Dollar Tree 2007 Annual Report Download - page 25

DOLLAR TREE, INC. • 2007 ANNUAL REPORT 23
Critical Accounting Policies
The preparation of financial statements requires the
use of estimates. Certain of our estimates require a
high level of judgment and have the potential to have
a material effect on the financial statements if actual
results vary significantly from those estimates.
Following is a discussion of the estimates that we
consider critical.
Inventory Valuation
As discussed in Note 1 to the Consolidated Financial
Statements, inventories at the distribution centers are
stated at the lower of cost or market with cost deter-
mined on a weighted-average basis. Cost is assigned to
store inventories using the retail inventory method on
a weighted-average basis. Under the retail inventory
method, the valuation of inventories at cost and the
resulting gross margins are computed by applying a
calculated cost-to-retail ratio to the retail value of
inventories. The retail inventory method is an averag-
ing method that has been widely used in the retail
industry and results in valuing inventories at lower of
cost or market when markdowns are taken as a reduc-
tion of the retail value of inventories on a timely basis.
Inventory valuation methods require certain sig-
nificant management estimates and judgments, includ-
ing estimates of future merchandise markdowns and
shrink, which significantly affect the ending inventory
valuation at cost as well as the resulting gross margins.
The averaging required in applying the retail inventory
method and the estimates of shrink and markdowns
could, under certain circumstances, result in costs not
being recorded in the proper period.
We estimate our markdown reserve based on the
consideration of a variety of factors, including, but not
limited to, quantities of slow moving or seasonal, car-
ryover merchandise on hand, historical markdown sta-
tistics and future merchandising plans. The accuracy of
our estimates can be affected by many factors, some of
which are outside of our control, including changes in
economic conditions and consumer buying trends.
Historically, we have not experienced significant dif-
ferences in our estimated reserve for markdowns com-
pared with actual results.
Our accrual for shrink is based on the actual,
historical shrink results of our most recent physical
inventories adjusted, if necessary, for current economic
conditions. These estimates are compared to actual
results as physical inventory counts are taken and rec-
onciled to the general ledger. Our physical inventory
counts are generally taken between January and
September of each year; therefore, the shrink accrual
recorded at February 2, 2008 is based on estimated
shrink for most of 2007, including the fourth quarter.
We have not experienced significant fluctuations in
historical shrink rates beyond approximately 10 basis
points in our Dollar Tree stores for the last two years.
However, we have sometimes experienced higher than
typical shrink in acquired stores in the year following
an acquisition. We periodically adjust our shrink esti-
mates to address these factors as they become apparent.
Our management believes that our application of
the retail inventory method results in an inventory val-
uation that reasonably approximates cost and results
in carrying inventory at the lower of cost or market
each year on a consistent basis.
Accrued Expenses
On a monthly basis, we estimate certain expenses in
an effort to record those expenses in the period
incurred. Our most material estimates include domes-
tic freight expenses, self-insurance programs, store-
level operating expenses, such as property taxes and
utilities, and certain other expenses. Our freight and
store-level operating expenses are estimated based on
current activity and historical trends and results. Our
workers’ compensation and general liability insurance
accruals are recorded based on actuarial valuations
which are adjusted annually based on a review per-
formed by a third-party actuary. These actuarial
valuations are estimates based on historical loss devel-
opment factors. Certain other expenses are estimated
and recorded in the periods that management
becomes aware of them. The related accruals are
adjusted as management’s estimates change.
Differences in management’s estimates and assump-
tions could result in an accrual materially different
from the calculated accrual. Our experience has been
that some of our estimates are too high and others are
too low. Historically, the net total of these differences
has not had a material effect on our financial condi-
tion or results of operations.