final march 2017 paper 1 no. of questions: 7 total marks: 100 · 2017-04-17 · prime/44th me/final...

PRIME/44th ME/FINAL 1

The Society of Auditors and Prime Academy Model Exam – FINAL – March 2017

Paper 1 – Financial Reporting No. of Questions: 7 Total Marks: 100 No. of Pages: 5 Time Allowed: 3 hrs

Your answers should be supported by working Notes and assumptions where required.

1. a) An employee Johar has joined a company ABC Ltd. in the year 2015. The annual emoluments

of Johar as decided is ` 14,90,210. The company also has a policy of giving a lump sum payment of 25% of the last drawn salary of the employee for each completed year of service if the employee retires after completing minimum 5 years of service. The salary of Johar is expected to grow @ 10% per annum. The company has inducted Johar in the beginning of the year and it is expected that he will complete the minimum five year term before retiring. What is the amount the company should charge in its Profit and Loss account every year as cost for the Defined Benefit obligation? Also calculate the current service cost and the interest cost to be charged per year assuming a discount rate of 8%. (P.V factor for 8% - 0.735, 0.794, 0.857, 0.926, 1)

b) Milton Ltd. is a full tax free enterprise for the first 10 years of its existence and is in the second year

of its operations. Depreciation timing difference resulting in a deferred tax liability in years 1 and 2 is ` 200 lakhs and 400 lakhs respectively. From the 3rd year onwards, it is expected that the timing difference would reverse each year by ` 10 lakhs. Assuming tax rate @ 35%, find out the deferred tax liability at the end of the second year and any charge to the profit and loss account.

c) On 1.4.2008, C Ltd. purchased an asset for ` 10 lakhs with an estimated useful life of 10 years

The machine is depreciated on straight line basis. On 1.4.2011, the asset was revalued to ` 8,40,000 and the surplus arising out of revaluation being credited to revaluation reserve. During the year ended 31.3.2014, the asset was reviewed for impairment and recoverable amount of the asset was ascertained to be only ` 4,30,000. Next year, there were some favourable changes in the market conditions and the recoverable amount of the asset was reassessed at ` 5,00,000. You are required to calculate the carrying amount of the asset as on 31.3.15 and show how changes in value of the asset is to be treated in the books of accounts, assuming C. Ltd. has the policy of writing down excess depreciation charged on revaluation to Revaluation Surplus.

d) On January 1, 2013, S Ltd. sold equipment to B Ltd. for ` 6,14,460. The carrying amount of the

equipment on that date was ` 1,00,000. The sale was a part of the package under which B Ltd. leased the asset to S Ltd. for a ten-year term. The economic life of the asset is estimated at 10 yea` The minimum lease rent payable by the lesser has been fixed at ` 1,00,000 payable annually beginning December 31, 2013. The incremental borrowing interest rate of S Ltd. is estimated at 10% per annum. Calculate the net effect on the profit and loss account?

(4 x 5=20 Marks)

PRIME A

CADEMY


2. Evil Ltd. purchased control of Devil Ltd. on 01.10.2012. Following are the summarized Balance Sheets

of Evil Ltd. and Devil Ltd. as at 31st March, 2013: Liabilities Evil Ltd. Devil Ltd. Assets Evil Ltd. ` Devil Ltd.

Equity Capital (Rs 10) General Reserves Profit & Loss Account Trade Payables

6,00,000 60,000

1,00,000 1,00,000

8,60,000

3,00,000 50,000

1,00,000 80,000

5,30,000

Goodwill Land & Buildings Plant & Machinery Investment:22,500 Shares of Devil Ltd. Inventory Trade Receivables Cash at Bank

10,000 1,00,000 2,00,000

3,37,500 1,17,500

50,000 45,000

8,60,000

40,000 1,00,000 1,80,000

1,00,000 90,000 20,000

5,30,000

On 01.04.2012, Devil Ltd. had ` 50,000 in General Reserve and Rs 60,000 in Profit and Loss A/c. On 30th September 2012, 10% dividend was declared by Devil Ltd. in respect of financial year 2011-12 from its profit and loss account. Evil Ltd. credited its share of dividend, on receipt, to the Profit and Loss Account. Trade receivables of Devil Ltd. include ` 10,000 due from Evil Ltd. Machinery of Devil Ltd. standing in books at ` 2,00,000 as on 1.4.2012, was revalued at ` 2,40,000. Inventory of Evil Ltd. includes goods valued at ` 16,000 purchased from Devil Ltd., on which the latter made a profit of 1/3rd on cost price. Prepare the Consolidated Balance Sheet of Evil Ltd. and its subsidiary Devil Ltd. as on 31.03.2013.

(16 Marks)

3. a) Jayadev Ltd. had earned a PAT of ` 48 lakhs for the year ended 2013. It wants you to ascertain the

value of its business, based on the following information. 1. Tax rate for the year 2013 was 36%. Future tax rate is estimated at 34%. 2. The company's equity shares are quoted at Rs 120 at the Balance Sheet date. The company had an

equity capital of Rs 100 lakhs, divided into shares of ` 50 each. 3. Profits for the year 2013 have been calculated after considering the following in the Profit and Loss

Account: (i) Subsidy ` 2 lakhs received from the Government towards fulfilment of certain social

obligations. The Government has withdrawn this subsidy and hence, this amount will not be received in future.

(ii) Interest 8 lakhs is on term loan. The final instalment of this term loan was fully settled in this year.

(iii) Managerial remuneration ` 15 lakhs. The shareholders have approved an increase of ` 6 lakhs in the overall managerial remuneration, from the next year onwards. Loss on sale of fixed assets and Investments amounting to ` 8 lakhs (8 Marks)

b) On 1.1.2010, Happy Ltd. grants to its senior officer, a right to choose either 250 shares (with some

post-vesting restrictions) or a cash payment equal to value of 200 shares, conditional upon remaining in service for 3 years Fair value of a share without considering post-vesting restrictions is ` 70 on 1.1.2010, ` 75 on 31.12.2010, 80 on 31.12.2011 and ` 85 on 31.12.2012. Fair value of a share after taking into account post-vesting restrictions is ` 68 on 1.1.2010. Face value per share is ` 10. Give the amounts to be recognised each year. Also, give the journal entries for settlement if (1) employee chooses cash payments (2) employee chooses shares (8 Marks)

PRIME A

CADEMY


4. a) The following information is available of a concern; calculate E.V.A.:

Debt capital 12% 2,000 crores Equity capital 500 crores Reserve and surplus ` 7,500 crores Capital employed ` 10,000 crores Risk-free rate 9% Beta factor 1.05 Market rate of return 19% Equity (market) risk premium 10% Net Operating profit after tax Rs 2,100 crores Tax rate 30% (6 Marks)

b) A Limited and B limited decided to amalgamate and form a new company C limited. Prior to the amalgamation A limited had 50 lakh equity shares which were valued at ` 20 per share. B limited, prior to the amalgamation had 30 lakh shares which were valued at ` 15 Rs per share. The value per share of new company C limited was ` 10/- per share. Discuss the concept of legal acquirer vis-à-vis accounting acquirer enshrined in IND AS 103 based on the above data. How does the situation change under AS 14. (10 Marks)

5. a) From the following data, prepare a Value Added Statement of Merit Ltd., for the year ended 31.3.2012:

Particulars Rs ` Rs Particulars `

Decrease in Stock 24,000 Sales 40,57,000 Purchases 20,20,000 Other Income 55,000 Wages & Salaries 10,00,000 Manufacturing & Other Expenses 2,30,000 Finance Charges 4,69,000 Depreciation 2,44,000 Profit Before Taxation 1,25,000 Total 41,12,000 41,12,000

Particulars Rs ` Profit Before Taxation 1,25,000 Less: Tax Provisions (40,000) Income Tax Payments (for earlier years) (3,000) Profit After Taxation 82,000 Appropriations of PAT Debenture Redemption Reserve 10,000 General Reserve 10,000 Proposed Dividend 35,000 Balance carried to balance Sheet 27,000 Total 82,000

(10 Marks) b) Mega Ltd. issued ` 100,00,000 worth of 8% debentures of face value ` 100 each on par value basis on

1st January 2011. These debentures are redeemable at 12% premium at the end of 2014 or exchangeable for ordinary shares of Mega Ltd. on 1:1 basis. The interest rate for similar debentures that do not carry conversion entitlement is 12%. You are required to calculate the value of debt portion of the above compound financial instrument. The PV of rupee at the end of years 1 to 4 at 8% and 12% are supplied to you as:

PRIME A

CADEMY


8% 12% End of year 1 0.926 0.893 End of year 2 0.857 0.797 End of year 3 0.794 0.712 End of year 4 0.735 0.636

(6 Marks)

6. Given below is the summarized Balance Sheet of Hello Ltd. as on 31.3.2015: (` in lakhs) Equity share capital 4.00 Block assets less depreciation to 6.00

(in equity shares of ` 10 date

each) Inventory and trade receivables 5.30

10% preference share capital 3.00

General reserve 1.00 Cash and bank 0.70

Profit and loss account 1.00

Trade payables 3.00

12.00 12.00

Good Ltd. another existing company holds 25% of equity share capital of Hello Ltd. purchased at ` 10 per share. It was agreed that Good Ltd. should take over the entire undertaking of Hello Ltd. on 30.9.2015 on which date the position of current assets (except cash and bank balances) and trade payables was as follows: Inventory and trade receivables ` 4 lakhs Trade payables ` 2 lakhs Profits earned for half year ended 30.09.2015 by Hello Ltd. was ` 70,500 after charging depreciation of ` 32,500 on block assets. Hello Ltd. declared 10% dividend for 2014-15 on 30.08.2015 and the same was paid within a week. Goodwill of Hello Ltd. was valued at ` 80,000 and block assets were valued o n d a te o f ta k e o ve r at 10% over their book value stated as on 31.3.2015, for purposes of take over. Preference shareholders of Hello Ltd. will be allotted 10% preference shares of ` 10 each by Good Ltd. Equity shareholders of Hello Ltd. will receive requisite number of equity shares of ` 10 each from Good Ltd. valued at ` 10 per share. (a) Compute the purchase consideration. (b) Explain, how the capital reserve or goodwill, if any, will appear in the Balance Sheet of Good Ltd. after absorption. (16 Marks)

7. Answer Any 4 Of The Following 5 Questions a) Rock star Ltd. discontinues a business segment. Under the agreement with employee’s union,

the employees of the discontinued segment will earn no further benefit. This is a curtailment without settlement, because employees will continue to receive benefits for services rendered before discontinuance of the business segment. Curtailment reduces the gross obligation for various reasons including change in actuarial assumptions made before curtailment. In this, if the benefits are determined based on the last pay drawn by employees, the gross obligation reduces after the curtailment because the last pay earlier assumed is no longer valid. Assuming the following: (i) Immediately before the curtailment, based on current actuarial assumption, the gross obligation

was estimated at ` 6,000. (ii) The fair value of plan assets on the date was estimated at ` 5,100. (iii) The unamortized past service cost was ` 180. (iv) Curtailment reduces the obligation by ` 600, which is 10% of the gross obligation.

PRIME A

CADEMY


Rock star Ltd. estimates the shares of unamortized service cost that relates to the part of the obligation that is estimated at 10% of ` 180 at ` 18. Calculate the gain from curtailment and liability after curtailment to be recognised in the balance sheet

b) P Ltd. had 12,00,000 equity shares of ` 10 each fully paid up outstanding prior to rights issue. The details of rights issue are as follows: (i) One new share for every two shares outstanding. (ii) Rights issue price – ` 18 (iii) Last date to exercise rights is 31st December, 2011 (iv) Fair value of each equity share prior to exercise of rights – Rs 24 The details of net profit earned by the company as follows: Year ended 31-3-2011 ` 40,00,000 Year ended 31-3-2012 ` 54,00,000 Calculate EPS to be reported under AS-20.

c) The Chief Accountant of S Ltd. gives the following data regarding its six Segments

` in lakhs The Chief accountant is of the opinion that segments “M” and “N” alone should be reported. Is he justified in his view? Discuss

d) Alert limited borrowed 10% debentures for ` 500 lakhs on 1st April 2014, interest is payable annually and principal is repayable after 3 years It incurred brokerage of ` 30 lakhs to an intermediary who arranged for the debentures to be fully subscribed on 1st April 2014. The Finance department worked out its pre tax cost of this debenture issue (Kd) @12.52% p.a. The chief accountant of Alert limited contends that the borrowing cost of Alert limited for the year ending 31st March 2015 is ` 50 lakhs being 10% of 500 lakhs borrowed. Comment on the accountants opinion assuming (i) AS 16 is applicable to Alert limited (ii) IND AS 23 is applicable to Alert limited.

e) From the following information, determine the possible value of brand as per potential

earning model: (` in lakhs)

Profits before tax 10,000

Income tax 2,500

Tangible fixed assets 30,000

Identifiable intangibles other than Brand 4,500

Weighted average cost of capital (%) 14%

Expected normal return on tangible assets (weighted average cost 14% 18%

+ Normal spread 4%)

Appropriate capitalization factor for intangibles is 25%. (4 x 4 =16 Marks)

Particulars M N O P Q R Total

Segment Assets Segment Results Segment Revenue

40 50

300

80 -190 620

30 10 80

20 10 60

20 -10 80

10 30 60

200 -100

1,200

PRIME A

CADEMY


The Society of Auditors and Prime Academy 44thsession Model Exam – Final – Financial Reporting

Suggested Answers

1. A) Calculation of Defined Benefit Obligation

Expected last drawn salary=`14,90,210 x 110% x 110% x 110% x 110% x 110% = ` 24,00,000 Defined Benefit Obligation (DBO)= ` 24,00,000 x 25% x 5= ` 30,00,000 Amount of `6,00,000 will be charged to Profit and Loss Account of the company every year as cost for Defined Benefit Obligation. Calculation of Current Service Cost Year Equal apportioned amount of

DBO [i.e. ` 30,00,000/ 5years]

Discounting @ 8% PV

factor

Current service cost

(Present Value) A B C d = b x c

1 6,00,000 0.735 (4 Years) 4,41,000

2 6,00,000 0.794 (3 Years) 4,76,400

3 6,00,000 0.857 (2 Years) 5,14,200

4 6,00,000 0.926 (1 Year) 5,55,600

5 6,00,000 1 (0 Year) 6,00,000

Calculation of Interest Cost to be charged per year Year Opening balance Interest cost Current service cost Closing balance

A b c = b x 8% d e = b + c + d

1 0 0 4,41,000 4,41,000

2 4,41,000 35,280 4,76,400 9,52,680

3 9,52,680 76,214 5,14,200 15,43,094

4 15,43,094 1,23,447 5,55,600 22,22,141

5 22,22,141 1,77,859* 6,00,000 30,00,000

*Due to approximations used in calculation, this figure is adjusted accordingly.

B) In the case of tax free companies, no deferred tax liability is recognized, in respect of timing differences that originate and reverse in the tax holiday period. Deferred tax liability or asset is created in respect of timing differences that originate in a tax holiday period but are expected to reverse after the tax holiday period. For this purpose, adjustments are done in accordance with the FIFO method. Of ` 200 lakhs, 80 lakhs will reverse in the tax holiday period. Therefore, Deferred Tax Liability will be created on ` 120 lakhs @ 35% i.e. ` 42 lakhs. In the second year, the entire ` 400 lakhs will reverse only after the tax holiday period. Therefore, deferred tax charge in the Profit and Loss Account will be ` 400 x 35% = `140 lakhs and deferred tax liability in the Balance Sheet will be (42+140) = ` 182 lakhs.

PRIME A

CADEMY


C) (a) Calculation of carrying amount as on 31.03.2015: `

Cost of the asset purchased on 01.04.2008 10,00,000

Less: Depreciation 3 years – upto 31.03.2011 (3/10) (3,00,000)

Carrying amount as on 31.03.2011 7,00,000

Add: Upward revaluation as on 01.04.2011 credited to Revaluation Reserve 1,40,000 Carry amount as on 01.04.2011 8,40,000

Less: Depreciation 3 years – upto 31.03.2014 (3/7) (3,60,000)

4,80,000

Less: Impairment loss due to recoverable amount being ` 4,30,000 (50,000)


Less: Depreciation for 2014-15 (4,30,000/4) (1,07,500)

3,22,500

Add: Reversal of impairment (as per Working Note 2) 37,500


Working Notes:

1. Statement showing balance of Revaluation Reserve

2. Treatment of Impairment loss: Reversal of impairment loss should not exceed the carrying amount

that would have been determined (net of depreciation) has no impairment loss been recognized for the asset in prior accounting periods. `

Carrying amount of the asset before impairment as on 4,80,000

31.03.2014

Less: Depreciation for the year 2014-15 (1,20,000)

Carrying amount of the asset as on 31.03.2015 3,60,000

Carrying amount as calculated after impairment (3,22,500)

Reversal of impairment to be transferred to Revaluation surplus 37,500

Impairment gain to be ignored: 5,00,000

Recoverable amount on 31.03.2015 (3,60,000)

Less: Carrying amount on 31.03.2015 1,40,000

`

Revaluation Reserve credited on 01.04.2011 1,40,000

Less: Excess depreciation charges due to revaluation for

3 years upto 31.03.2014 [(1,40,000/7) x 3] (60,000)

Revaluation Reserve balance on 31.03.2014 80,000

Less: Impairment loss on 31.03.2014 (50,000)


Less: Depreciation charge for 2014-15 (7,500)

22,500

Add: Reversal of impairment on 31.03.2015 37,500


PRIME A

CADEMY


D) The PV of minimum lease payments at 10% discount rate: = ` 1,00,000 X 6.1446 = ` 6,14,460 S Ltd. should recognize the asset and the liability at ` 6,14,460. The excess of sales proceeds over carrying amount = ` 6,14,460 – ` 1,00,000 = Rs5,14,460 As per para 48 of AS 19 ‘Leases’, if a sale and leaseback transaction results in a finance lease, any excess or deficiency of sale proceeds over the carrying amount should not be immediately recognised as income or loss in the financial statements of a lessee. Instead, it should be deferred and amortised over the lease term in proportion to the depreciation of the leased asset. Therefore, assuming that S Ltd. has decided to charge depreciation on straight line basis, AS 19 requires S Ltd. to: a. Recognize depreciation of ` 61,446 per annum for 10 years b. Allocate excess of ` 5,14,460 over the lease term at the rate of ` 51,446 p.a. The net effect is a debit of (` 61,446 – ` 51,446) ` 10,000 per annum to the profit and loss account for 10 years, as covered under the lease term. Had there been no sale and lease back transaction, the profit and loss account for each year covered in the lease term would have been charged by (` 1,00,000/10) or ` 10,000, towards depreciation. Thus, the sale and lease back transaction has no impact on profit or loss to be reported by the lessee (vendor in the sale transaction) over the lease period. The deferred income (excess) should be presented as a deduction from the carrying amount of the asset. Thus, the asset should be presented by S Ltd. in its Balance Sheet dated December 31, 2013 as follows:

`

Gross Block 6,14,460

Less: Accumulated depreciation (61,446)

Net Block 5,53,014

Less: Deferred Income (5,14,460 – 51,446) (4,63,014)

Net Block 90,000

In effect, the carrying amount of the equipment does not change with the sale and lease back transaction. In substance, the sale and lease back transaction is a borrowing transaction resulting in recognition of a liability in the balance sheet and recognition of interest expense in the profit and loss account.

2. Consolidated Balance Sheet of Evil Ltd. with its subsidiary Devil Ltd. as on 31st March, 2013 Notes No. `

I. Equity and Liabilities (1) Shareholder's Funds

(a) Share Capital 1 6,00,000

(b) Reserves and Surplus 2 1,93,000

Minority interest (W.N. 4) Current Liabilities

1,23,500

Trade payables Total 3

1,70,000

10,86,500 II. Assets (1) Non-current assets Fixed assets

Tangible assets 4 6,28,000

Intangible assets (2) Current assets

5

50,000

(a) Inventories 6 2,13,500

(b) Trade receivables 7 1,30,000

PRIME A

CADEMY


(c) Cash and cash equivalents

8

65,000

10,86,500 Notes to Accounts ` ` `

1. Share Capital

Equity shares of ` 10 each, fully paid up 6,00,000

2. Reserves and surplus

Capital reserve (W.N.3) 33,750

General reserve 60,000

Profit and loss account (W.N. 6) 99,250 1,93,000

3 Trade Payables.

Evil Ltd. 1,00,000

Devil Ltd 80,000

1,80,000

Less: Mutual indebtedness (10000) 1,70,000

3 Tangible Assets

Land and buildings

Evil Ltd. Devil Ltd.

1,00,000 1,00,000

2,00,000

Plant and machinery

Evil Ltd Devil Ltd. 1,80,000 Add: Upward revaluation 50,000 2,30,000 Less: Excess Depreciation on upward Revaluation (2,000)

2,00,000

2,28,000

4,28,000

6,28,000

4 Intangible Assets Evil Ltd. Devil Ltd.

10,000 40,000

50,000

5 Inventories Evil Ltd Devil Ltd Less: Unrealised profit)

1,17,500. 1,00,000 2,17,500

(4,000)

2,13,500 6 Trade receivables

Evil Ltd. Devil Ltd. Less: Mutual indebtness

50,000 90,000

1,40,000 (10,000)

1,30,000 7 Cash and cash equivalents

Bank Balances Evil Ltd. Devil Ltd.

45,000 20,000

65,000

PRIME A

CADEMY


` Pre-acquisition profitupto 1.10.2012 (Capital profits)

Post acquisition profits (2.10.2012–31.3.2013)) Profit and loss account

50000 General reserve as on 31.3.2013 Profit and loss account as on 31.3.2013 1,00,000 Less: Opening Balance 60,000 Less: Dividend for 2011-12 (out of pre acquisition profits (30000)

30000

70000 35000 35000 Upward revaluation of plant and machinery ason 1.10.2012 (W.N.2)

50000

Excess depreciation (for 6 months) due to upward revaluation (W.N.2)

(2000)

Total 165000 33000 Minority Interest (25%) 41,250 8,250 Share of Evil Ltd. (75%) 1,23,750 24,750 i) Revaluation of Plant & Machinery of Devil Ltd. and its book value as on 31.3.2013 Depreciation during the year = Opening Balance less Closing Balance = 2,00,000 – 1,80,000 = 20,000 Depreciation rate = (20,000/2,00,000) x 100 = 10% (a) Computation of Revaluation Gain / Loss `

Revalued Amount on 01.10.2012 (date of acquisition) Less: Book Value on 01.10.2012 (date of acquisition) Value on 01.04.2012 Rs 2,00,000

2,40,000

Less: Depreciation for 6 months at 10% (Rs10,000) 1,90,000

Revaluation Gain i.e. Capital Profit 50,000

(b) Computation of Depreciation on Revaluation Gain / Loss `

Depreciation on Revalued Plant for 6 months 2,40,000 × 6/12 × 10% Less: Depreciation already provided on Rs 2,00,000 × 6/12 × 10% Revenue Loss

12,000 (10,000)

2,000

ii) Calculation of cost of control `

Share capital in Devil Ltd. 2,25,000

Add: Capital profit 1,23,750

Less: Cost of Investments 3,37,500

3,48,750

Less: Pre-acquisition dividend received for 2011-12 (22,500) (3,15,000)

Capital Reserve 33,750

PRIME A

CADEMY


iii) Calculation of minority interest [25%] `

Share capital 75,000

Capital (pre-acquisition) profits [W.N.1] 41,250

Revenue (post-acquisition) profits - Profit and loss [W.N.1] 8,250 1,24,500 Less: Unrealised profit [W.N. 5]

(1,000) 1,23,500

iv) Stock reserve (plant and machinery) Unrealized profit =16 ,000 x 1/ 3 =Rs 4,000 4/3 To be adjusted from minority interest and consolidated profit and loss account in the ratio of 25:75. v) Consolidated profit and loss account as on 31.3.2013 `

Profit and loss account balance of Evil Ltd. as on 31.3.2013 1,00,000

Less: Pre-acquisition dividend wrongly credited (22,500) 77,500

Add: Share in post-acquisition profit and loss account of Devil Ltd. (W.N.1) 24,750

Less: Unrealized profit [W.N. 5] (3,000)

99,250

Note: Unrealized profits on closing stock have been eliminated to the extent of holding company’s share in Profit and Loss Account and balance adjusted in Minority Interest as it relates to upstream transaction.

3. A)Computation of Future Maintainable Profits

Particulars `

Profit after tax for the year 2013 48,00,000

Add: Tax expense (Tax is 36%, So, PAT = 64%. Hence, Tax = 48,00,000 x 36/64) 27,00,000

Profit before tax for the year 2013 Add/ (Less) Adjustments in respect of non-recurring items

75,00,000

Subsidy income not receivable in future (2,00,000)

Interest on term loan not payable in future, hence saved 8,00,000

Additional managerial remuneration Loss on sale of fixed assets and investments (non-

(6,00,000)

recurring) 8,00,000

Future maintainable profits before tax 83,00,000

Less: Tax expense at 34% Future maintainable profits after tax equity earnings

(28,22,000)

54,78,000

PRIME A

CADEMY


Computation of capitalization rate and value of business Particulars ` (a) Profit after tax for the year 2013 48 lakhs

(b) Number of equity shares (` 100 lakhs / ` 50 per share) 2 lakhs

(e) Earnings per share (EPS) = PAT/Number of Equity Shares Rs24

(d) Market price per share on balance sheet date Rs120

(e) Price Earnings Ratio = MPS / EPS 5

(f) Capitalization Rate = (1 / PE Ratio) x 100 20%

(g) Value of Business = Future Maintainable Profits /Capitalization Rate = ` 54.78 Lakhs / 20%

` 273.90 lakhs

B) Fair value under equity settlement = 250 shares x ` 68 = ` 17,000 Fair value under cash settlement = 200 shares x ` 70 = Rs 14,000 So, fair value of equity component = ` 17,000 –` 14,000 = ` 3,000 Fair value of liability component = ` 14,000 Fair value of liability component should be accounted for as per cash- settled employee share-based plan. Fair value of equity component should be accounted for as per equity-settled employee share-based payment plan. Amounts to be recognised for liability component:

Particulars 31.12.10 31.12.11 31.12.12

A Fair value of share without restrictions 75 80 85

B Closing provision required 5,000 10,667 17,000

[200 x 75 x 1 /3] [200 x 80 x 2/3] [200x85 x 3/3]

C Opening provision 0 5,000 10,667

D Expense for the year (B - C) 5,000 5,667 6,333

Amounts to be recognised for equity component:

Particulars 31.12.10 31.12.11 31.12.12

Cumulative expense to be recognised till date

1,000 3000x1/3,

2,000

3000x2/3

3,000

3000x2/3

Cumulative expense already

Recognized 0 1000 2000

Expense for the year (E - F) 1000 1000 1000

PRIME A

CADEMY


Particulars Debit Credit

Year 31.12.10 (`) ( `)

Employee compensation expense A/c Dr. 5,000

To Provision for liability component of employeeshare-based payment plan A/c 5,000

(Being expense recognised in respect of liability component of the plan with cash alternative)

Year 31.12.10


To Stock options outstanding A/c 1,000

(Being expense recognised in respect of equity component of the plan with cash alternative)

Year 31.12.11


To Provision for liability component of employee share-based payment plan AIc 5,667

(Being expense recognised in respect of liability component of the plan with cash alternative)

Year 31.12.11


To Stock options outstanding A/c 1,000

(Being expense recognised in respect of equity component of the plan with cash alternative)

Year 31.12.12


To Provision for liability component of employeeshare-based payment plan AIc 6,333

(Being expense recognised in respect of liabilitycomponent of the plan with cash alternative)

Year 31.12.12


To stock option O/S 1000

Being expense recognised in respect of equity component of the plan with cash alternative

PRIME A

CADEMY


Case (2) - When equity settlement is made: Stock options outstanding A/c Dr. 3000 Provision for liability component of employeeshare-based payment plan A/c

17000

To Share capital A/c 2500 To Securities premium A/c 17500 Being shares issued under the plan on exercise of equity alternative)

4. A) E.V.A. = NOPAT – COCE

NOPAT = Net Operating Profit after Tax COCE = Cost of Capital Employed COCE = Weighted Average Cost of Capital × Average Capital Employed

= WACC × Capital Employed Debt Capital ` 2,000 crores Equity capital (500 + 7,500) = ` 8,000 crores Capital employed = ` 2,000+ ` 8,000= ` 10,000 crores Debt to capital employed = 2,000 /10000= 0.20 Equity to Capital employed = 8,000/10000= 0.80 Debt cost before Tax 12% Less: Tax (30% of 12%) 3.6% Debt cost after Tax 8.4% According to Capital Asset Pricing Model (CAPM) Cost of Equity Capital = Risk Free Rate + Beta × Equity Risk Premium (Or)

= Risk Free Rate + Beta (Market Rate – Risk Free Rate) = 9 + 1.05 × (19-9) = 9 + 1.05 × 10 = 19.5%

WACC = Equity to CE x Cost of Equity capital + Debt to CE x Cost of debt = 0.8× 19.5% + 0.20× 8.40% = 15.60% + 1.68% = 17.28%

COCE = WACC × Capital employed = 17.28% × 10,000 crores = ` 1728 crores

E.V.A. = NOPAT – COCE = ` 2,100 – ` 1,728 = ` 372 crores

B) Computation of PC in shares to A limited 20/10 * 50 lakh shares = 100 lakh shares Computation of PC in shares to B limited 15/10*30 lakh shares = 45 lakh shares

Case (1) - When cash settlement is made:

Provision for liability component of employee share- based payment plan A/c 17000

To Bank A/c 17000

Being cash paid under the plan with cash alternative)

Stock options outstanding AIc 3000

To General reserve A/c 3000

(Being balance in the equity account transferred to general reserve)

PRIME A

CADEMY


Therefore the combined entity post merger will have 145 lakh shares. Out of this 145 lakh shares, shareholders of A limited will hold 100 lakh shares and therefore will control the combined entity. Hence under IND AS 103, A limited is the accounting acquirer although the legal seller. Therefore under IND AS, in the books of C (combined entity), A limited’s net assets will be at book value and B limited net assets will come in at fair values. Under AS 14, both A limited and B limited will be legal sellers and C limited will be the purchaser. Hence net assets of both A limited and B limited will come at fair values in the books of C limited after the merger.

5. A) Value Added Statement of Merit Ltd. For the year ended 31.03.2012

Particulars ` ` Sales/Turnover 40,57,000 Less: Cost of Bought out goods and services Decrease in Stock 24,000 Purchases 20,20,000 Manufacturing and other expenses 2,30,000 (22,74,000) Value Added by manufacturing and Trading Activities

17,83,000

Add: Other Income 55,000 Gross Value Added 18,38,000 Applied as follows: ` ` 1. To Pay Employees - Salaries, Wages, etc 10,00,000 2. To Pay Government as - Taxes, Duties etc (40,000) 40,000 3. To Pay Providers of capital - Interest on borrowings 4,69,000 - Dividends 35,000 5,04,000 4. To Pay for Maintenance and Expenses of the Company

- Depreciation 2,44,000 - Debenture Redemption Reserve 10,000 - General Reserve 10,000 - Retained Earnings 27,000 Income tax earlier years 3,000 2,94,000 Total Application of Value Added 18,38,000 Income tax earlier years can be disclosed as part of Holders or as part of Government. In the solution not shown as part of ‘G’ as it will alter the taxes paid to Government in current year. Hence adjusted in H (Holders of capital)

B) PV of debentures redeemable (including premium) in 2014

` 100,00,000 x 1.12 x 0.636) = ` 71,23,200

PV of interest on debentures ( ` 8,00,000 x 3.038 sum of 4 yrs disc fac @ 12%) = ` 24,30,400

Value of Debt portion of convertible debentures

= ` 95,53,600

Therefore Value of Equity portion = ` 100,00,000 – ` 95,53,600 =` 4,46,400

PRIME A

CADEMY


6.Calculation of Purchase Consideration (for net assets of Hello Ltd taken over) Assets taken over: `

Goodwill as agreed 80,000

Block Assets at 10% over their book value as on 31.3.2015 6,60,000*

(agreed value for purposes of take over 6,00,000 X 110%)

Inventory and trade receivables as on 30.09.2015 4,00,000

Cash and Bank (See Working Note) 1,33,000

12,73,000

Less: Liabilities taken over:

Trade payables as on 30.09.2014 (2,00,000)

Purchase Consideration 10,73,000

Calculation of Shares Allotted: `

Net Assets taken over 10,73,000

Less: Allotment of 10% preference shares to preference shareholders

of Hello Ltd. (3,00,000) 7,73,000

Less: Belonging to Good Ltd. (1/4 x` 7,73,000) (1,93,250)

Payable to other equity shareholders 5,79,750

Number of equity shares of `10 each to be issued (valued at `10 each)=57,975 Calculation of Capital Reserve: ` `

Net Assets taken over (3,00,000)

10,73,000

Less: Preference shares to be allotted

Equity shares to be allotted (5,79,750)

Cost of investments (1,00,000) (9,79,750)

Capital Reserve 93,250

Alternatively, Capital Reserve may be computed as

follows:

Value of investments in HELLO Ltd. 1,93,250

Less: Cost of investments (1,00,000)

93,250

Balance Sheet of Good Ltd. As at 30th September, 2015 (Extract) Particulars Note No. `

Equity and Liabilities Shareholder's Funds Reserves and Surplus

1

13,250

Notes to accounts 51. Reserves and Surplus Capital Reserve Less: Goodwill

93,250

(80,000)

`

13,250

PRIME A

CADEMY


Working Note: Ascertainment of Cash and Bank Balances as on 30th September,2015 Balance Sheet as at 30th September,2015 Particulars Note No. ` Equity and Liabilities Shareholder's Funds Share Capital Reserves and Surplus

1 2

7,00,000 2,00,500

(2) Current Liabilities Trade Payables Total Assets Non-current assets Fixed assets Tangible assets Current assets Inventories &Trade receivables Cash and cash equivalents (Bal. fig.) Total

3

4

5

2,00,000

11,00,500

5,67,500

4,00,000 1,33,000

11,00,500

Notes to Accounts ` ` `

1. 2. 3. 4.

Share Capital Equity Share Capital 10% Preference Share Capital Reserves and surplus General Reserve Profit and Loss Account: Balance brought forward Add: Profit for the first half Less: Dividend on preference share capital paid Dividend on equity share capital paid Trade Payables Tangible Assets Block Assets Less: Depreciation Inventories & Trade Receivables

1,00,000 70,500

4,00,000 3,00,000

1,70,500

(70,000)

6,00,000 (32,500)

7,00,000

1,00,000

1,00,500 30,000 40,000

1,00,500

2,00,500

2,00,000

5,67,500

4,00,000

PRIME A

CADEMY


7. A)Gain from curtailment is estimated as under

`

Reduction in gross obligation 600

Less: Proportion on unamortized past service cost 18

Gain from curtailment 582

The liability to be recognised after curtailment in the balance sheet is estimated as under:

`

Reduced gross obligation 5,400

Less: Fair value of plan assets 5,100

300

Less: Unamortized past service cost 162

Liability to be recognized in the balance sheet 138

B)Calculation of theoretical ex-rights fair value per share (12,00,000 shares × ` 24) + (6,00,000 shares × ` 18) 12,00,000 shares + 6,00,000 shares = ` 2,88,00,000 + ` 1,08,00,000 = 22 18,00,000 shares Calculation of adjustment factor =Fair value per share prior to exercise of rights / Theoretical ex –rights value per share ` 24 /` 22= 1.091 Calculation of EPS for the year ended 31.3.2009 EPS originally reported=` 40,00,000 = ` 3.33 12,00,000 shares EPS restated for rights issue = ` 40,00,000 = 12,00,000 shares × 1.091

40,00,000 13,09,200

= ` 3.05

Calculation of EPS for the year ended 31.3.2010

= ` 54,00,000 (12,00,000 × 1.091 × 9/12) + (18,00,000 × 3/12)

= 54,00,000 = 3.77 9,81,900 + 4,50,000

PRIME A

CADEMY


C) (i) As per para 27 of AS 17 ‘Segment Reporting’, a business segment or geographical segment should be identified as a reportable segment if: Its revenue from sales to external customers and from other transactions with other segments is 10% or more of the total revenue- external and internal of all segments; or (ii) Its segment result whether profit or loss is 10% or more of: (1) The combined result of all segments in profit; or (2) The combined result of all segments in loss, whichever is greater in absolute amount; or (iii) Its segment assets are 10% or more of the total assets of all segments. If the total external revenue attributable to reportable segments constitutes less than 75% of total enterprise revenue, additional segments should be identified as reportable segments even if they do not meet the 10% thresholds until at least 75% of total enterprise revenue is included in reportable segments. i) On the basis of turnover criteria segments M and N are reportable segments. ii) On the basis of the result criteria, segments M, N and R are reportable segments (since

their results in absolute amount is 10% or more of ` 200 lakhs). iii) On the basis of asset criteria, all segments except R are reportable segments. Since all the

segments are covered in at least one of the above criteria all segments have to be reported upon in accordance with Accounting Standard (AS) 17. Hence the opinion of chief accountant is wrong

D) The contention of the accountant is wholly incorrect.AS 16

Borrowing cost includes interest cost and amortization of related expenses on the borrowal of funds. Therefore, borrowing cost for the year ending 31/3/15 will be interest cost of 50 lakhs plus brokerage cost of 30 lakhs = 80 lakhs (assuming full brokerage cost is amortized immediately) IND AS 23 Under IND AS 23, borrowing cost is worked out on the effective amortization method. Since the effective rate is 12.52% p.a., borrowing cost for the year ending 31/3/15 will be (500-30) * 12.52%, i.e. 470*12.52% = 58.844 lakhs.

E) Calculation of Possible Value of Brand (` in lakhs)

Profits after Tax (`10,000 -2,500) lakhs 7,500

Less: Profit allocated to tangible assets (18% of ` 30,000 lakhs) (5,400)

Profit allocated to intangible assets including brand 2,100

Capitalization factor @ 25%

Capitalized value of intangibles including brand (` 2,100 lakhs/25%) 8,400

Less: Identifiable intangibles other than Brand (4,500)

Brand Value 3,900

PRIME A

CADEMY

PRIME/44th ME/FINAL (1)

The SocieTy of AudiTorS & Prime AcAdemy

model exam – fiNAL – march 2017

Paper 2 – STrATeGic fiNANciAL mANAGemeNT

No. of Questions: 7 Total marks: 100No. of Pages: 5 Time Allowed: 3 hrs

your answers should be supported by working Notes and assumptions where required.

[ Qn. 1 is compulsory. Answer any 5 from the rest ]

1(a). A company has invested Rs.500 lakhs in assets. There are 50 lakhs shares outstanding. The par value per share is Rs.10/-. It earns a rate of 15% on its investment and has a policy of retaining 50% of the earnings. If the appropriate discount rate of the firm is 10%, what is the price of its share using the Gordon’s model? What will happen to the price of the share if the company has a payout of 80% or 20%?

(b) A mutual fund began the year 2008 with a portfolio valued at Rs. 10 lakhs. It invested further into the fund and made withdrawals therefrom as per details below:

date contribution Withdrawal Portfolio value 31st Dec 07 10.031st Mar 08 1.0 10.530th June 08 2.0 11.030th Sep 08 12.031st Dec 08 13.0(i) Calculate the time-weighted rate of return for each quarter (ii) Calculate RWR for the year.

(c) M. Co. Ltd., is studying the possible acquisition of N Co. Ltd., by way of merger. The following data are available in respect of the companies: Particulars m co. Ltd. N co. Ltd. Earnings after tax (Rs.) 80,00,000 24,00,000 Number of equity shares 16,00,000 4,00,000 Market value per share (Rs.) 200 160

(i) Compute pre-merger EPS and PEM of both companies(ii) If the merger goes through the exchange of equity and the exchange ratio is based on the cur-

rent market price, what is the new earnings per share for M Ltd.? (iii) What is the gain or loss in (ii) above?(iv) N Co Ltd., wants to be sure that the earnings available to its shareholders will not be diminished

by the merger. What should be the exchange ratio in that case?

PRIME A

CADEMY


(d) The following data are available for a bondFace value Rs. 1,000

What is the current market price, duration and volatility of this bond? Calculate the expected market price, if increase in required yield is by 75 basis points.

Coupon Rate 16%Years to Maturity 6Redemption value Rs. 1,000Yield to maturity 17%

(4 x 5 = 20 marks)

2(a) Gretel Limited is setting up a project for manufacture of boats at a cost of Rs.300 lakhs. It has to decide whether to locate the plant in next to the sea shore (Area A) or in an inland area with no access to any waterway (Area B). If the project is located in Area B then Gretel Limited receives a cash subsidy of Rs.20 lakhs from the Central Government. Besides, the taxable profits to the extent of 20% is exempt for 10 years in Area B. the project envisages a borrowing of Rs.200 lakhs in either case. The rate of interest per annum is 12% in Area A and 10% in Area B.

The borrowing of principal has to be repaid in 4 equal installments beginning from the end of the 4th year.

With the help of the following information, you are required to suggest the proper location for the project to the CEO of Gretal Limited. Assume straight line depreciation with no residual value, income tax 50% and required rate of return 15%.

year earnings before depreciation, interest and Tax (eBdiT) (rs. in Lakhs)

Area A Area B1 (6) (50)2 34 (50)3 54 104 74 205 108 456 142 1007 156 1558 230 1909 330 23010 430 330

(b) Venkatesha & Co. Ltd., are planning to invest some amount in a machinery. From the table of fre-quency distribution for (i) estimated sales volume, (ii) selling price, and (iii) variable costs given be-low, determine the likely NPV of the project, using Monte Carlo simulation technique, and recom-mend its acceptance. The initial investment in the project is Rs.40,000 Annual fixed cost is Rs.7,500. Life of the project is six years. Cost of capital is 12%.

Sales Volume Selling Price Variable costsNumber Probability rupees Probability rupees Probability

5,000 0.3 3 0.2 1 0.37,500 0.3 4 0.5 2 0.612,500 0.4 5 0.3 3 0.1

Use the following random numbers: 81 32 60 04 46 31 67 2524 10 40 02 39 68 08 5966 90 12 64 79 31 86 6882 89 25 11 98 16 – –

(2 x 8 = 16 marks)

PRIME A

CADEMY


3(a) Alpha Ltd., and Gamma Ltd., are identical in every respect, except for their capital structure. Con-sider the following information, and compute the Equity Beta value of Gamma Ltd.a) Debt/Equity mix of Alpha : 1 : 4b) Equity beta value of Alpha : 1.30c) Debt/Equity mix of Gamma : 2 : 3d) Tax rate : 40%e) Debt is risk free.

(b) AB Ltd., is planning to acquire and absorb the running business of XY Ltd. The valuation is to be based on the recommendation of merchant bankers and the consideration is to be discharged in the form of equity shares to be issued by AB Ltd. As on 31.03.2006, the paid up capital of AB Ltd. consists of 80 lakhs shares of Rs.10 each. The highest and the lowest market quotation during the last 6 months were Rs.570 and Rs.430. For the purpose of the exchange, the price per share is to be reckoned as the average of the highest and lowest market price during the last 6 months ended on 31.03.06.

XY Ltd.’s Balance Sheet as at 31.03.2006 is summarised below: rs. lakhsSourcesShare Capital 20 lakhs equity shares of Rs.10 each fully paid 200 10 lakhs equity shares of Rs.10 each, Rs.5 paid 50Loans 100Total 350Uses Fixed Assets (Net) 150 Net Current Assets 200Total 350

An independent firm of merchant bankers engaged for the negotiation, have produced the following estimates of cash flows from the business of XY Ltd.:year ended By way of rs. lakhs31.03.07 After tax earnings for equity 10531.03.08 Do 12031.03.09 Do 12531.03.10 Do 12031.03.11 Do 100

Terminal value estimate 200

It is the recommendation of the merchant banker that the business of XY Ltd. may be valued on the basis of the average of (i) Aggregate of discounted cash flows at 8% and (ii) Net assets value. Present value factors at 8% for years

1-5: 0.93 0.86 0.79 0.74 0.68

You are required to:(i) Calculate the total value of the business of XY Ltd.(ii) The number of shares to be issued by AB Ltd.; and(iii) The basis of allocation of the shares among the shareholders of XY Ltd.

(2 x 8 = 16 marks)

PRIME A

CADEMY


4(a) An investor observes the market prices of 3-month calls and notes the following.

Exercise price Call price50 1160 770 6

The investor chooses to go long on two calls viz., 55 and 65 and writes two calls with an exercise price of Rs.60. Name the strategy adopted. Determine his payoff function for different levels of stock prices.

(b) An American firm is under obligation to pay interests of Can$ 1010000 and Can$ 705000 on 31st July and 30th September respectively. The Firm is risk averse and its policy is to hedge the risks involved in all foreign currency transactions. The Finance Manager of the firm is thinking of hedging the risk considering two methods i.e. fixed forward or option contracts.

It is now June 30. Following quotations regarding rates of exchange, US$ per Can$, from the firm’s bank were obtained:

Spot 1 month forward 3 months forward0.9284-0.9288 0.9301 0.9356

Price for a Can$ / US$ option on a U.S. stock exchange (cents per Can$, payable on purchase of the option, contract size Can$ 50000) are as follows:

Strike Price calls Puts(uS$/can$) July Sept. July Sept.

0.93 1.56 2.56 0.88 1.750.94 1.02 NA NA NA0.95 0.65 1.64 1.92 2.34

According to the suggestion of finance manager if options are to be used, one month option should be bought at a strike price of 94 cents and three month option at a strike price of 95 cents and for the remainder uncovered by the options the firm would bear the risk itself. For this, it would use forward rate as the best estimate of spot. Transaction costs are ignored.Recommend, which of the above two methods would be appropriate for the American firm to hedge its foreign exchange risk on the two interest payments.

(2 x 8 = 16 marks)

5(a) Kanpur Shoe Ltd. is having sluggish sales during the last few years resulting in drastic fall in market share and profit. The marketing consultant has drawn out a new marketing strategy that will be valid for next four years. If the new strategy is adopted, it is expected that sales will grow @ 20% per year over the previous year for the coming two years and @ 30% from the third year. Other parameters like gross profit margin, asset turnover ratio, the capital structure and the rate of Income tax @ 30% will remain unchanged. Depreciation would be 10% of the net fixed assets at the beginning of the year. The targeted return of the company is 15%.The financials of the company for the just concluded financial year 2015-16 are given below:

PRIME A

CADEMY


income statement Amount (rs.)

You are required to assess the incremental value that will accrue subsequent to the adoption of the new marketing strategy and advise the board accordingly.pv@15% for 1, 2 & 3 years are: 0.870, 0.756, 0.658 respectively.

Turnover 2,00,000Gross margin (20%) 40,000Admin, selling & distribution exp (10%) 20,000PBT 20,000Tax (30%) 6,000PAT 14,000Balance Sheet InformationFixed Assets 80,000Current Assets 40,000Equity share capital 1,20,000

(b) Gamma Limited is considering the acquisition of a computer costing Rs.50,000. The effective life of the computer is 5 years. The company plans to acquire the same either by borrowing Rs.50,000 from bankers at 15% p.a., or by lease. The company wishes to know the lease rentals to be paid annually, which will match the loan option. The following additional information is available:• Principal amount of loan is repayable in five equal instalments of Rs.10,000 at the end of each year.• Similarly, lease rentals as also interest on loan will also be paid at the end of the year• Depreciation on computer is on straight line basis, spread over its life• Tax rate is 40%, and after tax cost of capital is 9%• Resale value of the computer is Rs.2,222 at the end of five years, subject to a commission of

10% thereon, and taxes as applicable Determine the quantum of annual, equated lease rentals, for which Gamma’s would be indifferent

as between lease and borrow options? (2 x 8 = 16 marks)

6(a) FLL has agreed to extend a three year, HP loan on EMI basis to SBM Transports, for purchase of two numbers 2212 AL Trucks, invoice price of which is Rs.6.50 lakhs each. Body building costs Rs.2.50 lakhs each. If SBM Transports were to bring in their own money of Rs.1 lakh for each vehicle, and if the flat rate is 8.25% p.a., determine the quantum of EMI if (i) instalments are paid in arrears, and (ii) if instalments are to be paid in advance.

(b) Given below is information of market rates of Returns and Data from two Companies A and B:year 2002 year 2003 year 2004

Market (%) 12.0 11.0 9.0Company A (%) 13.0 11.5 9.8Company B (%) 11.0 10.5 9.5

Determine the beta coefficients of the Shares of Company A and Company B. (2 x 8 = 16 marks)

7. Write short notes on any four of the following:a. Standard deviaiton in the context of risk analysisb. Five merits of investing in mutual fundc. Three objectives of derivativesd. Four key issues in valuation of businesse. What is the difference between CAPM and Arbitrage Pricing Model

(4 x 4 = 16 marks)

PRIME A

CADEMY


The SocieTy of AudiTorS & Prime AcAdemymodel exam – fiNAL – march 2017

Paper 2 – STrATeGic fiNANciAL mANAGemeNT

SuGGeSTed ANSWerS

1(a). Pay out ratio = 50%WN 1: Earnings: 500L × 15% = 75L

EPS = Total Earnings––––––––––––No. of Shares =

75,00,000––––––––50,00,000 = 1.50

DPS = EPS×(1– retention ratio) DPS = 1.50 × (1 − 0.5) = 0.75

WN 2: g = b × r 50% × 15% = 7.5%

WN 3:

P0 = D1––––

Ke–g =

0.75––––––––––10% – 7.5%

P0 = Rs.30. Pay out ratio = 80%WN 1: EPS = 1.50 DPS = 1.5 × (1–0.2) = 1.20

WN 2: g = b × r = 20% × 15% = 3%

WN 3:

P0 = 1.2––––––––

10% – 3% = 1.2––––7%

P0 = Rs.17.143

Pay out ratio = 20%WN 1: EPS = 1.50 DPS = 1.50 × (1 − 0.8) = 0.30

WN 2: g = b × r = 80% × 15% = 12%

WN 3:

P0 = 0.3––––––––

10% – 12% = (Rs.15)

P0 is negative dividend indicating that Gordon’s model is inoperative when Ke < g

(b) (i) TWP for each quarterQuarter opening closing rate

1 10 10.5 5.00%2 10.5 11 4.76%3 11 12 9.09%4 12 13 8.33%

(ii) rWr for the year Qtr cash flow

0 (10)1 (1)2 23 04 13

RWR for the year = 35.73% (IRR)

(c) Part (i) details Acquirer (m) Target (N)(a) Earnings After Tax 8,000,000 2,400,000 (b) Number of Shares 1,600,000 400,000 (c) Market Price 200 160(d) Earnings Per Share [(a) / (b)] 5 6(e) PEM (a / d) 40.00 26.67

PRIME A

CADEMY

PRIME A

CADEMY


Part (ii) Post merger ePS XyZ ABc combined(a) Earnings After Tax 8,000,000 2,400,000 10,400,000 (b) Number of Shares 1,600,000 320,000 1,920,000 (c) Earnings Per Share [(a) / (b)] 5.42

Part (iii): New EPS/Adjusted EPS 5.42 4.336Old EPS 5 6Gain/Loss GAiN LoSS

Part (iv): The exchange ratio to ensure that EPS stays in tact is the ratio of EPS namely 6:5.

(d) (a) 1. calculation of market price

The market price of the bond is the present value of future cash flows associated with the bond discounted at the re-quired rate namely the YTM.

year cash flow df@17% dcf1 160 0.855 136.82 160 0.731 117.03 160 0.625 100.04 160 0.534 85.45 160 0.456 73.06 1160 0.390 452.4

Total 964.6

2. duration

year cash flow

df@ 17% dcf Proportion of

bond valueProportion of bond value x time (years)

1 160 0.855 136.80 0.142 0.1422 160 0.731 116.96 0.122 0.2443 160 0.624 99.94 0.104 0.3124 160 0.534 85.44 0.089 0.3565 160 0.456 72.96 0.076 0.3806 1160 0.390 452.40 0.467 2.802

964.40 1.000 4.236 Duration of the Bond is 4.236 years 3. Volatility Volatility of the bonds =

1.174.236

yields) 1 (Duration bonds theof Volatility =+

= = 3.62

4. The expected market price if increase in required yield is by 75 basis points. Price will fall by Rs. 960.26 × 0.75 (3.62/100) = Rs. 26.07 New Market Price Rs. 960.26 – Rs. 26.07 = Rs. 934.19

2(a) evaluation of Project A

evaluation from shareholders angle

year eBdiT depn. interest PBT Tax PAT cfAT Principal Total PVf PV1 (6) 30 24 (60) (30) (30) 0 0 0 0.87 0.02 34 30 24 (20) (10) (10) 20 0 20 0.76 15.23 54 30 24 0 0 0 30 0 30 0.66 19.84 74 30 24 20 10 10 40 50 (10) 0.57 (5.7)5 108 30 18 60 30 30 60 50 10 0.5 5.06 142 30 12 100 50 50 80 50 30 0.43 12.97 156 30 6 120 60 60 90 50 40 0.38 15.2

PRIME A

CADEMY

PRIME A

CADEMY


8 230 30 0 200 100 100 130 0 130 0.33 42.99 330 30 0 300 150 150 180 0 180 0.28 50.410 430 30 0 400 200 200 230 0 230 0.25 57.5

TOTAL 213.2Less Equity 100.0

Equity NPV 113.2If we assume that the 15% is the required rate of return for the project as a whole we need to evalu-ate from project angle. In that case, the computation will be as under.

year eBdiT depn. interest PBT Tax PAT cfAT Principal Total PVf PV1 (6) 30 0 (36) (18) (18) 12 0 12 0.87 10.442 34 30 0 4 2 2 32 0 32 0.76 24.323 54 30 0 24 12 12 42 0 42 0.66 27.724 74 30 0 44 22 22 52 0 52 0.57 29.645 108 30 0 78 39 39 69 0 69 0.5 34.506 142 30 0 112 56 56 86 0 86 0.43 36.987 156 30 0 126 63 63 93 0 93 0.38 35.348 230 30 0 200 100 100 130 0 130 0.33 42.909 330 30 0 300 150 150 180 0 180 0.28 50.4010 430 30 0 400 200 200 230 0 230 0.25 57.50

TOTAL 349.74Less: Project Cost 300.00Project NPV 49.74

Note in project evaluation, Interest payment and Principal repayment will not be deducted.evaluation of Project B evaluation from shareholders angle

year eBdiT depn. interest PBT Tax PAT cfAT Principal Total PVf PV1 (50) 28 20 (98) (39.2) (58.8) (30.8) 0 (30.8) 0.87 (26.80)2 (50) 28 20 (98) (39.2) (58.8) (30.8) 0 (30.8) 0.76 (23.41)3 10 28 20 (38) (15.2) (22.8) 5.2 0 5.2 0.66 3.434 20 28 20 (28) (11.2) (16.8) 11.2 50 (38.8) 0.57 (22.12)5 45 28 15 2 0.8 1.2 29.2 50 (20.8) 0.5 (10.40)6 100 28 10 62 24.8 37.2 65.2 50 15.2 0.43 6.547 155 28 5 122 48.8 73.2 101.2 50 51.2 0.38 19.468 190 28 0 162 64.8 97.2 125.2 0 125.2 0.33 41.329 230 28 0 202 80.8 121.2 149.2 0 149.2 0.28 41.7810 330 28 0 302 120.8 181.2 209.2 0 209.2 0.25 52.30

TOTAL 82.10Less Equity 80.00

Equity NPV 2.10

If we assume that the 15% is the required rate of return for the project as a whole we need to evalu-ate from project angle. In that case, the computation will be as under

PRIME A

CADEMY

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year eBdiT depn., interest PBT Tax PAT cfAT Principal Total PVf PV1 (50) 28 0 (78) (31.2) (46.8) (18.8) 0 (18.8) 0.87 (16.36)2 (50) 28 0 (78) (31.2) (46.8) (18.8) 0 (18.8) 0.76 (14.29)3 10 28 0 (18) (7.2) (10.8) 17.2 0 17.2 0.66 11.354 20 28 0 (8) (3.2) (4.8) 23.2 0 23.2 0.57 13.225 45 28 0 17 6.8 10.2 38.2 0 38.2 0.5 19.106 100 28 0 72 28.8 43.2 71.2 0 71.2 0.43 30.627 155 28 0 127 50.8 76.2 104.2 0 104.2 0.38 39.608 190 28 0 162 64.8 97.2 125.2 0 125.2 0.33 41.329 230 28 0 202 80.8 121.2 149.2 0 149.2 0.28 41.7810 330 28 0 302 120.8 181.2 209.2 0 209.2 0.25 52.30

TOTAL 218.64Less: Project Cost 280.00

Project NPV (61.36)Note in project evaluation, Interest payment and Principal repayment will not be deducted.

(b) For the first trial, use 81, 32, 60, and for second trial, use 04, 46 and 31, and so on respectively for selling price, variable costs, and sales volume.Step 1: Identify the critical variables. These are (i) Initial investment, (ii) Project life, and

(iii) Cost of capital. (iv) Annual fixed costs.Step 2: Identify the exogenous variables. These are (i) Sales Volume (ii) Selling price and

(ii) Variable costs.Step 3: Assign values for critical variables and probability distribution for exogenous variables.Step 4: Determine Random Number class intervals. Table Showing Random Number class in-

tervalsSales

Volume(rs.)

Probability cum.Prob.

random digit

allocation5000 0.3 0.30 00 – 297500 0.3 0.60 30 – 5912500 0.4 1.00 60 – 99

Variablecosts(rs.)


random digit

allocation1 0.3 0.3 00 – 292 0.6 0.9 30 – 893 0.1 1.0 90 – 99

SellingPrice(rs.)


randomdigit

allocation3 0.2 0.2 00 – 194 0.5 0.7 20 – 695 0.3 1.0 70 – 99

Step 5: Assign random Numbers and ascertain ValueSelling Price Variable costs Sales volume

random Number range Price

(rs.)random number range cost

(rs.)random number range Volume

81 70 - 99 5 32 30-89 2 60 60-99 12,50004 00 - 19 3 46 30-89 2 31 30-59 7,50067 20 - 69 4 25 00-29 1 24 00-29 5,00010 00 - 19 3 40 30-89 2 02 00-29 5,00039 20 - 69 4 68 30-89 2 08 00-29 5,00059 20 - 69 4 66 30-89 2 90 60-99 12,500

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12 00 - 19 3 64 30-89 2 79 60-99 12,50031 20 - 69 4 86 30-89 2 68 60-99 12,50082 70 - 99 5 89 30-89 2 25 00-29 5,00011 00 - 19 3 98 90-99 3 16 00-29 5,000

Step 6: Table Showing Computation of cash flow estimates, based on randomly generated values for uncertain variables.

Amount / rs. SellingPrice

Variablecost

contributionper unit

Salesvolume

Totalcontribution

fixed costs

Net cashflow

(rs.) (rs.) (rs.) (Nos.) (rs.) (rs.) (rs.)5 2 3 12,500 37,500 7,500 30,000 3 2 1 7,500 7,500 7,500 0 4 1 3 5,000 15,000 7,500 7,500 3 2 1 5,000 5,000 7,500 (2,500) 4 2 2 5,000 10,000 7,500 2,500 4 2 2 12,500 25,000 7,500 17,500 3 2 1 12,500 12,500 7,500 5,000 4 2 2 12,500 25,000 7,500 17,500 5 2 3 5,000 15,000 7,500 7,500 3 3 0 5,000 0 7,500 (7,500)

Average C/f 7,750

Step 7: Evaluation of the project cash flows Initial investment Rs.40,000 Annual cash flows Rs.7,750 Life Six years Cost of capital 12% PVAF for six years 4.111 PV of Cash flows Rs.31,860 Likely NPV Negative Rs.8,140 : Project is rejected

3(a) Step 1: Compute βu firm from the D/E of Alpha

βu = βg × E

E+D(1-t) = 1.30 ×

4–––––––––4+1(1–0.4) = 1.13 ⇒ βu = 1.13

Step 2: Compute beta of equity of Gamma from βu

βu = βg × E

E+D(1-t)⇒ βg = βU × E+D (1-t)

E=1.13×

3+2(1-0.4)–––––––––3 =1.582

⇒ βg = 1.58

(b) Price per share for determining the number of shares to be issued (Rs.570 + Rs.430)/2 = Rs.500

Net Assets Value = 350 – 100 = Rs.250 lakhsValuation based on dcf model

year Cash flow df dcf1 105 0.93 97.652 120 0.86 103.203 125 0.79 98.75

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4 120 0.74 88.805 100 0.68 68.005 200 0.68 136.00

Total 592.40Value of business Valuation based on NAV Rs.250 lakhs Valuation based on DCF = Rs.592.4 Average = Rs.421.2 lakhs Number of shares Value / Price = 421.4 lakhs / 500 = 84,240Allocation of shares

Fully paid shares 2,000,000 Equivalent fully paid shares for party paid share 500,000 Total 2,500,000 Total shares 84,240 Distribution to fully paid shareholders 84240 x 20/25 67,392 Balance to party paid shareholders 16,848

4(a)

Type of option

e1Bought

e2Wrote

e3 Bought

PremiumPaid

Premium received

Premium Paid

Call 50 60 70 (11) 7 (6)

Step1: Payoff Table code relationship call

Bought at 50

call Wrote at

60

call Bought

at 70

GPo Premium NPo BeP

R1 S<E1 Lapse Lapse LapseNil Nil Nil 0 (3) (3) NA

R2 E1<S<E2 Exercise Lapse LapseS-50 Nil Nil S-50 (3) S-53 53

R3 E2<S<E3 Exercise Exercise LapseS-50 -2(S-60) Nil 70-S (3) 67-S 67

R3 S>E2 Exercise Exercise ExerciseS-50 -2(S-60) S-70 0 (3) (3) NA

Step 2: Break even Table

range impact refer(a) 0-50 Fixed Loss R1(b) 51-52 Decreasing Loss R2(c) 53 Break Even R2(d) 54-60 Increasing Profit R2(e) 61-66 Decreasing Profit R3(f) 67 Break Even R3(g) 68-70 Increasing Loss R3(h) >70 Fixed Loss R4

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Step 3: Strategy Graph

Butterfly (Write 2 Calls at E2 and Buy Calls at E1 & E3)

(b) ALTerNATiVe 1: forWArd coNTrAcT customer is importer as there is an obligation to pay cAd

JuLy SePT a. CAD 1,010,000 705,000 b. Forward $ per CAD 0.9301 0.9356 c. $ Outflow 939,401 659,598

ALTerNATiVe 2: oPTioN coNTrAcTS d. Option 20 14 (a)/50,000e. CAD covered 1,000,000 700,000 (d) x 50,000f. CAD uncovered 10,000 5,000 (a)-(e)g. Strike Price 0.94 0.95 h. Premium Cents/CAD 1.02 1.64 i. Premium In Cents 1,020,000 1,148,000 (e) x (h)j. In Dollars 10,200 11,480 (i)/100k. If Exercised Option Exercised 940,000 665,000 e x gl. Uncovered part 9301 4678 b x fm. Premium cost 10200 11480 jn. $ Outflow 959,501 681,158 k+l+m Select LOWER 939,401 659,598

FORWARD FORWARD In either case Forward is preferred.

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5(a) computation of PAT & Balance Sheet

Particulars year 1 year 2 year 3 year 4 year 5Sales =200,000*120% =240,000*120% =288,000*130% =374,400*130%

240,000 288,000 374,400 486,720 486,720 PBT - 10% of Sales 24,000 28,800 37,440 48,672 48,672 PAT - 70 % of PAT 16,800 20,160 26,208 34,070 34,070 Fixed AssetsClosing Balance - 40% of Sales

=240,000*40% =288,000*40% =374,400*40% =486,720*40% =486,720*40%

96,000 115,200 149,760 194,688 194,688 Opening Balance 80,000 96,000 115,200 149,760 194,688 Depreciation on OB @10% 8,000 9,600 11,520 14,976 19,469 Balance Before Purchase 72,000 86,400 103,680 134,784 175,219 Assets Purchased 24,000 28,800 46,080 59,904 19,469 Current AssetsClosing Balance - 20% of Sales

=240,000 x 20%

= 288,000 x 20%

=374,400 x 20% =486,720 x 20% =486,720 x 20%

48,000 57,600 74,880 97,344 97,344 Opening Balance 40000 48,000 57,600 74,880 97,344 Net Inv in Currrent Assets 8,000 9,600 17,280 22,464 - Total Inv in Assets 32,000 38,400 63,360 82,368 19,469 Net CF =16,800+8,000-

32,000 =20160+9600-

38400 =26,208+11,520-

63,360

=34,070+14,976-82,368

=34,070+19,469-19,469

(7,200) (8,640) (25,632) (33,322) 34,070

computation of PV of cash flow

years cf PVf dcf1 (7,200) 0.8696 (6,260.87)2 (8,640) 0.7561 (6,533.08)3 (33,322) 0.6575 (21,909.49)4 34,070 0.5718 19,479.86 4* 227,136 0.5718 129,865.75

114,642.16

Value of Existing Strategy14,000–––––0.15 93,333.33

Incremental Value 21,308.83

* Residual Value until Perpetuity34,070–––––0.15 227,133

conclusion: Since the incremental value is positive, the Strategy needs to be adopted.Working Notes: Computation of Existing Ratios

PBT Ratio = 20,000––––––200,000

10% PAT to PBT Ratio 14,000––––––20,000 70%

Fixed Assets TO =

80,000––––––200,000 40% Current Assets TO

40,000––––––200,000 20%

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(b) Step 1: Borrow and Buy optionPurchase Price 50,000 Less: PV of TS on Depreciation (15,560)PV of Net Salvage Value (780)Total 33,660

WN1: PV of Tax Saved on depreciationAnnual Depreciation 10,000 Tax Rate 40%Tax Saved 4,000 PVAF9%,5 years 3.890PV of tax saved on depreciation 15,560

WN 2: PV Net Salvage Value

Sale Price 2222Commission 222Net Value 2000WDV 0Profit on sale 2000Tax at 40% 800After tax salvage value 1200PVF9%,5 years 0.65Present Value 780

Break even rentalAnnual Lease Rental after tax Y PVAF9%,5 years 3.890PV of Lease option 33,660 Hence 3.89 Y = 33,660. Or Y = 8,653Tax Rate 40%Pre tax lease rental 8653 / (1-0.4) 14,420

When annual lease rentals (payable at year end) stand at Rs.14,420 the net tax-adjusted cash outflows would be the same for both loan and lease options. At a level of Rs.14,420, Gamma would be indifferent.

6(a) Part (i) 1. a. Amount of loan (i) Cost (6.50 + 2.50) Rs.9.00 lakhs (ii) Owner’s stake Rs.1.00 lakh (iii) Loan amount Rs.8.00 lakh b. Period of loan 3 years c. Rate 8.25 % flat d. Flat interest Rs.8.00 lakhs × 8.25% × 3 years i.e. Rs.1.98 lakhs e. Total repayment amount (i) Principal Rs.8.00 lakhs (ii) Interest Rs.1.98 lakhs (iii) Total Rs.9.98 lakhs f. Instalments 36 g. EMI Rs.9.98/36 = Rs.27,722.22 (or say Rs.27,722) h. EMI for two vehicles: Rs.55,444

Part (ii) Interest quantum (8 lakh × 8.25% × 35) Rs.1,92,500Total amount Rs.9,92,500 (×)EMI (× /36) Rs.27,569 for one vehicleEMI for 2 vehicles Rs.55,138.00 (Note: Effective rate (IRR) in the first case will be 13.82%, and in the second case it will be 15.91%)

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(b) company AoBS Stock (X) market (y) Xy y2 dx dy dx dy dy2

1 13.0 12.0 156.0 144.0 1.567 1.333 2.089 1.7772 11.5 11.0 126.5 121.0 0.067 0.333 0.022 0.1113 9.8 9.0 88.2 81.0 (1.633) (1.667) 2.722 2.779

Average 11.433 10.667Total 370.7 346.0 0.001 (0.001) 4.833 4.667

Beta through formula:

370.7 – 3(11.433) x 10.667 346 – 3(10.667)2 =

∑

∑

XY - n X Y 22Y - nY

= 4.83 / 4.65 = 1.039

Beta through variance: Covariance 2.417 SD market 2.334 Beta 1.036

company BoBS Stock (X) market (y) Xy y2 dx dy dx dy dy2

1 11.0 12.0 132.0 144.0 0.667 1.333 0.889 1.777 2 10.5 11.0 115.5 121.0 0.167 0.333 0.056 0.111 3 9.5 9.0 85.5 81.0 (0.833) (1.667) 1.389 2.779

Average 10.333 10.667 Total 333.0 346.0 0.001 (0.001) 2.334 4.667

Beta through formula:

∑

∑

XY - n X Y 22Y - nY

333 – 3(10.333) x 10.667 346 – 3(10.667)2

=

= 2.334 / 4.667 = 0.5020

Beta through variance: Covariance 1.167 SD market 2.334 Beta 0.5

7. Write short notes ona. Standard deviaiton in the context of risk analysis

• Standard deviation is a measure of risk• It is expressed in the same units as the range of probable outcomes is expressed• Standard deviation is merely a unit of measure with which we can assess the extent to

which the possible outcomes can deviate from the expected mean value of the outcome• Between two projects which have same return , the one with the lower standard deviation

will be preffered

b. Five merits of investing in mutual fund• Diversification• Professional management• Economies of scale• Liquidity• Plenty of options

c. Three objectives of derivatives• The derivative markets helps people meet diverse objectives such as Hedging, Speculation

and Arbitrage• Most price changes are first reflected in the derivative markets. Thus derivative market

feeds the spot market.• A derivative instrument the distributes the risk among market players for a price

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d. Four key issues in valuation of business:• Identifying appropriate discount rate• Determining the normalizing adjustments to be made to income statement• Determining the premium/discount• Valuation of intangibles

e. What is the difference between CAPM and Arbitrage Pricing Model CAPM has only one factor and one beta. while APT formula has multiple factors that include

non-company factors, which requires the asset’s beta in relation to each separate factor. However, the APT does not provide insight into what these factors could be, so users of the APT model must analytically determine relevant factors that might affect the asset’s returns. On the other hand, the factor used in the CAPM is the difference between the expected market rate of return and the risk-free rate of return. Since the CAPM is a one-factor model and simpler to use, investors may want to use it to determine the expected theoretical appropriate rate of return rather than using APT, which requires users to quantify multiple factors.

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Paper 3 – Auditing Assurance and Professional Ethics No. of Questions: 7 Total Marks: 100 No. of Pages: 2 Time Allowed: 3 hrs

Question 1 is compulsory, Answer any 5 from the remaining 6 questions.

1. a) Mr. X was appointed as the auditor of M/s Easygo Ltd. and intends to apply the concept of materiality

for the financial statements as a whole. Please guide him as to the factors that may affect the identification of an appropriate benchmark for this project. (4 Marks)

b) The directors of a company are concerned about the reliability and usefulness of the monthly financial management information that they receive. As a result, the company’s auditors have been engaged to review the system and the information it generates, and to report their conclusions. What are the ordinary procedures you would suggest the auditors to include for the review of financial statements?

(6 Marks) c) As a Statutory Auditor, how would you deal with the following?

(a) While commencing the statutory audit of B Company Limited, the auditor undertook the risk assessment and found that the detection risk relating to certain class of transactions cannot be reduced to acceptance level. (5 Marks) (b) While auditing accounts of a public limited company for the year ended 31st March 2016, an auditor found out an error in the valuation of inventory, which affects the financial statement materially. Comment as per standards on auditing. (5 Marks)

2. a) You have been appointed as the auditor of a Multiplex Cinema House. Draw an audit programme in

respect of its Revenue and Expenditure (5 Marks) b) XY Ltd. is a manufacturing company, provided following details of wastages of raw materials in

percentage, for various months. You have been asked to enquire into causes of abnormal wastage of raw materials. Draw out an audit plan.

Wastage percentage are July 2016 1.5% Aug 2016 1.7% Sep 2016 1.4%

Oct 2016 4.1% (5 Marks) c) "Corporate accountability and civil and criminal penalties for white collar crimes." Comment on the

major provisions of Sarbanes Oxley Act. (6 Marks)

3. a) R Ltd. owns 51% voting power in S Ltd. It however holds and discloses all the shares as "Stock-in-

trade" in its accounts. The shares are held exclusively with a view to their subsequent disposal in the near future. R Ltd. represents that while preparing Consolidated Financial Statements, S Ltd. can be excluded from the consolidation. As a Statutory Auditor, how would you deal? (6 Marks)

b) MRE Ltd. provided ` 25 lakhs for Inventory obsolescence in 2015-16. In the subsequent years, it was determined that 50% of such inventory was usable. The Board of Directors wants to adjust the same through prior period adjustment. Comment. (5 Marks)

c) ABC & Co. and DEF & Co, Chartered Accountant firms were appointed as joint auditors of Good Health Care Ltd. for 2015-16. A special audit was conducted during March 2016 and observed gross understatement of Revenue. The revenue aspects were looked after by DEF & Co, but there was no documentation for the division of work between the joint auditors. Comment on the basis of the relevant standard on Auditing. (5 Marks)

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4. a) State the requirements regarding the maintenance of books of accounts with respect to a multi- state

co-operative society. (4 Marks) b) Write a short note on - Facultative reinsurance under Insurance Act, 1938. (4 Marks) c) J Ltd. is interested in acquiring S Ltd. The valuation of S Ltd. is dependent on future maintainable sales.

As the person entrusted to value S Ltd. what factors would you consider in assessing the future Maintainable turnover? (4 Marks)

d) In the audit of Hotel Luxury Ltd, the auditor wants to use the analytical procedure as substantive procedure in respect of room rental income as well as payroll costs. Guide him as to how it can be done.

(4 Marks) 5. a) A leading jewellery merchant used to value his inventory at cost on LIFO basis. However, for the

current year, in view of requirements of AS 2, he changed over to FIFO method of valuation. The difference in value of stock amounted to ` 55 lakhs which is higher than that under the previous method. In such a situation, what are the reporting responsibilities of a Tax Auditor under Section 44AB of Income-tax Act, 1961 (4 Marks)

b) A' Limited has paid minimum alternate tax under Section 115 JB of the Income-tax Act, 1961, for the year ended 31st March, 2016. The company wants to disclose the same as an 'Asset' since the company is eligible to claim credit for the same. Comment. (4 Marks)

c) Types of market under NEAT (National Exchange Automated Trading). (4 Marks) d) In assessment procedure of M/s Cloud Ltd., Income Tax Officer observed some irregularities.

Therefore, he started investigation of Books of Accounts audited and signed by Mr. Old, a practicing Chartered Accountant. While going through books he found that M/s Cloud Ltd. used to maintain two sets of Books of Accounts, one is the official set and other is covering all the transactions. Income Tax Department filed a complaint with the Institute of Chartered Accountants of India saying Mr. Old had negligently performed his duties. Comment. (4 Marks)

6. a) Write a short note on Record of Audit Assignments (as required by ICAI regulations). (4 Marks) b) Do you approve of the following? If not, why?

A firm of Chartered Accountants was appointed by a company to evaluate the costs of the various products manufactured by it for its information system. One of the partners of the firm was a Non-Executive Director of the company (4 Marks)

c) A partner of a firm of chartered accountants during a T.V. interview handed over a bio-data of his firm to the chairperson. Such bio-data detailed the standing of the international firm with which the firm was associated. It also detailed the achievements of the concerned partner and his recognition as an expert in the field of taxation in the country. The chairperson read out the said bio-data during the interview. Discuss whether this action by the Chartered Accountant would amount to misconduct or not. (4 Marks)

d) A, a practicing Chartered Accountant is appointed to conduct the peer review of another practicing unit. What areas A should review in the assessment of independence of the practicing unit? (4 Marks)

7. Write short notes on any 4 a) Haphazard Sampling? b) True and Fair Cost of Production. c) Walk through Tests d) Summary Written Report. e) "Mandatory Review" areas of the audit committee. (4 x 4 = 16 Marks)

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The Society of Auditors and Prime Academy 44th session Model Exam – Final – Advanced Auditing and Professional Ethics

Suggested Answers 1. a) SA 320 “Materiality in Planning and Performing an Audit” prescribes the use of Benchmarks in

Determining Materiality for the Financial Statements as a Whole. Determining materiality involves the exercise of professional judgment. A percentage is often applied to a chosen benchmark as a starting point in determining materiality for the financial statements as a whole. Factors that may affect the identification of an appropriate benchmark include the following: (i) The elements of the financial statements (for example, assets, liabilities, equity, revenue,

expenses); (ii) Whether there are items on which the attention of the users of the particular entity’s financial

statements tends to be focused (for example, for the purpose of evaluating financial performance users may tend to focus on profit, revenue or net assets);

(iii) The nature of the entity, where the entity is at in its life cycle, and the industry and economic environment in which the entity operates;

(iv) The entity’s ownership structure and the way it is financed (for example, if an entity is financed solely by debt rather than equity, users may put more emphasis on assets, and claims on them, than on the entity’s earnings); and

(v) The relative volatility of the benchmark.

b) Procedures for Review of Financial Statements: The following are the procedures which would be advised to the auditor to follow for the review of the financial statements. As per SRE 2400 “Engagements to Review Financial Statements”, procedures for the review of financial statements will ordinarily include- (i) Discuss terms and scope of the engagement with the client and the engagement team. (ii) Prepare an engagement letter setting forth the terms and scope of the engagement. (iii) Obtain an understanding of the entity’s business activities and the system for recording

financial information and preparing financial statements. (iv) Inquire whether all financial information is recorded: (a) Completely; (b) Promptly; and (c)

After the necessary authorisation. (v) Obtain the trial balance and determine whether it agrees with the general ledger and the

financial statements. (vi) Consider the results of previous audits and review engagements, including accounting

adjustments required. (vii) Inquire whether there have been any significant changes in the entity from the previous year

(e.g., changes in ownership or changes in capital structure). (viii) Inquire about the accounting policies and consider whether: (a) They comply with the

applicable accounting standards; (b) They have been applied appropriately; and (c) They have been applied consistently and, if not, consider whether disclosure has been made of any changes in the accounting policies.

(ix) Read the minutes of meetings of shareholders, the board of directors and other appropriate committees in order to identify matters that could be important to the review.

(x) Inquire if actions taken at shareholder, board of directors or comparable meetings that affect the financial statements have been appropriately reflected therein.

(xi) Inquire about the existence of transactions with related parties, how such transactions have been accounted for and whether related parties have been properly disclosed.

(xii) Inquire about contingencies and commitments. (xiii) Inquire about plans to dispose of major assets or business segments. (xiv) Obtain the financial statements and discuss them with management. (xv) Consider the adequacy of disclosure in the financial statements and their suitability as to

classification and presentation. (xvi) Compare the results shown in the current period financial statements with those shown in

financial statements for comparable prior periods and, if available, with budgets and forecasts. (xvii) Obtain explanations from management for any unusual fluctuations or inconsistencies in the

financial statements.

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(xviii) Consider the effect of any unadjusted errors – individually and in aggregate. Bring the errors to the attention of management and determine how the unadjusted errors will influence the report on the review.

(xix) Consider obtaining a representation letter from management.

c) Assessment of Risk and Acceptable Level: SA 315 and SA 330 “Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment” and “The Auditor’s Responses to Assessed Risks” establishes standards on the procedures to be followed to obtain an understanding of the accounting and internal control systems and on audit risk and its components: inherent risk, control risk and detection risk. SA 315 and SA 330 require that the auditor should use professional judgement to assess audit risk and to design audit procedures to ensure that it is reduced to an acceptably low level. “Detection risk” is the risk that an auditor’s substantive procedures will not detect a misstatement that exists in an account balance or class of transactions that could be material. The higher the assessment of inherent and control risks, the more audit evidence the auditor should obtain from the performance of substantive procedures. When both inherent and control risks are assessed as high, the auditor needs to consider whether substantive procedures can provide sufficient appropriate audit evidence to reduce detection risk, and therefore audit risk, to an acceptably low level. The auditor should use his professional judgement to assess audit risk and to design audit procedures to ensure that it is reduced to an acceptably low level. If it cannot be reduced to an acceptable level, the auditor should express a qualified opinion or a disclaimer of opinion as may be appropriate.

d) Errors in Valuation of Inventories and Auditor’s Responsibilities: SA 240, “The Auditor’s Responsibilities Relating Fraud in an Audit of Financial Statements”, requires that if circumstances indicate the possible existence of fraud or error, the auditor should consider the potential effect of the suspected fraud or error on the financial information. If the auditor believes the suspected fraud or error could have a material effect on the financial information, he should perform such modified or additional procedures as he determines to be appropriate. SA 240 also requires that when the auditor identifies a misstatement, the auditor shall evaluate whether such a misstatement is indicative of fraud. If there is such an indication, the auditor shall evaluate the implications of the misstatement in relation to other aspects of the audit, particularly the reliability of management representations, recognizing that an instance of fraud is unlikely to be an isolated occurrence. Further, SA 320 Materiality in Planning and Performing an Audit, also requires that in such circumstances, the auditor should consider requesting the management to adjust the financial information or consider extending his audit procedures. If the management refuses to adjust the financial information and the results of extended audit procedures do not enable the auditor to conclude that the aggregate of uncorrected misstatements is not material, the auditor should express a qualified or adverse opinion, as appropriate. In the instant case, the auditor has detected the material errors affecting the financial statements; the auditor should communicate his findings to the management on a timely basis, consider the implications on true and fair view and also ensure that appropriate disclosures have been made.

2. a) Audit Programme of Multiplex

(i) Peruse the Memorandum of Association and Articles of Association of the entity. (ii) Ensure the object clause permits the entity to engage in this type of business. (iii) In the case of income from sale of tickets:

1. Verify the control system as to how it is ensured that the collections on sale of tickets of various shows are properly accounted.

2. Verify the system of relating to online booking of various shows and the system of realization of money.

3. Check that there is overall system of reconciliation of collections with the number of seats available for different shows on a day.

(iv) Verify the internal control system and its effectiveness relating to the income from cafe shops, pubs etc., located within the multiplex.

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(v) Verify the system of control exercised relating to the income receivable from advertisements exhibited within the premises and inside the hall such as hoarding, banners, slides, short films etc.

(vi) Verify the system of collection from the parking areas in respect of the vehicles parked by the customers.

(vii) In the case of payment to the distributors verify the system of payment which may be either through out right payment or percentage of collection or a combination of both. Ensure at the time of settlement any payment of advance made to the distributor is also adjusted against the amount due.

(viii) Verify the system of payment of salaries and other benefits to the employees and ensure that statutory requirements are complied with.

(ix) Verify the payments effected in respect of the maintenance of the building and ensure the same is in order.

b) Audit Plan to locate the Abnormal Wastage of Raw Material: To locate the reasons for the abnormal wastage, the auditor should first of all assess the general requirements as under: (i) Procure a list of raw materials, showing the names and detailed characteristics of each raw

material. (ii) Obtain the standard consumption figures, and ascertain the basis according to which normal

wastage figures have been worked out. Examine the break-up of a normal wastage into that in process, storage and handling stages. Also obtain control reports, if any, in respect of manufacturing costs with reference to predetermined standards.

(iii) Examine the various records maintained for recording separately the various lots purchased and identification of each lot with actual material consumption and for ascertaining actual wastage figures therein.

(iv) Obtain reports of Preventive Maintenance Programme of machinery to ensure that the quality of goods manufacture is not of sub-standard nature or leads to high scrappage work.

(v) Assess whether personnel employed are properly trained and working efficiently. (vi) See whether quality control techniques have been consistent or have undergone any change. (vii) Examine inventory plans and procedures in report of transportation storage efficiency,

deterioration, pilferage and whether the same are audited regularly. (viii) Examine whether the basis adopted for calculating wastage for September is the same as was

adopted for the other three months. (ix) Obtain a statement showing break up of wastage figures in storage, handling and process for the

four months under reference and compare the results of the analysis for each of the four months. In addition, some specific reasons for abnormal wastage in process may be considered by the auditor are as under: (i) Examine laboratory reports and inspection reports to find out if raw materials purchased were of

a poor quality or were of sub-standard quality. This will be most useful if it is possible to identify the wastage out of each lot that has been purchased.

(ii) Machine breakdown, power failure, etc. may also result into loss of materials in process. Check the machine utilisation statements.

(iii) A high rate of rejections in the finished lots may also be responsible for abnormal wastage; therefore, examine the inspectors’ reports in respect of inspection carried out on the completion of each stage of work or process.

(iv) It is possible that the wastage may have occurred because the particular lot out of which issues were made was lying in the store for a long time, leading to deterioration in quality or because of a change in the weather which may have led to the deterioration. Compare the wastage figures.

(v) Abnormal wastage in storage and handling may arise due to the following reasons: (1) Write offs on account of reconciliation of physical and book inventories: In case of periodical

physical inventory taking, such write offs will be reflected only in the month such reconciliation takes place.

(2) Accidental, theft or fire losses in storage: The auditor should examine the possibility of these for the purpose.

(vi) Examine whether any new production line was taken up during the month in respect of which standard input-output ratio is yet to be set-up.

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c) Major provisions of Sarbanes Oxley Act: The Sarbanes Oxley Act of 2002 established corporate accountability and civil and criminal penalties for white – collar crimes. This act also known as the Public Company Accounting Reform and Investor Protection Act of 2002 and commonly called SOX or Sarbox; is a United States federal law passed in response to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, and WorldCom. These scandals resulted in a decline of public trust in accounting and reporting practices. This Act provides regulatory bodies and courts to take various actions –civil and criminal proceedings in connection of misstatements amounting to accounting scandals and fraudulent financial reports, other frauds on securities matters, obstruction of justice and retaliating against corporate whistle-blowers. The Act also enforce tougher civil and criminal penalties for fraud and accounting scandals, securities fraud and certain other forms of obstruction of justice. Some of the major provisions of Sarbanes-Oxley Act of 2002 are: (i) Creation of the Public Company Accounting Oversight Board (PCAOB); (ii) A requirement that public companies evaluate and disclose the effectiveness of their internal

controls as they relate to financial reporting, and that independent auditors for such companies "attest" (i.e., agree, or qualify) to such disclosure;

(iii) Certification of financial reports by chief executive officers and chief financial officers; (iv) Auditor independence, including outright bans on certain types of work for audit clients and pre-

certification by the company's Audit Committee of all other non-audit work; (v) Ban on most personal loans to any executive officer or director; (vi) Accelerated reporting of insider trading; (vii) Prohibition on insider trades during pension fund blackout periods; (viii) Enhanced criminal and civil penalties for violations of securities law; (ix) A requirement that companies listed on stock exchanges have fully independent audit

committees that oversee the relationship between the company and its auditor; (x) Additional disclosure; (xi) Significantly longer maximum jail sentences and larger fines for corporate executives who

knowingly and wilfully misstate financial statements, although maximum sentences are largely irrelevant because judges generally follow the Federal Sentencing Guidelines in setting actual sentences;

(xii) Employee protections allowing those corporate fraud whistle blowers who file complaints with OSHA within 90 days to win reinstatement, back pay and benefits, compensatory damages, and congressional page abatement orders, and reasonable attorney fees and costs.

3. a) Consolidation of Financial Statement: AS 21 “Consolidated Financial Statements”, states that a

subsidiary should be excluded from consolidation when: (i) Control is intended to be temporary because the shares are acquired and held exclusively with a

view to its subsequent disposal in the near future or (ii) Subsidiary operates under severe long term restrictions which significantly impair its ability to

transfer funds to the parent. Where an enterprise owns majority of voting power by virtue of ownership of the shares of another enterprise and all the shares held as ‘stock-in-trade’ are acquired and held exclusively with a view to their subsequent disposal in the near future, the control by the first mentioned enterprise would be considered temporary and the investments in such subsidiaries should be accounted for in accordance with AS 13 “Accounting for Investments”. However, as per Section 129(3) of the Companies Act, 2013 read with rule 6 of the Companies (Accounts) Rules, 2014, where a company having subsidiary, which is not required to prepare consolidated financial statements under the Accounting standards, it shall be sufficient if the company complies with the provisions on consolidated financial statements provided in Schedule III to the Act. In this case, R Ltd’s intention is to dispose off the shares in the near future as shares are being held as stock in trade and it is quite clear that the control is temporary, however for the compliance of provisions related to consolidation of financial statements given under the Section 129(3) of the Companies Act, 2013 read with Companies (Accounts) Rules, 2014, R Ltd. is required to consolidate

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the financial statements as per the provisions on consolidated financial statements provided in Schedule III to the Act.

b) Prior Period Adjustment: As per AS 5 on "Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies", prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods. The write-back of provision made in respect of inventories in the earlier year does not constitute prior period adjustment since it neither constitutes error nor omission but it merely involves making estimates based on prevailing circumstances when financial statements were being prepared. It is a mere estimate process involving judgement based on the latest information available. An estimate may have to be revised if changes occur regarding the circumstances on which the estimate was based, or as a result of new information, more experience or subsequent developments. The revision of the estimate, by its nature, does not bring the adjustment within the definitions of an extraordinary item or a prior period item. A change in an accounting estimate may affect the current period only or both the current period and future periods. In both cases, the effect of the change relating to the current period is recognised as income or expense in the current period. The effect, if any, on future periods, is recognised in future periods. Further, as per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures”, the auditor shall review the outcome of accounting estimates included in the prior period financial statements or where applicable, their subsequent re-estimation for the purpose of the current period. In this case, MRE Ltd. provided ` 25 lakhs for inventory obsolescence in 2015-16. In the subsequent year due to change in circumstances, it was determined that 50% of such inventory was usable. Revision of such an estimate does not bring the resulting amount of ` 12.5 lakhs within the definition either of a prior period item or of an extraordinary item. The amount, however, involved is material and requires separate disclosure to understand the financial position and performance of an enterprise. Accordingly, adjustment in the value of the inventory through prior period item would not be proper.

c) Documentation for Division of Work between the Joint Auditors: As per SA 299 “Responsibility of Joint Auditors”, where joint auditors are appointed, they should, by mutual discussion, divide the audit work among themselves. The division of work would usually be in terms of audit of identifiable units or specified areas. In some cases, due to the nature of the business of the entity under audit, such a division of work may not be possible. In such situations, the division of work may be with reference to items of assets or liabilities or income or expenditure or with reference to periods of time. Certain areas of work, owing to their importance or owing to the nature of the work involved, would not be divided and would be covered by all the joint auditors. The division of work among joint auditors as well as the areas of work to be covered by all of them should be adequately documented and preferably communicated to the entity. Further, each joint auditor is entitled to assume that the other joint auditors have carried out their part of the audit work in accordance with the generally accepted audit procedures. It is not necessary for a joint auditor to review the work performed by other joint auditors or perform any tests in order to ascertain whether the work has actually been performed in such a manner. Each joint auditor is entitled to rely upon the other joint auditors for bringing to his notice any departure from generally accepted accounting principles or any material error noticed in the course of the audit. In the present case, there was no documentation for the division of work and the responsibility of revenue aspect was delegated to DEF & Co., in which gross understatement of revenue has been observed. ABC & Co. has not reviewed the work as they have put their reliance on the work performed by DEF & Co. Hence, there is a violation of SA 299 as the division of work has not been documented. In the normal course DEF & Co. will be held liable for negligence. If DEF & Co. refuses to accept sole responsibility for the fault, ABC & Co. have to prove by other ways and means of evidences that the particular area of audit was exclusively done by DEF & Co. only.

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4. a) Maintenance of Books of Accounts with respect to a Multi-State Co-Operative Society: As per the

Multi State Co-operative Society Rules, 2002, every multi state co-operative society shall keep books of accounts with respect to- (i) all sum of money received and expended and the matters in respect of which the receipt and

expenditure took place. (ii) all sales and purchases of goods. (iii) the assets and liabilities of the society. (iv) in the case of Multi State Co-operative Society engaged in production, processing and

manufacturing particulars relating to utilization of materials or labour or other term of cost as may be specified in the bye laws of such a society.

Comprehensively, the following books of accounts may be maintained: (i) Cash book: It may be maintained to record particulars regarding cash receipts and expenses

under suitable heads, with clear distinction between capital and revenue items of receipts and expenses.

(ii) Stock register: It may contain detailed information as regards receipts, issues and balances of stock-in-trade, date-wise. In a producers co-operative society, perpetual inventory records may be maintained based on an appropriate costing method.

(iii) Register of assets and investments: It will contain detailed particulars regarding the various immovable and movable assets belonging to the society, such as, types of assets, location, date of acquisition, cost, depreciation provided, and so on.

(iv) Register of fixed deposits: In the case of a co-operative credit society, or a co-operative bank, or any other society which is authorised by its laws to accept deposits from members/ non-members, a register of fixed deposits may be maintained giving details as regards the dates of acceptance, maturity, interest accrual, repayment, etc.

(v) Register of sureties: In the case of a co-operative credit society, loans are given against personal security of members as also surety (guarantee) provided by two other members. The Register of Sureties will give particulars about the number of borrowers in respect of which a member has stood surety, and show whether it is within the overall limit of surety- ship that may be given by a member as prescribed by the bye-laws.

(vi) Register of loan disbursement and recovery: In the ease of a co-operative credit society, this Register will provide particulars regarding loans sanctioned by the society, the dates of disbursement and recovery.

b) Facultative Reinsurance: It is that type of reinsurance whereby the contract relates to one particular

risk and is expressed in the reinsurance policy. This is the oldest method of reinsurance and it necessitates consideration of each risk separately. Each transaction under facultative reinsurance has to be negotiated individually. Each party to the transaction has a free choice, i.e., for the ceding company to offer and the reinsurer to accept. The main drawbacks of this type of insurance are the volume of work involved and time taken to cover the risk. It is, however, still used even today, mainly when:- (i) Automatic covers have already been exhausted. (ii) The risk is excluded from the treaties. (iii) The insurer does not want his reinsurance treaties overburdened with particularly heavy and

abnormal risks. (iv) The insurer has no automatic cover at his disposal in a particular branch, where he issues policies

rarely. (v) The nature of business is such that technical guidance or consultation with the reinsurer is

required at every stage of acceptance of the risk itself or for a type of business where the number of risks is very small, for example, in atomic energy installations, oils rigs, etc.

c) In assessing the turnover which the business would be able to maintain in the future, the following factors should be taken into account: (i) Trend: Whether in the past, sales have been increasing consistently or they have been fluctuating.

A proper study of this phenomenon should be made.

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(ii) Marketability: Is it possible to extend the sales into new markets or that these have been fully exploited? Product wise estimation should be made.

(iii) Political and economic considerations: Are the policies pursued by the Government likely to promote the extension of the market for goods to other countries? Whether the sales in the home market are likely to increase or decrease as a result of various emerging economic trends?

(iv) Competition: What is the likely effect on the business if other manufacturers enter the same field or if products which would sell in competition are placed on the market at cheaper price? Is the demand for competing products increasing? Is the company’s share in the total trade constant or has it been fluctuating?

d) As per SA 520 on “Analytical Procedures”, in some cases, even an unsophisticated predictive model may be effective as an analytical procedure. In case of Payroll cost- Where an entity has a known number of employees at fixed rates of pay throughout the period, it may be possible for the auditor to use this data to estimate the total payroll costs for the period with a high degree of accuracy, thereby providing audit evidence for a significant item in the financial statements and reducing the need to perform tests of details on the payroll. In case of Room Rental Income of Hotel- Different types of analytical procedures provide different levels of assurance. Analytical procedures involving the prediction of total rental income in case of Hotel taking the room tariff rates, the number of rooms and vacancy rates into consideration, can provide persuasive evidence and may eliminate the need for further verification by means of tests of details, provided the elements are appropriately verified.

5. a) Reporting for change in the method of valuation of stock: The change in the method of valuation

of stock is not a change in method of accounting, as it is only a change in accounting policy. However in the Income-tax Act, 1961 this is considered under method of accounting. Under the Income-tax Act, 1961, if the change in method of valuation is bonafide, and is regularly and consistently adopted in the subsequent years as well, such change would be permitted to be made for tax purposes. In the instant case, the change in the valuation of stock from LIFO basis to FIFO basis is pursuant to mandatory requirements of the AS 2 ‘Valuation of Inventories’ and therefore should be viewed as bonafide change. This apart, the tax auditor in his report has to specifically refer to the method of valuation of stock under Clause 14 in Form 3CD. (a) Method of valuation of closing stock employed in the previous year. (b) Details of deviation, if any, from the method of valuation prescribed under section 145A and the effect thereof on profit or loss. The auditor has to see that the method of stock valuation is followed consistently from year to year. It is also necessary to ensure that method followed for valuation of stock results is correct profits or gain. The change from LIFO to FIFO is bonafide, the disclosure of which would have to be made the financial statements. As far as section 145A is concerned, the tax auditor need not change the method of valuation of purchases, sales and inventories which is regularly employed by the assessee. All that he has to do is to adjust the valuation for any tax, duty, cess or fee actually paid or incurred by the assessee, if the same had not already been adjusted.

b) As per Para 6 of the Guidance Note issued by ICAI on “Accounting for credit available in respect of MAT under the IT Act, 1961”, although MAT credit is not a deferred tax asset under AS 22, yet it gives rise to expected future economic benefit in the form of adjustment of future income tax liability arising within the specific period. The Framework for the preparation and presentation of financial statements, issued by the ICAI, defines the term ‘asset’ is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise. MAT paid in a year in respect of which the credit is allowed during the specified period under the Income-tax Act, 1961 is a resource controlled by the company as a result of past event, namely the payment of MAT. The MAT credit has expected future economic benefits in the form of its adjustment against the discharge of the normal tax liability if the same arises during the specified period. Accordingly, such credit is an asset. According to the Framework, once an item meets the definition of the term ‘Asset’, it has to meet the criteria for recognition of an asset, so that it may be recognised as such in the financial statements.

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Para 88 of the Framework provide the following criteria for recognition of an asset: An asset is recognised in the balance sheet when it is probable that the future economic benefits associated with it will flow to the enterprise and the asset has a cost or value that can be measured reliably. In addition to the above, the auditor shall take a confirmation letter from the assessee for the said facts. Thus, if the auditor is satisfied that the probability of the company to claim the said credit is high, it could recognise the same as an asset.

c) The types of market under NEAT are as follows: Normal Market: All orders which are of regular lot size or multiples thereof are traded in the normal market. For shares which are traded in the compulsory dematerialised mode the market lot of these shares is one. Normal market consists of various book types wherein orders are segregated as regular lot orders, special term orders, negotiated trade orders and stop loss orders, depending on their order attributes. Odd Lot Market: An order is called an odd lot order if the order size is less than regular lot size; such orders are traded in the odd-lot market. These orders do not have any special terms or attributes attached to them. In an odd-lot market, both the price and quantity of both the orders (buy and sell) should exactly match for the trade to take place. Spot Market: Spot orders are similar to the normal market orders except that spot orders have different settlement periods vis-a-vis normal market. These orders do not have any special terms or attributes attached to them. Auction Market: In the auction market, auctions are initiated by the Exchange on behalf of trading members for completing the settlement process. d. Liability of Auditor: “It is the auditor’s responsibility to audit the statement of accounts and prepare tax returns on the basis of books of accounts produced before him. Also if he is satisfied with the books and documents produced to him, he can give his opinion on the basis of those documents only by exercising requisite skill and care and observing the laid down audit procedure. In the instant case, Income tax Officer observed some irregularities during the assessment proceeding of M/s Cloud Ltd. Therefore, he started investigation of books of accounts audited and signed by Mr. Old, a practicing Chartered Accountant. While going through the books, he found that M/s Cloud Ltd. Used to maintain two sets of Books of Accounts, one is the official set and other is covering all the transactions. Income Tax Department filed a complaint with the ICAI saying Mr. Old had negligently performed his duties. Mr. Old, the auditor was not under a duty to prepare books of accounts of assessee and he should, of course, neither suggest nor assist in the preparations of false accounts. He is responsible for the books produced before him for audit. He completed his audit work with official set of books only. In this situation, as Mr. Old, performed the auditing with due skill and diligence; and, therefore, no question of negligence arises. It is the duty of the Department to himself investigate the truth and correctness of the accounts of the assessee.

6. a) Record of Audit Assignments: In exercise of the powers conferred by Chapter 8 of Council General

Guidelines 2008, the Council of the Institute of Chartered Accountants of India specified that a member of the Institute in practice shall be deemed to be guilty of professional misconduct, if he holds at any time appointment of more than the “specified number of audit assignments of the companies under Section 224 and /or Section 228 of the Companies Act, 1956 (now under Section 141(3)(g) and 143 of the Companies Act, 2013). As a part of this clause, to meet its requirements, a Chartered Accountants in practice as well as a firm in practice shall maintain a record of the audit assignments accepted as laid out in guidelines issued by the Council of the ICAI under Part II of Second Schedule to the Chartered Accountants Act, 1949 in respect of ceiling on audits containing following particulars: (i) Name of Company Audit/ Assignment. (ii) Registration. No. (iii) Date of appointment with Registrar of Companies. (iv) Date of acceptance. (v) Date on which form 23B filed (now Form ADT-1 as per the provisions and rules made under

Companies Act, 2013).

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b) Evaluation of Cost of Products: Clause (4) of Part I of the Second Schedule to Chartered Accountants Act, 1949, states that expressing an opinion on financial statements of any business or enterprise in which he, his firm or a partner in his firm has a substantial interest would constitute misconduct. Also, the Council of the Institute of Chartered Accountants of India has stated that in cases where a member of the Institute is a director of a company, or the firm in which the said member is a partner, should not express any opinion on its financial statements. As per facts of the case, the firm has been retained to evaluate the cost of products manufactured by it for its information system. It is a part of management consultancy service of the firm and moreover its partner was on the Board. Hence, the firm can perform this assignment and it will not constitute misconduct. However, the firm while accepting the position as auditor in future would have to consider whether it would be possible to act in independent manner and express opinion on financial statements.

c) Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 prohibits solicitation of client or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means since it shall constitute professional misconduct. The bio-data was handed over to the chairperson during the T.V. interview by the Chartered Accountant which included details about the firm and the achievements of the partner as an expert in the field of taxation. The chairperson simply read out the same in detail about association with the international firm as also the achievements of the partner and his recognition as an expert in the field of taxation. Such an act would definitely lead to the promotion of the firms’ name and publicity thereof as well as of the partner and as such the handing over of bio-data cannot be approved. The partner would be held guilty of professional miscount under Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949.

d) Review in the Assessment of Independence of the Practicing Unit – The reviewer should carry out the compliance review of the five general controls, i.e., independence, maintenance of professional skills and standards, outside consultation, staff supervision and development and office administration and evaluate the degree of reliance to be placed upon them. The degree of reliance will, ultimately, affect the attestation service engagements to be reviewed. A practicing Chartered Accountant should review following controls in respect of assessment of independence of the practicing unit: (i) Does the practice unit have a policy to ensure independence, objectivity and integrity, on the part

of partners and staff? Who is responsible for this policy? (ii) Does the practice unit communicate these policies and the expected standards of professional

behaviour to all staff? (iii) Does the practice unit monitor compliance with policies and procedures relating to

independence? (iv) Does the practice unit periodically review the practice unit's association with clients to ensure

objectivity and independence?

7. a) Haphazard Sampling: In haphazard selection, the auditor selects the sample without following a

structured technique. Although no structured technique is used, the auditor would nonetheless avoid any conscious bias or predictability for example, avoiding difficult to locate items, or always choosing or avoiding the first or last entries on a page and thus attempt to ensure that all items in the population have a chance of selection. Haphazard selection is not appropriate when using statistical sampling. Haphazard selection of sample, may be an acceptable alternative to random selection of sample, provided the auditor attempts to draw a representative sample from the entire population with no intention to either include or exclude specific units. When the auditor uses this method, care needs to be taken to guard against making a selection that is biased, for example, towards items which are easily located, as they may not be representative.

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b) True and Fair Cost of Production: A cost auditor checks the cost accounting records to verify that

the cost statements are properly drawn up as per the records and that they present a true and fair view of the cost of production and marketing of various products dealt with by the undertaking. The Companies (cost records and audit) Rules, 2014, prescribe the rules regarding the cost audit report and also prescribes the classes of companies required to include cost records in their books of account, applicability of cost audit, maintenance of records etc. The prescribed format of the report contains assertions regarding whether cost accounting records have been properly kept so as to give a true and fair view of the cost of production/ etc. The provisions of sub-section (12) of section 143 of the Companies Act, 2013 and the relevant rules on duty to report on fraud shall apply mutatis mutandis to a cost auditor during performance of his functions under section 148 of the Act and these rules. In any case, the true and fair concept is known to us in the context of financial accounts. Based on that knowledge, it may be assumed that the following are the relevant considerations in determining whether the cost of production determined is true and fair: (i) Determination of cost following the generally accepted cost accounting principles. (ii) Application of the costing system appropriate to the product. (iii) Materiality. (iv) Consistency in the application of costing system and cost accounting principles. (v) Maintenance of cost records and preparation of cost statements in the prescribed form and having

the prescribed contents. (vi) Elimination of material prior-period adjustments. (vii) Abnormal wastes and losses and other unusual transactions being ignored in determination of

cost.

c) Walk through Tests: A walk through is a procedure in which an auditor traces a transaction from its initiation through the company’s information systems to the point when it is reflected in the financial reports. The auditor should perform one walk through, at a minimum, for each major class of transactions. A walk-through provides evidence to confirm that the auditor understands (1) the process flow of transactions, (2) the design of identified controls for internal control components, including those related to preventing and detecting fraud, and (3) whether all points in the process have been identified at which misstatements related to relevant financial statement assertion could occur. Walk through also provide evidence to evaluate the effectiveness of the controls’ design and confirm that the controls have been placed in operation. When performing a walk-through, the auditor should: (i) Be sure that the walk-through encompasses the complete process (initiation, authorization,

recording, processing and reporting) for each significant process identified, including controls intended to address fraud risk.

(ii) Ask the entity’s personnel, at each of key stage in the process, about their understanding of what the company’s prescribed procedures require.

(iii) Determine whether processing procedures are performed as expected on a timely basis, and look for any exceptions to prescribed procedures and controls.

(iv) Evaluate the quality of evidence provided and perform procedures that produce a level of evidence consistent with the auditor’s objectives. The auditor should follow the whole process, using the same documents and technology that company staff use, asking questions of different personnel at each significant stage and asking follow- up questions to identify any abuse of controls or fraud indicators. Once a walk-through is performed, the auditor may carry forward the documentation, noting updates, unless significant changes make preparation of new documentation more efficient. If such significant changes occur in the process flow of transactions or supporting computer applications, the auditor should evaluate the nature of changes and the effect on related accounts. The auditor should determine whether it is necessary to walk through transactions that were processed both before and after the change.

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d) Summary Written Reports: These are known as flash reports. They are significant highlights for immediate attention of top management. Generally suspected defalcations are reported briefly to the appropriate management official on the 'flash' basis, often ending up in referral for criminal investigation and legal action. It is common practice in number of companies of issuing a report quite frequently summarising the various individual reports issued and describing the range of their contents in a very brief and comprehensive manner where only important points are highlighted. Such reports are primarily issued for audit committees of Board of Directors and for other top level managers who do not have sufficient time to go through the elaborate reports and matters which are required to be brought to their notice for immediate action.

e) Mandatory Review Areas of the Audit Committee: The Audit Committee shall mandatorily review the following information as per LODR Regulations- (i) Management discussion and analysis of financial condition and results of operations; (ii) Statement of significant related party transactions (as defined by the Audit Committee), submitted

by management; (iii) Management letters / letters of internal control weaknesses issued by the statutory auditors; (iv) Internal audit reports relating to internal control weaknesses; and (v) The appointment, removal and terms of remuneration of the Chief internal auditor shall be subject

to review by the Audit Committee. (vi) Statement of deviations: (a) quarterly statement of deviations including report of monitoring

agency if applicable and (b) annual statement of funds utilized for purposes other than those stated in the offer document/ prospectus/ notice.

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Paper 4– Corporate and Allied Laws

No. of Questions: 7 Total Marks: 100 No. of Pages: 3 Time Allowed: 3 hrs

Question 1 is compulsory Attempt any 5 from the remaining 6

1. a) A Public Company has been declaring dividend at the rate of 20% on equity shares during the last 3

years. The Company has not made adequate profits during the year ended 31st March, 2015, but it has got adequate reserves which can be utilized for maintaining the rate of dividend at 20%. Advise the Company as to how it should go about if it wants to declare dividend at the rate of 20% for the year 2014-15 as per the provisions of the Companies Act, 2013. (4 Marks)

b) Mr. G., an Indian national desires to obtain Foreign Exchange on current account transactions for the following purposes: (i) Payment of commission on exports made towards equity investment in wholly owned subsidiary

abroad of an Indian Company. (ii) Remittance of hiring charges of transponder by TV channels Advise G whether he can obtain Foreign Exchange and, if so, under what conditions? (4 Marks)

c) Mr. Enthu Student is a final year CA articles student in a big CA firm. He is excited about investing in the stock markets after having gone through the study materials issued to him. But he is unable to understand a few commonly used terms. Explain to him the following terms:

(i) Derivatives (ii) Option in Securities (iii) Spot delivery contract (4 Marks)

d) Selected Directors of Confidence Ltd. conspired with the Auditor of the company to embezzle the accounts of the company in their interest. Tribunal on an application filed by certain directors passed the order for the removal of auditor. In view of the given facts state the following- (i) Whether the order directing removal of auditor by tribunal on an application of certain directors

is valid? (ii) If an order of removal passed against the auditor, will he be eligible to be appointed in other

company? (4 Marks) e) Mr. X, an Indian national has failed to realise and repatriate foreign exchange worth more than ` 2

crores. Mr. X having realised that he had committed a contravention of the provisions of the Foreign Exchange Management Act, 1999, desires to compound the said offence. Advise Mr. X. (4 Marks)

2. a) Annual general meeting of Hero Ltd. has been scheduled in compliance with the requirements of the

Companies Act, 2013. In this connection, it has some directors who are rotational and out of which some have been appointed long back, some have been appointed on the same day. Decide in this connection: (i) Which of the directors shall be retiring by rotation? (ii) In case two directors were appointed on the same day, how would you decide their retirement by rotation? (iii) In case the meeting could not decide how the vacancies caused by retirement to be dealt with, what shall be consequences? (6 Marks)

b) What are the disqualifications for appointment of director. (5 Marks) c) What is the qualifications of the President and members of the National Company Law Tribunal.

(5 Marks)

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3. a) The Board of Directors of CDM Ltd was held on 2nd May 2014,at its registered office. State the salient

points to be taken into account while drafting the minutes of the said Board meeting. (4 Marks) b) Mr. Atharva, a director of Northway highway Tolls Private Limited, authorised by board of directors to

prepare and file return, report or other documents to registrar on behalf of the company. He timely filed all the required documents to Registrar; however, subsequently it is found that the filed documents are false in respect to material particulars (knowing it to be false) submitted to registrar. Explain the penal provision under the Companies Act, 2013. (4 Marks)

c) JKL Research Development Limited is a registered Public Limited Company. The company has a unique business idea emerging from research and development in a new area. However, it is a future project and the company has no significant accounting transactions and business activities at present. The company desires to obtain the status of a 'Dormant Company'. Advise the company regarding the provisions of the Companies Act, 2013 in this regard and the procedure to be followed in this regard.

(4 Marks) d) XLR Bank Limited is not managing its affairs properly. Employees as well as depositors of the bank

have complained to the Central Government from time to time about such mismanagement and requested the Central Government to acquire the undertaking of the Banking Company. Explain the powers of the Central Government in this regard under the Banking Regulation Act, 1949. (4 Marks)

4. a) XYZ is a public limited company with a paid up share capital of Rs.12 Crores and outstanding loans of

Rs.49 crores. The company has 6 directors out of which 1 is an independent directors (4 Marks) i) Whether the number of independent directors appointed by the company is as per the Rules

framed under the companies Act. (4 Marks) ii) Will your answer to (i) above change in the following scenario. The composition of the Audit

committee of the company is 4 directors. Comment on the sufficiency of the independent directors in view of the strength of the Audit Committee. (4 Marks)

iii) During the financial year one of the independent directors resigned 15th June 2015. What are the formalities that need to be followed by the Board to fill the vacancy. (4 Marks)

b) The Competition Commission of India has received a complaint that M/s ABC company has been

abusing its dominant position in the food processing industry. Explain briefly the factors that will be considered by the Commissions to ascertain whether M/s ABC company enjoys a dominant position in the industry. (4 Marks)

5. a) ABC Ltd. in its First General Meeting appointed six Directors whose period of office is liable to be

determined by rotation. Briefly explain the procedure and rules regarding retirement of these directors. Will it make any difference, if ABC Company Ltd. does not carry on business for Profit?

(4 Marks) b) What are provisions related to constitution and working of the Mediation and Conciliation Panel as

per Section 442 of the Companies Act, 2013? (8 Marks) c) ABC Private Limited is a company in which there are eight shareholders. Can a member holding less

than one-tenth of the share capital of the company apply to the Tribunal for relief against oppression and mismanagement? Give your answer according to the provisions of the Companies Act, 2013.

(4 Marks) 6. a) Explain the rule of ‘beneficial construction’ while interpreting the statutes quoting an example.

(4 Marks) b) Mr. Raman, an investor is not satisfied with the dealings of his stock broker who is registered with

Delhi Stock Exchange. Mr. Raman approaches you to guide him regarding the avenues available to him for making a complaint against the stock broker under Securities and Exchange Board of India Act, 1992 and also the grounds on which such complaint can be made. You are required to briefly explain the answer to his queries. (4 Marks)

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c) Working of City Stock Exchange Association Ltd., is not being carried on by its governing Board in

public interest. On receipt of representations from various investors and Investors’ Association, the Central government is thinking to withdraw the recognition granted to the said Stock Exchange. You are required to state the circumstances the procedure for withdrawal of such recognition as per the provisions of Securities Contracts (Regulation) Act, 1956 in this regard. Also state the effect of such withdrawal on the contracts outstanding on the date of withdrawal. (4 Marks)

d) Some changes in the particulars of a Director, who has already obtained a Director Identification Number have taken place. Now the Director wants to incorporate the changes in his DIN in the database maintained by the Central Government in this regard. Describe the procedure to be followed by the Director. (4 Marks)

7. Answer any four a) A life insurance policy, in favour of Kamal Kumar, came into force on 1st February, 2009. In February,

2012 the insurer came to know that there was a mis-statement in the proposal for insurance regarding the age of the insured. Decide, under the provisions of the Insurance Act, 1938, whether the said insurance policy can be called in question? (4 Marks)

b) Explain the meaning of the term “Money Laundering”. Z, a known smuggler was caught in transfer of funds illegally exporting narcotic drugs from India to some countries in Africa. State the maximum punishment that can be awarded to him under Prevention of Money Laundering Act, 2002.

(4 Marks) c) Define “contributory” in a winding up. Explain the liabilities of contributories as present and past

member. Give your answer according to the Companies Act, 1956. (4 Marks) d) Which offences are deemed to be Non- cognizable under the Companies Act, 2013? Enumerate the

relevant provisions. (4 Marks) e) As per provisions of the Companies Act, 2013, what is the status of XYZ Ltd., a Company incorporated

in London, U.K., which has a share transfer office at Mumbai? (4 Marks)

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The Society of Auditors and Prime Academy 44th session Model Exam – Final – Corporate and Allied Laws

Suggested Answers 1. a) As per Rule 3 of the Companies (Declaration and Payment of Dividend) Rules), 2014, in the event of

inadequacy or absence of profits in any year, a company may declare dividend out of surplus subject to the fulfilment of the following conditions: 1. The rate of dividend declared shall not exceed the average of the rates at which dividend was

declared by it in the three years immediately preceding that year; Provided that this sub-rule shall not apply to a company, which has not declared any dividend in each of the three preceding financial year.

2. The total amount to be drawn from such accumulated profits shall not exceed one-tenth of the sum of its paid-up share capital and free reserves as appearing in the latest audited financial statement;

The amount so drawn shall first be utilised to set off the losses incurred in the financial year in which dividend is declared before any dividend in respect of equity shares is declared; The balance of reserves after such withdrawal shall not fall below 15% of its paid up share capital as appearing in the latest audited financial statement. In the given case therefore, the company can declare a dividend of 20% provided it has the required residual reserve, after such payment, of 15% of its paid up capital as appearing it its latest audited financial statement. The company should have the dividend recommended by the Board and put up for the approval of the members at the Annual General Meeting as the authority to declare lies with the members of the company.

b) Under Section 5 of Foreign Exchange Management Act, 1999, certain rules have been framed for drawal of foreign exchange on current account. According to the said rules, drawal of foreign exchange for certain transactions are prohibited. In respect of certain transactions drawal of foreign exchange is permissible with the prior approval of Central Government. In respect of some of the transaction, prior permission of RBI is sufficient for drawal of foreign exchange. (i) In respect of item No.1 i.e. Payment of Commission on exports made towards equity investment in

wholly owned subsidiary abroad of an Indian company is prohibited. (ii) Drawal of foreign exchange for remittance of hiring charges of transponder by TV Channels, can be

made with the prior approval of the Central Government. In the case of (ii) above, approval of concerned authority is not required if the payment is made out of funds held in Resident Foreign Currency (RFC) Account or Exchange Earner’s Foreign Currency (EEFC) Account of the remitter. Further foreign Exchange can be drawn only from an authorised person.

c) Mr. Enthu Student, can be advised on following terms commonly used in any Stock Exchange. (i) Derivative: “derivative” includes— (A) a security derived from a debt instrument, share, loan,

whether secured or unsecured, risk instrument or contract for differences or any other form of security; (B) a contract, which derives its value from the prices, or index of prices, of underlying securities; (C) commodity derivatives; and (D) such other instruments as may be declared by the Central Government to be derivatives;

(ii) Option in Securities: Option in Securities means a contract for the purchase or sale of a right to buy or sell or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call securities.

(iii) Spot Delivery Contract: Spot delivery contract means a contract which provides for: (a) actual delivery of securities and the payment of a price therefore either on the same day as the date of the contract or on the next day, the actual period taken for the dispatch of the securities or the remittance of money therefore through the post being excluded from the computation of the period aforesaid if the parties to the contract do not reside in the same town or locality. (b) transfer of the securities by the depository from the account of a beneficial owner to the account of another beneficial owner when such securities are dealt with by a depository.

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d) According to the section 140(5) of the Companies Act, 2013 , without prejudice to any action under the provisions of this Act or any other law for the time being in force, the Tribunal either suo motu or on an application made to it by the Central Government or by any person concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, it may, by order, direct the company to change its auditors. Accordingly, in the given question, Tribunal on an application filed by certain directors for removal of auditor of the company on the account of embezzlement of the accounts of the company in the interest of selected directors, passed the order for removal. Referring the above provision, Tribunal, on being satisfied on an application filed by the certain directors alleging that the auditor of a company has embezzled the accounts of the company in the interest of the selected directors is colluded in the committing of the fraud, it may by order direct the company to change its auditor. Therefore, the act of tribunal by passing of an order of removal of auditor directing to company is valid. Proviso to section 140(5) of the Act provides that an auditor against whom final order has been passed by the Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order and the auditor shall also be liable for action under section 447.

e) Because of his failure to realise and repatriate foreign exchange, Mr. X has contravened the provisions of section 8 of FEMA and he is liable to the penalties leviable under section 13, followed by adjudication proceedings. Section 15 of FEMA permits the offending party to compound the contravention within 180 days from the date of receipt of application by the Director of Enforcement or such other officers of the Directorate of Enforcement and officers of the Reserve Bank of India as may be authorised in this behalf by the Central Government in such manner as may be prescribed. No contravention shall be compounded unless the amount involved in such contravention is quantifiable. Where a contravention has been compounded, no proceeding can continue or be initiated against the person in respect of the contravention so compounded.

2. a)

(i) According to section 152(6)(a)(i) of the Companies Act, 2013, unless the articles provide for the retirement of all directors at every annual general meeting, not less than two- thirds of the total number of directors of a public company shall be persons whose period of office is liable to determination by retirement of directors by rotation. Further, section 152(6)(c) of the Act states that one-third of such of the directors for the time being as are liable to retire by rotation, or if their number is neither three nor a multiple of three, then, the number nearest to one-third, shall retire from office. From the above provisions, it is clear that the directors who are liable for rotation at every annual general meeting shall be one third of those directors who constitute the two thirds of the total number of directors and who are liable for rotation at every AGM.

(ii) Under section 152(6)(d) the directors to retire by rotation at every annual general meeting shall be those who have been longest in office since their last appointment, but as between persons who became directors on the same day, those who are to retire shall, in default of and subject to any agreement among themselves, be determined by lot.. Therefore, the directors who will retire by rotation shall be those who have been in office for the longest term since their appointment. In case of two or more directors who were appointed on the same date at the same AGM, the retiring directors will be mutually agreed by them or in the absence of such agreement, will be determined by lots.

(iii) Under section 152(6)(e) of the Companies Act, 2013 the Vacancy caused by the retirement of directors at the AGM may be filled in the same annual general meeting by appointing either the retiring directors or some other person. The annual general meeting may also decide not to fill the vacancy arising from the retirement of one or more directors.

Section 152(7) (a) provides that if the vacancy of the director retiring by rotation, is not so filled-up and the meeting has not expressly resolved not to fill the vacancy, the meeting shall stand adjourned till the same day in the next week, at the same time and place, or if that day is a national holiday, till the next succeeding day which is not a holiday, at the same time and place.

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Section 152 (7)(b) further provides that if at the adjourned meeting also, the vacancy of the retiring director is not filled up and that meeting also has not expressly resolved not to fill the vacancy, the retiring director shall be deemed to have been re-appointed at the adjourned meeting, unless: (a) at that meeting or at the previous meeting a resolution for the re-appointment of such director has

been put to the meeting and lost; (b) the retiring director has, by a notice in writing addressed to the company or its Board of directors,

expressed his unwillingness to be so re-appointed; (c) he is not qualified or is disqualified for appointment; (d) a resolution, whether special or ordinary, is required for his appointment or re- appointment by

virtue of any provisions of this Act; or (e) section 162 (appointment of directors to be voted individually) is applicable to the case.

b) According to section 164 of the Companies Act, 2013:

(i) A person cannot be appointed as director of a company in any of the following cases: 1. he is of unsound mind and stands so declared by a competent court; 2. he is an undischarged insolvent; 3. he has applied to be adjudicated as an insolvent and his application is pending; 4. he has been convicted by a court of any offence, whether involving moral turpitude or otherwise,

and sentenced in respect thereof to imprisonment for not less than 6 months and a period of 5 years has not elapsed from the date of expiry of the sentence. However, if a person has been convicted of any offence and sentenced in respect thereof to imprisonment for a period of 7 years or more, he shall not be eligible to be appointed as a director in any company

5. an order disqualifying him for appointment as a director has been passed by a court or Tribunal and the order is in force;

6. The has not paid any calls in respect of any shares of the company held by him, whether alone or jointly with others, and 6 months have elapsed from the last day fixed for the payment of the call;

7. he has been convicted of the offence of dealing with related party transactions under section 188 at any time during the last preceding 5 years; or

8. he has not complied with sub-section (3) of section 152 which requires a director to have a Director Identification Number under section 154.

(ii) No person who is or has been a director of a company which— 1. has not filed financial statements or annual returns for any continuous period of 3 financial years; 2. has failed to repay the deposits accepted by it or pay interest thereon or to redeem any debentures

on the due date or pay interest due thereon or pay any dividend declared and such failure to pay or redeem continues for 1 year or more, shall be eligible to be re-appointed as a director of that company or appointed in other company for period of 5 years from the date on which the said company fails to do so. [Section 164(2)]

Government may by its articles provide However, the disqualifications referred to in clauses (d), (e) and (g) of sub-section (1) [given in point (i) above] shall not take effect—

1. for 30 days from the date of conviction or order of disqualification; 2. where an appeal or petition is preferred within 30 days as aforesaid against the conviction resulting

in sentence or order, until expiry of 7 days from the date on which such appeal or petition is disposed off; or

3. where any further appeal or petition is preferred against order or sentence within 7 days, until such further appeal or petition is disposed off.

c) Qualification of President and Members of the National Company Law Tribunal: Section 409 of the

companies Act 2013 deals with qualifications of the president and members of the tribunal. i) Qualifications of President: He shall be a person who is or has been a Judge of high court for 5 years ii) Qualification of Judicial Member: a person shall not be qualified for appointment as a judicial member unless he is or has been a judge of a high court or a district judge for at least 5 years or an advocate of a court for at least 10 years.

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For the purposes of clause 3 above, in computing the period for which a person has been an advocate of a court, there shall be included any period during which the person has held judicial office or the office of a member of a tribunal or any post under the union or a State requiring special knowledge of law after he became an advocate. iii) Qualification of a technical member: A person shall not be qualified for appointment as technical member unless he – has been a member of the Indian Corporate law Service or Indian Legal Service for at least 15 years out of which at least 3 years shall be in the pay scale of Joint Secretary to the Government of India or equivalent or above that in the service, or is or has been in practice as a chartered Accountant or a cost Accountant or a company Secretary for at least 15 years is a person of proven ability, integrity, and standing having specialised knowledge and experience, of not less than 15 years, in industrial finance, management or administration, reconstruction, investment, accountancy, labour matters or such other disciplines which are related to the management of the affairs including reconstruction, rehabilitation and winding up of companies.

3. a) While drafting the minutes of a board meeting following salient points should be kept in mind:

(a) the minutes may be drafted in a tabular form or they may be drafted in the form of a series of paragraphs, numbered consecutively and with relevant headings.

the place, date and time of the meeting should be stated. (b) The chairman of the meeting must be mentioned. The general phrase used in the Minutes is “Mr.---

chairman of the meeting took the chair and called the meeting to order”. (c) the minutes should clearly mention the attendance and the constitution of the meeting, i.e., persons

present and the capacity in which present, e.g. name of the person chairing the meeting, names of the directors and secretary, identifying them as director or secretary, names of persons in attendance like auditor, internal auditor etc. The minutes should also contain the subject of leave of absence granted, if any, to any of the board members.

(d) The adoption of the Minutes of the previous Board Meeting must be the first item on the Agenda by the directors giving their approval and the Chariman signing the Minutes as proof of approval of the Minutes.

(e) Conduct of the business at the meeting should be recorded in the chronological sequence as per the Agenda.

(f) In respect of each item of business the names of the directors dissenting or not concurring with any resolution passed at the board meeting should be mentioned.

(g) Reference about interested directors abstaining from voting is also required to be stated in the minutes.

(h) Chairman’s signature and date of verification of minutes as correct.

b) According to section 448 of the Companies Act, 2013, if any person makes a statement which is false in any material particulars, knowing it to be false or omits any material facts, knowing it to be material, such person shall be liable under section 447. As per Section 447, any person who is found to be guilty under this section shall be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to 3 times the amount involved in the fraud. Provided that, where the fraud involves public interest, the term of imprisonment shall not be less than 3 years. Hence, Mr. Atharva, a director of Northway highway Tolls Private Limited shall be punishable with imprisonment and fine prescribed as aforesaid.

c) The provisions related to the Dormant companies is covered under section 455 of the Companies Act, 2013. According to provisions- A company is formed and registered under this Act for the purpose of a future project or to hold an

asset or intellectual property and has no significant accounting transaction.

Such company or an inactive company may make an application to the Registrar in such manner as may be prescribed for obtaining the status of a dormant company.

The Registrar shall allow the status of a dormant company to the applicant and issue a certificate after considering of the application.

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The Registrar shall maintain a register of dormant companies in such form as may be prescribed. In case of a company which has not filed financial statements or annual returns for two financial years consecutively, the Register shall issue a notice to that company and enter the name of such company in the register maintained for dormant companies.

A dormant company shall have such minimum number of directors, file such documents and pay such annual fee as may be prescribed to the Registrar to retain its dormant status in the register and may become an active company on an application made in this behalf accompanied by such documents and fee as may be prescribed. However, the Registrar shall strike off the name of a dormant company from the register of dormant companies, which has failed to comply with the requirements of this section. Thus, JKL Research Development Limited may follow the above procedure to obtain the status of a ‘Dormant Company’.

d) Under Section 36AE of the Banking Regulation Act, 1949, if the Central Government upon a report from RBI, is of the opinion that a Banking company has failed to comply with the directions given by RBI relating to policy matters under section 21 and 35A and or the affairs of the Bank are being managed in a manner detrimental to the interest of depositors or that of the banking policy or for better provision of credit generally or of credit to any particular section of the community or in any particular area; it is necessary that the Government may after consultation with RBI, by notified order, acquire the undertaking of a Banking Company. In such a case, on the date specified in the notification, the undertaking of the Banking Company and its assets and liabilities shall stand transferred to and vest in Central Government. Before acquiring the undertaking, the Central Government shall give a reasonable opportunity of hearing to the Banking Company.

4. a) (i) According to section 149 (4) of the co act 2013 every listed public company shall have at least one-

third of the total number of directors as Independent directors. According to Rule 4 of the Companies (Appointment and Qualification of Directors) Rules 2014, the following classes of companies shall have at least 2 directors as independent directors: (1) Public companies having paid up share capital of Rs.10 crores or more (2) Public companies having turnover of Rs.100 crores or more and (3) Public companies having in aggregate, outstanding loans , debentures and deposits exceeding Rs.50

crores. Hence based on the above rule (i) since XYZ has a share capital of Rs.12 crores, the company is required to have a minimum of 2 independent Directors. (ii) As per section 177(2) of the companies Act 2013, the Audit committee shall consist of a minimum of three directors with independent directors forming majority. In this instance XYZ has an audit committee with a strength of 4 directors. Even if the company were to appoint one more independent director to comply with (i) above, the number of independent director is not enough to meet the criteria of minimum of 3 independent directors in the audit committee. Hence to comply with section 177 (2) the company has to appoint 2 independent directors to meet the minimum number of independent directors in the audit committee. (iii) According to Rule 4 of the Companies (Appointment and Qualification of Directors) Rules 2014, any intermittent vacancy of an independent director shall be filled up by the board at the earliest but not later than the immediate next board meeting or three months from the vacancy, whichever is later. In the given instance if the next board meeting after the vacancy was held on 14 th August 2015, then the vacancy shall be filled up by 14th August 2015 or 14th September 2015 whichever is later. In this case it shall be filled up by 14th September 2015. If the immediate board meeting after the vacancy was held on 14th October 2015, then the vacancy shall be filled by 14th Oct 2015 or by 14th Sept 2015 whichever is later. In this case it shall be filled by 14th October 2015.

b) Abuse of Dominant position: The Competition commission while inquiring whether the enterprise ABC company enjoys a dominant position or not under sub-section (4) of section 19 of the Competition Act, 2002 will take the following factors into account: 1. Market-share of the enterprise 2. Size and resources of the enterprise 3. Size and importance of the competitors.

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4. Economic power of the enterprise including commercial advantages over competitors. 5. Vertical integration of the enterprises or sale or service net work of such enterprises. 6. Dependence of consumers on the enterprise. 7. Monopoly or dominant position whether acquired as result of any statute or by virtue of being a

government company or a public sector undertaking or otherwise. 8. Entry barriers including barriers such as regulatory barriers, financial risk, high capital cost of

entry, marketing entry barriers, technical entry barriers, economies of scale, high cost of substitutable goods or services for consumers.

9. Countervailing buying power. 10. Market structure and size of market. 11. Social obligations and social cost. 12. Relative advantage, by way of contribution to the economic development, by the enterprise

enjoying a dominant position having or likely to have an appreciable adverse effect on competition. 13. Any other factor which the commission may consider relevant for the inquiry.

5. a) Under section 152(6) (a) unless the articles provide for the retirement of all directors at every annual

general meeting, not less than two-thirds of the total number of directors of a public company shall be persons whose period of office is liable to determination by retirement of directors by rotation. In the given case, it is assumed that the 6 directors appointed at the first general meeting of the company constitute at least two thirds of the total number of directors. Section 152(6)(c) further states that at every annual general meeting, one-third of such of the directors for the time being as are liable to retire by rotation, or if their number is neither three nor a multiple of three, then, the number nearest to one-third, shall retire from office. Therefore, in the given case 2 directors will be liable to retire by rotation at the next AGM of the Company. Section 152(6)(d) further states that the directors to retire by rotation at every annual general meeting shall be those who have been longest in office since their last appointment, but as between persons who became directors on the same day, those who are to retire shall, in default of and subject to any agreement among themselves, be determined by lot. In the given case, all the 6 directors were appointed on the same date. Hence, the choice of the 2 directors who would retire at the next AGM of the company will be made either mutually by these 6 directors failing which; it will be decided by lots. It will not make any difference under the Companies Act, 2013 if the company is a non profit organization.

b) Mediation and Conciliation Panel: In common parlance, Mediation means intervention of some third party in a dispute with the intention to resolve the dispute. Conciliation means the process of adjusting or settling disputes in a friendly manner through extra judicial means. This new provision introduced by the Companies Act, 2013 has come into force with effect from 1st April 2014,. Section 442 of the Companies Act, 2013 deals with the constitution and functioning of the mediation and conciliation panel in order to dispose the matter. Section 442 lays the following law with respect to the constitution and working of the Mediation and Conciliation Panel: (1) Central Government to maintain the Panel of Mediators: The Central Government shall maintain a panel of experts to be known as Mediation and conciliation panel for mediation between the parties during the pendency of any proceedings before the Central Government or the Tribunal or the Appellate Tribunal under this Act. Hence, it is important that the case should be pending before the Central Government or the Tribunal or the Appellate Tribunal under this Act. (2) Panel consisting of experts: The panel shall consist of such number of experts having such qualification as may be prescribed. (3) Filing of application: Application for mediation and conciliation can be made by: (i) any parties to the proceedings. (It shall be accompanied with such fees and in such form as may be prescribed. (ii) The Central Government or the Tribunal or the Appellate Tribunal before which any proceeding is pending may, suo motu refer any matter pertaining to such proceeding to such number of experts as it may deem fit.

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(4) Appointment of expert/s from panel: The Central Government or the Tribunal or the Appellate Tribunal before which any proceeding is pending may appoint one or more experts from the Panel as may be deemed fit. (5) Fees, terms and conditions of the experts: The fee and other terms and conditions of experts of the Mediation and Conciliation Panel shall be such as may be prescribed. (6) Procedure for the disposal of matter: In order to dispose the matter, the Mediation and Conciliation Panel shall follow such procedure as may be prescribed. (7) Period for the disposal of matter: The Mediation and Conciliation Panel shall dispose of the matter referred to it within a period of three months from the date of such reference and forward its recommendations to the Central Government or the Tribunal or the Appellate Tribunal, as the case may be. (8) Filing of objection on the recommendation of the panel: Any party aggrieved by the recommendation of the Mediation and Conciliation Panel may file objections to the Central Government or the Tribunal or the Appellate Tribunal, as the case may be.

c) Under section 244 of the Companies Act, 2013, in the case of a company having share capital, the following member(s) have the right to apply to the Tribunal under section 241: (a) Not less than 100 members of the company or not less than one-tenth of the total number of members, whichever is less; or (b) Any member or members holding not less than one-tenth of the issued share capital of the company provided the applicant(s) have paid all the calls and other sums due on the shares. In the given case, since there are eight shareholders. As per the condition (a) above, 10% of 8 i.e. 1 satisfies the condition. Therefore, a single member can present a petition to the Tribunal, regardless of the fact that he holds less then one-tenth of the company’s share capital.

6. a) Where the language used in a statute is capable of more than one interpretation, the most firmly

established rule for construction is the principle laid down in the Hey don’s case. This rule enables, consideration of four matters in constituting an act: (1) what was the law before making of the Act, (2) what was the mischief or defect for which the law did not provide, (3) what is the remedy that the Act has provided, and (4) what is the reason for the remedy. The rule then directs that the courts must adopt that construction which ‘shall suppress the mischief and advance the remedy’. Therefore even in a case where the usual meaning of the language used falls short of the whole object of the legislature, a more extended meaning may be attributed to the words, provided they are fairly susceptible of it. If the object of any enactment is public safety, then its working must be interpreted widely to give effect to that object. Thus in the case of Workmen’s Compensation Act, 1923 the main object being provision of compensation to workmen, it was held that the Act ought to be so construed, as far as possible, so as to give effect to its primary provisions. However, it has been emphasized by the Supreme Court that the rule in Heydon’s case is applicable only when the words used are ambiguous and are reasonably capable of more than one meaning [CIT v. Sodra Devi (1957) 32 ITR 615 (SC)].

b) Securities and Exchange Board of India (SEBI) was established for regulating the various aspects of stock

market. One of its functions is to register and regulate the stock brokers. In the light of this, Mr. Raman is advised that the complaint against the erring stock broker may be submitted to SEBI. The grounds on which or the defaults for which complaints may be made to SEBI are as follows: (a) Any failure on the part of the stock broker to issue contract notes in the form and manner specified by the stock exchange of which the stock broker is a member. (b) Any failure to deliver any security or any failure to make payment of the amount due to the investor in the manner within the period specified in the regulations. (c) Any collection of charges by way of brokerage which is in excess of the brokerage specified in the regulations.

c) Section 5 of the Securities Contracts (Regulation) Act, 1956 empowers the Central Government to withdraw the recognition granted to a stock exchange. The circumstances and procedure to be followed for withdrawal of such recognition is stated below

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(i) if considering the interest of the trade or the public interest, the Central government is of the opinion that the recognition granted to a stock exchange should be withdrawn, the Central Government shall serve a written notice on the governing body of the stock exchange.

(ii) The said notice shall specify the reasons for the proposed withdrawal of the recognition. (iii) The governing body of the stock exchange shall be afforded an opportunity of being heard by the

Central Government. (iv) Even after hearing the governing body, the Central Government is satisfied that the recognition

granted to the stock exchange should be withdrawn; the Central Government may, by way of a notification in the Official Gazette, withdraw the recognition granted to the stock exchange.

The proviso to the said section 5 states that no such withdrawal shall affect the validity of any contract entered into or made prior to the date of notification withdrawing the recognition and the Central Government may, after consultation with the stock exchange, make such provision as it deems fit in the notification of withdrawal or in any subsequent notification for the due performance of any contracts outstanding on that date.

d) Intimation of changes in particulars specified in DIN application: The Companies (Appointment and Qualification of Directors) Rules, 2014 provides for the procedure for intimation of changes in particulars specified in the DIN application. According to which every individual who has been allotted a DIN under these rules shall, in the event of any change in his particulars as stated in Form DIR-3, intimate such change(s) to the Central Government within a period of thirty days of such change(s) in Form DIR-6 in the following manner, namely :- 1. The applicant shall download Form DIR-6 from the portal and fill in the relevant changes, attach copy

of the proof of the changed particulars and verification in the Form DIR-7 all of which shall be scanned and submitted electronically;

2. The form shall be digitally signed by a chartered accountant in practice or a company secretary in practice or a cost accountant in practice;

3. The applicant shall submit the Form DIR-6.

7. a) Policy not to be called in question on ground of mis-statement: According to section 45 of the

Insurance Act, 1938 vide the Insurance Laws (Amendment) Act, 2015, no policy of life insurance is effected after the expiry of three years from the date of the policy, i.e., from the date of issuance of the policy or the date of commencement of risk or the date of revival of the policy or the date of the rider to the policy, whichever is later on the ground of the fraud. Nothing in this section shall prevent the insurer from calling for proof of age at any time if he is entitled to do so, and no policy shall be deemed to be called in question merely because the terms of the policy are adjusted on subsequent proof that the age of the life insured was incorrectly stated in the proposal.' Thus, the insurance policy cannot be called in question. Correction as to the age of the life insured can be made at any time on subsequent proofs.

b) Money Laundering: Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime and projecting it as untainted property shall be guilty of offence of money laundering. [Section 3 of the Prevention of Money Laundering Act, 2002] Paragraph 2 of Part A of the Schedule to the Prevention of Money Laundering Act, 2002, covers Offences under the Narcotic Drugs And Psychotropic Substances Act, 1985. Whereby, illegal import into India, export from India or transhipment of narcotic drugs and psychotropic substances (section 23) is covered under paragraph 2 of Part A. Punishment: Section 4 of the said Act provides for the punishment for Money-Laundering. Whoever commits the offence of money-laundering shall be punishable with rigorous imprisonment for a term which shall not be less than 3 years but which may extend to 7 years and shall also be liable to fine. But where the proceeds of crime involved in money-laundering relate to any offence specified under paragraph 2 of Part A of the Schedule, the maximum punishment may extend to 10 years instead of 7 years.

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c) Contributory: According to Section 428 of the Companies Act, 1956 in a winding up, the term “contributory” means a past or present member liable to contribute to the assets of the company in the event of its being wound up and includes holders of shares which are fully paid up. If a member is once placed in the list of contributories, he is liable to the extent of original shares that remain unpaid, unless he proves that he should not have been placed in the list. When a company goes into liquidation, every member, whether past or present, has to contribute to the assets of the company. However, a past member will not be required to contribute in the following circumstances: (a) if he had ceased to be a member for a period of one year or upwards before the commencement of winding up. (b) if the debt or liability of the company was contracted or incurred after he ceased to be a member. (c) if the present members are able to satisfy the contributions required to be made by them under the Act.

d) Offences to be non-cognizable: According to section 439 of the Companies Act, 2013: (i) Notwithstanding anything in the Code of Criminal Procedure, 1973, every offence under this Act

except the offences referred to in sub-section (6) of section 212 shall be deemed to be non-cognizable within the meaning of the said Code.

(ii) No court shall take cognizance of any offence under this Act which is alleged to have been committed by any company or any officer thereof, except on the complaint in writing of the Registrar, a shareholder of the company, or of a person authorised by the Central Government in that behalf.

(iii) Whereas in case of a government companies, court shall take cognizance of an offence under this Act which is alleged to have been committed by any company or any officer thereof on the complaint in writing of a person authorized by the Central Government in that behalf. [Vide Notification G.S.R. 463(E) dated (iii) The court may take cognizance of offences relating to issue and transfer of securities and non-payment of dividend, on a complaint in writing, by a person authorised by the Securities and Exchange Board of India.

(iv) Nothing in this sub-section shall apply to a prosecution by a company of any of its officers. (v) Where the complainant is the Registrar or a person authorised by the Central Government, the

presence of such officer before the Court trying the offences shall not be necessary unless the court requires his personal attendance at the trial.

(vi) The above provisions shall not apply to any action taken by the liquidator of a company in respect of any offence alleged to have been committed in respect of any of the matters in Chapter XX or in any other provision of this Act relating to winding up of companies.

(vii) The liquidator of a company shall not be deemed to be an officer of the company.

e) In terms of the definition of a foreign company under section 2 (42) of the Companies Act, 2013 a “foreign company” means any company or body corporate incorporated outside India which: 1. Has a place of business in India whether by itself or through an agent, physically or through electronic

mode; and 2. Conducts any business activity in India in any other manner

According section 386 of the Companies Act, 2013, for the purposes of Chapter XXII of the Companies Act, 2013 (Companies incorporated outside India), “Place of business” includes a share transfer or registration office.

From the above definition, the status of XYZ Ltd. will be that of a foreign company as it is incorporated outside India, has a place of business in India and it may be presumed that it carries on a business activity in India

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final march 2017 paper 1 no. of questions: 7 total marks: 100 · 2017-04-17 · prime/44th me/final...

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