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2 PAPER 1 : FINANCIAL REPORTING Question No.1 is compulsory. Candidates are also required to answer any five questions from the remaining six questions. Working notes should form part of the respective answers. Wherever necessary, candidates are permitted to make suitable assumptions which should be disclosed by way of a note. Question 1 (a) From the given information, you are required to compute the deferred tax assets and deferred tax liability for Ramanujam Limited as on 31 st March The tax rate applicable is 35%. (i) The company has charged depreciation of ` 7,42,900 in its books of accounts while as per income-tax computation, the depreciation available to the company is ` 8,65,400. (ii) The company has made provision for doubtful debts for ` 54,300 during the year. (iii) The company has debited share issue expenses of ` 6,23,500 which will be available for deduction under the Income-tax Act from the next year. (iv) The expense of ` 7,84,500 has been charged to profit and loss account which are disallowed under the Income-tax Act. (v) The company has made donation of `2,00,000 which has been debited to profit and loss account and only 50% thereof will be allowed as deduction as per Income-tax law. (b) ABC Limited has three segments viz. A, B and C. The total assets of the company is ` 15 crores. The assets of Segment A is ` 1.85 crores, Segment B is ` 6.15 crores and Segment C is ` 7.00 crores. Assets of each segment include deferred tax assets of ` 0.50 crores in A, ` 0.40 crores in B and ` 0.30 crores in C. The accountant of ABC Limited contends that all segments are reportable segments. Based on segment assets criteria, determine the veracity of the contention of the accountant. (c) Sunny Limited, is developing a new production process. During the financial year ended 31 st March 2013, the company has incurred total expenditure of ` 40 lacs on the process. On 1 st December, 2012, the process has met the norms to be recognized as intangible assets and the expenditure incurred till that date is ` 16 lacs. During the financial year ending on 31 st March 2014, the company has further incurred ` 70 lacs. The recoverable amount as on 31 st March 2014 of the process is estimated to be ` 62 lacs. You are required to work out: (i) Expenditure to be charged to profit and loss account for the financial year ending on 31 st March 2013 and 31 st March (ignore depreciation)

3 (d) (ii) Carrying amount of the 'Intangible asset' as at 31 st March 2013 and 31 st March XYZ Limited is having the following Fixed Deposit Receipts: Answer Date of FDR Maturity Date Amount (`) Axis Bank Limited 01 January, April, ,00,000 Punjab National Bank 01 January, June, ,00,000 State Bank of India 28 February, May, ,00,000 ICICI Bank 31 January, January, ,00,000 Prepare 'Notes to accounts showing the above deposits in accordance with the requirements of Revised Schedule VI. (4 x 5 = 20 Marks) (a) Statement showing calculation of Deferred Tax Asset (DTA) and Deferred Tax Liability (DTL) S. No. (i) Particulars Excess allowable depreciation as per income-tax law (ii) Provision for doubtful debts - disallowed as per income-tax law (iii) (iv) (v) Share issue expenses charged in the accounting books but allowed as deduction in the income-tax from the next year Disallowed expenses as per income tax Donation debited to Profit & Loss Account Amount of difference Nature of difference 35% 35% ` ` ` 1,22,500 Timing - 42,875 54,300 Permanent - - 6,23,500 Timing 2,18,225-7,84,500 Permanent - - Allowed as per income tax 1,00,000 No difference - - Disallowed as per income tax 1,00,000 Permanent - - 2,18,225 42,875 PS: Read Revised Schedule VI as Schedule III.

4 (b) Statement showing percentage of Segment net assets to Total assets of the company ` in crores Particulars Segments A B C Total Segment assets Less: Deferred tax assets (0.50) (0.40) (0.30) (1.20) Net segment assets Percentage to total net segment assets 9.78% 41.67% 48.55% 100% As per AS 17 Segment Reporting, one of the basis of segment asset criteria for identification of a business segment or geographical segment as a reportable segment is when its segment assets are 10% or more of the total assets of all segments. Accordingly, the reportable segments will be segments B and C only. Therefore, the contention of the accountant that all the segments are reportable segments is not tenable. (c) Statement showing amount to be charged to Profit and Loss Account and Carrying Amount of an intangible asset ` in lacs S. No. (i) (ii) Details For the year For the year ending on ending on 31 st March, st March, 2014 Expenditure to be charged to Profit and Loss account (W.N. 2) Carrying amount of an intangible asset (W.N. 1) Working Notes: 1. Carrying amount as on 31 st March, 2013 will be the expenditure incurred after 1 st December, 2012 till 31 st March, 2013 ` in lacs Total expenditure incurred 40 Less: Expenditure incurred till 1st December, 2012 to be expensed off (16) Expenditure incurred from to to be capitalised Total cost of an intangible asset till ` in lacs Capitalised cost as on Add: Further capitalised cost till Total book cost of an intangible asset till

5 3. Impairment loss ` in lacs Book cost as on (W.N.2) 94 Less: Recoverable amount as estimated on (62) Difference to be charged to Profit and Loss account as impairment loss 32 Therefore, carrying amount as on = ` 94 lacs ` 32 lacs = ` 62 lakhs. (d) Notes to Accounts S. No. Particulars Amount in ` 1. Other non-current assets 2. Current assets FDR of Axis Bank Limited 10,00,000 Cash and bank balances (See Note) (a) Cash and cash equivalents FDR of State Bank of India 10,00,000 (b) Other bank balances FDR of ICICI Bank 10,00,000 FDR of Punjab National Bank 15,00,000 35,00,000 Note: The above Notes to Accounts have been prepared on the basis of the Guidance Note on Revised Schedule VI to the Companies Act, It states that in case of bank deposits having maturity of more than 3 months but upto 12 months, the heading Cash and cash equivalents should be changed to Cash and bank balances which may have two sub-headings viz Cash and cash equivalents and Other bank balances. Since AS will prevail over Schedule and as per AS 3, an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. Therefore, even if the remaining maturity of FDR from reporting date is 3 months or less but its original maturity is more than 3 months from the date of acquisition it will be shown under the sub-heading Other Bank Balances. It also states that bank deposits having maturity of more than 12 months should be shown under the heading Other non-current assets. Assumption: It is assumed that the FDR having maturity of more than 12 months from the reporting date i.e are restricted from being exchanged or used to settle a liability for at least twelve months after the reporting date. Now Schedule III to the Companies Act, 2013.

6 Working Notes: Question 2 Amount in ` Date of FDR Maturity date Maturity months from the reporting date i.e Axis Bank Limited 10,00, Punjab National Bank 15,00, State Bank of India 10,00, ICICI Bank 10,00, ,00,000 The summarised Balance Sheets of 'S' Limited and 'H' Limited as on 30 th June 2014 were as follows: ` in crores Equity and Liabilities S Limited H Limited Equity Share Capital Reserves and Surplus Non-Current Liabilities 10%, 25,00,000 Debentures of ` 100 each 25 Other non-current liabilities 120 Current Liabilities Assets Total Fixed Assets (At cost) Less: Depreciation (100) 100 (50) 25 Investment in H Limited 2 Crores Equity shares of `10 each at cost 32 10%, 25,00,000 Debentures of ` 100 each at cost Current Assets Total In a duly approved scheme of absorption, 'S' Limited took over the assets of 'H' Limited at an agreed value of ` 330 crores and the liabilities were taken over at book value. Other shareholders of 'H' Limited were allotted equity shares in 'S' Limited at a premium of ` 90 per share in satisfaction of their claim. 'S' Limited valued the fixed assets taken over at

7 ` 40 crores and all other assets and liabilities were recorded at book value. The scheme of absorption was completed on 1 st July You are required to: (a) Pass necessary Journal Entries in the books of 'S' Limited to record the transactions. (b) Prepare the Balance Sheet of 'S' Limited after absorption in the Revised Schedule VI format along with Notes to accounts. (16 Marks) Answer (a) Journal Entries in the books of S Limited (` in crores) Dr. Cr. 1. Business Purchase Account (W.N.1) Dr. 105 To Liquidator of H Ltd. 105 (Being business purchased from H Ltd.) 2. Fixed Assets Account Dr. 40 Current Assets Account Dr. 300 To 10% Debentures Account 25 To Current Liabilities Account 200 To Business Purchase Account 105 To Capital Reserve Account 10 (Being incorporation of various assets and liabilities taken over from H Ltd. at agreed values) 3. 10% Debentures of H Ltd. Account Dr. 25 To Investment in 10% Debentures of H Ltd. 24 To Capital Reserve Account 1 (Being offsetting of 10% debentures held as liability as well as investment in debentures of H Ltd. and transferring the difference to capital reserve) 4. Liquidator of H Ltd. Account Dr. 21 To Equity share capital Account 2.10 To Securities Premium Account (Being discharge of purchase consideration to outside shareholders of H Ltd.) PS: Read Revised Schedule VI as Schedule III.

8 5. Liquidator of H Ltd. 84 To Investment in Equity shares of H Ltd. 32 To Capital Reserve Account 52 (Being Investment in H Ltd. cancelled and the resultant profit transferred to capital reserve account) (b) Balance Sheet of S Ltd. as at 1 st July, 2014 (after absorption) Particulars I. Equity and Liabilities II. (1) Shareholder's Funds Note No. (` in crores) (a) Share Capital (b) Reserves and Surplus (2) Non-current Liabilities Other non-current liabilities (3) Current Liabilities ( ) Assets 1,240 (1) Fixed assets ( ) (2) Current assets ( ) 6 1,100 Total 1,240 Notes to Accounts 1. Share Capital (` in crores) 8.21 crores equity shares of ` 10 each (Out of the above, 0.21 crores equity shares has been issued for consideration other than cash) 2. Reserves and Surplus As already shown in the S Ltd. s balance sheet 400 Capital Reserve ( ) 63 Securities Premium Other non- Current liabilities S Limited Current Liabilities

9 S Limited 356 Add: taken over from H Limited Fixed assets S Limited 100 Add: taken over from H Limited Current assets S Limited 800 Add: taken over from H Limited 300 1,100 Working Notes: 1. Calculation of Purchase consideration to outside shareholders of H Ltd. (` in crores) Assets of H Ltd. taken over at agreed value 330 Less: Liabilities taken over at 10% Debentures 25 Current liabilities 200 (225) Net assets of H Ltd./Purchase consideration 105 Less: Shares held by S Ltd. (80%) (84) Payable to outside ` ( ) 21 Number of Equity Shares to issued 21/100 = 21,00,000 lacs Nominal value of Equity shares of S Ltd. paid to outside shareholders (21/100 x 10) 2.10 Securities premium (21/100 x 90) Question 3 'HIM' Limited is a company carrying on the business of beauty products and is having a subsidiary 'SIM' Limited. Their Balance-sheets as on 31 st March 2014 were as under: HIM Limited (`) SIM Limited (`) Equity and Liabilities Shareholders Funds Share Capital 25,00,000 5,80,000 Reserves and Surplus General Reserve 2,00,000 1,20,000 Profit and Loss Account 3,12,500 2,05,000

10 Current Liabilities Assets Trade Payables 4,55,000 2,35,500 Bills Payables 28,000 83,000 Non-Current Assets Total 34,95,500 12,23,500 Fixed Assets 21,70,000 6,25,000 Investments 4060 Shares in SIM Limited 5,10,000 - Current Assets Inventories 4,80,000 3,19,200 Trade Payable 1,80,000 1,64,000 Bills Receivable 68,000 1,00,000 Cash and Bank Balance 87,500 15,300 HIM Limited has also given the following information: (i) 34,95,500 12,23,500 HIM Limited has acquired the shares in SIM Limited in two lots on two different dates. The relevant information at the time of acquisition of shares was as under: No. of shares acquired Balance in General Reserve Balance in Profit and Loss Account 1 st acquisition ,000 25,000 IInd acquisition ,000 1,02,000 (ii) Bills Receivables of HIM Limited includes `15,000 being acceptance from SIM Limited. (iii) Both the companies have declared dividends of 10% for the year ended on 31 st March 2014, but it has not been provided in the books of accounts. (iv) SIM Limited's inventory includes stock of ` 1,45,000 purchased from HIM Limited. HIM Limited sells goods at mark up of 25% on its cost. Prepare the Consolidated Balance Sheet of HIM Limited along with 'Notes to accounts. (16 Marks)

11 Answer Consolidated Balance Sheet of Him Ltd. and its subsidiary Sim Ltd. as on 31 st March, 2014 Particulars Note No. ` I. Equity and Liabilities (1) Shareholder's Funds Share Capital 1 25,00,000 Reserves and Surplus 2 3,79,300 (2) Minority Interest (W.N.2) 2,54,100 (3) Current Liabilities Trade payable 3 7,86,500 Short term Provisions 4 2,67,400 Total 41,87,300 II. Assets (1) Fixed Assets Tangible assets (21,70, ,25,000) 5 27,95,000 Intangible assets 6 22,300 (2) Current assets Inventories 7 7,70,200 Trade Receivables 8 4,97,000 Cash and Cash equivalents (87,500+15,300) 9 1,02,800 Total 41,87,300 Notes to Accounts 1. Share Capital Authorised, issued, Subscribed and Paid up 25,000 Equity shares of ` 100 each 25,00,000 ` 2. Reserves and Surplus General Reserve (W.N.4) 2,27,500 Profit & Loss Account (W.N.4) 1,51,800 3,79,300

12 3. Trade payables Trade Payables Him Ltd. 4,55,000 Sim Ltd. 2,35,500 6,90,500 Bills payable Him Ltd. 28,000 Sim Ltd. 83,000 Less: Mutual owings (15,000) 68,000 96,000 7,86, Short term provisions Proposed dividend Him Ltd. 2,50,000 Minority Interest 17,400 2,67, Tangible assets Him Ltd. 21,70,000 Sim Ltd. 6,25,000 27,95, Intangible assets Goodwill (W.N.3) 22, Inventories Him Ltd. 4,80,000 Sim Ltd. 3,19,200 7,99,200 Less: Unrealised profit (29,000) 7,70, Trade Receivables Trade Receivables Him Ltd. 1,80,000 Sim Ltd. 1,64,000 3,44,000 Bills Receivable Him Ltd. 68,000 Less: Mutual owings (15,000) 53,000 Sim Ltd. 1,00,000 1,53,000 4,97,000

13 9. Cash and Cash equivalents Him Ltd. 87,500 Sim Ltd. 15,300 1,02,800 Working Notes: 1. Analysis of Profits Pre-acquisition Profits General Reserve General Reserve 80,000 40,000 Post acquisition Profit & Loss Account ` ` ` Profit & Loss Account 25,000 1,80,000 For Lot 1 (A) 1,05,000 40,000 1,80,000 Pre-acquisition for Lot 2 General Reserve (85,000 80,000) 5,000 Profit & Loss Account (1,02,000-25,000) 77,000 Post acquisition for Lot 2 35,000 1,03,000 Him Ltd. (70%) of (A) 73,500 28,000 1,26,000 Adjustment of pre-acquisition General Reserve for Lot 2 (10%) 500 (500) Adjustment of pre-acquisition Profit & Loss Account for Lot 2 (10%) 7,700 (7,700) Him Ltd. 81,700 27,500 1,18,300 Minority Interest (30%) of (A) 31,500 12,000 54, Minority Interest Share Capital (30%) 1,74,000 Add: Share of pre-acquisition profit of Sim Ltd. 31,500 Share of post-acquisition General Reserve 12,000 Share of post-acquisition Profit & Loss Account 54,000 ` 2,71,500 Less: Share of Proposed Dividend (17,400) 2,54,100

14 3. Cost of Control/Goodwill Cost of investments 5,10,000 Less: Share capital (70%) (4,06,000) Share of pre-acquisition profit (81,700) Goodwill 22, Consolidated General Reserve & Profit and Loss Account General Reserve Profit and Loss Him Ltd. 2,00,000 3,12,500 Less: Dividend declared by Him Ltd. (2,50,000) Less: Unrealised profit (29,000) ` ` ` 2,00,000 33,500 Add: Share in post-acquisition item of Sim Ltd. 27,500 1,18,300 2,27,500 1,51,800 Note: Proposed dividend relating to Minority Interest viz ` 17,400 shown above as part of Short term provisions can also be shown as part of Minority interest. In that case, the amounts shown in the Consolidated Balance Sheet under Minority Interest (` 2,54,100) and Short term provision (` 2,67,400) would be changed to ` 2,71,500 and ` 2,50,000 respectively. Question 4 (a) Virtual Limited granted on 1 st April 2011, 1,00,000 Employees Stock Options at ` 40, when the market price was ` 60. These options will vest at the end of year 1, if the earnings of Virtual Limited is more than 15% or it will vest at the end of the year 2, if the average earnings of two years is more than 12% or lastly it will vest at the end of third year, if the average earnings of 3 years will be 9% or more unvested options lapsed on 31 st March unvested options lapsed on 31 st March 2013 and finally 3000 unvested options lapsed on 31 st March The earnings of Virtual Limited was as follows: Year ended on Earnings in % % % %

15 (b) Employees exercised for 85,000 stock options which vested in them at the first opportunity and the balance options were lapsed. Pass necessary journal entries and show the necessary working. (12 Marks) Adventure Limited issued 20,000, 9% convertible debentures of ` 100 each at par at the beginning of the year. The debentures are of 6 years term. The interest will be paid half yearly. The debenture-holders have the option to get 50% of the debentures converted into 2 ordinary shares at the end of 3 rd year. The debenture holders who do not opt for conversion will be paid 50% of their face value at the end of year 3. The balance nonconvertible portion will be repaid at 10% premium at the end of term of the debenture. At the time of issue, the prevailing market interest rate for similar debt without convertibility option is 10%. Present Value of annuity is as under: Period (half yearly) Annuity 10% Annuity 5% Present value of ` 1 at the end of 3 years at 10% and 5% is and respectively. Present value of ` 1 at the end of 6 years at 10% and 5% is and respectively. Compute the liability component and equity component and pass necessary journal entries recognizing the issue of debentures. (4 Marks) Answer (a) Journal Entries Date Particulars ` ` Employees compensation expense A/c Dr. 9,40,000 To ESOS outstanding A/c 9,40,000 (Being compensation expense recognized in respect of the 94,000 ESOs granted at a discount of ` 20 each, amortised on straight line basis over vesting years - Refer W.N.) Profit and Loss Account Dr. 9,40,000 To Employees compensation expense A/c 9,40,000 (Being compensation expense charged to Profit & Loss A/c) Employees compensation expense A/c Dr. 2,40,000 To ESOS outstanding A/c 2,40,000 (Being compensation expense recognized in respect of the 88,500 ESOs - Refer W.N.)

16 Profit and Loss Account Dr. 2,40,000 To Employees compensation expense A/c 2,40,000 (Being compensation expense charged to Profit & Loss A/c) Employees compensation expense A/c Dr. 5,30,000 To ESOS outstanding A/c 5,30,000 (Being compensation expense recognized in respect of the 85,500 ESOs Refer W.N.) Profit and Loss A/c Dr. 5,30,000 To Employees compensation expense A/c 5,30,000 (Being compensation expense charged to Profit & Loss A/c)??? Bank A/c (85,000 x ` 40) Dr. 34,00,000 ESOS outstanding A/c [(17,10,000/85,500) x 85,000] Dr. 17,00,000 To Equity share capital (85,000 x ` 10) 8,50,000 To Securities premium A/c (85,000 x ` 50) 42,50,000 (Being 85,000 ESOs exercised)??? ESOS outstanding A/c Dr. 10,000 To General Reserve A/c 10,000 (Being ESOS outstanding A/c transferred to General Reserve A/c, on lapse of 500 options at the end of the exercise period) Working Note: Statement showing compensation expenses to be recognised Particulars Year 1 ( ) Expected vesting period (at the end of the year) Number of options expected to vest Total compensation expenses ` 20 (i.e ) Compensation expenses of the year Year 2 ( ) Year 3 ( ) 2 nd year 3 rd year 3 rd year 94,000 options 88,500 options 85,500 options ` 18,80,000 ` 17,70,000 ` 17,10,000 (18,80,000 x 1/2) ` 9,40,000 (17,70,000 x 2/3) ` 11,80,000 ` 17,10,000 Compensation expenses recognized previously Nil ` 9,40,000 ` 11,80,000 Compensation expenses to be recognized for the year ` 9,40,000 ` 2,40,000 ` 5,30,000

17 (b) Statement showing computation of equity and liability component Half-year period Cash Flow Discounting Factor ` in 000s (5%) Present Value ` in 000s * , Value of host (Liability component) 1, Value of embedded derivative (Equity component) Issue proceeds 2, * = Question 5 Journal Entries Debit Bank A/c Dr. 2, ` in 000s Credit To Liability component 1, To Equity component (Being issue of debentures recorded at fair values) The majority shareholders of MSL Limited desire to sell their holding to Influx Funds. The following information has been provided by MSL Limited: ` in lacs Particulars Equity and Liabilities 12,000 Equity shares of ` 100 each General Reserve Profit and Loss Account Current Liabilities Assets Tangible Assets

18 Intangible Assets Goodwill Current Assets Inventories Other Current Assets (i) The valuation of tangible assets has been done by a professional valuer and increase of 10% in year and and 12.5% in is estimated over the given book value. (ii) The inventories have been valued at ` 6.32 lacs as on 31 st March 2012, ` 8.47 lacs as on 31 st March 2013 and `10.68 lacs as on 31 st March, (iii) The company has been charging 10% p.a. (iv) The balance of Profit and Loss account and General Reserve on 1 st April, 2011 was ` 2.18 lacs and ` 4.25 lacs respectively. (v) Tax rate was 30% in all the years. (vi) The goodwill shall be revalued based on 4 years purchase of average super profits of last three years. (vii) The normal expectation in the industry is 10%. Calculate the fair value of shares of MSL Limited. (16 Marks) Answer 1. Calculation of Capital Employed ` in lacs Tangible assets Inventories Other current assets Less: Current Liabilities (6.80) (5.45) (3.85) Net assets / Closing capital employed Opening capital employed (by net worth method for the year = = 18.43) Average capital employed (Opening capital employed + closing capital employed)/

19 2. Calculation of Future Maintainable Profit ` in lacs Closing balance of Profit and Loss Account as on 31 st March Add back: Transfer to General reserve (in the year = = 2.60) Less: Opening Balance (2.18) (2.64) (5.95) Profit after tax earned during the year Add back: 30% Profit before tax Add back: Amortisation of goodwill (see assumption) Less: Extra depreciation on upward revaluation (0.12) (0.13) (0.175) Add: Upward valuation of closing inventories Less: Upward valuation of opening inventories - (0.04) (1.13) Less: 30% (1.29) (2.39) (2.08) Future Maintainable Profit Calculation of Goodwill ` in lacs Future Maintainable Profit Less: Normal 10% of Average capital employed (1.74) (1.96) (2.58) Super Profit Average super profit ( )/ Goodwill (2.38 x 4 years) For valuation of shares as per fair value method A. Value of an Equity Share on net assets basis ` in lacs Net assets as on excluding goodwill Add: Goodwill 9.52 Total net assets Number of equity shares 12,000 shares

20 Value of an Equity Share on net assets basis = 38,22, ,000 =` B. Value of an equity share on yield basis ` in lacs Average Future Maintainable Profit [( )/3] 4.48 Less: Transfer to General Reserve - Average transfer [( )/3] (1.58) Profit available to equity shareholders Capitalised value of the profit = No. of Equity Shares = 12,000 shares 29,00,000 Value of an equity share on yield basis = = Rs Fair value of an equity share = Value of share as per Net assets method + Value of share as per yield method = = ` per share 2 Assumption: 1. Original cost of Goodwill is assumed as ` 6.30 lacs only. However, this goodwill has no relevance in future. Therefore, it is a non-recurring item. Hence, while computing future maintainable profit the amortisation of goodwill has been reverted back. 2. Since every year transfer to General reserve was made, so we have also made the necessary adjustment while calculating the profit available to equity shareholders. However, from the information given in the question it was clear that no fixed amount has been transferred to General reserve every year. Therefore, in the absence of the information transfer to General Reserve has been taken as an average of transfers of last 3 years. Note: The solution given above has been done on the assumption that goodwill is calculated on the basis of Average capital employed. If the solution is done on the basis of closing capital employed then the value of goodwill will be ` 8.88 lacs and fair value of an equity share will be ` per share. 2

21 Question 6 (a) (b) DISA & Co. has provided the following information: (` in lacs) Equity Share Capital (`10 each) % Preference Share Capital (`10 each) 200 Reserves and Surplus % Debentures % Non-trade Investments (Nominal Value `100 lacs) 140 Land and Building held as Investment 20 Advance given for Purchase of Plant 10 Capital Work in Progress 30 Underwriting Commission (not written off) 20 Earnings per share 16 Tax rate 30% Beta factor 1.65 Market rate of return 16.25% Risk free rate 9.85% Calculate Economic Value Added by the company. (8 Marks) From the following details, compute the total value of human resources of skilled and unskilled group of employees according to Lev and Schwartz (1971) model: (i) Answer Annual average earning of an employee till the retirement age Skilled Unskilled 75,000 50,000 (ii) Age of retirement 68 years 65 years (iii) Discount rate 15% 15% (iv) Number of employees in the group (v) Average age (8 Marks) Computation of Economic Value Added (EVA) Particulars (` in lacs) Net Operating Profit after Tax (NOPAT) Less: Weighted average cost of operating capital employed (13.35% of 2,200) (See W.N.7) (293.70) Economic Value Added (EVA)

22 Working Notes: 1. Net Operating Profit after Tax (NOPAT) Earnings per share ` 16 No. of Equity Shares 40 lacs ` in lacs Profit after Interest, Tax & Preference Dividend [40 lacs x ` 16] Add: Preference Dividend (15% of ` 200 lacs) Profit after Tax Add: 30% [670/70 x 30] Profit before Tax Add: Interest on Debentures [15% of ` 1,600 lacs] Profit before Interest & Tax 1, Less: Income from Non-Trade Investment [10% of ` 100 lacs] (10.00) Net Operating Profit before Tax 1, Less: 30% (356.14) Net Operating Profit after Tax [NOPAT] Cost of Equity = Risk Free Rate + Beta Factor x (Market Rate-Risk Free Rate) 3. Cost of Preference shares = 15% = 9.85% ( ) = 20.41% 4. Cost of Debt = Interest Rate x (1-.tax rate) = 15% x (1-.30) = 10.5% 5. Total Capital Employed = [Equity Share Capital + Retained Earning + Preference Share Capital + Debentures] 6. Weighted Average Cost of Capital (WACC) = [400+(220-20)+200+1,600] = 2, ,600 = 20.41% + 15% % 2,400 2,400 2,400 = % = 13.35% 7. Operating Capital Employed ` in lacs Total Capital 2,400 Less: Non-operating Capital Employed

23 10% Non-Trade Investment 140 Land and Building held as Investment 20 Advance given for purchase of a Plant 10 Capital work-in-progress 30 (200) Operating Capital Employed 2,200 (b) Value of employees as per Lev and Schwartz method, t V = t= τ Where, I( t) (1 τ + r) t V = the human capital value of a person. I(t) = the person s annual earnings up to retirement. r = a discount rate specific to the person. t = retirement age. Value of skilled employees: 75,000 = ( ) ( 68 65) + ( ) ( ) ( ) ( ) ,000 75, = ` 49, ` 56, ` 65, = ` 1,71, Total value of skilled employees is ` 1,71, = ` 68,49, Value of unskilled employees 50,000 50,000 = ( ) ( ) ( 65-64) ( ) = ` 37, ` 43, = ` 81, Total value of the unskilled employees = ` 81, = ` 40,64,272 Total value of human resources (skilled and unskilled) = ` 68,49,675 + ` 40,64,272 Question 7 Answer any FOUR of the followings: = ` 109,13, (a) JVR Limited has made investments of ` crores in equity shares of QSR Limited in pursuance of Joint Venture agreement till The investment has been made at par. QSR Limited has been in continuous losses for the last 2 years. JVR Limited is willing to re-assess the carrying amount of its investment in QSR Limited and wish to

24 (b) (c) (d) provide for diminution in value of investments. However, QSR Limited has a futuristic and profitable business plans and projection for the coming years. Discuss whether the contention of JVR Limited to bring down the carrying amount of investment in QSR Limited is in accordance with the Accounting Standard. What is a derivative? Define with reference to AS-30, Financial Instruments: Recognition and Measurement. Finished Goods costing ` 10 lacs were damaged due to flood in July These goods were included in Closing Stock as on March 31, 2014 at an estimated realizable value of ` 4.00 lacs. These goods could be ultimately sold for ` 3 lacs only in August The difference of ` 1 lac was debited as 'prior period' expenditure in financial year As an auditor, please comment in the light of provisions of accounting standards. XYZ Limited acquired a bank loan of `40 lacs on interest rate of 20% per annum on 1 st July The said loan was utilized by the company for three transactions as under: (i) Construction of factory shed ` 10,00,000 (ii) Purchase of Plant and Machinery ` 25,00,000 (iii) Balance loan was unallocated and used generally for the purpose of business The accountant of the company has charged the total interest to the Profit and Loss account. Comment in view of provisions of AS 16. (e) Samrat Limited has set up its business in a designated backward area which entitles the company for subsidy of 25% of the total investment from Government of India. The company has invested ` 80 crores in the eligible investments. The company is eligible for the subsidy and has received ` 20 crores from the government in February The company wants to recognize the said subsidy as its income to improve the bottom line of the company. Do you approve the action of the company in accordance with the Accounting Standard? (4 x 4 = 16 Marks) Answer (a) As per AS 27 Financial Reporting of Interests in Joint Ventures, in a venturer's separate financial statements, interest in a jointly controlled entity should be accounted for as an investment in accordance with AS 13 Accounting for Investments. As per AS 13 Accounting for Investments, long-term investments are usually carried at cost. However, when there is a decline, other than temporary, in the value of a long-term investment, the carrying amount is reduced to recognise the decline. Indicators of the value of an investment are obtained by reference to its market value, the investee s

25 assets and results and the expected cash flows from the investment. The type and extent of the investor s stake in the investee are also taken into account. However, where there is a decline, other than temporary, in the carrying amounts of long-term investments, the resultant reduction in the carrying amount is charged to the profit and loss statement. Since the investment was made in the year , it implies that the shares are held for more than a year and is a long term investment. In the given case, though the QSR Ltd. is in continuous losses for past 2 years, yet it has a futuristic and profitable business plans and projections for the coming years. Here, one of the indicators i.e. losses incurred to the company may lead to diminution in the value of the shares while the other indicator that the company has positive expected cash flows from its business plans does not lead to decline in the value of shares. Considering both the facts, the decline in the value of shares of QSR Ltd. will be taken as other than temporary in nature. Therefore, the investment in equity shares should be carried at cost only. Hence, the contention of JVR Ltd. to bring down the carrying amount of investment in QSR Ltd. is not in line with the provisions of AS 13. (b) As per AS 30, Financial Instruments: Recognition and Measurement, a derivative is a financial instrument or other contract within the scope of this Standard with all three of the following characteristics: (i) its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the underlying ); (ii) it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and (iii) it is settled at a future date. (c) Paragraph 4 of AS 5 on Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies, defines Prior Period items as "income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods. Prior period items should be distinguished from changes in Accounting Estimates. As a result of the uncertainties inherent in business activities, many financial statement items cannot be measured with precision but can only be estimated. The estimation process involves judgments based on the latest information available. Accounting Estimates are approximations that may need revision. The use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability.

26 In the instant case, there is no error or omission in prior periods. It is a case of a change in an accounting estimate when the damaged goods are finally sold. Thus, the difference of ` 1,00,000 should be treated as a change in accounting estimate and not prior period item. Therefore, the accounting treatment done i.e. difference of ` 1,00,000 debited as prior period expenditure in financial year is not correct. It should be debited to profit and loss account as a change in an accounting estimate in the financial year (d) Total interest amounting ` 6,00,000 (interest for 9 20% on ` 40,00,000) cannot be charged to Profit and Loss account. The amount to be charged to Profit and Loss account will be computed as under: Treatment of Interest (Borrowing cost) as per AS 16 Borrowing Costs S. No. (i) (ii) Particulars Nature Interest to be capitalized Construction of Factory Shed (Refer Note 1) Purchase of Machinery (Refer Note 2) Qualifying Asset Not a Qualifying Asset (iii) Working Capital (used Not a Qualifying generally for business) Asset (Refer Note 3) Interest to be charged to P & L A/c 6,00,000 x 10/ 40= 1,50,000 6,00,000 x 25/40= 3,75,000 6,00,000 x 5/ 40 = 75,000 Total 1,50,000 4,50,000 Notes: 1. Construction of a factory shed necessarily takes a substantial period of time to get ready for its intended use or sale; 2. It is assumed that the machinery purchased is immediately ready for use. Therefore, it is a non-qualifying asset. Hence, the interest cost on it, would not be capitalized. An assumption other than the above may be accepted by the valuer and marked accordingly. 3. As per AS 16 Borrowing Costs, borrowing costs that are directly attributable to the acquisition, construction or production of qualifying assets should be capitalized as part of the cost of that asset. Other borrowing costs are recognized as expense in the period in which they are incurred. Therefore, interest on balance loan used for A qualifying asset is an asset that necessarily takes substantial period of time to get ready for its intended use or sale.

27 general purpose of business will not qualify for capitalization and will be charged to profit and loss account. (e) As per AS 12 Accounting for Government Grants, where the government grants are in the nature of promoters contribution, i.e., they are given with reference to the total investment in an undertaking or by way of contribution towards its total capital outlay (for example, Central Investment Subsidy Scheme) and no repayment is ordinarily expected in respect thereof, the grants are treated as capital reserve which can be neither distributed as dividend nor considered as deferred income. The subsidy received by Samrat Ltd. for setting up its business in a designated backward area will be treated as grant by the government in the nature of promoter s contribution as the grant is given with reference to the total investment in an undertaking i.e. subsidy is 25% of the eligible investment and also no repayment is apparently expected in respect thereof. Since the subsidy received is neither in relation to specific fixed assets nor in relation to revenue. Thus, the company cannot recognize the said subsidy as income in its financial statements in the given case. It should be recognized as capital reserve which can be neither distributed as dividend nor considered as deferred income.