ACCT 622 Week 4 Discussion Board Forum 2 Reply/Critique Example

Was WorldCom Undetectable? A Critique of a Classmate's Case Study on the Auditor's Duty to Find Fraud

The Thesis and Its Strength

Rachel, your case study argues that the WorldCom fraud was effectively undetectable by the external auditors because the chief financial officer and controller colluded, instructed subordinates to make the entries and kept the auditors away from the evidence, and that the Sarbanes-Oxley internal control requirements have since closed the gap. Your account of the first phase of the scheme, the release of line cost accruals in 1999 and 2000, is the clearest in our class, and you are right that the executives worked to conceal what they were doing. I think your central claim goes further than the record supports, however, and the conclusion needs qualifying.

Was the Fraud Undetectable?

Collusion and concealment do make fraud harder to find, and the fraud standard acknowledges that a properly performed audit may not detect a material misstatement concealed by collusion (Public Company Accounting Oversight Board [PCAOB], n.d.). But the same standard requires auditors to test journal entries and other adjustments, focusing on entries made outside the normal course, by unusual personnel, in round amounts or to seldom-used accounts. WorldCom's capitalization entries had nearly every one of those characteristics. The board's special investigative committee concluded that the external auditors did not obtain and test the detail behind these entries, and that their reliance on analytical procedures left them looking at ratios the fraud had been designed to preserve (Beresford et al., 2003). Kuhn and Sutton (2006) went further, arguing that automated rules applied to the general ledger would have flagged the entries as they were made. A fraud that leaves large round-dollar entries in the ledger is concealed from the reader of the statements, not from the auditor who examines the ledger. I would revise your claim to say the fraud was hard to detect with the procedures the auditors chose, and detectable with the procedures the standard now requires.

Your paper also treats the internal auditors' discovery as the result of inside knowledge. The record suggests something more modest and more instructive: the internal auditors noticed an unusual capital account balance, asked for support and kept asking when it was not provided. Those are ordinary audit steps, available to any auditor willing to persist.

Has Internal Control Reporting Closed the Gap?

Your conclusion says that Section 404 of the Sarbanes-Oxley Act, by requiring management and auditors to report annually on internal control, has made a WorldCom impossible (Sarbanes-Oxley Act of 2002, 2002). The reporting requirement did change practice, and controls over manual journal entries became a standard focus of those audits. But the research suggests caution. Doyle et al. (2007) found that material weaknesses are concentrated in companies that are smaller, younger, financially weaker, more complex, growing rapidly or restructuring, which means the strongest controls tend to be at the companies least likely to need them. Hogan et al. (2008), reviewing fraud research, report that management override, the method at WorldCom, remains a common element of fraud precisely because it bypasses controls rather than exploiting their absence. Internal control reporting reduces the risk; it does not remove it.

A Caution About Hindsight

In fairness to your argument, a critique of an audit failure has to guard against hindsight. We know now where the fraud was; the engagement team did not, and it faced thousands of accounts and limited time. The question is not whether the auditors could have found the entries if they had known where to look, but whether the procedures a skeptical auditor would have chosen, given what was knowable then, pointed toward them. I think they did, for three reasons that were visible before 2002: WorldCom's expense ratios held steady while its industry's deteriorated, the company's executives limited the auditors' access to information, and the entries themselves sat in the ledger in round amounts. Each of those is a condition the fraud standard asks auditors to treat as a warning (PCAOB, n.d.). Your paper would be more persuasive if it addressed these three conditions directly and explained why, in your view, they were not enough to change the audit approach. If you can make that case, your conclusion about detectability becomes an argument rather than an assumption.

What the Paper Leaves Out

Your case study does not mention the audit committee. The committee received the internal auditors' findings and acted on them, which was the turning point of the case. It would strengthen your paper to discuss what the audit committee knew before 2002, how often it met with the internal and external auditors without management present, and how Sarbanes-Oxley later required audit committees to oversee the external auditor directly.

Recommended Revisions

First, restate the detectability claim as suggested above, citing the fraud standard's journal entry provisions. Second, describe the internal auditors' procedures accurately as ordinary persistence rather than inside access. Third, qualify the conclusion on Section 404 with the evidence on where weaknesses cluster and on management override. Fourth, add a short section on the audit committee's role. Fifth, address the three warning conditions described above, so that readers can see why you weigh them as you do.

On Giving and Receiving Correction

Proverbs pictures iron sharpening iron as one person sharpens another (English Standard Version Bible, 2001/2016, Proverbs 27:17). These comments are offered in that spirit; your paper is well researched, and these changes would make its conclusions match its evidence.

References

Beresford, D. R., Katzenbach, N. deB., & Rogers, C. B., Jr. (2003). Report of investigation by the Special Investigative Committee of the Board of Directors of WorldCom, Inc. WorldCom, Inc.

Doyle, J., Ge, W., & McVay, S. (2007). Determinants of weaknesses in internal control over financial reporting. Journal of Accounting and Economics, 44(1-2), 193-223. https://doi.org/10.1016/j.jacceco.2006.10.003

English Standard Version Bible. (2016). Crossway. (Original work published 2001)

Hogan, C. E., Rezaee, Z., Riley, R. A., Jr., & Velury, U. K. (2008). Financial statement fraud: Insights from the academic literature. Auditing: A Journal of Practice & Theory, 27(2), 231-252. https://doi.org/10.2308/aud.2008.27.2.231

Kuhn, J. R., & Sutton, S. G. (2006). Learning from WorldCom: Implications for fraud detection through continuous assurance. Journal of Emerging Technologies in Accounting, 3(1), 61-80. https://doi.org/10.2308/jeta.2006.3.1.61

Public Company Accounting Oversight Board. (n.d.). AS 2401: Consideration of fraud in a financial statement audit. https://pcaobus.org/oversight/standards/auditing-standards/details/AS2401

Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (2002).