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Nature of Qantas' business and the potential risks of financial mistatements

发布时间:2017-02-22
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Question 1

  1. Nature of the business ( ASA 315 Appendix 1 )

Queensland and Northern Territory Aerial Services Limited ( QANTAS ) , its main business is their two additional airline brands - Qantas and Jetstar, which operates the transportation of customers. It operates in an industry that susceptible to quality of customer satisfactions as a result in number of customers transport by air using their airline. For example, shareholders value maximization can be determined or fluctuated depending on the goods and services provided by the airline because it improves suppliers and customers relationship. The majority of losses held by Qantas during December 2012 to December 2013 are inherently more susceptible to an increase of competitors capacity such as Virgin Airline since 2009 (Qantas, 2014 ).

Why is it a risk? ( What is the potential misstatement ? )

Because of its business nature that consists high volatility and easily leads to market fluctuation, there is a high possibility that Qantas would manipulate its figure on the financial statement through revenue overstatement because it is the easiest way to get rid of poor financial condition of the company just by inflating its revenue fraudulently. One way to inflate its revenue is to recognize the sales while the shipping items were not ordered by customers. Another way is to recognize fictitious sales that would result changes in cost of goods sold. Record sales for produced item but haven’t shipped or partially shipped would also be a potential misstatement as it overstates the profit and understate the expenses. Moreover, there is also a possibility to bring forward a better profit into the current financial year and subsequently put the loss into the following financial period in order to make up a better view for the financial statement.

Evidence ( ASA 501 )

We could look through the documentation to identify whether sales till the end of the financial period were legitimate which often refers to as cut-off testing. We could also compare the invoices and purchase orders to determine if there is customers issued purchase order after the sale was recorded. This could be crucial because the purchase order could proof that the particular sale was recorded before the item was ordered. One of the important steps is to identify what would likely appear to be partial payments on accounts, which could result inflated invoice used to manipulate profits because customers would only pay what is legally owed, making it shown as if it only contains partial payments.

Method to check these assertions:

  •  Presentation & disclosure (occurrence, rights and obligations)
  • Analyze whether the company disclose its financial information appropriately by comparing it to the expectation of auditors that has been systematically derived from the macroeconomics, industry and company’s economy condition.
  •  Account balances (valuation and allocation)
  • Determine whether expenses are appropriately allocated to the correct accounts. Then, compare the balances to previous year and across industry data to investigate for any material inconsistency.
  1. Aging Fleet

Qantas brings forward theretirementof its fleet of old Boeing 767s and some of its older Boeing 747 jumbo jets to cut their operating costs, delays brand new aircraft orders and also reduces the fleet age ( Creedy, 2014 ). Those more modern planes are more fuel efficient than the older aircraft and that’s why the older ones are gradually being phased out by Qantas, although Boeing has sold a new passenger version of the 747, the 747-8, to a number of carriers (Creedy, 2014 ). The majority of the assets held by Qantas is eventually more prone to technical obsolescence. Therefore the amount of assets and liabilities are the key focuses on the balance related objective.

Why is it a risk? ( What is the potential misstatement ? )

Assets stored by Qantas could become obsolete due to higher technology becoming available at a massive increasing rate. For example, Boeing 747-200, 747-300 and the 767-200 which are the older aircraft should be replaced by Boeing 787, Airbus 330 and Airbus 380. The reason those old aircraft are being phased out is because the newer ones are expected to deliver at least 40% reduction of noise footprint and engine fan diameter increased from 110 inches to 116 inches ( Qantas, 2011 ). There is also a possibility of misappropriation of assets at the level of white collar jobs because they are the ones that have more power and controls within the company. Cash and cash equivalents such as vouchers and credit notes are commonly the assets been stolen. Therefore, it would directly make a massive impact on the cash flow statement of the company. This could easily results in window dressing to improve its financial statements’ liquidity and performance. The financial statement might consist of changes in asset depreciation, increase short-term borrowings or leaseback transaction at the end of the financial period which management embellishes and gains some benefit from it.

Evidence ( ASA 501 )

Qantas spent 50 million capitalization costs on overhauling and had fleet major maintenance. There would be an incentive overstated fixed assets to increase leverage and liquidity ratio due to a downgrade of Moody’s credit rating during early 2012.

  • Assertions for events and transactions (occurrence and accuracy)
  • Assume that the aircraft has an appropriate value which also stated in the balance sheet, therefore this could be done by sampling. We could also hire valuation experts to estimate and analyze the current market value of the aircraft.
  • Assertions for account balances (valuation and completeness)
  • We could determine whether it is appropriate by using this procedure and method. First, compare companies in similar industry (e.g Virgin Airline) with Qantas practices. Then, determine whether they had consulted with experts (analytical procedure) to measure the market value of the aircraft.
  1. Workers unions and industrial action

Qantas took an industrial action against its workers unions that caused them to lock-out for protesting and grounding of aircraft which affected at least 68,000 passengers globally during November 2011. Workers demanded for higher pay while Qantas refused to agree with them. The industrial made Qantas had a bad reputation and directly affected Qantas’s profitability during that financial year. Workers unions have limited Qantas’s ability to make decisions that are financially advantageous, such as outsourcing and slashing redundant jobs (Creedy & Hannan 2012).

Why is it a risk? ( What is the potential misstatement ? )

The industrial action taken by Qantas has not only relatively affects its management, but also directly affects its profitability. The reason may be its competitor such as Virgin Airline, pays a higher rate to its worker unions and there is an economic downturn during November 2011. These could easily result in corporate fraud due to financial pressure. In late 1940’s, criminologist Donald R. Cressey discovered that a majority of employees committed fraud to meet their financial obligations and due to management’s poor segregation of duties (Wells, 2001). This would lead Qantas to overstate in assets and revenue; understate in liabilities and expenses. Commission and bonus are where about inflating sales figure so compensation that based on Qantas revenue can be increased. By creating fictitious sales or early recording sales, worker unions can receive a higher pay. This is what called payroll fraud. Legal cost and provision might also arise from unions or customers legal action against Qantas.

Evidence ( ASA 501 )

The way to prevent payroll fraud is to examine payroll records thoroughly to verify the existence of the workers. Then, examine commissions and bonus paid as a percentage of revenue in order to look for unusual variations. Another way could be done by reviewing uncollectible accounts receivable to check if there are any sales that may have been fictitious and related to payroll scheme (Coenen, 2010).

Method to check for the assertions:

  • Presentation and disclosure (occurrence, right and obligations)

Test if method used to allocate the provision is correct and follow the accounting standard. Check if provision and legal cost has been correctly included in the financial statement.

  • Account balances (valuation and allocation)

Check if method used to calculate the provision for legal cost is appropriate (e.g. probability of legal course outcome x cost).

  1. Loss of market share

Qantas is losing its international premium passenger market share. Qantas basically used to have 35% of the market shares in 2003 and it fell down to just 18% in 2011 (Creedy, 2011; Newsport, 2011). One of the causes of this problem is the increasingly popular Singapore and Middle Eastern carriers such as Emirates and Etihad for premium Australian international flights (Creedy, 2011). They have cost advantage compared to Qantas. Changes in customers’ preference towards budget airlines are would affect Qantas market share. Qantas tried to jointly start with Malaysian Airlines a new premium carrier based in Asia (Creddy, 2012). This carrier will have cost advantage compared to Qantas which has to do most of its maintenance and administration in Australia. However, Malaysian Airlines did not continue from the negotiations. Qantas started discuss with Singapore on implementing a premium carrier there but it’s still at an early stage (AFP, 2012).

Why is it a risk? ( What is the potential misstatement ? )

There would be a possibility of overstating the assets and understating the liabilities in the balance sheet, as to make a positive image to the outsiders. This would also impact on the important ratios that involve assets such as assets turnover ratio, etc. This would result in financial statement fraud as failing to make write-off. There is a high possibility of fraud in the area of account receivables that auditors couldn’t likely to found out manipulations in these accounts. Moreover, fund managers would say that they weren’t aware of the account receivable should be written-off or it was overdue so much if they discovered there was fraud. The loss of market share would also possibly lead to reclassify cash flow from investing or financing activities to operating activities, which able to window-dress the cash flow statement from a negative to positive figure.

Evidence ( ASA 501 )

Compute a measure of window dressing for cash flow statement and balance sheet by comparing the quarterly average value to corresponding average of the beginning and the end of quarter levels. It can also be prevented from window dressing by requiring the fund manager to disclose all marketing materials which are the exact date that the client purchased the most material number of shares that presently constitutes the top heavy weighted shares in their portfolio and the exact date that the client sold the most material number of shares that presently constitutes the top heavy weighted that were sold in that particular quarter.

Method to check for the assertions:

  •  Account balances (valuation and allocation)

Analyze the items that are contained under equity accounts and test if appropriate according to the accounting standard. Compare the data with previous years regarding the recovery of equity and check if they are apportioned accordingly.

  •  Transaction and events (classification)

Test by sampling whether each item under equity accounts is appropriate. This does not need to be done if account balances check above indicates low risk.

Question 2

In Qantas business nature, I think that inherent risk is greater for some assertions and related types of transactions, disclosures and account balances than for others. For example, earning visibility for Qantas is typically poor and it is not easy to estimate long term value which would subject to significant estimation uncertainty. External environment that given rise to business risks could also affect inherent risk. For example, Qantas developments would result in some product become obsolete, such as aging fleets, which causing assets to be more prone to overstatement ( Creedy, 2014 ). Industrial action against worker unions would cause a lack of sufficient working capital to continue its operations and also a decline in industry with massive business failures (Creedy & Hannan, 2012). Loss of market share for Qantas would cause them to cease to continue as going concern (ASA 570).

Overall, I think that Qantas has an extensive inherent risk mainly because of its business nature that can be easily affected by competition and highly volatile.

Reference

http://www.abc.net.au/news/2014-02-27/qantas-profit-result-airline-posts-loss/5287188

http://www.ausbt.com.au/qantas-gets-a-second-slap-down-to-junk-status

http://www.theaustralian.com.au/business/aviation/qantas-speeds-up-fleet-overhaul/story-e6frg95x-1226836388538#

http://www.qantas.com.au/infodetail/about/investors/2013HYResults.pdf

http://www.businessinsider.com.au/in-detail-heres-why-alan-joyce-says-qantas-must-defend-its-65-market-share-2014-3

http://www.researchomatic.com/qantas-airways-149079.html

http://www.macrobusiness.com.au/2013/12/sp-downgrades-qantas/

http://www.accountingtools.com/inventory-audit-procedures

http://www.comlaw.gov.au/Details/F2013C00409

http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-00200.pdf

http://analysisreport.morningstar.com/stock/research?t=QAN&region=AUS&culture=en-US&productcode=MLE

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