Case 2-1 Worldcom

John Uy

Case 2-1

WorldCom

Question 1: What is the difference between accrual earnings and cash earnings? In addition to the effect on accrual earnings of capitalizing the line costs, how might the treatment mask the true nature of operating cash flows?

Accrual earnings are income that has been by a company, but has yet to be received in the next or future periods. Cash earnings are revenues from receipts or payments made in cash. In the case of WorldCom, the misstatements of WorldCom’s operating expenses and earnings was done to disguise their real operating performance by illicitly transferring certain costs that should be expensed to capital costs as “prepaid capacity.” Since amortization expense and net income is overstated, operating cash flows is overstated, misleading the stakeholders into thinking that the company had higher total assets, higher net income, and higher profitability when in reality they were losing billions of dollars.

Question 2: Identify the stakeholders in the WorldCom case and how their interests were affected by the financial fraud.

Stakeholders:

1. Investors – WorldCom’s illegal treatment of booking operating expenses as capitalizable costs violated GAAP principles of not disclosing the financial position of the company honestly to external users, thereby misleading and defrauding the investors and resulting in a $30 billion loss.

2. Employees and Stockholders – When WorldCom filed for bankcruptcy, the employees lost their severances and stock benefits, as well their jobs and financial security. Thousands of stockholders lost millions of dollars from the decline in WorldCom’s stock value.

3. Creditors and Suppliers – As a result of its bankcruptcy, WorldCom also failed to pay their debt to creditors and suppliers, resulting in a huge loss in their net income.

Question 3: Use ethical reasoning to compare the actions of Cynthia Cooper in the WorldCom case to those of Sherron Watkins in the Enron case, discussed...