Michael Dobe Jr. Bernie Ebbers(left)
4/6/2015 Scott Sullivan(right)
1. Two General Accounting employees-Dan Renfroe and Angela Walter-made journal entries
in the amount of $150 million and $771 million, respectively, without detailed support. It was
noted that this was not out of the ordinary at WorldCom. In your opinion, was this a proper
accounting practice? Explain.
Normally at the end of each month, Worldcom would estimate the costs of using “Off-net” facilities and connections. Worldcom would accrue these liability estimates. Line cost accrual estimates were very difficult to estimate with ...view middle of the document...
Support your position using
the authoritative accounting literature.
There were times when Worldcom HAD excess accruals and chose not to release them. This was to sustain the financial Line E/R ratio. This is definitely not an appropriate practice because expenses need to be recognized in accordance with the matching principle. It is not acceptable to hold expenses for a later date when you have excess revenue and can afford to recognize held back expenses.
3. On the topic of capitalizing line costs, critique the rationale included in CEO Scott Sullivan's
White Paper. Based on your own analysis of GAAP, explain the propriety or impropriety of
capitalizing line costs in the telecom industry.
Sullivan explained his rationale in a report to the Board of Directors referred as the “white papers.” In order to meet the customer demand for Internet and data expected to increase at the 8 times annual growth factor, Worldcom had to significantly increase its capital investments. Lease commitments were established to expedite the customer provisioning and revenue stream in accordance with SAB 101, and supplemented by FASB 91, “direct and
indirect costs associated with obtaining a customer may be deferred and amortized over the revenue stream associated with that contract.” So instead of recognizing these expenses immediately, the portion of the unused capacity was able to be expensed later when the revenue was realized. This might have been an O.K. practice in accordance of GAAP if the capitalization of these line costs was done correctly. However, the amounts to capitalize were decided by Sullivan. The capitalization entries were made in “round-dollar amounts, after the close of the quarter and only a few days before the company announced its earnings.” (SEC archives) In effect, expenses that were supposed to be recognized immediately were put on the balance sheet and postponed—not an acceptable accounting practice.
4. Consider the journal entry that recognizes $35 million of revenue in 2001 from the EDS contract based on WorldCom's expectation that the five-year required cumulative minimum payment would not be met. Based on your own analysis of GAAP, explain the propriety or impropriety of this journal entry.
It is as Scott Sullivan said himself in an email, “I do not think it is legitimate. Unlike the take or pay commitment, I believe this looks like a contingent asset and cannot be recorded until the final legal settlement.” And again due to pressures to close the gap, these EDS Ratable Accruals were recorded as revenues in the third quarter of 2001. According to GAAP, revenues are recognized when realized or realizable and earned. Here these revenues are not yet realizable. Collectability needs to be established with reasonable assurance.
5. Why do you think the professionals in this case, most of whom were CPAs, would agree to
record a material journal entry contrary to their best professional judgment?