Generally accepted accounting principles (GAAP) allow companies wide latitude in the choice of accounting policies. After a firm chooses a set of accounting policies, current accounting rules permit changes from one alternative policy to another at the discretion of the management. Since reported accounting figures are widely used by a number of external parties, managers of firms have incentives to choose accounting policies in order to influence the behavior of these parties. A variety of managerial motives for accounting policy decisions have been identified in the accounting literature. The Harnischfeger case is designed to encourage you to explore these motives.
Harnischfeger Corporation, a large New York Stock Exchange company, faced a financial crisis in 1982. New management was appointed to turn the company around. As part of its restructuring strategy, the new management team made a number of financial reporting policy changes in fiscal 1984. Together, these changes accounted for most of Harnischfeger’s reported 1984 profits. More significantly, these changes represented a substantial switch from the company’s earlier conservative reporting philosophy to a more aggressive one.
The case describes the company’s financial crisis, the turnaround strategy of the new management team, and the accounting policy changes that took place in 1984.
Assigned Case Questions:
1. Identify all the accounting policy changes and accounting estimates that Harnischfeger made during 1984. Estimate, as accurately as possible, the effect of these changes on the company’s 1984 reported profits.
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?
3. Assess the company’s future prospects given your insights from questions (1) and (2) and the information in the case on the company’s turnaround strategy.