Pottery Barn 2014 Annual Report Download - page 47

IMPACT OF INFLATION
The impact of inflation (or deflation) on our results of operations for the past three fiscal years has not been
significant. However, we cannot be certain of the effect inflation (or deflation) may have on our results of
operations in the future.
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 Consolidated 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
ongoing 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 used in the preparation of our Consolidated Financial
Statements include significant estimates and assumptions.
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. To determine if the value of our inventory should be marked down
below cost, we consider current and anticipated demand, customer preferences and age of the merchandise. The
significant estimates used in inventory valuation are obsolescence (including excess and slow-moving inventory
and lower of cost or market reserves) and estimates of inventory shrinkage. We reserve for obsolescence based
on historical trends, aging reports, specific identification and our estimates of future sales and selling prices.
Reserves for shrinkage are estimated and recorded throughout the year, at the brand and channel level, as a
percentage of net sales based on historical shrinkage results, expectations of future shrinkage and 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, the mix of our inventory (which
ranges from large furniture to small tabletop items) and execution against loss prevention initiatives in our stores,
distribution centers, off-site storage locations, and with our third party warehouse and transportation providers.
Accordingly, there is no shrinkage reserve at year-end.
Our obsolescence and shrinkage reserve calculations contain estimates that require management to make
assumptions and to apply judgment regarding a number of factors, including market conditions, the selling
environment, historical results and current inventory trends. If actual obsolescence or shrinkage estimates change
from our original estimate, we will adjust our reserves accordingly throughout the year. We have made no
material changes to our assumptions included in the calculations of the obsolescence and shrinkage reserves
throughout the year. In addition, we do not believe a 10% change in our inventory reserves would have a material
effect on net earnings. As of February 1, 2015 and February 2, 2014, our inventory obsolescence reserves were
$10,244,000 and $10,406,000, respectively.
Advertising and Prepaid Catalog Expenses
Advertising expenses consist of media and production costs related to catalog mailings, e-commerce advertising
and other direct marketing activities. All advertising costs are expensed as incurred, or upon the release of the
initial advertisement, with the exception of prepaid catalog expenses. Prepaid catalog expenses consist primarily
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 estimated e-commerce
revenues for the period to the total estimated e-commerce revenues over the life of the catalog on an individual
catalog basis. Estimated e-commerce revenues over the life of the catalog are based upon various factors such as
33
Form 10-K