LeapFrog 2012 Annual Report Download - page 39

write-downs would be required resulting in a negative impact on gross margin. We monitor the estimates of
inventory write-downs on a quarterly basis. When considered necessary, we make additional adjustments to
reduce inventory to its net realizable value, with corresponding increases to cost of sales. Inventories included
write-downs for slow-moving, excess and obsolete inventories of $4.5 million and $5.4 million at
December 31, 2012 and 2011, respectively.
Capitalization of Product Costs
We capitalize certain external costs related to the development of content for our learning products, including
design, artwork, animation, layout, editing, voice, audio and apps included in the learning products. Such costs
are capitalized once the technological feasibility of the product is established and costs are determined to be
recoverable. Amortization of these costs is included in cost of sales and begins when the products are initially
released for sale and generally continues over a two-year life using the straight-line method. We evaluate the
future recoverability of capitalized amounts periodically and recognize write-downs in the statements of
operations as needed. Capitalized content costs that are cancelled, abandoned or otherwise deemed impaired
are charged to cost of sales in the period of cancellation. Write-downs of capitalized costs related to platforms
being discontinued or non-performing titles resulted in an increase in cost of sales in the U.S. segment of
$0.2 million, $0.3 million and $0.7 million in 2012, 2011 and 2010, respectively.
We also capitalize external website development costs (‘‘website costs’’), which primarily include third-party
costs related to developing applications that are integral components of certain products we market, costs
incurred to develop or acquire and customize code for web applications, costs to develop HTML web pages or
develop templates, and costs to create initial graphics for the website that included the design or layout of
each page. Website costs are generally amortized on a straight-line basis over two years. We evaluate the
future recoverability of capitalized website costs periodically and if an impairment loss is considered to have
occurred during the period, we accelerate the amortization and record it in depreciation and amortization in
the statement of operations in the same period.
Our evaluations of capitalized content development costs and website costs require us to make complex and
subjective judgments, using currently available data as well as projections about the potential impact of
possible future events and conditions, which judgments and projections are inherently uncertain. If future
events and conditions do not meet expectations, we make additional adjustments to reduce the expected
realizable value of the assets, with corresponding increases to cost of sales. Capitalized content development
costs and website costs are both included in capitalized product costs on the balance sheet, net of
accumulated amortization.
Goodwill and Other Intangible Assets
We review goodwill for impairment at least annually, and between annual tests if events occur or
circumstances change that warrant a review. These events or circumstances could include a significant change
in the business climate, legal factors or operating performance indicators.
In September 2011, the Financial Accounting Standards Board (‘‘FASB’’) issued new guidance that permits an
entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a
reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the
two-step goodwill impairment test. Under this guidance, if an entity determines, after assessing such
qualitative factors, that it is not more likely than not that the fair value of a reporting unit is less than its
carrying amount, then performing the two-step impairment test is unnecessary. If the qualitative assessment
concludes that it is probable that there is impairment, then a quantitative assessment must be performed. We
early adopted this guidance for our December 31, 2011 annual goodwill impairment test.
Our qualitative assessment includes consideration of relevant events and circumstances that may impact the
carrying amount of the reporting unit to which our goodwill is allocated. The identification of relevant events
and circumstances and how these may impact a reporting unit’s fair value or carrying amount involve
significant judgment and assumptions. Relevant events and circumstances identified include, but are not
limited to: macroeconomic conditions, industry and market considerations, cost factors, overall financial
performance, LeapFrog-specific events and share price trends. Additional judgment is required to determine
relative importance and impact of each factor.
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