IBM 2010 Annual Report Download - page 80

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies78
Financing Receivables
Financing receivables include sales-type leases, direct financing
leases and loans. Leases are accounted for in accordance with
lease accounting standards. Loan receivables are financial assets
recorded at amortized cost which approximates fair value. Financing
income is recognized on the accrual basis using the effective inter-
est method. Estimates of fair value are based on discounted future
cash flows using current interest rates offered for similar loans to
clients with similar credit ratings for the same remaining maturities.
The company determines its allowances for credit losses on financ-
ing receivables based on two portfolio segments: lease receivables
and loan receivables (see note G, “Financing Receivables,” on
pages 90 to 92). The company further segments the portfolio via
two classes: major markets and growth markets.
When calculating the allowances, the company considers its
ability to mitigate a potential loss by repossessing leased equip-
ment and by considering the current fair market value of any other
collateral. The value of the equipment is the net realizable value.
The allowance for credit losses for capital leases, installment sales
and customer loans includes an assessment of the entire balance
of the capital lease or loan, including amounts not yet due. The
methodologies that the company uses to calculate its receivables
reserves, which are applied consistently to its different portfolios,
are as follows:
Individually Evaluated—The company reviews all financing receiv-
ables considered at risk on a quarterly basis. The review primarily
consists of an analysis based upon current information available
about the client, such as financial statements, news reports, pub-
lished credit ratings, current market-implied credit analysis, as well
as the current economic environment, collateral net of reposses-
sion cost and prior collection history. For loans that are collateral
dependent, impairment is measured using the fair value of the
collateral when foreclosure is probable. Using this information, the
company determines the expected cash flow for the receivable and
calculates an estimate of the potential loss and the probability of
loss. For those accounts in which the loss is probable, the company
records a specific reserve.
Collectively Evaluated—The company records an unallocated
reserve that is calculated by applying a reserve rate to its different
portfolios, excluding accounts that have been specifically reserved.
This reserve rate is based upon credit rating, probability of default,
term, characteristics (lease/loan), and loss history. Factors that could
result in actual receivable losses that are materially different from the
estimated reserve include sharp changes in the economy, or a sig-
nificant change in the economic health of a particular client that
represents a concentration in the company’s receivables portfolio.
Other Credit Related Policies
Non-Accrual— Certain receivables for which the company has
recorded a specific reserve may also be placed on non-accrual
status. Non-accrual assets are those receivables (impaired loans
or non-performing leases) with specific reserves and other
accounts for which it is likely that the company will be unable to
collect all amounts due according to original terms of the lease or
loan agreement. Income recognition is discontinued on these
receivables. Cash collections are first applied as a reduction to
principal outstanding. Any cash received in excess of principal
payments outstanding is recognized as interest income. Receivables
may be removed from non-accrual status, if appropriate, based
upon changes in client circumstances.
Write Off—Receivable losses are charged against the allowance
when management believes the uncollectibility of the receivable
is confirmed. Subsequent recoveries, if any, are credited to the
allowance.
Past Due—The company views receivables as past due when
payment has not been received after 90 days, measured from the
original billing date.
Impaired Loans—As stated above, the company evaluates all
financing receivables considered at-risk, including loans, for impair-
ment on a quarterly basis. The company considers any loan with
an individually evaluated reserve as an impaired loan. Depending
on the level of impairment, loans will also be placed on non-accrual
status as appropriate (see Non-Accrual discussion above). Global
Financing’s client loans are primarily for software and services and
are unsecured. These loans are subjected to credit analysis to
evaluate the associated risk and, when deemed necessary, actions
are taken to mitigate risks in the loan agreements which include
covenants to protect against credit deterioration during the life of
the obligation.
Estimated Residual Values of Lease Assets
The recorded residual values of the company’s lease assets are
estimated at the inception of the lease to be the expected fair value
of the assets at the end of the lease term. The company periodically
reassesses the realizable value of its lease residual values. Any
anticipated increases in specific future residual values are not
recognized before realization through remarketing efforts.
Anticipated decreases in specific future residual values that are
considered to be other-than-temporary are recognized immedi-
ately upon identification and are recorded as an adjustment to the
residual-value estimate. For sales-type and direct-financing leases,
this reduction lowers the recorded net investment and is recognized
as a loss charged to financing income in the period in which the
estimate is changed, as well as an adjustment to unearned income
to reduce future-period financing income.