McDonalds 2009 Annual Report Download - page 28

plan to dispose of the assets, the assets are available for dis-
posal, the disposal is probable of occurring within 12 months, and
the net sales proceeds are expected to be less than the assets’
net book value, among other factors. An impairment charge is
recognized for the difference between the net book value of the
business (including foreign currency translation adjustments
recorded in accumulated other comprehensive income in share-
holders’ equity) and the estimated cash sales price, less costs of
disposal.
An alternative accounting policy would be to recharacterize
some or all of any loss as an intangible asset and amortize it to
expense over future periods based on the term of the relevant
licensing arrangement and as revenue is recognized for royalties
and initial fees. Under this alternative for the 2007 Latam trans-
action, approximately $900 million of the $1.7 billion impairment
charge could have been recharacterized as an intangible asset
and amortized over the franchise term of 20 years, resulting in
about $45 million of expense annually. This policy would be
based on a view that the consideration for the sale consists of
two components–the cash sales price and the future royalties
and initial fees.
The Company bases its accounting policy on management’s
determination that royalties payable under its developmental
license arrangements are substantially consistent with market
rates for similar license arrangements. The Company does not
believe it would be appropriate to recognize an asset for the right
to receive market-based fees in future periods, particularly given
the continuing support and services provided to the licensees.
Therefore, the Company believes that the recognition of an
impairment charge based on the net cash sales price reflects the
substance of the sale transaction.
• Litigation accruals
From time to time, the Company is subject to proceedings, law-
suits and other claims related to competitors, customers,
employees, franchisees, government agencies, intellectual prop-
erty, shareholders and suppliers. The Company is required to
assess the likelihood of any adverse judgments or outcomes to
these matters as well as potential ranges of probable losses. A
determination of the amount of accrual required, if any, for these
contingencies is made after careful analysis of each matter. The
required accrual may change in the future due to new develop-
ments in each matter or changes in approach such as a change
in settlement strategy in dealing with these matters. The Com-
pany does not believe that any such matter currently being
reviewed will have a material adverse effect on its financial con-
dition or results of operations.
• Income taxes
The Company records a valuation allowance to reduce its
deferred tax assets if it is more likely than not that some portion
or all of the deferred assets will not be realized. While the Com-
pany has considered future taxable income and ongoing prudent
and feasible tax strategies, including the sale of appreciated
assets, in assessing the need for the valuation allowance, if these
estimates and assumptions change in the future, the Company
may be required to adjust its valuation allowance. This could
result in a charge to, or an increase in, income in the period such
determination is made.
In addition, the Company operates within multiple taxing juris-
dictions and is subject to audit in these jurisdictions. The
Company records accruals for the estimated outcomes of these
audits, and the accruals may change in the future due to new
developments in each matter. During 2008, the IRS examination
of the Company’s 2005-2006 U.S. tax returns was completed.
The tax provision impact associated with the completion of this
examination was not significant. During 2007, the Company
recorded a $316 million benefit as a result of the completion of
an IRS examination of the Company’s 2003-2004 U.S. tax
returns. The Company’s 2007-2008 U.S. tax returns are currently
under examination and the completion of the examination is
expected in 2010.
Deferred U.S. income taxes have not been recorded for
temporary differences totaling $9.2 billion related to investments
in certain foreign subsidiaries and corporate affiliates. The
temporary differences consist primarily of undistributed earnings
that are considered permanently invested in operations outside
the U.S. If management’s intentions change in the future,
deferred taxes may need to be provided.
EFFECTS OF CHANGING PRICES—INFLATION
The Company has demonstrated an ability to manage inflationary
cost increases effectively. This is because of rapid inventory
turnover, the ability to adjust menu prices, cost controls and sub-
stantial property holdings, many of which are at fixed costs and
partly financed by debt made less expensive by inflation.
RECONCILIATION OF RETURNS ON INCREMENTAL INVESTED
CAPITAL
Return on incremental invested capital (ROIIC) is a measure
reviewed by management over one-year and three-year time
periods to evaluate the overall profitability of the business units,
the effectiveness of capital deployed and the future allocation of
capital. This measure is calculated using operating income and
constant foreign exchange rates to exclude the impact of foreign
currency translation. The numerator is the Company’s incremental
operating income plus depreciation and amortization from the
base period.
The denominator is the weighted-average adjusted cash used
for investing activities during the applicable one- or three-year
period. Adjusted cash used for investing activities is defined as
cash used for investing activities less cash generated from inves-
ting activities related to the Boston Market, Chipotle, Latam, Pret
A Manger and Redbox transactions. The weighted-average
adjusted cash used for investing activities is based on a weight-
ing applied on a quarterly basis. These weightings are used to
reflect the estimated contribution of each quarter’s investing
activities to incremental operating income. For example, fourth
quarter 2009 investing activities are weighted less because the
assets purchased have only recently been deployed and would
have generated little incremental operating income (12.5% of
fourth quarter 2009 investing activities are included in the
one-year and three-year calculations). In contrast, fourth quarter
2008 is heavily weighted because the assets purchased were
deployed more than 12 months ago, and therefore have a full
year impact on 2009 operating income, with little or no impact to
the base period (87.5% and 100.0% of fourth quarter 2008
investing activities are included in the one-year and three-year
calculations, respectively). Management believes that weighting
cash used for investing activities provides a more accurate
reflection of the relationship between its investments and returns
than a simple average.
26 McDonald’s Corporation Annual Report 2009