The Gap 2007 Annual Report Download - page 30

Insurance and Self-Insurance
We use a combination of insurance and self-insurance for a number of risk management activities including
workers’ compensation, general liability, and employee-related health care benefits, a portion of which is paid by
our employees. Liabilities associated with these risks are estimated based primarily on actuarially determined
amounts, and accrued in part by considering historical claims experience, demographic factors, severity factors
and other actuarial assumptions.
Asset Retirement Obligations
We account for asset retirement obligations in accordance with SFAS 143, “Accounting for Asset Retirement
Obligations,” and the Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 47, “Accounting
for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143.” An asset retirement
obligation represents a legal obligation associated with the retirement of a tangible long-lived asset that is incurred
upon the acquisition, construction, development or normal operation of that long-lived asset. The company’s asset
retirement obligations are primarily associated with leasehold improvements which, at the end of a lease, we are
contractually obligated to remove in order to comply with the lease agreement. We recognize asset retirement
obligations at the inception of a lease with such conditions, if a reasonable estimate of fair value can be made.
The asset retirement obligation is recorded in lease incentives and other long-term liabilities in the accompanying
Consolidated Balance Sheets and is subsequently adjusted for changes in fair value. The associated estimated
asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and depreciated over
its useful life.
Treasury Stock
We account for treasury stock under the cost method, using a FIFO flow assumption, and include treasury stock
as a component of stockholders’ equity.
Revenue Recognition
We recognize revenue and the related cost of goods sold at the time the products are received by the customers
in accordance with the provisions of Staff Accounting Bulletin No. (“SAB”) 101, “Revenue Recognition in Financial
Statements,” as amended by SAB 104, “Revenue Recognition.” Revenue is recognized for store sales when the
customer receives and pays for the merchandise at the register. For online sales, we estimate and defer revenue
and the related product costs for shipments that are in-transit to the customer. Revenue is recognized at the time
we estimate the customer receives the product which is typically within a few days of shipment. Deferred revenue
was $4 million as of February 2, 2008 and February 3, 2007. Amounts related to shipping and handling that are
billed to customers are reflected in net sales and the related costs are reflected in cost of goods sold and
occupancy expenses. Revenues are presented net of any taxes collected from customers and remitted to
governmental authorities.
Allowances for estimated returns are recorded based on estimated gross profit using our historical return patterns.
We sell merchandise to franchisees under multi-year franchise agreements. We recognize revenue from sales to
franchisees at the time merchandise ownership is transferred to the franchisee. These sales are classified as net
sales in our Consolidated Statements of Earnings and the related cost of goods sold is classified as cost of goods
sold and occupancy expenses. We also receive royalties from these franchisees based on a percentage of the
total merchandise purchased by the franchisee, net of any refunds or credits due them. Royalty revenue is
recognized when merchandise ownership is transferred to the franchisee and is classified as net sales in our
Consolidated Statements of Earnings.
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Classification of Expenses
Cost of goods sold and occupancy expenses include:
• the cost of merchandise;
• inventory shortage and valuation adjustments;
• freight charges;
• costs associated with our sourcing operations, including payroll and related benefits;
• production costs;
• insurance costs related to merchandise; and
• occupancy, rent, common area maintenance, real estate taxes, utilities, and depreciation for our stores and
distribution centers.
Operating expenses include:
• payroll and related benefits (for our store operations, field management, distribution centers, and corporate
functions);
• advertising;
• general and administrative expenses;
• costs to design and develop our products;
• merchandise handling and receiving in distribution centers and stores;
• distribution center general and administrative expenses;
• rent, occupancy, and depreciation for headquarter facilities; and
• other expense (income).
The classification of the expenses noted above varies across the retail industry.
Rent Expense
Minimum rental expenses are recognized over the term of the lease. We recognize minimum rent starting when
possession of the property is taken from the landlord, which normally includes a construction period prior to store
opening. When a lease contains a predetermined fixed escalation of the minimum rent, we recognize the related
rent expense on a straight-line basis and record the difference between the recognized rental expense and the
amounts payable under the lease as a short-term or long-term deferred rent liability. We also receive tenant
allowances upon entering into certain store leases which are recorded as a short-term or long-term tenant
allowance liability and amortized as a reduction to rent expense over the term of the lease.
Certain leases provide for contingent rents that are not measurable at inception. These contingent rents are
primarily based on a percentage of sales that are in excess of a predetermined level. These amounts are
excluded from minimum rent and are included in the determination of rent expense when it is probable that the
expense has been incurred and the amount is reasonably estimable. Future payments for maintenance,
insurance and taxes to which the Company is obligated are excluded from minimum lease payments.
Impairment of Long-Lived Assets and Excess Facilities
We have a significant investment in property and equipment. In accordance with SFAS 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets,” we review the carrying value of long-lived assets, including lease
rights and key money, for impairment whenever events or changes in circumstances indicate that the carrying
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