Detailed Investigation Report: WorldCom Accounting Scandal Analysis

This investigation report examines the WorldCom accounting scandal, one of the largest accounting frauds in history. The report begins with a case background, highlighting the company's inflated revenue and assets, driven by the CEO's focus on investor returns. It identifies major red flags, i...Read More

Investigation Report: WorldCom Accounting
Scandal
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Contents
Case background...................................................................................................................................3
Major red flags......................................................................................................................................4
Procedure for investigating the red flags to identify the probability of fraud.......................................5
Arthur Andersen’s approach to detecting fraud in WorldCom..............................................................6
Changes made in accounting regulations after the WorldCom scandal................................................7
References.............................................................................................................................................8
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Case background
Accounting scandal in WorldCom is considered as one of the largest accounting and
corporate scandals the world till the date. It is estimated that management of the companies
has revenue by window dressing of their balance sheet and profit and loss account. The
primary objective of the CEO of the company was to increase the overall profitability of the
organization in order to provide more and more return to investors. For this purpose overall
revenue generated by the organization was inflated by management and represented in profit
and loss account (Kranacher & Riley, 2019). For example management of the company
represented a profit of 1.4 million dollars in quarter 1 of 2002 whereas actually management
of the company has incurred a net loss in quarter 1 of 2002.
The main objective of this essay would be to understand various aspects of this accounting
standard and evaluate strategy is through which it could have been awarded or detected by
internal auditors or external auditors. This essay will identify major red flags that were
presenting sign of corporate fraud and the process of fraud detection undertaken by the
external auditor of the organization (Comer, 2017). Changes made in accounting regulations
after this accounting fraud in the United States of America will also be discussed.
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Major red flags
While constructing an internal audit of the organization following are the red flags were
identified that indicated a chance of corporate fraud-
Organizational culture- One of the important factors that should be assessed by the internal
and external auditor is organizational culture. Auditors should assess whether the
organizational culture of the company is promoting honesty and integrity or not. After a
detailed assessment of internal processes, it was identified that the CEO of the company was
concerned with meeting stakeholder’s expectation at any cost. Due to this behaviour of the
CEO and other top management employee’s business organization was focused on providing
higher returns to its investors at any cost (Boyle, DeZoort & Hermanson, 2015). This was one
of the most important contributors to the inflated value of revenue and assets during the
period of 1999 to 2002.
Comparison with other organizations- During the year 1999 to 2002 the stock value of this
organization is in the stock exchange was very high. Stock value and total revenue generated
by the organization was significantly higher to other business organizations operating in this
industry. This is always an important red flag that should be assessed by the internal and
external auditor. All the business organizations are operating in similar conditions and if the
revenue generated by a particular organization are very higher than it is important to assess
the internal factors that are resulting in such a higher revenue (Diebold & Yılmaz, 2014).
The total value of debt- At the time of declaring bankruptcy total debt to suppliers and other
creditors amounted to $35 billion. It is not possible for an organization to hide this amount of
debt from books of accounts of the company. Amount of that on a business organization is a
huge red flag on the performance of the company. Overall revenue disclosed in profit and
loss account during the period of fraud was very high and if search revenue was true and fair
then management would not be required to raise money through that capital on a regular basis
(McCann, Offoha & Bryant, 2015). In addition, retained earning food have been used by the
organization for repayment of debt.
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Procedure for investigating the red flags to identify the
probability of fraud
An internal auditor or external auditor could have used the following audit procedures in
order to examine these red flags.
Auditors should have communicated with operational and management level employees to
identify the corporate culture adopted by the organization. The organizational structure of
WorldCom was a top-down structure with exclusive power assigned to the chief executive
officer and another top-level employee in the organization. Role of top-level employees could
be easily assessed by evaluating corporate structure and accountability of such employees
towards the board of directors (Petraşcu & Tieanu, 2014). It would have been identified by
auditors that chief executive officer and other top management employees were not
accountable to the board of directors which decrease the core concept of accountability and
transparency in business operations. Probability of fraud and errors increases in this type of a
corporate structure and culture.
As an internal auditor, financial statements of other large scale organizations operating in
Telecom industry of USA should have been analysed in order to compare the financial
position of these organization with WorldCom. Annual reports are considered as a public
document and these documents are easily available on official websites of the company.
Checking books of accounts could have also easily detected the inflated revenue of the
organization as the majority of such revenue was inflated with the help of bogus accounting
entries (Othman, Aris, Mardziyah, Zainan & Amin, 2015). Simple audit procedure of
vouching and external confirmation with clients would have been very useful in identifying
whether revenue recorded by the organization was genuine or not.
The total value of debt in the business organization could have been examined with the help
of financial statement analysis of previous financial years. In addition to that external
confirmation could have been taken from a banking organization with regard to the total
value of debt in the business. There are various approvals that are required to be taken by a
chief executive officer from the board of directors before taking any kind of loan. Detailed
examination of a minute of board meetings and annual general meetings could have been
useful in identifying the amount of loan (Johansson & Carey, 2016).
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Arthur Andersen’s approach to detecting fraud in
WorldCom
There were various deficiencies in the audit procedures undertaken by Arthur Andersen LLP
in conducting an audit for WorldCom that resulted in one of the biggest corporate fraud. First
of all auditor of the company blindly trusted on the internal audit reports issued by internal
auditors of the company. The internal audit committee of the organization was bride by the
board of directors in order to obtain an unmodified internal audit report (Kizil & Kaşbaşı,
2018). Auditor of the organization did not conduct any kind of additional audit procedures to
evaluate the work done by the internal auditor which is against the code of conduct issued for
statutory auditors.
One of the primary function of the audit form is to adopt the principle of independence and
professional scepticism while conducting Audit and identification of corporate frauds. Arthur
Andersen LLP was conducting auditor for WorldCom for a long period of time and due to
this long-term relationship, auditors were biased towards opinions provided by the board of
directors and CEO. Professional negligence on part of auditors was also an important factor
contributing towards non-identification of corporate fraud.
Professional negligence of auditors can be identified from the fact that the majority of the
revenue entry entered in books of accounts were bogus. At the time Arthur Andersen LLP
was one of the most reputed audit organizations in the world and experience auditor of this
organization were not able to identify bogus accounting entries (Diermeier, Crawford &
Snyder, 2017). This professional negligence clearly shows that the behaviour of statutory
auditors was clearly biased towards the company.
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Changes made in accounting regulations after the
WorldCom scandal
There were various changes introduced by the government of the United States of America as
an aftermath of the WorldCom corporate scandal. One of the major change was the
introduction of the Sarbanes Oxley Legislature. This legislature was signed by President
Bush in the year 2002 and developed by Congress. The main objective of this law was to
develop a new regulator for the accounting professional regulator. Name of the accounting
professional body was public companies accounting oversight board and primary
responsibility of this governing authority was to oversee the function of audit firms and
internal accountants appointed by public organizations (Kecskés, 2016).
The main focus was given on maintaining the independence of auditors and internal
accountants while preparing financial statements. In addition to that various ethical and
professional code of conduct were developed by this accounting board for maintaining
integrity and honesty in the accounting and auditing profession. Rules and regulations were
also developed for the establishment of an internal audit department in public sector
organizations. Roles and responsibility of these internal audit department were also
established by the government of the United States of America. One of the primary change
made in the role of the internal audit department was that such department was not reportable
to the CEO of the company.
Internal audit department was reportable to the board of directors and responsibility of
selecting external auditor also lies with the internal audit department. Internal audit
department was not considered as part of internal management as it was a separate unit with
the main focus on identification of errors and omissions in financial statements and internal
controls (Nogler, 2015). As an aftermath of this corporate fraud, accountability of
management and auditor towards shareholders of the company increased significantly. The
detailed report was required to be developed by auditor and management. This report was
required to be communicated to every shareholder in annual reports prepared by the
organization. Shareholders of the company were given the power to examine financial
statements and ask any query from management in annual general meeting.
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References
Boyle, D. M., DeZoort, F. T., & Hermanson, D. R. (2015). The effect of alternative fraud
model use on auditors’ fraud risk judgments. Journal of Accounting and Public
Policy, 34(6), 578-596.
Comer, M. J. (2017). Corporate fraud. Routledge.
Diebold, F. X., & Yılmaz, K. (2014). On the network topology of variance decompositions:
Measuring the connectedness of financial firms. Journal of Econometrics, 182(1), 119-
134.
Diermeier, D., Crawford, R. J., & Snyder, C. (2017). Arthur Andersen (c): The collapse of
Arthur Andersen. Kellogg School of Management Cases, 1-10.
Johansson, E., & Carey, P. (2016). Detecting fraud: The role of the anonymous reporting
channel. Journal of business ethics, 139(2), 391-409.
Kecskés, A. (2016). The Sarbanes-Oxley act from a legislative viewpoint. The Theory and
Practice of Legislation, 4(1), 27-43.
Kizil, C., & Kaşbaşı, B. (2018). Accounting Scandals and Eye-Catching Frauds: USA-Japan
Comparison by Considering the Role of Auditing. Journal of Asian Research, 2(3).
Kranacher, M. J., & Riley, R. (2019). Forensic accounting and fraud examination. Wiley.
McCann, J. T., Offoha, E., & Bryant, R. (2015). Student Perceptions of Accounting and
Business Scandals on the Accounting Profession. British Journal of Economics,
Management & Trade, 326-341.
Nogler, G. E. (2015). Working with auditors: tips and traps. Strategic Finance, 97(1), 38-46.
Othman, R., Aris, N. A., Mardziyah, A., Zainan, N., & Amin, N. M. (2015). Fraud detection
and prevention methods in the Malaysian public sector: Accountants’ and internal
auditors’ perceptions. Procedia Economics and Finance, 28, 59-67.
Petraşcu, D., & Tieanu, A. (2014). The role of internal audit in fraud prevention and
detection. Procedia Economics and Finance, 16, 489-497.
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