The Society of Auditors and Prime Academy Model Exam FINAL March 2017 Paper 1 Financial Reporting No. of Questions: 7 Total Marks: 100

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1 The Society of Auditors and Prime Academy Model Exam FINAL March 2017 Paper 1 Financial Reporting No. of Questions: 7 Total Marks: 100 No. of Pages: 5 Your answers should be supported by working Notes and assumptions where required. Time Allowed: 3 hrs 1. a) An employee Johar has joined a company ABC Ltd. in the year The annual emoluments of Johar as decided is ` 14,90,210. The company also has a policy of giving a lump sum payment of 25% of the last drawn salary of the employee for each completed year of service if the employee retires after completing minimum 5 years of service. The salary of Johar is expected to 10% per annum. The company has inducted Johar in the beginning of the year and it is expected that he will complete the minimum five year term before retiring. What is the amount the company should charge in its Profit and Loss account every year as cost for the Defined Benefit obligation? Also calculate the current service cost and the interest cost to be charged per year assuming a discount rate of 8%. (P.V factor for 8% , 0.794, 0.857, 0.926, 1) b) Milton Ltd. is a full tax free enterprise for the first 10 years of its existence and is in the second year of its operations. Depreciation timing difference resulting in a deferred tax liability in years 1 and 2 is ` 200 lakhs and 400 lakhs respectively. From the 3rd year onwards, it is expected that the timing difference would reverse each year by ` 10 lakhs. Assuming tax 35%, find out the deferred tax liability at the end of the second year and any charge to the profit and loss account. c) On , C Ltd. purchased an asset for ` 10 lakhs with an estimated useful life of 10 years The machine is depreciated on straight line basis. On , the asset was revalued to ` 8,40,000 and the surplus arising out of revaluation being credited to revaluation reserve. During the year ended , the asset was reviewed for impairment and recoverable amount of the asset was ascertained to be only ` 4,30,000. Next year, there were some favourable changes in the market conditions and the recoverable amount of the asset was reassessed at ` 5,00,000. You are required to calculate the carrying amount of the asset as on and show how changes in value of the asset is to be treated in the books of accounts, assuming C. Ltd. has the policy of writing down excess depreciation charged on revaluation to Revaluation Surplus. d) On January 1, 2013, S Ltd. sold equipment to B Ltd. for ` 6,14,460. The carrying amount of the equipment on that date was ` 1,00,000. The sale was a part of the package under which B Ltd. leased the asset to S Ltd. for a ten-year term. The economic life of the asset is estimated at 10 yea` The minimum lease rent payable by the lesser has been fixed at ` 1,00,000 payable annually beginning December 31, The incremental borrowing interest rate of S Ltd. is estimated at 10% per annum. Calculate the net effect on the profit and loss account? (4 x 5=20 Marks) PRIME/44 th ME/FINAL 1

2 2. Evil Ltd. purchased control of Devil Ltd. on Following are the summarized Balance Sheets of Evil Ltd. and Devil Ltd. as at 31st March, 2013: Liabilities Evil Ltd. ` Devil Ltd. ` Assets Evil Ltd. ` Devil Ltd. ` Equity Capital (Rs 10) General Reserves Profit & Loss Account Trade Payables 6,00,000 60,000 1,00,000 1,00,000 8,60,000 3,00,000 50,000 1,00,000 80,000 5,30,000 Goodwill Land & Buildings Plant & Machinery Investment:22,500 Shares of Devil Ltd. Inventory Trade Receivables Cash at Bank 10,000 1,00,000 2,00,000 3,37,500 1,17,500 50,000 45,000 8,60,000 40,000 1,00,000 1,80,000 1,00,000 90,000 20,000 5,30,000 On , Devil Ltd. had ` 50,000 in General Reserve and Rs 60,000 in Profit and Loss A/c. On 30th September 2012, 10% dividend was declared by Devil Ltd. in respect of financial year from its profit and loss account. Evil Ltd. credited its share of dividend, on receipt, to the Profit and Loss Account. Trade receivables of Devil Ltd. include ` 10,000 due from Evil Ltd. Machinery of Devil Ltd. standing in books at ` 2,00,000 as on , was revalued at ` 2,40,000. Inventory of Evil Ltd. includes goods valued at ` 16,000 purchased from Devil Ltd., on which the latter made a profit of 1/3rd on cost price. Prepare the Consolidated Balance Sheet of Evil Ltd. and its subsidiary Devil Ltd. as on (16 Marks) 3. a) Jayadev Ltd. had earned a PAT of ` 48 lakhs for the year ended It wants you to ascertain the value of its business, based on the following information. 1. Tax rate for the year 2013 was 36%. Future tax rate is estimated at 34%. 2. The company's equity shares are quoted at Rs 120 at the Balance Sheet date. The company had an equity capital of Rs 100 lakhs, divided into shares of ` 50 each. 3. Profits for the year 2013 have been calculated after considering the following in the Profit and Loss Account: (i) Subsidy ` 2 lakhs received from the Government towards fulfilment of certain social obligations. The Government has withdrawn this subsidy and hence, this amount will not be received in future. (ii) Interest ` 8 lakhs is on term loan. The final instalment of this term loan was fully settled in this year. (iii) Managerial remuneration ` 15 lakhs. The shareholders have approved an increase of ` 6 lakhs in the overall managerial remuneration, from the next year onwards. Loss on sale of fixed assets and Investments amounting to ` 8 lakhs (8 Marks) b) On , Happy Ltd. grants to its senior officer, a right to choose either 250 shares (with some post-vesting restrictions) or a cash payment equal to value of 200 shares, conditional upon remaining in service for 3 years Fair value of a share without considering post-vesting restrictions is ` 70 on , ` 75 on , ` 80 on and ` 85 on Fair value of a share after taking into account post-vesting restrictions is ` 68 on Face value per share is ` 10. Give the amounts to be recognised each year. Also, give the journal entries for settlement if (1) employee chooses cash payments (2) employee chooses shares (8 Marks) PRIME/44 th ME/FINAL 2

3 4. a) The following information is available of a concern; calculate E.V.A.: Debt capital 12% ` 2,000 crores Equity capital ` 500 crores Reserve and surplus ` 7,500 crores Capital employed ` 10,000 crores Risk-free rate 9% Beta factor 1.05 Market rate of return 19% Equity (market) risk premium 10% Net Operating profit after tax Rs 2,100 crores Tax rate 30% (6 Marks) b) A Limited and B limited decided to amalgamate and form a new company C limited. Prior to the amalgamation A limited had 50 lakh equity shares which were valued at ` 20 per share. B limited, prior to the amalgamation had 30 lakh shares which were valued at ` 15 Rs per share. The value per share of new company C limited was ` 10/- per share. Discuss the concept of legal acquirer vis-à-vis accounting acquirer enshrined in IND AS 103 based on the above data. How does the situation change under AS 14. (10 Marks) 5. a) From the following data, prepare a Value Added Statement of Merit Ltd., for the year ended : Particulars Rs ` Rs Particulars ` Decrease in Stock 24,000 Sales 40,57,000 Purchases 20,20,000 Other Income 55,000 Wages & Salaries 10,00,000 Manufacturing & Other Expenses 2,30,000 Finance Charges 4,69,000 Depreciation 2,44,000 Profit Before Taxation 1,25,000 Total 41,12,000 41,12,000 Particulars Rs ` Profit Before Taxation 1,25,000 Less: Tax Provisions (40,000) Income Tax Payments (for earlier years) (3,000) Profit After Taxation 82,000 Appropriations of PAT Debenture Redemption Reserve 10,000 General Reserve 10,000 Proposed Dividend 35,000 Balance carried to balance Sheet 27,000 Total 82,000 (10 Marks) b) Mega Ltd. issued ` 100,00,000 worth of 8% debentures of face value ` 100 each on par value basis on 1st January These debentures are redeemable at 12% premium at the end of 2014 or exchangeable for ordinary shares of Mega Ltd. on 1:1 basis. The interest rate for similar debentures that do not carry conversion entitlement is 12%. You are required to calculate the value of debt portion of the above compound financial instrument. The PV of rupee at the end of years 1 to 4 at 8% and 12% are supplied to you as: PRIME/44 th ME/FINAL 3

4 8% 12% End of year End of year End of year End of year (6 Marks) 6. Given below is the summarized Balance Sheet of Hello Ltd. as on : (` in lakhs) Equity share capital 4.00 Block assets less depreciation to 6.00 (in equity shares of ` 10 date each) Inventory and trade receivables % preference share capital 3.00 General reserve 1.00 Cash and bank 0.70 Profit and loss account 1.00 Trade payables Good Ltd. another existing company holds 25% of equity share capital of Hello Ltd. purchased at ` 10 per share. It was agreed that Good Ltd. should take over the entire undertaking of Hello Ltd. on on which date the position of current assets (except cash and bank balances) and trade payables was as follows: Inventory and trade receivables ` 4 lakhs Trade payables ` 2 lakhs Profits earned for half year ended by Hello Ltd. was ` 70,500 after charging depreciation of ` 32,500 on block assets. Hello Ltd. declared 10% dividend for on and the same was paid within a week. Goodwill of Hello Ltd. was valued at ` 80,000 and block assets were valued on d a te o f ta k e o ve r at 10% over their book value stated as on , for purposes of take over. Preference shareholders of Hello Ltd. will be allotted 10% preference shares of ` 10 each by Good Ltd. Equity shareholders of Hello Ltd. will receive requisite number of equity shares of ` 10 each from Good Ltd. valued at ` 10 per share. (a) Compute the purchase consideration. (b) Explain, how the capital reserve or goodwill, if any, will appear in the Balance Sheet of Good Ltd. after absorption. (16 Marks) 7. Answer Any 4 Of The Following 5 Questions a) Rock star Ltd. discontinues a business segment. Under the agreement with employee s union, the employees of the discontinued segment will earn no further benefit. This is a curtailment without settlement, because employees will continue to receive benefits for services rendered before discontinuance of the business segment. Curtailment reduces the gross obligation for various reasons including change in actuarial assumptions made before curtailment. In this, if the benefits are determined based on the last pay drawn by employees, the gross obligation reduces after the curtailment because the last pay earlier assumed is no longer valid. Assuming the following: (i) Immediately before the curtailment, based on current actuarial assumption, the gross obligation was estimated at ` 6,000. (ii) The fair value of plan assets on the date was estimated at ` 5,100. (iii) The unamortized past service cost was ` 180. (iv) Curtailment reduces the obligation by ` 600, which is 10% of the gross obligation. PRIME/44 th ME/FINAL 4

5 Rock star Ltd. estimates the shares of unamortized service cost that relates to the part of the obligation that is estimated at 10% of ` 180 at ` 18. Calculate the gain from curtailment and liability after curtailment to be recognised in the balance sheet b) P Ltd. had 12,00,000 equity shares of ` 10 each fully paid up outstanding prior to rights issue. The details of rights issue are as follows: (i) One new share for every two shares outstanding. (ii) Rights issue price ` 18 (iii) Last date to exercise rights is 31st December, 2011 (iv) Fair value of each equity share prior to exercise of rights Rs 24 The details of net profit earned by the company as follows: Year ended ` 40,00,000 Year ended ` 54,00,000 Calculate EPS to be reported under AS-20. c) The Chief Accountant of S Ltd. gives the following data regarding its six Segments ` in lakhs Particulars M N O P Q R Total Segment Assets Segment Results Segment Revenue The Chief accountant is of the opinion that segments M and N alone should be reported. Is he justified in his view? Discuss d) Alert limited borrowed 10% debentures for ` 500 lakhs on 1 st April 2014, interest is payable annually and principal is repayable after 3 years It incurred brokerage of ` 30 lakhs to an intermediary who arranged for the debentures to be fully subscribed on 1 st April The Finance department worked out its pre tax cost of this debenture issue p.a. The chief accountant of Alert limited contends that the borrowing cost of Alert limited for the year ending 31 st March 2015 is ` 50 lakhs being 10% of 500 lakhs borrowed. Comment on the accountants opinion assuming (i) AS 16 is applicable to Alert limited (ii) IND AS 23 is applicable to Alert limited. e) From the following information, determine the possible value of brand as per potential earning model: (` in lakhs) Profits before tax 10,000 Income tax 2,500 Tangible fixed assets 30,000 Identifiable intangibles other than Brand 4,500 Weighted average cost of capital (%) 14% Expected normal return on tangible assets (weighted average cost 14% 18% + Normal spread 4%) Appropriate capitalization factor for intangibles is 25%. (4 x 4 =16 Marks) ,200 PRIME/44 th ME/FINAL 5

6 The Society of Auditors and Prime Academy 44 th session Model Exam Final Financial Reporting Suggested Answers 1. A) Calculation of Defined Benefit Obligation Expected last drawn salary=`14,90,210 x 110% x 110% x 110% x 110% x 110% = ` 24,00,000 Defined Benefit Obligation (DBO)= ` 24,00,000 x 25% x 5= ` 30,00,000 Amount of `6,00,000 will be charged to Profit and Loss Account of the company every year as cost for Defined Benefit Obligation. Calculation of Current Service Cost Year Equal apportioned amount of DBO [i.e. ` 30,00,000/ 5years] 8% PV factor Current service cost (Present Value) A B C d = b x c 1 6,00, (4 Years) 4,41, ,00, (3 Years) 4,76, ,00, (2 Years) 5,14, ,00, (1 Year) 5,55, ,00,000 1 (0 Year) 6,00,000 Calculation of Interest Cost to be charged per year Year Opening balance Interest cost Current service cost Closing balance A b c = b x 8% d e = b + c + d ,41,000 4,41, ,41,000 35,280 4,76,400 9,52, ,52,680 76,214 5,14,200 15,43, ,43,094 1,23,447 5,55,600 22,22, ,22,141 1,77,859* 6,00,000 30,00,000 *Due to approximations used in calculation, this figure is adjusted accordingly. B) In the case of tax free companies, no deferred tax liability is recognized, in respect of timing differences that originate and reverse in the tax holiday period. Deferred tax liability or asset is created in respect of timing differences that originate in a tax holiday period but are expected to reverse after the tax holiday period. For this purpose, adjustments are done in accordance with the FIFO method. Of ` 200 lakhs, ` 80 lakhs will reverse in the tax holiday period. Therefore, Deferred Tax Liability will be created on ` % i.e. ` 42 lakhs. In the second year, the entire ` 400 lakhs will reverse only after the tax holiday period. Therefore, deferred tax charge in the Profit and Loss Account will be ` 400 x 35% = `140 lakhs and deferred tax liability in the Balance Sheet will be (42+140) = ` 182 lakhs. PRIME/44 th ME/FINAL 1

7 C) (a) Calculation of carrying amount as on : ` Cost of the asset purchased on ,00,000 Less: Depreciation 3 years upto (3/10) (3,00,000) Carrying amount as on ,00,000 Add: Upward revaluation as on credited to Revaluation Reserve 1,40,000 Carry amount as on ,40,000 Less: Depreciation 3 years upto (3/7) (3,60,000) 4,80,000 Less: Impairment loss due to recoverable amount being ` 4,30,000 (50,000) Carrying amount as on ,30,000 Less: Depreciation for (4,30,000/4) (1,07,500) 3,22,500 Add: Reversal of impairment (as per Working Note 2) 37,500 Carrying amount as on ,60,000 Working Notes: 1. Statement showing balance of Revaluation Reserve Revaluation Reserve credited on ,40,000 Less: Excess depreciation charges due to revaluation for 3 years upto [(1,40,000/7) x 3] (60,000) Revaluation Reserve balance on ,000 Less: Impairment loss on (50,000) Revaluation Reserve balance on ,000 Less: Depreciation charge for (7,500) 2. Treatment of Impairment loss: Reversal of impairment loss should not exceed the carrying amount that would have been determined (net of depreciation) has no impairment loss been recognized for the asset in prior accounting periods. ` Carrying amount of the asset before impairment as on 4,80, Less: Depreciation for the year (1,20,000) Carrying amount of the asset as on ,60,000 Carrying amount as calculated after impairment (3,22,500) Reversal of impairment to be transferred to Revaluation surplus 37,500 Impairment gain to be ignored: 5,00,000 Recoverable amount on (3,60,000) Less: Carrying amount on ` 22,500 Add: Reversal of impairment on ,500 Revaluation Reserve balance on ,000 1,40,000 PRIME/44 th ME/FINAL 2

8 D) The PV of minimum lease payments at 10% discount rate: = ` 1,00,000 X = ` 6,14,460 S Ltd. should recognize the asset and the liability at ` 6,14,460. The excess of sales proceeds over carrying amount = ` 6,14,460 ` 1,00,000 = Rs5,14,460 As per para 48 of AS 19 Leases, if a sale and leaseback transaction results in a finance lease, any excess or deficiency of sale proceeds over the carrying amount should not be immediately recognised as income or loss in the financial statements of a lessee. Instead, it should be deferred and amortised over the lease term in proportion to the depreciation of the leased asset. Therefore, assuming that S Ltd. has decided to charge depreciation on straight line basis, AS 19 requires S Ltd. to: a. Recognize depreciation of ` 61,446 per annum for 10 years b. Allocate excess of ` 5,14,460 over the lease term at the rate of ` 51,446 p.a. The net effect is a debit of (` 61,446 ` 51,446) ` 10,000 per annum to the profit and loss account for 10 years, as covered under the lease term. Had there been no sale and lease back transaction, the profit and loss account for each year covered in the lease term would have been charged by (` 1,00,000/10) or ` 10,000, towards depreciation. Thus, the sale and lease back transaction has no impact on profit or loss to be reported by the lessee (vendor in the sale transaction) over the lease period. The deferred income (excess) should be presented as a deduction from the carrying amount of the asset. Thus, the asset should be presented by S Ltd. in its Balance Sheet dated December 31, 2013 as follows: ` Gross Block 6,14,460 Less: Accumulated depreciation (61,446) Net Block 5,53,014 Less: Deferred Income (5,14,460 51,446) (4,63,014) Net Block 90,000 In effect, the carrying amount of the equipment does not change with the sale and lease back transaction. In substance, the sale and lease back transaction is a borrowing transaction resulting in recognition of a liability in the balance sheet and recognition of interest expense in the profit and loss account. 2. Consolidated Balance Sheet of Evil Ltd. with its subsidiary Devil Ltd. as on 31st March, 2013 Notes No. ` I. Equity and Liabilities (1) Shareholder's Funds (a) Share Capital 1 6,00,000 (b) Reserves and Surplus 2 1,93,000 Minority interest (W.N. 4) Current Liabilities 1,23,500 Trade payables Total 3 1,70,000 10,86,500 II. Assets (1) Non-current assets Fixed assets Tangible assets 4 6,28,000 Intangible assets 5 50,000 (2) Current assets (a) Inventories 6 2,13,500 (b) Trade receivables 7 1,30,000 PRIME/44 th ME/FINAL 3

9 (c) Cash and cash equivalents 8 65,000 10,86,500 Notes to Accounts ` ` ` 1. Share Capital Equity shares of ` 10 each, fully paid up 6,00, Reserves and surplus 3 Trade Payables. Capital reserve (W.N.3) 33,750 General reserve 60,000 Profit and loss account (W.N. 6) 99,250 1,93,000 Evil Ltd. 1,00,000 Devil Ltd 80,000 1,80,000 Less: Mutual indebtedness (10000) 1,70,000 3 Tangible Assets Land and buildings Evil Ltd. Devil Ltd. Plant and machinery Evil Ltd Devil Ltd. 1,80,000 Add: Upward revaluation 50,000 2,30,000 Less: Excess Depreciation on upward Revaluation (2,000) 4 Intangible Assets Evil Ltd. Devil Ltd. 5 Inventories Evil Ltd Devil Ltd Less: Unrealised profit) 6 Trade receivables Evil Ltd. Devil Ltd. Less: Mutual indebtness 7 Cash and cash equivalents Bank Balances Evil Ltd. Devil Ltd. 1,00,000 1,00,000 2,00,000 2,00,000 2,28,000 4,28,000 6,28,000 10,000 40,000 50,000 1,17,500. 1,00,000 2,17,500 (4,000) 2,13,500 50,000 90,000 1,40,000 (10,000) 1,30,000 45,000 20,000 65,000 PRIME/44 th ME/FINAL 4

10 General reserve as on Profit and loss account as on ,00,000 Less: Opening Balance 60,000 Less: Dividend for (out of pre acquisition profits (30000) ` Pre-acquisition profitupto (Capital profits) ` Post acquisition profits ( )) Profit and loss account ` Upward revaluation of plant and machinery ason (W.N.2) Excess depreciation (for 6 months) due (2000) to upward revaluation (W.N.2) Total Minority Interest (25%) 41,250 8,250 Share of Evil Ltd. (75%) 1,23,750 24,750 i) Revaluation of Plant & Machinery of Devil Ltd. and its book value as on Depreciation during the year = Opening Balance less Closing Balance = 2,00,000 1,80,000 = 20,000 Depreciation rate = (20,000/2,00,000) x 100 = 10% (a) (b) Computation of Revaluation Gain / Loss Revalued Amount on (date of acquisition) Less: Book Value on (date of acquisition) Value on Rs 2,00,000 ` 2,40,000 Less: Depreciation for 6 months at 10% (Rs10,000) 1,90,000 Revaluation Gain i.e. Capital Profit 50,000 Computation of Depreciation on Revaluation Gain / Loss Depreciation on Revalued Plant for 6 months 2,40,000 6/12 10% Less: Depreciation already provided on Rs 2,00,000 6/12 10% Revenue Loss ii) Calculation of cost of control ` 12,000 (10,000) 2,000 Share capital in Devil Ltd. 2,25,000 Add: Capital profit 1,23,750 Less: Cost of Investments 3,37,500 ` 3,48,750 Less: Pre-acquisition dividend received for (22,500) (3,15,000) Capital Reserve 33,750 PRIME/44 th ME/FINAL 5

11 iii) Calculation of minority interest [25%] Share capital 75,000 Capital (pre-acquisition) profits [W.N.1] 41,250 Revenue (post-acquisition) profits - Profit and loss [W.N.1] 8,250 1,24,500 Less: Unrealised profit [W.N. 5] (1,000) 1,23,500 ` iv) Stock reserve (plant and machinery) Unrealized profit =16,000 x 1/ 3 =Rs 4,000 4/3 To be adjusted from minority interest and consolidated profit and loss account in the ratio of 25:75. v) Consolidated profit and loss account as on ` Profit and loss account balance of Evil Ltd. as on ,00,000 Less: Pre-acquisition dividend wrongly credited (22,500) 77,500 Add: Share in post-acquisition profit and loss account of Devil Ltd. (W.N.1) 24,750 Less: Unrealized profit [W.N. 5] (3,000) 99,250 Note: Unrealized profits on closing stock have been eliminated to the extent of holding company s share in Profit and Loss Account and balance adjusted in Minority Interest as it relates to upstream transaction. 3. A)Computation of Future Maintainable Profits Particulars Profit after tax for the year ,00,000 Add: Tax expense (Tax is 36%, So, PAT = 64%. Hence, Tax = 48,00,000 x 36/64) 27,00,000 Profit before tax for the year 2013 Add/ (Less) Adjustments in respect of non-recurring items ` 75,00,000 Subsidy income not receivable in future (2,00,000) Interest on term loan not payable in future, hence saved 8,00,000 Additional managerial remuneration Loss on sale of fixed assets and investments (non- (6,00,000) recurring) 8,00,000 Future maintainable profits before tax 83,00,000 Less: Tax expense at 34% Future maintainable profits after tax equity earnings (28,22,000) 54,78,000 PRIME/44 th ME/FINAL 6

12 Computation of capitalization rate and value of business Particulars (a) Profit after tax for the year 2013 (b) Number of equity shares (` 100 lakhs / ` 50 per share) (e) Earnings per share (EPS) = PAT/Number of Equity Shares (d) Market price per share on balance sheet date ` 48 lakhs 2 lakhs Rs24 Rs120 (e) Price Earnings Ratio = MPS / EPS 5 (f) Capitalization Rate = (1 / PE Ratio) x % (g) Value of Business = Future Maintainable Profits /Capitalization Rate = ` Lakhs / 20% ` lakhs B) Fair value under equity settlement = 250 shares x ` 68 = ` 17,000 Fair value under cash settlement = 200 shares x ` 70 = Rs 14,000 So, fair value of equity component = ` 17,000 ` 14,000 = ` 3,000 Fair value of liability component = ` 14,000 Fair value of liability component should be accounted for as per cash- settled employee share-based plan. Fair value of equity component should be accounted for as per equity-settled employee sharebased payment plan. Amounts to be recognised for liability component: Particulars ` ` ` A Fair value of share without restrictions B Closing provision required 5,000 10,667 17,000 [200 x 75 x 1 /3] [200 x 80 x 2/3] [200x85 x 3/3] C Opening provision 0 5,000 10,667 D Expense for the year (B - C) 5,000 5,667 6,333 Amounts to be recognised for equity component: Particulars Cumulative expense to be recognised till date 1, x1/3, 2, x2/3 3, x2/3 Cumulative expense already Recognized Expense for the year (E - F) PRIME/44 th ME/FINAL 7

13 Particulars Debit Credit Year (`) ( `) Employee compensation expense A/c Dr. 5,000 To Provision for liability component of employeeshare-based payment plan A/c 5,000 (Being expense recognised in respect of liability component of the plan with cash alternative) Year Employee compensation expense A/c Dr. 1,000 To Stock options outstanding A/c 1,000 (Being expense recognised in respect of equity component of the plan with cash alternative) Year Employee compensation expense A/c Dr. 5,667 To Provision for liability component of employee share-based payment plan AIc 5,667 (Being expense recognised in respect of liability component of the plan with cash alternative) Year Employee compensation expense A/c Dr. 1,000 To Stock options outstanding A/c 1,000 (Being expense recognised in respect of equity component of the plan with cash alternative) Year Employee compensation expense A/c Dr. 6,333 To Provision for liability component of employeeshare-based payment plan AIc 6,333 (Being expense recognised in respect of liabilitycomponent of the plan with cash alternative) Year Employee compensation expense A/c Dr. 1,000 To stock option O/S 1000 Being expense recognised in respect of equity component of the plan with cash alternative PRIME/44 th ME/FINAL 8

14 Case (1) - When cash settlement is made: Provision for liability component of employee share- based payment plan A/c To Bank A/c Being cash paid under the plan with cash alternative) Stock options outstanding AIc 3000 To General reserve A/c 3000 (Being balance in the equity account transferred to general reserve) Case (2) - When equity settlement is made: Stock options outstanding A/c Dr Provision for liability component of employeeshare-based payment plan A/c To Share capital A/c 2500 To Securities premium A/c Being shares issued under the plan on exercise of equity alternative) 4. A) E.V.A. = NOPAT COCE NOPAT = Net Operating Profit after Tax COCE = Cost of Capital Employed COCE = Weighted Average Cost of Capital Average Capital Employed = WACC Capital Employed Debt Capital ` 2,000 crores Equity capital ( ,500) = ` 8,000 crores Capital employed = ` 2,000+ ` 8,000= ` 10,000 crores Debt to capital employed = 2,000 /10000= 0.20 Equity to Capital employed = 8,000/10000= 0.80 Debt cost before Tax 12% Less: Tax (30% of 12%) 3.6% Debt cost after Tax 8.4% According to Capital Asset Pricing Model (CAPM) Cost of Equity Capital = Risk Free Rate + Beta Equity Risk Premium (Or) = Risk Free Rate + Beta (Market Rate Risk Free Rate) = (19-9) = = 19.5% WACC = Equity to CE x Cost of Equity capital + Debt to CE x Cost of debt = % % = 15.60% % = 17.28% COCE = WACC Capital employed = 17.28% ` 10,000 crores = ` 1728 crores E.V.A. = NOPAT COCE = ` 2,100 ` 1,728 = ` 372 crores B) Computation of PC in shares to A limited 20/10 * 50 lakh shares = 100 lakh shares Computation of PC in shares to B limited 15/10*30 lakh shares = 45 lakh shares PRIME/44 th ME/FINAL 9

15 Therefore the combined entity post merger will have 145 lakh shares. Out of this 145 lakh shares, shareholders of A limited will hold 100 lakh shares and therefore will control the combined entity. Hence under IND AS 103, A limited is the accounting acquirer although the legal seller. Therefore under IND AS, in the books of C (combined entity), A limited s net assets will be at book value and B limited net assets will come in at fair values. Under AS 14, both A limited and B limited will be legal sellers and C limited will be the purchaser. Hence net assets of both A limited and B limited will come at fair values in the books of C limited after the merger. 5. A) Value Added Statement of Merit Ltd. For the year ended Particulars ` ` Sales/Turnover 40,57,000 Less: Cost of Bought out goods and services Decrease in Stock 24,000 Purchases 20,20,000 Manufacturing and other expenses 2,30,000 (22,74,000) Value Added by manufacturing and Trading 17,83,000 Activities Add: Other Income 55,000 Gross Value Added 18,38,000 Applied as follows: ` ` 1. To Pay Employees - Salaries, Wages, etc 10,00, To Pay Government as - Taxes, Duties etc (40,000) 40, To Pay Providers of capital - Interest on borrowings 4,69,000 - Dividends 35,000 5,04, To Pay for Maintenance and Expenses of the Company - Depreciation 2,44,000 - Debenture Redemption Reserve 10,000 - General Reserve 10,000 - Retained Earnings 27,000 Income tax earlier years 3,000 2,94,000 Total Application of Value Added 18,38,000 Income tax earlier years can be disclosed as part of Holders or as part of Government. In the solution not shown as part of G as it will alter the taxes paid to Government in current year. Hence adjusted in H (Holders of capital) B) PV of debentures redeemable (including ` 100,00,000 x 1.12 x 0.636) = ` 71,23,200 premium) in 2014 PV of interest on debentures ( ` 8,00,000 x sum of 4 yrs disc 12%) = ` 24,30,400 Value of Debt portion of convertible = ` 95,53,600 debentures Therefore Value of Equity portion = ` 100,00,000 ` 95,53,600 =` 4,46,400 PRIME/44 th ME/FINAL 10

16 6.Calculation of Purchase Consideration (for net assets of Hello Ltd taken over) Assets taken over: ` Goodwill as agreed 80,000 Block Assets at 10% over their book value as on ,60,000* (agreed value for purposes of take over 6,00,000 X 110%) Inventory and trade receivables as on ,00,000 Cash and Bank (See Working Note) 1,33,000 12,73,000 Less: Liabilities taken over: Trade payables as on (2,00,000) Purchase Consideration 10,73,000 Calculation of Shares Allotted: ` Net Assets taken over 10,73,000 Less: Allotment of 10% preference shares to preference shareholders of Hello Ltd. (3,00,000) 7,73,000 Less: Belonging to Good Ltd. (1/4 x` 7,73,000) (1,93,250) Payable to other equity shareholders 5,79,750 Number of equity shares of `10 each to be issued (valued at `10 each)=57,975 Calculation of Capital Reserve: ` ` Net Assets taken over Less: Preference shares to be allotted (3,00,000) Equity shares to be allotted (5,79,750) 10,73,000 Cost of investments (1,00,000) (9,79,750) Capital Reserve 93,250 Alternatively, Capital Reserve may be computed as follows: Value of investments in HELLO Ltd. 1,93,250 Less: Cost of investments (1,00,000) Balance Sheet of Good Ltd. As at 30 th September, 2015 (Extract) Particulars Note No. ` 93,250 Equity and Liabilities Shareholder's Funds Reserves and Surplus 1 13,250 Notes to accounts 51. Reserves and Surplus Capital Reserve Less: Goodwill 93,250 (80,000) ` 13,250 PRIME/44 th ME/FINAL 11

17 Working Note: Ascertainment of Cash and Bank Balances as on 30 th September,2015 Balance Sheet as at 30 th September,2015 Particulars Note No. ` Equity and Liabilities Shareholder's Funds Share Capital Reserves and Surplus (2) Current Liabilities Trade Payables Total Assets Non-current assets Fixed assets Tangible assets Current assets Inventories &Trade receivables Cash and cash equivalents (Bal. fig.) Total Notes to Accounts Share Capital Equity Share Capital 10% Preference Share Capital Reserves and surplus General Reserve Profit and Loss Account: Balance brought forward Add: Profit for the first half Less: Dividend on preference share capital paid Dividend on equity share capital paid Trade Payables Tangible Assets Block Assets Less: Depreciation Inventories & Trade Receivables ` ` ` 4,00,000 3,00,000 6,00,000 (32,500) 7,00,000 2,00,500 2,00,000 11,00,500 5,67,500 4,00,000 1,33,000 11,00,500 7,00,000 1,00,000 1,00,000 1,70,500 70,500 (70,000) 30,000 40,000 1,00,500 2,00,500 2,00,000 5,67,500 4,00,000 PRIME/44 th ME/FINAL 12

18 7. A)Gain from curtailment is estimated as under Reduction in gross obligation 600 Less: Proportion on unamortized past service cost 18 Gain from curtailment 582 ` The liability to be recognised after curtailment in the balance sheet is estimated as under: Reduced gross obligation 5,400 Less: Fair value of plan assets 5,100 ` 300 Less: Unamortized past service cost 162 Liability to be recognized in the balance sheet 138 B)Calculation of theoretical ex-rights fair value per share (12,00,000 shares ` 24) + (6,00,000 shares ` 18) 12,00,000 shares + 6,00,000 shares = ` 2,88,00,000 + ` 1,08,00,000 = 22 18,00,000 shares Calculation of adjustment factor =Fair value per share prior to exercise of rights / Theoretical ex rights value per share ` 24 /` 22= Calculation of EPS for the year ended EPS originally reported=` 40,00,000 = ` ,00,000 shares EPS restated for rights issue = ` 40,00,000 = 40,00,000 12,00,000 shares ,09,200 = ` 3.05 Calculation of EPS for the year ended = ` 54,00,000 (12,00, /12) + (18,00,000 3/12) = 54,00,000 = ,81, ,50,000 PRIME/44 th ME/FINAL 13

19 C) (i) As per para 27 of AS 17 Segment Reporting, a business segment or geographical segment should be identified as a reportable segment if: Its revenue from sales to external customers and from other transactions with other segments is 10% or more of the total revenue- external and internal of all segments; or (ii) Its segment result whether profit or loss is 10% or more of: (1) The combined result of all segments in profit; or (2) The combined result of all segments in loss, whichever is greater in absolute amount; or (iii) Its segment assets are 10% or more of the total assets of all segments. If the total external revenue attributable to reportable segments constitutes less than 75% of total enterprise revenue, additional segments should be identified as reportable segments even if they do not meet the 10% thresholds until at least 75% of total enterprise revenue is included in reportable segments. i) On the basis of turnover criteria segments M and N are reportable segments. ii) On the basis of the result criteria, segments M, N and R are reportable segments (since their results in absolute amount is 10% or more of ` 200 lakhs). iii) On the basis of asset criteria, all segments except R are reportable segments. Since all the segments are covered in at least one of the above criteria all segments have to be reported upon in accordance with Accounting Standard (AS) 17. Hence the opinion of chief accountant is wrong D) The contention of the accountant is wholly incorrect.as 16 Borrowing cost includes interest cost and amortization of related expenses on the borrowal of funds. Therefore, borrowing cost for the year ending 31/3/15 will be interest cost of 50 lakhs plus brokerage cost of 30 lakhs = 80 lakhs (assuming full brokerage cost is amortized immediately) IND AS 23 Under IND AS 23, borrowing cost is worked out on the effective amortization method. Since the effective rate is 12.52% p.a., borrowing cost for the year ending 31/3/15 will be (500-30) * 12.52%, i.e. 470*12.52% = lakhs. E) Calculation of Possible Value of Brand (` in lakhs) Profits after Tax (`10,000-2,500) lakhs 7,500 Less: Profit allocated to tangible assets (18% of ` 30,000 lakhs) (5,400) Profit allocated to intangible assets including brand 2,100 Capitalization 25% Capitalized value of intangibles including brand (` 2,100 lakhs/25%) 8,400 Less: Identifiable intangibles other than Brand (4,500) Brand Value 3,900 PRIME/44 th ME/FINAL 14

20 The Society of Auditors & Prime Academy Model Exam FINAL March 2017 Paper 2 STRATEGIC FINANCIAL MANAGEMENT No. of Questions: 7 Total Marks: 100 No. of Pages: 5 Time Allowed: 3 hrs Your answers should be supported by working Notes and assumptions where required. [ Qn. 1 is compulsory. Answer any 5 from the rest ] 1(a). A company has invested Rs.500 lakhs in assets. There are 50 lakhs shares outstanding. The par value per share is Rs.10/-. It earns a rate of 15% on its investment and has a policy of retaining 50% of the earnings. If the appropriate discount rate of the firm is 10%, what is the price of its share using the Gordon s model? What will happen to the price of the share if the company has a payout of 80% or 20%? (b) A mutual fund began the year 2008 with a portfolio valued at Rs. 10 lakhs. It invested further into the fund and made withdrawals therefrom as per details below: Date Contribution Withdrawal Portfolio value 31st Dec st Mar th June th Sep st Dec (i) Calculate the time-weighted rate of return for each quarter (ii) Calculate RWR for the year. (c) M. Co. Ltd., is studying the possible acquisition of N Co. Ltd., by way of merger. The following data are available in respect of the companies: Particulars M Co. Ltd. N Co. Ltd. Earnings after tax (Rs.) 80,00,000 24,00,000 Number of equity shares 16,00,000 4,00,000 Market value per share (Rs.) (i) Compute pre-merger EPS and PEM of both companies (ii) If the merger goes through the exchange of equity and the exchange ratio is based on the current market price, what is the new earnings per share for M Ltd.? (iii) What is the gain or loss in (ii) above? (iv) N Co Ltd., wants to be sure that the earnings available to its shareholders will not be diminished by the merger. What should be the exchange ratio in that case? PRIME/44th ME/FINAL (1)

21 (d) The following data are available for a bond Face value Rs. 1,000 Coupon Rate 16% Years to Maturity 6 Redemption value Rs. 1,000 Yield to maturity 17% What is the current market price, duration and volatility of this bond? Calculate the expected market price, if increase in required yield is by 75 basis points. (4 x 5 = 20 marks) 2(a) Gretel Limited is setting up a project for manufacture of boats at a cost of Rs.300 lakhs. It has to decide whether to locate the plant in next to the sea shore (Area A) or in an inland area with no access to any waterway (Area B). If the project is located in Area B then Gretel Limited receives a cash subsidy of Rs.20 lakhs from the Central Government. Besides, the taxable profits to the extent of 20% is exempt for 10 years in Area B. the project envisages a borrowing of Rs.200 lakhs in either case. The rate of interest per annum is 12% in Area A and 10% in Area B. The borrowing of principal has to be repaid in 4 equal installments beginning from the end of the 4th year. With the help of the following information, you are required to suggest the proper location for the project to the CEO of Gretal Limited. Assume straight line depreciation with no residual value, income tax 50% and required rate of return 15%. Year Earnings before depreciation, Interest and Tax (EBDIT) (Rs. in Lakhs) 1 Area A (6) Area B (50) 2 34 (50) (b) Venkatesha & Co. Ltd., are planning to invest some amount in a machinery. From the table of frequency distribution for (i) estimated sales volume, (ii) selling price, and (iii) variable costs given below, determine the likely NPV of the project, using Monte Carlo simulation technique, and recommend its acceptance. The initial investment in the project is Rs.40,000 Annual fixed cost is Rs.7,500. Life of the project is six years. Cost of capital is 12%. Sales Volume Selling Price Variable Costs Number Probability Rupees Probability Rupees Probability 5, , , Use the following random numbers: PRIME/44th ME/FINAL (2) (2 x 8 = 16 marks)

22 3(a) Alpha Ltd., and Gamma Ltd., are identical in every respect, except for their capital structure. Consider the following information, and compute the Equity Beta value of Gamma Ltd. a) Debt/Equity mix of Alpha : 1 : 4 b) Equity beta value of Alpha : 1.30 c) Debt/Equity mix of Gamma : 2 : 3 d) Tax rate : 40% e) Debt is risk free. (b) AB Ltd., is planning to acquire and absorb the running business of XY Ltd. The valuation is to be based on the recommendation of merchant bankers and the consideration is to be discharged in the form of equity shares to be issued by AB Ltd. As on , the paid up capital of AB Ltd. consists of 80 lakhs shares of Rs.10 each. The highest and the lowest market quotation during the last 6 months were Rs.570 and Rs.430. For the purpose of the exchange, the price per share is to be reckoned as the average of the highest and lowest market price during the last 6 months ended on XY Ltd. s Balance Sheet as at is summarised below: Rs. lakhs Sources Share Capital 20 lakhs equity shares of Rs.10 each fully paid lakhs equity shares of Rs.10 each, Rs.5 paid 50 Loans 100 Total 350 Uses Fixed Assets (Net) 150 Net Current Assets 200 Total 350 An independent firm of merchant bankers engaged for the negotiation, have produced the following estimates of cash flows from the business of XY Ltd.: Year ended By way of Rs. lakhs After tax earnings for equity Do Do Do Do 100 Terminal value estimate 200 It is the recommendation of the merchant banker that the business of XY Ltd. may be valued on the basis of the average of (i) Aggregate of discounted cash flows at 8% and (ii) Net assets value. Present value factors at 8% for years 1-5: You are required to: (i) Calculate the total value of the business of XY Ltd. (ii) The number of shares to be issued by AB Ltd.; and (iii) The basis of allocation of the shares among the shareholders of XY Ltd. (2 x 8 = 16 marks) PRIME/44th ME/FINAL (3)

23 4(a) An investor observes the market prices of 3-month calls and notes the following. Exercise price Call price The investor chooses to go long on two calls viz., 55 and 65 and writes two calls with an exercise price of Rs.60. Name the strategy adopted. Determine his payoff function for different levels of stock prices. (b) An American firm is under obligation to pay interests of Can$ and Can$ on 31st July and 30th September respectively. The Firm is risk averse and its policy is to hedge the risks involved in all foreign currency transactions. The Finance Manager of the firm is thinking of hedging the risk considering two methods i.e. fixed forward or option contracts. It is now June 30. Following quotations regarding rates of exchange, US$ per Can$, from the firm s bank were obtained: Spot 1 Month Forward 3 Months Forward Price for a Can$ / US$ option on a U.S. stock exchange (cents per Can$, payable on purchase of the option, contract size Can$ 50000) are as follows: Strike Price Calls Puts (US$/Can$) July Sept. July Sept NA NA NA According to the suggestion of finance manager if options are to be used, one month option should be bought at a strike price of 94 cents and three month option at a strike price of 95 cents and for the remainder uncovered by the options the firm would bear the risk itself. For this, it would use forward rate as the best estimate of spot. Transaction costs are ignored. Recommend, which of the above two methods would be appropriate for the American firm to hedge its foreign exchange risk on the two interest payments. (2 x 8 = 16 marks) 5(a) Kanpur Shoe Ltd. is having sluggish sales during the last few years resulting in drastic fall in market share and profit. The marketing consultant has drawn out a new marketing strategy that will be valid for next four years. If the new strategy is adopted, it is expected that sales will 20% per year over the previous year for the coming two years 30% from the third year. Other parameters like gross profit margin, asset turnover ratio, the capital structure and the rate of Income 30% will remain unchanged. Depreciation would be 10% of the net fixed assets at the beginning of the year. The targeted return of the company is 15%. The financials of the company for the just concluded financial year are given below: PRIME/44th ME/FINAL (4)

24 Income statement Amount (Rs.) Turnover 2,00,000 Gross margin (20%) 40,000 Admin, selling & distribution exp (10%) 20,000 PBT 20,000 Tax (30%) 6,000 PAT 14,000 Balance Sheet Information Fixed Assets 80,000 Current Assets 40,000 Equity share capital 1,20,000 You are required to assess the incremental value that will accrue subsequent to the adoption of the new marketing strategy and advise the board accordingly. for 1, 2 & 3 years are: 0.870, 0.756, respectively. (b) Gamma Limited is considering the acquisition of a computer costing Rs.50,000. The effective life of the computer is 5 years. The company plans to acquire the same either by borrowing Rs.50,000 from bankers at 15% p.a., or by lease. The company wishes to know the lease rentals to be paid annually, which will match the loan option. The following additional information is available: Principal amount of loan is repayable in five equal instalments of Rs.10,000 at the end of each year. Similarly, lease rentals as also interest on loan will also be paid at the end of the year Depreciation on computer is on straight line basis, spread over its life Tax rate is 40%, and after tax cost of capital is 9% Resale value of the computer is Rs.2,222 at the end of five years, subject to a commission of 10% thereon, and taxes as applicable Determine the quantum of annual, equated lease rentals, for which Gamma s would be indifferent as between lease and borrow options? (2 x 8 = 16 marks) 6(a) FLL has agreed to extend a three year, HP loan on EMI basis to SBM Transports, for purchase of two numbers 2212 AL Trucks, invoice price of which is Rs.6.50 lakhs each. Body building costs Rs.2.50 lakhs each. If SBM Transports were to bring in their own money of Rs.1 lakh for each vehicle, and if the flat rate is 8.25% p.a., determine the quantum of EMI if (i) instalments are paid in arrears, and (ii) if instalments are to be paid in advance. (b) 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. (2 x 8 = 16 marks) 7. Write short notes on any FOUR of the following: a. Standard deviaiton in the context of risk analysis b. Five merits of investing in mutual fund c. Three objectives of derivatives d. Four key issues in valuation of business e. What is the difference between CAPM and Arbitrage Pricing Model (4 x 4 = 16 marks) PRIME/44th ME/FINAL (5)

25 The Society of Auditors & Prime Academy Model Exam FINAL March 2017 Paper 2 STRATEGIC FINANCIAL MANAGEMENT SUGGESTED ANSWERS 1(a). Pay out ratio = 50% WN 1: Earnings: 500L 15% = 75L Total Earnings EPS = No. of Shares = 75,00,000 50,00,000 DPS = EPS (1 retention ratio) DPS = 1.50 (1 0.5) = 0.75 Pay out ratio = 80% WN 1: EPS = 1.50 DPS = 1.5 (1 0.2) = 1.20 Pay out ratio = 20% WN 1: EPS = 1.50 DPS = 1.50 (1 0.8) = 0.30 (b) (i) TWP for each quarter Quarter Opening Closing Rate % % % % (c) = 1.50 WN 2: g = b r = 20% 15% = 3% WN 2: g = b r = 80% 15% = 12% WN 2: g = b r 50% 15% = 7.5% WN 3: D P 0 = 1 Ke g = % 7.5% P 0 = Rs.30. WN 3: 1.2 P 0 = 10% 3% = 1.2 7% P 0 = Rs WN 3: 0.3 P 0 = 10% 12% = (Rs.15) P0 is negative dividend indicating that Gordon s model is inoperative when Ke < g (ii) RWR for the year Qtr Cash Flow 0 (10) 1 (1) RWR for the year = 35.73% (IRR) Part (i) Details Acquirer (M) Target (N) (a) Earnings After Tax 8,000,000 2,400,000 (b) Number of Shares 1,600, ,000 (c) Market Price (d) Earnings Per Share [(a) / (b)] 5 6 (e) PEM (a / d) PRIME/44th ME/FINAL (1)

26 Part (ii) Post Merger EPS XYZ ABC Combined (a) Earnings After Tax 8,000,000 2,400,000 10,400,000 (b) Number of Shares 1,600, ,000 1,920,000 (c) Earnings Per Share [(a) / (b)] 5.42 Part (iii): New EPS/Adjusted EPS Old EPS 5 6 Gain/Loss GAIN LOSS Part (iv): The exchange ratio to ensure that EPS stays in tact is the ratio of EPS namely 6:5. (d) (a) 1. calculation of Market price The market price of the bond is the present value of future cash flows associated with the bond discounted at the required rate namely the YTM. 2. duration Year Cash flow Year Cash Flow DF@17% DCF Total DF@ 17% DCF Proportion of bond value Duration of the Bond is years 3. Volatility Volatility of the bonds = Duration = (1+ yields) 1.17 = 3.62 Proportion of bond value x time (Years) 4. The expected market price if increase in required yield is by 75 basis points. Price will fall by Rs (3.62/100) = Rs New Market Price Rs Rs = Rs (a) Evaluation of Project A Evaluation from shareholders angle Year EBDIT Depn. Interest PBT Tax PAT CFAT Principal Total PVF PV 1 (6) (60) (30) (30) (20) (10) (10) (10) 0.57 (5.7) PRIME/44th ME/FINAL (2)