Please answer part C

-175- WorldCom, Inc.-Capitalized Costs and Earnings Quality Organized in 1983, WorldCom Inc. provides a broad range of comnication5 services to both S. and non-US based businesses and consummers. The company's strategy is to provide service through their own facilities phroughont the world instead of bebg restricted to a particular geographic location. The company's core business s communications services, which include voice, data, Internet and bternational services. During the second quarter of 2002, WorldCom anmounced that costs totaling $3.9 billion had been improperly capitalized in five preceding quarters which overstated pretax earnings by the same amount. Suhsequently, the magitde of the fruudulent accounting entries has increased and WorldCom filed for Chapier bankrptcy profection. (Source Company 200I Form 10-K) Learning Objcctives Distinguish between costs and expenses. Distinguish between costs that should be cupitalized and costs that should be expensed. Restate camings 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 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. Explain, in your own words, how SCON 6 defines "asset" and "expense." In general, when should costs be expensed and when should they be capitalized as assets? What becomes of "costs" after their initial capitalization? Describe, in general terms, how the balance sheet and the income statement are affected by a decision to capitalize a given cost. Process Refer to WorldCom's statement of operations. What did the company report as line costs for the year ended December 31, 2001? Prepare the journal entry to record these transactions for the year. Explain in your own words, what these "line costs" are. d. Refer to the Wall Street Journal article. Describe the types of costs that were improperly capitalized at WorldCom. Explain, in your own words, what transactions give rise to these costs. Do these costs meet your definition of assets in part a above? Prepare a single jounal entry to record the improperly capitalized line costs of S3.055 billion for the year. Where did these costs appear on the balance sheet? Where on the statement of cash flows? Analysis -181- WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Millions, Except Share Data) December 31, 2000 December 31, 2001 ASSETS Current asscts Cash and cash equivalents Accuunts receivable, net of allowance for bad debts pf $1.532 in 2000 and $1.086 in 2001 Deferred tax asset Other current assets 761 6815 172 2.007 1.416 5.308 251 2,230 Total current assets 9,755 9,205 Property and equipenent Tansimision equipoent Communicatians equipment Furniture, fisures and other Construction in progres 20,288 8.100 23,814 7878 11263 9.342 6897 506 48661 (9.852 44.627 204) 37,423 Accumulated depreciation 38.809 Goodwill and other intangible assets Other assets 46,54 5,131 50,537 5.363 98,903 S 103,914 LJABILITIES AND SHAREHOLDERS INVESTMENT Cur Sho s Accdiebt and current maturities of long-term deb Accounts Other curtet li erued line coste 7,200 446 173 interi 618. 4844 6022 4,005 ities. 3576 Total current liabilities 17,673 9210 Lang-term liahilities, less ourrent portion Long-term deht Deferred tax liability Other liabilities 17,696 3,611 1.124 30,038 4,065 576 Tocal kng term liabilities 22,431 34,650 Commitments and contingencies Minority interests Company obligated mandatorily redeemable and other preferred securities 2,592 101 798 1993 Shareholders investment Series B preferred stock, par value S.01 per share; authorized, issued and outstanding 10,693437 shares in 2000 and nane in 2001 (lioaidation preference of $1.00 per share plus unpaid dividends) Preferred stoek, par valae S01 per share; authorized: 31.1I55,008 shares in 2000 and 30,967637 shares in 2001; none issued.. Common stock WorklCom, Ine. common stock, par value S01 per share; authorized: 5000.000,000 shares in 2000I and none in 2001: issued and ootstanding: 2,887,96,378 shares in 2000 and mle in A00 i 4as0 no oup common stock, pt valuc $0 per share, authorizod: mone in 2000 and shares in 2001 MCI eru 1500 kn sto Additianal nuid.in i ed and outstanding: none in 2000 and 118,95.711 in 2001 Retained carnings Unrealized hokding eain (o on mrkathio cui Cumalative foreign currency franslation atie yocrities shares in 2001; issued and outslanding: nane in 2000 and 2,967,436,6) 30 300 value S.01 per share, autheried: none in 2000 and 1: capital. 52877 3160 345 (817 54.292 4400 (51) (562) Treasury stock, at cast, 6,766.316 shares ef WarldCom. Ine in 200, 6.76i5,316 shars of WorldCom group steck and 20,613 shares of MCI group stock in 200 Total shareholders' investment (185 (I85) 55,409 57.930 98,903 S 103,914 The accompanying notes are an integral part of these statements F-3 -182- WORLDCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Millions, Except Per Share Data) Fur the Vars Ended December 31 1999 2000 201 $39,090 $35.179 S35,9U8 Reeoues. Operating expeases Line costs r-ag Selling, general and admipistrative Deprecation and amortization Other chargs. 14,339 8,935 4,354 14,739 11.046 5,880 15.462 10597 4878 31.665 28.020 30,437 Total &153 3514 7888 Operting incnme Other income (expense: Interest epcose Miscellancous (1,533) 412 (970) 385 7,568 3.025 242 2.393 927 Income hefore income tases, minarity interests and cumulztive etfect of acoounting change Provisicn for inceme taxes . 7,154 2965 4.199 (186) 4013 146 4,543 (305) Income before minority interests and cumalative eflect of accounting change Minority interests. 4.238 1501 Income before cumulative effect af accoupting change. ... Cumulative effact of accoanting chinge (net of income tax of $50 in 200) (85) 1.501 4,013 4,153 Net income Distributicas on mandator hy redeemable preferred securities and other preferred dividend requirements- Net income applicable to cammon shareholders 65 117 72 S 4.088 $ 1.384 $ 3.941 S 1407 S 2,294 5 26C8 Net income attributed to WorkICom goup before camulative effect of accounting changes (751 Cumulative effect of accounting change $ 1,407 S 2.294 S 2.533 Net income atributed so WarldCom group $ 1.565 S1,647 Net income (los) attributed to MCI group before cumulative effect af accounting change (107 Cumulative effect of acoounting change 1,555 (2 S1647 Net income (koss) attributed to MCI group Pro Forma Earnings (loss) per cammon share WorldCom graup Net income attributed to WorldCom groap before camulative effoct of accoanting change Basi S 0.48 S 08 S 091 S 090 s 045 S 78 Diluted Curalative effeet of accounting change Net income attributed to WorldCom group Basic. S 048 S n8 S 0.88 S 045 $ 078 S 087 Diluted me (loss) attributed to MCI group before cumalstive effect af accounting change: Ne $ 14.32 $ 13.61 S (03 Hasic . $ 14.32 S 13.61 S (02 Diuted Cumulative effect of accounting change Net income (loss) attribated to MCI groupo Basic $ 14,32 $ 13.52 5(03 S (03 S 13.52 S 14.32 Diluted The accompanying notes are an integral part of these statements F-4 EL ELIE -183- WORLDCOM. INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Millions) For the Years Ended December 31, 1999 2000 2001 Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities Cumulative effect of accounting change Minority interests Other charges Depreciation and amortization Provision for deferred income taxes Change in assets and liabilities, net of effect of business combinations: Accounts receivable, net Other current assets Accounts pavable and other current liabilities All other operating activities.. S 4,013 4,153 S1,501 85 305 186 (8) 4.354 (35) 4,878 1,649 5,880 1,104 2,903 (875) 143 (1,126) (797) (1,050) (431) 281 164 692 (1,154) 253 (403) Net cash provided by operating activities 11,005 7,666 7,994 Cash flows from investing activities: Capital expenditures Acquisitions and related costs Increase in intangible assets Decrease in other liabilities. All other investing activities (8,716) (1,078) (743) (650) 1,632 (11,484) (14) (938) (839) (1,110) (7,886) (206) (694) (480) (424) Net cash used in investing activities Cash flows from financing activities Principal borrowings (repayments) on debt, net Common stock issuance Distributions on mandatorily redeemable and other preferred securities and dividends paid on other equity securities Redemptions of preferred stock All other financing activities Net cash provided by (used in) financing activities Effeet of exchange rate changes on cash Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Deconsolidation of Embratel (9,555) (14,385) (9,690) (2,894) 886 6,377 3,031 124 585 (72) (154) (200) (272) (65) (190) (84) (2,080) (221) 6,623 (19) 2,529 38 (851) 1,727 (115) 876 871 761 (216) Cash and cash equivalents at end of period $ 876 $ S 1,416 761 The accompanying notes are an integral part of these statements. F-6