O'Reilly Auto Parts 2010 Annual Report Download - page 51

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CRITICAL ACCOUNTING ESTIMATES
The preparation of our financial statements in accordance with GAAP requires the application of certain estimates and judgments by
management. Management bases its assumptions, estimates, and adjustments on historical experience, current trends and other factors
believed to be relevant at the time the consolidated financial statements are prepared. Management believes that the following policies
are critical due to the inherent uncertainty of these matters and the complex and subjective judgments required to establish these
estimates. Management continues to review these critical accounting policies and estimates to ensure that the consolidated financial
statements are presented fairly in accordance with GAAP. However, actual results could differ from our assumptions and estimates
and such differences could be material.
• Vendor concessions
– We receive concessions from our vendors through a variety of programs and arrangements, including co-
operative advertising, allowances for warranties, merchandise allowances and volume purchase rebates. Co-operative advertising
allowances that are incremental to our advertising program, specific to a product or event and identifiable for accounting
purposes, are reported as a reduction of advertising expense in the period in which the advertising occurred. All other material
vendor concessions are recognized as a reduction to the cost of inventory. Amounts receivable from vendors also include
amounts due to us relating to vendor purchases and product returns. Management regularly reviews amounts receivable from
vendors and assesses the need for a reserve for uncollectible amounts based on our evaluation of our vendors’ financial position
and corresponding ability to meet their financial obligations. Based on our historical results and current assessment, we have not
recorded a reserve for uncollectible amounts in our consolidated financial statements, and we do not believe there is a reasonable
likelihood that our ability to collect these amounts will differ from our expectations. The eventual ability of our vendors to pay us
the obliged amounts could differ from our assumptions and estimates, and we may be exposed to losses or gains that could be
material.
• 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, 2010, the financial impact would have been
approximately $10
million or 1.5% of pretax income for the year ended December 31, 2010.
• 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, 2010, the financial impact
would have been approximately $0.8 million or 0.1% of pretax income for the year ended December 31, 2010.
• 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. 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
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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 DCs. To the extent that
our estimates do not accurately reflect the actual unrecorded inventory shrinkage, we could potentially experience a material
impact to our inventory balances. We have historically been able to provide a timely and accurate measurement of shrink and
have not experienced material adjustments to our estimates. If unrecorded shrink changed 10% from the estimate that we
recorded based on our historical experience at December 31, 2010, the financial impact would have been approximately $0.6
million or 0.1% of pretax income for the year ended December 31, 2010.
•Valuation of Long-Lived Assets and Goodwill - We evaluate the carrying value of long-lived assets whenever events or
changes in circumstances indicate that a potential impairment has occurred. As part of the evaluation, we review performance at
the store level to identify any stores with current period operating losses that should be considered for impairment. A potential
impairment has occurred if the projected future undiscounted cash flows realized from the best possible use of the asset are less
than the carrying value of the asset. The estimate of cash flows includes management’s assumptions of cash inflows and outflows
directly resulting from the use of that asset in operations. If the carrying amount of an asset exceeds its estimated future cash
flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the
assets. Our impairment analyses contain estimates due to the inherently judgmental nature of forecasting long-term estimated
cash flows and determining the ultimate useful lives and fair values of the assets. Actual results could differ from these estimates,
which could materially impact our impairment assessment.
We review goodwill and other intangible assets for impairment annually on December 31, or when events or changes in
circumstances indicate the carrying value of these assets might exceed their current fair values. We have not historically recorded
an impairment to our goodwill or intangible assets. The process of evaluating goodwill for impairment involves the determination
of the fair value of our Company using the market approach. Inherent in such fair value determinations are certain judgments and
estimates, including estimates which incorporate assumptions marketplace participants would use in making their estimates of fair
value. In the future, if events or market conditions affect the estimated fair value to the extent that an asset is impaired, we will
adjust the carrying value of these assets in the period in which the impairment occurs, however, we do not believe there has been
any change of events or circumstances that would indicate that a reevaluation of goodwill or other intangible assets is required as
of December 31, 2010, nor do we believe goodwill or any other intangible assets are at risk of failing impairment testing. If the
price of O’Reilly stock, which was a primary input used to determine the Company’s market capitalization during step one of
goodwill impairment testing, changed by 10% from the value used during testing, the results and our conclusions would not have
changed and no further steps would have been required.
•Closed Property Reserves – We maintain reserves for closed stores and other properties that are no longer utilized in current
operations. We accrue for closed property operating lease liabilities using a credit-adjusted discount rate to calculate the present
value of the remaining non-cancelable lease payments, contractual occupancy costs and lease termination fees after the closing
date, net of estimated sublease income. The closed property lease liabilities are expected to be paid over the remaining lease
terms. We estimate sublease income and future cash flows based on our experience and knowledge of the market in which the
closed property is located, our previous efforts to dispose of similar assets and existing economic conditions. Adjustments to
closed property reserves are made to reflect changes in estimated sublease income or actual exit costs from original estimates.
Adjustments are made for changes in estimates in the period in which the changes become known. If closed property reserves
were changed 10% from our estimated reserves at December 31, 2010, the financial impact would have been approximately $2
million or 0.3% of pretax income for the year ended December 31, 2010.
•Legal Reserves – We maintain reserves for expenses associated with litigation for which O’Reilly is currently involved. We are
currently involved in litigation incidental to the ordinary conduct of our business as well as resolving the governmental
FORM 10-K