Mattel 2003 Annual Report Download - page 47

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Inventories—Allowance for Obsolescence
Inventories, net of an allowance for excess quantities and obsolescence, are stated at the lower of cost or
market. Inventory obsolescence reserves are recorded for damaged, obsolete, excess and slow-moving inventory.
Management believes that the accounting estimate related to the allowance for obsolescence is a “critical
accounting estimate” because changes in the assumptions used to develop the estimate could materially affect
key financial measures, including gross profit, net income and inventories. In addition, the valuation requires a
high degree of judgment since it involves estimation of the impact resulting from both current and expected
future events. As more fully described below, valuation of Mattel’s inventory could be impacted by changes in
public and consumer preferences, demand for product, or changes in the buying patterns of both retailers and
consumers and inventory management of customers.
In the toy industry, orders are subject to cancellation or change at any time prior to shipment since actual
shipments of products ordered and order cancellation rates are affected by consumer acceptance of product lines,
strength of competing products, marketing strategies of retailers, changes in buying patterns of both retailers and
consumers and overall economic conditions. Unexpected changes in these factors could result in excess inventory
in a particular product line, which would require management to make a valuation estimate on such inventory.
Mattel bases its production schedules for toy products on customer orders, historical trends, results of
market research and current market information. Mattel ships products in accordance with delivery schedules
specified by its customers, who usually request delivery within three months. In anticipation of retail sales in the
traditional holiday season in the fourth quarter, Mattel significantly increases its production in advance of the
peak selling period, resulting in a corresponding build-up of inventory levels in the first three quarters of the
year. These seasonal purchasing patterns and requisite production lead times cause risk to Mattel’s business
associated with the underproduction of popular toys and the overproduction of toys that do not match consumer
demand. Retailers are also attempting to manage their inventories more tightly, requiring Mattel to ship products
closer to the time the retailers expect to sell the products to consumers. These factors increase inventory
valuation risk since Mattel may not be able to meet demand for certain products at peak demand times, or
Mattel’s own inventory levels may be adversely impacted by the need to pre-build products before orders are
placed.
Additionally, the conditions in the domestic and global economies are extremely uncertain. As a result, it is
difficult to estimate the level of growth in various parts of the economy, including the markets in which Mattel
participates. Because all components of Mattel’s budgeting and forecasting are dependent upon estimates of
growth in the markets it serves and demand for its products, the prevailing economic uncertainties render
estimates of future demand for product more difficult. Such economic changes may affect the sales of Mattel’s
products and its corresponding inventory levels, which would potentially impact the valuation of its inventory.
At the end of each quarter, management within each business segment, Mattel Brands US, Fisher-Price
Brands US, American Girl Brands and International, performs a detailed review of its inventory on an item by
item basis and identifies which products are believed to be obsolete or slow-moving. Management assesses the
need for, and the amount of, an obsolescence reserve based on the following factors:
•Customer and/or consumer demand for the obsolete or slow-moving inventory item;
•Overall inventory positions of Mattel’s customers;
•Strength of competing products in the market;
•Quantity on hand of the obsolete or slow-moving inventory item;
•Standard retail price of the obsolete or slow-moving inventory item;
•Standard margin on the obsolete or slow-moving inventory item; and
•Length of time the obsolete or slow-moving item has been in inventory.
The time frame between when an estimate is made and the time of disposal depends on the above factors
and may vary significantly. Generally, slow-moving inventory is liquidated during the next annual selling cycle.
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