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)

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

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

Marmidan Mold Shop Inc. designs and builds molds for the automotive and aircraft industries. The account balances in the company’s general ledger on January 1, 2020 (first day of the new annual fiscal year) were as follows (all account balances are in their normal position):

Cash                                                                    $     3,700

Accounts receivable                                                   5,900

Supplies inventory                                                    29,300

Land                                                                        168,500  

Buildings                                                                 116,500

Accumulated depreciation, buildings                       37,500   

Equipment                                                                 58,500

Accumulated depreciation, equipment                     18,000

Accounts payable                                                      25,200

Income tax payable                                                   16,600

Interest payable                                                           4,200

Wages payable (due in 2020)                                    15,700                                         

9% Notes payable ($10,000 due June 30, 2021,

     balance due June 30, 2022)                                  61,500

Common shares                                                       151,500

Retained earnings, Dec. 31, 2019                              52,200        

Transactions during 2020:

1.The company provided sales services to customers, on credit, for $ 210,300. In addition, the company produced cash sales to customers of $ 62,300.

2.Accounts receivable from customers of $ 15,600 remains to be collected at December 31, 2020.

3.Inventory of $ 62,900 was purchased on credit and debited to the supplies inventory account.

4.Minor parts were purchased with cash for $ 7,400 and debited to the supplies inventory account.

5.Wages payable at the beginning of 2020 were paid early in 2020. In addition, wages were earned by employees and paid during 2020 in the amount of $ 112,000.

6.Income tax payable at the beginning of 2020 was paid early in 2020.

7.Payments of $ 73,000 were made to creditors for supplies previously purchased on credit.

8.One year’s interest at 9% was paid on the notes payable at July 1, 2020.

9. During 2020, Don Tallint, the principal shareholder, purchased a new car for his wife

    Debbie. The new car cost $ 45,000 and was paid for with cash from personal sources.

10.Property taxes were paid on the land and buildings in the amount of $ 17,000 with cash.

11.Dividends were declared and paid in cash in the amount of $ 7,200.

The information available for year-end adjusting entries:

12.•Supplies inventory was counted on December 31, 2020, and it was determined the supplies inventory still on hand at yearend was $ 31,900.

13. •Annual depreciation on the buildings is $ 6,000.

14•Annual deprecation on the equipment is $ 5,500

15•Additional wages of $4,000 were earned but are unpaid and unrecorded at December 31, 2020.

16•Interest for six months at 9% per year on the notes payable is unpaid and unrecorded at December 31, 2020.

17•Income taxes of $ 16,500 were unpaid and unrecorded at December 31, 2020.

Q:Prepare any necessary adjusting journal entries for items 11 to 17 above and record the adjusting journal entries in the T accounts while adding any new T accounts that you need as you complete this task.

Marmidan Mold Shop Inc. designs and builds molds for the automotive and aircraft industries. The account balances in the company’s general ledger on January 1, 2020 (first day of the new annual fiscal year) were as follows (all account balances are in their normal position):

Cash                                                                    $     3,700

Accounts receivable                                                   5,900

Supplies inventory                                                    29,300

Land                                                                        168,500  

Buildings                                                                 116,500

Accumulated depreciation, buildings                       37,500   

Equipment                                                                 58,500

Accumulated depreciation, equipment                     18,000

Accounts payable                                                      25,200

Income tax payable                                                   16,600

Interest payable                                                           4,200

Wages payable (due in 2020)                                    15,700                                         

9% Notes payable ($10,000 due June 30, 2021,

     balance due June 30, 2022)                                  61,500

Common shares                                                       151,500

Retained earnings, Dec. 31, 2019                              52,200         

Transactions during 2020:

1.The company provided sales services to customers, on credit, for $ 210,300. In addition, the company produced cash sales to customers of $ 62,300.

2.Accounts receivable from customers of $ 15,600 remains to be collected at December 31, 2020.

3.Inventory of $ 62,900 was purchased on credit and debited to the supplies inventory account.

4.Minor parts were purchased with cash for $ 7,400 and debited to the supplies inventory account.

5.Wages payable at the beginning of 2020 were paid early in 2020. In addition, wages were earned by employees and paid during 2020 in the amount of $ 112,000.

6.Income tax payable at the beginning of 2020 was paid early in 2020.

7.Payments of $ 73,000 were made to creditors for supplies previously purchased on credit.

8.One year’s interest at 9% was paid on the notes payable at July 1, 2020.

9. During 2020, Don Tallint, the principal shareholder, purchased a new car for his wife

    Debbie. The new car cost $ 45,000 and was paid for with cash from personal sources.

10.Property taxes were paid on the land and buildings in the amount of $ 17,000 with cash.

11.Dividends were declared and paid in caah in the amount of $ 7,200.

Information available for year end adjusting entries:

12.•Supplies inventory was counted on December 31, 2020 and it was determined the supplies inventory still on hand at yearend was $ 31,900.

13. •Annual depreciation on the buildings is $ 6,000.

14•Annual deprecation on the equipment is $ 5,500

15•Additional wages of $4,000 were earned but are unpaid and unrecorded at December 31, 2020.

16•Interest for six months at 9% per year on the notes payable is unpaid and unrecorded at December 31, 2020.

17•Income taxes of $ 16,500 were unpaid and unrecorded at December 31, 2020.

Required:

Prepare any necessary adjusting journal entries for items 11 to 17 above and record the adjusting journal entries in the T accounts while adding any new T accounts that you need as you complete this task.( Record your journal entries on the electronic worksheet )

Additional information from the accounting records:

1. Investment revenue includes Arduous Company’s $6 million share of the net income of Demur Company, an equity method investee.
2. Treasury bills were sold during 2021 at a gain of $2 million. Arduous Company classifies its investments in Treasury bills as cash equivalents.
3. Equipment originally costing $70 million that was one-half depreciated was rendered unusable by a flood. Most major components of the equipment were unharmed and were sold for $17 million.
4. Temporary differences between pretax accounting income and taxable income caused the deferred tax liability to increase by $3 million.
5. The preferred stock of Tory Corporation was purchased for $25 million as a long-term investment.
6. Land costing $46 million was acquired by issuing $23 million cash and a 15%, four-year, $23 million note payable to the seller.
7. The right to use a building was acquired with a 15-year lease agreement; present value of lease payments, $82 million. Annual lease payments of $7 million are paid at the beginning of each year starting January 1, 2021.
8. $60 million of bonds were retired at maturity.
9. In February, Arduous issued a 5% stock dividend (4 million shares). The market price of the $5 par value common stock was $7.50 per share at that time.
10. In April, 1 million shares of common stock were repurchased as treasury stock at a cost of $9 million.

Required:
Prepare the statement of cash flows for Arduous Company using the indirect method. (Amounts to be deducted should be indicated with a minus sign. Enter your answers in millions (i.e., 10,000,000 should be entered as 10).)

A study has been carried out to compare the United Way contributions made by university professors from four universities. A sample of 15 professors from each university is selected. The dollar amounts of their contributions are shown below.

1. Verify the required conditions of AOV.
2. Assuming that the conditions are satisfied, use SPSS to see whether there is any significant difference among the contributions from the four universities.A
3. i.    Determine the significantly different pairs using

1. Fisher’s LSD.
2. the SNK procedure.
3. Tukey’s HSD procedure.

ii.   Are there any differences in the three tests?

iii.  Consider a contrast {-1, -1, 3, -1}. What hypothesis is this contrast testing? Use SPSS to perform this test.

4. Transform the variables using logarithmic transformation.
5. Apply the AOV F test to the transformed variables.
6. Did transforming the data alter the conclusion that you arrived at in part (b), above?  And why do researchers sometimes transform their data via use of logarithms and similar mathematical operations?

Conflict Case

You are employed by a Fortune 500 company, based in Austin, working in their HR department. The company makes toys. Your specific role is to aid managers who are having difficulties. The CEO of the company has told one of the supervisors to come see you, because there is an issue with his department.

James comes to you because many of his employees have transferred out of the division or quit. When you ask James if anything has changed in his division to cause this, James tells you that he is not sure of the cause. If anything, he thinks his employees should be even more satisfied than before. James tells you that last month he decided to implement a new pay system for all his teams and also the team leaders. He decided that the workers in the teams would get 80% of their base pay from the year before, but would get a bonus for every 1000 toys they made beyond what they produced last year. By his calculations, if his division produces the same number of toys as last year, the bonuses will put the teams at 100% of their pay. If they produce fewer toys, they will make less money--but if they produce more, they will make more. In order to keep teams from competing against each other, the bonuses will be paid out according to how well the entire division does, not on how each individual team does. James decided to do this on a Monday and had it implemented on that Tuesday, with a memo sent out explaining the change.

So far as the team leaders are concerned, James decided to give them 80% of their pay but, instead of more money, the team leader bonuses would consist of company-paid trips to Europe. James thought that this was a great idea, as everyone likes to go on trips. Furthermore, the trips are actually worth more than the team leaders would be able to make if they were just being paid cash, even if the division suddenly became the top producer in the company. So they are worth more than the money they would get, but the system still saves the company money because the company owns a travel agency, meaning that they are able to get the trips at a huge discount. This new policy is the only change that James can think of that might have affected the teams in his division.

Both James and the CEO are looking to you for answers. And once again, the CEO wants a memo about the situation, and what you are going to do about it in the next two hours.*

*Note: As the CEO wants the information in 2 hours (although, obviously, you have until the assignment is due to turn in your memo), you are not expected to do any sort of advanced research. No citations are needed. Furthermore, as you are given no further information about the situation, your “plan” will be viewed in such a light.

You are to write a 1+ page, formal memo (the text needs to go onto the second page, even if it is a single word) addressing this situation. The memo should be single spaced, with a full space between paragraphs (like this document).

**There is no additional reading for this case.

Carla Vista Company manufactures equipment. Carla Vista’s products range from simple automated machinery to complex systems containing numerous components. Unit selling prices range from $235,000 to $1,620,000, and are quoted inclusive of installation. The installation process does not involve changes to the features of the equipment to perform to specifications. Carla Vista has the following arrangement with Winkerbean Inc.

Carla Vista delivers the equipment on June 1, 2020, and completes the installation of the equipment on September 30, 2020. Assume that the equipment and the installation are two distinct performance obligations that should be accounted for separately.

a) Prepare any journal entries for Carla Vista on May 2, June 1, and September 30, 2020.

Equity in Net Income and Noncontrolling Interest in Net Income

Palm Resorts acquired its 70 percent interest in Sun City on January 1, 2017, for $41,750,000. The fair value of the 30 percent noncontrolling interest at the date of acquisition was $14,750,000. Sun City’s date-of-acquisition reported net assets of $5,000,000 were carried at amounts approximating fair value, but it had unrecorded identifiable intangibles, capitalizable per ASC Topic 805, valued at $7,500,000. These intangibles are determined to have limited lives, amortized on a straight-line basis over five years. It is now December 31, 2020, and Sun City reports net income of $10,000,000.

Required

a. Calculate the amount of goodwill originally reported for this acquisition, and its allocation to the controlling and noncontrolling interests.

Enter answers in thousands (example, $41,750,000 equals $41,750 in thousands).

b. Calculate equity in net income and the noncontrolling interest in net income for 2020, assuming goodwill from this acquisition is impaired by $2,000,000 in 2020.

Enter answers in thousands (example, $3,000,000 equals $3,000 in thousands).

Use negative signs with answers that reduce net income amounts.

The Garvey Sign Company uses the allowance method in accounting for uncollectible accounts. Past experience indicates that 6% of accounts receivable will eventually be uncollectible. Selected account balances at December 31, 2019, and December 31, 2020, appear below:

Instructions:

(a) Record the following events in 2020. Omit explanations. 8pts

Aug. 10 - Determined that the account of Kurt West for $900 is uncollectible.

Sept. 12 - Determined that the account of Jill Lynch for $3,000 is uncollectible.

Oct. 10 - Received a check for $300 as payment on account from Kurt West, whose account had previously been written off as uncollectible.

(b) Prepare the adjusting journal entry to record the bad debt provision for the year ended December 31, 2020. SHOW CALCULATIONS.

(c) What is the balance of Allowance for Doubtful Accounts at December 31, 2020? SHOW CALCULATIONS.

Hedging Exposed Asset Position with Adjusting Entries

On November 3, 2020, Robin Franchises, a U.S. company, sold merchandise to a franchisee in the U.K., at a price of £8,000,000, payable in three months in pounds. To hedge its exposed asset position, on November 3, 2020, Robin entered a forward contract for delivery of £8,000,000 to the broker on February 3, 2021. On February 3, 2021, Robin received payment from the franchisee, and delivered the pounds to the broker to close the forward contract. Robin’s accounting year ends December 31. Exchange rates ($/£) are as follows:

a. Prepare the journal entries Robin Franchises made on November 3, 2020 and February 3, 2021, as well as the required end of year adjusting entry. (7 total entries)

b. Calculate the cash gain or loss realized by Robin Franchises by hedging compared with not hedging.