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Suggested Answer CAP II Dec 2011

(1) The document provides information about a question on the capital accounts of partners in a firm called LH & Co. (2) It asks to prepare the profit and loss adjustment account, capital accounts of the partners, and the balance sheet of the firm after admitting a new partner, Chakra, who is allotted a 20% share. (3) The answer provides the required accounts - the profit and loss adjustment account adjusts for expenses and incomes not previously accounted for, the partners' capital accounts reflect the redistribution of past profits and admission of the new partner, and the balance sheet incorporates the new partner's capital.

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0% found this document useful (0 votes)
466 views98 pages

Suggested Answer CAP II Dec 2011

(1) The document provides information about a question on the capital accounts of partners in a firm called LH & Co. (2) It asks to prepare the profit and loss adjustment account, capital accounts of the partners, and the balance sheet of the firm after admitting a new partner, Chakra, who is allotted a 20% share. (3) The answer provides the required accounts - the profit and loss adjustment account adjusts for expenses and incomes not previously accounted for, the partners' capital accounts reflect the redistribution of past profits and admission of the new partner, and the balance sheet incorporates the new partner's capital.

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Sankalpa Neupane
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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(1)

CAP-II, Advanced Accounting, Dec 2011


Suggested Answer

Roll No……………. Maximum Marks - 100


Total No. of Questions - 6 Total No. of Printed Pages - 4
Time Allowed - 3 Hours
Marks
Attempt all questions. Working notes should form part of the answer.

1. Laxman and Hari are partners of the firm LH & Co., from 1.4.2007. Initially both of
them contributed Rs. 1,00,000 each as capital. They did not contribute any capital
thereafter. They maintain accounts of the firm on mercantile basis. They were sharing
profits and losses in the ratio of 5:4. After the accounts for the year ended 31.3.2011
were finalized, the partners decided to share profits and losses equally with effect
from 1.4.2007. It was also discovered that in ascertaining the results in the earlier
years certain adjustments, details of which are given below, were not taken into
account.
Year ended 31st March 2008 2009 2010 2011
Rs. Rs. Rs. Rs.
Profit as per accounts
prepared and finalized 1,40,000 2,60,000 3,20,000 3,60,000
Expenses not provided
for (as at 31st March) 30,000 20,000 36,000 24,000
Incomes not taken into
account (as at 31st March) 18,000 15,000 12,000 21,000
The partners decided to admit Chakra as a partner with effect from 1.4.2011. It was
decided that Chakra would be allotted 20% share in the firm and he must bring 20%
of the combined capital of Laxman and Hari.
Following is the Balance sheet of the firm as on 31.3.2011 before admission of
Chakra and before adjustment of revised profits between Laxman and Hari.
Balance Sheet of LH & Co. as at 31.3.2011
Liabilities Rs. Assets Rs.
Capital Accounts: Plant and machinery 60,000
Laxman 2,11,500 Cash on hand 10,000
Hari 1,51,500 Cash at bank 5,000
Sundry creditors 2,27,000 Stock in trade 3,10,000
Sundry debtors 2,05,000
5,90,000 5,90,000
You are required to prepare: 20

a) Profit and Loss Adjustment account;


b) Capital accounts of the partners; and
c) Balance Sheet of the firm after the admission of Chakra.

YSZ P.T.O.
(2)

Answer No. 1
(i) Profit and Loss Adjustment Account
Particulars Rs. Particulars Rs.
To Expenses not provided for: By Income not considered for:
Year ended 31.03.2008 30,000 Year ended 31.03.2008 18,000
Year ended 31.03.2009 20,000 Year ended 31.03.2009 15,000
Year ended 31.03.2010 36,000 Year ended 31.03.2010 12,000
Year ended 31.03.2011 24,000 110,000 Year ended 31.03.2011 21,000 66,000
By Partners capital account:
Laxman 22,000
Hari 22,000 44,000
110,000 110,000

(ii) Partners’ Capital Accounts


Laxman Hari Chakra Laxman Hari Chakra
Particulars Particulars
Rs. Rs. Rs. Rs. Rs. Rs.
To P / L Adj. A/c - Loss 22,000 22,000 - By Balance b/d 211,500 151,500 -
To Hari 60,000 - - By Laxman - 60,000 -
To Balance c/d 129,500 189,500 63,800 By Cash/Bank - - 63,800
211,500 211,500 63,800 211,500 211,500 63,800

(iii) Balance Sheet of LH & Co. as on 1.4.2011


(After admission of Chakra)
Liabilities Rs. Assets Rs.
Capital Accounts: Plant & Machinery 60,000
Laxman 129,500 Stock in Trade 310,000
Hari 189,500 Sundry Debtors 205,000
Chakra 63,800 382,800 Accrued Income 66,000
Sundry Creditors 227,000 Cash at Bank 5,000
Outstanding Expenses 110,000 Cash in Hand 73,800
719,800 719,800

Working Notes
1. Computation of Profit and Loss distributed among partners:
Rs.
Profit for the year ended 31.3.2008 140,000
31.3.2009 260,000
31.3.2010 320,000
31.3.2011 360,000
Total Profit 1,080,000

Laxman Hari Total


Rs. Rs. Rs.
Profit shared in old ratio i.e 5 : 4 600,000 480,000 1,080,000
Profit to be shared as per new ratio i.e. 1 : 1 540,000 540,000 1,080,000
Excess / (Deficit) Profit 60,000 (60,000) -

YSZ P.T.O.
(3)

Laxman to be debited by Rs. 60,000 and Hari to be credited by Rs. 60,000

2. Capital brought in by Chakra – 20% of the combined capital of Laxman & Hari:
Particulars Rs.
Capital of Laxman (As per Capital Account above) 129,500
Capital of Hari (As per Capital Account above) 189,500
Combined Capital 319,000
20% of Rs. 319,000 63,800

3. Cash in hand:
Particulars Rs.
Cash balance as per Balance Sheet 10,000
Add: Cash brought in by Chakra 63,800
Total 73,800

2.
a) The hire purchase department of Whirlpool Finance Ltd. sells television sets and
room coolers. This department was newly started in 2068. The relevant
information is as follows:
Television Room
Set Coolers
Cost (Rs.) 5,400 2,000
Cash Price (Rs.) 6,300 2,400
Cash down payment (Rs.) 900 400
Monthly installment (Rs.) 600 200
Number of installments 10 12
During the year, 100 television sets and 120 room coolers were sold on hire
purchase basis. Two television sets on which 3 installments only could be
collected and 4 room coolers on which 5 installments had been collected were
repossessed. These were valued at Rs. 10,000 and after reconditioning at a cost
of Rs. 1,000 were sold outright for Rs. 14,000. Other installments collected and
those due (customer still paying) were respectively as follows:
Television sets 270 and 20
Room coolers 400 and 30
Prepare Accounts on Stocks and Debtors System to reveal the profit of the
Department. 10

b) White Ltd. agreed to acquire the business of Green Ltd. as on 32nd Ashad, 2068
The summarized Balance Sheet of Green Ltd. at that date was as follows:
Balance Sheet as on 32nd Ashad, 2068

Liabilities Rs. Assets Rs.


Share Capital in fully paid
equity shares of Rs. 10
each 6,00,000 Goodwill 1,00,000
General Reserve 1,70,000 Land and Buildings 2,30,000
Profit and Loss Account 1,10,000 Plant and Machinery 4,10,000
12% Debentures 1,00,000 Stock in Trade 1,68,000
Creditors 20,000 Debtors 36,000
YSZ P.T.O.
(4)

Cash at Bank 56,000


10,00,000 10,00,000
The consideration payable by White Ltd. was agreed as follows:
i) A cash payment equivalent to Rs. 2.50 for every Rs. 10 share in Green Ltd.

ii) The issue of 90,000 shares of Rs.10 each fully paid up in White Ltd. having an
agreed value of Rs. 15 per share.

White Ltd. also agreed to discharge the 12% Debentures of Green Ltd. at a
premium of 20% by allotment of its 14% Debentures at 96 percent.
When computing the agreed consideration, the directors of White Ltd. valued the
following assets at values noted against them:
Rs.
Land and Buildings 7,50,000
Plant and Machinery 4,50,000
Stock in Trade 1,42,000
Debtors Subject to an allowance of 5% to cover
doubtful debts.
The cost of liquidation of Green Ltd. came to Rs. 5,000 which was borne by
White Ltd.
Give ledger accounts to close the books of the Green Ltd. 10

YSZ P.T.O.
(5)

Answer No. 2
a)
Whirlpool Limited
Hire Purchase Stock A/c
Particulars Rs. Particulars Rs.
To Goods sold on H.P. A/c 1,026,000 By H.P. Debtors A/c 405,600
By Goods Repossessed A/c –
Installments not due on
repossessed goods. 14,000
By Balance c/d – Installments
not yet due 606,400
1,026,000 1,026,000

Hire Purchase Debtors A/c


Particulars Rs. Particulars Rs.
To Hire Purchase Stock A/c 405,600 By Bank A/c 387,600
By Balance c/d 18,000
405,600 405,600

Goods Repossessed A/c


Particulars Rs. Particulars Rs.
To H.P. Stock A/c 14,000 By H.P. Adjustment A/c – Bal. fig. 4,000
By Balance c/d 10,000
14,000 14,000
To Balance b/d 10,000 By Bank – Sales 14,000
To Bank – Expenses 1,000
To H.P. Adjustment A/c – Profit 3,000
14,000 14,000

Goods sold on Hire Purchase A/c


Particulars Rs. Particulars Rs.
To Hire Purchase Adj. A/c – Loading 246,000 By Hire Purchase Stock A/c 1,026,000
To Trading A/c 780,000
1,026,000 1,026,000

Hire Purchase Adjustment A/c


Particulars Rs. Particulars Rs.
To Goods Repossessed A/c - Loss 4,000 By Goods Sold on H.P. – Loading 246,000
To Stock Reserve 144,971 By Goods Repossessed A/c - Profit 3,000
To Profit 100,029
249,000 249,000

YSZ P.T.O.
(6)

Working Notes:
(i) Hire Purchase Price is Rs. 6,900 for each Television Set and Rs. 2,800 for each Room
Cooler. Total cost and sales on this basis are as follows:
H.P. Price Cost Price
Rs. Rs.
Television Sets – 100 690,000 540,000
Room Coolers – 120 336,000 240,000
Total 1,026,000 780,000

(ii) Cash Collected:


T.V. Set Cooler
Rs. Rs.
Down payment (Rs. 900 × 100) & (Rs. 400 × 120) 90,000 48,000
Installments collected (Rs. 600 × 270) & (Rs. 400 × 200) 162,000 80,000
Amount collected on repossessed goods (Rs. 600 × 2 × 3)
& (Rs. 200 × 5 × 4) 3,600 4,000
255,600 132,000
(iii) Installment not yet due:
Television Set: Total installments on 98 sets 980
Installments collected & due 290
Balance 690
Amount of 690 installments @ Rs. 600 each [A] Rs. 414,000
Room Cooler: Total installments on 116 sets 1,392
Installments collected & due 430
Balance 962
Amount of 962 installments @ Rs. 200 each [B] Rs. 192,400
Total Amount [A] + [B] Rs. 606,400

(iv) Stock Reserve:


Television Set: [1,500 / 6,900 × 414,000] Rs. 90,000
Room Cooler: [800 / 2,800 ×192,400] Rs. 54,971
Total Rs. 144,971

(v) Installment not due on repossessed goods:


2 Television Sets 7 installments on each @ Rs. 600 Rs. 8,400
4 Room Coolers 7 installments on each @ Rs. 200 Rs. 5,600
Total Rs. 14,000

(vi) Installment due but not collected:


Television Sets: (20 × 600) Rs. 12,000
Room Cooler: (30 × 200) Rs. 6,000
Total Rs. 18,000

YSZ P.T.O.
(7)

b)
In the books of Green Ltd.
Realization Account
Particulars Rs. Particulars Rs.
To Goodwill 100,000 By 12% Debenture 100,000
To Land & Buildings 230,000 By Sundry Creditors 20,000
To Plant & Machinery 410,000 By White Ltd. – Consideration 1,500,000
To Stock in Trade 168,000
To Sundry Debtors 36,000
To Bank 56,000
To Shareholders A/c – Profit 620,000
1,620,000 1,620,000
White Ltd. Account
Particulars Rs. Particulars Rs.
To Realization Account 1,500,000 By Bank 150,000
By Shares in White Ltd. 1,350,000
1,500,000 1,500,000
Equity Shareholders Account
Particulars Rs. Particulars Rs.
To Bank 150,000 By Equity Share Capital Account 600,000
To Shares in White Ltd. 1,350,000 By General Reserve 170,000
By Profit & Loss Account 110,000
By Realization Account – Profit 620,000
1,500,000 1,500,000
Cash Book (Bank Column)
Particulars Rs. Particulars Rs.
To Balance b/d 56,000 By Realization Account 56,000
To White Ltd. 150,000 By Equity Shareholders Account 150,000
206,000 206,000
Working Note:
Calculation of purchase consideration:
Rs.
Cash [Rs. 2.5 × 60,000] 150,000
Shares [Rs. 15 × 90,000] 1,350,000
Total 1,500,000

YSZ P.T.O.
(8)

3.
a)
i) What is Profit or Loss prior to Incorporation? 2

ii) M. Ltd. resolved on 32nd Ashad, 2067 that the company be wound up
voluntarily. The following was the trial balance extracted from its
books as on that date:

Dr. Cr.
Rs. Rs.
Equity shares of Rs. 10 2,00,000
9% Preference shares of Rs. 10 each 1,00,000
Plant (Less depreciation w/off Rs. 85,000) 2,15,000
Stock in trade 2,50,000
Sundry Debtors 55,000
Sundry Creditors 75,000
Bank Balance 74,000
Preliminary Expenses 6,000
Profit & Loss A/c (Balance as on 1-4-2066) 30,000
Trading loss for the year 2066/67 24,000
Preference dividend for the year 2066/67 6,000
Outstanding expenses (Including mortgage interest) 25,000
4% Mortgage loan 2,00,000
Total 6,30,000 6,30,000
On 1st Shrawan, 2067 the liquidator sold to N. Ltd. Plant for Rs. 2,05,000
and stock in trade for Rs. 2,00,000. The sale was completed in Shrawan,
2067 and the consideration satisfied as to Rs. 2,62,200 in cash and as to
the balance in 6% Debentures of the purchasing company issued to the
liquidator at a premium of 2%.
The remaining steps in the liquidation were as follows:
(a) The liquidator realized Rs. 52,000 out of the book debts and the cost
of collection amounted to Rs. 2,000.

(b) The loan mortgage was discharged on 31st Shrawan, 2067 along with
interest from 31st Magh 2066. Creditors were discharged subject to
discount of 2% and outstanding expenses excluding mortgage interest
were settled for Rs. 2,000;

(c) On 30th Poush 2067 six month‟s interest on debentures was received
from N. Ltd.

(d) Liquidation expenses amounting to Rs. 3,000 and liquidator‟s


remuneration of 3% on disbursements to members were paid on 30th
Poush, 2067 when:

 The preference shareholders were paid out in cash; and

 The debentures of N. Ltd. and the balance of cash were distributed


ratably among the equity shareholders.
YSZ P.T.O.
(9)

Prepare the Liquidator‟s Statement of Account showing the distribution. 8


b) The following is the Balance Sheet of a concern on 32.3.2067:
Liabilities Rs. Assets Rs.
Capital 10,00,000 Fixed Assets 4,00,000
Creditors (Trade) 1,40,000 Stock 3,00,000
Profit & Loss A/c 60,000 Debtors 1,50,000
________ Cash & Bank 3,50,000
12,00,000 12,00,000
The management estimates the purchases and sales for the year ended
32.3.2068 as under:
Up to Jestha 2068 Ashad 2068
Rs. Rs.
Purchases 14,10,000 1,10,000
Sales 19,20,000 2,00,000
It was decided to invest Rs. 1,00,000 in purchases of fixed assets, which
are depreciated @ 10% on cost.
The time lag for payment to Trade Creditors for purchase and receipt
from Sales (Debtor's) is one month. The business earns a gross profit of
30% on turnover. The expenses against gross profit amount to 10% of the
turnover. The amount of depreciation is not included in these expenses.
Draft a Balance Sheet as at 32.3.2068 assuming that creditors are all
Trade Creditors for purchases and Debtors for sales and there is no other
item of current assets and liabilities apart from stock and cash and bank
balances. 10
Answer No. 3
a)
i) When a running business is taken over by the promoters of a company, from a date
before the company which is to manage and own the business is registered, the amount
of profit or loss of such a business for the period prior to the date the company came
into existence is referred to as pre incorporation profits or losses. Such profits or
losses, though belonging to the company or payable by it, are of capital nature, it is
necessary to disclose them separately.

ii)
M. Ltd. (in liquidation)
Liquidator’s Statement of Account from 1st Shrawan, 2067 to 30th Poush, 2067
Particulars Rs. Rs. Particulars Rs. Rs.
Balance at Bank 74,000 Liquidators Remuneration 7,302
Realization from: Liquidation Expenses 3,000
Sundry Debtors 52,000 Mortgage loan with Interest 204,000
Less: Cost of Collection 2,000 50,000 Creditors including Outstanding Exp. 75,500
N Ltd.: 6% Pref. Shareholders @ Rs. 10 each 100,000
6% Debenture @ Rs. 102 142,800 Equity Shareholders:
Cash 262,200 405,000 6% Debentures 142,800
Interest on Debentures – 6 months 4,200 Cash – Approximately
03 paisa per share 598 143,398
533,200 533,200

YSZ P.T.O.
(10)

Working note:
(i) Calculation of Liquidators Remuneration:
Particulars Rs. Rs.
Total realization including debentures in N Ltd. 533,200
Distribution to outsiders:
Liquidation expenses 3,000
Mortgage loan with interest 204,000
Creditors including outstanding expenses 75,500 282,500
Amount available for liquidators remuneration & members settlement 250,700
Liquidators remuneration [Rs. 250,700 × 3 / 103] 7,302

(ii) It is assumed that loan is secured by a floating charge.

(iii) Calculation of debentures to be issued: value of Assets sold 205,000

Add: value of stock sold 200,000

Total 405,000

Less: cash received 262,200

6% debenture @ Rs. 102 = 142,800

(Assumption: face value of debenture to be issued at Rs. 100 each)

b)
Projected Balance Sheet of......
As on 32.3.2068
Liabilities Rs. Assets Rs.
Capital 1,000,000 Fixed Assets 450,000
Profit & Loss Account: Stock in Trade 336,000
01.04.2067 60,000 Sundry Debtors 200,000
Add: Profit for the year 374,000 434,000 Cash & Bank Balances 558,000
Trade Creditors 110,000
1,544,000 1,544,000

Working Notes:
1. Projected Trading and Profit and Loss Account
For the year ended 32.3.2068
Particulars Rs. Particulars Rs.
To Opening Stock 300,000 By Sales 2,120,000
To Purchases 1,520,000 By Closing Stock – Bal. fig. 336,000
To Gross Profit c/d – 30% on Sales 636,000
2,456,000 2,456,000
To Sundry Expenses – 10% on Sales 212,000 By Gross Profit b/d 636,000

YSZ P.T.O.
(11)

To Depreciation 50,000
To Net Profit 374,000
636,000 636,000

2. Cash and Bank Account


Particulars Rs. Particulars Rs.
To Balance b/d 350,000 By Sundry Creditors - Payment 1,550,000
To Sundry Debtors - Collection 2,070,000 By Expenses 212,000
By Fixed Assets 100,000
By Balance c/d 558,000
2,420,000 2,420,000
3. Fixed Assets and Depreciation:
Rs.
Opening Balance 400,000
Add: Purchases during the year 100,000
500,000
Less: Depreciation @ 10% 50,000
Closing Balance 450,000

4. Sundry Debtors A/c

Particulars Rs. Particulars Rs.


To Balance b/d 150,000 By Cash & Bank 2,070,000
To Sales 2,120,000 By Balance c/d 200,000
2,270,000 2,270,000

5. Sundry creditors A/c

Particulars Rs. Particulars Rs.


To Cash & Bank 1,550,000 By Balance b/d 140,000
To Balance c/d 110,000 By Purchases 1,520,000
1,660,000 1,660,000

YSZ P.T.O.
(12)

4.
a) On 30/06/2068, an accidental fire destroyed a major part of the stocks in the shop
of Davidson Enterprises. Stocks costing Rs. 60,000 could be salvaged but not their
stores ledgers. A fire insurance policy was in force under which the sum insured
was Rs. 700,000. From available records, the following information was retrieved:
i) Total of sales invoices during the period 01/04/2068-30/06/2068 amounted to
Rs. 6,040,000. An analysis showed that goods of the value of Rs. 600,000 had
been returned by the customers before the date of the fire.
ii) Opening stock as on 01/04/2068 was Rs. 440,000 including stocks of the value
of Rs. 40,000 being lower of cost and net value subsequently realized.
iii) Purchases during the period 01/04/2068-30/06/2068 amounted to Rs. 4,200,000.
iv) Normal gross profit rate was 33.33% on sales.
v) A sum of Rs. 60,000 was incurred by way of fire fighting expenses on the day
of the fire.
Prepare a statement showing the Insurance Claim Recoverable. 5
b) A company sold 25% of the goods on cash basis and the balance on credit basis.
Debtors are allowed 2 months credit and their balance as on 31.3.2011 is Rs.
140,000. Assume that the sale is uniform throughout the year. Calculate the total
sales of the company for the year ended 31.3.2011. 5
c) What are the classifications of Loans/Advances as per Nepal Rastra Bank
Directives for Banking & Financial Institution? 5

Answer No. 4
a) Calculation of Insurance Claim Recoverable
Stock Destroyed: Rs.
Stock on the date of fire – Working note 1,000,000
Less: Salvaged Stock 60,000
Stock Destroyed by fire 940,000
As the policy amount is less than the value of Closing Stock, average clause will apply.
Therefore, Amount of Claim = [Policy Amount × Loss / Stock on the date of fire]
= [Rs. 700,000 × 940,000 / 1,000,000]
= Rs. 658,000
As fire fighting expenses have been incurred, these expenses may be admitted as part of
the loss. In that case loss will be Rs. 940,000 + Rs. 60,000 = Rs. 1,000,000.
Applying average clause, claim = [Rs. 700,000 × 1,000,000 / 1,000,000] = Rs. 700,000
Working note:
Memorandum Trading Account
for the three months period ended on 30th Aswin, 2068
Particulars Rs. Rs. Particulars Rs. Rs.
To Opening Stock 440,000 By Sales 6,040,000
Less: Abnormal Item 40,000 400,000 Less: Abnormal Item 40,000
To Purchases 4,200,000 6,000,000
To Gross Profit – 1/3 of Sales
rd
1,800,000 Less: Return 600,000 5,400,000
By Closing Stock – Bal. figure 1,000,000
6,400,000 6,400,000
YSZ P.T.O.
(13)

b) Calculation of Total Sales for the year ended 31st March, 2011
Since debtors are allowed two months credit term, debtors as on 31st March (Rs. 140,000)
represents two months (February & March) credit sales. Therefore, monthly credit sales
are Rs. 70,000. As per question, cash sales is 25% of total sales and sales being uniform
throughout the year, total sales will be calculated as follows:
Rs.
Total Credit Sales for the year [Rs. 70,000 × 12] 840,000
Add: Cash Sales – Being 25% of total sales [Rs. 840,000 × 25 / 75] 280,000
Total Sales 1,120,000

c) Entire loans and advances extended by a licensed institution have to be classified as


follows based on expiry of the deadline of repayment of the principal and interest of such
loans/advances:
1. Pass: Loans/advances which have not overdue and which are overdue by a period up to
three months.
2. Sub-Standard: Loans/advances which are overdue by a period from three months to a
maximum period of six months.
3. Doubtful: Loans/advances which are overdue by a period from six-months to a
maximum period of one year.
4. Loss: Loans/advances which are overdue by a period of more than one year.

The loans which are in pass class and which have been rescheduled/restructured are called
as "the performing loan, and the sub-standard, doubtful and loss categories are called non-
performing loans.
Note: Loans/advances also include bills purchased and discounted.

5.
a) Explain „Recognition of Assets‟ as per Framework for the Preparation
and Presentation of Financial Statements under NAS. 5
b) What are the items that are to be excluded in determination of the cost of
inventories as per NAS-04? 5
c) X Limited has recognized Rs. 10 lakhs on accrual basis income from
dividend on shares of the face value of Rs. 50 lakhs held by it as at the
end of the financial year 32.3.2068. The dividends on shares were
declared at the rate of 20% on 15.6.2068. The dividend was proposed on
10.4.2068 by the declaring company. Whether the treatment is as per the
relevant Accounting Standard? Answer with reference to provisions of
NAS-07. 5

Answer No. 5
a) An asset is recognized in the balance sheet when it is probable that the future economic
benefits will flow to the enterprise and the asset has a cost or value that can be measured
reliably.
An asset is not recognized in the balance sheet when expenditure has been incurred for
which it is considered improbable that economic benefits will flow to the enterprise
beyond the current accounting period. Instead such a transaction results in the recognition
of an expense in the income statement. This treatment does not imply either that the
intention of management in incurring expenditure was other than to generate future
economic benefits for the enterprise or that management was misguided. The only

YSZ P.T.O.
(14)

implication is that the degree of certainty that economic benefits will flow to the enterprise
beyond the current accounting period is insufficient to warrant the recognition of an asset.

b) Items that are to be excluded in determination of the cost of inventories as per NAS 4 on
„Valuation of Inventories‟ are:
1. Abnormal amounts of wasted materials, labor or other production costs.
2. Storage costs unless those costs are necessary in the production process prior to a
further production stage.
3. Administrative overheads that do not contribute to bringing the inventories to their
present location and condition; and
4. Selling costs.

c) NAS 07 states that dividends from investments in shares are not recognized in the
statement of profit and loss until a right to receive payment is established. In the given
case, the dividend is proposed on 10.4.2068, while it is declared on 15.6.2068. Hence, the
right to receive payment is established only on 15.6.2068. As per NAS 07, income from
dividend on shares should be recognized by X Ltd. in the financial year ended 31.3.2069.
The recognition of Rs. 10 lakhs on accrual basis in the financial year 2066.68 is not as per
NAS 07 'Revenue.'

6. Write short notes on following: (4×2.5=10)


a) Going Concern
b) Classification of Reserves
c) Re-Insurance
d) Sinking Fund

Answer No. 6
a) The financial statements are normally prepared on the assumption that an enterprise is a
going concern and will continue in operation for the foreseeable future. Hence, it is
assumed that the enterprise has neither the intention nor the need to liquidate or curtail
materially the scale of its operations; if such an intention or need exists, the financial
statements may have to be prepared on a different basis and, if so, the basis used is
disclosed.
b) Reserves are generally classified into: (a) Capital Reserves and (b) Revenue Reserves.
1. Capital Reserves are those which are not distributed (expected for certain
circumstances) as profits as a matter of law, prudence or business policy. They arise
mainly out of capital profits, for example, profits on sale of fixed asset or upward
revaluation of fixed assets or from capital receipts, e.g. issue of shares or debentures at
a premium. They also arise from non–trading incomes during the period prior to
incorporation. These reserves may or may not involve any receipts of cash.
2. Revenue Reserves are any reserves which are not capital reserves and are available for
distribution as profits. These are created by retaining profits. Examples of revenue
reserves are credit balance of the Profit and Loss Account, general reserve, dividend
equalization reserves, investment fluctuation reserves etc. Revenue reserves can
further be classified into: (a) General Reserves and (b) Specific Reserves.
(i) General Reserves: These reserves are not created for any particular purpose.
These are created for safeguarding the business against unforeseen losses in the
future or with a view to planning for further development of the business. General
reserves are not earmarked against any particular asset.

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(ii) Specific Reserves: These reserves are created for some specific purpose and are
utilized for these purposes only. These are generally earmarked against some
particular asset and expressed as „reserve fund‟. An amount of the reserve created
is invested outside the business in securities for a specified period. At the end of
that specified period, all investments are sold away. The proceeds are utilized for
meeting that particular purpose for which the reserve was created.

c) Re – Insurance:
If an insurer does not wish to bear the whole risk of policy written by him, he may reinsure
a part of the risk with some other insurer. In such a case the insurer is said to have ceded a
part of his business to other insurer. The reinsurance transaction may thus be defined as an
agreement between a „ceding company‟ and „reinsurer‟ whereby the former agreed to
„cede‟ and the latter agrees to accept a certain specified share of risk or liability upon terms
as set out in the agreement. A „ceding company‟ is the original insurance company which
has accepted the risk and has agreed to „cede‟ or pass on that risk to another insurance
company or a reinsurance company. It may however be emphasized that the original
insured does not acquire any right under a reinsurance contract against the reinsurer. In the
event of loss, therefore, the insured‟s claim for full amount is against the original insurer.
The original insurer has to claim the proportionate amount from the reinsurer. There are
two types of reinsurance contracts, namely, facultative reinsurance and treaty reinsurance.
Under facultative reinsurance each transaction has to be negotiated individually and each
party to the transaction has a free choice, i.e., for the ceding company to offer and the
reinsurer to accept. Under treaty reinsurance a treaty agreement is entered into between
ceding company and the reinsurer whereby the volume of the reinsurance transactions
remain within the limits of the treaty.

d) Sinking Fund:
The most common method of supplementing capital available to a company is to issue
debentures, which are usually redeemable. Redeemable debentures may be redeemed after
a fixed number of years or any time after a certain number of years has elapsed since their
issue, on giving a specified notice or by annual drawing.
Usually, according to the conditions of the issue, the company is required to create a fund
by appropriating annually a certain percentage of, or a fixed amount out of, its profit. The
fund so created is normally known as Sinking Fund or Debenture Redemption Reserve
Fund. The company invests the amount of the fund either in the purchase of securities
which are readily saleable or takes a policy that shall mature at the time the debentures will
fall due for payment. Such an arrangement would ensure that the company will have
sufficient liquid funds for the redemption of debentures at the time they shall fall due for
payment. In the case of debentures that are redeemable at premium, the appropriation to
the Sinking Fund should be sufficient to pay both the amount of debenture and the
premium on redemption. On redemption of debentures, out of the balance lying in the
Sinking Fund an amount equal to the debentures so redeemed is transferred to General
Reserve.

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CAP-II, Audit & Assurance, Dec 2011


Suggested Answer
Roll No……………. Maximum Marks - 100

Total No. of Questions- 7 Total No. of Printed Pages- 2


Time Allowed - 3 Hours
Marks
Attempt all the questions.
1. G
ive your opinions with reasons on the following cases: (45=20)
a) Audit of the Sagarmatha Byapar Co. Pvt. Ltd. is in final stage and the audit
report is being drafted. Management of the company, including Chief
Executive Officer, is of the view that auditors are primarily responsible for
preparation and fair presentation of financial statements. Management of the
company is of the view that they are free to prepare accounts in their own way
and it is the duty of the auditor to satisfy about financial statements to
government and other regulatory agencies.
b) Grand Industries Ltd. is engaged in manufacturing and supply of gear boxes to
Suzaki Vehicles Ltd. As per terms of supply, full price of the goods are not
released by Suzaki Vehicles Ltd. but 15% thereof is retained and paid after
one year, if there is satisfactory performance of the parts supplied. Grand
Industries Ltd. accounts for only 85% of the invoice value as sale at the time
of supply and balance 15% is accounted as sale in the year of receipt of
payment.
c) During the audit period, the liaison officer deputed by the client Lumbini
Insurance Company constantly asks you to participate in lunch arranged
outside office premises. He has also informed you that there is a program of
welcome and farewell dinner too. Liaison officer has also informed you that
you need not worry about time schedule, as there would be someone available
among client's staff to bailout if needed. Daily newspapers and magazines are
made available in plenty in the audit room. Other staff of the client are also
having regular visit in the working area.
d) The Company`s plant & machinery was Rs. 200 million as on 1st Shrawan
2067. It provided depreciation at 15% per annum under WDV method.
However it noticed that about Rs. 20 million worth of imported asset, which is
component of above plant & machinery acquired on 1st Shrawan 2067, would
be obsolete in 2 years. Company wants to write off this asset over 2 years. Can
Company do so? Give Comments.
Answer No. 1
a) Paragraph 15 of Nepal Standard on Auditing (NSA 200) mentions that while the
auditor is responsible for forming and expressing an opinion on the financial statements,
the responsibility for preparing and presenting the financial statements is that of the
management of the entity. The audit of the financial statements does not relieve
management of its responsibility. Management rather than the auditor is responsible for
the preparation and fair presentation of financial statements. This responsibility
includes designing, implementing and maintaining internal control relevant to the
preparation and fair presentation of financial statements that are free from material
misstatements, whether due to fraud or error, selecting and applying appropriate
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accounting policies, and making accounting estimates that are reasonable in the
circumstances. Thus, the contention of the management is not correct.
b) According to NAS-7 on Revenue, revenue recognition from sale of goods should be
recognized when the seller has transferred to the buyer, the property or the goods for a
price or when the seller has transferred all significant risk and rewards and the seller
has no effective control over goods and no significant uncertainty exists regarding the
amount of consideration and its collectability. In the given case the goods as well as
the risk and ownership has been transferred by Grand Industries Ltd., to Suzaki
Vehicles Ltd., on the basis of invoice and delivery of material. In the instant case,
therefore, Grand Industries Ltd. should recognize sale at full 100% of the invoice
value in spite of the fact that 15% payment will be released after one year. However,
depending upon the past experience regarding collectability of 15% amount, they can
make a provision for the amount that is not likely to be realized. Hence, the treatment
given by the company is not correct and if they do not correct it, the auditor should
qualify his report.

c) Section 260 of Code of Ethics for the members of the Institute of Chartered
Accountants of Nepal -2060 prescribed the ICAN states about the gift and hospitality
to the auditors by the client.

The existence and significance of any threat will depend on the nature, value, and
intent of the offer. Where gifts or hospitality are offered that a reasonable and
informed third party, weighing all the specific facts and circumstances, would
consider trivial and inconsequential, a professional accountant in public practice may
conclude that the offer is made in the normal course of business without the specific
intent to influence decision making or to obtain information. In such cases, the
professional accountant in public practice may generally conclude that any threat to
compliance with the fundamental principles is at an acceptable level.

The objectives of the accountancy profession are to work to the highest standards of
professionalism, to attain the highest levels of performance and generally to meet the
public interest requirement set out above. These objectives require four basic needs to
be met. They are credibility, professionalism, quality of services and confidence. An
auditor is expected to maintain the highest degree of integrity, professionalism and
independence. He represents the trust and faith of the whole professional body. There
could be various obstacle and impediments while conducting his professional duty.
However, he should remain intact and vigilant towards achieving his professional
goal.

Provision of lunch is governed by conditions laid in engagement letter and


appointment letter. If the contract states provision of lunch, it should not be construed
as accepting any undue advantage whether arranged inside or outside. However,
attendance in farewell party is not concerned with the auditor. Thus, the auditor needs
to avoid such attendance. Receiving Newspapers as courtesy from the client and the
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regular visits by the staff of the client in the working place is not the problem but it
must be seen that there would be no compromise in the professional ethics and
standards.

d) As per Nepal Accounting Standard 6 (Property, Plant and Equipment), where the
addition or extension retains a separate identity and is capable being used after the
existing asset is disposed off, depreciation should be provided independently on the
basis of an estimate of its own useful life. As it appears that imported assets of Rs. 20
million, which is component of plant and machinery, is having independent useful
life. Therefore, the company`s policy to write off over two years is correct.

2. A
nswer the following:
a) You are appointed as manager of quality control section in one of the leading
audit firm of Nepal, the senior partner of the firm instructs you to draft
objectives statement for quality control policies & procedures. 8
b) List out the analytical procedures that you would adopt in audit of Revenue of
an entity. What are the factors that determine the extent of reliance on such
analytical procedures? 7

Answer No. 2
a) As per Nepal Standards on Quality Control(NSQC) 1, it is necessary for quality control
for firm`s that perform audits and review of historical financial information and other,
accordingly, the relevance of quality control The relevance of quality control issue in
auditing services is equal importance like in other services. If quality control could not
be done in auditing work, quality services could not be provided to client which may
result negative consequences both for auditor and client including in overall all
economy. Hence, every auditor should carry out the audit work based on formal quality
control policy & procedures. The objective statement of quality control policies &
procedures would be:
i. Professional Requirements
personnel in the firm should adhere to the principles of independence,
integrity, objectivity, confidentiality and professional behavioral number
of procedures may be framed to achieve this objective .for example, a
firm may require all its personnel to make a written statement every year
as to whether they hold any shares or any other interest in the enterprises
being audited by the firm.
ii. Skills and Competence
the audit skills firm should be staffed by personnel who have attained
and maintain the technical standards and professional required to enable
them to fulfill their responsibilities with due care .for example, a firm
can achieve this objective through proper recruitment procedures,
periodic staff and a system whereby latest information relating to current
development in professional standards, law, etc is regularly
communicated to audit staff.
iii. Assignment
Audit work should be assigned to such personnel as have the degree of
technical training and proficiency required in the circumstances.
iv. Delegation

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There should be sufficient direction, supervision and review of work at


all levels to provide reasonable assurance that the work performed meets
appropriate quality standards. For example, a firm may establish
guidelines relating to the form and content of working papers; use of
standardized forms, etc .similarly, the audit plans may identify the
staffing requirements and timing of various phases of audit to facilitate
delegation of audit now.
v. Consultation
Where ever necessary, persons having appropriate expertise, within or
outside the firm, should be consulted.
vi. Acceptance and Retention of Clients
Before accepting an audit, the firm should evaluate its independence and
ability to serve the prospective client properly. A similar review should
be made, on-going basis, of association with the existing clients.
vii. Monitoring
The continued adequacy and operational effectiveness of the quality
control policies and procedures should be maintained.

b) Analytical procedures are one of many audit processes which help an auditor
understand the client's business and changes in the business, and to identify potential
risk areas to plan other audit procedures. It includes comparison of financial
information, relating financial and non financial information and consideration of
practicable relationship of data.

The analytical procedures that will be adopted in obtaining audit evidence regarding the
various assertions relating to revenue are as follows:
i. Comparison of Gross-profit ratio to sales for the current year with the
corresponding figures of the previous years.
ii. Comparison of ratio of sales returns to sales for the current year with the
corresponding figures for previous years.
iii. Comparison of trade discount to sales for the current year with previous year.
iv. Review of Reconciliation of Excise/VAT booked during the year with
Excise/VAT returns submitted with the total sales booked.
v. Comparison of dividend/interest/royalty for the current year with the
corresponding figures for previous years.
vi. Comparison of ratio of income on investments to average investment for the
current year with corresponding figures for the previous year.

The factors that affect the extent of reliance on analytical procedures are as follows:
i. Materiality: When items are material, the auditor doesn‟t solely rely on the
analytical procedures in forming conclusions but will carry other substantive
procedures also.
ii. Other procedures: When other procedures are also directed towards the same
objective, it might confirm or dispel the questions raised from the application of
analytical procedures.
iii.Weak controls: When internal controls are weak, greater reliance is placed on tests
of balances and tests of details of transactions rather than on analytical procedures.
iv. Accuracy: The accuracy with which expected results of analytical procedures can be
predicted. For example greater reliance is place on gross profit ratio compared to
previous year than in comparing discretionary expenses such as donation.

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3. G
ive your comments on the following: (35=15)
a) Mr. Alex Pitt, partner of M/s Pitt Marwick & Associates, a Chartered
Accountant firm was appointed as an auditor of Cosmopolitan Commercial
Bank Ltd. One of the shareholders of the bank lodged a complain against the
auditor for not assuming the responsibilities to consider laws and regulations
with regards to lending to a business house in an audit of financial statements
of the bank. You are asked to identify the auditors' responsibilities to consider
laws and regulations in an audit of financial statements of bank with regards to
complaint lodged against the auditor?

b) On being appointed, the auditor of a company for the first time you find that
the cashier also handles the books of account and the cash receipt are not
being banked intact but parts of these are being utilized for cash payments.
What are the risks involved? What could be your recommendations to mitigate
the risks envisaged?
c) Xylocain Communications Company is one of the leading companies dealing
with various telecommunication services, wireless networking and internet
related services. It receives huge collection of cash daily from its customer on
various accounts. Everything looked well, until one day it was noticed that
large amount was missing in the bank account. In fact that said amount was
not credited in the bank account at all and it was missing since last few years.
When the case was revealed, probably it was too late to recover the money.
Considering the above case, what are the likely documents you would like to
examine as an auditor of the company?
Answer No. 3
a) In accordance with NSA 200: “Objective and General Principles Governing an Audit of
Financial Statements,” the auditor should plan and perform the audit with an attitude of
professional skepticism recognizing that the audit may reveal conditions or events that
would lead to questioning whether an entity is complying with laws and regulations. In
accordance with specific statutory requirements, the auditor may be specifically
required to report as part of the audit of the financial statements whether the entity
complies with certain provisions of laws or regulations. In these circumstances, the
auditor would plan to test for compliance with these provisions of the laws and
regulations.
Further, the auditor should obtain sufficient appropriate audit evidence about
compliance with those laws and regulations generally recognized by the auditor to have
an effect on the determination of material amounts and disclosures in financial
statements. The auditor should have a sufficient understanding of these laws and
regulations in order to consider them when auditing the assertions related to the
determination of the amounts to be recorded and the disclosures to be made. Section
115(3) (e) of the Nepal Company Act, 2063 specially states that the auditor should
report any non compliance of prevailing laws. Further, Banks and financial Institutions
Act 2063 also requires report of auditors on certain matters. Thus, Here, in given
situation, the auditor should plan his audit and report for lending to a business house in
accordance with the prevailing banking rules and regulations. He should have sufficient
knowledge of statutory provisions of lending and its reporting in prescribed format.

b) Since the cashier handles books of accounts and cash is not deposited intact in the bank
account the internal control system of the company is found very weak. There are the
risks of cash being misappropriated. Examples could be:
 failure to record purchases properly in order to misappropriate cash.
 misappropriation cash from a machine or whilst cash is in transit.
 acceptance or solicitation of money or a benefit to provide cash to a third party.
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 acceptance or solicitation of money or a benefit to provide goods or services to a


third party without taking a cash payment from that party.

This may create significant risk to the company that may erupt from the weak internal
control system. Recommendations to company for the enhancement of the internal
control system of the company are as follows:
a. The cashier should not have access to the books of accounts. The books of account
should be handled by the accountants who should not be directly involved with the
cash transaction.
b. All the cash collections should be deposited to the bank.
c. Cash payments should be made through the Bank.
d. Petty expenses should be managed through the Petty cash book, for which purpose
the petty cash, imprest should be provided to the petty cashier through the bank.

c) Considering the case presented the auditor of Xylocain Communications Company


should check all the books of accounts and documents related with the cash and bank
transactions. Hence, the likely documents the auditor should examine in the
circumstances presented are mentioned hereunder:

i) Separ
ate Cash receipt register for different services like tele-communication, wireless
networking and internet related services
ii) Prenumbered Receipt pad for collecting cash.
iii) Security arrangement in the counter area.
iv) Procedures followed to deposit the amount in the bank
v) Special arrangements with bank for transferring funds, if any
vi) Bank reconciliation statement
vii) Duty rotation of the personnel, directly handling cash collection
viii) Reporting arrangement to central office
ix) Fidelity Insurance etc
x) Bank deposit slips

4. A
nswer the following: (35=15)
a) What is the relationship between materiality and audit risk and how audit risk
can be reduced to an acceptable level?
b) What are the points to be considered while using the work of an expert?
c) What are the steps followed while conducting audit of incomplete records?
Answer No. 4

a)
The auditor is concerned with expressing opinion on true and fairness of the the
financial statements. Similarly, as per NSA-240 Nepal Standards on Auditing the
auditors' responsibility to consider fraud and error in an audit of financial statements. Audit
Risk is the risk that the auditor gives an inappropriate audit opinion when the financial
statements are materially misstated or the frauds and errors are not reported. Due to nature
of audit evidence and the characteristics of fraud, the auditor is not able to obtain absolute
assurance of detecting misstatements and frauds. Thus, the auditor gives only reasonable
assurance that material misstatements are detected.

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The concept of materiality recognizes that some matters, either individually or in the
aggregate, are important for fair presentation of financial statements in conformity with
generally accepted accounting principles, while other matters are not important. As per
NSA-320 on Audit Materiality the auditor should consider materiality and its relationship
with audit risk when conducting an audit. "Materiality" is defined in the Nepal Accounting
Standards Board's "Framework for the Preparation and Presentation of Financial
Statements" in the following terms: "Information is material if its omission or misstatement
could influence the economic decisions of users taken on the basis of the financial
statements. Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement. Thus, materiality provides a threshold or
cut-off point rather than being a primary qualitative characteristic which information must
have if it is to be useful."

According to NSA-320 on Audit materiality, there is an inverse relationship between


materiality and degree of audit risk. Higher the materiality level, lower the audit risk
and vice-versa. The risk that a particular account balance or class of transaction would
be mis-stated by an extremely large amount might be very low. But the risk that it could
be mis-stated by an extremely small amount might be very high. The auditor considers
this inverse relationship when he determines the nature, timing and extent of his audit
procedures. If after planning for specific audit procedures, he concludes that acceptable
materiality level is lower, audit risk is increased. The auditor should try to reduce the
audit risk to an acceptable level by:-
i. Reducing the assessed degree of control risk by carrying out extended or
additional test of control, or
ii. Reducing detection risk by modifying the nature, timing and extent of his
substantive procedures.

b) NSA 620 Nepal Standards on Auditing using the work of an expert prescribes that when
using the work performed by an expert, the auditor should obtain sufficient appropriate audit
evidence that such work is adequate for the purposes of the audit. During the audit, the auditor
may seek to obtain, in conjunction with the client or independently, audit evidence in the
form of reports, opinions, valuations, and statements of an expert. Examples are:

a. Valuations of certain types of assets, for example, land and buildings, plant and
machinery, works of art, and precious stones.
b. Determination of quantities or physical condition of assets, for example,
minerals stored in stockpiles, mineral and petroleum reserves, and remaining
useful life of plant and machinery.
c. Determination of amounts using specialized techniques or methods, for
example, an actuarial valuation.
d. The measurement of work completed and to be completed on contracts in
progress for the purpose of revenue recognition.
e. Legal opinions concerning interpretations of agreements, statutes, regulations,
notifications circulars, etc.

When determining whether to use the work of an expert or not, the auditor should
consider:
a) The materiality of the item being examined in relation to the financial
information as a whole.
b) the nature and complexity of the item including the risk of error therein,
and
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c) the other audit evidence available with respect to the item.


When the auditor plans to use the expert‟s work as audit evidence, he should satisfy
himself as to the expert‟s skills and competence by considering the expert‟s
professional certification, license or membership in an appropriate professional body
and experience and reputation in the field in which the auditor is seeking evidence.
However, when the auditor uses the work of an expert employed by him, he will not
need to inquire into his skills and competence.
The auditor should also consider the objectivity of the expert. The risk that an expert‟s
objectivity will be impaired increases when the expert is employed by the client, or
related in some other manner to the client.
Accordingly, in these circumstances, the auditor should (after taking into account the
factors stated above) consider performing more extensive procedures than would
otherwise have been planned, or lie might consider engaging another expert.

c) Incomplete records emanate risk of misstatement of financial statement due to omission


and wrong recording of transactions. Therefore, the auditor should be careful in this
regard. Steps that are followed in audit of incomplete records are as below:
a) Ascertain the exact status of accounting records available including memoranda
records.
b) Ensure that the management compiles / reconstructs accounting records to the
extent practicable.
c) Perform compliance procedure to assess whether any control system is in
operation.
d) Vouch transactions recorded in books of account with reference to appropriate
audit evidence. Check posting, casting etc.
e) Examine the system in operation in respect of custody managed cash memos,
receipts, check books etc.
f) Verify fixed assets by observing physical verification.
g) Conduct surprise checks to verify cash in hand, inventory etc.
h) Apply analytical review procedures in depth and notice deviations to investigate
in detail.
i) Formulate an appropriate audit opinion based on above findings.

5. A
nswer the following: (35=15)
a) Mr. Saroj Khandelwal, a professional accountant and member of ICAN
performs his auditing services in a country other than Nepal also. He
published his advertisement in one of the country other than Nepal explaining
about his competency and skill to perform auditing, management and
consultancy services at very reasonable fee. He argued that it was permitted
by the local ethical requirement of that country. How would you analyze this
issue if you were a member of disciplinary committee of ICAN and the issue
had been lodged before the committee?
b) Mr. Shushil Maharjan, a Chartered Accountant published a book and gave his
personal details as the author. These details also mentioned his professional
experience and his present association as partner with M/s Daniel Brisk, a
Swedish firm of Chartered Accountant Firm. What will be your opinion in this
respect?
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c) Mr. Shanti Das a Chartered Accountant audited a religious institution


established for purely promoting social values without charging any audit fee.
Give your comment.
Answer No. 5
a) The issue mentioned in the question above should be analyzed as per section 6 of the
Code of Ethics issued by the ICAN to its members which states that a professional
accountant qualifying in Nepal may reside in another country or may be temporarily
visiting that country to perform professional services. In all circumstances, the
professional accountant should carry out professional services in accordance with the
relevant technical standards and ethical requirements. When a professional accountant
performs services in a country other than Nepal and differences on specific matters
exist between ethical requirements of the two countries the following provisions should
be applied:
i. When the ethical requirements of the country in which the services are
being performed are less strict than the ICAN Code of Ethics, then the
ICAN Code of Ethics should be applied.
ii. When the ethical requirements of the country in which services are
being performed are stricter than the ICAN Code of Ethics, then the
ethical requirements in the country where services are being performed
should be applied.
iii. When the ethical requirements of Nepal are mandatory for services
performed outside that country and are stricter than set out in (i) and (ii)
above, then the ethical requirements of Nepal should be applied.
Hence, in the given context, Mr Saroj Khandelwal will be held liable for disciplinary
action under the Codes of Ethics of ICAN.

b) The supplementary Directive to code of ethics issued by the Institute of Chartered


Accountants of Nepal on “Publicity and Advertisement” prescribes the provisions for
publishing book or article. It allows the members to state their name, professional
qualification and the name of their firms but restricts the members from disclosing the
services provided by them. In the given case, Mr. Shushil Maharjan. a chartered
accountant, published the book and mentioned his professional experience and his
association as a partner with M/s Daniel Brisk, a Swedish firm of chartered accountants.
Mr. Shushil Maharjan being a chartered accountant in practice has committed the
professional misconduct by mentioning that at present he is a partner in M/s Daniel
Brisk, a Swedish firm of chartered accountants.

c) The Code of Ethics issued by the Institute of Chartered Accountants of Nepal on


“Soliciting Business, Accepting New Engagement, Fees and Commission” prescribes
the provisions for providing service free of cost. Subject to non compromise in the
quality of professional services being offered, it allows the members to provide services
without charging any fee to the welfare or spiritual institutions established with an
objective of providing social services. Further, the council of The Institute of Chartered
Accountants of Nepal has waved (vide decision dated 2067/6/17) requirement of
minimum fee for the religious organizations which have annual transactions of less than
2 lacs.

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Accordingly in the given case, if the transactions of the institution does not exceed 2
lacs, it will not be termed as guilty of professional misconduct as the service was
provided to a religious institution established for purely promoting social values.
However, if the transactions of the institution exceeds 2 lacs, the auditor shall be guilty
of violating code of conduct.

6. W
rite short notes on the following (Any Two): (25=10)
a) Inherent Limitations of an Audit
b) Audit trail in a computerized accounting environment
c) Management representation
d) Control Risk

Answer No. 6
a) Inherent Limitations of an Audit
An auditor cannot obtain absolute assurance that material misstatements in the financial
statements will be detected. Owing to the inherent limitations of an audit, there is an
unavoidable risk that some material misstatements of the financial statements will not
be detected, even though the audit is properly planned and performed in accordance
with NSAs. An audit does not guarantee all material misstatements will be detected
because of such factors as the use of judgment, the use of testing, the inherent
limitations of internal control and the fact that much of the evidence available to the
auditor is persuasive rather than conclusive in nature. For these reasons, the auditor is
able to obtain only reasonable assurance that material misstatements in the financial
statements will be detected.

b) Audit Trail in a Computerized Accounting Environment:


An audit trail refers to a situation where it is possible to relate „one-to-one‟ basis, the
original input along with the final output. The work of an auditor would be hardly
affected if “Audit Trail” is maintained i.e. if it were still possible to relate, on a „one-to-
one‟ basis, the original input with the final output. It refers to a simplified
representation of the documentation in a manually created audit trail. The particular
credit notes may be located by the auditor at any time he may wish to examine them,
even months after the balance sheet date. He also has the means, should he so wish, of
directly verifying the accuracy of the totals and sub-totals that feature in the control
listing, by reference to individual credit notes. He can, of course, check all detailed
calculations, casts and postings in the accounting records, at any time. In first and early
second-generation computer systems, such a complete and trail was generally available,
no doubt, to management‟s own healthy skepticism of what the new machine could be
relied upon to achieve – an attitude obviously shared by the auditor. In such a system (i)
the output itself is as complete and as detailed as in any manual system. (ii) The trail,
from beginning to end, is complete, so that all documents may be identified by located
for purposes of vouching, totaling and cross-referencing.

Any form of audit checking is possible, including depth testing in either direction. In
case audit trail is missing, the auditor employs Computer Assisted Techniques
(CAATs) to ensure the validity of accounting data.

c) Management representation

It is a representation made by management to the auditor during the course of an audit,


either unsolicited or in response to specific enquiries. It acknowledges its responsibility
for the implementation and operation of accounting and internal control system that are
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designed to prevent and detect fraud and error. Nepal Standard on Auditing – 580,
Management Representation states that the auditor should obtain appropriate
representation from management evidencing that the management acknowledges its
responsibility for the fair presentation of the financial statements in accordance with the
relevant financial reporting framework and has approved the financial statements. The
auditor can obtain evidence of management‟s acknowledgment of such responsibility and
approval from relevant minutes of meetings of the board of directors or similar body or by
obtaining a written representation from management or a signed copy of the financial
statements. The possibility of misunderstandings between the auditor and management is
reduced when oral representations are confirmed by management in writing. However,
representations by management cannot be a substitute for other audit evidence that the
auditor could reasonably expect to be available. If the auditor is unable to obtain sufficient
appropriate audit evidence regarding a matter which has, or may have, a material effect on
the financial statements and such evidence is expected to be available; this will constitute a
limitation in the scope of the audit, even if a representation from management has been
received on the matter.

d) Control Risk
Audit risk is the risk that an auditor may give an inappropriate opinion on financial
information that is materially misstated. Audit risk is composed of three components
viz. inherent risk, control risk and detection risk. Control risk is the risk that
misstatement that could occur in an account balance or class of transactions and that
could be material, individually or when aggregated with misstatements in other
balances or classes, will not be prevented or detected on a timely basis by the system of
internal control. There will always be some control risk because of the intrinsic
limitations of any system of internal control.
For assessing control risk, the auditor should consider the adequacy of control design,
as well as test adherence to control procedures. In the absence of such assessment, the
auditor should assume that control risk is high. The auditor ordinarily assesses control
risk at a high level for some or all assertions where:
- The entity`s policies and procedures relating to an assertion are not effective or
- Evaluating the effectiveness of the entity`s policies and procedures would be
inefficient
The auditor may make a preliminary assessment of control risk at less than a high level
only when the auditor:
- Is able to identify policies and procedures of the accounting and internal control
systems relevant to specific assertions which are likely to prevent or detect material
misstatements in the financial statements ; and

- Plans to perform tests of control or support the assessment.


It may be noted that nature, timing and extent of substantive audit procedures to be
performed would depend upon the auditor`s assessment of the inter-relationship
between inherent risk, control risk and detection risk.

7. D
istinguish between the following (Any Two): (25=10)
a) Audit Planning and Audit Program
b) Management Audit and Operational Audit
c) Compliance Procedures and Substantive Procedure
d) Tagging and Tracing

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Answer No. 7
a) Audit Planning and Audit Program

As per NSA-300 on Audit Planning, the auditor should plan the audit work so that the audit
will be performed in an effective manner. The "Audit Planning" means developing a general
strategy and a detailed approach for the expected nature, timing and extent of the audit. The
auditor plans to perform the audit in an efficient and timely manner. Audit planning is one of
the basic principles of auditing. Plan should be based on knowledge of the clients business.
Audit planning is a continuous process throughout the audit engagement and covers
developing an overall plan for the expected scope and conduct of the audit and developing
an audit program showing the nature, timing and extent of audit procedures. Adequate
planning of the audit work helps to ensure that appropriate attention is devoted to important
areas of the audit, those potential problems are identified and that the work is completed
expeditiously. Planning also assists in proper assignment of work to assistants and in
coordination of work done by other auditors and experts. The extent of planning will vary
according to the size of the entity, the complexity of the audit and the auditor's experience with
the entity and knowledge of the business. Matters to be considered by the auditor in developing
the overall audit plan include knowledge of business, understanding the accounting and internal
control systems, risk and materiality, nature, timing and extent of procedures, coordination,
direction supervision and review process etc.
The same NSA-300 mentions that the auditor should develop and document an audit program
setting out the nature, timing and extent of planned audit procedures required to implement the
overall audit plan. Hence, audit program is nothing but a list of examination and
verification steps to be applied set out in such a way that the inter-relationship of one step
to another in clearly shown and designed, keeping in view the assertions discernible in the
statements of account produced for audit or on the basis of an appraisal of the accounting
records of the client. In other words, an audit program is a detail plan of applying the audit
procedures in the given circumstances with instructions for the appropriate techniques to be
adopted for accomplishing the audit objectives.
The difference between audit plan and audit program is that audit program is a part of audit
plan. While audit plans involves each step of audit from engagement to issuance of final
report audit program deals with only nature, timing and extent of audit procedures.
b) Management Audit and Operational Audit.
Management audit is an audit of the management. The management audit is, therefore,
concerned itself with the whole field of activities of the concern, from top to bottom
starting from the top, because we are primarily concerned with whether the general
management is functioning smoothly and satisfactorily. Management audit is concerned
with appraising management‟s accomplishment of organizational objectives, the
management functions of planning, organizing, directing and controlling, and the adequacy
of management‟s decisions and actions in moving towards its stated objectives.
Management audit is a complex task closely linked with the process of management. It
usually involves the following steps:
a) Identification of the objectives of the organization.
b) The overall objectives are to be split down into detailed targets and plans for
various segments.
c) The organizational structure is to be reviewed to assess whether or not it can
effectively achieve the overall objectives and detailed targets.
d) The performance of each functional area or responsibility center is to be examined
and compared with the targets and objectives.
e) On
the basis of above examination, a realistic course of action may be recommended.

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On the other hand, operational audit is an audit for the management. It is undertaken at
the instance of the management for providing it with information and appraisal of
operations and activities. Operational auditing is essentially a review and appraisal of
operations of an organization carried on by a competent independent person. Hence,
operational audit refers to a systematic independent appraisal activity within an
organization for a review of the entire departmental operations as a service to
management. Operations audit is a technique for regularly and systematically,
appraising unit or function effectiveness against corporate and industry standards by
utilizing personnel who are not specialists in the area of study with the objective of
assuring a given management that its aims are being carried out in identifying
conditions capable of being improved.
Management audit deals with various aspects of the management process whereas
operational audit is confined to various activities and operations in the functional areas.
Management audit attempts to evaluate the performance of various management
process and functions.

c) Compliance procedures and substantive procedure


Compliance procedures are those tests designed to obtain reasonable assurance that
those internal controls on which audit reliance is to be placed are in effect. In obtaining
audit evidence from compliance procedures, the auditor is concerned with assertions that
the control exists, the control is operating effectively and the control has so operated
throughout the period of intended reliance.
Whereas substantive procedures are tests designed to obtain evidences as to the
completeness, accuracy and validity of the data produced by accounting system. They
are of two types: tests of details of transactions and balances and analysis of significant
ratios and trends. As mentioned in NSA-500 Audit Evidence, when obtaining audit
evidence from substantive procedures, the auditor should consider the sufficiency and
appropriateness of audit evidence from such procedures together with any evidence from
tests of control to support financial statement assertions.

d) It is a technique better than Integrated Test Data Facility. It involves tagging the client`s
input data in such a way that relevant information is displayed at key points. It uses the
actual data, and so the question of elimination of special entries test data designed under
Integrated Test Data Facility does not arise. The hard copy, so produced is available
only to the auditor and may describe such inputs as hours worked in a pay period in
excess of 60; or sales orders processed in excess of Rs. 200,000 etc. This enables the
auditor to examine transactions at the intermediate steps in processing.
The advantage of tagging and tracing approach lies in the use of actual data and
elimination of the need for reversing journal entries. The disadvantage is that the
erroneous data will not necessarily be tagged. An effective combination approach may
be to use the ITF approach (Integrated Test Facility) for a few hypothetical transactions
and the tagging and tracing approach to follow line data through a complex system.

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CAP-II, Corporate & other Laws, Dec 2011


Suggested Answer
Maximum Marks - 100

Total No. of Questions - 7

Time Allowed - 3 Hours


Marks
All questions are compulsory.

Part : "A"
1.
a) Mrs. Sindhu had applied for the allotment of 1,000 shares in a company. No
allotment of shares was made to her by the company. Later on, without any
further application from Mrs. Sindhu, the company transferred 1,000 partly-
paid shares to her and placed her name in the Register of Members. Mrs.
Sindhu, knowing that her name was placed in the Register of Members, took
no steps to get her name removed from the Register of members. The
company later on made final call. Mrs. Sindhu refuses to pay for this call.
Referring to the provisions of the Companies Act, 1956, examine whether
Mrs. Sindhu‟s refusal to pay for the call is tenable and whether she can
escape herself from the liability as a member of the company. 8
b) Who is an 'Expert'? When is an expert not liable for the mis-statement in the
prospectus of a public company as per the provisions of the Companies Act,
1956? 7
c) B issued a cheque for Rs. 1, 25,000 in favour of S. B had sufficient amount
in his account with the Bank. The cheque was not presented within
reasonable time to the Bank for payment and the Bank in the meantime,
became insolvent.

Decide, under the provisions of the Negotiable Instrument Act, 1881


whether S can recover the money from B. 5
d) The governor of a state is a member of Nava Bharat Fertilizer Ltd. and has
appointed X, a member of the company as his representative for the purpose
of attending meetings of the company. Both the Governor and his
representative are unable to attend the forthcoming general meeting though
they are anxious to do so. Answer following question referring the
Companies Act, 1956.

i) Do you think X can appoint another proxy instead of himself? 3


ii) Would your answer be different in case X was the non member of the
company? 2
Answer No. 1
a) According to Section 164 of the Companies Act, 1956, the register of member is a
prima facie evidence of the truth of its contents. The contents of the register of
members are of decisive importance in determining as to who were the
shareholders of the company at a crucial time. Accordingly, if a person‟s name, to
his knowledge, is there in the register, she/he shall be deemed to be a member. In
the given case Mrs. Sindhu knows that her name is included in the register of
shareholders and stands by and allows her name to remain, she is holding out to the
public that she is shareholder and thereby she will be liable as shareholder.

YSZ P.T.O.
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b) According to Section 59(2) of the Companies Act, 1956, the expression "expert"
includes an engineer, a valuer, an accountant and any other person whose profession
gives authority to a statement made by him in the prospectus.

Restriction as per Section 57:


The report of an expert cannot be included in a prospectus if he is in any way
connected with the formation or promotion or management of the company.

When an expert is not liable [Section 62(3)]: An expert who would be liable by reason
of having given his consent under Section 58 to the issue of the prospectus containing
a statement made by him shall not be so liable if he can prove:
(a) that, having given his consent under section 58 to the issue of the prospectus, he
withdrew it in writing before delivery of a copy of the prospectus for registration;
(b) that, after delivery of a copy of the prospectus for registration and before allotment
thereunder, he, on becoming aware of the untrue statement, withdrew his consent in
writing and gave reasonable public notice of the withdrawal and of the reason
therefore; or
(c) that he was competent to make the statement and that he had reasonable ground to
believe, and did up to the time of the allotment of the shares or debentures, believe,
that the statement was true.

c) The problem as asked in the question is based on Sections 72 and 74 of the Negotiable
Instrument Act, 1881; subject to the Provision of Section 84.
As per Section 72, it is the duty of the holder of a cheque to present the same to the
bank for payment before the relationship between the bank and drawer is spoilt. It is
only if he does so that he can hold the drawer liable in case of non payment and not
otherwise.
As per Section 74, if the cheque is not presented by the holder for payment within
reasonable time and meanwhile the relation between drawer/customer of the bank is
spoilt and if the bank refuses to make payment or is incapable of making such
payment, then the drawer cannot be held liable for such dishonour.
Section 31 prescribes the liability of drawee of cheque. The drawee of a cheque having
sufficient funds of the drawer in his hands properly applicable to the payment of such
cheque must pay the cheque when duly required so to do, and in default of such
payment, must compensate the drawer of any loss or damage caused by such default.
Accordingly Section 84 prescribes the situation when cheque not duly presented and
drawer damaged there by under Section 84(1) where a cheque is not presented for
payment within a reasonable time of its issue, and the drawer or person on whose
account it is drawn had the right, at the time when presentment ought to have been
made, as between himself and the banker, to have the cheque paid and suffers actual
damage through the delay, he is discharged to the extent of such damage, that is to say,
to the extent to which such drawer a person is a creditor of the banker to a large
amount than he would have been if such cheque had been paid.
Hence applying the above provisions, S cannot recover the money from B.

d)
i) Under Section 187A(1) The president of India or the Governor of a State, if he is a
member of a company, may appoint such person as he thinks fit to act as his
representative at any meeting of the company or at any meeting of any class of
members of the company.
(2) A person appointed to act as aforesaid shall for the purposes of this Act be deemed
to be a member of such a company and shall be entitled to exercise the same rights
YSZ P.T.O.
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and powers (including the right to vote by proxy) as the President or as the case
may be, the Governor could exercise as a member of the company.
On the basis of above provision X can shall be entitled to exercise the same rights
and power of governor including the right to vote by proxy. Hence governor is
entitled to appoint proxy; X is also entitled to appoint another proxy instead of
himself. So X can appoint another proxy.
ii) Under section 176 any person whether a member or not may be appointed as
proxy. So the answer would not be different. A non member can also be appointed
as proxy. In this context, even if X were non member of the company, he would be
eligible to be appointed as proxy and for this purpose he shall be deemed to be a
member of such company.
Part: "B"
2.
a) Mr. Sharma was convicted by the Supreme Court of an offense of
corruption and was sent to imprisonment for the period of 5 years in the
year 2050. In the year 2060, he was appointed as a director of Jagadamba
Traders Ltd. Do you think his appointment was valid under Companies Act,
2063? Would your answer be different in case it was the case of Jagadamba
Hydropower Private Limited? 7

b) What is the procedure on deciding a resolution at a general meeting and


mention the matters requiring Special Resolution at the general meeting of
a company as per the Companies Act, 2063. 8
Answer No. 2
a) Under Section 89(1) (d) of the Companies Act, 2063: Person convicted of an offense
of corruption or of an offense involving moral turpitude shall not be eligible to be
appointed to the office of director.
Provided, that in the case of a private company, a period of three years has not lapsed
from the date of such sentence.
Since Mr. Sharma was appointed in the post of director of public limited company. He
was disqualified to be appointed in the post. He has disqualified to be appointed in the
post of director of public company forever once he was convicted of an offense of
corruption. The completion of five years imprisonment does not matter. If he were
appointed in the private limited company, it would have been valid because in case of
private limited company the limitation even the case is an offense of corruption shall
be extended only upto three years from the date of offense. On the basis of above
observation, Mr. Sharma could not be appointed in the post of director of Jadamba
Traders Ltd. However, he could be appointed in the post of director of Jagadamba
Hydropower Pvt. Ltd. as the period of three years has been completed.

b)
Procedure for taking decision at a general meeting:

Section 74(3) of the Companies Act, 2063: The opinion of majority of the shareholders
present in the meeting shall be deemed to be the decision of that meeting on every
matter put to vote. Such voting may be taken in such manner including a show of
hands, voice voting, division of shareholders in groups or poll as well as other
appropriate method as prescribed by the chairman.

Provided, however, that in the case of a special resolution, the resolution shall be
deemed to have been adopted by the meeting only if the shareholders representing
seventy five per cent shares out of the shareholders present in the meeting vote in favor
of the resolution.
YSZ P.T.O.
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The matters requiring Special Resolution at the general meeting of a company is


specified in Section 83 of the Companies Act 2063 as follows:

Section 83: Special resolutions to be presented:


Special resolutions shall be presented in the general meeting of a company for decision
on the following matters:
(i) Increasing the authorized capital of the company,
(ii) Decreasing or altering the share capital of the company,
(iii) Altering the name or main objects of the company,
(iv) Amalgamating one company into another company,
(v) Issuing bonus share,
(vi) Buying back of own shares by the company,
(vii) Selling shares at a discount,
(viii) Converting a private company into a public company or vice versa,
(ix) Such other matter in respect of which the company is required by this Act or
the articles of association to adopt a special resolution.

3.
a) A Public Company proposes to purchase its own shares. State the sources
of funds that can be utilized by the Company for purchasing its own shares
and the requirements to be complied with by the Company under
Companies Act, 2063. 5

b) Enumerate the provisions regarding appointment of Company Secretary as


provided in the Companies Act, 2063. 5

Answer No. 3
a) Section 61(2) of the Companies Act, 2063 allows a company to buy its own shares
out of its free reserves available for being distributed as dividends. The conditions
for buy back under this section are as follows:
(i) Where the shares issued by the company are fully paid up;
(ii) Where the shares issued by a public company have been listed in the Securities
Board;
(iii) Where the buy-back of shares is authorized by the articles of association of the
concerned company;
(iv) Where a special resolution has been adopted at the general meeting of the
concerned company authorizing the buy-back;
(v) Where the ratio of the debt owed by the company is not more than twice the
capital and general reserve fund after buy-back of shares;
Explanation: For the purpose of this Clause, "debt" means all amounts of secured
or unsecured debts borrowed by a company.
(vi) Where the value of shares to be bought back by a company is not more than
twenty percent of the total paid up capital and general reserve fund of that
company;
(vii) Where the buy-back of shares is not in contravention of the directives issued
by the Office in this respect.
A resolution to be presented at the general meeting shall state the
following matters;
(a) The reason and necessity for the buy-back of shares.

YSZ P.T.O.
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(b) A statement of the evaluation of possible impacts of the financial situation of


the concerned as a result of the buy-back of shares,
(c) The class and number of shares intended to be bought back;
(d) The maximum or minimum amount required to buy-back shares as referred to
in Clause (c) and financial sources of such amount;
(e) The time limit for the buy-back of shares;
(f) The mode of the buy-back shares;
(g) Such other necessary matters as specified by the office and as required to be
disclosed under the prevailing law, in respect of the buy-back of shares;

b) The provisions of Companies Act, 2063 regarding the appointment of company


secretary are as follows (Section 185 )
(1) A company with the paid-up capital of ten million rupees or more shall appoint to
the post of company secretary a Nepalese citizen who has the qualification
mentioned in sub-section (2).
(2) A Nepalese citizen who has worked in the related field for at least two years after
obtaining the professional certificate of company secretary issued by a native or
foreign body authorized to issue the professional certificate of company secretary
pursuant to the prevailing law or who has worked in the related field or in the field
of company management for at least three years after doing at least bachelor
degree in law, management, commerce or economics may be appointed to the post
of company secretary.
Provided, however, that this provision shall not apply to the company secretary
who is incumbent at the time of commencement of this Act for three years after the
date of commencement of this Act.
(3) No director of the concerned company shall be eligible to be appointed as the
company secretary of such company.
(4) A person shall not be appointed to the post of company secretary of more than one
company at the same time.
Provided, however, that this provision shall not bar the appointing of the company
secretary of any principal company to the post of company secretary of the
subsidiary company of such company.
(5) Where it is provided by this Act, the prevailing law or articles of association that
any act has to be done by or through the company secretary, and the post of
company secretary remains vacant in the company for any reason or the incumbent
company secretary fails to do such act or shows his inability to do such act, then
any such employee of the company, who has the qualification referred to in this
Act, as designated by the board of directors to do such act may perform such act in
the capacity of company secretary.

4.
a) What acts are deemed as offences under Banks & Financial Institutions
Act, 2063? 5

b) Enumerate the circumstances under which the Nepal Securities Board may
revoke a license issued under the Securities Act, 2063. 5

Answer No. 4
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a) Commission of any of the following acts shall be deemed to be a commission of an


offense under Banks and Financial Institutions Act, 2063( Section 70)

(i) Carrying on the financial transactions without obtaining a license under this Act
or in contravention of the conditions of the license or accepting deposits or
supplying credit or issuing debentures or other financial instruments in
violation of this Act or the orders or
directives issued under this Act or paying or obtaining interest in contravention
of the term prescribed by the Rastra Bank or dealing in foreign exchange in
contravention of this Act or the laws in force or the orders or directives issued
under this Act;
(ii) Failure of any officer who is responsible for maintaining the secrecy of the
financial transactions, accounts, records, ledgers, books and other accounts
related documents of the licensed institution pursuant to this Act or the orders
or directives issued under this Act to maintain such secrecy;
(iii) Violation by any one of this Act or any order or directive issued under this
Act, other than that mentioned in Clause (i) or (ii).

Above acts have been deemed to be a commission of an offense under the Act.
In nutshell, any acts in contravention of BAFIA, rules framed there under or
directives shall be deemed an offense under the Act.

b) Section 89. Revocation of License by the Nepal Securities Board:


(1) The Board may, on any of the following circumstances, revoke a license obtained
by any stock exchange or securities business (the licensee) to operate the stock
exchange or securities business under this Act:-
(a) If the licensee stops operating the stock exchange or securities business,
(b) If the licensee operates the stock exchange or securities business in contrary to
the interest of investors,
(c) If the licensee violates the terms set forth in the license,
(d) If the licensee violates any provision of this Act or the rules and bye-laws
framed under this Act,
(e) If the licensee fails to comply with any order or direction issued by the Board,
(f) If the licensee becomes insolvent being unable to repay its dues to its creditors,
(g) If the company or body having obtained a license to operate the stock exchange
or securities business is wound up,
(h) If the licensee having obtained a license to operate the stock exchange or
securities business makes an application for the revocation of the license,
(i) If the securities business having removed the agent appointed by it does not
appoint another agent in lieu of such an agent,
(j) If the licensee fails to submit such financial and transaction related statements
as required to be submitted to the Board,
(k) If the licensee fails to pay such fees as required to be paid pursuant to Section
50 to the Board within the specified time limit.
(2) No revocation of a license made pursuant to subsection (1) shall have any
effect on any liabilities arising from any activities done by such a stock
exchange or securities business person prior to the cancellation of license.

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5.
a) AED Company Ltd. could not avail skilled manpower for its specialized
operation in Nepal and hence intends to hire manpower from the
international market. What are the provisions in this regard as provided by
the Labor Act, 2048? 5

b) What are the disqualifications for becoming an Insurance Agent, Surveyor


and Broker as per the Insurance Act, 2049? 5

c) Explain the provisions of Nepalese Negotiable Instruments Act, 2034 with


regard to notice of dishonor and mode in which notice may be given. 5
Answer No. 5
a) The employer is prohibited from employing foreigners in Nepalese organizations
except satisfying the grounds of employment. Section 4A provides of the Labor Act,
2048 provides for employment of foreigners in certain cases as follows.

Section 4A: Prohibition on Engaging Non-Nepalese Citizens at Work:


(1) Non-Nepalese citizens shall not be permitted to be engaged at work in any of the
posts classified pursuant to Section 3.
(2) Notwithstanding anything contained in Sub-section (1), if a Nepalese citizen
could not be available for any skilled technical post even after publishing an
advertisement in national level public newspapers and journals, the Manager may
submit an application to the Department of Labour along with the evidence of
such fact for the approval to appoint a non-Nepalese citizen.
(3) If it is found, in conduction of an inquiry upon the submission of any application
pursuant to Sub-section (2), that a Nepalese citizen would not be available for the
skilled technical post mentioned in the application, the Department of Labour
may, on the recommendation of the Labour Office, grant approval to engage a
non-Nepalese citizen at work years for a maximum period of upto five years not
exceeding two years at a time and, in the specialized kind of skilled technical
post, for a period upto seven years.
(4) The Manager, who engages non-Nepalese citizens at work pursuant to Sub-
section (3), shall have to make arrangements for making the Nepalese citizens
skilled and for replacing the non-Nepalese citizens gradually by them. "

AED Company Ltd can hire foreign manpower seeking approval of the
Department of Labor as mentioned above.

b) Disqualifications of Insurance Agents, Surveyors and Brokers (Section 32 of the


Insurance Act , 2049):
No person can become an Insurance Agent, Surveyor or Broker in the following
circumstances:
i. In case he/she has not attained the age of 16 years,
ii. In case he/she is of unsound mind,
iii. In case he/she has been declared insolvent and bankrupt,
iv. In case he she has been convicted and sentenced to punishment by a court
in the offence involving any type of theft , fraud and misappropriation or
embezzlement of the property entrusted to him, or

YSZ P.T.O.
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v. In case he/she has done anything in the course of work regarding to


Insurance Business causing loss or damage to the insurer or to any
Insurance Policy Holder.

c) Notice of Dishonor
When a Bill of Exchange is dishonored by non acceptance or non- payment ,the
holder thereof , or some party thereto who remains liable thereon , must give notice to
all other parties related to such instrument , and if any party among them has not been
noticed , such party shall not be liable to that instrument .
Provided that, nothing in this section renders it necessary to give notice of
dishonor to the maker of the Promissory Note, acceptor of the Bill of Exchange or the
Drawee.
Mode in which notice may be given:
Notice of dishonor may be given to a person to whom it is required to be given or to
his /her duly authorized agent or, where he /she has died ,to his/ her heir , may be oral
or written . While giving written notice, it can be sent by post and may be in any form.
In such notice it must be informed to the party to whom it is given, either in express
terms or reasonable intendment that the Negotiable Instrument has been dishonored
and he / she will be held liable thereon and it must be given within reasonable time, at
his place of business or residence. If the notice is duly directed and sent by post and
miscarries, such miscarries does not tender the notice invalid.

6.
a) What are the provisions of Nepal Chartered Accountants Act, 2053 with
regard to removal and re-instatement of the name of any member? 5
b) The General Manager of PQR Industry, a corporate body wholly owned by
Government of Nepal, has appointed Mr. Aryal, a Chartered Accountant, to
audit the PQR Industry. Is the appointment legally valid? Answer referring
the provisions of Audit Act, 2048. 5

Answer No. 6
a) Provision of Removal of Names and Re-instatement (Section 22 of Nepal Chartered
Accountants Act, 2053)
(1) The council may issue an order to remove the name of any member from the
Membership Register on any of the following circumstances:-
(a) If he is convicted by an court in a criminal offense involving moral turpitude
and punished there for,
(b)If he fails to pay any fees required to be paid to the institute,
(c) If he fails to abide by the professional conduct referred to in this Act and the
Rules framed under this Act,
(d)If he becomes unsound-minded, or
(e)If he is dead.
(2) In case, a member whose name has been removed from the Membership
Register pursuant to sub-section (1) makes an application, along with the fees as

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prescribed, stating reasonable ground to restore his membership, the Council


may consider restoring his membership by reinstating his name in the
Membership Register

b) As per section 6 of Audit Act, 2048, the audit of the corporate bodies wholly owned by
Government of Nepal shall be audited by the Auditor General of Nepal. If the Auditor
General is constrained by time and resources to audit such corporate bodies, he may
appoint professional auditors according to the existing laws as his assistants. In the
given situation, auditor was appointed by the General Manager. As per Audit Act,
audit of such corporate bodies wholly owned by the Government of Nepal shall be
done by Auditor General and in certain condition Auditor General may appoint other
professional auditors to audit such corporate bodies.
Viewing the above provisions, the appointment of Mr. Aryal as an auditor by the
General Manager is illegal. General Manager has acted beyond his legal authority.

7. Write short notes on the following: (3×5=15)

a) Sale through Samples

b) Constitution of Industrial Promotion Board

c) Welfare Fund under Bonus Act, 2030

Answer No. 7
a) Sale through Samples
In case provisions have been made in a contract to sell goods after inspecting their
samples directly or otherwise, it shall be deemed to have been signed to sell goods
after inspecting their samples. In case a contract has been signed to sell goods after
inspecting their samples, it shall be deemed to include the following conditions, except
when otherwise provided for in the contract:
(i) The bulk of goods shall correspond to the samples in quality.
(ii) They buyer shall have, a reasonable opportunity to compare the quality of the
bulk of the goods with the sample.
(iii) The goods sold or to be sold shall be free from any defect, and that their
merchantable quality shall be apparent while inspecting them at the time of
comparing them with the sample.
b) Constitution of Industrial Promotion Board:

Government of Nepal shall constitute an Industrial Promotion Board consisting of the


following members:
(a) The Minister or State Minister for Industries -Chairman
(b) The Assistant Minister for Industries -Member
(c) Member (looking after industries), National Planning commission -Member
(d) The Governor, Nepal Rastra Bank -Member
(e) The Secretary, Ministry of Industry -Member
(f) The Secretary, Ministry of Finance -Member
(g) The Secretary, Ministry of commerce -Member
(h) The Secretary, Ministry of Tourism -Member
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(i) The Director General, Department of Cottage and Small Industries - Member
(j) Representative, Federation of Nepal Chamber of Commerce and Industry -
Member
(k) Two persons nominated by Government of Nepal, either from among the
industry, commerce and tourism sector organizations or from among the persons
of high distinction in the same field -Member
(l) The Director General, Department of Industries -Member Secretary

c) Welfare Fund under Bonus Act


Seventy percent of the residuary amount after distribution of bonus from the allocated
amount for bonus pursuant to section 5 of Bonus Act, 2030 shall be deposited with the
welfare Fund established in accordance with section 37 of the Labour Act 2048 and
remaining thirty percent shall be deposited with the National Level Welfare Fund,
established by Government of Nepal for the interest of the employees of the
enterprises. The operation of the welfare fund mentioned above shall be in
participation of the employees as prescribed.

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CAP-II, Cost & Management Accounting, Dec 2011


Suggested Answer
Maximum Marks - 100
Total No. of Questions: 6
Time Allowed - 3 Hours

Marks
All questions are compulsory. Working notes should form part of the
answer.
Make assumptions wherever necessary.
1. Z Ltd. makes a range of five products to which the following standard
apply:
Per unit
Particulars A B C D E
Rs. Rs. Rs. Rs. Rs.
Selling Price 500 600 700 800 900
Direct Materials 90 100 170 120 210
Direct Wages 160 200 240 280 320
Variable Production Overheads 80 100 120 140 160
Variable Selling & Distribution Overheads 50 60 70 80 90
Fixed Overheads 40 50 60 70 80
Total Cost 420 510 660 690 860
The direct labour wage rate is Rs. 40 per hour. Fixed overheads have
been allocated on the basis of direct labour hours. The company has
commitments to produce a minimum of 400 units of each product
per month. Direct labour hours cannot exceed 13,000 hours per
month due to restriction of space.
The Board is now considering an offer of a new three year contract
to produce an additional 400 units of product B per month at a
selling price of Rs. 580 per unit. The contract would involve an
outlay of Rs. 1,000,000 on the lease of additional factory premises
and purchase of new plant and equipment. There would be no
residual value at the end of the contract. Variable production costs
would be in accordance with existing standards and variable selling
& distribution costs would be one-half of the existing rate and cash
outflows on fixed costs would be Rs. 200,000 per annum. There
would be no changes to existing production arrangements.
An outside supplier has offered to supply 400 units of product B per
month at a price of Rs. 480 per unit. If purchased externally cash
outflows on additional fixed costs will be Rs. 250,000 per annum.
Required: (7+5+8=20)
a) Give recommendations, supported by calculations, to show
how direct labour hours in the existing factory should be
utilised in order to maximise profits.
b) Calculate budgeted trading results on the basis of your
recommendation in (a).

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c) Determine whether or not the proposed contract for product B


should be accepted and, if so, whether it should be purchased
externally or manufactured in the new premises. The
company's cost of capital is 10%. You may take the present
value of an annuity of Rs. 1 for three years at 10% as Rs. 2.49.
Ignore taxation and inflation.
Answer
a) Since availability of direct labour hours is a constraint, 13,000
direct labour hours per month should be utilised as shown by the
following statement to maximise contribution per labour hour:

Statement showing contribution per labour hour


Rs. per unit
Particulars
A B C D E
Selling Price 500 600 700 800 900
Variable Costs:
Direct Materials 90 100 170 120 210
Direct Wages 160 200 240 280 320
Production
80 100 120 140 160
Overheads
Selling &
50 60 70 80 90
Distribution OHs.
Total Variable Costs 380 460 600 620 780
Contribution per unit 120 140 100 180 120
Labour hours per unit (160/40)=4 (200/40)=5 (240/40)=6 (280/40)=7 (320/40)=8
Contribution per labour
30.00 28.00 16.67 25. 71 15.00
hour
Ranking I II IV III V

Since the company has commitments to produce minimum of 400 units of each product,
production should be planned in such a way that product B, C, D & E each are produced to
the extent of 400 units only and balance labour hours should be utilised to produce product
A. Therefore, production should be in the following pattern:
Labour hour Total labour Balance labour
Product Units produced
per unit hours used hours
B 400 5 2,000 11,000
C 400 6 2,400 8,600
D 400 7 2,800 5,800
E 400 8 3,200 2,600
A 650* 4 2,600 -
(b) *2600/4=650
Budgeted trading result as per recommendation in (a) above
Products
Particulars
A B C D E Total

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Units 650 400 400 400 400 2,250


Rs. Rs. Rs. Rs. Rs. Rs.
Selling Price/unit 500 600 700 800 900 -
Sales 325,000 240,000 280,000 320,000 360,000 1,525,000
Direct Materials 58,500 40,000 68,000 48,000 84,000 298,500
Direct Wages 104,000 80,000 96,000 112,000 128,000 520,000
Variable Production Ohs. 52,000 40,000 48,000 56,000 64,000 260,000
Variable Selling Ohs. 32,500 24,000 28,000 32,000 36,000 152,500
Variable Costs 247,000 184,000 240,000 248,000 312,000 1,231,000
Contribution 78,000 56,000 40,000 72,000 48,000 294,000
Fixed Overheads* 26,000 20,000 24,000 28,000 32,000 130,000
Net Profit 52,000 36,000 16,000 44,000 16,000 164,000
* Allocated on the basis of direct labour hour – given in the question.

[c] (i)
Statement showing additional contribution if contract is accepted and product B is
manufactured in new premises
Per unit 4,800 units**
Particulars
(Rs.) (Rs.)
Selling Price 580 2,784,000
Direct Materials 100 480,000
Direct Wages 200 960,000
Variable Production Overheads 100 480,000
Variable Selling Overheads – 50% of Rs. 60 30 144,000
Variable Cost 430 2,064,000
Contribution 150 720,000
Additional Fixed Overheads 200,000
Increase in Annual Cash Flow 520,000
** Unit for one year.
The present value of cash inflows for 3 years at 10% = Rs. 520,000 × 2.49 = Rs. 1,294,800
Initial capital outlay being Rs. 1,000,000, NPV of the proposal = Rs. 294,800. Hence
the proposal should be accepted.
[c] (ii)
Statement showing additional contribution if contract is accepted and product
B is purchased externally
Per unit 4,800 units**
Particulars
(Rs.) (Rs.)
Selling Price 580 2,784,000
Purchase Price 480 2,304,000
Contribution 100 480,000
Additional Fixed Overheads 250,000
Increase in Annual Cash Flow 230,000
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** Units for one year.


The present value of cash inflows for 3 years at 10% = Rs. 230,000 × 2.49 = Rs. 572,700
Initial capital outlay being zero, NPV of the proposal = Rs. 572,700
Conclusion / Recommendation:
Both 'Make Internally' and 'Purchase Externally' options give a positive
NPV. Hence, the contract should be accepted. However, the 'Purchase'
option gives a greater NPV hence product B should therefore be
purchased externally. This option has added advantages of minimising
risk, since in the circumstances, it appears unnecessary to make any
capital investment to cope with the contract.
2.
a) The direct labor hour requirements of three of the product
manufactured in a factory, each involving more than one labor
operation is estimated as follows:

Direct labor hours per unit (in minutes)


Operation Product
1 2 3
A 18 42 30
B - 12 24
C 9 6 -

The factory works 8 hours per day, 6 days in a week. The budget
quarter is taken as 13 weeks and during a quarter, lost hours due to
leave and holidays and other causes is estimated to be 124 hours.
The hourly budgeted rates for the workers manning the operation A,
B and C are Rs. 2.00; Rs. 2.50 and Rs. 3.00 respectively.
The sales of the products during the quarter are:

Product 1 9,000 units


2 15,000 units
3 12,000 units
There is a carryover of 5,000 units of product 2 and 4,000 units of
product 3 and it is proposed to build up a stock at the end of the
budget quarter as follows:
Product 1 1,000 units
3 2,000 units
Prepare a man-power budget for the quarter showing for each
operation (i) direct labor hours (ii) direct labor cost, and (iii) the
number of workers. 10

b) In a chemical manufacturing company, three products A, B and


C emerges at a single split off stage in department P. Product A
is further processed in department Q, Product B in department R
and Product C in department S. There is no loss in further
processing of any of the three products. The cost data for a
particular month are as under:
Rs.

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Cost of raw materials introduced in department P 1,268,800


Direct Wages: Department P 384,000
Department Q 96,000
Department R 64,000
Department S 36,000
Factory overheads of Rs. 464,000 are to be apportioned to the
departments on direct wages basis. During the month under
reference, the company sold all three products after processing
them further as under:
A B C
Output sold in kg. 44,000 40,000 20,000
Selling Price per kg. (Rs.) 32 24 16
There is no Opening or Closing Stocks. If these products were
sold at the split off stage i.e. without further processing, the
selling prices would have been Rs. 20, Rs. 22 and Rs. 10 per kg.
for A, B and C respectively.
Required: (3+3+2+2=10)
i) Prepare a statement showing the apportionment of joint costs to
three products.
ii) Prepare a statement showing product-wise and total profit
for the month under reference as per the company's current
processing policy.
iii) What processing decision should have been taken to
improve the profitability?
iv) Calculate the product-wise and total profit arising from your
recommendation in (iii).

Answer (a)
Quarterly man-power
Operation Hourly Product 1 Product 2 Product 3 Total No. of
rate workers
Rs. DL Cost DL Cost DL Cost DL Cost
Hrs Rs. Hrs Rs. Hrs Rs. Hrs Rs.
A 2.00 3,000 6,000 7,000 14,000 5,000 10,000 15,000 30,000 30
B 2.50 - - 2,000 5,000 4,000 10,000 6,000 15,000 12
C 3.00 1,500 4,500 1,000 3,000 - - 2,500 7,500 5
Total 4,500 10,500 10,000 22,000 9,000 20,000 23,500 52,500 47

Working Notes
1. Production budget
Product 1 2 3
Units Units Units
Sales 9,000 15,000 12,000
Add: Closing Stock 1,000 - 2,000
Less: Opening - 5,000 4,000
Stock
Production Budget 10,000 10,000 10,000

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2. Total available hours in a quarter per worker


Total hours = 8 * 6 * 13 = 624
Less: hours lost due to leave etc. = 124
Total available hours per man = 500

3. The calculation of direct labor hours, direct labor cost and number of men has been
made as follows (illustrated for product 1):

Direct labor hours = (18*10,000)/60 = 3,000 Hours


Direct labor cost = 3,000 hours * Rs. 2 = Rs. 6,000
Number of men required = (Direct labor hours required/Total available hours per
man)
= 15,000/500
= 30 men.
Similarly, calculations have been made for the other products.

Answer (b)
i) Statement showing the apportionment of joint costs to joint products:
Particulars A B C Total
Output sold in kg. 44,000 40,000 20,000
Selling price per kg. at split off (Rs.) 20 22 10
Sales value at split off (Rs.) 880,000 880,000 200,000 1,960,000
Ratio 22 22 5
Joint costs apportioned(W.N. a) 880,000 880,000 200,000 1,960,000

Working Note (a)

Computation of joint cost:


Cost of raw materials 1,268,800
Direct wages 384,000
Factory overhead (464000/580000×384000) 307,200
(Apportioned on direct wages basis.) 1,960,000

(ii) Statement showing product-wise and total profit for the month under reference as
per company's current processing policy:
Particulars A B C Total
Output sold in kg. 44,000 40,000 20,000
Selling price per kg. (Rs.) 32 24 16
Sales value (Rs.) 1,408,000 960,000 320,000 2,688,000
Joint costs (Rs.) 880,000 880,000 200,000 1,960,000
Further processing costs (Rs.)
172,800 115,200 64,800 352,800
W.N. (b)
Total costs (Rs.) 1,052,800 995,200 264,800 2,312,800
Profit / (Loss) (Rs.) 355,200 (35,200) 55,200 375,200

Working Note (b) Q R


S

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Direct wages 96,000 64,000


36,000
Factory Overhead (464,000/580,000×96,000) (464,000/580,000×64,000)
(464,000/580,000×36,000)
(Apportioned on direct wages basis) =76,800 =51,200
=28,800
172,800 115,200
64,800

(iii) Statement of incremental profit on further processing:


Particulars A B C
Output sold in kg. 44,000 40,000 20,000
Incremental selling price per kg (Rs.) 12 2 6
Incremental sales value (Rs.) 528,000 80,000 120,000
Further processing costs (Rs.) 172,800 115,200 64,800
Profit / (Loss) (Rs.) 355,200 (35,200) 55,200

Processing decision:
44,000 kg of product A and 20,000 kg of product C should be further processed
because the incremental sales revenue generated after further processing is more than
the further processing costs incurred. 40,000 kg of product B should be sold at the
point of split off because the incremental revenue generated after further processing is
less than the further processing costs incurred.

(iv) Product-wise and total profit arising from the recommendation in (iii) is as follows:

Profit for A 355,200


Profit for C 55,200
Profit for B (At split -off)
Sales- (as per i above) 880,000
Less: Joint cost (W.N.a) 880,000
Profit /Loss Nil
Total Profit 410,400
W.N (C): Costs incurred in the department P are joint costs of products A, B and C.
Similarly costs incurred in the departments Q, R and S are further
processing costs of products A, B and C respectively.
3.
a) Siddhartha Transport Pvt. Ltd. has been given a route of 300
km. long to run bus. The bus costs Rs. 4,000,000. It has been
insured at 3% p.a. and the annual tax will amount to Rs. 2,000.
Garage rent is Rs. 800 per month. Annual repairs will be Rs.
30,000 and the bus is likely to last for 8 years. The driver and
the conductor‟s salary will be Rs. 15,000 and Rs. 10,000 per
month respectively in addition to 10% of takings as
commission, to be shared equally. Office expenses including
stationery will be Rs. 1,600 per month. A manager cum
accountant is employed for a monthly salary for Rs. 20,000. The
bus gives mileage of 3 km. per liter of fuel, which costs Rs. 85
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per liter. The bus will make one round trip in 2 days carrying on
an average 40 passengers on each single way trip. The bus will
run on an average 28 days in a month.
Required:
Assuming 20% profit on takings, calculate the bus fare to be
charged from each passenger for a single way trip, and bus fare
per passenger km. 8

b) Rolland Limited operates a group incentive scheme in one of its


department. A minimum hourly rate is guaranteed to each of the
six employees in the group if actual output for the week is less
than the standard output. If actual output is greater than the
standard output, the hourly rate of each employee is increased
by 4% for each additional 600 units of output produced. The
standard output for the group is 12,000 units for a 40 hour week.
During the week ended 31st December, 2010, each employee in
the group worked 40 hours; actual output and minimum hourly
rates were as follows:
Employee Actual output (units) Minimum hourly rate (Rs.)
Lal 2,500 60
Hari 2,700 100
Mohan 2,400 60
Shyam 2,500 80
Hanuman 2,460 60
Krishna 2,440 40
You are required to: (5+2=7)
i) Calculate the earnings of each employee;
ii) Appraise the effectiveness to the company of this group incentive
scheme.

c) During Poush 2067, a company purchased 1,200 kg. of raw


materials. The following particulars relate to the purchase:
i) Lot prices quoted by supplier and accepted by the company for
placing the purchase order:
Lot up to 1000 kg. @ Rs.22/ kg.
Between 1000 – 1500 kg. @ Rs.20/ kg.
Between 1500 – 2000 kg. @ Rs.18/ kg.
ii) Trade discount 20%.
iii) VAT at 13% extra; credit is to be taken.
iv) Freight paid Rs. 240.
v) Insurance paid at 2.5% on Invoice Value.
vi) Stores overhead applied at 5% on total purchase cost of material.
The entire quantity was received and issued to production.
Required:
Prepare a statement showing total cost of material purchased
and unit cost of material issued to production. 5
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Answer a)
Statement showing charge per passenger for single way trip
Particulars Annual Amount Monthly Amoun
(Rs.) (Rs.)
Standing charges:
Insurance premium @3% on Rs.4,000,000 120,000.00 10,000.
Tax 2,000.00 166.
Garage rent 800.
Driver's salary 15,000.
Conductor's salary 10,000.
Office expenses 1,600.
Manager cum accountant's salary 20,000.
Total standing charges 57,566.
Running expenses:
Depreciation 500,000.00 41,666.
Repairs 30,000.00 2,500.
Fuel 238,000.
Total running charges excluding commission 282,166.
Total cost without commission 339,733.
Commission (WN1) 48,533.
Total Cost 388,266.
Profit 97066.
Total Takings 485,333.3
Fare per passenger per single way trip (485,333.33/1120) 433.3
Fare per passenger km (485,333.33/336000) 1.4

Working Note:1
Let total taking be x
Commission = 10% of x = x/10
Profit = 20% of x = x/5
Now,
x = 339733.33+x/10+x/5
x-x/10-x/5 = 339733.33
(10x-x-2x)/10 =339733.33
7x = 3397333.30
x = 3397333.30/7
x = 485333.33
Now,
Commission = 10% of 485,333.33 = Rs.48,533.33
Profit = 20% of 48533.33 = Rs.97,066.67
Working Note:2
Average no.of passengers carried during the month (28/2×2×40) 1120
Average passenger km(28/2×2×40×300) 336000
Cost of fuel
Total distance (km) covered 300× 28 = 8,400
Fuel required = 8,400/3 = 2800 Litre.
Cost per liter = Rs. 85
Total cost = Rs. 85 × 2,800 = Rs. 228,000

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Answer (b)
ii) Statement showing the earning of each employee in the group during the
week ended 31st December 2010.
Employee Minimum Hourly premium Total rate (Rs.) Total wages for
hourly rate (Rs.) rate (Rs.)(20%of the week 40
minimum Wages Hours (Rs.)
W.N (a)
Lal 60 12 72 2,880
Hari 100 20 120 4,800
Mohan 60 12 72 2,880
Shyam 80 16 96 3,840
Hanuman 60 12 72 2,880
Krishna 40 8 48 1,920
Total 19,200

Working notes:
a) Calculation of the percentage increase in the hourly rate due to higher
efficiency:
(Output for 40 hour week)
Standard 12,000 units
Actual 15000 units
Additional production 3,000 units
Increase in wage rate is 4% for each additional 600 units. Hence total increase;
= (3000/600) * 4% = 20%

ii) Hourly rate for all employee (60+100+60+80+60+40) =Rs.400.


Std production per hour 12000/40×6= 50units.
Hence Std. wages cost of actual production =Rs. 400×50units =Rs. 20000.
Actual wages paid Rs. 19,200.
Therefore, there is a saving of Rs. 800. The gain on account of efficiency of the
worker has thus been shared by the employer and the employee.

Answer (c) Answer:


Statement of total and per unit cost of materials
Particulars Total Amount Per unit Amoun
(Rs.) (Rs.)
Raw material 1200 kg @ Rs.20/ kg 24,000.00 20.
Less: Trade discount @ 20% 4,800.00 4.
19,200.00 16.
Add: VAT @13% 2,496.00 2.
Invoice Value 21,696.00 18.
Freight paid 240.00 0.
Insurance @2.5% on Rs.21,696.00 542.40 0.
22,478.40 18.
Add: Stores overhead @5% 1,123.92 0.
Less: VAT credit 2,496.00 2.
` 21,106.32 17.5

4.
a) In a factory, the expenses of factory are charged on a fixed
percentage basis on wages and office overhead expenses are
calculated on the basis of percentage of works cost.
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Following information is supplied to you:


Order I (Rs.) Order II (Rs.)
Materials 12,500 18,000
Wages 10,000 14,000
Selling Price 44,850 61,880
Percentage of profit on cost 15% 12%
Find out percentage for factory overhead and office overhead. Justify
with verification. 7

b) Alcon Construction Company Ltd. commenced its business of


construction on 1st April, 2010. The Trial Balance as on 31st
March, 2011 showed the following balances:
Debit Credit
Particulars
Rs. Rs.
Share capital 1,000,000
Cash received on account of contract - 80% of work certified 1,200,000
Land and Buildings 300,000
Machinery at cost (75% at site) 400,000
Bank balances 40,000
Material at site 400,000
Direct Wages 550,000
Expenses at site 20,000
Lorries and Vehicles 300,000
Furniture 10,000
Office Equipment 100,000
Office Expenses 5,000
Postage and Telegrams 20,000
Rate and Taxes 30,000
Fuel and Power 25,000
2,200,000 2,200,000
The contract price is Rs. 3,000,000 and work certified is Rs.
1,500,000. The work completed since certification is estimated at
Rs. 10,000 (at cost). Machinery costing Rs. 20,000 was returned
to stores at the end of the year. Stock of material at site on 31 st
March, 2011 was of the value of Rs. 50,000. Wages outstanding
were Rs. 2,000. Depreciation on machinery is at 10% per annum.
Prepare Contract Account showing the profit from the contract
and also show how the work-in-progress will appear in the
Balance Sheet as at 31st March, 2011. 9

c) Explain briefly the factors to be considered before establishing


an integrated cost accounting system. 4

Answer (a) Order I


Selling price = Rs. 44,850 including 15% profit on cost.

Cost of production is therefore, 44,850* (100/115) = Rs. 39,000


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Order II
Selling price = Rs. 61,880 including 12% profit on cost.

Cost of production is therefore, 61,880 *(100/112) = Rs. 55,250

Cost of production = Direct material (DM) + Direct Wages (DW) + Factory Overhead
(FO) + Office
Overhead (OH)

According to the problem factory expenses is charged at a fixed percentage on


wages while OH is charged at a percentage of Works cost (WC). Both these
figures are unknown. Hence we have to solve it algebraically.

Let FO be x% of wages and OH be y% of works cost.

Then in the Order I the equation will be:


39,000 = 12,500 + 10,000 + (x% * 10,000) + y% (22500 + 100x)
39,000 = 22,500 +100x + 225y + y% (22500 + 100x)
16,500 = 100x + 225y + xy ……………………………………..
……………………………….(i)

And in the Order II the equation will be :


55,250 = 18,000+14,000 +(x% *14,000) + y% (32,000+140x)
Or, 23,250 = 140x + 320y +1.4xy
…………………………………………………………………(ii)

On multiplying equation (i) by 1.4 and equation (ii) by 1.0 we get


23.100 = 140x + 315y +1.4xy
…………………………………………………………………...(iii)
23,250 = 140x +320y + 1.4xy
…………………………………………………………………… (iv)

Bu subtracting (iii) from (iv) we get


150 = 5y or y = 30
On putting the value of y in (i) we get
16,500 = 100x + 6750 + 30x
Or, 9750 = 130x
Or, x = 75
Factory overhead is therefore 75% of wages and office overhead is 30% on works cost.
Verification
Order I (Rs.) Order II (Rs.)
Material 12,500 18,000
Wages 10,000 14,000
Factory Overhead (75% on wages) 7,500 10,500
Works cost 30,000 42,500
Office overhead (30% on works cost) 9,000 12,750
Cost of production 39,000 55,250
Add: Profit 15% and 12% respectively for I & 2 order 5,850 6,630
Selling price 44,850 61,880

b)
Contract Account
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For the year ending 31st March, 2011


Particulars Rs. Rs. Particulars Rs. Rs.
By Work-in-
To Materials 400,000
progress:
To Machinery (400,000 × 75%) 300,000 Work Certified 1,500,000
Work
To Wages 550,000 10,000 1,510,000
Uncertified
Add: By Machinery
2,000 552,000 20,000
Outstanding returned
To Expenses at Less:
20,000 2,000 18,000
site Depreciation
To Notional Profit c/d 558,000 By Machinery at site 280,000
Less:
28,000 252,000
Depreciation
By Material at site 50,000
1,830,000 1,830,000
To Profit & Loss By Notional Profit
297,600 558,000
A/c (W.N. i) b/d
To WIP – Reserve (balancing
260,400
figure)
558,000 558,000

Extracts from Balance Sheet as at 31st March, 2011


Liabilities Rs. Rs. Assets Rs. Rs.
Work-in-progress:
Work Certified 1,500,000
Work Uncertified 10,000
1,510,000
Less: Reserve 260,400
1,249,600
Less: Cash received 1,200,000 49,600

Working Notes:
(i) Profit taken to Profit & Loss Account:
(Rs. 558,000 × 2 / 3 × 80 / 100) = Rs. 297,600
(ii)Postage and Telegrams, Office Expenses, Rates and Taxes, Fuel
and Power, Depreciation on Machinery Costing Rs. 100,000 (25%)
will be charged to Profit and Loss Account of the company
c) The following factors should be considered before establishing an integrated cost
accounting system:
i) Degree of integration: The degree of integration should be determined. Some
business firms may integrate up to the stage of prime cost or factory cost. On the
other hand, many undertakings integrate the whole of the records.
ii) Control accounts: In place of classifying expenditure according to its nature,
control accounts may be prepared for each of the elements of cost, such as:

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Material Control Account


Direct Labor Control Account
Factory Overhead Control Account
Administrative Overhead Control Account
Selling and Distribution Overhead Control Account
Some of the above control accounts should be separated into fixed and variable
depending on the circumstances.
iii) Cost accumulation purposes: Full details about the cost data are provided in the
cost accounting department so as achieve the following objectives;
a. To provide the necessary costing data
b. To form the basis of journal entries so that the control accounts can
be cleared to suitable revenue accounts resulting into a cost of sales
accounts
iv) Provision for accrued expenses, prepayments and stocks should be dealt with by
transfers to suitable suspense accounts, so that the balance remaining in each
control account represents the charges for the period
5. Distinguish between: (4×2.5=10)
a) Protective purpose and constructive purpose of cost audit
b) Cost allocation and cost apportionment
c) Cost control and cost reduction
d) Methods of costing and techniques of costing

Answer
a) Protective purpose of Cost Audit: Under this, cost audit aims at
examining that there is no undue wastage or losses and the costing
system brings out the correct and realistic cost of production or
processing. The benefit of this protective function is derived by the
organization, its owners and consumers.
Constructive purpose of Cost Audit: Cost audit has a constructive
purpose as well. Cost auditor plays a constructive role by providing
management of the company with information useful in regulating
production; choosing economical methods of operation, reducing
operations costs and re-formulating plans etc. on the basis of his
findings during the course of cost audit

b) Cost allocation is the process of charging the full amount of an


individual item of cost directly to a cost centre for which this item of
cost was incurred. For example, where separate electric meters are
installed in each of the department, the electricity charges on the basis
of electricity bill can be allocated to the respective departments.
Similarly, salary and wages paid to indirect workers of each
department can be allocated to the respective departments.
Cost apportionment on the other hand, is the process of charging the
proportion of common items of cost to two or more cost centres on
some reasonable and equitable basis. For example, where only one
electric meter is installed in a factory, the common electricity
charges should be apportioned to all the departments on the basis of
number of light points or floor area. Similarly, if factory rent is
incurred for the factory as a whole and benefits all the departments in
the factory, it should be apportioned to all the departments on the
basis of floor area occupied by each department.
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c)
 Cost control process involves setting standards, ascertaining actual
performance, comparing actual with standards, investigating
variances, and taking corrective actions where as cost reduction is
the final result in the cost control process.
 Cost control aims at achieving standards where as cost reduction
aims at improving the standards. Cost reduction assumes existence
of concealed potential savings in the standards.
 Cost control lacks dynamic approach where as cost reduction is
dynamic and always looks for measures of reducing cost.
 Cost control is preventive. It attempts to optimize costs before they
are incurred. Cost reduction is corrective and attempts to find scope
of reducing incurred costs under controlled conditions.
 Cost control is applicable to items which have standards where as
cost reduction is applicable to every activity of the business.
 Cost control contains the management guidelines where as cost
reduction provides guidelines to management
d)
Method of costing refers to the techniques and processes of determining
costs of a product manufactured or a service rendered. Broadly there are
two methods of costing, i.e. Job costing and Process costing. All other
methods of costing are only variants of the two.
Techniques of costing refer to the manner of ascertaining costs of a
product, job or activity. It indicates what types of costs are being
ascertained such as historical cost, standard cost, full cost, marginal cost
etc. The general techniques of costing are historical costing, standard
costing, full or absorption costing, marginal or variable costing etc
6. Write short notes on: (4×2.5=10)
a) Efficiency audit
b) Reciprocal method of cost allocation
c) Multiple costing
d) Synergetic effect in cost reduction
Answer
a) Efficiency audit is directed towards the measurement of whether corporate
plans have been effectively executed. It is concerned with the utilisation of
the resources in economic and most remunerative manner to achieve the
objective of the concern. It comprises of studying the plans of organisation,
comparing actual performance with plans and investigating the reasons for
variances to take remedial action. For example, the effective utilisation of
capital in an organisation can be gauged by determining the return on
capital employed.
b) The reciprocal method allocates support department costs to operating
departments by fully recognizing the mutual services provided among all
support departments. For example, the Plant Maintenance department
maintains all the computer equipments in Information System department.
Similarly, Information System department provides database support for
Plant Maintenance. The reciprocal method fully incorporates
interdepartmental relationships into the support department cost allocations.
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c) Multiple costing involves the application of two or more methods of


costing in respect of same product. This costing method is used in
industries where a number of components are separately produced and then
assembled into a final product. Suppose a firm manufactures bicycles
including its components, the component parts will be costed by the system
of job or batch costing but the cost of assembling the bicycle will be
computed by the single or output costing method. The whole system of
costing is known as multiple or composite costing.
d) Synergy is the interaction of two or more agents or forces so that their
combined effect is greater than the sum of their individual effects. Business
interaction among groups, especially among the acquired subsidiaries or
merged parts of a corporation that creates an enhanced combined effect is
known as synergy effect. When the presence of one unit enhances the
effects of the second it is call synergistic effect. The word synergy means
that the sum of parts is greater than the total value of each part. The result
of two or more people, groups, processes or organizations working together
enhanced the combined effect of individual people, process or organization.
In other words, one and one equals three! The word is used quite often to
mean that combining forces produces a better product.

In the field of costing, synergy is the result of combined process or unit or


organization that result in cost reduction due to minimization of waste,
shortening processes, division of labour and enhancing productivity,
sharing common cost etc. Synergy affects cost control and ultimately
reduction. Synergy is usually accomplished by combining functions (such
as production or customer service) or facilities (such as warehousing)
eliminating some duplication. Synergetic effect normally helps cost
reduction as follows:
 It increases business volume, so the fixed cost per unit gets reduced.
 It eliminates duplication process or function.
 Labour productivity increases and the cost of labour per unit get reduced.
 Minimizes material waste due to process combination.
 Indirect cost e.g. administration, selling and distribution expenses
minimizes due combination of function

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CAP-II, Financial Management, Dec 2011


Suggested Answer

Roll No……………. Maximum Marks - 100


Total No. of Questions – 7 Total No. of Printed Pages – 4
Time Allowed – 3 Hours
Marks
Attempt all questions.

Working notes should form part of the answer. Make assumptions wherever
necessary.
1. SC Co. is evaluating the purchase of a new machine to produce product P,
which has a short product life-cycle due to rapidly changing technology. The
machine is expected to cost Rs. 1 million. Production and sales of product P
are forecasted to be as follows:
Year 1 2 3 4
Production and sales (units) 35,000 53,000 75,000 36,000
The selling price of product P (in current price terms) will be Rs. 20 per unit,
while the variable cost of the product (in current price terms) will be Rs. 12
per unit. Selling price inflation is expected to be 4% per year and variable
cost inflation is expected to be 5% per year. No increase in existing fixed
costs is expected since SC Co. has spare capacity in both space and labour
terms.
Producing and selling product P will call for increased investment in working
capital. Analysis of historical levels of working capital within SC Co.
indicates that at the start of each year, investment in working capital for
product P will need to be 7% of sales revenue for that year.
SC Co. pays tax of 30% per year in the year in which the taxable profit
occurs. Liability to tax is reduced by capital allowances on machinery (tax-
allowable depreciation), which SC Co. can claim on a straight-line basis over
the four-year life of the proposed investment. The new machine is expected
to have no scrap value at the end of the four-year period.
SC Co. uses a nominal (money terms) after-tax cost of capital of 12% for
investment appraisal purposes.
Required: (12+3+5=20)
a) Calculate the net present value of the proposed investment in new
machine for production of product P.
b) Calculate the internal rate of return of the proposed investment in new
machine for production of product P.
c) Advise on the acceptability of the proposed investment in new machine
for production of product P and discuss the limitations of the evaluations
that have been carried out.
Answer:
a) Calculation of net present value

Year 0 1 2 3 4
Rs. Rs. Rs. Rs. Rs.

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Sales revenue (WN 1) 728,000 1,146,390 1,687,500 842,400


Variable costs (WN 2) (441,000) (701,190) (1,041,750) (524,880)
––––––––– –––––––––– ––––––––––– –––––––––
Contribution 287,000 445,200 645,750 317,520
Capital allowances (depreciation)
(Cost ÷ 4) (250,000) (250,000) (250,000) (250,000)
––––––––– –––––––––– ––––––––––– –––––––––
Taxable profit 37,000 195,200 395,750 67,520
Taxation (11,100) (58,560) (118,725) (20,256)
––––––––– –––––––––– ––––––––––– –––––––––
After-tax profit 25,900 136,640 277,025 47,264
Capital allowances 250,000 250,000 250,000 250,000
––––––––– –––––––––– ––––––––––– –––––––––
After-tax cash flow 275,900 386,640 527,025 297,264

Initial investment (1,000,000)


Working capital (WN 4) (50,960) (29,287) (37,878) 59,157 58,968
––––––––––– ––––––––– –––––––––– ––––––––––– ––––––
Net cash flows (1,050,960) 246,613 348,762 586,182 356,232
PVIF at 12% 1·000 0·893 0·797 0·712 0·636
––––––––––– ––––––––– –––––––––– ––––––––––– ––––––
Present values (1,050,960) 220,225 277,963 417,362 226,564
––––––––––– ––––––––– –––––––––– ––––––––––– –––––––––
NPV = Rs. 91,154
Working Notes:
1) Sales revenue

Year 0 1 2 3 4
Selling price (Rs./unit) 20.00 20·80 21·63 22·50
23·40
(expected to increase @ 4% per year)
Sales volume (units) - 35,000 53,000 75,000
36,000
Sales revenue (Rs.) - 728,000 1,146,390 1,687,500
842,400

2) Variable costs

Year 0 1 2 3 4
Variable cost (Rs./unit) 12.00 12·60 13·23 13·89
14·58
(expected to increase @ 5% per year)
Sales volume (units) - 35,000 53,000 75,000
36,000
Variable costs (Rs.) - 441,000 701,190 1,041,750
524,880

3) Total investment in working capital

Year 0 investment = 728,000 x 0·07 = Rs. 50,960


Year 1 investment = 1,146,390 x 0·07 = Rs. 80,247
Year 2 investment = 1,687,500 x 0·07 = Rs. 118,125
Year 3 investment = 842,400 x 0·07 = Rs. 58,968

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4) Incremental investment in working capital

Year 0 investment = 728,000 x 0·07 = (Rs.50,960))


Year 1 investment = 80,247 – 50,960 = (Rs. 29,287)
Year 2 investment = 118,125 – 80,247 = (Rs. 37,878)
Year 3 recovery = 58,968 – 118,125 = Rs. 59,157
Year 4 recovery = Rs. 58,968

(b) Calculation of internal rate of return


Year 0 1 2 3 4
Rs. Rs. Rs. Rs. Rs.
Net cash flows (1,050,960) 246,613 348,762 586,182 356,232
PVIF at 20% 1·000 0·833 0·694 0·579 0·482
––––––––––– –––––––– –––––––– –––––––– ––––––––
Present values (1,050,960) 205,429 242,041 339,399 171,704
––––––––––– –––––––– –––––––– –––––––– ––––––––
NPV at 20% = (Rs.92,387)
NPV at 12% = Rs.91,154

IRR = 12 + [(20 – 12) x 91,154/(91,154 + 92,387)] = 12 + 4 = 16%(Approx.)

(c) Acceptability of the proposed investment in new machine production of Product P

 The NPV is positive. Hence, the proposed investment can be recommended on financial
grounds.
 The IRR is greater than the discount rate used by SC Co for investment appraisal
purposes. Hence, the proposed investment is financially acceptable. The cash flows of
the proposed investment are conventional and so there is only one internal rate of
return. Furthermore, only one proposed investment is being considered. Therefore,
there is no conflict between the advice offered by the IRR and NPV investment
appraisal methods.
Limitations of the investment evaluations
 Both the NPV and IRR evaluations are heavily dependent on the production and sales
volumes that have been forecast and so SC Co should investigate the key assumptions
underlying these forecast volumes. It is difficult to forecast the length and features of a
product‟s life cycle so there is likely to be a degree of uncertainty associated with the
forecast sales volumes. Scenario analysis may be of assistance here in providing
information on other possible outcomes to the proposed investment.
 The inflation rates for selling price per unit and variable cost per unit have been
assumed to be constant in future periods. In reality, interaction between a range of
economic and other forces influencing selling price per unit and variable cost per unit
will lead to unanticipated changes in both of these project variables. The assumption of
constant inflation rates limits the accuracy of the investment evaluations and could be
an important consideration if the investment were only marginally acceptable.
 Since no increase in fixed costs is expected because SC Co has spare capacity in both
space and labour terms, fixed costs are not relevant to the evaluation and have been
omitted. No information has been offered on whether the spare capacity exists in future
periods as well as in the current period. Since production of Product P is expected to be
more than double over three years, future capacity needs should be assessed before a
decision is made to proceed, in order to determine whether any future incremental fixed
costs may arise.
2.
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a) The market portfolio has an expected return of 15 percent and a


standard deviation of 20 percent. The standard deviation of ABC
Company's stock is 25 percent and its correlation coefficient with the
market portfolio is 0.50.
Required: (2+4+1+1=8)
i) What is the beta of ABC Company's stock?
ii) What would happen to the beta if ABC Company's standard
deviation were 40 percent? And, if the correlation coefficient were
0.60?
iii) Of the total variance of the stock in the original case, what
proportion is accounted for by Systematic risk? Unsystematic
risk? (The correlation coefficient squared is R-squared).
iv) What, in general, would happen to the total variance of a portfolio
if a portion of the ABC Company stock were sold and the
proceeds were invested in unrelated stocks having the same beta?
b) Three companies A, B and C are in the same type of business and
hence have similar operating risks. However, the capital structure of
each of them is different and the following are the details:
A B
C
Equity Share Capital (Rs.) 400,000 250,000
500,000
[Face value Rs. 10 per share]
Debentures (Rs) - 100,000
250,000
[Face value per debenture Rs. 100]
Market value per share (Rs.) 15 20
12
Market value per debenture (Rs.) - 125
80
Dividend per share (Rs.) 2.70 4
2.88
Interest Rate - 10%
8%
Assume that the current levels of dividends are generally expected to
continue indefinitely and the income-tax rate at 50%.
Required:
Compute the weighted average cost of capital of each company. 7

Answer:
a) Given,
Expected Return on market portfolio, E (Rm) =15%
Standard Deviation on market portfolio,σm = 20%
Standard Deviation on ABC Company, σB = 25%
Correlation coefficient between the company & market,pBm =0.50

i) ρBm * σB * σm
The beta of ABC company (βB) =
σm2
= 0.50 * 0.25 * 0.2/ (0.2)2 = 0.625

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ii) In both the instances, Beta increases which is evident from the following equation:
First, if the standard deviation of the company is 40 percent.
ρBm * σB * σm
The beta of ABC company (βB) =
σ m2
= 0.50 * 0.40 * 0.2/ (0.2)2 = 1
Second, if the correlation coefficient were 0.60.
ρBm * σB * σm
The beta of ABC company (βB) =
σ m2
= 0.60 * 0.25 * 0.2/ (0.2)2 = 0.75

iii) R- squared measures the proportion of the total variance of the dependent variable
explained by the independent variable. In our case, R squared = 0.5 * 0.5 = 0.25.
Therefore, 25 percent of the ABC Company's total variance is explained by market
movements (Systematic Risk) while unsystematic risk accounts for 75 percent of the
total variance.

iv) The more stocks with the same beta are added to a portfolio and at the same time the
ABC Company's stock is subtracted, the total variance of the portfolio declines.
Systematic risk stays the same, but unsystematic risk declines with diversification.

b) Calculation of Weighted Average Cost of Capital(WACC)

Amount Weights After Tax Weighted

(Rs.) Cost Cost

i) Cost of Capital of Shares at Market Value

A (400000×15/10) 6,00,000 1.00 (2.70/15) = 18% 18%


B (250000×20/10) 5,00,000 0.80 (4/20) = 20% 16%
C (500000×12/10) 6,00,000 0.75 (2.88/12) = 24% 18%

ii) Cost of capital of Debenture at Market Value


A - - - - -
B (100000×125/100) 1,25,000 0.20 (10/125) ×(1 - 0.5) = 4%
0.80%
C (250000×80/100) 2,00,000 0.25 (8/80) - 0.5) = 5%
1.25%

Weighted average cost of capital


A= + 00% = 18%
B= + 0.8% = 16.8%
C= + 1.25% = 19.25%
Working notes:
Weight of Share capital = MV of Share
MV of Share + MV Debenture.

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Weight of Debenture = MV of Debenture


MV of Share +MV
of Debenture
3.
a) Exorbitant Ltd. has investigated the profitability of its assets and the
cost of its funds. The result of such an investigation has indicated
that:
Current assets earn 1%, Fixed assets return 13%, Current liabilities cost
3%, and Average long-term funds cost 10%.
The current condensed balance sheet of the company is as follows:
Liabilities Amount (Rs.) Assets Amount (Rs.)
Long-term funds 140,000 Fixed assets 120,000
Current liabilities 20,000 Current assets 40,000
160,000 160,000
Required: (3+4.5+1.5=9)
i) Ascertain the net profitability of the firm.
ii) The company is contemplating lowering its net working capital to
Rs. 14,000 by (A) either shifting Rs. 6,000 of its current assets
into fixed assets, or (B) shifting Rs. 6,000 of its long-term funds
into current liabilities. Work out the profitability for each of these
alternatives. Which do you prefer? Why?
iii) Ascertain the effects on the net profitability, if both these
alternatives are implemented simultaneously.
b) A bank offers a fixed deposit scheme whereby Rs. 100,000 matures to
Rs. 126,250 after 2 years, on half-yearly compounding basis. If the
bank wishes to amend the scheme by compounding interest every
quarter, what will be the revised maturity value? 6

Answer
a)
(i) Computation of Net profit of the Firm:
Net profit = Total profit – Total cost of financing
Total profit = Return on fixed assets + Return on current assets
Return on fixed assets = 13% of Rs.120,000 = Rs. 15,600
Return on current assets = 1% of Rs. 40,000 = Rs. 400
Total Rs. 16,000

Total cost of financing = Cost of long-term financing + Cost of current liabilities (short-
term funds)
Cost of long-term funds = 10% of Rs. 140,000 = Rs. 14,000
Cost of current liabilities = 3% of Rs. 20,000 = Rs. 600
= Rs. 14,600
Net profit = Rs. 16,000 – Rs. 14,600 = Rs. 1,400

(ii) (A) Net profit on Shift of Rs. 6,000 of current assets into fixed assets:
Total Profit
Return on fixed assets = 13% of 126,000 = Rs. 16,380
Return on current assets = 1% of Rs. 34,000 = Rs. 340
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Rs. 16,720
Cost of financing:
As computed in (i) above Rs. 14,600
Net Profit = Rs. 16,720 – 14,600= Rs. 2,120

(B) Net profit on Shift of Rs. 6,000 of its long-term funds into current liabilities:
Total Profit = As computed in (i) above Rs. 16,000
Cost of financing:
Cost of long-term funds = 10% of Rs. 134,000 = Rs. 13,400
Cost of current liabilities = 3% of Rs. 26,000 = Rs. 780
= Rs. 14,180
Net profit = Rs. 16,000 – Rs. 14,180 = Rs. 1,820

The profitability of alternative (A) is more, i.e. when Rs. 6000 of current assets are
shifted to fixed assets. It is, therefore, preferable.

(iii)If both alternatives (ii) (A) and (ii) (B) are implemented simultaneously:
Total return = Rs.16,720 [as computed in (ii) (A)]
Total cost = Rs. 14,180 [as computed in (ii (B)]
Net profit = Rs. 16,720 – Rs. 14,180 = Rs. 2,540
Net Profit will increase.

b) Computation of Rate of Interest:


Principal = Rs. 100,000
Amount = Rs. 126,250
100,000 = 126,250
(1 + i)4
Pn = A X (PVF n, i)
100,000 = 126,250 (PV 4, i)
(PV 4, i) = 0.7921
According to the Table on Present Value Factor (PVF4, i), a PVF of 0.7921 for
half-yearly interest of 6 per cent becomes a lump sum of Re. 1. Therefore, the
annual interest rate is 2 X 0.06 = 12 per cent.
Revised maturity value, if interest is compounded quarterly:
Revised maturity value = 100,000 (1 + 12 X 1) 2 X 4 = 100,000 ( 1 + 3 )8
100 4 100
= 100,000 × (1.03) 8
= 100,000 × 1.267 [since (CVF 8, 3) = 1.267]
= Rs. 126,700
Therefore, the revised maturity value will be Rs. 126,700.

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4.
a) A 10-year, 12% semi-annual coupon bond, with a par value of Rs.
1,000 may be called in 4 years at a call price of Rs. 1,060. The bond
sells for Rs. 1,100. Assume that the bond has just been issued.
Required: (4+1+1+4=10)
i) What is the bond‟s effective annual yield to maturity?
ii) What is the bond‟s annual current yield?
iii) What is the bond‟s capital gain or loss?
iv) What is the bond‟s effective annual yield to call?
b) For each of the companies described below, would you expect it to
have a low, medium, or high dividend payout ratio? Explain why? 5
i) A company with a large proportion of inside ownership, all of
whom are high income individuals.
ii) A growth company with an abundance of good investment
opportunities.
iii) A company that has high liquidity and much unused borrowing
capacity and experiencing ordinary growth.
iv) A dividend paying company that experiences an unexpected drop
in earnings from an upward sloping trend line.
v) A company with volatile earnings and high business risk.
Answer
a) Given,

Par value (M) = Rs. 1,000


Coupon rate = 12%
Annual coupon (I) = 12% of Rs 1,000 = Rs 120
Maturity period (n) = 10 years
Call period = 4 years
Call price = Rs. 1,060
Selling price = Rs 1,100
Semi-annual compounding.

i. Calculation of bond‟s effective annual yield to maturity (YTM)

Vd = I(PVIFAkd% , n) + M(PVIFkd% , n)

So, for semiannual bond,

Rs 1,100 = I/2(PVIFAkd%/2 , n x 2) + M(PVIFkd%/2 , n x 2) ………………..(1)

Approximate semiannual YTM

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= 5.16%
Now, trying at 5%,

PV = Rs 60(PVIFA5% , 20 ) + 1,000(PVIF5% , 20)


= 60 x 12.4622 + 1,000 x 0.3769 = Rs 1,124.63 > Rs 11,00
Trying at 6%,

PV = Rs 60(PVIFA6% , 20 ) + 1,000(PVIF6% , 20)


= 60 x 11.4699 + 1,000 x 0.3118 = Rs 999.99 < Rs 1,100

By interpolating,

Semiannual YTM = 5.2%

Therefore, nominal YTM = 5.2% x 2 = 10.4%

The effective annual YTM = (1 + 0.052)2 – 1 = 1.1067 – 1 = 0.1067 = 10.67%

ii. Calculation of bond‟s current yield


= Coupon payments / Price of the Bond
= 120/1,100 = 0.1091
= 10.91%

iii. Calculation of bond‟s Capital gain or loss


We have,

YTM = Current Yield + Capital Gain or Loss Yield


10.67% = 10.91% + Capital Gain or Loss Yield
Capital Gain or Loss Yield = 10.67% - 10.91% = (0.24%)
So, Capital loss is 0.24%
iv. Calculation Bond‟s Yield to Call (YTC)
We have,

Rs 1,100 = Rs 60(PVIFAkd%/2 , 2 x 4) + Rs 1,060(PVIFkd%/2 , 2 x 4)

Approximate semiannual YTC

= 5.061%

Now, trying at 5%,

PV = Rs 60(PVIFA5% , 8 ) + 1,060(PVIF5% , 8)
= 60 x 6.4632 + 1,060 x 0.6768
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= Rs 1,105.20 > Rs 1,100

Trying at 6%,

PV = Rs 60(PVIFA6% , 8 ) + 1,060(PVIF6% , 8)
= 60 x 16.2098 + 1,060 x 0.6274
= Rs 1037.63 < Rs 1,100

By interpolating,

Semiannual YTC = 5.08%

Therefore, nominal YTC = 5.08% x 2 = 10.16%

The effective annual YTC = (1 + 0.0508)2 – 1 = 1.1042 – 1 = 0.1042 =


10.42%

b)
i. Low payout ratio. Highly taxed owners probably will want to realize their
returns through capital gains.
ii. Low payout ratio. There will be no or low residual funds.
iii. Medium or high payout ratio. There are likely to be funds left over after
funding capital expenditures. Moreover, the liquidity and access to borrowing
give the company considerable flexibility.
iv. Medium or high payout ratio. Unless the company cuts its dividend, which
probably is unlikely in the short run, its payout ratio will rise with the drop in
earnings.
v. Low payout ratio. The company will probably wish to retain earnings to build
its financial strength in order to offset the business risk

5.
a) Maya Limited is planning to change its credit policy which is
expected to increase the average collection period from one month to
two months. The relaxation of credit terms is expected to produce an
increase in sales volume by 25%. Following are other relevant data:
Sales price per unit Rs.10
Profit per unit Rs.1.5
Current Sales Revenue per annum Rs. 2,400,000
Required rate of return on investment 20%
Assume that the 25% increase in sales would result additional stock
of Rs. 100,000 and additional creditors of Rs. 20,000.
Required:
Advise the company whether the credit terms should be revised in
following circumstances: (4+3=7)
i) If all the customers take longer credit terms of 2 months.
ii) If current customers do not opt for revised credit terms and only
new customers opt the revised credit terms.

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b) Stock X has an expected rate of return of 10 percent, a beta


coefficient of 0.8, and a standard deviation of expected return of 15
percent. Stock Y has an expected rate of return of 15 percent, a beta
coefficient of 1.5, and a standard deviation of expected returns of 20
percent. The risk-free rate is 4 percent, and the market risk premium
is 6 percent.
Required: (2+2+2+2=8)
i) Which stock is riskier in terms of total risk?
ii) Which stock is riskier for diversified investor?
iii) Calculate each stock‟s required rate of return. What is its
significance?
iv) Calculate expected return of a portfolio that has Rs. 60,000
invested in Stock X and Rs. 40,000 invested in Stock Y?
Answer
a) The revision of credit terms is justifiable if the rate of return on the additional
investment in working capital exceeds 20%.

Extra profit from the revision


Profit Margin (1.5/10) = 15%
Increase in sales revenue = 2,400,000x25% = Rs. 600,000
Increase in profit = 600,000x15% = Rs. 90,000
Total sales revenue after revision = (2,400,000+600,000) = Rs. 3,000,000
Now, we need to calculate return on extra investment in working capital so as to assess whether
the revision of credit terms is justifiable. This is generally done by taking the figure of debtors
on the basis of cost of sales and sometimes on the basis of sales. Computations have been done
below by following both the basis.
(i) If all Debtors take two months’ Credit:
Cost of Sales
Sales Basis Basis
Rs. Rs.
Average Debtors after the Sales Increase 425,000 500,000
(2/12 x Rs. 3,000,000 x 85%)
(2/12 x Rs. 3,000,000)
Current Average Debtors 170,000 200,000
(1/12 x Rs 2,400,000 x 85%)
(1/12 x Rs 2,400,000)
Increase in Debtors 255,000 300,000
Increase in Stocks 100,000 100,000
355,000 400,000
Increase in Creditors (20,000) (20,000)
Net Increase in Working Capital Investment 335,000 380,000
Return on Extra Investment (Cost of Sales Basis) = 90,000/335,000 = 26.87%
Return on Extra Investment (Sales Basis) = 90,000/380,000 = 23.7%

(ii) If only the New Debtors take Two Months’ Credit:


Cost of Sales
Sales Basis Basis
Rs. Rs.
Increase in Debtors 85,000 100,000
(2/12 x Rs. 600,000 x 85%)
(2/12 x Rs. 600,000)
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Increase in Stocks 100,000 100,000


Increase in Creditors (20,000) (20,000)
Net Increase in Working Capital Investment 165,000 180,000

Return on Extra Investment (Cost of Sales Basis) = 90,000/165,000 = 54.55%


Return on Extra Investment (Sales Basis) = 90,000/180,000 = 50%

Recommendation:
In both the cases (i) and (ii), the new credit policy appears to be worthwhile
under both the basis. Furthermore, the most of the product can also support extra
sales. If the firm has high fixed costs but low variable costs, the extra production
and sales could provide a substantial contribution at little extra cost.

Alternative Solution:
Statement of evaluation of credit policy- if all debtors take 2 months' credit
Increase/
Particulars Current New (Decrease)
Average collection period (ACP) month 1 2
ACP in year 0.0833 0.1667
Required Rate of return on investment 20%
Sales Revenue Rs. 2,400,000 3,000,000
Sales Volume (SR/ SP) unit 240,000 300,000
Selling Price/ unit Rs. 10 10
Cost of sales/ unit (SP-P) Rs. 8.50 8.50
Profit/ unit Rs. 1.50 1.50

Profit before cost of investment Rs. 360,000 450,000 90,000


(Profit x Sales unit)
Less: Cost of investment (WN 1) 34,000 101,000 67,000
Net profit 326,000 349,000 23,000
Since net profit increases by Rs.23,000 the revision in credit policy is justifiable.

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Statement of evaluation of credit policy- if only the new debtors take 2 months' credit
Increase/
Particulars Current New (Decrease)
Average collection period (ACP) month 1 2
ACP in year 0.0833 0.1667
Required Rate of return on investment 20%
Sales Revenue Rs. 2,400,000 3,000,000
Sales Volume (SR/ SP) unit 240,000 300,000
Selling Price/ unit Rs. 10 10
Cost of sales/ unit (SP-P) Rs. 8.50 8.50
Profit/ unit Rs. 1.50 1.50

Profit before cost of investment Rs. 360,000 450,000 90,000


(Profit x Sales unit)
Less: Cost of investment (WN 2) 34,000 67,000 33,000
Net profit 326,000 383,000 57,000
Since net profit increases by Rs.57,000 the revision in credit policy is justifiable.

Working Notes:
1. Calculation of cost of investment: Rs. Rs. Rs.
Cost of Sales 2,040,000 2,550,000
(Sales unit * CoS per unit)
Investment in debtor (CoS x ACP in yr) 170,000 425,000
Increase in Stock 100,000
Increase in Creditors (20,000)
Additional working capital investment - 80,000
(a) Cost of investment in debtors 34,000 85,000 51,000
(Investment in Debtor x required rate of return)
(b) Cost of investment in additional WC - 16,000 16,000
(Additional WC x required rate of return)
Total cost of investment (a + b) 34,000 101,000 67,000

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2. Calculation of cost of investment: Rs. Rs. Rs.


Cost of Sales 2,040,000 2,550,000
(Sales unit * CoS per unit)
Investment in debtor (CoS x ACP in yr) 170,000 255,000
Increase in Stock 100,000
Increase in Creditors (20,000)
Additional working capital investment - 80,000
(a) Cost of investment in debtors 34,000 51,000 17,000
(Investment in Debtor x required rate of return)
(b) Cost of investment in additional WC - 16,000 16,000
(Additional WC x required rate of return)
Total cost of investment (a + b) 34,000 67,000 33,000

Note:
If only the new debtors take 2 months credit, New total investment in debtors is calculated as below:
Investment in debtors=
Current investment in debtor + (New CoS- Old CoS) x required rate of investment

b) Given,

Stock X Stock Y

Expected rate of return 10% 15%

Beta coefficient 0.8 1.5

Standard deviation of expected return 15% 20%

Rf = 4%
Market risk Premium (MRP) = 6%
i. Total risk is measured by coefficient of variance (CV).
CV of stock X= standard deviation/Expected rate of return
CV of stock X= 0.15/0.1= 1.5
CV of stock Y= 0.2/0.15=1.3333
Since stock X has higher CV, stock X is riskier than stock Y.

ii. Which stock is riskier for diversified investor?


For diversified investor, the stock having higher Beta is more riskier. Beta measures
the risk of individual assets relative to the market portfolio. The beta of the market
portfolio is 1. Assets with beta less than 1 are called defensive assets and assets with
beta greater than 1 are called aggressive assets. Risk free assets have a beta equal to
zero. Therefore, Stock Y is riskier as it has higher beta.

iii. Calculate each stock‟s required rate of return. What is its significance?
Required rate of return= Rf +Beta × MRP

Required rate of return of X = 4%+6% × 0.8=8.8%


Required rate of return of Y= 4%+6%×1.5=13%
iv) Calculate expected return of a portfolio that has Rs 60,000 invested in
Stock X and Rs 40,000 invested in Stock Y

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Expected Rate of Stock X = 10%

Expected Rate of Stock Y = 15%

Expected Rate of Portfolio = 10% 0.6 + 15% 0.4


= 6% + 6%
= 12%
6. Write short notes on: (4×2.5=10)
a) Debt Securitization
b) Significance of Debt-equity Ratio as a Measure of Long-term Solvency
c) Assumptions of Capital Asset Pricing Model (CAPM)
d) Sensitivity Analysis
Answer :
a) 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
asset pool, market securities can be issued, e.g. housing finance, auto
loans, and credit card receivables.
Process of Debt Securitisation:
(i) The origination function – A borrower seeks a loan from a bank
and financial institution. The credit worthiness of borrower is
evaluated and contract is entered into with repayment schedule
structured over the life of the loan.
(ii) The pooling function – Similar loans on receivables are clubbed
together to create an underlying pool of assets. The pool is
transferred in favour of Special purpose Vehicle (SPV), which acts
as a trustee for investors.
(iii) The securitisation function – SPV will structure and issue
securities on the basis of asset pool. The securities carry a coupon
and expected maturity which can be asset-based/mortgage based.
These are generally sold to investors through merchant bankers.
Investors are – pension funds, mutual funds, insurance funds.
The process of securitization is generally without recourse i.e.
investors bear the credit risk and issuer is under an obligation to pay to
investors only if the cash flows are received by him from the
collateral. The benefits to the originator are that assets are shifted off
the balance sheet, thus giving the originator recourse to off-balance
sheet funding
b) The Debt-equity (D/E) ratio is calculated by comparing the long term
debts with the total shareholders funds. The D/E ratio throws light on the
margin of safety available to the debt providers of the firm.
If a firm with a high D/E ratio fails, then a part of the financial loss may
have to be borne by the debt providers. Thus, the greater the D/E ratio,
higher would be the risk of the lenders. From the view point of
shareholders, a high D/E ratio implies that the firm is having a high
degree of financial leverage which offers the opportunity and benefit of
trading on equity. In such a case, if the rate of return of the firm is more
than the cost of debt, then higher degree of financial leverage means
relatively higher return to the shareholders.

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The higher D/E ratio may also have an impact on the ability of a firm to
service the debt. In addition to the payment of principal and interest on
debt, such a ratio might have an adverse impact on a firm‟s ability to pay
other fixed and contractual payments in addition to the principal and
interest. On the contrary, a low D/E ratio implies a low risk to the lenders
and creditors for the firm but it will not offer the benefit of trading on
equity. Therefore, a proper balance between the proportion of debt and
equity is very much essential in order to take care of the interests of both
the lenders and the shareholders and for the long term sustainability and
solvency of the firm.
c) The capital asset pricing model (CAPM) is based upon the following
assumptions:
i. The investors are basically risk averse and diversification is needed to
reduce the risk.
ii. All investors want to maximize the wealth and therefore choose a
portfolio solely on the basis of assessment of risk and return.
iii. All investors can borrow or lend an unlimited amount of funds at risk-
free rate of interest.
iv. All investors have identical estimates of risk and return of all securities.
v. All securities are perfectly divisible and liquid and there is no
transaction cost or tax.
vi. The security market is efficient and purchases and sales by a single
investor can not affect the prices which also mean that there is perfect
competition in the market.
vii. All investors are efficiently diversified and have eliminated the
unsystematic risk. Thus, only the systematic risk is relevant in the
determination of estimated return.

d) The net present value or Internal Rate of Return of a project is determined by analyzing the
after tax cash flows arrived at by combining forecasts of various variables like Sales
volume, unit selling price, unit variable cost, fixed cost etc. It is difficult to arrive at an
accurate and unbiased forecast of each variable. It can't be certain about the outcome of
any of these variables. The reliability of the NPV or IRR of the project will depend on the
reliability of the forecasts of variables underlying the estimates of net cash flows. To
determine the reliability of the project's NPV or IRR, we can work out how much difference it
makes if any of these forecasts go wrong.. We can change each of the forecasts, one at a
time, to at least three values: Pessimistic, expected and optimistic. The NPV of a project is
recalculated under these different assumptions. The method of recalculating NPV or IRR by
changing each forecast is called Sensitivity Analysis.

Sensitivity Analysis is a way of analyzing change in the project's NPV or


IRR for a given change in one of the variables. It indicates how sensitive a
project's NPV or IRR is to changes in particular variables. It basically
examines the sensitivity of the variables underlying the computation of NPV
or IRR rather than attempting to quantify risk. It can be applied to any
variable which is an input for the after tax cash flows. It can be conducted
with regard to volume, price, costs etc.
7. Distinguish between: (4×2.5=10)
a) External Capital Rationing and Internal Capital Rationing
b) Yield to Call and Yield to Maturity
c) Recourse and Non-recourse Factoring
d) Profit Maximization and Wealth Maximization Objective
Answer
a) External Capital Rationing mainly occurs on account of the imperfections in
capital markets. Imperfections may be caused be deficiencies in market
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information or by rigidities of attitude that may hamper the free flow of


capital. For example, A Ltd. is a closely held company. It borrows from the
financial institutions as much as it can. It still has investment opportunities,
which can be financed by issuing equity capital. But it doesn't issue shares.
The owners- managers do not approve the idea of the public issue of shares
because of the fear of losing control of the business.
Internal capital Rationing is caused by self- imposed restrictions by the
management. Various types of constraints may be imposed. e.g, it may be
decided not to obtain additional funds by incurring debt. This may be part of
management's conservative financial policy. Management may fix an
arbitrary limit to the amount of funds to be invested by the divisional
managers. Sometimes, management may resort to capital rationing by
requiring a minimum rate of return higher than the cost of capital.

b) The yield to Maturity (YTM) is the measure of a bond's rate of return that
considers both the interest income and any capital gain or loss. YTM is the
bond's internal rate of return. To calculate the Actual yield to maturity, first
the approximate yield to maturity is calculated as follws:
I + M – Vd
n ( 1- T)
AYTM=
M + 2 * Vd
3
Where, T = Tax Rate, M = Maturity Value, n = Maturity period, Vd = Market
Price of bond, I = Interest payment on bond.
After calculating the approximate yield to maturity, interpolation shall be
done by using the two rates which are below and above the approximate rates
to get the actual yield to maturity.
A number of companies issue bonds with buyback or call provision. Thus, a
bond can be redeemed or called before maturity. YTC is the yield or the rate
of return of a bond that may be redeemed before maturity. The procedure for
calculating the yield to call is the same as yield to maturity. The call period
would be different from the maturity period and the call or redemption value
could be different from the maturity value.

c) In a recourse or pure factoring, the factor firm is only involved in the work
of collection of the receivables. It does not bear any risk of default by the
debtors. Such a risk will have to be invariably borne by the selling firm.
Thus, in case of default by a customer, the selling firm will have to refund the
amount of advance together with charges as per the agreement which was
given by the factor to the selling firm against the receivables.
In a non-recourse factoring, the factor firm purchases the receivable of the
selling firm by paying the agreed amount (sales value less commission) to
the latter. The payment may be made immediately or after receiving from
the customer buying.
The main feature of non-recourse factoring is that the risk of default by the
buyer is borne by the factor firm and the selling firm receives the sales
amount. Thus, this type of factoring will result in the purchase of receivable
by the factor firm.

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In non-recourse factoring, the factor also undertakes the receivables


management including evaluation of creditworthiness, thereby also
assessing the risk of bad debts. In this type of factoring, the factor firm will
normally insist on discounting the seller‟s entire book debts subject to
careful examination of the debtors and their creditworthiness. In such cases,
the seller is entitled to sell to other customers not evaluated as credit-worthy
but these sales would obviously be excluded from the services of the non-
recourse factor.

d) The company may pursue profit maximization goal but that may not result
into creation of shareholder value. The profits will be maximized if company
grows through diversification and expansion. But all growth may not be
profitable. Only that growth is profitable where
ROA > WACC or ROE > KE or Firms invest in project with positive NPV,
However, profit maximization cannot be the sole objective of a company. It is at best a
limited objective. If profit is given undue importance, a number of problems can arise like the
term profit is vague, profit maximization has to be attempted with a realization of risks
involved, it does not take into account the time pattern of returns and as an objective it is too
narrow.
Whereas, on the other hand, wealth maximization, as an objective, means
that the company is using its resources in a good manner. If the share value
is to stay high, the company has to reduce its costs and use the resources
properly. If the company follows the goal of wealth maximization, it means
that the company will promote only those policies that will lead to an
efficient allocation of resources.

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CAP-II, Businesss Communication, Dec 2011


Suggested Answer

Maximum Marks –
100

Total No. of Questions - 10

Time Allowed – 3 Hours


Marks
All questions are compulsory.
Section -'A'
1. Read the following case carefully and answer the questions given below: 10
The CEO of the Siddhu Bank Ltd., with its head office based in Kathmandu,
has asked you, Senior Manager of the bank to write a reply to a group of
hard-working and devoted managers, who have frequently expressed their
dissatisfaction before the CEO that employees of some branches have to
work devotedly, whereas some in some other branches of the same office
spend their duty hours leisurely, gossiping and chit-chatting most of the
time. The complaint made argued that such a situation might have a negative
impact on the sincere and hard-working employees, ultimately resulting in
organizational ineffectiveness. Also they drew attention of the concerned
towards taking necessary measures.
Reply without concealing reality of the situation including the following:
a) That the top management of the bank is well aware of the situation.
b) That such a situation exists more or less in every organization, but it is
not good.
c) That decision has recently been taken to monitor and evaluate employee
performance of each and every section from the next month, and actions
would be taken against those who are negligent in their regular duties.

Answer No. 1

Jan 11, 2012

Siddhu Bank Limited


Babarmahal, Kathmandu
www.sidhu.org.np
014222133

Dear Managers,
We would, with serious concern, like to let you know that your complaint about the
lack of employee performance evaluation in the bank‟s operational system is justified to
some extent. The complaint clearly intends to hint upon negligence of top management
towards an absence of a fair and just employee evaluation system. Your suspicion
sounds reasonable to the extent that employees of some sections do not seem to be
working seriously and devotedly.
The reality of the situation is that disparity in staff performance exists in other
organizations also. This is a human factor and you would all realize that of all the
aspects of management, human resource management (HRM) is very crucial and
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challenging, because this is purely a subjective matter. But such an argument, however,
does not justify disparity in our organization. All the staff members of the organization
have to be equally performing better, ultimately contributing to organizational
effectiveness.
One thing, to the credit of the quality and excellence of your performance, your hard
work, devotion and dedication will pay off not only for your organization, but also for
honing up your own professional skills and performance effectiveness. Such a creative
activity should be taken as a stepping stone to career building.
For your information and satisfaction, the top management has recently taken decision
to regularly monitor and evaluate employee performance of all the sections to address
the problem with justice and impartiality. Departmental actions would be taken against
acts of negligence.
Rest assured that things will go well with the times.

On behalf of the top management,


Senior manager
Prakash Regmi

2. “Organizational communication cannot be complete and effective without


proper use of non-verbal communication”.
Justify this statement citing five different situations, in which organizational
people make the best use of non-verbal communication - cues, signs and
symbols, gestures, graphics, etc. to fulfill the intended communication need. 10

Answer No. 2

Non-verbal communication, entirely different from verbal communication, is employed in


particular circumstances in which the speaker remains incapable in communicating verbally,
or the speaker thinks that articulating something verbally might sound uneasy, impractical and
unethical. Non-verbal communication also applies to the style of directness and indirectness.
Indirect styles of non-verbal communication are used in circumstances in which the speaker is
poised to communicate matters (prohibited or inconvenient or unethical) indirectly.
There are lots of examples of situations in which verbal communication becomes inadequate,
inconvenient and non-verbal communication becomes indispensable.

Five different situations, in which organizational people make the best use of non-verbal
commutation – cues, signs and symbols, gestures, graphics, etc. to fulfill human
communication needs, are as follows:
Example No. 1.
During paper presentation, the director of an Insurance Company (ABC Insurance Company),
who intends to speak something in a Board meeting about the lingering corruption in the
organization he belongs to, cannot directly express the matter of corruption. At this, he is
obliged to use non-verbal communication. Wearing a reddish face, he rubs his palms together
to convey the message indirectly.
Example No 2.
Use of Signs: At offices and important public places “No smoking” message is transmitted
with a cross laid across a burning cigarette butt.
Example No. 3

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Someone wants to say good luck to a friend on his winning gold medal in a 200 meter race, but
he cannot do so because of the distance. Here, he holds his thumb upwards.
Example No 4.
Some villagers overtaken by a fear of vandalism created by a group of miscreants from a
neighboring village turn pale, wear frightened looks, and seem terrified, but afraid and unable
to speak anything. Their movements- the lowering of eyebrows, clenching of jaws and, labio-
dental contact (contact between lip and teeth) reflect their fear and anxiety.
Example No 5.
An angler in England will demonstrate the size of the fish he has caught by holding his two
hands, palms facing each other, but an angler from certain parts of Africa will measure off the
size along his left arm with his right hand.

3. Assume you didn‟t get the job. Although someone else was selected, you
hope that other jobs may become available. Write a 3-4 paragraph follow-up
letter that keeps the door open. Write in the „simplified letter style‟ format as
suggested in your textbook. 10

Answer No. 3

Prayag Marg
New Baneshwor, Kathmandu

July 23, 2011

Mr. Akhilesh Poudel


Human Resourse Manager
TransNepal Business House
Durbarmarg, Kathmandu

Dear Mr. Poudel

Although I am disappointed that someone else was selected for your accounting
position, I appreciate your promptness and courtesy in notifying me. I‟ve heard
much about the reputation and fame of your institution. I believe that the selection
process that you have adopted is highly reliable and justifying. The selected
candidate, I hope, is obviously more suitable than myself. I‟m well convinced that
my desire to serve in your institution will be fulfilled in the vacancy announcement
that will be made in the future.

Because I firmly believe that I have the technical and interpersonal skills needed to
work in your fast-paced environment, I hope you will keep my resume in your
active file. My desire to become a productive member of your TransNepal staff
remains strong.

I enjoyed our interview, and I especially appreciate the time you and Mr. Satish
Gyawali spent describing your company‟s expansion into international markets. To
enhance my qualifications, I‟ve enrolled in a course in International Accounting at
CSU. I have also submitted the certificate that I‟ve recently obtained after
completing the IT training launched by the Institution of Information Technology,
KU.

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Should you have an opening for which I am qualified, you may reach me at 9844-
××××××.

Sincerely
Hari Prasad Aryal

4. What do you understand by a meeting in organizational context? What are


the procedures to be followed for conducting an effective meeting? 10

Answer No. 4

Meeting is a formal gathering of people who are involved in an organization or office.


The members of the organization hold meetings in order to discuss and make decisions
about the issues related to their business. The participants of a meeting have to deserve
certain rules, regulations and maxims. Meeting is also defined as meeting is a series of
proceedings in which the chairperson and the secretary, apart from the members play
significant roles right from the first to the final stage/phase of the meeting.

Conducting an effective meeting in organizational context involves a series of


procedures.
Procedures followed during the preparation and meeting conducting phases are as
follows.
 Collecting facts, information available and relevant materials.
This is done by the secretary in consultation with the President
 Setting objectives with guidelines. This is done by the president with the support
and cooperation of the secretary.
 Preparing agendas and sub-agendas. The agendas are as per organizational
requirements. They are jointly produced by the president and the secretary.
 Considering procedures likely to be followed. They are decided as directed by the
president. In most cases, the members are informed about them before the meeting
is conducted.
 Pre-informing the participants about meeting details. This is the fundamental job of
the office- secretary. The information contains the agendas, venue, date and time of
the meeting. The secretary also makes available copies of decisions taken during the
preceding meeting.
 Getting and taking the attendance. The secretary should maintain in the attendance
register. The attendance should contain signatures put down against the names.
 Minuting down the discussions and decisions taken in the meeting. The secretary is
required to forward copies of the minutes after the meeting is over.

5. Write short notes on Any Four of the following: (4×2.5=10)


a) Minutes and follow-up
b) Checklist for improving listening
c) Ethical communication in business
d) Report and proposal
e) Executive summary

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Answer No. 5

a) Minutes and follow-up


The minutes of a meeting can be very different in style and detail: „minutes vary from the
cursory “bullet” variety to the long “court reporter” variety‟ (Tropman, 1996). At one end
of the scale, we have decisions or action points recorded as a list with no explanation or
elaboration of the discussion. This is appropriate for some meetings, say a small project
group. At the other end, we have a complete record of what everyone said. A verbatim
report of that kind is far too time-consuming, and is unnecessary for most if not all business
meetings. A useful compromise is to prepare „content minutes‟– for each item on the
agenda. A minute is written as two separate paragraphs which:
 summarize the main points in the discussion;
 summarize the decision taken or the action agreed, naming whoever has to carry it out,
and giving the timescale or deadline.

Follow-up is a process of confirming the implications of meeting decisions or minutes


when decisions are made in the meeting and they are not implemented well, then the
follow-up activities need to be carried out. The major goal of follow-up is to ensure the
implementation of the decisions of a meeting.

b) Checklist for improving listening: Listening is a receptive skill of communication. A


successful communication event requires very careful and decent subskills of listening. The
participants need to observe certain maxims for making listening more effective. The
following points can be involved in the checklist for improving listening.
 Stop talking
 Work hard at listening
 Block out competing thoughts
 Control the listening environment
 Maintain an open mind
 Paraphrase the speaker‟s ideas
 Listen between the lines
 Capitalize on lag time

c) Ethical communication in business


Every business is dependent on effective ethical communication. It's what makes
new policy in government, raises money for nonprofits and strengthens a business.
Business communication occurs any time a message is given or received, whether
it's verbal or nonverbal, between two businesses, a business and its employees or a
business and the public. The messages sent and received by a business need to
follow ethical norms that don't offend or make individuals feel uncomfortable.

d) Report and proposal


The general purpose of a report is to identify a specific problem, explain it and
recommend action that will lead to a solution. It is usually written to someone with
authority (e.g. manager, boss, director, public official, etc.) or peer (e.g. colleague,
associate, classmate, etc.). Generally, a report is written after a survey, research, or
action. It may include valuable recommendations related to the topic or isssue on
which it is written.

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The general purpose of a proposal is to identify a particular need, explain it and


recommend how this need can best be met. It is usually written to someone who
needs to make a decision usually which involves spending or investing money (e.g.
a client or customer, a committee, someone responsible for finances within
company or organization, etc.). A proposal is generally prepared before the action
or research. It may include details about plans, objectives, cost, time, methodology,
etc. needed for carrying out the action or research.

e) Executive summary
Executive summary denotes a short document that summarizes a longer report,
proposal or group of related reports in such a way that readers can rapidly become
acquainted with a large body of material without having to read it all. It will usually
contain a brief statement of the problem or proposal covered in the major
document(s), background information, concise analysis and main conclusions. It is
intended as an aid to decision making by business managers.

The executive summary will make a potential funder, partner or customer want to
go further. In many instances, it could be all that they look at to make a decision on
something important to you and your business success.

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CAP-II, Marketing, Dec 2011


Suggested Answer

Section -'B'

6. Read the following case carefully and answer the questions given below: (2×5=10)
Nabin Mahatto, a fresh chemical engineer, developed a new detergent
during his M. Tech. course. Upon passing out, he invested a small capital to
start manufacturing and selling the detergent under the brand name „Nippo‟.
Coming from a middle-class family himself, Mahatto decided to price his
detergent much lower than the other detergents available in the market at
that time. His pricing strategy paid rich dividends and Nippo became an
instant success. Using his newly acquired financial strength, Nabin
developed premium quality bathing soap with a unique colour and perfume
combination. Although, the cost price of this soap was high, Nabin priced it
lower to make it a comparable product in the market by maintaining a low
profit margin.
Questions:
a) Identify the factors Nabin considered in formulating pricing strategy of
the new bathing soap.
b) Comment on the suitability of pricing strategy in the case of the bathing
soap.
Answer No. 6
a) Determining the pricing strategy for a product depends on the product itself and
its distribution and promotion aspects. The pricing at the time of the launch of
the product is important from the point of growth or likely arrival of
competition. These factors were fully considered to formulate pricing strategy
for the new bathing soap.

b) I think, basically, keep an introductory price low and increase the same as the
sales build up. Stabilize the price as sales growth levels off. Reintroduce low
prices when the sales decline till the product has to be withdrawn.

Merits: Nabin's pricing strategy for the new bathing soap will help in easy and
quick growth of the sales during the introductory phase.

Demerits: This strategy doesn‟t take into account the fact that the product can
be easily copied. The strategy also doesn‟t cater to the effects of competition.
Even low price of a product like a new and unique bathing soap could create
doubts about the quality of the product among the customers.

7.
a) What is marketing? Explain the major features of marketing in Nepal. (2+3=5)
b) What are the requirements for effective segmentation of a consumer
market? 5

Answer No. 7

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a) Marketing is a total system of business activities designed to plan, price,


promote and distribute want satisfying product to target markets to achieve
organizational objectives. Marketing process involves planning and
implementation of all the marketing related activities to meet organizational
goals. It includes all the exchange related business activities which direct the
flow of goods and services from the producer to consumers. Today marketing is
fast growing, dynamic and highly competitive. The entire business activities
should be customer-oriented. Customer supremacy is seen in modern marketing,
besides realization of social responsibilities. Marketing provides values and
benefits to customers, firms and the society. Technology, globalization, growing
income and support services, have helped a lot in the fast growth of marketing
activities. A large number of people have got employment in this sector.

The following major features are found in Nepalese marketing:

 Low customer awareness


 Price sensitive customers
 Domination of middlemen
 Weak transportation system
 Lack of professionalism
 Small market size
 Uncertain environment
 Less customer orientation
 Weak information and communication
 Push selling; behavioral variables are neglected, etc.

b) Business organizations operate in different markets and the markets consist of


all types of existing and potential customers with their varying needs and wants.
Market Segmentation is the process of sub-dividing or breaking up the market
into different cohesive and homogeneous groups with a distinct marketing mix.
The Requirements for effective segmentation are:

Measurable: The size, purchasing power and profits of the segments should be
measured.

Accessible: The market segments should be effectively reached and served.

Substantial: The market segments should be large or profitable enough to serve.

Differential: The segments should be conceptually distinguishable and respond


differently to different marketing mix elements and programs.
Actionable: Effective programs should be designed for attracting and serving
the segments.
8.
a) "Buyer behavior is a decision making process". Comment. 5
b) Describe the role of product lifecycle in marketing decision making. 5
Answer No. 8

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a) While trying to understand the complex buyer decision making process,


marketers are making an attempt to understand the buyer behavior in terms of
who buys products or services, what they buy, how do they buy, when do they
buy, where do they buy, why do they buy, how often do they buy and so on
before developing marketing plans. It has been understood that factors
influencing the buyer behavior are social, cultural, personal and psychological.
Marketers are approaching this problem of trying to understand the complex
buyer behavior with the help of various models and theories. The buyer‟s choice
is the result of complex interplay of the influencing factors of buyer behavior.
Thus, buyer behavior is decision making process.

b) The product life cycle is a concept that attempts to describe a product's sales
profits, customers, competitors, and marketing emphasis from its beginning
until it is removed from the market. The product life cycle concept became
popular for the first time in 1965 through the efforts of Theodore Levitt.
Actually, the product life cycle is an attempt to recognize distinct stages in the
sales and profit history of the product. It explains the following facts to the
marketing decision makers:
 Products have a limited life after which the product may be dead if
appropriate strategies are not adopted.
 Product sales pass through distinct stages, each posing different challenges
to the seller.
 Product profits rise and fall at different stages of the product life cycle.
 Products require different marketing, financial, manufacturing, purchasing,
and personnel strategies at different stages of their life cycle.

The product life cycle helps marketers in the following ways:


i. It communicates the marketer that a product, like a living creature, has a
limited life.
ii. It helps the marketers in identifying the sales and profit situation of the
particular product in the market place.
iii. It helps to adopt right investment strategy at different stages of product
life cycle.
iv. It helps to adopt appropriate pricing, promotion, distribution, and
competitive policy in different stages of product life cycle.
v. It also warns the marketer and makes him alert about changes regarding
sales, profit, and competition.

More particularly, the product life cycle concept helps a marketer to formulate
and adopt suitable marketing, investment and competitive strategies at right
time.
9.
a) Discuss the effects of Socio-political environment on Nepalese
marketing system. 5
b) Give the meaning of advertising and explain the objectives of
advertising. 5

Answer No. 9
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a) The socio-political environment include two major marketing environmental


forces – social environmental and political environment. These are two major
environmental forces that affect freedom in work. If the social and political
environments are suitable, they will provide freedom in work and vice versa. In
Nepal both social and political environments are not supporting business
communities. Some of the major reasons are as follows:
i. Frequent change in government has annoyed business sector;
ii.Political unrest has created risk of security to the people;
iii.
Lawless situation has pushed the political cadres towards social barbarism;
iv.Labor unrest has damaged industrial sector and hence weakened production
and productivity in the country;
v. The present social and political environment has made the country
dependent on foreign products.

b) Advertising is any paid form of non-personal presentation and promotion of


ideas, goods, or service by an identified sponsor. It is a cost effective way to
disseminate message to scattered large masses. Advertising can be used to meet
the goals like giving information, persuading consumers, reminding and
reassuring customers.

Advertising today has got a prominent role in the promotion program of all
firms/companies. Many methods, media, agencies are playing active role to
meet advertising objectives of the companies. A lot of people are involved to
design attractive advertising focusing on mission, money, message, media, and
measurement elements known as the five Ms of advertising. Newspapers,
journals, posters, radio, TV, video are a few ad vehicles popularly used by the
organizations.

The following are some of the objectives of advertising:


 Communication of information/message
 Creation and extension of demand
 Introduce new product.
 Educate, persuade and remind.
 Influence at sight of buying decision.
 Save time and money.
 Selling on mass scale.
 Promotion of competition/ image building.
 Help middlemen, etc.

10. Briefly explain the following : (5×2=10)


a) Channel Dynamics
b) Decision support system as a component of MIS
c) Pull Vs Push strategy
d) Test marketing
e) E-commerce

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Answer No. 10
a) Channel Dynamics: The distribution channel system in marketing is dynamic.
Channel dynamics means the changes that evolve in the distribution channels
due to emergence of new marketing intermediaries (i.e. wholesalers and
retailers). Distribution channels do not stand still. They change in accordance
with the emergence of new channel participants. There are two types of channel
dynamics i.e. structural dynamics and behavioral dynamics.
b) Decision support system, also called as information analysis system or
marketing decision support system, is a set of statistical or mathematical tools
and decision models that help the marketing managers in analyzing data
gathered or supplied through MIS for making rational decision. Analytical
system helps marketers to make decisions on the problems by telling the truth
about the situations. In other words, analytical systems allow a firm to ask,
"Why did that happen?" and "What will happen if……..?" Mathematical and/or
statistical tools and decision models are used to solve several marketing
problems.
c) Pull Vs Push strategy: The promotion mix is affected by whether the
organization adopts a push strategy or a pull strategy. Pull strategy calls for
spending a lot on advertising and consumer promotion to build up consumer
demand. If the strategy is successful, consumers will ask their retailers for the
product, the retailers will ask the wholesalers and the wholesalers will ask the
producers. Push strategy calls for using the sales force and trade promotion to
push the product through channels. The producer promotes the product to the
wholesalers, the wholesalers to the retailers and the retailers to consumers.
d) It is related with testing commercial viability of new product and the marketing
mix designed for the product in the context of a market segment on a limited
scale. Marketing is done to make necessary changes in the marketing mix. The
product is sold in selected areas with the help of local level promotions in few
shops. Test marketing is periodically evaluated in terms of trial rate, advertising
effectiveness, and repeat purchase rate like variables.
e) E-commerce or electronic commerce refers to selling and buying something
electronically by using Internet facility. Therefore, e-commerce is also known as
„Internet shopping‟ or „Internet commerce‟. The buying or selling products
through Internet are software, documents, graphics, music, etc. These days,
physical products are also marketed through Internet.

Basically, there are three types of e-commerce; they are as follows:


i. Business-to-Consumer (B2C) Electronic Commerce: This type of
electronic commerce involves retailing products and services directly to
individual shoppers. For example, Barnes&Noble.com sells books, software,
and music to individual consumers.
ii. Business-to-Business (B2B) Electronic Commerce: This type of electronic
commerce involves in selling of goods and services among businesses. Web
auction site is used for selling cutting tools, grinding wheels, and metal
working fluids to more than 100,000 small machining businesses.
iii. Consumer-to-Consumer (C2C) Electronic Commerce: This type of
electronic commerce involves consumers selling directly to consumers. For
example, eBay, the giant Web auction site, allows people to sell their goods
to other consumers by auctioning the merchandise off to the highest bidder.

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CAP II - Income Tax & VAT – Dec 2011


Suggested Answers

Maximum Marks - 100

Total No. of Questions - 6

Time Allowed - 3 Hours


Marks
Attempt all questions. Working note should form part of the answer.

8. Answer the following with reference to the Indian Income Tax Act, 1961.
a) The term “Assessment Year” and “Previous Year” have the same
meaning. Do you agree? If not why? 2
b) List down the incomes which do not form part of Total Income? 2
c) During the previous year 2009-10 R and Sons HUF was partly
controlled from India by its Karta R who is citizen of India but stays
outside India. For the purpose of managing the affairs of the HUF, R has
been regularly visiting India. Determine the residential status of the HUF
for the assessment year 2010-11 if; 6
i) R has been visiting India for 100 days every year for the last 12 years
ii) R has been visiting India for 110 days every year for the last 12 years
iii) R has been visiting India for the last 12 years. During the
immediately preceding 4 previous years he was in India for 50 days
every year and prior to that for 200 days every year.
Answer No.1
a)
The terms “Assessment Year” and “Previous Year” have the different meaning as per
Income Tax Act, 1961 of India.
As per section 2(9) of Income Tax Act, 1961 of India, “Assessment Year” means the
period of twelve months commencing on the first day of April every year. It is
therefore, the period from 1st of April to 31st of March.
As per section 2(34) of Indian Income Tax Act, 1961 “Previous Year” means the
previous year as defined in section 3. According to section 3, “Previous Year” means
the financial year immediately preceding the assessment year.

b)
As per Income Tax Act, 1961 of India the following incomes do not form part of total
income subject to fulfilling the conditions mentioned in respective sections;
i. Income not included in total income of any person (section 10)
ii. Income of newly industrial undertaking in Free Trade Zone, etc (section
10A)
iii. Income of newly established units in Special Economic Zones (section
10AA)
iv. Income of newly established in 100% Export Oriented Undertaking
(section 10B)
v. Profit and gains derived by an undertaking from the export of eligible
article or things (section 10BA)
vi. Income from property held for charitable or religious purposes (section
11-13)
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vii. Income of political parties (section 13A)

c)
During the previous year 2009-10, the control and management of the affairs of the
HUF was partly situated in India. Hence the HUF is resident for the assessment year
2010-11.
It is further to be examined whether the HUF can be said to be “resident and ordinarily
resident in India”. For this purpose, the Karta should satisfy both the following
conditions;
i. He (Karta) has been resident in India in at least 2 out of 10 previous
years immediately preceding the relevant previous year; and
ii. He has been in India for a period of 730 days or more in 7 previous years
immediately preceding the relevant previous year

In case (A) R neither satisfies the first condition nor the second condition mentioned
above as Karta is citizen of India. Where an individual is citizen of India and who is
outside India makes a visit to India he shall be said to be resident of India only when he
was an in Indian in the relevant previous year for 182 days as the condition of 60 days
along with 365 days in the 4 preceding previous years shall not apply. In this case 60
days shall have to be substituted by 182 days. Therefore, the HUF is resident but not
ordinarily resident.

In case (B), R, although satisfies condition (ii) mentioned above as he was here for 770
days in the past 7 years but he does not satisfy the condition (i) above as he is not a
resident in India in at least two out of ten preceding previous years. Therefore, the HUF
is resident but not ordinarily resident in India.

In case (C) R was non-resident for 4 preceding previous years but prior to that he was
resident. Hence, the first condition of category B, being resident in at least 2 out of 10
preceding years is satisfied. Further, he has been in India for 800 days (50*4+200*3)
during 7 years preceding the relevant previous year. Therefore, the second condition of
being in India for 730 days or more is also satisfied. Hence, the HUF is resident and
ordinarily resident in India.

9.
a) Mr. Bhai Raja is a person working in a Financial Institution as Chief
Manager. Besides working in Financial Institution, he is a professor of
Account in Shankar Dev Campus. He generates the following income
from the employers in Fiscal Year 2067/68.
i) Monthly Remuneration NPR 40,000; Dashain Allowance NPR
40,000; Education Allowance NPR 2,000 per month; Expenditure
Allowance NPR 2,000 per month; Bonus NPR 60,000;
Remuneration from teaching in Shankar Dev Campus NPR 6,000
per month.
ii) He is provided a car along with driver for his official and personal
purpose. Monthly remuneration and allowance of driver is NPR
8,000.

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iii) Petrol Expenditure is provided for his car which is NPR 10,000 per
month and maintenance expenditure of such car is NPR 25,000 in
Fiscal Year 2067/68.
iv) He is provided a housing facility by the employer.
v) Monthly expenditure of Telephone connected in his resident is NPR
2,000 per month. Out of this 50% is his personal telephone
expenditure.
vi) A security guard is being provided in his resident and it is being
paid NPR 6,000 per month by the employer. Because of being used
the security guard in his resident, NPR 3,000 is being deducted from
his monthly salary.
vii) He has used the loan amounting to NPR 10, 00,000 under housing
loan facility at the rate of 5% interest. 8% interest rate is being
charged by the institution under similar loan to other borrowers.
viii) He has received one month salary against his house leave during
Mangsir, 2067.
ix) The employer contributes 10% of his drawn salary and the
employee same amount from his salary, to approved provident fund.
Also, the employer contributes NPR 20,000 per month to Citizen
Investment Fund up on request of employee.
x) He has covered the insurance of NPR 250,000 and NPR 150,000 of
his wife in Rastriya Beema Sansthan. He pays the premium of NPR
19,000 and NPR 14,000 respectively in that Fiscal Year. Also, he
has contributed to tax exempted entity approved from department as
donation amounting to NPR 60,000.
xi) He has expensed out NPR 20,000 for his treatment in Teaching
Hospital.
xii) He and his wife declared that they are couple in the Fiscal Year
2067/68 and his wife does not have any income in that Fiscal Year.
Compute Assessable Income, Taxable Income and Tax liability of Mr.
Bhai Raja for the Fiscal Year 2067/68. 12

b) Mr. Devan Mahara is lawer. He is using cash basis of accounting for the
income generated from his profession. He gave an application to the
department to change his basis of accounting from cash to accrual in
Fiscal Year (FY) 2067/68. In accordance with the generally accepted
accounting principles, Income Tax Department has given the approval to
account for his income on accrual basis in Fiscal Year 2067/68. The
accounts of Mr. Mahara immediately before changing the basis of
accounting, was as below;
i) Service has already been rendered in FY 2066/67 but amount has not
been received and hence no income is included in that FY NPR
80,000
ii) In FY 2066/67 advance has been taken (service has been rendered on
FY 2067/68) but amount is included in that FY on cash basis though
service is still to be rendered NPR 30,000
iii) In FY 2066/67 House Rent from Magh, 2066 to Poush 2067 has
been paid and expense has been claimed in FY 2066/67 on cash basis
of accounting NPR 48,000
State how you make adjustments of income and expense in FY 2067/68
in above conditions? 5
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c) Adishree & Co. is conducting business in Pokhara and has taken the
office premises on rent from Mr. Garibdash. According to agreement
between them, Adishree & Co. is required to pay the house owner NPR
50,000 per month. Further, Adishree & Co.has taken on rent a vehicle
for NPR 25,000 from Mr. Daman Thapa for its business purpose. Mr.
Daman Thapa has paid the annual tax as per Section 1 (13) of Schedule
1 of Income Tax Act.
State whether the TDS as per Income Tax Act, 2058 is to be deducted in
above circumstances. If yes, what is the amount to be deducted as TDS? 3

Answer No.2
a) Computation of Assessable Income, Taxable Income and Tax liability of Mr. Bhai Raja for
the Fiscal Year 2067/68
Amount
Particulars (NPR)

Salary 480,000

Dashain Allowance 40,000

Education Allowance 24,000

Expenditure Allowance 24,000

Bonus 60,000

Vehicle Facility (480,000*0.5%) 2,400


Driver's Salary Not taxable
Petrol Expenditure Not taxable
Maintenance Expenditure Not taxable

Housing Facility (480,000*2%) 9,600

Telephone Expenditure (2,000*12*50%) 12,000

Security Guard Facility [(6,000-3,000)*12] 36,000

Loan Facility (8%-5%)*10,00,000 30,000

Salary against House Leave 40,000

Contribution to Provident Fund (PF) 48,000

Income from employment from Financial Institution 806,000

Salary from teaching in Shankar Dev Campus 72,000

Assessable income from employment 878,000


Deductible Amount

Deductible amount against contribution to PF (292,667)


Actual Contribution
Employer's Contribution 48,000
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Employee's Contribution 48,000


Contribution to Citizen Investment Fund 240,000
Total Contribution Amount 336,000
1/3 rd of Assessable income 292,667
Maximum Limit 300,000

Adjusted Taxable Income 585,333

Donation Expenditure (29,267)


5% of Adjusted Taxable Income 29,267
Actual Donation Expenditure 60,000
Maximum Limit 100,000

Taxable Income 556,067

Deduction against Insurance (20,000)


Premium paid for himself and for his wife 33,000
Maximum Limit 20,000

Taxable Income (For Tax Calculation) 536,067


Computation of Tax Liability
Up to NPR 200,000 (For Couple) 2,000
NPR 100,000 @ 15% 15,000
Balance @ 25% 59,017
Total 760,17
Less: Medical Expenditure (750)

Total Tax Liability 75,267

Notes:
1. Mr. Bhai Raja has expensed out NPR 20,000 in medical treatment. 15% of NPR
20,000 comes to NPR 3,000. Out of this NPR 3,000, NPR 750 is deductible from his
tax liability as medical claim and balance NPR 2,250 can be claimed in subsequent
Fiscal Year.
2. Since Mr. Bhai Raja has claimed Donation expenditure, contributed to approved fund
and has two employers at the same time he has to file the return of income.
3. As per Income Tax Directive, 2066, In case the employer also provides driver and
fuel facility to the employee along with the vehicle facility, the salary of the driver and
the cost of fuel is also not required to add to the taxable salary of the employee.
4. As per sec. 1 (2) (ka) of Schedule 1 of the Act, income tax at the rate 1% is to be
deducted from the salary income up to Rs. 200,000. The 1% salary tax is also a part of
income tax, but, it is named as social security tax and as per a circular this amount is to
be deposited in a separate account.

b) As mentioned in Chapter 6 of Income Tax Act, 2058, if any person takes the approval
from Inland Revenue Department for the change in basis of accounting for the purpose
of taxation, or his basis of accounting is changed because of various provisions
mentioned in the same Chapter, inclusion of his income, claim of expenditure shall be
computed in such a manner that there is no repetition or short of income or claim of
expenditure in that Fiscal Year.
Accordingly, the following adjustments shall be made in Fiscal Year 2067/68;
i. For the service which has already been rendered in FY 2066/67 but no amount
is received, the amount of NPR 80,000 shall be included in income of FY

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2067/68 on accrual basis.

ii. The amount of NPR 30,000 taken as advance in FY 2066/67 and included in the
income of same FY is not required to be included in FY 2067/68 though
service has been rendered in this FY. The amount of NPR 30,000 already
included in income of FY 2066/67.

iii. House Rent of Six months amounting to NPR 24,000 though pertains to FY
2067/68 has already been claimed in FY 2066/67 on cash basis of
accounting, so no further claim is allowed in FY 2067/68.

After making adjustments of inclusion of income and claim of expenditure in FY


2067/68, the income or expenditure shall be accounted on accrual basis for subsequent
years.

c) As per section 88(1)(5) of Income Tax Act, 2058, resident person is required to deduct
withholding tax on payment of rent, having source in Nepal, on building or vehicle
@10% of the amount of the rent.

TDS deducted on house rent is final withholding income for Mr. Garibdash.

In case of rent for vehicle those taxed under sec. 1 (13) of schedule 1 of Income Tax
Act, 2058, even the tax paid is equal to the total of the tax liability of the person for the
year, but sec. 88 (4) does not relieve a person from deducting withholding tax under
such situation. Thus, TDS @ 10% should be deducted from payment of rent.

10.
a) Nirdhan Samaj Sewa is a not for profit organization registered in
Kathmandu. It has obtained tax exemption certificate from IRD. During
the year 2067/68 the organization received the following incomes:
Membership Fees Rs. 275,000
Interest Rs. 170,000
Donation Rs. 450,000
Dividend income Rs. 1,200,000
Net profit from runnig a school Rs. 120,000

Nirdhan Samaj Sewa has claimed that it is a tax exempted organization


and so it is not obliged to pay tax and has filed a refund application for
TDS on interest of Rs. 30,000. Justify its claim on the basis of the
provisions of Income Tax Act, 2058.
Also state the legal provisions regarding filing of income tax return and
renewal of tax exemption certificate by Nirdhan Samaj Sewa. 5
b) Torrent Co. Ltd. is a large publicly listed company whose main activity
involves construction contracts. Torrent won a global contract to build a
new football stadium owned by Star Youth Club at a contracted price of
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Rs. 40,00,000 thousand. This construction contract was to be completed


over the period of three years starting from financial year 2065/66.
Initially, the total cost of completing the said stadium was estimated at
Rs. 36,00,000 thousand.
Star Youth Club had placed additional variation order in 2nd and 3rd
financial years with the details as given below:
2066/67 2067/68
Variation order Rs. 70,000 thousand Rs. 80,000
thousand

As the consequence of variation orders as aforesaid, it had to incur the


additional cost which had been estimated as follows:
2066/67 2067/68
Additional estimated costs Rs. 50,000 thousand Rs. 4,20,000
thousand

Details of actual cumulative costs over the period of 3 years to build


above football stadium were as follows:

(Rs. In ‘000)
2065/66 2066/67 2067/68
Actual accumulated costs to date 18,00,000 26,28,000 39,86,000
Rectification costs - - 34,000

The rectification costs are the costs incurred in widening access roads to
the stadium. This was the result of an error by Torrent‟s architect when
he made his initial drawings.

Compute the extracts of taxable income over those three years ending
F/Y 2067/68 and amount of losses carried back. 15

Answer No.3
a) Applicability of tax in the income of Nirdhan Samaj Sewa is as follows:

a. As Nirdhan Samaj Sewa is “not for profit organization” and it has obtained tax
exemption certificate from IRD, its income from membership fees and donation
will be exempted from tax.

b. Interest Rs. 170,000 and dividend Rs. 1,200,000 are the final withholding
income. Therefore, claim of Nirdhan Samaj Sewa is not tenable and it could not
claim for the refund of TDS deducted in interest income as it is final
withholding tax.

c. Profit generated from the operation of school is exempt income of the


organization if it is operated as per its constitution/bidhan. If running of school
is not as per its constitution/bidhan, then it will be fully taxable treating it as
business income.

Filing of income tax return and renewal of tax exemption certificate:

According to Rule 5 of Income Tax Regulation, 2053 and Inland Revenue


Department Circular No 2065/66 dated 2065/05/02 prescribes the requirement to
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tax exempted organizations to submit the documents and renewal of tax exemption
certificate.

b) Statement of computation of Taxable Income for M/s Torrent Company Ltd.

(Rs. In „000)
Details F/Y 2065/66 F/Y 2066/67 F/Y 2067/68
Initial contract price 40,00,000 40,00,000 40,70,000
Variation Order - __ 70,000 __ 80,000
Sub-total 40,00,000 40,70,000 41,50,000
Total contract price (A) 40,00,000 40,70,000 41,50,000

Initial estimated total cost 36,00,000 36,00,000 -


Additional estimated cost - __ 50,000 -
Total estimated cost (B) 36,00,000 36,50,000 -

Actual yearly expenses (Cumulative) 18,00,000 26,28,000 39,86,000


Rectification costs - __ - 34,000
Total actual costs (C) 18,00,000 26,28,000 40,20,000

Contract completion percent (E)


C/B * 100 50% 72% 100%

Computation of annual income


Contract revenue (Total) 40,00,000 40,70,000 41,50,000
Contract cost actual (36,00,000) (36,50,000) 40,20,000
Estimated/income from the contract 4,00,000 4,20,000 1,30,000
Portion of this year‟s income 2,00,000 3,02,400 1,30,000
Previous year‟s income 0 2,00,000 3,02,400
Net income of the year 2,00,000 1,02,400 (172,400)

As per sec. 20(4) of the Act, the Company has to seek advice from IRD, and IRD may
allow it to carry back the loss up to profit assessed during the year. So the Company
shall get back the amount of tax paid as prescribed by IRD at the applicable rate on Rs.
172,400. The person can apply for refund of the amount.

11.
a) AMEXO Bank is registered in the USA and operating its liaison office
in Kathmandu. During the financial year 2067/68, it has following
summarized transactions.

(Rs. In ‘000)
Income recognized 50,00
Expenses 40,00 except income tax

The liaison office has policy to repatriate all the remaining profits to its
corporate office.

Compute maximum amount that can be repatriated from Kathmandu


liaison office. 5
YSZ P.T.O.
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b) The paid up share capital of ABC Ltd. consists of 1,50,000 shares of Rs.
100 each. As of Ashadh end 2068, the P&L Appropriation Accounts of
the company is abstracted as below:
P&L Appropriation Account:

Profit for the year Rs. 10,00,000


Accumulated profit b/d Rs. 15,00,000
Total distributable profit Rs. 25,00,000

The Board of Directors (BOD) of the company proposed to issue bonus


share at 10%. Also, it is proposed that dividend tax on the capitalized
profit (sec 88(1)) is to be borne by company by distributing cash
dividend so that shareholders do not have to pay any tax at source as
required under sec. 88(1).
You are required to compute the amount of such cash dividend. 5
Answer No.4
a) As per the provision of Income Tax Act, AMEXO is taxed at two stages i.e.

 Resident bank having taxable income @ 30% of taxable amount.


 5% on repatriated amount.

Now,
Taxable amount = Rs. 5000 thousand – Rs. 4000 thousand
= Rs. 1000 thousand
Tax @ 30% = Rs. 1000 thousand * 30%
= Rs. 300 thousand
Remaining profit = Rs. 1000 thousand - Rs. 300 thousand
= Rs. 700 thousand
Tax of repatriated amount = Rs. 700 thousand * 5/105
= Rs. 33.33 thousand

Therefore, amount that can be repatriated = Rs. 700 thousand – Rs. 33.33 thousand
= Rs. 666.66 thousand

b) Total number of bonus share to be issued @ 10% = 15,000 shares


Total amount of bonus shares = 15,000 share @ Rs. 100 each
= Rs. 15,00,000
Dividend Tax @ 5% = 5% of Rs. 15,00,000
= Rs. 75,000

In case withholding tax on such bonus shares is to be paid by ABC Ltd. itself by
proposing to declare cash dividend, such cash dividend (i.e. tax on bonus shares)
is deemed as further distribution of dividend subject to dividend tax @ 5%.

Therefore, total cash dividend to be proposed = Rs. 75,000 + (5/95 *75,000)


= Rs. 75,000 + Rs. 3,947.37
= Rs. 78,947

YSZ P.T.O.
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12. Explain the provisions of the Value Added Tax Act relating to the
following: (4×5=20)
a) Applicability of VAT on import of goods and services.
b) “Situation out of control” as prescribed in Section 19(4) of VAT Act,
2052.
c) Temporary registration of VAT.
d) Provisions relating to excess VAT credit under section 24 of VAT Act,
2052.
Answer No.5
a) Applicability of VAT on import of goods and services.

Section 28 of the VAT Act, 2052 prescribes provisions relating to import of goods. Customs
Officer shall collect VAT on the goods imported into Nepal as per VAT Act, 2052 if
Ministry of Finance, Government of Nepal has not prescribed otherwise.

The Customs Office can use all the authorities as per Value Added Tax Act, 2052 and
Customs Act for the purpose of collecting tax at the point of import.

As per section 8(2) of VAT Act, a person in Nepal receives services in Nepal from any person
not registered in Nepal and residing outside Nepal, in that case the person in Nepal is required
to assess tax on the value of the service and deposit the amount. The assessment of tax shall be
as per the Act.

b) “Situation out of control” as prescribed in Section 19(4) of VAT Act, 2052.

Section 19(4) of the Value Added Tax Act, 2052 prescribes the situation when the taxpayer
can apply to the Director General to waive the additional duty/tec which was applied due to
situation out of the control of the tax payer. In this situation the Director General can waive
the fine if he found the causes genuine.

The “situation out of control” as prescribed in this section is elaborated in the Rule 35, of
VAT Regulation, 2053. For the purpose of section 19(4) the following are the situation out of
control:
a. The tax payer recovered from the illness, then within 7 days from the date of recovery.
b. The tax payer has to do rituals due to the death of parents, then within 7 days from the
finishing date of ritual.
c. The female tax payer has given birth of a child, then within 35 days from the date of
maternity.
d. In case of death, mental disorder or missing, the legal heir has to apply within 35 days,
then within 7 days from the date of application.
e. In case of road blocked due to flood, landslide or snow and tax payer could not reach
to tax office, then within 7 days from the date of opening of the road.
f. The transportation has totally halted and the tax payer could not reach the tax office,
then in the very next day of opening.
The tax payer shall apply for the extension of date with the recommendation of
VDC/Municipality.

c) Temporary registration of VAT.

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Section 10Ka of the VAT Act, 2052 prescribes the special conditions of temporary
registration.
1. In case of exhibition or mela organized in temporary basis, the organizer of the mela
etc or any other person participating in the mela by hiring stall but who is not
registered with VAT dealing with taxable goods shall apply for the temporary
registration. The tax officer can ask for the deposit in this case.

2. The existing registered person can transfer its stock for the purpose of putting in the
exhibition.

3. The person registered temporarily, will have to file VAT return and deposit the tax
amount within 7 days of the closure of exhibition. He shall also get the temporary
registration cancelled.

d) Provisions relating to excess VAT credit under section 24 of VAT Act, 2052.

Section 24 of the VAT Act, 2052 prescribes the following provisions relating to excess VAT
credit:
1. A registered person can deduct the amount of VAT paid on input as per section 17 of
the Act, from the VAT collected on sales in that month, in case the VAT collected is
excess of the paid VAT.

2. VAT credit remaining in one month can be carried forward to next month and set off
with the amount of VAT payable in that month.

3. The tax payer can apply for the refund of VAT credit if there is excess amount of VAT
credit for continuous period of six months.

4. If the tax payer has exported 40% or more of his total sales of that month, then he can
apply for the refund of tax immediately in next month.

5. The tax officer shall refund the amount of tax as per the application of tax payer if he
found the amount is refundable to the tax payer. If the amount not refunded within the
prescribed time then the amount shall be refunded with interest.

6. After claiming the refund of tax, the tax payer cannot set off the amount with the
amount of VAT payable in the next month.

13.
a) You are a tax expert. Answer stating the provisions relating to “Time of
Supply” as per Value Added Tax (VAT) Act, 2052, what happens when: 10
i) A customer takes delivery of the goods from the business place
before the supplier issues invoice.

YSZ P.T.O.
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ii) A customer paid NPR 10,000 to a supplier along with a list of certain
goods to be supplied to the customer. As per the list the total goods
are worth NPR 12,000
iii) A supplier at Kathmandu receives order for supply goods from a
customer from Pokhara. The supplier packs the goods as per the
order, asks a labor to deliver the goods to the transporter and the
transporter gives delivery of the goods to the party of Pokhara at
Pokhara. When the buyer receives the goods, the supplier issues the
invoices.

b) Sharma & co, a registered person dealing in second hand vehicles has
purchased a secondhand motorcycle for NPR 10,000 plus chargeable
VAT on it. The following expenses are incurred for repair of the
motorcycle to make it saleable;
Particulars Amount (NPR) VAT (NPR)
Spare Parts 4,000 520
Labor Charges 2,000 0

The person sells the motorcycle for NPR 20,000. Calculate the taxable
value of the motorcycle as per VAT Act, 2052. 5

c) Tax Accountant of Subhashree & Co. contends that the terms “Zero
VAT” and “No VAT” have the same meaning. As a Tax Expert, express
your opinion within the framework of VAT Act, 2052. 5
Answer No.6
a)
Section 6 of VAT Act, 2052 deals with time of supply.
For the purpose of assessment and collection of tax under this Act, the supply of any
goods or services shall be considered to have taken place at the earliest time of the
following times;
a. When an invoice is issued by a supplier
b. In the case of the supply of the goods, when the recipient removes or takes
possession of the goods from the supplier‟s transaction place
c. In the case of supply of services when the services are provided; and
d. When the supplier receives a consideration for the goods or services.

Accordingly;
i. As soon as the customer takes delivery of the goods from the business place of
the supplier, as per section 6 of the Act, the supply is completed. Thus, supply
without issuing invoice is infringement of provisions of VAT Act.

ii. The customer has given order for supply of goods with cash before delivery of
NPR 10,000. Such consideration shall be treated as payment of consideration
and thus, VAT to be collected. Had it be the advance only, VAT would not
require to collect.

iii. As per the usual practice the labor when picks up the goods from the business
place of the supplier, it is supposed that the buyer itself has taken the delivery
of the goods. The supply of the goods is completed as and when the labor has
removed the goods from the place of supplier.
YSZ P.T.O.
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b)

Rule 33 of VAT, Rules, 2053 states that a person who is dealing in used or second
hand materials has to determine the taxable value as per this rule. The taxable value is
the selling value of the goods less purchase price including VAT.

Accordingly;
Selling price
NPR 20,000
Less: Purchase price and other expenses plus VAT
NPR 17,820
(NPR 10,000+1,300+4,520+2,000)
Taxable Value
NPR 2,180

So, in case of a registered person dealing in used or second hand materials is not
required to collect VAT on selling price but it has to collect VAT on the difference the
selling price and the expenses incurred for purchase and repair of it including VAT.

c)
All the transactions of goods and services are taxable, but transactions of those goods
and services which are included in Schedule 1 of the VAT Act, 2052 (called negative
list of goods and services) are exempted from tax. This is also called no VAT items.

Out of the goods or services, which are subject to VAT and are transacted as per
Schedule 2 of the Act, the rate of VAT shall be charged by zero percentage.

In both the conditions of no VAT and zero VAT, VAT is not collected. But, there are
fundamental differences in the concepts behind each of them. The concepts of no VAT
and Zero VAT are described hereunder:

No VAT
Those goods and services, which are necessary for the people and those that are
generally provided by the government, are included in the “No VAT Schedule”.
Exemptions primarily are proposed from three types of reasoning; they are: for basic
life necessities or services or on social welfare grounds and reducing complexities in
administration.

Where a supply of a commodity or services is exempt from VAT, the input tax is not
deductible or shall not be refunded.

Zero VAT
Schedule 2 of the Act has prescribed certain circumstances such as export etc, under
which the tax shall be charged at a zero rate. If a transaction of goods or service is
zero-rated the input tax or tax paid on purchases is creditable or refundable. This
means, the taxpayer not only does not pay tax on the value of his exports, it will be

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fully compensated for the tax it pays on inputs and, therefore, is truly exempt from
VAT.

Hence the contention of the Tax Accountant is incorrect.

YSZ P.T.O.
(98)

YSZ P.T.O.

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