Pizza Hut 2006 Annual Report Download - page 56

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CASH AND CASH EQUIVALENTS Cash equivalents represent
funds we have temporarily invested (with original maturities not
exceeding three months) as part of managing our day-to-day oper-
ating cash receipts and disbursements.
INVENTORIES We value our inventories at the lower of cost (com-
puted on the first-in, first-out method) or net realizable value.
PROPERTY, PLANT AND EQUIPMENT We state property, plant
and equipment at cost less accumulated depreciation and amor-
tization and valuation allowances. We calculate depreciation and
amortization on a straight-line basis over the estimated useful
lives of the assets as follows: 5 to 25 years for buildings and
improvements, 3 to 20 years for machinery and equipment and
3 to 7 years for capitalized software costs. As discussed above,
we suspend depreciation and amortization on assets related to
restaurants that are held for sale.
LEASES AND LEASEHOLD IMPROVEMENTS We account for our
leases in accordance with SFAS No. 13, “Accounting for Leases”
and other related authoritative guidance. When determining the
lease term, we often include option periods for which failure to
renew the lease imposes a penalty on the Company in such an
amount that a renewal appears, at the inception of the lease,
to be reasonably assured. The primary penalty to which we are
subject is the economic detriment associated with the existence
of leasehold improvements which might be impaired if we choose
not to continue the use of the leased property.
In 2004, we recorded an adjustment to correct instances
where our leasehold improvements were not being depreciated
over the shorter of their useful lives or the term of the lease,
including options in some instances, over which we were record-
ing rent expense, including escalations, on a straight line basis.
The cumulative adjustment, primarily through increased U.S.
depreciation expense, totaled $11.5 million ($7 million after tax).
The portion of this adjustment that related to 2004 was approxi-
mately $3 million. As the portion of the adjustment recorded
that was a correction of errors of amounts reported in our prior
period financial statements was not material to any of those
prior period financial statements, the entire adjustment was
recorded in the 2004 Consolidated Financial Statements and no
adjustment was made to any prior period financial statements.
We record rent expense for leases that contain scheduled
rent increases on a straight-line basis over the lease term, includ-
ing any option periods considered in the determination of that
lease term. Contingent rentals are generally based on sales levels
in excess of stipulated amounts, and thus are not considered
minimum lease payments and are included in rent expense as
they accrue. We generally do not receive leasehold improvement
incentives upon opening a store that is subject to a lease.
Prior to fiscal year 2006, we capitalized rent while we were
constructing a restaurant even if such construction period was
subject to a rent holiday. Such capitalized rent was then expensed
on a straight-line basis over the remaining term of the lease
upon opening of the restaurant. Effective January 1, 2006 as
required by FASB Staff Position No. 13-1, “Accounting for Rental
Costs Incurred during a Construction Period” (“FSP 13-1”), we
began expensing rent associated with leased land or buildings
for construction periods whether rent was paid or we were subject
to a rent holiday. The adoption of FSP 13-1 did not significantly
impact our results of operations in 2006 and we do not anticipate
significant future impact.
INTERNAL DEVELOPMENT COSTS AND ABANDONED SITE COSTS
We capitalize direct costs associated with the site acquisition
and construction of a Company unit on that site, including direct
internal payroll and payroll-related costs. Only those site-specific
costs incurred subsequent to the time that the site acquisition
is considered probable are capitalized. If we subsequently make
a determination that a site for which internal development costs
have been capitalized will not be acquired or developed, any previ-
ously capitalized internal development costs are expensed and
included in G&A expenses.
GOODWILL AND INTANGIBLE ASSETS The Company accounts
for acquisitions of restaurants from franchisees and other acquisi-
tions of businesses that may occur from time to time in accordance
with SFAS No. 141, “Business Combinations” (“SFAS 141”). Good-
will in such acquisitions represents the excess of the cost of a
business acquired over the net of the amounts assigned to assets
acquired, including identifiable intangible assets, and liabilities
assumed. SFAS 141 specifies criteria to be used in determining
whether intangible assets acquired in a business combination
must be recognized and reported separately from goodwill. We
base amounts assigned to goodwill and other identifiable intan-
gible assets on independent appraisals or internal estimates.
The Company accounts for recorded goodwill and other intan-
gible assets in accordance with SFAS No. 142, “Goodwill and
Other Intangible Assets” (“SFAS 142”). In accordance with SFAS
142, we do not amortize goodwill and indefinite-lived intangible
assets. We evaluate the remaining useful life of an intangible
asset that is not being amortized each reporting period to deter-
mine whether events and circumstances continue to support an
indefinite useful life. If an intangible asset that is not being amor-
tized is subsequently determined to have a finite useful life, we
amortize the intangible asset prospectively over its estimated
remaining useful life. Amortizable intangible assets are amortized
on a straight-line basis.
In accordance with the requirements of SFAS 142, goodwill
has been assigned to reporting units for purposes of impairment
testing. Our reporting units are our operating segments in the U.S.
(see Note 21) and our business management units internationally
(typically individual countries). We evaluate goodwill and indefinite-
lived assets for impairment on an annual basis or more often if an
event occurs or circumstances change that indicate impairments
might exist. Goodwill impairment tests consist of a comparison
of each reporting unit’s fair value with its carrying value. The
fair value of a reporting unit is an estimate of the amount for
which the unit as a whole could be sold in a current transaction
between willing parties. We generally estimate fair value based
on discounted cash flows. If the carrying value of a reporting unit
exceeds its fair value, goodwill is written down to its implied fair
value. We have selected the beginning of our fourth quarter as the
date on which to perform our ongoing annual impairment test for
goodwill. For 2006, 2005 and 2004, there was no impairment of
goodwill identified during our annual impairment testing.
For indefinite-lived intangible assets, our impairment test
consists of a comparison of the fair value of an intangible asset
with its carrying amount. Fair value is an estimate of the price a
willing buyer would pay for the intangible asset and is generally
estimated by discounting the expected future cash flows associ-
ated with the intangible asset. We also perform our annual test
for impairment of our indefinite-lived intangible assets at the
beginning of our fourth quarter. No impairment of indefinite-lived
intangible assets was recorded in 2006, 2005 or 2004.