WorldCom Fraud

Accounting case study

By Linda PU (RUILING)
 Introduction
• WorldCom (MCI Inc.) was the United
States's second largest long distance
telephone company (after AT&T).
• It consisted of an employee base of 85,000
workers at its peak with a presence in more
than 65 countries.
• In 2002, WorldCom filed for Chapter 11
bankruptcy protection in the largest such
filing in United States history at the time
• The corporation was purchased by Verizon
Communications with the deal finalizing on
January 6, 2006
 Overview

STEP 03

STEP 02 The company grew rapidly in

the 1990s, after completing a
In 1985, LDDS selected number of acquisitions and
Bernard Ebbers to be its CEO mergers.

STEP 01 STEP 04

The company began as Long On November 4, 1997, WorldCom and

Distance Discount Service (LDDS) MCI Communications announced their
in 1983 US$37 billion merger to form MCI
WorldCom, making it the largest
corporate merger in U.S. history.
• In March 2002, SEC （美国证券交易委员会） announced an inv
estigation into worldcom's past acquisitions and the compan
y's massive $366 million loan to CEO Bernard ebbers.

• During a routine capital expenditure check in June 2002,

the company's internal audit department uncovered $3.852
billion in accounting fraud

• Between 1999 and 2001 WorldcCom generated fictitious

revenues of more than $9 billion. A total of $11 billion in
misstatements was revealed by 2003.

• On July 21, 2002, the company filed for bankruptcy

protection, becoming the largest bankruptcy protection
case in U.S. history.
W o r ld co m s h ar e s f el l be lo w $ 1
Motivation

The turning point came in 2000, when Mr Ebbers took aim at Sprint, another
rival, with an announced $129 billion takeover that was blocked by American and
European antitrust authorities. Some observers and analysts believe it was the
aborted merger that weakened worldcom and set it on a downward path.

In 2001, worldcom, like its peers, suffered from the telecom world slump, with
its stock market value dropping to $25 billion. At the same time, the acquisition of
MCI makes worldcom bear a heavy burden, and the company is struggling. In this
case, in order to maintain the stock price and continue to attract investors,
worldcom company has to take the risk of fraud.
How do they commit financial fraud

1. Adjusting operating expenses to capital expenditures ( 少记“线路成本” )

In October 2000 and February 2001, Chief financial officer John Sullivan concluded
that the line cost (The cost of interconnection with other telecommunications networks)
was too high, and the profits reflected did not meet the earnings expectations.

Sullivan ordered accounting director John yeates to write down （ credit ） $828
million and $407 million in line costs in the third and fourth quarters, respectively, and
debit the same amount of deferred taxes, bad debt provisions and accrued expenses
and other reserve items to keep the loans in balance. Such manipulation inflated
worldcom's reported pre-tax profits by $828m in the third quarter of 2000 and by $407m
in the fourth.
2. Allocation of acquisition costs ( 分摊收购成本 )
This is a common tactic used by public companies in the United States. The approach is: as far
as possible to share the purchase price to the unfinished research and development
expenses( 将收购价格分摊至未完工研究开发支出 ), and as a one-time loss in the acquisition of
the current period to be recognized, in order to achieve in the future period to reduce the
amortization of goodwill or avoid impairment losses( 以达到在未来期间减少商誉摊销或避免减值
损失的目的 ).
3. Decrease the value of non-current asset

When it bought MCI, worldcom reduced the book value of MCI's non-current assets from $14.1bn to
$10.7bn, inflating the goodwill generated by the acquisition by $3.4bn( 此举使收购 MCI 的商誉虚增了
34 亿美元 ). According to MCI's accounting policy, the average depreciation life of non-current assets
is about 4.36 years. Through the provision of $3.4 billion of impairment loss of non-current assets,
WorldCom can reduce the depreciation of about $780 million annually in the next four years after the
acquisition of MCI.

The $3.4 billion in inflated goodwill is amortized over 40 years, or about $85 million a year. After
understating depreciation by $780m a year and overstating amortisation of goodwill by $85m,
WorldCom inflated pre-tax profits by about $695m a year between 1999 and 2001. ( 而虚增的 34 亿美
元商誉则分 40 年摊销，每年约为 0.85 亿美元。每年少提的 7.8 亿美元折旧和多提的 0.85 亿美元商誉
摊销相抵后，世通在 1999 至 2001 年每年约虚增了 6.95 亿美元的税前利润 )
Outcomes

On July 21, 2002, the company filed for bankruptcy protection,

becoming the largest bankruptcy protection case in U.S. history.

On April 14, 2003, the company changed its name to MCI and moved
its office from Mississippi to Virginia. The company will pay the SEC a
total of $7.5 billion in cash and stock to repay defrauded investors.

The restructured company has $5.7 billion in debt and $6 billion in cash, half of which will be spent on
litigation and liquidation. Pre-bankruptcy corporate bonds paid $35.7 to the dollar, while equity
investors were wiped out. （重组后的公司负债 57 亿美金，拥有资金 60 亿美元，这 60 亿美元中的一
半将用于赡后诉讼及清算。破产前公司的债券以一美元兑 35.7 美分获偿，而股票投资者则血本无
归。）
Outcomes

On February 14, 2005, Verizon announced the acquisition of MCI for $7.6 billion.

On March 15, 2005, Bernard Ebbers was convicted of fraud, conspiracy and forgery and
sentenced to 25 years' imprisonment. （ Bernard Ebbers 被判犯有欺诈、共谋、伪造罪，获刑 25
年监禁， Ebbers 于 2006 年 9 月开始服刑，时年 64 岁。）

Other members of the company connected to this case were also found guilty.
Thank you!