Note 1. Significant Accounting Policies

Basis of presentation. The accompanying unaudited consolidated financial statements of Polaris Industries Inc. ("Polaris" or the "Company") have been prepared in accordance with accounting principles generally accepted in the United States for interim financial statements and, therefore, do not include all information and disclosures of results of operations, financial position and changes in cash flow in conformity with accounting principles generally accepted in the United States for complete financial statements. Accordingly, such statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 previously filed with the Securities and Exchange Commission. In the opinion of management, such statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. Due to the seasonality of snowmobiles; Off-Road Vehicles (ORV), which include all-terrain vehicles (ATV) and side-by-side vehicles; motorcycles; Small Vehicles (SV); and Parts, Garments and Accessories (PG&A) businesses, and to certain changes in production and shipping cycles, results of such periods are not necessarily indicative of the results to be expected for the complete year.

Fair value measurements. Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Assets and liabilities measured at fair value are classified using the following hierarchy, which is based upon the transparency of inputs to the valuation as of the measurement date:

Level 1 — Quoted prices in active markets for identical assets or liabilities.

Level 2 — Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

In making fair value measurements, observable market data must be used when available. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement. The Company utilizes the market approach to measure fair value for its non-qualified deferred compensation assets and liabilities, and the income approach for foreign currency contracts and commodity contracts. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities, and for the income approach the Company uses significant other observable inputs to value its derivative instruments used to hedge foreign currency and commodity transactions.

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):



	Fair Value Measurements as of June 30, 2014
Asset (Liability)	Total			Level 1			Level 2			Level 3
Non-qualified deferred compensation assets	$	41,166		$	41,166		—			—
Total assets at fair value	$	41,166		$	41,166		—			—
Foreign exchange contracts, net	$	(1,608	)	—			$	(1,608	)	—
Non-qualified deferred compensation liabilities	(41,166		)	$	(41,166	)	—			—
Total liabilities at fair value	$	(42,774	)	$	(41,166	)	$	(1,608	)	—
	Fair Value Measurements as of December 31, 2013
Asset (Liability)	Total			Level 1			Level 2			Level 3
Commodity contracts, net	$	30		—			$	30		—
Non-qualified deferred compensation assets	24,711			$	24,711		—			—
Total assets at fair value	$	24,741		$	24,711		$	30		—
Foreign exchange contracts, net	$	(9	)	—			$	(9	)	—
Non-qualified deferred compensation liabilities	(24,711		)	$	(24,711	)	—			—
Total liabilities at fair value	$	(24,720	)	$	(24,711	)	$	(9	)	—

Inventories. Inventory costs include material, labor and manufacturing overhead costs, including depreciation expense associated with the manufacture and distribution of the Company's products. Inventories are stated at the lower of cost (first-in, first-out method) or market. The major components of inventories are as follows (in thousands):



	June 30, 2014			December 31, 2013
Raw materials and purchased components	$	113,841		$	107,496
Service parts, garments and accessories	150,241			125,765
Finished goods	322,153			206,290
Less: reserves	(26,359		)	(21,603		)
Inventories	$	559,876		$	417,948

Product warranties. Polaris provides a limited warranty for its ORVs for a period of six months, for a period of one year for its snowmobiles and motorcycles and a two year period for SVs. Polaris provides longer warranties in certain geographical markets as determined by local regulations and market conditions and may also provide longer warranties related to certain promotional programs. Polaris’ standard warranties require the Company or its dealers to repair or replace defective products during such warranty periods at no cost to the consumer. The warranty reserve is established at the time of sale to the dealer or distributor based on management’s best estimate using historical rates and trends. Adjustments to the warranty reserve are made from time to time as actual claims become known in order to properly estimate the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. Factors that could have an impact on the warranty accrual in any given period include the following: improved manufacturing quality, shifts in product mix, changes in warranty coverage periods, snowfall and its impact on snowmobile usage, product recalls and any significant changes in sales volume. The activity in the warranty reserve during the periods presented was as follows (in thousands):



	Three months ended June 30,						Six months ended June 30,
	2014			2013			2014			2013
Balance at beginning of period	$	47,224		$	40,941		$	52,818		$	47,723
Additions to warranty reserve through acquisitions	110			1,602			110			1,602
Additions charged to expense	12,270			13,154			23,297			21,990
Warranty claims paid	(14,793		)	(12,980		)	(31,414		)	(28,598		)
Balance at end of period	$	44,811		$	42,717		$	44,811		$	42,717

New Accounting Pronouncements. In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue from the transfer of goods or services to customers in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. Polaris is required to adopt the new pronouncement on January 1, 2017 using one of two retrospective application methods. The Company is evaluating the application method and the impact of this new standard on our financial statements.

There are no other new accounting pronouncements that are expected to have a significant impact on Polaris' consolidated financial statements.