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.