Electronic Arts 2014 Annual Report Download - page 104

rights, content and/or other intellectual property. Royalty payments to independent software developers are
payments for the development of intellectual property related to our games. Co-publishing and distribution royalties
are payments made to third parties for the delivery of products.
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, number of platforms we release on, 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 generally 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 carryforwards. 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.
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