The report is done from the perspective of auditing.

Multiple aspects of Virgin Blue such as

strengths, weakness, opportunities and threats are analyzed in the first part. And in the second
part five audit risks are identified and explained. Finally, since the appointment of new CEO,
the impact of Virgin Blue is illustrated.

1. SWOT analysis

 Strengths  Weakness

- Strong brand name and good reputation - Lacking experience in its new long

- Offering competitive fares with high haul business

quality customer service and awarded the - High percentage of cancellations

Best Low-Cost Airline in Australia 2009 - Lower margin compared with
- Excellent on-time performance record competitors

- Successful loyalty program - Loose supervision

- Unstable IT System
 Opportunities  Threats

- Develop corporate travel market: market - Competition from domestic airlines,

share against Qantas e.g. Qantas, etc

- International partnerships: Use Delta, - Upward pressure from fuel Jet fuel
Emirates partnerships to grow product prices
offering against Qantas - Greater international competition:
- Recovering global economy further expansion of Tiger network

- Increasing immigration - Heavily reliance on internet as sales

- Increasingly advanced technology channel exposes them to risks

enables airlines to provide more associated with system disruption

convenience to travelers

1 / 12
2. Key audit risks

2.1 Revenue Overstatement

There are several reasons listed as follows will lead to the decreasing of revenue, which might
make revenue account to be overstated.

Competition of aviation industry

Because of the competition in the aviation industry, the market share percentage of Virgin
Blue is likely to be reduced. Qantas Chief Alan Joyce has made a declaration that Jetstar will
be bigger than Virgin Blue within five years. 1 The operational goal of Jetstar is similar to
Virgin Blue, which is attracting potential customers by cheap tickets. The declaration of rival
Jetstar is obviously a threat to Virgin Blue. If Jetstar could successfully race to control those
original customers of Virgin Blue, the revenue Virgin Blue would definitely decrease.

Collapse of the airline's ticketing system

Due to the collapse of the Virgin Blue ticketing system in Australia, there are over 50,000
passengers were affected. Because of the information technology and computer systems being
unavailable, there are as many as 400 flights were cancelled or delayed. 2 The failure of the
ticketing system followed by large amount passengers holding in airports has an obviously
bad impact on the reputation of Virgin Blue. The revenue would be influenced without doubt.

Failure of alliance

Australian Competition and Consumer Commission (ACCC) rejected the trans-Tasman

services plan of two companies, namely Air New Zealand and Virgin Blue. The two airline
firms were planning to synchronize their fares, revenue management, schedules, capacity and
routes flown if the merger plans had been allowed. 3 Currently, Virgin Blue flies as Pacific
Blue on the Tasman and has commenced plans to pull out of the New Zealand domestic
market beginning October. However, the rejection by the ACCC made the plan worthless,
which impacted the revenue potentially.

1
http://www.heraldsun.com.au/business/jetstar-to-be-bigger-than-virgin-blue/story-e6frfh4f-1225928248469
2
http://www.buenosairesnews.net/story/690528
3
http://www.investinaustralia.com/news/air-new-zealand-and-virgin-blue-denied-permission-merge-their-trans-
tasman-services-australian-96t3
2 / 12
On the other hand, Virgin Blue also wants to cooperate with American Delta Air Line. But,
the approval of the alliance plan is pending. The spokesman of Virgin Blue confirmed that the
airline had requested the extra time for arguing its alliance with Delta Air Lines. Although at
this stage, we cannot predict whether Virgin Blue can succeed or not, if Virgin Blue could not
manage to get the approval of the alliance, the revenue would definitely be affected.

2.2 Operating Expenses Understatement

As we know, this year Virgin Blue got provisional from Australian competition and consumer
commission to ally with Etihad Airways. According to the strategy, the customers will enjoy a
new flight network on 1st October, as well as the status/tier points earning schedule. As a
result Virgin Blue network will have 45 new destinations in Australia, New Zealand, the
Pacific Islands, and the west coast of America. The alliance with Etihad Airways sees clear
advantage for both companies; however, the relevant expenses will increase sharply.
Comparing with the sharp increase of fuel cost, the other costs increase steadily although take
a smaller percentage in the total expense.

The operating expense increases by 274 million in 2010, commissions and marketing cost
increases by 6.8% to 195.3 million. Aircraft ownership costs, including lease costs and
depreciation, increased by 22.6% to 356.9 million. Labor and staff related costs increased by
7.5% to 639.8 million. The costs of production, reflecting ongoing cost saving and efficiency
initiatives increases by 23.4%.4 Also with the enlarging scale of Virgin Blue’s airplane team, it
is inevitable that more labor and maintain expenses are needed. With the two companies’
combination, IT system is facing adjustment and therefore the commencing expense will
increase. For example on 26th September 2010 Virgin experienced difficulties with the
reservation system for 24 hours, the financial impact is still being under investigation. The
GFC’s influence still lingers on, and kept coming back and disturbing Virgin’s economic
stabilization, for example foreign exchange expense will increase when exchange rate is
fluctuating, and profits will be deteriorated as a result. The company’s remuneration system is
influenced by the labor market in that labor’s cost increases year by year. The costs associated
with the flight’s delay due to weather are uncontrollable, and the provision sometimes has to

4
Virgin Blue Annual Report 2010, page 6
3 / 12
be taken into consideration. Therefore the expense (excluding fuel) is highly possible to be
understated, and the profit on balance sheet has the risk to be overstated.

2.3 Investment Overstatement

Investment overstatement is one of the five key audit risks which would impact on the audit
of Virgin Blue. V Australia is Virgin Blue’s new home-grown premium international airline
launched between Sydney and Los Angeles on 27 February 2009. On board V Australia’s
brand new 361-seat Boeing 777-300ER aircraft is a three-class cabin comprising International
Business with 33 fully lie-flat beds, International premium Economy with 40 club seats as
well as 288 International Economy seats.5

However, the future of V Australia hasn’t turned up quite clear by now. On Thursday, 9
September 2010, the U.S. Department of Transportation (DOT) issued a preliminary denial of
Virgin Blue and Delta Air Lines' application for antitrust immunity in relation to their
proposed joint venture on the Trans Pacific Route. The airline had requested the extra time to
allow it to give a "full and detailed” response to issues raised by the DoT. The potential
partners were originally given two weeks to respond to the DoT's show-cause notice but an
extension will give them until October 13.6 Furthermore, the Australian Competition and
Consumer Commission last week issued a draft determination "proposing to deny
authorization" for the alliance between Virgin Blue and Air New Zealand. Virgin Blue will
keep fighting for approval of its trans-tasman alliance with Air New Zealand despite a knock-
back from regulators, according to chief executive John Borghetti. 7

Should the alliances with Delta or Air New Zealand fail, investment will probably be
overstated for Virgin Blue. V Australia’s brand new aircraft is recorded as investment. And
the failure of alliance can lead to the airplanes unused to some degree which will decrease the
value of such investment. Therefore, one of the key audit risks is the overstatement of
investment.

2.4 Overstatement of fuel & oil expense

5
Virgin Blue Annual Report 2009
6
http://www.vaustralia.com.au/about-us/media-releases/view-media-releases/P_013531.html
7
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10673493
4 / 12
It can be observed from the chart above that fuel price rose sharply since December 2007
from 258.07 cent/gallon to reach a peak price of 392.49 in June 2008. Although declining
afterwards, the fuel price stayed above average historical level during FY 2009, which
coincided with a lower than average exchange rate (AUD/ USD) and might be responsible for
the highest ratio of fuel expense to revenue among 5 years (2006-2009).

In the 2010 Annual Report, lower fuel cost is a major contributor element to the company’s
financial improvement. The underlying EBIT for FY 2010 is 87, increased 521% from the
result of FY 2009. Strong cost control and lower fuel prices are held as reasons for this great
performance. Average price paid for fuel is said to decrease by 18.3%.

Actually the fuel price in this year has gone up from 126.75 cent/ gallon (Mar.2009) to around
200 cent/gallon ($84/barrel). Foreign exchange also rose above 0.85 in FY 2010. The fuel to
revenue ratio in FY2010 is down from 28.42% in the previous year to 26.23%, still higher
than the previous 3 years. There is a risk of overstatement of fuel and oil expense which may
reduce the profit of FY 2010 and extend the benefit of lower fuel price to the next year. As the
new management stepped up just before year end, there might be incentive to “take a big
bath” and save current benefits for the future.

*9 months to Jun.30, 2006

2010 2009 2008 2007 2006*

Fuel and oil expense 782.1 748.9 598.3 488.9 330.5

Revenue 2981.8 2635.4 2351.6 2169.1 1362.4

Ratio 26.23% 28.42% 25.44% 22.54% 24.26%

Table 1: Fuel and oil price ratio

Source: Jet fuel price from http://tonto.eia.doe.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=rjetsin5&f=a

Singapore Kerosene-Type Jet Fuel Spot Price FOB (Cents per Gallon)
500
450
400 392.49

350
300
299.02
250 286.89
258.07 208.43
200
216 206.6
150 192.02 178.79 198.08
157.51 188.6 179.86 178.71
100 126.75
50
0
5 / 12
05 p

06 p

07 p

08 p

09 p
un

06 n

un

un

un
05 r

06 r

08 r
06 c

07 c

08 c

09 c

ec

un
07 r

09 r

ar
a

a
e

e
e

e
u
-M

-M

-M

-M

-M

-M
-D

-D

-D

-D

-D
-S

-S

-S

-S

-S
-J

-J

-J

-J

-J

-J
10
05

05

07

08

09

10

Series1
price in USD Series2
price in AUD
 Source: Jet fuel price from http://tonto.eia.doe.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=rjetsin5&f=a

2.5 Intangible asset

Australian accounting policy states that Identifiable tangible assets with an identifiable useful
life, and goodwill, must be tested for impairment at least annually (Impairment of Assets
AASB 136). And assessment of impairment should take into account conditions such as a
decline in market value, asset idleness and economic performance failing expectation.
As per 2010 annual report8, total intangible assets are carried at net book value of 53.3
million, compared to 51.1 million of last year. There is no change of goodwill. Following
notes state that there was no impairment loss recognized on intangible assets during the year
and 5.5 million of internally developed software was capitalized.
The account of intangible assets is thus subject to risk of overstatement. Test of impairment
was based on management’s expectations regarding the market including guest numbers,
revenue yield and associated operating costs. The management has expressed in the treatment
of no impairment loss an optimistic estimation of the market. As analyzed before, the
proposed alliances with multiple airlines are pending and will possibly blocked by
government regulators. At the reporting date of the 2010 result, the prospect of partnership
and new market entrance being abolished is not clear and possibly excluded by management
in assessing impairment expense.

3. Impact of new CEO on the audit plan

Mr Borghetti spent 36 years with Qantas and his valuable international long-haul experience
with full-service product could fit in well with Virgin's move.

A key part of Mr Borghetti strategy is to capture a larger slice of the Australian corporate
business from 10% to 20% with the only practical way the airline group can offer a

8
Virgin Blue Annual Report 2010
6 / 12
comprehensive global network which is through alliances and partnerships currently being
sought.9 And to help achieve that goal, Borghetti has brought in some mates from Qantas who
have yield management expertise. During his time in Qantas, Qantas has profitably run the
same international-domestic feeder network since 1992, when it acquired Australian airlines
in the lead-up to its privatization the following year.10

Since the appointment of John Borghetti as CEO, main changes in Virgin Blue include
implemented a new organisational structure and developed a go-forward strategy.

Firstly, greater emphasis needs to be place on profitability because the increase in business
risk of the changing environment. And because the organisation structure changed, the audit
planning should based on the previous year’s audit plan and adjust the resource on the new
department and the valuation of the yield management. Furthermore, it is uncertain whether
the profitably international-domestic feeder network in Qantas still will successful in Virgin
Blue. The auditor needs to be more concerned with the possibility of overstatement of profit
through say manipulation of sales cut-offs or understatement of provision/expense accounts.

Appendix:

1. Main Industry sectors, players and relative positions

 Domestic (non regional): Capital cities, major hubs (>80% of sectors flown) competes
with Tiger, Jetstar/Qantas
 International Short Haul (Pacific islands): Fiji, New Zealand, etc. (<15% of sectors flown)
competes with Jetstar/Qantas, Air New Zealand and Air Pacific

9
The AGE, 14 September 2010, Borghetti says Virgin needs alliances, accessed 1 October 2010,
http://news.theage.com.au/breaking-news-business/borghetti-says-virgin-needs-alliances-20100914-15ade.html>
Australian Securities Exchange, 30 September 2010, Virgin Blue Annual Report 2010, page 10, accessed 1
October 2010,
http://www.asx.com.au/asx/statistics/displayAnnouncement.do?display=pdf&idsId=01103543
10
The Sydney Morning Herald, 27 August 2010, Virgin’s ambitions taking off, accessed 1 October 2010,
<http://www.smh.com.au/business/virgins-ambitions-taking-off-20100826-13u9i.html>
7 / 12
 International Long Haul (trans–pacific): North America, Thailand, South Africa (<5%)
competes with Jetstar/Qantas, Air New Zealand and Air Pacific, United Airlines, Cathay
Pacific

2. Main product groups and competition in domestic airline industry

Main product groups: Rather than analyze the different products available it is more
appropriate to analyze product competition in terms of products and services targeting either
the Corporate or the Leisure markets.
 Competition in the leisure market:
Competition in the leisure market is driven by rivalry between Tiger, Virgin Blue and
Jetstar, and the price elasticity of the product. Leisure market customers are very fickle,
and will fly domestic sectors based mostly on price. Tiger currently drives the lowest price
in an attempt to gain market share, however both VBA and Jetstar attempt to differentiate
their product through service, branding and frequent flyer clubs.
 Competition in the corporate market:
Competition in the corporate market is driven by fights between Sydney, Melbourne,
Brisbane and Canberra and the needs of some large corporations and government
organizations. Due to the bargaining power of corporate customers and the requirements
of this market there are only Qantas and Virgin Blue competing in this market.

8 / 12
3. Competitive analysis of the domestic airline industry

Po rte r’s Fo rc e s Le isure Pro d uc ts Co rp o ra te Pro d uc ts

Riv a lry a m o ng c o m p e t it o rs St ro ng c o m p e t it io n b e t w e e n G ro w ing c o m p e t it io n b e t w e e n

(Se g m e nt Riv a lry) J e t st a r, Virg in Blue a nd Tig e r Q a nt a s a nd Virg in Blue

Ba rg a ining p o w e r o f
Lim it e d Lim it e d
sup p lie rs

Ba rg a ining p o w e r o f La rg e c o rp o ra t e & g o v e rnm e nt

Hig h – p ric e d riv e s t his m a rke t
c ust o m e rs c ust o m e rs d riv e p ro fit a b ilit y

Thre a t o f ne w e nt ra nt s
Thre a t o f sub st it ut e s
Tig e r is t he la t e st e nt ra nt , using
Lim it e d , a s no w 2 la rg e p la ye rs in
p ric e d isc o unt ing t o e nt e r
c o m p e t it io n
m a rke t
Lim it e d – lo ng ha ul b us a nd
t ra in is a v a ila b le , ho w e v e r Lim it e d
im p a c t s m a rke t m a rg ina lly

4. Exchange Rate - AUD: USD

2005 2006 2007 2008 2009 2010

Mar 0.772 Mar 0.716 Mar 0.807 Mar 0.918 Mar 0.687 Mar 0.916

Jun 0.764 Jun 0.743 Jun 0.849 Jun 0.963 Jun 0.811 Jun 0.852

Sep 0.762 Sep 0.748 Sep 0.883 Sep 0.799 Sep 0.88 Sep 0.967

Dec 0.734 Dec 0.791 Dec 0.882 Dec 0.693 Dec 0.897

Source: Exchange rate from Reserve Bank of Australia http://www.rba.gov.au/statistics/hist-exchange-

rates/index.html

9 / 12
5. Virgin Blue on time performance

Source: Virgin Blue, “Our Performance”,

http://www.virginblue.com.au/Personal/Flightinfo/Ontimeperformance/VirginBlueOnTimePerformance/index.htm

Source: Department of Infrastructure, Transport, Regional Development and Local Government: Bureau of Infrastructure,
Transport and Regional Economics, Aviation: Domestic airline on time performance 2009-2010,
http://www.bitre.gov.au/publications/17/Files/BITRE%20OTP%20Report%202009-10.pdf

10 / 12
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30: Report 117. Canberra: Department of Infrastructure, Transport, Regional Development
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Infrastructure, Transport, Regional Development and Local Government.

BITRE-OnTime Performance. (2010, August 23). Airline On Time Performance Monthly

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Macquarie-Shaw/Thornton. (2010). Virgin Blue, Borghetti's long To-Do list. Sydney:

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The Australian-Damon Kitney. (2010, August 27). Virgin Blue wins alliance to chase
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