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For arrangements that include hardware and software where software is considered more than incidental to the hardware, provided
that the software is not essential to the functionality of the hardware and the hardware and software represent separate units of
accounting, revenue related to the software element is recognized under SOP 97-2 and revenue related to the hardware element is
recognized under SOP 81-1 or SAB 104. For arrangements where the software is considered more than incidental and essential to
the functionality of the hardware, or where the hardware is not considered a separate unit of accounting from the software
deliverables, revenue is recognized for the software and the hardware as a single unit of accounting pursuant to SOP 97-2 for off-
the-shelf products and pursuant to SOP 81-1 for customized products.
Prior to July 1, 2003, for contracts involving multiple elements, Nortel Networks allocated revenue to each element based on the
relative fair value or the residual method, as applicable. Provided none of the undelivered elements are essential to the functionality
of the delivered elements, revenue related to the software element is recognized under SOP 97-2 and revenue related to the
hardware element is recognized under SOP 81-1 or SAB 101.
For accounting units related to customized network solutions and certain network build outs, revenues are recognized under SOP
81-1 using the percentage-of-completion method. In using the percentage-of-completion method, revenues are generally recorded
based on a measure of the percentage of costs incurred to date on a contract relative to the estimated total expected contract costs.
Profit estimates on long-term contracts are revised periodically based on changes in circumstances and any losses on contracts are
recognized in the period that such losses become known. Generally, the terms of long-term contracts provide for progress billing
based on completion of certain phases of work. Contract revenues recognized, based on costs incurred towards the completion of
the project, that are unbilled are accumulated in the contracts in progress account included in accounts receivable — net. Billings in
excess of revenues recognized to date on long-term contracts are recorded as advance billings in excess of revenues within other
accrued liabilities.
Revenue for hardware that does not require significant customization, and where any software is considered incidental, is
recognized under SAB 104. Under SAB 104, revenue is recognized provided that persuasive evidence of an arrangement exists,
delivery has occurred or services have been rendered, the fee is fixed or determinable and collectibility is reasonably assured. For
hardware, delivery is considered to have occurred upon shipment provided that risk of loss, and title in certain jurisdictions, have
been transferred to the customer.
Engineering, installation and other service revenues are recognized as the services are performed.
Nortel Networks makes certain sales through multiple distribution channels, primarily resellers and distributors. These customers
are generally given certain rights of return. For products sold through these distribution channels, revenue is recognized from
product sale at the time of shipment to the distribution channel when persuasive evidence of an arrangement exists, delivery has
occurred, the fee is fixed or determinable and collection is reasonably assured. Accruals for estimated sales returns and other
allowances are recorded at the time of revenue recognition and are based on contract terms and prior claims experience.
Software revenue is generally recognized under SOP 97-2. For software arrangements involving multiple elements, Nortel
Networks allocates revenue to each element based on the relative fair value or the residual method, as applicable, and using vendor
specific objective evidence of fair values, which is based on prices charged when the element is sold separately. Software revenue
accounted for under SOP 97-2 is recognized when: persuasive evidence of an arrangement exists; the software is delivered in
accordance with all terms and conditions of the customer contracts; the fee is fixed or determinable; and collection is reasonably
assured. Revenue related to post-contract support, including technical support and unspecified when-and-if available software
upgrades (“PCS”), is recognized ratably over the PCS term. Nortel Networks provides extended payment terms on certain software
contracts and may sell these receivables to third parties. The fees on these contracts are considered fixed or determinable if the
contracts are similar to others for which Nortel Networks has a standard business practice of providing extended payment terms and
has a history of successfully collecting under the original payment terms without making concessions.
Under SAB 104 or SOP 97-2, if fair value does not exist for any undelivered element, revenue is not recognized until the earlier of
(i) the undelivered element is delivered or (ii) fair value of the undelivered element exists, unless the undelivered element is a
service, in which case revenue is recognized as the service is performed once the service is the only undelivered element.
(e)
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