Business and Summary of Accounting Policies

Business

As of January 31, 2015, we operated 1,162 department stores in 49 states and a website (www.Kohls.com) that sell moderately-priced private label, exclusive and national brand apparel, footwear, accessories, beauty and home products. Our stores generally carry a consistent merchandise assortment with some differences attributable to regional preferences. Our website includes merchandise which is available in our stores, as well as merchandise which is available only on-line.

Our authorized capital stock consists of 800 million shares of $0.01 par value common stock and 10 million shares of $0.01 par value preferred stock.

Consolidation

The consolidated financial statements include the accounts of Kohl’s Corporation and its subsidiaries including Kohl’s Department Stores, Inc., its primary operating company. All intercompany accounts and transactions have been eliminated.

Accounting Period

Our fiscal year ends on the Saturday closest to January 31^st each year. Unless otherwise stated, references to years in this report relate to fiscal years rather than to calendar years. The following fiscal periods are presented in this report.



Fiscal year	Ended	Number of Weeks
2014	January 31, 2015	52
2013	February 1, 2014	52
2012	February 2, 2013	53

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Cash and Cash Equivalents

In addition to money market investments, cash equivalents include commercial paper and certificates of deposit with original maturities of three months or less. We carry these investments at cost which approximates fair value.

Also included in cash and cash equivalents are amounts due from credit card transactions with settlement terms of less than five days. Credit and debit card receivables included within cash were $95 million at January 31, 2015 and $89 million at February 1, 2014.

Merchandise Inventories

Merchandise inventories are valued at the lower of cost or market with cost determined on the first-in, first-out (“FIFO”) basis using the retail inventory method (“RIM”). Under RIM, the valuation of inventory at cost and the resulting gross margins are calculated by applying a cost-to-retail ratio to the retail value inventory. RIM is an averaging method that has been widely used in the retail industry due to its practicality. The use of RIM will result in inventory being valued at the lower of cost or market since permanent markdowns are currently taken as a reduction of the retail value of inventory. We record an additional reserve if the future estimated selling price is less than cost.

1. Business and Summary of Accounting Policies (continued)

Property and Equipment

Property and equipment consist of the following:



	Jan 31, 2015			Feb 1, 2014
	(Dollars In Millions)
Land	$	1,103		$	1,095
Buildings and improvements:
Owned	7,844			7,713
Leased	1,848			1,845
Store fixtures and equipment	2,032			2,147
Computer hardware and software	1,368			1,033
Construction in progress	210			291
Total property and equipment, at cost	14,405			14,124
Less accumulated depreciation	(5,890		)	(5,379		)
Property and equipment, net	$	8,515		$	8,745

Construction in progress includes land, building and improvements, and computer hardware and software which is not ready for its intended use.

Property and equipment is recorded at cost, less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Leased property and improvements to leased property are amortized on a straight-line basis over the term of the lease or useful life of the asset, whichever is less.

The annual provisions for depreciation and amortization generally use the following ranges of useful lives:




Buildings and improvements	5-40 years
Store fixtures and equipment	3-15 years
Computer hardware and software	3-8 years

Long-Lived Assets

All property and equipment and other long-lived assets are reviewed for potential impairment when events or changes in circumstances indicate that the asset’s carrying value may not be recoverable. If such indicators are present, it is determined whether the sum of the estimated undiscounted future cash flows attributable to such assets is less than the carrying value of the assets. A potential impairment has occurred if projected future undiscounted cash flows are less than the carrying value of the assets. No impairments were recorded in 2014, 2013, or 2012 as a result of the tests performed.

Accrued Liabilities

Accrued liabilities consist of the following:



	Jan 31, 2015		Feb 1, 2014
	(Dollars In Millions)
Gift cards and merchandise return cards	$	307	$	296
Payroll and related fringe benefits	135		112
Sales, property and use taxes	185		166
Credit card liabilities	106		109
Other	427		455
Accrued liabilities	$	1,160	$	1,138

1. Business and Summary of Accounting Policies (continued)

Self-Insurance

We use a combination of insurance and self-insurance for a number of risks including workers’ compensation, general liability, and employee-related health care benefits, a portion of which is paid by our associates. Liabilities associated with these losses include estimates of both reported losses and losses incurred but not yet reported. We use a third-party actuary, which considers historical claims experience, demographic factors, severity factors and other actuarial assumptions, to estimate the liabilities associated with these risks. Total estimated liabilities for workers’ compensation, general liability and employee-related health benefits were approximately $46 million at January 31, 2015 and $47 million at February 1, 2014. Although these amounts are actuarially determined based on analysis of historical trends, the amounts that we will ultimately disburse could differ from these estimates.

As of January 1, 2015, our self insurance exposure for property losses differs based on the type of claim. For catastrophic claims like earthquakes, floods and windstorms, depending on the location, we are self insured for 2-5% of the insurance claim. For other standard claims like fire and building damages, we are self insured for the first $250,000 of property loss claims.

Treasury Stock

We account for repurchases of common stock and shares withheld in lieu of taxes when restricted stock vests using the cost method with common stock in treasury classified in the Consolidated Balance Sheets as a reduction of shareholders’ equity.

Accumulated Other Comprehensive Loss and Other Comprehensive Income

Accumulated other comprehensive loss consists of the following:



	Unrealized Gains (Losses) on Investments			Loss on Interest Rate Derivatives			Accumulated Other Comprehensive Loss
	(Dollars In Millions)
Balance at February 2, 2013	$	(19	)	$	(26	)	$	(45	)
Other comprehensive income	8			3			11
Balance at February 1, 2014	(11		)	(23		)	(34		)
Other comprehensive income	11			3			14
Balance at January 31, 2015	$	—		$	(20	)	$	(20	)

The tax effects of each component of other comprehensive income are as follows:



	2014			2013			2012
	(Dollars In Millions)
Unrealized gains on investments:
Before-tax amounts	$	18		$	12		$	9
Tax expense	(7		)	(4		)	(4		)
After-tax amounts	11			8			5
Interest rate derivatives:
Before-tax amounts	5			5			5
Tax expense	(2		)	(2		)	(2		)
After-tax amounts	3			3			3
Other comprehensive income	$	14		$	11		$	8

1. Business and Summary of Accounting Policies (continued)

Revenue Recognition

Revenue from the sale of merchandise at our stores is recognized at the time of sale, net of any returns. Sales of merchandise shipped to our customers are recorded based on estimated receipt of merchandise by the customer. Net sales do not include sales tax as we are considered a pass-through conduit for collecting and remitting sales taxes.

Revenue from Kohl's gift card sales is recognized when the gift card is redeemed. Gift card breakage revenue is based on historical redemption patterns and represents the balance of gift cards for which we believe the likelihood of redemption by a customer is remote.

Cost of Merchandise Sold and Selling, General and Administrative Expenses

The following table illustrates the primary costs classified in Cost of Merchandise Sold and Selling, General and Administrative Expenses:



Cost of Merchandise Sold		Selling, General and Administrative Expenses
• Total cost of products sold including product development costs, net of vendor payments other than reimbursement of specific, incremental and identifiable costs • Inventory shrink • Markdowns • Freight expenses associated with moving merchandise from our vendors to our distribution centers • Shipping and handling expenses of sales generated on-line • Terms cash discount		• Compensation and benefit costs including: • Stores • Corporate headquarters, including buying and merchandising • Distribution centers • Occupancy and operating costs of our retail, distribution and corporate facilities • Net revenues from the Kohl’s credit card program • Freight expenses associated with moving merchandise from our distribution centers to our retail stores and between distribution and retail facilities • Advertising expenses, offset by vendor payments for reimbursement of specific, incremental and identifiable costs • Other administrative revenues and expenses

The classification of these expenses varies across the retail industry.

Vendor Allowances

We receive consideration for a variety of vendor-sponsored programs, such as markdown allowances, volume rebates and promotion and advertising support. The vendor consideration is recorded as earned either as a reduction of inventory costs or Selling, General and Administrative (“SG&A”) expenses based on the application of Accounting Standards Codification (“ASC”) No. 605, Subtopic 50, “Customer Payments and Incentives.” Promotional and advertising allowances are intended to offset our advertising costs to promote vendors’ merchandise. Markdown allowances and volume rebates are recorded as a reduction of inventory costs.

Loyalty Program

We currently operate the Kohl's Yes2You Rewards program in which customers earn points based on their spending and other promotional activities. Upon accumulating certain point levels, customers receive rewards to apply to future purchases. We accrue the cost of anticipated redemptions related to the program when the points are earned at the initial purchase. The costs of the program are recorded in cost of merchandise sold.

1. Business and Summary of Accounting Policies (continued)

Fair Value

ASC No. 820, “Fair Value Measurements and Disclosures,” requires fair value measurements be classified and disclosed in one of the following pricing categories:



Level 1:		Financial instruments with unadjusted, quoted prices listed on active market exchanges.

Level 2:		Financial instruments lacking unadjusted, quoted prices from active market exchanges, including over-the-counter traded financial instruments. The prices for the financial instruments are determined using prices for recently traded financial instruments with similar underlying terms as well as directly or indirectly observable inputs, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3:		Financial instruments that are not actively traded on a market exchange. This category includes situations where there is little, if any, market activity for the financial instrument. The prices are determined using significant unobservable inputs or valuation techniques.

We carry our current assets and liabilities at cost, which approximate fair value.

Leases

We lease certain property and equipment used in our operations.

We are often involved extensively in the construction of leased stores. In many cases, we are responsible for construction cost over runs or non-standard tenant improvements (e.g. roof or HVAC systems). As a result of this involvement, we are deemed the “owner” for accounting purposes during the construction period, so are required to capitalize the construction costs on our Balance Sheet. Upon completion of the project, we perform a sale-leaseback analysis pursuant to ASC 840, “Leases,” to determine if we can remove the assets from our Balance Sheet. In many of our leases, we are reimbursed a portion of the construction costs via adjusted rental payments and/or cash payments or have terms which fix the rental payments for a significant percentage of the leased asset’s economic life. These items generally are considered “continuing involvement” which precludes us from derecognizing the assets from our Balance Sheet when construction is complete. In conjunction with these leases, we also record financing obligations equal to the cash proceeds or fair market value of the assets received from the landlord. At the end of the lease term, including exercise of any renewal options, the net remaining financing obligation over the net carrying value of the fixed asset will be recognized as a non-cash gain on sale of the property. We do not report rent expense for the properties which are owned for accounting purposes. Rather, rental payments under the lease are recognized as a reduction of the financing obligation and interest expense.

Some of our property and equipment is held under capital leases. These assets are included in property and equipment and depreciated over the term of the lease. We do not report rent expense for capital leases. Rather, rental payments under the lease are recognized as a reduction of the capital lease obligation and interest expense.

All other leases are considered operating leases in accordance with ASC 840. Assets subject to an operating lease and the related lease payments are not recorded on our balance sheet. Rent expense is recognized on a straight-line basis over the expected lease term.

The lease term for all types of leases begins on the date we become legally obligated for the rent payments or we take possession of the building or land, whichever is earlier. The lease term includes cancelable option periods where failure to exercise such options would result in an economic penalty. Failure to exercise such options would result in the recognition of accelerated depreciation expense of the related assets.

1. Business and Summary of Accounting Policies (continued)

Advertising

Advertising costs, which include primarily television and radio broadcast, direct mail, digital, and newspaper circulars, are expensed when the advertisement is first seen. Advertising costs, net of related vendor allowances, were as follows:



	2014			2013			2012
	(Dollars In Millions)
Gross advertising costs	$	1,189		$	1,185		$	1,163
Vendor allowances	(165		)	(172		)	(170		)
Net advertising costs	$	1,024		$	1,013		$	993
Net advertising costs as a percent of net sales	5.4		%	5.3		%	5.2		%

Income Taxes

Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recorded based on differences between the amounts of assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax purposes. Deferred tax assets and liabilities are calculated using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. We establish valuation allowances for deferred tax assets when we believe it is more likely than not that the asset will not be realizable for tax purposes.

We recognize interest and penalty expense related to unrecognized tax benefits in our provision for income tax expense.

Net Income Per Share

Basic net income per share is net income divided by the average number of common shares outstanding during the period. Diluted net income per share includes incremental shares assumed to be issued upon exercise of stock options.

The information required to compute basic and diluted net income per share is as follows:



	2014		2013		2012
	(In Millions, Except per Share Data)
Numerator—net income	$	867	$	889	$	986
Denominator—weighted average shares
Basic	203		218		235
Impact of dilutive employee stock options (a)	1		2		2
Diluted	204		220		237
Net income per share:
Basic	$	4.28	$	4.08	$	4.19
Diluted	$	4.24	$	4.05	$	4.17


(a)	Excludes 3 million share-based awards for 2014, 10 million share-based awards for 2013 and 14 million share-based awards for 2012 as the impact of such awards was antidilutive.

Share-Based Awards

Stock-based compensation expense is generally recognized on a straight-line basis over the vesting period based on the fair value of awards which are expected to vest. The fair value of all share-based awards is estimated on the date of grant.

Recent Accounting Pronouncements Not Yet Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We are required to adopt the new pronouncement in the first quarter of fiscal 2017 using one of two retrospective application methods. We are evaluating the application method and the impact of this new statement on our financial statements.