INTERNATIONAL BUSINESS

ASSIGNMENT

BY,
P.PRAVEEN KUMAR
DI10021
The financial world was rocked by accounting
scandals in the late 1990s and early 2000s.
Companies such as Enron, Global Crossing and Tyco
International collapsed under the weight of fraud and
destroyed investor confidence in corporate
accounting. But the biggest collapse was that of
WorldCom.
In 1983 Bernie Ebbers and several other people
invested in a newly formed company in Clinton,
Mississippi called Long Distance Discount Services,
Inc. (LDDS). LDDS was a provider of long distance
telephone service to residential and commercial
markets. Ebbers became CEO of LDDS in 1985. In
1989 the company merged with Advantage
Companies, Inc. and became publicly traded. In
1995 the company name was changed to LDDS
WorldCom, and later to just WorldCom. WorldCom
grew to be the second largest U.S. long distance
provider, second only to AT&T, primarily through
acquisitions. Among the companies it bought or
merged with were Advanced Communications Corp
(1992), Metromedia Communication Corp. (1993),
Reurgens Communications Group (1993), IDB
Communications Group, Inc. (1994), Williams
Technology Group, Inc. (1995), and MFS
Communications Company (1996). The MFS
acquisition included UUNet Technologies, Inc. In
February, 1998 WorldCom purchased CompuServe,
kept its Network Services Division, sold its online
service to America Online and acquired AOL’s
network division. On November 10, 1997 WorldCom
merged with MCI Communications. In 1999 MCI
WorldCom announced a planned merger with Sprint
for $129 billion. The US Department of Justice and
the EU put pressure on the companies to forego the
merger due to concerns about monopoly. The merger
was terminated on July 13, 2000 and the company
was renamed, once again, WorldCom
The telecommunications industry entered a
downturn in 1998, shortly after WorldCom acquired
MCI. The basic problem faced by WorldCom was the
“vast oversupply in telecommunication capacity that
emerged in the 1990s, as the industry rushed to
build fiber optic networks and other infrastructure
based on overly optimistic projections of Internet
growth”. Telecommunication firms “faced reduced
demand as the dot-com boom ended and the
economy entered recession”. Their revenues fell
short of expectations, while the debt taken on to
finance mergers and infrastructure investment
remained, As WorldCom’s stock prices began to fall
the company, under the direction of CFO Scott
Sullivan, Controller David Myers and Director of
General Accounting Buford Yates, “used fraudulent
accounting methods to mask its declining financial
condition by painting a false picture of financial
growth and profitability” .As stated in the CRS Report
for Congress, “The desire to avoid or postpone stock
market losses of this magnitude creates a powerful
incentive for corporate management to engage in
accounting practices that conceal bad news”

Expenditures incurred by a company in its normal

operations are treated as current or operating
expenses. Examples would include recurring costs
such as wages, insurance, equipment rental,
electricity and maintenance contracts. Other
expenditures, most commonly those which result in
the acquisition of, or improvement to, the company’s
assets, are treated like capital expenditures.
Purchases of real estate, manufacturing equipment,
or computer equipment are examples of capital
expenditures. Operating expenses are reported on a
company’s Income Statement as deductions from
revenues in the period in which they occur or are
paid, resulting in net income. In contrast, capital
expenditures are not reflected on the Income
Statement. Instead, they are reported on the
company’s Balance Sheet as an asset, and,
depending on the nature of the asset and its
expected useful life, are subject to depreciation.
Depreciation writes off a portion of an asset’s value
over a number of accounting periods. The portion of
the asset’s value which is depreciated in a period is
shown as a current expense of the period on the
Income Statement as a deduction from revenues. If a
company reclassifies an expenditure from an
operating expense to a capital expenditure, the
following occurs: (a) operating expenses will be
reduced, and net income will be increased by the
amount reclassified; and (b) the value of the capital
assets will be increased by that same amount
.
WorldCom’s business was to provide a variety of
communication services such as data transmission,
Internet, long distance, and other communication
services to U.S. and foreign businesses and
consumers. Through its various acquisitions
WorldCom “maintained extensive network facilities
to connect metropolitan centers and various regions
throughout the world” (United States of America v.
David F. Myers, para. 12). To service customers not
connected to its networks WorldCom paid line costs.
These line costs were paid to “other companies for
using their communications networks; they consist
primarily of access fees and transport charges for
messages for WorldCom customers”

. Prior to the first quarter of 2001 WorldCom treated

these line costs as operating expenses.
In 1999 WorldCom entered into long-term lease
agreements with third-party carriers to gain access
to out-of-network facilities. This was done in the
belief that increased Internet-related businesses
would increase the demand for WorldCom’s services.
These leases required payment regardless of
whether WorldCom made use of the facilities

WorldCom established reserve accounts to ensure

that sufficient funds were available to make certain
required payments. Two such reserve accounts were
for line costs and deferred taxes. The line cost
reserves were established by estimating the line
costs incurred for a given period and the level of
disputed claims related to line costs. Deferred tax
reserves were established by estimating the amount
of taxes owed in a given future period. These
reserves were shown on WorldCom’s Balance Sheet
as liabilities

Due to the unexpected decline in Internet-related

businesses, in or around July, 2000 WorldCom’s
expenses as a percent of revenues began to
increase. This resulted in a decline in the rate of
growth of WorldCom’s earnings, which created a risk
that WorldCom’s earnings would not meet analysts’
expectations and its market price of securities would
decline. To combat this problem, WorldCom’s senior
management decided to inflate earnings by reducing
line costs. This was done in October, 2000 by journal
entries which credited line costs expense and
debited reserve accounts such as accrued line costs,
deferred tax liability and other long-term liabilities.
This increased the third quarter, 2000 reported
earnings by $828 million. After reviewing the fourth
quarter, 2000 preliminary financial statements, it
was again determined that expenses were too high
to meet analysts’ expectations. In February, 2001
$407 million in line costs were credited against
reserve accounts. The net effect was a $1.2 billion
overstatement of net income for 2000
.
After the first quarter, 2001 preliminary financial
statements were reviewed it was determined that
expenses were still too high as a percentage of
revenue. Sullivan, Myers and Yates “agreed that it
was no longer possible to disguise WorldCom’s rising
ratio of expenses to revenue by reducing various
reserves”. It was then that the decision was made to
transfer certain line costs from an expense account
to a capital account. This practice continued for all of
2001 through the first quarter of 2002. The amounts
transferred were $771 million for the first quarter,
2001, $560 million for the second quarter, 2001,
$743 million for the third quarter, 2001, $941 million
for the fourth quarter, 2001 and $818 million for the
first quarter, 2002; a total of $3.8 billion over five
quarters (United States of America v. David F. Myers,
para. 23-31). These transfers increased both
WorldCom’s net income, by understating expense,
and its assets, by capitalizing costs. This would have
resulted in lower net income in later, potentially
profitable years, as the capital asset was depreciated
How was this fraud uncovered? Cynthia Cooper,
WorldCom’s internal auditor, discovered the
misclassification of line costs in May, 2002. Per
proper accounting procedures, she discussed the
irregularities with CFO Scott Sullivan and Controller
David Myers. She then reported to the head of the
audit committee of WorldCom’s board of directors,
Max Bobbitt. Mr. Bobbitt asked KPMG, the outside
audit firm which had replaced Arthur Andersen on
May 16, 2002, to investigate. CFO Sullivan was asked
to justify the treatment of line costs.
.It said in a statement that “The WorldCom CFO did
not tell Andersen about the line cost transfers nor did
he consult with Anderson about the accounting
treatment” Some observers say this reasoning is
irrelevant. They say that Andersen “should have
taken into account the increasingly precarious
financial condition of WorldCom and paid more
attention to the possibility of aggressive accounting
practices” James Duncan, an accounting professor at
Ball State University says that fraud uncovered in
recent years, and Arthur Andersen’s role in it, “has
ruined the credibility and reputation earned by
professional accountants over a great many years”
and that WorldCom’s fraud “undermines the trust of
investors in corporate America” What was the cost
of this massive fraud? On July 21, 2002 WorldCom
filed for Chapter 11 bankruptcy protection. It
changed its name to MCI on April 14, 2003 and was
forced to pay $750 million in cash and MCI stock to
the SEC to pay to wronged investors. MCI emerged
from bankruptcy in 2004 and was purchased by
Verizon Communication on February 14, 2005 for
$7.6 billion a deal with federal prosecutors CFO Scott
Sullivan, Controller David Myers, and Director of
General Accounting Buford Yates agreed to plead
guilty and testify against CEO Bernie Ebbers,
receiving relatively light sentences in exchange.
Sullivan received a five year sentence, while Myers
and Yates were each sentenced to serve a year and a
day in jail. Ebbers, the charismatic founder of
WorldCom, received a twenty-five year sentence The
harshness of Ebbers’ sentence has been called into
question, but one thing is clear: “Ebbers and the
other officers at WorldCom are guilty of presiding
over what is to date, the largest corporate fraud in
history”