In “Behind the Wave of Corporate Fraud: A Change in How Auditors Work,” the Wall Street Journal detailed several of the recent accounting scandals and the techniques management used to deceive both the auditors and the investing public. The article focused on audit techniques that contributed to the ability of management to undertake deceptive practices. For example, WorldCom reclassified ordinary expenses as assets, which the auditors missed because there was “no supporting documentation”; Tyco International, charged with inflating profits by over $1 billion, left “warning signs” that were not followed up on by auditors; and HealthSouth Corporation pulled it off by inflating the dollar amounts of a large number of small revenue recognition transactions because they “knew the auditors did not look at increases of less than $5,000.”

REQUIRED:

a. Explain how WorldCom showed higher profits in the current period by inaccurately classifying expenses as assets. How would this technique affect the profits of future periods?

b. Explain why management may be tempted to inflate profits in the current period.

c. Explain why auditors might not check transactions below a certain dollar amount.

d. How could high-quality internal controls have helped in avoiding these frauds?