Tyco Accounting

Scandal

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 Table of Content
1. Introduction..........................................................................................................................3
2. Issues of Tyco Scandal..........................................................................................................4
3. The Accounting Misconduct of Tyco International............................................................5
3.1 Accounting misconduct, Misappropriation of funds, Over/Under Stating of
Accounting figures....................................................................................................................5
4. Various consequences of the Tyco scandal..........................................................................7
5. The auditor’s involvement and the auditor’s responsibility on Tyco scandal..................8
6. How the auditing profession could prevent as well as safeguard itself from such
scandals.........................................................................................................................................9
6.1 The profession’s response to legal liability......................................................................10
6.2 Protecting individual CPAs from legal liability..............................................................10
7. Recommendations...............................................................................................................11
8. Conclusion...........................................................................................................................12
References...................................................................................................................................13

Word Count - 2667 words

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 1. Introduction

Tyco international was the world’s largest maker and service provider of electrical and
electronic components, they also engaged in designing and building undersea
telecommunication systems, building of fire secure systems and a dominant player in
disposable of plastics and medical products. Tyco engaged in selling variety of products
such as Fire alarm systems, Safety products, Circuit protection devices and Security
systems. (Beasley, 1999) Tyco has acquired over 40 major acquisitions and more minor
acquisitions. Tyco international scandal took place due to the unethical business practices
of many number of top management officers. In 1992 Kozlowski was appointed as the
CEO of Tyco International. (obringer, n.d.) During 2002, Kozlowski and Mark H. Swartz
the CFO of Tyco and Belnick charges were filed against them for not reveling the
information on huge amount of loans to shareholders.

2. Issues of Tyco Scandal

The major issue of the scandal is the conflicts of interest. It means when the managers
always trying to achieve their interest by ignoring the shareholder’s interest.

 Leader’s defalcation of company funds – This is a big issue that involved in the
conflicts of interest. The leaders of the Tyco international company give more
priority to their interest rather than the shareholder’s interest. The deeds of the
leaders of the company were unethical. In the Tyco scandal, the CEO had
exploited the funds of the company to fulfill the own desired of having a lavish
lifestyle.

 Bribery – Another ethical issue under conflicts of interest of the Tyco scandal is
bribery. In the Tyco scandal, there was two major bribery case. The first one is
Frank E. Walsh Jr, the director of the Tyco international had received $20million
for helping the arrangement of the acquisition of CIT group without the

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 knowledge of the nest of the board of director. The second case is Stephan W.
Foss, the member of Tyco’s board of director received $ 751101 for supplying a
Cessna Citation aircraft and pilot services.

These all issues were discussed under the conflicts of interest. The next major issue is the
inappropriate discharge of employees. In the Tyco scandal case, the CEO of the company
had discharged the employees without any notice. The CEO cannot discharge any
employee without any reason. In this scandal, the CEO does not treat his employees fairly
and justly.

3. The Accounting Misconduct of Tyco International

Kozlowski the CEO of Tyco International is the major person that involved and
persuaded other senior executives to get involved and disguise the operations in return of
huge financial benefits. According to (ROMERO, 2017) CEO and CFO started to collect
the assets of the company and use them for their own personal activities. Tyco scandal
was not merely stealing of funds but taking advantages of financial loopholes in the
company’s policies. In 1999 the Kozlowaski the CEO, Swartz the CFO and Belnick gave
themselves interest free loans. These loans were taken without the approval of the
company, they had taken loans amounted to $43.5 million with bonuses of $96 million
and in other hand they never tried to pay the loans back. The organizational structure
practiced by Tyco was very poor as it had poor internal controls with poor oversight of
operations by the directors, Dennis Kozlowski had hired people who are very loyal to
him and decentralization of Tyco’s divisions due to lack of organizational charts.

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3.1 Accounting misconduct, Misappropriation of funds, Over/Under
Stating of Accounting figures

Though 1996 to 2002 Tyco International reach the federal security laws by overstating
the balances of financial statements. They were engaged in hiding ample amount of
senior employee’s compensation from investors. To fulfill their self-goals, they use lots
of improper practices. So due to this the top management showed aggregate amounts in
the financial statements by overstating the figures. (Jones, 2006)
The internal control was very poor in Tyco, there was lots of worst practices adopted
within the company such as poor documentation, Lack of adequate policies and
procedures to prevent misconduct of senior executives, Improper auditing practices by
auditors and inadequate procedures for corporate approval.
Tyco acquired lots of companies, they did most of their acquisitions through improper
accounting practices. Over $500 million of Tyco’s operating income was due to their
improper accounting procedures. They also used range of reserve accounts to enhance
and show better results in their financial statements.
The other major part of Tyco’s accounting misconduct was they boost the operating
income with related to the transactions that took place between Tyco’s ADT Security
Services and security alarm dealers, so they boost the operating income and cashflow
from operational activities by approximately $567 million and $719 million respectively.
(commision, 2006)
Tyco did certain omissions in the accounting figures with related to executive bonuses it
paid during 2000 and 2001 fiscal years. They didn’t include the cost associated with these
bonuses.
During this period Tyco provides its investors with false statements by false, omissions
and misleading statements. So due to its improper practices Tyco finally violated the
Foreign Corrupt Practices Act.
Jerry Bogges, the President of Tyco Fire and Security involved in fraudulent booking of
Tyco’s transactions, this had greatly affected for the earnings per share. (ArmstrongStaff,
2003) . The former auditor of Tyco who audited financial documents from years 1997
until 2001, has failed to conduct the audit procedures properly and hence engage in

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improper professional conduct. Tyco’s top management has not involved in comparison
of the financial statements with the other companies due to the fraudulent picture of
Tyco.
The former Tyco CEO Dennis Kozlowski had enjoyed an extravagant lifestyle by
enjoying luxuries fixtures such as shower curtains for about $6000, umbrella stand for
$15000 and gave his wife with a grand birthday party worth to $2 million. He had also
purchased $19 million worth of house with no interest loan from Tyco. So likewise, he
had in appropriately used the funds of Tyco. They hid these illegal activities without
recording them in the accounting books. Kolzlowski, Swartz, Belnick had breach the
Business entity concept by using the company’s funds for their own activities. They had
not kept company’s accounting separate from owner’s personal affairs.

Tyco international mislead their financial analysts and investors by just showing the cash
flows from operations of the company without interpreting free cash flows after
acquisitions.

($ millions) 2002 2001 2000 1999

Reported cash flows from Operations 5696 6926 5275 3550

(CFFO)
Subtract: Capital expenditures (1709) (1798) (1704) (1632)
Subtract: Construction in Progress (1146) (2248) (111) -
Free cash flow 2841 2280 3430 1918
Subtract: Acquisitions (3709) (11851) (4791) (5135)
Free cash flow after acquisitions (868) (8971) (1331) (3217)

Source - (Howard M Schilit, 2010)

The table above shows that free cash flows before deducting acquisitions remain positive
while after deducting acquisitions its negative. The free cash flow after acquisitions
illustrates the real free cash flows of the company, so in this scandal the top executives

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has hide the real free cash flow to exhibit a false picture among the investors and the
financial analysts.

4. Various consequences of the Tyco scandal

 The president of Tyco International Company is Jerry Boggess. He was involved

in bookkeeping fraud that affects the earning per share of the company. Due to
this reason, the share value and the demand for the shares of the company
decreased drastically.
 The CEO of the Tyco international was tried to indicated on tax evasion for
avoiding just over $ 1 million in New York state and local sales tax. The tax
evasion of the company will cause the government to lose the chance to invest the
money for the development process.

5. The auditor’s involvement and the auditor’s

responsibility on Tyco scandal
The auditors of Tyco – Price Waterhouse Coopers were charged for the illegal behavior
of their responsibility in the scandal that was taken place financially at Tyco
International. The chief executive Dennis Kozlowski was paid with a bonus of $33
million. It is said that this has been ignored by PWC. The investors of the Tyco scandal
said that the audit team was aware of this fee which was awarded in August 2001 even
though they failed to warn the board of directors.

Tyco International’s annual proxy filings had been incorrect. The auditors do not have a
responsibility for approving proxy filings but under New York laws it is argued that Price
Waterhouse Coopers might have committed security frauds by assisting the company to
make incomplete disclosures.

The auditing company Price Waterhouse Coppers are ranked in the top 10 legal
compensation payments in large amount by accounting firms related to work on behalf of
the company.

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The auditor’s responsibility is to convey their point of view fairly and truthfully in all
material aspects, financial position of the organization, results of the operations, the cash
flows in comply is generally accepted accounting principles.

The responsibility of the auditor is to express their view and comply that financial
statements have followed the generally accepted accounting principles. Identification of
the situation where these standards have not been fairly treated in preparation of current
period financial statements and the prior period can be recognized as a responsibility of
the auditor.

Auditor has a responsibility on planning and performance of the audit in acquiring

rational assurance whether the financial statements are free from material misstatement,
whether they are caused by error or fraud. As mentioned above the auditor’s duty is to
express their opinion on the financial statements while the financial statements are held in
the responsibility of the management.

An auditor has to have the experience on determining the correct auditing procedures
required in different situations on a reasonable basis of the opinion held by the auditor.
These should be complied with the auditing standards accepted by his fellow
practitioners. The judgement of the auditor is supposedly the judgement of a qualified
professional person.

An audit failure occurs when an auditor come up with an incorrect opinion due to failing
to follow the accounting standards. The risk faced by the auditor is the inability to find
the material misstatements and issuance of unqualified opinions.

The transactions of the company that are related with assets, liabilities and equity are in
the knowledge and control of the management of the company. The knowledge of the
auditor on these affairs and the control of the company internally are limited to the extent
that is obtained through the audit. The fair representation of the financial statements
complied by the generally accepted accounting principles is a responsibility of the
auditor. The suggestions about the content of the financial statements in whole or
partially are built on the information obtained from the management while performing the
audit.

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However, expressing the point of view of the auditor with regard to the financial
statements is the major responsible action performed by the auditor.

6. How the auditing profession could prevent as well as

safeguard itself from such scandals

6.1 The profession’s response to legal liability

 Research in auditing - Research in auditing means the expectation gap. Auditor
should research on what are the shareholders or society expect from an auditor
and how an auditor think about their duty and gap of these two expectation is
wide or small. After the research auditor should release the research reports to the
public.
 Standard and rule setting – auditing standard should be more strength and make
higher requirements to auditors then auditors can perform well. Changes of
auditing standards of auditors’ responsibility and role to find out fraud were
issued to address users’ expectations as to auditor performance.
 Set requirements to protect auditors – As a profession need to establish desiderata
(conditions) or safeguards to protect auditors.
 Establish peer review requirements – peer review means one audit firm can check
another audit firms’ client audit files to make sure that audit firm perform
according to the audit standards. As an example, KPMG can check PWCs’ client
audit report.
 Oppose lawsuit – audit firms must continue to oppose for illogical (improper)
lawsuits against them (the entire profession will have to against lawsuit).
 Sanction members for improper conduct and performance – remove the members
or cancel the membership if any auditor done improper activity or not perform
well.
 Lobby for changes of law – if there any detrimental laws in government as a
profession will have to lobby the government and change those laws (in America

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 there is separate lobby groups to change the regulations but in Sri Lanka not
have).

6.2 Protecting individual CPAs from legal liability

 Understand the client business – before the audit auditor should understand the
client. Sometime lack of knowledge about client firm is major factor to audit
failure.
 Perform quality audits – as an auditor should do a quality work for client and
maintain quality. That means do the audit according to the auditing standards.
Ensure whether the individual perform according to the standards. In this case
PWC failed to do quality audit for tyco company.
 Document the work properly – auditor should document all work. The preparation
of documents helps to do quality audit as well as it will essential if an auditor has
to defend an audit in court. The most important documents are engagement letter
(auditors should have written agreement not verbal agreement) and a
representation letter. When PWC auditors came to Tyco to do audit they should
had written agreement (engagement letter) including their terms.
 Maintain confidential relation – as an auditor should not give confidential
information of clients to third party or out siders use it only for audit purposes.
 Carry adequate insurance – sometime auditor will have to pay compensation, so
auditor should take professional indemnity insurance (insurance taken by
professionals) because even if an auditor has to paid compensation insurance will
pay that on behalf of auditor.
 Exercise professional skepticism – as an auditor need to maintain a good level of
skepticism because when auditor is presented with information indicating a
problem and fail to recognize.

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7. Recommendations

 Tyco company should cultivate an ethical corporate culture and higher

management should have to follow that, when higher management work ethically
then entire subordinates and employees could have a good role to follow as well
as company should have more attention about their employees and check whether
they work properly or not.
 Government should have more attention about accounting practices of companies
(in this case tax evasion of the tyco company affected to the government and
government lost the chance to invest for development processes).
 The huge amount of power on one person within a business is unhealthy because
it can be affects in the long run (tyco CEO embezzled funds). So, there could be a
distribution of power across the company rather than giving power to one person.
 Tyco should have monitored the performance of the top management to make
sure they are doing their job correctly and acting as an agent of the shareholders
not their own personal objectives (whether the top management try to maximize
the wealth of shareholders, company profit not risking the reputation of the
company as well as financial activities of company).
 Training session for all employees: people are aware about the accounting frauds
but they not willing to come forward. It can be a damage for the company then
training sessions will teach employees what to do when they notice a fraud within
the company in future and how to report anonymously.

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 8. Conclusion

In the Tyco International scandal, it elaborates how corporate greed can eventually lead
to failure of large grown companies. After this scandal many people lost their trust with
the corporations. From above it gives all the details about the Tyco Scandal which took
place in 2002 had affect badly on the corporate world, the issues and the consequences of
Tyco Scandal.

The Sarbanes – Oxley Act in 2002 was passed to reestablish the trust and prevent future
senior professionals from engage in dishonest activities. So, to eliminate the conflicts of
interest the company can enhance the corporate governance practice, use more
conservative accounting to replace the aggressive accounting procedures that they
adopted early. These actions will bring good remarks to the company.

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 References

Alvin A. Arens, R. J. E. M. S. B. C. H., 2014. Auditing and assurance services. New Jersey: Pearson.

ArmstrongStaff, D., 2003. Tyco to Restate Financial Results. WALL STREET JOURNAL.
Beasley, H., 1999. www.caclubindia.com. [Online]
Available at: https://www.caclubindia.com/forum/how-cooking-the-books-works-
75658.asp
[Accessed 05 th November 2018].
commision, U. S. e., 2006. www.sec.gov. [Online]
Available at: https://www.sec.gov/news/press/2006/2006-58.htm
[Accessed 06 th november 2018].
Howard M Schilit, J. P., 2010. How to Detect Accounting Gimmicks and Fraud in
Financial Reports. New york: s.n.
Jones, S. E., 2006. www.sec.gov. [Online]
Available at: https://www.sec.gov/litigation/complaints/2006/comp19657.pdf
[Accessed 01 st November 2018].
obringer, L. A., n.d. Howstuffworks. [Online]
Available at: https://money.howstuffworks.com/cooking-books10.htm
[Accessed 05 th November 2018].
ROMERO, J., 2017. http://panmore.com. [Online]
Available at: http://panmore.com/tyco-corporate-scandal-2002-case-analysis
[Accessed 05 th november 2018].
Teacher, L., 2013. unethical issues or legal issues in tyco international. [Online]
Available at: www.lawteacher.net
[Accessed 8 November 2008].

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