Gap (GPS)

RESTATEMENT OF FINANCIAL STATEMENTS

As discussed in Note 2 to the condensed consolidated financial statements, during fiscal 2004, we re-evaluated our lease accounting practices and corrected the way we account for our leases, specifically the accounting for operating leases with scheduled rent and tenant allowances.

We have restated our third quarter of fiscal 2004 condensed consolidated statement of cash flows to reflect changes in restricted cash balances as an investing activity rather than a financing activity.

All items in this management’s discussion and analysis have been revised for the effects of these restatements.

RESTATEMENT OF FINANCIAL STATEMENTS

As discussed in Note 2 to the condensed consolidated financial statements, during fiscal 2004, we re-evaluated our lease accounting practices and corrected the way we account for our leases, specifically the accounting for operating leases with scheduled rent and tenant allowances.

During our second quarter 2005, we completed the updating of individual lease adjustments within our lease accounting system related to our review of our accounting for operating leases with scheduled rent and tenant allowances. As a result we recognized a benefit of $19 million before tax to true-up amounts which were estimated in our fiscal 2004 financial statements.

In addition, we have restated our second quarter of fiscal 2004 consolidated statement of cash flows to reflect changes in restricted cash balances as an investing activity rather than a financing activity.

All items in this management’s discussion and analysis have been revised for the effects of these restatements.

RESTATEMENT OF FINANCIAL STATEMENTS

As discussed in Note 2 to the condensed consolidated financial statements, during fiscal 2004, we re-evaluated our lease accounting practices and corrected the way we account for our leases, specifically the accounting for operating leases with scheduled rent and tenant allowances.

In addition, we have restated our first quarter of 2004 consolidated statements of cash flows to reflect changes in restricted cash balances as an investing activity rather than a financing activity.

All items in this management’s discussion and analysis have been revised for the effects of these restatements.

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Table of Contents

Restatement of Financial Statements

In light of a recent SEC clarification on lease accounting, we re-evaluated our lease accounting practices and have corrected the way we account for our leases, specifically the accounting for operating leases with scheduled rent and tenant allowances.

Under the requirements of FASB Technical Bulletin 85-3, “Accounting for Operating Leases with Scheduled Rent Increases,” rent expense should be amortized on a straight-line basis over the term of the lease. In prior periods, we had determined that the term of the lease begins on the commencement date of the lease, which generally coincides with the store opening date, instead of at the time we take physical possession of the property to start construction of leasehold improvements. This had the effect of excluding the construction period of the stores from the calculation of the period over which rent is expensed. We have restated our previously reported financial statements to correct our accounting for scheduled rent increases.

In addition, under FASB Technical Bulletin 88-1, “Issues Relating to Accounting for Leases,” lease incentives such as tenant allowances received from the landlord to cover construction costs incurred by us should be reflected as a deferred liability, amortized over the term of the lease and reflected as a reduction to rent expense. We had previously classified a portion of tenant allowances as a reduction to store build out costs instead of as a deferred lease credit on the consolidated balance sheet to reflect construction costs incurred on behalf of the landlord. As a result, we also amortized the deferred lease credit over the asset life instead of over the lease term and reflected the amortization as a reduction to depreciation expense instead of as a reduction to rent expense. We reassessed this accounting policy in 2003 and effective February 1, 2004, have prospectively changed our accounting policy to treat lease incentives received as deferred lease incentives. We have also corrected the prior years Consolidated Financial Statements to properly account for tenant allowances.

The restatement primarily resulted in a decrease to retained earnings of $131.7 million as of February 2, 2002 and an increase in net earnings of $0.6 million and $0.3 million in fiscal 2003 and 2002, respectively. In addition, we have restated our fiscal 2003 and 2002 Consolidated Statements of Cash Flows to reflect restricted cash balances as an investing activity rather than a financing activity to be consistent with the presentation in fiscal 2004.

See Note B to the Consolidated Financial Statements for a summary of the effects of these changes on our Consolidated Financial Statements. This Management’s Discussion and Analysis gives effect to these corrections.

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GAP INC. FINANCIALS 2004