a. ( i. ) Harmonizing to FASB Statement of Concepts No. 6. paragraph 25. assets are likely future economic benefits obtained or controlled by a peculiar entity as a consequence of past minutess or events. They represent likely future economic benefits controlled by the endeavor. Harmonizing to FASB Statement of Concepts No 6. paragraph 80. disbursals are escapes or other utilizing up of assets or incurrences of liabilities ( or a combination of both ) during a period from presenting or bring forthing goods. rendition services. or transporting out other activities that constitute the entity’s ongoing major. or cardinal. operations.

Expenses are gross escapes incurred in bring forthing grosss. ( ii. ) SCON No. 6. paragraph 148. provinces that costs should be expensed when they are used up or hold expired and when they have no future economic value which can be measured. SCON No. 6. paragraph 178-181. provinces costs should be capitalized or recorded as assets when the costs have non expired and they have future economic value.

B. Harmonizing to GAAP Accounting Principles. cost capitalisation is observed if a major disbursal virtues acknowledgment as an investing of capital financess alternatively of being recognized as an disbursal for the twelvemonth. A capitalized cost does non look on the income statement. but alternatively appears as a debit on the long-run assets account and a recognition on the hard currency history of the balance sheet. However. the depreciation disbursal related to the capitalized cost will look as an disbursal on the income statement. Since the long-run assets account is larger due to the consequence of capitalisation. the depreciation costs are besides proportionally larger. Therefore. the timing of expense acknowledgment is changed. but finally all disbursals do acquire recognized on the income statement.

Procedure

c. The company reported line costs of $ 14. 739 million for 2001. The journal entry for these minutess is debit to Line Costss Expense for $ 14. 739 million and a recognition to Cash for the same sum. Line costs are fees that WorldCom paid to other telecommunication companies to utilize their webs for long distance calls.

d. WorldCom capitalized $ 3. 8 billion in line cost disbursals. These were minutess that involved payment to local telephone companies to utilize their fibre ocular web. These line costs are besides called entree charges or conveyance charges and are an operating cost. These costs do non run into the definition of an plus as described in FASB Statement of Concepts No. 6. Telecommunication companies can capitalise the costs and labour of put ining lines or overseas telegram ; nevertheless. they should non capitalise fees paid to another company for the usage of their lines.

e. WorldCom improperly capitalized the line costs as a debit to the plus history Transmission Equipment for $ 3. 055 billion and recognition to hard currency for the same sum. These costs improperly appear on the balance sheet as an plus under the class of Property and Equipment. These costs are falsely categorized as a capital outgo in the investing subdivision of the Statement of Cash Flows.

Analysis

f. The center scope for straight-line depreciation of transmittal equipment is 22 old ages. The $ 771 million capitalized in the first one-fourth would be depreciated for a full twelvemonth ( $ 35. 045. 455 ) . The $ 610 million in the 2nd one-fourth would be depreciated for 9/12 of the twelvemonth ( $ 20. 795. 455 ) . The $ 743 million in the 3rd one-fourth would be depreciated for 6/12 of the twelvemonth ( $ 16. 886. 364 ) .

The $ 931 million capitalized in the 4th one-fourth would be depreciated for 3/12 of the twelvemonth ( $ 10. 579. 545 ) . The journal entry to enter the related depreciation disbursal for 2001 is a debit to Depreciation and Amortization Expense for $ 83. 306. 819 and a recognition to Accumulated Depreciation for the same sum. ( See attached schedule. )

g. The improperly capitalized histories resulted in a depreciation disbursal of $ 83. 306. 819 for 2001. This sum should be subtracted from depreciation disbursal for the twelvemonth. However. the entire line costs of $ 3. 055 billion should hold been expensed as line costs for the twelvemonth. Since the depreciation should non hold been expensed. the usage of by and large accepted accounting rules consequences in an extra $ 2. 971. 693. 181 in disbursals for 2001. Operating income would be reduced to $ 542. 306. 819. Assuming that Other Income stayed the same. Income before Income revenue enhancements. minority involvement. and cumulative consequence of accounting alteration would be a net operating loss of ( $ 578. 693. 181 ) .

Using the 2001 NOL Carryback to 1999 would ensue in a revenue enhancement refund of $ 647. 000. 000 ( rounded ) . Harmonizing to 740-20-45-3. “the revenue enhancement benefit of an operating loss carryforward or carryback ( other than for the exclusions related to the carryforwards identified at the terminal of this paragraph ) shall be reported in the same mode as the beginning of the income or loss in the current twelvemonth. ” Therefore. the revenue enhancement refund consequences in 2001 adjusted net income of $ 103. 000. 000 ( rounded ) . The difference in net income is material because net incomes per portion figures are materially misstated. ( See attached schedule. )

h. The possibility of being fired by the board of managers after losing its net incomes estimations for back-to-back quarters would be an inducement for direction to postpone costs. By capitalising costs that are usually instantly expensed. WorldCom direction was able to hike the company’s net income. By increasing net income. direction was able to describe monolithic net incomes for 2001. Massive net incomes please stockholders and fiscal establishments. transfuse public trust in the company. and increase market value. Management was besides likely to have fillips and stock options based on the public presentation of the company.

I. The primary beginning of internal control to forestall deceitful fiscal coverage is oversight and administration. which comes from the board of managers. WorldCom besides should hold implemented transaction-level controls which include: Mandates. Documentation ( beginning paperss ) . Segregation of Duties. and IT Application Controls ( input. processing. and end product ) . By utilizing the segregation of responsibilities. Mr. Sullivan’s responsibilities could hold been divided among two or more persons cut downing the hazard of mistake or inappropriate actions performed by any individual individual.

To be certain segregation of responsibilities was being enforced. WorldCom could hold used Monitoring. which is a procedure that assesses the quality of the public presentation of the enforced system over a period of clip. Arthur Anderson. WorldCom’s hearer. should hold been more involved in bring outing the disagreements. Other employees should hold noticed the improper accounting techniques and reported their findings to direction.

J. The economic effects that arise when a publically traded company’s fiscal studies are revealed as fraudulent is terrible in that it causes great fiscal loss to investors. the employees lose non merely their occupations but besides their pension. insurance. and 401k histories. With so many people out of work less money is being spent doing an economic rippling consequence. The company frequently declares bankruptcy.