1. 1. Accounting Scandals onWorldcom & Enron Presented by:- Abhishek Bansal
2. 2. WORLDCOM
3. 3. WORLDCOM: In 1998, the telecommunications industry began to slowdown and WorldComs stock was declining. CEO came underincreasing pressure from banks to cover margin calls on hisWorldCom. Beginning in 1999 and continuing through May2002, WorldCom used shady accounting methods to mask itsdeclining financial condition by falsely professing financialgrowth and profitability to increase the price of WorldComsstock.
4. 4. HOW THIS HAPPEN The fraud was accomplished in two main ways. First,WorldComs accounting department underreportedline costs (expenses with other telecommunicationcompanies) by capitalizing these costs on the balancesheet rather than properly expensing them. Second,the company inflated revenues with bogus accountingentries from corporate unallocated revenue accounts.
5. 5. How the Fraud took place NET INCOME xxx (Huge Increase) Revenues xxx COGS xxx (no change) (no change)CFOs directionsaffected the income statement:Fees companies phoneComputer expenses:networks: xxxxxx (Huge Decrease)(Huge Decrease)
6. 6. Overstating Asset Frauds (WorldCom) Overstatement of current assets(marketable securities) Overstating pension assets Capitalizing as assets amounts that should be expensed Failing to record depreciation/amortization expense Overstating assets through mergers and acquisitions Overstating inventory and receivables
7. 7. HOW WAS DISCOVER The first discovery of illegal activity was by WorldComsown internal audit department who uncovered $3.8 b. ofthe fraud in June 2002. The companys audit committeeand board of directors were notified of the fraud.The Securities and Exchange Commission (SEC)launched an investigation. By the end of 2003, it wasestimated that the companys total assets had beeninflated by around $11 billion.
8. 8. Largest Bankruptcy FilingsCompanyAssets (Billions) When Filed1. WorldCom$103.9July 20022. Enron $63.4 Dec. 20013. Conseco $61.4 Dec. 20024. Texaco$35.9 April 19875. Financial Corp of America $33.9 Sept. 19886. Global Crossing $30.2 Jan. 20027. PG&E$29.8 April 20018. UAL $25.2 Dec. 20029. Adelphia$21.5 June 200210. MCorp$20.2 March 1989
9. 9. CONSOLIDATING BALANCE SHEET (10K SEC) (IN MILLIONS) AT DECEMBER 31, 2000 WORLDCOM MCI GROUP ELIMINATIONS WORLDCOMCurrent assets......................................$ 9,068$ 2,312 $(1,625)$ 9,755Property and equipment, net......................... 35,1772,246--37,423Goodwill and other intangibles...................... 36,6859,909 -- 46,594Other assets........................................ 4,963168--5,131Total assets......................................$85,893 $14,635$(1,625)$98,903Current liabilities.................................$14,213$ 5,085 $(1,625)$17,673Long-term debt...................................... 11,6966,000--17,696 Noncurrent liabilities.............................. 3,6481,087-- 4,735 Minority interests.................................. 2,592-- -- 2,592 Company redeemable preferred securities...... 798----798Shareholders investment............................ 52,9462,463 -- 55,409Total liabilities and shareholders investment.... $85,893 $14,635$(1,625) $98,903============================ $ 9,755 / 17,673=(7,918) WORKING CAPITAL OR .55 CURRENT RATIOTHE HIGHER THIS RATIO THE BETTER TO MEET THEIR CURRENT OBLIGATIONS.
10. 10. WorldCom Statement of Cash flowCash flows from operating activities: 20002001Net income Operating Activities $4,153$1,501Originally Reported Revised as of April 15, 20042000 20012002NNet loss $ -48,909 -15,597 -9,173
11. 11. HOW ENDEDOn July 21, 2002, WorldCom filed for Chapter 11bankruptcy protection, the largest such filing in UnitedStates history. The company emerged from Chapter 11bankruptcy in 2004 becoming MCI. On March 15, 2005Bernard Ebbers (CEO) was found guilty of all charges andconvicted on fraud, conspiracy and filing false documentswith regulators. He was sentenced to 25 years in prison.I dont belief this happen to me .
12. 12. What do these dates have incommon? December 2, 2001 Enron declares bankruptcy July 19, 2002MCI WorldCom declares bankruptcy August 31, 2002Arthur Anderson agrees to stop auditing public companies
13. 13. How did this happen?Corporate IssuesAudit Firm Issues Earnings pressure Dependency on consulting fees Lack of mandated disclosure Assumed good intent of theirof company reporting model client Minimal oversight into Inability to continuously monitorcorporate business practices a companys internal controls No documented or enforced Unable to identify violations ofinternal controlsinternal controls
14. 14. How Did GovernmentRespond?Sarbanes Oxley Act
15. 15. Sarbanes Oxley Act Highlights Section 103: Your auditor (and therefore, you should)maintain all audit related records, including electronicones, for seven years. Section 201: Firms that audit your companys bookscan no longer provide you with IT related services. Section 301: You must provide systems or proceduresthat allow employees to communicate effectively withthe audit committee.
16. 16. Sarbanes Oxley ActHighlights (continued) Section 302: Your CEO and CFO must signstatements verifying the completeness and accuracy offinancial reports. Sections 404 CEOs, CFOs and outside auditors mustattest to the effectiveness and accuracy of financialreports. Section 409: Companies must report materialchanges in their financial conditions on a rapid andcurrent basis. The act calls it real-time disclosure butis unclear on what it means.
17. 17. SarbanesOxley Act SarbanesOxley Law Behavior ConsequenceAny CEO or CFO who recklessly violates hisFine of up to $1,000,000 and/or up to 10 yearsor her certification of the companys financial imprisonment.statements.Fine of up to $5 million and/or up to 20 yearsIf willfully violates.imprisonment.Any person who corruptly alters, destroys,conceals, etc., any records or documents with Fine and/or up to 20 years imprisonment.the intent of impairing the integrity of the recordor document or use in an official proceeding.
18. 18. Sarbanes - Oxley Impact onInformation Systems
19. 19. The 3 Cs of Sarbanes-Oxley CEOs, CFOs and CIOsThe jobs of the CEO, CFO & CIO got tougher onJuly 30, 2002 -- the day the Sarbanes-Oxley Actwas signed. The legislation requires significantchanges to financial practices and corporategovernance, and touches all corporate areas --including technology. For the first time ever, theCFO and CEO can look a CIO in the eye and say,Guess what, youre on the hook with us.
20. 20. Benefits of the New Oxley Act 1. Increased confidence of CEO/CFO in meeting requirements 2. Improved coordination of Company Management Team 3. Improved and clarified Corporate Governance process 4. Systematized process for early identification of business risks/ whistle blowing issues/incident management 5. Systematized approach to dealing with change (i.e., transactions, personnel, accounting principles, internal controls and operating procedures) 6. Increased operational effectiveness
21. 21. ENRON
22. 22. The Enron Scandal The Enron scandal was a corporate scandal involvingthe American energy Enron Corporation, the worldsleading energy company and the accounting, auditing,and consultancy firm Arthur Andersen. On October 16, 2001, in the first majorpublic sign of trouble, Enron announces a huge third-quarter loss of $618 million.
23. 23. The Enron Scandal On October 22, 2001, the Securities andExchange Commission (SEC) begins aninquiry into Enrons accounting practices. On December 2, 2001, Enron files for bankruptcy, the largest bankruptcy in US history up to that time
24. 24. Consequences Thousands of employees lost their jobs and even theirlife savings in 401(k) plans tied to the energy companysstock. Disastrous falling down on the whole stock marketduring the following months, especially in the financialservice industry. Arthur Andersen, which at the time was one of the fivelargest accounting firms in the world, was dissolved.
25. 25. How this happen The company used shortcomings of Rule-Based USGAAP , special purpose entities, and poor financialreporting to hide billions in debt from failed dealsand projects. Enrons audit committee failed to follow up onhigh-risk accounting issues Andersen was pressured by the company to ignoreaccounting practices.
26. 26. How this happen.Continued 1993-2001: Enron senior management used.Complex and foggy accounting schemes to reduce Enrons tax payments; to inflate Enrons income and profits; to inflate Enrons stock price and credit rating; to hide losses in off-balance-sheet subsidiaries; to engineer off-balance-sheet schemes to directmoney to themselves, friends, and family; to fraudulently misrepresent Enrons financialcondition in public reports.
27. 27. Profit to Enron from all this? $10 million in guarantee fee + fee based on loanbalance to JEDI. A total of $25.7 million revenues fromthis source. Increase in price of Enron stock held byJEDI. Enron recognized $126 million in the first quarter of 2000 from this. But everything began to fall apartwhen Enrons share price started todrop in Fall 2000.
28. 28. Generally Accepted Accounting Principles prior to 2002. Auditing companies often consult for thecompanies they audit (conflict of interest). Audit company partners often later acceptjobs from their client companies. Companies often retain the same auditingcompany for long periods of time. Auditing companies have been allowed to policethemselves. Appointment of auditor company is in theory byshareholders but in practice by senior management
29. 29. THANK YOU