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Tampico Airways Case Solution

Solution Id Length Case Author Case Publisher
1210 1537 Words (5 Pages)
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Since Tampico Airways is a private limited company, the standards relevant to it will be the International Financial Reporting Standards (IFRS). Therefore, the audit will be conducted accordingly, based on the guidelines provided by IAASB.

Following questions are answered in this case study solution

  1. Overview

  2. Accounting Issues

  3. Conclusion

Case Analysis for Tampico Airways

1. Overview

Users

The primary user of this memo will be the owner of Tampico Airways. Other users will include the management, who will be making accounting corrections and evaluating the performance of their employees using the information provided.

Potential bias

This memo has been prepared by taking the potential bias of the management into account. In an attempt to window dress their performance, the management may have the tendency to adopt accounting practices or policies that do one or more of the following:

  • Overstate Income to avail bonuses or other incentives.

  • Overstate assets and / or understate liabilities in order to improve liquidity ratios. This can be done for reasons ranging from wanting to secure more loans to getting ration based incentives.

  • Understate costs in order to meet bank ratios, for example, interest rate coverage.

Risk assessment

Environment

  • Internal: Internal controls seem lax, especially considering the fact that accounting is being conducted by the same person who manages the day to day operations. Considering the fact that his pay depends on the same information that he prepares himself, this is a gaping hole in the control environment.

  • External: The airline industry is tightly regulated and mandates all airline companies to follow strict codes and guidelines. This keeps pressure, from the authorities, on the airlines to play by the rules.

We consider the company to be a going concern since we have not identified any problems that might impact the company’s operations to such an extent as to bring them to a halt.

Resources for this mandate

  • After a preliminary review, it seems that there will be no need to hire any technical experts. The problems identified are limited to accounting; therefore, the current team should be able to handle it.

  • Identification of problems and their correction should not take more than the regular stipulated time.

Conclusion on risk

  • Based on the preliminary analysis, the overall level of risk in the firm is medium.

2. Accounting Issues

ISSUE #1: Externally Financed Asset Purchase

Tampico Airline purchased two aircraft, worth $4 million, which were partially financed by a local bank.

Recognition

  • The partially financed purchase should be treated as two different transactions, in terms of accounting. The financing should be properly recorded as a liability and the purchase as an asset.

  • The loan from the bank should be treated as any other liability and accounting entries made to that effect. Similarly, the asset should be recorded wholly and accounting entries made in that effect. The two transactions should not be net off against each other.

Measurement

  • The assets (aircraft) should be entered wholly as worth $4 million. The partial finance should be recorded as a liability while the remaining payment deducted from cash and other equivalents.

Presentation and disclosure

  • $4 million should be debited in the Aircraft Asset account while the cash payment credited in the cash and equivalent account and bank financing credited in the bank loan account.

  • Conclusion: the entries should be made in the manner discussed. It is possible that the management might want to net the accounts off in the financial statements in order to improve their financial ratios.

ISSUE #2: Purchase Financed by Common Stock Issue

The company bought some equipment with an issue of common stock

Recognition

  • The common stock issue has to be accounted for using the appropriate market value, divided into the share capital and share premium accounts. Any asset bought against such an issue must be recorded regardless of the exchange of cash.

  • The equipment bought should be initially entered in the books at the value of the share issue, which would be 3,800 shares at market value. Any subsequent appraisal will be reflected in the books using gain or loss on the said appraisal in the income statement. The sellers carrying amount is of no significance.

Measurement

  1. The equipment should be initially valued at $76,000 (3,800 x $20). The appraisal values the equipment at $74,500, which comes down a loss on the appraisal of $1,500. The loss will go into the income statement for the period as loss from other operations.

Presentation and disclosure

  • Equity will be credited by $76,000 while the equipment asset account is debited by the same amount. The appraisal will cause a reduction in the value of the asset, thus credit equipment account by $1,500 and debit profit and loss accounts by the same amount.

  • Conclusion; no transfer of cash does not warrant not making accounting entries. Both equity and asset should be properly accounted for, and the subsequent appraisal dealt with separately. Not recording this entry is an error on the part of the accountant and would have resulted in the profits being overstated by $1,500.

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