Group 4

Section 25050

Page 4

TYCO INTERNATIONAL, LTD.

Submitted by

Group 4

Maria Lugo

Lusine Avagyan

Mulex Aguirre

Yelena Zatulovsky

Prepared for

Dr. Barbara Wilson

ACCT 351COM

Section 25050

Wed 4 p.m.

March 5, 2003
TYCO INTERNATIONAL, LTD.

In June of 2002, the Securities and Exchange Commission (SEC) ordered Tyco International, LTD. (Tyco) to restate the value of its CIT subsidiary for the quarter ending March 31, 2002 by increasing the unit’s goodwill impairment and decreasing the unit carrying value from $11.3 billion to $6.5 billion (Markets: Tyco Raises . . . , 2002). This paper will discuss Tyco’s quarterly report (10Q/A) and the amended 10Q/A for the period of March 31, 2002. Specifically, it will examine the treatment of goodwill for its CIT segment and the application of FASB142 to recalculate the estimated impairment of goodwill. From the analysis of Tyco’s financials filed for the quarter ending March 31, 2002, three conclusions were drawn:

CONCLUSIONS

1.  The original 10-Q filing for the quarter ending March 31, 2002 should have shown a goodwill impairment for Tyco’s CIT segment.

2.  The application of FASB142 revealed that a two-step analysis was justified.

3.  The problems plaguing Tyco, including this impairment, had drastic effects on stock price and related stakeholders.

CIT’s Goodwill Impairment

An impairment was not recognized on Tyco’s March 31, 2002, 10-Q filing, and the SEC found issue with the treatment of goodwill reported for the CIT segment. Specifically, the SEC stated that “during the quarter ended March 31, 2002, Tyco experienced a decline in its market value caused by the failed conglomerate break-up plan, a negative credit rating, and a declined market capitalization” (SEC, Amendment No. 2 . . . , 2002, p. 13). Accordingly, Tyco revaluated the CIT unit and found an impairment. The fair value of the CIT segment was compared to its carrying book value to test for recoverability. The fair value was determined by using the discounted cash flows method. The analysis showed that CIT had an excess fair market value of approximately $1.5 billion over net book value (SEC, Amendment No. 2 . . ., 2002, p. 42).

Tyco was attempting to reposition the company economically to reduce its debt. According to Krasner, a reporter for the Boston Globe, Tyco had plans to sell the CIT segment because it needed to pay its $27 billion maturing debt. The potential sale prompted Tyco to gather market information and research how prospective investors would value the new company. Then it requested permission from the SEC to sell CIT in the stock market as an Initial Public Offering (IPO). The SEC approved the sale, but forced Tyco to reassess the value of the CIT unit (Krasner, 2002). In compliance with the SEC, Tyco refiled recognizing an impairment charge of $4.6 billion. The effect of this restatement was an increase in the originally reported net loss from $1.9 billion to $6.4 billion, resulting in an increased net loss per share from $0.96 to $3.22 (SEC, Amendment No. 2 . . . , 2002, p. 42).

Application of FASB 142

Tyco applied FAS142 (2001) to reassess the value of CIT. FAS142 (2001) requires that an impairment of goodwill be evaluated in a two-step process. The first step consists of comparing the fair value of the reporting unit to the carrying book value (including goodwill). If the fair value is greater than the book value, the reporting unit has not been impaired and the second step is not necessary. Contrarily, if the fair value is less than the carrying value, than the reporting unit has been impaired and a second step is needed to determine if an impairment loss has occurred (FAS142, 2001, ¶19).

Tyco’s intent to separate CIT from Tyco, improve their credit ratings, and regain access to unsecured financing options motivated management to reevaluate the impairment of CIT’s goodwill. In accordance with FASB142, Tyco performed a step one analysis and determined that due to the 100 percent offering for the sale of CIT and other market factors, the fair market value of the segment had decreased to less than the net book value. Accordingly, this showed that an impairment had occurred (SEC, Amendment No. 2 . . . , 2002, p. 42).

Tyco proceeded with a step-two analysis to compare implied goodwill (the fair value of goodwill) to the unit book carrying value. According to FAS142, if the unit carrying book value exceeds the implied goodwill, then an impairment loss should be reported. The loss, however, cannot exceed the unit’s carrying value. Furthermore, a recognized impairment cannot be reversed (FASB142, 2001, ¶20, 2003). Tyco estimated the goodwill impairment for the CIT unit at $4.6 billion (SEC, Amendment No. 2 . . . , 2002, p.13).

Impact on the Stock Market and Stakeholders

The recognition of the impairment, followed by the sale of CIT, had an impact on the employees and investors. According to Dow Jones International, Tyco sold the CIT unit as planned in an IPO in July 2002. It received $4.4 billion including underwriting fees, which was about $5 billion less than its original acquisition price. Furthermore, it reported the remaining impairment in the quarter ending June 2002. Then, the same week as the CIT segment IPO, Tyco announced a restructuring and laid-off 115 corporate employees (Tyco’s Kozlowski quits . . . , 2002).

An impairment of such large proportions had a large impact on the market and market participants. Following the announcement of the CIT sale, Tyco’s stock prices dropped by 34 percent from approximately $22 to $17 (Maremount, 2002). However, Tyco has been plagued with other problems including accusations of aggressive accounting policies, alleged theft by prior management, and an SEC investigation into its accounting and acquisition practices. The complexity of these problems would explain why from January to June 2002, its stock price dropped from approximately $60 to $14 per share (Tyco’s Kozlowski quits . . . , 2002).

REFERENCES

Financial Account Standard Board (FASB). (2001). FAS142-- Goodwill and other intangible assets. ¶19-20--Recognition and measurement of an impairment. Financial Accounting Standards Board. (2003). Financial Accounting Research System (FARS). Published by the Financial Accounting Standards Board.

Krasner, J. (2003, March 14). Tyco chief vows cleanup of problems at company. The Boston Globe, para. 20-23. Retrieved April 28, 2003, from Proquest via: http://libproxy.csun.edu.

Maremount, M. (2002, July 4). Questioning the books: Tyco plans charge of $2.4 billion. The Dow Jones, para. 4-9. Retrieved April 30, 2003, from Factiva via: http://libproxy.csun.edu

Markets: Tyco raises $4.6 billion in IPO. (2002, July 2). The Los Angeles Times, para. 2. Retrieved April 28, 2003, from Proquest via: http://libproxy.csun.edu

Securities and Exchange Commission (SEC). (2002, May 15). Amendment No. 2 on Form 10-Q/A: Pembroke, Bermuda: Tyco International LTD. Retrieved April 30, 2003, from Security Exchange Commission Reports Online via: http:www.sec.gov

Tyco’s Kozlowski quits amid news of probe. (2002, June 3). Dow Jones International News, para. 4-9. Retrieved April 28, 2003, from Dow Jones Interactive via: http://libproxy.csun.edu

Tyco to cut jobs: Consolidated troubled company is hoping to save $125M annually. (2002, June 14). The Boston Globe, para. 8-9. Retrieved April 28, 2003, from Proquest via: http://libproxy.csun.edu