Telecommunications Company Undergoes Audit of Its Financial Statements

This case involves a publicly traded telecommunications company. The company went public when it acquired a publicly traded long distance telecom services company. Throughout the 2000s, the company continued to grow by acquiring various companies and expanding its operations across the United States, using multiple software programs like Quickbooks to expand and manage their portfolio. The company used an aggressive acquisition strategy. Analysts remarked that the company, which had a negative cash flow of over $7 million after 11 years in business, would be able to generate only $64 million in free cash flow in two years and $100 million in three years. Considering the situation, many company observers predicted that the company would soon declare itself bankrupt. The company’s accounting department used accounting practices that showed constantly increasing profits. The accounting department wrote down millions of assets the company acquired and included in this charge against the earnings the cost of company expenses expected in the future. This created a profit picture that was constantly improving. The accounting department classified $800 thousand in line costs as capital expenditures rather than current expenses to increase net income and assets.

Question(s) For Expert Witness

1. Can a company use accounting practices that capitalize line costs to show positive revenue streams?

Expert Witness Response

One of the main things behind the troubles of a company like this is that telecommunications firms faced reduced demand as the dot-com boom ended and the economy entered a recession. The revenues of these companies fell short of expectations, while the debt they took on to finance expansion remained high. The first issue to look at in a case like this is auditing. Auditing is always important when a company’s financial situation is in trouble. There is always increasing pressure on a company to meet earnings goals and this means that the CEO and the CFO may be required to sign off on the fairness and accuracy of financial statements. In many cases like these, if company executives have carefully considered the possible consequences of manipulating numbers to meet earnings forecasts, there is less likelihood of fraud. In cases like this, Generally Accepted Accounting Principles (GAAP), are very difficult to interpret and apply because the standards are written in highly technical ways. The GAAP standards can be difficult for accountants to apply because they are rule-based and have to be applied in many types of transactions in varying business situations. In general, the quality of financial reporting within most large companies is very high. Most CFO’s are very concerned with fair and accurate reporting because of high pressure and penalties from the SEC. Also, more and more of these companies are trying to improve the transparency of their financial reporting by internal controls that focus on longer-run profit performance rather than focusing just on short-run profits.