Worldcom Accounting Scandal

Accounting Fraud > Accounting Scandals > Worldcom Accounting Scandal

The Worldcom Accounting Scandal was a large, well remembered fraud that will go down in history.

The origins of the Worldcom scandal began in 2000, when the telecommunications industry was entering a downturn. WorldCom was practicing aggressive growth strategies at the time and as a result of the industry downturn, took a setback when the US Justice Department blocked its merger with Sprint. This caused WorldCom’s stock to decline and the CEO was pressured by banks to cover margin calls on his WorldCom stock.

The issue was that Bernard Ebbers, the CEO, used the borrowed money to to finance other businesses and could not repay the margin calls. During 2001, he got the support of the WorldCom board of directors to provide corporate loans to the tune of approximately $400 million in order to back him.

Why did they do this? They hoped that the loans would persuade Ebbers to not sell substantial amounts of his WorldCom stock, thus further decreasing the investor sentiment and driving the price lower. Unfortunately for the board, this didn’t work and they replaced Ebbers with a new CEO in 2002, John Sidgmore. When replacing Ebbers, it became apparent that during his reign as CEO, he utilized accounting fraud to make the company look profitable when it was not in order to increase the stock price.

How did Worldcom do the scandal?

The fraud was accomplished primarily in two ways:

1) Underreporting ‘line costs’ (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them.

2) Inflating revenues with bogus accounting entries from “corporate unallocated revenue accounts”.

In 2002, internal auditors at WorldCom secretly worked together to investigate discover the $3.8 billion in fraud. Shortly after, the audit committee and board of directors fired those involved and Arthur Andersen withdrew its audit opinion for 2001, and the U.S. Securities and Exchange Commission (SEC) launched an investigation. By the end of 2003, it was estimated that the company’s total assets had been inflated by around $11 billion. The Worldcom Accounting Scandal was one of the largest at the time it was perpetrated.

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