Posted: February 10th, 2015

Audit Project

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Auditing Project Fall 2014

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Auditing Project Due December 2nd

Carter & McLean, a Halifax accounting firm, has just taken on the audit of EastJet, a small

airline providing private charter service that began operations in 2005. The airline is owned by

Dave Wilson and Ron Joyce. The previous auditor has resigned because of poor health. You are

an audit senior with Carter & McLean and have been asked to work on the audit.

EastJet uses rented facilities at Halifax International airport. It has purchased three of its

airplanes and is leasing six other planes. It employs six pilots full time and has a database of

pilots that can be called if additional flights are required at any given time.

EastJet has done well since it began operations but Carter and McLean are concerned about the

profit for the first six months of this year. In addition, two of EastJet’s planes have been

grounded because of faulty electrical connections. The warranty has expired on these planes.

You held an audit planning meeting with Dave Wilson, Ron Joyce and Bill Carter, the partner.

You were provided with the interim financial statements for the first six months of the current

year along with the prior year audited statements (Appendix 1). Your notes for the meeting are in

Appendix 2.

A junior accountant from your office has done work on the accounts receivables and property

plant and equipment. The work done is documented in Appendix 3.

Required:

1. Perform the planning analytical review for the financial statements of EastJet, analyzing

the key movements. Include supporting calculations. (10 marks)

2. Using the audit notes that you took, identify the audit risks and explain how each audit

risk could result in a material misstatement in the financial statements. Design the audit

approach for each significant audit risk identified. Present your answer in a table with

column one identifying the risk and column two explaining the risk. (20 marks)

3. Calculate planning materiality for the 2014 fiscal year-end audit. Provide both

quantitative and qualitative analysis supporting your figure for preliminary materiality. (5

marks)

4. Evaluate the audit work done by the audit junior on the accounts receivable and property

plant and equipment and outline additional procedures that should be performed by the

audit team on future work in this area.(20 marks)Auditing Project Fall 2014

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5. Prepare the property, plant and equipment (PPE) audit program that will be used by

Carter & McLean accounting for the December 31, 2014, fiscal year-end audit of EastJet.

(20 Marks)

6. Discuss the importance of documentation in the audit file and identify which parts of the

audit file require documentation.(10 marks)

7. Assume the 2014 fiscal year-end audit of EastJet is completed and that Carter and

McLean Accounting has determined that the financial statements of EastJet are presented

fairly, in all material respects, except for the area of capital leases. Capital leases are

material. Your audit work indicated the two capital leases should be accounted for as

capital leases; however, EastJet did not want to do this. The amount is material but not

pervasive to the financial statements. Draft the expected audit report that will be issued

by Carter and Mclean Accounting for this engagement. Assume that the financial

statements of EastJet are prepared under one of the two general purpose accounting

frameworks used in Canada.(15 marks)Auditing Project Fall 2014

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Appendix 1: Extracts from management financial statements

Income statement Extracts

Notes Six months ended

June 30, 2014

Year ended December

31, 2013

Revenue 1 549,330 856,852

Operating Expenses 2 489,403 762,722

Other income and expense 3 (4,113) (8,872)

Income before tax 55,814 85,258

Notes:

1. Revenue is evenly spread throughout the year.
2. Operating expenses include repairs and maintenance expense of property, plant and

equipment of 205,250 for the six months ended June 30, 2014 and 239,250 for the year

ended December 31, 2013.

3. The amount for the six months ended June 30, 2014 includes a loss on disposition of

equipment. Proceeds on sale of equipment was $30,000.Auditing Project Fall 2014

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Balance Sheet Extracts

Notes As at June 30, 2014 As at December 31, 2013

Assets

Current Assets

Cash and cash equivalents 157,075 352,049

Accounts Receivables 33,316 25,450

Inventory 9,180 8,898

Non-current assets

Property, plant and equipment 1 621,934 491,400

Goodwill 2 12,702 12,702

Total Assets 1,035,866 936,654

Liabilities and shareholders’

equity

Current liabilities

Accounts Payable 135,792 115,000

Advance ticket sales 3 137,755 115,236

Non-current liabilities

Long-term debt 172,300 143,535

Maintenance provision 4 35,600 36,414

Total Liabilities 638,406 568,576

Shareholders’ equity

Share capital 17,500 17,500

Retained earnings 5 229,198 198,324

Total liabilities and shareholders’

equity

1,035,866 936,654Auditing Project Fall 2014

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Notes to Financial Statements

1. Property, plant and equipment

Six months ended June

30, 2014

Year ended December

31, 2013

Cost

Opening 810,909 815,908

Additions 205,000 173,482

Disposals 39,817 178,481

Closing 976,092 810,909

Accumulated Depreciation

Opening 319,509 259,674

Depreciation expenses 74,466 134,835

Disposals 39,817 75,000

Closing 354,158 319,509

Net Book Value 621,934 491,400

2. Intangible asset – goodwill

Goodwill is stated at a cost of $12,702, and no impairment has been made to date.

3. Advance ticket sales relate to flights that have been booked for future dates.
4. Maintenance provision represents amounts accrued for leased planes that have been

returned at the end of the lease. The planes must be in a specific condition or the

company is charged the costs to bring the plane to the required condition.

5. Dividends paid during the six months to June 30, 2014 amounted to $37,053.Auditing Project Fall 2014

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Appendix 2: Notes from meeting

Dave Wilson and Ron Joyce explained that EastJet operates in a very competitive environment.

The economic downturn has resulted in fewer charter flights and airlines have been offering

reduced rates to remain competitive. EastJet has been paying strict attention to cost controls and

have introduced a bonus for management that is based on the company’s profitability.

Recently two of EastJet’s major customers have gone into bankruptcy. There is $55,000 in

advanced ticket sales related to these customers.

EastJet held a manager’s retreat last month to think of ways to boost the business. The company

intends on offering an exclusive business class service for business customers such that they can

fly to and from a major city in the same day. This service will begin in the new year. EastJet is

optimistic that there will be an 80% uptake of seats on these flights that will be offered from

Monday through Friday.

One of EastJet’s planes was damaged as a result of a fire in the cockpit. Although the plane was

insured the insurance company is disputing the claim because the company did not meet safety

standards that were required in the industry. The cost of the damage is estimated at $140,000.

Because EastJet is anticipating additional flights in the new year, it will need to lease or purchase

additional planes. EastJet has begun discussions with a leasing company in regards to leasing the

planes. They expect the leasing agreements to be in place by year end.Auditing Project Fall 2014

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Appendix 3: Notes regarding the accounts receivable and property, plant and equipment

work performed by the junior auditor.

Accounts Receivables / Unearned Revenue

When clients book charter flights, the flight is prepaid and the amounts are recorded in unearned

revenue. Once the service has been provided (the client takes the flight) the unearned revenue

related to the flight is transferred to revenue.

Large well established clients do not have to prepay and are invoiced for the amounts of the

flights. These represent the accounts receivable amounts on the balance sheet. The prior year

audit file indicates there were issues with accounts receivables in prior years – Eastjet had

accounted for unearned revenue as accounts receivable.

The junior accountant performed analytical review on the accounts receivable noting that

percentage of accounts receivable as a percentage of total assets was consistent with the prior

year. There were several credit balances in accounts receivable which the junior ignored. No

confirmations of accounts receivable were performed. The junior auditor concluded the accounts

receivable were fairly stated for the interim period.

Property Plant and Equipment

Property plant and equipment represents the largest item on the balance sheet and represents the

planes that East-jet owns as well as leased planes. They are separated in the general ledger

accounts. The junior auditor traced each item on the subsidiary ledger to the original invoice,

added the subsidiary ledger and agreed the total to the general ledger. Then the junior auditor

signed the working paper concluding that property plant and equipment was fairly stated for the

interim period.