Place yourself in the shoes of a corporate CFO, the CEO and COO of the Telecommu
ID: 2558164 • Letter: P
Question
Place yourself in the shoes of a corporate CFO, the CEO and COO of the Telecommunication company you work for came to you with a brilliant idea (At least in their mind). They wanted to capitalize charges related to leasing local communication lines, which are needed to provide service to the companies customers. As the CFO of the company you had a meeting with these executives and realized that these lease charges are for monthly use of local communication lines and provided no future benefit. However, after the discussion with the executives you were in agreement with them and gave your approval to capitalize these lease charges.
Why did the COO and CEO want to Capitalize the charges?
Was the decision in accordance with GAAP?
How did this accounting change affect the financial statements?
Did this mislead the investors and creditors, How?
What would be the future consequence of this accounting change?
Explanation / Answer
1. COO and CEO want to capitalise these monthly charges to reduce their expenses which will lead to an increased profitability and increase in the asset base (i.e. increase in the balance sheet size)
2. This decision is not in accordance with GAAP because these charges are of routine nature and there are no future benefits associated with them. Under GAAP, expenses shall be capitalised only when there is a future benefit associated with such expenses.
3. This accounting change improved the profitability of the company and also enhanced the asset base.
4. Yes, since capitalisation of expenses shows higher profit in the income statement and higher asset base. This does not provide a true and fair view of the financial statements.
5. The auditors can give adverse audit observation due to the incompliance of GAAP.