MCI

In 1997, WorldCom’s CEO bid successfully to acquire MCI Communications. The key questions that remained to be settled were how to structure the deal for tax purposes, and what impact the acquisition would have on the combined company’s reported earnings. The CEO knew that the tax and accounting structure of the MCI acquisition could have serious implications for the combined company’s future financial performance. He also knew that the composition of his offer (80% cash, 20% stock) for MCI would impact both. Under WorldCom’s 80% cash offer, purchase accounting was the only financial reporting option. Under purchase accounting, the target’s net assets were recorded at their fair value, and the unallocated purchase price was assigned to goodwill. However, the amount of goodwill created in a transaction depended on the tax structure of the acquisition. The creation of a new liability on the target’s books reduced its net asset value, thereby resulting in more goodwill. The case analyzes and illustrates by example how the tax implications of and the financial recording for an acquisition can both be affected by the transaction’s tax structure. The amount of tax paid, liabilities assumed, and goodwill recognized all depend on the transaction’s tax structure.