From 1999 to 2001, Tyco’s revenue grew approximately 24% and it acquired over 700 companies. It was widely rumored that Tyco executives aggressively managed the performance of the companies that they acquired by suggesting that before the acquisition, they should accelerate the payment of liabilities, delay recording the collections of revenue, and increase the estimated amounts in reserve accounts. Required:
a. What effect does each of the three items have on the reported net income of the acquired company before the acquisition and on the reported net income of the combined company in the first year of the acquisition and future years?
b. What effect does each of the three items have on the cash from operations of the acquired company before the acquisition and on the cash from operations of the combined company in the first year of the acquisition and future years?
c. If you are the manager of the acquired company, how do you respond to these suggestions?
d. Assume that all three items can be managed within the rules provided by GAAP but would be regarded by many as pushing the limits of GAAP. Is there an ethical issue? Describe your position as: (A) an accountant for the target company and (B) as an accountant for Tyco.

Tyco

a. Effect on the reported net income of the acquired company before the acquisition:

1. Accelerate the payment of liabilities: No effect

2. Delay recording the collections of revenue: No effect

3. Increase the estimated amounts in reserve accounts: Net income will decrease because reserves are made from profits.

a2: Effect on the reported net income of the combined company in the first year of the acquisition and future years.

1. Accelerate the payment of liabilities: No effect

2. Delay recording the collections of revenue: No effect

3. Increase the estimated amounts in reserve accounts: Reported net income will increase, as the reserves will no longer be increased.

b. Effect on the cash from operations of the acquired company before the acquisition

1. Accelerate the payment of liabilities: Increased operational cash outflow

2. Delay recording the collections of revenue: Decreased operational cash inflow

3. Increase the estimated amounts in reserve accounts: No effect

b2. Effect on the cash from operations of the combined company in the first year of the acquisition and future years.

1. Accelerate the payment of liabilities: Decreased operational cash outflow

2. Delay recording the collections of revenue: Increased operational cash inflow

3. Increase the estimated amounts in reserve accounts: No effect

c. Response of the manager of the acquired company to these suggestions:

I will not agree to these suggestions.  They are unethical.  Financial position is distorted by such reporting.

d. Ethical issue as an accountant of the target company:

The ethical issue involves creative accounting and misstatement of financial results and position to favor Tyco in the future.

d2. Ethical issue as an accountant for Tyco:

The financial positions of the acquirees will be deliberately misstated.

Explanation:

a) Data:

1. Accelerate the payment of liabilities

2. Delay recording the collections of revenue

3. Increase the estimated amounts in reserve accounts

b) A key concept of cash flow accounting requires that revenue collections should be recorded when received and payment of liabilities should be made to take advantage of discounts.  Suggesting for the acceleration of liability payments and the delay in the recording of revenue collections will distort the books and misstate the cash flow position of the target company and Tyco.