WorldCom was a large telecommunications company that filed for bankruptcy in 2002. The company's CEO, Bernard Ebbers, focused on growing the company through acquisitions and maintaining high stock prices. When the telecom industry declined in 2000, WorldCom began improperly capitalizing regular operating costs to inflate profits. This included capitalizing line costs that should have been treated as expenses. The improper capitalization allowed WorldCom to misstate billions in expenses as assets, which hid losses and misled investors about the company's financial health. This led to the accounting fraud being uncovered and WorldCom's bankruptcy.

1. WorldCom – The fraud Navin Bafna GMBA08A125 Investment Banking

2. The Background – WorldCom Company previously known as LDDS LDDS – Long Distance Discount Services Became WorldCom in 1995 Business – Telecommunications CEO – Bernard Ebbers Entered the Telecom business by acquiring MFS communication Filed for Bankruptcy on july21, 2002 Revenues – 30 bn US $, Assets – 104 bn US $

3. Business style - Ebbers Known as the “whiz kid” of wall street LDDS became the fourth largest operator in US Mergers & Acquisitions Specialist More than 60 acquisitions All acquisitions done on the power of the rising stock prices of WorldCom in Bourses Focus on the prices of the stock

4. The Problem – Recession 2000 Expense to Revenue ratio – 42 % Margins started decreasing due to industry recession. Estimation of Long term costs monthly Whereas the payment was done several months after the costs are incurred Creation of Accrual liability - outstanding expenses.

5. Accounting Analysis Line costs are to be treated as revenue expenses Future expenses are accounted as Accrual When the actual payment is made the amount is reduced by them and then a matching effect from Cash & Bank. If deficit or surplus in Accruals the same is transferred to income & expense account Thus creation of a provision for Future Expenses

6. Expense Capitalization Costs of extra network capacity. As the future liabilities of revenue nature directly reduces the profit or ‘Bottom line’ Ebbers to maintain the expense revenue ratio reduces the revenue expenses and capitalize them Treating them as an asset which can be used in future

7. Fraud The Accruals created for payments are released thus profits are inflated Doctrine of Conservatism – Account for all future expenses and payments. Line costs which are expenses of revenue nature World com Capitalized these expenses Created Assets out of expenses. Inflated the Asset side.

8. Example

9. 270000 270000 150000 150000 90000 Cash - hand 50000 Shares 20000 MR X Debtor 40000 Expenses 50000 Shares 25000 Dividend Recd 34500 Profit 50000 Plant 25000 Dividend 12000 Depreciation 30000 Goods 75000 Loan 25000 Profit on sale-shares 53500 Expenses 10000 Furniture 100000 Capital 100000 Sales 50000 Purchases Amount Payments Amount Receipts Amount Income Amount Expenses Cash Flow Income and Expenses A/c 243000 243000 80000 Debtor X's 13500 Accruals 90000 CASH 20000 CREDITORS 25000 Shares 34500 PROFITS 40000 PLANT & MCH 75000 LOANS 8000 FURNITURES 100000 CAPITAL 1 BALANCE SHEET

10. 270000 270000 150000 150000 90000 Cash-hand 50000 Shares 20000 Mr. DEBTOR 40000 Expenses 50000 Shares 25000 Dividend Recd 48000 Profit 50000 Plant 25000 Dividend Profit on sale MCH 12000 Depreciation 30000 Goods 75000 Loan 25000 Profit on sale-shares 40000 Expenses 10000 Furniture 100000 Capital 100000 Sales 50000 Purchases Amount Payments Amount Receipts Amount Income Amount Expenses Cash Flow Income and Expenses A/c 243000 243000 80000 Debtor X's 90000 CASH 20000 CREDITORS 25000 Shares 48000 PROFITS 40000 PLANT & MCH 75000 LOANS 8000 FURNITURES 100000 CAPITAL 2 BALANCE SHEET

11. 270000 270000 150000 150000 90000 Cash - hand 50000 Shares 20000 Mr.X DEBTOR 40000 Expenses 50000 Shares 25000 Dividend Recd 88000 Profit 50000 Plant 25000 Dividend Profit on sale MCH 12000 Depreciation 30000 Goods 75000 Loan 25000 Profit on sale-shares =0.00 Expenses 10000 Furniture 100000 Capital 100000 Sales 50000 Purchases Amount Payments Amount Receipts Amount Income Amount Expenses Cash Flow Income and Expenses A/c 283000 283000 40000 EXP CAPITALIZATION 80000 Debtor X's 90000 CASH 20000 CREDITORS 25000 Shares 88000 PROFITS 40000 PLANT & MCH 75000 LOANS 8000 FURNITURES 100000 CAPITAL 3 BALANCE SHEET

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