Auditing case
Case 1.2
1. Revenue recognition principle under GAAP determines the specific conditions under which income becomes realized as revenue. Generally, revenue is recognized only when a specific critical event has occurred and the amount of revenue is measurable.
For public company, performance of financial statement can have significant impact on stock price. It is essential for the users of financial statements to know that the real revenues are recorded and disclosed and not fraudulent revenues.
2. WorldCom’s business model was typical of a telecommunication industry these days, which depends heavily on the usage charge which may vary every year. In order to handle this, accounting practices have a concept of line cost expense and line cost release. Expenses under GAAP were supposed to be estimated and these estimates are supposed to be revised with appropriate procedure to fairly reflect the reality. If the expense are lower than the estimate, they are released, which again requires revisiting the cost in order to match the revenues and expenses. The company management had been involved in manipulating and offsetting these figures. One of the ways they violated matching principle was releasing various accruals that reduced the line costs without any analysis and support. Other ways they violated matching principle was when management did not release the accruals that had been established, so that they can be used during bad times of the company’s performance. This certainly violates the matching principle and destroys the purpose of periodic income statement.
3. I don’t think WorldCom had established an effective system of internal control over financial reporting related to the revenue recorded in its financial statement.
According to PCAOB Standard No.5, effective internal controls are supposed to be in place for gaining confidence of the Financial Statement users and there should not be any room for error that materially affects the report. The internal
1. Revenue recognition principle under GAAP determines the specific conditions under which income becomes realized as revenue. Generally, revenue is recognized only when a specific critical event has occurred and the amount of revenue is measurable.
For public company, performance of financial statement can have significant impact on stock price. It is essential for the users of financial statements to know that the real revenues are recorded and disclosed and not fraudulent revenues.
2. WorldCom’s business model was typical of a telecommunication industry these days, which depends heavily on the usage charge which may vary every year. In order to handle this, accounting practices have a concept of line cost expense and line cost release. Expenses under GAAP were supposed to be estimated and these estimates are supposed to be revised with appropriate procedure to fairly reflect the reality. If the expense are lower than the estimate, they are released, which again requires revisiting the cost in order to match the revenues and expenses. The company management had been involved in manipulating and offsetting these figures. One of the ways they violated matching principle was releasing various accruals that reduced the line costs without any analysis and support. Other ways they violated matching principle was when management did not release the accruals that had been established, so that they can be used during bad times of the company’s performance. This certainly violates the matching principle and destroys the purpose of periodic income statement.
3. I don’t think WorldCom had established an effective system of internal control over financial reporting related to the revenue recorded in its financial statement.
According to PCAOB Standard No.5, effective internal controls are supposed to be in place for gaining confidence of the Financial Statement users and there should not be any room for error that materially affects the report. The internal