarter of 2014.
 

 
20

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

  In February 2012, the Company’s Board of Directors unanimously voted to forfeit and cancel the PSU payout of approximately $18 million otherwise due in February 2012 to its former Chief Executive Officer (CEO) after determining that the former CEO was likely in breach of his non-compete and non-disclosure of confidential information conditions contained in the former CEO’s employment agreement. On February 4, 2013, the Company’s Executive Vice-President and Chief Operating Officer (COO) resigned to join the Company’s major competitor in Canada. As a result of the COO’s resignation, compensation amounts subject to non-compete, non-solicitation and other applicable terms of his long-term incentive award agreements and related plans, and certain amounts accumulated under non-registered pension plans and arrangements were forfeited. In February 2013, the Company entered into confidential agreements to settle these matters. As a result, in the quarter ended March 31, 2013, the stock-based compensation liability was reduced by approximately $20 million.

Voluntary Incentive Deferral Plan
The Company has a Voluntary Incentive Deferral Plan (VIDP), providing eligible senior management employees the opportunity to elect to receive their annual incentive bonus payment and other eligible incentive payments in deferred share units (DSUs). A DSU is equivalent to a common share of the Company and also earns dividends when normal cash dividends are paid on common shares. The number of DSUs received by each participant is established using the average closing price for the 20 trading days prior to and including the date of the incentive payment. For each participant, the Company will grant a further 25% of the amount elected in DSUs, which will vest over a period of four years. The election to receive eligible incentive payments in DSUs is no longer available to a participant when the value of the participant's vested DSUs is sufficient to meet the Company's stock ownership guidelines. The value of each participant’s DSUs is payable in cash at the time of cessation of employment. The Company’s liability for DSUs is marked-to-market at each period-end based on the Company’s closing stock price.

The following table provides the 2013 activity for all cash settled awards:

     
PSUs
 
VIDP
In millions
 
Nonvested
Vested
 
Nonvested
Vested
Outstanding at December 31, 2012
 
1.9 
1.4 
 (1)
2.8 
Granted (Payout)
 
0.8 
(0.9)
 
(0.6)
Transferred into plan
 
 
0.1 
Forfeited/Settled
 
(0.1)
(0.5)
 (1)
Vested during year
 
(0.9)
0.9 
 
Outstanding at December 31, 2013
 
1.7 
0.9 
 
2.3 
   
(1) The balance outstanding at December 31, 2012 included the units of the PSU payout otherwise due to the Company's former CEO that were in dispute which were settled in the first quarter of 2013.
 
 
21

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   
     The following table provides valuation and expense information for all cash settled awards:
   
                                       
In millions, unless otherwise indicated
PSUs (1)
VIDP (2)
   
Total
   
                                   
Year of grant
2013 
2012 
2011 
2010 
2009 
               
                                         
Stock-based compensation expense (recovery)
                                     
 
recognized over requisite service period
                                     
Year ended December 31, 2013 (3)
$
 34 
$
 37 
$
 34 
$
(4)
$
(9)
 
$
 35 
   
$
 127 
   
Year ended December 31, 2012
 
N/A
$
 24 
$
 26 
$
 26 
$
 - 
 
$
 19 
   
$
 95 
   
Year ended December 31, 2011
 
N/A
 
N/A
$
 19 
$
 27 
$
 35 
 
$
 21 
   
$
 102 
   
                                         
Liability outstanding
                                     
December 31, 2013
$
 34 
$
 61 
$
 80 
$
 - 
$
 - 
 
$
 145 
   
$
 320 
   
December 31, 2012
 
N/A
$
 24 
$
 45 
$
 70 
$
 18 
 
$
 134 
   
$
 291 
   
                                         
Fair value per unit
                                     
December 31, 2013 ($)
$
 55.12 
$
 59.66 
$
 60.56 
 
N/A
 
N/A
 
$
 60.56 
     
N/A
   
                                         
Fair value of awards vested during the year
               
Year ended December 31, 2013
$
 - 
$
 - 
$
 80 
 
N/A
 
N/A
 
$
 1 
   
$
 81 
   
Year ended December 31, 2012
 
N/A
$
 - 
$
 - 
$
 70 
 
N/A
 
$
 1 
   
$
 71 
   
Year ended December 31, 2011
 
N/A
 
N/A
$
 - 
$
 - 
$
 82 
 
$
 1 
   
$
 83 
   
                                         
Nonvested awards at December 31, 2013
                 
Unrecognized compensation cost
$
 26 
$
 15 
$
 - 
 
N/A
 
N/A
 
$
 1 
   
$
 42 
   
Remaining recognition period (years)
 
 2.0 
 
 1.0 
 
 N/A
 
N/A
 
N/A
   
N/A
 (4)
   
N/A
   
                                         
Assumptions (5)
                                     
Stock price ($)
$
 60.56 
$
 60.56 
$
 60.56 
 
N/A
 
N/A
 
$
 60.56 
     
N/A
   
Expected stock price volatility (6)
 
14%
 
14%
 
N/A
 
N/A
 
N/A
   
N/A
     
N/A
   
Expected term (years) (7)
 
 2.0 
 
 1.0 
 
N/A
 
N/A
 
N/A
   
N/A
     
N/A
   
Risk-free interest rate (8)
 
1.13%
 
0.99%
 
N/A
 
N/A
 
N/A
   
N/A
     
N/A
   
Dividend rate ($) (9)
$
 0.86 
$
 0.86 
 
N/A
 
N/A
 
N/A
   
N/A
     
N/A
   
                                         
(1)
Compensation cost is based on the fair value of the awards at period-end using the lattice-based valuation model that uses the assumptions as presented herein.
   
(2)
Compensation cost is based on intrinsic value.
               
(3)
Includes the reversal of stock-based compensation expense related to the forfeiture of PSUs by the Company's former CEO and COO.
   
(4)
The remaining recognition period has not been quantified as it relates solely to the 25% Company grant and the dividends earned thereon, representing a minimal number of units.
   
(5)
Assumptions used to determine fair value are at December 31, 2013.
   
(6)
Based on the historical volatility of the Company's stock over a period commensurate with the expected term of the award.
   
(7)
Represents the remaining period of time that awards are expected to be outstanding.
     
(8)
Based on the implied yield available on zero-coupon government issues with an equivalent term commensurate with the expected term of the awards.
   
(9)
Based on the annualized dividend rate.
               

(ii) Stock option awards
The Company has stock option plans for eligible employees to acquire common shares of the Company upon vesting at a price equal to the market value of the common shares at the date of granting. The options issued by the Company are conventional options that vest over a period of time. The right to exercise options generally accrues over a period of four years of continuous employment. Options are not generally exercisable during the first 12 months after the date of grant and expire after 10 years. At December 31, 2013, 20.2 million common shares remained authorized for future issuances under these plans.
For 2013, 2012 and 2011, the Company granted 1.1 million, 1.2 million and 1.3 million, respectively, of conventional stock options to designated senior management employees that vest over a period of four years of continuous employment.
The total number of conventional options outstanding at December 31, 2013 was 7.7 million.

 
22

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

  The following table provides the activity of stock option awards during 2013, and for options outstanding and exercisable at December 31, 2013, the weighted-average exercise price:

   
                                                     Options outstanding
 
Nonvested options
       
Weighted-
     
Weighted-
   
Number
 
average
 
Number
 
average grant
   
of options
exercise price
 
of options
date fair value
   
In millions
     
In millions
   
Outstanding at December 31, 2012 (1)
8.5 
$
26.05 
 
3.4 
$
7.28 
Granted
 
1.1 
$
 47.47 
 
1.1 
$
8.52 
Forfeited
 
(0.5)
$
 36.06 
 
(0.2)
$
7.93 
Exercised
 
(1.4)
$
 19.54 
 
N/A  
 
N/A  
Vested
 
N/A  
 
N/A  
 
(1.6)
$
 6.95 
Outstanding at December 31, 2013 (1)
7.7 
$
 30.97 
 
2.7 
$
 7.89 
Exercisable at December 31, 2013 (1)
5.0 
$
 25.58 
 
N/A  
 
N/A  
                 
(1) Stock options with a US dollar exercise price have been translated to Canadian dollars using the foreign exchange rate in effect at the balance sheet date.

The following table provides the number of stock options outstanding and exercisable as at December 31, 2013 by range of exercise price and their related intrinsic value, and for options outstanding, the weighted-average years to expiration. The table also provides the aggregate intrinsic value for in-the-money stock options, which represents the value that would have been received by option holders had they exercised their options on December 31, 2013 at the Company’s closing stock price of $60.56.

           
Options outstanding
 
Options exercisable
Range of exercise prices
Number of options
Weighted-average years to expiration
 
Weighted-average exercise price
 
Aggregate intrinsic value
 
Number of options
 
Weighted-average exercise price
 
Aggregate intrinsic value
           
In millions
       
In millions
 
In millions
     
In millions
$
15.52 
-
$
18.17 
 
 0.9 
 2.8 
 
$
17.47 
 
$
40 
 
 0.9 
 
$
 17.47 
 
$
 40 
$
18.18 
-
$
23.76 
 
 0.8 
 4.5 
 
$
21.96 
   
31 
 
 0.8 
 
$
 21.96 
   
 31 
$
23.77 
-
$
30.79 
 
 2.8 
 4.4 
 
$
26.18 
   
95 
 
 2.4 
 
$
 26.03 
   
 84 
$
30.80 
-
$
40.61 
 
 2.2 
 7.6 
 
$
37.79 
   
50 
 
 0.8 
 
$
 37.19 
   
 19 
$
40.62 
-
$
53.34 
 
 1.0 
 9.1 
 
$
49.13 
   
11 
 
0.1 
 
$
 42.25 
   
 -  
Balance at December 31, 2013 (1)
 7.7 
 5.7 
 
$
30.97 
 
$
227 
 
 5.0 
 
$
 25.58 
 
$
 174 
                                           
(1) 
Stock options with a US dollar exercise price have been translated to Canadian dollars using the foreign exchange rate in effect at the balance sheet date. As at December 31, 2013, all stock options outstanding were in-the-money. The weighted-average years to expiration of exercisable stock options was 4.5 years.
 
23

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

        The following table provides valuation and expense information for all stock option awards:
                                                     
In millions, unless otherwise indicated
                                             
Year of grant
     
2013 
   
2012 
   
2011 
   
2010 
   
2009 
   
2008 
   
2007 
 
Total
                                                     
Stock-based compensation expense
                                         
   recognized over requisite service period (1)
                           
Year ended December 31, 2013
 
$
 5 
 
$
 2 
 
$
 1 
 
$
 1 
 
$
 - 
   
N/A
   
N/A
$
 9 
Year ended December 31, 2012
   
N/A
 
$
 4 
 
$
 2 
 
$
 2 
 
$
 2 
 
$
 - 
   
N/A
$
 10 
Year ended December 31, 2011
   
N/A
   
N/A
 
$
 5 
 
$
 2 
 
$
 2 
 
$
 1 
 
$
 - 
$
 10 
                                                     
Fair value per unit
                                               
At grant date ($)
 
$
 8.52 
 
$
 7.74 
 
$
 7.83 
 
$
 6.55 
 
$
 6.30 
 
$
 6.22 
 
$
 6.68 
 
N/A
                                                     
Fair value of awards vested during the year
                                 
Year ended December 31, 2013
 
$
 - 
 
$
 2 
 
$
 3 
 
$
 2 
 
$
 4 
   
N/A
   
N/A
$
 11 
Year ended December 31, 2012
   
N/A
 
$
 - 
 
$
 2 
 
$
 2 
 
$
 4 
 
$
 3 
   
N/A
$
 11 
Year ended December 31, 2011
   
N/A
   
N/A
 
$
 - 
 
$
 2 
 
$
 4 
 
$
 3 
 
$
 3 
$
 12 
                                                     
Nonvested awards at December 31, 2013
                             
Unrecognized compensation cost
 
$
 3 
 
$
 2 
 
$
 1 
 
$
 -  
 
$
 -  
   
N/A
   
N/A
$
Remaining recognition period (years)
   
 3.0 
   
 2.0 
   
 1.0 
   
-  
   
 -  
   
N/A
   
N/A
 
N/A
                                                     
Assumptions
                                             
Grant price ($)
 
$
 47.47 
 
$
 38.35 
 
$
 34.47 
 
$
 27.38 
 
$
 21.07 
 
$
 24.25 
 
$
 26.40 
 
N/A
Expected stock price volatility (2)
   
23%
   
26%
   
26%
   
28%
   
39%
   
27%
   
24%
 
N/A
Expected term (years) (3)
   
 5.4 
   
 5.4 
   
 5.3 
   
 5.4 
   
 5.3 
   
 5.3 
   
 5.2 
 
N/A
Risk-free interest rate (4)
   
1.41%
   
1.33%
   
2.53%
   
2.44%
   
1.97%
   
3.58%
   
4.12%
 
N/A
Dividend rate ($) (5)
 
$
 0.86 
 
$
 0.75 
 
$
 0.65 
 
$
 0.54 
 
$
 0.51 
 
$
 0.46 
 
$
 0.42 
 
N/A
                                                     
(1)
Compensation cost is based on the grant date fair value using the Black-Scholes option-pricing model that uses the assumptions at the grant date.
                                                     
(2)
Based on the average of the historical volatility of the Company's stock over a period commensurate with the expected term of the award and the implied volatility from traded options on the Company's stock.
                                                     
(3)
Represents the period of time that awards are expected to be outstanding. The Company uses historical data to estimate option exercise and employee termination, and groups of employees that have similar historical exercise behavior are considered separately.
                                                     
(4)
Based on the implied yield available on zero-coupon government issues with an equivalent term commensurate with the expected term of the awards.
                                                     
(5)
Based on the annualized dividend rate.

The following table provides information related to stock options exercised for the years ended December 31, 2013, 2012 and 2011:
                   
In millions
Year ended December 31,
 
2013 
   
2012 
   
2011 
Total intrinsic value
 
$
45 
 
$
167 
 
$
122 
Cash received upon exercise of options
 
$
28 
 
$
101 
 
$
68 
Related excess tax benefit realized
 
$
 
$
16 
 
$

(iii) Stock price volatility
Compensation cost for the Company’s Share Unit Plan is based on the fair value of the awards at period end using the lattice-based valuation model for which a primary assumption is the Company’s share price. In addition, the Company’s liability for the VIDP is marked-to-market at period-end and, as such, is also reliant on the Company’s share price. Fluctuations in the Company’s share price cause volatility to stock-based compensation expense as recorded in net income. The Company does not currently hold any derivative financial instruments to manage this exposure. A $1 increase in the Company’s share price at December 31, 2013 would have increased stock-based compensation expense by $6 million, whereas a $1 decrease in the price would have reduced it by $5 million.


 
24

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

11 – Pensions and other postretirement benefits

The Company has various retirement benefit plans under which substantially all of its employees are entitled to benefits at retirement age, generally based on compensation and length of service and/or contributions. Senior and executive management employees (executive employees) subject to certain minimum service and age requirements, are also eligible for an additional retirement benefit under their Special Retirement Stipend Agreements (SRS), the Supplemental Executive Retirement Plan (SERP) or the Defined Contribution Supplemental Executive Retirement Plan (DC SERP). Executive employees who breach the non-compete, non-solicitation and non-disclosure of confidential information conditions of the SRS, SERP or DC SERP plans or other employment agreement will forfeit the retirement benefit under these plans. Should the Company reasonably determine that a current or former executive employee may have violated the conditions of their SRS, SERP, or DC SERP plan or other employment agreement, the Company may at its discretion withhold or suspend payout of the retirement benefit pending resolution of such matter.
On February 4, 2013, the Company’s COO resigned to join the Company’s major competitor in Canada. As a result, compensation amounts accumulated under the non-registered pension plans subject to non-compete and non-solicitation agreements were forfeited. The Company has recorded an actuarial gain related to the amounts forfeited. In 2012, the Company cancelled the $1.5 million annual retirement benefit otherwise due to its former CEO after determining that the former CEO was likely in breach of the non-compete, non-solicitation and non-disclosure of confidential information conditions contained in the former CEO’s employment agreement. The Company recorded a settlement gain of $20 million from the termination of the former CEO’s retirement benefit plan for the period beyond June 28, 2012, which was partially offset by the recognition of past accumulated actuarial losses of approximately $4 million. In February 2013, the Company entered into confidential agreements to settle these matters.
The Company also offers postretirement benefits to certain employees providing life insurance, medical benefits and, for a closed group of employees, free rail travel benefits during retirement. These postretirement benefits are funded as they become due. The information in the tables that follow pertains to all of the Company’s defined benefit plans. However, the following descriptions relate solely to the Company’s main pension plan, the CN Pension Plan, unless otherwise specified.

A.     Description of the CN Pension Plan
The CN Pension Plan is a contributory defined benefit pension plan that covers the majority of CN employees. It provides for pensions based mainly on years of service and final average pensionable earnings and is generally applicable from the first day of employment. Indexation of pensions is provided after retirement through a gain/loss sharing mechanism, subject to guaranteed minimum increases. An independent trust company is the Trustee of the Company’s pension trust funds (including the CN Pension Trust Fund). As Trustee, the trust company performs certain duties, which include holding legal title to the assets of the CN Pension Trust Fund and ensuring that the Company, as Administrator, complies with the provisions of the CN Pension Plan and the related legislation. The Company utilizes a measurement date of December 31 for the CN Pension Plan.

B.     Funding policy
Employee contributions to the CN Pension Plan are determined by the plan rules. Company contributions are in accordance with the requirements of the Government of Canada legislation, The Pension Benefits Standards Act, 1985, including amendments and regulations thereto, and are determined by actuarial valuations. Actuarial valuations are generally required on an annual basis for all Canadian plans, or when deemed appropriate by the Office of the Superintendent of Financial Institutions (OSFI). These actuarial valuations are prepared in accordance with legislative requirements and with the recommendations of the Canadian Institute of Actuaries for the valuation of pension plans. The Company’s most recently filed actuarial valuations conducted as at December 31, 2012 indicated a funding excess on a going-concern basis of approximately $1.4 billion and a funding deficit on a solvency basis of approximately $2.1 billion calculated using the three-year average of the Company's hypothetical wind-up ratio in accordance with the Pension Benefit Standards Regulations, 1985. The Company’s next actuarial valuations required as at December 31, 2013 will be performed in 2014. These actuarial valuations are expected to identify a going-concern surplus of approximately $1.7 billion, while on a solvency basis a funding deficit of approximately $1.7 billion is expected due to the level of interest rates applicable at their respective measurement dates. The federal pension legislation requires funding deficits, as calculated under current pension regulations, to be paid over a number of years. Actuarial valuations are also required annually for the Company’s U.S. pension plans.

 
25

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

  In 2013, in anticipation of its future funding requirements, the Company made voluntary contributions of $100 million in excess of the required contributions mainly to strengthen the financial position of its main pension plan, the CN Pension Plan. These voluntary contributions can be treated as a prepayment against its future required special solvency deficit payments. As at December 31, 2013, the Company had $470 million of accumulated prepayments which remain available to offset future required solvency deficit payments. The Company expects to use approximately $335 million of these prepayments to satisfy its 2014 required solvency deficit payment. As a result, the Company’s cash contributions for 2014 are expected to be $130 million, for all the Company’s pension plans. As at February 3, 2014, the Company contributed $89 million to its defined benefit pension plans for 2014.

C.     Plan assets
The assets of the Company’s various Canadian defined benefit pension plans are held in separate trust funds (Trusts) which are diversified by asset type, country and investment strategies. Each year, the CN Board of Directors reviews and confirms or amends the Statement of Investment Policies and Procedures (SIPP) which includes the plans’ long-term asset mix and related benchmark indices (Policy). This Policy is based on a long-term forward-looking view of the world economy, the dynamics of the plans’ benefit liabilities, the market return expectations of each asset class and the current state of financial markets.
Annually, the CN Investment Division (Investment Manager), a division of the Company created to invest and administer the assets of the plans, proposes a short-term asset mix target (Strategy) for the coming year, which is expected to differ from the Policy, because of current economic and market conditions and expectations. The Investment Committee of the Board (Committee) regularly compares the actual asset mix to the Policy and Strategy and compares the actual performance of the Trusts to the performance of the benchmark indices.
The Company’s 2013 target long-term asset mix and actual asset allocation for the Company’s pension plans based on fair value, are as follows:

 
 Target
 
Percentage
 
long-term
 
of plan assets
Asset allocation
asset mix
 
2013 
 
2012 
Cash and short-term investments
3%
 
5%
 
4%
Bonds and mortgages
37%
 
25%
 
28%
Equities
45%
 
41%
 
41%
Real estate
4%
 
2%
 
2%
Oil and gas
7%
 
8%
 
8%
Infrastructure
4%
 
5%
 
4%
Absolute return
 - 
 
10%
 
9%
Risk-based allocation
 - 
 
4%
 
4%
Total
100%
 
100%
 
100%

The Committee’s approval is required for all major investments in illiquid securities. The SIPP allows for the use of derivative financial instruments to implement strategies, hedge, and adjust existing or anticipated exposures. The SIPP prohibits investments in securities of the Company or its subsidiaries. Investments held in the Trusts consist mainly of the following:
(i)  
Cash and short-term investments consist primarily of highly liquid investments which ensure adequate cash flows are available to cover near-term benefit payments. Short-term investments are mainly obligations issued by Canadian chartered banks.
(ii)  
Bonds include bond instruments, issued or guaranteed by governments and corporate entities, as well as corporate notes. As at December 31, 2013, 91% of bonds were issued or guaranteed by Canadian, U.S. or other governments. Mortgages consist of mortgage products which are primarily conventional or participating loans secured by commercial properties.
(iii)  
Equity investments are primarily publicly traded securities, well diversified by country, issuer and industry sector. In 2013, the most significant allocation to an individual issuer was approximately 2% and the most significant allocation to an industry sector was approximately 25%.
(iv)  
Real estate is a diversified portfolio of Canadian land and commercial properties held by the Trusts’ wholly-owned subsidiaries.
(v)  
Oil and gas investments include petroleum and natural gas properties operated by the Trusts’ wholly-owned subsidiaries and listed and non-listed Canadian securities of oil and gas companies.
(vi)  
Infrastructure investments include participations in private infrastructure funds, public and private debt and publicly traded equity securities of infrastructure and utility companies. Some of these investments are held by the Trusts’ wholly-owned subsidiaries.


 
26

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

(vii)  
Absolute return investments are a portfolio of units of externally managed hedge funds, which are invested in various long/short strategies within fixed income, commodities, equities, global macro and multi-strategy funds, as presented in the table of fair value measurement. External managers are monitored on a continuous basis through investment and operational due diligence.
(viii)  
Risk-based allocation is a portfolio of externally managed funds where each asset class contributes equally to the overall risk of the portfolio in order to capture over time different asset classes risk premiums. Some of these investments are held by the Trusts’ wholly-owned subsidiaries.

The plans’ Investment Manager monitors market events and exposures to markets, currencies and interest rates daily. When investing in foreign securities, the plans are exposed to foreign currency risk that may be adjusted or hedged; the effect of which is included in the valuation of the foreign securities. Net of the effects mentioned above, the plans were 66% exposed to the Canadian dollar, 14% to the US dollar, 8% to European currencies, and 12% to various other currencies as at December 31, 2013. Interest rate risk represents the risk that the fair value of the investments will fluctuate due to changes in market interest rates. Sensitivity to interest rates is a function of the timing and amount of cash flows of the assets and liabilities of the plans. To manage credit risk, established policies require dealing with counterparties considered to be of high credit quality. Derivatives are used from time to time to adjust asset mix or exposures to foreign currencies, interest rate or market risks of the portfolio or anticipated transactions. Derivatives are contractual agreements whose value is derived from interest rates, foreign exchange rates, and equity or commodity prices. They include forwards, futures, options and swaps and are included in investment categories based on their underlying exposure. When derivatives are used for hedging purposes, the gains or losses on the derivatives are offset by a corresponding change in the value of the hedged assets.


 
27

 
Notes to Consolidated Financial Statements                                                                                                                   U.S. GAAP
   

  The following tables present the fair value of plan assets as at December 31, 2013 and 2012 by asset class, their level within the fair value hierarchy and the valuation techniques and inputs used to measure such fair value:

In millions
     
Fair value measurements at December 31, 2013
Asset class
 
Total
 
Level 1
 
Level 2
 
Level 3
Cash and short-term investments (1)
$
 897 
$
 16 
$
 881 
$
 - 
Bonds (2)
               
   Canada, U.S. and supranational
 
 1,416 
 
 - 
 
 1,416 
 
 - 
   Provinces of Canada and municipalities
 
 2,297 
 
 - 
 
 2,297 
 
 - 
   Corporate
 
 111 
 
 - 
 
 111 
 
 - 
   Emerging market