THQ 2004 Annual Report Download - page 35

CRITICAL ACCOUNTING POLICIES
The Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated
financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the
reporting period. The policies discussed below are considered by management to be critical because they are both important to the portrayal of our
financial condition and results of operations and their application places the most significant demands on management’s judgment, with financial reporting
results relying on estimates about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in
the following paragraphs. For all of these policies, management cautions that actual results may differ materially from these estimates under different
assumptions or conditions.
Allowances for price protection, returns and doubtful accounts. We derive revenues from sales of packaged software for video game systems and
personal computers and sales of software and services for wireless devices. Product revenue is recognized net of allowances for price protection and
returns and various customer discounts. We typically only allow returns for our personal computer products; however, we may decide to provide price
protection or allow returns for our video game system or personal computer products after we analyze: i) inventory remaining in the retail channel, ii)
the rate of inventory sell through in the retail channel, and iii) our remaining inventory on hand. We maintain a policy of giving credits for price
protection and returns, but do not give cash refunds.
We establish sales allowances based on estimates of future price protection and returns with respect to current period product revenue. We analyze
historical price protection granted, historical returns, current sell through of retailer and distributor inventory of our products, current trends in the video
game market and the overall economy, changes in customer demand and acceptance of our products, and other related factors when evaluating the
adequacy of the price protection and returns allowance. In addition, management monitors the volume of our sales to retailers and distributors and their
inventories, because slow-moving inventory in the distribution channel can result in the requirement for price protection or returns in subsequent
periods. In the past, actual price protection and returns have not generally exceeded our reserves. However, actual price protection and returns in any
future period are uncertain. While management believes it can make reliable estimates for these matters, if we changed our assumptions and estimates,
our price protection and returns reserves would change, which would impact the net revenue we report. In addition, if actual price protection and returns
were significantly greater than the reserves we have established, the actual results of our reported net sales would decrease. Conversely, if actual price
protection and returns were significantly less than our reserves, our reported net sales would increase.
Similarly, management must use significant judgment and make estimates in connection with establishing allowances for doubtful accounts in any
accounting period. Management analyzes customer concentrations, customer credit-worthiness and current economic trends when evaluating the
adequacy of the allowance for doubtful accounts. Material differences may result in the amount and timing of our bad debt expense for any period if
management made different judgments or utilized different estimates. If our customers experience financial difficulties and are not able to meet their
ongoing financial obligations to us, our results of operations may be adversely impacted.
For the fiscal year ended March 31, 2004, the three months ended March 31, 2003 and the calendar year ended December 31, 2002, we recorded
allowances for future price protection, returns and doubtful accounts of approximately $121 million, $10 million, and $69.6 million, respectively. The
increase in fiscal 2004 in allowances for future price protection, returns and doubtful accounts is related to the increase in sales during the fiscal year and
our estimate of future price protection and returns based on the factors discussed above. Additionally, during the fiscal year ended March 31, 2004 we
recorded approximately $7 million of bad debt expense due to KB Toys’ filing for bankruptcy protection on January 14, 2004. As of March 31, 2004,
March 31, 2003, and December 31, 2002, our aggregate reserves against accounts receivable for price protection, returns and doubtful accounts
were approximately $52.4 million, $43.4 million and $59.9 million, respectively.
Licenses. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded as an asset (licenses) and as a liability (accrued
royalties) at the contractual amount upon execution of the contract when no significant performance remains with the licensor. When significant
performance remains with the licensor, we record royalty payments as an asset (licenses) when actually paid rather than upon execution of the contract.
Royalty payments for intellectual property licenses are classified as current assets and current liabilities to the extent such royalty payments relate to
anticipated sales during the subsequent year and long-term assets and long-term liabilities to the extent such royalty payments relate to anticipated sales
after one year.
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THQ : 2004 : ANNUAL REPORT