Case Study - Aussie Airlines and the Global Pandemic

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 lastmost guesses range from two to twelve months, a small minority fear it will be worseand 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. Discuss the factors that would affect the preliminary assessment of inherent risk for the audit of Aussie Airlines. (5 marks).
2. Perform and document an analytical review comparing the AA financial statements for 2020 and 2019, using the financial information, context information and notes provided above. (15 marks)