NetFlix 2005 Annual Report Download - page 73

NETFLIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except share and per share data and percentages)
Revenue Recognition
Subscription revenues are recognized ratably over each subscriber’s monthly subscription period. Refunds
to subscribers are recorded as a reduction of revenues. Revenues from sales of used DVDs are recorded upon
shipment.
Cost of Revenues
Subscription. Cost of subscription consists of revenue sharing expenses, amortization of the DVD library,
amortization of intangible assets related to equity instruments issued to studios, and postage and packaging
expenses related to DVDs provided to paying subscribers. Revenue sharing expenses are recorded as DVDs
subject to revenue sharing agreements are shipped to subscribers.
The terms of some revenue sharing agreements with studios obligate the Company to make minimum
revenue sharing payments for certain titles. The Company amortizes minimum revenue sharing prepayments (or
accretes an amount payable to studios if the payment is due in arrears) as revenue sharing obligations are
incurred. A provision for estimated shortfall, if any, on minimum revenue sharing payments is made in the period
in which the shortfall becomes probable and can be reasonably estimated.
Fulfillment expenses. Fulfillment expenses represent those costs incurred in operating and staffing the
Company’s fulfillment and customer service centers, including costs attributable to receiving, inspecting and
warehousing the Company’s DVD library. Fulfillment expenses also include credit card fees.
Technology and Development
Technology and development expenses consist of payroll and related costs incurred in testing, maintaining
and modifying the Company’s Web Site, its recommendation service, developing solutions for downloading
movies to subscribers, telecommunications systems and infrastructure and other internal-use software systems.
Technology and development expenses also include depreciation on the computer hardware and capitalized
software.
Marketing
Marketing expenses consist of payroll and related expenses and advertising expenses. Advertising expenses
include marketing program expenditures and other promotional activities, including revenue sharing expenses,
postage and packaging expenses and library amortization related to free trial periods. Advertising costs are
expensed as incurred except for advertising production costs, which are expensed the first time the advertising is
run. Advertising expense totaled approximately $46,459, $91,799 and $135,874 in 2003, 2004 and 2005,
respectively.
In November of 2002, the Emerging Issues Task Force (“ EITF”) reached a consensus on Issue No. 02-16,
Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,which
addresses the accounting for cash consideration given to a reseller of a vendor’s products from the vendor. The
Company and its vendors participate in a variety of cooperative advertising programs and other promotional
programs in which the vendors provide the Company with cash consideration in exchange for marketing and
advertising of the vendor’s products. If the consideration received represents reimbursement of specific incremental
and identifiable costs incurred to promote the vendor’s product, it is recorded as an offset to the associated
marketing expense incurred. Any reimbursement greater than the specific incremental and identifiable costs
incurred is recognized as a reduction of cost of revenues when recognized in the Company’s statements of income.
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