THQ 2006 Annual Report Download - page 34

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the allowance for doubtful accounts. Material differences may result in the amount and timingof 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 ongoingfinancial obligations to
us, our results of operations may be adversely impacted.
Licenses. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded
on our balance sheet as an asset (licenses) and as a liability (accrued royalties) at the contractual amount
upon execution of the contract if no significant performance obligation remains with the licensor. When a
significant performance obligation remains with the licensor, we record royalty payments as an asset
(licenses) when payable rather than upon executionof the contract. Royalty payments for intellectual
property licenses are classified as current assets and current liabilities to the extentsuch royalty payments
relate to anticipated sales during the subsequent year and long-term assets and long-term liabilities if such
royalty payments relate to anticipated sales after one year.
We evaluate the future recoverability of our capitalized licenses on a quarterly basis. The recoverability of
capitalized license costs is evaluated based on the expected performance of the specific products in which
the licensed trademark or copyright is to be used. As many of our licenses extend for multiple products
over multiple years, we also assess the recoverability of capitalized license costs based on certain
qualitative factors such as the success of other products and/or entertainment vehicles utilizing the
intellectual property, whether there are any future planned theatrical releases or television series based on
the intellectual property and the rights holder’s continued promotion and exploitation of the intellectual
property. Prior to the related product’s release, we expense, as part of license amortization and royalties,
capitalized license costs when we believe such amounts are not recoverable.
Licenses are expensed to license amortization and royalties at the higher of (1) the contractual royalty rate
based on actual net product sales related to such license or (2) an effective rate based upon total projected
revenue related to such license. When, in management’s estimate, future cash flows will not be sufficient to
recover previously capitalized costs, we expense these capitalized costs to license amortization and
royalties. If actual revenues or revised forecasted revenues fall below the initial forecasted revenues for a
particular license, the charge to license amortization and royalties expense may be larger than anticipated
in any given quarter. As of March 31, 2006, the net carrying value of our licenses was $81.5 million. If we
were required to write off licenses, due to changes in market conditions or product acceptance, our results
of operations could be materially adversely affected.
Software Development.We utilize both internal development teams and third-party software developers
to develop our software. We account for software development costs in accordance with SFAS No. 86,
“Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.” We
capitalize software development costs once technological feasibility is established and we determine that
such costs are recoverable against future revenues. For products where proven game engine technology
exists, this may occur early in the development cycle. We capitalize the milestone payments made to third-
party software developers and the direct payroll and overhead costs for our internal development teams.
We evaluate technological feasibility on a product-by-product basis. Amounts related to software
development for which technological feasibility is not yet met are charged as incurred to product
development expense in our consolidated statements of operations.
On a quarterly basis, we compare our unamortized software development costs to net realizable value, on a
product-by-product basis. The amount by which any unamortized software development costs exceed their
net realizable value is charged to software development amortization. The net realizable value is the
estimated future gross revenues from the product, reduced by the estimated future costs of completingthe
product.
Commencing upon product release, capitalized software development costs are amortized to software
development amortization based on the ratio of current revenues to total projected revenues. If actual