Apple 2006 Annual Report Download - page 53

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environment, the financial condition of the Company’s distribution channels, and the aging of such receivables. If there is a deterioration of a
major customer’s financial condition, if the Company becomes aware of additional information related to the credit worthiness of a major
customer, or if future actual default rates on trade receivables in general differ from those currently anticipated, the Company may have to
adjust its allowance for doubtful accounts, which would affect earnings in the period the adjustments were made.
Inventory Valuation and Inventory Purchase Commitments
The Company must order components for its products and build inventory in advance of product shipments. The Company records a write-
down for inventories of components and products, including third-party products held for resale, which have become obsolete or are in excess
of anticipated demand or net realizable value. The Company performs a detailed review of inventory each fiscal quarter that considers multiple
factors including demand forecasts, product life cycle status, product development plans, current sales levels, and component cost trends. The
personal computer and consumer electronic industries are subject to a rapid and unpredictable pace of product and component obsolescence
and demand changes. If future demand or market conditions for the Company’s products are less favorable than forecasted or if unforeseen
technological changes negatively impact the utility of component inventory, the Company may be required to record additional write-downs
which would negatively affect gross margins in the period when the write-downs were recorded.
The Company accrues reserves for estimated cancellation fees related to component orders that have been cancelled or are expected to be
cancelled. Consistent with industry practice, the Company acquires components through a combination of purchase orders, supplier contracts,
and open orders based on projected demand information. These commitments typically cover the Company’s requirements for periods ranging
from 30 to 150 days. If there is an abrupt and substantial decline in demand for one or more of the Company’s products or an unanticipated
change in technological requirements for any of the Company’s products, the Company may be required to record additional reserves for
cancellation fees that would negatively affect gross margins in the period when the cancellation fees are identified.
Warranty Costs
The Company provides currently for the estimated cost for hardware and software warranties at the time the related revenue is recognized
based on historical and projected warranty claim rates, historical and projected cost-per-claim, and knowledge of specific product failures that
are outside of the Company’s typical experience. Each quarter, the Company reevaluates its estimates to assess the adequacy of its recorded
warranty liabilities considering the size of the installed base of products subject to warranty protection and adjusts the amounts as necessary. If
actual product failure rates or repair costs differ from estimates, revisions to the estimated warranty liability would be required and could
negatively affect the Company’s results of operations.
The Company periodically provides updates to its applications and system software to maintain the software’s compliance with specifications.
The estimated cost to develop such updates is accounted for as warranty costs that are recognized at the time related software revenue is
recognized. Factors considered in determining appropriate accruals related to such updates include the number of units delivered, the number of
updates expected to occur, and the historical cost and estimated future cost of the resources necessary to develop these updates.
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with SFAS No. 123R. Under the provisions of SFAS No. 123R, stock-
based compensation cost is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes-Merton (“BSM”)
option-pricing model and is recognized as expense ratably over the requisite service period. The BSM model requires various highly
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