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The WorldCom: Principle-Based Accounting Standards

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The WorldCom: Principle-Based Accounting Standards
Table of Contents
  1. Introduction
  2. The Role Of Accounting Standards
  3. Deceptive Profit Statements
  4. Financial Implications
  5. Non-financial implications
  6. Nature of accounting standards
  7. Conclusion
  8. Works Cited

Introduction

WorldCom was one of the companies that defrauded investors of billions of dollars through deceptive activities by the top management in the beginning of the last decade. The company started as a small enterprise with little value in the stock market. As the company grew bigger, the management noticed that the expanding profit margin was making the stock market value rise rapidly. Investors were attracted to the expanding profit margins. Due to the rising value of the company, managers and the Chief Executive Officer decided to devise a way to post a profit higher than the actual gain (Kaplan 12). This was done through an increase in reserve money. Reserve money could then be added to the real profit at the end of the financial year to give an impression of high profit (Gollakota 5). In addition to the inflated profit margin, the company chief financial officer, Scott Sullivan instructed his junior officers to delay the auditing of some of the company’s expenditures so that the profit margin for the particular year could be inflated further. These malpractices made investors compete for shares at WorldCom (Kaplan 45). Soon, people were paying too much for shares in a company that was not worth their investments.

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The Role Of Accounting Standards

Another criminal practice was the acquisition of loans by the CEO in the company’s name without proper approval. Furthermore, the CEO paid too much bonuses to some of the company’s employees without proper justification. Most of the company’s liquid assets ended up in the possession of the CEO and the employees. The remaining liquid assets were compromised as securities for the CEO’s loans. The company could not pay investors. Records of expenses beginning the year 2001 were not entered according to standard procedure. Generally Accepted Accounting Procedures were violated by the company’s financial officers during this period. Some officials who recorded payments to firms that offered services to customers for WorldCom omitted some information that made it possible for some individuals to finance their own projects. The processes were not only a violation of statutory regulation, but they also violated the expected ethical conduct of any public institution with significant financial transactions in its business operations. Even as the disclosure of the irregularities was imminent, the company’s officials fraudulently obtained funds to finance some overdue debts. It is unacceptable for any business entity to present false financial figures in order to acquire financial support (Gollakota 9). Although financial crimes were committed in the transactions at WorldCom, the existing IFRS guidelines for financial reporting did not facilitate early discovery of irregularities in the company. This was why WorldCom, among several other companies, perpetrated crippling fraudulent activities.

Deceptive Profit Statements

The improper practices at WorldCom gave the impression that the company was always making good profit. This helped to camouflage multiple financial frauds that were being executed as the top management paid individuals unnecessary bonuses. Payments to subcontractors were recorded as income in order to inflate the company’s profit margin (Kaplan 75). While in some cases the company reported a profit of half a billion dollars, the actual income figure was a loss of more than two hundred million dollars. The discovery of these inconsistencies led to the declaration of bankruptcy by the company in order to maintain provision of the existing services to WorldCom’s customers.

Financial Implications

There were several financial implications due to the malpractices at WorldCom. A restatement of the company’s financial reports revealed that the company had made financial losses consistently in all quarterly reports since the second quarter of the year 2001 (Sadka 3). These revelations made the value of the company’s shares in the stock market depreciate by more than ninety five percent. Shares that once sold for more than sixty dollars each were now selling at half a dollar (Sadka 7). Investors who had bought the shares at the height of the perceived success at WorldCom suffered a loss of almost all their investments.

Non-financial implications

Apart from the financial insolvency and the losses suffered by the parties involved, there were other effects of the inconsistencies in WorldCom’s financial conduct. At the time of bankruptcy, WorldCom was the second biggest telecommunication company in the world. It had its operations in almost all parts of the world. Millions of people who relied on WorldCom for communication services lost confidence in the company. This resulted to customer migrations and termination of services by those customers who were sensitive to business security (Sadka 14). The employees of the company were also demoralized by the conduct of their superiors. While the employees were working hard to generate profit, the top management was misusing the money all along. A large number of employees also lost their job. This was because they were a party to the fraudulent activities at WorldCom. Whistleblowers were also sacked before the filing of official declaration of bankruptcy. Several months after the company was placed under receivership, it had to merge with MCI communications in order to sustain business operations (Sadka 23). This disrupted customer relations and some services were unavailable since that time.

Nature of accounting standards

The major problem with accounting standards as applied at WorldCom is that they were principle based. This allowed the management of the company to manipulate the figures. Principles do not define precise procedures and limits in financial accounting. Application of principles can always be modified to suit the preference of the concerned party. Principles can be applied in many situations. On the other hand rule-based accounting standards govern procedures precisely such that no malpractice is allowed. Moreover, rule-based standards require elaborate definitions and coverage for them to be effective. Rules are only applicable in a limited number of events and situations.

Principle-based accounting standards used by the WorldCom have their setting in the public sector. Many situations that arise in the operations of companies in the private sector require application of principles to provide solutions to accounting problems (Jeter 37). Principles have the tendency to cover most situations without defining the expected conduct during particular events.

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Conclusion

Strict application of rules could have helped WorldCom and other companies involved in scandals at the time to avert the disastrous consequences of fraud. Rules governing the manner in which financial reporting should be done could have helped government officials detect fraud at WorldCom early enough. Principles such as the one that allowed a company to arbitrarily present expenditure as a part of the total income helped the management at WorldCom to deceive investors (Jeter 22). It is also necessary to analyze the effect of all major financial procedures within a company as business transactions are executed. This would help to keep track of all payments and ensure that all expenditure is justified. Finally, creation of an independent auditing department is necessary for all companies. Organizational structures such as the one at WorldCom allowed financial officers responsible for all expenditures to control auditors. This made it difficult for the auditors to express their opinion on the nature of financial transactions.

Works Cited

Gollakota, Kamala Gupta. “WorldCom Inc.: Survival at stake.” Journal of the International Academy for Case Studies 10.4 (2004): 49-54. Print.

Jeter, Lynne W.. Disconnected: deceit and betrayal at WorldCom. Hoboken, N.J.: J. Wiley, 2003. Print.

Kaplan, Robert S., and David Kiron. Accounting Fraud at WorldCom. Boston, MA: Harvard Business School, 2004. Print.

Sadka, Gil. “The Economic Consequences of Accounting Fraud in Product Markets: Theory and a Case from the U.S. Telecommunications Industry.” American Law and Economics Review 8.3 (2006): 439-475. Print.

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