THQ 2011 Annual Report Download - page 44

of content and services over the Internet and for wireless devices. Product sales are recognized net of allowances for price protection
and returns and various customer discounts. We typically only allow returns for our PC products; however, we may decide to
provide price protection or allow returns for our retail video game sales 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 use significant judgment and make estimates
in connection with establishing allowances for price protection, returns, and doubtful accounts in any accounting period. Included
in our accounts receivable allowances is our allowance for co-operative advertising that we engage in with our retail channel
partners. Our co-operative advertising allowance is based upon specific contractual commitments and does not involve estimates
made by management.
We establish sales allowances based on estimates of future price protection and returns with respect to current period product
sales. 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 industry 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,
we monitor 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. Actual price protection and
returns in any future period are uncertain. While we believe we 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 sales 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. In circumstances when we do not have a reliable basis to estimate returns and price protection
or are unable to determine that collection of a receivable is probable, we defer the sale until such time as we can reliably estimate
any related returns and allowances and determine that collection of the receivable is probable.
Similarly, we must use significant judgment and make estimates in connection with establishing allowances for doubtful accounts
in any accounting period. We analyze 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 we 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 further information, see "Note 5 — Accounts Receivable Allowances" in the notes to the consolidated financial statements
included in Item 8.
Licenses. Minimum guaranteed royalty payments for intellectual property licenses are initially recorded on our consolidated
balance sheets 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) and as a liability (accrued royalties) when payable 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 product sales during the subsequent year and long-term assets and long-
term liabilities if such royalty payments relate to anticipated product sales after one year. Licenses are expensed to "Cost of sales
— License amortization and royalties" in our consolidated statements of operations at the higher of (i) the contractual royalty rate
based on actual net product sales related to such license, or (ii) an effective rate based upon total projected net sales related to such
license.
Software Development. We utilize both internal development teams and third-party software developers to develop our software.
We capitalize software development costs once technological feasibility is established and we determine that such costs are
recoverable against future net sales. We evaluate technological feasibility on a product-by-product basis. For products where
proven game engine technology exists, the establishment of technological feasibility 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. 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. Commencing upon product
release, capitalized software development costs are amortized to "Cost of sales — Software amortization and royalties" in our
consolidated statements of operations based on the ratio of current gross sales to total projected gross sales.
Licenses and Software Development Impairment Analysis. We evaluate the future recoverability of our capitalized licenses and
software development on a quarterly basis in connection with the preparation of our financial statements. In this evaluation, we
compare the carrying value of such capitalized costs to their net realizable value, on a product-by-product basis. The net realizable
value is determined using Level 3 inputs, specifically, the estimated future net sales from the product, reduced by the estimated
future direct costs associated with the product such as completion costs, cost of sales and selling and marketing expenses. Net
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