Hanesbrands (HBI)

(a) Combination and Consolidation

The Combined and Consolidated Financial Statements include the accounts of the Company, its controlled divisions and subsidiary companies which are majority owned entities, and the accounts of variable interest entities (“VIEs”) for which the Company is deemed the primary beneficiary, as defined by the Financial Accounting Standards Board’s (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”) and related interpretations. Excluded from the accounts of the Company are Sara Lee entities which maintain legal ownership of certain of the Company’s divisions (“Parent Companies”). The results of companies acquired or disposed of during the year are included in the Combined and Consolidated Financial Statements from the effective date of acquisition, or up to the date of disposal. All intercompany balances and transactions have been eliminated in consolidation.

In January 2003, the FASB issued FIN 46, which addresses consolidation by business enterprises of VIEs that either: (1) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) have equity investors that lack an essential characteristic of a controlling financial interest.

Throughout calendar 2003, the FASB released numerous proposed and final FASB Staff Positions (“FSPs”) regarding FIN 46, which both clarified and modified FIN 46’s provisions. In December 2003, the FASB issued Interpretation No. 46 (“FIN 46-R”), which replaced FIN 46. FIN 46-R retains many of the basic concepts

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HANESBRANDS

Notes to Combined and Consolidated Financial Statements—(Continued)

(dollars in thousands, except per share data)

introduced in FIN 46; however, it also introduced a new scope exception for certain types of entities that qualify as a “business” as defined in FIN 46-R, revised the method of calculating expected losses and residual returns for determination of the primary beneficiary, included new guidance for assessing variable interests, and codified certain FSPs on FIN 46. The Company adopted the provisions of FIN 46-R in 2004.

The Company assessed its business relationship and the underlying contracts with certain vendors, as well as all other investments in businesses historically accounted for under the equity method, and determined that consolidation of two VIEs was required.

During the period from June 2002 through June 2005, the Company entered into a fixed supply contract with a third party sewing operation. The Company has evaluated the contract, and although the Company has no equity interest in the business, it was determined that it is the primary beneficiary and beginning in 2004, the Company consolidated the business. Beginning in 2005, the Company consolidated a second VIE, an Israeli manufacturer and supplier of yarn. The Company has a 49% ownership interest in the Israeli joint venture, however, based upon certain terms of the supply contract, the Company has a disproportionate share of expected losses and residual returns.

The effect of consolidating the above mentioned VIEs was the inclusion of $2,500 of total assets and $2,500 of total liabilities at July 3, 2004 and the inclusion of $21,396 of total assets and $13,219 of total liabilities at July 2, 2005 on the Combined and Consolidated Balance Sheets.