No. of Pages: 6 Total Marks: 100

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1 DING No. of Pages: 6 Total Marks: 100 No of Questions: 7 Time Allowed: 3 Hrs Question No. 1 is compulsory. Answer any five questions from the remaining six questions. Wherever appropriate, suitable assumption/s should be made and indicated in answer by the candidate. Working notes should form part of the answer a) An equipment having expected useful life of 5 years, is leased for 3 year. Both the cost and the fair value of the equipment are `6,00,000. The amount will be paid in 3 equal installments and at the termination of lease, lessor will get back the equipment. The unguaranteed residual value at the end of 3rd year is `60,000. The IRR of the investment is 10%. The present value of annuity factor of `1 due at the end of 3rd year at 10% IRR is The present value of `1 due at the end of 3rd year at 10% rate of interest is State with reason whether the lease constitutes finance lease and also compute the unearned finance income. b) A Company has its share capital divided into shares of `10 each. On 1st April 2010, it granted 20,000 employees stock options at `40, when the market price was `130. The options were to be exercised between 1st January 2011 to 15th March The employees exercised their options for 18,000 shares only; the remaining options lapsed. The company closes its books on 31st March every year. Pass Journal entries with regard to employees stock options. c) Rama Limited issued 8% Debentures of `3,00,000 in earlier year on which interest is payable half yearly on 31st March and 30th September. The company has power to purchase its own debentures in the open market for cancellation thereof. The following purchases were made during the financial year and cancellation made on 31st March, 2010: (a) On 1st April, `50,000 nominal value debentures purchased for `49,450, ex-interest. (b) On 1st September, `30,000 nominal value debentures purchased for `30,250 cuminterest. Show the Journal Entries (without narrations) for the transactions held in the year Recognizing the need to harmonize the diverse accounting policies and practices, accounting standards are framed. Give examples of areas in which different accounting policies may be adopted by the enterprise. (4 x 5 = 20 Marks) Sun Ltd. and Moon Ltd. were amalgamated on and from 1st April, A new company Star Ltd. was formed to take over the business of the existing companies. The Balance Sheets of Sun Ltd. and Moon Ltd. as at 31st March, 2009 are given below: `in Lakhs Liabilities Sun Moon Assets Sun Moon Share capital: Fixed Assets Equity shares of `.100 Each Land & Building PRIME/ME35/IPCC 1

2 12% Preference shares of Plant & Machinery `.100 each Reserves and surplus: Investments Revaluation reserve Current Assets, Loans General reserve and Advances: Investment allowance Stock reserve Profit and Loss Account Sundry Debtors Secured loan: Bills Receivable % Debentures (` Cash and bank each) Current liabilities and provisions: Sundry credito` Acceptance Additional information: (a) Star Ltd. will issue 5 equity shares for each equity share of Sun Ltd. and 4 equity shares for each equity share of Moon Ltd. The shares are to be `. 30 each, having a face value of `. 10 per share. (b) Preference shareholder of the two companies are issued equivalent number of 15% preference shares of Star Ltd. at a price of `. 150 per share (face value `. 100). (c) 10% Debenture holder of Sun Ltd. and Moon Ltd. are discharged by Star Ltd., issuing such number of its 15% Debentures of `.100 each so as to maintain the same amount of interest. (d) Investment allowance reserve is to be maintained for 4 more year. (e) Liquidation expenses are: Sun Ltd. `.2,00,000 Moon Ltd. `.1,00,000 It was decided that these expenses would be borne by Star Ltd. (f) All the assets and liabilities of Sun Ltd. and Moon Ltd. are taken over at book value. (g) Authorised equity share capital of Star Ltd. is `. 5,00,00,000, divided into equity shares of `. 10 each. After issuing required number of shares to the Liquidator of Sun Ltd. and Moon Ltd., Star Ltd. issued balance shares to Public. The issue was fully subscribed. Required : Prepare the Balance Sheet of Star Ltd. as at 1st April, 2009 after amalgamation has been carried out on the basis of Amalgamation in the nature of purchase. (16 Marks) 3. Extra Ltd. furnishes you with the following Balance Sheet as on 31st March, 2010: (` in lakhs) Liabilities Amount Assets Amount Equity share capital of `10 each 100 Fixed asset less depreciation 50 9% redeemable preference shares of 20 Investment at cost 120 `100 each Capital reserves 8 Current assets 142 Revenue reserves 50 Securities premium 60 10% debentures 4 Current liabilities PRIME/ME35/IPCC 2

3 (i) The company redeemed the preference shares at a premium of 10% on 1st April, (ii) It also bought back 3 lakhs equity shares of ` 10 each at `30 per share. The payment for the above were made out of huge bank balances, which appeared as a part of the current assets. (iii) Included in its investment were investments in own debentures costing `2 lakhs (face value `2.20 lakhs). These debentures were cancelled on 1st April, (iv) The company had 1,00,000 equity stock options outstanding on the above mentioned date, to the employees at `20 when the market price was `30. (This was included under current liabilities). On employees exercised their options for 50,000 shares. (v) Pass the journal entries to record the above. (vi) Prepare Balance Sheet as at (16 Marks) 4. (a) Ram Limited of Chennai has a branch at Nagpur to which office, goods are invoiced at cost plus 25%.Thebranch makes sales both for cash and on credit. Branch expenses are paid direct from Head Office and the branch has to remit all cash received into the Head Office Bank Account at Nagpur. From the following details, relating to the year 2009, prepare the accounts in Head Office Ledger and ascertain Branch Profit as per stock and debtor method. Branch does not maintain any books of accounts, but sends weekly returns to head office: ` Goods received from head office at invoice price 120,000 Returns to head office at invoice price 2,400 Stock at Nagpur branch on at invoice price 12,000 Sales during the year Cash 40,000 Credit 72,000 Debtor at Nagpur branch as on ,400 Cash received from debtors 64,000 Discounts allowed to debtors 1,200 Bad debts during the year 800 Sales returns at Nagpur branch 1,600 Salaries and wages at branch 12,000 Rent, rates and taxes at branch 3,600 Office expenses at Nagpur branch 1,200 Stock at branch on at invoice price 24,000 (8 Marks) (b) ABC Electricity Company laid down a main at a cost of `.24,00,000. Some year later the company replaced by improving the plant 2/3 portion of the main at a cost of `.40,00,000. The cost of material and labour having gone up by 25%. Sale of old material realised `.95,000. Old material value `.1,05,000 were used in renewal (including in above). Calculate the amount to be capitalised and show the journal entries for recording the transaction. (4 Marks) (c) A Ltd. entered into a binding contract with C Ltd. to buy a machine for `. 1,00,000. The machine is to be delivered on 15th February, On 1st January, 2009, A Ltd. changed its process of production. The new process will not require the machine ordered and it shall have to be scrapped after delivery. The expected scrap value of the machine is nil. Explain how A Ltd. Should recognise the entire transaction in the books of account for the year ended 31st March, (4 Marks) PRIME/ME35/IPCC 3

4 5. P, Q, R and S had been carrying on business in partnership sharing profits & losses in the ratio of 4:3:2:1.They decided to dissolve the partnership on the basis of following Balance Sheet as on 30th April, 2011: Liabilities Amount ` Assets Amount ` Capital Account Land & Buildings 246,000 P 168,000 Furniture & Fittings 65,000 Q 108, ,000 Stock 1,00,000 General Reserve 95,000 Debtors 72,500 Capital reserve 25,000 Cash in hand 15,500 Sundry Creditors 36,000 Capital overdrawn Mortgage Loan 1,10,00 R 25,000 S 18,000 43,000 5,42,000 5,42,000 (i) The assets were realized as under: ` Land & building `2,30,000 Furniture & fixtures` 42,000 Stock` 72,000 Debto`65,000 (ii) Expenses of dissolution amounted to `7,800. (iii) Further creditor of ` 18,000 had to be met. (iv) R became insolvent and nothing was realized from his private estate. Applying the principles laid down in Garner Vs. Murray, prepare the Realisation Account, Partners Capital Accounts and Cash Account. (16 Marks) 6. The Balance Sheet of Dee Limited on 31st March, 2009 was as follows: Balance Sheet as at 31st March, 2009 Amount Amount Liabilities ` Assets ` Share capital: Fixed assets (at cost less 8,00,000 Authorised capital depreciation) 50,000, Equity shares of Debenture redemption fund `.10 each 5,00,000 investment 2,00,000 Issued and subscribed capital Cash balance 2,50,000 25,000 Equity shares of `.10 Other current assets 10,00,000 each fully paid up 2,50,000 Reserves and surplus: General reserve 2,75,000 Profit and loss A/c 1,00,000 Debenture redemption reserve 2,50,000 Secured loans: 12% Convertible debentures (5,000 Debentures of `.100 each) 5,00,000 Other secured loans 2,50,000 Current liabilities and provisions 6,00,000 Proposed dividend 25,000 PRIME/ME35/IPCC 4

5 22,50,000 22,50,000 At the General Meeting it was resolved to: 1. Pay proposed dividend of 10% in cash. 2. Give existing shareholder the option to purchase one share of `10 each at `15 for every five shares held. This option was taken up by all the shareholder. 3. Redeem the debentures at a premium of 5% and also confer option to the Debentures holder to convert 50% of their holding into equity shares at a predetermined price of ` 15 per share and balance payment to be made in cash. Holder of `3,000 debentures opted to get their debentures redeemed in cash only while the rest opted for getting the same converted into equity shares as per the terms of issue. Debentures redemption fund investment realized `1,80,000 on sales. You are required to redraft the Balance Sheet after giving effects to the right issue and redemption of debentures. Also show the calculations in respect of number of equity shares issued and cash payment. (16 Marks) 7. From the following information prepare the Profit & Loss Account of Jawahar Bank Limited for the year ended 31st March, Also give necessary Schedules Figures are in `thousands Interest earned on term loans Interest earned on term loans classified as NPA 4.52 Interest received on term loans classified as NPA 2.04 Interest on cash credits and overdrafts Interest earned but not received on cash credit and overdraft treated as NPA 8.39 Interest on deposits 27.2 Commission 1.97 Profit on sale of investments Profit on revaluation of investments 2.76 Income from investments Salaries, bonus and allowances Rent, taxes and lighting 1.7 Printing and stationary 0.75 Director s fees, allowances expenses 1.33 Law charges 0.22 Repair and maintenance 0.18 Insurance 0.3 Other information: Make necessary provision on risk assets: (i) Sub-standard 15 (ii) Doubtful for one year 7 (iii) Doubtful for two years 2.4 (iv) Loss assets 0.65 Investments 3700 Bank should not keep more than 25% of its investments as held-for-maturity investment. The market value of its best 75% investments is ` 9,00,000 as on 31st March, (16 Marks) PRIME/ME35/IPCC 5

6 PRIME ACADEMY 35 th SESSION MODEL EXAM - IPCC ADVANCED ACCOUNTING SUGGESTED ANSWERS 1)a) (i) Determination of Nature of Lease It is assumed that the fair value of the leased equipments is equal to the present value of minimum lease payments. Present value of residual value at the end of 3rd year = ` 60,000 x = ` 45,078 Present value of lease payments = ` 6,00,000 ` 45,078= ` 5,54,922 The percentage of present value of lease payments to fair value of the equipment is (` 5,54,922 / ` 6,00,000) x 100 = %. Since, it substantially covers the major portion of the lease payments, the lease constitutes a finance lease. (ii) Calculation of Unearned Finance Income Annual lease payment = ` 5,54,922 / =` 2,23,147 (approx) Gross investment in the lease = Total minimum lease payment + unguaranteed residual value = (` 2,23,147 3) + ` 60,000 = ` 6,69,441 + ` 60,000 = ` 7,29,441 Unearned finance income = Gross investment - Present value of minimum lease payments and unguaranteed residual value = ` 7,29,441 ` 6,00,000 = ` 1,29,441 b) Date Particulars Debit ` Credit ` Employees compensation expense A/c 18,00,000 Dr 18,00,000. To Employees stock option outstanding A/c (Being grant of 20,000 stock option to employees at ` 40 when market price is ` 130) to ,20,000 16,20,000 Bank Ac Dr Employee stock option account Dr To Equity Share capital To Securities Premium (Being allotment to employees 18,000 equity shares of ` 10 each at a premium of ` 120 per share in exercise of their stock options ) Employees stock option outstanding A/c To Employees compensation expense A/c (Being entry for lapse of stock options for 2,000 shares) P&L A/c Dr To Employees compensation expense (Being transfer of employees compensation expense to profit & loss account) PRIME/ME35/IPCC 6 180,000 16,20, ,000 21,60, ,000 16,20,000

7 c) In the books of Rama Limited Journal Entries ` ` 1st April, 2009 Own debentures A/c Dr. 49,450 To Bank A/c 49,450 1st September 2009 Own debentures A/c Dr. 29,250 Interest on own debentures A/c Dr. 1,000 [30,000 x 8% x 5/12) To Bank A/c 30,250 30th Sept Interest on debentures A/c Dr. 12,000 To Bank A/c 8,800 To Interest on own debentures A/c 3,200 31st March, 2010 Interest on debentures A/c Dr. 12,000 To Bank A/c 8,800 To Interest on own debentures A/c 3,200 31st March, % Debentures A/c Dr. 80,000 To Own debentures A/c 78,700 To Profit on cancellation 1,300 31st March, 2010 Interest on own debentures A/c Dr. 5,400 To Profit and Loss A/c 5,400 ( 3,200+3,200-1,000) 31st March, 2010 Profit and Loss A/c Dr. 24,000 To Interest on debentures A/c 24,000 31st March, 2010 Profit on cancellation A/c Dr. 1,300 To Capital reserve A/c 1,300 d) The following are examples of the areas in which different accounting policies may be adopted by different enterprise: - Methods of depreciation, depletion and amortization; - Valuation of inventories; - Recognition of profit on long-term contracts; - Valuation of fixed assets. PRIME/ME35/IPCC 7

8 2) Balance Sheet of Star Ltd. as at 1 st April, 2009 (` in Lakhs) Liabilities Amount Assets Amount Share capital: Authorised share capital Fixed assets: Goodwill (10+2+1) 13 50,00,000 Equity shares of `10 each 500 Land and building 475 ( ) Issued and subscribed Plant and machinery ,00,000 Equity shares of `10 each 2,50,000 Preference shares of `100 each (Of the above shares 35,00,000 equity shares and all preference shares are allotted as fully paid up for consideration other than cash) Reserves and surplus: Securities premium ( ) Investment allowance reserve (25+25) Secured Loans: ( ) Investment (75+25) Current assets, loans and advances: Stock ( ) Sundry debtors ( ) Cash and bank ( ) Bills receivables (25+25) Miscellaneous expenditure: % Debentures (20+10) 30 Amalgamation adjustment 50 account Unsecured loans: Current liabilities and provisions: Acceptances (75+35) Sundry creditors (135+60) Nil ,960 1,960 PRIME/ME35/IPCC 8

9 Working notes 1 )Computation of Purchase Consideration ` in lakhs Sun Ltd. Moon Ltd. (a) Preference shareholders: 1,50,00,000/100 = 1,50,000 shares Share capital = 1,50,000 shares `100 each 150 Securities premium = 1,50,000 shares `50 each ,00,00,000/100 = 1,00,000 shares Share capital = 1,00,000 shares `100 each 100 Securities premium= 1,00,000 shares `50 each (b) Equity shareholders: 4,00,00,000/100 5 = 20,00,000 shares Share capital = 20,00,000 shares `10 each 200 Securities premium=20,00,000 shares `20 each ,75,00,000/100 4 = 15,00,000 shares Share capital = 15,00,000 shares `10 each 150 Securities premium = 15,00,000 shares `20 each Amount of purchase consideration Calculation of number of debentures issued 10% Debentures of `100 each 15% Debentures to be issued to maintain same amount of interest: Interest = `30,00,000 x 10% = `3,00,000 ` in lakhs Sun Ltd. Moon Ltd Net assets taken over Assets taken over Land and building Plant and machinery Investments Stock Sundry debtors Bills receivable Cash and bank ` in lakhs Sun Ltd. Moon Ltd , PRIME/ME35/IPCC 9

10 Less: Liabilities taken over Debentures Sundry Creditors Bills payable Net assets taken over Purchase consideration (Goodwill)/ Capital Reserve Net goodwill (55) (10) Liquidation expenses of Sun Ltd. and Moon Ltd., `2 lakhs and `1 lakhs respectively will be debited to Goodwill account in the books of Star Ltd. 3) Date Particulars Debit Credit ` ` % Redeemable preference share capital A/c Dr Premium on redemption of preference shares A/c Dr To Preference shareholders A/c (Being preference share capital transferred to shareholders account) Preference shareholders A/c Dr To Bank A/c (Being payment made to shareholders) Equity shares buy back A/c Dr To Bank A/c (Being 3 lakhs equity shares of ` 10 each bought ` 30 per share) Equity share capital A/c Dr Securities premium A/c Dr To Equity Shares buy back A/c (Being cancellation of shares bought back) Revenue reserve A/c ( ) Dr To Capital redemption reserve A/c (Being creation of capital redemption reserve account to the extent of the face value of preference shares redeemed and equity shares bought back as per the law) PRIME/ME35/IPCC 10

11 % Debentures A/c Dr To Investment (own debentures) A/c 2.00 To Profit on cancellation of own 0.20 debentures A/c (Being cancellation of own debentures costing ` 2 lakhs, face value being ` 2.20 lakhs and the balance being profit on cancellation of debentures) Profit on cancellation of debentures A/c To Capital reserve A/c (Being profit on cancellation of debentures transferred to capital reserve account) Bank A/c Employees stock option outstanding (Current liabilities) A/c To Equity share capital A/c To Securities premium A/c (Being the allotment to employees, of 50,000 shares of ` 10 each at a premium of 20 per share in exercise of stock options by employees) Securities premium A/c To Premium on redemption of preference shares A/c (Being premium on redemption of preference shares adjusted through securities premium) Dr. Dr. Dr. Dr PRIME/ME35/IPCC 11

12 Balance Sheet of Extra Ltd. as on (` in lakhs) Liabilities Amount Assets Amount Share capital Fixed assets less depreciation Equity shares of ` 10 each fully paid Capital reserve (W.N. 2) Securities premium (W.N.4) Capital redemption reserve 10% Debentures (W.N.5) Current liabilities (W.N. 6) Investments at cost (W.N. 7) 8.20 Current assets (W.N.8) Working Notes: (` in lakhs) 1. Equity share capital Opening balance Less : Cancellation of bought back shares (30.00) Add : Shares issued against ESOP PRIME/ME35/IPCC 12

13 2. Capital Reserve Opening balance 8.00 Add: Profit on cancellation of debentures Revenue reserves (` iin lakhs) Opening balance Less:Creation of Capital Redemption Reserve (50.00) Securities Premium in Opening balance Less : Adjustment for cancellation of (60.00) equity shares Less Adjustment for premium on redemption of (2.00) preference shares Add: Shares issued against ESOP shares at premium 10% Debentures Opening balance Less: Cancellation of own debentures Current liabilities Opening balance Less: Adjustment for ESOP outstanding (2.20) (5.00) Investments at cost Opening balance Less: Investment in own debentures (2.00) Current assets Opening balance Less : Payment to preference shareholders (22.00) PRIME/ME35/IPCC 13

14 Less : Payment to equity shareholders (90.00) Add : Share price received against ESOP )a) Nagpur Branch Stock Account Particulars Amount Particulars Amount (`) (`) To Balance b/d 12,000 By Goods sent to branch 2,400 A/c (Returns) To Goods sent to branch A/c 1,20,000 By Bank A/c (Cash sales) 40,000 To Branch debtors A/c (Returns) 1,600 By Branch debtors A/c 72,000 (credit sales) To Branch adjustment A/c By Balance c/d 24,000 (Surplus over invoice price) 4,800 1,38,400 1,38,400 Nagpur Branch Adjustment Account Particulars Amount Particulars Amount (`) (`) To Stock reserve - 20% of 4,800 By Stock reserve - 20% of 2,400 `24,000 (closing `12,000 (Opening stock) stock) To Branch profit & loss A/c 25,920 By Goods sent to branch A/c 23,520 (Gross profit) - 20% of `1,17,600 By Branch stock A/c 4,800 30,720 30,720 Branch Profit & Loss Account Particulars Amount Particulars Amount (`) (`) To Branch expenses A/c 16,800 By Branch adjustment A/c 25,920 (Gross Profit) To Branch debtors A/c 1,200 (Discount) To Branch debtors A/c 800 (Bad Debts) To Net profit (transferred to Profit & Loss A/c) 7,120 25,920 25,920 PRIME/ME35/IPCC 14

15 Branch Expenses Account Particulars Amount Particulars Amount (`) (`) To Bank A/c (Rent, rates 3,600 By Branch profit and loss A/c 16,800 & taxes) (Transfer) To Bank A/c (Salaries & 12,000 wages) To Bank A/c (Office expenses) 1,200 16,800 16,800 Branch Debtors Account Particulars Amount Particulars Amount (`) (`) To Balance b/d 14,400 By Bank A/c 64,000 To Branch stock A/c 72,000 By Branch profit and loss A/c 2,000 (Bad debts and discount) By Branch stock A/c (Sales 1,600 returns) By Balance c/d (bal.fig.) 18,800 86,400 86,400 Goods sent to Branch Account Particulars Amount Particulars Amount (`) (`) To Branch stock A/c 2,400 By Branch stock A/c 1,20,000 To Branch adjustment A/c 23,520 To Purchases A/c 94,080 1,20,000 1,20,000 b) Statement showing amount to be capitalised ` Cash cost of building new main 38,95,000 Add: Value of old material - in the construction of new main 1,05,000 40,00,000 Less: Estimated current cost of replacing old plant (Refer W.N.) (20,00,000) Total amount to be capitalized 20,00,000 PRIME/ME35/IPCC 15

16 ` Replacement A/c Dr. 20,00,000 To Bank 20,00,000 (Being current cost of replacement) ` New Main A/c Dr. 20,00,000 To Bank 18,95,000 To Replacement 1,05,000 (Being additional cost of New Main to be capitalised) Bank A/c Dr. 95,000 To Replacement 95,000 (Being the sale of old materials) Revenue A/c (Refer W.N.) Dr. 18,00,000 To Replacement 18,00,000 (Being the replacement cost to be written off to revenue) Statement showing amount to be written off to Revenue Account Cost of old plant 24,00,000 Replacement of 2/3 portion of old plant (`24,00,000 16,00,000 x 2/3) Add: 25% increase in cost of material and labour 4,00,000 Current cost of old plant 20,00,000 Less: Cost of material used 1,05,000 Cost of material sold 95,000 (2,00,000) Amount to be written off to Revenue A/c 18,00,000 ` c) A Ltd. entered into a binding contract with C Ltd. and therefore, it should recognise a liability of `1,00,000. The entire amount of purchase price of the machine should be recognised in the year ended 31st March, 2009 as loss because future economic benefit from the machine to the enterprise is improbable. The accounting entry should be as follows: ` ` P&L A/c Dr 1,00,000 To C Ltd 1,00,000 (Being value of machinery fully depreciated because of change in the process of production i.e. obsolescence) PRIME/ME35/IPCC 16

17 5) Realisation Account Particulars Amount (`) Particulars Amount (`) To To To To To To To Land and building Furniture and fixtures Stock Debtors Cash A/c (expenses on dissolution) Cash A/c (creditors ` 36,000 + ` 18,000) Cash A/c (Mortgage loan) 2,46,000 By 65,000 By 1,00,000 By 72,500 7,800 54,000 1,10,000 By Sundry creditors Mortgage loan Cash account - Land and building Furniture & fixtures Stock Debtors Partners' capital 36,000 1,10,000 2,30,000 42,000 72,000 65,000 accounts (Loss 4:3:2:1) P = 40,120 1,00,300 Q = 30,090 R = 20,060 S = 10,030 6,55,300 6,55,300 PRIME/ME35/IPCC 17

18 Partners' Capital Accounts Particulars P Q R S Particulars P Q R S ` ` ` ` ` ` ` ` To Balance b/d ,000 18,000 By Balance b/d 1,68,000 1,08,000 To Realization A/c By General (Loss) 40,120 30,090 20,060 10,030 Reserve 38,000 28,500 19,000 9,500 To R's Capital A/c By Capital (Deficiency) 12,636 8, Reserve 10,000 7,500 5,000 2,500 To Cash A/c 2,03,364 1,35, By Cash A/c (realization loss) 40,120 30,090-10,030 By P's Capital A/c 12,636 By Q's Capital A/c 8,424 By Cash A/c 6,000 2,56,120 1,74,090 45,060 28,030 2,56,120 1,74,090 45,060 28,030 Note: P, Q and S brought cash to make good, their share of the loss on realization. However, in actual practice they will not be bringing any cash, only a notional entry will be made. Cash Account Particulars Amount Particulars Amount (`) (`) To Balance b/d 15,500 By Realization A/c: To Realization A/c: Expenses on dissolution 7,800 Land and building 2,30,000 Creditors (36,000+18,000) 54,000 Furniture & fixtures 42,000 Mortgage loan 1,10,000 Stock 72,000 By P's capital A/c 2,03,364 Debtors 65,000 By Q's capital A/c 1,35,576 To P, Q, S's capital A/cs 80,240 (40,120+30,090+10,030) To S's capital A/c 6,000 5,10,740 5,10,740 Working Note: As per Garner Vs. Murray rule, solvent partners have to bear the loss due to insolvency of a partner in their capital ratio. Calculation of Capital Ratio of Solvent Partners P Q S (`) (`) (`) Opening capital 1,68,000 1,08,000 (18,000) Add: General reserve 38,000 28,500 9,500 Capital reserve 10,000 7,500 2,500 2,16,000 1,44,000 (6,000) PRIME/ME35/IPCC 18

19 Though S is a solvent partner yet he cannot be called upon to bear loss on account of insolvency of R because his capital account has a debit balance. Therefore, capital ratio of P & Q = 216 : 144 = 3 : 2 Deficiency of R = ` {(25, ,060) - (19, ,000)} = ` 45,060 - ` 24,000 = ` 21,060. Deficiency of R will be shared by P & Q in the capital ratio of 3 : 2 i.e. P = ` 21,060 X 3/5 = ` 12,636 Q = ` 21,060 X 2/5 = ` 8,424 6)a) Balance Sheet of Dee Ltd. as at 31st March, 2009 Liabilities Amount ` Assets Amount ` Authorised Capital 500,000 Fixed Assets (at cost less 800,000 50,000 Equity shares of `10 each depreciation) Issued and subscribed 370,000 Other current assets 10,00,000 capital 37,000 Equity shares of `10 each fully paid up Reserves & surplus Cash balance (W.N.4) 60,000 General reserve (W.N.2) 480,000 Securities premium (W.N.3) 60,000 Profit and loss A/c 1,00,000 Secured loan 250,000 Current liabilities and provisions 600,000 18,60,000 18,60,000 b) Calculation of number of equity shares issued: I. Number of equity shares issued as right issue (25,000 shares 5) 5,000 shares II Debentureholders who opted for the scheme of conversion into equity shares 2,000 debentureholders opted for the scheme Total value (2,000 debentures `100) `2,00,000 Premium on 5% `10,000 `2,10,000 50% of their holding converted into equity shares `1,05,000 Number of equity shares to be issued to debenture holders `1,05,000/15 7,000 shares Total number of equity shares issued (5, ,000) shares 12,000 shares PRIME/ME35/IPCC 19

20 (c) Cash payment to debenture holders: I. 3,000 Debentureholders preferred cash ` ` Total cash paid to them 3,00,000 Premium on 5% 5,000 3,15,000 II. 2,000 Debentureholders opted for the scheme Total value 2,00,000 Add: Premium on 5% 10,000 2,10,000 50% of their value converted into equity shares 1,05,000 Balance paid to debentureholders in cash 1,05,000 Total cash paid to debentureholders 4,20,000 Working notes Calculation of Securities Premium Number of equity shares of `10 issued at `15 per share 12,000 shares Security premium per share `5 Total securities premium (12,000 shares x `5) `60,000 Cash Account Particulars Amount(`) Particulars Amount(`) To Balance b/d 250,000 By Proposed dividend 25,000 To Equity shareholders (5,000 15) 75,000 By Debenture holders (`1,05,000+`3,15,000) 420,000 To Sale of Debenture Redemption Reserve Investment 180,000 By Balance c/d 60,000 5,05,000 5,05,000 Debenture redemption reserve account Particulars Amount (`) Particulars Amount (`) To Premium on redemption of debentures (15, ,000) 25,000 By Balance B/d 250,000 To Loss on sale of Debenture Redemption Reserve Investment To General Reserve 20, , , ,000 PRIME/ME35/IPCC 20

21 7) Jawahar Bank Limited Profit & Loss Account for the year ended 31st March, 2011 I. Income ` '000s Interest earned Other income Total II. Expenditure Interest expended Operating expenses Provisions & contingencies (Refer W.N.) Total III. Profit/Loss ( ) IV. Appropriations Nil Schedule 13 - Interest Earned ` '000s Interest / discount on advances bills Interest on term loans [ ( )] Interest on cash credits and overdrafts ( ) Income from investments PRIME/ME35/IPCC 21

22 Commission, exchange and brokerage Profit on sale of investments Profit on revaluation of investments Schedule 14 - Other Income ` '000s Interest on deposits Schedule 15 - Interest Expended Schedule 16 - Operating Expenses ` '000s ` '000s Payments to and provision for employees - salaries, bonus and allowances Rent, taxes and lighting Printing & stationery Director's fee, allowances and expenses Law charges Repairs & maintenance Insurance Working Note: Sl# Particulars % Amount ` 1 Substandard Doubtful one year 20% Doubtful two year 30% Loss 100% 0.65 Total Dimunition in value of investments 1875 Grand Total Note: It is assumed that all sub-standard and doubtful assets are fully secured. PRIME/ME35/IPCC 22

23 PRIME/ME35/IPCC 23

24 GANE No of Pages: 2 Total Marks: 100 No.of Questions: 7 Time Allowed: 3 Hours Question No.1 is compulsory Answer any 5 from the remaining questions 1. a) Explain the relationship between Materiality and Audit Risk 5 Marks b) X limited has received a government grant of ` 30 lacs relating to specific fixed asset. As an auditor suggest suitable methods for accounting government grant in the books of account of X limited. 5 Marks c) Should the branch auditor of a company comply with the request of the principal auditor of the company to give photocopy of the working papers pertaining to the branch audit Explain 5 Marks d) Comment on the following: XYZ & Co., is a chartered accountant firm having Mr. x, Mr. Y and Mr. Z as partners and It has been appointed as auditors of 45 companies. As Mr. Y and Mr. Z are busy handling other assignments Mr. X conducted the audit of all 45 companies and signed the audit reports of all companies 5 Marks 2. a) Briefly discuss how the audit is advantageous to Sole Trader? 8 Marks b) As an auditor, comment on the following: (i) The first auditors of Health & Wealth limited, a Government company, was appointed by the Board of Directors. (ii) The board of directors of X limited removed the first auditors appointed in the general meeting and appointed another firm of chartered accountants as auditors. 2x 4 =8 Marks 3. a) (i) Comment on the Interest on share capital was paid to the shareholders as the company had a long gestation period before it could become operational 4 Marks (ii) Write short notes on powers of C & AG under section 619(3) of the Companies Act, 1956 in relation to audit of government company 4 Marks b) What are the inherent limitations of internal controls? 8 Marks 4. a) State whether CARO, 2003 is applicable to the following companies: Particulars A private limited ` B private limited ` Paid up Capital - Equity 15,00,000 30,00,000 - Preference 15,00,000 Nil Loan outstanding from banks: - Short term loans 12,00,000 27,00,000 - Long term loans 15,00,000 Turnover 4 Crores 2 Crores Period of operations 1 year 3 months PRIME/ME35/IPCC 1 8 Marks b) State any ten areas where different accounting policies may be encountered 8 Marks 5. a) How will you vouch/verify the following: (i) Recovery of bad debts written off 4 Marks (ii) Discounted bills receivable dishonored 4 Marks

25 b) As an auditor, comment on the following: (i) X limited is good in profits, but suffers temporarily in liquidity. It proposes to declare dividend of 10% in annual general meeting, but the Board proposes to defer payment of dividend by two months from the date of annual general meeting by getting a resolution passed in AGM 4 Marks (ii) A portion of share premium is utilized to declare 40% dividend 4 Marks 6. a) Mention the special steps involved in the audit of an Education institution 12 Marks b) Doing an audit in an EDP environment is simpler since the trial balance always tallies Analyse critically. 4 Marks 7. Write short notes on any four of the following: (a) Cut-off procedure (b) Examination in depth (c) Management representation (d) Statutory Report (e) Financial indications to be considered for evaluating the assumption of going concern 4 x 4 = 16 Marks PRIME/ME35/IPCC 2

26 PRIME ACADEMY 35 th SESSION MODEL EXAM - IPCC AUDITING AND ASSURANCE SUGGESTED ANSWERS 1. (a) Relationship between materiality and audit risk: SA 320 on Materiality in Planning and Performing an Audit requires that the auditor should consider materiality and its relationship with audit risk when conducting an audit. Materiality depends on the size and the nature of the items judged in the particular circumstances of its misstatement. The audit should be planned so that audit risk is kept at an acceptably low level. There is an inverse relationship between Materiality and the degree of audit risk. Higher the materiality levels the lower the audit risk and vice-versa. After the auditor has assessed the inherent and control risks, he should consider the level of detection risk that he is prepared to accept and, based upon his judgment, select appropriate substantive audit procedures. If the auditor does not perform any substantive procedures, detection risk, that is, the risk that the auditor will fail to detect a misstatement, will be high. The auditor s assessment of audit risk may change during the course of an audit according to the need and development of the circumstances. (b) Accounting for government grants relating to specific fixed assets: AS 12 (Accounting for Government Grants) lays down the accounting treatment for government grants. Two methods of presentations in financial statements of grants (or the appropriate portions of grants) related to specific fixed assets are regarded as acceptable alternatives. Under one method, the grant is shown as a deduction from the gross value of the asset concerned in arriving at its book value. The grant is thus recognised in the profit and loss statement over the useful life of a depreciable asset by way of a reduced depreciation charge. Where the grant equals the whole, or virtually the whole, of the cost of the asset, the asset is shown in the balance sheet at a nominal value. Under the other method, grants related to depreciable assets are treated as deferred income which is recognised in the profit and loss statement on a systematic and rational basis over the useful life of the asset. Such allocation to income is usually made over the periods and in the proportions in which depreciation on related assets is charged. (c) Sharing of audit working papers: As per SA 230 Audit Documentation, working papers are the property of the auditor. He may at his discretion, make available portions or extracts from his working paper to his client. The auditor should adopt reasonable procedures for custody and confidentiality of his working papers. An auditor is not required to provide the clients or other auditors access to his working papers. Main auditor of the company does not have right of access to the working papers of the branch auditor. In the case of a company, the main auditor has, to consider the report of the branch auditor and has a right to seek clarification and to visit the branch but cannot ask for the copy of working paper and therefore, the branch auditor is under no compulsion to give photocopies of his working paper to the principal auditor. (d) Signing of audit reports: As per section 224(1B) of the Companies Act, no company or its Board of Directors shall appoint/re-appoint any person or firm as its auditor if such person or firm, at the date of such appointment or re-appointment, holding appointment as auditor of specified number of companies or more than the specified number of companies. Specified number of companies shall mean twenty companies of which not more than 10 shall be companies having paid up share capital of `25 lacs or more. As per section 229 of the Companies Act, where a firm has been appointed as auditor of the company, any partner in the firm practising in India, may sign the auditor s report, or sign or authenticate any other document of the company required by law to be signed or authenticated by the auditor. Thus, the ceiling limit prescribed in section 224(1B) is only with regard to appointment of auditors and not for signing the audit reports; In the given case, all 45 audit reports signed by Mr. X are valid. PRIME/ME35/IPCC 3

27 2. (a) Advantages of Audit to a Sole Trader: Although sole traders are not required by any law (except u/s 44AD, 44AE, 44AB and other provisions of the Income-tax Act, 1961) to have their accounts audited, yet it has become customary for many of them, who derive their large incomes from numerous sources and whose expenditure is vast and varied, to get their accounts audited. Also, sole traders get their financial statements audited due to regulatory requirements, such as stock brokers or on specific instructions of the bank for approval of loans, etc. The sole trader can determine the scope of the audit as well as the conditions under which it will be carried out. For example, he can stipulate that only a partial audit shall be carried out or certain parts of the accounts shall not be checked. It will also be decided that the audit will be carried out continuously or at the end of the year. Thus, the duties and the nature of auditor s work will depend upon the agreement that he has entered into with the sole trader. But he must obtain clear instructions from his clients in writing as to what he is expected to do. The following are some of the advantages that can be derived from an audit of this nature: a. The individual is assured of having his accounts properly maintained and his expenditure vouched. b. He is also assured of not being defrauded by the accountant and his agents. Even if they have done some defalcations, etc. these may be discovered by the auditors. c. The audited accounts are reliable and are generally accepted by the Income tax Department and hence, individuals do not feel any difficulty for taxation assessments, etc. d. The audited accounts of a deceased are very helpful for executors and administrators. (i) Appointment of first auditors of a Government Company: Section 224(5) of the companies Act, 1956 lays down that the first auditor or auditors of a company shall be appointed by the board of directors within one month of the date of registration of the company. Notwithstanding anything contained in section 224(5), in case of Government Company, the appointment or reappointment of auditors is governed by the provisions of section 619 of the Companies Act, 1956 according to which the auditors of a Government Company shall be appointed by the Comptroller and Audit General of India. Hence in the case of M/s health and Wealth Ltd. Being a government company, the first auditor shall be appointed by the CAG of India. The appointment of first auditors made by the Board of Directors of M/s. Health and Wealth Limited is null and void. (ii) Removal of first auditor appointed in the general meeting: As per section 224(5) of the Companies Act, the first auditor or auditors of a company shall be appointed by the Board of Directors within one month from the date of registration of the company, and the auditor or auditor so appointed shall hold office until the conclusion of the first annual general meeting. The auditor or auditors so appointed may be removed by the company at a general meeting. However if the auditor is appointed at the general meeting, the provisions of section 224(7) will become operative. As per section 224(7), any auditor or auditors appointed may be removed from office before the expiry of his term only by the company in general meeting, after obtaining the previous approval of the central government. Thus, the removal of first auditors appointed in the general meeting of X limited is null and void 3. (a) (i) Payment of interest out of capital: Section 208 of the Companies Act, 1956 permits payment of interest to shareholders out of capital, where there is a long gestation period. Payment of interest on capital is, however, capitalised as part of cost of construction of the project. The auditor should ensure that following conditions have been complied whenever such interest has been paid: a) Payment is authorised by the Articles or by special resolution of shareholders in general meeting; b) Payment is approved by the Central Government; c) It is paid only for the period determined by the Central Government not exceeding six months after the halfyear in which the project has been completed. d) The rate shall not exceed 12% p.a. or such other rate as may be prescribed by the Government. e) The payment of interest shall not operate as a reduction of the amount paid-up on the shares in respect of which it is paid. PRIME/ME35/IPCC 4

28 (ii) Power of CAG under section 619 (3) : In the case of audit of government company the Comptroller and Auditor General of India have the following powers under section 619 (3) of the Companies Act, a) To direct the manner in which the company s account shall be audited by the auditor and to give such instructions in regard to any matter relating to the performance of his function as auditor. b) To conduct a supplementary or test audit of the company s account by such person or persons as he may authorize in this behalf; and for the purpose of such audit, to require information or additional information to be furnished to person or persons so authorized, on such matters, by such person or persons and in such form, as the CAG may be general or special order, direct. (b) Inherent limitations of internal controls: a) Managements consideration that a control should be cost effective. b) The fact that the most controls do not tend to be directed at transactions of unusual nature c) Potential for human error d) Possibility of circumvention of controls through collusion with parties outside the entity or with employees of entity e) Possibility that a person responsible for exercising control could abuse that authority f) Possibility that controls could become inadequate due to changes in conditions and compliances with procedures may deteriorate g) Manipulations by management with respect to transactions or estimates and judgements required in the preparation of the financial statements 4. a) CARO 2003 is not applicable to the following private limited companies: Companies with a paid up capital and reserves not more than ` 50 lacs and Companies which does not have loan outstanding exceeding `25 lacs from any bank or financial institution and Companies which does not have a turnover exceeding `5 crore at any point of time during the financial year. In the given case Company A and B both are having paid up share capital of `30 lacs hence the first condition is not satisfied. However both the companies have loan outstanding of `27 lacs which is above the limit prescribed. Hence CARO,2003 will be applicable to both the companies irrespective of their turnover. b) Areas in which different accounting policies may be encountered are:- a. Method of depreciation, depletion and amortization-straight Line Method, Written Down Value method. b. Treatment of expenditure during construction i.e., write off, capitalization, deferment. c. Conversion or translation of foreign currency items average rate, actual, TT buying rate etc. d. Valuation of inventories FIFO, LIFO, weighted average etc. e. Treatment of goodwill write off, retain. f. Valuation of investment at cost, market or net realizable value etc. g. Recognition of profit on long term contracts year to year, % of completion etc. h. Treatment of retirement benefits-actuarial, funded through trust, insurance policy etc. i. Treatment of contingent liabilities j. Valuation of fixed assets-historical cost, revaluation price, exchange fluctuation etc. Note: (The above list is not exhaustive. There may be other examples as well.) 5. a) (i) Vouch / Verify- Recovery of bad debts written off: Check all corresponding and proper authorization of bad debts written off earlier and ensure that the decision of writing off of bad debts was recorded properly. Ascertain total bad debts and see whether all recovery of bad debts is recorded properly in the books of account and deposited into bank. Check all notifications from court or bankruptcy trustee and all correspondence from debtors and collecting agencies. Check credit managers files for amount recovered and confirm acknowledgement. (ii) Discounted Bills receivable dishonoured: Obtain the schedule of discounted bills receivable dishonoured. Check the entry in bank statement regarding the amount of bills dishonoured and see that the bank has debited the account of client Verify the bills receivable returned by the bank along with banks advice PRIME/ME35/IPCC 5

29 See that the dishonoured bills have been noted and protested by following the proper procedure and the account of the drawee or the debtor is also debited. Check that bank commission, if any, charged by the bank has been recovered from the party. (b) (i) Deferment of dividend Sec. 205A Provides that, dividend once declared cannot be revoked. In the present case, X limited has not declared the dividends so far, only the board proposed to recommend declaration of 10% dividend in AGM but in view of liquidity problem it proposes to defer the payment of dividend by two months from the date of AGM by getting a resolution passed in AGM. Conclusion: Till date it is only a proposal and resolution has not been passed by the shareholders. Therefore, in such case, X Limited may declare dividends in a subsequent general meeting. (ii) Utilisation of share premium Sec 78 of the companies Act, 1956 deals with application of premium received on issue of shares. Accordingly, securities premium account may be applied by the company: In paying up unissued shares of the company into be issued to members of the Company as fully paid bonus shares. In writing of the Preliminary expenses of the company; In writing of the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures of the company; or In providing for the premium payable on the redemption of any redeemable Preference shares or of any debentures of the company. Thus, it is clear from the above that share premium can be utilised only for specific purposes. Further, section 205 of the companies act, 1956 also specifies the sources from which dividends can be paid and requires the same to be only paid out of past profits, general reserve or any other free reserve. Conclusion: Declaration of dividends out of share premium is not proper and consequently the auditor shall have to qualify the audit report. 6 a) The special steps involved in the audit of an educational institution are the following: a) Examine the Trust Deed or Regulations in the case of school or college and note all the provisions affecting accounts. In the case of a university, refer to the Act of Legislature and the Regulations framed thereunder. b) Read through the minutes of the meetings of the Managing Committee or Governing Body, noting resolutions affecting accounts to see that these have been duly complied with, specially the decisions as regards the operation of bank accounts and sanctioning of expenditure. c) Check names entered in the Students Fee Register for each month or term, with the respective class registers, showing names of students on rolls and test amount of fees charged; and verify that there operates a system of internal check which ensures that demands against the students are properly raised. d) Check fees received by comparing counterfoils of receipts granted with entries in the cash book and tracing the collections in the Fee Register to confirm that the revenue from this source has been duly accounted for. e) Total up the various columns of the Fees Register for each month or term to ascertain that fees paid in advance have been carried forward and the arrears that are irrecoverable have been written off under the sanction of an appropriate authority. f) Check admission fees with admission slips signed by the head of the institution and confirm that the amount had been credited to a Capital Fund, unless the Managing Committee has taken a decision to the contrary. g) See that free studentship and concessions have been granted by a person authorised to do so, having regard to the prescribed Rules. h) Confirm that fines for late payment or absence, etc., have either been collected or remitted under proper authority. i) Confirm that hostel dues were recovered before students accounts were closed and their deposits of caution money refunded. j) Verify rental income from landed property with the rent rolls, etc. k) Vouch income from endowments and legacies, as well as interest and dividends from investment; also inspect the securities in respect of investments held. l) Verify any Government or local authority grant with the relevant papers of grant. If any expense has been disallowed for purposes of grant, ascertain the reasons and compliance thereof. m) Report any old heavy arrears on account of fees, dormitory rents, etc, to the Managing Committee. n) Confirm that caution money and other deposits paid by students on admission have been shown as liability in the balance sheet and not transferred to revenue. PRIME/ME35/IPCC 6