Western Digital 2008 Annual Report Download - page 48

Critical Accounting Policies and Estimates
We have prepared the accompanying consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America. The preparation of the financial statements requires the use of
judgment and estimates that affect the reported amounts of revenues, expenses, assets, liabilities and shareholders’ equity.
We have adopted accounting policies and practices that are generally accepted in the industry in which we operate. We
believe the following are our most critical accounting policies that affect significant areas and involve judgment and
estimates made by us. If these estimates differ significantly from actual results, the impact to the consolidated financial
statements may be material.
Revenue and Accounts Receivable
In accordance with standard industry practice, we have agreements with resellers that provide limited price
protection for inventories held by resellers at the time of published list price reductions and other incentive programs. In
accordance with current accounting standards, we recognize revenue upon delivery to OEMs, ODMs and resellers and
record a reduction to revenue for estimated price protection and other programs in effect until the resellers sell such
inventory to their customers. We base these adjustments on anticipated price decreases during the reseller holding period,
estimated amounts to be reimbursed to qualifying customers, as well as historical pricing information. If end-market
demand for hard drives declines significantly, we may have to increase sell-through incentive payments to resellers,
resulting in an increase in our allowances, which could adversely impact operating results.
We record an allowance for doubtful accounts by analyzing specific customer accounts and assessing the risk of loss
based on insolvency, disputes or other collection issues. In addition, we routinely analyze the different receivable aging
categories and establish reserves based on a combination of past due receivables and expected future losses based primarily
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. We generally warrant our products
for periods of one to five years. Our warranty provision considers estimated product failure rates and trends, estimated
repair or replacement costs and estimated costs for customer compensatory claims related to product quality issues, if any.
We use a statistical warranty tracking model to help with our estimates and we exercise judgment in determining the
underlying estimates. Our statistical tracking model captures 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, costs to repair
returned products or costs of customer compensatory claims differ significantly from our estimates, our future results of
operations could be materially affected. Our judgment is subject to a greater degree of subjectivity with respect to newly
introduced products because of limited field experience with those products upon which to base our warranty estimates.
We review our warranty accrual quarterly for products shipped in prior periods and which are still under warranty. Any
changes in the estimates underlying the accrual may result in adjustments that impact current period gross margin and
income. Such changes are generally a result of differences between forecasted and actual return rate experience and costs to
repair. For a summary of historical changes in estimates related to pre-existing warranty provisions, refer to Part II,
Item 8, Note 4 in 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 and weighted average methods) or net realizable value.
Weighted-average cost is calculated based upon the cost of precious metals at the time they are received by us. We have
determined that it is less practicable to assign specific costs to individual units of precious metal and as such, we relieve
our precious metals inventory based on the weighted-average cost of the inventory at the time the inventory is used in
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