cables, largely laid across the floor of the world’s oceans. After wiring
the world, Global Crossing would sell other communications compa-
nies the right to carry their traffic over its network of cables. In 1998
alone, Global Crossing spent more than $600 million to construct its
optical web. That year, nearly a third of the construction budget was
charged against revenues as an expense called “cost of capacity
sold.” If not for that $178 million expense, Global Crossing—which
reported a net loss of $96 million—could have reported a net profit of
roughly $82 million.
The next year, says a bland footnote in the 1999 annual report,
Global Crossing “initiated service contract accounting.” The company
would no longer charge most construction costs as expenses against
the immediate revenues it received from selling capacity on its net-
work. Instead, a major chunk of those construction costs would now
be treated not as an operating expense but as a capital expenditure—
thereby increasing the company’s total assets, instead of decreasing
its net income.^4
Poof! In one wave of the wand, Global Crossing’s “property and
equipment” assets rose by $575 million, while its cost of sales
increased by a mere $350 million—even though the company was
spending money like a drunken sailor.
Capital expenditures are an essential tool for managers to make a
good business grow bigger and better. But malleable accounting
rules permit managers to inflate reported profits by transforming nor-
Commentary on Chapter 12 325(^4) Global Crossing formerly treated much of its construction costs as an
expense to be charged against the revenue generated from the sale or lease
of usage rights on its network. Customers generally paid for their rights up
front, although some could pay in installments over periods of up to four
years. But Global Crossing did not book most of the revenues up front,
instead deferring them over the lifetime of the lease. Now, however, because
the networks had an estimated usable life of up to 25 years, Global Cross-
ing began treating them as depreciable, long-lived capital assets. While this
treatment conforms with Generally Accepted Accounting Principles, it is
unclear why Global Crossing did not use it before October 1, 1999, or what
exactly prompted the change. As of March 2001, Global Crossing had a
total stock valuation of $12.6 billion; the company filed for bankruptcy on
January 28, 2002, rendering its common stock essentially worthless.