Summary of Significant Accounting Policies (Policies)

12 Months Ended

Aug. 31, 2012

Basis of Presentation

Basis of Presentation

The accompanying consolidated financial statements include the accounts of Penford and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated. Certain reclassifications have been made to prior years’ financial statements in order to conform to the current year presentation.

Use of Estimates

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates are used in accounting for, among other things, the allowance for doubtful accounts, accruals, legal contingencies, the determination of fair value of net assets acquired in a business combination, the determination of assumptions for pension and postretirement employee benefit costs, useful lives of property and equipment, the assessment of a potential impairment of goodwill or long-lived assets, and income taxes including the determination of a need for a valuation allowance for deferred tax assets. Actual results may differ from previously estimated amounts.

Cash and Cash Equivalents

Cash and Cash Equivalents

Cash and cash equivalents consist of cash and temporary investments with maturities of less than three months when purchased. Amounts are reported in the balance sheets at cost, which approximates fair value.

Cash Overdrafts

Cash Overdrafts

Cash overdrafts represent the amount by which outstanding checks issued, but not yet presented to banks for disbursement, exceed balances on deposit in the applicable bank accounts. The changes in cash overdrafts are included as a component of cash flows from financing activities in the consolidated statements of cash flows.

Allowance for Doubtful Accounts and Concentration of Credit Risk

Allowance for Doubtful Accounts and Concentration of Credit Risk

The allowance for doubtful accounts reflects the Company’s best estimate of probable losses in the accounts receivable balances. Penford estimates the allowance for uncollectible accounts based on historical experience, known troubled accounts, industry trends, economic conditions, how recently payments have been received, and ongoing credit evaluations of its customers. Activity in the allowance for doubtful accounts for fiscal 2012, 2011 and 2010 is as follows (dollars in thousands):

	Balance Beginning of Year		Charged to Costs and Expenses			Deductions and Other			Balance End of Year
Year ended August 31:
2012	$	1,305	$	(42	)	$	(1,185	)	$	78
2011	$	350	$	958		$	(3	)	$	1,305
2010	$	605	$	(218	)	$	(37	)	$	350

Approximately 43%, 40% and 45% of the Company's sales in fiscal 2012, 2011 and 2010, respectively, were made to customers who operate in the paper industry. This industry suffered an economic downturn, which has resulted in the closure of a number of mills. In fiscal 2011, the increase in the allowance for uncollectible accounts was related to two paper industry customers. These receivables were written off in fiscal 2012.

Inventories and Cost of Sales

Inventories and Cost of Sales

Inventory is stated at the lower of cost or market. Inventory is valued using the first-in, first-out (“FIFO”) method, which approximates actual cost. Capitalized costs include materials, labor and manufacturing overhead related to the purchase and production of inventories.

The Company produces certain by-products from its corn starch manufacturing process. The proceeds from the sale of these by-products reduce the cost of corn and, accordingly, are included in cost of goods sold. Sales of by-products that reduced cost of goods sold were $70.0 million, $56.8 million and $38.7 million, for fiscal years 2012, 2011 and 2010, respectively.

Goodwill and Other Intangible Assets

Goodwill and Other Intangible Assets

Goodwill represents the excess of cost over the fair value of net assets acquired. The Company evaluates its goodwill for impairment annually and whenever events or circumstances make it more likely than not that impairment may have occurred. To determine whether goodwill is impaired, Penford compares the fair value of each reporting unit to that reporting unit's carrying amount. If the fair value of the reporting unit is greater than its carrying amount goodwill is not considered impaired. If the fair value of the reporting unit is lower than its carrying amount, Penford then compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill, and, if the carrying value is higher than the fair value, an impairment would be recorded. The implied fair value of a reporting unit is determined using a discounted cash flow method considering the Company's market capitalization.

Patents are amortized using the straight-line method over their expected economic useful lives. At August 31, 2012, the weighted average remaining amortization period for patents is four years. Penford has no intangible assets with indefinite lives.

Property, Plant and Equipment

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Expenditures for maintenance and repairs are expensed as incurred. The Company uses the straight-line method to compute depreciation expense over the estimated useful lives of the depreciable assets. Equipment and vehicles generally have average useful lives ranging from three to twelve years and real estate between twelve to forty-six years. Depreciation, which includes depreciation of assets under capital leases, of $12.7 million, $12.8 million and $13.1 million was recorded in fiscal years 2012, 2011 and 2010, respectively. For income tax purposes, the Company generally uses accelerated depreciation methods.

Interest is capitalized on major construction projects while in progress. During fiscal 2012, the Company capitalized $48,000 in interest costs. No interest was capitalized in fiscal years 2011 and 2010.

The Company reviews the net book value of property, plant and equipment for impairment whenever circumstances indicate that the net book value may not be recoverable from estimated future cash flows.

Income Taxes

Income Taxes

The provision for income taxes includes federal and state taxes currently payable and deferred income taxes arising from temporary 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 the rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The impact on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment.

A valuation allowance is provided to the extent that it is more likely than not that deferred tax assets will not be realized. Tax benefits from uncertain tax positions are recognized when it is more likely than not that the position will be sustained upon examination based on the technical merits of the position. The amount recognized is measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement. The Company recognizes interest and penalty expense associated with uncertain tax positions as a component of income tax expense.

The Company has not provided deferred taxes related to its investment in foreign subsidiaries, which are classified as discontinued operations, as it does not expect future distributions from the subsidiaries or repayments of permanent advances.

Revenue Recognition

Revenue Recognition

Revenue from sales of products and shipping and handling revenue are recognized at the time goods are shipped and title transfers to the customer. This transfer is considered complete when a sales agreement is in place, delivery has occurred, pricing is fixed or determinable and collection is reasonably assured. Costs associated with shipping and handling are included in cost of sales.

Research and Development

Research and Development

Research and development costs are expensed as incurred, except for costs of patents, which are capitalized and amortized over the lives of the patents. Research and development costs expensed were $5.8 million, $4.8 million and $4.4 million in fiscal 2012, 2011 and 2010, respectively.

Accrued Liabilities

Accrued Liabilities

Components of accrued liabilities are as follows:

	August 31,
	2012		2011
Employee-related costs	$	4,837	$	3,342
Other		4,305		4,221
Accrued liabilities	$	9,142	$	7,563

Employee-related costs include accrued payroll, compensated absences, payroll taxes, benefits and incentives.

Foreign Currency

Foreign Currency

Assets and liabilities of subsidiaries whose functional currency is deemed to be other than the U.S. dollar are translated at year end rates of exchange. Resulting translation adjustments are accumulated in the currency translation adjustments component of other comprehensive income. Statement of operations amounts are translated at average exchange rates prevailing during the year. The net foreign currency transaction gain recognized in earnings was $0.4 million for fiscal year 2010. Foreign currency transaction gains or losses in fiscal years 2012 and 2011 were not significant.

Derivatives

Derivatives

Penford uses derivative instruments to manage the exposures associated with commodity prices, interest rates and energy costs. The derivative instruments are reported at fair value in other current assets or accounts payable in the consolidated balance sheets.

For derivative instruments designated as fair value hedges, the gain or loss on the derivative instruments as well as the offsetting gain or loss on the hedged firm commitments or inventory are recognized in current earnings as a component of cost of goods sold. For derivative instruments designated as cash flow hedges, the effective portion of the gain or loss on the derivative instruments is reported as a component of other comprehensive income (loss), net of applicable income taxes, and recognized in earnings when the hedged exposure affects earnings. The Company recognizes the gain or loss on the derivative instrument as a component of cost of goods sold in the period when the finished goods produced from the hedged item are sold or, for interest rate swaps, as a component of interest expense in the period the forecasted transaction is reported in earnings. If it is determined that the derivative instruments used are no longer effective at offsetting changes in cash flows or fair value of the hedged item, then the changes in fair value would be recognized in current earnings as a component of cost of good sold or interest expense.

Acquisitions

Acquisitions

Acquisitions of businesses are accounted for using the purchase method of accounting and the financial statements include the results of the acquired operations from the date of acquisition. The purchase price of the acquired entity is allocated to the net assets acquired and net liabilities assumed based on the estimated fair value at the date of acquisition. The excess of cost over the fair value of the net assets acquired is recognized as goodwill.

Significant Customer and Export Sales

Significant Customer and Export Sales

The Company has several relatively large customers in each business segment. The Company’s sales of ethanol to its sole ethanol customer, Eco-Energy, Inc., represented approximately 28%, 34% and 27% of the Company’s net sales for fiscal years 2012, 2011 and 2010, respectively. Eco-Energy, Inc. is a marketer and distributor of biofuels in the United States and Canada, is a customer of the Company’s Industrial Ingredients business. Export sales accounted for approximately 9% of consolidated sales in each of the fiscal years ended August 31, 2012, 2011 and 2010.

Stock-Based Compensation

Stock-Based Compensation

The Company has a long-term incentive plan that provides for stock-based compensation, including the granting of stock options and shares of restricted stock to employees and directors. The Company utilizes the Black-Scholes option-pricing model to determine the fair value of stock options on the date of grant. This model derives the fair value of stock options based on certain assumptions related to expected stock price volatility, expected option life, risk-free interest rate and dividend yield. See Note 11 for further detail.

Recent Accounting Pronouncements

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”). To increase the prominence of items reported in other comprehensive income, the FASB eliminated the option of presenting components of other comprehensive income as part of the statement of changes in stockholders’ equity. ASU 2011-05 requires that all nonowner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Regardless of the presentation of the components of other comprehensive income, ASU 2011-05 requires that the Company present on the face of the financial statements the reclassification adjustments for items that are reclassified from other comprehensive income to net income. The amendments in ASU 2011-05 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 (fiscal 2013 for Penford). The amendments in this update are to be applied retrospectively and early application is permitted. In December 2011, the FASB indefinitely deferred the effective date for certain requirements included in ASU 2011-05 as they relate to presentation of reclassification adjustments for items that are reclassified from other comprehensive income to net income. The Company is evaluating the impact this update will have on its disclosures.

In December 2011, the FASB issued ASU 2011-11, Disclosures About Offsetting Assets and Liabilities (“ASU 2011-11”). This update creates new disclosure requirements about the nature of an entity’s rights of setoff and related arrangements associated with its financial instruments and derivative instruments. The disclosure requirements are effective for annual reporting periods, and interim reporting periods within those years, beginning on or after January 1, 2013 (fiscal 2014 for Penford). The Company is evaluating the impact this update will have on its disclosures.