E-Z-GO 2009 Annual Report Download - page 45

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these finance receivables is reclassified to the valuation allowance account, which is netted with finance receivables held for sale on the balance
sheet. After the valuation allowance is initially established, it is adjusted quarterly for any changes in the fair value of the receivables below the
carrying value, with subsequent adjustments included in earnings within segment profit. Fair value changes can occur based on market interest
rates, market liquidity and changes in the credit quality of the borrower and value of underlying loan collateral.
There are no active, quoted market prices for our finance receivables. The estimate of fair value was determined based on the use of discounted
cash flow models to estimate the exit price we expect to receive in the principal market for each type of loan in an orderly transaction, which
includes the sale of both pools of similar assets and the sale of individual loans. The models we used incorporate estimates of the rate of return,
financing cost, capital structure and/or discount rate expectations of prospective purchasers combined with estimated loan cash flows based on
credit losses, payment rates and credit line utilization rates. Where available, the assumptions related to the expectations of prospective
purchasers were compared with observable market inputs, including bids from prospective purchasers, and certain bond market indices for loans
of similar perceived credit quality. Although we utilize and prioritize these market observable inputs in our discounted cash flow models, these
inputs are rarely derived from markets with directly comparable loan structures, industries and collateral types. Therefore, all valuations of finance
receivables held for sale involve significant management judgment, which can result in differences between our fair value estimates and those of
other market participants and the sale price that we may ultimately recover.
Long-Term Contracts
We make a substantial portion of our sales to government customers pursuant to long-term contracts. These contracts require development and
delivery of products over multiple years and may contain fixed-price purchase options for additional products. We account for these long-term
contracts under the percentage-of-completion method of accounting.
Under the percentage-of-completion method, we estimate profit as the difference between total estimated revenues and cost of a contract. We then
recognize that estimated profit over the contract term based on either the costs incurred (under the cost-to-cost method, which typically is used
for development effort) or the units delivered (under the units-of-delivery method, which is used for production effort), as appropriate under the
circumstances. The percentage-of-completion method of accounting involves the use of various estimating techniques to project costs at
completion and, in some cases, includes estimates of recoveries asserted against the customer for changes in specifications. Due to the size,
length of time and nature of many of our contracts, the estimation of total contract costs and revenue through completion is complicated and
subject to many variables relative to the outcome of future events over a period of several years. We are required to make numerous assumptions
and estimates relating to items such as expected engineering requirements, complexity of design and related development costs, performance of
subcontractors, availability and cost of materials, labor productivity and cost, overhead and capital costs, manufacturing efficiencies and the
achievement of contract milestones, including product deliveries.
Our 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 semiannually or when circumstances significantly change. Adjustments to projected
costs are recognized in earnings when determinable. Anticipated losses on contracts are recognized in full in the period in which the losses
become probable and estimable. Due to the significance of judgment in the estimation process described above, it is likely that materially different
revenues and/or cost of sales amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. Our
earnings could be reduced by a material amount resulting in a charge to earnings 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 a reporting unit
might be impaired. Goodwill is reviewed for potential impairment using a two-step process. In Step 1, companies are required to estimate fair
value of their reporting units, which may be done using various methodologies, including the income method using discounted cash flows. If its
estimated fair value exceeds its carrying value, the reporting unit is not impaired, and no further analysis is performed. Otherwise, the amount of
the impairment must be determined in Step 2 of the goodwill impairment test. In Step 2, the implied fair value of goodwill is determined by
assigning a fair value to all of the reporting unit’s assets and liabilities, including any unrecognized intangible assets, as if the reporting unit had
been acquired in a business combination at fair value. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that
goodwill, an impairment loss would be recognized in an amount equal to that excess.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations