LeapFrog 2010 Annual Report Download - page 61

LEAPFROG ENTERPRISES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
The Company also capitalizes external website development costs (“website costs”), which primarily include
third-party costs related to developing applications that are an integral component of certain products the
Company markets, 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.
The Company evaluates the future recoverability of capitalized website costs periodically and if an impairment
loss is considered to have occurred during the period, accelerates the amortization and records it in “depreciation
and amortization” in the statement of operations in the same period.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation. Depreciation expense is calculated using
the straight-line method over the estimated useful life of the assets, generally between two and three years,
except for leasehold improvements, which are depreciated over the shorter of the estimated related useful life of
the asset or the remaining term of the lease. Amortization of equipment under capital leases, if any, is included in
depreciation expense. Depreciation expense for manufacturing tools is included in cost of sales.
Goodwill
The Company reviews its goodwill for impairment using a two step test at least annually on December 31, and
between annual tests if events occur or circumstances change that warrant a review. When evaluating goodwill
for impairment, the Company first compares the fair value of the reporting unit(s) to which the goodwill is
allocated, to the carrying value of the unit(s) to determine if there is an impairment loss. If the fair value of the
reporting unit exceeds its carrying value, goodwill allocated to that unit is considered not impaired. If the inverse
is true, the unit is considered to be impaired and the Company must then complete the second step of the test
which calls for a fair value analysis of the individual assets and liabilities assigned to the reporting unit to
determine the amount of impairment to record. Application of the goodwill impairment test requires significant
judgment by management, 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 Company considers the results generated from using both of the following approaches to estimate the fair
value of each relevant reporting unit to complete the first step of the impairment test:
1. The market approach is used to develop indications of fair value. This approach uses market values and
revenue multiples of other publicly traded companies engaged in the same or similar lines of business
as ours.
2. The discounted cash flow (“DCF”) methodology is used to develop an additional estimate of fair
value. The DCF methodology recognizes that current value is premised on the expected receipt of
future economic benefits. Indications of value are developed by discounting projected future net cash
flows to their present value at a rate that reflects both the current return requirements of the market and
the risks inherent in the specific investment.
The determination of whether goodwill is impaired involves numerous assumptions, estimates and the
application of significant judgment. For the market approach, considerable judgment is required to select
comparable companies and to estimate the multiples of revenue implied by their market values. For the DCF
methodology, management must exercise judgment in selecting an appropriate discount rate and must also make
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