American Eagle Outfitters 2001 Annual Report Download - page 33

AE Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
The Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States, which require
the Company to make estimates and assumptions that may affect the reported financial condition and results of operations should actual results differ.
The Company bases its estimates and assumptions on the best available information and believes them to be reasonable for the circumstances. The
Company believes that of its significant accounting policies, the following may involve a higher degree of judgement and complexity. See Note 2 of the
Consolidated Financial Statements.
Revenue Recognition. The Company principally records revenue upon purchase of merchandise by customers. Revenue is not recorded on the purchase
of stored value cards and gift certificates by customers. A current liability is recorded upon purchase and revenue is recognized when the card is
redeemed for merchandise. Revenue is recorded net of sales returns. A sales returns reserve is provided on gross sales for projected merchandise returns
based on historical average return percentages.
Revenue is not recorded on the sell-off of end-of-season, overstock and irregular merchandise to liquidators. These sell-offs are typically sold below
cost. Proceeds from sell-offs have an insignificant effect on cost of sales.
Leasehold Improvements. The Company capitalizes leasehold improvement costs, net of construction allowances. These assets are stated at cost and
amortized utilizing the straight-line method over the lesser of their estimated useful lives or the life of the lease (generally five to ten years). In accordance
with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, management evaluates the ongoing
value of leasehold improvements associated with retail stores which have been open longer than one year. When undiscounted cash flows estimated to
be generated by those assets are less than the carrying amounts of those assets, impairment losses are recorded. When events such as these occur,
the impaired assets are adjusted to estimated fair value and an impairment loss is recorded in selling, general and administrative expenses. Should actual
results or market conditions differ from those anticipated, additional losses may be recorded.
Inventory. Merchandise inventory is valued at the lower of average cost or market, utilizing the retail method. Average cost includes merchandise design
and sourcing costs and related expenses.
The Company reviews its inventory levels in order to identify slow-moving merchandise and generally uses markdowns to clear merchandise. If inventory
exceeds customer demand for reasons of style, seasonal adaptation, changes in customer preference, lack of consumer acceptance of fashion items,
competition, or if it is determined that the inventory in stock will not sell at its currently ticketed price, additional markdowns may be necessary. These
markdowns may have an adverse impact on earnings, depending on the extent and amount of inventory affected.
New Accounting Pronouncements
The Company will adopt SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, beginning in the first quarter
of Fiscal 2002. Upon adoption, the provisions of these standards will become critical accounting policies, as further explained under the heading Recent
Financial Accounting Standards Board Pronouncements in Note 2 of the Consolidated Financial Statements.
Certain Relationships and Related Party Transactions
The Company and its subsidiaries engage in certain transactions with related parties. The Company believes that the terms of these transactions are as
favorable to the Company as those that could be obtained from third parties. The Company’s related party transactions are as follows:
•The Company leases its distribution center and headquarters offices from Linmar Realty Company, an affiliate of the Company and of Schottenstein
Stores Corporation (“SSC”).
•The Company sells portions of its end-of-season, overstock and irregular merchandise to Value City Department Stores, Inc., a publicly-traded
subsidiary of SSC.
•SSC and its affiliates charge the Company for an allocated cost of various professional services provided to the Company, including certain legal,
real estate and insurance services.
•The Company has entered into a cost-sharing arrangement with an affiliate of SSC for the acquisition of an interest in several corporate aircraft.
The Company also incurred operating costs and usage fees during Fiscal 2001 under this arrangement.
•In connection with the liquidation of certain inventory from the Canadian acquisition, the Company contracted the services of a related party
consultant, an affiliate of SSC.
See Note 4 of the Consolidated Financial Statements for additional information regarding related party transactions.
32