In June 2002, it was discovered that Worldcom, a large US telecommunication company, committed one of the largest accounting frauds. Worldcom illegally capitalized $3.8 billion access fees during the year 2001 and the first quarter of 2002. The fees were paid to local network operators to connect calls from Worldcom services to telephones linked to local networks. This is a typical operating expense item for telecommunication companies. However, Worldcom capitalised these expenditures as assets and amortized them over future fiscal periods. Worldcom was persecuted and the penalties and corrections to the accounts eventually led it into bankruptcy.

The amount of capitalized access fees for each of the quarters are detailed as follows (in USD millions):

Quarter 1, 2001 $780

Quarter 2, 2001 $605

Quarter 3, 2001 $760

Quarter 4, 2001 $920

Quarter 1, 2002 $790

Required:

a) Describe how Worldcoms accounting treatment of access fees affect the line items in the income statements, balance sheets and statements of cash flows.

b) Which accounting principle did Worldcom violate?

c) Assume that capitalized access fees were amortized over 5 years using the straight-line method. Compute the amount of misstatement for each quarter.

d) Without considering tax effects, prepare the journal entries for correcting the misstatements as of the reporting date of Quarter 1, 2002.