You are the manager responsible for the audit of Verdi, a long-established limited liability company. Verdi manufactures, distributes and installs heavy engineering machinery (eg turbines) for the oil and gas industry. The draft financial statements for the year ended 30 September 20X8 show revenue of $330 million (20X7 - $228 million), profit before taxation of $15.9 million (20X7 - $13.7 million) and total assets of $187 million (20X7 - $159 million).
The following issues arising during the final audit have been noted on a schedule of points for your attention.
(a) During the year technological advancement of the manufacturing process resulted in an increase in production capacity in three of the company's factory buildings. The remaining factory building became surplus to Verdi's production requirements. On 29 September 20X8, Verdi contracted to sell this building for $11.5 million. The building had last been revalued in September 20X5 and had a carrying amount of $9.2 million at the date of sale.
The gain on disposal has been credited to revenue and the balance of the revaluation surplus relating to the building, $3.7 million, has been credited against other operating charges in the statement of profit or loss and other comprehensive income.
(b) $7 million was lent to Verdi on July 20X7 for five years at 50%, to finance investment in manufacturing equipment. The loan became repayable on demand on 1 July 20X8 when Verdi failed to pay the annual interest charge for the first year. On 17 October 20X8 the lender agreed to 'roll over' the overdue interest by adding it to the principal amount due. The draft financial statements classify the loan as a non-current financial liability and the first year's interest charge is accrued in 'trade and other payables'.
(c) Verdi's scale of charges for installing machinery was increased by 40% with effect from 1 January 20X8.
This increase takes into account Verdi now giving a warranty to reinstall any item which fails to perform to specification, through an installation defect, for a period of up to three years. The notes to the financial statements disclose the following.
'The company guarantees all installations of equipment sold since 1 July 20X7. No provision has been recognised as the amount of the obligation cannot be measured with sufficient reliability.'
Installation fees for the year to 30 September 20X8 amounted to $5.2 million of which $1 million related to the three months to 31 December 20X7.
Required
In undertaking your review of the audit working papers and financial statements of Verdi for the year ended 30 September 20X8, for each of the above issues:
(i) Comment on the matters that you should consider
(ii) State the audit evidence that you should expect to find
The mark allocation is shown against each of the three issues. You should assume it is 11 December 20X8.