Background Information

Newcastle Airlines Limited has been an audit client of Sydney Accountants since 2015.

You are an audit partner in Sydney Accountants involved in the planning of the 2019 audit of Newcastle Airlines.

The following circumstances relevant to the current financial year have come to your attention:

➢ The impact of fuel prices and intense competition in the airline industry.

➢ Along with new entrants like the budget airlines in the markets and an increased passenger capacity, airline companies have been lowering their airfares to capture more customers.

➢ Airlines will end up accepting very low prices while operating with very high costs.

➢ Take Emirates for instance. Emirates operates with a young fleet, meaning more fuel efficiency, lower maintenance costs, and the ability to fit more into each plane (which lowers the marginal costs of each passenger). Being based in Dubai means there are low taxes, no unions to battle with, and an abundance of cheap labour from nearby countries. Emirates’ competitive advantage is also in their reputation for excellence in service which Emirates can charge high prices for.

You reviewed Newcastle’s significant accounting policies and found that revenue and depreciation costs are material income statement accounts. Extract of the accounting policies for Revenue and Depreciation costs, together with additional relevant information, are included below:

Item 1: Revenue recognition policy

Passenger, freight, and tours and travel sales are credited to revenue received in advance and subsequently transferred to revenue in the income statement, when passengers or freight are uplifted or when tours and travel air tickets and land contentare utilised.

Your review of the prior year’s financial statements indicates revenue from passengers represents 80% of total revenue. Newcastle’s latest financial information shows a 6% fall in revenue from passengers and an 11% decrease in revenue from passengers in advance.

Item 2: Aircraft maintenance costs policy

The standard cost of major airframe and engine maintenance checks is capitalised and depreciated over the shorter of the scheduled usage period to the next major inspection or the remaining life of the aircraft.

Newcastle’s latest financial figures show the aircraft and engines at cost (including major maintenance costs) to be at a similar level as last year while depreciation costs have decreased by 5%.

You have read articles in the financial press which suggest an increased incidence of fraud due to the competitive environment, and that the majority of these frauds are committed by company directors and senior managers. In your study of corporate governance you realised that Newcastle Airline may be facing similar problems.

Required:

a) Explain why the revenue from passenger accounts in the income statement is at significant risk of fraudulent financial reporting by management.

b) Describe a relevant and practical internal control to address the fraud risk described in (a) above. Explain how the internal control will minimise the risk of fraud.

c) With reference to Item 1 and Item 2 in the Background Information, explain why each of the two income statement accounts Revenue and Depreciation costs may represent a significant risk of material misstatement

You will be presented with five transactions, and for each transaction, you will be asked to identify the appropriate accounting element and the change for each element. These transactions will be presented separately.

1.

For each of the descriptions below about The Company, identify the appropriate accounting element(s) and what direction they are moving. Note: There will be two questions for every description.

The Company paid $500 (a) in cash for (b) telephone services used the previous month.

a) Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

b)Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

2.

For each of the descriptions below about The Company, identify the appropriate accounting element(s) and what direction they are moving. Note: There will be two questions for every description.

One of the owners (a) received more stock for contributing (b) equipment worth $25,000 to The Company.

a) Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

b)Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

3.

For each of the descriptions below about The Company, identify the appropriate accounting element(s) and what direction they are moving. Note: There will be two questions for every description.

The Company (a) provided services to customers for $50,000 (b) in cash.

a) Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

b)Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

4.

For each of the descriptions below about The Company, identify the appropriate accounting element(s) and what direction they are moving. Note: There will be two questions for every description.

The Company (a) owes an attorney $1,000 for (b) legal services previously received.

a) Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

b)Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

5.

For each of the descriptions below about The Company, identify the appropriate accounting element(s) and what direction they are moving. Note: There will be two questions for every description.

The Company (a) purchased inventory costing $200,000, they will (b) pay their supplier next month.

a) Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

b)Accounting Element:(pick one) (Asset, Liability, Common stock, Revenue, Expense, Dividend)/ Direction of Movement:(pick one) ( Increasing, decreasing)

Converting Sales Revenue to Cash
Smith & Sons is converting its sales revenues to corresponding cash amounts using the direct method. Sales revenue on the income statement are $2,050,000.

Beginning and ending accounts receivable on the balance sheet are $116,000 and $68,000, respectively.

Calculate the amount of cash received from customers.

$Answer

Explain how each of the assumptions of perfect competition contributes to the fact that all decision makers in perfect competition are price takers.

If the assumptions of perfect competition are not likely to be met in the real world, how can the model be of any use?

Explain the difference between marginal revenue, average revenue, and price in perfect competition.

Which of the following would be an example of automatic fiscal stabilization? Select one: a. A decrease in income due to a decrease in government expenditure b. A decrease in tax revenue due to a lower tax rate c. A decrease in income due to an increase in the tax rate d. An increase in tax revenue due to an increase in investment

1. Perfect competition vs. monopoly:

a) What is the difference between the demand curve faced by a perfectly competitive firm and a perfectly competitive industry and a monopolist firm?

b) What is the difference between the total revenue curve faced by a perfectly competitive firm and a monopolist firm? How about the marginal revenue curve?

The federal government currently taxes the increase in the value of share of stock when they are sold. This is called the capital gains tax. Explain why, if the government reduced the tax rate on capital gains, it could actually receive more total revenue. In your answer, carefully distinguish between tax rates and tax revenue.

You are the manager of a shoe producer. Your company specializes in basketball shoes and a cleaning product for basketball shoes. While the shoes bring in more revenue ($500,000 per year), the cleaning product is a strong seller as well ($150,000 of revenue per year). You are considering a 2% decrease in the price of your company's basketball shoes. Assume that the shoes have an own price elasticity of demand of -1.8 and the shoes and cleaning product have a cross-price elasticity of demand of -1.4. How much do you estimate your company's total revenue to change if you go forward with the proposed 2% shoe price decrease?