Revision Test Paper (RTP), December 2023 CAP III – Group I

Contents
Paper 1 - Advanced Financial Reporting .............................................. 3
Paper 2 - Advanced Financial Management ...................................... 41
Paper 3 - Advanced Auditing ............................................................... 70
Paper 4 - Corporate Laws .................................................................... 92

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Revision Test Paper (RTP), December 2023 CAP III – Group I

Paper 1 - Advanced Financial Reporting

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Revision Test Paper (RTP), December 2023 CAP III – Group I

Consolidated Financial Statements

1. X Limited is a company carrying on the business of dairy products and is having a subsidiary
Y Limited. Balance Sheets of both the companies as at 16 July 2023 are as under:

Particulars Notes X Limited (Rs.) Y Limited (Rs.)

I. Equity and Liabilities:
1. Shareholder's Funds:
a. Share Capital 1 12,500,000 2,900,000
b. Reserves and Surplus 2 2,562,500 1,625,000
2. Current Liabilities
a. Trade Payables 3 2,415,000 1,592,500
Total 17,477,500 6,117,500
II. Assets:
1. Non-Current Assets
a. Property, Plant and
Equipment 10,850,000 3,125,000
b. Investments 4 2,550,000 -
2. Current Assets:
a. Inventories 2,400,000 1,596,000
b. Trade Receivables 5 1,240,000 1,320,000
c. Cash and Cash Equivalents 437,500 76,500
Total 17,477,500 6,117,500

Notes to Accounts:
Note X Limited Y Limited
No. (Rs.) (Rs.)
1 Share Capital
Authorized, Issued, Subscribed and Paid-up:
125,000 Equity Shares of Rs. 100 each 12,500,000
29,000 Equity Shares of Rs. 100 each 2,900,000
2 Reserve and Surplus
General Reserve 1,000,000 600,000
Profit and Loss Account 1,562,500 1,025,000
2,562,500 1,625,000
3 Trade Payables
Trade Payables 2,275,000 1,177,500
Bills Payables 140,000 415,000
2,415,000 1,592,500
4 Investments (20,300 Shares in Y Limited) 2,550,000
5 Trade Receivables
Trade Receivables 900,000 820,000
Bills Receivables 340,000 500,000
1,240,000 1,320,000

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X Limited has provided the following information:

1. X Limited has acquired the shares in Y Limited in two lots on two different dates during
the financial year 2022/23.
The relevant information at the time of acquisition of shares was as under:
No. of shares acquired Balance in General Reserve Balance in Profit or Loss
a/c
st
1 Acquisition – 17,400 400,000 125,000
2nd Acquisition – 2,900 425,000 510,000

2. Bills receivable of X Ltd includes Rs.75,000 being acceptance from Y Ltd.

3. Both the companies have proposed dividend of 10% for the year ended on 15 July 2023
but it has not been provided in the books of accounts.
4. Y Limited's inventory includes stock of Rs.725,000 purchased from X Ltd. X Ltd. sells
goods at mark up of 25% on its costs.

You are required to prepare the Consolidated Balance Sheet of X Limited along with the Notes
to Accounts.

Preparation of Financial Statements

2. The trial balance of ABC Ltd, as at 31 Ashadh 2080 is provided below:

Rs. '000 Rs. '000

Revenue 320,700
Cost of sales 215,700
Closing inventories (31/03/2080) (Note i) 15,750
Operating expenses 33,600
Income from Investment Property 1,800
Finance costs 6,300
Land and building at valuation (Note iii) 94,500
Plant and equipment at cost (Note iii) 54,000
Investment property (Note iii) 24,000
Accumulated depreciation on plant and equipment 25,200
(01/04/2079)
Trade receivables 20,250
Bank 11,850
Trade payables 17,700
Ordinary shares @RS. 0.25 30,000
10% Redeemable preference shares @ Rs. 1.00 15,000
Deferred Tax (Note iv) 7,800
Revaluation surplus 31,500
Retained earnings (01/03/2080) 26,250
475,950 475,950

The following information is provided:

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i) An inventory count at 31 Ashadh 2080 amounted to Rs. 15,750,000. This includes

damaged goods with a cost of Rs. 1,200,000. These will require remedial work costing Rs.
675,000 and could be sold for Rs.1,425,000.
ii) Finance cost is made up of the full year’s preference and ordinary dividends paid.
iii) Non-Current Assets
• Land and Building were revalued at Rs. 22,500,000 and Rs. 72,000,000 respectively on
1 Shrawan 2079, resulting in revaluation gain of Rs. 11,000,000 for the current year. At
that date, the remaining life of the building was 15 years. Depreciation is on straight line
basis. Ignore deferred tax implication.
• Depreciation on Plant and Equipment is at 12.5% on reducing balance basis.
• Investment Property: On 31 Asar 2080, a qualified surveyor valued the property at Rs.
20,250,000. ABC Ltd uses fair value model under NAS 40: Investment Property to
value its investment property.
• It is the policy of the company to charge depreciation on full year basis.
iv) The directors have estimated the provision for income tax for the year ended 31 Ashadh
2080 at Rs. 12,000,000. The deferred tax for the year ended 31 Ashadh 2080 is to be
adjusted so that the tax base of the company’s net assets is Rs. 18,000,000 less than the
carrying amount. Assume the rate of tax is 30%.
v) On 1 Baishakh 2080, ABC Ltd imported a piece of equipment from a Japanese supplier
for ¥ 1million and agreed to settle the bill in six months’ time. The relevant exchange rates
are provided below:

Date Exchange Rate

1 Baishakh 2080 ¥1:Rs. 6.20

31 Ashadh 2080 ¥1: Rs. 6.50

1 Kartik 2080 ¥1: Rs. 6.40

No entries have been made for the above transaction. Any exchange difference on
translation should be debited or credited to operating expenses.

Required: Prepare for ABC Ltd

a) Statement of Comprehensive Income for the year ended 31 Ashadh 2080.
b) Statement of Financial Position as at 31 Ashadh 2080.

NAS – 12 Income Taxes

3. An entity is finalising its financial statements for the year ended 31st Ashadh 2080. Before 31st
Ashadh 2080, the government announced that the tax rate was to be amended from 40 per cent
to 45 per cent of taxable profit from 30th Ashwin 2080.

The legislation to amend the tax rate has not yet been approved by the legislature. However,
the government has a significant majority and it is usual, in the tax jurisdiction concerned, to

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regard an announcement of a change in the tax rate as having the substantive effect of actual
enactment (i.e. it is substantively enacted).

After performing the income tax calculations at the rate of 40 per cent, the entity has the
following deferred tax asset and deferred tax liability balances:

Deferred tax asset Rs.80,000

Deferred tax liability Rs. 60,000

Of the deferred tax asset balance, Rs. 28,000 related to a temporary difference. This deferred
tax asset had previously been recognized in OCI and accumulated in equity as a revaluation
surplus.

The entity reviewed the carrying amount of the asset in accordance with para 56 of NAS 12
and determined that it was probable that sufficient taxable profit to allow utilisation of the
deferred tax asset would be available in the future.

Show the revised amount of Deferred tax asset & Deferred tax liability and present the
necessary journal entries.

NAS 20 Accounting for Government Grants and Disclosure of Government Assistance

4. On 1 Shrawan 2079, Kalanki Ltd received a Government grant of Rs.8 million towards the
purchase of new plant with a gross cost of Rs.64 million. The plant has an estimated life of 10
years and is depreciated on a straight-line basis. One of the terms of the grant is that the sale
of the plant before 31 Ashadh 2083 would trigger a repayment on a sliding scale as follows:

Intended sale in the year ended: Repayment amount

31 Ashadh 2080 100%

31 Ashadh 2081 75%

31 Ashadh 2082 50%

31 Ashadh 2083 25%

The directors propose to credit the statement of profit or loss with Rs.2 million (Rs.8 million
@ 25%) being the amount of the grant they believe has been earned in the year ended 31
Ashadh 2080. Kalanki Ltd accounts for government grants as a separate item of deferred credit
in its statement of financial position. Kalanki Ltd has no intention of selling the plant before
the end of its useful economic life.

Required: Explain with computations, the appropriate accounting treatment of the above
transaction in accordance with NAS 20 Accounting for Government Grants and Disclosure of

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Government Assistance in the financial statements of Kalanki Ltd for the year ended 31
Ashadh 2080.

NFRS 16 Leases

5. Kathmandu Ltd is a manufacturing company located in the Bagmati Province. It intends to

expand its production to take advantage of emerging economic activities in the new region. On
1 Shrawan 2079, the company entered into a lease agreement for a production equipment which
has a useful economic life of 8 years. The lease term is for four years and Kathmandu Ltd
agrees to pay annual rent of Rs.50,000 commencing on 1 Shrawan 2079 and annually
thereafter. The interest rate implicit in the lease is 7.5% and the lessee's incremental borrowing
rate is 10%. The present value of lease payments not yet paid on 1 Shrawan 2079 is Rs.130,026.
Kathmandu Ltd paid legal fees of Rs.1,000 to set up the lease.

Required: Prepare extracts for the Statement of Financial Position and Statement of Profit or
Loss for 2079/80 and 2080/81, showing how Kathmandu Ltd should account for this
transaction.

6. NFRS 15 Revenue from Contracts with Customers

Fashion Stores is a company in Nepal that manufactures clothes under its brand ‘Naya Look’
and exports them to clothes shop operators in India, the UK and Australia.

With a view of expanding its sales to other international retail markets, Fashion Stores recently
entered into an agreement with Unlimited Fashion, which operates a website to facilitate online
clothes sales and purchases in the international market.

Based on the above agreement:

• Fashion Stores displays its Naya Look brand products on the website operated by
Unlimited Fashion and the selling price will be decided by Fashion Stores.

• A 5% commission should be paid to Unlimited Fashion for each of the sales transactions.

• Once an order is placed on the website by a customer, it will be automatically

communicated to Fashion Stores and the shipments/delivery should be done through
Fashion Stores’s centralised warehouse.

• Upon the delivery of goods from the warehouse, the legal title of the goods is transferred
to Unlimited Fashion. However, the goods need to be insured by Fashion Stores.

• Customers will be given one week upon receipt of the goods to return any dissatisfied
goods to Unlimited Fashion. These goods need to be returned back to Fashion Stores by
Unlimited Fashion without a penalty.

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Evaluate whether Unlimited Fashion is acting as an agent or principal in this agreement, based
on the guidance given in NFRS 15 Revenue from Contracts with Customers.

NAS 24 – Related Party Disclosure

7. Pokhara Ltd (Pokhara) holds 56% of the voting shares of Nepal Ltd. Shyam holds 78% voting
shares of Pokhara. However, Shyam does not hold any directorship in either company.
Pratik, Kalum and Menaka are directors at Nepal Ltd. Mennan, Geetha and Kalum are directors
at Pokhara Ltd. Nepal Ltd has a 52% stake in Solex (Pvt) Ltd (Solex). Kamal, Anusha and
Priya are directors at Solex.
Other relevant information is given below.
• Geetha is married to Gayan who is the head of marketing at Winwin Pvt Ltd.
• Nepal Ltd owns 50% of Phenix Pvt Ltd (Phenix). Balance 50% of Phenix is owned by Jaya.
The contractual arrangement between them specifies that at least 51% of the voting rights are
required to make decisions about the relevant activities of the arrangement.

Comment on each party mentioned in the scenario above to identify whether they are related
parties to Nepal Ltd.

NFRS 13 – Fair value measurement

8. ABC Ltd acquired an entity (Entity A) and is required to measure fair values of the following
item by applying the requirements of NFRS 13 – Fair value measurement
Investment in an equity instrument

Entity A holds an investment in an equity instrument, which is pledged as collateral to support

a debt obligation of the entity. Until the debt is fully settled, the entity cannot sell this
instrument. The debt is due for repayment one year after the date of acquisition of Entity A by
ABC Ltd. It is highly likely that the entity will settle the debt on the due date. The following
details at the acquisition date are provided to you. Market price of the equity instrument: Rs.
13 million Discount (%) on the market price for the restriction period of one year: 7%

NAS 36 Impairment of Assets

9. Phillips acquired 75% of Little Ltd (Little) by purchasing 7.5 million of its voting shares on 7
May 2018 when the fair value of a share was Rs. 250. The goodwill recognised on the
acquisition was Rs. 375 million after fair valuing the non-controlling interest (NCI). The
carrying value of the investment in Little and the goodwill have not been impaired up to 31
March 2022. However, due to a decline in market conditions Phillips decided to carry out an
impairment review on 31 March 2023 for the investment in Little.

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The fair value of a share of Little as at 31 March 2023 was Rs. 225 and the estimated transaction
cost (at the time of disposal) was 1.5% of the fair value. The net asset value of Little as at the
year-end was Rs. 275 per share.

Little operates as a single cash-generating unit (CGU) and the following information relates to
the value-in-use assessment.

Year Pre-tax cash flows (Rs. In million)

2023/24 275
2024/25 325
2025/26 368
2026/27 412
2027/28 494
2027/28 onwards 1% terminal growth rate

Further, fair value of interest bearing borrowings and cash and cash equivalents balance of
Little as at the year-end were Rs. 275 million and Rs. 136 million respectively. These balances
have been considered in deriving net assets of Little. The pre-tax market rate of return for Little
was 15% per annum. The business income of the company is taxed at 24%.
Required:
Advise Phillips on the impairment assessments to be carried out in preparing the separate
financial statements and consolidated financial statements of Phillips as at 31 March 2023.
NAS 16: Property, Plant and Equipment and NAS 36: Impairment of Assets

10. B Ltd acquired 100% of a subsidiary, M Ltd, on 1 January 2021. The carrying amount of the
assets of M Ltd in the consolidated financial statements of the B group at 31 December 2021,
immediately before an impairment review, were as follows:

Particulars Rs. In million

Goodwill 1.4
Brand name 2
Property, plant and equipment 6
Current assets (at recoverable amount) 2.4
11.8

The recoverable amount of M Ltd was estimated at Rs. 9.6 million at 31 December 2021 and
the impairment of the investment in M Ltd was deemed to be Rs.2.2 million. B Ltd applies
NAS 16: Property, Plant and Equipment and NAS 36: Impairment of Assets in preparing
its financial statements.

Required:

Assuming M Ltd represents a cash generating unit, show the financial reporting treatment of
the brand name at 31 December 2021 in the books of B Ltd following the impairment review.

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NAS 19 – Employee Benefits

11. On 1 Shrawan 2079, the fair value of the assets of A Ltdʼs defined benefit plan were valued at
Rs.20,40,000 and the present value of the defined obligation was Rs.21,25,000. On 31 Ashadh
2080 the plan received contributions from A Ltd amounting to Rs. 4,25,000 and paid out
benefits of Rs. 2,55,000. The current service cost for the financial year ending 31 Ashadh 2080
is Rs. 5,10,000. An interest rate of 5% is to be applied to the plan assets and obligations.

The fair value of the plan assets at 31 Ashadh 2080 was Rs.23,80,000, and the present value
of the defined benefit obligation was Rs.27,20,000. Provide a reconciliation from the opening
balance to the closing balance for Plan assets and Defined benefit obligation. Also show how
much amount should be recognized in the statement of profit and loss, other comprehensive
income and balance sheet?

NAS 2 Inventories

12. From the following details of Amatya Ltd, you are required to compute the closing inventory:

Particulars
Raw Material – A
Closing Balance 600 units
Rs. Per unit
Cost Price 250
Freight inward 30
Handling charges 15
Tax refund 20
Replacement cost 180
Finished Goods – B
Closing Balance 1500 units
Rs. Per unit
Material Consumed 250
Direct Labour 70
Direct Overhead 30

Total fixed overhead for the year was Rs.300,000 on a normal capacity of 30,000 units while
actual production has been of 25,000 units

Calculate the value of closing inventory when

i) Net Realizable Value of the Finished Goods B is Rs. 450 per unit
ii) Net Realizable Value of the Finished Goods B is Rs. 340 per unit

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NFRS 8 Operating Segments

13. M Ltd. Group has three divisions A, B and C. Details of their turnover, results and net assets
are given below:
Rs. '000
Division A
Sales to B 3,050
Other Sales (Domestic) 60
Export Sales 4,090
7,200
Division B
Sales to C 30
Export Sales to Europe 200
230
Division C
Export sales to US 180

Head Office Division A Division B Division C(Rs.

(Rs. '000) (Rs. '000) (Rs. '000) '000)
Operating Profit 160 20 (8)
or Loss Before
tax
Reallocated cost 48 24 24
from Head office
Interest Costs 4 5 1
Fixed assets 50 200 40 120
Net current assets 48 120 40 90
Long term 38 20 10 120
liabilities
Prepare Segmental Report for publication in M Ltd

Value Added Statement

14. EV Ltd have announced bonus for staff @ 50 percent of any value added earned in excess of
Rs.1.15 per Re.1 of labour. EV Ltd's results for the year ended 30th Ashadh 2080 are as follows:
Rs.'000
Sales 5000
Cost of Sales
Cost of Production:
Materials 1000
Direct Labour 1200
Factory Overhead (Note 1) 1500 3700
Work in progress:
Opening 140
Closing 160 (20)
Finished good stock

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Opening 400
Closing 440 (40) 3640
Gross Profit 1360
Selling & administration overhead (Note 1) 870
Profit 490
Royalties received 10
Net Profit 500
Taxation 200
Net profit after tax 300
Dividends 100
Profit 200

Note 1:
Factory Selling &
Administration
Wages & Salaries 400 470
Equipment Leasing 50 10
Depreciation 200 50
Other rents, rates, etc. 850 340
EV Ltd is having beta factor of 1.1 and has the following capital structure:
Equity Shareholders' Fund 700
9% Preference Share Capital 200
Rate of tax is 40%
Risk Free Rate is 4%
Market rate of return is 6%
Company is planning to introduce EVA based bonus which will be 10% of EVA. Such
bonus will be shared by employees in ratio of their emoluments. Find the amount of Bonus
receivable by an employee whose annual wage bill of Rs.5000 under both plans of VA and
EVA.

NAS 33 Earnings per Share

15. At 30 June 20X1, the issued share capital of an entity consisted of 1,500,000 ordinary
shares of Rs. 1 each. On 1 October 20X1, the entity issued Rs. 1,250,000 of 8% convertible
loan stock for cash at par. Each Rs. 100 nominal of the loan stock may be converted, at
any time during the years ended 20X6 to 20X9, into the number of ordinary shares set
out below:
30 June 20X6: 135 ordinary shares;
30 June 20X7: 130 ordinary shares;
30 June 20X8: 125 ordinary shares; and 30 June 20X9: 120 ordinary shares.
If the loan stocks are not converted by 20X9, they would be redeemed at par.
This illustration assumes that the written equity conversion option is accounted for as a
derivative liability and marked to market through profit or loss. The change in the options’

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fair value reported in 20X2 and 20X3 amounted to losses of Rs. 2,500 and Rs. 2,650
respectively. It is assumed that there are no tax consequences arising from these losses.
The profit before interest, fair value movements and taxation for the year ended 30 June
20X2 and 20X3 amounted to Rs. 825,000 and Rs. 895,000 respectively and relate wholly
to continuing operations. The rate of tax for both periods is 33%.
Calculate Basic and Diluted EPS.

NAS 40 Investment Property

16. Define Investment Property as per NAS 40 and state whether the following properties will
meet the definition of Investment Property as per the accounting standard:
• Owned by the company and leased out under an operating lease
• Held under Finance Lease and Leased out under operating lease
• Held under Finance Lease and leased out under Finance Lease
• Property acquired with a view for development and re-sale

NFRS 9 – Financial Instrument

17. M Ltd purchased Rs. 30 million 10% debentures on 1 April 2019. These debentures are
redeemable on 31 March 2024 at Rs. 31 million. Interest on these debentures is paid annually
on 31 March each year. M Ltd intends to hold the debentures in order to collect the interest
payments and receive repayment on maturity. However, it may sell these debentures if the
opportunity of buying one with a greater return arises. Effective interest rate of these
debentures is 10.54%. Fair value of the debentures as at 31 March 2020 was Rs. 30.5 million.
As at 31 March 2021, the debentures had been impaired by Rs. 300,000. Fair value of the
debentures as at 31 March 2021 was Rs. 29.9 million. On 1 April 2021, M Ltd sold the
debentures at Rs. 29.9 million.
Required: Advise on the accounting treatment to be applied for the above debentures together
with the calculations required up to 31 March 2021.

NAS 38 Intangible Assets

18. An entity has an intangible asset in the form of a product protected by patented technology
which is expected to be a source of net cash inflows for at least 15 years. It has been recognized
in the books on initial date at Rs.1,200,000. The entity has a commitment from a third party to
purchase the patent in five years for 60 percent of the fair value of the patent at the date of
acquisition, and the entity intends to sell the patent in five years. Company is amortizing the
asset in 15 years considering its residual value to be zero. Annual amortization charted to Profit
or Loss account is Rs.80,000. You are required to state whether the accounting treatment done
by the company is in accordance with the NAS 38? If not, calculate the annual amortization of
the intangible asset and also the amount at which it will be reflected in the balance sheet.

NAS 34 Interim Financial Reporting

19. What are the components of interim financial statements (condensed or complete)?

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20. Write short notes on:

a. Expected Credit Loss Model
b. Reversal of Impairment Loss as per NAS 36
c. De-recognition of financial assets
d. Distinction between the treatment of contingent consideration classified as equity and
contingent consideration classified as either asset or liability
e. Distinguish between Joint Operation and Joint arrangement as explained under NRFS 11 Joint
Arrangements

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Answers
1. Consolidated Financial Statements
Consolidated Balance Sheet of X Ltd and its subsidiary Y Ltd
as on 16th July 2023
Particulars Notes X Limited (Rs.)
I. Equity and Liabilities:
1. Shareholder's Funds:
a. Share Capital 1 12,500,000
b. Reserves and Surplus 2 3,146,500
2. Non-controlling Interest (WN 2) 1,357,500
3. Current Liabilities
Trade Payables 3 3,932,500
Total 20,936,500
II. Assets:
1. Non-Current Assets
a. Property, Plant and Equipment 4 13,975,000
b. Investments 5 111,500
2. Current Assets:
a. Inventories 6 3,851,000
b. Trade Receivables 7 2,485,000
c. Cash and Cash Equivalents 8 514,000
Total 20,936,500
Notes to Accounts:
Note No. Rs. Rs.
1 Share Capital
Authorized, Issued, Subscribed and Paid-up:
125,000 Equity Shares of Rs. 100 each 12,500,000
2 Reserve and Surplus
General Reserve (WN 4) 1,137,500
Profit and Loss Account (WN 4) 2,009,000 3,146,500
3 Trade Payables
Trade Payables

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X Ltd 2,275,000
Y Ltd 1,177,500 3,452,500
Bills Payables
X Ltd 140,000
Y Ltd 415,000
Less: Mutual Owings (75,000) 340,000 480,000
3,932,500
4 Property, Plant and Equipment
X Ltd 10,850,000
Y Ltd 3,125,000 13,975,000
5 Intangible Assets
Goodwill (WN 3) 111,500
6 Inventories
X Ltd 2,400,000
Y Ltd 1,596,000
3,996,000
Less: Unrealized Prrofit (145,000) 3,851,000
7 Trade Receivables
X Ltd 900,000
Y Ltd 820,000 1,720,000
Bills Receivables
X Ltd 340,000
Less: Mutual Owings (75,000) 265,000
Y Ltd 500,000 765,000
2,485,000
8 Cash and Cash Equivalents
X Ltd 437,500
Y Ltd 76,500 514,000

Note: Since dividend has been proposed by both the companies, it has been considered as
dividends were declared after the reporting date. As per the NAS 10, no adjustment is required
to be made in the financial statements if dividend is declared after the reporting date. However,
the disclosure is required in the Notes to the Account.

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9. 10% dividend has been proposed by the group companies as follows:

X Ltd Rs. 1,250,000
Non-controlling Interest of Y Ltd (2,900,000*10%*30%) Rs.87,000
Rs.13,37,000
However, this being a non-adjusting event has not been recognized in the Consolidated
Financial Statement ended on 15.07.2023
Working Notes:
2. Analysis of Reserves and Surplus of Y Ltd
Pre- Post-acquisition
acquisition
General Profit & Loss
Profits
Reserve Account
General Reserve 400,000 200,000
Profit & Loss Account 125,000 900,000
For Lot 1 (A) 525,000 200,000 900,000
Pre-acquisition for 2nd Lot
General Reserve (425,000-400,000) 25,000
Profit & Loss Account (510,000- 385,000
125,000
X Ltd (70% of A) 367,500 140,000 630,000
Adjustment for pre-acquisition 2,500 (2,500)
General Reserve for Lot 2 (10%)
Adjustment for pre-acquisition 38,500 (38,500)
Profit or Loss Account for Lot 2
(10%)
X Ltd 408,500 137,500 591,500
Non-controlling Interest (30% of A 157,500 60,000 270,000
Ltd)

3. Non-controlling Interest
Amount (Rs.)
Share Capital (30%) 870,000
Add: Share of pre-acquisition profit of Y Ltd 157,500
Add: Share of post-acquisition General Reserve 60,000
Add: Share of post-acquisition Profit or Loss Account 270,000
1,357,500

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4. Cost of Control/Goodwill
Amount (Rs.)
Cost of Investments 2,550,000
Less: Share Capital (70%) (2,030,000)
Less: Share of pre-acquisition profit (408,500)
Goodwill 111,500

5. Consolidated General Reserve & Profit or Loss Account

General Reserve Profit or Loss Account
X Ltd. 1,000,000 1,562,500
Less: Unrealized Profit (145,000)
Add: Share in post- 137,500 591,500
acquisition profit of Y Ltd
1,137,500 2,009,000

Preparation of Financial Statements

2. Solution
ABC Limited
Statement of Profit or Loss and Other Comprehensive Income
For The Year Ended 31/03/2080
Particulars Rs. '000
Revenue 320,700
Cost of sales (225,325)
Gross Profit 95,375
Income from Investment Property 1,800
Total Income 97,175
Operating expenses (33,600 +300 exchange loss) (33,900)
Fair value loss on investment property (24,000-20,250) (3,750)
Profit before interest and tax 59,525
Finance cost (6,300-4,800 ordinary dividends) (1,500)
Profit before tax 58,025
Taxation (9,600)
Profit after tax 48,425

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Other comprehensive income:

Gain on revaluation -
PPE 11,000
Total comprehensive income 59,425

ABC Limited
Statement of Financial Position
as at 31/03/2080
Particulars Rs. '000 Rs. '000
Non-current assets
Property plant and equipment 120,325
Investment property 20,250
140,575
Current assets
Inventory (15,750-450) 15,300
Trade receivables 20,250
Bank 11,850
47,400
Total Assets 187,975
Current liabilities
Trade payables (17,700+6,500(w6)) 24,200
Current tax liability 12,000
36,200
Non-current liabilities
Deferred tax liability 5,400
10% Redeemable Preference shares 15,000
56,600
Equity
Stated capital (ordinary shares @ .25) 30,000
Retained earnings (26,250 +48,425-4,800 dividends) 69,875
Revaluation surplus 31,500
131,375

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Total Equity and Liabilities 187,975

Working Notes:
1. Depreciation
Rs.’000
Buildings (72,000/15) 4,800
Old plant and equipment (12.5% x (54,000-25,200)) 3,600
New plant and equipment (12.5% x 6,200(w5)) 775
9,175
2. Cost of Sales
Rs.’000
Per trial balance 215,700
Write down (below) 450
Depreciation charge for the year 9,175
225,325
Inventory
Cost 15,750
Damaged goods:
Cost 1,200
NRV (1,425-675) (750)
Write down (450)
Value at year end 15,300
3. Property Plant and Equipment
Land and Building Plant and Equipment Total
Cost/Valuation 83,500 54,000
(1/04/2079)
Accumulated - 25,200
depreciation
NBV (1/4/2079) 83,500 28,800
Revaluation gain 11,000 - 11,000
Addition - 6,200 6,200
Depreciation 4,800 4,375 9,175
NBV (31/03/2080) 89,700 30,625 120,325
Depreciation charge on building per annum = 72 m/15 years = 4.8 m

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Depreciation charge on Plant and Machinery is 12.5% x (54 m-25.2 m) = 3.6 m

4. Taxation
i. Income tax
Current charge for the year 12,000
Decrease in deferred Tax (2,400)
Charge to SPL 9,600
ii. Deferred Tax
Balance b/d 7,800
Decrease in deferred Tax (2,400)
Balance c/d 5,400
Note: Deferred tax liability at year end = 30% x 18,000,000 (temporary timing difference) =
Rs.5,400,000.
4. Foreign currency translation
At 1/01/2080 Rs’000
Dr: Equipment (100,000 x 6.2) 6,200
Cr: Payables 6,200
Note: the non-monetary item is not subject to retranslation but the foreign currency payable
should be retranslated as follows:
Payables Rs.’000
At 1/1/2080 6,200
Exchange loss (balance) 300
At 31/03/2080 (1,000,000 x 6.50) 6,500
5. Finance cost
Finance cost is stated less the ordinary dividends of Rs. 4,800,000 (i.e. 6,300,000 less
preference dividends of Rs. 1,500,000), as well as the net interest on defined benefit plan Rs.
10,000 (i.e. Rs. 20,000 interest cost – Rs. 10,000 return on plan assets).
Rs.’000
Per trial balance 6,300
Dividends (ordinary) (4,800)
10% x15,000 Preference shares 1,500

NAS – 12 Income Taxes

3. Calculation of Deductible temporary differences:
Deferred tax asset = Rs. 80,000

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Existing tax rate = 40%

Deductible temporary differences = 80,000/40%
= Rs. 2,00,000
Calculation of Taxable temporary differences:
Deferred tax liability = Rs. 60,000
Existing tax rate = 40%
Deductible temporary differences = 60,000 / 40%
= Rs. 1,50,000
Of the total deferred tax asset balance of Rs.80,000, Rs. 28,000 is recognized in OCI
Hence, Deferred tax asset balance of Profit & Loss is Rs.80,000 - Rs.28,000 = Rs.52,000
Deductible temporary difference recognized in Profit & Loss is Rs. 1,30,000 (52,000 / 40%)
Deductible temporary difference recognized in OCI is Rs.70,000 (28,000 / 40%)
The adjusted balances of the deferred tax accounts under the new tax rate are:
Deferred tax asset Rs.
Previously credited to OCI-equity 70,000 x 0.45 31,500
Previously recognised as Income 1,30,000 x 0.45 58,500
90,000
Deferred tax liability
Previously recognized as expense 1,50,000 x 0.45 67,500
The net adjustment to deferred tax expense is a reduction of Rs. 2,500. Of this amount,
Rs.3,500 is recognised in OCl and Rs.1,000 is charged to P&L.
The amounts are calculated as follows:
Carrying Carrying Increase
amount at amount at /(decrease)
45% 40%
in deferred tax
expense
Deferred tax assets
Previously credited to OCI-equity 31,500 28,000 (3,500)
Previously recognised as Income 58,500 52,000 (6,500)
90,000 80,000 (10,000)
Deferred tax liability
Previously recognized as expense 67,500 60,000 7,500
Net adjustment (2,500)

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An alternative method of calculation is:

DTA shown in OCI Rs. 70,000 x (0.45 - 0.40) 3,500
DTA shown in Profit or Loss Rs.1,30,000 x (0.45-0.40) 6,500
DTL shown in Profit or Loss Rs.1,50,000 x (0.45 -0.40) 7,500
Journal Entries
Deferred tax asset Dr 3,500
To OCI –revaluation surplus 3,500
Deferred tax asset Dr 6,500
To Deferred tax expense 6,500
Deferred tax expense Dr 7,500
To Deferred tax liability 7,500
Alternatively, a combined journal entry may be passed as follows:
Deferred tax asset Dr. 10,000
Deferred tax expense Dr. 1,000
To OCI –revaluation surplus 3,500
To Deferred tax liability 7,500
NAS 20 Accounting for Government Grants and Disclosure of Government Assistance
4. Government grants related to non-current assets should be credited to the statement of profit
or loss over the life of the asset to which they relate, not in accordance with the schedule of
any potential repayment. The directors’ proposed treatment is implying that the government
grant is a liability which decreases over four years. This is not correct as there would only be
a liability if the directors intended to sell the related plant, which they do not intend to do so.
Therefore, in the year ended 31st Asar 2080, Rs.800,000 (8 million/10 years) should be credited
to the statement of profit or loss and Rs.7·2 million should be shown as deferred income
(Rs.800,000 current and Rs.6·4 million non-current) in the statement of financial position.
NFRS 16 Leases
5. Solution
Kathmandu Ltd
Statements of financial position extract as at 31st Ashadh 2081
Particulars 2079/80 2080/81
Non-Current Asset
Right-of-use asset 181,026 181,026
Accumulated Depreciation (45,257) (90,514)
135,769 90,512
Non-current liabilities

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Lease Liability 89,778 46,511

Current Liabilities
Capital Sum 40,248 43,267
Financial Charge 9,752 6,733
50,000 50,000

Kathmandu Ltd
Statements of Profit or Loss extract for the year ended 31st Ashadh 2081
Particulars 2079/80 2080/81
Expenses
Depreciation (181,026/4) (45,257) (45,257)
Finance Costs (9,752) (6,733)
Working Notes
WN-1: Lease Liability
Year Opening Lease Liability for Implicit Closing
Balance payments the year Interest @ Balance
7.5%
2079/80 130,026 - 130,026 9,752 139,778
2080/81 139,778 (50,000) 6,733 96,511
89,778
2081/82 96,511 (50,000) 3,488 50,000
46,511
2082/83 50,000 (50,000) - -
-
WN-2: Right of use asset
Lease Liability (Opening) 130,026
Lease payment at 1 January 2020 50,000
Initial Direct Cost 1,000
181,026
Annual Depreciation = 181,026/4
=45,257
NFRS 15 Revenue from Contracts with Customers
6. NFRS 15 provides guidance to assess whether an entity is acting as an agent or a principal in
an arrangement. An entity is a principal if it controls the specified good or service before that
good or service is transferred to the customer.

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An entity is an agent if the entity’s performance obligation is to arrange for the provision of
the specified good or service by another party.
In this scenario Unlimited Fashion receives the title to the goods or services before it transfers
them to the customer. However, per paragraph B35 of NFRS 15, obtaining the title to the goods
is not necessarily a factor to determine whether an entity is a principal in a particular
arrangement.
There are indicators provided in paragraph B37 to assess whether an entity is acting as an agent
or a principal in a particular arrangement.
1. The entity is primarily responsible for fulfilling the promise to provide the specified good
or service.
Once an order has been placed it will automatically be communicated to Fashion Stores
and the shipments should be done by Fashion Stores itself. Once a good is returned by a
customer, it needs to be returned back to Fashion Stores. Unlimited Fashion will not take
any responsibility over that. Therefore it appears that the responsibility to fulfill the
promise lies with Fashion Stores and not with Unlimited Fashion.
2. The entity has an inventory risk before the specified good or service is transferred
tocustomer or after the transfer of control to the customer.
Although the title to the goods has been transferred to Unlimited Fashion, the inventories
are insured under the name of Fashion Stores. This indicated Unlimited Fashion does not
assume any inventory risk.
3. The entity has discretion in establishing the price for the specified good or service. The
price of the goods is determined by Fashion Stores and not by Unlimited Fashion. After
the evaluation of the terms of the arrangement against the above criteria, it can be
concluded that Unlimited Fashion is acting as an agent in the arrangement.
NAS 24 – Related Party Disclosure
7. Solution
Party Is the party related Explanation
or not?
Pokhara Ltd Related party 56% of the voting shares implies the
controlling power is with Pokhara. Hence it
is the parent company of Nepal Ltd
Shyam Related party 78% of Pokhara's shares are owned by
Shyam (ultimate controlling party of Nepal
Ltd)
Pratik, Kalum and Related Parties All of them are directors of Nepal Ltd (part
Menaka of Key Management Personnel) (KMP)
Mennan, Geetha and Related Parties All of them are directors of the parent
Kalum company Pokhara Ltd (they are part of Key
Management Personnel) (KMP)
Solex (Pvt) Ltd Related party Nepal Ltd has the controlling stake of Solex,
hence it is a subsidiary company

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Kamal, Anusha and May not be related They are directors of a subsidiary company
Priya parties of Nepal Ltd. That relationship alone will not
allow us to consider them as related parties.
Gayan Related party Geeta's husband and therefore the spouse of
a KMP.
Winwin Pvt Ltd May not be related Not enough facts available to determine the
parties relationship.
Phenix Pvt. Ltd Related party A Jointly controlled entity
Jaya May not be related Not enough facts available to determine the
parties relationship,
NFRS 13 – Fair value measurement
8. Fair value measurement is for a particular asset or liability. Therefore, when measuring fair
value, an entity should take into account the characteristics of the asset/liability if market
participants take those into account when pricing the asset/liability at the measurement date.
Restrictions (if any) on the sale or use of the asset is one such characteristic.
In this case, there is a restriction on the sale of the asset since the entity has pledged that asset
as collateral for a borrowing. This restriction is a characteristic of the entity rather than of the
asset (e.g. if the entity settles the loan early, the restriction will not apply).
Therefore, this characteristic would not be considered by the market participants in pricing the
asset (e.g. market participants may require the entity to settle the loan and release the security
before the sale).
Therefore, it is not required to discount the market price for the restriction. The fair value is
Rs. 13 million.
NAS 36 Impairment of Assets
9. Impairment is determined by assessing the recoverable amount of a cash generating unit to
which the investment/goodwill relates. The recoverable amount of a cash generating unit is
determined based on the higher of fair value, less cost to sell and the value in use (VIU)
calculation.
As per NAS 36 it’s mandatory to perform an impairment testing on goodwill at the end of each
financial year
Rs. In million
2023/24 2024/25 2025/26 2026/27 2027/28
Pre-tax Cash Flows 275 325 368 412 494
Terminal Value
(494*1.01)/(0.15-0.010 3,536.86
Year 1 2 3 4 5
Discounting Factor @15% 0.870 0.756 0.658 0.572 0.497
Discounted Cash Flows 239.25 245.70 242.14 235.66 2,003.34

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Rs. In million
Enterprise value 2,966.10
Add: Cash and cash equivalents 136
Less: Interest Bearing Liabilities -275
Equity Value 2,827.10
FV less cost to sell
Company (225*10*98.5%) 2216.25
Since the "value in use" (VIU) is higher, it will be taken as the recoverable value in determining
impairment.
Investment in Little Rs. In million
Carrying value as at 31st March 2023 (250*7.5) 1,875
Recoverable value (75%*2,840.88) 2,136.66
Since the recoverable value is higher than the carrying value, no impairment on the investment
is recognized in Little.
Goodwill Rs. In million
Carrying value as at 31st March 2023
Net asset value of Little 2,750
Goodwill 375
3,125
Recoverable Value 2,840.88
Impairment of Goodwill 284.12
Goodwill impairment will be charged to profit or loss as an expense in the year 2022/23.
Rs.90.88 million will be recognized in the Statement of Financial Position as at 31 March 2023
as carrying value of the goodwill.
NAS 16: Property, Plant and Equipment and NAS 36: Impairment of Assets
10. The impairment loss for the Cash Generating Unit is Rs.2.2 million (Rs.11.8 million – Rs.9.6
million). The impairment loss is initially allocated to the goodwill balance of Rs.1.4 million.
The unallocated impairment loss is Rs.0·8 million. This is allocated to the brand and PPE based
on their carrying amounts:
Rs. In million
Brand name 2
Property, plant and equipment 6
8

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2/8 *Rs.0.8 = 0.2 loss to be allocated to brand so new carrying amount

= Rs.2 million – Rs.0.2 million
= Rs.1.8 million.
NAS 19 - Employee Benefits
11. Reconciliation of Plan asset and Defined benefit obligations
Particulars Plan Asset Defined Benefit
(Rs.) Obligation (Rs.)
Fair value/present value as at 1 Shrawan 2079 20,40,000 21,25,000
Interest @ 5% 1,02,000 1,06,250
Current service cost 5,10,000
Contributions received 4,25,000 -
Benefits paid (2,55,000) (2,55,000)
Return on gain (assets) (balancing figure) 68,000 -
Actuarial Loss (balancing figure) - 2,33,750
Closing balance as at 31 Ashadh 2080 23,80,000 27,20,000
In the Statement of Profit and loss, the following will be recognised:
Rs.
Current service cost 5,10,000
Net interest on net defined liability (Rs. 1,06,250 – Rs. 1,02,000) 4,250
Defined benefit re-measurements recognized in other comprehensive income:
Rs.
Loss on defined benefit obligation (2,33,750)
Gain on plan assets 68,000
(1,65,750)
In the Balance sheet, the following will be recognised:
Rs.
Net defined liability (Rs. 27,20,000 – Rs. 23,80,000) 3,40,000
NAS 2 Inventories
12. When Net Realizable Value of the Finished Goods B is Rs. 450 per unit
Valuation Quantity Rate Amount
Base (Rs.) (Rs.)
Raw Material – A Cost 600 275 165,000
Finished Goods – B Cost 1500 360 540,000
Total value of closing inventory 705,000
When Net Realizable Value of the Finished Goods B is Rs. 340 per unit

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Since Net Realizable Value of Finished Good B is less than its cost i.e. Rs. 360 (Working
Note), Raw Material A is to be valued at replacement cost and finished goods is to be
valued at Net Realizable Value.
Valuation Base Qty Rate (Rs.) Amount
(Rs.)
Raw Material – A Replacement Cost 600 180 108,000
Finished Goods – B Net Realizable Value 1500 340 510,000
Total value of closing inventory 618,000
Working Note
Statement showing cost of Raw Material - A and Finished product – B
Raw Material A Rs.
Cost Price (250-20) 230
Add: Freight inward 30
Add: Handling Charges 15
275
Finished product – B Rs.
Material Consumed 250
Direct Labour 70
Direct Overhead 30
Fixed Overhead (300,000/30000 units) 10
360
NFRS 8 Operating Segments
13. Solution
M Ltd
Segment Report
(Rs. '000)
Division Division Division Eliminations Consolidated
A B C – Inter
Segment
Revenue
External Sales:
Domestic 60 - - - 60
Export 4,090 200 180 - 4,470
Inter-segment Sales 3,050 30 - 3,080 -

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Total Revenue 7,200 230 180 3,080 4,530

Result
Segment Result 160 20 8 - 172
Reallocated Cost - - - - 96
from Head Office
Operating Profit - - - - 76
Interest Cost - - - - (10)
Profit before tax - - - - 66
Other Information
Segment Assets:
a. Fixed Assets 200 40 120 - 360
b. Net Current 120 40 90 - 250
Assets
Unallocated - - - - 98
Corporate Assets
Segment Liabilities 20 10 120 - 150
(Long Term)
Unallocated - - - - 38
corporate liabilities
(Long term)
Sale revenue by Geographical Market
Domestic sales by Export Export to Export to Consolidated
Division A Sales of Europe US
Division A
60 4,090 200 180 4530
Value Added Statement
14. Solution
Working Notes
1. Value added based bonus
Value Added Statement
Sales 5000
Add: Royalty income 10
5010
Less: Cost of Production
Materials 1000

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Factory overhead (1500-400-200) 900

Work in progress (20)
Finished Stock (40)
Selling & administration overhead 350 2190
Value added by manufacturing and trading activity 2820
Payroll expenses
Direct Labour 1200
Factory overhead 400
Selling overhead 470
2070
Calculation of Bonus
Labour Cost =2070
Value added (Min) =2070*1.15=2380.50
Bonus =(2820-2380.50)*50%
=219.75
Bonus for employee
219.75/2070*5000 =530.79
Working Notes:
Economic Value Added
i) Calculation of Net Operating Profit after Tax
Earning before Interest & Taxes = 500
Less: Tax @ 40% =200
Net Operating Profit after Tax =300
ii) Calculation of Weighted Average Cost of Capital
Kp = 9%
Kc=4%+1.10(6%-4%) =6.2%
[9%*200/900]+[6.2%*700/900]=6.82%
iii) Economic Value Added = (Return on Operating Capital – Weighted
average cost of capital)*Operating Capital
= [(300/900*100)-6.82%]*900
= 238.60
iv) Economic Value added based Bonus = 238.6*10% = 23.86
Employee = 23.86/2070*5000 =57.60

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NAS 33 Earnings per Share

15. Solution
Trading results 20X3 20X2

Rs. Rs.

A. Profit before interest, fair value movements and tax 895,000 825,000

B. Interest on 8% convertible loan stock (20X2: 9/12 × (100,000) (75,000)

Rs.100,000)

C. Change in fair value of embedded option (2,650) (2,500)

Profit before tax 792,350 747,500

Taxation @ 33% on (A-B) (262,350) (247,500)

Profit after tax 530,000 500,000

Calculation of basic EPS

Number of equity shares outstanding 1,500,000 1,500,000

Earnings Rs. 530,000 Rs. 500,000

Basic EPS 0.35 0.33

Calculation of diluted EPS

Test whether convertibles are dilutive:
The saving in after-tax earnings, resulting from the conversion of Rs. 100 nominal of loan
stock, amounts to Rs. 100 × 8% × 67% + Rs. 2,650/12,500 = Rs. 5.36 + Rs. 0.21 = Rs. 5.57.
There will then be 135 extra shares in issue.
Therefore, the incremental EPS is Re.0.04 (ie. Rs. 5.57/135). As this incremental EPS is
less than the basic EPS at the continuing level, it will have the effect of reducing the basic
EPS of Re.0.35. Hence the convertibles are dilutive.

20X3 20X2
Adjusted earnings
Rs. Rs.

Profit for basic EPS 530,000 500,000

Add: Interest and other charges on earnings saved as 102,650 77,500

a result of the conversion
(100,000 + (75000+ 2500)
2,650)

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Less: Tax relief thereon (33,000) (24,750)

Adjusted earnings for equity 599,650 552,750

Adjusted number of shares

From the conversion terms, it is clear that the maximum number of shares issuable on
conversion of Rs. 1,250,000 loan stock after the end of the financial year would be at the
rate of 135 shares per Rs. 100 nominal (that is, 1,687,500 shares).

20X3 20X2

Number of equity shares for basic EPS 1,500,000 1,500,000

Maximum conversion at date of issue 1,687,500 × 9/12 – 1,265,625

Maximum conversion after balance sheet date 1,687,500

Adjusted capital 3,187,500 2,765,625

Adjusted earnings for equity Rs. 599,650 Rs. 552,750

Diluted EPS (approx.) 0.19 0.20

NAS 40 Investment Property

16. Investment property is property (land or building – or part of a building or both) held (by the
owner or by the lessee as a right-of-use) to earn rentals or for capital appreciation or both,
rather than for:
a. Use in the production or supply of goods or services or for administrative purposes; or
b. Sale in the ordinary course of business
Appropriate classification of given properties on basis of above definition as 'Investment
Property' or 'Not an Investment Property' is done as follows:
i) Owned by the company and leased out under an operating lease : Investment Property
ii) Held under Finance Lease and Leased out under operating lease : Investment Property
iii) Held under Finance Lease and leased out under Finance Lease : Not an Investment
Property
iv) Property acquired with a view for development and re-sale : Not an Investment
Property
NFRS 9 Financial Instruments
17. As per NFRS 9, a financial asset should be measured at fair value through other comprehensive
income (FVTOCI) if both of the following conditions are met.

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➢ The financial asset is held within a business model whose objective is achieved by both
collecting contractual cash flows and selling financial assets (Business Model Test); and
➢ the contractual terms of the financial asset give rise on specified dates to cash flows that
are solely payments of principal and interest on the principal amount outstanding (SPPI
Test)
M Ltd intends to hold the debentures in order to collect the interest payments and receive the
repayment on maturity. However, it may sell these debentures if the possibility of buying one
with a greater return arises.
Accordingly, the debentures are held within the business model of collecting contractual cash
flows and selling the financial asset. Therefore, the Business Model Test is satisfied.
The feature of this instrument is similar to a basic lending arrangement. There are no
contractual terms that introduce exposure to risks or volatility in the contractual cash flows that
are unrelated to a basic lending arrangement, such as exposure to changes in equity prices or
commodity prices. Accordingly, the SPPI test is also satisfied.
Accordingly, the investment should be classified as a financial asset measured at FVTOCI.
Initial measurement should be at the transaction price (i.e. Rs. 30 million).
At amortized cost, the debt would be measured as follows:
Calculations done by applying the same interest and cash flows as for the amortised cost model,
but re-measuring the asset to fair value at each period end.
Rs.'000
Opening balance 10.54% Repayments Closing balance
31.03.2020 30,000 3,162 (3,000) 30,162
31.03.2021 30,162 3,179 (3,000) 30,341
31.03.2022 30,341 3,198 (3,000) 30,539
31.03.2023 30,539 3,219 (3,000) 30,758
31.03.2024 30,758 3,242 (34,000) -
Calculations done by applying the same interest and cash flows, but re-measuring the asset to
fair value at each period end.
Rs.'000
Opening 10.54 Repayments Closing Impairment Balance after Fair Fair Value
% balance impairment value
balance changes

31.03.2020 30,000 3,162 (3,000) 30,162 338 30,500

31.03.2021 30,162 3,179 (3,000) 30,341 (300) 30,379 (479) 29,900
For the financial year ended 31 March 2020, a finance cost of Rs. 3.162 million should be
recognized in profit or loss.
A fair value gain of Rs. 0.338 million should be recognized in OCI.

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The carrying value of the asset as at 31 March 2020 is Rs. 30.5 million, which is the fair value.
For the financial year ended 31 March 2021, a finance cost of Rs. 3.179 million should be
recognized in profit or loss.
As per NFRS 9, a gain or loss on a financial asset measured at FVTOCI should be recognized
in other comprehensive income, except for impairment gains or losses and foreign exchange
gains and losses, until the financial asset is derecognized or reclassified.
So, the impairment of Rs. 0.3 million should be recognized in profit or loss.
The fair value reduction of Rs. 479 million should be recognized in OCI.
The carrying value of the investment as at 31 March 2021 is the fair value of Rs. 29.9 million.
NAS 38 Intangible Assets
18. For determination of amortization of intangible asset, which has the finite useful life, two
elements need to be determined: useful life and residual value.
Useful life is defined as:
a. The period over which an asset is expected to be available for use by an entity; or
b. The number of production or similar units expected to be obtained from the asset by an
entity
In the given case, since the entity expects that the asset will be available for use for 5 years and
thereafter it will be transferred, the useful life of the asset is 5 years.
For residual value, paragraphs 100-102 of NAS 38 states that the residual value of an intangible
assets with the finite useful life shall be assumed to be zero unless:
a. there is a commitment by a third party to purchase the asset at the end of its useful life; or
b. There is an active market for the asset and
i. residual value can be determined by reference to the market; and
ii. it is probable that such market will exist at the end of the asset's useful life.
The depreciable amount of an asset with a finite useful life is determined after deducting its
residual value. A residual value other than zero implies that an entity expects to dispose of the
intangible asset before the end of its economic life.
An estimate of an asset’s residual value is based on the amount recoverable from disposal using
prices prevailing at the date of the estimate for the sale of a similar asset that has reached the
end of its useful life and has operated under conditions similar to those in which the asset will
be used.
On the basis of above paragraphs, the depreciable amount of the patent will be determined after
deducting the residual value, which is 60% of its fair value at the date of its acquisition.
Accordingly, the patent will be amortized over the useful life of 5 years, with a residual value
equal to 60% of its fair value at the date of acquisition. The patent will also be tested for
impairment in accordance with NAS 36.Therefore the accounting policy of amortizing the
assets over a period of 15 years considering its residual value of zero is not in accordance with
NAS 38.

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Computation of correct amount of residual amount and annual amortization

Rs.
Cost of Intangible asset 1,200,000
Residual value (60% of 12 lakhs) 720,000
Depreciable value of intangible asset 480,000
Useful life 5 years
Annual amortization (480,000/5) Rs.96,000 p.a.
NAS 34 Interim Financial Reporting
19. Interim reports shall include interim financial statements (condensed or complete) for periods
as follows:
(a) statement of financial position as of the end of the current interim period and a comparative
statement of financial position as of the end of the immediately preceding financial year.
(b) statements of profit or loss and other comprehensive income for the current interim period
and cumulatively for the current financial year to date, with comparative statements of
profit or loss and other comprehensive income for the comparable interim periods (current
and year-to-date) of the immediately preceding financial year.
(c) statement of changes in equity cumulatively for the current financial year to date, with a
comparative statement for the comparable year-to-date period of the immediately
preceding financial year.
(d) statement of cash flows cumulatively for the current financial year to date, with a
comparative statement for the comparable year-to-date period of the immediately
preceding financial year.
20.
a. Expected Credit Loss Model
Expected Credit Loss (ECL) is the probability-weighted estimate of credit losses (i.e., the
present value of all cash shortfalls) over the expected life of a Financial Instrument. The
concept is particularly important in the context of NFRS 9.
The new impairment model under NFRS 9 provides for allowances for expected credit losses,
marking a shift away from the previous approach based on incurred losses. Financial reporting
thus moves closer to forward-looking credit risk management and means that a model is
required to measure credit risks for all financial assets not measured at fair value.
ECL can be measured either on an individual exposure level or a collective portfolio
level (grouped exposures based on shared credit risk characteristics)
Under the general approach, an entity must determine whether the financial asset is in one of
three stages in order to determine both the amount of ECL to recognize as well as how interest
income should be recognized.
Stage 1 is where credit risk has not increased significantly since initial recognition. For
financial assets in stage 1, entities are required to recognize 12 month ECL and recognize

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interest income on a gross basis – this means that interest will be calculated on the gross
carrying amount of the financial asset before adjusting for ECL.
Stage 2 is where credit risk has increased significantly since initial recognition. When a
financial asset transfers to stage 2 entities are required to recognize lifetime ECL but interest
income will continue to be recognized on a gross basis.
Stage 3 is where the financial asset is credit impaired. This is effectively the point at which
there has been an incurred loss event under the NAS 39 model. For financial assets in stage 3,
entities will continue to recognize lifetime ECL but they will now recognize interest income
on a net basis. This means that interest income will be calculated based on the gross carrying
amount of the financial asset less ECL.
b. Reversal of Impairment Loss as per NAS 36
An impairment loss recognised in prior periods for an asset other than goodwill shall be
reversed if, and only if, there has been a change in the estimates used to determine the asset’s
recoverable amount since the last impairment loss was recognised. If this is the case, the
carrying amount of the asset shall be increased to its recoverable amount. That increase is a
reversal of an impairment loss.
A reversal of an impairment loss reflects an increase in the estimated service potential of an
asset, either from use or from sale, since the date when an entity last recognised an impairment
loss for that asset. Paragraph 130 requires an entity to identify the change in estimates that
causes the increase in estimated service potential. Examples of changes in estimates include:
(a) a change in the basis for recoverable amount (ie whether recoverable amount is based on
fair value less costs of disposal or value in use);
(b) if recoverable amount was based on value in use, a change in the amount or timing of
estimated future cash flows or in the discount rate; or
(c) if recoverable amount was based on fair value less costs of disposal, a change in estimate
of the components of fair value less costs of disposal.
An asset’s value in use may become greater than the asset’s carrying amount simply because
the present value of future cash inflows increases as they become closer. However, the service
potential of the asset has not increased. Therefore, an impairment loss is not reversed just
because of the passage of time (sometimes called the ‘unwinding’ of the discount), even if the
recoverable amount of the asset becomes higher than its carrying amount.
c. De-recognition of financial assets
Before evaluating whether, and to what extent, de-recognition is appropriate, an entity
determines whether those requirements should be applied to a part of a financial asset (or a
part of a group of similar financial assets) or a financial asset (or a group of similar financial
assets) in its entirety, as follows:
(a) De-recognition requirements are applied to a part of a financial asset (or a part of a group
of similar financial assets) if, and only if, the part being considered for de-recognition
meets one of the following three conditions.
(i) The part comprises only specifically identified cash flows from a financial asset (or a
group of similar financial assets).

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(ii) The part comprises only a fully proportionate (pro rata) share of the cash flows from a
financial asset (or a group of similar financial assets).
(iii) The part comprises only a fully proportionate (pro rata) share of specifically identified
cash flows from a financial asset (or a group of similar financial assets).
(b) In all other cases, de-recognition requirements are applied to the financial asset in its
entirety (or to the group of similar financial assets in their entirety).
In the derecognition requirements, the term ‘financial asset’ refers to either a part of a financial
asset (or a part of a group of similar financial assets) as identified in (a) above or, otherwise, a
financial asset (or a group of similar financial assets) in its entirety.
An entity shall derecognize a financial asset when, and only when:
(a) the contractual rights to the cash flows from the financial asset expire, or
(b) it transfers the financial asset and the transfer qualifies for de-recognition.

d. Distinction between the treatment of contingent consideration classified as equity and

contingent consideration classified as either asset or liability
Contingent consideration classified as a liability or an asset: Contingent consideration
classified as either an asset or a liability (financial or nonfinancial) should be re-measured to
fair value at each reporting date and changes in fair value should be included in profit or loss
in accordance with NAS 39 or NFRS 9.
Contingent consideration classified as equity: Equity-classified contingent consideration is
measured initially at fair value on the acquisition date and is not re-measured subsequent to
initial recognition. Settlement of the equity-classified contingent consideration is accounted
for within equity. In other words, the initial value recognized for an equity contingent
consideration arrangement on the acquisition date is not adjusted, even if the fair value of the
arrangement on the settlement date is different.
e. Distinguish between Joint Operation and Joint arrangement as explained under NRFS 11 Joint
Arrangements
Basis Joint Operation Joint Venture
The terms The contractual arrangement The contractual arrangement
of the provides the parties to the joint provides the parties to the joint
contractual arrangement with rights to the assets, arrangement with rights to the net
arrangement and obligations for the liabilities, assets of the arrangement (i.e. it is
relating to the arrangement. the separate vehicle, not the parties,
that has rights to the assets, and
obligations for the liabilities,
relating to the arrangement).
Rights to The contractual arrangement The contractual arrangement
assets establishes that the parties to the joint establishes that the assets brought
arrangement share all interests (e.g. into the arrangement or
rights, title or ownership) in the assets subsequently acquired by the joint
relating to the arrangement in a arrangement are the arrangement’s
specified proportion (e.g. in assets. The parties have no interests

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proportion to the parties’ ownership (i.e. no rights, title or ownership) in

interest in the arrangement or in the assets of the arrangement.
proportion to the activity carried out
through the arrangement that is
directly attributed to them).
Obligations The contractual arrangement The contractual arrangement
for establishes that the parties to the joint establishes that the joint
liabilities arrangement share all liabilities, arrangement is liable for the debts
obligations, costs and expenses in a and obligations of the arrangement.
specified proportion (e.g. in The contractual arrangement
proportion to the parties’ ownership establishes that the parties to the
interest in the arrangement or in joint arrangement are liable to the
proportion to the activity carried out arrangement only to the extent of
through the arrangement that is their respective investments in the
directly attributed to them). The arrangement or to their respective
contractual arrangement establishes obligations to contribute any unpaid
that the parties to the joint or additional capital to the
arrangement are liable for claims arrangement, or both. The
raised by third parties. contractual arrangement states that
creditors of the joint arrangement do
not have rights of recourse against
any party with respect to debts or
obligations of the arrangement.
Revenues, The contractual arrangement The contractual arrangement
expenses, establishes the allocation of revenues establishes each party’s share in the
profit or and expenses on the basis of the profit or loss relating to the
loss relative performance of each party to activities of the arrangement.
the joint arrangement. For example,
the contractual arrangement might
establish that revenues and expenses
are allocated on the basis of the
capacity that each party uses in a plant
operated jointly, which could differ
from their ownership interest in the
joint arrangement. In other instances,
the parties might have agreed to share
the profit or loss relating to the
arrangement on the basis of a
specified proportion such as the
parties’ ownership interest in the
arrangement. This would not prevent
the arrangement from being a joint
operation if the parties have rights to
the assets, and obligations for the
liabilities, relating to the
arrangement.

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Paper 2 - Advanced Financial

Management

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Section 1: Questions:
Chapter: The Financial System (1)
Question No. 1
What do you understand by credit substitution?
Chapter 2 Financial Intermediaries (3)
Question No. 2
What are Leasing Companies?
Question No. 3
Elaborate about CAMELS system of credit rating.
Question No. 4
There are two Mutual Funds viz. Nabil Mutual Fund Ltd. and NIBL Mutual Fund Ltd. Each
having close ended equity schemes.
NAV as on 31-12-2014 of equity schemes of Nabil Mutual Fund Ltd. is 70.71 (consisting of
99% equity and remaining cash balance) and that of NIBL Mutual Fund Ltd. is 62.50
(consisting of 96% equity and balance in cash).
Following is the other information:
Particular Equity Schemes
Nabil Mutual Fund Ltd. NIBL Mutual Fund Ltd.
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Standard deviation 11.25 5
There is no change in portfolios during the next month and annual average cost is 3 per unit
for the schemes of both the Mutual Funds.
If Share Market goes down by 5% within a month, calculate expected NAV after a month for
the schemes of both the Mutual Funds.
For calculation, consider 12 months in a year and ignore number of days for particular month.
Chapter 3 Capital Markets (5)
Question No. 5
Mr. Babin an analyst of Box Securities Pvt. Ltd. has made risk and return projections for the
securities of Heart Ltd. and Start Ltd. which are as follows:
Returns % associated with
Scenario Probability Heart Ltd. Start Market
Ltd. Index
Recession & High Interest Rate 0.20 -13 -4 -9
Recession & Low Interest Rate 0.15 16 -2 8
Boom & High Interest Rate 0.40 32 21 16

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Boom & High Interest Rate 0.25 12 20 20

It is felt that the interest rate of 7% on the 91-day T-Bill is a good approximation of the risk-free
rate. Assume that CAPM holds good in the market.
You are required to
(i) Calculate the ex-ante Betas for Heart Ltd and Start Ltd
(ii) Comment on the proportions of systematic and unsystematic Risk in the two stocks.
(iii) Recommend for fresh investment in any of these two stocks.
Question No. 6
The settlement price of a NIFTY FUTURES contract, on a particular day in a particular month of
the year 2011 on NSE was 8288.4. The multiple associated with the contract is 50. The initial
margin for the contract is 30,000 and the maintenance margin is set at 20,000. The settlement
prices on subsequent 8 (eight) days were as follows:
Day Settlement Price
1 7968.40
2 8429.70
3 8580.00
4 8307.70
5 7754.60
6 8143.00
7 8231.00
8 8444.00
Required:
Calculate the Mark to Market (MTM) cash flows, the daily Closing Balances and Net-Profit
(or loss) in the Account of Mr. S an investor who has gone:
(i) Long at 8288.40
(ii) Short at 8288.40
Question No. 7
Explain the system of ‘circuit breakers’ and ‘indexed-based circuit breakers or market halt’ used
in practice by Nepal Stock Exchange Ltd.
Question No. 8
A secondary security market is composed of the following three securities:
Security Closing Prices (Rs.) Shares outstanding (Nos.)
Date 1 Date 2
X 225 250 2,500
Y 350 300 3,500

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Z 360 400 4,000

The index divisor is 3.
Required:
i) Calculate the price-weighted index's value on date 1 and date 2.
ii) Calculate the value-weighted index on date 2 assuming the value-weighted index of date 1
to be 320.
iii) If security Z splits 4 for 1 at the end of date 1 and the price is adjusted accordingly, what
will be the value of price-weighted index on date 2?
Question No. 9
The equity share of VCC Ltd. is quoted at Rs. 210. A 3-month call option is available at
a premium of Rs. 6 per share and a 3-month put option is available at a premium of Rs.
5 per share. Ascertain the net payoffs to the option holder of a call option and a put option.
(i) the strike price in both cases in Rs. 220; and
(ii) the share price on the exercise day is Rs. 200,210,220,230,240.
Also indicate the price range at which the call and the put options may be gainfully
exercised.
Chapter 4 Valuation of Assets, Shares and Companies (2)
Question No. 10
Rose Industries Ltd. (RIL) is considering a takeover of Sugar Industries Ltd. (SIL). The
particulars of 2 companies are given below:
Particulars Rose Industries Ltd Sugar Industries Ltd.
Earnings After Tax (EAT) 20,00,000 10,00,000
Equity shares Outstanding 10,00,000 10,00,000
Earnings per share (EPS) 2 1
PE Ratio (Times) 10 5
Required:
(i) What is the market value of each Company before merger?
(ii) Assume that the management of RIL estimates that the shareholders of SIL will accept an
offer of one share of RIL for four shares of SIL. If there are no synergic effects, what is the
market value of the Post-merger RIL? What is the new price per share? Are the shareholders
of RIL better or worse off than they were before the merger?
(iii) Due to synergic effects, the management of RIL estimates that the earnings will increase by
20%. What are the new post-merger EPS and Price per share? Will the shareholders be better
off or worse off than before the merger?

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Question No. 11
Milijuli Ltd. is contemplating calling Rs. 3 crores of 30 years, Rs. 1,000 bond issued 5 years ago
with a coupon interest rate of 14 per cent. The bonds have a call price of Rs. 1,140 and had
initially collected proceeds of Rs. 2.91 crores due to a discount of Rs. 30 per bond. The initial
floating cost was Rs. 3,60,000. The Company intends to sell Rs. 3 crores of 12 percent coupon
rate, 25 years bonds to raise funds for retiring the old bonds. It proposes to sell the new bonds at
their par value of Rs. 1,000. The estimated floatation cost is Rs. 4,00,000. The company is paying
40% tax and its after tax cost of debt is 8 per cent. As the new bonds must first be sold and their
proceeds, then used to retire old bonds, the company expects a two months period of overlapping
interest during which interest must be paid on both the old and new bonds. What is the feasibility
of refunding bonds?
Chapter 5 Investment Decisions and Strategies (2)
Question No. 12
Significance of payback period and discounted payback period in investment decision analysis
Question No. 13
Apex Ltd. sells computer services to its clients. The company has recently completed a
feasibility study and decided to acquire an additional computer, the details of which are as
follows:
(1) The purchase price of the computer is Rs. 2,30,000; maintenance, property taxes and
insurance will be Rs. 20,000 per year. The additional expenses to operate the
computer are estimated at Rs. 80,000. If the computer is rented from the owner, the
annual rent will be Rs. 85,000, plus 5% of annual billings. The rent is due on the
last day of each year.
(2) Due to competitive conditions, the company feels that it will be necessary to replace
the computer at the end of three years with a more advanced model. Its resale value
is estimated at Rs. 1,10,000.
(3) The corporate income tax rate is 50% and the straight-line method of depreciation is
followed.
(4) The estimated annual billing for the services of the new computer will be Rs.
2,20,000 during the first year, and Rs. 2,60,000 during the subsequent two years.
(5) If the computer is purchased, the company will borrow to finance the purchase from
a bank with interest at 16% per annum. The interest will be paid regularly, and the
principal will be returned in one lump sum at the end of the year 3.
Should the company purchase the computer or lease it? Assume (i) straight line method of
depreciation, (ii) salvage value of Rs. 1,10,000 and evaluate the proposal from the point of
view of lessor if its cost of capital is also 12%.
Question No. 14
Jagadamba Manufacturing Company is considering a new sales strategy that will be valid for
the next 4 years. They want to know the value of the new strategy. Following information
relating to the year which has just ended, is available:

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Income Statement Amount

Sales 20,000
Gross margin (20%) 4,000
Administration, Selling & distribution expense (10%) 2,000
PBT 2,000
Tax (30%) 600
PAT 1,400
Balance Sheet Information
Fixed Assets 8,000
Current Assets 4,000
Equity 12,000
If it adopts the new strategy, sales will grow at the rate of 20% per year for three years. The gross
margin ratio, Assets turnover ratio, the Capital structure and the income tax rate will remain
unchanged.
Depreciation would be at 10% of net fixed assets at the beginning of the year. The Company’s
target rate of return is 15%.
Determine the incremental value due to adoption of the strategy.
Chapter 6 International Financial Management (2)
Question No. 15
Companies A and B face the following interest rates:
A B
US Dollars(floating rate) Libor + 0.5% Libor + 1%
Canadian (fixed rate) 5% 6.5%
A wants to borrow US Dollars at a floating rate of interest and B wants to borrow Canadian Dollars
at a fixed rate of interest.
A financial institution is planning to arrange a swap and requires a 50 basis point spread.
If the swap is equally attractive to A and B, what rates of interest will A and B end up paying?
Question No. 16
Ammex Inc., a U.S. based Pharmaceutical Company has received an offer from Nepmed
Ltd., a company engaged in manufacturing of drugs to cure Dengue, to set up a
manufacturing unit in Nawalparasi, Nepal in a joint venture.
As per the Joint Venture agreement, Ammex Inc. will receive 55% share of revenues plus
a royalty @ US $0.01 per bottle. The initial investment will be Rs. 200 crores for
machinery and factory. The scrap value of machinery and factory is estimated at the end

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of five (5) year to be Rs. 5 crores. The machinery is depreciable @ 20% on the value net
of salvage value using Straight Line Method. An initial working capital to the tune of Rs.
50 crores shall be required and thereafter Rs. 5 crores each year.
As per government directions, it is estimated that the price per bottle of the medicine will
be Rs. 7.50 and production will be 24 crores bottles per year. The price in addition to
inflation of respective years shall be increased by Re. 1 each year. The production cost
shall be 40% of the revenues.
The applicable tax rate in Nepal is 30% and 35% in US and there is Double Taxation
Avoidance Agreement between Nepal and US. According to the agreement tax credit shall
be given in US for the tax paid in Nepal. In both the countries, taxes shall be paid in the
following year in which profit have arisen.
The Spot rate of $ is Rs. 57. The inflation in Nepal is 6% (expected to decrease by 0.50%
every year) and 5% in US.
As per the policy of the government, only 50% of the total earnings can be remitted in the
year in which they are earned and remaining in the following year.
Though WACC of Ammex Inc. is 13% but due to risky nature of the project it expects a
return of 15%. Determine whether Ammex Inc. should invest in the project or not based
on financial point of view.
Chapter 7 Portfolio Theory & Asset Pricing (1)
Question No. 17
The board of directors of World Portfolio Limited (WPL) wants to have a representation on the
board of directors of a leading company operating in the telecommunication sector. To achieve
this objective, three listed companies have been identified for equity investment. Details of these
potential investments are given below:
Investment Standard Correlation of Correlation of
Expected
Companies Required (In Deviation of Returns with Returns with
Return
Million) Returns NEPSE Index WPL
A 28 19.50% 10.50% 0.65 0.62
B 35 20% 8.30% 0.67 0.81
B 40 22% 8% 0.77 0.95
Annualized returns on NEPSE Index are 15% with a standard deviation of 6.9%. One-year treasury
bills are yielding 6% per annum.
The value of the existing equity investment portfolio of WPL is Rs. 110 million with a beta of 1.25
and standard deviation of 8.6%.
Required:
a. Determine which company you would recommend for investment by WPL.
b. Determine the revised systematic risk and expected return of WPL's equity investment
portfolio after investing in the company identified in part (a) above. Briefly discuss the impact
of revised systematic risk and expected return.

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Chapter 8 Foreign Exchange Management (2)

Question No. 18
Zaz plc, a UK Company is in the process of negotiating an order amounting €2.8 million with a
large German retailer on 6 month’s credit. If successful, this will be first time for Zaz has
exported goods into the highly competitive German Market. The Zaz is considering following 3
alternatives for managing the transaction risk before the order is finalized.
i. Mr. Peter the Marketing head has suggested that in order to remove transaction risk
completely Zaz should invoice the German firm in Sterling using the current €/£ average
spot rate to calculate the invoice amount.
ii. Mr. Wilson, CE is doubtful about Mr. Peter’s proposal and suggested an alternative of
invoicing the German firm in € and using a forward exchange contract to hedge the
transaction risk.
iii. Ms. Karen, CFO is agreed with the proposal of Mr. Wilson to invoice the German first in €,
but she is of opinion that Zaz should use sufficient 6 month sterling further contracts (to the
nearest whole number) to hedge the transaction risk.
Following data is available
Spot Rate € 1.1960 - €1.1970/£
6 months forward points 0.60 – 0.55 Euro Cents.
6 month further contract is currently trading at € 1.1943/£
6 month future contract size is £62,500
After 6 month Spot rate and future rate € 1.1873/£
You are required to :
(a) Calculate (to the nearest £) the £ receipt for Zaz plc, under each of 3 above proposals.
(b) In your opinion which alternative you consider to be most appropriate.
Question No. 19
JKL Ltd., an Indian company has an export exposure of JPY 10,000,000 receivable August
31, 2014. Japanese Yen (JPY) is not directly quoted against Indian Rupee.
The current spot rates are:
RS/US $ = Rs 62.22
JPY/US$ = JPY 102.34
It is estimated that Japanese Yen will depreciate to 124 level and Indian Rupee to depreciate
against US $ to RS 65.
Forward rates for August 2014 are
RS/US $ = Rs 66.50
JPY/US$ = JPY 110.35
Required:

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(i) Calculate the expected loss, if the hedging is not done. How the position will change, if the
firm takes forward cover?
(ii) If the spot rates on August 31, 2014 are:
RS/US $= Rs 66.25
JPY/US$ = JPY 110.85
Is the decision to take forward cover justified?
Chapter 9 Emerging Concept of Financing (1)
Question No. 20
Short notes on Cryptocurrency

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Section 2: Answers:
Answer to Question No. 1
Direct credit substitute means an arrangement in which an institution assumes, in form or in
substance, credit risk directly or indirectly associated with an on-or off-balance sheet asset or
exposure that was not previously owned by the institution (third-party asset) and the risk assumed
by the institution exceeds the pro rata share of the institution’s interest in the third- party asset.
In many cases delegation combined with credit substitution. A bank substitutes its own credit for
the credit of the borrower: depositors lend to the bank rather than to the ultimate borrower. In
insurance company substitutes its own credit for the credit of member of the risk pool. The futures
exchange substitutes its own credit for the credit of individual traders. However, delegation and
credit substitution do not always go together. Underwriters do not guarantee the issues they float:
there is delegation but not credit substitution. When the bank money is used in payment, the banks
substitute its own credit for the credit of the buyer: there is credit substitution but no delegation.
Credit substitution works because the promise of the bank, insurance company, or futures
exchange is more acceptable then the promise of the ultimate trading partner. There is so for two
reasons. The first is reputation: the financial institutions' reputation for being its promises is
essential to its business. The second reason is that the financial institution may be better able to
keep its promises. The principal reason for this is pooling.
Answer to Question No. 2
A leasing company is a type of financial organization that specializes in arranging and
underwriting lease deals. In addition to acting as lease brokers, leasing companies act as lease
originators in the various markets for lease assets.
Much of the recent growth in finance company lending has been in equipment leasing to medium-
size firms (the " middle market"). Under a lease, rather than lending a firm the money to buy a
piece of equipment, the finance company buys the equipment itself and lends the equipment to the
firm. Leases are used to finance such items as computers, commercial aircraft, construction
equipment, machine tools, and medical equipment.
There are two advantages to a lease. First, in case of default, repossession is easier (finance
companies have always specialized in secured loans). Second, the finance company enjoys the tax
benefits of ownership. These include depreciation allowances and investments tax credits. If the
financial company has profits to shelter and the borrowing firm does not, these tax advantages are
more valuable to the finance company. Some of the benefits are passed on to the firm by charging
it a lower interest rate than it would have to pay on a straight loan.
Answer to Question No. 3
Credit rating is a codified rating assigned to an issue by authorized credit rating agencies. It is an
exercise of assessing the credit record, integrity and capability of a prospective borrower to meet
its debt obligations. Credit rating agencies are engaged in rating of banks based on the following
six parameters also called CAMELS
C - C stands for capital adequacy of banks. A bank need to maintain at least 10 % capital against
risky assets of the bank.

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A - A stands for asset quality. The loan is examined to determine non-performing assets. An
asset/loan is considered non-performing asset where either interest or principal is unpaid for two
quarters or more. Ratios like NPA to Net Advances, Adequacy of Provision & Debt Service
Coverage Ratio are also calculated to know exact picture ofquality of asset of a bank.
M - M stands for management evaluation. Here, the efficiency and effectiveness of management
in framing plans and policies is examined. Ratios like ROI, Return on Capital Employed (ROC E),
Return on Assets (ROA) are calculated to comment upon bank‘s efficiency to utilise the assets.
L - L indicates liquidity position. Liquid and current ratios are determined to find out banks ability
to meet its short-term claims.
S - S stands for Systems and Control. Existing systems are studied in detail to determine their
adequacy and efficacy.
Thus, the above six parameters are analysed in detail by the rating agency and then final rating is
given to a particular bank. Ratings vary from A to D. Where A denotes financial, managerial and
operational soundness of a bank, and D denotes that bank is in financial crisis and lacks managerial
expertise and is facing operational problems.
Answer to Question No. 4
(i) Decomposition of Funds in Equity and Cash Components

Particulars Nabil Mutual Fund Ltd. NIBL Mutual Fund Ltd.

NAV on 31.12.14 70.71 62.50
% of Equity 99% 96%
Equity element in NAV 70 60
Cash element in NAV 0.71 2.50
(ii) Calculation of Beta
(a) Nabil Mutual Fund Ltd.

E(R) - Rf = 22.50

βD = 22.50/15= 1.50
(b) NIBL Mutual Fund Ltd.

E(R) - Rf = 16.50

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βK = 16.50/15= 1.10
(iii) Decrease in the Value of Equity

Particulars Nabil Mutual Fund Ltd. NIBL Mutual Fund Ltd.

Market goes down by 5.00% 5.00%
Beta 1.50 1.10
Equity component goes down 7.50% 5.50%
(iv) Balance of Cash after 1 month

Particulars Nabil Mutual Fund Ltd. NIBL Mutual Fund Ltd.

Cash in Hand on 31.12.14 0.71 2.50
Less: Exp. Per month 0.25 0.25
Balance after 1 month 0.46 2.25
(v) NAV after 1 month
Particulars Nabil Mutual Fund Ltd. NIBL Mutual Fund Ltd.
Value of Equity after 1 month
70 x (1 - 0.075) 64.75 -
60 x (1 - 0.055) - 56.70
Cash Balance 0.46 2.25
65.21 58.95
Answer to Question No. 5
(i) Stock-HEART LTD.
Probability Rs Prob. × Rs Rs- (Rs- ) 2 Prob.x(Rs-) 2
0.20 -13 -2.6 -28.6 817.96 163.592
0.15 16 2.4 0.4 0.16 0.024
0.40 32 12.8 16.4 268.96 107.584
0.25 12 3.0 -3.6 12.96 3.240
15.6 () 274.44(σS2)
Expected Return of Heart () = 15.6%
Variance of Heart (σS2) = 274.44
σS = 16.57%

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Stock-START LTD.

Probability RD Prob. × RD ̅
RD- ̅ )2
(RD-  ̅ )2
Prob. × (RD- 

0.20 -4 - 0.8 -16.3 265.69 53.138

0.15 -2 - 0.3 -14.3 204.49 30.674
0.40 21 8.4 8.7 75.69 30.276
0.25 20 5.0 7.7 59.29 14.822
̅)
12.30 ( 128.910(σD2)
̅ ) = 12.30%
Expected Return of Start (
Variance of Start (σD2) = 128.91
σD = 11.35%
MARKET RETURN

Probability RM Prob. × RM ̅
RM- ̅) 2
(RM-  ̅) 2
Prob. × (RM- 

0.20 -9 -1.8 -19.8 392.04 78.408

0.15 8 1.2 -2.8 7.84 1.176
0.40 16 6.4 5.2 27.04 10.816
0.25 20 5.0 9.2 84.64 21.160
̅)
10.8 ( 111.56(σM2)
̅ ) = 10.80%
Expected Return of Market (
Variance of Market (σM2) = 111.56
σm = 10.56%

Covariance (Heart, Market) = ∑Prob. (RS- ) (RM- 

̅)
= 0.20X(-28.6X-19.8)+0.15X(0.4X-2.8)+0.40X(16.4X5.2)+0.25X(-3.6X9.2)
= 113.256-0.168+34.112-8.28
=138.92%

̅ ) (RM- 
Covariance (Start, Market) = ∑Prob.(RD- ̅)
= 0.20X(-16.3X-19.8)+0.15X(-14.3X-2.8)+0.40X(8.7X5.2)+0.25X(7.7X9.2)
= 64.548+6.006+18.096+17.710

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=106.360%
Beta of Heart (βs) = Cov (Heart, Market)÷ σM2 = (138.92÷111.56) =1.25
Beta of Start(βD) = Cov (Start, Market)÷ σM2 = (106.360÷111.56) =0.95
(ii) Systematic Risk of Heart = σ2MX β2s = 111.56X(1.25)2 = 174.31%
Unsystematic Risk of Heart = 274.44-174.31=100.13%
Proportion of systematic Risk = (174.31)÷(274.44)X100 =63.51%
Proportion of unsystematic Risk = (100.13÷274.44)X100 =36.49%

Systematic Risk of Start = σ2MX β2D = 111.56X(0.95)2 = 100.68%

Unsystematic Risk of Start = 128.91-100.68=28.23%
Proportion of systematic Risk = (100.68÷128.91)X100 =78.10%
Proportion of unsystematic Risk = (28.23÷128.91)X100 =21.90%
Comment:
Both the securities therefore have little Unsystematic risk as compared to Systematic Risk.
But comparatively Heart has a higher Component of Unsystematic Risk as compared to Start.

(iii) Normal Retun = Rf+β(RM-Rf)

HEART Ltd: 7+1.25(10.8-7) = 11.75%
Alpha / Excess Return = 15.6-11.75=3.85%
Start Ltd : 7+0.95(10.8-7) = 10.61%
Alpha / Excess Return = 12.30-10.61=1.69%
The Alpha excess return of both the companies is positive. Hence the stock of Heart Ltd and
Start Ltd is underpriced.
Heart Ltd:
Excess return / Std deviation: (3.85 16.57) = 0.23
Start Ltd
Excess return / Std deviation: (1.69÷11.35) = 0.15
As the excess return / Alpha to Standard deviation is higher for the stock of Heart Ltd, investment
in the said stock (Heart Ltd) may be recommended.

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Answer to Question No. 6

Calculation of mark to market cash flows, daily closing balances and net profit / (loss)
1. Investor who has gone long, the Index at 8288.40 (Figures in Rs.)

Day Settlement Opening Mark to Margin Closing

Price Balance Market Cash Balance
1 7968.40 30000 (16000) 16000 30000
2 8429.70 30000 23065 - 53065
3 8580.00 53065 7515 - 60580
4 8307.70 60580 (13615) - 46965
5 7754.60 46965 (27655) 10690 30000
6 8143.00 30000 19420 - 49420
7 8231.00 49420 4400 - 53820
8 8444.00 53820 10650 - 64470
Net Profit / (Loss) : (16000)+23065+7515+(13615)+(27655)+19420+4400+10650= Rs. 7780
2. Investor who has gone short, the Index at 8288.40 (Figures in Rs.)
Day Settlement Price Opening Mark to Margin Closing Balance
Balance Market Cash
1 7968.40 30000 16000 - 46000
2 8429.70 46000 (23065) - 22935
3 8580.00 22935 (7515) 14580 30000
4 8307.70 30000 13615 - 43615
5 7754.60 43615 27655 - 71270
6 8143.00 71270 (19420) - 51850
7 8231.00 51850 (4400) - 47450
8 8444.00 47450 (10650) - 36800
Net Profit / (Loss) : 16000+(23065)+(7515)+13615+27655+(19420)+(4400)+(10650)= Rs.
(7780).

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Answer to Question No. 7

NEPSE has implemented new index-based circuit breakers with effect from April 2019. Index-
based Circuit Breakers or market halt system applies at 3 stages of the Nepse index movement on
either way by 4%, 5%, and 6%. These circuit breakers when triggered bring about a trading halt
in all equities.
• In the case of 4%, movement, either way, there would be a market halt for 15 minutes if the
movement takes place during the first hour of trading i.e. 12:00 hours. In case this movement
takes after 12:00 hours there will be no trading halt at this level and market shall continue
trading.
• In the case of 5% movement, either way, there would be a market halt for half an hour if the
movement takes place before 13:00 hours. In case this movement takes after 13:00 hours there
will be no trading halt at this level and market shall continue trading.
• In the case of 6% movement, either way, trading shall be halted for the remainder of the day.
Answer to Question No. 8
Calculation table
Security Shares Price (Rs.) Market Value (Rs.)
outstanding
Date 1 Date 2 Date 1 Date 2
X 2,500 225 250 562,500 625,000
Y 3,500 350 300 1,225,000 1,050,000
Z 4,000 360 400 1,440,000 1,600,000
Total 935 950 3,227,500 3,275,000
i) Calculation of the price-weighted index's value
Index on date 1 (I1) = Total Price/ Divisor (d) = 935/ 3 = 311.67
Index on date 2 (I2) = Total Price/ Divisor (d) = 950/ 3 = 316.67
ii) Value-weighted index on date 2 (I2) = (MV on date 2/ MV on date 1) × Index on date 1
= (3,275,000/ 3,227,500) × 320 = 324.71
iii) Price-weighted index on date 2, after Security Y undergoes 4 for 1 split
Adjusted price of Y after split on date 1= Rs. 360/ 4 = Rs. 90
Adjusted price of Y after split on date 2= Rs. 400/ 4 = Rs. 100
Revised divisor (d) = Total Price after split on date 1/ Index on date 1 (I1)
= (935-360+90)/ 311.67 = 665/ 311.67 = 2.13
Index on date 2 (I2) after split of Security Y
= Total adjusted price after split on date 2/ Revised divisor (d)
= (950-400+100)/ 2.13 = 305.16

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Answer to Question No. 9

Net payoff for the holder of the call option
(Rs.)
Share price on exercise day 200 210 220 230 240
Option exercise No No No Yes Yes
Outflow (Strike price) Nil Nil Nil 220 220
Out flow (premium) 6 6 6 6 6
Total Outflow 6 6 6 226 226
Less inflow (Sales proceeds) - - - 230 240
Net payoff -6 -6 -6 4 14
Net payoff for the holder of the put option
(Rs.)
Share price on exercise day 200 210 220 230 240
Option exercise Yes Yes No No No
Inflow (strike price) 220 220 Nil Nil Nil
Less outflow (purchase price) 200 210 - - -
Less outflow (premium) 5 5 5 5 5
Net Payoff 15 5 -5 -5 -5
The call option can be exercised gainfully for any price above Rs. 226 (Rs. 220 + Rs. 6) and put
option for any price below Rs. 215 (Rs. 220 – Rs. 5).
Answer to Question No. 10
(i) Market value of Companies before Merger
Particulars RIL SIL
EPS 2 Re.1
P/E Ratio 10 5
Market Price Per Share 20 5
Equity Shares 10,00,000 10,00,000
Total Market Value 2,00,00,000 50,00,000
(ii) Post-Merger Effects on RIL
Particulars Amount
Post-merger earnings 30,00,000
Exchange Ratio (1:4)

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No. of equity shares o/s (10,00,000 + 2,50,000) 12,50,000

EPS: 30,00,000/12,50,000 2.4
PE Ratio 10
Market Value 10 x 2.4 24
Total Value (12,50,000 x 24) 3,00,00,000
Gains From Merger: `
Post-Merger Market Value of the Firm 3,00,00,000
Less: Pre-Merger Market Value
RIL 2,00,00,000
SIL 50,00,000 2,50,00,000
Total gains from Merger 50,00,000
Apportionment of Gains between the Shareholders:
Particulars RIL SIL
Post-Merger Market Value:
10,00,000 x 24 2,40,00,000 --
2,50,000 x 24 - 60,00,000
Less: Pre-Merger Market Value 2,00,00,000 50,00,000
Gains from Merger: 40,00,000 10,00,000
Thus, the shareholders of both the companies (RIL + SIL) are better off than before
(iii) Post-Merger Earnings:
Increase Earnings by 20%
New Earnings: 30,00,000 x (1+0.20) 36,00,000
No .of equity shares outstanding: 12,50,000
EPS (36,00,000/12,50,000) 2.88
PE Ratio 10
Market Price Per Share: = 2.88 x 10 28.80
Shareholders will be better-off than before the merger situation.
Answer to Question No. 11
NPV for bond refunding

Particulars Amount
PV of annual cash flow savings (W.N. 2)
(3,49,600 x PVIFA (8%,25) i.e. 10.675) 37,31,980

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Less: Initial investment (W.N. 1) 29,20,000

NPV 8,11,980
Recommendation: Refunding of bonds is recommended as NPV is positive.
Working Notes:
(1) Initial investment:
(a) Call premium
Before tax (1,140 – 1,000) x 30,000 42,00,000
Less tax @ 40% 16,80,000
After tax cost of call prem. 25,20,000
(b) Floatation cost 4,00,000
(c) Overlapping interest

Before tax (0.14 x 2/12 x 3 crores) 7,00,000

Less tax @ 40% 2,80,000 4,20,000
(d) Tax saving on unamortized discount on
old bond 25/30 x 9,00,000 x 0.4 (3,00,000)
(e) Tax savings from unamortized floatation

Cost of old bond 25/30 x 3,60,000 x 0.4 (1,20,000)

29,20,000
(2) Annual cash flow savings:
(a) Old bond
(i) Interest cost (0.14 x 3 crores) 42,00,000
Less tax @ 40% 16,80,000 25,20,000
(ii) Tax savings from amortization of discount
9,00,000/30 x 0.4 (12,000)
(iii) Tax savings from amortization of
floatation cost 3,60,000/30 x 0.4
(4,800)
Annual after-tax cost payment under old Bond (A) 25,03,200
(b) New bond
(i) Interest cost before tax (0.12 x 3 crores) 36,00,000
Less tax @ 40% 14,40,000

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After tax interest 21,60,000

(ii) Tax savings from amortization of floatation
cost (0.4 x 4,00,000/25)
(6,400)
Annual after-tax payment under new Bond (B) 21,53,600
Annual Cash Flow Saving (A) – (B) 3,49,600
Answer to Question No. 12
The payback period is the number of years necessary to recover funds invested in a project. When
calculating the payback period, we don’t take time value of money into account.
The discounted payback period is the number of years after which the cumulative discounted cash
inflows cover the initial investment.
The payback period and the discounted payback period are measures that allow us to assess in how
many years the original investment will pay back.
Since the payback period and the discounted payback period don't account for cash flows after the
recovery of the original investment, they can't be used as measures of profitability. More
commonly, we use them to check if we will recover our outlays on a project before an arbitrarily
assumed date. We can say that these two measures are useful for assessing the liquidity of a project.
Answer to Question No. 13
Evaluation from the point of view of Lessee:
The lessee has two alternatives:
(i) To acquire the computer out of borrowed funds, and
(ii) To acquire the computer on lease basis.
The financial implications of these two options can be evaluated as follows:
Option I: To acquire computer out of borrowed funds. In this case, the company has to
pay interest @ 16% annually and repayment of loan at the end of 3rd year. However, the
salvage value of Rs. 1,10,000 will be available to it. The information can be presented as
follows:
Year Interest Depreciation Expenses Tax Shield Cash PVF PV (`)
(5)=50% of outflows (8%)
(2+3+4)
(1) (2) (3) (4) (5) 6=(2+4-5)
1 36,800 40,000 20,000 48,400 8,400 .926 7,778
2 36,800 40,000 20,000 48,400 8,400 .857 7,199
3 36,800 40,000 20,000 48,400 8,400 .794 6,670
4 Repayment – Savage (2,30,000 –1,10,000) 1,20,000 .794 95,280
Present Value of Outflows 1,16,927

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Option II: To acquire the Computer on lease basis: In this case, the Company will be
required to pay an annual lease rent of 85,000 + 5% of annual billing at the end of year. The
financial implications can be evaluated as follows:
Year Rental 5% of Tax Shield Cash Outflow PV (8%) (PV)
Billing
(1) (2) (3)= (50% of 1+2) (4)= (1+2+3)
1 85,000 11,000 48,000 48,000 .926 44,448
2 85,000 13,000 49,000 49,000 .857 41,993
3 85,000 13,000 49,000 49,000 .794 38,906
Present Value of Outflows 1,25,347
As the PV of outflows is less in case of buying option, the Company should borrow funds to
buyout the computer.
Note: 1. It may be noted that the additional expenses of Rs. 80,000 to operate the computer
have not been considered in the above calculation. These expenses are required in both the
options and are irrelevant to decide between lease or purchase.
Evaluation from the point of view of lessor:
Year 1 Year 2 Year 3
Lease Rental 85,000 85,000 85,000
5% of Billing 11,000 13,000 13,000
Total Income 96,000 98,000 98,000
Less: Maintenance Expenses 20,000 20,000 20,000
Depreciation 40,000 40,000 40,000
Income before tax 36,000 38,000 38,000
Tax @ 50% 18,000 19,000 19,000
Net Income after Tax 18,000 19,000 19,000
Depreciation added back 40,000 40,000 40,000
Cash Inflow (Annual) 58,000 59,000 59,000
Scrap Value - - 1,10,000
58,000 59,000 1,69,000
PVF (12%) 0.893 0.797 0.712
Present Value 51,794 47,023 1,20,328
Total Present Value 2,19,145
Less: Initial Cost 2,30,000
Net Present Value -10,855
As the NPV for the lessor is negative, he may not accept the proposal.

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Answer to Question No. 14

Projected Balance Sheet Year 1 Year 2 Year 3 Year 4
Fixed Assets (40% of Sales) 9,600 11,520 13,824 13,824
Current Assets (20% of Sales) 4,800 5,760 6,912 6,912
Total Assets 14,400 17,280 20,736 20,736
Equity 14,400 17,280 20,736 20,736
Projected Cash Flows:-
Particulars Year 1 Year 2 Year 3 Year 4
Sales 24,000 28,800 34,560 34,560
PBT (10% of sale) 2,400 2,880 3,456 3,456
PAT (70%) 1,680 2,016 2,419.20 2,419.20
Depreciation 800 960 1,152 1,382
Addition to Fixed Assets 2,400 2,880 3,456 1,382
Increase in Current Assets 800 960 1,152 -
Operating cash flow (FCFF) (720) (864) (1,036.80) 2,419.20
Projected Cash Flows:-
Present value of Projected Cash Flows:-
Cash Flows PVF at PV
15%
-720 0.870 -626.40
-864 0.756 -653.18
-1,036.80 0.658 -682.21
-1,961.79
Residual Value = 2419.20/0.15 = 16,128
Present value of Residual = 16128/(1.15)3
value
= 16128/1.521 = 10603.55
Total shareholders’ value = 10,603.55 – 1,961.79 = 8,641.76
Pre strategy value = 1,400 / 0.15 = 9,333.33
Value of strategy = 8,641.76 – 9,333.33 = – 691.57

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Answer to Question No. 15

Company A
1. Company A will borrow at Fixed Rate
2. Pay interest to Bankers at Fixed Rate, i.e. 5%
3. Will collect from Company B interest amount differential i.e. Interest computed at Fixed
Rate (5%) Less Interest computed at Floating Rate of (Libor + 0.5% ) = 4.5%-Libor
4. Receive it share of Gain from company B=0.25%
5. Effective Interest Rate (2-3-4) = LIBOR +0.25%

Company B
1. Company B will borrow at Floating Rate
2. Pay interest to its bankers at Floating rate (i.e. Libor+1%)
3. Will pay interest amount differential to Company A. i.e Interest computed at Fixed Rate
5% Less Interest Computed at Floating Rate of (Libor +0.5%) = 4.5%-Libor
4. Pay to Company A its share of Gain= 0.25%
5. Pay Commission Charges to the Financial Institution for arranging Interest Rate Swaps i.e.
0.5%
6. Effective Interest Rate:(2+3+4+5) = 6.25%
Answer to Question No. 16
Working Notes:
1. Estimated Exchange Rates (Using PPP Theory)
Year 0 1 2 3 4 5 6
Exchange rate 57 57.54 57.82 57.82 57.54 56.99 56.18
2. Share in sales
Year 1 2 3 4 5
Annual Units in crores 24 24 24 24 24
Price per bottle (Rs.) 7.50 8.50 9.50 10.50 11.50
Price fluctuating Inflation Rate 6.00% 5.50% 5.00% 4.50% 4.00%
Inflation adjusted Price (Rs.) 7.95 8.97 9.98 10.97 11.96
Inflation adjusted Sales Revenue (Rs. Crore) 190.80 215.28 239.52 263.28 287.04
Sales share @55% 104.94 118.40 131.74 144.80 157.87

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3. Royalty Payment

Year 1 2 3 4 5
Annual Units in crores 24 24 24 24 24
Royalty in $ 0.01 0.01 0.01 0.01 0.01
Total Royalty ($ Crore) 0.24 0.24 0.24 0.24 0.24
Exchange Rate 57.54 57.82 57.82 57.54 56.99
Total Royalty (Rs. Crore) 13.81 13.88 13.88 13.81 13.68
4. Tax Liability
(Rs. Crore)
Year 1 2 3 4 5
Sales Share 104.94 118.40 131.74 144.80 157.87
Total Royalty 13.81 13.88 13.88 13.81 13.68
Total Income 118.75 132.28 145.61 158.61 171.55
Less: Expenses
Production Cost 41.98 47.36 52.69 57.92 63.15
Depreciation 39.00 39.00 39.00 39.00 39.00

PBT 37.77 45.92 53.92 61.69 69.40

Tax on Profit @30% 11.33 13.78 16.18 18.51 20.82
Net Profit 26.44 32.14 37.74 43.18 48.58
5. Cash flow Calculation
(Rs. Crore)
Year 0 1 2 3 4 5 6
Sales Share 0.00 104.94 118.40 131.74 144.80 157.87 0.00
Total Royalty 0.00 13.81 13.88 13.88 13.81 13.68 0.00
Production Cost 0.00 -41.98 -47.36 -52.69 -57.92 -63.15 0.00
Initial Outlay -200.00 0.00 0.00 0.00 0.00 0.00 0.00
Working Capital -50.00 -5.00 -5.00 -5.00 -5.00 70.00 0.00
Scrap Value 0.00 0.00 0.00 0.00 0.00 5.00 0.00
Tax on Profit 0.00 0.00 -11.33 -13.78 -16.18 -18.51 -20.82
Free Cash Flow -250.00 71.77 68.59 74.15 79.51 164.89 -20.82

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6. Remittance of Cash Flows

(Rs. Crore)
Year 0 1 2 3 4 5 6
Free Cash Flow -250.00 71.77 68.59 74.15 79.51 164.89 -20.82
50% of Current Year Cash
Flow
0.00 35.89 34.29 37.07 39.76 82.45 0.00
Previous year remaining cash
flow
0.00 0.00 35.88 34.30 37.08 39.75 82.44
Total Remittance -250.00 35.88 70.17 71.37 76.84 122.20 61.62
Calculation of NPV of Project under Appraisal
Year 0 1 2 3 4 5 6
Total Remittance (Rs. Crore) -250.00 35.88 70.17 71.37 76.84 122.20 61.62
Exchange Rate 57.00 57.54 57.82 57.82 57.54 56.99 56.18
Remittance ($mn) -43.86 6.24 12.14 12.34 13.35 21.44 10.97
US Tax @35% ($mn) 0.00 0.00 2.18 4.25 4.32 4.67 7.50
Indian Tax ($mn) 0.00 0.00 1.96 2.38 2.82 3.25 3.71
Net Tax ($mn) 0.00 0.00 0.22 1.87 1.51 1.42 3.79
Net Cash Flow ($mn) -43.86 6.24 11.92 10.47 11.84 20.02 7.18
PVF 1.000 0.870 0.756 0.658 0.572 0.497 0.432
Present Value ($mn) -43.86 5.43 9.01 6.89 6.77 9.95 3.10
Net Present Value ($mn) = -2.71
Decision: Since NPV of the project is negative, Ammex Inc. should not invest in the project.
Answer to Question No. 17
a.

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a. The revised systematic risk of the WPL's portfolio can be measured as the weighted average
of all individual investment's beta which is computed as follows:

After selecting the company C, overall risk profile of WPL would be improved from 1.25 to
1.15. The reduction in expected return from 17.25% to 16.35% may be a cause of concern for
WPL. However, the reduction in expected return is compensated by reduction in risk from 8.6%
to 8.36% i.e. combined standard deviation. Now it is the decision of the management whether
this trade-off between risk and return is acceptable to WPL.

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Answer to Question No. 18

i.
(a) Proposal of Mr. Peter
Invoicing in £ will produce = € 2.8 million / 1.1965 = £ 2.340 million
(b) Proposal of Mr. Wilson
Forward Rate = €1.1970-0.0055 = 1.1915
Using Forward Market hedge Sterling receipt would be € 2.8million / 1.1915 = £ 2.35 million
(c) Proposal of Mr. Karen
The equivalent sterling of the order placed based on future price (€1.1943)
= € 2.8million / 1.1943 = £ 2,344,470 (rounded off)
Number of Contracts = £2, 344, 470 / 62, 500 = = 37 Contracts (to the nearest whole number)
Thus, € amount hedged by future contract will be = 37 X £62,500 = £23,12,500
Buy Future at €1.1943
Sell Future at €1.1873
€0.0070
Total loss on Future Contracts = 37 X £62,500 X €0.0070 = €16,188
After 6 months
Amount Received €28,00,000
Less: Loss on Future Contracts € 16,188
€ 27,83,812
Sterling Receipts
On sale of € at spot = € 27,83,812 / 1.1873 = = £ 2.3446 million
(ii) Proposal of option (b) is preferable because the option (a) & (c) produces least receipts.
Further, in case of proposal (a) there must be a doubt as to whether this would be acceptable
to German firm as it is described as a competitive market and Zaz is moving into it first
time.
Answer to Question No. 19
Since the direct quote for ¥ and Rs. is not available it will be calculated by cross exchange
rate as follows:
Rs/$ x $/¥ = Rs/¥
62.22/102.34 = 0.6080
Spot rate on date of export 1¥ = Rs 0.6080
Expected Rate of ¥ for August 2014 = Rs 0.5242 ( Rs 65/¥124)

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Forward Rate of ¥ for August 2014 = Rs 0.6026 ( Rs 66.50/¥110.35)

(i) Calculation of expected loss without hedging
Value of export at the time of export ( Rs 0.6080 x ¥10,000,000) Rs 60,80,000
Estimated payment to be received on Aug. 2014 (Rs 0.5242 x Rs 52,42,000
¥10,000,000)
Loss Rs 8,38,000
Hedging of loss under Forward Cover
Rs Value of export at the time of export (Rs 0.6080 x ¥10,000,000) Rs 60,80,000
Payment to be received under Forward Cover (Rs 0.6026 x Rs 60,26,000
¥10,000,000)
Loss Rs 54,000
By taking forward cover, loss is reduced to Rs 54,000.
(ii) Actual Rate of ¥ on August 2014 = Rs 0.5977 ( Rs 66.25/¥110.85)
Value of export at the time of export ( Rs 0.6080 x ¥10,000,000) Rs 60,80,000
Estimated payment to be received on Aug. 2014 ( Rs 0.5977 x Rs 59,77,000
¥10,000,000)
Loss Rs 1,03,000
The decision to take forward cover is still justified.
Note: If the actual loss goes below 54,000, the decision to take forward cover is still valid
because we cannot predict the rates for future with accuracy and now we are analyzing in
hindsight which is not correct.
Answer to Question No. 20
Cryptocurrency (or “crypto”) is a digital currency used as an alternative payment method or as an
investment. Cryptocurrencies get their name from the cryptographic techniques that enable people
to buy, sell or trade them securely without the need for a controlling authority, such as a
government or financial institutions.
Cryptocurrencies are supported by a technology known as blockchain, which maintains a tamper-
resistant record of transactions and keeps track of who owns what. The use of blockchains
addressed a problem faced by previous efforts to create purely digital currencies: preventing people
from making copies of their holdings and attempting to spend it twice.
Individual units of cryptocurrencies can be referred to as coins or tokens, depending on how they
are used. Some are intended to be units of exchange for goods and services, others are stores of
value, and some can be used to participate in specific software programs such as games and
financial products.

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Section 3: Exam tips to students:

Tip 1:
Allocate dedicated time for each question as per marks carried by the question. Students
have tendency of spending more time in long questions and questions which are
comparatively difficult due to which they might miss easier question which ultimately
limits the chance of scoring. Generally, 1.8 minutes (180 minutes/100 marks) can be
allocated fo1 mark which makes 36 minutes for 20 marks. There can be some variation in
allocated time, but students should not dwell for 50-60 minute for 20 marks question.
Tip 2:
Confidence is the key. Hence, don’t be upset if you are not able attempt 100 marks. Give
your best in questions that you can answer but try to attempt all the questions as far as
possible.
Tip 3:
Do not neglect theory portion as it carries around 15% weightage and theory makes it easier
to management time for other numerical and time-consuming questions.
Tip 4:
While making assumptions for solving questions, always prefer assumption or method by
which you can utilize most of information given in question. Information in question are
mostly provided for a reason.
Tip 5:
Write all the notes and assumptions wherever required so that the examiner will be clear
about your solution.

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Paper 3 - Advanced Auditing

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Nepal Standards in Auditing

1. P Limited is a listed company and its business activities are divided into three regions. The
company appointed PY & Co., KL & Co. and MK & Co., Chartered Accountants to conduct a
Joint Audit and report on the financial statements. Explain the relationship among the joint auditors
for the audit of the financial statements.
2. Mr. Pramod, a recently qualified practicing Chartered Accountant got his first audit assignment of
Unnati Pvt. Ltd. for the financial year 2079/80. He obtained all the relevant appropriate audit
evidence for the items related to Statement of Profit or Loss. However, while auditing the items of
the Statement of Financial Position, Mr. Pramod left out obtaining appropriate audit evidence, say,
confirmations, from the outstanding accounts receivable amounting Rs. 90 lakhs, continued as it
is from the last year, on the affirmation of the management that there is no receipts and further
credits during the year. Mr. Pramod, therefore, excluded from the audit programme, the audit of
accounts receivable on the understanding that it pertains to the preceding year which was already
audited by predecessor auditor. Comment.
3. JK Limited is engaged in the business of construction and real estate having various projects across
states. M/s YT & Co, Chartered Accountants have been appointed as a Statutory Auditor. Audit
team from M/s YT & Co for audit of JK Limited comprises of CA Z Engagement Partner, CA Q,
a paid assistant and 3 Articled Assistants. During preliminary verification, CA Z observed that
huge amount of sub-contract payments were made to M/s JB Associates, a partnership firm in
which director of JK Limited is a managing partner. The engagement team discussed that NSA
315 and NSA 240 shall include specific consideration of the susceptibility of the financial
statements to material misstatement due to fraud or error that could result from the JK Limited's
related party relationships and transaction. Highlight the matters that are to be addressed in the
discussion by CA Z with engagement team members with reference to the relevant Standard on
Auditing.
4. AB & Associates, Chartered Accountants is the auditor of XYZ Company Ltd., for the year ended
on Ashadh 2080. The Audit Report for that year was signed by the Auditors on 04/05/2080. The
Annual General Meeting was decided to be held during the month of Ashwin 2080. On 06/05/2080,
the Company had received a communication from the Government of Nepal that an amount of Rs.
5.8 crore kept pending on account of incentives pertaining to Financial Year 2079/80 has been
approved and the amount would be paid to the Company before the end of Bhadra 2080. To a
query to Chief Financial officer of the Company by the Board, it was informed that this amount
had not been recognized in the Audited Financial Statements in view of the same not being released
before the close of the Financial Year and due to uncertainty of receipt. Now, having received the
amount, the Board of Directors wished to include this amount in the Financial Statements of the
Company for the Financial Year ended on Ashadh 2080. On 08/05/2080, the Board amended the
accounts, approved the same and requested the auditor to consider this event and issue a fresh audit
report on the financial statements for the year ended on Ashad 2080. Analyse the issues involved
and give your views as to whether or not the auditor could accede to the request of the Board of
Directors.
5. Mr. A and Mr. B are joint auditors of Deed Bank Ltd. They are required to give the common audit
report. However, while drawing audit conclusion, they could not reach a common opinion. What
is the reporting responsibility of auditors? Give them the appropriate suggestion.

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Planning, Risk Assessment and Audit Test

6. While commencing the statutory audit of ABC Company Limited, what should be the
considerations of the auditor to assess risk of material misstatement and his response to such risks?
7. In evaluating the design of the entity’s control environment, what should auditor considers for
understanding and evaluating entity environment and its control system?
8. The identified risks are assessed by auditor as to its significance on account of its likely impact,
by way of material misstatement appearing in financial statements or by affecting internal control
system. What may be the points of indication that may direct the auditor to judge that the risks
identified may be significant?
9. Auditor while using the work of internal auditor should evaluate whether the internal audit function
applies a systematic and disciplined approach, including quality control. What are the factors that
may affect the external auditor’s determination of whether the internal audit function applies
systematic and disciplined approach?
Audit Opinion and Reporting
10. A Company's net worth is eroded and trade payables are unpaid due to liquidity constraints. The
management represents to the statutory auditor that the promoter’s wife is expected to give an
unsecured loan to meet the liquidity constraints and that negotiations are underway to secure large
export orders, so the management does not shown any impact of liquidity constraints and prepared
financial statement on normal basis with going concern assumption. How the auditor should deal
with the situation?
Audit of Specialized Enterprises
11. The hospitality sector in Nepal has growing faster with a development of tourism in Nepal.
Auditors are facing many problems involved in any hotel audit, some of which are peculiar to the
hotel industry such as control of cash assume greater proportions. As an auditor, mention some
specific and special problem in an audit of hotels.
Assurance and Other Related Services
12. What are the essential features of a internal audit report?
13. Due diligence is necessary to limit reliance placed on vendor’s warranties – it is better to discover
a “skeleton in the closet” before the business is bought than afterwards. Explain the planning phase
for due diligence?
14. What are the areas where the services of forensic accountants/ auditors are generally required?
15. When planning an audit, the auditor may consider an appropriate combination of manual and
computer assisted audit techniques. What are the factors to be considered in determining whether
to use CAATs by the auditor?
Governance
16. Elaborate the major elements of SOX Act.
NAS, NFRS and IFRS
17. UB Pvt. Ltd is well known for its expertise in building flyovers and maintaining these structures.
Impressed with UB’s track record, the local municipal authorities have invited them to submit a

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tender for a two-year contract to build a super flyover in the heart of the city (the largest in the
region) and another tender for maintenance of the flyover for 10 years after completion of the
construction. Evaluate whether these two contracts should be segmented or combined into one
contract for the purposes of NFRS 15.
Code of Ethics
18. AB & Associates, Chartered Accountant is getting new clients and has also been offered new
engagement services with existing clients. The proprietor is concerned about obtaining such
information as it considers necessary in the circumstances before accepting an engagement with
a new client and acceptance of a new engagement with an existing client especially on case of
change in auditor. What are the responsibility of the proprietor in the event of any information
received about the changes in professional appointment? Give your answers based on Guidelines
on Professional Appointment issued by the Institute.
19. While conducting an audit, you friend Mr. M as a senior professional accountant identifies or
suspects that noncompliance of laws and regulation has been occurred in the company. Explain
him, how can he deal with the situation?
20. There are variety of threats, threats to compliance with the fundamental principles might be
created by a broad range of facts and circumstances that could be encountered by professional
accountants in public practice, explain some of the examples of actions for safeguarding such
threats.

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Answer No. 1
In respect of the work divided amongst the joint auditors, each joint auditor is responsible only for
the work allocated to him, whether or not he has made a separate report on the work performed by
him.
I. On the other hand the joint auditors are jointly and severally responsible in respect of the audit
conducted by them as under:
(i) in respect of the audit work which is not divided among the joint auditors and is carried out by
all of them;
(ii) in respect of decisions taken by all the joint auditors concerning the nature, timing or extent of
the audit procedures to be performed by any of the joint auditors.
(iii) in respect of matters which are brought to the notice of the joint auditors by any one of them
and on which there is an agreement among the joint auditors;
(iv) for examining that the financial statements of the entity comply with the disclosure
requirements of the relevant statute; and
(v) for ensuring that the audit report complies with the requirements of the relevant statute.
II. It is the separate and specific responsibility of each joint auditor to study and evaluate the
prevailing system of internal control relating to the work allocated to him, the extent of enquiries
to be made in the course of his audit.
The responsibility of obtaining and evaluating information and explanation from the management
is generally a joint responsibility of all the auditors.
Each joint auditor is entitled to assure that the other joint auditors have carried out their part of
work in accordance with the generally accepted audit procedures and therefore it would not be
necessary for joint auditor to review the work performed by other joint auditors. Normally, the
joint auditors are able to arrive at an agreed report.
However, where the joint auditors are in disagreement with regard to any matters to be covered by
the report, each one of them should express their own opinion through a separate report. A joint
auditor is not bound by the views of majority of joint auditors regarding matters to be covered in
the report and should express his opinion in a separate report in case of a disagreement.
Answer No. 2
As per NSA 510 “Initial Engagements – Opening Balances”, while conducting an initial audit
engagement, the objective of the auditor with respect to opening balances is to obtain sufficient
appropriate audit evidence about whether-
(i) Opening balances contain misstatements that materially affect the current period’s financial
statements; and
(ii) Appropriate accounting policies reflected in the opening balances have been consistently
applied in the current period’s financial statements, or changes thereto are properly accounted for
and adequately presented and disclosed in accordance with the applicable financial reporting
framework.

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When the financial statements for the preceding period were audited by another auditor, the current
auditor may be able to obtain sufficient appropriate audit evidence regarding opening balances by
perusing the copies of the audited financial statements.
Ordinarily, the current auditor can place reliance on the closing balances contained in the financial
statements for the preceding period, except when during the performance of audit procedures for
the current period the possibility of misstatements in opening balances is indicated.
For current assets and liabilities, some audit evidence about opening balances may be obtained as
part of the current period’s audit procedures, say, the collection of opening accounts receivable
during the current period will provide some audit evidence of their existence, rights and
obligations, completeness and valuation at the beginning of the period.
In addition, according to NSA 580 “Written Representations”, the auditor may consider it
necessary to request management to provide written representations about specific assertions in
the financial statements; in particular, to support an understanding that the auditor has obtained
from other audit evidence of management’s judgment or intent in relation to, or the completeness
of, a specific assertion. Although such written representations provide necessary audit evidence,
they do not provide sufficient appropriate audit evidence on their own for that assertion.
In the given case, the management of Unnati Pvt. Ltd. has restrained Mr. Pramod, its auditor, from
obtaining appropriate audit evidence for balances of accounts receivable outstanding as it is from
the preceding year. Mr. Pramod, on believing that the preceding year balances have already been
audited and on the statement of the management that there are no receipts and credits during the
current year, therefore excluded the verification of Accounts Receivable from his audit
programme.
Thus, Mr. Pramod should have requested the management to provide written representation for
their views and expressions; and he should also not exclude the audit procedure of closing balances
of accounts receivable from his audit programme. Consequently, Mr. Pramod shall also be held
guilty for professional misconduct for not exercising due diligence, or grossly negligence in the
conduct of his professional duties as per the Code of Ethics.
Answer No. 3
NSA 550 ‘Related Parties’ deals with the auditor’s responsibilities regarding related party
relationships and transactions when performing an audit of financial statements. The engagement
team’s discussion was that NSA 315 and NSA 240 shall include specific consideration of the
susceptibility of the financial statements to material misstatement due to fraud or error that could
result from the entity’s related party relationships and transactions. The matters that are to be
addressed in the discussion by CA Z among the engagement team include:
1. The nature and extent of the entity’s relationships and transactions with related parties (using,
for example, the auditor’s record of identified related parties updated after each audit).
2. An emphasis on the importance of maintaining professional skepticism throughout the audit
regarding the potential for material misstatement associated with related party relationships and
transactions.
3. The circumstances or conditions of the entity that may indicate the existence of related party
relationships or transactions that management has not identified or disclosed to the auditor (e.g., a

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complex organizational structure, use of special - purpose entities for off-balance sheet
transactions, or an inadequate information system).
4. The records or documents that may indicate the existence of related party relationships or
transactions.
5. The importance that management and those charged with governance attach to the identification,
appropriate accounting for, and disclosure of related party relationships and transactions (if the
applicable financial reporting framework establishes related party requirements), and the related
risk of management override of relevant controls.
6. In addition, the discussion in the context of fraud may include specific consideration of how
related parties may be involved in fraud. For example:
(a) how special-purpose entities controlled by management might be used to facilitate earnings
management.
(b) how transactions between the entity and a known business partner of a key member of
management could be arranged to facilitate misappropriation of the entity’s assets.
Answer No. 4
As per NSA 560, “Subsequent Events”, the auditor has no obligation to perform any audit
procedures regarding the financial statements after the date of the auditor’s report. If the
practitioner becomes aware of events occurring between the date of the financial statements and
the date of the practitioner’s report that require adjustment of, or disclosure in, the financial
statements, the practitioner shall request management to correct those misstatements.
If, after the date of the practitioner’s report but before the date the financial statements are issued,
a fact becomes known to the practitioner that, had it been known to the practitioner at the date of
the practitioner’s report, may have caused the practitioner to amend the report, the practitioner
shall:
(a) Discuss the matter with management or those charged with governance, as appropriate;
(b) Determine whether the financial statements need amendment; and
(c) If so, inquire how management intends to address the matter in the financial statements.
If management amends the financial statements, the auditor shall carry out the audit procedures
necessary in the circumstances on the amendment. Further, the auditor shall extend the audit
procedures and provide a new auditor’s report on the amended financial statements. However, the
new auditor’s report shall not be dated earlier than the date of approval of the amended financial
statements.
In the instant case, XYZ Company Ltd. received an amount of Rs. 5.8 crore on account of
incentives pertaining to year 2079/80 in the month of Bhadra 2080 i.e. after finalization of financial
statements and signing of audit report. Board of Directors of XYZ Ltd. amended the accounts,
approved the same and requested the auditor to consider this event and issue a fresh audit report
on the financial statements for the year ended on Ashadh 2080.
After applying the conditions given in NSA 560, the auditor can issue new audit report subject to
date of audit report which should not be earlier than the date of approval of the amended financial
statements.

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Answer No. 5
It shall be the responsibility of each joint auditor to determine the nature, timing and extent of audit
procedures to be applied in relation to the areas of work allocated to the said joint auditor. It is the
individual responsibility of each joint auditor to study and evaluate the prevailing system of
internal control and assessment of risk relating to the areas of work allocated to the said joint
auditor. Before finalizing their audit report, the joint auditors shall discuss and communicate with
each other their respective conclusions that would form the content of the audit report.
Normally joint auditors have to arrive at an agreed report and issue a joint audit opinion on the
financial statement. However, where the joint auditors are in disagreement with regard to any
matters to be covered by the report, each one of them should express their own opinion through a
separate audit report. A joint auditor is not bound by the views of the majority of the joint auditors
regarding matters to be covered in the report and should express his opinion in a separate report in
case of disagreement. In such circumstances, the audit report(s) issued by the joint auditor(s) shall
make a reference to the separate audit report(s) issued by the other joint auditor(s). Further,
separate audit report shall also make reference to the audit report issued by other joint auditors.
Such reference shall be made under the heading “Other Matter Paragraph” as per NSA 706,
“Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s
Report”.
In above case, if Mr. A and Mr. B have disagreements to some matters and this leads to different
opinions, then each of them needs to issue a separate audit report. Further, each of them needs to
include an ‘Other Matter’ paragraph in their respective audit report wherein they would make a
reference to the separate audit reports issued by other joint auditors.
Answer No. 6
Nepal Standard on Auditing (NSA) 315 (revised), “Identifying and Assessing the Risks of Material
Misstatement through Understanding the Entity and Its Environment” deals with the auditor’s
responsibility to identify and assess the risks of material misstatement in the financial statements,
through understanding the entity and its environment, including the entity’s internal control. The
auditor should identify and assess the risks of material misstatement, whether due to fraud or error,
at the financial statement and assertion levels, through understanding the entity and its
environment, including the entity’s internal control, thereby providing a basis for designing and
implementing responses to the assessed risks of material misstatement.
As per the standard, the auditor shall identify and assess the risks of material misstatement at the
financial statement level; and the assertion level for classes of transactions, account balances, and
disclosures to provide a basis for designing and performing further audit procedures. For this
purpose, the auditor shall-
(i) Identify risks throughout the process of obtaining an understanding of the entity and its
environment, including relevant controls that relate to the risks, and by considering the classes of
transactions, account balances, and disclosures in the financial statements;
(ii) Assess the identified risks, and evaluate whether they relate more pervasively to the financial
statements as a whole and potentially affect many assertions;
(iii) Relate the identified risks to what can go wrong at the assertion level, taking account of
relevant controls that the auditor intends to test; and

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(iv) Consider the likelihood of misstatement, including the possibility of multiple misstatements,
and whether the potential misstatement is of a magnitude that could result in a material
misstatement.
Further as per NSA 330 ‘The Auditor’s Responses to the Assessed Risks’, the auditor shall design
and implement overall responses to address the assessed risks of material misstatement. In
designing the audit procedures to be performed, the auditor shall-
(i) Consider the reasons for the assessment given to the risk of material misstatement at the
assertion level for each class of transactions, account balance, and disclosure, including:
(1) The likelihood of material misstatement due to the particular characteristics of the relevant
class of transactions, account balance, or disclosure; and
(2) Whether the risk assessment takes into account the relevant controls, thereby requiring the
auditor to obtain audit evidence to determine whether the controls are operating effectively; and
(ii) Obtain more persuasive audit evidence the higher the auditor’s assessment of risk.
Answer No. 7
The primary responsibility for the prevention and detection of fraud and error rests with both those
charged with governance and the management of an entity.
Before audit procedure, auditor is required to understand the entity and its environment of its client
for risk assessment procedure for development of overall audit strategy and plan. After
understanding the overall structure, he need to consider overall control environment along with
procedure of control system for further audit procedure.
In evaluating the design of the entity’s control environment, the auditor considers the following
Elements and how they have been incorporated into the entity’s processes:
➢ Communication and enforcement of integrity and ethical values – essential elements which
influence the effectiveness of the design, administration and monitoring of controls.
➢ Commitment to competence – management’s consideration of the competence levels for
particular jobs and how those levels translate into requisite skills and knowledge.
➢ Participation by those charged with governance – independence from management, their
experience and stature, the extent of their involvement and scrutiny of activities, the
information they receive, the degree to which difficult questions are raised and pursued with
management and their interaction with internal and external auditors.
➢ Participation by those charged with governance – independence from management, their
experience and stature, the extent of their involvement and scrutiny of activities, the
information they receive, the degree to which difficult questions are raised and pursued with
management and their interaction with internal and external auditors.
➢ Organizational structure – the framework, within which an entity’s activities for achieving its
objectives are planned, executed, controlled and reviewed.
➢ Assignment of authority and responsibility – how authority and responsibility for operating
activities are assigned and how reporting relationships and authorization hierarchies are
established.

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➢ Human resource policies and practices – recruitment, orientation, training, evaluating,

counseling, promoting, compensating and remedial actions.
Answer No. 8
As per NSA 315“Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and Its Environment”, as part of the risk assessment the auditor shall
determine whether any of the risks identified are, in the auditor’s judgment, a significant risk. In
exercising this judgment, the auditor shall exclude the effects of identified controls related to the
risk. In exercising judgment as to which risks are significant risks, the auditor shall consider at
least the following:
I. Whether the risk is a risk of fraud;
II. Whether the risk is related to recent significant economic, accounting, or other
developments like changes in regulatory environment, etc., and, therefore, requires specific
attention;
III. The complexity of transactions;
IV. Whether the risk involves significant transactions with related parties;
V. The degree of subjectivity in the measurement of financial information related to the risk,
especially those measurements involving a wide range of measurement uncertainty; and
VI. Whether the risk involves significant transactions that are outside the normal course of
business for the entity, or that otherwise appear to be unusual.
However, risks of material misstatement may be greater for risks relating to significant non-
routine transactions arising from matters such as the following:
• Greater management intervention to specify the accounting treatment.
• Greater manual intervention for data collection and processing.
• Complex calculations or accounting principles.
• The nature of non-routine transactions, which may make it difficult for the entity to implement
effective controls over the risks.
When the auditor has determined that a significant risk exists, the auditor shall obtain an
understanding of the entity’s controls, including control activities, relevant to that risk.
Answer No. 9
The external auditor should evaluate the internal audit function to the extent he considers that it
will be relevant in determining the nature, timing and extent of his compliance and substantive
procedures. Depending upon such evaluation, the external auditor may be able to adopt less
extensive procedures than would otherwise be required. By its very nature, the internal audit
function cannot be expected to have the same degree of independence as is essential when the
external auditor expresses his opinion on the financial information. The report of the external
auditor is his sole responsibility, and that responsibility is not by any means reduced because of
the reliance he places on the internal auditor’s work.
The external auditor shall determine whether the work of the internal audit function can be used
for purposes of the audit by evaluating the following:

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(a) The extent to which the internal audit function’s organizational status and relevant policies and
procedures support the objectivity of the internal auditors;
(b) The level of competence of the internal audit function; and
(c) Whether the internal audit function applies a systematic and disciplined approach, including
quality control.
The application of a systematic and disciplined approach to planning, performing, supervising,
reviewing and documenting its activities distinguishes the activities of the internal audit function
from other monitoring control activities that may be performed within the entity. Factors that may
affect the external auditor’s determination of whether the internal audit function applies a
systematic and disciplined approach include the following:
• The existence, adequacy and use of documented internal audit procedures or guidance covering
such areas as risk assessments, work programs, documentation and reporting, the nature and extent
of which is commensurate with the size and circumstances of an entity.
• Whether the internal audit function has appropriate quality control policies and procedures, for
example, such as those policies and procedures in NSQC 1 that would be applicable to an internal
audit function (such as those relating to leadership, human resources and engagement
performance) or quality control requirements in standards set by the relevant professional bodies
for internal auditors. Such bodies may also establish other appropriate requirements such as
conducting periodic external quality assessments.
Answer 10
If the financial statements have been prepared using the going concern basis of accounting but, in
the auditor’s judgment, management’s use of the going concern basis of accounting in the
preparation of the financial statements is inappropriate, the auditor shall express an adverse
opinion regardless of whether or not the financial statements include disclosure of the
inappropriateness of management’s use of the going concern basis of accounting.
When the use of the going concern basis of accounting is not appropriate in the circumstances,
management may be required, or may elect, to prepare the financial statements on another basis.
The auditor may be able to perform an audit of those financial statements provided that the auditor
determines that the other basis of accounting is acceptable in the circumstances. The auditor may
be able to express an unmodified opinion on those financial statements, provided there is adequate
disclosure therein about the basis of accounting on which the financial statements are prepared,
but may consider it appropriate or necessary to include an Emphasis of Matter paragraph in the
auditor’s report to draw the user’s attention to that alternative basis of accounting and the reasons
for its use.
In this case, it is subjective, but prima-facie a mere expectation of future cash flows from the
promoter’s wife without any firm commitment and the possibility of an export order being
negotiated, may not that be sufficient appropriate audit evidence of mitigating factors for resolving
the going concerns question under NSA 570 “Going Concern”. So, auditor should modify or
disclaim his opinion.

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Answer No. 11
There are many problems involved in hotel audit, some of which are peculiar to the hotel industry
such as control of cash assume greater proportions. Almost all sales points in a hotel make both
cash and credit sales. The auditor should reconcile the total sales reported with the total of the bills
issued by the sales point; this total may take the form of a bill roll or a series of numerically
controlled bills. The special problems in a hotel audit can be summarized as follows:
(1) Internal Controls - Pilfering is one of the greatest problems in any hotel and the importance of
internal control cannot be over stressed. It is the responsibility of management to introduce controls
which will minimize the leakage as far as possible.
The auditor should obtain these regular trading accounts for the period under review, examine
them and obtain explanations for any apparent deviations. If the internal control in a hotel is weak
or perhaps breaks down, then a very serious problem exists for the auditor.
(2) Room Sales - The charge for room sales is normally posted to guest bills by the receptionist or
in the case of large hotels by the night auditor. The source of these entries is invariably the guest
register and audit tests should be carried out to ensure that the correct numbers of guests are
charged for the correct period. Any difference between the charge rates used on the guests' bills
and the standard room rate should be investigated to ensure that they have been properly
authorized.
(3) Stocks - The stocks in any hotel are both readily portable and saleable particularly the food and
beverage stocks. It is therefore extremely important that all movements and transfers of such stocks
should be properly documented to enable control to be exercised over each individual stores areas
and sales point. The auditor should carry out tests to ensure that all such documentation is
accurately processed. Areas where large quantities of stock are held should be kept locked, the key
being retained by the departmental manager. The key should be released only to trusted personnel
and unauthorized persons should not be permitted in the stores areas except under constant
supervision.
(4) Many hotels use specialized professional valuers to take and value the stocks on a continuous
basis throughout the year. Such a valuation is then almost invariably used as the basis of the
balance sheet stock figure at the year end. Although such valuers are independent of the audit
client, it is important that the auditor satisfies himself that the amounts included for such stocks
are reasonable. In order to satisfy himself of this the auditor should consider attending at the
physical stock taking and carrying out certain pricing and calculation tests. The extent of such tests
could well be limited since the figures will have been prepared independently of the hotel.
(5) Fixed Assets - The accounting policies for fixed assets of individual hotels are likely to differ.
However, many hotels account for certain quasi-fixed assets such as silver and cutlery on stock
basis. This can lead to confusion between each stock items and similar assets which are accounted
for on a more normal fixed assets basis. In such cases it is important that very detailed definitions
of stock items exist and the auditor should carry out tests to ensure that the definitions have been
closely followed.
(6) Casual Labour - The hotel trade operates to very large extent of casual labour. The records
maintained of such wage payments are frequently inadequate. The auditor should ensure that
defalcation on this account does not take place by suggesting proper controls to the management.

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(7) Other points:

a. For ledgers coming through travel agents or other booking agencies the bills are usually made
on the travel agents or booking agencies. The auditor should check that money are recovered from
the travel agents or booking agencies as per the terms of credit allowed.
b. Commission, if any, paid to travel agents or booking agents should be checked by reference to
the agreement on that behalf.
c. The auditor should ensure that proper records re-maintained for booking of halls and other
premises for special parties and recovered on the basis of the tariff.
d. The auditor should verify a few restaurant bills by reference to K.O.T.s (Kitchen Order Tickets)
or basic record. This would enable the auditor to ensure that controls regarding revenue cycle are
in order.
e. The auditor should see that costs of renovation and redecoration are treated as deferred revenue
expenditure, whereas costs of major alterations and additions to the hotel building and facilities
capitalized.
f. The auditor should ensure that proper valuation of occupancy-in-progress at the balance sheet
date is made and included in the accounts.
g. The auditor should satisfy himself that all taxes collected from occupants on food and occupation
have been paid over to the proper authorities.
h. In large hotels it is usual to operate a booth to facilitate conversion of foreign currencies to
Nepali rupees.
Answer No. 12
The contents of an internal audit report are influenced by various factors such as the nature of
internal auditing function in the organization, level of reporting, degree of management support
and capabilities of internal audit staff. However, for preparing a good internal audit report, the
following general rules may be observed:-
i. Objectivity - To maintain the credibility of internal audit function the comments and opinions
expressed in the report should be as objective and unbiased as possible.
ii. Clarity - The language used should be simple and straight-forward. As far as practicable use of
technical terms and jargon should be avoided. Each draft of the report should be reviewed by a
senior who should attempt to read it from the point of view of the users of the report.
iii. Accuracy - The information contained in the report, whether quantified or otherwise, should be
accurate. Where approximation or assumptions have been made the fact should be clearly stated
along with reasons, if material.
iv. Conciseness - Brevity is vital subject, of course, to the condition that important information
should not be omitted.
v. Constructiveness - Destructive criticism should carefully be avoided in the report. The report
should clearly demonstrate that the internal auditor is trying to assist the auditor in an effective
discharge of his responsibilities.

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vi. Readability - The reader’s interest should be captured and retained throughout. For this,
appropriate paragraph heading may be used.
vii. Timeliness - The report should be submitted promptly because if the time lag between the
occurrence of an event and its reporting is considerable, the opportunity for taking action may be
lost or a wrong decision may be taken in the absence of the information.
viii. Findings and conclusions - These may be given either department-wise or in the order of
importance. All the facts and data pertaining to the situation should be assembled, classified and
analysed. Each conclusion and opinion should normally follow the findings. Tables or graphs may
be used for the presentation of statistical data in appendices;
ix. Recommendations - An internal audit report usually includes recommendations for potential
improvements. In order to enable the management to accept and implement the recommendations,
the internal auditor should be able to convince the management that the conclusions are logical
and valid and the recommendations represent effective and feasible ways of taking action.
x. Auditee’s views - The auditee’s views about audit conclusions or recommendations may also
be included in the audit report in appropriate circumstances.
xi. Summary - A summary of conclusions and recommendations may be given at the end. This is
particularly useful in long reports.
xii. Supporting information - The internal auditor should supplement his report by such documents
and data which adequately and convincingly support the conclusions. Supporting information may
include the relevant standards or regulations.
xiii. Draft Report - Before writing the final report, the internal auditor should prepare a draft report.
This would help him in finding out the most effective manner of presenting his reports. It would
also indicate whether there is any superfluous information or a gap in reasoning.
xiv. Writing and issuing the Final Report - The final report should be written only when the auditor
is completely satisfied with the draft report. The head of the internal auditing department may
review and approve the final report. Before issuing the final report, the auditor should discuss
conclusions and recommendations at appropriate levels of management. The report should be duly
signed.
Answer No. 13
Due diligence involves investigation and evaluation of a management team’s characteristics,
investment philosophy, and terms and conditions prior to committing capital. Due diligence is
undertaken in order to determine the value of the subject of the due diligence and unearth any
issues or potential issues. It is necessary to limit reliance placed on vendor’s warranties – it is
better to discover a “skeleton in the closet” before the business is bought than afterwards. The
costs of buying a business with unexpected difficulties can be disastrous.
Due diligence is necessary to allow the investigating party to find out everything that he needs to
know about the subject of the due diligence. The objective is to allow the investigator to consider
his options in light of the facts. It exercise should reduce uncertainties, confirm assumptions and
define scope and prioritize issues. The exercise should combine an understanding of organization,
its operations, technologies, logistics, corporate strategy and finance and then summarize complex
issues into concise, easily understandable terms.

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The process would generally comprise of -

1. Planning phase
2. Data Collection Phase
3. Data Analysis phase
4. Report Finalization Phase
Planning phase: This stage includes the following processes:
a) Defining the scope
b) Deciding the focus areas
c) Finalizing the team structure
d) Clear definition of responsibilities
e) Defining time schedules
f) Timely communication of information requirements
g) Finalize the template and tools required
a) Defining the scope
Prior to conducting an engagement, the due diligence team needs to learn about the specifics of
the project. The due diligence team or the consultants should discuss the proposed transaction and
the due diligence needs. After establishing and prioritizing clear objectives, the availability of
resources should be studied and the areas on which the team has to focus on should be defined.
b) Deciding the focus areas
The first thing would be to decide on focus areas which normally include:
i. Sustainability of the business: The team can understand the sustainability of the business by
considering the target company’s business plan, vision, strategic alliances, synergies, new
products under development, new customers, order status and backlog, customer base
ii. Financials: The key financial data to be reviewed are assets, liabilities, cash flow, Inventory
turnovers, accounts receivable. accounts payable, ownership structure, revenues and
accounting procedures and policies
iii. Competition: It is essential to understand the market environment, and the significant
competitors
iv. Management team and organization culture: The prevailing culture and the outlook and
capability of the management team are of prime importance in taking a decision about the
target company.
v. Organizational Infrastructure: The organization’s facilities, quality systems, personnel talent
and policies should also be considered.
vi. Potential liabilities: It is important to understand the potential risks and liabilities which an
organization would face. The issues to be considered would include intellectual property
rights, pending regulatory issues, liens, lawsuits etc.

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vii. Technology: It is essential to explore the technological advantage, if any, which the target
company has over its competitors
viii. Existing market and potential. It is important to gather Information about sales, distribution,
marketing channels and promotional methods.
ix. Business to business fit: If there is a good fit between the two businesses, it would create
corporate synergy. The synergy might arise due to complementary strategy, personnel,
financial situation etc.
c) Finalizing the team structure
Ensure that the members who form the team are specifically chosen based on their skills and
background so that the project is successful. The team members should know the relevant
background information on the target company, the transaction, the industry, and due diligence
objectives. The members should be clear about what information should be collected, what site
visits should be conducted, what analyses should be performed, and what end products should be
delivered at the end of the project.
d) Clear definition of responsibilities:
The due diligence effort requires integration of efforts and communication with multiple parties.
It is therefore important that planning is done in such a manner that responsibilities and expected
outputs are clearly defined so that the team is working collectively towards a common goal. Define
the expectations from all sources like target company. Internal parties, third party sources, database
searches.
e) Defining time schedules
Before starting on the actual execution, it is best to define the scope, expectations and timing from
each step. Scheduling the time of each key step helps achieving results in desired timeframe and
helps the parties focus on the common goal.
f) Timely communication of information requirements:
The success of due diligence process depends upon complete, accurate and timely information.
This can be made possible if the information providers are informed of the expectations from them
and the timelines. Each party involved needs to provide as early and specifically as possible. For
example, instead of making repeated information requests, if the target company is provided
detailed information request list early, they can effectively manage the process and meet the
communication timelines.
g) Finalize the template and tools required
Based on scope, needs and objectives, the due diligence team should decide on tools to be used
like internet database search, regulatory database search, questionnaires, worksheets and other
communication methods like conducting interviews, emails etc.
Answer No. 14
Areas where the services of forensic accountants/ auditors are generally required:
i. Criminal Investigation: Matters relating to financial implications the services of the forensic
accountants are availed of. The report of the accountants is considered in preparing and
presentation as evidence.

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ii. Professional Negligence Cases: Professional negligence cases are taken up by the forensic
accountants. Non-conformation to Nepal Standards on Auditing (NSAs) or non-compliance
to auditing practices or ethical codes of any profession, Forensic Auditors are needed to
measure the loss due to such professional negligence or shortage in services.
iii. Arbitration service: Forensic accountants render arbitration and mediation services for the
business community. Their expertise in data collection and evidence presentation makes them
sought after in this specialized practice area.
iv. Fraud Investigation and Risk/Control Reviews: Forensic accountants render such services
both when called upon to investigate specific cases as well for a review of or for
implementation of Internal Controls. Another area of significance is Risk Assessment and
Risk Mitigation.
v. Settlement of insurance claims: Insurance companies engage forensic accountants to have
an accurate assessment of claims to be settled. In case of policyholders seek the help of a
forensic accountant when they need to challenge the claim settlement as worked out by the
insurance companies. A forensic accountant handles the claims relating to consequential loss
policy, property loss due to various risks, fidelity insurance and other types of insurance
claims.
vi. Dispute settlement: Business firms engage forensic accountants to handle contract disputes,
construction claims, product liability claims, and infringement of patent and trademarks cases,
liability arising from breach of contracts and so on.
Answer No. 15
In determining whether to use CAATs, the factors to consider includes the following:
(i) The availability of sufficient IT knowledge, expertise and experience of the audit team;
Auditing in computer information systems environment deals with the level of skill and
competence the audit team needs to conduct an audit in a Computer Information System (CIS)
environment. It provides guidance when an auditor delegates work to assistants with CIS skills or
when the auditor uses work performed by other auditors or experts with such skills. Specifically,
the audit team should have sufficient knowledge to plan, execute and use the results of the
particular CAAT adopted. The level of knowledge required depends on availability of CAATs and
suitable computer facilities.
(ii) The availability of CAATs and suitable computer facilities and data:
The auditor may plan to use other computer facilities when the use of CAATs on an entity’s
computer is uneconomical or impractical, for example, because of an incompatibility between the
auditor’s package program and entity’s computer. Additionally, the auditor may elect to use their
own facilities, such as pcs or laptops. The cooperation of the entity’s personnel may be required
to provide processing facilities at a convenient time, to assist with activities such as loading and
running of CAAT on the entity’s system, and to provide copies of data files in the format required
by the auditor.
(iii) Impracticability of Manual Tests due to lack of evidence:
Some audit procedures may not be possible to perform manually because they rely on complex
processing (for example, advanced statistical analysis) or involve amounts of data that would

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overwhelm any manual procedure. In addition, many computer information systems perform tasks
for which no hard copy evidence is available and therefore, it may be impracticable for the auditor
to perform tests manually. The lack of hard copy evidence may occur at different stages in the
business cycle.
(iv) Impact on effectiveness and efficiency in extracting a data:
The effectiveness and efficiency of auditing procedures may be improved by using CAATs to
obtain and evaluate audit evidence. CAATs are often an efficient means of testing a large number
of transactions or controls over large populations by analyzing and selecting samples from a large
volume of transactions; applying analytical procedures and performing substantive procedures.
Matters relating to efficiency that an auditor might consider include the time taken to plan, design,
execute and evaluate CAAT; technical review and assistance hours; designing and printing of
forms (for example, confirmations); and availability of computer resources.
(v) Time constraints
Certain data, such as transaction details, are often kept for a short time and may not be available
in machine-readable form by the time auditor wants them. Thus, the auditor will need to make
arrangements for the retention of data required, or may need to alter the timing of the work that
requires such data. Where the time available to perform an audit is limited, the auditor may plan
to use CAAT because its use will meet the auditor’s time requirement better than other possible
procedures.
Answer No. 16
The Sarbanes–Oxley Act of 2002, also known as the "Public Company Accounting Reform and
Investor Protection Act" or "Corporate and Auditing Accountability and Responsibility Act" and
more commonly called as Sarbanes–Oxley, Sarbox or SOX, is a United States federal law that set
new or expanded requirements for all U.S. public company boards, management and public
accounting firms. The intent of the SOX Act was to protect investors, and really all stakeholders
in a business firm, by improving the accuracy and reliability of corporate disclosures, such as
earnings reports, pursuant to securities laws and regulations.
The SOX Act holds company CEO's and CFO's responsible for the information presented by their
company in financial statements. It created new standards of accountability for corporations as
well as penalties of those standards of accountability are not met. SOX established new financial
reporting standards. All companies, according to SOX, must provide a yearend report about the
internal controls they have in place and the effectiveness of those internal controls.
The major elements of SOX Act are:
The Act contains eleven titles, or sections, ranging from additional corporate board responsibilities
to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement
rulings on requirements to comply with the law.
1. Public Company Accounting Oversight Board (PCAOB)
Title-I consists of nine sections and establishes the Public Company Accounting Oversight Board,
to provide independent oversight of public accounting firms providing audit services ("auditors").
It also creates a central oversight board tasked with registering auditors, defining the specific

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processes and procedures for compliance audits, inspecting and policing conduct and quality
control, and enforcing compliance with the specific mandates of SOX.
2. Auditor Independence
Title-II consists of nine sections and establishes standards for external auditor independence, to
limit conflicts of interest. It also addresses new auditor approval requirements, audit partner
rotation, and auditor reporting requirements. It restricts auditing companies from providing non-
audit services (e.g., consulting) for the same clients.
3. Corporate Responsibility
Title-III consists of eight sections and mandates that senior executives take individual
responsibility for the accuracy and completeness of corporate financial reports. It defines the
interaction of external auditors and corporate audit committees, and specifies the responsibility of
corporate officers for the accuracy and validity of corporate financial reports. It enumerates
specific limits on the behaviors of corporate officers and describes specific forfeitures of benefits
and civil penalties for non-compliance. For example, Section 302 requires that the company's
"principal officers" (typically the Chief Executive Officer and Chief Financial Officer) certify and
approve the integrity of their company financial reports quarterly.
4. Enhanced Financial Disclosures
Title-IV consists of nine sections. It describes enhanced reporting requirements for financial
transactions, including off-balance-sheet transactions, pro-forma figures and stock transactions of
corporate officers. It requires internal controls for assuring the accuracy of financial reports and
disclosures, and mandates both audits and reports on those controls. It also requires timely
reporting of material changes in financial condition and specific enhanced reviews by the stock
exchange.
5. Analyst Conflicts of Interest
Title-V consists of only one section, which includes measures designed to help restore investor
confidence in the reporting of securities analysts. It defines the codes of conduct for securities
analysts and requires disclosure of knowable conflicts of interest.
6. Commission Resources and Authority
Title-VI consists of four sections and defines practices to restore investor confidence in securities
analysts. It also defines the exchange authority to censure or bar securities professionals from
practice and defines conditions under which a person can be barred from practicing as a broker,
advisor, or dealer.
7. Studies and Reports
Title-VII consists of five sections and requires the Comptroller General and the exchange authority
to perform various studies and report their findings. Studies and reports include the effects of
consolidation of public accounting firms, the role of credit rating agencies in the operation of
securities markets, securities violations, and enforcement actions, and whether investment banks
assisted Enron, Global Crossing, and others to manipulate earnings and obfuscate true financial
conditions.

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8. Corporate and Criminal Fraud Accountability

Title-VIII consists of seven sections and is also referred to as the "Corporate and Criminal Fraud
Accountability Act of 2002". It describes specific criminal penalties for manipulation, destruction
or alteration of financial records or other interference with investigations, while providing certain
protections for whistle-blowers.
9. White Collar Crime Penalty Enhancement
Title-IX consists of six sections. This section is also called the "White Collar Crime Penalty
Enhancement Act of 2002." This section increases the criminal penalties associated with white-
collar crimes and conspiracies. It recommends stronger sentencing guidelines and specifically adds
failure to certify corporate financial reports as a criminal offense.
10. Corporate Tax Returns
Title-X consists of one section. Section 1001 states that the Chief Executive Officer should sign
the company tax return.
11. Corporate Fraud Accountability
Title-XI consists of seven sections. Section 1101 recommends a name for this title as "Corporate
Fraud Accountability Act of 2002". It identifies corporate fraud and records tampering as criminal
offenses and joins those offenses to specific penalties. It also revises sentencing guidelines and
strengthens their penalties. This enables the SEC to resort to temporarily freezing transactions or
payments that have been deemed "large" or "unusual".
Answer No. 17
As per paragraph 17 of NFRS 15, Revenue from Contracts with Customers, an entity shall combine
two or more contracts entered into at or near the same time with the same customer (or related
parties of the customer) and account for the contracts as a single contract if one or more of the
following criteria are met:

i) the contracts are negotiated as a package with a single commercial objective;

ii) the amount of consideration to be paid in one contract depends on the price or performance
of the other contract; or
iii) the goods or services promised in the contracts (or some goods or services promised in
each of the contracts) are a single performance obligation.
Answer No. 18
As per the Guidelines on Professional Appointment, 2023 issued by the Institute of Chartered
Accountants of Nepal (ICAN), in the event of any information received about the changes in
professional appointment, the professional accountant:
• shall think seriously whether there is any reason that might indicate not to accept engagement.
There could be reasons of self-interest threat and also accepting the engagement without
knowing all relevant facts might create non-compliance of fundamental principles relating to
professional competence and Due care. Therefore, it becomes the responsibility of the
professional Accountant, before communicating or responding to the client’s request, to verify
seriously all relevant facts that caused to changes in the professional engagements;

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• shall be allowed, as explicitly mentioned in the tender or mode of requesting documents of the
proposed client, to contact the predecessor accountant to get information about the reason
responsible for such change in the profession engagement. Such contact gives the professional
accountant the opportunity to enquire whether there are any reasons why the engagement
should not be accepted;
• shall, in the event if asked to undertake work that is complementary or additional to work of
an existing predecessor accountant, gather all relevant information and find out whether any
reason exists which might create self -interest threat to compliance with the principle of
professional competence and due care might be created as a result of incomplete information;
• shall not undertake any step to respond to the client’s offer through any means without
verifying reasons for changes in professional engagements or complete information of the
activities of the client for example whether the client is indulging in, illegal activities such as
tax evasion or manipulation, money laundering etc.
Answer No. 19
If the senior professional accountant identifies or suspects that noncompliance has occurred or
might occur, the accountant shall, subject to paragraph R260.9 of Code of Ethics issued by the
Institute of Chartered Accountants of Nepal, discuss the matter with the accountant’s immediate
superior, if any. If the accountant’s immediate superior appears to be involved in the matter, the
accountant shall discuss the matter with the next higher level of authority within the employing
organization.
The purpose of the discussion is to enable a determination to be made as to how to address the
matter.
The senior professional accountant shall also take appropriate steps to:
(a) Have the matter communicated to those charged with governance;
(b) Comply with applicable laws and regulations, including legal or regulatory provisions
governing the reporting of non-compliance or suspected non-compliance to an appropriate
authority;
(c) Have the consequences of the non-compliance or suspected noncompliance rectified,
remediated or mitigated;
(d) Reduce the risk of re-occurrence; and
(e) Seek to deter the commission of the non-compliance if it has not yet occurred.
The purpose of communicating the matter to those charged with governance is to obtain their
concurrence regarding appropriate actions to take to respond to the matter and to enable them to
fulfill their responsibilities.
Some laws and regulations might stipulate a period within which reports of non-compliance or
suspected non-compliance are to be made to an appropriate authority.
In addition to responding to the matter in accordance with the provisions of this section, the senior
professional accountant shall determine whether disclosure of the matter to the employing
organization’s external auditor, if any, is needed.

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Such disclosure would be pursuant to the senior professional accountant’s duty or legal obligation
to provide all information necessary to enable the auditor to perform the audit.
Answer No. 20
Safeguards vary depending on the facts and circumstances. Examples of actions that in certain
circumstances might be safeguards to address threats include:
• Assigning additional time and qualified personnel to required tasks when an engagement has
been accepted might address a self-interest threat.
• Having an appropriate reviewer who was not a member of the team review the work
performed or advise as necessary might address a self-review threat.
• Using different partners and engagement teams with separate reporting lines for the provision
of non-assurance services to an assurance client might address self-review, advocacy or
familiarity threats.
• Involving another firm to perform or re-perform part of the engagement might address self-
interest, self-review, advocacy, familiarity or intimidation threats.
• Disclosing to clients any referral fees or commission arrangements received for
recommending services or products might address a self-interest threat.
• Separating teams when dealing with matters of a confidential nature might address a self-
interest threat.

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