Kohl's 2012 Annual Report Download - page 28

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Retail Inventory Method and Inventory Valuation
We value our inventory at the lower of cost or market with cost determined on the first-in, first-out (“FIFO”) basis using
the retail inventory method (“RIM”). Under RIM, the valuation of inventories at cost and the resulting gross margins are
calculated by applying a cost-to-retail ratio to the retail value of the inventories. Inherent in the retail inventory method are
certain management estimates that may affect the ending inventory valuation as well as gross margin.
The use of RIM will generally result in inventories being valued at the lower of cost or market as permanent markdowns
are taken as a reduction of the retail value of inventories. Management estimates the need for an additional markdown reserve
based on a review of historical clearance markdowns, current business trends, expected vendor funding and discontinued
merchandise categories.
We also record a reserve for estimated inventory shrink between the last physical inventory count and the balance sheet
date. Shrink is the difference between the recorded amount of inventory and the physical inventory. Shrink may occur due to
theft, loss, inaccurate records for the receipt of inventory or deterioration of goods, among other things. We generally perform
an annual physical inventory count at the majority of our stores, distribution centers and E-Commerce fulfillment centers. The
shrink reserve is based on sales and actual shrink results from previous inventories.
We did not make any material changes in the methodologies used to value our inventory or to estimate the markdown and
shrink reserves during 2012, 2011 or 2010. We believe that we have sufficient current and historical knowledge to record
reasonable estimates for our inventory reserves. Though historical reserves have approximated actual markdowns and shrink
adjustments, it is possible that future results could differ from current recorded reserves.
Because we routinely record permanent markdowns for potentially obsolete merchandise, we do not believe that a
markdown reserve was required as of February 2, 2013. Changes in the assumptions used to estimate our markdown reserve
requirement would not have had a material impact on our financial statements. A 10 basis point change in estimated inventory
shrink would also have had an immaterial impact on our financial statements.
Vendor Allowances
We receive allowances from many of our merchandise vendors. These allowances often are reimbursements for
markdowns that we have taken in order to sell the merchandise and/or to support the gross margins earned in connection with
the sales of merchandise. The allowances generally relate to sold inventory or permanent markdowns and, accordingly, are
reflected as reductions to cost of merchandise sold. Allowances related to merchandise that has not yet been sold are recorded
in inventory.
We also receive vendor allowances which represent reimbursements of costs (primarily advertising) that we have
incurred to promote the vendors’ merchandise. These allowances are generally netted against advertising or the other related
costs as the costs are incurred. Advertising allowances in excess of costs incurred are recorded as a reduction of merchandise
costs.
Most of our vendor allowance agreements are supported by signed contracts which are binding, but informal in nature.
The terms and conditions of these arrangements vary significantly from vendor to vendor and are influenced by, among other
things, the type of merchandise to be supported. Vendor allowances will fluctuate based on the amount of promotional and
clearance markdowns necessary to liquidate the inventory as well as advertising and other reimbursed costs.
Insurance Reserve Estimates
We use a combination of insurance and self-insurance for a number of risks.
We retain the initial risk of $500,000 per occurrence in workers’ compensation claims and $250,000 per occurrence in
general liability claims. We record reserves for workers’ compensation and general liability claims which include the total
amounts that we expect to pay for a fully developed loss and related expenses, such as fees paid to attorneys, experts and
investigators. The fully developed loss includes amounts for both reported claims and incurred, but not reported losses.
We use a third-party actuary to estimate the liabilities associated with these risks. The actuary considers historical claims
experience, demographic and severity factors and actuarial assumptions to estimate the liabilities associated with these risks. As
of February 2, 2013, estimated liabilities for workers’ compensation and general liability claims, excluding administrative
expenses and before pre-funding, were approximately $86 million.
A change in claims frequency and severity of claims from historical experience as well as changes in state statutes and
the mix of states in which we operate could result in a change to the required reserve levels. Changes in actuarial assumptions