Notes on Major Case 6
Waste Management
Ethical Issues:
The Principle of Due Care in the AICPA Code of Professional Conduct obligates a CPA
to perform services with competence and diligence and with concern for the best interest of
investors and creditors who provide the capital needed for operations. Due Care also implies that
the auditor is independent of management, objective in decision making, and maintains integrity.
Auditors must properly plan the audit and supervisor assistants and obtain sufficient relevant
data. The ability to obtain sufficient, competent evidential matter is the basis for making
professional judgments that help to determine whether Waste Management’s financial statements
accurately record, in all material respects, the client’s actual income, financial position, and cash
flows. For example, auditors fail to meet these requirements if they rely extensively on
information provided by the client, often in the form of oral representations of management, and
fail to obtain sufficient documentary and other evidence from independent sources to verify
management’s representations. Andersen heavily relied on management’s assurances that the
steps outlined to correct for past misstatements in the financial statements would not continue
into the future. Not only did they persist, but the company failed to spread out the effect of the
misstatements over future income as had been agreed to with management.
In addition to a lack of due care, Andersen was not independent of the client, at least in
appearance, because of managing partner on the Waste Management engagement, Robert
Allgyer, was a member of the Steering Committee that oversaw the Strategic Review and that
made a recommendation on implementing a new operating model to “increase shareholder
value.” Andersen Consulting billed Waste Management for Allgyer’s time for these services. In
setting Allgyer’s compensation, Andersen took into account, among other things, the firm’s
billings to Waste Management for audit and non-audit services
(http://www.sec.gov/litigation/litreleases/lr17435.htm). Allgyer’s relationship with Waste
Management impaired audit independence because the firm would eventually audit results based
on the new model recommended by Allgyer.
Audit independence is the cornerstone of the ethical obligations of auditors because it
creates a barrier between the clients’ interests and what is in the public interest. The public relies
on the auditor’s independence and ability to make objective judgments. Independence is both a
factual requirement and auditors must also appear to be independent to a reasonable observer.
The relationship between former Andersen professional staff that had gone to work for Waste
Management in key financial reporting positions created the appearance that independence might
be impaired. This relationship brought into question whether Andersen lacked the intellectual
honesty and objectivity that was necessary to make professional judgments about the GAAP
conformity of the financial statements.
CPAs are expected to approach an audit with professional skepticism; to have an attitude
that includes a questioning mind and a critical assessment of audit evidence. The auditor should
plan and perform the audit with professional skepticism recognizing that circumstances may
exist that cause the financial statements to be materially misstated. Andersen knew Waste
Management’s statements contained many misstatements in the application of GAAP but the
firm rationalized accepting the statements without correction or restatement of prior years’
statements based on erroneous materiality judgments.
Another indication of Andersen’s lack of independence was the level of its audit fees in
comparison to non-audit fees. The firm may have been concerned that if it would lose
lucrative consulting jobs if it had maintained its integrity and not given in to the pressures
placed on them by top management. As pointed out in the case, Andersen reported to
the audit committee that it had billed Waste Management approximately $7.5 million in
audit fees. Over the seven-year period, while Andersen’s corporate audit fees remained
capped, Andersen also billed the company $11.8 million in other fees. A related entity,
Andersen Consulting, also billed Waste Management approximately $6 million in
additional non-audit fees, $3.7 million of which related to a Strategic Review that
analyzed the company’s overall business structure.
SEC Litigation Release 17435 notes that until 1997, every CFO and CAO in Waste
Management’s history as a public company had previously worked as an auditor at Andersen.
During the 1990s, approximately 14 former Andersen employees worked for Waste
Management, most often in key financial and accounting positions
(http://www.sec.gov/litigation/litreleases/lr17435.htm).
Andersen allowed client management to dictate the direction that would be taken to deal
with audit issues raised in the PAJEs. It is highly unusual for an audit firm to enter into an
agreement with a client to adjust for past accounting mistakes in the future by spreading them out
over a number of years and simply promise never to do it again. Andersen relinquished its role as
the decider of what should be done based on audit and ethics standards and allowed the client to
make important professional decisions. In doing so, the firm knowingly went along with material
misstatements in the financial statements ostensibly to keep the client happy.
Questions
1. The SEC charged Andersen with failing to quantify and estimate all known and
likely misstatements due to non-GAAP practices. What is the purpose of doing
this from an auditing perspective?
Auditors quantify all known and likely misstatements to evaluate the audit findings and
determine the appropriate audit opinion. To issue an unmodified opinion the auditors must
conclude that there is a low level of risk of material misstatement of the financial statements.
Known misstatements are specific misstatements identified during the course of the audit (i.e., a
2. Classify each of the accounting techniques described in the case that contributed
to the fraud into one of Schilit’s accounting shenanigans. Include a brief
discussion on how each technique violated GAAP.
Waste Management used the following improper accounting practices paired with Schilit’s
shenanigans:
Description of
Improper Accounting
Practice
Schilit’s
Shenanigan
Number
Description of
Shenanigan
Effect on Financial
Statements
Improperly eliminating
or deferring current
period expenses
4 Shifting Current
Expenses to a Latter
Period
Understate depreciate
expenses and
overstate earnings
Making unsupported
changes in depreciation
estimates
4 Shifting Current
Expenses to a Latter
Period
Understate depreciate
expenses and
overstate earnings
Failing to record
expenses for decreases
in the value of landfills
as they were filled with
waste
4 Shifting Current
Expenses to a Latter
Period
Understate depreciate
expenses and
overstate earnings
used to avoid recording
unrelated environmental
and other expenses
Netting one-time gains
against operating
expenses
3,5 Boosting Income with
a One-time Gain Offset
by Offsetting Expenses
Reducing current
revenue and reducing
current expenses; net
effect of inflating
earnings
3. Review the facts of the case with respect to Andersen’s role in the fraud and
describe the provisions of the AICPA Code of Professional Conduct that you
believe were violated by the firm. Comment on Andersen’s risk assessment as
part of its audit procedures.
Andersen audited and issued an unqualified (i.e., unmodified) report on each of Waste
Management’s original financial statements and on the financial statements in the restatement. In
The SEC complaint against Andersen charged that the firm knew of Waste Management’s
exaggerated profits during its audits of the financial statements from 1992 through 1996 and
repeatedly pleaded with the company to make changes. Each year, Andersen gave in and issued
• Determining the materiality of misstatements improperly; failing to record or disclose
information about such transactions; issuing an unqualified audit report.
• Written recognition in a memorandum prepared by Andersen of the company’s improper
netting practices and identification of SEC exposure; monitored continuing practice but
failed to adequately disclose the effect on current earnings.
At the outset of the fraud, management capped Andersen’s audit fees and advised the
Andersen engagement partner that the firm could earn additional fees through “special work.”
Andersen nevertheless identified the company’s improper accounting practices and quantified
The SEC was very critical of Andersen’s relationship with Waste Management. Litigation
Release 17039 notes that the firm had audited Waste Management since before it became a
public company in 1971 and considered the client its “crown jewel.” Until 1997, every CFO and
chief accounting officer (CAO) in Waste Management’s history as a public company had
previously worked as an auditor at Andersen. During the 1990s, approximately 14 former
Andersen employees worked for Waste Management, most often in key financial and accounting
positions. Andersen selected Allgyer to be the managing partner of the Waste Management
audit because he had demonstrated a “devotion to client service” and had a personal style that
“fit well with Waste Management officers.” During the time of the audit, Allgyer held the title of
The SEC found that Andersen and four of its auditors violated the anti-fraud provisions of
Rule 10b-5 of the Securities Exchange Act of 1934. These provisions make it unlawful for a CPA
The commission had alleged that Andersen and its partners failed to stand up to company
management and betrayed their ultimate allegiance to Waste Management’s shareholders and the
investing public by sanctioning false and misleading audit reports. Thus, the firm violated its
Andersen knew that Waste Management was not in compliance with GAAP. In planning and
performing the audit each year, Andersen should have assessed risks of material misstatements
by area, account, and overall. Andersen should have planned and performed the audit to detect