What effect does integration cost generally have on the financials of the acquiring company in the year of acquisition?

Integration costs typically represent the expenses incurred in merging two organizations following an acquisition. These costs can include various expenses such as employee severance, systems integration, legal fees, and other costs associated with aligning the operations, cultures, and management structures of the two companies.

When these integration costs are accounted for, they are usually recorded as operating expenses in the financial statements of the acquiring company. Since these expenses reduce the overall profitability of the firm for that fiscal year, they lead to a decline in net income. The recognition of these costs directly impacts the income statement, reflecting lower earnings in the year of acquisition.

In contrast, while total assets might increase due to the acquisition itself, the integration costs themselves do not add to asset value but rather impact expenses. Similarly, integration costs might not generate a new liability; instead, they are generally treated as a reduction in equity through their negative impact on net income. Lastly, unless the integration is exceptionally smooth or leads to immediate cash generation—which typically isn’t the case—improving cash flow is unlikely due to the expenses incurred. Overall, the first choice accurately captures the financial effects of integration costs on the acquiring firm in the acquisition year.