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It has been reported that WorldCom, in addition to improperly capitalizing expenses - line costs - that should have been reported as period costs, may also have improperly established reserve accounts that were later drawn upon when the company needed a source of income to "make its numbers." This practice, which involves the creation of reserve accounts with inflated balances that are subsequently taken down when the balances inevitably prove excessive, was prophetically criticized by former Securities and Exchange Commission Chairman Arthur Levitt as a principal method by which corporations can manage their earnings.
When a corporation entered into a restructuring plan - in accounting parlance an exit activity - Emerging Issues Task Force Issue No. 94-3 permitted it to establish a "reserve for restructuring" account that embodied a projection of the implementation costs. In cases in which the actual costs were smaller than the estimate, the company was required to reverse the reserve account and the shortfall was recorded as income.
Critics labeled the arrangement as nothing more than the creation and reversal of a cookie-jar reserve. Importantly, EITF Issue 94-3 deviated from accounting orthodoxy by permitting the affected corporation to recognize a liability before those costs ripened into a present obligation. It would be recognized at the time management adopted and communicated the components of the plan.
Similarly, in EITF Issue 95-3, the Financial Accounting Standards Board indicated that the costs to implement a restructuring plan that pertained to the activities of a corporation acquired in a purchase business combination would, if the plan conformed to the adoption and communication guidelines set forth in...