Restoration Hardware 2014 Annual Report Download - page 68

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realizable value. To determine if the value of inventory should be marked down below original cost, we consider
current and anticipated demand, customer preference and the merchandise age. The inventory value is adjusted
periodically to reflect current market conditions, which requires management judgments that may significantly
affect the ending inventory valuation, as well as gross margin. The significant estimates used in inventory
valuation are obsolescence (including excess and slow-moving inventory and lower of cost or market reserves)
and estimates of inventory shrinkage. We adjust our inventory for obsolescence based on historical trends, aging
reports, specific identification and our estimates of future retail sales prices.
Reserves for shrinkage are estimated and recorded throughout the period as a percentage of net sales based
on historical shrinkage results and current inventory levels. Actual shrinkage is recorded throughout the year
based upon periodic cycle counts and the results of our annual physical inventory count. Actual inventory
shrinkage and obsolescence can vary from estimates due to factors including the mix of our inventory (which
ranges from large furniture to decorative accessories) and execution against loss prevention initiatives in our
stores, distribution centers, off-site storage locations and with third-party transportation providers.
Due to these factors, our obsolescence and shrinkage reserves contain uncertainties. Both estimates have
calculations that require management to make assumptions and to apply judgment regarding a number of factors,
including market conditions, the selling environment, historical results and current inventory trends. If actual
observed obsolescence or periodic updates of our shrinkage estimates differ from our original estimates, we
adjust our inventory reserves accordingly throughout the period. Management does not believe that changes in
the assumptions used in these estimates would have a significant effect on our net income or inventory balances.
We have not made any material changes to our assumptions included in the calculations of the obsolescence and
shrinkage reserves during the periods presented or recorded significant adjustments related to the physical
inventory process.
Advertising Expenses
Advertising expenses primarily represent the costs associated with our catalog mailings, as well as print and
website marketing.
Capitalized Catalog Costs
Capitalized catalog costs consist primarily of third-party incremental direct costs to prepare, print and
distribute Source Books. Such costs are capitalized and amortized over their expected period of future benefit.
Such amortization is based upon the ratio of actual revenues to the total of actual and estimated future revenues
on an individual Source Book basis. Estimated future revenues are based upon various factors such as the total
number of Source Books and pages circulated, the probability and magnitude of consumer response and the
merchandise assortment offered. Each Source Book is generally fully amortized within a twelve-month period
after they are mailed and the majority of the amortization occurs within the first six to ten months, with the
exception of the Holiday Source Books, which are generally fully amortized within a six-month period after they
are mailed. Capitalized catalog costs are evaluated for realizability on a regular basis by comparing the carrying
amount associated with each Source Book to the estimated probable remaining future sales associated with that
Source Book.
Our catalog amortization calculation requires management to make assumptions and to apply judgment
regarding a number of factors, including market conditions, the selling environment and the probability and
magnitude of consumer response to certain Source Books and merchandise assortment offered. If actual revenues
associated with our Source Books differ from our original estimates, we adjust our catalog amortization
schedules accordingly. We do not believe that changes in the assumptions used in these estimates would have a
significant effect on our net income as changes in the assumptions do not impact the total cost of the Source
Books to be amortized. However, changes in the assumptions could impact the timing of the future catalog
amortization expense recorded to the consolidated statement of operations.
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