Major Accounting Scandal – A Case Study at WorldCom

Accounting can be describe as a language of business because accounting can help the users understand to the published financial report of a company in a simply comparable approach. In a simple definitions, accounting are consists of planning, preserving, and reviewing the accounting reports based on daily transactions of a company in order to appropriately understand about its financial position. There are some users, both internal and external users who will use the accounting records as a source of information entity. Each company have to deliver the actual depiction of financial position and release all important financial information they are obligated to. Its align with the objective of financial reporting as stated on Objective 2 of FASB Concept Statement no. 8: Conceptual Framework for Financial Reporting to provide financial information about the reporting object that is beneficial to potential and existing investors, creditors, and other lenders in making a decision about providing resource to the entity. The decisions are consist of selling, buying, or holding the equity and debt instrument as well as delivering loans and credits (Financial Accounting Foundation, 2010).

In the last period, there are some cases related with accounting fraud and scandal, remarkably the cases of Enron and Bernie Madoff scandals. Moreover, there are more accounting scandal in the following periods, such as Tyco International Ltd., Adelphia Communication, and WorldCom. Each of these cases are caused sufferers for both the company and people who involved in the company. Accounting scandals also can cause in the bankruptcy for the company, loss of livelihood for the employees, overwhelming lawsuits, and break down the legal authority of the highest offenders. Therefore, it will be important to learn and understand how previous accounting scandals was executed and how those scandals are concealed for so long in order to avoid the same accounting scandals happening in the future. So, this paper will be discuss more about accounting scandal with a case study at WorldCom which consisted of fraudulent financial accounting.

In 1983, WorldCom was founded when entrepreneurs, Murray Waldron and William Rector, planned to make a long-distance telephone service provider known as Long Distance Discount Service (LDDS). In 1984, his company started to operate their business as a long distance reseller on a napkin in a coffee shop at Hattiesburg. The early investor of LDDS Company, Bernard Ebbers, was appointed as CEO of the company.  Through major acquisitions and mergers, the company was speedily growing during 1990s. In 1995, the company name was changed into WorldCom after acquired William Telecommunication Group Inc. with the amount of $2.5 billion. In 1998, WorldCom have accomplished the largest merger by purchasing MCI Communication Inc. with the amount of $40 billion and ultimately expanded the Long distance telephone service to offer wider range of telecommunication services (Fox News, 2005). After that, WorldCom have become the second largest long distance telephone service company in United State and projected to be the largest telecommunication service company in the world. Through acquisitions and mergers strategy, the WorldCom company growth was magnificent and had taken place to make the company become more competitive. At the highest position of the company’s success, the stock of WorldCom was trading above $64 per share. However, WorldCom also became the biggest bankruptcy in U.S history at the same time when disgraced of financial accounting scandals in the early 21^st century was finally disclosed (Ferrell & Ferrell, 2011). 

 

During the internal audit in the early 2002, it was revealed that WorldCom has made some transfers that is not necessary acknowledged according to U.S General Accepted Accounting Principle (U.S GAAP). Therefore, Securities and Exchanges Commission (SEC) is asked for WorldCom to provide proven documentation related with those uncovered transfers. Unfortunately for all shareholders and the employees, WorldCom used disgraces accounting practice and inappropriately recorded $3.8 billion in capital expenditure in which increased the cash flow and profits of the company over the four quarters in 2001 and first quarter in 2002 (CNNMoney, 2012). $3.8 billion had been recorded as capitals assets of the company in the balance sheet instead of recorded as capital expenditure on the income statement. Therefore, increased of WorldCom’s cash flow was recorded of $3.055 billion over the four questers in 2011 and $797 million in the first quarter in 2002 had to be diminished form the reported books for that period. Furthermore, disgraced accounting scandals of WorldCom included huge number of controversial loan by the company with the total amount around $408 million to cover margin calls on loan that were secured by company stock (Ferrell & Ferrell, 2011). Those number of loan consisted of $341 million loan to the CEO of the company, Bernie Ebbers, which recorded as the biggest personal loan of public company to its CEO (Patra, 2011).

This inappropriate recording allowed the company to hide the actual net losses for several years because capital expenses can be deducted over a longer period of time. WorldCom also spread out cost for several years by decreasing the book value of acquired company assets which resulted in an exaggeration of company’s cash flows and net income. Furthermore, WorldCom also devalued the account receivables unsettled to the acquired companies. In addition, this kind of accounting practice by WorldCom made it look like the company’s financial condition is good and increasing in every quarter. The accountants are able to adjust the value of capital expenditures and capital assets as long as WorldCom are sustained to acquire new companies. On the other side, investors unacquainted to the fraudulent accounting records and continued to buy the stock of WorldCom that boosted the stock price to $64 per share. However, the financial condition of WorldCom was already in chaos even before the disgrace accounting practice were released. A determined acquisitions spree and weakening revenues rates had made the company fall deeper in debt. WorldCom had to use the expanding value of their stock to finance the acquisition of other company. But, the acquisition of those company, exclusively MCI Communication Group Inc., have made the company’s stock so attractive to investors to invest money on WorldCom Company.

Likewise, the internal problem in WorldCom, which less of competitive strategy, weak internal control, and forceful culture that wanted to generate high returns is the reasons why the company did major accounting scandal. Though, the most influential element that help WorldCom to do the accounting scandals is about motivation. The top management of WorldCom had their personal financial motivations to dishonestly report accounting and financial statement to blow up the financial position of the company. Top management of WorldCom want to create the company look good in term of income records without purely followed if the actual losses had been recorded as well. The WorldCom’s top management had three element of compensation plans, which are base salary, annual incentive compensation, and long term incentive compensation. First, base salary was agreed by the top management and was constructed according to the responsibility level of the position as well as paying levels of similar executive position in equivalent company. For annual incentive compensation, the main components in defining the amount of award consist of the financial performance of the company in term of the whole industry and economic environment. Commonly, it proven by the individual growth of the company as mostly restrained by the revenue or other performance achievement. It means, the top management in WorldCom is falsely showing good financial performance, because top management will be immolated enormous amount of personal compensation. Therefore. It was very strong motivation for top management to fraudulently commit in showing false financial performance. For long term incentive compensation, the committee assumes that long term incentive compensation in the form of stock decisions is the best way of creating executive compensation according to the growths of shareholder value. WorldCom’s stock decision strategies arrange for the means in which executive managements can make an investment in common stock that will support the economic interest as well as shareholder interest. In regarding to the long term incentive compensation, the company committed to do major accounting scandal because it will give the benefits where the stock price of the company will tremendously increase as well as increased in the profits. Means, the personal wealth of the top management would have been increased too and top management who hold the share of the company have a possibility to sell their shares during the periods of earning manipulation (Kennedy, 2012).

Eventually, the Securities and Exchange Commission (SEC) filled fraud charge against WorldCom and required the company release actual financial position in order to reaffirm the company financial statement for its 2001 and the first quarter of 2002. Scoot Sullivan, the CFO of WorldCom, have been organized the financial statement document for 2001 and early 2002. While audit committee and Arthur Andersen, firms outside auditors, have been deliberated the financial audit for the whole four quarter in 2001. Andersen had evaluated the WorldCom accounting practice to conclude whether there were sufficient control to avoid records errors in the company’s financial statement. As a result, Andersen proven that the process line cost accruals, equipment accounts, and capitalization of assets in property recorded by the WorldCom was effective. Furthermore, Anderson have been responded to particular questions by the committee also specified that the company’s auditors had no difference with top management in which it was contented with the fraud financial position occupied by WorldCom. Therefore, WorldCom have been confessed to violate the rule of General Accepted Accounting Practice (GAAP) and falsely adjusted the earning of the company with the amount of $11 billion starting from 1999 until 2002.  Some experts assessed that the total value of the major accounting fraud is $79.5 billion in relation to all of WorldCom financial records for those counted periods.

Instantaneously, the WorldCom stock price have significantly dropped after the SEC admitted the company for the accounting scandals charge. The stock price of WorldCom lately been trading around $15 per share, but it going even worse when the stock price feel to $0.2 after the succeeding reports of the major accounting scandals charge (CBSNews, 2009).  The impact of major accounting scandal done by WorldCom not only affected the investors who lost their investment, but also affected the employees who worked for the company. Several days after admitted doing accounting fraudulent, WorldCom fired around 17.000 employees. This strategy was estimated to save the expenses spent by company to pay employee’s salary around $900 million annually (Pandey & Verma, 2005). Within a month after SEC filled fraud charge to the company, WorldCom have officially confirmed Chapter 11 of bankruptcy on July 21, 2002 because WorldCom unable to pay $7.7 billion debt in cash. WorldCom have recorded $107 billion assets and $41 billion debt in its bankruptcy filing. WorldCom bankruptcy filing certified the company to pay current salary of the employees, maintain the ownership of company assets, continue to provide its service for the customers and gain a little opportunity to reorganize the company. Consequently, WorldCom as a large telecommunication service provider have lost their credibility in consort with lost faith from many larger corporate clients. Nevertheless, WorldCom was capable to positively reorganize the company and rebuild the company from bankruptcy under the name of MCI. This development of new company plans took just about two years after the bankruptcy, as did not take place until April, 2004 (Fox News, 2005).

After the fraud charge, several top management of WorldCom were accused for the accounting scandals that had emerged. 1n April 2002, the CEO of WorldCom, Bernard Ebbers, have been resigned from his position during the SEC’s investigation due the involvement of Ebbers in the $408 billion of controversial loan being investigated. Scott Sullivan, CFO of WorldCom, was fired and David Myers, vice president of WorldCom, was resign from his positon before SEC filed WorldCom with fraud charge. It’s because both of them were directed on a major accounting scandals in WorldCom. In 2003, SEC filed the charge for Bernard Ebbers due to a violation of securities regulation by giving the investors with fabricated WorldCom’s financial information. As a result, Ebbers was charged for 25 years in prison for his major accounting scandals. While in 2004, Scott Sullivan was admitted guilty by SEC for the charges of fraudulent, conspiracy, and making incorrect financial statement about WorldCom. As charged by the SEC because of his falsified, Scott Sullivan have been agreed for a lifetime sanction which make him unable to return as a top officer in a publicly traded company forever (Fox News, 2005).

Moreover, WorldCom accounting scandals have possibly impacted changes to the accounting regulation. Therefore, Sarbanes-Oxley Act (SOX Act) was implemented as an approach to ensure the reliability and accuracy of accounting information disclosed by publicly traded company. The aim of SOX Act is to manage and control the auditing and accounting occupations. In term of WorldCom case, the company caused some investors who invest in WorldCom lost their money by falsely exaggerating its financial statement that resulted in investors losing confidence to the securities market. Following to WorldCom case, SOX Act presented the new financial and reporting requirements which is executive certification of financial reports. SOX Act was expected to heighten punishment major accounting scandal for US publicly traded company and reconstruct the market confidence towards investor’s intention to invest stock capital (Nabukeera, 2010).

In Conclusion, WorldCom as a largest telecommunication company in the world have been succeed through acquisitions and mergers strategy with the stock price of $64 per share at the highest position. However, SEC was acknowledged the company with fraudulent charges due some transfers that is not necessary acknowledged according to U.S GAAP. This scandal happen due to lack of internal control and top management motivation to raise up the financial position of the company. As a result of fraudulent charges, WorldCom stock price was felt down to the lowest value, fired most of the employees, and the worst thing is the company declared their bankruptcy. Thus, Sarbanes-Oxley Act was introduced as a possibly changes in accounting regulation impacted by WorldCom scandals. This regulation purposed to ensure the reliability and accuracy of accounting information disclosed by publicly traded company.

As other traded company can learn from WorldCom case, the writer want to give a recommendation to prevent accounting scandals in the future. The company have to create strong control environment encompasses procuring management to demonstrate ethical behavior in reporting financial statement. A strong control environment was developed through complying written set of rules and regulations. Those rules and regulations will manage the moral behavior of any stakeholder of the company to prevent fraudulent, since there will be some written punishment stated on it for those who dare to violate. Also, the company have to develop strong internal control to ensure the integrity of its accounting records. Internal control program have to monitored regularly to ensure the effective in disclosing financial statement as well as avoid the company of doing fraudulent in the future (James, 2018).

References

CBSNews. (2009, February 11). World-Class Scandal At WorldCom. Retrieved from CBS Interactive: http://www.cbsnews.com/2100-201_162-513473.html

CNNMoney. (2012, September 4). WorldCom Adds to String of Scandals. Retrieved from Cable News Netword, n.d: http://money.cnn.com/2002/06/26/news/companies/accounting_scandals/

Ferrell, O., & Ferrell, L. (2011). WorldCom's Bancruptcy Crisis. University of New Mexico, 1-9.

Financial Accounting Foundation. (2010). Statement of Financial Accounting Concepts No. 8. 1-42.

Fox News. (2005, March 15). MCI-WorldCom Timeline, 1983-Present. Retrieved from FOX News Network: http://www.foxnews.com/story/0,2933,150521,00.html

James, K. (2018). How to Prevent Financial Statement Fraud. Retrieved from Chron: http://smallbusiness.chron.com/prevent-financial-statement-fraud-3789.html

Kennedy, K. A. (2012). An Analysis of Fraud: Causes, Prevention, and Notable Cases. Honors Theses and Capstones, 100.

Nabukeera, M. (2010). Impact of International Accounting Standards in implementation of national securities regulation. International Corporate Governance, Financial Regulation and Economic Law (ICGFREL), 13-15.

Pandey, S. C., & Verma, P. (2005). WorldCom Inc. VIKALPA, VOLUME 30, NO.2, 114.

Patra, B. P. (2011). Moral Weakness: An Analysis of Self Indulgent Actions of CEOs of Enron, WorldCom and Satyam Computers. The XIMB Journal of Management (n.d.), 168-80.