Red Lobster 2011 Annual Report Download - page 53

Notes to Consolidated Financial Statements
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2011 Annual Report 51
FOOD AND BEVERAGE COSTS
Food and beverage costs include inventory, warehousing, related purchasing and
distribution costs and gains and losses on certain commodity derivative contracts.
Vendor allowances received in connection with the purchase of a vendor’s products
are recognized as a reduction of the related food and beverage costs as earned.
Advance payments are made by the vendors based on estimates of volume to be
purchased from the vendors and the terms of the agreement. As we make purchases
from the vendors each period, we recognize the pro rata portion of allowances
earned as a reduction of food and beverage costs for that period. Differences
between estimated and actual purchases are settled in accordance with the
terms of the agreements. Vendor agreements are generally for a period of one
year or more and payments received are initially recorded as long-term liabilities.
Amounts which are expected to be earned within one year are recorded as
current liabilities.
INCOME TAXES
We provide for federal and state income taxes currently payable as well as for
those deferred because of temporary differences between reporting income and
expenses for financial statement purposes versus tax purposes. Federal income
tax credits are recorded as a reduction of income taxes. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in earnings
in the period that includes the enactment date. Interest recognized on reserves
for uncertain tax positions is included in interest, net in our consolidated state-
ments of earnings. A corresponding liability for accrued interest is included as a
component of other current liabilities in our consolidated balance sheets. Penalties,
when incurred, are recognized in selling, general and administrative expenses.
ASC Topic 740, Income Taxes, requires that a position taken or expected to be
taken in a tax return be recognized (or derecognized) in the financial statements
when it is more likely than not (i.e., a likelihood of more than 50 percent) that the
position would be sustained upon examination by tax authorities. A recognized tax
position is then measured at the largest amount of benefit that is greater than
50฀percent฀likely฀of฀being฀realized฀upon฀ultimate฀settlement.฀See฀Note฀16฀—฀Income฀
Taxes for additional information.
Income tax benefits credited to equity relate to tax benefits associated with
amounts that are deductible for income tax purposes but do not affect earnings.
These benefits are principally generated from employee exercises of non-qualified
stock options and vesting of employee restricted stock awards.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We enter into derivative instruments for risk management purposes only, including
derivatives designated as hedging instruments as required by FASB ASC Topic
815, Derivatives and Hedging, and those utilized as economic hedges. We use
financial and commodities derivatives to manage interest rate, compensation,
commodities pricing and foreign currency exchange rate risks inherent in our
business operations. Our use of derivative instruments is currently limited to
interest฀rate฀hedges;฀equity฀forwards฀contracts;฀commodities฀futures฀and฀
options contracts and foreign currency forward contracts. These instruments
are generally structured as hedges of the variability of cash flows related to
forecasted transactions (cash flow hedges). However, we do at times enter into
instruments designated as fair value hedges to reduce our exposure to changes in
fair value of the related hedged item. We do not enter into derivative instruments
for trading or speculative purposes, where changes in the cash flows or fair value
of the derivative are not expected to offset changes in cash flows or fair value of
the hedged item. However, we have entered into equity forwards to economically
hedge changes in the fair value of employee investments in our non-qualified
deferred compensation plan and certain commodity futures contracts to eco-
nomically hedge changes in the value of certain inventory purchases, for which
we have not applied hedge accounting. All derivatives are recognized on the
balance sheet at fair value. For those derivative instruments for which we intend
to elect hedge accounting, on the date the derivative contract is entered into, we
document all relationships between hedging instruments and hedged items, as
well as our risk-management objective and strategy for undertaking the various
hedge transactions. This process includes linking all derivatives designated as
cash flow hedges to specific assets and liabilities on the consolidated balance
sheet or to specific forecasted transactions. We also formally assess, both at the
hedge’s inception and on an ongoing basis, whether the derivatives used in
hedging transactions are highly effective in offsetting changes in cash flows of
hedged items.
To the extent our derivatives are effective in offsetting the variability of the
hedged cash flows, and otherwise meet the cash flow hedge accounting criteria
required by Topic 815 of the FASB ASC, changes in the derivatives’ fair value are
not included in current earnings but are included in accumulated other compre-
hensive income (loss), net of tax. These changes in fair value will be reclassified
into earnings at the time of the forecasted transaction. Ineffectiveness measured
in the hedging relationship is recorded currently in earnings in the period in which
it occurs. To the extent our derivatives are effective in mitigating changes in fair
value, and otherwise meet the fair value hedge accounting criteria required by
Topic 815 of the FASB ASC, gains and losses in the derivatives’ fair value are
included in current earnings, as are the gains and losses of the related hedged
item. To the extent the hedge accounting criteria are not met, the derivative
contracts are utilized as economic hedges and changes in the fair value of such
contracts are recorded currently in earnings in the period in which they occur.
Cash฀flows฀related฀to฀derivatives฀are฀included฀in฀operating฀activities.฀See฀Note฀10฀—฀
Derivative Instruments and Hedging Activities for additional information.
LEASES
For operating leases, we recognize rent expense on a straight-line basis over the
expected lease term, including cancelable option periods where failure to exercise
the options would result in an economic penalty to the Company. Differences
between amounts paid and amounts expensed are recorded as deferred rent.
Capital leases are recorded as an asset and an obligation at an amount equal to
the present value of the minimum lease payments during the lease term. Within
the provisions of certain of our leases, there are rent holidays and escalations in
payments over the base lease term, as well as renewal periods. The effects of the
holidays and escalations have been reflected in rent expense on a straight-line
basis over the expected lease term, which includes cancelable option periods
where failure to exercise such options would result in an economic penalty to the
Company. The lease term commences on the date when we have the right to
control the use of the leased property, which is typically before rent payments