Harris Teeter 2011 Annual Report Download - page 20

component of cost of sales as they are earned, the recognition of which is determined in accordance with the underlying
agreement with the vendor, the authoritative guidance and completion of the earning process. Portions of vendor allowances
that are refundable to the vendor, in whole or in part, by the nature of the provisions of the contract are deferred from recognition
until realization is reasonably assured.
Harris Teeter’s practices are in accordance with ASC Subtopic 605-50 and are based on the premise that the accounting
for these vendor allowances should follow the economic substance of the underlying transactions, which is evidenced by the
agreement with the vendor as long as the allowance is distinguishable from the merchandise purchase. Consistent with this
premise, Harris Teeter recognizes allowances when the purpose for 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
Merchandise inventory is valued at the lower of cost or market with the cost of a substantial portion of inventories being
determined using the last-in, first-out (LIFO) method. Limited categories of inventories are valued 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.
The proper valuation of inventory also requires management to estimate the net realizable value of the Company’s obsolete
and slow-moving inventory at the end of each period. Management bases its net realizable values upon many factors including
historical recovery rates, the aging of inventories on hand, the inventory movement of specific products and the current economic
conditions. When management has determined inventory to be obsolete or slow moving, the inventory is reduced to its net
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