Worldcom scandal explained

Week 1 Discussion Responses - Why Weren't the Misstatements of Enron and WorldCom Caught? - Accounting

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Discussion 1

By: J,G

Following the events of WorldCom and Enron, the SOX Act corrected many of the issues regarding lack of oversight. Unfortunately, these regulations were resulting consequences of these incredible accounting failures.

Both GAAP and IFRS standards, when used correctly, are sufficient for creating clear and understandable accounting profiles of a company. The create pipelines for financial information regarding both internal and external users and should be transparent. To prevent error, these records must be thoroughly reviewed by both internal and external accountants.

In the cases of Enron and WorldCom, egregious accounting errors and deliberate misstating of information led to two of the world’s largest corporate downfalls and criminal investigations in modern history. Both companies made errors in their accounting. Enron shuffled debt obligations and reported future contracts as revenue, altering their records to show massive growth (O’Leary, 2017.) WorldCom similarly euphemized their records by filing clear expenses as investments which do not appear on the income statement and thus, falsified their income as significantly higher than actual (Tran, 2002.) Both of these accounting errors, whether deliberate or not, are inexcusable and such negligence on this scale should be means for corporate bankruptcy and criminal investigation.

The third party that conveniently, and illegally, played a role in these situations was Arthur Anderson – a account consulting firm. Specifically in the case of Enron, Arthur Anderson deliberately shredded audit documents confirming the oil company’s failures (O’Leary, 2017.) Though AA did not have similar criminal investigations for their involvement in WorldCom, they did settle the lawsuit – which neither confirms or denies guilt - brought by WorldCom investors for failing to disclose pertinent accounting failures (USA Today, 2005.)

The SOX Act is designed to mitigate the lack of transparency and illegal behavior that caused these two mega-corporations to collapse; however, examples like Wells Fargo have proven that illegal and unethical accounting and business practices can exist in the face of regulation. It remains critical that corporations, as well as auditing accounting firms, are held to the utmost discipline with their reporting and indiscretion is considered criminal. Failure to competently and honestly report accounting figures, as seen in these cases, greatly affects employees, investors, and the greater stock market.

References:

O'Leary, C. (2002, December 31). Enron-What Happened?: Year In Review 2002. Retrieved August 30, 2017, from https://www.britannica.com/topic/Enron-What-Happened-1517868

Tran, M. (2002, August 09). WorldCom accounting scandal. Retrieved August 30, 2017, from https://www.theguardian.com/business/2002/aug/09/corporatefraud.worldcom2

USA Today. (2005, April 25). Arthur Andersen settles with WorldCom investors. Retrieved August 30, 2017, from https://usatoday30.usatoday.com/money/industries/telecom/2005-04-25-worldcom_x.htm

Discussion 2

By: B,R

          Generally accepted accounting principles (GAAP) are common accounting principles and standards that give guidance on the way in which a company must assemble and report its financial statements. When correctly used and followed GAAP helps to increase the clearness of the communication of financial information. “GAAP is meant to ensure a minimum level of consistency in a company’s financial statements, which makes it easier for investors to analyze and extract useful information. GAAP also facilitates the cross comparison of financial information across different companies” (Investopedia, n.d.a).

            Prior to the collapse of Enron and WorldCom, there was not as much regulation of public accounting and auditing. This lax regulation allowed both of the companies to fudge the numbers in the books making the companies look more financially sound than they actually were. With Enron, the company was able to hide financial losses of the trading business using mark to market accounting (Investopedia, 2016b). This is when “trading securities where you measure the value of a security based on its current market value, instead of its book value” (Investopedia, 2016b). Enron would build an asset and then claim the projected profit immediately instead of waiting to if the profit was truly generated. If the asset did not generate the projected profit Enron would transfer the asset to off the book corporations so that the loss would not be reported (Investopedia, 2016b). Using mark to market accounting was able to help make the company appear more profitable than it was in reality.

            WorldCom, one of the world’s biggest telecommunication companies manipulated its financial statements to inflate its earnings by several billion dollars (Kennon, 2016). The company took operating costs and spread them out over years. This allowed WorldCom to fraudulently hide the costs from investors and show a net profit. If the costs had been properly reported WorldCom would have lost money in both 2001 and 2002. The inaccurate reporting of the operating costs meant that analysts and investors could not properly value the business.

            In the aftermath of these two major scandals the Sarbanes-Oxley Act was enacted. It is a broad reform of business practices that worked on enhancing regulation. “The 2002 Sarbanes-Oxley Act aims particularly at public accounting firms that participate in audits of corporations . . . This act set new standards for public account firms, corporate management, and corporate boards of directors (Peavler, 2017).

References

Investopedia. (n.d.a). Generally Accepted Accounting Principles – GAAP. Retrieved on August 30, 2017 from http://www.investopedia.com/terms/g/gaap.asp

Investopedia. (n.d.b.). Enron Scandal: The Fall of a Wall Street Darling. Retrieved on August 30, 2017 from http://www.investopedia.com/updates/enron-scandal-summary/

Kennon, Joshua. (2016). WorldCom’s Magic Trick – The WorldCom Scandal Explained. The Balance. Retrieved on August 30, 2017 from https://www.thebalance.com/worldcom-s-magic-trick-356121

Peavler, Rosemary. (2017, July). The Enron Scandal That Prompted the Sarbanes-Oxley Act. The Balance. Retrieved August 30, 2017 from https://www.thebalance.com/sarbanes-oxley-act-and-the-enron-scandal-393497

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