1. Read the footnotes carefully. Identify four accounting policy changes and accounting estimates that Harnischfeger made during 1984 and estimate as accurately as possible the effect of these changes on the company’s 1984 reported profits?
One accounting change that Harnischfeger made was that they were going to include products purchased from Kobe Steel in their net sales. Before November 1, 1983 only the gross margin on Kobe products was included in their net sales. Harnischfeger was also going to include the financial statements of certain foreign subsidiaries were included on the basis of their fiscal years ended July 31 to September 30.
Even though there was no significant impact on net income, this did help to increase their net sales by $28 million from Kobe Steel and $5.4 million from foreign subsidiaries. A second accounting change that Harnischfeger made was that they were going to change their method for computing depreciation expense on plants, machinery, and equipment to the straight-line method. Before 1984, Harnischfeger used the principally accelerated method for all US operating plants.
This was then applied retroactively to all assets previously subject to the accelerated depreciation. The cumulative effect of this change increased net income by $11 million. A third accounting change that was made was that because of the new depreciation method being used they changed their estimated useful lives on certain US plants, machinery, and equipment. They also had to change the residual value on certain machinery and equipment. This also helped to increase their net income in 1984 by $3.2 million. A final accounting change that Harnischfeger made was their inventory method. They changed from using the FIFO method to LIFO in 1984. Once this change was made the inventories that were valued using LIFO way made up about 82% of total inventories. The inventory reductions led to a liquidation of LIFO inventory that were carried at a lower cost. This led to an increase in net income by $2.4 million.
2. What do you think are the motives of Harnischfeger’s management in making the changes in its financial reporting policies?
One of the major motives for management was that management promised they
would get back on track by 1984 after the financial crisis of 1982. This was their 100 year anniversary of being a business and they wanted to illustrate that the company was still lively. If they could prove this to investors that they could turn the company around after such a large loss from the previous years they would be sure to come back and start buying stock again. This could lead to the stock price increasing, which will also help the company to raise more capital. Management was also hoping that by changing the accounting policies it could help to improve the brand name of the company.
Another motive was the new incentive compensation plan that had been put into effect by the Board of Directors. This plan provided an incentive compensation opportunity of 40% of annual salary for 11 senior executive officers. This would only hold true if Harnischfeger would reach a specific net after-tax profit. If the corporation exceeded this objective seven of the eleven executives would also receive an additional compensation of up to 40%. Even though this policy does not start until 1985 it will make sure to give management that extra push to make sure everything is reported accurately. An example would be how they are now going to be including the purchases from Kobe Steel in net sales.
3. The efficient market hypothesis maintains that the stock market and stock prices react efficiently to publicly available information about a firm. In other words, market participants react intelligently and quickly to publicly available information and rapidly re-price stocks. One implication of an efficient capital market is that financial statement analysts can’t find “undervalued” or “overvalued” securities. Another implication is that the market will “see through” cosmetic accounting changes as long as they are publicly disclosed in the footnotes. Do you believe investors in Harnischfeger will “see through” the company’s accounting changes?
I believe that Harnischfeger’s management strategy was a good idea. It provided motivation and showed, through the financial statements, that the company was able to make a profit again. Since the company increased net income this may lead investors to believe that the changes are part of a
forward looking business strategy and could increase the company’s stock price . It does seem very suspicious that all of these changes occurred within a year and I think this will raise a lot of questions with their investors. The investors might think that the company is trying too hard to make their financial statements look good by their 100th anniversary. Investors might also find out that a lot of this motivation will come at a large cost, with having the top executive officers have incentive compensation. Investors might also be concerned that the company is decreasing the amount of R&D spending, but still trying to explore different high technology product lines and services. I would have thought with trying to do this they would want to spend more money on R&D. A final thing investors might notice is the extension of deprecation lives for their plants, machinery, and equipment. Although this is being done to increase their net income, this might not be such a smart strategy for the company.
4. Assess the company’s future prospects given your insights from question 1 & 2 above, and the information in the case on the company’s turnaround strategy. (Attempt to answer this question as if you were back in 1984, without the benefit of an additional 25 years of history.)
I would think the company’s future is still unstable. Harnischfeger was able to operate more profitably than they had in previous years by reducing workforce, closing plants, losing money, and planning to have a reorientation of their business. They were able to increase net income and hopefully encourage investors to buy stock to boost the stock price. They were also able to issue new stock and corporate bonds. Although they were able to do this they took on a very large risk by relying and expecting the increase of net income to help the company expand internationally and grow in high technology products and services. With this new strategy in place to get into new technology I would be concerned that they were not putting enough money into R&D. They have never experienced this market and relying on it to keep the company going made me would think they would spend more to ensure they were approaching this correctly. It also was a large risk that they thought this one time boost in net income would make the company profitable from here forward by putting into place the incentive plan which
will wind up costing a lot of money if they are able to meet their expectations. I do think it was a very good implementation to start to include products purchased from Kobe Steel in their net income rather than gross margin. Even though it winded up not having an impact on net income it helped to boost their sales, which could show the investors they are selling more products. I would be concerned with the change in their depreciation method and the useful lives, even though this saved the money and increased net income; they might wind up paying more depreciation, maintenance, and operating costs in years to come. I think it was a good idea to do a LIFO liquidation to help with getting rid of their old inventory. The only bad with this is that there is going to be a higher tax liability. Another disadvantage to this is that older, lower cost inventories are matched with current revenues, which leads to other costs being lost within their sales. With these increases in costs in other areas mean that Harnischfeger could go back to reporting a loss.
5. For S+ (optional). Using either current financial periodicals (e.g., Wall Street Journal, Financial Times, etc.) or the UWM article database, find an article related to this company either in terms of its finances or business. Summarize the article in a paragraph or two. (Do not use an article that merely announces the company’s earnings.) Give a complete citation for your article. (Presenters do not answer this S+ question. Presenters’ requirement is in #9 below.)
The article I found from the UWM libraries database talked about Harnischfeger filing for reorganization. This Plan along with its Disclosure Statement covered Harnischfeger and 57 of its domestic subsidiaries. Once approved by the creditors and confirmed by the court this Plan would emerge Harnischfeger from Chapter 11 Bankruptcy and allow flexibility in its industry. This was the last step that Harnischfeger needed to do to emerge from bankruptcy and planned to surface by spring of 2001.
Harnischfeger files plan of reorganization. (2000, Oct 26). PR Newswire. Retrieved from
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