Read the following excerpt from a complaint filed by the Securities and Exchange Commission against WorldCom (posted online at https:// www. sec. gov/ litigation/ complaints/ https://www.sec.gov/litigation/complaints/ comp17829. htm).
WorldCom officers and employees fraudulently made and caused the making of false and fictitious entries in WorldCom's general ledger which effectively transferred a significant portion of its line cost expenses to a variety of capital asset accounts, thereby effectively recharacterizing, without any supporting documentation, and in a manner inconsistent with GAAP, the operating expenses it had incurred for access to third party networks as assets.
1. When a company incurs a cost, its accountants have to decide whether to record the cost as an asset or expense. When costs are recorded as an asset, they are said to be capitalized. This builds on ideas first presented in Chapter 2, where you learned that it was appropriate to record costs as assets, provided that they possess certain characteristics. What are those characteristics?
2. Some authors claim that even with clear rules like those referenced in question 1 above, accounting still allows managers to use tricks like capitalizing expenses. What do you suppose is meant by the expression capitalizing expenses?
3. Suppose that, in the current year, a company inappropriately records a cost as an asset when it should be recorded as an expense. What is the effect of this accounting decision on the current year's net income? What is the effect of this accounting decision on the following year's net income?
4. Do you think it is always easy and straightforward to determine whether costs should be capitalized or expensed? Do you think it is always easy and straightforward to determine whether a manager is acting ethically or unethically? Give examples to illustrate your views.