Red Lobster 2016 Annual Report Download - page 37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DARDEN
DARDEN RESTAURANTS, INC. • 2016 ANNUAL REPORT 33
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 eco-
nomic hedges. We use financial derivatives to manage interest rate and
compensation risks inherent in our business operations. Our use of derivative
instruments is currently limited to equity forwards 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.
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 comprehensive 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 8 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 we are
reasonably assured to exercise the options. 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. Sale-leasebacks
are transactions through which we sell assets (such as restaurant properties)
at fair value and subsequently lease them back. The resulting leases generally
qualify and are accounted for as operating leases. Financing leases are gen-
erally the product of a failed sale-leaseback transaction and result in retention
of the “sold” assets within land, buildings and equipment with a financing
lease obligation equal to the amount of proceeds received recorded as a
component of other liabilities on our consolidated balance sheets.
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. 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. 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 on sales levels and
is accrued at the point in time we determine that it is probable that such
sales levels will be achieved. Amortization expense related to capital leases
is included in depreciation and amortization expense in our consolidated
statements of earnings. 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. Gains on sale-leaseback
transactions are recorded as a deferred liability and amortized as a reduction
of rent expense on a straight-line basis over the expected lease term.
PRE-OPENING EXPENSES
Non-capital expenditures associated with opening new restaurants are
expensed as incurred.
ADVERTISING
Production costs of commercials are charged to operations in the fiscal
period the advertising is first aired. The costs of programming and other
advertising, promotion and marketing programs are charged to operations
in the fiscal period incurred and reported as marketing expenses on our
consolidated statements of earnings.
STOCK-BASED COMPENSATION
We recognize the cost of employee service received in exchange for awards
of equity instruments based on the grant date fair value of those awards. We
recognize compensation expense on a straight-line basis over the employee
service period for awards granted. We utilize the Black-Scholes option pricing
model to estimate the fair value of stock option awards. The dividend yield
has been estimated based upon our historical results and expectations for
changes in dividend rates. The expected volatility was determined using
historical stock prices. The risk-free interest rate was the rate available on
zero coupon U.S. government obligations with a term approximating the
expected life of each grant. The expected life was estimated based on the
exercise history of previous grants, taking into consideration the remaining
contractual period for outstanding awards. We utilize a Monte Carlo simula-
tion to estimate the fair value of our market-based equity-settled performance
awards. See Note 15 for further information.