WorldCom Inc.'s use of so-called cookie jar accounting--inflating provisions for expected expenses and later reversing them to boost earnings--is the largest among numerous cases of misuse of reserves.
Companies set reserves to cover the estimated costs of taxes, litigation, bad debts, job cuts and acquisitions. Once the costs are incurred, the excess amount in the reserve can be reversed to boost earnings. Company managers estimate reserves and the outside auditor judges whether the reserves are reasonable.
WorldCom, the carrier of about half of all Internet traffic, filed the largest U.S. bankruptcy case last month after revealing that it hid $3.9 billion in expenses since 2001. The company said Thursday that it found $3.3 billion more in improper accounting since 1999, most from overestimating reserves to create a slush fund that was drawn from to inflate profit, spokesman Brad Burns said.
"This is by far the biggest case of this that has come to light," said Walter Schuetze, a former chief accountant for the Securities and Exchange Commission. "Companies can just reach into these reserves any time they want to and make any earnings number they need to."
Auditors rarely challenge company estimates because there are unclear guidelines for calculating reserves, accountants said. Arthur Andersen audited Clinton, Miss.-based WorldCom's financial statements from 1989 to May 14, when the telecommunications company dropped Andersen and hired KPMG.
Microsoft Corp. this year agreed to settle SEC allegations it misstated earnings from 1994 to 1998 by moving $900 million to reserve accounts for anticipated expenses, over-reporting earnings in some quarters and underreporting earnings at other times. Microsoft neither admitted nor denied wrongdoing.
Xerox Corp. paid a $10-million fine to settle SEC charges that it inflated revenue by $2 billion between 1997 and 2000. The SEC charged that Xerox created reserves for liabilities including vacation pay that the company knew were too high so it could draw on reserves in years when it needed a boost to meet earnings estimates.
The SEC last year accused Sunbeam Corp. and former Chief Executive Al Dunlap of boosting earnings at the appliance maker by creating cookie jar reserves to inflate income, in addition to other improper accounting practices.
"It certainly became increasingly a concern over the last five years," said Tim Lucas, former research director for the rule-making Financial Accounting Standards Board. "The SEC has accused companies of overdoing it, creating big reserves then taking that money out at very convenient times."
WorldCom's reserves for estimated costs related to acquisitions fell to $938 million at the end of 2000 from $2 billion in 1998 and most of the liabilities were unpaid, according to the company's annual report for 2000.
WorldCom reduced earnings before interest, taxes, depreciation and amortization by $217 million in 1999, $2.86 billion in 2000, $161 million in 2001 and $88 million in the first quarter of 2002 after the most recent accounting errors were uncovered.
KPMG and WorldCom auditors may uncover more improper accounting, WorldCom said in a statement last week.
Critics, including former SEC Chairman Arthur Levitt, say companies may inflate charges and reserves when they make acquisitions because most investors ignore or discount large, one-time write-offs associated with purchases. WorldCom acquired at least 15 businesses in the 1990s, including MCI Communications and SkyTel Communications.
"This is traditionally abused when companies want to push reserves into future earnings," said Ron Kasznik, an accounting professor at Stanford Business School. "The question is whether companies are accruing too little or too much. That's when people get concerned."