Estee Lauder 2004 Annual Report Download - page 41

THE EST{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-
formity with U.S. generally accepted accounting princi-
ples. The preparation of these financial statements
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 conse-
quently actual results could differ from those estimates.
Our most critical accounting policies relate to revenue
recognition; concentration of credit risk; inventory; pen-
sion 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
computed by deducting from gross sales the amount of
actual returns received and an amount established for
anticipated 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 4.6%, 5.1% and 4.8% in fiscal
2004, 2003 and 2002, respectively.
CONCENTRATION OF CREDIT RISK
An entity is vulnerable to concentration of credit risk if it is
exposed to risks of loss greater than it would have had it
mitigated its risks through diversification of customers.
The significance of such credit risk depends on the extent
and nature of the concentration.
We have three major customers that owned and oper-
ated retail stores that in the aggregate accounted for
$1,253.8 million, or 22%, of our consolidated net sales in
fiscal 2004 and $166.6 million, or 25%, of our accounts
receivable at June 30, 2004. These customers sell products
primarily within North America. Although management
believes that these customers are sound and creditworthy,
a severe adverse impact on their business operations
could have a corresponding material adverse effect on
our net sales, cash flows and/or financial condition.
In the ordinary course of business, we have established
an allowance for doubtful accounts and customer deduc-
tions in the amount of $30.1 million and $31.8 million as
of June 30, 2004 and 2003, respectively. Our allowance
for doubtful accounts is a subjective critical estimate that
has a direct impact on reported net earnings. The
allowance for doubtful accounts was reduced by $25.6
million, $30.3 million and $24.8 million for customer
deductions and write-offs in fiscal 2004, 2003 and 2002,
respectively, and increased by $23.9 million, $31.5 million
and $28.6 million for additional provisions in fiscal 2004,
2003 and 2002, respectively. 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 and work in process that will be sold or
used in future periods. Inventory cost includes raw mate-
rials, 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 nec-
essary, 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.