sa ipcc group-ii nov. 2009

Volume 1Volume 1IPCE, Group II, November, 2009

Board of StudiesThe Institute of Chartered Accountants of IndiaA-94/4, Sector-58, Noida- 201 301Phone : 0120 - 3045900Fax : 0120 - 3045940E-mail : [email protected] : http://www.icai.org

ISBN: 978-81-8441-329-8

March / 2010

November, 2009

Integrated ProfessionalCompetence Examination Group II

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(Set up by an Act of Parliament)

Board of Studies

New Delhi

SUGGESTED ANSWERS TO QUESTIONS SET AT THE

INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION GROUP II

NOVEMBER, 2009

BOARD OF STUDIES

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA (Set up by an Act of Parliament)

The suggested Answers published in this volume do not constitute the basis for evaluation of the students answers in the examination. The answers are prepared by the Faculty of the Board of Studies with a view to assist the students in their education. While due care is taken in preparation of the answers, if any errors or omissions are noticed, the same may be brought to the attention of the Director of Studies. The Council of the Institute is not in anyway responsible for the correctness or otherwise of the answers published herein. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior permission, in writing, form the publisher. Website : www.icai.org Department/Committee : Board of Studies E-mail : [email protected] Price : Rs.40/- ISBN No. : 978-81-8441-329-8 Published by : The Publication Department on behalf of The Institute of Chartered

Accountants of India, ICAI Bhawan, Post Box No. 7100, Indraprastha Marg, New Delhi- 110 002, India

Typeset and designed at Board of Studies. Printed by : Sahitya Bhawan Publications, Hospital Road, Agra 282 003 March / 2010 / 10,000 Copies

Contents

Page Nos.

Paper 5. Advanced Accounting ...................................................................................1 24 Paper 6. Auditing and Assurance ..............................................................................25 38 Paper 7. Information Technology and Strategic Management...................................39 56

Summary of Examiners comments on the performance of the candidates

PAPER 5 : ADVANCED ACCOUNTING All questions are compulsory

Working notes should form part of the answer. Wherever necessary, suitable assumption(s) may be made and disclosed by the candidates.

Question 1

Answer the following questions:

(i) Goods worth Rs. 5,00,000 were destroyed due to flood in September, 2006. A claim was lodged with insurance company. But no entry was passed in the books for insurance claim in the financial year 2006-07.

In March, 2008, the claim was passed and the company received a payment of Rs.3,50,000 against the claim. Explain the treatment of such receipt in final accounts for the year ended 31st March, 2008.

(ii) Briefly indicate the items which are included in the expressions Borrowing Cost as per AS 16.

(iii) Sterling Ltd. purchased a plant for US $ 20,000 on 31st December, 07 payable after 4 months. The company entered into a forward contract for 4 months @ Rs. 48.85 per dollar. On 31st December, 07, the exchange rate was Rs. 47.50 per dollar.

How will you recognize the profit or loss on forward contract in the books of Sterling Limited for the year ended 31st March, 2008.

(iv) A company created a provision of Rs. 75,000 for staff welfare while preparing the financial statements for the year 2007-08. On 31st March, in a meeting with staff welfare association, it was decided to increase the amount of provision for staff welfare to Rs. 1,00,000. The accounts were approved by Board of Directors on 15th April, 2008.

Explain the treatment of such revision in financial statements for the year ended 31st March, 2008.

(v) Explain Employees stock option plan.

(vi) A company entered into an agreement to sell its immovable property to another company for 35 lakhs. The property was shown in the Balance Sheet at Rs.7 lakhs. The agreement to sell was concluded on 15th February, 2008 and sale deed was registered on 30th April, 2008. The financial statements for the year 2007-08 were approved by the board on 12th May,2008.

You are required to state, how this transaction would be dealt with in the financial statements for the year ended 31st March, 2008.

INTEGRATED PROFESSIONAL COMPETENCE EXAMINATION: NOVEMBER, 2009

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(vii) A Ltd. entered into a binding contract with C Ltd. to buy a machine for Rs. 1,00,000. The machine is to be delivered on 15th February, 2009. On 1st January, 2009, A Ltd. changed its process of production. The new process will not require the machine ordered and it shall have to be scrapped after delivery. The expected scrap value of the machine is nil.

Explain how A Ltd. should recognise the entire transaction in the books of account for the year ended 31st March, 2009.

(viii) Goods are transferred from Department P to Department Q at a price 50% above cost.

If closing stock of Department Q is Rs. 27,000, compute the amount of stock reserve.

(ix) X Ltd. received a revenue grant of Rs.10 crores during 2006-07 from Government for welfare activities to be carried on by the company for its employees. The grant prescribed the conditions for utilization.

However during the year 2008-09, it was found that the prescribed conditions were not fulfilled and the grant should be refunded to the Government.

State how this matter will have to be dealt with in the financial statements of X Ltd. for the year ended 2008-09.

(x) Conversion of debt into equity is a non-cash transaction. Comment. (10 2 = 20 Marks) Answer (i) As per the provisions, of AS 5 Net Profit or Loss for the Period, Prior Period Items and

Changes in Accounting Policies, prior period items are income or expenses, which arise in the current period as a result of error or omissions in the preparation of financial statements of one or more prior periods. Further, the nature and amount of prior period items should be separately disclosed in the statement of profit and loss.

In the given situation, it is clearly a case of error in preparation of financial statements for the financial year 2006-07. Hence claim received in the financial year 2007-08 is a prior period item and should be separately disclosed in the statement of profit and loss for the year ended 31st March, 2008.

(ii) Borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds. Borrowing cost may include:

(a) Interest and commitment charges on bank borrowings and other short term and long term borrowings.

(b) Amortisation of discounts or premiums relating to borrowings. (c) Amortisation of ancillary costs incurred in connection with the arrangement of

borrowings. (d) Finance charges in respect of assets required under finance leases or under other

similar arrangements; and (e) Exchange differences arising from foreign currency borrowings to the extent that

they are regarded as an adjustment to interest costs.

PAPER 5 : ADVANCED ACCOUNTING

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(iii) Calculation of profit or loss to be recognised in the books of Sterling Limited

Forward contract rate Rs.48.85 Less: Spot rate Rs.47.50 Loss Rs.1.35 Forward Contract Amount $20,000 Total loss on entering into forward contract = ($20,000 Rs.1.35) Rs.27,000 Contract period 4 months Loss for the period 1st January, 2008 to 31st March, 2008 i.e.

3 months falling in the year 2007-2008 will be Rs.27,000 43 =

Rs.20,250

Balance loss of Rs.6,750 (i.e. Rs. 27,000 Rs. 20,250) for the month of April, 2008 will be recognised in the financial year 2008-2009.

(iv) As per AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies, the change in amount of staff welfare provision amounting Rs. 25,000 is neither a prior period item nor an extraordinary item. It is a change in estimate, which has been occurred in the year 2007-2008.

As per the provisions of the standard, normally, all items of income and expense which are recognised in a period are included in the determination of the net profit or loss for the period. This includes extraordinary items and the effects of changes in accounting estimates. However, the effect of such change in accounting estimate should be classified using the same classification in the statement of profit and loss, as was used previously, for the estimate.

(v) Employee Stock Option Plan is a plan in which option is given for a specified period, to employees of a company, which gives such directors, officers or employees the right, but not the obligation, to purchase or subscribe, the shares of the enterprise at a fixed or determinable price.

(vi) According to para 13 of AS 4 Contingencies and Events Occurring after the Balance Sheet Date, assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date.

In the given case, sale of immovable property was carried out before the closure of the books of accounts. This is clearly an event occurring after the balance sheet date but agreement to sell was effected on 15th February 2009 i.e. before the balance sheet date. Registration of the sale deed on 30th April, 2009, simply provides additional information relating to the conditions existing at the balance sheet date. Therefore, adjustment to assets for sale of immovable property is necessary in the financial statements for the year ended 31st March, 2009.


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(vii) A Ltd. entered into a binding contract with C Ltd. and therefore, it should recognise a liability of Rs.1,00,000. The entire amount of purchase price of the machine should be recognised in the year ended 31st March, 2009 as loss because future economic benefit from the machine to the enterprise is improbable.

The accounting entry should be as follows:

Rs. Rs.Profit and Loss A/c Dr. 1,00,000 To C Ltd. 1,00,000(Being value of machinery fully depreciated because of change in the process of production i.e. obsolescence)

(viii) Calculation of Stock Reserve

Rs.Closing stock of Department Q 27,000Goods sent by Department P to Department Q at a price 50% above cost

Hence, profit of Department P included in the stock will be

150

50000,27.Rs 9,000

Amount of stock reserve will be Rs.9,000 (ix) As per para 11 of AS 12 Government Grants, a grant that became refundable should be

treated as an extra-ordinary item as per Accounting Standard 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies. The amount refundable in respect of a government grant related to revenue, is applied first against any unamortised deferred credit remaining in respect of the grant. To the extent that the amount refundable exceeds any such deferred credit, or where no deferred credit exists, the amount is charged immediately to profit and loss statement. Therefore, refund of grant of Rs. 10 crores should be shown in the profit and loss account of the company as an extra-ordinary item during the financial year 2008-09.

(x) Sometimes debenture holders are offered an option to convert their debts into equity by issuing equity share capital. In such transactions, debentures are redeemed by issuing fresh share capital.

Journal Entry will be as follows:

Debentures A/c Dr. To Equity share capital A/c

In the above entry, no cash account is opened. Therefore, one can conclude that the conversion of debt to equity is a non-cash transaction.


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Question 2

Sun Ltd. and Moon Ltd. were amalgamated on and from 1st April, 2009. A new company Star Ltd. was formed to take over the business of the existing companies. The Balance Sheets of Sun Ltd. and Moon Ltd. as at 31st March, 2009 are given below:

(Rs. in lakhs)

Liabilities Sun Ltd. Moon Ltd. Assets

Sun Ltd.

Moon Ltd.

Share capital: Fixed Assets: Equity shares of Rs.100 each

400 375 Land & Building 275 200

12% Preference shares of Rs.100 each

150 100 Plant & Machinery Investments

175 75

12525

Reserves and surplus: Current Assets, Loans and Advances:

Revaluation reserve 75 50 Stock 175 125General reserve 85 75 Sundry Debtors 125 150Investment allowance reserve

25 25 Bills Receivables Cash and Bank balances

25 150

25100

Profit and Loss Account 25 15 Secured loan: 10% Debentures (Rs.100 each)

30 15

Current liabilities and provisions:

Sundry creditors 135 60 Acceptance 75 35 1,000 750 1,000 750Additional information:

(a) Star Ltd. will issue 5 equity shares for each equity share of Sun Ltd. and 4 equity shares for each equity share of Moon Ltd. The shares are to be issued @ Rs. 30 each, having a face value of Rs. 10 per share.

(b) Preference shareholders of the two companies are issued equivalent number of 15% preference shares of Star Ltd. at a price of Rs. 150 per share (face value Rs. 100).

(c) 10% Debentureholders of Sun Ltd. and Moon Ltd. are discharged by Star Ltd., issuing such number of its 15% Debentures of Rs.100 each so as to maintain the same amount of interest.


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(d) Investment allowance reserve is to be maintained for 4 more years.

(e) Liquidation expenses are:

Sun Ltd. Rs.2,00,000

Moon Ltd. Rs.1,00,000

It was decided that these expenses would be borne by Star Ltd.

(f) All the assets and liabilities of Sun Ltd. and Moon Ltd. are taken over at book value.

(g) Authorised equity share capital of Star Ltd. is Rs. 5,00,00,000, divided into equity shares of Rs. 10 each. After issuing required number of shares to the Liquidators of Sun Ltd. and Moon Ltd., Star Ltd. issued balance shares to Public. The issue was fully subscribed.

Required :

Prepare the Balance Sheet of Star Ltd. as at 1st April, 2009 after amalgamation has been carried out on the basis of Amalgamation in the nature of purchase. (16 Marks)

Answer Balance Sheet of Star Ltd. as at 1st April, 2009

(Rs. in Lakhs)Liabilities Amount Assets AmountShare capital: Fixed assets: Authorised share capital Goodwill (10+2+1) 1350,00,000 Equity shares of Rs.10 each 500 Land and building

(275+200) 475

Issued and subscribed Plant and machinery (175+125)

300

50,00,000 Equity shares of Rs.10 each 500 Investment (75+25) 1002,50,000 Preference shares of Rs.100 each

250 Current assets, loans and advances:

(Of the above shares 35,00,000 equity shares and all preference shares are allotted as fully paid up for consideration other than cash)

Stock (175+125) 300

Reserves and surplus: Sundry debtors (125+150) 275Securities premium (75 + 50 + 400 + 300) 825 Cash and bank (250+150-3) 397Investment allowance reserve (25+25) 50 Bills receivables (25+25) 50Secured Loans: Miscellaneous expenditure:


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15% Debentures (20+10) 30 Amalgamation adjustment account

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Unsecured loans: Nil Current liabilities and provisions: Acceptances (75+35) 110 Sundry creditors (135+60) 195 1,960 1,960

Working Notes:

1. Computation of Purchase Consideration Rs. in lakhs Sun Ltd. Moon Ltd. (a) Preference shareholders: 1,50,00,000/100 = 1,50,000 shares Share capital = 1,50,000 shares Rs.100 each 150 Securities premium = 1,50,000 shares Rs.50 each 75 225 1,00,00,000/100 = 1,00,000 shares Share capital = 1,00,000 shares Rs.100 each 100 Securities premium= 1,00,000 shares Rs.50 each 50 150 (b) Equity shareholders: 4,00,00,000/100 5 = 20,00,000 shares Share capital = 20,00,000 shares Rs.10 each 200 Securities premium=20,00,000 shares Rs.20 each 400 600 3,75,00,000/100 4 = 15,00,000 shares Share capital = 15,00,000 shares Rs.10 each 150 Securities premium = 15,00,000 shares Rs.20 each 300 450 Amount of purchase consideration 825 600 2. Calculation of number of debentures issued Rs. in lakhs Sun Ltd. Moon Ltd. 10% Debentures of Rs.100 each 30 15 15% Debentures to be issued to maintain same amount of

interest:

Interest = Rs.30,00,000 x 10% = Rs.3,00,000


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Number of 15% Debentures = 10015

000,00,3.Rs 20 Interest = Rs.15,00,000 x 10% Number of 15% Debentures = 100

15000,50,1.Rs 10

3. Net assets taken over Rs. in lakhs Sun Ltd. Moon Ltd. Assets taken over Land and building 275 200 Plant and machinery 175 125 Investments 75 25 Stock 175 125 Sundry debtors 125 150 Bills receivable 25 25 Cash and bank 150 100 1,000 750 Less: Liabilities taken over Debentures 20 10 Sundry Creditors 135 60 Bills payable 75 35 230 105 Net assets taken over 770 645 Purchase consideration 825 600 (Goodwill)/ Capital Reserve (55) 45 Net goodwill (10) 4. Liquidation expenses of Sun Ltd. and Moon Ltd., Rs.2 lakhs and Rs.1 lakhs respectively

will be debited to Goodwill account in the books of Star Ltd.


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Question 3

The Balance Sheet of Dee Limited on 31st March, 2009 was as follows:

Balance Sheet as at 31st March, 2009

Liabilities Amount Assets Amount Rs. Rs.Share capital: Authorised capital

Fixed assets (at cost less depreciation)

8,00,000

50,000, Equity shares of Rs.10 each 5,00,000

Debenture redemption fund investment 2,00,000

Issued and subscribed capital 25,000 Equity shares of Rs.10 each fully paid up

2,50,000

Cash balance Other current assets

2,50,000 10,00,000

Reserves and surplus: General reserve 2,75,000 Profit and loss A/c 1,00,000 Debenture redemption reserve 2,50,000 Secured loans: 12% Convertible debentures (5,000 Debentures of Rs.100 each)

5,00,000

Other secured loans 2,50,000 Current liabilities and provisions

6,00,000

Proposed dividend 25,000 22,50,000 22,50,000

At the General Meeting it was resolved to: 1. Pay proposed dividend of 10% in cash. 2. Give existing shareholders the option to purchase one share of Rs.10 each at Rs.15 for

every five shares held. This option was taken up by all the shareholders. 3. Redeem the debentures at a premium of 5% and also confer option to the

debentureholders to convert 50% of their holding into equity shares at a predetermined price of Rs. 15 per share and balance payment to be made in cash.

Holders of 3,000 debentures opted to get their debentures redeemed in cash only while the rest opted for getting the same converted into equity shares as per the terms of issue. Debenture redemption fund investment realized Rs. 1,80,000 on sales.


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You are required to redraft the Balance Sheet after giving effects to the right issue and redemption of debentures. Also show the calculations in respect of number of equity shares issued and cash payment. (16 Marks) Answer (a) Balance Sheet of Dee Ltd.

as at 31st March, 2009

Liabilities Amount (Rs.)

Assets Amount (Rs.)

Authorised Capital 50,000 Equity shares of Rs.10 each

5,00,000

Fixed Assets (at cost less depreciation) 8,00,000

Issued and subscribed capital 37,000 Equity shares of Rs.10 each fully paid up

3,70,000

Other current assets 10,00,000

Reserves & surplus Cash balance (W.N.4) 60,000General reserve (W.N.2) 4,80,000 Securities premium (W.N.3) 60,000 Profit and loss A/c 1,00,000 Secured loan Other secured loan 2,50,000 Current liabilities and provisions 6,00,000

18,60,000 18,60,000

(b)

Calculation of number of equity shares issued: I. Number of equity shares issued as right issue (25,000 shares 5) 5,000 shares

II. Debentureholders who opted for the scheme of conversion into equity shares

2,000 debentureholders opted for the scheme Total value (2,000 debentures Rs.100) Rs.2,00,000 Premium on redemption @ 5% Rs.10,000

Rs.2,10,000

50% of their holding converted into equity shares Rs.1,05,000


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Number of equity shares to be issued to debentureholders

=

15.Rs

000,05,1.Rs 7,000 shares

Total number of equity shares issued (5,000 + 7,000) shares 12,000 shares

(c) Cash payment to debentureholders:

Rs.

I. 3,000 Debentureholders preferred cash Total cash paid to them 3,00,000 Premium on redemption @ 5% 15,000 3,15,000II. 2,000 Debentureholders opted for the scheme Total value 2,00,000 Add: Premium on redemption @ 5% 10,000 2,10,000 50% of their value converted into equity shares 1,05,000 Balance paid to debentureholders in cash 1,05,000

Total cash paid to debentureholders 4,20,000 Working Notes:

1. Debenture Redemption Reserve Account

Particulars Rs. Particulars Rs.To Premium on redemption of

debentures (15,000 + 10,000) 25,000 By Balance b/d 2,50,000

To Loss on sale of Debenture Redemption Reserve Investment

20,000

To General Reserve 2,05,000 2,50,000 2,50,000

2. General Reserve Account

Particulars Rs. Particulars Rs.To Balance c/d 4,80,000 By Balance b/d 2,75,000

By Debenture redemption reserve

(W.N.1) 2,05,000 4,80,000 4,80,000


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3. Calculation of Securities Premium

Number of equity shares of Rs.10 issued at Rs.15 per share 12,000 shares

Security premium per share Rs.5

Total securities premium (12,000 shares x Rs.5) Rs.60,0004. Cash Account

Particulars Amount (Rs.)


To Balance b/d 2,50,000 By Proposed dividend 25,000To Equity shareholders

(5,00015) 75,000 By Debentureholders

(Rs.1,05,000+Rs.3,15,000) 4,20,000

To Sale of Debenture Redemption ReserveInvestment 1,80,000

By Balance c/d 60,000

5,05,000 5,05,000

Question 4

DM Ltd., Delhi has a branch in London. London branch is an integral foreign operation of DM Ltd. At the end of the year 31st March, 2009, the branch furnishes the following trial balance in U.K. Pound:

Particulars Dr. Cr.Fixed assets (Acquired on 1st April, 2005) 24,000 Stock as on 1st April, 2008 11,200 Goods from head office 64,000 Expenses 4,800 Debtors 4,800 Creditors 3,200Cash at bank 1,200 Head office account 22,800Purchases 12,000 Sales 96,000 1,22,000 1,22,000


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In head office books, the branch account stood as shown below:

London Branch A/c

Particulars Amount Particulars Amount Rs. Rs.To Balance b/d 20,10,000 By Bank A/c 52,16,000To Goods sent to branch 49,26,000 By Balance c/d 17,20,000 69,36,000 69,36,000

The following further information are given: (a) Fixed assets are to be depreciated @ 10% p.a on straight line basis.

(b) On 31st March, 2009 :

Expenses outstanding - 400 Prepaid expenses - 200 Closing stock - 8,000

(c) Rate of Exchange:

1st April, 2005 - Rs. 70 to 1 1st April, 2008 - Rs. 76 to 1 31st March, 2009 - Rs. 77 to 1 Average - Rs. 75 to 1

You are required to prepare:

(i) Trial balance, incorporating adjustments of outstanding and prepaid expenses, converting U.K. pound into Indian rupees.

(ii) Trading and profit and loss account for the year ended 31st March, 2009 and the Balance Sheet as on that date of London branch as would appear in the books of Delhi head office of DM Ltd. (16 Marks)

Answer (i) Trial Balance of London Branch as on 31st March, 2009

Particulars U.K. Pound

Rate per U.K.

Pound

Dr. (Rs.) Cr. (Rs.)

Fixed assets 24,000 70 16,80,000 Stock (as on 1st April, 2008) 11,200 76 8,51,200 Goods from head office 64,000 - 49,26,000


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Sales 96,000 75 72,00,000Purchases 12,000 75 9,00,000 Expenses (4,800 + 400 200) 5,000 75 3,75,000 Debtors 4,800 77 3,69,600 Creditors 3,200 77 2,46,400Outstanding expenses 400 77 30,800Prepaid expenses 200 77 15,400 Cash at bank 1,200 77 92,400 Head office account - 17,20,000Difference in foreign exchange translation

12,400

92,09,600 92,09,600 Closing stock will be ( 8,000 Rs. 77) = Rs.6,16,000 (ii) Trading and Profit & Loss Account

for the year ended 31st March, 2009



To Opening stock 8,51,200 By Sales 72,00,000To Purchases 9,00,000 By Closing stock 6,16,000To Goods from head office 49,26,000 To Gross profit 11,38,800 78,16,000 78,16,000To Expenses 3,75,000 By Gross profit 11,38,800To Depreciation 1,68,000 By Profit due to foreign exchange

difference 12,400To Net profit 6,08,200 11,51,200 11,51,200

(iii) Balance Sheet as on 31st March, 2008

Liabilities Rs. Rs. Assets Rs. Rs.Head office Fixed Assets 16,80,000 Balance 17,20,000 Less: Depreciation 1,68,000 15,12,000Add: Net profit 6,08,200 23,28,200 Debtors 3,69,600


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Outstanding expenses

30,800 Prepaid expenses 15,400

Creditors 2,46,400 Closing stock 6,16,000 Cash at bank 92,400 26,05,400 26,05,400

Question 5

(a) From the following information, you are required to prepare Profit and Loss Account of Zee Bank Ltd., for the year ending 31st March, 2009:

Rs. Rs.Interest and Discount 44,00,000 Interest expended 13,60,000Other Income 1,25,000 Operating expenses 13,31,000Income on investments 5,000 Interest on balance with RBI 25,000

Additional information:

(a) Rebate on bills discounted to be provided for Rs. 15,000 (b) Classification of advances:

Rs. Standard assets 25,00,000Sub-standard assets 5,60,000Doubtful assets not covered by security 2,55,000Doubtful assets covered by security For 1 year 25,000For 2 years 50,000For 3 years 1,00,000For 4 years 75,000Loss assets 1,00,000

(c) Make tax provision @ 35% (d) Profit and Loss A/c (Cr.) Rs. 40,000.

(b) Dee Limited furnishes the following Balance Sheet as at 31st March, 2008:

Rs.000 Rs.000

Liabilities

Share capital:

Authorised capital 30,00


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Issued and subscribed capital:

2,50,000 Equity shares of Rs.10 each fully paid up 25,00

2,000, 10% Preference shares of Rs.100 each

(Issued two months back for the purpose of buy back) 2,00 27,00

Reserves and surplus:

Capital reserve 10,00

Revenue reserve 30,00

Securities premium 22,00

Profit and loss account 35,00 97,00

Current liabilities and provisions: 14,00

1,38,00

Assets

Fixed assets 93,00

Investments 30,00

Current assets, loans and advances (including cash and bank balance) 15,00

1,38,00 The company passed a resolution to buy back 20% of its equity capital @ Rs.50 per

share. For this purpose, it sold all of its investment for Rs.22,00,000.

You are required to pass necessary journal entries and prepare the Balance Sheet.

(8 + 8 = 16 Marks) Answer (a) Form B

Zee Bank Ltd. Profit & Loss Account for the year ended 31st March, 2009

Particulars Schedule No. Year ended 31st March,

2009I. Income: Interest Earned 13 44,30,000 Other Income 14 1,25,000 Total 45,55,000


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II. Expenditure Interest Expended 15 13,60,000 Operating Expense 16 13,31,000 Provisions and Contingencies (W.N.3) 10,17,050 Total 37,08,050III. Profit/Loss Net profit for the year 8,46,950 Profit brought forward 40,000 Total 8,86,950IV. Appropriations: Transfer to Statutory Reserve (@ 25% on Rs.8,46,950) 2,11,737.50 Balance carried forward to Balance Sheet 6,75,212.50

Total 8,86,950

Schedule 13: Interest Earned

Particulars Rs.Interest and discount 44,00,000Income on Investment 5,000Interest on balance with RBI 25,000Total 44,30,000

Working Notes: 1. Calculation of provisions on non-performing assets

Particulars Amount

Rs. % of

Provisions Provision

Rs. Standard assets 25,00,000 0.40 10,000Sub-standard assets 5,60,000 10 56,000Doubtful assets not covered by security 2,55,000 100 2,55,000Doubtful assets covered by security For 1 year 25,000 20 5,000 For 2 years 50,000 30 15,000 For 3 years 1,00,000 30 30,000

It is assumed that the all sub-standard assets are fully secured.


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For 4 years 75,000 100 75,000Loss assets 1,00,000 100 1,00,000 5,46,000

2. Calculation of provision for tax Tax = 35% of [Total income Total expenditure (excluding tax)]. Tax = 35% of [Rs.44,30,000+Rs.1,25,000(Rs.13,60,000+Rs.13,31,000+Rs.5,46,000+Rs.15,000)] Tax = Rs.4,56,050 3. Total amount of provisions and contingencies = Provision for non-performing assets + Provision for tax + Rebate on bills discounted = Rs.5,46,000 + Rs.4,56,050 + Rs.15,000 = Rs.10,17,050 (b) In the books of Dee Limited

Journal Entries

Particulars Dr. Cr.

(Rs. in 000)

(i) Bank Account Dr. 22,00 Profit and Loss Account Dr. 8,00 To Investment Account 30,00 (Being the investments sold at loss for the purpose of buy back)

(ii) Equity Share Capital Account Dr. 5,00 Premium payable on buy back Account Dr. 20,00 To Equity shares buy back Account 25,00 (Being the amount due on buy back)

(iii) Securities Premium Account Dr. 20,00 To Premium payable on buy back Account 20,00 (Being the premium payable on buy back adjusted against

securities premium account)


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(iv) Revenue Reserve Account Dr. 3,00

To Capital Redemption Reserve Account 3,00 (Being the amount equal to nominal value of equity shares

bought back out of free reserves transferred to capital redemption reserve account)

(v) Equity shares buy-back Account Dr. 25,00 To Bank Account 25,00 (Being the payment made on buy back)

Balance Sheet of Dee Limited as on 1st April, 2008

(After buy back of shares)

Liabilities Rs.000 Rs.000

Share capital Authorised capital: 30,00Issued and subscribed capital: 2,00,000 Equity shares of Rs.10 each fully paid up 20,00 2,000 10% Preference shares of Rs.100 each fully paid up 2,00 22,00

Reserves and surplus: Capital reserve 10,00 Capital redemption reserve 3,00 Revenue reserve 29,00 Profit and loss A/c (35,00 8,00) 27,00 69,00

Current liabilities and provisions 14,00

10,500

Fixed Assets 93,00Current assets loans and advances (including cash and bank balance) (15,00+22,00- 25,00)

12,00

10,500

Alternatively, Securities Premium account may also be used for transfer to Capital Redemption Reserve Account.


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Question 6

(a) P, Q and R are partners sharing profits and losses in the ratio of 2 : 2 : 1. Their Balance Sheet as on 31st March, 2009 is as follows:

Liabilities Rs. Assets Rs.

Capital Accounts: Plant & Machinery 1,08,000

P 1,20,000 Fixtures 24,000

Q 48,000 Stock 60,000

R 24,000 1,92,000 Sundry debtors 48,000

Reserve fund 60,000 Cash 60,000

Creditors 48,000

3,00,000 3,00,000 They decided to dissolve the firm. The following are the amounts realized from the

assets:

Rs.

Plant and Machinery 1,02,000

Fixtures 18,000

Stock 84,000

Sundry debtors 44,400 Creditors allowed a discount of 5% and realization expenses amounted to Rs.1,500. A

bill for Rs.4,200 due for sales tax was received during the course of realization and this was also paid.

You are required to prepare:

(a) Realization account

(b) Partners capital accounts

(c) Cash account. (6 Marks)

(b) Answer the following:

(i) Axe Limited began construction of a new plant on 1st April, 2008 and obtained a special loan of Rs.4,00,000 to finance the construction of the plant. The rate of interest on loan was 10%.


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The expenditure that were made on the project of plant were as follows:

Rs.1st April, 2008 5,00,0001st August, 2008 12,00,0001st January, 2009 2,00,000

The companys other outstanding non-specific loan was Rs.23,00,000 at an interest rate of 12%.

The construction of the plant completed on 31st March, 2009. You are required to:

(a) Calculate the amount of interest to be capitalized as per the provisions of AS 16 Borrowing Cost.

(b) Pass a journal entry for capitalizing the cost and the borrowing cost in respect of the plant. (5 Marks)

(ii) Compute Basic Earnings per share from the following information:

Date Particulars No. of shares

1st April, 2008 Balance at the beginning of the year 1,500

1st August, 2008 Issue of shares for cash 600

31st March, 2009 Buy back of shares 500 Net profit for the year ended 31st March, 2009 was Rs.2,75,000. (5 Marks)

Answer (a) Realisation Account

Particulars Amount Amount

To Debtors A/c 48,000 By Creditors A/c 48,000To Stock A/c 60,000 By Cash A/c (assets

realised):

To Fixtures A/c 24,000 Plant & Machinery 1,02,000 To Plant and machinery

A/c 1,08,000 Fixtures 18,000

To Cash A/c (Creditors) 45,600 Stock 84,000 To Cash A/c(Sales Tax) 4,200 Debtors 44,400 2,48,400

To Cash A/c (realisation expenses) 1,500


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To Profit on realisation P 2,040 Q 2,040 R 1,020 5,100

2,96,400 2,96,400

Partners Capital Accounts

Particulars P Q R Particulars P Q R

To Cash A/c (Bal. fig.)

1,46,040 74,040 37,020 By Balance b/d

1,20,000 48,000 24,000

By Reserve fund

24,000 24,000 12,000

By Realisation A/c (Profit)

2,040

2,040 1,020

1,46,040 74,040 37,020 1,46,040 74,040 37,020

Cash Account



To Balance b/d 60,000 By Realisation A/c (Creditors) 45,600To Realisation A/c (assets

realised) 2,48,400 By Realisation A/c (Expenses) 1,500

By Realisation A/c (Sales tax) 4,200 By Partners Capital Accounts P 1,46,040 Q 74,040 R 37,020

3,08,400 3,08,400


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(b) Total expenses to be capitalised for borrowings as per AS 16 Borrowing Costs:

Rs.

Cost of Plant (5,00,000 + 12,00,000 + 2,00,000) 19,00,000Add: Amount of interest to be capitalised (W.N.2) 1,54,000

20,54,000

Journal Entry Rs. Rs.

31st March, 2009 Plant A/c Dr. 20,54,000

To Bank A/c 20,54,000

[Being amount of cost of plant and borrowing cost thereon capitalised]

Working Notes:

1. Computation of average accumulated expenses

Rs.

1st April, 2008 Rs.5,00,000

1212

5,00,000

1st August, 2008 Rs.12,00,000

128

8,00,000

1st January, 2009 Rs.2,00,000

123

50,000

13,50,000

2. Amount of interest capitalised

Rs.On specific borrowing (Rs. 4,00,000 %)10 40,000

On non-specific borrowings (Rs. 13,50,000 Rs. 4,00,000) 12% 1,14,000

Amount of interest to be capitalised 1,54,000


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(b) (ii) Computation of weighted average number of shares outstanding during the period

Date No. of equity shares Period outstanding

Weights (months)

Weighted average number of shares

(1) (2) (3) (4) (5) = (2) x (4) 1st April,

2008 1,500

(Opening) 12 months 12/12 1,500

1st August, 2008

600 (Additional issue) 8 months 8/12 400

31st March, 2009 500 (Buy back) 0 months 0/12 -

Total 1,900

Basic Earnings Per Share =period the during goutstandin SharesEquity of Number AverageWeightedrsShareholdeEquity to leattributab period the for Loss orProfit Net

= shares 900,1

000,75,2 .Rs = Rs.144.74

PAPER 6 : AUDITING AND ASSURANCE

Answer all questions Question 1

State with reasons (in short) whether the following statements are true or false. (Answer any ten): (10 x 2 = 20 Marks)

(i) While auditing the accounts of a company, it is obligatory that the auditor must adopt sampling technique.

(ii) Interim dividend is not a part of dividend.

(iii) A casual vacancy caused by resignation of the auditor can be filled by the Board of Directors.

(iv) The auditor, in the interest of the users, while explaining the nature of his reservation, can describe the work of the expert with his name, in the audit report without obtaining prior consent of the expert.

(v) The auditee firm has no right to compel the auditor to provide copies of the working papers.

(vi) Comptroller and Auditor General of India can be removed by the Prime Minister of India on the recommendation of his Council of Ministers.

(vii) Provisions of Companies (Auditor's Report) order 2003 as amended upto date, apply to clubs, chambers of commerce, research institutes etc, which have been established under Section 25 of the Companies Act, 1956.

(viii) Mr. X, a Chartered Accountant, is an employee of M/s M & N Co., a firm of Chartered Accountants of India. The firm is the Auditors of ABC & Co. Ltd. After auditing the accounts of the Company the Auditor firm allowed Mr. X, their employee, to sign the audit report; which he did.

(ix) The Auditor disagreed with the management with regard to the acceptability of the Accounting Policies and the inadequacy of disclosures in the financial statements and issued a .disclaimer.

(x) Analytical procedures are unable to help the Auditor in determining the nature, timing and extent of other audit procedures at the planning stage.

(xi) A Company which has been unable to negotiate borrowings from its bankers claims that it will be able to continue as a 'going concern'.

(xii) The overall objective of audit changes in Computer Information System (CIS) environment.


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Answer (i) False: It is not obligatory that the auditor must adopt sampling technique in auditing the

accounts. But he should ensure that the relevant standards on auditing has been followed. It is in the interest of the auditor if he decides to form his opinion on the basis of audit sample using standards and techniques which are widely followed and recognised.

(ii) False: The definition of dividend has been amended by the Companies (Amendment) Act, 2000 where the interim dividend has been treated as part of dividend. With an amendment in Section 205, the interim dividend has been brought at par with dividends declared in the normal course.

(iii) False: Casual vacancy caused by resignation of an auditor can be filled only in the General Meeting of the company and not by the Board of Directors.

(iv) False: As per SA 620, Using the Work of an Expert, if the auditor, in the interest of the users includes the name of the expert in his audit report, he can do so only after obtaining the prior consent of the expert.

(v) True: Working papers are the property of the auditors. Auditee has no right to compel the auditors firm to provide it with the copies of working papers. However, the auditors may at their discretion make portions of or extracts from their working papers available to the auditee.

(vi) False: The Comptroller and Auditor General of India cannot be removed by the Prime Minister of India on the recommendation of his Council of Ministers. He can be removed on the ground of proven misbehaviour or incapacity, when each House of Parliament decides to do so by majority of not less than 2/3 of the members of the house present and voting.

(vii) False: Companies (Auditors Report) Order, 2003 provides that it shall not apply to companies which have been licensed to operate under Section 25 of the Companies Act, 1956 to promote commerce, art, science, religion, charity and which prohibit the payment of any dividends to their members. Such companies include clubs, chambers of commerce, research Institutes etc.

(viii) False: An employee Chartered Accountant cannot sign the auditors report on behalf of the auditing firm. Only a partner in the firm can sign the audit report in compliance with the provisions of Section 229.

(ix) False: The auditor is wrong in issuing a disclaimer. If the auditor disagrees with the management in the matters relating to the acceptability of Accounting policies selected and inadequacy of the disclosures in the financial statements, he should issue a qualified report or express an adverse opinion.

(x) False: SA 520 Analytical Procedure states that application of analytical procedures helps the auditor to find the aspects of the business of which he was unaware and it will also assist him in determining the nature, timing and extent of audit procedures.

PAPER 6: AUDITING AND ASSURANCE

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(xi) False: In the case of the company which has not been able to negotiate its borrowings with its bankers, there will be a substantial doubt in its ability to continue as a going concern without such financial support.

Alternative Answer True: If the company is not able to negotiate borrowings from its bankers for reasons like delay/failure in the submission of adequate documents/information or for other reasons other than the companys financial status then the statement is true.

(xii) False: Overall objective of audit does not change in Computer Information System (CIS) environment. But the use of computer changes the processing and storage, retrieval and communication of financial information.

Question 2

Comment on the following situations:

(a) XYZ Ltd. Co. gave a donation of Rs.50,000 each to a Charitable Society running a school and a trust set up for the service of Blind during financial year ending on 31st March, 2009. The average net profits of the company for the last three years were 15 lakhs. (8 Marks)

(b) Mr. X, a shareholder of the company pointed out that:

(i) The goodwill in the Balance Sheet of the company has appeared on same figure during the past three years.

(ii) Premium received on issue of shares prior to the date of balance sheet has been transferred to Profit and Loss account for arriving at the figure of commission payable to the managing director. (6 Marks)

(c) A, B & C Company Ltd. removed its first Auditor before the expiry of his term without obtaining approval of the Central Government. (6 Marks)

Answer (a) Donation to Charitable Institutions Section 293 of the Companies Act, 1956 provides that the Board of Directors of a public

listed company can contribute with the approval of the company in General Meeting to a charitable organisation and other such organizations not directly related to the business of the company or the welfare of its employees subject to the limit as under:

(i) Rs.50, 000/- or

(ii) 5% of the average net profits of the last three years, whichever is greater.

Facts of the case: The company has given donation of Rs.50,000/- each to the two charitable organisations which amounts to 1,00,000. Assuming that the charitable organisations are not related to the business of the company, the average profits of the last 3 years is Rs. 15 lakhs and the 5% of this works out to Rs. 75,000. Hence the maximum of donation could be Rs.75,000 only.


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Conclusion: By paying donations of Rs.1,00,000 which is more than Rs.75,000, the Board has contravened the provisions of Section 293 of the Companies Act, 1956. Hence the auditor should qualify his audit report accordingly.

(b) (i) As per the provisions of AS 26 Intangible Assets, an intangible assets should be carried in the books at cost loss accumulated amortization and accumulated impairment losses. The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. There is a reputable presumption that the useful life of an intangible asset will not exceed ten years from the date when the asset is available for use according to Para 63 of AS 26. In the given case, the company has not amortized any value of goodwill since past three years. The auditor should have indicated this fact in his report that no amount of goodwill has been written off during the past three years.

(ii) Premium received on issue of shares is capital receipt and should not credited to profit and loss account. As per the provisions of Section 349 of the Companies Act, premium on issue of shares should not be considered in computation of net profit for the purpose of managerial remuneration. The auditor should have qualified the audit report and qualified the amount by which the profit stands inflated.

(c) Removal of first auditor As per provision of Sub-section (7) of Section 224, an auditor may be removed from his

office before the expiry of his term by the company in general meeting after obtaining prior approval of the Central Government in that behalf, except that such approval is not required for the removal of first auditor appointed by the directors under the proviso to sub-section (5) of Section 224. This is a very stringent provision to ensure that any auditor who is inconvenient to the management cannot be removed so easily. This provision goes a long way to ensure independence of auditor.

However, the first auditor appointed by the Board of Directors can be removed by merely passing an ordinarily resolution in General Meeting of the company without the prior approval of the Central Government.

Therefore, the stand taken by the company in removing the services of an auditor is in order. Question 3

Discuss the basic principles governing an audit. (10 Marks) Answer 3. Basic principles governing an audit SA 200 Basic Principals Governing an Audit, describes the basic principles which

govern the auditors professional responsibilities and which should be complied with wherever an audit is carried. They are described below: (i) Integrity objectivity and independence: An auditor should be honest, sincere,

impartial and free from bias. He should be a man of high integrity and objectivity.


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(ii) Confidentiality: The auditor should respect confidentiality of information acquired during the course of his work and should not disclose the information without the prior permission of the client , unless there is a legal duty to disclose.

(iii) Skill and competence: The auditor must acquire adequate training and experience. He should be competent, skillful and keep himself abreast of the latest developments including pronouncements of ICAI on accounting and auditing matters.

(iv) Work performed by others: If the auditor delegates some work to others and uses work performed by others including that of an expert, he continues to be responsible for forming and expressing his opinion on the financial information.

(v) Documentation: The auditor should document matters which are important in providing evidence to ensure that the audit was carried out in accordance with the basic principles.

(vi) Planning: The auditor should plan his work to enable him to conduct the audit in an effective, efficient and timely manner. He should acquire knowledge of clients accounting system, the extent of reliance that could be placed on internal control and coordinate the work to be performed.

(vii) Audit evidence: The auditor should obtain sufficient appropriate evidences through the performance of compliance and other substantive procedures to enable him to draw reasonable conclusions to form an opinion on the financial information.

(viii) Accounting System and Internal Control: The management is responsible for maintaining an adequate accounting system incorporating various internal controls appropriate to the size and nature of business. He auditor should assure himself that the accounting system is adequate and all the information which should be recorded has been recorded. Internal control system contributes to such assurance.

(ix) Audit conclusions and reporting: On the basis of the audit evidence, he should review and assess the audit conclusions. He should ascertain: (a) As whether accounting policies have been consistently applied; (b) whether financial information complies with regulations and statutory

requirements; and (c) there is adequate disclosure of material matters relevant to the presentation of

financial information subject to statutory requirements. The auditors report should contain a clear written opinion on the financial

information. A clean audit report indicates the auditors satisfaction in all respects and when a qualified, adverse or a disclaimer of opinion is to be given or reservation of opinion on any matter is to be made, the audit report should state the reasons thereof.


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Question 4

(a) Explain concept of materiality and factors which act as guiding factors to this concept.

(6 Marks) (b) Describe a set of instructions, which an auditor has to give to his client before the start of

actual audit. (4 Marks) Answer (a) Concept of materiality: SA 320 Materiality in Planning and Performing an Audit,

establishes standards on the concept of materiality and the relationship with audit risk while conducting an audit. Hence, the auditor requires more reliable evidence in support of material items. SA 320 defines material items as relatively important and relevant items, i.e., items the knowledge of which would influence the decision of the user of financial statements. Financial statements materially affect if such statement is erroneously stated or omitted to be stated there in and economic decision of the users taken on the basis of such information is influenced by such misstatements or omissions.

The auditor has to ensure that such items are properly and distinctly disclosed in the financial statements.

The concept of materiality is fundamental to the process of accounting. It covers all the stages from recording to classification and presentation. It is very important for the auditor who has constantly to judge whether a particular item is material or not.

There is an inverse relationship between materiality and the degree of audit risk. The higher the materiality level, the lower the audit risk and vice versa. For example, the risk that a particular account balance or class of transactions could be misstated by an extremely large amount might be very low but the risk that it could be misstated by an extremely small amount might be very high.

Factors to be considered for determining materiality (i) Item of materiality may be determined individually or in aggregate. (ii) The materiality depends on the regulatory or legal considerations. (iii) Materiality is not often reckoned with respect to quantitative details above. It has

qualitative dimensions as well. (iv) Even insignificant items in terms of quality may be material in special

circumstances. (v) Sometimes the materiality of an item in terms of quantity is described in law itself.

For example, Schedule VI requires disclosure of items of expenditures which are in excess of one percent or Rs.500, whichever is less.

(vi) An item whose impact is insignificant at present, but in future it may be significant, may be material item.


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(b) Following instructions are given by the auditor to the client before the start of audit: (i) The accounts should be totalled up and trial balance and final accounts be kept

ready. (ii) Vouchers should be serially arranged. (iii) Schedule of debtors and creditors should be prepared. (iv) Schedule of outstanding expenses, prepaid expenses and accrued income to be

kept ready. (v) A list of bad and doubtful debts should be prepared. (vi) Schedule of investments should be prepared. (vii) Certified list of goods returned to be prepared. (viii) Statement of permanent capital expenditure to be prepared. (ix) Schedule of deferred revenue expenditures to be prepared. (x) Names and addresses of managers and other officers should be kept ready.

Alternative answer (1) It is the responsibility of the management to prepare the financial statements, to

select and consistently apply the appropriate accounting policies (2) Management is responsible for the maintenance of adequate accounting records

and internal controls for safeguarding assets of the company (3) Unrestricted access to whatever records, documentation and other information

required in connection with the audit. (4) Managements responsibility for making judgements of estimates that are

reasonable and prudent so as to give a true and fair view of the state of affairs of the entity.

(5) Managements responsibility for preparation of the financial statements as a going concern.

Question 5

(a) What are the six important points that will attract your attention in the case of audit of a Hotel? (5 Marks)

(b) State the information to be disclosed in the financial statements according to the requirements of AS 6. (5 Marks)

Answer (a) Audit of a hotel Following important points will attract the attention of the auditor in the case of audit of a

Hotel:


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(i) Internal Controls: In view of the problems of pilfering in any hotel, the importance of internal controls cannot be overstressed. It is the responsibility of the management to introduce controls which will minimise the leakage as far as possible. If the internal control in a hotel is weak then there exist serious problems for the auditor. The hotel must prepare regularly (preferably weekly) its trading accounts for each sale point and undertake detailed scrutiny of the resulting profit percentages to ensure that is within the anticipated percentage. If the variation is above the permissible limit, he has to get the explanation from the concerned persons.

(ii) Room Sales: The charge for room sales is posted to guest bills by the receptionist and 1 night auditor. The source of these entries is the guest register and test checks should be carried out to ensure that the correct number of guests is charged for the current period. Difference, if any, should be investigated to ensure that they have been properly authorised.

(iii) Stocks: The stocks in the hotels are readily portable and salable such as food and beverages stocks. All movements and transfers of such stocks should be properly documented to exercise control over each individual stored areas and sale points. The auditor should carry out test checks to ensure that all such documentation is accurately processed.

Areas where large quantities are stored should be kept locked by the manager. Unauthorised persons should not be permitted to enter the store area.

(iv) Fixed Assets: Accounting policies for fixed aspects are likely to differ. Many hotels account for quasi-fixed assets such as silver cutlery on stock basis. This may lead to confusion between each stock items and similar assets. In these cases, it is important that very detailed definitions of stock items exist and the auditor should carry out tests to ensure that the definitions have been closely followed.

(v) Casual labour: The hotel trade operates, to a very large extent, on casual labour. The record maintained of such wage payments is frequently found to be inadequate. Hence the auditor should ensure that proper internal control system exists to ensure that defalcation on this account does not take place.

(vi) Booking of hotel for special parties: The auditor should ensure that the adequate and proper records are being maintained for booking of halls and other premises for special parties and receipts from guests are made on the basis of the tariff.

(b) Requirements of AS 6: AS 6 requires following information to be disclosed in the financial statements: (i) Historical cost or other amount substituted for historical cost of each class of

depreciating asset;

(ii) Total depreciation for the period for each class of assets.


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(iii) The related accumulated depreciation.

It also requires following disclosure of information in the financial statements along with the disclosure of other accounting polices:

(i) Depreciation method used and

(ii) Depreciation rates or the useful life of the assets, if any, if they are different from the principal rates specified in the statute governing the enterprise.

Question 6

(a) State clearly provisions of the Companies Act, 1956 with regard to issue of shares at a discount. (5 Marks)

(b) As an auditor, comment on the following situation: (5 Marks)

MNR Co. Ltd. did not provide for depreciation during the financial year 2007-08 due to inadequacy of profits. The company declared dividend during the financial year 2008-09 without providing for the previous year's depreciation.

Answer

(a) Issue of Shares at a Discount: According to Section 79 of the Companies Act, 1956, a company can issue shares at a discount on the following conditions:

(i) The issue should be authorised by an ordinary resolution of the company sanctioned by the Central Government.

(ii) No such issue of shares at discount can be sanctioned by the Central Government in case the maximum rate of discount should exceed 10% unless the Central Government is of the opinion that a higher rate for discount is justified by the special circumstances of the case

(iii) The issue should be made within two months of the sanction by the Central Government and not earlier than one year after the date of commencement of business.

(iv) The issue should be a class already issued by the company.

(v) It is the duty of the auditor to confirm that the conditions given above have been complied with by the company at the time the allotment was made.

(b) Payment of dividend without providing for arrears of depreciation Section 205 (1) of the Companies Act, 1956, prescribes that if a company has not made

provision for depreciation for any previous financial year, it should provide for such depreciation before declaring / paying dividend:

(i) Either out of the profits of that financial year or


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(ii) Out of the profits of any other previous years.

In the present case, it would be necessary to make provisions for depreciation in respect of 2007-08 and 2008-09 in the first instance and the balance of profit after providing depreciation including the previous year, could be used for distribution as dividend. Since the company has contravened the provisions of Section 205(1), the auditor should qualify his audit report.

Question 7

(a) Comment on the following situation: (5 x 2 = 10 Marks)

XYZ Co. Ltd. reappointed A and B as their joint auditors in the Annual General Meeting. The AGM authorised the Board for fillup the vacancy on their own in the event of both or either of auditors declined to accept the assignment. The Board passed a resolution to appoint C if any of the auditors declined to accept the assignment.

B declined to accept the assignment and Board of Directors appointed C in place of B as per its resolution.

Note: How would you vouch/verify the following. (Answer anyone) :

(b) Leasehold property.

Or Goods sent out on Sale or Return Basis.

(c) Bank overdraft. Answer

(a) Filling up the vacancy of an auditor

In the present case B is one of the joint auditors who was appointed in Annual General Meeting, but declined to accept the appointment. The Board of Directors as per their resolution, appointed C as a joint auditor in his place.

In this case, the vacancy created by B is neither caused by resignation of B nor is it a casual vacancy because Bs appointment had not become effective. Hence, appointment of C as joint auditor by the Board is not valid. C can only be appointed as joint shareholders in the General Meeting.

(b) Lease Hold Property: Following are the main steps involved in verification/vouching of lease hold property:

(i) Inspect the lease agreement to ascertain the amount of premium, if any, for securing the lease and terms and conditions. A lease exceeding the period of one year is not valid unless it has been registered by an instrument. Hence this has to be ensured.


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(ii) Ascertain that all the conditions, the failure of which may result in cancellation of the lease have been complied with, e.g. payment of ground rent, insurance premium, maintenance of lease and property in satisfactory state etc.

(iii) Ensure that due provisions for any claims that might arise under the dilapidation clause on the expiry of the lease have been made. If such provision has not been made, the auditor should draw the clients attention to it.

(iv) Ensure that the outlay and legal expenses incurred to acquire lease property have been capitalised. The property must be written off in such a way that it completely wipes off the asset at the end of the lease period.

(v) He should ascertain that the clause entitles the lessee to sub let any part of the leased property and ensure its proper compliance.

OR

Goods sent out on sale or return basis

(i) A record of goods sent out on sale or return basis should be kept in a specially ruled day book. In this book, first memoranda entries are made.

(ii) When the goods are sold, entry is made by debiting the party and crediting the Sales Account.

(iii) The auditor should refer the memoranda record to confirm that on receipt of acceptance from each party, his account is debited and corresponding sales account is credited.

(iv) For the goods in respect of which period of approval has expired are either received back subsequently and customers accounts debited.

(v) He should ensure that for the stock of goods sent out on approval, the period of approval, in respect of which had not expired till the close the year, are included in closing stock.

(c) Bank Overdraft

(i) The auditor should ensure that the facility of overdraft is authorised by the Boards resolution / partners resolution.

(ii) Persue the agreement with the bank and see whether the overdraft is clean or against hypothecation or pledge of companys property.

(iii) Verify the register of charges and ensure that the charge has been registered with Registrar of Companies.

(iv) Verify the rate of interest and other terms and conditions from the agreement.


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(v) Verify the amount of overdraft from the books of accounts and compare it with the passbook.

(vi) If the overdraft is against hypothecation of assets like stocks, a certificate from the bank should be obtained.

(vii) If the overdraft is against hypothecation of assets or pledge of companys property, see that overdraft is properly shown under secured loans and nature of security has been property disclosed.

Question 8

(a) X, a Chartered Accountant was engaged by PQR & Co. Ltd. for auditing their accounts. He sent his letter of engagement to the Board of Directors, which was accepted by the Company. In the course of audit of the company, the auditor was unable to obtain appropriate sufficient audit evidence regarding receivables. The client requested for a change in the terms of engagement. (5 x 2 = 10 Marks)

Offer your comments in this regard.

Note: Write short notes on the following. (Answer anyone):

(b) Cut-off arrangements Or

Audit risk at the account balance level and at the class of transactions level. (c) Powers of C & AG in connection with the performance of his duties. Answer

(a) Change in terms of engagement

1. An auditor who is required to change the engagement which requires lower level of assurance before the completion of engagement should consider the appropriateness of doing so.

2. But when the terms of engagement are changed, both the auditor and the client should agree on the new terms.

3. However, the auditor should not agree to a change in terms where there is no reasonable justification for doing so.

4. In the instant case, the auditor was unable to obtain sufficient evidence regarding receivables. The client requested him for a change in the terms of the agreement to avoid qualified/adverse opinion. Hence there is no reasonable justification for change in the terms of engagement.

5. Thus the auditor should not agree for change in the terms of engagement letter.


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(b) Cut-off arrangements

While doing accounting of financial transactions, it is essential that transactions of one period should be separated from those of the ensuing period so that the working results of each period can be correctly ascertained. This type of arrangement is known as Cut-off arrangement. It essentially forms part of the internal check of the organisation. Accounts other than sales, purchase and stock are not generally affected by the continuity of the business, and therefore, this arrangement is generally applied only to the above mentioned accounts. The auditor has to satisfy himself by examination and test checks that cut-off procedures adequately ensure that:

(i) Goods purchased, where the property in the goods has been passed to the client, are included in the inventories and that the liability has been provided for in case of credit purchases.

(ii) Similarly, goods sold have been excluded from the inventories and credit has been taken for the sales. If the value of sales is to be received, the concerned party has been debited.

OR

Audit risk at the account balance level and at the class of transactions level

Majority of audit procedures are directed to and carried out at the account balance level and the class of transactions level. At these levels, the auditor uses professional judgment to evaluate numerous factors to assess inherent risk:

(i) Financial statement of accounts likely to be susceptible to mismanagement.

(ii) The complexity of underlying transactions which might require the use of the work of an expert.

(iii) The amount of judgment involved in determining account balances.

(iv) Susceptibility of assets to loss or misappropriation.

(v) The completion of unusual and complex transactions, particularly at or near year end.

(c) Powers of Comptroller and Auditor General in connection with the performance of his duties:

(i) To inspect any an office of accounts under the control of the union or a State Government including office responsible for creation of initial or subsidiary accounts.

(ii) To require that any accounts, books, papers and other documents which deal with or are otherwise relevant to the transactions under audit, be sent to specified places.


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(iii) To put such questions or make such observations as he may consider necessary to the person in-charge of the office and to call for such information as he may require for preparation of any account or report, which is his duty to prepare.

In carrying out the audit, the C&AG has the power to dispense with any part of detailed audit of any accounts or class of transactions and to apply such limited checks in relation to such accounts or transaction as he may determine

PAPER 7 : INFORMATION TECHNOLOGY AND STRATEGIC MANAGEMENT Attempt all questions.

Question 1 (a) Describe briefly the following terms: (i) LSI Circuit (ii) USB Connectors (iii) Touch Screen (iv) Layer 3 or Network Layer (v) Data Dictionary (5x1 = 5 Marks) (b) Explain each of the following: (i) BIOS (ii) Transaction Log (iii) Random Access (iv) FAT (v) E-mail (5x1 = 5 Marks) Answers (a) (i) LSI Circuit : LSI or Large Scale Integrated Circuits led to the development of the

fourth generation computer. The LSI is a microchip containing thousands of small electronic components which function as a complete system.

(ii) USB Connectors : USB stands for Universal Serial Bus. USB connectors provide the user with higher data transfer speeds for different USB devices like keyboard, mouse, scanner or digital camera.

(iii) Touch Screen : Touch Screens are mainly used in Information providing systems like Railway Reservation counters, stock exchanges, hotels, restaurants etc. When an invisible infrared beam matrix crisscrossing the screen is pressed by finger over a function or program displayed on the screen, the infrared beam is broken at that intersection and the system is activated. The beam emanates from holes along the bottom and sides of the display unit.

(iv) Layer 3 or Network Layer : Network Layer corresponds to the layer 3 of the OSI model and enables a choice of the physical route of transmission of a message packet by - creating a virtual circuit for upper layers to make them independent of data

transmission and switching. - establishing, maintaining, and terminating connections between the nodes. - ensuring proper routing of data.


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(v) Data Dictionary : Data Dictionary maintains information pertaining to structure and usage of data and meta data. Each piece of data and various synonyms of data field are determined in consultation with database users.

(b) (i) BIOS : BIOS (stands for Basic Input Output System) is a small chip on the motherboard that loads the hardware settings required to load various devices like keyboards, monitors, or disk drives. It is a boot firmware program that controls the computer from the time we start it up until the operating system takes over. The BIOS also manages data flow between the computers operating system and attached devices such as hard disk, video card, keyboard, mouse and printer.

(ii) Transaction Log : Transaction Log is a file that records database modifications that consist of inserts, updates, deletes, commits, rollbacks, and database schema changes. The database engine makes use of this log to apply any changes made between the most recent checkpoint and the system failure.

(iii) Random Access : Random Access pertains to the method of file organization in a storage device in which the access time of the storage device is not significantly affected by the location of the data to be accessed. It means that any item of data which is stored online can be accessed within a relatively short time (usually in part of a second).

(iv) FAT : File Allocation table (FAT) is a log that records the location of each file and the status of each sector. When a file is written to a disk, the operating system checks the FAT for an open area, stores the file, and then identifies the file and its location in the FAT.

(v) E-mail : E-mail is a method of composing, sending, storing and receiving messages over electronic communication systems. The term e-mail applies both to the Internet e-mail system based on the Simple Mail Transfer Protocol (SMTP) and to intranet systems allowing users within one company to e-mail each other.

Question 2

Answer the following:

(a) Define an Image Processing. Describe the steps involved to document imaging. Also mention any five advantages of Image Processing. (5 Marks)

(b) What are Decision Support Systems? Describe various characteristics of a DSS.

(5 Marks) Answers (a) Image Processing : Image Processing captures an electronic image of data so that it

can be stored and shared. Imaging systems can capture almost anything, including keystroked or handwritten documents (such as invoices or tax returns), flowcharts, drawings, and photographs.

PAPER 7 : INFORMATION TECHNOLOGY AND STRATEGIC MANAGEMENT

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There are five steps to document imaging: 1. Data Capture : The most common means of converting paper documents into

electronic images is to scan them. By using scanner, the text and pictures can be converted into digitized electronic code.

2. Indexing : Document images must be stored in a manner that facilitates their retrieval. Normally they are stored in an index. Great care is needed in designing the indexing scheme.

3. Storage : As large amount of space is involved in storing, the images are usually stored on an optical disk. An appropriate size optical disk should be selected.

4. Retrieval : Keying in any information stored in an index can retrieve documents. The index tells the system which optical disk to search and the requested information can be quickly retrieved.

5. Output : An exact replica of the original document is easily produced on the computers monitor or on paper, or is transmitted electronically to another computer.

Some of the advantages of Image Processing are as follows: (i) Accessibility : Documents can be accessed and reviewed simultaneously by many

people, even from remote locations. (ii) Accuracy : Accuracy is much higher because costly and error-prone manual data-

entry processes are eliminated. (iii) Capacity : Vast amounts of data can be stored in very little space, which

significantly reduces storage and office space. (iv) Cost : When large volumes of data are stored and processed, the cost per

document is quite inexpensive. As a result, the costs to input, file, retrieve, and re-file documents are reduced significantly.

(v) Security : Various levels of passwords (network, data base, files, etc.) and clearances can be assigned to restrict document access.

(b) Decision Support System : Decision Support System (DSS) is a specific class of computerized information system that supports business and organizational decision-making activities. A properly designed DSS is an interactive software-based system intended to help decision maker to compile useful information from raw data, documents, personal knowledge, and/or business models to identify and solve problems and make decisions. A DSS may present information graphically and may include an expert system or artificial intelligence. DSS have also achieved broad use in accounting and auditing today.

The common characteristics of Decision Support Systems are as mentioned below : (i) DSS support management decision making These enhance decision quality.

While the system might not point to a particular decision, it is the user who ultimately makes the final choice.


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(ii) DSS solve relatively unstructured problems The unstructured problems with lesser well-defined questions do not have easy solution procedures and therefore need some managerial judgment. Such problems can be handled and addressed with the help of appropriate DSS.

(iii) DSS are friendly computer interface A friendly computer interface is also a characteristic of a DSS. As the managers and other decision makers using DSS are not necessarily good programmers, such systems must be easy to use. The communication between the user and the DSS is made easy through nonprocedural modeling languages.

(iv) DSS should be able to respond quickly to the changing needs of the decision makers As managers must plan for future activities, they rely heavily on assumptions. Any DSS should address the decision making for a variety of assumptions. A key characteristic of many systems is that these allow users to ask what-if questions and examine the results of these questions.

Question 3 (a) Describe the various factors being considered in determining the best file organization for an

application. (5 Marks)

(b) What is meant by Electronic Data Interchange? State some of its advantages. (5 Marks) Answers (a) Factors to be considered for best file organization are briefly discussed below :

(i) File Volatility : It refers to the number of additions and deletions to the file in a given period of time. A file that constantly keeps changing is a highly volatile file. An Indexed-sequential file organization will not be suitable for such files, because additions have to be placed in the overflow area and constant reorganization of the file would have to occur. Other direct access methods would be a better choice. Even the sequential file organization could be appropriate if there are no interrogation requirements.

(ii) File Activity : It is the proportion of master file records that are actually used or accessed in a given processing run. At one extreme is the real-time file where each transaction is processed immediately and hence at a time, only one master record is accessed. This situation obviously requires a direct access method. At the other extreme is a file, such as a payroll master file, where almost every record is accessed when the weekly payroll is processed. In such case, a sequentially ordered file would be more efficient.

(iii) File Interrogation : It refers to the retrieval of information from a file. When the retrieval of individual record needs to be fast to support a real-time operation such as airline reservation, then some direct organization would be required. But if requirements of data can be delayed, then all the individual requests or information can be batched and run in a single processing run with a sequential file organization.


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(iv). File Size : Large files that require many individual references to records with immediate response, must be organized for certain direct access method. However, with small files, it may be more efficient to search sequentially or with more efficient binary search, to find an individual record.

(b) Electronic Data Interchange (EDI) : EDI is the transmission, in a standard syntax, of unambiguous information of business or strategic significance between computers of independent organizations. Or simply, EDI is computer-to-computer communication using a standard data format to exchange business information electronically between independent organizations.

Advantages of Electronic Data Interchange (EDI) are as stated below : (i) Issue and receive orders faster - Since most purchasing transactions are routine,

they can be handled automatically, utilizing the staff for more demanding and less routine tasks.

(ii) Make sales more easily - Quotes, estimates, order entry and invoicing will proceed more smoothly and efficiently. Orders received electronically ensure that information is available immediately, so that an organization can respond faster and be more competitive.

(iii) Get paid sooner - Invoices received electronically can be reconciled automatically, which means they are earmarked for fast payment. In turn, the purchase department is in a position to negotiate for better terms including faster payments.

(iv) Minimize capital tied up in inventory - For manufacturing organization with a just-in-time strategy, the right balance is crucial, but every organization stands to benefit from reducing order lead times.

(v) Reduce letters and memos - Letters and memos do not follow rigid rules for formatting. They can be handled by an electronic mail system.

(vi) Decrease enquiries - Customers or suppliers can make direct on-line enquiries on product availability, or other non-sensitive information instead of consuming the staffs precious time.

(vii) Make bulk updates of catalogues and parts listings - One can provide updates of data files, such as catalogues to customers or part listings to franchisees.

Question 4

(a) Write the output sequence (at least first five numbers) for the given flowchart, if N = 0 is selected as the value for N as input. (5 Marks)

(b) If the statement N = N * N in the computation box of the flowchart is modified as N = N * (N -1). Write the output sequence (at least first five numbers) for the flowchart with N = 0 as the input value for N. (5 Marks)


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Answers (a) The output sequence will be : 0 1 4 25 676 (b) The output sequence in this case will be : 0 0 0 0 0 Being in loop, the program will continue to write 0 endlessly. Question 5

(a) Describe the Ring Network. Discuss its advantages and disadvantages. (5 Marks)

(b) Describe Caching Server and Proxy Server. How are they different from each other?

(5 Marks)

No

Yes

Start

Input N

N > 1000?

Print N

N= N+1

N= N * N

Stop


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Answer

(a) Ring Network : This is one of the structures for local area networks. In this topology, the network cable passes from one node to another until all nodes are connected in the form of a loop or ring. There is a direct point-to-point link between two neighboring nodes. These links are unidirectional which ensures that transmission by a node traverses the whole ring and comes back to the node, which made the transmission. Ring Network topology is particularly appropriate for organizations that require a centralized database or a centralized processing facility.

Advantages:

(i) Ring networks offer high performance for a small number of workstations.

(ii) These can span longer distances compared to other types of networks.

(iii) Ring networks are easily extendable.

Disadvantages:

(i) It is relatively expensive and difficult to install.

(ii) Failure of one computer on the network can affect the whole network.

(iii) It is difficult to trouble shoot a ring network. Adding or removing computers can disrupt the network.

(b) Caching Server : A caching server is used to restrict number of ones own access to the Internet. Basically, a caching server sits between the client computer and the server that would normally fulfill a clients request. The caching server intercepts the request sent and maintains a library of files that have been requested in the recent past by users on the Internet. If the request is found in the library, the server returns the desired information without going out to the Internet. Thus, a caching server does not restrict information flow. Instead, it makes a copy of requested information, so that frequent requests can be served locally, rather than from the original Internet source. It provides a good means to reduce overall traffic to and from the Internet. It is also possible to connect the caching servers in a hierarchy so that if the requested information is not available locally, it can be passed to the nearby caching servers for possible availability.

Proxy server : A proxy server is designed to restrict access to information on the Internet. A proxy server can be configured to refuse to pass the request to the intended Internet server. Such a server operates on a list of rules given to it by a System Administrator. Some proxy software use list of specific forbidden sites, the others examine the content of a page pertaining to the request.


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Difference Between the Two Servers :

Technologically, theres no substantial difference between a caching server and a proxy server. The difference comes in the desired outcome.

A caching server could be preferred when it is decided to reduce the overall amount of traffic exchanged between the network and the Internet. On the other hand, a proxy server could be preferred if we wish to restrict or prohibit the flow of certain types of information on the network.

Question 6 State with reasons which of the following statements is correct or incorrect:

(a) A business, even if it continually remains passive to the relevant changes in the environment, would still grow and flourish.

(b) A corporate culture is always identical in all the organisations.

(c) There is both opportunity and challenge in Change. (3 2 = 6 Marks) Answer (a) Incorrect: Businesses function within a whole gamut of relevant environment and have

to negotiate their way through it. A successful business has to identify appraise and respond to various opportunities and threats in its environment. The extent to which the business thrives depends upon the manner in which it interacts with environmental situations or constraints. A business remaining passive to changes in its environment is destined to gradually fade away into oblivion.

(b) Incorrect: Every company has its own organisational culture. Each has its own business philosophy and principles, its own ways of approaching to the problems and making decisions, its own work climate, work ethics, etc. Therefore, corporate culture need not be identical in all organisations. However, every organisation over a period of time inherits and percolates down its own specific work ethos and approaches.

(c) Correct: It is said that change is inevitable, especially in the context of business environment. Changes in the business environment from time to time throw up new is