LeapFrog 2010 Annual Report Download - page 48

Capitalization of Product Costs
We capitalize certain external costs related to the development of content for our learning products, including
design, artwork, animation, layout, editing, voice, audio and software included in the learning products. Such
costs are capitalized once the technological feasibility of the product is established and costs are determined to be
recoverable. Amortization of these costs begins when the products are initially released for sale and continues
over a two-year life using the straight-line method, and is included in cost of sales. We evaluate the future
recoverability of capitalized amounts periodically and recognize write-downs of these amounts in the statements
of operations as needed. Capitalized content costs that are cancelled, abandoned or otherwise deemed impaired
are charged to cost of sales in the period of cancellation. Our evaluation in identified capitalized costs related to
several platforms that had been discontinued, while the 2009 evaluation resulted in minor impairments and 2008
evaluation identified capitalized costs related to several platforms that had been retired or discontinued.
Accordingly, we accelerated the amortization of these costs, resulting in an increase in cost of sales in the U.S.
segment of $0.7 million, $0.3 million and $2.2 million in 2010, 2009 and 2008, respectively.
We also capitalize external website development costs (“website costs”), which primarily include third-party
costs related to developing applications that are an integral component of certain products we market, as well as
costs incurred to develop or acquire and customize code for web applications, costs to develop HTML web pages
or develop templates, and costs to create initial graphics for the website that included the design or layout of each
page. Website costs are amortized on a straight-line basis over two years. We evaluate the future recoverability
of capitalized website costs periodically and if an impairment loss is considered to have occurred during the
period, we accelerate the amortization and record it in “depreciation and amortization” in the statement of
operations in the same period.
Our evaluations of capitalized content development costs 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. Capitalized content development costs and website costs
are both included in “Capitalized product costs” on the balance sheet, net of accumulated amortization.
Goodwill and Other Intangible Assets
We review goodwill for impairment at least annually, and between annual tests if events occur or circumstances
change that warrant a review. 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 requires
significant judgment, including identification of reporting units, assignment of assets and liabilities to reporting
units, assignment of goodwill to reporting units, determination of the fair value of each reporting unit, and
projections of future net cash flows, which projections are inherently uncertain. The fair value of each reporting
unit is estimated using a combination of a market approach and a discounted cash flow methodology. The market
approach requires considerable judgment in selecting comparable companies and estimating the multiples of
revenue implied by their market values. The discounted cash flow methodology requires management to exercise
judgment in selecting an appropriate discount rate and to make numerous assumptions in order to develop future
business and financial forecasts and the related estimates of future net cash flows. Future net cash flows depend
primarily on future sales of our products, which are inherently difficult to predict. This is especially true when a
significant portion of our future net sales is expected to be generated by both mature products as well as products
introduced in 2010 and planned to be introduced in 2011. After analyzing our goodwill at December 31, 2010
and 2009, we concluded no impairment charge was required in either period. At December 31, 2010 and 2009 we
had $25.2 million and $22.2 million of goodwill and other intangible assets, respectively.
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