Baker Hughes 2007 Annual Report Download - page 115

32 Baker Hughes Incorporated
selection of our critical accounting estimates with the Audit/
Ethics Committee of our Board of Directors and the Audit/
Ethics Committee has reviewed the disclosure presented below.
During the past three fiscal years, we have not made any
material changes in the methodology used to establish the
critical accounting estimates discussed below, except as required
by the adoption of FIN 48. We believe that the following are
the critical accounting estimates used in the preparation of our
consolidated financial statements. In addition, there are other
items within our consolidated financial statements that require
estimation but are not deemed critical as defined above.
Allowance for Doubtful Accounts
The determination of the collectibility of amounts due
from our customers requires us to use estimates and make
judgments regarding future events and trends, including moni-
toring our customers’ payment history and current credit wor-
thiness to determine that collectibility is reasonably assured, as
well as consideration of the overall business climate in which
our customers operate. Inherently, these uncertainties require
us to make frequent judgments and estimates regarding our
customers’ ability to pay amounts due us in order to deter-
mine the appropriate amount of valuation allowances required
for doubtful accounts. Provisions for doubtful accounts are
recorded when it becomes evident that the customer will not
make the required payments at either contractual due dates
or in the future. At December 31, 2007 and 2006, allowance
for doubtful accounts totaled $59.0 million, or 2.4%, and
$50.5 million, or 2.4%, of total gross accounts receivable,
respectively. We believe that our allowance for doubtful
accounts is adequate to cover potential bad debt losses under
current conditions; however, uncertainties regarding changes
in the financial condition of our customers, either adverse or
positive, could impact the amount and timing of any addi-
tional provisions for doubtful accounts that may be required.
A five percent change in the allowance for doubtful accounts
would have had an impact on income from continuing opera-
tions before income taxes of approximately $3.0 million in 2007.
Inventory Reserves
Inventory is a significant component of current assets
and is stated at the lower of cost or market. This requires us
to record provisions and maintain reserves for excess, slow
moving and obsolete inventory. To determine these reserve
amounts, we regularly review inventory quantities on hand
and compare them to estimates of future product demand,
market conditions, production requirements and technologi-
cal developments. These estimates and forecasts inherently
include uncertainties and require us to make judgments
regarding potential outcomes. At December 31, 2007 and
2006, inventory reserves totaled $221.2 million, or 11.3%,
and $211.7 million, or 12.2%, of gross inventory, respectively.
We believe that our reserves are adequate to properly value
potential excess, slow moving and obsolete inventory under
current conditions. Significant or unanticipated changes to our
estimates and forecasts could impact the amount and timing
of any additional provisions for excess or obsolete inventory
that may be required. A five percent change in this inventory
reserve balance would have had an impact on income from
continuing operations before income taxes of approximately
$11.1 million in 2007.
Impairment of Long-Lived Assets
Long-lived assets, which include property, goodwill, intan-
gible assets, investments in affiliates and certain other assets,
comprise a significant amount of our total assets. We review
the carrying values of these assets for impairment periodi-
cally, and at least annually for goodwill, or whenever events
or changes in circumstances indicate that the carrying amounts
may not be recoverable. An impairment loss is recorded in the
period in which it is determined that the carrying amount is
not recoverable. This requires us to make judgments regarding
long-term forecasts of future revenues and costs related to the
assets subject to review. In turn, these forecasts are uncertain
in that they require assumptions about demand for our prod-
ucts and services, future market conditions and technological
developments. Significant and unanticipated changes to these
assumptions could require a provision for impairment in a
future period. Given the nature of these evaluations and their
application to specific assets and specific times, it is not pos-
sible to reasonably quantify the impact of changes in these
assumptions; however, based upon our evaluation of the cur-
rent business climate in which we operate, we do not currently
anticipate that any significant asset impairment losses will be
necessary in the foreseeable future.
Income Taxes
The liability method is used for determining our income
taxes, under which current and deferred tax liabilities and
assets are recorded in accordance with enacted tax laws and
rates. Under this method, the amounts of deferred tax liabilities
and assets at the end of each period are determined using the
tax rate expected to be in effect when taxes are actually paid
or recovered. Valuation allowances are established to reduce
deferred tax assets when it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
In determining the need for valuation allowances, we have
considered and made judgments and estimates regarding
estimated future taxable income and ongoing prudent and
feasible tax planning strategies. These estimates and judg-
ments include some degree of uncertainty and changes in
these estimates and assumptions could require us to adjust the
valuation allowances for our deferred tax assets. Historically,
changes to valuation allowances have been caused by major
changes in the business cycle in certain countries and changes
in local country law. The ultimate realization of the deferred
tax assets depends on the generation of sufficient taxable
income in the applicable taxing jurisdictions.
We operate in more than 90 countries under many legal
forms. As a result, we are subject to the jurisdiction of numer-
ous domestic and foreign tax authorities, as well as to tax
agreements and treaties among these governments. Our oper-
ations in these different jurisdictions are taxed on various bases:
actual income before taxes, deemed profits (which are gener-
ally determined using a percentage of revenues rather than
profits) and withholding taxes based on revenue. Determination