Circuit City 2005 Annual Report Download - page 50

enacted tax laws and rates. Valuation allowances are provided for deferred tax assets to the extent it is more
likely than not that deferred tax assets will not be recoverable against future taxable income.
Revenue Recognition and Accounts Receivable
– The Company recognizes sales of products, including shipping
revenue, when persuasive evidence of an order arrangement exists, delivery has occurred, the sales price is fixed
or determinable and collectibility is reasonably assured. Generally, these criteria are met at the time the product is
received by the customers when title and risk of loss have transferred. Allowances for estimated subsequent
customer returns, rebates and sales incentives are provided when revenues are recorded. Costs incurred for the
shipping and handling of its products are recorded as cost of sales. Revenue from extended warranty and support
contracts on the Company’s assembled PCs is deferred and recognized over the contract period.
Accounts receivable are shown in the consolidated balance sheets net of allowances for doubtful collections and
subsequent customer returns. The changes in these allowance accounts are summarized as follows (in thousands):
Years ended December 31,
2005
2004
2003
Balance, beginning of year
$11,318
$10,000
$11,275
Charged to expense
7,316
5,079
3,906
Deductions
(6,126
)
(3,761
)
(5,181
)
Balance, end of year
$12,508
$11,318
$10,000
Advertising Costs
— Advertising costs, consisting primarily of catalog preparation, printing and postage
expenditures, are amortized over the period of catalog distribution during which the benefits are expected,
generally one to six months. Expenditures relating to television and local radio advertising are expensed in the
period the advertising takes place.
Net advertising expenses of $39.4 million in 2005, $43.8 million in 2004 and $43.7 million in 2003 are included
in the accompanying Consolidated Statements of Operations. The Company utilizes advertising programs to
support vendors, including catalogs, internet and magazine advertising, and receives payments and credits from
vendors, including consideration pursuant to volume incentive programs and cooperative marketing programs.
The Company follows the provisions of Emerging Issues Task Force (“EITF”) Issue No. 02-16, “Accounting by
a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” EITF 02-16 requires that
consideration received from vendors, such as advertising support funds, be accounted for as a reduction of cost of
sales unless certain conditions are met showing that the funds are used for specific, incremental, identifiable
costs, in which case the consideration is accounted for as a reduction in the related expense category, such as
advertising expense. The amount of vendor consideration recorded as a reduction of selling, general and
administrative expenses totaled $39.1 million for the year ended December 31, 2005, $34.1 million for the year
ended December 31, 2004 and $38.1 million for the year ended December 31, 2003.
Prepaid expenses at December 31, 2005 and 2004 include deferred advertising costs of $5.0 million and $5.6
million, respectively, which are reflected as an expense during the periods benefited, typically the subsequent
fiscal quarter.
Research and Development Costs
— Costs incurred in connection with research and development are expensed
as incurred. Such expenses were approximately $488,000 for the year ended December 31, 2005, $411,000 for
the year ended December 31, 2004 and $800,000 for the year ended December 31, 2003.
Derivative Financial Instruments
– In accordance with the provisions of SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities,” as amended, all of the Company’s derivative financial instruments are
recognized as either assets or liabilities in the consolidated balance sheets based on their fair values. Changes in
the fair values are reported in earnings or other comprehensive income depending on the use of the derivative and
whether it qualifies for hedge accounting. Derivative instruments are designated and accounted for as either a
hedge of a recognized asset or liability (fair value hedge) or a hedge of a forecasted transaction (cash flow
hedge). For derivatives designated as effective cash flow hedges, changes in fair values are recognized in other