The Magenta Majesty Hotel is located close to the main railway station in a large regional city. Its main client base is business people visiting the city for work-related purposes. Other important groups of clients include groups of (mainly) women visiting the city for its great shopping, and (mainly) men visiting the city to attend important sport matches.

Occupancy rates have been reasonable, but not growing, during the last few years, providing a steady but low rate of return for the owners of the hotel. Revenues have been sufficient to cover operating costs, but no substantial progress has been made on repaying the large, longterm loans used to finance the hotel. In an effort to increase the hotel’s profitability, a major renovation program was undertaken and completed earlier this year. The renovation was predicted to increase the relative attractiveness of the hotel to guests. It was also undertaken to earn additional revenue from the rent of a new coffee shop on the ground floor. The coffee shop is run by a separate company that has purchased a franchise of a major international brand.

Business travel is down by 30 per cent across the country this year due to tougher economic conditions. Further, discretionary retail spending is down by 42 per cent, particularly in the regions. Several specialty shops in the city have already shut and others are cutting their opening hours. The sport matches have not drawn large crowds, and the coffee shop owners went bankrupt and closed down, breaking their lease. The hotel owners are seeking legal advice on whether they can claim penalty fees on the broken lease.

Finally, the hotel owners’ bank is warning that the short-term finance obtained for the renovations will not be renewed when it is due (one month after year-end). The hotel managers had expected to repay the debt from this year’s bookings and the coffee shop lease. The hotel owners are still hopeful that the winter will bring a large lift in occupancy (and revenue) as the local football teams are doing very well and several key games are scheduled for the city. This expected winter trade is essential to meet repayments on the long-term debt as well as convince the bank to extend the short-term debt.

Required

(a) Is there a going concern issue in this case? Explain.

(b) Are there mitigating factors? Explain them and how they would affect the auditor’s conclusion.