Aarons 2007 Annual Report Download - page 23

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Rental Merchandise
Our sales and lease ownership division depreciates merchan-
dise over the agreement period, generally 12 to 24 months
when rented, and 36 months when not rented, to 0% salvage
value. Our corporate furnishings division depreciates mer-
chandise over its estimated useful life, which ranges from
six months to 60 months, net of salvage value, which ranges
from 0% to 60%. Sales and lease ownership merchandise
is generally depreciated at a faster rate than our corporate
furnishings merchandise. As sales and lease ownership
revenues continue to comprise an increasing percentage of
total revenues, we expect rental merchandise depreciation
to increase at a correspondingly faster rate.
Our policies require weekly rental merchandise counts by
store managers and write-offs for unsalable, damaged, or
missing merchandise inventories. Full physical inventories are
generally taken at our fulfillment and manufacturing facilities
on a quarterly basis with appropriate provisions made for
missing, damaged and unsalable merchandise. In addition,
we monitor rental merchandise levels and mix by division,
store and fulfillment center, as well as the average age of
merchandise on hand. If unsalable rental merchandise cannot
be returned to vendors, its carrying value is adjusted to net
realizable value or written off. All rental merchandise is
available for rental and sale.
We record rental merchandise carrying value adjustments
on the allowance method, which estimates the merchandise
losses incurred but not yet identified by management
as of the end of the accounting period. The 2005 rental
merchandise adjustments include write-offs of merchandise
in the third quarter that resulted from losses associated
with Hurricanes Katrina and Rita. These hurricane-related
write-offs were $2.8 million, net of insurance proceeds.
Rental merchandise adjustments totaled $30.0 million,
$20.8 million, and $21.8 million for the years ended
December 31, 2007, 2006, and 2005, respectively.
Leases and Closed Store Reserves
The majority of our company-operated stores are operated
from leased facilities under operating lease agreements. The
substantial majority of these leases are for periods that do
not exceed five years. Leasehold improvements related to
these leases are generally amortized over periods that do
not exceed the lesser of the lease term or five years. While
a majority of our leases do not require escalating payments,
for the leases which do contain such provisions we record
the related lease expense on a straight-line basis over the
lease term. Finally, we do not generally obtain significant
amounts of lease incentives or allowances from landlords.
The total amount of incentives and allowances received in
2007, 2006, and 2005 totaled $1.4 million, $1.5 million,
and $1.5 million, respectively. Such amounts are recognized
ratably over the lease term.
From time to time, we close or consolidate stores. Our
primary cost associated with closing or consolidating stores
is the future lease payments and related commitments. We
record an estimate of the future obligation related to closed
or consolidated stores based upon the present value of the
future lease payments and related commitments, net of
estimated sublease income which we base upon historical
experience. For the years ended December 31, 2007 and
2006, our reserve for closed or consolidated stores was
$1.3 million and $693,000, respectively. If our estimates
related to sublease income are not correct, our actual
liability may be more or less than the liability recorded
at December 31, 2006.
Insurance Programs
Aaron Rents maintains insurance contracts to fund workers
compensation and group health insurance claims. Using
actuarial analysis and projections, we estimate the liabilities
associated with open and incurred but not reported work-
ers compensation claims. This analysis is based upon an
assessment of the likely outcome or historical experience,
net of any stop loss or other supplementary coverages. We
also calculate the projected outstanding plan liability for our
group health insurance program. Our workers compensation
insurance claims and group health insurance balance was a
prepaid expense of $5.6 million and $656,000 at December
31, 2007 and 2006, respectively.
If we resolve existing workers compensation claims for
amounts that are in excess of our current estimates and
within policy stop loss limits, we will be required to pay
additional amounts beyond those accrued at December 31,
2007. Additionally, if the actual group health insurance
liability exceeds our projections, we will be required to
pay additional amounts beyond those accrued at December
31, 2007.
The assumptions and conditions described above reflect
management’s best assumptions and estimates, but these
items involve inherent uncertainties as described above,
which may or may not be controllable by management. As a
result, the accounting for such items could result in different
amounts if management used different assumptions or if
different conditions occur in future periods.
Same Store Revenues
We believe the changes in same store revenues are a key
performance indicator. The change in same store revenues
is calculated by comparing revenues for the year to revenues
for the prior year for all stores open for the entire 24-month
period, excluding stores that received rental agreements
from other acquired, closed, or merged stores.