Ca Accounting

PAPER - 1 : ACCOUNTING QUESTIONS 1.

On 31st March, 2006 Kanpur Branch submits the following Trial Balance to its Head Office at Lucknow : Debit Balances Furniture and Equipment Depreciation on furniture Salaries Rent Advertising Telephone, Postage and Stationery Sundry Office Expenses Stock on 1st April, 2005 Goods Received from Head Office Debtors Cash at bank and in hand Carriage Inwards

Rs. in lacs 18 2 25 10 6 3 1 60 288 20 8 7 448

Credit Balances Outstanding Expenses Goods Returned to Head Office Sales Head Office

3 5 360 80 448

Additional Information :

Stock on 31st March, 2006 was valued at Rs. 62 lacs. On 29th March, 2006 the Head Office despatched goods costing Rs. 10 lacs to its branch. Branch did not receive these goods before 1st April, 2006. Hence, the figure of goods received from Head Office does not include these goods. Also the head office has charged the branch Rs. 1 lac for centralised services for which the branch has not passed the entry. You are required to : (i)

Pass Journal Entries in the books of the Branch to make the necessary adjustments

(ii) Prepare Final Accounts of the Branch including Balance Sheet, and (iii) Pass Journal Entries in the books of the Head Office to incorporate the whole of the Branch Trial Balance. 2.

FGH Ltd. has three departments I.J.K. The following information is provided for the year ended 31.3.2006:

Opening stock Opening reserve for unrealised profit Materials consumed Direct labour Closing stock Sales Area occupied (sq. mtr.) No. of employees

I Rs. 5,000 ― 16,000 9,000 5,000 ― 2,500 30

J Rs. 8,000 2,000 20,000 10,000 20,000 ― 1,500 20

K Rs. 19,000 3,000 ― ― 5,000 80,000 1,000 10

2 Stocks of each department are valued at costs to the department concerned. Stocks of I are transferred to J at cost plus 20% and stocks of J are transferred to K at a gross profit of 20% on sales. Other common expenses are salaries and staff welfare Rs. 18,000, rent Rs. 6,000. Prepare Departmental Trading, Profit and Loss Account for the year ending 31.3.2006. 3.

ABC Ltd. sells goods on Hire-purchase by adding 50% above cost. From the following particulars, prepare Hire-purchase Trading account to reveal the profit for the year ended 31.3.2005: Rs. 1.4.2004 1.4.2004

Instalments due but not collected Stock at shop (at cost)

10,000 36,000

1.4.2004

Instalment not yet due

18,000

31.3.2005

Stock at shop

40,000

31.3.2005 Other details:

Instalments due but not collected

18,000

Total instalments became due Goods purchased

1,32,000 1,20,000

Cash received from customers

1,21,000

Goods on which due instalments could not be collected were repossessed and valued at 30% below original cost. The vendor spent Rs. 500 on getting goods overhauled and then sold for Rs. 2,800. 4.

On 1st December, 2005, Vishwakarma Construction Co. Ltd. undertook a contract to construct a building for Rs. 85 lakhs. On 31st March, 2006 the company found that it had already spent Rs. 64,99,000 on the construction. Prudent estimate of additional cost for completion was Rs. 32,01,000. What amount should be charged to revenue in the final accounts for the year ended 31st March, 2006 as per provisions of Accounting Standard 7 (Revised)?

5.

On 1.4.2005, Mr. Ramesh purchased 1,000 equity shares of Rs. 100 each in TELCO Ltd. @ Rs. 120 each from a Broker, who charged 2% brokerage. He incurred 50 paise per Rs. 100 as cost of shares transfer stamps. On 31.1.2006 Bonus was declared in the ratio of 1 : 2. Before and after the record date of bonus shares, the shares were quoted at Rs. 175 per share and Rs. 90 per share respectively. On 31.3.2006 Mr. Ramesh sold bonus shares to a Broker, who charged 2% brokerage. Show the Investment Account in the books of Mr. Ramesh, who held the shares as current assets and closing value of investments shall be made at Cost or Market value whichever is lower.

6.

Firm X & Co. consists of partners A and B sharing Profits and Losses in the ratio of 3 : 2. The firm Y & Co. consists of partners B and C sharing Profits and Losses in the ratio of 5 : 3. On 31st March, 2006 it was decided to amalgamate both the firms and form a new firm XY & Co., wherein A, B and C would be partners sharing Profits and Losses in the ratio of 4:5:1.

Balance Sheets as at 31.3.2006 Liabilities Capital: A B C Reserve Creditors

X & Co., Y & Co. Assets Rs. Rs. Cash in hand/bank 1,50,000 --Debtors 1,00,000 75,000 Stock --50,000 Vehicles 50,000 40,000 Machinery 1,20,000 55,000 Building 4,20,000 2,20,000

X & Co. Y & Co. Rs. Rs. 40,000 30,000 60,000 80,000 50,000 20,000 --90,000 1,20,000 --1,50,000 --4,20,000 2,20,000

3 The following were the terms of amalgamation: (i)

Goodwill of X & Co., was valued at Rs.75,000. Goodwill of Y & Co. was valued at Rs.40,000. Goodwill account not to be opened in the books of the new firm but adjusted through the Capital accounts of the partners.

(ii) Building, Machinery and Vehicles are to be taken over at Rs.2,00,000, Rs.1,00,000 and Rs.74,000 respectively. (iii) Provision for doubtful debts at Rs.5,000 in respect of X & Co. and Rs.4,000 in respect of Y & Co. are to be provided. You are required to: (i)

Show, how the Goodwill value is adjusted amongst the partners.

(ii) Prepare the Balance Sheet of XY & Co. as at 31.3.2006 by keeping partners capital in their profit sharing ratio by taking capital of ‘B’ as the basis. The excess or deficiency to be kept in the respective Partners’ Current account. 7.

Ram commenced business on 1.7.2000 with a capital of Rs. 2,00,000. On 31st March, 2006 an adjudication order for insolvency was made against him. Following are the other details available relating to his business as on 31.3.2006: Sundry Creditors

Rs. 1,50,000

Mortgage Loan (of building) Godown Rent (2 months)

1,00,000 5,000

Wages due Mrs. Ram loan (given out of her own source) Cost of Building (estimated to realise Rs. 1,00,000) Debtors (includes bad of Rs. 10,000) Stock in trade (Realisation value 10,000) Cash in Hand/Bank

8,000 25,000 1,60,000 90,000 15,000 10,000

He maintained books upto 31.3.2003 and profit up to 31.3.2003 was Rs. 1,40,000. He did not maintain books from 1.4.2003 onwards. He has been drawing Rs. 4,000 per month and goods worth Rs. 1,500 per month uniformly from April, 2003 onwards. Prepare statement of affairs and deficiency account. 8.

Apha Limited recently made a public issue in respect of which the following information is available: (a) No. of partly convertible debentures issued 2,00,000; face value and issue price Rs.100 per debenture. (b) Convertible portion per debenture 60%, date of conversion on expiry of 6 months from the date of closing of issue. (c) Date of closure of subscription lists 1.5.2005, date of allotment 1.6.2005, rate of interest on debenture 15% payable from the date of allotment, value of equity share for the purpose of conversion Rs. 60 (Face Value Rs. 10). (d) Underwriting Commission 2% (e) No. of debentures applied for 1,50,000. (f)

Interest payable on debentures half-yearly on 30th September and 31st March.

Write relevant journal entries for all transactions arising out of the above during the year ended 31st March, 2006 (including cash and bank entries).

4 9.

Following is the Balance Sheet as at March 31, 2005: (Rs. ‘000) Liabilities

Max Ltd.

Mini Ltd.

Share capital:

Assets Goodwill

1,000

Other fixed assets

Equity shares of Rs. 100 each

1,500

9% Preference shares of Rs. 100 each

500

400

Debtors Stock

General reserve

180

170

Cash at bank

Profit and loss account 12% Debentures of Rs. 100 each



15

600

200

Sundry creditors

415

225

_____

_____

3,195

2,010

Own debenture (Nominal value Rs. 2,00,000) Discount on issue of debentures Profit and loss account

Max Ltd.

Mini Ltd.

20



1,500

760

651 393

440 680

26

130

192

2 411

_____

3,195

2,010

On 1.4.2005, Max Ltd. adopted the following scheme of reconstruction: (i)

Each equity share shall be sub-divided into 10 equity shares of Rs. 10 each fully paid up. 50% of the equity share capital would be surrendered to the Company.

(ii) Preference dividends are in arrear for 3 years. Preference shareholders agreed to waive 90% of the dividend claim and accept payment for the balance. (iii) Own debentures of Rs. 80,000 were sold at Rs. 98 cum-interest and remaining own debentures were cancelled. (iv) Debentureholders of Rs. 2,80,000 agreed to accept one machinery of book value of Rs. 3,00,000 in full settlement. (v) Creditors, debtors and stocks were valued at Rs. 3,50,000, Rs. 5,90,000 and Rs. 3,60,000 respectively. The goodwill, discount on issue of debentures and Profit and Loss (Dr.) are to be written off. (vi) The Company paid Rs. 15,000 as penalty to avoid capital commitments of Rs. 3,00,000. On 2.4.2005 a scheme of absorption was adopted. Max Ltd. would take over Mini Ltd. The purchase consideration was fixed as below: (a) Equity shareholders of Mini Ltd. will be given 50 equity shares of Rs. 10 each fully paid up, in exchange for every 5 shares held in Mini Ltd. (b) Issue of 9% preference shares of Rs. 100 each in the ratio of 4 preference shares of Max Ltd. for every 5 preference shares held in Mini Ltd. (c) Issue of one 12% debenture of Rs. 100 each of Max Ltd. for every 12% debentures in Mini Ltd. You are required to give Journal entries in the books of Max Ltd. and draw the resultant Balance Sheet as at 2nd April, 2005. 10. Omega Ltd. had equity capital of Rs. 2,00,000 divided into shares of Rs.100 each, 11% cumulative redeemable preference share of Rs.100 each for Rs. 1,00,000 and Rs. 50,000 and Rs. 40,000 respectively to the credit of Profit and Loss Account and General Reserves as on 31st March, 2006. It had also Rs. 8,000 to the credit of Share Premium Account. As per the agreement with the preference shareholders, the Directors decided to redeem the shares on 1.4.2006 at premium of 10%. It was also decided to sell certain investments whose book and market values on 31.3.2006 were Rs. 40,000 and Rs. 50,000 respectively to enable redemption.

5 For purposes of redemption, the Board decided to utilise free reserve to the minimum extent possible. It was decided to issue right equity shares at a premium of 20% to finance the redemption. After redemption, the Board decided to issue bonus shares to equity holders in the ratio of 2 for 5 Holders of 100 preference shares were not traceable. Show the necessary journal entries to record the above transactions in the books of Omega Ltd., and also how the items will appear on the Balance Sheet of the Company. 11. A company made a public issue of 1,25,000 equity shares of Rs. 100 each. Rs. 50 is payable on application. The entire issue was underwritten by four parties – A, B, C and D in the proportion of 30%, 25%, 25% and 20% respectively. Under the terms agreed upon, a commission of 2% was payable on the amounts underwritten. A, B, C and D had also agreed on “firm” underwriting of 4,000, 6,000, Nil and 15,000 shares respectively. The total subscriptions, excluding firm underwriting, including marked applications were for 90,000 shares. Marked applications received were as under : A : 24,000

B : 12,000

C : 20,000

D : 24,000

Ascertain the liability of the individual underwriters. All workings should form part of your answer. 12. X and Y had been carrying on business independently. They agreed to amalgamate and form a new company Z Ltd. with an authorised share capital of Rs. 2,00,000 divided into 40,000 equity shares of Rs. 5 each. On 31st December, 2005, the respective Balance Sheets of X and Y were as follows : X Rs. 3,17,500 1,63,500

Y Rs. 1,82,500 83,875

4,81,000

2,66,375

Less: Current Liabilities

2,98,500

90,125

Representing Capital

1,82,500

1,76,250

Fixed Assets Current Assets

Additional Information : (a) Revalued figures of Fixed and Current Assets were as follows :

Fixed Assets Current Assets

X Rs. 3,55,000 1,49,750

Y Rs. 1,95,000 78,875

(b) The debtors and creditors—include Rs. 21,675 owed by X to Y. The purchase consideration is satisfied by issue of the following shares and debentures : (i)

30,000 equity shares of Z Ltd., to X and Y in the porportion to the profitability of their respective business based on the average net profit during the last three years which were as follows : 2003 Profit 2004 (Loss)/Profit 2005 Profit

X 2,24,788 (1,250) 1,88,962

Y 1,36,950 1,71,050 1,79,500

6 (ii) 15% debentures in Z Ltd., at par to provide an income equivalent to 8% return on capital employed in their respective business as on 31st December, 2005 after revaluation of assets. You are requested to : (1) Compute the amount of debentures and shares to be issued to X and Y. (2) A Balance Sheet of Z Ltd., showing the position immediately after amalgamation. 13. The position of Unfortunate Ltd. on its liquidation is as under: Issued and paid up Capital: 3,000

11% preference shares of Rs. 100 each fully paid.

3,000

Equity shares of Rs. 100 each fully paid.

1,000

Equity shares of Rs. 50 each Rs. 30 per share paid.

Calls in Arrears are Rs. 10,000 and Calls received in Advance Rs. 5,000. Preference Dividends are in arrears for one year. Amount left with the liquidator after discharging all liabilities is Rs. 4,13,000. Articles of Association of the company provide for payment of preference dividend arrears in priority to return of equity capital. You are required to prepare the Liquidators final statement of account. 14. (a) Outstanding Balance

Rs.4 lakhs

ECGC Cover Period for which the advance has remained doubtful

50% More than 3 years remained doubtful (as on March 31, 2004)

Value of security held (excludes worth of Rs.) Calculate the amount of required provision.

Rs.1.50 lakhs

(b) The following is an extract from Trial Balance of overseas Bank Ltd. as at 31st March, 2006 Rs. Bills discounted 12,64,000 Rebate on bills discounted not due on March 31st, 2005 Discount received An analysis of the bills discounted is as follows: Amount Due Date 2006 Rs. (i) 1,40,000 June 5 (ii) 4,36,000 June 12 (iii) 2,82,000 June 25 (iv) 4,06,000 July 6 Calculate Rebate on Bills Discounted as on 31-3-2006.

Rs.

22,160 1,05,708 Rate of Discount (%) 14 14 14 16

15. From the following balances extracted from the books of Perfect General Insurance Company Limited as on 31.3.2006, you are required to prepare Revenue Accounts in respect of Fire and marine Insurance business for the year ended 31.3.2006 to and a Profit and Loss Account for the same period : Directors’ Fees Dividend received Provision for Taxation (as on 1.4. 2005)

Rs. 80,000 1,00,000 85,000

Interest received Fixed Assets (1.4.2005) Income-tax paid during the year

Rs. 19,000 90,000 60,000

7

Fire Outstanding Claims on 1.4.2005 28,000 Claims paid 1,00,000 Reserve for Unexpired Risk on 1.4.2005 2,00,000 Premiums Received 4,50,000 Agent’s Commission 40,000 Expenses of Management 60,000 Re-insurance Premium (Dr.) 25,000 The following additional points are also to be taken into account : (a) Depreciation on Fixed Assets to be provided at 10% p.a.

Marine 7,000 80,000 1,40,000 3,30,000 20,000 45,000 15,000

(b) Interest accrued on investments Rs. 10,000. (c) Closing provision for taxation on 31.3.2006 to be maintained at Rs. 1,24,138 (d) Claims outstanding on 31.3.2006 were Fire Insurance Rs. 10,000; Marine Insurance Rs. 15,000. (e) Premium outstanding on 31.3.2006 were Fire Insurance Rs. 30,000; Marine Insurance Rs. 20,000. (f)

Reserve for unexpired risk to be maintained at 50% and 100% of net premiums in respect of Fire and Marine Insurance respectively.

(g) Expenses of management due on 31.3.2006 were Rs. 10,000 for Fire Insurance and Rs. 5,000 in respect of marine Insurance. 16. The following balances relate to NTPC Ltd. and pertains to the accounts for the year ended on 31st December, 2006: (Rs.in lakhs) Share Capital 200 Fixed Assets 400 Monthly Average of Current Assets 40 Reserve Fund (invested in 6% Govt. Securities Face Value Rs. 120 lakhs) 120 Contingencies Reserve (invested in 6% State Govt. Loans) 40 Loan from Electricity Board 60 Developments Reserve 20 10% Debentures 16 Depreciation Reserve on Fixed Assets 160 Security Deposits of Customers 150 Customers’ Contribution to main lines 4 Preliminary Expenses 10 Tariffs and Dividend Control Reserve 12 The company earned a post tax profit of Rs. 20.4 lakhs. Indicate the disposal of profit, bearing in mind the provisions of the Electricity (Supply) Act, 1948, assuming the Reserve Bank of India rate on the relevant date was 8%. 17. From the following Summary Cash Account of X Ltd. prepare Cash Flow Statement for the year ended 31st March, 2007 in accordance with AS 3 (Revised) using the direct method. The company does not have any cash equivalents. Summary Cash Account for the year ended 31.3.2007 Balance on 1.4.2006 Issue of Equity Shares

Rs. ’000 50 300

Payment to Suppliers Purchase of Fixed Assets

Rs. ’000 2,000 200

8 Receipts from Customers Sale of Fixed Assets

2,800 100

_____ 3,250

Overhead expense Wages and Salaries Taxation Dividend Repayment of Bank Loan Balance on 31.3.2007

200 100 250 50 300 150 3,250

18. (a) Explain, why Accounting in Agricultural operation is not popular. Mention a few pealiar features of Farm Accounting. (b) Whether government accounting is totally different from commercial accounting ? State your opinion with reasons. 19. Write short notes on: (a) Basis of common expenditure among departments. (b) Preferential creditors. (c) Co-insurance. (d) Fluctuating capital method in partnership accounts. (e) Accounting in case of over subscription of shares. (f)

Dividend on partly paid up shares.

(g) Reserve for unexpired risks in an insurance company. 20. Theory questions based on Accounting Standards (a) What are the main considerations in selection and application of accounting policies? (b) What are the components of costs of inventories? Explain in brief. (c) Define the following terms for the purpose of AS 5: (i)

Ordinary activities.

(ii) Extraordinary Activities. (d) What are the two approaches for accounting of government grants? Explain in brief. (e) Explain the disclosure requirements as regards the investor ,where the associate has contingent liabilities. (f)

Describe “ theoretical ex-right value per share” in context of AS 20.

(g) Explain the difference between direct and indirect methods of reporting cash flows from operating activities with reference to Accounting Standard 3( AS 3) revised. (h) Briefly indicate the items, which are included in the expression “borrowing cost” as explained in AS 16. 21. Practical questions based on Accounting Standards (a) A Ltd. had acquired 80% share in the B Ltd. for Rs. 15 lacs. The net assets of B Ltd. on the day are Rs. 22 lacs. During the year A Ltd. sold the investment for Rs. 30 lacs and net assets of B Ltd. on the date of disposal was Rs. 35 lacs. Calculate the profit or loss on disposal of this investment to be recognised in consolidated financial statement. (b) XYZ is an export oriented unit and was enjoying tax holiday upto 31.3.2002. No provision for deferred tax liability was made in accounts for the year ended 31.3.2002. While finalising the accounts for the year ended 31.3.2003, the Accountant says that the entire deferred tax liability upto 31.3.2002 and current year deferred tax liability should be routed through Profit and Loss Account as the relevant Accounting Standard has already become mandatory from 1.4.2001. Do you agree?

9 (c) The accounting year of X Ltd. ends on 30 th September, 2006 and it makes its reports quarterly. However for the purpose of tax, year ends on 31 st March every year. For the Accounting year beginning on 1-10-2005 and ends on 30-9-2006, the quarterly income is as under:1st quarter ending on 31-12-2005

Rs. 200 crores

2nd

quarter ending on 31-3-2006 quarter ending on 30-6-2006

Rs. 200 crores Rs. 200 crores

4th quarter ending on 30-9-2006

Rs. 200 crores Rs. 800 crores

3rd

Total

Average actual tax rate for the financial year ending on 31-3-2006 is 20% and for financial year ending 31-3-2007 is 30%. Calculate tax expense for each quarter. (d) X Ltd. is having a plant (asset) carrying amount of which is Rs. 100 lakhs on 31.3.2004. Its balance useful life is 5 years and residual value at the end of 5 years is Rs. 5 lakhs. Estimated future cash flow from using the plant in next 5 years are:For the year ended on 31.3.2005 31.3.2006 31.3.2007 31.3.2008 31.3.2009

Estimated cash flow (Rs. in lakhs) 50 30 30 20 20

Calculate “value in use” for plant if the discount rate is 10% and also calculate the recoverable amount if net selling price of plant on 31.3.2004 is Rs. 60 lakhs. (e) Top & Top Limited has set up its business in a designated backward area which entitles the company to receive from the Government of India a subsidy of 20% of the cost of investment. Having fulfilled all the conditions under the scheme, the company on its investment of Rs. 50 crore in capital assets, received Rs. 10 crore from the Government in January, 2005 (accounting period being 2004-2005). The company wants to treat this receipt as an item of revenue and thereby reduce the losses on profit and loss account for the year ended 31st March, 2005. Keeping in view the relevant Accounting Standard, discuss whether this action is justified or not. (f)

The notes to accounts of X Ltd. for the year 2005-2006 include the following: “Interest on bridge loan from banks and Financial Institutions and on Debentures specifically obtained for the Company’s Fertiliser Project amounting to Rs. 1,80,80,000 has been capitalized during the year, which includes approximately Rs. 1,70,33,465 capitalised in respect of the utilization of loan and debenture money for the said purpose.” Is the treatment correct? Briefly comment.

(g) Mr. Raj a relative of key Management personnel received remuneration of Rs. 2,50,000 for his services in the company for the period from 1.4.2004 to 30.6.2004. On 1.7.2004 he left the service. Should the relative be identified as at the closing date i.e. on 31.3.2005 for the purposes of AS 18? (h) Global Ltd. has initiated a lease for three years in respect of an equipment costing Rs.1,50,000 with expected useful life of 4 years. The asset would revert to Global Limited under the lease agreement. The other information available in respect of lease agreement is: (i)

The unguaranteed residual value of the equipment after the expiry of the lease term is estimated at Rs.20,000.

10 (ii) The implicit rate of interest is 10%. (iii) The annual payments have been determined in such a way that the present value of the lease payment plus the residual value is equal to the cost of asset. Ascertain in the hands of Global Ltd. (i)

The annual lease payment.

(ii) The unearned finance income. (iii) The segregation of finance income, and also, (iv) Show how necessary items will appear in its profit and loss account and balance sheet for the various years. (i)

Net profit for the year 2005

Rs. 11,00,000

Net profit for the year 2006

Rs. 15,00,000

No. of shares outstanding prior to rights issue Rights issue price Last date to exercise rights

5,00,000 shares Rs. 15.00 1st March 2006

Rights issue is one new share for each five outstanding (i.e. 1,00,000 new shares) Fair value of one equity share immediately prior to exercise of rights on 1st March 2006 was Rs. 21.00. Compute Basic Earnings Per Share. (j)

A firm of contractors obtained a contract for construction of bridges across river Revathi. The following details are available in the records kept for the year ended 31st March, 2007. (Rs. in lakhs) Total Contract Price

1,000

Work Certified

500

Work not Certified Estimated further Cost to Completion

105 495

Progress Payment Received

400

To be Received

140

The firm seeks your advice and assistance in the presentation of accounts keeping in view the requirements of AS 7 (Revised) issued by your institute. (k) The Board of Directors decided on 31.3.2006 to increase the sale price of certain items retrospectively from 1st January, 2006. In view of this price revision with effect from 1st January 2006, the company has to receive Rs. 15 lakhs from its customers in respect of sales made from 1st January, 2006to 31st March, 2006 and the Accountant cannot make up his mind whether to include Rs. 15 lakhs in the sales for 2005-2006. (l)

ABC Ltd. is constructing a fixed asset. Following are the expenses incurred on the construction: Materials Rs. 10,00,000 Direct Expenses Rs. 2,50,000 Total Direct Labour Rs. 5,00,000 (1/10th of the total labour time was chargeable to the construction) Total office & administrative expenses Rs. 8,00,000 (5% is chargeable to the construction) Depreciation on the assets used for the construction of this assets Rs. 10,000 Calculate the cost of fixed assets.

11 (m) The closing inventory at cost of a company amounted to Rs. 2,84,700. The following items were included at cost in the total: (a) 400 coats, which had cost Rs. 80 each and normally sold for Rs. 150 each. Owing to a defect in manufacture, they were all sold after the balance sheet date at 50% of their normal price. Selling expenses amounted to 5% of the proceeds. (b) 800 skirts, which had cost Rs. 20 each. These too were found to be defective. Remedial work in April cost Rs. 5 per skirt, and selling expenses for the batch totaled Rs. 800. They were sold for Rs. 28 each. What should the inventory value be according to AS 2 after considering the above items? (n) From the following information, calculate cash flow from operating activities: Summary of Cash Account for the year ended March 31, 2007 Particulars

Rs.

Particulars

Rs.

To Balance b/d

1,00,000 By Cash Purchases

1,20,000

To Cash sales

1,40,000 By Creditors

1,57,000

To Debtors

1,75,000 By Office & Selling Expenses

75,000

To Trade Commission

50,000 By Income Tax

30,000

To Sale of Investment

30,000 By Investment

25,000

To Loan from Bank To Interest & Dividend

1,00,000 By Repay of Loan

75,000

1,000 By Interest on loan

10,000

By Balance c/d.

1,04,000

5,96,000

5,96,000

SUGGESTED ANSWERS/HINTS 1

(i)

Books of Branch Journal Entries

(ii)

Goods in Transit A/c To Head Office A/c (Goods dispatched by head office but not received by branch before 1st April, 2006)

Dr.

Dr. 10

Expenses A/c To Head Office A/c (Amount charged by head office for centralised services)

Dr.

1

Trading and Profit & Loss Account of the Branch for the year ended 31st March, 2006 Rs. in lacs To Opening Stock 60 By Sales To Goods received from By Closing Stock Head Office 288 Less : Returns 5 283 To Carriage Inwards 7 To Gross Profit c/d 72 422

(Rs. in lacs) Cr. 10

1

Rs. in lacs 360 62

422

12 To Salaries 25 To Depreciation on Furniture 2 To Rent 10 To Advertising 6 To Telephone, Postage & Stationery 3 To Sundry Office Expenses 1 To Head Office Expenses 1 To Net Profit Transferred to Head Office A/c 24

By Gross Profit b/d

72

72

72

Balance Sheet as on 31st March, 2006 Liabilities Head Office Add : Goods in transit Head Office Expenses Net Profit

80 10

Rs. in lacs

1 24

Outstanding Expenses (iii)

115 3 118

Assets Furniture & Equipment 20 Less : Depreciation 2 Stock in hand Goods in Transit Debtors Cash at bank and in hand

Rs. in lacs 18 62 10 20 8 118

Books of Head Office Journal Entries Branch Trading Account To Branch Account (The total of the following items in branch trial balance debited to branch trading account Rs. in lacs Opening Stock 60 Goods received from Head Ofice 288 Carriage Inwards 7)

Dr.

Rs. Dr. 355

Branch Account To Branch Trading Account (Total sales, closing stock and goods returned to Head Office credited to branch trading account, individual amounts being as follows: Rs. in lacs Sales 360 Closing Stock 62 Goods returned to Head Office 5)

Dr.

427

Branch Trading Account T0 Branch Profit and Loss Account (Gross profit earned by branch credited to Branch Profit and Loss Account)

Dr.

72

Branch Profit and Loss Account To Branch Account (Total of the following branch expenses debited to Branch Profit & Loss Account

Dr.

48

Rs. Dr. 355

427

72

48

13 Rs. in lacs Salaries 25 Rent 10 Advertising 6 Telephone, Postage & Stationery 3 Sundry Office Expenses 1 Head Office Expenses 1 Depreciation on furniture & Equipment 2 Branch Profit & Loss Account To Profit and Loss Account (Net profit at branch credited to (general) Profit & Loss A/c) Branch Furniture & Equipment Branch Stock Branch Debtors Branch Cash at Bank and in Hand Goods in Transit To Branch (Incorporation of different assets at the branch in H.O. books)

Dr.

24

Dr. Dr. Dr. Dr. Dr.

18 62 20 8 10

Branch To Branch Outstanding Expenses (Incorporation of Branch Outstanding Expenses in H.O. books)

Dr.

3

2.

To To To To To To To To To

118

3

FGH Ltd. Departmental Trading and Profit and Loss Account for the year ended 31st March, 2006 I

To To

24

Opening stock Material consumed Direct labour Interdepartmental transfer Gross profit Salaries and staff welfare Rent Net profit Net loss (I) Stock reserve (J+K) (Refer W.N.) Balance transferred to Profit and loss account

Rs. 5,000 16,000

J Rs. 8,000 20,000

K Rs. 19,000

Total Rs. 32,000 36,000

9,000

10,000

5,000 35,000

30,000 12,000 80,000

60,000 6,000 85,000

90,000 23,000 2,00,000

9,000 3,000 ______ 12,000

6,000 1,800 4,200 12,000

3,000 1,200 1,800 6,000

18,000 6,000 6,000 30,000 7,000

19,000

3,000

1,000 11,000

I By By By

By By

Sales Interdepartmental transfer Closing stock

Rs.

J Rs.

30,000 5,000

Gross profit b/d Net loss

By

Stock reserve b/d (J + K)

By

Net profit (J + K)

K Rs. 80,000

Total Rs. 80,000

60,000 20,000

5,000

90,000 30,000

______ 35,000 5,000 7,000

______ 80,000 12,000

______ 85,000 6,000

_______ 2,00,000 23,000 7,000

_____ 12,000

_____ 12,000

_____ 6,000

_____ 30,000 5,000 6,000

_____ 11,000

14 Working Note: Calculation of unrealized profit on closing stock Rs. Stock reserve of J department Cost Transfer from I department

30,000 30,000 60,000 20,000

Stock of J department Proportion of stock of I department = Rs. 20,000 Stock reserve =Rs.10,000 

Rs.30,000 = Rs.10,000 Rs.60,000

20 = Rs.1667 (approx.) 120

Stock reserve of K department

Rs.

Stock transferred from J department Less: Profit (stock reserve) 5,000  20% Cost to J department

5,000 1,000 4,000

Proportion of stock of I department =Rs. 4,000  Stock reserve  Rs.2,000 

Rs.30,000  Rs.2,000 Rs.60,000

20  Rs.333 (approx.) 120

Total stock reserve = Rs.1,000 + Rs.333 = Rs.1,333 3.

In the Books of ABC Ltd. Hire Purchase Trading Account for the year ended 31st March, 2005

Dr. 1.1.2004 To Hire purchase stock 1.1.2004 To Goods sold on hire to Purchase 31.3.2005 To Loss on repossession of goods (W.N. 5) 31.3.2005 To Stock reserve To Profit and loss account (Transfer of profit)

Rs. 18,000

1.1.2004

By Stock reserve (1/3 of Rs. 18,000)

1,74,000

1.1.2004 By Hire purchase sales to By Goods sold on hire 31.3.2005 purchase (1/3 of Rs. 1,600 1,74,000) 20,000 By Profit on sale of repossessed goods (W.N. 4)

43,300 31.3.2005 By Hire purchase stock (W.N. 3) 2,56,900

Cr. Rs. 6,000 1,32,000 58,000 900 60,000 2,56,900

15 Alternatively, Hire Purchase Trading Account can be prepared in the following manner: Hire Purchase Trading Account for the year ended 31st March, 2005 Dr. 1.1.2004 1.1.2004 to 31.3.2005

To To To

31.3.2005

To To

To

Hire purchase stock Hire purchase debtors Goods sold on hire purchase Cash (Overhauling charges) Stock reserve Profit and loss account (Transfer of profit)

20,000

By

1.1.2004 to 31.3.2005

By

31.3.2005

By

Stock reserve (1/3 of Rs. 18,000) Cash (Rs. 1,21,000 + Rs. 2,800) Goods sold on hire purchase

By By

(1/3 of Rs. 1,74,000) Hire purchase stock Hire purchase debtors

Balance b/d Hire purchase sales

To

Balance b/d

To

Purchases

Rs. 10,000 By By 1,32,000 _______ By 1,42,000

Cash Repossessed stock (Balancing figure) Balance c/d

Rs. 36,000 By

Goods sold on hire purchase

1,20,000

(Balancing figure)

_______ By

Balance c/d

1,56,000

60,000 18,000

Cr. Rs. 1,21,000 3,000 18,000 1,42,000

Cr. Rs. 1,16,000 40,000 1,56,000

Memorandum Instalment not yet due (hire purchase stock) account

Dr. Balance b/d Goods sold on hire purchase [1,16,000 + (1,16,000  50%)]

Rs. 18,000 By By 1,74,000 1,92,000

Hire purchase Sales Balance c/d (Balancing figure)

Cr. Rs. 1,32,000 60,000 _______ 1,92,000

Goods Repossessed account

4. Dr. To

58,000

Memorandum shop stock account

Dr.

To To

1,23,800

Memorandum Instalment due but not collected (hire purchase debtors) account

2.

3.

Cr. Rs. 6,000

_______ 2,65,800

2,65,800

Dr. To To

500

1.1.2004

43,300

Working Notes: 1.

Rs. 18,000 10,000 1,74,000

Hire purchase debtors

Rs. 3,000 By _____ By 3,000

Hire purchase trading account (W.N. 5) Balance c/d (W.N. 5)

Cr. Rs. 1,600 1,400 3,000

16 To To

Balance b/d Cash account (expenses) Profit on sale

To

1,400 By 500 900 2,800

5.

4.

Cash account

2,800 _____ 2,800

Rs.

100  Original cost of goods repossessed  Rs. 3,000   150  

2,000

Instalments due but not received

3,000

Valuation of repossessed goods (70% of Rs. 2,000)

1,400

Loss on repossession

1,600

Cost incurred till 31 st March, 2006 Prudent estimate of additional cost for completion Total cost of construction Less: Contract price Total foreseeable loss According to para 35 of AS 7 (Revised 2002), the amount of Rs. 12,00,000 is recognized as an expense. Contract work in progress =

Rs. 64,99,000  100 97,00,000

Rs. 64,99,000 32,01,000 97,00,000 85,00,000 12,00,000 required to be

= 67%

Proportion of total contract value recognized as turnover as per para 21 of AS 7 (Revised) on Construction Contracts. = 67% of Rs.85,00,000 = Rs.56,95,000. 5.

In the books of Mr. Krishna Investment Account for the year ended 31st March, 2003 (Scrip: Equity Shares of TELCO Ltd.) Dr.

Date

1.4.2002 31.1.2003 31.3.2003

To To To

Particulars

Nominal Value (Rs.)

Bank A/c Bonus shares Profit & loss A/c

1,00,000 50,000  1,50,000

Working Notes: (i)

Cost (Rs.) 1,23,000  3,100 1,26,100

Date

31.3.2003 31.3.2003

By By

Cr. Cost

Particulars

Nominal Value (Rs.)

Bank A/c Balance c/d

50,000 1,00,000

(Rs.) 44,100 82,000

1,50,000

1,26,100

Cost of equity shares purchased on 1.4.2002 = 1,000  Rs. 120 + 2% of Rs. 1,20,000 + ½% of Rs. 1,20,000 = Rs. 1,23,000

(ii) Sale proceeds of equity shares sold on 31st March, 2003 = 500  Rs. 90 – 2% of Rs. 45,000 = Rs. 44,100. (iii) Profit on sale of bonus shares on 31st March, 2003 = Sales proceeds – Average cost Sales proceeds

= Rs. 44,100

Average cost

= Rs. (1,23,000  50,000)/1,50,000 = Rs. 41,000

Profit = Rs. 44,100 – Rs. 41,000 = Rs. 3,100.

17 (iv) Valuation of equity shares on 31st March, 2003 Cost = (Rs. 1,23,000 × 1,00,000)/1,50,000 = Rs. 82,000) Market Value = 1,000 shares × Rs. 90 = Rs. 90,000 Closing balance has been valued at Rs. 82,000 being lower than the market value. 6.

(i)

Adjustment for raising and writing off of goodwill Raised in old profit sharing ratio

Total Written off in new ratio

Difference

X & Co.

Y & Co.

3:2 Rs.

5:3 Rs.

Rs.

Rs.

Rs.

A. B.

45,000 30,000

--25,000

45,000 Cr. 55,000 Cr.

46,000 Dr. 57,500 Dr.

1,000 Dr. 2,500 Dr.

C

---

15,000

15,000 Cr.

11,500 Dr.

3,500 Cr.

75,000

40,000

1,15,000

(ii)

1,15,000

Nil

Balance Sheet of X Y & Co.(New firm) as on 31.3.2006 Liabilities

Rs. Assets

Capital Accounts: A B C

Vehicle 1,72,000 Machinery

74,000 1,00,000

2,15,000 Building 43,000 Stock

2,00,000 70,000

Current Accounts: A

Debtors 22,000 Cash & Bank

C

1,31,000 70,000

18,000

Creditors

1,75,000

Working Notes: 1.

Rs.

6,45,000

6,45,000

Balance of Capital Accounts at the time of amalgamation of firms X & Co. Profit and loss sharing ratio 3:2 Balance as per Balance Sheet Add: Reserves Revaluation profit (Building) Less: Revaluation loss (Machinery) Provision for doubtful debt. Y & Co. Profit and loss sharing ratio 5:3 Balance as per Balance sheet Add: Reserves Less: Revaluation (vehicle) Provision for doubtful debts

A’s Capital Rs..

B’s Capital Rs.

1,50,000 30,000

1,00,000 20,000

30,000 (12,000)

20,000 (8,000)

(3,000) 1,95,000

(2,000) 1,30,000

B’s Capital Rs.

C’s Capital Rs.

75,000

50,000

25,000 (10,000)

15,000 (6,000)

(2,500) 87,500

(1,500) 57,500

18 2.

Balance of Capital Accounts in the balance sheet of the new firm as on 31.3.2006

Balance b/d:

A Rs. 1,95,000

X & Co.

Y & Co.

--

Adjustment for goodwill

Total capital Rs. 4,30,000 (B’s capital i.e. Rs.2,15,000 x 2) to be contributed in 4:5:1 ratio. Transfer to Current Account 7.

B Rs. 1,30,000

C Rs. --

87,500

57,500

1,95,000

2,17,500

57,500

(1,000) 1,94,000

(2,500) 2,15,000

3,500 61,000

1,72,000

2,15,000

43,000

22,000

---

18,000

Statement of Affairs as on 31.3.2006 Rs.

Rs.

1,80,000

Unsecured creditors As per list A

1,00,000

Creditors fully secured as per list B

Rs. 1,80,000

1,00,000

Estimated value of Nil 8,000

_______

Security Creditors partly secured as per list C Creditors for taxes, wages etc. being payable in full as per list D Deducted as per contra

1,00,000

Nil

Property as per list E Cash in hand

Rs.

Rs.

10,000

10,000

Stock in hand Books debts as per list F

15,000

10,000

Good

80,000

80,000

Bad

10,000

Nil 1,00,000

Nil Deduct creditors for wages as per list D

8,000 8,000

2,88,000

Deficiency as explained in list H 1,80,000

8,000 92,000 88,000 1,80,000

Deficiency Account (List H) Rs. Excess of assets over liabilities on 1.7.2000 Net profit upto 31.3.2003 Deficiency



Rs.

Net loss arising from carrying on of 2,00,000 business from 1.4.2003 to the date of 1,40,000 adjudication (W.N. 2)

1,55,000

88,000 Loss on realisation of Building

60,000

Stock in trade Debtors

5,000 10,000

Drawings for household expenses _______ since 1.4.2003

1,98,000

4,28,000

4,28,000

B’s Capital Rs.21,500 being one-half of the total capital of the firm.

19 Working Notes: (1) The unsecured creditors in this case will be as follows:

Rs. Sundry Creditors

1,50,000

Godown Rent

5,000

Mrs. Ram loan

25,000

(Since loan was given out of her own sources) 1,80,000 (2) Since accounts were not prepared for the period of 1.4.2003 to 31.3.2006 it is necessary to ascertain the profit or loss incurred in these three years. Hence, the following trial balance has been prepared with the given book figures. Trial Balance Dr.

Cr. Rs.

Building

Rs.

1,60,000 Capital introduced

Book debt Good

80,000

Bad

10,000

Add: Profit upto 30.3.2003

1,40,000

90,000

3,40,000

Stock in trade

15,000 Less: Drawings for

Cash in hand/bank

10,000

Loss (balancing figure)

1,55,000

2,00,000

(Rs. 5,500 × 36 months)

1,98,000

Creditors

1,50,000

Mortgage on building

1,00,000

Godown rent

5,000

Wages due

8,000

_______ Mrs. Ram’s loan

25,000

4,30,000 8.

1,42,000

4,30,000

In the books of ALPHA Ltd. Journal Entries

Date

Particulars

1.5.05

Bank A/c To Debenture Application A/c (Application money received on 1,50,000 debentures @ Rs. 100 each)

Dr.

Dr. Amount Rs. 150,00,000

1.6.05

Debenture Application A/c Underwriters A/c To 15% Debentures A/c (Allotment of 1,50,000 debentures to applicants and 50,000 debentures to underwriters)

Dr. Dr.

150,00,000 50,00,000

Underwriting Commission A/c To Underwriters A/c (Commission payable to underwriters @ 2% on Rs. 200,00,000)

Dr.

4,00,000

Cr. Amount Rs. 150,00,000

200,00,000

4,00,000

20 Bank A/c To Underwriters A/c (Amount received from underwriters in settlement of account)

Dr.

46,00,000

Debenture Interest A/c To Bank A/c (Interest paid on debentures for 4 months @ 15% on Rs. 200,00,000)

Dr.

10,00,000

31.10.05 15% Debentures A/c To Equity Share Capital A/c To Share Premium A/c (Conversion of 60% of debentures into shares of Rs.60 each with a face value of Rs.10)

Dr.

120,00,000

31.3.2006

Dr.

7,50,000

30.9.05

Debenture Interest A/c To Bank (Interest paid on debentures for the half year) Working Note:

46,00,000

10,00,000

20,00,000 100,00,000

7,50,000

Calculation of Debenture Interest for the half year ended 31 st March, 2006 On Rs. 80,00,000 for 6 months @ 15%

=

Rs. 6,00,000

On Rs. 120,00,000 for 1 month @ 15%

=

Rs. 1,50,000 Rs. 7,50,000

9.

Particulars

In the Books of Max Ltd.

01.04.2005 Equity share capital A/c

Dr.

Dr.

Cr.

Amount

Amount

Rs.

Rs.

15,00,000

To Equity share capital A/c

15,00,000

(Being sub-division of one share of Rs. 100 each into 10 shares of Rs. 10 each) Equity share capital A/c

Dr.

7,50,000

To Capital reduction A/c

7,50,000

(Being reduction of capital by 50%) Capital reduction A/c

Dr.

13,500

To Bank A/c

13,500

(Being payment in cash of 10% of arrear of preference dividend) Bank A/c

Dr.

78,400

To Own debentures A/c

76,800

To Capital reduction A/c

1,600

(Being profit on sale of own debentures transferred to capital reduction A/c)

21

12% Debentures A/c

Dr.

1,20,000

To Own debentures A/c

1,15,200

To Capital reduction A/c

4,800

(Being profit on cancellation of own debentures transferred to capital reduction A/c) 12% Debentures A/c

Dr.

2,80,000

Capital reduction A/c

Dr.

20,000

To Machinery A/c

3,00,000

(Being machinery taken up by debentureholders for Rs. 2,80,000) Creditors A/c

Dr.

65,000

Capital reduction A/c

Dr.

29,000

To Debtors A/c

61,000

To Stock A/c

33,000

(Being assets and liabilities revalued) Capital reduction A/c

Dr.

4,33,000

To Goodwill A/c

20,000

To Discount on debentures A/c

2,000

To Profit and Loss A/c

4,11,000

(Being the balance of capital reduction transferred to capital reserve account) Capital reduction A/c

Dr.

15,000

To Bank A/c

15,000

(Being penalty paid for avoidance of capital commitments) Capital reduction A/c

Dr.

2,45,900

To Capital reserve A/c

2,45,900

(Being penalty paid for avoidance of capital commitments) 02.04.2005 Business Purchase A/c

Dr.

13,20,000

To Liquidators of Mini Ltd.

13,20,000

(Being the purchase consideration payable to Mini Ltd.) Fixed Assets A/c

Dr.

7,60,000

Stock A/c

Dr.

6,80,000

Debtors A/c

Dr.

4,40,000

Cash at Bank A/c

Dr.

1,30,000

To Sundry Creditors A/c

2,25,000

To 12% Debentures A/c of Mini Ltd.

2,00,000

To Profit and Loss A/c

15,000

22 2,50,000

To General reserve A/c Rs. (1,70,000 + 80,000) To Business purchase A/c

13,20,000

(Being the take over of all assets and liabilities of Mini Ltd. by Max Ltd.) Liquidators of Mini Ltd. A/c

Dr.

13,20,000

To Equity Share Capital

10,00,000

To 9% Preference share capital

3,20,000

(Being the purchase consideration discharged) 12% Debentures of Mini Ltd. A/c

Dr.

2,00,000

To 12% Debentures A/c

2,00,000

(Being Max Ltd. issued their 12% Debentures in against of every Debentures of Mini Ltd.) Balance Sheet of Max Ltd. as at 2.4.2005 Rs. Assets

Liabilities Share Capital:

Rs.

Fixed Assets

Equity Share Capital

19,60,000

17,50,000 Stock

9% Preference share capital

10,40,000

8,20,000 Debtors

Profit and Loss A/c

10,30,000

15,000 Cash in hand/Bank

2,05,900

General Reserve

4,30,000

Capital Reserve

2,45,900

12% Debentures

4,00,000

Sundry Creditors

5,75,000

________

42,35,900

42,35,900

Working Notes: 1.

Purchase Consideration 50  Rs. 10 5 4 9% Preference share capital 4,000   Rs. 100 5

Equity share capital 10,000 

2.

= 10,00,000 = 3,20,000 Rs. 13,20,000

General Reserve Rs. Share Capital of Mini Ltd. (Equity + Preference)

14,00,000

Less: Share Capital issued by Max Ltd.

13,20,000

General reserve (resulted due to absorption)

80,000

Add: General reserve of Mini Ltd.

1,70,000

General reserve of Max Ltd.

1,80,000 4,30,000



Rs. 80,000 is the balancing figure adjusted to general reserve A/c as per AS 14 “Accounting for Amalgamation”.

23 10.

In the Books of Omega Ltd.

Bank A/c To Investment A/c To Profit and Loss A/c (Being the entry for sale of investments for Rs. 50,000) Bank A/c To Equity Share Capital A/c To Securities Premium A/c (Being the entry for issue of right share @ 20% premium) 11% Redeemable Preference Share Capital A/c Premium on Redemption of Preference Shares A/c To Preference Shareholders A/c (Being the entry for transfer of preference Share capital and premium on redemption to Shareholders A/c) Preference Shareholders A/c To Bank A/c (Being the entry for payment made to preference Shareholders) General Reserve A/c Profit and Loss A/c To Capital Redemption Reserve A/c (Being the entry for transfer of accumulated profits to Capital Redemption reserve) Capital Redemption Reserve A/c Profit & Loss A/c To Equity Share Capital A/c (Being the entry for issuing 2 bonus shares for every 5 shares held) Securities Premium A/c To Premium on Redemption of Preference Share A/c (Being the entry for transfer of premium on redemption of preference shares to Share Premium A/c)

Dr.

Debit Rs. 50,000

Dr.

60,000

Dr. Dr.

1,00,000 10,000

Dr.

1,08,900

Dr. Dr.

40,000 10,000

Dr. Dr.

50,000 50,000

Dr.

10,000

Omega Ltd. Balance Sheet as at ...................(an extract) (After the redemption of 11% preference Share) Liabilities Rs. Assets Share Capital : Fixed Assets Issued and paid up Capital : Investments Current assets, loans Equity Shares3,500 shares 3,50,000 and Advances of Rs. 100 each fully paid Cash in hand Reserves and Surplus 8,000 Miscellaneous expenses Securities premium Secured Loans Unsecured Loans Current Liabilities and 1,100 Provisions

Credit Rs. 40,000 10,000 50,000 10,000

1,10,000

1,08,900

50,000

1,00,000

10,000

Rs.

1,100

24 11. (i)

Computation of Unmarked Applications

Shares subscribed excluding firm underwriting but including marked applications Less : Marked Applications (24,000 + 20,000 + 12,000 + 24,000) Unmarked Applications (ii) Statement showing Liability of Underwriters Particulars

No. of Shares 90,000 80,000 10,000

A

B

C

D

Total

Gross Liability (30 : 25 : 25 : 20)

37,500

31,250

31,250

25,000

1,25,000

Less : Marked Applications

24,000

20,000

12,000

24,000

80,000

13,500

11,250

19,250

1000

45,000

3,000

2,500

2,500

2,000

10,000

10,500

8,750

16,750

+1,000

35,000

4,000

6,000

--

+15,000

25,000

6,500

2,750

16,750

16,000

--

6,000

5,000

5,000

--

--

500 500

+2,250 --

11,750 1,750

---

10,000 --

--

--

10,000

--

10,000

--

D 15,000

Total 25,000

Less : Unmarked Applications (in gross liability ratio) Less : Firm Underwriting Surplus of D allocated to A B and C 30 : 25 : 25 Surplus of B allocated

(iii)

Statement of Underwriters’ Liability Firm (No. of Shares) Others (No. of Shares) Total

(iv)

A 4,000

B 6,000

C

--

--

10,000

--

10,000

4,000

6,000

10,000

15,000

35,000

Statement of Amounts due from Underwriters Shares to be subscribed As per (iii) above Amount due @ Rs. 50 per share (Rs.) Less : Commission due @ 2% on nominal value of share underwritten (Rs.)

A

B

4,000

6,000

2,00,000

3,00,000

C

D

10,000

15,000

5,00,000

7,50,000

Total 35,000 17,50,000

75,000

62,500

62,500

50,000

2,50,000

1,25,000

2,37,500

4,37,500

7,00,000

15,00,000

12. (1) Computation of Amount of Debentures and Shares to be issued: X Rs.

(i) Average Net Profit

2,24,788 – 1,250  1,88,962 3

1,36,950  1,71,050  1,79,500 3

= =

Y Rs.

1,37,500 1,62,500

25 (ii) Equity Shares Issued (a) Ratio of distribution X : 1,375 (b) Number X : 13,750 Y : 16,250

Y 1,625

30,000 (c)

Amount 13,750 shares of Rs. 5 each = 16,250 shares of Rs. 5 each = (iii) Capital Employed (after revaluation of assets) Fixed Assets Current Assets

68,750

Less: Current Liabilities (iv) Debentures Issued 8% Return on capital employed 15% Debentures to be issued to provide equivalent income : X : 16,500 × 100

=

Y : 14,700 × 100

=

15

15

(2)

81,250

3,55,000 1,49,750

1,95,000 78,875

5,04,750 2,98,500

2,73,875 90,125

2,06,250

1,83,750

16,500

14,700

1,10,000 98,000

Balance Sheet of Z Ltd. As at 31st December, 2005

Liabilities Share Capital: Authorised 40,000 Equity Shares of Rs. 5 each Issued and Subscribed 30,000 Equity Shares of Rs. 5 each (all the above shares are allotted as fully paid-up pursuant to a contract without payments being received in cash) Reserves and Surplus Capital Reserve Secured Loans 15% Debentures Unsecured Loans Current Liabilities and Provisisons Current Liabilties Provisions

Amount Rs.

2,00,000

Assets Fixed Assets Current Assets

Amount Rs. 5,50,000 2,06,950

1,50,000

32,000 2,08,000 – 3,66,950 – 7,56,950

7,56,950

26 Working Notes :

(1) Purchase Consideration Equity Shares Issued 15% Debentures Issued (2) Capital Reserve (a) Net Assets Taken Over Fixed Assets Current Assets Less : Current Liabilities (b) (c) (d) (e)

Purchase Consideration Capital Reserve [(a) - (b)] Goodwill [(b) - (a)] Capital Reserve [Final Figure(c) - (d)]

13.

X Rs.

Y Rs.

Total Rs.

68,750 1,10,000 1,78,750

81,250 98,000 1,79,250

1,50,000 2,08,000 3,58,000

3,55,000 1,49,750 5,04,750 2,76,825£ 2,27,925 1,78,750 49,175

1,95,000 57,200 2,52,200 90,125 1,62,075 1,79,250

5,50,000 2,06,950 7,56,950 3,66,950 3,90,000 3,58,000

17,175

32,000

Liquidators’ Final Statement of Account Receipts

Rs.

Cash

Payments

Rs.

4,13,000 Return to contributors:

Realisation from: Calls in arrears

Preference dividend 10,000 Preference shareholders

Final call of Rs. 5 per

Calls in advance

equity share of Rs. 50 each (Rs. 5  1,000)

Equity shareholders of 5,000 Rs. 100 each (3,000  Rs. 30) 4,28,000

33,000 3,00,000 5,000 90,000 4,28,000

Working Note: Cash account balance Less: Payment for dividend Preference shareholders Calls in advance

33,000 3,00,000 5,000

Add: Calls in arrears Add: Amount to be received from equity shareholders of Rs. 50 each (1,000  20) Amount disposable Number of equivalent equity shares: 3,000 shares of Rs. 100 each = 6,000 shares of Rs. 50 each 1,000 shares of Rs. 50 each = 1,000 shares of Rs. 50 each = 7,000 shares of Rs. 50 each  £

78, 875 - 21,675 2,98,500 - 21,675

Rs. 4,13,000

3,38,000 75,000 10,000 85,000 20,000 1,05,000

27

Final payment to equity shareholders =

Amount left for distribution Total number of equivalent equity shares

= Rs. 1,05,000 / 7,000 shares = Rs. 15 per share to equity shareholders of Rs. 50 each. 100  Therefore for equity shareholders of Rs. 100 each  Rs. 15   50  

= Rs. 30 per share to equity shareholders of Rs. 100 each. Calls in advance must be paid first, so as to pay the shareholders on prorata basis. Equity shareholders of Rs. 50 each have to pay Rs. 20 and receive Rs. 15 each. As a result, they are required to pay net Rs. 5 per share. 14. (a) Outstanding balance

Rs.4.00 lakhs

Less: Value of security held Unrealised balance

Rs.1.50 lakhs Rs.2.50 lakhs

Less: ECGC Cover (50% of unrealizable balance)

Rs.1.25 lakhs.

Net unsecured balance

Rs.1.25 lakhs

Provision for unsecured portion of advance Provision for secured portion of advance (as on March 31, 2006)

Rs.1.25 lakhs (@ 100% of unsecured portion)

Total provision to be made

Rs.2.375 lakhs (as on March 31, 2006)

Rs.1.125 lakhs (@ 75% of the secured portion)

(b) In order to determine the amount to be credited to the Profit and Loss A/c it is necessary to first ascertain the amount attributable to the unexpired portion of the period of the respective bills. The workings are as given below : (i)

The bill is due on 5th June; hence the number of days after March 31st, is 66. The discount on Rs. 1,40,000 for 66 days @ 14% per annum will be 14/100 × 66/365 × Rs. 1,40,000 = Rs. 3,544.

(ii) Number of days in the unexpired portion of the bill is 73: discount on Rs. 4,36,000 for 73 days @ 14% per annum will be Rs. 12,208. (iii) Number of days in the unexpired portion of the period of the bill is 86: discount on Rs. 2,82,000 for 86 days @ 14% per annum will be Rs. 9,302. (iv) Number of days in the unexpired portion of the period of the bill is 97: discount on Rs. 4,06,000 for 97 days @ 16 % p.a. will be Rs. 17,263. The amount of discount to be credited to the Profit and Loss Account will be: Transfer from Rebate on bills discount as on 31-3-2005 Add: Discount received during the year ended 31-3-2006 Less: Rebate on bills discounted as on 31.3.2006 (see above)

Rs. 22,160 1,05,708 1,27,868 42,317 85,551

28 15.

Form B – RA (Prescribed by IRDA) Perfect General Insurance Co. Ltd Revenue Account for the year ended 31 st March, 2006 Fire and Marine Insurance Businesses Sche dule

Fire Current Year

Marine Current Year

Rs.

Rs.

4,55,000 (-)27,500

3,35,000 (-) 1,95,000

Interest, Dividends and Rent – Gross

—

—

Double Income Tax refund

—

—

Profit on sale of motor car Total (A)

— 4,27,500

— 1,40,000

Premiums earned (net) Change in provision for unexpired risk

1

Claims incurred (net)

2

82,000

88,000

Commission Operating expenses related to Insurance business

3 4

40,000 70,000

20,000 50,000

Bad debts

—

—

Indian and Foreign taxes

—

—

1,92,000 2,35,500

1,58,000 (18000)

Total (B) Profit from Marine Insurance business ( A-B) Schedules forming part of Revenue Account Schedule –1 Premiums earned (net)

Fire Current Year

Marine Current Year

Premiums from direct business written

Rs. 4,80,000

Rs. 3,50,000

Less: Premium on reinsurance ceded Total Premium earned (net)

25,000 4,55,000

15,000 33,5000

82,000

88,000

70,000

50,000

Schedule – 2 Claims incurred (net) Schedule – 4 Operating expenses related to insurance business Expenses of Management

29 Form B-PL Perfect General Insurance Co. Ltd. Profit and Loss Account for the year 31st March, 2006 Particulars Schedule Current Year

Previous Year

Rs.

Rs.

Operating Profit/(Loss) (a) Fire Insurance (b) Marine Insurance (c) Miscellaneous Insurance

2,35,500 (18,000) —

Income From Investments (a) Interest, Dividend & Rent–Gross (b) Profit on sale of investments Less : Loss on sale of investments Other Income (To be specified) Total (A) Provisions (Other than taxation) Depreciation

1,29,000

3,46,500 — 9,000

Other Expenses –Director’s Fee

80,000

Total (B)

89,000

Profit Before Tax Provision for Taxation

2,57,500 99,138

Profit After Tax Working Notes :

1,58,362

1.

Claims under policies less reinsurance Claims paid during the year Add: Outstanding on 31st March, 2006 Less : Outstanding on 1st April, 2005

2.

Expenses of management Expenses paid during the year Add: Outstanding on 31st March, 2006

3.

Premiums less reinsurance Premiums received during the year Add: Outstanding on 31st March, 2006

4.

Fire Rs.

Marine Rs.

1,00,000 10,000 1,10,000 28,000 82,000

80,000 15,000 95,000 7,000 88,000

60,000 10,000 70,000

45,000 5,000 50,000

4,50,000 3,30,000 30,000 20,000 4,80,000 3,50,000 Less : Reinsurance premiums 25,000 15,000 4,55,000 3,35,000 Reserve for unexpired risks is 50% of net premium for fire insurance and 100% of net premium for marine insurance.

30 5.

Provision for taxation account 31.3.2006 To Bank A/c (taxes paid) 31.3.2006 To Balance c/d

16. (a)

Rs.

1.4.2005 60,000 31.3.2006 1,24,138

By Balance b/d By P & L A/c

1,84,138 Computation of Capital Base Fixed Assets Less:Customers’ Contribution Add: Cost of Intangible Assets (Preliminary Expenses) Investments against Contingencies Reserve Monthly average of Current Assets

Rs. 85,000 99,138 1,84,138

Rs. 4,00,00,000 4,00,000

3,96,00,000

(A)

10,00,000 40,00,000 40,00,000 4,86,00,000

Less: Amount written off on account of Depreciation Loans advanced by Electricity Board 10% Debentures Security Deposits by Customers Balance of Tariffs and Dividend Control Reserve Balance of Development Reserve Capital Base (A)  (B) (b) Computation of Reasonable Return Yield 10% (i.e. 8% + 2%) on Capital Base Income from Reserve Fund Investments  6% on Rs. 1,20,00,000 (Investments other than of Contingencies reserve) 1/2% of Loans from Electricity Board 1/2% of Development Reserve 1/2% of Debentures Reasonable Return (c) Computation of Surplus Post tax Profit Less: Reasonable Return Surplus (d) Disposal of Surplus 20% of Reasonable return = Rs. 14,48,000  20/100 = (1) Excess of 20% of Reasonable Return to be Credited to Customers Benefit Account: Rs.5,92,000  Rs. 2,89,600 (Amount refundable to consumers) (2) Balance of Rs. 2,89,600 has to be disposed of as follows: (a) 1/3 of the surplus not exceeding 5% of Reasonable Return at the disposal of the company  5% of 14,48,000 or 1/3 of 2,89,600, whichever is less

(B)

Rs.

1,60,00,000 60,00,000 16,00,000 1,50,00,000 12,00,000 20,00,000 4,18,00,000 68,00,000 Rs. 6,80,000 7,20,000 30,000 10,000 8,000 14,48,000 20,40,000 14,48,000 5,92,000 Rs. 2,89,600

3,02,400

72,400

31 (b)

17.

1/2 of the balance to be credited to Tariff and Dividend Control Reserve (c) The balance to be credited to Customers Rebate Account (in addition to Rs. 3,02,400 shown above) Total Surplus Amount to be refunded to customers (Rs. 3,02,400 + Rs. 1,08,600) Amount to be transferred to Tariff and Dividend Control Reserve Amount at disposal of the company (Rs. 14,48,000 + Rs. 72,400) Net Profit X Ltd. Cash Flow Statement for the year ended 31st March, 2007

1,08,600 1,08,600 5,92,000 4,11,000

1,08,600 15,20,400 20,40,000

(Using the direct method) Rs. ’000

Rs. ’000

Cash flows from operating activities Cash receipts from customers Cash payment to suppliers

2,800 (2,000)

Cash paid to employees

(100)

Cash payments for overheads

(200)

Cash generated from operations Income tax paid

500 (250)

Net cash from operating activities

250

Cash flows from investing activities Payment for purchase of fixed assets Proceeds from sale of fixed assets

(200) 100

Net cash used in investing activities Cash flows from financing activities Proceeds from issuance of equity shares Bank loan repaid Dividend paid

(100) 300 (300) (50)

Net cash used in financing activities

(50)

Net increase in cash

100

Cash at beginning of the period Cash at end of the period

50 150

18. (a) The features of farm accounting are as follows: (i)

Agricultural sector in India is unorganized and dominated by small farmers. Most agricultural farms are family oriented and part of the farms produce is consumed by the family members. Level of the education of the average farmers appears to be the principal barrier for adaptation of agricultural accounting system. Farmers are not aware of the technique of using accounting data for the purpose of management decision and usefulness of data base management.

(ii) The family takes part in management and provides labour for the farm. Farmers cannot

32 afford the additional expenses involved in hiring a person to maintain accounts. (iii) Agriculture is in some cases a seasonal occupation and many farmers have other occupations also. Farming operations are uncertain due to natural calamities. (iv) There are many divisions in farm accounting. Finished product of one division can become the raw material for another. (v) Tax authorities do not rigorously insist on maintenance of books of account. Collection of statistics by the government is also not adequate. (b) The primary objective of commercial accounting is to ascertain the gain or loss of an enterprise for a given period and to find out the position of assets and liabilities at the end of the accounting period. Against this, government accounts are designed to enable government to determine how much money it needs to mobilize in order to maintain its necessary activities at the proper standard of efficiency. It is thus clear that the purpose of government accounting is totally different from that of commercial accounting. The other broad differences between government accounting and commercial accounting can be enumerated as follows : 1.

Financial Statements : Every commercial enterprise prepares a profit and loss account and a Balance Sheet. But in case of government accounting, following two statements are generally prepared: (i)

Government account — to show the net result of all incomes and expenditure including expenditure on capital account ;

(ii) Statement of balancing accounts — to show whether the government owes or has to receive money. 2.

Method of accounting : Government accounts are maintained on cash basis as against commercial accounting in which accounts are normally maintained on mercantile basis.

3.

System of accounting : In commercial accounting, double entry system of book keeping is followed. On the other hand, mass of the government accounts are kept on single entry. There is, however, a portion of accounts which is maintained on double entry basis.

4.

Classification of accounts : In commercial accounting, accounts are broadly classified into (i) personal (ii) real, and (iii) nominal accounts. Government accounts are kept in three parts : Part 1 – Consolidated fund ; Part II – Contingency fund ; and Part III – Public account.

5.

Classification of financial transactions : One of the most distinctive features of the system of government accounts in India is the minute elaboration with which the financial transactions of government under both receipts and payments, are differentiated and classified. Government expenditure in India is classified into a five tier system : Sectors, Major heads, Minor heads, Sub-heads and Detailed heads of accounts. In case of commercial accounting, no such elaborate details are provided.

19. (a) While preparing department accounts, expenses should be allocated among the different departments on the basis of the following principles : 1.

Expenses incurred specially for each department are charged directly thereto e.g., insurance charges of stock held by a department.

2.

Common expenses, the benefit of which is shared by all the dpeartments and which are capable of precise allocation, (e.g., rent, lighting expenses etc.) are distributed among the departments concerned on some equitable basis considered suitable in the circumstances of the case. Rent is charged to different departments according to the floor area occupied by each department, having regard to any favourable location specially allocated to a department. Lighting and heating expenses are distributed on the basis of consumption of energy by each department and so on.

33 3.

Common expenses which are not capable of accurate measurement are dealt with as follows: (i)

Selling expenses, e.g., discount, bad debts, selling commission, etc. are charged on the basis of sales.

(ii)

Administrative and other expenses, e.g., salaries of managers, directors, common advertisement expenses, depreciation on assets, etc., are allocated equally among all the departments that have benefited thereby. Alternatively, no allocation may be made and such expenses may be charged to the combined profit and loss account.

(b) Preferential Creditors: Section 530 specifies the creditors that have to be paid in priority to unsecured creditors or creditor having a floating charge. Such creditors are known as Preferential Creditors. These are the following: (a) All revenues, taxes, cesses and rates, becoming due and payable by the company within 12 months next before the commencement of the winding up. (b) All wages or salaries (including wages payable for time or piece work and salary earned wholly or in part by way of commission) of any employee due for the period not exceeding 4 months within the twelve months next before commencement of winding up provided the amount payable to one claimant will not exceed Rs. 20,000. (c) All accrued holiday remuneration becoming payable to any employee on account of winding up. Note: Persons who advance money for the purpose of making preferential payments under (b) and (c) above will be treated as preferential creditors, provided the money is actually so used. (d) Unless the company is being wound up voluntarily for the purpose of reconstruction, all contributions payable during the 12 months next under the Employees State Insurance Act, 1948, or any other law for the time being in force. (e) All sums due as compensation to employees under the Workmen’s Compensation Act, 1923. (f) All sums due to any employee from a provident fund, pension fund, gratuity fund or any other fund, for the welfare of the employees maintained by the company. (g) The expenses of any investigation held under section 235 or 237 in so far as they are payable by the company. (c) Co-Insurance: In cases of large risks the business is shared between more than one insurer under co-insurance arrangements at agreed percentages. The leading insurer issues the documents, collects premium and settles claims. Statements of Account are rendered by the leading insurer to the other co-insurers. Accounting for premium, claims etc. under coinsurance is done in the same manner as that of the direct business except in respect of the following peculiar features. Incoming co-insurance (i) Premium:The co-insurer books the premium based on the statement received from the leading insurer usually by issuing dummy documents. Entries are made in the Premium Register from which the Premium Account is credited and the Leading Insurer Company’s Account debited. In case the statement is not received, the premium is accounted for on the basis of advices to ensure that all premium in respect of risk assumed in any year is booked in the same year; share of premium relatable to further extension/endorsements on policies by the leading insurer are also accounted for on the basis of subsequent advices. Reference to the relevant communications should be made from the concerned companies to ensure that premium collected by them and attributable to the company is recorded. (ii) Claims Paid: Normally, on the basis of claims paid, advices received from the leading

34 insurer, the Claims Paid Account is debited with a credit to the co-insurer. All such advices are entered into the Claims Paid Register. It is a practice to treat all claims paid advices relating to the accounting year received upto 31st January of the subsequent year from leading insurer as claims paid. Outgoing co-insurance: The share of the insurer only for both premium and claims has to be accounted under respective accounts. The share of other co-insurers is credited or debited, as the case may be, to their personal accounts and not routed through revenue accounts. (d) Under fluctuating capital method, no current account is maintained. All such transactions and events are passed through capital accounts. Naturally, capital account balance of the partners fluctuates everytime. So in fixed capital method a fixed capital balance is maintained over a period of time while in fluctuating capital method, capital account balances fluctuate all the time. (e) In actual practice, issue of shares are either under-or-over subscribed. When an issue is under-subscribed, entries are made on the basis of the shares applied for, provided the minimum subscription has been raised and the company can proceed to allotment. On the other hand, if an issue is over-subscribed, some applications may be rejected and application money refunded and in respect of others, only a part of the shares applied for may be allotted and the excess amount received can be utilized towards allotment or call money which has fallen or will soon fall due for payment. The entries are: (1) On refund of application money to applicants to whom shares have not been allotted: Share Application A/c

Dr.

To Bank A/c (2) When only a part of shares applied for are allowed: Share Application A/c Dr. To Share Allotment A/c To Share Calls-in-Advance Account (f)

(With the amount received in advance for allotment)

In the case of partly paid-up shares, the dividend is payable either on the nominal, called-up or the paid-up amount of shares, depending on the provisions in this regard that there may be in the articles of the company. In the absence of any such provisions, Table A would be applicable. In such a case the amount of dividend payable will be calculated on the amount paid-up on the shares, and while doing so, the dates on which the amounts were paid must be taken into account. Calls paid in advance do not rank for payment of dividend. Instead, interest may be paid on such calls, the rate of interest is 6% p.a. according to Table A; Articles of a company may prescribe different rate. A company may if so authorised by its articles, pay a dividend in proportion to the amount paid on each share, where a larger amount is paid on some shares than on others (Section 93 of the Companies Act, 1956). But where the articles are silent and Table A has been excluded, the amount of dividend payable will have to be calculated on the nominal amount of shares. It should, however, be noted that according to Clause 88 of Table A dividends are to be declared and paid according to the amounts paid or credited as paid on the shares in respect whereof the dividend is paid, but if and so long as nothing is paid upon any of the shares of the company, dividends may be declared and paid according to the nominal amounts of the shares.

(g) In most cases policies are renewed annually except in some cases where policies are issued for a shorter period. Since insurers close their accounts on a particular date, not all risks under policies expire on that date. Many policies extend into the following year during which the risk continues. Therefore on the closing date, there is unexpired liability under various policies which may occur during the remaining term of the policy beyond the year and therefore, a provision for unexpired risks is made at normally 50% in case of Fire Insurance and 100% of in case of Marine Insurance. This Reserve is based on the net premium income earned by the insurance company during the year.

35 20. (a) The main considerations in selection of accounting policies is the presentation of true and fair picture. The financial picture presented by Balance Sheet and the net result shown by Profit & Loss Account should be true and fair. To ensure the true and fair consideration this statement issues following guidelines: Prudence: As defined in the statement, prudence means recognising all losses immediately but ignoring anticipated profits. Business environment is highly dynamic, therefore, enterprises has to keep anticipate the future and take managerial decisions accordingly. This statement suggests that accounting policies should be such that no profit is recognised on the basis of anticipation but all anticipated losses are provided for. For Example: If valuation of stock is always done at cost, consider a situation where market price of the relevant goods has reduced below the cost price, then valuing stock at cost price means ignoring anticipated losses. Similarly if stock is always valued at market price, then take a situation where cost price is below market price, indirectly we are recognising the anticipated gross profit on stock in the books. Therefore, accounting policy should be cost price or market price whichever is less, in this case we are ignoring anticipated profits (if any) but any anticipated losses would be taken care of. Substance over form: While recording a transaction one should look into the substance of the transaction and not only the legal form of it. For Example: The ownership of an asset purchased on hire purchase is not transferred till the payment of the last instalment is made but the asset is shown in the books of the hire purchaser. Similarly, in the case of the amalgamation, the entry for amalgamation in the books of the amalgamated company is recorded on the basis of the status of the shareholders of amalgamating company after amalgamation i.e. if all or almost all the shareholders of the amalgamated company has become shareholder of the amalgamating company by virtue of amalgamation, we record all the transactions as Amalgamation in nature of Merger otherwise it is recorded as Amalgamation in nature of Purchase. Materiality: All the items which are material should be recorded. The materiality of an item is decided on the basis that whether non-disclosure of the item will effect the decision making of the user of accounts. If the answer is positive then the item is material and should be disclosed, in case answer is negative, item is immaterial. By this statement does not mean that immaterial item should not be disclosed, disclosure or non-disclosure of an immaterial item is left at the discretion of the accountant but disclosure of material item is been made mandatory. For Example, Any penalty paid by the enterprise should be disclosed separately even though the amount paid is negligible, payment of any tax also should be disclosed separately and not to be merged with office expenses or miscellaneous expense. (b) Inventories should be valued at the lower of cost and net realisable value. Cost of goods is the summation of: (a) Cost of Purchase. (b) Cost of Conversion. (c) Other cost necessary to bring the inventory in present location and condition. Finished goods should be valued at cost or market price whichever is lower, in other words, finished goods are valued at the lower of cost or net realisable value. Cost has three elements as discussed below: Cost of Purchase: Cost of purchase includes the purchase price plus all other necessary expenses directly attributable to purchase of stock like, taxes, duties, carriage inward, loading/unloading excluding expenses recoverable from the supplier. From the above sum, following items are deducted, duty drawback, CENVAT, VAT, trade discount, rebates. Cost of Conversion: For a trading company cost of purchase along with other cost

36 (discussed below) constitutes cost of inventory, but for a manufacturer cost of inventory also includes cost of conversion. Readers can recollect the calculation of factory cost calculated in Cost Accounting: Direct Material + Direct Labour = Prime Cost Prime Cost + Factory Variable Overhead + Factory Fixed Overhead = Factory Cost. Direct material is included in cost of purchase and the rest items i.e. direct labour and overheads are termed as cost of conversion. Direct labour is cost of workers in the unit who are directly associated with the production process, in other words we can say that direct labour is the cost of labour which can be directly attributed to the units of production. Overheads are indirect expenses. Variable overheads are indirect expenses which is directly related to production i.e., it changes with the change in production in the same proportion. Fixed overheads generally remains constant, it varies only there is some major shift in production. Other Costs: Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. For example, it may be appropriate to include overheads other than production overheads or the costs of designing products for specific customers in the cost of inventories. In determining the cost of inventories, it is appropriate to exclude the following costs and recognise them as expenses in the period in which they are incurred: (a) Abnormal amounts of wasted materials, labour, or other production costs. (b) Storage costs, unless those costs are necessary in the production process prior to a further production stage. (c) Administrative overheads that do not contribute to bringing the inventories to their present location and condition and (d) Selling and distribution costs. (c) (i)

Ordinary activities: Any activities which are undertaken by an enterprise as part of its business and such related activities in which the enterprise engages in furtherance of, incidental to, or arising from, these activities. For example profit on sale of merchandise, loss on sale of unsold stock at the end of the season.

(ii) Extraordinary items: Income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly. For example, profit on sale of furniture or heavy loss of goods due to fire. (d) Two broad approaches may be followed for the accounting treatment of government grants: the ‘capital approach’, under which a grant is treated as part of shareholders’ funds, and the ‘income approach’, under which a grant is taken to income over one or more periods. Those in support of the ‘capital approach’ argue as follows: (i)

Many government grants are in the nature of promoters’ contribution, i.e., they are given by way of contribution towards its total capital outlay and no repayment is ordinarily expected in the case of such grants.

(ii) They are not earned but represent an incentive provided by government without related costs. Arguments in support of the ‘income approach’ are as follows: (i)

The enterprise earns grants through compliance with their conditions and meeting the envisaged obligations. They should therefore be taken to income and matched with the associated costs which the grant is intended to compensate.

(ii) As income tax and other taxes are charges against income, it is logical to deal also with government grants, which are an extension of fiscal policies, in the profit and loss

37 statement. (iii) In case grants are credited to shareholders’ funds, no correlation is done between the accounting treatment of the grant and the accounting treatment of the expenditure to which the grant relates. It is generally considered appropriate that accounting for government grant should be based on the nature of the relevant grant. Grants which have the characteristics similar to those of promoters’ contribution should be treated as part of shareholders’ funds. Income approach may be more appropriate in the case of other grants. (e) Paragraph 21 of Accounting Standard 23 on Accounting for Investments in Associates says that where the associate has a contingent liability , the investor has to disclose the following in the consolidated financial statements in accordance with AS 4:-

(f)

-

Its share of the contingencies and capital commitments of an associate for which it is also contingently liable; and

-

those contingencies that arise because the investor is severally liable for the liabilities of the associate.

As per paragraph 25 of Accounting Standard 20 on Earnings Per Share: “The theoretical ex-rights fair value per share is calculated by adding the aggregate fair value of the shares immediately prior to the exercise of the rights to the proceeds from the exercise of the rights, and dividing by the number of shares outstanding after the exercise of the rights. Where the rights themselves are to be publicly traded separately from the shares prior to the exercise date, fair value for the purposes of this calculation is established at the close of the last day on which the shares are traded together with the rights.”

(g) As per para 18 of AS 3 (Revised) on Cash Flow Statements, an enterprise should report cash flows from operating activities using either: (a) the direct method whereby major classes of gross cash receipts and gross cash payments are disclosed; or (b) the indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows. The direct method provides information which may be useful in estimating future cash flows and which is not available under the indirect method and is, therefore, considered more appropriate than the indirect method. Under the direct method, information about major classes of gross cash receipts and gross cash payments may be obtained either: (a) from the accounting records of the enterprise; or (b) by adjusting sales, cost of sales (interest and similar income and interest expense and similar charges for a financial enterprise) and other items in the statement of profit and loss for: (i)

changes during the period in inventories and operating receivables and payables:

(ii) other non-cash items; and (iii) other items for which the cash effects are investing or financing cash flows. Under the indirect method, the net cash flow from operating activities is determined by adjusting net profit or loss for the effects of: (a) changes during the period in inventories and operating receivables and payables; (b) non-cash items such as depreciation, provisions, deferred taxes, and unrealized foreign exchange gains and losses; and (c) all other items for which the cash effects are investing or financing cash flows.

38 Alternatively, the net cash flow from operating activities may be presented under the indirect method by showing the operating revenues and expenses, excluding non-cash items disclosed in the statement of profit and loss and the changes during the period in inventories and operating receivables and payables. (h) Borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds. As per para 4 of AS 16 on Borrowing Costs, borrowing costs may include : (a) interest and commitment charges on bank borrowings and other short-term and longterm 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 acquired 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. 21. (a)

Calculation of Profit/Loss on disposal of investment in subsidiary Particulars

Rs.

Net Assets of B Ltd. on the date of disposal

Rs. 3,500,000

Less: Minority Interest (35 lacs x 20%)

700,000

A Ltd.'s Share in Net Assets

2,800,000

Proceeds from the sale of Investment

3,000,000

Less: A Ltd.'s share in net assets

2,800,000 200,000

Less: Capital Reserve in the Consolidated Financial Statement A Ltd.'s Share in net asset on the date (22 lacs x 80%)

1,760,000

Less: Cost of investment

1,500,000

Profit on sale of investment

260,000 460,000

(b) Paragraph 33 of AS 22 on “Accounting For Taxes on Income” relates to the transitional provisions. It says, “On the first occasion that the taxes on income are accounted for in accordance with this statement, the enterprise should recognise, in the financial statements, the deferred tax balance that has accumulated prior to the adoption of this statement as deferred tax asset/liability with a corresponding credit/charge to the revenue reserves, subject to the consideration of prudence in case of deferred tax assets. Further Paragraph 34 lays down, “For the purpose of determining accumulated deferred tax in the period in which this statement is applied for the first time, the opening balances of assets and liabilities for accounting purposes and for tax purposes are compared and the differences, if any, are determined. The tax effects of these differences, if any, should be recognised as deferred tax assets or liabilities, if these differences are timing differences.” Therefore, in the case of XYZ, even though AS 22 has come into effect from 1.4.2001, the transitional provisions permit adjustment of deferred tax liability/asset upto the previous year to be adjusted from opening reserve. In other words, the deferred taxes not provided for alone can be adjusted against opening reserves.

39 Provision for deferred tax asset/liability for the current year should be routed through profit and loss account like normal provision. (c) Calculation of tax expense 1st quarter ending on 31-12-2005

20020%

Rs. 40 lakhs

2nd quarter ending on 31-3-2006

20020%

Rs. 40 lakhs

3rd quarter ending on 30-6-2006

20030%

Rs. 60 lakhs

4th

20030%

Rs. 60 lakhs

quarter ending on 30-9-2006 (d) Present value of future cash flow Year ended 31.3.2005

Future Cash Flow 50

Discount @ 10% Rate 0.909

Discounted cash flow 45.45

31.3.2006

30

0.826

24.78

31.3.2007

30

0.751

22.53

31.3.2008 31.3.2009

20 20

0.683 0.620

13.66 12.40

Present value of residual price on 31.3.2009 = 5  0.620 Present value of estimated cash flow by use of an asset and residual value, which is called “value in use”.

118.82 3.10 121.92

If net selling price of plant on 31.3.2004 is Rs. 60 lakhs, the recoverable amount will be higher of Rs. 121.92 lakhs (value in use) and Rs.60 lakhs (net selling price), hence recoverable amount is Rs.121.92 lakhs (e) As per para 10 of AS 12 ‘Accounting for Government Grants’, where the government grants are of the nature of promoters’ contribution, i.e. they are given with reference to the total investment in an undertaking or by way of contribution towards its total capital outlay (for example, central investment subsidy scheme) and no repayment is ordinarily expected in respect thereof, the grants are treated as capital reserve which can be neither distributed as dividend nor considered as deferred income. In the given case, the subsidy received is neither in relation to specific fixed asset nor in relation to revenue. Thus it is inappropriate to recognise government grants in the profit and loss statement, since they are not earned but represent an incentive provided by government without related costs. The correct treatment is to credit the subsidy to capital reserve. Therefore, the accounting treatment followed by the company is not proper. (f)

The treatment done by the company is not in accordance with AS 16 ‘Borrowing Costs’. As per para 10 of AS 16, to the extent that funds are borrowed specifically for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalisation on that asset should be determined as the actual borrowing costs incurred on that borrowing during the period. Hence, the capitalisation of borrowing costs should be restricted to the actual amount of interest expenditure i.e. Rs. 1,70,33,465. Thus, there is an excess capitalisation of Rs. 10,46,535. This has resulted in overstatement of profits by Rs. 10,46,535 and amount of fixed assets has also gone up by this amount.

(g) According to para 10 of AS 18 on Related Party Disclosures, parties are considered to be related if at any time during the reporting period one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions. Hence, Mr. Raj, a relative of key management personnel should be identified as relative as at the closing date i.e. on 31.3.2005.

40 (h) (i)

Calculation of Annual Lease Payment Rs. 1,50,000 20,000 15,020

Cost of the equipment Unguaranteed Residual Value PV of residual value for 3 years @ 10% (Rs.20,000 x 0.751) Fair value to be recovered from Lease Payment (Rs.1,50,000 – Rs.15,020) PV Factor for 3 years @ 10% Annual Lease Payment (Rs. 1,34,980 / PV Factor for 3 years @ 10% i.e. 2.487) (ii) Unearned Financial Income Total lease payments [Rs. 54,275 x 3] Add: Residual value Gross Investments Less: Present value of Investments (Rs.1,34,980 + Rs.15,020) Unearned Financial Income

1,34,980 2.487 54,275 1,62,825 20,000 1,82,825 1,50,000 32,825

(iii) Segregation of Finance Income Year

Lease Rentals Rs. 54,275 54,275 74,275 1,82,825

0 I II III

Finance Charges @ 10% on outstanding amount of the year Rs. 15,000 11,073 6,752 32,825

Repayment

Outstanding Amount

Rs. 39,275 43,202 67,523 1,50,000

Rs. 1,50,000 1,10,725 67,523 --

(iv) Profit and Loss Account ( Relevant Extracts) Credit side

Rs.

I Year

By Finance Income

15,000

II year III year

By Finance Income By Finance Income

11,073 6,752

Balance Sheet ( Relevant Extracts) Assets side



Rs.

I year Lease Receivable

1,50,000

Less: Amount Received II year Lease Receivable

39,275 1,10,725

1,10,725

Less: Received III year :Lease Amount Receivable

43,202 67,523

67,523

Less: Amount received Residual value

47,523 20,000

Annual lease payments are considered to be made at the end of each accounting year. Rs. 74,275 includes unguaranteed residual value of equipment amounting Rs. 20,000.



Rs.

NIL

41

Year 1

Notes to Balance Sheet

Rs.

Minimum Lease Payments (54,275 + 54,275) Residual Value

1,08,550 20,000 1,28,550

Unearned Finance Income(11,073+ 6,752)

17,825

Lease Receivables Classification: Not later than 1 year Later than 1 year but not more than 5 years Total

1,10,725 43,202 67,523 1,10,725

Year II: Minimum Lease Payments Residual Value (Estimated)

54,275 20,000

Unearned Finance Income

74,275 6,752

Lease Receivables (not later than 1year)

67,523

III Year: Lease Receivables (including residual value)

67,523

Amount Received

67,523 NIL

(i)

Fair value of shares immediately prior to exercise of rights  Total amount received from exercise Number of shares outstanding prior to exercise  Number of shares issued in the exercise

(Rs.21.00  5,00,000 shares)  (Rs. 15.00  1,00,000 Shares 5,00,000 Shares  1,00,000 Shares

Theoretical ex-rights fair value per share = Rs. 20.00 Computation of adjustment factor: Fair value per share prior to exercise of rights Rs.( 21.00) = Theoretical ex - rights value per share Rs.( 20.00)

= 1.05

Computation of earnings per share: EPS for the year 2005 as originally reported: Rs. 11,00,000/5,00,000 shares = Rs. 2.20 EPS for the year 2005 restated for rights issue: Rs. 11,00,000/ (5,00,000 shares x 1.05) = Rs. 2.10 EPS for the year 2006 including effects of rights issue: (5,00,000 x 1.05 x 2/12) + (6,00,000 x 10/12) = 5,87,500 shares EPS = 15,00,000/5,87,500 = Rs. 2.55 (j)

(a)

Amount of foreseeable loss Total cost of construction (500 + 105 + 495) Less: Total contract price Total foreseeable loss to be recognized as expense

(Rs in lakhs) 1,100 1,000 100

42 According to para 35 of AS 7 (Revised 2002), when it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognized as an expense immediately. (b)

Contract work-in-progress i.e. cost incurred to date are Rs. 605 lakhs Work certified

(Rs in lakhs) 500

Work not certified

105 605

This is 55% (605/1,100  100) of total costs of construction. (c) Proportion of total contract value recognised as revenue as per para 21 of AS 7 (Revised). 55% of Rs. 1,000 lakhs = Rs. 550 lakhs (d) Amount due from/to customers = Contract costs + Recognised profits – Recognised losses – (Progress payments received + Progress payments to be received) = [605 + Nil – 100 – (400 + 140)] Rs. in lakhs = [605 – 100 – 540] Rs. in lakhs Amount due to customers

= Rs. 35 lakhs

The amount of Rs. 35 lakhs will be shown in the balance sheet as liability. (e) The relevant disclosures under AS 7 (Revised) are given below: Rs. in lakhs Contract revenue Contract expenses Recognised profits less recognized losses Progress billings (400 + 140)

550 605 (100) 540

Retentions (billed but not received from contractee) Gross amount due to customers

140 35

(k) Price revision was effected during the current accounting period 2005-2006. As a result, the company stands to receive Rs. 15 lakhs from its customers in respect of sales made from 1st January, 2006 to 31st March, 2006. If the company is able to assess the ultimate collection with reasonable certainty, then additional revenue arising out of the said price revision may be recognised in 2005- 2006 vide Para 10 of AS 9. (l)

Calculation of the cost of construction of Assets Particulars Direct Materials Direct Labour Direct Expenses Office & Administrative Expenses Depreciation Cost of the Asset

Rs. 1,000,000 50,000 250,000 40,000 10,000 1,350,000

43 (m) Valuation of Closing Stock Particulars Closing Stock at cost Less :Cost of 400 coats (400 x 80) Less: Net Realisable Value (400 x 75) – 5%

Rs.

Rs. 2,84,700

32,000 28,500

3,500 2,81,200 4,000 2,77,200

Provision for repairing cost to be incurred in future (800 x 5) Value of Closing Stock

(n) Cash Flow Statement of …… for the year ended March 31, 2007 (Direct Method) Particulars

Rs.

Rs.

Operating Activities: Cash received from sale of goods

1,40,000

Cash received from Debtors

1,75,000

Trade Commission received

50,000

Less: Payment for Cash Purchases

3,65,000

1,20,000

Payment to Creditors

1,57,000

Office and Selling Expenses

75,000

Payment for Income Tax

30,000

Net Cash Flow from Operating Activities

3,82,000 (17,000)

APPENDIX – I Accounting Standard (AS) 15 ( revised 2005) on ‘Employee Benefits’ comes into effect in respect of accounting periods commencing on or after April 1, 2006. AS 15 (revised 2005) was originally published in March, 2005 issue of the ICAI’s Journal ‘The Chartered Accountant’. Subsequently, the ICAI, in January 2006, made limited revision to AS 15 (revised 2005) primarily with a view to bring the disclosure requirements of the standard relating to the defined benefit plans in line with the corresponding International Accounting Standard (IAS) 19, Employee Benefits; to clarify the application of the transitional provisions ; and to provide relaxation/exemption to the small and medium-sized enterprises(SMEs). The limited revision has been duly incorporated by the ICAI in AS 15 (revised 2005) which has been published in published in the ‘The Chartered Accountant’, March 2006 (page nos. 1354 to 1385). Note: AS 1 to AS 29 [including AS 15 (Revised 2005)] are applicable for May, 2007 Examination. APPENDIX-II Announcements and Limited Revisions to Standards Applicability of Accounting Standard (AS) 11 (revised 2003), The Effects of Changes in Foreign Exchange Rates, in respect of exchange differences arising on a forward exchange contract entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction  1. 

The revised Accounting Standard (AS) 11, The Effects of Changes in Foreign Exchange Rates, was published in the March 2003 issue of the Institute's Journal, 'The Chartered Accountant', (pp.

Issued on the basis of the decision of the Council at its meeting held on June 24-26, 2004.

44 916 to 922). AS 11 (revised 2003) has come into effect in respect of accounting periods commencing on or after 1-4-2004 and is mandatory in nature from that date. 2.

AS 11 (revised 2003) deals, inter alia, with forward exchange contracts. Paragraphs 36 and 37 of AS 11 (revised 2003) deal with accounting for a forward exchange contract or any other financial instrument that is in substance a forward exchange contract, which is not intended for trading or speculation purposes, i.e., it is for hedging purposes. Paragraphs 38 and 39 of AS 11 (revised 2003) deal with forward exchange contracts intended for trading or speculation purposes.

3.

An issue has been raised regarding the applicability of AS 11 (revised 2003) to the exchange difference arising on a forward exchange contract or any other financial instrument that is in substance a forward exchange contract (hereinafter the term 'forward exchange contract' is used to include such other financial instruments also), entered into by an enterprise to hedge the foreign currency risk of a firm commitment 1 or a highly probable forecast transaction. 2

4.

In this regard, it may be noted that paragraphs 36 and 37 of AS 11 (revised 2003) are not intended to deal with forward exchange contracts which are entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction. Further, paragraphs 38 and 39 are also not applicable in respect of such forward exchange contracts since these contracts are not for trading or speculation purposes. Accordingly, it is clarified that AS 11 (revised 2003) does not deal with the accounting of exchange difference arising on a forward exchange contract entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction.

5.

It may be noted that the hedge accounting, in its entirety, including hedge of a firm commitment or a highly probable forecast transaction, is proposed to be dealt with in the accounting standard on Financial Instruments: Recognition and Measurement, which is presently under formulation.

Accounting for exchange differences arising on a forward exchange contract entered into to hedge the foreign currency risk of a firm commitment or a highly probable  The Institute of Chartered Accountants of India (ICAI) issued an Announcement on ‘Applicability of Accounting Standard (AS) 11 (revised 2003), The Effects of Changes in Foreign Exchange Rates, in respect of exchange differences arising on a forward exchange contract entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction ’ (see ‘The Chartered Accountant’, July 2004 (pp. 110)). As per the Announcement, AS 11 (revised 2003) is not applicable to the exchange differences arising on forward exchange contracts entered into to hedge the foreign currency risks of a firm commitment or a highly probable forecast transaction. It is stated in the Announcement that the hedge accounting, in its entirety, including hedge of a firm commitment or a highly probable forecast transaction, is proposed to be dealt with in the Accounting Standard on ‘Financial Instruments: Recognition and Measurement’, which is under formulation.  It may be noted that as per the above Announcement, AS 11 (revised 2003) is not applicable to the exchange differences arising on the forward exchange contracts entered into to hedge the foreign currency risks of a firm commitment or a highly probable forecast transaction. Accordingly, the premium or discount in respect of such contracts continues to be governed by AS 11 (revised 2003), The Effects of Changes in Foreign Exchange Rates.

A firm commitment is a binding agreement for the exchange of a specified quantity of resources at a specified price on a specified future date or dates. 2 A forecast transaction is an uncommitted but anticipated future transaction. Note: Clarification on Applicability of AS 11 to Forward Exchange Contracts Some persons have expressed a view that the Announcement amounts to withdrawal of AS 11 with regard to forward exchange contracts. It is hereby clarified that AS 11 continues to be applicable to exchange differences in respect of all forward exchange contracts other than those entered into, to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction. 1

45  It has been noted that in the absence of any authoritative pronouncement of the Institute on the subject, different enterprises are accounting for exchange differences arising on such contracts in different ways which is affecting the comparability of financial statements. Keeping this in view, the matter has been reconsidered and the Institute is of the view that pending the issuance of the proposed Accounting Standard on ‘Financial Instruments: Recognition and Measurement’, which is under formulation, exchange differences arising on the forward exchange contracts entered into to hedge the foreign currency risks of a firm commitment or a highly probable forecast transaction should be recognised in the statement of profit and loss in the reporting period in which the exchange rate changes. Any profit or loss arising on renewal or cancellation of such contracts should be recognised as income or expense for the period. Applicability Date of Announcement on 'Accounting for exchange differences arising on a forward exchange contract entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction'  The Institute of Chartered Accountants of India (ICAI), in January 2006, issued an Announcement on 'Accounting for exchange differences arising on a forward exchange contract entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction'. Pending the issuance of the proposed Accounting Standard on 'Financial Instruments: Recognition and Measurement', which is under formulation, the said Announcement prescribes the accounting treatment which should be followed in respect of the exchange differences arising on the forward exchange contracts entered into to hedge the foreign currency risks of a firm commitment or a highly probable forecast transaction.  An issue has been raised regarding the applicability date of the Announcement. The ICAI has considered the issue and it has been decided that this Announcement is applicable in respect of accounting period(s) commencing on or after April 1, 2006. Earlier application of the Announcement is however encouraged. Limited Revision to Accounting Standard (AS) 29, Provisions, Contingent Liabilities and Contingent Assets The Council of the Institute of Chartered Accountants of India has decided to make the following limited revisions of Accounting Standard (AS) 29, Provisions, Contingent Liabilities and Contingent Assets. Paragraphs 1, 3 and 5 of AS 29 have been decided to be modified as under (modifications are shown as underlined): Scope 1. This Statement should be applied in accounting for provisions and contingent liabilities and in dealing with contingent assets, except: (a) those resulting from financial instruments that are carried at flair value; (b) those resulting from executory contracts, except where the contract is onerous; (c) those arising in insurance enterprises from contracts with policy-holders; and (d) those covered by another Accounting Standard.” “3. Executory contracts are contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent. This Statement does not apply to executory contracts unless they are onerous.” “5. Where another Accounting Standard deals with a specific type of provision, contingent liability or contingent asset, an enterprise applies that Statement instead of this Statement. For example, certain types of provisions are also addressed in Accounting Standards on: (a) construction contracts (see AS 7, Construction Contracts); (b) taxes on income (see AS22, Accounting for Taxes on income);

46 (c) leases (see AS 19, Leases). However, as AS 19 contains no specific requirements to deal with operating leases that have become onerous, this Statement applies to such cases; and (d) retirement benefits (see AS 15, Accounting for Retirement Benefits in the Financial Statements of Employers). Pursuant to the above limited revision, paragraph 2 of Appendix E (dealing with comparison of AS 29 with IAS 37) to AS 29 stands withdrawn. Consequently, the numbering of subsequent paragraphs of Appendix E is also changed. The limited revision comes into effect in respect of accounting periods commencing on or after April 1, 2006. As a consequence to the Limited Revision to AS 29, Accounting Standards Interpretation (ASI) 30 has been issued. Limited Revision to AS 25 The Council of the Institute of Chartered Accountants of India has decided to make the following limited revision to Accounting Standard (AS) 25, Interim Financial Reporting: Paragraph 29(c) of AS 25 has been decided to be revised as under. The revisions made are shown in strike-through form. “29. To illustrate: (a) …………..(no change) (b) …………..(no change) (c) income tax expense is recognised in each interim period based on the best estimate of the weighted average annual effective income tax rate expected for the full financial year. Amounts accrued for income tax expense in one interim period may have to be adjusted in a subsequent interim period of that financial year if the estimate of the annual effective income tax rate changes.” As a consequence to the above, the following revisions are made in the relevant paragraphs of Appendix 3 to AS 25 (the revisions made are shown in strike-through form). “Measuring Income Tax Expense for Interim Period 8.

………….. (no change)

9.

This is consistent with the basic concept set out in paragraph 27 that the same accounting recognition and measurement principles should be applied in an interim financial report as are applied in annual financial statements. Income taxes are assessed on an annual basis. Therefore, interim period income tax expense is calculated by applying, to an interim period’s pre-tax income, the tax rate that would be applicable to expected total annual earnings, that is, the estimated average annual effective income tax rate. That estimated average annual effective income-tax rate would reflect the tax rate structure expected to be applicable to the full year’s earnings including enacted or substantively enacted changes in the income tax rates scheduled to take effect later in the financial year. The estimated average annual effective income tax rate would be re-estimated on a year-to-date basis, consistent with paragraph 27 of this Statement. Paragraph 16(d) requires disclosure of a significant change in estimate.

10. …………..(no change) 11. As illustration, an enterprise reports quarterly, earns Rs. 150 lakhs pre-tax profit in the first quarter but expects to incur losses of Rs 50 lakhs in each of the three remaining quarters (thus having zero income for the year), and is governed by taxation laws according to which its estimated average annual effective income tax rate is expected to be 35 per cent. The following table shows the amount of income tax expense that is reported in each quarter:

47 (Amount in Rs. lakhs) 1st

2nd

3rd

4th

Quarter

Quarter

Quarter

Quarter

Annual

52.5

(17.5)

(17.5)

(17.5)

0

Tax Expense

Difference in Financial Reporting Year and Tax Year 12. ……………… (no change) 13. To illustrate, an enterprise’s financial reporting year ends 30 September and it reports quarterly. Its year as per taxation laws ends 31 March. For the financial year that begins 1 October, Year 1 ends 30 September of Year 2, the enterprise earns Rs 100 lakhs pre-tax each quarter. The estimated weighted average annual effective income tax rate is 30 per cent in Year 1 and 40 per cent in Year 2. (Amount in Rs. lakhs)

Tax Expense

Quarter

Quarter

Quarter

Quarter

Year

Ending

Ending

Ending

Ending

Ending

31 Dec.

31 Mar.

30 June

30 Sep.

30 Sep.

Year 1

Year 1

Year 2

Year 2

Year 2

30

30

40

40

140

Tax Deductions/Exemptions 14. ……………(no change) Tax Loss Carry forwards 15. …………(no change) 16. To illustrate, an enterprise that reports quarterly has an operating loss carryforward of Rs 100 lakhs for income tax purposes at the start of the current financial year for which a deferred tax asset has not been recognised. The enterprise earns Rs 100 lakhs in the first quarter of the current year and expects to earn Rs 100 lakhs in each of the three remaining quarters. Excluding the loss carryforward, the estimated average annual effective income tax rate is expected to be 40 per cent. The estimated payment of the annual tax on Rs. 400 lakhs of earnings for the current year would be Rs. 120 lakhs {(Rs. 400 lakhs – Rs. 100 lakhs) x 40%}. Considering the loss carryforward, the estimated average annual effective income tax rate would be 30% {(Rs. 120 lakhs/Rs. 400 lakhs) x 100}. This average annual effective income tax rate would be applied to earnings of each quarter. Accordingly, tax expense would be as follows: (Amount in Rs. lakhs)

Tax Expense

1st

2nd

3rd

4th

Quarter

Quarter

Quarter

Quarter

Annual

30.00

30.00

30.00

30.00

120.00”

The limited revision comes into effect in respect of accounting periods commencing on or after 1-4-2004. It may be noted that the limited revision has been made to align the drafting of AS 25 with the corresponding International Accounting Standard (IAS) 34.

48 Deferment of the Applicability of AS 22 to Non-Corporate Enterprises Non-corporate enterprises, such as sole proprietors, partnership firms, trusts, Hindu Undivided Families, association of persons and co-operative societies will now be required to follow Accounting Standards (AS) 22, Accounting for Taxes on Income, in respect of accounting periods commencing on or after 1-4-2006. The decision to this effect has been taken by the Council of the Institute of Chartered Accountants of India (ICAI), at its meeting, held on June 24-26, 2004. The applicability of AS 22 has been deferred for those non-corporate enterprises which were required to follow AS 22 in respect of accounting periods commencing on or after 1-4-2003. It may be noted that the applicability paragraphs of AS 22 provided as below: " Accounting Standards (AS) 22, 'Accounting for Taxes on Income', issued by the Council of the Institute of Chartered Accountants of India, comes into effect in respect of accounting periods commencing on or after 1-4-2001. It is mandatory in nature for: a.

All the accounting periods commencing on or after 01.04.2001, in respect of the following: i.

Enterprises whose equity or debt securities are listed on a recognized stock exchange in India and enterprises that are in the process of issuing equity or debt securities that will be listed on a recognized stock exchange in India as evidenced by the board of directors' resolution in this regard.

ii.

All the enterprises of a group, if the parent presents consolidated financial statements and the Accounting Standard is mandatory in nature in respect of any of the enterprises of that group in terms of (i) above.

b.

All the accounting periods commencing on or after 01.04.2002, in respect of companies not covered by (a) above.

c.

All the accounting periods commencing on or after 01.04.2003, in respect of all other enterprises."

The decision to defer the applicability of AS 22 to enterprises covered by ( c ) above so as to make it mandatory in respect of accounting periods commencing on or after 1-4-2006 instead of 1-4-2003 has been taken by the Council on a consideration of certain representations and views expressed at various forums. The decision has been taken with a view to provide some more time to such enterprises for effective implementation of AS 22. Announcement Elimination of unrealized profits and losses under AS 21, AS 23 and AS 27 Accounting Standard (AS) 21, Consolidated Financial Statements, came into effect in respect of accounting periods commencing on or after 1-4-2001 and is mandatory from that date if an enterprise presents consolidated financial statements. Paragraph 16 of AS 21 requires that intragroup balances and intragroup transactions and resulting unrealised profits should be eliminated in full. It further provides that unrealised losses resulting from intragroup transactions should also be eliminated unless cost cannot be recovered. There may be transactions between a parent and its subsidiary(ies) entered into during accounting periods commencing on or before 31-3-2001. While preparing consolidated financial statements, in respect of some of the transactions entered into during accounting periods commencing on or before 31-3-2001, it may not be practicable to eliminate resulting unrealised profits and losses. It has, therefore, been decided that elimination of unrealised profits and losses in respect of transactions entered into during accounting periods commencing on or before 31-3-2001, is encouraged, but not required on practical grounds. The above position also applies in respect of AS 23, Accounting for Investments in Associates in

49 Consolidated Financial Statements and AS 27, Financial Reporting of Interests in Joint Ventures while applying the 'equity method' and 'proportionate consolidation method' respectively. Announcement Treatment of Inter-Divisional Transfers Attention of the members is invited to the definition of the term 'revenue' in Accounting Standard (AS) 9, Revenue Recognition, issued by the Institute of Chartered Accountants of India, which is reproduced below: "Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from he use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration." (emphasis supplied) The use of the word 'enterprise' in the definition of the term 'revenue' clearly implies that the transfers within the enterprise cannot be considered as fulfilling the definition of the term 'revenue'. Thus, the recognition of inter-divisional transfers as sales is an inappropriate accounting treatment and is inconsistent with Accounting Standard (AS) 9, Revenue Recognition. This aspect is further strengthened by considering the recognition criteria laid down in AS 9. Paragraphs 10 and 11 of AS 9, reproduced below, provide as to when revenue from the sale of goods should be recognised: "10. Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraphs 11 and 12 are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed. 11. In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled: (i)

the seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership; and

(ii) no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods." Since in case of inter-divisional transfers, risks and rewards remain within the enterprise and also there is no consideration from the point of view of the enterprise as a whole, the recognition criteria for revenue recognition are also not fulfilled in respect of inter-divisional transfers. AnAnnouncement Disclosures in cases where a Court/ Tribunal makes an order sanctioning an accounting treatment which is different from that prescribed by an Accounting Standard Paragraph 4.2 of the ‘Preface to the Statements of Accounting Standards’ (revised 2004) provides as under: “4.2 The Accounting Standards by their very nature cannot and do not override the local regulations which govern the preparation and presentation of financial statements in the country. However, the ICAI will determine the extent of disclosure to be made in financial statements and the auditor’s report thereon. Such disclosure may be by way of appropriate notes explaining the treatment of particular

50 items. Such explanatory notes will be only in the nature of clarification and therefore need not be treated as adverse comments on the related financial statements.” In the case of Companies, Section 211 (3B) of the Companies Act, 1956, provides that “Where the profit and loss account and the balance sheet of the company do not comply with the accounting standards, such companies shall disclose in its profit and loss account and balance sheet, the following, namely:a.

the deviation from the accounting standards;

b.

the reasons for such deviation; and

c.

the financial effect, if any, arising due to such deviation.”

In view of the above, if an item in the financial statements of a Company is treated differently pursuant to an Order made by the Court/Tribunal, as compared to the treatment required by an Accounting Standard, following disclosures should be made in the financial statements of the year in which different treatment has been given: 1.

A description of the accounting treatment made along with the reason that the same has been adopted because of the Court/Tribunal Order.

2.

Description of the difference between the accounting treatment prescribed in the Accounting Standard and that followed by the Company.

3.

The financial impact, if any, arising due to such a difference.

It is recommended that the above disclosures should be made by enterprises other than companies also in similar situations.ca Applicability of AS 4 to impairment of assets not covered by present Indian Accounting Standard 1. Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, issued by the Institute in November 2003, comes into effect in respect of accounting periods commencing on or after 1-4-2004. As per AS 29, from the date of this Accounting Standard becoming mandatory, all paragraphs of Accounting Standard (AS) 4, Contingencies and Events Occurring After the Balance Sheet Date, that deal with contingencies (viz., paragraphs 1 (a), 2, 3.1, 4 (4.1 to 4.4), 5 (5.1 to 5.6), 6, 7 (7.1 to 7.3), 9.1 (relevant portion), 9.2, 10, 11, 12 and 16), stand withdrawn. 2. Paragraph 7 of AS 29 provides that this Statement defines provisions as liabilities which can be measured only by using a substantial degree of estimation. It further provides that the term ‘provision’ is also used in the context of items such as depreciation, impairment of assets and doubtful debts: these are adjustments to the carrying amounts of assets and are not addressed in this Statement. In view of this, impairment of assets and doubtful debts are not covered by AS 29. 3. It may be noted that the paragraphs of AS 4 dealing with contingencies also cover provision for contingent loss in case of impairment of assets, not covered by other Accounting Standards, such as, AS 2, Valuation of Inventories, AS 10, Accounting for Fixed Assets, AS 13, Accounting for Investments and AS 28, Impairment of Assets (coming into effect from 1-4-2004). Accordingly, AS 4 deals with impairment of certain assets, for example, the impairment of financial assets like receivables (commonly referred to as the provision for bad and doubtful debts). 4. As may be noted from paragraph 1 above, pursuant to AS 29 coming into effect, the paragraphs of AS 4 that deal with contingencies stand withdrawn. It may further be noted that while impairment of certain assets is covered by some existing Accounting Standards referred to in paragraph 3 above, impairment of financial assets such as receivables, which are not covered by AS 29, is expected to be covered in an Accounting Standard on Financial Instruments: Recognition and Measurement, which is under preparation. 5. In view of the above, it is brought to the notice of the members and others that till the issuance of the proposed Accounting Standard on financial instruments, the paragraphs of AS 4 which deal with contingencies would remain operational to the extent they cover the impairment of assets not covered

51 by other Indian Accounting Standards. Thus, for instance, impairment of receivables (commonly referred to as the provision for bad and doubtful debts) would continue to be covered by AS 4. Announcement Applicability of Accounting Standard (AS) 28, Impairment of Assets, to Small and Medium Sized Enterprises (SMEs) 1. Accounting Standard (AS) 28, Impairment of Assets, issued by the Council of the Institute of Chartered Accountants of India, comes into effect in respect of accounting periods commencing on or after 1-4-2004. The Standard is mandatory in nature from different dates for different levels of enterprises as below: (i)

To Level I enterprises- from accounting periods commencing on or after 1.4.2004.

(ii) To Level II enterprises- from accounting periods commencing on or after 1.4.2006. (iii) To Level III enterprises- from accounting periods commencing on or after 1.4.2008. The criteria for different levels are given in Annexure I. 2.

Considering the feedback received from various interest-groups and the concerns expressed at various forums, it is felt that relaxation should be given to Level II and Level III enterprises (referred to as ‘Small and Medium Sized Enterprises’ (SMEs)), from the measurement principles contained in AS 28, Impairment of Assets.

3.

AS 28 defines, inter alia, the following terms: An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. Recoverable amount is the higher of an asset’s net selling price and its value in use. Net selling price is the amount obtainable from the sale of an asset in an arm’s length transaction between knowledgeable, willing parties, less the costs of disposal. Value in use is the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life.

4.

The relaxations for SMEs in respect of AS 28 have been decided as below: (i) Considering that detailed cash flow projections of SMEs are often not readily available, SMEs are allowed to measure the ‘value in use’ on the basis of reasonable estimate thereof instead of computing the value in use by present value technique. Therefore, the definition of the term ‘value in use’ in the context of the SMEs would read as follows: “Value in use is the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life, or a reasonable estimate thereof”. (ii) The above change in the definition of ‘value in use’ implies that instead of using the present value technique, a reasonable estimate of the ‘value in use’ can be made. Consequently, if an SME chooses to measure the ‘value in use’ by not using the present value technique, the relevant provisions of AS 28, such as discount rate etc., would not be applicable to such an SME. Further, such an SME need not disclose the information required by paragraph 121(g) of the Standard. Subject to this, the other provisions of AS 28 would be applicable to SMEs.

5.

An enterprise, which, pursuant to the above provisions, does not use the present value technique for measuring value in use, should disclose, the fact that it has measured its ‘value in use’ on the basis of the reasonable estimate thereof and the manner in which the estimate has been arrived at including assumptions that govern the estimate.

6.

Where an enterprise has been covered in Level I and subsequently, ceases to be so covered, the enterprise will not qualify for relaxation/exemption from the applicability of this Standard, until the enterprise ceases to be covered in Level I for two consecutive years.

52 7.

Where an enterprise has previously qualified for the above relaxations (being not covered in Level 1) but no longer qualifies for relaxation in the current accounting period, this Standard becomes applicable from the current period without the above relaxations. However, the corresponding previous period figures in respect of the relevant disclosures need not be provided.

The above provisions are applicable in respect of the accounting periods commencing on or after 1-42006 (for Level II enterprises) and 1-4-2008 (for Level III enterprises). However, if an enterprise being a Level II enterprise starts applying AS 28 from accounting periods beginning on or after 1-4-2006, it will continue to apply this Standard even if it ceases to be covered in Level II and becomes a Level III enterprise. Annexure I Criteria for classification of enterprises Level I Enterprises Enterprises which fall in any one or more of the following categories, at any time during the accounting period, are classified as Level I enterprises: (i)

Enterprises whose equity or debt securities are listed whether in India or outside India.

(ii) Enterprises which are in the process of listing their equity or debt securities as evidenced by the board of directors’ resolution in this regard. (iii) Banks including co-operative banks. (iv) Financial institutions. (v) Enterprises carrying on insurance business. (vi) All commercial, industrial and business reporting enterprises, whose turnover for the immediately preceding accounting period on the basis of audited financial statements exceeds Rs. 50 crore. Turnover does not include ‘other income’. (vii) All commercial, industrial and business reporting enterprises having borrowings, including public deposits, in excess of Rs. 10 crore at any time during the accounting period. (viii) Holding and subsidiary enterprises of any one of the above at any time during the accounting period. Level II Enterprises Enterprises which are not Level I enterprises but fall in any one or more of the following categories are classified as Level II enterprises: (i)

All commercial, industrial and business reporting enterprises, whose turnover for the immediately preceding accounting period on the basis of audited financial statements exceeds Rs. 40 lakhs but does not exceed Rs. 50 crore. Turnover does not include ‘other income’.

(ii) All commercial, industrial and business reporting enterprises having borrowings, including public deposits, in excess of Rs. 1 crore but not in excess of Rs. 10 crore at any time during the accounting period. (iii) Holding and subsidiary enterprises of any one of the above at any time during the accounting period. Level III Enterprises Enterprises which are not covered under Level I and Level II are considered as Level III enterprises.

53 ANNOUNCEMENT Tax effect of expenses/income adjusted directly against the reserves and/or Securities Premium Account 1. It has been noticed that some companies are charging certain expenses, which are otherwise required to be charged to the profit and loss account, directly against reserves and/or Securities Premium Account pursuant to the court orders. In such a case, while the expenses are charged to reserves and/or Securities Premium Account, the tax benefit arising from admissibility of such expenses for tax purposes is not recognised in the reserves and/or Securities Premium Account. Such a situation may also arise where an enterprise adjusts its reserves to give effect to a change, if any, in accounting policy consequent upon adoption of an Accounting Standard, in accordance with the transitional provisions contained in the standard. Further, a company may adjust an expense against the Securities Premium Account as allowed under the provisions of section 78 of the Companies Act, 1956. A similar situation may arise where, pursuant to a court order or under transitional provisions prescribed in an accounting standard, an income, which should have otherwise been credited to the profit and loss account in accordance with the requirements of generally accepted accounting principles, may have been directly credited to a reserve account or a similar account and the tax effect thereof is not recognised in the reserve account or a similar account. 2. Not recognising the tax benefit, arising from admissibility of expense charged to the reserves and/or Securities Premium Account, in the reserves and/or Securities Premium Account is contrary to the generally accepted accounting principles because it results in recognition and presentation of tax effect of an expense in a manner which is different from the manner in which the expense itself has been recognised and presented. Similarly, recognising and presenting the tax effect of an income in a manner which is different from the manner in which income itself has been recognised and presented is contrary to the generally accepted accounting principles. Accordingly, any expense charged directly to reserves and/or Securities Premium Account should be net of tax benefits expected to arise from the admissibility of such expenses for tax purposes. Similarly, any income credited directly to a reserve account or a similar account should be net of its tax effect. 3. In view of the above, any item of income or expense adjusted directly to reserves and/or Securities Premium Account should be net of its tax effect. ANNOUNCEMENT Applicability of Accounting Standards to an Unlisted Indian Company, which is a Subsidiary of a Foreign Company Listed Outside India 1. The Council of the Institute of Chartered Accountants of India has issued an Announcement (see ‘The Chartered Accountant’, November 2003 (pp. 480-489)) on ‘Applicability of Accounting Standards’ with a view to lay down the scheme of applicability of Accounting Standards to Small and Medium Sized Enterprises (SMEs). As per the said scheme, all accounting standards are applicable to Level I enterprises. Level I enterprises, inter alia, include (i) enterprises whose equity or debt securities are listed whether in India or outside India, and (ii) holding or a subsidiary of a Level I enterprise. 2. With regard to above, an issue has been raised as to whether, as per the above scheme, a foreign company which is incorporated and listed outside India would also be considered as a Level I enterprise and consequent to this, whether an unlisted Indian company, which is a subsidiary of this foreign company, would become a Level I enterprise merely because of it being a subsidiary of the said foreign company.

54 3. It is clarified that, in the above-stated scheme, the term ‘enterprise’ includes all entities that are required to prepare their financial statements as per the Indian GAAPs. Accordingly, all Indian entities, i.e., the entities which are incorporated in India, are covered in the said scheme. The scheme also covers those foreign entities which are required to prepare their financial statements as per the Indian GAAPs. Thus, in case a foreign company, which is incorporated and listed outside India, is required to prepare its financial statements as per the Indian GAAPs, it will be considered as a Level I enterprise. In such a case, the Indian company, which is a subsidiary of the aforesaid foreign company, would also be considered as a Level I enterprise for the reason that it is a subsidiary of another Level I enterprise. In case the parent foreign company is not required to prepare its financial statements as per the Indian GAAPs, its Indian subsidiary would not be considered to be a Level I enterprise provided it does not meet any other criteria for becoming Level I enterprise as per the said scheme. Thus, in such a situation, the status of the Indian company under the above scheme will be determined independent of the status of its parent foreign company. APPENDIX-III ACCOUNTING STANDARDS INTERPRETATIONS The authority of the Accounting Standards Interpretations (ASI) is the same as that of the Accounting Standard to which it relates. The contents of the ASI are intended for the limited purpose of the Accounting Standard to which it relates. ASI is intended to apply only to material items. The Institute of Chartered Accountants of India has, so far, issued 30 ASIs. These interpretations are available at the institute’s website www.icai.org. The students are advised to refer PE-II Course Study Material (June, 2004 edition) for the text of ASI 1 to ASI 28. The further interpretations - ASI 29 and ASI 30 including revised ASI 3, ASI 4, ASI 14 and ASI 20 are given below: Accounting Standards Interpretation (ASI) 29 Turnover in case of Contractors Accounting Standard (AS) 7, Construction Contracts (revised 2002) ISSUE 1. AS 7, Construction Contracts (revised 2002) deals, inter alia, with revenue recognition in respect of construction contracts in the financial statements of contractors. It requires recognition of revenue by reference to the stage of completion of a contract (referred to as ‘percentage of completion method’). This method results in reporting of revenue which can be attributed to the proportion of work completed. Under this method, contract revenue is recognised as revenue in the statement of profit and loss in the accounting period in which the work is performed. The issue is whether the revenue so recognised in the financial statements of contractors as per the requirements of AS 7 can be considered as ‘turnover’. CONSENSUS 2. The amount of contract revenue recognised as revenue in the statement of profit and loss as per the requirements of AS 7 should be considered as ‘turnover’. BASIS FOR CONCLUSIONS 3.

The paragraph dealing with the ‘Objective’ of AS 7 provides as follows:

“Objective The objective of this Statement is to prescribe the accounting treatment of revenue and costs associated with construction contracts. Because of the nature of the activity undertaken in construction contracts, the date at which the contract activity is entered into and the date when the activity is

55 completed usually fall into different accounting periods. Therefore, the primary issue in accounting for construction contracts is the allocation of contract revenue and contract costs to the accounting periods in which construction work is performed. This Statement uses the recognition criteria established in the Framework for the Preparation and Presentation of Financial Statements to determine when contract revenue and contract costs should be recognized as revenue and expenses in the statement of profit and loss. It also provides practical guidance on the application of these criteria.” From the above, it may be noted that AS 7 deals, inter alia, with the allocation of contract revenue to the accounting periods in which construction work is performed. 4. Paragraphs 21 and 31 of AS 7 provide as follows: “21. When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. An expected loss on the construction contract should be recognised as an expense immediately in accordance with paragraph 35.” “31. When the outcome of a construction contract cannot be estimated reliably: a. revenue should be recognised only to the extent of contract costs incurred of which recovery is probable; and b. contract costs should be recognised as an expense in the period in which they are incurred. An expected loss on the construction contract should be recognised as an expense immediately in accordance with paragraph 35.” From the above, it may be noted that the recognition of revenue as per AS 7 may be inclusive of profit (as per paragraph 21 reproduced above) or exclusive of profit (as per paragraph 31 above) depending on whether the outcome of the construction contract can be estimated reliably or not. When the outcome of the construction contract can be estimated reliably, the revenue is recognised inclusive of profit and when the same cannot be estimated reliably, it is recognised exclusive of profit. However, in either case it is considered as revenue as per AS 7. 5. ‘Revenue’ is a wider term. For example, within the meaning of AS 9, Revenue Recognition, the term ‘revenue’ includes revenue from sales transactions, rendering of services and from the use by others of enterprise resources yielding interest, royalties and dividends. The term ‘turnover’ is used in relation to the source of revenue that arises from the principal revenue generating activity of an enterprise. In case of a contractor, the construction activity is its principal revenue generating activity. Hence, the revenue recognised in the statement of profit and loss of a contractor in accordance with the principles laid down in AS 7, by whatever nomenclature described in the financial statements, is considered as ‘turnover’.

56 Accounting Standards Interpretation (ASI) 30 1 Applicability of AS 29 to Onerous Contracts Accounting Standard (AS) 29, Provisions, Contingent Liabilities and Contingent Assets ISSUE 1. An ‘onerous contract’ is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. The issue is how the recognition and measurement principles of AS 29 should be applied to the ‘onerous contracts’ covered within its scope. CONSENSUS 2. If an enterprise has a contract that is onerous, the present obligation under the contract should be recognised and measured as a provision as per AS 29. 3. For a contract to qualify as an onerous contract, the unavoidable costs of meeting the obligation under the contract should exceed the economic benefits expected to be received under it. The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfill it. 4. The amount of provision in respect of an onerous contract should be measured by applying the principles laid down AS 29. Accordingly, the amount of the provision should not be discounted to its present value. The Appendix to this Interpretation illustrates the application of the above requirements. BASIS FOR CONCLUSIONS 5. Paragraph 14 of AS 29 provides as follows: “14. A provision should be recognised when: (a)

an enterprise has a present obligation as a result of a past event;

(b)

it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

(c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision should be recognised.” Many contracts (for example, some routine purchase orders) can be cancelled without paying compensation to the other party, and therefore, there is no obligation. Other contracts establish both rights and obligations for each of the contracting parties. Where events make such a contract onerous, a liability exists, which is recognised. In respect of such contracts the past obligating event is the signing of the contract, which gives rise to the present obligation. Besides this, when such a contract becomes onerous, an outflow of resources embodying economic benefits is probable. 6. Recognition of losses with regard to onerous contracts relating to items of inventory are recognised, under AS 2, Valuation of Inventories, by virtue of the consideration of the net realisable value. Further, the recognition of losses in case of onerous construction contracts is dealt with in AS 7, Construction Contracts. Therefore, it is inappropriate if in case of onerous contracts to which AS 29 is applicable, the provision is not recognised.

This ASI has been issued as a consequence to the Limited Revision to AS 29, Provisions, Contingent Liabilities and Contingent Assets. The said Limited Revision comes into effect in respect of accounting periods commencing on or after April 1, 2006 (see the ‘Limited Revision’ under the heading ‘Resources: Accounting Standards’). 1

57 Appendix Note: This appendix is illustrative only and does not form part of the Accounting Standards Interpretation. The purpose of this appendix is to illustrate the application of the Interpretation to assist in clarifying its meaning. An enterprise operates profitably from a factory that it has leased under an operating lease. During December 2005 the enterprise relocates its operations to a new factory. The lease on the old factory continues for the next four years, it cannot be cancelled and the factory cannot be relet to another user. Present obligation as a result of a past obligating event - The obligating event occurs when the lease contract becomes binding on the enterprise, which gives rise to a legal obligation. An outflow of resources embodying economic benefits in settlement - When the lease becomes onerous, an outflow of resources embodying economic benefits is probable. (Until the lease becomes onerous, the enterprise accounts for the lease under AS 19, Leases). Conclusion - A provision is recognised for the best estimate of the unavoidable lease payments. Accounting Standards Interpretation (ASI) 3 (Revised) Accounting for Taxes on Income in the situations of Tax Holiday under Section 80-IA and 80-IB of the Income-tax Act, 1961 Accounting Standard (AS) 22, Accounting for Taxes on Income ISSUE 1. Sections 80-IA and 80-IB of the Income-tax Act, 1961 (hereinafter referred to as the ‘Act’) provide certain deductions, for certain years, in determining the taxable income of an enterprise. These deductions are commonly described as ‘tax holiday’ and the period during which these deductions are available is commonly described as ‘tax holiday period’. 2. The issue is how AS 22 should be applied in the situations of tax-holiday under sections 80-IA and 80-IB of the Act. CONSENSUS 3. The deferred tax in respect of timing differences which reverse during the tax holiday period should not be recognised to the extent the enterprise’s gross total income is subject to the deduction during the tax holiday period as per the requirements of the Act. 4. Deferred tax in respect of timing differences which reverse after the tax holiday period should be recognised in the year in which the timing differences originate. However, recognition of deferred tax assets should be subject to the consideration of prudence as laid down in paragraphs 15 to 18 of AS 22. 5. For the above purposes, the timing differences which originate first should be considered to reverse first. The Appendix to this Interpretation illustrates the application of the above requirements. BASIS FOR CONCLUSIONS 6. Section 80A (1) of the Act provides that in computing the total income of an assessee, there shall be allowed from his gross total income, in accordance with and subject to the provisions of this Chapter, the deductions specified in sections 80C to 80U. Therefore, the deductions under sections 80-IA and 80-IB are the deductions from the gross total income of an assessee determined in accordance with the provisions of the Act. For example, depreciation under section 32 of the Act is provided for arriving at the amount of gross total income even if it is not claimed in view of Explanation 5 to clause (ii) of sub-section (1) of section 32 of the Act.

58 7. In view of the above, the amount of the deduction under sections 80-IA and 80-IB of the Act, is based on the gross total income which is determined in accordance with the provisions of the Act. In respect of the situations covered under sections 80-IA and 80-IB, the difference in the relevant accounting income and taxable income (relevant gross total income minus deduction allowed under sections 80-IA and 80-IB) of an enterprise during a tax holiday period is classified into permanent differences and timing differences. The amount of deduction in respect of sections 80-IA and 80-IB is a permanent difference whereas the differences which arise because of different treatment of items of income and expenses for determination of relevant accounting income and relevant gross total income such as depreciation are timing differences. 8. The Framework for the Preparation and Presentation of Financial Statements provides that “An asset is recognised in the balance sheet when it is probable that the future economic benefits associated with it will flow to the enterprise and the asset has a cost or value that can be measured reliably”. The Framework also provides that “A liability is recognised in the balance sheet when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably”. In the situation of tax holiday under Sections 80-IA and 80-IB of the Act, it is probable that deferred tax assets and liabilities in respect of timing differences which reverse during the tax holiday period, whether originated in the tax holiday period or before that (refer provisions of section 80-IA(2) of the Act), will not be realised or settled. Accordingly, a deferred tax asset or a liability for timing differences which reverse during the tax holiday period does not meet the above criteria for recognition of asset or liability, as the case may be, and therefore is not recognised to the extent the gross total income of the enterprise is subject to the deduction during the tax holiday period. 9. Deferred tax assets/liabilities for timing differences which reverse after the tax holiday period, whether originated in the tax holiday period or before that, are recognised in the period in which these differences originate because these can be realised/paid after the expiry of the tax holiday period by payment of lesser or higher amount of tax after the tax holiday period because of reversal of timing differences. 10. According to one view, during the tax holiday period, no deferred tax should be recognised even for the timing differences which reverse after the tax holiday period, because timing differences do not originate, for example, in the situation of a 100 percent tax holiday period the taxable income is nil. This view was not accepted because in the aforesaid situation, although the current tax is nil but deferred tax, on account of the timing differences which will reverse after the tax holiday period, exists. Further, even in case of carry forward of losses which can be set-off against future taxable income, deferred tax may be recognised, as per AS 22, in respect of all timing differences irrespective of the fact that the taxable income of the enterprise is nil in the period in which the timing differences originate. 11. According to another view, the timing differences which will reverse after the tax holiday period should be recognised at the beginning of the first year after the expiry of the tax holiday period and not in the year in which the timing differences originate. Accordingly, as per this view, during the tax holiday period, deferred tax should not be recognised. This view was also not accepted because as per AS 22 deferred tax should be recognised in the period in which the relevant timing differences originate. Appendix Note: This appendix is illustrative only and does not form part of the Accounting Standards Interpretation. The purpose of this appendix is to illustrate the application of the Interpretation to assist in clarifying its meaning.

59 Facts: 1.

The income before depreciation and tax of an enterprise for 15 years is Rs. 1000 lakhs per year, both as per the books of account and for income-tax purposes.

2.

The enterprise is subject to 100 percent tax-holiday for the first 10 years under section 80-IA. Tax rate is assumed to be 30 percent.

3.

At the beginning of year 1, the enterprise has purchased one machine for Rs. 1500 lakhs. Residual value is assumed to be nil.

4.

For accounting purposes, the enterprise follows an accounting policy to provide depreciation on the machine over 15 years on straight-line basis.

5.

For tax purposes, the depreciation rate relevant to the machine is 25% on written down value basis.

The following computations will be made, ignoring the provisions of section 115JB (MAT), in this regard: Table 1 Computation of depreciation on the machine for accounting purposes and tax purposes (Amounts in Rs. lakhs) Year Depreciation for accounting purposes Depreciation for tax purposes 1 100 375 2 100 281 3 100 211 4 100 158 5 100 119 6 100 89 7 100 67 8 100 50 9 100 38 10 100 28 11 100 21 12 100 16 13 100 12 14 100 9 15 100 7 At the end of the 15th year, the carrying amount of the machinery for accounting purposes would be nil whereas for tax purposes, the carrying amount is Rs. 19 lakhs which is eligible to be allowed in subsequent years. Table 2 Computation of Timing differences 1 Year

2 Income before depreciation and tax (both for accounting purposes and tax purposes

3 Accounting Income after depreciation

4 Gross Total Income (after deducting depreciation under tax laws)

5 Deduction under Section 80-IA

6 Taxable Income (4 – 5)

1 2

1000 1000

900 900

625 719

625 719

Nil Nil

7

Total Difference between accounting income and taxable income (3 – 6)

900 900

(Amounts in Rs. lakhs) 8 9 Permanent Timing Difference Difference (deduction (due to pursuant to different section 80- amounts of IA) depreciation for accounting purposes and tax purposes) (0 = Originating and R = Reversing) 625 275 (0) 719 181 (0)

60 3 4 5 6 7 8 9 10 11 12 13 14 15

1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000

900 900 900 900 900 900 900 900 900 900 900 900 900

789 842 881 911 933 950 962 972 979 984 988 911 993

789 842 881 911 933 950 962 972 Nil Nil Nil Nil Nil

Nil Nil Nil Nil Nil Nil Nil Nil 979 984 988 911 993

900 900 900 900 900 900 900 900 79 84 88 91 93

789 842 881 911 933 950 962 972 Nil Nil Nil Nil Nil

111 (0) 58 (0) 19 (0) 11 (R) 33 (R) 50 (R) 62 (R) 72 (R) 79 (R) 84 (R) 88 (R) 91 (R) 74 (R) 19 (0)

Notes: 1. Timing differences originating during the tax holiday period are Rs. 644 lakhs, out of which Rs. 228 lakhs are reversing during the tax holiday period and Rs. 416 lakhs are reversing after the tax holiday period. Timing difference of Rs. 19 lakhs is originating in the 15th year which would reverse in subsequent years when for accounting purposes depreciation would be nil but for tax purposes the written down value of the machinery of Rs. 19 lakhs would be eligible to be allowed as depreciation. 2. As per the Interpretation, deferred tax on timing differences which reverse during the tax holiday period should not be recognised. For this purpose, timing differences which originate first are considered to reverse first. Therefore, the reversal of timing difference of Rs. 228 lakhs during the tax holiday period, would be considered to be out of the timing difference which originated in year 1. The rest of the timing difference originating in year 1 and timing differences originating in years 2 to 5 would be considered to be reversing after the tax holiday period. Therefore, in year 1, deferred tax would be recognised on the timing difference of Rs. 47 lakhs (Rs. 275 lakhs - Rs. 228 lakhs) which would reverse after the tax holiday period. Similar computations would be made for the subsequent years. The deferred tax assets/liabilities to be recognised during different years would be computed as per the following Table. Table 3 Computation of current tax and deferred tax (Amounts in Rs. lakhs) Year

Current tax (Taxable Income x 30%)

Deferred tax (Timing difference x 30%)

Accumulated Deferred tax (L= Liability and A= Asset)

Tax expense

1

Nil

47  30% = 14 (see note 2 above)

14 (L)

14

2

Nil

181  30% = 54

68 (L)

54

3

Nil

111  30% = 33

101 (L)

33

4

Nil

58  30% = 17

118 (L)

17

5

Nil

19  30% = 6

124 (L)

6

6

Nil

Nil1

124 (L)

Nil

7

Nil

Nil1

124 (L)

Nil

8

Nil

Nil1

124 (L)

Nil

9

Nil

Nil1

124 (L)

Nil

10

Nil

Nil1

124 (L)

Nil

1

No deferred tax is recognized since in respect of timing differences reversing during the tax holiday period, no deferred tax was recognized at their origination.

61 11

294

79  30% = 24

100 (L)

270

12

295

84  30% = 25

75 (L)

270

13

296

88  30% = 26

49 (L)

270

14

297

91  30% = 27

22 (L)

270

15

298

74  30% = 22

Nil

270

19  30% = 6

(A)2

6

Accounting Standards Interpretation (ASI) 4 (Revised) Losses under the head Capital Gains Accounting Standard (AS) 22, Accounting for Taxes on Income [This revised Accounting Standards Interpretation replaces ASI 4 issued in December 2002.] ISSUE 1. The issue is how AS 22 should be applied in respect of ‘loss’ arising under the head ‘Capital gains’ of the Income-tax Act, 1961 (hereinafter referred to as the ‘Act’), which can be carried forward and setoff in future years, only against the income arising under that head as per the requirements of the Act. CONSENSUS 2. Where an enterprise’s statement of profit and loss includes an item of ‘loss’ which can be set-off in future for taxation purposes, only against the income arising under the head ‘Capital gains’ as per the requirements of the Act, that item is a timing difference to the extent it is not set-off in the current year and is allowed to be set-off against the income arising under the head ‘Capital gains’ in subsequent years subject to the provisions of the Act. In respect of such ‘loss’, deferred tax asset should be recognised and carried forward subject to the consideration of prudence. Accordingly, in respect of such ‘loss’, deferred tax asset should be recognised and carried forward only to the extent that there is a virtual certainty, supported by convincing evidence, that sufficient future taxable income will be available under the head ‘Capital gains’ against which the loss can be set-off as per the provisions of the Act. Whether the test of virtual certainty is fulfilled or not would depend on the facts and circumstances of each case. The examples of situations in which the test of virtual certainty, supported by convincing evidence, for the purposes of the recognition of deferred tax asset in respect of loss arising under the head ‘Capital gains’ is normally fulfilled, are sale of an asset giving rise to capital gain (eligible to setoff the capital loss as per the provisions of the Act) after the balance sheet date but before the financial statements are approved, and binding sale agreement which will give rise to capital gain(eligible to set-off the capital loss as per the provisions of the Act). 3. In cases where there is a difference between the amounts of ‘loss’ recognised for accounting purposes and tax purposes because of cost indexation under the Act in respect of long-term capital assets, the deferred tax asset should be recognised and carried forward (subject to the consideration of prudence) on the amount which can be carried forward and set-off in future years as per the provisions of the Act. Transitional Provision 4. Where an enterprise first applies this revised ASI, the deferred tax asset recognized previously considering the reasonable level of certainty, as per the pre-revised ASI 4, and no longer meets the recognition criteria laid down in the revised ASI, should be written-off with a corresponding charge to the revenue reserves.

Deferred tax asset of Rs. 6 lakhs would be recognized at the end of year 15 subject to consideration of prudence as per AS 22. If it is so recognized, the said deferred tax asset would be realized in subsequent periods when for tax purposes deprecation would be allowed but for accounting purposes no depreciation would be recognized. 2

62 BASIS FOR CONCLUSIONS 5. Section 71 (3) of the Act provides that “Where in respect of any assessment year, the net result of the computation under the head “Capital gains” is a loss and the assessee has income assessable under any other head of income, the assessee shall not be entitled to have such loss set off against income under the other head”. 6. Section 74 (1) of the Act provides that “Where in respect of any assessment year, the net result of the computation under the head “Capital gains” is a loss to the assessee, the whole loss shall, subject to the other provisions of this Chapter, be carried forward to the following assessment year, and— (a)

in so far as such loss relates to a short-term capital asset, it shall be set off against income, if any, under the head “Capital gains” assessable for that assessment year in respect of any other capital asset;

(b)

in so far as such loss relates to a long-term capital asset, it shall be set off against income, if any, under the head “Capital gains” assessable for that assessment year in respect of any other capital asset not being a short-term capital asset;

(c) if the loss cannot be wholly so set-off, the amount of loss not so set off shall be carried forward to the following assessment year and so on.” Section 74 (2) of the Act provides that “No loss shall be carried forward under this section for more than eight assessment years immediately succeeding the assessment year for which the loss was first computed”. 7. AS 22 defines ‘timing differences’ as “the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods”. 8. Where an enterprise’s statement of profit and loss includes an item of loss, which is considered a ‘loss’ under the head ‘Capital gains’ as per the provisions of the Act, the loss is a timing difference, to the extent the same is not set-off in the current year, because this loss can be allowed to be set-off against income arising under the head ‘Capital gains’ in future, subject to the provisions of the Act, and to that extent the amount of income under that head will not be taxable in the future year even though the said income would be included in the determination of the accounting income of that year. 9. AS 22 provides that “Deferred tax should be recognised for all the timing differences, subject to the consideration of prudence in respect of deferred tax assets as set out in paragraphs 15-18”. Paragraph 15 of AS 22 provides that “Except in the situations stated in paragraph 17, deferred tax assets should be recognised and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable income will be available against which such deferred tax assets can be realised.” Paragraphs 17 and 18 of AS 22 provide as follows: “17. Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realised. 18. The existence of unabsorbed depreciation or carry forward of losses under tax laws is strong evidence that future taxable income may not be available. Therefore, when an enterprise has a history of recent losses, the enterprise recognises deferred tax assets only to the extent that it has timing differences the reversal of which will result in sufficient income or there is other convincing evidence that sufficient taxable income will be available against which such deferred tax assets can be realised. In such circumstances, the nature of the evidence supporting its recognition is disclosed.” The income under the head ‘Capital gains’ does not arise in the course of the operating activities of an enterprise. Thus, for the purpose of recognition of a deferred tax asset, the degree of certainty of such an income arising in future should be higher. Accordingly, in case of ‘loss’ under the head ‘Capital gains’, deferred tax asset should be recognised and carried forward only to the extent that there is a virtual certainty, supported by convincing evidence, that sufficient future taxable income will be available under the head ‘Capital gains’ against which the loss can be set-

63 off as per the provisions of the Act. In this regard, virtual certainty of the availability of sufficient future taxable income against which deferred tax assets can be realised, will be construed to mean virtual certainty of the availability of taxable income under the head “Capital gains” in future in accordance with the provisions of the Act. 10. In cases where there is a difference between the amounts of ‘loss’ recognised for accounting purposes and tax purposes because of cost indexation under the Act in respect of long-term capital assets, deferred tax asset is recognised and carried forward (subject to the consideration of prudence) on the amount which can be carried forward and set-off in future years as per the provisions of the Act since that is the amount which will be available for set-off in future years as per the provisions of the Act. 11. As per the requirements of the pre-revised ASI 4, deferred tax asset in respect of a loss arising under the head ‘Capital Gains’, in certain situations, was recognised on the consideration of the reasonable certainty. The revised ASI 4, however, requires that in all cases, deferred tax asset in respect of such loss is recognised only to the extent there is a virtual certainty, supported by convincing evidence, that sufficient future taxable income will be available under the head ‘Capital gains’ against which the loss can be set-off as per the provisions of the Act. As a result, a deferred tax asset, recognised as per the pre-revised ASI 4, may not meet the recognition criteria laid down in the revised ASI and consequently, would be required to be written-off. A deferred tax asset, which is required to be written-off in this manner, is charged to the revenue reserves. Accounting Standards Interpretation (ASI) 14 (Revised) Disclosure of Revenue from Sales Transactions Accounting Standard (AS) 9, Revenue Recognition [This revised Accounting Standards Interpretation replaces ASI 14 issued in March 2004.] ISSUE 1. What should be the manner of disclosure of excise duty in the presentation of revenue from sales transactions (turnover) in the statement of profit and loss. CONSENSUS 2. The amount of turnover should be disclosed in the following manner on the face of the statement of profit and loss: Turnover (Gross)

XX

Less: Excise Duty XX Turnover (Net)

XX

3. The amount of excise duty to be shown as deduction from turnover as per paragraph 2 above should be the total excise duty for the year except the excise duty related to the difference between the closing stock and opening stock. The excise duty related to the difference between the closing stock and opening stock should be recognised separately in the statement of profit and loss, with an explanatory note in the notes to accounts to explain the nature of the two amounts of excise duty. BASIS FOR CONCLUSIONS 4. Financial analysts and other users of financial statements, sometimes, require the information related to turnover gross of excise duty as well as net of excise duty for meaningful understanding of financial statements. However, it was noted that some enterprises disclose turnover net of excise duty while others disclose turnover at gross amount. Accordingly, this Interpretation requires disclosure of turnover gross of excise duty as well as net of excise duty on the face of the statement of profit and loss.

64 INVITATION TO EMPLOYERS 5. The excise duty related to the difference between the closing stock and opening stock is not shown as deduction from turnover since it is not included in the turnover (gross). As per the interpretation, the excise duty related to the difference between the closing stock and opening stock is recognised separately in the statement of profit and loss. 6. As per the interpretation, two amounts of excise duty would be appearing in the statement of profit and loss: one as deduction from turnover and the other as a separate item in the statement of profit and loss. With a view to explain the nature of these two amounts of excise duty appearing in the statement of profit and loss, this Interpretation requires an explanatory note to be included in this regard in the notes to accounts. Accounting Standards Interpretation (ASI) 20 (Revised) Disclosure of Segment Information Accounting Standard (AS) 17, Segment Reporting ISSUE 1. Whether an enterprise, which has neither more than one business segment nor more than one geographical segment, is required to disclose segment information as per AS 17. CONSENSUS 2. In case by applying the definitions of ‘business segment’ and ‘geographical segment’, contained in AS 17, it is concluded that there is neither more than one business segment nor more than one geographical segment, segment information as per AS 17 is not required to be disclosed. However, the fact that there is only one ‘business segment’ and ‘geographical segment’ should be disclosed by way of a note. BASIS FOR CONCLUSIONS 3. The paragraph of AS 17 dealing with ‘Objective’ provides as under: “The objective of this Statement is to establish principles for reporting financial information, about the different types of products and services an enterprise produces and the different geographical areas in which it operates. Such information helps users of financial statements: a. b.

better understand the performance of the enterprise; better assess the risks and returns of the enterprise; and

c.

make more informed judgements about the enterprise as a whole.

Many enterprises provide groups of products and services or operate in geographical areas that are subject to differing rates of profitability, opportunities for growth, future prospects, and risks. Information about different types of products and services of an enterprise and its operations in different geographical areas - often called segment information - is relevant to assessing the risks and returns of a diversified or multi-locational enterprise but may not be determinable from the aggregated data. Therefore, reporting of segment information is widely regarded as necessary for meeting the needs of users of financial statements.” In case of an enterprise, which has neither more than one business segment nor more than one geographical segment, the relevant information is available from the balance sheet and statement of profit and loss itself and, therefore, keeping in view the objective of segment reporting, such an enterprise is not required to disclose segment information as per AS 17. The disclosure of the fact that there is only one ‘business segment’ and ‘geographical segment’ and, therefore, the segment information is not provided by the concerned enterprise is useful for the users of the financial statements while making a comparison among various enterprises.

65 PAPER – 2 : AUDITING QUESTIONS 1.

(a) Briefly explain the procedure for the formulation of Auditing and Assurance Standards. (b) Is compliance with documents issued by the Institute of Chartered Accountants of India necessary for the proper discharge of functions of members of the Institute?

2.

(a) “The detection of errors and frauds is no longer an audit objective.” Comment. (b) What are the inherent limitations of audit? Explain in brief.

3.

What is audit evidence? Explain different types of audit evidence.

4.

“Audit materiality requires that the auditor should consider materiality and its relationship with audit risk when conducting an audit.” Explain this statement.

5.

(a) What is meant by the term internal control? (b) Draft a form of questionnaire, which you would use for determining the effectiveness of the client’s internal control over bank balances.

6.

How will you vouch and/or verify the following? (a)

Recovery of Bad Debts written off

(b) Foreign Travel Expenses (c) Goodwill (d) Work-in-Progress 7.

Give your comments and observations on the following: (a) Balance confirmations from debtors/creditors can only be obtained for balances standing in their accounts at the year-end. (b) The management has obtained a certificate from an actuary regarding provision of gratuity payable to employees. (c) Fixed assets have been revalued and the resulting surplus has been adjusted against the brought forward losses.

8.

(a) As an auditor comment on the following situation: A company had a branch office, which recorded a turnover of Rs.1,99,000 in the earlier year. The auditor’s report of the earlier year had no reference regarding the branch although, the branch audit had not been carried out by the statutory auditor. (b) When an application for exemption is made to the Central Government,, it may, after making the necessary inquiry, exempt the branch office of a company from the provisions of audit What are the various grounds under which exemption may be given?

9.

Comment on the following: (a) In case the existing auditor(s) appointed at the Annual General Meeting refused to accept the appointment, whether the Board of Directors could fill up the vacancy. (b) X and Co., Chartered Accountants, who were appointed as the first auditors of the company, were removed without the prior approval of the Central Government, before the expiry of their term, by calling an Extraordinary General Meeting. (c) Due to the resignation of the existing auditor(s), the Board of directors of X Ltd appointed Mr. Hari as the auditor. Is the appointment of Hari as auditor valid? (d) At the Annual General Meeting of the Company, a resolution was passed by the entire body of shareholders restricting some of the powers of the Statutory Auditors. Whether powers of the Statutory Auditors can be restricted?

66 10. What is Computer Information System Environment (CIS)? Describe the nature of the risks and the internal control characteristics in CIS environment. 11. (a) True and fair report of the auditor on the financial statements of the enterprises ensures the future viability of the enterprises. Comment. (b) Who is responsible for the preparation of the financial statements? (c) How the auditor should determine the scope and extent of auditing? (d) Can terms of engagements restrict the scope of audit? (e) Does audit ensures that there are no frauds or errors? 12. (a) Who are joint auditors? Discuss the responsibility of joint auditors. (b) In case of difference of opinion among joint auditors, is a joint auditor bound by the views of the majority of the joint auditors. (c) Is it necessary to review the work of other joint auditor? 13. Discuss the duties of Comptroller and Auditor General as defined in C & AG (Duties, Powers and Conditions of Service) Act, 1971. 14. What is the meaning of ‘Analytical Procedures’ ? What are the purposes of Analytical Procedure? 15. Write short notes on the following : (a) Option on share capital (b) Capital Redemption Reserve (c) Fundamental Accounting Assumptions (d) Buy Back of Own Securities 16. Distinguish between: (a) Auditing and Investigation (b) Auditing around the computer and Auditing through the computer (c) Depreciation and Fluctuation in Value (d) Clean Audit Report and Qualified Audit Report SUGGESTED ANSWERS/HINTS 1.

(a) Broadly, the following procedure is adopted for the formulation of Auditing and Assurance Standards. (i)

The Auditing and Assurance Standards Board (AASB) determines the broad areas in which the Auditing and Assurance Standards (AASs) need to be formulated and the priority in regard to the selection therefor.

(ii) In the preparation of AASs, the AASB is assisted by study groups constituted to consider specific subjects. In the formation of study groups, provision is made for participation of a cross-section of members of the Institute. (iii) On the basis of the work of the study groups, an exposure draft of the proposed AAS is prepared by the Board and issued for comments by members of the Institute. (iv) After taking into consideration the comments received, the draft of the proposed AAS is finalised by the AASB and submitted to the Council of the Institute. (v) The Council of the Institute will consider the final draft of the proposed AAS, and if necessary, modify the same in consultation with the AASB. The AAS is issued under the authority of the Council.

67 (b) The Institute has, from time to time, issued ‘Guidance Notes’ and ‘Statements’ on a number of matters. The ‘Statements’ have been issued with a view to securing compliance by members on matters which, in the opinion of the Council, are critical for the proper discharge of their functions. ‘Statements’ therefore are mandatory. Accordingly, while discharging their attest function, it will be the duty of the members of the Institute: (a) to examine whether ‘Statements’ relating to accounting matters are complied with in the presentation of financial statements covered by their audit. In the event of any deviation from the ‘Statements’, it will be their duty to make adequate disclosures in their audit reports so that the users of financial statements may be aware of such deviations; and (b) to ensure that the ‘Statements’ relating to auditing matters are followed in the audit of financial information covered by their audit reports. If, for any reason, a member has not been able to perform an audit in accordance with such ‘Statements’, his report should draw attention to the material departures thereform. ‘Guidance Notes’ are primarily designed to provide guidance to members on matters which may arise in the course of their professional work and on which they may arise in the course of their professional work and on which they may desire assistance in resolving issues which may pose difficulty. Guidance Notes are recommendatory in nature. A member should ordinarily follow recommendations in a guidance note relating to an auditing matter except where he is satisfied that in the circumstances of the case, it may not be necessary to do so. Similarly, while discharging his attest function, a member should examine whether the recommendations in a guidance note relating to an accounting matter have been followed or not. If the same have not been followed, the member should consider whether keeping in view the circumstances of the case, a disclosure in his report is necessary. 2.

(a) Detection of errors and frauds is indeed an audit objective because statements of account drawn up from books containing serious mistakes and fraudulent entries cannot be considered as a true and fair statement. To establish whether the financial statements show a true and fair state of affairs, the auditors must carry out a process of examination and verification and, if errors and frauds exist they would come to his notice in the ordinary course of checking. But detection of errors and frauds is not the primary aim of audit; the primary aim is the establishment of a degree of reliability of the annual statements of account. If there remains a deep laid fraud in the accounts, which in the normal course of examination of accounts may not come to light, it will not be construed as failure of audit, provided the auditor was not negligent in the carrying out his normal work. This principle was established as early as in 1896 in the leading case in Re-Kingston Cotton Mills Co. (b) The process of auditing is such that it suffers from certain inherent limitations, i.e., the limitation which cannot be overcome irrespective of the nature and extent of audit procedures. It is very important to understand these inherent limitations of an audit since understanding of the same would only provide clarity as to the overall objectives of an audit. The inherent limitations are : (i)

Auditor’s work involves exercise of judgment, for example, in deciding the extent of audit procedures and in assessing the reasonableness of the judgment and estimates made by the management in preparing the financial statements. Further much of the evidence available to the auditor can enable him to draw only reasonable conclusions therefrom. The audit evidence obtained by an auditor is generally persuasive in nature rather than conclusive in nature. Because of these factors, the auditor can only express an opinion. Therefore, absolute certainty in auditing is rarely attainable. There is also likelyhood that some material misstatements of the financial information resulting from fraud or error, if either exists, may not be detected.

(ii) The entire audit process is generally dependent upon the existence of an effective system of internal control. Further, it is clearly evident that there always be some risk of an internal control system failing to operate as designed. No doubt, internal control

68 system also suffers from certain inherent limitations. Any system of internal control may be ineffective against fraud involving collusion among employees or fraud committed by management. Certain levels of management may be in a position to override controls; for example, by directing subordinates to record transactions incorrectly or to conceal them, or by suppressing information relating to transactions. Such inherent limitations of internal control system also contribute to inherent limitations of an audit. 3.

Types of Audit Evidence: Internal evidence and external evidence : Evidence which originates within the organisation being audited is an internal evidence. Example-sales invoice. Copies of sales challan and forwarding notes, goods received note, inspection report, copies of cash memo, debit and credit notes, etc.External evidence on the other hand is the evidence that originates outside the client’s organisation; for example, purchase invoice, supplier’s challan and forwarding note, debit notes and credit notes coming from parties, quotations, confirmations, etc. Types of Audit Evidence Depending upon nature

Depending upon source

Internal Visual

External

Oral Documentary

In an audit situation, the bulk of evidence that an auditor gets is internal in nature. However, substantial external evidence is also available to the auditor. Since in the origination of internal evidence, the client and his staff have the control, the auditor should be careful in putting reliance on such evidence. It is not suggested that they are to be suspected; but an auditor has to be alive to the possibilities of manipulation and creation of false and misleading evidence to suit the client or his staff. The external evidence is generally considered to be more reliable as they come from third parties who are not normally interested in manipulation of the accounting information of others. However, if the auditor has any reason to doubt the independence of any third party who has provided any material evidence e.g. an invoice of an associated concern, he should exercise greater vigilance in that matter. As an ordinary rule the auditor should try to match internal and external evidence as far as practicable. Where external evidence is not readily available to match, the auditor should see to what extent the various internal evidence corroborate each other. 4.

AAS-13 on “Audit Materiality” requires that the auditor should consider materiality and its relationship with audit risk when conducting an audit. According to it, information is material if its misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken on the basis of the financial information. Materiality depends on the size and nature of the item, judged in the particular circumstances of its misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which the information must have if it is to be useful. It stresses that the assessment of what is material is a matter of professional judgement. The audit should be planned so that audit risk is kept at an acceptably low level. After the auditor has assessed the inherent and control risks, he should consider the level of detection risk that he is prepared to accept and, based upon his judgement, select appropriate substantive audit procedures. If the auditor does not perform any substantive procedures, detection risk, that is, the risk that the auditor will fail to detect a misstatement, will be high. The auditor reduces detection risk by performing substantive procedures - the more extensive the procedures performed, the lower the detection risk. The nature and timing of substantive procedures will also affect the detection risk, for example, confirmation with third parties will lead to lower detection risk than reliance on internal data, as will procedures carried out closer to year-end.

69 5.

(a) According to AAS-6 (Revised) entitled, “Risk Assessment and Internal Control”, the system of internal control may be defined as “the plan of organization and all the methods and procedures adopted by the management of an entity to assist in achieving management’s objective of ensuring, as far as practicable, the orderly and efficient conduct of its business, including adherence to management policies, the safeguarding of assets, prevention and detection of fraud and error, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information. The system of internal control extends beyond those matters which relate directly to the functions of the accounting system. (b) Questionnaire for determining the effectiveness of the client’s internal control over bank balances: 1.

Are bank statements opened by a person other than the person signing cheques, recording cash and receiving or disbursing?

2.

Are the bank accounts reconciled at regular intervals?

3.

Is Bank reconciliation statement drawn by a person independent of cash receipt and disbursement function?

4.

Does the reconciler compare each item in the deposit and withdrawal columns of the bank statement with amount deposited or withdrawn as shown by the cash records both as regards date and amount?

5.

Is there a periodic follow-up of old : (i)

outstanding deposits?

(ii) outstanding payments? (iii) outstanding stop-payment advices? 6.

Are the items under reconciliation reviewed by a responsible official promptly or upon completion?

7.

Are confirmations of balances obtained periodically in respect of all bank balances and compared with the bank statements?

8.

Is there a periodic review of balances held as security, for letters of Credit, Guarantees, etc., to ensure the need for their continuance?

9.

Are Fixed Deposit Receipts held in safe custody?

10. Is there a register of Fixed Deposits showing maturity dates, rates of interest and dates for payment of interest? 11. Is there a follow-up system to ensure that interest on Fixed Deposits is received on due dates? 12. Is a Certificate obtained from the bank for Deposit Receipts lodged as security? 6.

(a) Recovery of Bad Debts written off: (i)

Ascertain the total amount of bad debts.

(ii) Ensure that all recoveries of bad debts have been properly recorded in the books of account. (iii) Examine notification from the Court or from bankruptcy trustee, letters from collecting agencies or from debtors should also be seen. (iv) Check Credit Manager’s file for the amount received and see that the said amount has been deposited into the bank promptly. (b) Foreign Travel Expenses: (i)

Examine T.A. bills submitted by the employees stating the details of tour, details of expenses, etc.

(ii) Verify that the tour programme was properly authorised by the competent authority.

70 (iii) Check the T.A. bills along with accompanying supporting documents such as air tickets, travel agents bill, hotel bills with reference to the internal rules for entitlement of the employees and also make sure that the bills are properly passed. (iv) See that the tour report accompanies the T.A. bill. The tour report will show the purpose of the tour. Satisfy that the purpose of the tour as shown by the tour report conforms with the authorisation for the tour. (v) Check Reserve Bank of India’s permission, if necessary, for withdrawing the foreign exchange. For a company the amount of foreign exchange spent is to be disclosed separately in the accounts as per requirement of Part I of Schedule VI to the Companies Act, 1956. (c) Goodwill: (a) Ensure that as required by AS 10 on "Accounting for Fixed Assets", goodwill has been recorded in the books only when some consideration in money or money's worth has been paid for. Goodwill arises from business connections, trade name or reputation of an enterprise or from other intangible benefits enjoyed by an enterprise. (b) Check the vendor's agreement on the basis of which assets of the running business have been acquired by the company at a price existing in the book value of the assets or where a specific sum has been paid for the goodwill. (c) See that only the amount paid to the vendors not represented by tangible assets has been debited to the goodwill account. Therefore, it is not prudent that goodwill should be shown in the company's accounts by way of writing up the value of its assets on revaluation or writing back the amount of goodwill earlier written off by the company. (d) See whether goodwill has been written off as a matter of financial prudence. (d) Work-in-Progress: The audit procedures regarding work-in-progress are similar to those used for raw materials and finished goods. However, the auditor has to carefully assess the stage of completion of the work-in-progress for assessing the appropriateness of its valuation. For this purpose, the auditor may examine the production/costing records (i.e., cost sheets), hold discussions with the personnel concerned, and obtain expert opinion, where necessary. The auditor may advise his client that where possible the work-in-progress should be reduced to the minimum before the closing date. Cost sheets of work-in-progress should be verified as follows: (i)

Ascertain that the cost sheets are duly attested by the works engineer and works manager.

(ii) Test the correctness of the cost as disclosed by the cost records by verification of quantities and cost of materials, wages and other charges included in the cost sheets by reference to the records maintained in respect thereof. (iii) Compare the unit cost or job cost as shown by the cost sheet with the standard cost or the estimated cost expected. (iv) Ensure that the allocation of overhead expenses had been made on a rational basis. Compare the cost sheet in detail with that of the previous year. If they vary materially, investigate the cause thereof. 7.

(a) Confirmation of Balances: Direct confirmation of balances from debtors/creditors in respect of balances standing in their accounts at the year-end is, perhaps, the best method of ascertaining whether the balances are genuine, accurately stated and undisputed particularly where the internal control system is weak. The confirmation date, method of requesting confirmation, etc. are to be determined by the auditor. Guidance Note on Audit of Debtors, Loans and Advances issued by the Institute recommends that the “debtors may be requested to confirm the balance either as at the date of the balance sheet, or as at any other selected date which is reasonably close to the date of the balance sheet.

71 The date should be settled by the auditor in consultation with the entity. Where the auditor decides to confirm the debtors at a date other than the balance sheet date, he should examine the movements in debtor balances which occur between the confirmation date and the balance sheet date and obtain sufficient evidence to satisfy himself that debtor balances stated in the balance sheet are not materially mis-stated”. Therefore, it is not necessary that balances of debtors/ creditors should necessarily be verified only at the end of the year only. In fact, in order to incorporate an element of surprise, the auditor may consider different confirmation dates periodically, i.e., Dec, 31 as a cut-off date in one year and June 30 in another year and so on. Therefore, the statement that balance confirmation from debtors/creditors can only be obtained for balances standing in their accounts at the year-end is not correct. (b) Certificate from an Expert: The computation of gratuity liability payable to employees is dependent upon several factors such as age of the employee, expected span of service in the organisation, life expectancy of the employee, prevailing economic environment, etc. Thus, it gives rise to uncertainty in the determination of provisions of liabilities. Under such circumstances, the management is required to make an assessment and estimate the amount of provision. In view of this, the management may engage an expert in the field to assist them in arriving at fair estimation of the liability. Therefore, it is an accepted auditing practice to use the work of an expert. SAP-9 on “Using the Work of an Expert” also states that an expert may be engaged/employed by the client. It further requires the auditor to assess skill, competence and objectivity of the expert amongst other factors and evaluate the work of an expert independently to conclude whether or not to rely upon such a certificate obtained by the management from the actuary. Therefore, the auditor must follow the requirements of AAS-9 before relying upon the certificate obtained by the management from the actuary. (c) Revaluation of Fixed Assets: The revaluation of fixed assets is a normally accepted practice which involves writing up the book value of fixed assets. AS-10 on ‘Accounting for Fixed Assets’ requires that “an increase in net book value arising on revaluation of fixed assets is normally credited directly to owner’s interests under the heading of revaluation reserves and is regarded as not available for distribution”. Thus, creation of revaluation reserves does not result into any cash inflows and represents unrealised gains. However, brought forward losses are in the nature of revenue losses. As a matter of prudence, revenue losses can be adjusted against revenue reserves only and not the capital reserves. Therefore, the accounting treatment followed by the entity is not correct and the auditor should qualify the audit report by mentioning the above fact. 8.

(a) Reference to branch audit in the audit report: Under section 228(4) of the Companies Act, 1956, the Central Government has formulated Companies (Branch Audit Exemption) Rules, 1961 to exempt any branch office of a company from being audited having regard to quantum of activity. These Rules require that, if during the said financial year, the average quantum of activity of the branch does not exceed Rs.2 lakhs or 2% of the average of total turnover and the earnings from other sources of the company as a whole, whichever is higher, the said branch is exempted. In the case under review, the turnover is below Rs. 2 lakhs and other information has not been furnished. Accordingly, it may be presumed, exemption may have been granted but still it is necessary that the fact must be mentioned in the audit report. Since, reference to branch is called for in the auditor’s report even if the same has been exempted by the Central Government, the auditor remains responsible. The auditor has, however, no responsibility in respect of the audit of earlier period accounts. (b) When an application for exemption is made to the Central Government, it may, after making the necessary inquiry, exempt the branch office from the provisions of audit in section 228 on any one of the following grounds, viz.

72 (i)

that the company carrying on activities other than those of manufacturing or processing, or trading, has made satisfactory arrangements for the security and check, at regular intervals, of the accounts of the branch office by a responsible person competent to scrutinise and check the accounts;

(ii) that the company has made arrangements for the audit of the accounts of the branch office by a person otherwise qualified for appointment as branch auditors, even though such a person is an employee of the company; (iii) that having regard to the nature and the quantum of activity carried on at the branch office or for any other reason a branch auditor is not likely to be available at a reasonable cost; and (iv) that, for any other reason, the Central Government is satisfied that exemption may be granted. A copy of the Central Government’s order or exemption is required to be forwarded to the company which shall forthwith send a copy thereof to the auditor of the company and shall also cause it to be read before the next general meeting (Rule 4). In every case in which an exemption is granted on the above grounds the company shall afford such a person access, at all the times, to the books, accounts and vouchers maintained at the branch office and also shall furnish him with such information and explanation as he may require. Such a person, during the period of exemption, is required to prepare in respect of each financial year, a report on the accounts of the branch office examined by him, as well as, to forward the same to the company’s auditor. A certificate to the effect that no material change had taken place in the arrangements made for the audit of the accounts of the branch office shall have to be attached to the balance sheet for each financial year. Such a certificate shall be signed by the manager or secretary of the company and by two directors, one of whom shall be managing director where there is one (Rule 6). 9.

(a) Board's Powers to Appoint an Auditor: The appointment of an auditor is complete only on the acceptance of the offer by the auditor. The non-acceptance of appointment by the auditor does not result in any casual vacancy. Moreover, even if the auditor is existing one, the matter would not make any difference since the appointment has to be made at each AGM and the auditor must accept the same. The casual vacancy is said to arise only in case of death, resignation, etc. Therefore, the Board is not empowered to fill such a vacancy. Thus, the Board of Directors are not authorised to fill up the vacancy in case the existing auditor (s) appointed at the Annual General Meeting refuse to accept the appointment. (b) Removal of First Auditors: With a view to safeguarding the auditor's independence, the law provides very stringent provisions so far as removal of an auditor before the expiry of the term is concerned. Section 224(7) of the Companies Act, 1956 provides that an auditor may be removed before the expiry of his term by the company in a general meeting only after obtaining the prior approval of the Central Government. An exception to this rule is that no such approval is required for the removal of the first auditor appointed by the Board of Directors under Section 224(5) of the Companies Act, 1956. Accordingly, X & Co., Chartered Accountants, being the first auditor of the company can be removed without the approval of the Central Government by the company by passing a general resolution to that effect in the extra-ordinary general meeting called for the purpose. (c) Board's Powers to Appoint Auditor(s): The resignation of the existing auditor(s) would give rise to a casual vacancy. As per Section 224(6) (a) of the Act, casual vacancy can be filled by the Board of Directors, provided such vacancy has not been caused by the resignation of the auditor. The rationale behind such a provision is to ensure that resignation is a matter of great concern and, thus, it is necessary that all shareholders must be apprised of reasons connected with resignation in case of a casual vacancy arising on account of resignation. The vacancy shall only be filled by the company in general meeting. Thus the appointment of Mr. Hari as the auditor of the company is not valid.

73 (d) Restrictions on Powers of Statutory Auditors: Section 227(1) of the Companies Act, 1956 provides that an auditor of a company shall have right of access at all times to the books and accounts and vouchers of the company whether kept at the Head Office or other places and shall be entitled to require from the offices of the company such information and explanations as the auditor may think necessary for the purpose of his audit. These specific rights have been conferred by the statute on the auditor to enable him to carry out his duties and responsibilities prescribed under the Act, which cannot be restricted or abridged in any manner. Hence' any such resolution even if passed by entire body of shareholders is ultra vires and therefore void. In the case of Newton vs.Birmingham Small Arms Co., it was held that any regulations which preclude the auditors from availing themselves of all the information to which they are entitled under the Companies Act, are inconsistent with the Act. 10. A CIS environment exists when one or more computer(s) of any type or size is (are) involved in the processing of financial information, including quantitative data, of significance to the audit, whether those computers are operated by the entity or by a third party. When the computer information systems are significant, the auditor should also obtain an understanding of the CIS environment and whether it may influence the assessment of inherent and control risks. The nature of the risks and the internal control characteristics in CIS environments include the following: (a) Lack of transaction trails: Some computer information systems are designed so that a complete transaction trail that is useful for audit purposes might exist for only a short period of time or only in computer readable form. Where a complex application system performs a large number of processing steps, there may not be a complete trail. Accordingly, errors embedded in an application’s program logic may be difficult to detect on a timely basis by manual (user) procedures. (b) Uniform processing of transactions: Computer processing uniformly processes like transactions with the same processing instructions. Thus, the clerical errors ordinarily associated with manual processing are virtually eliminated. Conversely, programming errors (or other systemic errors in hardware or software) will ordinarily result in all transactions being processed incorrectly. (c) Lack of segregation of functions: Many control procedures that would ordinarily be performed by separate individuals in manual systems may become concentrated in a CIS environment. Thus, an individual who has access to computer programs, processing or data may be in a position to perform incompatible functions. (d) Potential for errors and irregularities: The potential for human error in the development, maintenance and execution of computer information systems may be greater than in manual systems, partially because of the level of detail inherent in these activities. Also, the potential for individuals to gain unauthorised access to data or to alter data without visible evidence may be greater in CIS than in manual systems. (e) Initiation or execution of transactions: Computer information systems may include the capability to initiate or cause the execution of certain types of transactions, automatically. The authorisation of these transactions or procedures may not be documented in the same way as that in a manual system, and management’s authorisation of these transactions may be implicit in its acceptance of the design of the computer information systems and subsequent modification. (f)

Dependence of other controls over computer processing: Computer processing may produce reports and other output that are used in performing manual control procedures. The effectiveness of these manual control procedures can be dependent on the effectiveness of controls over the completeness and accuracy of computer processing. In turn, the effectiveness and consistent operation of transaction processing controls in computer applications is often dependent on the effectiveness of general computer information systems controls.

74 (g)

Potential for increased management supervision: Computer information systems can offer management a variety of analytical tools that may be used to review and supervise the operations of the entity. The availability of these analytical tools, if used, may serve to enhance the entire internal control structure.

(h) Potential for the use of computer-assisted audit techniques: The case of processing and analysing large quantities of data using computers may require the auditor to apply general or specialised computer audit techniques and tools in the execution of audit tests. Both the risks and the controls introduced as a result of these characteristics of computer information systems have a potential impact on the auditor’s assessment of risk, and the nature, timing and extent of audit procedures. 11. (a) The auditor’s opinion helps determination of the true and fair view of the financial position and operating results of an enterprise. But it does not mean that the auditor’s opinion is an assurance as to the future viability of the enterprise or the efficiency or effectiveness with which management has conducted the affairs of the enterprise. (b) While the auditor is responsible for forming and expressing his opinion on the financial statements, the responsibility for their preparation is that of the management of the enterprise. Management’s responsibilities include the maintenance of adequate accounting records and internal controls, the selection and application of accounting policies and the safeguarding of the assets of the enterprise. (c) The scope of an audit of financial statements will be determined by the auditor having regard to the  Terms of the engagement  The requirements of relevant legislation and  The pronouncements of the Institute. (d) Terms of engagements prescribe the scope of the audit are determined by the appointing authority of the auditor. However, The terms of engagement cannot restrict the scope of an audit in relation to matters which are prescribed by legislation or by the pronouncements of the Institute. (e) AAS-2 states that audit cannot ensure that there are no frauds errors in audited financial statements. 12. (a) In some cases a large entity appoints the joint auditors to conduct the audit of the entity jointly. Such auditors, known as joint auditors, conduct the audit jointly and report on the financial statements of the entity. Responsibility of joint auditors: In respect of audit work divided among the joint auditors, each joint auditor is responsible only for the work allocated to him, whether or not he has prepared a separate report on the work performed by him. On the other hand, all the joint auditors are jointly and severally responsible – (i)

in respect of the audit work which is not divided among the joint auditors and is carried out by all of them;

(ii) in respect of decisions taken by all the joint auditors concerning the nature, timing or extent of the audit procedures to be performed by any of the joint auditors. It may, however, be clarified that all the joint auditors are responsible only in respect of the appropriateness of the decisions concerning the nature, timing or extent of the audit procedures agreed upon among them; proper execution of these audit procedures is the separate and specific responsibility of the joint auditor concerned; (iii) in respect of matters which are brought to the notice of the joint auditors by any one of them and on which there is an agreement among the joint auditors; (iv) for examining that the financial statements of the entity comply with the disclosure requirements of the relevant statute; and

75 (v) for ensuring that the audit report complies with the requirements of the relevant statute. (b) Normally, the joint auditors are able to arrive at an agreed report. However, where the joint auditors are in disagreement with regard to any matters to be covered by the report, each one of them should express his own opinion through a separate report. A joint auditor is not bound by the views of the majority of the joint auditors regarding matters to be covered in the report and should express his opinion in a separate report in case of a disagreement. (c) Each joint auditor is entitled to assume that the other joint auditors have carried out their part of the audit work in accordance with the generally accepted audit procedures. 3[3] It is not necessary for a joint auditor to review the work performed by other joint auditors or perform any tests in order to ascertain whether the work has actually been performed in such a manner. Each joint auditor is entitled to rely upon the other joint auditors for bringing to his notice any departure from generally accepted accounting principles or any material error noticed in the course of the audit. 13. The Comptroller & Auditor General’s (Duties, Powers and Conditions of Service) Act, 1971 defines functions and powers in detail. The relevant provisions are discussed hereunder :— Duties of the C & AG : (i)

Compile and submit Accounts of Union and States - The Comptroller and Auditor General shall be responsible for compiling the accounts of the Union and of each State from the initial and subsidiary accounts rendered to the audit and accounts offices under his control by treasuries, offices or departments responsible for the keeping of such account. The Comptroller and Auditor General shall, from the accounts compiled by him or [by the Government or any other person responsible in that behalf] prepare in each accounts (including, in the case of accounts compiled by him, appropriation accounts) showing under the respective heads the annual receipts and disbursements for the purpose of the Union, of each State and of each Union Territory having a Legislative Assembly, and shall submit those accounts to the President or the Governor of a State or Administrator of the Union Territory having a Legislative Assembly, as the case may be, on or before such dates as he may, with the concurrence of the Government concerned, determine. The C & AG Act of 1971 has provisions for relieving him of this responsibility to give information and render assistance to the Union and States : The Comptroller and Auditor General shall, in so far as the accounts, for the compilation or keeping of which he is responsible, enable him so to do, give to the Union Government, to the State Government or to the Governments of Union Territories having Legislative Assemblies, as the case may be, such information as they may, from time to time, require and render such assistance in the preparation of the annual financial statements as they may reasonably ask for.

(ii) General Provisions Relating to Audit - It shall be the duty of the Comptroller and Auditor General— (a) to audit and report on all expenditure from the Consolidated Fund of India and of each State and of each Union Territory having a Legislative Assembly and to ascertain whether the moneys shown in the accounts as having been disbursed were legally available for and applicable to the service or purpose to which they have been applied or charged and whether the expenditure conforms to the authority which governs it; (b) to audit and report all transactions of the Union and of the States relating to Contingency Funds and Public Accounts; (c) to audit and report on all trading, manufacturing profit and loss accounts and balancesheets and other subsidiary accounts kept in any department of the Union or of a State. (iii) Audit of Receipts and Expenditure - Where any body or authority is substantially financed by grants or loans from the Consolidated Fund of India or of any State or of any Union Territory having a Legislative Assembly, the Comptroller and Auditor General shall, subject to the

76 provisions of any law for the time being in force applicable to the body or authority, as the case may be, audit all receipts and expenditure of that body or authority and to report on the receipts and expenditure audited by him. Where the grant or loan to a body or authority from the Consolidated Fund of India or of any State or of any Union Territory having a Legislative Assembly in a financial year is not less than rupees twenty-five lakhs and the amount of such grant or loan is not less than seventyfive per cent of the total expenditure of that body or authority, such body or authority shall be deemed, for this purpose to be substantially financed by such grants or loans as the case may be. (iv) Audit of Grants or Loans - Where any grant or loan is given for any specific purpose from the Consolidated Fund of India or of any State or of any Union Territory having a Legislative Assembly to any authority or body, not being a foreign State or international organisation, the Comptroller and Auditor General shall scrutinise the procedures by which the sanctioning authority satisfies itself as to the fulfillment of the conditions subject to which such grants or loans were given and shall for this purpose have right of access, after giving reasonable previous notice, to the books and accounts of that authority or body. (v) Audit of Receipts of Union or States - It shall be the duty of the Comptroller and Auditor General to audit all receipts which are payable into the Consolidated Fund of India and of each State and of each Union Territory having a Legislative Assembly and to satisfy himself that the rules and procedures in that behalf are designed to secure an effective check on the assessment, collection and proper allocation of revenue and are being duly observed and to make for this purpose such examination of the accounts as he thinks fit and report thereon. (vi) Audit of Accounts of Stores and Stock - The Comptroller and Auditor General shall have authority to audit and report on the accounts of stores and stock kept in any office or department of the Union or of a State. (vii) Audit of Government Companies and Corporations - The duties and powers of the Comptroller and Auditor General in relation to the audit of the accounts of government companies shall be performed and exercised by him in accordance with the provisions of the Companies Act, 1956. 14. “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. The auditor should apply analytical procedures at the planning and overall review stages of the audit. Analytical procedures may also be applied at other stages. Purposes of analytical procedures : Analytical procedures are used for the following purposes: (a) To assist the auditor in planning the nature, timing and extent of other audit procedures: The auditor should apply analytical procedures at the planning stage to assist in understanding the business and in identifying areas of potential risk. Application of analytical procedures may indicate aspects of the business of which the auditor was unaware and will assist in determining the nature, timing and extent of other audit procedures. Analytical procedures in planning the audit use both financial and non-financial information, for example, the relationship between sales and square footage of selling space or volume of goods sold. (b) Analytical procedures as substantive procedures: 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.The auditor will ordinarily inquire of management as to the availability and reliability of information

77 needed to apply analytical procedures and the results of any such procedures performed by the entity. It may be efficient to use analytical data prepared by the entity, provided the auditor is satisfied that such data is properly prepared. When intending to perform analytical procedures as substantive procedures, the auditor will need to consider a number of factors such as the:  Objectives of the analytical procedures and the extent to which their results can be relied upon  Nature of the entity and the degree to which information can be disaggregated  Availability of information, both financial, such as budgets or forecasts, and nonfinancial, such as the number of units produced or sold.  Reliability of the information available, for example, whether budgets are prepared with sufficient care.  Relevance of the information available, for example, whether budgets have been established as results to be expected rather than as goals to be achieved.  Source of the information available, for example, sources independent of the entity are ordinarily more reliable than internal sources.  Comparability of the information available  Knowledge gained during previous audits, together with the auditor's understanding of the effectiveness of the accounting and internal control systems and the types of problems that in prior periods have given rise to accounting adjustments. (c) Analytical procedures in overall review of the financial statements in the final review stage of the audit: The auditor should apply analytical procedures at or near the end of the audit when forming an overall conclusion as to whether the financial statements as a whole are consistent with the auditor's knowledge of the business. The conclusions drawn from the results of such procedures are intended to corroborate conclusions formed during the audit of individual components or elements of the financial statements and assist in arriving at the overall conclusion as to the reasonableness of the financial statements. However, in some cases, as a result of application of analytical procedures, the auditor may identify areas where further procedures need to be applied before the auditor can form an overall conclusion about the financial statements. 15. (a) Option on Share Capital: Part I of Schedule VI to the Companies Act, 1956 requires disclosure of the particulars of any option on unissued share capital. An option on shares arises when a person has acquired a right under an agreement with the company to subscribe for share in the company if he so chooses. Such options generally arise under the following circumstances: (i)

Under the promoter's agreements, subsequently ratified by the company;

(ii) Collaboration agreement; (iii) Loan agreements, debenture deeds (Refer to Section 81 of the Companies Act, 1956); (iv) Other contracts, such as for supply of capital goods and/or merchandise. (b) Capital Redemption Reserve: As per section 80 of the Companies Act, 1956 where preference shares are redeemed otherwise than out of a fresh issue, these shall be out of profits, otherwise available for dividends, be transferred to a reserve fund called Capital Redemption Reserve Account, an amount equal to the nominal value of the shares redeemed. The provisions of the Companies Act, 1956, relating to the reduction of share capital of a company shall apply as if the Capital Redemption Reserve account were paid up share capital of the company. The Capital Redemption Reserve Account may be applied by the company in paying up in issued share of the company to be issued to members of the company as fuIly paid up bonus shares. Capital Redemption Reserve should be disclosed under the head "Reserves & Surplus" on the Liabilities side of the Balance Sheet as per Part-I of Schedule VI to the Companies Act, 1956.

78 (c) Fundamental Accounting Assumptions: AS-1 states that certain fundamental accounting assumptions underlie the preparation and presentation of financial statements. The following have been generally accepted as fundamental accounting assumptions: (i)

Going Concern: The enterprise is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.

(ii) Consistency: It is assumed that accounting policies are consistent from one period to another. (iii) Accrual: Revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. If the fundamental accounting assumptions, viz., Going Concern, Consistency and Accrual are followed in financial statements, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed. (d) Buy Back of Own Securities: Section 77A of the Companies (Amendment) Act, 1999 contains elaborate provisions enabling a company to buy-back its own securities. The auditor should ensure the compliance of all the provisions relating to buy-back and also see that proper accounting entries have been passed. Audit procedure to be followed may be as under: (i)

Ensure that the buy-back has been done only out of the company’s free reserves or its securities premium account or out of the proceeds of any shares or other specified securities other than out of the proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.

(ii) Check authorisation in the Articles of Association which is a prerequisite of any buyback. (iii) Examine special resolution passed in the general meeting authorising buyback. (iv) Ascertain that quantum of buy-back is either equal to or less than 25% of the total paid up share capital and free serves but in case of buy-back of equity shares in any financial year it should not exceed 25% of its total paid-up equity capital in that financial year. (v) Check that the debt equity ratio should not be more than 2 : 1 except in cases where Central Government allows higher ratio for a class or classes of companies. (vi) Ensure that shares or other specified securities to be bought back should be fully paidup. (vii) Buy-back should be completed within 12 months from the date of passing the special resolution. (viii) Ascertain that declaration of solvency in Form No.4A was filed with the SEBI and/or the Registrar of Companies before making buy-back but subsequent the passing of the special resolution. (ix) See that SEBI (buy-back of securities) Regulations, 1998 have been followed by listed company. 16. (a) Auditing is different from investigation which is another significant service, a professional accountant renders. Investigation is a critical examination of the accounts with a special purpose. For example if fraud is suspected and an accountant is called upon to check the accounts to whether fraud really exists and if so, the amount involved, the character of the enquiry changes into investigation. Investigation may be undertaken in numerous areas of accounts, e.g., the extent of waste and loss, profitability, cost of production, etc. It normally concerns only specified areas, but at times, it may involve the whole field of accounting. Its essence lies in going into the matter with some pre-conceived notion suited to the objective.

79 The techniques fit the circumstances of the case. For auditing on the other hand, the general objective is to find out whether the accounts show a true and fair view. Audit never undertakes discovery of specific happenings and is never started with a preconceived notion about the state of affairs. The auditor seeks to report what he finds in the normal course of examination of the accounts adopting generally followed techniques unless circumstances call for a special probe : fraud, error, irregularity, whatever comes to the auditor’s notice in the usual course of checking, are all looked into in depth and sometimes investigation results from the prima facie findings of the auditor. (b) Audit Around the Computer: Audit around the computer involves forming of an audit opinion wherein the existence of computer is not taken into account. Rather the principle of conventional audit like examination of internal controls and substantive testing is done. The auditor views the computer as a black box, as the application system processing is not examined directly. The main advantage of auditing around the computer is its simplicity. Audit around the computer is applicable in the following situations: (i)

The system is simple and uses generalised software that is well tested and widely used.

(ii) Processing mainly consists of sorting the input data and updating the master file in sequence. (iii) Audit trail is clear. Detailed reports are prepared at key processing points within the system. (iv) Control over input transactions can be maintained through normal methods, i.e. separation of duties, and management supervision. Generalised software packages, like payroll and provident fund package, accounts receivable and payable package, etc. are available, developed by software vendors. Though the auditor may decide not to go in details of the processing aspects, if there are well tested widely used packages provided by a reputed vendor. However, he has to ensure that there are adequate controls to prevent unauthorised modifications of the package. However, it may be noted that all such generalised packages do not make the system amenable to audit. Some software packages provide generalised functions, that still must be selected and combined to achieve the required application system. In such a case, instead of simply examining the systems input and output, the auditor must check the system in depth to satisfy himself about such system. The main disadvantages of the system of auditing around the computer are: (a) It is not beneficial for complex systems of large scale in very large multi unit, multi locational companies, having various inter unit transactions. It can be used only in case of small organisations having simple operations. (b) It is difficult for the auditor to assess the degradation in the system in case of change in environment, and whether the system can cope with a changed environment. Auditing Through the Computer: This approach involves actual use of computer for processing the information by auditor. The circumstances, where auditing through the computer is done are as follows: (i)

The organisation has developed either in house or through a reputed vendor, a software package suitable to its requirement, because of inability of a generalised package to cater to the complex nature of transactions.

(ii) The system processes very large volumes of output. This makes examination of validity of input and output difficult. (iii) The major part of the internal control system in the organisation is in the computer system itself, as the majority of the records is processed through the computer. Examples are system in bank, insurance companies, online booking in case of Railway, etc. (iv) The logic of the system is quite complex, and there is virtually no visible audit trail. The auditor has to use the computer to test the logic and controls existing within the system.

80 The auditor has to use the computer system itself for verification, for which he has to be sufficiently computer literate, and should have adequate technical knowledge and expertise. The auditor can through the computer, increase his performance, and can rely on the data processing by carrying out the required tests and applying his skill. (c) Depreciation and Fluctuation in Value: Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. It directly affects the earning capacity of an asset. Hence, it is a charge against the profit of the year. Fluctuation, on the other hand, is a temporary shrinkage or decrease and increase in the value of an asset usually due to external causes such as rise and fall in market price of an asset. But the fluctuation does not affect the earning capacity or working life of an asset. Hence, it is not taken into account and no charge is made against the profit of the year. Depreciation is only in connection with fixed assets while fluctuation is usually in connection with current assets. Depreciation generally means fall in the value of fixed asset while fluctuation may mean either increase or decrease in the value of any asset, current as well as fixed. Depreciation has a significant effect determining and presenting the financial position and results of operations of an enterprise. Depreciation is charged in each accounting period by reference to the extent of the depreciable amount, irrespective of an increase in the market value of the assets. (d) Clean Audit Report and Qualified Audit Report: A clean report which is otherwise known as unconditional opinion is issued by the auditor when he does not have any reservation with regard to the matters contained in the financial statements. In such a case, the audit report may state that the financial statements give a true and fair view of the state of affairs and profit and loss account for the period. Under the following circumstances an auditor is justified in issuing a clean report: (a) the financial information has been prepared using acceptable accounting policies, which have been consistently applied; (b) the financial information complies with relevant regulations and statutory requirements; and (c) there is adequate disclosure of all material matters relevant to the proper presentation of the financial information, subject to statutory requirements, where applicable. Qualified audit report, on the other hand, is one which does not give a clear cut about the truth and fairness of the financial statements but makes certain reservations. The gravity of such reservations will vary depending upon the circumstances. In majority of cases, items which are the subject matter of qualification are not so material as to affect the truth and fairness of the whole accounts but merely create uncertainty about a particular item. In such cases, it is possible for the auditors to report that in their opinion but subject to specific qualifications mentioned, the accounts present a true and fair view. Thus, an auditor may give his particular objection or reservation in the audit report and state "subject to the above, we report that balance sheet shows a true and fair view……..". The auditor must clearly express the nature of qualification in the report. The auditor should also give reasons for qualification. According to 'Statement on Qualifications in Auditor's Report' issued by the ICAI, all qualifications should be contained in the auditor's report. The words "subject to" are essential to state any qualification. It is also necessary that the auditors should quantify, wherever possible the effect of these qualifications on the financial statements in clear and unambiguous manner if the same is material and state aggregate impact of qualifications. Thus, it is clear from the above that in case of a clean report, the auditor has no reservation in respect of various matters contained in the financial statements but a qualified report may involve certain matters involving difference of opinion between the auditor and the management.

81 PAPER – 3 : BUSINESS AND CORPORATE LAWS QUESTIONS 1.

Mr. X, is employed as a cashier on a monthly salary of Rs. 2,000 by ABC bank for a period of three years. Y gave surety for X’s good conduct. After nine months, the financial position of the bank deteriorates. Then X agrees to accept a lower salary of Rs. 1,500/- per month from Bank. Two months later, it was found that X has misappropriated cash since the time of his appointment. What is the liability of Y?

2.

Comment on the following: (i)

Principal is not always bound by the acts of a sub-agent.

(ii)

In a sale of goods ‘goods’ sold must be of merchantable quality.

(iii) To form a valid contract consideration must be adequate. (iv) Risk prima facie passes with the property in the goods. 3.

What are the principles of law of guarantee with regard to contribution of the same debt between the co-sureties?

4

A, who owes B Rs. 10,000, appoints B as his agent to sell his landed property at Delhi and after paying himself (B) what is due to him, to hand over the balance to A. Can A revoke his authority delegated to B?

5.

M advances to N Rs. 5,000 on the guarantee of P. The loan carries interest at ten percent per annum. Subsequently, N becomes financially embarrassed. On N’s request, M reduces the interest to six per cent per annum and does not sue N for one year after the loan becomes due. N becomes insolvent. Can M sue P?

6.

Mr. S an industrialist has been fighting a long drawn litigation with Mr. R another industrialist. To support his legal campaign Mr. S enlists the services of Mr. X a legal expert stating that an amount of Rs. 5 lakhs would be paid, if Mr. X does not take up the brief of Mr. R. Mr. X agrees, but at the end of the litigation Mr. S refuses to pay. Decide whether Mr. X can recover the amount promised by Mr. S under the provisions of the Indian Contract Act, 1872.

7.

(a) What is meant by Anticipatory Breach of Contract? (b) Mr. Dubious textile enters into a contract with Retail Garments Show Room for supply of 1,000 pieces of Cotton Shirts at Rs. 300 per shirt to be supplied on or before 31 st December, 2006. However, on 1st November, 2006 Dubious Textiles informs the Retail Garments Show Room that he is not willing to supply the goods as the price of Cotton shirts in the meantime has gone upto Rs. 350 per shirt. Examine the rights of the Retail Garments Show Room in this regard.

8.

‘A’ applies to a banker for a loan at a time where there is stringency in the money market. The banker declines to make the loan except at an unusually high rate of interest. A accepts the loan on these terms. Whether the contract is induced by undue influence? Decide.

9.

A’ stands surety for ‘B’ for any amount which ‘C’ may lend to B from time to time during the next three months subject to a maximum of Rs. 50,000. One month later A revokes the guarantee, when C had lent to B Rs. 5,000. Referring to the provisions of the Indian Contract Act, 1872 decide whether ‘A’ is discharged from all the liabilities to ‘C’ for any subsequent loan. What would be your answer in case ‘B’ makes a default in paying back to ‘C’ the money already borrowed i.e. Rs. 5,000?

10. For the purpose of making uniform for the employees B bought dark blue coloured cloth from Vivek, but did not disclose to the seller the purpose of said purchase. When uniforms were prepared and used by the employees, the cloth was found unfit. However, there was evidence that the cloth was fit for caps, boots and carriage lining. Advise B whether he is entitled to have any remedy under the sale of Goods Act, 1930? 11. Mr. J sells and consigns certain goods to Mr. S for cash and sends the Railway Receipt to him. Mr. S becomes insolvent and while the goods are in transit, he assigns the Railway Receipt to Mr. N who does not know that Mr. S is insolvent. Mr. J being an unpaid seller wants to exercise his rights.

82 Advise: (a) whether Mr. J can exercise the right of stoppage of goods in transit ? (b) would your answer be different if Mr. N was aware of Mr. J’s insolvency before the assignment of the Railway Receipt in favour of Mr. N ? 12. What are the exceptions to the doctrine of ‘Caveat Emptor’ ? 13. Ram, Shyam and Gopal are partners in a firm. Ram retires. Shyam and Gopal continue to carry on firm’s business in the same “firm name”. Do you agree that in this situation change in the relationship between partners is involved, but this is not extinguishment of the existence of the firm itself? Give reasons. 14. Briefly explain minor’s position in a partnership firm. 15. State the privileges of a “Holder in due course” under the Negotiable Instruments Act, 1881. A induced B by fraud to draw a cheque payable to C or order. A obtained the cheque, forged C’s indorsement and collected proceeds to the cheque through his Bankers. B the drawer wants to recover the amount from C’s Bankers. Decide in the light of the provisions of Negotiable Instruments Act, 1881(i)

Whether B the drawer, can recover the amount of the cheque from C’s Bankers?

(ii)

Whether C is the Fictitious Payee?

(iii) Would your answer be still the same in case C is a fictitious person? 16. A issues a cheque for Rs. 25,000/- in favour of B. A has sufficient amount in his account with the Bank. The cheque was not presented within reasonable time to the Bank for payment and the Bank, in the meantime, became bankrupt. Decide under the provisions of the Negotiable Instruments Act, 1881, whether B can recover the money from A? 17. On 1st January, 2006, Aryan Textiles Ltd. agreed with the employees for payment of an annual bonus linked with production or productivity instead of bonus based on profits subject to the limit of 30% of their salary wages during the relevant accounting year. It was also agreed by the employees that they will not claim minimum bonus stated under Section 10 of the Payment of Bonus Act, 1965. As per the agreement the employees of Aryan Textiles Ltd claimed annual bonus linked with production or productivity in the relevant accounting year. On refusal of the company the employees of the company moved to the court for relief. Decide in reference to the provisions of the payment of Bonus Act, 1965 whether the employees will get the relief? Inspite of the aforesaid agreement whether the employees are still entitled to receive minimum bonus. 18. In an accounting year, a company to which the payment of Bonus Act, 1965 applies, suffered heavy losses. The Board of Directors of the said company decided not to give bonus to the employees. The employees of the company move to the Court for relief. Decide in the light of the provisions of the said Act whether the employees will get relief? 19. Manorama Group of Industries sold its textile unit to Giant Group of Industries. Manorama Group contributed 25% of total contribution in Pension Scheme, which was due before sale under the provisions of Employees Provident Fund and Miscellaneous Provisions Act, 1952. The transferee company (Giant Group of Industries) refused to hear the remaining 75% contribution in the Pension Scheme. Decide, in the light of the Employees Provident Fund and Miscellaneous Provisions Act, 1952, who will be liable to pay for the remaining contribution in case of transfer of establishment and upto what extent? 20

An employee leaves the establishments in which he was employed and gets employment in another establishment wherein he has been employed. Explain the procedure laid down in the Employees' Provident Fund and Miscellaneous Provisions Act, 1952 in this relation.

21. M/s Supreme Society Ltd., a Multi-state Cooperative Society, is contemplating to transfer some of its assets and liabilities to another Multi-state Cooperative Society. Advise the management of the

83 society about the steps to be taken in this regard. 22. Sohan is a member of a co-operative society registered with the unlimited liability under the Cooperative Societies Act, 1912. Holding shares of the society for ten months, Sohan transfers his shares to Mohan. Decide whether transfer of shares in favour of Mohan is valid? 23. A Co-operative Society with unlimited liability wants to expel its member, who prejudices the society by his misconduct. For this purpose, the society wants to amend its bye-laws. State the grounds which should be included in the bye-laws of the society so as to expel such member from the membership of the society. 24. Some of the creditors of M/s Get Rich Quick Ltd. have complained that the company was formed by the promoters only to defraud the creditors and circumvent the compliance of legal provisions of the Companies Act, 1956. In this context they seek your advice as to the meaning of corporate veil and when the promoters can be made personally liable for the debts of the company. 25. M/s ABC Ltd. a company registered in the State of West Bengal desires to shift its registered office to the State of Maharashtra. Explain briefly the steps to be taken to achieve the purpose. Would it make a difference, if the Registered Office is transferred from the Jurisdiction of one Registrar of Companies to the jurisdiction of another Registrar of Companies within the same State? 26. M/s Honest Cycles Ltd. has received an application for transfer of 1,000 equity shares of Rs.10 each fully paid up in favour of Mr. Balak. On scrutiny of the application form it was found that the applicant is minor. Advise the company regarding the contractual liability of a minor and whether shares can be allotted to the Balak by way of transfer. 27. Annual General Meeting of a Public Company was scheduled to be held on 15.12.2006. Mr. A, a shareholder, issued two Proxies in respect of the shares held by him in favour of Mr. ‘X’ and Mr. ‘Y’. The proxy in favour of ‘Y’ was lodged on 12.12.2006 and the one in favour of Mr. X was lodged on 15.12.2006. The company rejected the proxy in favour of Mr. Y as the proxy in favour of Mr. Y was of dated 12.12.2006 and thus in favour of Mr. X was of dated 13.12.2006. Is the rejection by the company in order ? 28. A company issued a prospectus. All the statements contained therein were literally true. It also stated that the company had paid dividends for a number of years, but did not disclose the fact that the dividends were not paid out of trading profits, but out of capital profits. An allottee of shares wants to avoid the contract on the ground that the prospectus was false in material particulars. Decide. 29. The Articles of Association of Mars Company Ltd. provides that documents may be served upon the company only through Fax. Ramesh despatches a document to the company by post, under certificate of posting. The company does not accept it on the ground that it is in violation of the Articles of Association. As a result Ramesh suffers loss. Explain with reference to the provisions of the Companies Act, 1956: (i)

What refusal of document by the company is valid?

(ii)

Whether Ramesh can claim damages on this basis?

30. A Company was incorporated on 6th October, 2006. The certificate of incorporation of the company was issued by the Registrar on 15th October, 2006. The company on 10th October, 2006 entered into a contract, which created its contractual liability. The company denies from the said liability on the ground that company is not bound by the contract entered into prior to issuing of certificate of incorporation. Decide, under the provisions of the Companies Act, 1956, whether the company can be exempted from the said contractual liability. 31. Dinesh, a director in a company, gave in writing to the company that notice for any General Meeting and the Board of Directors' Meeting be sent to him at his address in India only by Registered Mail and for which he paid sufficient money. The company sent two notices to him, of such meetings, by ordinary mail, under certificate of posting. Dinesh did not receive the said notices and could not attend the meetings and the proceedings thereof on the ground of improper notice. Decide in the light of the provisions of the Companies Act, 1956:

84 (i)

Whether the contention of Dinesh is valid?

(ii)

Would you answer be still the same in case Dinesh remained outside India for two months (when such notices were given and meetings held). SUGGESTED HINTS / ANSWERS

1.

If the creditor makes any variance (i.e. change in terms) without the consent of the surety, then surety is discharged as to the transactions subsequent to the change. In the instant case Y is liable as a surety for the loss suffered by the bank due to misappropriation of cash by X during the first nine months but not for misappropriations committed after the reduction in salary. [Section 133, Indian Contract Act, 1872].

2.

(i)

The statement is correct. Normally, a sub-agent is not appointed, since it is delegation of power by an agent given to him by his principal. The governing principle is, a delegate cannot delegate’. (Latin version of this principle is, “delegates non potest delegare”). However, there are certain circumstances where an agent can appoint sub-agent. In case of proper appointment of a sub-agent, by virtue of Section 192 of the Indian Contract Act, 1872 the principal is bound by and is held responsible for the acts of the sub-agent. Their relationship is treated to be as if the sub-agent is appointed by the principal himself. However, if a sub-agent is not properly appointed, the principal shall not be bound by the acts of the sub-agent. Under the circumstances the agent appointing the sub-agent shall be bound by these acts and he (the agent) shall be bound to the principal for the acts of the sub-agent.

(ii) Goods must be of Merchantable Quality: It is one of the implied conditions that the goods sold to a customer must be of merchantable quality. Section 16(2) of the Sale of Goods Act, 1930 provides where goods are bought by description from a seller who deals in goods of that description (whether he is the manufacturer or producer or not), there is an implied condition that the goods are of merchantable quality. The expression “merchantable quality” though not defined in the Act, nevertheless connotes goods of such a quality and in such condition that a man of ordinary prudence would accept them as goods of that description. Goods should also be such as are commercially saleable under the description by which they are known in the market at their full value. If goods are of such a quality and in such a condition that a reasonable person acting reasonably would accept them after having examined them thoroughly, they are of merchantable quality. Sub-section (2) of Section 16 further provides that where the buyer has examined the goods, there is an implied condition as regards defects which such examination ought to have revealed. (iii) The law provides that a contract should be supported by consideration. So long as consideration exists, the Courts are not concerned to its adequacy, provided it is of some value. The adequacy of the consideration is for the parties to consider at the time of making the agreement, not for the Court when it is sought to be enforced (Bolton v. Modden). Consideration must however, be something to which the law attaches value though it need not be a equivalent in value to the promise made. According to Explanation 2 to Section 25 of the Indian Contract Act, 1872, an agreement to which the consent of the promisor is freely given is not void merely because the consideration is inadequate but the inadequacy of the consideration may be taken into account by the Court in determining the question whether the consent of the promisor was freely given. (iv) Section 26 of the Sale of Goods Act, 1930 lays down the general rule that “risk prima facie passes with the property”. In other words, risk always follows ownership and the owner has to bear the burden or loss. Thus, whoever is the owner, carries the risk. The goods remain at the seller’s risk until the ownership therein is transferred to the buyer and the goods are at buyer’s risk when their ownership is transferred to him whether the delivery has been made to him or not.

85 However, there are following exceptions to the general rule that risk prima facie passes with the property-

3.

1.

If the parties have by a special agreement stipulated that the risk will pass sometime after or before the ownership has passed.

2.

where the delivery of the goods has been delayed due to the fault of either the seller or the buyer, in such cases the goods are at the risk of that party who is responsible for such fault as resulted in loss of any kind. The defaulting party will bear the loss.

3.

Sometimes trade customs may put the ownership and risk separately in two parties.

Contribution as between co-sureties: The principle in this regard is laid down in Section 146 of the Indian Contract Act, 1872 which is as follows: “When two or more persons are co-sureties for the same debt, or duty either jointly, or severally and whether under the same or different contracts and whether with or without the knowledge of each other, the co-sureties in the absence of any contract to the company, are liable, as between themselves, to pay each an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor”. A co-surety is entitled to recover from other sureties the amount that he has paid but the right arises only if the surety has paid an amount beyond his share of the debt to the creditor, for only then does it become certain that there is ultimately a case for contribution at all. A judgement against the surety at the suit of the creditor for the full amount of the guarantee will have the same effect as payment made for these parties and would entitle the surety or his representative to a declaration of the right to contribution on the very same principle by which the rights of company trustees in respect of amount which they are made liable to pay are settled. Liabilities of two sureties are not affected by mutual agreements between them. This principle has been laid down in Section 132 which runs thus, where two persons, contract with a third party to undertake a certain liability, and also contract with each other that one of them shall be liable only on the default of the other the third person not being a party to such contract, the liability of each of such two persons to the third person under the first contract is not affected by the existence of the second contract, although such third person may have been aware of its existence. This position is applicable when the liability is undertaken jointly by two parties in respect of the same debt but not in different debts [Pogose v. Bank of Bengal (1877)].

4.

According to Section 202 of the Indian Contract Act, 1872 where the agent has himself an interest in the property which forms the subject-matter of the agency, the agency cannot, in the absence of an express contract, be terminated to the prejudice of such interest. In the instant case the doctrine of agency coupled with interest applies. Therefore, A cannot revoke the authority delegated to B.

5.

M cannot sue P, because a surety is discharged from liability when, without his consent, the creditor makes any change in the terms of his contract with the principal debtor, no matter whether the variation is beneficial to the surety or does not materially affect the position of the surety (Sec. 133, Indian Contract Act, 1872).

6.

The problem as asked in the question is based on one of the essentials of a valid contract. Accordingly, one of the essential elements of a valid contract is that the agreement must not be one which the law declares to be either illegal or void. A void agreement is one without any legal effect. Thus any agreement in restraint of trade, marriage, legal proceedings etc., are void agreements. Thus Mr. X cannot recover the amount of Rs. 5 lakhs promised by Mr. S because it is an illegal agreement and cannot be enforced by law.

7.

Anticipatory breach of contract Anticipatory breach of contract occurs when the promisor refuses altogether to perform his promise and signifies his unwillingness even before the time for performance has arrived. In such a situation the promise can claim compensation by way of loss or damage caused to him by the refusal of the promisor. For this, the promisee need not wait till the time stipulated in the contract for fulfillment of the promise by the poimisor is over.

86 In the given problem Dubious Textiles has indicated its unwillingness to supply the cotton shirts on 1st November 2006 itself when it has time upto 31st December 2006 for performance of the contract of supply of goods. It is therefore called anticipatory breach of contract. Thus Retail Garments show room can claim damages from Dubious Textiles immediately after 1 st November, 2006, without waiting upto 31st December 2006. The damages will be calculated at the rate of Rs. 50 per shirt i.e. the difference between Rs. 350/- (the price prevailing on 1st November) and Rs. 300/- the contracted price. 8.

In the given problem, A applies to the banker for a loan at a time when there is stringency in the money market. The banker declines to make the loan except at an unusually high rate of interest. A accepts the loan on these terms. This is a transaction in the ordinary course of business, and the contract is not induced by undue influence. As between parties on an equal footing, the court will not hold a bargain to be unconscionable merely on the ground of high interest. Only where the lender is in a position to dominate the will of the borrower, the relief is granted on the ground of undue influence. But this is not the situation in this problem, and therefore, there is no undue influence.

9.

The problem as asked in the question is based on the provisions of the Indian Contract Act 1872, as contained in Section 130 relating to the revocation of a continuing guarantee as to future transactions which can be done mainly in the following two ways: 1.

By Notice: A continuing guarantee may at any time be revoked by the surety as to future transactions, by notice to the creditor. 2. By death of surety: The death of the surety operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee, so far as regards future transactions. (Section 131). The liability of the surety for previous transactions however remains. Thus applying the above provisions in the given case, A is discharged from all the liabilities to C for any subsequent loan. Answer in the second case would differ i.e. A Is liable to C for Rs. 5,000 on default of B since the loan was taken before the notice of revocation was given to C. 10. As per the provision of Section 16(1) of the Sale of Goods Act, 1930, an implied condition in a contract of sale that an article is fit for a particular purpose only arises when the purpose for which the goods are supplied is known to the seller, the buyer relied on the seller’s skills or judgement and seller deals in the goods in his usual course of business. In this case, the cloth supplied is capable of being applied to a variety of purposes, the buyer should have told the seller the specific purpose for which he required the goods. But he did not do so. Therefore, the implied condition as to the fitness for the purpose does not apply. Hence, the buyer will not succeed in getting any remedy from the seller under the Sale of Goods Act [Jones v. Padgett. 14 Q.B.D. 650]. 11. (a) Mr. J cannot exercise the right of stoppage of goods in transist, because the goods are being taken by Mr. N in good faith and for consideration. (b) Yes, Mr. J in this case can exercise his right of stoppage of goods in Transit, as Mr. N has not acted in good faith. (Refer to section 27 of The Sale of Goods Act, 1930) 12. The term Caveat Emptor means let the buyer beware; i.e. it is the duty of the buyer to select the goods of his requirement. The seller is in no way responsible for the bad selection of the buyer and not bound to disclose the defects in the goods which is selling. If the goods turn out to be defective, the buyer cannot hold the seller responsible. This is known as the doctrine of ‘Caveat Emptor’. This doctrine is however, subject to the following exceptions: 1. Where the buyer makes it known to the seller the particular purpose for which the goods are required, so as to show that he relies on the seller’s skill or judgement and the goods are of a description which is in the course of seller’s business to supply, it is the duty of the seller to supply such goods are reasonable fit for that purpose. 2. Where the goods are sold by description there is an implied condition that the goods shall correspond with the description (Section 15 of Sale of Goods Act, 1930).

87 3.

Where the goods are bought by description from a seller who deals in goods of that description there is an implied condition that the goods shall be of merchantable quality. But where the buyer has examined the goods this rule shall apply if the defects were such which ought to have been revealed by an ordinary examination (Section 16(2)).

4.

Where the goods are bought by sample, this rule of Caveat Emptor does not apply if the bulk does not correspond with the sample (Section 17).

5.

Where the goods are brought by sample as well as description, the rule of Caveat Emptor is not applicable in case the goods do not correspond with both the sample and description (Section 15).

6.

An implied warranty or condition as to quality or fitness for a particular purpose may be annexed by the usage of trade and if the seller deviates from that, this rule of Caveat Emptor is not applicable.

7.

Where the seller sells the goods by making some misrepresentation or fraud and the buyer relies on it or when the seller actively conceals some defect in the goods so that the same could not be discovered by the buyer on a reasonable examination, then the rule of Caveat Emptor will not apply. In such a case the buyer has a right to avoid the contract and claim damages.

13. As per the provision of Section 39 of the Indian Partnership Act, 1932, “The dissolution of partnership between all the partners of a firm is called the dissolution of firm.” But when one or more partner cease to be a partner in a firm, but other continue the business of partnership, it is called dissolution of partnership. Thus in this case when Ram retires and Shyam and Gopal continue to carry on firm’s business in the old firm’s name. The firm in such a case is called a reconstituted firm. Re-constitution of a firm involves a change in the relation of partner and not the end of the firm. 14. Minor’s Position in a partnership firm: In order to constitute a partnership there must be a contract. Since a minor is incompetent to enter into an agreement, he cannot become a partner in a firm. Section 30 of the Partnership Act, 1932, provides that though a minor cannot become a partner, he may be admitted to the benefits of partnership. The position of minor is very peculiar. He is entitled to all the benefits as a partner but he is not subject to all the liabilities of a partner. His position may be broadly studied under two heads- (a) before attaining majority, and (b) on attaining majority. (i)

Before attaining majority: Rights: A minor has right to: (1) share in the property and the profits of the firm as agreed upon. (2) have access to and inspect and copy any of the accounts of the firm. (3) sue the partners for accounts and payment. Liabilities: (1) A minor’s liability is limited to his share in the partnership business. In other words, the minor’s personal property cannot be held liable for the debts of the firm. (2) A minor cannot be adjudged as insolvent if the debts of the firm cannot be satisfied out of property of the firm.

(ii) On attaining majority: When he opts to become a partner: (1) He becomes personally liable to the third parties for all acts of the firm done from the date when he was admitted to the benefits of partnership. (2) His share in the profits and the property will remain the same as it was when he was a minor.

88 When he opts not to become a partner: (1) His rights and liabilities as a minor continues up to the date on which he gives notice of his intention not to become a partner.

public

(2) His share shall not be liable for any act of the firm after the date of such notice. (3) He shall have a right to sue the partners for his share of the property and profits of the firm. 15. Privileges of a “Holder in Due Course”: According to the provisions of the Negotiable Instruments Act, 1881, a holder in due course has the following privileges: (i)

A person signing and delivering to another a stamped but otherwise inchoate instrument is debarred from asserting, as against a holder in due course, that the instrument has not been filled in accordance with the authority given by him, the stamp being sufficient to cover the amount (Section 20).

(ii)

In case of bill of exchange is drawn payable to drawer’s order in a fictitious name and is endorsed by the same hand as the drawer’s signature. It is not permissible for acceptor to allege as against the holder in due course that such name is fictitious (Section 42).

(iii) In case a bill or note is negotiated to a holder in due course, the other parties to the bill or note cannot avoid liability on the ground that the delivery of the instrument was conditional or for a special purpose only (Section 42 and 47). (iv) The person liable in a negotiable instrument cannot set up against the holder in due course the defences that the instrument had been lost or obtained from the former by means of an offence or fraud or far an unlawful consideration (Section 58). (v) No maker of a promissory note, and no drawer of a bill or cheque and no acceptor of a bill for the honour of the drawer shall, in a suit thereon by a holder in due course be permitted to deny the validity of the instrument as originally made or drawn (Section 120). (vi) No maker of a promissory note and no acceptor of a bill payable to order shall, in a suit thereon by a holder in due course, be permitted to deny the payee’s capacity, at the rate of the note or bill, to endorse the same (Section 121). In brief, it is clear that a holder in due course gets a good title in many respects. According to Section 42 of the Negotiable Instruments Act, 1881 an acceptor of a bill of exchange drawn in a fictitious name and payable to the drawer’s order is not, by reason that such name is fictitious, relieved from liability to any holder in due course claiming under an instrument by the same hand as the drawer’s signature, and purporting to be made by the drawer. The word ‘fictitious payee’ means a person who is not in existence or being in existence, was never intended by the drawer to have the payment. Where drawer intends the payee to have the payment, then he is not a fictitious payee and the forgery of his signature will affect the validity of the cheque. Applying the above, answers to the questions asked can be as under: I.

In this case B, the drawer can recover the amount of the cheque from C’s bankers because C’s title was derived through forged endorsement.

II.

Here C is not a fictitious payee because the drawer intended him to receive payment.

III.

The result would be different if C is not a real person or is a fictitious person or was not intended to have the payment.

16. The problem as asked in the question is based on the provisions of the Negotiable Instruments Act, 1881 as contained in Section 84. The section provides that where a cheque is not presented by the holder for payment within a reasonable time of its issue and the drawer suffers actual damage through the delay because of the failure of the bank, he is discharged from liability to the extent of such damage. In determining what is reasonable time, regard shall be had to the nature of the instrument, the usage of trade and bankers, and the facts of the particular case. Accordingly, in the given case, the drawer is discharged from the liability to pay the amount of

89 cheque to B. However, B can sue against the bank for the amount of the cheque applying the above provisions. 17. As per Section 31(A) of the Payment of Bonus Act, 1965, there may be an agreement or settlement by the employees with their employer for payment of an annual bonus linked with production or productivity in lieu of bonus based on profits, as is payable under the Act. Accordingly, when such an agreement has been entered into the employees are entitled to receive bonus as per terms of the agreement/settlement, subject to the following restriction imposed by Section 31A: (a) any such agreement/settlement whereby the employees relinquish their right to receive minimum bonus under Section 10, shall be null and void in so far as it purports to deprive the employees of the right of receiving minimum bonus. (b) If the bonus payable under such agreement exceed 20% of the salary/wages earned by the employees during the relevant accounting year, such employees are not entitled to the excess over 20% of salary/wages. In the given case Aryan Textile Ltd. agreed with the employees for payment of an annual bonus linked with production or productivity instead of based on profits subject to the limit of 30% of their salary/ wages during the relevant accounting year. According to Section 31A the maximum bonus under this provision can be given which should not exceed 20% of the salary/wages earned by the employee during the relevant accounting year. Hence, the maximum bonus may be paid upto 20% of the salary/wages. If the company agrees to pay more than 20% then it will be against the provisions of the Payment of Bonus Act, 1965. The employees of Aryan Textiles also agreed not to claim minimum bonus stated in Section 10 of the Payment of Bonus Act, 1965 such an agreement shall be null and void as it purports to deprive the employees of their right of receiving minimum bonus. Hence, the relief may be given by the court, as regards to the payment of bonus to the employees, based on the production or productivity, if it is agreed, subject to a maximum of 20%. The employees will also be entitled legally to claim bonus which is minimum prescribed under Section 10 of the Act, even though they have relinquished such right as per the agreement. 18. Section 10 of the Payment of Bonus Act, 1965 provides that subject to the other provisions of the Act, every employer shall be bound to pay to employee in respect of the accounting year commencing on any day in 1979 and in respect of any subsequent year, a minimum bonus which shall be 8.33 per cent of the salary or wage earned by the employee during the accounting year or Rs. 100 (Rs. 60 in case of employees below 15 years of age), whichever is higher. The minimum bonus is payable whether or not employer has any allocable surplus in the accounting year. Therefore based on the above provision (Section 10) the question asked in the problem can be answered as under: Yes, applying the provisions as contained in Section 10 the employees shall succeed and they are entitled to be paid minimum bonus at rate 8.33% of the salary or wage earn during the accounting year or Rs. 100 (Rs. 60 in case of employees below 15 Years of age), whichever is higher. 19. Problem relating to liability in case of transfer of establishment The problem as asked in the question is based on the provisions of section 17(B) of the Employees Provident Funds and Miscellaneous Provisions Act, 1952. Accordingly where an employer in relation to an establishment, transfers that establishment in whole or in part by sale, gift, lease or licence or in any other manner whatsoever, the employer and the person to whom the establishment is so transferred shall be jointly or severally liable to pay the contribution and other sums due from the employer under the provisions of this Act of the scheme or pension scheme, as the case may be, in respect of the period upto the date of such transfer. It is provided that the liability of the transferee shall be limited to the value of the assets obtained by him by such transfer. It would be thus evident from the aforesaid provisions that 17-B deals with the liability of transferor and transferee in regard to the money due under (a) the Act or (b) the scheme (c) and pension scheme. In the case of the transfer of the establishment brought in by sale, gift, lease etc. The liability of the transferor and transferee is joint and several, but it is limited to the period upto the

90 date of transfer. Therefore applying the above provisions in the given case the transferor Manorama Group of Industries, the transferor has paid only 25% of the total liability as contribution in pension scheme before sale of the establishment. With regards to remaining 75% liability both the transferor and transferee companies are jointly and severally liable to contribute. In case, the transferor refuses to contribute, the transferee will be liable. The liability is limited upto the date of transfer and upto remaining amount. Further, the liability of the transferee i.e. Giant Group of Industries, is limited to the extent of assets obtained by it from the transfer of the establishment. 20. Transfer of accumulated amount to the credit of Employees Provident Fund on change of employment: Section 17-A of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 provides for the transfer of accounts of an employee in case of his leaving the employment and taking up employment and to deal with the case of an establishment to which the Act applies and also to which it does not apply. The option to get the amount transferred is that of the employee. Where an employee of an establishment to which the Act applies leaves his employment and obtains re-employment in another establishment to which the Act does not apply, the amount of accumulations to the credit of such employees in the Fund or, as the case may be, in the provident Fund in the establishment left by him shall be transferred to the credit of his account in the provident fund of the establishment in which he is re-employed, if the employee so desires and the rules in relation to that provident fund permit such transfer. The transfer has to be made with in such time as may be specified by the Central Govt. in this behalf. [Sub-Section (I)]. Conversely, when an employee of an establishment to which the Act does not apply leaves his employment and obtains re-employment in another establishment to which this Act applies, the amount of accumulations to the credit of such employee in the provident fund of the establishment left by him, if the employee so desires and the rules in relation to such provident fund permit, may be transferred to the credit of his account in the fund or as the case may be, in the provident fund of the establishment in which he is re-employed. [Sub-Section (2)]. 21. Transfer of Assets & Liabilities - Steps to be taken 1.

M/s Supreme Society Ltd can transfer its assets and liabilities in whole or in part to any other Multi-State Co-operative Society by passing a resolution by a majority of not less than twothirds of the members present and voting at a general meeting of the society held for this purpose. The resolution should contain the particulars of the assets and liabilities to be transferred.

2.

After passing the resolution, M/s Supreme Society Ltd should give notice thereof in writing to all the members and creditors giving them an option of withdrawing their shares, deposits or loans as the case may be. This option has to be exercised within a period of one month of the date of service of the notice and if any member or creditor who does not exercise his option within one month, shall be deemed to have assented to the proposal contained in the resolution. The resolution passed by the society shall not take effect until the assent thereto of all the members and creditors has been obtained.

3.

The society should make arrangements for meeting in full or otherwise satisfy all claims of the members and creditors who exercise the option to exist from the society.

4.

On receipt of necessary documents relating to the resolution passed by the society, the Central Registrar on being satisfied that the resolution has become effective will issue an order under Section 21 of the Multi-state Co-operative Societies Act, 2002. This will be a sufficient conveyance to vest the assets and liabilities in the transferee society without any further assurance.

22. Transfer of Share of a Member In a Co-operative Society According to Section 14(2) of the Co-operative Societies Act, 1912, in case of a society registered with unlimited liability, a member cannot transfer any share held by him or his interest in the capital of the society or any part thereof unless:

91 (i)

he has held such shares or interest for not less than one year; and

(ii) the transfer or charge is to the society or to a member of the society. A member can transfer his shares only when both the conditions are fulfilled. Hence, the transfer of shares by Sohan is not valid since he had held these shares only for 10 months. 23. Expulsion of a member of a society: A member who degenerates in conduct or character and thereby prejudices the society may be expelled from the society subject to the provisions in the bye-laws of the society for this purpose. The bye-laws of the society should contain such provisions and thereupon he may be expelled if : (i)

he fails to fulfil his obligations in the matter of dues ( the number of months arrears being specified).

(ii) he becomes a member of another similar society and refuses to withdraw and thereby it may be possible that he may pass on such information to a rival society of which he is a member. (iii) he is to be proceeded against for debts; (iv) he becomes insolvent. (v) he engages in such activities as might be contrary to the principles of the society; (vi) he becomes insane; (vii) he is convicted by a criminal court, especially of bribery, forgery, theft or fraud; and (viii) he has committed an act which is considered dishonourable by a managing committee. If a member of a society with unlimited liquidity joins another society and so pledges his liquidity twice over he should be expelled. 24. Corporate Veil After incorporation the company in the eyes of law is a different person altogether from the shareholders who have formed the company. The company has its own existence and as a result the shareholders cannot be held liable for the acts of the company even though the shareholders control the entire share capital of the company. This is popularly known as Corporate Veil and in certain circumstances the courts are empowered to lift or pierce the corporate veil by ignoring the company and directly examine the promoters and others who have managed the affairs of the company after its incorporation. Thus, when the corporate veil is lifted by the courts, (i.e., the courts have disregarded the company as an entity), the promoters can be made personally liable for the debts of the company. In the following circumstances, corporate veil can be lifted by the courts and promoters can be held personally liable for the debts of the company. (i)

Trading with enemy country.

(ii) Evasion of taxes. (iii) Forming a subsidiary company to act as its agent. (iv) The benefit of limited liability is destroyed by reducing the number of members below 7 in the case of public company and 2 in the case of private company for more than six months. (v) Under law relating to exchange control. (vi) Device of incorporation is adopted to defraud creditors or to avoid legal obligations. 25. Transfer of Registered Office of a Company In order to shift the registered office from the State of West Bengal to the State of Maharashtra, M/s ABC Ltd has to take the following steps: (i)

To pass a special resolution and thereafter file the same with the Registrar of Companies.

(ii)

To file a Petition before the Company Law Board (Central Government)* under Section 17, of the Companies Act, 1956.

92 (iii) To give an advertisement in two newspapers one in English language and the other in local language indicating the change and any member/creditor having objection can write to the Company Law Board (Central Government)*. (iv) To give notice to the State Government of West Bengal. (v) To submit all the required documents along with the fee to Company Law Board (Central Government)*. The Company Law Board (Central Government)* after hearing the petition passes an order confirming the alteration in the memorandum of association of the company regarding the shifting of the registered office. The Company Law Board’s (Central Government)* order should be filed by ABC Ltd with both the Registrars of Companies West Bengal and Maharashtra. After registration of the said order the Registrar of Companies Maharashtra will issue a certificate which is the conclusive proof that all the formalities have been complied with. Change of registered office from the jurisdiction of one Registrar to the other Registrar within the same State: The procedure and law pertaining to the change of registered office from the jurisdiction of one Registrar to the other Registrar within the same State is contained in Section 17A of the Companies Act, 1956 as amended upto date is as follows: (i)

Company can do so only if the Regional Director permits to it.

(ii) Application for permission has to be made on a prescribed form. (iii) The Regional Directors are required to confirm the Company’s application and inform it accordingly within a period of four weeks. (iv) After getting the confirmation of the Regional Director, the company must file a copy of the same with the Registrar of Companies within two months from the date of the confirmation together with a copy of the altered memorandum. (v) The Registrar is required to register the same and inform the company within one month from the date of filing. (vi) The Registrar’s certificate is a conclusive evidence of the fact of alteration and of compliance with the requirements (Section 17-A). (*Note: Students may kindly note that, all Sections of the Companies (Second Amendment) Act, 2002 have not come into force. Till such time, jurisdiction of Company Law Board will continue to remain unchanged.) 26. The Companies Act, 1956 does not prescribe any qualification for membership. Membership entails an agreement enforceable in a court of law. Therefore, the contractual capacity as envisaged by the Indian Contract Act, 1872 should be taken into consideration. It was held in the case of Mohri Bibi Vs. Dharmadas Ghose (1930) 30 Cal. 531 (P.C.) that since minor has no contractual capacity, the agreement with a minor is void. Therefore, a minor or a lunatic cannot enter into an agreement to become a member of the company. However, the Punjab High Court held in the case of Diwan Singh vs. Minerva Films Ltd (AIR 1956 Punjab 106) that there is no legal bar to a minor becoming a member of a company by acquiring shares by way of transfer provided the shares are fully paid up and no further obligation or liability is attached to these. The same view was upheld by the Company Law Board in the case of S.L. Bagree Vs. Britannia Industries Ltd (1980). In view of the above, M/s Honest Cycles Ltd can give membership to Balak through 1000 shares, received by way of transfer, in favour of Mr. Balak a minor because the shares are fully paid up and no further liability is attached to these. 27. In case more than one proxies have been appointed by a member in respect of the same meeting, one which is later time shall prevail and the earlier one shall be deemed to have been revoked. Thus, in the normal course, the proxy in favour of Mr. X, being later in time, should be upheld as valid. But, as per Section 176 of the Companies Act, 1956, a proxy should be deposited 48 hours before the time of the meeting. In the given case, the proxies should have, therefore, been deposited on or

93 before 13.12.2006 (the date of the meeting being 15.12.2006). X deposited the proxy on 15.12.2006. Therefore, proxy in favour of Mr. X has become invalid. Thus, rejecting the proxy in favour of Mr. Y is unsustainable. Proxy in favour of Y is valid since it is deposited in time. 28. Mis-leading Prospectus Any person who takes shares on the faith of statement of facts contained in a prospectus can rescind the contract if those statements are false or untrue. The words ‘untrue statement’ have to be construed as explained in Section 65(1)(a), which says that a statement included in a prospectus shall be deemed to be untrue, if the statement is misleading in the form and context in which it is included. Again, where the omission from a prospectus of any matter is calculated to mislead, the prospectus is deemed, in respect of such omission to be a prospectus in which an untrue statement is included [Section 65(1)(b)]. In this case, the fact that dividends were paid out of capital profit and not out of trading profits was not disclosed in the prospectus and to that extent the prospectus contained a material misrepresentation of a fact giving a false impression that the company was a profitable one. Hence the allottee can avoid the contract of allotment of shares. (Rex V. Lord Kylsant). 29. Problem on service of document upon a company: The problem as asked in the question is based on the provisions of the Companies Act, 1956 as contained in Section 51. Accordingly a document may be served on a company or on its officer at the registered office of the company. It must be sent either by post or by leaving it at its registered office. If it is sent by post, it must be either by post under a certificate of posting or by registered post. When a notice has been addressed to the company and served on the directors, it constitutes a good service (Benabo v. Jay (William) and Partners Ltd.) The articles of a company which contain the provisions contrary to Section 51 cannot be enforced nor can they limit the mode of service to only one of the modes provided by the Statute (Sadasiv Shankar Dandige V. Gandhi Seva Samaj Ltd.). Accordingly in the first case the refusal by the Mars Company Ltd. of the service of the document is not valid. In the second case Ramesh can claim damages on this account from the Company. 30. Problem on Company Law; Certificate of Incorporation and the binding effect: Upon the registration of the documents as required under the Companies Act, 1956 for incorporation of a company, and on payment of the necessary fees, the Registrar of Companies issues a Certificate that the company is incorporated (Section 34). Section 35 provides that a certificate of incorporation issued by the Registrar is conclusive as to all administrative acts relating to the incorporation and as to the date of incorporation. The facts as given in the problem are similar to those in case of Jubilee Cotton MIlls v. Lewis (1924) A.C. 1958 where it was held that an allotment of shares made on the date after incorporation could not be declared void on the ground that it was made before the company was incorporated when the certificate of incorporation was issued at a later date. Applying the above principles the contention of the company in this case cannot be tenable. It is immaterial that the certificate of incorporation was issued at a later date. Since the company came into existence on the date of incorporation stated on the certificate, it is quite legal for the company to enter into contracts. To conclude the contracts entered into by the company before the issue of certificate of incorporation shall be binding upon the company. The date of issue of certificate is immaterial. 31. Problem on notice and validity of proceedings of the meeting: The problem as asked in the question is based on the provisions of the Companies Act, 1956 as contained in Section 172 read with Section 53. Accordingly, the notice may be served personally or sent through post to the registered address of the members and, in the absence of any registered office in India, to the address, if there be any within India furnished by him to the company for the purpose of servicing notice to him. Service through post shall be deemed to have effected by correctly addressing, preparing and posting the notice. If, however, a member wants to notice to be served on him under a certificate or by registered post with or with acknowledgement due and has deposited money with

94 the company to defray the incidental expenditure thereof, the notice must be served accordingly, otherwise service will not be deemed to have been effected. Accordingly, the questions as asked may be answered as under: (i)

The contention of Diensh shall be tenable, for the reason that the notice was not properly served and meetings held by the company shall be invalid.

(ii) In view of the provisions of the Companies Act, 1956, as contained in Section 172, the company is not bound to send notice to Dinesh at the address outside India. Therefore, answer in the second case shall differ from the first one.

95

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

PROFESSIONAL COMPETENCE COURSE(PCC) SYLLABUS GROUP I Paper – 1 :

Advanced Accounting

Paper – 2 :

Auditing and Assurance

Paper – 3 :

Law, Ethics and Communication

GROUP II Paper – 4 :

Cost Accounting and Financial Management

Paper –5 :

Taxation

Paper – 6 :

Information Technology and Strategic Management

96 PAPER – 1 : ADVANCED ACCOUNTING (One paper – Three hours – 100 Marks) Level of Knowledge: Working knowledge Objectives: (a) To lay a theoretical foundation for the preparation and presentation of financial statements, (b) To gain working knowledge of the professional standards, principles and procedures of accounting and their application to different practical situations, (c) To gain the ability to solve simple problems and cases relating to company accounts including special type of corporate entities, partnership accounts and (c) To familiarize students with the fundamentals of computerized system of accounting. Contents 1.

Conceptual Framework for Preparation and Presentation of Financial Statements

2.

Accounting Standards An overview; standards setting process Working knowledge of: AS 1:

Disclosure of Accounting Policies

AS 2:

Valuation of Inventories

AS 3:

Cash Flow Statements

AS 4:

Contingencies and Events occurring after the Balance Sheet Date

AS 5:

Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies

AS 6:

Depreciation Accounting

AS 7:

Construction Contracts (Revised 2002)

AS 9:

Revenue Recognition

AS 10: Accounting for Fixed Assets AS 11: The Effects of Changes in Foreign Exchange Rates (Revised 2003) AS 12: Accounting for Government Grants AS 13: Accounting for Investments AS 14: Accounting for Amalgamations AS 16: Borrowing Costs AS 19

Leases

AS 20

Earnings Per Share

AS 26: Intangible Assets AS 29: Provisions, Contingent Liabilities and Contingent Assets. 3.

Company Accounts (a) Preparation of financial statements – Profit and Loss Account, Balance Sheet and Cash Flow Statement (b) Profit (Loss) prior to incorporation (c) Alteration of share capital, Conversion of fully paid shares into stock and stock into shares, Accounting for bonus issue, Accounting for employee stock option plan, Buy back of securities, Equity shares with differential rights, Underwriting of shares and debentures, Redemption of debentures

97 (d) Accounting for business acquisition, Amalgamation and reconstruction (excluding problems of amalgamation on inter-company holding) (e) Accounting involved in liquidation of companies, Statement of Affairs (including deficiency/surplus accounts) and Iiquidator’s statement of account of the winding up. 4.

Financial Statements of Banking, Insurance and Electricity Companies

5.

Average Due Date, Account Current, Self-Balancing Ledgers

6.

Financial Statements of Not-for-Profit Organisations

7.

Accounts from Incomplete Records

8.

Accounting for Special Transactions (a) Hire purchase and instalment sale transactions (b) Investment accounts (c) Departmental and branch accounts including foreign branches (d) Insurance claims for loss of stock and loss of profit.

9.

Advanced Issues in Partnership Accounts Final accounts of partnership firms – Admission, retirement and death of a partner including treatment of goodwill; Dissolution of partnership firms including piecemeal distribution of assets; Amalgamation of partnership firms; Conversion into a company and Sale to a company.

10. Accounting in Computerised Environment An overview of computerized accounting system–Salient features and significance, Concept of grouping of accounts, Codification of accounts, Maintaining the hierarchy of ledger, Accounting packages and consideration for their selection, Generating Accounting Reports. Note –

If either old Accounting Standards (ASs), Announcements and Limited Revisions to ASs are withdrawn or new ASs, Announcements and Limited Revisions to ASs are issued by the Institute of Chartered Accountants of India in place of existing ASs, Announcements and Limited Revisions to ASs, the syllabus will accordingly include/exclude such new developments in place of the existing ones with effect from the date to be notified by the Institute. PAPER– 2: AUDITING AND ASSURANCE (One Paper —Three hours — 100 Marks)

Level of knowledge: Working Knowledge Objective: To understand objective and concepts of auditing and gain working knowledge of generally accepted auditing procedures and of techniques and skills needed to apply them in audit and attestation engagements and solving simple case-studies. Contents 1.

Auditing Concepts —Nature and limitations of Auditing, Basic Principles governing an audit, Ethical principles and concept of Auditor’s Independence, Relationship of auditing with other disciplines.

2.

Auditing and Assurance Standards —Overview, Standard-setting process, Role of International Auditing and Assurance Standards Board and Auditing and Assurance Standards Board in India.

3.

Auditing engagement —Audit planning, Audit programme, Control of quality of audit work— Delegation and supervision of audit work.

98 4.

Documentation — Audit working papers, Audit files: Ownership and custody of working papers.

5.

Audit evidence — Audit procedures for obtaining evidence, Sources of evidence, Reliability of audit evidence, Methods of obtaining audit evidence % Physical verification, Documentation, Direct confirmation, Re-computation, Analytical review techniques, Representation by management.

6.

Internal Control — Elements of internal control, Review and documentation, Evaluation of internal control system, Internal control questionnaire, Internal control check list, Tests of control, Application of concept of materiality and audit risk, Concept of internal audit.

7.

Internal Control and Computerized Environment, Approaches to Auditing in Computerised Environment.

8.

Audit Sampling — Types of sampling, Test checking, Techniques of test checks.

9.

Analytical review procedures.

Permanent and current audit files,

10. Audit of payments — General considerations, Wages, Capital expenditure, Other payments and expenses, Petty cash payments, Bank payments, Bank reconciliation. 11. Audit of receipts — General considerations, Cash sales, Receipts from debtors, Other Receipts. 12. Audit of Purchases — Vouching cash and credit purchases, Forward purchases, Purchase returns, Allowance received from suppliers. 13. Audit of Sales — Vouching of cash and credit sales, Goods on consignment, Sale on approval basis, Sale under hire% purchase agreement, Returnable containers, Various types of allowances given to customers, Sale returns. 14. Audit of suppliers’ ledger and the debtors’ ledger — Self-balancing and the sectional balancing system, Total or control accounts, Confirmatory statements from credit customers and suppliers, Provision for bad and doubtful debts, Writing off of bad debts. 15. Audit of impersonal ledger — Capital expenditure, deferred revenue expenditure and revenue expenditure, Outstanding expenses and income, Repairs and renewals, Distinction between reserves and provisions, Implications of change in the basis of accounting. 16. Audit of assets and liabilities. 17. Company Audit — Audit of Shares, Qualifications and Disqualifications of Auditors, Appointment of auditors, Removal of auditors, Powers and duties of auditors, Branch audit , Joint audit , Special audit, Reporting requirements under the Companies Act, 1956. 18. Audit Report — Qualifications, Disclaimers, Adverse opinion, Disclosures, Reports and certificates. 19. Special points in audit of different types of undertakings, i.e., Educational institutions, Hotels, Clubs, Hospitals, Hire-purchase and leasing companies (excluding banks, electricity companies, cooperative societies, and insurance companies). 20. Features and basic principles of government audit, Local bodies and not-for-profit organizations, Comptroller and Auditor General and its constitutional role. Note: Candidates are expected to have working knowledge of relevant Auditing and Assurance Standards issued by the ICAI with reference to above-mentioned topics.

99 PAPER – 3 : LAW, ETHICS AND COMMUNICATION (One paper – Three hours — 100 Marks) Level of Knowledge: Working knowledge Part I : Law ( 60 Marks) Objective: To test working knowledge of business laws and company law and their practical application in commercial situations. Contents Business Laws (30 Marks) 1.

The Indian Contract Act, 1872

2.

The Negotiable Instruments Act, 1881

3.

The Payment of Bonus Act, 1965

4.

The Employees’ Provident Fund and Miscellaneous Provisions Act, 1952

5.

The Payment of Gratuity Act, 1972.

Company Law (30 Marks) The Companies Act, 1956 – Sections 1 to 197 (a) Preliminary (b) Board of Company Law Administration — National Company Law Tribunal; Appellate Tribunal (c) Incorporation of Company and Matters Incidental thereto (d) Prospectus and Allotment, and other matters relating to use of Shares or Debentures (e) Share Capital and Debentures (f)

Registration of Charges

(g) Management and Administration – General Provisions – Registered office and name, Restrictions on commencement of business, Registers of members and debentures holders, Foreign registers of members or debenture holders, Annual returns, General provisions regarding registers and returns, Meetings and proceedings (h) Company Law in a computerized Environment – E-filing. Note: If new legislations are enacted in place of the existing legislations, the syllabus would include the corresponding provisions of such new legislations with effect from a date notified by the Institute. Part II : Business Ethics (20 Marks) Objective: To have an understanding of ethical issues in business. Contents 1.

Introduction to Business Ethics The nature, purpose of ethics and morals for organizational interests; Ethics and Conflicts of Interests; Ethical and Social Implications of business policies and decisions; Corporate Social Responsibility; Ethical issues in Corporate Governance.

2.

Environment issues Protecting the Natural Environment – Prevention of Pollution and Depletion of Natural Resources; Conservation of Natural Resources.

100 3.

Ethics in Workplace Individual in the organisation, discrimination, harassment, gender equality.

4.

Ethics in Marketing and Consumer Protection Healthy competition and protecting consumer’s interest.

5.

Ethics in Accounting and Finance Importance, issues and common problems. Part III : Business Communications (20 Marks)

Objective: To nurture and develop the communication and behavioural skills relating to business Contents 1.

Elements of Communication (a) Forms of Communication: Formal and Informal, Interdepartmental, Verbal and non-verbal; Active listening and critical thinking (b) Presentation skills including conducting meeting, press conference (c)

Planning and Composing Business messages

(d) Communication channels (e) Communicating Corporate culture, change, innovative spirits (f)

Communication breakdowns

(g) Communication ethics (h) Groups dynamics; handling group conflicts, consensus building; influencing and persuasion skills; Negotiating and bargaining

2.

(i)

Emotional intelligence - Emotional Quotient

(j)

Soft skills – personality traits; Interpersonal skills ; leadership.

Communication in Business Environment (a) Business Meetings – Notice, Agenda, Minutes, Chairperson’s speech (b) Press releases (c)

Corporate announcements by stock exchanges

(d) Reporting of proceedings of a meeting. 3.

Basic understanding of legal deeds and documents (a) Partnership deed (b) Power of Attorney (c)

Lease deed

(d) Affidavit (e) Indemnity bond (f)

Gift deed

(g) Memorandum and articles of association of a company (h) Annual Report of a company.

101

GROUP – II PAPER – 4: COST ACCOUNTING AND FINANCIAL MANAGEMENT (One paper – Three hours — 100 Marks) Level of Knowledge: Working knowledge Part I : Cost Accounting (50 Marks) Objectives: (a) To understand the basic concepts and processes used to determine product costs, (b) To be able to interpret cost accounting statements, (c) To be able to analyse and evaluate information for cost ascertainment, planning, control and decision making, and (d) To be able to solve simple cases. Contents 1.

Introduction to Cost Accounting (a) Objectives and scope of Cost Accounting (b) Cost centres and Cost units (c) Cost classification for stock valuation, Profit measurement, Decision making and control (d) Coding systems (e) Elements of Cost (f)

Cost behaviour pattern, Separating the components of semi-variable costs

(g) Installation of a Costing system (h) Relationship of Cost Accounting, Financial Accounting, Management Accounting and Financial Management. 2.

Cost Ascertainment (a) Material Cost (i)

Procurement procedures— Store procedures and documentation in respect of receipts and issue of stock, Stock verification

(ii) Inventory control —Techniques of fixing of minimum, maximum and reorder levels, Economic Order Quantity, ABC classification; Stocktaking and perpetual inventory (iii) Inventory accounting (iv) Consumption — Identification with products of cost centres, Basis for consumption entries in financial accounts, Monitoring consumption. (b) Employee Cost (i)

Attendance and payroll procedures, Overview of statutory requirements, Overtime, Idle time and Incentives

(ii) Labour turnover (iii) Utilisation of labour, Direct and indirect labour, Charging of labour cost, Identifying labour hours with work orders or batches or capital jobs (iv) Efficiency rating procedures (v) Remuneration systems and incentive schemes.

102 (c) Direct Expenses Sub-contracting — Control on material movements, Identification with the main product or service. (d) Overheads (i)

Functional analysis — Factory, Administration, Selling, Distribution, Research and Development Behavioural analysis — Fixed, Variable, Semi variable and Step cost

(ii) Factory Overheads — Primary distribution and secondary distribution, Criteria for choosing suitable basis for allotment, Capacity cost adjustments, Fixed absorption rates for absorbing overheads to products or services (iii) Administration overheads — Method of allocation to cost centres or products (iv) Selling and distribution overheads — Analysis and absorption of the expenses in products/customers, impact of marketing strategies, Cost effectiveness of various methods of sales promotion. 3.

Cost Book-keeping Cost Ledgers—Non-integrated accounts, Integrated accounts, Reconciliation of cost and financial accounts.

4.

Costing Systems (a) Job Costing Job cost cards and databases, Collecting direct costs of each job, Attributing overhead costs to jobs, Applications of job costing. (b) Batch Costing (c) Contract Costing Progress payments, Retention money, Escalation clause, Contract accounts, Accounting for material, Accounting for plant used in a contract, Contract profit and Balance sheet entries. (d) Process Costing Double entry book keeping, Process loss, Abnormal gains and losses, Equivalent units, Inter-process profit, Joint products and by products. (e) Operating Costing System

5.

Introduction to Marginal Costing Marginal costing compared with absorption costing, Contribution, Breakeven analysis and profit volume graph.

6.

Introduction to Standard Costing Various types of standards, Setting of standards, Basic concepts of material and Labour standards and variance analysis. Part II : Financial Management (50 Marks)

Objectives: (a) To develop ability to analyse and interpret various tools of financial analysis and planning, (b) To gain knowledge of management and financing of working capital, (c) To understand concepts relating to financing and investment decisions, and (d) To be able to solve simple cases.

103 Contents 1. Scope and Objectives of Financial Management (a) Meaning, Importance and Objectives (b) Conflicts in profit versus value maximisation principle (c) Role of Chief Financial Officer. 2. Time Value of Money Compounding and Discounting techniques— Concepts of Annuity and Perpetuity. 3. Financial Analysis and Planning (a) Ratio Analysis for performance evaluation and financial health (b) Application of Ratio Analysis in decision making (c) Analysis of Cash Flow Statement. 4. Financing Decisions (a) Cost of Capital — Weighted average cost of capital and Marginal cost of capital (b) Capital Structure decisions — Capital structure patterns, Designing optimum capital structure, Constraints, Various capital structure theories (c) Business Risk and Financial Risk — Operating and financial leverage, Trading on Equity. 5.

Types of Financing (a) Different sources of finance (b) Project financing — Intermediate and long term financing (c) Negotiating term loans with banks and financial institutions and appraisal thereof (d) Introduction to lease financing (e) Venture capital finance.

6.

Investment Decisions (a) Purpose, Objective, Process (b) Understanding different types of projects (c) Techniques of Decision making: Non-discounted and Discounted Cash flow Approaches — Payback Period method, Accounting Rate of Return, Net Present Value, Internal Rate of Return, Modified Internal Rate of Return, Discounted Payback Period and Profitability Index (d) Ranking of competing projects, Ranking of projects with unequal lives.

7.

Management of Working Capital (a) Working capital policies (b) Funds flow analysis (c) Inventory management (d) Receivables management (e) Payables management (f)

Management of cash and marketable securities

(g) Financing of working capital.

104 PAPER – 5 : TAXATION (One paper — Three hours – 100 Marks) Level of Knowledge: Working knowledge Objectives: (a) To gain knowledge of the provisions of Income-tax law relating to the topics mentioned in the contents below and (b) To gain ability to solve simple problems concerning assessees with the status of ‘Individual’ and ‘Hindu Undivided Family’ covering the areas mentioned in the contents below. Part I : Income-tax (75 marks) Contents 1.

Important definitions in the Income-tax Act, 1961

2.

Basis of charge; Rates of taxes applicable for different types of assessees

3.

Concepts of previous year and assessment year

4.

Residential status and scope of total income; Income deemed to be received / deemed to accrue or arise in India

5.

Incomes which do not form part of total income

6.

Heads of income and the provisions governing computation of income under different heads

7.

Income of other persons included in assessee’s total income

8.

Aggregation of income; Set-off or carry forward and set-off of losses

9.

Deductions from gross total income

10. Computation of total income and tax payable; Rebates and reliefs 11. Provisions concerning advance tax and tax deducted at source 12. Provisions for filing of return of income. Part II : Service tax and VAT (25 marks) Objective: To gain knowledge of the provisions of service tax as mentioned below and basic concepts of Value added tax (VAT) in India. Contents: 1. Service tax – Concepts and general principles 2. Charge of service tax and taxable services 3. Valuation of taxable services 4. Payment of service tax and filing of returns 5. VAT – Concepts and general principles. Note:

If new legislations are enacted in place of the existing legislations the syllabus will accordingly include the corresponding provisions of such new legislations in the place of the existing legislations with effect from the date to be notified by the Institute. Students shall not be examined with reference to any particular State VAT Law.

105

PAPER – 6 : INFORMATION TECHNOLOGY AND STRATEGIC MANAGEMENT (One paper – Three hours – 100 Marks) Level of Knowledge: Working knowledge Section A : Information Technology (50 Marks) Objective: To develop an understanding of Information Technology and its use by the business as facilitator and driver. Contents 1.

Introduction to Computers

(a) Computer Hardware Classification of Computers - Personal computer, Workstation, Servers and Super computers Computer Components - CPU, Input output devices, Storage devices (b) BUS, I/O CO Processors, Ports (serial, parallel, USB ports), Expansion slots, Add on cards, On board chips, LAN cards, Multi media cards , Cache memory, Buffers, Controllers and drivers (c) Computer Software Systems Software - Operating system, Translators (Compilers, Interpreters and Assemblers), System utilities General Purpose Software/ Utilities - Word Processor, Spread Sheet, DBMS, Scheduler / Planner, Internet browser and E-mail clients Application Software - Financial Accounting, Payroll, Inventory Specialised Systems – Enterprise Resource Planning (ERP) , Artificial Intelligence , Expert Systems, Decision Support Systems – An Overview 2.

Data Storage, Retrievals and Data Base Management Systems (a) Data and Information Concepts: Bits, Bytes, KB, MB, GB, TB (b) Data organization and Access Storage Concepts : Records, Fields, Grouped fields, Special fields like date, Integers, Real, Floating, Fixed, Double precision, Logical, Characters, Strings, Variable character fields (Memo); Key, Primary key, Foreign key, Secondary key, Referential integrity, Index fields. Storage techniques: Sequential, Block Sequential, Random, Indexed, Sequential access, Direct access, Random access including Randomizing Logical Structure and Physical structure of files (c) DBMS Models and Classification: Need for database, Administration, Models, DML and DDL (Query and reporting); Data Dictionaries, Distributed data bases, Object oriented databases, Client Server databases, Knowledge databases (d) Backup and recovery – backup policy, backup schedules, offsite backups, recycling of backups, frequent checking of recovery of backup (e) Usage of system software like program library management systems and tape and disk management systems – features, functionalities, advantages (f)

Data Mining and Data Warehousing - An overview

106 3.

Computer Networks & Network Security (a) Networking Concepts – Need and Scope, Benefits Classification: LAN, MAN, WAN, VPN; Peer-to-Peer, Client Server Components- NIC, Router, Switch, Hub, Repeater, Bridge, Gateway, Modem Network Topologies– Bus, Star,, Ring, Mesh, Hybrid, Architecture :Token ring, Ethernet Transmission Technologies and Protocols – OSI, TCP/IP, ISDN etc. Network Operating System (b) Local Area Networks- Components of a LAN, Advantages of LAN (c) Client Server Technology Limitation of Single user systems and need for Client Server Technology Servers - Database, Application, Print servers, Transaction servers, Internet servers, Mail servers, Chat servers, IDS Introduction to 3- tier and “n” tier architecture (COM, COM+) (d) Data centres: Features and functions, Primary delivery centre and disaster recovery site (e) Network Security Need; Threats and Vulnerabilities; Security levels; techniques

4.

Internet and other technologies (a) Internet and world-wide web, Intranets, Extranets, applications of Internet, Internet protocols (b) E-Commerce - Nature, Types (B2B, B2C, C2C), Supply chain management, CRM, Electronic data interchange (EDI), Electronic fund transfers (EFT), Payment portal, E-Commerce security; (c) Mobile Commerce, Bluetooth and Wi-Fi

5.

Flowcharts, Decision Tables. Section B : Strategic Management (50 Marks)

Objectives: (a) To develop an understanding of the general and competitive business environment, (b) To develop an understanding of strategic management concepts and techniques, (c) To be able to solve simple cases. Contents 1.

Business Environment General Environment % Demographic, Socio-cultural, Macro-economic, Legal/political, Technological, and Global; Competitive Environment.

2.

Business Policy and Strategic Management Meaning and nature; Strategic management imperative; Vision, Mission and Objectives; Strategic levels in organisations.

3.

Strategic Analyses Situational Analysis – SWOT Analysis, TOWS Matrix, Portfolio Analysis % BCG Matrix.

4.

Strategic Planning Meaning, stages, alternatives, strategy formulation.

107 5.

Formulation of Functional Strategy Marketing strategy, Financial strategy, Production strategy, Logistics strategy, Human resource strategy.

6.

Strategy Implementation and Control Organisational structures; Establishing strategic business units; Establishing profit centers by business, product or service, market segment or customer; Leadership and behavioural challenges.

7.

Reaching Strategic Edge Business Process Reengineering, Benchmarking, Total Quality Management, Six Sigma, Contemporary Strategic Issues.

108 TRANSITION SCHEME FOR STUDENTS OF PROFESSIONAL EDUCATION (COURSE -II) (1) Professional Education (Course-II) students who have passed Professional Education (Examination-I) / Foundation Examination can switch over to Professional Competence Course. Such students are classified into two categories – Category (a) Students who have passed one of the Groups of Professional Education (Examination-II); Students who have appeared in Professional Education (Examination-II), but not passed any of the Groups; and Students who have registered for Professional Education (Course- II) and eligible to appear in Professional Education (Examination-II), but not yet appeared.

Category (b) Students who are registered, provisionally or otherwise, for Professional Education (Course-II), but ineligible to appear in Professional Education (Examination-II). Transition scheme for the students falling under Category (a) above is as under:

(i) Register concurrently for Professional Competence Course (PCC), Articled / Audit training and 100 Hours Information Technology Training. Complete 100 hours Information Technology Training: Appear in Professional Competence Examination (PCE) in the eligible attempt of Professional Competence Examination without the requirement of completion of minimum 18 months of practical training in accordance with the eligibility norm stated in Para (2); or (ii) Continue with Professional Education (Examination-II) till the last Professional Education (Examination - II) to be held in May 2008. Transition scheme for the students falling under Category (b) above is as under: (i)

Register concurrently for Professional Competence Course (PCC), Articled / Audit training and 100 Hours Information Technology Training; Complete 100 hours Information Technology Training; Appear in Professional Competence Examination (PCE) in May 2008 or thereafter, after completion of minimum 15 months of articled training or equivalent period of audit training 3 months prior to the first day of the month in which examination is held. The students are permitted to undergo training partly as an articled assistant and partly as an audit assistant.

(ii) Continue with Professional Education (Course-II)/Examination till the last Professional Education (Examination-II) to be held in May 2008.

Note: 6 months of articleship training is equivalent to 8 months of audit training. Any fractional period of audit training is not counted. So a student who falls under Category (a) and who is undergoing audit training has to complete 24 months of training for appearing in PCE. Relevant extracts of Implementation Schedule Commencement of New Scheme

September 13, 2006

Registration commences for Articles under New Scheme [Applicable to students who are studying Professional Education (Course-II) after passing Professional Education (Examination-I) / Foundation Examination]

September 13, 2006

Last Professional Education (Examination–II)

May, 2008

First Professional Competence Examination for students joining Professional Competence Course after passing Professional Education (Examination–I) /Foundation Examination

May, 2007

109 (2) Eligibility norm of Professional Education ( Course –II) students who have switched over / will switch over to Professional Competence Course (PCC) to appear in Professional Competence Examination ( PCE) (i)

All such students have already appeared in Professional Education (Examination –II) and passed one of the Groups or could not pass any of the Groups or eligible to appear Professional Education ( Examination-II) .

(ii) Students should successfully complete 250 Hours Compulsory Computer Training programme / 100 Hours Information technology Training programme before appearing in the PCE. Sl No.

1 Category of students of PE-II

2 Eligibility to appear in Professional Competence Examination \ ( PCE) As Modified

1.

PE- II students who have passed foundation examination

May 2007

2.

PE- II students who have passed PE-I examination held in May 2005 or in any earlier term

May 2007

3.

PE- II students who have passed PE-I examination held in November 2005

November 2007

4.

PE-II students who have passed PE-I examination held in May, 2006

These students fall in category (b) and will appear PCE as per the transition scheme

See also Figure-1. (3) Transition Scheme for Professional Education (Course-II) Students other than those who have passed Professional Education (Examination –I) or Foundation Examination Continue with Professional Education (Examination-II) till the last Professional Education (Examination-II) to be held in May 2008; or Switch over to Common Proficiency Test.See Figure-2.

110

Students of Professional Education (Course-II) who have passed PEI/Foundation Examination

Category A: Students who have passed one of the groups of Professional Education (Examination-II);

Category B Students who are registered, provisionally or otherwise, for Professional Education (CourseII), but not eligible to appear in Professional Education (Examination-II)

Students who have appeared in Professional Education (Examination-II), but not passed any of the Groups; and Students who have registered for Professional Education (Course-II) and eligible to appear in Professional Education (Examination-II) but not yet appeared

Register for Professional Competence Course (PCC), Articled/Audit training and 100 Hours Information Technology Training;

Register for Professional Competence Course (PCC), Articled / Audit training and 100 Hours Information Technology Training;

Join articles thereafter for 3 ½ years / equivalent period of audit training (56 months);

Join articles concurrently for 3 ½ years / equivalent period of audit training (56 months);

Complete 100 Hours Technology Training;

Complete 100 Hours Technology Training;

Information

Appear in Professional Competence Examination (PCE) as stated in para (2) without the requirement of completion of minimum 18 months of practical training; or

Information

Appear in Professional Competence Examination (PCE) In May 2008 or thereafter on completion of minimum 18 months of articled training; or Continue with Professional Education (Course-II) / Examination till the last Professional Education (ExaminationII) to be held in May 2008.

Continue with Professional Education (Examination-II) till the last Professional Education (ExaminationII) to be held in May 2008

Figure-1

111

Students of Professional Education (Course-II) who have not passed PE-I/Foundation

Switch over to CPT

Continue in PE-II till last PE-II examination is held, complete 250 Hours CCT/100 Hours ITT and join 3 years articleship In case a student does not qualify PE (Examination-II) in the last PE (Examination-II) to be held in May, 2008, he / she is allowed to appear in Professional Competence Examination (PCE) to be held in November, 2008 and thereafter. On qualifying PCE and completion of 250 Hours CCT/100 Hours ITT, he / she is allowed to join 3 years articleship

Figure-2

(4) Subject-wise exemption: A Professional Education (Course-II) student who has been granted an exemption under Regulation 37A(7) in one or more papers shall continue to enjoy the said exemption in the corresponding paper(s) under PCC as given below :

Subject-wise Exemption for PE-II Examination Existing

New

Professional Education (Course-II)

Professional Competence Course

Group I Paper 1: Accounting

Group I Advanced Accounting (100 Marks)

Paper 2: Auditing

Auditing and Assurance (100 Marks)

Paper 3: Business and Corporate Laws Section A: Business Law (60 marks) Section B: Corporate Laws (40 marks)

Law, Ethics and Communication Part I: Law (60 Marks) Business Laws (30 Marks) Part II: Business Ethics (20 Marks) Part III: Business Communication (20 Marks)

Group II Paper 4: Cost Accounting and Financial Management Section A: Cost Accounting (60 marks) Section B: Financial Management (40 marks)

Group II Cost Accounting and Financial Management Part I: Cost Accounting (50 Marks) Part II: Financial Management (50 Marks)

Paper 5: Income-tax and Central Sales Tax Section A: Income Tax (75 marks) Section B: Central Sales Tax (25 marks)

Taxation Part I: Income-tax (75 Marks) Part II: Service Tax and VAT (25 Marks)

Paper 6: Information Technology

Information Technology and Strategic Management Section A: Information Technology (50 Marks) Section B: Strategic Management (50Marks)

112 (5) Group-wise exemption: A student of Professional Education (Course-II) who has passed in any one but not in both the groups of the Professional (Education-II) is granted exemption from passing the same group in PCE, i.e., if a student has passed Group I of Professional Education (Course-II) he is granted exemption from appearing in Group I of PCE, or if a student has passed Group II of Professional Education (Examination-II) he is granted exemption from appearing in Group II of PCE.

113

RECENT PUBLICATIONS OF THE BOARD OF STUDIES Postal Charges By Registered Parcel English

Hindi

English

Hindi

Rs.

Rs.

Rs.

Rs.

200

140

50

40

General Economics

100

70

Quantitative Aptitude

250

150

Self Assessment CD

40

40

640

440

145

145

I.

STUDY MATERIALS

COMMON PROFICIENCY TEST

(CPT)

Fundamentals of Accounting Mercantile Laws

PROFESSIONAL COMPETENCE COURSE (PCC) Group I Advanced Accounting Vol. I & Vol. II

500

Auditing and Assurance

175

Law, Ethics and Communication

275 950

215

Group II Cost Accounting & Financial Management

300

Taxation

200

Information Technology

150

Strategic Management

100

Both Groups

750

180

1700

395

FINAL (NEW COURSE) Group I Financial Reporting

600

Strategic Financial Management

260

Advanced Auditing and Professional Ethics

520

Corporate and Allied Laws

200 1580

320

Group II Advanced Management Accounting

240

Information Systems Control and Audit

150

Direct Tax Laws

340

Indirect Tax laws

290

Both Groups

1020

225

2600

540

500

90

Information Technology Training Course Material Information Technology Training Programme - Modules I & II

114 II.

COMPILATIONS OF SUGGESTED ANSWERS

Professional Education (Course-II) Auditing (May, 2000 to May, 2005)

40

40

Income Tax and Central Sales Tax (May, 1996 to Nov. 2005)

40

40

Advanced Auditing (May, 2000 to May, 2005)

60

40

Direct Taxes (May 2000 to Nov. 2005)

60

40

Final

III.

SUGGESTED ANSWERS FOR NOV. 2006 Professional Education (Course –I) Professional Education (Course –II) (Group I & II) Final (Group I & II)

Each Suggested Answer is priced Rs.40 per volume plus Postal charges for Registered parcel Rs.40. IV.

V.

REVISION TEST PAPERS FOR MAY 2007 Professional Education (Course –I)

40

40

Professional Education (Course –II) (Group I & II)

80

55

Final (Group I & II)

80

55

100

40

100

40

50

40

40

40

PROSPECTUS 1.

Common Proficiency Test – A Simplified Entry to the Chartered Accountancy Course

2.

Professional Competence Course – First Stage of Theoretical Education of the Chartered Accountancy Course inclusive of conversion form – With Form Nos. 102 and 103 – Without Form Nos. 102 and 103

VI.

MISCELLANEOUS

1

Select cases Direct and Indirect Taxes - 2006

2.

Information Brochure about Common Proficiency Test – A Simplified Entry to the Chartered Accountancy Course Both in English and Hindi

3.

Information Brochure about Professional Competence Course – First Stage of Theoretical Education of the Chartered Accountancy Both in English and Hindi

4.

Information Brochure on 100 Hours Information Technology Training

5.

Information Brochure about Chartered Accountancy - Global Career Opportunities through a premier Professional Institute Both in English and Hindi

Available free of cost in all Decentralised Offices and Branches of the Institute

VII. COMPACT DISCS (CDs) New Series 1.

Membership in Company

- PE-II

50

40

2.

Capital Gains (Part I and Part II)

- Final

50

40

3.

Insurance Claims

- PE-I / CPT

50

40

4.

Hire Purchase and Instalment Payment - PE-II/PCC

50

40

5.

Taxation of Salaries

50

40

- PE-II/ PCC

115 Applicability of various Publications for Professional Education (Examination –II) to be held in May 2007 Paper – 1 : Accounting Accounting Standards 1 to 29 [including revised AS 15(2005)]. For the students at PE-II level, Accounting Standards and Guidance Notes related to the topics given in the study material are more relevant. They are not expected to know in detail the advanced standards like Consolidated Financial Statements (AS 21), Accounting for Investments in Associates in Consolidated Financial Statements (AS 23), Discontinuing Operations (AS 24), Financial Reporting of Interests in Joint Ventures (AS 27), Impairment of Assets (AS 28) and Provisions, Contingent Liabilities and Contingent Assets (AS 29). For the topic of Accounts of Insurance Companies, the Insurance Regulatory and Development Authority (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2002 will be applicable. Students should refer to Fifth Edition (December 2005) of the study materials. Paper – 2 : Auditing Auditing and Assurance Standards – 1 to 30. Students at PE II level are expected to have familiarity with all these Auditing and Assurance Standards. They are expected to know in-depth only such Auditing Standards, which have been dealt within the main text of the study material. Students should refer to Fifth Edition (September 2005) of the study materials. Paper – 3 : Business & Corporate Laws The study material revised and updated as on 15 th November 2005 edition is relevant for May, 2007 Examination. There has been no legislative change since then. Paper – 5 : Income-tax and Central Sales Tax Study Material for Income-tax and Central Sales Tax - June 2005 edition read along with “Professional Education (Course-II) – Supplementary Study Paper - 2006 – Income-tax and Central Sales-tax” containing amendments made by the Finance Act, 2006, relevant for assessment year 2007-08. Note – For the purposes of setting the questions in Income-tax and central sales tax, the June 2005 edition of the study material read along with the “Supplementary Study Paper - 2006 – Income-tax and Central Sales-tax” containing the amendments made by the Finance Act, 2006, relevant for assessment year 2007-08 should be taken into account. The study material contains the amendments made by notifications/circulars/other legislations up to 30.04.2005 and the supplementary study paper – 2006 contains the amendments made by the Finance Act, 2006 as well as amendments made by notifications/circulars/other legislations between 1.5.05 and 30.04.2006. Further, the amendments made between 1.05.2006 and 31.10.2006 would be published in the Revision Test Papers for May 2007 examination. All these amendments are relevant for May 2007 examination and hence should be taken into account for the purpose of setting questions for this exam.