Mattel 2012 Annual Report Download - page 55

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.
Inventory allowances are charged to cost of sales and establish a lower cost basis for the 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. 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 record a valuation allowance on such
inventory.
Mattel bases its production schedules for toy products on customer orders and forecasts, taking into account
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, 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 its fiscal year. These seasonal purchasing patterns and requisite production lead times create 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’s inventory levels may be adversely impacted by the need to pre-build
products before orders are placed.
When current conditions in the domestic and global economies become uncertain, it is difficult to estimate
the level of growth or contraction for the economy as a whole. It is even more difficult to estimate growth or
contraction in various parts of the economy, including the economies in which Mattel participates. Because all
components of Mattel’s budgeting and forecasting are dependent upon estimates of growth or contraction in the
markets it serves and demand for its products, economic uncertainty makes 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 could potentially impact the valuation of its inventory.
At the end of each quarter, management within each business segment, North America, International, and
American Girl, performs a detailed review of its inventory on an item-by-item basis and identifies products that
are believed to be impaired. Management assesses the need for, and the amount of, an obsolescence reserve
based on the following factors:
• Customer and/or consumer demand for the item,
• Overall inventory positions of Mattel’s customers,
• Strength of competing products in the market,
• Quantity on hand of the item,
• Standard retail price of the item,
• Mattel’s cost for the item, and
• Length of time the item has been in inventory.
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