CVS 2015 Annual Report Download - page 46

Management’s Discussion and Analysis
of Financial Condition and Results of Operations
44 CVS Health
Inventory
Effective January 1, 2015, the Company changed its methods of accounting for “front store” inventories in the
Retail/LTC Segment. Prior to 2015, the Company valued front store inventories at the lower of cost or market on a
first-in, first-out (“FIFO”) basis in retail stores using the retail inventory method and in distribution centers using the
FIFO cost method. Effective January 1, 2015, all front store inventories in the Retail/LTC Segment have been valued
at the lower of cost or market using the weighted average cost method. These changes affected approximately 36%
of consolidated inventories.
These changes were made primarily to provide the Company with better information to manage its retail front store
operations and to bring all of the Company’s inventories to a common inventory valuation methodology. The
Company believes the weighted average cost method is preferable to the retail inventory method and the FIFO cost
method because it results in greater precision in the determination of cost of revenues and inventories at the stock
keeping unit (“SKU”) level and results in a consistent inventory valuation method for all of the Company’s inventories
as all of the Company’s remaining inventories, which consist of prescription drugs, were already being valued using
the weighted average cost method.
The Company recorded the cumulative effect of these changes in accounting principle as of January 1, 2015. The
Company determined that retrospective application for periods prior to 2015 is impracticable, as the period-specific
information necessary to value front store inventories in the Retail/LTC Segment under the weighted average cost
method is unavailable. The Company implemented a new perpetual inventory system to manage front store inven-
tory at the SKU level and valued front store inventory as of January 1, 2015 and calculated the cumulative impact.
The effect of these changes in accounting principle as of January 1, 2015, was a decrease in inventories of $7 million,
an increase in current deferred income tax assets of $3 million and a decrease in retained earnings of $4 million.
All prescription drug inventories in the Retail/LTC Segment have been valued at the lower of cost or market using the
weighted average cost method. The weighted average cost method is used to determine cost of sales and inventory
in our mail service and specialty pharmacies in our Pharmacy Services Segment.
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 store and
a continuous cycle count process is the primary procedure used to validate the inventory balances on hand in each
distribution center and mail facility to ensure that the amounts reflected in the accompanying 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 physical inventory loss trends.
Our total reserve for estimated inventory losses covered by this critical accounting policy was $225 million as of
December 31, 2015. 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 $23 million as of December 31, 2015.
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.