THQ 2012 Annual Report Download - page 46

38
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 3 — 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 sales inputs are developed using recent internal sales performance for similar titles, adjusted for current market
trends and comparable products. As certain of our licenses extend for multiple products over multiple years, we also assess the