Costco 2006 Annual Report Download - page 34

stock-based compensation and income taxes. We base our estimates on historical experience and on
other assumptions that management believes to be reasonable under the circumstances.
Revenue Recognition
We recognize sales, net of estimated returns, at the time customers take possession of merchandise
or receive services. When we collect payment from customers prior to the transfer of ownership of
merchandise or the performance of services, the amount received is recorded as deferred revenue on
the balance sheet until the sale or service is completed. We provide for estimated sales returns based
on historical returns levels.
We evaluate the criteria of the Financial Accounting Standards Board (FASB) Emerging Issues Task
Force (EITF) 99-19, “Reporting Revenue Gross as a Principal Versus Net as an Agent,” in determining
whether it is appropriate to record the gross amount of merchandise sales and related costs or the net
amount earned as commissions. Generally, when we are the primary obligor, subject to inventory risk,
have latitude in establishing prices and selecting suppliers, influence product or service specifications,
or have several but not all of these indicators, revenue is recorded on a gross basis. If we are not the
primary obligor and do not possess other indicators of gross reporting as noted above, we record the
net amounts as commissions earned, which is reflected in net sales.
Membership fee revenue represents annual membership fees paid by substantially all of our members.
We account for membership fee revenue on a deferred basis, whereby membership fee revenue is
recognized ratably over one year. Our Executive members qualify for a 2% reward (which can be
redeemed only at Costco warehouses), up to a maximum of $500 per year, on all qualified purchases
made at Costco. We account for this 2% reward as a reduction in sales, with the related liability being
classified within other current liabilities.
Merchandise Inventories
Merchandise inventories are valued at the lower of cost or market, as determined primarily by the retail
method of accounting, and are stated using the last-in, first-out (LIFO) method for substantially all U.S.
merchandise inventories. Merchandise inventories for all foreign operations are primarily valued by the
retail method of accounting and are stated using the first-in, first-out (FIFO) method. We believe the
LIFO method more fairly presents the results of operations by more closely matching current costs with
current revenues. We record an adjustment each quarter, if necessary, for the expected annual effect
of inflation, and these estimates are adjusted to actual results determined at year-end. At both
September 3, 2006 and August 28, 2005 merchandise inventories valued at LIFO approximated FIFO
after considering the lower of cost or market principle.
We provide for estimated inventory losses between physical inventory counts as a percentage of net
sales. The provision is adjusted periodically to reflect the actual physical inventory count results, which
generally occur in the second and fourth fiscal quarters of the fiscal year.
Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as we
progress toward earning those rebates, provided they are probable and reasonably estimable. Other
consideration received from vendors is generally recorded as a reduction of merchandise costs upon
completion of contractual milestones, terms of agreement, or other systematic and rational approach.
Impairment of Long-Lived Assets and Warehouse Closing costs
We periodically evaluate our long-lived assets for indicators of impairment. Our judgments are based
on existing market and operational conditions. Future events could cause us to conclude that
impairment factors exist, requiring an adjustment of these assets to their then-current fair market value.
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