Safeway 2006 Annual Report Download - page 62

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SAFEWAY INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Off-Balance Sheet Financial Instruments The Company has, from time to time, entered into interest rate swap
agreements to change its portfolio mix of fixed- and floating-rate debt to more desirable levels. Interest rate swap
agreements involve the exchange with a counterparty of fixed- and floating-rate interest payments periodically over
the life of the agreements without exchange of the underlying notional principal amounts. The differential to be paid
or received is recognized over the life of the agreements as an adjustment to interest expense. The Company’s
counterparties have been major financial institutions.
Energy Contracts The Company has entered into contracts to purchase electricity and natural gas at fixed prices for
a portion of its energy needs. Safeway expects to take delivery of the electricity and natural gas in the normal course
of business, and these contracts are not net settled. Since these contracts qualify for the normal purchase exception of
SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” they are not marked to market. Energy
purchased under these contracts is expensed as delivered.
Fair Value of Financial Instruments Generally accepted accounting principles require the disclosure of the fair
value of certain financial instruments, whether or not recognized in the balance sheet, for which it is practicable to
estimate fair value. The Company estimated the fair values presented below using appropriate valuation
methodologies and market information available as of year end. Considerable judgment is required to develop
estimates of fair value, and the estimates presented are not necessarily indicative of the amounts that the Company
could realize in a current market exchange. The use of different market assumptions or estimation methodologies
could have a material effect on the estimated fair values. Additionally, the fair values were estimated at year end, and
current estimates of fair value may differ significantly from the amounts presented.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
Cash and equivalents, accounts receivable, accounts payable and short-term debt. The carrying amount of these
items approximates fair value.
Long-term debt. Market values quoted on the New York Stock Exchange are used to estimate the fair value of
publicly traded debt. To estimate the fair value of debt issues that are not quoted on an exchange, the Company uses
those interest rates that are currently available to it for issuance of debt with similar terms and remaining maturities.
At year-end 2006, the estimated fair value of debt was $5.3 billion compared to a carrying value of $5.2 billion. At
year-end 2005, the estimated fair value of debt was $5.8 billion compared to a carrying value of $5.7 billion.
Interest rate swaps. Interest rate swaps, under which the Company agrees to pay variable rates of interest, are
designated as fair value hedges of fixed-rate debt. For these fair value hedges that qualify for hedge accounting
treatment, Safeway uses the short-cut method, and thus, there are no gains or losses recognized due to hedge
ineffectiveness. Unrealized gains or losses from changes in the value of fair value hedges are offset by changes in the
fair value of the hedged underlying debt. The fair value of the interest rate swaps outstanding at year-end 2006 was a
liability of $25.9 million.
Store Closing and Impairment Charges Safeway regularly reviews its stores’ operating performance and assesses
the Company’s plans for certain store and plant closures. In accordance with SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets,” losses related to the impairment of long-lived assets are recognized
when expected future cash flows are less than the asset’s carrying value. At the time a store is closed or because of
changes in circumstances that indicate the carrying value of an asset may not be recoverable, the Company evaluates
the carrying value of the assets in relation to its expected future cash flows. If the carrying value is greater than the
future cash flows, a provision is made for the impairment of the assets to write the assets down to estimated fair
value. Fair value is determined by estimating net future cash flows, discounted using a risk-adjusted rate of return. The
Company calculates impairment on a store-by-store basis. These provisions are recorded as a component of operating
and administrative expense and are disclosed in Note C.
When stores that are under long-term leases close, the Company records a liability for the future minimum lease
payments and related ancillary costs, net of estimated cost recoveries that may be achieved through subletting
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