BACKGROUND
Worldcom Group, a telecommunication company, is a gigantic multi-national company. In early 1980’s it had earned its customers’ satisfaction as well as it had also built a brand image throughout the country. Worldcom had been awarded as an excellent telecommunication service provider which had increased in its customers’ loyalty towards the company.
In 2002, World Com had applied for bankruptcy and liquidation. The reason for such liquidation is the manipulation in the financial records of the company. The records were exceedingly manipulated over a long period of time, and on the detection of fraud the company went into dissolution.
ANSWER TO QUESTION # 1
In the early 90’s, when the telecommunication market was growing at its peak, Bernard Ebbers, Chief Executive Officer, thought that if the area of operations of Worldcom is increased, it would increase the profitability of the company. He believed that expansion in Long Distant Discounted Services (LDDS) will enable the company to earn handsome profits.
On considering and observing the increasing demand of LDDS, Ebbers was only concerned about the profitability of the company and was prepared to take in any expenditure which could subsequently increase the profitability of the company.
The expansion in LDDS requires setting up a long distant network, which is associated with highly expensive line cost. He undertook a long term highly expensive lease agreement of line cost with castigatory termination provisions. The lease agreement also includes the provision that the company will have to pay full line cost whether it utilizes the whole network or not. The lease was undertaken without any proper decision making; as a result most of the area of network was remained unused and costs the company with unnecessary expenditures.
Later Government passed a law prohibiting LDDS, due to which there was a drastic decrease in the whole telecommunication market. WC was highly affected by such law as it has entered into a long term fixed rate binding contract with highly expensive termination costs, and is now unable to gain benefit from such lease.
The rising costs and the decline in market demand have caused the company to plunge into heavy losses. Ebbers thought that the only way to make the company look profitable in the current market situation is to manipulate the accounting records.
He started pressuring the accounts department from directors to managers to manipulate the financial records of the company in such a way that the company looks profitable. Many of the employees in accounts department refused to do such manipulation in the accounts, but Ebbers purchased their interests either by offering financial and non-financial interests to them or by putting undue influence on them.
Ebbers, the CEO of the company has many other businesses too which he has not disclosed. He has financed many of these businesses via bank loan, which is secured by his private stock of shares of World Com. It could be assumed that it may be the reason that Ebbers wanted to maintain the profitability of the company so that the stock secured to the bank remains same. Because when the profitability of the company decreases, the shares of Worldcom also decreases, due to which bank will ask Ebbers for repayment of the loan.
These are the pressures that have caused lead executives and managers to cook the books.
ANSWER TO QUESTION # 2
Earning smoothing refers to deliberate fluctuations in revenues and expenses of the company. It is also referred as creative accounting. The company may understate its revenues in order to save tax or it may overstate its expenses for the same purpose. On the other hand, the company may overstate its profits or understates its expense in order to show profitability to attract the potential investorsAccounting Fraud At Worldcom Case Solution
Fraudulent Financial Reporting refers to misapplication of accounting policies and accounting treatment in the accounting records of the company in order to gain unjust personal advantage. The management may make dummy invoices or dummy accounts and get cash from the company fraudulently. The management may do teaming and lading in order to gain personal advantage. The management may enhance their salaries beyond the prescribed scales set by the company.
The main difference between earning smoothing and fraudulent financial reporting is that, generally, earning smoothing is done to benefit the company and to mislead the third parties of the company. On the other hand, fraudulent financial reporting is done to gain unjust personal advantage from the company as well as to mislead share-holders of the company................
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