Harnischfeger Corporation

1. Identify all the accounting policy changes and the accounting estimates that Harnischfeger made during 1984. Estimate, as accurately as possible, the effect of these on the companys 1984 reported profits. a. Changes that affect the Harnischfeger Revenues: The company start to account Kobe Steel sales in US, previously it only a gross margin in the financial statement. !this sales represents "#$ millions% Sales to a foreign subsi iary starts to be consoli ate as a net revenues !this sales represents "&,' millions% b. Changes that affect the Harnischfeger profitability: Change in the epreciation accounting metho from accelerate to straight line metho . (ncrease of ")) million in )*$' income Change on the company+s net resi ual value. (ncrease net income in " ,,' millions c. (nventories -i.ui ation: The company ha a " #,' million increase in its net income, as a result of -(/0 inventory li.ui ation. the

. !hat do you thin" are the moti#es of Harnischfeger$s management in ma"ing the changes in its financial reporting policies% &o you thin" in#estors 'ill see through these changes% (t seems that the company ha a better accounting result, not a better 1operating2 result. (n or er to report a better financial Statement !an increase its bonus base on accounting net income% the management ecrease epreciation 1levels2, increase revenues an s3itch inventories metho of accounting. (n my point of vie3, the e4pense re uction in S567 might be not enough to change the scenario. 8orst than that is the cut on... 9:; The principal motive for the Harnischfeger management 3as to sho3 profit in )*$'. This 3as necessary since the company 3as preparing to celebrate )<< years of oing business an management 3as eager to prove to investors that the company 3as oing 3ell. =anagement 3as also motivate by incentive compensation> the boar of irectors establishe an ?4ecutive (ncentive @lan 3hich provi e an incentive compensation opportunity of '<A of annual salary for )) senior e4ecutive officers only if the Corporation reache a specific net afterBta4 profit obCective for the year. =anagement

coul also receive another '<A of salary if the company e4cee s the obCective !)*$& ?4ecutive (ncentive @lan%. 9:; 7n aggressive accounting strategy an earnings management as implemente by Harnischfeger9:Ds management in )*$' is not a ba i ea. Ho3ever, for all of these changes to occur 3ithin a year is rather suspicious an 3ill raise a lot of .uestions from investors. (nvestors may thinE the company is trying so har because it 3ants to looE goo for its )<<th anniversary. 7lso all these changes come at a cost of incentive compensation for the top e4ecutives !$<A of their salaries if they e4cee the obCective%. (nvestors may also be concerne 3ith the contra iction of the ecrease in R6F spen ing an the ne3 strategy to e4plore ifferent high technology pro uct lines an services. Some investors might be able to see that the e4tension of epreciation lives for plant an e.uipment, to reflect an increase in net income, might not be a smart strategy. (. )ssess the company*+,s future prospects, gi#en your insights from -uestions 1 and and the information in the case about the company*+,s turnaround strategy. 9:; Harnischfeger is taEing a huge risE by relying an e4pecting that the oneBtime boost in income an cash in )*$' 3ill enable the company to successfully e4pan internationally an gro3 in ne3 high tech areas an become profitable once again. 9:; Gecause of a prevalent ecreasing interest rate environment, it is e4pecte that Harnischfeger 3ill have to eal 3ith the problem of high interest e4pense in the future. 9:; 7lso, the aggregate effect of the changes in epreciation policy might mean higher epreciation costs in future years an thus higher operating costs. 9:; 7s e.uipment ages, higher maintenance costs as 3ell as epreciation costs 3ill mean there coul be significantly higher operating costs. 9:; Thus it is highly probable that Harnischfeger might sho3 a loss in the procee ing years.