Restoration Hardware 2015 Annual Report Download - page 60

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Certain of our property and equipment are held under capital leases. These assets are included in property and equipment and
depreciated over the lesser of the useful life of the asset or the lease term. For buildings held under capital leases, unless the fair value
of the land at lease inception exceeds 25% of the aggregate fair value of the leased land and buildings, rent payments under the leases
are recognized using the effective interest method as a reduction of the capital lease obligation and interest expense. Pursuant to ASC
840, at lease inception, if the fair value of the underlying land exceeds 25% of the fair value of the real estate (land and buildings), we
allocate a portion of the cash payments under the lease to land rent expense equal to the product of the fair value of the leased land at
construction commencement and our incremental borrowing rate. The remaining cash payment is treated as debt-service payments and
recognized as a reduction of the capital lease obligation and an increase in interest expense.
All other leases are considered operating leases in accordance with ASC 840. Assets subject to an operating lease and the related
lease payments are not recorded on the consolidated balance sheets. For leases that contain lease incentives, premiums and minimum
rent expenses, we recognize rent expense on a straight-line basis over the lease term. Tenant improvement allowances received from
landlords under operating leases are recorded in deferred rent and lease incentives on the consolidated balance sheets, and are
amortized on a straight-line basis over the lease term.
Stock-Based Compensation
We use the straight-line method of accounting for stock-based compensation, which we believe is the predominant method used
in our industry. We recognize the fair value of stock-based compensation in the consolidated financial statements as compensation
expense over the requisite service period. In addition, excess tax benefits related to stock-based compensation awards are reflected as
financing cash flows. For service-only awards, compensation expense is recognized on a straight-line basis, net of forfeitures, over the
requisite service period for the fair value of awards that actually vest. Fair value for restricted stock units is valued using the closing
price of our stock on the date of grant. The fair value of each option award granted under our award plan is estimated on the date of
grant using a Black-Scholes Merton option pricing model with the following assumptions:
• Expected volatility—Based on the lack of historical data for our own shares, we base our expected volatility on a
representative peer group that takes into account industry, market capitalization, stage of life cycle and capital structure.
• Expected term—Represents the period of time that options granted are expected to be outstanding. We elected to calculate
the expected term of the option awards using the “simplified method.” This election was made based on the lack of
sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term. Under the
“simplified” calculation method, the expected term is calculated as an average of the vesting period and the contractual
life of the options.
• Risk-free interest rate—Based on the U.S. Treasury zero-coupon bond rate with a remaining term approximate of the
expected term of the option.
• Dividend yield—As we have not paid dividends, nor do we currently plan to pay dividends in the future, the assumed
dividend yield is zero.
Income Taxes
We account for income taxes under an asset and liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been recognized in our consolidated financial statements or tax
returns. In estimating future tax consequences, we generally take into account all expected future events then known to us, other than
changes in the tax law or rates which have not yet been enacted and which are not permitted to be considered. Accordingly, we may
record a valuation allowance to reduce our net deferred tax assets to the amount that is more-likely-than-not to be realized. The
determination as to whether a deferred tax asset will be realized is made on a jurisdictional basis and is based upon management’s best
estimate of the recoverability of our net deferred tax assets. Future taxable income and ongoing prudent and feasible tax planning are
considered in determining the amount of the valuation allowance, and the amount of the allowance is subject to adjustment in the
future. Specifically, in the event we are to determine that we are not more-likely-than-not able to realize our net deferred tax assets in
the future, an adjustment to the valuation allowance would decrease income in the period such determination is made. This allowance
does not alter our ability to utilize the underlying tax net operating loss and credit carryforwards in the future, the utilization of which
is limited to achieving future taxable income.
In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of
realization of the deferred tax assets. If, based on the weight of available evidence, it is more-likely-than-not the deferred tax assets
will not be realized, we record a valuation allowance. The weight given to the positive and negative evidence is commensurate with
the extent to which the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected
future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial
reporting losses. United States GAAP states that cumulative losses in recent years are a significant piece of negative evidence that is
difficult to overcome in determining that a valuation allowance is not needed against deferred tax assets.