American Home Shield 2008 Annual Report Download - page 58

Table of Contents
Critical Accounting Policies and Estimates
The preparation of the financial statements requires management to make certain estimates and assumptions required under GAAP which may differ
from actual results. The more significant areas requiring the use of management estimates relate to revenue recognition; the allowance for uncollectible
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 outcome 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. In 2008, there have been no changes in the significant areas that require estimates or in the underlying methodologies used in determining the amounts
of these associated estimates.
Revenues from lawn care and pest control services, as well as liquid and fumigation termite applications, are recognized as the services are provided.
Revenues from landscaping services are recognized as they are earned based upon contract arrangements or when services are performed for non-contractual
arrangements. The Company eradicates termites through the use of baiting systems, as well as through non-baiting methods (e.g., fumigation or liquid
treatments). Termite services using baiting systems, termite inspection and protection contracts, 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. Those costs
bear a direct relationship to the fulfillment of the Company's obligations under the contracts and are representative of the relative value provided to the
customer (proportional performance method). Home warranty contract revenue is recognized based on the expected emergence of total claim costs. The
Company regularly reviews its estimates of direct costs for its termite bait and home warranty contracts and adjusts the estimates when appropriate. Revenues
from trade name licensing arrangements are recognized when earned. Franchise revenue consists principally of monthly fee revenue, which is recognized
when the related customer level revenue is reported by the franchisee and collectibility is assured. Franchise revenue also includes initial fees resulting from
the sale of franchises. 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.
In determining the Company's accrual for self-insured claims, the Company uses historical claims experience to establish both the current year accrual
and the underlying provision for future losses. This actuarially determined provision and related accrual include both known claims, as well as incurred but
not reported claims. The Company adjusts its estimate of accrued self-insured claims when required to reflect changes based on factors such as changes in
health care costs, accident frequency and claim severity.
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 balance. 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 purchases insurance from third-party insurance carriers. These policies typically incorporate significant deductibles or
self-insured retentions. The Company is required to pay all claims that fall within the retention 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. Termite damage claim accruals are recorded based on both the historical rates of claims incurred within a contract
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