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F-7
amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. Estimates are used
when accounting for items and matters such as revenue recognition, allowances for uncollectible accounts receivable and customer
financing, receivables sales, inventory obsolescence, product warranty, amortization, asset valuations, impairment assessments,
employee benefits including pensions, taxes, restructuring and other provisions, in-process research and development (“IPR&D”),
stoc
k
-based compensation and contingencies.
(c) Translation o
ff
orei
g
n currencies
The consolidated financial statements of Nortel Networks are presented in U.S. dollars. The financial statements of Nortel
Networks operations whose functional currency is not the U.S. dollar (except for highly inflationary economies as described below)
are translated into U.S. dollars at the exchange rates in effect at the balance sheet dates for assets and liabilities, and at average rates
for the period for revenues and expenses. The unrealized translation gains and losses on Nortel Networks net investment in these
operations, including long-term intercompany advances considered to form part of the net investment, are accumulated as a
component of other comprehensive income (loss) (“OCI”).
Transactions and financial statements for Nortel Networks operations in countries considered to have highly inflationary economies
and whose functional currency is not the U.S. dollar are translated into U.S. dollars at the exchange rates in effect at the balance
sheet dates for monetary assets and liabilities, and at historical exchange rates for non-monetary assets and liabilities. Revenue and
expenses are translated at average rates for the period, except for amortization and depreciation which are translated on the same
basis as the related assets. Resulting translation gains or losses are reflected in net earnings (loss).
When appropriate, Nortel Networks may hedge a designated portion of the exposure to foreign exchange gains and losses incurred
on the translation of specific foreign operations. Hedging instruments used by Nortel Networks can include foreign currency
denominated debt, foreign currency swaps and foreign currency forward contracts that are denominated in the same currency as the
hedged foreign operations. The translation gains and losses on the effective portion of the hedging instruments that qualify for
hedge accounting are recorded in OCI; other translation gains and losses are recorded in net earnings (loss).
(d)
R
evenue reco
g
nition
Nortel Networks products and services are generally sold as part of a contract and the terms of the contracts, taken as a whole,
determine the appropriate revenue recognition methods.
Depending upon the terms of the contract and types of products and services sold, Nortel Networks recognizes revenue under
American Institute of Certified Public Accountants Statement of Position (“SOP”) 81-1, “Accounting for Performance of
Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”), SOP 97-2, “Software Revenue Recognition” (“SOP 97-
2”), and SEC Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition” (“SAB 104”), which was preceded by SAB 101,
“Revenue Recognition in Financial Statements” (“SAB 101”). Revenue is recognized net of cash discounts and allowances.
Effective July 1, 2003, for contracts involving multiple deliverables, where the deliverables are governed by more than one
authoritative accounting standard, Nortel Networks generally applies the FASB Emerging Issues Task Force (“EITF”) Issue
No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”), and evaluates each deliverable to determine
whether it represents a separate unit of accounting based on the following criteria: (a) whether the delivered item has value to the
customer on a standalone basis, (b) whether there is objective and reliable evidence of the fair value of the undelivered item(s), and
(c) if the contract includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s)
is considered probable and substantially in the control of Nortel Networks. If objective and reliable evidence of fair value exists for
all units of accounting in the contract, revenue is allocated to each unit of accounting or element based on relative fair values. In
situations where there is objective and reliable evidence of fair value for all undelivered elements, but not for delivered elements,
the residual method is used to allocate the contract consideration. Under the residual method, the amount of revenue allocated to
delivered elements equals the total arrangement consideration less the aggregate fair value of any undelivered elements. Each unit
of accounting is then accounted for under the applicable revenue recognition guidance.