Red Lobster 2010 Annual Report Download - page 28

26 DARDEN RESTAURANTS, INC. | 2010 ANNUAL REPORT
Notes to Consolidated Financial Statements
Darden Restaurants
26 DARDEN RESTAURANTS, INC. | 2010 ANNUAL REPORT
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
Darden
IMPACT OF INFLATION
We attempt to minimize the annual effects of inflation through appropriate
planning, operating practices and menu price increases. We do not believe
inflation had a significant overall effect on our annual results of operations during
fiscal 2010. However, we experienced higher than normal inflationary costs
during the first half of fiscal 2009, consistent with those experienced during
fiscal 2008, although the overall impact of inflation was less in fiscal 2009
than in fiscal 2008 as these inflationary costs subsided during the second
half of fiscal 2009. During periods of higher than expected inflationary costs,
we have been able to reduce the annual impact utilizing these strategies.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in conformity with U.S.
generally accepted accounting principles. The preparation of these financial
statements requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of sales and expenses during the reporting period. Actual results could differ
from those estimates.
Our significant accounting policies are more fully described in Note 1 to the
consolidated financial statements. However, certain of our accounting policies
that are considered critical are those we believe are both most important to the
portrayal of our financial condition and operating results and require our most
difficult, subjective or complex judgments, often as a result of the need to make
estimates about the effect of matters that are inherently uncertain. Judgments
and uncertainties affecting the application of those policies may result in
materially different amounts being reported under different conditions or
using different assumptions. We consider the following policies to be most
critical in understanding the judgments that are involved in preparing our
consolidated financial statements.
Land, Buildings and Equipment
Land, buildings and equipment are recorded at cost less accumulated
depreciation. Building components are depreciated over estimated useful lives
ranging from seven to 40 years using the straight-line method. Leasehold
improvements, which are reflected on our consolidated balance sheets as a
component of buildings in land, buildings and equipment, net, are amortized
over the lesser of the expected lease term, including cancelable option periods,
or the estimated useful lives of the related assets using the straight-line
method. Equipment is depreciated over estimated useful lives ranging from
two to ten years, also using the straight-line method.
Our accounting policies regarding land, buildings and equipment, including
leasehold improvements, include our judgments regarding the estimated useful
lives of these assets, the residual values to which the assets are depreciated
or amortized, the determination of what constitutes expected lease term and
the determination as to what constitutes enhancing the value of or increasing
the life of existing assets. These judgments and estimates may produce
materially different amounts of reported depreciation and amortization expense
if different assumptions were used. As discussed further below, these judg-
ments may also impact our need to recognize an impairment charge on the
carrying amount of these assets as the cash flows associated with the assets
are realized, or as our expectations of estimated future cash flows change.
Leases
We are obligated under various lease agreements for certain restaurants. For
operating leases, we recognize rent expense on a straight-line basis over the
expected lease term, including option periods as described below. Capital
leases are recorded as an asset and an obligation at an amount equal to the
present value of the minimum lease payments during the lease term.
Within the provisions of certain of our leases, there are rent holidays and
escalations in payments over the base lease term, as well as renewal periods.
The effects of the holidays and escalations have been reflected in rent expense
on a straight-line basis over the expected lease term, which includes cancel-
able option periods we are reasonably assured to exercise because failure to
exercise such options would result in an economic penalty to the Company.
The lease term commences on the date when we have the right to control the
use of the leased property, which is typically before rent payments are due
under the terms of the lease. The leasehold improvements and property held
under capital leases for each restaurant facility are amortized on the straight-line
method over the shorter of the estimated life of the asset or the same expected
lease term used for lease accounting purposes. Many of our leases have
renewal periods totaling five to 20 years, exercisable at our option, and require
payment of property taxes, insurance and maintenance costs in addition to
the rent payments. The consolidated financial statements reflect the same
lease term for amortizing leasehold improvements as we use to determine
capital versus operating lease classifications and in calculating straight-line
rent expense for each restaurant. Percentage rent expense is generally based
upon sales levels and is accrued when we determine that it is probable that
such sales levels will be achieved.
Our judgments related to the probable term for each restaurant affect
the classification and accounting for leases as capital versus operating, the
rent holidays and escalation in payments that are included in the calculation
of straight-line rent and the term over which leasehold improvements for
each restaurant facility are amortized. These judgments may produce materi-
ally different amounts of depreciation, amortization and rent expense than
would be reported if different assumed lease terms were used.
Impairment of Long-Lived Assets
Land, buildings and equipment and certain other assets, including definite-lived
intangible assets, are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of the assets to the future undiscounted
net cash flows expected to be generated by the assets. Identifiable cash flows
are measured at the lowest level for which they are largely independent of the
cash flows of other groups of assets and liabilities, generally at the restaurant
level. If these assets are determined to be impaired, the amount of impairment
recognized is measured by the amount by which the carrying amount of the
assets exceeds their fair value. Fair value is generally determined by appraisals
or sales prices of comparable assets. Restaurant sites and certain other assets
to be disposed of are reported at the lower of their carrying amount or fair
value, less estimated costs to sell. Restaurant sites and certain other assets
to be disposed of are included in assets held for sale within prepaid expenses
and other current assets in our consolidated balance sheets when certain
criteria are met. These criteria include the requirement that the likelihood of
disposing of these assets within one year is probable. For assets that meet
the held-for-sale criteria, we separately evaluate whether those assets also