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Now You See It, Now You Do Not: The Case of Jet Airways and Its Accounting Policies:

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Read and evaluate this case by answering the questions presented. Your well-written analysis must be 2 pages in length, in addition to the title and reference pages, and be formatted APA.


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IMB 331 PADMINI SRINIVASAN NOW YOU SEE IT, NOW YOU DO NOT: THE CASE OF JET AIRWAYS AND ITS ACCOUNTING POLICIES If you want to become a millionaire, start with a billion and buy an airline. It's sad but true. Richard Branson The year 2008±2009 was a very difficult year for the airline industry. Airline companies globally lost nearly US $10 billion. Oil prices touching a peak of $147 per barrel coupled with global recession later led to difficult times for the airline companies. Recession also hit travel plans of both business as well as leisure travelers thereby affecting the revenues. Earnings fell drastically for most companies, however Jet Airways¶ first quarter 2008±2009 net earnings grew by 364%, as compared to the previous year¶s first quarter. Overall revenues were up 46% as compared to the same period a year ago, and up 6% versus the immediately preceding quarter. Our operations as a whole showed a pre-tax profit of Rs. 2191 million or US $50.9 million versus a profit of Rs. 495 million or US $12.21 million during the same period last year. The breakdown of this number shows a profit of Rs. 5022 million on the domestic operations, and a loss of 2831 million on the international operations. These numbers will also be need to be read along with the changes in the accounting policy. Vishwanath, General Manager, MIS, Jet Airways 1 The last line of the conference call gives us an indication of the issues in accounting followed by Jet Airways . BACKGROUND OF JET AIRWAYS (INDIA) LTD. Jet Airways India Ltd. (Jet Airways) is India¶s largest private domestic and international airline with a turnover of Rs. 114,770 million2 for the year ended March 31, 2009. Jet Airways, an Indian company was promoted by Naresh Goyal, its founder and chairman. Naresh Goyal, a graduate in commerce started his career in the travel and tourism industry as a sales agent for the Lebanese International Airlines. He started his own travel agency, Jetair in 1974 3 after gaining considerable experience in the travel industry. Jet Airways was launched in 1992, to take advantage of the business opportunities that arose with the opening up of the Indian economy. Naresh Goyal has been the recipient of many national and international awards as an entrepreneur in the travel industry.4 Jet Airways commenced its operations in 1993 with a fleet of four Boeing 737 aircraft. By 2008, the company operated around 380 flights daily to 64 destinations both within India and overseas. Some of the key destinations 1 At the analyst meet while announcing the first quarter numbers. http://www.jetairways.com/EN/IN/Uploads/InvestorRelations/TranscriptofAnalystcallforresultsJuly.pdf 2 Conversion rate of $0.023 to Re. 1; 1 crore = 100 million and 10 lacs = 1 million 3 http://www.jetairways.com/EN/IN/AboutUs/ChairmanProfile.aspx accessed on 2/7/10. Excerpts of the conference call to analysts are given in Exhibit 6. 4 Some of the awards include: Business Person of the Year award by UK Trade & Investment in 2008, Man of the Year Award by the Aviation Press Club (APC) at its 30th Anniversary in Belgium (2008), Travel Entrepreneur of the Year award at the 19 th Annual Travel Trade Gazette, Travel Awards in 2007 in Bangkok, etc. http://www.jetairways.com/EN/CH/AboutUs/ChairmanProfile.aspx Professor Padmini Srinivasan assisted by R. Subash and M. Satish prepared this case for class discussion. This case is not intended to serve as an endorsement, source of primary data, or to show effective or inefficient handling of decision or business processes. Copyright © 2010 by the Indian Institute of Management Bangalore. No part of the publication may be reproduced or transmitted in any form or by any means ± electronic, mechanical, photocopying, recording, or otherwise (including internet) ± without the permission of Indian Institute of Management Bangalore. This document is authorized for use only in KRIS MICHAELSON's ACT350 - S18B at Colorado State University - Global Campus from Mar 2018 to Sep 2018. Now You See It, Now You Do Not: The Case of Jet Airways and Its Accounting Policies Page 2 of 11 were New York, Toronto, Brussels, London, Hong Kong, and others. Its fleet of aircraft included Boeing 777-300, Airbus A330-200 aircraft, Boeing 737- 700/800/900 aircraft, and ATR 72-500. The company offered both passenger and cargo transportation services. Jet Airways had been acclaimed for its excellence in operations. It also set a 5 record by flying 36,406 passengers with a seat factor of 86% in 2006 . In April 2007, Jet Airways acquired Sahara Airlines (which was later renamed as JetLite), a low-cost carrier to gain synergy with the existing operations. Jet 6 Airways was the largest private sector airline in India with a market share of 29.2% in the domestic market as on March 2008. The company went public in 2005, through a public issue of 17,266,801 shares at an issue price of Rs. 1,100 and listed at the National Stock Exchange and the Bombay Stock Exchange on March 14, 2005. On listing, 7 they were quoted at Rs. 1,155 which touched a high of Rs. 1,428 on that day . The equity held by the promoters and its affiliates was 80% in 2009. The Jet Airways board comprised eminent individuals globally both from the private and public sectors. The financials of the company from 2006 to 2009 are given in Exhibits 1 and 2. TURBULENCE IN THE AIRLINE INDUSTRY After the year 2000, India saw the emergence of many airlines such as Air Deccan, Spice Jet, Indigo, GoAir, Kingfisher Airlines, etc. As air travel became affordable, volumes grew as people started using air travel especially with the advent of low-cost airlines, thereby intensifying the competition for full fare airlines such as Jet Airways. To counter competition, many airlines resorted to discounted airfares. The airline industry went through a turbulent period shortly after 2006. Rising oil prices increased the cost of operations for the airlines. The price of aviation turbine fuel was hiked by nearly 20% in May 2008. Added to this was the onset of recession across many countries. Business growth was hindered and consumers become conservative in their traveling. The average passenger load factor was just 67.7% and the revenue passenger was 21,444 million kilometers that year. Rising oil prices in 2007 and 2008 forced companies to increase the airfares. The domestic traveler hit by inflation and high airfares resorted to other modes of transport, especially for short distance travel. The shifting of airports in key cities away from the city, the charges of user development fee by the newer airports, and austerity measures enforced by companies as well as by leisure travelers resulted in reduction of air travel, thereby leading to poor performance of the airline industry as a whole. The Indian aviation industry continued to grow, though at a slower rate, during the year under review. Economic growth, the emergence of India as a global economic power and other factors, that have had a positive impact on air travel into and from India, were sustained all through the year under review. However, the aviation industry worldwide was adversely affected by the spiraling cost of aviation turbine fuel, caused by the continuing increase in crude oil prices. The resultant increases in fares and fuel surcharges that the airlines had to implement, resulted in a slowdown in air travel, both in India and worldwide. Director¶s Report, Annual Report of Jet Airways, 20088. The performance of the Company¶s domestic operations was also adversely affected by lower domestic passenger traffic in the country, primarily due to the economic slowdown and unrealistic pricing adopted by carriers, caused by the overcapacity that resulted, in order to attract passenger traffic. The performance of the Company¶s international operations, particularly its long-haul sectors, was adversely affected by weak demand and yields, primarily caused by the slowdown and recessionary conditions in most global economies. Director¶s Report, Annual Report of Jet Airways, 20099. Most airline companies were looking at novel ways to increase their revenues and to combat the crisis. Jet Airways entered into mutually beneficial agreements with its alliance partners as well as other airlines. Routes were restructured and some of the company¶s aircraft were leased out to other airlines. 5 Datamonitor ± Airlines in India ± November 2008 Ref Code 0102±0756 Jet Airways (India) Ltd. ± 16th Annual Report, 2007±2008 7 http://www.thehindubusinessline.com/2005/02/28/stories/2005022802090100.htm 8 Annual Report for the year ended March 31, 2008 9 Annual Report for the year ended March 31, 2009 6 This document is authorized for use only in KRIS MICHAELSON's ACT350 - S18B at Colorado State University - Global Campus from Mar 2018 to Sep 2018. Now You See It, Now You Do Not: The Case of Jet Airways and Its Accounting Policies Page 3 of 11 First Quarter (2008-2009) Results of Jet Airways During the first quarter of the year 2008±2009, many airlines reported losses, citing rise in the crude oil prices and slowing down of demand as the major factors affecting the poor performance. New entrants in the airline industry had added capacity which led to surplus supply. Airline companies were trying to restructure and revaluate various routes to increase the load factor. Airfares were also increased by most airlines to meet higher costs. Although many other airlines declared losses during the first quarter, Jet Airways reported an increase in net profit by 364% as compared to the first quarter of the previous year 2007±2008. Income (Sales) recorded in the quarter were Rs. 28,671.6 million as compared to the first quarter of 2007 at Rs. 18,066.7 million, an increase of 58%. The net profit after tax for the quarter ended June 30, 2008 was Rs. 1,433.8 million as compared to the quarter ended June 30, 2007 of Rs. 308.8 million. Refer to Exhibit 3, for quarterly results, of the first quarter ended June 30, 2008 announced on July 30, 2008. What was the reason for such growth in the bottom line contrary to what one would have expected? The conference call transcript from Jet has the answers. During this quarter, we have changed our accounting policy for charging depreciation on our narrow-body aircraft through a straight-line method from a written-down method to be in line with our policies of the wide-body aircraft as well as to be in line with international practices. On account of this change, there was a one-time impact of Rs. 9,159 million or US $ 212.8 million, which has been considered in the current quarter. The other change in accounting policy that we will be able to operate is to the extent of foreign currency translation loss or gain. We have now adopted a policy by which the same will be adjusted in the carrying cost of asset, rather than accounting for the same in the profit and loss. Thus, the rise in earnings would not have been possible without the change in the depreciation method for its narrow-body aircraft and the accounting treatment for the foreign currency translation losses. Accounting Policy of Jet Airways 1. Depreciation (For the year ended March 31, 2009) The airline industry is a capital intensive industry and fixed assets form a major component of the assets of an airline company. Jet Airways reported a net block of fixed assets (property plant and equipment including intangible assets) of Rs. 162,619 million. Out of these, the aircraft accounted for Rs. 139,043 million, nearly 85% of the total assets. Although other expenses such as fuel cost or administrative expenses are accounted using the accrual method of accounting, requiring very less or no estimation, depreciation is an area requiring considerable judgment and estimation. Depreciation accounting can sometimes result in distortion of the company¶s bottom lines and hamper the comparison of companies. The depreciation policy of Jet Airways is reproduced below after the change: Depreciation on tangible fixed assets has been provided at the rates and in the manner prescribed under the schedule XIV to the Companies Act, 1956 on Written Down Value method, other than Narrow and Wide Body aircraft which are depreciated on straight line method and expenditure incurred on improvements of assets acquired on operating lease are written off evenly over the balance period of the lease. Premium on leasehold land is amortized over the period of lease.10 Depreciation rates are given in Schedule XIV of the Companies Act, 1956, in India, which represent a minimum threshold rate. However, companies can choose a higher rate of depreciation if justified. The Indian accounting standard does not mention any rates for depreciation. Jet Airways fixed assets schedule for the year ended March 31, 2009 is given in Exhibit 4. 10 Annual Report for the year ended March 31, 2009. This document is authorized for use only in KRIS MICHAELSON's ACT350 - S18B at Colorado State University - Global Campus from Mar 2018 to Sep 2018. Now You See It, Now You Do Not: The Case of Jet Airways and Its Accounting Policies Page 4 of 11 The airline industry has been using different types of aircraft for passenger transportation, the popular classification being the wide-body aircraft (WBA) and the narrow-body aircraft (NBA). These aircraft differ in terms of technology, performance, and efficiency in operations. Jet Airways normally used WBA for international operations and NBA for domestic purposes. During the first quarter ending June 2008, Jet Airways changed its accounting policy by adopting the straight-line method (SLM) instead of the written down value (WDV, also termed as reducing balance) method for its NBA. The effective rate of depreciation under SLM was 5.6% per year, down from 16.2% under WDV. The residual value was 5% irrespective of the method used. The company justified the change stating: Depreciation on narrow-body aircraft was hitherto provided on written down value method. Based on the usage of such aircraft, the industry practice followed in domestic and international markets, the Company, in order to reflect a more appropriate preparation/presentation of financial statements, has changed the method of depreciation on such aircraft to straight-line method. The accounting impact for the quarter on account of the one-time depreciation write-back was Rs. 9159 million which was added to the profit and loss account before tax. 2. Accounting for Foreign Currency Exchange Difference Jet Airways also changed in its policy related to accounting for foreign exchange difference arising out of liability designated in foreign currency. The accounting changes involved adjusting the difference in foreign currency rates through the asset account instead of the income statement. The impact on account of the foreign currency loss being directly taken into the fixed assets was Rs. 6242 million 11 for the quarter. Explaining the accounting policy change to a caller during the conference call: Obviously, you have not seen all the balance sheets because we have read many more. We think quite a lot of companies taking a stand that it is a company law which is a primary thing that companies need to follow, and the accounting standards get overridden by the company law requirement. Company law very clearly states that any foreign currency loss or gains needs to be taken to the carrying cost of the asset, and we also have taken a legal opinion in this regard to support this case. Going forward, even to the extent, there is going to be a gain, the same will be taken to the carrying cost of assets and not adjusted in the profit and loss statement. There seems to be a conflict between the Indian accounting standards and the Companies Act, 1956 with respect to the treatment of the foreign currency translation difference. 12 3. Revaluation of Fixed Assets A quick look at the note in the balance sheet schedule of fixed assets of 2009 (see Exhibit 4) reveals the following additional information: 11 Jet Airways Quarterly results announced contains the note as follows: The Company, based on legal advice has, from the current quarter, adjusted the foreign currency differences on amounts borrowed for acquisition of fixed assets acquired from outside India aggregating Rs. 62,42.9 as on 30 June, 2008 to the carrying cost of the fixed assets, in compliance with Schedule VI of the Companies Act, 1956 which is in variance with the WUHDWPHQW SUHVFULEHG LQ $FFRXQWLQJ 6WDQGDUG $6   RQ µ(IIHFWV RI &KDQJHV LQ )RUHLJQ ([FKDQJH 5DWHV¶ QRWLILHG LQ WKH &RPSDQLes (Accounting Standards) Rules. Had the treatment as per AS 11 been followed, the net profit before tax for the quarter would have been lower by Rs. 6224 million. 12 The notification dated 31.03.2009 issued by the Ministry of Corporate Affairs seeks to insert paragraph 46 after paragraph 45 in the Accounting 6WDQGDUG $6 UHODWLQJWRWKH³7KH(IIHFWVRI&KDQJHVLQ)RUHLJQ([FKDQJH5DWHV´,WUHTXLUHVWKDW exchange differences arising on reporting of long-term foreign currency monetary items at rates different from those at which they were initially recorded during the period (in respect of accounting periods commencing on or after December 7, 2006) or reported in previous financial statements, in so far as it relates to the acquisition of a depreciable capital asset, can be added to or deducted from the cost of the asset. See Exhibit 5 for details. This document is authorized for use only in KRIS MICHAELSON's ACT350 - S18B at Colorado State University - Global Campus from Mar 2018 to Sep 2018. Now You See It, Now You Do Not: The Case of Jet Airways and Its Accounting Policies Page 5 of 11 (a) Leasehold land was revalued on March 31, 2008 with reference to the existing market prices; amount added on revaluation was Rs. 14811.9 million; the revalued amount substituted for the historical cost on March 31, 2008 was Rs. 18450 million. The annual report of 2008, carried the following explanation provided on revaluation: During the year, in order to reflect the current reinstatement cost/market value, the Company revalued the Leasehold Land and Narrow Body aircraft (including aircraft revalued in the year ended 31st March, 2002) owned by the Company as at 31st March, 2008. Such revaluation for aircraft has been carried out by International Aircraft valuers and for Leasehold Land by a registered valuer considering the present market/reinstatement value and considering the book value of such assets as at 31st March, 2008. Accordingly, the resultant appreciation in respect of land of Rs. 148,119 lac and in respect of aircraft of Rs. 118,133 lac has been added to respective assets and the aggregating amount of Rs. 266,252 lac has been credited to Revaluation Reserves. Since the valuation of the aforesaid assets has been carried out as on 31st March, 2008, there is no additional charge on account of depreciation on the assets so revalued. Depreciation includes Rs. 1563 lac (Previous Year Rs. 2958 lac) on the aircraft revalued in the earlier year, which has been withdrawn from the revaluation reserve as per the accounting policy followed. 7KHGHSUHFLDWLRQH[SHQVHVKDGEHHQUHGXFHGE\DQDPRXQWRI5VPLOOLRQDV³GHSUHFLDWLRQRQDPRXQWDGGHGDV UHYDOXDWLRQFKDUJHGWRUHYDOXDWLRQUHVHUYH´ VHHExhibit 2 for the income statement). The preparation of financial statements is not an exact science. It requires the management to make estimates and assumptions that affect the reported amounts of assets, liabilities, incomes and expenses on the date of the financial statements, and the results of operations during the reporting periods, respectively. Although these estimates are based on the management's best knowledge of the existing events and actions, sometimes the purpose of these changes is in itself a conundrum. Questions for Analysis 1. How does a company decide on the method of ...
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Msharon
School: Cornell University

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Running head: CRITICAL ANALYSIS

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Critical analysis
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CRITICAL ANALYSIS

2

Question 1
The method used to charge depreciation in the company changed from written down method
(WDV) to (SLM) straight line method. The reason for the charge from the written down method
to straight-line method is for the industry to be in line with the company practice adhered to in the
international as well as the domestic market (Srinivasan, 2010). The effect on the first quarter of
change was the depreciation written back 9,159 added to the income statement before tax.
Question 2
Straight-line method refers to a depreciation method whereby the fixed amount is written
off every year (Goshunovaa & Kirpikovb, 2016). The asset cost in normally uniformly spread over
the assets lifetime. The straight-line method of depreciation is also known as fixed installment
method.
1/3=*100=33.33%
33.33% *30000
=9,999.99 depreciation per year
Straight line= 9,999.99/35000*100
=28.57%
The method is also known as the reducing balance method as the annual depreciation
charge keeps on reducing every year.
Written down value= 1- 3 5000/35000
=0.133
=13.34%

CRITICAL ANALYSIS

3

Question 3
Jet Airways being one of the largest private international and domestic airlines whose turnover
in 2009 is Rs. 114,770 Million. The Company came into existence in 1992 launched by Naresh
Goyal. The company affiliates and promoters has equity of about eighty percent in 2009. Jet
Airways in 2007 acquired Sahara airways to enhance the low carrier synergies in the company
operations (Srinivasan, 2010). In the first quarter 2008-2009, that company expe...

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