LeapFrog 2008 Annual Report Download - page 48

We capitalize certain external costs related to the development of content for our learning products
according to the guidance provided in Emerging Issues Task Force (“EITF”) Issue No. 96-6, “Accounting for
Film and Software Costs Associated with Developing Entertainment and Educational Software Products” and
SFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,”
(“SFAS 86”). Our capitalized external costs generally relate to design, artwork, animation, layout, editing, voice,
audio and software included in the learning products. We capitalize these costs once technological feasibility has
been established for the related projects. We evaluate the future recoverability of capitalized content and website
costs on a quarterly basis. Capitalized costs for products that are cancelled, abandoned or otherwise deemed
impaired are charged to expense in the period of cancellation. We also capitalize external website development
costs (“website costs”) in accordance with Emerging Issues Task Force (“EITF”) No. 00-02, “Accounting for
Website Development Costs.” Website costs presently comprise primarily third-party costs related to developing
applications that are an integral component of certain products we market, as well as some costs incurred to
develop or acquire and customize code for web applications, costs to develop HTML web pages or develop
templates. We evaluate the future recoverability of website costs on a quarterly basis and if an impairment loss is
considered to have occurred during the period, the loss is recorded in the statement of operations in the same
period. Our evaluations of capitalized content and website costs require us to make complex and subjective
judgments, using currently available data as well as projections about the potential impact of possible future
events and conditions, which judgments and projections are inherently uncertain. If future events and conditions
do not meet expectations, we make additional adjustments to reduce the expected realizable value of the assets,
with corresponding increases to cost of sales. Both of these capitalized costs are included in “Capitalized product
costs” on the balance sheet.
In accordance with the requirements of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS
142”), we evaluate goodwill for impairment at the end of each fiscal year and between annual tests if an event
occurs or circumstances change that would more likely than not reduce the fair value of the applicable reporting
unit below its carrying value. These events or circumstances could include a significant change in the business
climate, legal factors or operating performance indicators. Application of the goodwill impairment test involves
numerous assumptions, estimates and the application of significant judgment, including the identification of
reporting units, evaluation of current market indicators and projections of future product sales and net cash flows,
among others. These judgments and projections are inherently uncertain. Any future impairment tests may result
in a write-down of goodwill and a corresponding non-cash charge to earnings if we experience sales shortfalls,
fail to reduce our expenses or if our market capitalization as of the measurement date exceeds the carrying value
of our net assets at the same date by an amount that cannot be attributed to any specific asset on our balance
sheet. As discussed above, after analyzing our goodwill at December 31, 2008 and 2007, we concluded no
impairment charge was required in either period. See Footnote 2—“Significant Accounting Policies” in our
Consolidated Financial Statements included in this Form 10-K for more information on our goodwill policy and
its application.
We account for income taxes in accordance with the requirements of SFAS 109, “Accounting for Income
Taxes” and FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”). We
calculate our deferred tax assets and liabilities based on differences between the financial reporting and tax bases
of assets and liabilities, using enacted tax rates and laws that we expect will be in effect when the differences are
expected to reverse. We accrue for uncertain tax positions in accordance with FIN 48. Determining our income
tax assets, liabilities and expense requires us to make significant estimates and judgments in assessing the future
tax consequences of events that have been recognized in our financial statements or tax returns. Variations in the
actual outcome of these future tax consequences could materially impact our financial position, results of
operations or cash flows. We provide valuation allowances when it is more likely than not that all or a portion of
a deferred tax asset will not be realized. Determining whether a valuation allowance is warranted requires
judgment about factors such as prior earnings history, expected future earnings, carryback and carryforward
periods, and tax strategies that could potentially enhance the likelihood of realization of a deferred tax asset. Our
financial statements also include accruals for the estimated amounts of probable future assessments that may
result from the examination of federal, state or international tax returns. Our tax accruals, tax provision, deferred
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