Question

9. Briefly explain how WorldCom’s method of ‘Closing the Gap’ worked.

10. What is the difference between a ‘disinterested judgment’ and an ‘interested judgment’?

11. Give at least two reasons why Sullivan’s decision to capitalize line costs was an ‘interested judgment’.

12. What is the difference between the burden of ownership and the way WorldCom’s lines were a burden’ to the company?

Answer 1

9. WorldCom’s method of closing the gap worked by including new items in the revenue of the company so as to artificially inflate it. The main purpose of closing the gap was to shore up the operating performance of WorldCom up to the level of market guidance expectations. The items that were included in revenues were nothing but accounting fluff and junk.

The main purpose of closing the gap was to falsify the revenue growth of the company and under the closing the gap method of the company any gap that existed between the actual revenue and the expected number was artificially and wrongly closed and filled.

10. Disinterested judgment is that judgment in which there is a clear disconnect from your biases, desires and preferences. On the other hand an interested judgment is one in which the decision maker and the person making the judgment has a clear connection with his/her preferences.

11. Two reasons why Sullivan’s decision to capitalize line costs was an ‘interested judgment’ are – (i) Capitalizing the line costs will lead to shifting the items from income statement to balance sheet. This will lead to overstating the income statement (although incorrectly or wrongly) of WorldCom and will hence reflect well on the work ethics and efficiency of Sullivan. (ii) Higher reported income will also lead to Sullivan stand a better chance of earning a handsome bonus and salary increment for the next financial year.

12. Burden of ownership means that line costs will not be expensed if burden of ownership is assumed. WorldCom capitalized its line costs to manage its earnings. WorldCom’s lines were a burden’ to the company as these lines were not expensed considering the benefits, risks and burden of ownership of the lines.

The lines were a burden simply because WorldCom was still paying for the leases on the cables even though no revenue was being generated from these lines.