Fraud in the AIS - Essay Example

Fraud in the AIS The accounting information system (AIS) has faced many changes in the recent past, such as changes from paper-based ledgers and journals to purely paperless and automates systems. It has also faced changes due to development of new regulations that was mainly as a result of major company scandals that involved big companies like Enron, WorldCom, and Arthur Andersen LLP. The AIS has faced a lot of difficulties especially with the development of technology that resulted in new security issues. In many cases, the threats and risks to the AIS are as a result of internal sources, mainly human beings and are not natural. The risks and threats are clearly seen in the case of WorldCom (Beltran, 2002). Company Background WorldCom was a telecommunication company founded in the year 1983. The company became so successful to the point where its stock price went up the peak, making the CEO, Bernard Ebbers, one of the richest men in the United States. The company continued with its expansion strategies by acquiring more companies. It was seen as one of the success stories in the business world in 1990s (Fernando, 2009). Background information of the company’s fraud In the year 2002, the company announced that it had used improper accounting method that resulted to an overstatement in earnings in 2001and during the first quarter of the year 2002 by more than $3.8 billion. As a result, in 2002 the company filed for Chapter 11 bankruptcy, which was the largest filing in the history of the United States. It has $41 billion debt load and $107 billion in assets, making the bankruptcy even larger than that of Enron Corporation. The company had to lay off about a fifth of its employees in an effort to stay in business. Investigations showed that the accounting maneuver was exposed by the internal auditor in WorldCom. One of the main discoveries was on the company’s revenue expenditure that had been treated as capital expenditure. It resulted to an overstatement of the profits by $3.8 billion. As a result, the company’s external auditors, Arthur Andersen LLP released a statement stating that it acted according to the professional standards and that the internal audit could not be relied on in relations to the accounting manipulations. Arthur Anderson had acted in collusion with top management at WorldCom to falsify the company’s profits with the aim of increasing its stocks. The company’s audit committee in turn replaced Arthur Andersen LLP with KPMG to further investigate the matter. This led to the discovery of fraud, misstatements in the financial statements, and filing false documents that led to the collapse of the company. Fraud was committed in two main ways including underreporting the expenses so that they can overestimate the profits. These expenses were instead reported as capital investments in the balance sheet. The stock price of the company, in turn, increased. The second way was by reducing the reserve accounts. The company increased its revenues by falsifying accounting entries from the ‘corporate unallocated revenue accounts’. It decreased its reserve accounts to cover the liabilities of the companies that it had acquired. The result was an increase in its profits. How the company’s accounting information system contributed to fraud Accounting information system has a number of functions that failed in the case of WorldCom, resulting in the scandal. The first function of AIS is to supply information that is useful for decision making purposes. This function failed because the Board of Directors in the company did not gain knowledge of the financial manipulation in company in time to correct the mistake. It got the information when it changed its external auditors and when much damage had been done. The second function is to make sure that the controls are available to make sure that data is accurately recoded and processed. This function failed because the company laced effective internal controls. Internal controls are crucial in preventing fraud from occurring in the company and in making sure that operations run smoothly. Lack of effective internal controls allowed many fraudulent activities to happen at WorldCom. The lack of proper segregation of duties and checks and balances made it easy for fraud to occur with the knowledge of only a few people. The components of the AIS at WorldCom also contributed to the scandal. The most obvious component that led to the scandal is the people, including the managers, auditors and accountants. When the telecommunications industry started to decline, many investors were afraid that WorldCom would also go down. However, to the surprise of many people, the company was still able to meet the expectations in its earnings. It was never expected that the company would use fraudulent accounting practices to improve their performance. There were high indications that fraud and improper conduct were taking place in the organization. For instant, the top management team of the company participated in fraudulent activities regularly. The CEO is a good example because he had submitted false SEC reports. He had also instructed other executives to achieve the financial results expected by all means, that is, including fraud. The strategy made the middle line team to commit to the fraudulent behavior. The auditors, Arthur Andersen also contributed to the scandal because of failing to identify the accounting irregularities and by not being keen to identify them. It got a lot of criticism for failing to uncover the activities of the company. It also failed to design its audit to be able to detect the misstatements in the financial statements, thus resulting in the scandal. After reviewing the company’s statements for the first quarter of the year 2002, Arthur Andersen said that they were professional and complied with the Securities and Exchange Commission Standards. He in turn blamed the CFO of WorldCom for not informing him about the accounting treatments and line cost transfers. It means that the management team of WorldCom failed to provide crucial information that would have helped its auditor’s detect the fraud. Above all, the company had poor ethics, values, and it promoted fraudulent conduct. The second component that failed at WorldCom is the procedure of collecting, storing, retrieving, and processing data. The company had poor segregation of duty in the way financial data was being handled. The lack of segregation of duty in turn made it easier for a few people to do fraudulent acts without the knowledge of others. It played a big role in allowing the fraud to continue for a long time without being detected. The third component that failed the company is its poor internal control system (Simkin, 2014). Internal controls are crucial in preventing fraud from occurring in a company. The most obvious indication of this is the absence of proper checks and balances and lack of segregation of duties. The CEO had been given the excess powers. It means that he was able to fire any employee who would try to report the fraudulent activities of the company. It means that employees of the company were hindered from providing information about the activities for fears of being fired. Effectiveness of the firm’s stakeholders in the event that a third-party accounting system suffered a breach Third party accounting systems have become very effective in businesses, including QuickBooks, Peachtree Complete Accounting for Windows and Peachtree Premier Accounting, and Business! Accounting. These systems are prone to breach. Theft of information or data from third-party accounting systems are a gig threat in any company. Even though they rarely occur, this is very prone in competitive industries. This is mainly because businesses under such intense rivalry would go to great length to steal information so as to gain a competitive edge. In cases where a third-party accounting system has suffered a breach, the company’s stakeholders have the responsibility to act effectively. It is crucial because data breach can severely restrict the company’s ability to conduct business, destroy the reputation of the company, and cause severe harm to the stakeholders. In the event of a breach, the IT becomes crucial in containing the breach. They also help in determining the cause of the breach. The legal team also becomes crucial providing legal notifications as expected by regulators. The team also helps the company avoid liability and get remedies if needed. The corporate communications also become crucial in providing mass notifications if required. Software providers have the responsibility of making sure that their systems are reliable and secure. It is crucial because accuracy in the systems affect the information in the financial statements and in turn determines how it can be relied on by stakeholders. How advances in accounting and information technology would have prevented the WorldCom scandal After the scandal, there have been advances in accounting and information technology that would have prevented fraudulent activities from occurring in the company. The advances are seen in the corporate governance and information technology. Corporate Governance After the collapse of WorldCom and Enron, the issue of corporate governance was brought into light. The aim of the initiative is to make sure that the expectations of stakeholders have been met and that companies operate in a way to give transparency and credibility in corporate financial reporting. A good corporate governance system makes sure that there is a means for people within and outside the company to monitor and control activities of managers and the company. The main principle of corporate governance is disclosure and transparency. Companies are now expected to make it public and clarify the roles and responsibilities of management and the board. It aims at providing some level of accountability to shareholders. They are also expected to come up with procedures that will help to safeguard the integrity and verify of the company’s financial reporting. Disclosure and transparency would have helped the company detect fraudulent activities in good time to avoid its collapse. WorldCom directors and CEO would have been required to disclose their personal compensation plans and benefits to the stakeholders. It would have made sure that they did not act in their personal interest but in the best interest of the company. At the time, the financial misstatements at the company were encouraged by the personal interests of a few. Thus, if the shareholders interest would have been protected then the fraudulent activities would have been prevented. Corporate governance has also increased the roles and responsibilities of the board. They are now expected to have a range of understanding and skills that will help them deal with a number of business issues. They are also expected to have the ability to challenges and review the performance of the management team. This advancement in the corporate governance principle would have prevented fraud at WorldCom as top management would have acted in the best interest of the company. At the time that the company collapsed, the CEO had the powers to arbitrarily remove employees that try to report the fraudulent activities in the company. The board would have reviewed these powers by making sure that the executives report to both the Board and the CEO. The strategy would have prevented the CEO from engaging in fraudulent activities for his personal gains. The Board would have the opportunity to access the financial statements and avoid any power abuse. Development of information technology The development of information technology has made it hard for companies to engage in fraudulent activities as was seen in the case of WorldCom. Information technology makes it easier for vendors, customers, and employees to report any suspected fraudulent activities (Gelinas, 2010). In the case of WorldCom, the internal auditor, Cynthia Cooper reported to the CEO once she discovered the fraud. However, no action was taken until she reported the matter to the audit committee. Advancement of technology like having a hotline, would have given the internal auditor the opportunity to directly report any suspicion of fraud. In turn, this would have helped the company solve the issue earlier before becoming very serious. Changes in the Sarbanes-Oxley Act of 2002 and other laws The Sarbanes-Oxley Act (SOX), whose official name is the “Public Company Accounting Reform and Investment Protection Act of 2002”, is one of the most recognized and crucial federal and legislation disclosure in the United States since the Securities Exchange Act (the Exchange Act) of 1934 and the Securities Act of 1933. The SOX was signed into law after a major financial scandal that involved many large companies including Xerox, WorldCom, Xerox, Enron, and Arthur Anderson. The Act has given the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO) the duties of making sure that the company’s records and financial statements are accurate and give a legitimate representation of the company. The aim of the act is to discouraging and punishing corporate and accounting fraud (Holt, 2008). It also protects the interest of shareholders by imposing penalties to companies that do not adopt strict internal controls and those that are involved in fraud. The introduction of Soc has led to an improvement in companies; however, some changes need to be made for the Act to be more effective. Most companies complain the implementation costs related to these Act is high. As a result, some public companies have been forced to delist themselves from the NYSE like Art Company. This hinders the ability of the Act to regulate these forms of companies. Therefore, a reduction in the implementation costs needs to be considered so as to encourage many companies to enlist themselves. This will make sure that all companies are regulated, thus deterring them from committing fraud. The interests of shareholders will also be secured. The Federal securities laws have also been crucial in preventing companies from committing fraud. It has introduced strict criminal penalties in cases where it is evident that there are violations in the accounting regulations as stated in the act and in the Federal security laws. However, changes need to be done in the laws to include smaller companies that are not regulated by the SOX as they are not listed. Recommendations WorldCom faced the one of the largest scandals to be witnessed in the United States. After the scandal, the company was purchase by Verizon Communications for $7.6 billion. It is now referred as the Verizon Enterprise Solutions. To avoid future business failures, the company needs to implement a number of strategies including having a positive corporate culture. The culture of a company is crucial for its success because it’s a reflection of its principles and values. The top management helps in creating the corporate culture for the bottom level to follow. Top management need to act ethically internally and also in public. The top management of the company needs to work ethically and report any form of fraudulent activity. The second strategy is encouraging segregation of duties so that no one party has all the powers as was the case of the CEO. The CEO should not have the powers to arbitrarily fire employees who try to report cases of fraudulent activities. This can be done by giving the board some powers to fire some employees after conducting a disciplinary session. The process will encourage employees to disclose cases of fraudulent activities, especially those done by top management without fear. The company also needs to establish a reporting system to help stakeholders report any form of fraud activities. The process also includes not victimizing whistle blowers because they act to the best interest of the company and its stakeholders. The company should also require for its CEO and directors to disclose any conflict of interest related to the activities of the company. The process discourages the top management from engaging in fraud for their personal interest in the expense of the interests of the stakeholders. When disclosure is clear and complete, they will act in the best interest of the company. Finally, the company needs to get reliable auditors who do not have personal interests in the company. The auditors also need to be changed frequently unlike in the case Arthur Andersen LLP who had been WorldCom’s auditors from 1989. The strategy will make sure that there is no conflict of interest and there is professionalism from the auditors. Cases such as overseeing potential fraudulent misrepresentations will not occur. Bibliography Beltran, L. (2002, 07 22). WorldCom files largest bankruptcy ever . Retrieved from CNN Money: http://money.cnn.com/2002/07/19/news/worldcom_bankruptcy/ Fernando, A. C. (2009). Corporate governance: Principles, policies and practices. New Delhi: Pearson Education. Gelinas, U. J., & Dull, R. B. (2010). Accounting information systems. Australia: South-Western/ Cengage Learning. Holt, M. F. (2008). The Sarbanes-Oxley Act: Costs, benefits and business impact. Amsterdam: CIMA. Simkin, M. G. (2014). Core concepts of accounting information systems. Place of publication not identified: John Wiley. Read More