Instructions:
Assume that WorldCom paid $7,000 million (i.e. $7 billion or $7,000,000,000) rental fees to other phone companies in cash at the beginning of Year 1. Instead of correctly debiting the ‘Rent Expense” account (i.e. as a revenue expenditure), WorldCom debited $7,000 million to the “Equipment” account (i.e. as a capital expenditure). And, assume that WorldCom depreciated its long-lived assets such as equipment using the straight-line method over 10 years without salvage value.
Use numbers in millions (i.e. do NOT write $7,000,000,000 with nine zeros) to:
Explain how would recording the $7,000 million to the Equipment account “delay expense recognition to future periods” and thus “boost net income for Year 1.”
(Ignore tax as tax rules for capitalization and depreciation are different from financial accounting rules.) And,
Besides net income in the income statement, total assets in the balance sheet would also be wrong. Indicate how would total assets at the end of Year 1 be wrong (“overstated” or “understated”) and by how much (in millions of dollars).
(Hint: Answer is NOT $7,000 million. You might want to write out and compare (1) correct entry to record the $7,000 million expenditure in the Rent Expense account and (2) wrong entry to record the $7,000 million expenditure in the Equipment account and then depreciate it over ten years.)
