Chapter 3: Harnischfeger Case
1. Identify all the accounting policy changes and accounting estimates that Harnischfeger made during 1984. Estimate, as accurately as possible, the effect of these on the company's 1984 reported profits.
Harnischfeger made the following accounting policy changes and accounting estimates during the year 1984.
There was a change in the recognition of some types of sales. This resulted in a change in sales calculation. Harnischfeger incorporated products purchased from Kobe Steel, which were re-sold by the company, into its net sales. This increased aggregate sales and cost of sales by $28 million.
There was a change in the fiscal year for some foreign subsidiaries.
There was a …show more content…
An aggressive accounting strategy and earnings management as implemented by Harnischfeger's management in 1984 is not a bad idea. However, for all of these changes to occur within a year is rather suspicious and will raise a lot of questions from investors. Investors may think the company is trying so hard because it wants to look good for its 100th anniversary. Also all these changes come at a cost of incentive compensation for the top executives (80% of their salaries if they exceed the objective). Investors may also be concerned with the contradiction of the decrease in R&D spending and the new strategy to explore different high technology product lines and services. Some investors might be able to see that the extension of depreciation lives for plant and equipment, to reflect an increase in net income, might not be a smart strategy.
3. Assess the company's future prospects, given your insights from questions 1 and 2 and the information in the case about the company's turnaround strategy.
Harnischfeger is taking a huge risk by relying and expecting that the one-time boost in income and cash in 1984 will enable the company to successfully expand internationally and grow in new high tech areas and become profitable once again.
Because of a prevalent decreasing interest rate environment, it is expected that Harnischfeger will have to deal with the problem of high interest expense in the future.