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## POWELL INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

## A. BUSINESS AND ORGANIZATION 

Powell Industries, Inc. (we, us, our, Powell or the Company) was incorporated in the state of Delaware in 2004 as a successor to a Nevada company incorporated in 1968. The Nevada corporation was the successor to a company founded by William E. Powell in 1947, which merged into the Company in 1977. Our major subsidiaries, all of which are wholly-owned, include: Powell Electrical Systems, Inc.; Transdyn, Inc.; Powell Industries International, B.V.; Switchgear & Instrumentation Limited (S&I) and Powell Canada Inc. 

We develop, design, manufacture and service custom engineered- to-order equipment and systems for the management and control of electrical energy and other critical processes. Headquartered in Houston, Texas, we serve the transportation, environmental, energy, industrial and utility industries. 

## B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 

## Principles of Consolidation 

The consolidated financial statements include the accounts of Powell and our wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. 

## Reclassifications 

Reclassifications have been made in prior years’ financial statements to conform and expand the presentation of deferred income taxes and research and development used in the current year. These reclassifications have not resulted in any changes to previously reported net income or cash flows for any periods. 

## Use of Estimates 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (U.S. GAAP) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying footnotes. The most significant estimates used in our financial statements affect revenue and cost recognition for construction contracts, the allowance for doubtful accounts, provision for excess and obsolete inventory, goodwill and other intangible assets, self-insurance, warranty accruals and income taxes. The amounts recorded for insurance claims, warranties, legal, income taxes and other contingent liabilities require judgments regarding the amount of expenses that will ultimately be incurred. 

We base our estimates on historical experience and on various other assumptions, as well as the specific circumstances surrounding these contingent liabilities, in evaluating the amount of liability that should be recorded. Estimates may change as new events occur, additional information becomes available or operating environments change. Actual results may differ from our estimates. 

## Cash and Cash Equivalents 

Cash and cash equivalents include cash on hand, deposits with banks and highly liquid investments with original maturities of three months or less. 

## Supplemental Disclosures of Cash Flow Information (in thousands): 

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## Fair Value of Financial Instruments 

Financial instruments include cash, cash equivalents, receivables, payables and debt obligations. Except as described below, due to the short-term nature of account receivables and account payables, the book value is representative of their fair value. The carrying value of debt approximates fair value as interest rates are indexed to the Federal Funds Rate, the Canadian Prime Rate or the bank’s prime rate. 

## Accounts Receivable 

Accounts receivable are stated net of allowances for doubtful accounts. We maintain and continually assess the adequacy of the allowance for doubtful accounts representing our estimate for losses resulting from the inability of our customers to pay amounts due to us. This estimated allowance is based on historical experience of uncollected accounts, the level of past due accounts, the overall level of outstanding accounts receivable, information about specific customers with respect to their inability to make payments and expectations of future conditions that could impact the collectability of accounts receivable. Future changes in our customers’ operating performance and cash flows, or in general economic conditions, could have an impact on their ability to fully pay these amounts, which could have a material impact on our operating results. 

In most cases, receivables are not collateralized. However, we utilize letters of credit to secure payment on sales when possible. 

At September 30, 2013 and 2012, accounts receivable included retention amounts of $11.5 million and $8.7 million, respectively. 

Retention amounts are in accordance with applicable provisions of engineering and construction contracts and become due upon completion of contractual requirements. Approximately $1.0 million of the retained amount at September 30, 2013, is expected to be collected subsequent to September 30, 2014. 

## Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts 

Costs and estimated earnings in excess of billings on uncompleted contracts arise when revenues are recorded on a percentage- of-completion basis but cannot be invoiced under the terms of the contract. Such amounts are invoiced upon completion of contractual milestones. 

