Harris Teeter 2007 Annual Report Download - page 25

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which the vendor funds were intended and committed to be used has been fulfilled and a cost has been incurred
by the retailer. Thus, it is the Company’s policy to recognize the vendor allowance consistent with the timing
of the recognition of the expense that the allowance is intended to reimburse and to determine the accounting
classification consistent with the economic substance of the underlying transaction. Where the Company
provides an identifiable benefit or service to the vendor apart from the purchase of merchandise, that transaction
is recorded separately. For example, co-operative advertising allowances are accounted for as a reduction of
advertising expense in the period in which the advertising cost is incurred. If the advertising allowance exceeds
the cost of advertising, then the excess is recorded against the cost of sales in the period in which the related
expense is recognized.
There are numerous types of rebates and allowances in the retail industry. The Company’s accounting
practices with regard to some of the more typical arrangements are discussed as follows. Vendor allowances
for price markdowns are credited to the cost of sales during the period in which the related markdown was
taken and charged to the cost of sales. Slotting and stocking allowances received from a vendor to ensure that
its products are carried or to introduce a new product at the Company’s stores are recorded as a reduction of
cost of sales over the period covered by the agreement with the vendor based on the estimated inventory turns
of the merchandise to which the allowance applies. Display allowances are recognized as a reduction of cost
of sales in the period earned in accordance with the vendor agreement based on the estimated inventory turns
of the merchandise to which the allowance applies. Volume rebates by the vendor in the form of a reduction of
the purchase price of the merchandise reduce the cost of sales when the related merchandise is sold. Generally,
volume rebates under a structured purchase program with allowances awarded based on the level of purchases
are recognized, when realization is assured, as a reduction in the cost of sales in the appropriate monthly period
based on the actual level of purchases in the period relative to the total purchase commitment and adjusted for
the estimated inventory turns of the merchandise. Some of these typical vendor rebate, credit and promotional
allowance arrangements require that the Company make assumptions and judgments regarding, for example,
the likelihood of attaining specified levels of purchases or selling specified volumes of products, the duration
of carrying a specified product and the estimation of inventory turns. The Company constantly reviews the
relevant, significant factors and makes adjustments where the facts and circumstances dictate.
Inventory Valuation
The inventories of the Company’s operating subsidiaries are valued at the lower of cost or market with the
cost of substantially all domestic U.S. inventories being determined using the last-in, first-out (LIFO) method.
Foreign inventories and limited categories of domestic inventories are valued on the weighted average and
on the first-in, first-out (FIFO) cost methods. LIFO assumes that the last costs in are the ones that should be
used to measure the cost of goods sold, leaving the earlier costs residing in the ending inventory valuation.
The Company uses the “link chain” method of computing dollar value LIFO whereby the base year values of
beginning and ending inventories are determined using a cumulative price index. The Company generates an
estimated internal index to “link” current costs to the original costs of the base years in which the company
adopted LIFO. The Company’s determination of the LIFO index is driven by the change in current year costs
as well as the change in inventory quantities on hand. Under the LIFO valuation method at Harris Teeter, all
retail store inventories are initially stated at estimated cost as calculated by the Retail Inventory Method (RIM).
Under RIM, the valuation of inventories at cost and the resulting gross margins are calculated by applying
a calculated cost-to-retail ratio to the retail value of inventories. RIM is an averaging method that has been
widely used in the retail industry due to its practicality. Inherent in the RIM calculation are certain significant
management judgments and estimates, including markups, markdowns, lost inventory (shrinkage) percentages
and the purity and similarity of inventory sub-categories as to their relative inventory turns, gross margins and
on hand quantities. These judgments and estimates significantly impact the ending inventory valuation at cost
as well as gross margin. Management believes that the Company’s RIM provides an inventory valuation which
reasonably approximates cost and results in carrying the inventory at the lower of cost or market. Management
does not believe that the likelihood is significant that materially higher LIFO reserves are required given its
current expectations of on-hand inventory quantities and costs.