Time Magazine 2011 Annual Report Download - page 85

TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Inventories of merchandise are stated at the lower of cost or estimated realizable value. Cost is determined
using primarily the average cost method. Returned merchandise included in Inventory is valued at estimated
realizable value, but not in excess of cost. For more information, see Note 6.
Film Cost Recognition, Participations and Residuals and Impairments
One aspect of the accounting for film and television production costs, as well as related revenues, that
impacts the Filmed Entertainment segment (and the Networks segment, to a lesser degree) and requires the
exercise of judgment relates to the process of estimating a film’s ultimate revenues and is important for two
reasons. First, while a film is being produced and the related costs are being capitalized, as well as at the time the
film is released, it is necessary for management to estimate the ultimate revenues, less additional costs to be
incurred (including exploitation and participation costs), in order to determine whether the value of a film has
been impaired and, thus, requires an immediate write-off of unrecoverable film costs. Second, it is necessary for
management to determine, using the film forecast computation method, the amount of capitalized film costs and
the amount of participations and residuals to be recognized as Costs of revenues for a given film in a particular
period. To the extent that the film’s ultimate revenues are adjusted, the resulting gross margin reported on the
exploitation of that film in a period is also adjusted.
Prior to the theatrical release of a film, management bases its estimates of ultimate revenues for each film on
factors such as the historical performance of similar films, the star power of the lead actors and actresses, the
rating and genre of the film, pre-release market research (including test market screenings) and the expected
number of theaters in which the film will be released. Management updates such estimates based on information
available during the film’s production and, upon release, the actual results of each film. Changes in estimates of
ultimate revenues from period to period affect the amount of film costs amortized in a given period and,
therefore, could have an impact on the segment’s financial results for that period. For example, prior to a film’s
release, the Company often will test market the film to the film’s targeted demographic. If the film is not
received favorably, the Company may (i) reduce the film’s estimated ultimate revenues, (ii) revise the film,
which could cause the production costs to increase or (iii) perform a combination of both. Similarly, a film that
generates lower-than-expected theatrical revenues in its initial weeks of release would have its theatrical, home
video and television distribution ultimate revenues adjusted downward. A failure to adjust for a downward
change in estimates of ultimate revenues could result in the understatement of film costs amortization for the
period. The Company recorded film cost amortization of $3.970 billion, $3.407 billion and $3.180 billion in
2011, 2010 and 2009, respectively. Included in film cost amortization are film impairments primarily related to
pre-release theatrical films of $74 million, $78 million and $85 million in 2011, 2010 and 2009, respectively.
Barter Transactions
Time Warner enters into transactions that involve the exchange of advertising, in part, for other products and
services, such as a license for programming. Such transactions are recognized by the programming licensee (e.g.,
a television network) as programming inventory and deferred advertising revenue at the estimated fair value
when the product is available for telecast. Barter programming inventory is amortized in the same manner as the
non-barter component of the licensed programming, and Advertising revenue is recognized when delivered.
From the perspective of the programming licensor (e.g., a film studio), incremental licensing revenue is
recognized when the barter advertising spots received are either used or sold to third parties.
Multiple-Element Transactions
In the normal course of business, the Company enters into transactions, referred to as multiple-element
transactions, that involve making judgments about allocating consideration to the various elements. While the
more common type of multiple-element transactions encountered by the Company involve the sale or purchase of
multiple products or services (e.g., licensing multiple film titles in a single arrangement), multiple element
transactions can also involve contemporaneous purchase and sales transactions, the settlement of an outstanding
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