NEW ACCOUNTING RULE IMPACTS COSTCO

MARK HAMSTRA

ISSAQUAH, Wash. -- Costco Wholesale Corp. here said a new accounting rule would reduce its sales by about $400 million during the next 12 months, although net income will not be affected.

The new rule requires that vendor payments made to a retailer to subsidize a discount for consumers -- such as a retailer-specific coupon -- be subtracted from the cost of goods sold. The rule, EITF 03-10, was created by the Financial Accounting Standards Board's Emerging Issues Task Force as a follow-up to EITF 02-16, the rule that dictates how vendor allowances should be treated on a retailer's income statement.

According to Costco, the new rule requires the company to subtract the value of the Costco-specific discounts in its passport and wallet promotions from its cost of goods sold, rather than treating them like traditional coupons. Retailers generally have treated all coupons like cash, and have included their value in total sales. The effect for Costco will be less total sales, but a higher margin as a percent of total sales. Net income will remain constant, however.

Ron Lunde, an industry consultant based in Ponte Vedra, Fla., said the new rule may affect Costco differently than it does traditional supermarkets because of the way Costco structures its pricing. It could also depend on how the retailer receives the money for a promotion, he said. If the money that funds the price reduction is received up front and later passed on to consumers in the form of retailer-specific coupons, it is subtracted from the cost of goods sold. If the money is given to a retailer after the coupons are redeemed, it should still count toward the retailer's total sales, Lunde explained.

"Theoretically, this will have no impact on earnings, but it is going to make the revenue line and the margin line look different," he said.

As an example, Costco cited a box of detergent that costs the company $8 and retails for $10, for a margin of $2. When a customer pays for that using a $2 Costco-specific discount from the company's passport or wallet program, Costco subtracts the $2 from the sale price and the cost of goods and counts the sale as $8, and the cost of goods as $6, preserving the $2 margin. It thus increases the margin as a percent of the sale, to 25% ($2 divided by $8), up from 20% ($2 divided by $10).

Costco said that on average, during the next four quarters the adoption of EITF 03-10 will result in an increase of 10 basis points in gross margin as a percent of sales per quarter.