MCI - understated bad debt provisions
MCI was one of WorldCom’s largest clients and a competitor. Like WorldCom, MCI laid optical fibre.
Like WorldCom, MCI had grown very quickly through aggressive acquisitions, had a record of very high earnings growth and thus had a highly-inflated market value. There was pressure on MCI to maintain earnings growth.
One of the ways MCI grew revenue was through an aggressive sales approach. The sales team targeted resellers who would buy capacity and resell to customers at a premium. The sales team eager to grow sales (and get their bonuses), took on customers and gave them credit, with little or no due diligence. Thus, MCI ended up with many poor paying customers whose balances were well over 180 days past due.
What MCI should have done was made a provision against these poor payers. But provisions reduce earnings. MCI didn’t want high debtor provisions.
An enthusiastic senior member of the debtor collection team came up with a solution. When cash arrived from a customer it would be allocated against an account, but not necessarily the account of the customer who paid it. Instead it would be allocated against a poor paying customer’s account that was outstanding for over 180 days.
In the next month, the cash would be properly reallocated to the correct customer. The poor paying customers debtor balance would then go back to the balance it was. But in the MCI accounting software the balance showed no longer as being over 180 days old, but as a new, current balance. As the old debt no longer showed as being 180 days overdue, it didn’t need to have a provision.
In 1998 WorldCom acquired MCI. Half of the reseller accounts WorldCom inherited from the MCI acquisition were three to seven years past their due by dates.