Sunday, November 07, 2010 10:27 PM
The following entries are hypothetical and intended to illustrate the initial recording, and subsequent ‘release’ and ‘capitalization’ of line costs. a. Prepare a journal entry to record $3,500 million of estimated line costs for quarter 1. DR - Accrued Line cost $3,500
CR - Cash and Cash Equivalents $3,500 b. Assume that you find out in quarter 2 that the prior quarter’s estimate was too large by $100 million. Prepare the necessary journal entry to reflect this new information. What is the effect on pre-tax operating income for quarter 2? DR - Cash and Cash Equivalent $100 CR - Accrued Line cost $100
Pre-tax income for the quarter is higher
c. Now ignore part b above and assume that you find out in quarter 2 that the prior quarter’s estimate was too low by $50 million. Prepare the necessary journal entry to reflect this information. What is the effect on pre-tax operating income for quarter 2? DR - Accrued Line cost $50
CR - Cash and Cash Equivalent $50
Pre-tax income for the quarter is lower
d. Prepare a journal entry to capitalize $225 million of line costs in quarter 3. What is the effect on pre-tax operating income for quarter 3? DR - Cash and Cash Equivalent $225 CR - Adj Accrued Line cost $225
Pretax income is now $225 Higher
2. WorldCom entered into long-term, fixed-rate leases for network capacity in order to meet the anticipated increase in customer demand. What arguments can be made for capitalizing the long-term capacity agreements made between WorldCom and other telecommunications companies? What facts in the case undermine these arguments? WorldCom page 15 Arguments for capitalization of line costs: (1) It embodies a probable future benefit - World Com obtains revenue from assets it does not own
EMBA 505B - Accoutning Page 1
(2) A particular entity can obtain the benefit and control other's access to it - WorldCom is controlling assets they do not own (3) The transaction or other event giving rise to the entity's right to or control of the benefit has already occurred- WorldCom is using the classic "OFF THE BOOK Accounting" were they have a contract for services they might use in the future, and have place the assets down but not the expense or liabilities.
3. Compute the line cost-to-revenue ratio as reported for quarter 1, 1999 through quarter 1, 2002 from the information in Exhibit 1. Refer to Exhibits 2 and 3, and estimate the revised line cost-to-revenue ratio for each quarter after adjusting for a) the release of accruals, b) the line costs that were capitalized, c) other line cost adjustments not discussed in the case, and d) ‘improper’ and ‘questionable’ adjustments to revenue. What do you observe? Q1 99 Q2 99 Q3 99 Q4 99 Q1 00 Q2 00 Q3 00 Q4 00 Q1 01 Q2 01 Q3 01 Q4 01
- Line adjustments got increasing higher
4. Refer to Exhibits 1 through 3 and estimate revised quarterly statements of operating income for quarter 1, 1999 through quarter 1, 2002. Comment on how the reported and restated amounts differ. - Restated amounts show that accrual releases great drastically from Q2 99 to Q4 2000 - Capitalization began in the following Q1 of 2001 and the capitalization amounts continued to grow at the same rate the accrual releases were growing - "other" jumped drastically at the same time they began capitalizing in Q1 01 5. The article in Exhibit 4 notes that the “expected restatement of operating results for 2001 and 2002 is not expected to have an impact on WorldCom's cash position.” What effect will the restatement have on the cash reported on the balance sheet at December 31, 2001?...
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