Case Scenario:
Joe Hughes has never been in such a pensive mood since he started working in the airline industry 30 years ago. He started his career as a Navy pilot, moved on to work for a commercial airline as a manager of fleet maintenance, and then took up the position of Vice President of Operations (VPO) with a small airline that provides private jet services and leasing arrangements. Luxury Airlines attracted Mr. Hughes with a handsome salary and bonus package. As the VPO, Joe Hughes used his experience to improve on Luxury Airlines's operations. The airline expanded its market share by over 50% in 5 years and increased profitability by more than 20% in each of the 5 consecutive years. During the same period, Luxury's stock price more than tripled on the New York Stock Exchange. It did not come as a surprise to management and employees that the board of directors voted to offer Mr. Hughes the Chief Executive Officer (CEO) position when the airline's CEO retired.
The airline industry has been struggling to recover from terrorist acts in which airplanes were used. Luxury Airlines was an exception. Its business soared. It was evident that affluent individuals, entertainers, and sports clubs preferred to travel in private or leased jets. Further, the airline's safety record contributed to its success. Luxury has experienced just one fatal disaster since its formation 40 years ago.
Suddenly, the airline's fortunes began to change for the worse. Joe Hughes did not see it coming. The resignation of his Chief Financial Officer (CFO) a year ago marked the beginning of the airline's woes. The former CFO had a knack for identifying accounting and operational irregularities. For the first time in 10 years, Luxury reported losses and could not pay dividends. Joe Hughes has been trying to figure out a way to steer Luxury back to profitability. Joe stared at the internal audit report on his desk and was visibly shaken by the contents. Passenger claims filed within the last 12 months surpassed the total for the previous 60 months. Some of the claims resulted in costly litigations. Additionally, workers' compensation claims per month had more than doubled. The resignation of the external auditors worsened matters for the airline. The auditors disagreed with the financial controller on some major accounting practices. The controller prevailed due to his influence on the audit committee. As a result, the external auditors resigned.
Rumors and complaints about the controller include the following:
His ownership interest in an insurance company that does business with Luxury
His relationship with two members on the audit committee
His lavish lifestyle
His frequent use of Luxury's jets for personal trips
Assume that you are the senior partner of J&J Forensic Accountants. Write an engagement proposal to the CEO of Luxury including the following:
Explain the services that you and your forensic accounting team offer (Hint: Think of what a forensic accountant does).
Show how the work of your forensic accounting team will benefit Luxury. Specifically, explain how each of the following areas (given the scenario for Luxury) will be examined or evaluated and why investigating the following is important:
Passenger claims
Workers' compensation claims
Compliance with accounting practices
Dealings of the controller (e.g., third-party dealings)
Evidence of fraudulent activities
Further Guidance:
An engagement proposal defines the legal relationship between J&J and Luxury Airlines.