ACC 630 Final Submission

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Final Submission: Advanced Accounting Report ACC 630 Final Submission: Advanced Accounting Report Home Depot Sara Millis Southern New Hampshire University ACC 630 Financial Reporting III Dr. Melissa Hickman September 2, 2023 1

Final Submission: Advanced Accounting Report Introduction The Home Depot Inc. was opened in 1979 by founders Bernie Marcus and Arthur Blank. Their goal was to create a home improvement superstore offering low prices, highly trained staff, and a variety of do-it-yourself merchandise. In 1981 the company went public and has grown to over 2,300 brick and mortar stores along with an online presence offering more than 1 million products. The company focuses on serving the needs of professional contractors and individual do it yourself consumers alike. The acquisitions made Home Depot reflect their ongoing efforts to fulfill the needs of the changing market. The deals are focused on strengthening the core of the business and looking for acquisitions that will increase product offerings, bring in highly trained experts in specific niches, and expand an online presence. Business Entities Damage Estimates Partnerships are pass-through entities consisting of two or more partners. Revenues and expenses are assigned directly to each partner based on the articles of partnership. The income from the business is taxed based on the tax bracket of the individual partner and their percentage of income received. All liabilities are passed onto the partners and their personal assets. Corporations on the other hand, are considered separate taxable entities from the shareholders. The income of a corporation is taxed twice, first at the corporate level when earned and again at the shareholder level when dividends are paid. If a partnership faced a $2,000,000 lawsuit, the partners would be responsible to pay the damages based on the terms in the articles of partnership. If one partner is insolvent, the remaining partners will most likely be expected to absorb the costs. Often these events lead to the termination of the partnership and the business ceases operations. A corporation, such as Home Depot, is liable for its own damages. As a separate entity, the business is responsible for damages and these financial obligations are not passed through to shareholders. When a corporation must pay damages from a lawsuit, these losses are called contingent liabilities. Contingent liability is an obligation that will likely occur in the future and the amount of the liability is unknown. If the timing and the amount of liability can be estimated 2

Final Submission: Advanced Accounting Report with a degree of accuracy the FASB allows for that liability to be recorded in the accounting records. U.S. GAAP requires that a contingency liability with a 50% chance of or greater is considered “high probability”. Because the lawsuit damages are known, $2,000,000, they can be recorded on the corporation’s financial statements. On the balance sheet the damages would be recorded as a liability and on the income statement it would be an expense. Disclosure Requirements Partnerships and corporations each have different disclosure requirements. A partnership does not have to report contingent liability in a specific accounting period. Instead, it can disclose the lawsuit and any damages per the articles of partnership and report the liability throughout the period. Partnerships are more significantly affected by lawsuits in regards to the value of the company in the eyes of a future potential partner. Corporations listed on public stock markets are regulated by the Securities Exchange Commission and U.S. GAAP standards. These publicly traded companies are required to provide standardized financial reporting on incomes, expenses, assets, and liabilities. Companies such as The Home Depot must release quarterly and annual financial reports as well as hold an annual shareholder meeting to discuss operations. If The Home Depot was named in a lawsuit, it would become public knowledge almost immediately and the accounting records would be adjusted once a reasonably accurate estimate was determined. The legal expense account would be debited $2,000,000 and the accrued liabilities account would be credited the same amount. At completion of the lawsuit, accrued liabilities would be debited and the same amount would be credited from cash. Personal Liability – Corporation Shareholders face zero personal liability when a corporation is faced with a $2,000,000 lawsuit. As a corporation, The Home Depot is a separate legal entity and is financially responsible for damages or other liabilities. The only risk to shareholders is the loss of their initial investment if the corporation liquidates, and creditors cannot seek recoupment beyond the accounts of the business. 3

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Final Submission: Advanced Accounting Report Personal Liability – Partnership Partnerships can be set up differently and are outlined in the articles of partnership. When a partnership is created it can be formed as a general partnership, meaning that each partner is equally responsible for all losses and liabilities of the business. It can also be formed to adjust the liability and risk each partner is responsible for. A limited partnership is designed for those interested in the tax benefits of a partnership without the manual work or the risk of unlimited liability. Limited liability partnerships follow the same concepts as a general partnership except that it limits individual partners’ liability. A partner is not responsible for damages resulting from the negligence of a different partner. Limited liability companies have become a popular business structure as it ensures the liability protection for partners without restricting the number of partners involved. These liability protections cover the personal assets of the partners but do not exclude assets belonging to the business that may be in the possession of partners. Consolidations of Financial Statements Corporate Structure The company uses a divisional organization structure. This can be attributed to acquisitions of subsidiaries outside of the United States. Home Depot breaks down their structure into three main components: Geographic Divisions, Global Functional Groups, and Global Hierarchy. The Home Depot, Inc, remains the parent company and has direct control of all subsidiaries. In the 2023 Environmental, Social, and Governance Report, the Home Depot lists twelve companies under “Our Home Depot Family.” While many of the companies listed carry the Home Depot name, there are several acquisitions that brought existing companies under their umbrella. Over the years, Home Depot has acquired Compact Power Equipment, The Company Store, Interline Brands, Blinds.com, Redbeacon, and HD Supply. Flow of Accounting Information The consolidation of financial statements is the responsibility of the parent company. The parent company is that which holds voting control thru controlling shares or majority board positions. Each subsidiary retains their individual financial statements; however the parent 4

Final Submission: Advanced Accounting Report company uses a consolidation process to combine the financial statements of all subsidiaries. The Quarterly Report for period ending May 2, 2021, Home Depot discusses their 2020 acquisition of HD Supply. It states, “The acquisition was accounted for in accordance with Topic 805 ‘Business Combinations’ and, accordingly, HD Supply’s results of operations have been consolidated in the Company’s financial statements since December 24, 2020, the date of acquisition.” (Home Depot, 2021.) The consolidation process begins by collecting financial statements from each subsidiary in a timely manner. Once all reports are accounted for, all intra-entity transfers between the parent company and the subsidiary are adjusted to eliminate overstating revenues or expenses. Financial statements must also be adjusted to account for any differences in accounting methods. For example, the United States follows GAAP reporting methods, but more than 144 countries globally follow IFRS. Until the Securities and Exchange Commission can convert to the IFRS, Home Depot will have to continue adjusting the financial statements of subsidiaries outside the United States. Consolidated financial statements give a comprehensive overview of the parent company and the value created by the subsidiaries, allowing shareholders and investors transparency. Income Tax Benefits One of the most beneficial results of consolidating financial statements is the ability to offset the losses by one subsidiary with the gains from another. Being able to lower the taxable income for a high earning company can be accomplished if the parent company has a less successful subsidiary. By consolidating the revenues under the parent company, the gains or losses of individual companies offset each other on the financial statements being reported by the parent company. Inter-entity transfers of inventory are not taxed in the same manner of sales transactions outside of the conglomerate. 5

Final Submission: Advanced Accounting Report Estate Planning Estate planning is the process of ensuring there is a financially responsible plan in place to ensure the estate is taxed as minimally as possible in the event of the individual’s death. The IRS website states, “The Estate Tax is a tax on your right to transfer property at your death.” (Estate Tax, 2023). Multiple steps can be taken to minimize the liabilities assigned to the estate in order to pass along as much wealth as possible. Some of the beginning steps in estate planning involve creating a will that clearly states the individual’s wishes, appointing an executor that will be responsible for ensuring the distribution according to the will, and how the estate tax liability will be handled. Estate planning for businesses can be a bit more complicated but is none the less important. Partnerships cease to exist if the owner dies and there is not a succession plan in place, and corporations can experience extreme volatility in their market value if a majority shareholder dies. Estate planning creates the outline for transfer of management, voting power, assets, and liabilities when the time comes. Minimizing Tax Liability Minimizing tax liability is the key to ensuring largest sum of wealth is passed on after the individual’s death. In a partnership the financials of the business pass through to the owners. When creating the business, partners will draw up the Articles of Partnership, which should include directives for the business if one of the partners decides to leave or dies. If the business is successful, the partners have increased their wealth and estate planning helps minimize the estate tax liability. Partnerships are not considered as separate entities from their partners, and like individuals, they can reduce their tax obligations through donations. The government has a list of acceptable charities that qualify the individual for a tax deduction on the amount donated. The donation frequency and amount have no maximum and educational donations can be designated to a specific school, cause, or individual. Charitable donations are a useful way for businesses to minimize tax liabilities before death as well. Corporations are treated differently than partnerships, as they are considered separate legal entities from their shareholders. These businesses are taxed at the corporate tax rate which is regulated by the IRS. Like partnerships, corporations can donate to approved charities. However, these tax benefits do not extend to the shareholders. Shareholders are looking to maximize profits but minimize tax liabilities, and investment in a corporate life insurance fund is 6

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Final Submission: Advanced Accounting Report often a viable option. Through a corporate transfer strategy, the corporation can invest in a special life insurance policy that they are both the beneficiary and the owner of. As the policy increases from deposits of excess cash flows, the increase is not subject to taxation. These life insurance policies increase the value of assets for the corporation while maintaining tax free status when they are transferred. Advantages – Corporation versus Partnership There are a few distinct advantages to setting up a corporation over a partnership with regards to estate planning. Partnerships, as we have discussed, are pass through entities and therefore the individual partners are each responsible for certain liabilities and obligations. These individuals can be held personally responsible in the event the partnership cannot pay in its debts. Because a corporation is a separate legal entity, the death of a shareholder does not constitute the termination of business operations. The structure of a corporation allows for the business to continue, regardless of if a shareholder or member of management dies. Dependent on the Articles of Partnership, the business may continue operations but there may be a need to liquidate assets and settle the debts of the deceased partner’s personal estate. This task may be difficult for partnerships that, unlike corporations, cannot issue stock or raise capital as easily. Transferring ownership is less complicated for a corporation as the owners are the stockholders who usually have little involvement in the daily operations, and stocks can be sold on the open market without affecting business operations. Succession Plan Home Depot is known for promoting from within and molding top executives as they move up the ranks. This strategy allows the company to ensure the company’s core values and mission statement are followed in all areas of operations. The values of the company include Creating Shareholder Value, Entrepreneurial Spirit, and Taking Care of Our People. The current plan to develop top talents from within the company was a result of poor planning in the earlier years of the company. In the 90s, Home Depot hired a CEO from outside the company. Mr. Robert Nardelli, who has recently been passed over by General Electric, was selected with hopes of bringing optimism and new ideas to the company. Instead, Nardelli held onto his failures and often created conflict among the founding members and long-time upper 7

Final Submission: Advanced Accounting Report executives. While there was a short-term decline in the business, the company was able to recover and develop a promising succession plan by learning from past mistakes. Strategy In order to create a successful estate planning strategy, a corporation like Home Depot should create an estate transfer strategy to minimize tax liabilities. The estate transfer strategy will allow Home Depot to issue dividends tax free, minimizing tax obligations for the estate. Corporate trusts can also be established to protect shareholders from excess taxation. As a corporation, Home Depot will not be forced to cease operations if one of the shareholders or top managers passes away. The corporation as well as the shareholders must ensure proper estate planning in order to minimize all forms of tax liabilities. Ideally, the estate should cover all taxes so that all distributions are tax free. Trusts The goal of operating a business is to accumulate wealth and to pass that wealth from one generation to the next. To pass the assets to the next generation a legal plan must be in order. A trust is one method that has grown in popularity for ensuring the main goals of the grantor are met. “Often they are established to reduce the size of a person’s taxable estate, and thus, the amount of estate taxes that must eventually be paid.” (Hoyle, etc. 2021). Purpose A trust is created to manage assets and ensure they are distributed in accordance with the wishes of the individual or business. A business may establish a trust to minimize income tax liabilities, but also to ensure that future use of assets is dictated. Since their founding in 1979, The Home Depot has changed CEO’s twice since the initial changeover from the co-founders. The company’s majority shareholders consist of 71% institutional, 28% public, and 1% inside ownership. Based on this information, it can be assumed that the Home Depot is not run thru a trust. The company is run by a CEO, who follows the wishes of a board of directors that represent shareholders. 8

Final Submission: Advanced Accounting Report Estate Planning There are several reasons for a small business to create a trust, the most significant is for estate planning purposes. Business owners want to ensure that the business will continue to run in their absence or death. They also want to protect the assets and wealth that have been created and retained. By creating a trust, the owners can create a plan for how the company will continue to run and how financial decisions will be made in the future. If the business owner, or one of the owners incurs personal debts, a trust can protect the assets of the business from being taken by creditors. A trust can also lower the tax burden on the estate which helps minimize the debts to be satisfied. The trust also provides the legal documentation needed to avoid probate proceedings. Protect Income When deciding on a business structure for a company, owners must decide if they will operate as a corporation, or through a trust. A corporation is considered an independent legal entity, responsible for its own gains, losses, and obligations. Corporations operate as a business, are typically for profit, and are owned and controlled by shareholders. A trust is a legal arrangement that dictates asset management, protection, and estate planning. Operating as a corporation allows businesses to benefit from a set rate on taxable income. The shareholders, or owners, are protected against losses beyond their initial investment. Operating through a trust can provide multiple tax advantages that cannot be provided to businesses operating as a corporation. Distribution of profits among beneficiaries can be planned in a manner that provides the lowest possible tax rates for each recipient. A discretionary trust offers protection of the assets of the beneficiaries if the business becomes insolvent. Operating through a trust puts future ownership on current assets, making it difficult for creditors to claim. This protection often sways business owners to operate through a trust, or at the very least create a trust for estate planning purposes. 9

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Final Submission: Advanced Accounting Report References Internal Revenue Service. (2023). Tax Information for Partnerships. IRS.GOV. Partnerships | Internal Revenue Service (irs.gov) Hoyle, J., Schaefer, T., Doupnik, T. (2021). Advanced Accounting, Fourteenth Edition. McGraw- Hill Education. Table of Contents and Preface (mheducation.com) Home Depot. (2023). 2023 Environmental, Social and Governance Report. The Home Depot, Inc. 2023 Home Depot ESG Home Depot. (May 2, 2021). United States Securities and Exchange Commision Form 10-Q. The Home Depot Inc. HD_10Q_05.02.2021 (homedepot.com) Shoulberg, Warren. (July 17, 2019). The 5 things Home Depot needs to do as it marks 40 years in business. Forbes, Business. The 5 Things Home Depot Needs To Do As It Marks 40 Years In Business (forbes.com) Home Depot. (2023.) Our Values. The Home Depot. Our Values | The Home Depot Internal Revenue Service. (2023). Estate Tax. IRS.gov. h ttps://www.irs.gov/businesses/small- businesses-self-employed/estate-tax The Home Depot. (Retrieved August 20, 2023). Investor Relations; Annual Report 2022. The Home Depot Inc. Annual Reports Recent | The Home Depot Lapin, Candace. (July 18, 2023). Why every business owner needs a trust. Legal Zoom. Why every business owner needs a trust | Legalzoom Reynolds, Stuart. (July 1, 2019). Corporate Structure: Should You Choose A Trust Or A Company? Full Stack. Corporate Structure: Should You Choose a Trust or a Company? - Fullstack 10