MIDLANDS STATE UNIVERSITY

FACULTY OF BUSINESS SCIENCES

DEPARTMENT OF ACCOUNTING SCIENCES

SESSIONAL EXAMINATION
FEBRUARY 2022
DURATION: 3 HOURS

100 MARKS

INSTRUCTIONS
1. Attempt all questions
2. Begin an answer to a new question on a new page.
3. Make and state any necessary assumptions in answering any question
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Question 1 (40 marks)

WorldCom Case Study

The Growth through Acquisition Merry-Go-Round

As acquisition process began to unfold, the analysts' recommendations, coupled with the
continued rise of the stock market, made WorldCom stock desirable, and the market's view of
the stock was that it could only go up. As the stock value went up, it was easier for
WorldCom to use stock as the vehicle to continue to purchase additional companies. The
acquisition of MFS Communications and MCI Communications were, perhaps, the most
significant in the long list of WorldCom acquisitions. With the acquisition of MFS
Communications and its UUNet unit, "WorldCom suddenly had an investment story to offer
about the value of combining long distance, local service and data communications." In late
1997, British Telecommunications Corporation made a $19 billion bid for MCI. Very
quickly, Ebbers made a counter offer of $30 billion in WorldCom stock. In addition, Ebbers
agreed to assume $5 billion in MCI debt, making the deal $35 billion or 1.8 times the value of
the British Telecom offer. MCI took WorldCom's offer making WorldCom a truly significant
global telecommunications company. All this would be just another story of a successful
growth strategy if it weren't for one significant business reality--mergers and acquisitions,
especially large ones, present significant managerial challenges in at least two areas. First,
management must deal with the challenge of integrating new and old organizations into a
single smoothly functioning business. This is a time-consuming process that involves
thoughtful planning and considerable senior managerial attention if the acquisition process is
to increase the value of the firm to both shareholders and stakeholders. With acquisitions in
six years and several of them large ones, WorldCom management had a great deal on their
plate. The second challenge is the requirement to account for the financial aspects of the
acquisition. The complete financial integration of the acquired company must be
accomplished, including an accounting of assets, debts, good will and a host of other
financially important factors. This must be accomplished through the application of generally
accepted accounting practices (GAAP).

WorldCom's efforts to integrate MCI illustrate several areas senior management did not
address well. In the first place, Ebbers appeared to be an indifferent executive who "paid
scant attention to the details of operations."; For example, customer service deteriorated. One
business customer's service was discontinued incorrectly, and when the customer contacted
customer service, he was told he was not a customer.

Ultimately, the WorldCom representative told him that if he was a customer, he had called
the wrong office because the office he called only handled MCI accounts. This poor customer
stumbled "across a problem stemming from WorldCom's acquisition binge: For all its talent
in buying competitors, the company was not up to the task of merging them. Dozens of
conflicting computer systems remained, local systems were repetitive and failed to work
together properly, and billing systems were not coordinated."

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Poor integration of acquired companies also resulted in numerous organizational problems.
Among them were:

 Senior management made little effort to develop a cooperative mindset among the
various units of WorldCom.
 Inter-unit struggles were allowed to undermine the development of a unified service
delivery network.
 WorldCom closed three important MCI technical service centers that contributed to
network maintenance only to open twelve different centers that, in the words of one
engineer, were duplicate and inefficient.
 Competitive local exchange carriers (Clercs) were another managerial nightmare.

WorldCom purchased a large number of these to provide local service. According to one
executive, "the WorldCom model was a vast wasteland of Clercs, and all capacity was
expensive and very underutilized. There was far too much redundancy, and we paid far too
much to get it." Regarding financial reporting, WorldCom used a liberal interpretation of
accounting rules when preparing financial statements. In an effort to make it appear that
profits were increasing, WorldCom would write down in one quarter millions of dollars in
assets it acquired while, at the same time, it "included in this charge against earnings the cost
of company expenses expected in the future. The result was bigger losses in the current
quarter but smaller ones in future quarters, so that its profit picture would seem to be
improving." The acquisition of MCI gave WorldCom another accounting opportunity. While
reducing the book value of some MCI assets by several billion dollars, the company
increased the value of "good will," that is, intangible assets-a brand name, for example-by the
same amount. This enabled WorldCom each year to charge a smaller amount against earnings
by spreading these large expenses over decades rather than years. The net result was
WorldCom's ability to cut annual expenses, acknowledge all MCI revenue and boost profits
from the acquisition.

WorldCom managers also tweaked their assumptions about accounts receivables, the amount
of money customers owe the company. For a considerable time period, management chose to
ignore credit department lists of customers who had not paid their bills and were unlikely to
do so. In this area, managerial assumptions play two important roles in receivables
accounting. In the first place, they contribute to the amount of funds reserved to cover bad
debts. The lower the assumption of non-collectable bills, the smaller the reserve fund
required. The result is higher earnings.

Secondly, if a company sells receivables to a third party, which WorldCom did, then the
assumptions contribute to the amount or receivables available for sale. So long as there were
acquisition targets available, the merry-go-round kept turning, and WorldCom could continue
these practices. The stock price was high, and accounting practices allowed the company to
maximize the financial advantages of the acquisitions while minimizing the negative aspects.
WorldCom and Wall Street could ignore the consolidation issues because the new
acquisitions allowed management to focus on the behavior so welcome by everyone, the
continued rise in the share price.

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All this was put in jeopardy when, in 2000, the government refused to allow WorldCom's
acquisition of Sprint. The denial stopped the carousel, put an end to WorldCom's acquisition-
without-consolidation strategy and left management a stark choice between focusing on
creating value from the previous acquisitions with the possible loss of share value or trying to
find other creative ways to sustain and increase the share price.

In July 2002, WorldCom filed for bankruptcy protection after several disclosures regarding
accounting irregularities. Among them was the admission of improperly accounting for
operating expenses as capital expenses in violation of generally accepted accounting practices
(GAAP). WorldCom has admitted to a $9 billion adjustment for the period from 1999
thorough the first quarter of 2002.

The Hero of the Case

No integrity questions can be raised about Cynthia Cooper whose careful detective work as
an internal auditor at WorldCom exposed some of the accounting irregularities apparently
intended to deceive investors. Originally assigned responsibilities in operational auditing,
Cynthia and her colleagues grew suspicious of a number of peculiar financial transactions
and went outside their assigned responsibilities to investigate. What they found was a series
of clever manipulations intended to bury almost $4 billion in misallocated expenses and
phony accounting entries.

A native of Clinton, Mississippi, where WorldCom's headquarters was located, Ms. Cooper
conducted her detective work was in secret, often late at night to avoid suspicion. The thing
that first aroused her curiosity came in March 2002 when a senior line manager complained
to her that her boss, CFO Scott Sullivan, had usurped a $400 million reserve account he had
set aside as a hedge against anticipated revenue losses.

That didn't seem kosher, so Cooper inquired of WorldCom's accounting firm, Arthur
Andersen. They brushed her off, and Ms. Cooper decided to press the matter with the board's
audit committee. That put her in direct conflict with her boss, Sullivan, who ultimately
backed down. The next day, however, he warned her to stay out of such matters.

Undeterred and emboldened by the knowledge that Andersen had been discredited by the
Enron case and that the SEC was investigating WorldCom, Cynthia decided to continue her
investigation. Along the way, she learned of a WorldCom financial analyst who was fired a
year earlier for failing to go along with accounting chicanery. Ultimately, she and her team
uncovered a $2 billion accounting entry for capital expenditures that had never been
authorized. It appeared that the company was attempting to represent operating costs as
capital expenditures in order to make the company look more profitable. To gather further
evidence, Cynthia's team began an unauthorized search through WorldCom's computerized
accounting information system.

What they found was evidence that fraud was being committed. When Sullivan heard of the
ongoing audit, he asked Cooper to delay her work until the third quarter. She bravely
declined. She went to the board's audit committee and in June, Scott Sullivan and two others

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were terminated. What Ms. Cooper had discovered was the largest accounting fraud in U.S.
history.

Required

a) Evaluate the complexity of the level of fraud in the case above and the methods that
could be used to unearth such practices and the effects thereon on financial
statements. (15 marks)
b) Suggest the important fraud prevention steps which could have been applied in
WorldCom as an entity. (15 marks)
c) Comment on any 4 of the skills, abilities, and or knowledge necessary for an effective
forensic accountant. (10 marks)

Question 2 (20 marks)

Within the past few years, a new class of crime scenes has become more prevalent, that is,
crimes committed within electronic or digital domains, particularly within cyberspace.
Criminal justice agencies throughout the world are being confronted with an increased need
to investigate crimes perpetrated partially or entirely over the Internet or other electronic
media.

Required

Using the example of the financial sector identify and evaluate 5 types of business
computer forensics technology. (20 marks)

Question 3 (20 marks)

Investigators have developed a variety of interrogation styles and techniques over the
years. The decision to choose one style over the other may depend on many factors,
including the personality of the suspect, the personality of the interrogator, and the
nature of the case.

Required

Based on the fraud triangle theory evaluate how interrogation techniques can
effectively yield results during an interrogation. (20 marks)

Question 4 (20 marks)

a) The Association of Certified Fraud Examiners has developed a model for categorizing
known frauds that it calls the fraud tree. How useful is this framework in executing a
forensic audit? (20 marks)

END OF EXAMINATION

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