Usefulness of financial statements Essay

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Literature Review 5

Description on “Audit and Assurance Standard – 13”6


Decision 10




Misstatement or skip in the fiscal statements are considered material if they could act upon the economic and fiscal determinations of the users of the information based on the provided statements. This research is an empirical research, which provides that a relevant outlook spread sing materiality of misstatements exists between hearers and the users of the fiscal statements. This spread can be explained chiefly by deficiency of communicating between these two.

WorldCom and other telecommunications houses faced decreased demand as the dot–com roar ended and the economic system entered recession. Their grosss have fallen short of outlooks, while the debt they took on to finance enlargement remains high. As the stock market value of these houses has plunged, corporate direction had a powerful inducement to prosecute in accounting patterns that conceal bad intelligence.


Accounting and Auditing Standard 13 provinces that the information is information is material if its skips or misstatement could act upon the economic determinations of users taken on the footing of the fiscal statements.

Equally long as misstatement do non go against the just and true position the fiscal statements spring of the fiscal place of a company, they are considered immaterial. It is the duty of the hearer of the fiscal statements to be moderately certain that the fiscal statements are free from material misstatement.

Because the user is the Ne, who makes determinations based on the one-year fiscal statements, in theory it should be the user of the fiscal statement, who decides what is material and what is non. However, users of the fiscal statements are non a homogenous group. Stockholders, creditors and clients have different information demands and penchants and hence see other things as being stuff to their determinations.

Therefore, in pattern the hearer decides on materiality baseline for the audit of the fiscal statements. The hearer is the intimate of the fiscal statement users who audits the fiscal statements of a company on behalf of the users.

Although the definition of the term explicitly addresses user’s economic decision-making, in pattern, user are non involved in the construct at all. This gives ground to surmise that the deduction of the construct of materiality are non known, or non to the full known to users of the fiscal statements.

Harmonizing to the research on WorldCom Inc. dirt we know that, the company began as a little Mississippi supplier of long distance telephone service. During 1990s, the house made a series of acquisitions of other telecommunication houses that boosted its reported gross from $ 154 million in 1990 to $ 39.2 million in 2001, puting its 42neodymiumamong Fortune 500 companies. The acquisition of MCI in 1998 made the company second largest U.S. long distance bearer, and the acquisition of UUNet, America Online and CompuServe’s information web. Which made WorldCom among the taking operators of Internet substructure.

In its 25Thursdaystatement, WorldCom admitted that the company had payments over $ 3.8 billion for line cost as capital outgo instead than current disbursals. Line costs are what WorldCom pays other companies for utilizing their communicating web ; they consist chiefly of entree fees and transit charges for WorldCom clients. Reportedly, $ 3.05 billion was misclassified in 2001 and

$ 797 million in the first one-fourth of 2002. Harmonizing to the company, another $ 14.7 billion in 2001 line costs in 2001 line costs was treated as a current disbursals.

Literature Review

New York Times published intelligence about WorldCom’s prostration on jully 22, 2002. WorldCom, plagued by the rapid eroding of its net incomes and an accounting dirt that created one million millions in illusive net incomes which was the largest bankruptcy filing in U.S. history.

The WorldCom filing listed more than $ 107 billion in assets, exceling those of Enron instance, which was filed before this instance. Thee WorldCom filing had been anticipated since the company disclosed in late June of that twelvemonth that it had improperly accounted for more than $ 3.8 billion of disbursals. WorldCom’s revelation of possible new accounting job came in a filing that the Securities and Exchange Commission had ordered to supply inside informations of its 2011 and 2001 accounting abnormalities, the S.E.C. filed civil fraud allegation against the company.

In the revelation by WorldCom, to the S.E.C, they disclosed that Mr. Sullivan, who was fired by WorldCom’s board so, to continue paperss and records related to his determinations to capitalise the cost of renting infinite on competitors’ phone lines. Alternatively, those costs should hold been recorded as current concern disbursals, cut downing its hard currency flows and its net incomes. The Securities and Exchange Commission had charged WorldCom with fraud and the Justice Department had begun a condemnable probe of WorldCom’s full concern patterns.

Description on “Auditing and Assurance Standard – 13”

Audit Materiality

This Standard on Auditing, explains the auditor’s duty to use the construct of materiality in planning and executing an audit of fiscal statements.

Date of Effectiveness

This accounting criterion is effectual for audits of fiscal statements for periods get downing on or after April 1, 2010.

Aim of the Standard

The aim of the hearer is to use the construct of materiality suitably in planning and executing the audit.


AAS 13 ballads down standard on construct of materiality and its relationship with audit hazard. Information is material if its misstatement could act upon the economic determinations of Ti users taken on the footing of the fiscal information. Materiality is the cut off bound with mention to which the misstatements are considered, it may be the sum, nature of the point, size or frequence.

For illustration, the wage to manager may hold to be specifically disclosed. The sum of which judged from entire wage of the staff may be negligible. But the nature of the point would do it material for misstatement.

The materiality is observed with the mention to the single points or sum of them. Some points which are non by themselves stuff may cumulatively ensue in stuff significance. Some points though by size non material, may associate to legal or statutory affairs the non0compliance of which make the fiscal statements materially misdirecting. Other peculiar points may qualitatively show material misstatements. For illustration, inappropriate application of accounting policy may ensue in stuff misstatements either in current period or may consequence stuff misstatements in fiscal statement that follow the period.

The relationship between Materiality and Audit Risk

The hearer plans to maintain the audit hazard at a minimal degree while be aftering the audit. While planning, he decides the materiality degree of specific history balances or category of minutess, which helps him in make up one’s minding the points to be selected, the sample to be chosen and which audit processs to be applied on them.

There is an reverse relationship between audit hazard and audit materiality. If the materiality is high, the audit hazard is low. If the hearer chooses to maintain the materiality bound of few hundred rupees for the truth and rightness of net income, the opportunities that that audit carried out may neglect to observe the mistakes within which such a narrow scope may be higher. In such instance, the hearer reduces the audit hazard by more appropriate checking of control systems, balances and minutess. The hearer lays purely a lower control hazard and carry out extra trials to command. Similarly he puts a lower sensing hazard and carry out extra processs. These two in combination would assist the hearer in cut downing the entire audit hazard to level he wanted, in malice of his repairing tolerable materiality degree at a lower degree.

Materiality and audit hazard in measuring audit groundss

At the planning phase, the hearer may put for himself a materiality degree, which nevertheless, may alter as he proceed along the audit. The cognition gained or alteration in the fortunes in the audit may alarm the hearer to revise the materiality degree to take down or higher side.

In organizing an sentiment about the fiscal statement, the hearer should see whether the consequence of sum uncorrected misstatement on the fiscal information is material. The sum of uncorrected misstatement comprise of specific misstatement identified by hearer during his audit, the net misstatement brought down form old period without rectification, the projected misstatement where misstatements are projected from a trying trial of balances and minutess. The direction should rectify and set the fiscal information in mention to misstatement showed to them. The accommodation should affect application of appropriate accounting policy, supplying revelation where it was conspicuous by absence, following with the statue for affairs impacting fiscal statements, rectification of mistakes, undoing, suitableness, by revelation or otherwise, the consequence of fraud, ECT. If the hearer could non happen the consequence of stuff misstatements within materiality degree fixed for the fiscal statement as a whole, he may make up one’s mind to show a qualified or inauspicious sentiment about the fiscal statement suitably.


The method which I am utilizing is Case Study Analysis for my survey. The instance survey methodological analysis helps to understand the fortunes in which the informations can be collected through assorted research techniques, such as instance observation or articles. In order to explicate the AAS-13 in inside informations, I have taken existent instance survey in this paper sing the WorldCom Inc. dirt in 2002 in which the direction and such as document observation or articles. In order to explicate the AAS – 2 in inside informations, I have taken existent illustration in this paper sing the WorldCom dirt in which the direction and internal hearers were every bit at mistake.

WorldCom was non the lone telecommunications house in fiscal problem. The troubles of Qwest Communications, Global Crossing, Adelphia, Lucent Technologies, and Enron ( which had major investings in internet ventures ) have been widely reported at the same clip. As in these other houses, investors in WorldCom have suffered major losingss: the market value of the company’s common stock plunged from about $ 150 billion in January 2000 to less than $ 150 million as of July 1, 2002. The desire to avoid or prorogue stock market losingss of this magnitude creates a powerful inducement for corporate direction to prosecute in accounting patterns that conceal bad intelligence.

WorldCom increased both its net income and its assets by reassigning portion of a current disbursal to a capital history. Had it non been detected, the manoeuvre would hold resulted in lower net income in subsequent old ages as the capitalized plus was depreciated. Basically, capitalising line costs would hold enabled the company to distribute its current disbursals into the hereafter, possibly for 10 old ages or even longer.

the SEC requested informations from the house about a scope of fiscal coverage subjects, including ( 1 ) disputed measures and gross revenues committees, ( 2 ) a 2000 charge against net incomes related to sweeping clients, ( 3 ) accounting policies for amalgamations, ( 4 ) loans to the CEO, ( 5 ) integrating of WorldCom’s computing machine systems with those of MCI, and ( 6 ) WorldCom’s trailing of Wall Street analysts’ net incomes outlooks.

Harmonizing to initial histories, the intervention of line costs as capital outgos was discovered by WorldCom’s internal hearer, Cynthia Cooper, in May, 2002. Ms. Cooper reported the affair to the caput of the audit commission of WorldCom’s board of managers, Max Bobbitt, on or about June 12th, who in bend asked the company’s current outside hearer, KPMG, to look into.

On July 15th, nevertheless, Representative Tauzin, Chairman of the House Energy and Commerce Committee, said that internal WorldCom paperss and e-mail messages indicated that the Company’s executives knew every bit early as the summer of 2000 that the accounting intervention was improper.


After intense research on the subject, I discovered that the internal hearers were an early line of defense mechanism against accounting mistakes ( e.g. , misguided categorizations with no purpose to lead on ) and accounting fraud ( e.g. , wittingly false categorizations with purpose to lead on ) . I observed one thing about the instance that it took more than a twelvemonth for the company’s internal hearers to detect the misclassification ; harmonizing to AAS-13 it was auditor’s responsibility to take into consideration the incorrectness of the misstatement. But it did non happened in the due class of clip, sing the sum of costs being capitalized about, $ 750 million each one-fourth and the impact on net income and assets. This might hold been caught earlier if the company had followed the accounting criterion of audit materiality. When I observed closely, I noticed the fact that Andersen was non notified that line costs were being capitalized was irrelevant ; harmonizing to me, Andersen should hold designed their audit to observe misclassifications of this magnitude. We can besides observe that Andersen should hold taken into history the fiscal status of WorldCom and paid more attending to the possibility of aggressive accounting patterns.


An internal hearer has an huge function for the good corporate administration. The fraud has happened outside India, but the effects were enormous. Now we know the possible defects in the corporate activities and we can work to do our ordinances even stricter. Since the irresistible impulse of the audit from 1996 under Company’s Act in India, the function of internal and external hearer has brought down transparence and dependability of fiscal statements in many organisations. All the stakeholders rely on the fiscal statements for their economic determinations because of the function and duty of the hearer. But in this instance survey we have observed that the hearers and the direction were at mistake. Though the actions were taken by the governments but the effects were irreversible.


I would wish to urge:

  1. All the auditing criterions should be conveyed to all the corporate entities.
  2. Information about the criterions and the regulations should be followed by the direction.
  3. Though in theory, all the regulations and ordinances are followed by the company, but in practical universe we should adhere to the ICAI guidelines and concentrate more on internal direction.
  4. The Indian Government and ICAI must forestall big houses to pull strings the internal auditing criterions by uninterrupted cheque on the companies.
  5. Severe actions must be taken in instance of such frauds other than fiscal punishments.




Web sites:

  1. 2014.WORLDCOM ‘S Collapse: THE OVERVIEW ; WORLDCOM FILES FOR BANKRUPTCY ; LARGEST U.S. CASE. [ on-line ] Available at: hypertext transfer protocol: // [ Accessed: 16 Feb 2014 ] .
  2. 2014.IFRS – Home. [ on-line ] Available at: hypertext transfer protocol: // [ Accessed: 16 Feb 2014 ] .
  3. Markham, J. W. 2006.A fiscal history of modern U.S. corporate dirts. Armonk, N.Y. : M.E. Sharpe.
  4. Rooij, D. D. 2009.Materiality of misstatements from the position of the users of the fiscal statements – Narrowing the outlook spread between users and hearers. Rotterdam: Erasmus University.



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