Cracker Barrel 2006 Annual Report Download - page 45

43
TAX PROVISION
The Company must make estimates of certain items that
comprise its income tax provision. These estimates
include employer tax credits for items such as FICA taxes
paid on employee tip income, Work Opportunity and
Welfare to Work credits, as well as estimates related to
certain depreciation and capitalization policies.
These estimates are made based on the best available
information at the time of the provision and historical
experience. The Company files its income tax
returns many months after its year end. These returns
are subject to audit by various federal and state
governments years after the returns are filed and could
be subject to differing interpretations of the tax laws.
The Company then must assess the likelihood of
successful legal proceedings or reach a settlement, either
of which could result in material adjustments to the
Company’s Consolidated Financial Statements and its
consolidated financial position.
SHARE-BASED COMPENSATION
In accordance with the adoption of SFAS No. 123R, the
Company recognized share-based compensation expense
in 2006. This included expensing stock options as
share-based compensation in 2006, which had not been
required or done in previous years. The fair value of
each option award granted subsequent to July 29, 2005
was estimated on the date of grant using a binomial
lattice-based option valuation model. This model incor-
porates the following ranges of assumptions:
•The expected volatility is a blend of implied volatility
based on market-traded options on the Company’s
stock and historical volatility of the Company’s stock
over the contractual life of the options.
•The Company uses historical data to estimate option
exercise and employee termination behavior within
the valuation model; separate groups of employees
that have similar historical exercise behavior are
considered separately for valuation purposes. The
expected life of options granted is derived from the
output of the option valuation model and repre-
sents the period of time the options are expected
to be outstanding.
•The risk-free interest rate is based on the U.S.
Treasury yield curve in effect at the time of grant for
periods within the contractual life of the option.
•The expected dividend yield is based on the
Company’s current dividend yield as the best estimate
of projected dividend yield for periods within the
contractual life of the option.
The expected volatility, option exercise and termina-
tion assumptions involve management’s best estimates
at that time, all of which impact the fair value of
the option calculated by the binomial lattice-based
option valuation model and, ultimately, the expense
that will be recognized over the life of the option.
Management updates the historical and implied compo-
nents of the expected volatility assumption quarterly.
Management updates option exercise and termination
assumptions quarterly. The expected life is a by-
product of the lattice model, and is updated when new
grants are made.
SFAS No. 123R also requires that compensation
expense be recognized for only the portion of options
that are expected to vest. Therefore, an estimated
forfeiture rate derived from historical employee termi-
nation behavior, grouped by job classification, is
applied against share-based compensation expense. The
forfeiture rate is applied on a straight-line basis over
the service (vesting) period for each separately vesting
portion of the award as if the award was, in-substance,
multiple awards. Management updates the estimated
forfeiture rate to actual on each of the vesting dates
and adjusts compensation expense accordingly, so
that the amount of compensation cost recognized at
any date is at least equal to the portion of the grant-
date value of the award that is vested at that date.
UNREDEEMED GIFT CARDS AND CERTIFICATES
Unredeemed gift cards and certificates represent a
liability of the Company related to deferred revenue and
are recorded at their expected redemption value. For
those states that exempt gift cards and certificates
from their escheat laws, the Company makes estimates
of the ultimate unredeemed (“breakage”) gift cards and
certificates in the period of the original sale for those
states that exempt gift cards and certificates from their
escheat laws and amortizes this breakage over the
redemption period that other gift cards and certificates
historically have been redeemed by reducing its liability
and recording revenue accordingly. For those states
that do not exempt gift cards and certificates from