Cummins Inc. Equity Valuation and Analysis

Management has no accounting flexibility when recording Research and
Development in accordance with GAAP. R&D has to be expensed in the time
period it occurs and severely limits management’s ability to accurately convey its
true economic position. The rigidity of accounting standards for reporting R&D
restricts management flexibility in presenting a key success factor of the firm.
Current accounting standards allow significant management discretion in
estimating warranty liabilities. Warranty liability estimates can result in higher or
lower expenses depending on management estimates. Management can increase
warranty liability estimates to increase expenses and smooth earnings or
decrease estimates to reduce the perceived present and future liability
obligations, increasing net income and improving the appearance of the capital
structure.
Cummins Inc., over many years of acquisitions, has increased its focus on brandimage.
This is reflected in its $358 million in goodwill. SFAS no. 142 grants the
company the option to check for goodwill impairment annually. Management’s
estimate on the fair value of goodwill determines whether or not goodwill is
considered impaired. For the period of 2003-2005, Cummins Inc.’ management
has decided not to impair goodwill stating that the individual business segments’
fair value of has exceeded their book value, and therefore in management’s
opinion does not require impairment.
Post-retirement benefits and pension plans make-up a significant portion of
company liabilities and could potentially affect Cummins Inc. ability to achieve
their goal of cost-leadership. Cummins Inc. has a defined benefit plan for hourly
employees and a cash basis formula for salaried employees. The defined benefit
plan creates a greater liability for the company as it states the expected future
outflow of cash to be distributed to employees when they draw down from the
account. Management estimates on the growth of these defined benefit plans
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