Earthlink 2003 Annual Report Download - page 32

Income taxes
We have historically reported net losses and, in accordance with accounting principles generally accepted in the United States, have not
recorded any income tax benefits from those losses. We reported net income for the third and fourth quarters of 2003 but reported a net loss for
the year ended December 31, 2003. Therefore, we have recorded income taxes at an effective tax rate of 0% throughout 2003 in consideration
of the benefit of prior year losses. We have provided a valuation allowance against our deferred tax assets, consisting primarily of net operating
loss carryforwards, and may recognize additional benefits of deferred tax assets in periods when they are estimated to be realizable.
Related Party Transactions
Through its ownership interest in EarthLink, Sprint is considered a related party. Our marketing relationship with Sprint generated
approximately 10% of our total gross organic subscriber additions during the years ended December 31, 2002 and 2003. In connection with our
marketing relationship with Sprint, we provide wholesale broadband and other services to Sprint. We received approximately $22.0 million,
$26.4 million and $27.3 million during the years ended December 31, 2001, 2002 and 2003, respectively, for these services. As of
December 31, 2002 and 2003, we had accounts receivable related to these arrangements with Sprint of $6.3 million and $5.2 million,
respectively.
Sprint is one of our principal telecommunications service providers. We paid Sprint approximately $75.2 million, $75.4 million and
$74.0 million during the years ended December 31, 2001, 2002 and 2003, respectively, associated with network service agreements. The
aggregate amount due to Sprint pursuant to these network service agreements was $11.0 million and $15.8 million at December 31, 2002 and
2003, respectively.
See Item 13 of this Form 10-
K, "Certain Relationships and Related Transactions," and Note 17, "Related Party Transactions," in the Notes
to Consolidated Financial Statements for further information related to transactions with related parties.
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Critical Accounting Policies and Estimates
Set forth below is a discussion of the accounting policies and related estimates that we believe are the most critical to understanding our
consolidated financial statements, financial condition, and results of operations and which require complex management judgments,
uncertainties and/or estimates. The preparation of financial statements in accordance with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure
of contingent assets and liabilities, and the reported amounts of revenues and expenses during a reporting period; however, actual results could
differ from those estimates. Management has discussed the development, selection and disclosure of the critical accounting policies and
estimates with the Audit Committee of the Board of Directors. Information regarding our other accounting policies is included in the Notes to
Consolidated Financial Statements.
Revenue recognition
Gross versus net revenue recognition. EarthLink maintains relationships with certain telecommunications partners (including cable
companies) in which it provides services to customers using the "last mile" element of the telecommunications providers' networks. The term
"last mile" generally refers to the element of telecommunications networks that is directly connected to homes and businesses. In these
instances, management evaluates the criteria outlined in Emerging Issues Task Force ("EITF") Issue No. 99-
19, "Reporting Revenue Gross as a
Principal versus Net as an Agent," in determining whether it is appropriate to record the gross amount of revenue and related costs or the net
amount due from the telecommunications partner as revenue. Generally, when EarthLink is the primary obligor in the transaction with the
subscriber, has latitude in establishing prices, is the party determining the service specifications or has several but not all of these indicators,
EarthLink records the revenue at the amount billed the subscriber. If EarthLink is not the primary obligor and/or the telecommunications
partner has latitude in establishing prices, EarthLink records revenue associated with the related subscribers on a net basis, netting the cost of
revenue associated with the service against the gross amount billed the customer and recording the net amount as revenue. The determination of
whether EarthLink meets many of the attributes specified in EITF No. 99-19 for gross and net revenue recognition is judgmental in nature and
is based on an evaluation of the terms of each arrangement. A change in the determination of gross versus net revenue recognition could have
an impact on the gross amounts of revenues and cost of revenues EarthLink recognizes and the gross profit margin percentages in the period in
which such determination is made; however, such a change in determination of revenue recognition would not effect net income (loss).
Multiple element arrangements. Certain customer arrangements encompass multiple deliverables, such as Internet access services,
hardware and installation. We account for these arrangements in accordance with EITF Issue No. 00-
21, "Revenue Arrangements with Multiple
Deliverables." If the deliverables meet the criteria in EITF No. 00-21, the deliverables are separated into separate units of accounting and
revenue is allocated to the deliverables based on their relative fair values. The criteria specified in EITF Issue No. 00-21 are that the delivered
item has value to the customer on a stand-alone basis, there is objective and reliable evidence of the fair value of the undelivered item, and if
the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item is considered
probable and substantially in the control of the vendor. For our purpose, fair value is generally defined as the price at which a customer could