Sears 2012 Annual Report Download - page 65

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SEARS HOLDINGS CORPORATION
Notes to Consolidated Financial Statements—(Continued)
65
working capital requirements. Our final estimate of fair value of reporting units is developed by weighting the fair
values determined through both the market and income approaches.
If the carrying value of the reporting unit is higher than its fair value, there is an indication that impairment
may exist and the second step must be performed to measure the amount of impairment loss, if any. The amount of
impairment is determined by comparing the implied fair value of reporting unit goodwill to the carrying value of the
goodwill in the same manner as if the reporting unit was being acquired in a business combination. See Note 12 for
further information regarding goodwill and related impairment charges recorded during 2012 and 2011.
Intangible Asset Impairment Assessments
We consider the income approach when testing intangible assets with indefinite lives for impairment on an
annual basis. We utilize the income approach, specifically the relief from royalty method, for analyzing our
indefinite-lived assets. This method is based on the assumption that, in lieu of ownership, a firm would be willing to
pay a royalty in order to exploit the related benefits of this asset class. The relief from royalty method involves two
steps: (1) estimation of reasonable royalty rates for the assets and (2) the application of these royalty rates to a net
sales stream and discounting the resulting cash flows to determine a value. We multiplied the selected royalty rate by
the forecasted net sales stream to calculate the cost savings (relief from royalty payment) associated with the assets.
The cash flows are then discounted to present value by the selected discount rate and compared to the carrying value
of the assets.
Financial Instruments and Hedging Activities
We are exposed to fluctuations in foreign currency exchange rates as a result of our net investment in Sears
Canada. Further, Sears Canada is exposed to fluctuations in foreign currency exchange rates due to inventory
purchase contracts denominated in U.S. dollars. As a result, we primarily use derivatives as a risk management tool
to decrease our exposure to fluctuations in the foreign currency market. We primarily use foreign currency forward
contracts to hedge the foreign currency exposure of our net investment in Sears Canada against adverse changes in
exchange rates and foreign currency collar contracts to hedge against foreign currency exposure arising from Sears
Canada's inventory purchase contracts denominated in U.S. dollars.
Hedges of Net Investment in Sears Canada
When applying hedge accounting treatment to our derivative transactions, we formally document our hedge
relationships, including identification of the hedging instruments and the hedged items, as well as our risk
management objectives and strategies for undertaking the hedge transaction. We also formally assess, both at
inception and at least quarterly thereafter, whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in either the fair value or cash flows of the hedged item. If it is determined that a
derivative ceases to be a highly effective hedge, we discontinue hedge accounting.
For derivatives that are designated as hedges of our net investment in Sears Canada, we assess effectiveness
based on changes in spot currency exchange rates. Changes in spot rates on the derivatives are recorded in the
currency translation adjustments line in Accumulated Other Comprehensive Income (Loss) and remain there until
such time that we substantially liquidate or sell our holdings in Sears Canada.
Sears Canada Hedges of Merchandise Purchases
Sears Canada mitigates the risk of currency fluctuations on offshore merchandise purchases denominated in
U.S. currency by purchasing U.S. dollar denominated collar contracts for a portion of its expected requirements.
Since the Company's functional currency is the U.S. dollar, we are not directly exposed to the risk of exchange rate
changes due to Sears Canada's merchandise purchases, and therefore we do not account for these instruments as a
hedge of our foreign currency exposure risk. Changes in the fair value of these contracts are recorded in the
Consolidated Statements of Operations as a component of other income (loss) each period.