Financial_Accounting_EndTerm_Project.docx

**[Financial Accounting]** **End of Term Project** ----------------------- --------------- **Malik Sameer Abid** **BCS213079** **Taha Zamir** **BCS213080** **Rizwan Ahmed** **BCS213013** ----------------------- --------------- [The Accounting Fraud by WorldCom] Table...

**[Financial Accounting]** **End of Term Project** ----------------------- --------------- **Malik Sameer Abid** **BCS213079** **Taha Zamir** **BCS213080** **Rizwan Ahmed** **BCS213013** ----------------------- --------------- [The Accounting Fraud by WorldCom] Table Of Contents [Executive Summary] [[Background] ](%5Cl) [[Case Evaluation] ](%5Cl) [[Proposed Solutions] ](%5Cl) [[Conclusion] ](%5Cl) [[Recommendations] ](%5Cl) [[Implementation] ](%5Cl) [[References] ](%5Cl) Executive Summary Over the years, there has been a rise in the number of accounting frauds committed by large businesses, either due to greed or due to fear of failure. One such company was WorldCom. WorldCom was one of the largest telecom and long-distance communication companies at the time. It was valued at over 100 billion dollars, until it went bankrupt in 2002. So how did a company like that go bankrupt so suddenly? In this case study we will go into detail regarding what happened, what allowed it to happen, what motivated it, and other relevant information. The fraud committed by WorldCom is, to date, one of the biggest accounting frauds in history. To understand it properly, we first need to understand the business model of WorldCom and the way it operates. Instead of building landlines and towers, WorldCom used to rent out the necessary things from other companies and then provide the services to their customers. Due to this, they were able to offer services at a discounted rate, cheaper than other companies of the kind. Even though the company was struggling in its initial years and had a huge debt, it managed to rise up to being one of the largest companies at the time by buying other companies or by merging with them. Background In 2000, WorldCom was preparing for a merger with Sprint Corporation, another large telecommunications company. Had it gone through, it would have been the biggest merger in history, valuing over 115 billion dollars (about \$350 per person in the US). It would have made WorldCom the world leader in this industry. However, they decided not to go through with this merger due to the pressure from regulatory authorities. The regulators were worried that this merger would form a telecommunications company so large that it would reduce competition in the industry, along with other concerns such as higher prices, less innovation, and fewer choices for customers. This failed merger with the Sprint Corporation was the origin of the WorldCom accounting fraud. As WorldCom's strategy for growing was to either acquire other companies or to merge with them, this failure exhausted all options for growth through takeovers and mergers. The internet had also been introduced to the public, which meant that very soon the long-distance telecommunications business would not be as profitable as it once was. The telecom industry suffered huge losses on WallStreet, with WorldCom stock going from 62 dollars a share to only 18 dollars a share. All of this contributed to WorldCom getting desperate and resorting to fraud. Case Evaluation In 1999, the head accountant, David Myers, showed the financial earnings report to the Chief Financial Officer (CFO), Upon seeing that there were no tangible profits, he asked the head accountant to recheck the numbers. When nothing changed after the rechecking, he still believed that the numbers were wrong and ordered Myers to rewrite the financial entries with the numbers that he thought should be there. Unable to refuse the orders of the CFO, his superior, he made fake entries for the earnings report. The plan was to somehow handle this problem before the next earnings release, but they failed to do so, and the head accountant was once again told to make fake entries. The same thing repeated once more in the next quarter at the time of earnings release. In the words of David Myers, "The real pressure that the accounting department was put under was producing an entry that was based on the CFO's thought process of what the number should be as opposed to what we knew the underlying answer was." After realizing that the fake entries alone are not going to be enough in order to make the report look outstanding, the CFO made the head accountant do another unlawful act. In order to make WorldCom appear financially strong, the costs of renting cell and landline infrastructure were recorded as assets. This meant that instead of recording costs of rental at a monthly basis, they were taking those costs and moving them to the balance sheet, where they would be spread out over 10 to 15 years. This would make the costs appear lower for each month. In this way, the report would look much more favorable for the company, while creating a false sense of stability. Not long after all this, WorldCom's internal auditors noticed the irregularities in the accounting books. The vice-president of internal audit, Cynthia Cooper's doubts first started when she read the term "Prepaid Capacity". She asked what the term meant, but was met with uncertainty. Suspicious of illegal activities, she started searching for all the entries made under that term, which lead to her discovering over 3 billion dollars of fake entries. When confronted about it, Scott Sullivan (the CFO) said that prepaid capacity was the cost of leasing fiber optic lines that were being underutilized. The idea was that this will help them when internet gains popularity, hence the reason it was recorded as assets. However, this did not convince Cynthia that these needed to be listed as assets instead of expenses. So she researched into it further and started interviewing the accountants who had made the entries. By doing so, she realized that the accountants did not know either why the entries were being made, they were just doing what they were told to do by their superiors. As a result of Cynthia's perseverance, Myers eventually admitted that the entries were fabricated. However, Scott Sullivan kept defending the entries and claimed them to be legitimate. The audit committee asked KPMG, an auditing firm, to conduct a review. KPMG asked Sullivan for explanation, and they were not satisfied by the answer he provided. By now, the telecommunications industry was shifting due to the popularity of the internet, and the WorldCom stock began to fall. So now the banks wanted their money back. On June 25^th^ 2002. the WorldCom board made the decision to go public with this whole issue. They fired Scott Sullivan, and David Myers resigned. WorldCom confessed that it had made 3.8 billion dollars in false entries. Furthermore, it was also revealed that the earnings from the years 1999, 2000, and 2001 all had misclassified expenses as assets. After including this, the total fraud committed by the company came to **11 billion dollars.** This made it one of the largest accounting frauds in history. Proposed Solutions - WorldCom could have been more transparent about the difficulties it was having with investors, its employees and more generally with stakeholders and explained the specifics of what went wrong as well as the changing industry structure with the advent of the Internet. - Some operational cost cutting and potentially renegotiating contracts and process improvement would have helped stabilize financials. Going into new markets with their product and service - They could also have changed their strategy to Diversification. It would have provided an opportunity to have new revenue stream and decrease the reliance on the standard long distance telecommunication business. - They could create partnerships or alliances with other companies especially with respect to new technology sectors due to the increase in internet and technology advancements, so that could provided new options to the company for growth and success. - Negotiations and longer time period for repayment with Creditors could have benefited the company and might have helped in lowering the debt burden. - New people in the leadership position with a fresh mindset and strong ethical values might have gotten the company on the right track. - Rebuild trust between the customers and the company, and prevent fraudulent behavior by imposing strict rules & regulations, which would help ease the minds of the investors and consumers at the same time. Conclusion To avoid bankruptcy, WorldCom fired 17,000 employees, around one-fifth of its workforce. Even this could not save them and the company eventually filed for bankruptcy. This fraud had the most affect on investors, who suffered massive losses due to the lies and deceits of the company. When the WorldCom stock hit the bottom due to the scandal, the investors collectively lost 30 Billion Dollars. David Myers, the head accountant was sent to jail for 1 year, and the CFO Scott Sullivan was sent there for 5 years. Even though there were numerous claims that the CEO of WorldCom, Bernie Ebbers, knew nothing of the fraud and didn't have any role in it, The judge did not agree with this and sentenced him to prison for 25 years. Even thought the WorldCom Scandal was huge and one of the largest frauds in the world, it was conducted in a very simple manner by misclassifying and wrongly recording numbers. It didn't involve the use of any technology or engineering. Most of the company workers didn't even know all this was happening, and even the board of directors were not aware that a fraud this huge was being conducted. According to the investigation, the fraud continued this long because of the lack of courage of the employees to blow the whistle and rat out their superiors. These things all went unquestioned due to the belief and the expectations that the person in a senior or a higher role is doing the right thing and it should be respected. Recommendations WorldCom could have increased its profit and addressed its financial difficulties by implementing cost-cutting measures, diversifying its service offerings, increasing operational efficiency, and investigating strategic alliances or acquisitions, among other legal actions, rather than committing fraud. **[Cost Reduction:]** Cost reduction through operational efficiency involves finding and removing inefficiencies in the company\'s processes to reduce total costs. This may be done by simplifying processes, automating repetitive jobs, improving supply chain management, and renegotiating supplier agreements. The aim is to provide the same level of service or product quality at a lower cost, boosting profit margins. Implementing cost-cutting measures would have been extremely helpful for WorldCom, especially considering the circumstances at the time. Here\'s how it applies to their situation: - **Huge Debt:** - **Decreased Revenue and Industry Competition:** - **Need for long-term profitability:** - **Operational Streamlining:** **[Revenue Enhancement]** At the time of WorldCom\'s financial difficulties, the telecommunications sector was undergoing substantial changes due to rising competition and technical advances. WorldCom was under enormous pressure to satisfy market expectations while also experiencing falling revenue growth. The company\'s ambitious development and acquisition strategy had resulted in high debt levels, making it critical to discover new income sources to stabilize and grow the firm. Diversifying their goods and entering new markets might have been a smart response to these issues. - **New Markets and Products:** - **Customer Retention & Acquisition:** - **Boosting Investor trust:** **[Debt Management:]** - **Lower Interest Costs:** - **Improved Creditworthiness:** - **Reduced Financial Risk:** - **Improved Investor trust:** - **Increased Flexibility:** **[Customer Retention and Acquisition:]** Customer retention strategies aim to keep existing customers engaged and pleased so that they keep using the company\'s services. This might involve enhancing customer service, providing loyalty programs, and connecting with consumers on a frequent basis to better understand their requirements and handle any concerns that arise. Customer acquisition entails enticing new clients to the company\'s offerings. This may be carried out through marketing efforts, competitive pricing, and the introduction of new or enhanced products that address the demands of potential customers. - **Stabilizing revenue streams:** - **Reduced Customer Churn:** - **Increasing Market Share:** - Enhancing Customer Lifetime Value: Implementation [Cost Reduction ] Conduct a comprehensive assessment of current procedures to find inefficiencies. Use lean management strategies to reduce waste and streamline processes. Invest in automation technology to decrease manual labour expenses while increasing service delivery accuracy and speed. - **Supplier Negotiations:** - Re-negotiate contracts with suppliers to get better costs on products and services. - - Conduct a thorough evaluation of the budget to cut unnecessary spending. - Concentrate on essential company tasks that directly generate money. - Take steps to cut utility expenses, such as employing energy-efficient equipment and improving building management. [Revenue Enhancement] - **Increase revenue through new markets and products:** - Conduct market research to find prospective new markets for growth. - Analyse client requirements and preferences in order to adjust products and services accordingly. - Product diversification: - Creating new goods and services that complement current offers. - Invest in R&D to innovate and remain ahead of the competition. - Marketing Initiatives: - Create focused marketing initiatives to attract new client segments. - Use data analytics to personalize marketing campaigns and increase consumer engagement. - **Partnerships:** - Form strategic alliances with other businesses to cross-sell products and services, therefore extending your consumer base. [Debt Management] - Assess the situation: - Conduct a thorough examination of the company\'s debt structure to discover high-interest obligations that may be refinanced at reduced interest rates. - - Find and sell non-core assets to get funds for debt repayment. - Concentrate on preserving critical assets that contribute to the core business. - Cash Flow Management: - Implement strict cash flow management strategies to ensure timely debt payments. - Regularly evaluate cash flow and alter budgets as needed. Set away a part of revenues to cover future debt commitments and unforeseen costs. [Customer Retention and Acquisition] - **Apology and Compensation:** - Provide adequate compensation to the people financially affected by the scandal - Address the scandal and issue a formal apology, outlining steps to prevent reoccurrence - **Building Trust and Transparency:** - - Offer assurances regarding the integrity of services and billing practices to regain trust. References