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Catalogue

1. Description of Qantas Airway Limited .......................................................................................... 1

A. Nature of revenue sources ................................................................................................... 1

B. Conduct of operations, Product and services ................................................................ 1

C. Market conditions & Competitions .................................................................................... 2

D. Regulatory environment ....................................................................................................... 2

2. PEST analysis...................................................................................................................................... 3

A. Political factors ....................................................................................................................... 3

B. Economic factors ................................................................................................................... 3

C. Social factors ........................................................................................................................... 4

D. Technical factors .................................................................................................................... 4

3. Audit Risk ............................................................................................................................................. 5

1) Audit risk on aircraft and engines on financial report level ............................................ 5

2) Audit risk on revenue received in advance account ......................................................... 6

3) Audit risk on revenue account ................................................................................................ 7

4) Audit risk on fluctuation of foreign exchange rate ............................................................ 8

4. Impact of Grounding on audit planning ....................................................................................... 8

1) General impact ............................................................................................................................ 9

2) Customer recovery initiatives ................................................................................................. 9

3) Industrial Action........................................................................................................................ 10

Reference: .................................................................................................................................................... 1

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1. Description of Qantas Airway Limited

A. Nature of revenue sources

Source: Annual report for the financial year ended 30 June 2011 of The Qantas Group.

Passenger and freight revenue is measured at the fair value of the consideration

received, net of sales discount, passenger and freight interline/IATA commission and

Goods and Services Tax (Qantas Annual Report, 2011).

B. Conduct of operations, Product and services

Founded in the Queensland in 1920, Qantas has grown to be Australia's largest

domestic and international airline. The main business of Qantas Group’s is the

transportation of passengers using two complementary airlines, Qantas and Jetstar,

operating international, domestic and regional services. In addition to the core

business of transporting passengers and air freight, Qantas operates a number of

wholly owned subsidiaries as followings:

QantasLink operates over 2000 flights each week to 56 metropolitan, regional and

international destinations across Australia and to Papua New Guinea.

Qantas Catering Group Limited operates two catering businesses—Q Catering and

Snap Fresh. Q Catering has catering centres in six Australian ports. Snap fresh built in

Queensland to centralise meal production for airlines non-aviation markets.

Qantas Freight not only markets the freight capacity of all international Qantas,

Jetstar and Jetstar Asia aircraft but also operates its own ground handling facilities in

Sydney, Melbourne, Brisbane, Perth and Los Angeles.

Express Ground Handling provides comprehensive ground handling services to

Net passenger revenue

81%

Net freight revenue5%

Other14%

REVENUE AND OTHER INCOME

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Jetstar and several regional airlines.

Qantas Holidays, part of the Jetset Travelworld Group wholesale suite, is one of

Australia's leading travel wholesalers.

Jetstar is Australia's and Singapore's low fares airline for Australia and Asia-Pacific.

Jetstar's Australian operation is wholly owned by Qantas.

C. Market conditions & Competitions

The Qantas Group’s main business is the transportation of passengers using two

complementary airline brands—Qantas and Jetstar.

Qantas group retains a 65 per cent share of the Australian domestic market and

carries 18.7% of all passengers travelling in and out of Australia.

In the domestic market, Qantas is more focused on the business market, where there

is not any strong market competitor. However Qantas is trying to control the budget

airlines through the introduction of Jetstar, where Virgin Blue and Tiger Airways could

be seen as competitors.

In the international market, Qantas faces a number of competitors, such as Singapore

airline which is its major competitor, Emirates and other more up-market airlines.

D. Regulatory environment

The regulator of aviation safety and security in Australia is the Civil Aviation Safety

Authority (CASA).

The International Air Transport Association (IATA) Operational Safety Audit

Certification requires Qantas to be subject to frequent external audits and assessed

against stringent standards. In addition, comprehensive internal audit programs

underpin ongoing compliance and oversight of safety performance.

The Qantas risk management and internal control system aligns with the AS/NZS ISO

31000:2009 principles included in the Australian/New Zealand Standard on Risk

Management () and the Committee of Sponsoring Organisations of the Treadway

Commission (COSO) framework for evaluating internal controls.

Financial statements are prepared according to the Corporations Act 2001,

Accounting Standards and Interpretations, and other requirements of the law.

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2. PEST analysis

A. Political factors

1) Carbon tax

After long debating, carbon tax is adopted in an increasing amount of countries. From

January 2012, a carbon price which estimated to be 15% of the emissions generates

from services to and from the EU will be charged. Domestically, from July 2012, a

fixed carbon price of $23 per ton will be introduced by Australian government

(QANTAS Annual Review 2011). All these will be passed to passengers and have

negative effects to the aviation industry.

2) Passenger movement charge

Passenger movement charge was increased by $9, to $47, with effect from 1 July

2008, which increased the cost on international flight (Commonwealth of Australia

Explanatory Memoranda 2008)i.

B. Economic factors

1) The growth of Asia-Pacific

The Asia-Pacific is now the world’s fastest-growing region for air travel demand, which

comes from air cargo market and passengers, as the region's economies continue to

expand. Boeing has forecasted that air traffic in the region will grow by 6.7% per year

during the next 20 years, as a result of which the region's carriers will order planes

worth $1.5 trillion over the same period (BBC News, 2012)ii. The Qantas Group must

capitalise on the opportunities which Asia-Pacific presents as well as position strong

brands and portfolio strategy in this highly competitive market.

2) The escalation of fuel prices

Fuel is one of the most important inputs in aviation industry. However, the global fuel

price has been rising significantly during recent years. According to the Index Mundi

2012, the Brent Crude Oil price has increased from US$40 per barrel in late 2008 to

over US$120 per barrel by 2012iii. At current prices, jet fuel prices are close to the

tipping point for airline profitability and it is doubtful whether the market is sufficiently

resilient to absorb much more in the way of higher fares (Airline Leader, 2012)iv. Even

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fuel surcharges, fare increases and hedging are unlikely to fully offset this cost

increase.

3) The fluctuation of foreign exchange

Australian aviation industry heavily relies on import. Although the prices for factors

associated in airline service, including fuel, aircraft and spare parts, are extremely

high, the appreciation of Australian dollar over the past 5 years decreased costs in

aviation industry. Recent fluctuation of Australian dollar takes serious toll on airline

companies.

C. Social factors

1) Migration country

As an ocean surrounded migration country, a huge portion of Australians’ hometown

visit plans rely on international flights, which lead to a greater demand of international

flights than other countries. This demand is enlarging with the growing number of the

immigration population (Australian Bureau of Statistics 2011)v.

2) Increasing popularity of international business and tourism

A booming international business and tourism needs is forming under globalization

(Australian Bureau of Statistics 2012)vi. What accompanies with that is increasing

demand of international flights. Evidence can be found in the latest statistic of

Australian government (BITRE2012)vii.

D. Technical factors

1) Maturation of internet and mobile website

Internet plays an indispensable role in contemporary airline service. A well-designed

online booking and check-in system could provide inestimable value to customers. In

addition, a mobile website allows customers to create new bookings, change existing

bookings and check flight status more conveniently.

2) Faster and smarter airport facilities

More simplified and convenient facilities have been introduced to airports all around

the world, such as self-serve check-in facilities, permanent bag tags and automated

bag drop facilities. The availability of faster and smarter airport facilities can not only

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save time for customers, but also reduce costs for airline companies.

3. Audit Risk

1) Audit risk on aircraft and engines on financial report level

The net value of Aircraft and engines is approximately AUD10, 462 million which is

76.7% of the total Plant, property and equipment’s net value in 2011. The table below

briefly describes what we concern on these items.

Audit Risk Key Account Key Assertion

Misstatement of the value of

Aircraft and engines Total Aircraft and engines V+A

① Difficulty in physically inspect (related account Aircraft and Engines owned &

Aircraft and Engines finance leased)

Scattered locations may cause trouble for auditors to physically inspect the existence

of aircraft and engines as they may well exist in documents but actually have been

disposed.

② Diversity of aircraft would give rise to the risk of manipulation or misstatement.

(related account Accumulated Depreciation)

There are different types of aircrafts and engines in Qantas with different service life,

fair values and different methods for impairment testing. Although Qantas uses

straight line method to calculate depreciation for simplicity, there is still a big chance

for accountants to miscalculate the depreciation and the carrying amount of aircraft

and engines. For a single aircraft the amount might be immaterial, however, the

accumulation of miscalculation could give rise to materiality.

③ Complication for auditors to audit the maintenance costs. (related account

maintenance of aircraft and engines)

“Modifications that enhance the operating performance or extend the useful lives of

airframes or engines are capitalised and depreciated over the remaining estimated

useful life of the asset.” viiiThere is a significant risk of whether the capitalised

amounts judged by the expert reliable or not, as the auditors are 100% responsible for

relying on the independent expert’s work.

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2) Audit risk on revenue received in advance account

Qantas Frequent Flyer (hereafter referred to as “QFF”) is a leading coalition loyalty

program in Australia. Members of QFF could accumulate points with Qantas as well

as its partner airlines and spend them on flights or a range of other goods and

services. According to the Notes to the Financial Statements of Qantas Group,

“Revenue received for the issuance of points is deferred as a liability (revenue

received in advance) until the points are redeemed or the passenger is uplifted, in the

case of Qantas Group flight redemptions” (Qantas Annual Report, 2011).

Audit Risk Key Account Key Assertion

Risk on misstatement of the

obligation arising under the

Frequent Flyer program

Revenue Received in Advance Completeness

QFF contributes to most part of Revenue Received in Advance account of the Qantas

Group (a total amount of $1,858 million in both current and non-current revenue

received in advance in 2011). Failure to redeem the points from the passengers is a

business risk which may damage the reputation of the company.

The complexity of the QFF program may lead to the material misstatement of the

Revenue Received in Advance account. First of all, members can accumulate points

in many ways, as a result of which there would be a risk for the omission of the

transaction which has been authorized by the system and can earn new point.

Therefore, the omission will have a great impact on the amount of the revenue

received for the issuance of points and eventually affect the balance of the Revenue

Received in Advance account. Besides, the level of membership may range from

bronze to platinum which means that revenue received for the issuance of points

would be quite different between levels. Thus, there would be a risk that some

members might be omitted or temporarily understate their membership level at the

balance date when they level up their membership with QFF, which may eventually

lead to the understatement of Revenue Received in Advance account. Furthermore,

due to the complicated of the QFF program, it requires the auditors to understand the

process of the program, acquire professional knowledge of the IT system and the

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method of calculating revenue received in advance based on the accumulated points

which all increase the possibility of the failure to detect the misstatement of the

Revenue Received in Advance account.

In conclusion, as the Revenue Received in Advance is one of the primary liabilities of

Qantas’s Group, the QFF program should be audited carefully. Considering the risk

mentioned above, the key assertion should be completeness.

3) Audit risk on revenue account

The airline industry operates under the concept of delayed revenue. Typically, airlines

collect payments for airfare before they deliver the purchased services. The basic

principle that revenue should only be recognised when transportation is provided is

well established, reflecting the application of the accruals basis (Akers, 2011)ix.

Audit Risk Key Account Key Assertion

Revenue manipulation risk Net passenger revenue Occurrence

When Qantas receives payments for services that it has not yet delivered, it should

recognise its liability as unavailed passenger revenue (revenue received in advance)

for the amount of the payment, which means the company still owes its customers

services. Recording the same amount under both cash and unearned revenue

ensures that the company balances its assets and liabilities. As a consequence, it is

possible that the payment is received in previous accounting period but the revenue

cannot be recognised until the next period.

The company should not recognise revenue until the service is actually provided.

However, in order to window dress the revenue for the current period, the company

has an incentive to recognise the payment as revenue when it is received rather than

when the customer boards. Furthermore, cancellations are always a possibility with

the purchase of airline tickets and the company may need to refund customer

payments. If the company recognises revenue when receiving payments and does not

write off the revenue when the cancellations happen, the revenue account will be

overstated.

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4) Audit risk on fluctuation of foreign exchange rate

The fluctuation and the volatility in the currency exchange market have great influence

on Qantas Group because the purchase of fuel, aircraft and leasing costs are

primarily paid in US dollars. The company use derivative instrument such as forward

contracts to mitigate the risk of inaccurate payments and hedge the risk of future

exchange rate fluctuations. However, the recognition and measurements of hedging

instrument could be highly risk. Qantas have a significant decrease in other

comprehensive income from 101 million gains in 2010 to 33 million loss in 2011,

almost 53.82% of the statutory profit for the year 2011.

Audit Risk Key Account Key Assertion

Misstatement of Other

comprehensive income

Other comprehensive income Accuracy

When the company enters into purchase contracts, the hedging instruments are

initially measured at fair value at the same date, and are subsequently re-measured

as their fair value at each reporting date. Any gain or loss proportion of the hedge,

which initially deemed as being effective, will go to equity as other comprehensive

income rather than profit or loss. In the future, the amounts recognized in equity

relative to hedging instrument shall be transferred to profit or loss in the same period

as the cash flows on the hedged item occurx. These complicated procedures need

quite a high level of knowledge to implement. There will be a great chance that

company may fail to comply with the requirement, which will lead to the misstatement

of the other comprehensive income. As a result of the complicities, there is also a risk

for the omission of the hedging transaction, which has been authorized properly. Also,

there is a risk that the company may manipulate the profit through the fluctuation of

foreign exchange rate, which is not allowed by the accounting standard. Thus, by

considering the risk of failing to comply with the accounting standard, omission of the

transaction and the incentive to manipulate the profit, the key assertion should be

accuracy.

4. Impact of Grounding on audit planning

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1) General impact

A series of event happened in the second half of 2011 exposed a number of problems

of corporate governance, which lead to a higher business risk. Therefore, the reliance

of internal control should be adjusted; business risks should be reassessed; the

materiality of audit risk should be revaluated.

2) Customer recovery initiatives

Aviation industry is highly competitive and customers value a lot on punctuality of the

flight; therefore, failing to do so will result in loss of market share. Qantas act very

positively on customer relationship management upon this issue.

Respond 1

Anyone whose Australian flight was cancelled because of the grounding between

October 29 and October 31 is eligible for a return domestic flight (Qantas 2012)xi.This

response can recover Qantas’s reputation in some degree, thus decrease the

business risk. However, the account of provision and expense is very likely to be

undervalued. Those free tickets can be redeemed in flexible time (customer can take

the flights any time before 14 December2013) and flexible destination. Therefore, the

value of the provision account relies heavily on estimation. Since there are incentives

for Qantas to manipulate profit in crisis, this response brings audit risk.

Response 2

Up to a total value of AUD 350 per person per day may be reimbursed by Qantas to

customer with cancelled flights as a direct result of the grounding (Qantas

2011)xii.This response can also decrease the business risk of losing market share.

The materiality of the audit risk depends on whether Qantas’s insurance covers this

issue and the extent if it covers.

However, there are still a number of actions against Qantas, which may lead to a huge

amount of liability or contingent liability. The audit risk exists in the valuation and

allocation of liability and contingent liability. These can also raise high business risk,

such as going concern raised by shot of liquidity, and further damage of reputation.

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3) Industrial Action

As a union action the ultimate subject was nothing but employment issue. One of the

result is a large amount of employment contract was renewed with more benefit for

employees (Steve O'Neill 2012)xiii. Another is that Qantas cut 500 jobs to recover from

the action (Jessica Wright 2012)xiv.

First, the renewed contracts result in higher cost base and further enlarge the cost

difference between Qantas and industry average, where the former already has a

relative poor performance. This is a significant business risk because Qantas can

either decrease the profit margin or charge customer, both of which will lead to lower

profit.

Audit risk also exists associated with the renewed contracts. As a result of the

bringing in of more employee benefits, employee benefit cost (in profit & loss

statement) and long service leave (in balance sheet) may be undervalued.

The job cut have more effect than those contracts. Firstly, it can reduce cost to some

extent, but the compensation is huge and many of which have complex terms;

therefore, Compensation cost and Provisions for termination benefits may be

undervalued. Secondly, it is a shock on corporate culture, and has negative impact on

employee loyalty. Therefore, the long service live may be overvalued. Last but not

least, a high employee turnover undoubtedly will lead to higher cost and down grading

of the safety level of flight, as a result, the provision maybe undervalued as one of the

sequences. Actually, in half year report Qantas did adjust the estimation index: the

discount rate was adjusted higher resulting in a 9 million decrease in the total of

compensation and long service leave, which shows that they are trying to hide the

effect on Profit and Loss statement.

An aggressive operating style is also shown in the action of job cut, which implies

higher risk of profit manipulate.

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Reference:

i Commonwealth of Australia Explanatory Memoranda 2008, PASSENGER MOVEMENT CHARGE

AMENDMENT BILL 2008, viewed 8 April 2012,

http://www.austlii.edu.au/au/legis/cth/bill_em/pmcab2008341/memo_0.html

ii Boeing forecasts $1.5tn growth for Asia-Pacific market 2012, BBC News, viewed 17 April 2012,

http://www.bbc.co.uk/news/business-17008827

iii Crude Oil (petroleum); Dated Brent Monthly Price - US Dollars per Barrel, Index Mundi, viewed 17 April

2012, http://www.indexmundi.com/commodities/?commodity=crude-oil-brent&months=60

iv Rising fuel prices: the constant sorrow of the airline industry 2012, Airline leader, viewed 17 April 2012,

http://www.airlineleader.com/this-months-highlights/rising-fuel-prices-the-constant-sorrow-of-the-airline

-industry

v 3412.0 - Migration, Australia, 2009-10, Australian Bureau of Statistics, viewed 8 April 2012,

http://www.abs.gov.au/ausstats/abs@.nsf/Products/83C762F4BB0D22FECA2578B00011968B?opendocu

ment

vi 3401.0 - Overseas Arrivals and Departures, Australia, Feb 2012, Australian Bureau of Statistics, viewed 8

April 2012, http://www.abs.gov.au/ausstats/abs@.nsf/mf/3401.0/

vii International airline activity, The Bureau of Infrastructure, Transport and Regional Economics (BITRE),

viewed 8 April 2012,http://www.bitre.gov.au/statistics/aviation/international.aspx

viii Qantas annual report, Qantas, viewed 15 March 2012, http://www.qantas.com.au/

ix Akers, H 2011, What is delayed revenue, ehow, June 10, viewed 21 April 2012,

<http://www.ehow.com/info_8576519_delayed-revenue.html>

x Deegan, C 2009, Australian Financial Accounting, 6th edn, McGraw-Hill Irwin

xi Qantas free flight offer, Qantas, viewed 15 April 2012,

http://www.qantas.com.au/travel/airlines/fly-with-us/au/en

xii Form for expense claims arising from the grounding of Qantas Flights, Qantas, viewed 15 April 2012,

http://www.qantas.com.au/travel/airlines/refund-form-disruptions-flight-grounding/global/en

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xiii Steve O'Neill 2012, The gods must be crazy: chronology of and issues in the Qantas industrial dispute

2011, Parliament of Australia, 23 January, viewed 15 April 2012,

http://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/BN/

2011-2012/ChronQantas

xiv Jessica Wright 2012, “Jobs take centre stage after Qantas announces 500 to go”, National Times, 16

February, viewed 15 April

2012,http://www.nationaltimes.com.au/opinion/political-news/jobs-take-centre-stage-after-qantas-anno

unces-500-to-go-20120216-1taen.html