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Harnischfeger Corporation Study

Harvard Business Case:
9-186-160
August 21, 1997

Harnischfeger Corporation

1. Describe clearly the accounting changes Harnischfeger made in 1984 as stated in Note 2 of its financial statements.

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?

3. What is the effect of the depreciation lives change? How will this change affect future reported profits?

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?

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.

6. Note 8 states Harnischfeger's allowance for doubtful accounts. 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?

7. Note 9, on page 216, states that Harnischfeger decreased R&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?

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?

9. How did the pension plan changes affect Harnischfeger's financial statements in 1984? Are these changes likely to affect future profits?

10. Summarize all the accounting changes Harnischfeger made in 1984 and their effects on pre-tax profits and cash flows in 1984.

11. Accounting statements are used by investors, lenders, customers, employees, and governments in dealing with Harnischfeger. Among these groups, who is most likely to "see through" the above accounting changes, and who is least likely to do so?

12. Are the accounting changes likely to help or to hinder Harnischfeger's ability to implement its business plan? Be as specific as possible.

13. Overall, what is your assessment of Harnischfeger's future as of 1984?

Solution Preview

1. Describe clearly the accounting changes Harnischfeger made in 1984 as stated in Note 2 of its financial statements.

The accounting changes Harnischfeger made in 1984 as stated in note 2 are that the net sales of the products purchased from Kobe Steel and sold by Harnischfeger are added to the net sales of the company. Earlier only the gross margin on the Kobe equipment was included. The effect was that in 1984 such sales totaled $28.0 million.

Also effective November 1, 1983 the financial statements of some financial subsidiaries are included on the basis of their fiscal years ended July 31. The impact of this change was that the net sales increased by $5.4 million for the year ended Oct, 31, 1984.

Also Harnischfeger changed its method of depreciation from accelerated method to the straight line method increasing the net income for 1984 by $11.0 million. Further the company increased its depreciation lives of some US plant and machinery and residual value of certain machinery and equipment which increased the net income for 1984 by $3.2 million.

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?

Harnischfeger using the depreciation accounting change has increased its net income by $11.0 million plus $3.2 million that is $14.2 million. This accounting change will decrease the future net income. The overall impact on future years will be that the net profits will decrease because of the depreciation accounting changes.

3. What is the effect of the depreciation lives change? How will this change affect future reported profits?

The effect of depreciation lives change is that Harnischfeger will have to continue using the machinery and plant for a longer period of time before it can be replaced. The using of machinery and plant for a longer period means loss of efficiency and productivity. It also means higher frequency of breakdowns and down time for repairs. The effect will be that the future reported profits will go down. There will be a negative effect on future reported profits.

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 business conditions that Harnischfeger faced were worldwide recession in early 1980s. There was a large drop in the demand for the company's products beginning in 1981. The company was facing reduced sales. The company faced persistent weakness in the basic industries both ...

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