Cisco 2009 Annual Report Download - page 14

Management’s Discussion and Analysis of Financial Condition and Results of Operations
Allowances for Receivables and Sales Returns
The allowances for receivables were as follows (in millions, except percentages):
July 25, 2009 July 26, 2008
Allowance for doubtful accounts $ 216 $ 177
Percentage of gross accounts receivable 6.4% 4.4%
Allowance for lease receivables $ 213 $ 136
Percentage of gross lease receivables 10.7% 7.9%
Allowance for loan receivables $88 $ 128
Percentage of gross loan receivables 10.2% 21.1%
The allowances are based on our assessment of the collectibility of customer accounts. We regularly review the allowances to ensure their
adequacy by considering factors such as historical experience, credit quality, age of the receivable balances, and economic conditions that
may affect a customer’s ability to pay. In addition, we perform credit reviews and statistical portfolio analysis to assess the credit quality of
our receivables. We also consider the concentration of receivables outstanding with a particular customer in assessing the adequacy of
our allowances. 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 25, 2009 and July 26, 2008 was $75 million and $103 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.
Inventory Valuation and Liability for Purchase Commitments with Contract Manufacturers and Suppliers
Our inventory balance was $1.1 billion and $1.2 billion as of July 25, 2009 and July 26, 2008, respectively. Inventory is written down based
on excess and obsolete inventories determined primarily by future demand forecasts. Inventory write-downs are measured as the
difference between the cost of the inventory and market, based upon assumptions about future demand, and are 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.
We record a liability for firm, noncancelable, and unconditional purchase commitments with contract manufacturers and suppliers for
quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. As of July 25, 2009,
the liability for these purchase commitments was $175 million, compared with $184 million as of July 26, 2008, and was included in other
current liabilities.
Our provision for inventory was $93 million, $102 million, and $214 million for fiscal 2009, 2008, and 2007, respectively. The provision
for the liability related to purchase commitments with contract manufacturers and suppliers was $87 million, $97 million, and $34 million in
fiscal 2009, 2008, and 2007, respectively. If there were to be a sudden and significant 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 write-downs and our liability for purchase commitments with contract manufacturers and suppliers and gross
margin could be adversely affected. In light of the macroeconomic conditions in fiscal 2009 and the resulting potential for changes in future
demand forecasts, we continued to regularly evaluate the exposure for inventory write-downs and the adequacy of our liability for
purchase commitments. Inventory and supply chain management remain areas of focus as we balance the need to maintain supply chain
flexibility to help ensure competitive lead times with the risk of inventory obsolescence.
Warranty Costs
The liability for product warranties, included in other current liabilities, was $321 million as of July 25, 2009, compared with $399 million as
of July 26, 2008. See Note 11 to the Consolidated Financial Statements. Our products are generally covered by a warranty for periods
ranging from 90 days to five years, and for some products we provide a limited lifetime warranty. We accrue for warranty costs as part of
our cost of sales based on associated material costs, technical support labor costs, and associated overhead. Material cost is estimated
based primarily upon historical trends in the volume of product returns within the warranty period and the cost to repair or replace the
equipment. Technical support labor cost is estimated based primarily upon historical trends in the rate of customer cases and the cost to
support the customer cases within the warranty period. Overhead cost is applied based on estimated time to support warranty activities.
12 Cisco Systems, Inc.