Republic of the Philippines

BATANGAS STATE UNIVERSITY

COLLEGE OF ACCOUNTANCY BUSINESS ECONOMICS
AND INTERNATIONAL HOSPITALITY MANAGEMENT

A Case Study on

WORLDCOM:
THE INTERNAL AUDIT FUNCTION

MGT 209
Governance, Business Ethics,
Risk Management and Internal Control

Evangelista, Cindy B.
Fernandez, Janelle Ann Marie M.
Roxas, Trisha Mae B.

Ms. Rodelyn B. Ruga

Instructor

AY 2019-2020

Case Study Governance, Business Ethics, Risk Management and Internal Control Page 1 of 8
 Republic of the Philippines
BATANGAS STATE UNIVERSITY
COLLEGE OF ACCOUNTANCY BUSINESS ECONOMICS
AND INTERNATIONAL HOSPITALITY MANAGEMENT

I. Executive Summary

WorldCom was not just the biggest accounting scandal in the history of

the United States — it was also one of the biggest bankruptcies. The revelation

that telecommunications giant WorldCom had cooked its books came on the

heels of the Enron and Tyco frauds, which had rocked the financial markets.

However, the scale of the WorldCom fraud put even them in the shade. This

spate of corporate crime led to the Sarbanes-Oxley Act in July 2002, which

strengthened disclosure requirements and the penalties for fraudulent

accounting. In the aftermath, WorldCom left a stain on the reputation of

accounting firms, investment banks, and credit rating agencies that had never

quite been removed.

The company's CFO, Scott Sullivan, fraudulently took billions of dollars

in operating expenses and spread them out across so-called property accounts,

which are a type of capital expense account. This allowed WorldCom to show the

expenses in smaller amounts over a span of years, instead of reporting them

immediately to investors. As a result, in 2001, the company reported a $1.4

billion profit. Had the operating costs been correctly reported, WorldCom would

have lost money for fiscal 2001 as well as first-quarter 2002.

WorldCom filed for bankruptcy on July 21, 2002, only a month after its

auditor, Arthur Andersen, was convicted of obstruction of justice for shredding

documents related to its audit of Enron. Arthur Andersen—which had audited

WorldCom's 2001 financial statements and reviewed WorldCom’s books for Q1

2002—was found later to have ignored memos from WorldCom executives

informing them that the company was inflating profits by improperly accounting

for expenses.

Case Study Governance, Business Ethics, Risk Management and Internal Control Page 2 of 8
 Republic of the Philippines
BATANGAS STATE UNIVERSITY
COLLEGE OF ACCOUNTANCY BUSINESS ECONOMICS
AND INTERNATIONAL HOSPITALITY MANAGEMENT

WorldCom has become a byword for accounting fraud and a warning to

investors that when things seem too good to be true, they just might be. Its CEO,

Bernie Ebbers—a larger-than-life figure whose trademark was cowboy boots and

ten-gallon hat—had built the company into one of America’s leading long-

distance phone companies by acquiring other telecom companies. At the peak of

the dotcom bubble, its market capitalization had grown to $175 billion. WorldCom

CEO Bernard Ebbers was sentenced to 25 years in jail for his role in the scandal,

and former CFO Scott Sullivan was sentenced to five years after pleading guilty

and testifying against Ebbers. The company went bankrupt, recording the largest

bankruptcy in American history until the financial crisis of 2008. Thousands of

people lost their jobs.

II. Statement of the Problem / Discussion Questions

WorldCom’s downfall was due to their negligence and to cover their

mistakes they had engaged in improper accounting that took two major forms.

They overstate the company’s revenue by at least $958 million and understate

the line cost, its largest category of expenses, by over $7 billion. Upon examining

the bankruptcy of WorldCom, Dick Thornburgh, court examiner, found that the

company’s internal audit department focused its audit primarily on the areas that

were expected to yield cost savings or result in additional revenues. The

examiner also found that the department’s lack of consultation with WorldCom’s

external auditor resulted in even further audit coverage gap.

The following are the discussion questions:

1. What should the WorldCom have done to prevent their downfall?

Case Study Governance, Business Ethics, Risk Management and Internal Control Page 3 of 8
 Republic of the Philippines
BATANGAS STATE UNIVERSITY
COLLEGE OF ACCOUNTANCY BUSINESS ECONOMICS
AND INTERNATIONAL HOSPITALITY MANAGEMENT

2. What are the ethical considerations that the WorldCom didn’t consider to

resolve the issue?

3. What are some things that could have been done by audit committees and

internal audit to prevent the accounting scandal?

4. What are the major problems that led them to this kind of situation?

5. What are some of the company’s decisions that did not do well on their

business?

III. Causes of the Problem / Situation

WorldCom’s internal environment was a mess waiting to happen. It

appears that even without the fraud, the company would have collapsed

anyways, yet perhaps sooner than it really did. The lack of proper personnel to

detect and fix the hole was the auditing failure. The internal problems at

WorldCom were its lack of a competitive strategy, weak internal controls, an

aggressive culture that demanded high returns, and the failure to look out for

what was best for the stock holder as well as the stake holder of the company.

While the growth of a company is necessary for its sustainability, it is also

important for the company to focus on the long term rather than only on the next

quarterly report. Employees of a company are also drivers for its growth and

success.

The company's CFO, Scott Sullivan, fraudulently took billions of dollars

in operating expenses and spread them out across so-called property accounts,

which are a type of capital expense account. This allowed WorldCom to show the

expenses in smaller amounts over a span of years, instead of reporting them

immediately to investors. As a result, in 2001, the company reported a $1.4

Case Study Governance, Business Ethics, Risk Management and Internal Control Page 4 of 8
 Republic of the Philippines
BATANGAS STATE UNIVERSITY
COLLEGE OF ACCOUNTANCY BUSINESS ECONOMICS
AND INTERNATIONAL HOSPITALITY MANAGEMENT

billion profit. Had the operating costs been correctly reported, WorldCom would

have lost money for fiscal 2001 as well as first-quarter 2002.

However, the competitive culture at WorldCom was characterized by

loyalty to management with no regards to ethics, honesty, or integrity. The Board

of Directors served as an internal control that was a failure on its own part. The

duty of the Board was to correct the weakness of the company that management

was unable to see due to its lack of the independence from the company.

IV. Decision Criteria and Alternative Solution

In order to have a concrete decision and to better understand such

instances, criteria is an essential component and concept to deal with the

alternatives since decision criteria are principles, guidelines and requirement that

are used to come up with the best decision.

 An active and independent Board of Directors and Committees.

 A corporate culture of candor, in which ethical conduct is encouraged and

expected, as exemplified by the ethics pledge that the Company and the

Corporate Monitor have developed and that senior management has

signed.

 A corporate culture in which the advice of lawyers is sought and

respected.

 Formalized and well-documented policies and procedures, including a

clear and effective channel through which employees can raise concerns

or report acts of misconduct.

 Compensation policies and practices that create incentives consistent with

the interests of the Company’s shareholders.

Case Study Governance, Business Ethics, Risk Management and Internal Control Page 5 of 8
 Republic of the Philippines
BATANGAS STATE UNIVERSITY
COLLEGE OF ACCOUNTANCY BUSINESS ECONOMICS
AND INTERNATIONAL HOSPITALITY MANAGEMENT

 An expanded role for Internal Audit, with commensurate resources and

expertise.

 Integrated financial accounting and reporting systems, to which all

appropriate personnel have access.

 Formalized and well-documented accounting policies and procedures,

including robust internal controls surrounding the capture and reporting of

financial data.

 Open and candid dealings with the Company’s outside auditors, reflecting

the critical role they play in the ability of the markets, shareholders, the

Board, and senior management to perform their functions.

 Whenever feasible, housing significant corporate organizations or groups

that perform similar or related functions (such as finance, accounting, and

internal audit) in the same location.

 Use of budgets and financial targets as benchmarks, rather than as

drivers of reported financial results or influencing the accounting treatment

of transactions.

V. Recommended Solution, Implementation and Justification

WorldCom was the biggest accounting scandal in the history of the United

States as well as one of the biggest bankruptcies. After the tech bubble burst and

companies slashed spending on telecom services, WorldCom resorted to

accounting tricks to maintain the appearance of ever-growing profitability. After

the information gathered, the researcher came up with the following

recommended solutions.

Case Study Governance, Business Ethics, Risk Management and Internal Control Page 6 of 8
 Republic of the Philippines
BATANGAS STATE UNIVERSITY
COLLEGE OF ACCOUNTANCY BUSINESS ECONOMICS
AND INTERNATIONAL HOSPITALITY MANAGEMENT

WHO WHAT WHEN HOW

The board of directors should be

Regular
Atleast having atleast quarterly or monthly
consultation and
Board of Monthly/ meeting with the top level
meeting with the
Directors Quarterly management in order to know,
top level
monitor and resolve issues or
management
problem arising from the company.

Top Level Management will conduct

seminars and trainings in order for

Conduct seminars/ them to improve their skills and

Top Level Quarterly/
trainings/ team have a strong bond within each
Management Monthly
building employee so that they will have

strong and food working

environment.

Internal Audit Committee needs to

Monitoring monitor their financial statements

financial regularly in order to maintain and

Internal Audit statements and Once a ensure awareness of internal

Committee implementing strict Month auditor weakness, and also they

rules and should implement rules that will limit

regulations the employees in company's

financial system.

Case Study Governance, Business Ethics, Risk Management and Internal Control Page 7 of 8
 Republic of the Philippines
BATANGAS STATE UNIVERSITY
COLLEGE OF ACCOUNTANCY BUSINESS ECONOMICS
AND INTERNATIONAL HOSPITALITY MANAGEMENT

VI. External Sourcing

Beresford, D. Katzenbach, N. Rogers, C. (March 2003). Report of investigation

by the Special Investigative Committee of the Board of Directors of

WorldCom, Inc. Retrieved from

https://www.sec.gov/Archives/edgar/data/723527/000093176303001862/d

ex991.htm#ex991902_95

Kennon, J. (November 2019). The Worldcom Scandal Explained. Retrieved from

https://www.thebalance.com/worldcom-s-magic-trick-356121

Kenton, W. (March 2019). Investopedia: WorldCom. Retrieved from

https://www.investopedia.com/terms/w/worldcom.asp

Moberg, D. & Romar, E. (April 2009). World Com Case Study. Retrieved from

https://www.academia.edu/24755478/WorldCom_Case_Study_WorldCom

_Case_Study_1?fbclid=IwAR3NajXSWX015qs4ZW-

s_dnhnTSnnaHTY171TafoBYdB4V2FzVfoYBz3FzY

Tran, M. (August 2002). World Com Accounting Scandal. Retrieved from

https://www.theguardian.com/business/2002/aug/09/corporatefraud.worldc

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