The U.S. Congress investigated the telecommunications industry in 2002 because of its practice of recognizing revenue by swapping fiber-optic capacity. Companies such as Qwest and Global Crossing exchanged equal amounts of line capacity.
Each company recognized revenue for the exchange and recorded the cost of pro viding the capacity as a capital expense. Witnesses before the House Energy Panel described the business environment in the telecom industry as a "pressure cooker." During this time, executives at the companies pushed their sales representative to meet the companies' quarterly earnings targets.
According to Patrick Joggerst, former head of sales at Global Crossing, "Not meeting the number was absolutely unacceptable." To meet the revenue targets, representatives from one company called their counterparts at the other company and worked out swap arrangements that helped the companies meet their sales targets. Robin Szwliga, Qwest's chief financial officer, testified that "there were well known consequences for not making the numbers but no clear consequences for cutting corners (Dennis Berman, "Three Telecom Companies Testify They Cut Side Deals with Qwest," The Wall Street Journal, September 25, 2002).
a. Is this type of misstatement difficult to prevent or detect by internal controls? Why? Explain your answer.
b. Is it likely that the auditors tested internal controls in the revenue process? Is it possible that the auditors found that control risk was low for the revenue process, even if these revenue misstatements were present in the financial statements?