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Worldcom FS Fraud: Accounting Anomalies

BUS707 – Applied Business Research

Structured Literature Review 

This assessment is designed to allow students to identify relevant sources for their research and undertake review on a theoretical concepts/constructs that has real world business implications. This assessment relates to Learning Outcomes a, b and d

This article collections and structured review set a basis for literature review section of Research Proposal in Assessment 4. Following consultation with the lecturer or tutor, the students research the field to find four academic articles relating to the research topic as proposed in Assessment 2. The articles must be from 2010 onwards, and all articles must be full papers (not research note or book reviews) sourced from refereed academic journals.

The structured literature review should addresses the following information: 

1. Brief summary of the theory and progression in the field (i.e how has the theory developed) 

2. Common themes/findings across the four articles 

3. Different themes/findings across the four articles 

4. Managerial implication of the four articles 

5. Study limitations and future research direction proposed in the four articles.


Answer

Financial Statement Fraud

Summary:

Generally, the financial statement fraud means the asset, revenue and profit overstating or liability, expense and loss understating in a manipulative way. The intentional misrepresentation of operational data can use skipping or omit important amount of information from the regular disclosures to mislead the key FS users. Therefore, the major aim is to mislead the key investors, stakeholders with the misstatement in the financial statement. In this context, the cash flow statement, balance sheet or income statement can be falsified to create the misleading environment for the major users. Usually, the misleading actors do the same for personal gain. That means the self-interest theory can misrepresent the information in the financial statement. Moreover, if the company is facing poor business conditions than upper management sometimes generates misleading statement to show good operational performance for the investors to make them happy. In the case of management fraud schemes, the major focus is on the accounting terms which means the management can manipulate the accounting schemes to show that everything is working well. In this context, it is significant that FS fraud can be of different types. The major types involve misrepresenting the sales, misleading expense recognition, false asset valuation, concealed liabilities as well as non-suitable disclosures. In this case, the primary focus is on the Worldcom FS fraud where the former CEO was involved in the accounting anomalies in terms of personal gain in the business. However, the situation also questions the internal controls and corporate governance of Worldcom. 

Common & Different themes:

Common themes:

From the historical data, it is clear that the late 90s to the initial part of 2000 have observed a fundamental shift in the business environment due to two top accounting scandals involving Worldcom and Enron. In this context, the financial crisis of 2008 is significant as pre-2008 these fraudulent schemes were more visible and the engagement of big firms has made the accounting environment highly uncomfortable. It is also true that before the issue no public company was under standard financial scrutiny where the market sentiment involves both investors and the government. The pre-2000 crisis time has made it clear that major public and private companies were dealing with outdated honor systems. The fraud cases had helped the government change the major accounting legislation in terms of checks and balances. Those financial scandals and market sentiment have introduced the SOX act 2002 to help the internal and external auditors as well as the terms in the financial statement. The SOX legislation has aimed the disclosure of accurate information in the FS where the activities of the CEOs (former) in both firms (Worldcom and Enron) were considered (Ashraf, 2011). The historical background suggests that Worldcom has filed as an incorporated company since 1983. This company was famous for its long distance discount services for the domestic customer base. In this context, it is important that the telecommunication giant had an aggressive attitude in terms of merging and acquisition policy. The merging of Advantage Inc during 1995 has made the Worldcom a publicly traded company with the name LDDS Worldcom. The merger was involved in the write off of large expense in the balance sheets to fraudulently evade the pending debts for liquidity and lending security. The 2002 has observed the announcement of FS revision to tune 3.85 million. The CEO Ebbers as a large shareholder was responsible for the 400 million dollar loan to save the personal belongings in the business. However, the protective measure of the CEO failed due to the stock devaluation of the company. The WorldCom based article identifies how at that crucial moment the CEO position was changed introducing the new CEO Sidhmore. But that was not completely helpful in the bankruptcy pressure from the financial environment. The inevitable bankruptcy agreement settled to make Worldcom pay for 750 million dollars along with restating the FS for the key investors. In this context, the fraud schemes article is significant due to the introduction of classical fraud theory. According to the theory, there are three key cognitions which involve the people in financial fraud. The three cognitions are the three vertices of the fraud triangle and determined as pressure, opportunity, and rationalization (Albrecht et al., 2015). This article mainly covers the hypothetical implications on the financial fraud where the background is highly important. As an example, the first element or perceived pressure refers to the external or internal force which directs the actor's intensity, movement, persistence and it is related to the basic needs of the actor. In the Worldcom, the CEO was eyeing personal gain which has led such fraudulent scheme. However, the second element or opportunity identifies that the actor must have adequate space to construct the fraud where the system and structure of the organization become visible.  So, the reasonable opportunity includes the recognized ways an actor can escape the fraud cases according to the controls in the organization. Finally, the third element or rationalization covers the ethical perspective of the organization. The cognitive dissonance is usually compensated by the core values of the actor where moral standards are key factors. However, the collusion theory with multiple fraud players introduces the power and decision points where the corporate governance participant article is important. In this case, the major aim is on the internal environment and how the control gaps help the financial fraud cases. Covering the COSO report and MIS survey it is derived that effective CG can detect FSF quickly considering the capital market integrity, anti-fraud policies as well as roles and responsibilities of CG actors. Again, the article has identified the harmful effects of FSF including objectivity, quality, transparency, career, economic crisis and auditing efficacy. So, the solutions to detect and prevent fraud schemes cover proxy access of directive SEC, consistent voting for directive elections, BOD disclosures according to section 14B of SEC 1934, broker right determination according to exchange act and presence of standard risk committee (Rezaee & Kedia,2012).

Different themes:

 In the case of the experimental testing article, the major emphasis is on the SOX act, audit and SEc based internal control which somehow seems similar to the corporate governance article. However, this article introduces the gender bias considering the female manager and their performance more ethical without direct proof. The performance and opportunity are considered as the major theme behind the FSF but except the Worldcom article, none of the articles state the solutions of FSF with direct Worldcom example. According to this article the internal control system of the Worldcom, as well as other companies with the same issue, should pay attention to the control environment, accounting system and control activities for the solution. As an example, the audit system should rely on fair transactions, proper authorization, completion, clarification, timing, validation, and summarization of the FS. The solution structure is given below:

The solution structure for financial fraud

Source: (Ashraf, 2011)

Managerial Implication:

The term managerial implications refer to the summary of the results in terms of actions. All the four articles are somehow cover the fraud triangle, SOX, SEC and auditing standards where corporate governance is actively involved. However, the Worldcom article has directly identified the case-specific issues and the lesson learned section provides direct measures for the FSF. In the other three articles, the expressed information is mostly generalized but the fraud schemes article has presented the gaps properly which can be helpful for similar fraud cases. The term collusion is successfully added to understand the relationship between conspirators where the power of decision making seems supportive of the corporate governance article. Finally, the experimental testing article seems more hypothetical and experiment based where major emphasis is on the analytical results than the real-life case points.

Limitations:

The Worldcom article seems the most descriptive one informing the background, overall scandal, blaming point, features, new acts as well as lessons from the issue. But the article misses the generalized view of fraud issue and implications. Moreover, it is focused on the specific type of fraud Worldcom faced which limits the article as the future scope and issues are not covered here related to the fraud case. In the fraud scheme article power is the key point which is expressed through different organizational terms and theories. That means it has missed the importance of internal controls as well as audit standards in the fraud cases. The power element is somehow limited to the internal environment which means the external environment issues like the financial crisis, regulation changes cannot be dealt with in this article. The experimental testing article is very theoretical where examples seem vague and cannot complement real issues. Finally, the corporate governance article is limited in terms of external environment and hierarchical structure.

Interrelationships:

The context and relationship among the four articles seem clear as all of them deals with FSF. However, the term fraud triangle, corporate governance, economic crisis and internal controls have appeared repetitively indicating that Worldcom had the poor internal structure where the functions were not well defined. Moreover, the four articles have confirmed that failure of disclosures mean certain gaps in the business and internal communication where the role of BOD was not protective (Woolley, 2016). Moreover, the BOD of Worldcom especially, the CEO was more into personal gains than helping the company profit and productivity. This somehow determines the conflicts of interest in the business environment where ethics or moral standards seem missing. 

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