Toyota 2006 Annual Report Download - page 84

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policies, the following may involve a higher degree of judg-
ments, estimates and complexity:
Product Warranty
Toyota generally warrants its products against certain manufac-
turing and other defects. Product warranties are provided for
specific periods of time and/or usage of the product and vary
depending upon the nature of the product, the geographic
location of the sale and other factors. All product warranties are
consistent with commercial practices. Toyota provides a provi-
sion for estimated product warranty costs as a component of
cost of sales at the time the related sale is recognized. The
accrued warranty costs represent management’s best estimate
at the time of sale of the total costs that Toyota will incur to
repair or replace product parts that fail while still under warran-
ty. The amount of accrued estimated warranty costs is primarily
based on historical experience as to product failures as well as
current information on repair costs. The amount of warranty
costs accrued also contains an estimate of warranty claim recov-
eries to be received from suppliers. The foregoing evaluations
are inherently uncertain, as they require material estimates and
some products’ warranties extend for several years.
Consequently, actual warranty costs will differ from the estimat-
ed amounts and could require additional warranty provisions. If
these factors require a significant increase in Toyota’s accrued
estimated warranty costs, it would negatively affect future oper-
ating results of the automotive operations.
Allowance for Doubtful Accounts and Credit Losses
Natures of estimates and assumptions
Sales financing and finance lease receivables consist of retail
installment sales contracts secured by passenger cars and com-
mercial vehicles. Collectibility risks include consumer and dealer
insolvencies and insufficient collateral values (less costs to sell)
to realize the full carrying values of these receivables. As a mat-
ter of policy, Toyota maintains an allowance for doubtful
accounts and credit losses representing management’s estimate
of the amount of asset impairment in the portfolios of finance,
trade and other receivables. Toyota determines the allowance
for doubtful accounts and credit losses based on a systematic,
ongoing review and evaluation performed as part of the credit-
risk evaluation process, historical loss experience, the size and
composition of the portfolios, current economic events and
conditions, the estimated fair value and adequacy of collateral
and other pertinent factors. This evaluation is inherently judg-
mental and requires material estimates, including the amounts
and timing of future cash flows expected to be received, which
may be susceptible to significant change. Although manage-
ment considers the allowance for doubtful accounts and credit
losses to be adequate based on information currently available,
additional provisions may be necessary due to (i) changes in
management estimates and assumptions about asset impair-
ments, (ii) information that indicates changes in expected future
cash flows, or (iii) changes in economic and other events and
conditions. To the extent that sales incentives remain an integral
part of sales promotion with the effect of reducing new vehicle
prices, resale prices of used vehicles and, correspondingly, the
collateral value of Toyota’s sales financing and finance lease
receivables could experience further downward pressure. If
these factors require a significant increase in Toyota’s allowance
for doubtful accounts and credit losses, it could negatively
affect future operating results of the financial services opera-
tions. The level of credit losses, which impacts larger on
Toyota’s results of operations, is influenced primarily by two
factors: frequently of occurrence and loss severity. For evalua-
tion purposes, exposures to credit loss are segmented into the
two primary categories of “consumer” and “dealer”. Toyota’s
consumer portfolio consists of smaller balance homogenous
retail finance receivables and lease earning assets. The dealer
portfolio consists of wholesale and other dealer financing
receivables. The overall allowance for credit losses is evaluated
at least quarterly, considering a variety of assumptions and fac-
tors to determine whether reserves are considered adequate to
cover probable losses.
Sensitivity analysis
The level of credit losses, which could significantly impact
Toyota’s results of operations, is influenced primarily by two
factors: frequency of occurrence and loss severity. The overall
allowance for credit losses is evaluated at least quarterly, consid-
ering a variety of assumptions and factors to determine whether
reserves are considered adequate to cover probable losses. The
following table illustrates the effect of an assumed change in
expected loss severity, which we believe is one of the key critical
estimates for determining the allowance for credit losses,
assuming all other assumptions are held consistent. The table
below represents the impact on the allowance for credit losses