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Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

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Page 1: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

Case 6.3

WorldCom

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Page 2: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB Ethics and Independence Rule 3520 “a registered public accounting firm and

its associated persons must be independent of the firm's audit client throughout the audit and professional engagement period.”

2

Page 3: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS #13 - Paragraph #7 “auditor's responses to the assessed risks

of material misstatement, particularly fraud risks, should involve the application of professional skepticism in gathering and evaluating audit evidence.”

3

Page 4: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS No. 15 – Paragraphs 13-21 Paragraph #13 classifies auditing procedures

into three categories, risk assessment procedures, test of controls, and substantive procedures. Next, paragraphs #15-21 describe a number of specific audit procedures, including inspection, observation, inquiry, confirmation, recalculation and re-performance.

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Page 5: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS #15 - Paragraph #13 There are two primary ways of conducting

substantive tests: 1) substantive analytical review and 2) test of details.

5

Page 6: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS #5 – Paragraph #14 the auditor should evaluate whether the

company's controls sufficiently address identified risks of material misstatement due to fraud and controls intended to address the risk of management override

PCAOB AS #5 – Paragraph #A8 controls over financial reporting may be

preventive controls or detective controls

6

Page 7: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

Revenue Recognition Principle Revenue must be both earned and

realized before it is recognized. That is, the product must have been delivered or the services must have been provided to the customer. In addition, the amount of the sale needs to be fixed and determinable. And, there must be a belief that the cash will be collected from the customer in a timely manner.

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Page 8: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS#12 – Paragraph #68 “the auditor should presume that

there is a fraud risk involving improper revenue recognition and evaluate which types of revenue, revenue transactions, or assertions may give rise to such risks”

8

Page 9: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

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PCAOB AS #5 - Paragraph #25 “because of its importance to effective

internal control over financial reporting, the auditor must evaluate the control environment at the company.” The control environment is influenced heavily by a company’s management team and is therefore often referred to as “the tone at the top.”

9

Page 10: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS #13 - Paragraph #7 “auditor's responses to the assessed risks

of material misstatement, particularly fraud risks, should involve the application of professional skepticism in gathering and evaluating audit evidence.”

10

Page 11: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

Matching Principle Costs need to be matched to the

revenues that they helped to generate. A key point is that expenses should not necessarily be recognized when the work is completed or a product is produced. Rather, the costs should be recognized when the costs can be matched to revenue that has been recorded.

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Page 12: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS No. 5 – Paragraph A5 “Internal controls provide reasonable

assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.”

12

Page 13: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS No. 15 – Paragraphs 13-21 Paragraph #13 classifies auditing procedures

into three categories, risk assessment procedures, test of controls, and substantive procedures. Next, paragraphs #15-21 describe a number of specific audit procedures, including inspection, observation, inquiry, confirmation, recalculation and re-performance.

13

Page 14: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS #12 – Paragraph #7 “The auditor should obtain an understanding of

the company and its environment to understand the events, conditions, and company activities that might reasonably be expected to have a significant effect on the risks of material misstatement.”

14

Page 15: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical KnowledgePCAOB AS #13 – Paragraph #6 The auditor should determine whether it is necessary

to “make pervasive changes to the nature, timing, or extent of audit procedures to adequately address the assessed risks of material misstatement. Examples of such pervasive changes include modifying the audit strategy to: a) Increase the substantive testing of the valuation of numerous significant accounts at year end because of significantly deteriorating market conditions, and b) Obtain more persuasive audit evidence from substantive procedures due to the identification of pervasive weaknesses in the company's control environment.”

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Page 16: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS #5 – Paragraph #33 the auditor should follow Appendix B to

determine which locations need to be visited.

PCAOB AS #5 – Paragraph #B10 Must assess the risk of material

misstatement related to each location or business unit and then increase or decrease audit work depending on risk.

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Page 17: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical KnowledgePCAOB AS #12 – Paragraph #65 “fraud risk factors are events or conditions

that indicate (1) an incentive or pressure to perpetrate fraud, (2) an opportunity to carry out the fraud, for example, the absence of controls, ineffective controls, or the ability of management to override controls—that provide an opportunity for a fraud to be perpetrated, or (3) an attitude or rationalization that justifies the fraudulent action”

17

Page 18: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS No. 5 – Paragraph A5 “Internal controls provide reasonable

assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.”

18

Page 19: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

SARBOX Section 301 requires that the “audit committee of an

issuer shall be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by that issuer.”

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Page 20: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

AU Section 322 – Paragraph #7 makes clear that there can be relevant

activities completed by internal auditors in their work related to the internal control system.

AU Section 322 – Paragraph #8 makes clear that the external auditor may

find the work of internal auditors to be beneficial on the audit.

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Page 21: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB AS #5 – Paragraph #18 “the auditor should assess the

competence and objectivity of the persons whose work the auditor plans to use to determine the extent to which the auditor may use their work. The higher the degree of competence and objectivity, the greater use the auditor may make of the work.”

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Page 22: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

WorldCom CaseRelevant Technical Knowledge

PCAOB ET #102 - Paragraph #1 “in the performance of any professional

service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.”

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Page 23: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

Epilogue - WorldCom CEO Bernard Ebbers sentenced to

25 years in prison

CFO Scott Sullivan pardoned from paying $13 million settlement due to having no significant assets remaining after selling $11 million mansion and surrendering his IRA

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Page 24: Case 6.3 WorldCom Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill

Epilogue - WorldCom SEC set up a $150 million fund to

compensate investor losses

WorldCom emerged from bankruptcy as MCI, which was later bought by Verizon Communications

24


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