Big Lots 2008 Annual Report Download - page 101

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store leases for which we may have an indemnification or guarantee obligation. Because of uncertainty inherent in
the assumptions used to estimate this liability, our estimated liability could ultimately prove to be understated and
could result in a material adverse impact on our financial condition, results of operations, and liquidity.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the
United States of America (“GAAP”) requires management to make estimates, judgments, and assumptions
that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period, as well as the related disclosure of contingent
assets and liabilities at the date of the financial statements. The use of estimates, judgments, and assumptions
creates a level of uncertainty with respect to reported or disclosed amounts in our consolidated financial
statements or accompanying notes. On an on-going basis, management evaluates its estimates, judgments, and
assumptions, including those that management considers critical to the accurate presentation and disclosure of
our consolidated financial statements and accompanying notes. Management bases its estimates, judgments,
and assumptions on historical experience, current trends, and various other factors that management believes
are reasonable under the circumstances. Because of the inherent uncertainty in using estimates, judgments, and
assumptions, actual results may differ from these estimates.
Our significant accounting policies are described in note 1 to the accompanying consolidated financial
statements. We believe the following assumptions and estimates are the most critical to understanding and
evaluating our reported financial results. Management has reviewed these critical accounting estimates and
related disclosures with the Audit Committee of our Board of Directors.
Merchandise Inventories
Merchandise inventories are valued at the lower of cost or market using the average cost retail inventory
method. Market is determined based on the estimated net realizable value, which generally is the merchandise
selling price at or near the end of the reporting period. The average cost retail inventory method requires
management to make judgments and contains estimates, such as the amount and timing of markdowns to clear
slow-moving inventory, the estimated allowance for shrinkage, and the estimated amount of excess or obsolete
inventory, which may impact the ending inventory valuation and prior or future gross margin. These estimates
are based on historical experience and current information.
When management determines the salability of merchandise inventories is diminished, markdowns for
clearance activity and the related cost impact are recorded at the time the price change decision is made. Factors
considered in the determination of markdowns include current and anticipated demand, customer preferences
and age of merchandise, as well as seasonal trends. Timing of holidays within fiscal periods, weather, and
customer preferences could cause material changes in the amount and timing of markdowns from year to year.
The inventory allowance for shrinkage is recorded as a reduction to inventories, charged to cost of sales,
and calculated as a percentage of sales for the period from the last physical inventory date to the end of the
reporting period. Such estimates are based on our historical and current year experience based on a sample of
recent physical inventory results. Independent physical inventory counts are taken at each store once a year,
and typically the majority of these counts occur during January through April. Because only a sampling of our
stores are counted prior to making our fiscal year end shrink estimate, we rely on the results of these sample
stores along with our historical results to estimate our fiscal year end shrink accrual. During the first fiscal
quarter, the majority of the physical inventories are completed and actual results are recorded on a store by store
basis. In addition, we evaluate our go-forward shrink accrual rate based on the results of the completed physical
inventories. At January 31, 2009, a 10% difference in our shrink reserve would have affected gross margin,
operating profit and income from continuing operations before income taxes by approximately $5 million.
While it is not possible to quantify the impact from each cause of shrinkage, we have loss prevention programs
and policies aimed at minimizing shrinkage.