audit failure
AUDIT FAILURE OF WORLDCOM
Group 1
Background
• WorldCom, first named LDDS (Long Distance
Discount Services), grew largely by aggressively acquiring other telecommunications companies in 1990s.
• For a time, it was the United State's second largest long distance phone company (after
AT&T).
Background
However, the year 2002 comes…
• In March, the SEC began to investigate
WorldCom as it reported large profit while
AT&T reported loss.
• In May, Arthur Anderson was replaced by
KPMG as the audit of WorldCom.
Background
• In June, a small team of internal auditors at
WorldCom unearthed $3.8 billion in fraud and made known of the company’s audit committee and board of directors. Then, Sullivan, the CFO, was fired; Arthur Andersen withdrew its audit opinion for 2001; and SEC launched an investigation into these matters.
• In July, WorldCom filed for bankruptcy protection, in the largest such filing in United
States history at the time.
Background
The fraud was accomplished primarily in two ways:
• Underreporting ‘line costs’ (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them. • Inflating revenues with bogus accounting entries from "corporate unallocated revenue accounts".
Analysis
Reasons for the fraud:
1. Internal control defects
2. Economic motivation
3. External Audit failure
1.Internal control defects
• Weak internal audit:
a. It didn’t cover financial statement auditing;
b. It were not independent as internal auditors was responsible for CFO;
c. Its advices were not valued even though reported drawbacks.
1.Internal control defects
• Management override: Corporate headquarters asked subsidiaries to adjust accounts directly, providing no documentation or authorization signatures. • Poor incentives: Financial incentive program made managers eager to make profit as managers’ bonus was based on
Group 1
Background
• WorldCom, first named LDDS (Long Distance
Discount Services), grew largely by aggressively acquiring other telecommunications companies in 1990s.
• For a time, it was the United State's second largest long distance phone company (after
AT&T).
Background
However, the year 2002 comes…
• In March, the SEC began to investigate
WorldCom as it reported large profit while
AT&T reported loss.
• In May, Arthur Anderson was replaced by
KPMG as the audit of WorldCom.
Background
• In June, a small team of internal auditors at
WorldCom unearthed $3.8 billion in fraud and made known of the company’s audit committee and board of directors. Then, Sullivan, the CFO, was fired; Arthur Andersen withdrew its audit opinion for 2001; and SEC launched an investigation into these matters.
• In July, WorldCom filed for bankruptcy protection, in the largest such filing in United
States history at the time.
Background
The fraud was accomplished primarily in two ways:
• Underreporting ‘line costs’ (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them. • Inflating revenues with bogus accounting entries from "corporate unallocated revenue accounts".
Analysis
Reasons for the fraud:
1. Internal control defects
2. Economic motivation
3. External Audit failure
1.Internal control defects
• Weak internal audit:
a. It didn’t cover financial statement auditing;
b. It were not independent as internal auditors was responsible for CFO;
c. Its advices were not valued even though reported drawbacks.
1.Internal control defects
• Management override: Corporate headquarters asked subsidiaries to adjust accounts directly, providing no documentation or authorization signatures. • Poor incentives: Financial incentive program made managers eager to make profit as managers’ bonus was based on