Worldcom Case Study Summary

1) There are two types of qualitative characteristics of financial statements: fundamental and enhancing.

Fundamental qualitative characteristics include relevance and faithful representation. Relevance has an impact on decisions made by users based on its predictive value and confirmatory value. Relevance is affected by materiality, which is critical information or information with significant importance. The same with relevance, materiality affects the decision-making of users.

Faithful representation means that economic phenomena should be presented in a most appropriate (faithful) way. For this, financial statements must be complete, neutral and free from error. Complete financial statements include all the necessary information; neutrality

The most obvious one was the relevance. It is clear that WorldCom manipulated its accounting records and books, by making unsanctioned entries and inserting fraudulent numbers. As an example, I can show deliberate overstatement of revenue and pre-tax income, writing-off reported assets, accrual releases, the misstatement and capitalization of line costs (unused capacity expenses), the transfer of bad debt expenses to boost earnings, removal of corporate unallocated revenue items from corporate unallocated schedule and non-documentation of computer expenses. The information provided by WorldCom and the numbers in the statements were irrelevant and therefore did not reflect on the real financial position of the company. This significantly affected the ability of users to predict the future cash flows of WorldCom - so, the predictive value of relevance was violated. In addition, the confirmatory value of relevance was violated as well, because the financial statements did not allow the users to reconfirm or reassure their previous knowledge about the financial position of WorldCom. Relevance is affected by materiality; WorldCom did not show its real revenue (overstatement of actual pre-tax income)and costs (capitalization of significant amount of costs) and the fact that it was making serious losses. This omission of critical information had significant influence on investment decisions of the

Both of them will affect the decision-making of users of financial statements of WorldCom. The reported results will not be reliable. The reasons are the same as well: inflation of wealth and increase of the company value. In any case, both the judgment and fraudulent reporting will lead to incorrect information about the earnings of WorldCom. What is even more interesting, in many cases companies start with earnings management and later on this transforms to accounting fraud; once again, the line to be crosses is GAAP and this line is crossed when manipulations take their place. As per the case specifically, I think that the management was engaged more in accounting fraud than profit smoothing. Top management (Sullivan and his direct reports) were engaged in "cooking the books" to improve financial