INDIVIDUAL ASSIGNMENTQuestion 1: Identify all the accounting policy changes and estimates that Harnischfeger made during 1984.
Estimate, as accurately as possible, the effect of these on the company’s 1984 reported pro?ts.Answer:Following are the accounting policy changes made by Harnischfeger during 1984 and its effects on the company’s reported pro?ts: Changes in Sales Calculation: Prior to October 1983, Harnischfeger only recognised gross margins from products purchased from Kobe and then resold, as sales. But post it, they incorporated the resale of these products as net sales. As a results of this change both aggregate sales as well as cost of sales increased by $28 million. Also it had an effect on pro?t margins i.e., quality of earnings.
Pro?t margin had a change 0f 7.1%. Also they adjusted the ending period of certain subsidiaries which increased the reporting period of company from 12 to 14 months and as a result increasing sales by $5.4 million.Changes in pension plans: In the footnotes of 1984 ?nancials, they stated that their salaried employee pension plan was well over-funded. The policy of Harnischfeger was to fund at a minimum the amount required under the Employee Retirement Income Security Act of 1974.
This new plan included in increased minimum pension bene?t, which probably served to make the pension restructuring more appetising to employees. Cash resulting from the liquidation of the original plan was divided into two groups: $36.7 million went toward purchasing individual annuities in order to cover the obligations of the original plan, and $39.
3 million went into an account called “Accrued Pension Costs”. This plan had certain signi?cant effects on ?nancial statements. It resulted in positive cash ?ow situation for 1984 and also increased net income by $3.
9 million. Changes in Depreciation: Before 1984, company was using accelerated method of depreciation for its plants, but from Financial Note 2, its evident that, in 1984, they had calculated depreciation expense on plant, machinery and equipment by straight line method for its US operating plants. As a cumulative effect of this, net income for 1984 was increased by $3.2 million or $0.27 per share. No income tax effect was applied to this change.
Also, effective from November 1,1993, as a result of the review of its depreciation policy, the company had changed its estimated depreciation lives on certain US plants, machinery and equipment and residual values on certain machinery and equipment, which increased net income for 1984 by $3.2 million or $0.27 per share. Also for this, no income tax effect was applied.
Changes in allowance for Doubtful debts: In 1984, they adjusted their allowance for doubtful accounts to 6.7% of sales in place of 10% of sales as in 1983. As a result of this operating income was 2.9 million for 1984. This aggressive change to increase sales is quite risky and skeptical and the company provides no reason and explanation for it.Inventory liquidation: Liquidation of LIFO inventory happened as a result of company reducing its inventory in 1984, 1983 as well as 1982. The process led to gains, as the inventory which was acquired at lower cost earlier was now sold at higher prices.
Foreign operations were included: The net sales, net income or loss and net assets of subsidiaries located outside U.S. and Canada were also included in the consolidated ?nancial statements.
As a result of this change net sales increased by $5.4 million. Changes in R&D expenses: In 1984, operating pro?t of Harnischfeger was drastically increased by $9.1 million when Harnischfeger didn’t follow the same level of R;D activities as in 1983, re?ected in the percentage of R;D as of sales.Question 2: What do you thinks are the motives of Harnischfeger’s management in making these changes in its ?nancial reporting policies? Do you think investors will see through these changes?Answer:Harnischfeger Corporation had a period of explosive growth during 1970s and then on they expanded rapidly. But the worldwide recession during 1980s badly hit the company and also dropped down the demand of its products signi?cantly . All these led to a series of events that shook the ?nancial stability of the company.
So therefore, in order to recover and get back on track they have to make the changes in the accounting and ?nancial reporting policies.Following are the main motives which have caused the management to make changes in depreciation, R&D, pension plans, doubtful debts etc:All the changes made in the accounting policies have been done with a simple motive of increasing pro?ts,sales and positive cash ?ows for current ?scal year, 1984. A positive pro?t will even lead to high stock price which ?ll further help the company to raise capital. Also most of the Board members hold certain shares in the company.For the next ?scal year 1985 an incentive was set. According to it compensation opportunity of 40% of annual salary for 11 senior executive of?cers only if the company reaches a speci?c net after-tax pro?t objective. In addition to it another incentive was set if the company exceeds the target.
This incentive will lead to greater dedication on part of employees and in turn bene?t the company.The loan borrowed from the lenders for a speci?c period requires minimum levels of cash, receivables and working capital.As a result of all the positive changes, increase in pro?ts, positive cash ?ows etc; company will be again able to get back to its same brand image that it had earlier and also will enjoy better goodwill in the market.WHETHER INVESTORS WILL SEE THROUGH OR NOT?The changes made by Harnischfeger’s management in accounting and ?nancial policies are quite signi?cant and would attract the investors. From making loses to completely turning around the strategy and making pro?ts in the current ?scal year (1984) is the key strength of the company.
But if we look at the ?nancial statements and notes to accounts of the company, one major drawback would be the aggressive changes made in R;D and even no explanation is provided for it. In the long run this change will hamper the working of the company and even its strength. Also this contradicts the earlier policy which the company had followed. Apart from this, changes even made in allowance for doubtful debts are quite aggressive and can raise alarming questions on part of the investors.
These drawbacks can play a signi?cant role while investors make a decision. So in my opinion, investors won’t see through these changes as the company has recently started coming back on track after the ?nancial crisis and also their policies in the long run won’t be pro?table. Question 3: Access the company’s future prospects, given your insights from question 1 and 2 and the information in the case about company’s turnaround strategy.Answer:Turnaround strategy of Harnischfeger is quite impressive. After a serious recession period, they have come up with corporate recovery plans and also took great strategic decisions to reorient the business which have given them favourable returns. They have a great scope ahead too and could operate more pro?tably. Their strategies provide greater range of future success.
Their ?nancial surroundings are better now as they have successfully issued new stocks and corporate bonds. However, there are certain aspects of the strategy which are skeptical and can cause adverse effects too in the long run.-Cutting down the bene?ts of the employees or freezing their wages could be a massive issue.
This would demoralise the employees and would lead to high employee turnover. -Even the policy declared by the company to give incentives to the employees in case they attain their desired objectives contradicts to their aim of improving the cash ?ows.-Then they had even cut down their R;D expenses just to show increment in operating pro?t. In the long run this will hamper their business as they can’t focus on high technology.
Also they aim to get new technology however this contradicts with R&D expenditure.-Also they don’t have any strategy to realise payments faster from the customers and maintain positive cash?ows rather they are depending on bank loans with harsh terms and conditions.So in the long run all these short comings need to be taken care of, for company to ?ourish well and continue making pro?ts. Also strategies give 100 percent results when proper execution takes place.