Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors

Costco Wholesale Corporation:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of September 2, 2018 and September 3, 2017, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 2, 2018, the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 2, 2018 and September 3, 2017, and the results of its operations and its cash flows for the 52-week period ended September 2, 2018, the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of September 2, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 25, 2018 expressed an adverse opinion on the effectiveness of the Company’s internal control over financial reporting.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ KPMG LLP

We have served as the Company’s auditor since 2002.

Seattle, Washington

October 25, 2018

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors

Costco Wholesale Corporation:

Opinion on Internal Control Over Financial Reporting

We have audited Costco Wholesale Corporation and subsidiaries’ (the Company) internal control over financial reporting as of September 2, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, because of the effect of the material weakness, described below, on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of September 2, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of September 2, 2018 and September 3, 2017, and the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 2, 2018, the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016, and the related notes (collectively, the consolidated financial statements), and our report dated October 25, 2018 expressed an unqualified opinion on those consolidated financial statements.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment:

There were ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Company’s financial reporting processes. As a result, business process automated and manual controls that were dependent on the affected ITGCs were ineffective because they could have been adversely impacted. These control deficiencies were a result of: IT control processes lacked sufficient documentation; insufficient knowledge and training of certain individuals with IT expertise; and risk-assessment processes inadequate to identify and assess changes in IT environments and personnel that could impact internal control over financial reporting.

The material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the fiscal year 2018 consolidated financial statements, and this report does not affect our report on those consolidated financial statements.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting (Item 9A). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal

control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ KPMG LLP

Seattle, Washington

October 25, 2018

COSTCO WHOLESALE CORPORATION

CONSOLIDATED BALANCE SHEETS

(amounts in millions, except par value and share data)

	September 2, 2018				September 3, 2017
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	6,055			$	4,546
Short-term investments	1,204				1,233
Receivables, net	1,669				1,432
Merchandise inventories	11,040				9,834
Other current assets	321				272
Total current assets	20,289				17,317
PROPERTY AND EQUIPMENT
Land	6,193				5,690
Buildings and improvements	16,107				15,127
Equipment and fixtures	7,274				6,681
Construction in progress	1,140				843
	30,714				28,341
Less accumulated depreciation and amortization	(11,033		)		(10,180		)
Net property and equipment	19,681				18,161
OTHER ASSETS	860				869
TOTAL ASSETS	$	40,830			$	36,347
LIABILITIES AND EQUITY
CURRENT LIABILITIES
Accounts payable	$	11,237			$	9,608
Accrued salaries and benefits	2,994				2,703
Accrued member rewards	1,057				961
Deferred membership fees	1,624				1,498
Other current liabilities	3,014				2,725
Total current liabilities	19,926				17,495
LONG-TERM DEBT, excluding current portion	6,487				6,573
OTHER LIABILITIES	1,314				1,200
Total liabilities	27,727				25,268
COMMITMENTS AND CONTINGENCIES
EQUITY
Preferred stock $0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding	0				0
Common stock $0.01 par value; 900,000,000 shares authorized; 438,189,000 and 437,204,000 shares issued and outstanding	4				4
Additional paid-in capital	6,107				5,800
Accumulated other comprehensive loss	(1,199		)		(1,014		)
Retained earnings	7,887				5,988
Total Costco stockholders’ equity	12,799				10,778
Noncontrolling interests	304				301
Total equity	13,103				11,079
TOTAL LIABILITIES AND EQUITY	$	40,830			$	36,347

The accompanying notes are an integral part of these consolidated financial statements.

COSTCO WHOLESALE CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(amounts in millions, except per share data)

	52 Weeks Ended				53 Weeks Ended				52 Weeks Ended
	September 2, 2018				September 3, 2017				August 28, 2016
REVENUE
Net sales	$	138,434			$	126,172			$	116,073
Membership fees	3,142				2,853				2,646
Total revenue	141,576				129,025				118,719
OPERATING EXPENSES
Merchandise costs	123,152				111,882				102,901
Selling, general and administrative	13,876				12,950				12,068
Preopening expenses	68				82				78
Operating income	4,480				4,111				3,672
OTHER INCOME (EXPENSE)
Interest expense	(159		)		(134		)		(133		)
Interest income and other, net	121				62				80
INCOME BEFORE INCOME TAXES	4,442				4,039				3,619
Provision for income taxes	1,263				1,325				1,243
Net income including noncontrolling interests	3,179				2,714				2,376
Net income attributable to noncontrolling interests	(45		)		(35		)		(26		)
NET INCOME ATTRIBUTABLE TO COSTCO	$	3,134			$	2,679			$	2,350
NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO:
Basic	$	7.15			$	6.11			$	5.36
Diluted	$	7.09			$	6.08			$	5.33
Shares used in calculation (000’s)
Basic	438,515				438,437				438,585
Diluted	441,834				440,937				441,263
CASH DIVIDENDS DECLARED PER COMMON SHARE	$	2.14			$	8.90			$	1.70

The accompanying notes are an integral part of these consolidated financial statements.

COSTCO WHOLESALE CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(amounts in millions)

	52 Weeks Ended				53 Weeks Ended				52 Weeks Ended
	September 2, 2018				September 3, 2017				August 28, 2016
NET INCOME INCLUDING NONCONTROLLING INTERESTS	$	3,179			$	2,714			$	2,376
Foreign-currency translation adjustment and other, net	(192		)		98				26
Comprehensive income	2,987				2,812				2,402
Less: Comprehensive income attributable to noncontrolling interests	38				48				30
COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO	$	2,949			$	2,764			$	2,372

The accompanying notes are an integral part of these consolidated financial statements.

COSTCO WHOLESALE CORPORATION

CONSOLIDATED STATEMENTS OF EQUITY

(amounts in millions)

	Common Stock							Additional Paid-in Capital				Accumulated Other Comprehensive Income (Loss)				Retained Earnings				Total Costco Stockholders’ Equity				Noncontrolling Interests				Total Equity
	Shares (000’s)			Amount
BALANCE AT AUGUST 30, 2015	437,952			$	2			$	5,218			$	(1,121	)		$	6,518			$	10,617			$	226			$	10,843
Net income	—			—				—				—				2,350				2,350				26				2,376
Foreign-currency translation adjustment and other, net	—			—				—				22				—				22				4				26
Stock-based compensation	—			—				459				—				—				459				—				459
Stock options exercised, including tax effects	4			—				—				—				—				—				—				—
Release of vested restricted stock units (RSUs), including tax effects	2,749			—				(146		)		—				—				(146		)		—				(146		)
Conversion of convertible notes	3			—				—				—				—				—				—				—
Repurchases of common stock	(3,184	)		—				(41		)		—				(436		)		(477		)		—				(477		)
Cash dividends declared and other	—			—				—				—				(746		)		(746		)		(3		)		(749		)
BALANCE AT AUGUST 28, 2016	437,524			2				5,490				(1,099		)		7,686				12,079				253				12,332
Net income	—			—				—				—				2,679				2,679				35				2,714
Foreign-currency translation adjustment and other, net	—			—				—				85				—				85				13				98
Stock-based compensation	—			—				518				—				—				518				—				518
Release of vested RSUs, including tax effects	2,673			—				(165		)		—				—				(165		)		—				(165		)
Conversion of convertible notes	5			—				—				—				—				—				—				—
Repurchases of common stock	(2,998	)		—				(41		)		—				(432		)		(473		)		—				(473		)
Cash dividends declared and other	—			2				(2		)		—				(3,945		)		(3,945		)		—				(3,945		)
BALANCE AT SEPTEMBER 3, 2017	437,204			4				5,800				(1,014		)		5,988				10,778				301				11,079
Net income	—			—				—				—				3,134				3,134				45				3,179
Foreign-currency translation adjustment and other, net	—			—				—				(185		)		—				(185		)		(7		)		(192		)
Stock-based compensation	—			—				547				—				—				547				—				547
Release of vested RSUs, including tax effects	2,741			—				(217		)		—				—				(217		)		—				(217		)
Repurchases of common stock	(1,756	)		—				(26		)		—				(296		)		(322		)		—				(322		)
Cash dividends declared and other	—			—				3				—				(939		)		(936		)		(35		)		(971		)
BALANCE AT SEPTEMBER 2, 2018	438,189			$	4			$	6,107			$	(1,199	)		$	7,887			$	12,799			$	304			$	13,103

The accompanying notes are an integral part of these consolidated financial statements.

COSTCO WHOLESALE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in millions)

	52 Weeks Ended				53 Weeks Ended				52 Weeks Ended
	September 2, 2018				September 3, 2017				August 28, 2016
CASH FLOWS FROM OPERATING ACTIVITIES
Net income including noncontrolling interests	$	3,179			$	2,714			$	2,376
Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities:
Depreciation and amortization	1,437				1,370				1,255
Stock-based compensation	544				514				459
Other non-cash operating activities, net	(6		)		(14		)		(57		)
Deferred income taxes	(49		)		(29		)		269
Changes in operating assets and liabilities:
Merchandise inventories	(1,313		)		(894		)		(25		)
Accounts payable	1,561				2,258				(1,532		)
Other operating assets and liabilities, net	421				807				547
Net cash provided by operating activities	5,774				6,726				3,292
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of short-term investments	(1,060		)		(1,279		)		(1,432		)
Maturities and sales of short-term investments	1,078				1,385				1,709
Additions to property and equipment	(2,969		)		(2,502		)		(2,649		)
Other investing activities, net	4				30				27
Net cash used in investing activities	(2,947		)		(2,366		)		(2,345		)
CASH FLOWS FROM FINANCING ACTIVITIES
Change in bank checks outstanding	80				(236		)		81
Repayments of short-term borrowings	—				—				(106		)
Proceeds from short-term borrowings	—				—				106
Proceeds from issuance of long-term debt	—				3,782				185
Repayments of long-term debt	(86		)		(2,200		)		(1,288		)
Tax withholdings on stock-based awards	(217		)		(202		)		(220		)
Repurchases of common stock	(328		)		(469		)		(486		)
Cash dividend payments	(689		)		(3,904		)		(746		)
Other financing activities, net	(41		)		11				55
Net cash used in financing activities	(1,281		)		(3,218		)		(2,419		)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS	(37		)		25				50
Net change in cash and cash equivalents	1,509				1,167				(1,422		)
CASH AND CASH EQUIVALENTS BEGINNING OF YEAR	4,546				3,379				4,801
CASH AND CASH EQUIVALENTS END OF YEAR	$	6,055			$	4,546			$	3,379
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest (reduced by $19, $16, and $19, interest capitalized in 2018, 2017, and 2016, respectively)	$	143			$	131			$	123
Income taxes, net	$	1,204			$	1,185			$	953
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Property and equipment acquired, but not yet paid	$	113			$	—			$	—
Cash dividend declared, but not yet paid	$	250			$	—			$	—

The accompanying notes are an integral part of these consolidated financial statements.

COSTCO WHOLESALE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(amounts in millions, except share, per share, and warehouse count data)

Note 1—Summary of Significant Accounting Policies

Description of Business

Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At September 2, 2018, Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan.

Basis of Presentation

The consolidated financial statements include the accounts of Costco Wholesale Corporation, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Company’s equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. The Company’s net income excludes income attributable to the noncontrolling interest in Taiwan. During the first quarter of 2018, Costco purchased its former joint-venture partner's remaining equity interest in its Korean operations. Unless otherwise noted, references to net income relate to net income attributable to Costco.

Fiscal Year End

The Company operates on a 52/53 week fiscal year basis with the fiscal year ending on the Sunday closest to August 31. References to 2018 and 2016 relate to the 52-week fiscal years ended September 2, 2018, and August 28, 2016, respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions.

Cash and Cash Equivalents

The Company considers as cash and cash equivalents all cash on deposit, highly liquid investments with a maturity of three months or less at the date of purchase, and proceeds due from credit and debit card transactions with settlement terms of up to four days. Credit and debit card receivables were $1,348 and $1,255 at the end of 2018 and 2017, respectively.

The Company provides for the daily replenishment of major bank accounts as checks are presented. Included in accounts payable at the end of 2018 and 2017 are $463 and $383, respectively, representing the excess of outstanding checks over cash on deposit at the banks on which the checks were drawn.

Short-Term Investments

In general, short-term investments have a maturity at the date of purchase of three months to five years. Investments with maturities beyond five years may be classified, based on the Company’s determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest income and other, net in the consolidated statements of income. Short-term investments classified as held-to-maturity are financial instruments that the Company has the intent and ability to hold to maturity and are reported net of any related amortization and are not remeasured to fair value on a recurring basis.

The Company periodically evaluates unrealized losses in its investment securities for other-than-temporary impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be other-than-temporarily impaired, the Company recognizes the loss in interest income and other, net in the consolidated statements of income.

Fair Value of Financial Instruments

The Company accounts for certain assets and liabilities at fair value. The carrying value of the Company’s financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate fair value due to their short-term nature or variable interest rates. See Notes 2, 3, and 4 for the carrying value and fair value of the Company’s investments, derivative instruments, and fixed-rate debt, respectively.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Significant unobservable inputs that are not corroborated by market data.

The Company’s valuation techniques used to measure the fair value of money market mutual funds are based on quoted market prices, such as quoted net asset values published by the fund as supported in an active market. Valuation methodologies used to measure the fair value of all other non-derivative financial instruments are based on independent external valuation information. The pricing process uses data from a variety of independent external valuation information providers, including trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to treasury benchmarks and Libor and swap curves, discount rates, and market data feeds. All are observable in the market or can be derived principally from or corroborated by observable market data. The Company reports transfers in and out of Levels 1, 2, and 3, as applicable, using the fair value of the individual securities as of the beginning of the reporting period in which the transfer(s) occurred.

Current financial liabilities have fair values that approximate their carrying values. Long-term financial liabilities include the Company's long-term debt, which are recorded on the balance sheet at issuance price and adjusted for unamortized discounts or premiums and debt issuance costs, and are being amortized to interest expense over the term of the loan. The estimated fair value of the Company's long-term debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit.

Receivables, Net

Receivables consist primarily of vendor, reinsurance, credit card incentive, third-party pharmacy and other receivables. Vendor receivables include coupons, volume rebates or other purchase discounts. Balances are generally presented on a gross basis, separate from any related payable due. In certain circumstances, these receivables may be settled against the related payable to that vendor, in which case the receivables are presented on a net basis. Reinsurance receivables are held by the Company’s wholly-owned captive insurance subsidiary and primarily represent amounts ceded through reinsurance arrangements gross of the amounts assumed under reinsurance, which are presented within other current liabilities in the consolidated balance sheets. Credit card incentive receivables primarily represent amounts earned under the co-branded credit card arrangement in the U.S. Third-party pharmacy receivables generally relate to amounts due from members’ insurers. Other receivables primarily consist of amounts due from governmental entities, mostly tax-related items.

Receivables are recorded net of an allowance for doubtful accounts. The allowance is based on historical experience and application of the specific identification method. Write-offs of receivables were immaterial for fiscal years 2018, 2017, and 2016.

Merchandise Inventories

Merchandise inventories consist of the following:

	2018				2017
United States	$	8,081			$	7,091
Canada	1,189				1,040
Other International	1,770				1,703
Merchandise inventories	$	11,040			$	9,834

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. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company 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 2, 2018 and 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 was recorded to merchandise costs in 2016.

The Company provides for estimated inventory losses between physical inventory counts as a percentage of net sales, using estimates based on the Company’s experience. The provision is adjusted periodically to reflect 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 the Company progresses towards earning those rebates, provided that they are probable and reasonably estimable.

Property and Equipment

Property and equipment are stated at cost. In general, new building additions are classified into components, each with an estimated useful life, generally five to fifty years for buildings and improvements and three to twenty years for equipment and fixtures. Depreciation and amortization expense is computed using the straight-line method over estimated useful lives or the lease term, if shorter. Leasehold improvements made after the beginning of the initial lease term are depreciated over the shorter of the estimated useful life of

the asset or the remaining term of the initial lease plus any renewals that are reasonably assured at the date the leasehold improvements are made.

The Company capitalizes certain computer software and software development costs incurred in developing or obtaining computer software for internal use. These costs are included in equipment and fixtures and amortized on a straight-line basis over the estimated useful lives of the software, generally three to seven years.

Repair and maintenance costs are expensed when incurred. Expenditures for remodels, refurbishments and improvements that add to or change the way an asset functions or that extend the useful life are capitalized. Assets that were removed during the remodel, refurbishment or improvement are retired. Assets classified as held-for-sale at the end of 2018 and 2017 were immaterial.

The Company evaluates long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances may indicate the carrying amount of the asset group, generally an individual warehouse, may not be fully recoverable. For asset groups held and used, including warehouses to be relocated, the carrying value of the asset group is considered recoverable when the estimated future undiscounted cash flows generated from the use and eventual disposition of the asset group exceed the respective carrying value. In the event that the carrying value is not considered recoverable, an impairment loss is recognized for the asset group to be held and used equal to the excess of the carrying value above the estimated fair value of the asset group. For asset groups classified as held-for-sale (disposal group), the carrying value is compared to the disposal group’s fair value less costs to sell. The Company estimates fair value by obtaining market appraisals from third party brokers or using other valuation techniques. There were no impairment charges recognized in 2018, 2017 or 2016.

Insurance/Self-Insurance Liabilities

The Company is predominantly self-insured for employee health care benefits, workers’ compensation, general liability, property damage, directors’ and officers’ liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit the exposure arising from catastrophic events. It uses different mechanisms including a wholly-owned captive insurance subsidiary (the captive) and participates in a reinsurance program. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. At the end of 2018 and 2017, these insurance liabilities were $1,148 and $1,059 in the aggregate, respectively, and were included in accrued salaries and benefits and other current liabilities in the consolidated balance sheets, classified based on their nature.

The captive receives direct premiums, which are netted against the Company’s premium costs in selling, general and administrative expenses, in the consolidated statements of income. The captive participates in a reinsurance program that includes other third-party participants. The reinsurance agreement is one year in duration, and new agreements are entered into by each participant at their discretion at the commencement of the next calendar year. The participant agreements and practices of the reinsurance program limit a participating members’ individual risk. Income statement adjustments related to the reinsurance program and related impacts to the consolidated balance sheets are recognized as information becomes known. In the event the Company leaves the reinsurance program, the Company retains its primary obligation to the policyholders for prior activity.

Derivatives

The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Company’s international subsidiaries with functional currencies other

than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. Some of these contracts contain credit-risk-related contingent features that require settlement of outstanding contracts upon certain triggering events. At the end of 2018 and 2017, the aggregate fair value amounts of derivative instruments in a net liability position and the amount needed to settle the instruments immediately if the credit-risk-related contingent features were triggered were immaterial. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $717 and $637 at the end of 2018 and 2017, respectively. See Note 3 for information on the fair value of unsettled forward foreign-exchange contracts at the end of 2018 and 2017.

The unrealized gains or losses recognized in interest income and other, net in the accompanying consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts were immaterial in 2018, 2017, and 2016.

The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the “normal purchases or normal sales” exception under authoritative guidance and require no mark-to-market adjustment.

Foreign Currency

The functional currencies of the Company’s international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Translation adjustments are recorded in accumulated other comprehensive loss. Revenues and expenses of the Company’s consolidated foreign operations are translated at average exchange rates prevailing during the year.

The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the accompanying consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items were immaterial for 2018 and 2017 and resulted in net gains of$38 for 2016.

Revenue Recognition

The Company generally recognizes sales, which include gross shipping fees where applicable, net of returns, at the time the member takes possession of merchandise or receives services. When the Company collects payments from members prior to the transfer of ownership of merchandise or the performance of services, the amounts received are generally recorded as deferred sales, included in other current liabilities in the consolidated balance sheets, until the sale or service is completed. The Company reserves for estimated sales returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The sales returns reserve is based on an estimate of the net realizable value of merchandise inventories expected to be returned. Amounts collected from members for sales or value added taxes are recorded on a net basis.

Generally, when Costco is the primary obligor, is subject to inventory risk, has latitude in establishing prices and selecting suppliers, can influence product or service specifications, or has several but not all of these indicators, revenue is recorded on a gross basis. It otherwise records the net amounts earned, which is reflected in net sales.

The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership. The Company's Executive members qualify for a 2% reward on qualified purchases

(up to a maximum reward of approximately $1,000 per year), which can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales. The sales reduction and corresponding liability (classified as accrued member rewards in the consolidated balance sheets) are computed after giving effect to the estimated impact of non-redemptions, based on historical data. The net reduction in sales was $1,394, $1,281, and $1,172 in 2018, 2017, and 2016, respectively.

Merchandise Costs

Merchandise costs consist of the purchase price or manufacturing costs of inventory sold, inbound and outbound shipping charges and all costs related to the Company’s depot operations, including freight from depots to selling warehouses, and are reduced by vendor consideration. Merchandise costs also include salaries, benefits, depreciation, and utilities in fresh foods and certain ancillary departments.

Vendor Consideration

The Company has agreements to receive funds from vendors for coupons and a variety of other programs. These programs are evidenced by signed agreements that are reflected in the carrying value of the inventory when earned or as the Company progresses towards earning the rebate or discount, and as a component of merchandise costs as the merchandise is sold. Other vendor consideration is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by another systematic approach.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of salaries, benefits and workers’ compensation costs for warehouse employees (other than fresh foods departments and certain ancillary businesses) as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include substantially all building and equipment depreciation, stock compensation expense, utilities, credit and debit card processing fees, as well as other operating costs incurred to support warehouse operations.

Retirement Plans

The Company's 401(k) retirement plan is available to all U.S. employees who have completed 90 days of employment. The plan allows participants to make wage deferral contributions, a portion of which the Company matches. In addition, the Company provides each eligible participant an annual discretionary contribution. The Company also has a defined contribution plan for Canadian employees and contributes a percentage of each employee's wages. Certain subsidiaries in the Company's Other International operations have defined benefit and defined contribution plans that are not material. Amounts expensed under all plans were $578, $543, and $489 for 2018, 2017, and 2016, respectively, and are predominantly included in selling, general and administrative expenses in the accompanying consolidated statements of income.

Stock-Based Compensation

Restricted stock units (RSUs) granted to employees generally vest over five years and allow for quarterly 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. Actual forfeitures are recognized as they occur.

Compensation expense for stock-based awards is predominantly recognized using the straight-line method over the requisite service period for the entire award. Awards for employees and non-employee directors provide for accelerated vesting of a portion of outstanding shares based on cumulative years of service with the Company. Compensation expense for the accelerated shares is recognized upon achievement of the long-service term. The cumulative amount of compensation cost recognized at any point in time equals at least the portion of the grant-date fair value of the award that is vested at that date. The fair value of RSUs is calculated as the market value of the common stock on the measurement date less the present value of the expected dividends forgone during the vesting period.

Stock-based compensation expense is predominantly included in selling, general and administrative expenses in the consolidated statements of income. Certain stock-based compensation costs are capitalized or included in the cost of merchandise. See Note 7 for additional information on the Company’s stock-based compensation plans.

Leases

The Company leases land and/or buildings at warehouses and certain other office and distribution facilities, primarily under operating leases. Operating leases expire at various dates through 2064, with the exception of one lease in the U.K., which expires in 2151. These leases generally contain one or more of the following options, which the Company can exercise at the end of the initial lease term: (a) renewal of the lease for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase of the property at the then-fair market value; or (c) right of first refusal in the event of a third-party purchase offer.

The Company accounts for its lease expense with free rent periods and step-rent provisions on a straight-line basis over the original term of the lease and any extension options that the Company more likely than not expects to exercise, from the date the Company has control of the property. Certain leases provide for periodic rental increases based on price indices, or the greater of minimum guaranteed amounts or sales volume.

The Company has capital leases for certain warehouse locations, expiring at various dates through 2059. Capital lease assets are included in land and buildings and improvements in the accompanying consolidated balance sheets. Amortization expense on capital lease assets is recorded as depreciation expense and is included in selling, general and administrative expenses. Capital lease liabilities are recorded at the lesser of the estimated fair market value of the leased property or the net present value of the aggregate future minimum lease payments and are included in other current liabilities and other liabilities in the accompanying consolidated balance sheets. Interest on these obligations is included in interest expense in the consolidated statements of income.

The Company records an asset and related financing obligation for the estimated construction costs under build-to-suit lease arrangements where it is considered the owner for accounting purposes, to the extent the Company is involved in the construction of the building or structural improvements or has construction risk prior to commencement of a lease. Upon occupancy, the Company assesses whether these arrangements qualify for sales recognition under the sale-leaseback accounting guidance. If the Company continues to be the deemed owner, it accounts for the arrangement as a financing lease.

The Company’s asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are recorded as a liability with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the leasehold improvements. These liabilities are accreted over time to the projected future value of the obligation using the Company’s incremental borrowing rate. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases were immaterial at the end of 2018 and 2017, respectively, and are included in other liabilities in the accompanying consolidated balance sheets.

Preopening Expenses

Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and are expensed as incurred.

Income Taxes

The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial

statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts that are more likely than not expected to be realized.

The timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions requires significant judgment. The benefits of uncertain tax positions are recorded in the Company’s consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes as appropriate.

Net Income per Common Share Attributable to Costco

The computation of basic net income per share uses the weighted average number of shares that were outstanding during the period. The computation of diluted net income per share uses the weighted average number of shares in the basic net income per share calculation plus the number of common shares that would be issued assuming vesting of all potentially dilutive common shares outstanding using the treasury stock method for shares subject to RSUs.

Stock Repurchase Programs

Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 6 for additional information.

Recent Accounting Pronouncements Adopted

In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09 related to the accounting for share-based payment transactions. The guidance relates to income taxes, forfeitures, and minimum statutory tax withholding requirements. The new standard was effective for fiscal years and interim periods within those years beginning after December 15, 2016, with early adoption permitted. The Company adopted this guidance at the beginning of its first quarter of fiscal year 2018. As a result, the Company recognized a net tax benefit in fiscal 2018 of $33 as part of its income tax provision in the accompanying consolidated statements of income, which includes the impact of the lower tax rate from the 2017 Tax Act. Previously, tax benefits associated with the release of employee RSUs were reflected in equity. These amounts are now reflected as cash flows from operations instead of cash flows from financing activities in the consolidated statements of cash flows on a prospective basis. Adoption of this guidance did not have a material impact on the consolidated balance sheets, consolidated statements of cash flows, or related disclosures.

Recent Accounting Pronouncements Not Yet Adopted

In May 2014, the FASB issued ASU 2014-09 providing for changes in the recognition of revenue from contracts with customers. The guidance converges the requirements for reporting revenue and requires disclosures sufficient to describe the nature, amount, timing, and uncertainty of revenue and cash flows arising from these contracts. The new standard is effective for fiscal years and interim periods within those years beginning after December 15, 2017. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2019, using the modified retrospective approach through a cumulative effect adjustment to retained earnings. The Company has substantially completed its assessment of the new standard and it does not believe the impacts to be material to the Company's consolidated financial statements. The Company continues to evaluate the disclosure requirements related to the new standard.

In February 2016, the FASB issued ASU 2016-02 which will require recognition on the balance sheet for the rights and obligations created by leases with terms greater than twelve months. The new standard is effective for fiscal years and interim periods within those years beginning after December 15, 2018, with early adoption permitted. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2020 and plans to utilize the transition option which does not require application of the guidance to comparative periods in the year of adoption. While the Company continues to evaluate this standard and the effect on related disclosures, the primary effect of adoption will be recording right-of-use assets and corresponding lease obligations for current operating leases. The adoption is expected to have a material impact on the Company's consolidated balance sheets, but not on the consolidated statements of income or cash flows. Additionally, the Company is in the process of reviewing current accounting policies, changes to business processes, systems and controls to support adoption of the new standard, which includes implementing a new lease accounting system.

Note 2—Investments

The Company’s investments were as follows:

2018:	Cost Basis				Unrealized Losses, Net				Recorded Basis
Available-for-sale:
Government and agency securities	$	912			$	(14	)		$	898
Held-to-maturity:
Certificates of deposit	306								306
Total short-term investments	$	1,218			$	(14	)		$	1,204

2017:	Cost Basis				Unrealized Gains, Net				Recorded Basis
Available-for-sale:
Government and agency securities	$	947			$	0			$	947
Mortgage-backed securities	1				0				1
Total available-for-sale	948				0				948
Held-to-maturity:
Certificates of deposit	285								285
Total short-term investments	$	1,233			$	0			$	1,233

Gross unrealized gains and losses on available-for-sale securities were not material in 2018, 2017, and 2016. At the end of 2018 and 2017, the Company's available-for-sale securities that were in a continuous unrealized-loss position were not material. The Company had no available-for-sale securities in a continuous unrealized-loss position in 2016. Gross unrealized gains and losses on cash equivalents were not material at the end of 2018, and there were no gross unrealized gains and losses on cash equivalents at the end of 2017 or 2016.

The proceeds from sales of available-for-sale securities were $39, $202, and $291 during 2018, 2017, and 2016, respectively. Gross realized gains or losses from sales of available-for-sale securities were not material in 2018, 2017, and 2016.

The maturities of available-for-sale and held-to-maturity securities at the end of 2018 were as follows:

	Available-For-Sale								Held-To-Maturity
	Cost Basis				Fair Value
Due in one year or less	$	307			$	305			$	306
Due after one year through five years	584				572				0
Due after five years	21				21				0
Total	$	912			$	898			$	306

Note 3—Fair Value Measurement

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The tables below present information regarding the Company’s financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine such fair value.

2018:	Level 1				Level 2
Money market mutual funds(1)	$	9			$	0
Investment in government and agency securities(2)	0				903
Forward foreign-exchange contracts, in asset position(3)	0				16
Forward foreign-exchange contracts, in (liability) position(3)	0				(2		)
Total	$	9			$	917

2017:	Level 1				Level 2
Money market mutual funds(1)	$	7			$	0
Investment in government and agency securities(2)	0				947
Investment in mortgage-backed securities	0				1
Forward foreign-exchange contracts, in asset position(3)	0				2
Forward foreign-exchange contracts, in (liability) position(3)	0				(8		)
Total	$	7			$	942

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(1)	Included in cash and cash equivalents in the accompanying consolidated balance sheets.

(2)	At September 2, 2018, immaterial cash and cash equivalents and $898 short-term investments are included in the accompanying condensed consolidated balance sheets. At September 3, 2017, there were no securities included in cash and cash equivalents and $947 included in short-term investments in the accompanying condensed consolidated balance sheets.

(3)	The asset and the liability values are included in other current assets and other current liabilities, respectively, in the accompanying consolidated balance sheets. See Note 1 for additional information on derivative instruments.

During and at the end of both 2018 and 2017, the Company did not hold any Level 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers in or out of Level 1 or 2 during 2018 and 2017.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets measured at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. There were no fair value adjustments to these items during 2018 and 2017.

Note 4—Debt

Short-Term Borrowings

The Company maintains various short-term bank credit facilities with a borrowing capacity of $857 and $833, in 2018 and 2017, respectively. Borrowings on these short-term facilities were immaterial during 2018 and 2017, and there were no outstanding borrowings at the end of 2018 and 2017.

Long-Term Debt

The Company's long-term debt consists primarily of Senior Notes, which have various principal balances, interest rates, and maturity dates as described below. In May 2017, the Company issued $3,800 in aggregate principal amount of Senior Notes, with maturity dates between May 2021 and May 2027. Additionally, in 2017 the Company repaid long-term debt totaling $2,200.

The Company at its option may redeem the Senior Notes at any time, in whole or in part, at a redemption price plus accrued interest. The redemption price is equal to the greater of 100% of the principal amount or the sum of the present value of the remaining scheduled payments of principal and interest to maturity. Additionally, upon certain events, as defined by the terms of the Senior Notes, the holder has the right to require the Company to purchase this security at a price of 101% of the principal amount plus accrued and unpaid interest to the date of the event. Interest on all outstanding long-term debt is payable semi-annually.

The estimated fair value of Senior Notes is valued using Level 2 inputs. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japanese subsidiary and are valued using Level 3 inputs. At the end of 2018 and 2017, the fair value of the Company's long-term debt, including the current portion, was approximately $6,492 and $6,753, respectively. The carrying value of long-term debt consisted of the following:

	2018				2017
1.70% Senior Notes due December 2019	$	1,199			$	1,198
1.75% Senior Notes due February 2020	499				498
2.15% Senior Notes due May 2021	995				994
2.25% Senior Notes due February 2022	498				497
2.30% Senior Notes due May 2022	794				793
2.75% Senior Notes due May 2024	992				991
3.00% Senior Notes due May 2027	987				986
Other long-term debt	613				702
Total long-term debt	6,577				6,659
Less current portion(1)	90				86
Long-term debt, excluding current portion	$	6,487			$	6,573

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(1) Included in other current liabilities in the consolidated balance sheets.

Maturities of long-term debt during the next five fiscal years and thereafter are as follows:

2019	$	90
2020	1,700
2021	1,091
2022	1,300
2023	90
Thereafter	2,343
Total	$	6,614

Note 5—Leases

Operating Leases

The aggregate rental expense for 2018, 2017, and 2016 was $265, $258, and $250, respectively. Sub-lease income and contingent rent were not material in 2018, 2017, or 2016.

Capital and Build-to-Suit Leases

Gross assets recorded under capital and build-to-suit leases were $427 and $404 at the end of 2018 and 2017, respectively. These assets are recorded net of accumulated amortization of $94 and $78 at the end of 2018 and 2017, respectively.

At the end of 2018, future minimum payments, net of sub-lease income of $105 for all years combined, under non-cancelable operating leases with terms of at least one year and capital leases were as follows:

	Operating Leases				Capital Leases(1)
2019	$	227			$	34
2020	214				35
2021	193				36
2022	183				36
2023	175				36
Thereafter	2,215				647
Total	$	3,207			824
Less amount representing interest					(427		)
Net present value of minimum lease payments					397
Less current installments(2)					(7		)
Long-term capital lease obligations less current installments(3)					$	390

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(1)	Includes build-to-suit lease obligations.

(2)	Included in other current liabilities in the accompanying consolidated balance sheets.

(3)	Included in other liabilities in the accompanying consolidated balance sheets.

Note 6—Stockholders’ Equity

Dividends

The Company’s current quarterly dividend rate is $0.57 per share. In May 2017, the Company paid a special cash dividend of $7.00 per share. The aggregate payment was approximately $3,100. Subsequent to the end of 2018, the Board of Directors declared a quarterly cash dividend in the amount of $0.57 per share, which is payable on November 23, 2018.

Stock Repurchase Programs

The Company’s stock repurchase program is conducted under a $4,000 authorization by the Board of Directors, which expires April 17, 2019. As of the end of 2018, the remaining amount available for stock repurchases under the approved plan was $2,427. The following table summarizes the Company’s stock repurchase activity:

	Shares Repurchased (000’s)			Average Price per Share				Total Cost
2018	1,756			$	183.13			$	322
2017	2,998			157.87				473
2016	3,184			149.90				477

These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year.

Note 7—Stock-Based Compensation Plans

The Company grants stock-based compensation primarily to employees and non-employee directors. RSU grants to all executive officers are performance-based. Through a series of shareholder approvals, there have been amended and restated plans and new provisions implemented by the Company. RSUs are subject to quarterly vesting upon retirement or voluntary termination. Employees who attain certain years of service with the Company receive shares under accelerated vesting provisions on the annual vesting date rather than upon retirement. The Seventh Restated 2002 Stock Incentive Plan (Seventh Plan) is the Company’s only stock-based compensation plan with shares available for grant at the end of 2018. Each share issued in respect of stock awards is counted as 1.75 shares toward the limit of shares made available under the Seventh Plan. The Seventh Plan authorized the issuance of 23,500,000 shares (13,429,000 RSUs) of common stock for future grants in addition to the shares authorized under the previous plan. The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of statutory withholding taxes.

Summary of Restricted Stock Unit Activity

RSUs granted to employees and to non-employee directors generally vest over five and three years, respectively. Additionally, the terms of the RSUs, including performance-based awards, provide for accelerated vesting for employees and non-employee directors who have attained 25 or more and five or more years of service with the Company, respectively. Recipients are not entitled to vote or receive dividends on non-vested and undelivered shares. At the end of 2018, 8,313,000 shares were available to be granted as RSUs under the Seventh Plan.

The following awards were outstanding at the end of 2018:

•	7,246,000 time-based RSUs that vest upon continued employment over specified periods of time;

•	332,000 performance-based RSUs, of which 205,000 were granted to executive officers subject to the certification of the attainment of specified performance targets for 2018. This certification occurred in October 2018, at which time a portion vested as a result of the long service of all executive officers. The remaining awards vest upon continued employment over specified periods of time.

The following table summarizes RSU transactions during 2018:

	Number of Units (in 000’s)			Weighted-Average Grant Date Fair Value
Outstanding at the end of 2017	8,199			$	128.15
Granted	3,722			156.19
Vested and delivered	(4,088	)		129.49
Forfeited	(255	)		138.57
Outstanding at the end of 2018	7,578			$	140.85

The weighted-average grant date fair value of RSUs granted was $156.19, $144.12, and $153.46 in 2018, 2017, and 2016, respectively. The remaining unrecognized compensation cost related to non-vested RSUs at the end of 2018 was $693 and the weighted-average period of time over which this cost will be recognized is 1.6 years. Included in the outstanding balance at the end of 2018 were approximately 2,658,000 RSUs vested but not yet delivered.

Summary of Stock-Based Compensation

The following table summarizes stock-based compensation expense and the related tax benefits under the Company’s plans:

	2018				2017				2016
Stock-based compensation expense before income taxes	$	544			$	514			$	459
Less income tax benefit (1)	(116		)		(167		)		(150		)
Stock-based compensation expense, net of income taxes	$	428			$	347			$	309

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(1)	In 2018, the income tax benefit reflects the reduction in the U.S. federal statutory income tax rate from 35% to 21%.

Note 8—Income Taxes

Income before income taxes is comprised of the following:

	2018				2017				2016
Domestic	$	3,182			$	2,988			$	2,622
Foreign	1,260				1,051				997
Total	$	4,442			$	4,039			$	3,619

The provisions for income taxes are as follows:

	2018				2017				2016
Federal:
Current	$	636			$	802			$	468
Deferred	(35		)		7				233
Total federal	601				809				701
State:
Current	190				161				108
Deferred	22				8				21
Total state	212				169				129
Foreign:
Current	487				389				398
Deferred	(37		)		(42		)		15
Total foreign	450				347				413
Total provision for income taxes	$	1,263			$	1,325			$	1,243

In December 2017, the 2017 Tax Act was signed into law. Except for certain provisions, the 2017 Tax Act is effective for tax years beginning on or after January 1, 2018. The Company is a fiscal-year taxpayer, so most provisions will become effective for fiscal 2019, including limitations on the Company’s ability to claim foreign tax credits, repeal of the domestic manufacturing deduction, and limitations on certain business deductions. Provisions with significant impacts that were effective starting in the second quarter of fiscal 2018 and throughout the remainder of fiscal 2018 included: a decrease in the U.S. federal income tax rate, remeasurement of certain net deferred tax liabilities, and a transition tax on deemed repatriation of certain foreign earnings. The decrease in the U.S. federal statutory income tax rate to 21.0% resulted in a blended rate for the Company of 25.6% for fiscal 2018.

The reconciliation between the statutory tax rate and the effective rate is as follows:

	2018							2017							2016
Federal taxes at statutory rate	$	1,136			25.6	%		$	1,414			35.0	%		$	1,267			35.0	%
State taxes, net	154				3.4			116				2.9			91				2.5
Foreign taxes, net	32				0.7			(64		)		(1.6	)		(21		)		(0.6	)
Employee stock ownership plan (ESOP)	(14		)		(0.3	)		(104		)		(2.6	)		(17		)		(0.5	)
2017 Tax Act	19				0.4			—				—			—				—
Other	(64		)		(1.4	)		(37		)		(0.9	)		(77		)		(2.1	)
Total	$	1,263			28.4	%		$	1,325			32.8	%		$	1,243			34.3	%

During fiscal 2018, the Company recognized a net tax expense of $19 related to the 2017 Tax Act. This expense included $142 for the estimated tax on deemed repatriation of foreign earnings, and $43 for the reduction in foreign tax credits and other immaterial items, largely offset by a tax benefit of $166 for the provisional remeasurement of certain deferred tax liabilities. These items were predominantly recorded in the second quarter as provisional amounts and reflect the Company's current interpretations and estimates that it believes are reasonable. As the Company continues to evaluate the 2017 Tax Act and available data, it anticipates that adjustments may be made in future periods up to and including the second quarter of fiscal 2019 in accordance with Staff Accounting Bulletin 118.

In fiscal 2018, we also recognized net tax benefits of $76, which was largely driven by the adoption of an accounting standard related to stock-based compensation and other immaterial net benefits. In fiscal 2017, the Company’s provision for income taxes was favorably impacted by a net tax benefit of $104, primarily

due to tax benefits recorded in connection with the May 2017 special cash dividends paid by the Company to employees through the Company's 401(k) retirement plan of $82. Dividends on these shares are deductible for U.S. income tax purposes. There was no similar special cash dividend in 2018 or 2016.

The components of the deferred tax assets (liabilities) are as follows:

	2018				2017
Equity compensation	$	72			$	109
Deferred income/membership fees	136				167
Accrued liabilities and reserves	484				647
Property and equipment	(478		)		(747		)
Merchandise inventories	(175		)		(252		)
Other(1)	(40		)		18
Net deferred tax (liabilities)/assets	$	(1	)		$	(58	)

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(1)	Includes foreign tax credits of $36 for 2017. There were no foreign tax credits in 2018.

The deferred tax accounts at the end of fiscal 2018 and 2017 include deferred income tax assets of $316 and $254, respectively, included in other assets; and deferred income tax liabilities of $317 and $312, respectively, included in other liabilities.

The Company no longer considers current fiscal 2018 and future earnings of our non-U.S. consolidated subsidiaries to be permanently reinvested and has recorded the estimated incremental foreign withholding (net of available foreign tax credits) on current fiscal year earnings and state income taxes payable assuming a hypothetical repatriation to the U.S. The Company continues to consider undistributed earnings of certain non-U.S. consolidated subsidiaries prior to fiscal 2018, which totaled $3,071, to be indefinitely reinvested and has not provided for withholding or state taxes.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2018 and 2017 is as follows:

	2018				2017
Gross unrecognized tax benefit at beginning of year	$	52			$	52
Gross increases—current year tax positions	6				3
Gross increases—tax positions in prior years	6				17
Gross decreases—tax positions in prior years	(17		)		0
Settlements	(1		)		(11		)
Lapse of statute of limitations	(10		)		(9		)
Gross unrecognized tax benefit at end of year	$	36			$	52

The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2018 and 2017, these amounts were immaterial. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority. The total amount of such unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods is $32 and $29 at the end of 2018 and 2017, respectively.

Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Interest and penalties recognized during 2018 and 2017 and accrued at the end of each respective period were not material.

The Company is currently under audit by several jurisdictions in the United States and in several foreign countries. Some audits may conclude in the next 12 months and the unrecognized tax benefits recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months.

The Company files income tax returns in the United States, various state and local jurisdictions, in Canada, and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2014. The Company is currently subject to examination in California for fiscal years 2007 to present. No other examinations are believed to be material.

Note 9—Net Income per Common and Common Equivalent Share

The following table shows the amounts used in computing net income per share and the weighted average number of shares of potentially dilutive common shares outstanding (shares in 000’s):

	2018				2017				2016
Net income attributable to Costco	$	3,134			$	2,679			$	2,350
Weighted average number of common shares used in basic net income per common share	438,515				438,437				438,585
RSUs and other	3,319				2,500				2,678
Weighted average number of common shares and dilutive potential of common stock used in diluted net income per share	441,834				440,937				441,263

Note 10—Commitments and Contingencies

Legal Proceedings

The Company is involved in a number of claims, proceedings and litigation arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters reach a stage where they present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded an immaterial accrual with respect to one matter described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties.

The Company is a defendant in a class action alleging violation of California Wage Order 7-2001 for failing to provide seating to member service assistants who act as greeters and exit attendants in the Company’s California warehouses. Canela v. Costco Wholesale Corp., et al. (Case No. 5:13-cv-03598, N.D. Cal. filed July 1, 2013). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys’ fees. The Company filed an answer denying the material allegations of the complaint. The plaintiff has since indicated that exit attendants are no longer a subject of the litigation. The action in the district court

has been stayed pending review by the Ninth Circuit of the order certifying a class. On September 6, 2018, counsel claiming to represent an employee notified the California Labor and Workforce Development agency of an intention to bring similar claims concerning Costco employees engaged at member services counters.

On November 23, 2016, the Company’s Canadian subsidiary received from the Ontario Ministry of Health and Long Term Care a request for an inspection and information concerning compliance with the anti-rebate provisions in the Ontario Drug Benefit Act and the Drug Interchangeability and Dispensing Fee Act. The Company is seeking to cooperate with the request. The Ministry has indicated it has reason to believe the Company received payments in violation of these laws and is seeking disgorgement of these sums.

In December 2017, the United States Judicial Panel on Multidistrict Litigation consolidated numerous cases filed against various defendants by counties, cities, hospitals, Native American tribes and third-party payors concerning the impacts of opioid abuse. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are federal court cases that name the Company, including actions filed by a number of counties and cities in Michigan, New Jersey and Ohio, and a third-party payor in Ohio. Similar cases that name the Company have been filed in state courts in New Jersey and Oklahoma. The Company is defending these matters.

In November 2016 and September 2017, the Company received notices of violation from the Connecticut Department of Energy and Environmental Protection regarding hazardous waste practices at its Connecticut warehouses, primarily concerning unsalable pharmaceuticals. The Company is seeking to cooperate concerning the resolution of these notices.

The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Company’s financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter.

Note 11—Segment Reporting

The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the U.S., Canada, Mexico, U.K., Japan, Korea, Australia, Spain, Iceland, and France and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on management’s organization of the operating segments for operational decisions and assessments of financial performance, which considers geographic locations. The material accounting policies of the segments are as described in Note 1. Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, incurred on behalf of the Company's Canadian and Other International operations, are included in the U.S. operations because those costs generally come under the responsibility of U.S. management.

	United States Operations				Canadian Operations				Other International Operations				Total
2018
Total revenue	$	102,286			$	20,689			$	18,601			$	141,576
Operating income	2,787				939				754				4,480
Depreciation and amortization	1,078				135				224				1,437
Additions to property and equipment	2,046				268				655				2,969
Net property and equipment	13,353				1,900				4,428				19,681
Total assets	28,207				4,303				8,320				40,830
2017
Total revenue	$	93,889			$	18,775			$	16,361			$	129,025
Operating income	2,644				841				626				4,111
Depreciation and amortization	1,044				124				202				1,370
Additions to property and equipment	1,714				277				511				2,502
Net property and equipment	12,339				1,820				4,002				18,161
Total assets	24,068				4,471				7,808				36,347
2016
Total revenue	$	86,579			$	17,028			$	15,112			$	118,719
Operating income	2,326				778				568				3,672
Depreciation and amortization	946				109				200				1,255
Additions to property and equipment	1,823				299				527				2,649
Net property and equipment	11,745				1,628				3,670				17,043
Total assets	22,511				3,480				7,172				33,163

The following table summarizes the percentage of net sales by merchandise category:

	2018			2017			2016
Food and Sundries	41	%		41	%		43	%
Hardlines	16	%		16	%		16	%
Fresh Foods	14	%		14	%		14	%
Softlines	11	%		12	%		12	%
Ancillary	18	%		17	%		15	%

Note 12—Quarterly Financial Data (Unaudited)

The two tables that follow reflect the unaudited quarterly results of operations for 2018 and 2017.

	52 Weeks Ended September 2, 2018
	First Quarter (12 Weeks)				Second Quarter (12 Weeks)				Third Quarter (12 Weeks)				Fourth Quarter (16 Weeks)				Total (52 Weeks)
REVENUE
Net sales	$	31,117			$	32,279			$	31,624			$	43,414			$	138,434
Membership fees	692				716				737				997				3,142
Total revenue	31,809				32,995				32,361				44,411				141,576
OPERATING EXPENSES
Merchandise costs	27,617				28,733				28,131				38,671				123,152
Selling, general and administrative	3,224				3,234				3,155				4,263				13,876
Preopening expenses	17				12				8				31				68
Operating income	951				1,016				1,067				1,446				4,480
OTHER INCOME (EXPENSE)
Interest expense	(37		)		(37		)		(37		)		(48		)		(159		)
Interest income and other, net	22				7				41				51				121
INCOME BEFORE INCOME TAXES	936				986				1,071				1,449				4,442
Provision for income taxes	285				273				309				396				1,263
Net income including noncontrolling interests	651				713				762				1,053				3,179
Net income attributable to noncontrolling interests	(11		)		(12		)		(12		)		(10		)		(45		)
NET INCOME ATTRIBUTABLE TO COSTCO	$	640			$	701			$	750			$	1,043			$	3,134
NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO:
Basic	$	1.46			$	1.60			$	1.71			$	2.38			$	7.15
Diluted	$	1.45			$	1.59			$	1.70			$	2.36			$	7.09
Shares used in calculation (000’s)
Basic	437,965				439,022				438,740				438,379				438,515
Diluted	440,851				441,568				441,715				442,427				441,834
CASH DIVIDENDS DECLARED PER COMMON SHARE	$	0.50			$	0.50			$	0.57			$	0.57			$	2.14

	53 Weeks Ended September 3, 2017
	First Quarter (12 Weeks)				Second Quarter (12 Weeks)				Third Quarter (12 Weeks)				Fourth Quarter (17 Weeks)				Total (53 Weeks)
REVENUE
Net sales	$	27,469			$	29,130			$	28,216			$	41,357			$	126,172
Membership fees	630				636				644				943				2,853
Total revenue	28,099				29,766				28,860				42,300				129,025
OPERATING EXPENSES
Merchandise costs	24,288				25,927				24,970				36,697				111,882
Selling, general and administrative	2,940				2,980				2,907				4,123				12,950
Preopening expenses	22				15				15				30				82
Operating income	849				844				968				1,450				4,111
OTHER INCOME (EXPENSE)
Interest expense	(29		)		(31		)		(21		)		(53		)		(134		)
Interest income and other, net	26				(4		)		18				22				62
INCOME BEFORE INCOME TAXES	846				809				965				1,419				4,039
Provision for income taxes	291				288				259			(1)	487				1,325
Net income including noncontrolling interests	555				521				706				932				2,714
Net income attributable to noncontrolling interests	(10		)		(6		)		(6		)		(13		)		(35		)
NET INCOME ATTRIBUTABLE TO COSTCO	$	545			$	515			$	700			$	919			$	2,679
NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO:
Basic	$	1.24			$	1.17			$	1.59			$	2.10			$	6.11
Diluted	$	1.24			$	1.17			$	1.59			$	2.08			$	6.08
Shares used in calculation (000’s)
Basic	438,007				439,127				438,817				437,987				438,437
Diluted	440,525				440,657				441,056				441,036				440,937
CASH DIVIDENDS DECLARED PER COMMON SHARE	$	0.45			$	0.45			$	7.50		(2)	$	0.50			$	8.90

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(1)	Includes an $82 tax benefit recorded in the third quarter in connection with the special cash dividend paid to employees through the Company's 401(k) Retirement Plan.

(2)	Includes the special cash dividend of $7.00 per share paid in May 2017.