Auditing Case Study: Nortel

Topics: Auditing, Management, Risk Pages: 10 (1857 words) Published: December 9, 2014
Auditing Case Study
Specific cases of fraud and wrongdoings by the auditors in US and Canada Nortel was involved in two types of fraudulent accounting schemes from 2000-2003 Revenue Fraud
Accelerated material amounts of revenues into 2000 and created false appearance that Nortel was not prone to economic difficulties that similar companies in this field of business faced. Earnings Management Fraud

Increased or decreased the amounts of revenues reported in numerous years to create the appearance to shareholders that Nortel had a strong continuity of business in the future, as well as a profitable one. External Environment influenced the actions of Nortel

Nortel’s primary business fields were:
Telecommunications
Internet
In the late 1990s these sectors experienced substantial and rapid growth In 2000 there was a large economic downturn that greatly reduced the demand for Nortel’s products. This decline in demand created an inherent risk in Nortel’s field of business, reducing the availability of capital to continue operations. Nortel experienced a decreased of nearly 2 billion dollars of actual revenues compared to expected. Despite the obvious fact that Nortel’s field of business was on a decline, they issued statements proclaiming that they would be unaffected, and continue to grow. Beginning in October 2000, Nortel began use to accounting principles that were not recognized by US Generally Accepted Accounting Principles. They were not following the revenue recognition policy of recognizing revenues when they were billed. This would be considered as a timing error in the financial statements, as well as a lack of accuracy, and completeness. Revenues and earnings were carried forward or backward in order to satisfy the expectations of shareholders. The Fraud took two forms, beginning in November 2000.

Nortel altered their revenue recognition policies to accelerate optical internet revenues into 2000, as this was needed to meet its quarterly and annual revenue guidance. These changes in policy enabled them to recognize revenues on idle, undelivered inventory sitting in warehouses and offsite storage locations. Auditors should have done a walk-through of the premises in order to properly verify the actual amounts of inventory Nortel had on hand. That way cost of goods sold and revenues would be more accurate and reliable. These accounting policies did not satisfy the requirements of GAAP. Nor were these changes disclosed in the financial statements to aware shareholders. Even though they had a highly material impact on the reliability of financial statements. Management assertions should be tested here to determined which were not satisfied when this lack of disclosure was allowed.

February 2001
Nortel finally gave factual guidance to its shareholders as to the financial expectations for the remainder of 2001. It was only after a year that Nortel disclosed this, however the external market continued to decline in the mean-time. Resulting in an accelerated rate of losses. To try and bring back some confidence in shareholder interest, Nortel reduced its workforce by two-thirds. This resulted in a significant write-down Summer 2002

The external environment began to regain economic strength, and Nortel announced publicly that it expected to return to profitability by the second quarter of 2003. These expectations of profitability are what led Nortel to conduct the second part of their fraudulent activities. Nortel began to manipulate its reserves in order to manage its publicly reported earnings and created a false return to profitability. This allowed Nortel’s executives to pay out millions of dollars in bonuses to its top exectuives.

July 2002 – June 2003
Nortel began to improperly establish, maintain, and release excess reserves. This was a majoring timing error because the reserves were unreasonable and probably created unjustified tax benefits. Nortel determine that they were going to return to...
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