Callaway 2004 Annual Report Download - page 27

claims signiÑcantly exceeds the estimated warranty reserve, the Company's cost of sales, gross proÑt and net
income would be signiÑcantly adversely aÅected.
Taxes
Current income tax expense (beneÑt) is the amount of income taxes expected to be payable or receivable
for the current year. A deferred income tax asset or liability is established for the expected future
consequences resulting from temporary diÅerences in the Ñnancial reporting and tax bases of assets and
liabilities. The Company provides a valuation allowance for its deferred tax assets when, in the opinion of
management, it is more likely than not that such assets will not be realized. While the Company has
considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the
need for the valuation allowance, in the event the Company were to determine that it would be able to realize
its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax
asset would increase income in the period such determination was made. Likewise, should the Company
determine that it would not be able to realize all or part of its net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to income in the period such determination was made.
The Company is required to Ñle federal and state tax returns in the United States and various other tax
returns in foreign jurisdictions. The preparation of these tax returns requires the Company to interpret the
applicable tax laws and regulations in eÅect in such jurisdictions, which could aÅect the amount of tax paid by
the Company. The Company, in consultation with its tax advisors, bases its tax returns on interpretations that
are believed to be reasonable under the circumstances. The tax returns, however, are subject to routine reviews
by the various taxing authorities in the jurisdictions in which the Company Ñles its returns. As part of these
reviews, a taxing authority may disagree with respect to the interpretations the Company used to calculate its
tax liability and therefore require the Company to pay additional taxes. As required under applicable
accounting rules, the Company therefore accrues an amount for its estimate of additional tax liability the
Company could incur as a result of the ultimate resolution of disagreements with the various taxing
authorities. The tax contingency accrual is recorded as a component of the Company's net income taxes
payable/receivable balance, which the Company reviews and updates over time as more deÑnitive information
becomes available from taxing authorities, completion of tax audits or upon occurrence of other events.
Change in Accounting Estimate
As discussed above, the Company has a stated two-year warranty policy for its golf clubs, although the
Company's historical practice has been to honor warranty claims well after the two-year stated warranty
period. Prior to the third quarter of 2002, the Company's method of estimating both its implicit and explicit
warranty obligation was to utilize data and information based on the cumulative failure rate by product after
taking into consideration speciÑc risks the Company believes existed at the time the Ñnancial statements were
prepared. These additional risks included product-speciÑc risks, such as the introduction of products with new
technology or materials that would be more susceptible to failure or breakage, and other business risks, such as
increased warranty liability as a result of acquisitions. In many cases, additions to the warranty reserve for new
product introductions have been based on management's judgment of possible future claims derived from the
limited product failure data that was available at the time.
Beginning in the second quarter of 2001, the Company began to compile data that illustrated the timing
of warranty claims in relation to product life cycles. In the third quarter of 2002, the Company determined it
had gathered suÇcient data and concluded it should enhance its warranty accrual estimation methodology to
utilize the additional data. The analysis of the data, in management's judgment, provided management with
more insight into timing of claims and demonstrated that some product failures are more likely to occur early
in a product's life cycle while other product failures occur in a more linear fashion over the product's life cycle.
As a result of its analysis of the additional information, the Company believes it has gained better insight and
improved judgment to more accurately project the ultimate failure rates of its products. As a result of this
reÑnement in its methodology, the Company concluded that it should change its methodology of estimating
warranty accruals and reduce its warranty reserve by approximately $17.0 million. The $17.0 million reduction
is recorded in cost of sales and favorably impacted gross proÑt as a percentage of net sales by two percentage
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