Question

Case Study - Aussie Airlines and the Global Pandemic

Your Role

1. Your firm, DUA, has been the auditor of Aussie Airlines for the past three years.

2. You are the audit team manager and you are about to commence the risk assessment phase, as well as the risk response work plan for the audit of AA’s financial statements for the year ending 30th June 2020.

Context

1. Aussie Airlines (AA) is a large listed Australian airline and has been operating for more than fifty years.

2. In recent years, under pressure to improve profitability as fuel costs rose, the airline successfully undertook a comprehensive cost cutting and business efficiency drive, which returned it to profit three years ago. According to the CEO and Chairperson, Andrew Norris, “the operations of AA are now as lean as they could be; we have squeezed the fruit dry.”

3. In March 2020, the World Health Organisation declared a pandemic, people and governments have responded, and the volume of global business-related and leisure-related air travel has fallen by 95%.

4. It is not known how long the pandemic will last, how long restrictions on air travel will last—most guesses range from two to twelve months, a small minority fear it will be worse—and the Australian government has not yet announced how it’s economic response to the pandemic will specifically help the airline industry.

5. AA has ‘temporarily’ laid off 90% of its workforce, including cabin staff, pilots, and 95% of its airport ground crew. There are murmurs about a class action by employees if they do not receive adequate payments while they are laid off. Some fear the change may be permanent.

6. The company is not taking bookings from customers; the AA website says “for the foreseeable future”.

7. The CEO has told the press that while the current situation represents “an existential crisis”, he is absolutely confident that AA will get through it and come out stronger the other side.

8. The Chief Financial Officer, Clara Major, stopped you in the corridor to say hello and offered you these words: “Look, everything might seem dire but we have it in hand. We will be here this time next year, so keep that in mind.”

9. As expected, you have been offered access to any records and to people inside and outside the AA organisation that you feel will be necessary to complete your risk assessment and interim work.

10. You are also confident that AA’s internal controls remain very strong, although you do not know if or how they have been changed/enhanced to respond to the effects of the global pandemic on AA.

Forecast Financial Statements

On your second day at AA’s head office, you have been given the forecast financial statements for the full year to 30 June 2020, as well as the previous two years’ audited results.

Aussie Airlines: Consolidated Income Statement (Selected) Year Ended 30th June
Currency AUD Millions (figures are rounded)

			Forecast 2020	Actual 2019	Actual 2018
		Revenue	12.0	18.0	18.0
		Expenditure
		Wages	3.3	5.0	5.0
		Aircraft Costs	4.0	4.0	3.7
		Fuel	2.5	3.0	3.0
		Depreciation	1.6	1.4	1.4
		Other	2.5	3.1	3.4
		PBIT	(1.9)	1.5	1.5
		Finance Costs	(0.2)	(0.2)	(0.2)
		Income Tax	0.0	(0.4)	(0.4)
		Statutory Profit for the Year	(2.1)	0.9	0.9

Aussie Airlines: Consolidated Balance Sheet (Selected) As at 30th June
Currency AUD Millions (figures are rounded)

			Forecast 2020	Actual 2019	Actual 2018
		Current Assets
		Cash & Cash Equivalents	0.5	1.8	1.5
		Receivables	2.0	1.5	1.0
		Other	0.7	1.0	1.0
		Total Current Assets	3.2	4.3	3.5
		Non-Current Assets
		Property, Plant & Equipment	12.3	13.0	13.0
		Intangible Assets	0.7	2.0	2.1
		Other	1.0	0.0	0.1
		Total Non-Current Assets	14.0	15.1	15.2
		Total Assets	17.2	19.4	18.7
		Current Liabilities
		Payables	4.0	1.8	1.7
		Revenue Received in Advance	1.0	5.0	4.5
		Interest Bearing Liabilities	2.0	0.6	0.4
		Provisions	0.9	1.0	1.0
		Other
		Total Current Liabilities	7.9	8.6	7.6

		Non-Current Liabilities	Forecast 2020	Actual 2019	Actual 2018
		Revenue Received in Advance	0.2	1.5	1.5
		Interest Bearing Liabilities	6.5	4.6	4.3
		Provisions	0.4	0.4	0.4
		Deferred Tax Liabilities	0.8	0.8	0.9
		Other	0.1	0.1	0.0
		Total Non-Current Liabilities	8.0	7.4	7.1
		Total Liabilities	15.9	15.9	14.7
		Net Assets	1.3	3.5	4.0
		Equity
		Issued Capital	1.9	1.9	2.5
		Treasury Shares	(0.2)	(0.2)	(0.1)
		Reserves	0.2	0.2	0.5
		Retained Earnings	(0.5)	1.6	1.1
		Total Equity	1.3	3.5	4.0

Notes:

You have received additional information from AA’s Chief Financial Officer and from your initial review of AA Board minutes:

1. Not all 2020 forecast Income Statements line items and Balance Sheet balances have been finalised at this point, though they are best guesses.

2. Intangible Assets constitute goodwill relating to an international airline business AA acquired five years ago. This business mainly services South East Asia, China, and Polynesia destinations.

3. Property, Plant & Equipment consists primarily of aircraft, aircraft engines, and aircraft parts.

4. Revenue Received in Advance relates to customers’ prepaid flights.

5. Aircraft are leased from third parties. A reduction in monthly payments and a restructuring of the lease terms are under negotiation but, so far, nothing has been agreed with the aircraft makers/lessors.

6. AA is currently negotiating with its bank to receive a grace period for repayment of short term and long-term debt as the company is currently in breach of its debt covenants per the loan agreement. If no deal is reached, this debt becomes due and payable on August 31st 2020.

7. AA is seeking a financial bail-out package from the government of $7million to fund its ongoing operating costs for 12 months while its fleet of aircraft is grounded. The Federal government has made positive noises about the request but has not yet committed to support the request and has told AA that it will take at least two months to reach a decision.

8. Under the current conditions, the CFO’s papers to the AA Board estimate that cash coming in from operations will, on average, be $0.5million per month while unavoidable operating costs are estimated to be $0.8million per month.

9. AA has an unused line of credit of $2.5million provided by its banking syndicate. It can access this money to fund its cash requirements. Currently, there are no other sources of cash beyond this line of credit.

QUESTION

1. Assuming that you have completed the work in previous questions and determined that AA is a going concern, select one material account from AA’s Balance Sheet and one material account from the Income Statement and prepare a brief plan for auditing each account. Give particular attention to the following:

   1. An assessment of the audit risk for the account, given the information in this case study and your assumptions.

   2. The relevant/significant audit assertions for this account.

   3. Name two controls that you would expect management to implement for this account. How would you test these controls.

   4. Describe two substantive testing procedures that you would perform in relation to this account to address the relevant/significant assertions.

NOTE: please refer to previous questions asked and answer them first please

Answer 1

Balance Sheet

Interest bearing liabilities i.e. debt taken by the company is one of significant account cycle.

Audit Plan to cover borrowings/debt cycle will be as follows-:

(i) Audit approach to cover this account cycle will to go through each loan agreements.

(ii) Understand the covenants required to be met as per the loan agreement.

(iii) To obtain waiver letter in case of non-compliance with the loan agreement.

(iv) Payment from the bank statements needs to be traced as this is the uncertain time and management might be doing fraud.

(v) Obtain independent confirmation from the bankers of the company.

(vi) Value of mortgages given to the banker needs to be critically evaluated. As it will effect secured borrowings.

Audit Risk

Whether debt covenants met by the company is the audit risk for this accounting cycle. As chances are high that management will not be able to met all the covenants mentioned.

Assertion

Presentation and Disclosure is the assertion for this area as it will affect the classification.

Controls

(i) Authorization of debt covenant by appropriate individual. It will tested by going through the compliance statement prepared by the client.

(ii) Interest recomputation and computation of mortgage value to be approved by CFO. This computation needs to be re-performed by the audit team.

Substantive Procedures

(i) Obtain independent confirmation from the bankers of the company.

(ii) Evaluating loan agreements

Statement of profit and loss

Revenue is the significant accounting cycle for auditing

Audit Plan to cover revenue cycle will be as follows-:

(i) Audit approach to cover this account cycle will to go through entire sales register.

(ii) Vouch the selected samples

(iii) Rolling out independent confirmation to the debtors

(iv) Ascertain collectibility of the amount of revenue recognized

Audit Risk

Whether revenue recognized is per the accounting policy of the Company. As the company will try to manipulate the no. of revenue in the financials

Assertion

Existence is the assertion for this area as it will have fictitious revenue.

Controls

(i) Whether revenue approved by authorized individual

(ii) Proper reconciliation and inquires performed for debtors

Substantive Procedures

(i) Obtain independent confirmation from the debtors of the company.

(ii) Vouch the samples selected for revenue testing