Mattel 2002 Annual Report Download - page 45

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one or more of these customers experience liquidity problems, then the allowance for doubtful accounts of
$23.3 million, or 4.5% of trade accounts receivable, at year end 2002 may not prove to be sufficient to cover such
losses. Any incremental bad debt charges would negatively affect the results of operations of one or more of
Mattel’s business segments.
Inventories—Allowance for Obsolescence
Inventories, net of an allowance for excess quantities and obsolescence, are stated at the lower of cost or
market. Inventory obsolescence reserves are recorded for damaged, obsolete, excess and slow-moving inventory.
Management believes the accounting estimate related to the inventory allowance is a “critical accounting
estimate” because changes in it could materially affect key financial measures including, gross profit, net income
and inventories. In addition, the valuation requires a high degree of judgment since it involves estimation of the
impact resulting from both current and expected future events. As more fully described below, valuation of
Mattel’s inventory could be impacted by changes in public and consumer preferences, demand for product, or
changes in the buying patterns and inventory management of customers.
In the toy industry, orders are subject to cancellation or change at any time prior to shipment since actual
shipments of products ordered and order cancellation rates are affected by consumer acceptance of product lines,
strength of competing products, marketing strategies of retailers and overall economic conditions. Unexpected
changes in these factors could result in excess inventory in a particular product line, which would require
management to make a valuation estimate on such inventory.
Mattel bases its production schedules for toy products on customer orders, historical trends, results of
market research and current market information. Mattel ships products in accordance with delivery schedules
specified by its customers, which usually request delivery within three months. In anticipation of retail sales in
the traditional holiday season in the fourth quarter, Mattel significantly increases its production in advance of the
peak selling period, resulting in a corresponding build-up of inventory levels in the first three quarters of the
year. These seasonal purchasing patterns and requisite production lead times cause risk to Mattel’s business
associated with the underproduction of popular toys and the overproduction of toys that do not match consumer
demand. Retailers are also attempting to manage their inventories more tightly, requiring Mattel to ship products
closer to the time the retailers expect to sell the products to consumers. These factors increase inventory
valuation risk since Mattel may not be able to meet demand for certain products at peak demand times, or that
Mattel’s own inventory levels may be adversely impacted by the need to pre-build products before orders are
placed.
Additionally, current conditions in the domestic and global economies are extremely uncertain. As a result,
it is difficult to estimate the level of growth in various parts of the economy, including the markets in which
Mattel participates. Because all components of Mattel’s budgeting and forecasting are dependent upon estimates
of growth in the markets it serves and demand for its products, the prevailing economic uncertainties render
estimates of future demand for product more difficult. Such economic changes may affect the sales of Mattel’s
products and its corresponding inventory levels, which would potentially impact the valuation of its inventory.
At the end of each quarter, management within each business segment, US Girls, US Boys-Entertainment,
US Infant & Preschool, and International, performs a detailed review of its inventory on an item by item basis
and identifies which products are believed to be obsolete or slow-moving. Management then applies an
allowance for inventory obsolescence to such inventory based on certain expectations, including customer and
consumer demand for product and the aging of the inventory, which are impacted by the factors discussed above.
At year end 2002, Mattel’s obsolescence reserve was $49.1 million (or 12.7% of total inventory),
$63.1 million (or 11.5% of total inventory) and $58.6 million (or 10.7% of total inventory) at year end 2002,
2001 and 2000, respectively. The decrease in the obsolescence reserve at year end 2002 compared to 2001 and
2000 was due to Mattel’s focus on reducing its obsolete and slow moving inventory in 2002. Management
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