You are the independent auditor engaged to audit Millay Ltd.'s December 31, 2019, financial statements. Millay manufactures household appliances. During the course of your audit, you discovered the following situations.
1. Millay began production of a new dishwasher in June 2019 and, by December 31, 2019, sold 120,000 to various retailers for £500 each. Each dishwasher is under a one-year warranty. The company estimates that its warranty expense per dishwasher will amount to £25. At year-end, the company had already paid out £1,000,000 in warranty expenses. Millay's income statement shows warranty expenses of £1,000,000 for 2019.
2. In response to your attorney's letter, Morgan Chye, Esq., has informed you that Millay has been cited for dumping toxic waste into the Loden River. Clean-up costs and fines amount to £2,750,000. Although the case is still being contested, Chye is certain that Millay will most probably have to pay the fine and clean-up costs. No disclosure of this situation was found in the financial statements.
3. Millay is the defendant in a patent infringement lawsuit by Megan Drabek over Millay's use of a hydraulic compressor in several of its products. Chye claims that, if the suit goes against Millay, the loss may be as much as £5,000,000. However, Chye believes the loss of this suit to be only possible. Again, no mention of this suit is made in the financial statements.
As presented, these situations are not reported in accordance with IFRS, which may create problems in issuing a favorable audit report. You feel the need to note these problems in the work papers.
Instructions
Heading each page with the name of the company, statement of financial position date, and a brief description of the problem, write a brief narrative for each of the above issues in the form of a memorandum to be incorporated in the audit work papers. Explain what led to the discovery of each problem, what the problem really is, and what you advised your client to do (along with any appropriate journal entries) in order to bring these situations in accordance with IFRS.