Lucent Technologies, Inc., was formed from AT&T's Bell Laboratories research organization after the breakup of AT&T in to the Baby Bells. Lucent designs, develops, and manufactures communication systems, supplying these systems to most of the world's telecom operators for both wired and wireless services for voice, data, and video delivery. In 1999 Lucent reported $38.301 billion in revenues, against $31.806 billion in 1998 and $27.611 billion in 1997.
Analysts have complained about the quality of Lucent's reported earnings over the years.
A. What questions arise regarding the quality of Lucent's earnings for 1997, 1998, and 1999 from the partial cash flow statements in Exhibit 17.5?
B. How do deferred tax footnotes help in ascertaining the quality of the accounting? Does the note below (from the 1999 report) raise any quality questions? The components of deferred tax assets and liabilities at September 30, 1999, and 1998 are as follows:
C. Lucent reported effective tax rates of 33.9 percent in 1999, 35.3 percent in 1998, and 36.8 percent1997. Do these rates raise quality questions?
D. Look at the footnote for the pension cost that follows. Does this note revise your assessment as to the quality of earnings reported from1997 to 1999?
Effective October 1, 1998, Lucent changed its method for calculating the market-related value of plan assets used in determining the expected return-on-asset component of annual net pension and postretirement benefit cost. Under the previous accounting method, the calculation of the market-related value of plan assets included only interest and dividends immediately, while all other realized and unrealized gains and losses were amortized on a straight-line basis over a five-year period. The new method used to calculate market-related value includes immediately an amount based on Lucent's historical asset returns and amortizes the difference between that amount and the actual return on a straight-line basis over a five-year period. The new method is preferable under Statement of Financial Accounting Standards No.87 because it results in calculated plan asset values that are closer to current fair value, thereby lessening the accumulation of unrecognized gains and losses while still mitigating the effects of annual market value fluctuations.
The cumulative effect of this accounting change related to periods prior to fiscal year 1999 of $2, 150 ($1,308 after-tax, or $0.43 and $0.42 per basic and diluted share, respectively) is a one-time, noncash credit to fiscal 1999 earnings. This accounting change also resulted in a reduction in benefit costs in the year ended September 30, 1999, that increased income by $427($260 after-tax, or $0.09 and $0.08 per basic and diluted share, respectively) as compared with the previous accounting method. A comparison of pro forma amounts below shows the effects if the accounting change were applied retroactively: