(b) You are the manager responsible for the audit of Awdry Co, a listed entity whose principal activity is the operation of a regional railway network. The audit for the year ended 28 February 20X9 is the first year your firm has audited Awdry Co. The draft financial statements recognise total assets of $58 million and profit before tax of $7·4 million. The detailed audit fieldwork has started and the audit supervisor has brought the following matters to your attention in relation to the testing of key accounting estimates:

(ii) Regulatory penalties
Awdry Co has been subject to a review by the national railways regulator following a complaint from a member of staff with safety concerns. The regulator identified breaches in safety regulations and issued a penalty notice on 30 September 20X8. Awdry Co has appealed against the initial penalty payable. Negotiations with the regulator are still ongoing and the amount payable has not yet been finalised. Awdry Co currently estimates that the total penalty payable as a result of the breach will be $1·3 million which it expects to repay in equal annual instalments over the next ten years with the first payment falling due on 1 March 20X9. The company’s draft statement of profit or loss for the current year recognises an expense of $1·3 million and the draft statement of financial position includes a liability for the same amount. (6 marks)

Required:
(i) Evaluate the client’s accounting treatments and the difficulties which you might encounter when auditing each of the accounting estimates described above; and

(ii) Design the audit procedures which should now be performed to gather sufficient and appropriate audit evidence.

Note: The split of the mark allocation is shown against each of the issues above