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expected residual returns. Intercompany accounts and transactions are eliminated upon consolidation and unrealized intercompany
gains and losses are eliminated when accounting under the equity method.
(b) Use o
f
estimates
Nortel Networks S.A. makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the consolidated financial statements and the reported 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, taxes,
restructuring and other provisions, stock-based compensation and contingencies.
(c) Translation of foreign currencies
The functional currency of Nortel Networks S.A. is the euro.
Transactions and financial statement items denominated in a currency other than the euro are translated into euros 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).
(d)
R
evenue reco
g
nition
Nortel Networks S.A. 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 S.A. 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 S.A. 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 S.A. 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.
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 S.A. 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