Read the WSJ article "Accounting Spot-Check Unearthed A Scandal in WorldCom's Books" about the WorldCom scandal dated June 27, 2002 and find MCI Inc’s 2001 10-K405 (i.e. 10-K that is filed late) to answer the following questions:
1. In general, when should costs be expensed and when should they be capitalized as assets?
2. What becomes of “costs” after their initial capitalization? Describe, in general terms, how the balance sheet and the income statement are affected by the decision to capitalize a given cost.
3. Refer to MCI WoldCom’s statement of operations. What did the company report as line costs for the year ended December 31, 2001? Explain in your own words, what these “line costs” are.
4. Refer to the WSJ article. Describe the types of costs that were improperly capitalized at MCI WorldCom. Explain, in your won words, what transactions give rise to these costs. Do these costs meet your definition of assets in part 1 above?
5. In a sworn in statement to the SEC, MCI WorldCom revealed details of the improperly capitalized amounts (in millions) in 2001: $771, $610, $743, and $931 in the 1st, 2nd, 3rd and 4th quarter respectively. Assuming that WorldCom planned to depreciate those assets over 22 years, and the depreciation begins in the quarter that assets are acquired, or their costs capitalized. Calculate the related depreciation expense for 2001.
6. Determined what MCI WorldCom’s net income would have been in 2001 had line-costs not been improperly capitalized. Used 35% as an approximation of its 2001 marginal income tax rate. State any other assumptions you make.
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