Refer to the Professional Judgment in Context feature “Deficiencies in Auditing Debt Obligations and Stockholders’ Equity Accounts: Insights from SEC Releases” and review the panel related to Delphi Corporation. Answer the following questions:

a. What risks of material misstatement were present in the case?

b. What are the auditor’s responsibilities related to auditing retained earnings? What procedures should the auditor have performed?

c. Identify ways in which the audit team appeared to have a lack of appropriate professional skepticism.

Debt Obligations: Federico Quinto, Jr., CPA

In August 2012, the SEC issued an Aa:ounting and Auditing Enforcement Release in the matter of Federico Quinto, Jr., CPA. Quirto was an audit engagement partner for Soyo Group, Inc, in 2007. During 2007 and the first three quarters of 2008, Soyo hooked over $47 trillion in fictitious revenues. At the same time, Soyo was finning its business with debt from United Commercial Bank (MB). As of December 31, 2007, Soyo's debt with UCR was approximately $27.8 million, whih represented 63% of Soyo's tom! habitat. Because of Soyo's struggling business, the company often found itself in violation of its debt covenants with UCB. Quinto 's audit team conducted an analysis that identified that Soyo was not in compliance with three of its six debt covenants with LiC:B as of Da:emIxr 31, 2007. Because of the debt covenant violations, UCB could tale action that would force Soyo into hankrupicy, as Soyo needed the financing to fund is backless operations. The audit term did not follow up on the identified debt covenant violations and did not obtain any evidence indicating whether a waiver had been granted by I1013. The audit work papers did not provide any
evidence that the audit team considered whether these violations could impact the going cmccrn slams of Soyo. Further, the audit report for 2007 included an unquabficd opinion, akhough Soyo did not make the required disclosures regarding noncompliance with its debt covenants.

Adjustments to Stockholders' Equity Accounts: Delphi Corporation

In 2006, the Securities and Exchange Commissim outlined its case of alegations involving Ddphi Corporation and ctrtail of its senior officers, accounting staff, and treasury staff. The allegations involve a pattern of violations of federal securities laws from 2000 through 2004. flit of the alleged violations related to Delphi improperly accounting for an increase in warranty reserves related to warranty claims made by its former parent company. Ddphi recorded the reserve increase as a direct adjuctnrnt to retained earnings rather than as an expense. There was no basis for Delphi to record the resent adjustment as an adjustment to retained earrings. The SEC further alleged that Delphi disclosed the adjustment in an intentionally and materially misleading way. Specifically, the disclosure suggested, falsely, that the adjustment primarily related to certain pension and other postemployment benefit ("OPES") matters and Delphi failed to disdose highly material information concerning the reserve increase and the fanner parent company's warranty claim. The misdassification of the reserve increase as a direct adjustment to equity, rather than as an ocpcmc item, resulted in Delphi materially overstating its net income for 2000 by $69 million.

As you read through this chapter, consider the following questions:

• What are the risks of material misstatement associated with debt obligations and stock-holders' equity accounts? (10 2, 3, 4)

• What are the typical substantive procedures that auditors should perform when auditing debt obligations and stockholders' equity accounts? (LO 8)

• How could a lack of appropriate professional skepticism by auditors lead to material misstate-ments related to debt obligations and stock-holders' equity accounts? OM 2, 3, 5, 6, 8)