Question

SUBJECT: AUDIT & ASSURANCE

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

QUESTION: After discovering that Aussie Airlines 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.

Answer 1

As per the profit and loss statement the Airline is generating 18 million AUD from there sales.So it is a material item of profit and loss.We need to do the audit of revenue in this case.Revenue is derived primarily from the carriage of passengers, cargo, and mail. The objective of the revenue accounting system is to recognize revenue according to the principle:

Revenue is generally recognized when both of following conditions are met

(1) the earning process is complete or virtually complete, and

(2)an exchange has taken place

Since airline tickets are usually issued in advance of the scheduled transportation date, the ticket sales date seldom coincides with the revenue recognition date, also referred to as the service date. Therefore, the task for airline revenue accounting is two fold:
(1) to record unearned revenue when a ticket is sold and scheduled service is at a later date, and
(2) to recognize revenue when the carrier provides the transportation service and thereby completes the
earnings process.

Revenue recognition is a complex task within the airline industry.It involves the quantification for financial statement presentation of four major balances related to transportation revenues: earned revenue, unearned revenue, accounts receivable, and accounts payable.

This process is complicated by the many fare types available (firstclass,coach, economy, joint and various forms of discounts) and the possibility that one or more segments of a flight may be on another airline, requiring the total ticket fare to be prorated for each airline's share. The process is further complicated by the large volume
of tickets to be processed.

Airlines usually sell tickets in advance for full consideration.Soe tickets are not used for travel and cannot be exchanged or refunded.Certain flexible air tickets include a right to re schedule the ticket.An entity recognises a prepayment from a customer as a contract liablity and recognises revenue when the promised goods or service are transferred in the future.

Substantive audit procedures /Financial Assertion Related to Revenues:

The following are the key financial statements assertion related to revenues:

• Completeness: This assertion concern the completeness of recording in the financial statements. The incomplete record of revenues might be happen because of many difference reasons including entity’s process and procedure could not capture all the revenues, errors and sometime fraud.
• Cut off: cut off assertion concerning that revenues are recording in the different period that they are belonging to. This could cause the understated and overstate of revenues that being show in the income statement.
• Occurrence: Auditor should consider assess the whether the revenues recorded in the period were really occurred. There is a risks that revenues recorded might not occurred.
• Right and Obligation: Right and obligation is very importance and it is concerning about entity right and obligation over the goods that sold to customers. This is link to the risks and reward then auditors performing cut off testing.

  Common Risks Related to Revenues:

• Factitious sales amount at end of or during the year that recording in the financial statements to reach to certain amount that could let top management to get certain reward like bonus or incentive.
• Factitious of sales amount might also committed by sales team or sales manager to get bonus as well inventive like top management.
• Goods or services that sold are not collectable. These might be the poor customer’s creditability assessment that perform by sales managers or the poor internal control over sales process.
• Fraud over cash collection from selling of goods or services.

Audit Procedures:

• Review the sales occurrence: This is performing by obtaining the sales transactions that recorded in the financial statements during the period as well as sales report that link to the financial statements. Then perform an audit sampling to total population of those sales transactions to review against quotation, sales orders, invoices, contracts and goods delivery noted. Ensure that the sampling items are represent the total population, otherwise the conclusion might go wrong.
• Perform Sales Revenues Analysis could help auditor to identify the unusual event or transactions related to sales. For example, comparing the sales trend again the goods of goods sold or inventories. This analysis could help auditors to perform additional review if they found that the trend go in different direction. There are many different method to perform an analysis over the revenues that auditors could use such as seasonal sales revenues, trend analysis of revenues compare with related non-financial data.
• Review the sales price authorization. The fraud over this area is likely to happen. Of cause management is the one who handle to manage and make sure that fraud risk is protected and minimize. But, auditor should also review the control over this area. Focus on unauthorized sales, and unauthorized sales commission that link to performance inventive of sales team and sales manager.
• Review the collectability: Sales increase is good but collectability of those sales amount is importance. Account receivable analysis should be performed, and credit policy should be review. Review the written off amount of account receivable during the year and then assess its reasonableness.
• Review the sales recognition whether the recognition of sales during the period are respecting the IFRS 15 or not. It is importance to assess that the future economic related to sales will be inflow into the company and the sales amount is measurable.
• Review the completeness of revenues recording in the financial statements. Revenues might be understated if they are under recording.

We can see in the balance sheet PPE consists of around 13 m AUD i.e 67% of the total assets.

So we shoud do the audit of PPE as per .An air carrier's fixed assets generally consist of flight equipment,
ground property and equipment, and capital leases.rotable parts and assemblies and work-in-progress accounts used to accumulate costs to be capitalized are also classified as fixed assets.

Operating property and equipment include all items in use in air transportation services or in
services related to air transportation. In addition, property and equipment undergoing overhaul, modification or repair and property and equipment held for standby use (ready for immediate use as backup)
remain in the operating accounts.Ground property and equipment consist of land, buildings, leasehold
improvements (such as those made in passenger and cargo terminals) and equipment (including that used to service aircraft and traffic loads on airport ramps and in terminals, to prepare and service food,
to maintain flight and ground properties, and to conduct sales, training, and other office functions).

Capital leases recorded by an air carrier include leases that meet the requirements for capitalization.Both flight equipment and ground property and equipment may be acquired through capital leases.

The total cost recorded by the air carrier for property and equipment includes all expenditures applicable to its acquisition These include the manufacturer's sales price, no refundable sales tax, freight costs and costs of any additions, improvements and modifications.In addition, interest related to funds for major project expenditures
(such as progress payments on aircraft purchase contracts and many construction projects) generally are capitalized as part of the cost of the asset.

Airlines frequently negotiate purchase incentives with aircraft manufacturers whereby as an inducement to purchase a particular manufacturers aircraft the manufacturer will issue credits which can be used for the purchase of spare parts but may not be applied as part of the purchase price of aircraft. Examples of other incentives might
be guaranteed trade-in values and purchase credits for flight crewtraining equipment (flight simulators). For accounting purposes,though, the credit can be applied as a reduction of the purchase price of the aircraft or amortized over the life of the related aircraft.

A depreciation method may be applied to a single asset (unit depreciation) or to a group or pool of assets that are similar in nature (group depreciation). Under the unit method, the airline depreciates the cost of the individual items of property and equipment.Under the group method, the airline depreciates the aggregate cost of
a group of properties that are fairly homogeneous, despite differences in the service lives of individual items.
An air carrier can use unit or group depreciation methods on different groups of assets. Group depreciation is usually applied to groups of assets that are significant in number but have relatively small unit values, such as rotable parts and assemblies. In these cases, the ease of application is the basis of selection between
the two methods. Unit depreciation is generally used for other fixed assets, such as aircraft and engines, that have large unit costs and are comparatively few in number.The period over which an asset is depreciated (its expected
useful life) and its estimated residual value are determined on the basis of many factors. Aircraft are maintained in relatively the same condition throughout their service lives; therefore, property and equipment is replaced primarily because of market growth, technological developments, operating cost efficiency and revenue-generating
capability. Because such factors may affect each carrier in a different way, various air carriers often have different estimated useful lives for the same type of equipment. Residual values for the same type of equipment also vary among air carriers for the same reason.The determination of aircraft lives and residual values also varies according to each company's projections of when aircraft will be replaced, its ability to finance replacements, and such factors as length of flights, number of takeoffs and landings and similar factors affecting the cost of maintaining aircraft in flying condition.

We should check whether the impairent has been recorded carefully or not.

Substantive procedures:

Existence-Vouch a sample of aircraft and physically inspect by matching the same.

Valuation-Select a sample of aircraft and check the valuation by recalculation check depreciation by examining depreciation ethod ,salvage value and useful life.New aircraft check all appropiate costs included in value.

Completeness:Analysis of costs to determine if they represent correct number of planes.Reconcile plane costs to individual aircraft.

Rights and obligations;For a sample of planes -obligation proof i.e sale contract,lease contract.Type of lease contract to deterine the lease type whether operating or finance lease.

Common Risks Related to Revenues:

• The cost recorded is not properly done.
• The depreciation calculation not done properly
• The impairment loss has not been taken into account
• The Lease type classification is wrong or the recording is wrong.
• The depreciation is not done as per the pool of assets.
• They may be showing some fictitious planes which they are not having with them.
• They might be undercharging depreciation.