Three conditions are often present when fraud exists. First, management or employees have an incentive or are under pressure, which provides them a reason to commit the fraud act. Second, circumstances exist – for example, absent or ineffective internal controls or the ability for management to override controls – that provide an opportunity for the fraud to be perpetrated. Third, those

Question

involved are able to rationalize the fraud as being consistent with their personal code of ethics. Some individuals possess an attitude, character, or set of ethical values that allows them to knowingly commit a fraudulent act. Using hindsight, identify factors present at Waste Management that are indicative of each of the three fraud conditions: incentives, opportunities, and attitudes.

What will be an ideal response?

Answer 1

Senior management faced several incentives that may have pressured them to engage in issuing
fraudulent financial statements. Since commencing operations in 1968, the company had grown
to be a leader in the waste management services industry. Recognition as an industry leader and
the company’s sheer size, with revenues and assets over $9 billion and $18 billion, respectively,
placed tremendous pressure on senior management to maintain the company’s reputation and
stature in the industry and business community. With that kind of presence and reputation,
management faced even greater pressure as industry competition intensified in the mid-1990s,
causing company profits to decline between 1994 and 1996 despite increasing revenues. Internal
budgets and earnings targets set by the chairman and CEO, Dean Buntrock, created an internal
incentive for other members of the management team to identify ways to satisfy expectations of
senior management. As acknowledged in the case, the SEC alleged that the defendants’ fraudulent
conduct was also driven by greed and a desire to retain their corporate positions and status in the
business and social communities. Buntrock, CEO, posed as a successful entrepreneur and used
the inflated company stock to make charitable contributions to his alma mater to fund a building
in his name. Furthermore, members of the senior management team received bonuses based on
company performance targets. These conditions collectively provided numerous incentives that
pressured members of senior management to identify creative ways to artificially inflate company
performance.
Given these incentives, management took advantage of opportunities to engage in fraudulent
financial reporting. With a significant portion of the company’s assets tied up in property, plant, and equipment items, management identified an opportunity to inflate company operations by taking
advantage of the inherent subjectivity involved in developing key assumptions used to calculate
depreciation charges associated with those assets. With the ability to manipulate key assumptions
related to asset useful lives and residual values, management was able to modify depreciation expenses
so that earnings targets could be met. In addition, they took advantage of other judgment-based
estimates by failing to reflect known decreases in the value of landfills as those disposals neared capacity
and they failed to write-off costs of unsuccessful and abandoned landfill development projects. Finally,
they took advantage of the subjectivity associated with establishing various environmental and other
reserve accounts. Many of these fraudulent judgments affected accounting entries that management

made outside the traditional accounting system, through the use of last minute, end of period “top-
level adjustments” to actual results. To conceal the fraudulent intent of many of these “adjustments,”

management often spread the effects of unusual entries across various lines in the financial statements.
In some cases, management took advantage of its senior position to override accounting decisions made
by others within the company, in order to meet targeted earnings expectations.
Management’s attitude towards financial reporting was revealed once the auditors from
Andersen presented management the Proposed Adjusting Journal Entries to correct the errors in the
financial statements. At that point, management revealed its lack of regard towards quality financial
reporting by consistently refusing to make the adjustments. The lack of an ethical attitude became more
evident when management approached Andersen with a secret agreement to write off the accumulated
errors in future periods. Clearly, management had rationalized their actions and wanted others to
accept their scheme.
In this case, all the ingredients of fraud were present. Management had tremendous incentives
to engage in fraud, and they took advantage of opportunities present to manipulate significant estimates

in the financial statements. Finally, their refusal to correct identified errors and their scheme to cover-
up the inappropriate accounting reflected their attitude towards the financial reporting process.