. 59
( 82 .)


• Inventory pricing methods
• Accounting for research and development costs
• Basis for foreign currency translation

For a more detailed discussion of reporting publicly on internal control, see Curtis C. Verschoor, “Re-
porting on Internal Control: An Analysis of Empirical Evidence,” Internal Auditing 12, No. 1 (Sum-
mer 1996), pp. 43“45; Frank R. Urbanic, “A Content Analysis of Audit Committee Reports,” Internal
Auditing 12, No. 1 (Summer 1996), pp. 36“42; and Chapter 8 of this book.
See Opinions of the Accounting Principles Board, No. 22, “Disclosure of Accounting Policies”
(New York: AICPA, 1972), par. 15.
As previously noted, the reader may wish to consult a standard accounting text. Also see Appendix
A for further reference information.
Accounting Policy Disclosures 297

• Accounting treatment for:
Pension plans
Intangible assets, such as goodwill
Income taxes and investment credits
Revenue recognition on long-term construction contracts
• Accounting changes

A summary of significant accounting policies of Wal-Mart Stores, Inc., is illus-
trated in Exhibit 10.2.
Obviously, the disclosure of the key accounting policies will vary from com-
pany to company; however, it is incumbent on the independent auditors to concur
with management on the adequacy of such policy disclosures. If management™s
disclosures are inadequate, the independent auditors cannot express an unqualified
opinion on the financial statements.
Therefore, as part of its financial review responsibilities, the committee should
discuss “any significant disagreement between management and the independent
accountants and whether such disagreement has been resolved to the satisfaction
of both.”12 Concerning the resolution of such disagreements, the committee should
stress the overall objectives of financial reporting as discussed in Chapter 3.

Critical Accounting Policies
Recall in Chapters 5, 6, 7, and 8 that generally accepted auditing standards require
the independent auditors to communicate certain matters to the audit committee.
The reader may wish to revisit these chapters at this point. As previously noted,
Section 204 of the Sarbanes-Oxley Act requires the independent auditors to make
certain timely communications to the audit committee. Therefore, prior to the fil-
ing of the auditors™ report, the Securities and Commission requires the indepen-
dent auditors to communicate this information:

Background Information
1. Critical Accounting Policies and Practices
Consistent with our proposal, we are establishing rules requiring communication by
accountants to audit committees of all critical accounting policies and practices. In
December 2001, we issued cautionary advice regarding each issuer disclosing in the
Management™s Discussion and Analysis section of its annual report those accounting
policies that management believes are most critical to the preparation of the issuer™s
financial statements. The cautionary advice indicated that “critical” accounting poli-
cies are those that are both most important to the portrayal of the company™s finan-
cial condition and results and require management™s most difficult, subjective or
complex judgments, often as a result of the need to make estimates about the effect
of matters that are inherently uncertain. As part of that cautionary advice, we stated:
the selection, application and disclosure of critical accounting policies. Consistent
with auditing standards, audit committees should be apprised of the evaluative

Schornack, “The Audit Committee,” p. 76.
298 Reviewing Accounting Policy Disclosures

Exhibit 10.2 Significant Accounting Policies

1 Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of subsidiaries. Significant
intercompany transactions have been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers investments with a maturity of three months or less when pur-
chased to be cash equivalents. The majority of payments due from banks for customer
credit card transactions process within 24“48 hours. All credit card transaction that
process in less than seven days are classified as cash and cash equivalents. Amounts due
from banks for credit card transactions that were classified as cash totaled $276 million
and $173 million at January 31, 2003 and 2002, respectively.
Accounts receivable consist primarily of trade receivables from customers of our McLane
subsidiary, receivables from insurance companies generated by our pharmacy sales,
receivables from real estate transactions and receivables from suppliers for marketing or
incentive programs. Additionally, amounts due from banks for customer credit card trans-
actions that take in excess of seven days to process are classified as accounts receivable.
The Company uses the retail last-in, first-out (LIFO) method for general merchandise
within the Wal-Mart Stores segment, cost LIFO for the SAM™S CLUB segment and gro-
cery items within the Wal-Mart Stores segment, and other cost methods, including the
retail first-in, first-out (FIFO) and average cost methods, for the International segment.
Inventories are not recorded in excess of market value.
Financial Instruments
The Company uses derivative financial instruments for purposes other than trading to
reduce its exposure to fluctuations in foreign currencies and to minimize the risk and
cost associated with financial and global operating activities. Generally, contract terms
of a hedge instrument closely mirror those of the hedged item providing a high degree
of risk reduction and correlation. Contracts that are highly effective at meeting the risk
reduction and correlation criteria are recorded using hedge accounting. On February 1,
2001, the Company adopted Financial Accounting Standards Board (FASB) Statements
No. 133, 137 and 138 (collectively “FAS 133”) pertaining to the accounting for deriva-
tives and hedging activities. FAS 133 requires all derivatives to be recorded on the bal-
ance sheet at fair value and establishes accounting treatment for three types of hedges.
If a derivative instrument is a hedge, depending on the nature of the hedge, changes in
the fair value of the instrument will either be offset against the change in fair value of
the hedged assets, liabilities, or firm commitments through earnings or recognized in
other comprehensive income until the hedged item is recognized in earnings. The inef-
fective portion of an instrument™s change in fair value will be immediately recognized
in earnings. Instruments that do not meet the criteria for hedge accounting or contracts
for which the Company has not elected hedge accounting, are marked to fair value with
unrealized gains or losses reported currently in earnings. At January 31, 2001, the
majority of the Company™s derivatives were hedges of net investments in foreign opera-
tions, and as such, the fair value of these derivatives had already been recorded on the
balance sheet as either assets or liabilities and in other comprehensive income under the
current accounting guidance. As the majority of the Company™s derivative portfolio was
already recorded on the balance sheet, the adoption of FAS 133 did not have a material
impact on the Company™s consolidated financial statements taken as a whole.
Accounting Policy Disclosures 299

Interest During Construction
For interest costs to properly reflect only that portion relating to current operations,
interest on borrowed funds during the construction of property, plant and equipment is
capitalized. Interest costs capitalized were $124 million, $130 million, and $93 million
in 2003, 2002 and 2001, respectively.

Long-lived Assets
The Company periodically reviews long-lived assets, if indicators of impairments exist
and if the value of the assets is impaired, an impairment loss would be recognized.

Goodwill and Other Acquired Intangible Assets
Following the adoption of FAS 142, see the new accounting pronouncements section of
this note, goodwill is not amortized, instead it is evaluated for impairment annually.
Other acquired intangible assets are amortized on a straight-line basis over the periods
that expected economic benefits will be provided. The realizability of other intangible
assets is evaluated periodically when events or circumstances indicate a possible inabil-
ity to recover the carrying amount. These evaluations are based on undiscounted cash
flow and profitability projections that incorporate the impact of existing Company busi-
nesses. The analyses require significant management judgment to evaluate the capacity
of an acquired business to perform within projections. Historically, the Company has
generated sufficient returns from acquired businesses to recover the cost of the goodwill
and other intangible assets.
Goodwill is recorded on the balance sheet in the operating segments as follows (in
January 31, 2003 January 31, 2002
International $8,985 $8,028
SAM™S CLUB 305 305
Other 231 233
Total Goodwill $9,521 $8,566

Changes in International segment goodwill are the result of foreign currency exchange
rate fluctuations and the addition of $197 million of goodwill resulting from the Com-
pany™s Amigo acquisition. See Note 6.

Foreign Currency Translation
The assets and liabilities of all foreign subsidiaries are translated at current exchange
rates. Related translation adjustments are recorded as a component of other accumulated
comprehensive income.
Revenue Recognition
The Company recognizes sales revenue at the time it sells merchandise to the customer,
except for layaway transactions. The Company recognizes layaway transactions when
the customer satisfies all payment obligations and takes possession of the merchandise.
The Company recognizes SAM™S CLUB membership fee revenue over the twelve-
month term of the membership. Customer purchases of Wal-Mart/SAM™S CLUB shop-
ping cards are not recognized until the card is redeemed and the customer purchases
merchandise by using the shopping card.

SAM™S CLUB Membership Revenue Recognition
The Company recognizes SAM™S CLUB membership fee revenues both domestically and
internationally over the term of the membership, which is 12 months. The following table

300 Reviewing Accounting Policy Disclosures

Exhibit 10.2 (Continued)

provides unearned revenues, membership fees received from members and the amount of
revenues recognized in earnings for each of the fiscal years 2001, 2002 and 2003:

Deferred revenue January 31, 2000 $337
Membership fees received 706
Membership revenue recognized (674)
Deferred revenue January 31, 2001 369
Membership fees received 748
Membership revenue recognized (730)
Deferred revenue January 31, 2002 387
Membership fees received 834
Membership revenue recognized (784)
Deferred revenue January 31, 2003 $437

SAM™S CLUB membership revenue is included in the other income line in the revenues
section of the consolidated statements of income.
The Company™s deferred revenue is included in accrued liabilities in the consolidated
balance sheet. The Company™s analysis of historical membership fee refunds indicates
that such refunds have been insignificant. Accordingly, no reserve exists for member-
ship fee refunds at January 31, 2003.
Cost of Sales
Cost of sales includes actual product cost, change in inventory, buying allowances
received from our suppliers, the cost of transportation to the Company™s warehouses
from suppliers and the cost of transportation from the Company™s warehouses to the
stores and Clubs and the cost of warehousing for our SAM™S CLUB segment.
Payments from Suppliers
Wal-Mart receives money from suppliers for various reasons, the most common of
which are as follows:
Warehousing allowances - allowances provided by suppliers to compensate the
Company for distributing their product through our distribution systems which are more
efficient than most other available supply chains. These allowances are reflected in cost
of sales when earned.
Volume discounts - certain suppliers provide incentives for purchasing certain volumes
of merchandise. These funds are recognized as a reduction of cost of sales at the time
the incentive target is earned.
Other reimbursements and promotional allowances - suppliers may provide funds for
specific programs including markdown protection, margin protection, new product lines,
special promotions, specific advertising and other specified programs. These funds are
recognized at the time the program occurs and the funds are earned.
At January 31, 2003 and 2002, the Company had $286 million and $279 million respec-
tively, in accounts receivable associated with supplier funded programs. Further, the
Company had $185 million and $178 million in unearned revenue included in accrued
liabilities for unearned vendor programs at January 31, 2003 and 2002, respectively.
Accounting Policy Disclosures 301

Operating, Selling and General and Administrative Expenses
Operating, selling and general and administrative expenses include all operating costs of
the Company that are not related to the transportation of products from the supplier to
the warehouse or from the warehouse to the store. Additionally, the cost of warehousing
and occupancy for our Wal-Mart segment distribution facilities are included in operat-
ing, selling and general and administrative expenses. Because we do not include the
cost of our Wal-Mart segment distribution facilities in cost of sales, our gross profit and
gross margin may not be comparable to those of other retailers that may include all
costs related to their distribution facilities in costs of sales and in the calculation of
gross profit and gross margin.

Advertising Costs
Advertising costs are expensed as incurred and were $676 million, $618 million and
$574 million in 2003, 2002 and 2001, respectively. Advertising cost consists primarily
of print and television advertisements.

Pre-opening Costs
The costs of start-up activities, including organization costs and new store openings, are
expensed as incurred.

The Company uses a combination of insurance, self-insured retention, and self-insur-
ance for a number of risks including workers™ compensation, general liability, vehicle
liability and employee related health care benefits, a portion of which is paid by the
Associates. Liabilities associated with these risks are estimated in part by considering
historical claims experience, demographic factors, severity factors and other actuarial

Depreciation and Amortization
Depreciation and amortization for financial statement purposes are provided on the
straight-line method over the estimated useful lives of the various assets. Depreciation
expense, including amortization of property under capital lease, for the years 2003,
2002 and 2001 was $3.1 billion, $2.7 billion and $2.4 billion, respectively. For income
tax purposes, accelerated methods are used with recognition of deferred income taxes
for the resulting temporary differences. Estimated useful lives for financial statements
purposes are as follows:

Building and improvements 5“50 years
Fixtures and equipment 5“12 years


. 59
( 82 .)