The Gap 2009 Annual Report Download - page 45

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We have assigned certain store and corporate facility leases to third parties as of January 30, 2010. Under these
arrangements, we are secondarily liable and have guaranteed the lease payments of the new lessees for the
remaining portion of our original lease obligation. The maximum potential amount of future lease payments we
could be required to make is approximately $31 million as of January 30, 2010. The carrying amount of the liability
related to the guarantees was approximately $2 million as of January 30, 2010.
We are a party to a variety of contractual agreements under which we may be obligated to indemnify the other
party for certain matters. These contracts primarily relate to our commercial contracts, operating leases,
trademarks, intellectual property, financial agreements, and various other agreements. Under these contracts, we
may provide certain routine indemnifications relating to representations and warranties (e.g., ownership of assets,
environmental or tax indemnifications) or personal injury matters. The terms of these indemnifications range in
duration and may not be explicitly defined. Generally, the maximum obligation under such indemnifications is not
explicitly stated, and as a result, the overall amount of these obligations cannot be reasonably estimated.
Historically, we have not made significant payments for these indemnifications. We believe that if we were to
incur a loss in any of these matters, the loss would not have a material effect on our financial condition or results
of operations.
As party to a reinsurance pool for workers’ compensation, general liability, and automobile liability, we have
guarantees with a maximum exposure of $14 million, of which $0.2 million has been cash collateralized. We are
currently in the process of winding down our participation in the reinsurance pool. Our maximum exposure and
cash collateralized balance are expected to decrease in the future as our participation in the reinsurance
pool diminishes.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the
United States of America requires management to adopt accounting policies and make significant judgments
and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are
alternative policies or estimation techniques that could be used. We maintain a thorough process to review the
application of our accounting policies and to evaluate the appropriateness of the many estimates that are
required to prepare the financial statements of a large, global corporation. However, even under optimal
circumstances, estimates routinely require adjustment based on changing circumstances and the receipt of
new or better information.
Our significant accounting policies can be found in Item 8, Financial Statements and Supplementary Data, Note 1
of Notes to Consolidated Financial Statements. The policies and estimates discussed below include the financial
statement elements that are either judgmental or involve the selection or application of alternative accounting
policies and are material to our financial statements. Management has discussed the development and selection
of these critical accounting policies and estimates with the Audit and Finance Committee of our Board of Directors,
which has reviewed our disclosure relating to critical accounting policies and estimates in this annual report on
Form 10-K.
Merchandise Inventory
We value inventory at the lower of cost or market (“LCM”), with cost determined using the weighted-average cost
method. We review our inventory levels in order to identify slow-moving merchandise and broken assortments
(items no longer in stock in a sufficient range of sizes) and use markdowns to clear merchandise. We record a
reserve when future estimated selling price is less than cost. Our LCM reserve calculation requires management to
make assumptions to estimate the amount of slow-moving merchandise and broken assortments subject to
markdowns, which is dependent upon factors such as historical trends with similar merchandise, inventory aging,
forecasted consumer demand, and the promotional environment. In addition, we estimate and accrue shortage for
the period between the last physical count and the balance sheet date. Our shortage estimate can be affected by
changes in merchandise mix and changes in actual shortage trends. Historically, actual shortage has not differed
materially from our estimates.
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