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Sales Returns and Allowances and Bad Debt Reserves
We reduce revenue primarily for estimated future returns and price protection which may occur with our
distributors and retailers ("channel partners"). Price protection represents our practice to provide our channel
partners with a credit allowance to lower their wholesale price on a particular product in the channel. The amount
of the price protection is generally the difference between the old wholesale price and the new reduced wholesale
price. In certain countries for our PC and console packaged goods software products, we also have a practice of
allowing channel partners to return older software products in the channel in exchange for a credit allowance. As
a general practice, we do not give cash refunds.
When evaluating the adequacy of sales returns and price protection allowances, we analyze the following:
historical credit allowances, current sell-through of our channel partner's inventory of our software products,
current trends in retail and the video game industry, changes in customer demand, acceptance of our software
products, and other related factors. In addition, we monitor the volume of sales to our channel partners and their
inventories, as substantial overstocking in the distribution channel could result in high returns or higher price
protection in subsequent periods.
In the future, actual returns and price protections may materially exceed our estimates as unsold software
products in the distribution channels are exposed to rapid changes in consumer preferences, market conditions or
technological obsolescence due to new platforms, product updates or competing software products. While we
believe we can make reliable estimates regarding these matters, these estimates are inherently subjective.
Accordingly, if our estimates change, our returns and price protection allowances would change and would
impact the total net revenue, accounts receivable and deferred net revenue that we report.
We determine our allowance for doubtful accounts by evaluating the following: customer creditworthiness, current
economic trends, historical experience, age of current accounts receivable balances, changes in financial condition
or payment terms of our customers. Significant management judgment is required to estimate our allowance for
doubtful accounts in any accounting period. The amount and timing of our bad debt expense and cash collection
could change significantly as a result of a change in any of the evaluation factors mentioned above.
Royalties and Licenses
Royalty-based obligations with content licensors and distribution affiliates are either paid in advance and
capitalized as prepaid royalties or are accrued as incurred and subsequently paid. These royalty-based obligations
are generally expensed to cost of revenue generally at the greater of the contractual rate or an effective royalty
rate based on the total projected net revenue for contracts with guaranteed minimums. Significant judgment is
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 expenses that we recognize.
Each quarter, we 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.