ACCT7102 Case Study- WorldCom
WorldCom as one of the world’s largest telecommunications companies, filed for bankruptcy on 2012 after numerous accounting irregularities were disclosed. It is essential for us to analyze the several underlying issues from WorldCom case to avoid its repetition. The origin of WorldCom can be traced to a LDDS provider in 1983 and it became officially known as WorldCom in 1995. The company maintained a rapid growth through a series of acquisitions using highly valued stock, which provided substantial international presence and competitive advantage. However, company’s earnings began to slip in 2000 and market condition became worse due to increased competition and reduced demand. Under this situation, to maintain its E/R ratio and meet Wall Street earning target, the company utilized accounting techniques to manage its earnings.
2.0 Identification of issues
Following issues are identified and analyzed in this report: Issue 1: What factors motivate managers in WorldCom to engage in earning management? Issue 2: Whether or not WorldCom crossed line from earnings management to fraudulent reporting? Issue3: Why were the actions of WorldCom managers not detected over a long time? Issue4: Why Cooper and Vinson’s actions are so different in terms of ethical values?
3.0 Analysis of Issues in WorldCom
3.1 Earning Management
Earning management is defined as “the process of taking deliberate actions within the constraints of GAAP so as to achieve a desired level of reported earnings” (Koumanakos, 2005, p. 31). It is closely associated with three factors which are existence of motivation, availability of earning management tactics and weak corporate governance which encourages earning manipulation (Kassem, 2010). There are different ways for managers to engage earning management. For example, accounting judgment can be used by managers to make financial report more informative for users. They also can choose make or defer expenditure and determine how to structure corporate transactions (Healy & Wahlen, 1999). Managers manage earnings for different motivations which 1
can be divided into internal and external factors. External factors include pressure of meeting analysts’ forecast, contractual obligations, and avoidance of regulatory intervention and internal factors include pressure for meeting bonus and promotions (Duncan, 2001). In terms of the consequence of earnings management, it can affect the credibility of financial information for shareholders, which can lead to major financial scandals, such as WorldCom (Man, 2013)
3.2 Two Motivations in WorldCom
One motivation for WorldCom manages to manage earnings is meeting capital market expectation. Managers usually manage earnings upward in order to avoid reporting earnings lower than analysts’ expectations (Burgstahler & Eames, 2006). They also manipulate financial figures to beat analysts’ forecast when these forecasts would not otherwise have been met. Senior managers in WorldCom chose to manipulate earning as they focused on achieving No.1 stock in Wall Street to meet its expectations and maintain high stock value. Dechow (2011) claimed that firms often have unusual strong stock price performance before committing fraud, which further pressure them to involve in fraud to avoid sacrificing high stock price.
The other motivation for WorldCom managers is compensation and bonus arrangement. Managers have opportunities to manage their income since they have inside information (Man, 2013). They are more likely to utilize income-increasing discretionary accruals to boost their current or future bonus if bonuses are increasing in earnings (Healy & Wahlen, 1999). They can also choose to defer income when the earning objective in their bonus plan will not be achieved. Senior managers in WorldCom have generous stock options and overly generous compensation, which actually motivated them to boost their compensations by...
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