Analysis: Nature of Business, Basis of Reporting, Significant Accounting Policies, Revenues Recognition

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany transactions have been eliminated. The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and include amounts based on management's prudent judgments and estimates. Actual results may differ from these estimates.

The Company's 45% proportionate share of earnings in the Alliance Boots GmbH (Alliance Boots) equity method investment is included in consolidated net earnings.  The Company reports its share of equity earnings in Alliance Boots within the operating section in the Consolidated Statements of Earnings because operations of Alliance Boots are integral to Walgreens.  The companies share common board of director members, recognize purchasing synergies through Walgreens Boots Alliance Development GmbH, a 50/50 joint venture, as well as engage in intercompany sales transactions on select front-end merchandise.  Because of the three-month lag and the timing of the closing of this investment, only the ten months of August through May's results of operations are reflected in the equity earnings in Alliance Boots included in the Company's reported net earnings for year ended August 31, 2013 compared to twelve months operating results for June through May in the current fiscal year.

The Company directly owns a 50% interest in Walgreens Boots Alliance Development GmbH and indirectly owns an additional ownership interest through its 45% ownership in Alliance Boots, representing a direct and indirect economic interest of 72.5%. The financial results of the Walgreens Boots Alliance Development GmbH joint venture are fully consolidated into the Company's consolidated financial statements and reported without a lag.  As the joint venture is included within the Company's operating results, Alliance Boots proportionate share of Walgreens Boots Alliance Development GmbH earnings is removed from equity earnings and presented as a component of noncontrolling interests.

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany transactions have been eliminated. The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and include amounts based on management's prudent judgments and estimates. Actual results may differ from these estimates.

The Company's 45% proportionate share of earnings in the Alliance Boots GmbH (Alliance Boots) equity method investment is included in consolidated net earnings.  The Company reports its share of equity earnings in Alliance Boots within the operating section in the Consolidated Statements of Earnings because operations of Alliance Boots are integral to Walgreens.  The companies share common board of director members, recognize purchasing synergies through Walgreens Boots Alliance Development GmbH, a 50/50 joint venture, as well as engage in intercompany sales transactions on select front-end merchandise.  Because of the three-month lag and the timing of the closing of this investment, only the ten months of August through May's results of operations are reflected in the equity earnings in Alliance Boots included in the Company's reported net earnings for year ended August 31, 2013 compared to twelve months operating results for June through May in the current fiscal year.

The Company directly owns a 50% interest in Walgreens Boots Alliance Development GmbH and indirectly owns an additional ownership interest through its 45% ownership in Alliance Boots, representing a direct and indirect economic interest of 72.5%. The financial results of the Walgreens Boots Alliance Development GmbH joint venture are fully consolidated into the Company's consolidated financial statements and reported without a lag.  As the joint venture is included within the Company's operating results, Alliance Boots proportionate share of Walgreens Boots Alliance Development GmbH earnings is removed from equity earnings and presented as a component of noncontrolling interests.

Notes to Consolidated Financial Statements

Description of Business

The Company is principally in the retail drugstore business and its operations are within one reportable segment.  At August 31, 2014, there were 8,309 drugstore and other locations in all 50 states, the District of Columbia, Puerto Rico and U.S. Virgin Islands.  Prescription sales were 64.2% of total sales for fiscal 2014 compared to 62.9% in 2013 and 63.2% in 2012.

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany transactions have been eliminated. The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and include amounts based on management's prudent judgments and estimates. Actual results may differ from these estimates.

The Company's 45% proportionate share of earnings in the Alliance Boots GmbH (Alliance Boots) equity method investment is included in consolidated net earnings.  The Company reports its share of equity earnings in Alliance Boots within the operating section in the Consolidated Statements of Earnings because operations of Alliance Boots are integral to Walgreens.  The companies share common board of director members, recognize purchasing synergies through Walgreens Boots Alliance Development GmbH, a 50/50 joint venture, as well as engage in intercompany sales transactions on select front-end merchandise.  Because of the three-month lag and the timing of the closing of this investment, only the ten months of August through May's results of operations are reflected in the equity earnings in Alliance Boots included in the Company's reported net earnings for year ended August 31, 2013 compared to twelve months operating results for June through May in the current fiscal year.

The Company directly owns a 50% interest in Walgreens Boots Alliance Development GmbH and indirectly owns an additional ownership interest through its 45% ownership in Alliance Boots, representing a direct and indirect economic interest of 72.5%. The financial results of the Walgreens Boots Alliance Development GmbH joint venture are fully consolidated into the Company's consolidated financial statements and reported without a lag.  As the joint venture is included within the Company's operating results, Alliance Boots proportionate share of Walgreens Boots Alliance Development GmbH earnings is removed from equity earnings and presented as a component of noncontrolling interests.

Subsequent Matters

Subsidiary Issuer Information

Walgreens Boots Alliance, Inc. (WBA) is a new corporation incorporated on September 2, 2014 under the laws of Delaware and is currently a direct 100% owned finance subsidiary of the Company.  Walgreens Boots Alliance, Inc. is anticipated to be the issuer of one or more series of unsecured, unsubordinated notes (WBA notes) in connection with the financing of a portion of the cash consideration payable in connection with the second step transaction, the refinancing of substantially all of Alliance Boots' total borrowings in connection with the second step transaction and/or the payment of related fees and expenses. Following the completion of the second step transaction, a portion of the net proceeds from the issuance of the WBA notes may also be used for general corporate purposes, including the repayment and/or refinancing of existing Company obligations.  The Company will guarantee the WBA notes and such guarantee will be full and unconditional. 

The Company anticipates that neither the WBA notes nor any other potential Company or WBA financings in connection with the second step transaction will contain any significant restrictions on the ability of the Company's subsidiaries to make dividend payments, loans or advances to the Company or WBA.

In addition, Company is the issuer of five series of senior unsecured notes (Company Notes) and the borrower under two revolving credit facilities (Company Credit Facilities).  Neither the Company Notes nor Company Credit Facilities are guaranteed by any of the Company's subsidiaries.  The Company Notes and Company Credit Facilities do not contain any significant restrictions on the ability of the Company's subsidiaries to make dividend payments, loans or advances to the Company.

Other Information

In addition, this Amendment No. 1 on Form 10-K/A corrects the number of warrants to purchase shares of AmerisourceBergen common stock issued to the Company and Alliance Boots GmbH in Note 10 to 11,348,456; the number of unvested stock options at August 31, 2014, in Note 14 to 18,896,912 and typographical errors in Note 1 and Note 8.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and all highly liquid investments with an original maturity of three months or less. Credit and debit card receivables from banks, which generally settle within two business days, of $229 million and $160 million were included in cash and cash equivalents at August 31, 2014 and 2013, respectively.  At August 31, 2014 and 2013, the Company had $1.9 billion and $1.6 billion, respectively, in money market funds, all of which was included in cash and cash equivalents.

The Company's cash management policy provides for controlled disbursement. As a result, the Company had outstanding checks in excess of funds on deposit at certain banks. These amounts, which were $267 million at August 31, 2014, and $274 million at August 31, 2013, are included in trade accounts payable in the accompanying Consolidated Balance Sheets.

Allowance for Doubtful Accounts

The provision for bad debt is based on both historical write-off percentages and specifically identified receivables. Activity in the allowance for doubtful accounts was as follows (in millions):

Inventories

Inventories are valued on a lower of last-in, first-out (LIFO) cost or market basis.  At August 31, 2014 and 2013, inventories would have been greater by $2.3 billion and $2.1 billion, respectively, if they had been valued on a lower of first-in, first-out (FIFO) cost or market basis.  As a result of declining inventory levels, the fiscal 2014, 2013 and 2012 LIFO provisions were reduced by LIFO liquidations of $187 million, $194 million and $268 million, respectively.  Inventory includes product costs, inbound freight, warehousing costs and vendor allowances not classified as a reduction of advertising expense.

Equity Method Investments

The Company uses the equity method to account for investments in companies if the investment provides the ability to exercise significant influence, but not control, over operating and financial policies of the investee.  The Company's proportionate share of the net income or loss of these companies is included in consolidated net earnings.  Judgment regarding the level of influence over each equity method investment includes considering key factors such as the Company's ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions.

The Company purchases inventory from Alliance Boots in the ordinary course of business.  These related party inventory purchases, which began in fiscal 2013, were not material in fiscal 2014 or 2013.

The underlying net assets of the Company's equity method investment in Alliance Boots include goodwill and indefinite-lived intangible assets.  These assets are evaluated for impairment annually or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.  Based on the Company's evaluation as of August 31, 2014, the fair value of one Alliance Boots pharmaceutical wholesale reporting unit did not exceed its carrying amount by a significant amount.  Goodwill allocated to this reporting unit by Alliance Boots as of May 31, 2014 was £255 million, £115 million based on the Company's 45% ownership percentage (approximately $193 million using May 31, 2014 exchange rates).  The Company utilizes a three-month lag in reporting its share of equity income in Alliance Boots, including this reporting unit.  The Company will continue to monitor this reporting unit in accordance with Accounting Standards Codification 350, Intangibles - Goodwill and Other.

Property and Equipment

Depreciation is provided on a straight-line basis over the estimated useful lives of owned assets. Leasehold improvements and leased properties under capital leases are amortized over the estimated useful life of the property or over the term of the lease, whichever is shorter. Estimated useful lives range from 10 to 39 years for land improvements, buildings and building improvements; and 2 to 13 years for equipment. Major repairs, which extend the useful life of an asset, are capitalized; routine maintenance and repairs are charged against earnings. The majority of the business uses the composite method of depreciation for equipment. Therefore, gains and losses on retirement or other disposition of such assets are included in earnings only when an operating location is closed, completely remodeled or impaired. Fully depreciated property and equipment are removed from the cost and related accumulated depreciation and amortization accounts. Property and equipment consists of (in millions):

Depreciation expense for property and equipment was $923 million in fiscal 2014, $894 million in fiscal 2013 and $841 million in fiscal 2012.

The Company capitalizes application stage development costs for significant internally developed software projects, such as upgrades to the store point-of-sale system. These costs are amortized over a five-year period. Amortization expense was $111 million in fiscal 2014, $100 million in fiscal 2013 and $70 million in fiscal 2012.  Unamortized costs at August 31, 2014 and August 31, 2013, were $410 million and $374 million, respectively.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of assets acquired and liabilities assumed.  The Company accounts for goodwill and intangibles under ASC Topic 350, Intangibles – Goodwill and Other, which does not permit amortization, but requires the Company to test goodwill and other indefinite-lived assets for impairment annually or whenever events or circumstances indicate impairment may exist.

Impaired Assets and Liabilities for Store Closings

The Company tests long-lived assets for impairment whenever events or circumstances indicate that a certain asset may be impaired. Store locations that have been open at least five years are reviewed for impairment indicators at least annually. Once identified, the amount of the impairment is computed by comparing the carrying value of the assets to the fair value, which is based on the discounted estimated future cash flows. Impairment charges included in selling, general and administrative expenses were $167 million in fiscal 2014, primarily resulting from the Company's store optimization plan.  Impairment charges recognized in fiscal 2013 and 2012 were $30 million and $27 million, respectively.

The Company also provides for future costs related to closed locations. The liability is based on the present value of future rent obligations and other related costs (net of estimated sublease rent) to the first lease option date. The reserve for store closings, including $137 million from locations closed under the Company's optimization plan, was $257 million as of August 31, 2014 compared to $123 million as of August 31 2013. See Note 2 for additional disclosure regarding the Company's reserve for future costs related to closed locations.

Financial Instruments

The Company had $151 million and $197 million of outstanding letters of credit at August 31, 2014 and 2013, respectively, which guarantee the purchase of foreign goods, and additional outstanding letters of credit of $259 million and $263 million at August 31, 2014 and 2013, respectively, which guarantee payments of insurance claims. The insurance claim letters of credit are annually renewable and will remain in place until the insurance claims are paid in full. Letters of credit of $9 million and $4 million were outstanding at August 31, 2014, and August 31, 2013, respectively, to guarantee performance of construction contracts. The Company pays a facility fee to the financing bank to keep these letters of credit active. The Company had real estate development purchase commitments of $169 million and $185 million at August 31, 2014 and 2013, respectively.

The Company uses interest rate swaps to manage its interest rate exposure associated with some of its fixed-rate borrowings.  At August 31, 2014, the Company had $1 billion of fixed-rate debt swapped to floating designated as fair value hedges.  The Company also manages its interest rate exposure associated with its anticipated debt issuance.  In fiscal 2014, the Company entered into a series of forward starting interest rate swap transactions locking in the then current three-month LIBOR interest rate on $1.5 billion of anticipated debt issuance.  These forward starting swap transactions are designated as cash flow hedges.  The Company's fair value and cash flow hedges are accounted for according to ASC Topic 815, Derivatives and Hedging, and measured at fair value in accordance with ASC Topic 820, Fair Value Measurement and Disclosures.  See Notes 10 and 11 for additional disclosure regarding financial instruments.

Revenue Recognition

The Company recognizes revenue at the time the customer takes possession of the merchandise. Customer returns are immaterial. Sales taxes are not included in revenue.

Gift Cards

The Company sells Walgreens gift cards to retail store customers and through its website.  The Company does not charge administrative fees on unused gift cards and most gift cards do not have an expiration date.  Income from gift cards is recognized when (1) the gift card is redeemed by the customer; or (2) the likelihood of the gift card being redeemed by the customer is remote (gift card breakage) and there is no legal obligation to remit the value of unredeemed gift cards to the relevant jurisdictions.  The Company's gift card breakage rate is determined based upon historical redemption patterns.  Gift card breakage income, which is included in selling, general and administrative expenses, was not significant in fiscal 2014, 2013 or 2012.

Loyalty Program

The Company's rewards program, Balance® Rewards, is accrued as a charge to cost of sales at the time a point is earned.  Points are funded internally and through vendor participation, and are credited to cost of sales at the time a vendor-sponsored point is earned.  Breakage is recorded as points expire as a result of a member's inactivity or if the points remain unredeemed after three years.  Breakage income, which is reported in cost of sales, was not significant in fiscal 2014 or 2013.

Cost of Sales

Cost of sales is derived based upon point-of-sale scanning information with an estimate for shrinkage and is adjusted based on periodic inventories.  In addition to product costs, cost of sales includes warehousing costs, purchasing costs, freight costs, cash discounts and vendor allowances.

Vendor Allowances

Vendor allowances are principally received as a result of purchases, sales or promotion of vendors' products.  Allowances are generally recorded as a reduction of inventory and are recognized as a reduction of cost of sales when the related merchandise is sold.  Those allowances received for promoting vendors' products are offset against advertising expense and result in a reduction of selling, general and administrative expenses to the extent of advertising costs incurred, with the excess treated as a reduction of inventory costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses mainly consist of store salaries, occupancy costs, and expenses directly related to stores.  In addition, other costs included are headquarters' expenses, advertising costs (net of advertising revenue) and insurance.

Advertising Costs

Advertising costs, which are reduced by the portion funded by vendors, are expensed as incurred.  Net advertising expenses, which are included in selling, general and administrative expenses, were $265 million in fiscal 2014, $286 million in fiscal 2013 and $291 million in fiscal 2012.  Included in net advertising expenses were vendor advertising allowances of $256 million in fiscal 2014, $240 million in fiscal 2013 and $239 million in fiscal 2012.

Insurance

The Company obtains insurance coverage for catastrophic exposures as well as those risks required by law to be insured.  It is the Company's policy to retain a significant portion of certain losses related to workers' compensation, property, comprehensive general, pharmacist and vehicle liability.  Liabilities for these losses are recorded based upon the Company's estimates for claims incurred and are not discounted.  The provisions are estimated in part by considering historical claims experience, demographic factors and other actuarial assumptions.

Available-for-Sale Investments

The Company, Alliance Boots and AmerisourceBergen Corporation (AmerisourceBergen) entered into a Framework Agreement dated as of March 18, 2013, pursuant to which Walgreens and Alliance Boots together were granted the right to purchase a minority equity position in AmerisourceBergen, beginning with the right, but not the obligation, to purchase up to 19,859,795 shares of AmerisourceBergen common stock (approximately 7 percent of the then fully diluted equity of AmerisourceBergen, assuming the exercise in full of the warrants described below) in open market transactions.  As of August 31, 2014, the Company held 11.5 million shares of AmerisourceBergen common stock which are classified as available-for-sale.  See Note 6 for additional disclosure regarding the Company's available-for-sale investments.

Warrants

The Company and Alliance Boots were each issued (a) a warrant to purchase shares of AmerisourceBergen common stock exercisable during a six-month period beginning in March 2016, and (b) a warrant to purchase shares of AmerisourceBergen common stock exercisable during a six-month period beginning in March 2017.  The Company's warrants are valued at the date of issuance and the end of the period using a Monte Carlo simulation.  Key assumptions used in the valuation include risk-free interest rates using constant maturity treasury rates; the dividend yield for AmerisourceBergen's common stock; AmerisourceBergen's common stock price at the valuation date; AmerisourceBergen's equity volatility; the number of shares of AmerisourceBergen's common stock outstanding; the number of employee stock options and the exercise price; and the details specific to the warrants. The fair value of the Company's warrants on March 18, 2013, the date of issuance, was $77 million.  The Company recorded the fair value of its warrants as a non-current asset with a corresponding deferred credit in its Consolidated Balance Sheets.  The deferred credit attributable to the warrants will be amortized over the life of the warrants.  The fair value of the Company's warrants at August 31, 2014 and 2013 was $553 million and $188 million, respectively, resulting in the Company recording other income of $366 million and $111 million within its Consolidated Statements of Earnings.  The increase in the fair value of the warrants was primarily attributable to the increase in the price of AmerisourceBergen's common stock.  In addition, the Company recorded $19 million and $9 million in fiscal 2014 and 2013, respectively, of other income relating to the amortization of the deferred credit.  See Note 10 for additional disclosure regarding the Company's warrants.

Pre-Opening Expenses

Non-capital expenditures incurred prior to the opening of a new or remodeled store are expensed as incurred.

Stock-Based Compensation Plans

In accordance with ASC Topic 718, Compensation – Stock Compensation, the Company recognizes compensation expense on a straight-line basis over the employee's vesting period or to the employee's retirement eligible date, if earlier.  Total stock-based compensation expense for fiscal 2014, 2013 and 2012 was $114 million, $104 million and $99 million, respectively.  The recognized tax benefit was $31 million, $30 million and $9 million for fiscal 2014, 2013 and 2012, respectively.  Unrecognized compensation cost related to non-vested awards at August 31, 2014, was $188 million.  This cost is expected to be recognized over a weighted average of three years.  See Note 14 for more information on the Company's stock-based compensation plans.

Interest Expense

The Company capitalized $6 million, $7 million and $9 million of interest expense as part of significant construction projects during fiscal 2014, 2013 and 2012, respectively.  Interest paid, which is net of capitalized interest, was $161 million in fiscal 2014, $158 million in fiscal 2013 and $108 million in fiscal 2012.

Income Taxes

The Company accounts for income taxes according to the asset and liability method.  Under this method, deferred tax assets and liabilities are recognized based upon the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured pursuant to tax laws using rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date.  Valuation allowances are established when necessary to reduce deferred tax assets to the amounts more likely than not to be realized.

In determining the Company's provision for income taxes, an annual effective income tax rate based on full-year income, permanent differences between book and tax income, and statutory income tax rates are used.  The effective income tax rate also reflects the Company's assessment of the ultimate outcome of tax audits in addition to any foreign-based income deemed to be taxable in the United States.  Discrete events such as audit settlements or changes in tax laws are recognized in the period in which they occur.

The Company is subject to routine income tax audits that occur periodically in the normal course of business.  U.S. federal, state and local and foreign tax authorities raise questions regarding the Company's tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions.  In evaluating the tax benefits associated with its various tax filing positions, the Company records a tax benefit for uncertain tax positions using the highest cumulative tax benefit that is more likely than not to be realized.  Adjustments are made to the liability for unrecognized tax benefits in the period in which the Company determines the issue is effectively settled with the tax authorities, the statute of limitations expires for the return containing the tax position or when more information becomes available.  The Company's liability for unrecognized tax benefits, including accrued penalties and interest, is included in other long-term liabilities on the Consolidated Balance Sheets and in income tax expense in the Consolidated Statements of Earnings.

Earnings Per Share

The dilutive effect of outstanding stock options on earnings per share is calculated using the treasury stock method.  Stock options are anti-dilutive and excluded from the earnings per share calculation if the exercise price exceeds the average market price of the common shares.  Outstanding options to purchase common shares that were anti-dilutive and excluded from earnings per share totaled 3,510,395, 12,316,949 and 32,593,870 in fiscal 2014, 2013 and 2012, respectively.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers, as a new Topic, ASC Topic 606.  The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized.  The core principle is that a company should recognize revenue to depict the transfer of promised 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.  This ASU is effective for annual periods beginning after December 15, 2016 (fiscal 2018) and shall be applied retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption.  The Company is evaluating the effect of adopting this new accounting guidance, but does not expect adoption will have a material impact on the Company's results of operations, cash flows or financial position.

In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This ASU raises the threshold for a disposal to qualify as discontinued operations and requires new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. Under the new standard, companies report discontinued operations when they have a disposal that represents a strategic shift that has or will have a major impact on operations or financial results.  This update will be applied prospectively and is effective for annual periods, and interim periods within those years, beginning after December 15, 2014 (fiscal 2016). Early adoption is permitted provided the disposal was not previously disclosed.  This update will not have a material impact on the Company's reported results of operations and financial position.  This ASU is non-cash in nature and will not affect the Company's cash position.

In May 2013, the FASB reissued an exposure draft on lease accounting that would require entities to recognize assets and liabilities arising from lease contracts on the balance sheet.  The proposed exposure draft states that lessees and lessors should apply a "right-of-use model" in accounting for all leases.  Under the proposed model, lessees would recognize an asset for the right to use the leased asset, and a liability for the obligation to make rental payments over the lease term. When measuring the asset and liability, variable lease payments are excluded, whereas renewal options that provide a significant economic incentive upon renewal would be included.  The accounting by a lessor would reflect its retained exposure to the risks or benefits of the underlying leased asset.  A lessor would recognize an asset representing its right to receive lease payments based on the expected term of the lease. The lease expense from real estate based leases would continue to be recorded under a straight-line approach, but other leases not related to real estate would be expensed using an effective interest method that would accelerate lease expense. A final standard is currently expected to be issued in calendar 2014 and would be effective no earlier than annual reporting periods beginning on January 1, 2017 (fiscal 2018 for the Company).  The proposed standard, as currently drafted, would have a material impact on the Company's financial position and the impact on the Company's reported results of operations is being evaluated.  The impact of this exposure draft is non-cash in nature and would not affect the Company's cash position.

In March 2014, the Board of Directors approved a plan to close underperforming stores in efforts to optimize and focus resources in a manner intended to increase shareholder value.  Total pre-tax charges associated with the plan are estimated to be between $240 million and $280 million.  In fiscal 2014, the Company incurred pre-tax charges of $209 million as a result of closing 67 stores; $137 million from lease termination costs, $71 million from asset impairment charges and $1 million of other charges.

The Company owns approximately 20% of its operating locations; the remaining locations are leased premises.  Initial terms are typically 20 to 25 years, followed by additional terms containing renewal options at five-year intervals, and may include rent escalation clauses.  The commencement date of all lease terms is the earlier of the date the Company becomes legally obligated to make rent payments or the date the Company has the right to control the property.  The Company recognizes rent expense on a straight-line basis over the term of the lease.  In addition to minimum fixed rentals, some leases provide for contingent rentals based upon a portion of sales.

The Company continuously evaluates its real estate portfolio in conjunction with its capital needs.  In fiscal 2014, the Company entered into several sale-leaseback transactions.  In some of these transactions, the Company negotiated fixed rate renewal options which constitute a form of continuing involvement, resulting in the assets remaining on the balance sheet and a corresponding finance lease obligation.

Minimum rental commitments at August 31, 2014, under all leases having an initial or remaining non-cancelable term of more than one year are shown below (in millions):

The capital and finance lease amounts include $1.5 billion of imputed interest and executory costs.  Total minimum lease payments have not been reduced by minimum sublease rentals of approximately $141 million on leases due in the future under non-cancelable subleases.

The Company provides for future costs related to closed locations.  The liability is based on the present value of future rent obligations and other related costs (net of estimated sublease rent) to the first lease option date.  In fiscal 2014, 2013 and 2012, the Company recorded charges of $177 million, $43 million and $20 million, respectively, for facilities that were closed or relocated under long-term leases, including stores closed through the Company's store optimization plan.  These charges are reported in selling, general and administrative expenses on the Consolidated Statements of Earnings.

The changes in reserve for facility closings and related lease termination charges include the following (in millions):

The Company remains secondarily liable on 20 assigned leases.  The maximum potential undiscounted future payments are $33 million at August 31, 2014.  Lease option dates vary, with some extending to 2041.

Rental expense, which includes common area maintenance, insurance and taxes, was as follows (in millions):

In June 2014, the Company completed the sale of a majority interest in its subsidiary, Take Care Employer Solutions, LLC (Take Care Employer) to Water Street Healthcare Partners (Water Street).  At the same time, Water Street made an investment in CHS Health Services (CHS), an unrelated entity and merged CHS with Take Care Employer to create a leading worksite health company dedicated to improving the cost and quality of employee health care.  Water Street owns a majority interest in the new company while Walgreens owns a significant minority interest and has representatives on the new company's board of directors.  The value of the investment at August 31, 2014 was $67 million.  The Company recognized an immaterial gain on the transaction.

In November 2013, the Company completed its acquisition of certain assets of Kerr Drug and its affiliates for $173 million, subject to adjustment in certain circumstances.  This acquisition included 76 retail locations as well as a specialty pharmacy business and a distribution center.  The preliminary purchase accounting for the Kerr Drug acquisition added $45 million to goodwill and $54 million to intangible assets, primarily prescription files and payer contracts, with $74 million allocated to net tangible assets.  This allocation is subject to change as the Company finalizes purchase accounting.

The aggregate purchase price of all business and intangible asset acquisitions, excluding Kerr Drug, was $171 million in fiscal 2014.  These acquisitions added $13 million to goodwill and $119 million to intangible assets, primarily prescription files.  The remaining fair value relates to immaterial amounts of tangible assets, less liabilities assumed.  Operating results of businesses acquired have been included in the Consolidated Statements of Earnings from their respective acquisition dates forward and were not material.

In fiscal 2013, the Company acquired Stephen L. LaFrance Holdings, Inc. (USA Drug) for $436 million net of assumed cash.  This acquisition increased the Company's presence in the mid-South region of the country.  The purchase price allocation for this acquisition added $220 million to goodwill and $156 million to intangible assets, primarily prescription files and non-compete agreements, with $60 million allocated to net tangible assets, primarily inventory.  The Company also acquired an 80% interest in Cystic Fibrosis Foundation Pharmacy LLC for $29 million net of assumed cash and a call option to acquire the remaining 20% interest in 2015.  The investment provides joint ownership in a specialty pharmacy for cystic fibrosis patients and their families and a provider of new product launch support and call center services for drug manufacturers.  The investment added $16 million to goodwill and $21 million to intangible assets, primarily payer contracts.

Equity method investments as of August 31, 2014 and 2013, were as follows (in millions, except percentages):

Alliance Boots

On August 2, 2012, pursuant to a Purchase and Option Agreement dated June 18, 2012, by and among the Company, Alliance Boots GmbH and AB Acquisitions Holdings Limited (the Purchase and Option Agreement), the Company acquired 45% of the issued and outstanding share capital of Alliance Boots in exchange for $4.025 billion in cash and approximately 83.4 million shares of Company common stock.  On August 5, 2014, the Company entered into an amendment to the purchase and option agreement, which among other things, accelerated the option period from August 5, 2014 to February 5, 2015.  The Purchase and Option Agreement, as amended on August 5, 2014, provides, subject to the satisfaction or waiver of specified conditions, a call option that gives the Company the right, but not the obligation, to acquire the remaining 55% of Alliance Boots (second step transaction) in exchange for an additional £3.1 billion in cash (approximately $5.2 billion using August 31, 2014 exchange rates) as well as an additional 144.3 million Company shares, subject to certain adjustments.  Pursuant to the amended Option Agreement, the Company exercised its option on August 5, 2014.  In certain circumstances, if the second step transaction does not close, the Company's ownership of Alliance Boots will reduce from 45% to 42% in exchange for nominal consideration.  The Company's equity earnings, initial investment and the call option exclude the Alliance Boots minority interest in Galenica Ltd. (Galenica).  The Alliance Boots investment in Galenica was distributed to the Alliance Boots shareholders other than the Company in May 2013, which had no impact on the Company's financial results.

The call option, prior to its amendment and subsequent exercise, was valued using a Monte Carlo simulation using assumptions surrounding Walgreens equity value as well as the potential impacts of certain provisions of the Purchase and Option Agreement that are described in the Form 8-K filed by the Company on June 19, 2012.  The call option was accounted for at cost and subsequently adjusted for foreign currency translation gains or losses.  The final purchase price allocation resulted in $6.1 billion of the total consideration being allocated to the investment and $866 million being allocated to the call option based on their relative fair values.  The amendment to the call option was accounted for as a non-monetary exchange with the amended call option valued as an out-of-the-money option using a Monte Carlo simulation.  The $866 million remeasurement loss was recorded in other (expense)/income on the Consolidated Statements of Earnings.

The Company accounts for its 45% investment in Alliance Boots using the equity method of accounting.   Investments accounted for under the equity method are recorded initially at cost and subsequently adjusted for the Company's share of the net income or loss and cash contributions and distributions to or from these entities.  Because the underlying net assets in Alliance Boots are denominated in a foreign currency, translation gains or losses will impact the recorded value of the Company's investment.  The Company utilizes a three-month lag in reporting equity income in Alliance Boots.  Due to the lag and timing of the investment, only 10 months results of Alliance Boots were recorded in fiscal 2013 compared to 12 months of results recorded in fiscal 2014.  The Company's investment is recorded as "Equity investment in Alliance Boots" in the Consolidated Balance Sheets.

The Company's initial investment in Alliance Boots exceeded its proportionate share of the net assets of Alliance Boots by $2.4 billion.  This premium of $2.4 billion is recognized as part of the carrying value in the Company's equity investment in Alliance Boots.  The difference is primarily related to the fair value of Alliance Boots indefinite-lived intangible assets and goodwill.  The Company's equity method income from the investment in Alliance Boots is adjusted to reflect the amortization of fair value adjustments in certain definite-lived assets of Alliance Boots.  The Company's incremental amortization expense associated with the Alliance Boots investment was approximately $42 million in fiscal 2014.  In fiscal 2013, the Company recognized approximately $57 million, including the inventory step-up, which was amortized over the first inventory turn.

During July 2013, the UK Government enacted a law to reduce the UK corporate tax rate effective April 2014 with a further reduction scheduled to take effect in April 2015.  The non-cash impact of $71 million was recorded in fiscal 2014 due to the three-month lag.

Other Equity Method Investments

Other equity method investments relate to joint ventures associated with the Company's infusion and respiratory business and its equity method investment received through the sale of the Take Care Employer business.  These investments are included within other non-current assets on the Consolidated Balance Sheets.  The Company's share of equity income is reported within selling, general and administrative expenses in the Consolidated Statements of Earnings.

Summarized Financial Information

Summarized financial information for the Company's equity method investees is as follows:

Balance Sheet (in millions)

Income Statement (in millions)

⁽¹⁾ Net assets in Alliance Boots are translated at the May 31, 2014 spot rate of $1.68 to one British pound Sterling, corresponding to the three-month lag.  Fiscal 2013 net assets in Alliance Boots were translated at a spot rate of $1.52 to one British pound Sterling.

⁽²⁾ Shareholders' equity at August 31, 2014 and 2013, includes $257 million and $374 million related to non-controlling interests, respectively.

⁽³⁾ The Company utilizes a three-month lag in reporting its share of equity income in Alliance Boots.  The fiscal year ended August 31, 2013 included only ten month's results for Alliance Boots because of the three-month lag and the timing of the investment on August 2, 2012, compared to twelve months results recorded in fiscal 2014.  Earnings in Alliance Boots are translated at the average exchange rate of $1.61 and $1.57 to one British pound Sterling for the years ended August 31, 2014 and 2013 respectively.  Walgreens Boots Alliance Development GmbH operations are excluded from these results as the Company consolidates the joint venture.

In conjunction with its long-term relationship with AmerisourceBergen, the Company has the right to acquire up to 7% of the common shares of AmerisourceBergen through open market transactions.  The Company's cost basis of common shares acquired in fiscal 2014 and 2013 were $493 million and $224 million, respectively.  The available-for-sale investment is classified as long-term and reported at fair value within other non-current assets in the Consolidated Balance Sheets.  The Company also holds other investments with maturities greater than 90 days that are reported at fair value within other current assets in the Consolidated Balance Sheets.

Fair value adjustments are based on quoted stock prices with the unrealized holding gains and losses reported in other comprehensive income.  Unrealized holding gains at August 31, 2014 and 2013 were $170 million and $1 million, respectively.  See Note 11 for additional fair value disclosures.  Available-for-sale investments reported at fair value at August 31, 2014 and 2013 were $887 million and $225 million, respectively.

Goodwill and other indefinite-lived intangible assets are not amortized, but are evaluated for impairment annually during the fourth quarter, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.  As part of the Company's impairment analysis for each reporting unit, the Company engaged a third party appraisal firm to assist in the determination of estimated fair value for each unit.  This determination included estimating the fair value using both the income and market approaches.  The income approach requires management to estimate a number of factors for each reporting unit, including projected future operating results, economic projections, anticipated future cash flows and discount rates.  The market approach estimates fair value using comparable marketplace fair value data from within a comparable industry grouping.

The determination of the fair value of the reporting units and the allocation of that value to individual assets and liabilities within those reporting units requires the Company to make significant estimates and assumptions.  These estimates and assumptions primarily include, but are not limited to: the selection of appropriate peer group companies; control premiums appropriate for acquisitions in the industries in which the Company competes; the discount rate; terminal growth rates; and forecasts of revenue, operating income, depreciation and amortization and capital expenditures.  The allocation requires several analyses to determine the fair value of assets and liabilities including, among other things, purchased prescription files, customer relationships and trade names.  Although the Company believes its estimates of fair value are reasonable, actual financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates.  Changes in assumptions concerning future financial results or other underlying assumptions could have a significant impact on either the fair value of the reporting units, the amount of the goodwill impairment charge, or both.  The Company also compared the sum of the estimated fair values of its reporting units to the Company's total value as implied by the market value of its equity and debt securities.  This comparison indicated that, in total, its assumptions and estimates were reasonable.  However, future declines in the overall market value of the Company's equity and debt securities may indicate that the fair value of one or more reporting units has declined below its carrying value.

One measure of the sensitivity of the amount of goodwill impairment charges to key assumptions is the amount by which each reporting unit "passed" (fair value exceeds the carrying amount) or "failed" (the carrying amount exceeds fair value) the first step of the goodwill impairment test.  The Company's reporting units' fair values exceeded their carrying amounts ranging from approximately 12% to more than 117%.

Generally, changes in estimates of expected future cash flows would have a similar effect on the estimated fair value of the reporting unit.  That is, a 1% change in estimated future cash flows would change the estimated fair value of the reporting unit by approximately 1%.  The estimated long-term rate of net sales growth can have a significant impact on the estimated future cash flows, and therefore, the fair value of each reporting unit.  Of the other key assumptions that impact the estimated fair values, most reporting units have the greatest sensitivity to changes in the estimated discount rate.  The Company believes that its estimates of future cash flows and discount rates are reasonable, but future changes in the underlying assumptions could differ due to the inherent uncertainty in making such estimates.

Changes in the carrying amount of goodwill consist of the following activity (in millions):

In June 2014, the Company completed the sale of a majority interest in its subsidiary, Take Care Employer.  As a result, $92 million of goodwill allocated to this business was removed from goodwill on the consolidated balance sheet.

In November 2013, the Company purchased certain assets of Kerr Drug and its affiliates for $173 million, subject to adjustment in certain circumstances.  The Company recorded $45 million of goodwill and $54 million of intangible assets in conjunction with the preliminary purchase accounting for this acquisition.

In September 2012, the Company purchased the regional drugstore chain USA Drug from Stephen L. LaFrance Holdings, Inc. and members of the LaFrance family for $436 million net of assumed cash and selected other assets (primarily prescription files).  In December 2012, the Company purchased an 80% interest in Cystic Fibrosis Foundation Pharmacy LLC for $29 million, net of assumed cash.  The USA Drug and Cystic Fibrosis acquisitions added $220 million and $16 million of goodwill, respectively.

The carrying amount and accumulated amortization of intangible assets consists of the following (in millions):

Amortization expense for intangible assets was $282 million in fiscal 2014, $289 million in fiscal 2013 and $255 million in fiscal 2012.  The weighted-average amortization period for purchased prescription files was six years for fiscal 2014 and seven years for fiscal 2013.  The weighted-average amortization period for favorable lease interests was 11 years for fiscal 2014 and 2013.  The weighted-average amortization period for purchasing and payer contracts was 13 years for fiscal 2014 and 2013.  The weighted-average amortization period for non-compete agreements was five years for fiscal 2014 and six years for fiscal 2013.  The weighted-average amortization period for trade names was 12 years for fiscal 2014 and 12 years for fiscal 2013.  The weighted-average amortization period for other amortizable intangible assets was eight years for fiscal 2014 and 10 years for fiscal 2013.

Expected amortization expense for intangible assets recorded at August 31, 2014, not including amounts related to Alliance Boots that will be amortized through equity method investment income, is as follows (in millions):

The components of Earnings Before Income Tax Provision were (in millions):

The non-U.S. amount reported above includes equity earnings in Alliance Boots of $617 million.  Prior to 2014, the non-U.S. component of the Earnings Before Income Tax provision was not material.

The provision for income taxes consists of the following (in millions):

The difference between the statutory federal income tax rate and the effective tax rate is as follows:

⁽¹⁾ Upon the amendment and immediate exercise of the call option to acquire the remaining 55% ownership of Alliance Boots, the Company was required to compare the fair value of the amended option with the book value of the original option with a gain or loss recognized for the difference.  The fair value of the amended option resulted in a financial statement loss of $866 million.  The loss on the Alliance Boots call option will be, in part, a capital loss and available to be carried forward and offset future capital gains through fiscal 2020.  The loss also contributed to the increased valuation allowance amount reported in the deferred income tax table below.

The deferred tax assets and liabilities included in the Consolidated Balance Sheets consist of the following (in millions):

At August 31, 2014, the Company has recorded deferred tax assets of $430 million, primarily reflecting the benefit of $1.0 billion in federal and $713 million in state ordinary and capital losses.  These deferred tax assets will expire at various dates from 2015 through 2033, with the majority of the federal losses expiring in 2019 and 2020.

The Company believes it is more likely than not that the benefit from certain net operating and capital loss carryforwards will not be realized.  In recognition of this risk, the Company has recorded a valuation allowance of $223 million on certain deferred tax assets relating to these loss carryforwards as of August 31, 2014.

Income taxes paid were $1.2 billion for fiscal years 2014, 2013 and 2012.

ASC Topic 740, Income Taxes, provides guidance regarding the recognition, measurement, presentation and disclosure in the financial statements of tax positions taken or expected to be taken on a tax return, including the decision whether to file in a particular jurisdiction.  As of August 31, 2014, all unrecognized tax benefits were reported as long-term liabilities on the Consolidated Balance Sheet.  As of August 31, 2013, $32 million, of unrecognized tax benefits were reported as current income tax liabilities, with the balance classified as long-term liabilities on the Consolidated Balance Sheet.

The following table provides a reconciliation of the total amounts of unrecognized tax benefits (in millions):

At August 31, 2014, 2013 and 2012, $105 million, $116 million and $118 million, respectively, of unrecognized tax benefits would favorably impact the effective tax rate if recognized.  During the next twelve months, the Company does not expect a material change in the amount of the unrecognized tax benefits.  

The Company recognizes interest and penalties in the income tax provision in its Consolidated Statements of Earnings.  At August 31, 2014, and August 31, 2013, the Company had accrued interest and penalties of $21 million and $28 million, respectively.  For the year ended August 31, 2014, the amount reported in income tax expense related to interest and penalties was an immaterial benefit.

The Company files a consolidated U.S. federal income tax return, as well as income tax returns in various states.  It is no longer under audit examination for U.S. federal income tax purposes for any years prior to fiscal 2012.  With few exceptions, it is no longer subject to state and local income tax examinations by tax authorities for years before fiscal 2007.

The Company has received tax holidays from Swiss cantonal income taxes relative to its Swiss operations.  The income tax holidays are expected to extend through September 2022.  The holidays had an immaterial impact on the Company's results during the current fiscal year.  At August 31, 2014, the Company has an unrecorded deferred tax liability for temporary differences related to its investments in certain foreign subsidiaries of approximately $85 million.

Short-term borrowings and long-term debt consist of the following at August 31 (in millions):

On September 13, 2012, the Company received net proceeds from a public offering of $4.0 billion of notes with varying maturities and interest rates, the majority of which are fixed rate.

The following details each tranche of notes issued on September 13, 2012:

We have periodically borrowed under our commercial paper program during the current fiscal year, and may continue to borrow in future periods.  We had average daily short-term borrowings of $4 million of commercial paper outstanding at a weighted average interest rate of 0.23% for the fiscal year ended August 31, 2014.  We had no commercial paper outstanding at August 31, 2014.  In connection with the commercial paper program, the Company maintains two unsecured backup syndicated lines of credit that total $1.35 billion.  The first $500 million facility expires on July 20, 2015, and allows for the issuance of up to $250 million in letters of credit.  The second $850 million facility expires on July 23, 2017, and allows for the issuance of up to $200 million in letters of credit.  The issuance of letters of credit under either of these facilities reduces available borrowings.  The Company's ability to access these facilities is subject to compliance with the terms and conditions of the credit facilities, including financial covenants.  The covenants require the Company to maintain certain financial ratios related to minimum net worth and priority debt, along with limitations on the sale of assets and purchases of investments.  At August 31, 2014, the Company was in compliance with all such covenants.  The Company pays a facility fee to the financing banks to keep these lines of credit active.  At August 31, 2014, there were no letters of credit issued against these credit facilities and the Company does not anticipate any future letters of credit to be issued against these facilities.  

The Company uses derivative instruments to manage its interest rate exposure associated with some of its fixed-rate borrowings.  The Company does not use derivative instruments for trading or speculative purposes.  All derivative instruments are recognized in the Consolidated Balance Sheets at fair value.  The Company designates interest rate swaps as fair value hedges of fixed-rate borrowings.  For derivatives designated as fair value hedges, the change in the fair value of both the derivative instrument and the hedged item are recognized in earnings in the current period.  The Company's forward starting interest rate swaps used to hedge anticipated debt issuances are designated as cash flow hedges.  Changes in the fair value of cash flow hedges deemed effective are recognized in other comprehensive income.  At the inception of a hedge transaction, the Company formally documents the hedge relationship and the risk management objective for undertaking the hedge.  In addition, it assesses both at inception of the hedge and on an ongoing basis whether the derivative in the hedging transaction has been highly effective in offsetting changes in fair value of the hedged item and whether the derivative is expected to continue to be highly effective.  The impact of any ineffectiveness is recognized currently in earnings.

Counterparties to derivative financial instruments expose the Company to credit-related losses in the event of nonperformance, but the Company regularly monitors the credit worthiness of each counterparty.

Fair Value Hedges

In prior fiscal years, the Company entered into a series of interest rate swaps converting $750 million of its 5.250% fixed rate notes to a floating interest rate based on the six-month LIBOR in arrears plus a constant spread and an interest rate swap converting $250 million of its 5.250% fixed rate notes to a floating interest rate based on the one-month LIBOR in arrears plus a constant spread.  All swap termination dates coincide with the notes maturity date, January 15, 2019.  The changes in fair value of the notes attributable to the hedged risk are included in short-term and long-term debt on the Consolidated Condensed Balance Sheets.  No material gains or losses were recorded in fiscal 2014 or 2013 from ineffectiveness.

Cash Flow Hedges

In the current fiscal year, the Company entered into a series of forward starting interest rate swap transactions locking in the then current three-month LIBOR interest rate on $1.5 billion of anticipated debt issuance, with expected maturity tenures of 10 and 30 years.  The swap transactions are designated as cash flow hedges.  Changes in the fair value of swaps are recorded in other comprehensive income.  Any ineffectiveness is recognized in interest expense on the Consolidated Balance Sheets.

The notional amounts of derivative instruments outstanding at August 31, 2014 and 2013, were as follows (in millions):

The changes in fair value of the Company's debt that was swapped from fixed to variable rate and designated as fair value hedges are included in long-term debt on the Consolidated Balance Sheets (see Note 9).  At August 31, 2014, the cumulative fair value adjustments resulted in an increase in long-term debt of $12 million compared to a decrease in fair value of $3 million at August 31, 2013.

Changes in fair value of the cash flow hedges are included in other comprehensive income, with any ineffectiveness recorded directly to interest expense.  The fair value change in fiscal 2014 reported in other comprehensive income was $44 million, $27 million net of tax, at August 31, 2014.  Upon termination of the cash flow hedges, cumulative changes included in other comprehensive income will be amortized with the debt's cash flow.  No material fair value changes or ineffectiveness was recorded through other comprehensive income in fiscal 2014.

The fair value and balance sheet presentation of derivative instruments at August 31, 2014 and 2013, were as follows (in millions):

Warrants

The Company, Alliance Boots and AmerisourceBergen Corporation entered into a Framework Agreement dated as of March 18, 2013, pursuant to which (1) Walgreens and Alliance Boots together were granted the right to purchase a minority equity position in AmerisourceBergen, beginning with the right, but not the obligation, to purchase up to 19,859,795 shares of AmerisourceBergen common stock (approximately 7 percent of the then fully diluted equity of AmerisourceBergen, assuming the exercise in full of the warrants described below) in open market transactions; (2) the Company and Alliance Boots were each  issued (a) a warrant to purchase up to 11,348,456  shares of AmerisourceBergen common stock at an exercise price of $51.50 per share exercisable during a six-month period beginning in March 2016, and (b) a warrant to purchase up to 11,348,456 shares of AmerisourceBergen common stock at an exercise price of $52.50 per share exercisable during a six-month period beginning in March 2017.  The parties and affiliated entities also entered into certain related agreements governing relations between and among the parties thereto, including the Shareholders Agreement, the Transaction Rights Agreement and the Limited Liability Company Agreement of WAB Holdings LLC, a newly formed limited liability company jointly owned by the Company and Alliance Boots for the purpose of acquiring and holding AmerisourceBergen common stock, described in the Company's Current Report on Form 8-K filed on March 20, 2013.

The Company reports its warrants at fair value.  See Note 11 for additional fair value measurement disclosures.

The Company reports its warrants at fair value.  See Note 11 for additional fair value measurement disclosures.  The fair value and balance sheet presentation of derivative instruments not designated as hedges at August 31, 2014 and 2013, were as follows (In millions):

The Company measures certain assets and liabilities in accordance with ASC Topic 820, Fair Value Measurements and Disclosures. ASC Topic 820 defines fair value as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. In addition, it establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels:

Assets and liabilities measured at fair value on a recurring basis were as follows (in millions):

⁽⁴⁾      Forward interest rate swaps are valued using three-month LIBOR in arrears rates.  See Note 10 for additional disclosure regarding financial instruments.

Assets measured at fair value on a nonrecurring basis were as follows (in millions):

The call option was valued using a Monte Carlo simulation.  Key assumptions used in the valuation include expected term, Walgreens equity value, the value of Alliance Boots, and the potential impacts of certain provisions of the Purchase and Option Agreement dated June 18, 2012, by and among the Company, Alliance Boots and AB Acquisitions Holdings Limited.  The option was amended, and exercised, on August 5, 2014, resulting in a new fair value determination that resulted in a loss on the option of $866 million.

The Company reports its debt instruments under the guidance of ASC Topic 825, Financial Instruments, which requires disclosure of the fair value of the Company's debt in the footnotes to the consolidated financial statements.  See Note 9 for further details.

The Company is involved in legal proceedings and is subject to investigations, inspections, audits, inquiries and similar actions by governmental authorities, arising in the normal course of the Company's business, including the matters described below.  Legal proceedings, in general, and securities and class action litigation, in particular, can be expensive and disruptive.  Some of these suits may purport or may be determined to be class actions and/or involve parties seeking large and/or indeterminate amounts, including punitive or exemplary damages, and may remain unresolved for several years.  From time to time, the Company is also involved in legal proceedings as a plaintiff involving antitrust, tax, contract, intellectual property and other matters.  Gain contingencies, if any, are recognized when they are realized.  The results of legal proceedings are often uncertain and difficult to predict, and the costs incurred in litigation can be substantial, regardless of the outcome.  The Company believes that its defenses and assertions in pending legal proceedings have merit, and does not believe that any of these pending matters, after consideration of applicable reserves and rights to indemnification, will have a material adverse effect on the Company's consolidated financial position.  However, substantial unanticipated verdicts, fines and rulings do sometimes occur.  As a result, the Company could from time to time incur judgments, enter into settlements or revise its expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on its results of operations in the period in which the amounts are accrued and/or its cash flows in the period in which the amounts are paid.   

On a quarterly basis, the Company assesses its liabilities and contingencies for outstanding legal proceedings and reserves are established on a case-by-case basis for those legal claims for which management concludes that it is probable that a loss will be incurred and that the amount of such loss can be reasonably estimated. Substantially all of these contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex.  With respect to litigation and other legal proceedings where the Company has determined that a loss is reasonably possible, the Company is unable to estimate the amount or range of reasonably possible loss in excess of amounts reserved due to the inherent difficulty of predicting the outcome of and uncertainties regarding such litigation and legal proceedings.  The Company's assessments are based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause the Company to change those estimates and assumptions.  Therefore, it is possible that an unfavorable resolution of one or more pending litigation or other contingencies could have a material adverse effect on the Company's consolidated financial statements in a future fiscal period.  Management's assessment of current litigation and other legal proceedings, including the corresponding accruals, could change because of the discovery of facts with respect to legal actions or other proceedings pending against the Company which are not presently known. Adverse rulings or determinations by judges, juries, governmental authorities or other parties could also result in changes to management's assessment of current liabilities and contingencies.  Accordingly, the ultimate costs of resolving these claims may be substantially higher or lower than the amounts reserved.

On June 11, 2013, the Company entered into a Settlement and Memorandum of Agreement (the Agreement) with the United States Department of Justice and the United States Drug Enforcement Administration (DEA) that settled and resolved all administrative and civil matters arising out of DEA's previously-disclosed concerns relating to the Company's distribution and dispensing of controlled substances. Under the terms of the Agreement, the Company paid an $80 million settlement amount, surrendered its DEA registrations for six pharmacies in Florida until May 26, 2014, and for its Jupiter, Florida distribution center until Sept. 13, 2014, and agreed to implement certain remedial actions.  In addition, the Company dismissed with prejudice its petition with the United States Court of Appeals for the District of Columbia Circuit that challenged certain enforcement authority of the DEA. On July 31, 2013 and August 13, 2013, putative shareholders filed derivative actions in federal court in the Northern District of Illinois against the Walgreens Board of Directors and Walgreen Co. as a nominal defendant (collectively, the defendants), arising out of the Company's June 2013 settlement with the DEA described above.  The actions assert claims for breach of fiduciary duty on the grounds that the directors allegedly should have prevented the events that led to the settlement.  The plaintiffs filed an amended consolidated complaint on October 4, 2013, pursuant to which they seek damages and other relief on behalf of the Company.  The defendants filed their motion to dismiss on December 3, 2013.  Subsequent thereto, the plaintiffs filed an opposition brief on February 7, 2014 and the defendants filed their reply brief on March 10, 2014.  In June 2014, the parties executed a settlement term sheet reflecting an agreement in principle to settle this matter, subject to, among other things, the execution of final settlement documentation and court approval.  On September 11, 2014, the defendants, denying all wrongdoing and liability, entered into a Stipulation and Agreement of Settlement whereby the Company agreed to certain corporate governance measures and the payment of up to $3.5 million for plaintiffs' counsel fees and costs in exchange for a complete release of all claims against all defendants.  The Court entered an order preliminarily approving the Stipulation and Agreement of Settlement on September 19, 2014.  A final hearing to approve the settlement is scheduled for December 9, 2014.  Settlement of this matter on the agreed terms would not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows.

The Company's long-term capital policy is to maintain a strong balance sheet and financial flexibility; reinvest in its core strategies; invest in strategic opportunities that reinforce its core strategies and meet return requirements; and return surplus cash flow to shareholders in the form of dividends and share repurchases over the long term.  In connection with the Company's capital policy, the Board of Directors set a long-term dividend payout ratio target between 30 and 35 percent of net income.  On July 13, 2011, the Board of Directors authorized the 2012 repurchase program, which allows for the repurchase of up to $2.0 billion of the Company's common stock prior to its expiration on December 31, 2015.  In August 2014, the Board of Directors approved the 2014 share repurchase program, which replaces the 2012 repurchase program, that allows for the purchase of up to $3.0 billion of the Company's common stock prior to its expiration on August 31, 2016.

Activity related to these programs was as follows (in millions):

The Company determines the timing and amount of repurchases from time to time based on its assessment of various factors including prevailing market conditions, alternate uses of capital, liquidity, the economic environment and other factors.  The timing and amount of these purchases may change at any time and from time to time.  The Company has and may from time to time in the future repurchase shares on the open market through Rule 10b5-1 plans, which enable a company to repurchase shares at times when it otherwise might be precluded from doing so under insider trading laws.

In addition, the Company continued to repurchase shares to support the needs of the employee stock plans.  Shares totaling $705 million were purchased to support the needs of the employee stock plans during fiscal 2014 as compared to $615 million in fiscal 2013.  At August 31, 2014, 48.4 million shares of common stock were reserved for future issuances under the Company's various employee benefit plans.

The Walgreen Co. Omnibus Incentive Plan (the "Omnibus Plan") which became effective in fiscal 2013, provides for incentive compensation to Walgreens non-employee directors, officers and employees, and consolidates into a single plan several previously existing equity compensation plans: the Executive Stock Option Plan, the Long-Term Performance Incentive Plan, the Broad Based Employee Stock Option Plan, and the Nonemployee Director Stock Plan (collectively, the "Former Plans").  As of the effective date of the Omnibus Plan, no further grants may be made under the Former Plans and shares that were available for issuance under the Former Plans and not subject to outstanding awards became available for issuance (in addition to newly authorized shares) under the Omnibus Plan.  A total of 60.4 million shares became available for delivery under the Omnibus Plan.

A summary of the equity awards authorized and available for future grants under the Omnibus Plan and Former Plans follows:

A summary of the Company's stock options outstanding under the Omnibus Plan and Former Plans follows:

The fair value of each option grant was determined using the Black-Scholes option pricing model with the following weighted-average assumptions used in fiscal 2014, 2013 and 2012:

The intrinsic value for options exercised in fiscal 2014, 2013 and 2012 was $346 million, $159 million and $22 million, respectively.  The total fair value of options vested in fiscal 2014, 2013 and 2012 was $58 million, $51 million and $125 million, respectively.

Cash received from the exercise of options in fiscal 2014 was $490 million compared to $471 million in the prior year.  The related tax benefit realized was $130 million in fiscal 2014 compared to $60 million in the prior year.

The Walgreen Co. 1982 Employees Stock Purchase Plan permits eligible employees to purchase common stock at 90% of the fair market value at the date of purchase.  Employees may make purchases by cash or payroll deductions up to certain limits.  The aggregate number of shares that may be purchased under this Plan is 94 million.  At August 31, 2014, 15 million shares were available for future purchase.

Restricted performance shares issued under the Omnibus and Former Plans offer performance-based incentive awards and equity-based awards to key employees.  Restricted stock units are also equity-based awards with performance requirements that are granted to middle managers and key employees.  The restricted performance shares and restricted stock unit awards are both subject to restrictions as to continuous employment except in the case of death, normal retirement or total and permanent disability.  In accordance with ASC Topic 718, Compensation – Stock Compensation, compensation expense is recognized on a straight-line basis over the employee's vesting period or to the employee's retirement eligible date, if earlier.

A summary of information relative to the Company's restricted stock units follows:

A summary of information relative to the Company's performance shares follows:

The Company also issues shares to nonemployee directors.  Each director receives an equity grant of shares every year on November 1.  The number of shares granted is determined by dividing $175,000 by the price of a share of common stock on November 1.  Each nonemployee director may elect to receive this annual share grant in the form of shares or deferred stock units.  In fiscal 2014, nonemployee directors received a share grant of 2,892 shares compared to 4,789shares and 4,788 shares in fiscal 2013 and 2012, respectively.  New directors in any fiscal year earned a prorated amount.  Payment of the annual retainer is paid in the form of cash, which may be deferred.

A summary of total stock-based compensation expense follows (in millions):

The principal retirement plan for employees is the Walgreen Profit-Sharing Retirement Trust, to which both the Company and participating employees contribute.  The Company's contribution, which has historically related to FIFO earnings before interest and taxes and a portion of which is in the form of a guaranteed match, is determined annually at the discretion of the Board of Directors.  The profit-sharing provision was $355 million in fiscal 2014, $342 million in fiscal 2013 and $283 million in fiscal 2012.  The Company's contributions were $328 million in fiscal 2014, $262 million in fiscal 2013 and $372 million in fiscal 2012.

The Company provides certain health insurance benefits for retired employees who meet eligibility requirements, including age, years of service and date of hire.  The costs of these benefits are accrued over the service life of the employee.  In fiscal 2012, the Company amended its prescription drug program for certain Medicare-eligible retirees to a group-based Company-sponsored Medicare Part D program, or employer group waiver program, effective January 1, 2013.  The Company's postretirement health benefit plan is not funded.

Components of net periodic benefit costs (in millions):

Change in benefit obligation (in millions):

Change in plan assets (in millions):

Funded status (in millions):

Amounts recognized in the Consolidated Balance Sheets (in millions):

Amounts recognized in accumulated other comprehensive (income) loss (in millions):

Amounts expected to be recognized as components of net periodic costs for fiscal year 2015 (in millions):

The measurement date used to determine postretirement benefits is August 31.

The discount rate assumption used to compute the postretirement benefit obligation at year-end was 4.40% for 2014 and 5.20% for 2013.  The discount rate assumption used to determine net periodic benefit cost was 5.05%, 4.15% and 5.40% for fiscal years ending 2014, 2013 and 2012, respectively.

The consumer price index assumption used to compute the postretirement benefit obligation was 2.00% for 2014 and 2013.

Future benefit costs were estimated assuming medical costs would increase at a 7.15% annual rate, gradually decreasing to 5.25% over the next nine years and then remaining at a 5.25% annual growth rate thereafter.

A one percentage point change in the assumed medical cost trend rate would have the following effects (in millions):

Estimated future federal subsidies are immaterial for all periods presented. Future benefit payments are as follows (in millions):

The expected benefit to be paid net of the estimated federal subsidy during fiscal year 2015 is $12 million.

Significant non-cash transactions in fiscal 2014 include $322 million for additional capital lease obligations.  Significant non-cash transactions in fiscal 2013 include $77 million related to the initial valuation of the AmerisourceBergen warrants.  Significant non-cash transactions in fiscal 2012 include $3 billion in stock issuance relating to the investment in Alliance Boots.

Included in the Consolidated Balance Sheets captions are the following assets and liabilities (in millions):

Summary of Quarterly Results (Unaudited)

(In millions, except per share amounts)

 Common Stock Prices (Unaudited)

The following table sets forth the sales price ranges of the Company's common stock by quarter during the fiscal years ended August 31, 2014 and August 31, 2013 as reported by the Consolidated Transaction Reporting System.

Revenue Recognition

The Company recognizes revenue at the time the customer takes possession of the merchandise. Customer returns are immaterial. Sales taxes are not included in revenue.