<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                   FORM 10-K

                 ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended May 3, 1997            Commission File No. 1-7923


                               HANDLEMAN COMPANY
--------------------------------------------------------------------------------
            (Exact name of registrant as specified in its charter)

          MICHIGAN                                       38-1242806
--------------------------------------------------------------------------------
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

500 Kirts Boulevard, Troy, Michigan                     48084 - 4142
--------------------------------------------------------------------------------
(Address of principal executive offices)                 (Zip Code)

                                 248-362-4400
--------------------------------------------------------------------------------
             (Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

       Title of each class             Name of each exchange on which registered
   ---------------------------         -----------------------------------------
   COMMON STOCK $.01 PAR VALUE                  NEW YORK STOCK EXCHANGE


Securities registered pursuant to Section 12(g) of the Act:

                                     NONE
                              ------------------
                               (Title of Class)


Indicate by checkmark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for at least the past 90 days.

                                 YES  X     NO
                                    -----     -----

State the aggregate market value of the voting stock held by non-affiliates of
the registrant.  The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within 60 days prior to the date of filing.
The aggregate market value as of July 14, 1997 was $222,534,000.

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.  The number of shares of common
stock outstanding as of July 14, 1997 was 33,366,996.

Item 14(a) 3. on page 35 describes the exhibits filed with the Securities and
Exchange Commission.

Certain sections of the definitive Proxy Statement to be filed for the 1997
Annual Meeting of Shareholders are incorporated by reference into Part III.



                                 Page 1 of 38
<PAGE>
 
                                    PART 1


Item 1.                           BUSINESS

Handleman Company, a Michigan corporation (herein referred to as the "Company"
or "Handleman" or "Registrant"), which has its executive office in Troy,
Michigan, is the successor to a proprietorship formed in 1934, and to a
partnership formed in 1937.

DESCRIPTION OF BUSINESS:

Handleman Company is engaged in the sale and distribution of music, video, book,
and personal computer software products primarily to mass merchants throughout
the United States, Canada, Mexico, Argentina and Brazil.  The operations of the
Company are divided into three operating units:  Handleman Entertainment
Resources ("H.E.R."), North Coast Entertainment ("NCE") and Handleman
International ("International").  The Company's H.E.R. and International
operating units provide additional services as a category manager (rackjobber)
to their accounts.  The Company's H.E.R. division provides such products and
services in the United States, while the International division provides such
products and services in Canada, Mexico, Argentina and Brazil.  NCE is in the
business of acquiring or licensing video, music and software products, giving it
exclusive rights to manufacture and distribute such products.

The following table sets forth net sales, and the approximate percentage
contribution to consolidated sales, for the fiscal years ended May 3, 1997,
April 27, 1996 and April 29, 1995, for the Company's three operating divisions:
<TABLE>
<CAPTION>
 
 
                                                                  Year Ended
                                                            (Amounts in Millions)
                                            ------------------------------------------------------
                                            May 3, 1997       April 27, 1996(B)   April 29, 1995(B)
                                            -----------       --------------      --------------

Handleman Entertainment Resources
<S>                                        <C>                <C>                   <C>
  Music                                      $  595.6            $  560.9           $  581.6
  % of Total                                     50.4                49.5               47.4

  Video                                         266.4               293.4              401.6
  % of Total                                     22.6                25.9               32.8

  Book                                           55.6                53.7               57.3
  % of Total                                      4.7                 4.8                4.7

  Personal Computer Software                     41.7                50.2               49.3
  % Total                                         3.5                 4.4                4.0
                                             --------            --------           --------

 Sub-Total                                      959.3               958.2            1,089.8
 % of Total                                      81.2                84.6               88.9
                                             --------            --------           --------

North Coast Entertainment (A)                   134.4               101.5               81.0
% of Total                                       11.4                 9.0                6.6

International                                   117.0                72.2               70.5
% of Total                                        9.9                 6.4                5.7

Eliminations                                    (29.7)              (18.1)             (40.4)
% of Total                                       (2.5)               (1.6)              (3.3)

Discontinued Operations                           ---                18.8               25.2
% of Total                                                            1.6                2.1
                                             --------            --------           --------

TOTAL                                        $1,181.0            $1,132.6           $1,226.1
                                             ========            ========           ========
 
</TABLE>

(A)  Excludes Entertainment Zone sales in fiscal years 1996 and 1995. Such sales
     are reported as discontinued operations.

(B)  Restated for reclassification of Canadian sales to International from
     H.E.R.

                                       2
<PAGE>

                               Business Segments
                               -----------------

The Company operates in one business segment, selling home entertainment
software to mass merchants, specialty chain stores, drugstores and supermarkets.
The Company has United States, Canadian, Mexican, Brazilian and Argentine
operations. All operations outside of the U.S. are included in "Other" which is
displayed separately below.
<TABLE>
<CAPTION>


                                         Dollar Amounts in Thousands
                                     ------------------------------------

                                        1997         1996         1995
                                     ----------   ----------   ----------
<S>                                  <C>          <C>          <C>

Net sales:
  United States                      $1,053,358   $1,050,545   $1,152,681
  Other                                 127,679       82,062       73,381
                                     ----------   ----------   ----------
Total net sales                      $1,181,037   $1,132,607   $1,226,062
                                     ==========   ==========   ==========

Operating income (loss):
  United States                      $   20,051   $  (18,562)  $   53,532
  Other                                   3,921       (5,130)      (1,079)
Interest expense, net                   (10,967)     (12,039)      (8,024)
                                     ----------   ----------   ----------
Income (loss) before income taxes
  and minority interest              $   13,005   $  (35,731)  $   44,429
                                     ==========   ==========   ==========

Identifiable assets:
  United States                      $  632,900   $  660,465   $  705,916
  Other                                  34,986       33,449       48,160
                                     ----------   ----------   ----------
Total assets                         $  667,886   $  693,914   $  754,076
                                     ==========   ==========   ==========

</TABLE>

                                    General
                                    -------

The Company's major business activity is to act as a link between manufacturers
of home entertainment software products and mass merchant chain stores.
Customers purchase from Handleman due to the value-added benefits the Company
adds to the basic product, and due to the benefit of only dealing with one
vendor for each product line. Manufacturers utilize the Company's services to
avoid the necessity of distributing to thousands of individual stores throughout
a vast geographic range. Information regarding the number of active vendors from
which the Company purchases, number of titles the Company is currently
distributing and number of retail departments presently serviced follows:
<TABLE>
<CAPTION>

                         Number of      Number of
                       SKUs Currently    Retail
            Number of   Distributed    Departments
             Vendors   by the Company   Serviced
            ---------  --------------  -----------
<S>         <C>            <C>         <C> 

Music          168         25,400         6,350
Video          107          6,900         6,550
Book           181          6,000         3,150
Software       115            700         4,025
</TABLE>

                                       3
<PAGE>
 
         Handleman Entertainment Resources and Handleman International
         -------------------------------------------------------------

The following discussion pertains to the category management (rackjobbing)
activities of the H.E.R. and International divisions, which together comprise
approximately 90% of the Company's sales.



Vendors
-------

An important reason customers utilize H.E.R.'s and International's services is
due to the multitude of manufacturers and suppliers offering products for-sale,
the complexity of programs offered by those vendors, the "hits" nature of the
business, and the high risk of inventory obsolescence.

The Company must anticipate consumer demand for individual titles. In order to
maximize sales, the Company must be able to immediately react to "breakout"
titles, while simultaneously minimizing inventory exposure for artists or titles
which do not sell. In addition, because the Company distributes throughout vast
geographic regions (U.S., Canada, Mexico, Argentina and Brazil) it must adapt
selections it offers to local tastes. This is accomplished via a coordination of
national and local purchasing responsibility, both monitored by inventory
control programs.

The Company purchases from many different vendors. The volume of purchases from
individual vendors fluctuates from year-to-year based upon the salability of
selections being offered by such vendor. Though within each product line a small
number of major, financially sound vendors account for a high percentage of
purchases, product must be selected from a variety of additional vendors in
order to maintain an adequate selection for consumers. The Company must closely
monitor its inventory exposure and accounts payable balances with smaller
vendors which may not have the financial resources to honor their return
commitments. At this time, the high risk vendors which require close monitoring
tend to be concentrated in the video, book and software product lines.

Since the public's taste in music, video, book, and personal computer software
is broad and varied, Handleman is required to maintain sufficient inventories to
satisfy diverse tastes. The Company minimizes the effect of obsolescence through
planned purchasing methods and computerized inventory controls. Since
substantially all vendors from which the Company purchases product offer some
level of return allowances and price protection, the Company's exposure to
markdown risk is limited unless vendors are unable to fulfill their return
obligations or non-saleable product purchases exceed vendor return limitations.
Vendors offer a variety of return programs, ranging from 100% returns to zero
return allowance. Other vendors offer incentive and penalty arrangements to
restrict returns. It is possible that the Company may possess in its inventories
certain product that it cannot utilize in the ordinary course of business and
may only be returnable with cost penalties or may be non-returnable until the
Company can comply with the provisions of the vendor's return policies.

Handleman generally does not have distribution contracts with manufacturers or
suppliers; consequently, its relationships with them may be discontinued at any
time by such manufacturers or suppliers, or by Handleman.

                                       4
<PAGE>
 
Customers
---------

H.E.R.'s and International's customers utilize their services for a variety of
reasons. Products must be selected from a multitude of vendors offering numerous
titles, different formats (e.g., compact discs, cassettes) and different payment
and return arrangements. As a result, customers avoid most of the risks inherent
in product selection and the risk of inventory obsolescence.

H.E.R. and International also offer their customers a variety of "value-added"
services:


Store Service: Sales representatives visit individual retail stores and meet
with store management to discuss upcoming promotions, special merchandising
efforts, department changes, current programs, or breaking releases which will
increase sales. They also monitor inventory levels, check merchandise displays,
and install point-of-purchase advertising materials.


Advertising:  Handleman supplies point-of-purchase materials and assists
customers in preparing radio, television and print advertisements.


Fixturing:  Handleman provides specially designed fixtures that emphasize
product visibility and accessibility.


Freight:  Handleman coordinates delivery of product to each store.


Product Exchange:  Handleman protects its continuing customers against product
markdowns by offering the privilege of exchanging slower-selling product for
newer product.


The nature of the Company's business lends itself to computerized ordering,
distribution and store inventory management techniques.  The Company is able to
tailor the inventories of individual stores to reflect the customer profile of
each store and to adjust inventory levels, product mix and selections according
to seasonal and current selling trends.

The Company determines the selections to be offered in its customers' retail
stores, and ships these selections to the stores from one of its distribution
centers.  Slow selling items are removed from the stores by the Company and are
recycled for redistribution or return to the manufacturers.  Returns from
customer stores occur for a variety of reasons, including new releases which did
not achieve their expected sales potential, ad product to be returned after the
ad has run, regularly scheduled realignment pick-ups and customer directed
returns.  The Company provides a reserve for the gross profit margin impact of
expected customer returns.

During the fiscal year ended May 3, 1997, one customer, Kmart Corporation,
accounted for approximately 38% of the Company's consolidated sales, while a
second customer, Wal-Mart, accounted for approximately 23%.  The Company does
not generally have contracts with its customers, and relationships may change or
be discontinued at any time by the customers or Handleman; the discontinuance or
a significant unfavorable change in the relationships with either of the two
largest customers would have a materially adverse effect upon the Company's
future sales and earnings.

                                       5
<PAGE>
 
                                  Operations
                                  ----------

The Company distributes products from facilities throughout the U.S., Canada,
Mexico, Brazil and Argentina. Besides economies of scale and through-put
considerations in determining the number of facilities it operates, the Company
must also consider freight costs to and from customers' stores and the
importance of timely delivery of new releases. Due to the nature of the home
entertainment software business, display of new releases close to authorized
"street dates" is an important driver of both retail sales and customer
satisfaction.

The Company also operates three regional return centers in the United States and
one in Canada as a means to expedite the processing of customer returns. In
order to minimize inventory investment, customer returns must be sorted and
identified for either redistribution or return to vendors as expeditiously as
possible. An item returned from one store may be required for shipment to
another store. Therefore, timely recycling prevents purchasing duplicate product
for a store whose order could be filled from returns from other stores.

During fiscal 1996, the Company opened its second high-technology Automated
Distribution Center ("ADC") in Indianapolis, Indiana. The Company had previously
realigned its Western region by replacing certain distribution centers with its
first ADC located in Sparks, Nevada. Due to the opening of the two ADCs, the
Company has been able to transfer the operations of 10 music/video/software
shipping branches, 4 book shipping branches and 3 product return centers to
either the ADCs or other existing facilities. Management expects that
implementation of the ADCs will reduce operating costs and decrease inventory
levels, while improving the Company's speed and reliability in supplying
products to its customers. See Note 4, Provisions for Inventory Reduction and
Realignment of Operations, on page 26 under Item 8, for additional information
regarding the facility realignment.

The Company also has installed a new proprietary inventory management system
("PRISM"). PRISM automates and integrates the functions of ordering product,
receiving, warehousing, order fulfillment, ticket printing and perpetual
inventory maintenance. PRISM also provides the basis to develop title specific
billing to allow the Company to better serve its customers.



                           North Coast Entertainment
                           -------------------------

NCE, a subsidiary of Handleman Company, includes the Company's proprietary
product operations. NCE is the umbrella company for subsidiaries which acquire
or develop existing master recordings, exclusive licensing and distribution
agreements, and original productions. Such items are manufactured and then
distributed to either rackjobbers, including H.E.R. and International,
distributors or directly to retailers. NCE has operations in the United States
and Canada, and to a much lesser extent in Germany and the United Kingdom. In
addition, NCE products are available in Mexico and South America. Most NCE
products are categorized as budget, with most retailing for under $10. Products
are designed to provide high margins to the retailer at prices that generate
impulse sales.

NCE, the non-rackjobbing portion of the Company, has the goal to grow as a
global source of innovative entertainment and educational content products.  NCE
provides the following opportunities to the Company:

 . NCE provides a platform from which to distribute proprietary music, video, and
  personal computer (PC) software products.

 . NCE enables the Company to take a more active, and more profitable, role in
  the production of home entertainment and educational products.  This enhances
  the Company's profit potential.

                                       6
<PAGE>
 
 . NCE provides the Company with a wide array of product development and
  licensing opportunities for music, video, and software products.  This enables
  the Company to offer a broader range of more profitable products to its
  customers.

 . NCE gives the Company access to new distribution channels, new markets and new
  customers.  For example, the Company can cross-sell music, video and PC
  software to new or existing customers through any NCE subsidiary sales
  organization.

NCE is comprised of a group of enterprises operating under different names:

 . Anchor Bay Entertainment develops an assortment of videos through licensing
  and distribution agreements.  It also is the producer of original children's
  and exercise programming.  Anchor Bay's catalog consists of over 2,000
  selections which encompass many categories.  Labels include Video Treasures,
  Audio Treasures, MNtex and Starmaker.  Anchor Bay supplies products to
  rackjobbers, specialty stores, mass merchants and distributors, as well as via
  direct response and catalog channels.

 . Madacy Entertainment Group offers value-priced music and video products
  primarily within the United States and Canada.  Madacy's audio catalog has
  more than 5,100 selections which encompass many categories.  Its video
  collection consists of over 1,000 licensed as well as public domain titles.
  Mediphon GmbH, a German-based subsidiary, owns over 800 hours of classical
  audio recordings from which it has already created masters for over 2,000
  selections.  Such selections, as well as other licensed products, are
  distributed throughout Germany and the rest of Europe.

 . Sofsource, Inc. acquires and develops software titles through exclusive
  licensing, production and distribution agreements.  Its catalog consists of
  over 300 selections.  Sofsource is among the industry leaders in the sale of
  educational software.  It supplies PC software to distributors, rackjobbers,
  specialty stores and other retailers.

 . Sellthrough Entertainment (formerly Holly Music) distributes year-round theme
  promotions such as Christmas and Halloween throughout the U.S.  In addition to
  the Company, its customers include mass merchants, drug stores, grocery stores
  and specialty stores.

NCE's management will continue to focus its attention on growing the business
through licensing, acquiring or producing new products, as well as via new
markets, geographical growth, growth within the home entertainment and
educational categories, and selective acquisitions and joint ventures.

                                  Competition
                                  -----------

Handleman is primarily a category manager (rackjobber) of music, video, book and
personal computer software products.  The business of the Company is highly
competitive as to both price and alternative supply arrangements in all of its
product lines.  Besides competition among the Company's mass merchant customers,
the Company's customers compete with alternative sources from which consumers
could purchase the same product, such as (1) specialty retail outlets, (2)
electronic specialty stores, (3) video rental outlets, and (4) record and book
clubs.  The Company competes directly for sales to its customers with (1)
manufacturers which bypass wholesalers and sell directly to retailers, (2)
independent distributors, and (3) other rackjobbers.  In addition, some large
mass merchants have "vertically integrated" so as to provide their own
rackjobbing.  Some of these companies, however, also purchase from independent
rackjobbers.  Also, new methods of in-home delivery of entertainment software
products are being introduced, including Pay Per View and home satellite video
viewing.

H.E.R. video sales were $266.4 million in fiscal 1997, compared to $401.6
million in fiscal 1995.  Video sales to a major customer that began to purchase
a substantial portion of its video product directly from manufacturers in fiscal
1995 have decreased from $57.5 million in fiscal 1995 to less than $1.0 million
in fiscal 1997.  Certain other customers have begun to purchase video products
directly from manufacturers, or are exploring such purchase arrangements.  The
Company expects that the downward trend in video sales will continue in fiscal
1998.

The Company believes that the distribution of home entertainment software will
remain highly competitive.  The Company believes that customer service and
continual progress in operational efficiencies are the keys to growth in this
competitive environment.

                                       7
<PAGE>
 
                                Industry Outlook
                                ----------------

Information regarding industry outlook by product line follows (all years cited
herein are calendar years):


Music
-----

According to the Recording Industry Association of America, the U.S. music
industry posted sales, at list price, of $12.5 billion in 1996, growing 2% from
1995.  According to Veronis, Suhler & Associates ("Veronis"), an entertainment
industry investment banker, the U.S. market is expected to grow at an 8.1%
compound annual rate through 2000.

Compact discs ("CDs") accounted for over 81% of music industry net revenues in
1996.

Despite the growing dominance of CDs, cassettes still remain a popular format.
Industry-wide sales of cassettes, including cassette singles, still represent
sales of over $2.0 billion.  Car stereos and portable systems, two areas where
CDs have had less impact, still rely principally on the cassette.  The size,
cost and convenience of cassettes are also important factors in the continuing
market for this music format.


Video
-----

According to Adams Media Research, an independent market research firm, for-sale
home video sales in the United States grew 14% in 1996, at retail.  Veronis
projects industry video sales to grow at a 6.6% compound annual rate through
2000.


Book
----

Book industry sales grew an estimated 7.3% in 1996 to $16.8 billion, according
to Veronis.  In addition, consumer books are projected to grow at a 5.8%
compound annual rate through 2000.

The book industry is a more mature market, and thus a less volatile market, than
either the music or video industry.  However, mass media promotions have helped
spur increased interest and consumer demand.  Both paperbacks and hardcovers are
being promoted via print and television advertising, and many talk show programs
profile authors and their books.  In addition, mega-star authors such as John
Grisham, Stephen King and Danielle Steel continue to produce best sellers which
are purchased by their loyal readers.


Software
--------

Personal computer software sales, at retail, grew in excess of 21% in 1996,
compared to 1995, and are forecasted to grow at a 16.5% compound annual rate
through 2000, both according to Veronis.  Increases in personal computer
software sales are driven by sales of the related hardware.  According to the
Consumers Electronics Manufacturers Association, PC hardware unit sales grew 12%
in 1996 versus 1995.

The above-referenced forecast information is not Company information, but
instead has been extracted from material obtained from certain industry
analysts.  With respect to these forecasts, as well as any other forward-looking
statements contained throughout this document, we wish to express cautionary
statements that actual results could differ materially based on many meaningful
factors, such as the number of departments shipped; customer requirements; the
nature and extent of new product releases; the introduction of new
configurations (e.g., CD, cassettes or VHS, DVD); implementation of new
operating facilities and expense control items; the retail environment and the
success of the Company's customers in such environment; and pricing and
competitive pressures.  An adverse impact from any one of these factors could
offset the benefit from another factor.

                                       8
<PAGE>
 
                                   * * * * *



      See Management's Discussion and Analysis of Financial Condition and
Results of Operations for additional information regarding the Company's
activities.

      The Company's sales and earnings are of a seasonal nature.  Note 10,
Quarterly Financial Summary (Unaudited), on page 32 under Item 8 discloses
quarterly results which indicate the seasonality of the Company's business.

      The Company has approximately 3,500 employees, of whom approximately 72
are members of a local union.

                                       9

<PAGE>
 
Item 2.                          PROPERTIES


     The Company's H.E.R. division occupies five leased warehouses, four owned
warehouses and six leased satellite sales offices, all in the United States. The
leased warehouses are located in Albany, New York, Indianapolis, Indiana (2),
Reno, Nevada and Youngstown, Ohio. The owned warehouse are located in Atlanta,
Georgia, Baltimore, Maryland, Brighton, Michigan and Chicago, Illinois. The
satellite sales offices are located in the states of Massachusetts, Ohio,
Missouri, Arkansas, California and Oregon. The lease on the warehouse in Ohio
expires on July 31, 1997, and will not be renewed or replaced due to the
operations being integrated into other warehouses, primarily the Midwest
automated distribution center. A second satellite sales office will be opened in
Ohio coincident with closing the Youngstown warehouse. The Company-owned
warehouses in Brighton, Michigan and Chicago, Illinois are being sold in
connection with implementation of the Company's Midwest ADC (see note 4 on page
26 under Item 8). The sales of the Brighton and Chicago warehouses should close
by the end of the second quarter of the Company's fiscal year ending May 1,
1998.

The Company's NCE division owns one warehouse located in Tampa, Florida, and
leases four warehouses located in Columbus, Ohio, Montreal, Quebec (2), and
Toronto, Ontario. NCE also occupies leased office space within the United States
in the states of Texas, New Mexico, New Jersey and Missouri, as well as in
Canada and Germany.

The Company's International division has leased warehouses in Montreal and
Toronto, Canada, Buenos Aires, Argentina, Sao Paulo, Brazil and Mexico City,
Mexico. The International division also has a leased satellite sales office in
Calgary, Canada.

The Company owns its 130,000 square feet corporate office building located in
Troy, Michigan. H.E.R.s Atlanta building is encumbered by Economic Development
Corporation Revenue Bonds as explained in Note 6 to Handleman's Consolidated
Financial Statements under Item 8. The bonds were issued in connection with the
construction of the building.



Item 3.                        LEGAL PROCEEDINGS


     There are no material pending legal proceedings to which the Registrant or
any of its subsidiaries is a party other than ordinary routine litigation
incidental to the business.



Item 4.                      SUBMISSION OF MATTERS
                         TO A VOTE OF SECURITY HOLDERS


Not applicable.

                                       10
<PAGE>
 
                                    PART II


Item 5.                   MARKET FOR THE REGISTRANT'S COMMON
                        STOCK AND RELATED STOCKHOLDER MATTERS



The Company's common stock is traded on the New York Stock Exchange.


Below is a summary of the market price of the Company's common stock as traded
on the New York Stock Exchange:


<TABLE>
<CAPTION>
                                                              Fiscal Year Ended
                                                ---------------------------------------------
                                                    May 3, 1997             April 27, 1996
                                                --------------------     --------------------

                             Quarter              Low         High         Low          High
                             -------            ---------------------------------------------
                         <S>                    <C>          <C>          <C>          <C>

                         First...............   4 3/4        7 3/8        9 1/2        11 7/8

                         Second..............   4 5/8        7            8 1/8        10 1/2

                         Third...............   6 3/8        9            5 1/4         8 1/4

                         Fourth..............   6 1/8        9            4             7 3/8
                         --------------------------------------------------------------------
</TABLE>

As of July 14, 1997, the Company had 5,042 shareholders of record.



Below is a summary of the dividends declared during the past two fiscal years:
<TABLE>
<CAPTION>

                                                              Fiscal Year Ended
                                                ---------------------------------------------
                            Quarter                May 3, 1997               April 27, 1996
                            -------             -----------------          ------------------
                         <S>                    <C>                        <C>
                         First..............           ---                        $.11

                         Second.............           ---                         .11

                         Third..............           ---                         .05

                         Fourth.............           ---                         ---
                                                    =========                   ========
                             TOTAL......            $  ---                      $  .27
                                                    =========                   ========
</TABLE>



                                       11
<PAGE>
 
Item 6.                     SELECTED FINANCIAL DATA

                               HANDLEMAN COMPANY
                                FIVE YEAR REVIEW
            (amounts in thousands except per share data and ratios)

<TABLE>
<CAPTION>
                                         1997       %       1996       %       1995       %       1994       %       1993       %
                                      ----------  -----  ----------  -----  ----------  -----  ----------  -----  ----------  -----
<S>                                   <C>         <C>    <C>         <C>    <C>         <C>    <C>         <C>    <C>         <C>
SUMMARY OF OPERATIONS:

Net sales                             $1,181,037  100.0  $1,132,607  100.0  $1,226,062  100.0  $1,066,566  100.0  $1,121,705  100.0
Gross profit, after direct
 product costs *                         274,258   23.2     244,685   21.6     278,464   22.7     249,049   23.4     278,159   24.8
Selling, general & administrative 
 expenses                                244,161   20.7     244,412   21.6     213,497   17.4     187,663   17.6     191,882   17.1
Depreciation: included in selling, 
 general & administrative expenses        29,205    2.5      28,919    2.6      24,787    2.0      24,189    2.3      21,722    1.9
Provision for realignment of 
 operations                                  ---              1,500     .1       5,500     .4       2,000     .2
Amortization of acquisition costs          6,125     .5       7,965     .7       7,014     .6       7,536     .7       8,679     .8
Interest expense, net                     10,967     .9      12,039    1.1       8,024     .7       6,211     .6       6,713     .6
Income (loss) before income taxes
 & minority  interest                     13,005    1.1     (35,731)    **      44,429    3.6      45,639    4.3      70,885    6.3
Income tax expense (benefit)               4,909     .4     (12,738)    **      17,809    1.4      17,983    1.7      27,142    2.4
Effective tax rate                          37.7%              35.6%              40.1%              39.4%              38.3%
Minority interest                         (2,744)    .2         517     **       1,403     **
Net income (loss)                          5,352     .5     (22,476)    **      28,023    2.3      27,656    2.6      43,743    3.9
Dividends                                    ---              9,070             14,755             14,701             13,589
Average number of shares outstanding      33,481             33,576             33,518             33,389             33,229

PER SHARE DATA:

Earnings (loss) per share             $      .16         $     (.67)        $      .84               $.83              $1.32
Dividends per share                          ---                .27                .44                .44                .41

FINANCIAL DATA:

Cash and receivables                  $  302,520         $  277,764         $  283,043         $  237,846         $  257,319
Inventories                              188,215            212,700            276,109            234,594            241,502
Current assets                           500,378            509,813            560,931            477,376            501,052
Additions to property and equipment       22,635             33,596             40,675             28,737             33,391
Total assets                             667,886            693,914            754,076            640,998            659,076
Debt, current                             15,000              4,000                ---             32,200             17,860
Current liabilities                      239,442            264,484            289,961            261,227            259,723
Debt, non-current                        135,520            143,600            146,200             76,364            105,702
Working capital                          260,936            245,329            270,970            216,149            241,329
Shareholders' equity                     283,653            279,560            311,652            299,493            288,700

FINANCIAL RATIOS:

Quick ratio
 (Cash and receivables/current
  liabilities)                               1.3                1.1                1.0                 .9                1.0
Working capital ratio
 (Current assets/current 
  liabilities)                               2.1                1.9                1.9                1.8                1.9
Inventory turns
 (Direct product costs/average
  inventories throughout year)               4.1                3.4                3.5                3.2                3.3
Debt to total capitalization ratio
 (Debt, non-current/debt, non-current 
  plus shareholders' equity)                32.3%              33.9%              31.9%              20.3%              26.8%
Return on assets
 (Net income/average assets)                  .8%                **                4.0%               4.3%               6.7%
Return on beginning shareholders' 
 equity
 (Net income/beginning shareholders' 
  equity)                                    1.9%                **                9.4%               9.6%              16.8%
</TABLE>

*  - Fiscal 1996 amount is before inventory reduction provision of $14,500.

** - Not meaningful

     Note 1:  See Item 7., Management's Discussion and Analysis of Financial
              Condition and Results of Operations, for additional information
              regarding the Company's activities.

     Note 2:  The Company's fiscal year ends on the Saturday closest to April
              30th. Fiscal 1997 consisted of 53 weeks, whereas fiscal years 
              1993 - 1996 consisted of 52 weeks.

                                       12
<PAGE>
 
Item 7.


                          Management's Discussion and
                        Analysis of Financial Condition
                           and Results of Operations


The Company operates principally in one business segment: selling music, video,
book and personal computer software products primarily to mass merchants, and
also to specialty chain stores, drugstores and supermarkets.

Comparison of 1997 with 1996
----------------------------

Net sales for the fiscal year ended May 3, 1997 ("fiscal 1997") were $1.18
billion, compared to $1.13 billion for the fiscal year ended April 27, 1996
("fiscal 1996"), an increase of 4%. Net income for fiscal 1997 was $5.4 million
or $.16 per share, compared to a net loss of $22.5 million or $.67 per share for
fiscal 1996. The operating results for fiscal 1996 included a $14.5 million pre-
tax provision ($.26 per share) recorded for markdowns and other costs incurred
in connection with the Company's inventory reduction program, and a $1.5 million
pre-tax charge ($.03 per share) in connection with closing Entertainment Zone, a
subsidiary which sold music, video and book products in departments leased from
certain retailers.

The Company's fiscal year ends on the Saturday closest to April 30th. Fiscal
1997 consisted of 53 weeks, whereas fiscal 1996 consisted of 52 weeks.
Management believes the inclusion of one additional week in fiscal 1997 did not
have a material effect on results of operations for fiscal 1997.

The Company has three operating units: Handleman Entertainment Resources
("H.E.R."), North Coast Entertainment ("NCE") and Handleman International
("International"). H.E.R. is a category manager of music, video, book and
personal computer software products to mass merchants in the United States. NCE,
which includes the Company's proprietary operations, sells music, video and
personal computer software products to retailers and category managers
(including H.E.R. and International). International provides category management
services in Canada, Mexico, Brazil and Argentina. The sales amounts discussed
below include sales between operating units which are eliminated in
consolidation.

H.E.R. net sales for fiscal 1997 were $959.3 million, approximately equal to
fiscal 1996 net sales of $958.2 million. Following is a discussion of sales for
each of H.E.R.'s four major product lines:

Music sales for fiscal 1997 increased 6% to $595.6 million from $560.9 million
for fiscal 1996, mainly due to increased sales of compact discs. Compact disc
("CD") sales for fiscal 1997 were $460.7 million or 77% of H.E.R.'s music sales,
compared to $401.1 million or 72% of H.E.R's music sales for fiscal 1996.
According to the Recording Industry Association of America ("RIAA"), a music
industry trade group, music industry CD dollar sales reached 81% of total music
industry revenues for calendar 1996. Though CDs have reached 77% of Handleman's
music sales, the Company continues to emphasize the sale of cassette products
for which a substantial base of user hardware continues to exist. According to
RIAA, music industry sales of cassettes, at suggested list price, were $2.1
billion in calendar 1996.

Video sales for fiscal 1997 were $266.4 million, a decline of 9% from $293.4
million for fiscal 1996, substantially attributable to a $17.8 million decline
in sales of mega-hit titles. Certain major customers and vendors are exploring
the expansion of direct relationships for selling certain video products,
primarily mega-hit videos. It is unclear what impact, if any, these direct
relationships will have on the Company's results of operations. Mega-hit video
sales carry low gross profit margin percentages and the customers may continue
to require a provider of other video products, as well as merchandising services
for their video departments.

Book sales increased 4% to $55.6 million for fiscal 1997 from $53.7 million for
fiscal 1996, principally resulting from an increase in the number of departments
shipped.

Personal computer software sales decreased 17% to $41.7 million for fiscal 1997
from $50.2 million for fiscal 1996, primarily the result of an $8.3 million
sales decline from a major customer which exited the product line during the
third quarter of fiscal 1997.

                                       13
<PAGE>
 
NCE net sales were $134.4 million for fiscal 1997, compared to $101.5 million
for fiscal 1996, an increase of 32%. This increase was driven by sales growth
ranging from $7.9 million to $12.6 million in each of NCE's three primary
operating units. NCE net sales for fiscal 1996 exclude $18.8 million of sales
from NCE's Entertainment Zone subsidiary, which closed during fiscal 1996. NCE
sales to other divisions within the Company were $29.2 million in fiscal 1997
and $18.0 million in fiscal 1996.

International net sales for fiscal 1997 were $117.0 million, compared to $72.2
million for fiscal 1996, an increase of 62%. Approximately 68% of the increase
in International net sales was driven by the addition of new customers to the
account base in Mexico. In addition, approximately 23% of the increase in
International net sales resulted from expansion of operations in Brazil and
Argentina. The growth of the International operating unit and expansion to
additional foreign countries has introduced operating risks (e.g., currency
fluctuation, political and economic instability) that could have an effect on
results of operations.

The consolidated gross profit margin percentage for fiscal 1997 was 23.2%. The
gross profit margin percentage for fiscal 1996, before the impact of an
inventory reduction provision recorded in the fourth quarter of fiscal 1996, was
21.6% (20.3% after the impact of the inventory reduction provision). The year-
over-year increase in gross profit margin percentage resulted from a number of
factors including an increase in the proportion of NCE sales in the overall
sales mix. This positively impacted the overall gross profit margin percentage
since sales of NCE products carry higher gross profit margin percentages than
the overall gross profit margin percentage. A significant portion of the
increase in the gross profit margin percentage as compared to last year resulted
from improved margin percentages at each operating unit. The improvement within
H.E.R. was substantially the result of music sales becoming a larger proportion
of the H.E.R. sales mix and a reduction in sales of low margin mega-hit video
titles. Approximately 80% of the 1.6 percentage point increase in gross profit
margin percentage from 21.6% for fiscal 1996 to 23.2% for fiscal 1997 could be
attributed to the increase in NCE sales in the overall sales mix and improved
gross profit margin percentage within H.E.R.

Selling, general and administrative ("SG&A") expenses were $244.2 million (20.7%
of net sales) for fiscal 1997, compared to $244.4 million (21.6% of net sales)
for fiscal 1996. The decrease in SG&A expenses as a percentage of net sales was
attributable to improvements in the International and H.E.R. operating units.
Within the International operating unit, which accounted for approximately 60%
of the reduction in the SG&A expense to net sales percentage, the improvement
principally resulted from the spreading of fixed costs over the higher sales
level and the inclusion of costs in fiscal 1996 related to the start-up of
operations in Brazil and Argentina. The lower SG&A expense to net sales
percentage at H.E.R., which accounted for approximately 40% of the overall
improvement, was driven by the impact of the various initiatives implemented to
improve operational efficiency, such as implementing best practices at the
warehouse and distribution facilities. These improvements were partially offset
by higher SG&A expenses related to proprietary product activities in the NCE
operating unit.

During fiscal 1997, the operations of two music/video shipping branches and two
book shipping branches were transferred to the Indianapolis, Indiana automated
distribution center (ADC), which opened during the third quarter of fiscal 1996.

Interest expense for fiscal 1997 decreased to $11.0 million from $12.0 million
for last year. The decrease in interest expense was primarily attributable to
lower borrowing levels.

The Company's first fiscal quarter is traditionally its weakest quarter. The
Company has historically generated the predominant share of its sales and
earnings after the first quarter. For the first quarter of fiscal 1997, the
Company incurred a loss of $.24 per share. Based on these facts, the Company
expects that a loss will be incurred during the first quarter of fiscal 1998
(ending August 2, 1997).

Accounts receivable were $290.1 million at the end of fiscal 1997, compared to
$257.8 million at the end of fiscal 1996, an increase of 13%. The increase in
accounts receivable was partially the result of the higher level of sales during
the fourth quarter of this year compared to the fourth quarter of last year; in
addition, the impact of customers immediately reducing payments for product
returns also contributed to the increase in accounts receivable. Over 50% of the
year-over-year increase in accounts receivable can be attributed to these
factors.

                                       14
<PAGE>
 
Merchandise inventories were $188.2 million as of May 3, 1997, compared to
$212.7 million as of April 27, 1996, a decrease of $24.5 million or 12%. The
decrease was substantially the result of the Company's inventory reduction
program and ADC implementation.

The decrease in other current assets at May 3, 1997 compared to April 27, 1996
was primarily due to a decrease in income taxes receivable.

The decrease in property and equipment from fiscal 1996 to fiscal 1997 was due
to the disposal of certain Company owned facilities resulting from the
transition to the ADC distribution system.

The accounts payable balance at the end of fiscal 1997 was $197.3 million,
compared to $223.0 million last year. Net inventory investment (inventory less
accounts payable) was a negative $9.1 million as of May 3, 1997, compared to a
negative $10.3 million as of April 27, 1996.

Comparison of 1996 with 1995
----------------------------

Net sales for fiscal 1996 were $1.13 billion, compared with $1.23 billion for
fiscal 1995, a decrease of 8%. The Company's operating results were negatively
impacted by the lower sales level, coupled with a lower gross profit margin
percentage and higher selling, general and administrative (SG&A) expenses. As a
result of these factors, the Company experienced a net loss of $22.5 million or
a loss of $.67 per share for fiscal 1996, compared with net income of $28.0
million or $.84 per share for fiscal 1995. The results for fiscal 1996 included
a $14.5 million pre-tax provision ($.26 per share) recorded for markdowns and
other costs being incurred in connection with the Company's inventory reduction
program, and a $1.5 million pre-tax charge ($.03 per share) in connection with
closing Entertainment Zone, a subsidiary which sold music, video and book
products in departments leased from certain retailers.

Fiscal 1996 and fiscal 1995 both consisted of 52 weeks. Effective with fiscal
1997, Canadian operations were transferred from the H.E.R. operating unit to the
International operating unit. Sales information for fiscal 1996 and fiscal 1995
have been restated to include sales related to Canadian operations in
International.

H.E.R. net sales for fiscal 1996 were $958.2 million, compared to $1.09 billion
for fiscal 1995, a decrease of 12%. Following is a discussion of sales for
H.E.R.'s four major product lines:

Music sales for fiscal 1996 were $560.9 million, compared with $581.6 million
for fiscal 1995, a decrease of 4%. The decrease in music sales was primarily
caused by overall softness in the retail music marketplace. In addition,
customer shipment restrictions contributed to the decrease in music sales. CD
sales for fiscal 1996 were $401.1 million or 72% of H.E.R.'s music sales,
compared to $339.6 million or 58% of H.E.R.'s music sales in fiscal 1995.

Fiscal 1996 video sales were $293.4 million, compared to $401.6 million for
fiscal 1995, a decrease of 27%. Over 90% of the decrease in video sales was
attributable to a $53 million reduction in sales to a major customer which began
to purchase a substantial portion of its product directly from manufacturers and
lower sales of catalog and budget products.

Book product sales for fiscal 1996 were $53.7 million, compared to $57.3 million
in fiscal 1995, a decrease of 6%. The decline in book sales was predominantly
caused by lower sales to a major customer resulting from a decrease in number of
departments shipped.

Personal computer software sales increased 2% to $50.2 million in fiscal 1996,
from $49.3 million in fiscal 1995; the increase in sales of personal computer
products was principally due to sales to a customer the Company added to its
account base.

NCE sales, excluding Entertainment Zone sales, were $101.5 million in fiscal
1996, compared to $81.0 million in fiscal 1995, an increase of 25%. This sales
increase was primarily attributable to sales from companies acquired in fiscal
1995. NCE sales to other divisions within the Company were $18.0 million in
fiscal 1996 and $29.9 million in fiscal 1995.

During fiscal 1996, NCE closed Entertainment Zone, a subsidiary that sold music,
video and book products in departments leased from certain retailers.
Entertainment Zone sales for fiscal 1996 and fiscal 1995 were $18.8 million and
$25.2 million, respectively.

                                       15
<PAGE>
 
During fiscal 1996, the Company recorded a $1.5 million pre-tax charge ($.03 per
share), principally related to display fixture write-offs, in connection with
closing Entertainment Zone.

International sales were $72.2 million in fiscal 1996, compared to $70.5 million
in fiscal 1995, an increase of 2%. Over 60% of this increase was attributable to
sales in Argentina and Brazil, new markets the Company entered during fiscal
1996.

The gross profit margin percentage for the Company, before the impact of the
inventory reduction provision, was 21.6% for fiscal 1996, compared to 22.7% for
fiscal 1995. Approximately 75% of this decline can be attributed to the shift of
music sales to higher priced CD product, which carries a lower gross profit
margin percentage than other music products. CD unit sale prices, however, are
greater than cassette unit sales prices; thus gross profit dollars per CD unit
sold are higher than gross profit dollars per cassette unit sold.

SG&A expenses were $244.4 million or 21.6% of net sales in fiscal 1996, compared
to $213.5 million or 17.4% of net sales for fiscal 1995. H.E.R. contributed to
the increase in SG&A expenses as a percentage of net sales due to: incremental
costs associated with providing services not offered last year, including
servicing key account book departments, expansion of in-store interactive
devices and re-fixturing programs; the effect of the relationship of fixed costs
(e.g., computer and administrative staffs) on a lower sales level; and
additional costs resulting from transition to the Midwest ADC.

NCE and start-up costs within the Company's International division also
contributed to the increase in SG&A expenses as a percentage of net sales. NCE
has a higher SG&A expense to net sales percentage than the comparable percentage
for the Company as a whole. NCE sales represented a greater proportion of
overall sales this year than last year, thus increasing the overall SG&A expense
to net sales percentage.

The Company's second ADC, located in Indianapolis, Indiana, opened during the
third quarter of fiscal 1996, with the operations of three music/video shipping
branches and one book shipping branch transferring to the ADC. In fiscal 1995,
the Company opened its first ADC, located in Sparks, Nevada, to service the
Western region of the U.S.

Interest expense increased to $12.0 million in fiscal 1996 from $8.0 million in
fiscal 1995 due to both higher borrowings and higher average interest rates. The
higher average borrowing level, which accounted for approximately 85% of the
increase in interest expense, was primarily caused by the operating losses, as
well as the acquisition of certain companies during fiscal 1995.

Merchandise inventories were $212.7 million at April 27, 1996, compared to
$276.1 million at April 29, 1995, a decrease of $63.4 million or 23%. This
decrease was substantially the result of the Company's inventory reduction
program.

Other current assets were higher at April 27, 1996 than April 29, 1995 due to
the inclusion of an income tax receivable at April 27, 1996 which resulted from
the loss incurred in fiscal 1996.

The decrease in property and equipment from 1995 to 1996 was the result of the
disposal of facilities as part of the transition to the ADC distribution system.

The accounts payable balance was $223.0 million as of April 27, 1996, compared
to $243.1 million as of April 29, 1995. This decrease was primarily attributable
to the lower inventory level. Net inventory investment (inventory less accounts
payable) was a negative $10.3 million as of April 27, 1996, an improvement of
$43.3 million from the previous year.

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

Working capital at May 3, 1997 was $260.9 million compared to $245.3 million at
April 27, 1996, an increase of $15.6 million or 6%. The increase in working
capital primarily resulted from an increase in accounts receivable, partially
offset by a decrease in merchandise inventories. The working capital ratio
increased to 2.1 to 1 at May 3, 1997 from 1.9 to 1 at April 27, 1996. For fiscal
1997, net cash provided from operating activities primarily resulted from non-
cash charges for depreciation, amortization and recoupment of license advances.

                                       16
<PAGE>
Capital assets consist primarily of display fixtures, warehouse equipment and
facilities. The Company also acquires or licenses video, music and software
products which it markets. Purchases of these assets are expected to be funded
primarily by cash flow from operations.

The Company has a credit agreement, as amended, which management believes will
continue to provide sufficient amounts to fund its day-to-day operations and
higher peak seasonal demands. At May 3, 1997, the Company had $82,000,000
available for borrowings under its credit agreement of which $55,000,000 was
outstanding at that date. For further information, reference should be made to
note 6 of the notes to consolidated financial statements.

Effects of Inflation on Operations
----------------------------------

The Company's financial statements have reported amounts based on historical
costs which represent dollars of varying purchasing power and do not measure the
effects of inflation. If the financial statements had been restated for
inflation, net income would have been lower because depreciation expense would
have to be increased to reflect the most current costs.

Inflation within the economies in which the Company does business has not had a
material effect on the Company's results of operations.

                                   * * * * *

                                       17
<PAGE>
 
Item 8.         FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


The following financial statements and supplementary data are filed as a part of
this report:


Report of Independent Accountants

Consolidated Balance Sheet at May 3, 1997, April 27, 1996 and April 29, 1995.

Consolidated Statement of Operations - Years Ended May 3, 1997, April 27, 1996
and April 29, 1995.

Consolidated Statement of Shareholders' Equity - Years Ended May 3, 1997, April
27, 1996 and April 29, 1995.
 
Consolidated Statement of Cash Flows - Years Ended May 3, 1997, April 27, 1996
and April 29, 1995.

Notes to Consolidated Financial Statements

                                       18
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Shareholders of
Handleman Company:


We have audited the consolidated financial statements and the financial
statement schedule listed in Item 14(a) of this Annual Report on Form 10-K of
Handleman Company and Subsidiaries.  These financial statements and financial
statement schedule are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement.  An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Handleman Company
and Subsidiaries as of May 3, 1997, April 27, 1996, and April 29, 1995 and the
related consolidated results of operations and cash flows for the years then
ended, in conformity with generally accepted accounting principles.  In
addition, in our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.



Coopers & Lybrand L.L.P.


Detroit, Michigan
June 11, 1997

                                       19

<PAGE>
 
                               HANDLEMAN COMPANY
                           CONSOLIDATED BALANCE SHEET
                 MAY 3, 1997, APRIL 27, 1996 AND APRIL 29, 1995
                    (amounts in thousands except share data)
                                ----------------


<TABLE>
<CAPTION>
 

ASSETS                                                 1997         1996         1995
------                                               --------     --------     --------
<S>                                                  <C>          <C>          <C>
Current assets:
  Cash and cash equivalents                          $ 12,449     $ 19,936     $ 24,392
  Accounts receivable, less allowance of
     $21,834 in 1997, $22,141 in 1996
     and $24,053 in 1995 for gross profit
     impact of estimated future returns               290,071      257,828      258,651
  Merchandise inventories                             188,215      212,700      276,109
  Other current assets                                  9,643       19,349        1,779
                                                     --------     --------     --------
     Total current assets                             500,378      509,813      560,931
Property and equipment, net                            95,719      111,355      124,772
Other assets, net of allowances                        71,789       72,746       68,373
                                                     --------     --------     --------

     Total assets                                    $667,886     $693,914     $754,076
                                                     ========     ========     ========


LIABILITIES
-----------

Current liabilities:
  Accounts payable                                   $197,301     $223,023     $243,138
  Accrued and other liabilities                        42,141       41,461       46,823
                                                     --------     --------     --------
     Total current liabilities                        239,442      264,484      289,961
Debt, non-current                                     135,520      143,600      146,200
Other liabilities                                       9,271        6,270        6,263


SHAREHOLDERS' EQUITY
--------------------

Preferred stock, par value $1.00; 1,000,000
  shares authorized; none issued                           --           --           --
Common stock, $.01 par value; 60,000,000
  shares authorized; 33,373,000, 33,498,000
  and 33,533,000 shares issued in 1997,
  1996 and 1995                                           334          335          335
Paid-in capital                                        30,800       32,089       33,188
Foreign currency translation adjustment and other      (7,546)      (7,577)      (8,130)
Retained earnings                                     260,065      254,713      286,259
                                                     --------     --------     --------

     Total shareholders' equity                       283,653      279,560      311,652
                                                     --------     --------     --------

     Total liabilities and shareholders' equity      $667,886     $693,914     $754,076
                                                     ========     ========     ========
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       20
<PAGE>
 
                               HANDLEMAN COMPANY
                      CONSOLIDATED STATEMENT OF OPERATIONS
           YEARS ENDED MAY 3, 1997, APRIL 27, 1996 AND APRIL 29, 1995
                  (amounts in thousands except per share data)
                               ------------------

<TABLE>
<CAPTION>
                                                   1997         1996         1995
                                                  ------       ------       ------
<S>                                             <C>          <C>          <C>
Net sales                                       $1,181,037   $1,132,607   $1,226,062

Direct product costs                               906,779      887,922      947,598

Inventory reduction provision                       --           14,500       --
                                                ----------   ----------   ----------

  Gross profit                                     274,258      230,185      278,464

Selling, general and administrative expenses       244,161      244,412      213,497

Provision for realignment of operations             --            1,500        5,500

Amortization of acquisition costs                    6,125        7,965        7,014

Interest expense, net                               10,967       12,039        8,024
                                                ----------   ----------   ----------

  Income (loss) before income taxes and
     minority interest                              13,005      (35,731)      44,429

Income tax (expense) benefit                        (4,909)      12,738      (17,809)

Minority interest                                   (2,744)         517        1,403
                                                ----------   ----------   ----------

  Net income (loss)                             $    5,352   $  (22,476)  $   28,023
                                                ==========   ==========   ==========

Earnings (loss) per average common share
  outstanding during the year                   $      .16   $     (.67)  $      .84
                                                ==========   ==========   ==========

Average number of common shares outstanding
  during the year                                   33,481       33,576       33,518
                                                ==========   ==========   ==========
</TABLE>

   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       21
<PAGE>
 
                               HANDLEMAN COMPANY
                 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
           YEARS ENDED MAY 3, 1997, APRIL 27, 1996 AND APRIL 29, 1995
                  (amounts in thousands except per share data)
                                ----------------

<TABLE>
<CAPTION>

                                                               Foreign
                               Common Stock                   Currency
                            ------------------               Translation                  Total
                             Shares               Paid-In    Adjustment    Retained    Shareholders'
                             Issued     Amount    Capital     and Other    Earnings       Equity
                            --------    ------    -------    ----------    --------    -------------
<S>                         <C>         <C>       <C>         <C>          <C>         <C>
April 30, 1994               33,411      $ 334    $31,900     $(5,732)     $272,991       $299,493


Net income                                                                   28,023         28,023
Cash dividends, $.44
  per share                                                                 (14,755)       (14,755)
Common stock issued for
  employee benefit plans,
  net of forfeitures            122          1      1,288        (951)                         338
Adjustment for foreign
  currency translation                                         (1,447)                      (1,447)
                             ------      -----    -------      ------      --------        -------

April 29, 1995               33,533        335     33,188      (8,130)      286,259        311,652



Net loss                                                                    (22,476)       (22,476)
Cash dividends, $.27
  per share                                                                  (9,070)        (9,070)
Common stock issued for
  employee benefit plans,
  net of forfeitures            (35)               (1,099)      1,000                          (99)
Adjustment for foreign
  currency translation                                           (447)                        (447)
                             ------      -----    -------      ------      --------        -------

April 27, 1996               33,498        335     32,089      (7,577)      254,713        279,560


Net income                                                                    5,352          5,352
Common stock forfeitures
  in connection with
  employee benefit plans       (125)        (1)    (1,289)      1,290                         ---
Adjustment for foreign
  currency translation                                         (1,259)                      (1,259)
                             ------      -----    -------     -------      --------       --------

May 3, 1997                  33,373      $ 334    $30,800     $(7,546)     $260,065       $283,653
                             ======      =====    =======     =======      ========       ========
</TABLE>



   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       22
<PAGE>
 
                               HANDLEMAN COMPANY
                      CONSOLIDATED STATEMENT OF CASH FLOWS
           YEARS ENDED MAY 3, 1997, APRIL 27, 1996 AND APRIL 29, 1995
                             (amounts in thousands)
                                ----------------
<TABLE>
<CAPTION>
 
                                                          1997          1996          1995
                                                       -----------   -----------   -----------
<S>                                                    <C>           <C>           <C>
Cash flows from operating activities:
  Net income (loss)                                    $     5,352   $   (22,476)  $    28,023
                                                       -----------   -----------   -----------
  Adjustments to reconcile net income (loss) to
    net cash provided by operating activities:
    Depreciation                                            29,205        28,919        24,787
    Amortization of acquisition costs                        6,125         7,965         7,014
    Recoupment of license advances                           9,123         7,496        10,057
    (Increase) decrease in assets from
          operating activities:
        Accounts receivable                                (32,243)          823       (17,122)
        Merchandise inventories                             24,485        63,409       (35,194)
        Other assets                                        10,167       (22,400)           16
    Increase (decrease) in liabilities from
          operating activities:
        Accounts payable                                   (25,722)      (20,115)       39,432
        Accrued and other liabilities                       (5,216)       (1,138)        6,585
                                                       -----------   -----------   -----------

        Total adjustments                                   15,924        64,959        35,575
                                                       -----------   -----------   -----------

        Net cash provided from operating activities         21,276        42,483        63,598
                                                       -----------   -----------   -----------

Cash flows from investing activities:
  Additions to property and equipment                      (22,635)      (33,596)      (40,675)
  Retirements of property and equipment                      3,963        11,033         3,142
  License advances                                         (11,752)      (12,160)      (11,343)
  Acquisition of Madacy Entertainment Group, Inc.              ---           ---       (22,670)
                                                       -----------   -----------   -----------
        Net cash used by investing activities              (30,424)      (34,723)      (71,546)
                                                       -----------   -----------   -----------

Cash flows from financing activities:
  Issuances of debt                                      1,363,311     2,053,087     1,680,200
  Payments of debt                                      (1,360,391)   (2,055,687)   (1,642,564)
  Cash dividends                                               ---        (9,070)      (14,755)
  Other changes in shareholders' equity, net                (1,259)         (546)       (1,109)
                                                       -----------   -----------   -----------

        Net cash provided from (used by)
          financing activities                               1,661       (12,216)       21,772
                                                       -----------   -----------   -----------
        Net increase (decrease) in cash and
          cash equivalents                                  (7,487)       (4,456)       13,824
        Cash and cash equivalents at
          beginning of year                                 19,936        24,392        10,568
                                                       -----------   -----------   -----------
        Cash and cash equivalents at
          end of year                                  $    12,449   $    19,936   $    24,392
                                                       ===========   ===========   ===========
</TABLE>


   The accompanying notes are an integral part of the consolidated financial
                                  statements.

                                       23
<PAGE>
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                ----------------

1.  Accounting Policies:
    -------------------

    Business

    The Company operates principally in one business segment: selling music,
    video, book and personal computer software products primarily to mass
    merchants, and also to specialty chain stores, drugstores and supermarkets.

    Annual Closing Date

    The Company's fiscal year ends on the Saturday closest to April 30th. 
    Fiscal year 1997 consisted of 53 weeks, whereas fiscal years 1996 and 1995
    consisted of 52 weeks.

    Principles of Consolidation

    The consolidated financial statements include the accounts of the Company
    and its domestic and foreign subsidiaries where the Company has voting or
    contractual control.  All material intercompany accounts and transactions
    have been eliminated.  Minority interest recognized in the statement of
    operations represents the minority shareholders' portion of the income
    (loss) for less than wholly-owned subsidiaries.  The minority interest share
    of the net assets of these subsidiaries of $2,343,000 as of May 3, 1997 is
    included in other liabilities in the accompanying consolidated balance
    sheet.

    Estimates

    The preparation of financial statements in conformity with generally
    accepted accounting principles requires management to make estimates and
    assumptions that affect the reported amounts of assets and liabilities,
    disclosure of contingent assets and liabilities at the date of the financial
    statements, and the reported amount of revenues and expenses during the
    reporting period.  Actual results could differ from those estimates.

    Foreign Currency Translation

    The Company utilizes the policies outlined in Statement of Financial
    Accounting Standards No. 52, "Foreign Currency Translation", to convert the
    balance sheet and operations of its foreign subsidiaries to United States
    dollars.  Net transaction gains (losses), and net translation gains (losses)
    resulting from translating results of operations in foreign countries deemed
    highly inflationary, included in the statement of operations were
    $(40,000), $(235,000) and $254,000 for the years ended, May 3, 1997, April
    27, 1996 and April 29, 1995, respectively.

    Recognition of Revenue and Future Returns

    Revenues are recognized upon shipment of the merchandise.  The Company
    reduces gross sales and cost of sales for estimated future returns at the
    time the merchandise is sold.

    Pension Plan

    The Company has a noncontributory defined benefit pension plan covering
    substantially all hourly and salaried employees.  Pension benefits are
    generally based upon length of service and average annual compensation for
    the five highest years of compensation in the last 10 years of employment.
    Net periodic pension cost is accrued on a current basis, and funded as
    permitted or required by applicable regulations.

    Inventory Valuation

    Merchandise inventories are recorded at the lower of cost (first-in, first-
    out method) or market.  The Company accounts for inventories using the full
    cost method which includes costs associated with acquiring and preparing
    inventory for distribution.  Costs associated with acquiring and preparing
    inventory for distribution of $ 15,946,000, $17,582,000 and $19,299,000 were
    incurred during the years ended May 3, 1997, April 27, 1996 and April 29,
    1995, respectively.  Merchandise inventories as of May 3, 1997, April 27,
    1996 and April 29, 1995 include $ 3,078,000, $3,056,000 and $3,554,000,
    respectively, of such costs.

                                       24
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
                               ----------------



1.  Accounting Policies:  (continued)

    Property and Equipment

    Property and equipment are recorded at cost. Upon retirement or disposal,
    the asset cost and related accumulated depreciation are eliminated from the
    respective accounts and the resulting gain or loss is included in the
    consolidated statement of operations for the period. Repair costs are
    charged to expense as incurred.


    Depreciation

    Depreciation is computed using primarily the straight-line method based on
    the following estimated useful lives:


              Buildings and improvements        10-40 years
              Display fixtures                  3-5 years
              Equipment, furniture and other    3-10 years


 
    Licenses

    The Company acquires video, audio and software licenses giving it exclusive
    rights to manufacture and distribute such products. The cost of license
    advances are included in other assets in the consolidated balance sheet and
    are amortized over a period which is the lesser of the term of the license
    agreement or its estimated useful life. The effective lives of the licenses
    tend to range from three to five years. As of May 3, 1997, April 27, 1996
    and April 29, 1995, licenses, net of amortization, amounted to $30,570,000,
    $26,744,000 and $22,571,000, respectively.


    Intangible Assets

    Intangible assets, included in other assets in the consolidated balance
    sheet, consist of the excess of consideration paid over the estimated fair
    values of net assets of businesses acquired and non-competition and other
    ancillary agreements. These assets are amortized using the straight-line
    method over periods predominantly ranging from 5 to 15 years. As of May 3,
    1997, the weighted average period remaining to be amortized was
    approximately 10 years.


    Cash Equivalents

    The Company considers all highly liquid debt instruments purchased with a
    maturity of three months or less to be cash equivalents.


    Financial Instruments

    The Company has evaluated the fair value of those assets and liabilities
    identified as financial instruments under Statement of Financial Accounting
    Standards No. 107. The Company estimates that fair values generally
    approximated carrying values at May 3, 1997, April 27, 1996 and April 29,
    1995. Fair values have been determined through information obtained from
    market sources and management estimates.

                                      25
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
                                ----------------



2.  Acquisition of Business:

    Effective January 1, 1995, two majority-owned subsidiaries of the Company
    acquired the assets of Madacy Entertainment Group, Inc. The aggregate cash
    consideration paid for the assets approximated $22,670,000, including
    certain transaction costs. The acquisition was accounted for as a purchase
    transaction and, accordingly, the purchase price was allocated to assets and
    liabilities based on estimated fair values as of the acquisition date. The
    excess of the consideration paid over the estimated fair values of net
    assets acquired of approximately $20,000,000 is being amortized on the
    straight-line basis over 15 years.


3.  Sales and Accounts Receivable:

    The Company's customers are comprised mainly of mass merchant retail chains
    located predominantly in the United States, Canada and Mexico. For the years
    ended May 3, 1997, April 27, 1996 and April 29, 1995, one customer accounted
    for approximately 38 percent, 40 percent and 40 percent of the Company's net
    sales, and a second customer accounted for approximately 23 percent, 21
    percent and 25 percent of the Company's net sales, respectively.
    Collectively, these customers accounted for approximately 45 percent, 54
    percent and 57 percent of accounts receivable at May 3, 1997, April 27, 1996
    and April 29, 1995, respectively.


4.  Provisions for Inventory Reduction and Realignment of Operations

    The Company implemented an inventory reduction program to reduce financing
    costs, as well as lower selling, general and administrative costs due to
    increased operating efficiency. During the fourth quarter of fiscal 1996,
    the Company recorded a $14,500,000 pre-tax provision related to markdowns
    and other costs to be incurred in connection with the inventory reduction
    program. As of May 3, 1997, most of the identified inventory has been marked
    down or disposed of.

    During fiscal 1996, the Company closed its Entertainment Zone subsidiary,
    which sold music, video and book products in departments leased from certain
    retailers. In connection with closing this subsidiary, the Company
    recognized a $1,500,000 pre-tax charge in the third quarter of fiscal 1996
    primarily related to write-offs of display fixtures and other equipment.

    The Company has been realigning its operations by replacing existing
    distribution centers with new automated distribution centers (ADCs). The
    Company recorded a $5,500,000 pre-tax charge against fourth quarter fiscal
    1995 results related to costs associated with the transition from the prior
    distribution structure to an ADC in its Midwestern region. This charge
    included costs for disposal of certain existing facilities and certain
    compensation costs.

                                      26
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
                               ----------------


5.  Pension Plan:

    The Handleman Company Pension Plan's funded status, the components of net
    pension expense, and the amount which is recorded in the Company's
    consolidated balance sheet at May 3, 1997, April 27, 1996 and April 29, 1995
    are as follows: 
<TABLE>
<CAPTION>
                                                            1997          1996          1995
                                                        -----------   -----------   -----------
<S>                                                     <C>           <C>           <C>
    Actuarial present value of benefit obligations:
      Accumulated benefit obligation, including
        vested benefits of $14,339,000, $12,783,000,
        and $12,057,000 in 1997, 1996 and
        1995, respectively                              $15,403,000   $13,769,000   $12,835,000
                                                        ===========   ===========   ===========

      Projected benefit obligation                      $18,158,000   $16,918,000   $15,648,000
    Plan assets at fair value                            16,492,000    15,627,000    13,102,000
                                                        -----------   -----------   -----------
    Projected benefit obligation in excess of
      plan assets                                        (1,666,000)   (1,291,000)   (2,546,000)
    Unrecognized net loss from past
      experience different from that assumed                188,000       503,000     1,450,000
    Unrecognized net gain from excess funding,
      being amortized over eighteen years                  (728,000)     (847,000)     (966,000)
    Unrecognized prior service cost                         246,000       257,000       268,000
                                                        -----------   -----------   -----------
    Accrued pension liability included in
      other liabilities                                 $(1,960,000)  $(1,378,000)  $(1,794,000)
                                                        ===========   ===========   ===========

</TABLE>

   Assumptions used in determining the actuarial present value of the projected
   benefit obligation included a weighted average discount rate of 7.75 percent
   for 1997 and 1996 and 8.0 percent for 1995, and a rate of increase in future
   compensation levels of 5.0 percent for all periods.

<TABLE>
<CAPTION>
                                               1997         1996          1995
                                              ------       ------        ------
<S>                                       <C>           <C>           <C>
   Net pension expense included the
      following components:
         Service cost                     $   886,000   $   869,000   $   797,000
         Interest cost                      1,321,000     1,182,000     1,132,000
         Actual return on plan assets      (2,046,000)   (2,149,000)   (1,031,000)
         Net amortization and deferral        626,000       926,000      (140,000)
                                          -----------   -----------   -----------

              Net pension expense         $   787,000   $   828,000   $   758,000
                                          ===========   ===========   ===========

</TABLE>

    The assumed long-term rate of return on assets was 8.5 percent for all
    periods. Plan assets are invested in various pooled investment funds and
    mutual funds maintained by the Plan trustee and common stock of the Company.

                                       27
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
                               ----------------



6.  Debt:

    The Company has a contractually committed, unsecured, five-year,
    $145,000,000 credit agreement with a consortium of banks, which is scheduled
    to expire in July 1999. Under the agreement, the Company may make borrowings
    according to a formula based on eligible accounts receivable. At May 3,
    1997, the maximum borrowings available under the agreement were
    approximately $82,000,000, of which $55,000,000 was outstanding at that
    date. The Company may elect to pay interest under a variety of formulae tied
    principally to either prime or "LIBOR". As of May 3, 1997, the interest rate
    on the borrowings outstanding was 7.06%.

    Management believes that the agreement, as amended, will continue to provide
    sufficient amounts to fund its day-to-day operations and higher peak
    seasonal demands. As the Company intends to extend the maturities of the
    outstanding balance under the credit agreement beyond one year, and has the
    ability to do so, the debt has been classified as non-current. Borrowings
    outstanding will be due on the termination date of the agreement.

    In November 1994, the Company entered into a $100,000,000 senior note
    agreement with a group of insurance companies. The balance outstanding as of
    May 3, 1997 was $92,000,000 of which $15,000,000 is classified as current
    and included in accrued and other liabilities in the accompanying
    consolidated balance sheet. These notes bear interest at rates of 7.81% to
    8.59%.

    Scheduled maturities for the senior note, credit agreement, and $3,200,000
    of Economic Development Corporation (EDC) limited obligation revenue bonds
    are as follows:

<TABLE>
<CAPTION>
 
 
<S>                               <C>
             1999................ $18,891,000
             2000................ $73,572,000
             2001................ $14,571,000
             2002................ $14,572,000
             After 2002.......... $13,914,000
</TABLE>
    The EDC bonds, senior note and the credit agreement all contain certain
    restrictions and covenants, relating to, among others, interest coverage
    ratios, working capital, debt and net worth.

    Interest expense for the years ended May 3, 1997, April 27, 1996 and April
    29, 1995, was $12,099,000, $13,119,000 and $9,136,000, respectively.
    Interest paid for the years ended May 3, 1997, April 27, 1996 and April 29,
    1995 was $11,222,000, $13,178,000 and $8,004,000, respectively.

                                      28
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)

                                ---------------


7.   Income Taxes:
     ------------

     The domestic and foreign components of income (loss) before income taxes
     and minority interests for the years ended May 3, 1997, April 27, 1996 and
     April 29, 1995 are as follows:
<TABLE>
<CAPTION>
                                            1997            1996           1995
                                            ----            ----           ----
     <S>                                <C>             <C>             <C>
     Domestic                           $10,896,000     $(33,663,000)   $44,127,000
     Foreign                              2,109,000       (2,068,000)       302,000
                                        -----------     ------------    -----------
     Income (loss) before income
       taxes and minority interests     $13,005,000     $(35,731,000)   $44,429,000
                                        ===========     ============    ===========

</TABLE>
     Provisions for income taxes for the years ended May 3, 1997, April 27, 1996
     and April 29, 1995 consist of the following:
<TABLE>
<CAPTION>
                                           1997             1996           1995
                                           ----             ----           ----
     Currently payable:
     <S>                                <C>             <C>             <C>
       Federal                          $ 9,054,000     $(11,059,000)   $14,738,000
       Foreign                              477,000        1,049,000        475,000
       State and other                      794,000       (2,560,000)     2,882,000

     Deferred, net:
       Federal                           (4,646,000)          87,000       (390,000)
       Foreign, state and other            (770,000)        (255,000)       104,000
                                        -----------     ------------    -----------
                                        $ 4,909,000     $(12,738,000)   $17,809,000
                                        ===========     ============    ===========
</TABLE>
     The following table provides a reconciliation of the Company's effective
     income tax rate to the statutory federal income tax rate:
<TABLE>
<CAPTION>
                                                Percent of Income/Loss
                                                ----------------------

                                            1997          1996          1995
                                            ----          ----          ----
       <S>                                  <C>           <C>           <C>
       Federal statutory rate               35.0%         35.0%         35.0%
       State and local income taxes         (1.8)          5.1           4.4
       Effect of foreign tax provisions     (2.6)         (4.1)          0.6
       Effect of minority interests          1.9           0.5          (1.2)
       Other                                 5.2          (0.9)          1.3
                                            ----          ----          ----
            Effective tax rate              37.7%         35.6%         40.1%
                                            ====          ====          ====
</TABLE>
     Items that gave rise to significant portions of the deferred tax accounts
     at May 3, 1997, April 27, 1996 and April 29, 1995 are as follows:
<TABLE>
<CAPTION>
                                         May 3, 1997                 April 27, 1996             April 29, 1995
                                 ----------------------------  --------------------------  --------------------------
                                 Deferred Tax    Deferred Tax  Deferred Tax  Deferred Tax  Deferred Tax  Deferred Tax
                                    Assets        Liabilities     Assets      Liabilities     Assets      Liabilities
     ----------------------------------------------------------------------------------------------------------------
     <S>                         <C>             <C>           <C>           <C>           <C>           <C>
     Allowances                   $10,612,000     $ 6,503,000   $ 6,807,000   $ 5,228,000    $4,732,000   $ 2,972,000
     Employee benefits              2,139,000          10,000     1,585,000       122,000     1,810,000       370,000
     Property and equipment           738,000       8,190,000     1,462,000     8,076,000       856,000     7,459,000
     Inventories                      906,000       2,053,000       278,000     4,513,000       342,000     4,861,000
     Other                            550,000         408,000       172,000           ---       176,000        57,000
                                  -----------     -----------   -----------   -----------    ----------   -----------
                                  $14,945,000     $17,164,000   $10,304,000   $17,939,000    $7,916,000   $15,719,000
                                  ===========     ===========   ===========   ===========    ==========   ===========
</TABLE>

     The Company intends to reinvest indefinitely the undistributed earnings of
     its foreign subsidiaries. Accordingly, the potential withholding tax of
     approximately $1,300,000 on undistributed earnings of foreign subsidiaries
     of approximately $26,500,000 has not been recorded as of May 3, 1997. The
     Company has net operating loss carryforwards in certain of its foreign
     subsidiaries for tax purposes of $8,393,000 which expire predominantly in
     2001 to 2006.

     Income taxes paid in 1997, 1996 and 1995 were approximately $8,833,000,
     $1,865,000 and $19,569,000, respectively.

                                      29
<PAGE>
 
       NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
                          ----------------

8.   Property and Equipment:

     Property and equipment consists of the following:

<TABLE>
<CAPTION>
                                             1997          1996          1995
                                         ------------  ------------  ------------
       <S>                               <C>           <C>           <C>
       Land                              $  4,238,000  $  4,877,000  $  6,741,000
       Buildings and improvements          24,564,000    31,793,000    42,312,000
       Display fixtures                    96,721,000   112,207,000   101,051,000
       Equipment, furniture and other      67,450,000    60,983,000    61,513,000
                                         ------------  ------------  ------------
                                          192,973,000   209,860,000   211,617,000
       Less accumulated depreciation
        and amortization                   97,254,000    98,505,000    86,845,000
                                         ------------  ------------  ------------
                                         $ 95,719,000  $111,355,000  $124,772,000
                                         ============  ============  ============
</TABLE>

9.   Stock Plans:

     The Company's shareholders approved the adoption of the Handleman Company
     1992 Performance Incentive Plan (the "Plan"), which authorizes the granting
     of stock options, stock appreciation rights and restricted stock.  At any
     given time, the maximum number of shares of stock which may be issued
     pursuant to restricted stock awards or granted pursuant to stock options or
     stock appreciation rights shall not exceed 5% of the number of shares of
     the Company's common stock outstanding as of the immediately preceding
     fiscal year end.  After deducting restricted stock, options and awards
     issued or granted under the Plan since adoption in September 1992, 724,999
     shares of the Company's stock are available for use under the Plan as of
     May 3, 1997.

     Pursuant to the restricted stock provisions of the Plan, 124,529 shares of
     common stock were forfeited during the year ended May 3, 1997.  Restricted
     shares are held in the custody of the Company and vest only if specified
     performance goals are achieved.  These shares are treated as outstanding
     for purposes of calculating earnings per share and payment of dividends.
     If the  minimum performance goals under which an award is issued are not
     satisfied, the shares are forfeited.  If performance goals are exceeded, a
     maximum of 81,826 additional shares can be issued.  The number of shares
     which may vest will be prorated to the extent actual results are between
     minimum and maximum performance goals.  Through 1997, the Company has not
     recorded any net compensation expense related to the restricted stock
     because minimum performance goals have not been achieved.

     Information with respect to options outstanding under the previous and
     current stock option plans, which have various terms and vesting periods as
     approved by the Compensation and Stock Option Committee of the Board of
     Directors, for the years ended April 29, 1995, April 27, 1996 and May 3,
     1997 is set forth below.  Options were granted during such years at no less
     than fair market value at the date of grant.
<TABLE>
<CAPTION>
                                                     Number        Option         Weighted
                                                   Of Shares     Price Range     Average Price
                                                   ---------   ---------------   -------------
       <S>                                         <C>         <C>               <C>      
 
       Balance, April 30, 1994                     1,217,454   $11.75 - $22.17      $14.64
       Granted                                        99,200    10.44 -  14.25       12.36
       Terminated                                    (93,825)   10.44 -  21.83       14.70
       Exercised                                       - 0 -       --       --          -- 
                                                   ---------   ---------------      ------  
       Balance, April 29, 1995                     1,222,829   $10.44 - $22.17       14.45
       Granted                                       336,000    10.06 -  10.06       10.06
       Terminated                                   (256,145)   10.06 -  21.83       13.65
       Exercised                                       - 0 -       --       --          --
                                                   ---------   ---------------      ------  
       Balance, April 27, 1996                     1,302,684   $10.06 - $22.17       13.48
       Granted                                       350,000     6.75 -   8.31        6.80
       Repriced                                       56,975     6.38 -   7.13        7.03
       Terminated, including repriced options       (396,744)    6.75 -  22.17       12.93
       Exercised                                       - 0 -       --       --          --
                                                   ---------   ---------------      ------  
       Balance, May 3, 1997                        1,312,915   $ 6.38 - $21.83      $11.58
                                                   =========   ===============      ======
       Number of shares exercisable
        at May 3, 1997                               777,940
                                                   =========
</TABLE>

                                       30
<PAGE>
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,(continued)
                               ----------------


                                        
  9. Stock Plans:  (continued)
     -----------              

     The Company has elected to continue to apply the provisions of Accounting
     Principles Board Opinion No. 25, "Accounting for Stock Issued to
     Employees," and accordingly, no stock option compensation expense is
     included in the determination of net income in the statement of operations.
     Had stock option compensation expense been determined pursuant to the
     methodology of Statement of Financial Accounting Standards No. 123,
     "Accounting for Stock-Based Compensation," the pro forma effects on the
     Company's earnings and earnings per share in fiscal years 1997 and 1996
     would not have been material.

                                      31
<PAGE>

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
                               ----------------


10.  Quarterly Financial Summary (Unaudited):
     (amounts in thousands except per share data)


                                         FOR THE THREE MONTHS ENDED
                                         --------------------------

<TABLE>
<CAPTION>


                                            July 27,    Oct. 26,    Jan. 31,     May 3,
     Fiscal Year 1997                         1996        1996        1997        1997
     ----------------                      --------    --------    --------    --------
<S>                                        <C>         <C>         <C>         <C>
     Net sales                             $225,026    $347,080    $330,532    $278,399
     Gross profit                            50,729      78,331      79,979      65,219
     Income (loss) before income taxes      (11,967)     11,897      12,076         999
     Minority interest                         (659)       (371)     (1,471)       (243)
     Net income (loss)                       (8,181)      6,822       6,527         184
     Earnings (loss) per share                 (.24)        .20         .19         .01*
     Dividends per share                         --          --          --          --



                                           July 29,    Oct. 28,    Jan. 31,    April 27,
     Fiscal Year 1996                        1995        1995        1996        1996
     ----------------                      --------    --------    --------    --------

     Net sales                             $230,789    $295,170    $345,605    $261,043
     Gross profit                            52,558      71,079      70,930      35,618
     Income (loss) before income taxes       (9,727)      4,662       1,543     (32,209)
     Minority interest                         (104)        389          90         142
     Net income (loss)                       (6,469)      3,365       1,097     (20,469)
     Earnings (loss) per share                 (.19)        .10         .03*       (.61)*
     Dividends per share                        .11         .11         .05         ---




                                           July 30,    Oct. 29,    Jan. 31,    April 29,
     Fiscal Year 1995                        1994        1994        1995        1995
     ----------------                      --------    --------    --------    ---------

     Net sales                             $212,464    $347,160    $362,911    $303,527
     Gross profit                            51,016      80,232      82,087      65,129
     Income before income taxes               1,401      25,229      17,457         342
     Minority interest                           63         (19)      1,437         (78)
     Net income                                 901      15,480      11,096         546
     Earnings per share                         .03         .46         .33         .02*
     Dividends per share                        .11         .11         .11         .11

</TABLE>


   * Earnings per common share were improved by $.06 and $.04 for the fourth
     quarters of fiscal 1997 and fiscal 1995, respectively, resulting from
     various year-end adjustments to previous accrual estimates. Income before
     income taxes for the quarter ended April 27, 1996 includes the effect of a
     $14,500,000 pre-tax inventory reduction provision ($.26 per share after
     tax). Income before income taxes for the quarters ended January 31, 1996
     and April 29, 1995 include the effect of pre-tax provisions for realignment
     of operations of $1,500,000 ($.03 per share after tax) and $5,500,000 ($.10
     per share after tax), respectively. See note 4 to the consolidated
     financial statements.

                                      32
<PAGE>

Item 9.                 DISAGREEMENTS ON ACCOUNTING AND
                              FINANCIAL DISCLOSURES

   Not applicable

                                   PART III.

Item 10.       DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Item 10, with the exception of the following information regarding executive
officers of the Registrant required by Item 10, is contained in the Handleman
Company definitive Proxy Statement for its 1997 Annual Meeting of Shareholders
to be filed on or before August 28, 1997, and such information is incorporated
herein by reference.  All officers serve at the discretion of the Board of
Directors.

                      EXECUTIVE OFFICERS OF THE REGISTRANT

<TABLE>
<CAPTION>
      Name and Age                       Office and Year First Elected
------------------------    ----------------------------------------------------
<S>                         <C> 

Stephen Strome        52    (1) President (1990), Chief Executive Officer (1991)
                                and Director (1989)

Peter J. Cline        50    (2) Executive Vice President/President of Handleman
                                Entertainment Resources (1994)

Lawrence R. Hicks     52    (3) Executive Vice President/Sales and Merchandising
                                (1994)

Stephen Nadelberg     56    (4) Senior Vice President/President of NCE (1997)

Arnold Gross          56    (5) Senior Vice President/President of Handleman
                                International (1997)

Leonard A. Brams      46    (6) Senior Vice President/Finance, Chief Financial
                                Officer and Secretary (1997)

Thomas C. Braum, Jr.  42    (7) Vice President (1992) and Corporate
                                Controller (1988)
</TABLE>

1.   Stephen Strome has served as President since March 1990.  On May 1, 1991,
     Mr. Strome was named Chief Executive Officer.

2.   Peter J. Cline has served as Executive Vice President/President of
     Handleman Entertainment Resources since joining the Company in April 1994.
     Prior to joining Handleman Company, Mr. Cline was employed by the Snacks
     and International Consumer Products Division of Borden, Inc. from August
     1990 until April 1994 where he served in various executive positions, most
     recently as Group Vice President - North American Snacks.

3.   Lawrence R. Hicks has served as a Vice President since January 1982.  Mr.
     Hicks was elected Senior Vice President in June 1988, and Executive Vice
     President in April 1994.

4.   Stephen Nadelberg has served as Senior Vice President/President of North
     Coast Entertainment since joining the Company in February 1997.  Prior to
     joining Handleman Company, Mr. Nadelberg was employed from 1974 to 1996 by
     Allied Domecq Spirits & Wines, parent company of Hiram Walker, Inc., where
     he held various positions most recently as Vice President and General
     Manager of global product development.

5.   Arnold Gross has served as Senior Vice President/International since 1996.
     In June of 1997, Mr. Gross was elected Senior Vice President/President of
     Handleman International.  From 1994 to 1995, Mr. Gross served as Director
     General of Rackjobbing, S.A. de C.V., the Company's joint venture in
     Mexico.  Prior to joining Handleman Company, Mr. Gross served from 1983 to
     1993 as President of A&M Development.

6.   Leonard A. Brams has served as Senior Vice President/Finance, Chief
     Financial Officer and Secretary since joining the Company in June 1997.
     Prior to joining Handleman Company, Mr. Brams was Vice
     President/Administration and Chief Financial Officer for Talon LLC from
     1995 until 1997, and Vice President Finance of United Technologies
     Automotive from 1990 until 1994.

7.   Thomas C. Braum, Jr. has served as Corporate Controller since June 1988.
     In February 1992, Mr. Braum was elected Vice President.

                                       33
<PAGE>
 
Item 11.                    EXECUTIVE COMPENSATION

     Information required by this item is contained in the Handleman Company
definitive Proxy Statement for its 1997 Annual Meeting of Shareholders, to be
filed on or before August 28, 1997 and such information is incorporated herein
by reference.

Item 12.                 SECURITY OWNERSHIP OF CERTAIN
                        BENEFICIAL OWNERS AND MANAGEMENT

     Information required by this item is contained in the Handleman Company
definitive Proxy Statement for its 1997 Annual Meeting of Shareholders, to be
filed on or before August 28, 1997 and such information is incorporated herein
by reference.

Item 13.        CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Information required by this item is contained in the Handleman Company
definitive Proxy Statement for its 1997 Annual Meeting of Shareholders, to be
filed on or before August 28, 1997 and such information is incorporated herein
by reference.

                                    PART IV

Item 14.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

     (a)  1.  The following financial statements and supplementary data are
              filed as a part of this report under Item 8.:

              Report of Independent Accountants

              Consolidated Balance Sheet at May 3, 1997, April 27, 1996
                           and April 29, 1995.

              Consolidated Statement of Operations - Years Ended May 3, 1997,
                           April 27, 1996 and April 29, 1995.

              Consolidated Statement of Shareholders' Equity - Years Ended
                           May 3, 1997, April 27, 1996 and April 29, 1995.

              Consolidated Statement of Cash Flows - Years Ended May 3, 1997,
                           April 27, 1996 and April 29, 1995.

              Notes to Consolidated Financial Statements
 
          2.  Financial Statement Schedules

              II.  Valuation and Qualifying Accounts and Reserves

              All other schedules for Handleman Company have been omitted since
              the required information is not present or not present in an
              amount sufficient to require submission of the schedule, or
              because the information required is included in the financial
              statements or the notes thereto.

                                       34
<PAGE>
 
     3. Exhibits as required by Item 601 of Regulation S-K.

        S-K Item 601 (3)

          The Registrant's Restated Articles of Incorporation dated June 30,
          1989 were filed with the Form 10-K dated May 1, 1993, and are
          incorporated herein by reference.  The Registrant's Bylaws adopted
          March 7, 1990, as amended June 16, 1993 and further amended December
          6, 1995, were filed with the Form 10-K dated April 27, 1996, and are
          incorporated herein by reference.

        S-K Item 601 (10)

          The Registrant's 1983 Stock Option Plan was filed with the Commission
          in Form S-8 dated January 18, 1985, File No. 2-95421.  The first
          amendment to the 1983 Stock Option Plan, adopted on March 11, 1987,
          was filed with the Commission with the Form 10-K for the year ended
          May 2, 1987.  The plan, as amended, is incorporated herein by
          reference.

          The Registrant's 1992 Performance Incentive Plan was filed with the
          Commission in Form S-8, dated March 5, 1993, File No. 33-59100.

          The advisory agreement with David Handleman was filed with the Form
          10-K for the year ended April 28, 1990.

          The Credit Agreement among Handleman Company, the Banks named therein
          and NBD Bank, N.A., as Agent, dated July 12, 1994 was filed with the
          Form 10-K for the year ended April 28, 1995.  Amendments Nos. 1, 2 and
          3 to the Credit Agreement were filed with Commission with the Form 10-
          K for the year ended April 27, 1996.

          The Note Agreement dated as of November 1, 1994 was filed with the
          Form 10-K for the year ended April 28, 1995.

          The change in control agreements dated March 17, 1997 between
          Handleman Company and certain executive officers of the Company are
          filed as Exhibits A and B to this Form 10-K.

        S-K Item 601 (21) - Subsidiaries of the Registrant:

          Handleman Company of Canada, Limited, an Ontario Corporation
          Scorpio Productions, Inc., a Texas Corporation
          Hanley Advertising Company, a Michigan Corporation
          Rackjobbing, S.A. de C.V.
          Rackjobbing Services, S.A. de C.V.
          Michigan Property and Risk Management Company, a Michigan Corporation
          North Coast Entertainment, Inc., a Michigan Corporation
          Anchor Bay Entertainment, Inc., a Michigan Corporation
          Sellthrough Entertainment, Inc., a Michigan Corporation
          North Coast Entertainment, Ltd., a Canadian Corporation
          Sofsource, Inc., a Michigan Corporation
          Madacy Entertainment Group, Inc., a Michigan Corporation
          Mediaphon, Gmbh, a German Corporation
          Madacy Entertainment Group, Ltd., a Canadian Corporation
          American Sterling Corp., a Delaware Corporation
          Handleman de Argentina S.A.
          Handleman do Brasil Commercial Ltd.
          Sellthrough Entertainment, Limited, a Canadian Corporation
          Madacy Entertainment (U.K.) Limited
          Bosco Music, Inc., a Michigan Corporation
          HGV Video Productions, Inc., an Ontario Corporation

        S-K Item 601 (23) - Consent of Independent Accountants:
          Filed with this report.

   (b) No reports on Form 8-K have been filed during the last quarter of the
       period covered by this report.

Note:  The Exhibits attached to this report will be furnished to requesting
       security holders upon payment of a reasonable fee to reimburse the
       Registrant for expenses incurred by Registrant in furnishing such
       Exhibits.

                                       35
<PAGE>
 
                                                                    Exhibit (23)



                       CONSENT OF INDEPENDENT ACCOUNTANTS



We consent to the incorporation by reference in the registration statements of
Handleman Company and Subsidiaries on Form S-3 (File Nos. 33-16553, 33-26456,
33-33797 and 33-42018) and Form S-8 (File Nos. 2-60162, 2-95421, 33-59100, 
33-16637 and 33-69030) of our report dated June 11, 1997, on our audits of the
consolidated financial statements and financial statement schedule of Handleman
Company and Subsidiaries as of May 3, 1997, April 27, 1996, and April 29, 1995
and for the years then ended, which report is included in this Annual Report on
Form 10-K.



Coopers & Lybrand L.L.P.



Detroit, Michigan
July 24, 1997

                                       36
<PAGE>
 
          SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
           YEARS ENDED APRIL 29, 1995, APRIL 27, 1996 AND MAY 3, 1997

<TABLE>
<CAPTION>
             COLUMN A                 COLUMN B     COLUMN C       COLUMN D         COLUMN E
      ----------------------         ----------   ----------   --------------   -------------
 
                                                                 Deductions: 
                                     Balance at   Additions:     Adjustments
                                     Beginning    Charged to   of, or Charges     Balance at
           Description               Of Period     Expense      to, Reserve     end of Period
      ----------------------         ----------   ----------   --------------   -------------
<S>                                  <C>          <C>          <C>              <C>

Year ended April 29, 1995:
 
     Accounts receivable,
     allowance for gross
     profit impact of estimated
     future returns                  $19,613,000  $ 8,510,000      $ 4,070,000    $24,053,000
                                     ===========  ===========      ===========    ===========
     Other assets, collectability
     allowance for receivables
     from bankrupt customers         $13,060,000  $   698,000      $   582,000    $13,176,000
                                     ===========  ===========      ===========    ===========
                                     
Year ended April 27, 1996:
 
     Accounts receivable,
     allowance for gross
     profit impact of estimated
     future returns                  $24,053,000  $13,972,000      $15,884,000    $22,141,000
                                     ===========  ===========      ===========    ===========
     Other assets, collectability
     allowance for receivables
     from bankrupt customers
                                     $13,176,000  $ 4,687,000      $ 3,913,000    $13,950,000
                                     ===========  ===========      ===========    ===========

Year ended May 3, 1997:
 
     Accounts receivable,
     allowance for gross
     profit impact of estimated
     future returns                  $22,141,000  $ 7,959,000      $ 8,266,000    $21,834,000
                                     ===========  ===========      ===========    ===========
     Other assets, collectability
     allowance for receivables
     from bankrupt customers         $13,950,000  $ 3,805,000      $ 4,754,000    $13,001,000
                                     ===========  ===========      ===========    ===========
</TABLE>

                                       37
<PAGE>

                                   SIGNATURES


     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                                        HANDLEMAN COMPANY



DATE:     July 25, 1997                 BY:       /s/ Stephen Strome
       -------------------                  -------------------------------
                                            Stephen Strome, President, Chief
                                            Executive Officer and Director

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE> 
<CAPTION> 

    /s/ Leonard A. Brams                           /s/ Thomas C. Braum, Jr.
---------------------------------------     ------------------------------------
<S>                                         <C> 
Leonard A. Brams, Senior Vice President,    Thomas C. Braum, Jr., Vice President,
Finance and Chief Financial Officer          Corporate Controller
(Principal Financial Officer)                (Principal Accounting Officer)
</TABLE> 

              July 25, 1997                             July 25, 1997
---------------------------------------     ------------------------------------
                 DATE                                       DATE



           /s/ David Handleman                    /s/ Richard H. Cummings
---------------------------------------     ------------------------------------
David Handleman, Director                   Richard H. Cummings, Director
 (Chairman of the Board)

             July 25, 1997                            July 25, 1997
---------------------------------------     ------------------------------------
                 DATE                                     DATE



        /s/ James B. Nicholson                     /s/ Alan E. Schwartz
---------------------------------------     ------------------------------------
James B. Nicholson, Director                Alan E. Schwartz, Director

             July 25, 1997                             July 25, 1997
---------------------------------------     ------------------------------------
                 DATE                                      DATE


          /s/ Lloyd E. Reuss                        /s/ Gilbert R. Whitaker
---------------------------------------     ------------------------------------
Lloyd E. Reuss, Director                    Gilbert R. Whitaker, Jr., Director

             July 25, 1997                               July 25, 1997
---------------------------------------     ------------------------------------
                 DATE                                        DATE


           /s/ John M. Barth
---------------------------------------
John M. Barth, Director

             July 25, 1997
---------------------------------------
                 DATE



                                       38