Chipotle 2006 Annual Report Download - page 37

subjective or complex judgments, often because we need to estimate the effect of inherently uncertain matters.
We base our estimates and judgments on historical experiences and various other factors that we believe to be
appropriate under the circumstances. Actual results may differ from these estimates, and we might obtain
different estimates if we used different assumptions or conditions. We believe the following critical accounting
estimates affect our more significant judgments and estimates used in the preparation of our financial statements:
Leases
We lease most of our restaurant locations. Our leases contain escalating rentals over the lease term as well
as optional renewal periods. We account for our leases under FASB Statement No. 13, Accounting for Leases
(“FAS 13”) which requires rent to be recognized on a straight-line basis over the lease term including reasonably
assured renewal periods. We have estimated that our lease term, including reasonably assured renewal periods, is
the lesser of the lease term or 20 years. If the estimate of our reasonably assured lease terms were changed our
depreciation and rent expense could differ materially.
Stock-based Compensation
Effective January 1, 2005, we adopted FAS 123R which requires recognition of the fair value of stock-based
compensation over the vesting period of the option. We use the Black-Scholes valuation model to determine the
fair value of our stock options, which requires assumptions to be made regarding our stock price volatility, the
expected life of the option and expected dividend rates. The volatility assumptions were derived from our annual
independent stock valuations and historical volatilities of competitors whose shares are traded in the public
markets and are adjusted to reflect anticipated behavior specific to us. Had we arrived at different assumptions of
stock price volatility or expected lives of our options, our stock-based compensation expense and results of
operations could have been different.
Insurance Liability
We maintain various insurance policies for employee health, workers’ compensation, general liability and
property damage. Pursuant to these policies we are either responsible for losses up to certain limits or are self
insured but have third party insurance coverage to limit exposure to these claims. We record a liability that
represents our estimated cost of claims incurred and unpaid 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, and is closely monitored and adjusted when warranted by changing
circumstances. In addition, our history of claims experience is short and our significant growth rate could affect
the accuracy of estimates based on historical experience. Should a greater amount of claims occur compared to
what was estimated or medical costs increase beyond what was expected, our accrued liabilities might not be
sufficient and additional expenses may be recorded. Actual claims experience could also be more favorable than
estimated resulting in expense reductions. Unanticipated changes may produce materially different amounts of
expense than that reported under these programs.
Reserves/Contingencies for Litigation and Other Matters
We are involved in various claims and legal actions that arise in the ordinary course of business. These
actions are subject to many uncertainties, and we cannot predict the outcomes with any degree of certainty.
Consequently, we were unable to ascertain the ultimate aggregate amount of monetary liability or financial
impact with respect to these matters as of December 31, 2006 and 2005. Once resolved, however, these actions
may affect our operating results and cash flows. In addition, we’re involved in claims relating to the possible
theft of our customers’ credit and debit card data. In 2004, we recorded charges of $4.0 million to establish a
reserve for claims seeking reimbursement for purportedly fraudulent credit and debit card charges and the cost of
replacing cards and monitoring expenses and fees. As of December 31, 2006, the remaining reserve was
$1.2 million. As the situation develops and more information becomes available, the amount of the reserve may
increase or decrease accordingly. See Item 1A. “Risk Factors—We may have experienced a security breach with
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