Accounting Fraud at WorldCom

Abstract

The case discusses the accounting frauds committed by the leading US telecommunications giant, WorldCom during the 1990s that led to its eventual bankruptcy. The case provides a detailed description of the growth of WorldCom over the years through its policy of mergers and acquisitions. The case is explain in the light of the Sarbanes-Oxley Act. Moreover, the significane, cost and effectiveness of Sarbanes-Oxley Act are also highlighted in this reprt.

Accounting Fraud at WorldCom

Introduction

On June 26, 2002, the US-based telecommunications major WorldCom received unprecedented media coverage all over the world. Not for good reasons though. The company had earned the dubious distinction of being involved in the largest accounting scandal ever to hit the US corporate history. WorldCom had reportedly misrepresented its financial statements to an extent of around $ 4 billion (Accounting Fraud at WorldCom, 2008). The company admitted that it had resorted to fraudulent accounting practices for five quarters (four quarters of 2001 and the first quarter of 2002). Soon after, WorldCom terminated the services of some of its top executives including Scott Sullivan (Sullivan), the Chief Financial Officer and David Myers, the Senior Vice President and Controller.

The company's auditors held Sullivan responsible for the accounting mess and Sullivan was soon arrested on charges of fraud and misrepresentation (Horngren & Sundem, 2008). Adding fuel to the fire was the fact that Arthur Anderson was WorldCom's auditor while the inappropriate accounting was taking place. However, Arthur Andersen tried to wash its hands off the crisis stating that it was not aware of the accounting discrepancies. They accused Sullivan for withholding crucial information about book-keeping practices followed at WorldCom.

With the sudden appearance of a $ 4 billion hole in its balance sheet, WorldCom was in an acute financial crisis. A severe cash crunch forced the company to lay off 17000 workers, which constituted 20% of its global workforce. Eventually, the financial crisis forced WorldCom to file for reorganization under chapter 113 of the Bankruptcy Code in July 2002. (Kennedy, 2003), In August 2002, WorldCom shocked company observers and stakeholders yet again by reporting an additional improper reporting in its financial statements. This time around, the amount involved was $ 3.3 billion, carried out by manipulating the EBITDA4during 1999-2001, and the first quarter of 2002. By late 2002, the extent of misappropriation by WorldCom was estimated to be well over $ 9 billion (Matt , 2002).

Case of WorldCom

To understand the fraud occurring at WorldCom, we should basically understand the difference between operating and capital expenditures first, and then we would move on to the details on how the books were adjusted to cause problems.

To begin with, what are operating and capital expenditures? Examples would be provided to clarify these notions in the simplest way. If company X spends $1000 on annual maintenance of the central server computer, the expenditure will be recorded as an operating income and posted to the Repairs & Maintenance Expense account, which consequently decrease current net income. However, if this company pays $5000 to replace ...