a. How many shares of stock did Electronic Arts issue during 2011 due to employees through stock plans?

b. If so, what was the value of shares issued from this activity?

MANAGEMENT 120A CASE ASSIGNMENT 1 Intangible Assets ELECTRONIC ARTS INC. Electronic Arts (EA), headquartered in Redwood City, California, is the world's leading interactive entertainment software company. Founded in 1982, the company develops, publishes, and distributes interactive software worldwide for videogame systems, personal computers and the Internet. EA's homepage and online game site is www.ea.com. We develop, market, publish and distribute game software and content that can be played by consumers on a variety of video game machines and electronic devices (which we call \"platforms\"), including: Video game consoles, such as the Sony PLAYSTATION 3, Microsoft Xbox 360 and Nintendo Wii, Personal computers, including the Apple Macintosh (we refer to personal computers and the Macintosh together as \"PCs\"), Mobile phones, such as the Apple iPhone, Google Android compatible phones, and feature phones, Tablets and electronic readers, such as the Apple iPad and the Amazon Kindle, The Internet, including on social networking sites such as Facebook, and Handheld game players such as the Sony PlayStation Portable (\"PSP\") and Nintendo DS and 3DS. Our ability to publish games across multiple platforms has been, and will continue to be, a cornerstone of our product strategy. Technology advances continue to create new platforms for interactive entertainment. Examples include wireless technologies, streaming gaming services, and Internet-connected televisions. We expect that new platforms such as these will continue to grow the consumer base for our products while also providing competition for established video game platforms. Our products for videogame consoles, PCs and handhelds are delivered on physical media (disks and cartridges) that are sold at retailers (we call these \"packaged goods\" products) or by us directly to consumers. We also deliver game content and services online for the platforms listed above through digital downloads. In addition, we offer online delivered content and services as add-ons or as related features to our packaged goods products ( e.g. , add-on content or matchmaking services); while other games, content and services that we offer, such as games for mobile devices, and Internet-only games, are available only through online delivery. We believe that online delivery of game content and services has become and will continue to be an increasingly important part of our business. Page | 1 Management 120A Case 1 Using the excerpts from Electronic Arts's 2011 financial statements and footnotes, please answer the following questions: 1. What is software development? How does the company handle software development? What are the guidelines for capitalizing software development? Is this similar or dissimilar to research and development (R&D) and if there is a difference, what would it be? 2. What is the percentage of operating tangible assets to shareholders equity in 2011? How has this changed from previous years? 3. What are the operating asset turnover, gross profit margin and net profit margin in 2011? How has this changed from previous years? 4. What are the major costs of Electronic Arts and how are these reflected on the financial statement in 2011? 5. What are the critical drivers of value creation for Electronic Arts and how are these reflected on the financial statements in 2011? 6. How would you adjust the accounting measures (if at all) if you are: a. Evaluating the performance of the management? b. Forecasting the future performance of the business? 7. Treasury Stock a. How much did Electronic Arts pay for the Treasury Stock it held at fiscal year-end 2011? b. How much cash did Electronic Arts pay to repurchase its own shares during 2011? c. Did Electronic Arts use these Treasury shares for anything during 2011? (For example, did Electronic Arts use these Treasury shares to issue shares for stock options that were exercised by employees?) 8. Issuance of stock a. How many shares of stock did Electronic Arts issue during 2011 due to employees through stock plans? b. If so, what was the value of shares issued from this activity? 9. Earnings per Share (EPS) a. What was the weighted average number of shares outstanding during 2011? b. What was the Basic net income per share? c. In addition to reporting Basic earnings per share, FASB requires firms to report an earnings number assuming that some shares had diluted EPS. What was Diluted EPS for 2011 and how does this compare to previous years? d. Why do you think diluted EPS is different than basic EPS? e. Which of these would be more informative and why? Page | 2 Management 120A Case 1 ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions, except par value data) March 31, 2011 March 31, 2010 $ $ ASSETS Current assets: Cash and cash equivalents Short-term investments Marketable equity securities Receivables, net of allowances of $304 and $217, respectively Inventories Deferred income taxes, net Other current assets Total current assets Property and equipment, net Goodwill Acquisition-related intangibles, net Deferred income taxes, net Other assets TOTAL ASSETS 1,579 497 161 335 77 56 327 1,273 432 291 206 100 44 239 3,032 2,585 513 1,110 144 49 80 537 1,093 204 52 175 $ 4,928 $ 4,646 $ 228 768 1,005 $ 91 717 766 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable Accrued and other current liabilities Deferred net revenue (packaged goods and digital content) Total current liabilities 2,001 1,574 Income tax obligations Deferred income taxes, net Other liabilities 192 37 134 242 2 99 2,364 1,917 Total liabilities Commitments and contingencies (See Note 11) Stockholders' equity: Preferred stock, $0.01 par value. 10 shares authorized Common stock, $0.01 par value. 1,000 shares authorized; 333 and 330 shares issued and outstanding, respectively Paid-in capital Retained earnings (accumulated deficit) Accumulated other comprehensive income Total stockholders' equity TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 3 2,495 (153 ) 219 3 2,375 123 228 2,564 2,729 4,928 $ 4,646 Page | 3 Management 120A Case 1 ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In millions, except per share data) Net revenue Cost of goods sold Gross profit Operating expenses: Marketing and sales General and administrative Research and development Restructuring and other charges Amortization of intangibles Acquisition-related contingent consideration Goodwill impairment Certain abandoned acquisition-related costs Acquired in-process technology Total operating expenses Year Ended March 31, 2011 2010 2009 $ 3,589 1,499 $ 3,654 1,866 $ 4,212 2,127 2,090 1,788 2,085 747 301 1,153 161 57 (17 ) 730 320 1,229 140 53 2 691 332 1,359 80 58 368 21 3 2,402 2,474 2,912 Operating loss Gains (losses) on strategic investments, net Interest and other income, net (312 ) 23 10 (686 ) (26 ) 6 (827 ) (62 ) 34 Loss before provision for (benefit from) income taxes Provision for (benefit from) income taxes (279 ) (3 ) (706 ) (29 ) (855 ) 233 $ (276 ) $ (677 ) $ (1,088 ) $ (0.84 ) $ (2.08 ) $ (3.40 ) Net loss Net loss per share: Basic and Diluted Number of shares used in computation: Basic and Diluted 330 325 320 Page | 4 Management 120A Case 1 ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS (In millions, share data in thousands) Paid-in Capital Retained Earnings (Accumulated Deficit) Accumulated Other Comprehensive Income Total Stockholders' Equity 3 $ 1,864 $ $ $ (366 ) (366 ) 55 55 14 14 (10 ) (10 ) (88 ) (88 ) Common Stock Balances as of March 31, 2008 Net loss Change in unrealized losses on available-for-sale securities, net Reclassification adjustment for losses realized on available-forsale securities, net Change in unrealized gains on derivative instruments, net Reclassification adjustment for gains realized on derivative instruments, net Foreign currency translation adjustments Shares Amount 317,681 $ 1,888 (1,088 ) 584 Total comprehensive loss Issuance of common stock Stock-based compensation Tax benefit from exercise of stock options Balances as of March 31, 2009 Net loss Change in unrealized losses on available-for-sale securities, net Reclassification adjustment for losses realized on available-forsale securities, net Change in unrealized losses on derivative instruments, net Reclassification adjustment for losses realized on derivative instruments, net Foreign currency translation adjustments Balances as of March 31, 2010 Net loss Change in unrealized losses on available-for-sale securities, net Reclassification adjustment for gains realizedon available-forsale securities, net (1,088 ) (1,483 ) 5,161 73 203 73 203 2 2 322,842 3 2,142 800 189 3,134 (677 ) (677 ) (54 ) (54 ) 21 21 (2 ) (2 ) 1 1 73 73 Total comprehensive loss Issuance of common stock Stock-based compensation Tax benefit from exercise of stock options Equity consideration granted in connection with acquisition 4,339 (638 ) 6,745 21 187 21 187 14 14 11 11 329,587 3 2,375 123 228 2,729 (276 ) (4 ) (4 ) (28 ) (28 ) (276 ) Page | 5 Management 120A Change in unrealized losses on derivative instruments, net Reclassification adjustment for losses realized on derivative instruments, net Foreign currency translation adjustments Case 1 (7 ) (7 ) 5 5 25 25 Total comprehensive loss Issuance of common stock Repurchase and retirement of common stock Stock-based compensation Tax costs from exercise of stock options Balances as of March 31, 2011 (285 ) 6,081 4 4 (3,104 ) (58 ) 176 (58 ) 176 (2 ) (2 ) 332,564 $ 3 $ 2,495 $ (153 ) $ 219 $ 2,564 Page | 6 Management 120A Case 1 ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) OPERATING ACTIVITIES Net loss Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation, amortization and accretion, net Stock-based compensation Other non-cash restructuring charges Net losses (gains) on investments and sale of property and equipment Acquisition-related contingent consideration Goodwill impairment Acquired in-process technology Change in assets and liabilities: Receivables, net Inventories Other assets Accounts payable Accrued and other liabilities Deferred income taxes, net Deferred net revenue (packaged goods and digital content) Year Ended March 31, 2011 2010 2009 $ (276 ) Net cash provided by operating activities INVESTING ACTIVITIES Purchase of headquarters facilities Capital expenditures Proceeds from sale of marketable equity securities Proceeds from maturities and sales of short-term investments Purchase of short-term investments Acquisition-related restricted cash Acquisition of subsidiaries, net of cash acquired Net cash provided by (used in) investing activities FINANCING ACTIVITIES Proceeds from issuance of common stock Excess tax benefit from stock-based compensation Repurchase and retirement of common stock Net cash provided by (used in) financing activities Effect of foreign exchange on cash and cash equivalents Increase (decrease) in cash and cash equivalents Beginning cash and cash equivalents Ending cash and cash equivalents Supplemental cash flow information: Cash paid (refunded) during the year for income taxes, net Non-cash investing activities: Change in unrealized losses on available-for-sale securities, net of taxes Equity consideration granted in connection with acquisition $ (677 ) $ (1,088 ) 180 176 1 (25 ) (17 ) 192 187 39 22 2 198 203 25 65 368 3 (122 ) 25 5 114 (4 ) 24 239 (66 ) 123 18 (57 ) (138 ) 2 505 221 (49 ) 52 (26 ) (56 ) 222 (126 ) 320 152 12 (59 ) 132 442 (514 ) (16 ) (233 ) (72 ) 17 710 (611 ) (100 ) (283 ) (115 ) 891 (695 ) (58 ) (15 ) (572 ) 23 34 1 (58 ) 39 14 89 2 (23 ) 53 91 24 19 (58 ) 306 1,273 (348 ) 1,621 68 1,553 $ 1,579 $ 1,273 $ 1,621 $ 21 $ (34 ) $ 25 $ $ (4 ) $ $ (54 ) 11 $ $ (366 ) Page | 7 Management 120A Case 1 ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES We develop, market, publish and distribute game software and content that can be played by consumers on a variety of platforms, including video game consoles (such as the Sony PLAYSTATION 3, Microsoft Xbox 360 and Nintendo Wii), personal computers, mobile phones (such as the Apple iPhone and Google Android compatible phones), tablets and electronic readers (such as the Apple iPad and Amazon Kindle), the Internet, and handheld game players (such as the PlayStation Portable (\"PSP\") and the Nintendo DS and 3DS). Some of our games are based on content that we license from others ( e.g. , FIFA, Madden NFL, Harry Potter, and Hasbro's toy and game intellectual properties), and some of our games are based on our own wholly-owned intellectual property ( e.g. , The Sims, Need for Speed, and Dead Space). Our goal is to publish titles with global mass-market appeal, which often means translating and localizing them for sale in non-English speaking countries. In addition, we also attempt to create software game \"franchises\" that allow us to publish new titles on a recurring basis that are based on the same property. Examples of this franchise approach are the annual iterations of our sports-based products ( e.g. , FIFA, Madden NFL, and NCAA Football), wholly-owned properties that can be successfully sequeled ( e.g. , The Sims, Need for Speed, and Battlefield) and titles based on long-lived literary and/or movie properties (e.g. , Harry Potter). A summary of our significant accounting policies applied in the preparation of our Consolidated Financial Statements follows: Consolidation The accompanying Consolidated Financial Statements include the accounts of Electronic Arts Inc. and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in the consolidation. Fiscal Year Our fiscal year is reported on a 52- or 53-week period that ends on the Saturday nearest March 31. Our results of operations for the fiscal years ended March 31, 2011 and 2009 each contained 52 weeks and ended on April 2, 2011 and March 28, 2009, respectively. Our results of operations for the fiscal year ended March 31, 2010 contained 53 weeks and ended on April 3, 2010. For simplicity of disclosure, all fiscal periods are referred to as ending on a calendar month-end. Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and the accompanying notes. Such estimates include sales returns and allowances, provisions for doubtful accounts, accrued liabilities, service period for deferred net revenue, income taxes, losses on royalty commitments, estimates regarding the recoverability of prepaid royalties, inventories, long-lived assets, assets acquired and liabilities assumed in business combinations, certain estimates related to the measurement and recognition of costs resulting from our share-based payment awards, deferred income tax assets and associated valuation allowance as well as estimates used in our goodwill, short-term investments, and marketable equity securities impairment tests. These estimates generally involve complex issues and require us to make judgments, involve analysis of historical and future trends, can require extended periods of time to resolve, and are subject to change from period to period. In all cases, actual results could differ materially from our estimates. Page | 8 Management 120A Case 1 Cash, Cash Equivalents, Short-Term Investments and Marketable Equity Securities Cash equivalents consist of highly liquid investments with insignificant interest rate risk and original or remaining maturities of three months or less at the time of purchase. Short-term investments consist of securities with original or remaining maturities of greater than three months at the time of purchase and are accounted for as available-for-sale securities and are recorded at fair value. Short-term investments are available for use in current operations or other activities such as capital expenditures and business combinations. Marketable equity securities consist of investments in common stocks of publicly traded companies and are accounted for as available-for-sale securities and are recorded at fair value. Unrealized gains and losses on our short-term investments and marketable equity securities are recorded as a component of accumulated other comprehensive income in stockholders' equity, net of tax, until either (1) the security is sold, (2) the security has matured, or (3) we determine that the fair value of the security has declined below its adjusted cost basis and the decline is other-than-temporary. Realized gains and losses on our short-term investments and marketable equity securities are calculated based on the specific identification method and are reclassified from accumulated other comprehensive income to interest and other income, net, and gains (losses) on strategic investments, net, respectively. Determining whether the decline in fair value is other-than-temporary requires management judgment based on the specific facts and circumstances of each security. The ultimate value realized on these securities is subject to market price volatility until they are sold. Our short-term investments and marketable equity securities are evaluated for impairment quarterly. We consider various factors in determining whether we should recognize an impairment charge, including the credit quality of the issuer, the duration that the fair value has been less than the adjusted cost basis, severity of the impairment, reason for the decline in value and potential recovery period, the financial condition and near-term prospects of the investees, and our intent to sell and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value, any contractual terms impacting the prepayment or settlement process, as well as if we would be required to sell an investment due to liquidity or contractual reasons before its anticipated recovery. If we conclude that an investment is other-than-temporarily impaired, we will recognize an impairment charge at that time in our Consolidated Statements of Operations. Inventories Inventories consist of materials (including manufacturing royalties paid to console manufacturers), labor and freight-in and are stated at the lower of cost (first-in, first-out method) or market value. We regularly review inventory quantities on-hand. We write down inventory based on excess or obsolete inventories determined primarily by future anticipated demand for our products. Inventory writedowns are measured as the difference between the cost of the inventory and market value, based upon assumptions about future demand that are inherently difficult to assess. At the point of a loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established basis. Property and Equipment, Net Property and equipment, net, are stated at cost. Depreciation is calculated using the straight-line method over the following useful lives: Buildings Computer equipment and software Furniture and equipment 20 to 25 years 3 to 5 years 3 to 5 years Page | 9 Management 120A Leasehold improvements Case 1 Lesser of the lease term or the estimated useful lives of the improvements, generally 1 to 10 years We capitalize costs associated with customized internal-use software systems that have reached the application development stage and meet recoverability tests. Such capitalized costs include external direct costs utilized in developing or obtaining the applications and payroll and payroll-related expenses for employees, who are directly associated with the development of the applications. Capitalization of such costs begins when the preliminary project stage is complete and ceases at the point in which the project is substantially complete and is ready for its intended purpose. The net book value of capitalized costs associated with internal-use software was $50 million and $37 million as of March 31, 2011 and 2010, respectively, and are being depreciated on a straight-line basis over each asset's estimated useful life, which is generally three years. Acquisition-Related Intangibles and Other Long-Lived Assets We record acquisition-related intangible assets that have finite useful lives, such as developed and core technology, in connection with business combinations. We amortize the cost of acquisition-related intangible assets on a straight-line basis over the lesser of their estimated useful lives or the agreement terms, typically from two to fourteen years. We evaluate acquisition-related intangibles and other longlived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. This includes assumptions about future prospects for the business that the asset relates to and typically involves computations of the estimated future cash flows to be generated by these businesses. Based on these judgments and assumptions, we determine whether we need to take an impairment charge to reduce the value of the asset stated on our Consolidated Balance Sheets to reflect its estimated fair value. Judgments and assumptions about future values and remaining useful lives are complex and often subjective. They can be affected by a variety of factors, including but not limited to, significant negative industry or economic trends, significant changes in the manner of our use of the assets or the strategy of our overall business and significant under-performance relative to expected historical or projected future operating results. When we consider such assets to be impaired, the amount of impairment we recognize is measured by the amount by which the carrying amount of the asset exceeds its fair value. We recognized $14 million, $39 million and $25 million in impairment charges in fiscal years 2011, 2010 and 2009, respectively. The charges for fiscal years 2010 and 2009 are included in restructuring and other charges in our Consolidated Statements of Operations. The charges for fiscal year 2011 are included in restructuring and other charges and research and development in our Consolidated Statements of Operations. Goodwill We are required to perform a two-step approach for testing goodwill for impairment for each reporting unit annually, or whenever events or changes in circumstances indicate that fair value of a reporting unit is below its carrying amount. Our reporting units are determined by the components of our operating segments that constitute a business for which (1) discrete financial information is available and (2) segment management regularly reviews the operating results of that component. The first step measures for impairment by applying fair value-based tests at the reporting unit level. The second step (if necessary) measures the amount of impairment by applying fair value-based tests to the individual assets and liabilities within each reporting unit. The fair value of each reporting unit is estimated using a combination of the market approach, which utilizes comparable companies' data, and/or the income approach, which utilizes discounted cash flows. Page | 10 Management 120A Case 1 During the fiscal years ended March 31, 2011 and 2010, we completed the first step of the annual goodwill impairment testing in the fourth quarter of each year and found no indicators of impairment of our recorded goodwill. We did not recognize an impairment charge on goodwill in fiscal years 2011 and 2010. Adverse economic conditions, including the decline in our market capitalization and our expected financial performance at the time, indicated that a potential impairment of goodwill existed during the fiscal year ended March 31, 2009. As a result, we performed goodwill impairment tests for our reporting units and determined that the fair value of our EA Mobile reporting unit fell below the carrying value of that reporting unit. As a result, we conducted the second step in the impairment testing and determined that the EA Mobile reporting unit's goodwill was impaired. The fair value of the EA Mobile reporting unit was determined using the income approach. Substantially all of our goodwill associated with our EA Mobile reporting unit was derived from our fiscal 2006 acquisition of JAMDAT Mobile Inc. During the fiscal year ended March 31, 2009, we recognized a goodwill impairment charge of $368 million related to our EA Mobile reporting unit. See Note 17 for information regarding our segment information. Taxes Collected from Customers and Remitted to Governmental Authorities Taxes assessed by a government authority that are both imposed on and concurrent with specific revenue transactions between us and our customers are presented on a net basis in our Consolidated Statements of Operations. Concentration of Credit Risk We extend credit to various companies in the retail and mass merchandising industries. Collection of trade receivables may be affected by changes in economic or other industry conditions and may, accordingly, impact our overall credit risk. Although we generally do not require collateral, we perform ongoing credit evaluations of our customers and maintain reserves for potential credit losses. Invoices are aged based on contractual terms with our customers. The provision for doubtful accounts is recorded as a charge to operating expense when a potential loss is identified. Losses are written off against the allowance when the receivable is determined to be uncollectible. Short-term investments are placed with high quality financial institutions or in short-duration, investment-grade securities. We limit the amount of credit exposure in any one financial institution or type of investment instrument. Revenue Recognition We evaluate revenue recognition based on the criteria set forth in FASB ASC 985-605, Software: Revenue Recognition and Staff Accounting Bulletin (\"SAB\") No. 101, Revenue Recognition in Financial Statements , as revised by SAB No. 104, Revenue Recognition . We evaluate and recognize revenue when all four of the following criteria are met: Evidence of an arrangement . Evidence of an agreement with the customer that reflects the terms and conditions to deliver products must be present. Delivery . Delivery is considered to occur when a product is shipped and the risk of loss and rewards of ownership have been transferred to the customer. For online game services, delivery is considered to occur as the service is provided. For digital downloads that do not have an online service component, delivery is generally considered to occur when the download is made available. Fixed or determinable fee . If a portion of the arrangement fee is not fixed or determinable, we recognize revenue as the amount becomes fixed or determinable. Page | 11 Management 120A Case 1 Collection is deemed probable . We conduct a credit review of each customer involved in a significant 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 satisfied often involves assumptions and management judgments that can have a significant impact on the timing and amount of revenue we report in each period. 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 specific objective evidence (\"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 management 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. Depending on the type of product, we may offer an online service that permits consumers to play against others via the Internet and/or receive additional updates or content from us. For those games that consumers can play via the Internet, we may provide a \"matchmaking\" service that permits consumers to connect with other consumers to play against each other online. In those situations where we do not require an additional fee for this online service, we account for the sale of the software product and the online service as a \"bundled\" sale, or multiple element arrangement, in which we sell both the software product and the online service for one combined price. We defer net revenue from sales of these games for which we do not have VSOE for the online service that we provided in connection with the sale, and recognize the revenue from these games over the estimated online service period, which is generally estimated to be six months beginning in the month after shipment. In addition, for some software products we also provide updates or additional content (\"digital content\") to be delivered via the Internet that can be used with the original software product. In many cases we separately sell digital content for an additional fee; however, some purchased digital content can only be accessed via the Internet ( i.e. , the consumer never takes possession of the digital content). We account for online transactions in which the consumer does not take possession of the digital content as a service transaction and, accordingly, we recognize the associated revenue over the estimated service period. In other transactions, at the date we sell the software product we have an obligation to provide incremental unspecified digital content in the future without an additional fee. In these cases, we account for the sale of the software product as a multiple element arrangement and recognize the revenue on a straight-line basis over the estimated period of game play. Determining whether a transaction constitutes an online service transaction or a digital content download of a product requires judgment and can be difficult. The accounting for these transactions is significantly different. Revenue from product downloads is generally recognized when the download is made available (assuming all other recognition criteria are met). Revenue from an online game service is recognized as the service is rendered. If the service period is not defined, we recognize the revenue over the estimated service period. Determining the estimated service period is inherently subjective and is subject to regular revision based on historical online usage. In addition, determining whether we have an implicit obligation to provide incremental unspecified future digital content without an additional fee can be difficult. Product Revenue. 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 offerings, which may occur with our customers and channel partners. Page | 12 Management 120A Case 1 Shipping and Handling. We recognize amounts billed to customers for shipping and handling as revenue. Additionally, shipping and handling costs incurred by us are included in cost of goods sold. Online Subscription Revenue. Online subscription revenue is derived principally from subscription revenue collected from customers for online play related to our massively multiplayer online games and Pogo-branded online games services. These customers generally pay on an annual basis or a month-to-month basis and prepaid subscription revenue is recognized ratably over the period for which the services are provided. Software Licenses. We license software rights to manufacturers of products in related industries (for example, makers of personal computers or computer accessories) to include certain of our products with the manufacturer's product, or offer our products to consumers who have purchased the manufacturer's product. We call these combined products \"OEM bundles.\" These OEM bundles generally require the customer to pay us an upfront nonrefundable fee, which represents the guaranteed minimum royalty amount. Revenue is generally recognized upon delivery of the product master or the first copy. Per-copy royalties on sales that exceed the minimum guarantee are recognized as earned. Sales Returns and Allowances and Bad Debt Reserves We estimate potential future product returns, price protection and stock-balancing programs related to product revenue. When evaluating the adequacy of sales returns and price protection allowances, we analyze historical returns, current sell-through of distributor and retailer inventory of our software products, current trends in retail and the video game industry, changes in customer demand and 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 costs in subsequent periods. Page | 13 Management 120A Case 1 Similarly, significant judgment is required to estimate our allowance for doubtful accounts in any accounting period. We analyze customer concentrations, customer credit-worthiness, current economic trends, and historical experience when evaluating the adequacy of the allowance for doubtful accounts. 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 royaltybased obligations are generally expensed to cost of goods sold generally at the greater of the contractual rate for contracts with guaranteed minimums, or an effective royalty rate based on the total projected net revenue. 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. 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. 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 goods sold. We evaluate long-lived royalty-based assets for impairment generally using undiscounted cash flows when impairment indicators exist. Unrecognized minimum royaltybased 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. Advertising Costs We generally expense advertising costs as incurred, except for production costs associated with media campaigns, which are recognized as prepaid assets (to the extent paid in advance) and expensed at the first run of the advertisement. Cooperative advertising costs are recognized when incurred and are included in marketing and sales expense if there is a separate identifiable benefit for which we can reasonably estimate the fair value of the benefit identified. Otherwise, they are recognized as a reduction of revenue and are generally accrued when revenue is recognized. We then reimburse the channel partner when qualifying claims are submitted. We are also reimbursed from our vendors for advertising costs, and such amounts are recognized as a reduction of marketing and sales expense if the advertising (1) is specific to the vendor, (2) represents an identifiable benefit to us, and (3) represents an incremental cost to us. Otherwise, vendor reimbursements are recognized as a reduction of cost of goods sold as the related revenue is recognized. Vendor reimbursements of advertising costs of $31 million, $39 million, and $31 million reduced marketing and sales expense for the fiscal years ended March 31, 2011, 2010 and 2009, respectively. For the fiscal years ended March 31, 2011, 2010 and 2009, advertising expense, net of vendor reimbursements, totaled approximately $312 million, $326 million, and $270 million, respectively. Software Development Costs Page | 14 Management 120A Case 1 Research and development costs, which consist primarily of software development costs, are expensed as incurred. We are required to capitalize software development costs incurred for computer software to be sold, leased or otherwise marketed after technological feasibility of the software is established or for development costs that have alternative future uses. Under our current practice of developing new products, the technological feasibility of the underlying software is not established until substantially all product development and testing is complete, which generally includes the development of a working model. The software development costs that have been capitalized to date have been insignificant. Stock-Based Compensation We are required to estimate the fair value of share-based payment awards on the date of grant. We recognize compensation costs for stock-based payment awards to employees based on the grant-date fair value using a straight-line approach over the service period for which such awards are expected to vest. The fair value of restricted stock units and restricted stock is determined based on the quoted market price of our common stock on the date of grant. The fair value of stock options and stock purchase rights granted pursuant to our equity incentive plans and our 2000 Employee Stock Purchase Plan (\"ESPP\"), respectively, is determined using the Black-Scholes valuation model. The determination of fair value is affected by our stock price, as well as assumptions regarding subjective and complex variables such as expected employee exercise behavior and our expected stock price volatility over the expected term of the award. Generally, our assumptions are based on historical information and judgment is required to determine if historical trends may be indicators of future outcomes. The key assumptions for the Black-Scholes valuation calculation are: Risk-free interest rate . The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant for the expected term of the option. Expected volatility . We use a combination of historical stock price volatility and implied volatility computed based on the price of options publicly traded on our common stock for our expected volatility assumption. Expected term . The expected term represents the weighted-average period the stock options are expected to remain outstanding. The expected term is determined based on historical exercise behavior, post-vesting termination patterns, options outstanding and future expected exercise behavior. Expected dividends . Employee stock-based compensation expense is calculated based on awards ultimately expected to vest and is reduced for estimated forfeitures. Forfeitures are revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates and an adjustment to stock-based compensation expense will be recognized at that time. Changes to our assumptions used in the Black-Scholes option valuation calculation and our forfeiture rate, as well as future equity granted or assumed through acquisitions could significantly impact the compensation expense we recognize. Page | 15