Friendly Furniture, Inc., a manufacturer of fine hardwood furniture, is a publicly held SEC-registered company with a December 31 year-end. During May, Friendly had a flood due to heavy rains at its major manufacturing facility that damaged about $525,000 of furniture. Friendly is insured for the property loss at replacement value and carries business interruption insurance for lost production. The company anticipates that the total insurance proceeds will exceed the carrying value of the destroyed furniture and the cost of repairing the facility will be in the range of $700,000 to $1.75 million. The company believes that the insurance carrier will advance approximately 50 percent of the expected proceeds sometime during July. The company has resumed its operations to about one-half of normal capacity and expects to operate at full capacity by September. The company does not expect to file a formal insurance claim until then because it expects that the entire cost of the business interruption will not be known until September. Friendly expects to receive the proceeds of the settlement from the insurance carrier during its fourth quarter.

The company is in the process of making a stock offering and will file a registration statement with the SEC at the end of July, in which it will present stub period financial statements covering the six-month period through June 30. Based on the minimum amount of the expected proceeds, Friendly would like to recognize a receivable for the insurance proceeds and to report a gain in its financial statements for the period ended June 30. The company would also like to allocate a portion of the expected proceeds to cost of products sold.

Required:

a. How much of the expected proceeds from insurance coverage, if any, should Friendly include in its June 30 financial statements? Justify your answer with relevant accounting pronouncements.

b. Assuming that Friendly records a receivable from the insurance company at June 30 for the proceeds, what type of audit evidence would the auditor gather to support the amount recorded?