SEC Reporting of Practices … Essay
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Accounting Procedures Discussion
Off Balance Sheet Activities
One accounting decision that Home Depot has to make pertain to its off balance sheet activities. Not all of Home Depot's operations are accounted for in its primary balance sheet. One example of this might be how the company has structured its real estate holdings. For example, each Home Depot location is leased from another related organization that actually owns the property. In this way the company can separate its primary operations from subsidiary operations that might generate income or a significant amount of assets and/or liabilities that are not directly related to the company's primary operations.
"The Company leases certain retail locations, office space, warehouse and distribution space, equipment and vehicles. While most of the leases are operating leases, certain locations and equipment are leased under capital leases. As leases expire, it can be expected that in the normal course of business certain leases will be renewed or replaced (Home Depot, N.d.)."
Although these financial activities are not directly related to the company's primary operations, they may be particularly interesting to investors because they can make a big difference in determining the overall health of a company. Furthermore, many of these items can be much harder to track and represent hidden liabilities. Collateralized debt obligations, for instance, may become a toxic asset before investors realize a company's exposure (Investopedia, N.d.). In regards to their SEC filing, Home Depot must simply list in the notes that it handles some of its financial information "off balance sheet." "
Another accounting policy that can have significant implications for a company's financial reporting measures is how the account for their inventory holdings. There are two basic ways to determine the costs of inventory holdings. One way uses a first-in, first-out, or FIFO, cost flow which assumes that you sell your oldest inventory first. This inventory system can affect how the company profitability is stated because inventory costs tend to rise over time (Bank, N.d.). Therefore, FIFO uses your lowest costs to figure cost of goods sold, or COGS and this can make the company appear most profitable as well as make its tax liability greater and this is the system that Home Depot uses for a portion of their inventory.
Home Depot's Merchandise Inventories are stated at the lower of cost (first-in, first-out) or market, with approximately 74% valued under the retail inventory method and the remainder under a cost method (Home Depot, N.d.). Home Depot's inventory holding are large and diverse and there are many retailers that use a retail inventory method to attempt to reflect the actual costs that are associated with holding such large inventories. These methods can then adjust the inventory values according to reflect current marketing conditions. For example, many of Home Depot's products can vary significantly in costs depending on movements in the prices of raw materials or fuel costs related to moving this inventory. Therefore, in regards to major retailers, determining the actual costs of large inventories can represent a complex procedure.
Home Depot must also decide how it deals with inventory shrinkage and report this on their financial statements. Inventory shrinkage deals with the any portion of the inventory that has basically disappeared from the inventory. For example, as is the case with many retailers, some of the inventory can be stolen and often this does not become realized until the retailer counts their inventory. In other case some of the inventory can break or become deformed to the extent that it can no longer be sold and must be disposed of. Other cases of inventory shrinkage might arise from simply counting inventory wrong at some point in the shipping or stocking procedures. Many companies spend considerable to attempt to secure their inventories and reduce the potential for shrinkage (Marfo, N.d.)
Despite the various ways in which inventory shrinkage can occurs, retailers must decide how they will account for the shrinkage. Home Depot uses an independent physical inventory count or cycle counts are taken on a regular basis in each store and distribution center to ensure that amounts reflected in the financial statements accurate reflect the quantities that are stated (Home Depot, N.d.). During the period between physical inventory counts in the stores, Home Depot will accrue figures for actual losses that are then are compared to estimated losses related to shrink on a store-by-store basis. Retailers often use shrinkage estimates to apply to inventory holdings between periods in which an actual physical inventory is taken. This allows the company to account for the shrinkage in their financial estimates without actually have to take a physical inventory and these figures are typically based on historical averages or industry averages. Then when the actual inventories levels are counted, these accounts can then be reconciled.
Impairment of Long-Lived Assets
Home Depot must maintain a slew of long-term assets to support its operations. Most of these assets are only valuable for a certain time frame. For example, a warehouse might be estimated to have a useful life to the company for a period of ten to twenty years. The useful life must be estimated in order to distribute the carrying costs of these assets over several accounting periods. The warehouse, in the same example, might be depreciated over the course of seven years in the financial statements. However, it is often common for the actual useful life and the estimated useful life to be substantially different. Therefore, given the subjective nature of these estimates, the company's accounting policy on how they treat these items in their reporting must be stated in their filings.
An impairment exists when the carrying amount of a long-lived asset or group of assets exceeds its fair value and is nonrecoverable and when a company recognizes an impairment loss for an asset group, it must allocate the loss to the assets in the group on a pro rata basis (Luecke & Meeting, 2002). Home Depot recorded impairments and lease obligation costs on closings and relocations in the ordinary course of business as well as when it closed many locations in China in 2012 (Home Depot, N.d.). Given the fact that Home Depot is a major retailor with hundreds of locations and must consider the potential for impairment on a regular basis. However, most of these locations are owned by subsidiary companies and leased back the primary company. Therefore some of the reporting of asset impairment could appear off the balance sheet for many of their assets that are organized in this manner. Thus investor should also consider the off sheet activities to gain a comprehensive understanding of the Home Depot's financial health.
Goodwill and Intangible Assets
The goodwill and intangible asset accounts are arguably one of the most subjective measures that accountants have to estimate. Companies looking to grow and expand in their business strive not only to acquire tangible assets like land, buildings and factories, but also intangible assets like trademarks, copyrights, patents, formulas, franchises, goodwill, etc. (Bajpai, 2014). An intangible asset is one that does not actually have any sort of physical substance but is valuable to the company none the less. Some examples of intangible assets customer loyalty, brand name and reputation and all these assets of which make the company worth more than its book value despite the fact that many of these factors are sometimes difficult to quantify.
Before 2001, companies were allowed to amortize intangible assets and goodwill over a period not to exceed 40 years but in 2001, there was a change in rules according to which goodwill could not be amortized; but rather was evaluated annually to determine impairment loss (Bajpai, 2014). Therefore, if the company records an impairment in any account associated with an intangible asset or goodwill then it has to be reported so that these estimates are clear. In the last five years, the Home Depot only had one impairment that it had to report. In fiscal 2012, the company recorded a charge of $97 million to impair all of the goodwill associated with the former China reporting units (Home Depot, N.d.). It was previously estimated that the Home Depot had some level of intangible value operating in the Chinese market most likely due to the perceived value of the growth in that market. However, when the Home Depot decided to close the operations in China, then it had to reconcile the intangible asset accounts to recognize this loss.
Bajpai, P. (2014, October 6). Goodwill vs. Other Intangible Assets: What's the Difference? Retrieved from Investopedia: http://www.investopedia.com/articles/investing/100614/goodwill-vs.-other-intangible-assets-whats-difference.asp
Bank, E. (N.d.). Inventory Accounting Policies. Retrieved from Business Chronicle: http://smallbusiness.chron.com/inventory-accounting-policies-67818.html
Home Depot. (N.d.). SEC Annual Filings. Retrieved from Investor Relations: http://ir.homedepot.com/phoenix.zhtml?c=63646&p=irol-sec&secCat01.1_rs=11&secCat01.1_rc=10&control_symbol=
Investopedia. (N.d.). Off Balance Sheet - OBS. Retrieved from Investopedia: http://www.investopedia.com/terms/o/off-balance-sheet-obs.asp
Luecke, R., & Meeting, D. (2002, February 28). Asset Impairment and Disposal. Retrieved from Journal of Accountancy: http://www.journalofaccountancy.com/issues/2002/mar/assetimpairmentanddisposal.html
Marfo, A. (N.d.). How to Reduce Inventory Shrinkage. Retrieved from Business Chronicle: http://smallbusiness.chron.com/reduce-inventory-shrinkage-19240.html [END OF PREVIEW]
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