Electronic Arts 2005 Annual Report Download - page 80

‚ Collection is deemed probable: At the time of the transaction, we conduct a credit review of each
customer involved in a signiÑcant transaction to determine the creditworthiness of the customer.
Collection is deemed probable if we expect the customer to be able to pay amounts under the
arrangement as those amounts become due. If we determine that collection is not probable, we
recognize revenue when collection becomes probable (generally upon cash collection).
Determining whether and when some of these criteria have been satisÑed often involves assumptions and
judgments that can have a signiÑcant impact on the timing and amount of revenue we report. For example, for
multiple element arrangements, we must make assumptions and judgments in order to: (1) determine whether
and when each element has been delivered; (2) determine whether undelivered products or services are
essential to the functionality of the delivered products and services; (3) determine whether vendor-speciÑc
objective evidence of fair value (""VSOE'') exists for each undelivered element; and (4) allocate the total
price among the various elements we must deliver. Changes to any of these assumptions or judgments, or
changes to the elements in a software arrangement, could cause a material increase or decrease in the amount
of revenue that we report in a particular period.
Product revenue, including sales to resellers and distributors (""channel partners''), is recognized when the
above criteria are met. We reduce product revenue for estimated future returns, price protection, and other
oÅerings, which may occur with our customers and channel partners. In certain countries, we have stock-
balancing programs for our PC products, which allow for the exchange of PC products by resellers under
certain circumstances. It is our general practice to exchange products or give credits, rather than give cash
refunds.
In certain countries, from time to time, we decide to provide price protection for both our PC and video game
system products. In our decision, we analyze historical returns, current sell-through of distributor and retailer
inventory of our products, current trends in the video game market and the overall economy, changes in
consumer demand and acceptance of our products and other related factors when evaluating the adequacy of
the sales returns and price protection allowances. In addition, we monitor the volume of our sales to our
channel partners and their inventories, as substantial overstocking in the distribution channel could result in
high returns or higher price protection costs in subsequent periods. While historically actual returns and price
protection have not generally exceeded our reserves, as we have previously publicly stated, in the quarter
ended March 31, 2005 we incurred higher actual returns and price protection than we had anticipated. We
have reviewed current sell-through information through the date of this Ñling and do not intend to accept sales
returns or provide price protection on unsold product in our distribution channels existing as of March 31,
2005 in amounts in excess of our March 31, 2005 allowances.
In the future, actual returns and price protections may materially exceed our estimates as unsold 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 products. For example, the
risk of product returns and/or price protection for our products may increase as the PlayStation 2, Xbox and
Nintendo GameCube consoles move through their lifecycles and an increasing number and aggregate amount
of competitive products heighten pricing and competitive pressures. While management believes it can make
reliable estimates regarding these matters, these estimates are inherently subjective. Accordingly, if our
estimates changed, our returns and price protection reserves would change, which would impact the total net
revenue we report. For example, if actual returns and/or price protection were signiÑcantly greater than the
reserves we have established, our actual results would decrease our reported total net revenue. Conversely, if
actual returns and/or price protection were signiÑcantly less than our reserves, this would increase our
reported total net revenue.
SigniÑcant judgment is required to estimate our allowance for doubtful accounts in any accounting period. We
determine our allowance for doubtful accounts by evaluating customer creditworthiness in the context of
current economic trends. Depending upon the overall economic climate and the Ñnancial condition of our
customers, the amount and timing of our bad debt expense and cash collection could change signiÑcantly.
Royalties and Licenses
Our royalty expenses consist of payments to (1) content licensors, (2) independent software developers, and
(3) co-publishing and/or distribution aÇliates. License royalties consist of payments made to celebrities,
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