Red Lobster 2012 Annual Report Download - page 26

Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Darden
22 Darden Restaurants, Inc. 2012 Annual Report
Our significant accounting policies are more fully described in Note 1 to the
consolidated financial statements. However, certain of our accounting policies
that are considered critical are those we believe are both most important to the
portrayal of our financial condition and operating results and require our most
difficult, subjective or complex judgments, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain. Judgments
and uncertainties affecting the application of those policies may result in
materially different amounts being reported under different conditions or using
different assumptions. We consider the following policies to be most critical in
understanding the judgments that are involved in preparing our consolidated
financial statements.
Land, Buildings and Equipment
Land, buildings and equipment are recorded at cost less accumulated
depreciation. Building components are depreciated over estimated useful lives
ranging from 7 to 40 years using the straight-line method. Leasehold improve-
ments, which are reflected on our consolidated balance sheets as a component
of buildings in land, buildings and equipment, net, are amortized over the lesser
of the expected lease term, including cancelable option periods, or the estimated
useful lives of the related assets using the straight-line method. Equipment is
depreciated over estimated useful lives ranging from 2 to 10 years, also using the
straight-line method.
Our accounting policies regarding land, buildings and equipment, including
leasehold improvements, include our judgments regarding the estimated useful
lives of these assets, the residual values to which the assets are depreciated or
amortized, the determination of what constitutes expected lease term and the
determination as to what constitutes enhancing the value of or increasing the
life of existing assets. These judgments and estimates may produce materially
different amounts of reported depreciation and amortization expense if different
assumptions were used. As discussed further below, these judgments may also
impact our need to recognize an impairment charge on the carrying amount of
these assets as the cash flows associated with the assets are realized, or as our
expectations of estimated future cash flows change.
Leases
We are obligated under various lease agreements for certain restaurants.
For operating leases, we recognize rent expense on a straight-line basis over the
expected lease term, including option periods as described below. 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 we are reasonably assured to exercise because 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 are due under the terms
of the lease. The leasehold improvements and property held under capital leases
for each restaurant facility are amortized on the straight-line method over the
shorter of the estimated life of the asset or the same expected lease term used
for lease accounting purposes. Many of our leases have renewal periods totaling
5 to 20 years, exercisable at our option, and require payment of property
taxes, insurance and maintenance costs in addition to the rent payments. The
consolidated financial statements reflect the same lease term for amortizing
leasehold improvements as we use to determine capital versus operating lease
classifications and in calculating straight-line rent expense for each restaurant.
Percentage rent expense is generally based upon sales levels and is accrued
when we determine that it is probable that such sales levels will be achieved.
Our judgments related to the probable term for each restaurant affect
the classification and accounting for leases as capital versus operating, the rent
holidays and escalation in payments that are included in the calculation of
straight-line rent and the term over which leasehold improvements for each
restaurant facility are amortized. These judgments may produce materially
different amounts of depreciation, amortization and rent expense than would
be reported if different assumed lease terms were used.
Impairment of Long-Lived Assets
Land, buildings and equipment and certain other assets, including definite-lived
intangible assets, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recover-
able. Recoverability of assets to be held and used is measured by a comparison
of the carrying amount of the assets to the future undiscounted net cash flows
expected to be generated by the assets. Identifiable cash flows are measured at
the lowest level for which they are largely independent of the cash flows of other
groups of assets and liabilities, generally at the restaurant level. If these assets
are determined to be impaired, the amount of impairment recognized is measured
by the amount by which the carrying amount of the assets exceeds their fair
value. Fair value is generally determined by appraisals or sales prices of com-
parable assets. Restaurant sites and certain other assets to be disposed of are
reported at the lower of their carrying amount or fair value, less estimated costs
to sell. Restaurant sites and certain other assets to be disposed of are included
in assets held for sale within prepaid expenses and other current assets in our
consolidated balance sheets when certain criteria are met. These criteria include
the requirement that the likelihood of disposing of these assets within one year
is probable. For assets that meet the held-for-sale criteria, we separately evaluate
whether those assets also meet the requirements to be reported as discontinued
operations. Principally, if we discontinue cash flows and no longer have any sig-
nificant continuing involvement with respect to the operations of the assets, we
classify the assets and related results of operations as discontinued. We consider
guest transfer (an increase in guests at another location as a result of the closure
of a location) as continuing cash flows and evaluate the significance of expected
guest transfer when evaluating a restaurant for discontinued operations reporting.
To the extent we dispose of enough assets where classification between continu-
ing operations and discontinued operations would be material to our consolidated
financial statements, we utilize the reporting provisions for discontinued operations.
Assets whose disposal is not probable within one year remain in land, buildings
and equipment until their disposal within one year is probable.
We account for exit or disposal activities, including restaurant closures,
in accordance with Financial Accounting Standards Board (FASB) Accounting
Standards Codification (ASC) Topic 420, Exit or Disposal Cost Obligations.