The Regents - University of California | Office of The President

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103. If a company maintains reserves which are not probable and
reasonably estimable exposures, then the reserves are not recorded in conformity
with GAAP.
104. Beginning in or about 1999, WorldCom improperly used reserve
accounts as a slush fund. WorldCom took reserves for potential losses for bad
debt, court judgments and other contingencies, and improperly drew down those
reserves and used the money to inflate profits. In 2000 and 2001, WorldCom
improperly reduced their reserve levels to generate an artificially high level of net
income. WorldCom had been able to increase its reserves because of its mergers
and acquisitions.
B. Improper Accounting for Line Costs
105. By the first quarter of 2001, WorldCom was not able to convert
sufficient amount of reserves to income and thus the executives at WorldCom
looked for another way to inflate income. They decided, with the agreement and
assistance of the Defendants, on a scheme to capitalize Line Costs which were a
significant portion of WorldCom’s operating expenses on its Consolidated
Statements of Operations. Line Costs represent the various fees WorldCom paid
to third-party telecommunications carriers for WorldCom's right to access the
third-party's network facilities in order to serve customers.
106. Under GAAP, these fees must be reported as an expense in the year in
which they were incurred because they are a cost. See FASB Statement of
Concepts No. 5, 85.
107. Until approximately the first quarter of 2001, WorldCom reported
Line Costs as an expense. Beginning in or about the first quarter of 2001, in order
to manage earnings to meet analyst’s expectations, WorldCom began capitalizing
the Line Costs rather than recording them as an expense. The following chart
shows the amount of Line Costs that WorldCom reported in its financial
statements compared with its actual line costs:
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COMPLAINT