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WorldCom accounting scandal

What did WorldCom say?

The company said an internal audit had discovered that $3.3bn in


profits were improperly recorded on its books from 1999 to the first quarter
of 2002. That is on top of the $3.8bn in expenses the company said it had
improperly reported as capital investments. WorldCom now says it must
issue revised financial statements for 2000 and 1999 as well. The revision
will reduce 2000 profits by more than $3.2bn, but this may not be the end of
accounting horrors as the company warned it may find more problems.

Is there a new twist to the latest disclosures?


WorldCom said most of the $3.3bn irregularity involved the
manipulation of reserves. Companies set aside reserves to cover estimated
losses such as uncollected payments from customers and judgements in
lawsuits and other expected costs.

Are reserves normal business practice?


It is a perfectly legitimate practice, like setting aside funds for a rainy
day. But reserves can be abused to create the accounting equivalent of a
slush fund. If a company wanted to massage profits to meet Wall Street
expectations it can transfer the necessary sums from the reserve. The
suspicion is that WorldCom deliberately inflated its reserves to be able to dip
into them to boost profits in order to meet profit projections.

Who is to blame?
WorldCom's chief executive, John Sidgmore, blamed the company's
former chief financial officer, Scott Sullivan, and the former controller, David
Myers. The two were fired for claiming $3.8bn in regular expenses as capital
investment in 2001. The pair were arrested in New York, handcuffed and
paraded in front of TV cameras as part of the Bush's administration
crackdown on corporate crime. Charged with securities fraud, conspiracy and
other charges, they face 65 years in prison. WorldCom's founder and former
chief executive, Bernie Ebbers, says he was unaware of the accounting
problems, and has not been charged.

What is wrong with filing expenses as investment?


Operating expenses must be subtracted from revenue immediately, while
the cost of capital expenses can be spread over time. Improperly spreading
operating costs inflated WorldCom's profits.

Why did WorldCom's accountants not spot the problem?


WorldCom's accountants at the time were Arthur Andersen, the same
people that looked after Enron's books as well as other companies hit by
accounting issues - Tyco, Global Crossing and Adelphia. Andersen accused Mr
Sullivan of withholding information from them. The deputy US attorney
general, Larry Thompson, said: "We have to ask where the professionals
were, the accountants and the lawyers."

What is being done to get a proper accounting?

WorldCom has new accountants, KPMG, who have been asked to scour
the books back to 1999. It will be virtually impossible to get an accurate
picture until a comprehensive audit for the past several years is done, a
process expected to last months. The company is also under investigation by
the department of justice and the securities and exchange commission, the
US financial regulator. WorldCom, which has been charged with fraud for
allegedly hiding $1.2bn in losses, is now under bankruptcy protection.

Any other bad news?

WorldCom said it may have to write off $50bn when it restates ifs
finances. One of the largest write-offs in corporate history, that would
amount to the 2001 gross domestic products of Hungary and the Czech
Republic. Only Time Warner's $54bn write-off was bigger.

Link: http://www.theguardian.com/business/2002/aug/09/corporatefraud.worldcom2