Critical Accounting Policies & Estimates
Critical accounting policies covering areas of greater complexity or those particularly subject to the exercise of judgment are listed below. There are no material off-balance sheet structures. The principal accounting policies are set out in the financial statements in Item 8.
Foreign currency translation
The results of subsidiaries with functional currencies other than US dollars are translated into US dollars at the weighted average rates of exchange during the period and their balance sheets are translated at the rates at the balance sheet date. The average exchange rate is calculated using the weekly exchange rates weighted by the level of sales within the relevant period. The income statement for Fiscal 2011 used an average exchange rate of $1.55 to £1 pound sterling and there is no significant exposure to movements in exchange rates of other currencies. A one cent increase in this rate would increase reported net income by $0.2 million. Exchange differences arising from the translation of the net assets of these subsidiaries are included in other comprehensive income.
Revenue recognition
Revenue from the sale of extended service plans is deferred and recognised over the anticipated period of claims arising under the plans. Signet reviews the patterns of claims, including estimates of future claims costs expected to be incurred, to determine the appropriate deferral period for revenue recognition. All direct costs associated with the sale of these plans are deferred and amortized in proportion to the revenue recognized. Management reviews the trends in current and estimated future claims to assess whether changes are required to the revenue and cost recognition rates used.
When promotional vouchers providing an incentive to enter into a future purchase are issued, the estimated fair value of these vouchers anticipated to be redeemed is treated as deferred revenue. The fair value of these vouchers is calculated based on prior years’ experience.
The deferred revenue that represents income under extended warranty plans, voucher promotions and other items at the end of Fiscal 2011 was $499.2 million (Fiscal 2010: $475.7 million).
Provision is made for future returns expected within the stated return period, based on previous percentage return rates experienced.
Depreciation and impairment
Depreciation is provided on freehold and long leasehold premises over a useful life not exceeding 50 years. Freehold land is not depreciated. Depreciation is provided on other fixed assets at rates between 10% and 331⁄3%. Storefit depreciation rates have been set based on the refit cycle for each store and the useful lives of each individual element of the storefit. Cash registers and other IT equipment have separately determined depreciation rates.
In the UK, there are circumstances where refurbishments are carried out close to the end of the lease term, such that the expected life of the newly installed leasehold improvements will exceed the lease term. Where the renewal of the lease is reasonably assured, such storefronts, fixtures and fittings are depreciated over a period equal to the lesser of their economic useful life, or the remaining lease term plus the period of reasonably assured renewal. Reasonable assurance is gained through evaluation of the right to enter into a new lease, the performance of the store and potential availability of alternative sites.
Where appropriate, impairments are made on assets that have a fair value less than net book value. Management has identified potentially impaired assets considering the cash flows of individual stores where trading since the initial opening of the store has reached a mature stage. Where such stores deliver negative cash flows, the related store assets have been considered for impairment by reference to estimated future cash flows for these stores. In Fiscal 2011, the income statement includes a charge of $2.9 million for impairment of assets (Fiscal 2010: $2.9 million).
Taxation
Accruals for income tax contingencies require management to make judgments and estimates in relation to tax audit issues and exposures. Amounts reserved are based on management’s interpretation of country-specific tax law and the likelihood of settlement. Tax benefits are not recognized unless the tax positions are more likely than not to be sustained. Once recognized, management reviews each material tax benefit taking account of potential settlement through negotiation and/or litigation. Any recorded exposure to interest and penalties on tax liabilities is included in the income tax charge.
Accounts receivable
Accounts receivable are stated net of an allowance for uncollectible balances. This allowance is based on Signet’s past experience and the payment history of customers, which reflect the prevailing economic environment. The allowance at January 29, 2011 was $68.3 million against a gross accounts receivable balance of $1,004.2 million. This compares to a valuation allowance of $73.2 million against a gross accounts receivable balance of $931.2 million at January 30, 2010. Management regularly reviews its receivable balances and when it assesses that a balance has become irrecoverable it is fully written off. Signet provides credit facilities to customers upon completing appropriate credit tests.
Interest receivable from the US customer in-house finance program is classified as other operating income.
Inventory valuation
Inventory is valued on an average cost basis and includes appropriate overheads. Overheads allocated to inventory cost are only those directly related to bringing inventory to its present location and condition. These include relevant warehousing, distribution and certain buying, security and data processing costs.
Where necessary, inventory is written down for obsolete, slow-moving and damaged items. This write down represents the difference between the cost of the inventory and its estimated market value, based upon inventory turn rates, market conditions and trends in consumer demand. The size of any write down also reflects the timing of the physical scrappage of aged, damaged or defective merchandise. The total inventory write down at January 29, 2011 was $27.8 million (Fiscal 2010: $32.5 million). Total net inventory at January 29, 2011 was $1,184.2 million, an increase of $11.1 million on January 30, 2010.
In the US, inventory losses are recognized at the mid-year and fiscal year end based on complete physical inventories. In the UK, inventory losses are recorded as identified on a perpetual inventory system and an estimate is made of losses for the period from the last inventory count date to the end of the fiscal year on a store by store basis. These estimates are based on the overall divisional inventory loss experience since the last inventory count.
Hedge accounting
Changes in the fair value of financial instruments that are designated and effective as hedges of future cash flows are recognized directly in equity through the statement of accumulated other comprehensive income. Any ineffective portion of the gain or loss is recognized immediately in the income statement.
UK retirement benefits
The expected liabilities of the UK Plan are calculated based primarily on assumptions regarding salary and pension increases, inflation rates, discount rates, projected life expectancy and the long term rate of return expected on the UK Plan’s assets. A full actuarial valuation was completed as of April 5, 2009 and the UK Plan valuation is updated at each year end. The discount rate assumption of 5.6% applied for Fiscal 2011 is based on the yield at the balance sheet date of long dated AA rated corporate bonds of equivalent currency and term to the UK Plan’s liabilities. A 0.1% increase in this discount rate would decrease the net periodic benefit cost of $7.0 million in Fiscal 2011 by $0.3 million. The value of the assets of the UK Plan is measured as of the balance sheet date, which is particularly dependent on the value of equity investments held at that date. The overall impact on the consolidated balance sheet is significantly mitigated as the members of the UK Plan are only in the UK and account for about 9% of UK employees. The UK Plan ceased to admit new employees as of April 2004. In addition, if net accumulated actuarial gains and losses exceed 10% of the greater of plan assets or plan liabilities, Signet amortizes those gains or losses that exceed this 10% over the average remaining service period of the employees. The funded status of the UK Plan at January 29, 2011 was a $22.8 million asset (Fiscal 2010: $4.8 million obligation).
Accounting changes and recent accounting standards
For a description of accounting changes and recent accounting standards, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements, see Note 1 (y), Principal accounting policies — Recently issued accounting pronouncements, in Item 8 of this Annual Report on Form 10-K.