E-Z-GO 2004 Annual Report Download - page 47

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
The preparation of our consolidated financial statements in conformity with generally accepted accounting principles requires
management to make complex and subjective judgments in the selection and application of accounting policies. The accounting
policies that we believe are most critical to the portrayal of Textron’s financial condition and results of operations, and that require
management’s most difficult, subjective and complex judgments in estimating the effect of inherent uncertainties, are listed below.
This section should be read in conjunction with Note 1 to the consolidated financial statements, which includes other significant
accounting policies.
Receivable and Inventory Reserves
We evaluate the collectibility of our commercial and finance receivables based on a combination of factors. In circumstances where
we are aware of a specific customer’s inability to meet its short-term financial obligations to us (e.g., bankruptcy filings, substantial
downgrading of credit scores, geographic economic conditions, etc.), we record a specific reserve for bad debts for amounts we
estimate to be potentially uncollectible. Receivables are charged off when deemed uncollectible. For homogeneous loan pools and
all other receivables, we recognize reserves for bad debts based on current delinquencies, the characteristics of the existing
accounts, historical loss experience, the value of underlying collateral, and general economic conditions and trends. Finance
receivables are written down to the fair value (less estimated costs to sell) of the related collateral at the earlier of the date when the
collateral is repossessed or when no payment has been received for six months, unless we deem the receivable collectible.
Reserves on certain finance receivables are determined using estimates of related collateral values based on historical recovery
rates and current market conditions. Management reviews the market conditions for used equipment and aircraft inventories on a
periodic basis. A deterioration in market conditions resulting in lower recovery rates would result in lower estimated collateral val-
ues, increasing the amount of reserves required on related receivables and used inventories on hand. Based on current market
conditions and recovery rates, we believe our reserves are adequate as of January 1, 2005.
Long-Term Contracts
We recognize revenue and profit as work on certain government long-term engineering, development and production contracts
progresses using the contract method of accounting, which relies on estimates of the total contract cost and revenue. Estimated
contract cost and revenue are based on current contract specifications, expected engineering requirements and the achievement of
contract milestones, including product deliveries. Contract costs are typically incurred over a period of several years, and the esti-
mation of these costs requires substantial judgments. The cost estimation process is based on the professional knowledge and
experience of engineers and program managers along with finance professionals. We update our projections of costs at least semi-
annually or when circumstances significantly change. Adjustments to projected costs are recognized in net earnings when deter-
minable. Favorable changes in estimates result in additional profit recognition, while unfavorable changes in estimates result in
the reversal of previously recognized earnings. Any anticipated losses on contracts are charged to earnings when identified. Earn-
ings on long-term contracts could be reduced by a material amount resulting in a charge to income if (a) total estimated contract
costs are significantly higher than expected due to changes in customer specifications prior to contract amendment, (b) total esti-
mated contract costs are significantly higher than previously estimated due to cost overruns or inflation, (c) there is a change in
engineering efforts required during the development stage of the contract or (d) we are unable to meet contract milestones.
Goodwill
We evaluate the recoverability of goodwill annually in the fourth quarter or more frequently if events or changes in circumstances,
such as declines in sales, earnings or cash flows or material adverse changes in the business climate, indicate that the carrying
value of an asset might be impaired. We completed our annual impairment test in the fourth quarter of 2004 using the estimates
from our long-term strategic plans. No adjustment was required to the carrying value of our goodwill based on the analysis per-
formed.
Goodwill is considered to be impaired when the net book value of a reporting unit exceeds its estimated fair value. Fair values are
primarily established using a discounted cash flow methodology using assumptions consistent with market participants. The
determination of discounted cash flows is based on the businesses’ strategic plans and long-range planning forecasts. The rev-
enue growth rates included in the plans are management’s best estimates based on current and forecasted market conditions, and
the profit margin assumptions are projected by each reporting unit based on the current cost structure and anticipated net cost
reductions. If different assumptions were used in these plans, the related undiscounted cash flows used in measuring impairment
could be different, potentially resulting in an impairment charge.