Costco 2011 Annual Report Download - page 40

We evaluate 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 our members. We account for
membership fee revenue, net of estimated refunds, on a deferred basis, whereby revenue is
recognized ratably over the one-year membership period.
Our Executive members qualify for a 2% reward (which can be redeemed only at Costco warehouses),
up to a maximum of approximately $500 per year, on 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. The sales reduction and corresponding liability are computed after giving effect to the
estimated impact of non-redemptions based on historical data.
Investments
Investments are reviewed quarterly for indicators of other-than-temporary impairment. This
determination requires significant judgment. We employ a methodology that considers available
quantitative and qualitative evidence. If the cost of an investment exceeds its fair value, we evaluate,
among other factors, general market conditions, the duration and extent to which the fair value is less
than cost, and our intent and ability to hold the investment. We also consider specific adverse
conditions related to the financial health of and business outlook for the issuer, including industry and
sector performance, operational and financing cash flow factors, and rating agency actions. Once a
decline in fair value is determined to be other-than-temporary, an impairment charge is recorded and a
new cost basis in the investment is established. If market, industry, and/or issuer conditions
deteriorate, we may incur future impairments.
Merchandise Inventories
Merchandise inventories are valued at the lower of cost or market, as determined primarily by the retail
inventory method, 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 inventory method 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 estimated effect of
inflation or deflation, and these estimates are adjusted to actual results determined at year-end. Due to
inflation, in 2011 the merchandise inventories valued at LIFO were lower than the FIFO value, resulting
in a charge to merchandise costs of $87. During 2009, due to overall net deflationary trends, the
Company recorded a $32 benefit to merchandise costs to adjust inventories valued at LIFO. At the end
of 2010 and 2009, merchandise inventories valued at LIFO approximated FIFO after considering the
lower of cost or market principle.
We provide for estimated inventory losses (shrink) between physical inventory counts as a percentage
of net sales. The provision is adjusted periodically to reflect results of the actual physical inventory
counts, which generally occur in the second and fourth quarters of the 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.
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