Mattel 2004 Annual Report Download - page 48

management, such as a bankruptcy filing of a customer, the allowance is reviewed for adequacy and adjusted to
reflect the change in the estimated amount to be received from the customer. Changes in the allowance for
doubtful accounts between year end 2002 and 2004 reflect management’s assessment of the factors noted above,
including past due accounts, disputed balances with customers, and the financial condition of customers. The
allowance for doubtful accounts is also affected by the time at which uncollectible accounts receivable balances
are actually written off.
Mattel believes that its allowance for doubtful accounts at year end 2004 is adequate and proper. However,
as described above, Mattel’s business is greatly dependent on a small number of customers. Should one or more
of Mattel’s major customers experience liquidity problems, then the allowance for doubtful accounts of
$32.8 million, or 4.1% of trade accounts receivable, at year end 2004 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 that the accounting estimate related to the allowance for obsolescence is a “critical
accounting estimate” because changes in the assumptions used to develop the estimate 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 of both retailers and
consumers 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, changes in buying patterns of both retailers and
consumers 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 and forecasts, taking into account
historical trends, results of market research and current market information. Mattel ships products in accordance
with delivery schedules specified by its customers, who usually request delivery within three months. In
anticipation of retail sales in the traditional holiday season, 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 its fiscal 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 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 have a certain level of uncertainty.
As a result, it is difficult to estimate the level of growth or contraction for the economy as a whole. It is even
more difficult to estimate growth or contraction 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 or contraction 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.
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