1. In 1984, Harnischfeger made four accounting policy changes and accounting estimates. It is important to carefully read the footnotes to identify these changes. Additionally, it is necessary to estimate the impact of these changes accurately on the company’s reported profits for that year.
Harnischfeger made several accounting changes. Firstly, they decided to include products purchased from Kobe Steel in their net sales, instead of only including the gross margin. Additionally, they began including the financial statements of certain foreign subsidiaries based on their fiscal years ended from July 31 to September 30. These changes resulted in a $28 million increase in net sales from Kobe Steel and a $5.4 million increase from foreign subsidiaries, although net income was not significantly affected.
Another accounting change involved the depreciation expense calculation. Harnischfeger switched to the straight-line method for computing depreciation on plants, machinery, and equipment, whereas previously they used the accelerated method for all US operating plants. This change was applied retroactively to all assets that were subject to accelerated depreciation, and it increased net income by $11 million.
The third accounting change related to estimated useful lives and residual values of certain US plants, machinery, and equipment due to the new depreciation method. This adjustment resulted in a $3.2 million increase in net income in 1984.
Finally, Harnischfeger made changes to their inventory method.In 1984, a transition was made from using the FIFO method to LIFO. As a result, approximately 82% of the total inventories were now valued using LIFO. The change in inventory valuation method resulted in reductions in inventory, which led to the liquidation of LIFO inventory that had been carried at a lower cost. This liquidation ultimately contributed to a $2.4 million increase in net income.
What are Harnischfeger’s management’s motives for making changes to its financial reporting policies?
Management made a promise to investors that they would recover from the financial crisis of 1982 by 1984, which coincided with their 100th anniversary as a business. The goal was to show that the company was still vibrant and attractive. A successful turnaround would encourage investors to resume purchasing stocks, potentially driving up the stock price and enabling the company to raise more capital. Additionally, management believed that implementing changes in accounting policies could enhance the company’s brand reputation.
Another reason for the motivation was the recent implementation of a new incentive compensation plan by the Board of Directors. This plan offered a potential compensation opportunity of 40% of annual salary for 11 senior executives. However, this would only be granted if Harnischfeger achieved a specific net after-tax profit. Furthermore, if the company exceeded this target, seven out of the eleven executives would receive an additional compensation of up to 40%. Although this policy is scheduled to begin in 1985, it will ensure that management is encouraged to report all information accurately. For instance, they will now include the purchases from Kobe Steel in their net sales calculation.
The efficient market hypothesis claims that the stock market and stock prices respond efficiently to publicly available information regarding a company. This means that market participants react intelligently and swiftly to such information and promptly adjust stock prices. One consequence of an efficient capital market is that financial analysts cannot identify securities that are either undervalued or overvalued. Another consequence is that the market can perceive cosmetic accounting changes as long as they are publicly disclosed in the footnotes. Do you think investors in Harnischfeger will be able to perceive the company’s accounting changes?
I believe that Harnischfeger’s management strategy was a positive move. It provided motivation and demonstrated through the financial statements that the company was able to generate profit again. By increasing net income, investors may view these changes as part of a forward-looking business strategy that could potentially raise the company’s stock price. However, it is worth noting the suspicious timing of all these transformations occurring within a year, which may raise concerns among investors.
They might perceive the company’s efforts to manipulate their financial statements in order to present a favorable picture for their 100th anniversary. Furthermore, investors might discover that this motivation comes at a substantial cost, involving incentive compensation for top executive officers. Additionally, investors may be worried about the decrease in R&D spending while still venturing into new high technology product lines and services. One would expect increased investment in R&D for such endeavors.
Lastly, investors could observe the extension of depreciation lives for plants, machinery, and equipment. While this move aims to boost net income, it may not be a wise long-term strategy for the company.
4. Assess the possible future of the company by considering the insights gained from question 1 and 2, as well as the information given in the case about the company’s turnaround strategy. (Attempt to answer this question while disregarding any knowledge beyond what was known in 1984.)
Harnischfeger’s actions, such as downsizing staff, shutting down plants, and incurring losses, were aimed at increasing profitability and realigning the business. These measures led to a rise in net income, attracting potential investors and improving the stock price. The company also issued new stock and corporate bonds. However, there is a significant risk involved as they rely on the growth of net income to expand internationally and venture into high-tech products and services. Concern arises from the possibility that they may not be allocating sufficient funds for research and development in this new market. Additionally, the company’s profitability depends on the success of this approach with the assumption that increased net income will sustainably cover expenses related to incentive plans. Including Kobe Steel products in overall net income calculations was beneficial as it boosted sales and indicated increased product sales to potential investors. Changing depreciation methods and useful lives raises concerns about potentially higher depreciation costs, maintenance expenses, and operating costs in the future despite saving money and increasing net income. While implementing a LIFO liquidation strategy to clear old inventory was advantageous, it comes with the downside of higher tax liabilities.Furthermore, the combination of older and cheaper inventories with present revenues results in the abandonment of additional expenditures associated with their sales. These escalating costs across various sectors may potentially result in Harnischfeger experiencing a future loss once again.
5. Optional S+ requirement: Utilize current financial periodicals such as the Wall Street Journal or Financial Times, or access articles from the UWM article database to locate a relevant article pertaining to this particular company’s finances or business operations. Summarize the article content in one to two paragraphs, avoiding articles that solely announce the company’s earnings. Be sure to provide a complete citation for the selected article. (Presenters are not required to respond to this S+ inquiry; please refer to requirement #9 for presenters.)
The article I found from the UWM libraries database discusses Harnischfeger’s filing for reorganization. This Plan and its Disclosure Statement cover Harnischfeger and 57 of its domestic subsidiaries. Once approved by creditors and confirmed by the court, this Plan would enable Harnischfeger to emerge from Chapter 11 Bankruptcy and gain flexibility in its industry. This is the final step for Harnischfeger to exit bankruptcy, and they anticipate emerging by spring of 2001.
PR Newswire reported that Harnischfeger has filed a reorganization plan on October 26, 2000.
