Financial Statements of - Shoppers Drug Mart

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SHOPPERS DRUG MART CORPORATION Notes to the Consolidated Financial Statements (unaudited) (in thousands of Canadian dollars, except per share data) 3. SIGNIFICANT ACCOUNTING POLICIES (continued) Financial instruments measured at amortized cost are initially recognized at fair value and then subsequently at amortized cost using the effective interest method, less any impairment losses, with gains and losses recognized in earnings in the period in which the gain or loss occurs. Changes in fair value of financial instruments classified as held for trading are recorded in net earnings in the period of change. Changes in the fair value of the Company’s derivative instruments designated as effective cash flow hedges are recognized in other comprehensive income (loss) and changes in derivative instruments not designated as effective hedges are recognized in net earnings, in operating and administrative expenses, in the period of the change. The Company categorizes its financial assets and financial liabilities that are recognized in the consolidated balance sheets at fair value using the fair value hierarchy. The fair value hierarchy has the following levels: Level 1 – quoted market prices in active markets for identical assets or liabilities; Level 2 – inputs other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices); Level 3 – unobservable inputs such as inputs for the asset or liability that are not based on observable market data. The level in the fair value hierarchy within which the fair value measurement is categorized in its entirety is determined on the basis of the lowest level input that is significant to the fair value measurement in its entirety. (ii) Transaction Costs Transaction costs are added to the initial fair value of financial assets and liabilities when those financial assets and liabilities are not measured at fair value subsequent to initial measurement. Transaction costs are amortized to net earnings, in finance expense, using the effective interest method. (iii) Derivative Financial Instruments and Hedge Accounting The Company is exposed to fluctuations in interest rates by virtue of its borrowings under its bank credit facilities, commercial paper program and financing programs available to its Associates. Increases or decreases in interest rates will negatively or positively impact the financial performance of the Company. The Company may use, from time to time, interest rate derivatives to manage this exposure. The earnings or expense arising from the use of these instruments is included in finance expenses for the financial year. 31
SHOPPERS DRUG MART CORPORATION Notes to the Consolidated Financial Statements (unaudited) (in thousands of Canadian dollars, except per share data) 3. SIGNIFICANT ACCOUNTING POLICIES (continued) The Company uses cash-settled equity forward agreements to limit its exposure to future price changes in the Company’s share price for share unit awards under the Company’s long-term incentive plan (“LTIP”) and restricted share unit plan (“RSU Plan”). The earnings or expense arising from the use of these instruments is included in other comprehensive income and in operating and administrative expenses, based on the amounts considered to be a hedge or a derivative, for the financial year. See Note 15 to the Company’s 2010 annual financial statements reported under Canadian GAAP and Note 11 to these consolidated financial statements for further discussion of the LTIP and RSU Plan. The Company formally identifies, designates and documents all relationships between hedging instruments and hedged items, as well as its risk assessment objective and strategy for undertaking various hedge transactions. The Company assesses, both at the inception of the hedge and on an ongoing basis, including on re-designation, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When such derivative instruments cease to exist or to be effective as hedges, or when designation of a hedging relationship is terminated, any associated deferred gains or losses are recognized in earnings in the same period as the corresponding gains or losses associated with the hedged item. When a hedged item ceases to exist, any associated deferred gains or losses are recognized in earnings in the period the hedged item ceases to exist. The Company does not have any significant embedded features in contractual arrangements that require separate accounting or presentation from the related host contracts. (iv) Share Capital Common Shares Common shares issued by the Company are recorded in the amount of the proceeds received, net of direct issue costs. Repurchase of Share Capital The Company, from time to time, may repurchase its common shares under a Normal Course Issuer Bid. When common shares are repurchased, the amount of the consideration paid which includes directly attributable costs and is net of any tax effects, is recognized as a deduction from share capital. Any repurchased common shares will be cancelled. (j) Business Combinations Business combinations are accounted for by applying the acquisition method. On acquisition, the assets, including intangible assets, and any liabilities assumed are measured at their fair value. Purchase price allocations may be preliminary when initially recognized and may change pending finalization of the valuation of the assets acquired. Purchase price allocations are finalized within one year of the acquisition and prior periods are restated to reflect any adjustments to the purchase price allocation made subsequent to the initial recognition. 32
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Financial Statements of - Shoppers Drug Mart

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