How did Mr. Sullivan’s reclassifying some costs as asset purchases affect net income at the time? In the future? How did this action affect cash flows? What does this tell you about the impotence of examining cash flow relative to net income?

In June 2002, WorldCom, the telecommunications giant, surprised investors when it announced that it had overstated net income in the prior two years by $3.8 billion. At the center of the controversy was Scott D. Sullivan, the former CFO. WorldCom had leased telephone lines at a higher price. Under GAAP, these costs should have been reported as an expense on the income statement. Reportedly, however, Mr. Sullivan ordered that the costs be treated as money spent to purchase a fixed asset, so they were to be shown on the balance sheet as an asset and subsequently depreciated.