lucent technologies case report
DESCRIPTION
Case Study on Lucent TechnologiesTRANSCRIPT
-
Albano. Chung. Cordeta. Manio. Somo. Uy. Valdivieso
-
Company Background American multinational equipment company Established September 30, 1996 by AT&T Corporation. Lead by Henry Schacht and succeeded by Richard
McGinn IPO in April 1996 was the largest in US history (5.3
million shareholders) Stock prices raised from $7.56/ share to $84/share at
zenith full-stream network supplier
-
Company-wide initiative Lucent GROWS G- lobal Growth Mindset R- esults Focused O- bssessed with customers and about W- orkplace that is open, supportive ,and diverse S-peed
Company Background
-
Exceeded Analyst expectations for 14 straight quarters until December 31, 1999
2000 - Private bubble burst Failed to regain former company status after 2000 Merged with Alcatel on December 1, 2006
Company Background
-
FRAUD PERFORMED
-
VIOLATION OF REVENUE RECOGNITION PRINCIPLE
December 2000: $700 million overstated revenues $ 452 million: Channel stuffing (revenue from
distributors; not customers)$199 million: Credit offers (discounts not reflected in sales recorded) $ 28 million: Partial shipment to customers
Risky vendor financing (e.g. Winstar).
-
A. Anixter International Inc. & Graybar Electric Company
General nature: If they took the products offered by Lucent, they will not get hurt in any given transaction
Inducement: Assistance in moving product to end customers, returns of product, etc.
GAAP violation: Materially misstating Lucents pre-tax income for fiscal year 2000 by approximately 7%.
-
B. Winstar General nature: Allows Winstar to select software by
September 29, 2001, and Lucent to recognize $135 Million in revenue in its fiscal year ending September 30, 2000.
Inducement: the parties would separately document additional elements of the software pool transaction that would give Winstar additional value. (e.g. $35 Million credit for future purchases, $45 Million credit for network integration laboratory, reduced pricing for purchases of building and hub sites)
Post-dated 3 letters documenting side agreements occurred after September 30, 2000
GAAP violation: Recording of $125 Million worth of revenue
-
C. AT&T Wireless Services General nature: VPP would be retroactively applied
to product purchased between April 1, 2000 and the date the agreement was reached
Inducement: Difference in pricing between VPP and conventional pricing would be adjusted through $53 Million (conventional pricing) of income and on June 30, 2000, at the end of third quarter of fiscal year 2000
-
D. BellSouth Telecommunications, Inc. General Nature: Software pooling agreement (LOA105)
wherein BellSouth would pay $95 Million by April 1, 2001 for software it had to select by September 30, 2002.
Inducement: $20 Million credit and 2% price discount ($1 Million)
Executed a letter wherein the credit and discount had been granted October 10, 2000 rather than September 30, 2000.
GAAP Violation: Recorded $95 Million rather than $74 Million ($95M-$20M-$1M)
-
Management Assertions Adversely Affected
Occurrence - sales revenues were recorded for shipment of goods to distribution partners, which were undelivered to customers as of year end
Existence - accounts receivable were recorded when the customer when they were yet to owe the company
Cutoff - sales revenues that would be earned in the next quarter were recorded near the end of the current quarter
-
Management Assertions Adversely Affected
Completeness - loans to customers were not recorded in the books nor were they disclosed in the financial statements
Valuation/Allocation- allowances for bad debts did not accurately reflect the risk of non-collection/goodwill was not properly valued nor amortized
Accuracy -loans to customers were not disclosed/credit offers were not reflected in revenues recorded
-
BIG BATH ACCOUNTING
General Nature: makes current years earnings poor so the succeeding year looks profitable
Inducement: enables managers to hit future earnings targets
Lucent set up a $2.8 billion reserve to cover future costs of restructuring
-
COOKIE JAR ACCOUNTING
General Nature: periods of good financial results are used to create reserves that increase profits in lean years
Inducement: smooth out earnings whenever the company needs extra revenue to meet earnings targets
reversed more than $500 million to pretax income increasing and smoothing out the earnings over the 4 following years
-
OVERSTATED IN-PROCESS RESEARCH AND DEVELOPMENT COSTS
General Nature: In-process Research and Development Cost - R&D costs incurred by a company being acquired by another company
Inducement: enables the reduction of goodwill and its amortization in the future
Included in the purchase price is the estimate of the future value of research and development in the target company
Lucent has avoided $2.5 billion in goodwill since 1996 Lucent conservatively expensed In-Process Research and
Development Costs to avoid large future amortizations of goodwill
-
INTERNAL CONTROL
DEFICIENCIES
-
The Audit Committee of Lucent was comprised mostly of insiders
Paul Allaire - Former Chairman and CEO of Xerox Franklin Thomas - Lucent Director and Alcoa board member Betsy Atkins - Cofounder of Ascend Communications (A
Lucent Acquisition) Paul O Neill - Alcoa CEO Donald Perkins - Committee Chairman (left on 1999)
Why did Perkins leave the committee? - one possible red flag Possibility of Management Override Shows a lack of Auditor Independence
-
Lack of Independence Both the independent auditors and the internal auditors
regularly meet privately with the committee and have unrestricted access to the committee. The Audit and Finance Committee recommends to the Board the appointment of the independent auditors. The Audit and Finance Committee reviews the company's financing plans and reports recommendations to the full Board for approval and to authorize action.
Management is focused on reaching the target growth rate, and is also involved in the audit committee, which shows a lack of independence
-
Internal Control Deficiencies
No proper authorization and approval Management override of controls Insufficient control consciousness (e.g tone at the top) Failure to perform reconciliation of accounts Absence of internal process to report deficiencies Inadequate design of monitoring controls Lack of objectivity and independence with regards to
accounting decisions
-
TEST OF CONTROLS
The objective of the tests of controls in an audit of internal control over financial reporting is to obtain evidence about the effectiveness of controls to support the
auditor's opinion on the company's internal control over financial reporting. The auditor's opinion relates to the effectiveness of the company's internal control over financial
reporting as of a point in time and taken as a whole.
-
Segregation of Duties
Observe and make inquiries about the performance of various functions and duties
There is still the issue of collusion
-
Authorization
Obtain credit approval of sales prior to shipment by making inquiries about credit policies, select a sample of sales transactions and examine evidence of credit approval
Management override is an issue.
-
Recorded Sales Represent Goods Shipped
Test a sample of sales invoices for authorized sales order form and shipping documentation. Review and test entitys procedures for accounting for numerical sequences of invoices.
-
Clerical Accuracy and Completeness
Select a sample of sales invoices and examine them for evidence of second-person review. Observe, make inquiries about the process, re-perform and reconcile selected listings to the accounting records
-
Cutoff
Compare dates on sales invoices with dates of correspondence shipping documentation. Compare dates on sales invoices with dates recorded in the sales ledger
-
Classification of AccountsReview general and sales ledger and examine a sample of documents for proper classification.
-
Presentation and Disclosure
Review cash receipts journal for unusual items. Trace cash receipts from listing to cash receipts journal for proper classification. Review reconciliations of receivables ledger to control account.
Review the notes to FS regarding the R&D costs and its corresponding amortization
-
SUBSTANTIVE TESTS UNDER I.
S.A. 500Substantive tests or procedures are what auditors perform in
order to either detect fraud or support their claim that there are no material misstatements in a companys financial statements.
-
Inspection: Data Analysis
Matching purchasing records to inventory and capital asset records, to explain the controversial purchases of new fixed assets
safekeeping or invoices searching for duplicates sampling data/ data matching analysis of gaps
-
Inspection: Data Analysis
Inquiring credit rating agencies regarding the credit-worthiness of credit customers and as well as the credit manager regarding credit histories as a basis for evaluating the reasonableness of the valuation of accounts receivable.
-
Recalculation
Recalculation using database analysis Setting up computer scripts or logs to
run against large volumes of data to identify those anomalies as they occur over a period of time
-
External Confirmation Channel Data Inspection This is to ensure that Lucent Technologies is
not engaging in channel stuffing, which is holding back on orders until the end of the suppliers quota period
Confirming with credit customers whether or not the goods (equipment) were received as of the end of the quarter.
-
Reperformance: Inventory Management Procedures
Constant comparison of the inventory storage procedures actually done versus the procedures written on the reports to check if all the processes are being executed fairly
-
Recalculation: Supply Chain Inspecting true cost of sales, Margins and
volume discounting arrangements, Returns policy, Product recall conditions ,Trading terms and conditions, Sales incentive schemes, Sales performance expectations, Customer service policy, Length of sales cycle, fixing biddings between the suppliers
-
Analytical Procedures Evaluating the relationship of internal
and external stakeholders and how it affects financial and non-financial reports
Constant comparison of the internal auditors reports and the management reports to ensure that no crucial information is being hidden
-
Inquiry: Buyer and Supplier InformationTo avoid vendor financing, which is The lending of money by a company to one of its customers so that the customer can buy products from it. By doing this, the company increases its sales even though it is basically buying its own products
-
FINANCIAL STATEMENTS
-
Sourceshttp://www.investopedia.com/terms/v/vendorfinancing.aspwww.aicpa.org/InterestAreas/AccountingEducation/Resources/DownloadableDocuments/lucent.ppthttp://www.kycbs.net/PriceWaterhouse.htmhttp://www.investopedia.com/terms/v/vendorfinancing.asphttps://vendorfinanceinstitute.com.au/10-mistakes-to-avoid-with-vendor-finance/http://www.acl.com/pdfs/ACL_fraud_ebook.pdfhttp://www.corporatecomplianceinsights.com/7-steps-preventing-detecting-fraud/http://www.accountingtools.com/control-assessment-updateshttp://www.evancarmichael.com/Sales/4476/Whats-channel-stuffing-and-why-is-it-problematic.htmlhttp://www.sec.gov/litigation/litreleases/lr18715.htmhttp://www.sec.gov/news/press/2004-67.htmwww.spell.org.br/documentos/download/26131http://www.getfilings.com/o0000950123-00-011855.htmlhttp://www.evancarmichael.com/Sales/4476/Whats-channel-stuffing-and-why-is-it-problematic.html