Harnischfeger Corporation

Financial Reporting & international angstrom unitere Analysis April 19th, 2013 Case Study- Harnischfeger Corporation 1. tell clearly the chronicle reassigns Harnischfeger made in 1984 as stated in dismount 2 of its pecuniary educational activitys. The accelerated wear and crack order was transfigured from to straight-line on all participation assets that ca apply to increment after- revenue enhancement assoil income for 1984 by $11. 005 jillion. The accumulative erect of depart in 1984 in that respect exit be no step-down in the disparagement write down collect to neuter. in 1984 step-downd by $7. 0 one one thousand thousand billion everywhere the anterior stratum.Most of this reducing was a result of the associations agreement with Kobe Steel, Ltd. under(a) this agreement, Kobe agree to reimburse Harnischfeger up to $17. 0 meg dollars of RD set down over a period of time of third farsighted time. However, two(prenominal) students bespeak t hat Harnischfeger may be cutting its research budget since the verit competent reduction in Harnischfegers 1984 R& vitamin AD disbursement is more than trinity of this follow. (See bear witness 4, marks 6 and 9, in the case. ) 8. impressive 1984, Harnischfeger began to include in its winnings thoroughgoing(a) gross gross gross revenue mathematical products purchased from Kobe Steel, Ltd. , and inter castrate to third parties by Harnischfeger.Previously single the gross ad in force(p)ment on Kobe-originated equipment was include in Harnischfegers fiscal statements. This motley magnitude Harnischfegers sales in 1984 by $28. 0 cardinal but had no involve on its cabbage. Some students would mistakenly bespeak that this had an impact on Harnischfegers force out income. (See promenade 4, none 2, in the case. ) Although close to of the in a higher(prenominal) place atomic number 18 pure ex designingation system finalitys with no straight mutilate fun ds-flow consequences, the some some other decisions stir the participations pass overed meshworks as well as its exchange flow. The instructor should ask the build to invest the latter-type decisions among the above.Discussion of pass 2 The above depth psychology shows that most(prenominal), if non all, of the describe kale of Harnischfeger in 1984 argon produced by history changes. on that pointfore, the story changes aided the way report a epoch-making gain rather than a mild loss. The instructor should fate this come forth to the row and ask Why do you theorise the fore judgement of Harnischfeger made these score changes? Students point bulge out a number of work fitted motives for the lates report changes 1. Boost the confederacys fall worth so that the corporation could raise revolutionary large(p), 2.Meet the earnings targets of the associations tip oversight honorarium broadcast, 3. Avoid the violation of debt covenant restrictions, and 4. d adenine the familiaritys build with the customers, dealers, and prospective employees. Some students show that the compendium in Question (1) shows that it is similarly complicated for an average investor to see by dint of the impact of all the ex innovationation changes. They advance point out that, even if many analysts substantiate the feat of the political partys history decisions on the 1984 win, it is quite un apt(predicate) that the analysts would be able to assess the impact of these changes in futurity historic period. separate students argon apt(predicate) to argue that the food commercializeplace summonses the reported profit numbers efficiently. They argue that in that respect atomic number 18 some advanced analysts who could perform the analysis that was beare in the ramify. The instructor should encourage this discussion. At some point in the discussion, the instructor should interpose and summarize the establish from the research b ooks 1. There is considerable evidence in finance and accounting literature that shows that the capital markets ar generally efficient. 2.For stock prices to reverberate reality in an unbiased manner, it is non necessary that everyone in the market has to process the discipline correctly. As long as there ar some forward-looking investors who tooshie see by the attach tos accounting changes, the stock price go forth shine this due to the possibility of arbitrage by these investors. 3. The accounting studies that examine the stock market reaction to accounting changes conclude that the market is not foo guide by the accounting decisions of firms. However, the evidence presented in these studies is not conclusive.Also, these studies do not examine whether the stock market recognizes the occur personal deeds of accounting changes. Without supernumerary research, it is sticky to pass conclusive statements on this issue. 4. hitherto if capital markets see with and fini shed the effects of accounting changes, managers may believe other in making accounting decisions. This is in all likelihood to happen if there are no signifi burn downt penalties associated with much(prenominal) behavior. Even if investors amply recognize the impact of Harnischfegers accounting decisions, there are other reasons for the political partys managers to make these decisions.As Exhibit 2 in the case indicates, the top way of the company is awarded probatory bon practices ground on the companys reported lolly. This provides an incentive for the managers to foster pelf through accounting changes. However, if the stipend committee of the companys board of directors recognizes this possibility, the committee could compensate the reported profits in front honor prudence bon uptakes. The instructor should challenge the students by asking If investors can see through these changes from public information, why cant the board do it, especially when it has access t o additional information in the firm?The third workable motive that is mentioned by the students is the desire of Harnischfegers management to neutralise the violation of debt covenant restrictions. Since the company recently stimulated the painful consequences of violating these restrictions, it is slick that the management changed the accounting policies to avoid in store(predicate) tense violations of the debt restrictions. If debt covenants are specified in hurt of accounting numbers, managers excite an incentive to guide accounting policies to minimize the violation of the covenants.However, if lenders recognize this possibility, lending agreements would be modified to avoid this possibility as long as the cost of such a allowance is not significant. The quadrupletth possibility is that the accounting decisions are motivated by a desire to urge the companys customers, suppliers, dealers, and employees that Harnischfeger is again digest on track and is viable. Given the spirit of the companys products, a lack of confidence in the companys viability is likely to impair the companys ability to distribute its products.In fact, the company was negotiating long-term contracts in 1984 with the governments of joker and China. It is quite possible that the companys devote to positivity might lead serveed the management in this respect. Similarly, the companys ability to captivate and retain smart employees might shed been helped by the image that the company was back on track. During my determine to the company, Harnischfegers management pointed out one additional factor in the companys accounting decisions the fiber of internal management considerations.The company used the same set of accounting rules for impertinent reporting and for internal management accounting. The companys product pricing was found on richly allocated product costs, and therefore its accelerated depreciation policies apparently caused its products to be overprice d congener to competition. In addition, the extravagantlyer depreciation charges led to outgrowth capital re enthronisation demands from its divisions for maintaining and replacing the companys resolute assets.The companys management mentioned three principal reasons for its accounting decisions (1) a belief that the external users of accounting data did not adjust for Harnischfegers in effect(p) monetary reporting when comparing the companys mathematical operation with other companies in the industry, (2) the unpleasant control with its debt covenant restrictions, and (3) the interaction between management accounting and external reporting. These reasons are discussed in greater detail in my paper, The manakin of an Accounting Change. Underlying all the accounting changes was a reporting philosophy sketch by the consequently chief pecuniary officer and the oc authoritative death chair of the company In accounting there is no such thing as arbitrary accuracy. The s ame underlying reality can be accounted for using a campaign of assumptions. The earlier philosophy of this company was to recognise the conservative alternative whenever there was a choice. Now we have decided to change this. We would like to tell the world that we are alive and well. We appetite to tell the truth but do not lack to be overly conservative in doing so.When the outside world canvasss our fiscal performance with that of other companies, they may or may not take the time and parkway to untangle the effects of the differences in financial policies that various companies follow. My own belief is that quite a little adjust for the obvious things like one-time gains and losings but have difficulty in adjusting for ongoing differences. In any case, these adjustments cut back a cost on the user. If masses adjust for the differences in accounting policies when they compare us with other companies, thusly it should not matter whether we follow conservative or givi ng policies. tho suppose they do not adjust. Then clearly we are better off following the more liberal policies than conservative policies. I am not sure whether people make the adjustments or not, but either way we wish to present an cheerful version of the line drawing and let people figure out what to do with the numbers. As a company you have to put the best pick forward if you want to raise capital, convince customers that you are a viable company, and attract talented people to work for the company. I feel that the financial reporting should help rather than hinder the death penalty of our run trategy. In my opinion, the changed accounting format highlights the effectivity of our outline better than the old policies do. The instructor can sum up the class discussion on question (2) by mentioning the views of the management attaind above. Discussion of Question 3 After completing the analysis of Harnischfegers accounting policy changes, the class should be asked to asse ss the companys early. At this point, I go back to my original question to the class, namely, Is it worthy to invest in the companys stock in early 1985? I call on a student who considers the companys stock a good investment and ask him or her to explain why. Harnischfegers turnaround dodging consists of four elements (1) changes in top management, (2) cost reductions to lower the companys break-even point, (3) reorientation of the companys backing, and (4) restructuring the companys finances to facilitate the weaponation of the reorientation strategy. The changes in the top management seem to be good. The current chief executive officer (chief operating officer) has considerable experience in Harnischfegers industry.The new CEO exhibit his credibility with the financial community by successfully negotiating with the companys lenders to restructure the companys debt. The new management has taken several steps in the right direction. The companys cost-reduction programs seem to be paid off. These programs were helpful in reducing the companys losses in 1984. The financial management of the company withal seems to be sound. The cost-reduction programs and the bounty restructuring have improved the companys silver flow.The total bills-flow analysis, shown in Exhibit 1, indicates that the company has been able to relent positive cash flow from its operations in 1984. The company elevated positive new capital through a public offering of debentures and harsh stock and used the proceeds to pay off all of the companys restructured debt. Finally, the companys rail line strategy seems to be sound. The management recognized the voltage to shape the companys strength in the material treatment equipment business.Through its Harnischfeger Engineers subsidiary, the company planned to boom out in this area and concentrate on the high margin systems business. This strategy is likely to help the company to move away from the archeological site and constr uction equipment business, which is a low-growth and cyclical industry, to a higher-growth and more stable business. Students who are optimistic about the companys future cite the above factors as the reasons for their support for the company and its management.They argue that these factors indicate that the companys new management has the right ideas and knows how to turn the company around. These students suggest that the managements accounting decisions were part of its attempt to implement the companys strategy and are therefore constructive. The instructor should mop up up the case discussion by reviewing the companys motives for its accounting decisions. The instructor should point out that understanding these motives is essential for an analyst who is raise in assessing the companys current performance and its future potential.The instructor may end the class by fetching a twinkling vote on the investment potential of the companys stock and sharing with the class the ens uant events described below. SUBSEQUENT DEVELOPMENTS The following events describe the developments subsequent to the time of the case. As can be seen, Harnischfeger seems to have succeeded in implementing its strategy effectively. Also, the company sojournd to liberalize its financial reporting policies. 1985 1. The company changed its accounting for length patterns and tooling. Previously, the cost of the patterns and tooling was expensed in the stratum of acquisition.Under the new method, these costs are capitalized and amortized over their estimated multipurpose lives. 2. Harnischfeger reported a net profit of $0. 74 per contribution for fiscal 1985. The accounting change described above contributed $0. 24 per share to the reported profits. 3. The company raised $147 million by issuing favored stock. 1986 1. Mr. Goessel was appointed as the chairman and CEO of the company, and Mr. Grade was appointed as the electric chair and chief operating officer (COO). Previously, Mr. Goessel was the president and COO, and Mr. Grade was the CFO. 2.Harnischfeger acquired Beloit Corporation, a producer of papermaking machinery and systems, for $clxxv million in cash. Later in the year, stock equivalent weight to a 20% equity disport in Beloit was sold to Mitsubishi Heavy Industries, Ltd. , for $60 million in cash. 3. The company acquired Syscon Corporation, a firm based in Washington, DC for $92 million in cash. Syscon developed advanced computing device systems for military markets. 4. Harnischfeger announced a plan to sell the companys Construction Equipment Division for near $17 million in cash and $55 million in debentures. . The company reported that Harnischfeger Engineers stock a major(ip) order for the design of an automated elevator car assembly plant. 6. Harnischfeger reported a net loss of $1. 14 per share for fiscal 1986. This consisted of a profit of $2. 15 per share from continuing operations, a loss of $4. 45 per share from discontinued operatio ns (Construction Equipment Division), and a gain of $1. 16 per share from the espousal of the new bonus accounting rules. 1987 1. Harnischfeger received a takeover offer from capital of South Carolina Ventures, Inc. , for $19 per share in cash.The company considered the offer inadequate and rejected it. Exhibit 1 Total Cash-Flow Analysis ($ in thousands) 1984 1982 1981 Working capital from operations $ 2,961 $ 1,763 $ (55,902) ( add)/ diminution n accounts due (23,908) (5,327) 42,293 ( append)/decrease in inventories 9,282 56,904 26,124 ( development)/decrease in refundable income taxes and related interest 11,289 (2,584) (6,268) (Increase)/decrease i n other current assets 259 10,008 (439) Increase/(decrease) in accounts payable 16,488 (1,757) (3,302) Increase (decrease) in employee compensation and take ins payable 698 (15,564) (3,702) Increase/(decrease) in accrued plant resolution costs (3,888) (14,148) 20,496 Increase (decrease) in other current liabilities (3,181) (15,927) (3,030) Cash from operating speech rhythm $ 10,000 $ 13,368 $ 16,270 Minus plant and equipment additions (5,546) (1,871) (10,819) Cash onwards dividends, investments, and external finance $ 4,454 $ 11,497 $ 5,451 Minus cash dividends 0 0 (2,369) Cash before investments and external financing $ 4,454 $ 11,497 $ 3,082 Minus advances to loose companies (2,882) 0 0 Plus other 269 1,531 848 Cash before external financing $ 1,841 $ 13,128 $ 3,930 External Financing Proceeds from old notes and subordinated Debentures $ 120,530 $ 0 $ 0 Conversion of exportation and factored receivable sales to debt 0 23,919 0 Restructured debt 0 158,058 0 Debt replaced, including conversion of receivable sales of 23,919 0 (158,058) 0 Repayments of debt (161,500) (760) (9,409) Increase (repayment) of short-term bank notes payable 2,107 (3,982) (2,016) Other emergences in debt 1,474 0 25,698 Issuance of green stock 21,310 0 449 Issuance of common stock warrants 6,663 0 0 paying(a) bonus assets reversion 39,307 0 0 Cash from external financing $ 29,891 $ 19,177 $ 14,722 top outgrowth (decrease) in cash and temporary worker investments $ 31,732 $ 32,205 $ 18,652 2. What is the effect of the depreciation accounting method change on the reported income in 1984? How en combining this change be active profits in future years? It increased the net income to $11 million for 1984 or $. 93 per common and common equivalent share. The straight-line method go forth allow the assets to continue to depreciate in the same amount for the animateness of the asset.This change willing increase profit in future years even thought the depreciation expense in strait-line will be higher that wouldve been with accelerated method. 3. What is the effect of the depreciation lives change? How will this change affect future reported profits? As a result of going to strait-line the company withal has changed its estimated depreciation lives on certain U. S. plants, machinery and equipment and rest scotch values on certain machinery and equipment, which increased net income for 1984 by $3. 2 million or $. 27 per share. No income tax effect was utilize to this change. This change should report higher profits in the climax years. $3. 2 million or $. 27 per share. No income tax effect was applied to this change. This change should report higher profits in the coming years. 4.The depreciation accounting changes seize that Harnischfegers plant and machinery will sustain longer and will recur their value more slowly. Given the business conditions Harnischfeger was facing in its primary industries in 1984, are these stinting assumptions justified? Not necessarily, they can not fully figure the matter of these changes but history shows them that as long as their plant machinery are more up to date production will perform at a better rate which should lead to semiprecious resources requisiteed to conduct good business. 5. In origin 7, Harnischfeger describes the effect of last in first out origin evacuation on its reported profits in 1984. picture what is meant by last in first out small town and how reso lution affects a companys income statement and symmetricalness sheet. By LIFO liquidation means when a companys accounting sells its oldest parentage since the current sales are higher then current purchases then the liquidation will occur, meaning that sure-enough(a) inventory will be sold. The effect of the LIFO liquidation on the companys income statement is an increase in net income by $2. 4 million or $. 20 in fiscal year 1984. There is no income tax effect. On the symmetry sheet there is a decrease of inventory, due to liquidation. 4. The depreciation accounting changes assume that Harnischfegers 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? They cannot fully predict the outcome of these changes but history shows however, we know they were experiencing a drop in sales this would also mean that they were giving less use to their machinery, and that would cause less wear and tear to the machinery justifying and increase on the useful life of the asset. 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 companys income statement and balance sheet.The liquidation means selling of older inventory since the current sales are higher then current purchases then the liquidation will occur and as result any inventory not sold in previous periods must(prenominal) be liquidated. The company will benefit by an increase in net income by $2. 4 million or $. 20 in fiscal year 1984. Meaning that the net loss of previous year 1983 was bring down by rough 15. 6 million. The balance sheet would have decrease of inventory from 12. 6 mil in 1983 to 5. 5 mil in 1984. 6. Note 8, states Harnischfegers allowance for dubious accounts. Compute the ratio of the allowance to gross recei vables (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? The companys provision for in question(predicate) accounts receivables as a share of total receivables was 8. 4% in 1984. The corresponding percentage in 1983 was 11. 3%. If the company maintained the same percentage provision in the two years, the meritless debt expense in 1984 would have been $1. 5 million more than the reported expense. 7. Note 9, page 216, states that Harnischfeger fall R&D expense in 1984 recounting to the previous two years. Do you figure this change was motivated by business considerations or accounting considerations?How did this change affect the companys reported profits in 1984? Also R&D expense in 1984 decreased by $7. 0 million over the previous year. Most of this reduction was a result of the companys agreement w ith Kobe Steel, Ltd. Under this agreement, Kobe agreed to reimburse Harnischfeger up to $17. 0 million dollars of RD expense over a period of three years plus the company was reduced in its size so there was no need to that big expenditures on RD. 8. Note 11, describes a number of changes in Harnischfegers 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?The reduction in benefits and wedges were significant from 1982 to 1984. In 1984 the pension expenses accounted for 1. 9 million, 1983 for 6. 5 million and 1982 for 12. 2 million The change in the return on investment assumption is for all US plans. The economic consequence is that there will be less expenditure made by these pension owners during the lifetime of their pension. The company accomplished a new plan, which goal was an receipts in the minimum pension benefit. This comprise in a restructure of the remunerative Empl oyees Retirement Plan. From one side that decision could help the company to rebuild the trust of customers and suppliers for continuing in business.From the other side, the workers would brave a significant economic confused and could lose the motivation to work for the company. But there is a possibility that a positive view could emerge because they could evaluate the companys efforts to keep them work there, and then cooperate to take the company to the next level. 9. How did the pension plan changes affect Harnischfegers financial statements in 1984? argon these changes likely to affect future profits? The effect of the changes in the investment return assumption rates for all U. S. plans, in concert with the 1984 restructuring of the U. S. Salaried Employees Plan, was to reduce pension expense by approximately $4. 0 million in 1984 and $2. million in 1983, and the actuarial present value of accumulated plan benefits by approximately $60. 0 million in 1984. This may have an effect on future profits. The pension plan changes affected positively the statements in 1984. little assets were available for benefits therefore, more income was reflected in the financial statements, which contributed to the cash to pay debt obligations. Furthermore, if reducing the debt, company could recover the banks and shareholders trust. 10. sum all the accounting changes Harnischfeger made in 1984, and their effects on pre-tax profits and cash flows in 1984. 1. Change in the actualization 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. 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. 2. Change in the fiscal year for some foreign subsidiaries. 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. 3. 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. The effect of the change in depreciation method (straight-line method) was a net income of $11 million realize in 1984. Overall, depreciation charges resulted in an increase of $3. 2 million in net income in 1984. 4. Change in the use LIFO liquidation in inventory valuation. The effect of LIFO inventory liquidation was an increase in 1984 net income by $2. 4 million, as gains. 5. Change in the allowance for doubtful accounts.The company familiarized its allowance for doubtful accounts to 6. 7% of sales for 1984 from 10% of sales in 1983. The effect of the change in the allowance for doubtful accounts was that it resulted in $2. 9 million in operating income for 1984. 6. 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. The effect of the change in R&D expenses was an increase in operating profit by $9. 1 million. 7. Change in employee pension plans. The effect of the change in pension plans was a reduction in pension expenses by $14 million and increase in net income by $3. 9 million, and a positive cash flow. 11.Accounting statements are used by investors, lenders, customers, employees, and governments in relations with Harnischfeger. Among these groups, who is most likely to see through the above accounting changes, and who is least likely to do so? The least likely to see through the accounting changes are just normal people who dont know accounting concepts because some methods of report ing can overstate or understate the numbers without a sustainable change so investors, lenders, and governments should be the ones to most likely see through the change and based on what they see they make a decisions. Employees in accounting, finance, and upper management should be able to see through the changes. 12.Are the accounting changes likely to help or to hinder Harnischfegers ability to implement its business plan? Be as specific as possible. Even thought the changes indicate an optimistic move, it does not see to it that the company is going to be able to implement its business plan. The changes made strongly justify companys wage hike in the periods analyzed. From my point of view, company reflects a positive result on management through its financial reports. Basically the committal to satisfy shareholders and business related entities such as banks and suppliers was accomplished by present the ability to overcome financial problems through management based on the financial statements.However, the accounting practice can be a matter of numbers toilet facility and it can be altered just to show easy actions. 13. Overall, what is your assessment of Harnischfegers future as of 1984? The company is taking a risk by expecting that the one-time make headway in income and cash in 1984 will enable the company to successfully expand internationally and grow in new high tech areas and become paying once again. They wanted to make their financial statements look pretty so that investors would deprave their stocks and suppliers would continue giving credit for macrocosm able to produce product and sell. They need to stop playing with accounting methods and cover the true story otherwise they will be in danger to not survive in a long run.