June 26, 2002

WORLDCOM QUESTIONS: Prof. John Ayer, who has books on this kind of thing, writes:

The following is not a rhetorical question, though obviously I have my suspicions. Anyway —

Observers of the unfolding WorldCom collapse are invited to ask: how much, in principle, does Worldcomm’s strategy (of capitalizing expenses) differ from AOL’s strategy in 1995-96 — of taking cash inflows into “income” before they were earned (i.e., of /not/ capitalizing inflows)? Both have the effect of artificially inflating income. One obvious difference: AOL fiddled its books in a rising market, where all is forgiven.

Separate WorldCom point: early stories are saying that the improper capitalizations were left off the cash flow statement. Almost certainly not so. It appears they were left off the statement of cash flow /from operations/. But the cash flow statement has three parts: operations, investment, finance. Presumably the capitalized expenses, though removed from operations, did show up in investment. Of course the point is right in principle, considering that cash flow /from operations/ is the only portion of the statement the market seems to consider.

These seem like reasonable questions to me, though I don’t have books, or even articles, on accounting issues.

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