Worldcom appeared to be a great success story. However, the success began to unravel with the accumulation of debt and expenses, the fall of the stock market, and long distance rates and revenue. It would take 2 years for the extent of these problems to become public, and accounting scandals like that of Worldcom would make history in the finance and telecommunication areas. While the intent is to make money to benefit a person or a group of people through illegal acts while disguising their illegal origin, a whistleblower may be lurking amongst you. This history tells us how fragile the monitoring process of the company’s financial system is. Companies often rely on accountants to safeguard company ethics. Accountants have a special responsibility to make sure that managers act with integrity and that information disclosed to customers, suppliers, regulators, and the public is accurate. If accountants do not take this responsibility seriously, or if the company ignores the accountants’ reports, dire consequences can follow.
The situation leads to accountancy scandals that hurt investors, employees, and the industries. As the second largest long-distance phone company in the U.S., Worldcom stock dropped from $60 per share to 20 cents per share, Seventeen thousand employees lost their jobs, and in 2002 Worldcom filed the world’s largest bankruptcy (Ulick, 2002). These scandals have left the public with many questions regarding the way companies try to recover from the scandals especially when it comes to fair treatment for the hurt employees. In addition to revealing sloppy and fraudulent bookkeeping, the post-bankruptcy audit found two important new pieces of information that only served to increase the amount of fraud at WorldCom. First, “WorldCom had overvalued several acquisitions by a total of $5.8 billion”(McCafferty, 2004). In addition, Sullivan and Ebbers, “had claimed a pretax profit for 2000 of $7.6 billion” (McCafferty, 2004). In reality, WorldCom lost “$48.9 billion (including a $47 billion write-down of impaired assets).” Consequently, instead of a $10 billion profit for the years 2000 and 2001, WorldCom had a combined loss for the years 2000 through 2002 (the year it declared bankruptcy) of $73.7 billion.
If the $5.8 billion of overvalued assets is added to this figure, the total fraud at WorldCom amounted to a staggering $79.5 billion (McCafferty, 2004). There are more losers in the aftermath of the WorldCom wreck. The reemerged MCI was left with about 55,000 employees, down from 88,000 at its peak. Since March 2001, however, “about 300,000 telecommunications workers have lost their jobs. The sector’s total employment: 1.032 million, an eight year low” (Alexander, 2005). The carnage does not stop there. Telecommunications equipment manufacturers such as Lucent Technologies, Nortell Networks, and Corning, while benefiting initially from WorldCom’s groundless predictions, suffered in the end with layoffs and depressed share prices. Perhaps most significant, in December 2005, the venerable AT&T Corporation ceased to exist as an independent company (Alexander, 2005).
Next, you got to love these companies when it comes to making these huge mistakes. The bankruptcy process has allowed the company to slash its debt from $41 billion to about $6 billion. That will shave $2.1 billion a year off interest payments for a company producing about $21 billion a year in revenue (AP, 2004). Banks want Chapter 11 bankruptcy because the banks that provide the loans will be the first to collect payments. The $2.6 billion loan WorldCom received from 27 banks is unsecured, meaning the lenders would have a claim on WorldCom’s assets in the event of a bankruptcy filing. Without bankruptcy, the banks do not have collateral on the loans they have already given. The banks would want to lend the company more money to keep it functioning, expecting the company to eventually be able to repay them. Plus, the banks have first shot at WorldCom’s assets when they go under. Unfortunately, for the 17,000 WorldCom employees who lost jobs, retirement funds can be lost during bankruptcy. Severance is typically paid in a lump sum.
WorldCom has elected to spread it out into multiple payments. If a company files bankruptcy before paying severance packages, employees will be bumped to the back of the line with other low-ranking creditors and could possibly see their severance capped (Romero). Auditors must realize that the procedures generally cannot provide the positive assurance that is required of principal substantive test procedures. Nonetheless, APs play an important role in an audit. In planning and review, they can alert the auditor to unusual or unexpected behavior in data; however, they cannot be relied upon to do so in a substantive test because of the possibility of management override of controls, as WorldCom revealed. In the case of estimates of provisions and allowances, APs are the only procedures available to the auditor. Positive assurance that material misstatement does not exist may be unattainable at any level, regardless of the audit procedures employed to test an estimate.
Thus, an auditor may be expressing opinions on a financial statement that are necessarily a mixture of positive and negative assurance. The audit risk model conveys a false impression that risk of reaching an incorrect audit conclusion is controllable. To correct this impression, standards setters must provide a clearer understanding of the nature of assurance, including a clear-cut definition of positive assurance, as well as the conditions that distinguish between positive and negative assurance procedures. Standards setters should also better inform users of financial statements of the intrinsic limitations of an audit. Simply to state that auditors give “reasonable” assurance is no longer sufficient. Auditing standards must be revised to reflect the obvious realities illuminated by such scandals as WorldCom and to require the application of more rigorous audit test procedures.
Otherwise, more audit failures will follow (Hitzig). In the case of WorldCom, the company underreported many of its operating costs by not including them in its operating expenses and fabricated sources of revenue to inflate its earnings statements. In the end, WorldCom’s assets had been inflated by an estimated $11 billion dollars (Grill). During the course of WorldCom’s legal proceedings, its accounting firm Arthur Andersen lost its privileges to perform accounting services due to felony charges stemming from its activities with Enron. The accounting firm, considered one of the “Big Five,” was revealed to have willfully participated in the fraud and deception of both Enron and WorldCom and was never able to recover to offer accounting services again (Grill).
Then came Sarbanes-Oxley to the rescue. The Sarbanes-Oxley Act, also known as the Public Company Accounting Reform and Investor Protection Act, was passed in 2002 with the goal of creating a more responsible environment for the disclosure of financial information. As a result, the creation of the Public Company Accounting Oversight Board is to regulate and enforce honest accounting activities (Grill).
Alexander, Steve. Star Tribune. “Former Holders of MCI Stock Miss Out: The bidding war for MCI will enrich the firm’s shareholders – the current ones.”1 May 2005. Web. http://www.highbeam.com/doc/1G1-132098938.html
Associated Press. MSNBC. MCI Emerges from Bankruptcy. April 2004. Web. http://www.msnbc.msn.com/id/4785653/ns/business-corporate_scandals/t/mci-emerges-bankruptcy/#.T8urSI4gKfQ Grill, Bennet. (n.d.) Gaebler Ventures. Web. http://www.gaebler.com/The-Sarbanes-Oxley-Act-An-Introduction.htm Hitzig, Neal J. (n.d). The Accounting Journal. The Hidden Risk in Analytical Procedure: What Worldcom Revealed. Web. http://www.fraudlaw.org/Fraud/Fraud%20by%20Type/Public%20Companies/World%20Com/How%20auditors%20failed%20WorldCom.htm McCafferty, Joseph. CFO Magazine. “Extreme Makeover: How Robert Blakely and an Army of Accountants Turned Fraud-ridden WorldCom into Squeaky-clean MCI.” July 2004. Web. http://www.cfo.com/printable/article.cfm/3014763?f=options Romero, Simon and Riva Atlas. The New York Times. Worldcom’s Collapse: The Overview; Worldcom files for Bankruptcy; Largest U.S. Case. 22 July 2002. Web. http://www.nytimes.com/2002/07/22/us/worldcom-s-collapse-the-overview-worldcom-files-for-bankruptcy-largest-us-case.html?src=pm Ulick, Jake. CNN Money. Worldcom’s Financial Bomb. 26, June 2002. Web. http://money.cnn.com/2002/06/25/news/worldcom/index.htm