LeapFrog 2010 Annual Report Download - page 62

LEAPFROG ENTERPRISES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
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 the Company’s products, which
are inherently difficult to predict.
Research and Development Costs
Internal and external research and development costs incurred before a project reaches technological feasibility
are expensed as incurred. External costs incurred after a project reaches technological feasibility are capitalized.
Capitalized costs are amortized into cost of sales when the product is released to the market, over two years using
the straight-line method. Capitalized research and development costs are reviewed for future recoverability
periodically. Impairment losses are charged to cost of sales in the period in which they occur.
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 arrangements with certain of its customers, the Company reduces the net selling price of its products as an
incentive (sales allowances) for the customers to independently promote LeapFrog products for resale. If the
benefits LeapFrog receives from the customer in these cooperative sales or advertising 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.
Royalty Expense
The Company licenses certain of its content from third parties under exclusive and nonexclusive agreements,
which permit the Company to utilize characters, stories, illustrations and trade names throughout specified
geographic territories. Royalty payments are typically calculated as a percentage of the unit product selling price.
Royalty expense is recorded when the products are shipped to a customer and is reported under cost of sales in
the statements of operations.
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. All forward
contracts are carried on the balance sheet at fair value as assets or liabilities. The estimated fair values of forward
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