(2)	Summary of Significant Accounting Policies

A summary of the Company

’s significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows:

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Build-A-Bear Workshop, Inc. an

d its wholly-owned subsidiaries. All significant intercompany accounts are eliminated in consolidation.

Fiscal Year

The Company operates on a

- or

-week fiscal year ending on the Saturday closest to

December

31.

The periods presented in these financial statements are fiscal

2016

(52

weeks ended

December

31,

2016),

fiscal

2015

(52

weeks ended

January

2016)

and fiscal

2014

(53

weeks ended

January

2015).

References to years in these financial statements relate to fiscal years or year ends rather than calendar years.

Cash and Cash Equivalents

Cash and cash equivalents include cash and short-term highly liquid investments with an original maturity of

three

months or less held in both domestic and foreign financial institutions.

The majority of the Company

’s cash and cash equivalents exceed federal deposit insurance limits. The Company has not experienced any losses in such accounts and management believes that the Company is not exposed to any significant credit risk on cash and cash equivalents.

Inventories

Inventories are stated at the lower of cost or market, with cost determined on an average-cost basis. Inventory includes supplies of

$3.1

million and

$2.7

million as of

December

31,

2016

and

January

2016,

respectively. A reserve for estimated shortage is accrued throughout the year based on detailed historical averages.

Receivables

Receivables consist primarily of amounts due to the Company in relation to

tenant

allowances,

wholesale and corporate product sales, franchisee royalties and product sales, certain amounts due from taxing authorities and licensing revenue. The Company assesses the collectability of all receivables on an ongoing basis by considering its historical credit loss experience, current economic conditions, and other relevant factors. Based on this analysis, the Company has established an allowance for doubtful accounts of

$3.6

million and

$3.0

million as of

December

31,

2016

and

January

2016,

respectively.

Property and Equipment

Property and equipment consist of leasehold improvements, furniture and fixtures, computer equipment and software, building and land

and are stated at cost. Leasehold improvements are depreciated using the straight-line method over the shorter of the useful life of the assets or the life of the lease which is generally

ten

years. Furniture and fixtures and computer equipment are depreciated using the straight-line method over the estimated service lives ranging from

three

seven

years. Computer software includes certain costs, including internal payroll costs incurred in connection with the development or acquisition of software for internal use and

is amortized using the straight-line method over a period of

three

five

years. New store construction deposits are recorded at the time the deposit is made as construction-in-progress and reclassified to the appropriate property and equipment category at the time of completion of construction, when operations of the store commence. Maintenance and repairs are expensed as incurred and improvements are capitalized. Gains or losses on the disposition of fixed assets are recorded upon disposal.

Other Intangible Assets

Other intangible assets consist primarily of initial costs related to trademarks and other intellectual

property. Trademarks and other intellectual property represent

third

-party costs that are capitalized and amortized over their estimated lives ranging from

one

three

years using the straight-line method.

Other Assets

Other assets consist primarily of

the non-current portion of prepaid income taxes, deferred leasing fees and deferred costs related to franchise agreements. The prepaid income taxes will amortize through income tax expense over the life of the related asset. Deferred leasing fees are initial, direct costs related to the Company’s operating leases and are amortized over the term of the related leases. Deferred franchise costs are initial costs related to the Company’s franchise agreements that are deferred and amortized over the life of the respective franchise agreement. Amortization expense related to other assets was

$0.1

million,

$0.1

million and

$0.2

million for

2016,

2015

and

2014

, respectively.

Long-lived Assets

Whenever facts and circumstances indicate that the carrying value of a long-lived asset

may

not be recoverable, the carrying value is reviewed. If this review indicates that the carrying value of the asset will not be recovered, as determined based on projected undiscounted cash flows related to the asset over its remaining life, the carrying value of the asset is reduced to its estimated fair value.

The Company performs an annual assessment of the store assets in the direct-to-consumer (DTC) segment, based on operating performance and forecasts of future performance. Total impairment charges were

$2.7

million,

$0.3

million and

$1.1

million in

2016,

2015

and

2014,

respectively.

See Note

– Property and Equipment for further discussion regarding the impairment of long-lived assets.

The calculation of fair value requires multiple assumptions regarding our future operations to determine future cash flows, including but not limited to, sales volume, margin rates and discount rates.

If different assumptions were used in the analysis, it is possible that the amount of the impairment charge

may

have been significantly different than what was recorded.

Deferred Rent

Certain of the Company

’s operating leases contain predetermined fixed escalations of minimum rentals during the original lease terms. For these leases, the Company recognizes the related rental expense on a straight-line basis over the life of the lease and records the difference between the amounts charged to operations and amounts paid as deferred rent. The Company also receives certain lease incentives in conjunction with entering into operating leases. These lease incentives are recorded as deferred rent at the beginning of the lease term and recognized as a reduction of rent expense over the lease term. In addition, certain of the Company’s leases contain future contingent increases in rentals. Such increases in rental expense are recorded in the period that it is probable that store sales will meet or exceed the specified target that triggers contingent rental expense.

Franchises

The Company defers initial,

one

-time nonrefundable franchise fees and amortizes them over the

initial term of the respective franchise agreements, which extend for periods up to

years. The Company’s obligations under the contract are ongoing and include operations and product development support and training, generally concentrated around new store openings. Continuing franchise fees are recognized as revenue as the fees are earned.

Retail Revenue Recognition

Net retail sales are net of discounts, exclude sales tax, and are recognized at the time of sale.

Shipping and handling costs billed to customers are included in net retail sales.

Revenues from the sale of gift cards are recognized at the time of redemption. Unredeemed gift cards are included in gift cards and customer deposits on the consolidated balance sheets.

For gift cards issued prior to the establishment of Build-A-Bear Card Services LLC in

December

2015,

the Company recorded income from unredeemed gift cards in a manner consistent with the delayed recognition method. Beginning in

December

2015,

for gift cards issued through Build-A-Bear Card Services, gift card breakage revenue is recorded as a component of net retail sales based on historical redemption patterns and represents the balance of gift cards for which the likelihood of redemption by a customer is considered remote using the redemption recognition method. The amount of revenue from gift card breakage was

$4.5

million and

$0.5

million in

2016

and

2015,

respectively.

The Company has

a customer loyalty program, Build-A-Bear Rewards, whereby guests enroll in the program and receive points based on the value of the transaction and receive awards for various discounts on future purchases after achieving defined point thresholds. Historical patterns for points converting into awards and ultimate award redemption are applied to actual points and awards outstanding at the respective balance sheet date to calculate the liability and corresponding adjustment to net retail sales. In

2014,

the Company changed the program to eliminate certain discounts and reduced its liability by

$0.5

million with a corresponding increase to net retail sales and a

$0.4

million increase to net income.

Management reviews these patterns and assesses the adequacy of the deferred revenue liability at the end of each fiscal quarter

. Due to the estimates involved in these assessments, adjustments to the historical rates are generally made no more often than annually in order to allow time for more definite trends to emerge. Based on the assessment at the end of

2016,

the deferred revenue liability was not adjusted. In

2015

and

2014,

the deferred revenue liability was adjusted downward by

$0.1

million and

$1.3

million, respectively, with corresponding increases to net retail sales; net income was increased by

$0.1

million and

$1.2

million in

2015

and

2014,

respectively.

Cost of Merchandise Sold

Cost of merchandise sold

- retail includes the cost of the merchandise, including royalties paid to licensors of

third

party branded merchandise; store occupancy cost, including store depreciation and store asset impairment charges; cost of warehousing and distribution; packaging; stuffing; damages and shortages; and shipping and handling costs incurred in shipment to customers. Cost of merchandise sold - commercial includes the cost of the merchandise, including royalties paid to licensors of

third

party branded merchandise; cost of warehousing and distribution; packaging; stuffing; damages and shortages; and shipping and handling costs incurred in shipment to customers.

Selling, General, and Administrative Expenses

Selling, general, and administrative expenses include store payroll and related benefits, advertising, credit card fees, store supplies

and store closing costs, as well as central office management payroll and related benefits, travel, information systems, accounting, insurance, legal, and public relations. It also includes depreciation and amortization of central office leasehold improvements, furniture, fixtures, and equipment, as well as amortization of trademarks and intellectual property.

Store Preopening Expenses

Store preopening expenses

include costs incurred prior to store openings, remodels and relocations including certain store set-up, labor and hiring costs, rental charges, payroll, marketing, travel and relocation costs. They are expensed as incurred and are included in selling, general and administrative expenses.

Advertising

The costs of advertising and marketing programs are charged to operations in the

first

period the program takes place.

Advertising expense was

$20.7

million,

$25.3

million and

$25.8

million for fiscal years

2016,

2015

and

2014

, respectively.

Income Taxes

Income taxes are accounted for using a balance sheet approach known as the asset and liability method. The asset and liability method accounts for deferred income taxes by applying the statutory tax rates in effect at the date of the consolidated balance sheets to differences between the book basis and the tax basis of assets and liabilities.

Deferred taxes are reported on a jurisdictional basis.

Tax positions are reviewed at least quarterly and adjusted as new information becomes available.

The recoverability of deferred tax assets is evaluated by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These estimates of future taxable income inherently require significant judgment. To the extent it is considered more likely than not that a deferred tax asset will be not recovered, a valuation allowance is established.

The Company accounts for its total liability for uncertain tax positions according to the provisions of ASC

740

25.

The Company recognizes estimated interest and penalties related to uncertain tax positions in income tax expense. See Note

7—Income

Taxes for further discussion.

ncome

Per Share

Under the

two

-class method, b

asic income per share is determined by dividing net income allocated to common stockholders by the weighted average number of common shares outstanding during the period. In periods of net loss, no effect is given to the Company’s participating securities as they do not contractually participate in the losses of the Company. Diluted income per share reflects the potential dilution that could occur if options to issue common stock were exercised. In periods in which the inclusion of such instruments is anti-dilutive, the effect of such securities is not given consideration.

Stock-Based Compensation

The Company has share-based compensation plans covering the majority of its management groups and its Board of Directors.

The Company accounts for share-based payments utilizing the fair value recognition provisions of ASC

718.

The Company recognizes compensation cost for equity awards over the requisite service period for the entire award. See Note

– Stock Incentive Plans. For fiscal

2016,

2015

and

2014

, selling, general and administrative expense includes

$3.0

million,

$2.1

million and

$2.1

million, respectively, of stock-based compensation expense.

Comprehensive

Income (

Los

)

Comprehensive

income (loss) is comprised of net income (loss) and foreign currency translation adjustments.

eferred Compensation Plan

The Company maintains a Deferred Compensation Plan for the benefit of certain management employees. The investment funds offered to the participant generally correspond to the funds offered in the Company

’s

401(k)

plan, and the account balance fluctuates with the investment returns on those funds. The fair value of the assets, classified as trading securities, and corresponding liabilities are based on unadjusted quoted market prices for the funds in active markets with sufficient volume and frequency (Level

1).

As of

December

31,

2016,

the current portions of the assets and related liabilities of

$0.1

million are presented in prepaid expenses and other current assets and accrued expenses in the accompanying consolidated balance sheets, and the non-current portions of the assets and the related liabilities of

$0.7

million are presented in other assets, net and other liabilities in the accompanying consolidated balance sheets. As of

January

2016,

the assets and related liabilities of the Deferred Compensation Plan of

$0.6

million are all non-current and are presented in other assets, net and other liabilities in the accompanying consolidated balance sheets.

Fair Value of Financial Instruments

For purposes of financial reporting, management has determined that the fair value of financial instruments, including cash and cash equivalents, receivables,

short term investments, accounts payable and accrued expenses, approximates book value at

December

31,

2016

and

January

2016.

Use of Estimates

The preparation of the consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.

The assumptions used by management in future estimates could change significantly due to changes in circumstances, including, but not limited to, challenging economic conditions. Accordingly, future estimates

may

change significantly. Significant items subject to such estimates and assumptions include the calculation of revenue from gift card breakage, valuation of long-lived assets, including deferred income tax assets, and the determination of deferred revenue under the Company’s customer loyalty program.

Sales Tax Policy

The Company

’s revenues in the consolidated statement of operations are net of sales taxes.

Foreign Currency

Assets and liabilities of the Company

’s foreign operations with functional currencies other than the U.S. dollar are translated at the exchange rate in effect at the balance sheet date, while revenues and expenses are translated at average rates prevailing during the year. Translation adjustments are reported in accumulated other comprehensive income, a separate component of stockholders’ equity. Gains and losses resulting from foreign exchange transactions, including the impact of the re-measurement of the Company’s balance sheet, are recorded as a component of selling, general and administrative expenses. Losses in fiscal

2016,

2015

and

2014

were

$0.3

million,

$2.3

million and

$1.6

million, respectively.

ecent Accounting Pronouncements – Adopted in the current year

Effective

December

31,

2016,

the Company adopted

Accounting Standards Update No.

2014

15,

Disclosure of Uncertainties

about an Entity’s Ability to Continue as a Going Concern

that requires the Company to evaluate, at each annual and interim period, whether substantial doubt exists about its ability to continue as a going concern, and if applicable, to provide related disclosures. The new guidance was effective for the Company for the year ending

December

31,

2016.

The adoption of this standard did not have a material effect on our financial position or results of operations or on our disclosures in the current period.

ecent Accounting Pronouncements – Pending adoption

March

2016,

the FASB issued Accounting Standards Update No.

2016

09,

Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting

(ASU

2016

09).

The standard is intended to simplify several areas of accounting for share based compensation arrangements, including the income tax impact, classification in the statement of cash flows and forfeitures. The Company adopted the ASU

2016

effective

January

2017.

The Company made an accounting policy election to account for forfeitures as they occur. The impact of this election along with the adoption of the other provisions of the standard was to increase deferred tax assets by

$1.6

million, increase additional paid-in-capital by

$0.3

million, increase retained earnings by

$1.9

million and decrease taxes payable by

$0.6

million.

October

2016,

the FASB issued Accounting Standards Update No.

2016

16,

come Taxes – Intra-Entity Transfers of Assets Other Than Inventory

(ASU

2016

16).

The standard is intended to address diversity in practice and complexity in financial reporting, particularly for intra-entity transfers of intellectual property. The Company early adopted ASU

2016

effective

January

2017.

Using the modified retrospective method, the impact of the adoption of the standard was to increase deferred tax assets by

$1.0

million, decrease other assets, net by

$2.3

million and decrease retained earnings by

$1.3

million.

May

2014,

the FASB issued Accounting Standards Update No.

2014

09,

Revenue from Contracts with Customers

(ASU

2014

09),

which will replace most existing revenue recognition guidance in U.S. generally accepted accounting principles (GAAP). The core principle of the ASU is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASU

2014

requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. ASU

2014

will be effective for the Company beginning in fiscal

2018,

and allows for both retrospective and modified retrospective methods of adoption. Early adoption beginning fiscal

2017

is permitted. In

2016,

the Company established a cross-functional team to use a bottom-up approach to assess the impact of the new standard. The team is in the process of reviewing current accounting policies and practices to identify potential differences that would result from applying the provisions of the new standard to our existing revenue contracts. To date, the review has focused on net retail sales which represented over

98%

of total revenues in

2016.

While the team continues to assess all potential impacts of the new standard, the Company expects the most significant impact to result from changes to the accounting for deferred revenue, specifically related to gift cards and the Company’s loyalty program. Currently, the Company expects to adopt ASU

2014

effective the

first

day of fiscal

2018

using the modified retrospective method.

February

2016,

the FASB issued Accounting Standards Update No.

2016

02,

Leases

(ASU

2016

02),

which will replace most existing lease accounting guidance in U.S. GAAP. The core principle of the ASU is that an entity should recognize the rights and obligations resulting from leases as assets and liabilities. ASU

2016

requires qualitative and specific quantitative disclosures to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities, including significant judgments and changes in judgments. ASU

2016

will be effective for the Company beginning in fiscal

2019,

and requires the modified retrospective method of adoption. Early adoption is permitted. The Company is in the process of determining the method and timing of adoption and assessing the impact of ASU

2016

on its consolidated financial statements.