Question

Measuring Sustainable Earnings Harnishfeger Corporation was a mining machinery and equipment company based in Wisconsin. The company voluntarily changed its depreciation accounting policy from the accelerated method to the straight-line method It disclosed the cumulative effect of this accounting policy change, equal to $11.005 million (net of applicable income taxes), in its financial statements In addition, the company also voluntarily changed the estimated useful lives of certain of its U.S. plant and equipment. This estimate change increased its pretax reported profit by $3.2 million. The following are selected excerpts from the company's financial statements
(in thousands)
Income before income taxes, equity items,
and cumulative effect of accounting method change 5838
Provision for income taxes (2452)
Income after taxes 3386
Equity items 858
Cumulative effect of change in depreciation method 11005
Net income 15249
(a) Calculate Harnishfeger's sustainable earnings. Round tax rate to the nearest whole percentage for your calculation. (Example: 0.34567 = 35%) Round your answer to the nearest thousand dollar. thousand
(b) How would the capital market react to the company's decision to change its depreciation accounting policy and to change the estimated useful lives of its depreciable assets?

Answer 1

Answer:

Harnischfeger Corporation

Measuring Sustainable Earnings

a. Sustainable earnings = $1,530,000

b. Most analysts at the capital market would like to recalculate the net income to the actual income without the change in Harnischfeger depreciation accounting policy in order to understand the effect of the change.

Explanation:

a) Data and Calculations:

Excerpts from Harnischfeger financial statements

(in thousands)

Income before income taxes, equity items,

and cumulative effect of accounting method change    5,838

Provision for income taxes                                              (2,452)

Income after taxes                                                            3,386

Equity items                                                                         858

Cumulative effect of change in depreciation method  11,005

Net income                                                                      15,249

Sustainable Earning:

(in thousands)

Income before income taxes, equity items,

and cumulative effect of accounting method change    5,838

Change in estimate                                                         (3,200)

Adjusted income                                                              2,638

Income taxes   (42%)                                                        (1,108)

Income after taxes                                                             1,530

Income taxes rate = 2,452/5838 * 100 = 42%

b) Sustainable earnings differ from actual net earnings or income by removing the amount of irregular revenues, expenses, gains, and losses included in the financial year's net income. Sustainable earnings enable the users of financial statements to estimate a company's future earnings without the “noise” generated by irregular accounting items around the net income figure.