BUS7C2 Finance & Accounting for Business Assignment Sample
Introduction
Market investors put complete confidence on organisations by analysing the financial reports of organisations. The accounting scandals potentially lower the confidence level of the investors and impacts them negatively thereby causing financial crisis. In the past two decades, companies like Tyco, HealthSouth, WorldCom, and Enron have been found to conduct accounting scandals, out of which the story of WorldCom has been prominent. The report, hereby, discusses one of the accounting scandal that happened in the past two decades thereby analysing the accounting or financial violations that have been conducted by the organisation. In addition, it focuses on discussing the strategies that the organisation could have taken to prevent the accounting scandal. However, the report also emphasises the discussion of the lessons learned from the scandal.
Identifying the accounting scandal happened in past 2 decades and background of the scandal
Identification of the scandal happened in past two decades
WorldCom was a telecommunication company in the United States established in 1983 by William Rector, Murray Waldron, and early investor Bernard Ebbers. The company provided long-distance services to the customers by offering discounts. WorldCom was identified as the second-largest long-distance telecommunications company in the United States in 2002. The accounting scandal conducted by the company is considered to be one of the major scandals that happened between 1999 and 2002. The company has been found to be overstating its assets as well as inflating its revenue earnings in the market thereby misleading the investors. In this context, it has arisen that unlike the scandal of Enron where the company had to dissolve; WorldCom came out of the bankruptcy and rebranded itself in the market. In addition, most of the assets of the company were sold to Verizon (International Banker, 2021). The CEO and the CFO of the company were found to be questionable for conducting the accounting scandals.
The company was established after the breakup of AT&T as the company leased its phone lines to WorldCom as per the order of the court. WorldCom further offered the services at a low rate to the customers which helped the company gain a substantial position in the US maket. In addition to this, with the acquisition strategy, the company has been found to acquire 30 telecom companies in the US market thereby reducing the number of competitors (Petra & Spieler, 2020). It has been found that the company’s market cap went upto a valuation of $175 billion. In this regard, despite all the progress, the company included accounting tricks to reflect a higher profitability positon which has been recorded as one of the biggest scandal in the US record reflecting the biggest bankruptcies.
Background of the scandal
WorldCom became the second-largest company offering long-distance telecommunication services by June 2002. This has been due to the acquisition strategy that organisation incorporated that helped the company acquire telecommunication oganisations like MCI communications which has a total valuation more than WorldCom. Around 2001, the company was found to handling half of the e-mail and internet traffic in the United States (Clikeman, 2019). This further assisted the company in developing a consistent capital market performance where the stock price of the company has been consistently moving upwards. This strategy has been found to be working effectively especially for the CEO Ebbers, who was considered to be the 174th Richest American person with a worth of $1.4 billion (International Banker, 2021). The Wall Street analysts were found to state that the company has the potential to grow further in the market. On the other hand, the revenue growth of the company began to slow down due to oversupply of the telecommunication networks.
BUS7C2 Finance & Accounting for Business Assignment Sample
In this situation, in order to meet the projections made by the analyst, the senior management of the company and the CEO were found to include accounting tricks. WorldCom was found to tamper the financial statements as it reduced the reserves amount and represented it as the revenue earned which was a worth of $2.8 billion (George, 2021). In addition to this, concerning the operational expenses, the company represented the payments to the telecommunication companies as long-term investments. Altogether, the reclassification of the amounts reflected an addition to the company’s revenue reflecting an amount of $3.85 billion whereas the actual profit generated by the company has been $1.38 billion (International Banker, 2021). Ebbers have been found to manipulate the employees as well as the other board of directors with the financial report thereby misleading them regarding the performance of the company. However, the CFO had the knowledge of the accounting violations, yet, supported the false accounting transaction recordings by tying up with the CEO.
Accounting/Financial violations related to the scandal
Accounting frauds relates to the violations conducted by organisations to manipulate financial information before the stakeholders that includes employees, investors as well as the board of directors. It majorly arises due to the unethical leadership practices employed by the organisational leaders who thrive to meet personal gains compared to organisational success (Rajgopal et al., 2021). As per the opinion of Fernandhytia & Muslichah (2020), deceptive or unethical practices developed by organisational leaders causes financial trouble for the investors in the market thereby inflating revenue earnings, manipulating financial transactions and reports, as well as hiding financial expenses and losses. Additionally, organisational leaders intend to mislead the market by representing false financial statements that reflects stable and strong performance of the company especially in terms of financial performance to fulfill personal gains by gaining further support from the investors to cope up with the losses.
In this respect, it can be stated that accounting violations are majorly conducted by unethical leaders who focus on personal gains. Concerning the case of WorldCom, the company was found to inflate revenue, hide the operating expenses and manipulate the financial statements such as balance sheet and income statements (George, 2021). The accounting violations related to the scandal can be therefore discussed as follows:
Unethical capitalisation of expenses
Referring to the scandal, it has been evident that WorldCom hid the operating expenses such as payment to the other companies for accessing their networks for phone calls as long-term investments (Ferreira, 2020). The costs for leases of network lines were therefore recognised as capital expenses by the company. In this context, operating expenses are referred to the costs that organisations recogises fully at the time of their occurrence whereas capital expenses reflects the cost for the assets which are distributed across period of years (Wild & Shaw, 2019). This reflects that by hiding the operating expenses, the company represented a high net income in the financial statements which presented the company as a profitable before the investors. It can be stated that the capitalisation of expenses has been a severe accounting violation according to the “Generally Accepted Accounting Principles (GAAP)” (Laurion, 2020). The company, however, was stepping towards bankruptcy.
Inflating revenues
The company was found to even inflate the revenue earnings thereby reclassifying the reserves as revenue earnings. It has emerged that the company had generated a profit of worth $1.38 billion whereas with the reclassification of the financial items, it reflected revenue of $3.85 billion (International Banker, 2021). In addition to this, the company has been found to reflect a net income of $797 million in the first quarter of 2002, whereas the company was actually facing a net loss. Furthermore, the company was booking the revenue from the long-trm contracts that were not realised to present a higher profitability position to the market investors. Also, the company was found to sell its capacity to other companies as well as purchase the same at lower prices, thereby inflating the revenue earnings. Therefore, the company has conducted a major violation of accounting principles by inflating revenues.
Manipulation of financial statements
WorldCom has been further found to manipulate the financial statements such as the income statement and the balance sheet. The company manipulated the operating expenses in the financial statements and increased the operating profit. In addition, it changed the reserves into revenue earnings which further increased the net income of the company. On the other hand, the company was found to affect the financial line items of the balance sheet thereby changing the amounts of capital reserves, long-term investments as well as debt levels. Thus, it can be said that manipulation of the financial statements has been another accounting or financial violation.
Covering of debts
WorldCom was also observed to hide its increasing debt levels as the company classified the debts as mere liabilities. Moreover, the company falsely stated the debt items in the balance sheet whereas it was essential to report them and reflect as debt in the balance sheet rather than certain liabilities. This further impacted the investors and their investment decisions as they were misled by the company regarding the securities. However, this accounting violation impacted the investors by reducing their confidence as well as caused financial distress due to purchase of stocks.
Lessons learned from the scandal and strategies
Learnings from the scandal
Referring to the analysis of the scandal, it has been evident that accounting violations has been conducted due to the inadequate accounting rules which helped the CEO and the CFO of the company conduct such violations. It has arisen from the studies that the accounting scandal has been conducted under the direction of the CFO of the company (George, 2021). The scandal sheds light on an understanding that it is essential for organisations to create a strong corporate governance structure where employees, managers as well as the board of directors are provided with a proper guideline regarding the practices that needs to be carried out. The inclusion of corporate governance can help organisations in developing transparency concerning the business activities which potentially increases the confidence of the investors (Ruwanti et al., 2019). In addition to this, by providing clear guidance regarding the roles and responsibilities, organisations can be capable of increasing the accountability which can prevent from conducting any kind of misconduct.
On the other hand, it is important for organisations to appoint ethical leaders as with ethical leaership practices, organisations are accustomed to integrating business activities that are fair and transparent (Kaptein, 2019). In other words, it can be stated that with the inclusion of ethical leadership, organisations are capable of preventing any kind of accounting or financial violations that further helps in developing trust within the investors. Furthermore, it can be stated that it is essential for the organisations to incorporate regulatory compliance and auditing system (Burdon & Sorour, 2020). The inclusion of accounting regulations and regular audit can potentially assist organisations in reducing the chances of any kind of corporate frauds thereby helping organisations to maintain a positive image in the market. However, this can further help in improving investor’s confidence as well.
Strategies that could have been taken by WorldCom
Based on the scandal, it can be stated that one of the major strategies that WorldCom could have been taken was to appoint ethical leaders as the top management who could have incorporated ethical practices to prevent the practices of inflating revenues and manipulating financial statements by misleading financial items. In addition to this, with the inclusion of corporate governance, the organisation could have helped in developing strong investor confidence thereby depicting transparent and fair financial reports which could have further helped the company survive the losses with the genuine support of the investors. It could have helped the company in improving the debt position as well. Moreover, the implementation of internal and external auditing could have further helped the organisation in preventing the financial frauds. However, with regular reviews of the financial statements, accounting violations could have been restricted.
Conclusion
The study hereby concludes that WorldCom conducted accounting violations by manipulating financial reports and statements, hiding losses as well as inflating revenue incomes. It shook the confidence level of the investors in the market. The organisation could have included auditing system, ethical leadership practices, and a strong corporate governance to overcome the accounting misconduct. Thus, it is essential for organisations to focus on developing regulations that support transparent accounting procedures.
Reference list
Burdon, W. M., & Sorour, M. K. (2020). Institutional theory and evolution of ‘a legitimate’compliance culture: The case of the UK financial service sector. Journal of Business Ethics, 162, 47-80.
Clikeman, P. M. (2019). Called to Account: Financial frauds that shaped the accounting profession. Routledge.
Fernandhytia, F., & Muslichah, M. (2020). The effect of internal control, individual morality and ethical value on accounting fraud tendency. Media Ekonomi Dan Manajemen, 35(1), 112-127.
Ferreira, H. M. P. (2020). Financial accounting scandals and the role of auditors (Doctoral dissertation).
George. B, (2021). Fraudulent Accounting and the Downfall of WorldCom, Available at https://sc.edu/about/offices_and_divisions/audit_and_advisory_services/about/news/2021/worldcom_scandal.php (Accessed on 28th February, 2024)
International Banker, (2021). THE WORLDCOM SCANDAL (2002), Available at https://internationalbanker.com/history-of-financial-crises/the-worldcom-scandal-2002/ (Accessed on 28th February, 2024)
Kaptein, M. (2019). The moral entrepreneur: A new component of ethical leadership. Journal of Business Ethics, 156, 1135-1150.
Laurion, H. (2020). Implications of Non-GAAP earnings for real activities and accounting choices. Journal of Accounting and Economics, 70(1), 101333.
Petra, S., & Spieler, A. C. (2020). Accounting scandals: Enron, Worldcom, and global crossing. In Corporate fraud exposed (pp. 343-360). Emerald Publishing Limited.
Rajgopal, S., Srinivasan, S., & Zheng, X. (2021). Measuring audit quality. Review of Accounting Studies, 26, 559-619.
Ruwanti, G., Candrarin, G., & Assih, P. (2019). Corporate social responsibility and earnings management: The role of corporate governance. Humanities & Social Sciences Reviews, 7(5), 1338-1347.
Wild, J. J., & Shaw, K. W. (2019). Fundamental accounting principles. McGraw-Hill.
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