Banana Republic 2005 Annual Report Download - page 32

G A P I N C . F I N A N C I A L S 2 0 0 5
30 gap inc. 2005 annual report
Our significant accounting policies can be found in Note A to the Consolidated Financial Statements. The policies and estimates discussed below
include the financial statement elements that are either judgmental or involve the selection or application of alternative accounting policies and are
material to our financial statements. Management has discussed the development and selection of these critical accounting policies and estimates
with the Audit and Finance Committee of our Board of Directors.
Merchandise Inventory
Inventory is valued using the cost method, which values inventory at the lower of the actual cost or market. Cost is determined using the first-in,
first-out (“FIFO”) method. Market is determined based on the estimated net realizable value, which generally is the merchandise selling price. We
review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of
sizes) and use markdowns to clear merchandise. We estimate and accrue shortage for the period between the last physical count and the balance
sheet date. Our shortage estimate can be affected by changes in merchandise mix and changes in actual shortage trends. The change in shortage
expense as a percentage of cost of goods sold was an increase of 0.6 percentage points, a decrease of 0.2 percentage points and a decrease of 1.4
percentage points for fiscal 2005, 2004 and 2003, respectively.
Long-lived Assets, Impairment and Excess Facilities
We have a significant investment in property and equipment. Depreciation and amortization are computed using estimated useful lives of up to 39
years. A reduction in these estimated useful lives would result in higher annual depreciation expense for the related assets.
In accordance with SFAS 144, we review the carrying value of long-lived assets for impairment whenever events or changes in circumstances indi-
cate that the carrying value of an asset may not be recoverable. Events that result in an impairment review include decisions to close a store, head-
quarter facility or distribution center, or a significant decrease in the operating performance of the long-lived asset. For our store assets that are
identified as potentially being impaired, if the undiscounted future cash flows of the long-lived assets are less than the carrying value, we recognize
a loss equal to the difference between the carrying value and the asset’s fair value. The fair value of the store’s long-lived assets is estimated using
the discounted future cash flows of the assets based upon a rate that approximates our weighted-average cost of capital. Our estimate of future cash
flows is based upon our experience, knowledge and third-party advice or market data. However, these estimates can be affected by factors such as
future store profitability, real estate demand and economic conditions that can be difficult to predict. We recorded a charge for the impairment of
store assets of $3 million, $5 million, and $23 million during fiscal 2005, 2004 and 2003, respectively.
The decision to close or sublease a store, distribution center or headquarter facility space can result in accelerated depreciation over the revised
estimated useful life of the long-lived asset. In addition, we record a charge and corresponding sublease loss reserve for the net present value of the
difference between the contract rent obligations and the rate at which we expect to be able to sublease the properties. We estimate the reserve
based on the status of our efforts to lease vacant office space, including a review of real estate market conditions, our projections for sublease in-
come and sublease commencement assumptions. Most store closures occur upon the lease expiration.
Insurance/Self-insurance
We use a combination of insurance and self-insurance for a number of risk management activities including workers’ compensation, general liability,
automobile liability and employee related health care benefits, a portion of which is paid by our employees. Liabilities associated with these risks are
estimated based on actuarially determined amounts, and accrued in part by considering historical claims experience, demographic factors, severity
factors and other actuarial assumptions. Any actuarial projection of losses concerning our liability is subject to a high degree of variability. Among the
causes of this variability are unpredictable external factors affecting future inflation rates, litigation trends, legal interpretations, benefit level changes
and claim settlement patterns.