Leslie Donald is the audit manager responsible for the annual audit of ABC Electronics Ltd. (ABC), a Canadian pub¬ lic company involved in the manufacture and distribution of highly competitive electronic products. He has completed his review of the audit files and has discussed a number of issues with the audit senior. Since the partner in charge of the engagement has arranged to meet with the chairman of ABC's audit committee three days from now, Leslie has decided to write a memo to the partner to outline a number of matters that bother him. These concerns arise as a result of the following information that has come to his attention:

1.Based on results for the first three quarters of the year, ABC management estimated annual net income of \($1,000,000\). Primarily as a result of audit adjustments to provide for obsolete inventory, net income has been reduced to slightly more than \($300,000\). Consequently, management will not be receptive to proposals for any adjustments that further reduce earnings.

2. The senior had written short audit notes throughout the files, including the following:

Testing of controls over disbursements showed that, out of a sample of 150 cheques tested, 24 cases of incomplete supporting documentation were discov¬ ered.

Twelve of the 24 exceptions found in our disbursement tests were payments totalling \($50,000\) to some free¬ lance management consultants who traditionally have been paid without an invoice. These payments have been satisfactorily verified by telephone conversations. The other 12 cheques were issued to Sales Promotion Enterprises Ltd., and, although not supported by invoices, were approved by Bill Rogerson, the general manager. These cheques total \($85,000\) and all bear a second endorsement by I. B. Graten. They have been charged to account 809, Inventory on Consignment, and the inventory has been confirmed by Sales Promo¬ tion Enterprises Ltd. as being on hand at year end. Sales Promotion Enterprises Ltd. is properly included in the master vendor files. Therefore, there appears to be no weakness in computer controls relating to these payments.
Our tests of sales invoices disclosed no errors or unusual conditions except that invoices to Global Galaxy Stores (Global) are priced at 5 percent over the approved price list. By industry standards, it appears that such conditions are not justified. The invoicing clerk's explanation was that this policy was established verbally by Bill Rogerson, and Global was the only cus¬ tomer to which this price applied. This explanation appears to be satisfactory since Global has always paid its account within 30 days. Since Global is also our client, I have agreed the year end balance to our Global audit files.
3. Leslie asked Bill Rogerson for an explanation for pay¬ ments to Sales Promotion Enterprises Ltd. Bill claimed that he could not remember the transaction well but, in view of the immaterial amount involved and his approval for each payment, suggested that the payments were of no audit significance. Later, Leslie and Bill had lunch together, and Bill offered some additional informa¬ tion on a confidential basis. He said that Sales Promotion Enterprises Ltd. was owned by a buyer for one of ABC's largest customers. Global. The payments guaranteed orders from Global at prices favourable to ABC, and orders in the past year had exceeded \($8,000,000\). Bill explained that the arrangements were made by ABC's president and, for obvious reasons, were to be consid¬ ered highly confidential.
Since Bill seemed to be in a talkative mood, Leslie asked him about the other unsupported payments. Bill claimed to have no knowledge of the management con¬ sultants.
Required Assume the role of Leslie Donald, the audit manager, and prepare the memo to the audit partner. Identify potential problems. For each problem, indicate the parties affected by the problem, alternative methods of dealing with the prob¬ lem, reporting responsibilities, and a recommended course of action.
(CICA adapted)