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required to estimate the effective royalty rate for a particular contract. Because the computation of effective
royalty rates requires us to project future revenue, it is inherently subjective as our future revenue projections
must anticipate a number of factors, including (1) the total number of titles subject to the contract, (2) the timing
of the release of these titles, (3) the number of software units we expect to sell, which can be impacted by a
number of variables, including product quality, the timing of the title's release and competition, and (4) future
pricing. Determining the effective royalty rate for our titles is particularly challenging due to the inherent
difficulty in predicting the popularity of entertainment products. Furthermore, if we conclude that we are unable
to make a reasonably reliable forecast of projected net revenue, we recognize royalty expense at the greater of
contract rate or on a straight-line basis over the term of the contract. Accordingly, if our future revenue
projections change, our effective royalty rates would change, which could impact the amount and timing of
royalty expense we recognize.
Prepayments made to thinly capitalized independent software developers and co-publishing affiliates are
generally made in connection with the development of a particular product, and therefore, we are generally
subject to development risk prior to the release of the product. Accordingly, payments that are due prior to
completion of a product are generally expensed to research and development over the development period as the
services are incurred. Payments due after completion of the product (primarily royalty-based in nature) are
generally expensed as cost of revenue.
Our contracts with some licensors include minimum guaranteed royalty payments, which are initially recorded as
an asset and as a liability at the contractual amount when no performance remains with the licensor. When
performance remains with the licensor, we record guarantee payments as an asset when actually paid and as a
liability when incurred, rather than recording the asset and liability upon execution of the contract. Royalty
liabilities are classified as current liabilities to the extent such royalty payments are contractually due within the
next 12 months.
Each quarter, we also evaluate the expected future realization of our royalty-based assets, as well as any
unrecognized minimum commitments not yet paid to determine amounts we deem unlikely to be realized through
product sales. Any impairments or losses determined before the launch of a product are charged to research and
development expense. Impairments or losses determined post-launch are charged to cost of revenue. We evaluate
long-lived royalty-based assets for impairment generally using undiscounted cash flows when impairment
indicators exist. Unrecognized minimum royalty-based commitments are accounted for as executory contracts,
and therefore, any losses on these commitments are recognized when the underlying intellectual property is
abandoned (i.e., cease use) or the contractual rights to use the intellectual property are terminated.
Income Taxes
We recognize deferred tax assets and liabilities for both the expected impact of differences between the financial
statement amount and the tax basis of assets and liabilities and for the expected future tax benefit to be derived
from tax losses and tax credit carry forwards. We record a valuation allowance against deferred tax assets when it
is considered more likely than not that all or a portion of our deferred tax assets will not be realized. In making
this determination, we are required to give significant weight to evidence that can be objectively verified. It is
generally difficult to conclude that a valuation allowance is not needed when there is significant negative
evidence, such as cumulative losses in recent years. Forecasts of future taxable income are considered to be less
objective than past results, particularly in light of the economic environment. Therefore, cumulative losses weigh
heavily in the overall assessment.
In addition to considering forecasts of future taxable income, we are also required to evaluate and quantify other
possible sources of taxable income in order to assess the realization of our deferred tax assets, namely the
reversal of existing deferred tax liabilities, the carry back of losses and credits as allowed under current tax law,
and the implementation of tax planning strategies. Evaluating and quantifying these amounts involves significant
judgments. Each source of income must be evaluated based on all positive and negative evidence; this evaluation
involves assumptions about future activity. Certain taxable temporary differences that are not expected to reverse
during the carry forward periods permitted by tax law cannot be considered as a source of future taxable income
that may be available to realize the benefit of deferred tax assets.