Published:
2 months ago
Fall Semester Accounting: Top Grades with Quiz and Exam
categories:
Online course help
District Court in Chicago, charged that the defendants engaged in a systematic scheme to falsify and misrepresent Waste Management’s financial results between 1992 and 1997. According to Thomas C. Newkirk, associate director of the SEC’s Division of Enforcement, “Our complaint describes one of the most egregious accounting frauds we have seen. For years, these defendants cooked the books, enriched themselves, preserved their jobs, and duped unsuspecting shareholders.”1 The SEC’s complaint alleges that company management fraudulently manipulated the company’s fnancial results to meet predetermined earnings targets. The company’s revenues were not growing fast enough to meet those targets, so the defendants resorted to improperly eliminating and deferring current period expenses to infate earnings. They employed a multitude of improper accounting practices to achieve this objective. Among other things, the SEC noted that the defendants: ƒ Avoided depreciation expenses on their garbage trucks by both assigning unsupported and inflated salvage values and extending their useful lives, ƒ Assigned arbitrary salvage values to other assets that previously had no salvage value, ƒ Failed to record expenses for decreases in the value of landfills as they were filled with waste, ƒ Refused to record expenses necessary to write off the costs of unsuccessful and abandoned landfill development projects, ƒ Established inflated environmental reserves (liabilities) in connection with acquisitions so that the excess reserves could be used to avoid recording unrelated operating expenses, ƒ Improperly capitalized a variety of expenses, and ƒ Failed to establish sufficient reserves (liabilities) to pay for income taxes and other expenses. The SEC alleged that the improper accounting practices were centralized at corporate headquarters, with Dean L. Buntrock, founder, chairman, and CEO as the driving force behind the fraud. Allegedly, Buntrock set the earnings targets, fostered a culture of fraudulent accounting, personally directed certain of the accounting changes to make the targeted earnings, and was the spokesperson who announced the company’s phony numbers. During the year, Buntrock and other corporate officers monitored the company’s actual operating results and compared them to the quarterly targets set in the budget. To reduce expenses and inflate earnings artificially, the officers used “top-level adjustments” to conform the company’s actual results to the predetermined earnings targets. The inflated earnings of one period became the floor for future manipulations. To sustain the scheme, earnings fraudulently achieved in one period had to be replaced in the next period. According to the SEC, the defendants allegedly concealed their scheme by using accounting manipulations known as “netting” and “geography” to make reported results appear better than they actually were and to avoid public scrutiny. The netting activities allowed them to eliminate approximately $490 million in current period accounting misstatements by offsetting them against unrelated one-time gains on the sale or exchange of assets. The geography entries allowed them to move tens of millions of dollars between various line items on the company’s income statement to make the financial statements appear as management wanted. In addition to Buntrock, the SEC complaint named other Waste Management officers as participants in the fraud. Phillip B. Rooney, president and chief operating officer (COO), and James Koenig, executive vice president CFO, were among the six officers named in the complaint. According to the SEC, Rooney was in charge of building the profitability of the company’s core solid waste operations and at all times exercised overall control over the company’s largest subsidiary. He ensured that required write-offs were not recorded and, in some instances, overruled accounting decisions that would have a negative impact on operations. Koenig was primarily responsible for executing the scheme. He ordered the destruction of damaging evidence, misled the audit committee and internal accountants, and withheld information from the outside auditors. According to the SEC staff, the defendants’ fraudulent conduct was driven by greed and a desire to retain their corporate positions and status in the business and social communities. Buntrock posed as a successful entrepreneur.
With charitable contributions made with the fruits of the ill-gotten gains or money taken from the company, Buntrock presented himself as a pillar of the community. According to the SEC, just 10 days before certain of the accounting irregularities first became public, he enriched himself with a tax benefit by donating inflated company stock to his college alma mater to fund a building in his name. He was the primary beneficiary of the fraud and allegedly reaped more than $16.9 million in ill-gotten gains from, among other things, performancebased bonuses, retirement benefits, charitable giving, and selling company stock while the fraud was ongoing. Rooney allegedly reaped more than $9.2 million in ill-gotten gains from, among other © 201 things, performance-based bonuses, retirement benefits, and selling company stock while the fraud was ongoing. Koenig profited by more than $900,000 from his fraudulent acts. According to the SEC, the defendants were allegedly aided in their fraud by the company’s long-time auditor, Arthur Andersen, LLP, which had served as Waste Management’s auditor since before the company became a public company in 1971. Andersen regarded Waste Management as a “crown jewel” client. Until 1997, every CFO and chief accounting officer (CAO) in Waste Management’s history as a public company had previously worked as an auditor at Andersen. During the 1990s, approximately 14 former Andersen employees worked for Waste Management, most often in key financial and accounting positions. During the period 1991 through 1997, Andersen billed Waste Management approximately $7.5 million in audit fees and $11.8 million in other fees related to tax, attest work, regulatory issues, and consulting services. A related entity, Andersen Consulting (now Accenture) also billed Waste Management corporate headquarters approximately $6 million in additional non-audit fees. The SEC alleged that at the outset of the fraud, Waste Management executives capped Andersen’s audit fees and advised the Andersen engagement partner that the firm could earn additional fees through “special work.” Andersen nevertheless identified the company’s improper accounting practices and quantified much of the impact of those practices on the company’s financial statements. Andersen annually presented company management with what it called Proposed Adjusting Journal Entries (PAJEs) to correct errors that understated expenses and overstated earnings in the company’s financial statements. Management consistently refused to make the adjustments called for by the PAJEs, according to the SEC’s complaint. Instead, the defendants secretly entered into an agreement with Andersen to write off the accumulated errors over periods up to ten years and to change the underlying accounting practices in future periods. The signed, four-page agreement, known as the Summary of Action Steps, identified improper accounting practices that went to the core of the company’s operations and prescribed 32 “must do” steps for the company to follow to change those practices. The Action Steps thus constituted an agreement between the company and its outside auditor to cover up past frauds by committing additional frauds in the future, according to the SEC complaint. As time progressed, the defendants did not comply with the Action Steps agreement. Writing off the errors and changing the underlying accounting practices as prescribed in the agreement would have prevented the company from meeting earnings targets, and the defendants from enriching themselves. The fraud scheme eventually unraveled. In mid-July 1997, a new CEO ordered a review of the company’s accounting practices. That review ultimately led to the restatement of the company’s financial statements for 1992 through the third quarter of 1997. EPILOGUE In addition to the fraudulent activities related to the 1992 through 1997 financial statements, Waste Management’s fraudulent activities continued. In July 1999 the SEC issued a cease and desist order alleging that management violated U.S. securities laws when they publicly projected results for the company’s 1999 second quarter. According to the SEC, in June 1999 management continued to reiterate projected results for the quarter ended June 30, 1999, despite being aware of significant adverse trends in its business which made continued public support of its announced forecasts unreasonable. Apparently, Waste Management’s information system failures made June’s earnings forecast even more unreasonable since the company could not generate information from which reliable forecasts could be made. The SEC’s order was triggered by a July 6, 1999 company announcement of revenue shortfalls versus its internal budget of approximately $250 million for the second quarter. This news sent the share prices falling. On July 7, 1999, share prices went from $53.56 to $33.94 per share, and by August 4, 1999, share prices were down to $22.25 per share. The Wall Street Journal subsequently reported that the company evidentially settled a class action suit related to these 1999 charges for $457 million.2 Despite these negative events, the company continues to operate. As for Arthur Andersen, the SEC eventually settled charges with Andersen and four of its partners related to the 1992 through 1996 audited financial statements. Andersen agreed to pay a penalty of $7 million, the largest ever assessed against an accounting firm at that time. The SEC’s complaint against Andersen said that the firm knew Waste Management was exaggerating its profits throughout the early and mid-1990s, and repeatedly pleaded with the company to make changes. Each year Andersen gave in, certifying the company’s annual financial statements conformed to generally accepted accounting principles. According to Richard Walker, SEC Director of Enforcement, “Arthur Andersen and its partners failed to stand up to company management and thereby betrayed their ultimate allegiance to Waste Management’s shareholders and the investing public. Given the positions held by these partners and the duration and gravity of the misconduct, the firm itself must be held responsible for the false and misleading audit reports.” The SEC filed a civil fraud complaint against three Andersen partners who were involved in the audit, all of whom settled without admitting or denying the allegations. The three partners agreed to pay fines of $30,000 to $50,000 each and agreed to be banned from auditing public companies for up to five years. A fourth partner was barred from auditing for one year. These charges against Andersen related to the Waste Management fraud and other high profile frauds, including the fraud at Sunbeam Corporation, provided a significant backdrop for all the allegations against Andersen in 2001 and 2002 for its role in the audits of Enron Corporation and the accounting firm’s ultimate demise.
[1] Review Waste Management’s Consolidated Balance Sheet as of December 31, 1996. Identify accounts whose balances were likely based on significant management estimation techniques. Describe the reasons why estimates were required for each of the accounts identified.
[2] Describe why accounts involving significant management estimation are generally viewed as inherently risky.
[3] Review professional auditing standards to describe the auditor’s responsibilities for examining management-generated estimates. Also, describe the techniques commonly used by auditors to evaluate the reasonableness of management’s estimates.
[4] The Waste Management fraud primarily centered on inappropriate estimates of salvage values and useful lives for property and equipment. Describe techniques Andersen auditors could have used to assess the reasonableness of those estimates used to create Waste Management’s financial statements.
[5] Three conditions are often present when fraud exists. First, management or employees have an incentive or are under pressure, which provides them a reason to commit the fraud act. Second, circumstances exist – for example, absent or ineffective internal controls or the ability for management to override controls – that provide an opportunity for the fraud to be perpetrated. Third, those involved are able to rationalize the fraud as being consistent with their personal code of ethics. Some individuals possess an attitude, character, or set of ethical values that allows them to knowingly commit a fraudulent act. Using hindsight, identify factors present at Waste Management that are indicative of each of the three fraud conditions: incentives, opportunities, and attitudes.
[6] Several of the Waste Management accounting personnel were formerly employed by the company’s auditor, Arthur Andersen. What are the risks associated with allowing former auditors to work for a client in key accounting positions? Research Section 206 of the Sarbanes−Oxley Act of 2002 and provide a brief summary of the restrictions related to the ability of a public company to hire accounting personnel who were formerly employed by the company’s audit firm.
[7] Discuss possible reasons why the Andersen partners allegedly allowed Waste Management executives to avoid recording the identified accounting errors. How could accounting firms ensure that auditors do not succumb to similar pressures on other audit engagements?
[8] What is meant by the term professional judgment?
[9] What kind of professional judgments did the auditors of Waste Management have to make in regards to the examination of the accounting for property, plant, and equipment?
[10]What are some examples of judgment traps and tendencies that likely affected the auditor's judgment when auditing Waste Management's financial statements?
12. Wiater Company operates a small manufacturing facility. On January 1, 2015, an asset account...
Wiater Company operates a small manufacturing facility. On January 1, 2015, an asset account for the company showed the following balances: Equipment $ 375,000 Accumulated Depreciation (beginning of the year) 258,750 During the first week of January 2015, the following expenditures were incurred for repairs and maintenance: Routine maintenance and repairs on the equipment $ 3,850 Major overhaul of the equipment that improved efficiency 44,000 The equipment is being depreciated on a straight-line basis over an estimated life of 20 years with a $30,000 estimated residual value. The annual accounting period ends on December 31. Required: Indicate the effects (accounts, amounts, and + for increase and - for decrease) of the following two items on the accounting equation, using the headings shown below. (Enter any decreases to Assets, Liabilities or Stockholder's Equity with a minus sign.) 1. The adjustment for depreciation made last year at the end of 2014. 2. The two expenditures for repairs and maintenance during January 2015.
company showed the following balances: Equipment $375,000 Accumulated Depreciation (beginning of the year) 258,750 During the first week of January 2015, the following expenditures were incurred for repairs and maintenance Routine maintenance and repairs on the equipment 3,850 Major overhaul of the equipment that improved efficiency 44,000 The equipment is being depreciated on a straight-ine basis over an estimated life of 20 years with a $30,000 estimated residual value. The annual accounting period ends on December 31. Required: Indicate the effects (accounts, amounts, and for increase and for decrease) of the following two items on the accounting equation, using the headings shown below (Enter any decreases to Assets, Liabilities or Stockholder's Equity with a minus sign.) 1. The adjustment for depreciation made last year at the end of 2014. 2. The two expenditures for repairs and maintenance during January 2015. Assets Liabilities tem 2014 2015
13. 1. What are the issues confronting Thomas in this case? 2. How well is Thomas dealing with these...
1. What are the issues confronting Thomas in this case? 2. How well is Thomas dealing with these issues? 3. What suggestions would you have for Thomas in managing this project? Michael Thomas shouted, “Sasha, Tor-Tor, we’ve got to go! Our driver is waiting for us.” Thomas’s two daughters were fighting over who would get the last orange for lunch that day. Victoria (“Tor-Tor”) prevailed as she grabbed the orange and ran out the door to the Mercedes Benz waiting for them. The fighting continued in the back seat as they drove toward the city of Budapest, Hungary. Thomas finally turned around and grabbed the orange and proclaimed that he would have it for lunch. The back seat became deadly silent as they made their way to the American International School of Budapest.
14. Which of the following tasks is not normally associated with an activity-based costing system? A....
15.
Which of the following tasks is not normally associated with an activity-based costing system? A. Calculation of pool rates. B. Identification of cost pools. C. Preparation of allocation matrices. D. Identification of cost drivers. E. Assignment of cost to products.
15. (Objectives 9-1, 9-2) The following questions deal with materiality. Choose the best response. a....
(Objectives 9-1, 9-2) The following questions deal with materiality. Choose the best response.
a. Which one of the following statements is correct concerning the concept of materiality?
(1) Materiality is determined by reference to guidelines established by the AICPA.
(2) Materiality depends only on the dollar amount of an item relative to other items in the financial statements.
(3) Materiality depends on the nature of an item rather than the dollar amount.
(4) Materiality is a matter of professional judgment.
b. Which of the following is not correct about materiality?
(1) The concept of materiality recognizes that some matters are important for fair presentation of financial statements in conformity with accounting standards, whereas other matters are not important. (2) An auditor considers materiality for planning purposes in terms of the largest aggregate level of misstatements that could be considered material to any one of the financial statements.
(3) Materiality judgments are made in light of surrounding circumstances and neces - sarily involve both quantitative and qualitative judgments.
(4) An auditor’s consideration of materiality is influenced by the auditor’s perception of the needs of a reasonable person who will rely on the financial statements.
c. In considering materiality for planning purposes, an auditor believes that misstate - ments aggregating $10,000 will have a material effect on an entity’s income statement, but that misstatements will have to aggregate $20,000 to materially affect the balance sheet. Ordinarily, it is appropriate to design audit procedures that are expected to detect misstatements that aggregate
(1) $10,000
(2) $15,000
(3) $20,000
(4) $30,000
(Objective 9-1)
MATERIALITY
Materiality is a major consideration in determining the appropriate audit report to issue. The concepts of materiality discussed in this chapter are directly related to those we introduced in Chapter 3. FASB Concept Statement 2 defines materiality as: • The magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement. [italics added] Because auditors are responsible for determining whether financial statements are materially misstated, they must, upon discovering a material misstatement, bring it to the client’s attention so that a correction can be made. If the client refuses to correct the statements, the auditor must issue a qualified or an adverse opinion, depending on the materiality of the misstatement. To make such determinations, auditors depend on a thorough knowledge of the application of materiality. A careful reading of the FASB definition reveals the difficulty that auditors have in applying materiality in practice. While the definition emphasizes reasonable users who rely on the statements to make decisions, auditors must have knowledge of the likely users of the client’s statements and the decisions that are being made. For example, if an auditor knows that financial statements will be relied on in a buy–sell agreement for the entire business, the amount that the auditor considers material may be smaller than that for an otherwise similar audit. In practice, of course, auditors may not know who all the users are or what decisions they may make based on the financial statements. Auditors follow five closely related steps in applying materiality, as shown in Figure 9-1. The auditor first sets a preliminary judgment about materiality and then allocates
this estimate to the segments of the audit, as shown in the first bracket of the figure. These two steps, which are part of planning, are our primary focus for the discussion of materiality in this chapter. Step 3 occurs throughout the engagement, when auditors estimate the amount of misstatements in each segment as they evaluate audit evidence. Near the end of the audit, during the engagement completion phase, auditors proceed through the final two steps. These latter three steps, as shown in the second bracket in Figure 9-1, are part of evaluating the results of audit tests.
(Objective 9-2)
