Xerox 2010 Annual Report Download - page 32

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Management’s Discussion
Xerox 2010 Annual Report
RevenueRecognitionforBundledLeaseArrangements
We sell our products and services under bundled lease arrangements,
which typically include equipment, service, supplies and financing
components for which the customer pays a single negotiated
monthly fixed price for all elements over the contractual lease term.
Approximately 40% of our equipment sales revenue is related to sales
made under bundled lease arrangements. Typically these arrangements
include an incremental, variable component for page volumes in excess
of contractual page volume minimums, which are often expressed
in terms of price per page. Revenues under these arrangements
are allocated, considering the relative fair values of the lease and
non-lease deliverables included in the bundled arrangement, based
upon the estimated fair values of each element. Lease deliverables
include maintenance and executory costs, equipment and financing,
while non-lease deliverables generally consist of supplies and non-
maintenance services. The allocation for lease deliverables begins by
allocating revenues to the maintenance and executory costs plus profit
thereon. These elements are generally recognized over the term of
the lease as services revenue. The remaining amounts are allocated
to the equipment and financing elements, which are subjected to the
accounting estimates noted above under “Revenue Recognition for
Leases.” We perform 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, 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. We reassess our pricing interest rates quarterly
based on changes in the local prevailing rates in the marketplace. These
interest rates have generally been adjusted if the 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Services–Percentage-of-Completion
A significant portion of our services revenue is recognized based
on objective criteria that do not require significant estimates or
uncertainties. For example, transaction volume, time and materials
and cost-reimbursable arrangements are based on specific, objective
criteria under the contracts. Accordingly, revenues recognized under
these contracts do not require the use of significant estimates that
are susceptible to change. However, revenue recognized using the
percentage-of-completion accounting method does require the use
of estimates and judgment as discussed below. During 2010, we
recognized approximately $270 million of revenue using the percentage-
of-completion accounting method.
Application of Critical Accounting Policies
In preparing our Consolidated Financial Statements and accounting
for the underlying transactions and balances, we apply various
accounting policies. Senior management has discussed the development
and selection of the critical accounting policies, estimates and related
disclosures included herein with the Audit Committee of the Board
of Directors. We consider the policies discussed below as critical
to understanding our Consolidated Financial Statements, as their
application places the most significant demands on management’s
judgment, since financial reporting results rely on estimates of the
effects of matters that are inherently uncertain. In instances where
different estimates could have reasonably been used, we disclosed
the impact of these different estimates on our operations. In certain
instances, like revenue recognition for leases, the accounting rules are
prescriptive; therefore, it would not have been possible to reasonably
use different estimates. Changes in assumptions and estimates are
reflected in the period in which they occur. The impact of such changes
could be material to our results of operations and financial condition
in any quarterly or annual period.
Specific risks associated with these critical accounting policies are
discussed throughout the MD&A, where such policies affect our
reported and expected financial results. For a detailed discussion of
the application of these and other accounting policies, refer to Note
1 – Summary of Significant Accounting Policies in the Consolidated
Financial Statements.
RevenueRecognitionforLeases
Our accounting for leases involves specific determinations under
applicable lease accounting standards. These determinations affect the
timing of revenue recognition for our equipment. If a lease qualifies as a
sales-type capital lease, equipment revenue is recognized as sale revenue
upon delivery or installation of the equipment as opposed to ratably
over the lease term. The critical elements that we consider with respect
to our lease accounting are the 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 measure
to be the original contract term, since most equipment is returned by
lessees at or near the end of the contracted 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 are for 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.