Item 7A. Quantitative and Qualitative Disclosures about Market Risk

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Item 7A. Quantitative and Qualitative Disclosures about Market Risk

CSX does not hold or issue derivative financial instruments for trading purposes. Historically, the Company has used derivative financial instruments to address market risk exposure to fluctuations in interest rates. As of December 2016, CSX does not have a material amount of floating rate debt obligations outstanding, and therefore fluctuations in the interest rate would not have a material impact on the Company's financial condition, results of operations or liquidity.

CSX 2016 Form 10-K p. 56

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm58
CSX Corporation
Consolidated Financial Statements and Notes to Consolidated Financial Statements
Herewith:
Consolidated Income Statements for the Fiscal Years Ended:59
December 30, 2016
December 25, 2015
December 26, 2014
Consolidated Comprehensive Income Statements for the Fiscal Years Ended:60
December 30, 2016
December 25, 2015
December 26, 2014
Consolidated Balance Sheets as of:61
December 30, 2016
December 25, 2015
Consolidated Cash Flow Statements for Fiscal Years Ended:62
December 30, 2016
December 25, 2015
December 26, 2014
Consolidated Statements of Changes in Shareholders' Equity:63
December 30, 2016
December 25, 2015
December 26, 2014
Notes to Consolidated Financial Statements64

CSX 2016 Form 10-K p. 57

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors of CSX Corporation

We have audited the accompanying consolidated balance sheets of CSX Corporation as of December 30, 2016 and December 25, 2015, and the related consolidated statements of income, comprehensive income, cash flows, and changes in shareholders’ equity for each of the three fiscal years in the period ended December 30, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits 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 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of CSX Corporation at December 30, 2016 and December 25, 2015, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended December 30, 2016, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), CSX Corporation's internal control over financial reporting as of December 30, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 14, 2017 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP
Certified Public Accountants

Jacksonville, Florida

February 14, 2017

CSX 2016 Form 10-K p. 58

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

CONSOLIDATED INCOME STATEMENTS

(Dollars in Millions, Except Per Share Amounts)

Fiscal Years
201620152014
Revenue$11,069$11,811$12,669
Expense
Labor and Fringe3,1593,2903,377
Materials, Supplies and Other2,0692,3362,484
Fuel7139571,616
Depreciation1,3011,2081,151
Equipment and Other Rents438436428
Total Expense7,6808,2279,056
Operating Income3,3893,5843,613
Interest Expense(579)(544)(545)
Debt Repurchase Expense(115)—(16)
Other Income (Expense) - Net (Note 10)4698(8)
Earnings Before Income Taxes2,7413,1383,044
Income Tax Expense (Note 11)(1,027)(1,170)(1,117)
Net Earnings$1,714$1,968$1,927
Per Common Share (Note 2)
Net Earnings Per Share
Basic$1.81$2.00$1.93
Assuming Dilution$1.81$2.00$1.92
Average Common Shares Outstanding (Millions)
Basic9479831,001
Assuming Dilution9489841,002
Cash Dividends Paid Per Common Share$0.72$0.70$0.63

Certain prior year data has been reclassified to conform to the current presentation.

See accompanying Notes to Consolidated Financial Statements.

CSX 2016 Form 10-K p. 59

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

CONSOLIDATED COMPREHENSIVE INCOME STATEMENTS

(Dollars in Millions)

Fiscal Years
201620152014
Net Earnings$1,714$1,968$1,927
Other Comprehensive Income (Loss) - Net of Tax:
Pension and Other Post-Employment Benefits2110(149)
Other4(9)6
Total Other Comprehensive Income (Loss)251(143)
Comprehensive Earnings (Note 14)$1,739$1,969$1,784

See accompanying Notes to Consolidated Financial Statements.

CSX 2016 Form 10-K p. 60

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

CONSOLIDATED BALANCE SHEETS

(Dollars in Millions)

DecemberDecember
20162015
ASSETS
Current Assets:
Cash and Cash Equivalents (Note 1)$603$628
Short-term Investments417810
Accounts Receivable - Net (Note 1)938982
Materials and Supplies407350
Other Current Assets12270
Total Current Assets2,4872,840
Properties43,22741,574
Accumulated Depreciation(12,077)(11,400)
Properties - Net (Note 6)31,15030,174
Investment in Conrail (Note 12)840803
Affiliates and Other Companies619591
Other Long-term Assets318337
Total Assets$35,414$34,745
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts Payable$806$764
Labor and Fringe Benefits Payable545490
Casualty, Environmental and Other Reserves (Note 5)115131
Current Maturities of Long-term Debt (Note 9)33120
Income and Other Taxes Payable129108
Other Current Liabilities114439
Total Current Liabilities2,0401,952
Casualty, Environmental and Other Reserves (Note 5)259269
Long-term Debt (Note 9)10,96210,515
Deferred Income Taxes - Net (Note 11)9,5969,179
Other Long-term Liabilities8631,162
Total Liabilities23,72023,077
Shareholders' Equity:
Common Stock, $1 Par Value (Note 3)928966
Other Capital138113
Retained Earnings (Note 1)11,25311,238
Accumulated Other Comprehensive Loss (Note 14)(640)(665)
Noncontrolling Minority Interest1516
Total Shareholders' Equity11,69411,668
Total Liabilities and Shareholders' Equity$35,414$34,745

Certain prior year data has been reclassified to conform to the current presentation.

See accompanying Notes to Consolidated Financial Statements.

CSX 2016 Form 10-K p. 61

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

CONSOLIDATED CASH FLOW STATEMENTS

(Dollars in Millions)

Fiscal Years
201620152014
OPERATING ACTIVITIES
Net Earnings$1,714$1,968$1,927
Adjustments to Reconcile Net Earnings to Net Cash
Provided by Operating Activities:
Depreciation1,3011,2081,151
Deferred Income Taxes405456298
Contributions to Qualified Pension Plans (Note 8)(250)——
Gain on Property Dispositions(128)(90)(11)
Other Operating Activities(70)2214
Changes in Operating Assets and Liabilities:
Accounts Receivable84149(119)
Other Current Assets(113)(84)(26)
Accounts Payable40(79)1
Income and Other Taxes Payable23(62)74
Other Current Liabilities35(118)34
Net Cash Provided by Operating Activities3,0413,3703,343
INVESTING ACTIVITIES
Property Additions(2,398)(2,562)(2,449)
Purchase of Short-term Investments(929)(1,739)(1,433)
Proceeds from Sales of Short-term Investments1,3251,2251,674
Proceeds from Property Dispositions19514762
Other Investing Activities937(37)
Net Cash Used in Investing Activities(1,798)(2,892)(2,183)
FINANCING ACTIVITIES
Long-term Debt Issued (Note 9)2,2001,2001,000
Long-term Debt Repaid (Note 9)(1,419)(229)(933)
Dividends Paid(680)(686)(629)
Shares Repurchased(1,056)(804)(517)
Other Financing Activities(313)—(4)
Net Cash Used in Financing Activities(1,268)(519)(1,083)
Net (Decrease) Increase in Cash and Cash Equivalents(25)(41)77
CASH AND CASH EQUIVALENTS
Cash and Cash Equivalents at Beginning of Period628669592
Cash and Cash Equivalents at End of Period$603$628$669
SUPPLEMENTAL CASH FLOW INFORMATION
Interest Paid - Net of Amounts Capitalized$606$566$575
Income Taxes Paid$580$768$741
Seller Financed Assets$—$307$—

See accompanying Notes to Consolidated Financial Statements.

CSX 2016 Form 10-K p. 62

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

CONSOLIDATED STATEMENTS OF CHANGES

IN SHAREHOLDERS’ EQUITY

(Dollars in Millions)

Common Shares Outstanding (Thousands)Common Stock and Other CapitalRetained EarningsAccumulated Other Comprehensive Income (Loss) (a)Non- controlling InterestTotal Shareholders' Equity
December 27, 20131,008,860$1,070$9,936$(523)$21$10,504
Comprehensive Earnings:
Net Earnings——1,927——1,927
Other Comprehensive Loss (Note 14)———(143)—(143)
Total Comprehensive Earnings1,784
Common stock dividends, $0.63 per share——(629)——(629)
Share Repurchases(17,010)(17)(500)——(517)
Bond Conversions1341———1
Other(393)30——333
December 26, 2014991,5911,08410,734(666)2411,176
Comprehensive Earnings:
Net Earnings——1,968——1,968
Other Comprehensive Income (Note 14)———1—1
Total Comprehensive Earnings1,969
Common stock dividends, $0.70 per share——(686)——(686)
Share Repurchases(26,359)(26)(778)——(804)
Bond Conversions13—————
Other26921——(8)13
December 25, 2015965,5141,07911,238(665)1611,668
Comprehensive Earnings:
Net Earnings——1,714——1,714
Other Comprehensive Income (Note 14)———25—25
Total Comprehensive Earnings1,739
Common stock dividends, $0.72 per share——(680)——(680)
Share Repurchases(38,379)(38)(1,018)——(1,056)
Bond Conversions941———1
Other95124(1)—(1)22
December 30, 2016928,180$1,066$11,253$(640)$15$11,694

(a) Accumulated Other Comprehensive Loss year-end balances shown above are net of tax. The associated taxes were $354 million, $347 million and $335 million for 2014, 2015 and 2016, respectively. For additional information see Note 14, Other Comprehensive Income.

See accompanying Notes to Consolidated Financial Statements.

CSX 2016 Form 10-K p. 63

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. Nature of Operations and Significant Accounting Policies

Business

CSX Corporation (“CSX”), together with its subsidiaries (the “Company”), based in Jacksonville, Florida, is one of the nation's leading transportation companies. The Company provides rail-based transportation services including traditional rail service and the transport of intermodal containers and trailers.

The Company’s number of employees was approximately 27,000 as of December 2016, which includes approximately 22,000 union employees. Most of the Company’s employees provide or support transportation services.

CSX Transportation, Inc.

CSX’s principal operating subsidiary, CSX Transportation, Inc. (“CSXT”), provides an important link to the transportation supply chain through its approximately 21,000 route mile rail network, which serves major population centers in 23 states east of the Mississippi River, the District of Columbia and the Canadian provinces of Ontario and Quebec. It has access to over 70 ocean, river and lake port terminals along the Atlantic and Gulf Coasts, the Mississippi River, the Great Lakes and the St. Lawrence Seaway. The Company’s intermodal business links customers to railroads via trucks and terminals. CSXT also serves thousands of production and distribution facilities through track connections to approximately 240 short-line and regional railroads.

Lines of Business

During 2016, the Company services generated $11.1 billion of revenue and served three primary lines of business:

•The merchandise business shipped 2.8 million carloads and generated 64% of revenue and 43% of volume in 2016. The Company’s merchandise business is comprised of shipments in the following diverse markets: agricultural and food products, fertilizers, chemicals, automotive, metals and equipment, minerals and forest products.
•The coal business shipped about 838 thousand carloads and accounted for 17% of revenue and 13% of volume in 2016. The Company transports domestic coal, coke and iron ore to electricity-generating power plants, steel manufacturers and industrial plants as well as export coal to deep-water port facilities. Roughly one-third of export coal and the majority of the domestic coal that the Company transports is used for generating electricity.
•The intermodal business accounted for 16% of revenue and 44% of volume in 2016. The intermodal business combines the superior economics of rail transportation with the short-haul flexibility of trucks and offers a cost advantage over long-haul trucking. Through a network of more than 50 terminals, the intermodal business serves all major markets east of the Mississippi River and transports mainly manufactured consumer goods in containers, providing customers with truck-like service for longer shipments.

Other revenue accounted for 3% of the Company’s total revenue in 2016. This revenue category includes revenue from regional subsidiary railroads, demurrage, revenue for customer volume commitments not met, switching, other incidental charges and adjustments to revenue reserves. Revenue from regional railroads includes shipments by railroads that the Company does not directly operate. Demurrage represents charges assessed when freight cars are held beyond a specified period of time. Switching revenue is primarily generated when CSXT switches cars for a customer or another railroad.

CSX 2016 Form 10-K p. 64

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 1. Nature of Operations and Significant Accounting Policies, continued

Other Entities

In addition to CSXT, the Company’s subsidiaries include CSX Intermodal Terminals, Inc. (“CSX Intermodal Terminals”), Total Distribution Services, Inc. (“TDSI”), Transflo Terminal Services, Inc. (“Transflo”), CSX Technology, Inc. (“CSX Technology”) and other subsidiaries. CSX Intermodal Terminals owns and operates a system of intermodal terminals, predominantly in the eastern United States and also performs drayage services (the pickup and delivery of intermodal shipments) for certain customers and trucking dispatch operations. TDSI serves the automotive industry with distribution centers and storage locations. Transflo connects non-rail served customers to the many benefits of rail by transferring products from rail to trucks. The biggest Transflo markets are chemicals and agriculture, which includes shipments of plastics and ethanol. CSX Technology and other subsidiaries provide support services for the Company.

CSX’s other holdings include CSX Real Property, Inc., a subsidiary responsible for the Company’s operating and non-operating real estate sales, leasing, acquisition and management and development activities. These activities are classified in either operating income or other income - net depending upon the nature of the activity. Results of these activities fluctuate with the timing of real estate transactions.

Basis of Presentation

In the opinion of management, the accompanying consolidated financial statements contain all normal, recurring adjustments necessary to fairly present the financial position of CSX and its subsidiaries at December 30, 2016 and December 25, 2015, and the consolidated statements of income, comprehensive income, cash flows and changes in shareholders’ equity for fiscal years 2016, 2015 and 2014. In addition, management has evaluated and disclosed all material events occurring subsequent to the date of the financial statements up to the date this annual report is filed on Form 10-K.

Fiscal Year

CSX follows a 52/53 week fiscal reporting calendar. This fiscal calendar allows every quarter to consistently end on a Friday and typically, to be of equal duration (13 weeks), resulting in a 52 week fiscal year. To maintain this type of reporting calendar every fifth or sixth year (depending on the Gregorian calendar and when leap year falls), an extra week will be included in the fourth quarter (a 14-week fiscal quarter) and, therefore, that full fiscal year will have 53 weeks. Fiscal fourth quarter 2016 included an extra week, so the quarter consisted of 14 weeks and fiscal year 2016 consisted of 53 weeks ending on December 30, 2016. Fiscal years 2015 and 2014 each consisted of 52 weeks ending on December 25, 2015 and December 26, 2014, respectively. Except as otherwise specified, references to full years indicate CSX’s fiscal periods ended on these dates.

Principles of Consolidation

The consolidated financial statements include results of operations of CSX and subsidiaries over which CSX has majority ownership or financial control. All significant intercompany accounts and transactions have been eliminated. Most investments in companies that were not majority-owned were carried at cost (if less than 20% owned and the Company has no significant influence) or were accounted for under the equity method (if the Company has significant influence but does not have control). These investments are reported within Investment in Conrail or Affiliates and Other Companies on the consolidated balance sheets.

Cash and Cash Equivalents

On a daily basis, cash in excess of current operating requirements is invested in various highly liquid investments having a typical maturity date of three months or less at the date of acquisition. These investments are carried at cost, which approximated market value, and are classified as cash equivalents.

CSX 2016 Form 10-K p. 65

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 1. Nature of Operations and Significant Accounting Policies, continued

Investments

Investments in instruments with original maturities greater than three months that will mature in less than one year are classified as short-term investments. Investments with original maturities of one year or greater are classified within other long-term assets.

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts on uncollectible amounts related to freight receivables, government reimbursement receivables, claims for damages and other various receivables. The allowance is based upon the creditworthiness of customers, historical experience, the age of the receivable and current market and economic conditions. Uncollectible amounts are charged against the allowance account. Allowance for doubtful accounts of $33 million and $37 million is included in the consolidated balance sheets as of December 2016 and December 2015, respectively.

Materials and Supplies

Materials and supplies in the consolidated balance sheets are carried at average costs and consist primarily of fuel and parts used in the repair and maintenance of CSXT’s freight car and locomotive fleets, equipment and track structure.

Goodwill

Goodwill represents purchase price in excess of fair value and is related to affiliates of CSXT, primarily P&L Transportation, Inc. Goodwill of $63 million is recorded in other long-term assets in the consolidated balance sheets as of December 2016 and December 2015, respectively.

Revenue and Expense Recognition

The Company recognizes freight revenue using Free-On-Board Origin pursuant to the Revenue Recognition Topic in the Accounting Standards Codification ("ASC"). Accounting guidance in this topic provides for the allocation of revenue between reporting periods based on relative transit time in each reporting period. Expenses are recognized as incurred.

The certain key estimates included in the recognition and measurement of revenue and related accounts receivable under the policies described above are as follows:

•revenue associated with shipments in transit is recognized ratably over transit time and is based on average cycle times to move commodities and products from their origin to their final destination or interchange;
•adjustments to revenue for billing corrections, billing discounts and bad debts or to accounts receivable for allowances for doubtful accounts;
•adjustments to revenue for overcharge claims filed by customers, which are based on historical cash paid to customers for rate overcharges as a percentage of total billing;
•incentive-based refunds to customers, which are primarily based on customers achieving certain volume thresholds, are recorded as a reduction to revenue on the basis of management’s best estimate of the projected liability (this estimate is based on historical activity, current volume levels and forecasted future volume).

CSX 2016 Form 10-K p. 66

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 1. Nature of Operations and Significant Accounting Policies, continued

The Company regularly updates the estimates described above based on historical experience and current conditions. All other revenue, such as demurrage, switching and other incidental charges are recorded upon completion of the service.

New Accounting Pronouncements

In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU"), Improvements to Employee Share-based Payment Accounting, which requires excess tax benefits and deficiencies to be recorded as income tax expense or benefit in the income statement rather than being recorded in additional paid-in capital. The Company adopted the provisions of this ASU during the second quarter of 2016 which did not have a material effect on the Company's financial condition, results of operations or liquidity.

In November 2015, the FASB issued ASU, Balance Sheet Classification of Deferred Taxes, which requires that all deferred income taxes be classified as noncurrent in the balance sheet, rather than being separated into current and noncurrent amounts. The Company adopted the provisions of this ASU during second quarter 2016 and applied them retrospectively. Current deferred income tax assets of $126 million as of December 25, 2015 have been reclassified and reported as a reduction of deferred income tax liabilities on the consolidated balance sheet. Adoption did not have a material effect on the Company's financial condition, results of operations or liquidity

In May 2014, the FASB issued ASU, Revenue from Contracts with Customers, which supersedes previous revenue recognition guidance. The new standard requires that a company recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration the company expects to receive in exchange for those goods or services. Companies will need to use more judgment and estimates than under the guidance currently in effect, including estimating the amount of variable revenue to recognize over each identified performance obligation. Additional disclosures will be required to help users of financial statements understand the nature, amount and timing of revenue and cash flows arising from contracts. This standard will become effective for CSX beginning with the first quarter 2018 and can be adopted either retrospectively to each prior reporting period presented or as a cumulative effect adjustment as of the date of adoption.

The FASB has recently issued several amendments to the revenue standard, including clarification on accounting for principal versus agent considerations (i.e., reporting gross versus net), licenses of intellectual property and identifying performance obligations. These amendments do not change the core principle of the standard, but provide clarity and implementation guidance.

The Company is currently finalizing its review of the impact of adopting this new guidance and developing a comprehensive implementation plan. In-depth reviews of a significant portion of commercial contracts have been completed and changes to processes and internal controls have been identified to meet the standard’s reporting and disclosure requirements. At this time, the Company does not believe this standard will have a material effect on the Company's financial condition, results of operations or liquidity.

CSX 2016 Form 10-K p. 67

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 1. Nature of Operations and Significant Accounting Policies, continued

In February 2016, the FASB issued ASU, Leases, which will require lessees to recognize most leases on their balance sheets as a right-of-use asset with a corresponding lease liability, and lessors to recognize a net lease investment. Additional qualitative and quantitative disclosures will also be required. This standard will become effective for CSX beginning with the first quarter 2019 and will be adopted using a modified retrospective method. Changes to processes and internal controls to meet the standard’s reporting and disclosure requirements have been identified and are being implemented. For example, software has been implemented that will assist in recognition of additional assets and liabilities to be included on the balance sheet related to operating leases with durations greater than twelve months, with certain allowable exceptions. The Company continues to evaluate the expected financial impact of this standard update.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires that management make estimates in reporting the amounts of certain assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of certain revenues and expenses during the reporting period. Actual results may differ from those estimates. Critical accounting estimates using management judgment are made for the following areas:

•casualty, environmental and legal reserves (see Note 5, Casualty, Environmental and Other Reserves);
•pension and post-retirement medical plan accounting (see Note 8, Employee Benefit Plans);
•depreciation policies for assets under the group-life method (see Note 6, Properties); and
•income taxes (see Note 11, Income Taxes).

Other Items

Share Repurchases

In April 2015, the Company announced a $2 billion share repurchase program, which is expected to be completed by April 2017. Management's assessment of market conditions and other factors guide the timing and volume of repurchases. Future share repurchases are expected to be funded by cash on hand, cash generated from operations and debt issuances. During 2016, 2015 and 2014, CSX repurchased $1.1 billion, or 38 million shares, $804 million or 26 million shares, and $517 million, or 17 million shares, respectively, of common stock. Shares are retired immediately upon repurchase. In accordance with the Equity Topic in the ASC, the Company elected to allocate the excess of repurchase price over par value and record in retained earnings. Generally, retained earnings is only impacted by net earnings and dividends.

Workforce Reduction Plans, Separation & Other Costs

Union agreements, facility closures and management streamlining under workforce reduction plans resulted in payment of separation benefits to employees of $51 million and $39 million in 2015 and 2014, respectively. These amounts are recognized in labor and fringe and materials, supplies and other on the consolidated statements of income. Separation benefits incurred in 2016 related to workforce reduction plans were not material.

CSX 2016 Form 10-K p. 68

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 1. Nature of Operations and Significant Accounting Policies, continued

Union agreements

In November 2015, CSX finalized a union agreement that will improve efficiency across the CSX network. This agreement allowed certain employees impacted by work transitions to voluntarily separate from the Company with enhanced benefits and provided relocation benefits to employees not electing to separate. As a result, approximately 300 union employees were impacted. Separation benefits were paid from general corporate funds.

Facility closures

In October 2015, CSX closed facilities in Erwin, Tennessee and Corbin, Kentucky as a result of the decline in coal movements in these regions. These closures impacted approximately 500 positions. The Company recorded a charge resulting from separation, relocation and furlough costs, as well as asset impairment charges related to the facility closures. Separation benefits were paid from general corporate funds.

Management streamlining

In 2014, the Company announced a workforce reduction plan to streamline the organization. The initiative reduced management workforce by approximately 300 positions through a voluntary separation program with enhanced benefits as well as a subsequent involuntary severance program during the fourth

quarter of 2014 and the first quarter of 2015. The majority of separation benefits were paid from CSX’s qualified pension plans, while the remainder was paid from general corporate funds.

NOTE 2. Earnings Per Share

The following table sets forth the computation of basic earnings per share and earnings per share, assuming dilution:

Fiscal Years
201620152014
Numerator (Dollars in Millions):
Net Earnings$1,714$1,968$1,927
Dividend Equivalents on Restricted Stock(1)(1)(1)
Net Earnings, Attributable to Common Shareholders$1,713$1,967$1,926
Denominator (Units in Millions):
Average Common Shares Outstanding9479831,001
Other Potentially Dilutive Common Shares111
Average Common Shares Outstanding, Assuming Dilution9489841,002
Net Earnings Per Share, Basic$1.81$2.00$1.93
Net Earnings Per Share, Assuming Dilution$1.81$2.00$1.92

Basic earnings per share is based on the weighted-average number of shares of common stock outstanding. Earnings per share, assuming dilution, is based on the weighted-average number of shares of common stock equivalents outstanding adjusted for the effects of common stock that may be issued as a result of potentially dilutive instruments. CSX's potentially dilutive instruments are made up of equity awards, which include long-term incentive awards and employee stock options.

CSX 2016 Form 10-K p. 69

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 2. Earnings Per Share, continued

The Earnings Per Share Topic in the ASC requires CSX to include additional shares in the computation of earnings per share, assuming dilution. The additional shares included in diluted earnings per share represent the number of shares that would be issued if all of the above potentially dilutive instruments were converted into CSX common stock.

When calculating diluted earnings per share, CSX is required to include the potential shares that would be outstanding if all outstanding stock options were exercised. This number is different from outstanding stock options, which is included in Note 4, Stock Plans and Share-Based Compensation, because it is offset by shares CSX could repurchase using the proceeds from these hypothetical exercises to obtain the common stock equivalent. Approximately 2.8 million and 2.5 million of total average outstanding stock options for 2016 and 2015, respectively, were excluded from the diluted earnings per share calculation because their effect was antidilutive. There were no stock options outstanding for 2014.

NOTE 3. Shareholders’ Equity

Common and preferred stock consists of the following:

Common Stock, $1 Par ValueDecember 2016
(Units in Millions)
Common Shares Authorized1,800
Common Shares Issued and Outstanding928
Preferred Stock
Preferred Shares Authorized25
Preferred Shares Issued and Outstanding—

Holders of common stock are entitled to one vote on all matters requiring a vote for each share held. Preferred stock is senior to common stock with respect to dividends and upon liquidation of CSX.

CSX 2016 Form 10-K p. 70

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 4. Stock Plans and Share-Based Compensation

Under CSX's share-based compensation plans, awards consist of performance units, restricted stock units, restricted stock awards and stock options for management and stock grants for directors. Awards granted under the various programs are determined and approved by the Compensation Committee of the Board of Directors or, in certain circumstances, by the Chief Executive Officer for awards to management employees other than senior executives. The Board of Directors approves awards granted to the Company’s non-management directors upon recommendation of the Governance Committee.

Share-based compensation expense is measured at fair value of the Company’s stock on the grant date and is recognized on a straight-line basis over the service period of the respective award. Forfeitures are recognized as they occur. Total pre-tax expense associated with share-based compensation and its related income tax benefit is shown in the table below.

Fiscal Years
(Dollars in Millions)201620152014
Share-Based Compensation Expense
Performance Units$17$(1)$20
Restricted Stock Units and Awards111111
Stock Options7——
Stock Awards for Directors222
Total Share-based Compensation Expense$37$12$33
Income Tax Benefit$14$4$13

Long-term Incentive Plans

The CSX Long-term Incentive Plans (“LTIP”) were adopted under the 2010 CSX Stock and Incentive Award Plan. The objective of these plans is to motivate and reward certain employees for achieving and exceeding certain financial and strategic initiatives. Grants were made in performance units, with each unit being equivalent to one share of CSX common stock, and payouts will be made in CSX common stock. The payout range for participants will be between 0% and 200% of the target awards depending on Company performance against predetermined goals for each three-year cycle. In 2014, 2015 and 2016, target performance units were granted to certain employees under three separate LTIP plans covering three-year cycles: the 2014-2016 (“2014-2016 LTIP”), 2015-2017 (“2015-2017 LTIP”) and 2016-2018 (“2016-2018 LTIP”) plans (collectively, the “plans”).

The key financial targets for the plans will be based on the achievement of goals related to both operating ratio and return on assets (tax-adjusted operating income divided by net property) excluding non-recurring items as disclosed in the Company's financial statements. The three-year cumulative operating ratio and average return on assets over the performance period will each comprise 50% of the payout and are measured independently of the other. The plans state that payouts for certain executive officers are subject to downward adjustment by up to 30% based upon total shareholder return relative to specified comparable groups.

CSX 2016 Form 10-K p. 71

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 4. Stock Plans and Share-Based Compensation, continued

Performance unit grant and vesting information is summarized as follows:

Fiscal Years
201620152014
Weighted-average grant date fair value$24.17$35.45$28.13
Fair value of units vested in fiscal year ending (in millions)$31$34$—

The performance unit activity related to the outstanding long-term incentive plans and corresponding fair value is summarized as follows:

Performance Units Outstanding (in Thousands)Weighted-Average Fair Value at Grant Date
Unvested at December 25, 20151,941$31.73
Granted85224.17
Forfeited(118)29.22
Vested(1,094)28.60
Unvested at December 30, 20161,581$30.00

As of December 2016, there was $18 million of total unrecognized compensation cost related to performance units that is expected to be recognized over a weighted-average period of approximately two years.

Restricted Stock Grants

Restricted stock grants consist of units and awards, each equivalent to one share of CSX stock. Restricted stock units are issued along with corresponding LTIP plans and vest three years after the date of grant. Separately, restricted stock awards generally vest over an employment period of up to five years. Participants receive cash dividend equivalents on the unvested shares during the restriction period. These awards are time-based and not based upon CSX’s attainment of operational targets.

Restricted stock grant and vesting information is summarized as follows:

Fiscal Years
201620152014
Weighted-average grant date fair value$24.21$35.94$28.08
Fair value of units and awards vested during fiscal year ended (in millions)$14$9$11

CSX 2016 Form 10-K p. 72

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 4. Stock Plans and Share-Based Compensation, continued

The restricted stock activity related to the outstanding long-term incentive plans and corresponding fair value is summarized as follows:

Restricted Stock Units and Awards Outstanding (in Thousands)Weighted-Average Fair Value at Grant Date
Unvested at December 25, 20151,157$28.66
Granted50924.21
Forfeited(52)28.19
Vested(538)25.44
Unvested at December 30, 20161,076$28.19

As of December 2016, unrecognized compensation expense for these restricted stock units and awards was approximately $13 million, which will be expensed over a weighted-average remaining period of two years.

Stock Options

Stock options were granted in 2016 along with the corresponding LTIP plan and in 2015 to certain members of management. No stock options were granted in 2014. Under this program, an employee receives an award that provides the opportunity in the future to purchase CSX shares at the closing market price of the stock on the date the award is granted (the strike price). The options become exercisable after a three-year vesting period and expire 10 years from the grant date if they are not exercised.

The fair value of stock options granted was estimated as of the dates of grant using the Black-Scholes-Merton option model which uses the following assumptions: dividend yield, risk-free interest rate, annualized volatility and expected life. The annual dividend yield is based on the most recent quarterly CSX dividend payment annualized. The risk-free interest rate is based on U.S. Treasury yield curve in effect at the time of grant. The annualized volatility is based on historical volatility of daily CSX stock price returns over a 6.5year look-back period ending on the grant date. The expected life is calculated using the safe harbor approach due to lack of historical data on CSX options, which is the midpoint between the vesting schedule (three year cliff) and contractual term (10 years).

CSX 2016 Form 10-K p. 73

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 4. Stock Plans and Share-Based Compensation, continued

Assumptions and inputs used to estimate fair value of stock options are summarized as follows:

Fiscal Years
20162015
Weighted-average grant date fair value$4.68$5.31
Stock options valuation assumptions:
Annual dividend yield3%3%
Risk-free interest rate1%2%
Annualized volatility27%28%
Expected life (in years)6.56.5
Other pricing model inputs:
Weighted-average grant-date market price of CSX stock (strike price)$24.13$24.99

The stock option activity is summarized as follows:

Stock Options Outstanding (in Thousands)Weighted-Average Exercise Price
Outstanding at December 25, 20152,514$24.99
Granted2,38324.13
Forfeited(316)24.63
Outstanding4,582$24.57
Exercisable at December 30, 2016——

Unrecognized compensation expense related to stock options as of December 2016 was $15 million and is expected to be recognized over a weighted-average period of approximately two years.

The terms of performance units, restricted stock units and stock options all require participants to be employed through the final day of the respective performance or vesting periods as applicable, except in the case of death, disability or retirement.

Stock Awards for Directors

CSX’s non-management directors receive a base annual retainer of $90,000 to be paid quarterly in cash, unless the director chooses to receive the retainer in the form of CSX common stock. Additionally, non-management directors receive an annual grant of common stock in the amount of approximately $150,000, with the number of shares to be granted based on the average closing price of CSX stock in the months of November, December and January.

CSX 2016 Form 10-K p. 74

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 5. Casualty, Environmental and Other Reserves

Activity related to casualty, environmental and other reserves is as follows:

CasualtyEnvironmentalOther
(Dollars in Millions)ReservesReservesReservesTotal
December 27, 2013$280$100$71$451
Charged to Expense (a)895730176
Payments(104)(63)(42)(209)
December 26, 20142659459418
Charged to Expense604537142
Payments(56)(57)(47)(160)
December 25, 20152698249400
Charged to Expense524630128
Change in Estimate(b)(28)——(28)
Payments(64)(33)(29)(126)
December 30, 2016$229$95$50$374
(a)Casualty expense in 2014 was higher due to the resolution of personal injury claims for prior years.
(b)Changes in estimates are the result of continued safety improvements and a continuing decline in the severity of injuries.

These reserves are considered critical accounting estimates due to the need for significant management judgment. They are provided for in the consolidated balance sheets as shown in the table below.

December 2016December 2015
(Dollars in Millions)CurrentLong-termTotalCurrentLong-termTotal
Casualty:
Personal Injury$46$124$170$57$147$204
Occupational (a)75259125365
Total Casualty$53$176$229$69$200$269
Environmental425395424082
Other203050202949
Total$115$259$374$131$269$400
(a)Occupational reserves include asbestos-related diseases and occupational injuries.

These liabilities are accrued when reasonably estimable and probable in accordance with the Contingencies Topic in the ASC. Actual settlements and claims received could differ and final outcomes of these matters cannot be predicted with certainty. Considering the legal defenses currently available, the liabilities that have been recorded and other factors, it is the opinion of management that none of these items individually, when finally resolved, will have a material adverse effect on the Company's financial condition, results of operations or liquidity. Should a number of these items occur in the same period, however, their combined effect could be material in that particular period.

CSX 2016 Form 10-K p. 75

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 5. Casualty, Environmental and Other Reserves, continued

Casualty

Casualty reserves of $229 million and $269 million for 2016 and 2015, respectively, represent accruals for personal injury, occupational disease and occupational injury claims. The Company's self-insured retention amount for these claims is $50 million per occurrence. Currently, no individual claim is expected to exceed the self-insured retention amount. In accordance with the Contingencies Topic in the ASC, to the extent the value of an individual claim exceeds the self-insured retention amount, the Company would present the liability on a gross basis with a corresponding receivable for insurance recoveries. These reserves fluctuate based upon the timing of payments as well as changes in estimate. Actual results may vary from estimates due to the number, type and severity of the injury, costs of medical treatments and uncertainties in litigation. Most of the Company's casualty claims relate to CSXT unless otherwise noted below. Defense and processing costs, which historically have been insignificant and are anticipated to be insignificant in the future, are not included in the recorded liabilities.

Personal Injury

Personal injury reserves represent liabilities for employee work-related and third-party injuries. Work-related injuries for CSXT employees are primarily subject to the Federal Employers' Liability Act ("FELA"). In addition to FELA liabilities, employees of other current or former CSX subsidiaries are covered by various state workers’ compensation laws, the Federal Longshore and Harbor Workers’ Compensation Program or the Maritime Jones Act.

CSXT retains an independent actuary to assist management in assessing the value of personal injury claims. An analysis is performed by the actuary quarterly and is reviewed by management. The methodology used by the actuary includes a development factor to reflect growth or reduction in the value of these personal injury claims. It is based largely on CSXT's historical claims and settlement experience.

As a direct result of improvements in safety in recent years, the Company has experienced a downward trend in the severity of injuries, which has resulted in a decrease in the estimate of costs per incident. During 2016, the Company reduced casualty reserves, primarily personal injury reserves, by $28 million, resulting in an after-tax effect on earnings from continuing operations and net earnings of $18 million and an after-tax effect on earnings per share of $0.02. The personal injury reserve reductions were included in materials, supplies and other on the consolidated income statements. During 2015 and 2014, there were no significant changes in estimate recorded to adjust casualty reserves.

Occupational

Occupational reserves represent liabilities for occupational disease and injury claims. Occupational disease claims arise primarily from allegations of exposure to asbestos in the workplace. Occupational injury claims arise from allegations of exposure to certain other materials in the workplace, such as solvents, soaps, chemicals (collectively referred to as “irritants”) and diesel fuels (like exhaust fumes) or allegations of chronic physical injuries resulting from work conditions, such as repetitive stress injuries.

The greatest possible exposure to asbestos for employees resulted from work conducted in and around steam locomotive engines that were largely phased out beginning around the 1950s. Other types of exposures, however, including exposure from locomotive component parts and building materials, continued until these exposures were substantially eliminated by 1985. Diseases associated with asbestos typically have long latency periods (amount of time between exposure to asbestos and the onset of the disease) which can range from 10 to 40 years after exposure.

CSX 2016 Form 10-K p. 76

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 5. Casualty, Environmental and Other Reserves, continued

Management reviews asserted asbestos claims quarterly. Unasserted or incurred but not reported ("IBNR") asbestos claims are analyzed by a third-party specialist and reviewed by management annually.

CSXT’s historical claim filings, settlement amounts, and dismissal rates are analyzed to determine future anticipated claim filing rates and average settlement values for asbestos claims reserves. The potentially exposed population is estimated by using CSXT’s employment records and industry data. From this analysis, the specialist estimates the IBNR claims liabilities.

Environmental

Environmental reserves were $95 million and $82 million for 2016 and 2015, respectively. The Company is a party to various proceedings related to environmental issues, including administrative and judicial proceedings involving private parties and regulatory agencies. The Company has been identified as a potentially responsible party at approximately 222 environmentally impaired sites. Many of these are, or may be, subject to remedial action under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"), also known as the Superfund Law, or similar state statutes. Most of these proceedings arose from environmental conditions on properties used for ongoing or discontinued railroad operations. A number of these proceedings, however, are based on allegations that the Company, or its predecessors, sent hazardous substances to facilities owned or operated by others for treatment, recycling or disposal. In addition, some of the Company’s land holdings were leased to others for commercial or industrial uses that may have resulted in releases of hazardous substances or other regulated materials onto the property and could give rise to proceedings against the Company.

In any such proceedings, the Company is subject to environmental clean-up and enforcement actions under the Superfund Law, as well as similar state laws that may impose joint and several liability for clean-up and enforcement costs on current and former owners and operators of a site without regard to fault or the legality of the original conduct. These costs could be substantial.

In accordance with the Asset Retirement and Environmental Obligations Topic in the ASC, the Company reviews its role with respect to each site identified at least quarterly, giving consideration to a number of factors such as:

•type of clean-up required;
•nature of the Company’s alleged connection to the location (e.g., generator of waste sent to the site or owner or operator of the site);
•extent of the Company’s alleged connection (e.g., volume of waste sent to the location and other relevant factors); and
•number, connection and financial viability of other named and unnamed potentially responsible parties at the location.

CSX 2016 Form 10-K p. 77

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 5. Casualty, Environmental and Other Reserves, continued

Based on the review process, the Company has recorded amounts to cover contingent anticipated future environmental remediation costs with respect to each site to the extent such costs are reasonably estimable and probable. The recorded liabilities for estimated future environmental costs are undiscounted. The liability includes future costs for remediation and restoration of sites as well as any significant ongoing monitoring costs, but excludes any anticipated insurance recoveries. Payments related to these liabilities are expected to be made over the next several years. Environmental remediation costs are included in materials, supplies and other on the consolidated income statements.

Currently, the Company does not possess sufficient information to reasonably estimate the amounts of additional liabilities, if any, on some sites until completion of future environmental studies. In addition, conditions that are currently unknown could, at any given location, result in additional exposure, the amount and materiality of which cannot presently be reasonably estimated. Based upon information currently available, however, the Company believes its environmental reserves accurately reflect the estimated cost of remedial actions currently required.

Other

Other reserves of $50 million and $49 million for 2016 and 2015, respectively, include liabilities for various claims, such as property, automobile and general liability. Also included in other reserves are longshoremen disability claims related to a previously owned international shipping business (these claims are in runoff) as well as claims for current port employees.

CSX 2016 Form 10-K p. 78

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 6. Properties

A detail of the Company’s net properties are as follows:

(Dollars in Millions)AccumulatedNet BookAnnual DepreciationEstimated Useful LifeDepreciation
December 2016CostDepreciationValueRate( Avg. Years)Method (a)
Road
Rail and Other Track Material$7,326$(1,493)$5,8332.5%40Group Life
Ties5,368(1,292)4,0763.7%27Group Life
Grading2,600(514)2,0861.4%90Group Life
Ballast2,897(860)2,0372.7%37Group Life
Bridges, Trestles, and Culverts2,306(317)1,9891.6%70Group Life
Signals and Interlockers2,523(496)2,0274.0%25Group Life/ Straight Line
Buildings1,238(447)7912.5%40Group Life
Other4,566(1,905)2,6614.2%24Group Life
Total Road28,824(7,324)21,500
Equipment
Locomotive6,110(2,504)3,6063.5%29Group Life
Freight Cars3,386(1,046)2,3402.9%35Group Life
Work Equipment and Other2,108(1,190)9187.4%14Group Life/ Straight Line
Total Equipment11,604(4,740)6,864
Land1,833—1,833N/AN/AN/A
Construction In Progress913—913N/AN/AN/A
Other53(13)40N/A32Straight Line
Total Properties$43,227$(12,077)$31,150

(a) For depreciation method, certain asset categories contain technology-related assets, which are depreciated using the straight-line method.

CSX 2016 Form 10-K p. 79

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 6. Properties, continued

(Dollars in Millions)AccumulatedNet BookAnnual DepreciationEstimated Useful LifeDepreciation
December 2015CostDepreciationValueRate(Avg. Years)Method (a)
Road
Rail and Other Track Material$7,150$(1,414)$5,7362.5%40Group Life
Ties5,077(1,147)3,9303.7%27Group Life
Grading2,533(479)2,0541.4%90Group Life
Ballast2,793(802)1,9912.7%37Group Life
Bridges, Trestles, and Culverts2,238(283)1,9551.6%70Group Life
Signals and Interlockers2,315(416)1,8994.0%25Group Life/ Straight Line
Buildings1,152(424)7282.5%40Group Life
Other4,306(1,793)2,5134.2%24Group Life
Total Road27,564(6,758)20,806
Equipment
Locomotive5,673(2,461)3,2123.6%28Group Life
Freight Cars3,362(1,018)2,3443.2%31Group Life
Work Equipment and Other2,073(1,154)9197.1%13Group Life/ Straight Line
Total Equipment11,108(4,633)6,475
Land1,858—1,858N/AN/AN/A
Construction In Progress1,003—1,003N/AN/AN/A
Other41(9)32N/A32Straight Line
Total Properties$41,574$(11,400)$30,174

(a) For depreciation method, certain asset categories contain technology-related assets, which are depreciated using the straight-line method.

Railroad Assets

The Company depreciates its railroad assets, including main-line track, locomotives and freight cars, using the group-life method of accounting. Assets depreciated under the group-life method of accounting comprise 86% of total fixed assets of $43 billion on a gross basis as of December 2016. The remaining depreciable assets of the Company are depreciated on a straight-line basis. The group-life method aggregates assets with similar lives and characteristics into groups and depreciates each of these groups as a whole. When using the group-life method, an underlying assumption is that each group of assets, as a whole, is used and depreciated to the end of its recoverable life.

The Company currently utilizes more than 130 different depreciable asset categories to account for depreciation expense for the railroad assets that are depreciated under the group-life method of accounting. Examples of depreciable asset categories include 18 different categories for crossties due to the different combinations of density classifications and asset types. By utilizing various depreciable categories, the Company can more accurately account for the use of its assets. All assets of the Company are depreciated on a time or life basis.

CSX 2016 Form 10-K p. 80

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 6. Properties, continued

The Company believes the group-life method of depreciation closely approximates the straight-line method of depreciation. Additionally, due to the nature of most of its assets (e.g. track is one contiguous, connected asset) the Company believes that this is the most effective way to properly depreciate its assets.

Management performs a detailed review of depreciation expense and useful lives on a regular basis. Under the group-life method of accounting, the service lives and salvage values for each group of assets are determined by completing periodic depreciation studies and applying management’s assumptions regarding the service lives of its properties. A depreciation study (also referred to as a life study) is the periodic review of asset service lives, salvage values, accumulated depreciation, and other related factors for group assets conducted by a third-party specialist, analyzed by the Company’s management and approved by the STB, the regulatory board that has broad jurisdiction over railroad practices. The STB requires depreciation studies be performed for equipment assets generally every three years and for road (e.g. bridges and signals) and track (e.g. rail, ties and ballast) assets generally every six years. The Company believes the frequency currently required by the STB provides adequate review of asset service lives and that a more frequent review would not result in a material change due to the long-lived nature of most of the assets. In 2016, the Company completed a deprecation study for its equipment assets. In 2014, the Company completed a depreciation study for its road and track assets. The Company plans to complete the next depreciation study for equipment assets in 2019 and road and track assets in 2020.

The results of the depreciation study process determine the service lives for each asset group under the group-life method. Road assets, including main-line track, have estimated service lives ranging from eight years for system roadway machinery to 90 years for grading (construction of protection for the roadway, tracks and embankments). Equipment assets, including locomotives and freight cars, have estimated service lives ranging from four years for technology assets to 40 years for work equipment. Changes in asset service lives due to the results of the depreciation studies are applied on a prospective basis and could significantly impact future periods’ depreciation expense, and thus, the Company's results of operations.

There are several factors taken into account during the depreciation study and they include:

•statistical analysis of historical life and salvage data for each group of property;
•statistical analysis of historical retirements for each group of property;
•evaluation of current operations;
•evaluation of technological advances and maintenance schedules;
•previous assessment of the condition of the assets;
•management's outlook on the future use of certain asset groups;
•expected net salvage to be received upon retirement; and
•comparison of assets to the same asset groups with other companies.

Recent experience with depreciation studies has resulted in depreciation rate changes that did not materially affect the Company’s annual depreciation expense of $1.3 billion, $1.2 billion and $1.2 billion for 2016, 2015 and 2014, respectively. In general, changes in depreciation rates result from updated average asset service lives as determined during depreciation studies.

CSX 2016 Form 10-K p. 81

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 6. Properties, continued

For retirements or disposals of depreciable rail assets that occur in the ordinary course of business, the asset cost (net of salvage value or sales proceeds) is charged to accumulated depreciation and no gain or loss is recognized. As individual assets within a specific group are retired or disposed of, resulting gains and losses are recorded in accumulated depreciation. This practice is consistent with accounting treatment normally prescribed under the group-life method. As part of the depreciation study, an assessment of the recorded amount of accumulated depreciation is made to determine if it is deficient (or in excess) of the appropriate amount indicated by the study. Any such deficiency (or excess), including any deferred gains or losses, is amortized as a component of depreciation expense over the remaining service life of the asset group until the next required depreciation study. Since the overall assumption with the group-life method of accounting is that the assets within the group on average have the same service life and characteristics, it is therefore concluded that the deferred gains and losses offset over time.

Since the rail network is one contiguous, connected network it is impractical to maintain specific identification records for these assets. For road assets (such as rail and track related items), CSX utilizes a first-in, first-out approach to asset retirements. The historical cost of these replaced assets is estimated using inflation indices previously published by the Bureau of Labor Statistics, adjusted using Consumer Price Index inflationary figures, applied to the replacement value based on the age of the retired asset. The indices are used because they closely correlate with the major cost of the materials comprising the applicable road assets.

Equipment assets (such as locomotives and freight cars) are specifically identified at retirement. When an equipment asset is retired that has been depreciated using the group-life method, the cost is reduced from the cost base and recorded in accumulated depreciation.

In the event that large groups of assets are removed from service as a result of unusual acts or sales, resulting gains and losses are recognized immediately. These acts are not considered to be in the normal course of business and are therefore recognized when incurred. Examples of such acts would be the major destruction of assets due to significant storm damage (e.g. major hurricanes), the sale of a rail line segment or the disposal of an entire class of assets (e.g. disposal of all refrigerated freight cars). Abnormal operating gains were $23 million in 2015 primarily related to the sale of an operating rail line segment. There were no abnormal operating gains or losses in 2016 or 2014.

CSX 2016 Form 10-K p. 82

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 6. Properties, continued

Non-Railroad Assets, Capital Leases and Land

Non-railroad assets and assets under capital leases are not depreciated using the group-life method; rather, they are depreciated using the straight-line method on a per asset basis. The depreciable lives of these assets are periodically reviewed by the Company and any changes are applied on a prospective basis. Amortization expense recorded under capital leases is included in depreciation expense on the consolidated income statements. Land is not depreciated. For retirements or disposals of non-railroad depreciable assets and all dispositions of land, the resulting gains or losses are recognized in earnings at the time of disposal. During 2016, the Company recognized $115 million of earnings related to a $110 million gain on the sale of an operating property and a $5 million reimbursement of environmental costs related to the sale, which is recognized in materials, supplies and other on the consolidated statements of income. During 2015, the Company recognized a gain of $59 million related to the sale of non-operating easements, which is recognized in other income on the consolidated statements of income. (For additional information regarding cost reimbursements related to this sale, see Note 10, Other Income.) These gains and losses were not material in 2014.

Impairment Review

Properties and other long-lived assets are reviewed for impairment annually or whenever events or business conditions indicate the carrying amount of such assets may not be fully recoverable. Initial assessments of recoverability are based on estimates of undiscounted future net cash flows associated with an asset or a group of assets in accordance with the Property, Plant, and Equipment Topic in the ASC. Where impairment is indicated, the assets are evaluated and their carrying amount is reduced to fair value based on discounted net cash flows or other estimates of fair value.

Capital Expenditures

The Company’s capital investment includes purchased and self-constructed assets and property additions that substantially extend the service life or increase the utility of those assets. Indirect costs that can be specifically traced to capital projects are also capitalized. The Company is committed to maintaining and improving its existing infrastructure and expanding its network capacity for long-term growth. Rail operations are capital intensive and CSX accounts for these costs in accordance with GAAP and the Company’s capitalization policy. All properties are stated at historical cost less an allowance for accumulated depreciation.

CSX 2016 Form 10-K p. 83

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 6. Properties, continued

The Company’s largest category of capital investment is the replacement of track assets and the acquisition or construction of new assets that enable CSX to enhance its operations or provide new capacity offerings to its customers. These construction projects are primarily completed by CSXT employees. Costs for track asset replacement and capacity projects that are capitalized include:

•labor costs, because many of the assets are self-constructed;
•costs to purchase or construct new track or to prepare ground for the laying of track;
•welding (rail, field and plant) which are processes used to connect segments of rail;
•new ballast, which is gravel and crushed stone that holds track in line;
•fuels and lubricants associated with tie, rail and surfacing work which is the process of raising track to a designated elevation over an extended distance;
•cross, switch and bridge ties which are the braces that support the rails on a track;
•gauging which is the process of standardizing the distance between rails;
•handling costs associated with installing rail, ties or ballast;
•usage charge of machinery and equipment utilized in construction or installation; and
•other track materials.

The primary cost in self-constructed track replacement work is labor. CSXT engineering employees directly charge their labor to the track replacement project (the capitalized depreciable property). These employees concurrently perform deconstruction and installation of track material. Because of this concurrent process, CSX must estimate the amount of labor that is related to deconstruction versus installation. Through analysis of CSXT’s track replacement process, CSX determined that approximately 20% of labor costs associated with track material installation is related to the deconstruction of old track and 80% is associated with the installation of new track.

Capital investment related to locomotives and freight cars comprises the second largest category of the Company’s capital assets. This category includes purchase costs of locomotives and freight cars as well as certain equipment leases that are considered to be capital leases in accordance with the Leases Topic in the ASC. In addition, costs to modify or rebuild these assets are capitalized if the investment incurred extends the asset’s service life or improves utilization. Improvement projects must meet specified dollar thresholds to be capitalized and are reviewed by management to determine proper accounting treatment. Routine repairs and maintenance costs, for all asset categories, are expensed as incurred.

CSX 2016 Form 10-K p. 84

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 7. Commitments and Contingencies

Lease Commitments

The Company has various lease agreements with other parties with terms up to 30 years. Non-cancelable, long-term leases may include provisions for maintenance, options to purchase and options to extend the terms. Rent expense on operating leases is included in equipment and other rents on the consolidated income statements. The Company uses the straight-line method to recognize rent expense on operating leases that include escalations over their terms. These amounts are shown in the table below.

Fiscal Years
(Dollars in Millions)201620152014
Rent Expense on Operating Leases$50$66$61

At December 2016, minimum rentals on land, buildings, track and equipment under operating leases are disclosed in the table below. Also, payments to Conrail for leases on shared rail infrastructure are included in these amounts. (See Note 12, Related Party Transactions).

(Dollars in Millions)OperatingSubleaseNet Lease
YearsLeasesIncomeCommitments
2017$78$(3)$75
201866(3)63
201962(3)59
202049(3)46
202140(3)37
Thereafter153(7)146
Total$448$(22)$426

Purchase Commitments

CSXT has a commitment under a long-term maintenance program that currently covers 50% of CSXT’s fleet of locomotives. The agreement is based on the maintenance cycle for each locomotive. Under CSXT’s current obligations, the agreement will expire no earlier than 2031. The costs expected to be incurred throughout the duration of the agreement fluctuate as locomotives are placed into or removed from service, or as required maintenance schedules are revised.

The following table summarizes the number of active and inactive locomotives covered and CSXT’s payments under the long-term maintenance program.

Fiscal Years
(Dollars in Millions)201620152014
Amounts Paid$230$233$247
Number of Locomotives2,2432,3101,886

CSX 2016 Form 10-K p. 85

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 7. Commitments and Contingencies, continued

As of December 2016, the Company has no outstanding locomotive purchase obligations. Annual payments related to the long-term locomotive maintenance program are estimated in the table below.

Additionally, the Company has various other commitments to purchase technology, communications, railcar maintenance and other services from various suppliers. Total annual payments under all of these purchase commitments are also estimated in the table below.

(Dollars in Millions)Locomotive Maintenance PaymentsOther CommitmentsTotal
2017$234$129$363
201824492336
201926052312
202027046316
202127436310
Thereafter3,6902533,943
Total$4,972$608$5,580

Insurance

The Company maintains numerous insurance programs with substantial limits for property damage (which includes business interruption) and third-party liability. A certain amount of risk is retained by the Company on each of the property and liability programs. The Company has a $25 million retention per occurrence for the non-catastrophic property program (such as a derailment) and a $50 million retention per occurrence for the liability and catastrophic property programs (such as hurricanes and floods). While the Company believes its insurance coverage is adequate, future claims could exceed existing insurance coverage or insurance may not continue to be available at commercially reasonable rates.

Legal

The Company is involved in litigation incidental to its business and is a party to a number of legal actions and claims, various governmental proceedings and private civil lawsuits, including, but not limited to, those related to fuel surcharge practices, tax matters, environmental and hazardous material exposure matters, FELA and labor claims by current or former employees, other personal injury or property claims and disputes and complaints involving certain transportation rates and charges. Some of the legal proceedings include claims for compensatory as well as punitive damages and others are, or are purported to be, class actions. While the final outcome of these matters cannot be predicted with certainty, considering, among other things, the legal defenses available and liabilities that have been recorded along with applicable insurance, it is currently the opinion of management that none of these pending items will have a material adverse effect on the Company's financial condition, results of operations or liquidity. An unexpected adverse resolution of one or more of these items, however, could have a material adverse effect on the Company's financial condition, results of operations or liquidity in that particular period.

The Company is able to estimate a range of possible loss for certain legal proceedings for which a loss is reasonably possible in excess of reserves established. The Company has estimated this range to be $6 million to $126 million in aggregate at December 30, 2016. This estimated aggregate range is based upon currently available information and is subject to significant judgment and a variety of assumptions. Accordingly, the Company's estimate will change from time to time, and actual losses may vary significantly from the current estimate.

CSX 2016 Form 10-K p. 86

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 7. Commitments and Contingencies, continued

Fuel Surcharge Antitrust Litigation

In May 2007, class action lawsuits were filed against CSXT and three other U.S.-based Class I railroads alleging that the defendants' fuel surcharge practices relating to contract and unregulated traffic resulted from an illegal conspiracy in violation of antitrust laws. In November 2007, the class action lawsuits were consolidated in federal court in the District of Columbia, where they are now pending. The suit seeks treble damages allegedly sustained by purported class members as well as attorneys' fees and other relief. Plaintiffs are expected to allege damages at least equal to the fuel surcharges at issue.

In June 2012, the District Court certified the case as a class action. The decision was not a ruling on the merits of plaintiffs' claims, but rather a decision to allow the plaintiffs to seek to prove the case as a class. The defendant railroads petitioned the U.S. Court of Appeals for the D.C. Circuit for permission to appeal the District Court's class certification decision. In August 2013, the D.C. Circuit issued a decision vacating the class certification decision and remanded the case to the District Court to reconsider its class certification decision. The District Court remand proceedings are underway and the class certification hearing was held in September 2016. The District Court has delayed proceedings on the merits of the case pending the outcome of the class certification remand proceedings. The court has given no indication of timing on its ruling regarding class certification.

CSXT believes that its fuel surcharge practices were arrived at and applied lawfully and that the case is without merit. Accordingly, the Company intends to defend itself vigorously. However, penalties for violating antitrust laws can be severe, and resolution of this matter or an unexpected adverse decision on the merits could have a material adverse effect on the Company's financial condition, results of operations or liquidity in that particular period.

Environmental

CSXT is indemnifying Pharmacia LLC (formerly known as Monsanto Company) for certain liabilities associated with real estate located in Kearny, New Jersey along the Lower Passaic River (the “Property”). The Property, which was formerly owned by Pharmacia, is now owned by CSXT. CSXT's indemnification and defense duties arise with respect to several matters. The U.S. Environmental Protection Agency ("EPA"), using its CERCLA authority, seeks cleanup and removal costs and other damages associated with the presence of hazardous substances in the 17-mile Lower Passaic River Study Area (the "Study Area”). CSXT, on behalf of Pharmacia, and a significant number of other potentially responsible parties are together conducting a Remedial Investigation and Feasibility Study of the Study Area pursuant to an Administrative Settlement Agreement and Order on Consent with the EPA.

In March 2016, EPA issued its Record of Decision detailing the agency’s mandated remedial process for the lower 8 miles of the Study Area, which was based on a Focused Feasibility Study. EPA has estimated that it will take the potentially responsible parties approximately ten years to complete the work. At a later date, EPA will select a remedy for the remainder of the Study Area and is expected to again seek the participation of private parties to implement the selected remedy using EPA’s CERCLA authority to compel such participation, if necessary.

CSXT is also defending and indemnifying Pharmacia in a cooperative natural resource damages assessment process related to the Property. Based on currently available information, the Company does not believe any indemnification or remediation costs potentially allocable to CSXT with respect to the Property and the Study Area would be material to the Company's financial condition, results of operations or liquidity.

CSX 2016 Form 10-K p. 87

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 8. Employee Benefit Plans

The Company sponsors defined benefit pension plans principally for salaried, management personnel. For employees hired prior to 2003, the plans provide eligible employees with retirement benefits based predominantly on years of service and compensation rates near retirement. For employees hired in 2003 or thereafter, benefits are determined based on a cash balance formula, which provides benefits by utilizing interest and pay credits based upon age, service and compensation.

In addition to these plans, the Company sponsors a post-retirement medical plan and a life insurance plan that provide certain benefits to full-time, salaried, management employees hired prior to 2003, upon their retirement if certain eligibility requirements are met. Eligible retirees who are age 65 years or older (Medicare-eligible) are covered by a health reimbursement arrangement, which is an employer-funded account that can be used for reimbursement of eligible medical expenses. Eligible retirees younger than 65 years (non-Medicare eligible) are covered by a self-insured program partially funded by participating retirees. The life insurance plan is non-contributory.

The Company engages independent actuaries to compute the amounts of liabilities and expenses relating to these plans subject to the assumptions that the Company determines are appropriate based on historical trends, current market rates and future projections. These amounts are reviewed by management. In order to perform this valuation, the actuaries are provided with the details of the population covered at the beginning of the year, summarized in the table below, and projects that population forward to the end of the year.

Summary of Participants as of
January 1, 2016
Pension PlansPost-retirement Medical Plan
Active Employees4,8231,139
Retirees and Beneficiaries12,01811,893
Other(a)3,85354
Total20,69413,086

(a) For pension plans, the other category consists mostly of terminated but vested former employees. For post-retirement plans, the other category consists of employees on long-term disability that have not yet retired.

The benefit obligation for these plans represents the liability of the Company for current and retired employees and is affected primarily by the following:

•service cost (benefits attributed to employee service during the period);
•interest cost (interest on the liability due to the passage of time);
•actuarial gains/losses (experience during the year different from that assumed and changes in plan assumptions); and
•benefits paid to participants.

CSX 2016 Form 10-K p. 88

CSX CORPORATION

PART II

Item 8. Financial Statements and Supplementary Data

NOTE 8. Employee Benefit Plans, continued

Cash Flows

Plan assets are amounts that have been segregated and restricted to provide qualified pension plan benefits and include amounts contributed by the Company and amounts earned from invested contributions, net of benefits paid. Qualified pension plan obligations are funded in accordance with regulatory requirements and with an objective of meeting or exceeding minimum funding requirements necessary to avoid restrictions on flexibility of plan operation and benefit payments. The Company funds the cost of the post-retirement medical and life insurance benefits as well as nonqualified pension benefits on a pay-as-you go basis. No qualified pension plan contributions were made during 2014 and 2015. Although no contributions to the Company's qualified pension plans were required, CSX made voluntary contributions totaling $250 million during 2016. No contributions to the Company's qualified pension plans are expected in 2017.

Future expected benefit payments are as follows:

Expected Cash Flows
(Dollars in Millions)Pension BenefitsPost-retirement Benefits
2017$183$39
201818528
201918426
202018224
202118222
2022-202690486
Total$1,820$225

Plan Assets

The CSX Investment Committee (the “Investment Committee”), whose members were selected by the Chief Financial Officer and approved by the Chief Executive Officer, is responsible for oversight and investment of plan assets. The Investment Committee utilizes an investment asset allocation strategy that is monitored on an ongoing basis and updated periodically in consideration of plan or employee changes, or changing market conditions. Periodic studies provide an extensive modeling of asset investment return in conjunction with projected plan liabilities and seek to evaluate how to maximize return within the constraints of acceptable risk. The current asset allocation targets 70% equity investments and 30% fixed income investments and cash. Within equity, a further target is currently established for 42% of total plan assets in domestic equity and 28% in international equity. Allocations are evaluated for levels within 3% of targeted allocations and are adjusted quarterly as necessary. The distribution of pension plan assets as of the measurement date is shown in the table below, and these assets are netted against the pension liabilities on the balance sheet.

December 2016December 2015
Percent ofPercent of
(Dollars in Millions)AmountTotal AssetsAmountTotal Assets
Equity$1,80671%$1,62670%
Fixed Income6652664128
Cash and Cash Equivalents683422
Total$2,539100%$2,309100%

CSX 2016 Form 10-K p. 89

CSX CORPORATION

PART II

Previous: Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations · Next: Item 8. Financial Statements and Supplementary Data