American Home Shield 2006 Annual Report Download - page 46

Notes To The Consolidated Financial Statements
Significant Accounting Policies
Summary: The consolidated financial statements include the accounts of ServiceMaster and its majority-owned subsidiary
partnerships and corporations, collectively referred to as the Company. Intercompany transactions and balances have been
eliminated. In 2005, the Company reported its gross debt borrowings and payments in the Consolidated Statements of Cash Flows.
Historically, the Company netted debt borrowings and payments. The 2004 and 2003 information has been changed to conform to
the 2005 presentation.
The preparation of the consolidated financial statements requires management to make certain estimates and assumptions required
under generally accepted accounting principles ("GAAP") which may differ from actual results. The more significant areas
requiring the use of management estimates relate to the allowance for receivables, accruals for self-insured retention limits related
to medical, workers' compensation, auto and general liability insurance claims, accruals for home warranty and termite damage
claims, the possible outcomes of outstanding litigation, accruals for income tax liabilities as well as deferred tax accounts, the
deferral and amortization of customer acquisition costs, useful lives for depreciation and amortization expense, and the valuation of
tangible and intangible assets.
The allowance for receivables is developed based on several factors including overall customer credit quality, historical write-off
experience and specific account analyses that project the ultimate collectibility of the outstanding balances. As such, these factors
may change over time causing the reserve level to vary.
The Company carries insurance policies on insurable risks at levels which it believes to be appropriate, including workers'
compensation, auto and general liability risks. The Company has self-insured retention limits and insured layers of excess insurance
coverage above those limits. Accruals for self-insurance losses and warranty claims in the American Home Shield business are
made based on the Company's claims experience and actuarial projections. Current activity could differ causing a change in
estimates. The Company has certain liabilities with respect to existing or potential claims, lawsuits, and other proceedings. The
Company accrues for these liabilities when it is probable that future costs will be incurred and such costs can be reasonably
estimated. Any resulting adjustments, which could be material, are recorded in the period the adjustments are identified.
The Company records deferred income tax balances based on the net tax effects of temporary differences between the carrying
value of assets and liabilities for financial reporting purposes and income tax purposes. There are significant amortizable intangible
assets for tax reporting purposes (not for financial reporting purposes) which arose as a result of the Company's reincorporation
from partnership to corporate form in 1997. The Company records its deferred tax items based on the estimated value of the tax
basis. The Company adjusts tax estimates when required to reflect changes based on factors such as changes in tax laws, results of
tax authority reviews and statutory limitations.
Fixed assets and intangible assets with finite lives are depreciated and amortized on a straight-line basis over their estimated useful
lives. These lives are based on the Company's previous experience for similar assets, the potential for market obsolescence and
other industry and business data. An impairment loss would be recognized if and when the undiscounted future cash flows derived
from the asset are less than its carrying amount. Changes in the estimated useful lives or in the asset values could cause the
Company to adjust its book value or future expense accordingly.
The Company does not amortize its goodwill or indefinite-lived intangible assets. The Company tests these assets for impairment,
at a minimum, on an annual basis (October 1st) by applying a fair-value based test. An impairment loss would be recorded if and
when the Company determines that the expected present value of the future cash flows is less than the book value. As permitted
under SFAS 142, the Company carries forward a reporting unit's valuation from the most recent valuation under the following
conditions: the assets and liabilities of the reporting unit have not changed significantly since the most recent fair value calculation,
the most recent fair value calculation resulted in an amount that exceeded the carrying amount of the reporting unit by a substantial
margin, and based on the facts and circumstances of events that have occurred since the last fair value determination, the likelihood
that a current fair value calculation would result in an impairment would be remote.
Revenue: Revenue from lawn care, pest control, liquid and fumigation termite applications are recognized as the services are
provided. Revenue from landscaping services are recognized as they are earned based upon monthly contract arrangements or when
services are performed for non-contractual arrangements. The Company eradicates termites through the use of baiting stations, as
well as through non-baiting methods (e.g., fumigation or liquid treatments). Termite services using baiting stations, as well as home
warranty services, are frequently sold through annual contracts for a one-time, upfront payment. Direct costs of these contracts
(service costs for termite contracts and claim costs for warranty contracts) are expensed as incurred. The Company recognizes
revenue over the life of these contracts in proportion to the expected direct costs. Revenue from trade name licensing arrangements
is recognized when earned. Franchised revenue (which in the aggregate represents approximately three percent of consolidated
revenue) consists principally of continuing monthly fees based upon the franchisee's customer level revenue. Monthly fee revenue
is recognized when the related customer level revenue is reported by the franchisee and collectibility is assured. Franchised revenue
also includes initial fees resulting from the sale of a franchise. These fees are fixed and are recognized as revenue when
collectibility is assured and all material services or conditions relating to the sale have been substantially performed. Total franchise
fee profits (excluding trade name licensing) comprised 10.5, 10.3 and 10.9 percent of consolidated operating income (excluding the
impairment charge in 2003) before headquarter overhead in 2005, 2004 and 2003, respectively.
The Company had $433 million and $430 million of deferred revenue at December 31, 2005 and 2004, respectively, which consist
primarily of payments received for annual contracts relating to home warranty, termite baiting, pest control and lawn care services.