Chipotle 2005 Annual Report Download - page 43

evaluated and classified as operating or capital leases for financial reporting purposes. We recognize
rent expense for our operating leases, which have escalating rentals over the term of the lease (which
includes reasonably assured renewal options), on a straight-line basis over the lease term. In addition,
the lease term is deemed to commence when we take physical possession of the leased property. We
currently capitalize the straight-line rent amounts during the period prior to store opening. We will,
however, begin expensing these amounts beginning January 1, 2006 as a result of the issuance of FSP
13-1. We use a consistent lease term when calculating depreciation of leasehold improvements, when
determining straight-line rent expense and when determining classification of our leases as either
operating or capital. Contingent rents are generally amounts we must pay to landlords when we have
sales in excess of certain thresholds stipulated in certain store leases and are included in rent expense
as they accrue. Some of our leases contain tenant improvement allowances. For purposes of recognizing
tenant improvement allowances, we amortize the incentives over their estimated useful lives. For tenant
improvement allowances, we also record a deferred rent liability or an obligation on our consolidated
balance sheet.
Insurance Liability
We maintain, or in some cases McDonald’s maintains on our behalf, various insurance policies for
workers’ compensation, employee health, general liability and property damage. Pursuant to those
policies, we’re responsible for losses up to certain limits for our general liability and property damage
insurance and are required to estimate a liability that represents our ultimate exposure for aggregate
losses below those limits. This liability is based on our estimates of the ultimate costs to be incurred to
settle known claims and claims not reported as of the balance sheet date. Our estimated liability is not
discounted and is based on a number of assumptions and factors, including historical trends, actuarial
assumptions and economic conditions. If actual trends differ from our estimates, our financial results
could be affected.
Income Taxes
Prior to our initial public offering in January 2006, we were not a separate taxable entity for
federal or most state income tax purposes. Consequently, McDonald’s included our results of
operations in its consolidated federal and state income tax returns for the periods prior to our initial
public offering. We will remain in McDonald’s consolidated tax returns for some states until their
ownership percentage decreases to below 50%. Our tax provision is computed based on a separate
return basis. We’ve accounted for, and currently account for, income taxes in accordance with SFAS
No. 109, Accounting for Income Taxes (‘‘SFAS 109’’). SFAS 109 established financial accounting
reporting standards for the effects of income taxes resulting from an enterprise’s activities during the
current and preceding years. It requires an asset and liability approach for financial accounting and
reporting of income taxes. We recognize deferred tax liabilities and assets for the future consequences
of events that have been recognized in our consolidated financial statements or McDonald’s tax returns.
If the future consequences of differences between financial reporting basis and tax basis of our assets
and liabilities result in a net deferred tax asset, we evaluate the probability of our ability to realize the
future benefits indicated by that asset. If it is more likely than not that some portion or all of the
deferred tax asset will not be realized, we’ll record a valuation allowance related to a deferred tax
asset. Our ability to realize that net deferred tax asset generally depends on whether we have enough
taxable income of an appropriate character within the carry-forward period permitted by the tax law.
Unless we have enough taxable income to offset the deductible amounts and carry forwards, the related
tax benefits will expire unused. We evaluate both positive and negative evidence in making a
determination as to whether it is more likely than not that all or some portion of the deferred tax asset
will not be realized, and we measure deferred items based on enacted tax laws. This evaluation requires
us to project our taxable income to determine if our income is sufficient to realize the tax assets. The
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