Virgin America Inc. Audit Planning Memo

VIRGIN AMERICA INC.

Audit Planning Memorandum

December 31, 2015

To: Virgin America

Date: 02/01/2016

Subject: Virgin America Inc. Audit Planning Memo ________________________________________________________________________

ENGAGEMENT OBJECTIVES

We are issuing this audit memorandum to set out our proposed strategy for auditing Virgin America Inc. (the Company) for the year ended December 31, 2015. Our review focuses on understanding the Company’s business environment, strategy and operation. We will list relevant financial statement assertions to be investigated in the upcoming audit, by effectively identifying risks that potentially impact the Company’s financial statements’ capability of reflecting economic reality and the Company’s ability to continue as a going concern. Our work is gathering sufficient, appropriate evidence to identify the important external forces that could impact the Company’s operation, and to perform analytical procedures based on research, lastly, to document the risk of material misstatement and our planning to address the risks.  

UNDERSTANDING THE BUSINESS

The Company is a US-based airline company, which primarily targets the “creative class” (young, urban, professional and new technology users). The target customers are mainly 25 to 40 years old, living in urban areas, and constantly traveling for work and business. The Company sets its operations in Silicon Valley, San Francisco Bay, where is well-known for its technological innovations. This allows the Company to gain access to sufficient information and technological support. In addition, given the fact that Silicon Valley is a site of technology-focused institutions, the location provides the Company a great deal of potential customers, especially business travelers. The Company is strategized for good in-flight entertainment offering with all aircraft Wi-Fi equipped, with the support of innovative low cost carrier, for the comfort and conveniences of travellers.

We note that on March 23, 2016, the founder of Virgin Group Richard Branson discussed the potential sale to Alaska Airline. We believe and understand the Company’s decision and business strategy, and the potential merger will create a stronger and more competitive airline, as well as offering even more destinations and flights in the market. We, as auditors, also concern about the potential reporting risk. We will audit if the company has “window dressing” in their financial statement to try to increase the stock price.

RISK ANALYSIS

Business Strategy & Industry (Business Risk)

-Foreign Currency:

Although the Company operates primarily in the focus cities of Los Angeles and San Francisco, with a smaller presence at Dallas Love Field, it orders their planes from Airbus, aerospace company from France, rather than Boeing from US. Such transactions involve foreign currency could make it difficult to value and match with the timing of currency fluctuation, thus, giving the Company a huge task of managing revenues, assets, liabilities, capital, investment in different currencies.

 -Union Strike: Airline industry has a high risk of union strikes. It is difficult for a company to find substitutes during a short period time, as there are regulations that a company cannot replace workers on strike. Temporary workers are often expensive and in such context that not only requires professional knowledge and skills, but also experiences, it is less preferred to hire temporary workers for the safety of passengers. Last November, workers, coming from Jetblue, Delta, and United Airline, were striking for a new contract, which included more medical benefits and higher wages. Such strikes made hundreds of flight delay and thousands of customers unsatisfied. As auditors, we have a responsibility to remind our client to negotiate and come to an agreement with the union. A big union strike has profound negative impacts, for example, losing customers and the potential markets, and most importantly, safety. The Company also faces the problem to pay compensation to customers with the risk of litigation.

Customers (Business Risk)

-Word of mouth: Social media has become a powerful tool if used properly. However, one complaint by any user on the social media, such as Twitter, may become a heated topic and affect the Company’s image negatively, especially for those potential new customers. If customers are unsatisfied with our service, it may turn out to be a public relation crisis, which is not limited to loss of revenue, damage of the Company’s reputation and even boycott. Therefore, the quality of customer service is way more emphasized than before. We need to make sure our client has an entire set of plans in response to such reputation crisis.

-Price disadvantage: As the Company’s strategy is to provide in-flight entertainment and comfortability to its customers, it has a price disadvantage when compared with other low-cost carriers, or LCCs. Since many LCCs charge ancillary fees for basic services that the Company provides free of charge and do not have premium-class services or low-density seating configurations, we are unable to set our fares as low as they do. This disadvantage makes it challenging for the Company to attract and retain customers who care less about comfortability and entertainment. The Company should differentiate itself by improving its customer service and in-flight entertainment.

Suppliers (Reporting Risk and Compliance Risk)

-Oil price: We noticed that the Company had a significant jump in earnings due to a sharp drop in fuel costs. For the last quarter the airline expected capacity to climb by 9.5% to 10.5%. We believe that the falling oil price is a short-term blessing for airlines, but then it comes with hidden risks for airlines. In order to get a higher market share, some airline companies lower their ticket price to attract more customers. However, lower fares will not increase adequate demand to eliminate the overcapacity.^[1] Also, capacity increases are more likely to be excessive, if cheaper fuel prompts all the industry’s leaders to invest in an expanding market, based on the expectation of gaining market share. The likely result is a profit-destroying competition. Over the decades, airlines around the world have often expanded too much in the good times. Cheaper oil offers an opportunity to repeat this mistake. Investors need to be on guard.

In addition, due to the unpredictability of oil prices, oil suppliers may want to store a huge amount of oil, waiting for the price to go up so that they can gain more profits. The oil price may change significantly in the future, and the oil supply may be unstable. Therefore, as auditors, we have the responsibility to remind our client to be aware of the potential business risk in advance, and adjust its business strategy accordingly.

-Food Safety: As reported in USA Today, most airline food also lacks adequate attention to food safety.  The U.S. Food and Drug Administration (FDA) has recently released reports highlighting a number of serious food safety infractions at the three leading airline food supply kitchens. ^[2]The quality and safety of food is really important for an airline company. The low quality of on flight food may result in a loss of customers and even lawsuits. As auditors, we want to remind our client to focus on the Company’s food supply and its high compliance risks, as our profit may decrease substantially if the Company cannot control its food safety according to FDA’s regulations.

Competition (Business Risk)

-Alliances: The airline industry has high fixed costs and been adopting price-competing strategy. Therefore, major airline companies created several alliances to take the market and increase revenue. There are big three airline alliances: “OneWorld with a market share of 22.7%, SkyTeam with 28.3%, and Star Alliance with a market share of 37.6%.” However, the Company is an independent airline without any alliance. It is a big disadvantage, as the independent status makes it difficult for the Company to increase revenues by increasing the customer sharing. Compared with other US-based airlines, such as Alaska Airlines, JetBlue Airways, and Spirit Airlines, the Company’s operating profit is always at the bottom.

-Price War and Promotion: In the war to capture more customer, airline companies use different ways, the most common of which is the price war and promotion. Creating the lowest price is the goal of airline companies, but the result is the decline in industry profits.

Social (Business Risk)

-Terrorism:  “A leading airline boss has urged the travelling public to refuse to let themselves be ‘dictated to’ by terrorists - or inadvertently risk further attacks.”^[3] Last year the whole airline industry was under the ISIS threat. Terrorism is an unexpected risk for the airline industry. Last year, terrorism forced a huge amount of travelers cancel their travel plan; some of them changed their mind and chose other transportations. It is a big hit to the airline industry. There is the compliance risk, and like the majority of airline companies, the Company may also lose customers due to the terrorism risk. In addition, there is also compliance risk for airline companies because they have to follow the guideline from FAA to deal with the terroristic threat and emergency problems.