PROFESSIONAL SKEPTICISM:Delphi Corporation

PROFESSIONAL SKEPTICISM

Delphi Corporation (LO 1, 2, 3, 4, 6, 8, 9) Refer to the Focus on Fraud feature “Fraud Risks Related to Debt and Equity: Insights from SEC Accounting and Auditing and Enforcement Releases.” Review the panel related to Delphi Corporation.

-What risks of material misstatement were present in the case?

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

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

Focus on Fraud Fraud Risks Related to Debt and Equity: Insights from SEC Accounting and Auditing Enforcement Releases

This feature provides examples of frauds related to debt and equity.

Debt: Federico Quinto Jr., CPA

The client involved in this case, Soyo Group, acted fraudulently by not accurately disclosing violations of its debt covenants.

In August 2012, the SEC issued an Accounting and Auditing Enforcement Release in the matter of Federico Quinto Jr., CPA. Quinto was an audit engagement partner for Soyo Group, Inc., in 2007. During 2007 and the first three quarters of 2008, Soyo booked over $47 million in fictitious revenues. At the same time, Soyo was financing its business with debt from United Commercial Bank (UCB). As of December 31, 2007, Soyo’s debt with UCB was approximately $27.8 million, which represented 63% of Soyo’s total liabilities. 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 UCB as of December 31, 2007. Because of the debt covenant violations, UCB could take action that would force Soyo into bankruptcy, as Soyo needed the financing to fund its business operations. The audit team did not follow up on the identified debt covenant violations and did not obtain any evidence indicating whether a waiver had been granted by UCB. The audit workpapers did not provide any evidence that the audit team considered whether these violations could impact the going concern status of Soyo. Further, the audit report for 2007 included an unqualified opinion, although Soyo did not make the required disclosures regarding noncompliance with its debt covenants.

Source: Securities and Exchange Commission, Accounting and Auditing Enforcement Release No. 3403, August 31, 2012, available at http://www.sec.gov/litigation/admin/2012/34-67767.pdf

Equity: Delphi Corporation

In this case, members of Delphi’s management and staff acted fraudulently by charging expenses directly to retained earnings rather than to the appropriate expense accounts.

In 2006, the SEC outlined its case of allegations involving Delphi Corporation and certain of its senior officers, accounting staff, and treasury staff. The allegations involve a pattern of violations of federal securities laws from 2000 through 2004. One 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.

Delphi recorded the reserve increase as a direct adjustment to retained earnings rather than as an expense. There was no basis for Delphi to record the reserve adjustment as an adjustment to retained earnings. 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 (OPEB) matters and Delphi failed to disclose highly material information concerning the reserve increase and the former parent company’s warranty claim.

The misclassification of the reserve increase as a direct adjustment to retained earnings, rather than as an expense item, resulted in Delphi materially overstating its net income for 2000 by $69 million. Given that either way, Delphi management was recording this transaction, why would it care about charging it to retained earnings as compared to net income? Some reasons include meeting or beating analysts forecasted earnings expectations, and attempting to focus users’ attention on net income, a very common benchmark in terms of users’ assessments of profitability. In this case, appropriate classification among the financial statement accounts was very important, and management was misleading in its allocation choices.

Source: SEC Accounting and Auditing Enforcement Release No. 2504, October 30, 2006. A related SEC complaint in this matter is available at http://www.sec.gov/litigation/complaints/2006/comp19891.pdf

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Written Assignment Case – Analysis Format

The purpose of the Case Study Analysis learning tool is to provide an opportunity for the student(s) to demonstrate the application of knowledge to a management/organizational scenario. Since most management problems are inherently multidimensional, the use of the Case Study Analysis tool is a ‘hands-on’ process that helps students experience organizational complexities within a thoughtful forum. Therefore, the quality of your responses is more important than the quantity.  Keep in mind the student-learning model: Absorb, Synthesize, Analyze, Apply, Conclude and Demonstrate.  Your report will be (1-2 pages in length, APA format).  

Defining the central problem (Introduction)      5 PTS                                   

Provide a summary statement to demonstrate an understanding of the problem being presented. Summary statements are, typically, 3 – 5 sentences.  This introduction supports your thesis or proposition statement.

Case Summary       5 PTS

The summary should be brief and highlight the key factors or events relevant to your analysis or position.

Identify the relevant factor(s) and explain why they are important to the case.    10 PTS

It is not unusual for a case to have several relevant factors that are crucial to identifying a course of action. However, it is critical to the analysis that the relevant factors number no more than 3 and that it represents the graduate student’s choice (not the instructor) and it is important to state ‘Why’ you think the factor(s) you have chosen are important.

Analysis                10     PTS                                                                                      

The analysis section must be organized in a logical fashion, be written in a manner that advances your thesis; be supported by supplemental research, and demonstrate the ability to apply key course concepts to the actual case.

Recommendations       5 PTS

The recommendations section must include your solutions to the problems you have identified in the analytical section.  It is important that your recommendations, if implemented, adequately address all of the problems that you indicate are in existence.  Additionally, each recommendation needs to meet the test of feasibility.  In other words, are these actions cost-effective, could they realistically be implemented, and are they in compliance with regulations?

Conclusions            5  PTS                                                                                   

Identify a course of action you would take to resolve the case problem and what do you think needs to happen once the action has been taken. Feel free to support your course of action through personal, vicarious and/or classroom experiences.

References            5   PTS                                                                          

All sources cited within your work are to be included in your references section in APA form.

APA Format, Grammar and Style 5 PTS

Paper must be written in the appropriate APA format and style 6th ed.

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