Changes That Affected Harnischfeger's Profitability: Accounting Policy Changes and Accounting Estimates
1. Identify all the accounting policy changes and accounting estimates that Harnischfeger made during 1984. Estimate, as accurate as possible, the effect of these on the company’s 1984 reported profits.
Changes that affect the Harnischfeger Revenues:
• The company started to account Kobe Steel sales in US, previously it only added the gross margin in the financial statement. (this sales represented $28 million)
• Sales to a foreign subsidiary started to be consolidated as a net revenues (this sales represented $5.4 million)
Changes that affected Harnischfeger’s Profitability:
• Change in the depreciation accounting method from accelerated to straight line method. Increase of $11 million in 1984 income
• Change on the company’s net residual value. Increased net income in $ 3,4 millions Inventories Liquidation:
• The company had a $ 2.4 million increase in its net income, as a result of changing inventories method to LIFO
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 Harnischfeger’s management in making changes in its financial reporting policies was to show an accounting profit in 1984. This was necessary as the company was doing badly in the previous years due to market conditions and needed to restructure its debt to avoid violating debt covenants. Since the company was also about to celebrate its 100 years of existence, management was eager to paint the company in good light and to prove to investors that the company is doing well. Management was also motivated by incentive compensation; the board of directors established an Executive Incentive Plan which provided an incentive compensation opportunity of 40% of annual salary for 11 senior executive officers only if the company reached a specific net after-tax profit objective for the year.
Changes that affect the Harnischfeger Revenues:
• The company started to account Kobe Steel sales in US, previously it only added the gross margin in the financial statement. (this sales represented $28 million)
• Sales to a foreign subsidiary started to be consolidated as a net revenues (this sales represented $5.4 million)
Changes that affected Harnischfeger’s Profitability:
• Change in the depreciation accounting method from accelerated to straight line method. Increase of $11 million in 1984 income
• Change on the company’s net residual value. Increased net income in $ 3,4 millions Inventories Liquidation:
• The company had a $ 2.4 million increase in its net income, as a result of changing inventories method to LIFO
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 Harnischfeger’s management in making changes in its financial reporting policies was to show an accounting profit in 1984. This was necessary as the company was doing badly in the previous years due to market conditions and needed to restructure its debt to avoid violating debt covenants. Since the company was also about to celebrate its 100 years of existence, management was eager to paint the company in good light and to prove to investors that the company is doing well. Management was also motivated by incentive compensation; the board of directors established an Executive Incentive Plan which provided an incentive compensation opportunity of 40% of annual salary for 11 senior executive officers only if the company reached a specific net after-tax profit objective for the year.