Fraud at WorldCom: Red Flags and Consequences

Explore the fraud at WorldCom, a telecom firm that declared bankruptcy in 2002 due to accounting irregularities. Discover red flags that could have been detected and learn about the changes in laws and auditing practices after the scandal.

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.

How WorldCom and other high profile scandals changed laws in America
After the emerging fraudulent scandals in big firms like WorldCom and Enron, Tyco
international, peregrine systems, Adelphia among other companies in early 2000’s, new acts
have been implemented to prevent future scandals and one of the major changes is the
implementation of the Sarbanes –Oxley Act (SOX) and to ensure audit reports in companies are
accurate. SOX has two critical provisions. The first provision of SOX to establish the public
company accounting oversight board .the role of the board is to go through all audit reports that
have been done by external and internal auditors. They have the power to audit these reports
according to the act as well as questioning auditors on the decisions made. This act has brought
significant changes in the accounting industry and affected the big companies since they are
under unprecedented scrutiny (Krambia Kapardis, & Papastergiou,2016)
Auditors in Asia and Europe have not been left out either. The bill was spurring local regulation,
but it’s not certain in some countries. Jurisdiction has been asserted by the American board to all
companies that sell securities in the USA to register and allow their work to be inspected by the
American board, but foreign countries prefer strategy that would allow foreign inspectors to
inspect with help from Americans. This has stirred up other countries to come up with their
regulatory bodies
The Serbanese -Oxley act 404 is the most controversial part of the act because of its power to
assess internal control strengths of a company as well as reporting on its weaknesses. Auditors
are required to state whether the controls are adequate.in this act while Public companies are
required to access their internal financial controls.

SOX has implemented actionable features like creating a public company accounting oversight
board (PCAOB). The work of the PCAOB is to stop auditors from using other peoples to work in
their reports. It gives a limit of the extent to which an auditor should rely on work that has been
done by another auditor. Section 3077 of the SOX prevents criminal charges to be issued against
employees who report their employers. Auditing teams are required to be ethical while filing
their reports to ensure they don’t harm the whistleblower's career because the management might
hinder whistle-blowing channels
All these rules have impacted both positively and negatively to firms since there is a rise in cost
spend on audits and complains have been raised about it. As a result of these rules and
regulations, American security markets are finding it hard to get foreign listings while the
London market that has no strict laws has gained listings, especially in Chinese firms. Concerns
have been raised by some business groups that more companies are listing their stock overseas
because of the regulatory climate in the United States
Investigating red flags accounting
There are many ways of detecting fraud in audits and when of the ways is looking out for red
flags. Red flags are indicators of irregularities in accounting systems and they should be
analyzed to find out if there is any fraud occurring.
Some of the red flags include complaints from employees and customers about the management
or the services being provided. Find out the main cause of the complaint and anything else that
could be behind it and come up with an appropriate way to handle the situation.

Check if there is any removal of inventory from storage for personal use or resale. Red flags
include missing receipts, customers complaining about lost goods and drops in sales in busy
periods. Do random checks physically and Install cameras in the warehouse to prevent inventory
theft (Huber, 2017)
Find misstatements in inventory balances. Check if there is understating or overstating in the
profits. The red flags in misstatement errors can be detected especially when the inventory
balances remain stagnant for a consecutive period of time. The signs also include inventory
balances increasing rapidly tan sales. This can be solved by doing random audits and making the
shipping and invoice responsibilities being separated
Another red flag to investigate is returned or cancelled checks. If a wrong check is returned in
the wrong hands, it can easily be rewritten. Go through the check books and investigate all check
transactions to see if the checks were cashed and to who.
There are many other red flags in accounting like duplicate payments, invoices with rounded
amounts among others and if they are detected on time, fraud can be prevented.
Conclusion
The fraud at WorldCom and its collapse was as a result of a failure in corporate governance. The
board of directors played a role in the financial crisis that erupted WorldCom. This shows how
fragile the monitoring process of the company is and how delicate its financial system is.
Accountants have a responsibility in every company to make sure the managers have integrity
and also to ensure the information they give out is accurate. Such cases if not well-handled lead
to scandals and in turn hurt employees, investors, and industries.

References
Abernathy, J. L., Kubick, T. R., & Masli, A. N. (2019). The effect of general counsel prominence
on the pricing of audit services. Journal of Accounting and Public Policy.
Huber, W. (2017). Forensic accounting, fraud theory, and the end of the fraud triangle. Journal
of Theoretical Accounting Research, 12(2).
Kim, H., & Lee, K. (2015). Accounting Practices for Allowance for Bad Debts Due to K-IFRS
Adoption in the Banking Industry. Study on Accounting, Taxation, and Auditing, 57(2), 1-31.
Krambia Kapardis, M., & Papastergiou, K. (2016). Fraud victimization in Greece: room for
improvement in prevention and detection. Journal of Financial Crime, 23(2), 481-500.
West, J., & Bhattacharya, M. (2016). Intelligent financial fraud detection: a comprehensive
review. Computers & security, 57, 47-66.