Auditing Assigment Qantas Case

The Company operates through three segments: regular public transport revenue, charter revenue and training revenue. This report contains Four major parts. In first part, it analyze business operation of REX by elaborate the sources of revenue, conduct of operation ,products and services, etc. And then we use PEST model to evaluate external environment influences that have been particularly important in the past of the company. Furthermore, this part explained that Four key audit risks which would impact on the financial report.

It includes Measurement risk of aircraft, Revenue manipulate risk, Derivative financial instruments risk, Employee benefit risk. At the end, it provides practical internal control respectively which could mitigate the risk. 1. 0 Business operation 1. 1 Nature of revenue sources Source: Annual report for the financial year ended 30 June 2011 Regional Express Holdings Limited Revenue from providing air passenger and freight services is recognized when the relevant flights are made. 1. 2 Conduct of operations Regional Express Holdings Limited was incorporated on 12 February 2002, and is listed on the ASX.

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It is the holding company of the following subsidiaries. Regional Express (Rex) is Australia’s largest independent regional airline. It services various regional routes. It is the sole provider in the majority of its routes which are too small to be profitably serviced by Qantas, Virgin Blue, or Jetstar. It holds the Air Operator’s Certificate to conduct the company’s airline and charter activities as well as the Certificate of Approval to undertake aircraft and aircraft component maintenance and overhaul. Air Link Pty Limited is an aircraft charter operation based in Dubbo, NSW.

Air Link focuses on providing the highest level of service through charter operations all over Australia with this level of service extending to the aircraft engineering and maintenance services within the company. Pel-Air Aviation is an aircraft charter operator specializing in the market segments such as defence and government related aviation support operations. The Australian Airline Pilot Academy was established to offer an intensive training program that enables students to graduate with a Commercial Pilots License. 1. 3. Products and services * Regional airline services Aircraft charter services for business and leisure * Ad-hoc Fly-in / Fly-out activity, Air Ambulance, Freight and Defence * Airline pilot training programs 1. 4. market conditions and competitions On time performance for the year ended June 2011 | Sectors| Departures On Time| Arrivals On Time| Cancellations| | Scheduled| Flown| No. | %| No. | %| No. | %| REX| 64 940| 64 677| 55 750| 86. 2| 52 588| 81. 3| 263| 0. 4| QantasLink| 101 259| 99 309 | 77 986| 78. 5| 74 311| 74. 8| 1 950| 1. 9| Regional airline services are services within regional areas of Australia and between regional centers and the capital cities.

The main regional airlines include: • Qantaslink – a trading name under which a group of Qantas owned subsidiary regional airlines operate being Airlink, Eastern Australia Airlines and Sunstate Airlines; • Rex – Australia’s largest independent regional airline, operating services to 27 regional destinations with hubs in Sydney, Melbourne and Adelaide REX holds monopoly positions on most of its routes. There is currently little incentive for competitors to set up, with most routes unable to service more than one provider profitably. Recent growth into Queensland is hard work with Qantas defending its monopoly vigorously.

There will be no easy gains at Qantas’ expense. 1. 5. Regulatory environment * The regulator of aviation safety and security in Australia is the Civil Aviation Safety Authority (CASA). CASA is working with the aviation industry to embed a safety management system culture in Australian aviation. * Rex continues to be an active participant in programs aimed at maximizing energy efficiency and reducing Greenhouse gas emissions in accordance with the Energy Efficient Opportunities Act 2006 (EEO) and the National Greenhouse Energy Reporting Act 2007 (NGER). REX generates financial statements which have been prepared in accordance with the Corporations Act 2001, Accounting Standards and Interpretations, and complies with other requirements of the law. Accounting Standards include Australian equivalents to International Financial Reporting Standards (‘A-IFRS’). Compliance with A-IFRS ensures that the financial statements and notes of the Group comply with International Financial Reporting Standards (‘IFRS’). 2. 0PEST analysis 2. 1 Political factors

The changing of political and legal environment significantly affects corporation’s operation and interest. Compare with global aviation industry, Australia’s political environment is relatively stable and associated with lower risk. By providing regional aviation, REX has been relatively protected from global political shocks. For many years, rigid air traffic control policies have been a bottleneck for the development of aviation industry. Australian aviation industry policy has been experienced great change after collapse of the Ansett group. A. Entry restriction

Australian government prescribes that there is no restriction on freedom of entry and exist to domestic trunk routes by domestic airlines. However, federal transportation are in forced. In the aftermath of the Ansett collapse, the federal government mitigate federal transportation restrictions. In the meantime, Central government of Australia allow some individual states implement some restrictions on the entry to intra-state routes(NSW, western Australia) to make sure that state financial position keep stable. Rex inherits a monopoly on some of its internal Western Australia routes from Ansett.

It can make sure Rex entry and exist state freely. B. Government eased price control policy and reduced taxation for airline industry. Base | Previous year| Now | Departure tax| $46| $38| Air passenger ticket levy| $10 per ticket| $5 per ticket| The changing of this policy make more Australian can afford to fly. C. environment policy Australia airline industry also restrict by environment protection policy. For example, Sydney airport has curfew restrictions covering times when aircraft can operate to minimize noise pollution. 2. 2 Economic factors A. Import dependence

Australia is an import country, so its airline industry also heavily depends on the import. All the factors associated with airline service are very expensive especially fuel, aircraft and spare parts. The appreciation of Australian dollar over the past 5 years decreased cost in aviation industry. But recent fluctuation of Australian dollar takes serious toll on company like REX, JET STAR. Because Australian needs to import aircrafts from USA. Company like Qantas can offset cost of fluctuation of exchange rate to an extent because some of its earnings are in foreign currency.

In contrast, the Rex revenue is completely on AUS dollar. Such fluctuation becomes a destabilizing factor in the way of company expansion. B. Economics of scale The airline industry is characteristic by low profit and high overhead which means that company needs to increase the selling volume to lower its average cost. Rex as the largest independent regional airline as provider holding monopoly position on most routes which is too small to be profitable served by Qantas. It can take advantage of economics of scale by increasing sales distribution channel. C.

Trade practice Act 1974 regulates the conducts of each enterprise which provide good economic environment to avoid malignant competitions. 2. 3 Social factors A. The changing of taste and fashion on tourism The aviation industry and the tourism industry are highly correlated with each other. Most of the service provided by Air Company is for the purpose of tour. Nowadays, Passengers undertake higher education and have tour experience at certain extent. So, they have personal requirements for the products. REX noticed this trend and work out most suitable routes through corporation with “DOGO”- travel.

B. Enhancement of group consciousness With the popular of civil aviation, customer’s awareness toward service has been through a dramatically increase. Consumer group activities occur frequently, focus on the airport strike and flight delay compensation. Along with the higher recognition about the air transport details,consumers become more and more conscious of their entitlements and rights. This situations force air company to think how to provide humanistic service and induct customer to understand the specialty of air service. C. Enhance the value of enterprise’s responsibility

The strike of Qantas had severe influence on whole industry which causes the decline of the corporate-satisfaction. REX should take the warning from Qantas. Guarantee the running smoothly by providing the assurance for employee. 2. 4Technical factors A. Maturation of internet The internet has brought significant changes to our lives in recent years. Every company build their own website to promote and publicize their products and services. The extensive application of electrical-ticket realizes the B2C direct selling which bases on the internet.

On line check-in, Paperless boarding card is the manifestation of Internet applications. B. Application of Sabre reservation system REX adopts sabre system in 2003 which span the entire operation of an airline, including market planning, customer sales and service. REX open the market quickly with the help of this system. Four parts of the system: C. REX recently has a project to upgrade its aircraft, replacing 10-34 seat saab aircraft with 10 updated. 3. 0 Audit risks 3. 1. Measurement risk of aircraft on financial report level.

Aircraft could be considered one of the most important accounts in REX’s statement of land property and equipment. The net value of Aircraft is approximately 112. 16 million which is almost 60. 39% of the total Plant, property and equipment’s net value in 2011(according to the relevant figure provided in PP25 in AR). If there are misstatements or manipulations in Aircraft, the impacts will probably significant for REX. Moreover, it relate with the valuation of depreciation and impairment closely, which would increase the risk of accuracy and give rise to an unfair valuation.

The table below briefly describes what we concern on this item. Audit Risk| Effect on auditing (Explanation of significance)| Key account| Assertion| Other related account| Measurement risk of aircraft| 1. Diversity of aircraft would give rise to the risk of manipulation or misstatement. 2. Complexity of identify 3. It is complicated for auditors doing auditing. | Aircraft| V&A:Whether the calculation is correct or not| 1. Accumulated depreciation & impairment2. Engineering & maintenance cost| The following is the further explanation of the Measurement risk of aircraft and its effect on audit. Diversity of aircraft would give rise to the risk of manipulation or misstatement. The assets appraisal of aircraft need take various aspects into consideration, such as the plane’s identification, design, fabrications and installation of accessories, etc. The diversity of the aircrafts in this company would relatively increase the workload of auditors and the inaccuracy of the stated result. Moreover, different type of aircraft in REX might have different service life and other elements which may influence the calculation among different aircrafts’ depreciation.

It could increase the opportunity of fabricating by manipulating Depreciation and impairment. ? Complexity of identifying whether it is the value of Assets or Impairment Expense If there is a situation such as entirely impair certain aircrafts with changing almost all of the important components of the aircraft, the impairment fee must be a large amount of spending for the company. Whereas, the problem is, it is might equivocating to identify whether it should be considered as purchasing a new aircraft or just an impairing behavior. It is complicated for auditors doing auditing. Auditors are required with high level of professional quality to comprehensively understand and calculate the depreciation and impairment as the complexity of asset’s depreciation and impairment test. It contained large amount of calculation and judgment for many documents and records. These would give rise to the increasing difficulty of auditing. 3. 2. Measurement the Revenue manipulated risk Audit Risk| Effect on auditing (Explanation of significance)| Key account| Assertion| Other related account| Revenue manipulate risk| 1.

Incentive to makeup the profit2. Requirement of the internal control| Revenue| Occurrence| | The following is the further explanation of the Measurement the Revenue manipulated risk. ?Incentive to makeup the profit. As revenue is a relatively straight part to show the performance in a financial year for a company, which is relevant with attracting public investment or the opportunity of obtaining bank loan, it is possible for relevant employees potential to manipulate or been told to manipulate the revenue result. Requirement of the internal control is needed to reduce the risk. Firstly, it is necessary to indicated that the passenger revenue is the largest part for the total revenue. Therefore, auditor could concentrate on checking or inspecting the passengers’ receipts or some original invoices, and then recalculate it by using certain professional formulas to check whether could correspond with the stated figures. 3. Audit risk on misstatement foreign exchange hedging at the financial report level (1) Items in the financial report and briefly describe of the audit risk The foreign exchange risk is the main financial risk for the company, and the annual exposure is around US 36 million (43. 78% of the purchase cost in 2011). The company uses derivative instrument to hedge the risk, the misstatement of which will have a significant impact on the control of the financial risk. The table below briefly describes our concern on this item.

Audit Risk| Explanation of audit risk(Effect on auditing)| Key account| Key Assertion| Related account| Misstatement of foreign exchange hedging| 1. Company’s omission of the transaction or failure to comply with the accounting standard or the incentive to manipulate the profit may lead to the material misstatement of the hedging transaction. 2. The auditor may fail to detect the misstatement of the transactions. | Cash flow hedge reserve| Completeness:Whether recording all the movement of fair value according to the accounting standard.

Whether omitting the transaction authorized by the management. | Net foreign exchange gain| (2) Further explanation of misstatement foreign exchange hedging and its effect on audit * Company’s error may lead to the material misstatement of the hedging transaction. As the value of the hedging is not recorded, there is a risk for the omission of the hedging transaction which has been authorized by the management. However, the hedging needs to be disclosed in the notes, so the omission will affect the quality of the disclosure.

According to the accounting standard, the unrealized profit or loss caused by the movement of fair value of the hedging instrument should be recorded in reserve in equity, but the company may fail to comply with this requirement and not record it, which will lead to the understatement of the reserve account. Besides, the company may recognize the unrealized profit as gain before the hedging expires or is sold in order to manipulate the profit which is not allowed by the accounting standard. And the measurement calculation of the account requires professional knowledge may also increase the probability of the misstatement. The auditor may fail to detect the misstatement of the transactions. The hedging transaction could be complicated and requires the auditors to understand the objectives of the derivative instrument, acquire professional knowledge of the derivatives and the method of calculating the profit and loss, inspecting related authorization document which all increase the probability of failure to detect the misstatement of the account. (3) Conclusion As the major financial risk is foreign exchange risk, the hedging transaction should be audited carefully.

And considering the risk of omission of the transaction or failure to comply with the accounting standard or the incentive to manipulate the profit, the key assertion should be completeness. 3. 4 Audit risk on salary and employee-related expense at the financial report level (1) Items in the financial report and briefly describe of the audit risk In 2011, the salary and employee-related expense is AUD85 million, account for 39% of the total cost and expense, and increase 10% comparing with 2010 which is a material part of the company’s cost and expense.

The table below briefly describes what we concern on this item. Audit Risk| Effect on auditing(Explanation of significance)| Key account| Assertion| Related account| Risk on salary and employee-related expense| 1. Company may incorrectly calculate the expense because of the unstable employment and the complex bonus plan, compensation scheme and superannuation plan. 2. The auditor may fail to detect the incorrect calculation of the transactions. | Salaries and employee-related expense| Accuracy:1. Whether the calculation is correct. 2.

Whether the calculation comply with the plan or scheme authorized by the management of the company. | N/A| (2) Further explanation of the foreign exchange risk and its effect on audit * Company may incorrectly calculate the salary and employee-related expense The calculation of the bonus, compensation and superannuation may be incorrect as failing to comply with the plan or scheme authorized by the management of the group. Besides, some calculation need professional skill such as superannuation may also lead to the incorrect calculation. The auditor may fail to detect the incorrect calculation of the transactions. The complexity of the expense calculation and the requirement of the profession knowledge increase the difficulty of the recalculation which increase the probability for failing to find the error. (3) Conclusion As the significant amount and the dramatic increase, the salary and employee-related expense should be audited carefully. And considering the risk of incorrect calculation or failure to comply with the relevant plan and scheme authorized by the management, the key assertion should be Accuracy. . 0 Internal control According to four risks discussed above, relevant internal control suggestions are offered as follow: Audit risk 1 | The measure of aircrafts risk | Internal Control Suggestion| * To determine the fair value of different aircrafts, relevant external information has some reference value. Accountants need to compare the costs of aircrafts, the method of depreciation, and the depreciation expense with that in competitors’ annual report to check whether there is a large deviation.

If yes, accountants should investigate reasons and submit an assessment report to CFO for review and approval. * Additionally, impairment test of aircrafts should be implemented every year to prevent huge decrease in value due to the fast progress of technology. It is usually executed by accountants with professional knowledge and experience or by Certified Public Value. Once the net realizable value of aircrafts falls below the carrying amount, relevant adjustments should be done in the financial statement. | Relevant Department| * Finance Department, * Administrative Department|

Audit Risk 2| Revenue manipulation risk | Internal Control Suggestion| * The revenue only can be recognized after REX providing services to passengers even though the money is already on hand. So the objective of internal control is to ensure that passengers have received services when the revenue is recorded. The following process can guarantee that the revenue is actually occurred, not faked. | Relevant Department| * Operation Department, Sales Department, * Finance Department| Audit Risk 3| Derivative financial instruments risk|

Internal Control Suggestion| * Internal auditors check whether all forward foreign exchange transactions have effective contracts with directors’ authorization and approval, and review whether the purpose of these contracts is to hedge business risk rather than speculate on the futures. * They also need to review whether all value in contracts has been compared with the fair value monthly in order to ensure all differences have been transferred from reserve to the profit or loss. | Relevant Department| * Internal Audit Department, Finance Department, * Board of Directors. |

Audit Risk 4| Employee benefit risk | Internal Control Suggestion| * To ensure the accuracy salaries and employee-related costs, directors should firstly make a regulation to guide how to calculate salaries and bonus. Then creating an IT system and inputting records (e. g. all employees’ name, their positions, salary rates) into the system by authorized staffs. Someone should double check these records to guarantee one position is consistent with the specified salary rate. When HR makes the payroll and the bonus list, they should strictly follow the regulation and calculate the amount through IT system.