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Inventory
Home Depot and Lowes use FIFO inventory cost method, which approximates merchandise
inventories at lower of cost or market. Thus, the company report a truthful value of inventory.
They reported that the allowance for loss was not material to their financial statement.
2. Lease
Home Depot and Lowes declared a portion of their lease payments as operating leases. Based
on their current capital leases of each company, it appears that the interest rate for the
payment is 8.03% and 7.04% for Home Depot and Lowes respectively. We quantified the
missing assets and liabilities as $4,945 and $3,981 for Home Depot and Lowes respectively,
representing more than 12%. This will affect the balance sheet and the income statement as
well.
This is an important adjustment to the balance sheet for both companies.
3. Revenue
Home Depot and Lowes comply with FASB rules in terms of revenue recognition. Revenue is
recognized only when customers take possession of product or overtime when there is a service
contract.
Sales allowances
They record revenue net of allowance for sales returns or discount.
Home Depot has not communicated its sales returns data for past year. Lowes recorded on
average 0.0073% of its sales as allowance for sales. After adjustment, we estimate that Lowes
have a consistent level of allowance since no return was made in the past three years.
Lowe's
2014 2015 2016
Balance at beginning of period 58 65 66
Allowance for sales returns $7 1 5
Deductions 0 0 0
Balance at beginning of period 65 66 71
Sales 56223 59074 65017
AVERAGE
Allowance/Sales 0.0125% 0.0017% 0.0077% 0.0073%
Unearned revenue
Home Depot offers gift card items to its customers. Revenue for gift card breakage is recorded
based on historical redemption patterns. For the past years, the proportion of that revenue has
decreased. This might mean that the company will earn more revenue later, which is a good
indication for the future.
Similarly, Lowes unearned revenue for extended warranty has increased in 2016, meaning that
the company will collect more revenue in the future.
Home Depot and Lowes offers credit to customers through a credit program with a third party.
While Home Depot shows accounts receivable on its balance sheet, Lowes does not. It seems
like Lowes has transfer all its accounts receivable to its partner, Synchrony Bank.
Home Depot has a higher turnover ratio compared to Lowes. This indicates that Lowes more
lenient in granting credit to its customers or the credit quality of its customers is deteriorating.
Home Depot and Lowes effective tax rate were 36.3% and 40.5%, which is a huge gap. Effective tax
rates are also inconsistent with federal statutory rate of 35%.
Lowes report more valuation allowance in 2015 and 2016, which explains the difference in effective tax
rate between both companies. In top of the federal tax, companies are paying some state taxes. Thus,
the effective tax rates reconcile with federal tax.
Home Depot increased its DTA by 1.6% and decreased its DTL by 4% in 2016, which is good. The
company is managing earnings downwards and will incurs less tax expenses in the future.
Similarly, Lowes decrease its DTL by 18% in 2016 and increased its valuation allowance by 29%. Thus,
the company is reporting low GAAP income.
5. Selfinsurance reserves
Home Depot estimates self-insurance contingency based on historical data. The value is
recorded on the balance sheet as a liability.
For operating locations, Home Depot evaluates for impairment each quarter while Lowes look
for consistent negative cash flow for a 12-month period. Both companies will record impairment
if the carrying value is greater than the undiscounted cash flow.
They make assumptions on variables such as future sales, operating margin, growth rate,
economic conditions, market competition and inflation to complete impairment assessment for
its long-lived assets. They reported that a 10% reduction in their projected sales used to
estimate future cash flows for operating locations would not have a significant impact
impairment loss during 2016.