CVS 2006 Annual Report Download - page 28

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
2006 Annual Report 25
Inventory
Our inventory is stated at the lower of cost or market on a first-in, first-out
basis using the retail method of accounting to determine cost of sales
and inventory in our stores, and the cost method of accounting to
determine inventory in our distribution centers. Under the retail method,
inventory is stated at cost, which is determined by applying a cost-to-
retail ratio to the ending retail value of our inventory. Since the retail
value of our inventory is adjusted on a regular basis to reflect current
market conditions, our carrying value should approximate the lower of
cost or market. In addition, we reduce the value of our ending inventory
for estimated inventory losses that have occurred during the interim
period between physical inventory counts. Physical inventory counts are
taken on a regular basis in each location (other than the two recently
constructed distribution centers, which perform a continuous cycle
count process to validate the inventory balance on hand) to ensure that
the amounts reflected in the consolidated financial statements are
properly stated.
The accounting for inventory contains uncertainty since we must use
judgment to estimate the inventory losses that have occurred during the
interim period between physical inventory counts. When estimating
these losses, we consider a number of factors, which include but are not
limited to, historical physical inventory results on a location-by-location
basis and current inventory loss trends.
Our total reserve for estimated inventory losses covered by this critical
accounting policy was $125.1 million as of December 30, 2006. Although
we believe we have sufficient current and historical information available
to us to record reasonable estimates for estimated inventory losses, it is
possible that actual results could differ. In order to help you assess the
aggregate risk, if any, associated with the uncertainties discussed above,
a ten percent (10%) pre-tax change in our estimated inventory losses,
which we believe is a reasonably likely change, would increase or decrease
our total reserve for estimated inventory losses by about $12.5 million
during 2006.
We have not made any material changes in the accounting methodology
used to establish our inventory loss reserves during the past three years.
Although we believe that the estimates discussed above are reasonable
and the related calculations conform to generally accepted accounting
principles, actual results could differ from our estimates, and such
differences could be material.
Our total closed store lease liability covered by this critical accounting
policy was $489.4 million as of December 30, 2006. This amount is
net of $246.6 million of estimated sublease income that is subject to
the uncertainties discussed above. Although we believe we have sufficient
current and historical information available to us to record reasonable
estimates for sublease income, it is possible that actual results could
differ. In order to help you assess the risk, if any, associated with the
uncertainties discussed above, a ten percent (10%) pre-tax change in
our estimated sublease income, which we believe is a reasonably likely
change, would increase or decrease our total closed store lease liability
by about $24.7 million during 2006.
We have not made any material changes in the reserve methodology
used to record closed store lease reserves during the past three years.
Self-Insurance Liabilities
We are self-insured for certain losses related to general liability, workers’
compensation and auto liability although we maintain stop loss coverage
with third party insurers to limit our total liability exposure. We are also
self-insured for certain losses related to health and medical liabilities.
The estimate of our self-insurance liability contains uncertainty since we
must use judgment to estimate the ultimate cost that will be incurred to
settle reported claims and unreported claims for incidents incurred but not
reported as of the balance sheet date. When estimating our self-insurance
liability we consider a number of factors, which include, but are not limited
to, historical claim experience, demographic factors, severity factors and
valuations provided by independent third party actuaries.
On a quarterly basis, we review our assumptions with our independent
third party actuaries to determine that our self-insurance liability is adequate
as it relates to our general liability, workers’ compensation and auto liability.
Similar reviews are conducted semi-annually to determine that our self-
insurance liability is adequate for our health and medical liability.
Our total self-insurance liability covered by this critical accounting policy
was $290.4 million during 2006. Although we believe we have sufficient
current and historical information available to us to record reasonable
estimates for our self-insurance liability, it is possible that actual results
could differ. In order to help you assess the risk, if any, associated with
the uncertainties discussed above, a ten percent (10%) pre-tax change
in our estimate for our self-insurance liability, which we believe is a
reasonably likely change, would increase or decrease our self-insurance
liability by about $29.0 million during 2006.
We have not made any material changes in the accounting methodology
used to establish our self-insurance liability during the past three years.