WORLDCOM- AUDITING FAILURE

Summary- On June 25,2002, WorldCom announced that it intended to restate

financial statement for 2001 and the first quarter of 2002. It was stated by him that it
had determined certain transfers of the amount totalling $ 3.852 billion during that
period from “line cost” expenses (cost of transmitting calls) to assets account were
not made in accordance in GAAP.
Less than one month later, WorldCom substantially all of its
active U.S subsidiaries filed voluntary petition for reorganization under Chapter 11
of Bankruptcy code. WorldCom Subsequently announced that it had discover an
additional $3.831 billion in improperly reported earnings before taxes for 1999, 2000,
2001 and first quarter 2002. It has also written off approximately $80 billion of the
stated book value of the Assets on the company’s balance sheet at the time the fraud
was announced. On June 26, 2002. the United States securities and exchange
Commission filed a lawsuit captioned Securities and exchange Commission versus
WorldCom, inc., No. 02-CV-4963 (JSR).
On July 3, the honourable Jed S. Rakoff, of the United States District Court for the
southern district of New York, appointed Richard C.Breeden , former chairman of
the SEC, as corporate monitor, with the consent of WorldCom. This committee was
established by the board of directors.
On July 21,2002. The board directed to conduct of full and
independent investigation of accounting irregularities that give rise to the
announced intention to restate and such other matter as we concluded should be
considered, without any limitation. The member of the committee were new to the
board of WorldCom at that time.

Audit Committee (to detect or to neglect) - Committee was established to

conduct relation with Arthur Andersen, the external auditor. In WorldCom’s case,
the lack of independence and awareness of the Board as a whole trickled down to
the audit committee. The committee’s chairman, Max Bobbitt, was very loyal to
Ebbers. Hence, the members of the committee, including Bobbitt, were either
unaware or had known about the fraudulent misstatements for the years 1999, 2000,
and 2001 and choose to ignore it.

Internal Audit

- WorldCom’s Audit Committee failed to meet with the Internal Auditors of

the company, who had the duty to provide the Audit Committee with an
independent and objective view on how to improve and add value to
WorldCom’s operations.
- The internal auditors were provided with limited access to the income
statements and balance sheets with only a partial picture of the company’s
financial situation that prohibited them from properly assessing the finances
of the company.
- The Internal Audit department is intended to be independent and report
directly to the Audit Committee to avoid the influence of top management.
This form of relationship was lacking at WorldCom.

External Auditors

- The external auditor, Arthur Andersen, was the one responsible for providing
an independent opinion of the financial situation at WorldCom for investors
and creditors. The auditing firm also failed to carry out its duties properly.
- Arthur Andersen’s failed to detect the fraud was due in part to negligence
and in part to the tight control top management kept over information.
- Andersen failed to bring this problem to the attention of the Audit
Committee.

Effects on Internal Environment- After the fraud was announced to the public
on June 25, 2002, new measures were taken quickly to reform WorldCom and restore
the public’s confidence in the company. The entire Board of Directors was replaced
with a new Board to guarantee independence and objectivity about management’s
decision. While more than four hundred new finance and accounting personnel were
hired, 17,000 of the existing 85,000 employees at WorldCom were let go. A new
independent auditor was 40 brought in to re-audit the financial statements for the
fraudulent period. The overstated assets were evaluated for impairment and the
goodwill from the previous acquisitions was written down. The use of stock options
was also abolished and restricted stock with full expensing value of equity grants
was implemented A new ethics program was implemented with training programs
for employees to educate them on the manner of their responsibility at the company
and on the accounting issues that may signal an irregularity.

Effects on External Environment- The largest effect on the external

environment was on the investors of WorldCom. The New York State Common
Retirement Fund is the second largest public pension fund in the U.S. It invested the
assets of the New York state and local employee’s retirement system and of the New
York State and Local Police and Fire retirement system. The pension fund lost over
$300 million of its investments in WorldCom.

How it could have been prevented?

The main problem is not following the accounting principles. They should have
followed the following principle:

- Employees should have that courage to highlight the issue to the internal
audit team & should not feel insecure.
- The executive shall change the autocratic culture during even at a small
mistake or any of the data fudging activities.
- Internal audit should be conducted among the employees within the same
department, instead of formal audit and also the same should be cross done
by accounting executive