Lack of Professional Scepticism

Running head: AUDIT
Audit
Name of the Student
Name of the University
Author’s Note

1AUDIT
Introduction
Auditing is considered as the process to examine as well as assess the financial
statements of the companies in order to assess that whether there is many material
misstatements in them and whether the financial statements have been prepared in fair and
truthful way (William Jr, Glover and Prawitt 2016). It is the responsibility of the auditors to
comply with all the audit standards and to take into consideration all the obligatory factors at
the time to perform the audit engagement program. Over the years, there are many cases of
the collapse of large business organizations all over the world due to their involvement in
fraudulent financial reporting activities and other illegal actions (Byrnes et al. 2018). The
auditors have the responsibility to identify the frauds in financial reporting and report the
same. However, there are many instances where the auditors were involved with the
management of the clients in accounting manipulation; and this raises serious audit and
accounting issues such as independence, valuation, due diligence and many others. This essay
aims at analysing one of the largest corporate collapses occurred in USA which is WorldCom
collapse. More specifically, this essay discusses about three auditing and/or accounting issues
raised during the collapse of WorldCom; and then further sheds light on the relevance of
WorldCom collapse for the Australian auditors.
Three Audit and/or Accounting Issues raised During the WorldCom Collapse
The collapse of WorldCom is considered as one of the major corporate collapse in
USA as well as in the world where the involvement of the auditors was spotted. There are
many auditing and accounting issues raised during the collapse of WorldCom
(chicagotribune.com 2020). The following discussion sheds light on there of those crucial
issues:

2AUDIT
Lack of independence was a major issues that raised during the collapse of
WorldCom. WorldCom’s audit committee, internal auditors and external auditors majorly
lacked the independence required in the auditing profession (apesb.org.au 2020). An audit
committee was developed in WorldCom for conducting relation with the external auditors,
Arthur Andersen. The main responsibilities of the audit committee of WorldCom were to
meet time to time basis with the external auditors, discussing progress of the audit and
findings and resolving any conflict of interest that may take place between the external
auditors and the management. However, the audit committee of WorldCom was gradually
trickled down due to the lack of indepdence of its management and audit committee. Since
the chairman of the audit committee was very loyal to Bernard Ebbers, the co-founder of
WorldCom, the committee was either unaware or aware of the accounting manipulation for
the years 1999, 2000 and 2001 and decided to ignore it. WorldCom was acknowledged as a
‘maximum risk’ client by Arthur Andersen while mentioning that the company misapplied
GAAP in the areas of certain investments, the audit committee decided to ignore the same
and Arthur Andersen went on issuing unqualified audit opinion to WorldCom. This shows the
involvement of Arthur Andersen to breach the principles of independence in the presence of
its personal interest in the audit client which pushed the auditor to issue unqualified opinion
even in the presence of material mistsement due to comply with inappropriate accounting
standards (theguardian.com 2020).
Another major issues that raised during the collapse of WorldCom is lack of due
diligence and negligence in the audit work. There was not any check and balance in the
auditing of WorldCom. The internal audit team lacked adequate number of staffs and the
management of WorldCom restricted them in accessing all the required information; this
prevented them in the appropriate reporting to the audit committee. The audit committee was
also not effective in its operations. In spite of these aspects, Arthur Andersen issues

3AUDIT
unqualified audit opinion to WorldCom which indicates towards the failure in carrying out
the duties properly (Wisner and Brown 2015). The failure of Arthur Andersen to detect was
because of the negligence. A major flaw in the audit approach of Arthur Andersen was that
the audit firm did limit its testing of account balances through putting major reliance on the
prescribed strong internal control environment of WorldCom. Since there were major
deficiencies of the internal control environment of WorldCom, it allowed the audit firm in
overlooking the key deficiencies in the internal control. It could be possible to detect the
fraud before 2002 in case Arthur Andersen had performed its work properly without any
negligence. The audit firm also failed to bring the matter in the attention of the audit
committee. To Arthur Andersen, the audit of WorldCom was the largest audit and therefore,
the audit form spent a huge time in selling the consulting services to WorldCom instead of
conducting analytical reviews and testing of controls so that it can retain the client (Chou
2015). This contributed to the development of a conflict of interest as Arthur Andersen put
more value on the relationship with WorldCom than performing the audit work. This resulted
in lack of professional scepticism as the audit firm did not have a questioning mind when
performing the audit of WorldCom.
Inappropriate valuation in financial statements was another major issues that raised
during the collapse of WorldCom. Commencing from 1998 to 2000, the management of
WorldCom did continuously decrease the reserve account held for covering liabilities of
acquired firms; and this accounting malpractice increased its revenue by $2.8 billion. This
strategy was not adequate to save the company and make the investors happy; and therefore,
it started to misclassify its operating expenses as long-term investments in 2000; and this
move increased the net income of WorldCom radically along with the earnings per share. In
the year of 2002, the internal auditors of WorldCom began to look into these suspicious
accounting activities and discovered more questionable accounting practices in the books of

4AUDIT
WorldCom. The internal auditor tool the matter to Arthur Andersen and did not get any
suitable response and then, the CFO of WorldCom told the internal auditors not to take these
matters to the audit committee or external auditors. This proves the fact that both the
management of WorldCom and Arthur Andersen were involved in the wrong valuation of the
items in the financial statements which turned out to be the key reason for its WorldCom
collapse. It needs to be mentioned that the fraud carried out was so basic that Arthur
Andersen did not make any excuse of not catching the frauds (Keyser 2015).
Relevance of the WorldCom Scandal to Australian Auditors
The WorldCom is considered as one of the largest accounting scandals in USA as
well as all over the world which raised certain crucial auditing and accounting issues such as
indepdence of the auditors, lack of due diligence, presence of negligence in performing audit,
conflict of interest due to providing different consulting services to the audit clients and lack
of professional scepticism when performing the audit. It needs to be mentioned that these are
the common issues in the auditing profession all over the world and thus, have major
relevance to the Australian auditors. In Australia, auditing plays a crucial role in the
identification of material misstatements in the financial statements of the firms due to any
financial statement associated fraud (Damiani, Bourne and Foo 2015). Therefore, the issues
from WorldCom such as audit independence, due diligence, valuation, negligence,
professional scepticism and conflict of interest are applicable in the context of Australian
audit. Australian has witnessed many corporate collapses where the auditors were involved
like WorldCom and one of such crucial cases is the HIH Insurance scandal. The timeline of
the collapse of these two companies are almost same and both the scandals raised same types
of audit and accounting issues. Therefore, the relevance of the collapse of WorldCom in
Australia auditors can be discussed through comparing the same with the HIH Insurance
collapse (Crockett and Ali 2015).

5AUDIT
While considering the case of HIH Insurance, the main issues that raised during the
collapse include audit independence and roles of the audit committee and these two happen to
be among the issues raised during the collapse of WorldCom (smh.com.au 2020). The issue
of audit independence is considered as fundamental in the collapse of HIH Insurance (Ball,
Tyler and Wells 2015). Audit independence refers to providing an unbiased audit opinion
after performing the necessary audit procedures in the most appropriate manner. Both
WorldCom and HIH Insurance had the same audit partner that is Arthur Andersen. Like the
close relationship between the management of WorldCom and Arthur Andersen, the audit
partner developed a close relationship with the management of HIH Insurance as it was
Arthur Andersen’s largest audit client in Australia. This close relationship between Arthur
Andersen and HIH Insurance created threat to audit indepdence like WorldCom such as
familiarity threat and self-interest threat (apesb.org.au 2020). On the other hand, the audit
committee of HIH Insurance failed in performing its tasks alike WorldCom. In Australia,
audit committee is considered as an integral part of corporate governance and its main
responsibility involves in supervising the role of the managements in financial reporting and
communicate the same to the external auditors. However, the guidelines as well as
responsibilities of the audit committees were violated in case of HIH Insurance same as
WorldCom. The audit committee of HIH Insurance acted contrary to the actual practice
which raised question on the impartiality and biasness of the audit committee. Therefore, it
can be seen that the occurrence of the same issues in WorldCom can be seen in case of the
collapse of HIH Insurance which makes the WorldCom collapse crucially relevant to the
auditors of Australia (Jones and Beattie 2015).
The Australia auditing profession witnessed certain major reforms after the
occurrence of the collapse of WorldCom and HIH Insurance. A report was produced by
Professor Ramsey in October 2001 outlining the existing professional and legislative

6AUDIT
requirements on the independence of the auditors along with other concerning audit issues
(Appuhami and Tashakor 2017). A number of proposals were incorporated in this report
having future implications on the audit profession as a result of the collapse of HIH
Insurance. The major recommendations in this report include the inclusion of a statement in
the Corporations Act that the auditors are to be Indepdent. This report also recommends that
an annual declaration need to be made by the auditors to the Board of Directors on
maintaining their independence in line with the acts and rules of the accounting bodies (Hay
et al. 2017). One of the recommendations outline the prohibited relationships between the
auditor and client. One specific restriction is one the joining of the retired audit partner in the
Board of Directors of the audit client as this situation was there in HIH Insurance. Bringing
improvement in the audit committee was another crucial recommendation in the report. On
the overall basis, it can be said that this report put major emphasis on improving audit
independence and audit committee so that financial frauds can be prevented (Kuan 2015). All
these imply that the collapse of WorldCom had major relevance in the auditors of Australia.
Conclusion
There were many audit and accounting issues raised during the collapse of WorldCom
and three of those major issues are lack of independence of the auditors, lack of due diligence
in the presence of audit negligence and improper valuation of the items of financial
statements by the clients and auditors. It is believed that all these issues together contributed
to the collapse of one of the major companies of USA, WorldCom. WorldCom scandal has
major similarity with the HIH Insurance scandal in Australia which makes WorldCom
crucially relevant to the auditors of Australia. This is because the repetition of the same issues
raised during WorldCom scandal can be seen in HIH Insurance scandal; such as lack of audit
independence and ineffective functioning of the audit committees. After consideration of
these issues, Ramsey Report suggested certain ways to enhance audit independence and audit

7AUDIT
committees. This regulatory and legislative reform of the audit profession in Australia can be
considered as the direct effect of HIH Insurance scandal and indirect effect of WorldCom
scandal.

8AUDIT
References
Alexander, J. 2020. Andersen was WorldCom auditor. [online] chicagotribune.com.
Available at: https://www.chicagotribune.com/sns-worldcom-andersen-ct-story.html
[Accessed 8 Apr. 2020].
Apesb.org.au. 2020. APES 110 Code of Ethics for Professional Accountants (including
Independence Standards). [online] Available at:
https://www.apesb.org.au/uploads/home/02112018000152_APES_110_Restructured_Code_
Nov_2018.pdf [Accessed 8 Apr. 2020].
Appuhami, R. and Tashakor, S., 2017. The impact of audit committee characteristics on CSR
disclosure: An analysis of Australian firms. Australian Accounting Review, 27(4), pp.400-
420.
Ball, F., Tyler, J. and Wells, P., 2015. Is audit quality impacted by auditor
relationships?. Journal of Contemporary Accounting & Economics, 11(2), pp.166-181.
Byrnes, P.E., Al-Awadhi, A., Gullvist, B., Brown-Liburd, H., Teeter, R., Warren Jr, J.D. and
Vasarhelyi, M., 2018. Evolution of auditing: From the traditional approach to the future
audit. Continuous auditing: Theory and application, pp.285-297.
Chou, D.C., 2015. Cloud computing risk and audit issues. Computer Standards &
Interfaces, 42, pp.137-142.
Crockett, M. and Ali, M.J., 2015. Auditor independence and accounting
conservatism. International Journal of Accounting & Information Management.
Damiani, C., Bourne, N. and Foo, M., 2015. The HIH claims support scheme. Economic
Round-up, (1), p.37.

9AUDIT
Hay, D., Stewart, J. and Botica Redmayne, N., 2017. The role of auditing in corporate
governance in Australia and New Zealand: A research synthesis. Australian Accounting
Review, 27(4), pp.457-479.
Jones, G. and Beattie, C., 2015. Local government internal audit compliance. Australasian
Accounting, Business and Finance Journal, 9(3), pp.59-71.
Keyser, J.D., 2015. The PCAOB's role in audit conduct and conscience. Research in
Accounting Regulation, 27(2), pp.111-118.
Kuan, K., 2015. Why private interest theory should be used to evaluate the adequacy of the
auditor independence requirements in CLERP 9.
The Sydney Morning Herald. 2003. HIH : The Inside Story Of Australia's Biggest Corporate
Collapse. [online] Available at: https://www.smh.com.au/entertainment/books/hih-the-inside-
story-of-australias-biggest-corporate-collapse-20030315-gdgff3.html [Accessed 8 Apr.
2020].
Theguardian.com. 2020. WorldCom 'failed to act' against fraud | Corporate governance |
The Guardian. [online] Available at:
https://www.theguardian.com/business/2002/jul/03/corporatefraud.worldcom1 [Accessed 8
Apr. 2020].
William Jr, M., Glover, S. and Prawitt, D., 2016. Auditing and assurance services: A
systematic approach. McGraw-Hill Education.
Wisner, D.L. and Brown, B.A., 2015. Corporate Toxicity: The WorldCom/MCI Scandal.