CarMax 2016 Annual Report Download - page 28
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arrangement. We recognize transfers of auto loan receivables into the warehouse facilities and term securitizations as secured
borrowings, which result in recording the auto loan receivables and the related non-recourse notes payable on our consolidated
balance sheets. CAF income included in the consolidated statements of earnings primarily reflects the interest and fee income
generated by the auto loan receivables less the interest expense associated with the debt issued to fund these receivables, a provision
for estimated loan losses and direct CAF expenses.
Auto loan receivables include amounts due from customers related to retail vehicle sales financed through CAF. The receivables
are presented net of an allowance for estimated loan losses. The allowance for loan losses represents an estimate of the amount
of net losses inherent in our portfolio of managed receivables as of the applicable reporting date and anticipated to occur during
the following 12 months. The allowance is primarily based on the credit quality of the underlying receivables, historical loss
trends and forecasted forward loss curves. We also take into account recent trends in delinquencies and losses, recovery rates and
the economic environment. The provision for loan losses is the periodic expense of maintaining an adequate allowance.
See Notes 2(F), 2(I) and 4 for additional information on securitizations and auto loan receivables.
Revenue Recognition
We recognize revenue when the earnings process is complete, generally either at the time of sale to a customer or upon delivery
to a customer. As part of our customer service strategy, we guarantee the retail vehicles we sell with a , money-back
guarantee. We record a reserve for estimated returns based on historical experience and trends, and results could be affected if
future vehicle returns differ from historical averages.
We also sell ESPs and GAP on behalf of unrelated third parties, who are the primary obligors, to customers who purchase a vehicle.
The ESPs we currently offer on all used vehicles provide coverage up to 60 months (subject to mileage limitations), while GAP
covers the customer for the term of their finance contract. We recognize revenue at the time of sale, net of a reserve for estimated
contract cancellations. Periodically, we may receive additional revenue based upon the level of underwriting profits of the third
parties who administer the products. These additional amounts are recognized as revenue when received. The reserve for
cancellations is evaluated for each product and is based on forecasted forward cancellation curves utilizing historical experience,
recent trends and credit mix of the customer base. Our risk related to contract cancellations is limited to the revenue that we
receive. Cancellations fluctuate depending on the volume of ESP and GAP sales, customer financing default or prepayment rates,
and shifts in customer behavior related to changes in the coverage or term of the product. Results could be affected if actual events
differ from our estimates. A 10% change in the estimated cancellation rates would have changed cancellation reserves by
approximately $11.0 million as of February 29, 2016. See Note 8 for additional information on cancellation reserves.
Customers applying for financing who are not approved by CAF may be evaluated by other third-party finance providers. These
providers generally either pay us or are paid a fixed, pre-negotiated fee per contract. We recognize these fees at the time of sale.
We collect sales taxes and other taxes from customers on behalf of governmental authorities at the time of sale. These taxes are
accounted for on a net basis and are not included in net sales and operating revenues or cost of sales.
Income Taxes
Estimates and judgments are used in the calculation of certain tax liabilities and in the determination of the recoverability of certain
deferred tax assets. In the ordinary course of business, transactions occur for which the ultimate tax outcome is uncertain at the
time of the transactions. We adjust our income tax provision in the period in which we determine that it is probable that our actual
results will differ from our estimates. Tax law and rate changes are reflected in the income tax provision in the period in which
such changes are enacted. See Note 9 for additional information on income taxes.
We evaluate the need to record valuation allowances that would reduce deferred tax assets to the amount that will more likely than
not be realized. When assessing the need for valuation allowances, we consider available loss carrybacks, tax planning strategies,
future reversals of existing temporary differences and future taxable income. Except for a valuation allowance recorded for capital
loss carryforwards that may not be utilized before their expiration, we believe that our recorded deferred tax assets as of February 29,
2016, will more likely than not be realized. However, if a change in circumstances results in a change in our ability to realize our
deferred tax assets, our tax provision would be affected in the period when the change in circumstances occurs.
In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We
recognize potential liabilities for anticipated tax audit issues in the U.S. federal and other tax jurisdictions based on our estimate
of whether, and the extent to which, additional taxes will be due. If payments of these amounts ultimately prove to be unnecessary,
the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no
longer necessary. If our estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would
result in the period of determination.