Note 1 – Summary of Significant Accounting Policies

Nature of Operations

Toyota Motor Credit Corporation was incorporated in California in 1982 and commenced operations in 1983. References herein to “TMCC” denote Toyota Motor Credit Corporation, and references herein to “we”, “our”, and “us” denote Toyota Motor Credit Corporation and its consolidated subsidiaries. We are wholly-owned by Toyota Financial Services Americas Corporation (“TFSA”), a California corporation, which is a wholly-owned subsidiary of Toyota Financial Services Corporation (“TFSC”), a Japanese corporation. TFSC, in turn, is a wholly-owned subsidiary of Toyota Motor Corporation (“TMC”), a Japanese corporation. TFSC manages TMC’s worldwide financial services operations. TMCC is marketed under the brands of Toyota Financial Services and Lexus Financial Services.

We provide a variety of finance and insurance products to authorized Toyota (including Scion) and Lexus vehicle dealers or dealer groups and, to a lesser extent, other domestic and import franchise dealers (collectively referred to as “vehicle dealers”) and their customers in the United States (excluding Hawaii) (the “U.S.”) including Puerto Rico. Our business is substantially dependent upon the sale of Toyota, Lexus and Scion vehicles.

Our products fall primarily into the following product categories:

Finance - We acquire a broad range of retail finance products including consumer and commercial installment sales contracts (“retail contracts”) in the U.S. and Puerto Rico and leasing contracts accounted for as either direct finance leases or operating leases (“lease contracts”) from vehicle and industrial equipment dealers in the U.S. We also provide dealer financing, including wholesale financing (also referred to as floorplan financing), working capital loans, revolving lines of credit and real estate financing to vehicle and industrial equipment dealers in the U.S. and Puerto Rico.

Insurance - Through Toyota Motor Insurance Services, Inc., a wholly-owned subsidiary, and its insurance company subsidiaries (collectively referred to as “TMIS”), we provide marketing, underwriting, and claims administration related to covering certain risks of vehicle dealers and their customers. We also provide coverage and related administrative services to certain of our affiliates in the U.S.

Our primary finance operations are located in the U.S. and Puerto Rico with earning assets principally sourced through Toyota and Lexus vehicle dealers. As of March 31, 2015, approximately 21 percent of vehicle retail contracts and lease assets were concentrated in California, 10 percent in Texas, 8 percent in New York, and 6 percent in New Jersey. Our insurance operations are located in the U.S. As of March 31, 2015, approximately 26 percent of insurance policies and contracts were concentrated in California, 7 percent in New York and 6 percent in New Jersey. Any material adverse changes to the economies or applicable laws in these states could have an adverse effect on our financial condition and results of operations.

Basis of Presentation

Our accounting and financial reporting policies conform to accounting principles generally accepted in the United States of America (U.S. GAAP). Certain prior period amounts have been reclassified to conform to the current year presentation.

Related party transactions presented in the Consolidated Financial Statements are disclosed in Note 15 – Related Party Transactions.

Note 1 – Summary of Significant Accounting Policies (Continued)

Principles of Consolidation

The consolidated financial statements include the accounts of TMCC, its wholly-owned subsidiaries and all variable interest entities (“VIE”) of which we are the primary beneficiary. All intercompany transactions and balances have been eliminated.

Variable Interest Entities

A VIE is an entity that either (i) has insufficient equity to permit the entity to finance its activities without additional subordinated financial support or (ii) has equity investors who lack the characteristics of a controlling financial interest. The primary beneficiary of a VIE is the party with both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb the losses or the right to receive benefits that could potentially be significant to the VIE.

To assess whether we have the power to direct the activities of a VIE that most significantly impact its economic performance, we consider all the facts and circumstances including our role in establishing the VIE and our ongoing rights and responsibilities. This assessment includes identifying the activities that most significantly impact the VIE’s economic performance and identifying which party, if any, has power over those activities. In general, the party that makes the most significant decisions affecting the VIE is determined to have the power to direct the activities of a VIE. To assess whether we have the obligation to absorb the losses or the right to receive benefits that could potentially be significant to the VIE, we consider all of our economic interests, including debt and equity interests, servicing rights and fee arrangements, and any other variable interests in the VIE. If we determine that we are the party with the power to make the most significant decisions affecting the VIE, and we have an obligation to absorb the losses or the right to receive benefits that could potentially be significant to the VIE, then we consolidate the VIE.

We perform ongoing reassessments, usually quarterly, of whether we are the primary beneficiary of a VIE. The reassessment process considers whether we have acquired or divested the power to direct the most significant activities of the VIE through changes in governing documents or other circumstances. We also reconsider whether entities previously determined not to be VIEs have become VIEs, based on new events, and therefore are subject to the VIE consolidation framework.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Because of inherent uncertainty involved in making estimates, actual results could differ from those estimates and assumptions. The accounting estimates that are most important to our business are the determination of residual value and the allowance for credit losses as well as estimates related to the fair value of our derivative instruments and marketable securities.

Note 1 – Summary of Significant Accounting Policies (Continued)

Revenue Recognition

Retail and Dealer Financing Revenues

Revenues associated with retail and dealer financing are recognized so as to approximate a constant effective yield over the contract term. Incremental direct fees and costs incurred in connection with the acquisition of retail contracts and dealer financing receivables, including incentive and rate participation payments made to vehicle and industrial equipment dealers, are capitalized and amortized so as to approximate a constant effective yield over the expected term of the related contracts. Expected term is based on historical experience. Payments received on affiliate sponsored special rate programs (“subvention”) are deferred and recognized to approximate a constant effective yield over the term of the related contracts. Included in financing revenues are other fees, including late fees and other service charges, the amounts of which are not significant to total financing revenues.

Operating Lease Revenues

Operating lease revenues are recorded to income on a straight-line basis over the term of the lease. Incremental direct fees and costs received or paid in connection with the acquisition of operating leases, including incentive and rate participation payments made to vehicle and industrial equipment dealers and acquisition fees collected from customers, are capitalized or deferred and amortized on a straight-line basis over the expected term of the related contract. Expected term is based on historical experience. Payments received on subvention programs are deferred and recognized on a straight-line basis over the term of the related contracts. Operating lease revenue is recorded net of sales taxes collected from customers. Included in operating lease revenues are other fees, including late fees and other service charges, the amounts of which are not significant to total operating lease revenue.

Direct Finance Lease Revenues

Revenue is recognized over the lease term so as to approximate a constant effective yield on the outstanding net investment. Incremental direct costs and fees paid or received in connection with the acquisition of direct finance leases, including incentive and rate participation payments made to vehicle and industrial equipment dealers and acquisition fees collected from customers, are capitalized or deferred and amortized to approximate a constant effective yield over the term of the related contracts. Payments received on subvention programs are deferred and recognized to approximate a constant effective yield over the term of the related contracts. Included in direct finance lease revenues are other fees, including late fees and other service charges, the amounts of which are not significant to total direct finance lease revenue.

Note 1 – Summary of Significant Accounting Policies (Continued)

Insurance Earned Premiums and Contract Revenues

Revenues from providing coverage under various contractual agreements are recognized over the term of the coverage in relation to the timing and level of anticipated claims and administrative expenses. Revenues from insurance policies, net of premiums ceded to reinsurers, are earned over the terms of the respective policies in proportion to the estimated loss development. Management relies on historical loss experience as a basis for establishing earnings factors used to recognize revenue over the term of the contract or policy.

The portion of premiums and contract revenues applicable to the unexpired terms of the agreements is recorded as unearned insurance premiums and contract revenues. Agreements sold range in term from 3 to 120 months. Certain costs of acquiring new business, consisting primarily of dealer commissions and premium taxes, are deferred and amortized over the term of the related policies on the same basis as revenues are earned.

Service commissions and fees are recognized over the term of the coverage in relation to the timing of services performed. The effect of subsequent cancellations is recorded as an offset to unearned insurance premiums and contract revenues.

Depreciation on Operating Leases

Depreciation on vehicle operating leases is recognized using the straight-line method over the lease term, typically two to five years. The depreciable basis is the original cost of the vehicle less the estimated residual value of the vehicle at the end of the lease term. During the lease term, adjustments to depreciation expense reflecting revised estimates of expected residual values at the end of the lease terms are recorded prospectively on a straight-line basis.

Allowance for Credit Losses

We maintain an allowance for credit losses to cover probable and estimable losses on our finance receivables and operating leases resulting from the failure of customers or dealers to make contractual payments. Management evaluates the allowance at least quarterly, considering a variety of factors and assumptions to determine whether the allowance is considered adequate to cover probable and estimable losses incurred as of the balance sheet date. The allowance for credit losses is management’s estimate of the amount of probable incurred credit losses in our existing finance receivables and investment in operating leases portfolios.

Note 1 – Summary of Significant Accounting Policies (Continued)

Management develops and documents the allowance for credit losses on finance receivables based on three portfolio segments. We also separately develop and document the allowance for credit losses for investments in operating leases. Investments in operating leases are not within the scope of accounting guidance governing the disclosure of portfolio segments. The determination of portfolio segments is based primarily on the qualitative consideration of the nature of our business operations and the characteristics of the underlying finance receivables. The three portfolio segments within finance receivables, net are:

Retail Loan Portfolio Segment – The retail loan portfolio segment consists of retail contracts acquired from vehicle dealers in the U.S. and Puerto Rico (“retail loan contracts”). Under a retail loan contract, we are granted a security interest in the underlying collateral which consists primarily of Toyota, Scion or Lexus vehicles. Based on the common risk characteristics associated with the finance receivables, the retail loan portfolio segment is considered a single class of finance receivable.

Commercial Portfolio Segment – The commercial portfolio segment consists of commercial contracts (“commercial loan contracts”) and leasing contracts accounted for as direct finance leases acquired from commercial truck and industrial equipment dealers in the U.S. Under commercial loan and direct finance leases, we are granted a security interest in the underlying collateral which consists of various types of commercial trucks and industrial equipment. Based on the common risk characteristics associated with the finance receivables and the similarity of the credit risk with respect to the two types of contracts, the commercial portfolio segment is considered a single class of finance receivable.

Dealer Products Portfolio Segment – The dealer products portfolio segment consists of wholesale financing (also referred to as floorplan financing), working capital loans, revolving lines of credit and real estate financing to vehicle and industrial equipment dealers in the U.S. and Puerto Rico. Wholesale loans are primarily collateralized by new or used vehicle or equipment inventory with the outstanding balance fluctuating based on the level of inventory. Real estate loans are collateralized by the underlying real estate, are underwritten on a loan-to-value basis and are typically for a fixed term. Working capital loans and revolving lines of credit are granted for working capital purposes and are secured by dealership assets. Based on the risk characteristics associated with the underlying finance receivables, the dealer products portfolio segment consists of three classes of finance receivables: wholesale, real estate, and working capital.

Note 1 – Summary of Significant Accounting Policies (Continued)

Methodology Used to Develop the Allowance for Credit Losses

Retail Loan Portfolio Segment and Investments in Operating Leases

The level of credit risk in our retail loan portfolio segment and our investments in operating leases is influenced primarily by two factors: default frequency and loss severity, which in turn are influenced by various factors such as economic conditions, the used vehicle market, purchase quality mix, contract term length, and operational changes.

We evaluate the retail loan portfolio segment and investments in operating leases using methodologies that include roll rate, credit risk grade/tier, and vintage analysis. We review and analyze external factors, including changes in economic conditions, actual or perceived quality, safety and reliability of Toyota, Lexus and Scion vehicles, unemployment levels, the used vehicle market, and consumer behavior. In addition, internal factors, such as purchase quality mix and operational changes are also considered in the reviews.

Commercial Portfolio Segment

The level of credit risk in our commercial portfolio segment is influenced primarily by two factors: default frequency and loss severity, which in turn are influenced by various economic factors, the used equipment and truck markets, purchase quality mix, contract term length, and operational changes.

We evaluate the commercial portfolio segment using methodologies that include product grouping analysis, historical loss and loss frequency by product. We review and analyze external factors, including changes in economic conditions, unemployment level, and the used equipment and truck markets. In addition, internal factors, such as purchase quality mix and operational changes, are also considered in the reviews.

Dealer Products Portfolio Segment

The level of credit risk in our dealer products portfolio segment is influenced primarily by the financial strength of dealers within our portfolio, dealer concentration, collateral quality, and other economic factors. The financial strength of dealers within our portfolio is influenced by, among other factors, general economic conditions, the overall demand for new and used vehicles and industrial equipment and the financial condition of automotive manufacturers in general.

We evaluate the dealer portfolio by aggregating dealer financing receivables into loan-risk pools, which are determined based on the risk characteristics of the loan (e.g. secured by either vehicles and industrial equipment, real estate or dealership assets, or unsecured). We analyze the dealer pools using internally developed risk ratings for each dealer. In addition, field operations management and our special assets group are consulted each quarter to determine if any specific dealer loan is considered impaired. If impaired loans are identified, specific reserves are established, as appropriate, and the loan is removed from the loan-risk pool for separate monitoring.

Note 1 – Summary of Significant Accounting Policies (Continued)

Accounting for the Allowance for Credit Losses and Impaired Receivables

The majority of the allowance for credit losses covers estimated losses on the retail loan portfolio segment which is collectively evaluated for impairment. The remainder of the allowance for credit losses covers the estimated losses on investments in operating leases, the dealer products portfolio segment, and the commercial portfolio segment. Within the dealer products portfolio segment, we establish specific reserves to cover the estimated losses on individual impaired loans (including loans modified in a troubled debt restructuring). The specific reserves are assessed based on discounted cash flows, the loan’s observable market price, or the fair value of the underlying collateral if the loan is collateral dependent.

Troubled debt restructurings in the retail loan and commercial portfolio segments are aggregated with their respective portfolio segments when determining the allowance for credit losses. These loans are homogenous in nature and insignificant for individual evaluation and we have determined that the allowance for credit losses for each of the retail loan and commercial portfolio segments would not be materially different if they had been individually evaluated for impairment.

Increases to the allowance for credit losses are accompanied by corresponding charges to the provision for credit losses on the Consolidated Statement of Income. The uncollectible portion of finance receivables and operating leases is charged to the allowance for credit losses at the earlier of when an account is deemed to be uncollectible or when an account is greater than 120 days past due. In the event we repossess the collateral, the receivable is charged-off and we record the collateral at its estimated fair value less costs to sell and report it in Other Assets in the Consolidated Balance Sheet. Recoveries of finance receivables previously charged off as uncollectible are credited to the allowance for credit losses.

Insurance Losses and Loss Adjustment Expenses

Insurance losses and loss adjustment expenses include amounts paid and accrued for loss events that are known and have been recorded as claims, estimates of losses incurred but not reported that are based on actuarial estimates and historical loss development patterns, and loss adjustment expenses that are expected to be incurred in connection with settling and paying these claims.

Accruals for unpaid losses, losses incurred but not reported, and loss adjustment expenses are included in other liabilities in the Consolidated Balance Sheet. Estimated liabilities are reviewed regularly and we recognize any adjustments in the periods in which they are determined. If anticipated losses, loss adjustment expenses, and unamortized acquisition and maintenance costs exceed the recorded unearned premium, a premium deficiency is recognized by first charging any unamortized acquisition costs to expense and then by recording a liability for any excess deficiency.

Cash Equivalents

Cash equivalents, which consist of money market instruments, commercial paper and certificates of deposit, represent highly liquid investments with maturities of three months or less at purchase.

Restricted Cash and Cash Equivalents

Restricted cash represents proceeds from certain debt issuances for which the use of the cash is restricted, as well as customer collections on securitized receivables to be distributed to investors as payments on the related secured debt and certain reserve deposits held for securitization trusts. Restricted cash equivalents represent proceeds from the issuance of debt secured by retail loans in March 2014. The proceeds from this issuance were restricted to be used solely to acquire retail and lease contracts financing new Toyota and Lexus vehicles of certain specified “green” models. These amounts were fully utilized as of March 31, 2015.

Note 1 – Summary of Significant Accounting Policies (Continued)

Investments in Marketable Securities

Investments in marketable securities consist of debt and equity securities. Debt and equity securities designated as available-for-sale (“AFS”) are recorded at fair value using quoted market prices where available with unrealized gains or losses included in accumulated other comprehensive income (“AOCI”), net of applicable taxes in the Consolidated Statement of Shareholder’s Equity. Realized gains and losses are determined using either the specific identification method or first in first out method, depending on the type of investment in our portfolio. Realized investment gains and losses are reflected in Investment and other income, net in the Consolidated Statement of Income.

Other-than-Temporary Impairment

An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. Unrealized losses that are determined to be temporary in nature are recorded, net of tax, in AOCI. We conduct periodic reviews of securities in unrealized loss positions for the purpose of evaluating whether the impairment is other-than-temporary.

As part of our ongoing assessment of other-than-temporary impairment (“OTTI”), we consider a variety of factors. Such factors include the length of time and extent to which the market value of a security has been less than amortized cost, adverse conditions specifically related to the industry, geographic area or financial condition of the issuer or underlying collateral of the security and the volatility of the fair value changes.

An OTTI loss with respect to debt securities must be recognized in earnings if we have the intent to sell the debt security or it is more likely than not that we will be required to sell the debt security before recovery of its amortized cost basis. If we have the intent to sell, the cost basis of the security is written down to fair value and the write down is reflected in Investment and other income, net in the Consolidated Statement of Income. If we have no intent to sell and we believe that it is more likely than not we will not be required to sell these securities prior to recovery, the credit loss component of the unrealized losses is recognized in Investment and other income, net in the Consolidated Statement of Income, while the remainder of the loss is recognized in AOCI. The credit loss component recognized in Investment and other income, net in the Consolidated Statement of Income is identified as the portion of the amortized cost of the security not expected to be collected over the remaining term as projected using a cash flow analysis for debt securities.

We perform periodic reviews of our AFS equity securities to determine whether unrealized losses are temporary in nature. We consider our intent and ability to hold the security for a period of time sufficient for recovery of fair value. Where we lack that intent or ability, the equity security’s decline in fair value is deemed to be other-than-temporary. If losses are considered to be other-than-temporary, the cost basis of the security is written down to fair value and the write down is reflected in Investment and other income, net in the Consolidated Statement of Income.

Note 1 – Summary of Significant Accounting Policies (Continued)

Finance Receivables

Our finance receivables consist of retail loan, commercial and dealer products portfolio segments. Finance receivables recorded on our balance sheet include accrued interest and deferred fees and costs, net of the allowance for credit losses, certain other dealer funds and deferred income. Direct finance leases are recorded on our balance sheet as the aggregate future minimum lease payments, contractual residual value of the leased vehicle or industrial equipment, and deferred income.

Finance receivables are classified as held-for-investment if the Company has the intent and ability to hold the receivables for the foreseeable future or until maturity or payoff. As of March 31, 2015 and 2014, all finance receivables were classified as held-for-investment.

Impaired Receivables

A receivable account balance is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the terms of the contract. Factors such as payment history, compliance with terms and conditions of the underlying loan agreement and other subjective factors related to the financial stability of the borrower are considered when determining whether a loan is impaired.

Troubled Debt Restructurings

A troubled debt restructuring occurs when an account is modified through a concession to a borrower experiencing financial difficulty. An account modified under a troubled debt restructuring is considered to be impaired. In addition, troubled debt restructurings include accounts for which the customer has filed for bankruptcy protection. For such accounts, we no longer have the ability to modify the terms of the agreement without the approval of the bankruptcy court and the court may impose term modifications that we are obligated to accept.

Nonaccrual Policy

Dealer Products Portfolio Segment

Impaired receivables in the dealer product portfolio segment are placed on nonaccrual status if full payment of principal or interest is in doubt, or when principal or interest is 90 days or more past due. Interest accrued, but not collected at the date a receivable is placed on nonaccrual status, is reversed against interest income. In addition, the amortization of net deferred fees is suspended. Interest income on nonaccrual receivables is recognized only to the extent it is received in cash. Accounts are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured. Receivable balances are charged off against the allowance for credit losses when the loss has been realized.

Retail Loan and Commercial Portfolio Segments

The accrual of revenue is discontinued at the time a receivable is determined to be uncollectible (generally after 120 days past due). Accounts may be restored to accrual status only when a customer settles all past due deficiency balances and future payments are reasonably assured. For receivables in non-accrual status, subsequent financing revenue is recognized only to the extent a payment is received. Payments are generally applied first to outstanding interest and then to the unpaid principal balance.

Note 1 – Summary of Significant Accounting Policies (Continued)

Investments in Operating Leases

We record our investments in operating leases at acquisition cost, net of deferred fees and costs, deferred income, accumulated depreciation and the allowance for credit losses.

Nonaccrual Policy

The accrual of revenue on operating leases is discontinued at the time an account is determined to be uncollectible (generally after 120 days past due). For operating leases in non-accrual status, subsequent operating lease revenue is recognized only to the extent a payment is received.

Determination of Residual Value

Substantially all of our residual value risk relates to our vehicle lease portfolio. Residual values of lease earning assets are estimated at lease inception by examining external industry data, the anticipated Toyota, Lexus and Scion product pipeline and our own experience. Factors considered in this evaluation include, but are not limited to, local, regional and national economic forecasts, new vehicle pricing, new vehicle incentive programs, new vehicle sales, future plans for new Toyota, Lexus and Scion product introductions, competitor actions and behavior, product attributes of popular vehicles, the mix of used vehicle supply, the level of current used vehicle values, buying and leasing behavior trends, and fuel prices. We use various channels to sell vehicles returned at lease end.

On a quarterly basis, we review the estimated end-of-term market values of leased vehicles to assess the appropriateness of the carrying values at lease end. To the extent the estimated end-of-term market value of a leased vehicle is lower than the residual value established at lease inception, the residual value of the leased vehicle is adjusted downward so that the carrying value at lease end will approximate the estimated end-of-term market value. Factors affecting the estimated end-of-term market value are similar to those considered in the evaluation of residual values at lease inception discussed above. These factors are evaluated in the context of their historical trends to anticipate potential future changes in the relationship among these factors. For operating leases, adjustments are made prospectively on a straight-line basis over the remaining terms of the leases and are included in depreciation on operating leases in the Consolidated Statement of Income. For direct finance leases, adjustments are made at the time of assessment and are recorded as a reduction of direct finance lease revenues which is included under our retail revenues in the Consolidated Statement of Income.

We review our investments in operating leases for impairment whenever events or changes in circumstances indicate that the carrying value of the operating leases may not be recoverable. If such events or changes in circumstances are present, we perform a test for recoverability by comparing the expected undiscounted future cash flows (including expected residual values) over the remaining lease terms to the carrying value of the asset group. If the test for recoverability identifies a possible impairment, the asset group's fair value is measured in accordance with the fair value measurement framework. An impairment charge is recognized for the amount by which the carrying value of the asset group exceeds its estimated fair value and is recorded in the current period Consolidated Statement of Income.

Note 1 – Summary of Significant Accounting Policies (Continued)

Used Vehicles Held for Sale

Used vehicles held for sale consist of off-lease vehicles and repossessed vehicles. These vehicles are recorded at the lower of their carrying value or estimated fair value less costs to sell. These vehicles are sold promptly after grounding or repossession.

Debt Issuance Costs

Costs that are direct and incremental to debt issuance are capitalized and amortized to interest expense on an effective yield basis over the contractual term of the debt. All other costs related to debt issuance are expensed as incurred.

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. If quoted prices in an active market are available, fair value is determined by reference to these prices. If quoted prices are not available, fair value is determined by valuation models that primarily use, as inputs, market-based or independently sourced parameters, including but not limited to interest rates, volatilities, foreign exchange rates and credit curves. Additionally, we may reference prices for similar instruments, quoted prices or recent transactions in less active markets. We use prices and inputs that are current as of the measurement date, including during periods of market disruption. In periods of market disruption, the availability of prices and inputs may be reduced for certain financial instruments. This condition could result in a financial instrument being reclassified from Level 1 to Level 2 or from Level 2 to Level 3.

Level 1: Quoted (unadjusted) prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Quoted prices in active markets for similar assets and liabilities, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Unobservable inputs that are supported by little or no market activity may require significant judgment in order to determine the fair value of the assets and liabilities.

The use of observable and unobservable inputs is reflected in the fair value hierarchy assessment disclosed in the tables within this document. The availability of observable inputs can vary based upon the financial instrument and other factors, such as instrument type, market liquidity and other specific characteristics particular to the financial instrument. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires additional judgment by management. The degree of unobservable inputs can result in financial instruments being classified as or transferred to the Level 3 category.

Note 1 – Summary of Significant Accounting Policies (Continued)

Valuation Methods

We maintain policies and procedures to value instruments using the best and most relevant data available. Our Treasury Risk and Analytics Group (“TR&A”) is responsible for determining the fair value of our financial instruments. TR&A consists of quantitative analysts and risk and accounting professionals. Using benchmarking techniques, TR&A reviews our valuation pricing models at least annually to assess their ongoing propriety. As markets and products develop and the pricing for certain products becomes more or less transparent, TR&A refines its valuation methodologies. TR&A reviews the appropriateness of fair value measurements including validation processes, key model inputs, and the reconciliation of period-over-period fluctuations based on changes in key market inputs. Where possible, valuations, including both internally and externally obtained transaction prices, are validated against independent valuation sources. Our Fair Value Working Group (“FVWG”) reviews and approves the fair value measurement results and other relevant data quarterly. The FVWG consists of a cross-section of internal stakeholders who are knowledgeable in the area of financial valuations. All changes to our valuation methodologies are reviewed and approved by the FVWG.

We conduct reviews of our primary pricing vendors to understand and assess the reasonableness of inputs used in their pricing process. While we do not have access to our vendors’ proprietary models, we perform detailed reviews of the pricing process, methodologies and control procedures for each asset class for which prices are provided. Our reviews include examination of the underlying inputs and assumptions for a sample of individual securities selected based on the nature and complexity of the securities. In addition, our pricing vendors have established processes in place for all valuations, which facilitates identification and resolution of potentially erroneous prices. We believe that the prices received from our pricing vendors are representative of prices that would be received to sell the assets or paid to transfer the liabilities at the measurement date and are classified appropriately in the hierarchy.

Valuation Adjustments

We may make valuation adjustments to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, our own creditworthiness, as well as constraints due to market illiquidity or unobservable parameters.

Counterparty Credit Valuation Adjustments – Adjustments are required when the market price (or parameter) is not indicative of the credit quality of the counterparty.

Non-Performance Credit Valuation Adjustments – Adjustments reflect our own non-performance risk when our liabilities are measured at fair value.

Liquidity Valuation Adjustments – Adjustments are necessary when we are unable to observe prices for a financial instrument due to market illiquidity.

Recurring Fair Value Measurements

Cash Equivalents

Cash equivalents include money market instruments, commercial paper and certificates of deposits, which represent highly liquid investments with maturities of three months or less at purchase. Where money market funds produce a daily net asset value in an active market, we use this value to determine the fair value of the fund investment and classify the investment in Level 1 of the fair value hierarchy. All other types of cash equivalents are classified in Level 2 of the fair value hierarchy.

Note 1 – Summary of Significant Accounting Policies (Continued)

Investments in Marketable Securities

The marketable securities portfolio consists of debt and equity securities. We estimate the value of our debt securities using observed transaction prices, independent pricing vendors, and internal pricing models.

Pricing methodologies and inputs to valuation models used by the pricing vendors depend on the security type. Where possible, quoted prices in active markets for identical securities are used to determine the fair value of the investment securities; these securities are classified in Level 1 of the fair value hierarchy. Where quoted prices in active markets are not available, the pricing vendor uses various pricing models for each asset class that are consistent with what market participants use. The inputs and assumptions to the models of the pricing vendors are derived from market observable sources including: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market-related data. Since many fixed income securities do not trade on a daily basis, the pricing vendors use applicable available information, such as benchmark curves, benchmarking of similar securities, sector groupings, and matrix pricing. These investments are classified in Level 2 of the fair value hierarchy. Our pricing vendors may provide us with valuations that are based on significant unobservable inputs; in such circumstances, we classify these investments in Level 3 of the fair value hierarchy. Valuations obtained from third party pricing vendors are validated to assess their reasonableness.

We hold investments in actively traded open-end equity mutual funds and private placement fixed income mutual funds. Where the funds produce a daily net asset value that is quoted in an active market, we use this value to determine the fair value of the fund investment and classify the investment in Level 1 of the fair value hierarchy. Where the funds produce a daily net asset value that is not quoted in an active market, we estimate the fair value of the investment using the net asset value per share and we classify such funds in Level 2 of the fair value hierarchy as we have the ability to redeem our investment at the net asset value per share at the balance sheet date.

Derivatives

We estimate the fair value of our derivatives using industry standard valuation models that require observable market inputs, including market prices, yield curves, credit curves, interest rates, foreign exchange rates, volatilities and the contractual terms of the derivative instruments. For derivatives that trade in liquid markets, model inputs can generally be verified and do not require significant management judgment. These derivative instruments are classified in Level 2 of the fair value hierarchy.

Certain other derivative transactions trade in less liquid markets with limited pricing information. For such derivatives, key inputs to the valuation process include quotes from counterparties and other market data used to corroborate and adjust values where appropriate. Other market data includes values obtained from a market participant that serves as a third party pricing vendor. Inputs obtained from counterparties and third party pricing vendors are internally validated using valuation models to assess the reasonableness of changes in factors such as market prices, yield curves, credit curves, interest rates, foreign exchange rates and volatilities. These derivative instruments are classified in Level 3 of the fair value hierarchy.

Our derivative fair value measurements consider assumptions about counterparty credit risk and our own non-performance risk. We consider counterparty credit risk and our own non-performance risk through credit valuation adjustments.

Note 1 – Summary of Significant Accounting Policies (Continued)

Nonrecurring Fair Value Measurements

Impaired Dealer Finance Receivables

For finance receivables within the dealer products portfolio segment for which there is evidence of impairment, we may measure impairment based on discounted cash flows, the loan’s observable market price or the fair value of the underlying collateral if the loan is collateral-dependent. If the loan is collateral-dependent, the fair values of impaired finance receivables are reported at fair value on a nonrecurring basis. The methods used to estimate the fair value of the underlying collateral depends on the specific class of finance receivable. For finance receivables within the wholesale class of finance receivables, the collateral value is generally based on wholesale market value or liquidation value for new and used vehicles. For finance receivables within the real estate class of finance receivables, the collateral value is generally based on appraisals. For finance receivables within the working capital class of finance receivables, the collateral value is generally based on the expected liquidation value of the underlying dealership assets. Adjustments may be performed in circumstances where market comparables are not specific to the attributes of the specific collateral or appraisal information may not be reflective of current market conditions due to the passage of time and the occurrence of market events since receipt of the information. As these valuations utilize unobservable inputs, our impaired finance receivables are classified in Level 3 of the fair value hierarchy.

Impaired Retail Receivables

Retail contracts greater than 120 days past due are measured at fair value based on the fair value of the underlying collateral less costs to sell. The fair value of collateral is based on the current average selling prices for like vehicles at wholesale used vehicle auctions. Vehicles are sold promptly upon repossession.

Financial Instruments Not Carried at Fair Value

Finance Receivables

Our finance receivables consist of retail loans, comprised of retail loan contracts and commercial loan contracts, and dealer loans, comprised of wholesale, real estate and working capital financing. Retail loans are primarily valued using a securitization model that incorporates expected cash flows. Cash flows expected to be collected are estimated using contractual principal and interest payments adjusted for specific factors, such as prepayments, default rates, loss severity, credit scores, and collateral type. The securitization model utilizes quoted secondary market rates if available, or estimated market rates that incorporate management's best estimate of investor assumptions about the portfolio. Dealer loans are valued using a discounted cash flow model. Discount rates are derived based on market rates for equivalent portfolio bond ratings. As these valuations utilize unobservable inputs, our finance receivables are classified in Level 3 of the fair value hierarchy.

Commercial Paper

The carrying value of commercial paper issued is assumed to approximate fair value due to its short duration and generally negligible credit risk. We validate this assumption by recalculating the fair value of our commercial paper using quoted market rates. Commercial paper is classified in Level 2 of the fair value hierarchy.

Note 1 – Summary of Significant Accounting Policies (Continued)

Unsecured Notes and Loans Payable

Unsecured notes and loans payable are primarily valued using current market rates and credit spreads for debt with similar maturities. Our valuation models utilize observable inputs such as standard industry curves; therefore, we classify these unsecured notes and loans payables in Level 2 of the fair value hierarchy. Where observable inputs are not available, we use quoted market prices to estimate the fair value of unsecured notes and loans payable. These unsecured notes and loans payable are classified in Level 3 of the fair value hierarchy since the market for these instruments is not active. In a limited number of instances, where neither observable inputs nor quoted market prices are available, we estimate the fair value of unsecured notes and loans payable using quotes from counterparties or a third party pricing vendor. We review the appropriateness of these fair value measurements by assessing the reasonableness of period over period fluctuations. Since the valuations utilize unobservable inputs, we classify the unsecured notes and loans payable in Level 3 of the fair value hierarchy.

Secured Notes and Loans Payable

Fair value is estimated based on current market rates and credit spreads for debt with similar maturities. We also use internal assumptions, including prepayment speeds and expected credit losses on the underlying securitized assets, to estimate the timing of cash flows to be paid on these instruments. As these valuations utilize unobservable inputs, our secured notes and loans payables are classified in Level 3 of the fair value hierarchy.

Derivative Instruments

All derivative instruments are recorded on the balance sheet at fair value, taking into consideration the effects of legally enforceable master netting agreements that allow us to net settle asset and liability positions and offset cash collateral held with the same counterparty on a net basis. Changes in the fair value of derivatives are recorded in interest expense in the Consolidated Statement of Income.

We categorize derivatives as those designated for hedge accounting (“hedge accounting derivatives”) and those that are not designated for hedge accounting (“non-hedge accounting derivatives”). At the inception of a derivative contract, we may elect to designate a derivative as a hedge accounting derivative if certain criteria are met.

In order to qualify for hedge accounting, a derivative must be considered highly effective at reducing the risk associated with the exposure being hedged. When we designate a derivative in a hedging relationship, we contemporaneously document the risk management objective and strategy. This documentation includes the identification of the hedging instrument, the hedged item and the risk exposure, how we will assess effectiveness prospectively and retrospectively, and how often we will carry out this assessment.

We use the “long-haul” method of assessing effectiveness for our fair value hedges, except for certain types of existing hedge relationships that meet stringent criteria where we apply the shortcut method. The shortcut method provides an assumption of zero ineffectiveness that results in equal and offsetting changes in fair value in the Consolidated Statement of Income for both the hedged debt and the hedge accounting derivative. When the shortcut method is not applied, any ineffective portion of the derivative that is designated as a fair value hedge is recognized as a component of interest expense in the Consolidated Statement of Income. We recognize changes in the fair value of derivatives designated in fair value hedging relationships (including foreign currency fair value hedging relationships) in interest expense in the Consolidated Statement of Income along with the fair value changes of the related hedged item.

Note 1 – Summary of Significant Accounting Policies (Continued)

If we elect not to designate a derivative instrument in a hedging relationship, or the relationship does not qualify for hedge accounting treatment, the full change in the fair value of the derivative instrument is recognized as a component of interest expense in the Consolidated Statement of Income with no offsetting adjustment for the economically hedged item.

We review the effectiveness of our hedging relationships at least quarterly to determine whether the relationships have been and continue to be effective. We use regression analysis to assess the effectiveness of our hedges. When we determine that a hedging relationship is not or has not been effective, hedge accounting is no longer applied. If hedge accounting is discontinued, we continue to carry the derivative instrument as a component of other assets or other liabilities in the Consolidated Balance Sheet at fair value, with changes in fair value reported in interest expense in the Consolidated Statement of Income. Additionally, for discontinued fair value hedges, we cease to adjust the hedged item for changes in fair value and amortize the cumulative fair value adjustments recognized in prior periods over the remaining term of the hedged item.

We will also discontinue the use of hedge accounting if a derivative is sold, terminated, or if management determines that designating a derivative under hedge accounting is no longer deemed appropriate based on current investment strategy (“de-designated derivatives”). De-designated derivatives are included within the category of non-hedge accounting derivatives.

We also issue debt which is considered a “hybrid financial instrument”. These debt instruments are assessed to determine whether they contain embedded derivatives requiring separate reporting and accounting. The embedded derivative may be bifurcated and recorded on the balance sheet at fair value or the entire financial instrument may be recorded at fair value. Changes in the fair value of the bifurcated embedded derivative or the entire hybrid financial instrument are reported in interest expense in the Consolidated Statement of Income.

Offsetting of Derivatives

The accounting guidance permits the net presentation on the Consolidated Balance Sheet of derivative receivables and derivative payables with the same counterparty and the related cash collateral when a legally enforceable master netting agreement exists. When we meet this condition, we elect to present such balances on a net basis. Our embedded derivative contracts do not meet the accounting guidance permitting netting and therefore balances are presented on a gross basis.

We use master netting agreements to mitigate counterparty credit risk in derivative transactions. A master netting agreement is a contract with a counterparty that permits multiple transactions governed by that contract to be cancelled and settled with a single net balance paid to either party in the event of default or other termination event outside the normal course of business, such as a ratings downgrade of either party to the contract.

Our reciprocal collateral agreements require the transfer of cash collateral to the party in a net asset position across all transactions governed by the master netting agreement. Upon default, the collateral agreement grants the party in a net asset position the right to set-off amounts receivable against any posted collateral.

Note 1 – Summary of Significant Accounting Policies (Continued)

Foreign Currency Transactions

Certain transactions we have entered into related to debt are denominated in foreign currencies. If the debt is not in a designated hedge accounting relationship, the debt is translated into U.S. dollars using the applicable exchange rate at the transaction date and retranslated at each balance sheet date using the exchange rate in effect at that date. Gains and losses related to foreign currency transactions are included in interest expense in the Consolidated Statement of Income. Payments on debt in the Consolidated Statement of Cash Flows include repayment of principal and the net amount of exchange of notional on currency swaps that economically hedge these transactions. Proceeds from issuance of debt in the Consolidated Statement of Cash Flows include both the proceeds from the initial issuance of debt and the net amount of exchange of notional on currency swaps that economically hedge these transactions.

Risk Transfer

Our insurance operations transfer certain risks to protect us against the impact of unpredictable high severity losses. The amounts recoverable from reinsurers and other companies that assume liabilities relating to our insurance operations are determined in a manner consistent with the related reinsurance or risk transfer agreement. Amounts recoverable from reinsurers and other companies on unpaid losses are recorded as a receivable but are not collectible until the losses are paid. Revenues related to risks transferred are recognized on the same basis as the related revenues from the underlying agreements. Covered losses are recorded as a reduction to insurance losses and loss adjustment expenses.

Income Taxes

We use the liability method of accounting for income taxes under which deferred tax assets and liabilities are adjusted to reflect changes in tax rates and laws in the period such changes are enacted resulting in adjustments to the current fiscal year’s provision for income taxes.

TMCC files a consolidated federal income tax return with its subsidiaries and TFSA. TMCC files either separate or consolidated/combined state income tax returns with Toyota Motor North America (“TMNA”), TFSA, or subsidiaries of TMCC. State income tax expense is generally recognized as if TMCC and its subsidiaries filed their tax returns on a stand-alone basis. In those states where TMCC and its subsidiaries join in the filing of consolidated or combined income tax returns, TMCC and its subsidiaries are allocated their share of the total income tax expense based on combined allocation/apportionment factors and separate company income or loss. Based on the federal and state tax sharing agreements, TFSA and TMCC and its subsidiaries pay for their share of the income tax expense and are reimbursed for the benefit of any of their tax losses utilized in the federal and state income tax returns.

Note 1 – Summary of Significant Accounting Policies (Continued)

New Accounting Guidance

In May 2014, the Financial Accounting Standards Board ("FASB") issued new guidance on the recognition of revenue from contracts with customers. This comprehensive standard will supersede virtually all existing revenue recognition guidance. This accounting guidance is expected to be effective for us on April 1, 2018 with optional early adoption on April 1, 2017. We are currently evaluating the potential impact of this guidance on our consolidated financial statements.

In February 2015, the FASB issued new guidance that amends the analysis a reporting entity must perform to determine whether it should consolidate certain legal entities. This accounting guidance is effective for us on April 1, 2016. We are currently evaluating the potential impact of this guidance on our consolidated financial statements.

In April 2015, the FASB issued new guidance that requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset. This accounting guidance will be effective for us on April 1, 2016. We are currently evaluating the potential impact of this guidance on our consolidated financial statements.

In April 2015, the FASB issued new guidance to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement. While similar guidance exists under current U.S. GAAP for cloud service providers, this update provides explicit guidance for a customer's accounting. This accounting guidance will be effective for us on April 1, 2016. We are currently evaluating the potential impact of this guidance on our consolidated financial statements.

In May 2015, the FASB issued new guidance that removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. This accounting guidance will be effective for us on April 1, 2016. We are currently evaluating the potential impact of this guidance on our consolidated financial statements.

In May 2015, the FASB issued new guidance that requires additional disclosures related to short-duration insurance contracts. This accounting guidance will be effective for us for the annual period beginning April 1, 2016 and for interim periods within annual periods beginning April 1, 2017. We are currently evaluating the potential impact of this guidance on our consolidated financial statements.

Recently Adopted Accounting Guidance

In April 2014, we adopted new FASB accounting guidance which requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The adoption of this guidance did not have an impact on our consolidated financial statements.

In April 2014, we adopted new FASB accounting guidance related to the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements. Pursuant to the new guidance, an entity is required to measure these obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. Additionally, the guidance requires each reporting entity to disclose the nature and amount of each obligation as well as other information about those obligations in the footnotes to its financial statements. The adoption of this guidance did not have a material impact on our consolidated financial statements.