An Analysis of Accounting Fraud at WorldCom

Overall Accounting Strategies

Organizations require an accounting culture that must highly value transparency and individual accountability in order for the organization to be successful. Such organizational cultures should encompass a functional internal controls system, proper corporate governance, and personal liabilities (Kaplan & Kiron, 2007). Accounting fraud in a company arises as a result of a lack of effective accountability and transparency policies as well as ineffective practices in the organization.

WorldCom is a good example of an organization that has experienced accounting fraud due to the lack of responsible individuals and problems with transparency in business operations. Therefore, it is essential for other large organizations to learn from the case of WorldCom in order to avoid similar cases of accounting fraud.

Bookkeeping Practices

Financial accounting fraud is facilitated through inappropriate bookkeeping practices and falsifying the accounting data. Organizations undertake such courses of action in order to misdirect those parties who might benefit from accounting data, for example, creditors and investors, to the benefit of the organization. Such practices are referred to by the euphemism “creative accounting”. Manipulating financial information typically involves overstating the profits and assets and/or understating the level of losses, debts, and liabilities (Sharma & Panigrahi, 2012).

According to the Generally Accepted Accounting Principles, the case of accruals requires an application of the matching principle. This principle requires expenses and related revenue to be presented in the same financial period as they are incurred. WorldCom conducted fraudulent bookkeeping practices of understating liabilities through accrual releases. An accrual value of $3.3 billion was released in 1999-2000. This allowed the company to report lower values of accruals as compared to the actual values (Kaplan & Kiron, 2007). The company also committed fraud by falsifying the ‘expenses’ data.

In 2002 it was discovered that the not documented computer expenses amounted to approximately $500 million. WorldCom also perpetrated another accounting fraud by overstating its profits. There was a pre-tax income overstatement of approximately $7 billion in the period of 1999-2002 (Kaplan & Kiron, 2007).

Ethical and Stakeholder Strategies

Senior management of an organization commits fraud in order to misrepresent the business performance of its organization and to retain the control as well as maintain the status and income of the business (Bhasin, 2013). In the case of WorldCom, the company acknowledged that Bernard Ebber, as a top-level manager, was lacking in technological experience, (Kaplan & Kiron, 2007); this lack of relevant skills could have resulted in the manager’s predisposition toward committing fraud. Senior management also limited the role of lawyers in the company; lawyers are almost always important advisory agents for businesses, especially for large companies (Kaplan & Kiron, 2007).

In most cases, a company’s employees commit fraud in an attempt to misrepresent the poor personal performance or to fulfill the requirements for bonuses. In some circumstances, employees may be forced to commit fraud by their superiors (Bhasin, 2013). At WorldCom, the employees were supposed to act only under the supervision of their superiors and even received threats of termination of employment in case their actions in any way compromised the financial security of the firm. Those financial accounting employees who were loyal to the management received undue bonuses from the organization (Kaplan & Kiron, 2007).

The main objective of auditors is to detect possible accounting frauds and this raises the issue of incidences of fraud in the presence of auditors. Numerous auditors lack the required professional experience when it comes to dealing with cases of fraud in companies, especially due to the relatively infrequent occurrence of such cases. Internal and external auditors must remain independent and keen; however, they might not be aware of the existing data manipulation as they rely on financial data from the accountants and the financial managers (Sharma & Panigrahi, 2012). In the case of WorldCom, many employees presumed that the internal audit department was under the control of the management. Independent employees were thus unable to report any misdeeds regarding the financial transactions of the company due to the lack of objectivity of the accounting officials, which compromised the independence of the auditors (Kaplan & Kiron, 2007).

Causal Analysis: Reasons for the Ethical Breakdown

Legal interventions in a particular industry and increased market competition are some of the most challenging market factors for many organizations; the pressures of competition are sufficient to provoke a company to resort to committing an accounting fraud (Sharma & Panigrahi, 2012). The industrial factors which negatively impacted the company caused the breakdown of ethical principles at WorldCom. Increased competition in any industry usually results in lower prices of products due to the market forces of demand and supply that push down the prices of offered commodities and services; severe competition usually stems from new entrants into the market. The pressure of augmented competition in the telecommunications industry resulted in a declining profit from operations, leading to a lower business position. The management of WorldCom resorted to committing fraud in an effort to maintain the expense-to-revenue ratio at 42% (Kaplan & Kiron, 2007). The legal intervention of the United States Justice Department aimed at preventing the corporate acquisition of Sprint by WorldCom played a critical role in the decision-making process of WorldCom’s managers – their business solution of mergers and acquisitions was limited by law and they had to come up with alternative solutions (Kaplan & Kiron, 2007).

Macroeconomic trends, for example, an economic recession, also threaten the wellbeing of organizations. Economic recessions lead to a decreased demand for commodities and services and this in turn negatively affects the suppliers. WorldCom suffered the effects of the economic recession in 2000, which led to a sharp decrease in demand for telecommunication services. The company’s expectations of customer traffic were not met and this meant that the company had to incur costs for line capacity that it did not utilize (Kaplan & Kiron, 2007).

Lack of an effective internal environment strategy and proper planning is another threat to any business. The financial data of different departments were located in different cities. The acquisition and mergers of about sixty different companies made it practically impossible to integrate a single company culture at WorldCom (Kaplan & Kiron, 2007). The top-down management structure that was present at WorldCom is another cause for the lack of a strong internal environment. This factor has also contributed to committing the fraud, as the employees were not allowed to question their superiors, as would be the case in a horizontal approach (Kaplan & Kiron, 2007).

Alternative Solutions

Removal of Top Management

In a case where the top management of an organization is corrupt or involved in fraudulent activates, then the entire company is put at risk because this is the group that steers the direction of the company (Bhasin, 2013). One of the main solutions for the case of WorldCom accounting fraud is the removal of top managers.

Ebbers chose to resign, while others had to be forcefully removed from the office. The vacant top management positions were subsequently occupied by completely new individuals. The board of directors had also been replaced. This course of action is a viable solution as it restores the faith of stakeholders such as customers, investors and creditors to the company (Beresford et al., 2003).

New Independent Auditors

The most important quality of an auditor to a company is the auditor’s objectivity. Auditors must not allow themselves to be swayed by the company’s management or accountants as this would compromise their work and consequently the validity and reliability of the audit information that they produce. In the case of WorldCom, both the internal and external auditors’ independence was compromised. This situation created a need for a new audit process for the financial statements of the company upon the discovery of fraudulent activities. The role of the new auditors was to reevaluate the company’s assets and goodwill as well as re-audit the financial statements (Beresford et al., 2003).

Strengthened Internal Controls System

Auditing a firm’s affairs is free and fair only in those cases when the existing internal control systems are functional and effective. This would allow for proper accounting practices and a proper environment for ethical business operations. In the case of WorldCom, the internal control environment was compromised in terms of quality and, consequently, in terms of its effectiveness. Strengthening the internal control system of the company is an essential solution to regaining balance in the organization’s business operations (Beresford et al, 2003).

New Ethics Program

The issue of ethics was the main cause of WorldCom’s predisposition to commit accounting fraud. Therefore, a solution that would focus on promoting ethical standards and define ethical considerations is integral to the survival of the organization. Perpetrating fraud is an individual decision that affects all of the stakeholders in an organization. Thus, there is a need to promote ethical standards in order to deter unethical types of behavior. The implementation of an ethics program at the organization is essential. Training the company’s employees on how to detect and react to instances of accounting fraud in their place of work would help to alleviate the occurrence of accounting fraud in the organization (Beresford et al, 2003).

Recommendations

Forensic Accounting

The problem of a defective internal auditing system can be resolved through forensic accounting and specifically through the data mining process. The practice of fraud detection is quite tedious for auditors. Automating the process of detecting and controlling fraud by employing data mining techniques would alleviate the auditing process for the professionals. Data mining entails the process of analyzing information in large databases, such as those of large corporations, through extracting patterns that could be useful for gaining important knowledge (Sharma & Panigrahi, 2012). The consolidation of headquarter and branches information should be comprehensive however this was not the case at WorldCom. The general ledger, which contained the consolidated financial information of the company’s acquisitions, which amounted to over sixty companies, had been maintained at the headquarters in Mississippi, while other important financial information was held at different departments located in different cities (Kaplan & Kiron, 2007). This made it difficult to compile and compare the financial data of the organization. Application of data mining techniques would have proven effective in detecting the fraud, despite of the company’s widely-spread database (Sharma & Panigrahi, 2012).

Accountability in Corporate Governance

A relevant case study conducted on the Indian company, Satyam, that was also a subject in a discovered case of accounting fraud, provides applicable alternatives to the case at hand. Investigating inaccuracies at the time when they occur as well as strengthening corporate governance is essential in dealing with cases of accounting fraud (Bhasin, 2013).

The selection of executives is especially important for the reputation of an organization, as the decisions made by the top management affect the entire company. WorldCom executives were at the center of committing fraud in the company. Consequently, the low-level and middle-level employees, including the firm’s internal auditors, were forced to follow their orders (Kaplan & Kiron, 2007). Bernard Ebbers, who was among the company managers who decided to commit the fraud, did not have sufficient prior experience or knowledge of managing a large corporation and thus lacked the necessary skill set. He also made threats to the lower management and other employees who did not follow his orders (Kaplan & Kiron, 2007). The board of directors at WorldCom thus failed in their ethical responsibility in selecting a model leader for the company and lack of accountability in the governance of the company resulted in fraud.

External Oversight

Internal auditors can be easily manipulated by the management into performing fraudulent tasks. There is a need to ensure that every large organization, such as WorldCom, is subject to independent external audits. Since these auditors would not be employed by the company, they would be much less vulnerable to threats and compromise, as it was the case in the situation at hand (Kaplan & Kiron, 2007). Constant and irregular audits of financial information and business practices by independent parties are essential in determining accounting practices and policies in place at an organization; oversight by external auditors would have given the employees and internal auditors at WorldCom an avenue to report instances of fraud.

Conclusion

In conclusion, accounting fraud occurs when certain stakeholders in an organization modify the financial information for their own personal benefit or for the benefit of the company. Organizations and individuals that resort to committing an accounting fraud actually threaten the survival and success of their business due to a destroyed reputation.

Top management is sometimes inclined to conduct accounting fraud in order to falsify the performance of the business. However, it is very risky for this group to be involved in fraud as it threatens the integrity of other stakeholders such as employees and auditors. Accounting fraud can be identified in a company’s operations through fraudulent bookkeeping practices, such as overstating assets and profits as well as understating the liabilities and expenses. Auditors are supposed to be independent and objective in their work in order to detect fraud in business operations however they are faced with numerous challenges in carrying out this task.

In the case of WorldCom, the main issue that led the firm to commit an accounting fraud was the lack of ethical considerations, especially on part of the company’s top management. The organization failed to observe the generally accepted accounting principles, which in turn led to fraudulent bookkeeping. The main perpetrators of the fraud were the top-level managers, such as Ebber, who resorted to threats and undue remunerations in order to encourage lower-level management and employees to carry out fraudulent activities. The proposed solutions to the WorldCom accounting fraud case are to implement a new ethics program in the company, to alter the internal control systems, and to completely replace the top managers as well as the board of directors. Recommendations for the company are to evaluate the accountability of corporate governance as well as to introduce forensic accounting practices into the organization in order to avoid further occurrences of cases of accounting fraud.