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Management Discussion
International Business Machines Corporation and Subsidiary Companies
53
ROLL-FORWARD OF FINANCING RECEIVABLES
ALLOWANCE FOR DOUBTFUL ACCOUNTS
($ in millions)
ADDITIONS/
ALLOWANCE (REDUCTIONS) DEC. 31,
JAN. 1, 2007 USED* A/R PROVISION OTHER** 2007
$370 $(101) $70 $29 $368
* Represents reserved receivables, net of recoveries, that were disposed of during the period.
** Primarily represents translation adjustments.
The percentage of financing receivables reserved decreased from 1.5
percent at December 31, 2006, to 1.3 percent at December 31, 2007
primarily due to the decrease in the specific allowance for doubtful
accounts. Specific reserves decreased 21.8 percent from $294 million
at December 31, 2006 to $230 million at December 31, 2007 due to
the disposition of reserved receivables during the period combined
with lower requirements for additional specific reserves. This lower
requirement is generally due to the credit quality of the portfolio, as
well as portfolio management to reduce credit risk. Unallocated
reserves increased 81.6 percent from $76 million at December 31,
2006, to $138 million at December 31, 2007 primarily due to the
significant growth of the financing receivables portfolio. Global
Financing’s provision expense was an addition of $70 million for the
year ended December 31, 2007 and a reduction of $20 million for the
year ended December 31, 2006. The increase was primarily attrib-
uted to the growth of the unallocated reserves.
RESIDUAL VALUE
Residual value is a risk unique to the financing business and manage-
ment of this risk is dependent upon the ability to accurately project
future equipment values at lease inception. Global Financing has
insight into the product plans and cycles for the IBM products under
lease. Based upon this information, Global Financing continually
monitors projections of future equipment values and compares them
with the residual values reflected in the portfolio. See note A,
“Significant Accounting Policies,” on page 73 for the company’s
accounting policy for residual values.
Global Financing optimizes the recovery of residual values by
selling assets sourced from end of lease, leasing used equipment to
new clients or extending lease arrangements with current clients.
Sales of equipment, which are primarily sourced from equipment
returned at end of lease, represented 37.3 percent of Global
Financing’s revenue in 2007 and 39.8 percent in 2006. The decrease
was due to the decline in internal used equipment sales, partially
offset by the increase in external used equipment sales. The gross
margin on these sales was 43.7 percent and 38.1 percent in 2007 and
2006, respectively. The increase was driven primarily by higher mar-
gin internal used equipment sales.
The table on page 54 presents the recorded amount of unguaran-
teed residual value for sales-type and operating leases at December
31, 2006 and 2007. In addition, the table presents the residual value
as a percentage of the original amount financed, and a schedule of
when the unguaranteed residual value assigned to equipment on
leases at December 31, 2007 is expected to be returned to the com-
pany. In addition to the unguaranteed residual value, on a limited
basis, Global Financing will obtain guarantees of the future value of
the equipment to be returned at end of lease. These third-party
guarantees are included in minimum lease payments as provided for
by accounting standards in the determination of lease classifications
for the covered equipment and provide protection against risk of loss
arising from declines in equipment values for these assets. The resid-
ual value guarantee increases the minimum lease payments that are
utilized in determining the classification of a lease as a sales-type lease
or an operating lease. The aggregate asset values associated with the
guarantees were $682 million and $794 million for financing transac-
tions originated during the years ended December 31, 2007 and 2006,
respectively. In 2007, the residual value guarantee program resulted
in the company recognizing approximately $483 million of revenue
that would otherwise have been recognized in future periods as oper-
ating lease revenue. If the company had chosen to not participate in
a residual value program in 2007 and prior years, overall revenues
would not have been materially affected due to the relatively constant
year-to-year aggregate asset value associated with the residual value
guarantees. The associated aggregate guaranteed future values at the
scheduled end of lease were $38 million each for financing transac-
tions originated during the same time periods, respectively. The cost
of guarantees was $5 million per year in 2007 and 2006.