O'Reilly Auto Parts 2015 Annual Report Download - page 42

FORM 10-K
34
• Inventory Obsolescence and Shrink:
Inventory, which consists of automotive hard parts, maintenance items, accessories and tools, is stated at the lower of cost or market.
The extended nature of the life cycle of our products is such that the risk of obsolescence of our inventory is minimal. The products
that we sell generally have applications in our markets for a relatively long period of time in conjunction with the corresponding
vehicle population. We have developed sophisticated systems for monitoring the life cycle of a given product and, accordingly, have
historically been very successful in adjusting the volume of our inventory in conjunction with a decrease in demand. We do record
a reserve to reduce the carrying value of our inventory through a charge to cost of sales in the isolated instances where we believe
that the market value of a product line is lower than our recorded cost. This reserve is based on our assumptions about the marketability
of our existing inventory and is subject to uncertainty to the extent that we must estimate, at a given point in time, the market value
of inventory that will be sold in future periods. Ultimately, our projections could differ from actual results and could result in a
material impact to our stated inventory balances. We have historically not had to materially adjust our obsolescence reserves due to
the factors discussed above and do not anticipate that we will experience material changes in our estimates in the future.
We also record a reserve to reduce the carrying value of our perpetual inventory to account for quantities in our perpetual records
above the actual existing quantities on hand caused by unrecorded shrink. We estimate this reserve based on the results of our
extensive and frequent cycle counting programs and periodic, full physical inventories. To the extent that our estimates do not
accurately reflect the actual unrecorded inventory shrinkage, we could potentially experience a material impact to our inventory
balances. We have historically been able to provide a timely and accurate measurement of shrink and have not experienced material
adjustments to our estimates. If the shrink reserve changed 10% from the estimate that we recorded based on our historical experience
at December 31, 2015, the financial impact would have been approximately $1 million or 0.1% of pretax income for the year ended
December 31, 2015.
• Valuation of Long-Lived Assets and Goodwill:
We evaluate the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate the carrying
value of these assets might exceed their current fair values. As part of the evaluation, we review performance at the store level to
identify any stores with current period operating losses that should be considered for impairment. A potential impairment has occurred
if the projected future undiscounted cash flows realized from the best possible use of the asset are less than the carrying value of the
asset. The estimate of cash flows includes management's assumptions of cash inflows and outflows directly resulting from the use
of that asset in operations. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is
recognized for the amount by which the carrying amount of the asset exceeds the fair value of the assets. Our impairment analyses
contain estimates due to the inherently judgmental nature of forecasting long-term estimated cash flows and determining the ultimate
useful lives and fair values of the assets. Actual results could differ from these estimates, which could materially impact our impairment
assessment.
We review goodwill for impairment annually during the fourth quarter, or when events or changes in circumstances indicate the
carrying value of these assets might exceed their current fair values. We have never recorded an impairment to goodwill. The process
of evaluating goodwill for impairment involves the determination of the fair value of our Company using the market approach.
Inherent in such fair value determinations are certain judgments and estimates, including estimates that incorporate assumptions
marketplace participants would use in making their estimates of fair value. In the future, if events or market conditions affect the
estimated fair value to the extent that an asset is impaired, we will adjust the carrying value of these assets in the period in which
the impairment occurs; however, we do not believe there has been any change of events or circumstances that would indicate that a
reevaluation of goodwill is required as of December 31, 2015, nor do we believe goodwill is at risk of failing impairment testing.
If the price of O'Reilly stock, which was a primary input used to determine our market capitalization during step one of goodwill
impairment testing, changed by 10% from the value used during testing, the results and our conclusions would not have changed
and no further steps would have been required.
• Supplier Concessions:
We receive concessions from our suppliers through a variety of programs and arrangements, including co-operative advertising,
allowances for warranties, merchandise allowances and volume purchase rebates. Co-operative advertising allowances that are
incremental to our advertising program, specific to a product or event and identifiable for accounting purposes, are reported as a
reduction of advertising expense in the period in which the advertising occurred. All other material supplier concessions are recognized
as a reduction to the cost of sales. Amounts receivable from suppliers also include amounts due to us relating to supplier purchases
and product returns. Management regularly reviews amounts receivable from suppliers and assesses the need for a reserve for
uncollectible amounts based on our evaluation of our suppliers' financial position and corresponding ability to meet their financial
obligations. Based on our historical results and current assessment, we have not recorded a reserve for uncollectible amounts in our
consolidated financial statements, and we do not believe there is a reasonable likelihood that our ability to collect these amounts will
differ from our expectations. The eventual ability of our suppliers to pay us the obliged amounts could differ from our assumptions
and estimates, and we may be exposed to losses or gains that could be material.