The Regents - University of California | Office of The President

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101. Beginning in 1999, the Defendants began another type of financial
manipulation in its scheme to defraud so that its fraud could continue. WorldCom,
with the substantial assistance of Defendants, began to improperly use reserve
accounts to boost profits to meet analysts’ expectations. This scheme to defraud
was a continuation of the original scheme of financial manipulation. By 2001,
WorldCom had fraudulently depleted its reserves to a level where the reserves
could no longer be used to boost profitability. The company then began to hide
expenses to manage profitability to meet analyst’s expectations. The primary
method to hide the expenses was to reclassify them as investment costs which
allowed the company to capitalize the costs over several years rather than
deducting the costs as expenses in the year they were incurred. As a result, the
profits were inflated.
A. Improper Accounting for Reserves
102. Companies establish reserves when it is doubtful that they will
recognize an asset or it is probable that they will incur a liability. Statement of
Financial Accounting Standards (FAS) No. 5, Accounting for Contingencies
provides that reserves may only be recorded when they are probable and the
amount of loss can be reasonably estimated:
8. An estimated loss from a loss contingency (as defined
in paragraph 1) shall be accrued by a charge to income if
both of the following conditions are met:
a. Information available prior to issuance of the
financial statements indicates that it is probable that an
asset has been impaired or a liability had been incurred at
the date of the financial statements. It is implicit in this
condition that it must be probable that one or more future
events will occur confirming the fact of the loss.
b. The amount of the loss can be reasonably
estimated.
FAS 5 defines “probable” as: “The future event or events are likely to occur” as
contrasted with reasonably possible or remote contingencies.
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COMPLAINT