Chapter 7
Corporations: The Financial Statements
381
Critical Thinking
CT-1 (
2
3
5
6
7
)
Manipulation of financial statements by overstating revenue (or profit) and understating
expenses (or costs), is one of the most common methods to commit accounting fraud. One of
the famous case is WorldCom. In 2003, the company reported that it had overstated earnings
and understated expenses for a total value of $74.5 billion.
One of the primary methods it used was to classify regular operating expenses as capital
expenditure (also known as capital investment). By doing that, it allowed the company to
amortize operating expenses over several financial periods.
Required
a) Discuss the impact this activity would have on the statement of comprehensive income
and statement of financial positions, by specifying which item would be overstated or
understated. Fill in your answer in the provided table.
Statement Name
Item
Overstated or Understated?
Statement of
Comprehensive
Income
Operational Expenses
Depreciation and Amortization Expenses
Net Income
Tax Expense
Earnings Per Share
Statement of
Financial Position
Non-Current Assets
Accumulated Depreciation and Amortization
Long-Term Investments
Retained Earnings
b) Discuss what impact this activity would have on the ratios used to evaluate earnings
and dividend performance, by specifying if the ratio would be overstated or understated
(assuming all other factors remain unchanged).
