Question

WORLDCOM’S CREATIVE ACCOUNTING

In 1996 Betty Vinson landed a midlevel accounting position at WorldCom, a small long-distance telephone company in Jackson, Mississippi. During the next few years, the company grew very rapidly via acquisitions of companies such as Brooks Fiber, a high-speed telecom services company; Skytel, a leading paging firm; and UUNet, a major owner of Internet backbone. Two years after joining WorldCom, Vinson was promoted to a senior manager in the firm’s corporate accounting division, reporting to Buford Yates, Director of General Accounting. She and her staff of 10 compiled quarterly reports and analyzed company operating expenses and loss reserves. The reserves were set aside to cover specific kinds of expenses.

WorldCom’s profits grew rapidly until the middle of 2000 when the telecommunications industry entered a protracted slump. The company’s line costs, lease fees paid to other telephone companies to use portions of their networks, began to increase as a percentage of the firm’s revenue.

This ratio was closely watched by Wall Street as an indicator of the firm’s health. The company’s CEO, Bernard Ebbers, and CFO, Scott Sullivan, warned Wall Street that earrings for the second half of the year would fall below expectations. During the third quarter, due to the failure of some of its small customers, WorldCom was saddled $685 million in unpaid bills.

Vinson, Yates, and Troy Normand, the accountant in charge of monitoring the firm’s fix expenses, searched for ways to cover the shortfall in preparation of the release of the third-quarter report. They were able to locate $50 million that could be applied to the unpaid bills, but that was far cry from $685 million. In October Yates met with Vinson and Normand and told them that Sullivan and David Myers, the firm’s controller, directed him to take $828 million out of the reserve account designated to cover line cost and other items for the telecommunications unit and use it to cover other expenses. That would reduce reported expenses and increase earnings.

Vinson, Yates, and Normand were concerned that the adjustment was not approved accounting transaction. Accounting rules state that reserves can be established only if there is an expectation that a loss will occur in the unit where the reserve is established. The reserve can be depleted only if there is a good business reason for doing so. Because no business reason existed for dipping into the reserve account, Vinson and Normand told Yates that doing so was not following good accounting practices. Yates replied that he was not pleased with the action, but he was assured that this was a one-time transaction and would never happen again; thus, he had agreed to go along with the transfer. On that basis Vinson and Normand agreed to make the transfer.

The company’s third-quarter results were reported on October 26. On that day Vinson told Yates that she was planning to resign. Normand expressed similar inclinations. Ebbers got wind of the unrest in the accounting department and told Myers that the accountants will never again be placed in such an untenable position. Myers and Sullivan met with Vinson and Normand several days later. Sullivan explained that he was working on the firm’s financial problems. He appealed for them to stay until he was able to get things under control and then they could leave if they wanted to, but he needed them to right the ship.

Normand stated that he was concerned that he would be held liable for making the accounting changes. Sullivan told the two that nothing they had done was illegal and that he would resume all responsibility for their actions. He further stated that the profit projections for the coming quarter had been cut in half and an accounting manipulation would not be needed. Following the meeting, Vinson’s resolve to find another position weakened. She told her husband about the meeting and her concern over the accounting irregularities, and he urged her to quit. But she was the chief breadwinner of the family earning more than her husband’s $40,000 a year, and her job provided the family health insurance. She was also worried about finding a new position because she was a middle aged woman.

Vinson rationalized that because Sullivan was considered one of the top CFOs in the country and had approved the transaction, it must be all right. After talking to Normand about how difficult it would be to find another job, both decided to stay. During the first quarter of 2001, things got worse. There were no reserves to tap and the funds gap was $771 million.

Sullivan ordered that the amount of line costs be transferred from an operating expense account to a capital expense account. That moved them from a direct expense against income to a depreciable expense, thus increasing short-term “profitability”. Vinson was shocked with this directive. She knew that line costs were operating costs that could not legally be counted as a capital expense.

In fact, Yates had balked at the plan when Myers had told him about it, and Myers had told Sullivan that the transfer could not be justified when he was given the order. However Sullivan told Myers that the transfer was WorldCom’s only way out of it’s financial troubles. Vinson felt trapped. The threat to resign had already been used and she was afraid to quit her job before she had another one. Vinson, Normand, and Yates met to discuss the order but did not resolve the issue. Vinson decided to update her resume and begin looking for another job.

Vinson, Normand, and Yates finally went along with the order to transfer the expenses. To do so they had to decide which of five capital expense accounts to transfer the expenses to. Myers met with them during this process and they all expressed how unhappy they were with the transaction. But they felt they had to do it to save the company. Vinson executed the entries to transfer the $771 million, changing dates of numerous transactions in the computer. The same process took place during the following three quarters: $560 million for the second quarter, $743 million for the third quarter and $941 million for the fourth quarter. Early the next year, Vinson was promoted from senior manager to Director of Management Reporting, and Normand was promoted to Director of Legal Entity Accounting.   

Answer these QUESTIONS

a. Who are the stakeholders in the case?

b. What actions should Vinson have taken and when? What prevented her from taking such actions?

c. What actions should Vinson’s colleagues have taken?

Answer 1

a. For a corporate, there are multiple stakeholders. Stakeholder is anyone who is affected by the financials or operations of a firm. For worldcom, its stakeholders who were all affected in one way or the other by its creative accounting practice were:

i. Customers

ii. Vendors

iii. Government

iv. Tax authorities

v. Employees and management

vi. Shareholders

vii. Analysts and credit rating agencies etc.

b. For Vinson, it was like sailing in a sinking boat and trying to drown the people to save the sinking ship. In this case, the sinking ship was Worldcom and the people were its stakeholders. As the captain of the ship i.e. the manager of accounting practices on which the entire world relies for information, a conscious decision should have been made. However, she was in an ethical dilemma and also had a conflict of personal interests with professional duties. She could have taken the following actions:

i. Resigned and declined to make the wrongful changes.

ii. Communicated with the appropriate regulatory authorities and be a whistleblower.

iii. Requested the management to hire a consultant for a turnaround or restructuring exercises.

c. Vinson’s colleagues were equally responsible for the accounting malpractices. All of them failed to take any action despite being convinced that it was not right. However, in retrospect, they could have taken the following actions:

i. Resigned from the post and convinced Vinson to do the same rather than the opposite.

ii. Go to the regulatory authorities or the accounting bodies and sought consultations on the same.