Costco 2006 Annual Report Download - page 50

Merchandise Costs
Merchandise costs consist of the purchase price of inventory sold, inbound shipping charges and all
costs related to the Company’s depot operations, including freight from depots to selling warehouses.
Merchandise costs also include salaries, benefits, depreciation on production equipment, and other
related expenses incurred by the Company’s cross-docking depot facilities and in certain fresh foods
and ancillary departments.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of salaries, benefits and workers’
compensation costs for warehouse employees, other than depots, fresh foods and certain ancillary
businesses, as well as all regional and home office employees, including buying personnel. Selling,
general and administrative expenses also include utilities, bank charges and substantially all building
and equipment depreciation, as well as other operating costs incurred to support warehouse
operations.
Marketing and Promotional Expenses
Costco’s policy is generally to limit marketing and promotional expenses to new warehouse openings,
occasional direct mail marketing to prospective new members and direct mail marketing programs to
existing members promoting selected merchandise. Marketing and promotional costs are expensed as
incurred and are included in selling, general and administrative expense in the accompanying
consolidated statements of income.
Preopening Expenses
Preopening expenses related to new warehouses, major remodels/expansions, new regional offices
and other startup operations are expensed as incurred.
Stock-Based Compensation
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004),
“Share-Based Payment” (SFAS No. 123R) at the beginning of fiscal 2006, which requires companies to
measure all employee stock-based compensation awards using a fair value method and record such
expense in its consolidated financial statements. In addition, the adoption of SFAS No. 123R required
additional accounting and disclosure related to income tax and cash flow effects resulting from stock-
based compensation.
Previously, at the beginning of fiscal 2003, the Company adopted SFAS 123, “Accounting for Stock-
Based Compensation” and all employee stock option grants made since the beginning of fiscal 2003
have or will be expensed ratably over the related vesting period based on the fair value at the date the
options were granted. Prior to fiscal 2003, the Company applied Accounting Principles Board Opinion
(APB) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting
for stock options. No compensation cost was recognized for option grants in periods prior to fiscal
2003, since the Company historically treated its stock options as having been granted at the fair market
value on the date of grant, (however, see “Review of Stock Option Grant Practices” in Note 11, for a
discussion of a special committee review of historical grant practices which resulted in, among other
things, the use of new measurement dates for certain grants).
Under SFAS 123R, the Company is required to select a valuation technique or option-pricing model
that meets the criteria as stated in the standard, which includes a binomial model and the Black-
Scholes model. At present, the Company is continuing to use the Black-Scholes model, which requires
the input of subjective assumptions. These assumptions include estimating the length of time
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