1.

Write short notes on the following:

a) Challenges faced by BFI undergoing NFRS implementation
b) Corporate Governance Reporting
c) The significance of the earnings per share (EPS) figure to the analysis of company
performance based on NAS 33.
d) Types of Hedging Relationship
e) Operating Segment
Answer:
a) Challenges faced by BFI undergoing NFRS implementation:
1. Technical Challenges:
a. Impairment of financial assets:
b. Fair value measurement criteria for assets and liabilities
c. Consolidation of financial statements
d. Disclosures requirement
e. Income recognition
2. Other Challenges:
a. Amendment to existing legal framework and policies
b. Shortage of trained and experienced resources
c. Complexity in financial reporting
d. Increased initial cost
e. Measurement of business performance
3. Change Management
b) Corporate governance involves balancing the interests of the stakeholders in a company
– these include its shareholders, management, customers, suppliers, financiers, government and the
community. Corporate governance provides the framework for attaining a company‘s objectives
and encompasses practically every sphere of management, from action plans and internal controls
to performance measurement andcorporate disclosure. Most companies strive to have a high level
of corporate governance. These days, it is not enough for a company to merely be profitable; it also
needs to demonstrate good corporate citizenship through environmental awareness, ethical behavior
and sound corporate governance practices. Good corporate governancerequires a joint effort of the
promoters who need to be more transparent, responsible and socially accountable; the
shareholders who must actively participate in theircorporate affairs to help prevent any fraudulent
and insider practices and; the regulatory authority that should effectively enforce rules and
regulations in order to protect the rights of all stakeholders and create favorable environment to
enhance good corporategovernance culture.
c) Significance of Earnings per Share (EPS)
 EPS gives a way to measure a company’s profits relative to the number of shares in issue. It is
argued that as owners hold equity shares, it is more relevant to them to know how much profit
each share has earned than to know the overall profit figure.
 EPS feeds into the price / earnings ratio, one of the most important stock market measures of
value. This gives an estimate of the number of years it would take for an investment in an equity
share to return itself in earnings terms, assuming current performance continues into the future.
 It is essential that such an important measure of performance have clear guidelinesregarding its
 calculation. NAS 33 Earnings per Share gives us a standardised method of calculating both
earnings, and the number of shares.
 Many investors feel that other measures are more appropriate, and that the NAS 33definition of
EPS is too conservative. NAS 33 allows alternative measures of EPS to be published, as long as
the NAS 33 figure gets equal or greater prominence.
 There is a danger in relying on a single measure of performance, as no single measure can
encapsulate all aspects of an entity’s performance.
 Also, there is a danger that EPS may be seen by unsophisticated investors as a definite exact
number, when in reality it is subject to all the accounting estimates and judgments that are
necessary in preparing a set of financial statements.
 Despite these fears, it is generally agreed that NAS 33 gives a very fair method of calculating
EPS, and that the consistency it offers is of value to the investor and analyst.
d) Types of Hedging Relationship:
There are three types of hedge accounting: fair value hedges, cash flow hedges and hedges
of the net investment in a foreign operation.
1. Fair Value Hedges:
The risk being hedged in a fair value hedge is a change in the fair value of an asset or a liability.
For examples, changes in fair value may arise through changes in interest rates (for fixed-rate
loans), foreign exchange rates, equity prices or commodity prices.
2. Cash Flows Hedges
The risk being hedged in a cash flow hedge is the exposure to variability in cash flows that is
attributable to a particular risk and could affect the income statement. Volatility in future cash
flows will result from changes in interest rates, exchangerates, equity prices or commodity
prices.
3. Hedges of net investment in a foreign operation
An entity may have overseas subsidiaries, associates, joint ventures or branches (‘foreign
operations’). It may hedge the currency risk associated with the translation of the net assets
of these foreign operations into the group’s currency
e) NFRS defines an operating segment as a component of an entity;
(i) That engages in business activities from which it may earn revenues and incur expenses
(including revenues and expenses relating to transactions with other components of the same
entity)
(ii) Whose operating results are reviewed regularly by the entity’s chief operating decision
maker to make decisions about resources to be allocated to the segment and assess its performance
and
(iii) For which discrete financial information is available.
It also sets out various disclosure requirement for operating segments.

4. Write short notes on the following:

a) Treatment of the cost of internally generated software.
b) Matters to be included in annual reports in cases of material environmental impacts by
actions/operations of a company.
c) Embedded derivatives
d) Economic entity principle of accounting
 e) During the year ended 31 Ashadh, 2077, Dorjee provided consultancy service to acustomer
regarding the installation of a new production system. The system has caused the customer
considerable problems, so the customer has taken legal action against Dorjee for the loss of
profits that has arisen as a result of the problems with the system. There is a 25% chance that
the claim can be successfully defended, but a 75% chancethat Dorjee will be required to pay
damage of Rs. 1.6 millions. Dorjee is covered by insurance against this type of loss and a claim
will be made as soon as the outcome of thecase is confirmed. No accounting has taken place
because the claim is expected toexactly offset against the damages payable. Advise Dorjee
about accounting treatment.

Answer:
a) Internally generated software should be treated according to provisions of NAS 38, Intangible
Assets. As per NAS 38, Intangible Assets an Intangible asset shall be recognized if, and only if,
 It is probable that the expected future economic benefit that are attributable to the asset will
flow to the entity; and
 The cost of the asset can be measured reliably
To assess whether as internally generated intangible asset meets the recognition criteria, an entity
classifies the generation of asset into a research phase and a development phase. Intangible asset arising
from research shall not be recognized and the expenditure on research phase shall be recognized as an
expenses when it is incurred.
An intangible asset arising from development shall be recognized if, and only if, an entitycan demonstrate
all of the following:
 The technical feasibility of completing the intangible asset so that it will be available for
use or sale;
 Its intention to complete the intangible asset and use or sell it;
 Its ability to use of sale the intangible asset;
 How the intangible asset will generate probable future economic benefits. Among other
things, the entity can demonstrate the existence of a market for the output of the intangible
asset or, if it is to be sued internally, the usefulness of such asset;
 The availability of adequate technical, financial and other resources to complete the
development and to use or sale the software;
 Its ability to measure reliably the expenditure attributable to the software during its
development.
If the entity cannot distinguish the research phase from the development phase of an internal project to
create an intangible asset, or is not able to demonstrate the occurrence of development phase, the entity
charges the expenditure incurred on software to the statement of income.
b) In cases where there are material environmental impacts, they will normally expect to see a
statement of corporate commitment, policies and strategy, showing the importance attached to
such issues. There could well be a competitive advantage to be gained from being seen as a
leader in responsible environmental practices. The statement wouldusually deal with the overall
control over such issues, whether through a committee of the board or a senior manager with
practical experience of environmental issues in a corporate context.
Most users, particularly investors and lenders, will also be concerned to know whether there are any
material financial impacts, actual or potential, arising from environmental issues. Where this is the case,
discussion of environmental risks and uncertainties in the annual report, together with the related action
taken, may therefore be appropriate as wellas information about environmental performance. Depending
on the nature of the entity, there could be a call for information about matters such as site remediation,
disposal of waste, resource recycling or supply chain performance. In identifying the environmental
matters likely to be of particular concern to report users, some form of stakeholder engagement is
 beneficial.
In reviewing a company’s annual report, the environmental matters attracting attention will tend to vary
according to its nature, size and geographical location but, where environmental matters are
significant, will generally fall within the following main areas:
 Commitments, policies and strategies.
 Environmental management
 Principal environmental impacts.
 Environmental performance – absolute and relative.
 Fines, penalties or awards.
In appropriate cases, it is often helpful to users if reference is made to compliance with environment laws,
or The Natural Step, or certification to a particular standard or Project Acorn. This would normally help
to demonstrate the adoption of desirable environmental policies.
c) An embedded derivative is a component of a hybrid (combined) instrument that also includes a
non-derivative host contract with the effect that some of the cash flows of the combined
instrument vary in a way similar to a standalone derivative. An embedded derivative causes
some or all of the cash flows that otherwise would be required by the contract to be modified
according to a specified interest rate, financial instrument price, commodity price, foreign
exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided
in the case of a nonfinancial variable that the variable is not specific to a party to the contract. A
derivative that is attached to a financial instrument but is contractually transferable
independently of that instrument, or has a different counterparty form that instrument, is not an
embedded derivative, but a separate financial instrument.
An embedded derivative should be separated from the host contract and accounted for as derivative if,
and only if;
(i) The economic characteristics and risks of the embedded derivative are not closely related
to the economic characteristics and risks of the host contract.
(ii) A separate instrument with the same terms as the embedded derivative would meet the
definition of a derivative; and
(iii) The hybrid instrument is not measured at fair value with changes in fair value recognized
in the statement of profit and loss (i.e. a derivative that is embedded in a financial asset or
financial liability at fair value though profit or loss is not separated).
d) The economic entity principle states that the recorded activities of a business entityshould
be kept separate from the recorded activities of its owner(s) and any other business entities.
This means that you must maintain separate accounting records and bank accounts for each
entity, and not intermix with them the assets and liabilities of its owners or business partners.
Also, you must associate every business transaction with an entity.
A business entity can take a variety of forms, such as a sole proprietorship, partnership, corporation, or
government agency. The business entity that experiences the most trouble with the economic entity principle is
the sole proprietorship, since the owner routinely mixes business transactions with his own personal transactions.
It is customary to consider a commonly-owned group of business entities to be a single entity for the purposes
of creating consolidated financial statements for the group, so the principle could be considered to apply to the
entire group as though it were a single unit.
The economic entity principle is a particular concern when businesses are just being started, for that is when the
owners are most likely to commingle their funds with thoseof the business. A typical outcome is that a trained
accountant must be brought in after a business begins to grow, in order to sort through earlier transactions and
remove thosethat should be more appropriately linked to the owners.
e) It is necessary to consider the two parts of this issue separately
The claim made by the customer needs to be recognised as a liability in the financialstatements for the
year ended 31 Ashad, 2077.
NAS 37, Provisions, Contingent liabilities and Contingent Assets states that a provision
should be made when, at the reporting date:
i) An entity has a present obligation arising out of past event
ii) There is a probable outflow of economic benefits.
iii) A reasonable estimate can be made of the outflow.
All three of those conditions are satisfied here, and so a provision is appropriate.
The provision should be measured as the amount the entity would rationally pay to settlethe obligation of the
reporting date.
Where there is a range of possible outcomes, the individual most likely outcome is oftenthe most appropriate
measure to use.
In this case a provision of Rs. 1.6 millions seems appropriate, with corresponding chargeto profit or loss
The insurance claim against Dorjee’s supplier is a contingent asset.
NAS 37 states that contingent assets should not be recognised until their realization is virtually certain, but should
be disclosed where their realization is probable. This appears to be the situation here.
Therefore the contingent asset would be disclosed in the financial statement. Any credit to profit or loss arises
when the claim is settled.

4. Write short note/answer on the following:

a) Objectives of financial reporting
b) Cash generating unit and reason of impairment based on it rather than individual assets
c) Recognition of impairment losses in the financial statements
d) Is hedging a diversification? Explain with examples.
e) When does debt seem to be equity?
Answer
a) The following are the objectives of financial reporting:
(i) To provide information that is useful to present and potential investors, creditors and other users in making
rational investment, credit and similar decisions.
(ii) To provide information to help investors, creditors and others to assess the amount, timing anduncertainty of
prospective net cash inflows to the related entity.
(iii) To provide information about the economic resources of an entity, the claims to those resources(obligations of the
entity to transfer resources to other entities and owners' equity), and the effects of transactions, events and
circumstances that change resources and claims to those resources.
(iv) To provide information about an entity’s financial performance during a period.
(v) To give information about an entity’s performance provided by measures of earnings and its components.
(vi) To provide information about how an entity obtains and spends cash, about its borrowing and repayment of
borrowing, about its capital transactions, including cash dividends and other distributions of entity’s resources
to owners, and about other factors that may affect an entity’sliquidity or solvency.
(vii) To provide information about how management of an entity has discharged its stewardship responsibility to
owners for the use of entity resources entrusted to it.
b) A cash generating unit is defined as the smallest possible identifiable group of assets that generates cash
inflows that are largely independent of the reporting entity’s other cash generating units. Identifying the
smallest possible group of assets is important as this means there will be fewer assets within each cash
generating unit.
 To determine whether impairment of a cash generating unit has incurred, it is necessary tocompare the
carrying amount of the asset with its recoverable amount. The recoverable amount is the higher of fair
value less costs of disposal and value in use.
It is not always easy to estimate value in use. In particular, it is not always practicable to identify cash
flows arising from an individual noncurrent asset. For, example, the individual assets in a supermarket are
unlikely to generate cash flows in their own right, but when combined (as a cash generating unit), it is
possible to identify the cash flows. If this is the case, value in use should be calculated at the level of cash
generating unit.
c) An impairment loss is normally charged immediately in the Income Statement / Statement of Comprehensive
Income, to the same heading as the related depreciation (i.e. cost of sales, administration or distribution).
That is: Debit Income Statement and Credit Asset Account with the amount of the impairment loss
But, if the asset has previously been revalued upwards, the impairment should be treated as a revaluation decrease
(and shown in “Other Comprehensive Income”). That is, the loss is first set against any revaluation surplus for
that asset until the surplus relating to that asset has been exhausted. Then, any excess is recognised as an expense
in the Income Statement.
After adjusting for the impairment loss, the new carrying amount is written off over the remaining useful life of
the asset.
Any related deferred tax assets or liabilities are determined under NAS 12 by comparing the revised carrying value
of the asset with its tax base.
d) It's important to note that hedging is not the same as portfolio diversification. Diversification is a portfolio
management strategy that investors use to smooth out specific risk in one investment, while hedging helps to
decrease one's losses by taking an offsetting position. If an investor wants
to reduce his overall risk, the investor should not put all of their money into one investment. Investors can spread
out their money into multiple investments to reduce risk.
For example, suppose an investor has Rs. 500,000 to invest. The investor can diversify and put their money into
multiple stocks in various sectors, real estate and bonds. This technique helps to diversify unsystematic risk; in
other words, it protects the investor from being affected by any individual event in an investment.
When an investor is worried about an adverse price decline in their investment, the investor can hedge their
investment with an offsetting position to be protected. For example, suppose an investor is invested in 100 shares
of stock in oil company XYZ and feels that the recent drop in oilprices will have an adverse effect on its earnings.
The investor does not have enough capital to diversify their position; instead, the investor decides to hedge their
position by buying options for protection. The investor can purchase one put option to protect against a drop in
the stock price, and pays a small premium for the option. If XYZ misses its earnings estimates and prices fall,
the investor will lose money on their long position, but will make money on the put option, which limits losses.
e) Many financial instruments have both features of debt and equity that this can lead to inconsistencyof reporting. It is
not always easy to distinguish the debt and equity in an entity's statement of financial position.
The key feature of debt is that the issuer is obliged to deliver either cash or another financial asset to the holder.
In contrast, equity is any contract that evidences a residual interest in the entity's assets after deducting all of its
liabilities. Thus, A financial instrument is an equity instrument only if the instrument includes no contractual
obligation to deliver cash or another financial asset to another entity, and if the instrument will or may be settled
in the issuer's own equity instruments.
A contract is not an equity instrument solely because it may result in the receipt or delivery of the entity's own
equity instruments. The classification of this type of contract is dependent on whether there is variability in either
the number of equity shares delivered or variability in the amount of cash or financial assets received. A contract
that will be settled by the entity receiving or delivering a fixed number of its own equity instruments in exchange
for a fixed amount of cash, or another financial asset, is an equity instrument.
However, if there is any variability in the amount of cash or own equity instruments that will be delivered or
received, then such a contract is a financial asset or liability as applicable.
Other factors that may result in an instrument being classified as debt are:
  Is redemption at the option of the instrument holder?
 Is there a limited life to the instrument?
 Is redemption triggered by a future uncertain event that is beyond the control of both the holder and issuer of
the instrument?
 Are dividends non-discretionary?
Similarly, other factors that may result in the instrument being classified as equity are whether the shares are non-
redeemable, whether there is no liquidation date or where the dividends are discretionary.
Some instruments are structured to contain elements of both a liability and equity in a single instrument. Such
instruments – for example, bonds that are convertible into a fixed number of equity shares and carry interest –
are accounted for as separate liability and equity components. 'Split accounting' is used to measure the liability
and the equity components upon initial recognition of the instrument. This method allocates the fair value of the
consideration for the compound instrument into its liability and equity components.

4. Write short note/ answer on the following:

a) Defined Conglomerate Merger
b) Lev and Schwartzon model of Human Resource Value Accounting
c) What is insurance contract? List down the examples that are insurance contract.
d) Fair value as set out in NFRS 13
e) When does debt seem to be equity?
Answer
3 a) Defined Conglomerate merger
This is joining of two or more companies whose businesses are not related with each other either vertically
or horizontally. The companies involved in the merger may be manufacturing totally different products. Of
course, there may be some common features between them such as same channel of distribution or
technological area.
The basic objective behind such a merger is the diversification of activities. Such a merger may also lead
to concentration of economic power by virtue of controlling by the merged corporation different fields of
business activities. For example, a company engaged inmanufacturing activities may get itself merged with
a company engaged in Insurance business. The two companies are totally different and therefore such
merger is defined conglomerate merger.

4 b) Lev and Schwartzon Model on Human Resource Value Accounting:

Human resource accounting is the process of identifying and reporting investments made in the human
resources of an organization that are presently unaccounted for in the conventional accounting practices.
It is an extension of standard accounting principles. Measuring the value of the human resources can assist
organizations in accurately documenting their assets.
One of the important approach to the evaluation of human resource assets is to calculate their economic
values. The economic value of the firm can be determined by obtaining the present value of future earnings.
A number of valuation models have been developed for determining the present value of future earnings.
Lev and Schwartzon
Lev & Schwartz advocated the estimation of future earnings during the remaining service life of the
employee and then arriving at the present value by discounting the estimated earnings at the cost of capital.
The assumptions in this method are realistic and scientific.
The method has practical applicability when the availability of quantifiable and analyzable data is
concerned.
Still, this model cannot give any method to record the value of human resources in theBooks of
Accounts. According to this model, the value of human resources is ascertained in the following ways:
 All employees are classified into specific groups according to age, experience, and skill.
 Average annual earnings are determined for various ranges of age.
  The total earnings each group will get up to retirement age are calculated.
 The total earnings calculated as above are discounted at the rate of the cost of capital.
 The value thus arrived at will be the value of human resources/assets. This method has some
limitations, which are as follows:
 This method does not indicate the accounting treatment of human resources.
 This method only considers wages and salaries, but wages and salaries are not only the costs associated
with the employees. Other costs are associated with the employees.
 The model ignores the possibility and probability that an individual may leave an organization for reasons
other than death or retirement. The model’s expected value of human capital measures a person’s human
capital’s expected ‘conditional value.’ The implicit condition is that the person will remain in an
organization until death or retirement. This assumption is not practical. 

4 c) Insurance contract is a "contract under which one party (the insurer) accepts significant insurance risk from
another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future
event (the insured event) adversely affects the policyholder." The following are examples of insurance
contracts:
 Insurance against theft or damage to property
 Insurance against product liability, professional liability, civil liability or legal expenses
 Life insurance and prepaid funeral expenses
 Life-contingent annuities and pensions
 Disability and medical cover
 Surety bonds, fidelity bonds, performance bonds and bid bonds
 Credit insurance that provides for specified payments to be made to reimburse the holder for a loss it
incurs because a specified debtor fails to make payment when due
 Product warranties (other than those issued directly by a manufacturer, dealer or retailer)
 Title insurance
 Travel assistance
 Catastrophe bonds that provide for reduced payments of principal, interest or both if aspecified event
adversely affects the issuer of the bond
 Insurance swaps and other contracts that require a payment based on changes in climatic, geological or
other physical variables that are specific to a party to the contract
 Reinsurance contracts.

4 d) Fair value as set out in NFRS 13

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. Basically it isan exit price. Fair value
is focused on the assumptions of the market place and is not entity specific. It therefore takes into account
any assumptions about risk. Fair value is measured using the same assumptions and taking into account
the same characteristics of the asset or liability as market participants would. Such conditions would
include the condition and location of the asset and any restrictions on its sale or use. Further, it is not
relevant if the entity insists that prices are too low relative to its own valuation of the asset and that it
would be unwilling to sell at low prices. Prices to be used are those in ‘an orderly transaction’.
An orderly transaction is one that assumes exposure to the market for a period before the date of
measurement to allow for normal marketing activities and to ensure that it is not a forced transaction. If
the transaction is not ‘orderly’, then there will not have been enough time to create competition and
potential buyers may reduce the price that they are willing to pay. Similarly, if a seller is forced to accept
a price in a short period of time, the price may not be representative. It does not follow that a market in
which there are few transactions is not orderly. If there has been competitive tension, sufficient time and
information about the asset, then this may result in a fair value for the asset.
Fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place in
the principal market for the asset or liability or, in the absence of a principal market, in the most
advantageous market for the asset or liability. The principal market isthe one with the greatest volume
 and level of activity for the asset or liability that can be accessed by the entity.
The most advantageous market is the one which maximizes the amount that would be received for the asset
or minimizes the amount that would be paid to transfer the liability after transport and transaction costs.

4 e) Many financial instruments have both features of debt and equity that this can lead to inconsistency of
reporting. It is not easy always to distinguish the debt and equity in an entity‘s statement of financial
position.
The key feature of debt is that the issuer is obliged to deliver either cash or another financial asset to the
holder. In contrast, equity is any contract that evidences a residual interest in the entity‘s assets after
deducting all of its liabilities. Thus, A financial instrument is an equity instrument only if the instrument
includes no contractual obligation to deliver cash or another financial asset to another entity, and if the
instrument will or maybe settled in the issuer's own equity instruments.
For example,
 a bond that requires the issuer to make interest payments and redeem the bond for cash is classified as debt.
 ordinary shares, where all the payments are at the discretion of the issuer, are classified as equity of the
issuer.
 preference shares required to be redeemed on a fixed date, or on the occurrence of an event that is certain
to occur, should be classified as debt.
 preference shares required to be converted into a fixed number of ordinary shares on a fixed date, or on the
occurrence of an event that is certain to occur, should be classified as equity.

1. Write short notes on the following:

a) Minimum components of an interim financial report
b) Difference between Market Value Added and Economic Value Added
c) Stress testing for banks
d) Classification of assets held for sale
e) A director of Rhivam Cement Ltd. has expressed concern about the accounting treatment of some of the company’s
items of property, plant and equipment which have increased in value. His main concern is that the statement of
financial position does not show the true value of assets which have increased in value and that this ‘undervaluation’
is compounded by having to charge depreciation on these assets, which also reduces reported profit. He argues that
this does not make economic sense. Respond to the director’s concern in line with relevant NAS.
Answer
a) An interim financial report may consist of a condensed version of the full financial statements and should include an
explanation of the events and transactions that are significant to an understanding of the interim financial statements.
At a minimum, they should include:
i) Condensed balance sheet
ii) Condensed income statement
iii) Condensed statement showing changes in equity
iv) Condensed cash flow statement; and
v) Selected explanatory note
If the entity publishes a set of condensed financial statements in its interim financial report, those condensed
statements should include, at a minimum each of the headings and subtotals that were included in its most
recent annual financial statements, together with selected explanatory notes as outlined by NAS 34.
The recognition and measurement principle should be the same as those used in the main financial statements.
Additional line items or notes should be included if their omission would render the interim reports misleading.
Basic and diluted earnings per share should be presented on the face of an income statement for an interim
period.
If, however, an entity chooses to publish a complete set of financial statements in its interim financial report,
the form and content of those statements must conform to NAS 1 for a complete set of financial statements.
b) Market Value Added (MVA) is the difference between the current market value of a firm and the capital contributed
by investors.
If the MVA is positive, the firm has added value. If it is negative, the firm has diminished value. The amount of
value added needs to be greater than the firm's investors could have achieved investing in the market portfolio,
adjusted for the leverage (beta coefficient) of the firm relative to the market. The formula for MVA is:

Where: MVA is market value added, V is the market value of the firm, including the value of the firm's equity
and debt, and K is the capital invested in the firm.
In corporate finance, Economic Value Added (EVA), is an estimate of a firm's economic profit – being the
value created in excess of the required return of the company's investors (being shareholders and debt holders).
Quite simply, EVA is the profit earned by the firm, less the cost of financing the firm's capital. The idea is that
value is created when the return on the firm's economic capital employed is greater than the cost of that capital.
EVA is net operating profit after taxes (or NOPAT) less a capital charge, the latter being the product of the cost
of capital and the economic capital.
The basic formula is: EVA = (r - c) * K = NOPAT - c * K
where r is the return on investment capital (ROIC); c is the weighted average of cost of capital (WACC); K is
the economic capital employed; NOPAT is the net operating profit after tax.
The firm's market value added is the discounted sum (present value) of all future expected economic value added:
MVA = Present Value of a series of EVA values.
c) An analysis conducted under unfavourable economic scenarios which is designed to determine whether a bank has
enough capital to withstand the impact of adverse developments. Stress tests can either be carried out internally by
banks as part of their own risk management, or by supervisory authorities as part of their regulatory oversight of the
banking sector. These tests are meant to detect weak spots in the banking system at an early stage, so that preventive
action can be taken by the banks and regulators.
Stress testing should be designed to provide information on the kinds of conditions under which strategies or
positions would be most vulnerable, and thus may be tailored to the risk characteristics of the bank. Possible
stress scenarios might include:
• abrupt changes in the general level of market rates;
• changes in the relationships among key market rates (i.e. basis risk);
• changes in the slope and the shape of the yield curve (i.e. yield curve risk);
• changes in the liquidity of key financial markets or changes in the volatility of market rates; or
• conditions under which key business assumptions and parameters break down.
d) A non-current asset (or disposal group) should be classified as held for sale if its carrying amount will be recovered
principally through a sale transaction rather than through continuing use. A number of detailed criteria must be met:
a) The asset must be available for immediate sale in its present condition.
b) Its sale must be highly probable (i.e. significantly more likely than not). For the sale to be highly probable for
immediate sale in its present condition.
a) Management must be committed to plan to sell the asset.
b) There must be an active programme to locate a buyer.
c) The asset must be marketed for sale at a price that is reasonable in relation to its current fair value.
d) The sale should be expected to take place within one year from the date of classification.
It is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.
An asset can still be classified as held for sale, even if the sale has not actually taken place within one year.
However, the delay must have been caused by events or circumstances beyond the entity’s control and there
must be sufficient evidence that the entity is still committed to sell the asset or
disposal group. Otherwise the entity must cease to classify the asset as held for sale.
If an entity acquires an asset (a disposal group) (e.g. a subsidiary) exclusively with a view to its subsequent
disposal it can classify the asset as held for sale only if the sale is expected to take place within one year and it is
highly probable that all the other criteria will be met within a short time (normally three months).
An asset that is to be abandoned should not be classified as held for sale. This is because its carrying amount will
be recovered principally through continuing use. However, a disposal group to be abandoned may meet the
definition of a discontinued operation and therefore separate disclosure may be required.
e) The requirements of NAS 16, Property, Plant and Equipment may, in part, offer a solution to the director’s concerns.
NAS 16 allows (but does not require) entities to revalue their property, plant and equipment to fair value; however,
it imposes conditions where an entity chooses to do this. First, where an item of property, plant and equipment is
revalued under the revaluation model of NAS 16, the whole class of assets to which it belongs must also be revalued.
This is to prevent what is known as ‘cherry picking’ where an entity might only wish to revalue items which have
increased in value and leave other items at their (depreciated) cost. Second, where an item of property, plant and
equipment has been revalued, its valuation (fair value) must be kept up-to-date. In practice, this means that, where
the carrying amount of the asset differs significantly from its fair value, a (new) revaluation should be carried out.
Even if there are no significant changes, assets should still be subject to a revaluation every three to five years.
A revaluation surplus (gain) should be credited to a revaluation surplus (reserve), via other comprehensive
income, whereas a revaluation deficit (loss) should be expensed immediately (assuming, in both cases, no
previous revaluation of the asset has taken place). A surplus on one asset cannot be used to offset a deficit on a
different asset (even in the same class of asset). Subsequent to a revaluation, the asset should be depreciated
based on its revalued amount (less any estimated residual value) over its estimated remaining useful life, which
should be reviewed annually irrespective of whether it has been revalued. An entity may choose to transfer
annually an amount of the revaluation surplus relating to a revalued asset to retained earnings corresponding to
the ‘excess’ depreciation caused by an upwards revaluation. Alternatively, it may transfer all of the relevant
surplus at the time of the asset’s disposal.
The effect of this, on company’s financial statements, is that its statement of financial position will be
strengthened by reflecting the fair value of its property, plant and equipment. However, the downside (from the
director’s perspective) is that the depreciation charge will actually increase (as it will be based on the higher fair
value) and profits will be lower than using the cost model. Although the director may not be happy with the
higher depreciation, it is conceptually correct. The director has misunderstood the purpose of depreciation; it is
not meant to reflect the change (increase in this case) in the value of an asset, but rather the cost of using up
part of the asset’s remaining life.

4. Write short note/ answer on the following:

a) Joint venture arrangement
b) Evaluate the treatment of development expenditure set out in NAS 38 'Intangible Assets' against the
characteristics of relevance and reliability.
c) Describe four circumstances in which a parent entity may not be required to present consolidated
financial statements under Nepal Financial Reporting Standards.
d) Briefly explain how lessee must account for leases within the scope of NFRS 16 Leases.
e) Explain 'Plain Vanilla Swap' with example. Answer
4 a) A joint venture is an association of two or more businesses established for a special purpose. Some joint
ventures are in the form of partnerships or other unincorporated forms of business. Others are in the form
of corporations jointly owned by two or more other firms.
The accounting principles for joint ventures are flexible because of their many forms. The typical problem
concerns whether a joint venture should be carried as an investment or consolidated. Some joint ventures
are very significant in relation to the parent firm. There is typically a question as to whether the parent
firm has control or
only significant influence. When the parent firm has control, it usually consolidates joint ventures by
using a pro rata share. Other joint ventures are usually carried in an investment account by using the equity
method. In either case, disclosure of significant information often appears in a note.
 When a firm enters into a joint venture, it frequently makes commitments such as guaranteeing a bank loan
for the joint venture or a long-term contract to purchase materials with the joint venture. This type of action
can give the company significant potential liabilities or commitments that do not appear on the face of the
balance sheet. This potential problem exists with all joint ventures, including those that have been
consolidated. To be aware of these significant potential liabilities or commitments, read the note that relates
to the joint venture. Then consider this information in relation to the additional liabilities or commitments
to which the joint venture may commit the firm.
4 b) Under NAS 38 development expenditure should be recognized as an asset, but only where it meets a number
of stringent conditions. These relate to the technical feasibility of the project, how the probable future
economic benefits will be generated and the availability of resources to complete the development. It must
also be possible to measure the development expenditure reliably.
The most reliable information would be provided if the costs are recognized in the income statement as
they are incurred (indeed this is the approach to be taken to research expenditure and to development
expenditure where the recognition criteria are not met).
However, this does not provide relevant information where benefits from the expenditure will flow into
the entity over several accounting periods. However, the reliability of this more relevant information can
be seriously compromised where there are uncertainties surrounding the future outcome of the project.
Hence, NAS 38 adopts the relevanceapproach but only where the information backing up that approach is
reliable, i.e. there is sufficient certainty surrounding the viability/profitability of the project.
4 c) NFRS 10 Consolidated financial Statements outlines the following exemptions when the parent entity need
not present consolidated financial statements:
(i) The parent itself is a wholly owned subsidiary or a partially owned subsidiary and its owners have
been informed about it and do not object to the parent not preparing the consolidated financial
statements.
(ii) The parent‘s debt or equity instruments are not traded in a public market.
(iii) The financial statements of the parent are not filed with any regulatory organisationfor the purpose
of issuing debt or equity instruments on any stock exchange.
(iv) The ultimate or immediate parent of the entity produces publicly available financial statements that
comply with NFRSs.
4 d) NFRS 16 requires that all leases with its scope must be capitalised by lessee by recognising lease liabilities
and Right Of Use Assets (ROUA). However, a lessee may not capitalise a lease but merely account for
lease rentals if any of the two exemptions has been used:
 The lease is of a small value asset
 Short term Lease
Lease liabilities must initially be measured at the present value of the lessee‘s Minimum
Lease Payments (MLPs) payable in future discounted at the interest rate implicit in the lease. The
ROUA is initially measured at the aggregate of:
 Cash incurred at inception of the lease
 Initial carrying amount of lease liability
 Provision for decommissioning the lease.
Subsequently, lease liabilities must be measured at amortized cost using the interest rate implicit in the
lease, charging the finance costs in the SPL. ROUA must normally be amortized on a straight line basis
over the shorter of the asset under lease‘s useful economic life and the lease term.
4 e) A plain vanilla swap is one of the simplest financial instruments contracted in the over-the-counter market
between two private parties, both of which are usually firms or financial institutions. There are several
types of plain vanilla swaps, including an interest rate swap, commodity swap, and a foreign currency
swap. The term plain vanilla swap is most commonly used to describe an interest rate swap in which a
floating interest rate isexchanged for a fixed rate or vice versa.
 A plain vanilla interest rate swap is often done to hedge a floating rate exposure, althoughit can also be
done to take advantage of a declining rate environment by moving from a fixed to a floating rate. Both legs
of the swap are denominated in the same currency, and interest payments are netted. The notional principal
does not change during the life of the swap, and there are no embedded options.
In a plain vanilla interest rate swap, Company A and Company B choose a maturity, principal amount,
currency, fixed interest rate, floating interest rate index, and rate reset and payment dates. On the specified
payment dates for the life of the swap, Company A pays Company B an amount of interest calculated by
applying the fixed rate to the principal amount, and Company B pays Company A the amount derived from
applying the floating interest rate to the principal amount. Only the netted difference between the interest
payments changes hands.

4. Write short note/ answer on the following:

a) ‘Close out’ in securities trading
b) Plain vanilla swap
c) Explain opportunity cost in the context of human resource accounting.
d) Capital expenditure may not be represented by assets. Explain.
e) Embedded derivative as per NFRS

Answer
4 a) ‘Close out’ in securities trading
In case of purchases on behalf of clients, member brokers shall be a at liberty to close out the transactions by
selling the securities, in case the client fails to make the full payment to the member broker for the execution of the
contract within two days of contract note having been delivered for cash and seven days for specified shares or
before pay in day (as fixed by stock exchange for the concerned settlement period), whichever is earlier; unless
the client already has an equivalent credit with the member. The loss incurred in this regard, if any, will be met
from the margin money of that client. In case of sales on behalf of clients, member broker shall be at liberty to
close out the contract by effecting purchases if the client fails to deliver the securities sold with valid transfer
documents within two days of the contract note having been delivered or before delivery day (as fixed by Nepal
Stock Exchange for the concerned settlement period from time to time), whichever is earlier. Loss on the
transaction, if any, will be deductible from the margin money of that client.

4 b) Plain vanilla swap

A plain vanilla swap is one of the simplest financial instruments contracted in the over-the-counter market between
two private parties, both of which are usually firms or financial institutions. There are several types of plain vanilla
swaps, including an interest rate swap, commodity swap, and a foreign currency swap. The term plain vanilla
swap is most commonly used to describe an interest rate swap in which a floating interest rate is exchanged for a
fixed rate or vice versa.
A plain vanilla interest rate swap is often done to hedge a floating rate exposure, although it can also be done to
take advantage of a declining rate environment by moving from a fixed to a floating rate. Both legs of the swap are
denominated in the same currency, and interest payments are netted. The notional principal does not change during
the life of the swap, and there are no embedded options.
In a plain vanilla interest rate swap, Company A and Company B choose a maturity, principal amount, currency,
fixed interest rate, floating interest rate index, and rate reset and payment dates. On the specified payment dates
for the life of the swap, Company A pays Company B an amount of interest calculated by applying the fixed rate
to the principal amount, and Company B pays Company A the amount derived from applying the floating interest
rate to the principal amount. Only the netted difference between the interest payments changes hands.

4 c) It is one of the Economic value models used for measurement and valuation of Human assets. As per this
model, opportunity cost is the value of an employee in his alternative use. This opportunity cost is used as a
basis for estimating the value of Human resources. Opportunity cost value may be established by competitive
bidding within the firm so that in effect, Managers must bid for any scarce employee. A Human asset will
 have a value only if it is a scarce resource, that is, when its employment in one division denies it to another
division. This method excludes employees of the type of which can be readily hired from outside the firm.
Also, it is in very rare cases that managers would like to bid for an employee.

4 d) Capital expenditures (CapEx) are investments made by a company in long-term assets, such as property,
plant, and equipment, with the expectation of generating future benefits. While capital expenditures are
typically represented by assets on a company's balance sheet, it is possible for some capital expenditures to
not be represented by assets.
This can happen when a company makes an expenditure that does not meet the criteria for capitalization as
an asset under accounting standards. For example, if a company spends money on research and development,
the costs associated with this expenditure may not be capitalized as an asset because the future benefits of
the research and development are uncertain.
In addition, some capital expenditures may be expensed immediately rather than being capitalized as an asset.
For example, if a company spends money on repairs and maintenance to an existing asset, the cost of these
expenditures may be expensed immediately rather than being capitalized as an improvement to the asset.
Furthermore, there may be situations where a company invests in a long-term asset that generates future
benefits, but these benefits are not expected to be sufficient to recover the full cost of the asset. In such cases,
the asset may be impaired and its carrying value reduced, resulting in a loss on the company's income
statement.
In summary, while capital expenditures are typically represented by assets on a company's balance sheet, there
are situations where capital expenditures may not be represented by assets, such as when the expenditures
do not meet the criteria for capitalization, are expensed immediately, or result in an impairment loss.

4 e) Embedded Derivative as per NFRS

An embedded derivative is a component of a hybrid contract that also includes a non-derivative host with the
effect that some of the cash flows of the combined instrument vary in a way similar to a stand alone derivative.
An embedded derivative causes some or all of the cash flows that otherwise would be required by the contact to
be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange
rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non financial
variable that the variable is not specified to a party to the contract. A derivative that is attached to a financial
instrument but is contractually transferable independently of that instrument, or has a different counterparty, is
not an embedded derivative, but a separate financial instrument.

2. Write short note/ answer on the following:

a) Watch list loans

b) Types of hedging relationship
c) Sustainability reporting and its advantages
d) Explain the concept of actuarial valuation in retirement scheme.
e) Option contract and its features
Answer
3 a) Watch List Loans
Nepal Rastra Bank (NRB) has formulated a new category of loan for provisioning purposes. As per the
NRB’s Directive, all loans are required to be classified into 5 different categories including Watch List
whereby 5% of the total loan is required to be kept as provisioning though the provision can be
reversed when the loan becomes performing later. Provision made for watch list loans is a general loan
loss provision. As per the circular issued by NRB, the loans having the following characteristics are to be
classified as Watch List loans:
1. If interest and principal repayments are overdue for more than a month and less than 3 months.
2. Short term/Working Capital Loans that are not renewed on time and are renewed on temporarybasis.
 3. Loan and advances to customers/ group of customers who have been categorized as non per-
forming by other banks and financial institutions.
4. Firms/Companies/Organizations having negative net worth or net loss though interest and prin-cipal are
served on regular basis.
5. Loan and advances having multiple banking exposure more than Rs. 2 billion and have not entered into
consortium agreement.
6. Specifically specified by NRB after due inspection.
7. Loans having debt-equity ratio greater than 80:20.
8. Loans having inadequate debt to income ratio as prescribed by Nepal Rastra Bank.

4 b) Types of Hedging Relationship

There are three types of hedge accounting: fair value hedges, cash flow hedges and hedges of the
net investment in a foreign operation.
1. Fair Value Hedges:
The risk being hedged in a fair value hedge is a change in the fair value of an asset or a liability. For
examples, changes in fair value may arise through changes in interest rates (for fixed-rate loans), foreign
exchange rates, equity prices or commodity prices.
2. Cash Flows Hedges
The risk being hedged in a cash flow hedge is the exposure to variability in cashflows that is attributable
to a particular risk and could affect the income statement. Volatility in future cash flows will result from
changes in interest rates, exchange rates, equity prices or commodity prices.
3. Hedges of net investment in a foreign operation
An entity may have overseas subsidiaries, associates, joint ventures or branches (‘foreign operations’).
It may hedge the currency risk associated with the translation of the net assets of these foreign
operations into the group’s currency.
4 c) A sustainability report is a report published by a company or organization about the economic,
environmental and social impacts caused by its everyday activities. A sustainability report also presents
the organization’s values and governance model, and demonstrates the link between its strategy and its
commitment to a sustainable global economy. It details actions and policies towards helping future
generations meet their needs.
Sustainability reporting can help organizations to measure, understand and communicate their economic,
environmental, and social and governance performance, and then set goals, and manage change more
effectively. A sustainability report is the key platform communicating sustainability performance and
impacts, whether positive or negative.
Sustainability means meeting our own needs without compromising the ability of future generationsto meet
their own needs. In addition to natural resources, we also need social and economic resources.
Some of the advantages of corporate sustainability reports:
1. Enhances company image and reputation.

2. Attracts and retains employees. Employees tend to be happier working with companies thattake
care of them, and give them the opportunities to give back to, and volunteer in their local communities.
Such happy employees stay longer, and attract other people that are likeminded and want to work for
such organisation.
3. Increases understanding of risks and opportunities for sustainability projects. Similar to SWOT analysis
in marketing, a report, because it is so detailed and tied in with overall company goals.
4. Engages stakeholders.

4 d) A concept of actuarial valuation in retirement scheme

Actuarial valuation is the process used by an actuary* to estimate the present value of benefits to be paid
 under a retirement scheme and the present values of the scheme assets and, sometimes, of future
contributions. In the case of defined benefit scheme the cost of retirement benefits, tobe charged to
Profit and Loss Account on year to year basis, is determined on actuarial basis. According to NAS 19, an
enterprise should use the Projected Unit Credit method to determine thepresent value of its defined benefit
obligations and the related current service cost and, wherever applicable, past service cost.
4 e) Option Contract and its features
Option contract is a derivative instrument under which a buyer gets the right to buy or sell and a seller
undertakes an obligation to sell or buy a given quantity of the underlying asset at a given price at a given
future date for a payment of option premium by the buyer to the seller. For example;equity share option (eg.
Big Bank option), commodity options (eg. Gold/silver option).
Features of option contracts
1. Only the seller of an option is under an obligation to sell/buy the underlying asset as and whenthe buyer
exercises his/her right
2.Buyer of an option pays the option premium in full to the seller of an option at the time of buyingan
option.
3. For buyer of an option, profits are potentially unlimited and losses are limited to the option premium
paid to the seller. For seller of an option, profits are limited to the option premium received from the
buyer and losses are potentially unlimited.
4. Only seller/writer is required to pay the margi