Sprinkle it around so no one will notice. That’s apparently what telecommunications giant WorldCom did in improperly accounting for some expenses over the last year. Eventually, though, someone did notice–it’s hard to hide $3.8 billion.
This is a massive case of apparent accounting fraud, but it’s also a fairly simple case.
Under U.S. accounting rules, companies are allowed to differentiate between buying a factory, for example, and buying pencils and paper clips. That’s true even if the company spent, say, $100 million on each in a given year.
One is an investment that is going to produce benefits for a long time. As such, it’s considered a capital expense that legitimately can be divided up and accounted for over years. The other is an ongoing operating expense and must be counted as such right away.
Beginning last year, WorldCom began spreading the cost of ongoing telecommunication system expenses (think pencils and paper clips) among capital expense accounts (think factories).
That reduced stated costs and boosted the bottom line. Properly accounting for those $3.8 billion in expenses wipes out every penny–and then some–that WorldCom told investors it made over the last five quarters.
Unfortunately for those shareholders, this revelation comes much too late. WorldCom’s stock is now trading below a buck a share and the company may soon be forced to file for bankruptcy protection.
This isn’t a gray area. It’s Accounting 101. What WorldCom did doesn’t follow Generally Accepted Accounting Principles. Given the flawed accounting that has already been revealed in previous financial scandals, outraged investors may wonder what credibility GAAP still holds. But even by the late 1990s pushing-the-envelope ethos, this still looks like pretty straightforward cooking the books.
What links this crime to the murky mess that is Enron and the Tycos, Global Crossings, Adelphias, Qwests and the rest is that they all needed phenomenal, relentless growth to keep the music going. Investors were buying growth and potential, dazzled by the promise of a future with no downside.
That growth hid a multitude of sins, but it came to a screeching halt with the bursting of the tech bubble. Some companies resorted to keeping the illusion of growth going by hiding the truth in phony accounting.
It hardly matters what motivated this. Some may have been true believers in a limitless future. Others were caught up in the frenzy of boom and bubble or a frayed ethos that they were justified because “everyone” was doing it or a desire to meet Wall Street’s unrealistic expectations or to enrich execs by keeping stock prices artificially high.
The result is a loss of trust. In the booming ’90s, there was no bad news. No profits. No problem. Now there is no good news. But that will change once it becomes clear to investors that the guilty will be punished.
