Home Depot Case Study: Accounting Capstone Task 2, Exams of Accounting

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Accounting C251 Capstone Task 2: Analysis of

Home Depot Paper Western Governors University.

A. Company Information Template Complete the template for your chosen company based on the 2013 10-K and the 2013 annual report. A1. Company Information Identify the company’s basic information, including each of the following: Company’s name The Home Depot Company’s date of formation The Home Depot was formed in Delaware in 1978. Industry in which the company operates The Home Depot is part of the retail industry, selling building materials and home improvement products. Company’s size in terms of annual sales $78,812,000, Company’s size in terms of total assets $40,518,000, Company’s size in terms of employees (all full- and part-time) Approximately 365,000 associates were employed at the end of

Company’s size in terms of total market value

This calculation is based on the outstanding number of shares for the 2013 fiscal year end of 1.38 billion shares and the closing stock price of $76.85 on Jan 31,2014, which is the last closing date before the fiscal year end. Location of company headquarters, including the states and countries in which it operates The Home Depot store headquarters is in Atlanta, Georgia. There was a total of 2, stores. 1,977 of these stores were in the United States, which includes stores in all 50 states, the District of Columbia, Guam, Puerto Rico and the Virgin Islands. There were also 180 stores in Canada and 106 stores in Mexico.

A4. Related Parties Identify the company’s related parties, including people and other companies The annual report lists no related parties. A5. Company Life Cycle Identify the current stage in the company’s life cycle. The Home Depot would be in the growth phase. They are passed their introductory phase since they have been in business since

1978. They are not yet in their maturity phase since they are continuing to grow and be profitable, they are also still releasing and developing new products. A6. Risks Identify three risks associated with this business and/or industry.
1979. Strong competition could make them have to lower their prices and could also lower their demand in the marketplace.
1980. Since The Home Depot relies on third party suppliers if they are unable to create and maintain relationships with a significant number of suppliers it could lower the quality of their products or demand of their products.
1981. Disruptions in the supply chain and other issues could have a negative impact on their business. A7. Economic Factors Identify two key economic factors that affect the company and how it stands with respect to these factors.
1982. The Home Depot relies a lot on the residential and commercial housing market and their ability to build or renovate homes. If the housing market crashes due to things like foreclosures, unemployment increases and home interest rates then \ people will not be building, buying or renovating homes which will have a huge impact on their sales.

2. The inflation or deflation of commodity prices would also affect their prices and overall margins. If the tariffs, shipping, customs, etc. increase significantly for their products and they are unable to increase prices in the same manner then it will have a significant impact of the gross profit. A8. Accounting One unique accounting principle that would be relevant to The Home Depot and the retail industry would be related to sales tax. Companies generally know whether to collect sales tax when they are selling from a physical store based on the laws of the state that their store is located in. The issue with sales tax arises with companies like The Home Depot and other business in the retail industry when they not only sell from a physical store, but also online through an eCommerce store. There has been a lot of confusion in the past as to when or not an eCommerce company should collect sales tax. There have been new guidelines and laws put in place so that companies know when they must collect sales tax. The rule used to be that you only had to collect sales tax from states that you had a physical store. There are now other requirements that may require an eCommerce company to have to collect sales tax other than have a physical store, some of these are: economic activity, remote employees, click-through nexus, and affiliate relationships. Since The Home Depot would most likely meet one of these requirements for all states that collect sales tax, they will need to ensure

A regulatory matter that The Home Depot would have to worry about and make sure that they are following all laws and regulations would be federal and state employment and labor laws. Since

they have stores in all 50 states and other US territories they would need to ensure that they are staying up to date on federal laws and that each stores are following said laws, as well as any state laws that may pertain to their particular stores. The Home Depot also has stores in Canada and Mexico so they would need to make sure they are aware and following any international employment laws that would be applicable. Social Matter The Home Depot invests a lot into its corporate philanthropic responsibility. In 2011 they created The Home Depot Foundation, which was created to help people in their local communities. The foundation is used to improve the homes of U.S. veterans, fill the labor gap by training skilled tradespeople and support the communities impacted by natural disasters. Since inception The Home Depot Foundation has been able to invest $350 million in veteran causes, improve over 47,000 veteran homes in 4,500 cities alone [ CITATION The20 \l 1033 ]. A10: Additional Questions What is The Home Depot doing to make sure that they are keeping up with current trends and the needs of their customers? The Home Depot listed that one of the risks that they deal with is not responding to trends or needs of customers in a timely matter. I would reach out to Mark Q. Holifield, the

Vice President—Supply Chain and Product Development to get an appropriate response. Trends in the home improvement and renovation market are constantly changing. I would like to know how they are making sure that they are adjusting orders and receiving inventory in a timely manner to account for these changes and make sure that they are able to get supplies to their customers in a timely manner. This is key for The Home Depot because if they lag on supplying proper inventory they miss out on sales and could potentially be left with a lot of inventory that is hard to sale if the trends have changed. With the types of fraud and scams that happen daily online, what is The Home Depot doing to ensure the safety and privacy of their customers information? In order to get a proper response to this question I would reach out to Matthew A. Carey, the Executive Vice President and Chief Information Officer. The Home Depot based on their 2013 fiscal year net sales of 78.8 billion was the world’s largest home improvement retailer. With such a large share of the market and being an online retailer, they would need to make sure that they have strict and secure systems to protect their clients and any personal information that may be stored in their systems. Just like any large retailer a breach in their information systems could be very costly.

B: Three Primary Audit Concerns Inventory Balances and Calculations At the end of the 2013 fiscal year The Home Depot operated 133 warehouses that were in 35 states and providences. In the notes about accounting for their inventory they state most of their inventory is accounted for at the lower of first-in, first-out, “FIFO”, or market value. The remaining inventory is accounted for at the lower of cost or market value. They say that a physical count is done regularly at each of their inventory locations. The concern is with so many different inventory locations how they are ensuring that each facility is maintaining the correct cost records and making sure to record the inventory value at the correct costing method. At the end of the 2013 fiscal year end they had $11.057 million worth of inventory, which makes up approximately 27% of their total assets so you would want to make sure this is being accounted for appropriately, since these same costs would also effect their cost of goods sold which then would affect their gross margins. Vendor Allowances The Home Depot states in their notes that they account for vendor allowances which are rebates based on the volume of product that they order or advertising allowances for promoting a vendor’s products. When these allowances are order regarding rebates for product it is recorded as a reduction to Merchandise Inventory account and then when it is sold it is recorded as a reduction to cost of sales. There is a lot of room for error if these allowances are tied to the

C1: Vertical Analysis of financial statements for 2011- These Balance Sheet and Income Statement data is pulled directly from the 2014 10-K filing and the 2013 10-K filing. Vertical Analysis of the Balance Sheet

Vertical Analysis of the Income Statement C2: Evaluate whether your company is growing or declining Based on the vertical analysis of The Home Depot’s financial statements I would conclude that they are continuing to grow. Their net sales increase from the 2011 fiscal year to the 2012 fiscal year by $4.359 billion and again increased by another $4.058 billion between the 2012 fiscal year and the 2013 fiscal year, this shows a steady growth. Over the three-year period their gross

C3: Determine how the stock price of your company has moved Based on the 2013 Fiscal Year End 10-K filing for The Home Depot their 4th^ quarter or 2013 fiscal year end stock price ranged from a high of $82.34 to a low of $75.37. For the 4 th^ quarter or 2012 fiscal year end their stock had a price range from high of $67.82 to low of $60.65. Overall, the stock price from the 2012 fiscal year end to the 2013 fiscal year end increased, with even the low price being well above the previous high price. C4: Choose two financial strengths for your company during the year C4a: Discuss each financial strength in comparison to prior periods C4b: Discuss each financial strength in comparison to the strength of the industry. One financial strength that The Home Depot shows from period to period is their ability to increase net sales at a steady rate, while continuing to maintain their gross profit margin. Between the 2011 fiscal year and the 2012 fiscal year they increase net sales by approximately $4 billion and were able to again increase sales by approximately another $4 billion between the 2012 fiscal year and the 2013 fiscal year. All while maintaining a gross profit margin of 34%. This shows that they can their product costs at a consistent rate and they are able to also stabilize their expenses while continuing to grow their company. Lowe’s Companies, Inc. one of The Home Depot’s largest competitors also maintained a 34% gross profit margin according to their 2014 10-K filing. The largest difference is that Home Depot continues to increase their net sales significantly quicker and hold their place in the marketplace. Between the 2013 fiscal year end and the 2014 fiscal year end Lowes Companies, Inc. increase their sales by $2.896 billion which is 71% of the increase that The Home Depot had, this shows why The Home Depot continues to be at the top of the marketplace.

Another strength that The Home Depot has developed over the years is increasing their inventory turnover ratio. At the 2009 fiscal year end their inventory turnover ratio was 4.1x, over the years it is has steadily increased bringing their inventory turnover ratio to 4.6x, meaning they are selling through their inventory more than quarterly. The 2013 fiscal year-end inventory balance was $11.057 billion, this shows the large amounts of inventory that they can sell through every year. In comparison Lowes Corporation, Inc. had a 2013 fiscal year-end inventory balance of 9.127 billion, which is significantly lower than the value of The Home Depot’s inventory, and they have a lower inventory ratio in 2013 of 3.9x. This means not only are they selling through their inventory less than quarterly they are also selling through much less quantities of inventory than The Home Depot. D1: Determine the impact of the prior year’s audit opinion on the current year’s audit plan Based on The Home Depot’s 2012 Annual Filing the opinion of the independent registered public accounting firm was that they expressed and unqualified opinion on the consolidated financial statements. This means that the outside accounting company concluded that The Home Depot followed GAAP procedures and that their financial statements are fairly stated and transparent. The effect that this has on the current year’s audit plan is that the ending balances can be trusted as beginning balances for the current year and there should be no major surprises that arise when performing the current year’s audit.

Timing For large companies like The Home Depot it is often hard to gather data multiple times throughout the year. Continuing to audit the risk of material misstatement at year end would be ideal. If the risk of material misstatement increases and becomes high, it would be wise to audit these risks quarterly until the control risk is controlled at a lower level. Accounts such as inventory would be hard to assess risk on more than quarterly so at the maximum, I would do this quarterly. If there is a concern related to sales and the cost of sales this is something that could be done monthly more easily. Extent Based on the size of The Home Depot and because they were determined to be less likely to material misstate financial statements due to their effective controls, you will not need to look at every account separately. Since there is little fluctuation over in The Home Depot’s statements there may even be smaller, less material accounts that we will pass over. D4: Identify areas of focus for the upcoming audit The area of the balance sheet that I would make sure that I focused on would be the merchandise inventories account. Since this balance on average between the 2011 fiscal year and 2013 fiscal year made up 26.3% of The Home Depot’s total assets you would want to ensure that these are being accounted for correctly and not being misstated.

The area on the income statement that would be important to look at would be The Home Depot’s revenue account. Since they are reporting such large amounts of net sales you would want to make sure that their revenue is being accounted for accurately, properly and timely. Since Inventory makes up about a quarter of their total assets this would be a good account to look at. You could compare the inventory value and compare it to invoices from different suppliers, what is being expensed for cost of goods sold and what is currently sitting on the balance sheet to look for any major discrepancies that may cause material misstatement. D5: Recommend whether to use analytical procedures or substantive tests of details to evaluate accounts in D When evaluating the inventory balance, I think that it would help to evaluate these accounts with analytical procedures. Since the value that we give inventory effects many accounts it would be helpful to analyze it in comparison to those accounts that it touches, such as: cost of goods sold, net sales and accounts payable. Looking at invoices from suppliers would let you know if the costs associated with the products are correct, it will give insight as what is really outstanding to suppliers and if net sales are being calculated correctly. Each of these accounts touches each other so comparing them over time and to one another would help to catch any material misstatements. When looking at the revenue recognized on the income statement I do not thing you need to look at every detail. The revenue account could be analyzed using a substantive procedure and could be as simple as