notes to consolidated financial statements Pioneer-Standard Electronics, Inc. and Subsidiaries Operations — Pioneer-Standard Electronics, Inc. and its subsidiaries (the ‘‘Company’’ or ‘‘Pioneer-Stan- dard’’) distributes and resells a broad range of enterprise computer systems products, including servers, storage, software and services. These products are sold to value-added resellers and commercial end-users. The Company has operations in North America and strategic investments in the United States and Europe. Principles of Consolidation — The consolidated financial statements include the accounts of the Company and its subsidiaries. Investments in affiliated companies in which the Company does not have control, but has the ability to exercise significant influence over operating and financial policies are accounted for using the equity method. Other investments are accounted for using the cost method. All significant inter-company transactions and accounts have been eliminated in consolidation. Use of Estimates — The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates. Revenue Recognition — Revenue from product sales is generally recognized upon shipment provided persua- sive evidence of an arrangement exists, the sales price is fixed or determinable, collectibility is reasonably assured and title and risk of loss have passed to the customer. Sales are recorded net of discounts, customer sales incentives and returns. The Company monitors and tracks the amount of product returns and reduces revenue at the time of shipment for the estimated amount of such future returns, based on historical experience. In addition, the Company also provides for bad debts. Shipping and handling fees billed to customers are recognized as revenue and the related costs are recognized in ‘‘Cost of Goods Sold’’ in the accompanying Consolidated Statements of Operations. A portion of the Company’s business involves shipments directly from its suppliers to its customers. In these transactions, the Company is responsible for negotiating price both with the supplier and customer, payment to the supplier, establishing payment terms with the customer, product returns, and has risk of loss if the customer does not make payment. The Company, acting as principal to the sale, recognizes revenue when the Company is notified by the supplier that the product is shipped. In addition, the Company has certain business with select customers and suppliers that is accounted for on an agency basis in accordance with Emerging Issues Task Force (‘‘EITF’’) No. 99-19 ‘‘Reporting Revenue Gross as a Principal versus Net as an Agent.’’ In such cases, the terms of the transactions govern revenue recognition. Supplier Programs — Pioneer-Standard participates in certain programs provided by various suppliers that enable it to earn volume incentives. These incentives are generally earned by achieving quarterly sales targets. The amounts earned under these programs are recorded as a reduction of cost of sales when earned. In addition, the Company receives incentives from suppliers related to cooperative advertising allowances, price protection and other programs. These incentives generally relate to agreements with the suppliers and are recorded, when earned, as adjustments to gross margin or net advertising expense, as appropriate. All costs associated with advertising and promoting products are expensed in the year incurred. Cooperative reimbursements from suppli- ers, which are earned and available, are recorded in the period the related advertising expenditure is incurred. Income Taxes — Income tax expense includes U.S. and foreign income taxes and is based on reported income before income taxes. Deferred income taxes reflect the effect of temporary differences between assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for income tax purposes. These deferred taxes are measured by applying currently enacted tax laws. Valuation allowances are recognized to reduce the deferred tax assets to an amount that is more likely than not to be realized. Foreign Currency — The functional currency of the Company’s foreign subsidiaries is the applicable local currency. For those foreign operations, the assets and liabilities are translated into U.S. dollars at the exchange rates in effect at the balance sheet dates. Income statement accounts are translated at the monthly average exchange rates prevailing during the year. The gains or losses resulting from these translations are recorded as a 1 OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 31