Identifying and Describing the Ethical Issue. Worldcom - Essay Example

? Identifying and Describing the Ethical Issue A) The major ethical and legal issue regarding Worldcom's accounting manipulations stem from the fact that the company decided to treat $3.8 billion in everyday expenses from its operating accounts relating to a Sprint merger as capital investments. The company manipulated the company's financial results in order to meet Wall Street expectations and artificially inflate their stock price amidst declining financial performance. Treating operational expenses as capital investments inflated the company's operating income since expenses are supposed to be accounted for in the quarter that they are incurred, instead of being spread out over a period of years. In this case this illegal accounting practice allowed Worldcom to treat operational expenses that should have been fully recognized each operating quarter as a long term capital expenditure, where related costs are expensed during the operating lifetime of a specific asset instead of being accounted for during one specific accounting period. As a result three former Worldcom executives were convicted of accounting fraud. David Myers, the third executive in command and Worldcom's former controller, was convicted to one year and one day in prison. The former controller received a much lesser sentence than the other executives due to his early admission of responsibility and remorse as well as extraordinary cooperation with the government in exposing the extent of the fraud including the major players involved (Cbsnews, 2009).Scott D. Sullivan, Worldcom's former chief financial officer, was convicted to five years in prison as part of a plea agreement in which he testified against the company's CEO Bernard J. Ebbres. Bernard Ebbres was eventually convicted to 25 years in prison for the Worldcom accounting fraud ultimately leading to the company's bankruptcy (Sullivan, 2013). In 2001Worldcom reported $7.7 billion in cash flow from operating activities instead of the true amount of $4.6 billion as a result of misrepresenting $3.8 billion of operational expenses resulting from the Sprint merger. Mr. Sullivan failed to inform Arthur D. Anderson, the firm's accountant at the time, of his decision to treat the expenses as capital expenditures in a clear and blatant attempt to disguise his illegal accounting manipulations from the accounting firm. This deceptive accounting manipulation resulted in the company overstating its EBITDA (earnings before interest, taxes, depreciation and amortization) which is the barometer that most investors utilize to evaluate a company's overall financial health and performance. As the company started the accounting fraud in the first quarter of 2001, Worldcom reported an EBITDA of $2.1 billion instead of $1.4 billion. By the end of 2001 the company had originally reported an EBITDA of $10.5 billion instead of the correct figure of $6.3 billion. Consequently Worldcom reported a profit of $1.4 billion for 2001 and $172 million in the first quarter of 2002, where in reality the company had loses amounting to billions during that accounting period (Eichenwald, 2002). This accounting fraud directly violates the accounting principles of reliability in accounting practice, as well as the “full disclosure” and the “matching” principle, where all expenses incurred during an accounting period are matched with the period revenues which it directly affects (Businessweek, 2002). Explaining Alternative Courses of Action and Related Trade-Offs B) Troy Normand, as the manager for the corporate reporting department, was responsible of the accuracy and reliability of corporate financial reports. Based on his testimony and full account of the conversation with Scott Sullivan regarding the events that transpired, we can conclude that Mr. Normand was in full knowledge and understood the implications and illegal nature of the accounting treatment given to the Sprint merger expense accounts. Therefore his actions regarding the treatment of the Sprint expense accounts was both unethical and illegal based on GAAP (generally accepted accounting principles) as well as legal reporting requirements outlined by the FASB (Financial Accounting Standards Board) (Kieso & Weygandt, 1998). C) Troy Normand as an accountant should have insisted to Mr. Sullivan to provide concrete evidence that the expense accounts were overstated and to launch an internal inquiry to prove the accuracy of the expense accounts. If none of these requirements were accepted by Mr. Sullivan his responsibility should have been to follow the chain of command and report his concerns directly to the CEO Bernard J. Ebbres, and if no satisfactory result was achieved he should have reported the findings directly to the Board of Directors. Until a satisfactory alternative to an internal review regarding the treatment of the expense accounts was presented, Mr. Normand was obligated to continue to treat the Sprint expense accounts as an operational expense. Additionally he was obligated to provide notes in the financial statements providing full disclosure regarding the internal review being performed by the company. Of course the company would have incurred in operating losses for 2001 and first quarter 2002, but it would have provided stakeholders with the transparent, accurate and reliable financial information necessary to derive investing or financing decisions (Garrison & Noreen, 2003). Identifying Major Stakeholders and Explaining the Related Consequences to Major Stakeholders D The major stakeholders in this case would be the common stockholders, bondholders, and financial institutions providing financing to Worldcom. Inevitably as a result of the Sprint acquisition and the unforeseen expenses derived from this merger the company would have ended up reporting operating losses for 2001 and first quarter 2002. Consequently investors as well as financial institutions would view the stock as a riskier investment and much less desirable investment compared with the historic financial performance of Worldcom. The stock price would have dropped significantly during this period, but it would have provided an accurate picture of its finances and ability to continue operations. Additionally the price of its corporate bonds would have dropped due to the significant additional risks related to the Sprint acquisition and operational efficiency of the merger. Finally the overall costs of acquiring additional capital for operations or expansion from financial institutions would have increased significantly due to higher interest rates requirements for loans and lines of credit. Ultimately for the company it would have been better to provide stakeholders with accurate financial reporting information instead of destroying the reputation of Worldcom as well as eroding the reliability and trust investors and stakeholders place in the financial markets and corporate financial reporting as a whole. References Businessweek.com (2002). How to Hide $3.8 Billion in Expenses. Businessweek. Retrieved November 9, 2013 from http://www.businessweek.com/stories/2002-07-07/how-to-hide-3-dot-8-billion-in-expenses Cbsnews.com (2009). Former Worldcom Exec Gets Prison. Retrieved November 9, 2013 from http://www.cbsnews.com/2100-201_162-770079.html Eichenwald, K. (2002). 2 Ex-Officials at Worldcom are Charged in Huge Fraud. The New York Times. Retrieved November 9, 2013 from http://www.nytimes.com/2002/08/02/business/2-ex-officials-at-worldcom-are-charged-in-huge-fraud.html?pagewanted=all&src=pm Garrison, R., Noreen, E. (2002). Managerial Accounting (10th ed.). Boston: McGraw-Hill Irwin. Kieso, D., Weygandt, J. (1998). Intermediate Accounting (9th ed.). New York: John Wiley & Sons. Sullivan, S. (2013). Scott Sullivan biography. Retrieved November 9, 2013 from http://www.biography.com/people/scott-sullivan-235388 Read More