Wendy's 2015 Annual Report Download - page 56

Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements in conformity with accounting principles generally
accepted in the United States of America requires us to make estimates and assumptions in applying our critical
accounting policies that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses
during the reporting period. Our estimates and assumptions affect, among other things, impairment of goodwill and
indefinite-lived intangible assets, impairment of long-lived assets, restaurant dispositions, realizability of deferred tax
assets, Federal and state income tax uncertainties and legal and environmental accruals. We evaluate those estimates
and assumptions on an ongoing basis based on historical experience and on various other factors which we believe are
reasonable under the circumstances.
We believe that the following represent our more critical estimates and assumptions used in the preparation of
our consolidated financial statements:
• Impairment of goodwill and indefinite-lived intangible assets:
For goodwill impairment testing purposes, Wendy’s includes two reporting units comprised of its
(1) North America (defined as the United States of America and Canada) company-owned and franchise
restaurants and (2) international franchise restaurants. As of January 3, 2016, all of Wendy’s goodwill of
$770.8 million was associated with its North America restaurants since its international franchise
restaurants goodwill was determined to be fully impaired during the fourth quarter of 2013.
We test goodwill for impairment annually, or more frequently if events or changes in circumstances
indicate that the asset may be impaired. We did not initially assess our goodwill for impairment using only
qualitative factors in 2015 and, therefore, we performed our test for impairment using a two-step
quantitative process. Under the first step, the fair value of the reporting unit is compared with its carrying
value (including goodwill). If the fair value of the reporting unit is less than its carrying value, an
indication of goodwill impairment exists for the reporting unit and we must perform step two of the
impairment test (measurement). Step two of the impairment test, if necessary, requires the estimation of
the fair value for the assets and liabilities of a reporting unit in order to calculate the implied fair value of
the reporting unit’s goodwill. Under step two, an impairment loss is recognized to the extent the carrying
amount of the reporting unit’s goodwill exceeds the implied fair value of goodwill. The fair value of the
reporting unit is determined by management and is based on the results of (1) estimates we made
regarding the present value of the anticipated cash flows associated with each reporting unit (the “income
approach”) and (2) the indicated value of the reporting units based on a comparison and correlation of the
Company and other similar companies (the “market approach”).
The income approach, which considers factors unique to each of our reporting units and related long range
plans that may not be comparable to other companies and that are not yet publicly available, is dependent
on several critical management assumptions. These assumptions include estimates of future sales growth,
gross margins, operating costs, income tax rates, terminal value growth rates, capital expenditures and the
weighted average cost of capital (discount rate). Anticipated cash flows used under the income approach
are developed every fourth quarter in conjunction with our annual budgeting process and also incorporate
amounts and timing of future cash flows based on our long range plan.
The discount rates used in the income approach are an estimate of the rate of return that a market
participant would expect of each reporting unit. To select an appropriate rate for discounting the future
earnings stream, a review is made of short-term interest rate yields of long-term corporate and government
bonds, as well as the typical capital structure of companies in the industry. The discount rates used for
each reporting unit may vary depending on the risk inherent in the cash flow projections, as well as the risk
level that would be perceived by a market participant. A terminal value is included at the end of the
projection period used in our discounted cash flow analyses to reflect the remaining value that each
reporting unit is expected to generate. The terminal value represents the present value in the last year of the
projection period of all subsequent cash flows into perpetuity. The terminal value growth rate is a key
assumption used in determining the terminal value as it represents the annual growth of all subsequent
cash flows into perpetuity.
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