Fraud at WorldCom: Red Flags and Consequences

Fraud
Introduction
WorldCom telecom firm was the number 2 US telephone and data provider with over 20 million
customers in more than 140 countries. Founded in 1968, the company multiplied until 1999
when it started experiencing a financial crisis because of lack of demand. It was declared
bankrupt in June 2002 and charged with fraud by the security and exchange commission (SEC)
after an internal audit brought to light accounting irregularities whereby its profits turned out to
be losses. In the audit report released, there was capitalization of line cost and inflation of
revenues with fake accounting revenue. This led to investors losing confidence in the companies’
financial statements. After this scandal, Much is needed to restore accountability and integrity in
the co-operate world as many big companies such as Enron have also gone through the same
before and after the WorldCom scandal.
Fraud Red flags at WorldCom
Transfer of capital expenditures
WorldCom Telecom Company committed fraud by transferring their expenses into capital
expenditures. This could have been prevented if the company had adhered to accounting
principles that don’t allow companies to use 3rd party network services as capital expenditures.
It’s fraudulent to transfer obvious expenses into capital expenditures because if the costs are
transferred, then there will be an inflation of net income as well as the earnings before interest,
amortization, depreciation, and taxes. Such expenses are supposed to be recognized in the period
incurred. If the company believed what they were doing was right despite going against the set

rules then the best thing to do could have been to be transparent about the transfer by including it
in their annual report and making it public (West & Bhattacharya,2016)
Reversal of reverse accounts
In a statement to (SEC), WorldCom revealed that they were looking into material reversals of
reserve accounts which are known as the cookie-jar accounting, but this could be an allowance
for bad debt because anytime sales are made, there is an estimate for uncollectible debt. These
debts are written off against the reserve whenever bad debts occur. Auditors are supposed to look
at the history of bad debts and make a judgment whether the reserves are adequate or excessive.
When reserves are reversed, earnings bump up, and this is something that could have been
noticed before the damage was done by just checking how the percentage of the allowance for
bad debt against receivables keep changing every year (Kim & Lee,2015)
To avoid such cases in companies, the companies should compare trends in expenditures and
capitalized investments to see if the allowances for bad debts are similar or if the terms of leases
across companies are the same. The trends in cash flow should be looked into as well as any
changes in earnings as has been calculated by the accepted accounting principles.
Change of auditors and legal counsels
When a firm changes its auditors or its legal counsels, there is a reason to be alarmed because of
potential disagreements on booking of sales. Any dispute in the companies administration should
raise the alarm in the company because the company, managers, company's senior executives
may differ and leave the company under questionable circumstances. In many cases, they vary

about overly aggressive booking of sales so this should be looked into, and everyone investigated
to be cleared of any mischief in the company (Abernathy, Kubick, & Masli,2019)
Anderson’s approach to fraud in the WorldCom audit
Andersen’s audit report claimed that WorldCom executives concealed the information from them
thus making them unable for him to detect the fraud. Many people disagreed with Andersons
report because of the reasonably transparent issues of asset evaluation that could have easily
attracted the attention of the auditor. The blame lied on the auditor as much as it did the directors
because the auditor failed to spot the problem that could be easily detected. His report limited the
likelihood to identify the accounting irregularities. Andersen missed many chances in his
research to discover the fraudulent acts in the company’s financial statements by the chief
executives at WorldCom.
According to Andersen, the information needed was in control by the company's personnel, and
documents were altered to conceal anything that might have raised questions. Even though
Andersen knew that there was no full cooperation and the information was given was minimal,
he did not bring all these irregularities to the attention of the WorldCom committee. Anderson
put all his focus on identifying risks and finding out if WorldCom had measures in place to
mitigate risks instead of emphasizing on going through and testing the information given in the
company’s financial statements. His approach led to the failure to detect fraud at WorldCom.