Cisco 2006 Annual Report Download - page 18

2006 Annual Report 21
Contracts, Internet commerce agreements, and customer purchase orders are generally used to determine the existence of an
arrangement. Shipping documents and customer acceptance, when applicable, are used to verify delivery. We assess whether the fee is
xed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or
adjustment. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analysis,
as well as the customer’s payment history. When a sale involves multiple elements, such as sales of products that include services, the entire
fee from the arrangement is allocated to each respective element based on its relative fair value and recognized when revenue recognition
criteria for each element are met. The amount of product and service revenue recognized is impacted by our judgment as to whether an
arrangement includes multiple elements and, if so, whether vendor-specic objective evidence of fair value exists. Changes to the elements
in an arrangement and our ability to establish vendor-specic objective evidence for those elements could affect the timing of the revenue
recognition. Our total deferred revenue for products was $1.6 billion and $1.4 billion as of July 29, 2006 and July 30, 2005, respectively.
Technical support services revenue is deferred and recognized ratably over the period during which the services are to be performed,
which is typically from one to three years. Advanced services revenue is recognized upon delivery or completion of performance. Our total
deferred revenue for services was $4.1 billion and $3.6 billion as of July 29, 2006 and July 30, 2005, respectively.
We make sales to distributors and retail partners and recognize revenue based on a sell-through method using information provided
by them. Our distributors and retail partners participate in various cooperative marketing and other programs, and we maintain estimated
accruals and allowances for these programs. If actual credits received by our distributors and retail partners for these programs were to
deviate signicantly from our estimates, which are based on historical experience, our revenue could be adversely affected.
Allowance for Doubtful Accounts and Sales Returns
Our accounts receivable balance, net of allowance for doubtful accounts, was $3.3 billion and $2.2 billion as of July 29, 2006 and July 30, 2005,
respectively. The allowance for doubtful accounts was $175 million, or 5.0% of the gross accounts receivable balance, as of July 29, 2006
and $162 million, or 6.8% of the gross accounts receivable balance, as of July 30, 2005. The allowance is based on our assessment of the
collectibility of customer accounts. We regularly review the allowance by considering factors such as historical experience, credit quality,
age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay.
Our provision for doubtful accounts was $24 million for scal 2006. We had no provision for doubtful accounts in scal 2005 and our
provision for doubtful accounts was $19 million in scal 2004. If a major customer’s creditworthiness deteriorates, or if actual defaults are
higher than our historical experience, or if other circumstances arise, our estimates of the recoverability of amounts due to us could be
overstated, and additional allowances could be required, which could have an adverse impact on our revenue.
A reserve for future sales returns is established based on historical trends in product return rates. The reserve for future sales returns as
of July 29, 2006 and July 30, 2005 was $80 million and $63 million, respectively, and was recorded as a reduction of our accounts receivable.
If the actual future returns were to deviate from the historical data on which the reserve had been established, our revenue could be
adversely affected.
Allowance for Inventory and Liability for Purchase Commitments with Contract Manufacturers and Suppliers
Our inventory balance was $1.4 billion and $1.3 billion as of July 29, 2006 and July 30, 2005, respectively. Our inventory allowance was
$152 million and $159 million as of July 29, 2006 and July 30, 2005, respectively. We provide allowances for inventory based on excess and
obsolete inventories determined primarily by future demand forecasts. The allowance is measured as the difference between the cost of
the inventory and market based upon assumptions about future demand and is charged to the provision for inventory, which is a component
of our cost of sales. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes
in facts and circumstances do not result in the restoration or increase in that newly established cost basis.
Our provision for inventory was $162 million, $221 million, and $205 million for scal 2006, 2005, and 2004, respectively. If there were to
be a sudden and signicant decrease in demand for our products, or if there were a higher incidence of inventory obsolescence because
of rapidly changing technology and customer requirements, we could be required to increase our inventory allowances, and our gross margin
could be adversely affected. In the third quarter of scal 2006, we began the initial implementation of the lean manufacturing model.
Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead
times with the risk of inventory obsolescence.
In addition, we record a liability for rm, noncancelable, and unconditional purchase commitments with contract manufacturers and
suppliers for quantities in excess of our future demand forecasts consistent with our allowance for inventory. As of July 29, 2006, the liability for
these purchase commitments was $148 million, compared with $87 million as of July 30, 2005, and was included in other accrued liabilities.
Management’s Discussion and Analysis of Financial Condition and Results of Operations