WorldCom accounting fraud case study

¶ … Accounting Fraud at World Com

Accounting fraud is not an issue that often grabs the media's attention. It is hardly a 'sexy' issue, and the public often has difficulty understanding the exact nature of fraudulent financial transactions, why they have occurred, and how they are in violation of the Generally Accepted Accounting Principles (GAAP) of the United States. Business reporter Matt Krantz of USA Today calls the scheme used by the infamous World.com company as "the oldest trick in the book," and shows that "accounting gimmicks may fade but never really go away" (Krantz, 2002:1) Simply put, WorldCom improperly recorded its costs, a technique that is often used to "fudge" a balance sheet, but usually in far smaller amounts. By capitalizing its costs, or by not recording the regular overhead costs of running its business as costs, but as investments, WorldCom was able to show stratospheric profits over a very short period of time.

The technique is simple. Imagine a small business that wishes to show inflated gains. It records its revenue from the products and services it has sold, but does not deduct the overhead costs of simply running a business, like electricity bills, labor costs, etcetera. Instead, it records these items as investments, which are not deducted from its profits. Investments, presumably, will result in a profit later on for the company, such as buying more warehouse space to store more items which can be sold to meet increased demand. On the surface, WorldCom's routine costs for maintaining the telecommunication systems that were vital to their business were recorded as investments, in, for example, a new telecommunication system it could sell to the public or new technology which would save the company money later on. But these expenditures were simply the day-to-day costs of running the business.

From an accounting perspective, what is so striking about the WorldCom scam is its utter transparency of its fraud, and how long WorldCom was able to perpetuate it upon the public. One thing that worked to WorldCom's advantage, however, is that unlike a small brick and mortar business, reviewing the expenses of a technologically oriented firm can prove far more difficult for oversight committees, to ensure that they conform to GAAP. Companies that stress financial results measured as earnings before interest, taxes, depreciation and amortization, should be one potential red flag for regulators (Krantz 2002:2).