ABC Stores is a large discount catalog department store chain. The company has recently expanded from 8 to 60 stores by borrowing from several large financial institutions and from a public offering of common stock. A recent investigation has disclosed that ABC materially overstated net income. This was accomplished by understating account payable a recording fictitious supplier credits that further reduced

accounts payable. An SEC investigation was critical of the evidence gathered by ABC's audit firm, John & Peter, in testing account payable and the supplier credits. The following is a description of some of the fictitious supplier credits and unrecorded amounts in account payable, as well as the audit procedure.

1. Banana Advertising Credits - ABC had arrangements with some vendors to share the cost of advertising the vendor's product. The arrangements were usually agreed to in advance by the vendor and supported by evidence of the placing of the advertisements. ABC created a 115-page list of approximately 1,100 vendors, supporting advertising credits of RM300,000. ABC's auditors selected a sample of 5 of the 1,100 items for direct confirmation. One item was confirmed by telephone, one traced to cash receipts, one to a vendor credit memo for part of the

amount and cash receipts differed from the amount on the list, but the auditors did not seek an explanation for the differences because the amount were not material. The rest of the credits were tested by selecting 20 items. Twelve of the items were supported by examining the

advertisements placed, and eight were supported by ABC debit memos charging the vendors for the promotional allowances.

REQUIRED

Identify deficiencies in the sufficiency and appropriateness of the evidence gathered in the audit of account payable of ABC Stores.

(Well organized thinking that reviews major factors affecting client business risk and acceptable risk for this audit.)