Pottery Barn 2005 Annual Report Download - page 46

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CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our
consolidated financial statements, which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and
related disclosures of contingent assets and liabilities. These estimates and assumptions are evaluated on an
on-going basis and are based on historical experience and various other factors that we believe to be reasonable
under the circumstances. Actual results could differ from these estimates.
We believe the following critical accounting policies affect the significant estimates and assumptions used in the
preparation of our consolidated financial statements.
Merchandise Inventories
Merchandise inventories, net of an allowance for excess quantities and obsolescence, are stated at the lower of
cost (weighted average method) or market. We estimate a provision for damaged, obsolete, excess and slow-
moving inventory based on inventory aging reports and specific identification. We generally reserve, based on
inventory aging reports, for 50% of the cost of all inventory between one and two years old and 100% of the cost
of all inventory over two years old. If actual obsolescence is different from our estimate, we will adjust our
provision accordingly. Specific reserves are also recorded in the event the cost of the inventory exceeds the fair
market value. In addition, on a monthly basis, we estimate a reserve for expected shrinkage at the concept and
channel level based on historical shrinkage factors and our current inventory levels. Actual shrinkage is recorded
at year-end based on the results of our physical inventory count and can vary from our estimates due to such
factors as changes in operations within our distribution centers, the mix of our inventory (which ranges from
large furniture to small tabletop items) and execution against loss prevention initiatives in our stores, off-site
storage locations, and our third party transportation providers.
Prepaid Catalog Expenses
Prepaid catalog expenses consist of third party incremental direct costs, including creative design, paper,
printing, postage and mailing costs for all of our direct response catalogs. Such costs are capitalized as prepaid
catalog expenses and are amortized over their expected period of future benefit. Such amortization is based upon
the ratio of actual revenues to the total of actual and estimated future revenues on an individual catalog basis.
Estimated future revenues are based upon various factors such as the total number of catalogs and pages
circulated, the probability and magnitude of consumer response and the assortment of merchandise offered. Each
catalog is generally fully amortized over a six to nine month period, with the majority of the amortization
occurring within the first four to five months. Prepaid catalog expenses are evaluated for realizability on a
monthly basis by comparing the carrying amount associated with each catalog to the estimated probable
remaining future profitability (remaining net revenues less merchandise cost of goods sold, selling expenses and
catalog related-costs) associated with that catalog. If the catalog is not expected to be profitable, the carrying
amount of the catalog is impaired accordingly.
Property and Equipment
Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets. The decision to close, relocate, remodel or expand a store prior to the end of
its lease term can result in accelerated depreciation over the revised useful life of the long-lived assets. For any
store closures where a lease obligation still exists, we record the estimated future liability associated with the
rental obligation on the date the store is closed in accordance with Statement of Financial Accounting Standards
(“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” However, most store
closures occur upon the lease expiration.
We review the carrying value of all long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be recoverable. In accordance with SFAS
No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we review for impairment all
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