Cisco 2004 Annual Report Download - page 16

In fiscal 2005, we will continue to focus on our three major growth areas of core routing and switching, service provider, and
Advanced Technologies, as well as our expectation of network architecture evolution, while maintaining our focus on profit contribution.
Among the key external factors that will influence our fiscal 2005 performance are the continued improvement of the global economy
and our customers’ perspective regarding the prospects for improving conditions.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the
United States requires us to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial
Statements and accompanying notes. Note 2 to the Consolidated Financial Statements describes the significant accounting policies
and methods used in the preparation of the Consolidated Financial Statements. We consider the accounting policies described below
to be affected by critical accounting estimates. Such accounting policies are impacted significantly by judgments, assumptions, and
estimates used in the preparation of the Consolidated Financial Statements, and actual results could differ materially from the amounts
reported based on these policies.
Revenue Recognition
Our networking and communications products are integrated with software that is essential to the functionality of the equipment. We
provide unspecified software upgrades and enhancements related to the equipment through our maintenance contracts. Accordingly, we
account for revenue in accordance with Statement of Position No. 97-2, “Software Revenue Recognition,” and all related interpretations.
Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and
collectibility is reasonably assured. In instances where final acceptance of the product, system, or solution is specified by the customer,
revenue is deferred until all acceptance criteria have been met. Our total deferred revenue for products was $1.5 billion and $1.4 billion
as of July 31, 2004 and July 26, 2003, respectively. Service revenue is generally deferred and, in most cases, recognized ratably over
the period during which the services are to be performed, which is typically from one to three years. Our total deferred revenue for
services was $3.0 billion and $2.5 billion as of July 31, 2004 and July 26, 2003, respectively.
Contracts, Internet commerce agreements, and customer purchase orders are generally used to determine the existence of an
arrangement. Shipping documents and customer acceptance, when applicable, are used to verify delivery. We assess whether the fee
is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund
or adjustment. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and
analysis, as well as the customer’s payment history.
When a sale involves multiple elements, such as sales of products that include services, the entire fee from the arrangement is
allocated to each respective element based on its relative fair value and recognized when revenue recognition criteria for each element
are met. The amount of product and service revenue recognized is impacted by our judgments as to whether an arrangement includes
multiple elements and, if so, whether vendor-specific objective evidence of fair value exists for those elements. Changes to the elements
in an arrangement and our ability to establish vendor-specific objective evidence for those elements could affect the timing of the
revenue recognition.
We make sales to distributors and retail partners and recognize revenue based on a sell-through method using information provided
by them. Our distributors and retail partners participate in various cooperative marketing and other programs, and we maintain
estimated accruals and allowances for these programs. If actual credits received by our distributors and retail partners for these programs
were to deviate significantly from our estimates, which are based on historical experience, our revenue could be adversely affected.
Allowance for Doubtful Accounts and Sales Returns
Our accounts receivable balance, net of allowance for doubtful accounts, was $1.8 billion as of July 31, 2004, compared with $1.4 billion
as of July 26, 2003. The allowance for doubtful accounts as of July 31, 2004 was $179 million, compared with $183 million as of
July 26, 2003. The allowance is based on our assessment of the collectibility of customer accounts. We regularly review the allowance
by considering factors such as historical experience, credit quality, age of the accounts receivable balances, and current economic
conditions that may affect a customer’s ability to pay.
Our provision (credit) for doubtful accounts was $19 million, ($59) million, and $91 million for fiscal 2004, 2003, and 2002,
respectively. In fiscal 2003, we recorded a credit for doubtful accounts as a result of the improvement in the collectibility of specific
customer accounts due to increased credit quality and resolution of disputes. If a major customer’s creditworthiness deteriorates, or
if actual defaults are higher than our historical experience, or if other circumstances arise, our estimates of the recoverability of amounts
due to us could be overstated, and additional allowances could be required, which could have an adverse impact on our revenue.
A reserve for sales returns is established based on historical trends in product return rates. The reserve for sales returns as of
July 31, 2004 and July 26, 2003 included $74 million and $73 million, respectively, for estimated future returns that were recorded
as a reduction of our accounts receivable. If the actual future returns were to deviate from the historical data on which the reserve
had been established, our revenue could be adversely affected.
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