Electronic Arts 2006 Annual Report Download - page 110

an eÅective royalty rate based on expected net product sales. SigniÑcant judgment is required to estimate
the eÅective royalty rate for a particular contract. Because the computation of eÅective royalty rates
requires us to project future revenue, it is inherently subjective as our future revenue projections must
anticipate (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, and (4) future pricing. Determining the eÅective
royalty rate for hit-based titles is particularly diÇcult due to the inherent risk of such titles. Accordingly, if
our future revenue projections change, our eÅective royalty rates would change, which could impact the
royalty expense we recognize. Prepayments made to thinly capitalized independent software developers and
co-publishing aÇliates are generally 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 as research and
development as the services are incurred. Payments due after completion of the product (primarily royalty-
based in nature) are generally expensed as cost of goods sold generally at the greater of the contractual
rate or an eÅective royalty rate based on expected net product sales.
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 signiÑcant performance remains
with the licensor. When signiÑcant performance remains with the licensor, we record royalty payments as
an asset when actually paid and as a liability when incurred, rather than upon execution of the contract.
Minimum royalty payment obligations are classiÑed as current liabilities to the extent such royalty
payments are contractually due within the next twelve months. As of March 31, 2006 and 2005,
approximately $9 million and $51 million, respectively, of minimum guaranteed royalty obligations had
been recognized.
Each quarter, we also evaluate the 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 determined before the launch of a product are charged to research
and development expense. Impairments determined post-launch are charged to cost of goods sold. In either
case, we rely on estimated revenue to evaluate the future realization of prepaid royalties and commitments.
If actual sales or revised revenue estimates fall below the initial revenue estimate, then the actual charge
taken may be greater in any given quarter than anticipated. During Ñscal 2006, 2005 and 2004, we
recorded impairment charges of $16 million, $8 million and $2 million, respectively.
Valuation of Long-Lived Assets
We evaluate both purchased intangible assets and other long-lived assets in order to determine if events or
changes in circumstances indicate a potential impairment in value exists. This evaluation requires us to
estimate, among other things, the remaining useful lives of the assets and future cash Öows of the business.
These evaluations and estimates require the use of judgment. Our actual results could diÅer materially
from our current estimates.
Under current accounting standards, we make judgments about the recoverability of purchased intangible
assets and other long-lived assets whenever events or changes in circumstances indicate a potential
impairment in the remaining value of the assets recorded on our Consolidated Balance Sheet. In order to
determine if a potential impairment has occurred, management makes various assumptions about the
future value of the asset by evaluating future business prospects and estimated cash Öows. Our future net
cash Öows are primarily dependent on the sale of products for play on proprietary video game consoles,
handheld game players, PCs and cellular handsets (""platforms''). The success of our products is aÅected
by our ability to accurately predict which platforms and which products we develop will be successful.
Also, our revenue and earnings are dependent on our ability to meet our product release schedules. Due to
product sales shortfalls, we may not realize the future net cash Öows necessary to recover our long-lived
assets, which may result in an impairment charge being recorded in the future. We did not record any
asset impairment charges in Ñscal 2006 and Ñscal 2005. During Ñscal 2004, we recognized less than
$1 million of asset impairment charges.
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