Bainbridge

You are the auditor of Bainbridge, a regional-based limited liability company which manufactures top of the range kitchen units and accessories. The company is owned and run by the Bainbridge family who first set up the business in the 1950s. In recent years the company has experienced increasing success fuelled by the housing boom and the trend for home improvements. The draft financial statements for the year ended 30 June 20X5 show revenue of $20.2 million, profit before tax for the period of $1.6 million and total assets of $30 million. The following mtters remain outstanding and have been brought to your attention.

Inventories

Inventories of finished goods are included in the draft financial statements at a cost of $4.5 million. The majority of items are produced for inventories with the cost being calculated using a standard costing system. Standard costs are calculated for materials, labour, production overheads and other overheads.

The standards used have been kept the same as those applied last year and variance calculations have not been performed. Management have justified this by saying that costs have remained constant over the last two years and that historically variances have been negligible.

A small number of items in inventories have been made to customer specification. In respect of these management have included overheads relating to design.

Warehouse

On 1 July 20X4 Bainbridge entered into a ten-year lease for a warehouse. Under the terms of the lease the company have been given a one-year rent-free period after which the annual rental is $50,000 per year. At the end of the initial term Bainbridge has the option to extend the lease for a further two years at a notional rental.

Currently no charge has been included in the financial statements in respect of the lease on the basis that the rent-free period means that no charge has been incurred for the year. In future management intend to account for the lease as an operating lease.

Convertible debenture

On 1 July 20X4 Bainbridge issued a $5m debenture at par. The debenture carries interest at 4% and is redeemable on 1 July 20X9 at which date the holder has the option to convert the debenture to 3 million

$1 ordinary shares in Bainbridge.

Currently the only entries that have been made in relation to the debenture were to credit the net proceeds to a long-term liability account and to record the first payment of interest on 31 June 20X4

Required

For each of the above issues:

• Comment on the matters you should consider, and
• The evidence you should expect to find, in undertaking your review of the audit working papers and financial statements of Bainbridge.