Estee Lauder 2011 Annual Report Download - page 125

THE EST{E LAUDER COMPANIES INC. 123
well as inbound freight. Manufacturing overhead is
allocated to the cost of inventory based on the normal
production capacity. Unallocated overhead during peri-
ods of abnormally low production levels are recognized
as cost of sales in the period in which they are incurred.
Promotional merchandise is charged to expense at the
time the merchandise is shipped to the Company’s
customers. Included in inventory and promotional
merchandise is an inventory obsolescence reserve, which
represents the difference between the cost of the inven-
tory and its estimated realizable value, based on various
product sales projections. This reserve is calculated using
an estimated obsolescence percentage applied to the
inventory based on age, historical trends and require-
ments to support forecasted sales. In addition, and as nec-
essary, specific reserves for future known or anticipated
events may be established.
Derivative Financial Instruments
The Company’s derivative financial instruments are
recorded as either assets or liabilities on the balance
sheet and measured at fair value. All derivatives are
(i) designated as a hedge of the fair value of a recognized
asset or liability or of an unrecognized firm commitment
(“fair-value” hedge), (ii) designated as a hedge of a fore-
casted transaction or of the variability of cash flows to be
received or paid related to a recognized asset or liability
(“foreign currency cash-flow” hedge), or (iii) not desig-
nated as a hedging instrument. Changes in the fair value
of a derivative that is designated and qualifies as a fair-
value hedge that is highly effective are recorded in cur-
rent-period earnings, along with the loss or gain on the
hedged asset or liability that is attributable to the hedged
risk (including losses or gains on unrecognized firm com-
mitments). Changes in the fair value of a derivative that is
designated and qualifies as a foreign currency cash-flow
hedge of a foreign-currency-denominated forecasted
transaction that is highly effective are recorded in OCI.
Gains and losses deferred in OCI are then recognized
in current-period earnings when earnings are affected
by the variability of cash flows of the hedged foreign-
currency-denominated forecasted transaction (e.g., when
periodic settlements on a variable-rate asset or liability are
recorded in earnings). Changes in the fair value of deriva-
tive instruments not designated as hedging instruments
are reported in current-period earnings.
Property, Plant and Equipment
Property, plant and equipment, including leasehold and
other improvements that extend an asset’s useful life or
productive capabilities, are carried at cost less accumu-
lated depreciation and amortization. Costs incurred for
computer software developed or obtained for internal use
are capitalized during the application development stage
and expensed as incurred during the preliminary project
and post-implementation stages. For financial statement
purposes, depreciation is provided principally on the
straight-line method over the estimated useful lives
of the assets ranging from 3 to 40 years. Leasehold
i mprovements are amortized on a straight-line basis over
the shorter of the lives of the respective leases or the
expected useful lives of those improvements.
Goodwill and Other Indefinite-lived Intangible Assets
Goodwill is calculated as the excess of the cost of
purchased businesses over the fair value of their under-
lying net assets. Other indefinite-lived intangible assets
principally consist of trademarks. Goodwill and other
indefinite-lived intangible assets are not amortized.
The Company assesses goodwill and other indefinite-
lived intangibles at least annually for impairment as of the
beginning of the fiscal fourth quarter, or more frequently
if certain events or circumstances warrant. The Company
tests goodwill for impairment at the reporting unit level,
which is one level below the Company’s operating seg-
ments. The Company identifies its reporting units by
assessing whether the components of its operating seg-
ments constitute businesses for which discrete financial
information is available and management of each report-
ing unit regularly reviews the operating results of those
components. The Company makes certain judgments and
assumptions in allocating assets and liabilities to deter-
mine carrying values for its reporting units. Impairment
testing is performed in two steps: (i) the Company deter-
mines impairment by comparing the fair value of a report-
ing unit with its carrying value, and (ii) if there is an
impairment, the Company measures the amount of
impairment loss by comparing the implied fair value
of goodwill with the carrying amount of that goodwill.
The impairment test for indefinite-lived intangible assets
encompasses calculating a fair value of an indefinite-lived
intangible asset and comparing the fair value to its carry-
ing value. If the carrying value exceeds the fair value,
impairment is recorded.
Testing goodwill for impairment requires the Company
to estimate fair values of reporting units using significant
estimates and assumptions. The assumptions made will
impact the outcome and ultimate results of the testing.
The Company uses industry accepted valuation models
and set criteria that are reviewed and approved by various
levels of management and, in certain instances, the
Company engages third-party valuation specialists for
advice. To determine fair value of the reporting unit,
the Company generally uses an equal weighting of the