University Financial Accounting Case Study: WorldCom's Collapse

This case study examines the financial accounting scandal of WorldCom, a telecommunications company that filed for bankruptcy in 2002 due to widespread fraud. The company deliberately manipulated its financial statements from 1998 to 2000, decreasing reserve accounts and misstating operating costs as long-term investments to inflate profits. Key issues included the improper recording of capital expenditures, questionable entries, and the unethical reversal of reserve accounts. The fraud, initially uncovered by the internal auditing team, resulted in significant misstatements in the financial statements, leading to the termination of the CFO and a decline in the company's share price. The case study analyzes the impact of the fraud on the company's cash flow statements, the role of the external auditor, and the failures of the audit committee and management communication. It highlights the importance of ethical practices in financial reporting and the consequences of fraudulent activities.

Running head: FINANCIAL ACCOUNTING
Financial Accounting
Student’s Name:
University Name:
Author Note

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Table of Contents
Answer to Question 1.................................................................................................................2
Answer to Question 2.................................................................................................................3
Answer to Question 3.................................................................................................................3
References..................................................................................................................................5

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Answer to Question 1
On the date of July 21, 2002, the WorldCom Group which is essentially a
telecommunications company with a revenue amount of more than $30 billion did file for
protection for bankruptcy under Chapter 11 of the U.S. Bankruptcy code. The issue that
occurred in the company was that from the year of 1998 to 2000, WorldCom did deliberately
decrease the amount of reserve accounts in order to cover up for the liabilities of the
companies that it had acquired. WorldCom did make an addition of $2.8 billion from the part
of the revenue to these reserves. The reserves were not able to cover it as a result a particular
mail was sent on December, 2000 to the respective Texas division reporting this issue. In
order to manage this, the CFO, Sullivan instructed the employees or the key members of the
organization to tune up the operating costs as long-term investments by an amount of $3.85
billion. This resulted in the scandal that turned the huge losses into enormous profits. To be
more clear the net income of the company increased by $1.38 billion in the financial year of
2001. The assets were also overstated (Yallapragada, Roe and Toma 2012).
The disparities that were observed in the financial statements of the company was that
the capital expenditure in the domain of computer expenses was not recorded by the amount
of $500 million. The entry of $2 billion was also questionable. Even the profits were
increased by the amount of $3.8 billion.
The issue or the misstatements that were carried out in the year of 2001 and in 2002
were that the line costs especially the costs related to the utilization of third-party network
facilities and services were misstated in the financial statement as capital expenditures. This
unethical practice was at first noticed and reported by Cynthia Cooper who was the vice
president of the internal auditing team and then reported to the Securities and Exchange
Commission. The company accepted its fault and surrendered that these transactions were not

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in accordance to the generally accepted accounting principles and this resulted in the
termination of the CFO, Sullivan. The suit filed by SEC was published on the following day.
The turning of line costs into capital expenditures resulted in the fake increase of the net
income and earnings before interest, tax, depreciation and amortization (EBITDA). The
statement submitted by the company to the SEC also projected the fact that some reserve
accounts were materially reversed thus further increasing the revenue unethically (Lennox,
Lisowsky and Pittman 2013).
Answer to Question 2
The situation that was most critical in the case was that capital expenditure in the
domain of computer expenses was not recorded by the amount of $500 million. The entry of
$2 billion was also questionable. Even the profits were increased by the amount of $3.8
billion. Such fraudulent tasks led to the downfall of the company (Sharma and Panigrahi,
2013).
Answer to Question 3
From the cash point of view the fraud hugely did affect the cash flow statements of
the company that is the operating expenses were purposely shown as investing expenses. The
entire fraud committed not only brought upon the downfall of the company but also resulted
in the lowering of the share price of WorldCom to a figure as low as $0.6 due to the negative
vibe about the company which had already captured the market. In addition to this almost
17000 employees lost their jobs.
WorldCom’s external auditor Arthur Andersen developed his own auditing approach
rather than the traditional approach towards the financial statements. He overlooked many
journal entries with absurd amounts without any proper background data or documentation.

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Even the audit committee was not competent enough to notice the improper entries or
identify the material misstatements done or the fraud committed. The relationship or the
communication between the management of the firm and the audit committee was also poor.
This resulted in delay of the SCF in showing red flag to the company. SCF came to know
about the fraudulent activities after the internal auditor of the firm Cynthia Cooper did
uncover the fraud worth $3.8 billion (Pedneault et al., 2012).

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References
Lennox, C., Lisowsky, P. and Pittman, J., 2013. Tax aggressiveness and accounting fraud.
Journal of Accounting Research, 51(4), pp.739-778.
Pedneault, S., Silverstone, H., Rudewicz, F. and Sheetz, M., 2012. Forensic accounting and
fraud investigation for non-experts. John Wiley & Sons.
Sharma, A. and Panigrahi, P.K., 2013. A review of financial accounting fraud detection based
on data mining techniques. arXiv preprint arXiv:1309.3944.
Yallapragada, R.R., Roe, C.W. and Toma, A.G., 2012. Accounting fraud, and white-collar
crimes in the United States. Journal of Business Case Studies (Online), 8(2), p.187.