Question

WorldCom improperly capitalized costs that should have been expensed. The effect of this fraud on its accounting equation resulted in ______. (Check all that apply.)

a) stockholders' equity being overstated
b) assets being overstated

Answer 1

Capitalizing expenses that should be expensed causes an overstatement in both assets and stockholders' equity. This is due to inflated asset values and artificially high net income leading to greater retained earnings.

Step-by-step explanation:

When WorldCom improperly capitalized costs that should have been expensed, the effect of this fraud on its accounting equation resulted in both assets being overstated and stockholders' equity being overstated. Capitalizing an expense means recording it as an asset, which leads to an increase in the assets on the balance sheet without the corresponding expense reducing income. As a result, net income is higher than it should be, leading to an overstatement of retained earnings, which is part of stockholders' equity.