The Wellington Plaza 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. The second largest group of clients consists of groups of (mainly) women visiting the city for its great shopping. All major department stores have a presence in the city and there are also lots of specialty shops and factory outlets. Another large group of clients are groups of (mainly) men visiting the city for various sports events, including several important hockey games during the winter.
Occupancy rates have been reasonable but stagnant for several years, providing a steady but unsatisfactory 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, long-term 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.
The global financial crisis has hit the hotel business very hard this financial year. Business travel is down by 25 percent across the country. Further, discretionary retail spending is down by 40 percent. Several specialty shops in the city have already shut down and others are cutting their opening hours. In addition, the hockey series was won by the local team in four games (instead of the possible seven games). Thousands of visitors left the city early once the game was over. Just before the hockey games began, 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 financing 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 summer will bring a large lift in occupancy (and revenue) as the weather is expected to be nice. This expected summer trade is essential to meet repayments on the long-term debt and to 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.
