harnischfeger case

1. Describe clearly all of the accounting changes Harnischfeger made in 1984. -In 1984, there was a switch from accelerated to straight line depreciation retroactively. Because of this, the depreciation expense decreased. -The estimated depreciation lives on certain U. S. plants, machinery and equipment changed. The economic life of these assets was increased, so the depreciation expense was lowered. -There was an improvement in the minimum pension benefit. This change produced a lower pension expense. -The was a liquidation of LIFO inventory quantities carried at lower cost compared with the current cost of their acquisitions.

Because of this, COGS decreased. -The accounts receivable were net of allowances for doubtful accounts of $5. 9 million and $6. 4 million at October 31, 1984 and 1983, respectively. This decrease results in higher accounts receivable. -The was a change of the fiscal year from July 31 to September 30. This increased the sales by $5. 4 million. -The R&D expense was decreased by $7 million -The structure of the long-term debt was changed. Subordinated debentures replaced term obligation and the debt payable in German marks retired. The company entered into a long-term agreement with Kobe Steel, Ltd, to supply Harnischfeger requirements for construction cranes for sale in the United States.

2. What is the effect of the depreciation accounting method change on the reported income in 1984? How will this change affect profits in future years? In 1984, the Corporation has computed depreciation expense on plants, machinery and equipment using the straight-line method for financial reporting purposes. Prior to 1984, the Corporation used principally accelerated methods for its U. S. operating plants.

The cumulative effect of this change, which was applied retroactively to all assets previously subjected to accelerated depreciation, increased net income for 1984 by $11. 0 million or $. 93 per common and common equivalent share. In the future years the profits will be lower compared to the profits calculated with the depreciation accelerated method. With the accelerated method, the depreciation expense would decrease every year, while the depreciation expense is the same every year with the straight-line method. So in future years the depreciation expenses will be higher compared to the accelerated method.

Because of this, in future years profits will be lower. 3. What is the effect of the change in depreciation lives? How will this change affect future reported profits? As a result of the review of its depreciation policy, the Corporation, effective November 1, 1983, has changes its estimated depreciation lives on certain U. S. plants, machinery and equipment and residual values on certain machinery and equipment, which increased profits for 1984 by $3. 2 million or $. 27 per share. The change in depreciation lives will reduce the future profits. 4.

The depreciation accounting changes assume that Harnischfeger’s plant and machinery will last longer and will lose their value more slowly. Given the business conditions Harnischfeger was facing in its primary industries in 1984, are these economic assumptions justified? The changes in accounting for depreciation were made to conform the Corporation’s depreciation policy to those used by manufacturers in the Corporation’s and similar industries and to provide a more equitable allocation of the cost of plants, machinery and equipment over their useful lives.

I think these assumptions were justified, because they were experiencing a diminishment in sales. In the Consolidated Statement of Operations, revenues went down to $398,708 in 1984 from $447,461 in 1982. This means that they were giving less use to their machinery and that causes an increase on the useful life of the asset. 5. Note 8 indicates Harnischfeger’s allowance for doubtful accounts. Compute the ratio of the allowance to gross receivables (receivables before the allowance) in 1983 and 1984. What would the allowance have been if the company maintained the ratio at the 1983 level?

How much did the pre-tax income increase as a result of the changed ratio in 1984? The ratio of the allowance to gross receivables in 1983 is: $6. 4 million/$70. 1 million*100=9. 1%. The ratio of the allowance to gross receivables in 1984 is: $5. 9 million/$93. 5 million*100=6. 3% The allowance would have been $8. 5 million if they would have had consistency on the ratio from 1983 in 1984. As a result, the pre-tax income increase is $2. 6 million due to the changed ratio in 1984. In Millions of US$ 1984 1983 AR Net 87. 6 63. Allowance for Doubtful accounts5. 9 6. 4 AR Gross 93. 5 70. 1 Allowance for Doubtful accounts ratio 6. 3% 9. 1% 6. Note 9 indicates that Harnischfeger decreased its R&D expense considerably in 1984 relative to the previous two years. Do you think this change was motivated by business considerations or accounting considerations? How did this change affect the company’s reported profits in 1984?

In 1984, Harnischfeger’s reported profits during each of the four quarters, ending the year with a pre-tax operating profit of $5. million and a net income after tax and extraordinary credits of $15 million. So I think that this action was motivated by business considerations, since the accounting practices were not the best. These actions made profits look positive. Research and development expense incurred in the development of new products or significant improvements to existing products was $5. 1 million in 1984. $12. 1 million in 1983 and $14. 1 million in 1982. This change affected the company’s report profits by 7 million from 1984 to 1983 and by 9 million from 1984 to 1982. . Note 11 describes a number of changes in Harnischfeger’s pension plans in 1984. Describe these changes as clearly as you can. What are the economic consequences of these changes to Harnischfeger and its workers? -The change in the return on investment assumption is for all US plans. The economic consequence is that there will be less injection of cash by these pension owners during the lifetime of their pension. -In 1984 the corporation established a new plan, which goal was an improvement in the minimum pension benefit.

This constituted in a restructure of the Salaried Employees Retirement Plan. 8. How did the pension plan changes affect Harnischfeger’s financial statements in 1984? Are these changes likely to affect future profits? The effect of the changes in the investment return assumption rates for all U. S. plans, together with the 1984 restructuring of the U. S. Salaries Employees Plan, was to reduce pension expense by approximately $4. 0 million in 1984 and $2. 0 million in 1983, and the actuarial present value of accumulated plan benefits by approximately $60. 0 million in 1984.

This may have an effect on future profits. 9. Summarize all the accounting changes Harnischfeger made in 1984 and their effects on pre-tax profits and cash flows in 1984. Change of depreciation method +$11M Change in useful life’s or residual values +$3. 2M Reduced Pension expense +$4. 0M LIFO Liquidation +$2. 4M Bad debt reserve +$2. 1M R&D Expense +$7. 0M Transactions with Kobe $0. M 10. Accounting statements are used by investors, lenders, customers, employees, and governments in dealing with Harnischfeger. Among these groups, who is most likely to “see through” the above accounting changes, and who is least likely to do so? I think that investors, lenders, and governments should be the ones to most likely see through the changes. Certain employees in the company, such as those in accounting, finance, and upper management, should be able to see through the changes as they are more familiarized with financial statements. 11.

Are the accounting changes likely to help or to hinder Harnischfeger’s ability to implement its business plan? Be as specific as possible. An increase in profit causes an increase in tax expense, making the finances negative. So these changes will most likely hinder Harnischfeger’s ability to implement its business plan. The accounting changes were made to seem attractive and to encourage investors into buying their stocks and bond, but because of the increase in tax expense, these changes are not likely to help Harnischfeger’s ability to implement its business plan. 2. Overall, what is your assessment of Harnischfeger’s future as of 1984? For Harnischfeger it is only a matter of time before the company goes bankrupt. They might survive for a while by adjusting the books with accounting techniques. However, sooner or later, the truth will come out, especially if this illusion of profit is used for incentives and other activities that don’t contribute to the overall recovery of the company.

They wanted to make their financial statements look pretty so that investors would buy their stocks so they can buy themselves some time before their poor management decisions came to the public light. All of the profits that we have seen in 1984 were not a result of good business practices or an increase in sales, but just the result of using questionable accounting methods intended to make it look as if they were making money when they really weren’t.

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