Red Lobster 2014 Annual Report Download - page 12

Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Darden
10 Darden Restaurants, Inc.
IMPACT OF INFLATION
We attempt to minimize the annual effects of inflation through appropriate
planning, operating practices and menu price increases. We experienced
higher than normal inflationary costs during fiscal 2014 and fiscal 2012 and
were able to partially reduce the annual impact utilizing these strategies. We
do not believe inflation had a significant overall effect on our annual results
of operations during fiscal 2013.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in conformity with U.S.
generally accepted accounting principles. The preparation of these financial
statements requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of sales and expenses during the reporting period. Actual results
could differ from those estimates.
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 dif-
ferent 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
improvements, 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 cancel-
able 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. Landlord allowances are
recorded based on contractual terms and are included in accounts receivable,
net and as a deferred rent liability and amortized as a reduction of rent
expense on a straight-line basis over the expected lease term.
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 recoverable. 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 comparable
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 significant 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