America Online 2014 Annual Report Download - page 73

AOL INC.
PART II—ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
In addition to customer credit risk, our note hedge transactions expose us to credit risk to the extent that the
counterparties may be unable to meet the terms of the agreements. We mitigate such risk by limiting the
counterparties to major financial institutions and by spreading the risk across several major financial institutions.
Critical Accounting Policies
Our accompanying consolidated financial statements are prepared in accordance with GAAP, which require
management to make estimates, judgments and assumptions that affect the amounts reported in the
accompanying consolidated financial statements and the accompanying notes. Management considers an
accounting policy to be critical if it is important to our financial condition and results of operations and if it
requires significant judgment and estimates on the part of management in its application. The development and
selection of these critical accounting policies have been determined by our management. Due to the significant
judgment involved in selecting certain of the assumptions used in these areas, it is possible that different parties
could choose different assumptions and reach different conclusions. We consider the policies related to the
following matters to be critical accounting policies: (a) gross versus net revenue recognition; (b) impairment of
goodwill; and (c) income taxes.
Gross versus Net Revenue Recognition
We generate a significant portion of our advertising revenues from our advertising offerings on the Third
Party Properties, which consist of sales of display, video and search advertising. In connection with our
advertising offerings on the Third Party Properties, we sometimes act as or use an intermediary or agent in
executing transactions with third parties. The significant judgments made in accounting for these arrangements
relate to determining whether we should report revenue based on the gross amount billed to the customer or on
the net amount received from the customer after commissions and other payments to third parties. To the extent
revenues are recorded on a gross basis, any commissions or other payments to third parties are recorded as costs
of revenues so that the net amount (gross revenues less expense) is reflected in operating income. Accordingly,
the impact on operating income is the same whether we record revenue on a gross or net basis.
The determination of whether revenue should be reported gross or net is based on an assessment of whether
we are acting as the principal or an agent in the transaction. If we are acting as a principal in a transaction, we
report revenue on a gross basis. If we are acting as an agent in a transaction, we report revenue on a net basis.
The determination of whether we are acting as the principal or an agent in a transaction involves judgment and is
based on an evaluation of the terms of an arrangement. We recognize revenue on a gross basis in situations in
which we believe we are the principal in the transactions, considering all of the indicators set forth in the
accounting guidance for principal agent considerations. While none of the indicators individually are considered
presumptive or determinative, in reaching our conclusions on gross versus net revenue recognition, we place the
most weight on the analysis of whether or not we are the primary obligor in the arrangement.
The determination of whether we should report our revenue based on the gross amount billed to our
advertising customers, with the amounts paid to the Third Party Properties website owner (for the advertising
inventory acquired) reported as TAC within costs of revenues, requires a significant amount of judgment based
on an analysis of several factors. In these arrangements, we are generally responsible for (i) identifying and
contracting with third-party advertisers, (ii) establishing the selling prices of the inventory sold, (iii) serving the
advertisements at our cost and expense, (iv) performing all billing and collection activities including retaining
credit risk, (v) bearing sole liability for fulfillment of the advertising and (vi) bearing general inventory risk.
Accordingly, in these arrangements, we generally believe that we are the primary obligor and therefore report
revenues earned and costs incurred related to these transactions on a gross basis. During 2014, we earned and
reported gross advertising revenues of $856.2 million and incurred TAC of $555.8 million related to providing
advertising services on the Third Party Properties.
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