Foot Locker 2006 Annual Report Download - page 34

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18
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 Company provides
reserves based on current selling prices when the inventory has not been marked down to 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 was an improvement in gross margin in 2006, as a percentage of sales, of 20 basis points as compared
with 2005. 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 2006 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 it reimburses specific,
incremental and identifiable costs incurred to date, is 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 2006 and
approximately 9 percent of catalog costs in 2006.
Impairment of Long-Lived Assets
In accordance with SFAS No. 144, the Company recognizes an impairment loss when circumstances indicate that
the carrying value of long-lived tangible and intangible assets with finite lives may not be recoverable. Management’s
policy in determining whether an impairment indicator exists, a triggering event, comprises measurable operating
performance criteria as well as qualitative measures. If an analysis is necessitated by the occurrence of a triggering
event, the Company uses assumptions, which are predominately identified from the Company’s three-year strategic
plans, in determining the impairment amount. The calculation of fair value of long-lived assets is based on estimated
expected discounted future cash flows by store, which is generally measured by discounting the expected future cash
flows at the Company’s weighted-average cost of capital. Management believes its policy is reasonable and is consistently
applied. Future expected cash flows are based upon estimates that, if not achieved, may result in significantly different
results.
The Company is required to perform an impairment review of its goodwill at least annually. The Company has
chosen to perform this review at the beginning of each fiscal year, and it is done in a two-step approach. The initial
step requires that the carrying value of each reporting unit be compared with its estimated fair value. The second step
— to evaluate goodwill of a reporting unit for impairment — is only required if the carrying value of that reporting unit