Harnischfeger Corp Essay

I. IntroductionIn 1984 Harnischfeger muckle was a leading producer of braid equipment. During the decade of the 1970s the society lowgo tremendous growth. Annual gross revenue grew from $150 one thousand one one thousand million million in 1970 to $646 million in 1981. However the c every(prenominal)er-out began to experience financial trouble in 1979. This was ca holdd by a variety of positionors the fraternity wasted a salient amount of resources on an unsuccessful merger, the government of Iran defaulted on a $20 million night club of equipment after the f all of the Shah, and the U.S. economy was in a diaphragm of recession with double digit places of inflation. The spicy society affix an operating loss in 1979 for the first time since 1938. The callers financial difficulties continued until 1984. At this time care decided that restructuring was requisite if the company wanted to survive. (Harnischfeger, 1985)II. Restructuring StrategyThe overriding objectiv e of restructuring the company was to relapse to sustained pull aheadability. The goals of the design were four-fold managerial/personnel repositions, fruition be reduction, channel in overall telephone circuit focus (e.g. in foreign fit ventures, and high gear engineering areas), and a restructuring of debt (Palepu, 2000). The new executive position of caput Operating Officer was created. Two new members of the executive team were leased in order to help push the company in a new strategic direction. As a result, engineering, manu eventuring, and marketing divisions underwent significant varys in order to cut be and reorient the companys product offerings toward much profit sufficient markets. (Palepu, 2000).The company started to focus its business on to a greater extent overseas markets, where demand for mining and construction equipment remained strong. A relationship was ceremonious with Kobe Steel, Ltd., in which Harnischfeger agreed to source all of its constr uction cranes for sale in the US through the Japanese company. In addition, a contract to cheat on $60 million worth of mining shovels was entered into with the Peoples democracy of China (Harnischfeger, 1985). Lastly, the company restructured its debt into three-year loans that required the company to maintain certain levels of cash, receivables, and profits worth (Palepu, 2000).Accounting StrategyThe new care at Harnischfeger implement aggressive commutes in accounting insurance in an effort to go the company appear more profitable. The major areas in which accounting policy was substantially effected were in changes in derogation modes on assets, the use of LIFO colony in arsenal valuation, the restructuring of the employees pension plan, a change in the way of life close to types of gross sales were recognized, and a change in the fiscal year for foreign subsidiaries. (Palepu, 2000). In addition, prudence significantly change the percentage of sales allocated to allowance for bad debt. Analysis stages that management exercised a great deal of flexibility allowed under GAAP in order to raise enlighten income for 1985.Motivation for Accounting StrategyThe new management has ii long-term goals in mind. First, to increase the companys front in high-technical school areas such as aerospace and pharmaceuticals and second, to make the company more global. These goals seem to require the company to pursue an aggressive honorarium management outline. In the short term the company needs vocalize ventures to survive. These joint ventures will provide Harnischfeger access to many new foreign markets and could be a potential source for cheaper labor. Effective earnings management could induce partners like Kobe Steel to be more receptive to investment funds in Harnischfeger. In addition the company needs cash to be able to participate in joint ventures that may require cross investment to build factories, hire foreign employees etc. Cash is also undeniable to invest in high tech industries which usually require queen-sized capital outlays in research and using.Management had strong motivation to examine a profit in 1984. First, the company was preparing for its 100th anniversary celebration, and wherefore needed a quick turnaround. As trivial as it sounds, this setting probably sped up the timetable to recovery via aggressive accounting policy. Second, and more tangible, the restructuring plan included a provision which would award top executives an additional 40% of their base salary if the company achieved its financial goals for the year. Amazingly, management could receive some opposite 40% of salary if the company outperformed those goalsIII. Accounting ChangesEffect of change in Sales Calculation Effective November 1, 1983, Harnischfeger incorporated products purchased from Kobe Steel, Limited and then re-sold by the company, into its authorise sales. During previous accounting periods, only the gross margin on these products was recognized as sales. As a result, both aggregate sales and cost of sales change magnitude by $28 million. This accounting change did not concord material impact on the overall nett operating income as stated in the financial statement, however, it did have an determine on the quality of earnings, which is reflected by profit margin. Profit margin dropped to 1.44% from 1.55%, reflecting a 7.1% change in profit margin, after such a change was in place.The management claimed that this change reflected more effectively the nature of the Corporations transaction with Kobe, (Palepu, 2000, p.3-39) and we agree with the managements view for two major reasons. First, Harnischfeger was operating in a macro business environs in which the company had to significantly reduce cost to survive. Outsourcing, an effective way of transferring production cost to more effective producers, could make the Harnischfeger focus on its core strength in product development capabilit y and high brand power penetration. Second, Harnischfeger did phase out its own manufacture of construction cranes in Michigan and enter into a long-term agreement, under which Kobe would sum up construction cranes.Also, effective November 1, 1983, Harnischfeger adjusted some subsidiaries ending period to kinfolk 30 instead of the previous ending July 31. This had the effect of lengthening the 1984 account period for these companies from 12 months, to 14 months, and increased sales by $5.4 million. presumptuous these companies had the same profit margin as the parent, the change increased cost of sales by $4.3 million. We agree that the influence on net income is so-so(p) and that this change reflects more effectively the subsidiarys business operation. but it does represent a one-time event which should be corrected for during analytic thinking of the companys potential for future profitability.Effect of Changes in Depreciation ruleIn 1984, Harnischfeger changed its deprecia tion policy for financial reporting purposes to a straight-line method from a principally intensify method. A net income of $11 million was realized for 1984 when the straight-line method was applied retroactively to all assets depreciated under the accelerated method. The management viewed this as an preliminary to match the companys banner with that of indus bear witness peers. We agree with the management in a way that this approach provides comparable patronizeard. However, the timing of this action is questionable.This approach artificially improve the companys financial strength in the short run and helped Harnischfeger treat its debt restructuring process with bankers. In the long run, however, the straight-line method will reduce profit in the years to come. Also, it was too aggressive to realize this income just in a one-year period, which reflected the incentive for management to achieve profit. In addition, Harnischfeger extensive its estimated depreciation lives o n certain US plants, machinery and equipment, and increased residual time value on certain machinery and equipment.These changes resulted in an increase of $3.2 million in net income in 1984. Again, this reflected incentive for profit realization. The then-current high interest rate surroundings was supportive for residual value upward-adjustment, however, there were great risks involved. First, interest rate was on a down-trend after it peaked in 1982. Second, the liquidity of Harnischfeger machinery, for heavy-machinery manufacture, was low. Also, offstage of depreciation lives would increase the maintenance costs and reduce profit in the years to come. Therefore, we suggest that Harnischfegers depreciation policies be closely watched when the frugal environment changesEffect of LIFO Inventory LiquidationHarnischfeger reduced its inventory level in 1984, 1983 and 1982, resulting in a liquidation of LIFO inventory. This liquidation process led to gains when inventory, acquired at a lower cost in the earlier years, were sold at a higher price, resulting from higher inflation. moolah income in 1984 increased by $2.4 million (in the form of gains), and liquidity was improved on the balance sheet. We view this as a sound business decision when the management can reduce operating cost by decreasing inventory level.Effect of Changes in Allowance for Doubtful AccountsHarnischfeger, for some reasons, adjusted its allowance for indeterminate accounts to 6.7% of sales for 1984 from 10% of sales in 1983, resulting in $2.9 million in operating income for 1984. The company might try to increase sales by aggressively extending credit to doubtful customers, risking losing all of relevant sales. This is very skeptical as Harnischfeger gives no explanation.Effect of Changes in R&D ExpensesHarnischfeger significantly cut its research and development expenses to $5.1 million in 1984, from $12.1 million in 1983 and $14.1 million in 1982. In 1984, operating profit was pu mped up by $9.1 million when Harnischfeger didnt follow the same level of R&D activities in 1983, reflected in the percentage of R&D as of sales. This is debatable to managements strategy of focusing on the high technology part of its business and will damage its strength in the future. We conclude, therefore, that the management managed to increase profit by reducing R&D expenses on purpose.Effect of Changes in Pension PlanThe company states, in the footnotes of its 1984 financials, that its salaried employee pension plan was well over-funded. The policy of Harnischfeger was to fund at a minimum the amount required under the Employee Retirement Income certificate Act of 1974. (Palepu, 2000, p.3-38) This probably meant, in light of recent financial difficulties, that the company intended to fund at the minimum. Over-funding most likely came almost as a result of the company reducing its workforce by about 45% in 1983. Harnischfeger terminated its Salaried Employee Retirem ent Plan in 1984, and created a new plan. This new plan included in increased minimum pension benefit, which probably served to make the pension restructuring more savory to employees.Cash resulting from the liquidation of the original plan was divided into two groups $36.7 million went toward purchasing individual annuities in order to cover the obligations of the original plan, and $39.3 million went into an account called Accrued Pension Coststo be amortized to income over a ten-year period (Palepu, 2000, p.3.42) This pension plan change has three significant effects on the financial statements. First, pension expense was reduced in 1984 by $4 million. Second, net income increased by $3.9 million.Third, and most importantly, the company was able to show a positive cash flow for the year. Without this one-time injection, cash flow would have been ($7.6 million). Bottom Line Financial Performance, Net of Accounting Changes The purpose of our analysis is to arrive at an estimated n et income based only on the companys core operations. That is, to determine its financial health without the distraction of one-time events and earnings management. The first step is arrive at a revised sales figure. The next step is to construct a table summarizing our estimation of Harnischfegers net income, net of the effects of all the accounting policy changes strike out that our analysis has tax-affected the result of changes in the fiscal year of subsidiaries, and the annual amortization amount for pension fund gains.Critique of Accounting ChangesOur issue is not with the fact that Harnischfeger management now has an aggressive accounting strategy and is tenanted in earnings management. Indeed, it seems perfectly reasonable to bring all subsidiaries under one fiscal year timetable. This will result in administrative efficiency. Also, the change in recognition of costs and revenues of Kobe Steel equipment is logical. Next, the company claims that all changes in depreciation policy are made to conform with other manufacturers in the industry. Further, the pension plan restructuring was authorized by the Pension service Guaranty Corporation, and we have no other sources of information which cast the last in doubt. It seems logical that cutting the number of employees by 50% should nominate a similar change in pension plan funding.In short, these accounting changes may be largely justifiable even though they represent aggressive earnings management. We do take issue with the fact that all of these accounting changes occurred in one year. That is, it seems suspicious that financial stability is neatly restored just in time for the 100th anniversary of the company, when executives stand to make an additional 80% of their salaries if goals are surpassed.As further deduction of the validity of this concern, we see a contradiction between the decrease in R&D spending, and the companys new strategy to explore different high technology product lines and services. Further, extension of depreciation lives for plant and equipment seems like a shameless way to increase net income. Finally, a dramatic decrease in the percentage allowance for doubtful accounts is difficult to justify, especially in a period of rising receivables. In conclusion, it seems that the company is taking a huge risk by forebode that this one-time boost in income and cash will allow the company to successfully expand internationally and grow in new high tech areas and become profitable once again.IV. Financial OutlookRather than a full recovery, it seems 1984 performance may be simply an aberration. Management cannot hide out the effects of operations inefficiencies and uncooperative markets for long. We are encouraged by the fact that our estimated net $.41 loss per share far outshines the 1983 loss of $3.49. But we judge to see a negative cash flow in 1985, brought on by the absence of the one-time pension plan change. Contributing to this is a high balance in accounts receivable, which rose by 37.5% from 1983 to 1984. And at the onset of a decreasing interest rate environment, we expect the company to be charge with high interest expense well into the future. Note, too, that the aggregate effect of the changes in depreciation policy will mean higher depreciation costs in future years. This, coupled with higher maintenance costs as equipment ages, will mean significantly higher operating costs. Finally, we expect the company to show a loss for 1985.