E-Z-GO 2005 Annual Report Download - page 50

ments include deterioration in finance receivable portfolio quality, downgrades in Textron Finance’s debt credit ratings and a reduction of new
finance receivable originations in the businesses that utilize these funding arrangements. Textron Finance does not expect any of these factors to
have a material impact on its liquidity or income from continuing 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 are listed below. We believe these policies require our most diffi-
cult, subjective and complex judgments in estimating the effect of inherent uncertainties. 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. For larger balance commercial loans,
Textron Finance considers borrower specific information, industry trends and estimated discounted cash flows, as well as the factors reviewed for
its homogeneous loan pools. 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. Textron Finance
estimates that its losses will range from 0.5% to 4.0% of finance receivables depending on the specific homogeneous loan pool. Finance receiv-
ables 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 repos-
sessed 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 values, 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 December 31, 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 estimation of these costs requires substantial judgment. The cost esti-
mation 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 semiannually or when circumstances significantly change. Adjustments to projected costs are recognized
in net earnings when determinable. 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. Earnings 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 estimated 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 2005 using the estimates from our long-term strategic plans. No
adjustment was required to the carrying value of our goodwill based on the analysis performed.
Goodwill is considered to be impaired when the net book value of a reporting unit exceeds its estimated fair value. Fair values are primarily estab-
lished 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 revenue growth rates included in the plans are manage-
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Textron Inc.