The paper "Accounting Fraud at Worldcom" is a great example of an assignment on finance and accounting. WorldCom Company was the second-largest long-distance organization after AT& T before its bankruptcy. Before going public in 1989, the company acquired other companies hence making to grow rapidly. The general performance of the telecommunication industry declined in 2000 which in turn led to a decline in stock prices. WorldCom started engaging in financial fraud so as to maintain its stock prices. The chief executive of the WorldCom made the company issue corporate loans so he could use it to meet his margin calls that the bank wanted (Ayeir, 2011).
The company managed to commit financial fraud by capitalizing costs rather than expensing them and also they made the revenues go up by application of improper entries of accounts. Unluckily, the corporate culture of WorldCom was not in favoring the prevention of frauds, and also the external auditors as well as the internal auditors did not work in an efficient manner. At the time of fraud discovery, the company had a fraud worth $3.8 billion and it was estimated that the company assets had been inflated to $11 billion.
The senior management who were involved was legally liable. QUESTION 1 (a) Explain what is meant by earnings management, and outline two motivations for managers to manage earnings. Earnings management is the manipulation of the financial earnings of a company by either direct or applying indirect methods of accounting. There is a high tendency of occurrence earnings management when a company is repeatedly not meeting the expectations of its investors or in financial periods where earnings are volatile.
Earnings management is oftentimes regarded as materially misleading and thus termed to be a fraudulent activity (Cecilia, 2007). Even though all the changes may be abiding by all the laws and accounting standards, they may take paths that are against the laws and standards were primarily trying to constitute. Earnings management is a strategy applied by the company management to intentionally manipulate the earnings of the company so that earnings figures are in line with the pre-determined target. Earnings management is purposively carried out to smooth out income. Offensive earnings management is considered by the Securities and Exchange Commission to be a material and deliberate misrepresentation of earnings results. The 2 competing explications for motivation for earnings management by the management are contracting motivations and capital market motivations. Capital market motivations. Capital market motivations explain that the extensive use of accounting information by shareholders, potential investors, and financial analysts for purposes of valuing stock bring into existence incentives for managing executives of a company to manage with the aim of influencing the short term performance of the stock. Contracting motivations Contracting motivations emphasizes the application of accounting data to control and regulate the contracts that exist between companies and their owners.
Definite and implied executive management rewarding contracts between are applied to rank executive management and owner incentives, and debt agreements are noted to safeguard executive management behavior that might be considered exceptionable by current or potential creditors of the company (Clarke, 2012). Researchers on contracting motivation have recommended that these contracts create incentives for earnings management because of the capability for the committee on compensation and costs related to creditors.
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