Harnischfeger Corporation free essay sample

Describe clearly the accounting changes Harnischfeger made in 1984 as stated in Note 2 of its financial statements. Harnischfeger made two accounting changes from which one made its net sales increase, and the second change made its net income increase. For the net sales increases, they included sales from certain foreign subsidiaries which increased their net sales. Also, in the past when having sold equipment generated from their supplier Kobe Steel, they only included the gross margin from the sale of Kobe originated equipment, but now they include the net sales products purchased from Kobe and sold by Harnischfeger. This was done mainly to reflect more effectively on the transactions between the corporation and Kobe, since they were now working with a long-term supply agreement which was part of their restructuring plans. The other change was to use the straight-line method for the computation of depreciation expenses for plants, machinery and equipment. This changed method of computing depreciation made their net income rise by million. We will write a custom essay sample on Harnischfeger Corporation or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page 2. What is the effect of the depreciation accounting method change on the reported income in 1984? How will this change affect profits in future years? Depending on the useful life of the asset being depreciated, salvage value and purchase price, the straight line method (used in accounting changes for Harnischfeger), this computing method will spread the depreciation expense evenly in the useful life. Whereas the accelerated method of depreciation uses larger depreciation values in the beginning years of the assets useful life, and for the remaining years it is a lower expense until becoming zero. The overall effect per year on net income with straight line methods is to make it appear a bit higher (depends on what type of business, manufacturing business makes net income higher since the cost of manufacturing equipment is usually very high leading to larger depreciation expense values). In the future years net income will remain steady using straight line depreciation methods, and when depreciation ends with the assets useful life, it will either be disposed giving a temporary increase in net income or will be replaced with a new asset with a new depreciation expense. 3. What is the effect of the depreciation lives change? How will this change affect future reported profits? If the depreciation lives changes, there can be two of the following consequences:a) If the plant, property and manufacturing quipment are used for less time than the indicated useful life, the future profits could decrease if there is no productivity. Overhead expenses would reduce, but depreciation would still continue and would make profits smaller. b) If the plant, property and manufacturing equipment are used for a longer period than the estimated useful life, then the depreciation will reduce by the end of the useful life, but the maintenance expense will increase because as these assets g et older, they need constant maintenance. If production output is not high enough to compensate maintenance expense, then profits could reduce. 4. The depreciation accounting changes assume that Harnischfeger’s plant and machinery will last longer and will lose their value more slowly. Given the business conditions Harnischfeger was facing in its primary industries in 1984, are these economic assumptions justified? The case said that they used straight line depreciation method in the accounting change, but it doesnt mean that the plant and machinery will last longer, the useful life of the plant and machinery will be the same. The only way it lasts longer is because less of it is being used because now Harnischfeger is buying their equipment from overseas to save on manufacturing costs and increase their profit. It is true that it will lose the value more slowly because the depreciation expense is divided in the years of useful life of the equipment. Are these economic assumptions justified? In my opinion, they are not. There is no credible forecast or sales leads that show that profits will continue at that steady stream, so in my opinion these depreciation accounting changes are just temporary measurers to first appease creditors and restore confidence to attract investment. To be able to justify economic assumptions, it would be better to see through two quarters of the following accounting period to see if the company made any significant changes rather than just cost cutting and accounting changes to increase net income. 5. In Note 7, Harnischfeger describes the effect of LIFO inventory liquidation on its reported profits in 1984. Describe what is meant by LIFO liquidation and how liquidation affects a company’s income statement and balance sheet. LIFO liquidation means that a company show that it has sold its oldest inventories first. Since LIFO means to sell inventory that last came in first, LIFO liquidation occurs when a company makes it appear that it sold its oldest inventory first. This inflates profits because the old purchase price will be used ith a new selling price assuming inflation. Consequently, LIFO liquidation makes it look like the company made more money in the given accounting period. For the given period, LIFO liquidation bolsters the net income in the income statement, and in the balance sheet the inventory would be less valuable because it is recorded at the historical cost, rather than the current cost. 6. Note 8, states Harnischfeger’s allowance for doubtful accoun ts. Compute the ratio of the allowance to gross receivables (receivables before the allowance) in 1983 and 1984. What would the allowance have been if the company maintained the ratio at the 1983 level? How much did the pre-tax income increase as a result of the changed ratio in 1984? | 1984 | 1983 | Allowance for Doubtful Accounts | $5,900,000 | $6,400,000 | Net Accounts receivable | $87,648,000 | $63,740,000 | Gross Receivables | $93,548,000 | $70,140,000 | Ratio | 6. 31% | 9. 12% | If the company would have maintained their ratio at the 1983 level of 9. 12%, the allowance for doubtful accounts would have been $8,535,888. 2. The pre-tax increased by 2. 81% (9. 12% 6. 31%) 7. Note 9, page 216, states that Harnischfeger decreased Ramp;D expense in 1984 relative to the previous two years. Do you think this change was motivated by business considerations or accounting considerations? How did this change affect the company’s reported profits in 1984? On Kobes side, this change was motivated by business considerations since it would benefit a lot because Harnischfeger phased out its own man ufacturing of construction cranes and buys it from Kobe. Aside from that Harnischfeger would hold the exclusive distribution for Kobe-built cranes in the United States, so this Ramp;D cooperation agreement helps Kobe to manufacture products that are jointly developed. I believe that on Harnischfegers side the change is motivated by both accounting and business considerations because Harnischfeger must show profits this year to show that its restructuring plan has given favorable results and returned the company back to success, and since it needs to be still in business but is phasing out the manufacturing of construction cranes, it still has the ability to sell by ourcing it from another supplier (Kobe). In 1984, the Ramp;D expense reduced by 137% for Harnischfeger since Ramp;D was now in joint cooperation with Kobe steel and was going to be funded in a term of 3 years, considering a total cost of $17 million starting from year 1984. This huge saving of 137% in Ramp;D can be extrapolated in the total reduction of 19% in the Product develo pment, selling and administrative expenses from year 1983 to 1984. Their interest expenses, and provisions for income taxes increased in 1984, but the savings in Ramp;D were good enough to show remarkable change from a net loss in 1983 to a net income in 1984. 8. Note 11, describes a number of changes in Harnischfeger’s pension plans in 1984. Describe these changes as clearly as you can. What are the economic consequences of these changes to Harnischfeger and its workers? Pension expenses are reduced from $12. 2 million in 1982 to $1. 9 million in 1984. Net assets for employee benefits dropped from $124,2 millions in 1983 to $62 million in 1984. The reason for restructuring being that the program was over funded. The excess plan assets that totaled $39. 3 million reverted to Harnischfeger on receiving regulatory approval from the Pension Benefit Guaranty Corporation. This money has been added to the Accrued Pension Costs and will be amortized to income over the next ten year period. The other effect is that the The US Salaried Employees Plan was restructured and reduced the pension expense by $4. million. The actuarial gains of $39. 3 million are going to be amortized to income over the next 10 years starting from 1984. The economic consequences to Harnischfeger are substantial gains and income over the next ten years in their financial statements. The consequences for the workers are that their retirement benefits and pension plans are no longer going to contribute as much to their benefits as they did in the past. 9. How did the p ension plan changes affect Harnischfeger’s financial statements in 1984? Are these changes likely to affect future profits? Harnischfeger got actuarial gains of $39. 3 million which will be amortized as income over the next years starting from 1984 for the next ten years. This translate to an profit of $3. 93 million each year over a period of ten years. 10. Summarize all the accounting changes Harnischfeger made in 1984, and their effects on pre-tax profits and cash flows in 1984. The changes made by Harnischfeger and their respective effects on pre-tax profits are as follow:a) Changes in depreciation computation to traight-line methods: makes the net income appear stable and steady and reduces the larger expenses brought in in the initial years of accelerated depreciation, therefore shows slightly higher net incomesb) LIFO liquidation: inflates profits for the accounting period where liquidation was donec) Changes in ratio of allowance for doubtful debts: could increase profit by the change in the ratio from 1983 to 1984d) Decreased its Ramp;D expense, and got it funded by Kobe: huge decrease in their own expenditure, and funded by Kobe through a 3 year agreemente) Restructuring of its pension plans: got back $39. million of actual gains that would be amortized and distributed as income for the following years 11. Accounting statements are used by investors, lenders, customers, employees, and governments in dealing with Harnischfeger. Among these groups, who is most likely to â€Å"see through† the above accounting changes, and who is least likely to do so? I think the first ones to â€Å"see through† the accounting changes above thoroughly are going to be the employees who are currently working and the ones who were laid off as they might wonder how did the company show profit after a deep net loss in the past year. Government (regulators) are also likely to see this since Harnischfeger has become a â€Å"turnaround† stock within a year. Investors are concerned more with their per share profits, and lenders have been paid with newly raised capital. 2. Are the accounting changes likely to help or to hinder Harnischfeger’s ability to implement its business plan? Be as specific as possible. We must acknowledge facts before deciding if it will help or hinder. a) The period of overall recession did not only hit Harnischfeger, but many industries in the US and the world. b) Many of these affected companies were publicly listed corporations in the stock market, and feared a collapse due to fearful investors. ) Many if not all of the accounting changes that were questionable in nature such as (LIFO liquidation, actuarial gains, depreciation method changes) were done on purpose to save the company from a share price plummeting and keep or restore investors confidence until it devised a proper plan to grow once things were back to normal. These accounting have already helped Harnischfeger to implement its business plan because it already raised $150 million more, which it used to pay back its debts and use their current assets and strategic agreements ith foreign investors and suppliers to further grow. 13. Overall, what is your assessment of Harnischfeger’s future as of 1984? The future of Harnischfeger is promising, but the corporation must seek to diversify into more product lines and seek ways to reduce its cost by outsourcing the manufacturing of certain parts more than it is currently doing, and produce a more aggressive business plan that will secure a good amount of sales in th e near future. I think that the accounting changes and manipulation of figures and cutting on employee benefits were drastic and questionable to a point, but were measures taken to confront the most immediate problems. In that process the corporation realized many past mistakes and started to seek newer ways for growth. If the companys plans were a simply a scam, then the directors and top officers would have simply let the company collapse and run away with their compensations.