Name: Agil Mundita Assandy

NIM : 165020307141013

CASE 4.4

1. They used estimates for vehicle and equipment, landfill cost, the costs plus estimated earnings
in excess of billings -capitalization of losses

2. They are inherently risky because management has incentive to exaggerate these estimates in
order to present strong financial statements. When management’s earnings are tied to the
profitability of the company there is always inherent risk in relying on estimates.

3. AU 342 is the professional standard that relates to management and the auditing firm’s
responsibility concerning accounting estimates. The auditor’s objective is to obtain sufficient
evidence to validate the estimates that management has made when the accounting estimate
could be material to the financial statements. The estimates must be reasonable under the
circumstances and conform to to the applicable accounting principles, as well as proper
disclosure.

4. The auditors could have compared Waste Management’s estimate for useful lives to those of
other companies in the industry and to other depreciation sources (MACRS). They also could
have looked to companies in the industry for salvage values on property and equipment as well
as using the market price. The following table shows the useful lives for different classes of
property used by Waste Management, Allied Waste (a competitor), and MACRS (useful lives
required for tax purposes).
Waste Management Allied Waste MACRS

Vehicles 3-20 yrs 3-15 yrs 5 yrs

Equipment 3-20 yrs 5-10 yrs 7 yrs
Buildings 10-40 yrs 30-40 yrs 39 yrs
Leasehold Life of lease n/a 15. yrs
Improvements

4. Anderson’s auditors could have compared the estimates of Waste Management to estimates
made by other companies in the same industry. They also should have looked at how Waste
Management made their estimates historically and compared them to that. For the salvage values
Anderson should have done some research to see what the equipment actually sold for at the end
of it’s useful life. They also could have independently developed their own estimates of the
salvage values and useful lives and then compared them to those of Waste Management.

5.Incentives:
 a. Financial pressures from changes in the market and industry
b. Intense competition (national, regional, local)
c. Under cut prices from municipalities that could offer lower prices by using tax revenued.
d. Pressure to meet earnings expectationse.
e. Stock ownership benefits
f. Retirement benefits
g. Performance based bonuses
h. Maintain growing stock price
i. Maintain industry leadership
j. Maintain reputation

Opportunities:
a. Able to use a lot of estimates in depreciation of PPE (over 1/2 of assets)
b. Accounting firm (Arthur Andersen) thought of Waste Management as a “crown jewel”
and would be lenient to keep from losing their account, working together since before
1971
c. Lot of former Andersen employees were working at Waste Management
d. CFO and CAOs all former Anderson auditors
e. Arthur Anderson hadn’t forced them to change yet
f. Arthur Anderson’s action steps- working together to cover up past fraud with new fraud
g. Top executives working together in the fraud
h. Netting and geography
Attitudes:
a. If their auditor was approving the accounting treatment of certain items, it must have
been correct
b. These entries were needed to stay competitive
c. keep their jobs and status in community
d. Buntrock’s charitable contributions- “pillar of the community”
e. Keep shareholders happy and willing to invest more

6. Section 206 states that the chief executive officer, controller, chief financial officer, and chief
accounting officer (or equivalents) cannot have been employed by the audit firm during the one
year period before the audit. In short, any audit firm employee wanting to seek employment with
the company must wait a one-year “cooling off” period. This section of Sarbanes-Oxley attempts
to control the risks of personal relationships of company officers and audit firms/teams. This
would impair the independence of the auditors. The company executives could easily influence
the audit through their relationships with the auditors. Also, the auditors and management could
collude and/or continue in bad practices. Another risk is “insider knowledge” of the audit – that
is, the company could know what the audit firm will check and thus find a way to keep any fraud
from being detected.
7. The company executives and auditors had personal relationships, so the management was able
to manipulate the auditors and capitalize on unearned trust. The auditors could also have
believed that management knew what they were doing because they were former auditors and
familiar with GAAP rules and accounting procedures. Another possible reason would be that the
company had been committing this fraud for years already, and the auditors’ reputation would be
hurt if the fraud was discovered. Obviously, the audit firm also stood to lose a prize client (and
the revenue) if they forced changes, not only on the audit side of things, but also on the other
services Andersen provided (non-audit, tax, consulting, etc.). Forcing the changes could also
cause Waste Management to go under, and then once again they lose the prize client and the
revenue from them. Audit partners are expected to bring in business, not lose it.

Sarbanes-Oxley does help some with the independence issues an audit firm could face.
SOX Section 203 introduces the partner rotation, which forces the audit partner on the
engagement to rotate off the engagement after five years. The audit firm could also rotate the
audit team or at the very minimum ensure that the rest of the audit team has no personal
connection to the company being audited. The audit firms also need to instill and emphasize
corporate values such as integrity over profits and clients brought in. Audit firms could also hire
a more ethical workforce and have mandatory training about the ethics their firm requires.
Lastly, an audit firm could have a place to voice the concerns of the employees if unethical
practices are taking place.

8. 8. Professional judgment is defined as the application of the accumulated knowledge and

experience gained through a relevant auditing training, by making use of the ethical standards,
resulting in making informed decisions about the courses of action that are appropriate in
specific circumstances. Professional judgment is a skill of that an auditor gains through
experienced and training.

9. 9. The auditors of Waste Management had to make the following kinds of professional
judgement when examining the accounting for property, plant, and equipment:
•Whether the assignment of salvage values were appropriate
•Whether environmental reserves are representative
•Whether depreciation is properly charged
•Whether expenses should be recorded for decreases in the value of landfills as they are filled
with waste

10. The auditors must have handled certain work experiences over time which make their skills of
professional judgement stronger. Therefore, a well-rounded auditor will make professional
judgement calls based on their experiences, skills, and training.

The auditors of Waste Management had to make the following kinds of professional judgement
when examining the accounting for property, plant, and equipment:
Whether the assignment of salvage values were appropriate
Whether environmental reserves are representative
Whether depreciation is properly charged
Whether expenses should be recorded for decreases in the value of landfills as they are filled with
waste

Listed below are several judgement traps and tendencies that likely affected the auditor’s
judgement when auditing Waste Management’s financial statements:
Whether the capitalized assets, expenses, and depreciation is properly accounted for
Whether all of the accounting estimates and methods were properly implemented
Whether any irregularities were noted by the internal audit department

QUALITY OF EARNINGS
The quality of earnings refers to the amount of earnings attributable to higher sales or lower costs
ratherthan artificial profits created by accounting anomalies such as inflation of inventory. Quality
of earnings is considered poor during times of high inflation. Also, earnings that are calculated
conservatively are considered to have higher quality than those calculated by aggressive
accounting policies.One way to gauge Waste Management’s the quality of earnings is to start with
the top of the income statement and work down. As seen on Exhibit 1, Waste Management went
from a net income of in 1996 to a significant net loss in 1997. This drastic change was primarily
due to the large increase in operating costs/expenses related to asset impairments and unusual
items, probably related to the improper

The auditors of Waste Management had to make the following kinds of professional judgement
when examining the accounting for property, plant, and equipment:
•Whether the assignment of salvage values were appropriate
•Whether environmental reserves are representative
•Whether depreciation is properly charged
•Whether expenses should be recorded for decreases in the value of landfills as they are filled
with waste