Page 158 - DCOM204_AUDITING_THEORY

Auditing Theory

Notes Beginning modestly in mid-year 1999 and continuing at an accelerated pace through May
2002, the company (under the direction of Ebbers, Scott Sullivan (CFO), David Myers
(Controller) and Buford “Buddy” Yates (Director of General Accounting)) used fraudulent
accounting methods to mask its declining earnings by painting a false picture of financial
growth and profitability to prop up the price of WorldCom’s stock.

The fraud was accomplished primarily in two ways:
1. Underreporting ‘line costs’ (interconnection expenses with other telecommunication
companies) by capitalizing these costs on the balance sheet rather than properly
expensing them.
2. Inflating revenues with bogus accounting entries from “corporate unallocated
revenue accounts”.
In 2002, a small team of internal auditors at WorldCom worked together, often at night
and in secret, to investigate and unearth $3.8 billion in fraud. Shortly thereafter, the
company’s audit committee and board of directors were notified of the fraud and acted
swiftly: Sullivan was fired, Myers resigned, Arthur Andersen withdrew its audit opinion
for 2001, and the U.S. Securities and Exchange Commission (SEC) launched an investigation
into these matters on June 26, 2002 (see accounting scandals). By the end of 2003, it was
estimated that the company’s total assets had been inflated by around $11 billion.
Bankruptcy
On July 21, 2002, WorldCom filed for Chapter 11 bankruptcy protection in the largest such
filing in United States history at the time (since overtaken by the collapse of Lehman
Brothers and Washington Mutual in September 2008). The WorldCom bankruptcy
proceedings were held before U.S. Federal Bankruptcy Judge Arthur J. Gonzalez who
simultaneously heard the Enron bankruptcy proceedings which were the second largest
bankruptcy case resulting from one of the largest corporate fraud scandals. None of the
criminal proceedings against WorldCom and its officers and agents was originated by
referral from Gonzalez or the Department of Justice lawyers. WorldCom changed its
name to MCI, and moved its corporate headquarters from Clinton, Mississippi, to Dulles,
Virginia, on April 14, 2003.
Under the bankruptcy reorganization agreement, the company paid $750 million to the
SEC in cash and stock in the new MCI, which was intended to be paid to wronged investors.
In the previous units, we have discussed in detail about the concept of internal audit in
general. Obviously, a question may come to your mind that whether it makes any difference
to internal audit in an Electronic Data Processing (EDP) environment. The answer is both
Yes and No. While the objectives of internal audit do not change in an EDP environment,
the audit techniques, procedures used will often differ from those used in manual or
mechanical data processing environment.

8.8 Planning an Internal Audit in an Electronic Data Processing
Environment

In planning the portions of the internal audit which may be affected by the entity’s EDP
Environment, the auditor should obtain an understanding of the significance and complexity of
the EDP activities and the availability of data for use in the audit. This understanding would
include such matters as:
1. The organizational structure of the entity’s EDP activities and the extent of concentration
or distribution of computer processing and development throughout the entity, particularly
as they may affect segregation of duties at both the user and EDP personnel levels.

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