LeapFrog 2004 Annual Report Download - page 31

We provide estimated allowances for product returns, charge backs, promotions and defectives on product
sales in the same period that we record the related revenue. We estimate our allowances by utilizing historical
information for existing products. For new products, we estimate our allowances for product returns on specific
terms for product returns and our experience with similar products. In estimating returns, we analyze (i) historical
returns and sales patterns, (ii) analysis of credit memo data, (iii) current inventory on hand at customers, (iv)
changes in demand, and (v) introduction of new products. We continually assess our historical experience and
adjust our allowances as appropriate, and consider other known factors. If actual product returns, charge backs,
promotions and defective products are greater than our estimates, additional allowances may be required.
Historically, our estimated reserves for accounts receivables, returns, charge backs, promotions and defectives
have been adequate to cover actual charges.
In the third quarter of 2004, we changed our disclosure of receivable allowances to include only allowances
for doubtful accounts to better conform to the prevailing practice in our industry. Our other receivable
allowances include allowances for product returns, charge backs, defective products and promotional
markdowns. These other allowances totaled $45.8 million at December 31, 2004 and $25.4 million at December
31, 2003. The increase in other receivable allowances was primarily due to allowances for short-shipments and
service-related sales allowances, and to a lesser extent, higher promotional allowances. These amounts are now
treated as reductions of gross accounts receivable. All prior period financial statements have been adjusted to
conform to the current period’s presentation.
Inventories and Related Allowance For Slow-Moving, Excess and Obsolete Inventory
Inventories are stated at the lower of cost, on a first-in, first-out basis, or market value and are reduced by an
allowance for slow-moving, excess and obsolete inventories. Our estimate for slow-moving, excess and obsolete
inventories is based on our management’s review of on hand inventories compared to their estimated future
usage and demand for our products. If actual future usage and demand for our products are less favorable than
those projected by our management, additional inventory write-downs may be required. For example, lower than
planned sales in 2004 resulted in higher charges for excess and obsolete raw materials and finished goods.
Provisions for excess and obsolete inventory were $14.6 million in 2004.
Intangible Assets
Intangible assets, including excess purchase price over the cost of net assets acquired (Goodwill), arose from
our September 23, 1997 acquisition of substantially all the assets and business of our predecessor, LeapFrog RBT,
and our acquisition of substantially all the assets of Explore Technologies on July 22, 1998. At December 31,
2004, our intangible assets had a net balance of $29.5 million. The Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS 142).
SFAS 142 requires the use of a nonamortization approach to account for goodwill and some other intangible
assets. We adopted the pronouncement effective January 1, 2002, and accordingly we no longer amortize goodwill
and other indefinite-lived intangible assets. As of December 31, 2004, we had $19.5 million, net, of goodwill and
other indefinite-lived intangible assets, which are no longer subject to amortization. At December 31, 2004, we
tested our goodwill and other intangible assets for impairment based on the fair value of the cash flows that the
business can be expected to generate in the future, known as the income approach. Based on this assessment we
determined that no adjustments were necessary to the stated values. Intangible assets also include patents, and
trademarks and licenses, which include a ten-year technology license agreement entered into in January 2004 to
jointly develop and customize our optical scanning technology.
The determination of related useful lives and whether the intangible assets are impaired involves significant
judgment. Changes in strategy or market conditions could significantly impact these judgments and require that
adjustments be recorded to asset balances. We review intangible assets, as well as other long-lived assets, for
impairment whenever events or circumstances indicate that the carrying value may not be fully recoverable.
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