Far600 Case Study Worldcom

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FAR600 CASE STUDY WORLDCOM

QUESTION 1

a) Discuss the earnings management technique employed by the management of World Com.

WorldCom admitted that the company had classified over $3.8 billion in payments for line costs as capital expenditures rather than current expenses. Line costs are what WorldCom pays other companies for using their communications networks; they consist principally of access fees and transport charges for messages for WorldCom customers. Reportedly, $3.055 billion was misclassified in 2001 and $797 million in the first quarter of 2002. According to the company, another $14.7 billion in 2001 line costs was treated as a current expense.

WorldCom’s accounting had been questioned before its June 25 admission. In March 2002, the SEC requested data from the firm about a range of financial reporting topics, including (1) disputed bills and sales commissions, (2) a 2000 charge against earnings related to wholesale customers, (3) accounting policies for mergers, (4) loans to the CEO, (5) integration of WorldCom’s computer systems with those of MCI, and (6) WorldCom’s tracking of Wall Street analysts’ earnings expectations. On July 1, 2002, WorldCom announced that it was also investigating possible irregularities in its reserve accounts. Companies establish these accounts to provide a cushion for predictable events, such as future tax liabilities, but they are not supposed to manipulate them to change reported earnings. On August 8th, WorldCom admitted that it had improperly used its reserves in recent years. The indictments issued August 28th charged that reserve accounts were reduced in order to provide credits against line expenses.

b) In your opinion, why do managers of WorldCom want to manage their earnings and subsequently be engaged in fraudulent activities?

In my opinion the main reason why the managers of WorldCom want to manage their earnings which then subsequent leads the to be...
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