* In 1998, How were membership fees recorded in COSTCO’s financial statements?
The membership fees recorded as revenue when received in Costco’s financial statement in 1998 according to the cash accounting. * Was this correct? If not, what accounting principle does it violate?
No. It violates the revenue recognition principle because they did not provide services to members when they pay the membership fee during this fiscal year. It can only record this item as unearned revenue under the liabilities and change them into revenue at the end of the year. * How did they fix it?
They changed to use accrual accounting instead of cash accounting to fix the membership fees revenue. * What were the effects of the fix?
The effects of the fix hit the net income in 1999 as the net income decreases in 1999. While using the pro forma to assume, the change also should have affected the net income in 1998 and 1997 because both of the net incomes in 1997 and 1998 were decreased.
However, the problem here is we don’t know how Costco deal with the “deferred basis” membership fees revenue. Let’s make an example to explain it easy. After Costco changed their accounting method in fiscal 1999, assume there are two people, one joined the Costco membership on Aug 31st 1998, and the other joined the Costco membership on Aug 29th 1999. Both of them paid the membership fee in fiscal 1999. Costco cannot defer both fees into next fiscal year because the first person who joined on Aug 31st 1998 has already received the membership right for a year. That means we should record it as revenue, we provided the service and the amount of revenue is measurable. But the second person, who joined in on Aug 29th 1999, does not receive the membership rights. He just paid the fee and we do not provide our service. So we should make this deferred as revenue. Maybe Costco should average membership fees into every month or distribute fees according to the weight of...