PRIME ACADEMY 31st SESSION MODEL EXAM - FINAL FINANCIAL REPORTING QUESTION PAPER FRT. No. of Pages: 6 Total Marks: 100

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1 PRIME ACADEMY 31st SESSION MODEL EXAM - FINAL FINANCIAL REPORTING QUESTION PAPER FRT No. of Pages: 6 Total Marks: 100 No of Questions: 6 Time Allowed: 3 Hrs All are compulsory 1. a) While preparing its final accounts for the year ended 31 st March 2007 Rainbow Limited created a provision for Bad and Doubtful debts are 2% on trade debtors. A few weeks later the company found that payments from some of the major debtors were not forthcoming. Consequently the company decided to increase the provision by 10% on the debtors as on 31 st March 2007 as the accounts were still open awaiting approval of the Board of Directors. Is this to be considered as an extra-ordinary item or prior period item. Comment. b) Y Co. Ltd. used certain resources of X Co. Ltd. In return X Co. Ltd. received Rs.10 lakhs and Rs.15 lakhs as interest and royalties respective from Y Co. Ltd. during the year You are required to state whether and on what basis these revenues can be recognized by X Co. Ltd. c) Omega Limited belongs to the Engineering industry. The company received an actuarial valuation for the first time for its pension scheme which revealed a surplus of Rs.6 lakhs. It wants to spread the same over the next 2 years by reducing the annual contribution to Rs.2 lakhs instead of Rs.5 lakhs. The average remaining life of the employees is estimated to be 6 years. You are required to advise the company on the following items from the view point of finalization of accounts, taking notice of the mandatory accounting standards. d) Calculate the weight number of shares: Date Particulars No. of shares Paid up value Face Value 1 st January Balance at beginning of year 1,800 Rs.10 Rs st October Issue of Shares 600 Rs.10 Rs.5 e) Accountants of Poornima Ltd. show a net profit of Rs.7,20,000 for the third quarter of 2005 after incorporating the following : (i) Bad debts of Rs.40,000 incurred during the quarter. 50% of the bad debts have been deferred to the next quarter. (ii) Extra ordinary loss of Rs.35,000 incurred during the quarter has been fully recognized in this quarter. (iii) Additional depreciation of Rs.45,000 resulting from the change in the method of charge of depreciation. Ascertain the correct quarterly income. 5x4= 20 Marks 2. Able Ltd. made an offer to acquire all the shares of Baker Ltd. at a price of Rs.25 per share to be satisfied by the allotment of five shares of Able Ltd. for every four shares in Baker Ltd. By the date of expiration of the offer, which was on 1 st January 2006, share holders owning 75% of the shares in Baker Ltd. accepted the offer and the acquisition was effective from that date. PRIME / ME31 / FINAL 1

2 The accounting date of Baker Ltd. was on 31 st March in each year, but to conform with Able Ltd. accounts were prepared to 30 th June 2006, covering the fifteen months to the date. The draft summarized accounts of the companies on 30 th June 2006 which do not include any entries regarding the acquisition of shares in Baker Ltd. were as follows : Balance Sheet as on 30 th June 2006 Able Ltd. Baker Ltd. Liabilities Rs. Rs. Rs. Rs. Share Capital - Equity shares of Rs.10 each Authorised : 3,00,000 75,000 Issued and Fully paid 1,50,000 60,000 Reserves and Surplus General Reserve 55,000 Profit & Loss Account 62,000 1,17,000 20,000 Current Liabilities 27,000 7,000 Provision for taxation 33,000 6,000 3,27,000 93,000 Assets Freehold property, at cost 2,00,000 38,000 Plant & Machinery at cost 50,000 12,000 Less : Depreciation 18,000 32,000 3,000 9,000 Quoted investment at cost 7, Stock at cost 32,000 21,000 Debtors 41,000 17,000 Balance at Bank 15,000 8,000 3,27,000 93,000 Profit & Loss Account for the period ended on 30 th June 2006 Able Ltd. Baker Ltd. One Year 15 months Rs. Rs. Balance brought forward 14,000 12,000 Profit for the period 80,000 18,000 94,000 30,000 Taxation for the period 32,000 6,000 Interim dividend paid 30 th November ,000 Balance carried forward 62,000 20,000 94,000 30,000 The Directors of Able Ltd. recommended a final divided of 20% to the shareholders on register as on 30 th June The Directors of Baker Ltd. proposed a final dividend of 12 ½% on 30 th September PRIME / ME31 / FINAL 2

3 You are required to prepare the consolidated Balance Sheet of Able Ltd. and Baker Ltd. on 30 th June (16 Marks) 3. Given below Balance Sheets of AX Ld. And TX Ltd. as on TX Ltd. was merged with AX Ltd. with effect from and the merger was in the nature of purchase. Liabilities Share Capital Equity Shares of Rs.10 each Balance Sheet as on AX Ltd. TX Ltd. Assets AX Ltd. TX Ltd. Rs. Rs. Rs. Rs. 7,00,000 2,50,000 Sundry Fixed Assets 9,50,000 4,00,000 General Reserve 3,50,000 1,20,000 Investments (Non trade) 2,00,000 50,000 P & L A/c 2,10,000 65,000 Stock 1,20,000 50,000 Export Profit Reserve 70,000 40,000 Debtors 75,000 80,000 12% Debentures 1,00,000 1,00,000 Advance Tax 80,000 20,000 Sundry Creditors 40,000 45,000 Cash & Bank Balances 2,75,000 1,30,000 Provision for taxation 1,00,000 60,000 Preliminary Expenses 10,000 Proposed Dividend 1,40,000 50,000 17,10,000 7,30,000 17,10,000 7,30,000 AX Ltd. would issue 12% Debentures to discharge the claims of the debenture holders of TX Ltd. at par. Non trade investments of AX Ltd. 25% while those of TX Ltd. 18% Profit (Pre Tax) by AX Ltd. and TX Ltd. during 2004, 2005 and 2006 and were as follows: AX Ltd. TX Ltd Rs. Rs ,00,000 1,50, ,50,000 2,10, ,75,000 1,80,000 Goodwill may be calculated on the basis of capitalisation method taking 20% as the pre-tax normal rate of return. Purchase consideration is discharged by AX Ltd. on the basis of intrinsic value per share. The company decided to cancel the proposed dividend. Prepare Balance Sheet of AX Ltd. after merger. (16 Marks) 4. The Balance Sheets of Big Ltd. and Small Ltd. as on were as follows: Liabilities Big Ltd Small Assets Big Ltd Small Ltd Ltd Rs. Rs. Rs. Rs. Equity Share Capital 8,00,000 3,00,000 Building 2,00,000 1,00,000 (Rs.10) 10% Preference Share -- 2,00,000 Machinery 5,00,000 3,00,000 Capital (Rs.100) General Reserve 3,00,000 1,00,000 Furniture 1,00,000 60,000 Profit & Loss Account 2,00,000 1,00,000 Investment : ,000 shares of Small Ltd. Creditors 2,00,000 3,00,000 Stock 1,50,000 1,90,000 Debtors 3,50,000 2,50,000 Cash and Bank 90,000 70,000 PRIME / ME31 / FINAL 3

4 Preliminary Expenses 50,000 30,000 15,00,000 10,00,000 15,00,000 10,00,000 Big Ltd. has taken over the entire undertaking of Small Ltd. on , on which date the position of current assets except Cash and Bank balances and Current Liabilities were as under: Big Ltd. Small Ltd Rs. Rs. Stock 1,20,000 1,50,000 Debtors 3,80,000 2,50,000 Creditors 1,80,000 2,10,000 Profits earned for the half year ended after charging depreciation at 5% on building, 15% on machinery and 10% on furniture, are : Big Ltd. Small Ltd. Rs.1,02,500 Rs.54,000 On both Companies have declared 15% dividend for Goodwill of Small Ltd. has been valued at Rs.50,000 and other Fixed Assets at 10% above their book values on Preference shareholders of Small Ltd. are to be allotted 10% Preference Shares of Big Ltd. and equity shareholders of Small Ltd. are to receive requisite number of equity shares of Big Ltd. valued at Rs.15 per share in satisfaction of their claims. Show the Balance Sheet of Big Ltd. as of assuming absorption is through by that date. (16 Marks) 5. a) Balance Sheet of John Engg. Ltd. as on is given below: Liabilities Rs. Assets Rs. Share Capital Sundry Fixed Assets 22,00,000 1,50,000 Equity Shares of Rs.10 each 15,00,000 Investments 4,00,000 2,00,000 Equity Shares of Rs.10 each Rs.6 paid 12,00,000 Stock 8,00,000 up 9% Cumulative Preference Shares 6,00,000 Debtors 4,00,000 18% Term Loan 14,00,000 Cash & Bank 4,00,000 Sundry Creditors 8,00,000 P & L Account 13,00,000 55,00,000 55,00,000 Other Information: (1) Current Cost of Sundry Fixed Assets Rs.37,00,000 and stock of Rs.10,00,000 (2) Investments could fetch only Rs.100,00,000 (3) 50% debtors are doubtful (4) Preference dividend was in arrear for the last five years. Find out the intrinsic value per share of John Engg Ltd. PRIME / ME31 / FINAL 4

5 b) Prepare a Gross Value Added Statement from the following Profit and Loss Account of Strong Ltd. Show also the reconciliation between Gross Value Added and Profit before Taxation. Profit & Loss Account for the year ended 31 st March 2006 Note Amount Income (Rs. in Lakhs) (Rs. in Lakhs) Sales 610 Other Income Expenditure Production & Operational Expenses Administration Expenses 2 19 Interest & Other charges 3 27 Depreciation Profit before Taxes 110 Provision for Taxes Balance as per last balance sheet Transferred to General Reserve 60 Proposed Dividend Surplus carried to Balance Sheet 30 `101 Notes: 1. Production & Operational Expenses Rs. in lakhs Increase in Stock 112 Consumption of Raw materials 185 Consumption of Stores 22 Salaries, Wages, Bonus and other benefits 41 Cess and Local Taxes 11 Other Manufacturing Expenses Administration Expenses include inter-alia audit fees of Rs.4.80 lakhs, salaries and commission to directors Rs.5 lakhs and provision for doubtful debts Rs.5.20 lakhs. 3. Interest and other charges Rs. in lakhs On Working Capital Loans from Bank 8 On Fixed Loans from IDBI 12 Debentures 7 27 (2 x 8 = 16 Marks) PRIME / ME31 / FINAL 5

6 6. a) Zero Limited commenced its business on 1 st April 2006, 2,00,000 Equity Shares of Rs.10 each at par and 12.5 % debentures of the aggregate value of Rs.2,00,000 were issued and fully taken up. The proceeds were utilized as under: Rs. Fixtures and Equipments (Estimated life 10 years, no scrap 16,00,000 value) Goods purchased for resale at Rs.200 per unit 6,00,000 The goods were entirely sold by 31 st January 2006, at a profit of 40% on selling price. Collections from debtors outstanding on 31 st March 2006, amounted to Rs.60,000, goods sold were replaced at a cost of Rs.7,20,000, the number of units purchased being the same as before. A payment of Rs.40,000 to a supplier was outstanding as on 31 st March The replaced goods remained entirely in stock on 31 st March Replacement cost as at 31 st March 2006 was considered to be Rs.280 per unit. Replacement cost of fixtures and equipments (depreciation on straight line basis) was Rs.20,00,000 as at 31 st March Draft the Profit and Loss Account and the Balance Sheet on replacement cost (entry value) basis and on historical cost basis. b) Winners reported net earnings $25,000 for the year ending 20X1. The company had 12,500 shares of $1 par value common tock and 3,000 shares of $40 par value convertible preference shares outstanding during the year. The dividend rate on the preference shares is $2 per share. Each share of the convertible preference shares can be converted into two shares of Winners Class A shares. During the year no convertible preference shares were converted. What is Winners diluted earnings per share? ( = 16 Marks) PRIME / ME31 / FINAL 6

7 1. PRIME ACADEMY 31st SESSION MODEL EXAM - FINAL FINANCIAL REPORTING SUGGESTED ANSWERS a. The preparation of financial statements involve making estimates which are based on the circumstances existing at the time when the financial statements are prepared. It may be necessary to revised an estimate in a subsequent period if there is a change in the circumstances on which the estimate is based. Revision of an estimate does not bring the resulting amount within the definition either of prior period item or of an extra ordinary item. In the given case, Rainbow Limited created a provision for bad and doubtful debts at 2% on trade debtors while preparing its final accounts for the year ended 31 st March Subsequently the company decided to increase the provision by 10%. As per AS 5 (Revised), this change in estimate is neither a prior period item nor an extraordinary item. However, as per Para 27 of AS 5 (Revised) a change in accounting estimate which has a material effect in the current period should be disclosed and quantified. Any change in an accounting estimate which is expected to have a material effect in later periods should also be disclosed. b. As per para 13 of AS 9 on Revenue Recognition, revenue arising from the use by others of enterprise resources yielding interest and royalties, should only be recognized when no significant uncertainty as to measurability or collectability exists. These revenues are recognized on the following bases : (i) Interest: on a time proportion basis taking into account the amount outstanding and the rate applicable. (ii) Royalties: on an accrual basis in accordance with the terms of the relevant agreement. c. According to AS 15 (Revised 2005) Employee Benefits, actuarial gains and losses should be recognized immediately in the statement of profit and loss as income or expense. Therefore surplus amount of Rs.6 lakhs is required to be credited to the profit and loss statement of the current year. d. Assuming that partly paid shares are entitled to participate in the dividend to the extent of amount paid, number of partly paid equity shares would be taken as 300 for the purpose of calculation of earnings per share. Computation of weighted average would be as follows: (1,800 x 12/12) + (300 x 2/12) = 1,850 shares In case of a bonus issue or a share split, equity shares are issued to existing shareholders for no additional consideration. Therefore, the number of equity shares outstanding is increased without an increase in resources. The number of equity shares outstanding before the event is adjusted for the proportionate change in the number of equity shares outstanding as if the event had occurred at the beginning of the earliest period reported. e. In the above case, the quarterly income has not been correctly stated. As per AS 25 Interim Financial Reporting, the quarterly income should be adjusted and restated as follows : Bad debts of Rs.40,000 have been incurred during current quarter. Out of this, the company has deferred 0%(i.e. Rs.20,000) to the next quarter. Therefore, Rs.20,000should be deducted from Rs.7,20,000.The treatment of extra ordinary loss of RS.35,000 being recognized in the same quarter is PRIME / ME31 / FINAL 7

8 correct. Recognizing additional depreciation of Rs.45,000 in the same quarter is in tune with AS 25. Hence, no adjustments are required for these two items. Poornima Ltd. should report quarterly income as Rs.7,00,000 (Rs.7,20,000 - Rs.20,000). 2. Consolidated Balance Sheet of Able Ltd. and its subsidiary Baker Ltd. as on 30 th June 2006 Liabilities Rs. Rs. Assets Rs. Rs. Share Capital (Equity shares of Rs.10 Goodwill 56,100 each) Authorised : 3,00,000 Freehold property Issued & fully paid 2,06,250 Able Ltd. 2,00,000 Share Premium A/c 56,250 Baker Ltd. 38,000 2,38,000 General Reserve 55,000 Plant & Machinery Profit & Loss A/c 24,350 At cost less depreciation Minority Interest 18,125 Able Ltd. 32,000 Provision for taxation 39,000 Baker Ltd. 9,000 41,000 Current Liabilities Quoted investments Able Ltd. 27,000 Able Ltd. 7,000 Baker Ltd. 7,000 34,000 Able Ltd. 41,000 Proposed Dividend Baker Ltd. 17,000 58,000 Minority Interest 1,875 Stock Own shareholders 41,250 43,125 Able Ltd. 32,000 Baker Ltd. 21,000 53,000 Bank Able Ltd. 15,000 Baker Ltd. 8,000 23,000 Working Notes: 4,76,100 4,76,100 (i) Number of shares to be issued : Rs. Rs. 75% of shares of Bakers Ltd. 4,500 No. of shares of Able Ltd. 4,500 x 5/4 5,625 Value of 4,500 Rs.25 1,12,500 Face value of 5,625 Rs.10 56,250 Share Premium 56,250 (ii) Cost Control Rs. Rs. Cost of Shares in Baker Ltd. Share Capital 56,250 PRIME / ME31 / FINAL 8

9 Share Premium 56,250 1,12,500 Less : Face value of shares acquired 45,000 Pre-acquisition profits 11,400 56,400 Goodwill on consolidation 56,100 (iii) Minority Interest Rs. Share Capital Account ¼ 15,000 Profit & Loss Account ¼ 5,000 20,000 Less : Proposed Dividend 12 ½% on Rs.15,000 shown separately 1,875 18,125 (iv) Pre-acquisition profit of Baker Ltd. Rs. Rs. Profit & Loss A/c as per Balance Sheet 20,000 Less:Post acquisition profit 6/15 of 7,200 Rs.18,000 Less:Taxation thereon 6/15 of Rs.6,000 2,400 4,800 15,200 3/4 thereof 11,400 (v) Profit & Loss A/c - Able Ltd. Rs. Rs. Balance as per P & L A/c 62,000 Less:Proposed Dividend (20% on 41,250 Rs ) Balance to Consolidated P & L A/c 20,750 (vi) Profit & Loss A/c - Baker Ltd. Rs. Rs. Balance as per Profit & Loss A/c 20,000 Less : Minority Interest 5,000 Pre-acquisition profit 11,400 16,400 Balance in Consolidated P & L A/c 3,600 Total of (v) and (vi) 24,350 Note: It is assumed that whole of the dividend of Rs.41,250 proposed by Able Ltd. will be appropriated from revenue, although part of that dividend is due to the ex-shareholders of Baker Ltd. 3. (1) Valuation of Goodwill AX Ltd TX Ltd. (i) Capital Employed Rs. Rs. Rs. Rs. Sundry-Assets as per Balance Sheet 17,10,000 7,30,000 PRIME / ME31 / FINAL 9

10 Less : Preliminary Expenses 10, Less : Non Trade Investment 2,00,000 2,10,000 50,000 50,000 15,00,000 6,80,000 Less : Sundry Liabilities 12% Debentures 1,00,000 1,00,000 Sundry Creditors 40,000 45,000 Provision for Taxation 1,00,000 2,40,000 60,000 2,05,000 12,60,000 4,75,000 AX Ltd TX Ltd. (ii) Average Pre-Tax Profit Rs. Rs ,00,000 1,50, ,50,000 2,10, ,75,000 1,80,000 17,25,000 5,40,000 Simple Average 5,75,000 1,80,000 Less : Non Trading Income 50,000 9,000 5,25,000 1,71,000 AX Ltd TX Ltd. (iii) Goodwill Rs. Rs. Capitalisation Value of average profit (5,25,000/20)x100 26,25,000 (1,71,000/20)x100 8,55,000 Less : Capital Employed 12,60,000 4,75,000 13,65,000 3,80,000 (2) Intrinsic Value per share AX Ltd TX Ltd. Rs. Rs. Rs. Rs. Goodwill 13,65,000 3,80,000 Sundry Other Assets less Preliminary 17,00,000 7,30,000 Expenses 30,65,000 11,10,000 Less : Liabilities 12% Debentures 1,00,000 1,00,000 Sundry Creditors 40,000 45,000 Provision for Taxation 1,00,000 2,40,000 60,000 2,05,000 28,25,000 9,05,000 Intrinsic value per share = (Rs.28,25,000 / 70,000) = Rs = (Rs. 9,05,000 / 25,000) = Rs (3) Purchase Consideration 25,000 Rs To be discharged by 22,400 Rs. 9,05,000 PRIME / ME31 / FINAL 10

11 25,000 x (36.20 x 40.40) Rs Rs. 9,04,960 Cash for Fraction Rs. 40 Balance Sheet of AX Ltd. (After merger with TX Ltd) Liabilities Rs. Rs. Assets Rs. Rs. Share Capital Goodwill 3,80,000 92,400 Equity Shares of Rs.10 each 9,24,000 Sundry Fixed Assets (of which 22,400 shares Balance 9,50,000 were issued to the vendors otherwise 65,000 Add: Assets taken over 4,00,000 13,50,000 than cash) General Reserve 3,50,000 Investments P & L A/c 2,10,000 Balance 2,00,000 Add: Proposed dividend 1,40,000 3,50,000 Add: Investments taken over 50,000 2,50,000 written off Share Premium 6,80,960 Stock Balance 1,20,000 Export profit Reserve Add : Stock Taken over 50,000 1,70,000 Balance 70,000 Debtors : Balance 75,000 Add : Balance of TX Ltd. 40,000 1,10,000 Add : Taken over 80,000 1,55,000 12% Debentures Balance 1,00,000 Advance Tax Balance 80,000 Add: 12% Debentures Add : Balance of TX Ltd. 20,000 1,00,000 issued at par other than cash 1,00,000 2,00,000 Cash and Bank Balance 2,75,000 Sundry Creditors Balance 40,000 Add: Balance of TX Ltd. 1,30,000 taken over Add: Liabilities taken over 45,000 85,000 4,05,000 Provision for Taxation 1,00,000 Less: Purchase 40 4,04,960 consideration discharged Add: Prov. for taxation for TX Ltd. 60,000 1,60,000 Preliminary Expenses 10,000 Amalgamation Adjustment 40,000 A/c 28,59,960 28,59, Balance Sheet of Big Ltd. as at 30 th September 2005 Liabilities Rs. Assets Rs. Rs. SHARE CAPITAL FIXED ASSETS 1,09,600 Equity Shares of Rs.10 10,96,000 Building 2,00,000 each 10% Preference shares 2,00,000 Less : Depreciation 5,000 (Of the above shares, 29,600 equity 1,95,000 shares and all preference shares are allotted as Add : Taken over 1,07,500 3,02,500 PRIME / ME31 / FINAL 11

12 fully paid up for consideration other than cash) Machinery 5,00,000 RESERVES AND SURPLUS Less : Depreciation 37,500 Capital Reserve 1,000 4,62,500 Securities Premium Account 1,48,000 Add: Taken over 3,07,500 7,70,000 General Reserve 3,00,000 Furniture 1,00,000 Profit and Loss Account 1,91,500 Less : Depreciation 5,000 SECURED LOANS -- 95,000 UNSECURED LOANS -- Add: Taken over 63,000 1,58,000 CURRENT LIABILITIES & INVESTMENTS PROVISIONS Sundry Creditors Working Notes: 3,90,000 CURRENT ASSETS, LOANS AND ADVANCES Current Assets 2,70,000 Stock 6,30,000 Cash and Bank 1,46,000 MISCELLANEOUS EXPENDITURE (to the extent not written off or adjusted) Preliminary Expenses 50,000 23,26,500 23,26, Ascertainment of Cash and Bank Balances as on 30 th September 2005 Balance Sheets as at 30 th September 2005 Liabilities Big Ltd Rs. Small Ltd Rs. Assets Big Ltd Rs. Small Ltd Rs. Equity Share Capital 8,00,000 3,00,000 Building** 1,95,000 97,500 10% Preference Share -- 2,00,000 Machinery** 4,62,500 2,77,500 Capital General Reserve 3,00,000 1,00,000 Furniture** 95,000 57,000 Profit & Loss Account* 1,91,500 89,000 Investment 60, Creditors 1,80,000 2,10,000 Stock 1,20,000 1,50,000 Debtors 3,80,000 2,50,000 Cash and Bank (Balancing 1,09,000 37,000 Figure) Preliminary Expenses 50,000 30,000 14,71,500 8,99,000 14,71,500 8,99,000 PRIME / ME31 / FINAL 12

13 *Balance of Profit and Loss Account on 30 th September 2005 Big Ltd Rs. Small Ltd Rs. Net Profit (for the first half) 1,02,500 54,000 Balance brought forward 2,00,000 1,00,000 3,02,500 1,54,000 Less : Dividend on Equity Share Capital Paid 1,20,000 45,000 1,82,500 1,09,000 Less : Dividend on Preference Share Capital Paid -- 20,000 1,82,500 89,000 Add: Dividend (1/5) x 45,000 9, ,91,500 89,000 **Fixed Assets on 30 th September 2005 (Before absorption) Big Ltd Rs. Small Ltd Rs. (1) Building As on ,00,000 1,00,000 Less : Depreciation (5% p.a.) 5,000 2,500 1,95,000 97,500 (2) Machinery As on ,00,000 3,00,000 Less : Depreciation (5% p.a.) 37,500 22,500 4,62,500 2,77,500 (3) Furniture As on ,00,000 60,000 Less : Depreciation (10% p.a.) 5,000 3,000 95,000 57, Calculation of Shares Allotted Assets Taken over Rs. Rs. Goodwill 50,000 Building 1,00,000 Add : 10% 10,000 1,10,000 Less : Depreciation 2,500 1,07,500 Machinery 3,00,000 Add : 10% 30,000 3,30,000 Less : Depreciation 22,500 PRIME / ME31 / FINAL 13

14 3,07,500 Furniture 60,000 Add : 10% 6,000 66,000 Less : Depreciation 3,000 63,000 Stock 1,50,000 Debtors 2,50,000 Cash and Bank 37,000 9,65,000 Less : Liabilities Taken Over : Creditors 2,10,000 Net Assets taken over 7,55,000 Less : Allotment of 10% Preference shares to 2,00,000 preference share holders of Small Ltd. 5,55,000 Less : Belonging to Big Ltd.*** (1/5 x 5,55,000) 1,11,000 Payable to other equity shareholders 4,44,000 Number of equity shares of Rs.10 each to be issued (valued at Rs.15 each) (4,44,000) / (15) = 29,600 [*** 6,000 shares out of 30,000 shares of Small Ltd are already with Big Ltd.] 3. Ascertainment of Goodwill / Capital Reserve Rs. Rs. (A) Net Assets taken over 7,55,000 (B) Preference Shares allotted 2,00,000 Payable to other equity share holders 4,44,000 Cost of investments 60,000 7,04,000 (C) Capital Reserve (A) - (B) 51,000 (D) Goodwill taken over 50,000 (E) Final figure of Capital Reserve (C) - (D) 1, a. (i) Net Assets available to the equity shareholders Amount in Rs. 000 Sundry Fixed assets Investments 1.00 Stock Debtors 2.00 Cash & Bank PRIME / ME31 / FINAL 14

15 Less : Outside liabilities & 9% cumulative pref.shares Sundry creditors % Term Loan % Cumulative preference shares 6.00 Arrear Pref. Dividend Net Assets (ii) Valuation of Equity Shares Amount in Rs. 000 Net Assets as per (i) above Add : Notional call on 2,00,000 partly paid up 8.00 equity Rs.4 each Number of Equity shares 350,000 Value per fully paid up equity share : Rs.31,30,000 / 3,50,000 = Rs Value per partly paid up equity share : Rs Rs.4 = Rs b) Strong Limited Value Added Statement for the year ended 31 st Mach 2006 Rs. in lakhs Rs. in lakhs Sales 610 Less : Cost of bought in material and services Production and operational expenses 413 Administration Expenses 14 Interest on working capital loans Value added by manufacturing and trading activities 175 Add : Other income 25 Total Value added 200 % Application of Value added Rs. in lakhs Rs. in lakhs To Pay Employees Salaries, Wages, Bonus and other benefits To Pay Directors Salaries and Commission % PRIME / ME31 / FINAL 15

16 To Pay Government Cess and Local Taxes 11 Income Tax To Pay Providers of Capital Interest on Debentures 7 Interest on Fixed Loans 12 Dividend To Provide for Maintenance and Expansion of the Company Depreciation 14 General Reserve 60 Retained Profit (30-7) Reconciliation Between Total Value Added and Profit Before Taxation : Rs. in lakhs Rs. in lakhs Profit before Tax 110 Add Back : 41 Depreciation 14 Salaries, Wages, Bonus and other benefits 41 Directors Remuneration 5 Cess and Local Taxes 11 Interest on Debentures 7 Interest on Fixed Loans 12 Total Value Added a) Profit and Loss Account for the year ended 31 st March 2006 Historical Cost Basis Replacement Cost Basis Rs. Rs. Sales 10,00,000 10,00,000 Less : Cost of Sales 6,00,000 7,20,000 Gross Profit 4,00,000 2,80,000 Less : Depreciation 1,60,000 1,80,000 Profit before interest 2,40,000 1,00,000 Less : Debenture Interest 25,000 25,000 Net Profit 2,15,000 75,000 Balance Sheet of Zero Limited as at 31 st March 2006 Historical Cost Replacement PRIME / ME31 / FINAL 16

17 Basis Cost Basis Liabilities Rs. Rs. Equity Share Capital 20,00,000 20,00,000 Profit & Loss Account 2,15,000 75,000 Replacement Reserve -- 6,20, % Debentures 2,00,000 2,00,000 Creditors 40,000 40,000 24,55,000 29,35,000 Assets Fixtures and Equipments 14,40,000 18,00,000 Stock 7,20,000 8,40,000 Debtors 60,000 60,000 Cash and Bank 2,35,000 2,35,000 24,55,000 29,35,000 Working Notes: (i) Replacement of cost of sales on the basis of replacement cost on the date of sale = Rs.240 x 3,000 = Rs.7,20,000 (ii) Under replacement cost basis, depreciation, calculated on the average basis = 10% of (Rs.16,00,000 + Rs.20,000) / 2 = Rs.1,80,000 (iii) Fixtures and Equipments at net current replacement cost: Rs. Gross replacement cost 20,00,000 Less : Depreciation 10% of Rs.20,00,000 2,00,000 18,00,000 (iv) Replacement Reserve = Realised holding gains + Unrealised holding gains Realised holding gains Unrealised holding gains Stocks Rs. Rs. Sold (replacement cost at the date of sale - historical cost) (Rs.7,20,000 - Rs.6,00,000) 1,20,000 Unsold (Closing Stock x (Closing rate - rate at the date of purchase) = 3,000 x [Rs Rs.240] 1,20,000 Fixtures and Equipments : Depreciation (Rs.1,80,000 - Rs.1,60,000) 20,000 Net Book value at year end (Rs.18,00,000 - Rs.14,40,000) 3,60,000 1,40,000 4,80,000 Replacement + Reserve = Rs.1,40,000 + Rs.4,80,000 = Rs.6,20,000 PRIME / ME31 / FINAL 17

18 b) Diluted earnings per share Net income - Preference dividends+ Dividends on converted securities = Shares outstanding + Additional shares if securities were converted $25,000 - $6,000 + $6,000 = ,500 + (3000x2) Earnings per share amounts should be restated in the following circumstances. If the number of shares outstanding is effected as a result of a capitalization, bonus issue, share split or a reverse share split, the calculation of basic EPS and diluted EPS should be adjusted retrospectively. If these changes occur after balance sheet date, but before issue of financial statements the per share calculations are based on the new number of shares. IAS 33 specifies disclosures about earnings per share information PRIME / ME31 / FINAL 18

19 PRIME ACADEMY 31st SESSION MODEL EXAM - FINAL STRATEGIC FINANCIAL MANAGEMENT QUESTION PAPER SFT No. of Pages: 5 Total Marks: 100 No of Questions: 6 Time Allowed: 3 Hrs All are compulsory 1. a. A company is considering projects X and Y with following information: Project Expected NPV Standard Deviation Rs X 1,22,000 90,000 Y 2,25,000 1,20,000 (i) (ii) (iii) Which project will you recommend based on the above data? Explain whether your opinion will change, if you use coefficient of variation as s measure of risk Which measure is more appropriate in this situation and why. (4 Marks) b. Determine the risk adjusted net present value of the following projects A B C Net cash outlay (Rs.) Project life Annual cash inflow (Rs.) Coefficient of variation 1,00,000 5 years 30, ,20,000 5 years 42, ,10,000 5 years 70, The company selects the risk adjusted rate of discount on the basis of the coefficient of variation Coefficient of variation Risk adjusted rate of discount Present value factor 1 to 5 at risk adjusted rate of discount More than % 12% 14% 16% 18% 22% 25% (5 Marks) PRIME / ME31 / FINAL 1

20 c. XYZ Ltd., is considering a project for which the following estimates are available: Rs. Initial cost of the project 10,00,000 Sales price / unit 60 Cost / unit 40 Sales volumes Year I 20,000 units Year II 30,000 units Year III 30,000 units Discount rate 10% p.a. You are required to measure the sensitivity of the project in relation to each of the following parameters: a. Sales price / unit b. Unit cost c. Sales volume d. Initial outlay e. Project life time Taxation may be ignored (11 Marks) 2. a. The Expected returns on two stocks particular market returns are given in the following table: Market return Aggressive stock Defensive stock 7% 4% 9% 25% 40% 18% You are required to calculate: a. The Betas of the two stocks b. Expected return of each stock, if the market return is equally likely to be 7% or 25% c. The Security Market Line (SML), if the risk free rate is 7.5% and market return is equally likely to be 7% or 25%. d. The Alphas of the two stocks (8 Marks) b. Mr. X on , during the initial offer of some Mutual Fund invested in 10,000units having face value of Rs.10 for each unit. On the dividend operated by the Mutual Fund was 10% and Mr. X found that his annualized yield was %. On , 20% dividend was given. On Mr. X redeemed all his balance of 11,296.11units when his annualized yield was 73.52% what are the NAVs as on , and ? (8 Marks) PRIME / ME31 / FINAL 2

21 3. a. Given below is information of market rates of Returns and data from two companies A and B : Year 2002 Year 2003 Year 2004 Market (%) Company A (%) Company B (%) Determine the beta coefficients of the shares of company A and company B. (11 Marks) b. Explain the impact of Global Depository Receipts (GDRs) on Indian Capital Mark (5 Marks) 4. a. You have been provided the following Financial data of two companies: Krishna Rama Ltd Ltd Earnings after taxes Rs.7,00,000 Rs.10,00,000 Equity shares (outstanding) Rs.2,00,000 Rs. 4,00,000 EPS P/E ratio 10 times 14 times Market price per share Rs.35 Rs. 35 Company Rama Ltd. Is acquiring the company Krishna Ltd., exchanging its shares on a one-to-one basis for company Krishna Ltd. The exchange ratio is based on the market prices of the shares of the two companies. Required: (i) What will be the EPS subsequent to merger? (ii) What is the change in EPS for the shareholders of companies Rama Ltd. And Krishna Ltd.? (iii) Determine the market value of the post merger firm. PE ratio is likely to remain the same (iv) Ascertain the profits accruing to shareholders of both the companies. (10 Marks) b. An investors is considering the purchase of the following Bond: Face value Rs.100 Coupon rate 11% Maturity 3 years PRIME / ME31 / FINAL 3

22 (i) If he wants a yield of 13% what is the maximum price he should be ready to pay for? (ii) If the Bond is selling for Rs.97.60, what would be his yield? (4 Marks) c. Write any two assumptions under Modgilani & Miller model (2Marks) 5. a. An exporter is a UK based company. Invoice amount is $3,50,000. Credit period is three months. Exchange rates in London are : Spot Rate ($/ ) month Forward Rate ($/ ) Rates of interest in Money Market : Deposit Loan $ 7% 9% 5% 8% Compute and show how a money market hedge can be put in place. Compare and contrast the outcome with a forward contract. (6 Marks) b. An Indian exporting firm, Rohit and Bros., would be cover itself against a likely depreciation of pound sterling. The following data is given : Receivables of Rohit and Bros : 500,000 Spot rate : Rs.56,00/ Payment date : 3-months 3 months interest rate : India : 12 per cent per annum : UK : 5 per cent per annum What should the exporter do? (6 Marks) c. Write short notes on Cross border leasing (4 Marks) PRIME / ME31 / FINAL 4

23 6. a. The closing value of Sensex for the month of October, 2007 is given below: Date Closing Sensex Value You are required to test the week form of efficient market hypothesis by applying the run test at 5% and 10% level of significance. Following value can be used : Value of t at 5% is at 18 degrees of freedom Value of t at 10% is at 18 degrees of freedom Value of t at 5% is at 20 degrees of freedom. Value of t at 10% is at 20 degrees of freedom. (8 Marks) b. What are the drawbacks of mutual fund investments? (8 Marks) PRIME / ME31 / FINAL 5

24 PRIME ACADEMY 31st SESSION MODEL EXAM - FINAL STRATEGIC FINANCIAL MANAGEMENT SUGGESTED ANSWERS 1. a) (i) Based on the standard deviation project X can be chosen because it is less risky than project Y. (ii) Coefficient of Variation = Standard Deviation Expected Net Present Value b) Co Vx = 90,000 = ,22,000 Co Vy = 1,20,000 = Coefficient of variation as a measure of risk indicates, project X to be more risky than project Y. Therefore Project Y can be selected. (i) Determination of discount factor and the present value (i) Coefficient of Variation (ii) Relevant risk adjusted rate of discount (iii) Present value annuity for 5 years Particulars A B C % 14% % (ii) Computation of risk adjusted Net present value Particulars A B C 1,00,000 1,20,000 30,000 42,000 (a) Net cash Outlay (b) Annual cash inflows (c) Present value annuity factor for 5 years (as per the above table) (d) Discount cash inflows (e) Risk adjusted factor NPV (d-a) ,08,150 8,150 3,433 1,44,186 25,186 2,10,000 70,000 3,274 2,29,180 19,180 PRIME / ME31 / FINAL 6

25 c) Working Note1: Basic Data Sales price 60 Cost price 10 Profit 20 Volume (Units) Sales (Rs.) Cost price (Rs.) Profit and Cash flow Year A B C 20,000 30,000 12,00,000 18,00,000 8,00,000 12,00,000 4,00,000 6,00,000 30,000 18,00,000 12,00,000 6,00,000 Sensitivity analysis measures the percentage change in input parameter which leads to a reversal o the investment decision i.e. which turns NPV to zero. Year Cash flow 10% DCF (10,00,000) 4,00,000 6,00,000 6,00, (10,00,000) 3,63,600 4,95,600 4,50,600 Working Note 2: NPV (a) Sensitivity to Sale price Step 1: PV of Sales Year Cash flow 10% DCF 1 12,00, ,90, ,00, ,86, ,00, ,51,800 Total 39,29,400 Step 2: Sensitivity percentage NPV / PV of Sales = 7.9% If price falls by 7.9% approx the project becomes unviable (b) Sensitivity to Unit cost Step 1: PV of Cost Year Cash flow 10% DCF ,00,000 12,00,000 12,00, ,27,200 9,91,200 9,01,200 NPV 26,19,600 Step 2: Sensitivity percentage NPV / PV of Sales = 11.8% PRIME / ME31 / FINAL 7

26 If price falls by 11.8% approx the project becomes unviable (c) Sensitivity to Volume Since all costs are assumed to be variable the project will become unviable only when the volume is zero. That is 100% fall in volume (d) Initial outlay Sensitivity = (NPV / Initial Outlay) X 100 = 3,09,800 / 10,00,000 = 30.9 % (e) Project Life Year CF PVF DCf Cum DCF (10,00,000) 4,00,000 6,00,000 6,00, (10,00,000) 3,63,600 4,95,600 4,50,600 (10,00,000) (6,36,400) (1,40,800) 3,09,800 NPV 3,09, The project will become unviable when DCF in Year 3 is 1,40, The cash flow corresponding to that will be 1,40,800 / = 1,87, This Rs. 1,87,483 is 0.31 of Rs. 6,00,000 the annual cash flow 4. Hence if the life of the project falls below 2 years and 4 months the project become unviable i.e. 8/36= 22.2% 2. (a) Beta of the Stocks Aggressive OBS Stock (X) Market (Y) X x Y Y² 1 2 Average β = XY n X Y = 1028 (2 x 22 x 16) = 2.0 _ Y² - n Y² 674 (2 x 16 x 16) Defensive OBS Stock (X) Market (Y) X x Y Y² 1 2 Average PRIME / ME31 / FINAL 8

27 β = XY n X Y = 513 (2 x 13.5 x 16) = 0.5 _ Y² - n Y² 674 (2 x 16 x 16) (b) Expected return of each Stocks The probability of the two observation lead to 1. We are told that they are equally likely to happen. Hence the probability is 0.5 each. Aggressive : 0.5 x 4% x 40% = 22% Defensive : 0.5 x 9% x 18% = 13.5% (c) Expected return of market portfolio a. 0.5 x 7% x 25% = 16% b. Risk premium = 16% - 7.5% = 8.5% c. SML = 7.5% + Beta x 8.5% (d) Alpha of the two Stocks Alpha = Actual Return CAPM Return Aggressive: 22.0% - (7.5% x 8.5%) = (2.5)% Defensive :13.5% - (7.5% x 8.5%) = 1.75% 2 b) The basic information is captured in the following matrix Investment Action NAV Units Return Date Buy 10 10, Dividend 10% Dividend 20% Redemption 11, WN 1: Yield =(Closing NAV-Opening NAV) /Opening NAV X 12/N x100 Opening NAV =10; N=9 months; Yield = Using these value we get closing NAV as 21.5 cum dividend. Since the dividend rate is 10% the dividend value is Rs.10,000 on 10,000 units. The units issued for this will be Rs.10000/closing NAV = WN 2: Number of dividend units declared on Total Units 11, Units on hand 10, Units now issued Total dividend (20%)on 10,465 units =20, If 831 units were issued for Rs.20r,931.The NAV is PRIME / ME31 / FINAL 9

28 WN 3: Using the yield formula we get the closing NAV for year 3 as Opening NAV N 3months Yield Closing NAV Conclusion: NAV NAV NAV a) Company A OBS Stock(X) Market (y) xy Y dx dy dxdy dy (1.633) (1.667) Avg Total (0.001) Beta through formula Beta through variance Covariance SD market Beta Company B OBS stock(x) Market(Y) xy y dx dy dxdy dy (0.833) (1.667) Avg Total (0.001) Beta through formula Beta through variance Covariance SD market Beta 0.5 PRIME / ME31 / FINAL 10

29 3 b) PRIME / ME31 / FINAL 11

30 4 a) PRIME / ME31 / FINAL 12

31 4 c) # Perfect market Companies operate in a world of perfect capital markets # No tax There are no corporate taxes and personal taxes. # There is no risk of uncertainty # All investments are funded either by equity or by retained earnings. 5 a) PRIME / ME31 / FINAL 13

32 PRIME / ME31 / FINAL 14

33 6 a) PRIME / ME31 / FINAL 15

34 PRIME / ME31 / FINAL 16

35 6 b. DRAWBACKS OF INVESTMENT IN MUTUAL FUNDS a) There is no guarantee of return as some Mutual Funds may under perform and Mutual Fund b) Investment may depreciate in value which may even effect erosion /Depletion of principal amount c) Diversification may minimize risk but does not guarantee higher return. d) Mutual funds performance is judged on the basis of past performance record of various companies. But this can not take care of or guarantee future performance. e) Mutual Fund cost is involved like entry load, exit load, fees paid to Asset f) Management Company etc. g) There may be unethical Practices e.g. diversion of Mutual Fund amounts by Mutual Fund /s to their sister concerns for making gains for them. h) MFs, systems do not maintain the kind of transparency, they should maintain i) Many MF scheme are, at times, subject to lock in period, therefore, deny the j) market drawn benefits k) At times, the investments are subject to different kind of hidden costs l) Redressal of grievances, if any, is not easy PRIME / ME31 / FINAL 17

36 PRIME ACADEMY 31st SESSION MODEL EXAM - FINAL - AUDITING AND ASSURANCE QUESTION PAPER APS No. of Pages: 2 Total Marks: 100 No of Questions: 6 Time Allowed: 3 Hrs All are compulsory 1. a) T Ltd. purchased goods on credit for Rs.5 crores for export from ABC Ltd. Upon the export order being cancelled, T Ltd. decided to sell the same in the domestic market at a discounted price. Accordingly ABC Ltd was requested to offer a price discount of 25%.ABC Ltd. wants to adjust the sales figure to the extent of discount requested by T Ltd. (5 marks) b) The company has a turnover exceeding Rs.5 crores for a period of three consecutive financial years immediately preceding the financial year concerned, but does not have any internal audit system. (5 marks) c) Y Ltd. Has accumulated losses of Rs.12 crores. The Reserves and Surplus of the said company also include Share Premium Account of Rs. 15 crores. The company intends to adjust the accumulated losses against the Share Premium Account. Is the company permitted to do so under the provisions of the Companies Act, 1956? (5 marks) d) P Ltd. of whom you are the Statutory Auditor appoints M/s XYZ as Branch Auditors for one of its branches. M/s XYZ conducted the audit of the branch without visiting the branch and instead getting the books at the H.O. M/s XYZ has submitted their Branch Audit Report to you. (5 marks) 2. a) Discuss whether the following actions by a Chartered Accountant would amount to misconduct or not: i. A Chartered Accountant practicing in India enters into partnership with a Certified Public Accountant in New York. (4 Marks) ii. iii. The offer document of a listed company in which Mr. D, a practicing Chartered Accountant is a director mentions the name of Mr. D as a director along with his various professional attainments and spheres of specialization (4 Marks) Z, a Chartered Accountant wrote several letters to Government Department, pointing out seniority of his firm, sending his life sketch and stating that he had a glorious record of service to the country as well as to the organization of accountancy profession with a view to get the audit work. (4 Marks) b) Write a short note on - Maintenance of branch offices by a Chartered Accountant in practice. (4 Marks) PRIME / ME31 / FINAL 1

37 3. Answer the following: a) Mention the difference between report and certificate. (4 marks) b) What are the contents of reports and certificates for special purposes? (6 marks) c) Briefly describe the auditor's responsibility regarding subsequent events. (6 marks) 4. You have been appointed the statutory auditor of a private limited company for the first time. Apart from adopting the conventional audit procedures such as posting, casting and vouching, what other auditing techniques would you employ for conducting the statutory audit? (16 marks) 5. a) State the items contained in the SEBI s check list for auditors in respect of contract notes issued by a Stock Broker. (8 Marks) b) What are the key functions of an Energy Auditor? (8 Marks) 6. Write short notes on the following: a) Decision Tree b) Utility Routine c) Audit vs. Investigation d) Facultative reinsurance under Insurance Act, (4 X 4 =16 marks) PRIME / ME31 / FINAL 2

38 PRIME ACADEMY 31st SESSION MODEL EXAM - FINAL - AUDITING AND ASSURANCE SUGGESTED ANSWERS 1 a) ABC Ltd. had sold goods on credit worth Rs.5 crores to T Ltd. and, therefore, the sale was complete in all respects. T Ltd s decision to sell the same in the domestic market at a discount does not affect the amount booked under sales by ABC Ltd. The price discount of 25% offered by ABC Ltd. at the request of T Ltd. was not in the nature of discount given during the ordinary course of trade because otherwise same would have been given at the time of sale itself. Now as far as ABC Ltd. is concerned, there appears to be an uncertainty relating to collectability, which has arisen subsequent to the time of sale. Therefore, it would be appropriate to make a separate provision to reflect the uncertainty relating to collectability rather than to adjust the amount of revenue originally recorded. Therefore such discount should be written off to the profit and loss account and not shown as deduction from the sales figure. b) Existence of Internal Audit System: Para 4(A)(xv) of the CARO, 2003 issued under section 227(4A) of the Companies Act, 1956, requires a statutory auditor to comment whether the audited company has an internal audit system commensurate with its size and nature of its business. This is, however, applicable only if the company has a paid up capital exceeding Rs.50 lakhs as at the commencement of the financial year concerned or has an average annual turnover exceeding Rs.5 crores for a period of three consecutive financial years immediately preceding the financial year concerned, whether the company has an internal audit system commensurate with its size and nature of its business. In the instant case, the second condition is met and thus the auditor is required to make an inquiry whether the company has an internal audit system commensurate with its size and nature of its business. Since the internal audit system is not in existence, the auditor will have to mention the fact of not having such a system in his CARO Report. The fact that the company does not have an internal audit system commensurate with its size and nature of its business would also have repercussions on the normal audit procedures since the efficacy of internal control system would itself be questionable. Under the circumstances, apart from disclosing the fact of non-existence of the internal audit system in the report, the auditor should also modify substantive audit procedures as well. c) Section 78 of the Companies Act, 1956 deals with the application of premium received an issue of securities (The word securities was substituted for the word Share by the Companies (Amendment) Act, 1999 w.e.f. October 31, 1998). Sub-section (1) of the said section provides that where a company issues shares at a premium, whether for cash or otherwise, the amount received as premium on such shares shall be transferred to an account called Securities Premium Account and the provisions of the Companies Act, 1956 relating to reduction of the securities capital of a company except as provided in the section shall apply as if the securities premium accounts were paid up securities capital of the company. Subsection (2) of the said section provides that notwithstanding anything contained in sub-section (1), Securities Premium Account may be applied by the company for: a) Issue of fully paid bonus securities. PRIME / ME31 / FINAL 3

39 b) Writing off of the preliminary expenses of the company. c) Writing off of expenses of the commission paid or the discount allowed on any issue of securities or of any debentures of the company. d) Providing the premium payable on the redemption of any redeemable preference securities or of any debentures of the company. In view of the above provisions of the Companies Act, 1956, the company is not permitted to adjust its accumulated loss against the Share Premium Account. d) Branch Auditor s Report: As per provisions of the Companies Act, 1956, the accounts of a branch office of a company are required to be audited either by the company s auditor or by any other person qualified for appointment as auditor of the company. It is not necessary for branch auditor M/s XYZ to visit the branch and conduct the audit only at branch s premises. It is a matter of professional judgment for the branch auditor to decide as to whether he needs to visit the branch. At the same time, the statutory auditor has the right to visit branch offices and to have access to the books of accounts and vouchers maintained at the branch office in this case. In any case, the principal auditor i.e. the statutory auditor of Head Office P Ltd. Is entitled to rely on the work of branch auditor unless there are special circumstances to make it essential for him to visit the branch and examine the books of account and voucher records. As per basic principles governing an audit, the principal auditor is entitled to rely upon the work performed by others provided he exercises adequate skill and care and is not aware of any reason to believe that he should not have so relied. As per SA 600, Using the work of another auditor, the principal auditor is not required to evaluate professional competence because branch auditor happens to be member of ICAI. The statutory auditor is also required to deal with the Branch Auditor s report in the manner, he considers necessary. Therefore, the statutory auditor is required to deal with M/s XYZ s report in the manner it considers fit under the circumstances. 2 a) (i) Partnership with a CPA in New York: Clause (4) of Part I to the First Schedule to the Chartered Accountants Act, 1949 specifies that a chartered accountant in practice shall be deemed to be guilty of professional misconduct in case a member of our Institute enters into partnership with any person other than a chartered accountant in practice. However, partnership between members of the Institute and members of foreign professional bodies are permissible provided members of such bodies are eligible for the membership of the Institute and provided further that they share in the fees or profits of the business of the partnership both within and without India. Thus, chartered accountant would be guilty of professional misconduct since certified public accountants (CPA) are not eligible to become members of the Institute. (ii) The Council of the ICAI has in a communication to members stated that if a public company, in which a chartered accountant in practice is a director, issues a prospectus or gives any announcement that gives descriptions about the Chartered Accountant s expertise, specialization and knowledge in any particular field, it shall constitute a violation of Clauses 6 and 7 of Part I of the First Schedule to the Chartered Accountants Act, The Council has further stated that in such cases the member concerned has to take necessary steps to ensure that such prospectus or public announcements or public communications do not advertise his professional attainments and also that such prospectus or public announcements or public PRIME / ME31 / FINAL 4