Costco 2007 Annual Report Download - page 40

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 fiscal year-end. At both
September 2, 2007 and September 3, 2006 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 results of the actual physical inventory count,
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
approaches.
Impairment of Long-Lived Assets and Warehouse Closing costs
We periodically evaluate our long-lived assets for indicators of impairment, such as a decision to
relocate or close a warehouse location. Our judgments are based on existing market and operational
conditions. Future events could cause us to conclude that impairment factors exist, requiring a
downward adjustment of these assets to their then-current fair market value.
We provide estimates for warehouse closing costs for both leased and owned locations to be closed or
relocated. A considerable amount of judgment is involved in determining any impairment or our net
liability, particularly related to the estimated sales price of owned locations and the potential sublease
income at leased locations. These estimates are based on real estate conditions in the markets and
our experience in those markets. We make assumptions about the average period of time it would take
to sublease the location and the amount of potential sublease income for each leased location. We
reassess our liability each quarter and adjust our liability accordingly when our estimates change.
Insurance/Self Insurance Liabilities
We use a combination of insurance and self-insurance mechanisms, including a wholly-owned captive
insurance entity and participation in a reinsurance pool, to provide for potential liabilities for workers’
compensation, general liability, property damage, director and officers’ liability, vehicle liability and
employee health care benefits. Liabilities associated with the risks that we retain are not discounted
and are estimated, in part, by considering historical claims experience and evaluations of outside
experts, demographic factors, severity factors and other actuarial assumptions. The estimated accruals
for these liabilities could be significantly affected if future occurrences and claims differ from these
assumptions and historical trends.
Income Taxes
The determination of our provision for income taxes requires significant judgment, the use of estimates,
and the interpretation and application of complex tax laws. Significant judgment is required in
assessing, among other things, the timing and amounts of deductible and taxable items. We establish
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