Estee Lauder 2007 Annual Report Download - page 35

CRITICAL ACCOUNTING POLICIES
AND ESTIMATES
The discussion and analysis of our fi nancial condition at
June 30, 2007 and our results of operations for the three
fi scal years ended June 30, 2007 are based upon our con-
solidated fi nancial statements, which have been prepared
in conformity with U.S. generally accepted accounting
principles. The preparation of these fi nancial statements
requires us to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues and
expenses reported in those fi nancial statements. These
judgments can be subjective and complex, and conse-
quently actual results could differ from those estimates.
Our most critical accounting policies relate to revenue
recognition, concentration of credit risk, inventory,
pension and other post-retirement benefi t costs, goodwill
and other intangible assets, income taxes, derivatives and
stock-based compensation.
Management of the Company has discussed the selec-
tion of signifi cant accounting policies and the effect of
estimates with the Audit Committee of the Company’s
Board of Directors.
REVENUE RECOGNITION
Revenues from merchandise sales are recognized upon
transfer of ownership, including passage of title to the cus-
tomer and transfer of the risk of loss related to those
goods. In the Americas region, sales are generally recog-
nized at the time the product is shipped to the customer
and in the Europe, Middle East & Africa and Asia/Pacifi c
regions sales are generally recognized based upon the
customer’s receipt. In certain circumstances, transfer of
title takes place at the point of sale, for example, at our
retail stores. Sales at our retail stores and online are recog-
nized in accordance with a 4-4-5 retail calendar.
Revenues are reported on a net sales basis, which is
computed by deducting from gross sales the amount of
actual product returns received, discounts, incentive
arrangements with retailers and an amount established for
anticipated product returns. Our practice is to accept
product returns from retailers only if properly requested,
authorized and approved. In accepting returns, we typi-
cally provide a credit to the retailer against accounts
receivable from that retailer. As a percentage of gross
sales, returns were 4.2%, 5.0% and 4.6% in fi scal 2007,
2006 and 2005, respectively.
Our sales return accrual is a subjective critical estimate
that has a direct impact on reported net sales. This accrual
is calculated based on a history of actual returns, estimated
future returns and information provided by authorized
retailers regarding their inventory levels. Consideration of
these factors results in an accrual for anticipated sales
returns that refl ects increases or decreases related to sea-
sonal fl uctuations. Experience has shown a relationship
between retailer inventory levels and sales returns in the
subsequent period, as well as a consistent pattern of
returns due to the seasonal nature of our business. In
addition, as necessary, specific accruals may be
established for signifi cant future known or anticipated
events. The types of known or anticipated events that we
have considered, and will continue to consider, include,
but are not limited to, the financial condition of our
customers, store closings by retailers, changes in the retail
environment and our decision to continue or support new
and existing products.
CONCENTRATION OF CREDIT RISK
An entity is vulnerable to concentration of credit risk if it
is exposed to risks of loss greater than it would have if
it mitigated its risks through diversifi cation of customers.
The signifi cance of such credit risk depends on the extent
and nature of the concentration.
During fi scal 2006, Federated Department Stores, Inc.
acquired The May Department Stores Company, resulting
in the merger of our previous two largest customers
(collectively “Macy’s, Inc.”). This customer sells products
primarily within North America and accounted for $958.8
million, or 14%, and $1,005.8 million, or 16%, of our
consolidated net sales in fi scal 2007 and 2006, respec-
tively. This customer accounted for $105.3 million, or
12%, and $105.4 million, or 14%, of our accounts receiv-
able at June 30, 2007 and 2006, respectively. Although
management believes that this customer and our other
major customers are sound and creditworthy, a severe
adverse impact on their business operations could have a
corresponding material adverse effect on our net sales,
cash fl ows and/or fi nancial condition.
In the ordinary course of business, we have established
an allowance for doubtful accounts and customer deduc-
tions in the amount of $23.3 million and $27.1 million as
of June 30, 2007 and 2006, respectively. Our allowance
for doubtful accounts is a subjective critical estimate that
has a direct impact on reported net earnings. The allow-
ance for doubtful accounts was reduced by $18.2 million,
$12.0 million and $12.6 million for customer deductions
and write-offs in fi scal 2007, 2006 and 2005, respectively,
and increased by $14.4 million, $10.2 million and $11.4
million for additional provisions in fi scal 2007, 2006 and
34 THE EST{E LAUDER COMPANIES INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS