Notes to
Consolidated Financial Statements
NOTE 1
ACCOUNTING POLICIES
ACCOUNTING POLICIES
Basis
of presentation
The consolidated financial statements include the accounts of
Kellogg Company and its majority-owned subsidiaries.
Intercompany balances and transactions are eliminated.
The Company’s fiscal year normally ends on the Saturday
closest to December 31 and as a result, a 53rd week is
added approximately every sixth year. The Company’s 2007,
2006 and 2005 fiscal years ended on December 29, December
30 and December 31, respectively. Our 2008 fiscal year will
have a 53rd week ending on January 3, 2009.
Cash
and cash equivalents
Highly liquid temporary investments with original maturities of
less than three months are considered to be cash equivalents.
Accounts
receivable
Accounts receivable consist principally of trade receivables,
which are recorded at the invoiced amount, net of allowances for
doubtful accounts and prompt payment discounts. Trade
receivables generally do not bear interest. Terms and collection
patterns vary around the world and by channel. In the United
States, the Company generally has required payment for goods
sold eleven or sixteen days subsequent to the date of invoice as
2% 10/net 11 or 1% 15/net 16, and days sales
outstanding (DSO) has averaged approximately 19 days during
the periods presented. The allowance for doubtful accounts
represents management’s estimate of the amount of probable
credit losses in existing accounts receivable, as determined
from a review of past due balances and other specific account
data. Account balances are written off against the allowance
when management determines the receivable is uncollectible. The
Company does not have any off-balance sheet credit exposure
related to its customers. Refer to Note 15 for an analysis
of the Company’s accounts receivable and allowance for
doubtful account balances during the periods presented.
Inventories
Inventories are valued at the lower of average cost or market.
Property
The Company’s property consists mainly of plant and
equipment used for manufacturing activities. These assets are
recorded at cost and depreciated over estimated useful lives
using straight-line methods for financial reporting and
accelerated methods, where permitted, for tax reporting. Major
property categories are depreciated over various periods as
follows (in years): manufacturing machinery and equipment 5-20;
computer and other office equipment 3-5; building components
15-30;
building structures 50. Cost includes an amount of interest
associated with significant capital projects. Plant and
equipment are reviewed for impairment when conditions indicate
that the carrying value may not be recoverable. Such conditions
include an extended period of idleness or a plan of disposal.
Assets to be abandoned at a future date are depreciated over the
remaining period of use. Assets to be sold are written down to
realizable value at the time the assets are being actively
marketed for sale and the disposal is expected to occur within
one year. As of year-end 2006 and 2007, the carrying value of
assets held for sale was insignificant.
Goodwill
and other intangible assets
The Company’s intangible assets consist primarily of
goodwill and major trademarks arising from the 2001 acquisition
of Keebler Foods Company (“Keebler”). Management
expects the Keebler trademarks, collectively, to contribute
indefinitely to the cash flows of the Company. Accordingly, this
asset has been classified as an “indefinite-lived”
intangible pursuant to SFAS No. 142 “Goodwill and
Other Intangible Assets.” Under this standard, goodwill and
indefinite-lived intangibles are not amortized, but are tested
at least annually for impairment. Goodwill impairment testing
first requires a comparison between the carrying value and fair
value of a reporting unit, which for the Company is generally
equivalent to a North American product group or an International
market. If carrying value exceeds fair value, goodwill is
considered impaired and is reduced to the implied fair value.
Impairment testing for
non-amortized
intangibles requires a comparison between the fair value and
carrying value of the intangible asset. If carrying value
exceeds fair value, the intangible is considered impaired and is
reduced to fair value. The Company uses various market valuation
techniques to determine the fair value of intangible assets.
Refer to Note 2 for further information on goodwill and
other intangible assets.
Revenue
recognition and measurement
The Company recognizes sales upon delivery of its products to
customers net of applicable provisions for discounts, returns,
allowances, and various government withholding taxes.
Methodologies for determining these provisions are dependent on
local customer pricing and promotional practices, which range
from contractually fixed percentage price reductions to
reimbursement based on actual occurrence or performance. Where
applicable, future reimbursements are estimated based on a
combination of historical patterns and future expectations
regarding specific in-market product performance. The Company
classifies promotional payments to its customers, the cost of
consumer coupons, and other cash redemption offers
34
in net sales. The cost of promotional package inserts are
recorded in cost of goods sold. Other types of consumer
promotional expenditures are normally recorded in selling,
general, and administrative (SGA) expense.
Advertising
The costs of advertising are generally expensed as incurred and
are classified within SGA expense.
Research
and development
The costs of research and development (R&D) are generally
expensed as incurred and are classified within SGA expense.
R&D includes expenditures for new product and process
innovation, as well as significant technological improvements to
existing products and processes. Total annual expenditures for
R&D are disclosed in Note 15 and are principally
comprised of internal salaries, wages, consulting, and supplies
attributable to time spent on R&D activities. Other costs
include depreciation and maintenance of research facilities and
equipment, including assets at manufacturing locations that are
temporarily engaged in pilot plant activities.
Stock
compensation
The Company uses various equity-based compensation programs to
provide long-term performance incentives for its global
workforce. Refer to Note 8 for further information on these
programs and the amount of compensation expense recognized
during the periods presented.
In December 2004, the FASB issued SFAS No. 123(R)
“Share-Based Payment,” which generally requires public
companies to measure the cost of employee services received in
exchange for an award of equity instruments based on the
grant-date fair value and to recognize this cost over the
requisite service period. The Company adopted
SFAS No. 123(R) as of the beginning of its 2006 fiscal
year, using the modified prospective method. Accordingly, prior
years were not restated, but 2006 results include compensation
expense associated with unvested equity-based awards, which were
granted prior to 2006.
Prior to adoption of SFAS No. 123(R), the Company used
the intrinsic value method prescribed by Accounting Principles
Board Opinion (APB) No. 25 “Accounting for Stock
Issued to Employees” to account for its employee stock
options and other stock-based compensation. Under this method,
because the exercise price of stock options granted to employees
and directors equaled the market price of the underlying stock
on the date of the grant, no compensation expense was
recognized. Expense attributable to other types of stock-based
awards was generally recognized in the Company’s reported
results under APB No. 25.
Certain of the Company’s equity-based compensation plans
contain provisions that accelerate vesting of awards upon
retirement, disability, or death of eligible employees and
directors. Prior to adoption of SFAS No. 123(R), the
Company generally recognized stock compensation expense over the
stated vesting period of the award, with any unamortized expense
recognized immediately if an acceleration event occurred.
SFAS No. 123(R) specifies that a stock-based award is
considered vested for expense attribution purposes when the
employee’s retention of the award is no longer contingent
on providing subsequent service. Accordingly, beginning in 2006,
the Company has prospectively revised its expense attribution
method so that the related compensation cost is recognized
immediately for awards granted to retirement-eligible
individuals or over the period from the grant date to the date
retirement eligibility is achieved, if less than the stated
vesting period.
The Company classifies pre-tax stock compensation expense
principally in SGA expense within its corporate operations.
Expense attributable to awards of equity instruments is accrued
in capital in excess of par value within the Consolidated
Balance Sheet.
SFAS No. 123(R) also provides that any corporate
income tax benefit realized upon exercise or vesting of an award
in excess of that previously recognized in earnings (referred to
as a “windfall tax benefit”) will be presented in the
Consolidated Statement of Cash Flows as a financing (rather than
an operating) cash flow. Realized windfall tax benefits are
credited to capital in excess of par value in the Consolidated
Balance Sheet. Realized shortfall tax benefits (amounts which
are less than that previously recognized in earnings) are first
offset against the cumulative balance of windfall tax benefits,
if any, and then charged directly to income tax expense. Under
the transition rules for adopting SFAS No. 123(R)
using the modified prospective method, the Company was permitted
to calculate a cumulative memo balance of windfall tax benefits
from post-1995 years for the purpose of accounting for
future shortfall tax benefits. The Company completed such study
prior to the first period of adoption and currently has
sufficient cumulative memo windfall tax benefits to absorb
arising shortfalls, such that earnings were not affected in
2007. Correspondingly, the Company includes the impact of pro
forma deferred tax assets (i.e., the “as if” windfall
or shortfall) for purposes of determining assumed proceeds in
the treasury stock calculation of diluted earnings per share
under SFAS No. 128 “Earnings Per Share.”
Employee
postretirement and postemployment benefits
The Company sponsors a number of U.S. and foreign plans to
provide pension, health care, and other welfare benefits to
retired employees, as well as salary continuance, severance, and
long-term disability to former or inactive employees. Refer to
Notes 9 and 10
35
for further information on these benefits and the amount of
expense recognized during the periods presented.
In order to improve the reporting of pension and other
postretirement benefit plans in the financial statements, in
September 2006, the FASB issued SFAS No. 158
“Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans,” which was effective for the
Company at the end of its 2006 fiscal year. Prior periods were
not restated. The standard generally requires company plan
sponsors to measure the net over- or
under-funded
position of a defined postretirement benefit plan as of the
sponsor’s fiscal year end and to display that position as
an asset or liability on the balance sheet. Any unrecognized
prior service cost, experience gains/losses, or transition
obligation are reported as a component of other comprehensive
income, net of tax, in shareholders’ equity. In contrast,
under
pre-existing
guidance, these unrecognized amounts were generally disclosed
only in financial statement footnotes, often resulting in a
disparity between plan balance sheet positions and the funded
status. Furthermore, plan measurement dates could occur up to
three months prior to year end.
Uncertain
tax positions
In July 2006, the FASB issued Interpretation No. 48
“Accounting for Uncertainty in Income Taxes”
(FIN No. 48) to clarify what criteria must be met
prior to recognition of the financial statement benefit, in
accordance with SFAS No. 109, “Accounting for Income
Taxes,” of a position taken in a tax return. The provisions
of the final interpretation apply broadly to all tax positions
taken by an enterprise, including the decision not to report
income in a tax return or the decision to classify a transaction
as tax exempt. The prescribed approach is based on a
two-step
benefit recognition model. The first step is to evaluate the tax
position for recognition by determining if the weight of
available evidence indicates it is more likely than not, based
on the technical merits and without consideration of detection
risk, that the position will be sustained on audit, including
resolution of related appeals or litigation processes, if any.
The second step is to measure the appropriate amount of the
benefit to recognize. The amount of benefit to recognize is
measured as the largest amount of tax benefit that is greater
than 50 percent likely of being ultimately realized upon
settlement. The tax position must be derecognized when it is no
longer more likely than not of being sustained. The
interpretation also provides guidance on recognition and
classification of related penalties and interest, classification
of liabilities, and disclosures of unrecognized tax benefits.
The change in net assets, if any, as a result of applying the
provisions of this interpretation is considered a change in
accounting principle with the cumulative effect of the change
treated as an offsetting adjustment to the opening balance of
retained earnings in the period of transition.
The Company adopted FIN No. 48 as of the beginning of
its 2007 fiscal year. Prior to adoption, the Company’s
pre-existing
policy was to establish reserves for uncertain tax positions
that reflected the probable outcome of known tax contingencies.
As compared to the Company’s historical approach, the
application of FIN No. 48 resulted in a net decrease
to accrued income tax and related interest liabilities of
approximately $2 million, with an offsetting increase to
retained earnings.
Interest recognized in accordance with FIN No. 48 may
be classified in the financial statements as either income taxes
or interest expense, based on the accounting policy election of
the enterprise. Similarly, penalties may be classified as income
taxes or another expense. The Company has historically
classified income
tax-related
interest and penalties as interest expense and SGA expense,
respectively, and continues to do so under FIN No. 48.
Recently
issued pronouncements
Fair value. In
September 2006, the FASB issued SFAS No. 157
“Fair Value Measurements” in order to establish a
single definition of fair value and a framework for measuring
fair value in generally accepted accounting principles (GAAP)
that is intended to result in increased consistency and
comparability in fair value measurements. SFAS No. 157
also expands disclosures about fair value measurements, with the
intention of improving the quality of information provided to
users of financial statements. The standard applies whenever
other authoritative literature requires (or permits) certain
assets or liabilities to be measured at fair value, but does not
expand the use of fair value. SFAS No. 157 was
originally effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim
periods within those years with early adoption permitted. In
early 2008, the FASB issued Staff Position (FSP)
FAS-157-2,
which delays by one year, the effective date of
SFAS No. 157 for all
non-financial
assets and
non-financial
liabilities, except those that are recognized or disclosed at
fair value in the financial statements on a recurring basis (at
least annually). The delay pertains to items including, but not
limited to,
non-financial
assets and
non-financial
liabilities initially measured at fair value in a business
combination, reporting units measured at fair value in the first
step of evaluating goodwill for impairment under
SFAS No. 142 “Goodwill and Other Intangible
Assets”,
indefinite-lived
intangible assets measured at fair value for impairment
assessment under SFAS No. 142, and
long-lived
assets measured at fair value for impairment assessment under
SFAS No. 144 “Accounting for the Impairment or
Disposal of
Long-Lived
Assets”. The Company plans to adopt the portion of
SFAS No. 157 that has not been delayed by FSP
FAS-157-2 as
of the beginning of its
36
2008 fiscal year, and plans to adopt the balance of its
provisions as of the beginning of its 2009 fiscal year. For the
Company, balance sheet items carried at fair value on a
recurring basis (to which SFAS No. 157 applies in
2008) consist primarily of derivative financial instruments
which are valued primarily based on quoted prices in active or
brokered markets for identical as well as similar assets and
liabilities. Balance sheet items carried at fair value on a
non-recurring
basis (to which SFAS No. 157 will apply in
2009) consist of assets held for sale and exit liabilities.
Relevant to the “Intangibles” section beginning
on page 23, the Company also uses fair value concepts to
test various
long-lived
assets for impairment and to initially measure assets and
liabilities acquired in a business combination. Management does
not currently expect the adoption of SFAS No. 157 in
2008 to have a material effect on the measurement of the
Company’s financial assets and liabilities. The Company is
continuing to evaluate the impact the standard will have on the
determination of fair value related to
non-financial
assets and
non-financial
liabilities in
post-2008 years.
Business combinations and
noncontrolling interests. In December 2007, the FASB
issued SFAS No. 141 (Revised 2007) “Business
Combinations” and SFAS No. 160 “Noncontrolling
Interests in Consolidated Financial Statements,” which are
effective for fiscal years beginning after December 15,
2008. These new standards represent the completion of the
FASB’s first major joint project with the International
Accounting Standards Board (IASB) and are intended to improve,
simplify, and converge internationally the accounting for
business combinations and the reporting of noncontrolling
interests (formerly minority interests) in consolidated
financial statements. Kellogg Company will adopt these standards
at the beginning of its 2009 fiscal year. The effect of adoption
will generally be prospectively applied to transactions
completed after the end of the Company’s 2008 fiscal year,
although the new presentation and disclosure requirements for
pre-existing
noncontrolling interests will be retrospectively applied to all
prior-period
financial information presented.
SFAS No. 141(R) retains the underlying fair value
concepts of its predecessor (SFAS No. 141), but
changes the method for applying the acquisition method in a
number of significant respects including the requirement to
expense transaction fees and expected restructuring costs as
incurred, rather than including these amounts in the allocated
purchase price; the requirement to recognize the fair value of
contingent consideration at the acquisition date, rather than
the expected amount when the contingency is resolved; the
requirement to recognize the fair value of acquired
in-process
research and development assets at the acquisition date, rather
than immediately expensing; and the requirement to recognize a
gain in relation to a bargain purchase price, rather than
reducing the allocated basis of
long-lived
assets. Because this standard is generally applied
prospectively, the effect of adoption on the Company’s
financial statements will depend primarily on specific
transactions, if any, completed after 2008. Management is
currently evaluating the effects that SFAS No. 141(R)
is likely to have on potential
post-2008
transactions.
Under SFAS No. 160, consolidated financial statements
will be presented as if the parent company investors
(controlling interests) and other minority investors
(noncontrolling interests) in
partially-owned
subsidiaries have similar economic interests in a single entity.
As a result, the investment in the noncontrolling interest,
previously recorded on the balance sheet between liabilities and
equity (the “mezzanine”), will be reported as equity
in the parent company’s consolidated financial statements,
subsequent to the adoption of SFAS No. 160.
Furthermore, consolidated financial statements will include 100%
of a controlled subsidiary’s earnings, rather than only the
parent company’s share. Lastly, transactions between the
parent company and noncontrolling interests will be reported in
equity as transactions between shareholders, provided that these
transactions do not create a change in control. Previously,
acquisitions of additional interests in a controlled subsidiary
generally resulted in remeasurement of assets and liabilities
acquired; dispositions of interests generally resulted in a gain
or loss.
Management is currently evaluating the impact of adopting
SFAS No. 160 on the Company’s financial
statements. Presently, there are no significant
non-controlling
interests in any of the Company’s consolidated
subsidiaries. Therefore, the Company currently believes that the
impact of SFAS No. 160, if any, will primarily depend
on the materiality of noncontrolling interests arising in future
transactions, including those entered into during 2008, to which
the financial statement presentation and disclosure provisions
of SFAS No. 160 will apply.
Use
of estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
