ABCD

COSO case study

Case Study WorldCom

The situation
WorldCom is a telecommunications company which was lead by CEO, Bernard Ebbers, and CFO, Scott Sullivan. In 1999, WorldCom was not meeting Wall Streets revenue and earnings expectations, and it appeared that the coming year would produce more bad news. The CFO argued for setting realistic targets. However, the CEO insisted that the company needed double digit growth, and pushed for aggressive targets. These aggressive targets were not supported by historical data or strategic assessments. In order to meet these targets, WorldCom began boosting its revenue through a wide range of accounting measures, including drawing down on reserves set aside for expenses. The economic situation at the time was not taken into account when implementing these aggressive accounting measures. Other similar companies were reporting declining revenues. It was identified that the management who were making the aggressive accounting decisions, were also posting the journals to the general ledger, and reviewing and approving the reporting. Pressure was placed on personnel who did not support the aggressive targets. A great deal of focus was put on team work and being a strong team player, which is said to have been a strategy to reduce dissenting opinions, eventually leading the organisation to follow a groupthink attitude. In 2000, the telecommunications industry entered a downturn and WorldComs aggressive growth strategy suffered a serious set back. However, due to the accounting measures used, by Q3 in 2000, the company managed to meet the Wall Street expectations. Finally, WorldComs stock price started to plummet, and the CEO faced margin calls from his bankers, forcing him to either sell his shares or repay the loans. He did not want to sell his shares as his doing so would put further downward pressure on the stock price. Therefore, WorldCom directors lent the CEO US$400 million to meet the loans requirements. Before the release of Q1 results, 2002, the companys revenue was dec lining, making the task of showing revenue growth through accounting manoeuvres nearly impossible. The disastrous first quarter results were released, and the CEO, Bernard Ebbers, was asked to resign.

What are the issues?

Beginning modestly in mid-year 1999 and continuing at an accelerated pace through May 2002, the company (under the direction of Ebbers (CEO) and Sullivan (CFO)) used fraudulent accounting methods to mask its declining earnings by painting a false picture of financial growth and profitability to prop up the price of WorldComs stock. The fraud was accomplished primarily in two ways: Underreporting line costs (interconnection expenses with other telecommunication companies) by capitalising these costs on the balance sheet rather than properly expensing them. Inflating revenues with bogus accounting entries from "corporate unallocated revenue accounts".

The outcome
Over the course of its operations, WorldCom has successfully acquired a total of 65 companies, of which 11 were acquired between 1991 and 1997, and in that course has accumulated around $41 billion in debt. By the time it declared bankruptcy in 2002, the organization had a combined loss of $73.7 billion. In 2002, a small team of internal auditors at WorldCom worked together, often at night and in secret, to investigate and unearth $3.8 billion in fraud. Shortly thereafter, the companys audit committee and board of directors were notified of the fraud and acted

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COSO case study swiftly: Sullivan was fired, Arthur Andersen withdrew its audit opinion for 2001, and the U.S. Securities and Exchange Commision (SEC) launched an investigation into these matters on June 26, 2002. By the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion. On July 21, 2002, WorldCom filed for Chapter 11 Bankruptcy Protection

Analysis Control environment

Unrealistic growth targets (double digits) when expectations were low. Managements philosophy was to be aggressive. Increased pressure on people who did not support the aggressive targets. The culture and atmosphere encouraged by aggressive targets led to dishonest, illegal and unethical activities. A great deal of focus was put on team work and being a strong team player, which is said to have been a strategy to reduce dissenting opinions, eventually leading the organisation to follow a groupthink attitude. Directors were allowed to loan $400m to WorldCom to meet loan requirements to cover up financial difficulties. The control environment allowed this unethical activity to happen.

Risk assessment
Inadequate assessment of internal and external factors, and objectives before setting aggressive targets. Economic conditions were not considered when implementing aggressive accounting measures. Other similar companies were declining.

Control activities
Poor segregation of duties: Reconciliation preparation and reviews Journals preparation and reviews

Information and communication

WorldCom CEO, Bernard Ebbers, and CFO, Scott Sullivan knowingly reported information to their stakeholders, including employees and shareholders, that lacked support and integrity. They communicated false targets and outcomes to Wall Street to ensure the stock price of WorldCom continued to escalate and consequently decided to use a wide range of accounting measures to meet these targets. Access to data entry and manipulation was not appropriately segregated.

Monitoring
There is limited evidence to suggest appropriate review financial reporting controls were being reviewed independently. There was a lack of stringent monitoring of the internal control system and therefore the quality of the controls around the posting of journal entries to the general ledger was not identified as a weak control.