Harnischfeger Corporation

1. All the accounting policy changes and accounting estimates that Harnischfeger made
during 1984 and the effect of these on the company’s 1984 reported profits.
- The Corporation includes in its net sales products purchased from Kobe Steel, Ltd. and sold
by the Corporation rather than only the gross margin on Kobe-originated equipment was included.
This change reflects more effectively the nature of the Corporation’s transactions with Kobe.
During fiscal year 1984 such sales aggregated $28.0 million.
- Change of fiscal year from July 31 to October 31 for certain foreign subsidiaries. This
change had the effect of increasing net sales by $5.4 million for the year ended October 31, 1984.
- The Corporation computed depreciation expense on plants, machinery and equipment using
the straight-line method instead of principally accelerated methods for U.S. operating plants. The
effect of this change increased net income for 1984 by $11.0 million.
- The Corporation changed its estimated depreciation lives on certain U.S. plants, machinery
and equipment and residual values on certain machinery and equipment, which increased net
income for 1984 by $3.2 million.
- Inventory reductions resulted in a liquidation of LIFO inventory quantities carried at lower
costs compared with the current cost of their acquisitions. The effect of these liquidations was to
increase net income by 2.4 million.

2. Motives of Harnischfeger’s management in making the changes in its financial reporting

policies.
- The significant operating losses recorded in 1982 and the credit losses experienced by its
finance subsidiary caused Harnischfeger to default on certain covenants of its loan agreements.
The Corporation has difficult to meet covenants related to minimum working capital, consolidated
net worth and ratio of current assets to current liabilities. As a result of these covenant violations,
the company was forced to stop paying dividends and began negotiations with tis lenders to
restructures its debt to permit operations to continue. Therefore, managers of Harnischfeger have
an incentive to select accounting policies and estimates to reduce the probability of these covenant
violations.
- Managers would receive bonus compensation if they exceed certain pre-specified profit
targets. This provides motivation for managers to decrease depreciation “levels”, increase revenues

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 and switch inventories method of accounting to maximise their expected compensation. However
one of cost cutting measures was to eliminate management bonuses.
- William Goessel, the new chief operation officer, appointed in August 1982. Jeffrey Grade, the
new senior vice president of finance and administration and chief financial officer, appointed in
1983. When the top management is changed, there is a motivation to make provisions that ensure
that any losses appear as the responsibility of the previous manager. Therefore, the new
management team was expected to choose accounting policies and estimates to increase provisions
for loan losses in the year of change in manager and increase the profits in the next year.

It is too complicated for a general investor to see through the impact of all the accounting changes. But
there are opportunities for superior analysts to fathom these changes through analyze the financial
statement. However changes in estimates are more difficult to understand than accounting changes and
often require additional information.

3. The company’s future prospects

- The accounting changes increase net income in 1984 and some investors may believe that the
increment of net income is the result of business strategy, and thus this would encourage investors
to boost the stock price.
- An increased stock price may help company raise capital to pay off the debt.
- From consolidated statement of operations, some investors may found that majority of net
income in 1984 is from the result of cumulative effect of change in depreciation method. In other
words, it is the result of management incentive.
- The new CEO, William Goessel, had considerable experience in the machinery industry. So he
can demonstrate his credibility with the financial community by successfully negotiating with the
company's lenders to restructure the company's debt.