Walgreens 2006 Annual Report Download - page 28

Summary of Major Accounting Policies
Description of Business
The company is principally in the retail drugstore business and its operations are
within one reportable segment. At August 31, 2006, there were 5,461 stores,
located in 47 states and Puerto Rico. Prescription sales were 64.3% of total sales
for fiscal 2006 compared to 63.7% in 2005 and 63.2% in 2004.
Basis of Presentation
The consolidated statements include the accounts of the company and its sub-
sidiaries. All significant intercompany transactions have been eliminated. The
consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America and include
amounts based on management’s prudent judgments and estimates. Actual
results may differ from these estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and all highly liquid investments
with an original maturity of three months or less. Short-term investment objectives
are to minimize risk, maintain liquidity and maximize after-tax yields. To attain these
objectives, investment limits are placed on the amount, type and issuer of securities.
Investments are principally in top-tier money market funds and commercial paper.
Included in cash and cash equivalents are credit card and debit card receivables
from banks, which settle within two business days, of $54.7 million at August 31,
2006, and $55.4 million at August 31, 2005. The company’s cash management
policy provides for controlled disbursement. As a result, the company maintains
overdraft positions at certain banks. Such overdrafts, which were $575.3 million
as of August 31, 2006, and $339.4 million as of August 31, 2005, are included
in trade accounts payable in the accompanying consolidated balance sheets.
Short-Term Investments – Available for Sale
The company’s short-term investments – available for sale are principally auction
rate securities. The company invests in municipal bonds and student obligations
and purchases these securities at par. The underlying security is issued as a long-
term investment. However, auction rate securities are classified as short-term
investments because they typically can be purchased and sold every 7, 28 and
35 days. The trading of auction rate securities takes place through a descending
price auction with the interest rate reset at the beginning of each holding period.
At the end of each holding period the interest is paid to the investor. The unrealized
gains on these securities at August 31, 2006 and 2005, were not significant.
Financial Instruments
The company had $105.1 million and $66.2 million of outstanding letters of credit at
August 31, 2006 and 2005, respectively, which guarantee foreign trade purchases.
Additional outstanding letters of credit of $282.2 million and $313.8 million at
August 31, 2006 and 2005, respectively, guarantee payments of casualty claims.
The casualty claim letters of credit are annually renewable and will remain in place
until the casualty claims are paid in full. Letters of credit of $1.7 million were
outstanding at both August 31, 2006 and 2005, to guarantee performance of
construction contracts. The company pays a nominal facility fee to the financing
bank to keep these letters of credit active. The company also had purchase com-
mitments of approximately $782.8 million and $437.6 million at August 31, 2006
and 2005, respectively, related to the purchase of store locations and distribution
centers. There were no investments in derivative financial instruments during fiscal
2006 and 2005.
Inventories
Inventories are valued on a lower of last-in, first-out (LIFO) cost or market basis. At
August 31, 2006 and 2005, inventories would have been greater by $899.5 million
and $804.2 million, respectively, if they had been valued on a lower of first-in,
first-out (FIFO) cost or market basis. Inventory includes product cost and inbound
freight. Cost of sales is primarily derived based upon point-of-sale scanning informa-
tion with an estimate for shrinkage and is adjusted based on periodic inventories.
In addition to merchandise cost, cost of sales includes warehousing costs,
purchasing costs, freight costs and vendor allowances not included as a reduction
of advertising expense.
Vendor Allowances
Vendor allowances are principally received as a result of purchase levels, sales or
promotion of vendors’ products. Allowances are generally recorded as a reduction
of inventory and are recognized as a reduction of cost of sales when the related
merchandise is sold. Those allowances received for promoting vendors’ products are
offset against advertising expense and result in a reduction of selling, occupancy and
administration expenses to the extent of advertising costs incurred, with the excess
treated as a reduction of inventory costs.
Property and Equipment
Depreciation is provided on a straight-line basis over the estimated useful lives of
owned assets. Leasehold improvements and leased properties under capital leases
are amortized over the estimated physical life of the property or over the term of the
lease, whichever is shorter. Estimated useful lives range from 121
/2to 39 years for
land improvements, buildings and building improvements and 3 to 121
/2years for
equipment. Major repairs, which extend the useful life of an asset, are capitalized
in the property and equipment accounts. Routine maintenance and repairs are
charged against earnings. The composite method of depreciation is used for
equipment; therefore, gains and losses on retirement or other disposition of
such assets are included in earnings only when an operating location is closed,
completely remodeled or impaired. Fully depreciated property and equipment are
removed from the cost and related accumulated depreciation and amortization
accounts. Property and equipment consists of (In Millions):
2006 2005
Land and land improvements
Owned stores $ 1,667.4 $1,459.4
Distribution centers 94.2 81.6
Other locations 93.5 59.1
Buildings and building improvements
Owned stores 1,824.6 1,521.3
Leased stores (leasehold improvements only) 537.6 500.5
Distribution centers 483.4 453.0
Other locations 229.0 183.5
Equipment
Stores 3,157.7 2,853.9
Distribution centers 773.3 679.8
Other locations 214.4 166.0
Capitalized system development costs 171.7 143.7
Capital lease properties 40.2 48.4
9,287.0 8,150.2
Less: accumulated depreciation and amortization 2,338.1 1,985.2
$ 6,948.9 $6,165.0
The company capitalizes application stage development costs for significant inter-
nally developed software projects, including “SIMS Plus,” a strategic inventory
management system, and “Ad Planning,” an advertising system. These costs are
amortized over a five-year period. Amortization was $24.2 million in 2006, $20.4
million in 2005 and $19.0 million in 2004. Unamortized costs as of August 31,
2006 and 2005, were $109.6 million and $90.1 million, respectively.
Page 26 2006 Walgreens Annual Report