Omega Airways is a public company and a new client of your audit firm. Its accounting policy for revenue is to credit unearned revenue when cash is received, and subsequently transfer to revenue in the income statement when passengers or freight are transported.

Your review of last year’s financial statements reveals that realized revenue from passengers represents 80% of total revenue, and that this year there is little change in realized revenue from passengers but an 11% decrease in unearned revenue from passengers. You have also read articles in the financial press that suggest an increased incidence of fraud due to a global decrease in the number of passenger air miles. At quarter-end, Omega Airway’s controller evaluates the unearned revenue account and related revenue recognition. This adjusting journal entry is later reviewed by the CFO and the company’s disclosure committee.

Required

a. Research PCAOB AS 2201 and summarize the auditor’s responsibility to address the risk of fraud when understanding the entity’s system of internal control.

b. Consider what you know about Omega Airways and explain why the revenue in the income statement is at significant risk of fraudulent financial reporting by management.

c. Evaluate the internal controls Omega has established over unearned revenue and revenue recognition.