Note 1: Summary of Significant Accounting Policies

Basis of Presentation: The consolidated financial statements include Electro Rent Corporation and its wholly owned subsidiaries (collectively “we”, “us”, or “our” hereafter). All intercompany balances and transactions have been eliminated in consolidation.

Business and Organization: We primarily engage in the short-term rental, lease, and sale of state-of-the-art electronic equipment. We maintain an equipment portfolio composed primarily of test and measurement equipment (“T&M”) and personal computer-related data products (“DP”) equipment purchased from leading manufacturers. Another aspect of our business is the sale of equipment after its utilization for rental or lease and the sale of a range of new T&M equipment for Agilent Technologies, Inc. (“Agilent”) beginning on December 1, 2009, as well as other smaller vendors. Agilent has given us the exclusive right to sell Agilent’s more complex T&M equipment to small and medium size customers (who previously purchased directly from Agilent) in the United States and Canada.

We conduct our business activities in the United States, as well as through our wholly owned subsidiaries, Electro Rent, LLC, Electro Rent Europe, NV, and Electro Rent (Beijing) Test and Measurement Equipment Rental Co., Ltd. which conduct some or all of these business activities in Canada, Europe and China, respectively. Our wholly owned subsidiary, Electro Rent Asia, Inc., is the U.S. parent company of Electro Rent (Beijing) Test and Measurement Equipment Rental Co., Ltd., and our wholly owned subsidiary, ER International, Inc., is the U.S. parent company of Electro Rent Europe, NV.

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as the disclosures of contingent assets and liabilities as of the date of these financial statements and the reported amounts of revenues and expenses during the reporting period. On a regular basis, we review these estimates including those related to asset lives and depreciation methods, impairment of long-lived assets, including rental and lease equipment, goodwill and intangibles, investments, allowance for doubtful accounts, income taxes and contingencies and litigation. These estimates are based on our evaluation of current business and economic conditions, historical experience and on various other assumptions believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe, however, that our estimates, including those for the above-listed items, are reasonable.

Revenue Recognition: We generate revenues primarily through the rental and leasing of T&M and DP equipment and through the sale of new and used equipment. Rental revenues comprise short term agreements that can be daily, weekly or monthly. Rental revenues are recognized in the month they are due on the accrual basis of accounting. Our operating lease agreements have varying terms, typically one to three years. Upon lease termination, customers have the option to renew the lease term, purchase the equipment at fair market value, or continue to rent on a month-to-month basis. Our operating leases do not provide for contingent rentals. Revenues related to operating leases are recognized on a straight-line basis over the term of the lease. Negotiated lease early-termination charges are recognized upon receipt. Rentals and leases are primarily billed to customers in advance, and unearned billings are recorded as deferred revenue.

We enter into finance leases as lessor for some of our equipment. Our finance lease agreements contain bargain purchase options and are accounted for as sale-type leases. Revenues from finance leases, which are recorded at the present value of the aggregate future lease payments, less unearned interest, are included in sales of equipment and other revenues in our consolidated statements of operations. Unearned interest is recognized over the life of the finance lease term using the effective interest method. Our finance lease terms vary, and are typically one to three years. The net investment in finance leases, which represents the receivables due from lessees, net of unearned interest, is included in other assets in our consolidated balance sheets. Historically, we have not required security deposits based on our assessed credit risk within our customer bases.

Initial direct costs for operating and finance leases are insignificant.

Sales of new equipment through our resale channel are recognized in the period in which the equipment is delivered and risk of loss passes to the customer, while sales of used equipment from our rental and lease equipment pool are recognized in the period in which the equipment is shipped and risk of loss passes to the customer. In the case of equipment sold to customers that is already on rent or lease to the same party, revenue is recognized at the agreed-upon date when the rent or lease term ends and risk of loss passes to the customer.

In accordance with accounting guidance, we are acting as the principal with respect to sales of new equipment through our Agilent resale agreement, based on several factors, including: (1) We act as the primary obligor by working directly with our customers to define their needs, providing them with options to satisfy such needs, contracting directly with the customer, and, to the extent required, providing customers with instruction on the use of the product and additional technical support once the product is received by the customer. The product manufacturer is not a party to our customer sales agreements, nor is it referenced in the agreements, and therefore has no obligation to our customers with the exception of the manufacturer’s standard warranty on the product. (2) We bear back-end risk of inventory loss with respect to any product return from the customer as the original manufacturer is not required to accept returns of equipment from us. We also bear front-end risk of inventory loss in those cases where we acquire products for resale into our inventory prior to shipment to customers. (3) We have full discretion in setting pricing terms with our customers and to negotiate all such terms ourselves. (4) We assume all credit risk. Accordingly, sales of new equipment through our resale channel are recorded in sales of equipment and other revenues and the related equipment costs are recorded in costs of sales of equipment and other revenues in our consolidated statements of operations.

Other revenues, consisting primarily of billings to customers for delivery and repairs, are recognized in the period in which the respective services are performed.

Operating expenses: Costs of rentals and leases, excluding depreciation, primarily include labor related costs of our operations personnel, supplies, repairs, insurance and warehousing costs associated with our rental and lease equipment, relating to our rental and lease revenues.

Costs of sales of equipment and other revenues primarily include the cost of new equipment and the carrying value of used equipment sold.

Selling, general and administrative expenses include sales and advertising costs, payroll and related benefit costs, insurance expenses, property taxes on our property and rental and lease equipment, legal and professional fees, and administrative overhead. Advertising costs are expensed as incurred. Total advertising expenses were $982, $962 and $1,013 for fiscal 2013, 2012 and 2011, respectively. SG&A expenses also include shipping and handling costs of $3,951, $4,184 and $3,638 for fiscal 2013, 2012 and 2011, respectively.

Reclassifications: We have expanded the presentation of our costs of revenues to separately present costs associated with each of the revenue streams presented in the condensed consolidated statements of operations, to comply with the applicable income statement disclosure requirements for public companies. Accordingly, the previously reported statement of operations line item captioned “costs of revenues other than depreciation of rental and lease equipment” has been replaced with separate line items for “costs of rentals and leases, excluding depreciation” and “costs of sales of equipment and other revenues”.

Further, in order to more closely align activity related to our rental and lease operations, including revenues and the expenses associated with providing those revenues, we have reclassified certain expenses previously included in selling, general and administrative expenses to costs of rentals and leases, excluding depreciation, which resulted in a reduction to previously reported selling, general and administrative expenses of $10,710 and $10,010 for fiscal 2012 and 2011, respectively. These reclassified costs primarily include direct expenses of supporting our rental and lease operations, including labor related costs of our operations personnel, supplies, repairs, and insurance and warehousing costs associated with our rental and lease equipment.

Rental and Lease Equipment and Other Property: Assets are generally stated at cost, less accumulated depreciation. Upon retirement or disposal of assets, the cost and the related accumulated depreciation are eliminated from the accounts and any gain or loss is recognized. We depreciate our buildings over 31.5 years, furniture and other equipment over three to ten years, and leasehold improvements over the lease period, typically three to five years. Each is depreciated on a straight-line basis. Depreciation of rental and lease equipment assets is provided over the estimated useful lives of the respective assets. We depreciate $428,957 and $414,631 of equipment, at acquisition cost, at May 31, 2013 and 2012, respectively, using straight-line methods ranging from two to ten years, and $30,296 and $32,650 of equipment, at acquisition cost, at May 31, 2013 and 2012, respectively, using accelerated methods ranging from two to four years. We generally use straight-line methods for our T&M equipment, which we believe maintains its value consistently throughout the equipment’s useful life, and accelerated methods primarily for our DP equipment, which tend to depreciate faster due to frequent technological advancements. Depreciation methods and useful lives are periodically reviewed and revised, as deemed appropriate, including revisions to reflect shorter useful lives to more closely match depreciation expense with rental revenue for rental arrangements where the customer can acquire title through payment of all required rentals. Normal maintenance and repairs are expensed as incurred. Rental and lease equipment at net book value comprised $230,074 of T&M equipment and $4,782 of DP equipment at May 31, 2013, and $239,620 of T&M equipment and $3,553 of DP equipment at May 31, 2012.

Income Taxes: We recognize a liability or asset for the deferred tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. These temporary differences will result in taxable or deductible amounts in future years when reported amounts of the assets or liabilities are recovered or settled. Deferred tax assets are periodically reviewed for recoverability.

We recognize the tax impact from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax impact recognized in the financial statements from such a position is measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. We recognize interest, penalties and foreign currency gains and losses with respect to uncertain tax positions as components of our income tax provision. Accrued interest and penalties are included within accrued expenses in the consolidated balance sheet. Significant judgment is required in the identification of uncertain tax positions and in the estimation of penalties and interest on uncertain tax positions. During the second quarter of fiscal 2011 we effectively settled our remaining uncertain tax positions, and derecognized $4,515 of previously recognized uncertain tax positions, and the related deferred tax asset, and $1,396 for interest and penalties previously recognized. (See Note 6 for further discussion.)

Impairment of Long-Lived Assets: The carrying value of equipment held for rental and lease and finite lived intangible assets (subject to amortization) are evaluated whenever events or circumstances have occurred, or our outlook for future market conditions would indicate the carrying amount is not fully recoverable. We recognize impairment losses on equipment held for rental and lease when the expected future undiscounted cash flows are less than the asset’s carrying value, in which case the asset is written down to its estimated fair value. There were no such impairment charges during fiscal 2013, 2012 and 2011.

Goodwill and Intangible Assets: Goodwill, which represents the excess of purchase price over the fair value of net assets acquired, and intangible assets, comprising purchased customer relationships and trade names, are discussed further in Note 4. Pursuant to FASB ASC Topic No. 350, Intangibles – Goodwill and Other (“ASC 350”), goodwill and intangible assets with indefinite lives are not amortized but tested annually for impairment, or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. In connection with the annual impairment test for goodwill and indefinite lived intangibles, we have the option to perform a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If we determine that it was more likely than not that the fair value of the reporting unit is less than its carrying amount, then we perform the impairment test. The impairment test involves a two-step process. The first step involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. We generally determine the fair value of our reporting units using the market approach methodology of valuation. If the carrying value of a reporting unit exceeds the reporting unit’s fair value, we perform the second step of the test to determine the amount of impairment loss. The second step involves measuring the impairment by comparing the implied fair values of the affected reporting unit’s goodwill and intangible assets with the respective carrying values. We completed the required impairment review at the end of fiscal 2013, 2012 and 2011 and concluded that there were no impairments.

Cash and Cash Equivalents: We consider highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Cash equivalents consist primarily of AAA-rated money market funds in all periods presented.

Allowance for Doubtful Accounts: We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make rental and lease payments. The estimated losses are based on historical collection experience in conjunction with an evaluation of the current status of the existing accounts. If the financial condition of our customers were to deteriorate, then additional allowances could be required that would reduce income. Conversely, if the financial condition of our customers were to improve or if legal remedies to collect past due amounts were more successful than expected, then the allowance for doubtful accounts may need to be reduced and income would be increased.

A roll forward of the allowance for doubtful accounts is as follows at May 31:


	2013			2012			2011
Beginning of year	$	522		$	602		$	536
Provision for doubtful accounts		445			233			500
Write-offs		(510	)		(313	)		(434	)

End of year	$	457		$	522		$	602

Other Assets: We include demonstration equipment used in connection with our resale activity, totaling $6,057 and $5,495 as of May 31, 2013 and 2012, respectively, in other assets for a period up to two years. Demonstration equipment is recorded at the lower of cost or estimated market value until the units are sold or transferred to our rental and lease equipment pool. Demonstration equipment transferred to our rental and lease equipment pool is depreciated over its remaining estimated useful life.

Other assets consisted of the following at May 31:


	2013		2012
Net investment in sales-type leases	$	9,437	$	11,681
Demonstration equipment		6,057		5,495
Supplemental executive retirement plan assets		2,947		2,370
Income taxes receivable		—		861
Prepaid expenses and other		2,905		2,865

	$	21,346	$	23,272

Concentration of Credit Risk: Financial instruments that potentially expose us to concentration of credit risk consist primarily of cash equivalents and trade accounts receivable. We invest excess cash primarily in money market funds of major financial institutions. Excess cash of $14 and $2,507 as of May 31, 2013 and 2012, respectively, was invested in four large money market funds that invest in government securities. We believe that we are not exposed to any significant financial risk with respect to cash and cash equivalents. For trade accounts receivable, we sell primarily on 30-day terms, perform credit evaluation procedures on each customer’s individual transactions and require security deposits or personal guarantees from our customers when significant credit risks are identified. Typically, most customers are large, established firms.

We purchase rental and lease equipment from numerous vendors and resale equipment from Agilent. During fiscal 2013, 2012 and 2011, Agilent accounted for approximately 74%, 75% and 82%, respectively, of all new equipment purchases, including rental equipment and equipment purchased for resale. No other vendor accounted for more than 10% of such purchases.

Foreign Currency: The U.S. dollar has been determined to be the functional currency of all foreign subsidiaries. The assets and liabilities of our foreign subsidiaries are remeasured from their local currency to U.S. dollars at current or historic exchange rates, as appropriate. Revenues and expenses are remeasured from any foreign currencies to U.S. dollars using historic or average monthly exchange rates, as appropriate, for the month in which the transaction occurred. Remeasurement gains and losses are included in selling, general and administrative expenses or income taxes, as appropriate. The assets, liabilities, revenues and expenses of our foreign subsidiaries are individually less than 10% of our respective consolidated amounts. The euro, Canadian dollar and Chinese yuan are our primary foreign currencies. Remeasurement gains and losses have not been significant.

We enter into forward contracts to hedge against unfavorable currency fluctuations in our monetary assets and liabilities in our European and Canadian operations. These contracts are designed to minimize the effect of fluctuations in foreign currencies. Such derivative instruments are not designated as hedging instruments and, therefore, are recorded at fair value as a current asset or liability, and any changes in fair value are recorded in our consolidated statements of operations.

The fair value of our foreign exchange forward contracts in the consolidated balance sheets is shown in the table below:

Derivatives Not Designated as

Hedging Instruments

Consolidated Balance Sheet
Location

May 31,
2013

May 31,
2012

Foreign exchange forward contracts

Other assets

114

179

The table below provides data about the amount of fiscal 2013 and 2012 losses recognized in income for derivative instruments not designated as hedging instruments:


Derivatives Not Designated	Location of Loss Recognized	Year ended May 31,
as Hedging Instruments	in Income on Derivatives	2013		2012
Foreign exchange forward contracts	Selling, general and administrative expenses	$	306	$	507

Net Income Per Common and Common Equivalent Share: Basic earnings per share (“EPS”) is computed as net income divided by the weighted average number of shares of common stock outstanding and shares issuable for vested restricted stock units for the reported year, excluding the dilutive effects of restricted stock, stock options and other potentially dilutive securities. Diluted EPS is computed as net income divided by the weighted average number of shares outstanding of common stock and common stock equivalents for the reported year. The dilutive effects of restricted stock and stock options are computed using the treasury stock method.

Cash Flow:

Non-Cash Investing and Financing Activities:

We had rental equipment purchases, not yet paid for, totaling $4,965 and $5,418 as of May 31, 2013, and 2012 respectively. We had sales of used equipment, not yet collected, of $11,419 and $10,021 as of May 31, 2013 and 2012, respectively, included in accounts receivable, and net investment in sales-type leases included in other assets. During fiscal 2013 and 2012, we transferred $2,937 and $2,207 respectively, of demonstration equipment, included in other assets, to rental and lease equipment.

Supplemental disclosures of cash paid (refunded) during the fiscal year for:


Year ended May 31,	2013		2012			2011
Interest	$	180	$	21		$	56
Income taxes		15,579		(543	)		(2,048	)

Stock-Based Compensation: Share-based payments to employees, including grants of employee stock options, are recognized in the consolidated financial statements as compensation expense over the period that an employee provides service in exchange for the award based on its fair value on the date of grant. Compensation expense resulting from restricted stock and restricted stock units is measured at fair value on the date of grant and is recognized in selling, general and administrative expenses over the vesting period (see Note 12 for further discussion).

Recent Accounting Pronouncements: In June 2011, the financial accounting standards board (“FASB”) issued guidance on presentation of comprehensive income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity is required to present components of comprehensive income in either (1) a continuous statement of net income or (2) two separate but consecutive statements. This guidance was effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption of the new guidance is permitted and full retrospective application is required. We adopted this guidance effective June 1, 2013 with no material impact on our financial condition, results of operations or cash flows.

In September 2011, the FASB issued guidance to simplify how an entity tests goodwill for impairment. The amendments in the update provide for an option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity that adopts this option will no longer be required to calculate the fair value of a reporting unit (Step 1) unless the entity determines, based on a qualitative assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. We adopted this guidance effective June 1, 2012 with no material impact on our consolidated financial position, results of operations or cash flows.

In July 2012, the FASB issued guidance to simplify how an entity tests indefinite-lived intangible assets other than goodwill for impairment and permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying amount as a basis for determining whether it is necessary to perform a quantitative impairment test. This guidance is effective for annual and interim impairment tests performed for fiscal years beginning after December 15, 2011. The guidance for the qualitative process became effective for our first quarter of fiscal 2013, and had no material impact on our consolidated financial position, results of operations or cash flows.

In February 2013, the FASB issued guidance on reporting the effect of significant reclassifications out of accumulated other comprehensive income. If the amount being reclassified is required under GAAP to be reclassified in its entirety to net income, an entity is required to report the effect of these reclassifications on the respective line items in net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. The guidance is effective prospectively for reporting periods beginning after December 15, 2013. The new guidance affects disclosures only, and is not expected to impact our consolidated financial position, results of operations or cash flows.

Other Comprehensive Income: Comprehensive income is equivalent to net income for all periods presented.