The Harnischfeger Case

ACC 613

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 change in the depreciation methods on assets. The depreciation policy for financial reporting purposes was changed to a straight-line method from a principally accelerated method.

* There was a change in the use of last-in, first-out (LIFO) liquidation in inventory valuation.

* There was a change in the allowance for doubtful accounts. The company adjusted its allowance for doubtful accounts to 6.7% of sales for 1984 from 10% of sales in 1983.

* There was change in the R&D expenses. Harnischfeger significantly reduced its R&D expenses to $5.1 million in 1984, from 412.1 million in 1983.

* There was change in employee pension plans. The Salaried Employee Retirement Plan was terminated in 1984 and a new plan was created.

The effect of the accounting policy changes on the company's 1984 reported profits are as follows:

* The effect of the change in sales calculation was an increase in both aggregate sales and cost of sales by $28 million. Also, profit margin dropped from 1.55% to 1.44%, which represented a 7.1% change in profit margin.

* By changing the fiscal year of foreign subsidiaries (ending period of September 30 instead of July 31), the effect was the lengthening of the 1984 reporting period for the subsidiaries from 12 months to 14 months. This increased sales by $5.4 million.

* The effect of the change in depreciation method (straight-line method) was a net income of $11 million realized in 1984. Overall, depreciation changes resulted in an increase of $3.2 million in net income in 1984.

* The effect of LIFO inventory liquidation was an increase in 1984 net income by $2.4 million, as gains. The balance sheet also reflected an improvement in liquidity.

* The effect of the change in the allowance for doubtful accounts was that it resulted in $2.9 million in operating income for 1984.

* The effect of the change in R&D expenses was an increase in operating profit by $9.1 million.

* The effect of the change in pension plans was a reduction in pension expenses by $14 million, increase in net income by $3.9 million, and a positive cash flow.

2. What do you think are the motives of Harnischfeger's management in making the changes in its financial reporting policies? Do you think investors will see through these changes?

* The principal motive for the Harnischfeger management was to show profit in 1984. This was necessary since the company was preparing to celebrate 100 years of doing business and management was eager to