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Target Profit 12.5% of capital base (4,37,20,000). 54,65,000. Profits achieved due to Mr. X 54,65,000+ 10% (54,65,000).
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The Council of the Institute is not in anyway

responsible for the correctness or otherwise of the answers published herein.

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PAPER – 1 : FINANCIAL REPORTING Question No.1 is compulsory and candidates are required to answer any five questions from the remaining six questions. Wherever necessary, suitable assumptions may be made and disclosed by way of a note. Working notes should form part of the answers. Question 1 (a) An employee Roshan has joined a company XYZ Ltd. in the year 2013. The annual emoluments of Roshan 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 the Roshan is expected to grow @ 10% per annum. The company has inducted Roshan 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% - 0.735, 0.794, 0.857, 0.926, 1) (b) Quick Ltd. is a company engaged in the trading of spare parts used in the repair of automobiles. The company has been regular in depositing the tax, as such there is no liability of Income Tax etc. for the Financial Year 2012-13. The figures for the year are as under: Income chargeable to tax Total income after adjustments Tax thereon TDS deducted during the year Tax paid for the year

` 211.64 lakhs ` 228.48 lakhs ` 74.13 lakhs ` 30.45 lakhs ` 43.68 lakhs

The company has prepared its Balance Sheet as per above figures. However, during the assessment proceeding held before the finalization of the Balance Sheet the Income Tax Officer has issued demand of ` 7.52 lakhs, insisting that this amount of TDS has not been uploaded online and thus is not acceptable as deduction. The company has in reply to the same filed a rectification with the Assessing Officer. The company is trying to collect the TDS certificates, but ` 2.39 lakhs deducted by XY LTD., is not traceable. The rectification is lying pending with the Assessing Officer. Please suggest the treatment of ` 2.39 lakhs and ` 7.52 lakhs in Balance Sheet.

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2

FINAL EXAMINATION: MAY, 2014

(c) Comptech Ltd. having office at Chennai, acquired a sophisticated three dimensional (3D) computer printer having all inclusive MRP (Maximum Retail Price) of ` 50 lakhs from a supplier located at New Delhi. The terms of the purchase were as under: (i)

The supplier would buy back the existing unit with Comptech that has carrying amount of ` 10.20 lakhs. Prevailing CST rate is 2%.

(ii)

The supplier would give a special discount of 10% on MRP to Comptech considering their long standing relationship.

(iii) A cash payment of ` 38.25 lakhs would be made by Comptech Ltd. to the supplier. (iv) Accessories required to operate the machine costing ` 7.60 lakhs (inclusive of all taxes) will be purchased by Comptech. (v) The supplier will deliver free of cost certain heavy duty cables etc. having MRP of ` 5.75 Iakhs, that are required to run the machine. (vi) Transit insurance cost will be borne by Comptech @ 2% of MRP. (vii) Freight and other incidentals amounting to ` 2.30 lakhs is borne by Comptech. You are required to arrive at the cost of the new asset and show the profit/(loss) incurred by Comptech on the buy back arrangement and also draft the Journal Entries to record the above transaction. (d) Compute Basic and Adjusted Earnings per share from the following information: Net Profit for 2012-13 Net Profit for 2013-14

` 22 lakhs ` 33 lakhs

No. of shares before Rights Issue

1,10,000

Rights issue Ratio

One for Every Four Held

Rights Issue Price

` 180

Date of exercising Rights option

31.7.2013 (fully subscribed on this date)

Fair value of share before Rights Issue

` 270

All workings may be rounded off to two decimals.

(4 x 5 = 20 Marks)

Answer (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.

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PAPER – 1 : FINANCIAL REPORTING

3

Calculation of Current Service Cost Equal apportioned amount of DBO [i.e. ` 30,00,000/5 years]

Discounting @ 8% PV factor

Current service cost (Present Value)

a

b

c

d=bxc

1

6,00,000

0.735 (4 Years)

4,41,000

2

6,00,000

0.794 (3 Years)

4,76,400

3

6,00,000

0.857 (2 Years)

5,14,200

4

6,00,000

0.926 (1 Year)

5,55,600

5

6,00,000

1 (0 Year)

6,00,000

Year

Calculation of Interest Cost to be charged per year Opening balance

Interest cost

Current service cost

Closing balance

a

b

c = b x 8%

d

e=b+c+d

1

0

0

4,41,000

4,41,000

2

4,41,000

35,280

4,76,400

9,52,680

3

9,52,680

76,214

5,14,200

15,43,094

4

15,43,094

1,23,447

5,55,600

22,22,141

5

22,22,141

1,77,859*

6,00,000

30,00,000

Year

*Due to approximations used in calculation, this figure is adjusted accordingly. (b) As per para 10 of AS 29 ‘Provisions, Contingent Liabilities and Contingent Assets’, a contingent liability is: (a) a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or (b) a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or (ii) a reliable estimate of the amount of the obligation cannot be made. An obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date is considered probable, i.e., more likely than not. In the given case, TDS shall be allowed by the IT department on submission of duplicate TDS certificates. Since the company is making efforts and is hopeful for its ultimate collection, contingent liability will be made for ` 2.39 lakhs in the books of account. Further as per para 15 of the standard, where it is more likely that no present obligation exists at the balance sheet date and the possibility of an outflow of resources embodying economic benefits is remote, no contingent liability is disclosed.

© The Institute of Chartered Accountants of India

4

FINAL EXAMINATION: MAY, 2014

TDS certificates for ` 5.13 lakhs (` 7.52 lakhs less ` 2.39 lakhs) have been submitted and the company has filed a rectification with the Assessing Officer. Therefore, the possibility of an outflow of resources embodying economic benefits is remote; the company shall not disclose it as contingent liability. This amount should be disclosed by way of a note to the accounts. Note: An alternative view can also be considered on the basis of the paragraph 14 of the standard which states that a provision should be recognised in the books when (a) an enterprise has a present obligation as a result of a past event; (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. Accordingly, in the given case, since there is a probability of outflow of resources and also the amount can be quantified on account of non-traceability of TDS certificates, a provision may be made for ` 2.39 lakhs in the books of account. Regarding the balance amount of ` 5.13 lakhs (` 7.52 lakhs less ` 2.39 lakhs), since TDS certificated have been submitted, it is likely that the Income-tax Officer may accept the rectification filed by the assessee. However, since the TDS details have not been uploaded online because of which demand has been issued, there may be a possibility that the rectification may also not be accepted. Therefore, taking a conservative approach, ` 5.13 lakhs may be disclosed as a contingent liability. (c) As per para 22 of AS 10 ‘Accounting for Fixed Assets’, when a fixed asset is acquired in part exchange for another asset, the cost of the asset acquired should be recorded either at fair market value or at the net book value of the asset given up, adjusted for any balancing payment. In the given question the FMV of the new machine is its MRP net of special concession given to the buyer. 1. Calculation of Cost of New Asset

` in lakhs MRP of Printer Less: Special Discount 10% of MRP

50 5 45

Add: Accessories Add: Transit Insurance Cost (2% of 50 lakh) Add: Freight and other incidental amount

7.6 1 2.30 55.9

2. Calculation of Profit /Loss incurred on buy-back arrangement

` in lakhs Discounted price of new machine

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45.00

PAPER – 1 : FINANCIAL REPORTING

5

Less: Cash portion thereof

38.25

FMV of old machine

6.75*

Less: Book Value thereof

10.20

Loss on Buy back

3.45

*This includes CST of 2%. Thus the CST will be 6.75 x 2/102 = 0.13 lakh 3. Journal Entries 1.

3D Computer Printer A/c

Dr.

49.15

To Cash A/c

49.15

(Being the expenses incurred for purchase of 3D computer – cash payment 38.25 + accessory 7.6 + insurance 1 and freight 2.3) 2.

3D Computer Printer A/c

Dr.

6.75

Loss on buy back of old machine A/c

Dr.

3.45

To Old Machine A/c

10.20

(Being the transfer of FMV of ` 6.75 lakhs of old machine to new printer under buy-back scheme and recognition of loss on buy back) Note:

It is assumed that the cash payment of ` 38.25 lakhs is the full and final payment to the supplier for the printer.

(d) Computation of earnings per share EPS for the year 2012-13 as originally reported = ` 22,00,000/1,10,000 shares = ` 20 EPS for the year 2012-13 restated for rights issue = ` 22,00,000/ (1,10,000 shares x 1.07) = ` 18.69 EPS for the year 2013-14 including effects of rights issue = (1,10,000 x 1.07 x 4/12) + (1,37,500 x 8/12) = 1,30,900 =

33,00,000 1,30,900

= 25.21

Working Note:

1.

Calculation of Theoretical ex-rights fair value per share

Fair value of shares immediately prior to exercise of rights + Total amount received from exercise Number of shares outstanding prior to exercise + Number of shares issued in the exercise

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6

FINAL EXAMINATION: MAY, 2014

(` 270×1,10,000 shares) + (` 180 ×27,500 Shares) 3,46,50,000 = 1,10,000 + 27,500 Shares 1,37,500 Theoretical ex-rights fair value per share = ` 252 2.

Calculation of Computation of adjustment factor:

Fair value per share prior to exercise of rights Theoretical ex - rights value per share ` (270) ` (252) = 1.071 Question 2 A Company Q is willing to sell its business. The purchaser has sought professional advice for the valuation of the goodwill of the company. He has the last audited financial statements together with some additional information. Help him to ascertain the correct price for the purpose of purchase: The extract of the Balance Sheet as on 31-3-2014 is as under: Liabilities

` Assets

`

Equity Share Capital (shares of ` 100 each)

9,50,000

Goodwill

2,75,000

8% Preference Share Capital (shares of ` 100 each)

2,25,000

Land & Building

5,45,000

Plant & Machinery

4,55,000

Reserves & Surplus

10,25,500

9% Debentures

5,60,000

Investments in shares

4,85,000

Current Liabilities

3,25,640

Inventories

3,80,000

Trade Receivables (net)

4,25,620

Cash & Bank balance

5,20,520

30,86,140

30,86,140

(1) The purchaser wants to acquire all the equity shares of the company. (2) The Debentures will be redeemed at a discount of 25% of the value in Balance Sheet and investments in share will be sold at their present market value which is quoted as ` 4,95,200. The above will be prior to the purchase of the equity shares. For the purpose of pricing of Goodwill: (3) The normal rate of return on net assets for equity shares is 10%.

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PAPER – 1 : FINANCIAL REPORTING

7

(4) Profits for the past three years after debenture interest but before Preference Share Dividend have been as under: 31-3-2014 31-3-2013 31-3-2012

` 2,95,000 ` 4,99,000 ` 3,25,000

(5) Goodwill is valued at three years purchase of the adjusted average super profit. (6) In the year 2013, 20% of the profit mentioned above was due to non recurring transaction resulting in increase of profit. (7) The Land & Building has a current rental value of ` 62,400 and a 8% return is expected from the property. (8) On 31-3-2014, 8% of debtors existing on the date had been written as bad and charged to Profit and Loss Account as Provision for Bad debts. The same are now recoverable Tax is applicable at 35%. (9) A claim of compensation long contingent of ` 25,000 has perspired and is to be accounted for. (10) No Debenture interest shall be payable in future due to its redemption.

(16 Marks)

Answer Valuation of goodwill: Super profits method

Particulars

`

`

Net trading assets attributable to equity share holders As computing in (WN 1)

23,18,506

Less: Preference share Capital

(2,25,000)

20,93,506

Normal Rate of Return (NRR) to equity share holders

10%

Normal Profit available to equity share holders (a × b)

2,09,351

Future Maintainable Profits (FMP) to equity share holders As computed in (WN 3)

3,75,096

Less: Preference dividend* (8% of 2,25,000)

(18,000)

3,57,096

Super profits to equity share holders

1,47,745

Goodwill (1,47,745 x 3)

4,43,235

*Since, NRR is given as percentage of net assets attributable to equity shareholders, preference share capital and preference share dividend have been deducted from the net assets and future maintainable profit respectively.

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8

FINAL EXAMINATION: MAY, 2014

Value Per Equity Share

Net Trading Assets attributable to equity shareholders

` 20,93,506

Add: Goodwill

` 4,43,235 ` 25,36,741

Number of Equity Shares = 9,500 shares, Value per share=

25,36,741 = ` 267 (approx.) 9,500

Working Notes:

1.

Computation of net trading assets

Particulars

`

`

Sundry assets i

Land & Building (62,400 ÷ 8%)

7,80,000

ii

Plant and Machinery

4,55,000

iii

Inventory

3,80,000

iv

Trade receivables (4,25,620 ÷ 92%)

4,62,630

v

Bank balance (given balance 5,20,520 + Sale of investment 4,95,200 - redemption of debentures 5,60,000 × 75%)

5,95,720

26,73,350

Less: Outside liabilities:

i

Current Liabilities

ii

Contingent Liability now to be accounted for

iii

Tax provision (WN 2)

3,25,640 25,000 4,204

Net assets 2.

(3,54,844) 23,18,506

Calculation of tax provision

` Profit on reversal of provision for bad debts

37,010

Loss on recognizing omitted claim (assuming tax deductible)

(25,000)

Net incremental profit on which tax is payable

12,010

Tax provision 35% 3.

4,204

Computation of future maintainable profit for the year ended on 31st March

Particulars Profit after tax

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2012 2013 2014 3,25,000 4,99,000 2,95,000

PAPER – 1 : FINANCIAL REPORTING

9

- (99,800) Less: Non-recurring profits (after tax) (20% of 2013 Profit) Less: Claims not recorded (after tax) - (16,250) [25,000 x (1-35%)] Add: Provision no longer required (net of tax) [4,25,620 × 8/92 × (1-35%)] 24,057 Adjusted profits after tax 3,25,000 3,99,200 3,02,807 Simple average of the profits (as profits are fluctuating) Adjustments for items which will not be reflected in future Add: Debenture interest (net of tax) [5,60,000 × 9% × (1 – 0.35)] Future maintainable profit [for shareholders- both preference and equity)

3,42,336 32,760 3,75,096

Assumptions 1. Tax effect has been ignored on profit on sale of investments and discount on redemption of debentures. 2. Assets and liabilities are recorded at realizable value or fair value. In the absence of information, book values are assumed to be fair values. 3. Additional depreciation on revaluation of property is ignored. 4. Profits for past three years given in the question have been assumed as profits after tax. Question 3 The Balance Sheets of the Greatness Group of Companies as at 31st March, 2014 is given below: Capital & Liabilities

Greatest Ltd.

BIG Ltd.

SMALL Ltd.

`

`

`

Ordinary shares of ` 10

5,00,000

2,00,000

1,00,000

General reserve

1,00,000

50,000

30,000

Profit & Loss Account

2,00,000

1,00,000

50,000

Creditors

3,00,000

2,00,000

1,00,000

11,00,000

5,50,000

2,80,000

7,75,000

4,10,000

2,35,000

Share Capital:

Total Assets: Fixed Assets

© The Institute of Chartered Accountants of India

10

FINAL EXAMINATION: MAY, 2014

Investments: 16,000 shares in BIG Ltd. 6,000 shares in SMALL Ltd. Other (Non-current) Current Assets Total :

2,00,000

-

-

-

90,000

-

25,000

-

15,000

1,00,000

50,000

30,000

11,00,000

5,50,000

2,80,000

(1) The investment in BIG Ltd. was made on 1st April, 2007 and that in SMALL Ltd. was made on 1st April, 2009. (2) The Balances in Reserves and P & L Account on relevant dates are as under: BIG Ltd.

1st April 2007

1st April 2009

`

`

Reserves

20,000

22,000

P&L Account

60,000

68,000

1st April 2007

1st April 2009

`

`

8,000

10,000

17,000

20,000

SMALL Ltd. Reserves P&L Account

(3) Current Assets of SMALL Ltd. includes inventories of ` 10,800 acquired at a mark up of 20% from Greatest Ltd. You are required to prepare the Consolidated Balance Sheet of the group as at 31st of March, 2014. (16 Marks) Answer Consolidated Balance Sheet of Greatest Ltd. with its subsidiaries Big Ltd. and Small Ltd. as on 1st April, 2014

Particulars I.

Note

`

EQUITY AND LIABILITIES 1.

Shareholders’ funds a.

Share capital

1

5,00,000

b.

Reserves and surplus

2

3,86,600

c.

Minority interest (W.N.3)

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1,51,600

PAPER – 1 : FINANCIAL REPORTING

2.

11

Current Liabilities Trade payables

3

6,00,000

Total II.

16,38,200

ASSETS 1.

Non-current assets (i) (ii)

2.

Fixed assets Tangible assets

4

14,20,000

Other non current assets

5

40,000

6

1,78,200

Current assets

16,38,200 Notes to the financial statements

1

2

3

4

5

6

Particulars Share capital Authorised, Issued, subscribed and fully paid up 50,000 shares of ` 10 each Reserves and surplus General Reserve (WN 5) Capital Reserve (WN 4) Profit & loss A/c (WN 5) Trade payables Greatest Ltd. Big Ltd. Small Ltd. Tangible assets Greatest Ltd. Big Ltd. Small Ltd. Other non current assets Greatest Ltd. Small Ltd. Current assets Greatest Ltd. Big Ltd.

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`

5,00,000 1,33,600 8,400 2,44,600

3,86,600

3,00,000 2,00,000 1,00,000

6,00,000

7,75,000 4,10,000 2,35,000

14,20,000

25,000 15,000

40,000

1,00,000 50,000

12

FINAL EXAMINATION: MAY, 2014

Small Ltd. Less: Unrealised profit on downstream transaction 20 ⎞ ⎛ ⎜ 10,800 × ⎟ 120 ⎠ ⎝

30,000 (1,800)

1,78,200

Working Notes: 1.

Apportionment of reserve & profits of ‘Small’ Ltd.

Particulars

2.

Post acquisition

Capital Profit

Reserve

P&L

`

`

`

Profit and loss A/c

20,000

-

30,000

General Reserve

10,000

20,000

-

Total

30,000

20,000

30,000

Big Ltd.’s share (60%)

18,000

12,000

18,000

Minority interest (40%)

12,000

8,000

12,000

Apportionment of reserve & profits of Big Ltd. (Indirect Method)

Particulars

3.

Pre-acquisition

Pre-acquisition

Post acquisition

Capital Profit

Reserve

P&L

`

`

`

Share from Small Ltd.

18,000

12,000

18,000

Profit and Loss A/c

60,000

Reserves

20,000

30,000

Total

98,000

42,000

58,000

Greatest Ltd. share (80%)

78,400

33,600

46,400

Minority interest (20%)

19,600

8,400

11,600

40,000

Calculation of Minority interest

Particulars

Big Ltd.

Small Ltd.

(20%)

(40%)

`

`

Equity share capital

40,000

40,000

Capital profit

19,600

12,000

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PAPER – 1 : FINANCIAL REPORTING

Revenue Profit Revenue Reserve Total Total minority interest 4.

13

11,600

12,000

8,400

8,000

79,600

72,000

1,51,600

Calculation of Cost of control

Particulars

Greatest Ltd. in Big Ltd.

Big Ltd. in Small Ltd.

(80%)

(60%)

2,00,000

90,000

Share capital

(1,60,000)

(60,000)

Capital profit

(78,400)

-

(38,400)

30,000

Cost of investment: Less: Share of net assets as on the date of acquisition:

Goodwill/(Capital reserve) Capital reserve for Consolidated Balance Sheet 5.

8,400

Consolidated Reseves & P/L (Post acquisition)

Particulars Greatest Ltd.’ Balances as per its balance sheet Add: Share of post acquisition Reserves /P&L of Big Ltd.

Reserves Profit and Loss A/c

`

`

1,00,000

2,00,000

33,600

46,400

Less: Unrealized profit on downstream transaction

Reserves for consolidated balance sheet

(1,800) 1,33,600

2,44,600

Question 4 (a) Quittle Ltd. announced a Stock Appreciation Rights (SAR) Scheme to its employees on 1st April, 2011. The salient features of the scheme is given below: (1) The scheme will be applicable to employees who have completed three years of continuous service with the company. (2) Each eligible employee can claim cash payment amounting to the excess of Market Price of the company's shares on exercise date over exercise price in respect of 60 (sixty) shares. (3) The exercise price is fixed at ` 75 per share.

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14

FINAL EXAMINATION: MAY, 2014

(4) The option to exercise the SAR is open from 1st April, 2014 for 45 days and the same vested on 975 employees. (5) The intrinsic value of the company's share on date of closing (15th May, 2014) was ` 30 per share. (6) The fair value of the SAR was ` 20 in 2011-12; ` 25 in 2012-13 and ` 27 in 2013-14. (7) In 2011-12, the expected rate of employee attrition was 5% which rate was doubled in the next year. (8) Actual attrition year wise was as under: 2011-12

35 employees of which 5 had served the company for less than 3 years.

2012-13

30 employees of which 20 employees served for more than 3 years.

2013-14

20 employees of which 5 employees served for less than 3 years.

You are required to show the Provision for Stock Appreciation Rights Account by Fair Value Method. (8 Marks) (b) Peoples Financiers Ltd. is an NBFC providing Hire Purchase Solutions for acquiring consumer durables. The following information is extracted from its books for the year ended 31st March, 2014: Asset Funded

Interest Overdue but recognized in Profit & loss Period Overdue

Interest Amount

Net Book Value of Assets outstanding

(` in crore)

(` in crore)

Upto 12 months

480.00

20,123.00

Washing Machines

For 24 months

102.00

2,410.00

Refrigerators

For 30 months

50.50

1,280.00

Air Conditioners

For 45 months

26.75

647.00

LCD Televisions

You are required to calculate the amount of provision to be made.

(4 Marks)

(c) The capital structure of W Ltd. whose shares are quoted on the NSE is as under: Equity Shares of ` 100 each fully paid 9% Convertible Pref. Shares of ` 10 each 12% Secured Debentures of ` 10 each Reserves Statutory Fund

© The Institute of Chartered Accountants of India

` 505 lakhs ` 150 lakhs 5,00,000

` 101 lakhs ` 50,50,000

PAPER – 1 : FINANCIAL REPORTING

15

The Statutory Fund is compulsorily required to be invested in Government Securities. The ordinary shares are quoted at a premium of 500%; Preference Shares at ` 30 per share and debentures at par value. You are required to ascertain the Market Value added of the company and also give your assessment on the market value added as calculated by you. (4 Marks) Answer (a)

Provision for SARs Account

Year

Particulars

Amount Year

2011-12 To Balance c/d

2012-13 To Balanced c/d

Particulars

Amount

3,56,667 2011-12 By Employees Compensation

3,56,667

3,56,667

3,56,667

8,18,100 2012-13 By Balanced B/d

3,56,667

-

By Employees Compensation

8,18,100 2013-14 To Balance c/d

8,18,100

15,79,500 2013-14 By Balance B/d

8,18,100

By Employees Compensation 2014-15 To Bank (975x60x30)

4,61,433

7,61,400

15,79,500

15,79,500

17,55,000 2014-15 By Balance B/d By Employees

15,79,500

Compensation 17,55,000

1,75,500 17,55,000

Working Notes:

1.

No. of eligible employees = 975 + 35 - 5 + 20 + 20 - 5 = 1040

2.

Expenses to be recognized each year: 2011-12 No. of SARS to 1040 x 0.95 x Vest 0.95 x .95 x 60 53,500∗ Fair Value of SAR 20



2012-13

2013-14

1040 - (35-5) x 0.90 x 0.90 x 60

1040 - (35-5) – 20 (20-5) x 60

49,086

58,500

25

27

SARs expected to vest in years 2011-12 and 2012-13 can also be worked out by rounding off the number of employees.

© The Institute of Chartered Accountants of India

16

FINAL EXAMINATION: MAY, 2014

Total Fair Value

10,70,000

12,27,150

15,79,500

Expenses to be 10,70,000 x1/3 = 12,27,150x2/3-3,56,667 recognized each 3,56,667 = 4,61,433 year

3.

15,79,500 – (3,56,667 + 4,61,433) = 7,61,400

Expenses to be recognized in the year 2014-15.

Total intrinsic Value of SARs less expense recognized till date. = (975 x 60 x 30) -15,79,500 = 1,75,500. (b) On the basis of the information given, in respect of hire purchase and leased assets, additional provision shall be made as under:

(` in crore) (a) Where hire charges are overdue upto 12 months (b) Where hire charges are overdue for more than 12 months but upto 24 months (c) Where hire charges are overdue for more than 24 months but upto 36 months (d) Where hire charges or lease rentals are overdue for more than 36 months but upto 48 months

Nil

-

10% of the net book value 10% x 2,410

241

40 percent of the net book value 40% x 1,280

512

70 percent of the net book value 70% x 647

452.90

Total

1,205.90

(c) Market Value Added (MVA) is the difference between the current market value of a firm and the capital contributed by investors (both debentureholders and shareholders). In other words, it is the sum of all capital claims held against the company plus market value of debt and equity. If MVA is positive, firm has added value.

Market Value Added = Market value of firm less amount invested in the firm

` in lakhs Equity Share Capital (market value) (505 lakhs x 600%) Preference share capital (15,00,000 x 30) Debentures Current market value of firm Less: Equity Share Capital Preference share capital Reserves

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3030 450 50 3,530 505 150 101

PAPER – 1 : FINANCIAL REPORTING

17

Debentures 50 Statutory Reserve 50.50 (856.50) Market Value Added 2,673.50 The significant Market Value addition implies that the management of W Ltd. has created wealth for its shareholders and that market investors are willing to pay a price greater than the historical net worth of the company. Question 5 The summarized Balance Sheets of A Ltd. and B Ltd., as at 31-3-2014 were as follows:

(` in lakhs) Liabilities

A Ltd.

B Ltd.

Share Capital

Assets Fixed Assets

A Ltd.

B Ltd.

60

18

6

-

(Share of ` 10 each)

50

10

Investment in B Ltd.

General Reserves

50

20

(60,000 shares)

Profit & Loss Account

20

15

Debtors

35

5

Secured Loan

20

3

Inventories

30

25

Current Liabilities

30

2

Cash at bank

39

2

170

50

170

50

A Ltd. holds 60% of the paid up capital of B Ltd. and balance is held by a foreign company. The foreign company agreed with A Ltd. as under: (i)

The shares held by the foreign company will be sold to A Ltd. at ` 50 above than nominal value of per share.

(ii)

The actual cost per share to the foreign company was ` 11, gain accruing to foreign company is taxed @ 20%. The tax payable will be deducted from the sale proceeds and paid to Government by A Ltd., 50% of the consideration (after payment of tax) will be remitted to foreign company by A Ltd., and also any cash for fractional shares allotted.

(iii) For the balance consideration A Ltd. would issue its shares at their intrinsic value. It was also decided that A Ltd. would also absorb B Ltd., simultaneously by writing down the fixed assets of B Ltd. by 10%. The Balance Sheet figure included a sum of ` 1,00,000 due by B Ltd. to A Ltd. and stock of A Ltd. included stock of ` 1,50,000 purchased from B Ltd., who sold them at cost plus 20%. The entire arrangement was approved and put through by all concern effective from 1-4-2014. You are required to prepare the Balance Sheet of A Ltd., after absorption of B Ltd. Workings should form part of your answer. (16 Marks)

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FINAL EXAMINATION: MAY, 2014

Answer A Ltd. Balance Sheet as at 1st April, 2014 Particulars

Note No.

Amount (`)

(a) Share Capital

1

53,34,660

(b) Reserves and Surplus

2

89,64,320

3

23,00,000

4

31,00,000

I. Equity and Liabilities (1) Shareholder's Funds

(2) Non-Current Liabilities Long-term borrowings (3) Current Liabilities Total

1,96,98,980

II. Assets (1) Non-current assets (a) Fixed assets Tangible assets

5

76,20,000

(a) Inventories

6

54,75,000

(b) Trade receivables

7

39,00,000

(2) Current assets

(c) Cash and cash equivalents (WN 5)

27,03,980 Total

1,96,98,980

Notes to Accounts

` 1.

Share Capital 5,33,466 shares of ` 10 each

53,34,660

(Out of the above 33,466 shares of ` 10 each had been issued for consideration other than cash) 2.

`

Reserves and surplus General Reserve

50,00,000

Capital Reserve (W.N.4)

13,20,000

Profit and Loss Account

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` 20,00,000

PAPER – 1 : FINANCIAL REPORTING

Less: Unrealized profit on inventory

(` 25,000)

Securities Premium (` 33,466×20) 3.

19

19,75,000 6,69,320

Long Term Borrowings Secured Loans (` 20,00,000 + ` 3,00,000)

4.

5.

6.

23,00,000

Current Liabilities (` 30,00,000 + ` 2,00,000)

32,00,000

Less: Mutual owings

(1,00,000)

31,00,000

Tangible Assets Fixed Assets (60,00,000 +18,00,000)

78,00,000

Less :Revaluation loss

(1,80,000)

Inventories (` 30,00,000+ ` 25,00,000) Less: Unrealised profit on inventory

7.

89,64,320

76,20,000

55,00,000 (25,000)

54,75,000

Trade receivables Trade receivables (` 35,00,000+ ` 5,00,000)

40,00,000

Less: Mutual owings

(1,00,000)

39,00,000

Working Notes:

(1) Price per share paid by A Ltd. to Foreign Company for shares held by them ` 60 (i.e., ` 50 above the normal value of ` 10) (2) Calculation of intrinsic value of shares of A Ltd.

` Total Assets of A Ltd. excluding Investment in B Ltd.

1,64,00,000

Value of Investment in B Ltd. (60,000 shares × ` 60)

36,00,000 2,00,00,000

Less: Outside Liabilities:

Secured Loan

20,00,000

Current Liabilities

30,00,000

Net Assets Intrinsic value per share = Net Assets = ` 1,50,00,000 = ` 30 per share 5,00,000 No. of Shares

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(50,00,000) 1,50,00,000

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FINAL EXAMINATION: MAY, 2014

(3) Discharge of purchase consideration by A Ltd. to Foreign Company Equity share capital

Cash

Total

`

`

`

--- 3,92,000

3,92,000

(i) Payment of Tax [` 24 Lakhs - ` 4.40 Lakhs] x 20

100

(ii) Issue of shares to foreign company [50% of (24 lakhs – 3.92 lakhs) = 10.04 lakhs No. of shares issued by A Ltd. 10,04,000 = 30

33,466.6666 shares Value of shares capital (33,466 × ` 30)

10,03,980

--- 10,03,980

(iii) Cash Payment [50% of (` 24 Lakhs – ` 3.92 Lakhs = 10.04 lakhs

--- 10,04,000 10,04,000

(iv) Cash for fractional shares = 0.6666 shares × ` 30

---

20

20

10,03,980 13,96,020 24,00,000 (4) Calculation of Goodwill/Capital Reserve to A Ltd. ` Total of assets of B Ltd. as per the Balance Sheet Less:

10% Reduction in the value of Fixed Assets ⎛ 10 × 18,00,000 ⎞ ⎜ 100 ⎟ ⎝ ⎠

50,00,000 (1,80,000) 48,20,000

Less:

Outside Liabilities Secured Loan

3,00,000

Current Liabilities

2,00,000

Net Assets Less:

Purchase consideration (paid to Foreign Company)

(5,00,000) 43,20,000 (24,00,000) 19,20,000

Less:

Investment in B Ltd. as per Balance Sheet of A Ltd.

Capital Reserve

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(6,00,000) 13,20,000

PAPER – 1 : FINANCIAL REPORTING

21

(5) Cash and Bank Balance of A Ltd. after acquisition of B Ltd.

` Opening Balance (A Ltd.) Cash and Bank Balance of B Ltd. Less:

Remittance to foreign company

Less:

T.D.S. paid to Government

(6) Unrealized profit included in inventory of A Ltd. = ` 1,50,000 x

39,00,000 2,00,000 41,00,000 (10,04,020) 30,95,980 (3,92,000) 27,03,980 20 = ` 25,000 120

Question 6 (a) The following information is supplied to you about Lookdown Ltd. Capital & Reserves Equity Shares of ` 100 each of which ` 75 has been called up Equity Shares in respect of which calls are in arrear @ 25 per share General Reserve Profit & Loss account (balance at beginning of the year) Profit/(loss) for the year

5,00,000

` 1,00,000 ` 10,00,000 ` (25,00,000) ` (1,80,000)

Industry Average Profitability

12.50%

8% Debentures of ` 10 each

8,00,000

Lookdown Ltd. is proposing to hire the services of Mr. X to turn the company around. Minimum take home salary per month demanded by Mr. X Average Income tax rate on salaries above ` 3 lakhs per annum Provident Fund contribution by Employer per month Profits over and above target expected by hiring Mr. X

` 4,00,000 25%

` 50,000 10%

You are required to analyze the proposal and see whether it is worthwhile to employ Mr. X and also suggest the maximum emoluments that could be paid to him. Note: (i)

PF contributions are tax exempt.

(ii)

Take home salary is that remaining after employee's contribution to PF @ ` 50,000 per month and after deduction of Income-tax on salary. (8 Marks)

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FINAL EXAMINATION: MAY, 2014

(b) Gold Ltd. has provided the following data for the Financial Year ending 2014: Liabilities

(Fig. in lakhs)

Assets

(Fig. in lakhs)

Share Capital

1,000

Fixed Assets

3,000

Reserve & Surplus

2,000

Investments

150

Current Assets

100

Long Term Debt

200

Trade Payables

50 3,250

3,250

Additional information provided is as follows: Profit before Interest and Tax is

` 1,000 lakhs.

Interest is

` 20 Lakhs

Tax Rate

35.875%

Risk Free Rate

10%

Market Rate

15%

Beta ( β ) factor

1.4

Calculate the Economic Value Added by Gold Ltd.

(8 Marks)

Answer Cost to Company in employing to Mr. X

(a)

` Salary before tax ` 4,00,000 x 12 =

48,00,000

0.75 Add: Employee’s PF contribution (50,000 x 12) Add: Employer’s PF contribution (50,000 x 12)

64,00,000*

6,00,000 70,00,000 6,00,000 76,00,000

Capital base

`

Equity Share Capital paid up (5,00,000 shares of ` 75 each) Less: Calls in arrears

3,75,00,000 (1,00,000) 3,74,00,000

General Reserve

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10,00,000

PAPER – 1 : FINANCIAL REPORTING

Profit & Loss A/c (balance) at the beginning of the year

23

(25,00,000)

Loss for the year

(1,80,000)

8% Debentures

8,000,000

Capital base

4,37,20,000

Target Profit 12.5% of capital base (4,37,20,000)

54,65,000

Profits achieved due to Mr. X 54,65,000+ 10% (54,65,000)

60,11,500

Maximum emoluments that can be paid to Mr. X = 60,11,500 Thus, the company is advised not to hire him as his CTC ` 76,00,000 is more than ` 60,11,500 Note: It is assumed that the average income tax rate of 25% given in the question is after considering the impact of ` 3 lakhs p.a. i.e., the exemption amount. (b)

Computation of Economic Value Added Particulars

` in lakhs

Profit after taxes (as per Profit and Loss A/c W.N.5)

628.425

Add: Interest on long term borrowing adjusted net of tax (W.N.2)

12.825

Total return to Providers of funds Less: Cost of Capital (W.N.4)

641.250 (522.825)

Economic Value Added

118.425

Working Notes:

1.

Cost of Equity = Risk Free Rate + β Factor (Market Rate – Risk Free Rate)

= 10% + 1.4 (15% - 10%) = 10% + 7% = 17% 2.

Cost of Debt (Post tax) Particulars

` in lakhs

Interest

20.000

Less: Tax Saving (20 x 35.875%)

(7.175)

Interest after tax savings

12.825

Cost of Debt = Cost of Debt =

Interest on Longterm Debt Longterm Debts ` 12.825 ` 200

= 6.4125%

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FINAL EXAMINATION: MAY, 2014

3.

Capital Employed Particulars

Amount

Share capital

1,000

Reserves and surplus

2,000

Amount

3,000

Long term Debts

200

Total Capital employed 4.

Weighted Average Cost of Capital Particulars a. Cost of Equity b. Cost of Debt c. Total (a+b)

WACC = 5.

3,200

522.825 3200

3,000 x 17% (WN 1) 200 x 6.4125% (WN 2)

` in lakhs 510.000 12.825 522.825

= 16.34%

Profit after Tax Particulars Profit before interest & tax Less: Interest Less: Tax (980 x 35.875%) Profit after Tax

Amount 1,000 (20)

Amount

980.000 351.575 628.425

Question 7 Answer any four of the following: (a) KAY Ltd. is in the process of finalizing its accounts for year ended 31st March, 2014 and furnishes the following information: (i)

Finished goods normally are held for 30 days before sale.

(ii)

Sales realization from Debtors usually takes 60 days from date of credit invoice.

(iii) Raw materials are held in stock to cover one month's production requirements. (iv) Packing materials, being specifically made for the company and having lead time of 90 days is held in stock for 90 days. (v) The holding period in respect of unfinished goods is 30 days. (vi) Being a monopoly KAY Ltd. enjoys a credit period of 12.5 months from its suppliers who sometimes at the end of their credit period opt for conversion of their dues into long term debt of KAY Ltd.

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PAPER – 1 : FINANCIAL REPORTING

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You are required to compute the operating cycle of KAY Ltd. as per revised Schedule IV∗ of Companies Act, 1956. As the suppliers of the company are paid off after a credit period of 12.5 months should this be part of Current Liability? Would your answer be the same if the creditors are settled in 330 days? (b) A Mutual Fund has launched a new scheme “All Purpose Scheme“. The Mutual Fund's Asset management company wishes to invest 25% of the NAV of the Scheme in an unrated debt instrument of a company Y Ltd. which has been paying above average returns for the past many years. The promoters of the company seek your professional advice in light of the Regulations of SEBI. Will the position change in case the debt instruments of the company Y Ltd., is a rated. (c) What are Timing Differences and Permanent Differences as per Accounting Standard 22? Explain with example. (d) X Ltd. has leased equipment over its useful life that costs ` 7,46,55,100 for a three year lease period. After the lease term the asset would revert to the Lessor. You are informed that: (i)

The estimated unguaranteed residual value would be ` 1 lakh only.

(ii)

The annual lease payments have been structured in such a way that the sum of their present values together with that of the residual value of the asset will equal the cost thereof.

(iii) Implicit interest rate is 10%. You are required to ascertain the annual lease payment and the unearned finance income. P.V. factor @ 10% for years 1 to 3 are 0.909, 0.826 and 0.751 respectively. (e) AQ Ltd., an investment company is finalizing its account for the Financial Year ending 2013 in the month of August 2013. How will the following incomes be accounted for in the books of AQ Ltd.? (1) X Ltd., has declared interim dividend which has not been received till 31-3-2013 but received on 25-4-2013.

(2) Y Ltd., has declared dividend on 8th May 2013 for the year ending 31-3-2013 which has been approved by the shareholders of the company on 30th June 2013. (3) Z Ltd., a subsidiary of AQ Ltd., has declared dividend for the year ended 31-3-2013 on 25th May 2013 the AGM for which is to be held on September 2013. (4 x 4 = 16 Marks) ∗

PS : Read Schedule IV as Schedule VI.

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FINAL EXAMINATION: MAY, 2014

Answer (a) Operating cycle of Kay Ltd. will be computed as under:

Raw material stock holding period + Work-in-progress holding period + Packing Materials holding period+ Finished goods holding period + Debtors collection period = 1 + 1 + 3 + 1 + 2 = 8 months Classification of liability to suppliers: Revised Schedule VI provides that:

“A liability shall be classified as current when it satisfies any of the following criteria: (i)

it is expected to be settled in the company’s normal operating cycle;

(ii)

it is held primarily for the purpose of being traded;

(iii) it is due to be settled within twelve months after the reporting date; or (iv) the company does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date. Terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments and do not affect its classification.” There are two situations: (a) When credit period given by supplier is 12.5 months: The nature of classification of liability is to be seen with reference to the reporting date. Hence all liabilities except those that arise in the last fortnight of the accounting period will be “Current” as this will have to be settled within 12 months of the reporting date. Thus, all liabilities that do not arise in the last fortnight of the accounting period will be “Non Current”. (b) When credit period given by suppliers is 330 days (i.e. 11 months approx.): If the creditors are settled in 330 days i.e. within 11 months. This satisfies the third condition i.e. it is due to be settled within twelve months after the reporting date and there is no option to defer it. Hence, in the case it will be treated as current liability. (b) The Seventh Schedule of SEBI (Mutual funds) Regulations, 1996 states that a mutual fund scheme shall not invest more than 10% of its NAV in unrated debt instruments issued by a single issuer and the total investment in such instruments shall not exceed 25% of the NAV of the scheme. All such investments shall be made with the prior approval of the Board of Trustees and the Board of Asset Management Company. It also states that a mutual fund scheme shall not invest more than 15% of its NAV in debt instruments issued by a single issuer which are rated not below investment grade by an authorised credit rating agency. Such investment limit may be extended to 20% of the NAV of the scheme with the prior approval of the Board of Trustees and the Board of Asset Management Company.

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Accordingly, (i)

If the debts instruments of Y Ltd. unrated then Mutual fund’s Asset Management Company (AMC) cannot invest more than 10% of its NAV in it.

(ii) If the debts instruments of Y Ltd are rated, then also, Mutual Fund’s AMC cannot invest more than 20% of its NAV in it. Therefore, investment of 25% of its NAV of the scheme in debts instrument of Y Ltd. by Mutual Fund’s AMC is not permissible as per the SEBI (Mutual Fund) Regulation 1996. (c) The differences between taxable income and accounting income can be classified into permanent differences and timing differences as follows: (i) Permanent differences are those differences between taxable income and accounting income which originate in one period and do not reverse subsequently. For instance, if for the purpose of computing taxable income, the tax laws allow only a part of an item of expenditure, the disallowed amount would result in a permanent difference. (ii) Timing differences are those differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods. Timing differences arise because the period in which some items of revenue and expenses are included in taxable income do not coincide with the period in which such items of revenue and expenses are included or considered in arriving at accounting income. For example, machinery purchased for scientific research related to business is fully allowed as deduction in the first year for tax purposes whereas the same would be charged to the statement of profit and loss as depreciation over its useful life. The total depreciation charged on the machinery for accounting purposes and the amount allowed as deduction for tax purposes will ultimately be the same, but periods over which the depreciation is charged and the deduction is allowed will differ. (d) (i)

Calculation of Annual Lease Payment∗

` Cost of the equipment Unguaranteed Residual Value PV of unguaranteed residual value for 3 years @ 10% (` 1,00,000 x 0.751) Fair value to be recovered from Lease Payment (` 7,46,55,100 – ` 75,100) PV Factor for 3 years @ 10% Annual Lease Payment (` 7,45,80,000 / PV Factor for 3 years @ 10% i.e. 2.486) ∗

7,46,55,100 1,00,000 75,100 7,45,80,000 2.486 3,00,00,000

Annual lease payments are considered to be made at the end of each accounting year.

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FINAL EXAMINATION: MAY, 2014

(ii) Unearned Finance Income

Total lease payments [` 3,00,00,000 x 3] Add: Residual value Gross Investments Less: Present value of Investments (` 7,45,80,000+ ` 75,100) Unearned Finance Income

9,00,00,000 1,00,000 9,01,00,000 (7,46,55,100) 1,54,44,900

(e) As per para 8 of AS 9 “Revenue Recognition”, dividends from investment in shares is recognized in the statement of Profit and Loss only when the owner’s right to receive the payment is established.

(i)

In the first case, it is clear that interim dividend was declared by X Ltd. before 31st March 2013 which implies that the dividend had been vested (acrrued) to the shareholders of AQ Ltd. in the year 2012-13. Therefore, though it is received on 25.4.13 (before finalization of accounts) yet it should be recognized in the financial statements for the year ended 31st March, 2013.

(ii)

Dividend declared by Y Ltd and approved by the shareholders of AQ Ltd. after balance sheet date but before finalization of accounts cannot be accounted for in the financial statements for the year ended 31st March, 2013. This will be accounted in 2013-14 as the right to receive dividend will arise when the AGM will approve the dividend i.e. on 30th June 2013. Since right to receive the dividend was not established on or before 31st March, 2013, it will not be accounted for in the books for the year ended 31st March, 2013.

(iii) In the given case, dividend declared by Z Ltd. will be approved in the AGM to be held on 30th September, 2013. Before that right to receive dividend cannot be established. Hence it will not be accounted for in the financial year ended on 31st March, 2013.

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