* Step one: Identify Potential Red Flags
After analyzing Wal-Mart’s annual report for 2010, attention has been brought to several items that require closer examination. A common “red flag” to questionable accounting has been found within Wal-Mart’s statement of cash flows and income statement. There is an increasing gap between the company’s reported income and the cash flow from operating activities. In the year 2008 reported income and cash flow from operating activities differed by $484 million. However the difference increased a considerable $2,249 and $4,183 billion in the years 2009 and 2010 respectively. This increasing gap is a significant warning sign that the company may be changing accrual estimates.
Another factor to consider when analyzing Wal-Mart’s financial position is the firm’s uncertain tax position. At the current time, Wal-Mart has $1.0 billion of unrecognized tax benefits related to continuing operations. However note 8 of the consolidated financial statements observe, “During the next 12 months, it is reasonably possible that tax audit resolutions could reduce unrecognized tax benefits by between $350 million and $500 million, either because the tax positions are sustained on audit or because the company agrees to their disallowance.” The company also states that any change should not have a significant change on financial position; however in my opinion an investor should not over look this red flag.

* Step two: Identify Principal Accounting Policies Wal-Mart has several policies and estimates used to measure its critical factors and risks. Inventory management is one of the most important key success factors in the retail industry. Wal-Mart uses the last-in, first-out (“LIFO”) method in valuing inventories at the lower of cost or market. When analyzing Wal-Mart’s key accounting policies one will find a significant accounting