Worldcom Case

Introduction

In 1996, WorldCom began as a small Mississippi provider of long distance telephone service and entered the local service market by purchasing MFS Communications Company, Inc. for $12.4 billion. By 1998 it had become a full service telecommunications company with the ability to supply virtually any size business with a full complement of telecom services. The company used its Internet strengths and integrated service packages as an advantage over its major competitors, AT&T and Sprint. In 1999, the company was not meeting Wall Street’s revenue and earnings expectations and it appeared that the coming year would produce more bad news.

WorldCom, the Nation’s second largest long distance telecommunications company announced on June 25, 2002 that they had overstated earnings in 2001 and the first quarter of 2002 by more than $3.8 billion. They failed because of the bad business decisions of its executives to manipulate earnings with improper accounting entries. The company was classifying payments for using other companies’ communications networks as capital expenditures which had a noticeable effect on the financial market. This deliberate miscalculation was the largest in history and caused WorldCom to file for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code on July 21, 2002. After WorldCom fraudulent scandal, seventeen thousand employees lost their jobs, many left the company with worthless retirement accounts, and it jeopardized service to twenty million retail customers and on government contracts affecting eighty million people.

The Situation

The fundamental economic problem that confronted WorldCom was the vast oversupply in telecommunications capacity that emerged in the 1990s. The revenues had fallen short of expectations while debt taken on to finance mergers and infrastructure investments remained because WorldCom and other telecommunications firms were faced with reduced demand and the economy entered recession. The CEO insisted that the company needed double digit growth and pushed for aggressive targets granted the CFO argued for setting realistic targets. In order for WorldCom to meet those targets they had to begin boosting its revenue through a wide range of accounting measures. The management who was making the aggressive accounting decisions had also posted the journals to the general ledger, reviewed, and approved the reporting.

Earnings management is a strategy used by the management of a company to influence or manipulate reported earnings by using specific accounting methods and this practice is carried out for the purpose of income smoothing. Fraudulent financial reporting is an aggressive act taken by executives within a company to intentionally conceal financial information about the company and to deceive others about the wealth of the company. Both actions will