Accounting Capstone Task 2: Analysis of Home Depot

Erin Bybee

Student ID# 496517

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.

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 that their website is able to account for and calculate the sales tax on their sales appropriately. If they are not accounting for their sales tax appropriately then there could be huge consequences.

For a company as large as The Home Depot that could have to be hundreds of thousands of dollars in sales taxes due and fees and fines incurred from not paying them in the first place. In severe cases your business assets could be seized or you could even be accused of fraud (Plaster, 2018). It is vital for retail companies that also sell online, especially companies as large as The Home Depot to make sure that they are accurately capturing sales tax.

A9. Relevant Matters

Legal Matter

As of the 2013 fiscal year end there was a pending legal proceeding in which The Home Depot had been subpoenaed from the District Attorney of Alameda Country, California which was related to the company’s improper disposal of hazardous materials at its California facilities. The Home Depot is not able to estimate the outcome of the pending allegations, but they do not expect them to have a material effect on the financial position of the company.

Regulatory Matter

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 (The Home Depot Product Authority, LLC, 2020).

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 Executive 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 wrong products since they effect the cost of sales. I think that it is important to determine how The Home Depot receives these allowances are they cash refunded, a discount on a single purchase or a credit to their account with the vendor. Depending on how the allowance is given could create other issues complicating the appropriate allocation of these allowances. For instance, if the vendor gives it as future credit for their next purchase it would lower the cost of unrelated product and would need to be tied to that product and not the product that earned the rebate. As far as the advertising co-op allowances, they currently account for them by offsetting the advertising expense by the allowance amount. For the 2013 fiscal year this total value was $114 million. Being such a large amount, it would be important to evaluate how they are receiving this allowance, whether it be cash, a credit on their account, etc. to ensure that the values are being appropriately accounted for and tracked.

Accounts Receivable

The Home Depot has a third-party that handles their credit to customers and the receivables related to their store specific credit card. These receivables are not consolidated on their balance sheet since they are considered immaterial. It would be important to possibly verify with the third-party company that this is the case and the value of these receivables since there is no record of them on The Home Depot’s balance sheet. The Receivables on their balance sheet are those related to their subsidiary companies that extend credit to customers. It would be important to verify the total value of outstanding receivables since The Home Depot does account for deferred interest from these sales and the sum of the fees charged by the third-party company.

C1: Vertical Analysis of financial statements for 2011-2013

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 profit margins stayed consistent, fluctuating less than 0.5%. The gross profit margin for the 2013 fiscal year, 2012 fiscal year and 2011 fiscal year were 34.75%, 34.57% and 34.47% respectively. They are continuing increase their revenue from selling product without disproportionately acquiring more expenses or costs.

C2A: Identify Any Major Increase or Decreases in Accounts

C2Ai: Justify your identifications made in part C2A

Over the three-year analysis of The Home Depot’s financial statement there was not much change overall to each of the accounts. The largest change on their balance sheet was the change in their Long-Term Debt, excluding current installments account. Between the 2012 fiscal year end and the 2013 fiscal year end there was an increase of $5.216 billion, which increase Long-Term debt by 36% between the two years. The previous year from the 2011 fiscal year end to the 2012 fiscal year there was a decrease in Long-Term Debt of $1.283 billion.

The increase in Long-Term Debt increased the Total Liabilities significantly overall, which then caused a decent decrease in the Total Stockholders’ Equity account. Between the 2011 fiscal year end and the 2012 fiscal year end there was less than a 1% change, then between the 2012 fiscal year end and the 2013 fiscal year end there was a 12.4% change, this change was due to the decrease in Treasury stock from $10.694 billion to $19.194 billion and increase to retained earnings of $3.142 billion.

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 4^th 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.

D2: Recommend whether the control risk should be assessed at the maximum level or below.

D2A: Justify your recommendation made in part D2.

The independent registered public accounting firm was that they expressed and unqualified opinion on the effectiveness of The Home Depot’s control over financial reporting, they concluded that The Depot Home would be able to detect any material misstatement on their financial statements. Since it was determined that the control risk was effective The Home Depot would be controlling their risk below maximum level.

D3: Discuss the control risk assessment and what impact it will have on the audit procedures to be performed

Nature

Since The Home Depot is a large company and does not have significant fluctuation in their financial statements substantive analytical procedures would be ideal when obtaining assurance of their control risk. These procedures are effective and more efficient, for a large company such as The Home Depot. Large companies, like the Home Depot, could spend tons of money looking at each individual account, which is most often money wasted when they have been evaluated to have a low risk.

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 D4

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 monthly comparing sales receipts to what is recorded as revenue to ensure that there are no large discrepancies.

D6: Discuss whether there is going concern consideration

Based on the comparison of the previous year’s financial statements to the 2013 fiscal year financial statements The Home Depot would have no going concern issues. They continue to grow their net sales and can maintain their profit margins.

D7: Recommend whether the audit should be conducted at one main location or the audit team should be dispersed to other locations

Since The Home Depot is a large company with stores and warehouses located throughout the United States and other provinces, as well as in Canada and Mexico there are portions of the audit that should be done at different locations. The headquarters in Atlanta could take care of most of the audit process but things related to specific locations, such as inventory held at their warehouses should be done at those specific locations.

D8: Describe the five main steps the audit team will perform

The first step in the audit process would be to accept a new client or confirm work for a current client. Before initiated in a relationship with The Home Depot you would want to reach out to the previous auditor, you would also want to gather information about the client’s integrity, competency and compliance with requirements. Often time background checks would be done on top management, which in the case of The Home Depot would most likely include their director and executive officers reported in the 10-K filing. If it is determined that this would be a valuable relationship you would issue an engagement letter which each party would sign, agreeing upon their responsibilities.

Before the audit process can begin you would then need to plan your audit. If an audit is to be planned appropriately it will not be efficient or effective. It is important to obtain knowledge about the overall entity, especially its internal control system. Knowledge about The Home Depot needs to be gathered and about their risks, such as those mentioned before, related to their supply chain, vendor relationships, and the economy. It is important the purpose of the entity and how they measure their financial performance. The most important part of this stage is understanding their internal controls. It would be important to talk to the executives at The Home Depot to get a grasp on the controls they have in place and whether they are sufficient in catching material misstatements. Based on the internal controls in place you will then plan the audit accordingly.

The next step is to gather the actual audit data and evidence. Since The Home Depot can produce substantial evidence for the audit, for example physical inventory counts being done at each warehouse location, the auditor can begin substantive procedures. The auditor will then perform tests to compare date and to look for large discrepancies and errors in the financial statements. This like mentioned above for The Home Depot could be looking at the inventory account in comparison to other related accounts on the balance sheet. Different procedures can be applied to different account based on the depth the account needs to be evaluated due to its likelihood to have material misstatements. Larger accounts on the balance sheet and income statement will be analyzed, whereas smaller accounts may be skipped over since The Home Depot is such a large corporation with very little fluctuation in their accounts that the likelihood that these smaller accounts would contain material misstatement is low.

Once all the necessary data is collected the auditor will then complete the audit process. The auditor will make sure that the data provided from The Home Depot was sufficient and related to his purpose. If the data received is acceptable then the auditor will evaluate the final materiality of the statements to determine whether there is material misstatement in the financial statements. They will also access any going concern issues they may have. Based on the data they gathered and the evidence it provides they will then formulate their opinion.

The last step in the audit process is reporting the conclusions found during the audit process. It will outline the auditor’s opinion, such as in the case of the 2012 Fiscal Year end audit of The Home Depot the auditor gave an unqualified opinion. They will also lay out the details of how they arrived as this option and list any issues or concerns that they have that may need to be addressed. In the case of The Home Depot as of the 2012 fiscal audit report there were no concerns that needed to be addressed.

Works Cited

Lowe’s Companies, I. (2014). 2013 Annual Report. Retrieved from https://corporate.lowes.com/investors/financial-information/annual-reports-proxy-statements

Plaster, M. (2018, August 10). Tax Q&A: What happens if I don’t collect sales tax? Retrieved from Avalara: https://www.avalara.com/us/en/blog/2018/08/tax-q-a-what-happens-if-i-dont-collect-sales-tax.html#:~:text=And%20often%2C%20sellers%20had%20no,them%2C%20potentially%20damaging%20your%20credit.

The Home Depot Product Authority, LLC. (2020). The Home Depot Foundation. Retrieved from On a Mission To Make a Difference: https://corporate.homedepot.com/foundation

The Home Depot, I. (2013). 2012 Annual Report. Retrieved from https://ir.homedepot.com/financial-reports/sec-filings

The Home Depot, I. (2014). 2013 Annual Report. Retrieved from https://ir.homedepot.com/financial-reports/sec-filings