Reference no: EM132755984

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 accounts payable and 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 accounts payable and the supplier credits.

The following is a description of some of the fictitious supplier credits and unrecorded amounts in accounts payable, as well as the audit procedures.

• Orange Credits-$130,000 in credits based on 35 credit memoranda from Orange, Inc., were purportedly for the return of overstocked goods from several ABC stores. A John & Peter staff auditor noted the size of the credit and that the credit memos were dated subsequent to year-end. He further noticed that a sentence on the credit memos from Orange had been obliterated by a felt-tip marker.

• When held to the light, the accountant could read that the marked-out sentence read, "Do not post until merchandise received." The staff auditor thereafter called Harold Orange, treasurer of Orange, Inc., and was informed that the $130,000 in goods had not been returned and the money was not owed to ABC by Orange. Marry advised Jack, the audit partner, that he had talked to Harold Orange, who claimed he had been misunderstood by the staff auditor. Marry told Jack not to have anyone call Ridolfi to verify the amount because of pending litigation between ABC and Orange, Inc.

Required

Problem 1: Identify deficiencies in the sufficiency and appropriateness of the evidence gathered in the audit of accounts payable of ABC Stores.