PRIME/ME34/FINAL  1

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

Question No.1 is compulsory. Answer any five from the rest Working notes should form part of the respective answers.

1a. Compute the Original and Restated EPS for 2010 and 2011 including effects of Rights issue.

Account Year: 01-01-2010 to 31-12-2011

Net Profit Year 2010: `11, 00,000 Year 2011: `15, 00,000

No of shares outstanding prior to rights issue – 5, 00,000 shares

Rights issue – One new share for each five outstanding (i.e. 1, 00,000 new share) Rights issue price: `15 Last date to exercising rights: 1st March 2011.

Fair value of one equity share immediately - ` 21 prior to exercise of rights on 1st March 2011 (4 marks) 1b.The following data apply to ‘X’ Ltd. defined benefit pension plan for the year ended 31.03.09, calculate the actual

return on plan assets:

-Benefits paid ` 2, 00,000

-Employer contribution ` 2, 80,000

-Fair market value of plan assets on 31.03.09 `11, 40,000

-Fair market value of plan assets as on 31.03.08 ` 8, 00,000 (4 marks)

1c. XY Ltd. was making provisions for non-moving stocks based on no issues for the last 12 months upto 31.03.08. Based on technical evaluation the company wants to make provisions during the year 31.03.09.

Total value of stock – `150 lakhs

Provisions required based on 12 months issue `4.0 lakhs.

Provisions required based on technical evaluation `3.20 lakhs.

Does this amount to change in accounting policy? Can the company change the method of provision? (4 marks)

1d. On 1.4.2008., a mutual fund scheme had 18 lakhs units of face value of `10 each was outstanding. The scheme earned `162 lakhs in 2008-09, out of which `90 lakhs was earned in the first half of the year. On 30.09.2008, `2 lakhs units were sold at a ‘NAV’ of `70 Pass journal entries for the sale of units and distribution of dividend at the end of 2008-09. (4 marks)

1e. While closing its books of account as on 31.12.2009 non-banking finance company (NBFC) has its advances classified as under:

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` in lakhs Standard assets 10,000 Sub-standard assets 1,000 Secured portion of doubtful debts -Upto one year 160 -One year to three year 70 -More than three years 20 Unsecured portion of doubtful debts 90 Loss assets 30 Calculate the provision to be made against advances by NBFC as per prudential norms. (4 marks)

2. The following are the Balance Sheets of H Ltd. and S Ltd. as at 31.03.09: In lakhs

Particulars H Ltd. `

S Ltd. `

Particulars H Ltd. `

S Ltd. `

Share capital Share of Rs.10 each General Reserve Profit and loss Secured Loan Current liabilities

50 50 20 20 30

10 20 15 3 2

Fixed asset Investment in S Ltd. (60,000 shares) Debtors Inventories Cash at bank

60 6

35 30 39

18 -

5 25 2

170 50 170 50 H Ltd. holds 60% of the paid up capital of S Ltd. and balance is held by a foreign company. The foreign company agreed with H Ltd. as under:

(i) The shares held by the foreign company will be sold to H Ltd. at `50 above than nominal value of per share. (ii) The actual cost per share to the Foreign Company was `11; gain accruing to Foreign Company is taxable @ 20%. The tax payable will be deducted from the sale proceeds and paid to Government by H Ltd. 50% of the consideration (after payment of tax) will be remitted to Foreign Company by H Ltd. and also any cash for fractional shares allotted. (iii) For the Balance of consideration H Ltd. would issue its shares at their intrinsic value. It was also decided

that H Ltd. would also absorb S Ltd. simultaneously by writing down the fixed assets of S Ltd. by 10%. The Balance Sheet figure included a sum of `1 lakh due by S Ltd. to H Ltd, included stock of ` 1.5 lakhs purchased from S Ltd. who sold them at cost plus 20%. Pass Journal entries in the books of H Ltd. to record the above arrangement on 31.03.09 and prepare the Balance Sheet of H Ltd. after absorption of S Ltd. Workings should form part of your answer.

(16 marks) 3. P Ltd. owns 80% of S and 40% of J and 40% of A. J is jointly controlled entity and A is an associate. Balance Sheet of four companies as on 31.03.09 are: (` In lakhs) Assets P Ltd S J A Investment in S Investment in J Investment in A Fixed assets

800 600 600

1000

- - -

800

- - -

1400

- - -

1000

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Current assets

2200 3300 3250 3650

Total 5200 4100 4650 4650 (` In lakhs) Liabilities P Ltd S J A Share Capital Re.1 Equity share Retained earnings Creditors

1000 4000 200

400

3400 300

800

3600 250

800

3600 250

Total 5200 4100 4650 4650

P Ltd. acquired shares in ‘S’ many years ago when ‘S’ retained earnings were ` 520 lakhs. P Ltd. acquired its shares in ‘J’ at the beginning of the year when ‘J’ retained were `400 lakhs. P Ltd. acquired its shares in ‘A’ on 01.04.08 when ‘A’ retained earnings were `400 lakhs. The balance of goodwill relating to S had been written off three years ago. The value of goodwill in ‘J’ remains unchanged. Prepare the Consolidated Balance Sheet of P Ltd. as on 31.03.09 as per AS 21, 23 and 27. (16 marks)

4a.The following is the Profit and Loss account of Murali Ltd.; for the year ended 31st March 2010. Prepare a Gross

value added statement of Murali Ltd.

Profit and Loss Account for the year ended 31st march, 2010 Amount (` In Lakhs)

Income Sale 890 Other income 55 945 Expenditure Production and Operational expenses(a) 641 Administrative Expenses(factory) (b) 33 Interest 29 Depreciation 17 720 Profit before tax 225 Provision for taxation 30 Profit after tax 195 Balance as per last balance sheet 10 205 Transferred to general reserve 45 Dividend paid 95 140 Surplus carried to balance sheet 65 205

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Notes:

(a) ` In lakhs Production and operational expenses Consumption of raw materials 293 Consumption of stores 59 Salaries, wages. Gratuities etc., (Admn) 82 Cess and Local 98 Other manufacturing expenses 109

641 (b) Administration expenses include salaries, commission to

Directors `9.00 lakhs, provision for doubtful debts `6.30 lakhs

(c) Interest on loan from bank for working capital 9 Interest on fixed loan from bank 10 Interest on loan from financial institution for fixed loan 8 Interest on Debentures 2 29

(d) The charges for taxation include a transfer of `3.00 lakhs to the Credit of deferred tax account.

(e) Cess and local taxes include excise duty, which is equal to 10% of Cost of bought-in materials. (10 marks)

4b. Global Ltd. has initiated a lease for three years in respect of an equipment costing ` 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 un guaranteed residual value of the equipment after the expiry of the lease term is estimated at

`20,000. (ii) The implicit rate of interest is 10% (iii) The annual payments have been determined in such a way that the present value of lease payment plus the

residual value is equal to the cost of asset. Ascertain in the hands of Global limited (i) The annual lease payment. (ii) The unearned finance income. (iii) The segregation of finance income for each year. (iv) Show how necessary items will appear in its profit and loss account and balance sheet for the various years.

(6 marks)

5 a.Timby Ltd. is in the business of making sports equipment. The Company operates from Thailand. To globalise its operations Timby has identified Fine Toys Ltd. an Indian Company, as a potential takeover candidate. After due diligence of Fine Toys Ltd. the information is available: (a) Cash flow forecasts (` In crore):

Year Fine Toys Ltd. Timby Ltd. 10 9

24 21

108 70

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8 7 6 5 4 3 2 1

15 16 15 12 10 8 6 3

55 60 52 44 32 30 20 16

(b) The Net worth of Fine Toys Ltd. (in lakh `) after considering certain adjustments suggested by the due

diligence team reads as under: Tangible 750 Inventories 145 Receivables 75 970 Less: Creditors 165 Bank Loans 250 (415) Represented by equity shares of `1000 each 555 Talks for takeover have crystallized on the following: 1.Timby Ltd. will not be able to use Machinery worth `75 Lakhs which will be disposed of by them

subsequent to takeover. The expected realization will be `50 lakhs. 2.The inventories and receivables are agreed for takeover at values of `100 and `50 lakhs respectively

which is the price they will realize on disposal 3.The liabilities of Fine Toys Ltd will be discharged in full on takeover along with an employee settlement

of `90 lakhs for the employees who are not interested in continuing under the new management. 4.Timby Ltd. will invest a sum of `150 Lakhs for upgrading the Plant of Fine Toys Ltd. on takeover. A

further sum of `50 lakhs will also be incurred in the second year to revamp the machine shop floor of Fine Toys Ltd.

5. The anticipated cash flows (in `Crore) post takeover are as follows: Year Cash flows 1 2 3 4 5 6 7 8 9 10

18 24 36 44 60 80 96 100 140 200

You are required to advise the management the maximum price which they can pay per share of Fine Toys Ltd. if a discount factor of 20 percent is considered appropriate.

(12 marks)

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5b. An airline is required by law to overhaul its aircraft once in every three years. Super fisher airlines, which operates aircrafts does not provide any provision as required by law in its final account. Discuss with reference to relevant accounting standard. (4 marks)

  6a.From the following details, compute according to Lev and Schwartz (1971) model, the total value of human

resources of the employee groups skilled and unskilled. 

Skilled Unskilled

(i) Annual average earning of an employee till the

retirement age `50,000 `30,000

(ii) Age of retirement 65 years 62 years

(iii) Discount rate 15% 15%

(iv) No. of employees in the group 20 25

(v) Average age 62 years 60 years (6 marks)

6b.The following particulars in respect of stock options granted by a company are available: Grant date April 1,2006 Number of employees covered 500 Number options granted per employee 100 Fair value of option per share on grant dare (`) 25 The vesting period shall be determined as below: (a) If the company earns ` 120 crore or above after taxes in 2006-07, the options will vest on 31/03/07. (b) If condition (a) is not satisfied but the company earns ` 250 crores or above after taxes in aggregate in 2006-07

and 2007-08, the options will vest on 31/03/08. (c) If conditions (a) and (b) are not satisfied but the company earns ``400 crores or above after taxes in aggregate

in 2006-07, 2007-08 and 2008-09, the options will vest on 31/03/09. Position on 31/03/07 (a) The company earned `115 crore after taxes in 2006-07 (b) The company expects to earn ``140 crores in 2007-08 after taxes (c) Expected vesting date: March 31, 2008 (d) Number of employees expected to be entitled to option = 474 Position on 31/03/08 (a) The company earned `130 crore after taxes in 2007-08 (b) The company expects to earn `160 crores in 2008-09 after taxes (c) Expected vesting date: March 31, 2009 (d) Number of employees expected to be entitled to option = 465 Position on 31/03/09 (a) The company earned `165 crore after taxes in 2008-09 (b) Number of employees on whom the option actually vested= 450 Compute expenses to recognize in each year. (10 marks)

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7. Answer any four from the following:

a) Explain the requirements relating to Capital adequacy norms of NBFC. (4 marks) b) From the following details of A ltd. for the year ended 31-03-206, calculate the deferred tax asset/ liability as

per AS-22 Particulars ` Accounting Profit Book profit as per MAT Profit as per Income Tax Act Tax Rate MAT Rate

6,00,000 3,50,000 60,000 20% 7.50%

(4 marks) 

c) A Ltd. acquire 45% of B Ltd. shares on April 01, 2005 the price paid was `15,00,000. Following are the extract of balance sheet of B Ltd.: Paid up Equity Share Capital ` 10,00,000 Securities Premium ` 1,00,000 Reserve & Surplus ` 5,00,000 B Ltd. has reported net profits of ` 3,00,000 and paid dividends of `1,00,000. Calculate the amount at which the investment in B Ltd. should be shown in the consolidated balance sheet of A Ltd. as on March 31,2006. (4 marks)

d) X Ltd is having a plant (asset) carrying amount of which is `100 lakhs on 31.03.2004.Its balance useful life is 5 years and residual value at the end of 5 years is `5 lakhs. Estimated future cash flow from using the plant in next 5 years are:- For the year ended on Estimated cash flow (` in lakhs) 31.3.2005 50 31.3.2006 30 31.3.2007 30 31.3.2008 20 31.3.2009 20 Calculate “Value in Use” as per AS-28 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 `60 lakhs. (4 marks)

e) On February1,2011 Omega Ltd enters in to a contract with ltd. to receive the fair value of 1000 omega’s own equity shares outstanding as of 31.1.2012 in exchange for payment of `1,04,000 in cash i.e.., `104 per share on 31.3.2012.The contract will be settled in net cash

1. Fair value of forward on 1.2.2011- Nil 2. Fair value of forward 31.12.2011- `6,300 3. Fair value of forward 31.1.2012- `2,000

Give Journal entries on the basis that the net amount is settled in cash. Omega Ltd. closes its books on 31st December. (4 marks)

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PRIME ACADEMY 34th SESSION MODEL EXAM - FINAL – FINANCIAL REPORTING

SUGGESTED ANSWERS 1(a)

Computation of theoretical ex-rights fair value per share

Fair value of all outstanding 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 (`21X5, 00,000 shares) – (`15X1, 00,000 shares) 5, 00,000 shares + 1, 00,000 shares

Theoretical ex-rights fair value per share = `20

Computation of adjustment factor

Fair value per share prior to exercise of rights = `21 = 1.05 Theoretical ex-rights value per share `20

Computation of earnings per share Year 2010 Year 2011

EPS for the year 2010 as originally reported: `11, 00,000/5, 00,000 shares `2.20

EPS for the year 2010 restated for rights issue: `11, 00,000/(5,00,000 shares X 1.05) `2.10

EPS for the year 2011 including effects of Rights issue

`15, 00,000 `2.55

(5,00,000X1.05X2/12)+(6,00,000X10/12) 1(b) ` Fair value of plan assets on 31.3.08 8, 00,000 Add: Employer contribution 2, 80,000 Less: Benefits Paid 2, 00,000 ` (A) 8, 80,000 Fair market valuer of plan assets at 31.3.09 (B) 11, 40,000

Actual return on plan assests (B-A) 2, 60,000 1(c) The decision of making provision for non-moving stocks on the basis of technical evaluation does not amount to

change in accounting policy as per AS 5 “Net Profit or Loss for the period, Prior Period Items and changes in Accounting Policies”. The method of estimating the period of provision may be changed, in case, a more prudent estimate can be made by adopting the changed method.

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“In the given case, considering the total value of stocks, the change in the amount of required provision of non-moving stocks from `3.20 lakhs is also not material. The disclosure can be made for such change by way of notes to the accounts in the financial statements of XY Ltd. For the year ending non 31.03.09, in the following manner.

‘The company has provided for non-moving stocks on the basis of technical evaluation unlike preceding years. Had the same method been followed as in the previous year, the profit for the year and the corresponding effect on the year end, the net assets would have been higher by `0.80 lakhs”.

1(d)

Allocation of units Old Unit Holders (18 lakh units)

` in laKhs

New Unit Holders (2 lakh units)

` in lakhs

Total

` in laKhs First half year (`5 per unit) Second half year(`3.60 per unit) Add: Equalization payment Recovered Available for distribution

90.00 64.80 154.80

-

Nil 7.2 7.2 -

90.00 72.00 162.00

10.00 172.00

Equalization Payment: `90 lakh/18 lakh =`5 per unit. Old unit holders New unit holders ` ` Dividend distributed 8.60 8.60 Less: Equalization payment - 5.00 8.60 3.60

JOURNAL ENTRIES ` in lakh

Date Particulars Debit Credit 30.09.2008

31.03.2009

31.03.2009

Bank A/c Dr. To Unit Capital A/c To Reserves A/c To Dividend equalization A/c (Being the amount received on sale of 2 lakh unit at a NAV of `70/- per unit) Dividend Equalization A/c Dr. To Revenue A/c (Being the amount transferred to Revenue account) Revenue Account A/c Dr. To Bank A/c (Being the amount distributed among 20 lakhs unit holders @ `8.60 per unit)

150.00 10.00 172.00

20.00 120.00 10.00 10.00 172.00

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1(e) Calculation of provision on advances as on 31.12.2009

Amount ` In lakhs

Provisions % ` In lakhs

Standard assets Sub standard assets Secured portion of doubtful debts: Upto one year One year to three years More than three years Unsecured portion of doubtful debts Loss assets Total Provision

10,000 1,000

160 70 20 90

30

Zero Nil 10% 100 20% 32 30% 21 50% 10 100% 90 100% 30 ____ 283 _____

2 Journal Entries in the books of H Ltd.

Particulars ` ` Business Purchase A/c Dr. To Foreign Company (Being business purchased) Fixed Assets A/c Dr. Debtors A/c Dr. Inventories A/c Dr. Cash at Bank A/c Dr. To Current Liabilities A/c To Secured Loan A/c To Investment in S Ltd. A/c To Business Purchase A/c To Capital Reserve A/c (B.F.) (Being various assets and liabilities taken over)

Profit and Loss A/c Dr. To Inventories A/c (Being elimination of unrealized profit)

Current Liabilities A/c Dr. To Debtors A/c (Being elimination of mutual Owings)

Foreign Company Dr. To Tax Payable A/c

24,00,000 16,20,000 5,00,000 25,00,000 2,00,000 25,000 1,00,000

24,00,000 2,00,000 3,00,000 6,00,000 24,00,000 13,20,000 25,000 1,00,000

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To Bank A/c (`10,04,000+20)* To Equity Shares Capital A/c To Securities Premium A/c (Being payment made to foreign company) Tax Payable A/c Dr. To Bank A/c (Being tax paid to Government)

24,00,000 3,92,000

3,92,000 10,04,020 3,34,660 6,69,320 3,92,000

*It is assumed that payment of fractional shares has also been routed through Bank A/c along with 50% payment remitted to Foreign Company.

Balance Sheet of H Ltd. (After Absorption)

Liabilities ` Assets ` 5,34,466 Shares of `10 each (out of above 33,466 shares issued for consideration other than cash) General Reserve Profit & loss (20,00,000-25,000) Capital Reserve Securities Premium Secured Loan (20,00,000+3,00,000) Current Liabilities (30,00,000+2,00,000-1,00,000)

53,34,660 50,00,000 19,75,000 13,20,000 6,69,320 23,00,000 31,00,000

Fixed Assets (60,00,000+16,20,000) Sundry Debtors (35,00,000-1,00,000+5,00,000) Inventories (30,00,000-25,000+25,00,000) Cash at Bank (39,00,000+2,00,000-10,04,020-3,92,000)

76,20,000 39,00,000 54,75,000 27,03,980

196,98,980 196,98,980 Working Notes:

1. Amount payable to foreign company Price per share of S Ltd.= `50+ `10(Nominal value)= `60 Value of 40% shares held by foreign company = 10,00,000 x 40% x60/10=`24,00,000 Capital gain = ` 24,00,000-(4,00,000x11/10)= ` 19,60,000 Tax on capital gain = ` 19,60,000 x 20% = `3,92,000 Amount payable to Foreign Company after tax = ` 24,00,000- `3,92,000=`20,08,000 50% of `20,08,000 = `10,04,000 to be remitted to foreign company.

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3 Intrinsic value of shares of H Ltd. and balance payment to foreign company

` ` Total assets (Excluding Investment in S Ltd.) Add: Investment in S Ltd. (60,000 shares x `.60) Less: Liabilities: Secured Loan Current Liability

20,00,000 30,00,000

1,64,00,000 36,00,000 2,00,00,000 50,00,000

1,50,00,000 No. of equity shares 5,00,000 Intrinsic Value per share `30 Number of shares to be issued for payment of 50% balance amount `10,04,000/30= 33,466 shares Cash for fractional shares = `10,04,000-(33,466x `.30) = `20

4 Consolidated balance Sheet of P Ltd

Liabilities ` In lakhs Assets `in lakhs Share capital Retained Earning (W.N.2) Creditors9200+300+40% of 2500 Minority interest (W.N.3)

1,000 8,800

600

760

Goodwill (W.N.1) Fixed assets [1,000+800+560(1400 x 40%)] Current assets [2,200+3,300+1,300(3,250x40%)] Investment in Associates (W.N.4)

120 2,360

6,800

1,880 11,160 11,160

Working Notes : 1.computation of goodwill (` in laKhs)

S (subsidiary) Cost of investment Less: paid up value shares acquired Share in pre-acquisition profits of S ltd.(520x80%) goodwill

320 416

800 736 64

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J (Jointly controlled Entity) (` in laKhs) Cost of investment Less: Paid up value of shares acquired (40% of 800) Share in Pre-acquisition profits (40% of 400) Goodwill

320 160

600 480 120

Note: jointly controlled entity “j” to be considered on proportionate basis i.e. 40% as per AS 27

Associate A (AS23) (` in laKhs)

Cost of investment Less: Paid up value of share acquired (800x40%) Share in pre-acquisition profits (400x40%) Goodwill

320 160

600 480 120

Goodwill shown in the consolidated balance sheet

` In lakhs Goodwill of “j” Goodwill of “s” Less: goodwill written off of “s” Goodwill

120 64 64

120 2.Consolidated Retained Earnings (` in laKhs)

P ltd. Share in post acquisition profits of S-80% (3,400-520) Share in post acquisition profits of J-40% (3,600-400) Share in post acquisition profits of A-40% (3,600-400) Less; Goodwill written off

4,000 2,304 1,280 1,280

(64) 8,800

3.Minority interest ‘s’ (` in laKhs)

Share Capital (20% of 400) Share in Retained Earnings (20% of 3,4000

80 680 760

4.Investment in Associates (` in laKhs)

Cost of investments (including goodwill `120 lakhs Share of post acquisition profits Carrying amount of investment (including goodwill `120 lakhs)

600 1,280 1,880

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4(a) Murali Ltd. Gross Value Added Statement for the year ended 31st March,2010

`in lakhs `in lakhs Sales Less: Cost of bought in materials and services: Production and operational expenses * (293+59+109) Administration expenses (33-9) Interest on working capital lo0an Excise duty (Refer W.N) Value added by manufacturing and trading activities Add: other income Total Value Added Application of Value Added To Employees Salaries, Wages, Gratuities etc. To Directors Salaries and commission To Government Cess and local taxes (98-35.20) Income- tax To providers of capital Interest on Debentures Interest on Fixed loan (10+8) Dividend To provide for maintenance and expansion of the company Depreciation General Reserve Deferred tax Retained profits(65-10)

461 24 9

35.20

62.80 27

2 18 95

17 45 3

55

890

529.20 360.80

55

415.80

82

9

89.80

115

120

%

19.72

2.16

21.60

27.66

28.86 415.80 100

*As no increase or decrease in stock is given in the question, therefore, it is assumed that whatever raw material and stores were bought, had been consumed.

Working Note: Calculation of Excise duty Excise duty is 10% of `352 lakhs (i.e. 293+59)= ` 35.20 lakhs.

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4(b) (a) (i) Calculation of Annual Lease Payment

Particulars ` Cost of the equipment Unguaranteed Residual Value PV of residual value for 3 years @ 10% (` 20,000*0.751) Fair value to be recovered from Lease Payment (` 1,50,000-` 15,020) PV Factor for 3 years @ 10%

1,50,000 20,000 15,020 1,34,980 2,487

Annual Lease Payment (`1,34,980/ PV Factor

for 3 Years@ 10% i.e. 2,487 `54,275 (ii) Unearned Financial Income ` Total Lease payments [`54,275 *3] 1,62,825 Add: Residual Value 20,000 Gross Investments 1,82,825 Less: Present Value of Investments (`1,34,980+`15,020) 1,50,000 Unearned Financial Income 32,825 (iii) Segregation of Finance Income

year Lease rentals ` Finance Charges @ 10% on outstanding amount of the year `

Repayment `

Outstanding Amount `

0 --- --- --- 1,50,000 I 54,275 15,000 39,275 1,10,725 II 54,275 11,073 43,202 67,523

III 74,275** 6,752 67,523 --- 1,82,825 32,825 1,50,000

(iv) Profit and loss Account (Relevant Extracts)

Credit side ` I year By Finance Income 15,000 II year By Finance Income 11,073 III year By Finance Income 6,752

Balance sheet (Relevant Extracts)

Assets side ` ` I year Lease Receivable 1,50,000 Less: amount Received 39,275 1,10,725 Ii year Lease Receivable 1,10,725 Less: Received 43,202 67,523 III year: Lease received 67,523 Less: Amount received 47,523 Residual value 20,000 NIL

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Notes to Balance Sheet

Year 1 ` Minimum Lease payments (54,275+54,275) 1,08,550 Residual Value 20,000 1,28,550 Unearned Finance Income (11,073+6,752) 17,825 Lease Receivables 1,10,725 Classification Not later than one year 43,202 Later than one year but not more than 5 years 67,523 Total 1,10,725 Year II Minimum Lease payments 54,725 Residual value (Estimated) 20,000 74,275 Unearned Finance Income 6,752 Lease Receivables (not later than 1year) 67,523 III year Lease Receivables (including residual value ) 67,523 Amount Received 67,523 NIL

5(a) Calculation of Maximum price that can be quoted for takeover of Fine Toys Ltd.

` In lakhs `In lakhs Present (discounted0value of incremental cash flows Add: Proceeds from disposal of fixed assets Proceeds from disposal of inventories Receipts from debtors Less: Settlement of creditors Bank loans Employee settlement Renovation of plant Revamp of machine shop floor (`50 lakhs x0.6944) maximum value that can be offered

50.00 100.00

50.00

165.00 250.00

90.00 150.00

34.72

7,845.02

200.00 8,045.02

689.72

7,355.30 Maximum price per share of Fine Toys Ltd. (`7,355.30 lakhs /55,500shares) = `13,352.79

working note: Present Value of incremental Cash flows

PRIME/ME34/FINAL  17

Year Cash flow after take

over `

Cash flows before take

over `

Incremental Cash

flows `

Discount factor @20%

Discounted Cash flows

1 2 3 4 5 6 7 8 9 10

1,800 2,400 3,600

4,400 6,000 8,000 9,600

10,000 14,000 20,000

1600 2000 3000 3200 4400 5200 6000 5500 7000

10800

200 400 600

1200 1600 2800 3600 4500 7000 9200

0.8333 0.6944 0.5787 0.4823 0.4019 0.3349 0.2791 0.2326 0.1938 0.1615

166.66 277.76 347.22 578.76 643.04 937.72

1004.76 1046.70 1356.60 1485.80 7,845.02

5(b) A provision should be recognised only when an enterprise has a present Obligation as a result of a past event. In the given case, there is no present Obligation, therefore no provision is recognized as per AS 29 ‘ Provisions, Contingent Liabilities and Contingent Assets’.

The cost of overhauling aircraft is not recognized as a provision because It is a future obligation and the incurring of the expenditure depends on the Company’s decision to continue operating the aircrafts. Even a legal requirement To overhaul does not require the company to make a provision for the cost Of overhaul the aircrafts. Further, the enterprises can avoid the future Expenditure by its future action, for example by selling the aircraft. However, an obligation might arise to pay fines or penalties under the Legislation after completion of three years. Assessment of probability of Incurring fines and penalties depends upon the provision of the legislation And the stringency of the enforcement regime. A provision should be Recognized for the best estimate of any fines and penalties if airline Continues to operate aircrafts for more than three years.

6(a) According to Lev and Schwartz, the value of human capital embodied in a person of age

� is the present value of his remaining future earnings from employment. Their valuation

model for a discrete income stream is given by the following formula

t V�= ∑ I(t)___

t = � (1+r)t-� Where, V�= the human capital value of a person �years old.

I(t) = the person’s annual earnings up to retirement.

r = a discount rate specific to the person.

PRIME/ME34/FINAL  18

t = retirement age.

Value of skilled employees:

= 50000__ + 50000__ + 50000__

(65-62) (65-63) (65-64)

(1+0.15) (1+0.15) (1+0.15)

` 32,875.81 + ` 37,807.18 + `43,478.26 = `1,14,161.25

Total value of skilled employees is `1, 14,161.25 × 20 = `22,83,225.

Value of unskilled employees

= 30000__ + 30000__

(62-60) (62-61)

(1+0.15) (1+0.15)

= 30000__ + 30000__

2 1

(1+0.15) (1+0.15)

= 22,684.31 + 26,086.96 = 48,771.27

Total value of the unskilled employees = `48,771.27× 25 = `12,19,282

Therefore, Total value of human resources (skilled and unskilled) = `22,83,225 + `12,19,282

= `35, 02,507.

6(b)

Year 2006-07

Fair Value of option per share =`25 Number of shares expected to vest under the scheme = 474 x 100 =47,400 Fair Value = 47,400 x `25

= `11,85,000 Expected vesting period = 2 years Value of option recognized as expense in 2006-07 =`11,85,000/2

= `5,92,500 Year 2007-08

PRIME/ME34/FINAL  19

Fair value of option per share = ` 25 Number of shares expected to vest under the scheme = 465 x 100

= 46,500 Fair value = 46,500 x `25

= ` 11,62,500 Expected vesting period = 3 period Cumulative value of option to recognize as expense in 2006-07 and 2007-08

= (`11,62,500/3) x 2 = `7,75,000 Value of option recognized as expense in 2006-07 = `5,92,500 Value of option recognized as expense in 2007-08

= `7,75,000- `5,92,500 = `1,82,500 Year 2008-09 Fair value of option per share = `25 Number of shares actually vested under the scheme = 450 x 100

= 45,000 Fair value = 45,000 x `25 = `11,25,000 Vesting period = 3 years Cumulative value of option to recognize as expense in 2006-07, 2007-08 And 2008-09 = ` 11,25,000 Value of option recognized as expense in 2006-07 and 2007-08

= `7,75,000 Value of option recognized as expense in 2008-09

                  = `11,25,000‐ `.7,75,000 = `3,50,000 

7(a)

Every NBFC shall, maintain a minimum capital ratio consisting of Tier I and Tier II capital which shall be less than 12% of its aggregate risk-weighted assets. The total of Tier II capital, at any point of time, shall not exceed 100% of Tier I capital.

Tier I Capital” means owned fund as reduced by investment in shares of other NBFCs and in shares debenture, bond, outstanding loans, advances including hire purchase and lease finance made to and deposits with subsidiaries and companies in the same group exceeding, in aggregate, 10% of the owned fund;

Tier-II Capital” includes the following:-

(a) Preference shares. (b) Revaluation reserves at discounted rate of 55% (c) General provisions and loss reserves to the extent these are not attributable to actual

diminution in value or identifiable potential loss in any specific asset and are available meet unexpected losses, to the extent of one and one fourth percent of risk weighted assets.

(d) Hybrid debt and (e) Subordinated debt

PRIME/ME34/FINAL  20

Subordinated debt means a fully paid up capital instrument, which is unsecured and is

subordinated to the claims of other creditors and is free from restrictive clauses and is not redeemable at the instance of the holder or without the consent of the supervisory authority of the NBFC.The book value of such instrument shall be subjected to discounting as provided hereunder: Remaining maturity of the instrument Rate of discounting

a. Upto One year b. More than one year but upto two years c. More than two years but upto three years d. More than three years but upto four years e. More than four years but upto five years

100% 80% 60% 40% 20%

7(b)

Tax as per accounting profit 6,00,000*20% =`1,20,000 Tax as per Income-tax profit 60,000*20% = `12,000 Tax as per MAT 3,50,000*7.50%= ` 26,250

Tax Expense= Current tax + Deferred Tax `1,50,000= `15,000 + Deferred tax Therefore, Deferred tax liability as on 31-03-2004

= `1,20,000-`12,000= `1,08,000

Amount of tax debited in Profit and Loss Account for the year 31-03-2006 Current tax + Deferred tax liability+ Excess of MAT over current tax =`12,000 +` 1,08,000+`14,250 = `1,34,250

7(c) Calculation of the carrying amount of investment as per equity method

Particulars ` ` Equity Shares Security Premium Reserves & Surplus Net assets 45% of Net assets Add: 45% of profits for the year Less: Dividend Received Less: Cost of Investment Goodwill

10,00,000 1,00,000 5,00,000 16,00,000 7,20,000 1,35,000 8,55,000 45,000

8,10,000 15,00,000 6,90,000

Consolidated Balance Sheet (Extract)

Assets ` ` Investment in B Ltd. Add: Goodwill

8,10,000 6,90,000

15,00,000

PRIME/ME34/FINAL  21

7(d) Present Value of future cash flow

Present Value of residual price on 31.3.2009= 5*0.620 3.10 Present value of estimated cash flow by use of an asset And residual value, which is called “value in use”. 121.92

If net selling price of plant on 31.3.2004 is `60 lakhs, the recoverable amount will be higher of ` 121.92 lakhs (value in use) and `60 lakhs (net selling price), hence recoverable amount is `121.92 lakhs.

7(e) (a) 1.2.2011

No entry is required because the fair value of derivatives is Zero and no cash is paid or received.

Particulars ` ` (b) 31.12.2011

Forward Asset Dr. To Gain

(c) 31.1.2012 Loss Dr. To Forward Asset

(d) Cash Dr. To Forward Asset

6,300 4,300 2,000

6,300 4,300 2,000

 

Year ended Future Cash flow Discount @ 10% Rate Discounted Cash flow 31.3.2005 31.3.2006 31.3.2007 31.3.2008 31.3.2009

50 30 30 20 20

0.909 0.826 0.751 0.683 0.620

45.45 24.78 22.53 13.66 12.40

118.82

PRIME/ME34/FINAL  22

PRIME/ME34/FINAL  1

FE

Number of pages: 4 Total Marks: 100 Number of Questions: 7 Time Allowed: 3 Hrs

Question No.1 is compulsory. Attempt any five from the rest. Working notes should form part of the answer.

. 1.(a) An investor is holding 2,000 shares of F ltd. At present the rate of dividend paid by the company is `2

per share and the share is being sold at `25 per share in the market. However, several factors are likely to change during the course of the year:

Existing Revised Risk free rate 12% 10% Market risk premium 6% 4% Beta value 1.4 1.25 Expected growth rate 5% 9% In the view of above factors whether the investor should buy, hold or sell the shares? (5 marks)

(b) MP Ltd issued new series of bonds on January 1, 2010. The bonds were sold at par (`1,000), having a coupon rate of 10% p.a and mature on 31st December, 2025. Coupon payments are made semi-annually on June 30th and December 31st each year. Assume that you purchased an outstanding MP ltd. bond on 1st March, 2018 when the going interest rate was 12%. What was the YTM of MP Ltd as on January 1, 2010? What amount you should pay to compute the transaction? (5 marks)

(c) S ltd. has been regularly paying a dividend of `3.50 on their shares. The number of equity shares is

25,000. What is the value of equity, if the return for the investors is 14%? Determine the value of equity, if the dividend is expected to grow at 8% p.a on a constant basis. (5 marks)

(d) M ltd. is to receive `1.04 mn after 6 months from today. They plan to deposit this amount with their bank for three months immediately on the receipt. They want to use this amount for purchasing a machine after 9 months from today. They apprehend decline in interest rates by the time they were to deposit the money with the bank. Currently interest rates are:

Three months : 7 - 8.5% Six months : 7.5 - 8% Nine months : 9 - 10%. How the interest rate risk can be hedged? (5 marks)

2.(a) Welsh ltd. is faced with a decision to purchase or acquire on lease a mini car. The cost of the mini car is `126,965. It has life for 5 years. The mini car can be obtained on lease by paying equal lease rentals annually. The leasing company desires a return of 10% on the gross value of the asset. Welsh limited can also obtain 100% finance from its regular banking channel. The rate of interest will be 15% p.a and the loan will be paid in five equal instalments, inclusive of interest. The effective tax rate of the company is 40%. For the purpose of taxation it is to be assumed that the asset will be written off a period of 5 years on straight line basis. Advise Welsh ltd about the method of acquiring the car. What should be the annual lease rental to be charged by the leasing company to match the loan option? For your exercise use the following discount factors for five years:

PRIME/ME34/FINAL  2

Discount rate 1 2 3 4 5 10% 0.91 0.83 0.75 0.68 0.62 15% 0.87 0.76 0.66 0.57 0.49 9% 0.92 0.84 0.77 0.71 0.65

(8 marks)

(b) D ltd has 10 lac equity shares outstanding at the beginning of the accounting year 2011. The current market price of the shares is`150 each. The Board of Directors of the company has recommended `8 per share as dividend. The rate of capitalization, appropriate to the risk-class to which the company belongs is 12%. (i) Based on MM approach, calculate the market price of the share of the company when

recommended dividend is (a) Declared and (b) not declared? (ii) How many new shares are to be issued by the company at the end of the accounting year on the

assumption that the net income for the year is `2 crores and the investment budget is`4 crores and when (a) the above dividends are distributed and (b) dividends are not declared.

(iii) Show that the market value of the shares at the end of accounting year will remain same whether dividends are distributed or not declared. (8 marks)

3.(a) Infoway is considering the purchase of an automatic pack machine to replace the 2 machines which are currently used to pack Product X. The new machine would result in reduced labour costs because of the more automated nature of the process and in addition, would permit production levels to be increased by creating greater capacity at the packing stage with an anticipated rise in the demand for product X, it has been estimated that the new machine will lead to increased profits in each of the next years. Due to uncertainty in demand however, the annual cash flows(including savings) resulting from purchase of the new machine cannot be fixed with certainty and have therefore, been estimated probability as follows:

Annual cost flows: Year 1 Year 2 Year 3 10 0.30 10 0.10 10 0.30 15 0.40 20 0.20 20 0.50 20 0.30 30 0.40 30 0.20 40 0.30 Because of the overall uncertainty in the sales of product X, it has been decided that only 3 years cash flows will be considered in deciding whether to purchase the new machine. After allowing for the scrap value for the existing machines, the net cost of the new machine will be `42,000. The effects of taxation should be ignored. Required: (i) Ignoring the time value of money, identify which combinations of annual cash flows will lead to

an overall negative cash flow, and determine the total probability of this occurring. (ii) On the basis of the average cost flow for each year, calculate the net present value of the new

machine given that the company’s cost of capital is 15%. Relevant discount factors are: Year 1-0.8696; Year 2-0.7561; Year 3 -0.6575.

(iii) Analyse the risk inherent in this situation by simulating the net present value calculation. On the basis of your simulation results what is the expected net present value and what is the probability of the new machine yielding a negative net present value? Random numbers are: Year 1 4 7 6 5 0 Year 2 2 4 8 0 1 Year 3 7 9 4 0 3 (10 marks)

PRIME/ME34/FINAL  3

(b) A ltd wishes to acquire B ltd. The shares issued by the two companies are 10 lacs and 5 lacs respectively: (i) Calculate the increase in the total value of B ltd. resulting from the acquisition on the basis of

the following conditions: Current expected growth rate of B ltd. 7% Expected growth rate under control of A ltd. (without 8% any additional capital investment and without any change in risk of operations) Current market price per share of A ltd. `100 Current market price per share of B ltd. ` 20 Current dividend per share of B ltd. `0.60

(ii) On the basis of aforesaid conditions calculate the gain or loss to shareholders of both the companies, if A ltd. were to offer one of its shares for every four shares of B ltd. (6 marks)

4.(a) CHC ltd. in UK will need to make payment of $250000 in six months time. It is currently 1st January. The

company is considering the various choices it has, in order to hedge its transaction exposure. Following market information is available:

Exchange rate £ spot rate $1.5617-1.5773 Six month £ forward rate $ 1.5455-1.5609

Foreign currency option prices: Exercise price : $ 1.70 Call option (June) : $ 0.037 Put option (June) : $ 0.096 Contract size (1 unit is £ 12500) Evaluate the hedging alternatives with necessary calculations and decide which of the same is most attractive to CHC ltd. (8 marks)

(b) A ltd. has an expected return of 22% and standard deviation of 40%. B ltd has an expected return of 24% and standard deviation of 38%. A ltd has a beta of 0.86 and B ltd. of 1.24. The correlation coefficient between the return of A ltd. and B ltd. is 0.72. The standard deviation of the market return is 20%. Suggest (i) is investing in B ltd. better than investing in A ltd. (ii) If you invest 30% in B ltd. and 70% in A ltd., What is your expected rate of return and portfolio’s standard deviation? (iii) What is the market portfolio’s expected rate of return and how much is the risk free rate? (iv)What is the beta of portfolio if A’s weight is 70% and B’s weight is 30%? (8 marks)

5.(a) X is holding 5,00,000 ordinary shares of Y ltd. He apprehends a decline in the prices of the shares and hence he is thinking of selling these shares, though he is quite sure that after 3 months these shares will be the share market’s darling. His portfolio manager has suggested that the risk of Y ltd’s shares falling by more than 5% from their current value could be protected against by buying an option. The appropriate option maturity 3 months option is being traded for £ 11 million. Other information:

(i) The current market price of Y’s ordinary shares is £360. (ii) The annual volatility (SD) of Y’s shares for the last year was 50% (iii) The risk free rate is 10% per year. (iv) No dividend is expected to be paid by Y ltd during the next six months.

Evaluate whether or not the price of the option is a fair price. (8 marks)

Country Money market rates Borrow % Deposit % US $ 6 4.5 UK 7 5.5

PRIME/ME34/FINAL  4

(b) Gopi invested `10,000 in the new Fund offer of a close ended scheme of Sundaram Mutual fund. The fund is

listed in a stock exchange. Consider the following details: End of the year NAV Market price as a % of Discount/premium over the NAV 1 10.90 -0.20 2 12.00 -0.10 3 14.00 +0.20 4 15.70 +0.30 5 18.90 +0.50

(a) Calculate the annualized return if her time horizon is 5 years (b) What is the annually compounded growth rate in NAV over 4years? (c) Calculate the % annual return of a person who invested in the scheme at the end of 1st year and

disinvested at the end of the 2nd year (d) What is the annually compounded growth rate of return of person who invested at the end of 1st year

and disinvested at the end of the 5th year? (8 marks) 6.(a) A company has to pay `10mn after 6years from today. The company wants to fund this obligation today

only. The current interest rate in the market is 8%. Two zero coupon bonds are traded in the market on the basis of 8% YTM (a) maturity 5 years and (b) maturity 7 years. Suggest the interest rate risk immunized investment plan. Calculate the total amount to be received from the investments in following three cases:

(i) market interest remains unchanged throughout the period of 6 years (ii) market interest rate declines to 6% 2 years after the investment was made and (iii) market interest rate rises to 10% immediately after the investment was made. (8marks)

(b) S ltd. specializes in the manufacture of novel transistors. They have recently developed technology to

design a new radio transistor capable of being used as an emergency lamp also. They are quite confident of selling all the 8,000 units that they would be making in a year. The capital equipment that would be required will cost `25 lakh. It will have an economic life of 4 years and no significant technical salvage value. During each of the first four years promotional expenses are planned as under:

Year 1 2 3 4 Advertisement 1,00,000 75,000 60,000 30,000 Other expenses 50,000 75,000 90,000 1,20,000

Variable costs of producing and selling the unit would be`250 per unit. Additional fixed operating costs incurred because of this new product are budgeted at `75,000 per year. The company’s profit goals call for a discounted rate of return of 15% after taxes on investments on new products. The income tax rate on an average works out to 49%. You can assume that the straight line method of depreciation is used. Work out an initial selling price per unit of the product that may be fixed for obtaining the desired rate of return on investment. (8 marks)

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

(i) Embedded derivatives (ii) Factors affecting economic analysis (iii) Repo and reverse repo (iv) Debt securitization (v) Forward rate agreement (vi) Takeover by reverse bid (4x4=16marks)

PRIME/ME34/FINAL  5

PRIME ACADEMY 34th SESSION MODEL EXAM - FINAL – STRATEGIC FINANCIAL MANAGEMENT

SUGGESTED ANSWERS  1(a) On the basis of existing and revised factors, rate of return and price of share is to be calculated.

Existing rate of return = Rf + β (Rm-RF) = 12% +1.4(6%) = 20.4% Revised rate of return = 10%+1.25(4%) = 15% Price of share (Original) P0 = D (1+g)/Ke-g = 2(1.05)/(0.204-0.05) = 2.10/0.154 = `13.63 Price of share (revised) =P0 = 2(1.09)/0.15-0.09 = 2.18/0.06 = `3.36.33

In case of existing market price of `25 per share, rate of return (20.4%) and possible equilibrium price of share at `13.63, this share needs to be sold because the share is overpriced(`25-13.63) by `11.37. However, under the changed scenario where growth of dividend has been revised at 9% and the return though decreased at 15% but the possible price of share is to be at `36.33 and therefore, in order to expect price appreciation to `36.33 the investor should hold the shares, if other things remain the same.

1(b)

(i) YTM on 1st January, 2012 = 10%

(ii)Assumption: Current interest rate on 1st January,2018 = 12% p.a semi annually

Market value on 1st January 2018 = 50 (9.712) + 1050 (0.394) = 899.30 Market value on 1st march 2018: 899.30 (1.02) = 917.29 Payment for complete transaction = 917.29 Interest accrued = 1000 x 0.10 x (2/12) = 16.67 Bond’s basic value = 917.29 – 16.67 = 900.62

1(c) No Growth Growth at 8%

Last year dividend `3.50 `3.50 Growth rate Nil 8% Next year dividend `3.50 `3.78 Capitalisation rate (ke-g) 14% (14-8)=6% Price of share(D1/(ke-g) 3.50/0.14 3.78/0.06 Fair value of one share is `25.00 `63.00 No. of shares 25000 25000 Equity value (Fair value x shares) `625000 `1575000

1(d) (i) Borrow `1.04m/1.04 i.e 1 m for six months

(ii) The borrowed amount plus interest on that amount may be repaid using the business receipt of `104mn

(iii) The borrowed amount may be invested at 9% for 9 months. Investment proceeds: `1m (1.0675) i.e `1.0675m. Use this amount for purchasing the machine/other business purposes. Interest income =`1.0675m-`1.04m = `0.0275m

PRIME/ME34/FINAL  6

2(a)

BUY OPTION: Annual loan repayment: Loan amount/PVIFA (15%,5)= ` 126965/3.86 = `32892 Interest computation:

Year 0 1 2 3 4 Opening bal. ` 126965 94073 75292 53694 28856 Interest 15% ` 0 14111 11294 8054 4036 Total ` 126965 108184 86586 61748 32892 Repayment ` 32892 32892 32892 32892 32892 Closing bal. ` 94073 75292 53694 28856 0 Debt option: Cash flows

Year Instalment ` Interest @

15% ` Depreciation ` Tax shield on Int

& dep ` Net cash outflow ` PVF @ 9% PV of cash

outflows 0 32892 0 0 0 32892 1 32892 1 32892 14111 25393 15802 17090 0.92 15723 2 32892 11294 25393 14675 18217 0.84 15302 3 32892 8054 25393 13379 19513 0.77 15025 4 32892 4036 25393 11772 21120 0.71 14995 5 32892 0 25393 10157 -10157 0.65 -6602

Total present value of cash outflows 87335 LEASE OPTION: Annual lease rentals = cost of assets: [1+PVIFA (10%, 4)] [Note rentals paid in advance] = `126965:4.17 = `30447 Leasing alternative:

Year Lease payment

Tax shield on outflows

`

After tax cash flow `

PV factors at 9% `

PV of cash outflows

0 30447 0 30447 1 30447 1-4 30447 12179 18268 3.24 59188 5 0 12179 -12179 0.65 -7916

Total present value of cash outflows 81719 Decision: Since PV of leasing is lower than that of buying, it is advisable to go for leasing. Let the annual rentals be L After tax cost of lease rentals = 0.60L PV of lease rentals = 0.60L x 4.17 = 2.502 L Equation 2.502L = `87335, we get Lacs as `34906.

PRIME/ME34/FINAL  7

2(b) Under M-M approach, P0=P1+D1/1+Ke

P0 = `150; D1 =`8 ; Ke = 12%

(i) (a) Share price when dividend is declared:

150= P1 + 8/(1+0.12) 150 +18 = P1 + 8 P1 = 168-8 = `160

(b) Share price when dividend is not declared:

150= P1 + 0/(1+0.12) P1= 150 +18-0 = `168

(ii) No. of shares to be issued:

Particulars If dividend is

Declared ` If dividend is not declared `

Net income 200 200 Less: Dividend paid 80 0 retained earnings 120 200 Investment budget 400 400 Amount to be raised by issue of new shares 280 200 Market price per share 160 168 No. of shares to be issued 175000 119048

(iii) Verification of MM dividend irrelevancy theory:

Particulars If dividend is Declared `

If dividend is not Declared `

Existing shares 1000000 1000000 New equity shares 175000 119048 Total no. of shares at year end 1175000 1119048 Market price per share 160 168 Total market value at end of the year (` Lacs) 1880 1880

From the above analysis we can observe that the market value of the shares at the end of the year will remain same whether dividends are distributed or not declared.

3(a) if total cash flows in Years 1,2 and 3 is less than `42,000 the net cash flow will be negative. The combinations of cash flow which total less than `42000 are given in table below:

Year 1 Year 2 Year 3 Total Probability 10 10 10 30 0.3x0.1x0.3=0.009 10 10 20 40 0.3x0.1x0.5=0.015 10 20 10 40 0.3x0.2x0.3=0.018 15 10 10 35 0.1x0.1x0.3=0.012 20 10 10 40 0.3x0.1x0.3=0.009

Total 0.063

PRIME/ME34/FINAL  8

The probability of a negative cash flow is 0.063

b. Expected cash flow = S[Cash flow x probability]

PV of cash = (15x0.8696) + (29x0.7561)+(19x0.6575) = 47.4634 The NPV of the new machine(47463 – 42000) = `5463 c. Allocate random number ranges to cash flows for each year

Cash flow (`'000) Probability Cum.Prob

Random no.

Year1 10 0.30 0.30 0-2 15 0.40 0.70 3-6 20 0.30 1.00 7-6

Year 2

10 0.10 0.10 0 20 0.20 0.30 1-2 30 0.40 0.70 3-6 40 0.30 1.00 7-9

Year 3 10 0.30 0.30 0-2 20 0.50 0.80 3-7 30 0.20 1.00 8-9

We can now carry on the simulation

Year 1 Year 2 Year 3 Number Random

no. Cash DCF Random no. Cash DCF Rando

m no. Cash DCF 1 4 15 13.044 2 20 15.122 7 20 13.15 -0.684 2 7 20 17.392 4 30 22.683 9 30 19.725 17.8 3 6 15 13.044 8 40 30.244 4 20 13.15 14.438 4 5 15 13.044 0 10 7.561 0 10 6.575 -14.82 5 0 10 8.696 1 20 15.122 3 20 13.15 -5.032

Total 11.702

The average NPV of the cash flow = 11702/5= `2340.40 Three out of the five simulations produced negative NPV, therefore we estimate the probability of a negative NPV as 3/5=0.6. Since the simulation i small, the estimates are unlikely to be reliable.

3 (b)(i) For B ltd before acquisition

The cost of capital of b ltd may be calculated by using the following formula:

` (‘000s) Year 1 EV = (10x0.3)+(15x0.4)+(20x0.3) 15

Year 2 EV = (10x0.1)+(20x0.2)+(30x0.4)+(40x0.3) 29

Year 3 EV = (10x0.3)+(20x0.5)+(30x0.2) 19

PRIME/ME34/FINAL  9

(Dividend/Price)+growth% = (0.60/20)+0.07 = 0.10 After acquisition g becomes 0.08. Therefore, price per share after acquisition = 0.60/(0.10-0.08) = `30 The increase in value therefore is = ` (30-20) x 500000 = `50,00,000/-

(ii) To shareholders of B ltd. the immediate gain is `100-`20x4 = `20 per share. The gain can be higher if price of shares of A ltd. rise following merger which they should undertake. To A ltd. shareholders ` (lacs) Value of company now 1000 Value of B ltd 150

1150 No. of shares 11.25 Value per share (1150/11.25) 102.22 Gain to shareholders of B ltd `102.22-(RS.4x20) =`22.22

Gain to shareholders of A ltd `102.22-100 =`2.22

4(a) Total exposure = $250000 (i) Forward market:

UK Company has a US $ liability. To meet his $commitment, the company needs to buy dollars. Return rate = bank’s bid for pounds. Cost of forward cover (cost of his liability) = 250000/1.5455 = £161759.95

(ii) Money market hedging: Borrow in UK . Deposit in US. Repy 6 months later. If the money that has to be paid in $25000, amount to be borrowed=250000/(1+0.045/2) = $ 244498.78. This amount has to be converted in £ to find out the amount to be borrowed in U.K. =£ (244498.78/1.5617)= £156559.38(1.5617 is the spot applicable as we are borrowing today)

On maturity, $ liability will be settled with maturity proceeds of US $asset. The principal amount of loan is £156559.38. the principal and interest at the end of six months is 156559.38 + interest @ 7% for 6 months = (156559.38+5479.58) = £162038.96. Total cost of hedging through Money market = £ 162038.96

(iii) Currency options: Since UK is importing it needs to pay in dollars. It has to buy USD and has to sell £. Therefore the company should £ Put option. Now each contract = £ 12500 x $1.70 = $ 21250 Maximum number of contract that can be purchased = 25000/21250 = 11.76 or 12 (approx) Therefore exposure covered = 12 x £ 12500 = £ 150000 Premium to be paid for the exposure = 12x0.096x12500 = $14400. Cost of put option in £ = £ (14400/1.5617) = £ 9220.72

Exposure covered £ 150000 Premium for exposure £ 9220.72 Total cost £ 159220.72 Less: Excess $ covered:$ for 12 contracts = 12x12500x1.70 = $ 255000 Excess = $ 5000 Excess in pounds equivalent at forward rate of 1.5455(treated as future spot rate) £ 3235.20 Net cost £ 155985.52

PRIME/ME34/FINAL  10

Thus total cash flow exposure = £ 155985.52

Decision: Hedging through foreign currency option is cheapest. This is most attractive for CHC ltd. 4(b)

(i) Yes, investing in B is better than investing in A as B has higher return and lower risk. (Security B dominates security A), Every rational investor will prefer B as compared to A.

(ii) (a) Expected rate of return = (0.70 x 22) + (0.30 x 24) = 22.60% (b) Portfolio SD = (0.70)2 (0.40)2 + (0.30)2(0.38)2 +

2(0.70)(0.30)(0.72)(0.40)(0.38) =37.062 (iii) 22 = RF + 0.86 (RM-RF).......(1)

24 = RF + 1.24 (RM-RF)....... (2) Solving the equations, (RM-RF) = 5.263 Putting this value in (1), RF = 17.474 & RM = 22.737

(iv) Beta of portfolio = (0.86 x 0.70 + 1.24 x 0.30) = 0.974

5 (a) In case of (360/342) = 1.0526 (1.05) = 0.0488 (1.06) = 0.0583 For LHS diff of 0.01, RHS diff is 0.0095 For LHS diff. Of 0.0026, RHS diff is (0.0095/0.01) x 0.0026 i.e 0.0025 In case of (1.0526) = 0.0488 + 0.0025 = 0.0513 D1 = (0.0513 + [0.10+0.50(0.50)2] x 0.25)/0.50x0.50 = 0.4301 D2 = (0.0513 + [0.10-0.50(0.50)2] x 0.25)/0.50x0.50 = 0. 1801 Calculation of N(d1): For D1 =0.43, N(D1)=0.6664 For D1 =0.44, N(D1)=0.6700 When LHS by 0.01, RHS by 0.0039 When LHS by 1, RHS by 0.39 When LHS by 0.0001, RHS by 0.39 x 0.0001 i.e by 0.000039 Hence, D2 =0.1801, N(D2)=0.5714 + 0.000039 = 0.571439 Value of Eco = 360 x 0.666436-342 x e-10x25 x 0.571439=49.31 As per “Put call parity theory”, Spot price + put premium = call premium + PV of strike price 360+put premium = 49.31+342 x e-10x25

Value of EPO(also called as put premium) = £22.87 Optimum put premium on 5,00,000 shares = 5,00,000 x 22.87 = £1,14,35,000 The premium quoted in the market is fair (rather it is slightly less than the fair amount)

5(b)

(a) Realization at the end of 5 years = 18.90 +18.90(0.50/100) = 18.9945 Holding period return = [(18.9945-10)/10] x 100 = 89.945% Annualized return = 89.945/5 = 17.989%

(b) Annually compounded growth rate (ACGR) in NAV [(15.70/10.00)1/4]-1 = 11.94%

(c) Purchase cost = 10.90-10.90 (0.20/100) = 10.8782 = Redemption = 1-12(0.10/100) = 11.988 = Annual return = [(11.988/10.8782)-1] = 10.20%

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(d) Cost at the end of 1 year: 10.8782 Redemption value at the end of 5th year = 18.90 +18.90(0.50/100) = 18.9945 ACGR = [(18.9945/10.8782) 1/4]-1 = 14.95%

6(a) Amount of investment to fund the obligation: `10m/(1.08)6 = `6.301696m Investor’s time horizon is 6 years. The duration of the bond portfolio should be 6. Duration of 5 years maturity bond id 5 and that of 7 years maturity is 7. Let’s invest W1 in 5 years maturity bonds and the balance of the investment amount in 7 years maturity bond.

W1(5) + (1-W1)(7) = 6

W1 = 0.50

For interest rate immunization, the investor should invest `3.150848m in 5 years maturity bonds and `3.150848m in 7 years maturity bonds.

Bond Maturity amount 5 years maturity `4.629629m 7 years maturity `5.40m If market interest continues to be 8%.

Period Value of bonds 5 4.629629m 4.629629m(1.08) = 5m 6 5m 5m

Total 10m

If market interest declines:

Period Value of bonds 5 4.629629m 4.629629m(1.06) = 4.907407m 6 5.094400m 5.094400m = 5.09440 m

Total 10.001807m

If market interest rises:

Period Value of bonds 5 4.629629m 4.629629m(1.06) = 5.092592m 6 4.909090m 4.909090m

Total 10.001682m

6(b)

Year 1 2 3 4 Advertising 100000 75000 60000 30000 Other promotional expenses 50000 75000 90000 120000 Additional FC incurred 75000 75000 75000 75000 Total FC 225000 225000 225000 225000

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Fixed costs amount to be `225000 each year

Let unit selling price = `y

(a) Annual profit before depreciation and tax = [(8000y-8000 x 250 – 225000)] = (8000y – 2225000) (b) Table income = (8000y- 2225000 – 625000) = 8000y-2850000 (c) Tax = 0.40(800y-2850000) = 320y – 1140000 (d) Annual cash flow from operation = 8000y – 2225000 – 3200y + 1140000 = 4800y -1085000

For obtaining 15% return from the project, NPV at 15% should be zero. Hence:

(4800y-1085000)(2.855)-2500000 = 0

13704y = 5597675

Y = 408.47

Unit selling price = `408.47

7.

(i) Embedded derivatives

An embedded derivative is a derivative instrument that is embedded in another contract – the host contract. The host contract might be a debt or equity instrument, a lease, an insurance contract or a sale or purchase contract. Derivatives require to be marked-to-market through the income statement, other than qualifying hedging instruments. This requirement on embedded derivatives are designed to ensure that mark-to-market through the income statement cannot be avoided by including - embedding - a derivative in another contract or financial instrument that is not marked-to market through the income statement.

An embedded derivative can arise from deliberate financial engineering and intentional shifting of certain risks between parties. Many embedded derivatives, however, arise inadvertently through market practices and common contracting arrangements. Even purchase and sale contracts that qualify for executory contract treatment may contain embedded derivatives. An embedded derivative causes modification to a contract's cash flow, based on changes in a specified variable.

(ii) Factors affecting Economic Analysis

Some of the economy wide factors are discussed as under:

(a) Growth Rates of National Income and Related Measures: For most purposes, what is important is the difference between the nominal growth rate quoted by GDP and the ‘real’ growth after taking inflation into account. The estimated growth rate of the economy would be a pointer to the prospects for the industrial sector, and therefore to the returns investors can expect from investment in shares.

(b) Growth Rates of Industrial Sector: This can be further broken down into growth rates of various industries or groups of industries if required. The growth rates in various industries are estimated based on the estimated demand for its products.

(c) Inflation: Inflation is measured in terms of either wholesale prices (the Wholesale Price Index) or retail prices (Consumer Price Index). The demand in some industries, particularly the consumer products industries, is significantly influenced by the inflation rate. Therefore, firms in these industries make

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continuous assessment about inflation rates likely to prevail in the near future so as to fine-tune their pricing, distribution and promotion policies to the anticipated impact of inflation on demand for their products.

(d) Monsoon: Because of the strong forward and backward linkages, monsoon is of great concern to investors in the stock market too.

(iii) Repo and a Reverse Repo A Repo deal is one where eligible parties enter into a contract another to borrow money at a predetermined rate against the collateral of eligible security for a specified period of time. The legal title of the security does changes. The motive of the deal is to fund a position. Though the mechanics essentially remains the same and the contract virtually remains the same, in case of reverse Repo deal the underlying motive of the deal is to meet the security/instrument specific needs or to lend the money. Indian Repo market is governed by Reserve Bank of India. At present Repo is permitted between 64 players against Central and State Government Securities (including T-Bills) at Mumbai.

(iv) Debt Securitisation It is a method of recycling of funds. It is especially beneficial to financial intermediaries to support the lending volumes. Assets generating steady cash flows are packaged together and against this assets pool market securities can be issued. The process can be classified in the following three functions: 1. The origination function – A borrower seeks a loan from finance company, bank, housing company or a financial institution. On the basis of credit worthiness repayment schedule is structured over the life of the loan.

2. The pooling function – Many similar loans or receivables are clubbed together to create an underlying pool of assets. This pool is transferred in favour of a SPV (Special Purpose Vehicle), which acts as a trustee for the investor. Once the assets are transferred they are held in the organizers portfolios.

3. The securitisation function – It is the SPV’s job to structure and issue the securities on the basis of asset pool. The securities carry coupon and an expected maturity, which can be asset base or mortgage based.

(v) Forward rate agreement A Forward Rate Agreement (FRA) is an agreement between two parties through which a borrower/ lender protects itself from the unfavourable changes to the interest rate. Unlike futures FRAs are not traded on an exchange thus are called OTC product. Following are main features of FRA. • Normally it is used by banks to fix interest costs on anticipated future deposits or interest revenues on

variable-rate loans indexed to LIBOR.

• It is an off Balance Sheet instrument.

• It does not involve any transfer of principal. The principal amount of the agreement is termed "notional" because, while it determines the amount of the payment, actual exchange of the principal never takes place.

• It is settled at maturity in cash representing the profit or loss

(vi) Takeover by Reverse Bid

In a 'reverse takeover', a smaller company gains control of a larger one. The concept of takeover by reverse bid, or of reverse merger, is thus not the usual case of amalgamation of a sick unit which is non-viable with a healthy or prosperous unit but is a case whereby the entire undertaking of the healthy and prosperous company is to be merged and vested in the sick company which is non-viable.

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PRIME/ME34/FINAL  1

PS No. of Pages: 3 Total Marks: 100 No of Questions: 7 Time Allowed: 3 Hrs Question No.1 is compulsory. Answer any five from the rest 1 (Answer any 4 out of 5)

As a practising chartered accountant do you approve the following? If not, why?

(a) In a representation to be submitted to a company under section 225(3) of the Companies Act, 1956, the partner of the firm of auditors wants to include the contributions made by the firm in strengthening the control procedures of the company during their association with the company. (5 Marks)

(b) The Chairman of an Audit Committee of a Bluechip Company, who is a chartered accountant asked the firm in which he was previously a partner to quote their fee on a success fee basis so as to ensure that a professional work is assigned to such firm. (5 Marks)

(c) A firm of chartered accountants were appointed by a company to evaluate the costs of the various products manufactured by it for their information system. One of the partners of the firm of chartered accountants was a non-executive director of the company. (5 Marks)

(d) A Chartered Accountant in practice had confirmed in the application made by his articled clerk to the Council for permission to study that the normal working hours of his office were 11 a.m. to 6 p.m. and the hours during which the articled clerk was required to attend college classes were 7 a.m. to 9.30 a.m. On inquiry from Principal of College, it was ascertained that the articled clerk used to attend classes from 10 a.m. to 1.55 p.m. The Chartered Accountant pleaded ignorance about the articled clerk attending the college classes during office hours. Will the Chartered Accountant be held guilty of professional misconduct? (5 marks)

(e) Mr. J started his practice as Chartered Accountant in 1996. During 1999, he got an offer for the post of Chief Accountant of a Software Development Company, as a fulltime employee, for a salary of `60,000 per month. On accepting this offer, Mr. J converted his practice into a partnership firm by taking a fresh Chartered Accountant as his partner. Mr. J neither intimated the Institute nor obtained permission from the Institute about his employment. Will Mr. J be held guilty under the CA Act? (5 marks)

2 (a) On 30th September, 2000 a company’s issued and paid up capital was `25 crores comprising of fully paid equity shares of `10 each. This included `50,00,000 capital issued for cash; `4,50,00,000 capital issued for purchase of a business; `20 crores on issue of bonus shares from time to time by capitalising various reserves including `5 crores by capitalising capital redemption reserve.

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The company had fixed assets costing `2 crores on which depreciation provision was `1.95 crores, which was equal to the full cost of depreciable assets. The balance `5 lakhs represented the cost of land. It has discontinued its operations for last many years.

The company had made investments in various companies to the tune of `30 crores. Unfortunately all these investee companies have turned out to be BIFR cases. Nothing is expected to be realised on such investments. The company has dues from customers totalling to `4.95 crores of which `4.90 crores are due from business which have become defunct. The balance `5 lakhs are due for over 3 years. The accumulated losses are `10 crores. The amounts due to suppliers are `3 crores and they are overdue. The balancing figure in the Balance Sheet refers to loan from Financial Institutions.

Workers who had put in long years of service have lodged claims for termination benefits of `10 crores, which have been decreed in their favour. No accounting entry has been passed for the same since the decree on 1.1.1997. In the light of Statement on Auditing and Assurance Standard – SA 570, relating to Going Concern, you are asked to write appropriate paragraph of audit report. Give reason for supporting your report. (6 marks)

(b) A Company gets its accounting data processed by a third party to achieve cost reduction. As a Statutory Auditor of such a company, what are the additional precautions/checks that you would consider for conduct of the audit? (5 marks)

(c) During the course of audit of ABC Ltd. it is noticed that out of `12 lakhs of provident fund contribution accounted in the books, only`2 lakhs has been remitted to the authorities during the year. On enquiry the Chief Accountant informed that due to financial problems they have not remitted but will remit the same as and when the position improves. (5 marks)

3

(a) A public charitable trust earns ‘income’ of `10 lakhs from Unit Trust of India, which is not taxable under Section 10(33) of Income-tax Act, 1961. It spends `7 lakhs on its activities. The entire expenditure is vouched and is in accordance with the trust objects and is fully allowable as ‘application’. As Auditor of the Trust, would you require the trust to make any provision for tax in its accounts? (6 marks)

(b) RQ Insurance Ltd. has made a provision of 25% on unexpired risks reserve in its books.

Comment (5marks) (c) Write a short note on - Vostro and Nostro Accounts. (5 marks)

4 As a statutory auditor, how would you deal with the following:

I. ABC Ltd. having a paid up capital of `1 crore earned as total net profit of `1 crore for the years 2001-02 to 2003-04. The Company did not declare any dividend nor transferred any amount to Reserves for these years. The entire profit was retained in the Profit & Loss Account. In 2004-05,

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the company made a profit of `20 lacs. The company also proposed in 2004-05 to declare dividend @25% out of accumulated profits. (4 marks)

II. Miranda Spinning Mills Ltd. is a sick company and has accumulated losses of `10 crores. The company has `12 crores in its share Premium Account. The Management desires to adjust the accumulated losses against the share premium balance. Advise the company giving your reasons.

(4 marks)

III. M/s LNK’s group gratuity scheme’s valuation by actuary shows wide variation compared to the previous year’s figures.                                                   (4 marks)

IV. National Tourism Ltd., a wholly owned Government Company approaches you to give a revised report on the revised accounts, as the original accounts has undergone changes consequent to the audit of Comptroller and Auditor General of India. (4 marks)

5

I. Enumerate the risks and internal control characteristics in an audit conducted in Computer Information Systems (CIS) environment. (6marks)

II. Write a short note on - Audit vs. Investigation. (5 marks) III. Write note on Report to be set out in prospectus under Section 60(3); (5 marks)

6

I. ABC Ltd., is a company engaged in the business of construction of roads and bridges. It follows completed contract method for all its projects and therefore revenue is recognised only when the contract is completed or substantially completed. For the year ended 31stMarch, 2001, the ABC Ltd., has earned a sum or `25 lakhs as interest on short-term deposits with their bank. These deposits are made out of advances received from the customers towards the projects that they are executing. ABC Ltd. while filing their Return of Income for the year 31st March, 2001 with the tax authority declared NIL income for that year. While calculating progress payments at the year-end, the interest of `25 lakhs earned was considered as part of the funds received for the project. Is the treatment given by ABC Ltd. with regard to the interest earned on short-term deposit correct? (6 marks)

II. XYZ Ltd., as part of overall cost cutting measure announced voluntary retirement scheme (VRS)

to its employees, to reduce the employee strength. During the first half year ended 30.9.2002 the company paid a compensation of `72 lakhs to those who availed the scheme. The Chief Accountant has reflected this payment as part of regular salaries and wages paid by the company. Is this correct? (5 marks)

III. While auditing accounts of a public limited company for the year ended 31st March 2003, an auditor found out an error in the valuation of inventory, which affects the financial statement materially – Comment as per auditing and assurance standards (5 marks)

7. What do you mean by consolidated financial statements? What are the responsibilities of the auditor of the consolidated financial statements? (16 marks)

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PRIME ACADEMY 34th SESSION MODEL EXAM FINAL– ADVANCED AUDITING

SUGGESTED ANSWERS

1 (a) Section 225(3) of the Companies Act, 1956 permits a retiring auditor to make a

representation in writing (not exceeding a reasonable length) to the company. The proposition of the partner to highlight contributions made by the firm in strengthening the control procedures in the representation is not acceptable because the representation letter should not be prepared in a manner so as to seek publicity. The Code of Ethics issued by the Institute makes it amply clear that the right to make representation does not mean that an auditor has any prescriptive right or a lien on an audit. The wording of his representation should be such that, apart from the opportunity not being abused to secure needless publicity, it does not tantamount directly or indirectly to canvassing or soliciting for his continuance as an auditor. The letter should merely set out in a dignified manner how he has been acting independently and conscientiously through the term of office and may in addition, indicate if he so chooses his willingness to continue as auditor if re-appointed by the shareholders. Thus, such action proposed by a partner could not be approved since, it would lead to his being held guilty of professional misconduct under Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949.

(b) Professional services cannot and should not be offered under an agreement which entails that fees shall be payable on a success fee basis. The fees payable, therefore, become contingent in nature. It is obvious that a person who is to receive payment in direct proportion to the benefit received by his client, may be tempted to exaggerate the advantage of his service or may adopt means which are not ethical. It will have the effect of undermining his integrity and impairing his independence. Therefore, the remuneration based on a percentage of the profits or on the happening of a particular contingency such as, the successful outcome of an appeal in revenue proceedings is prohibited. Therefore, the action of the firm to quote fees in such a manner on the advice of the Chairman of the Audit Committee to ensure their appointment could not be accorded approval and the member would be held guilty of professional misconduct under Clause (10) of Part I of the Chartered Accountants Act, 1949.

(Note: In the instant case, the Chairman of Audit Committee who also happens to be a chartered accountant would also be guilty of misconduct under the Chartered Accountants Act, 1949.)

(c) The Council of the Institute of Chartered Accountants of India has categorically stated that in cases where a member is a director of a company, the firm in which the said member is a partner, should not express any opinion on its financial statements. Clause 4 of Part I of the Second Schedule desists a chartered accountant to express opinion on financial statements of an enterprise in which he, his firm or a partner in his firm has a substantial interest unless he discloses the interest in his report. Since the firm has been appointed to evaluate the costs of the various products manufactured by it for their

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information system, it cannot be construed to be a misconduct under Clause (4) Part I of the Second Schedule to Chartered Accountants Act, 1949.

(d) Failure to Observe the Regulations: As per Clause(i) of Part II of Second Schedule to the Chartered Accountants Act, 1949 a member shall be held guilty of professional misconduct if he contravenes any provision of the Act or the regulations made thereunder. The chartered accountant, as per Regulations also, is expected to impart proper practical training. In the instant case, the articled clerk must have not been attending office on a regular basis and the explanation of the Chartered Accountant cannot be accepted particularly in view of the fact that the chartered accountant did not obtain certificate from the Principal to confirm the timings. It is also quite likely that the articled clerk would be availing leave quite often and coming late to the office. Under the circumstances, the Chartered Accountant is guilty of professional misconduct in regard to the discharge of his professional duties.

(e) Failure to take Permission Before Accepting Employment: As per Clause 11 of Part I of First Schedule to the Chartered Accountants Act, 1949, Mr. J will be held guilty since he has accepted the full time salaried employment in addition to the practice of Chartered Accountancy without obtaining permission of the Institute. The Chartered Accountants Regulation, 1988 provide that a Chartered Accountant in practice shall not engage in any business or occupation other than the profession of accountancy except with the permission granted in accordance with the provisions contained in Regulation 190A. Part (B) of Appendix 10 to the Chartered Accountants Regulations, 1988 requires member of the Institute in practice to engage in full-time or part-time employment after obtaining the specific and prior approval of the Council. Further, Mr. J will be held guilty of professional misconduct under clause (i) of Part II of Second Schedule to the Chartered Accountants Act, 1949 if contravenes any of the provisions of the Act since he has failed to inform the Institute.

2a) SA 570 on “Going Concern” requires the auditor to consider the appropriateness of the going concern assumption underlying the preparation of the financial statements which may no longer be appropriate. The following indications inter alia have to be taken into consideration in determining the appropriateness of the going concern assumption:

(i) Financial indications such as negative net worth, adverse key financial ratios, substantial operating losses, inability to pay creditors on due dates, etc.

(ii) Operating indications such as labour difficulties, loss of major market, etc.

(iii) Other indications include pending legal proceedings which may affect the concern adversely, sickness of entity under statutory definition, etc.

Having regard to aforesaid indicators and as per the facts of the case, the company is not a going concern as on September 30, 2000 on account of following reasons:

(i) The company has discontinued its operations for last many years. Its productive fixed assets are fully depreciated. The only productive asset left is land worth of `5 lakhs.

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(ii) The claim of workers for termination benefits amounting to `10 crores though decreed on January 1, 1997 has not been provided for in the books of account.

(iii) The amounts recoverable from customers totalling `4.95 crores of which `4.90 crores are due from businesses which are totally defunct are doubtful of recovery in its entirety. Even the balance amount is due for more than three years. Hence, the entire amount is doubtful of recovery.

(iv) The company has not been able to pay to its suppliers amounting to `3 crores which are overdue.

(v) The company’s investment to the tune of `30 crores are not realisable and are worthless in view of the fact that all investor companies have turned sick.

(vi) The balance figure for term loan from financial institutions works out to be `17 crores as per records even which the company is unable to pay.

Thus, in view of the aforesaid financial, operating and other indicators, the assumption of going concern is not appropriate.

Paragraph in the Audit Report: “The company as at September 30, 2000 has an accumulated loss of `10 crores, has irrecoverable debts of `4.95 crores as at that date, the diminution in value of its investments is of `30 crores as at that date and a non-provision of decreed obligations in favour of employees of `10 crores. The company has discontinued its operations for last many of years and has not been able to honour its obligation to creditors and financial institutions for quite some time. Thus, total accumulated losses are`54.9 crores (and not as……… reported).

After taking into account the above factors we are of the opinion that the company is not a going concern as at September 30, 2000 and, thus, the usage of going concern assumption in the preparation of financial statements is inappropriate.

In our opinion, subject to the information given in preceding paragraph, the financial statements do not give a true and fair view of the financial position of the company at September 30, 2000 and the results of its operations for the year then ended”.

Note:The Companies (Amendment) Act, 2000 also requires that the auditor’s report shall also state in thick type or in italics the observation or comments of the auditors which have any adverse effect on the functioning of the company.

(b) Precaution to be taken by auditor in case Accounting Data Processed by Third Party: Processing of accounting data may be given to a third party on account of various considerations such as economy, own computer working to full capacity, an interim measures restricting accessibility to sensitive information, etc. A client may use a service organisation such as one that executes transactions and maintains related accountability or records transactions and processes related data (e.g., a computer systems service organisation). If a client uses a service organisation, certain policies, procedures and

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records maintained by the service organisation might be relevant to the audit of the financial statements of the client. Consequently, the auditor would consider the nature and extent of activities undertaken by service organisations so as to determine whether those activities are relevant to the audit and, if so, to assess their effect on audit risk. SA 402, “Audit Considerations Relating to Entities Using Service Organisations”, while planning the audit, the auditor of the client should determine the significance of the activities of the service organisation to the client and their relevance to the audit. In doing so, the auditor of the client would need to consider the following, as appropriate:

• Nature of the services provided by the service organisation. • Terms of contract and relationship between the client and the service organisation. • The material financial statement assertions that are affected by the use of the service

organisation. Inherent risk associated with those assertions. • Extent to which the client's accounting and internal control systems interact with the

systems at the service organisation. • Client's internal controls that are applied to the transactions processed by the service

organisation. • Service organisation's capability and financial strength, including the possible effect of

the failure of the service organisation on the client. • Information about the service organisation such as that reflected in user and technical

manuals, if any. • Information available on general controls and computer systems controls relevant to the

client's applications.

The auditor of the client would also consider the availability of third-party reports from service organisation’s auditors, internal auditors, or regulatory agencies as a means of providing information about the accounting and internal control systems of the service organisation and about its operation and effectiveness.

(c) Depositing Provident Fund Dues: The Companies Audit Report’s Order, 2003 required the auditor to state whether the dues of provident fund have been regularly deposited with the appropriate authorities and, if not, the extent of arrears shall have to be indicated by the auditor. A company is required to deposit provident fund dues to appropriate authorities with in the period prescribed under the Rules governing it. In the case of fund constituted by the company, the company is required to follow provisions of section 418 of the Act. In this case there is a default in not depositing the provident fund contribution to the extent of `10 lakhs which is a lapse on the part of the company.

The reason put forward by the Chief Accountant that the amount has not been deposited due to financial problems faced by the Company is no excuse for not remitting the provident fund. In fact, the company has not at all been regular in depositing the amount. Thus, the auditor shall include this in his report indicating the extent of arrears.

(Note: The Companies (Auditor’s Report) Order, 2003 (now applicable) requires the auditor to comment upon the regularity aspects as also the extent of arrears in case the same has

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been outstanding for a period of more than six months. In the given case, it may be noted that M/s ABC Ltd. has failed to deposit the provident funds regularly and the major part of it has been outstanding for more than six months.)

3 a)Tax audit of Public Trusts:

(a) Section 10(33) of the Income-tax Act, 1961 provides exemption in respect of income received in respect of units from UTI to all assessees including a public charitable trust. Hence, `10 lakhs received from UTI is not taxable income of the trust. The Income-tax Act, 1961 requires that for claiming full exemption by the trust, it is required to apply at least 85% of such income during the previous year for charitable or religious purposes.

(b) As per the facts given, the trust has applied only `7 lakhs i.e. 70% of its total income towards the trust objects and, thus, contravened the requirements of the Act. Yet the trust shall not be required to pay tax on its income because the income has been received on account of units,which in any case is fully exempt.

(c) Accordingly, the trust is not required to make any provisions for tax in the accounts. The fact that not spending `3 lakhs out of `10 lakhs, though contravening the requirement of spending at least 85% of "income" would, therefore, not attract tax. Hence, no tax provision is necessary.

b) Unexpired risks reserve: The need for unexpired risks reserve arises from the fact that

all policies are renewed annually except in specific cases where short period policies are issued. Since the insurers close their accounts on a particular date, not all risks under policies expire on that date. In other words at the closing date, thee is an unexpired liability under various policies which may occur during the remaining term of the policy beyond the year end. The minimum amount of unexpired risks reserve to be created is determined as per the Insurance Act, 1938 at a specified percentage of net premium as under:

(i) for marine hull insurance – 100% of net premium

(ii) For fire, marine cargo and miscellaneous business – 50% of net premium.

Provisions of income Tax Act, 1961 and Income Tax rules, 1962 permit deduction of above reserves at the prescribed rates.

Conclusion: In the given case, the Auditor of RQ Insurance Ltd should qualify his report as the company has made a provision of only 25% against the prescribed minimum of 50% or 100% as mentioned above, thereby resulting in overstatement of profit.

c) Vostro and Nostro Accounts: Bank’s maintain stocks of foreign currencies in the form of Bank Accounts with their overseas branches/correspondents. Such foreign currency accounts maintained by Indian banks at other overseas centres is designated by it as “Nostro Account”. For example, all banks in India would be maintaining a US Dollar Account with their New York office/branch/correspondents, such account would be

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designated by the Indian office as Nostro Account. “Vostro Account” is the opposite of Nostro accounts. Here a foreign bank in another country maintains stocks of Indian rupees with their Indian branch/correspondent/local bank. Such Indian Rupee Accounts are designated as a Vostro Account. For example, a German Bank might maintain a Vostro Account in rupees in terms with Indian Bank. While examining the transaction in foreign exchange, the auditor should also pay attention to reconciliation of Nostro Accounts with the respective minor account. The amount in the Nostro account is stock of foreign currency in the form of bank accounts with the overseas branches and correspondents. Unreconciled Nostro Accounts, on an examination, may reveal unauthorized payments from the foreign currency account, unauthorized withdrawals, and unauthorized debit to minor account. The auditor should also evaluate the internal control with regard to inward/ outward messages. The inward/ outward messages should be properly authenticated and discrepancies noticed, should be properly dealt with, in the books of accounts.

The auditor should also verify whether prescribed procedure in relation to inter bank confirmation in the Vostro account is followed or not. In case balance confirmation certificate have been received but the same have not been reconciled, or where confirmation has not been received the same should be reported, in respect of each Vostro Account.

4

I) Declaration of Dividends: ABC Ltd. earned a total net profit of Rs.1 crore for three years 2001-02 to 2003-04 but it did not declare any dividend nor transferred any amount to Reserves for these three years. Since it did not declare any dividend, there was no compulsion to transfer any amount to Reserves. It appears that the company has retained the profit of previous years as “surplus” under the heading of “Reserves & Surplus”. ABC Ltd. wants to declare dividend of ` 25 lacs for the financial year 2004-05, which works out to 25% of its paid up capital. However, since this rate of dividend exceeds 20% of the paid up share capital, as per the requirements of Companies (Transfer of Profit to Reserves) Rules, 1975, the company should transfer at least 10% of its current profit that is `2 lacs to reserves resulting into deficiency of ` 7 lacs in the amount of current profit which could be available for the purpose of distribution of dividend. The company, however, is well within its power to cover the said deficiency of profit out of its accumulated profit in spite of restrictions laid down in the rules prescribed under section 205A (3) of the Act, viz., Companies (Declaration of Dividend out of Reserves) Rules, 1975, since the company had not transferred any of its profit for the years 2001-2002 to 2002-04 to reserves. Thus, the company is well within its powers and right to declare the dividend of `25 lacs for the year 2004-05.

II) Application of Share Premium Account: Section 78 of the Companies Act, 1956 deals with the application of premium received on issue of shares. Sub-section (1) of the said section provides that where a company issues shares at a premium, whether for cash or otherwise, the amount received as premium on such shares shall be transferred to an

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account called “Share Premium Account” and the provisions of the Companies Act, 1956 relating to reduction of share capital of a company except as provided in the section shall apply as if the share premium account was paid up share capital of the company. Sub-section (2) of the said section provides that notwithstanding anything contained in sub-section(1), share premium account may be applied by the company for issue of bonus shares, writing off of preliminary expenses of the commission paid or discount allowed on any issue of shares or debentures of the company or for paying the premium on redemption of preference shares or debentures of the company. In view of these provisions of the Companies Act, 1956, it is not permitted to adjust its accumulated losses against the share premium account.

III) Valuation by Actuary: SA 620, “Using the Work of an Expert” states that the auditor has to evaluate the work of an expert, say, actuary, before adopting the same. This becomes more crucial since M/s LNK’s group gratuity scheme’s valuation by actuary shows wide variation compared to previous year figures. There is no doubt that appropriateness, reasonableness of assumptions and methods used are the responsibility of the expert, but the auditor has to determine whether they are reasonable based on the auditor’s knowledge of the client’s business and result of his audit procedures. In the present case, the auditor must verify the reasonableness of assumptions made and methods adopted by the actuary in the evaluation particularly with reference to factors such as rate of return on investments, retirement age, number and salary of employees, etc. Accordingly, the auditor has to satisfy himself whether valuation done by the actuary can be adopted, otherwise he may report on his findings for wide variation.

IV) Auditor’s Report on Revised Accounts: The Guidance Note on Auditor’s Report on Revised Accounts of Companies Before Circulation to Shareholders deals with those situations wherein the statutory auditor is required to give report on the revised accounts. The auditors of National Tourism Ltd. have been asked to give revised report on the revised accounts as the original accounts have undergone changes consequent to audit of the C&AG. The Guidance Note requires that the statutory auditor must observe the following steps while issuing the revised report:

(i) All copies of the original accounts and reports thereon are returned to the auditor.

(ii) The adequate disclosure has to be made that the accounts which were earlier approved by the Board of Directors and reported by the auditors have been revised and re-approved by the Board of Directors as a specific note on the amended accounts.

(iii) In case the notes to accounts do not contain any note on revision or such a note is not considered adequate or comprehensive, the statutory auditor shall have to indicate that accounts have been revised based on the audit report of C&AG. The auditors at the time of issue of revised report has to bring these facts in his report if not included as a note in the revised accounts.

(iv) Finally, the auditor’s report (revised) should clearly draw the attention to their earlier audit report.

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5

I)The risks and internal control characteristics in CIS environment as per SA 315, “Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment” and SA 330 “The Auditor’s Responses to Assessed Risks” include the following:

♦ 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.

♦ 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.

♦ 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.

♦ 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. In addition, decreased human involvement in handling transactions processed by computer information systems can reduce the potential for observing errors and irregularities. Errors or irregularities occurring during the design or modification of application programs or systems software can remain undetected for long periods of time.

♦ 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.

♦ 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

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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.

♦ 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.

♦ 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.

II)Audit vs. Investigation: Etymologically, auditing and investigation are largely overlapping

concepts because auditing is nothing but an investigation used in a broad sense. Both auditing and investigation are fact finding techniques but their basic nature and objectives differ as regards scope, frequency, basis, thrust, depth and conclusiveness. Audit and investigation differ in objectives and in their nature. Auditing is general while investigation is specific. The object of auditing is to ensure that the financial statements are free and fair and not misleading or unreliable. The merit of auditing lies in its ability to pronounce in general terms whether the accounts are basically reliable or not and in accordance with the legal requirements and regulations applicable to the particular audit. Audit is not based on suspicion unless circumstances exist to arouse suspicion of the auditor. Investigation implies systematic, critical and special examination of the records of a business for a specific purpose. The examination conducted under investigation is intensive as well as exhaustive so far as the activities or areas of accounting is concerned. Investigation requires a concentrated focus on the subject matter of inquiry and related matters. Often, investigations may spread over a period longer than one year and its scope may extend to inquiry beyond the books of accounts if the circumstances so require.

III)Report to be set out in the prospectus u/s 60(3): Section 60(3) of the Act provides that a

prospectus should be accompanied inter alia by the consent in writing of the person named therein as the auditor of the company or intended company, to act in that capacity. Part II of Schedule II to the Act prescribes the reports to be set out in a prospectus. The report contains particulars about profit and losses of the company for five preceding year, assets and liabilities, rates of dividend, etc. The significance of the report lies in the fact that a prospectus is issued by a company when it seeks to raise funds from the public and gives detailed information about the company to enable prospective investors to take a well-informed decision. The functional approach on the part of auditor involves obtaining information from the management, particularly, in respect of estimation of current and future profits. He has to also ensure that all adjustments have been made properly.

6 I) Accounting Treatment of Interest on Short-term Deposits: As per AS 7, “Accounting for Construction Contracts” ABC Ltd. is free to use either Percentage of Completion Method or

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Completed Contract Method. Normally contractors who build highways, buildings, bridges and other structures, use the Percentage of Completion method since the projects they execute are completed over a long period of time. However, there is nothing wrong in adopting the Completed Contract Method by ABC Ltd. as per the accounting treatment permitted by the existing standard. Under the Completed Contract method, the costs and progress payments received are accumulated during the course of the contract but revenue is not recognised until the contract activity is fully or substantially completed. The interest of ` 25 lakhs earned by ABC Ltd., for the year ended 31st March 2001 is to be treated as ‘income from other sources’ and ABC Ltd. should declare that as income earned in their Return of Income for they ended 31st March 2001. Also as per AS 9, “Revenue Recognition” the interest earned on short term deposits cannot be treated as progress payments received for the contracts that are under progress and the interest earned should be recognised as revenue in the year in which it is earned.

(Note I: Alternatively, in case there exists a specific contract between ABC Ltd. and their customers that interest received on deposits made by them shall be adjusted towards the progress payments then the treatment accorded by the company is correct.

Note II: Candidates may note that the above answer is based on old AS 7 “Accounting for Construction Contracts”, issued in 1985. The revised AS 7 comes into force in respect of all contracts entered during accounting periods commencing on or after 1.4.2003.)

II) Accounting Treatment of Payment on account of VRS: As per AS 5, “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies” the payment made to its employees on account of VRS as an overall cost cutting measure would fall in the ambit of ordinary activities connected with the business of the enterprise. AS 5 requires that when items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately. In fact an activity like VRS can very well be treated as restructuring exercise carried by the enterprise. Though this is not an extraordinary item, AS 5 requires that items of income and expense which are not extraordinary items, the nature and amount of such items may be relevant to users of financial statements in understanding the financial position and performance of an enterprise and in makingprojections about financial position and performance. Disclosure of such information is sometimes made in the notes to the financial statements.

Considering the above, the compensation of ` 72 Lakhs paid towards VRS availed by employees should be shown separately in the profit and loss account of XYZ Ltd., so that the effect of it on the operating results of the Company during the previous year can be perceived. Therefore, clubbing of ` 72 lakhs with the regular salaries and wages of the company by the Chief Accountant is not appropriate and, thus, the separate disclosure is necessary.

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

7. AS 21 ‘Consolidated Financial Statements’ lays down principles and procedures for preparation and presentation of consolidated financial statements. Consolidated financial statements are presented for a group of entities under the control of a parent. A ‘parent’ is an entity that has one or more subsidiaries. A group comprises a parent and its subsidiaries. Thus, consolidated financial statements are the financial statements of a group presented as those of a single entity. AS 21 is applicable to a parent that presents

consolidated financial statements. In other words, whenever a parent decides to prepare and present consolidated financial statements, it should do so in accordance with the requirements of Accounting Standard (AS) 21, Consolidated Financial Statements. Consolidated financial statements normally include consolidated balance sheet, consolidated statement of profit and loss, and notes, explanatory material that form an integral part thereof, and also consolidated cash flow statement (in case a parent presents its own cash flow statement). Consolidated financial statements are presented, to the extent possible, in the same format as adopted by the parent for its separate financial statements.

Responsibility of the Auditor of the Consolidated Financial Statements : The auditor of the consolidated financial statements is responsible for expressing an opinion on whether the consolidated financial statements are prepared, in all material respects, in accordance with the financial reporting framework under which the parent prepares the consolidated financial statements.

Therefore, the auditor's objectives in an audit of consolidated financial statements are:

(a) to satisfy himself that the consolidated financial statements have been prepared in accordance with the requirements of Accounting Standard (AS) 21, Consolidated Financial

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Statements, Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements and Accounting Standard (AS) 27, Financial Reporting of Interests in Joint Ventures; and

(b) to enable himself to express an opinion on the true and fair view presented by the consolidated financial statements.

Before commencing an audit of consolidated financial statements, the auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner. The auditor should make plans, among other things, for the following:

(a) understanding of accounting policies of the parent, subsidiaries, associates and joint ventures;

(b) determining the extent of use of other auditor’s work in the audit;

(c) determining and programming the nature, timing, and extent of the audit procedures to be performed; and

(d) coordinating the work to be performed.

A parent which presents consolidated financial statements is required to consolidate all subsidiaries, include all associates and jointly controlled entities in the consolidated financial statements other than those for which exceptions have been provided in the relevant Accounting Standards.

The auditor should obtain a listing of subsidiaries, associates and joint ventures included in the consolidated financial statements. The auditor should review the information provided by the management of the parent identifying the subsidiaries, associates and joint ventures. The auditor should verify that all the subsidiaries, associates and joint ventures have been included in the consolidated financial statements unless a subsidiary, associate or joint venture meets a criterion for exclusion. In respect of completeness of this information, the auditor should perform the following procedures:

(a) review his working papers for the prior years for the known subsidiaries, associates and joint ventures;

(b) review the parent’s procedures for identification of subsidiaries, associates and joint ventures;

(c) review the investments to determine the shareholding in other entities;

(d) review the joint venture and other relevant agreements entered into by the parent;

(e) review the statutory records maintained by the parent, for example registers under section 302, 372A of the Companies Act, 1956.

The auditor should also identify the changes in the shareholding that might have taken place since the last audit.

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It is also important to note that ownership of voting power is not necessary for an entity to own more than one-half of the voting power of another to control the other enterprise. Control of the composition of the Board of Directors (in the case of a company) or corresponding governing body (in the case of any other enterprise), with a view to obtain economic benefits from its activities, ownership of voting power is not important. For example, an entity holds only 10 percent of the share capital of another entity but it has

control over the composition of the Board of Directors/governing body of the second entity. In such a case, the first entity would be considered as a parent of the second entity and, therefore, it would consolidate the second entity in the consolidated financial statements as subsidiary. The auditor, therefore, apart from carrying out above procedures, should verify whether the parent controls the composition of the Board of Directors or corresponding governing body of any entity. There would be various means by which such kind of control can be obtained. In this regard, the auditor may verify the Board’s minutes, shareholder agreements entered into by the parent, agreements with the entities to which the parent might have provided any technology or know how, enforcement of statute, as the case may be, etc. The auditor would have to use his professional judgement to determine whether the parent controls the composition of the Board of Directors of any other entity. If yes, whether that entity has been consolidated as a subsidiary in the consolidated financial statements.where a subsidiary or an associate or a jointly controlled entity is excluded from the consolidated financial statements, the auditor should examine the reasons for exclusion. There could be two reasons for exclusion of a subsidiary, associate or jointly controlled entity – one, that the relationship of parent with the subsidiary, associate or jointly controlled entity is intended to be temporary or the subsidiary, associate or joint venture operates under several long-term restrictions which significantly impair its ability to transfer funds to the parent. The auditor should satisfy himself that the exclusion made by the management falls within these two categories. The auditor should verify such long-term restrictions from the relevant laws and regulations, agreements entered by the parent with such entities which prohibit transfer of funds. In the case of an entity which is excluded from consolidation on the ground that the relationship of parent with the other entity as subsidiary, associate or joint venture is temporary, the auditor should verify that the intention of the parent, to dispose the subsidiary, investment in associate or interest in jointly controlled entity, in the near future, existed at the time of acquisition of the subsidiary, making investment in associate or jointly controlled entity. The auditor should also verify that the reasons for exclusion are given in the consolidated financial statements. If an entity is excluded from the consolidated financial statements for reasons other than those allowed by the relevant accounting standards, the auditor should consider its effect on the report to be issued. The auditor should consider the need to issue a modified report on the consolidated financial statements. The auditor should also verify that in consolidated financial statements, investments in such subsidiaries, associates or jointly controlled entities should be accounted for in accordance with Accounting Standard (AS) 13, Accounting for Investments.

The auditor should also examine whether any subsidiary, associate or jointly controlled entity has ceased to be a subsidiary, associate or jointly controlled entity during the period under audit. It is also possible that a subsidiary might have become an associate or an associate might have become a subsidiary of the parent. The auditor, in such cases, should examine

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whether these changes have been appropriately accounted for in the consolidated financial statements as required by the respective accounting standards.

In preparing consolidated financial statements, the financial statements of the parent and its subsidiaries are combined on a line by line basis by adding together like items of assets, liabilities, income and expenses and then certain calculations like determination of goodwill or capital reserve, minorities interest and adjustments like elimination of intra group transactions, balances and unrealised profits etc. are made in accordance with the requirements of Accounting Standard (AS) 21, Consolidated Financial Statements.

Investments in associates are accounted for using the Equity Method as prescribed in Accounting Standard (AS) 23, Accounting for Investments in Associates in Consolidated Financial Statements. A parent that has an interest in a jointly controlled entity, reports its interest in the consolidated financial statements using proportionate consolidation method in accordance with Accounting Standard (AS) 27, Financial Reporting of Interests in Joint Ventures. Many of the procedures appropriate for the application of equity method and the proportionate consolidation are similar to the consolidation procedures set out in Accounting Standard (AS) 21, Consolidated Financial Statements.

The auditor should verify that the adjustments warranted by the relevant accounting standards have been made wherever required and have been properly authorised by the management of the parent. The preparation of consolidated financial statements gives rise to permanent consolidation adjustments and current period consolidation adjustments.

s

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LS

No. of Pages: 4 Total Marks: 100

No of Questions: 7 Time Allowed: 3 Hrs

Question No 1 is compulsory. Attempt any five questions from the remaining six questions.

1a. Mr. Smart, a director, verbally resigned from his office at the Board meeting. His resignation was accepted although the articles provided for resignation in writing. Is the resignation valid? (5marks)

1b. Mr. E, a shareholder in M/s JKP Ltd. holding ten equity shares of `10 each fully paid up wants to give a special notice to the company for removal of a Mr. S, a director of M/s JKP ltd. without stating reasons in the notice. You are required to state as per provisions of the Companies Act, 1956 and/pr any decided case law whether Mr. E is entitled to do so? (5 marks)

1c.P, son of A, who is the managing director of ABC Ltd, proposes to give his flat on lease to the company. The paid-up share capital of ABC Ltd. is `10 crores. Advise the company explaining the restrictions, if any, under the companies Act, 1956. (5marks)

1d. M/S XYZ Ltd was wound up with effect from 15.3.2010 by an order of the court. Mr.A, who ceases to be a member of the company from 1.6.2009, has received a notice from the liquidator that he should deposit a sum `5,000 as his contribution towards the liability on the shares previously held by him. In this context explain whether Mr.A can be called a contributory and whether he can be made liable and whether there is any limitation on his liability. (5 marks)

2(i) An arrangement has been made among the Cotton producers that the cotton produced by them will not be sold to mills below a certain price. The arrangement was in writing but it was not intended to be enforced by legal proceeding. Examine whether the above arrangement can be considered as an agreement within the meaning of Sec 2(b) of Competition Act, 2002. (4 marks)

2(ii) The Central Government has formed the opinion that Mr.CBM (A member of the Competition Commission of India) has abused his position which may be prejudicial to public interest as a member of the commission. Examine the powers of the Central Government in this regard. (4marks)

2(iii)On the complaint of Mr.Gupta, after enquiry SEBI finds that Mr.Mehta a Chief Executive Officer of the company, on the basis of unpublished price sensitive information, has indulged in the trading of the securities of that company. Explain, on the basis of the said finding, what action SEBI can take against Mr.Mehra under the Securities and exchange Board of India Act, 1992. (8 marks)

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3a. Super Chemicals Ltd, a closely held unlisted company, is in need of about `.20 crores for financing its expansion programme. The Company has not declared any divided so far though it has made good profits from the commencement of commercial operations on 1st January, 2005. The paid-up capital of the company was increased to `3.5 crores on 1st April, 2008. The net worth of the company as per lasted audited balance sheet as at 31st March, 2011 is `5crores. The Company seeks your advice as to its eligibility to raise `20 crores through public issue of equity shares at a premium. Advise with reference to relevant guidelines issued by SEBI. (8marks)

3b. A group of individuals eligible to form a Producer Company within the meaning of the Companies Act, 1956 has entrusted you with the job of preparing the memorandum of Association of the proposed Producer Company. You are required to state the matters, which are required to be included in such Memorandum of Association. (8marks)

4a.X ltd is being managed by Mr.Sudhir as the Managing Director. Serious allegations have been made by some shareholders and creditors of the company that the managing director has misused his position and caused enormous loss to the company. The said shareholders and creditors of the company make a complaint to the central government to intervene and provide relief to them. They want the managing director to be removed from the post. Explain the powers of the central government in this regard. (8marks)

4b. Sunrise ltd. whose year ended on 31st March, 2011 held its annual general meeting on 30th September, 2012. The meeting transacted all other businesses except that accounts as they were not ready and adjourned the meeting to 20th December 2011 for consideration of accounts. The Registrar of Companies issued show cause notice for violation of Section 210 of the Companies Act, 1956. Advice. (8 marks)

5a. Answer the following with reference to the scheme of amalgamation of companies explaining the relevant provisions of the Companies Act, 1956:

(i) Whether companies being amalgamated must be companies registered in India.

(ii)What is the majority required for approving the scheme of amalgamation in a meeting of members of a company called as per directions of the court? Is the scheme to be approved by preference shareholders?

(iii)When will the court order dissolution of the transferor company?

(2.5+3+2.5=8 marks)

5b. HIG ltd is a company incorporated outside India. 50% of its preference share capital and 20% of its equity share capital is held by companies incorporated in India. It issued prospectus inviting subscriptions in India for its shares but did not state the country in which it is incorporated.

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(i) Is the prospectus of the company valid?

(ii)What if none of the shares (preference and equity) were held by companies incorporated in India? (8 marks)

6a. Advise M/s Sujit ltd. in respect of the following proposals under consideration of its Board of Directors.

(i) Appointment of Managing Director who is more than 70 years of age;

(ii) Payment of commission of 4% of the net profits per annum to the ordinary directors of the company;

(iii)Payment of remuneration to an ordinary director for rendering professional services and;

(iv)Payment of remuneration of `40,000 per month to the whole time director of the company running in loss and having an effective capital of ` 95 lacs. (8 marks)

6b.

(i)The wife of the Managing Director, who was a chartered Accountant and the Financial advisor in the Company, was given a salary advance of `10,000. Advice (4 marks)

(ii)Secret ltd. having paid-up capital `50 lacs entered into a contract with S ltd. in which Director D was holding 20% shares. The director did not disclose his interest at the time of approval of the contract by the board. Advice (4 marks)

7. Attempt any four:

(a) What are the internal aids to interpretation of statues? Give four examples.

(4 marks)

(b) The promoters of a company to be registered under the Companies Act, 1956 having its main object of carrying on the business as manufacturers and stockists of Iron and Steel proposes that the name of the company is to be “ABC steel bank ltd”. You are required to state with reference to the provisions of the “banking regulations Act, 1949” whether the said company with the proposed name can be registered.

(4 marks)

(c) Mr.David, an Indian National desires to obtain foreign exchange for the following purposes:

(i) Payment of US $10,000 as commission on exports under Rupee state credit route.

(ii) US$ 30,000 for a business trip to U.K.

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Advise him, if he can get the foreign exchange and under what conditions.

(4 marks)

(d)M/s A to Z technologies ltd. has been wound up and the official liquidator has been asked to take charge of the company. Briefly explain the relevant provisions regarding filing of statement of affairs in relation to the company in liquidation. (4 marks)

(e)Mr.Morris is a director of MNC ltd. which had accepted deposits from public. The financial position of MNC turned very bad and it failed to repay deposits which fell due for payment on 10th April 2010 and such repayment has not been made till 5th may 2011. Another company JKL ltd. wants to appoint the said Mr.Morris as its director at its AGM to be held on 6th May 2011. You are required to state with reference to the provisions of the Companies Act, 1956 whether Mr.Morris can be appointed as a director of JKL Ltd. (4 marks)

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PRIME ACADEMY

34th SESSION MODEL EXAM – FINAL CORPORATE AND ALLIED LAWS

SUGGESTED ANSWERS

1 (a) There is no provision in the Companies act relating to the resignation of the office by a director. The articles of association usually provide for resignation by a director by giving written notice to the company. Even if the Articles contain no provision regarding resignation by a director, he may resign his office at any time by giving reasonable notice to the company, no matter whether the company accepts it or not.

A verbal resignation would not however, e effective in the light of such an article if made to, and accepted by, the board since the board would have no authority to accept. In the given case, the director resigned verbally, though the articles provided for a written resignation and the board of directors accepted his oral resignation. Hence his resignation is invalid.

1(b) The problems as stated in the question is governed by the provisions of section 284 of the Companies Act, 1956.Sub-section(2) of the said section stated that a special notice is required of any resolution to remove a director. The section that states a special notice is required of any resolution to remove a director. The section does not put any condition in respect of the number of members or their shareholding and furnishing any reason therefore. Accordingly the Karnataka High Court in the case of Karnataka Bank Ltd. Vs A.B.Datar & Other reported at [1994]79 Comp. Cases 417 held that there is no requirement with regard to the number of members of their shareholding and even one member is entitled to give special notice for removal of director, The Court also held that there is no need to give any reason for removal of a director in the resolution proposed to be moved. Hence Mr.SDR holding only ten equity shares can alone give a special notice for removal of Mr.EDM from the office of the director of M/s.JK Ltd.

1(c) Lease of flat: Section 297 of the Companies Act,1956 requires certain contracts on which the directors of a company are interested to be sanctioned by the Board of Directors of the Company and in certain cases(i.e. where the paid up share capital of the company is Rs.1 crore or more) it is also required to be approved with the previous approval of the Central Government.Section 297 applies only to contracts of sale, purchase or supply of goods, materials and services or for underwriting the subscriptions of any shares in, or debentures of the company. Providing premises on a rental or lease basis by a director or his relative to company is not covered by Section 297.Since this Section does not apply to transactions in immovable properties, hence the proposed lease does not require either board resolution or approval of the Central Government.

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However it is an arrangement in which the Managing Director is interested and as such he is required to make a disclosure under Section 299 of the said act and he should not participate in the Board’s proceedings (Section 300) and the lease arrangement must be entered in the Register of Contract maintained under Section 301 of the said Act.

1(d)Contributory is a term used in the case of winding up of a company.A contributory can be a past or present member and is liable to contribute to the assets of the company in the event of winding up.In the present case Mr.A ceased to be a member of the company when it went into liquidation from 15.3.2000.Thus Mr.A will be treated as a past member.He will not be required to contribute to the assets of the company if the following conditions are fulfilled:

(a) if Mr.A had ceased to be a member of the company for a period of one year or upwards

before the commencement of winding up.In this case since one year has not elapsed,Mr.A will be liable to contribute to the assets of the company. (b) if the debt or liability of the company was contracted or incurred after he ceased to

be a member. (c) if the present members are able to satisfy the contributions required to be made by

them under the Act.

In any case,the liability of the past or present member cannot exceed the unpaid amount on the shares and if the shares are fully paid up no contributions is required to be made by the members past or present [Section 426 of Companies Act,1956].

2(a)

(i) As per Section 2(b) of Competition Act,2002 an ‘agreement’ includes any arrangement or understanding or action in concert,-

• whether or not, such a arrangement or understanding or action is formal or in writing; or

• Whether or not, such a arrangement or understanding or action is formal or in enforceable by legal proceedings.

In the given case the understanding reached among the cotton produces not to sell below a certain price shall amount to an agreement as defined under Section 2(b) notwithstanding the fact that arrangement is writing but no intended to enforce by legal proceeding.

(ii) Section 11(2) (e) of the Competition Act,2002 empowers the Central Government to remove by an order, a member of the Competition Commission of India from his office if such a member has abused his position as to render his continuance in office prejudicial as a member of competition commission. However provision of Section 11(3) of the said act puts some restrictions on such powers of the Central

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Government. According to this section, in case as stated in the question, Central Government wants to remove a member or the Competition Commission from his office on the above ground, it has to make a reference to the Supreme Court. The Supreme Court shall hold an enquiry in accordance with the procedure formulated by it and then report that the member in question ought to be removed from his office on such ground. Thus the Central Government can remove a member of Competition Commission from his office by following the above procedure.

2(b) Section 15G of the Securities and Exchange Board of India (SEBI) Act,1992 deals with penalty for Insider Trading. According to this, if any insider

(i) either on his own behalf or on behalf of any other person, deals in securities of a body corporate on any stock exchange on the basis of any unpublished price sensitive information; or

(ii) communicates any unpublished price sensitive information to any person, with or without his request for such information except as required in the ordinary cause of business or under any law, or

(iii)counsels or procures for, any other person to deal in any securities of anybody corporate on the basis of unpublished price sensitive information,

Shall be liable to a penalty of twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher. As such SEBI can, after following the prescribed procedure, impose a penalty on Mr.P.Mehra. The maximum penalty that SEBI can impose is Rupees twenty-five crores or three times the amount of profits made out of insider trading, whichever is higher.

3(a) Super Chemicals Ltd, a closely held company is eligible to raise `20 crores through public issue of equity shares at a premium provided it satisfies the Conditions for initial public offer contained in Regulation 26 of the SEBI (ICDR) Regulations 2009.

(a) it has net tangible assets of at least three crore rupees in each of the preceding three full years (of twelve months each),of which not more than fifty per cent are held in monetary assets: Provided that if more than fifty per cent. of the net tangible assets are held in monetary assets, the issuer has made firm commitments to utilise such excess monetary assets in its business or project;

(b) it has a track record of distributable profits in terms of section 205 of the Companies Act,1956,for at least three out of the immediately preceding five years: Provided that extraordinary items shall not be considered for calculating distributable profits;

(c) it has a net worth of at least one crore rupees in each of the preceding three full years (of twelve months each);

(d) the aggregate of the proposed issue and all previous issues made in the same financial year in terms of issue size does not exceed five times its pre-issue net worth as per the audited balance sheet of the preceding financial year;

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(e) if it has changed its name within the last one year, at least fifty per cent. of the revenue for the preceding one full year has been earned by it from the activity indicated by the new name.

3(b)As per Section 581F of the Companies Act,1956,the Memorandum of Association of a Producer Company has to state the following:

(a) the name of the company with “Producer Company Limited” as the last words of the name of such company;

(b) the state in which the registered office of the Producer Company is to situate; (c) the main objects of the Producer Company confirming to the objects specified in

Section 581B of the Companies Act,1956; (d) the names and and addresses of the persons who have subscribed to the memorandum

of association; (e) the amount of share capital with which the Producer Company is to be registered and

division thereof into shares of a fixed amount; (f) the names, addresses and occupations of the subscribers being producers, who shall

act as the first directors in accordance with section 581J(2) of the Companies Act,1956;

(g) that the liability of its members is limited; (h) opposite to the subscriber’s name the number of shares each subscriber takes (Each

subscriber must take at least one share); (i) in case the objects of the Producer Company are not confined to one State, the States

to whose territories the objects extend.

4(a) On receipt of the complaint from some of the shareholders and creditors of X Ltd., that its managing director Mr.Clever has misused his office and thereby caused loss to the company, the Central Government, if satisfied with the contents of the complaint may make a reference to the Company Law Board with a request to inquire into the case and record a finding whether or not Mr.Clever is a fit and proper person to hold the office of Managing Director. The application made to CLB must contain a concise statement of the circumstances and material as the Central Government may consider necessary for the purpose of the enquiry.The Company Law Board will hear both the parties viz.(1)The Central Government and(2)The Respondent Mr.Clever as well as the company.The CLB has powers to pass any interim order to the effect that the respondent Mr.Clever shall not discharge any of the duties of his office until further orders and appoint a suitable person in place of the respondent. At the conclusion of the hearing the CLB will record its finding. If the finding of the CLB is against the respondent ,the Central Government, by order, shall remove him from office, as provided in Section 388E(1) of the Companies Act,1956.The person against whom such an order is passed is debarred from holding the post of director etc.,for a period of 5 years from the date of order of removal. Also no compensation is payable to him for termination of office.

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4(b) As per Section 166(1) of the Act,every company must hold its first annual general meeting within 18 months of its incorporation and subsequently one in each calendar year.Not more than 15 months shall elapse between the two annual general meetings.Powers are vested in the Registrar of Companies to grant extension of time up to 3 months for holding an annual general meeting for genuine reasons (Accounts not being ready is considered as a valid reason for this extension).

Section 210(3)(b) provides that every subsequent annual general meeting its annual accounts within six months or the extended period for holding annual general meeting,if any,granted by the Registrar of Companies,from the date of closure of the accounts.

In the given case,Sunshine Ltd. Convened and held the annual general meeting within six months from date of closure of the accounts,but failed to lay the accounts within the six months and it had also not obtained permission for extension of time for holding annual general meeting under second provision to sub-section (1)of section 166 from the Registrar of Companies.Hence,it has violated the provisions of section 210 of the Act and Registrar of Companies was justified in issuing the show-cause notice.

5(a)

(i)a scheme of compromise or arrangement may provide for amalgamation of companies under Section 394 of the Companies Act,1956.Section 394(4)(b) defines the ‘transferee’ and ‘transferor’ companies.While the ‘transferee company’ does not include any company other than a company within the meaning of the Companies Act,1956 the transferor company includes anybody corporate whether a company within the meaning of the Companies Act or not.Hence the scheme of amalgamation may provide for transfer of foreign companies to Indian companies.

(ii)Majority in number representing three-fourths in value of members or class of members,as the case may be,present and voting either in person or by proxy,where proxies are allowed under the rules made under Section 643 must approve the scheme or arrangement providing for amalgamation of companies [Section 391(2)].Any member who though present at the meeting,does not vote for or against,but remains neutral,is not to be taken into consideration.

As the expression used is ‘member’,not only holders of equity shares but also preference shareholders will have to be taken into account and the value of their shares be included or,if the meeting of holders of preference shares and equity shares are ordered by the court to be held separately,the three-fourths majority of each class will have to be ascertained separately.

(iii)The scheme may provide for the dissolution,without winding up,of any transferor company [Section 394(1)].The Court shall not order dissolution of any transferor company unless the official liquidator has,on scrutiny of the books and papers of the company,made a report to the court that the affairs of the company have not been

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conducted in a manner prejudicial to the interests of its members or to public interest [Second provision to Section 394(2)].

5(b) Section 591(2) of the Companies Act,1956,provides that where not less than fifty per cent of the paid up share capital (whether equity or preference or partly equity and partly preference) of the company incorporated outside India and having an established place of business in India,is held by one or more citizens of India or by one or more bodies corporate incorporated in India,whether singly or in the aggregate,such company shall comply with such of the provisions of this Act as may be prescribed with regard to the business carried on by it in India,as if it were a company incorporated in India.

(i)As 50% of the preference share capital and 20% of the equity share capital of Ashes Ltd. is held by companies incorporated in India,it shall be treated as if it were a company incorporated in India.As such it is not necessary for Ashes Ltd. to comply with the provisions relating to foreign companies.So the prospectus of the company shall be valid.

(ii) If none of the shares (preference and equity) were held by companies incorporated in India,Ashes Ltd. would be a foreign company within the meaning of Section 591 of the Act.Section 595 of the Act provides that every foreign company shall in every prospectus inviting subscriptions in India for its shares or debentures,state the country in which the company is incorporated,the prospectus shall not be valid.

6(a)

(i) Under Schedule XIII,Part I,Paragraph (c) of the Companies Act,1956,a person shall be eligible for appointment as Managing Director who has attained the age of 70 years where his appointment is approved by a Special resolution passed by the company in the general meeting.In that case,approval of the Central Government is not required.

(ii) Under Section 309(4)(b) of the Companies Act,1956 ordinary directors may be paid commission if the company by special resolution authorize such payment not exceeding 1% of net profit,if the company has MD/WTD/Manager or upto 3% of the net profits in any other case.Further,under Section 309(7) of the Act,Special resolution shall not remain in force for a period of more than 5 years at a time.

Second provision to Section 309(4) states that a company in general meeting may,with the approval of the Central Government,authorize the payment of such remuneration at a rate exceeding one per cent or,as the case may be,three per cent of its net profits.

Thus,in the present case,commission of 4% of net profits of the company per annum can only be paid to the ordinary directors with the approval of the Central Government.

(iii)Under provision to Section 309(1) of the Act,any remuneration for services rendered to any director in any other capacity shall not be so included if-

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(a) the services rendered are of a professional nature,and (b) in the opinion of the Central Government,the director possesses the requisite qualification for the practice of the profession.

In that case,approval of the Central Government will not be required for payment of any remuneration to the concerned director.

(iv)In terms of Section II of Part II of Schedule XIII of the Act,approval of the Central Government is not required for payment of monthly remuneration upto `75,000/- in case of a company with effective capital of less than `1 crore and having no profit or its profits are inadequate,to its managerial persons,provided-

(1) the payment of remuneration is approved by the Remuneration Committee; (2) the company has not defaulted in repayment of its debts,including public

deposits or debentures or interest payable thereon for a continuous period of 30 days in the preceding year before the date of such appointment.

Thus,in the given case,the company may pay the remuneration of `40,000 P.M. to its WTD without approval of the Central Government subject to the above restrictions.

6 (b)

(i) As per Sec 295, without obtaining approval of the central government, a public limited company or a subsidiary company of a public limited company cannot give loan or provide guarantee or provide security in connection with a loan taken by any other person to or to any other person by, inter alia, a relative of such director. In the view of above, it is clear that the loan given to the wife of the MD attracts the provisions of Sec 295.

However, since the wife of the MD is the financial advisor of the company and working as an employee, she, as an employee should be entitled to a salary advance, in accordance with the scheme of salary advance given to general to the employees of the company. If the amount so given is not disproportionate to the salary it should not be treated as loan and the provisions of Sec 295 may not be attracted.

Thus, an amount of `10,000 given as salary advance, recoverable from salary does not be disproportionate to salary of a financial advisor and provisions of Sec 295 may not be attracted.

(ii) Sec 299 requires every director to disclose his direct or indirect interest any contract entered by the company or proposed to be entered by the company. Disclosure are of the contract is inquired to be made by the director in the board meeting where the said contract or proposed contract is being first approved or considered. If the director had no interest at the time the contract was entered he should make such disclosure, in the first board meeting held after he become interested. Every director who fails to disclose his interests in any contractor arrangement shall be punishable with fine upto `5000.

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It is further provided that nothing contained in sec 299 shall apply to contract between two companies where the director of one company or two of them holds or hold not more than 2% of the paid-up share capital of the company.

In the instant case, the director has failed to disclose interest and shall therefore be liable to punishment under Sec 299, besides liable to vacate the office under Sec 283 of the Companies act, 1956.

7(a) Internal aids to interpretation/construction are those which are found within the text of the statutes. On the other hand external aids of interpretation are those factors which are external to the text of the statute but are of great help.

Examples of internal aids to interpretation:

1.Definitional sections and clauses 2.Illustrations 3.Provisions 4.Long title and short title.

7(b) As per provisions of Section 7 of the Banking Regulation Act,1949 no company other

than a banking company can use,as part of its name,the word “Bank” unless it is a banking company as defined in Section 5(c) of the Said Act.In view of such a legal provision,the promoters of the company having the main object of carrying on the business as manufacturers and stockists of iron & steel can not keep the name of the company as “ABC Steel Bank Limited”.

7(c)Under provisions of Section 5 of the Foreign Exchange Management Act,1999 certain Rules have been made for drawal of Foreign Exchange for Current Account transactions.As per these Rules,Foreign Exchange for some of the Current Account transactions is prohibited.As regards some other Current Account transactions,Foreign Exchange can be drawn with prior permission of the Central Government while in case of some Current Account transactions,prior permission of Reserve Bank of India is required:

(i)In respect of item No.(i),i.e.,payment of commission on exports under Rupee State Credit Route,such payment is prohibited and the same is included in First Schedule to the Foreign Exchange Management (Current Account Transactions) Rules,2000.

(ii)Foreign Exchange for business trip upto US$ 25,000 can be obtained by any person.If a person wants to exceed this limit,then prior permission of Reserve Bank of India is required as per Third Schedule to the Foreign Exchange Management (Current Account Transactions) Rules,2000.In respect of item (ii),since the amount involved is more than US$ 25,000,Mr.F can obtain the foreign exchange after getting the permission of Reserve Bank of India.

7 (d) According to section 454 of the Companies Act, 1956 where the Court has made a winding up order or the Official Liquidator has been appointed a provisional liquidator,

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a statement as regards the affairs of the company in the prescribed Form No. 57 shall be filed with the Official Liquidator. The said statement should be verified by an affidavit and contain particulars of

(i) the assets of the company stating separately the cash balance in hand and at bank (ii) its debts and liabilities (iii)the details of creditors including their names, residence, occupations and amounts

due to them as secured and unsecured (iv) the details of debtors including the particulars of securities and their values, the

names and particulars of debtors (with estimated amount to be realized) and (v) such further or other information as may be prescribed or required by the Official Liquidator.

The said statement is required to be verified by one or more directors at the time of passing the winding up order by the court. Further the said statement is required to be submitted within 21 days of the winding up order or within such extended time not exceeding three months as may be fixed by the Official Liquidator or the court for special reasons.

7(e)Section 274(1) (g) of the Companies Act,1956 states that where a person is a director of a

public company which has failed to repay its deposit on due date and such failure continues for one year or more,then such person shall not be eligible to be appointed as a director of any other public company for a period of five years from the date on which such public company,in which he is a director,failed to repay its deposit.In the instant case,MNC Ltd., has failed to repay its deposit on due dates and the default continues for more than one year.Hence,Mr.John will not be eligible to be appointed as a director of JKL Ltd.