Pier 1 2007 Annual Report Download - page 32

specifically addressed below, the Company does not believe that its critical accounting policies are subject to
market risk exposure that would be considered material and as a result, has not provided a sensitivity analysis.
The use of estimates is pervasive throughout the consolidated financial statements, but the accounting policies
and estimates considered most critical are as follows:
Revenue recognition — The Company recognizes revenue from retail sales, net of sales tax and third
party credit card processing fees, upon customer receipt or delivery of merchandise, including sales under
deferred payment promotions on its proprietary credit card. Typically, credit card receivable deferral programs
offer deferred payments for up to 90 days or monthly installment payments over 12 months. Historically these
payment deferral programs have not resulted in significant increases in bad debt losses arising from such
receivables. As a result of the sale of the Company’s credit card business in fiscal 2007, these deferred
programs will result in an upfront reduction of sales based on the fees charged by Chase for such programs
going forward. The Company records an allowance for estimated merchandise returns based on historical
experience and other known factors. Should actual returns differ from the Company’s estimates and current
provision for merchandise returns, revisions to the estimated merchandise returns may be required.
Gift cards — Revenue associated with gift cards is deferred until redemption of the gift card. Gift card
breakage is estimated and recorded as income based upon an analysis of the Company’s historical redemption
patterns and represents the remaining unused portion of the gift card liability for which the likelihood of
redemption is remote. If actual redemption patterns vary from the Company’s estimates, actual gift card
breakage may differ from the amounts recorded. For all periods presented, gift card breakage was recognized
after a period of 30 months from the original issuance and was $6.2 million, $5.1 million and $4.5 million in
fiscal 2007, 2006 and 2005, respectively.
Beneficial interest in securitized receivables — In September 2006, the Company allowed its securitiza-
tion agreement to expire. At that time, the Company purchased $144.0 million of proprietary credit card
receivables in exchange for $44.0 million of beneficial interest and $100.0 million of cash. Therefore, at fiscal
2007 year end, the Company had no beneficial interest. Additionally, all Class B Certificates, which are
discussed below, were settled at the time the securitization agreement expired. Prior to the expiration of this
agreement, the Company securitized its entire portfolio of proprietary credit card receivables. During most of
fiscal 2007, and all of fiscal 2006 and 2005, the Company sold all of its proprietary credit card receivables,
except an immaterial amount of those that failed certain eligibility requirements, to a special-purpose wholly
owned subsidiary, Pier 1 Funding, LLC (“Funding”), which transferred the receivables to the Pier 1 Imports
Credit Card Master Trust (“Master Trust”). Neither Funding nor the Master Trust was consolidated by the
Company, and the Master Trust met the requirements of a qualifying special-purpose entity under
SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities.” The Master Trust issued beneficial interests that represented undivided interests in the assets of
the Master Trust consisting of the transferred receivables and all cash flows from collections of such
receivables. The beneficial interests included certain interests retained by Funding, which were represented by
Class B Certificates, and the residual interest in the Master Trust (the excess of the principal amount of
receivables held in the Master Trust over the portion represented by the certificates sold to third-party investors
and the Class B Certificates). Gain or loss on the sale of receivables depended in part on the previous carrying
amount of the financial assets involved in the transfer, allocated between the assets sold and the retained
interests based on their relative fair value at the date of transfer.
The beneficial interest in the Master Trust was accounted for as an available-for-sale security and was
recorded at fair value. The Company estimated fair value of its beneficial interest in the Master Trust, both
upon initial securitization and thereafter, based on the present value of future expected cash flows using
management’s best estimates of key assumptions including credit losses and payment rates. As of February 25,
2006, the Company’s assumptions used to calculate the present value of the future cash flows included
estimated credit losses of 4.75% of the outstanding balance, expected payment within a six-month period and
a discount rate representing the average market rate the Company would expect to pay if it sold securities
representing ownership in the excess receivables not required to collateralize the Class A Certificates. A
sensitivity analysis performed assuming a hypothetical 20% adverse change in both interest rates and credit
losses resulted in an immaterial impact on the fair value of the Company’s beneficial interest. See Note 3 of
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