O'Reilly Auto Parts 2008 Annual Report Download - page 46

PG.44 O’REILLY AUTOMOTIVE 2008 ANNUAL REPORT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
WARRANTY COSTS
e Company oers warranties on the merchandise it sells with warranty periods ranging from 30 days to lifetime, limited warranties. e
risk of loss arising from warranty claims is typically the obligation of the Company’s vendors, but for a small portion of merchandise sold, the
Company bears the risk of loss associated with the cost of warranty claims. Estimated warranty costs, which are recorded as obligations at the
time of sale, are based on the historical failure rate of each individual product line. e Company’s historical experience has been that failure
rates are relatively consistent over time and that the ultimate cost of warranty claims to the Company has been driven by volume of units sold
as opposed to uctuations in failure rates or the variation of the cost of individual claims. To the extent vendors provide upfront allowances in
lieu of accepting the obligation for warranty claims and the allowance is in excess of the related warranty expense, the excess is recorded as a
reduction to cost of sales.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
e Company’s accounting policies for derivative nancial instruments are based on whether the instruments meet the criteria for designation
as cash ow or fair value hedges. A designated hedge of the exposure to variability in the future cash ows of an asset or a liability qualies
as a cash ow hedge. A designated hedge of the exposure to changes in fair value of an asset or a liability qualies as a fair value hedge. e
criteria for designating a derivative as a hedge includes the assessment of the instrument’s eectiveness in risk reduction, matching of the
derivative instrument to its underlying transaction and the probability that the underlying transaction will occur. For derivatives with cash
ow hedge accounting designation, the Company reports the aer-tax gain or loss from the eective portion of the hedge as a component of
accumulated other comprehensive income (loss) and reclassies it into earnings in the same period or periods in which the hedged transaction
aects earnings, and within the same income statement line item as the impact of the hedged transaction. For derivatives with fair value hedge
accounting designation, the Company would recognize gains or losses from the change in fair value of these derivatives, as well as the osetting
change in the fair value of the underlying hedged item, in earnings.
e Company currently holds derivative nancial instruments to manage interest rate risk. e Company has designated these derivative
nancial instruments as cash ow hedges. e derivative nancial instruments are recorded at fair value and are included in other long-term
liabilities. Derivative instruments recorded at fair value as liabilities totaled $18.9 million as of December 31, 2008. e Company did not hold
any derivative instruments at December 31, 2007. On a quarterly basis, the Company measures the eectiveness of the derivative nancial
instruments by comparing the present value of the cumulative change in the expected future interest to be paid or received on the variable leg
of the instruments against the expected future interest payments on the corresponding variable rate debt. In addition, the Company compares
the critical terms, including notional amounts, underlying indexes and reset dates of the derivative nancial instruments with the respective
variable rate debt to ensure all terms agree. Any ineectiveness would be reclassied from accumulated other comprehensive income (loss) to
interest expense. As of December 31, 2008, the Company had no ineectiveness on its derivative nancial instruments. See Note 8 for further
information concerning these derivative instruments accounted for as hedges.
INCOME TAXES
e Company accounts for income taxes using the liability method in accordance with Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences
of events that have been included in the nancial statements. Under this method, deferred tax assets and liabilities are determined based on
dierences between the nancial reporting and tax bases of assets and liabilities using enacted tax rules currently scheduled to be in eect for
the year in which the dierences are expected to reverse, and also includes the amount of tax carryforwards. e eect of a change in tax rates
on deferred tax assets and liabilities is recognized in income in the period of the enactment date. e Company records a valuation allowance
against deferred tax assets to the extent it is more likely than not the amount will not be realized, based upon evidence available at the time of
the determination, and any change in the valuation allowance is recorded in the period of a change in such determination.
ADVERTISING COSTS
e Company expenses advertising costs as incurred. Advertising expense charged to operations amounted to $65,640,000, $40,472,000 and
$34,929,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
PRE-OPENING COSTS
Costs associated with the opening of new stores, which consist primarily of payroll and occupancy costs, are charged to operations as incurred.
SHARE-BASED COMPENSATION PLANS
e Company currently sponsors share-based employee benet plans and stock option plans. In accordance with Statement of Financial
Accounting Standards No. 123R, Share Based Payment (“SFAS No. 123R”), the Company recognizes compensation expense for its share-based
payments based on the fair value of the awards on the date of the grant. Share-based payments include stock option awards issued under the
Company’s employee stock option plan, director stock option plan, stock issued through the Company’s employee stock purchase plan and
stock awarded to employees through other benet programs. See Note 11 for further information concerning these plans.