Foot Locker 2005 Annual Report Download - page 32

The Company does not have any off-balance sheet financing, other than operating leases entered into in the normal
course of business as disclosed above, or unconsolidated special purpose entities. The Company does not participate in
transactions that generate relationships with unconsolidated entities or financial partnerships, including variable interest
entities. The Company’s policy prohibits the use of derivatives for which there is no underlying exposure.
In connection with the sale of various businesses and assets, the Company may be obligated for certain lease
commitments transferred to third parties and pursuant to certain normal representations, warranties, or indemnifications
entered into with the purchasers of such businesses or assets. Although the maximum potential amounts for such
obligations cannot be readily determined, management believes that the resolution of such contingencies will not
significantly affect the Company’s consolidated financial position, liquidity, or results of operations. The Company is also
operating certain stores for which lease agreements are in the process of being negotiated with landlords. Although there
is no contractual commitment to make these payments, it is likely that leases will be executed.
Critical Accounting Policies
Management’s responsibility for integrity and objectivity in the preparation and presentation of the Company’s
financial statements requires diligent application of appropriate accounting policies. Generally, the Company’s accounting
policies and methods are those specifically required by U.S. generally accepted accounting principles (“GAAP”). Included
in the “Summary of Significant Accounting Policies” footnote in “Item 8. Consolidated Financial Statements and
Supplementary Data” is a summary of the Company’s most significant accounting policies. In some cases, management
is required to calculate amounts based on estimates for matters that are inherently uncertain. The Company believes the
following to be the most critical of those accounting policies that necessitate subjective judgments.
Merchandise Inventories
Merchandise inventories for the Company’s Athletic Stores are valued at the lower of cost or market using the retail
inventory method. The retail inventory method (“RIM”) is commonly used by retail companies to value inventories at cost
and calculate gross margins due to its practicality. Under the retail method, cost is determined by applying a cost-to-retail
percentage across groupings of similar items, known as departments. The cost-to-retail percentage is applied to ending
inventory at its current owned retail valuation to determine the cost of ending inventory on a department basis. The RIM
is a system of averages that requires management’s estimates and assumptions regarding markups, markdowns and shrink,
among others, and as such, could result in distortions of inventory amounts. Significant judgment is required for these
estimates and assumptions, as well as to differentiate between promotional and other markdowns that may be required
to correctly reflect merchandise inventories at the lower of cost or market. The failure to take permanent markdowns on
a timely basis may result in an overstatement of cost under the retail inventory method. The decision to take permanent
markdowns includes many factors, including the current environment, inventory levels and the age of the item.
Management believes this method and its related assumptions, which have been consistently applied, to be reasonable.
Vendor Reimbursements
In the normal course of business, the Company receives allowances from its vendors for markdowns taken. Vendor
allowances are recognized as a reduction in cost of sales in the period in which the markdowns are taken. The effect of
vendor allowances on gross margin, as a percentage of sales, as compared with the corresponding prior year period was
not significant. The Company also has volume-related agreements with certain vendors, under which it receives rebates
based on fixed percentages of cost purchases. These volume-related rebates are recorded in cost of sales when the product
is sold and they contributed 10 basis points to the 2005 gross margin rate.
The Company receives support from some of its vendors in the form of reimbursements for cooperative advertising
and catalog costs for the launch and promotion of certain products. The reimbursements are agreed upon with vendors
for specific advertising campaigns and catalogs. Cooperative income, to the extent that they reimburse specific,
incremental and identifiable costs incurred to date, are recorded in SG&A in the same period as the associated expenses
are incurred. Reimbursements received that are in excess of specific, incremental and identifiable costs incurred to date
are recognized as a reduction to the cost of merchandise and are reflected in cost of sales as the merchandise is sold.
Cooperative reimbursements amounted to approximately 27 percent of total advertising costs in 2005 and approximately
9 percent of catalog costs in 2005.
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