LeapFrog 2008 Annual Report Download - page 71

LEAPFROG ENTERPRISES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
Advertising Expense
Production costs of commercials and programming are expensed when the production is first aired. The
Company’s direct costs of advertising, in-store displays and promotion programs are expensed as incurred.
Under the Company’s arrangements with certain of its customers, it reduces the net selling price of its
products as an incentive (sales allowances) for the customers to independently promote LeapFrog products for
resale. The Company accounts for the costs associated with these cooperative sales/advertising agreements in
accordance with EITF No. 01-09 “Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor’s Products).” If the benefits LeapFrog receives from the customer in these cooperative
arrangements are not specifically identifiable, the Company recognizes the costs as a direct reduction of revenue
earned from the customer during the period, with a corresponding reduction in accounts receivable. In those
cases where the benefits received from the customer are sufficiently separable and can be specifically identified,
these costs are included as advertising expense during the fiscal period in which the advertisements are run.
Derivative Financial Instruments
The Company transacts business in various foreign currencies, primarily in the British Pound, Canadian
Dollar, Euro and Mexican Peso. As a safeguard against financial exposure from potential adverse changes in
currency exchange rates, the Company engages in a foreign exchange hedging program. The program utilizes
foreign exchange forward contracts that generally settle within 30 to 60 days to enter into fair value hedges of
foreign currency exposures of underlying non-functional currency assets and liabilities that are subject to
re-measurement. The exposures are generated primarily through inter-company sales in foreign currencies and
through U.S. Dollar-denominated sales by the Company’s foreign affiliates. The hedging program is designed to
reduce, but does not always eliminate, the impact of the re-measurement of balance sheet items due to
movements of currency exchange rates.
LeapFrog does not use forward exchange hedging contracts for speculative or trading purposes. In
accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” all forward
contracts are carried on the balance sheet at fair value as assets or liabilities. The estimated fair values of forward
contracts are based on quoted market prices for similar assets and liabilities. The corresponding gains and losses
are recognized immediately in earnings as an offset to the changes in fair value of the assets or liabilities being
hedged. These gains and losses are included in “other income (expense)” in the statements of operations.
The Company believes that the counterparties to these contracts, multinational commercial banks, are
creditworthy; thus, the risks of counterparty nonperformance associated with these contracts are not considered
to be significant. The Company updates its evaluation of the creditworthiness of its counterparties on a quarterly
basis. Notwithstanding the Company’s efforts to manage foreign exchange risk, there can be no assurance that its
hedging activities will adequately protect against the risks associated with foreign currency fluctuations.
Income Taxes
The Company accounts for income taxes in accordance with the requirements of SFAS No. 109, “Accounting
for Income Taxes,” (“SFAS 109”). Deferred tax assets and liabilities are calculated based on differences between
the financial reporting and tax bases of assets and liabilities, using enacted tax rates and laws that are expected to be
in effect when the differences are expected to reverse. The Company accrues for uncertain tax positions in
accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”). The
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