Xerox 2005 Annual Report Download - page 37

Xerox Corporation
29
The remaining amounts are allocated to the equipment and
financing elements. We perform extensive analyses of available
verifiable objective evidence of equipment fair value based on
cash selling prices during the applicable period. The cash selling
prices are compared to the range of values included in our lease
accounting systems. The range of cash selling prices must be
reasonably consistent with the lease selling prices, taking into
account residual values that accrue to our benefit, in order for us
to determine that such lease prices are indicative of fair value.
Our pricing interest rates, which are used in determining customer
payments, are developed based upon a variety of factors including
local prevailing rates in the marketplace and the customer’s
credit history, industry and credit class. Effective in 2004, our
pricing rates are reassessed quarterly based on changes in local
prevailing rates in the marketplace and are adjusted to the extent
such rates vary by twenty-five basis points or more, cumulatively,
from the last rate in effect. The pricing interest rates generally
equal the implicit rates within the leases, as corroborated by our
comparisons of cash to lease selling prices.
Revenue Recognition for Leases: Our accounting for leases
involves specific determinations under applicable lease accounting
standards, which often involve complex and prescriptive provi-
sions. These provisions affect the timing of revenue recognition
for our equipment. If the leases qualify as sales-type capital leases,
equipment revenue is recognized upon delivery or installation of
the equipment as sale revenue as opposed to ratably over the
lease term. The critical elements that we consider with respect
to our lease accounting arethe determination of the economic life
and the fair value of equipment, including the residual value. For
purposes of determining the economic life, we consider the most
objective measureto be the original contract term, since most
equipment is returned by lessees at or near the end of the con-
tracted term. The economic life of most of our products is five
years, since this represents the most frequent contractual lease
term for our principal products and only a small percentage of our
leases arefor original terms longer than five years. There is no
significant after-market for our used equipment. We believe five
years is representative of the period during which the equipment
is expected to be economically usable, with normal service, for
the purpose for which it is intended. Residual values areestab-
lished at lease inception using estimates of fair value at the
end of the lease term and are established with due consideration
to forecasted supply and demand for our various products,
product retirement and future product launch plans, end-of-lease
customer behavior, remanufacturing strategies, competition
and technological changes.
Accounts and Finance Receivables Allowance for Doubtful Accounts
and Credit Losses: We perform ongoing credit evaluations of our
customers and adjust credit limits based upon customer payment
history and current creditworthiness. We continuously monitor
collections and payments from our customers and maintain a
provision for estimated credit losses based upon our historical
experience and any specific customer collection issues that have
been identified. While such credit losses have historically been
within our expectations and the provisions established, we cannot
guarantee that we will continue to experience credit loss rates
similar to those we have experienced in the past. Measurement of
such losses requires consideration of historical loss experience,
including the need to adjust for current conditions, and judgments
about the probable effects of relevant observable data, including
present economic conditions such as delinquency rates and
financial health of specific customers. We recorded bad debt
provisions of $72 million, $110 million and $224 million in
selling, administrative and general expenses in our Consolidated
Statements of Income for the years ended December 31, 2005,
2004 and 2003, respectively. The declining trend in our provision
for doubtful accounts is primarily due to improvements in customer
administration, receivables aging, write-off trends, collection
practices and credit approval policies.
As discussed above, in preparing our Consolidated Financial
Statements for the three years ended December 31, 2005,
we estimated our provision for doubtful accounts based on
historical experience and customer-specific collection issues.
This methodology has been consistently applied for all periods
presented. During the five-year period ended December 31,
2005, our allowance for doubtful accounts ranged from 3.6%
to 5.5% of gross receivables. Holding all other assumptions
constant, a 1-percentage point increase or decrease in the
allowance from the December 31, 2005 rate of 3.6% would
change the 2005 provision by approximately $100 million.
Historically, about half of the provision for doubtful accounts
relates to our finance receivables portfolio. This provision is
inherently more difficult to estimate than the provision for trade
accounts receivable because the underlying lease portfolio
has an average maturity, at any time, of approximately two to
three years and contains past due billed amounts, as well as
unbilled amounts. The estimated credit quality of any given
customer and class of customer or geographic location can
significantly change during the life of the portfolio. We consider
all available information in our quarterly assessments of the
adequacy of the provision for doubtful accounts.
Pension and Post-retirement Benefit Plan Assumptions: We sponsor
pension plans in various forms in several countries covering
substantially all employees who meet eligibility requirements.
Post-retirement benefit plans cover primarily U.S. employees for
retirement medical costs. Several statistical and other factors
that attempt to anticipate future events are used in calculating
Xerox Annual Report 2005