Grogus Limited (GL) is a private company, incorpo¬ rated in 1997 under federal legislation. GL was audited for the first time for the year ended July 31, 2001, by a CA who issued a qualified audit opinion because GL did not record amortization. According to the CA's estimate, the amount not recorded last year was \($125,000\) or approximately 20 per¬ cent of last year's income. During the current year, the vice- president of finance approached the CA indicating that he wanted an unqualified opinion for the year ending July 31, 2002, as he anticipates that the company will become a pub¬ lic company in the near future.

The vice-president of finance has presented the CA with the following contentious accounting issues facing the com¬ pany:

1.GL has not in the past recorded amortization on its fixed assets. The president's feelings about this subject were noted in last year's report to the shareholders as follows: "Our capital assets are increasing, not decreasing in value. In my opinion, the recording of this fictitious expense (amortization) will make our financial state¬ ments misleading."

The Board of Directors, however, has agreed that amortization will be recorded this year in order to obtain an unqualified opinion. The computation of the amorti¬ zation expense would take into consideration residual value of the capital assets and a remaining asset life of 12 years, which the CA agrees is the maximum remaining life of the assets. According to the Board of Directors, residual values have been estimated after giving effect to expected increases of \($1,000,000\) in those values over the next 12 years.

2. During 2001, GL was sued by a customer who used one of GL's products to manufacture items that were returned by its customers due to failure of the GL com¬ ponent. The amount in dispute is \($250,000\). It is estimated that the legal fees will amount to \($50,000\).
Correspondence this year indicates that an out-of- court settlement for \($100,000\) would be acceptable to the customer. GL wants to accrue no more than \($74,000\) because GL officials feel that the customer will eventually accept this amount or less.
3. During the year, the company has incurred expenditures of \($400,000\) related to the development of a refinement on one of its existing products. The large majority of the costs were related to the design, construction, and testing of pre-production prototypes. The technical feasibility of the refinement has been clearly established and manage¬ ment is now optimistic that it will be a profitable product for the company.
Similar expenditures of \($200,000\) had been written off last year, as at that time it was management's opinion that they would not continue with the project. Manage¬ ment has reinstated the \($200,000\) of expenditures incurred last year by a credit to miscellaneous income and intends to write off the total development costs incurred of \($600,000\) over a period of five years.
4. In connection with the installation of a new computer system during the year, software costs of \($270,000\) were incurred and capitalized. GL is willing to amortize such costs over this year and the next five years to the end of the computer lease.
5. During the year, the company sold a building for a gain of \($200,000\) which has been included in miscellaneous income- The related income taxes of \($75,000\) were included in the provision for income taxes.
6. Last year GL^qpitalized \($60,000\) of interest on debt dur¬ ing the period ojyonstruction of one of its manufacturing buildings. Thef'\($60,000\) was expensed for income tax pur¬ poses, but no future income tax liability was recorded. GL is willing to amortize the capitalized sums over a period of 20 years, commencing in the current year.
7. In both this and the previous year, GL has received approximately 40 percent of its revenue from one cus¬ tomer. The loss of this customer would result in signifi¬ cant excess capacity for the company.
GL's net income for the current year was \($1,500,000\) prior to recording any adjustment(s) required to resolve the contentious accounting issues.
Required

a. Discuss the audit report considerations for each issue presented. Describe the alternative methods available for resolving each contentious issue.

b. Assume management has agreed with all your recom¬ mendations. Draft your auditor's report, omitting the scope paragraph.