1.Two General Accounting employees—Dan Renfroe and Angela Walter—made journal entries in the amount of $150 million and $171 million, respectively, without detailed support. It was noted that this was not out of the ordinary at WorldCom. In your opinion, was this a proper accounting practice? Explain. Though this may not be out of the ordinary for WorldCom, this is not a correct accounting practice. The way the entries were made does not comply with the proper account practice according to GAAP.
Detailed support is an important part of providing support to a journal entry and it explains the reason or purpose as to why the journal entry was created.
2.Based on GAPP, describe the propriety or impropriety of releasing of $150 million in line cost accruals in the Wireless division over Deloris DiCicco’s objections. Support your position using the authoritative accounting literature. When instructed to reduce the Wireless Division’s line cost by $150 million due to savings from the prior period, DiCicco refused because there was no support for the entry.
WorldCom would prepare an adjusting entry each month to recognize the estimated cost of the period as period expense, by capitalizing the expense as an accrued interest. According to GAAP, a line item cost must be reported as an expense on a company’s income statement. WorldCom capitalized the line expense, instead of expensing it and placed it on the balance sheet as an accrued liability rather than on the income statement as an operating expense.
3.On the topic of capitalizing line costs, critique the rationale included in CEO Scott Sullivan’s White Paper.
Based on your own analysis of GAAP, explain the propriety or impropriety of capitalizing line costs in the telecom industry. In the White Paper presented to the Board of Directors, the CEO Scott Sullivan supported the decision to capitalize line costs. Sullivan provided that the White Paper was in line with the company’s goal of maintaining strong growth rate through increasing its capital investment. Management noted that the treatment of the E/R cots as an asset was in no way in any contradiction of the definition of an asset as per FASB Concept Statement No. 6 which states, “Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events”. However, as per GAAP, line costs must be reported as an expense in the company’s income statement as these are fundamentally, operating expenses. It was put in the Balance Sheet as an accrued liability rather than in the income statement as an accrued expense. This resulted in falsely projecting income and profits; and concealing huge losses by wrongly capitalizing the line costs.
4.Consider journal entry that recognized $35 million of revenue in 2001 from the EDS contract based on WorlCom’s expectation that the five-year required cumulative minimum payment would not be met. Based on your own analysis of GAAP, explain the propriety to impropriety of this journal entry. This is not in compliance with the provisions of GAAP or SAB 101. Revenue should not be recognized until it is realized or becomes realizable and earned. If we followed this statement the company did not have realized revenue Furthermore, the penalty payments if enforced could not be paid till the year 2005 as stated in the contract. Also, the journal entry resulted in recognizing revenue when it was not earned or realized and thus, overstated the profits.
5.Why do you think the professionals in this case, most of whom are CPA’s, would agree to record a material journal entry contrary to their best professional judgment? I think that in many situations employees were able to twist statements which follow GAAP guidelines. May employees were convinced they were doing the right thing and those that were unwilling to participate were overlooked. Most of the material journal entries which were made contrary to best judgment were so done with a view to mask the declining profits and to show increasing profits, which in turn would increase stock prices.
6.In general, how does the role of Internal Auditing differ from the role of Independent (or External) Auditing? What is the role of Internal Auditing in a well-run corporation? When performed by internal auditors, what is a financial audit versus an operating audit? Do you think WorldCom’s Internal Audit Department was functioning as it should have been? Explain. Internal auditors work within an organization and report to its audit committee and/or directors. They help to design the company’s organizing systems and help develop specific risk management policies. External auditors are independent of the organization they are auditing. They report to the company’s shareholders. They provide their experienced opinion on the truthfulness of the company’s financial statements and perform work on a test basis to monitor systems in place. Internal Auditing is designed to look at the key risks facing the business and how the business is managing those risks effectively. It usually results in recommendations for improvement across departments. Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations.
It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. A financial audit is an audit or examination of the financial reporting process, determining the reliability and integrity of the financial statements and preparation of such statements. It also involves an appraisal of the internal controls related to the finance function of the enterprise. An operational audit, on the other hand, is a systematic review and evaluation of an operational unit in terms of its effectiveness and efficiency of operations, accomplishment of its laid down objectives and goals, and determining its appropriateness in the use of various resources. It is clear that the WorldCom’s Internal Audit department was not functioning as it should have been. It was concentrating only on operational audits and totally avoiding financial audits. On the cause of cost-saving, it clearly avoided any and every function which could overlap with the role of the external auditors.