Summary of Significant Accounting Policies (Policies)

3 Months Ended

Mar. 31, 2013

Summary of Significant Accounting Policies

Basis of Presentation

Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information.  Accordingly, these statements do not include all of the information and notes required for complete financial statements prepared under GAAP.  In our opinion, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Our results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the full year.  For further information, refer to the Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012 (“2012 10-K”).  Certain prior period amounts have been reclassified to conform to the current period presentation.

Principles of Consolidation

Principles of Consolidation

We consolidate all majority owned subsidiaries, investments in entities in which we have controlling influence and variable interest entities where we have been determined to be the primary beneficiary.  Non-majority owned investments are accounted for using the equity method when we have the ability to significantly influence the operating decisions of the investee.  When we do not have the ability to significantly influence the operating decisions of an investee, the cost method is used.  All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

Use of Estimates

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense for each reporting period.  Estimates are used in accounting for, among other things, allowances for doubtful accounts, self-insurance obligations, deferred taxes and related valuation allowances, uncertain tax positions, loss contingencies, the useful lives and residual value surrounding our rental library inventory, estimated accruals related to revenue-sharing titles that are subject to performance guarantees, fair value of financial instruments, fair value of options granted under our stock-based compensation plans, fair value of assets and liabilities acquired in business combinations, fair value of multi-element arrangements, capital leases, asset impairments, estimates of future cash flows used to evaluate impairments, useful lives of property, equipment and intangible assets, asset retirement obligations, retailer incentives, programming expenses, subscriber lives and royalty obligations.  Weak economic conditions have increased the inherent uncertainty in the estimates and assumptions indicated above.  Actual results may differ from previously estimated amounts, and such differences may be material to the Condensed Consolidated Financial Statements.  Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected prospectively in the period they occur.

Fair Value Measurements

Fair Value Measurements

We determine fair value based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants.  Market or observable inputs are the preferred source of values, followed by unobservable inputs or assumptions based on hypothetical transactions in the absence of market inputs.  We apply the following hierarchy in determining fair value:

· Level 1, defined as observable inputs being quoted prices in active markets for identical assets, including U.S. treasury notes;

· Level 2, defined as observable inputs other than quoted prices included in Level 1, including quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and derivative financial instruments indexed to marketable investment securities; and

· Level 3, defined as unobservable inputs for which little or no market data exists, consistent with reasonably available assumptions made by other participants therefore requiring assumptions based on the best information available.

As of March 31, 2013 and December 31, 2012, the carrying value for cash and cash equivalents, marketable investment securities, trade accounts receivable (net of allowance for doubtful accounts), derivative financial instruments, and current liabilities (excluding the “Current portion of long-term debt and capital lease obligations”) is equal to or approximates fair value due to their short-term nature or proximity to current market rates.  See Note 5.

Fair values for our publicly traded debt securities are based on quoted market prices, when available.  The fair values of private debt are estimated based on an analysis in which we evaluate market conditions, related securities, various public and private offerings, and other publicly available information.  In performing this analysis, we make various assumptions regarding, among other things, credit spreads, and the impact of these factors on the value of the notes.  See Note 10 for the fair value of our long-term debt.

Derivative Financial Instruments

Derivative Financial Instruments

We may purchase and hold derivative financial instruments for, among other reasons, strategic or speculative purposes.  We record all derivative financial instruments on our Condensed Consolidated Balance Sheets at fair value as either assets or liabilities.  Changes in the fair values of derivative financial instruments are recognized in our results of operations and included in “Other, net” income and expense on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).  We currently have not designated any derivative financial instrument for hedge accounting.

During the first quarter 2013, we purchased derivative financial instruments that are indexed to the trading price of the common equity securities of Sprint, which generally can be terminated at our option at any time.  Under the terms of these derivative financial instruments, we are entitled to any increase in value and are responsible to the counterparty for any decrease in value based on the change in the fair value of the underlying securities.  As of March 31, 2013, we held an aggregate notional amount of $341 million of these derivative financial instruments.  We had also made prepayments of $209 million prior to the balance sheet date, which we used to purchase additional derivative financial instruments subsequent to March 31, 2013.  All amounts associated with these derivative financial instruments have been classified as “Other current assets” on our Condensed Consolidated Balance Sheets.  We recorded an unrealized gain of $8 million on these derivative financial instruments included in “Other, net” income and expense on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) during the three months ended March 31, 2013.  We held no derivative financial instruments as of December 31, 2012.

In addition to the $341 million of derivative financial instruments that are indexed to the trading price of the common equity securities of Sprint, we held common equity securities in Sprint with a fair value of $75 million as of March 31, 2013, which is included in “Marketable investment securities” on our Condensed Consolidated Balance Sheets.  The fair value of the derivative financial instruments and our investment in Sprint’s common equity is dependent on the market value of Sprint’s common equity which may be volatile and vary depending on, among other things, Sprint’s financial and operational performance and market conditions.

Subsequent to March 31, 2013, we had purchased an additional aggregate notional amount of $251 million of these derivative financial instruments, consisting of the $209 million in prepayments held as of March 31, 2013 and $42 million of incremental funds.  As of May 1, 2013, we held $592 million aggregate notional amount of these derivative financial instruments.

Advertising Costs

Advertising Costs

Our advertising costs associated with acquiring new Pay-TV and Broadband subscribers and Blockbuster customers are expensed as incurred.  During the three months ended March 31, 2013 and 2012, we recorded advertising costs of $122 million and $99 million, respectively, within “Other subscriber acquisition costs” and “General and administrative expenses” on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).