WorldCom is one of the major players in telecomuniocation industry in the U.S. It has also gained popularity by undergoing a number of mergers and acquisitions, and the bypassing of accounting regulations which resulted in their bankruptcy as a lawsuit was filed against them. The company’s growth under WorldCom was fueled primarily through acquisitions during the 1990s and reached its apex with the acquisition of MCI in 1998.
WorldCom underwent a lot of mergers and acquisitions (CompuServe, H&R Block, Digex ) during a relatively short period of time. WorldCom were the main architect behind AOL’s network, which added to their reputation, as they developed into a strong contender in the telecommunication sector.
THE CORPORATE FRAUD
In 2002 a lawsuit was filed against WorldCom for violation of accounting regulations, which included revenue recognition and capitalizing of the expenses. Subsequently, in July 2002 WorldCom filed for bankruptcy protection. WorlCom was found guilty of commiting a fraud which involved debate over the approaches of US GAAP, which works on the basis of “rules based” accounting, conflicting with International Accounting Standards (IAS) and UK GAAP, which takes a “principles-based” approach. The infringement is on accounting reforms which lies somewhere between rules-based and principles-based approach.
It is a known fact that operating expenses must be subtracted from revenue , while the cost of capital expenses can be spread over time. Improperly distributing and strewing operating costs inflated WorldCom’s profits beyond truth. The problem arose when $3.3 billion imroperly recorded in 2002. Moreover, expenses were recorded $3.8 billion and improperly reported as capital investments.After the audit, revised financial statements reported reduction in 2000 profits by more than $3.2bn.
IMPROPER ACCOUNTING PRACTICES
Problems of WorldCom started mounting when they tried to conceal their bad debts, understating costs, and backdating contracts. Before the scandal developed the stock price was on a peak at $64.50 in the year June 1999 but after the corporate fraud was disclosed in the year 2002 their stock price was reported to be $0.83 and a drastic decline of 98.7% in their stock prices was observed. Subsequently WorlCom came under severe pressure from banks to cover margin calls on their WorldCom stock that was used to finance its other businesses.
The fraud was accomplished primarily in two ways:
Underrating costs by capitalizing these costs on the balance sheet rather than properly expensing them (bit by bit). These sort of problems often occur with Financial Institutions when they capitalize costs under the accounting head of “Non Performing Loans” in the Balance Sheet, however, if it is reported in the balance sheet without proper disclosure, this may create a whimsical in the mind of investor.
Inflating revenues with bogus accounting entries from ‘corporate unallocated revenue accounts’ and this problem is in relation with improper revenue recognition technique.
LOOKING AHEAD IN RESPECT OF ACCOUNTING PRACTICES
In order to bring some uniformity to its net income, companies like WorldCom may use big bath accounting.This technique misleads information transfers to the stock holders as well as the goodwill of the firm. Organizations should always look closely on the following accounting issues, as these are on most occasions the reason why a company may find itself in troule.
Proper Revenue Recognition technique (Percentage Completion method,Complete contract method,Installment method etc)
Financial Statements always stands firmly means the earning quality reflects the true picture.
Adequate Disclosures
Make reversals in a right way.
Not frequently changes the inventory valuation techniques (LIFO,FIFO,etc)
Earnings either capitalizing oe expensing both in a proper manner that this issue make effect on earning quality.