WorldCom Case

Ashley Coubra 9/29/2013 ACCTG 301 WorldCom Assignment 1) Discuss the fraud at WorldCom in terms of the objective of financial reporting. How was the objective subverted by the actions taken by the managers of WorldCom? 

Accountants have the responsibility of recording and reporting financial information without bias. External users are supposed to be able to trust the financial statements given by companies in order to make informed decisions. In the case of WorldCom financial data became biased and fraudulent. External users then made what they thought were sound decisions when in reality they could have been making a grave mistake. Bernard Ebbers and Scott Sullivan were two of the most powerful people in the company. They wanted power, money, and success no matter the cost. With this mentality accountants and employees within the company could no longer complete their tasks objectively. Accountants were asked to capitalize expenses and release accruals even when it went against the generally accepted accounting principles. When they declined they were threatened or persuaded to do the task anyway. The management’s need for power and money caused the objectivity of financial reporting to be undermined.

2) The fraud at WorldCom revolved around two accounting irregularities: accrual releases and expense capitalization. 

Explain how these two account treatments increased WorldCom’s net income? i. Accrual releases and expense capitalization both increase net income. Net income is the difference between revenue and expenses. First, accrual

releases are basically saying that a bill is not as much as you thought and you are deducting from the original estimate. In a normal situation accrual releases are accepted and follow the generally accepted accounting principles. In the case of WorldCom they did not follow GAAP. WorldCom released accruals when they knew that the bill was going to be much larger. Because of this their expenses went down therefore increasing their net income for the short-term. Eventually sometime in the future the creditors were going to come looking for their money and as we know from the article, they eventually did. ii. Capital expenditure is a fixed asset that will create a future benefit. When you capitalize expenditures they go into an asset account. What WorldCom did was capitalize their excess network that they were not really using. So, what used to be an operating cost was now an asset. WorldCom’s expenses then decreased therefore increasing their net income. 

What effect did these accounting treatments on the balance sheet? i. Capital expenditures and accrual releases both appear on the balance sheet. Accrual expenses show up in the section labeled “current liabilities”. This section is for the expenses that the company, in this case WorldCom has incurred but, has yet to pay. With accrual releases some of this expense is taken away and the current liabilities decrease. In regards to capital expenditure it is recorded in the assets section of the balance sheet. Things like land, buildings, and equipment are all examples of

capital expenditure and they are all depreciated over time to match revenues with expenses. However, WorldCom was not using the excess network. It was generating an expense for the network but, gaining no revenue. Scott Sullivan thought that “the contracted excess capacity gave the company an opportunity to enter the market quickly” even though the market was decreasing and they would probably not be using the excess network (Kaplan 5). That is how both capital expenditure and accrual releases affected the balance sheet at WorldCom. 

Discuss the effect on the financial statements in terms of the fundamental qualitative characteristics of accounting information (i.e., relevance and faithful representation). i. Qualitative characteristics include relevance, faithful representation, comparability, verifiability, timeliness, and understandability. In order to have relevance you have to be able to predict the future cash flows, omit information that is not material, and have a confirmatory value. WorldCom manipulated their books and therefore with those fraudulent numbers future cash flows could not be predicted. WorldCom’s financials became irrelevant. The next qualitative characteristic is a faithful representation which includes freedom from error, free from bias, and completion. Once again because WorldCom manipulated their book they no longer had a faithful representation of their company. Then we have comparability. GAAP guidelines were not always followed by WorldCom so; the financial were not comparable to other companies.

3) What were the pressures that led executives and managers at WorldCom to “cook the books”? 

There were a few pressures that caused WorldCom to “cook their books”. Upper management, which included Scott Sullivan and Bernard Ebbers, were under pressure to produce and E/R ratio that was 42%. The employees that were lower in the hierarchy were under pressure to please their employers’. In the article it talks about how upper management would come out and make speeches to the employees about how they would lose everything if the E/R ratio did not stay at 42%, which in put a lot of pressure on the employees. The employees were also being threatened or persuaded to change things in the books. For example some employees were persuaded to complete tasks by compensation (Kaplan 3). An example of an employee being threatened is when David Myers requested that David Schneeman release accruals. When Schneeman questioned him and refused he was sent emails telling him to do so. One email said “I guess the only way I am going to get this booked is to fly to D.C. and book it myself. Book it right now…” (Kaplan 5). Those are just some of the reason why the “books were cooked” at WorldCom.

4) Why were the actions taken by WorldCom managers not detected earlier? What processes or systems should be in place to prevent or detect quickly the types of actions that occurred in WorldCom? 

There are many reasons why WorldCom managers were not detected earlier. One of the reasons is because the auditors conducting the audits on WorldCom were biased toward their client. They also were not granted access to all of the financial

data for WorldCom, allowing them to only see part of the big picture. Lastly, employees were not willing to report what was going on at WorldCom because management was threatening them and they had no other job to go to. Those are some of the reasons why I think WorldCom managers were not caught earlier 

Many processes and systems should have been in place to prevent the actions that occurred at WorldCom. One process should have been an auditing board that oversaw the audits. Another is that a new auditor should have come in. The auditor they had was biased toward WorldCom therefore they were not effective. The CFO’s and CEO’s should have had to certify the financial statements like in the Sarbanes-Oxley act. Lastly, the audits should have been double checked by the SEC. It is apparent there were many processes that should have been in place that were not. Now because of SOX these processes are in place, enforced, and fraud scandals are not usually on that grand a scale.

5) Betty Vinson: victim or villain? Should criminal fraud charges have been brought against her? How should employees react when ordered by their employer to do something they do not believe in or feel uncomfortable doing? 

It is in my opinion that criminal fraud charges should not have been brought against Betty Vinson. What she did was unethical but, when you have a family to support and nowhere else to go there are not many options to choose from. Betty should have left the company, found employment elsewhere, or reported to someone what was going on. She did not have the strength or backbone to leave but, I do not think she should be punished for that. I understand it is hard to say no

to a superior, especially when they have such a threatening and powerful influence as aforementioned. 

If or when an employee is told to do something that makes them feel uncomfortable, they should let their employer know that it makes them uncomfortable and that they would rather not do the task they were asked to complete. In other words, try and take care of the problem by themselves before going up the chain of command. If talking to your employer or whoever assigned them to the task does not work go up the chain of command until someone listens. By bringing up the problems that are taking place management will hopefully be able to control and fix the problem. Do not just meekly standby when you don’t think something is right; because, it is important to express your opinion, especially when it comes down to problems you feel are unethical.