Oracle 2005 Annual Report Download - page 28

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Table of Contents
• Accounting for Income Taxes
• Legal Contingencies
• Stock-Based Compensation
• Allowances for Doubtful Accounts and Returns
In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its
application. There are also areas in which management’s judgment in selecting among available alternatives would not produce a materially different result. Our
senior management has reviewed these critical accounting policies and related disclosures with the Finance and Audit Committee of the Board of Directors.
Business Combinations
In accordance with business combination accounting, we allocate the purchase price of acquired companies to the tangible and intangible assets acquired and
liabilities assumed as well as to in-process research and development based on their estimated fair values. We engage third-party appraisal firms to assist
management in determining the fair values of certain assets acquired and liabilities assumed. Such valuations require management to make significant estimates
and assumptions, especially with respect to intangible assets.
Management makes estimates of fair value based upon assumptions believed to be reasonable. These estimates are based on historical experience and
information obtained from the management of the acquired companies and are inherently uncertain. Critical estimates in valuing certain of the intangible assets
include but are not limited to: future expected cash flows from license sales, maintenance agreements, consulting contracts, customer contracts and acquired
developed technologies and patents; expected costs to develop the in-process research and development into commercially viable products and estimated cash
flows from the projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the
acquired brand will continue to be used in the combined company’s product portfolio; and discount rates. Unanticipated events and circumstances may occur
which may affect the accuracy or validity of such assumptions, estimates or actual results.
In connection with purchase price allocations, we estimate the fair value of the support obligations assumed in connection with acquisitions. The estimated fair
value of the support obligations is determined utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs related
to fulfilling the obligations plus a normal profit margin. The estimated costs to fulfill the support obligations are based on the historical direct costs related to
providing the support services and to correct any errors in the software products acquired. We do not include any costs associated with selling efforts or research
and development or the related fulfillment margins on these costs. Profit associated with selling effort is excluded because the acquired entities would have
concluded the selling effort on the support contracts prior to the acquisition date. The estimated research and development costs are not included in the fair value
determination, as these costs are not deemed to represent a legal obligation at the time of acquisition. The sum of the costs and operating profit approximates, in
theory, the amount that we would be required to pay a third party to assume the support obligation.
As a result, we did not recognize software license updates and product support revenues related to support contracts in the amount of $391 million and $320
million that would have been otherwise recorded by acquired businesses as independent entities in fiscal 2006 and 2005, respectively. Historically, substantially
all of our customers, including customers from acquired companies, renew their contracts when the contract is eligible for renewal. To the extent these
underlying support contracts are renewed, we will recognize the revenue for the full value of the support contracts over the support periods, the majority of which
are one year. Had we included our estimated selling and research and development activities, and the associated margin for unspecified product upgrades and
enhancements to be provided under our assumed support arrangements, the fair value of the support obligations would have been significantly higher than what
we have recorded and we would have recorded a higher amount of software license updates and product support revenue historically and in future periods related
to these assumed contracts.
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Source: ORACLE CORP, 10-K, July 21, 2006 Powered by Morningstar® Document Research℠