Introduction
WorldCom Telecommunication Company was one of the largest service providers that supplied vast amounts of telecommunication services in the United States. Founded in Mississippi, as a small firm, the company had gradually grown to become one of the leading telecommunication providers serving several people and companies in the country. The acquisition of other companies, which offered telecommunication services, was one of the drivers that facilitated its growth. Some of the companies acquired by WorldCom during the 90s include CompuServe, UUNet, and MCI. However, the end of the dot-com boom and the recession that characterized the country’s economy in 2001 and 2002 led to a decline in its revenues and plunged the company into a financial challenge. WorldCom accounting scandal was occasioned when the company discovered that there was a problem relating to overstated earnings in 2001 and early 2002. The scandal had adverse effects on the company and compelled it to file a case of bankruptcy. Therefore, the paper analyses the company’s overview and recession, the scandal, its identification, and effects to examine the WorldCom accounting scandal.
Overview of the Company and Recession
Since its inception in Mississippi, WorldCom had transformed into a leading provider of telecommunication services in and outside the United States. Martin (2011) explains that through the acquisition of service providers such as CompuServe, UUNet, and MCI, WorldCom became one of the largest providers of telecommunication services serving companies and individuals in and outside the United States. To increase the quality of its services, the company built fiber optics aimed at serving the rising demand for internet services. The decision to purchase fiber optics and mergers compelled the company to borrow a substantial amount of money from investment banks as it anticipated a continued rise in the demand for internet services. However, when the country’s economy experienced recession and the boom associated with the dot-com phenomenon decreased, the effects on WorldCom Company were significant. The declining revenues in the firm and the high debt burden, which was occasioned because of funding mergers and infrastructure, were among the major effects that the company experienced.
Remarkably, the declining dot-com boom and recession had adverse effects on several other companies. Due to the recession, some companies incurred high losses and experienced sharp declines in their revenues. The high losses and declining revenues transpired since the majority of the firms including WorldCom invested heavily in infrastructure and acquisitions during the boom. Therefore, the end of the boom meant that these companies had to invent other avenues to settle the debts incurred from investments and acquisitions. Some companies that incurred high losses during the 2001 and 2002 recession included Global Crossing, Enron, Qwest Communications, and Adelphia Lucent Technologies. According to Fernando (2009), the recession decreased the progress of WorldCom and initiated a high debt burden that occasioned from mergers, acquisitions, and infrastructural developments. Therefore, it is evident that WorldCom incurred pronounced levels of losses from the recession.
The Scandal
WorldCom experienced a major scandal when its financial department overstated the 2001 and 2002 earnings. In the assertion of Jones (2011), the company practiced several illegal accounting activities that resulted in overstated earnings and overall revenues. The scandal led to a range of negative effects on the company and its shareholders. Evidently, accounting officials from the company classified a considerable amount of money as expenditures and not as current expenses. The officials also classified line costs as capital, a factor that increased the amount of capital and reduced the level of expenses in the company. Consequently, the minimized levels of expenditure and current expenses of the company implied that it had a smart and attractive financial statement. It is fundamental to highlight that irrespective of its attractive financial statement, the real state of affairs in the company reflected a different picture associated with declining revenues and poor performance. As such, the scandal initiated several investigations, which culminated with the arrest of some company officials like Scott Sullivan.
Overstated earnings implied that the company projected its overall growth and development for a number of years. In essence, the projection occasioned because the company reduced its expenses and increased its working capital and revenues. As a result, the overall revenues and capital of the company demonstrated good and impressive performance different from its actual state of affairs. The fact that the wrong classification involved a large amount of money indicated that the officials in the accounting and auditing department engaged in wrong and illegal accounting practices. Apparently, the amount of cash overstated by the company through wrongful classification in 2001 and early 2002 exceeded 3.9 billion (Jennings, 2014). Another scandal that emerged after scrutiny was wrongful classification of reserves by the company. To ensure that line expenses incorporated credits, WorldCom accounting officials wrongfully reduced the company reserves.
Identification of the Scandal
An internal auditor of the company, Cynthia Cooper identified that there was a misclassification of line expenses. The discovery compelled Cooper to involve the chief financial officer of the company, Scott Sullivan. In response to the misclassification identified by the auditor, Scott Sullivan and David Myers, who was the company’s controller, contacted Max Bobbitt the head of the audit committee and updated him on the matter. Max Bobbitt then requested KPMG, an outside auditor, to investigate and ascertain the authenticity of the matter. It is vital to elucidate that the company had replaced its former external auditor, Arthur Andersen, with a new external auditor, KPMG. Fernando (2009) explains that in their quest to scrutinize the matter, the company discovered that Mr. Sullivan did not contact the auditors during the wrongful misclassification. After listening to the justifications submitted by Mr. Sullivan, the company dismissed him and made a public announcement concerning the scandal.
The announcement regarding the scandal initiated a series of questions pertaining to the effectiveness of the auditors from the company and externally. While some scholars explained that the internal auditors had contributed greatly to the scandal, others argued that that external auditor should have detected the problem at earlier stages. According to Ferrell, Fraedrich, and Ferrell (2010), the external auditor should have developed a good detection strategy so that it could help identify the problem in the initial stages. Moreover, since the misclassified amount was considerable, failure of the auditors to detect the problem in its early stages portrays them as ineffective. Failure to detect the problem early also challenges the auditor’s competences because it took them more than one year to identify and report the scandal. In essence, an effective identification strategy would facilitate early detection and management of the scandal.
Effects of the Scandal
The scandal had serious effects on various aspects of the company, which comprised its consumers, shareholders, and its employees. After the announcement, some of its major consumers decided to purchase the services from other companies instead of WorldCom. The decision to purchase services from other companies compounded when the company filed a case of bankruptcy. Some major consumers that started expressing their disinterest in the company services included the Federal Aviation Administration (Fernando, 2009). The company’s nature of being a service provider meant that problems such as misclassified funds had adverse impacts on its demand from prospective consumers, who valued the image and reputation of a company before purchasing their products. As a result, the announcement increased consumer reluctance and unwillingness to purchase telecommunication services from the company.
Consequently, the scandal affected several shareholders of the company, who had various amounts of shares. Before the scandal, the shares of the company had depreciated because of recession and low demand on internet services. Therefore, the announcement of the scandal and misclassification of funds worsened the situation. The company shares dropped drastically from dollars to cents. Besides the shareholders, the scandal instigated a number of effects on the employees of the company. After discovering the scandal, the company dismissed several employees in an attempt to recover from the crisis. According to Jennings (2014), WorldCom Company dismissed over 17,000 employees. The dismissals were very high and reflected the magnitude of the scandal.
Conclusion
WorldCom was among the leading suppliers of telecommunication services in the United States and outside. The scandal in WorldCom Company was a factor that greatly affected its performance and market share. Notably, the scandal occasioned after the accounting department misclassified some of its funds leading to an overstatement of more than $3.9 billion. When an auditor discovered the problem and reported it to the relevant authorities, they attained a conclusive establishment concerning the scandal. In the establishment of the authorities, Mr. Sullivan, the chief financial officer, had engaged in unlawful misclassification without the consent and knowledge of the external auditor. The overstatement led to a serious scandal that affected the shareholders, employees, and consumers of the company.
References
Fernando, A. (2009). Business Ethics: An Indian Perspective. New Jersey: Prentice Hall.
Ferrell, C., Fraedrich, J., & Ferrell, L. (2010). Business Ethics: Ethical Decision Making and Cases: 2009 Update. London: Cengage Learning.
Jennings, M. (2014). Business Ethics: Case Studies and Selected Readings. London: Cengage Learning.
Jones, M. (2011). Creative Accounting, Fraud, and International Accounting Scandals. New York: John Wiley& sons.
Martin, F. (2011). A Decade of Delusions: From Speculative Contagion to the Great Recession. New Jersey: Hoboken, N.J: Wiley.