Lowe's 2005 Annual Report Download - page 22

20฀
|
฀ L O W E ’ S ฀ ฀2 0 0 5 ฀ ฀A N N U A L ฀ ฀R E P O RT
CRITICAL฀ACCOUNTING฀POLICIES฀AND฀ESTIMATES
The฀following฀discussion฀and฀analysis฀of฀our฀financial฀condition฀and฀results฀of฀
operations฀are฀based฀on฀the฀consolidated฀financial฀statements฀and฀notes฀to฀con-
solidated฀financial฀statements฀presented฀in฀this฀annual฀report฀that฀have฀been฀
prepared฀in฀accordance฀with฀accounting฀principles฀generally฀accepted฀in฀the฀
United฀States฀of฀America.฀The฀preparation฀of฀these฀financial฀statements฀requires฀
us฀to฀make฀estimates฀that฀affect฀the฀reported฀amounts฀of฀assets,฀liabilities,฀sales฀
and฀expenses,฀and฀related฀disclosures฀of฀contingent฀assets฀and฀liabilities.฀We฀
base฀these฀estimates฀on฀historical฀results฀and฀various฀other฀assumptions฀
believed฀to฀be฀reasonable,฀all฀of฀which฀form฀the฀basis฀for฀making฀estimates฀con-
cerning฀the฀carrying฀values฀of฀assets฀and฀liabilities฀that฀are฀not฀readily฀available฀
from฀other฀sources.฀Actual฀results฀may฀differ฀from฀these฀estimates.
฀ Our฀significant฀accounting฀policies฀are฀described฀in฀Note฀1฀to฀the฀consol-
idated฀financial฀statements.฀We฀believe฀that฀the฀following฀accounting฀policies฀
affect฀the฀more฀significant฀estimates฀used฀in฀preparing฀the฀consolidated฀
financial฀statements.
Merchandise฀Inventory
Description฀–฀We฀record฀an฀inventory฀reserve฀for฀the฀loss฀associated฀with฀sell-
ing฀discontinued฀inventories฀below฀cost.฀This฀reserve฀is฀based฀on฀our฀current฀
knowledge฀with฀respect฀to฀inventory฀levels,฀sales฀trends฀and฀historical฀experi-
ence฀relating฀to฀the฀liquidation฀of฀discontinued฀inventory.฀During฀2005,฀we฀
increased฀our฀discontinued฀inventory฀reserve฀by฀$27฀million฀to฀$104฀million฀฀
as฀of฀February฀3,฀2006.฀We฀also฀record฀an฀inventory฀reserve฀for฀the฀estimated฀
shrinkage฀between฀physical฀inventories.฀This฀reserve฀is฀based฀primarily฀on฀
actual฀shrinkage฀results฀from฀previous฀physical฀inventories.฀During฀2005,฀we฀
increased฀our฀inventory฀shrinkage฀reserve฀by฀$19฀million฀to฀$113฀million฀as฀of฀
February฀3,฀2006.
Judgments฀and฀uncertainties฀involved฀in฀the฀estimate฀–฀We฀do฀not฀believe฀that฀
our฀merchandise฀inventories฀are฀subject฀to฀significant฀risk฀of฀obsolescence฀in฀
the฀near฀term,฀and฀we฀have฀the฀ability฀to฀adjust฀purchasing฀practices฀based฀on฀
anticipated฀sales฀trends฀and฀general฀economic฀conditions.฀However,฀changes฀in฀
consumer฀purchasing฀patterns฀could฀result฀in฀the฀need฀for฀additional฀reserves.฀
Likewise,฀changes฀in฀actual฀shrinkage฀results฀from฀completed฀physical฀invento-
ries฀could฀result฀in฀revisions฀to฀previously฀estimated฀shrinkage฀expense.
Effect฀if฀actual฀results฀differ฀from฀assumptions฀–฀Although฀we฀believe฀that฀we฀
have฀sufficient฀current฀and฀historical฀knowledge฀to฀record฀reasonable฀estimates฀
for฀both฀of฀these฀inventory฀reserves,฀it฀is฀possible฀that฀actual฀results฀could฀differ฀
from฀recorded฀reserves.฀A฀10%฀difference฀in฀our฀discontinued฀inventory฀reserve฀
would฀have฀affected฀net฀earnings฀by฀approximately฀$6฀million฀for฀2005.฀A฀10%฀
difference฀in฀our฀estimated฀shrinkage฀reserve฀would฀have฀affected฀net฀earnings฀
by฀approximately฀$7฀million฀for฀2005.
Vendor฀Funds
Description฀–฀We฀receive฀funds฀from฀vendors฀in฀the฀normal฀course฀of฀business฀
for฀a฀variety฀of฀reasons,฀including฀purchase-volume-related฀discounts฀and฀
rebates,฀advertising฀allowances,฀reimbursements฀for฀third-party฀in-store฀service฀
related฀costs,฀defective฀merchandise฀allowances฀and฀reimbursements฀for฀
selling฀expenses฀and฀display฀costs.฀We฀use฀projected฀purchase฀volumes฀to฀
estimate฀accrual฀rates,฀validate฀those฀projections฀based฀on฀actual฀purchase฀
trends฀and฀apply฀those฀rates฀to฀actual฀purchase฀volumes฀to฀determine฀the฀
amount฀of฀funds฀accrued฀and฀receivable฀from฀the฀vendor.
฀ Under฀Emerging฀Issues฀Task฀Force฀Issue฀No.฀02-16฀(EITF฀02-16),฀“Account-
ing฀by฀a฀Customer฀(Including฀a฀Reseller)฀for฀Certain฀Consideration฀Received฀from฀
a฀Vendor,”฀vendor฀funds฀are฀treated฀as฀a฀reduction฀of฀inventory฀cost,฀unless฀they฀
represent฀a฀reimbursement฀of฀specific,฀incremental฀and฀identifiable฀costs฀incurred฀
by฀the฀customer฀to฀sell฀the฀vendor’s฀product.฀Substantially฀all฀of฀the฀vendor฀funds฀
that฀we฀receive฀do฀not฀meet฀the฀specific,฀incremental฀and฀identifiable฀criteria฀in฀
EITF฀02-16.฀Therefore,฀for฀vendor฀fund฀agreements฀entered฀into฀after฀Decem-
ber฀31,฀2002,฀which฀was฀the฀effective฀date฀of฀the฀related฀provision฀of฀EITF฀02-16,฀
we฀treat฀funds฀that฀do฀not฀meet฀the฀specific,฀incremental฀and฀identifiable฀criteria฀
as฀a฀reduction฀in฀the฀cost฀of฀inventory฀and฀recognize฀these฀funds฀as฀a฀reduction฀
of฀cost฀of฀sales฀when฀the฀inventory฀is฀sold.฀Prior฀to฀the฀adoption฀of฀EITF฀02-16,฀
these฀funds฀were฀recorded฀as฀an฀offset฀to฀the฀related฀expense฀in฀Selling,฀General฀
and฀Administrative฀(SG&A)฀expense.
Judgments฀and฀uncertainties฀involved฀in฀the฀estimate฀–฀Amounts฀accrued฀could฀
be฀impacted฀if฀actual฀purchase฀volumes฀differ฀from฀projected฀purchase฀volumes.
Effect฀if฀actual฀results฀differ฀from฀assumptions฀–฀If฀actual฀results฀are฀not฀con-
sistent฀with฀the฀assumptions฀and฀estimates฀used,฀we฀could฀be฀exposed฀to฀
additional฀adjustments฀that฀could฀positively฀or฀negatively฀impact฀gross฀margin฀
and฀inventory.฀Changes฀in฀these฀estimates฀would฀have฀a฀greater฀effect฀on฀
interim฀periods฀than฀our฀annual฀results,฀as฀purchase฀volume฀estimates฀are฀
updated฀for฀actual฀purchase฀volumes฀at฀each฀year฀end.
Self-Insurance
Description฀–฀We฀are฀self-insured฀for฀certain฀losses฀relating฀to฀workers’฀
compensation,฀automobile,฀property,฀general฀and฀product฀liability,฀and฀certain฀
medical฀and฀dental฀claims.฀Self-insurance฀claims฀filed฀and฀claims฀incurred฀but฀
not฀reported฀are฀accrued฀based฀upon฀our฀estimates฀of฀the฀discounted฀ultimate฀
cost฀for฀self-insured฀claims฀incurred฀using฀actuarial฀assumptions฀followed฀in฀
the฀insurance฀industry฀and฀historical฀experience.฀The฀self-insurance฀liability฀
was฀$571฀million฀and฀$467฀million฀at฀February฀3,฀2006฀and฀January฀28,฀
2005,฀respectively.
Judgments฀and฀uncertainties฀involved฀in฀the฀estimate฀–฀These฀estimates฀are฀
subject฀to฀changes฀in฀the฀utilized฀discount฀rate,฀forecasted฀payroll,฀sales฀and฀
vehicle฀units,฀as฀well฀as฀the฀frequency฀and฀severity฀of฀claims.
Effect฀if฀actual฀results฀differ฀from฀assumptions฀–฀Although฀we฀believe฀that฀we฀
have฀the฀ability฀to฀adequately฀record฀estimated฀losses฀related฀to฀claims,฀it฀is฀pos-
sible฀that฀actual฀results฀could฀differ฀from฀recorded฀self-insurance฀liabilities.฀A฀10%฀
difference฀in฀our฀self-insurance฀liability฀would฀have฀affected฀net฀earnings฀by฀
approximately฀$35฀million฀for฀2005.฀A฀1%฀change฀in฀our฀discount฀rate฀would฀
have฀affected฀net฀earnings฀by฀approximately฀$8฀million฀for฀2005.