(continued) Notes to Consolidated Financial Statements Financial Instruments: The Company has financial instruments, including cash, accounts receivable and accounts payable. The carrying amounts of these financial instruments approximate fair value because of their short maturities. A discussion of the carrying values and fair values of the Company’s debt is included in Note F, while a discussion of the Company’s fair values of its derivatives is included in Note B. Income Taxes: The Company accounts for income taxes under the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Revenue Recognition: The Company recognizes sales at the time the sale is made and the product is delivered to the customer. Vendor Allowances and Advertising Costs: The Company receives various payments and allowances from its vendors based on the volume  of purchases or for services that AutoZone provides to the vendors. Monies received from vendors include rebates, allowances and  promotional funds. Typically, these funds are dependent on purchase volumes and advertising plans. The amounts to be received are subject to changes in market conditions, vendor marketing strategies and changes in the profitability or sell-through of the related merchandise  for AutoZone. Rebates and other miscellaneous incentives are earned based on purchases or product sales. These monies are treated as a reduction of inventories and are recognized as a reduction to cost of sales as the inventories are sold. Certain vendor allowances are used exclusively for promotions and to partially or fully offset certain other direct expenses. Such vendor funding arrangements, that were entered into on or before December 31, 2002, were recognized as a reduction to selling, general and administrative expenses when earned. However, for such vendor funding arrangements entered into or modified after December 31,  2002, the Company applied the new guidance pursuant to the Emerging Issues Task Force Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor” (EITF Issue No. 02-16). Accordingly, all vendor funds are recognized as a reduction to cost of sales as the inventories are sold. As a result of the adoption of EITF Issue No. 02-16, fiscal 2003 selling, general, and administrative expenses were approximately $53 million higher and gross margin was approximately $43 million higher than such amounts would have been prior to the accounting change. Advertising expense, net of vendor funding, was approximately $32.5 million in fiscal 2003, $17.5 million in fiscal 2002 and $20.7 million  in fiscal 2001. The higher expense for fiscal 2003 reflects the impact of vendor allowances, from agreements entered into or modified  subsequent to December 31, 2002, that are no longer netted against advertising expense but recorded as a reduction of cost of sales. The Company expenses advertising costs as incurred. Warranty Costs: The Company or the vendors supplying its products provide its customers with a warranty on certain products. Estimated warranty obligations are provided at the time of sale of the product and are charged to cost of sales. Shipping and Handling Costs: The Company does not generally charge customers separately for shipping and handling. The cost the Company incurs to ship products to the stores for delivery to the customer is included in cost of sales in the Consolidated Statements of Income. Preopening Expenses: Preopening expenses, which consist primarily of payroll and occupancy costs, are expensed as incurred. Earnings Per Share: Basic earnings per share is based on the weighted average outstanding common shares. Diluted earnings per share is based on the weighted average outstanding shares adjusted for the effect of common stock equivalents. At this time, stock options are the Company’s only common stock equivalents. Stock Options: At August 30, 2003, the Company has stock option plans that provide for the purchase of the Company’s common stock by some of its employees and directors, which are described more fully in Note I. The Company accounts for those plans using the intrinsic- value-based recognition method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no stock-based employee compensation cost is reflected in net income, as options are granted under those plans at an exercise price equal to the market value of the underlying common stock on the date of grant. SFAS 123, “Accounting for Stock-Based Compensation,” and SFAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” estab- lished accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed under SFAS 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting and has adopted only the disclosure requirements of SFAS 123. The following table illustrates the effect on net income and earnings per share had the Company applied the fair-value recognition provisions of SFAS 123 to stock-based employee compensation. 36