Company Chase a.2

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183

A.2Waste Management

SynopsisIn February 1998 Waste Management announced that it was restating itsfinancial statements for 1993 through 1996. In its restatement, Waste Man-agement said that it had materially overstated its reported pretax earningsby $1.43 billion. After the announcement, the company’s stock dropped bymore than 33 percent, and shareholders lost over $6 billion.

The SEC brought charges against the company’s founder, Dean Buntrock,and five other former top officers. The charges alleged that managementhad made repeated changes to depreciation-related estimates to reduceexpenses and had employed several improper accounting practices relatedto capitalization policies, also designed to reduce expenses.1 In its final judg-ment, the SEC permanently barred Buntrock and three other executivesfrom acting as officers or directors of public companies and required pay-ment from them of $30.8 million in penalties.2

History

In 1956 Dean Buntrock took over Ace Scavenger, a garbage collector owned byhis father-in-law, who had recently died. After merging Ace with a number ofother waste companies, Buntrock founded Waste Management in 1968.3 UnderBuntrock’s reign as its CEO, the company went public in 1971 and then expandedduring the 1970s and 1980s through several acquisitions of local waste haulingcompanies and landfill operators. At one point the company was performingclose to 200 acquisitions a year.4

From 1971 to 1991 the company enjoyed 36 percent average annual growth inrevenue and 36 percent annual growth in net income. By 1991 Waste Management

Case

1 SEC, Accounting and Auditing Enforcement Release No. 1532, March 26, 2002.2 SEC, Accounting and Auditing Enforcement Release No. 2298, August 29, 2005.3 “Waste Management: Change with the Market or Die,” Fortune, January 13, 1992.4 SEC v. Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A. Getz, and Bruce D. Tobecksen, Complaint No. 02C 2180 (Judge Manning).

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184 Appendix Company Cases

5 SEC v. Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A. Getz, and Bruce D. Tobecksen, Complaint No. 02C 2180 (Judge Manning).6 SEC v. Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A. Getz, and Bruce D. Tobecksen, Complaint No. 02C 2180 (Judge Manning).7 1995 10-K.8 1995 10-K.

had become the largest waste removal business in the world, with revenue ofmore than $7.5 billion.5 Despite a recession, Buntrock and other executives at WasteManagement continued to set aggressive goals for growth. For example, in 1992the company forecast that revenue and net income would increase by 26.1 percentand 16.5 percent, respectively, over 1991’s figures.6

Waste Management’s Core Operations

Waste Management’s core solid waste management business in North Americaconsisted of the following major processes: collection, transfer, and disposal.

CollectionSolid waste management collection from commercial and industrial customerswas generally performed under one- to three-year service agreements. Mostresidential solid waste collection services were performed under contractswith—or franchises granted by—municipalities giving the company exclusiverights to service all or a portion of the homes in their respective jurisdictions.These contracts or franchises usually ranged in duration from one to five years.Factors that determined the fees collected from industrial and commercial cus-tomers were market conditions, collection frequency, type of equipment fur-nished, length of service agreement, type and volume or weight of the wastecollected, distance to the disposal facility, and cost of disposal. Similar factorsdetermined the fees collected in the residential market.7

TransferAs of 1995 Waste Management operated 151 solid waste transfer stations—facilities where solid waste was received from collection vehicles and thentransferred to trailers for transportation to disposal facilities. In most instances,several collection companies used the services of these facilities, which wereprovided to municipalities or counties. Market factors, the type and volume orweight of the waste transferred, the extent of processing of recyclable materials,the transport distance involved, and the cost of disposal were the major factorsthat determined the fees collected.8

DisposalAs of 1995 Waste Management operated 133 solid waste sanitary landfill facilities,103 of which were owned by the company. All of the sanitary landfill facili-ties were subject to governmental regulation aimed at limiting the possibility of

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Case A.2 Waste Management 185

9 1995 10-K.10 SEC v. Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A. Getz, and Bruce D. Tobecksen, Complaint No. 02C 2180 (Judge Manning).11 1995 10-K.

water pollution. In addition to governmental regulation, land scarcity and localresident opposition also conspired to make it difficult to obtain permission tooperate and expand landfill facilities in certain areas. The development of anew facility also required significant up-front capital investment and a lengthyamount of time, with the added risk that the necessary permits might not beultimately issued. In 1993, 1994, and 1995 approximately 52 percent, 55 percent,and 57 percent, respectively, of the solid waste collected by Waste Managementwas disposed of in sanitary landfill facilities operated by it. These facilities weretypically also used by other companies and government agencies on a noncon-tract basis for fees determined by market factors and by the type and volume orweight of the waste.9

Corporate Expansion

As the company grew, Waste Management expanded its international opera-tions and into new industries, including hazardous waste management, wasteto energy, and environmental engineering businesses. By the mid-1990s WasteManagement had five major business groups that provided the following serv-ices: solid waste management; hazardous waste management; engineeringand industrial services; trash to energy, water treatment, and air quality serv-ices; and international waste management. (See Table A.2.1 for a description ofthe primary services these groups provided and their revenues in 1993, 1994,and 1995.)

Challenges

By the mid-1990s the company’s core North American solid waste business wassuffering from intense competition and excess landfill capacity in some of itsmarkets. New environmental regulations also added to the cost of operating alandfill, and they made it more difficult and expensive for Waste Managementto obtain permits for constructing new landfills or expanding old ones.10

Several of Waste Management’s other businesses (including its hazardouswaste management business and several international operations) were alsoperforming poorly. After a strategic review that began in 1994, the company wasreorganized into four global lines of business: waste services, clean energy, cleanwater, and environmental and infrastructure engineering and consulting.11

In the summer of 1996 Dean Buntrock, who founded Waste Management in1968, retired as CEO; but he continued to serve as chairman of the board ofdirectors. Buntrock was initially replaced by Phillip Rooney, who had started


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186

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Confirming pages

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12 SEC v. Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A. Getz, and Bruce D. Tobecksen, Complaint No. 02C 2180 (Judge Manning), www.sec.gov/litigation/complaints/complr17435.htm.

working at Waste Management in 1969. In early 1997 Rooney resigned as direc-tor and CEO because of mounting shareholder discontent.

After a five-month search, Waste Management chose Ronald LeMay, the presi-dent and COO of Sprint, to assume its post of chairman and CEO. Surprisingly, justthree months into his new role, LeMay quit to return to his former job at Sprint.

In addition, several other key executives who, unlike LeMay, had worked forWaste Management for several years—including CFO James Koenig, corporatecontroller Thomas Hau, and vice president of finance Bruce Tobecksen—alsoresigned by the end of 1997.

Capitalization of Landfill Costs and Other Expenses12

Waste Management capitalized the costs related to obtaining the required per-mits to develop and expand its many landfills. It also capitalized interest onlandfill construction costs, as well as costs related to systems development.

GAAP for Capitalizing CostsUnder GAAP, a cost can be capitalized if it provides economic benefits to be usedor consumed in future operations. A company is required to write off, as a currentperiod expense, any deferred costs at the time the company learns that the under-lying assets have been either impaired or abandoned. Any costs to repair or returnproperty to its original condition are required to be expensed when incurred.Finally, interest can be capitalized as part of the cost of acquiring assets for theperiod of time that it takes to put the asset in the condition required for itsintended use. However, GAAP requires that the capitalization of interest mustcease once the asset has become substantially ready for its intended use.

Capitalization of Landfill Permitting CostsAs part of its normal business operations, Waste Management allocated sub-stantial resources toward development of new landfills and expansion of existinglandfills. A significant part of the landfill development and expansion costsrelated to the process of obtaining required permits from the appropriate gov-ernment authorities. Over the years, the company faced increased difficulty inobtaining the required landfill permits; it often invested significantly in projectsthat had to be abandoned or were materially impaired.

The company routinely capitalized the costs related to obtaining therequired permits so that it could defer recording expenses related to the land-fills until they were put in productive use. However, instead of writing off thecosts related to impaired and abandoned landfill projects and disclosing theimpact of such write-offs, management disclosed only the risk of future write-offsrelated to such projects.


http://www.sec.gov/litigation/complaints/

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The management team of Waste Management also allegedly transferred thecosts of unsuccessful efforts to obtain permits for certain landfill sites to othersites that had received permits or other sites for which they were still seekingpermits. In effect, they were commingling impaired or abandoned landfill proj-ect costs with the costs of a permitted site (a practice known as basketing, whichdid not comply with GAAP). In addition to basketing, the company alsoallegedly transferred unamortized costs from landfill facilities that had closedearlier than expected to other facilities that were still in operation (a practiceknown as bundling, which also did not comply with GAAP). Managementnever disclosed the use of bundling or basketing in its form 10K.

In 1994, after its auditor Arthur Andersen discovered these practices, manage-ment allegedly agreed to write off $40 million related to dead projects over a spanof 10 years; management also promised to write off future impairments and aban-donments in a prompt manner. However, during 1994, 1995, 1996, and 1997,management effectively buried the write-offs related to abandoned and impairedprojects by netting them against other gains, as opposed to identifying the costsseparately.

Capitalization of Interest on Landfill Construction CostsIn accordance with GAAP, Waste Management was able to capitalize interestrelated to landfill development because of the relatively long time required toobtain permits, construct the landfill, and ultimately prepare it to receive waste.However, Waste Management utilized a method, referred to as the net book value(NBV) method, that essentially enabled it to avoid GAAP’s requirement that inter-est capitalization cease once the asset became substantially ready for its intendeduse. Waste Management’s auditor, Arthur Andersen, advised the company from itsfirst use of the NBV method (in 1989) that this method did not conform to GAAP.

Corporate controller Thomas Hau even admitted that the method was “tech-nically inconsistent with FAS Statement No. 34 [the controlling GAAP pro-nouncement] because it included interest [capitalization] related to cells oflandfills that were receiving waste.” Yet the company wrote in the footnotes toits financial statements that “[i]nterest has been capitalized on significant landfills,trash-to-energy plants, and other projects under development in accordancewith FAS No. 34.”

Ultimately the company agreed to utilize a new method, one that conformedto GAAP, beginning January 1, 1994. Corporate controller Thomas Hau andCFO James Koenig allegedly determined that the new GAAP method wouldresult in an increased annual interest expense of about $25 million, and there-fore they chose to phase in the new method over three years, beginning in 1995.However, the company appeared to still utilize the NBV method for interestcapitalization as of 1997.

Capitalization of Other CostsThe company’s management also chose to capitalize other costs, such as systemsdevelopment costs, rather than record them as expenses in the period in which


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13 SEC v. Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A. Getz, and Bruce D. Tobecksen, Complaint No. 02C 2180 (Judge Manning).

they were incurred. In fact, they allegedly used excessive amortization periods(10- and 20-year periods for the two largest systems) that did not recognize theimpact of technological obsolescence on the useful lives of the underlying systems.

The SEC found evidence that the company’s auditor Arthur Andersen pro-posed several adjusting journal entries to write off the improperly deferredsystems development costs. Andersen also repeatedly advised managementto shorten the amortization periods. In 1994 management finally agreed toshorten the amortization periods and to write off financial statement mis-statements resulting from improperly capitalized systems costs over a periodof five years. During 1995 management changed the amortization periodsand wrote off improperly capitalized systems costs by netting them againstother gains.

Waste Management’s Major Fixed Assets

The major fixed assets of Waste Management’s North American business consistedof garbage trucks, containers, and equipment, which amounted to approximately$6 billion in assets. The second largest asset of the company (after vehicles, con-tainers, and equipment) was land, in the form of the more than 100 fully operationallandfills that the company both owned and operated. Under GAAP, depreciationexpense is determined by allocating the historical cost of tangible capital assets(less the salvage value) over the estimated useful life of the assets.

Unsupported Changes to the Estimated Useful Livesof Assets

From 1988 through 1996 management allegedly made numerous unsupportedchanges to the estimated useful lives and/or the salvage values of one or morecategories of vehicles, containers, or equipment. Such changes reduced theamount of depreciation expense recorded in particular periods. In addition,such changes were recorded as top-side adjustments at the corporate level(detached from the operating unit level). Most often the entries were made duringthe fourth quarter and then improperly applied cumulatively from the beginningof the year. It appeared that management never disclosed the changes or theirimpact on profitability to investors.13

Carrying Impaired Land at Cost

Because of the nature of landfills, GAAP also requires that a company comparea landfill’s cost to its anticipated salvage value, with any difference depreciatedover its estimated useful life. Waste Management disclosed in the footnotes to


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14 Ibid.15 Ibid.

the financial statements in its annual reports that “[d]isposal sites are carried atcost and to the extent this exceeds end use realizable value, such excess is amor-tized over the estimated life of the disposal site.” However, in reality, the SECfound evidence that Waste Management allegedly carried almost all of its land-fills on the balance sheet at cost.14

Auditor Assessment15

In a letter to the management team dated May 29, 1992, Arthur Andersen’steam wrote, “[i]n each of the past five years the Company added a new consol-idating entry in the fourth quarter to increase salvage value and/or useful lifeof its trucks, machinery, equipment, or containers.” Andersen recommendedthat the company conduct a “comprehensive, one-time study to evaluate theproper level of WMNA’s salvage value and useful lives,” and then send theseadjustments to the respective WMNA groups. Top management continued tochange depreciation estimates at headquarters, however.

In March 1994 Executive Vice President and CFO James Koenig, who hadworked as an auditor at Arthur Andersen before joining Waste Management in1977, allegedly instructed a purchasing agent to draft a memo concluding thatthe agent supported one of the company’s salvage value estimates. In November1995 a study was initiated to determine the appropriate lives and salvage valuesof the company’s vehicles, equipments, and containers. Koenig allegedly orderedthe study to be stopped after he was informed that the interim results of thestudy revealed that the company’s salvage values should be reduced. Koenigalso was said to have ordered the destruction of all copies of the memo thatreleased the study’s interim results and that the document be deleted from theauthor’s computer. The memo was never provided to the company’s auditors.

Regarding the issue of Waste Management’s treatment of landfills on thebalance sheet, Andersen issued a management letter to the board of directorsrecommending that the company conduct a “site by site analysis of its landfillsto compare recorded land values with its anticipated net realizable value basedon end use” after its 1988 audit. Andersen further instructed that any excessneeded to be amortized over the “active site life” of the landfill. Andersen madesimilar demands after its audit in 1994. Despite this letter, management neverconducted such a study and also failed to reduce the carrying values of over-valued land, despite their commitment to do so after Andersen’s audit in 1994.

Top-Side Adjusting Journal Entries

Top-side adjusting journal entries are typically made by upper managers at theend of the reporting process, usually at corporate headquarters. Because thesejournal entries are typically not generated at the business process (such as


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Internet sales) or the business unit level (such as the North American division),they can be used by upper managers to circumvent the internal control systemand possibly perpetrate fraud.

Waste Management seemed to routinely use top-side adjusting entries whenconsolidating the results of several of its business units and entities in which thecompany had an interest, to prepare its annual and quarterly financial statements.Indeed, Waste Management’s use of several unbudgeted and unsupported top-side adjustments in the early 1990s caused observers (including Arthur Andersen)to question whether management had employed these adjustments as tools tohelp manage reported earnings.

Waste Management set its earnings targets during an annual budget process.The company followed a top-down budgeting process whereby the CEO (Bun-trock until 1996 and Rooney from Buntrock’s retirement until early 1997) setgoals for earnings growth, and the operating units would in turn determinetheir budgets based on the goals set at the top. The budgets were then consoli-dated to arrive at the budgeted consolidated earnings. At this time the uppermanagers also set budgets for the anticipated top-side adjustments, which werebased on the existing accounting assumptions used.

As operating results were recorded by Waste Management’s operating unitsat the end of each quarter, upper management allegedly monitored the gapbetween the results and the goals and made a number of different types ofunbudgeted top-side adjusting entries to “close the gap.” Management did notdisclose to investors the impact of the top-side adjustments on the company’searnings. In fact, management did not inform its own internal operating unitsabout the top-side adjusting entries that were made and their resulting expensereductions.

As early as 1992, the company’s auditor Arthur Andersen advised manage-ment against its use of top-side adjusting entries as a tool to manage its earningsin a postaudit letter recommending accounting changes. Andersen auditors wrotethat “individual decisions are not being evaluated on the true results of theiroperations” as a result of the extensive use of top-side adjustments. Andersen rec-ommended that “all such corporate adjustments should be passed back to therespective” divisions. Yet top management allegedly increased the budget forthe top-side adjustments from 1992 to 1997, and each year the actual adjust-ments made exceeded the budgeted adjustments. From the first quarter of 1992through the first quarter of 1997, top management used unsupported top-sideadjustments in 14 of 21 quarters to achieve reported results that ultimately fellwithin the range of the company’s public earnings projections or its internalbudgeted earnings.

In February 1998, Waste Management announced that it was restating thefinancial statements it had issued for the years 1993 through 1996. In its restate-ment, Waste Management said that it had materially overstated its reportedpretax earnings by $1.43 billion and that it had understated elements of its taxexpense by $178 million. When the company’s improper accounting wasrevealed, the stock dropped by more than 33 percent and shareholders lostover $6 billion.


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16 SEC Auditing and Enforcement Release No. 1410, June 19, 2001.17 SEC Auditing and Enforcement Release No. 1405, June 19, 2001.18 SEC Auditing and Enforcement Release No. 1410, June 19, 2001.19 SEC Auditing and Enforcement Release No. 1405, June 19, 2001.20 Ibid.

Waste Management’s Relationship with IndependentAuditor Arthur Andersen

Even before Waste Management became a public company in 1971, ArthurAndersen served as the company’s auditor. In the early 1990s Waste Manage-ment capped Andersen’s corporate audit fees at the prior year’s level, althoughit did allow the firm to earn additional fees for “special work.” Between 1991and 1997 Andersen billed Waste Management approximately $7.5 million inaudit fees.16 During this seven-year period Andersen also billed Waste Manage-ment $11.8 million in fees related to the following services: $4.5 million foraudit work under ERISA, special-purpose letters (EPA), franchise audits andother reports, registration statements and comfort letters, international publicoffering, SFAS 106 and 109 adoption, accounting research/discussions andother (audit committee meetings); $4.5 million for various consulting servicesthat included $450,000 for information systems consulting; and $1.1 million formiscellaneous other services.17

During the 1990s approximately 14 former Andersen employees worked forWaste Management.18 While at Andersen, most of these individuals worked inthe group responsible for auditing Waste Management’s financial statementsprior to 1991, and all but a few had left Andersen more than 10 years before the1993 financial statement audit commenced.19

In fact, until 1997 every chief financial officer (CFO) and chief accountingofficer (CAO) at Waste Management since it became public had previouslyworked as an auditor at Andersen. Waste Management’s CAO and corporatecontroller from September 1990 to October 1997, Thomas Hau, was a formerAndersen audit engagement partner for the Waste Management account. WhenHau left Andersen, he was the head of the division within Andersen responsiblefor conducting Waste Management’s annual audit, but he was not the engagementpartner at that time.20

Andersen’s Engagement Partners on the WasteManagement Audit

In 1991 Andersen assigned Robert Allgyer, a partner at Andersen since 1976, tobecome the audit engagement partner for the Waste Management auditengagement. He held the title of partner-in-charge of client service and servedas marketing director for Andersen’s Chicago office. Among the reasons for


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21 Ibid.22 Ibid.23 Ibid.24 Ibid.25 Ibid.26 Ibid.

Allgyer’s selection as engagement partner were his “extensive experience inEurope,” his “devotion to client service,” and his “personal style that . . . fit wellwith the Waste Management officers.”21 In setting Allgyer’s compensation,Andersen took into account fees for audit and nonaudit services.22 WalterCercavschi, who was a senior manager when he started working on the WasteManagement engagement team in the late eighties, remained on the engage-ment after becoming partner in 1994.

In 1993 Edward Maier became the concurring partner on the engagement. Asconcurring partner, Maier’s duties included reading the financial statements;discussing significant accounting, auditing, or reporting issues with the engage-ment partner; reviewing certain working papers (such as the audit risk analysis,final engagement memoranda, summaries of proposed adjusting, and reclassi-fying entries); and inquiring about matters that could have a material effect onthe financial statements or the auditor’s report. Maier also served as the riskmanagement partner for the Chicago office in charge of supervising suchprocesses as client acceptance and retention decisions.23

Andersen’s Proposed Adjusting Journal Entries

In early 1994 the Andersen engagement team quantified several current andprior period misstatements and prepared proposed adjusting journal entries(PAJEs) in the amount of $128 million for the company to record in 1993. Ifrecorded, this amount would have reduced net income before special items by12 percent. The engagement team also identified accounting practices that gaverise to other known and likely misstatements primarily resulting in the under-statement of operating expenses.24

Allgyer and Maier consulted with Robert Kutsenda, the practice directorresponsible for Andersen’s Chicago, Kansas City, Indianapolis, and Omahaoffices. Kutsenda and the audit division head, who was also consulted, deter-mined that the misstatements were not material and that Andersen couldtherefore issue an unqualified audit report on the 1993 financial statements.Nevertheless, they instructed Allgyer to inform management that Andersenexpected the company to change its accounting practices and to reduce thecumulative amount of the PAJEs in the future.25 After consulting with the man-aging partner of the firm, Allgyer proposed a “Summary of Action Steps” toreduce the cumulative amount of the PAJEs, going forward, and to change theaccounting practices that gave rise to the PAJEs and to the other known andlikely misstatements.26


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27 SEC, “Arthur Andersen LLP Agrees to Settlement Resulting in First Antifraud Injunction in MoreThan 20 Years and Largest-Ever Civil Penalty ($7 million) in SEC Enforcement Action against a BigFive Accounting Firm,” Press Release 2001–62.28 SEC v. Dean L. Buntrock, Phillip B. Rooney, James E. Koenig, Thomas C. Hau, Herbert A. Getz, andBruce D. Tobecksen, Complaint No. 02C 2180 (Judge Manning).29 Ibid.30 SEC, “Arthur Andersen LLP Agrees to Settlement Resulting in First Antifraud Injunction in MoreThan 20 Years and Largest-Ever Civil Penalty ($7 million) in SEC Enforcement Action against a BigFive Accounting Firm,” Press Release 2001–62.

Although the company’s management agreed to the action steps, the com-pany allegedly continued to engage in the accounting practices that gave rise tothe PAJEs, and the other misstatements. Despite Waste Management’s failure tomake progress on the PAJEs, Andersen’s engagement team continued to issueunqualified audit reports on Waste Management’s financial statements. In fact,Waste Management’s financial statements for the years 1993 through 1996 over-stated the company’s pretax income by more than $1 billion.27

The SEC brought charges against founder Buntrock and five other formertop officers on charges of earnings management fraud. The SEC’s charges allegedthat top management had made several top-side adjustments in the process ofconsolidating the results reported by operating groups and intentionally hid theseadjustments from the operating groups themselves. In addition, top manage-ment had allegedly employed several other improper accounting practices toreduce expenses and artificially inflate earnings.28

To help conceal the intentional understatement of expenses, top manage-ment allegedly used a practice known as netting, whereby one-time gains realizedon the sale or exchange of assets were used to eliminate unrelated current periodoperating expenses, as well as accounting misstatements that had accumulatedfrom prior periods. Top management also allegedly used geography entries,which involved moving millions of dollars to different line items on the incomestatement to make it harder to compare results across time. In addition, man-agement allegedly made or authorized false and misleading disclosures infinancial statements.29

Because the financial statements for the years 1993 through 1996 were notpresented in conformity with GAAP, Waste Management’s independent audi-tor, Arthur Andersen, came under fire for issuing unqualified opinions on thesefinancial statements. The SEC filed suit against Andersen on charges that itknowingly or recklessly issued materially false and misleading audit reportsfor the period 1993 through 1996. Andersen settled with the SEC for $7 million,the largest ever civil penalty at the time, without admitting or denying any alle-gations or findings.30

Three Andersen partners who worked on the Waste Management audit dur-ing the period 1993 through 1996 were implicated in the SEC’s charges: RobertAllgyer, the partner responsible for the Waste Management engagement;Edward Maier, the concurring partner on the engagement and the risk manage-ment partner for Andersen’s Chicago office; and Walter Cercavschi, a partner


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31 SEC Auditing and Enforcement Release No. 1410, June 19, 2001.

on the engagement. Allgyer, Maier, and Cercavschi agreed to pay a civil penaltyof $50,000, $40,000, and $30,000, respectively. Allgyer, Maier, and Cercavschiwere also denied privileges of practicing before the SEC as accountants, withthe right to request reinstatement after five years, three years, and three years,respectively. A fourth Andersen partner, Robert Kutsenda, the central regionaudit practice director responsible for Andersen’s Chicago, Kansas City, Indi-anapolis, and Omaha offices, was also implicated in the SEC charges for improperconduct. Kutsenda was penalized by being denied the privilege of practicingbefore the SEC as an accountant. Kutsenda was given the right to request rein-statement after one year.31

Case Questions1. Refer to the second general standard of Generally Accepted Auditing Stan-

dards (GAAS). What is auditor independence, and what is its significance tothe audit profession? In what ways was Arthur Andersen’s independencepotentially affected on the Waste Management audit, if any?

2. Considering the example in the Waste Management case, explain why areview by the practice director and the audit division head is important inthe operations of a CPA firm. In your opinion, was this review effective atWaste Management? Why or why not?

3. Explain what is meant by an auditor’s proposed adjusting journal entries(PAJEs). Do you believe that Andersen’s final decision regarding the PAJEswas appropriate under the circumstances? Would your opinion change ifyou knew that all of the adjustments were based on subjective differences(such as a difference in the estimate of the allowance for doubtful accounts)as compared to objective differences (such as a difference in the accountreceivable balance of their biggest customer)?

4. Refer to Sections 203 and 206 of SARBOX. How would these sections of thelaw have impacted the Waste Management audit? Do you believe thatthese sections are needed? Why or why not?

5. Consider the principles, assumptions, and constraints of GenerallyAccepted Accounting Principles (GAAP). Define the matching principle andexplain why it is important to users of financial statements.

6. Based on the case information provided, describe specifically how WasteManagement violated the matching principle.

7. Consult Paragraph 2 and Paragraph A5 (in Appendix A) of PCAOB AuditingStandard No. 5. Do you believe that Waste Management had establishedan effective system of internal control over financial reporting related tothe depreciation expense recorded in its financial statements? Why orwhy not?


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8. Under what circumstances is a company allowed to change the useful lifeand salvage value of its fixed assets under GAAP? As an auditor, what typeof evidence would you want to examine to determine whether Waste Man-agement’s decision to change the useful life and salvage value of its assetswas appropriate under GAAP?

9. Consider the principles, assumptions, and constraints of Generally AcceptedAccounting Principles (GAAP). What is the specific definition of an asset?

10. Consider the practices of basketing and bundling. Briefly explain why eachpractice is not appropriate under GAAP.

11. Describe why netting would be effective for Waste Management’s manage-ment team when trying to cover up their fraudulent behavior.

12. As an auditor, what type of evidence would allow you to detect whetheryour client was engaging in behaviors designed to mask fraud (such as bas-keting, bundling, or netting)?

13. In your own words, explain what is meant by a top-side adjusting journal entry.If you were auditing Waste Management, what type of documentary evi-dence would you require to evaluate the propriety of such a journal entry?

14. Consult Paragraph 14 of PCAOB Auditing Standard No. 5. Based on thecase information, do you think this paragraph relates to the use of top-sideadjusting journal entries at an audit client like Waste Management? Why orwhy not?

15. Consult Paragraphs 26–27 of PCAOB Auditing Standard No. 5. Do youbelieve that the period-end financial reporting process should always beevaluated by auditors as a significant and material process during an auditof internal control? Why or why not?

16. Refer to Paragraphs 39–41 and A8 (in Appendix A) of PCAOB AuditingStandard No. 5. Identify one specific control procedure that could preventor detect a misstatement related to a top-side adjusting journal entry.

17. Based on your understanding of fraud risk assessment, what three condi-tions are likely to be present when fraud occurs (the fraud triangle)? Basedon the information provided in the case, which condition was most preva-lent at Waste Management, and why?

18. Consult Paragraph 69 of PCAOB Auditing Standard No. 5 and Sections204 and 301 of SARBOX. What is the role of the audit committee in thefinancial reporting process? Do you believe that an audit committee canbe effective in providing oversight of a management team such as that ofWaste Management?

19. Consult Sections 302 and 305 and Title IX of SARBOX. Do you believe thatthese new provisions will help to deter fraudulent financial reporting by a topmanagement group such as that of Waste Management? Why or why not?


Company Chase a.2

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