WorldCom Accounting Fraud and the Law

.....pressures that lead executives and managers to "cook the books?" Although a company's profitability is ultimately only demonstrated in the long-term, short-term perceptions can affect the price of a company's stock which can in turn threaten its ability to thrive in the future.

WorldCom was part of the highly competitive telecommunications industry and the desire to show that it was more profitable than its competitors as well as the fact that it needed to show that its recent mergers has been financially worthwhile (a difficult task that can take many years to do) fueled corruption at the company.

What is the boundary between earnings smoothings and or earnings management and fraudulent reporting? Certain aspects of GAAP (generally accepted accounting principles) actually worked in favor of WorldCom's desire to make the company seem more profitable than it actually was; for example, line costs had to be estimated as profit given that they were not paid until several months afterward (Kaplan & Kiron, 2007, p.4). Transferring line costs and misstating them as capital expenditures further distorted profits (Kaplan & Kiron, 2007, p.7).

But while certain practices which may result in inflation of profits may be acceptable, even necessary, this fact should be noted to contextualize the figures. There is a clear boundary between acceptable types of earnings management and the practice of deliberately making the company seem more profitable and engaging in fraud. The actions of WorldCom were clearly designed to distort the public's perceptions of the company's profits, not merely to comply with existing regulations.

Even when the law allows figures to be reported in a particular manner, if it causes distorted perceptions of profitability, this should be noted in the company's report. WorldCom also withheld documents and altered records, neither of which were caught in the original audits of the company by Arthur Anderson.

Why were the actions of WorldCom managers not detected earlier? What processes or systems should be in place to prevent or detect quickly the types of actions that occurred in WorldCom? WorldCom repeatedly denied its accounting firm Arthur Anderson the ability to access its computerized general ledger. Its corporate structure was also designed to minimize the ability of company employees to contact outside directors if they had concerns about accounting irregularities (Kaplan & Kiron, 2007, p.11).

Anderson clearly contributed to the extent to which WorldCom's fraud was perpetuated by focusing on potential errors and inaccuracies, versus outright misstatements in company financial records (Kaplan & Kiron, 2007, p.9). Holding auditing firms such as Arthur Anderson accountable for overlooking potentially fraudulent statements is a critical first step in preventing fraud. Additionally, companies should be held to the standard of ensuring that their reports comply with generally accepted accounting ethical principles, not simple generally accepted accounting procedures.

Were the external auditors blameworthy in this case? Why or why not? The external auditors clearly bear part of the blame in regards to the extent to which WorldCom perpetuated its fraud and the length of time it was able to do so. Despite the fact that Arthur Anderson's software flagged WorldCom as a potential high risk and the complexity of WorldCom's accounting statements, the external auditing firm did not exercise due diligence in reviewing accounting statements for attempts at deliberate fraud.

Betty Vinson: victim or villain? Should criminal fraud charges have been brought against her? How should employees react when ordered by their employer to do.