Describe the mechanisms that WorldCom’s management
used to transfer profit from other time
periods to inflate the current period.
1.More specifically, in the third and fourth quarter of 2000, at the direction and with the knowledge of WorldCom’s senior management, Vinson Normand and others, by making and causing to be made entries in WorldCom’s books which improperly decreased certain revenues to reduce WorldCom’s line costs. This caused WorldCom to be overstated pretax earnings by $828 million and at least $407 million respectively.
Then, after WorldCom had drawn down its reserves so far that the revenue could not be drawn down further without taking what senior management believe was an unacceptable risk of discovery. Vinson Normand and others again at the direction and with the knowledge of senior management make and caused to be made entries in WorldCom’s books which improperly capitalized certain line costs for the next five quarters, from the first quarter 2001 through the first quarter of 2002. This accounting gimmick resulted in an overstatement of WorldCom’s pretax earnings by approximately $3.8 billion for those five quarters.
WorldCom, a telecommunications company, used various mechanisms to transfer profit from other time periods to inflate the current period. These mechanisms were employed to manipulate financial statements and create an illusion of healthy financial performance. The primary techniques employed by WorldCom's management can be described as follows:
1. Capitalizing Expenses: Instead of recording certain expenditures as expenses in the period they were incurred, WorldCom's management capitalized those expenses as assets held on the balance sheet. By doing so, they inflated the company's assets while understating expenses, leading to higher reported profit in the current period.
2. Overstating Revenues: WorldCom's management engaged in fraudulent accounting practices by inflating revenue figures. They would record bogus or fictitious revenue entries, such as reporting sales that never occurred or inflating the value of contracts. This increased reported revenue and subsequently inflated profit figures.
3. Manipulating Reserves: Reserves are provisions set aside by companies to cover potential losses or expenses. WorldCom's management manipulated these reserves to artificially inflate earnings. They would release reserves into the income statement, boosting reported profits in the current period, while understating potential future losses.
4. Improperly Adjusting Line Costs: Line costs, also known as access charges, were major expenses for WorldCom related to interconnection fees paid to other telecommunications companies for using their networks. The management intentionally misallocated these costs, improperly capitalizing them or spreading them over future periods instead of correctly recording them as expenses in the current period. This inflated reported profit by understating expenses.
5. Inflating Assets through Acquisitions: WorldCom engaged in a series of acquisitions during its operations. Management would overvalue the assets acquired during these transactions, deliberately overstating their worth. This overstatement of asset values boosted the balance sheet, leading to inflated reported profit.
It should be noted that these fraudulent activities were eventually uncovered, leading to one of the largest accounting scandals in history. WorldCom filed for bankruptcy in 2002, resulting in criminal charges against its executives and substantial financial and reputational damages for the company.
WorldCom, once considered one of the largest telecommunications companies in the United States, engaged in fraudulent accounting practices to inflate its reported earnings. These practices allowed the transfer of profit from other time periods to artificially boost the current period's financial results. Here are the mechanisms used by WorldCom's management:
1. Capitalizing operating expenses: WorldCom altered its accounting practices by capitalizing various operating expenses, which means they were treated as assets on the balance sheet instead of being expensed immediately. By doing so, the expenses were spread out over a longer period, which inflated current profits.
2. Improper revenue recognition: WorldCom recorded revenue from long-term contracts and network usage agreements upfront, even though the revenue had not been earned or received. This allowed them to inflate current-period revenues, creating a false impression of strong financial performance.
3. Manipulating reserves: Reserves are funds set aside to cover potential losses or expenses in the future. WorldCom's management released reserves that were previously set aside for specific purposes, such as liability accruals or bad debt provisions. Releasing these reserves boosted current-period earnings by reducing expenses and increasing reported profits.
4. Erroneous accounting entries: WorldCom's accounting department made intentional errors and adjustments to financial statements to hide the actual financial performance. This involved misclassifying expenses, artificially inflating assets, and understating liabilities to make the financial statements appear more favorable.
5. Inflating asset values and subsequent write-offs: WorldCom used aggressive accounting techniques to inflate the value of its assets, including overstating the value of acquisitions and capitalizing costs that should have been expensed immediately. Later, these overvalued assets were intentionally written off, creating a one-time gain that boosted the current-period profits.
By using these fraudulent mechanisms, WorldCom's management manipulated the company's financial statements, making it seem more profitable and financially stable than it actually was. These practices ultimately led to the exposure of a massive accounting scandal and the subsequent bankruptcy of the company.