Dollar General 2011 Annual Report Download - page 147

10-K
Management believes the following policies and estimates are critical because they involve
significant judgments, assumptions, and estimates. Management has discussed the development and
selection of the critical accounting estimates with the Audit Committee of our Board of Directors, and
the Audit Committee has reviewed the disclosures presented below relating to those policies and
estimates.
Merchandise Inventories. Merchandise inventories are stated at the lower of cost or market with
cost determined using the retail last-in, first-out (‘‘LIFO’’) method. Under our retail inventory method
(‘‘RIM’’), the calculation of gross profit and the resulting valuation of inventories at cost are computed
by applying a calculated cost-to-retail inventory ratio to the retail value of sales at a department level.
The RIM is an averaging method that has been widely used in the retail industry due to its practicality.
Also, it is recognized that the use of the RIM will result in valuing inventories at the lower of cost or
market (‘‘LCM’’) if markdowns are currently taken as a reduction of the retail value of inventories.
Inherent in the RIM calculation are certain significant management judgments and estimates
including, among others, initial markups, markdowns, and shrinkage, which significantly impact the
gross profit calculation as well as the ending inventory valuation at cost. These significant estimates,
coupled with the fact that the RIM is an averaging process, can, under certain circumstances, produce
distorted cost figures. Factors that can lead to distortion in the calculation of the inventory balance
include:
• applying the RIM to a group of products that is not fairly uniform in terms of its cost and
selling price relationship and turnover;
• applying the RIM to transactions over a period of time that include different rates of gross
profit, such as those relating to seasonal merchandise;
• inaccurate estimates of inventory shrinkage between the date of the last physical inventory at a
store and the financial statement date; and
• inaccurate estimates of LCM and/or LIFO reserves.
Factors that reduce potential distortion include the use of historical experience in estimating the
shrink provision (see discussion below) and an annual LIFO analysis whereby all SKUs are considered
in the index formulation. An actual valuation of inventory under the LIFO method is made at the end
of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO
calculations are based on management’s estimates of expected year-end inventory levels, sales for the
year and the expected rate of inflation/deflation for the year and are thus subject to adjustment in the
final year-end LIFO inventory valuation. We also perform interim inventory analysis for determining
obsolete inventory. Our policy is to write down inventory to an LCM value based on various
management assumptions including estimated markdowns and sales required to liquidate such inventory
in future periods. Inventory is reviewed on a quarterly basis and adjusted to reflect write-downs as
appropriate.
Factors such as slower inventory turnover due to changes in competitors’ practices, consumer
preferences, consumer spending and unseasonable weather patterns, among other factors, could cause
excess inventory requiring greater than estimated markdowns to entice consumer purchases, resulting in
an unfavorable impact on our consolidated financial statements. Sales shortfalls due to the above
factors could cause reduced purchases from vendors and associated vendor allowances that would also
result in an unfavorable impact on our consolidated financial statements.
We calculate our shrink provision based on actual physical inventory results during the fiscal
period and an accrual for estimated shrink occurring subsequent to a physical inventory through the
end of the fiscal reporting period. This accrual is calculated as a percentage of sales at each retail
store, at a department level, and is determined by dividing the book-to-physical inventory adjustments
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