Additional Information, Tidbits, & Factoids
WorldCom Partial Organizational Chart
By capitalizing line costs, WorldCom avoided recognizing standard operating expenses when they were incurred, and instead postponed them into the future. The line costs that WorldCom capitalized were ongoing, operating expenses that required WorldCom to recognize immediately.
Capitalizing line costs exaggerated WorldCom’s pre-tax income. Pre-tax income is calculated by subtracting period expenses from revenues, and is reflected on the Company’s income statement. Capital expenditures do not appear on the income statement and do not
immediately reduce the Company’s pre-tax income. Instead, capital expenditures appear as assets on the Company’s balance sheet, and when put in service, are depreciated gradually over time. By capitalizing certain of its operating expenses, WorldCom improperly shifted these expenditures from its income statement to its balance sheet, increasing current income and postponing the time when these costs would offset revenue.
By reducing reported line costs, the capitalization entries also significantly improved WorldCom’s line cost E/R ratio. In its public filings, WorldCom consistently emphasized throughout 2001 that its line cost E/R ratio stayed the same—about 42%—quarter after quarter. Had it not capitalized line costs, WorldCom’s line cost E/R ratio would have been much higher, typically exceeding 50%.