Dollar General 2006 Annual Report Download - page 41

• applying the RIM to a group of products that is not fairly uniform in terms of its cost
and selling price relationship and turnover;
• applying the RIM to transactions over a period of time that include different rates of
gross profit, such as those relating to seasonal merchandise;
• inaccurate estimates of inventory shrinkage between the date of the last physical
inventory at a store and the financial statement date; and
• inaccurate estimates of LCM and/or LIFO reserves.
To reduce the potential of such distortions in the valuation of inventory, we expanded the
number of departments we utilize for our gross profit calculation from 10 to 23 in 2005. Other
factors that reduce potential distortion include the use of historical experience in estimating the
shrink provision (see discussion below) and the utilization of an independent statistician to assist
in the LIFO sampling process and index formulation. As part of this process we also perform an
inventory-aging analysis for determining obsolete inventory. Our policy is to write down
inventory to an LCM value based on various management assumptions including estimated
markdowns and sales required to liquidate such aged inventory in future periods. Inventory is
reviewed on a quarterly basis and adjusted as appropriate to reflect write-downs determined to be
necessary. The estimated amount of the below-cost inventory write-downs for the strategic
merchandising initiatives discussed above in the “Executive Overview” is based on
management’ s assumptions regarding the timing and adequacy of markdowns and the final
adjustment may vary materially from the estimate depending on various factors, including timing
of the execution of the plan, retail market conditions and the accuracy of assumptions used by
management in developing these estimates.
Factors such as slower inventory turnover due to changes in competitors’ tactics,
consumer preferences, consumer spending and unseasonable weather patterns, among other
factors, could cause excess inventory requiring greater than estimated markdowns to entice
consumer purchases, resulting in an unfavorable impact on our consolidated financial statements.
Sales shortfalls due to the above factors could cause reduced purchases from vendors and
associated vendor allowances that would also result in an unfavorable impact on our
consolidated financial statements.
We calculate our shrink provision based on actual physical inventory results during the
fiscal period and an accrual for estimated shrink occurring subsequent to a physical inventory
through the end of the fiscal reporting period. This accrual is calculated as a percentage of sales
at each retail store, at a department level, and is determined by dividing the book-to-physical
inventory adjustments recorded during the previous twelve months by the related sales for the
same period for each store. To the extent that subsequent physical inventories yield different
results than this estimated accrual, our effective shrink rate for a given reporting period will
include the impact of adjusting the estimated results to the actual results. Although we perform
physical inventories in virtually all of our stores on an annual basis, the same stores do not
necessarily get counted in the same reporting periods from year to year, which could impact
comparability in a given reporting period.
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