HP 2005 Annual Report Download - page 41

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
different countries concerning our transfer prices, execution of Advanced Pricing Agreements,
resolution with respect to individual audit issues, the resolution of entire audits, or the expiration of
statutes of limitations. Material adjustments are most likely to occur in the fiscal years in which major
ongoing audits, such as IRS audits, are closed. In addition, our tax contingency reserve includes certain
amounts for potential tax assessments for pre-acquisition tax years of acquired companies which, if
released, will impact the carrying value of goodwill attributable to the acquired company.
Allowance for Doubtful Accounts
We determine our allowance for doubtful accounts using a combination of factors to ensure that
we have not overstated our trade and financing receivables balances due to uncollectibility. We
maintain an allowance for doubtful accounts for all customers based on a variety of factors, including
the length of time receivables are past due, trends in overall weighted average risk rating of the total
portfolio, macroeconomic conditions, significant one-time events, historical experience and the use of
third-party credit risk models that generate quantitative measures of default probabilities based on
market factors, and the financial condition of customers. Also, we record specific provisions for
individual accounts when we become aware of a customer’s inability to meet its financial obligations to
us, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or
financial position. If circumstances related to customers change, we would further adjust our estimates
of the recoverability of receivables either upward or downward. The annual provision for doubtful
accounts is approximately 0.1% of net revenue over the last three fiscal years. Using our third-party
credit risk model at October 31, 2005, a 50 basis point deterioration in either the weighted average
default probabilities of our significant customers or in the overall mix of our portfolio would have
resulted in an approximately $23 million increase to our trade allowance at the end of fiscal year 2005.
Inventory
We state our inventory at the lower of cost or market. We make adjustments to reduce the cost of
inventory to its net realizable value, if required, at the product group level for estimated excess,
obsolescence or impaired balances. Factors influencing these adjustments include changes in demand,
rapid technological changes, product life cycle and development plans, component cost trends, product
pricing, physical deterioration and quality issues. Revisions to these adjustments would be required if
these factors differ from our estimates.
Valuation of Goodwill and Indefinite-Lived Purchased Intangible Assets
We review goodwill and purchased intangible assets with indefinite lives for impairment annually
and whenever events or changes in circumstances indicate the carrying value of an asset may not be
recoverable in accordance with SFAS No. 142, ‘‘Goodwill and Other Intangible Assets.’’ The provisions
of SFAS No. 142 require that we perform a two-step impairment test on goodwill. In the first step, we
compare the fair value of each reporting unit to its carrying value. Our reporting units are consistent
with the reportable segments identified in Note 18 of the Consolidated Financial Statements in Item 8.
We determine the fair value of our reporting units based on a weighting of income and market
approaches. Under the income approach, we calculate the fair value of a reporting unit based on the
present value of estimated future cash flows. Under the market approach, we estimate the fair value
based on market multiples of revenue or earnings for comparable companies. If the fair value of the
reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not
impaired and we are not required to perform further testing. If the carrying value of the net assets
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