Introduction
Costco Wholesale Corporation is one of the leaders in the retail store chains in many aspects. This company was established in 1983 in Seattle, Washington, expanding in 2021 to more than 800 warehouses worldwide (Costco Wholesale, 2021). The main features that define their whole business model are the membership system and a limited number of suppliers. This company’s rational and strategic approach to providing products to its customers allowed it to maintain clients’ trust and ensure a steady increase in revenue.
Internal Control
Internal control is a process of providing accounting and financial information to prevent fraud and ensure accountability. It can be divided into detective, corrective, and preventive types of control (Reciprocity, 2022). Preventative control is for fraud or error debarment, the detective is for the second line of defense that discovers missed events or items, and corrective control resolves the identified issue (Reciprocity, 2022). Furthermore, the quality of a company’s internal control is defined by such determinants as a firm’s structure, audit characteristics, the market environment, and national culture (Chalmers et al., 2018). Petty cash funds can be used in different ways such as reconciliation, petty cash log, or bookkeeping interface for internal control purposes. Bank accounts are used by companies to organize, structure, and control money, and firms use bank reconciliation to control financial operations. In fact, bank reconciliation is a document that justifies the cash balance of depositors and other financial records. People and machines can make mistakes; thus, is why it is essential to record journal entries after the bank reconciliation has been prepared.
Cash Ratio
For a company to remain competitive in the market, it should be able to pay bills. In fact, the term that describes a firm’s ability to repay its obligations is known as the cash ratio (Miller-Nobles et al., 2020). It can be estimated by the following formula: Cash Ratio = (Cash + Cash Equivalents)/Total Current Liability (Miller-Nobles et al., 2020). Costco’s cash ratio for 2019 is ($8,384 millions)/$23,237 millions = 0.36 and for 2020, it is ($12,277 millions)/$24,844 millions = 0.49. For 2021, the cash ratio is equal to ($11,258 millions)/$29,441 millions = 0.38. The company’s biggest competitor is Walmart Inc, whose cash ratio fluctuated but still was higher than Costco’s numbers. Specifically, Walmart’s ratios in 2019, 2020, and 2021 were 0.81, 0.84, and 0.95 (Macrotrends, 2022). The cash ratio above 1 indicates that the firm has more assets and liabilities and vice versa (Miller-Nobles et al., 2020). In this case, both Costco and Walmart have cash ratios below 1, meaning that they have more debts to pay.
Accounts Receivable
Accounts receivable (AR) belong to assets and are listed on the company’s balance sheets. AR is defined as the money the firm can receive from clients in the future for the performed service (Miller-Nobles et al., 2020). The three types of AR are notes, trade accounts, and other receivables. ARs for Costco in 2019, 2020, and 2021 were $1,535, $1,550, and $1,803 millions, respectively (Costco Wholesale, 2021). These numbers show an increasing trend of payments done in favor of Costco, indicating that more purchases are made every year. It is vital to calculate account receivables because lack of payments can hurt businesses.
Allowance for Doubtful Accounts
When Costco’s financial statements are reviewed, the part cash dividend declared but not paid can be noticed. This part accounts for Allowance for Doubtful Accounts, which is the portion of AR that may never be collected from the customers (Miller-Nobles et al., 2020). In 2019, it was $286 million, while in the subsequent two years, 2020 and 2021, the company did not have any unpaid purchases (Costco Wholesale, 2021). Such low to nonexistent provision for Doubtful Accounts is probably explained by the fact that Costco’s sales are based exclusively on membership and one card payment (Kim, 2019). It means that those who become the store’s members are unlikely not to pay for their orders.
Plant Assets
Plant assets are equipment and inventory that the company owns. Costco reported these items in the assets section of the financial report. For example, in the 2021 report, the corporation listed property, inventories, and equipment for a total of approximately $37.7 million (Costco Wholesale, 2021). All these items not only show the company’s current assets but also represent potential future benefits Costco may gain from selling these pieces of equipment.
Depreciation and Book Value
Depreciation is an asset’s value decrease when its serving time has passed to allocate its cost. To calculate this value, the asset’s salvage number is divided by the years in the asset’s lifespan and then divided by twelve for monthly depreciation (Miller-Nobles et al., 2020). However, other formulas can also be used depending on the goals that a firm wants to attain. Costco depreciates its plant assets, which is seen from its financial statements. For example, in 2021, it depreciated equipment for almost $2 million (Costco Wholesale, 2021). The estimated useful lives for Costco’s equipment were 3-20 years and for buildings 5-50 years (Costco Wholesale, 2021). This company primarily used the linear depreciation method for its plant assets.
Book value is a value of an asset after depreciation. It is calculated using the assets’ current value and liabilities (Miller-Nobles et al., 2020). The cost and the net book value of Costco’s plant assets in 2021 were $23,400 million (Costco Wholesale, 2021). Although depreciation reduces the book value of buildings and equipment, it is not considered an asset or liability because it is an unavoidable but replaceable expense.
Intangible Assets and Goodwill
Intangibles are assets that do not have any physical form. They include patents, trademarks, book copyrights, or other intellectual rights protected by law (Miller-Nobles et al., 2020). On the company’s balance sheets, intangible assets are listed under the section of other long-term assets (Costco Wholesale, 2021). This type of asset undergoes amortization and lifespan estimation, which is equivalent to the period of continuous profit that it brings to the firm.
Costco reviews its intangible assets and goodwill annually closer to the end of the fourth quarter. Goodwill is the additional asset that comes from the acquired company and is not subjected to amortization (Costco Wholesale, 2021). This strategy protects the company from unwanted risks to shareholders’ equity and also makes the balance sheet much stronger. Costco listed goodwill in the United States, Canada, and other countries where its warehouses are located (Costco Wholesale, 2021). Like tangible assets, goodwill is listed in other long-term assets on the corporation’s balance sheets.
Unearned Revenue
Unearned revenue is money a company receives for a product that has not been delivered yet. It can be understood as a prepayment for the product and counts as a liability because there are certain obligations that the firm has (Miller-Nobles et al., 2020). However, this liability must be covered in a specific time period because of the service or product delivery. Examples of unearned revenue are airline tickets, legal retainers, and prepayments for different subscriptions. The way unearned revenue arises is when companies receive money before products are delivered. The liability is reduced to zero, and the amount of money for it transfers into earned revenue when companies provide the product or service for unearned revenue.
Debts and Warranties
Many businesses have debts since they often need to make large purchases that cannot be repaid immediately. Costco’s total long-term debt was $7.5 million in 2021, consisting primarily of senior notes (Costco Wholesale, 2021). The short-term borrowings in 2021 were more than $40 million (Costco Wholesale, 2021). There was a slight drop in the former compared to the preceding year, but the latter was nonexistent in 2020.
A warranty is a program of extended client service using specific loss coverage. At the same time, warranty expense is the number of money companies spends because of product replacement or renovation of goods that broke down (Miller-Nobles et al., 2020). Warranty expenses create liabilities and sometimes debts that must be repaid. Businesses record warranties as expenses in the situation when the product that was returned by a customer cannot be re-sold or repaired, requiring a total refund.
Contingent Liability
A contingent liability is a responsibility that may not arise but needs to be recorded because of possible negative consequences for customers and the company. Three main types of contingent liabilities are known: probable, reasonably possible, and remote (Miller-Nobles et al., 2020). Remote liability has a low probability of occurring; thus, there is no necessity to include it in the financial statement. Reasonably possible can appear but are unlikely to happen, and probable contingent liability has a high likelihood of taking place; therefore, these two should be described in the company’s financial statement (Miller-Nobles et al., 2020). If the firm does not include them, it may result in lawsuits and monetary expenses for the company.
Conclusion
Costco Wholesale Corporation seems to be a promising company for investors since it uses unique strategies that ensure steady growth. Specifically, Costco only sells products through memberships, substantially minimizing Doubtful Accounts. Although the company’s cash ratio calculations revealed that the firm still has more liabilities than assets, its steady countrywide and global expansion shows that Costco will be able to alter this situation. Overall, venture capitalists should consider providing financing for Costco because its stability will ensure continuous return on investment regardless of the situation in the market.
References
Chalmers, K., Hay, D., & Khlif, H. (2018). Internal control in accounting research: A review. Journal of Accounting Literature, 42(1), 80-103.
Costco Wholesale. (2021). Annual report 2021. Web.
Kim, J. J. (2019). The empirical study on purchasing behavior between Costco Wholesale members and non-members. Journal of Distribution Science, 17(9), 25–33.
Macrotrends. (2022). Walmart’s current ratio 2010-2022. Web.
Miller-Nobles, T., Mattison, B., & Matsumura, E. M. (2020). Horngren’s accounting: The financial chapters (12th Ed.). Pearson.
Reciprocity. (2022). What are the 3 types of internal control? Web.