Elics Case We are the auditors for Frito Inc., which is in considerable financial difficulty. In particular, debt covenants may be violated if liabilities are increased. In addition, the client's balance in retained earnings is minimal as a result of excessively high dividends and diminished earnings in the past several years.

Frito Inc. is dominated by its CEO, a person who has served the company for $30$ years. The CEO makes most of the major decisions in the company. This person is the company's primary representative working with the audit staff. There has been considerable turnover of audit committee members in the last two years. The CEO is very aggressive with respect to earnings.

From the minutes, we have discovered that extreme emphasis has been placed on meeting earnings projections. Department officers have been fired for not meeting earnings goals for two successive years. We know that, through PCAOB Audit Standard No$.8,$ part of our responsibility as an auditor is to develop an audit plan that is sensitive to audit risk. Audit risk is the probability that we may unknowingly fail to modify our audit report on financial statements that are materially misstated. Our audit plan should be designed to provide reasonable assurance that material errors and fraud are detected.

Required

We understand that the pressures faced by Frito Inc. may create incentives for unethical and fraudulent financial reporting. In a report of not more than two pages, discuss the aspects of pension accounting that should be considered with special care. What pension$-$related variables might be changed, and in what direction, to achieve reduced pension expense and liabilities? Include in your discussion reasons why you chose these variables.