Table of contents:
1. Table of contents: 2
2. Introduction: 3
3. Reasons as to why the managers cook the books: 4
4. Boundary between earning management and fraudulent reporting: 6
5. Reasons as to why it was not detected earlier? The processes that could be in place that would have helped in their detection: 7
6. Role of external auditors and board of director’s in the case: 9
7. Betty Vinson: Should criminal charges be brought against her? How should the employees react when they are required to do something by their employers that they do not believe in? 11
- 2. Introduction:
The World com scandal took place in the year 2002. The scandal was related with the Telecommunications Company, which is now called MCI Inc. The company inflated its assets by an amount of $11 billion that led to 30,000 employees to lose their jobs and $180billion in losses for the investors. The main player in this whole game was the CEO of the company, Bernie Ebbers. It was due to this scandal that the Surbanes-Oxley act was introduced. (Accounting-Degree.org, 2014)
- 3. Reasons as to why the managers cook the books:
In the year 1990, there was a decline in the revenue growth, as a result of which the stock of the company began to fall since there was a fall in the earnings of the company. The company started losing its revenue. It was for this reason that the managers started cooking up the books.
Each and every CEO wants his company to be on the top and in an effort to report a higher amount of revenue, the CEO demanded his employees to concentrate on the revenue and in the capacity building even if exceeded its benefits. As a result of the demand that was posted by the CEO, the managers started cooking up the books. The company entered into long term fixed rate leases for the network capacity so that it would be able to deal in the increase in the customer demand and such lease payments could only be avoided by paying a huge amount of termination charges. The telecommunication industry started going into losses due to increased competition and low customer demand. As the new entrants started entering the industry, the prices started to decrease further and the company was forced to match the amounts that were charged by its competitors. The company started to feel pressure for the maintenance of its revenues. The company faced tough times when trying to maintain its earnings price ratio since the same was being monitored by the analysts and the market observers. They had a huge amount committed line costs. Further, the analysts believed that the company may no longer be a good investment for the investors.
The CEO of the company blackmailed the senior most managers of the company by saying that f they did not do anything, they would end up losing everything. This led the managers to inflate the profits in order to show that they had met their performance and the targets of profits. They decided to do so by following the wrong method whereby they manipulate the accrual leases and the capitalization costs, so that they could show that the company was at a better off position.
This led the managers to cook the books.
The following table shows the amounts of capital expenditures that were shown to the board as against the actual amounts: ($ in thousands in millions)
|3rd quarter, 2000||
|4th quarter, 2000||
|1st quarter, 2001||
|2nd quarter, 2001||
|3rd quarter, 2001||
|4th quarter, 2001||
|1st quarter, 2002||
The following table shows the acquisitions that were made by the company from the year 1991 to 2001 along with their acquisition price:
Mergers and acquisitions
|1991||Mid – American Communications Corporation, AmeriCall, FirstPhone, Advanced Telecommunications Corporation Acquired, World Communications, Inc., Dial – Net, Inc., TRT Communications, Inc.
|For stock value of $850 million.|
|1993||Metromedia Communications Corporation and Resurgens Communications Group, Inc.ó||Acquired for $1.25 billion in stock and cash.|
|1994||IDB communications group|
|1995||Williams telecommunications group||$2.5billion|
|1996||MFS communications company and TCL telecom||$12.4billions|
|1997||BLT technologies Inc, NL net|
|1998||Brooks fibre properties,
Compuserve corporation and ANS communications Inc.
|1999||Active net, Skytel, CAI wireless systems Inc.|
|2001||Intermedia Communications, Inc. (thereby gaining control of Digex, a leading provider of managed Web and application hosting services)||Acquired for approximately $6 billion ($3 billion in equity and $3 billion in dept and preferred stock ).|
(S. KAPLAN and KIRON, 2014)
- 4. Boundary between earning management and fraudulent reporting:
The process of earning management is concerned with the management of the earnings, whereby the company tries to report inflated profits by using specific accounting methods, like deferring the reporting of a huge expense of reporting a deferred income etc. This would help the company in showing its investors that it is at a better off position and that it has earned a huge amount of income for the current year. On the other hand, fraudulent reporting is concerned with process whereby the management of the company conceals the relevant information from the public in order to deceive them.
Earnings management is not illegal whereas fraudulent reporting is.
The process of earnings management is concerned with reporting the inflated revenue and deflated expenses by following aggressive accounting methods whereas fraudulent reporting is concerned with manipulating the important financial figures, which if exposed would result in changing the price of the stock.
The process of earnings management is usually followed by the managers when they want to keep their investors from leaving and when they have contractual outcomes that is based upon the earnings that is shown in the financial statements. When a company indulges itself in fraudulent reporting and is caught, it ends up paying huge fines and penalties to the government and also compensating its shareholders for the losses caused. The management also ends up in jails for their wrong doing.
The conclusion that could be drawn from the above is that is that both the methods end up in deceiving the investors, stakeholders, the users of the financial statements by providing them with wrong information and figures. And therefore, both of them are wrong.
- 5. Reasons as to why it was not detected earlier? The processes that could be in place that would have helped in their detection:
The following are the reasons due to which the fraudulent reporting went undetected:
i. The information that was made available was very limited and nobody could have suspected anything fishy.
ii. The employees of the company believed in blindly following the instruction of their superiors, no counter questioning and remain silent even if you smell something cooking.
iii. The employees feared that if they say anything, they would end up in losing their jobs or worse.
iv. The employees did not even know what had to be done in case they were being the target by their bosses.
v. The auditor failed to fulfill his duties of acting as a watchdog; he failed to express his opinion fairly and truly. He further ridiculed his duties of ensuring the auditing principles of auditor’s independence, objectivity, due care, integrity, professional behavior etc.
Even when so much was happening, the auditor, Arthur Anderson gave an unqualified report on the financial statements of the company.
The following are some of the recommendations that can be made:
i. Application of the code of corporate governance: the code of corporate would enhance transparency and would also help in keeping a track of the policies, procedures and the actions that are being followed. The cod would further ensure board independence and ensure that all the decisions made are in the best interest of the company.
ii. Implementation of whistle blowing policy: this would help in early detection of frauds and uncertainties. The names of the whistle blowers must be kept confidential and they must be awarded for their work.
iii. Introduction of proactive auditing: due to the complexities involved in the organizations nowadays, the auditors must be requested to conduct half yearly audits, which would result in early detection of any type of fraud or error.
iv. Enhancing the communication between the employees in the organization: this would help in free exchange of information between the internal, external auditors and the audit committee.
v. Annual review of the performance of the auditor’s: the performance of the auditors must be reviewed on a yearly basis and if they are not performing well, they must be replaced.
The end reason as to why the fraud went undetected for years is that both the management as well as the auditors was involved in it. The temperament of the employees of not sharing information, not questioning added to the list of the reasons. The recommendations that have been stated above, if followed could help the world in putting an end to the frauds like that of WorldCom.
- 6. Role of external auditors and board of director’s in the case:
According to ISA 200, an auditor has to obtain a reasonable assurance that the financial statements are free from any kind of material errors and fraud. The auditor failed to fulfill his duties of acting as a watch dog, he failed to express his opinion fairly and truly. He further ridiculed his duties of ensuring the auditing principles of auditor’s independence, objectivity, due care, integrity, professional behavior etc. the auditor lacked professional skeptism, which means that he lacked the attitude that included questioning of the mind and critical assessment. (Botez, 2009)
Arthur Anderson, assumed that the accounting ledgers that were provided to him to be correct, he should have extended his audit procedures to determine the correctness of the same. He did not test the correctness of the account balances, the internal control environment. And this led him to overlook serious deficiencies that existed in the system. The auditor was just concerned with his fees. May be he feared losing the client.
All the above shows that the procedures that were followed for audit did not match the risk profile that the company was exposed to. This led the company in producing inaccurate records and the incorrect financial statement. Also, the company put restrictions on its auditors to access the records that made it even more difficult for them to conduct the audit and even then, the same was not reported to the audit committee.
The board of directors also must be blamed for the same. They act as trustees for their investors and they are charged with the responsibility of ensuring the interest of the investors. The board of directors lacked their active participation in the meetings. Also, the board meetings usually consisted of short presentations being conducted by the chairman and stock option committee that discussed about the legal and the regulatory issues that were being faced. The chief executive officer discussed only the issues that lasted for 30 minutes or less. The number of board meetings that took place was only 6 in one year.
Both the auditors as well as the board of directors are responsible for the fraud that took place in World Com. They failed to play their part in the company and a result of which, many lost their jobs and investments.
- 7. Betty Vinson: Should criminal charges be brought against her? How should the employees react when they are required to do something by their employers that they do not believe in?
Betty Vinson was the director of the management reporting of the company. She was being pressurized by the CFO of the company to manipulate the figures and was promised that this would not be repeated again and that any responsibility would be owned by the CFO. As a result, she went ahead and did what she was told. Here, she lacked her legal responsibility.
On the other hand, she was just doing what she was being told by her employers. She was just following their orders.
Further, the employees must know the measures that they must undertake in case they are faced with such a situation. They made be aware of the whistle blowing mechanism and enforcement rules and regulations, whereby the whistle blowers is no matter of ignorance.
When faced with a situation, whereby the employer wants them to do anything with which they do not agree morally, they must follow the following steps:
i. Would the activity be legal?
ii. Would it be unfair for the parties involved?
iii. How would he feel about it, if he takes it?
iv. Would he be ashamed before his family members and co-workers?
v. Would he be embarrassed in case his activities are reported in a local newspaper?
In nutshell, Betty Vinson should be held guilty and charged with the crime. Further, the employees must report anything that they suspect is cooking in the minds of the management. They must act as whistle blowers, when they feel the need.
- 8. References:
Accounting-Degree.org, (2014). The 10 Worst Accounting Scandals of All Time. [online] Available at: http://www.accounting-degree.org/scandals/ [Accessed 18 Jul. 2014].
Botez, D. (2009). Recently aspects regarding International Auditing Standard 200 „Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing”. Studies and Scientific Researches. Economics Edition, (14).