O'Reilly Auto Parts 2009 Annual Report Download - page 50

36
• Self-Insurance Reserves – We use a combination of insurance and self-insurance mechanisms to provide for potential liabilities
from workers’ compensation, general liability, vehicle liability, property loss, and employee health care benefits. With the
exception of employee health care benefit liabilities, which are limited by the design of these plans, we obtain third-party
insurance coverage to limit our exposure for any individual workers’ compensation, general liability, vehicle liability or property
loss claim. When estimating our self-insurance liabilities, we consider a number of factors, including historical claims experience
and trend-lines, projected medical and legal inflation, and growth patterns and exposure forecasts. The assumptions made by
management as they relate to each of these factors represent our judgment as to the most probable cumulative impact of each
factor to our future obligations. Our calculation of self-insurance liabilities requires management to apply judgment to estimate
the ultimate cost to settle reported claims and claims incurred but not yet reported as of the balance sheet date and the application
of alternative assumptions could result in a different estimate of these liabilities. Actual claim activity or development may vary
from our assumptions and estimates, which may result in material losses or gains. As we obtain additional information that affects
the assumptions and estimates we used to recognize liabilities for claims incurred in prior accounting periods, we adjust our self-
insurance liabilities to reflect the revised estimates based on this additional information. These liabilities are recorded at our
estimate of their net present value. These liabilities do not have scheduled maturities, but we can estimate the timing of future
payments based upon historical patterns. We could apply alternative assumptions regarding the timing of payments or the
applicable discount rate that could result in materially different estimates of the net present value of the liabilities. If self-
insurance reserves were changed 10% from our estimated reserves at December 31, 2009, the financial impact would have been
approximately $9.1
million or 1.8% of pretax income for the year ended December 31, 2009.
• Accounts Receivable – We provide credit to our commercial customers in the ordinary course of business. We estimate the
allowance for doubtful accounts on these receivables based on historical loss ratios and other relevant factors. Actual results have
consistently been within management’s expectations, and we do not believe there is a reasonable likelihood that there will be a
material change in the future that will require a significant change in the assumptions or estimates we use to calculate our
allowance for doubtful accounts. However, if actual results differ from our estimates, we may be exposed to losses or gains. If the
allowance for doubtful accounts were changed 10% from our estimated allowance at December 31, 2009, the financial impact
would have been approximately $0.7 million or 0.1% of pretax income for the year ended December 31, 2009.
• Taxes – We operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve
complex issues, which may require an extended period of time to resolve. We regularly review our potential tax liabilities for tax
years subject to audit. The amount of such liabilities is based on various factors, such as differing interpretations of tax
regulations by the responsible tax authority, experience with previous tax audits and applicable tax law rulings. Changes in our
tax liability may occur in the future as our assessments change based on the progress of tax examinations in various jurisdictions
and/or changes in tax regulations. In management’s opinion, adequate provisions for income taxes have been made for all years
presented. The estimates of our potential tax liabilities contain uncertainties because management must use judgment to estimate
the exposures associated with our various tax positions and actual results could differ from our estimates. Alternatively, we could
have applied assumptions regarding the eventual outcome of the resolution of open tax positions that could differ from our current
estimates but that would still be reasonable given the nature of a particular position. Our judgment regarding the most likely
outcome of uncertain tax positions has historically resulted in an estimate of our tax liability that is greater than actual results.
While our estimates are subject to the uncertainty noted in the preceding discussion, our initial estimates of our potential tax
liabilities have historically not been materially different from actual results except in instances where we have reversed liabilities
that were recorded for periods that were subsequently closed with the applicable taxing authority.
• Inventory Obsolescence and Shrink – Inventory, which consists of automotive hard parts, maintenance items, accessories and
tools, is stated at the lower of cost or market. The extended nature of the life cycle of our products is such that the risk of
obsolescence of our inventory is minimal. The products that we sell generally have applications in our markets for a relatively
long period of time in conjunction with the corresponding vehicle population. We have developed sophisticated systems for
monitoring the life cycle of a given product and, accordingly, have historically been very successful in adjusting the volume of our
inventory in conjunction with a decrease in demand. We do record a reserve to reduce the carrying value of our inventory through
a charge to cost of sales in the isolated instances where we believe that the market value of a product line is lower than our
recorded cost. This reserve is based on our assumptions about the marketability of our existing inventory and is subject to
uncertainty to the extent that we must estimate, at a given point in time, the market value of inventory that will be sold in future
periods. Ultimately, our projections could differ from actual results and could result in a material impact to our stated inventory
balances. We have historically not had to materially adjust our obsolescence reserves due to the factors discussed above and do
not anticipate that we will experience material changes in our estimates in the future.
We also record a reserve to reduce the carrying value of our perpetual inventory to account for quantities in our perpetual records
above the actual existing quantities on hand caused by unrecorded shrink. We estimate this reserve based on the results of our
extensive and frequent cycle counting programs and periodic, full physical inventories at our stores and distribution centers. To