Mattel 2005 Annual Report Download - page 56

returns in future years for which Mattel has already recorded a tax benefit in its consolidated statement of
operations. Mattel records a valuation allowance to reduce its deferred income tax assets if, based on the weight
of available evidence, management believes expected future taxable income is not likely to support the use of a
deduction or credit in that jurisdiction. Management evaluates the level of Mattel’s valuation allowances at least
annually, and more frequently if actual operating results differ significantly from forecasted results.
Management believes that Mattel’s tax positions are fully supported, but establishes reserves for certain tax
return positions that are likely to be challenged by the applicable taxing authority. Management reviews these
reserves in light of changing facts and circumstances, such as the progress and ultimate settlement of a tax audit
and developments in applicable law, and adjusts these reserves accordingly. In 2005, Mattel reduced its total
income tax reserves by $38.6 million as a result of settlements reached with various taxing authorities and a
reassessment of tax exposures based on the status of current audits in various jurisdictions around the world. In
the fourth quarter of 2004, Mattel reached a settlement with the IRS regarding the examination of Mattel’s US
federal income tax returns for the years 1998 through 2001. The settlement resulted in a net benefit of
$65.1 million from changes in tax estimates, and the benefit is reflected in the 2004 provision for income taxes in
the consolidated statement of operations. The ultimate settlement of any particular issue with the applicable
taxing authority could have a material impact on Mattel’s provision for income taxes, net income and deferred
income tax assets and liabilities.
New Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”), Share-Based
Payment, which replaced SFAS No. 123 and superseded APB Opinion No. 25. SFAS No. 123(R) requires all
share-based payments to employees, including grants of employee stock options, to be recognized in the financial
statements based on their fair values. The pro forma disclosures previously permitted under SFAS No. 123 will
no longer be an alternative to financial statement recognition. Under SFAS No. 123(R), Mattel must determine
the appropriate fair value method to be used for valuing share-based payments, the expense attribution method
for compensation cost and the transition method to be used at the time of adoption. The transition methods
include prospective and retroactive adoption options. The prospective method requires that compensation cost be
recorded for all unvested stock options, restricted stock and restricted stock units beginning in the first quarter of
adoption of SFAS No. 123(R), whereas the retroactive method requires recording compensation cost for all
unvested stock options, restricted stock and restricted stock units beginning with the first period restated.
In April 2005, the Securities Exchange Commission amended Rule S-X to delay the effective date for
compliance with SFAS No. 123(R). Based on the amended rule, Mattel is required to adopt SFAS No. 123(R) on
January 1, 2006. In 2006, Mattel plans to use the prospective method of adoption under SFAS No. 123(R), and
for new grants, to attribute expense to the service periods through the straight-line method. In December 2005,
the Compensation Committee of the Board of Directors of Mattel approved the acceleration of vesting of certain
outstanding unvested stock options primarily to avoid future compensation expense for those stock options, and
because there may be future benefits for the provision for income taxes for financial reporting purposes. See
Item 8 “Financial Statements and Supplementary Data—Note 1 to the Consolidated Financial Statements, Stock-
Based Compensation.” Mattel is evaluating the requirements of SFAS No. 123(R) and expects that the adoption
of SFAS No. 123(R) will negatively impact its results of operations; however, the amount and materiality of the
impact will depend on the amount and type of share-based payments granted in future periods.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs—An Amendment of ARB No. 43,
Chapter 4. SFAS No. 151 amends the guidance in Chapter 4, “Inventory Pricing,” of Accounting Research
Bulletin (“ARB”) No. 43, Restatement and Revision of Accounting Research Bulletins, to clarify the accounting
for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (“spoilage”). Among
other provisions, the statement requires that items such as idle facility expense, excessive spoilage, double
freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the
criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS No. 151 requires that the allocation of
fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities.
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