1.

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.

Fiscal year Home Depot Lowe's

2017 $ 907 $ 617
2018 826 590
2019 746 550
2020 661 508
2021 586 466
2022 586 466
2023 586 466
2024 586 466
2025 586 466
2026 586 466
2027 586 466
2028 211 326

Interest rate: 8.03% 7.04%

NPV of payments 4,945 3,981

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%

Adjustment (New allowance) 4 4 5

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.

Breakage of gift cards Home Depot

2014 2015 2016
Deferred revenue 979 1078 1253
Breakage of gift cards 32 27 34
Breakage of gift cards/ Deferred rev 3.27% 2.50% 2.71%
Assumption: Sales of gift cards has constant proportion for past 3 years

Similarly, Lowes unearned revenue for extended warranty has increased in 2016, meaning that
the company will collect more revenue in the future.

Extended protection plan Lowe's

2014 2015 2016
Balance at beginning of period 730 730 729
Additions to deferred revenue 318 350 387
Deferred revenue recognized -318 -351 -353
Balance at beginning of period 730 729 763

Allowance for uncollectable accounts

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 Dept Lowe's

2015 2016 2015 2016
Sales 88,519 94,595 59,074 65,017
Receivables on Balance sheet 1,890 2,029 - -
Credit program (Account receivables sold to third party) 253 216 8,800 9,600
Total receivables, net 2,143 2,245 8,800 9,600
Turnover ratio 43.12 7.07
4. Income taxes

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%.

Home Dept Lowe's

2015 2016 2015 2016
Pre-tax earnings 11,021 12,491 4,419 5,201
Income tax provision 4,012 4,534 1,873 2,108
Effective tax rate 36.4% 36.3% 42.4% 40.5%

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 Dept Lowe's

2015 2016 2015 2016
Tax at statutory US tax rate 35% 35% 35% 35%
State income taxes, net of federal income tax benefi 2.80% 2.80% 3.60% 3.60%
Valuation allowance - impairment 4.20% 2%
Other, net -1.40% -1.33% 0.40% 0.10%
Effective tax rate 36.40% 36.30% 42.39% 40.53%

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.

Home Dept Lowe's

2015 2016 2015 2016
Deferred tax assets DTA, net 1,482 1,505 788 651
Valuation allowance 3 3 447 578
Deferred Tax Liabilities DTL, net 1,778 1,707 547 451

5. Selfinsurance reserves
 Home Depot estimates self-insurance contingency based on historical data. The value is
recorded on the balance sheet as a liability.

6. Goodwill and intangible assets

Home Depot and Lowes test their goodwill for impairment on each fiscal year. Both companies
use qualitative and quantitative methods to assess the current value of their goodwill. They try
to determine if the willingness to pay for the reporting unit is still more than the fair value.
Otherwise, they will record quantify and record an impairment. There were no impairments
charge for Home Depot in 2016 while Lowes recorded $46 million.

7. Impairment of longlived assets

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.