Case Questions: 1. What method of content amortization should Netflix use for the streaming agreements? (Straight-line vs. accelerated)? Why?

2. Which method of amortization best matches the actual usage of the asset?

3. Should the streaming content acquired (but not created) by Netflix be listed as an asset, why or why not?

4. Are you concerned with the lower rate of content amortization under the streaming strategy versus the DVD-by-mail strategy?

5. What will be the impact on Netflixs net income of the lower content amortization under the new streaming strategy?

5. Under the asset recognition criteria, some content agreements do not qualify as assets. Therefore, the asset and associated liability would not appear on the balance sheet. Should this be a concern for investors? Why?

Netflix Case Netlix was founded by Reed Hastings and Marc Randolph in Scotts Valley, Califomia in 199. Netlix went public on March 12, 2003 when its shares began trading on the NASDAQ stock exchange. Initially, Netfix's business model was a suhscription service that allowed subscribers to have certain number of DVDs out at the same time with no due dates, late fees or shipping charges. For cxample, as of December 2003, the base sabscription plan alowed subscribers to have throc tles at a time for $1995 per month Subscribers chose titles at www.netfix.com and as soon as the subscriber returnad a DVD, a new one was shipped from the subscriber's queue DVDs were shippal via first-class mail and were returned by the customer through the mail in a propaid mailer Over time, and with the advent of new technology, Netlix's business model began to shitt. In its 2009 ual report to sharcholders, Netlix states that its core strategy Ts o grow a large subscription business onsisting of streaming and DVD-by-mail con" However, in its 2010 anmual report, Nefix states that its core strmcgy is to "grow our streaming sutscription business within the United States and gkobaily" As co-founder Roed Hastings amously statod, "We named the company Netflix for a reason, we didn'1 nameDVDs-by-mil" The shift from a DVD by mail company to an online video streaming company created challenges for Netflix. One of these challenges related to the company's financial reporting Under the DVD-by-mail business strategy, Netflix accounted for DVDs as long-erm assets amortized overone to three year penod using the the DVD's sseful lafe. The compmy typically usod a one-year usefial lise for new release DVDs and a three-year usefal life for older, back-calalog DVDs. The estimated useial life ook into aocount both the durability of the DVD as well as customer interest in the movie, Under the DVD model, approximately 40% of Netflix's DVD assets were amortized each quarter accelerated basis over Once Net lix began investing in streaming content, its conient aoquisition costs became much larg. The company typically acquirod 3 o 5 year streaming contracts with high up-front costs which were amortized over the life of the strcaming content. By 2011, Netflix's quanerly amortization had dropped to 24% Analysts and investors questioned the company on its new amortization methods concerned that Netlix was amortizing, in some cases, the same film over a longer time period based on it being in a streaming format rather than a physical DVD Additionally, the asset recognition crieria at the time required that in order for Netflix to treat a content streaming agreement as an asset, the titles included in the streaming agreement must be known, the cost per title must be deteminable, and the title must be available for streaming. While some of Netflix's content streaming agreements met these criteria, not all did (See Appendix 4). Netlix's historical financial statements are included in Appendices I through 3. An example ofstraight-line amortization for a DVD collection is included in Appendix 5. Finally Appendix 6 includes an example of DVD amortization using the"sum-of-the-months" acceleratod basis. Case Questions . What method of content amortization should Netflix use for the streaming agreemens? (Straight-line vs. accelerated)? Why? 2. Which method of amortization best matches the actual usage of the asser? 3. Should the streaming content aquired ut not create) by Neflix be listod as an asset, why or why nox? 4. Are you concerned with the lowet rate of content amortization under the streaming strategy versus the DVD-by-masl strateg 5. What will be the impact on Netlix's net income of the lower content amortization under the new streaming strategy? 5. Under the asset recognition criteria, sone contemt agreements do not qualify as assets. Theresore, the asset and associated liability would not appear on the balance sheet. Should this be a concern sor imvestors? Why? Case Instructions: Please type up your responses to these questions and submit the completed case assignment via Blackboard. Your response should make up approximately one page single spaced