The Gap 2008 Annual Report Download - page 43

Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the
United States of America requires management to adopt accounting policies and make significant judgments
and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are
alternative policies or estimation techniques that could be used. We maintain a thorough process to review the
application of our accounting policies and to evaluate the appropriateness of the many estimates that are
required to prepare the financial statements of a large, global corporation. However, even under optimal
circumstances, estimates routinely require adjustment based on changing circumstances and the receipt of
new or better information.
Our significant accounting policies can be found in Note 1 of Notes to the Consolidated Financial Statements.
The policies and estimates discussed below include the financial statement elements that are either judgmental
or involve the selection or application of alternative accounting policies and are material to our financial
statements. Management has discussed the development and selection of these critical accounting policies and
estimates with the Audit and Finance Committee of our Board of Directors, and the Audit and Finance Committee
of our Board of Directors has reviewed our disclosure relating to critical accounting policies and estimates in this
annual report on Form 10-K.
Merchandise Inventory
We review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no
longer in stock in a sufficient range of sizes) and use markdowns to clear merchandise. We value inventory at the
lower of cost or market (“LCM”) and record a reserve when future estimated selling price is less than cost. Our LCM
reserve calculation requires management to make assumptions to estimate the amount of slow-moving
merchandise and broken assortments subject to markdowns, which is dependent upon factors such as historical
trends with similar merchandise, inventory aging, forecasted consumer demand, and the promotional
environment. In addition, we estimate and accrue shortage for the period between the last physical count and the
balance sheet date. Our shortage estimate can be affected by changes in merchandise mix and changes in actual
shortage trends. Historically, actual shortage has not differed materially from our estimates.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or
assumptions we use to calculate our LCM or inventory shortage reserves. However, if estimates regarding
consumer demand are inaccurate or actual physical inventory shortage differs significantly from our estimate, our
operating results could be affected. We have not made any material changes in the accounting methodology used
to calculate our LCM or inventory shortage reserves in the past three fiscal years.
Impairment of Long-Lived Assets, Goodwill, and Intangible Assets
In accordance with FASB Statement of Financial Accounting Standards No. (“SFAS”) 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets,” we review the carrying value of long-lived assets, including lease
rights, key money, and intangible assets subject to amortization, for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be recoverable. Events that result in an
impairment review include the decision to close a store, corporate facility, or distribution center, or a significant
decrease in the operating performance of the long-lived asset. For assets that are identified as potentially being
impaired, if the undiscounted future cash flows of the long-lived assets are less than the carrying value, we
recognize a loss equal to the difference between the carrying value and the asset’s fair value. The fair value of the
asset is estimated based on discounted future cash flows of the assets using a discount rate commensurate with
the risk. Our estimate of future cash flows requires management to make assumptions and to apply judgment,
including forecasting future sales and expenses and estimating useful lives of the assets. These estimates can be
affected by factors such as future store results, real estate demand, and economic conditions that can be difficult
to predict. We have not made any material changes in the methodology to assess and calculate impairment of
long-lived assets in the past three fiscal years. We recorded charges for the impairment of long-lived assets of
$5 million, $42 million, and $32 million for fiscal 2008, 2007, and 2006, respectively. The impairment charge in
fiscal 2007 and 2006 included $29 million and $3 million, respectively, related to the discontinued operation of
Forth & Towne.
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