PRIME A

CADEMY

1

The Society of Auditors and Prime Academy

Final Model exam- September 2016

Financial Reporting- Paper 1

Question No 1 is Compulsory answer any five of the remaining questions

Working notes should form part of the respective answers

Wherever necessary candidates can make assumptions and disclose the same by

way of a note

(4 x 5 M = 20 M)

1(a) Z Limited ordered 13,000 kg. of chemicals at ` 90 per kg. The purchase price includes

excise duty of `5 per kg. in respect of which full CENVAT credit is admissible. Further, state

VAT is leviable at ` 2.5 per kg on purchase price. Freight incurred amounted to ` 30,000.

Normal transit loss is 4%. The company actually received 12,400 kg and consumed 10,000 kg.

of chemicals. The company has received trade discount later on in the form of their credit

note of Re. 1 per kg. The chemicals were delivered in containers. The containers were not

reusable, hence sold for Rs. 500. The administrative expenses incurred to bring the

chemicals were Rs. 10,000. Compute the value of inventory and allocate the material cost as

per AS 2.

1(b) Huge Ltd. acquired at the start of the financial year a fixed asset from USA at a price of

US $ 1,25,000 and made a down payment of US $ 25,000. The exchange rate was Rs. 61.50

per dollar at the date of transaction.The balance amount was payable in 4 equal half yearly

instalments with interest @ 8% per annum. The exchange rates on due dates of instalment

have been Rs. 61.60; Rs. 61.80; Rs. 61.90; and Rs. 62.10. The asset was under

construction during the period of six months from its acquisition. Ascertain the amount to

be capitalized and the gain or loss to be recognized in each of the years.

1(c) Dynamic Ltd. invested in the shares of another company on 31st

October, 2015 at

a cost of Rs. 4,50,000. It also earlier purchased Gold of Rs. 5,00,000 and Silver of

Rs. 2,25,000 on 31st March, 2013. Market values as on 31st March, 2016 of the above

investments are as follows: Shares Rs.3,75,000; Gold Rs.7,50,000 and Silver Rs.4,35,000.

How will the above investments be shown in the books of account of Dynamic Ltd. for the

year ending 31st March, 2016 as per the provision of AS13?

1(d) On 1st January, 2015, Sahara Ltd. Sold equipment for Rs.6,14,460. The carrying

amount of the equipment on that date was Rs. 1,00,000.The sale was a part of the package

under which Help Ltd. leased the asset to Sahara Ltd. for ten years term.

The economic life of the asset is estimated as 10 years. The minimum lease rents payable by

the lessee has been fixed at Rs. 1,00,000 payable annually beginning from 31st

PRIME A

CADEMY

2

December, 2015. The incremental borrowing interest rate of Sahara Ltd. is estimated at

10% p.a. Calculate the net effect on the Statement of Profit and Loss in the books of Sahara

Ltd.

2 . M Ltd. Acquired 12,000 shares in D Ltd. For rs. 1,70,000 on July 1,1988. The balance sheets

of the two companies on 31st March 1989 were as follows:( 16 Marks )

M Ltd D Ltd

M Ltd D Ltd

Liabilities Rs. Rs. Assets Rs. Rs.

Share Capital :

Goodwill 300,000 70,000

(share of Rs. 10 each) 1,000,000 300,000 Land and Buildings 400,000 100,000

General Reserve 420,000 50,000 Plant and machinery 500,000 100,000

Profit and loss account 260,000 85,000 Investments 170,000 -

Loan from D Ltd (incl.

interest)

57,500 -

Stock

200,000 40,000

Bills Payable 80,000 60,000 Book Debts 300,000 85,000

Creditors 182,500 42,000 Cash And Bank

Balances

80,000 62,000

Bills receivable 50,000 30,000

Loan to M Ltd - 50,000

20,00,000 5,37,000

20,00,000 5,37,000

On April 1, 1988, the Profit and loss account of D ltd stood at Rs. 40,000 out of which a dividend

of 15% for the year 1987-88 on the then capital of Rs. 2,00,000 was paid in September 1988. At

the same time, a bonus issue of one share (fully paid) for every two shares held, was also made

out of General Reserve. Bills Payable of D Ltd, represent bills issued in favour of M Ltd. Which

company still held Rs. 40,000 of the bills accepted by D ltd. The entire closing stock of D Ltd.

Represents goods supplied by M Ltd. At cost plus 20%.M Ltd. and D Ltd. agreed that, with

effect from July 1,1988, for services rendered M ltd. should charge Rs.500 p.m. from D Ltd.

Entries for this were not made when the accounts were drawn up. The loan to M Ltd. was made

by D ltd. on April 1, 1988.

Prepare the consolidated balance sheet of the two companies as at 31st March 1989.

3. As on 31st March,1989, 1/3 of the capital of Zed ltd. had been lost,not counting Goodwill. On

that date, the position was as follows: (16 Marks )

Rs. Rs.

Goodwill

200,000

Other Fixed Assets: Cost 2,000,000

Less: Depreciation 500,000 1,500,000

PRIME A

CADEMY

3

Current Assets

450,000

2,150,000

Less: Current Liabilities 600,000

Bank Loan 450,000 1,050,000

1,100,000

There was a capital reserve totalling Rs. 1,00,000. The capital consisted of equity shares and

10% preference shares in the ratio of 3:2, both shares being of Rs.100 each, fully paid.

It was found that the fixed assets needed further depreciation to the extent of Rs.1,50,000 and

the current assets were worth Rs. 4,00,000. A scheme of reconstruction was framed and

received all requisite approvals and sanctions; the main features were the following:-

(a) The preference shares were to be converted into 14% redeemable preference shares,

four new shares being issued for five old shares and 1/5 of the arrears of dividend which

was last paid for the year ending 31st March, 1985 was to be paid in cash.

(b) Equity shares were to be reduced to Rs. 10 each, fully paid.

(c) For every two equity shares held, each equity shareholder was to subscribe for one

equity share of Rs.10 each, fully paid.

(d) Of the profit earned in future, atleast 50% would be retained by the company.

Pass Journal entries and draft the balance sheet of the company after the scheme is

implemented.

4(a) Comment in case of following two situations: ( 8 Marks )

Company A is a listed company and has three Subsidiaries Company X, Company Y

and Company Z. As on 31st March 2014, the net worth of Company A is Rs.

600 crore, net worth of Company X is Rs. 100 crore, Company Y is Rs. 400 crore and

Company Z is Rs. 210 crore. All the three subsidiaries are non-listed public

companies.

(i) During the financial year 2015-16, Company A has sold off its investment in

Company Y on 31st December, 2015. Therefore, Company Y is no longer a

subsidiary of Company A for the purposes of preparation of financial statements as

on 31 March 2016.Should Company Y prepare its financial statements as per the

Companies (Accounting Standards) Rules, 2006 or the Companies (Indian

Accounting Standards) Rules, 2015?

(ii) During the financial year 2016-17, Company A has sold off its investment in

Company Z on 31st December 2016, therefore company Z is no longer a subsidiary

of Company A for the purposes of preparation of financial statements as on 31st

March 2017.Should Company Z prepare its financial statements as per the

Companies (Accounting Standards) Rules, 2006 or the Companies (Indian

Accounting Standards) Rules, 2015?

PRIME A

CADEMY

4

4(b) Comment on the following two situations with respect to Schedule III of the

Companies Act 2013:

( 8 Marks )

(i) Y Ltd purchased goods on 24 months credit but the creditor has the call option that

can be exercised after 15 months. On the reporting date such trade payable was

outstanding for 4 months (i.e payable after 20 months from the reporting date) Is the

trade payable current or non-current?

(ii) Where should the balances with banks to the extent held as margin money or

security against the borrowings, guarantees, other commitments be disclosed?

5(a) The Capital structure of Define Ltd . is as under: ( 8 Marks )

80,00,000,Equity shares of Rs 10 each = Rs 800Lacs

1,00,000, 12% Preference shares of Rs 250 each = 250Lacs

1,00,000, 10% Debentures of Rs 500 each = 500Lacs

Term loans from Bank @ 10% = Rs 450Lacs

The company’s statement of Profit & Loss for the year showed PAT of Rs 100lacs after

appropriating Equity dividend @ 20%. The company is in the 40% tax bracket. Treasury

bonds carry 6.5% interest and beta factor for the company may be taken as 1.5. The long

run market rate of return may be taken as 16.5%.Calculate Economic Value Added.

5(b) A Company announced a stock appreciation right on 01/04/2010 for each of its 525

employees. The scheme gives the employees the right to claim cash payment equivalent to

excess on market price of company’s shares on exercise date over the exercise price Rs 125 per

share in respect of 100 shares, subject to condition of continuous employment for 3 years. The

SAR is exercisable after 31/03/2013 but before 30/06/2013. The fair value of SAR was Rs 21 in

2010-11, Rs 23 in 2011-12, and Rs 24 in 2012-13. In 2010-11 the company estimates that 2% of

the employees shall leave the company annually. This was revised to 3% in 2011-12. Actually, 15

employees left the company in 2010-11, 10 in 2011-12 and 8 in left in 2012-13. The SAR

therefore actually vested to 492 employees. On 30/06/13, when the SAR was exercised, the

intrinsic value was Rs 25 per share . Show provision for SAR a/c by fair value method ( 8 Marks )

6(a) The capital structure of M/s XYZ Ltd on 31st March 2015 was as follows:

Rs. In Lacs

Equity share capital 18000 shares of Rs. 100 each 18

12% Preference capital 5000 shares of Rs. 100 each 5

12% secured Debentures 5

Reserves 5

PRIME A

CADEMY

5

PBIT during the year 7.2

Tax rate 40%

Generally the return on equity shares of this type of industry is 15%

Subject to:

(a) The profit after tax covers fixed interest and fixed dividends atleast four times.

(b) The Debt Equity ratio is atleast 2.

(c) Yield on shares is calculated at 60% of distributed profits and 10% of undistributed

profits.

The company has been paying regularly an equity dividend of 15%. The risk premium for

dividends is generally assumed at 1% and find out the value of equity dividends of the company.

( 12 Marks )

6 (b ) A mutual Fund raised 100 lakh on April 1,2015 by issue of 10 lakh units of Rs. 10per unit.

The fund invested in several capital market instruments to build a portfolio of Rs. 90 Lacs. The

initial expenses amounted to Rs. 7 lac.During April 2015, the fund sold certain securities of cost

Rs. 38 Lacs for 40 Lacs and purchased certain other securities for Rs. 28.2 lacs. The fund

management expenses for the month amounted to Rs. 4.5 lacs of which Rs. 0.25 Lacs was in

arrears. The dividend earned was Rs. 1.2 lacs. 75% of the realized earnings were distributed.

The market value of the portfolio on 30/04/2015 was Rs.100.9 Lacs. Determine NAV per unit

( 4 Marks )

7. Answer any four of the following: (4 x 4M= 16M)

(a) List down any four key differences between Ind AS-1presentation of Financial statements

and existing notified AS-1 disclosure of accounting policies.

(b) X Ltd had the following items under “Reserves and Surplus” in the Balance Sheet as on 31st

March 2015:

Particulars Rs. in Lacs

Securities Premium 50

Capital Reserve 30

General Reserve 21

The Company had accumulated loss of Rs 120 Lacs , on the same day , which it had disclosed

under the head “ statement of Profit & Loss “ as an asset in the Balance Sheet.

Comment on the correctness of this treatment in line with Schedule III to the Companies Act

2013.

PRIME A

CADEMY

6

( c ) Write a short note on other comprehensive income.

(d) write a short note on Corporate Social Responsibility according to the Companies Act 2013.

( e ) Explain the concept of fair value with reference to Indian Accounting Standards.

PRIME A

CADEMY

PRIME/43rd /FINAL 1

THE SOCIETY OF AUDITORS AND PRIME ACADEMY 43rd SESSION MODEL EXAM – FINAL – FINANCIAL REPORTING

SUGGESTED ANSWERS 1. (a) Computation of cost of inventory and allocation of material cost

Purchase price [13,000 kg. x `(90- 1)] 11,57,000

Less: Excise duty on which CENVAT credit is admissible (13,000 kg. x `5) (65,000)

10,92,000

Add: Freight 30,000

Allocated administrative expenses 10,000

A. Total material cost 11,32,000

B. Number of units to be normally received = 96% of 13,000 kg. 12,480kg.

C. Normal cost per kg. (A/B) 90.705

Allocation of material cost

Kg. /Kg.

Materials consumed 10,000 90.705(approx.)

9,07,050

Cost of inventory (12,400- 10,000) 2,400 2,17,692

Abnormal loss 80 7,258*

Total material cost 12,480 11,32,000

*The difference due to rounding off of cost per kg. has been adjusted. Thus, the inventory will be valued at ` 2,17,692 Notes:

I. Abnormal loss will be recognized as a separate expense. II. Containers are used for delivery of the chemicals and are not reusable. Cost of these

containers is treated as selling and distribution expense. The sale value of these containers will be credited to Profit and Loss Account and shall not be considered for the purpose of valuation of inventory.

III. Alternatively, candidates may deduct ` 500, the sales value of container assuming that the same is applicable to the purchases made,while computing Material cost. In that case the material cost will be computed as `11,31,500 (11,32,000 – 500) instead of `11,32,000.Accordingly the allocation of material cost will get change. State VAT has not been included in the cost of material assuming that the input credit is admissible on the same.

(b) As per AS 16, ‘Borrowing Costs’, an asset will be considered as a qualifying asset only when it

takes substantial period of time to get ready for its intended use. Ordinarily, a period of twelve months is considered as substantial period of time unless a shorter or longer period can be justified on the basis of facts and circumstances of the case. In the given case, since the asset was under construction for the period of six months from its acquisition, it is considered as a non-qualifying asset in an ordinary case. Accordingly, borrowing cost will not be capitalized.

Further, the company may opt to capitalize the exchange difference arising on the settlement of monetary items or on reporting an enterprise’s monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, or to recognize as income or expense in the period in which they arise. Applying the provisions of AS 11 (option to capitalize) amount to be capitalized in each of the years will be as follows:

PRIME A

CADEMY

PRIME/43rd /FINAL 2

Purpose ` Amount to be

capitalized `

Interest to be charged to

profit and loss account ̀

Initial cost at the time of acquisition of fixed asset

US $ 1,25,000 x Rs 61.50

76,87,500

On payment of 1st instalment US $ 25,000 x (61.60 - 61.50)

2,500

Interest paid with 1st instalment (1,00,000 x 8% x 6/12)x61.60

2,46,400

On payment of 2nd instalment US $ 25,000 x (61.80 - 61.50)

7,500

Interest paid with 2nd instalment (75,000 x 8% x 6/12) x 61.80

1,85,400

Exchange difference on closing balance of long term foreign currency

US $ 50,000 x (61.80 - 61.50)

15,000

At the end of the year 1 77,12,500 4,31,800

On payment of 3rd instalment

US $ 25,000 x (61.90 - 61.80)

2,500

Interest paid with 3rd instalment (50,000 x 8% x 6/12) x 61.90

1,23,800

On payment of 4th instalment

US $ 25,000 x (62.10 - 61.80)

7,500

Interest paid with 4th instalment (25,000 x 8% x 6/12) x 62.10

62,100

At the end of the year 2 10,000 1,85,900 The entire amount of exchange difference of ̀35,000 (25,000 + 10,000) will be capitalized to ‘Fixed Asset account’. This capitalized exchange difference will be depreciated over the useful life of the asset.

(c) As per AS 13 ‘Accounting for Investments’, if the shares are purchased with an intention to hold for short-term period then investment will be shown at the market value. In the given

case, shares purchased on 31st October, 2015, will be valued at ` 3,75,000 as on 31st March, 2016.Gold and silver are generally purchased with an intention to hold it for long term period until and unless given otherwise. Hence, the investment in gold and silver(purchased on

31st March, 2013) shall continue to be shown at cost as on 31st March, 2016 i.e., ` 5,00,000 and `2,25,000 respectively, though their realizable values have been increased. Thus the shares, gold and silver will be shown at ` 3,75,000, ` 5,00,000 and `2,25,000 respectively and hence, total investment will be valued at `11,00,000 in the books of account of

Dynamic Ltd. for the year ending 31st March, 2016 as per provisions of AS 13.

(d) Net effect on the Statement of Profit and Loss in the year of sale in the books of Lessee (Sahara Ltd.) For calculation of net effect on the statement of profit and loss on sale of equipment, it has to be judged whether lease is an operating lease or finance lease. The lease term is for 10 years which covers the entire economic life of the equipment. At the inception of the lease, the present value of the minimum lease payments (MLP) is ̀6,14,400 [` 1,00,000 x 6.144 (Annuity factor of Re. 1 @10% for 10 years)] and amounts to at least substantially all of the fair value (sale price i.e.`6,14,460) of the leased equipment. Thus lease is a finance lease. As per para 48 of AS 19 “Leases”, if a sale and leaseback transaction results in a finance lease, profit of ` 5,14,460 (Sale value ` 6,14,460 less carrying amount` 1,00,000) will not be recognized as income in the year of sale in the books of lessee i.e. Sahara Ltd. It should be deferred and amortised over the lease term in proportion to the depreciation of the leased asset.

PRIME A

CADEMY

PRIME/43rd /FINAL 3

Therefore, assuming that depreciation is charged on straight line basis, Sahara Ltd. will recognize depreciation of ` 61,446 per annum for 10 years (` 6,14,460/ 10) and amortise profit of ̀5,14,460 over the lease term of 10 years, i.e. ` 51,446 p.a. The net effect is a debit of ( ̀61,446 - ̀51,446) ` 10,000 p.a. to the Statement of Profit and Loss, for 10 years as covered under the lease term. Note: Had there been no sale and lease back transaction, the Statement of Profit and Loss for each year (covered in the lease term) would have been charged by(` 1,00,000/10) ̀10,000, towards depreciation. Thus, the sale and lease back transaction will have no impact on profit or loss account to be reported by the lessee (vendor in the sales transaction) over the lease period.

2.

Consolidated Balance Sheet of M Ltd. & its subsidiary D Ltd. as on 31st March 1989

Liabilities ` ` Assets ` ̀

Share Capital

Authorised ? Fixed Assets

Issued and Subscribed : Goodwill

100000 Equity shares of ` 10 each fully paid

1,000,000 M Ltd 300,000

Minority Interest 175,200 D Ltd 70,000

Reserves and Surplus 370,000

General reserve 420,000 Less: Capital reserve on consolidation

76,375 293,625

Profit & loss account

Balance as per M ltd's balance Sheet

260,000 Land and buildings

less: capital receipt M Ltd 400,000

15% Dividend on 12000 shares wrongly credited earlier

18,000 D Ltd 100,000 500,000

242,000

add: Charged to D ltd for services 4,500 Plant and machinery

add: M Ltd share of D ltd's profit 34,425 M Ltd 500,000

280,925 D Ltd 100,000 600,000

less: Unrealised Profit 6,667 274,258

Current liabilities and provisions Current Assets Loans and Advances

Current Liabilities Current Assets

Bills payable Stock

M Ltd 80,000 M Ltd 200,000

D Ltd 60,000 D Ltd 40,000

140,000 240,000

less: Mutual Owing 40,000 100,000 Less: unrealised profit 6,667 233,333

Creditors Book Debts

M Ltd 182,500 M Ltd 300,000

D Ltd 42,000 224,500 D Ltd 85,000 385,000

Provisions 0 Cash and Bank balance

M Ltd 80,000

D Ltd 62,000 142,000

PRIME A

CADEMY

PRIME/43rd /FINAL 4

Loans and Advances

Bills Receivable

M Ltd 50,000

D Ltd 30,000

80,000

Less: Mutual Owing 40,000 40,000

2,193,958 2,193,958

Working note 1:

D Ltd's profit and loss account

` `

To Dividend for 1987-88 30,000.00 By Balance b/d 40,000.00

To balance c/d 92,500.00 By Net Profit for the year 82,500.00

(Working note (ii) ) (Balancing figure)

1,22,500.00 1,22,500.00

Working Note 2:

` Balance of D ltd's Profit and Loss Account as on 1st April 1988

85,000

Add: Interest on Loan to M Ltd not yet accounted for

7,500 correct closing balance

92,500

Working Note 3: Capital Profits Balance of D Ltd's Profit and Loss Account as on 1st April 1988

40,000 Less: Dividend paid out of the above balance

30,000

Balance left

10,000 Add: Profit for the three months

ie till July 1,1988,` 82500 * 3/12

20,625 Add: D Ltd's general Reserve after bonus issue

50,000

80,625

M ltd's share ` 80625 * 60/100

48,375 Working Note 4: current Profits

` profit after 1st July 1988( ` 82500*9/12)

61,875

Less: Amount credited to M Ltd for services rendered

4,500 ` 500 * 9

correct post- acquisition profit

57,375 M ltd's share

` 57375 * 60/100

34,425 Working Note 5: Minority Interest

` Paid up value of 40% shares in D Ltd

1,20,000

PRIME A

CADEMY

PRIME/43rd /FINAL 5

Add: 40% of capital Profits

32,250 (` 80625 *40/100)

Add: 40% of current Profits

22,950 ` 57375 * 40/100

1,75,200 Working Note 6: Capital Reserve on consolidation:

` Paid up value of D Ltd's share held by M Ltd

1,80,000

Add: M ltd share of capital Profits

48,375 Working Note (iii)

2,28,375

less: Amount paid for the shares 170000 less: Dividend received out of pre-acquisition profit 18000 1,52,000

Capital reserve on consolidation

76,375

Working Note 7: Unrealised profit on stock

6,667 ` 40000*20/120

3.

Suppose total loss is ` X

Then, the capital lost is ` X – ` 1,00,000 because there is a capital reserve of ` 1,00,000.

Capital of the company is ` 3 (X – 1,00,000) or ` 3X – ` 3,00,000

Then,

3X – 3,00,000= 11,00,000 + X – 1,00,000

Or 3X – X = 11,00,000 – 1,00,000 + 3,00,000

Or 2X = 13,00,000

Hence, X = 6,50,000

Thus loss is ` 6,50,000 and total share capital is

= ` 3( 6,50,000 – 1,00,000) = ` 16,50,000 of which,

Equity share capital = ` 1,65,000 * 3/5 = ` 9,90,000 and

Preference share capital = ` 1,65,000 * 2/5 = ` 6,60,000

Balance Sheet of Zed ltd (Before Reconstruction)

Liabilities ̀ Assets ̀ ̀

Equity share capital

9,90,000 Goodwill

2,00,000

10% preference share capital 6,60,000 Other fixed assets: Cost 20,00,000 Capital reserve

1,00,000 Less: Depreciation 5,00,000 15,00,000

Bank Loan

4,50,000 Current Assets

4,50,000

Current liabilities

6,00,000 Profit and Loss Account( bal fig) 6,50,000

28,00,000

28,00,000

Contingent Liability: Preference dividend in arrears for four years amounting to ` 2,64,000

PRIME A

CADEMY

PRIME/43rd /FINAL 6

JOURNAL

` `

31-Mar-89 Equity Share capital a/c ( ` 100 each) 9,90,000

To Equity share capital a/c (` 10 each)

99,000.00

To Capital reduction a/c

8,91,000

(Being conversion of 9900 fully paid equity shares of `100 each into 9900 fully paid equity shares of ̀ 10 each as per scheme of reconstruction)

31-Mar-89 Bank a/c

49,500.00

To Equity share application and allotment a/c 49,500.00

(Being receipt of application money for 4950 shares @ `10 per share)

31-Mar-89 Equity share application and allotment a/c 49,500.00

To Equity Share Capital a/c (` 10 each) 49,500.00

(Being allotment of 4950 share in the ratio of 1:2 for cash to existing equity share holders)

31-Mar-89 10% Pref Share Cap. A/c 6,60,000.00

To 14% Pref Share Capital A/c

5,28,000.00

To Capital reduction A/c

1,32,000.00

(Being allotment of 5280, 145 fully paid redeemable Pref. Shares of `100 each in lieu of 6600 10% fully paid Pref Shares of `100 each; 4new shares being alloted for every 5 shares held as per scheme of reconstruction)

31-Mar-89 Capital Reduction A/c 52,800.00

To Pref Shareholder A/c

52,800.00

(Being 1/5th of the arrears of Pref dividend now payable to the aforesaid shareholder as per reconstruction scheme)

31-Mar-89 Pref Shareholder A/c 52,800.00

To bank a/c

52,800.00

(Being payment made)

31-Mar-89 Capital reserve a/c

79,800.00

To capital reduction a/c

79,800.00

(Transfer of requisite amount from capital reserve to capital reduction)

31-Mar-89 Capital Reduction A/c 10,50,000.00

To Goodwill A/c

2,00,000.00

To Depreciation of Fixed asset A/c

1,50,000.00

To Current Assets A/c

50,000.00

To Profit and Loss A/c

6,50,000.00

(Being losses wiped off and decrease made in the value of the asset as per scheme of reconstruction)

PRIME A

CADEMY

PRIME/43rd /FINAL 7

Balance Sheet of Z ltd as at 31st March, 1989 (After Reconstruction)

Liabilities ` ̀ Assets ̀ ̀

Share Capital

Authorised ? Fixed Assets

Issued and Subscribed : Goodwill 2,00,000.00

5280 14% Redeemable Pref Shares of `100 each fully paid

5,28,000.00 Less: Amount writtenoff under scheme of reconstruction

(2,00,000.00)

-

14850 Equity Shares of `10 each Fully Paid

1,48,500.00 6,76,500.00 Other Fixed Assets 20,00,000.00

Reserves and Surplus Less: Depreciation (5,00,000.00)

Capital Reserve 20,200.00 Less: Additional Depreciation

(1,50,000.00)

13,50,000.00

Secured loans Current Assets Loans and Advances

Bank Loans 4,50,000.00 Current Assets 3,96,700.00

Loans and Advances - 3,96,700.00

Current Liabilities and Provisions

Current Liabilities 6,00,000.00

Provisions - 6,00,000.00

17,46,700.00 17,46,700.00

4 (a) The Companies (Indian Accounting Standards) Rules, 2015, states that the following

companies shall comply with Ind AS for the accounting periods beginning on or after 1st

April, 2016, with the comparatives for the periods ending on 31st March, 2016, or thereafter, namely:- (a) companies whose equity or debt securities are listed or are in the process of being listed on

any stock exchange in India or outside India and having net worth of rupees five hundred crore or more;

(b) companies other than those covered by point (a) above and having net worth of rupees five hundred crore or more;

(c) holding, subsidiary, joint venture or associate companies of companies covered by point (a) and (b) as the case may be;

Further, the Companies (Indian Accounting Standards) Rules, 2015, states that for the purposes of calculation of net worth of companies, the following principles shall apply, namely:-

(a) the net worth shall be calculated in accordance with the stand-alone financial statements of

the company as on 31st March, 2014 or the first audited financial statements for accounting period which ends after that date;

(b) for companies which are not in existence on 31st March, 2014 or an existing company falling

under any of thresholds specified for the first time after 31st March, 2014, the net worth shall be calculated on the basis of the first audited financial statements ending after that date in respect of which it meets the thresholds specified.

PRIME A

CADEMY

PRIME/43rd /FINAL 8

The companies meeting the specified thresholds for the first time at the end of an accounting year shall apply Ind AS from the immediate next accounting year in the manner specified above. Once a company starts following Ind AS either voluntarily or mandatorily on the basis of criteria specified, it shall be required to follow Ind AS for all the subsequent financial statements even if any of the criteria specified in the rule does not subsequently apply to it. In view of the above requirements, Company A meets the criteria as specified the Companies

(Indian Accounting Standards) Rules, 2015, on 31st March, 2014. Accordingly, the Companies (Indian Accounting Standards) Rules, 2015, will become applicable to

the Company on mandatory basis from accounting periods commencing 1st April, 2016. A holding, subsidiary, joint venture or associate company of a Company to which the Companies (Indian Accounting Standards) Rules, 2015 applies will be required to follow the Companies (Indian Accounting Standards) Rules, 2015 for preparing and presenting its financial statements. In the abovementioned case, Company A has net worth of more than ` 500 crore in the financial

year ending 31st March 2014. Therefore, ordinarily Company A along with its subsidiaries will have to apply Indian Accounting Standards (Ind ASs) for preparing financial statements

fortheaccountingperiodscommencing1st April, 2016, except in situations Case A as discussed below:

A Company A has sold its investment in subsidiary Company Y on 31st December, 2015, in consequence of which Company Y is no longer subsidiary of Company A as at the

beginning of 1st April, 2016. Therefore, the Companies (Indian Accounting Standards) Rules, 2015 will not be applicableto Company Y. Therefore, Company Y would continue to prepare financial statements for accounting periods commencing April 1, 2016 under the Companies (Accounting Standards) Rules, 2006.

B Company A has sold its investment in subsidiary Company Z on 31st December,

2016; therefore, Company Z was a subsidiary of Company A as at the beginning of 1st April,

2016. Company Z being subsidiary of Company A as at the beginning of 1st April, 2016,

would have to prepare financial statements for the accounting periods commencing 1st April, 2016 as per the Companies (Indian Accounting Standards) Rules, 2015.

(b) (a) Under instant case the call option is exercisable within 12 months of reporting date (15

months minus 4 months), and accordingly the company does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date, and therefore same are to be classified as current trade payables.

(b) These are required to be disclosed under cash and cash equivalents separately in notes to accounts under Schedule III, however same is in conflict with the requirements of AS 3 “Cash Flow Statements” as they are neither in nature of demand deposits, nor readily available for use by the company, accordingly do-not meet the definition of cash equivalents. Hence the said items should also be included as ‘other bank balances’ under cash and bank balances along with FDR having balance maturity period of more than 12 months.

5. (a) Computation of Economic Value Added

Particulars ` in lakhs

Profit before Interest and Taxes (from W.N.1) 578.33 Less: Interest (50 + 45) (95.00)

483.33 Less: Taxes (193.33)

290 Add: Interest (net of tax) [95 x (1 - 0.40)] 57 Net Operating Profit After Taxes 347 Less: Cost of Capital (WACC x Capital Employed) (2,000 x 12.95%) (259.00) Economic Value Added 88.00

PRIME A

CADEMY

PRIME/43rd /FINAL 9

Working Notes:

1. Calculation of Profit Before Tax

Particulars Computation ` in lakhs

Profit before Interest and Taxes Balancing figure 578.33

Less: Interest on Debentures 10% x ` 500 lakhs (50.00)

Interest on Bank Term Loan 10% x ` 450 lakhs (45.00)

Profit Before Tax (` 290.00 ÷ 60%) 483.33

Less: Tax @ 40% (` 290.00 ÷ 60%) x 40%

(193.33)

Profit after Tax 290.00

Less: Preference Dividend 12% x ` 250 lakhs (30.00)

Residual earnings for equity shareholders

260.00

Less: Equity Dividend 20% x ` 800 lakhs (160.00)

Net balance in Profit and Loss Account Given 100.00

1. Computation of Cost of Equity :

= Risk Free Rate + Beta x (Market Rate – Risk Free Rate) = 6.5% + 1.5 (16.5% - 6.5%) = 21.5%

2. Cost of Debt

Interest ` 45 lakhs Less: Tax (40%) (` 18 lakhs)

Interest after Tax ` 27 lakhs

27 Cost of Debt = 6%

450 3. Computation of Weighted Average Cost of Capital

Component Amount Ratio Individual Cost WACC

Equity ` 800 lakhs

800 ÷ 2000 =0.40 Ke = 21.5 8.6

Preference ` 250 lakhs

250 ÷2000 = 0.125 Ke = 12 1.5

Debt (500+ 450) ` 950 lakhs

950 ÷ 2000 = 0.475 Ke = 6 2.85

Total ` 2,000 lakhs

Ke 12.95%

5 (b) Provision of SARs A/c (For 2010-11)

To Balance c/d 3,42,860 By Employee Compensation Expense

3,42,860

3,42,860 3,42,860

Provision of SARs A/c (For 2011-12) To Balance c/d 7,43,667 By Balance b/d 3,42,860

By Employee Compensation Expenses

4,00,807

7,43,667 7,43,667 Provision of SARs A/c (For 2013-14)

To Balance c/d 11,80,800 By Balance b/d 7,43,667

By Employee Compensation Expenses

4,37,133

11,80,800 11,80,800 Provision of SARs A/c (For 2013-14)

To Bank (49,200 x 25)

12,30,000 By Balance b/d 11,80,800

By Employee Expenses 49,200

12,30,000 12,30,000

PRIME A

CADEMY

PRIME/43rd /FINAL 10

The Provision for SAR is a liability as settlement of SAR is through cash payment equivalent to an excess of market price of company’s shares on exercise date over the exercise price.

Working Notes: Year 2010-11 Number of employees to whom SARs were announced = 525 employees Total estimated SARs, to be vested at the end of the vesting period, as on 2010-11

= (525 -15 x 0.98 x 0.98) x 100 SARs = 48,980 SARs Fair value of SARs = 48,980 SARs ` 21 = ` 10,28,580 Vesting period = 3 years Recognised as expense in 2010–11 = ` 10,28,580 / 3 years = ` 3,42,860 Year 2011-12 Total number of employees after three years, on the basis of the estimation in 2011-12

= [(525 – 15 - 10) x 0.97] x 100 SARs = 48,500 SARs Fair value of SARs = 48,500 SARs ` 23 = ` 11,15,500 Vesting period = 3 years No. of years expired = 2 years Cumulative value of SARs to recognize as expense

= 11,15,500/3 2 = ` 7,43,667 SARs recognize as expense in 2011–12

= ` 7,43,667 – ` 3,42,860 = ` 4,00,807 Year 2012-13 Fair value of SARs = ` 24 SARs actually vested = 492 employees 100 = 49,200 SARs Fair value = 49,200 SARs ` 24 = ̀ 11,80,800 Cumulative value to be recognized = ` 11,80,800 Value of SARs to be recognized as an expense = ` 11,80,800 – ` 7,43,667 = ` 4,37,133 Year 2013–14 Cash payment of SARs = 49,200 SARs ` 25 = ` 12,30,000 Value of SARs to be recognized as an expense in 2013–14

= ` 12,30,000 – ` 11,80,800 = ` 49,200

6. (a)

Calculation of Profit After Tax ` `

Profit Before Interest and Tax (PBIT) 7,20,000

Less : Debenture Interest ( 500000 * 12/100) (60,000)

Profit Before Tax (PBT) 6,60,000

less : Tax @ 40% (2,64,000)

Profit after Tax (PAT) 3,96,000

less : Preference dividend ( 500000*12/100) 60000

less : Equity Dividend (1800000 * 15/100) 270000 (3,30,000)

Retained Earnings ( Undistributed Profit) 66,000

PRIME A

CADEMY

PRIME/43rd /FINAL 11

Calculation of Interest and Fixed Dividend Coverage

= PAT+Debenture Interest

Debenture Interest+Preference Dividend =

3,96,000 +60,000

60,000 + 60,000 =

4,56,000

1,20,000 = 3.8 times

Calculation of Debt Equity Ratio

Debt Equity Ratio =Debt ( Long term loans)

Equity ( Shareholders′ 𝐹𝑢𝑛𝑑𝑠)

=Debentures

Preference Share Capital + equity share capital + Reserves

=5,00,000

5,00,000 + 18,00,000 + 5,00,000

Debt Equity Ratio =5,00,000

28,00,000 = .179

The ratio is less than the prescribed ratio Calculation of Yield on Equity Shares Yield on equity shares is calculated at 60% of distributed profits and 10% of undistributed profits:

`

60% of distributed profits (60% of 270000) 1,62,000

10% of undistributed profits (10% of 66000)

6,600

1,68,600

Yield on Equity Shares = Yield on shares

Equity share capital * 100 =

1,68,600

18,00,000 * 100 = 9.37%

Calculation of Expected yield on Equity shares

Normal return Expected 15%

Add : Risk premium for low interest and fixed dividend coverage (3.8 < 4) 1%*

Risk for Debt equity Ratio not required Nil**

16%

Value of an Equity share =Actual Yield

Expected Yield ∗ Paid up value of a share =

9.37

16∗ 100 = 58.56

*- When Interest and fixed dividend coverage is lower than the prescribed norm, the riskiness of the equity investors is high. They should claim additional risk premium over and above the normal rate of return.

** - The debt equity ratio is lower than the prescribed ratio, that means outside funds

(DEBTS) are lower as compared to shareholders’ funds. Therefore, the risk is less for equity shareholders. Therefore, no risk premium is to be added in this case.

PRIME A

CADEMY

PRIME/43rd /FINAL 12

(b) Table showing determination of NAV of a mutual fund

` in lakhs ` in lakhs

Opening bank balance [` (100 – 90 - 7) lakhs] 3.00

Add: Proceeds from sale of securities 40.00

Dividend received 1.20 44.20

Less: Cost of securities 28.20

Fund management expenses [` (4.50–0.25) lakhs]

4.25

Capital gains distributed [75% of ` (40.00 – 38.00) lakhs]

1.50

Dividends distributed (75% of ` 1.20 lakhs)

0.90 (34.85)

Closing bank balance 9.35

Closing market value of portfolio 100.90

110.25

Less: Arrears of expenses (0.25)

Closing net assets 110.00

Number of units 10,00,000

Closing Net Assets Value (NAV) ` 11.00

7 (a) Some key differences between Ind AS 1 and Existing AS 1 are: Ind AS 1 deals with presentation of financial statements, whereas existing AS 1 (issued 1979) deals only with the disclosure of accounting policies. The scope of Ind AS 1 is thus much wider and line by line comparison of the differences with the existing standard is not possible. However, the major requirements as laid down in Ind AS 1 are as follows: (i) An enterprise shall make an explicit statement in the financial statements of compliance with

all the Ind AS. Further, Ind AS 1 allows deviation from a requirement of an Accounting standard in case the management concludes that compliance with Ind AS will be misleading and if the regulatory framework requires or does not prohibit such a departure.

(ii) Ind AS 1 requires presentation and provides criteria for classification of Current / Non-current assets / liabilities.

(iii) Ind AS 1 prohibits presentation of any item as ‘Extraordinary Item’ in the statement of profit and loss or in the notes.

(iv) Ind AS 1 requires disclosure of judgments made by management while framing of accounting policies. Also, it requires disclosure of key assumptions about the future and other sources of measurement uncertainty that have significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within next financial year.

(v) Ind AS 1 requires classification of expenses to be presented based on nature of expenses. (vi) Ind AS 1 requires presentation of balance sheet as at the beginning of the earliest period when

an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in the financial statements, or when it reclassifies items in its financial statements.

(vii) In respect of reclassification of items, Ind AS 1 requires disclosure of nature, amount and reason for reclassification in the notes to financial statements.

(viii) Ind AS 1 requires the financial statements to include a Statement of Changes in Equity to be shown as a separate statement, which, inter alia, includes reconciliation between opening and closing balance for each component of equity.

PRIME A

CADEMY

PRIME/43rd /FINAL 13

(ix) Ind AS 1 requires that an entity shall present a single statement of profit and loss, with profit or loss and other comprehensive income presented in two sections. The sections shall be presented together, with the profit or loss section presented first followed directly by the other comprehensive income section.

(x) As per Ind AS 1, an entity shall include certain comparative information for understanding the current period’s financial statements.

(xi) Ind AS 1 clarifies that long term loan arrangement need not be classified as current on account of breach of a material provision, for which the lender has agreed to waive before the approval of financial statements for issue.

(b) In accordance with Note 6(B) given under part I of Schedule III to the Companies Act, 2013,the debit balance of Profit and Loss (after all allocations and appropriations), if any, shall be shown as a negative figure under the head ‘Surplus’. Similarly the balance of ‘Reserves and Surplus’ after adjusting negative balance of surplus, shall be shown under the head ‘Reserves and Surplus’, even if the resulting figure is in negative. In this case, the debit balance of `120 lakhs, exceeds the total of all the reserves i.e. `101 lakhs. Negative balance of `19 lakhs of “Reserves and Surplus” after adjusting debit balance of ‘Profit and Loss’ should be disclosed on the face of Balance Sheet under the sub-heading “Reserves and Surplus” under the heading “Shareholders’ Fund”. Thus the treatment done by the company is incorrect.

(c) Other comprehensive income comprises items of incomes and expenses (including

reclassification adjustments) that are not recognized in profit or loss as required or permitted by other Ind Ass.The standard requires an entity to disclose reclassification adjustments and income tax relating to each component of other comprehensive income. Reclassification adjustments are th amounts reclassified to profit or loss in the current period that were previously recognized in other comprehensive income. The other comprehensive income section shall present line items for amounts of other comprehensive income in the period , classified by nature (including share of the other comprehensive income of associates and joint ventures accounted for using the equity method ) and grouped into those that, in accordance with other Ind AS :

A. Will not be reclassified subsequently to profit or loss ; and B. Will be classified subsequently to profit or loss when specific conditions are met.

(d) Corporate Social Responsibility (CSR) Reporting is an information communiqué with respect to

discharge of social responsibilities of corporate entity. Through ‘CSR Report’ the corporate enterprises disclose the manner in which they are discharging their social responsibilities. More specifically, it is addressed to the public or society at large, although it can be squarely used by other user groups also. Section 135 of the Companies Act, 2013 mandated the companies fulfilling the criteria mentioned in the said section to spend certain amount of their profit on activities as specified in the Schedule VII to the Act. Companies not falling within that criteria can also spend on CSR activities voluntarily. However, besides the requirements of constitution of a CSR committee and a CSR policy, the corporate entities should also take care that expenditure incurred for CSR should not be the expenditure incurred for the activities in the ordinary course of business. If expenditure incurred is for the activities in the ordinary course of business, then it will not be qualified as expenditure incurred onCSR activities.

(e) Cost vs. Fair value Cost basis: The term cost refers to cost of purchase, costs of conversion on other costs incurred in bringing the goods to its present condition and location. Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.

PRIME A

CADEMY

PRIME/43rd /FINAL 14

Fair value:Fair value of an asset is the amount at which an enterprise expects to exchange an asset between knowledgeable and willing parties in an arm’s length transaction. Fair value concept requires a lot of estimation and to the extent, it is subjective in nature. Accounting Standards are generally based on historical cost with a very few exceptions: AS 2 “Valuation of Inventories”– Inventories are valued at net realizable value (NRV) if cost of inventories is more than NRV. AS 10 “Accounting for Fixed Assets”– Items of fixed assets that have been retired from active use and are held for disposal are stated at net realizable value if their net book value is more than NRV. AS 13 “Accounting for Investments”– Current investments are carried at lower of cost and fair value. The carrying amount of long term investments is reduced to recognize the permanent decline in value. AS 15 “Employee Benefits”– The provision for defined benefits is made at fair value of the obligations. AS 26 “Intangible Assets”– If an intangible asset is acquired in exchange for shares or other securities of the reporting enterprise, the asset is recorded at its fair value, or the fair value of the securities issued, whichever is more clearly evident.

AS 28 “Impairment of Assets”– Provision is made for impairment of assets.

PRIME A

CADEMY

(1)43F/SFM

Total No. of Printed Pages – 5 Total Marks – 100

Total No. of Questions – 7 Time Allowed – 3 Hours

THE SOCIETY OF AUDITORS & PRIME ACADEMY

Final - Model Exam - September 2016

Strategic Financial Management

Questions No.1 is compulsory.

Attempt any five out of the remaining six questions.

Wherever appropriate, suitable assumptions should be made and indicated in the answer by the candidate.

Working Notes should form part of the answer.

1. (a) Swastik Ltd manufacturers of special purpose machine tools, have two divisions that are peri-odically assisted by visiting teams of consultants. The Management is worried about the steady increase of expenses in this regard over the years. An analysis of last year’s expenses reveals: Consultants remuneration Rs.2,50,000; Travel & Conveyance Rs.1,50,000; Accommodation Ex-penses Rs.600,000; Boarding Charges Rs.2,00,000; Special Allowances Rs.50,000. The manage-ment estimates accommodation expenses to increase by Rs.2,00,000 annually. As part of a cost reduction drive, Swastik Ltd are proposing to construct a consultancy centre to take care of the accommodation requirements of the consultants. This center will additionally save the company Rs.50,000 in boarding charges and Rs.2,00,000 in the cost of Executive Training Programs hith-erto conducted outside the Company’s premises every year. The following details are available regarding the construction and maintenance of the new center. Land: At a cost of Rs. 8,00,000 already owned by the Company, will be used. Construction cost: Rs. 15,00,000 including special furnishings. Cost of annual maintenance Rs.1,50,000 Construction cost will be written off over 5 years being the useful life. Assuming that the write off of construction cost as aforesaid will be accepted for tax purposes, that the rate of tax will be 50% and that the desired rate of return is 15% you are required to analyse the feasibility of the proposal and make recommendation.

b. Investment in a four-year project is Rs.60,000, and expected CFAT carry the following probability distribution. Cash flows for each period is uncorrelated.

Probability CF (Rs.)Year 1

CF (Rs.)Year 2 to 4

0.10 18,000 12,0000.25 24,000 18,0000.30 30,000 24,0000.25 36,000 30,0000.10 42,000 36,000

Required: (i) Compute the NPV of the Project, assuming a discount rate of 10% . (ii) Compute standard deviation

PRIME A

CADEMY

(2)43F/SFM

c. X Ltd will pay Rs. 6 as dividend one year from today. The current market price of the share is Rs.90/-. This dividend will grow at 5% annually forever. Dividend distribution tax is 15% of the amount distributed. Compute cost of equity.

d. An investor is seeking the price to pay for a security, whose standard deviation is 3.00 per cent. The

correlation coefficient for the security with the market is 0.8 and the market standard deviation is 2.2 per cent. The return from government securities is 5.2 per cent and from the market portfolio is 9.8 per cent. The investor knows that, by calculating the required return, he can then determine the price to pay for the security. What is the required return on the security?

(4 x 5 = 20 marks)

2. (a) Sun Moon Mutual Fund (Approved Mutual Fund) sponsored open-ended equity oriented scheme “Chanakya Opportunity Fund”. There were three plans viz. ‘A’ – Dividend Re-investment Plan, ‘B’ – Bonus Plan & ‘C’ – Growth Plan.At the time of Initial Public Offer on 1.4.1995, Mr. Anand, Mr. Bacchan & Mrs. Charu, three investors invested Rs. 1,00,000 each & chosen ‘B’, ‘C’ & ‘A’ Plan respectively.The History of the Fund is as follows:Date Div (%) Bonus Plan A Plan B Plan C28.07.1999 20 30.70 31.40 33.4231.03.2000 70 5 : 4 58.42 31.05 70.0531.10.2003 40 42.18 25.02 56.1515.03.2004 25 46.45 29.10 64.2831.03.2004 1 : 3 42.18 20.05 60.1224.03.2005 40 1 : 4 48.10 19.95 72.4031.07.2005 53.75 22.98 82.07

On 31st July all three investors redeemed all the balance units. Calculate annual rate of return to each of the investors.Consider: 1. Long-term Capital Gain is exempt from Income tax. 2. Short-term Capital Gain is subject to 10% Income tax. 3. Security Transaction Tax 0.2 per cent only on sale/redemption of units. 4. Ignore Education Cess

b. (i) Identify the action to be taken in respect of the following situations?

Stock beta Stock position Stock Value (Rs.lakh) Hedge needed0.8 Long 2 Full1.2 Long 5 Full0.9 Short 1 Full1.0 Long 2 50%1.3 Short 4 110%

(ii) Consider the following data relating to KM stock. KM has a beta of 0.7 with NIFTY. Each Nifty contract is equal to 200 units. KM now quotes at Rs.150 and the Nifty futures is 5600 Index points. You are long on 12,000 shares of KM in the spot market. How many futures contracts will you have to take?

(2 x 8 = 16 marks)

PRIME A

CADEMY

(3)43F/SFM

3. (a) Bask PLC is a UK based importer. It has accepted an invoice for $ 350,000/- from a Florida supplier. The money is payable in six months. Exchange rates and money market rates in London are:

$/£ Spot 1.5865 - 1.59056 months Forward 1.5505 - 1.5545

(a) Compute and show how a money-market hedge can be put in place.

(b) Determine whether forward contract would be advantageous.

Money market ratesDeposit Loan

$ 5% 7%£ 7% 9%

3. (b) XYZ Limited borrows £ 15 Million of six months LIBOR + 10.00% for a period of 24 months. The company anticipates a rise in LIBOR, hence it proposes to buy a Cap Option from its Bankers at the strike rate of 8.00%. The lump sum premium is 1.00% for the entire reset peri-ods and the fixed rate of interest is 7.00% per annum. The actual position of LIBOR during the forthcoming reset period is as under:

Reset Period LIBOR 1 9.00% 2 9.50% 3 10.00%

You are required to show how far interest rate. Risk is hedged through Cap Option. For cal-culation, work out figures at each stage up to four decimal points and amount nearest to £. It should be part of working notes. (2 x 8 = 16 marks)

4. (a) Fair finance, a leasing company, has been approached by a prospective customer intending to acquire a machine whose Cash Down price is Rs. 3 crores. The customer, in order to leverage his tax position, has requested a quote for a three year lease with rentals payable at the end of each year but in a diminishing manner such that they are in the ratio of 3 : 2 : 1.Depreciation can be assumed to be on straight line basis and Fair Finance’s marginal tax rate is 35%. The target rate of return for Fair Finance on the transaction is 10%.Required: Calculate the lease rents to be quoted for the lease for three years.

4. (b) M. Co. Ltd., is studying the possible acquisition of N Co. Ltd., by way of merger. The follow-ing 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

current 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 di-

minished by the merger. What should be the exchange ratio in that case? (2 x 8 = 16 marks)

PRIME A

CADEMY

(4)43F/SFM

5. (a) The valuation of Hansel Limited has been done by an investment analyst. Based on an ex-pected free cash flow of Rs.54 lakhs for the following year and an expected growth rate of 9 percent, the analyst has estimated the value of Hansel Limited to be Rs.1800 lakh. However, he committed a mistake of using the book values of debt and equity.

The book value weights employed by the analyst are not known, but you know that Hansel Limited has a cost of equity of 20 percent and post tax cost of debt of 10 percent. The market value of equity is thrice its book value, whereas the market value of its debt is nine-tenths of its book value. What is the correct value of Hansel Ltd?

5. (b) 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%

(2 x 8 = 16 marks)

6. (a) On 1st April, 2015 an investor has a portfolio consisting of eight securities as shown below

Security Market price No. of shares β valueA 29.40 400 0.59B 318.70 800 1.32C 660.20 150 0.87D 5.20 300 0.35E 281.90 400 1.16F 275.40 750 1.24G 514.60 300 1.05H 170.50 900 0.76

The cost of capital for the investor is 20% p.a continuosly compounded. The investor fears a fall in the prices of the shares in the near future. Accordingly, he approaches you for the advice to protect the interest of his portfolio.You can make use of the following information1. The current Nifty value is 85002. Nifty futures can be traded in units of 25 only3. Futures for may are currently quoted at 8700 and Futures for June are being quoted at 8850You are required to calculate:i. The beta of his portfolioii. The theoretical value of the futures contracts expiring in may and June (Given e0.03 = 1.03045, e0.04 = 1.04081, e0.05 = 1.05127)iii. The number of Nifty contracts that he would have to sell if he desires to hedge until June

in each of the following cases:(A) His total portfolio(B) 50% of his portfolio(C) 120% of his portfolio

PRIME A

CADEMY

(5)43F/SFM

6. (b) On January 1,2013 an investor has a portfolio of 5 shares as given below:Security Price No. of Shares Beta

A 349.30 5,000 1.15B 480.50 7,000 0.40C 593.52 8,000 0.90D 734.70 10,000 0.95E 824.85 2,000 0.85

The cost of capital to the investor is 10.5% per annum.You are required to calculate:(i) The beta of his portfolio. (2 x 8 = 16 marks)

7. Write short notes on the following:1. What are the factors you will consider in selecting your Mutual fund? 2. Name four alternatives to dividend.3. What is the difference between national Capital Budgeting and International Capital Budgeting?4. Explain briefly:

i) Yield to maturityii) Deep discount bond. (4 x 4 = 16 marks)

PRIME A

CADEMY

PRIME/43rd /FINAL 1

THE SOCIETY OF AUDITORS AND PRIME ACADEMY

43rd SESSION MODEL EXAM – FINAL – STRATEGIC FINANCIAL MANAGEMENT SUGGESTED ANSWERS

1. (a) Step 1: Initial Outflow (Rs. Lakhs)

Construction Cost: 15.0 The cost of the land is irrelevant since it represents a sunk cost. Market value of land is rel-evant because it’s an opportunity cost. However, it is assumed that the company has no inten-tion of selling the land. Hence the market value of land is not relevant.

Step 2: In-between Cash flows (Rs. lakhs)

Details Note 1 2 3 4 5

Savings in accommodation costs 8 10 12 14 16 Savings in boarding charges 0.5 0.5 0.5 0.5 0.5 Savings in training programs 2.0 2.0 2.0 2.0 2.0

Less : Annual Maintenance Cost (1.5) (1.5) (1.5) (1.5) (1.5) Less : Depreciation 1 (3.0) (3.0) (3.0) (3.0) (3.0) Profit Before Tax 6.0 8.0 10.0 12.0 14.0

Tax 3.0 4.0 5.0 6.0 7.0

Profit After Tax 3.0 4.0 5.0 6.0 7.0

Cash flow after Tax 6.0 7.0 8.0 9.0 10.0 WN 1: With capital expenditure at Rs.15 lakhs and life 5 years, the annual depreciation is Rs.3 lakhs. Step 3: Terminal Flow: NIL Step 4: Capital Budgeting Analysis Statement (Disc Fact 15%)

Year CF DF DCF

0 (15) 1.000 (15.00) 1 6.0 0.870 5.21 2 7.0 0.756 5.29 3 8.0 0.658 5.26 4 9.0 0.572 5.15 5 10.0 0.497 4.92 Conclusion: Since NPV of the project is NPV 10.83 Positive, the project should be accepted.

(b)

Part (i): Computation of NPV

Step 1: Compute Expected Value of Cash Flows

Cash Flows Expected Value

Probability Year 1 Year 2 to 4 Year 1 Year 2 to 4 0.10 18,000 12,000 1,800 1,200 0.25 24,000 18,000 6,000 4,500 0.30 30,000 24,000 9,000 7,200 0.25 36,000 30,000 9,000 7,500 0.10 42,000 36,000 4,200 3,600

Total 30,000 24,000

PRIME A

CADEMY

PRIME/43rd /FINAL 2

Step 2: Compute NPV

Year Cash Flow Discount Factor Present Value

0 (60,000) 1.000 (60,000)

1 30,000 0.909 27,270

2 24,000 0.826 19,824 3 24,000 0.751 18,024

4 24,000 0.683 16,392

NPV 21,510

Part (ii): Computation of Standard Deviation Step 1: Compute Variance of each year’s cash flows WN 1: Variance of Year 1

Cash Flow Deviation Probability P*D*D

18,000 (12,000) 0.10 14,400,000 24,000 (6,000) 0.25 9,000,000 30,000 0 0.30 0 36,000 6,000 0.25 9,000,000 42,000 12,000 0.10 14,400,000

Variance 46,800,000

WN 2: Variance of Years 2 to 4

Cash Flow Deviation Probability P*D*D

12,000 (12,000) 0.10 14,400,000 18,000 (6,000) 0.25 9,000,000 24,000 0 0.30 0 30,000 6,000 0.25 9,000,000 36,000 12,000 0.10 14,400,000

Variance 46,800,000

Step 2: Double Discount the Variance

Year Variance DDF Value

1 46,800,000 0.826 38,656,800 2 46,800,000 0.683 31,964,400 3 46,800,000 0.564 26,395,200

4 46,800,000 0.467 21,855,600

Variance 118,872,000

Step 3: Standard Deviation

= 10,903

Variance= 118,872,000 (c)

• Dividend next year = Rs.6 • Distribution tax = Rs.6 x 15% = 0.90 • Total outflow = Rs.6.90

PRIME A

CADEMY

PRIME/43rd /FINAL 3

• Ke = (Dividend + DDT)/P0 + g

= 6+ 0.90 + 0.05 x 100 = 12.67% 90 (d)

Step 1: Beta computation β = σσm

j × corr jm = (0.8) × (0.03) = 1.091

Step 2: Required return (0.022)

Rj = Rf + β (Rm – Rf) = 5.2 + 1.091 (9.8 – 5.2)

= 5.2 + 5.02 = 10.22% 2. (a) PLAN A : DIVIDEND REINVESTMENT PLAN Note: Not entitled to bonus WN 1:

Date Details Div (%) Units Rs. Cost Cum Units Face Value

01-04-95 IPO 10,000 10.00 100,000 10,000 100,000

28-07-99 Dividend 0.20 651 30.70 20,000 10,651 106,510 31-03-00 Dividend 0.70 1,276 58.42 74,557 11,927 119,270

31-10-03 Dividend 0.40 1,131 42.18 47,708 13,058 130,580 15-03-04 Dividend 0.25 703 46.45 32,645 13,761 137,610

24-03-05 Dividend 0.40 1,144 48.10 55,044 14,905 149,050 • Cost is computed as face value multiplied with dividend percent. • This is the amount of dividend reinvested • Units issued is cost divided by NA V

WN 2:

Details Quantity Rate Tax Value

a. Redemption value 14,905 53.75 801,144

b. Less: STT at 0.2% (1,602) c. Net 799,542 d. Less: Short term capital gain 1,144 5.65 15.45% (998)

e. Less: Investment (100,000)

f. Net 698,544

Return f/e x l00 x 12/124 67.60% Note: From April ‘95 to July ‘05 there are 124 months.

PLAN B BONUS PLAN

Note: Not entitled to dividends WN 3:

Date Details Bonus Units Cum Units

01-04-95 IPO 10,000 10,000 31-03-00 Bonus 5 for 4 12,500 22,500 Rate and value are unimportant 31-03-04 Bonus 1 for 3 7,500 30,000

24-03-05 Bonus 1 for 4 7,500 37,500

PRIME A

CADEMY

PRIME/43rd /FINAL 4

WN 4:

Details Quantity Rate Tax Value

a. Redemption value 37,500 22.98 861,750 b. Less: STT at 0.2% (1,724) c. Net 860,026 d. Less: Short term capital gain 7,500 3.03 (22.98-19.95) 0.1 (2,273) e. Less: Investment (100,000) f. Net 757,754

Return f/e*100*12/124 73.33%

PLAN C : GROWTH PLAN

Note: No Dividend, No bonus

Details Computation Result In all plans simple

a. Market value 10,000 units x 82.07 820700 return has been b. Less: STT at 0.2% 0.2% of a 1641

computed whereas

c. Net a-b 819059

the more appropri-

d. Less Short term capital gain NIL 0

ate return will be the

e. Less Investment

(100000)

compounded annual

f. Net 719059

rate of growth.

Return f/e x 100 x 12/124 69.59%

b. (i) The action to be taken is the opposite of the spot market with adjustment for stock beta and hedge

required.

Spot Futures Calculation Result

Long Short 0.8 x 2 x 100% 1.60 Long Short 1.2 x 5 x 100% 6.00

Short Long 0.9 x 1 x 100% 0.90 Long Short 1.0 x 2 x 50% 1.00

Short Long 1.3 x 4 x 110%* 5.72

A 110 % hedge means that he is in fact taking a long position to the extent of 10% on NIFTY!

(ii) Since you are long on the spot market, you have to go short in the futures market. Hence you

have to sell NIFTY. Rupee value of spot position requiring hedging

Futures to be sold = Hedge ratio x

Rupee value underlying one futures contract

= 0.7 x (12,000 x 150) = 1.125 contracts

(5,600 x 200)

PRIME A

CADEMY

PRIME/43rd /FINAL 5

3. (a)

Part (a) Step 1: Identify • Transaction is import. • Foreign currency liability of $ 350,000 exists Step 2: Create

We must create a Dollar Asset. To this end, importer has to generate dollar funds. Step 3: Borrow • Borrow in Home Currency, Pounds, an amount equivalent to the PV of $ asset of

350,000. • $ Deposit rate for applicable period is 2.5%. • Amount of Borrowing = Present value of $ 350,000 discounted at 2.5% is $

3,41,463. Step 4: Convert • Relevant rate is spot Bid rate (Indirect quote; bid is on pounds) = 1.5865 • Actual borrowing $ 341,463 / 1.5865 would be £ 2,15,230. Step 5: Invest • The $ 3,41,463 is invested for 6 months at 2.5% per half year Step 6: Settle • $ Asset of 341,463 matures to $ 350,000 • This is used to settle the $ liability of 350,000 of Step 1 Part (b): Compare the money market hedge and forward rate: We compare cost of purchase of $ to yield maturity proceeds equivalent to import liability, and forward contract rates

Cost to the company in £

Now 6 months later

Forward Market – 2,25,733 (3,50,000/1.5505) Money Market Hedge 2,15,230 2,24,916 *

PRIME A

CADEMY

PRIME/43rd /FINAL 6

*(Since there is an initial outflow in £s, we have to compute the future value of these funds, based on an imputed cost at the borrowing rate of 9% for six months) Decision: Maturity value of the cost of £-funds under money market hedge is lower than quantum of £s involved for performing forward exchange contract at 1.5505. Hence we must opt for money market hedging. 3. (b)

Reset PeriodLIBOR RateCAP Rate Receive /Pay Value Premium Net Gain

1 9.0% 8.0% 1.0% 75,000 40,839 34,161

2 9.5% 8.0% 1.5% 1,12,500 40,839 71,661 3 10.0% 8.0% 2.0% 1,50,000 40,839 1,09,161

3,37,500 1,22,517 2,14,983

Note 1: If the LIBOR rate is greater than CAP rate, the borrower will receive the difference Note 2: Value = 15,00,000 x Col 4 Note 3: Premium is 1% on 150,00,000 ie 150,000 UKP

The interest rate is 7% per annum or 3.5% per half year The premium each quarter will be 150,000/PVAF(3.5%, 4) 150,000 40,839 –––––– 3,673 = .

Note 4: It is taken that the CAP rate is in exchange of “L”. Hence the +10% is not relevant. Conclusion: By taking the CAP the cost of interest has been reduced by Rs 214,983.

4. (a) WN 1: Rs. in lakh

Cash Down price of machine 300.00

Less: Present value of tax saved on depreciation [100 x 0.35 x 2.486] 87.03

Net Value 212.95

WN 2: Normal Lease Rental If the normal annual lease rent per annum is x, then cash flow will be:

Year Post-tax cash flow P.V. of After Tax Flow

1 3x(1 – 0.35) = 1.95x 1.95x (0.909) = 1.7726x

2 2x(1 – 0.35) = 1.3x 1.30x (0.826) = 1.0738x 3 x (1 – 0.35) = 0.65x 0.65x (0.751) = 0.4882x

= 3.3346x

WN 3: Year-wise lease rentals: Rs. in lakhs Y1 3 × 63.8607 lakhs = 191.58 Y2 2 × 63.8607 lakhs = 127.72 Y3 1 × 63.8607 lakhs = 63.86

Therefore 3.3346x = 212.95 OR x = Rs.63.8607 lakh.

PRIME A

CADEMY

PRIME/43rd /FINAL 7

(b)

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

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 4.336 Old EPS 5 6

Gain/Loss GAIN LOSS

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

5. a)

Step 1: Computation of Ko 54L / (Ko-9%) = 1800 L Hence Ko = 12%

Step 2: Computation of BV weights

Source BV Weight Cost Wt x Cost Equity S 20% 0.2 S Debt 1-S 10% 0.1 - 0.1S

Total 1 0.12

Hence, 0.2S + 0.10 - 0.1S = 0.12

Or, 0.1S = 0.02 Or, S=0.2

Hence weight of Equity is 0.2 and that of Debt is 0.8

Step 3: Computation of WACC based on MV weights

Source BV MV WT Cost WtxCost

Equity 0.2 0.6 0.454545455 20% 0.0909 MV thrice BV Debt 0.8 0.72 0.545454545 10% 0.0545 MV is 0.9 BV

1.32 0.1454

Step 4: Revised value of the firm 54L / (0.1454-0.09) = 972.97.

PRIME A

CADEMY

PRIME/43rd /FINAL 8

b) (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 required rate namely the YTM.

Year Cash Flow DF@17% DCF

1 160 0.855 136.8 2 160 0.731 117.0 3 160 0.625 100.0 4 160 0.534 85.4 5 160 0.456 73.0 6 1160 0.390 452.4

Total 964.6

2. Duration

Year Cash DF@ DCF Proportion of Proportion of bond

flow 17% bond value value x time (Years)

1 160 0.855 136.80 0.142 0.142 2 160 0.731 116.96 0.122 0.244 3 160 0.624 99.94 0.104 0.312 4 160 0.534 85.44 0.089 0.356 5 160 0.456 72.96 0.076 0.380 6 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 Duration 4.236

Volatility of the bonds = = 3.62

=

( 1 + yields) 1.17

PRIME A

CADEMY

PRIME/43rd /FINAL 9

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

6. (a)

(i) Beta of the Portfolio

Security MP No. of Shares Total Inv. Weights Beta Wt. Beta

A 29.40 400 11760 0.01 0.59 0.006977123 B 318.70 800 254960 0.26 1.32 0.338425461 C 660.20 150 99030 0.10 0.87 0.086636935 D 5.20 300 1560 0.00 0.35 0.000549047 E 281.90 400 112760 0.11 1.16 0.1315316 F 275.40 750 206550 0.21 1.24 0.25755141 G 514.60 300 154380 0.16 1.05 0.16300367

H 170.50 900 153450 0.15 0.76 0.117272864

994450 1.10

(ii) Theoretical value of futures contract

Theoretical Value = Current Value x ert For May =

8500 x e0.20 x 2/12

= 8500 x e0.03 = 8758.825 For June = 8500 x e0.20 x 3/12

= 8500 x e0.05 = 8935.795

(iii) Computation of number of Contracts to be hedged:

Value Requiring hedging x Hedge Ratio x Beta –––––––––––––––––––––––––––––––––––– Nifty Value x Multiplier

Full Hedge : 994450 x 100% x 1.10

= 4.94 Contracts

––––––––––––––––– 8850 x 25

50% Hedge : 994450 x 50% x 1.10 ––––––––––––––––– = 2.47Contracts

8850 x 25

120% Hedge : 994450 x 120% x 1.10

= 5.93 Contracts

–––––––––––––––––

8850 x 25

PRIME A

CADEMY

PRIME/43rd /FINAL 10

(b)

(i) Computation of BETA

Stock Price Quantity Value WT Beta W*B

A 349.30 5,000 17,46,500 0.093 1.15 0.107 B 480.50 7,000 33,63,500 0.178 0.40 0.071 C 593.52 8,000 47,48,160 0.252 0.90 0.227 D 734.70 10,000 73,47,000 0.390 0.95 0.371

E 824.85 2,000 16,49,700 0.087 0.85 0.074

1,88,54,860 1.000 0.850

7. Write short notes on any four of the following:

(a)

Past performance

Timing: good to buy when markets are down

Size: larger the better

Age

Fund manager

Expense ratio

Portfolio turnover

Largest holding

PE ratio

(b)

Bonus shares

Stock split

Reverse split

Buy back of shares

(c) difference between national Capital Budgeting and International Capital Budgeting International

capital budgeting is when the investment is made in a foreign country. The basic rules of capital

budgeting(national) remains unaltered. The following are the differences:

NPV is computed either using home country approach or host country approach

If there are repatriation restrictions, the same has to be considered

Cash flows are converted using spot and forward rates as applicable using IRPT.

(d) (i) Yield to maturity

This indicates the rate of return an investor who buys the bond in the market today earns, if he

holds the bond till maturity. This is computed by laying down the cash flow structure from the date

of purchase to the maturity of the bond and then computing its IRR.

(ii) Deep discount bonds

Similar to Zero coupon bonds these bonds do not carry any coupon rate.

However, these bonds are issued at a significant discount to face value and are redeemed at

face value. The difference between the issue price and the redemption price is the cost of the

DDB. For the investor the difference between purchase price and redemption price is the

return

PRIME A

CADEMY

PRI

ME

/43r

d

/FI

NA

L 11

PRIME A

CADEMY

PRIME/43rd /FINAL 1

The Society of Auditors and Prime Academy Model Exam – FINAL - Sep 2016

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

Question 1 is Compulsory

Answers any Five Questions from the rest 1.

a) You are the Statutory auditor of XYZ Ltd. In the month of May 2016 due to earth quake the inventory worth 50 Lakhs was lying in the warehouse was totally destroyed. The financial statements of the company had not been adopted till the date of the earth quake. The management of the company argues that since the loss occurred in the year 2016-17, no provision for the loss needs to be made in the financial statements of 2015-16. Comment as Statutory Auditor. (5 marks)

b) As the Team leader for the audit of a closely held public limited company, you have been asked by the Engagement Partner, to report on the existence of related party transactions. What are records, documents and other possible sources of informations which you would ask your team to inspect and check. (5 marks)

c) Mr.Kannan is a freshly qualified Chartered Accountant of the May 2016 batch, who has started practice. He has been appointed as the statutory auditor of a private limited company for the first time. What are the audit techniques that he would have adopted apart from the conventional audit procedures such as posting, casting, vouching. (5 marks)

d) As the auditor of a large multi locational company, during the planning process how would you identify the inherent risk at the account balance and class of transaction level. (5 marks)

2.

a) A mid sized pharma company having a turnover of Rs.75 crores has developed an ERP tailor made to meet its requirements. All transaction are processed and the final accounts are generated through the system.The management is of the view that the books need not be printed and audit can be conducted on the computer. The ERP has a module for query based reports. As a statutory auditor enumerate the procedures you would adopt to conduct the audit. (6 marks)

b) As a tax auditor, which are the accounting ratios required to be mentioned in the report in case of manufacturing entities? Explain in detail any one of the above ratios and how does it help the tax auditor in his analytical review. (5 marks)

c) Write a short note on Corporate Governance. ( 5 marks)

3. a) Describe the procedure for verification of the following balances appearing in the account books

of a bank: i. Drafts paid without advice ii. Branch adjustment account (6 Marks)

b) Write a short note on True and Fair Cost of Production. (5 marks) c) “Surprise Checks” help the auditors to ascertain whether the Internal control system is operating

effectively in a company or not.” Discuss. (5 marks)

4. a) During the audit of Airwave Telecom Ltd., you come across a report of the Internal auditor of a

fraud involving agents and the management to the tune of 5 Crores. This report was not shared with you, but you came across the report in one of the files which was made available for audit.

PRIME A

CADEMY

PRIME/43rd /FINAL 2

With reference to the companies Act 2013, what will be your approach and how will you report the fraud. (6 marks)

b) Comment on the following situation: The Board of Directors of Polite Ltd. made an aggregate of online contribution of ` 37.5 lakhs to a National Defense Fund for the financial year ending on31st March, 2015. All the contribution of the fund is used for the welfare of the members of the Armed Forces and their dependents. The average net profit of the company during the three immediately preceding financial years was ` 476 lakhs. The manager of the company is of the view that the maximum contribution that can be made to a National Defense Fund is ` 35.7 lakhs and, therefore, the company is violating the provisions of the Companies Act, 2013. (6 marks)

c) While doing the audit of consolidated financial statements, which current period adjustments are

to be taken into account. (4 marks)

5. a) Ever Bright Batteries Ltd., having turnover of 500 Crores, has appointed M/s ABC as the sole

statutory auditors for 2016-17. Till last year, M/s DEF were also one of the joint auditors along with M/s ABC. Mention the steps that should be taken by M/s ABC before commencing the audit. (4 marks)

b) As auditor of Go Slow Ltd. What steps will you take to ensure that the dividend has been paid only out of profits. (4 marks)

c) The Managing Director of X Ltd is concerned about the high attrition rate in his company. As the Internal auditor he requests you to analyse the causes for the same. What factor would you consider in such analysis. (4 marks)

d) What are the liabilities of the auditor u/s 35 of the Companies Act 2013, for making an untrue statement in the report (as an expert forming a part of the prospectus) (4 marks)

6. Comment on the following with reference to the ca act 1949 and the schedules thereto:

a) M/s QRS, a firm in practice, develops a website qrs.com. The color chosen for the website is a very bright yellow and the web site was to run on a “push” technology where the names of the partners of the firm and the major clients were to be displayed on the web site. (4 marks)

b) Rahul Junior cleared the CA final in November 2015 and started practice in December 2015. Rahul was able to set up a flourishing practice by sheer hard work. In August 2016 he got an offer to join Ta start up as a CFO with a monthly salary of Rs. 1lakh. He accepted the offer and converted his practice into a partnership firm by taking a Fresh CA as his partner. Rahul neither intimated the Institute nor obtained permission from the Institute for his employment. Will Rahul be held guilty under the CA ACT?

c) Priya a Chartered Accountant has sent letters under certificate of posting to the previous auditor informing him her appointment as an auditor before the commencement of audit by . Is she guilty of professional misconduct? Give your views with reasons in brief.

d) Mr. Annamalai a Chartered Accountant certified the financial statements of a company in which his wife is a Director holding substantial interest.

7. Write short notes on any 4 of the following:

a) Powers and duties of an auditor of a Multi State Cooperative society. b) Reporting on the Compliance engagement c) Classification of frauds by NBFC d) Scope of peer review e) Hap hazard Sampling (4 x 4 = 16 Marks)

PRIME A

CADEMY

PRIME/43rd /FINAL 1

THE SOCIETY OF AUDITORS AND PRIME ACADEMY

43rd SESSION MODEL EXAM – FINAL – ADVANCED AUDITING AND PROFESSIONAL ETHICS SUGGESTED ANSWERS

1. (a) Event occurring after the balance sheet date: This case requires attention to SA 560 “Subsequent

Events” and AS 4 “Contingencies and Events occurring after the Balance Sheet Date”. As per AS 4 “Contingencies and Events occurring after the Balance Sheet Date”, adjustments to assets and liabilities are required for events occurring after the balance sheet date that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date or that indicate that the fundamental accounting assumption of going concern (i.e., the continuance of existence or substratum of the enterprise) is not appropriate. AS 4 also requires disclosure of the non-adjusting event, in the report of the approving authority. Further, as per SA 560 “Subsequent Events”, the auditor should assure that all events occurring subsequent to the date of the financial statements and for which the applicable financial reporting framework requires adjustment or disclosure have been adjusted or disclosed. The event took place after the close of the accounting year and does not relate to conditions existing at the balance sheet date. Thus, it will have no effect on items appearing at the balance sheet date because as per AS 4 “Contingencies and Events Occurring after Balance Sheet Date” have to be adjusted that provide evidence of conditions existing as at the balance sheet date. However, the auditor has to ensure that this loss will not materially affect the substratum of the enterprises as per its size, nature and complexity of operations. Thus, subject to satisfaction in respect of non-violation of going concern concept, the company has correctly accounted by not providing provision. However, the auditor is required to ensure the proper disclosure of abovementioned event.

(b) Verification of Existence of Related Parties: As per SA 550 “Related Parties”, during the audit, the auditor shall remain alert, when inspecting records or documents, for arrangements or other information that may indicate the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor. Example- (i) Entity Income Tax Returns. (ii) Information supplied by the entity to regulatory authorities. (iii) Shareholder registers to identify the entity’s principal shareholders. (iv) Statements of conflicts of interest from management and those charged with governance. (v) Records of the entity’s investments and those of its pension plans. (vi) Contracts and agreements with key management or those charged with governance. (vii) Significant contracts and agreements not in the entity’s ordinary course of business. (viii) Specific invoices and correspondence from the entity’s professional advisors. (ix) Life insurance policies acquired by the entity. (x) Significant contracts re-negotiated by the entity during the period. (xi) Internal auditors’ reports. (xii) Documents associated with the entity’s filings with a securities regulator (e.g.,prospectuses). Arrangements that may indicate the existence of previously unidentified or undisclosed related party relationships or transactions. In particular, the auditor shall inspect the following for indications of the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor: (i) Bank, legal and third party confirmations obtained as part of the auditor’s procedures; (ii) Minutes of meetings of shareholders and of those charged with governance; and (iii) Such other records or documents as the auditor considers necessary in the circumstances of the entity.

PRIME A

CADEMY

PRIME/43rd /FINAL 2

(c) Mr. Kannan as a statutory auditor conducting audit of a private company for the first time would do well to obtain knowledge of the business of the company to understand and assess the kind of audit procedures to be employed by him as per 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” respectively. Knowledge of the business is a frame of reference within which the auditor exercises professional judgement. Understanding the business and using this information appropriately assists the auditor in: (i) Assessing risks and identifying problems. (ii) Planning and performing the audit effectively and efficiently. (iii) Evaluating audit evidence. Such knowledge would enable the auditor to identify and understand the events, transactions and practices that, in the auditor's judgement, may have a significant effect on the financial statements or on the examination or audit report. As far as adoption of conventional audit procedures is concerned, it would normally involve lot of time without commensurate benefits. In any case, if size of the business is large, the application of conventional procedure would involve extraordinary more time resulting into more cost and even then the auditor would not get the required satisfaction as to the figures contained in the financial statements. There may however, be some instances, say, where internal control systems are quite weak, it may perhaps be advisable to stick to conventional audit procedures such as vouching, etc. in detail. In any case, application of compliance procedure to evaluate the internal control systems in operations would enable the auditor to determine nature, extent and timing of substantive procedures. Depending upon various factors including size of the business, it is advisable to reduce the extent of checking by adopting test check approach. Test-check approach is an accepted auditing procedure, which aims to test transactions on the basis of selection of samples from the entire population. Audit sampling means the application of audit procedures to less than 100% of the items within an account balance or class of transactions to enable the auditor to obtain and evaluate audit evidence about some characteristic of the items selected in order to form or assist in forming a conclusion concerning the population. It is important to recognise that certain testing procedures do not come within the definition of sampling. Tests performed on 100% of the items within a population do not involve sampling. Likewise, applying audit procedures to all items within a population which have a particular characteristic (for example, all items over a certain amount) does not qualify as audit sampling with respect to the portion of the population examined, nor with regard to the population as a whole, since the items were not selected from the total population on a basis that was expected to be representative. Such items might imply some characteristic of the remaining portion of the population. The auditor would also consider the specific audit objectives to be achieved and the audit procedures which are likely to best achieve those objectives. In addition, when audit sampling is appropriate, consideration of the nature of the audit evidence sought and possible error conditions or other characteristics relating to that audit evidence will assist the auditor in defining what constitutes an error and what population to use for sampling. For example, when performing tests of control over an entity's purchasing procedures, the auditor will be concerned with matters such as whether an invoice was clerically checked and properly approved. On the other hand, when performing substantive procedures on invoices processed during the period, the auditor will be concerned with matters such as the proper reflection of the monetary amounts of such invoices in the financial statements. After performing vouching, it is necessary for an auditor to perform verification of balances contained in the financial statements. Verification and valuation of assets and liabilities contained in the balance sheet would involve obtaining evidence through methods like physical observations, confirmation, computation, inspection of documents and analytical reviews. Direct confirmation procedure provides an independent audit evidence to analyse the financial information contained in the accounting records. For example, confirmation may be done for trade receivables, trade payables, investments lying with third parties, bank balances, etc.

PRIME A

CADEMY

PRIME/43rd /FINAL 3

Apart from conducting audit procedures like vouching and verification, it is quite useful to employ analytical review procedures; In fact, analytical review procedures would provide substantive audit evidence to support various assertions in the financial statements. Over a period of time, the analytical review as a method of obtaining evidence has emerged as a significant auditing procedures. As per SA 520, analytical procedures means the analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or which deviate from predicted amounts. Analytical procedures in planning the audit use both financial and nonfinancial information, for example, the relationship between sales and square footage of selling space or volume of goods sold. The auditor's reliance on substantive procedures to reduce detection risk relating to specific financial statement assertions may be derived from tests of details, from analytical procedures, or from a combination of both. The decision about which procedures to use to achieve a particular audit objective is based on the auditor's judgement about the expected effectiveness and efficiency of the available procedures in reducing detection risk for specific financial statement assertions. It further states that when analytical procedures identify significant fluctuations or relationships that are inconsistent with other relevant information or that deviate from predicted amounts, the auditor should investigate and obtain adequate explanations and appropriate corroborative evidence. Therefore, a statutory auditor who has been appointed for the first time must resort to evaluation of internal control system through performance of compliance procedures based on the knowledge of the client's business followed by vouching on a selected basis having regard to sampling. Physical observation and direct confirmation are also useful audit techniques in the verification of items contained in the financial statements. Ratio analysis or analytical procedures would also provide audit evidence as to various assertions contained in the financial statements. (The answer need not be in so much detail, but the student can briefly summarise the above paras on test check, sampling and other methods of audit).

(d) Evaluating Inherent Risk: To assess inherent risk, the auditor would use professional judgment to evaluate numerous factors, having regard to experience of the entity from previous audit engagements of the entity, any controls established by management to compensate for a high level of inherent risk, and his knowledge of any significant changes which might have taken place since his last assessment. Inherent audit risk at the level of Account Balance and Class of Transactions is: (i) Quality of the accounting system. (ii) Financial statements are likely to be susceptible to misstatement, for example, accounts which required adjustment in the prior period or which involve a high degree of estimation. (iii) The complexity of underlying transactions and other events which might require using the work of an expert. (iv) The degree of judgement involved in determining account balances. (v) Susceptibility of assets to loss or misappropriation, for example, assets which are highly desirable and movable such as cash. (vi) The completion of unusual and complex transactions, particularly at or near period end. (vii) Transactions not subjected to ordinary processing.

2. (a) A key feature of the accounting software package used by the company definitely involves the absence

of a clear audit trail. In other words, transactions cannot be easily traced or correlated from the individual supporting documents of those transactions. As auditor, it must be conceded, the exception reports in the form of 'query-based reports' which isolate the above data provide the very material that is required for most of the verification work. The only problem which it raises, is that one cannot simply assume that the programmes which produce the exception reports are reliable in respect of the following factors:

PRIME A

CADEMY

PRIME/43rd /FINAL 4

(i) operating accurately; (ii) printing out all the exceptions which exist; and (iii) bound by programmed control parameters which meet the company's genuine internal control requirements. In view of the above, as the management relies upon exception reports, the audit trail between input and output has been effectively eliminated and as auditor, we are forced to test the invisible processes which purport to embody the controls, and produce the output such as it is. These tests, which invariably involve the use by the auditor of the computer itself, are known as tests through the machine. In the 'through the machine' approach, the auditor starts by proving the accuracy of the input data, and then thoroughly examines (by applying tests) the processing procedures with a view to establishing the following that: (i) all input is actually entered into the computer. (ii) neither the computer nor the operators can cause undetected irregularities in the final reports. (iii) the programmes appear, on the evidence of rejection and exception routines, to be functioning correctly. (iv) all operator intervention during processing is logged and scrutinised by the DP manager. The auditor in such circumstances will have to first evaluate the existing controls. For the same, the following has to be done: (i) Evaluate the internal control system especially the controls and checks existing for recording the transactions, i.e., verification as to at what level transactions can be entered into the system and what checks are available to prevent any unauthorised data entry and for rectifying errors/omissions in the transactions entered. (ii) Evaluate at what level there is authority given for modification of transactions already entered. Is there any authority given only to a senior employee to carry out modifications? Or is it that once transactions are entered and validated no further modifications are possible thereto. (iii) Whether there is a provision in the software for carrying out an on line audit of transactions, i.e. whether there a separate module in the package, where a separate password given to the auditor and once he has seen and approved a particular transaction/set of transactions, the same would be locked and no modifications would be possible by anyone (including the senior most employee) in the company. (iv) Whether there are proper procedures for backup of data on a regular basis and whether the said procedures are being strictly followed. (v) In case of any loss of data whether there is a clear defined recovery procedure to minimize the loss of data due to power failures or any human errors. (vi) As auditor some dummy data may also be introduced into the system and the results obtained. After evaluation of the the above procedures, an audit plan is prepared. Since the daybooks are not being printed, the plan can contain procedures wherein data is verified directly on the computer from the vouchers/invoices, etc. The audit plan will also require a lot of analytical procedures to be performed. Depending on the importance of various expense heads and other important account heads, various reports from the system will be obtained. Some illustrative reports can be: (i) To check whether proper classification is done for revenue/capital - a report can be obtained of all purchases (not being raw materials or other routine purchases) exceeding one lakh. (ii) To check whether all freight outward bills are accounted for a report containing a month wise co-relation between goods dispatched and freight amount paid. The same can be further co-related with the freight rates obtained from the bills. On the basis of the above procedures an opinion is formed on whether reliance can be placed on the accounting systems and the data recorded. If reliance cannot be placed then the management can be asked to print the books for audit. The finalisation procedures to be followed even under this system would remain more or less similar to other accounting systems. Reports of depreciation on fixed assets, inventory valuation to be

PRIME A

CADEMY

PRIME/43rd /FINAL 5

checked and using the normal procedures to find out whether reliance can be placed on them, e.g., if while valuing inventories the system is using the LIFO method, the same would not be acceptable and will need to be modified. Similarly depreciation calculations will have to be verified on a random basis to find out its reliability.

(b) Accounting Ratios in Form 3CD of Tax Audit: A tax auditor is required to provide details regarding turnover, gross profit, etc., for the previous year as well as for the preceding previous year in Form 3CD. The ratios which are to be calculated for manufacturing entities are:

Gross profit / Turnover Net Profit / Turnover Stock-in-trade/Turnover Material consumed / Finished goods provided Ratio analysis constitutes a substantive auditing procedure designed to obtain evidence as to the completeness, accuracy and validity of the data produced by the accounting system. Such assessment is necessary in organisations having large volumes of transactions and in the organisation following mechanised accounting system where it is not possible to check each and every transaction. It has the merit of bringing to focus the abnormal deviations and unexpected variations which the normal routine checking in auditing may fall to reveal. Ratios highlight only symptoms and that too as of a particular day and the auditor should study these symptoms properly, correlate them and reach definite conclusions or identify areas for further enquiries. The auditor should by relating sales with the net profit, various items of direct and indirect costs and gross profit gather information about the profitability and operating efficiency of an enterprise; variations in any of these ratios in a particular year should be inquired by the auditor. The fall in the gross profit ratio and profitability ratio should alert the auditor who should ask the management for the reasons thereof and which should be carefully examined by him. These ratios have to be given for the business as a whole and not product wise. While calculating these ratios, the tax auditor should assign a meaning to the terms used in the above ratios having due regard to the generally accepted accounting principles. All the ratios mentioned in the clause are to be calculated in terms of value only. The relationship of stock-in-trade to turnover over a period of time would reveal whether the entity has been accumulating stocks or there is a decline in the same. The auditor may obtain data for about 7-10 years, compute ratio of stock-in-trade/turnover and plot it on a graph paper over a period of time. This may give rise to several possibilities such as parallel horizontal lines, vertical rising line or a vertical falling line. A study of this relationship would reveal whether stocks are being accumulated or they are dwindling over a period. Such information would provide an input to tax auditor as to whether figures of either stock or turnover are being manipulated. Sometimes, while studying the relationship, it may show sudden decline or increase at a point of time which reflect that there is definitely something wrong with the figures of stock. Therefore, a close examination of such ratios helps the tax auditor to focus on major deviations and consequently reasons for the same.

(c) Corporate Governance: Corporate governance is the system by which companies are directed and controlled by the management in the best interest of the shareholders and others ensuring greater transparency and better and timely financial reporting. The Board of Directors are responsible for governance of their companies. A number of reports and codes of corporate governance have been published internationally. The Securities and Exchange Board of India (SEBI) with the objective to align its provisions to the recently notified provisions of the Companies Act, 2013, (‘the Act’) has specifically reviewed clause 49 of the Listing Agreement, to adopt leading industry practices on corporate governance and to make the corporate governance framework more effective. The revised clause 49 on corporate governance shall be applicable to all listed companies with effect from 1 October 2014, except for the clause relating to the constitution of a Risk Management

PRIME A

CADEMY

PRIME/43rd /FINAL 6

Committee which shall apply to the top 100 listed companies by market capitalisation, as at the end of the immediate previous financial year. Various clauses deal with composition of board, setting-up of audit committee including scope thereof, remuneration of directors, meetings of Board, contents of management discussions and analysis report, etc. Clause 49 also prescribes that there shall be a separate section on Corporate Governance in the annual reports of company, with a detailed compliance report on Corporate Governance. Non compliance of any mandatory requirement i.e. which is part of the listing agreement with reasons there of and the extent to which the non-mandatory requirements have been adopted, should be specifically highlighted. Further, the entity is required to obtain a certificate from the statutory auditor of the entity as regards compliance of conditions of corporate governance as stipulated in that clause. A monitoring cell set up by SEBI, will assess compliance by companies with the requirements of clause 49 and report non compliances to SEBI within 60 days from the end of each quarter.

3. (a) Drafts Paid Without Advice: This balance is in the nature of a suspense account in as much as it

represents payments made on account of drafts issued by other branches but for which the relevant advice from those branches have not been received. It is, therefore, most important to examine the system of internal control operating in the bank in this respect. The testing of the internal control system has to be made mainly with regard to the following: (i) the system of verifying the authenticity of the draft by reference to specimen signature of the signing authority and the prima facie correctness and completeness of the draft in all respects; (ii) the system of co-relating drafts paid with advices subsequently received; and (iii) the system of sending reminders where advices are not received within a reasonable time and the recording of reasons for their non receipt. The composition of the balances appearing in this account should be verified with particular reference to any long outstanding items. The auditor should also verify whether the items appearing in this account have been subsequently cleared on receipt of the relevant advices. It would also be useful to have on record the names and addresses of the payees of such drafts. The auditor may also seek confirmation of transactions relating to such outstanding cases. (b) Branch Adjustment Account: In the final balance sheet of the bank, this balance represents the difference between inter branch debits and credits and should normally comprise items which are in transit as on the closing date. This account is the one which is most commonly used by unscrupulous persons in committing a fraud. The verification of this account is, therefore, of great importance. The procedure for verification is as follows: (i) See that all branch accounts are periodically reconciled. (ii) Check all adjustments in the account and ensure that the adjustments are done properly and supported by adequate documentary evidence as to its validity. (iii) Verify that reversal entries are made under proper authority and after due explanation and evidence.

(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

PRIME A

CADEMY

PRIME/43rd /FINAL 7

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) Surprise Checks: SA 315 & 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” prescribes that “the auditor should obtain an understanding of the accounting and internal control systems sufficient to plan the audit and develop an effective audit approach. 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.” The understanding of the accounting and internal control system can be obtained in several ways including inspection of documents making inquires of appropriate management, observation of activities, etc. It is in this context, surprise checks intend to ascertain whether the system of internal control is operating effectively and whether the accounting and other records are prepared concurrently and kept up-to-date. Particularly, the observation of the entity’s activities and operations including observation of the organisation of computer operations, personnel performing control procedures and the nature of transaction processing on a surprise visit would reveal the exact manner in which the activities are being performed in the manner prescribed by the management. It has often been found that manipulations and frauds are facilitated under a system of book-keeping, which does not give proper emphasis to the need to keep the books up-to-date. Errors in book-keeping are often indicative of weaknesses in internal control which may be taken advantage of in order to perpetrate frauds or manipulations. Surprise checks are a useful method of determining whether or not such errors exist and where they exist, of bringing the matter promptly to the attention of the management so that corrective action is taken immediately. Consequently, surprise visits by the auditor can exercise a good moral check on the client’s staff. The Guidance Note issued by the Institute on the subject specifies that surprise checks are a part of the normal audit and the results of such checks are therefore important primarily to the auditor himself in deciding the scope of his audit and submitting his report thereon. The need for and frequency of surprise checks is obviously a matter to be decided having regard to the circumstances of each audit. It would depend upon the extent to which the auditor considers the internal control system as adequate, the nature of the clients’ transaction, the locations from which he operates and the relative importance of items like cash, investments, stores etc. However, wherever feasible a surprise check should be made at least once in the course of an audit. If this surprise check reveals any weaknesses in the system of internal control or any fraud or error or the fact that any book or register has not been properly maintained or kept up-to-date, the auditor should communicate the same to the management and ensure that action is taken on the matters communicated by him. It does not necessarily follow that all or any of the matters communicated to the management should form part of the auditor’s report on the accounts. Thus “surprise checks” help the auditors, during the course of their audit, to ascertain whether the internal control is operating effectively in a company or not.

4.

PRIME A

CADEMY

PRIME/43rd /FINAL 8

(a) I. Reporting to the Central Government- As per sub-section (12) of section 143 of the Companies Act, 2013, if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. In this regard, Rule 13 of the Companies (Audit and Auditors) Rules, 2014 has been prescribed. Sub-rule (1) of the said rule states that if an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of ` 1 crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government. The manner of reporting the matter to the Central Government is as follows: (a) the auditor shall report the matter to the Board or the Audit Committee, as the case may be, immediately but not later than 2 days of his knowledge of the fraud, seeking their reply or observations within 45 days; (b) on receipt of such reply or observations, the auditor shall forward his report and the reply or observations of the Board or the Audit Committee along with his comments (on such reply or observations of the Board or the Audit Committee) to the Central Government within 15 days from the date of receipt of such reply or observations; (c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of 45 days, he shall forward his report to the Central Government along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he has not received any reply or observations; (d) the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered Post with Acknowledgement Due or by Speed Post followed by an e-mail in confirmation of the same; (e) the report shall be on the letter-head of the auditor containing postal address, e-mail address and contact telephone number or mobile number and be signed by the auditor with his seal and shall indicate his Membership Number; and (f) the report shall be in the form of a statement as specified in Form ADT-4. II. Reporting to the Audit Committee or Board - Sub-section (12) of section 143 of the Companies Act, 2013 further prescribes that in case of a fraud involving lesser than the specified amount [i.e. less than ` 1 crore], the auditor shall report the matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in such manner as may be prescribed. In this regard, sub-rule (3) of Rule 13 of the Companies (Audit and Auditors) Rules, 2014 states that in case of a fraud involving lesser than the amount specified in sub-rule (1) [i.e. less than ̀ 1 crore], the auditor shall report the matter to Audit Committee constituted under section 177 or to the Board immediately but not later than 2 days of his knowledge of the fraud and he shall report the matter specifying the following: (a) Nature of Fraud with description; (b) Approximate amount involved; and (c) Parties involved. III. Disclosure in the Board's Report: Sub-section (12) of section 143 of the Companies Act, 2013 furthermore prescribes that the companies, whose auditors have reported frauds under this sub-section (12) to the audit committee or the Board, but not reported to the Central Government, shall disclose the details about such frauds in the Board's report in such manner as may be prescribed. In this regard, sub-rule (4) of Rule 13 of the Companies (Audit and Auditors) Rules, 2014 states that the auditor is also required to disclose in the Board’s Report the following details of each of the fraud reported to the Audit Committee or the Board under sub-rule (3) during the year: (a) Nature of Fraud with description; (b) Approximate Amount involved;

PRIME A

CADEMY

PRIME/43rd /FINAL 9

(c) Parties involved, if remedial action not taken; and (d) Remedial actions taken.

(b) Contribution to National Defence Fund: Section 183 of the Companies Act, 2013 deals with the power of Board and other persons to make contributions to National Defence Fund, etc. This section permits the Board and other person to make contributions to the National Defence Fund or any other Fund approved by the Central Government for the purpose of National Defence to any extent as it thinks fit. In the given case, the board of Polite Ltd. has made an aggregate of online contribution of 37.5 lakhs to a National Defence Fund. However, according to the manager of Polite Ltd., the maximum contribution that can be made to the Fund is ` 35.7 lakhs. In this context, it may be noted that there is no such restriction imposed on contributions to National Defence Fund. The board is free to contribute such amount as it thinks fit. Therefore, the view of the manager of Polite Ltd. is not appropriate and, thus, there is no such violation of the provisions of section 183 of the Companies Act, 2013. The data on average net profit of the company given in question is of no relevance here.

(c) Current Period Consolidation Adjustments: Current period adjustments are those adjustments that are made in the accounting period for which the consolidation of financial statements is done. Current period consolidation adjustments primarily relate to elimination of intra-group transactions and account balances. While doing the audit of consolidated Financial Statements, current period consolidation adjustments should be taken into account. The auditor should review the memorandum records to verify the adjustment entries made in the preparation of consolidated financial statements. This would also help the auditor in ascertaining whether there is any difference in the elimination. Following are the current period consolidation adjustments while making consolidation of financial statements: - Elimination of intra-group transactions relating to interest or management fees etc. - Elimination of unrealized intra-group profits on assets acquired from other subsidiaries. - Elimination of intra-group indebtedness. - Adjustments for harmonizing different accounting policies of parent unit and its subsidiaries. - Adjustments for impairment loss that might exist for goodwill. - Adjustment for significant events that occur between date of financial statements of the parent and of its components when the date/s of financial statements of components are different from the reporting date.Determination of movement in equity attributable to the minorities since the date of acquisition of the subsidiary. - Treatment of minority interests’ share of the losses, if such losses exceed the minority interests’ share in the equity.

5. (a) Steps before Commencing the Audit Work: When one of the joint auditors of the previous year is

considered for ratification by the members as the sole auditor for the next year, it is similar to non re-appointment of one of the retiring joint auditors. The provisions of section 140 of the Companies Act, 2013 (hereinafter referred as the Act) relating to non-reappointment of the retiring auditor need to be considered. As per sub-section 4 of section 140 of the Act, special notice shall be required for a resolution at an annual general meeting appointing as auditor a person other than a retiring auditor, or providing expressly that a retiring auditor shall not be re-appointed, except where the retiring auditor has completed a consecutive tenure of five years or, as the case may be, ten years, as provided under sub-section (2) of section 139 of the Act.

The following steps should be taken care of by M/s. ABC before commencing the audit: (i) Ascertain that special notice under Section 140(4) of the Act was duly received by the company, from such number of members holding not less than one percent of total voting power or holding shares on which an aggregate sum of not less than five lakh rupees has been paid up on the date of

PRIME A

CADEMY

PRIME/43rd /FINAL 10

the notice, not earlier than three months but at least 14 days before the AGM date as per Section 115 of the Act read with the Companies (Management and Administration) Rules, 2014. (ii) Check whether the said notice has been sent to all the members at least 7 days before the date of the AGM as per Section 115 of the Act. (iii) Verify the notice contains an express intention of a member for proposing the resolution for appointing a sole auditor in place of both the joint auditors who retire at the meeting but are eligible for re-appointment. (iv) Verify that the said notice is also sent to the retiring auditor as per Section 140(4)(ii) of the Act. (v) Verify whether any representation received from the retiring auditor was sent to the members of the company to whom notice of the meeting was sent as per Section 140(4)(iii) of the Act. (vi) Verify from the minutes book whether the representation received from the retiring joint auditor was considered at the AGM. (vii) Examine that proposed resolution was properly passed. Further, Clause (8) of Part I of the First Schedule to the Chartered Accountants Act, 1949, provides that a member in practice shall be deemed to be guilty of professional misconduct if he accepts a position as auditor previously held by another chartered accountant without first communicating with him in writing. Moreover, Clause (9) of Part I of the same Schedule, provides that a member in practice shall be deemed to be guilty of professional misconduct if he accepts an appointment as auditor of a company without first ascertaining from it whether the requirements of Sections 224 and 225 of the Companies Act, 1956 (now Section 139 and 140 read with section 141 of the Companies Act, 2013), in respect of such appointment have been duly complied with. Therefore, M/s ABC is required to comply with all the above mentioned provisions provided under Companies Act and Chartered Accountant Act before commencing the audit.

(b) Auditors have to take the following steps to ensure that the dividend has been paid only out of profits: 1. Check whether the dividend was declared out of profits arrived at after providing for depreciation as per Section 123(2) of the Companies Act, 2013 (herein after referred as the Act). 2. Check whether- (i) the depreciation was provided according to provision of Schedule II to the Act. (ii) a board resolution recommending dividend was passed. (iii) the dividend was declared only in the Annual General Meeting. (iv) no dividend declared in general meeting exceeds the amount recommended by the Board. (v) amount paid or credited as paid on a share in advance of calls is not treated for the purpose of this regulation as paid on the share. (vi) register of members was closed as per the provisions of section 91 of the Act. (vii) dividend has been paid in the prescribed manner within 30 days of time to the registered holder or their order for the compliance of Section 127 of the Act. (viii) Amount of dividend deposited in a separate bank account within five days from the date of declaration of dividend. (ix) intimation sent to Stock Exchange in the case of listed company. (x) were there any complaints of non-payment/delayed payment of dividend? If so, whether corrective action was taken.

(c) The factors responsible for high employee attrition rate are as under: (i) Job Stress & work life imbalance (ii) Wrong policies of the Management (iii) Unbearable behaviour of Senior Staff

PRIME A

CADEMY

PRIME/43rd /FINAL 11

(iv) Safety factors (v) Limited opportunities for promotion (vi) Low monetary benefits (vii) Lack of labour welfare schemes (viii) Whether the organization has properly qualified and experienced personnel for the various levels of works? (ix) Is the number of people employed at various work centres excessive or inadequate? (x) Does the organization provide facilities for staff training so that employees and workers keep themselves abreast of current techniques and practices?

(d) Liabilities of an Auditor under section 35 of the Companies Act, 2013: Under section 35 of the Companies Act, 2013, where a person has subscribed for securities of a company acting on any statement included, or the inclusion or omission of any matter, in the prospectus which is misleading and has sustained any loss or damage as a consequence thereof, the company and every person who— (a) is a director of the company at the time of the issue of the prospectus; (b) has authorized himself to be named and is named in the prospectus as a director of the company, or has agreed to become such director, either immediately or after an interval of time; (c) is a promoter of the company; (d) has authorised the issue of the prospectus; and (e) is an expert referred to in sub-section (5) of section 26, shall, without prejudice to any punishment to which any person may be liable under section 36, be liable to pay compensation to every person who has sustained such loss or damage. No person shall be liable under sub-section (1) of section 35 if he proves— (i) that, having consented to become a director of the company, he withdrew his consent before the issue of the prospectus, and that it was issued without his authority or consent; or (ii) that the prospectus was issued without his knowledge or consent, and that on becoming aware of its issue, he forthwith gave a reasonable public notice that it was issued without his knowledge or consent. It may be noted that notwithstanding anything contained in this section, where it is proved that a prospectus has been issued with intent to defraud the applicants for the securities of a company or any other person or for any fraudulent purpose, every person referred to in subsection (1) shall be personally responsible, without any limitation of liability, for all or any of the losses or damages that may have been incurred by any person who subscribed to the securities on the basis of such prospectus.

6. (a) Posting of Particulars on Website: The Council of the Institute had approved posting of particulars on

website by Chartered Accountants in practice under Clause (6) of Part I of First Schedule to the Chartered Accountants Act, 1949 subject to the prescribed guidelines. The relevant guidelines in the context of the website hosted by M/s QRS are:

- No restriction on the colours used in the website; - The websites are run on a “pull” technology and not a “push” technology - Names of clients and fees charged not to be given.

In view of the above, M/s QRS would have no restriction on the colours used in the website but failed to satisfy the other two guidelines. Thus, the firm would be liable for professional misconduct since it would amount to soliciting work by advertisement.

(b) Failure to take Permission before Accepting Employment: As per Clause (11) of Part I of First Schedule to the Chartered Accountants Act, 1949, Rahul Junior will be held guilty since he has accepted the full

PRIME A

CADEMY

PRIME/43rd /FINAL 12

time salaried employment in addition to the practice of Chartered Accountancy without obtaining permission of the Institute. The Chartered Accountants Regulation, 1988 provide that a Chartered Accountant in practice shall not engage in any business or occupation other than the profession of accountancy except with the permission granted in accordance with the provisions contained in Regulation 190A. Part (B) of Appendix 10 to the Chartered Accountants Regulations, 1988 requires member of the Institute in practice to engage in full-time or part-time employment after obtaining the specific and prior approval of the Council. Further, Rahul Junior will be held guilty of professional misconduct under Clause (1) of Part II of Second Schedule to the Chartered Accountants Act, 1949 if contravenes any of the provisions of the Act since he has failed to inform the Institute.

(c) Communication with the Previous Auditor: Clause (8) of Part I of the First Schedule to the Chartered Accountants Act, 1949 requires communication by the incoming auditor with the previous auditor before accepting a position by him. The Council of the Institute has taken the view that a mere posting of a letter “under certificate of posting” is not sufficient to establish communication with the retiring auditor unless there is some evidence to show that the letter has in fact reached the person communicated with. A Chartered Accountant who relies solely upon a letter posted “under certificate of posting” therefore does so at her own risk. Since the letters were sent by Priya to the previous auditor informing him of her appointment as an auditor before the commencement of audit by her under Certificate of Posting is not sufficient to prove communication with the retiring auditor. In the opinion of the Council, communication by a letter sent “Registered Acknowledgement Due” or by hand against a written acknowledgement would in the normal course provide positive evidence. Hence Priya is guilty of professional misconduct under Clause (8) of Part I of First Schedule to the Chartered Accountants Act, 1949.

(d) Relative of Auditor Holding Position of Director with Substantial Interest: Clause (4) of Part I of Second Schedule to the Chartered Accountants Act, 1949 states that if an auditor expresses his opinion on the financial statements of any business or enterprise in which he, his firm or partner in his firm has a substantial interest, he is committing professional misconduct. Further as per Council General Guidelines, 2008, a member of the Institute shall not express his opinion on financial statements of any business or enterprise in which one or more persons, who are his “relatives” within the meaning of AS 18 have, either by themselves or in conjunction with such member, a substantial interest in the said business or enterprise. The Council also emphasizes that the aforesaid requirement of Clause (4) is equally applicable while performing all types of attest functions by the members. This is further a contravention of section 141(3)(f) of the Companies Act, 2013, which requires that a person shall not be eligible for appointment as an auditor of a company whose relative is a director or is in the employment of the company as a director or key managerial personnel. In the given case, Mr. Shah, Chartered Accountant, has certified the financial statements of a company in which his wife is a director with substantial interest. Hence, this amounts to professional misconduct which attracts Clause (4) of Part I of Second Schedule to the Chartered Accountants Act, 1949 and Mr. Shah shall have to vacate the office accordingly.

7. a) Powers and duties of an auditor of a Multi-state Cooperative Society: Under Section 73 of the Multi-

State Cooperative Societies Act, 2002 every auditor of a multi – State Co-operative Society shall have a right of access at all times to the books, accounts and vouchers of the Multi-State Co-operative Society whether kept at the head office of the Multi-State Cooperative Society or elsewhere and shall be entitled to require from the officers or other employees of the Multi-State Co-operative Society such information and explanation as the auditor may think necessary for the performance of the duties as an auditor. As per section 73 (2) the auditor shall make the following inquiries:

PRIME A

CADEMY

PRIME/43rd /FINAL 13

(i) Whether loans and advances made by the Multi-State Co-operative Society on the basis of security have been properly secured and whether the terms on which they have been made are not prejudicial to the interests of the Multi-State Co-operative or its members; (ii) Whether transactions of the Multi-State Co-operative Society which are represented merely by book entries are not prejudicial to the interest of the Multi-State Co-operative Society; (iii) Whether personal expenses have been charged to revenue account; and (iv) Where it is stated in the books and papers of the Multi-State Co-operative Society that any shares have been allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading.

b) SRS 4410 “Engagements to Compile Financial Information”: The objective of a compilation engagement is to use accounting expertise, as opposed to auditing expertise, to collect, classify and summarise financial information. This ordinarily entails reducing detailed data to a manageable and understandable form without the requirement to test the assertions underlying that information. The procedures employed are not designed and do not enable the member to express any opinion on the financial information. Therefore, it is essential that the member clearly brings out the nature of association with the financial statement and the nature of the work performed by him. The following may be noted in this regard- (i) The title of the report should be “Accountant’s Report on Unaudited Financial Statement and not An Auditor’s Report”. (ii) The report should be addressed to the appointing authority. (iii) The report should identify the financial information compiled, also stating that it is based on the information provided by the management. (iv) The report should clearly state that the financial statements are not audited. (v) In describing the engagement, ambiguous terms such as review, general review, check, etc. should not be based. (vi) Date of the report should be mentioned. (vii) Name and address of the firm of the member appointed for carrying out the compilation engagement should be mentioned. (viii) Signature and the designation (sole proprietor/ partner) and membership number should appear in the report. c.Classification of Frauds by NBFC: In order to have uniformity in reporting, frauds have been classified as under - (i) Misappropriation and criminal breach of trust. (ii) Fraudulent encashment through forged instruments, manipulation of books of account or through fictitious accounts and conversion of property. (iii) Unauthorised credit facilities extended for reward or for illegal gratification. (iv) Negligence and cash shortages. (v) Cheating and forgery. (vi) Irregularities in foreign exchange transactions. (vii) Any other type of fraud not coming under the specific heads as above. Cases of ‘negligence and cash shortages’ and ‘irregularities in foreign exchange transactions’ referred to in items (iv) and (v) above are to be reported as fraud if the intention to cheat/ defraud is suspected/ proved. However, the following cases where fraudulent intention is not suspected/ proved, at the time of detection, will be treated as fraud and reported accordingly: (i) cases of cash shortages more than ` 10,000/- and (ii) cases of cash shortages more than ̀ 5000/- if detected by management/ auditor/ inspecting officer and not reported on the occurrence by the persons handling cash.

PRIME A

CADEMY

PRIME/43rd /FINAL 14

NBFCs having overseas branches/offices should report all frauds perpetrated at such branches/offices also to the Reserve Bank as per the prescribed format and procedures. d.Scope of peer review: The Statement on Peer Review lays down the scope of review to be conducted as under: The Peer Review process shall apply to all the assurance services provided by a Practice Unit. 1. Once a Practice Unit is selected for Review, its assurance engagement records pertaining to the Peer Review Period shall be subjected to Review. 2. The Review shall cover: (i) Compliance with Technical, Professional and Ethical Standards: (ii) Quality of reporting. (iii) Systems and procedures for carrying out assurance services. (iv) Training programmes for staff (including articled and audit assistants) concerned with assurance functions, including availability of appropriate infrastructure. (v) Compliance with directions and/or guidelines issued by the Council to the Members, including Fees to be charged, Number of audits undertaken, register for Assurance Engagements conducted during the year and such other related records. (vi) Compliance with directions and/or guidelines issued by the Council in relation to article assistants and/or audit assistants, including attendance register, work diaries, stipend payments, and such other related records. e.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.

PRIME A

CADEMY

PRIME/43rd /FINAL 1

THE SOCIETY OF AUDITORS AND PRIME ACADEMY MODEL EXAM – FINAL - SEP 2016

PAPER 4 CORPORATE AND ALLIED LAWS No. of Questions: 7 Total Marks: 100 No. of Pages: 3 Time Allowed: 3 hrs

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

1. a) ABC Company Limited suffered loss 2014-2015. In the second quarter of the profits. In order to

maintain credibility declare an interim dividend at the rate of The Managing Director of the company regarding the dividend declared, the final Financial year ending 31st March in the first quarter of the financial year company has earned large amount of of the company, the Board of Directors 25 % on the paid up equity share capital. gives the Board the following information dividend in the previous 4 years:: 2011

15%

2012

15%

2013

15%

2014 30% The Board of directors further decided not to transfer any amount of the profits to General Reserve for the financial year ended 31st March, 2015. Examine the provisions of the Companies Act, 2013, decide:

i) The validity of the Board’s declaration of 25% interim dividend as stated above. ii) The validity of the Board’s decision not to transfer any amount of profits to general reserve.

(6 Marks) b) SEBI received complaints from some investors alleging that X Ltd. and some brokers are indulging in

price manipulation in the shares of X Ltd. Explain the powers that can be exercised by SEBI under the Securities and Exchange Board of India Act, 1992 ¡n case the allegations are found to be correct. (4 Marks)

c) Honest Limited appointed Mr. Raman as its auditor ¡n the Annual General Meeting held on 30th September, 2016. Initially, he accepted the appointment. But he resigned from his office on 31st October, 2016 for personal reasons. The Board of directors seeks your advice for filling up the vacancy by appointment of Mr. Pinto as auditor. Advise as per the provisions of the Companies Act, 2013. Also suggest the procedure to be adopted in case Mr. Pinto is proposed to be removed from his office before the expiry of his term. (6 Marks)

d) X Ltd. is holding 30% of the paid up equity capital of XYZ Stock Exchange. The company appoints M Ltd.

as its proxy who is not a member of the XYZ Stock Exchange, to attend and vote at the meeting of the stock exchange. Examine whether the XYZ Stock Exchange can restrict the appointment of M Ltd. as proxy for X Ltd. and further restrict, the voting rights of X Ltd. in the XYZ Stock Exchange. (4 Marks)

PRIME A

CADEMY

PRIME/43rd /FINAL 2

2. a) On a reference made by the Central Government, the Company Law Board passed an order

authorizing the Central Government to appoint its nominees as directors of Bangalore Computers Ltd., to safeguard the interest of shareholders and public interest. Referring to the provisions of the Companies Act, 2013 state the restrictions, if any, on the number of directors and the period for which such appointment may be made. State also the action that may be taken by the Central Government with regard to the affairs of the company when such appointment of directors is made by the Central Government. (5 Marks)

b) What are the conditions to be fulfilled for calling meetings at shorter notice than as prescribed by Companies Act, 2013. One of the directors, a senior professional, objected to receiving the notice by e-mail. Advise him. (5 Marks)

c) State the conditions when prospectus of the companies incorporated outside India may be issued by the person. State the documents that shall be annexed to the prospectus. (6 Marks)

3. a) A scheme of merger of DJA Company Limited with MRN Company Limited was approved by the

shareholders at an extraordinary general meeting and the exchange ratio of 3 shares of MRN Company Limited for 20 shares in DJA Company Limited was approved. The proposal was also okayed by a lending financial institution which held 45% shares in DJA Company Limited. The valuation was carried out by one of the directors of DJA Company Limited, who was also a senior member of the Institute of Chartered Accountants of India. The valuation was affirmed by three independent valuers nominated by the shareholders in general meeting. However, certain leasehold properties, under license, which were not transferable, were not taken into accent in the valuation While the scheme was awaiting the Court’s sanction, it was challenged by certain shareholders on the ground that the exclusion of leasehold assets in the valuation, made the scheme Unfair’. Decide giving reasons under the Companies Act, 1956:

i) Whether the contention of the shareholders is tenable? ii) What factors would the court take into account in approving the exchange ratio?

(8 Marks) b) X Limited merged with Y Limited on account of amalgamation. Some workers of X Limited refused to

join as workers of Y Limited and claimed compensation on the ground of premature termination of their services. Y Limited resists the claim of the workers on the ground that their services have been transferred to Y Limited in view of the order of amalgamation and merger and hence the workers must join the service of Y Limited and cannot claim any compensation.

State the powers of the court about the matters that would be considered while sanctioning the scheme of amalgamation under the provisions of the Companies Act, 1956. Decide whether the contention of the workers is justified. (8 Marks)

4. a)

i) R Ltd. wants to constitute an Audit Committee. Draft a board resolution covering the following matters [compliance with Companies Act, 2013 to be ensured]. (1) Member of the Audit Committee (2) Chairman of the Audit Committee (3) Any 2 functions of the said Committee

ii) What would be the minimum likely turnover or capital of this company? iii) What is the role of the Audit Committee vis a vis the statutory auditor when the company wishes

to engage them to perform certain engagements not restricted under Section 144? (8 Marks)

PRIME A

CADEMY

PRIME/43rd /FINAL 3

b) Elaborate the provisions of the Companies Act, 2013 regarding Notice of Board Meeting. Draft a notice for the first meeting of the Board of Directors of India Timber Ltd. (8 Marks)

5. a) Mr.genius has been arrested for a cognizable and non-bailable offence punishable for a term of

imprisonment for more than three years under the Prevention of Money Laundering Act, 2002. Advise, as to how can he be released on bail in this case? (8 Marks)

b) The coconut producers ¡n Tirunelveli (Tam/I Nadu) have formed an association to control the production of coconuts. Referring to the provisions of the Competition Act, 2002, examine whether the said association to control the production ot coconuts shall fall within the jurisdiction of the term ‘Cartel’ under the provisions of the said Act. (8 Marks)

6. a) “Money Laundering” does not mean just siphoning of fund.” Comment on this statement explaining

the significance and aim of the Prevention of Money Laundering Act, 2002. (4 Marks) b) A Producer Company has received applications from Mr. R, a Director of the Company, and Mr. P, a

member of the Company, for grant of loan of ` 2,00,000 and ` 25,000 respectively. Discuss the relevant provision of the Companies Act, 1956 as to how the applications for grant of loan will be disposed of by the Company. (6 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 Company Law Board for relief against oppression and mismanagement? Give your answer according to the provisions of the Companies Act, 1956. (6 Marks)

7. Answer any four a) Some changes ¡n 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)

b) It is apprehended by the Directors of a Public Company that they are likely to be prosecuted for an

offence under the Companies Act, 2013 which is not compoundable. Explain the provisions of the Companies Act, 2013 under which the Directors can seek relief from the liability for offence. What will be the position in case prosecution has already been launched? (4 Marks)

c) How will you interpret the definitions in a statute, it the following words are used in a statute?

(i) Means, (ii) Includes (4 Marks) d) What do you understand by ‘public interest’? Explain, giving suitable examples, about its relevance

under the Companies Act, 1956. (4 Marks) e) Bharat Insurance Company issued a policy having sum assured of ` 5 Iakhs on the life of Ms. Nirmala.

While obtaining education loan of 4 lakh for higher studies, Ms. Nirmala assigned the above insurance policy ¡n favour of the Bank providing the loan. Who, in this case, will be called the ‘policy holder’ under the Insurance Act, 1938 and why? Explain. (4 Marks)

PRIME A

CADEMY

PRIME/43rd /FINAL 1

THE SOCIETY OF AUDITORS AND PRIME ACADEMY

43rd SESSION MODEL EXAM – FINAL – CORPORATE AND ALLIED LAWS SUGGESTED ANSWERS

1. (a) According to section 123(3), the Board of Directors of a company may declare interim dividend during

any financial year out of the surplus in the profit and loss account and out of profits of the financial year in which such interim dividend is sought to be declared. However, in case the company has incurred loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, such interim dividend shall not be declared at a rate higher than the average dividends declared by the company during the immediately preceding three financial years. The Board of directors may declare interim dividend and the amount of dividend including interim dividend, shall be deposited in a separate bank account within five days from the date of declaration of such dividend. Transfer to reserves: A company may, before the declaration of any dividend in any financial year, transfer such percentage of its profits for that financial year as it may consider appropriate to the reserves of the company. Therefore, the company may transfer such percentage of profit to reserves before declaration of dividend as it may consider necessary. Such transfer is not mandatory and the percentage to be transferred to reserves is to be decided at the discretion of the company. Taking into account the above provisions, the sub-sections as asked can be answered as under: (i) The declaration of Interim dividend at the rate of 25% is violative of the provisions of the Act and

therefore, invalid for the reasons that the rate of dividend so declared is in excess of the average profits of the preceding three years, which is 20%. The interim dividend proposed to be declared should not be more than 20%.

(ii) Regarding transfer of profits to general reserve, since it is at the discretion of the company to transfer certain profits to reserves or not, it is not mandatory for the company to transfer any amount to profits to reserve. Therefore, Board’s decision not to transfer of profits to reserves is quite valid.

(b) Price manipulation in the shares of X Ltd. can be considered as fraudulent and unfair trade practices

relating to securities market. In this case SEBI may exercise the following powers under section 11(4) of securities and Exchange Board of India Act, 1992. (i) Suspend the trading of any security (in this case the securities of X Ltd.) in a recognized stock exchange. (ii) Restrain persons (in this case X Ltd.) from accessing the securities market. It can also prohibit any person associated with securities market (i.e. brokers who have indulged in price manipulation) to buy, sell or deal in securities market. SEBI may issue the above orders for reasons to be recorded in wring. SEBI shall, either before or after passing such orders give an opportunity of hearing to company and brokers concerned [proviso 2 to Secon 11(4)1 SEBI may also appoint an adjudica6ng officer who may levy penalty under section 15 HA after holding an enquiry in the prescribed manner. According to section 15HA if any person indulges in fraudulent and unfair trade practices relating to securities, he shall be levied to a penalty which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of such practices, whichever is higher.

(c) Under section 139(8) of the Companies Act, 2013, any casual vacancy in the office of an auditor shall in the case of a company other than a company wbose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India, be filled by the Board of Directors within thirty days, but if such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be approved by the company at a general meeting convened within three months of the recommendation of the Board and he shall hold the office till the conclusion of the next annual general meeting.

PRIME A

CADEMY

PRIME/43rd /FINAL 2

Therefore, in the present case, as the auditor has resigned, the casual vacancy so created can be filled up by the Board appointing Mr. Pinto. However, the appointment of Mr. Pinto must be approved by the company by passing of an ordinary resolution at a general meeting of the company which must be convened by the Board within 3 months of the recommendation of the Board. Mr. Pinto will be entitled to hold office till the conclusion of the next Annual General Meeting. Under section 140(1) of the Companies Act, 2013, the auditor appointed under section 139 may be removed from his office before the expiry of his term only by a special resolution of the company, after obtaining the previous approval of the Central Government in that behalf in the prescribed manner: Provided that before taking any action under this sub-section, the auditor concerned shall be given a reasonable opportunity of being heard. Therefore, in terms of section 140 (1) of the Companies Act, 2013 read with rule 7 of the Companies (Audit & Auditors) Rules, 2014. the following steps should be taken for the removal of an auditor before the completion of his term: 1. The application to the Central Government for removal of auditor shall made in Form ADT-2 and shall be accompanied with fees as provided for this purpose under the Companies (Registration Offices and Fees) Rules. 2014 2. The application shall be made to the Central Government within thirty days of the resolution passed by the Board. 3. The company shall hold the general meeting within sixty days of receipt of approval of the Central Government for passing the special resolution.

(d) Section 7(a) of the Securities (Contracts) Regulation Act, 1956 provides that a recognised stock exchange is empowered to amend rules to provide for all or any of the following matters: (a) Restriction of voting right to members only. (b) Regulation of voting rights by specifying that each member is entitled to one vote only irrespective of number of shares held. (c) Restriction on right of members to appoint proxy. As such XYZ Stock Exchange can restrict the appointment of M Ltd., as proxy, if rules of the exchange so provide. If it is not so provided, rules may be amended and after getting approval of the Central Government regarding amendment, it can restrict appointment of proxies. XYZ Stock Exchange can also restrict the voting rights of X Ltd. if rules of the exchange so provide. If it is not so provided, rules maybe amended and after getting approval of Central Government regarding amendment, it can restrict the voting rights of X Ltd.

2. (a) Power of the Central Government to safeguard the interest of shareholders and public interest: The

Central Government ¡s empowered to appoint its nominees as directors of a company to effectively safeguard the interest of the company or its shareholders or the public ¡nterest. If the Central Government wants to appoint its nominees as Directors of such a company then it has to make a reference to the Company Law Board (CLB) and ¡f the CLB ¡s satisfied that the affairs of the company have been conducted in a manner oppressive to any member of the company or ¡n a manner prejudicial to the ¡nterests of the company or to public interest, it may pass an order asking the Central Government to appoint directors for a period not exceeding three years on any one occasion. There is no limit as to the number of directors that can be appointed. The Central Government may appoint such number of persons as the Company Law Board may, by order in writing, specify but such directors tenure shall not exceed three years at one time as it may think fit.

PRIME A

CADEMY

PRIME/43rd /FINAL 3

Notwithstanding anything contained in the Companies Act or in any other law for the time being ¡n force, where any person is appointed by the Central Government to hold office as director or additional director, Section 408 (6) of the Companies Act, 1956, empowers the Central Government to issue such directions to the company as it may consider appropriate in regard to its affairs. Such directions may include directions to remove an auditor already appointed and to appoint another auditor in his place or to alter the articles of the company. When such directions are given, the appointment, removal or alteration, as the case may be shall be deemed to have come into effect as if the provisions of the Companies Act in this behalf have been complied without requiring any further act or thing to be done. Though these powers are substantial, yet the same do not empower the Central Government to interfere in the day to day management of the company. Further, Section 408(7) empowers the Central Government to require the persons appointed as directors to report to the Central Government from time to time with regard to affairs of the company.

(b) NOTICE OF THE BOARD MEETING & CONDITION TO CALL MEETING AT SHORTER NOTICE - In terms of the proviso to Section 173(3) of the Companies Act, 2013 a meeting of the Board may be called at shorter notice to transact urgent business subject to the condition that at least one independent director, if any, shall be present at the meeting. No exception is made for any class or classes of companies. Under Section 173 (3) a meeting of the Board shall be called by giving not less than 7 days notice in writing to every director at his address registered with the company and such notice shall be sent by hand delivery or by post or by electronic means. Hence the senior Director’s objections to receiving the notice by email is not sustainable.

(c) Registration of prospectus (Section 389 of the Companies Act, 2013): According to this section, no person shall issue, circulate or distribute in India any prospectus offering for subscription in securities of a company incorporated or to be incorporated outside India, whether the company has or has not established, or when formed will or will not establish, a place of business in India, unless before the issue, circulation or distribution of the prospectus in India, a copy thereof certified by the chairperson of the company and two other directors of the company as having been approved by resolution of the managing body has been delivered for registration to the Registrar and the prospectus states on the face of it that a copy has been so delivered, and there is endorsed on or attached to the copy, any consent to the issue of the prospectus required by section 388 and such documents as may be prescribed. According to the Companies (Registration of Foreign Companies) Rules, 2014, the following documents shall be annexed to the prospectus, namely: (a) any consent to the issue of the prospectus required from any person as an expert; (b) a copy of contracts for appointment of managing director or manager and in case of a contract not reduced into writing, a memorandum giving full particulars thereof; (c) a copy of any other material contracts, not entered in the ordinary course of business, but entered within preceding 2 years: (d) a copy of underwriting agreement and (e) a copy of power of attorney, ¡f prospectus is signed through duly authorized agent of directors.

3. (a) Merger and Scheme of Valuation:

(i) The contention of the shareholders in this case shall not be tenable. The court is not to disturb a scheme unless the person who challenges the valuation satisfies the court that the valuation arrived at was grossly unfair. Valuation in this case was approved by the shareholders and also okayed by the lending institution(s) which are usually well-informed and scrutinize the scheme with expert’s eye and which are also presumed to act bonafide. In the similar case of Tala Oil Mills Ltd. Re (1994), the court held that the presumption of fairness was writ large on the face of the Scheme. The Court did not attach importance to the fact that certain leasehold assets and properties held under license were excluded from valuation. Such assets, the court said, were neither transferable nor heritable. They are in the nature of a personal privilege. The Supreme Court affirmed this decision in Hindustan Lever Employees

PRIME A

CADEMY

PRIME/43rd /FINAL 4

Union y, Hindustan Lever Ltd., (1994) and accepted the exchange ratio proposed. The Supreme Court found no objection to the valuation being done by one of the directors of TOMCO (DJA Co. in this case). His report did not show any prejudice and was also affirmed by the independent valuers. Supreme Court also enumerated all the possible methods of valuation such as, market price, book value and yield basis and pointed out that a combination of all or some of the methods, may have to be adopted in circumstances of a particular case Thus based on the above explanation and the decisions given by the Supreme Court it can be concluded that the contention of the shareholders that the exclusion of certain Lease hold assets in the valuation has made the scheme unfair, shall not be tenable. (ii) The court would take into account the following factors in determining the final share exchange ratio: 1. The stock exchange prices of the shares of the two companies before the commencement of negotiations cc the announcement of the bid. 2. The dividends presently paid on the shares of the two companies. 3. The relative growth prospects of the two companies. 4. The cover for the present dividends of the two companies. 5. The relative gearing of the shares of the two companies. 6. The values of the net assets of the two companies. 7. The voting strength in the merged enterprise of the shareholders of the two companies. 8. The past history of the prices of the shares of the companies.

b) While sanctioning the scheme of amalgamation, the Court under section 394 of the Companies Act, 1956 may make provision for all or any of the following matters: (j) The transfer to the transferee company of the whole or any part of the undertaking, property or liabilities of the transferor company. (ii) The allotment by the transferee company of any shares, debenture etc, in that company which under the scheme are to be allotted by that company to any person. (iii) The continuation of any legal proceedings by or against any transferor and transferee company. (iv) The dissolution, without winding up of any transferor company. (v) The provisions to be made for any persons who within such time and in such manner as the court directs, dissent from the scheme of amalgamation. (vi) Such incidental matters as are necessary to secure that the amalgamation shall be fully and effectively carried out. An order under section 394 of the Companies Act, 1956 transferring the property, rights and liabilities of one company to another does not automatically transfer contracts of personal service which are in their nature incapable of being transferred and no contract of service is thereby created between an employee of the transferor company on the one hand and the transferee company on the other. In Nakes vs. Doucaster Amalgamated collieries Ltd. ¡1940 (3) all 2k 549] the House of Lords clearly stated that the workers are not furniture and their services can not be transferred without their consent. Thus the contention of the workers of X Company Limited against the Y Limited is correct and justified.

4. (a)

(j) AUDIT COMMITTEE - BOARD’S RESOLUTION: “Resolved that pursuant to Section 177 of the Companies Act. 2013 an Audit Committee consisting of the following Directors be and is hereby constituted. 1. Mr. ---- Independent Director 2. Mr. ---- Independent Director 3. Mr. ---- Independent Director 4. Mr. ---- Independent Director 5. Mr. ---- Managing Director. 6. Mr. ---- Chief Financial Officer” ‘Further resolved that the Chairman of the Audit Committee shall be elected by its members from amongst themselves and shall be an independent director’.

PRIME A

CADEMY

PRIME/43rd /FINAL 5

“Further resolved that the quorum for a meeting of the Audit committee shall be three directors (other than the Managing Director), out of which at least two must be independent directors”. ‘ResoIved further that the Audit Committee shall perform all the functions as laid down in section 177(4) of the Companies Act. 2013 including but not limited to: a. make the recommendation for appointment, remuneration and terms of appointment of the auditors of the company; b. review and monitor the independence and performance of auditors of the company and the effectiveness of the audit process”. Further resolved that the Audit Committee shall review the quarterly and annual financial statements and submit the same to the Board with its recommendations if any”.

(b) Notice of Board Meeting: Notice of Board Meeting is required pursuant to Section 173(3) of the Companies Act, 2013. According to this section, a meeting of the Board shall be called by giving not less than seven days’ notice in writing to every director at his address registered with the company and such notice shall be sent by hand delivery or by post or by electronic means. Further, a meeting of the Board may be called at shorter notice to transact urgent business subject to the condition that at least one independent director, if any, shall be present at the meeting. In case of absence of independent directors from such a meeting of the Board, decisions taken at such a meeting shall be circulated to all the directors and shall be final only on ratification thereof by at least one independent director, if any. The Companies (Meetings of Board and its Powers) Rules, 2014, further provides that the notice of the meeting shall inform the directors regarding the option available to them to participate through video conferencing mode or other audio visual means, and shall provide all the necessary information to enable the directors to participate through video conferencing mode or other audio visual means. On receiving such a notice, a director intending to participate through video conferencing or audio visual means shall communicate his ¡ntention to the Chairperson or the company secretary of the company. He shall give prior intimation to the effect sufficiently in advance so that the company is able to make suitable arrangements in this behalf. If the director does not give any intimation of his intention to participate that he wants to participate through the electronic mode, it shall be assumed that the director shall attend the meeting in person. As per section 173(4) of the Companies Act, 2013, every officer of the company whose duty is to give notice under this section and who fails to do so shall be liable to a penalty of 25,000. Draft Notice India Timber Limited Address: ___________ Dated______________ Mr.____________ Address: _____________________ (each director to be addressed individually) Dear Sir, Notice is hereby given that first meeting of the Board of Directors will be held at the registered office of the company at (address) place) on (day), the (date) at AM/PM.

PRIME A

CADEMY

PRIME/43rd /FINAL 6

You are requested to make it convenient to attend the meeting. An option is also available to you to participate in the Board Meeting through video conferencing or audio visual means. Kindly communicate your preference in this regard.

A copy of the agenda of the meeting is enclosed for your perusal.

Yours faithfully,

For India Timber Ltd.

(Secretary)

End: A copy of agenda of the meeting.

5. (a) Section 45 of the Prevention of Money Laundering Act, 2002, provides that the offences under the Act

shall be cognizable and non-bailable. Notwithstanding anything contained in the Code of Criminal Procedure, 1973, no person accused of an offence punishable for a term of imprisonment of more than three years under Part A of the Schedule shall be released on bail or on his own bond unless- 1. The Public Prosecutor has been given an opportunity to oppose the application for such release and 2. Where the Public Prosecutor opposes the application, the court is satisfied that there are reasonable grounds for believing that he is not guilty of such offence and that he is not likely to commit any offence while on bail. In case of any person who is under the age of 16 years or in case of a woman or in case of a sick or infirm person, the Special Court can direct the release of such person on bail.

(b) In accordance with the Provisions of Section 2(c) of the Competition Act, 2002, the term ‘CarteF includes an association of producers. sellers, distributors, traders or service providers who, by agreement among themselves, limit, control or attempt to control the production, distribution, sale or price of or trade in goods or provision of services. The term ‘cartel’ has an inclusive meaning. Thus, an association formed to control the production of coconuts is within the aforesaid definition of a cartel. Hence. The association of coconut producers in Tirunelveli in the given case will be considered as a cartel under the provisions of the Act.

6. (a)“Money laundering” does not mean just siphoning of fund: Money Laundering is a moving of illegally

acquired cash through financial systems so that it appears to be legally acquired. Thus, money laundering is not just the siphoning of fund but it is the conversion of money which is illegally obtained. Prevention of Money Laundering Act, 2002 has been enacted with aim for combating channellising of money into illegal activities. Significance and Aim of Prevention of Money Laundering Act, 2002: The preamble to the Act provides that it aims to prevent money—laundering and to provide for confiscation of property derived from, or involved in, money— laundering and for matters connected therewith or incidental thereto. In order to further strengthen the existing legal framework and to effectively combat money laundering, terror financing and cross-border economic offences, an Amendment Act, 2009 was passed. The new law seeks to check use of black money for financing terror activities. Financial intermediaries like full-fledged money changers, money transfer service providers and credit card operators have also been brought under the ambit of the Prevention of Money- Laundering Act. Consequently, these intermedianes, as also casinos, have been brought under the reporting regime of the enforcement authorities. It also checks the misuse of promissory flotes by Fils, who would now be required to furnish all details of their source. The new law would check misuse of proceeds of crime’ be it from sale of banned narcotic substances or breach of the Unlawful Activities (Prevention) Act The passage of the Prevention of Money Laundering

PRIME A

CADEMY

PRIME/43rd /FINAL 7

(Amendment), 2009 have enabled India’s entry into Financial Action Task Force (FATF), an inter-9overnmental body that has the mandate to combat money laundering and terrorist financing.

(b)Under Section 581ZK of the Companies Act, 1956, the Board of the Producer Company may, subject to the provision in the Articles of Association, provide financial assistance by way of loan and advances against such security as may be specified in its Articles of Association to any member repayable within a period exceeding three months but not exceeding seven years from the date of disbursement of such loan or advances. In the instant case, member has applied for loan of Rs. 25,000. The period is not specified in the question. The Company may grant the member a loan of Rs. 25,000 against such security and at such rate of interest as may be specified in the Articles. However, in the case of a director, loan of Rs. 2 Iakh can be granted only after its approval by the members in general meeting.

(c)Under section 399(1)(a) of the Companies Act, 1956, in the case of a company having share capital, the following member(s) have the right to apply to the Company Law Board under section 397 or 398: 1. Not less than loo members of the company or not less than one-tenth of the total number of members, whichever is less; or 2. 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 (1) above, 10% of 8 i.e. 1 satisfies the condition. Therefore a single member can present a petition to the Company Law Board (CLB), regardless of the fact that he holds less then one-tenth of the company’s share capital.

7. (a) 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 :- A. 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; B. the form shall be digitally signed by a Chartered Accountant in practice or a Company Secretary in practice or a Cost Accountant in practice; C. the applicant shall submit the Form DIR-6.

(b)Relief under Section 463: Under section 463(1) of the Companies Act. 2013 if in any proceeding for negligence, default, breach of duty, misfeasance or breach of trust against an officer of a company, it appears to the court hearing the case he is or may be liable in respect of the negligence, default, breach of duty, misfeasance or breach of trust, but that he has acted honestly and reasonably, and that having regard to all the circumstances of the case, including those connected with his appointment, he ought fairly to be excused, the court may relieve him, either wholly or partly, from his liability on such terms, as it may think fit Provided that in a criminal proceeding under this sub-section, the court shall have no power to grant relief from any civil liability which may attach to an officer ¡n respect of such negligence, default, breach of duty, misfeasance or breach of trust. In the given case, the offence is not compoundable i.e. it carries imprisonment as a punishment either alone or with a fine. In either case, it would indicate that a criminal liability is indicated. Hence, the court will not have the power to grant relief under section 463. However, the nature of the offence will have to be examined.

PRIME A

CADEMY

PRIME/43rd /FINAL 8

(c) Interpretation of the words “Means” and “Includes” in the definitions- The definition of a word or expression in the definition section may either be restricting of its ordinary meaning or may be extensive of the same. When a word is defined to ‘mean’ such and such, the definition is ‘prima facie’ restrictive and exhaustive, we must restrict the meaning of the word to that given in the definition section. But where the word is defined to ‘include’ such and such, the definition is ‘prima facie’ extensive, here the word defined is not restricted to the meaning assigned to it but has extensive meaning which also includes the meaning assigned to it in the definition section. Example- Definition of Director (section 2(34) of the Companies Act, 2013]- Director means a director appointed to the board of a company. The word “means” suggests exhaustive definition. Definition of Whole time director [Section 2(94) of the Companies Act, 2013]- Whole time director includes a director in the whole time employment of the company. The word “includes” suggests extensive definition. Other directors may be included in the category of the whole time director.

(d) The expression ‘public interest’ implies general welfare of the society. Whatever furthers the general interest of the community is to be considered as ‘public interest. It pervades interest of the general public ¡n matters where regard for the social good is of prime importance. A thing is said to be in public interest where it is or can be made to appear to be contributive to the general welfare, rather than to the special privileges of a class, group or individual. A company is treated as a legal person, hence, public interest has been taken care of in the company law. The following provisions of the Companies Act. 1956 convey the relevance of the concept of public interest in the context of company law — (i) Section 396 empowers the Central Government to provide for compulsory amalgamation of companies into a single company in the public interest. (ii) Section 250 (3) and (4) impose restrictions on share transfer where as a result thereof a change in the composition of the Board of Directors is likely to take place. (iii) Under section 397 and 398, shareholders can file application to Company Law Board (NCLT) where affairs of the company are conducted in a manner prejudicial to public interest. (iv) Under Section 408, the Central Government is empowered to appoint directors to safeguard public interest. (v) Under Section 394. the Court is empowered to refuse its sanction to any compromise or arrangement, considering public interest.

(e) As per section 2(2) of the Insurance Act. 1938, ‘Policy holder’ includes a person to whom the whole of the interest of policy holder in the policy is assigned once and for all, but does not include an assignee thereof whose interest in the policy is defeasible or is for the time being subject to any condition. As per the given facts, Ms. Nirmata assigned insurance policy in favour of Bank. As of consequence, Bank becomes assignee. According to the above given definition of policy holder, assignee is excluded from its preview. Thus, in the given case. Ms. Nirmala will be the Policy holder.