O'Reilly Auto Parts 2015 Annual Report Download - page 56

FORM 10-K
48
suppliers and the Company did not record a reserve for uncollectable amounts from suppliers in the consolidated financial statements as
of December 31, 2015 or 2014.
Inventory:
Inventory, which consists of automotive hard parts, maintenance items, accessories and tools, is stated at the lower of cost or market.
Inventory also includes capitalized costs related to procurement, warehousing and distribution centers ("DCs"). Cost has been determined
using the last-in, first-out ("LIFO") method, which more accurately matches costs with related revenues. Over time, as the Company's
merchandise inventory purchases have increased, the Company negotiated improved acquisition costs from its suppliers and the
corresponding price deflation exhausted the Company's LIFO reserve balance. The Company's policy is to not write up the value of its
inventory in excess of its replacement cost, and accordingly, the Company's merchandise inventory has been effectively recorded at
replacement cost since December 31, 2013. The replacement cost of inventory was $2.63 billion and $2.56 billion as of December 31,
2015 and 2014, respectively. LIFO costs exceeded replacement costs by $85.9 million and $61.4 million at December 31, 2015 and
2014, respectively.
Fair value of financial instruments:
The Company uses the fair value hierarchy, which prioritizes the inputs used to measure the fair value of certain of its financial instruments.
The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement)
and the lowest priority to unobservable inputs (Level 3 measurement). The Company uses the income and market approaches to determine
the fair value of its assets and liabilities. The three levels of the fair value hierarchy are set forth below:
• Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at
the measurement date.
• Level 2 – Inputs other than quoted prices in active markets included within Level 1 that are observable for the asset or liability,
either directly or indirectly.
• Level 3 – Unobservable inputs for the asset or liability.
See Note 2 for further information concerning the Company's financial and non-financial assets and liabilities measured at fair value on
a recurring and non-recurring basis.
Property and equipment:
Property and equipment are carried at cost. Depreciation is calculated using the straight-line method generally over the estimated useful
lives of the assets. Leasehold improvements are amortized over the lesser of the lease term or the estimated economic life of the assets.
The lease term includes renewal options determined by management at lease inception for which failure to execute renewal options would
result in a substantial economic penalty to the Company. Maintenance and repairs are charged to expense as incurred. Upon retirement
or sale, the cost and accumulated depreciation are eliminated and the gain or loss, if any, is recognized in the Company's Consolidated
Statements of Income. The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be fully recoverable.
Notes receivable:
The Company had notes receivable from suppliers and other third parties amounting to $17.3 million and $17.5 million at December 31,
2015 and 2014, respectively. The notes receivable, which do not bear interest, are due in varying amounts through March 2023. The
Company regularly reviews its notes receivable for collectability and assesses the need for a reserve for uncollectable amounts based on
an evaluation of the Company's borrowers' financial positions and corresponding abilities to meet financial obligations. Management
does not believe there is a reasonable likelihood that the Company will be unable to collect the notes receivable and the Company did
not record a reserve for uncollectable notes receivable in the consolidated financial statements as of December 31, 2015 or 2014.
Goodwill and other intangibles:
The accompanying Consolidated Balance Sheets at December 31, 2015 and 2014, include goodwill and other intangible assets recorded
as the result of acquisitions. The Company reviews 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, rather than systematically amortizing
goodwill against earnings. During 2015 and 2014, the goodwill impairment test included a quantitative assessment, which compared the
fair value of the reporting unit to its carrying amount, including goodwill. The Company operates as a single reporting unit, and the
Company determined that its fair value exceeded its carrying value, including goodwill, as of December 31, 2015 and 2014; as such, no
goodwill impairment adjustment was required as of December 31, 2015 and 2014. Finite-lived intangibles are carried at cost and
amortization is calculated using the straight-line method, generally over the estimated useful lives of the intangibles.
Impairment of long-lived assets:
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value
of an asset may not be recoverable. When such an event occurs, the Company compares the sum of the undiscounted expected future
cash flows of the asset (asset group) with the carrying amounts of the asset. If the undiscounted expected future cash flows are less than