LeapFrog 2011 Annual Report Download - page 60

LEAPFROG ENTERPRISES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and money market funds with original maturities of three months
or less.
Fair Value of Financial Instruments
Fair values of the Company’s financial instruments, consisting of short-term money market funds and
long-term investments in auction rate securities (‘‘ARS’’), reflect the estimates of exit price, or the amounts
that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market
participants as of the measurement date.
The Company recognizes impairments to the carrying values of its financial instruments when their fair values
decline below their carrying values. A systematic methodology is employed on a quarterly basis that considers
available quantitative and qualitative evidence in evaluating investments for potential impairment. If the cost
of an investment exceeds its fair value, management evaluates, among other factors, general market
conditions, the duration of and the extent to which the fair value is less than cost and the Company’s intent
and ability to hold the investment. Further, the Company considers specific adverse conditions related to the
financial health of and business outlook for the investees, rating agency actions, the overall financial health of
the macro-economy and the financial markets, as well as the ability to liquidate the investments at par, given
prevailing and anticipated circumstances. The Company retains qualified third parties to perform independent
valuations of its ARS quarterly and considers these evaluations in its impairment evaluation process.
The Company bifurcates other-than-temporary impairments based on the portion of the loss related to credit
factors and the portion of the loss that is not related to credit factors. The credit loss portion is the difference
between the amortized cost of the security and the Company’s best estimate of the present value of the cash
flows expected to be collected from the debt security. The noncredit loss portion is the residual amount of the
other-than-temporary impairment. The credit loss portion is recorded as a charge to investment income, and
the noncredit loss portion is recorded as a separate component of other comprehensive income. Subsequent
recoveries in value are recorded to the accumulated other comprehensive income (loss).
Inventory Valuation
Inventories are stated at the lower of cost or market value, on a first-in, first-out basis. The Company records
inventory costs on the balance sheet based on third-party contract manufacturer invoices, which include the
contract manufacturers’ costs for materials, labor and manufacturing overhead related to its products.
Inventory valuation primarily requires estimation of slow-moving, obsolete or excess products. The
Company’s estimate of write-downs for slow-moving, excess and obsolete inventories is based on
management’s review of on-hand inventories compared to their estimated future usage, product demand
forecast, anticipated product selling prices, the expected product lifecycle, and products planned for
discontinuation. If actual future usage, demand for the Company’s products and anticipated product selling
prices were less favorable than those projected by management, additional inventory write-downs would be
required, resulting in a negative impact on the gross margin.
The Company monitors the estimates of inventory write-downs on a quarterly basis. When considered
necessary, the Company makes additional adjustments to reduce inventory to its net realizable value, with
corresponding increases to cost of sales.
Capitalized Product Costs
The Company capitalizes certain external costs related to the development of content for its learning products,
including design, artwork, animation, layout, editing, voice, audio and apps included in the learning products.
50