Estee Lauder 2003 Annual Report Download - page 40

THEEST{E LAUDER COMPANIES INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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CRITICAL ACCOUNTING POLICIES
AND ESTIMATES
The discussion and analysis of our financial condition and
results of operations are based upon our consolidated
financial statements, which have been prepared in con-
formitywith accounting principles generally accepted in
the United States. The preparation of these financial state-
ments requires us to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues
and expenses reported in those financial statements.
These judgments can be subjective and complex, and
consequently actual results could differ from those esti-
mates. Our most critical accounting policies relate to reve-
nue recognition; concentration of credit risk; inventory;
pension and other postretirement benefit costs; goodwill
and other intangible assets; income taxes; and derivatives.
REVENUE RECOGNITION
Generally, revenues from merchandise sales are recorded
at the time the product is shipped to the customer. We
report our sales levels on a net sales basis, which is com-
puted by deducting from gross sales the amount of actual
returns received and an amount established for antici-
pated returns.
As is customary in the cosmetics industry, our practice
is to accept returns of our products from retailers if prop-
erly requested, authorized and approved. In accepting
returns, we typically provide a credit to the retailer against
sales and accounts receivable from that retailer on a
dollar-for-dollar basis.
Our sales return accrual is a subjective critical estimate
that has a direct impact on reported net sales. This accrual
is calculated based on a history of gross sales and actual
returns by region and product category. In addition, as
necessary,specific accruals may be established for future
known or anticipated events. As a percentage of gross
sales, sales returns were 5.2%, 4.9% and 4.9% in fiscal
2003, 2002 and 2001, respectively.
CONCENTRATION OF CREDIT RISK
An entity is more vulnerable to concentrations of credit
risk if it is exposed to risk of loss greater than it would
have had it mitigated its risk through diversification of cus-
tomers. Such risks of loss manifest themselves differently,
depending on the nature of the concentration, and vary in
significance.
We have three major customers that owned and oper-
ated retail stores that in the aggregate accounted for
approximately $1.24 billion, or 24%, of our consolidated
net sales in fiscal 2003 and $179.8 million, or 28%, of our
accounts receivable at June 30, 2003. These customers
sell products primarily within North America. Although
management believes that these customers are sound
and creditworthy, a severe adverse impact on their busi-
ness operations could have a corresponding material
adverse effect on our net sales, cash flows, and/or finan-
cial condition.
In the ordinary course of business, we have established
an allowance for doubtful accounts and customer deduc-
tions in the amount of $31.8 million and $30.6 million as
of June 30, 2003 and 2002, respectively. Our allowance
for doubtful accounts is a subjective critical estimate that
has a direct impact on reported net earnings. This reserve
is based upon the evaluation of accounts receivable
aging, specific exposures and historical trends.
INVENTORY
We state our inventory at the lower of cost or fair market
value, with cost being determined on the first-in, first-out
(FIFO) method. We believe FIFO most closely matches
the flow of our products from manufacture through sale.
The reported net value of our inventory includes saleable
products, promotional products, raw materials and
componentry that will be sold or used in future periods.
Inventory cost includes raw materials, direct labor
and overhead.
We also record an inventory obsolescence reserve,
which represents the difference between the cost of the
inventory and its estimated market value, based on vari-
ous product sales projections. This reserve is calculated
using an estimated obsolescence percentage applied to
the inventory based on age, historical trends and require-
ments to support forecasted sales. In addition, and as
necessary,we may establish specific reserves for future
known or anticipated events.
PENSION AND OTHER POSTRETIREMENT
BENEFIT COSTS
We offer the following benefits to some or all of our
employees: a domestic trust-based noncontributory
defined benefit pension plan (“U.S. Plan”); an unfunded,
nonqualified domestic noncontributory pension plan to
provide benefits in excess of statutory limitations; a con-
tributory defined contribution plan; international pension
plans, which vary by country, consisting of both defined
benefit and defined contribution pension plans; deferred
compensation; and certain other postretirement benefits.
The amounts necessary to fund future payouts under
these plans are subject to numerous assumptions and
variables. Certain significant variables require us to
make assumptions that are within our control such as an
anticipated discount rate, expected rate of return on plan