Question990

Case study: a. i. An asset is generally defined as a probable future benefit owned or controlled by a company. An expense is defined as an outflow or the using up of an asset, or the incurrence of a liability, that is central to the company's operations. ii. When costs are central to the company's operations, they should typically be expensed and listed on the income statement. When costs have potential future benefit, they should be capitalized as assets. b. Capitalized costs are considered assets on the balance sheet, so the total assets are increased, depending the method of payment. Over time, these costs are depreciated, which is expensed and listed on the balance sheet. Also, as the costs are depreciated, the total assets on the balance sheet are decreased with every period in which depreciation is recorded. c. Line costs for WorldCom are, for example, charges paid to local telephone networks. For year ended December 31, 2001, line costs were reported as $14,739,000,000. Line costs expense 14,739,000,000 Cash, etc. 14,739,000,000 d. WorldCom improperly capitalized costs related to central operations. These types of costs would include things like, as mentioned above, charges paid to local telephone networks as well as other operating costs. Costs such as these do not meet the criteria for capitalization as they cannot be considered assets because they do not have the required probable future benefit. 32 e. The costs in the following journal entry appear in the assets section of the balance sheet. On the statement of cash flows, these costs would appear in the investing section, depending on the method and timing of payment. PP&E 3,055,000,000 Line costs expense 3,055,000,000 f. First quarter depreciation: ($771/22 years)*(4/4) = $35,045,455 million Second quarter depreciation: ($610/22 years)*(3/4) = $20,795,455 million Third quarter depreciation: ($743/22 years)*(2/4) = $16,886,364 million Fourth quarter depreciation: ($931/22 years)*(1/4) = $10,579,544 million Total depreciation for 2001: $83,306,818 g. A partial income statement for WorldCom for year ended December 31, 2001. WorldCom, Inc. Partial Income Statement For year ended December 31, 2001 Income before income taxes, as reported $ 2,393,000,000 Add: depreciation for year (from part f) $83,306,818 Deduct: Improperly capitalized line costs (3,055,000,000) Income (loss) before taxes, restated $ (578,693,182) Income tax benefit 202,542,614 Add: minority interests 35,000,000 Net income (loss), restated $ (341,150,568) This loss of $341,150,568 is a large material difference in net income. The income reported is almost $2,000,000,000 more than the loss actually incurred by WorldCom. A difference this large is clearly important for shareholders, as they are under the impression that WorldCom was profitable during the year 2001.

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