Costco Wholesale (COST)

Accounting Treatment

At the beginning of fiscal 2003, the Company adopted, on a prospective basis, Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), and all employee stock option grants made since the beginning of fiscal 2003 have been or will be expensed ratably over the related vesting period based on the fair value at the date the options were granted. The Company adopted SFAS 123R, “Share-Based Payment (as amended)” (SFAS 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 conjunction with the adoption of SFAS 123 at the beginning of fiscal 2003, the Company changed its method of attributing the value of stock-based compensation expense from the graded-vesting method to the straight-line method. Under the graded-vesting method, an award is accounted for as multiple awards, based on the number of vesting tranches, each tranche with a different requisite service period. The effect of graded-vesting attribution is to recognize more compensation expense in the early years of the overall vesting period. Compensation expense for all stock-based awards granted prior to fiscal 2003 will continue to be recognized using the graded-vesting method, while compensation expense for all stock-based awards granted subsequent to fiscal 2002 is being recognized using the straight-line method. SFAS 123R requires the estimation of the number of stock-based awards that will ultimately not complete their vesting requirements (forfeitures), and requires that the compensation expense recognized equals or exceeds the number of stock-based awards vested. While options and RSUs generally vest over five years with an equal amount vesting on each anniversary of the grant date, the Company’s plans allow for daily vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination. As such, the Company does not reduce stock-based compensation for an estimate of forfeitures because this would result in less compensation expense recognized than the number of stock-based awards vested. The impact of actual forfeitures arising in the event of involuntary termination is recognized as actual forfeitures occur.

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Accounting Treatment

The Company adopted the fair value based method of recording stock options consistent with Statement of Financial Accounting Standards No. 123 (SFAS No. 123) “Accounting for Stock-Based Compensation,” for all employee stock options granted subsequent to fiscal year end 2002. Specifically, the Company adopted SFAS No. 123 using the “prospective method” with guidance provided from SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure.” All employee stock option grants made since fiscal 2003 have been expensed over the related stock option 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. Beginning with the first quarter of fiscal 2006, the Company has adopted SFAS No. 123R, Share-Based Payment, under which the Company will apply a modified

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Black Scholes option pricing model for purposes of determining stock option expense. Under FAS 123R, the Company is also required to estimate at grant date the number of options that will be forfeited (options cancelled prior to vesting) rather than reflecting forfeitures in compensation in the period in which they occur. The Company is also required now to expense unvested options that were previously accounted for under APB 25 (i.e., not expensed). This expensing will occur as these prior grants vest.