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WorldCom: The Accounting Scandal

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Abstract:

On June 25, 2002, WorldCom, the Nation's second largest long distance telecommunications company, announced that it had overstated earnings in 2001 and the first quarter of 2002 by more than $3.8 billion. The announcement stunned financial analysts and, coming on top of accounting problems at other corporations, had a noticeable effect on the financial markets. The accounting maneuver responsible for the overstatement ­ classifying payments for using other companies' communications networks as capital expenditures ­ was characterized by the press as scandalous, and it was immediately asked why Arthur Andersen, the company's outside auditor at the time, had not detected it. WorldCom filed for bankruptcy protection on July 21st. On August 8th, the company announced that it had also manipulated its reserve accounts in recent years, affecting an additional $3.8 billion.

Response in Washington was swift. On June 26th, the U.S. Securities and Exchange Commission (SEC) charged the company with massive accounting fraud and quickly obtained court order barring the company from destroying financial records, limiting its payments to past and current executives, and requiring an independent monitor. Hearings were held by the House Committee on Financial Services on July 8th and by the Senate Committee on Commerce, Science, and Transportation on July 30th. Several company officials have been indicted.

The fundamental economic problem confronting WorldCom is the vast oversupply in the Nation's telecommunications capacity, a byproduct of overly optimistic projections of Internet growth. WorldCom and other telecommunications firms faced reduced demand as the dot­com boom ended and the economy entered recession. Their revenues have fallen short of expectations, while the debt they took on to finance expansion remains high. As the stock market value of these firms has plunged, corporate management has had a powerful incentive to engage in accounting practices that conceal bad news.