Case 1.

4
WorldCom: A Focus on Professional Responsibility
Synopsis
On June 25, 2002, WorldCom announced that it would be restating its financial statements for 2001 and the first
quarter of 2002. On July 21, 2002, WorldCom announced it had filed for banru!tcy. "t was later re#ealed that
WorldCom had engaged in im!ro!er accounting that too two ma$or forms% the o#erstatement of re#enue by at
least &'5( million and the understatement of line costs, its largest category of e)!enses, by o#er &* billion. With
+ernie ,bbers setting the tone of -hitting. the numbers at all costs, senior members of the cor!orate finance
organi/ation, led by C0O 1cott 1ulli#an, directed the im!ro!er accounting.
Andersens Relationship with WorldCom
2he 1!ecial "n#estigati#e Committee of the +oard of 3irectors 4the 1!ecial Committee5 found no e#idence that
WorldCom6s inde!endent auditor, 7rthur 7ndersen, in fact determined that WorldCom6s re#enues or line costs
were im!ro!erly re!orted. 8owe#er, it did find that 7ndersen6s failure to detect these im!ro!rieties liely
stemmed, in !art, from a failure to demand su!!orting e#idence for certain recorded transactions and some other
missed audit o!!ortunities that might ha#e resulted in the detection of these im!ro!rieties.
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7ndersen ser#ed as WorldCom6s auditor from at least as far bac as 1''0 through 7!ril 2002. "n a
!resentation to the 7udit Committee on :ay 20, 1''', 7ndersen stated that the firm #iewed its relationshi! with
WorldCom as a -long;term !artnershi!,. in which 7ndersen would hel! WorldCom im!ro#e its business
o!erations and grow in the future. "n its <ear 2000 audit !ro!osal, 7ndersen told the 7udit Committee that it
considered itself -a committed member of =WorldCom6s> team. and that WorldCom was -a flagshi! client and a
?crown $ewel6. of its firm.
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"n terms of the total amount of fees charged to clients, WorldCom was one of 7ndersen6s to! 20 engagements
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+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 25. 2he committee qualified its
analysis as follows% -We had access to only a !ortion of 7ndersen6s documents, and 7ndersen !ersonnel refused to
s!ea with us. 2herefore, we cannot answer with certainty the question why 7ndersen failed to detect such a large
fraud..
9@
+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 225.
in 2000, and the largest client of its Jacson, :ississi!!i, office. 0rom 1''' through 2001, WorldCom !aid
7ndersen &*.( million in fees to audit the financial statements of WorldCom, "nc.C &@.@ million for other audits
required by law in other countriesC and about &50 million for consulting, litigation su!!ort, and ta) ser#ices.
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Andersens Restricted Access to Information
WorldCom se#erely restricted 7ndersen6s access to informationC se#eral of 7ndersen6s requests for detailed
information and o!!ortunities to s!ea with certain em!loyees were denied. "n fact, 7ndersen was denied access to
WorldCom6s com!uteri/ed Deneral Eedger and had to rely on the !rinted ledgers. 7ccording to the !erson in
charge of security for WorldCom6s com!uteri/ed consolidation and financial re!orting system, WorldCom6s
treasurer in 1''( instructed him not to gi#e 7ndersen access to this com!uteri/ed re!orting system.
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"n addition, senior management of WorldCom berated em!loyees who disclosed unauthori/ed information to
7ndersen. 0or e)am!le, in October 2000, 1te#en +rabbs, the 3irector of "nternational 0inance and Control for
,:,7 4,uro!e, :iddle ,ast, and 7frica5, told 7ndersen6s F.G. office that line cost e)!enses for ,:,7 were
understated by &BB.@ million because senior management had reduced their line cost accruals and that ,:,7 did
not ha#e any su!!ort for this entry. WorldCom6s 1enior Hice Iresident and Controller 3a#id :yers re!rimanded
+rabbs and directed him ne#er to do it again. "n early 2002, after learning about another con#ersation between
+rabbs and 7ndersen about a !lanned restructuring charge, :yers s!ecifically instructed F.G. em!loyees that -JO
communication with auditors is allowed without s!eaing with 1te!hanie 1cott =Hice Iresident of 0inancial
Ae!orting> and myself. 2his goes for anything that might im!ly a change in accounting, charges, or anything else
that you would thin is im!ortant.. When :yers found out that the accountant had continued to s!ea with
7ndersen F.G. about the issue, he wrote the following message to the accountant%
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3o not ha#e any more meetings with 7ndersen for any reason. " s!oe to 7ndersen this morning and hear
that you are still taling about asset im!airments and facilities. " do not want to hear an e)cuse $ust sto!.
:ar Wilson has already told you this once. 3on6t mae me as you again.
7lthough 7ndersen was aware that it was recei#ing less than full coo!eration, it did not notify WorldCom6s
7udit Committee of this matter.
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9*
+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 225.
9(
+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 29@K29(.
9'
+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 250K251.
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+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 25K2@.
Audit Approach
7!!arently, the auditors from 7rthur 7ndersen understood the ele#ated ris associated with the WorldCom audit.
+ased on a re#iew of the wor!a!ers by the 1!ecial "n#estigati#e Committee of the +oard of 3irectors, it was
disco#ered that 7ndersen rated WorldCom a -ma)imum ris. client. +ecause of the ma)imum ris classification,
7ndersen6s internal !olicies required the engagement team to consult with 7ndersen6s Iractice 3irector, 7d#isory
Iartner, 7udit 3i#ision head, and Irofessional 1tandards Drou! 4where a!!ro!riate5 regarding all significant audit
issues. "n addition, the lead engagement !artner was required to hold an ,)!anded Ais 3iscussion on an annual
basis with the Concurring Iartner, the Iractice 3irector, and the 7udit 3i#ision head to consider the areas that
caused greatest audit ris. 1ur!risingly 7ndersen did not disclose to the !ublic that WorldCom was considered a
ma)imum ris client to the 7udit Committee of WorldCom.
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2he outcome of the ,)!anded Ais 3iscussion after the 1''' and 2000 year;end audits was that 7ndersen did
not find e#idence of aggressi#e accounting or fraud at WorldCom.
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8owe#er, during the discussion that was held
in 3ecember 2001, concerns were #oiced o#er WorldCom6s use of numerous -to!;side. $ournal entries. 1uch
entries are ty!ically recorded at the cor!orate le#el, detached from the economic acti#ity that is occurring at each of
the business units or di#isions within WorldCom. 7 handwritten note in 7ndersen6s wor!a!ers read% -:anual
Journal ,ntries 8ow dee! are we goingL 1ur!rise w=ith> loo =at> $ournal entries.. <et, there was no indication of
further testing on these entries.
5B
"n all, the 1!ecial "n#estigati#e Committee found hundreds of large, round;dollar
$ournal entries that were made by WorldCom6s Deneral 7ccounting grou! staff, without any su!!ort other than a
Iost;it
M
Jote or written instructions directing the entry to be made.
2he 1!ecial Committee found that 7ndersen relied hea#ily on substanti#e analytical !rocedures and conducted
only a limited amount of substanti#e tests of details. "n addition, the element of sur!rise was lost as 7ndersen often
!ro#ided WorldCom6s senior management team with a list of the auditing !rocedures that it antici!ated
!erforming in the areas of re#enues, line costs, accounts recei#able, ca!ital e)!enditures, and data integrity.
0urthermore, 7ndersen6s testing of ca!ital e)!enditures, line costs, and re#enues did not change materially from
1''' through 2001.
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51
+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 2*.
52
+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 2B2K2BB.
5B
+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 2B@.
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+oard of 3irectors6 1!ecial "n#estigati#e Committee Ae!ort, June ', 200B, 22(.
Case Questions
1. Ilease consult Iaragra!h NB2 of IC7O+ 7uditing 1tandard Jo. 2. +ased on the case information, do you
belie#e that 7ndersen #iolated any of the four basic !rinci!les of auditor inde!endence describedL Why or why
notL
2. Consult Iaragra!hs NB5KB@ of IC7O+ 7uditing 1tandard Jo. 2. Di#en the reluctance of WorldCom6s
management team to communicate with 7ndersen, do you belie#e that 7ndersen e)ercised -3ue Irofessional
Care. and -Irofessional 1e!ticism. in com!leting the auditL Why or why notL
B. "n terms of audit effecti#eness and efficiency, briefly e)!lain the difference between substanti#e analytical
!rocedures and substanti#e test of details. 3o you belie#e it was a!!ro!riate for 7ndersen to rely !rimarily on
substanti#e analytical !roceduresL Why or why notL
9. Consult Iaragra!h N159 of IC7O+ 7uditing 1tandard Jo. 2. Iro#ide an e)am!le of both a substanti#e
analytical !rocedure and a test of detail that could be used to gather e#idence about a -to!;side. ad$usting
$ournal entry.