Eastjet Airlines: Regional Airline Serving the Maritimes and Eastern Canada

About Eastjet Airlines

Eastjet Airlines Eastjet Airlines (EJA) is a regional airline that services most cities in the Maritimes and Eastern Canada. The company began in 2007 when three friends felt that the Maritimes was an underserviced market. Joe, Jack, and Jamal each own one third of all the issued common shares and exercise equal control over the company. After their start-up phase, management began to expand its routes. Currently, EJA offers only short-haul flights to and from Halifax, Moncton, and Sydney. However, EJA has planned an expansion of operations into Ontario as it received approval to fly into both Toronto's Pearson Airport, and the Thunder Bay International Airport. EJA plans to offer its first flights into Ontario in early 2022. In order to service the new routes into Ontario, EJA purchased a new airplane for $1 million. EJA obtained a 10-year mortgage from the Bank of Sydney in order to finance the acquisition of the planes. The terms and agreement of the mortgage can be found in Exhibit I. Exhibit I Mortgage Agreement with the Bank of Sydney Total balance: $1,000,000 Term: 10-year amortization, blended annual payments due on December 31. Commencement date: January 1, 2020 First payment: Due December 31, 2020 Interest rate: 8% fixed over the 10-year period Covenant: EJA shall maintain a debt to equity ratio that is no greater than 2:1. Collateral: Secured debt against the value of the aircrafts Compliance: Audited financial statements to be filed by January 31 of each year. Jack, who is responsible for the accounting functions, has always prepared the financial statements for internal reporting purposes. The statement of financial position, as at December 31, 2020, is included in Exhibit II. Exhibit II Internal Financial Statements Statement of Financial Position As at December 31 (unaudited) 2020 2019 Assets Current Cash $151,764 $160,502 Accounts receivable 334,894 411,760 Inventory 86,800 159,400 Prepaid insurance 4,720 2,060 578,178 733,722 Capital 661,897 382,158 Future income tax asset 35,000 35,000 Long-term note receivable 20,000 0 $1,295,075 $1,150,880 Liabilities and shareholders' equity Current Accounts payable $158,318 $130,146 Bank loan—current portion 41,998 72,000 Income taxes payable 44,609 92,920 244,925 295,066 Bank loan—FirstBank of Canada 93,434 130,664 Common shares 900 900 Preferred shares 20,300 20,300 Contributed surplus 4,000 4,000 Retained earnings 931,516 699,950 956,716 725,150 $1,295,075 $1,150,880 Note to the Statement of Financial Position: The statement of financial position does not include the impact of any of the issues related to: 1. The new bank debt (mortgage with the Bank of Sydney) or the related aircraft 2. Flight No. 877 [Exhibit III] 3. Common share redemption 4. The convertible bonds Exhibit III Notes from your Discussion with EJA Management Purchase of Aircrafts and New Bank Debt Jack informed you of the fact that the December 31, 2020, statement of financial position does not include the acquisition of the new aircraft, or the new bank debt. Jack did not even record the journal entry for the first payment made on December 31, 2020. Bank Loan with the First Bank of Canada The total outstanding balance of $93,434 is due in full on January 15, 2021. Jack has left the total balance as long-term as at the December 31 year end because on January 3, 2021, he was able to renegotiate the loan on a long-term basis. Jack has provided you with a copy of a non-cancellable agreement to refinance the debt as January 3, 2021. Flight No. 877 On November 24, 2020, 26 passengers on Flight No. 877 were injured upon landing when the plane skidded off the runway. Fortunately, no one was injured seriously; however, personal injury suits were still filed on December 1, 2020, for damages totaling $50,000. Legal counsel has studied each suit and advised EJA management that it is probable (about a 60% chance) that they will lose the lawsuit. The loss could range anywhere between $20,000 and $50,000. If the lawsuit is lost, there is a 20% chance that EJA will have to pay $20,000, a 55% chance that it will have to pay $50,000, and a 25% chance that EJA will pay $35,000. Cancellation of Common Shares On September 15, the company reacquired and cancelled 9 shares (3 from each of Jack, Joe, and Jamal). The redemption price was $1,035 per share. Jack was unsure of how to account for this transaction, and therefore did not make any entries as at year end for the redemption. Prior to the reacquisition, there were 900 shares outstanding. Convertible Bonds In order to obtain additional capital to finance the expansion, EJA issued $500,000 in 8%, 10-year convertible bonds on January 1, 2020, for $500,000 cash. Each $1,000 bond includes the right to purchase 1 share for $750 during the life of the bond. The current market rate for similar nonconvertible bonds is 9%. The fair value of the option using an option pricing model is $49,760. As a result of the new bank loan, the financial statements must now be audited. As a result, EJA has hired Lebeau and Liang LLP (L&L), a Certified Professional Accountant firm, to complete the audit. You are the senior accountant at L&L, assigned to the audit. You met with Jack as part of your auditing planning. Jack states "I understand that there is Part I (IFRS) and Part II (ASPE) GAAP in Canada. Currently, the bank has not disclosed which set of standards must be used to prepare the financial statements. Therefore, could you help me understand the significant differences between ASPE and IFRS, as they relate to our financial statements?" The notes from your meeting can be found in Exhibit III. It is now January 10, 2021. The partner has asked you to provide report addressing the client's concerns, and to discuss the policy differences between ASPE and IFRS. - Provide the report. Find as many issues as possible and explain them clearly.