Western Digital 2006 Annual Report Download - page 47

on our historical levels of bad debt losses. If the financial condition of a significant customer deteriorates resulting in its
inability to pay its accounts when due, or if our overall loss history changes significantly, an adjustment in our allowance
for doubtful accounts would be required, which could affect operating results.
We establish provisions against revenue and cost of revenue for estimated sales returns in the same period that the
related revenue is recognized. We base these provisions on existing product return notifications. If actual sales returns
exceed expectations, an increase in the sales return accrual would be required, which could negatively affect operating
results.
Warranty
We record an accrual for estimated warranty costs when revenue is recognized. Warranty covers costs of repair or
replacement of the hard drive over the warranty period, which generally ranges from one to five years. We have
comprehensive processes with which to estimate accruals for warranty, which include specific detail on hard drive
reliability, such as factory test data, historical field return rates, and costs to repair by product type. If actual product
return trends or costs to repair returned products demonstrate significant differences from expectations, a change in the
warranty provision is made. If these estimates differ significantly from actual results, the impact to the consolidated
financial statements may be material. For a summary of historical changes in estimates related to pre-existing warranty
provisions, refer to Part II, Item 8, Note 6 of the Notes to Consolidated Financial Statements, included in this Annual
Report on Form 10-K.
Inventory
We value inventories at the lower of cost (first-in, first-out basis) or net realizable value. We record inventory write-
downs for the valuation of inventory at the lower of cost or net realizable value by analyzing market conditions and
estimates of future sales prices as compared to inventory costs and inventory balances.
We evaluate inventory balances for excess quantities and obsolescence on a regular basis by analyzing backlog,
estimated demand, inventory on hand, sales levels and other information, and reduce inventory balances to net realizable
value for excess and obsolete inventory based on this analysis. Unanticipated changes in technology or customer demand
could result in a decrease in demand for one or more of our products, which may require an increase in inventory balance
adjustments that could negatively affect operating results.
Litigation and Other Contingencies
We apply SFAS No. 5, “Accounting for Contingencies,” to determine when and how much to accrue for and disclose
related to legal and other contingencies. Accordingly, we disclose contingencies deemed to be reasonably possible and
accrue loss contingencies when, in consultation with our legal advisors, we conclude that a loss is probable and reasonably
estimable (Refer to Part II, Item 8, Note 7 of the Notes to Consolidated Financial Statements, included in this Annual
Report on Form 10-K). The ability to predict the ultimate outcome of such matters involves judgments, estimates and
inherent uncertainties. The actual outcome of such matters could differ materially from management’s estimates.
Income Taxes
We account for income taxes under the asset and liability method, which provides that deferred tax assets and
liabilities be recognized for temporary differences between the financial reporting basis and the tax basis of our assets and
liabilities and expected benefits of utilizing net operating loss (“NOL”) and tax credit carryforwards. We record a
valuation allowance where it is more likely than not that the deferred tax assets will not be realized. Each period we
evaluate the need for a valuation allowance for our deferred tax assets and we adjust the valuation allowance so that we
record net deferred tax assets only to the extent that we conclude it is more likely than not that these deferred tax assets
will be realized.
We record estimated liabilities for tax uncertainties. To the extent a tax position does not meet a probable level of
certainty, a liability is established based on the best estimate of the amount that will not be sustained. However, the actual
liability in any such contingency may be materially different from our estimates, which could result in the need to record
additional tax liabilities or potentially adjust previously recorded tax liabilities.
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