IBM 2012 Annual Report Download - page 80

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
79
The company determines BESP by considering multiple factors
including, but not limited to, overall market conditions, including
geographic or regional specific factors, competitive positioning,
competitor actions, internal costs, profit objectives and pricing
practices. The determination of BESP is a formal process that
includes review and approval by the company’s management. In
addition, the company regularly reviews VSOE and TPE for its
products and services, in addition to BESP.
Services Costs
Recurring operating costs for services contracts, including costs
related to bid and proposal activities, are recognized as incurred.
For fixed-price design and build contracts, the costs of external
hardware and software accounted for under the POC method are
deferred and recognized based on the labor costs incurred to date,
as a percentage of the total estimated labor costs to fulfill the con-
tract. Certain eligible, nonrecurring costs incurred in the initial
phases of outsourcing contracts are deferred and subsequently
amortized. These costs consist of transition and setup costs related
to the installation of systems and processes and are amortized on
a straight-line basis over the expected period of benefit, not to
exceed the term of the contract. Additionally, fixed assets associated
with outsourcing contracts are capitalized and depreciated on a
straight-line basis over the expected useful life of the asset. If an
asset is contract specific, then the depreciation period is the shorter
of the useful life of the asset or the contract term. Amounts paid to
clients in excess of the fair value of acquired assets used in out-
sourcing arrangements are deferred and amortized on a straight-line
basis as a reduction of revenue over the expected period of benefit
not to exceed the term of the contract. The company performs peri-
odic reviews to assess the recoverability of deferred contract
transition and setup costs. This review is done by comparing the
estimated minimum remaining undiscounted cash flows of a contract
to the unamortized contract costs. If such minimum undiscounted
cash flows are not sufficient to recover the unamortized costs, an
impairment loss is recognized.
Deferred services transition and setup costs were $2,424 million
and $2,589 million at December 31, 2012 and 2011, respectively.
Amortization of deferred services transition and setup costs was
estimated at December 31, 2012 to be $819 million in 2013, $509
million in 2014, $430 million in 2015, $277 million in 2016 and $390
million thereafter.
Deferred amounts paid to clients in excess of the fair value of
acquired assets used in outsourcing arrangements were $51 million
and $65 million at December 31, 2012 and 2011, respectively. Amor-
tization of deferred amounts paid to clients in excess of the fair value
of acquired assets is recorded as an offset of revenue and was
estimated at December 31, 2012 to be $22 million in 2013, $19 million
in 2014, $9 million in 2015, $2 million in 2016 and less than $1 million
thereafter. In situations in which an outsourcing contract is termi-
nated, the terms of the contract may require the client to reimburse
the company for the recovery of unbilled accounts receivable, unam-
ortized deferred costs incurred to purchase specific assets utilized
in the delivery of services and to pay any additional costs incurred
by the company to transition the services.
Software Costs
Costs that are related to the conceptual formulation and design of
licensed software programs are expensed as incurred to research,
development and engineering expense; costs that are incurred to
produce the finished product after technological feasibility has been
established are capitalized as an intangible asset. Capitalized
amounts are amortized on a straight-line basis over periods ranging
up to three years and are recorded in software cost within cost of
sales. The company performs periodic reviews to ensure that unam-
ortized program costs remain recoverable from future revenue.
Costs to support or service licensed programs are charged to soft-
ware cost within cost of sales as incurred.
The company capitalizes certain costs that are incurred to pur-
chase or to create and implement internal-use software programs,
including software coding, installation, testing and certain data
conversions. These capitalized costs are amortized on a straight-
line basis over periods up to two years and are recorded in selling,
general and administrative expense.
Product Warranties
The company offers warranties for its hardware products that gener-
ally range up to three years, with the majority being either one or
three years. Estimated costs for warranty terms standard to the
deliverable are recognized when revenue is recorded for the related
deliverable. The company estimates its warranty costs standard to
the deliverable based on historical warranty claim experience and
estimates of future spending, and applies this estimate to the rev-
enue stream for products under warranty. Estimated future costs
for warranties applicable to revenue recognized in the current period
are charged to cost of sales. The warranty liability is reviewed quar-
terly to verify that it properly reflects the remaining obligation based
on the anticipated expenditures over the balance of the obligation
period. Adjustments are made when actual warranty claim experi-
ence differs from estimates. Costs from fixed-price support or
maintenance contracts, including extended warranty contracts, are
recognized as incurred.