Staples 2012 Annual Report Download - page 105

B-9
STAPLES, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Business unit income as a percentage of sales decreased to 2.1% for 2011 from 3.7% for 2010, primarily reflecting
deleverage of fixed costs and expenses associated with our system investments in Australia, and deleverage of fixed costs in our
European retail businesses.
Critical Accounting Policies and Significant Estimates
Our financial statements have been prepared in accordance with U.S. GAAP and are based on the application of significant
accounting policies (see Note A - Summary of Significant Accounting Policies in the Notes to the Consolidated Financial
Statements). Preparation of these statements requires management to make significant judgments and estimates. We believe that
the following are some of the more critical judgment areas in the application of our accounting policies that currently affect our
financial condition and results of operations.
Inventory: We record inventory at the lower of weighted-average cost or market value. We reserve for obsolete,
overstocked and inactive inventory based on the difference between the weighted-average cost of the inventory and the estimated
market value using assumptions of future demand and market conditions. If actual market conditions are less favorable than those
projected by management, additional reserves may be required.
Based on historical experience, we do not believe these estimates and assumptions will have a material impact upon the
financial statements. Past experience has shown little variability in reserve estimates. Over the past three years, our inventory
write-offs have been within a range that has averaged approximately a 6% difference from our additions to inventory reserves.
Purchase and Advertising Rebates: We earn rebates from our vendors, which are based on various quantitative contract
terms that can be complex and subject to interpretation. Amounts expected to be received from vendors relating to the purchase
of merchandise inventories and reimbursement of incremental costs, such as advertising, are recognized as a reduction of inventory
cost and realized as part of cost of goods sold as the merchandise is sold. Several controls are in place, including direct confirmation
with vendors, which we believe allows us to ensure that these amounts are recorded in accordance with the terms of the contracts.
Past experience has shown little variability in purchase and advertising rebate estimates, no collectability issues and no
significant write-off history. Given the historical accuracy of our estimates, we believe that a significant change in our estimates
is not likely.
Impairment of Goodwill: We review goodwill for impairment annually, in the fourth quarter, and when events or changes
in circumstances indicate that the carrying value of goodwill might exceed its current fair value. We determine fair value using
discounted cash flow (DCF) analysis, which requires significant management assumptions and estimates regarding industry
economic factors and the future profitability of our businesses. It is our policy to allocate goodwill and conduct impairment testing
at a reporting unit level based on our most current business plans, which reflect changes we anticipate in the economy and the
industry. We established, and continue to evaluate, our reporting units based on our internal reporting structure and define such
reporting units at the operating segment level or one level below. The key assumptions used in the discounted cash flow approach
include:
 The reporting unit's projections of financial results, which range from five to thirteen years depending on the maturity of
the underlying business. For established businesses such as our North American retail and contract operations, we use a
five year model, while in our emerging market businesses we use a thirteen year model which reflects management's
expectations of the development time for these growth-oriented businesses. In general, our reporting units' fair values
are most sensitive to our sales growth and operating profit rate assumptions, which represent estimates based on our
current and projected sales mix, profit improvement opportunities and market conditions. If the business climate
deteriorates, or if we fail to manage our businesses successfully, then actual results may not be consistent with these
assumptions and estimates, and our goodwill may become impaired.
 The projected terminal value for each reporting unit represents the present value of projected cash flows beyond the last
period in the discounted cash flow analysis. The terminal values are most sensitive to our assumptions regarding long-
term growth rates, which are based on several factors including local and macroeconomic variables, the market opportunity,
and future growth plans. While we believe our long-term growth assumptions are reasonable in relation to these factors
and our historical results, actual growth rates may be lower than our assumptions due to a variety of potential causes,
such as a secular decline in demand for our products and services, unforeseen competition, long-term GDP growth rates
in established economies being lower than historical growth rates, or a long-term deceleration in the growth rates of
emerging markets.
 The discount rate, which is used to measure the present value of the projected future cash flows, and which is set using
a weighted-average cost of capital method that considers market and industry data as well as our specific risk factors that