Rosetta Stone 2015 Annual Report Download - page 70

Table of Contents



In the first quarter of 2014, the Company determined sufficient indication existed to require performance of an interim goodwill impairment analysis
for the then extant Rest of World Consumer reporting unit. As a result, the Company recorded a goodwill impairment loss of $2.2 million, which represented
a full impairment of Rest of World Consumer’s goodwill. In the fourth quarter of 2014, the Company determined sufficient indication existed to require
performance of an interim goodwill impairment analysis for the then extant North America Consumer Language reporting unit. As a result of this test, the
Company recorded a goodwill impairment loss of $18.0 million, which represented a full impairment of North America Consumer Language’s goodwill.
For income tax purposes, the goodwill balances with tax basis are amortized over a period of 15 years.

Indemnifications are provided of varying scope and size to certain Enterprise & Education customers against claims of intellectual property
infringement made by third parties arising from the use of its products. The Company has not incurred any costs or accrued any liabilities as a result of such
obligations.

Cost of product revenue consists of the direct and indirect materials and labor costs to produce and distribute the Company's products. Such costs
include packaging materials, computer headsets, freight, inventory receiving, personnel costs associated with product assembly, third-party royalty fees and
inventory storage, obsolescence and shrinkage. The Company believes cost of subscription and service revenue primarily represents costs associated with
supporting the web-based subscription services, which includes online language conversation coaching, hosting costs and depreciation. Also included are
the costs of credit card processing and customer technical support in both cost of product revenue and cost of subscription and service revenue.

Research and development expenses include employee compensation costs, consulting fees and overhead costs associated with the development of
our solutions. The Company develops the majority of its language-learning software products for perpetual sale to external customers. The Company
considers technological feasibility to be established when all planning, designing, coding, and testing has been completed according to design
specifications. The Company has determined that technological feasibility for such software products is reached shortly before the products are released to
manufacturing. Costs incurred after technological feasibility is established have not been material, and accordingly, the Company has expensed all research
and development costs when incurred.

The Company capitalizes software development costs related to certain of its software platforms developed exclusively to provide its web-based
subscription services and other general and administrative use software in accordance with ASC subtopic 350-40: . Development costs
for internal-use software are expensed as incurred until the project reaches the application development stage. Internal-use software is defined to have the
following characteristics: (a) the software is internally developed, or modified solely to meet the entity's internal needs, and (b) during the software's
development or modification, no substantive plan exists or is being developed to market the software externally. Internally developed software is amortized
over a three-year useful life.
For the years ended December 31, 2015, 2014 and 2013, the Company capitalized $7.1 million, $8.8 million, and $4.8 million in internal-use software,
respectively.
For the years ended December 31, 2015, 2014 and 2013, the Company recorded amortization expense relating to internal-use software of $4.8 million,
$3.4 million, and $1.8 million, respectively.

The Company accounts for income taxes in accordance with ASC topic 740, ("ASC 740"), which provides for an asset and liability
approach to accounting for income taxes. Deferred tax assets and liabilities represent the future tax consequences of the differences between the financial
statement carrying amounts of assets and liabilities versus the tax basis of assets and liabilities. Under this method, deferred tax assets are recognized for
deductible temporary differences, and operating loss and tax credit carryforwards. Deferred liabilities are recognized for taxable temporary differences.
Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the
F-14