Estee Lauder 2005 Annual Report Download - page 42

THE EST{E LAUDER COMPANIES INC.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill is calculated as the excess of the cost of purchased
businesses over the fair value of their underlying net assets.
Other intangible assets principally consist of purchased
royalty rights and trademarks. Goodwill and other intangi-
ble assets that have an indefinite life are not amortized.
On an annual basis, or sooner if certain events or
circumstances warrant, we test goodwill and other intangi-
ble assets for impairment. To determine the fair value of
these intangible assets, there are many assumptions and
estimates used that directly impact the results of the test-
ing. We have the ability to influence the outcome and
ultimate results based on the assumptions and estimates
we choose. To mitigate undue influence, we use industry
accepted valuation models and set criteria that are
reviewed and approved by various levels of management.
INCOME TAXES
We account for income taxes in accordance with
Statement of Financial Accounting Standards (“SFAS”)
No. 109, “Accounting for Income Taxes.” This statement
establishes financial accounting and reporting standards
for the effects of income taxes that result from an enter-
prise’s activities during the current and preceding years.
It requires an asset and liability approach for financial
accounting and reporting of income taxes.
As of June 30, 2005, we have current net deferred tax
assets of $85.3 million and non-current net deferred tax
liabilities of $68.1 million. The net deferred tax assets
assume sufficient future earnings for their realization, as
well as the continued application of currently anticipated
tax rates. Included in net deferred tax assets is a valuation
allowance of approximately $5.1 million for deferred tax
assets, which relates to foreign tax loss carryforwards not
utilized to date, where management believes it is more
likely than not that the deferred tax assets will not be real-
ized in the relevant jurisdiction. Based on our assessments,
no additional valuation allowance is required. If we deter-
mine that a deferred tax asset will not be realizable, an
adjustment to the deferred tax asset will result in a reduc-
tion of earnings at that time.
We provide tax reserves for Federal, state, local and
international exposures relating to audit results, tax plan-
ning initiatives and compliance responsibilities. The devel-
opment of these reserves requires judgments about tax
issues, potential outcomes and timing, and is a subjective
critical estimate. Although the outcome of these tax audits
is uncertain, in management’s opinion adequate provisions
for income taxes have been made for potential liabilities
emanating from these reviews. If actual outcomes differ
materially from these estimates, they could have a material
impact on our results of operations.
DERIVATIVES
We account for derivative financial instruments in accor-
dance with SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities,” as amended, which
establishes accounting and reporting standards for deriva-
tive instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities.
This statement also requires the recognition of all derivative
instruments as either assets or liabilities on the balance
sheet and that they be measured at fair value.
We currently use derivative financial instruments to
hedge certain anticipated transactions and interest rates,
as well as receivables and payables denominated in foreign
currencies. We do not utilize derivatives for trading or
speculative purposes. Hedge effectiveness is documented,
assessed and monitored by employees who are qualified to
make such assessments and monitor the instruments.
Variables that are external to us such as social, political and
economic risks may have an impact on our hedging pro-
gram and the results thereof. For a discussion on the quan-
titative impact of market risks related to our derivative
financial instruments, refer to “Liquidity and Capital
Resources—Market Risk.”
QUANTITATIVE ANALYSIS
During the three-year period ended June 30, 2005, there
have not been material changes in the assumptions under-
lying these critical accounting policies, nor to the related
significant estimates, since the results of our business
underlying these assumptions have not differed signifi-
cantly from our expectations.
While we believe that the estimates that we have made
are proper and the related results of operations for the
period are presented fairly in all material respects, other
assumptions could reasonably be justified that would
change the amount of reported net sales, cost of sales,
operating expenses or our provision for income taxes as
they relate to the provisions for anticipated sales returns,
allowance for doubtful accounts, inventory obsolescence
reserve and income taxes. For fiscal 2005, had these
estimates been changed simultaneously by 2.5% in either
direction, our reported gross profit would have increased
or decreased by approximately $4.5 million, operating
expenses would have changed by approximately $0.7
million and the provision for income taxes would have
increased or decreased by approximately $0.8 million. The
collective impact of these changes on operating income,
net earnings and net earnings per diluted common share
would be an increase or decrease of approximately $5.2
million, $6.0 million and $0.03, respectively.
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