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## Analysis of Inventory

Difficulty: Advanced

- Inventory Accounting Policy
- Inventory Disclosure
- Adjustment to Inventory: from LIFO to FIFO
- Adjusted Ratios: LIFO vs. FIFO (Summary)
- Adjusted Current Ratio
- Adjusted Net Profit Margin
- Adjusted Total Asset Turnover
- Adjusted Financial Leverage
- Adjusted Return on Equity (ROE)
- Adjusted Return on Assets (ROA)

### Inventory Accounting Policy

Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. Costco believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. Costco records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation or deflation rates and inventory levels for the year have been determined. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the first-in, first-out (FIFO) basis.

As of September 3, 2017, U.S. merchandise inventories valued at LIFO approximated FIFO after considering the lower of cost or market principle. Due to net deflation, a benefit of $64 and $27 was recorded to merchandise costs in 2016, and 2015, respectively. At the end of 2017 and 2016, the cumulative impact of the LIFO valuation on merchandise inventories was zero and immaterial, respectively.

Costco provides for estimated inventory losses between physical inventory counts as a percentage of net sales, using estimates based on Costco's experience. The provision is adjusted periodically to reflect actual physical inventory counts, which generally occur in the second and fourth fiscal quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as Costco progresses towards earning those rebates, provided that they are probable and reasonably estimable.

Source: Costco Wholesale Corp., Annual Report

### Inventory Disclosure

**Costco Wholesale Corp., Statement of Financial Position, Inventory**

USD $ in millions

Sep 3, 2017 | Aug 28, 2016 | Aug 30, 2015 | Aug 31, 2014 | Sep 1, 2013 | Sep 2, 2012 | ||
---|---|---|---|---|---|---|---|

United States | |||||||

Canada | |||||||

Other International | |||||||

Merchandise inventories |

Source: Based on data from Costco Wholesale Corp. Annual Reports

Item | Description | The company |
---|---|---|

Merchandise inventories |
Carrying amount (lower of cost or market) as of the balance sheet date of inventories less all valuation and other allowances. Excludes noncurrent inventory balances (expected to remain on hand past one year or one operating cycle, if longer). | Costco Wholesale Corp.'s merchandise inventories increased from 2015 to 2016 and from 2016 to 2017. |

### Adjustment to Inventory: from LIFO to FIFO

**Adjusting LIFO Inventory to FIFO (Current) Cost**

USD $ in millions

Costco Wholesale Corp.'s inventory value on Sep 3, 2017 would be $9,834 (in millions) if the FIFO inventory method was used instead of LIFO. Costco Wholesale Corp.'s inventories, valued on a LIFO basis, on Sep 3, 2017 were $9,834 . Costco Wholesale Corp.'s inventories would have been $– higher than reported on Sep 3, 2017 if the FIFO method had been used instead.

### Adjusted Ratios: LIFO vs. FIFO (Summary)

**Costco Wholesale Corp., adjusted ratios**

Ratio | Description | The company |
---|---|---|

Adjusted current ratio |
A liquidity ratio calculated as adjusted current assets divided by current liabilities. | Costco Wholesale Corp.'s adjusted current ratio deteriorated from 2015 to 2016 but then slightly improved from 2016 to 2017. |

Adjusted net profit margin |
An indicator of profitability, calculated as adjusted net income divided by revenue. | Costco Wholesale Corp.'s adjusted net profit margin deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |

Adjusted total asset turnover |
An activity ratio calculated as total revenue divided by adjusted total assets. | Costco Wholesale Corp.'s adjusted total asset turnover improved from 2015 to 2016 but then slightly deteriorated from 2016 to 2017. |

Adjusted financial leverage |
A measure of financial leverage calculated as adjusted total assets divided by adjusted total equity. Financial leverage is the extent to which a company can effect, through the use of debt, a proportional change in the return on common equity that is greater than a given proportional change in operating income. |
Costco Wholesale Corp.'s adjusted financial leverage declined from 2015 to 2016 but then increased from 2016 to 2017 exceeding 2015 level. |

Adjusted ROE |
A profitability ratio calculated as adjusted net income divided by adjusted shareholders' equity. | Costco Wholesale Corp.'s adjusted ROE deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |

Adjusted ROA |
A profitability ratio calculated as adjusted net income divided by adjusted total assets. | Costco Wholesale Corp.'s adjusted ROA deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |

### Adjusted Current Ratio

*2017 Calculations*

^{1} Current ratio = Current assets ÷ Current liabilities

= ÷ =

^{2} Adjusted current ratio = Adjusted current assets ÷ Current liabilities

= ÷ =

Ratio | Description | The company |
---|---|---|

Adjusted current ratio |
A liquidity ratio calculated as adjusted current assets divided by current liabilities. | Costco Wholesale Corp.'s adjusted current ratio deteriorated from 2015 to 2016 but then slightly improved from 2016 to 2017. |

### Adjusted Net Profit Margin

*2017 Calculations*

^{1} Net profit margin = 100 × Net income attributable to Costco ÷ Net sales

= 100 × ÷ = %

^{2} Adjusted net profit margin = 100 × Adjusted net income attributable to Costco ÷ Net sales

= 100 × ÷ = %

Ratio | Description | The company |
---|---|---|

Adjusted net profit margin |
An indicator of profitability, calculated as adjusted net income divided by revenue. | Costco Wholesale Corp.'s adjusted net profit margin deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |

### Adjusted Total Asset Turnover

*2017 Calculations*

^{1} Total asset turnover = Net sales ÷ Total assets

= ÷ =

^{2} Adjusted total asset turnover = Net sales ÷ Adjusted total assets

= ÷ =

Ratio | Description | The company |
---|---|---|

Adjusted total asset turnover |
An activity ratio calculated as total revenue divided by adjusted total assets. | Costco Wholesale Corp.'s adjusted total asset turnover improved from 2015 to 2016 but then slightly deteriorated from 2016 to 2017. |

### Adjusted Financial Leverage

*2017 Calculations*

^{1} Financial leverage = Total assets ÷ Total Costco stockholders' equity

= ÷ =

^{2} Adjusted financial leverage = Adjusted total assets ÷ Adjusted total Costco stockholders' equity

= ÷ =

Ratio | Description | The company |
---|---|---|

Adjusted financial leverage |
A measure of financial leverage calculated as adjusted total assets divided by adjusted total equity. Financial leverage is the extent to which a company can effect, through the use of debt, a proportional change in the return on common equity that is greater than a given proportional change in operating income. |
Costco Wholesale Corp.'s adjusted financial leverage declined from 2015 to 2016 but then increased from 2016 to 2017 exceeding 2015 level. |

### Adjusted Return on Equity (ROE)

*2017 Calculations*

^{1} ROE = 100 × Net income attributable to Costco ÷ Total Costco stockholders' equity

= 100 × ÷ = %

^{2} Adjusted ROE = 100 × Adjusted net income attributable to Costco ÷ Adjusted total Costco stockholders' equity

= 100 × ÷ = %

Ratio | Description | The company |
---|---|---|

Adjusted ROE |
A profitability ratio calculated as adjusted net income divided by adjusted shareholders' equity. | Costco Wholesale Corp.'s adjusted ROE deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |

### Adjusted Return on Assets (ROA)

*2017 Calculations*

^{1} ROA = 100 × Net income attributable to Costco ÷ Total assets

= 100 × ÷ = %

^{2} Adjusted ROA = 100 × Adjusted net income attributable to Costco ÷ Adjusted total assets

= 100 × ÷ = %

Ratio | Description | The company |
---|---|---|

Adjusted ROA |
A profitability ratio calculated as adjusted net income divided by adjusted total assets. | Costco Wholesale Corp.'s adjusted ROA deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |