Vanessa Gail Woods
March 21, 2010
Accounting Fraud at WorldCom
The break up of AT&T opened the long distance service market to small companies during the mid- to late-1980s and 1990s. Long Distance Discount Service (LDDS) opened in 1983 with moderate growth until its stock went public in 1989. CEO Bernie Ebbers decided to grow the organization through acquisitions (70 companies over the course of its lifetime) with its largest in 1998, the acquiring of MCI for $37 billion. The acquisitions caused the company’s stock to increase and WorldCom used this strategy to fund additional acquisitions. Each company came with vast amounts of debt until the company had accumulated over $30 billion of debt. WorldCom then created an accounting category labeled “good will” to hide the fact that liabilities greatly exceeded assets. The culture at WorldCom was fractured. Corporate culture
Several aspects of the corporate culture contributed to the accounting fraud. While external stakeholders were willing to follow WorldCom for their share of the profits the culture within the organization was steeped in management secretly withholding financial facts from its board of directors and auditors. The lack of corporate governance promoted a culture that “implicitly forbid scrutiny and detailed questioning.” (1) Failure of the board of directors to carefully examine billion-dollar acquisitions supported by management was another tear in the corporate culture. “Its culture was dominated by a strong chief executive officer, who was given virtually unfettered discretion to commit vast amounts of shareholder resources and determine corporate direction without even the slightest scrutiny or meaningful deliberation or analysis by senior management or the board of directors.” (1) The trail of accounting fraud had begun based on one man’s understanding of what mattered to Wall Street investors and a lack of corporate governance. #1 stock on Wall Street
Ebbers intent was to keep the WorldCom stock price up as he understood Wall Street investors would only be interested in the value of the stock and not concerned with the underlying health of the organization. A high stock price also caught the attention of banks willing to give loans, analysts giving your company a high rating, media attention writing glowing reports on you and your company and politicians who were willing to look the other way. Handling book and release accruals
WorldCom’s managers were regularly pressed to find ways to reduce line cost expenses and this caused them to make line cost adjustments to accruals. When there were no more large accruals available to release they turned to capitalization of operating line costs in 2001 and 2002. WorldCom used three methods to diminish the organizations domestic line costs in 1999 and 2000. First they released accruals previously established to cover anticipated domestic line cost liabilities. Secondly they changed accounting policies to generate excess accruals. Third, accruals that were established for other purposes to offset line costs were released. In the accounting process releasing an accrual back into earnings is usually done because facts have changed and the expense will no longer occur or has been altered materially. The overall goal of the efforts by WorldCom was “to hold reported line costs to approximately 42% of revenues (when in fact they typically reached levels in excess of 50%), and to continue reporting double-digit revenue growth when actual growth rates were generally substantially lower.” (Beresford, Katzenbach & Rogers) Reviewing the financial statements of an organization alone makes it hard for one to detect this type of fraud so it is best found when investors compare companies’ financial statements to others in the same industry and inquire about capitalized costs that may seem out of line. Another...