Banana Republic 2005 Annual Report Download - page 55

G A P I N C . F I N A N C I A L S 2 0 0 5
gap inc. 2005 annual report 53
The reserve balances and activities are as follows:
In January 2004, we signed an agreement to sell our Gap stores and exit the market in Germany, effective August 1, 2004. Gap brand operations in
Germany represented our smallest international retail business, and with only 10 store locations, accounted for less than 1 percent of total Company
sales. This decision represented a strategic move toward re-allocating our international resources to optimize growth in our other existing markets
and focusing our attention on more attractive, longer-term growth opportunities in new markets. As a result of our decision, we recognized an oper-
ating expense charge of $14 million to write down the assets to their fair value in fiscal 2003, which was estimated based upon the expected net
selling price. In August 2004, we completed the sale of our Gap stores in Germany. The actual net selling price approximated our initial estimate.
NOTE F: DERIVATIVE FINANCIAL INSTRUMENTS
We operate in foreign countries, which exposes us to market risk associated with foreign currency exchange rate fluctuations. Our risk management
policy is to hedge substantially all forecasted merchandise purchases for foreign operations and intercompany obligations that bear foreign exchange
risk using foreign exchange forward contracts. The principal currencies hedged during fiscal 2005 were the Euro, British pound, Japanese yen, and
Canadian dollar. We do not enter into derivative financial contracts for trading purposes.
Forward contracts used to hedge forecasted merchandise purchases are designated as cash-flow hedges. Our derivative financial instruments are
recorded on the Consolidated Balance Sheets at fair value and are determined using quoted market rates. These forward contracts are used to hedge
forecasted merchandise purchases over approximately 12 months. Changes in the fair value of forward contracts designated as cash-flow hedges
are recorded as a component of accumulated other comprehensive earnings within shareholders’ equity, and are recognized in cost of goods sold
and occupancy expenses in the period which approximates the time the hedged merchandise inventory is sold. An unrealized loss of approximately
$3 million, net of tax, has been recorded in accumulated other comprehensive earnings at January 28, 2006, and will be recognized in cost of goods
sold over the next 12 months. The majority of the critical terms of the forward contracts and the forecasted foreign merchandise purchases are the
same. As a result, there were no material amounts reflected in fiscal 2005, fiscal 2004 or fiscal 2003 earnings resulting from hedge ineffectiveness.
At January 28, 2006 and January 29, 2005, the fair value of these forward contracts was approximately $14 million and $2 million, respectively, in
other current assets and $18 million and $52 million, respectively, in accrued expenses and other liabilities on the Consolidated Balance Sheets.
We also use forward contracts to hedge our market risk exposure associated with foreign currency exchange rate fluctuations for certain intercom-
pany loans and balances denominated in currencies other than the functional currency of the entity holding or issuing the loan and intercompany
balance. Forward contracts used to hedge intercompany transactions are designated as fair value hedges. At January 28, 2006 and January 29, 2005,
the fair value of these forward contracts was approximately $1 million and $8 million, respectively, in other current assets and $6 million and $28
million, respectively, in accrued expenses and other liabilities on the Consolidated Balance Sheets. Changes in the fair value of these foreign currency
contracts, as well as the underlying intercompany loans and balances, are recognized in operating expenses in the same period and generally offset,
thus resulting in no material amounts of ineffectiveness.
Periodically, we hedge the net assets of certain international subsidiaries to offset the foreign currency translation and economic exposures related to
our investments in these subsidiaries. We have designated such hedges as net investment hedges. The changes in fair value of the hedging instru-
ments are reported in accumulated other comprehensive earnings within shareholders’ equity to offset the foreign currency translation adjustments
on the investments. At January 28, 2006 and January 29, 2005, we used a non-derivative financial instrument, an intercompany loan, to hedge the net
Sublease Severance and Distribution
($ in millions) Loss Reserve Outplacement Facilities Charges Total
Balance at February 1, 2003 $ 115 $ - $ 4 $ 119
Additional provision (reversals), net 10 - (1) 9
Cash payments (23) - (3) (26)
Balance at January 31, 2004 102 - - 102
Additional provision, net 15 2 - 17
Cash payments (23) - - (23)
Balance at January 29, 2005 94 2 - 96
Additional provision (reversals), net (61) 6 - (55)
Cash payments (19) (6) - (25)
Balance at January 28, 2006 $ 14 $ 2 $ - $ 16