Aggressive Accounting Policies Used In Financial Statement Accounting Essay

Category: Accounting

Auditors need to be independent to add credibility to the financial report or other subject matter. APES 110 s.290.10 requires the auditor to identify and evaluate threats to independence and to respond by applying safeguards that eliminate the identified threats or reduce them to an acceptable level. WorldCom will not have collapsed if Arthur Andersen would be able to detect the fraud with proper review and auditing techniques. However, Andersen had approved most of the WorldCom's reporting without going through in-depth on unusual reporting, which the management was trying to hide by not giving access right. Andersen feedback that there were no significant or unusual transactions or material transactions and management had adequate controls to prevent a material error in the financial statements. Lastly, Andersen responded that there were no accounting position take by WorldCom with which Andersen was not comfortable without putting in extra effort on substantive testing of information maintained in financial accounting statements.

Parties most responsible for the crisis

Auditor's role in being the most responsible for the crisis

In order to mitigate the risk in auditing WorldCom, Arthur Anderson relied on WorldCom's control systems without conducting sufficient tests. They overlooked the documentation and controls that were exploited by WorldCom's finance personnel, resulting in a major flaw in the auditing approach. According to ASA500, auditors are required to obtain sufficient appropriate evidence to support their audit opinion. However, the WorldCom personnel were not fully co-operative with Arthur Andersen in the course of its audits.

They exerted unreasonable control over Andersen to access the information (S 310 Right of access the records) and alter documents for Andersen, making it difficult to discover accounting irregularities. In fact, Arthur Anderson should have disclosed to WorldCom's Audit Committee and overcome the problem when it is facing the right to access the accounting records.

Management's & Directors' role in being the most responsible for the crisis

In order to meet the earnings projections, Ebbers directed the CFO Sullivan to assist him in implementing the misrepresentation of accounting entries to create the financial reports that meet the financial targets promised by Ebbers. This resulted in overstatement of profit and decrease in cost. The CFO also tried to delay the internal audit on capitalization of line costs for fees paid to lease portions of other companies' telephone network till Q3 of 2002.

Myers and Yates assisted Sullivan by giving instructions to Ron Lomenzo (Senior Vice President of Financial Operations) to adjust line cost to move international results closer to budgeted margins. Though there were others in WorldCom who suspected in improper accounting, nobody raised the issue up to Human Resource Department or Internal Audit Committee.

Aggressive accounting policies used in financial statement

WorldCom (under the direction of Scott Sullivan (CFO), David Myers (Controller) and Buford Yates (Director of General Accounting)) used shady accounting methods which were not in accordance with GAAP (Generally Accepted Accounting Principles) to cloak its declining financial condition by falsely professing financial growth and profitability to increase the price of WorldCom's stock. There was a transfer of total $3.852 billion from 'line cost' expenses to asset accounts.

Two keys areas on WorldCom's improper accounting:

1) Reduction of reported line costs

WorldCom manipulated the process of adjusting accruals by improperly releasing the accruals without any visible analysis on excess accruals and kept the accruals, to release them when necessary to improve the reported result. Capitalization is also one of way that WorldCom had used to reduce reported line cost. They simply avoided recognizing incurred standard operating expenses and postponed them into the future.

2) Exaggeration of reported revenues

WorldCom made use of the non-recurring items to create a double-digit revenue growth.

Beside the two keys areas, WorldCom had also improperly reduced 3 categories of expenses (Selling, general and administrative cost, depreciation and income taxes). General accruals from other accounts were also accumulated, so as they could be later released to offset expense and write down asset accounts.


Auditor's Role in Fraud

The auditor has a duty to report fraud, irrespective of materiality, to an appropriate level of management when suspicious aroused during the course of normal, careful gathering of evidence. In WorldCom's case, Andersen had limited the chance to detect fraud on accounting irregularities due to the flaws in its audit approach. Therefore, Andersen missed many opportunities to discover the misuse of accruals, capitalization of line costs, and improper recognition of revenues.


In order to meet the high growth expectation from Wall Street, WorldCom's management made an effort to reduce the reserve by $2.8 billion. The money reduced was then moved into the revenue of its financial statement. They manipulated the process of adjusting accruals and capitalizing the operating costs. All these had caused WorldCom to be able to achieve a high revenue growth when in fact it should be substantially lower.

Auditor's negligence and contributory negligence

Auditor's negligence

A professional auditor has a duty to exercise the reasonable care and skill when performing their duties as the auditor's duty of care to a client arises both in contract and in the tort of negligence. If the auditor breaches this duty of care and has been negligent in conducting the audit work or has committed fraud, the auditor will be liable for any loss suffered as a result of the auditor's actions. In WorldCom's case, Arthur Andersen has failed to perform what a professional auditor expected to perform.

First of all, there were flaws in Arthur Andersen's audit approach and therefore, Arthur Andersen failed to detect accounting irregularities and frauds. Arthur Andersen applied the audit approach that concentrated more on identifying risks and assessing whether adequate controls is in place in the company to mitigate those risks, rather than accentuating the traditional substantive testing of information maintained in accounting records and financial statements. If there is failure in identifying a significant risk, or relying on company control without adequately determining by Arthur Andersen, there will be insufficient testing to make detection of fraud which is the consequences of this audit approach. Besides the consequence of the audit approach, it seems that adequate testing were not performed by Arthur Andersen to justify reliance on WorldCom's controls as there were journal entries and accrual reversals without proper support.

Secondly, Arthur Andersen failed to disclose to WorldCom's Audit Committee that they were not receiving full cooperation from WorldCom personnel on critical aspects of the work by controlling tightly over information that Andersen needed and providing modified documents with the apparent purpose of concealing from Andersen items that might have raised questions.

Lastly, Arthur Andersen did not devise sufficient auditing procedure to detect the possibility of fraud as it trusted and relied on senior management of WorldCom. Moreover, Arthur Andersen assumed that there was no cause for heightened scrutiny for the absence of variances in the financial statement and schedules in WorldCom's business environment without verifying with relevant people.

Contributory negligence by WorldCom

Contributory negligence is a failure by the plaintiff to meet the standard of care required for tis own protection where this is a contributing cause, together with the defendant's fault, in bringing about loss.

WorldCom personnel were not cooperative in providing the information that Andersen needed. They exerted excessive control over Andersen's access to information, as well as the access to the computerized General Ledger, that caused the difficulty for Andersen to perform its duties.

Moreover, significant documents were altered by certain members of WorldCom's management before providing them to Andersen in order to hamper Andersen's ability to identify problems at the Company.

Going concern

According to ASA 570.2, going concern assumption is defined as the entity is viewed as continuing in business for the foreseeable future without any intention or necessity to liquidate or otherwise cease its operations. ASA 570.10 requires that auditor must consider the appropriateness of the going concern assumption that underlies the financial report when planning and performing audit procedures and evaluating the results. Arthur Anderson failed to assess the "going concern" of WorldCom at the planning stage and overlook the going concern assumption as WorldCom is the major client and they had fear of losing future relation and audit fees. And hence, Arthur Andersen rendered an unbiased opinion on WorldCom's financial statement.

In conclusion, we concluded that both WorldCom's management and Arthur Anderson were the cause of WorldCom's fraud.