WorldCom Case
Read the attached WSJ article about the WorldCom scandal dated June 27, 2002 here, and find MCI Inc’s 2001
10-K405 (i.e. 10-K that is filed late) to answer the following questions:
1) In general, when should costs be expensed and when should they be capitalized as assets?
According to the article amounts being paid that create long-lasting assets can depreciate and be amortized
over several years. This means that costs that are expected to provide long-lasting benefits (more than 1 year)
can be capitalized, while costs with short-term benefits (less than 1 year) are expenses in the period incurred.
Furthermore, costs should be expensed when they are used up within the current accounting period with no
future benefits, whereas costs that provide benefits beyond the current period and will be used in future
operations can be capitalized as an asset. As the company’s 2001 10-K405 states “maintenance and repairs are
expenses as incurred. Replacements and betterments are capitalized.”
2) What becomes of “costs” after their initial capitalization? Describe, in general terms, how the balance sheet
and the income statement are affected by the decision to capitalize a given cost.
Once initially capitalized, the “costs” cease to be an expense and become part of the fixed assets. It is
recorded on the balance sheet as an assets, and then gradually “expensed” over time as it is used through
depreciation and amortization. It appears in the income statement as an expense each period until the asset is
fully depreciated. In general, the cost is spread out over the period of its useful life instead of being recognized
as an immediate expense.
3) Refer to MCI WoldCom’s statement of operations. What did the company report as line costs for the year
ended December 31, 2001? Explain in your own words, what these “line costs” are.
WorldCom reported $8.12 billion as line costs for the year ended December 31, 2001. Line costs can be
described as expenses that are incurred by a company for its operational activity or to produce a product or
service. They can typically be found on an income statement above the gross profit line. In WorldCom’s case,
they paid service providers for their call operations. Line costs accounted for half of the total expenses incurred
by WorldCom, although it typically should be expensed.
4) Refer to the WSJ article. Describe the types of costs that were improperly capitalized at MCI WorldCom.
Explain, in your own words, what transactions give rise to these costs. Do these costs meet your definition of
assets in part 1 above?
Back in 2001, WorldCom was found to have been systematically manipulating its financial statements to
appear more profitable for the past few years. The costs that were improperly categorized were line costs that
WorldCom paid to smaller telecommunications companies to use their networks. As the article states,
WorldCom has been using an “unorthodox technique to account for one of the long-distance company’s biggest
expenses: charges paid to local telephone networks to complete calls.” These costs are normally recorded as
operating expenses in the period they are incurred since they are associated with short-term operations and
maintenance of the business. These costs meet my definition of assets in part 1 since long-term assets should be
capitalized and short-term assets should be recorded as expenses. Furthermore, the company states that
maintenance and repairs are expenses.
5) In a sworn in statement to the SEC, MCI WorldCom revealed details of the improperly capitalized amounts
(in millions) in 2001: $771, $610, $743, and $931 in the 1st, 2nd, 3rd and 4th quarter respectively. Assuming
that WorldCom planned to depreciate those assets over 22 years, and the depreciation begins in the quarter that
assets are acquired, or their costs capitalized. Calculate the related depreciation expense for 2001.
Read the attached WSJ article about the WorldCom scandal dated June 27, 2002 here, and find MCI Inc’s 2001
10-K405 (i.e. 10-K that is filed late) to answer the following questions:
1) In general, when should costs be expensed and when should they be capitalized as assets?
According to the article amounts being paid that create long-lasting assets can depreciate and be amortized
over several years. This means that costs that are expected to provide long-lasting benefits (more than 1 year)
can be capitalized, while costs with short-term benefits (less than 1 year) are expenses in the period incurred.
Furthermore, costs should be expensed when they are used up within the current accounting period with no
future benefits, whereas costs that provide benefits beyond the current period and will be used in future
operations can be capitalized as an asset. As the company’s 2001 10-K405 states “maintenance and repairs are
expenses as incurred. Replacements and betterments are capitalized.”
2) What becomes of “costs” after their initial capitalization? Describe, in general terms, how the balance sheet
and the income statement are affected by the decision to capitalize a given cost.
Once initially capitalized, the “costs” cease to be an expense and become part of the fixed assets. It is
recorded on the balance sheet as an assets, and then gradually “expensed” over time as it is used through
depreciation and amortization. It appears in the income statement as an expense each period until the asset is
fully depreciated. In general, the cost is spread out over the period of its useful life instead of being recognized
as an immediate expense.
3) Refer to MCI WoldCom’s statement of operations. What did the company report as line costs for the year
ended December 31, 2001? Explain in your own words, what these “line costs” are.
WorldCom reported $8.12 billion as line costs for the year ended December 31, 2001. Line costs can be
described as expenses that are incurred by a company for its operational activity or to produce a product or
service. They can typically be found on an income statement above the gross profit line. In WorldCom’s case,
they paid service providers for their call operations. Line costs accounted for half of the total expenses incurred
by WorldCom, although it typically should be expensed.
4) Refer to the WSJ article. Describe the types of costs that were improperly capitalized at MCI WorldCom.
Explain, in your own words, what transactions give rise to these costs. Do these costs meet your definition of
assets in part 1 above?
Back in 2001, WorldCom was found to have been systematically manipulating its financial statements to
appear more profitable for the past few years. The costs that were improperly categorized were line costs that
WorldCom paid to smaller telecommunications companies to use their networks. As the article states,
WorldCom has been using an “unorthodox technique to account for one of the long-distance company’s biggest
expenses: charges paid to local telephone networks to complete calls.” These costs are normally recorded as
operating expenses in the period they are incurred since they are associated with short-term operations and
maintenance of the business. These costs meet my definition of assets in part 1 since long-term assets should be
capitalized and short-term assets should be recorded as expenses. Furthermore, the company states that
maintenance and repairs are expenses.
5) In a sworn in statement to the SEC, MCI WorldCom revealed details of the improperly capitalized amounts
(in millions) in 2001: $771, $610, $743, and $931 in the 1st, 2nd, 3rd and 4th quarter respectively. Assuming
that WorldCom planned to depreciate those assets over 22 years, and the depreciation begins in the quarter that
assets are acquired, or their costs capitalized. Calculate the related depreciation expense for 2001.
