Harnischfeger Case:

1
Harnischfeger Case

• A Study in Earnings Management

2
Restructuring Strategy
Managerial Business Focus Cost
Reduction Debt management
3
Accounting Changes

• Changes in sales recognition for Kobe Equip
  fiscal year
• Depreciation policy
• LIFO liquidation for inventory
• Allowance for doubtful accounts
• Research development
• New pension plan

4
Earnings Management
Joint Ventures Expansion in high tech areas
5
Accounting Change 1 Sales
1. Business transaction with Kobe New
policy incorporated into net sales products
purchased from Kobe and re-sold to
customers Previous policy only gross
margin on these products recorded Impact
Overall operating income not influenced
Profit margin dropped to 1.44 from
1.55 otherwise Justification Outsource
production, focus on core strength 2. Ending
period change for subsidiaries - real
situation 3. Revised statements Reported net
sales 398,708,000 Less transaction
of Kobe equipment 28,000,000 Less
change in fiscal year of subsidiaries
5,400,000 Net sales, net of effects of
accounting changes 365,308,000 Reported
Cost of goods sold 315,216,000
Less transaction of Kobe Equipment
28,000,000 Less change in fiscal year of
subsidiaries 4,300,000
Net cost of good sold 282,916,000
6
Accounting Change 2 Depreciation Policy
1. Depreciation method New policy
straight line Previous policy
accelerated depreciation Impact lower
cost in earlier years higher cost in later years
cost stream not stable,
higher maintenance cost later
Justification more aggressive approach, conform
to industry std. 2. Extension of depreciation
live and residual value Impact lower cost
Justification high interest environment
economic expansion
risk interest rate down trend liquidity for
heavy mach. 3. Revised statements Reported
RD, SA expense 72,196,000 Plus
change in dep. life residual value
5,540,000 Net RD, SA expense
77,736,000
7
Accounting Change 3 LIFO Inventory Liquidation
1. LIFO inventory liquidation process Book
value 100 Market value _at_ 20 inflation 120
Gain from liquidation 20 120 - 100
Impact lower inventory level, liquidation of
assets, gain realization Justification
sound inventory management skills
outsourcing crane production 2.
Revised statements Reported net income
15,176,000 Less gains in
liquidation of inventory 2,400,000 Net
income 12,776,000
8
Accounting Change 4 Allowance for Doubtful
Account

• Allowance for Doubtful Account
• New policy 6.7 of accounts receivables in
  1983
• Previous policy 10 of account receivables
  in 1984
• Impact extension of credit
• Justification very skeptical

9
Accounting Change 5 Research Development
1. Allowance for Doubtful Account New
policy 1.28 of sales in 1984 Previous
policy 3.77 of sales in 1983 Impact
operating income rises
product development capability weakened
Justification controversial to strategy focus
on high tech products 2. Revised statements
Based on sound management skills Reported
RD, SA 77,736,000 Plus change
in RD expenses 9,100,000 Net RD,
SA 86,836,000
10
Accounting Change 6 Pension Plan
Company determined the value of pension plan
for salaried employees exceeded minimum
levels set by Employee Retirement Income
Security Act of 1974 Over-funding probably
due to higher than expected stock market
returns in the portfolio Existing plan
terminated, and replaced 39.3 million in
cash reverted to the company, to be amortized
to income over 10 years (3.9 million per year)
11
Change in Cash Position
Reported Change in Cash, 1983 - 1984
31,732,000 Less effect of reversion of
pension assets 39,307,000 Change in
cash, net of one-time event (7,575,000)
12
Bottom Line
1) Sales are overstated Reported net
sales 398,708,000 Less effect of change
in recognition of sales of Kobe equipment
28,000,000 Less effect of change in fiscal
year of subsidiaries 5,400,000 Net
sales, net of effects of accounting
changes 365,308,000 Percentage change over
reported 1983 sales 13.8
13
Bottom Line
2) Net income is overstated Dollar Amt Per
Sh. Amt Reported Net Income
15,176,000 1.28 Less effect of change
in recognition of sales 0
0 of Kobe equipment Less effect of change in
fiscal year of subsidiaries 638,000
.05 Less effect of change in method of
depreciation 11,005,000 .93
Less effect of change in pension fund
2,829,600 .24 Less effect of change
in equipment depreciation lives
3,200,000 .27 Less effect of change
of reductions in LIFO inventories
2,400,000 .20 Net Income, net of
effects of earnings management
(5,133,000) (.41)
14
In Conclusion
Sales increased by 13.8, not 24 Negative
cash flow, net of one-time event (7.6
million) Net Loss of .41 per share
15
Financial Outlook
Encouraging signs consolidation and cost
cutting net loss of .45 compared with 1983 loss
of 3.49/sh. Changes which will continue to
affect net income in the future LIFO inventory
reductions inventory remains high at 36 of
reported sales Gain on restructure of pension
fund Negative cash flow likely for
1985 37.5 increase in accounts receivable from
1983 to 1984 however, cash reserve from pension
plan change will prevent further debt Greater
share of depreciation expense being deferred to
future years In an environment of decreasing
interest rates, the company will find itself
burdened by costly debt Stock remains a poor
investment, as the company is unlikely to
make a profit in 1985