Home Depot 2007 Annual Report Download - page 43

Critical Accounting Policies
Our significant accounting policies are disclosed in Note 1 of our Consolidated Financial Statements. The following discussion addresses our
most critical accounting policies, which are those that are both important to the portrayal of our financial condition and results of operations and
that require significant judgment or use of complex estimates.
Revenue Recognition
We recognize revenue, net of estimated returns and sales tax, at the time the customer takes possession of the merchandise or receives services.
We estimate the liability for sales returns based on our historical return levels. We believe that our estimate for sales returns is an accurate
reflection of future returns. We have never recorded a significant adjustment to our estimated liability for sales returns. However, if these
estimates are significantly below the actual amounts, our sales could be adversely impacted. When we receive payment from customers before
the customer has taken possession of the merchandise or the service has been performed, the amount received is recorded as Deferred Revenue
in the accompanying Consolidated Balance Sheets until the sale or service is complete. We also record Deferred Revenue for the sale of gift
cards and recognize this revenue upon the redemption of gift cards in Net Sales.
Merchandise Inventories
Our Merchandise Inventories are stated at the lower of cost (first-in, first-out) or market, with approximately 89% valued under the retail
inventory method and the remainder under the cost method. Retailers like The Home Depot, with many different types of merchandise at low
unit cost and a large number of transactions, frequently use the retail inventory method. Under the retail inventory method, Merchandise
Inventories are stated at cost, which is determined by applying a cost-to-retail ratio to the ending retail value of inventories. As our inventory
retail value is adjusted regularly to reflect market conditions, our inventory valued under the retail method approximates the lower of cost or
market. We evaluate our inventory valued under the cost method at the end of each quarter to ensure that it is carried at the lower of cost or
market. The valuation allowance for Merchandise Inventories valued under the cost method was not material to our Consolidated Financial
Statements as of the end of fiscal 2007 or 2006.
Independent physical inventory counts or cycle counts are taken on a regular basis in each store and distribution center to ensure that amounts
reflected in the accompanying Consolidated Financial Statements for Merchandise Inventories are properly stated. During the period between
physical inventory counts in our stores, we accrue for estimated losses related to shrink on a store-by-store basis. Shrink (or in the case of excess
inventory, "swell") is the difference between the recorded amount of inventory and the physical inventory. Shrink may occur due to theft, loss,
inaccurate records for the receipt of inventory or deterioration of goods, among other things. We estimate shrink as a percent of Net Sales using
the average shrink results from the previous two physical inventories. The estimates are evaluated quarterly and adjusted based on recent shrink
results and current trends in the business. Actual shrink results did not vary materially from estimated amounts for fiscal 2007, 2006 or 2005.
Self-Insurance
We are self-insured for certain losses related to general liability, product liability, automobile, workers' compensation and medical claims. Our
liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet date. The estimated liability is not discounted and is
established based upon analysis of historical data and actuarial estimates, and is reviewed by management and third-party actuaries on a
quarterly basis to ensure that the liability is appropriate. While we believe these
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