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