Read the attached WSJ article about the WorldCom scandal dated June 27, 2002 here Download 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?
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.
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 what these "line costs" are.
4. Refer to the WSJ article. Describe the types of costs that were improperly capitalized at MCI WorldCom. Explain, in your won words, what transactions give rise to these costs. Do these costs meet your definition of assets in part 1 above?
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.
6. Determined what MCI WorldCom's net income would have been in 2001 had line-costs not been improperly capitalized. Used 35% as an approximation of its 2001 marginal income tax rate. State any other assumptions you make.

in Mississippi. Mr. Sullivan became a trusted ally after Mr. Ebbers acquired his company, Advanced Telecommunications Corp., in 1992. The two executives worked in tandem as WorldCom, then known as LDDS, acquired dozens of companies, seemingly springing out of nowhere to snag MCI Communications Corp. in 1998. WorldCom's double-digit growth rates helped it win a takeover battle for MCI, trumping a bid by GTE Corp. But by early 2001, the growth had started to slow. The booming telecommunications market was beginning to falter from a glut of capacity after a frenzied investment in fiberoptic networks. Suddenly, it found it had too much capacity. It had signed multibilliondollar contracts with third-party telecommunications firms such as Baby Bells to insure it would be able to complete calls for its customers. An appraisal commissioned by WorldCom showed that roughly 15% of these costs weren't producing revenue, according to a WorldCom insider. Mr. Sullivan made an important decision, says a person familiar with his thinking. Instead of reducing profits by those costs whenever WorldCom issued results in 2001, Mr. Sullivan would spread those costs to a future time when the anticipated revenue might arrive

in a murky area. One of accounting's most basic rules is that capital costs have to be connected to long-term investments, not ongoing activities. According to WorldCom, the company transferred more than $3.8 billion in "line cost" expenses to its capital accounts. WorldCom hasn't provided more detail about what those costs included, or what portions of their line costs were improperly capitalized. But line costs, according to the company's most recent annual report filed with the SEC, consist principally of access charges and transport charges. WorldCom's "line costs" totaled $8.12 billion in 2001, according to the company's income statement.

hile companies can capitalize some costs like installation and labor, the magnitude of WorldCom's capitalization appears to be far beyond its industry peers. A person familiar with the matter says Mr. Sullivan didn't appear to have realized any personal financial gain from his strategy. At WorldCom's peak in 1999, his shares were worth more than $150 million, and he currently owns about 3.2 million shares. But he hasn't sold any WorldCom stock in nearly two years, according to Thomson Financial/Lancer Analytics, a data service. Mr. Sullivan never attempted to cover up the aggressive accounting method, the person familiar with the matter says. Details are spelled out clearly enough in internal company documents, this person says, that "other people had to see it unless they were blind." Still, Arthur Andersen, WorldCom's auditor at the time, said it wasn't consulted or notified about the capitalized expenses. The CFO capitalized costs in amounts ranging from $540 million to $797 million each quarter. When April results came out this year, though, he began to doubt whether some of his revenue projections related to the line costs would be realized. In May, according to people familiar with his thinking, Mr. Sullivan was contemplating taking a charge. On May 23, the board was notified that a charge would include the line costs, but didn't signal how much it would be, a person familiar with the matter said. Then in early June, Ms. Cooper called Mr. Bobbitt, chairman of the board's audit committee, notifying him that she had found suspect entries in the books. Mr. Bobbitt had been under fire for months for his controversial role in extending Mr. Ebbers the $408 million personal loan from WorldCom. He quickly notified the newly hired accountants, KPMG LLP, of the discrepancy. The firm set to work. Two weeks ago, KPMG came to WorldCom's offices in Washington and told the committee there was a problem. The investigation continued through the week and last Thursday the audit committee met at KPMG's Washington offices to ask Mr. Sullivan and company controller David Myers to justify their accounting treatment. Mr. Sullivan, according to people familiar with the situation, gave an impassioned defense of his decision, saying that since WorldCom wasn't receiving revenue, he could defer the costs of leasing the lines until they produced revenue. But KPMG officials weren't satisfied, citing accounting rules that clearly dictate that the costs of operating leases can't be delayed. The KPMG partner in charge of the WorldCom account, told Mr. Sullivan that he couldn't "get past he theory" but gave him the weekend to produce a so-called white paper that would set out his justification, a person close to the matter said. Accounting experts say the rules are clear on what costs can be capitalized and what has to be expensed. "If the amounts being paid out are going to have created a long-lasting asset, then the costs depreciate and can be amortized over several years," says Carr Conway, a former SEC official and senior forensic accountant with Dickerson Financial Group in Denver. Unless the asset is going to generate value in future years, the cost for it can't be capitalized, he adds. Weekend Huddle Mr. Sullivan spent the weekend huddled with his team in Clinton, Miss., reviewing documents and constructing the white paper. But it wasn't going well. "He was becoming increasingly pessimistic" that he would have enough time to satisfy KPMG, said one person familiar with the matter. At a board meeting Monday night at WorldCom's offices, Mr. Sullivan again made his case. A national practice specialist at KPMG said, however, that the issue was "an open-andshut case," said one person who attended. "The KPMG people left no door open." After asking Mr. Sullivan to leave the room, board members concluded at the meeting that they would have to restate earnings. The meeting ended without a vote, which was postponed until Tuesday when Mr. Sullivan was fired and Mr. Myers was asked to resign. Through it all, Mr. Sullivan was "very calm and articulate," says one person who attended the meetings. "He handled himself very well, though you could tell he was pained." As far as the board members, added another person, "most people were absolutely flabbergasted." In a speech Wednesday, Mr. Sidgmore tried to make the most out of a bad situation. "We want to make clear that WorldCom reported itself in this matter and moved swiftly to do so," he said. "We turned ourselves in, in other words." Write to Jared Sandberg at j..g@wsj.com, Deborah Solomon at d..n@wsj.com and Rebecca Blumenstein at r..n@wsj.com