Papa Johns 2005 Annual Report Download - page 56

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2. Significant Accounting Policies (continued)
Leases and Leasehold Improvements
We account for leases in accordance with Statement of Financial Accounting Standards (SFAS) No. 13,
Accounting for Leases, and other related guidance. SFAS No. 13 requires lease expense to be recognized
on a straight-line basis over the expected life of the lease term. A lease term often includes option
periods, available at the inception of the lease, when failure to renew the lease would impose a penalty to
us. Such penalty may include the recognition of impairment on our leasehold improvements should we
choose not to continue the use of the leased property.
During the fourth quarter of 2004, we completed a comprehensive review of our accounting for leases
and leasehold improvements, including the recognition of incentive payments received from landlords.
We determined leasehold improvements were in some cases amortized over a longer period than the
remaining underlying lease term, and that straight-line lease expense was in some cases calculated over
an insufficient expected remaining lease term. As a result, we recorded a cumulative adjustment of $1.9
million, of which $1.5 million was recorded as an increase to rent expense in general and administrative
expenses and $400,000 was recorded as an increase to depreciation expense in depreciation and
amortization in the accompanying 2004 consolidated statements of income. Approximately $1.6 million
of the adjustment was related to years prior to 2004 and was not considered material to any of the prior
period financial statements to warrant a restatement of those financial statements. There was no
significant impact on the 2005 income statement associated with the change in accounting for leases.
Long-Lived and Intangible Assets
The recoverability of long-lived assets is evaluated annually or more frequently if impairment indicators
exist. Indicators of impairment include historical financial performance, operating trends and our future
operating plans. If impairment indicators exist, we evaluate the recoverability of long-lived assets on an
operating unit basis (e.g., an individual restaurant) based on undiscounted expected future cash flows
before interest for the expected remaining useful life of the operating unit. Recorded values for long-
lived assets that are not expected to be recovered through undiscounted future cash flows are written
down to current fair value, which is generally determined from estimated discounted future net cash
flows for assets held for use or net realizable value for assets held for sale (see Note 8).
The recoverability of intangible assets (i.e., goodwill) is evaluated annually, or more frequently if
impairment indicators exist, on a reporting unit basis by comparing the fair value derived from
discounted cash flows of the reporting unit to its carrying value. Our United Kingdom subsidiary, PJUK,
has reported deteriorating operating results for the past three years primarily due to lower sales by Perfect
Pizza restaurants and a decrease in net franchise units due to restaurant closings. Based on our updated
analysis of PJUK’s estimated fair value during the fourth quarter of 2005, we concluded that an
impairment charge of $1.1 million was necessary, which is included in other general expenses in the
accompanying consolidated statements of income (no goodwill impairment charge was incurred in 2004
or 2003).
We have developed strategic plans for PJUK to improve future operating results. These plans include
selling the Perfect Pizza operations, consisting of the franchised units and related distribution operations,
initiatives to increase brand awareness and increase net Papa John’s brand franchise unit openings over
the next several years. If such initiatives, including the sale of the Perfect Pizza operations, are not
successful, additional impairment charges may occur. See Note 7 for additional information concerning
our carrying value for goodwill.