Worldcom Case

WorldCom, Inc.— Capitalized Costs and Earnings Quality

EXCERPTED WITH PERMISSION FROM

CASES IN FINANCIAL REPORTING

SIXTH EDITION ISBN: 1-934319-19-8

ELLEN ENGEL D. ERIC HIRST MARY LEA MCANALLY

© Copyright 2009 by Cambridge Business Publishers, LLC. All rights reserved. No part of this publication may be reproduced in any form for any purpose without the written permission of the publisher.

WorldCom, Inc.—Capitalized Costs and Earnings Quality

Organized in 1983, WorldCom, Inc. provides a broad range of communications services to both U.S. and non-U.S. based businesses and consumers. The company’s strategy is to provide service through their own facilities throughout the world instead of being restricted to a particular geographic location. The company’s core business is communications services, which include voice, data, Internet and international services. During the second quarter of 2002, WorldCom announced that costs totaling $3.9 billion had been improperly capitalized in five preceding quarters which overstated pretax earnings by the same amount. Subsequently, the magnitude of the fraudulent accounting entries has increased and WorldCom filed for Chapter 11 bankruptcy protection. (Source: Company 2001 Form 10-K)

Learning Objectives • Distinguish between costs and expenses. • Distinguish between costs that should be capitalized and costs that should be expensed. • Restate earnings to reflect generally accepted accounting principles. • Understand management’s incentives to engage in “aggressive accounting.” Refer to the 2001 financial statements and notes for WorldCom, Inc. and to the Wall Street Journal article dated June 27, 2002.   Concepts 

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a. FASB Statement of Concepts No. 6 (a replacement for SCON No. 3), Elements of Financial Statements, describes the building blocks with which financial statements are constructed. i. ii. Explain, in your own words, how SCON 6 defines “asset” and “expense.” In general, when should costs...