Question

Ethically and to avoid fraud, it is very important for companies to record capital expenditures and revenue expenditures correctly.

Read “Ethics, Fraud, & Corporate Governance” on p. 414 of Financial Accounting. (Shown below in quotations)

Research an article about another company (I AM USING ENRON COMPANY, PLEASE USE THEM AND NOT WORLDCOM, THANK YOU!) with a scandal related to fraudulent activities around capital expenditure versus revenue expenditure. You may not select the same article as another student.

Post a response in 150 to 200 words to the following questions, providing specific examples to support your answers:

• Provide a brief summary of the unethical fraudulent acts.
• How did the acts affect the shareholders and stakeholders?
• Did the company recover from the scandal? Where is the company now?

"A learning objective for this chapter is to distinguish between capital expenditures and revenue expenditures (a revenue expenditure is an operating expense). A capital expenditure is charged to an asset account rather than to an expense account. The largest instance of fraudulent financial reporting in U.S. history was primarily due to improper capitalization of operating expenditures. WorldCom Inc. (WorldCom) from as early as 1999 through the first quarter of 2002 overstated its reported income by approximately $11 billion, including approximately $7 billion of ordinary operating expenses that were improperly capitalized. The revelation of the fraud led to WorldCom ’s filing for protection from its creditors under the provisions of the U.S. Bankruptcy Code. Although the fraud at Enron had prompted congressional interest in auditing, financial reporting, and corporate governance, by the spring of 2002 congressional efforts to draft a law in response to the Enron fraud had stalled due to disagreements between the two houses of Congress. The fraud at WorldCom broke this congressional logjam and resulted in the passage of the Sarbanes-Oxley Act less than two months after the revelation of the WorldCom fraud.

Almost immediately after the revelation of the WorldCom fraud—in June 2002—the Securities and Exchange Commission (SEC) brought an enforcement action against WorldCom. WorldCom was a major global telecommunications provider, providing services in more than 65 countries. At the time of the fraud, WorldCom was traded on NASDAQ.

As the economy began to cool in 1999, demand for WorldCom’s telecommunications services was reduced, leading to a decline in profits. The slowing economy made it difficult for WorldCom to continue to meet the expectations of Wall Street analysts for reported profitability.

WorldCom’s senior management directed subordinates to take steps to hide the deterioration in WorldCom’s profitability from analysts and other external parties. A primary means of carrying out the fraud was to transfer ordinary operating expenses, line costs, to a capital asset account, fixed assets. This accounting treatment resulted in the overstatement of assets, the understatement of operating expenses, and an increase in income.

The fraud at WorldCom has numerous ethical and corporate governance implications. Although the fraud at WorldCom was directed by top management, much of the implementation was carried out by midlevel finance and accounting personnel.

WorldCom did not have a code of ethics. Attempts to develop such a code were met by the CEO’s description of a code of ethics as a “colossal waste of time.” The Sarbanes-Oxley Act and related SEC interpretations now require public companies to disclose whether they have a code of ethics that applies to the CEO, CFO, and chief accounting officer and, if not, why not. Moreover, the NYSE and NASDAQ now require companies listed on these exchanges to have a code of ethics. Although these requirements are a step in the right direction, they will fail to have their intended effect if senior management doesn’t fully embrace the written code."

Answer 1

Generally, expenditure is incurred to increase the efficiency of business and further returns. These are broadly classified into two categories, i.e. capital expenditure and revenue expenditure. Capital Expenditure is an expense made to acquire an asset or improve the capacity of the asset. Conversely, revenue expenditure implies the routine expenditure, that is incurred in the day to day business activities.

It is very important to distinguish between capital and revenue expenditure. Capital expenditure is money spent by a business or organization on acquiring or maintaining fixed assets, such as land, buildings, and equipment.

A revenue expenditure is a cost that is charged to expense as soon as the cost is incurred. ... Maintaining a revenue generating asset. This includes repair and maintenance expenses, because they are incurred to support current operations, and do not extend the life of an asset or improve it.

Case Study

The Enron Scandal, publicized in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the de facto dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron was cited as the biggest audit failure.

Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that – by the use of accounting loopholes, special purpose entities, and poor financial reporting – were able to hide billions of dollars in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives not only misled Enron's Board of Directors and Audit Committee on high-risk accounting practices, but also pressured Arthur Andersen to ignore the issues.

Enron shareholders filed a $40 billion lawsuit after the company's stock price, which achieved a high of US$90.75 per share in mid-2000, plummeted to less than $1 by the end of November 2001. The U.S. Securities and Exchange Commission (SEC) began an investigation, and rival Houston competitor Dynegy offered to purchase the company at a very low price. The deal failed, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. Enron's $63.4 billion in assets made it the largest corporate bankruptcy in U.S. history until WorldCom's bankruptcy the next year