question no.1 is compulsory. answer any five...

1 ME29 / Prime / Final

FLRG Number of Pages : 6 Total Marks: 100 Number of questions: 7 Time Allowed: 3 Hrs

Question No.1 is compulsory. Answer any five out of the remaining questions. Working notes should form part of the answer.

Wherever necessary, suitable assumptions may be made by the candidates.

1. Answer any four of the following:

(a) On 1st December, 2008, Ceebee Construction Co. Ltd. undertook a contract to construct a building for Rs.85 lakhs. On 31st March, 2009 the company found that it had already spent Rs.64, 99,000 on the construction. Prudent estimate of additional cost for completion was Rs.32, 01,000. What amount should be charged to revenue in the final accounts for the year ended 31st

March, 2009 as per provisions of Accounting Standard 7 (Revised)?

(b) While executing a new project, the company had to pay Rs.50 lakhs to the State Government as part of the cost of roads built by the State Government in the vicinity of the project for the purpose of carrying machinery and materials to the project site. The road so built is the property of the State Government. Advise the company on the following item while from the view point of finalization of accounts.

(c) The following details are available in the books of Sun Ltd.,

Particulars

Rs. in lakhs

(a) Provision for tax:

For 2005-2006 200 For 2006-2007 300 For 2007-2008 250

Advance tax paid:

For 2005-2006 175 For 2006-2007 350 For 2007-2008 270

Sun Ltd. estimates its Deferred Tax Liabilities to be Rs.100 lakhs and its Deferred. Tax Assets to be Rs.20 lakhs. How will the above be disclosed?

(d) Global Ltd. is showing an intangible asset at Rs.72 lakhs as on 01.04.2007 and that item

was required for Rs.96 lakhs on 01.04.2004 and that item was available for use from that date. Global Ltd. has been following the policy of amortization of the intangible asset over a period of 12 years on straight line basis. Comment on the accounting treatment of the above with reference to relevant accounting standard.


(e) During 2004, an enterprise incurred costs to develop and produce a routine, low risk computer software product, as follows:

Amount (Rs.)

Completion of detailed programmes and design 25,000 Coding and Testing 20,000 Other coding costs 42,000 Testing costs 12,000 Product masters for training materials 13,000 Duplication of computer software and training materials, from Product masters (2,000 units) 40,000 Packing the product (1,000 units) 11,000

What amount should be capitalized as software costs in the books of the company, on Balance Sheet date?

(4 x 5 =20 Marks) 2. On 1st

A Ltd. - 3,000 shares of Rs.10 each fully paid for Rs.35, 000

January, 2006, Andrew Ltd. a new company, raised its first capital of Rs.3, 00,000 from the issue of 30,000 shares of Rs.10 each at par, and on that date acquired the following shareholdings:

B Ltd. - 10,000 shares of Rs.10 each fully paid for Rs.72, 000 C Ltd. - 8,000 shares of Rs.10 each fully paid for Rs.92, 000.

Apart from these transactions and those detailed below, Andrew Ltd. neither paid not received other monies during 2006.

The following are the summarized Balance Sheets of the Subsidiary Companies on 31st

December, 2006:

A Ltd. Rs.

B Ltd. Rs.

C Ltd. Rs.

Goodwill 4,000 - 15,000 Freehold Property 18,000 41,000 50,000 Plant 16,000 30,000 12,000 Stock 11,000 32,000 21,000 Debtors 4,000 8,000 17,000 Cash at Bank 1,000 2,000 11,500 Profit and Loss Account - 18,000 - Total 54,000 1,31,000 Share Capital

1,26,500 40,000 1,20,000 1,00,000

Reserves (as on 1.1.2006) 3,000 - 7,500 Profit and Loss Account 6,000 - 15,000 Creditors 5,000 11,000 4,000 Total 54,000 1,31,000

1,26,500

Other relevant information: (1) The freehold property of C Ltd. is to be revalued at Rs.65, 000 as on 1.1.2006. (2) Additional depreciation for the year 2006 of Rs.3, 000 on the plant of B Ltd. is to be

provided.


(3) The stock of A Ltd. as on 31st

(4) As on 31

December, 2006 has been undervalued by Rs.2, 000 and is to be adjusted.

st

(5) The balances on Profit and Loss Accounts as on 31

December, 2006 Andrew Ltd. owed A Ltd. Rs.3, 500 and is owed Rs.6, 000 by B Ltd. C Ltd is owed Rs.1,000 by A Ltd., and Rs.2,000 by B Ltd.,

st

(6) During 2006, A Ltd. and C Ltd. declared and paid interim dividends of 8% and 10% respectively.

December, 2005 were: A Ltd. Rs.2, 000 (credit); B Ltd. Rs.12, 000 (debit); and C Ltd. Rs.4, 000 (credit).

You are required to prepare the Consolidated Balance Sheet of Andrew Ltd. and its subsidiary companies as on 31st

(16 Marks) December, 2006, ignore taxation.

3. The following is the Balance Sheet of Narmada Ltd. as on 31st

March, 2009:

Balance Sheet Liabilities Rs. Assets Rs.

4,00,000 Equity shares of Rs.10 each fully paid

40,00,000 Goodwill 4,00,000

13.5% Redeemable preference shares of Rs.100 each fully paid

20,00,000 Building 24,00,000

General Reserve 16,00,000 Machinery 22,00,000 Profit and Loss Account 3,20,000 Furniture 10,00,000 Bank Loan (Secured against fixed assets)

12,00,000 Vehicles 18,00,000

Bills Payable 6,00,000 Investments 16,00,000 Creditors 31,00,000 Stock 11,00,000 Debtors 18,00,000 Bank Balance 3,20,000 _____ __________ Preliminary Expenses 2,00,000 Total 1,28,20,000 Total

1,28,20,000

Further information: (i) Return on capital employed is 20% in similar businesses. (ii) Fixed assets are worth 30% more than book value. Stock is overvalued by rs.1,

00,000. Debtors are to be reduced by Rs.20, 000. Trade investments, which constitute 10% of the total investments, are to be valued at 10% below cost.

(iii) Trade investments were purchased on 1.4.2008. 50% of Non-Trade Investments were purchased on 1.4.2007 and the rest on 1.4.2006. Non-Trade Investments yielded 15% return on cost.

(iv) In 2006-2007 new machinery costing Rs.2, 00,000 was purchased, but wrongly charged to revenue. This amount should be adjusted taking depreciation at 10% on reducing value method.

(v) In 2007-2008 furniture with a book value of Rs.1, 00,000 was sold for Rs.60, 000. (vi) For calculating Goodwill two years purchase of super profits based on simple

average profits of last four years are to be considered. Profits of last four years are as under:


Year Rs. 2005-2006 16,00,000 2006-2007 18,00,000 2007-2008 21,00,000 2008-2009 22,00,000

(vii) Additional depreciation provision at the rate of 10% on the additional value of Plant and Machinery alone may be considered for arriving at average profit. Find out the intrinsic value of the equity share. Income-tax and Dividend tax are not to be considered.

(16 Marks)

4. (a) The following information is available of a concern: Calculate E.V.A.:

Debt capital 12% Rs.2,000 crores Equity capital Rs.500 crores Reserve and surplus Rs. 7,500 crores Capital employed Rs.10,000 crores Risk-free rate 9% Beta factor 1.05 Market rate of return 19% Equity (market) risk premium 10% Operating profit after tax Rs.2,100 crores Tax rate 30%

(b) Popular Ltd. started its business on 01.04.2007. It issued one lac Equity Shares of Rs.10 each at par and 30,000. 9% Debentures of Rs.50 each, both were fully subscribed. It purchased Plant and Machinery for worth Rs. 15 Lac and goods for trading worth Rs.12 lac @ Rs.100 per unit. Estimated life of plant and machinery was 10 years with no scrap value. Goods were sold at Profit of 40% on selling price. Collection from Debtors outstanding as on 31.3.2008 amounted to Rs.5 lac. Goods sold were replaced at a cost of Rs.120 per unit, the number of units being the same. Trade Creditors outstanding as on 31.3.2008 were Rs.3 lac. The replaced goods were entirely in stock on 31.3.2008; replacement cost of goods was considered to be Rs.140 per unit. Replacement cost of machine was Rs.20 lac as on 31.3.2008. Draft Profit and Loss Account and Replacement reserve on replacement cost basis.

(2 x 8 = 16 Marks) 5 Given below Balance Sheets of Bat Ltd. and Ball Ltd. as on 31.12.2006. Ball Ltd. was merged

with Bat Ltd. with effect from 1.1.2007 and the merger was in the nature of purchase.

Balance Sheets as on 31.12.2006

Liabilities Rs. Bat Ltd.

Rs. Ball Ltd. Assets

Rs. Bat Ltd.

Rs. Ball Ltd.

Share Capital: Equity Shares of Rs.10 each

7,00,000 2,50,000 Sundry Fixed Assets

9,50,000 4,00,000


General Reserve 3,50,000 1,20,000 Investments (Non-trade)

2,00,000 50,000

P & L A/c 2,10,000 65,000 Stock 1,20,000 50,000 Export Profit Reserve

70,000 40,000 Debtors 75,000 80,000

12% Debentures 1,00,000 1,00,000 Advance Tax 80,000 20,000 Sundry Creditors 40,000 45,000 Cash & Bank

Balances

2,75,000

1,30,000 Provisionfor Taxation

1,00,000

60,000

Preliminary Expenses

10,000

-

Proposed Dividend

1,40,000

50,000 _____

________

_______

Total 17,10,000 7,30,000 Total 17,10,000

7,30,000

Bat Ltd. would issue 12% Debentures to discharge the claims of the debenture holders of Ball Ltd. at par. Non-trade investments of Bat Ltd. fetched @ 25% while those of Ball Ltd. fetched @ 18% Profit (pre-tax) by Bat Ltd. and Ball Ltd. during 2004, 2005 and 2006 were as follows:

Year Bat Ltd.

Rs. Ball Ltd.

Rs. 2004 5,00,000 1,50,000 2005 6,50,000 2,10,000 2006 5,75,000 1,80,000

Goodwill may be calculated on the basis of capitalization method taking 20% as the pre-tax normal rate of return. Purchase consideration is discharged by Bat Ltd. on the basis of intrinsic value per share. The company decided to cancel the proposed dividend. Prepare Balance Sheet of Bat Ltd. after merger.

(16 Marks) 6 (a) Alpha Ltd. commenced its business on 1st

April, 2006, 2,00,000 equity shares of Rs.10 each at par and 12.5% debentures of the aggregate value of Rs.2,00,000 were issued and fully taken up. The proceeds were utilized as under:

Rs. Fixtures and Equipments (Estimated life 10 years, no scrap value)

16,00,000

Goods purchased for resale at Rs.200 per unit 6,00,000

The goods were entirely sold by 31st

January, 2006 at a profit of 40% on selling price.

Collections from debtors outstanding on 31st March, 2006 amounted to Rs.60,000, goods sold were replaced at a cost of Rs.7,20,000, the number of units purchased being the same as before. A payment of Rs.40,000 to a supplier was outstanding as on 31st

The replaced goods remained entirely in stock on 31 March, 2006.

st

March, 2006.

Replacement cost as at 31st

March, 2006 was considered to be Rs.280 per unit.


Replacement cost of fixtures and equipments (depreciation on straight line basis) was Rs.20,00,000 as at 31st

March, 2006.

Draft the Profit and Loss Account and the Balance Sheet on replacement cost (entry value) basis and on historical cost basis.

(b) The Balance Sheet of War Ltd. as on 31.3.2008 is given: (Rs. in ‘000)

Liabilities Rs.

Amount Assets Rs.

Amount

Share Capital: Equity shares of Rs.10 each

800 Fixed Assets 2,700

Securities Premium 100 Non-trade Investments 300 General Reserve 780 Stock 600 Profit and Loss A/c 120 Sundry Debtors 360 10% Debenture 2,000 Cash and Bank 160 Creditors 320 _____ _____ Total 4,120 Total

4,120

War Ltd. buy back 16,000 shares of Rs.20 per share. For this purpose, the Company sold its all non-trade investments for Rs.3, 20,000. Give Journal Entries with full narrations effecting the buy back.

(2 x 8 = 16 Marks) 7. Write short notes on any four from the following: (a) Explain significant differences and similarities between Indian Accounting Standards,

IAS/IFRS and US GAAPs on the issues of

(i) Changes in accounting policies. (ii) Inventories.

(b) Distinguish between Integral Foreign Operation and Non-integral Foreign Operation. (c) Difficulties in accounting Brands (d) Embedded derivatives (e) Asset Management Company in the context of Mutual Fund.

(4 x 4 = 16 Marks)

ME29 / Prime / Final 1

PRIME ACADEMY 29TH

SESSION MODEL EXAM FINANCIAL REPORTING- NEW SYLLABUS

SUGGESTED ANSWERS

1 (a) Rs.

Cost incurred till 31st 64,99,000 March, 2009 Prudent estimate of additional cost for completion 32.01,000 Total cost of construction 97,00,000 Less: Contract price 85,00,000 Total foreseeable loss 12,00,000

According to para 35 of AS 7 (Revised 2002), the amount of Rs.12, 00,000 is required to be recognized as an expense. Contract work in progress = Rs.64, 99,000 x 100

(c) Disclosure of Current and Deferred Tax balances will be on the basis of principles laid down in AS-22. These are:

= 67% 97, 00,000 Proportion of total contract value recognized as turnover as per para 21 of AS 7 (Revised) on Construction Contracts = 67% of Rs.85, 00,000 = Rs.56, 95,000.

(b) In this case, the capital expenditure incurred by the company would not be represented by any actual assets, since the roads would remain the property of the relevant State authorities even though a part of their cost has been defrayed by the company in order to facilitate its business. Having regard to the nature of the expenditure and the purpose for which it is incurred, it is suggested in para 10 of Guidance Note on Treatment of Expenditure. During Construction Period that it would be more appropriate and realistic to classify such expenditure in the balance sheet under the heading of “Capital Expenditure” rather than either, write-off the expenditure to revenue or classify the expenditure under the heading of “Miscellaneous Expenditure” or “Deferred Revenue Expenditure” subject to two conditions. In the first place, the description of the specific item on the balance sheet should be such as to indicate quite clearly that the capital expenditure is not represented by any assets owned by the company. In the second place, the capital expenditure should be written off over the approximate period of its utility or over a relatively brief period not exceeding five years, whichever is less.

(a) Current tax assets and liabilities can be set off, if the enterprise has a legally enforceable right to

set off the recognized amounts and intends to settle them on a net basis. (b) Deferred tax assets and liabilities can be set off, if the items relate to taxes on income levied by

the same governing taxation laws. Applying these principles, the required disclosures will be as follows:

Liabilities Rs. Rs. Assets Rs. Rs. Deferred tax liabilities Less: Deferred tax assets

100 20

80

Current assets, loans and advances Advance tax paid Less: Provisions

795 750

45


(d) As per Para 63 of As 26 “Intangible Assets”, the depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. There is a resuttable presumption that the useful life of an intangible asset will not exceed ten years from the date when the asset is available for use. Amortisaton should commence when the asset is available for use. Global Ltd. has been following the policy of amortization of the intangible asset over a period of 12 years on straight line basis. The period of 12 years is more than the maximum period of 10 years specified under As 26. Accordingly, Global Ltd. would be required to restate the carrying amount of intangible asset as on 1.4.2007 at Rs.96 lakhs less Rs.28.8 lakhs (Rs.9.6 lakhs x 3 years) = Rs.67.2 lakhs. If amortization had been as per As 26, the carrying amount would have been Rs.67.2 lakhs. The difference of Rs.4.8 lakhs i.e. (Rs.72 lakhs-67.2 lakhs) would be required to be adjusted against the opening balance of revenue reserves. The carrying amount of Rs.67.2 lakhs would be amortised over 7 ( 10 less 3 ) years in future.

(e) As per para 44 of AS-26, costs incurred in creating a computer software product should be charged to research and development expense when incurred until technological feasibility/ asset recognition criteria has been established for the product. Technological feasibility/asset recognition criteria has been established upon completion of detailed programme design or working model. In this case, Rs.45,000 would be recorded as an expense (Rs.25,000 for completion of detailed program design and Rs.20,000 for coding and testing to establish technological feasibility/ asset recognition criteria). Cost incurred from the point of technological feasibility/asset recognition criteria until the time when products costs are incurred are capitalized as software cost (Rs.42,000 + Rs.12,000 + Rs.13,000) Rs.67,000.

2. Consolidated Balance Sheet of Andrew Ltd. and its subsidiaries A Ltd. B Ltd. and C Ltd. as on 31st

Liabilities

December, 2006

Rs. Rs. Assets Rs. Rs.

Share Capital Fixed Assests Issued & Subscribed 30,000 shares of Rs 10 each fully paid

3,00,000

Goodwill Freehold Property Plant

19,000 1,24,000

55,000

Reserve & Surplus Investments - Reserve on Consolidation 25,950 Current Assets Profits & Loss A/c 20,900* Loans & Advances Secured Loans - Stock in trade 66,000 Unsecured Loans - Sundry Debtors 35,000 Current Liabilities & Provisions

Less: Inter Co. Debts

12,500

22,500

Sundry Creditors 23,500 Cash at Bank 1,28,100 Less: Inter Co. 12,500 11,000 Minority Interest 56,750 Total 4,14,600 Total 4,14,600 Analysis of Profits:

Capital Profit Rs.

Revenue Profit Rs.

(i) C Ltd. Profit & Loss Account on 1.1.2006 less Div (4000-4000)

-

Reserve on 1st 7,500 Jan 2006 Appreciation in the value of Freehold Property 15,000 Profit for the year after interim dividend 15,000 22,500 15,000 Minotiry interest 20% 4,500 3,000


Share of Andrew Ltd. 18,000 12,000 (ii) B Ltd. Loss on the date of acquisition -12,000 Loss suffered during the year (21,000 – 12,000)

-9,000

-12,000 -9,000 Minority Interest (1/6) 2,000 1,500 Share of Andrew Ltd. -10,000 -7,500 *Revenue Profit of C Ltd. Rs.12,000 Revenue Profit of B Ltd. -Rs.7,500 Revenue Profit of A Ltd. Rs.6,000 Rs.10,500 Add: Interim dividend received Rs.10,400 Rs.20,900 (iii) A Ltd. Reserve on 1.1.2006 3,000 Profit on 1.1.2006 less Dividend (2,000-2,000) - - Profit earned during the year (after interim dividend Rs.3,200)

8,000

3,000 8,000 Minority Interest (1/4) 750 2,000 2,250 6,000

(iv) Cost of Control / Capital Reserve

Cost of Investments in A Ltd. less Dividend (35,000-1,500)

33,500

Cost of Investments in B Ltd. 72,000 Cost of Investments in C Ltd. less Dividend (92,000-3,200)

88,800

1,94,300 Paid up value of shares held in A Ltd. 30,000 Paid up value of shares held in B Ltd. 1,00,000 Paid up value of shares held in C Ltd. 80,000 Capital Profits in A Ltd. 2,250 Capital Profits in B Ltd. -10,000 Capital Profits in C Ltd. 18,000 2,20,250 Capital Reserve 25,950

(v) Minority Interest

A Ltd.

Rs. B Ltd.

Rs. C Ltd.

Rs. Share Capital 10,000 20,000 20,000 Capital Profits 750 -2,000 4,500 Revenue Profits 2,000 -1,500 3,000 12,750 16,500 27,500

56,750


(vi) Bank A/c – Andrew Ltd.

Dr. Cr. Rs. Rs. To Share Capital 3,00,000 By Investments in A Ltd. 35,000 To Investments in A Ltd. 1,500 By Investments in B Ltd. 72,000 To Investments in C Ltd. 3,200 By Investments in C Ltd. 92,000 To Dividends- A Ltd. 2,400 By B Ltd. (indebtedness) 6,000 C Ltd. 8,000 By Balance c/d 1,13,600 To A Ltd. 3,500 3,18,600 3,18,600

(vii) Sundry Assets

Freehold Property

Rs.

Plant

Rs.

Stock

Rs.

Debtors

Rs.

Cash at Bank

Rs. (a) Andrew Ltd. - - - 6,000 1,13,600 (b) A Ltd. 18.000 16,000 13,000 4,000 1,000 (c) B Ltd. 41,000 27,000 32,000 8,000 2,000 (d) C Ltd. 65,000 12,000 21,000 17,000 11,500 1,24,000 55,000 66,000 35,000 1,28,100 Less: Inter Co. debts 12,500 22,500

3. Calculation of intrinsic value of equity shares of Narmada Ltd.

(a) Calculation of Goodwill:

1) Capital employed Rs. Rs. Fixed Assets Building 24,00,000 Machinery (Rs.22,00,000 + Rs.1,45,800) 23,45,800 Furniture 10,00,000 Vehicles 18,00,000 75,45,800 Add: 30% increase 22,63,740 98,09,540 Trade investments (Rs.16,00,000 x 10% x 90%) 1,44,000 Debtors (Rs.18,00,000- Rs.20,000) 17,80,000 Stock (Rs.11,00,000-Rs.1,00,000) 10,00,000 Bank balance 3,20,000 1,30,53,540 Less: Outside liabilities Bank Loan 12,00,000 Bills Payable 6,00,000 Creditors 31,00,000 49,00,000 Capital employed 81,53,540


2) Future maintainable profit

Calculation of average profit

2005-2006 Rs.

2006-2007 Rs.

2007-2008 Rs.

2008-2009 Rs.

Profit given 16,00,000 18,00,000 21,00,000 22,00,000 Add: Capital expenditure of machinery charged to revenue

2,00,000

Loss on sale of furniture 40,000 16,00,000 20,00,000 21,40,000 22,00,000 Less: Depreciation on machinery 20,000 18,000 16,200 Income from non-trade investments

1,08,000 2,16,000 2,16,000

Reduction in value of stock 1,00,000 Bad debts 20,000 Adjusted Profit 16,00,000 18,72,000 19,06,000 18,47,800

Rs. Total adjusted profit for four years (2005-2006 to 2008-2009) 72,25,800 Average profit (Rs.72,25,800/4) 18,06,450 Less: Depreciation at 10% on additional value of machinery (22,00,000+1,45,800) x 30/100 i.e. Rs.7,03,740

70,374

Adjusted average profit 17,36,076 3) Normal Profit

20% on capital employed i.e. 20% on Rs.81,53,540 Rs. 16,30,708

4) Super Profit Expected profit – normal profit Rs.17,36,076 – Rs.16,30,708 = Rs.1,05,368

5) Goodwill

2 years’ purchase of super profit Rs.1,05,368 x 2 = Rs.2,10,736

(b) Net assets available to equity shareholders

Rs. Rs. Goodwill as calculated in 1 (v) above 2,10,736 Sundry fixed assets 98,09,540 Trade and Non-trade investments 15,84,000 Debtors 17,80,000 Stock 10,00,000 Bank balance 3,20,000 1,47,04,276 Less: Outside liabilities Bank loan 12,00,000 Bills payable 6,00,000 Creditors 31,00,000 49,00,000 Preference share capital 20,00,000 Net assets for equity shareholders 78,04,276


(c) Valuation of equity shares Value of equity share= Net assets available to equity shareholders Number of equity shares =

1. Depreciation on the overall increased value of assets (worth 30% more than book value) has not been considered. Depreciation on the additional value of only plant and machinery has been considered taking depreciation at 10% on reducing value method while calculating average adjusted profit.

Rs.78,04,276 4,00,000 = Rs.19.51 Note:

2. Loss on sale of furniture has been taken as non-recurring or extraordinary item. 3. It has been assumed that preference dividend has been paid till date.

4. (a) E.V.A = NOPAT – COCE

NOPAT = Net Operating Profit after Tax COCE = Cost of Capital Employed COCE = Weighted Average Cost of Capital x Average Capital Employed = WACC x Capital Employed Debt Capital = Rs.2,000 crores Equity capital 500 + 7,500 = Rs.8,000 crores Capital employed = 2,000+8,000= Rs.10,000 crores Debt to capital employed = 2,000 = 0.20

10,000 Equity to capital employed = 8,000 = 0.80 10,000 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 x Equity Risk Premium Or = Risk Free Rate + Beta (Market Rate-Risk Free Rate) = 9 + 1.05 x (19-9) = 9 + 1.05 x 10 = 19.5% WACC = Equity to CE x Cost of Equity capital + Debt to CE x Cost of debt = 0.8 x 19.5% + 0.20 x 8.40 % = 15.60% + 1.68% = 17.28% COCE = WACC x Capital employed = 17.28% x 10,000 crores = 1728 crores E.V.A. = NOPAT – COCE = Rs.2,100 – Rs.1,728 = Rs.372 crores


(b) M/s Popular Ltd. Profit & Loss Account as on 31.03.2008

Rs. Sales 20,00,000 Less: Cost of sales (Refer W.N.1) 14,40,000 Gross Profit 5,60,000 Less: Depreciation (Refer W.N.2) 1,75,000 Profit before interest 3,85,000 Less: Debenture interest (Refer W.N.3) 1,35,000 Profit after charging depreciation and interest 2,50,000

Replacement Reserve

Realised Gain Rs.

Unrealised Gain

Rs. Stock: Sold (Rs.14,40,000-Rs.12,00,000) 2,40,000 Unsold goods 12,000 x (Rs.140-Rs.120) 2,40,000 Plant & Machinery Depreciation (Rs. 1,75,000-Rs.1,50,000) 25,000 Book value of asset [(Rs.20,00,000- Rs.2,00,000) less (Rs.15,00,000-Rs.1,50,000)]

4,50,000 2,65,000 6,90,000

Replacement Reserve= Rs.2,65,000 + Rs.6,90,000 = Rs.9,55,000 Working Notes:

1. Sales and Cost of sales Sale Price @ 40% profit on Selling Price = Rs.12,00,000 x (100/60) = Rs.20,00,000 Cost of Sales =12,000 x Rs.120 = Rs.14,40,000

2. Depreciation under replacement cost basis

Under replacement cost basis, depreciation is calculated (on average basis) which can be shown as follows: 15,00,000 + 20,00,000

3. Debenture Interest

=10% of Rs.17,50,000 = Rs.1,75,000 2

30,000 x Rs.50 x 9% = Rs.1,35,000

5. (1) Valuation of Goodwill

(i) Capital Employed Bat Ltd. Ball Ltd. Rs. Rs. Rs. Rs. Sundry-Assets as per Balance Sheet 17,10,000 7,30,000 Less: Preliminary Expenses 10,000 - Non-trade Investment 2,00,000 2,10,000 50,000 50,000 15,00,000 6,80,000 Less: Sundry Liabilities 12% Debentures 1,00,000 1,00,000 Sundry Creditors 40,000 45,000 Provision for Taxation 1,00,000 2,40,000 60,000 2,05,000 12,60,000 4,75,000


(ii) Average Pre-Tax Profit Bat Ltd.

Rs. Ball Ltd.

Rs. 2004 5,00,000 1,50,000 2005 6,50,000 2,10,000 2006 5,75,000 1,80,000 17,25,000 5,40,000 Simple Average 5,75,000 1,80,000 Less: Non-trading income 50,000 9,000 5,25,000 1,71,000 (iii) Goodwill Capitalisation Value of average profit 5,25,000 26,25,000 x 100

20 1,71,000 8,55,000 x 100 20

Less: Capital Employed 12,60,000 4,75,000 13,65,000 3,80,000 (2) Intrinsic Value per Share Bat Ltd. Ball Ltd. Rs. Rs. Rs. Rs. Goodwill 13,65,000 3,80,000 Sundry Other Assets less preliminary expenses

17,00,000

7,30,000

30,65,000 11,10,000 Less: Liabilities 12% Debentures 1,00,000 1,00,000 Sundry Creditors 40,000 45,000 Provision for Tax 1,00,000 2,40,000 60,000 2,05,000 28,25,000 9,05,000 Intrinsic value per share 28,25,000

70,000 =Rs.40.40

9,05,000 25,000 = Rs.36.20

(3) Purchase Consideration 25,000 Shares @ Rs.36.20

Liabilities

Rs. 9,04,960 To be discharged by 22,400 [25,000 x 36.20/40.40] Shares @ Rs.40.40 Rs. 9,04,960 Cash for fraction Rs.40

Balance Sheet of Bat Ltd. (after merger with Ball Ltd.)

Rs. Rs. Assets Rs. Rs.

Share Capital Goodwill 3,80,000* 92,400 Equity Shares of Rs.10 each

9,24,000 Sundry Fixed Assets Balance

9,50,000

(of which 22,400 shares were issued to the vendors

Add: Assets takenover

4,00,000

13,50,000

otherwise than cash) Investments General Reserve 3,50,000 Balance 2,00,000 P & L A/c 2,10,000 Add: Investments Add: Proposed taken over 50,000 2,50,000 Dividend written off 1,40,000 3,50,000 Stock Balance 1,20,000 Share Premium 6,80,960 Add: Stock taken over 50,000 1,70,000 Export Profit Reserve Debtors : Balance 75,000


Balance 70,000 Add: Taken over 80,000 1,55,000 Add: Balance of Ball Ltd. 40,000 1,10,000 Advance Tax Bal. 80,000 12% Debenture Balance 1,00,000 Add: Bal of Ball Ltd. 20,000 1,00,000 Add: 12% Debentures issued at par other than cash

1,00,000

2,00,000

Cash & Bank Balance Add: Balance of Ball Ltd. taken over

2,75,000

1,30,000

Sundry creditors Balance 40,000 4,05,000 Add: Liabilities taken over

45,000

85,000

Less: Purchase consideration discharged

40

4,04,960

Provision for Taxation 1,00,000 Preliminary expenses 10,000 Add: Prov.for Taxation of Ball Ltd.

60,000

1,60,000

Amalgamation Adjustment A/c

40,000

28,59,960 28,59,960 * Goodwill= Purchase consideration – Net Assets acquired Rs. 9,05,000-Rs. 5,25,000 = Rs. 3,80,000

6. (a)

Profit and Loss Account for the year ended 31st

March, 2006

Historical Cost Basis

Rs.

Replacement Cost Basis

Rs. Sales 10,00,000 10,00,000 Less: Cost of Sales 6,00,000 7,20,000 Gross Profit 4,00,000 2,80,000 Less: Depreciation 1,60,000 1,80,000 Profit before interest 2,40,000 1,00,000 Less: Debenture interest 25,000 25,000 Net Profit 2,15,000 75,000 Balance Sheet of Alpha Ltd. as at 31st

March, 2006

Historical Cost Basis

Rs.

Replacement Cost Basis

Rs. Liabilities Equity Share Capital 20,00,000 20,00,000 Profit and Loss Account 2,15,000 75,000 Replacement Reserve - 6,20,000 12.5% Debentures 2,00,000 2,00,000 Creditors 40,000 40,000 24,55,000 29,35,000 Assets Fixtures and Equipment 14,40,000 18,00,000 Stock 7,20,000 8,40,000 Debtors 60,000 60,000 Cash and Bank 2,35,000 2,35,000 24,55,000 29,35,000 Working Notes: (i) Replacement cost of sales on the basis of replacement cost on the date of sale = Rs.240 x

3,000=Rs.7,20,000


(ii) Under replacement cost basis, depreciation, calculated on the average basis = 10% of Rs.16,00,000 + Rs.20,000

= Rs.1,80,000 2 (iii) Fixtures and equipments at net current replacement cost.

Rs. Gross replacement cost 20,00,000 Less: Depreciation, 10% of Rs.20,00,000 2,00,000 18,00,000

(iv) Replacement Reserve+ Realised holding gains + Unrealised holding gains Realised holding

gains Rs.

Unrealised holding gains

Rs. Stocks: Sold (replacement cost at the date of sale- historical cost) Rs. (7,20,000 – 6,00,000)

1,20,000

Unsold [closing stock x (closing rate – rate at the date of purchase)] = 3,000 x Rs.280 – 240

1,20,000

Fixtures and Equipments: Depreciation Rs. (1,80,000 – 1,60,000) 20,000 Net book value at year end, (Rs.18,00,000- Rs.14,40,000) 3,60,000 1,40,000 4,80,000 Replacement + Reserve = Rs.1,40,000 + Rs. 4,80,000 = Rs.6,20,000.

(b) Journal Entries for Buy-back of shares of War Ltd.

Debit Rs.

Credit Rs.

(i) Bank A/c Dr. To Non-trade Investments To Profit & Loss A/c (Being the entry for sale of Non-trade Investments)

3,20,000 3,00,000

20,000

(ii) Shares Buy back A/c (16,000 x Rs.20) Dr. To Bank A/c (Being purchase of 16,000 shares @ Rs.20 per share)

3,20,000 3,20,000

(iii) Equity Share Capital A/c (16,000 x Rs.10) Dr. Buy-back Premium (16,000 x Rs.10) Dr. To Shares Buy-back A/c (Being cancellation of shares bought back)

1,60,000 1,60,00

3,20,000

(iv) Securities Premium A/c Dr. General Reserve Dr. To Buy-back Premium (Being adjustment of buy-back premium)

1,00,000 60,000

1,60,000

(v) General Reserve Dr. To Capital Redemption Reserve (Being the entry for transfer of General Reserve to Capital Redemption Reserve to the extent of face value of equity shares bought back)

1,60,000 1,60,000


7 (a) Indian Accounting

Standards IFRS/IAS US GAAPs

Changes in accounting policy

In the year of change, the effect of change is included in income statement of that year and also the impact of change is disclosed.

Retrospective effect of the change in accounting policy is accounted. Also comparative figures are restated; where the effect of period(s) not presented is adjusted against opening retained earnings.

Similar to IFRS from the date of adoption of FAS 154.

Inventories Carried at lower of cost and net realizable value. FIFO or weighted average method is used to determine cost. LIFO method is however, prohibited.

Carried at lower of cost and net realizable value. For cost determination, FIFO or weighted average method is used. LIFO basis of valuation is

1

ME29 / Prime / Final

SCFM

Number of Pages : 5 Total Marks: 100 Number of questions: 6 Time Allowed: 3 Hrs

Question 1 is compulsory. Answer any 4 from the rest

1a. Television Ltd. has a proposal for manufacturing car televisions. The project would involve cost of plant Rs.500 lacs, installation cost of Rs.100 lacs and working capital of Rs.125 lacs. The annual capacity of the plant is to manufacture 20,000 sets. Price per set is Rs.20, 000/-, with a variable cost ratio of 65%. Cash-fixed costs in the first year, including promotion expenditure of Rs. 120 lacs, is Rs. 420 lacs and is thereafter Rs. 300 lacs each year. Depreciation at is at 25% WDV. Working capital requirements is 25% of sales. The company expects that the plant’s capacity utilization over its estimated useful life of seven years is as under:

Year 1 2 3 4 5 6 7

Capacity utilization % 25 40 50 75 100 100 100

Terminal value of the project is 20% at invoice price. If the hurdle rate is 12%, and tax rate is 35% plus 5% surcharge, can the project be accepted? While evaluating, you have to keep in mind that the Company has other sources of income against which the losses if any from this project, can be set off. Also assume that the terminal value would include release of founds blocked in working capital.

(14 Marks)

b. An initial outlay of Rs. 12 lacs is contemplated in a project, for which the following cash flow estimates have been prepared:

2


Net CFAT (Rs.) Probability

Year 1

Year 2

Year 3

4,00,000

3,50,000

2,50,000

3,50,000

4,50,000

5,00,000

2,60,000

3,20,000

4,10,000

0.30

0.40

0.30

0.25

0.35

0.40

0.45

0.25

0.30

Advise whether the project is worthwhile, if RADR is 17%? What should be the maximum project cost, if it were to be taken up.

(6 Marks)

2.a Basic information: (i) Asset related: cost Rs.120 lace; tax depreciation 40%; Useful life 4 years; RV after three years

Rs.25.92 lacs (ii) Leasing: Full pay out: three years lease: lease Quote Rs.434 per 1000: payment annually in

arrears (iii) Borrow and buy three-years loan; interest rate 15%; Quantum to be determined, such that annual

repayment of principals will be equal to annual lease rental payment (iv) Others: tax rate is 40%, and opportunity cost of capital is 11%.

Based on information given above, determine the preferred option as between leasing and buying.

(12 Marks)

b. Write Short notes on Venture Capital.

(4 Marks)

3


c. You have a housing loan with one of India’s top housing finance companies. The amount outstanding is Rs.1, 89,540. You have just now paid an instilment. You next instilment falls due a year later. There are five more installments to go, each being Rs.50, 000. Another housing-finance company has offered to take over this loan on a seven year repayment basis. You will be required to pay Rs.36, 408 per annum, with the first instilment falling a year later. The processing fee is 3% of amount taken over. For swapping you will have to pay Rs.12, 000 to the first company .should you swap the loan?

(4 Marks)

3.a Imperial Ltd. Is evaluating the feasibility of acquiring control of Hospital surgical (HS), an unlisted, private company.

Turn over Rs.2400 lacs

Earnings Rs.30 lacs

Number of share 60,000

Share held by Small group of family members

% of Debt in total debt and equity 25%

Dividend pay out 50%

Estimated Growth in dividend 5% constant

Imperial expect to offer a price which would be at least 15% less than what would the price, if the share were to be listed. RBI Bond rate is presently ruling at 6% and market beta of 1.44, with debt level which is one –eighth of equity level. What price should Imperial pay for the share of HS? Assume that there is no taxation.

(16 Marks)

b Write Short notes on Net Asset Value.

(4 Marks)

4.a Consider the following data relating to KM stock. KM has a beta of 0.7 with NIFTY. Each Nifty contract is equal to 200 units. KM now quotes at Rs 150 and the Nifty future is 1400 Index points. You are long on 1200 shares of KM in the spot market.

(i) How many futures contracts will you have to take?

(ii) Suppose the price in the spot market spot market drops by 10%, how are you protected?

(iii) Suppose the price in the spot market jumps up by 5%, what happens?

(4 Marks)

4


b. you have invested in four securities (A,B,C and D),the following sums:

A: Rs.10,000; B: Rs20,000; C: Rs. 16,000; D: Rs.14,000

The β values of the securities are 0.80, 1.20, 1.40 and 1.75 respectively. (i) If the risk free return is 4.25%, and the market return is 11%, what is the expected return on the portfolio? (ii) If you encash your investment in security β and reinvest the funds in RBI Bonds yielding a return of 4.25%, what is the β value of the portfolio and its expected return?

(8 Marks)

c. Mr. A can earn a return of 16 per cent by investing in equity share his own. Now he is considering a recently announced equity based mutual fund scheme in which the initial expenses are 5.5 per cent and annual recurring expenses are 1.5 per cent. How much should the mutual fund earn to provide Mr. A a return of 16 per cent?

(4 Marks)

d. What do you mean by the term ‘spread’? What are the factors determining it?

(4 Marks)

5.a The balance sheet of K Ltd shows that its share have a par value of Rs.8 The paid up capital is Rs. 20 lacs. The share premium show Rs. 6 lacs and the retained earning are Rs. 84 lacs. The current market price is Rs. 60. What will happen to the equity account and to the number of share outstanding and to the market price in each of the following situation? Consider each situation independently and discuss

(i) If there is a 1:5 bonus issue (ii) If there is a 2:1 stock split (iii) If there is a 1:2 reverse slit

(8 Marks)

b. Write Short notes on constant dividend plus

(8 Marks)

c. Write short notes on Straddle

(4 Marks)

5


6 Write short notes on any four:

(i) Diversifiable risk or Non-Diversifiable risk

(ii) Options contract

(iii) Short selling

(iv) Global Depository Receipts (GDR)

(v) Zero coupons

(vi) Interest Rate Futures

(4 x 5 = 20 Marks)


PRIME ACADEMY 29TH SESSION MODEL EXAM

STRATEGIC FINANCIAL MANAGEMENT NEW SYLLABUS - SUGGESTED ANSWERS

1 (a) Step:1 Initial Outflow (Rs. lacs)

Capital Expenditure 600 Working Capital 125 Total 725 Step:2 In between cash flow

YR

WN 1 Depreciation

Opening WDV

Depreciation @ 25%

Closing WDV

600 150 450 2 450 113 337 3 337 84 253 4 253 63 190 5 190 48 142 6 142 36 106 7 106 27 79

W N 2 Tax 35+5% = 36.75% It is assumed that loss of first year can be adjusted in the first year itself Tax saved = 81 (220 X 36.75%) Step:3

Details

, Statement showing computation of CFAT during project life

Note 1 2 3 4 5 6 7 Volume % 25 40 50 75 100 100 100 Volume Units 5000 8000 10000 15000 20000 20000 20000 Sales (In lacs) 1000 1600 2000 3000 4000 4000 4000 Contribution @35% 350 560 700 1050 1400 1400 1400 Less: Cash Fixed Costs (420) (300) (300) (300) (300) (300) (300)

Less: Depreciation 1 (150) (113) (84) (63) (48) (36) (27) PBT (220) 147 316 687 1052 1064 1073 Less: Tax @ 36.75% 2 81 (54) (116) (252) (387) (391) (394)

PAT (139) 93 200 435 665 673 679 Add: Depreciation 150 113 84 63 48 36 27 Less: Change in Working Capital 3 (125) (150) (100) (250) (250) - -

Net CFAT (114) 56 184 248 463 709 706


Details

W N 3

Note 1 2 3 4 5 6 7 Working Capital ( 25% of Sales) 250 400 500 750 1000 1000 1000

Increase in working Capital 125 150 100 250 250 0 0

Step:4 Terminal Value: Invoice Price x 20% = 100 (-) WDV = (79) Excess of sales Proce over WDV = 21 Tax @ 36.75% = (8) Net Sale value = 92 Recapture of working Capital = 1000_____ Total = 1092 Lacs Step:5

Yr

, Capital Budgeting Analysis statement

CF (Rs) DF(12%) DCF(Rs) 0 (725) 1.000 (725) 1 (114) 0.893 (102) 2 56 0.797 45 3 184 0.712 131 4 248 0.636 158 5 463 0.567 263 6 709 0.507 359 7 (706+1092) 0.452 813 NPV 942

Conclusion: Since NPV of the project is positive, project may be accepted

1 (b) Step I: Compute Expected cash flow Year's Net CFAT ( Rs. Probability Amount Rs. Rs. Year 1 400,000 0.30 120,000

350,000 0.40 140,000

250,000 0.30 75,000 335,000

Year 2 350,000 0.25 87,500 450,000 0.35 157,500

500,000 0.40 200,000 445,000

Year 3 to 5 260,000 0.45 117,000

320,000 0.25 80,000

410,000 0.30 123,000 320,000


Step II : Compute RADR. This is given as 17% Step III : Compute NPV using a RADR of 17%

Year Cash Flow Discount Factor PV / Rs. (Rs) @ 17%

0 (12,00,000) 1.000 (12,00,000) 1 3,35,000 0.855 2,86,425 2 4,45,000 0.731 3,25,295 3 3,20,000 0.624 1,99,680 4 3,20,000 0.534 1,70,880 5 3,20,000 0.456 1,45,920

NPV (71,800)

Step IV:

Decision - The NPV of the project , at a RADR of 17% is negative , Hence the project should be rejected

Maximum Project cost. For Acceptance, the project cost, should be curtailed and Step V: revised downwards t Rs11,28,200

( Rs.12.00 Lacs, Less Rs.71,800).

2 (a) Step 1.

Lease quote Rs.434/1000

Compute annual lease rentals

Cost: Rs.120 lacs Rentals = Rs.52,08,000 Note: Rentals = 120 lacs x 434/1000 = Rs.52,08,000 Step 2.

• Discount the lease rentals at borrowing rate, and derive its PV.

Determine loan equivalent Loan amount bearing an interest of 15%, repayment in which equals lease rentals. Can be computed as under.

• Establish a link between the derived PV, with the PV of asset. • Determine PV per thousand of the value of asset. In the instant case, if lease rental of Rs.52,08,000 is an annuity. PVAF for 15% for three years 2.283. The PV of lease rentals is 11,891 (thousands), against current value of asset at Rs.120 lacs. This works out to 991 per thousand; hence, loan amount will be 0.991 x 12000 = Rs.11892. Amount / Rs.000

Commencement Interest at 15% Principal Repayment 11,892.00 1783.80 3434.20 5208 8467.80 1270.17 3937.83 5208 4529.97 679.50 4528.50 R/off dif. 1.47


Step 3.

Annual lease rentals

PV of tax shield on lease rentals (discounted at COC 11%) Amount/Rs.000

5208.00 Tax rate 0.40 Tax shield 2083.20 3 year PVAF at 11% 2.4437 PV of tax shield 5090.87

Step 4:

Depreciation on 120,00 @ 40%

PV of tax shield on depreciation (discounted at COC 11%) Tax Shield @ 0.40 Dis. Factor At 11% PV Rs.000

4800 1920 0.901 1729.92 2880 1152 0.812 935.42 1728 691 0.731 505.12

PV of tax shield 3170.46 Step 5:

Interest on loan At 11%

PV of Tax shield on interest on loan (Discount at COC 11%) Tax shield at 40%

PV Rs.000 Disc. Factor

1783.80 713.52 0.901 642.89 1270.17 508.07 0.812 412.56 679.50 271.80 0.731 198.69

PV of tax shield 1254.14 Step 6:Salvage: Rs.25.92 lacs

PV of Salvage value: (COC 11%) 0.731 Rs.18.95 lacs

Step 7:

Net Advantage to Lease = Difference between A and B Evaluation

A B (1) Initial Investment Rs.12000.00 (3) PV of Lease rentals Rs.11892.00 (2) PV of Tax Rs.5090.87 Shield on lease rentals

(4) PV of tax shield on depreciation

Rs.3170.46

(5) PV of tax shield on interest on loan

Rs.1254.14

(6) PV of net salvage value

Rs.1895.00

Rs.17090.87 Rs.18211.60 Decision: Since value of B > A, decision is in favour of borrowing and buying

2 (b) 1. Venture Capital

The phrase Venture Capital4 was first coined at the Harvard Business School in the early 1950s to define a century old activity!


What it means Venture Capital5

• Finance new and rapidly growing companies

is money provided by professionals who invest alongside management, in young, rapidly growing companies that have the potential to develop into economic powerhouses. A firm engaged in providing venture capital and related services is referred to as a venture capitalist. Venture Capital (VC) firms are generally private partnerships, or closely held private companies, funded by private and public pension funds. Venture Capital is also referred to as Risk Capital. What do they do? Venture capitalists:

• Purchase equity shares • Assist in the development of new products or services • Add value to the enterprise through active participation in management Where do they invest? Venture capitalists invest in: • First generation businesses promoted by first generation entrepreneurs. • Untried products and untested products and technology. • High risk projects that have high risk of failures but where the rewards, if successful, are

enormous. • Businesses that represent long-term investments ranging between 3 and 7 years. In short, Venture Capital is capital available for investment in the equity of an enterprise. The venturer may also park some money in debt but the distinguishing feature is that he retains some shares in the equity of the venture. But, as we will see in the later part of the Chapter, a venture capitalist is not a mere passive investor. His role is much wider.

2 (c) Step I: Present Interest rate On a loan amount of Rs.1, 89,540, annuity being Rs.50, 000, PVAF works out to 3.791 (1, 89,540/50,000). From the PVAF table for 5 years, we find that this corresponds to 10%. Step II: New rate On an identical loan amount, annuity of Rs. 36,408 for seven years results in a PV AF of 5.206, (1, and 89,540/36,408). From PVAF table for 5 years, we find that this corresponds to 8%. Step III: Base case decision Interest rate is prima facie beneficial. Step IV: Additional charges to be incurred are (a) Swap charges Rs.12, 000 (b) Processing fee 3% on loan amount Rs. 5,686 If we reckon these two factors, the IRR works out to 10.947% Step V: Evaluation & Decision Implicit interest rate on existing loan is 10%, while proposed loan is at 10.947%. Proposed loan is more expensive. Do not swap.


3 (a) An analysis We have to first determine the equity Beta of HS (using geared-ungeared Beta model). Estimated Beta value of HS will lead us assess the expected return on equity (Ke) of HS, from which, market price can be estimated by applying dividend growth model. Bid price will be at a 15% discount on the estimated listing price. Step 1:

(a) Unlevered Beta value β

Determination of Beta for HS

u = β

−+ )1( tDebtEquity

Equityg

If Equity = 1, then, Debt = 1 x (1/8) = 0.125

βu

125.1100= 1.44

βu

(b) Beta value for the leverage of HS (β

= 1.28

g

Β

assumed as X)

g = β 71.1)1(=

−+Equity

tDebtEquityu

Βg

75.01 = 1.28

Βg = 1.71

Expected Beta value of HS = 1.71 Step 2: E(r) of HS using CAPM [E(RHS) = Rf + βA (Rm – Rf)] = 6 + 1.71 (14 – 6) = 19.68% Step 3: Market price using dividend growth model Current year earnings Rs.50 per share (30 lacs/60,000) DPS0 Rs.25 per share DPS1 (25 x 1.05) Rs.26.25 Capitalisation rate Rs. (Ke – g) = 19.68 – 5 = 14.68% Market price 178.81 Step 4: Assessing price payable (estimated market price less 15% discount) = 178.81 x 85% = 151.9925 (or say Rs.152) Step 5: Value of the firm Estimate of price payable Rs.152 per share Number of shares 60,000 Price payable (60,000 x 152) = Rs.91,20,000 Or say Rs.91.20 lacs Recommendation: Maximum price payable by Imperial for acquisition of HS is Rs.91.20 lacs


3 (b) Net Asset Value (NAV): Each day, the mutual fund computes the net asset value of the unit. The NAV of a mutual fund is the amount which a unit holder would receive if the mutual fund were wound up that day. This value is obtained by deducting the total liabilities of the fund from the closing market value of the holdings and dividing it by the number of units outstanding. The NAV is the fund’s single most important number. If the value of the investment in the fund’s portfolio goes up, other things remaining equal, the value of the fund, and hence the net asset value of the unit, increases. Similarly if the value of the investment holdings in the fund’s portfolio comes down, the value of the fund and hence the net asset value of the fund, will come down. Thus, the net asset value per unit fluctuates every time any asset experiences a change in its market price.

4 (a) Part (i)

• Futures to be sold = Hedge ratio x [ Units of spot position requiring hedging / No of units underlying one futures contract]

since you are long on the spot market, you have to go short in the futures market. Hence you have to sell NIFTY.

= 0.7 x 1200 / 200 = 4.2

Part (ii)

• If the price of KM falls by 10%, it means it has fallen from Rs 150 to Rs 135 ie by Rs 15. Consequently the index will fall by 15/0.7 ie 21.429. It will fall to 1378.571 index points.

Price falls

• Since your stock fell by Rs 15, on your 1200 shares you have lost 1200 x 15 = Rs 18000.

• You have sold 4.2 contracts in index futures. You have gained 21.429 points. You have gained 4.2 x 200 x 21.429 = Rs 18000.

• Your gain is offset by your loss.

Part (iii)

• If the price of KM goes up by 5%, it means an increase of Rs 150 x 0.05 = Rs 7.5.

Price Increase

Consequently the index will rise by 7.5/0.7 ie 10.714 and will touch 1410.714 • Since your stock rose by 5% or Rs. 7.50, on your 1200 shares you gained 1200

x 7.5 = Rs 9000. • You have bought 4.2 contracts in index futures. You lost 10.714 points. Your total

loss on the futures is 4.2 x 200 x 10.714 = Rs 9000 • Your gain is offset by your loss.

4 (b) Part (i) Computation of expected return of a portfolio

Computation of β of portfolio, based on value-weightage. Value weight proportions are 10:20:16:14 Value weighted Beta would therefore be 1.3125 (shown below)


Security Amount

Invested Weighted Investment

β Wt * β

A 10000 0.17 0.80 0.1360 B 20000 0.33 1.20 0.3960 C 16000 0.27 1.40 0.3780 D 14000 0.23 1.75 0.4025 60000 1.00 Σ Wt. β = 1.3125

Applying CAPM. Expected return can be ascertained as follows: Rj = Rf + β x (Rm – Rf) = 4.25 + 1.3125 (11-4.25) = 4.25 + 1.3125 (6.75) Rj = 13.11% Part (ii)

Security

Re-computation of Beta of security B is substituted by a risk free investment. Beta for a risk free investment is zero, (RBI Bonds)

Amount invested

Weighted investment

β Wt x β

A 10000 0.17 0.80 0.1360 RBI Bonds 20000 0.33 0 0 C 16000 0.27 1.40 0.3780 D 14000 0.23 1.75 0.4025 60000 1.00 Σ Wt. β - 0.9165

Beta of new portfolio, in which RBI bond has been included is: 0.9165 Applying CAPM. Expected return can be ascertained as follows: Rj = Rf + β x (Rm – Rf

100%15%16055.01(

1×

+×−

) = 4.25 + 0.9165 (11-4.25) Expected Return on revised Portfolio = 10.44%

4 (c) Return required =

(i.e.) 18.43%.

4 (d) Spread: You will not be able to buy foreign currency from a bank at the same rate at which you can sell the same currency to it. This is because the bank whose business it is to buy and sell will have to make a margin to cover costs and make a small profit. For that matter, this is normal of any business. This difference between the banks’s buying rate (bit rate) and the bank’s selling rate (ask rate) is called the “spread”. If the bid rate for ∈ is Rs.50 and the ask rate is 52, the spread will be Rs2. The following two factors determine the size of the spread.

• Stability of the exchange rate:

•

If the exchange rate is expected to be stable, the spread will be narrow. If the exchange rate is volatile, the spread will be wider. Depth of the market:”Depth” refers to the volume of transactions in the market. A “deep” market has a high volume of transactions with several dealers simultaneously engaged in transacting business. In this case, the spread will be


narrower than for a “thin” market where there is a low volume of transactions and a few dealers.

5 (a) Part (i):

000,50,28

000,00,20==

Bonus issue W.N: 1 Current number of shares

shares.

W. N: 2 Bonus issue = 1:5 Therefore, number of shares to be issued = 50,000 shares. W.N: 3 Equity account A sum of Rs.4,00,000 (50,000 x 8) will be transferred from Retained Earnings to equity share capital. W.N: 4 No of shares outstanding = Current no of shares + Bonus shares = 2,50,000 + 50,000 = 3,00,000. W.N: 5 New P

share.per 50.000,00,3

60000,50,2S N

P S 0 Rs=×

=+×

=

0

Part (ii):

000,00,54

8000,50,2Value Face

Value Face Old shares of nos. =

×=

×=

NewOld

Stock split A 2:1 stock split means 2 shares will be issued for every one share held. W.N: 1 New nos. of shares

W.N: 2 Equity account

There will be no change in the equity account. Face value will drop to Rs. 4.218 Rs=×

W.N: 3 New P

share.per 30.000,00,5

60000,50,2shares ofnumber New

P Old shares ofnumber 0 RsOld

=×

=×

=

0

Part (iii):

shares. 000,25,116

8000,50,2=

×=

Reverse split A 1:2 reverse split means one share will be issued for every two shares held. W.N: 1 Number of Shares

Shares outstanding = 1, 25,000.


W.N: 2 Equity account There will be no change in the equity account. Face value will rise to 8 x 2 = Rs. 16 per share. W.N: 3

New share.per 120.000,25,1000,50,2

0 RsP ==

Summary: Particulars Shares (Nos) Equity A/c impact Market Price

Rs. (a) Existing 2,50,000 Not Applicable 60 (b) Bonus issue 3,00,000 24,00,000 50 (c) Stock split 5,00,000 FV at Rs.4 30 (d) Reverse split 1,25,000 FV at Rs.16 120

5 (b) The constant dividend model had its fair share of advantages and disadvantages. It was okay a company with stable earning. But not all companies can enjoy that advantage of stable earning. At the same time companies would like to offer a promised minimum dividend. The constant dividend plus approach does just this. Under this approach a fixed low dividend per share is always payable. An additional dividend per share in the form of either interim dividend or special dividend is than paid in years of good profits. In years of not so good profits the extra or special dividend is not paid. Advantages . A minimum return is guaranteed in line with the constant dividend plan. . Dividends are linked to profits in line with the constant payout plan. In a sense, one

enjoys the best of both the plans!

5 (c) Straddle 1. Straddles involve simultaneous purchase or sales of options with the same strike price and

same expiry date. 2. There are two types of straddles – Long and Short

a. In a long straddle you buy a call and buy a put (same number of calls and same number of puts) at the same exercise price and same expiry date.

b. In a short straddle you write a call and write a put (same number of calls and same number of puts) at the same exercise price and same expiry date. This is also called straddle write.

3. The implications are as follows: a. A long straddle will produce a limited loss zone in the middle ground; an increasing

profit zone in the upper ground and an increasing profit zone in the lower ground. In other words, if the market price moves away from the exercise price by an amount which is greater than the cost of the initial position, unlimited profits will be made. If it falls within the range, limited losses will be incurred. This strategy will be profitable if the


stock’s price moves above or below the strike price to a degree greater than the total cost of buying options.

b. A short straddle (aka straddle write) creates an opening credit position because it involves writing options. If the market price moves away from the exercise price by an amount which is greater than the initial credit, unlimited losses will be made. In the middle ground profits will be made. This strategy will be profitable if the stock’s price does not move above or below the striking price to a degree greater than the total proceeds received by the investor.

What should you do? You should do long straddle if you believe that the stock will either jump steeply or fall steeply. You should do short straddle if you believe that the stock will move within a narrow range. You should however remember that if the stocks move out of this narrow range you would lose heavily in a straddle write. Gross Payoff on Straddle

S ≤ E S > E Long Straddle E – S S – E Short Straddle S - E E - S

Note: Gross payoff adjusted for net premium received or paid gives net payoff. Where: S = Spot price; E = Exercise price

6 (i) Diversifiable risk or Unsystematic risk:

This risk affects only the particular security and is hence specific to the security. It is therefore also called Specific risk. For instance, an increase in the price of bamboo (Which is the raw material for making paper) will affect the fortune of a paper manufacturing company but will have no effect on the fortunes of a cement manufacturing company. This is a risk specific to the paper industry. Specific risk is the “contribution” per se of one security to the risk of a portfolio of securities and is therefore distinct for each individual investment. Such a risk can, by careful efforts at diversification, be reduced. Math Formula: Since there are only two types of risks, the value for under systematic risk is “total risk” less “systematic risk”. Non-diversifiable or systematic risk: This risk cuts across industries and affects all companies operating in the market. It is therefore also called portfolio risk or market risk. It is the risk that an entity’s cash flows may be affected by factors that are beyond the control of the management of entity. For example, changes in interest rate, inflation, taxation etc. affect all companies. Non-diversifiable risk reflects the sensitivity of an entity’s revenue to changes in macro-economic factors and depends on the degree of sensitivity of costs to total revenue. An entity with low revenue- sensitivity, i.e., where the revenues are relatively stable, will carry a low- risk relative to another with high revenue sensitivity.


Math Formula: The value of systematic risk is the product of two elements. One is the correlation between the stock and the Market.(Corrjm ).The other is the relationship between risk element in stock and risk element in stock market. (σj) This can be expressed as σj x Corrjm. . σm (σm

•

)

6 (ii) “An option is a contract between two parties under which the buyer of the option buys the right and not the obligation to buy or sell, a standardized quantity (contract size) of a financial instrument (underlying asset) at or before a pre determined date (expiry date) at a price, which is decided in advance (exercise price or strike price).” When the option gives the buyer of the option the right to buy it is called a call option. When the option gives the buyer of the option the right to sell it is called a put option. For providing the option the writer charges a price. We now proceed to break this definition down threadbare.

Right:•

An option is a derivative instrument involving a “right”. Holder and Writer:

•

One party “buys” the right and the other party “Sells” the right. The one who buys the right is called the “buyer” or the “holder” of the option. The one who sells the right is called the “Seller” or the “Writer” of the option. Call and put option:

•

The right can be the “right to buy” an underlying asset. Such a right is called a “Call option”. The right can be the “right to sell” an underlying asset. Such a right is called a “Put option”. Obligation:

•

The holder can demand performance; he is not obliged to perform. In contrast, the writer is obliged to perform; he cannot demand performance. Exercise price:

•

The price at which the underlying asset can be bought or sold, as the case may be, is called the exercise price. The exercise price is also referred to as the strike price. Expiry date:

•

The date by which the right should be exercised is called the expiry date. Option premium: When the buyer buys a right (either the right to buy or the right to sell) he has to pay the writer a price. this is called the option premium or option price.

The Right Example: The rights offer by a company is a typical example of an option. The rights offer gives the shareholder the right to subscribe. It does not compel him to subscribe. The shareholder buys the right to buy i.e. the right to subscribe. He is therefore the holder of the option. The company sells the option. It is therefore the writer of the option. This is a call option because the shareholder buys the right to buy shares. The rights price is the exercise price. The rights closure date is the expiry date. There is no option premium involved. Features:

a. Standardization: Like futures, the contract is standardized as to quantity, date and month of delivery, price, minimum amount by which price would move.

The features of an option contract are very similar to that of a futures contract except that only one of the two parties is obliged to perform.


b. Deal with the clearinghouse: The clearinghouse guarantees performance. Consequently there is no risk of default.

c. Mark to market margin: Since the clearinghouse acts as a guarantor, it would require the parties to maintain a deposit (margin) with it.

6 (iii) Short selling: Short selling involves selling a stock which you don’t own and buying it back later to square the position. A short seller resorts to this strategy because he expects prices to fall and wants to benefit from the fall. In a falling market this is a good way to make money. Consider this example. WIPRO is quoting at Rs 2400. You feel that the stock is overpriced and expect it to fall to Rs 2100 in a month’s time. The only way to gain in a falling market is to make sale. But you do not have WIPRO shares. You therefore elect to sell now and buy it back a month later and thereby profit Rs 300 per share. Since you don’t have shares and delivery has to be made within 2 days of the transaction, your broker borrows shares on your behalf and delivers them. This is called stock lending. You are required to pay stock lending charges. The concept of short selling is central to a number of futures and options strategies which we will outline later.

6 (iv) Global Depository Receipts (‘GDRs)

(a) The shares underlying the depository receipts do not carry voting rights.

: Many large Indian corporate entities have been able to tab global equity market to raise foreign currency funds by way of equity, through this route of issuing GDRs. An Indian company issues ordinary equity shares. These shares are “deposited” with custodian banks (mostly domestic banks). Custodian Banks establish a link with a Depository bank overseas. Depository bank, in turn issues Depository Receipts in US dollars. Funds are raised when overseas entities purchase these depository receipts, at a agreed price. The important characteristics are:

(b) The instruments are freely traded (listed in Luxemburg or other permitted Exchanges).

(c) They are marketed globally, without being confined to borders of any market or country (it can be traded in more than one currency).

(d) Investors (mostly institutional investors) earn fixed income by way of dividends (dividends are paid in issuer- currency, converted into dollars by depository and paid to investors, and hence exchange risk is with investor).

(e) The GDRs can be converted into underlying shares, by Depository/ Custodian banks redeeming the issue, with reference to price prevailing in NSE or BSE. At times, reverse- conversion (conversion of underlying shares into GDRs) is also permitted, though this area is not yet open to Indian companies.


6 (v) Zero-Coupons

1. Zero Coupon Bonds are debt instruments (in the nature of secured or unsecured debentures) evidencing loans borrowed for a given period.

:

2. The special feature of such bonds is that the borrower does not pay any interest during the “tenor” of the loan.

3. The bonds are issued at fore value and redeemed at a premium on face value. The premium represents the compensation the investor receives over tenor of the bond by way of compounded interest.

4. From the borrower’s point of view there is no cash outflow to cover interest, while from the investor’s point of view, the instrument provides little or no liquidity unless traded in the market.

5. In a scenario of reducing interest rates, the yield on Zero coupon bonds would be higher than what the market would otherwise offer, and the converse applies when interest rates begin to rise after the issue of Zero Coupon Bonds.

6 (vi) INTEREST RATE FUTURES (IRF)

1.

: Meaning: A Futures contract is, by definition, a forward contract, which trades on the exchange. IRF involves a national purchase and sale of a bond at the traded price and a notional delivery of the underlying asset on the specified expiry date. IR Futures are available in major currencies (US $, Sterling, Yen, Euros, Sw. Franc etc). These contracts can be used in both lending and borrowing situations. Why IRF: A CFO is generally faced with two different situations. Having tied his company to fixed interest rate, he might now expect interest rates to fall. Alternatively having tied the company to floating rates, he might now expect interest rates to rise. Both these will put him in difficulty. To overcome them he might trade in IRF. Central to understanding this is the principle of interest rate risk. When interest rates fall, instruments that offer higher coupon rates rise in value. When interest rates rise, instruments that offer lower coupon rates will fall in value. A couple of examples will help understand this.

Have a view that interest rates will fall:

2.

Suppose the current implied interest rate is 6%. He expects the interest rate to fall to say 5%. Suppose 1 contract = 2000 units. He buys one futures contract at say Rs 55.5. Suppose a few days later the implied interest rate falls to 5%. The IRF quotes Rs 60.8 in the market. He sells and gains Rs 60.8-55.5=5.3 per unit. On 2000 units he scores 2000 x 5.3 = Rs 10,600/- Have a view that interest rates will rise:

This derivative instrument comes as a useful means of hedging risk against the risk of the interest rate movements.

Suppose the current implied interest rate is 5%. The CFO expects the interest rate to climb. Suppose the current market price of a IRF is Rs 61. He sell one futures contract at Rs 61. Suppose a few days later the implied interest rate raises to 5.3% and the IRF quotes Rs 59. He buys one IRF and pockets the difference of Rs 2 per unit or Rs 4000 in all.


It must be noted that when you contract for 3-month interest rate futures for Euro 1 million, You are merely laying out an interest rate at which you will either borrow or lend Euro 1 million, beginning March. Commencement of the period of notional landing or borrowing is synchronized with the maturity of IRF. To understand that we should take a look at the following features which are relevant?

1. Period:

2.

IRF is standardized with reference to period. There are two types of IRF – short term and long term. The former runs for a three-month cycle, the latter for one year. Contract Size:

3.

The Contract Size standardized and depends on the currency. For example, for a short-term 3-month contract, sizes for USD, Euros and sterling is 1 million each. For Swiss Franc the size is 500,000. /-. For the INR it is Rs 200,000 irrespective of whether it is short term or long term. Rate of interest:

4.

The rate of interest is in built into the price of the futures contract. The price of IR- Futures is “100 minus interest rate”. If you buy an IRF quoted at 93.25, you would be dealing in an interest rate of 6.75% p.a. (100.00-93.25) Profit or loss:

5.

The profit or loss in a futures contract is represented by a TICK. A tick means a 0.01% “interest” on the amount represented by the contract size. This is also the minimum movement in price. If the contract size is 500,000, the value of a tick for a three month contract will be 12.50.[500,000 x 0.01 % x 3/12] Obligations:

6.

When you buy an IRF, You will be contracting to buy an “entitlement” to receive interest payment on a notional amount in a given currency Conversely, when you sell an IRF, you are making a promise to undertake an interest-payment obligation on a notional amount in a given currency Buying could be considered the equivalent of investing and selling the equivalent of borrowing. On maturity:

IRFs are closed out by the contracting party, by taking an opposite position. This part can be closed out with the following principles

• If you have an asset portfolio and expect interest rates to fall, you will buy IRF • If you have an asset portfolio and expect interest rates to rise, you will sell IRF • If you have a liability portfolio and expect interest rates to fall, you will sell IRF • If you have a liability portfolio and expect interest rates to rise, you will buy IRF

Interest Rate Expectation Asset Liability Down Up

Buy Sell

Sell Buy


AAPC

Number of Pages : 3 Total Marks: 100 Number of questions: 7 Time Allowed: 3 Hrs

Answer Question Nos. 1 and 2 and four from the rest.

1. As a statutory auditor, how would you deal with the following:

(a) Vishwak Ltd. has announced a voluntary retirement plan for its employees on January 1,

2008. The scheme is scheduled to close on June 30, 2008. The scheme envisaged an initial lump sum payment of maximum of Rs.2 lakhs and monthly payments over the balance period of service of employees coming under the plan. 200 employees opted for the scheme as on March 31, 2008. The total lump sum payment for these employees would be Rs.250 lakhs and the aggregate of future payments to them would amount to Rs.1,500 lakhs. However, no payment had been made to the employees under the scheme up to March 31, 2008, nor the company made any provision in its accounts towards any liability under the scheme.

(b) War Ltd. has borrowed Rs.25 crores from financial institutions during the financial year 2007/08. These borrowings are used to invest in shares of Peace Ltd. a subsidiary company which is implementing a new project estimated to cost Rs.50 crores. As on 31st March, 2008, since the said project was not yet complete, the directors of War Ltd. resolved to capitalize the interest on the borrowings amounting to Rs.3 Crores and add it to the cost of investments. As a statutory auditor for the year ended 31st

March 2008, how would you deal with this matter?

(c) Mr. Vijay is appointed as the auditor of KINGS Travels Ltd. with audit fees of Rs. 35,000. He purchased air ticket from Delhi to Kolkata and back for Rs.18, 000 from the client for his personal work and the amount remains unpaid at the end of the year as it is a general practice of the client to give credit to all. Mr. Vijay claims that he does not incur any disqualification as contained in Section 226(3)(d) of the Companies Act. How would you deal with the following, as a statutory auditor?

(d) Mr. Anand, who conducts the tax audit u/s 44AB of the Income-Tax Act, 1961 of M/s

ABC, a partnership firm has received the entire audit fees of Rs.25,000 in April 2008 in respect of the tax audit for the year ended 31.3.2008. The audit report was however signed in September, 2008.

(4 x5 = 20 Marks)


2. Comment on the following with reference to the Chartered Accountants Act, 1949 and schedules there to:

(a) Mr.Rajesh, a Chartered Accountant in practice has been elected as the treasurer of a Regional Council of the Institute. The Regional Council had organized an international tour through a tour operator during the year for its members. During the audit of the Regional Council, it was found that Mr. Rajesh had received a personal benefit of Rs.50,000 from the tour operator.

(b) CA Damodaran, a Chartered Accountant prepared a project report for one of its clients

to obtain bank finance (long-term) of Rs.50 lakhs from a Commercial Bank. Consequent to the sanction of the loan by the bank CA Damodaran raised a bill for his services @ 2% of the loan sanctioned.

(c) P, a Chartered Accountant had accepted appointed as an auditor of QRS Company

Limited without ascertaining from the Company whether the requirement of Sections 224 and 225 of the Companies Act had been complied with. However, he realized this defect only after acceptance.

(d) M/s. ABC, a firm of Chartered Accountants has taken a loan for acquiring computers,

from a company whose Managing Directors’ son is an Articled Trainee with A, a partner of M/s ABC.

( 4 x 4 = 16 Marks)

3 (a) AS a branch auditor of a nationalized bank, how would you verify the following?

1) Advances to DOT COM Companies. 2) Balances in account of a bank situated in a foreign country.

(b) Explain the Auditor’s liability in case of unlawful acts or defaults by clients. ( 4 + 4 + 8 = 16 Marks)

4 (a) Enumerate the ‘ Basic Elements of Audit Report’ as enshrined in AAS-28.

(b) Briefly discuss the compliance procedures and their use in evaluation of internal controls. ( 2 x 8 = 16 Marks)

5. Answer the following:

(a) Mention the difference between ‘report’ and ‘certificate’. (b) What are the contents of reports and certificates for special purposes? (c) For what purposes the Cost Auditor refers to financial records while conducting Cost

Audit of an entity? ( 4 + 6 + 6 = 16 Marks)


6. (a) Answer in brief : Sampling Risk (b) Explain what is meant by “Representations by Management” and indicate to what extent an

auditor can place reliance on such representations. (c) State the reporting responsibility of an auditor in the context of non-compliance of Law and

Regulation in a audit of Financial Statement. ( 4 + 6 + 6 = 16 Marks)

7. Write short notes on the following:

(a) Rolling Settlement

(b) Preliminary Report under Peer Review

(c) Human Resource Accounting

(d) Probable format of environmental statement.

( 4 x 4 = 16 Marks)

1 ME29 / PRIME / FINAL

PRIME ACADEMY

29TH

a. Those which provide further evidence of conditions that existed at the balance sheet date; and

SESSION – MODEL EXAM

ADVANCED AUDITING AND PROFESSIONAL ETHICS – NEW SYLLABUS

SUGGESTED ANSWERS

1 (a) Accounting Standard (AS) -4 (Revised) on ‘Contingencies and Events Occurring After the Balance Sheet Date’ states that events occurring after the ‘balance sheet date are those significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company, and, by the corresponding approving authority in the case of any other entity.

Two types of events can be identified as:

b. Those which are indicative (of conditions that arose subsequent to the balance sheet date).

It further states that assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date or that indicate that the fundamental accounting assumption of going concern (i.e., the continuance of existence or substratum of the enterprise) is not appropriate.

As per facts of the case, a condition existed on the balance sheet date (31st

As per Accounting Standard 13 on “Accounting for Investments”, the cost of investment includes acquisition charges such as brokerage, fees and duties. In the instant case, War Ltd. has used borrowed funds for making investment in shares of a subsidiary company. For acquiring shares of a subsidiary company, apart from any fees, duties etc. there are no cost incurred for investing in shares. Hence, any borrowing costs incurred cannot be treated as part of cost of investments and cannot be added to the cost of investments. The Accounting Standard 16 on “Borrowing Costs” also does not consider investment in

March, 2008) regarding the liability towards the Voluntary Retirement Plan (VRP) since the management started the VRP in the month of January, 2008 and 200 employees opted for the VRP as on March 31, 2008. Since it was probable that future events will confirm that a liability has been incurred on the balance sheet and that the amount could be estimated on reasonable basis, a provision for payments under the VRP would be required to be made for an appropriate amount for the aforesaid number of employees.

(b) Capitalisation of interest on Borrowings in respect of Investments:


shares as qualifying assets that can enable a company to add the borrowing costs to investments. In the instant case therefore, the statutory auditor would qualify his report by stating that the borrowing costs have been wrongly added to the cost of investments rather than charging them to the profit and loss account. The effect of the same on the profit for the year would also have to be mentioned in the audit report.

(c) Disqualification of auditors:

The guidance note on “Independence of Auditors” issued by the ICAI in this context recommends that a “question of indebtedness may also be raised where an auditor of a company purchases goods or services from the company audited by him. In such a case, if the amount outstanding exceeds RS.1000, irrespective of the nature of the purchase or period of credit allowed to other customers, the provisions concerning disqualification of auditor as contained in sec 226 (3) (d) will be attracted. This is applicable in the case of purchase of air tickets for personal work by the auditor of a company on normal terms and conditions of the business of the company as the amount outstanding at the end of the year exceeded Rs.1000. Therefore, the contention of Mr. Vijay that he does not incur disqualification is not correct as he has purchased a ticket of the value of Rs.18, 000. The provisions concerning disqualifications of auditor as contained in Sec 226 (3) (d) will be attracted.

(d) Receipt of Tax Audit Fees in Advance:

Under section 226(3)(d) of the Companies Act, 1956, a person is disqualified from being an auditor if he is indebted to the company for more than Rs.1,000. This provision for disqualification would apply only in case of an auditor appointed under the Companies Act, 1956. The intention of the Company Act, 1956 is to ensure that the auditor is not under any financial obligation of the company.

When a chartered accountant is appointed to conduct a tax audit u/s 44AB of the Income Tax Act, 1961, his appointment is not under the Companies Act, 1956 but under the Income Tax Act, 1961. In the Income Tax Act, 1961 there is no such provision for a person to be disqualified on his becoming indebted to the company. Thus in the instant case, though the entire audit fees are taken in advance, Mr.Anand would still be able to carry out the audit and he would not be disqualified. However, having regard to be professional ethics in general an auditor must avoid such situations and may consider Disclosing the same.

2 (a) Embezzlement of Funds:

Sec 21 of the Chartered Accountants Act, 1949 provides that a member is liable for disciplinary action if he is guilty of a professional or “Other Misconduct”. Though the term “Other Misconduct” has not been defined in the said Act, this provision enables the


Council at enquire into any misconduct of a member even if it does not arise out of his professional work. This is considered necessary because a chartered accountant is expected to maintain the highest standards of integrity even in his personal affairs and any deviation from these standards even in his non-professional work, would expose him to disciplinary action. The Council has also laid down that among other things “misappropriation by an office-bearer of a Regional Council of the Institute of a large amount and utilization thereof for his personal use” would amount to “other Misconduct”. Thus, in the instant case, Mr. Rajesh would be liable for disciplinary action.

(b) Clause 10 of part I to First Schedule to the Chartered Accountants Act prohibits a Chartered Accountant in practice to charge, to offer, to accept or accept fees which are based on a percentage of profits or which are contingent upon the findings or results of such work done by him.

However, this restriction is not applicable where such payment is permitted by the Chartered Accountants Act; the council of the Institute has framed regulation 192 which exempts certain professional misconduct.

(c) Compliance with Sections 224 and 225 of the Companies Act, 1956:

Clause 9 of the Part I of the First Schedule to the Chartered Accountant Act, 1949 require the auditor to ascertain from the company whether the relevant requirements have been complied with or not. However, in the instant case, “P” a chartered accountant, before acceptance of his appointment as an auditor has failed to astertain whether the provisions of Sections 224 and 225 have been complied with by the company. The fact that “P” has realised this defect only after acceptance would not save him from charge of misconduct. It is necessary for the incoming auditor to verify the relevant records of the company to enable him to ascertain whether the provisions of sections 224 and 225 have been complied with. Therefore, P was guilty of professional misconduct under Clause (9) of Part I of First Schedule to the Chartered Accountants Act, 1949.

(d) Loan from a Company:

As per Clause (i) of Part II Second Schedule to the Chartered Accountants Act, 1949, a chartered accountant is deemed to be guilty of professional misconduct if he contravenes any of the provisions of Chartered Accountants Act, 1949 or Regulations made there under. Regulation 47 of the Chartered Accountant’s Regulations, 1988 prohibits a member from accepting any premiums or loans or any deposit in any form from an articled clerk directly or indirectly. However, M/s ABC has taken loan from a company whose Managing Director happens to be father of articled clerk with Mr.A, a partner of M/s ABC. In this case, the articled trainee has no direct interest in that company. There has been a case wherein a chartered accountant was held guilty of professional misconduct because he took a loan from a firm in which the articled clerk and his father were both interested/ But, in this case as per the facts, the articled trainee has no direct interest in the company. However, if relationship, direct or indirect, can be established in


view of relationship of articled trainee with MD of the company, Mr.A of M/s ABC would be held liable for professional misconduct. Thus, M/s ABC would be guilty of professional misconduct under this clause if it is proved that the loan was related to the engagement of the articled clerk.

3 (a) (1) Advances to DOT COM Companies:

i. Evaluate the efficacy of internal control system in general to ascertain whether an advance is made only after satisfying itself as to the creditworthiness of the borrower and after obtaining sanction for an advance must specify, among other things, the limit of borrowing, nature of security, margin to be kept, interest, terms of repayment, etc. Also see that all the necessary documents, e.g., agreements, demand promissory notes, letters of hypothecation, etc. have been executed by the parties before advances are made.

ii. Examine loan documents such as certificate of commencement of business (in the case of public limited companies), resolution of board of directors, and resolution of shareholders (in cases covered by section 293(1)(d) of the Companies Act, 1956).

iii. Verify the business plan of the company expecially where the revenue model is in place. Verify whether the company depends only on outside funding or can self generate funds.

iv. Examine in case the security is in the form of mortgage, apart from mortgage deed (in the case of English Mortgage), or letter of intent to create mortgage (in the case of Equitable Mortgage), the evidence of registration of the charge with the Registrar of Companies.

v. Review the operation of advance account to see that limit is not generally exceeded; that the account is not becoming stagnant; that the customer is not drawing against deposits which are not free from lien; that the account is not window-dressed by running down overdrafts at the year end and again drawing further advances in the new year, etc.

vi. Examine whether there is a healthy turnover in the account. It should be seen that the frequency and the amounts of credits in the account are commensurate with the sanctioned limit and the nature and volume of business of the borrower. Any unusual items in the account should be carefully examined by the auditor. If the auditor’s review indicates any unhealthy trends, the account should be further examined. The auditor’s examination should also cover transactions in the post-balance sheet date period. Large transactions in major accounts particularly as at the year-end may be looked into to identify any irregularities in these accounts.

vii. Review periodic statements, cash flow statements, latest financial statements, etc. to assess the recoverability of advances.

viii. Verify whether the advance is secured and determine whether the security is legally enforceable, i.e., whether the necessary legal formalities regarding documentation, registration, etc., have been complied with; whether the security is in the effective control of the bank: and to what extent the value of the security, assessed realistically, covers the amount outstanding in the advance.


ix. Ensure that proper provisioning norms have been applied in view of non-observance of terms, coupled with irregular payment of interest and default in repayment of installments, if any.

(2) Balances in Account of a Bank situated in a Foreign Country

a. Verify the ledger balances in each account with reference to the bank confirmation certificates and reconciliation statements as at the year-end.

b. Review the reconciliation statements and pay particular attention to the following.

i. Examine that no debit for charges or credit for interest is outstanding and all the items which ought to have been taken to revenue for the year have been so taken. This should be particularly observed when the bills collected, etc., are credited with net amount and entries for commission,etc are not made separately in the statement of account.

ii. Examine that no cheque sent or received in clearing is outstanding. As per the practice prevalent amoung banks, any cheques returned unpaid are accounted for on the same day on which they were sent in clearing or on the following day.

iii. Examine that all bills or outstanding cheques sent for collection and outstanding as on the closing date have been credited subsequently.

c. Examine the large transactions in inter-bank accounts, particularly towards the year-end, to ensure that no transactions have been put towards the year-end, to ensure that no transactions have been put through for window-dressing.

d. Check original deposit receipts in respect of balances in deposit accounts in addition to confirmation certificates obtained from banks in respect of outstanding deposits.

e. Check whether these balances are converted into the Indian currency at the exchange rates prevailing on the balance sheet sate and ensure compliance with AS-11 on “Accounting for the Effects of Changes in Foreign Exchange Rates”.

(b) Auditor’s Liability in case of Unlawful Acts or Defaults by Clients:

The auditor’s basic responsibility is to report whether in his opinion the accounts show a true and fair view and in discharging his responsibility he has to see as to how the particular situations affected his position. The general thinking with regard to unlawful acts or defaults by clients appears to be that the auditor should not ‘aid or abet’ but he is


apparently not under any legal obligation to disclose the offence. A professional accountant would himself be guilty of a criminal offence if he advises his client to commit any criminal offence or helps or encourages in planning or execution of the same or conceals or destroys evidence to obstruct the course of public justice or positively assists his client in evading prosecution. A professional accountant in his capacity as auditor, accountant, or tax representative has access to a variety of information concerning his clients. On some occasions, he may acquire knowledge that his client has been guilty of some unlawful act, default, fraud or other criminal offence. The duty of the professional accountant in such a case would depend upon the actual circumstances of the situation. Due consideration should be given to the exact nature of services that a professional accountant is rendering to his client, i.e., is he representing the client in income-tax proceedings or is he acting in the capacity of an auditor or an accountant or a consultant.

The Institute of Chartered Accountants of INDIA has considered the role of chartered accountants in relation to taxation frauds by an assessee and has made the following major recommendations:

i. A professional accountant should keep in mind the provisions of section 126 of the Evidence Act whereby a barrister, an attorney, a pleader or a Vakil is barred from disclosing any communication made to him in the course of and for the purpose of his employment.

ii. If the fraud relates to past years when the accountant did not represent the client, the client should be advised to make a disclosure. The accountant should also be careful that the past fraud does not in any way affect the current tax matters.

iii. In case of fraud relating to accounts examined and reported upon by the professional accountant himself, he should advise the client to make a complete disclosure. In case the client refuses to do so, the accountant should inform him that he is entitled to dissociate himself from the case and that he would make a report to the authorities that the accountants prepared or examined by him are unreliable on account of certain information obtained later. In making such a report, the contents of the information as such should not be communicated unless the client consents in writing.

iv. In case of suppression in current accounts, the client should be asked to make a full disclosure. If he refuses to do so, the accountant should make a complete reservation in his report and should not associate himself with the return.

However, it can be argued that the auditor has a professional obligation to ensure that the client is fully aware of the seriousness of the offence and to seriously consider full disclosure of the matter.

It has been clearly established in various case laws that the auditor is expected to know the contents of documents and records and ascertain whether the affairs of the client are being conducted in an unlawful manner. It is in the course of the work, he comes across any unlawful acts, it is his duty to bring it to the notice of the client as also to make a disclosure in his report in appropriate cases. In this regard, one has to bear in mind the


consequence of the act in relation to the professional code to which an auditor is subjected. Under the code, an auditor cannot disclose confidential information unless permitted by the client or unless required by law. Each case has to be judged on its circumstances. However, in every case he has to assess the implications of the unlawful act or default on the true and fair character of the accounting statements.

The question of liability of an auditor for unlawful acts or defaults by clients should be considered in the light of the broad parameters given above. However, it appears that if an auditor was aware of any unlawful act having been committed by client in respect of accounts audited by him and the unlawfulness was not rectified by proper disclosure or any other appropriate means, the auditor owes a duty to make a suitable report. If he does not, he may be held liable, if the true and fair character of the accounts has been vitiated.

4 (a) Basic Elements of Auditor’s Report:

As per AAS 28, “ The Auditor’s Report on Financial Statements”, the auditor’s report includes the following basic elements:

i. Title: It is appropriate to use the term “Auditor’s Report” in the title so as to distinguish the same from other reports, e.g., Board of Directors’ Report, etc.

ii. Addressee: Ordinarily, the auditor’s report is addressed to the authority appointing the auditor.

iii. Opening or Introductory Paragraph: The auditor’s report should identify the financial statements of the enterprise that has been audited including the date of and period covered by the financial statements. This introductory paragraph must state that the preparation of financial statements is the responsibility of the management and that the auditor’s responsibility is to express an opinion based on audit.

iv. Scope Paragraph: The auditor’s report should describe the scope of the audit stating that the audit was conducted in accordance with auditing standards generally accepted in INDIA. It must also lay down breifly the work performed by the auditor and the constraints involved in discharge of his attest function.

v. Opinion Paragraph: This paragraph is mainly devoted for expression of opinion as to whether the financial statements give a true and fair view and whether they comply with the statutory requirements.

vi. Date of Report: The date of an auditor’s report on the financial statements is the date on which the auditor signs the report expressing an opinion on the financial statements. The date of report informs the reader that the auditor has considered the effect on the financial statements and on the report of the events and transactions of which the auditor became aware and that occurred up to that date. Since the auditor’s responsibility is to report on the financial statements as prepared and presented by management, the auditor should not date the report earlier than the date on which the financial statements are signed or approved by management.


vii. Place of Signature: The report should name specific loaction, which is ordinarily the city where the audit report is signed.

viii. Auditor’s Signature: The report should be signed by the auditor in his personal name. Where the firm is appointed as a auditor, the firm name should also be mentioned. The proprietor or partner signing the report should also mention his membership number.

(b) Compliance Procedures and Evaluation of Internal Controls:

AAS-1 on “Basic Principles Governing on Audit” states that, “the auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable him to draw reasonable conclusions therefrom on which to base his opinion on the financial information. According to it, compliance prodecures are tests designed to obtain reasonable assurance that those internal controls on which audit reliance is to be placed are in effect. Obtaining audit evidence from compliance procedures is intended to reasonably assure the auditor in respect of the following assertions:

Existence - that the internal control exists.

Effectiveness - that the internal control is operating effectively

Continuity - that the internal control has so operated throughout the period of intended

Reliance.

The auditor formulating his opinion on financial information needs reasonable assurance that transactions are properly authorised and recorded in the accounting records and that the transactions have not been omitted. Internal controls, even if fairly simple, may contribute to the reasonable assurance the auditor seeks. The auditor’s objective in studying and evaluating internal controls is to establish the reliance he can place thereon in determining the nature, timing and extent of his substantive auditing procedures.

Compliance procedures are tests designed to obtain reasonable assurance that those internal controls on which audit reliance is to be placed are in place and are also effective. Compliance procedures enable the auditor to determine the existence, effectiveness and continuous operation of the internal control system. These procedures include tests requiring inspection of documents supporting transactions to gain evidence that controls have operated properly. For example, the auditor may see that the documents have been properly authorised. The auditor may also make enquiries about the observation of controls, for example, determining who actually performs each function not merely who is supposed to perform it. Compliance procedures are conducted by the auditor to gain evidence that those internal controls on which he intends to rely operates generally as identified by him and they function effectively throughout the period of intended reliance. The concept of effective operation recognises that some deviations from prescribed controls may have occurred.


Based on the results of his compliance procedures, the auditor evaluates whether the internal controls are adequate for his purpose. If based on the results of the compliance procedures, the auditor concludes that it is not appropriate to rely on a particular internal control to the degree previously contemplated, he should ascertain whether there is another control which would satisfy his purpose and on which he might rely (after applying appropriate compliance procedures). Alternatively, he may modify the nature, Timing or the extent of his substantive audit procedures.

5 (a) Difference Between Report and Certificate:

A certificate is written confirmation of the accuracy of the facts stated therein and does not involve any estimate or opinion. A report on the other hand, is a formal statement usually made after an enquiry, examination or review of specified matters under report and includes the reporting auditor’s opinion thereon. These words are fundamentally distinct from each other. Etymologically, the work ‘certificate’ is derived from Latin words certus (Certain) and facere (to make). So, the certificate connotes verification of certain and exact facts. However, the rendition of this type of statement is an impossible task and the auditor’s duty indeed becomes onerous. The dictionary meaning of the word ‘report refers to formal account of results after an enquiry, examination or review given by an authorised person or group of reasons.

In other words, when a certificate is issued, the auditor is responsible for the factual accuracy of what is contained therein. However, when a report is given, the auditor is responsible for ensuring that the report is based on factual data, that his opinion is in due accordance with facts and that it is arrived at by the application of due care and skill.

(b) Contents of Reports and Certificates for Special Purposes:

The contents of reports and certificates for special purposes in many cases are specified by statute and cannot be changed. However, in cases where no format has been specified, the reporting auditor can choose the form and contents. In such cases, where a reporting auditor is free to draft his report or certificate, he should consider the following:

i. Specific elements, accounts or items covered by the report or certificate should be clearly identified and indicated.

ii. The report or certificate should indicate the manner in which the audit was conducted, e.g. by the application of generally accepted auditing practices, or any other specific tests.

iii. If the report or certificate is subject to any limitations in scope, such limitations should be clearly mentioned.

iv. Assumptions on which the special purpose statement is based should be clearly indicated if they are fundamental to the appreciation of the statement.

v. Reference to the information and explanations obtained should be included in the report or certificate. In certain cases apart from a general reference to information and explanations obtained, a reporting auditor may also find it necessary to refer


in his report or certificate to specific information or explanations on which he has relied.

vi. The title of the report or certificate should clearly indicate its nature, i.e., whether it is a report or a certificate. Similarly, the language should be unambiguous, i.e., it should clearly bring out whether the reporting auditor is expressing an opinion (as in the case of a report) or whether he is only confirming the accuracy of certain facts (as in the case of a certificate). For this, the choice of appropriate words and phrases is important.

vii. If the special purpose statement is based on general purpose financial statements, the report or certificate should contain a reference to such statements. However, the report or certificate should contain a reference to any other statement unless the same is attached therewith. It should be clearly indicated whether or not the statutory audit of the general purpose financial statements has been completed and also, whether such audit has been conducted by the reporting auditor or by another auditor. In case the general purpose financial statements have been audited by another auditor, the reporting auditor should specify the extent to which he has relied on them. He may communicate with the statutory auditor for securing his cooperation and in appropriate circumstances, discuss relevant matters with him, if possible.

viii. Where a report requires the interpretation of a statute, the reporting auditor should clearly indicate the fact that he is merely expressing his opinion in the matter. He should take sufficient care to ensure that in respect of matters which are capable of more than one interpretation, his report is not misconstrued as representing a settled legal position.

ix. An audit report or certificate should ordinarily be a self-contained document. It should not confine itself to a mere reference to another report or certificate issued by the reporting auditor but should include all relevant information contained in such report or certificate.

x. The reporting auditor should clearly indicate in his report or certificate, the extent of responsibility which he assumes. Where the statement on which he is required to give his report or certificate, includes some information which has not been audited, he should clearly indicate in his report or certificate the particulars of such information.

In certain cases, the form and / or contents of the report or certificate, as prescribed by a statute or a notification, may not be appropriate or adequate. In such situations, the reporting auditor may consider modifying the report or certificate on the basis of the aforesaid parameters, to the extent applicable. In case this it not possible, he should clearly indicate the limitations in his report or certificate itself.

(c) A cost auditor is ultimately required to express an opinion as to whether the company has maintained proper cost accounting records so as to give a true and fair view of cost of production, etc. In arriving at this opinion, the cost auditor is required to ascertain about multitude of information such as cost of raw materials consumed, cost of power, cost of stock, employer costs, provision for depreciation, royalty and technical payment,


abnormal cost, scrap, fuel etc. Annexures to the cost audit reports require detailed information in respect of financial position including capital employed, net worth, profit, net rates, operating profit, unit cost of power and fuel, total wages and salaries, etc. It is obvious therefore that cost audit cannot be done without reference to financial books, more so in the context of the statutory requirement to have a statement of reconciliation with financial accounts as part of cost audit report. Further, the cost statements also contain a summary of all expenditure incurred by the company and the share in such expenditure attributable to the activities covered by Cost Accounting Records Rules; Overhead expenditure also needs allocation between activities covered by rules and activities not so covered. Naturally, this can be done only with reference to financial ledger. Under Part II of Schedule VI to the Companies Act, 1956, quite a few matters which are to be mentioned in the Profit and Loss Account of the company are also to be covered in cost statements such as consumption of raw materials in quantity and value, sale of finished goods under classified headings in quantity and nature, actual production quantity of value, inventory in quantity of value for each class of goods, etc. A correlation between consumption of raw materials as per cost records and financial records may throw up the need for inquiry into errors, mistakes and manipulation. Material discrepancy between financial records and cost records will be highlighted in the reconciliation statement which would require that the cost auditor may examine deviation before reporting on the same. Thus it is imperative for the cost auditor to refer to financial records for conducting the cost audit.

6 (a) Sampling Risk:

Sampling Risk arises from the possibility that the auditor’s conclusion, based on a sample, may be different from the conclusion that would be reached if the entire population were subjected to the same audit procedure. The auditor is faced with sampling risk in both tests of control and substantive procedures as follows:

a. Tests of Control:

i. Risk of Under Reliance: The risk that, although the sample result does not support the auditor’s assessment of control risk, the actual compliance rate would support such an assessment.

ii. Risk of Over Reliance: The risk that, although the sample result supports the auditor’s assessment to control risk, the actual compliance rate would not support such an assessment.

b. Substantive Procedures:

i. Risk of Incorrect Rejection: The risk that, although the sample result supports the conclusion that a recorded amount balance or class of transactions is materially mis-stated, in fact it is not material mis-stated.


ii. Risk of Incorrect Acceptance: The risk that, although the sample result supports the conclusion that a recorded amount balance or class of transactions is no materially mis-stated, in fact it is materially mis-stated.

The risk of under reliance and the risk of incorrect rejection affect audit efficiency as they would ordinarily lead to additional work being performed by the auditor, or the entity, which would establish that the initial conclusions were incorrect. The risk of over reliance and the risk of incorrect acceptance affect audit effectiveness and are more likely to lead to an erroneous opinion on the financial statements then either the risk of under reliance or the risk of incorrect rejection.

Sample size is affected by the level of sampling risk the auditor is willing to accept from the results of the sample. The lower the risk the auditor is willing to accept, the greater the sample size will need to be.

(b) Representation by Management:

The management is responsible for the appropriate preparation and presentation of financial information. Thus, it is quite natural that during the course of audit, management would be required to make several representations on various matters relating to financial statements. These representations may be made by the management either in orally or in writing to the auditor. For example, the auditor may ask the management to confirm about the existence of contingent liabilities and disclosure thereof, etc. In other words, representation by management constitutes acknowledgement by the management about its responsibility for the preparation and approval of the financial management. A written representation may either take the form of a letter from the management or letter by auditor outlining auditor’s understanding and confirmation of the same.

Extent of Reliance: AAS-11, “Representations by Management”, states that management representations whether obtained orally or in writing unsituate audit evidence and establishes standards for evaluating the same. AAS-11 requires that the auditor may rely upon the management’s representation, preferably in writing, as a sort of information or evidence to consider and if the representations relate to matters which are material to financial information. Further, the auditor should:

a. Seek corroborative evidence from sources inside or outside the entity. b. Evaluate whether the representations made by the management appear reasonable

and consistent with other audit evidence obtained, including other representations; and

c. Consider whether the individuals making the representations are expected to be well informed on the matter.

However, it must note that representations by the management cannot be the substitute for other audit evidence that the auditor could reasonably expected to be available. For


example, a representation by the management as to existence, quantity and cost of inventories is not substitute for adopting audit procedures regarding verification and valuation of inventories. If a representation by management is contradicted by other evidence, the auditor should examine the circumstances and, when necessary, reconsider the reliability of other representations made by the management as well.

(c) Reporting responsibility of an auditor in the context of non-compliance of Law and Regulation:

The auditor should as soon as practicable, either communicate with the audit committee, the Board of Directors and senior management or obtain evidence that they are appropriately informed regarding non-compliance that comes to the auditors attention.

If in the auditor’s judgement, the non-compliance is believed to be intentional and/ or material, the auditor should communicate the findings without delay.

If the auditors concludes that the non-compliance has a material effect on the financial statements and has not been properly reflected in the financial statements the auditor should express a qualified or an adverse opinion.

If the auditor is precluded by the entity from obtaining sufficient and appropriate audit evidence to evaluate whether non-compliance is, or is likely to have occurred that have or may have material impact on the financial statements, the auditor should express a qualified opinion or a disclaimer of opinion on the financial statements on the basis of a limitation on the scope of the audit.

If the auditor is unable to determine whether non compliance has occurred because of limitations imposed by the circumstances rather than by the entity, the auditor should consider the effect on the auditor’s report.

The auditor’s duty of confidentiality would ordinarily preclude reporting non-compliance to a third part. However, in certain circumstances, that duty of confidentiality is overridden by statement, law or by courts of laws.

7 (a) Rolling Settlement:

rolling settlement is one in which a transaction outstanding at the end of the day have to be settled within X number of business days from the transaction date. If a transaction is entered on Monday on T + 2 rolling settlement, it will be settled on Wednesday when pay in or payout take place. SEBI has mandated most of the scrips to be settled exclusively on rolling settlement basis. Value at Risk (VaR) based margin approach has been adopted for transactions done in Compulsory Rolling Settlement. In the VaR system of margin, historical volatilities of scropes and overall market volatility is considered to arrive at a VaR margin percentage for a scrip. If a member fails ti deliver the shares sold in rolling settlement, the exchange conducts an auction session to meet the shortfall


credited by non-delivery of shares. If the auction price/close out price is less than the sale price, the difference is credited to Investor’s Education and Protection Fund. If the sale price is less than the auction price/close out price, the difference is payable by the defaulters.

(b) Preliminary Report under Peer Review:

In the process of peer review, at the end of the onsite review, the reviewer would send a preliminary report to the practice unit before making any report the Board on the areas in case systems and procedures of the practice unit reviewed have been found to be deficient or where non-compliance with reference to any other matter has been noticed by the reviewer during the course of review. The reviewer has to take care that the report does not contain name of any individual practice unit. However no preliminary report is required if no deficiency or non-compliance is observed. In preparing the report, he should assess the conclusion drawn from the review that indicates deficiency. The report is addressed to the practice unit. The report should also contain a paragraph that discusses the scope of the review. Limitations on the scope of review, if any, with fact thereof should also be communicated in the report. The report should be prepared on the letterhead of the reviewer with date, signature, and membership number and code number allotted to the reviewer.

(c) Human Resource Accounting:

Human resource is perhaps the most valuable asset in an undertaking. Flamholtz defines human resource as “accounting for people as an organisational resource. It involves measuring the costs incurred by business firm and other organizations to recruit, select, hire, train and develop human assets. It also includes measuring the economic value of people to organisations”. This definition gives two methods of valuing human resources, i.e., cost and the economic value. A company may value its human resources i.e., cost and the economic value. A company may value its human resources on the cost basis, i.e., at the costs incurred by it in procuring and developing these assets. Another method is to work out the replacement values of persons, representing the economic value. According to Flamholtz, an individual possesses value for an organisation because he is capable of rendering future services. Theoretically, therefore, his value to an organisation is equal to the present worth of his expected future services. Thus, an individual’s value to an organisation can be defined as the present worth of the set of future services that the person is expected to provide during the period he is anticipated to remain in the organisation. In this connection, putting a monetary value on human resources presents a lot of practical problems particularly from the auditor’s view point because of element of subjectivity is inherent in the process of such valuation.


(d) Probable format of “Environmental Statement”:

The following are the main aspects which may be covered in the probable format of Environmental Statement:

1. Name and address of the owner/occupier of the industry, operation or process. 2. Date of last environmental audit report submitted. 3. Consumption of water and other raw materials during current and previous year. 4. Pollution generated in air and water alongwith the output and the types of

pollutants and the deviation from standards. 5. Generation of hazardous waste in current year and previous year from processes. 6. Quantity of solid waste generated during current year and previous year and from

recycling or reutilisation of waste, etc. 7. Disposal practice for different type of waste. 8. Practice in operation for conservation of natural resources. 9. Additional investment proposal for environmental protection including abatement

of pollution.

CAAL

Number of Pages : 3 Total Marks: 100

Number of questions: 11 Time Allowed: 3 Hrs

QUESTION Nos.1, 2and 3 are compulsory

Answer any Four from the rest

1. Answer any TWO of the following: (2 x 6 = 12 Marks)

a) Confirm whether the following two companies can amalgamate under the Companies Act, 1956?

(i) Fast Foods Private Limited incorporated on 23rd July 2009 and Slow Foods Private Limited incorporated on 7th

(ii) XYZ Limited, a company carrying on the business of shares and ABC Limited, a company carrying on the business of transport.

October 2008

b)

(i) X Ltd sent notice for its Board Meeting to be held on 18th

(ii) Section 174 (1) of the Companies Act, 1956 sets down a quorum for general meetings which is as follows:

June 2009. Few directors were present for the meeting; However, the meeting could not be held for want of quorum. Is sitting fees, travelling allowance payable to the directors who were present at the meeting though no business could be transacted at that meeting?

Public limited company – five members personally present

Private limited company – two members personally present

Is a preference shareholder personally present at a general meeting included for the purpose of a quorum?

c) (i) X pvt Ltd is a private limited company incorporated in India. The entire share capital of this company is held by a Y, a Body Corporate incorporated outside India. The Holding company Y would be a public company if it was incorporated in India. Is X pvt Ltd. a private limited or a subsidiary of a public limited company under the Companies Act, 1956?

(ii) H is a Non-resident Indian (NRI). He wants to apply for a Directors Identification Number (DIN). Give a list of documents that are required for obtaining DIN by a NRI.


a) Fine Limited held their Annual General Meeting for the year 2005-06 on April 17, 2007 and on June 17, 2008 for the year 2006-07. In a petition under section 167, the Company Law Board passed an order directing the company to hold the annual general meeting for the year 2006-07 within 90 days from 20.11.2007. Is the order of the Company Law Board maintainable? Justify your answer with decided case law.

b) The requirement under Section 209 of the Companies Act, 1956, that a company must keep its books of account on accrual basis and according to the double entry system, does not apply to certain categories of companies. What are they?

c) What are the documents that can be inspected under Section 209A of the Companies Act, 1956?


a) A company wants to elect three directors. The number of candidates is five: A, B, C, D and E. The total number of votes cast is 100. The candidates secure first preference votes as follows:

A – 30, B – 12, C – 26, D – 24, E – 8 = Total – 100

Who will become the directors of the company using the method of single transferable vote?

b) What is the procedure for conversion of a Partnership Firm into a Limited Liability Partnership under the LLP Act?

c) Is Companies Act applicable to Limited Liability Partnerships?

4. a) Section 209 requires that a company must keep ‘proper books of account’. What does ‘proper books of account’ mean? (8 Marks)

b) What are the obligations of a Foreign Company regarding its Accounts? (8 Marks)

5. Elaborate on the scheme for filing of Statutory Documents and other Transactions by Companies in Electronic Mode? (16 Marks)

6. Draft the following:

a) Board Resolution to approve a scheme of compromise or arrangement other than Amalgamation?

b) Notice convening the meeting of the Members holding Equity shares under the scheme of amalgamation?

(16 Marks)

7. What are the compliances envisaged under Clause 41 of the Listing Agreement?

(16 Marks)

8. a) What are the latest guidelines under FEMA regarding Loans to Non-residents / third party against security of Non Resident (External) Rupee Accounts / Foreign Currency Non Resident (Bank) Accounts Deposits?

(8 Marks)

b) What are the latest guidelines under FEMA regarding Buyback/prepayment of Foreign Currency Convertible Bonds?

(8 Marks)

9. What is a producer company? What are its objects and salient features? (16 Marks)

10. In a scheme of compromise or arrangement, what is the procedure for seeking High Court Directions to convene meetings?

(16 Marks)

11. What are the specific requirements regarding Inter-Corporate guarantees and securities under Section 372A of the Companies Act, 1956?

(16 Marks)

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PRIME ACADEMY

29TH SESSION MODEL EXAM

CORPORATE LAWS AND ALLIED LAWS - NEW SYLLABUS

SUGGESTED ANSWERS

1. a) (i) There is no bar to a company amalgamating with a 15-day old company having no assets and business. Apco Industries Ltd (1996) 86 Comp Cas 457 (Guj)

(ii) There is nothing in law to prevent a company carrying on business in shares from amalgamating with one engaged in transport. EITA India Ltd. (1997) 24 CLA 37 Cal

1. b) i) DCA Circular 2/94 dated 10th February 1994.

ii) Section 174 does not, qualify the word “member” by the expression ‘entitled to attend and vote’. On a plain reading, therefore, the section does not specifically exclude preference shareholder personally present at a general meeting for the purpose of a quorum. The MCA, however, is of the view that if any business to be transacted at a general meeting does not include any item or resolution which directly affects the rights of the preference shareholders, their presence should not be taken into account for the purpose of determining the quorum, but if the subject-matter includes any resolution in which the rights of preference shareholders are directly affected, their presence should be taken into account for the purpose of quorum. DCA Circular, Company News & Notes, dated 16th June 1964.

1.c) i) As per section 4(7), a private company which is a subsidiary of a body corporate incorporated outside India is to be treated as a subsidiary of a public company for the purposes of the Companies Act, if two conditions are satisfied:

- That body corporate would be a public company if it was incorporated in India

- The entire share capital in the private company is not held by that body corporate (whether alone or together) with one or more other bodies corporate incorporated outside India.

In the instant case, since the entire share capital of X Ltd. Is held by Y Ltd., X Limited is a private limited company only under the Companies Act, 1956.

ii) LIST OF DOCUMENTS FOR NRI DIN

1. Passport in English. If the Passport is not in English, the English translation has to be obtained.

2. The passport and the translation of the passport if any, has to be certified by the notary in the home country of the applicant. If the applicant is holding an Indian passport, the passport along with the VISA should be attested by the Indian embassy in the country of the applicant.

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3. The passport has to contain the following:

Name of the applicant

Father’s Name

Date of birth in proof of the date of birth

Address in proof of the address

Photograph in proof of the identity

4. In case the passport does not contain one or more of the above referred particulars then apart from the attested copy of the passport, the copies of the following duly attested by the notary of the home country of the applicant are required

- Date of birth proof (such as driving licence, voters identity card etc) - Identity proof (such as driving licence, voters identity card etc) - Address proof (such as driving licence, voter’s identity card, telephone bill, electricity bill

etc). 5. Name of the applicant in the following order (should be the same as it is appearing in the

passport, address proof and identity proof)

First Name

Last Name

Middle name

6. Father’s Name of the applicant in the following order (should be the same as it is appearing in the passport, address proof and identity proof)

First Name

Last Name

Middle Name

7. If the address proof, identity proof and proof of date of birth are not in English, translation of the same into English duly certified by the notary of the home country of the applicant should be obtained.

8. Two passport size photographs

9.Biodata of the proposed director (should also contain the email id, phone nos, fax nos. and address.

10. Directorship/partner/proprietor in other companies, partnership firms and proprietorship concerns respectively.

11. Consent letter

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All attestation (copy of passport, id proof, address proof, photograph on the DIN application) in the case of NRI holding Indian passport should be by the Indian embassy abroad.

2. a) The company had held the annual general meeting for the year 2005-06 on April 17, 2007 and therefore the annual general meeting for the year 20006-07 became due to be held on or before July 17, 2008. The petitioner had no cause of action in November, 2007 to file a petition under section 167 seeking directions for conducting of meting for the year 2006-07. The company had not committed default. The order passed by the Board on November 19, 2007 was without jurisdiction as it had been passed without ascertaining whether default had taken place in holding the annual general meeting for the year 2006-07. The order dated November 19, 2007 was to be recalled and the petition was to be dismissed as not maintainable in terms of section 167 of the Act.

2. b) The requirement under Section 209 of the Companies Act, 1956, that a company must keep its books of account on accrual basis and according to the double entry system, does not apply to certain categories of companies.

The requirement under section 209 (3) (b), that a company must keep its books of account on accrual basis and according to the double entry system does not apply to a government company engaged in the business of financing industrial projects and approved by the Central Government under Section 36(1)(viii) of the Income tax Act, 1961 to the extent it relates to income from loans and advances, provided that such accrued income, which is not accounted for in the books of account, is disclosed by way of note in the annual accounts.

The provision also does not apply to a government company engaged in the promotion and development of industries, to the extent it relates to income from:

(a) Interest on seed money, loans or bridge loans

(b) Interest on instalments due on cost of industrial plots or allotted to entrepreneurs

(c) Claims from the Central Government or state governments in relation to special rebate on the sale of handloom clothes as declared by the Ministry of Textiles from time to time as a special measure for boosting the sale of handloom clothes produced in different parts of the country. However, such accrued income, which is not accounted for in the books of account is to be disclosed by way of a note in the company’s annual accounts.

2 c) WHAT ARE THE BOOKS THATCAN BE INSPECTED

The inspecting officer under Section 209A can inspect any books of account and other books and papers. ‘Books and papers’ include accounts, deeds, vouchers, writings and documents. ‘Documents’ include summons, notice, requisition, order, other legal process and registers, whether issued, sent or kept in pursuance of this or any other Act or otherwise.

It has, however, been held that books and papers referred to in section 209A (1) must have the character of books of account – CV Karuppunni v Joint Director, Inspection, Company Law Board (1986) 59 Comp Cas 814 (Ker)

The inspecting office can seek information about the company’s joint ventures with other bodies corporate that are not companies.

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Where the company is a partner in a firm, it has a right to get the accounts of the firm and to make them available to the inspecting officer under section 209A. The inspecting officer has the right to examine any officer of the company and to ascertain such information.

3 a) METHOD OF SINGLE TRANSFERABLE VOTE:

Using the method of single transferable vote, the appointment will be made in the following manner:

Quota = 100

---------- + 1 = 26 votes

3+1

As A an C have secured first preferences more than and equal to quota, both of them will be elected in the first count. However, A has secured four surplus votes. These will be transferred to B, D and E in the ratio of second preference shown on his 30 ballot papers. Suppose, the second preference shown by these are as follows:

In favour of B – 15

In favour of D – 0

In favour of E – 15

Total 30

Therefore, B and E will get two votes each. After such transfer, the position is as follows:

B= 14 votes

D = 24 votes

E = 10 votes

Now, the process of elimination will be employed. As E has secured the least first preferences, he will be eliminated. His first preferences will be transferred to B and D in the ratio of second preferences shown on his 10 votes. Suppose, these second preferences are as follows:

In favour of B – 8

In favour of D – 2

Such transfer elects D, as he obtains votes equal to the quota. Therefore, A, C and D will become the directors of the company.

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3 b) Section 55 of the LLP Act, 2008 provides that a firm may convert to limited liability partnership in accordance to the provisions of the Chapter X and the Second Schedule.

Sl.no Particulars Procedure

1 Essential conditions for conversion The firm may apply to convert into a limited liability partnership in accordance to the Second Schedule if and only if the partners of the limited liability partnership into which the firm is to be converted comprise all the partners of the firm and no one else.

2 Statements to be filed with the Registrar 1. A statement by all its partners in Part B of Form 17 accompanied by fee containing the name and registration number and the date on which the firm was registered under the Indian Partnership Act, 1932 or under any other law

2. Incorporation document and statement referred to in section 11

3 Registration of Conversion The registrar shall register the documents and issue a certificate of registration under his seal in From 19 specifying the date of registration

4 Information to be conveyed The limited liability partnership shall inform the concerned Registrar of firms about conversion of firm into limited partnership in From 14 within fifteen days of date of registration

5 Refusal of registration by Registrar If registrar refuses to register the LLP, the applicant firm may appeal to the Tribunal within 60 days from the date of receipt of such intimation of such refusal.

6 Effect of registration On and from the date of registration specified in the certificate of

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registration issue –

(i) A LLP by the name specified in the certificate of registration registered under this Act comes into existence

(ii) All tangible(movable and immovable) property as well as intangible property vested in the firm, all assets, interests, rights, privileges, liabilities, obligations relating to the firm and the whole of the undertaking of the firm shall be transferred to and shall vest in the LLP without further assurance, act or deed

(iii) The firm shall be deemed to be dissolved and if earlier registered under the Indian Partnership Act, 1932 removed from the records maintained under that Act.

7 Notice of conversion in correspondence Every official correspondence of the LLP for the period of twelve months commencing not later than fourteen days after the date of registration, shall bear a statement that it was, as from the date of registration converted, from a firm into a LLP and the name and registration number, if applicable of the firm from which it was converted.

3 c)

As per the LLP Act, the Central Government may, at any time, direct the application of the provisions of the Companies Act, 1956 to LLPs. This proposition, however, may not be easily acceptable to those who wish to convert from a company or a partnership firm to an LLP for the simple reason that procedures required under the Companies Act, 1956 are cumbersome and highly technical and the primary object of LLP is to avoid such technical procedures.

Secondly, the basis on which the Central Government can issue such directions has not been spelt out. This uncontrolled discretion vested with the government is likely to be misused in the absence of

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proper guidelines. Suitable provisions in this regard in the LLP Act itself with thus help in reducing this free hand discretion of the government.

4 a) PROPER BOOKS OF ACCOUNT

Section 209 requires that a company must keep proper books of account. But the section does not spell out as to what is proper books of account. The term proper means adapted or appropriate to the purpose or circumstances, fit, suitable, strict, accurate, complete or thorough.

Section 541(2) throws some light on the connotation of proper books of account.

According to the said section, proper books of account means

(a) Such books or accounts as are necessary to exhibit and explain the transactions and financial position of the business of the company, including books containing entries made from day to day in sufficient detail of all cash received and all cash paid, and

(b) Where the business of the company has involved dealings in goods, statements of the annual stock takings and of all goods sold and purchased showing the goods and the buyers and the sellers thereof in sufficient detail to enable those goods and those buyers and sellers to be identified.

Section 209 (3) declares that in the following two circumstances, proper books of account is not deemed to be kept with respect to the matters specified in Section 209 (1) and (2):

a) Such books are not kept as are necessary to give a true and fair view of the state of the affairs of the company or branch office and to explain its transactions and

b) Such books are not kept on accrual basis and according to the double entry system of accounting.

Thus proper books of account is deemed to be kept with respect to the matters specified in Section 209 (1) and (2) if

a) Such books are kept as are necessary to give a true and fair view of the state of the affairs of the company or branch office and to explain its transactions and

b) Such books are kept on accrual basis and according to the double entry system of accounting.

The books of account cannot be written in pencil. They must be written in indelible nick for giving a proper and adequate meaning to the words proper books of account.

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4 b) OBLIGATIONS OF A FOREIGN COMPANY REGARDING ITS ACCOUNTS

Section 594 imposes the following obligations regarding accounts:

(i) Every foreign company shall, in every calendar year, prepare a balance sheet and profit and loss account

(ii) The balance sheet and profit and loss account shall be made out in the same form, containing the same particulars and including or having annexed or attached thereto the same documents (including in particular, documents relating to every subsidiary of the foreign company) as are required under the provisions of this Act, as if the company had been a company within the meaning of the Companies Act.

(iii) However, any requirements exempted or modified by the Central Government by notifications shall not apply, or shall apply, subject to such exceptions and modifications as may be specified in the notification, to the balance sheet and profit and loss account.

(iv) If any such document as is mentioned in (i) above is not in the English language, there shall be annexed to it a certified translation thereof. The translation of the document into English should be done in the manner prescribed under Rule 19 of the Companies (Central Government’s) General Rules and Forms 1956, subject to the relaxation, if any, granted by the Central Government under Rule 21.

(v) Every foreign company shall deliver three copies of the balance sheet and profit and loss account to the Registrar within a period of nine months of the close of the financial year of the foreign company to which the documents relate. The Registrar may, for any special reason, and on application made in writing by the foreign company concerned, extend the said period by a period not exceeding three months.

(vi) Every foreign company shall send to the Registrar along with the balance sheet and profit and loss account, three copies of a list in the prescribed form of all places of business established by the company in India as at the date with reference to which the balance sheet is made out. This list will be delivered along with e-Form 52 and the filing fee.

5. Scheme for filing of Statutory Documents and other Transactions by Companies in Electronic Mode:

I BACKGROUND:

1 MCA-21 is one of the mission mode projects of the Government of India under the National e-Governance plan to provide easy and secure on-line services through the use of information technology to various stakeholders with the corporate sector in the country.

2 The MCA-21 project was initially launched at Coimbatore as a Pilot Project on 18.02.2006. The second pilot was launched at Delhi on 18.03.2006 by the Hon’ble Prime Minister of India. Thereafter the project was launched in a progressive manner and the nationwide roll-out has been completed across all Registrars of Companies (RoC) jurisdictions. The MCA-21 e-governance Project is the first of its kind for the Government of India. A programme of this size and magnitude, being comprehensive and complex, is bound to face transactional problems in the initial stages after the roll-out on the ground. As such, it has been found necessary to provide for a stabilization period of one year for the programme till 31.03.2007.

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3 (i) The e-Governance programme has been implemented following the BOOT (Built, Operate and Transfer) framework. The project consists of the period required for implementation till roll-out stage at all sites with testing and certification, and the operation period of six years over which payments towards project cost in the form of fixed equated quarterly instalments would be made to the BOOT Operator by the project owner. The BOOT Operator by the project owner. The BOOT Operator is responsible for:

(a) Designing and implementing the project till stage of roll-out at all sites with testing and certification thereof

(b) Owning, operating and maintaining the system for a period of six years after successful roll-out at all sites

(c) Undertaking necessary replacement investments at the end of the third year/beginning of the fourth year

(ii) M/s TCS-CMC consortium was selected as the BOOT Operator following an open competitive bidding process. The implementation of the project started on 01.03.2005.

4. With the enactment of Companies (Amendment) Act, 2006 (23 of 2006), published in the Gazette of India (Extraordinary), dated the 30.05.2006 the Companies Act, 1956, provides under section 610B of the Act, a comprehensive statutory framework for enabling electronic filing, storage, retrieval, viewing, processing and transmission of company data required to be filed with the Registrar of Companies under the Companies Act, 1956. The Central Government may appoint different dates in respect of different RoCs or Regional Directors from which such scheme shall come into force.

5. Since the processing of company documents submitted in the electronic form would also be carried out electronically, it is envisaged that filing of all statutory forms, their processing, approvals and response by the RoCs thereon would also be in electronic mode.

II THE SCHEME:

The Scheme for Filing of Statutory Documents and other Transactions by Companies in Electronic Mode relates to electronic filing, storage, retrieval, viewing, processing and transmission of company data required to be filed with the ROC, RDs and Central Government under the Companies Act, 1956.

III TRANSACTIONS COVERED UNDER THE SCHEME:

1. The transactions covered under the e-Governance programme are as under:

(a) Incorporation of company

(b) Filing of all annual returns

(c) Registration, modification and satisfaction of charges

(d) Statutory filings related to all events as stipulated in the Companies Act (with the exception of matters related to liquidation)

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(e) Inspection of documents

(f) Issue of certified copies

(g) Approvals from Regional Director

(h) Approvals from Central Government

(i) Investor complaints.

Provided that the scheme would not be applicable to matters pertaining to liquidation of companies.

IV Implementation of the Programme

a) Website/Portal and Electronic Registry

b) Director Identification Number

c) E-forms

d) E-filing

e) Authentication of Documents with Digital signature

f) Electronic Address

g) Attachments

h) Physical submission of paper

i) Scanning and Digitization of Company Records

j) Inspection of Public Documents

k) Requests for certified copies

l) Data verification and cleaning

m) Investor Complaints and grievance handling

n) Payment of statutory Fees

o) Availability of Services and Sustainability

p) Facilitation centres

The e-governance programme has been developed around a set of detailed processes, basically designed to be easily adaptive to scalability while accommodating changes to technology or other solution components.

The processes could also be impacted due to changes in law and also based on the evolution that is expected to occur with the passage of time.

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It may also be provided that where a filing does not require any immediate processing or approval, it may be taken on record through the Straight Through Process to be implemented through amendment of the relevant regulation.

Central Government may also introduce the process of electronic generation of stamp papers in due course of time, after the requisite authorisations have been received from the states, so as to completely eliminate the process of submission of physical documents.

The process innovations would entail changes and MCA will provide enough lead time including public announcements and information through the MCA portal for the benefit of users of this system.

6. (a) Board Resolution to approve a scheme of compromise or arrangement other than Amalgamation

The Board approves

(1) Pursuant to the provisions of sections 391 to 394 and 100 and other applicable provisions, if any, of the Companies Act, 1956, and subject to the approval of the members of the Company and the sanction of the Hon’ble High Court at Chennai and subject to such alterations and modifications as may be directed by the High Court, the scheme of Arrangement (the Scheme) for the restructuring of the Company’s Share Capital, a copy of which duly initialled by the Chairman is placed before this meeting.

(2) Authorises Mr....., Managing Director and Mr...., Company Secretary of the Company, jointly and severally to sign any application, affidavit, petition, notice of the meeting or any other document concerning the Scheme and make such alterations and changes in the Scheme as may be expedient or necessary for complying with the requirements or conditions imposed by the High Court at Chennai provided that prior approval of the Board shall be obtained for making any material changes in the said Scheme as approved in this meeting

(3) Authorises the Managing Director and the Company Secretary jointly and severally to do such acts, deeds and things as they consider in the interest of the Company and as may be required to give effect to the said Scheme, with such modifications and conditions, if any, as may be stipulated by the High Court, at Chennai in granting approval to the Scheme.

(4) The Managing Director and the Company Secretary to take all steps necessary in connection with the filing of:

(i)Applications to High Court at Chennai for Directions for holding meetings of the shareholders of the Company and for making application for dispensing o the meeting of the Creditors, signing, affirming and verifying applications/petitions/affidavits in the High Court of Judicature of Chennai

(ii) Petition for confirmations of the Scheme by the High Court and

(iii)To do all acts and things as may be considered necessary and expedient in relation thereto and for that purpose to engage any legal counsel.

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(5) Mr/Ms...., is appointed as Consultant for the purpose of generally advising the Company in regard to the law and procedure in connection with the Scheme and also to liase with an Advocate to be engaged for appearing before the Court and Mr/M/s .....Advocate, be and is hereby appointed as an advocate for the purpose of seeking sanction of the High Court to the Scheme.

a) Notice Convening the meeting of the Members holding Equity shares under the a scheme of amalgamation:

Notice Convening the Meeting of the Members Holding Equity Shares

In the High Court of Judicature at Chennai

Ordinary Original Civil Jurisdiction

Company Application NO...... of YYYY

In the Matter of Sections 391 to 394 of the Companies Act, 1956

And

In the matter of Scheme of Amalgamation Between

A Limited and B Limited

A Limited, a company incorporated under the Companies Act, 1956, having its registrar office at......................-Applicant

Notice Convening The Meeting Of the Meeting Holding Equity Shares in B Limited

To

The Members holding Equity shares in A Limited

By an order made on the ......., the High Court of .......has directed that a meeting of the members holding equity shares in A Limited, the applicant company, be convened and held at .....on....day, the .....for the purpose of considering and if thought fit, approving, with or without modification, the scheme of amalgamation between B Limited and the applicant company.

As per the Court’s order, a meeting of the members holding equity shares in the applicant company will be held at ....on....day, the ....., at ....am., when you are requested to attend.

You may attend and vote at the said meeting in person or by proxy, provided that the proxy in the prescribed form duly signed by you, is deposited at the Registered Office of the Company, at .....not later than 48 hours before the meeting.

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The Court has appointed Mr....and failing him, Mr....failing him, Mr...... to be the chairman of the said meeting.

A copy of the scheme of amalgamation, the statement under section 393 of the Companies Act, 1956 and a form of proxy are enclosed herewith.

Dated...............

Chairman appointed for the meeting

Note: All Alterations made in the form of Proxy should be initialled.

Explanatory Statement Under section 393

In the High Court of Judicature at Chennai

Ordinary Original Civil Jurisdiction

Company Application No......of YYYY

In the matter of Sections 391 to 394 of the Companies Act, 1956

And

In the matter of Scheme of Amalgamation of A Limited with B Limited

A Limited .......Applicant

Explanatory Statement under Section 393 of the Companies Act, 1956

(1) The accompanying notice is being sent to you pursuant to the orders dated......passed by the Hon’ble ......High Court in the above company application whereby a meeting of the equity shareholders of the applicant company is directed to be convened for the purpose of considering and, if thought fit, approving with or without modification, the scheme of amalgamation between B Limited (the transferor company) with the applicant company.

(2) A copy of the scheme of amalgamation setting out in detail the terms and conditions of the amalgamation of the transferor company with the applicant company is also enclosed herewith. The scheme, after it is sanctioned by the.........high court will come into operation with effect from.......

(3) The applicant company is engaged in the business of manufacture of diesel engines and engine bearings. The transferor company is engaged in the business of manufacture of......

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(4) Thus the transferor company and the applicant company are in the business of manufacture of.....and there can be synergy between both the companies.

(5) In these circumstances, the transferor company and the applicant company through it fit to amalgamate the transferor company with the applicant company which would result into synergistic operating economies, besides economy in costs by combing the business functions and related activities which would enable the amalgamated company to carry on business more profitably and efficiently.

(6) With the above objectives, the scheme of amalgamation of the transferor company with the applicant company has been prepared and in consideration of the transfer of the assets and liabilities under the scheme, the applicant company is required to allot to the shareholders of the transferor company, 20 equity shares of the face value of Rs.10 each of the applicant company credited as fully paid up for every one equity share of the face value of Rs.100 each of the transferor company.

(7) The share exchange ratio has been worked out by M/s.....a reputed firm of chartered accountants and in the view of the Board of directors of the applicant company, the same is fair and reasonable and it does not prejudicially affect the rights and interest of the members of the applicant company as well as the members of the transferor company and they will get fair compensation for their shareholding in the transferor company.

(8) In the opinion of the Board of directors of the Applicant Company, the scheme of amalgamation is in the interest of the applicant company and neither the rights and interests of the applicant company nor the rights and interests of its members and creditors are likely to be prejudicially affected in any manner whatsoever by the proposed scheme of amalgamation.

Save as aforesaid, the directors of the applicant company have no other interest in the proposed scheme of amalgamation.

Mr........is the Managing Director of the transferor company and to that extent; he is interested in the proposed amalgamation.

Save as aforesaid, the director of the transferor company, have other interest in the proposed scheme of amalgamation.

Dated this.....day of.....

Chairman appointed for the meeting

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7. COMPLIANCE UNDER CLAUSE 41 of the Listing Agreement

Clause Particulars of Compliance Due date

41 (I)(c) The company has an option either to submit audited or un audited quarterly and year to date financial results to the stock exchange within one month of end of each quarter (other than the last quarter), subject to the following:

Quarter Ended 30th June

Quarter Ended 30th September

Quarter Ended 31st

31

December

st Jul

31st Oct

31st Jan

(i) In case the company opts to submit un-audited financial results, a copy of Limited Review Report from statutory auditor shall be furnished to the stock exchange within 2 months from the end of the quarter.



Quarter Ended 31st

31

December

st Aug

30th Nov

28th Feb

(ii) And in case the company opts to submit audited financial results, they shall be accompanied by the audit report.



Quarter Ended 31st

31

December

st Jul

31st Oct

31st Jan

41 (I) (d) In respect of the last quarter, the company has an option either to submit un audited financial results for the quarter within one month of end of the financial year or to submit audited financial results for the entire financial year within three months of end of the financial subject to the following:

Un audited

30th April or

Audited

30th June

(i) In case the company opts to submit unaudited financial results for the last quarter, it shall also submit audited financial results for the entire financial year, as soon as they are approved by the Board. Such un audited financial results for the last quarter shall also be subjected

Limited Review report by 31st May

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to limited review by the statutory auditors of the company and a copy of the limited review report shall be furnished to the stock exchange within two months from the end of the quarter

(ii) In case the company opts to submit audited financial results for the entire financial year, it shall intimate the stock exchange in writing within one month of end of the financial year, about such exercise of option.

30th April

41(I)(e) If the company has subsidiaries

(i) It may, in addition to submitting quarterly and year to date stand alone financial results to the stock exchange i.e., within one month of the end of the quarter, also submit quarterly and year to date consolidated financial results within two months from the end of the quarter and



Quarter Ended 31st

31

December

st July & 31st August

31st oct and 30th Nov

31st Jan and 28th Feb

(ii) While submitting annual audited financial results prepared on stand-alone basis, it shall also submit annual audited consolidated financial results to the stock exchange

31st May

41(I)(f) Financial results (signed by Chairman or Managing Director or Whole time Director) shall be submitted to the stock exchange within 15 minutes of conclusion of the meeting of the Board or Committee in which they were approved pursuant to the sub-clause (II) of the said clause

Year Ended 31st March

Quarter Ended 30th

Within 15 minutes of conclusion of Board Meeting June

Within 15 minutes of conclusion of

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Quarter Ended 31st

Board Meeting

Within 15 minutes of conclusion of Board Meeting

Within 15 minutes of conclusion of Board Meeting

December

41(II)(b) The quarterly financial results shall be approved by the Board of Directors or by a ?Committee thereof (other than audit committee) and shall consist of not less than one third of the directors and shall include the managing director and at least one independent director

41(ii)(c) The financial results submitted to the stock exchange shall be signed by the Chairman or Managing Director or a whole time director. IN the absence of all of them, it shall be signed by any other director of the company who is duly authorized by the Board to sign the financial results

41(II)(d) The limited review report shall be placed before the Board of Directors or the Committee (other than audit committee), before being submitted to the stock exchange where the variation between un audited financials and financials amended pursuant to limited review for the same period, exceeds 10%.

Provided that when the limited review report is placed before the Committee they shall also be placed before the Board at its next meeting

41(II)(e) The annual audited financial results shall be approved by the Board of Directors of the company and shall be signed by the Chairman or Managing director, or a whole time director

41(III)(a) Notice to Stock Exchange (SE) for holding Board Meeting (BM) to approve unaudited financial Results (UAFR) subject to Limited Review Report(LRR) by Statutory auditors (excluding the date of the intimation and date of

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the meeting)

Year Ended 31st March



Quarter Ended 31st

7clear calendar days prior to meeting




December

41(III)(b) Publication of Notice in 2 Newspapers (one in English daily newspaper circulating in substantially whole of India and in one Regional Language daily newspaper of the State in which Registered Office of the Company is situated)

Quarter Ended 31st March



Quarter Ended 31st





December

41(IV)(a) Where there is a variation in net profit/loss after tax in excess of 10% or Rs.10 lakhs between the un audited

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quarterly or year to date financial results and the results amended pursuant to limited review for the same period then the Company shall submit tot he stock exchange an explanation of the reasons for variations (approved by Board of Directors)

41(IV)(c) If the auditor has expressed any qualification or other reservation in his audit report or limited review report in respect of the financial results of any previous financial year or quarter which has an impact on the profit or loss of the reportable period, the company shall include as a note to the financial results

(i) How the qualification or other reservation has been resolved or

(ii) If it has not been resolved, the reason therefor and the steps which the company intends to take in the matter

41(VI) (a) & (b)

Publish approved UAFR within 48 hours of BM held. Where the Company has submitted consolidated financial results in addition to standalone financial results, it shall publish only consolidated financial results in the newspaper.

Quarter Ended 31st March



Quarter Ended 31st December

With 48 hours of BM held




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8 a) FEMA 2000 – Loans to Non Residents/third party against security of NR(E) Rupee Accounts / FCNR(B) Accounts – Deposits

The Reserve Bank of India, vide AP (DIR Series) Circular No.66 dated 28.04.09 has

a) enhanced the existing cap of Rs.20 lac to Rs.100 lacs on loans against security of funds held in NR(E) and FCNR(B) deposits, either to the depositors or third parties.

b) Accordingly, banks may now grant loans against NR(E)RA and FCNR(B) deposits either to the depositors or third parties up to a maximum limit of Rs.100 lakhs

c) Banks are also advised not to undertake artificial slicing of the loan amount to circumvent the aforesaid ceiling.

8 b) BUYBACK/PREPAYMENT OF FCCSs

The Reserve Bank of India, vide AP (DIR Series) Circular No.65 dated 28.04.2009 has

a) Increased the total amount of permissible buyback of FCCBs, out of internal accruals, from USD 50 million of the redemption value per company to USD 100 million, under the approval route by linking the higher amount of buyback to larger discounts.

b) Accordingly, Indian companies may henceforth be permitted to buyback FCCBs up to USD 100 million of the redemption value per company, out of internal accruals, with the prior approval of the Reserve Bank, subject to a:

(i) Minimum discount of 25% of book value for redemption value up to USD 50 million

(ii) Minimum discount of 35% of book value for the redemption value over USD 50 million and up to USD 75 million and

(iii) Minimum discount of 50% of book value for the redemption value of USD 75 million and up to USD 100 million.

9. 1) PRODUCER COMPANY

A producer company is one whose main objects should contain one or more of the objects given under Sec.581B. Such objects pertain to dealing with production and harvesting of crops and other activities relating to such objects.

OBJECTS

581B deals with the objects of Producer Company.

The Producer Company may carry on any of the activities specified in this clause either by itself or through other institution.

The objects of the Producer Company shall relate to all or any of the following matters, viz.,

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a) Activities relating to production, harvesting and marketing of primary produce

b) Activities relating to processing of produce of its Members

c) Activities relating to manufacture and supply of machinery, equipment or consumables mainly to its members

d) Activities relating to

e) Activities relating to rendering technical, consultancy, training, research and development services and all other activities for the promoting of the interests of its Members

f) Generation, transmission and distribution of power, revitalisation of land and water resources, their use, conservation and communication relatable to primary produce.

g) Insurance of producers or their primary produce

h) Promoting techniques of mutuality and mutual assistance

i) Welfare measures or facilities for the benefit of Members as may be decided by the Board

j) Any other activity, ancillary or incidental to any of the activities given above which may promote the principles of mutuality and mutual assistance amongst the Members in any other manner

k) Financing for promotion of the above activities including extension of credit facilities or any other financial services to its Members

SALIENT FEATURES

- The liability of the Members of the new company shall be limited to the amount, if any unpaid on the shares held by them

- The new company shall be a company limited by shares

- All direct costs associated with the promotion and registration of the company will be reimbursed to the promoters by the company

- This shall be subject to the approval at its first general meeting of the Members

- Once registration is completed, the Producer Company shall become a body corporate as if it is a private limited company

- There shall be no limit to the number of Members of the producer company.

- Under no circumstance can it become or be deemed to become a public limited under this Act.

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10. In a scheme of compromise or arrangement, the procedure for seeking High Court Directions to convene meetings.

To get the approval of the members and/or creditors to a scheme of compromise or arrangement, the following procedure is involved:

1. Board approval:

To propose any scheme at a general meeting of a company, the Board of directors of the company will first approve the scheme at a Board meeting and pass resolutions:

- To approve the scheme

- To authorise a director/company secretary/other officer to make an application/petition to the court

- To authorise a director/company secretary/other officer to sign the application, petition, affidavit, notice of the meeting and other document in connection therewith; and

- To do such other things, acts and deeds as may be necessary or expedient in connection therewith, including changes in the scheme

2. Application to court for directions to convene meetings:

Members’ and Creditors’ approval to the scheme of compromise or arrangement is a pre condition for court’s sanction. Without that, court will not proceed with the scheme. This approval is to be obtained at meetings held as per court’s directions. However court may dispense with meetings of members/creditors. Normally, creditors’ meetings are dispensed with subject to certain conditions. Members’ meeting may also be dispensed with if all members’ individual consent is obtained. The scheme of compromise or arrangement has to be approved as directed by the high court, by

- Members of the company

- The members of each class, if the company has different classes of shares

- The creditors

- Each class of creditors, if the company has different classes of creditors.

The approval of the members and creditors has to be obtained at specially convened meetings as per high court directions. An application seeking directions to call, hold and conduct meetings is made to the high court, which has jurisdiction having regard to the location of the registered office of the company. An application under section 391(1) for an order convening meetings of creditors and/or members or any class of them shall be made by a judge’s Bench officer’s summons supported by an affidavit in Form no.33 prescribed under the Companies (Court) Rules. A copy of the proposed scheme of compromise or arrangement shall be annexed to the affidavit as exhibit thereto.

If the applicant is not the company, a copy of the summons and of the affidavit shall be served on the company at least 14 days before the date fixed for the hearing of the summons. If the company is being wound up, it shall be served on the liquidator. In such a case, the facts will have to be disclosed by the applicant in the affidavit. The court may give directions for the following matters:

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(i) To determine the class/classes of members and/or creditors whose meetings have to be held for considering the proposed compromise or arrangement.

(ii) To fix time and place of the meetings

(iii) To appoint chairman for the meetings

(iv) To determine the values of the members/creditors whose meetings have to be held

(v) Notice of the meeting and the manner in which it should be given

(vi) Time within which the chairman should file a report of the meeting

(vii) Any other matter the court may deem necessary

3. Notice of the meeting:

Notice of the meeting must be given to the members or any class of them and the creditors or any class of them at least 21 clear days before the meeting as per the court’s directions. The notice must be accompanied by:

(i) The scheme of compromise or arrangement

(ii) A statement under sec 393

(iii) Proxy in Form no.37 prescribed under Court rules

The notice must be sent individually to each member and creditor by:

(i) The chairman appointed for the meeting by the court

(ii) If the court so directs, by the company

(iii) The liquidator

(iv) Any other person as the court may direct

The notice must be sent by post under certificate of posting to the last known addresses of the members/creditors. The notice must be published in newspapers as directed by the court, at least 21 clear days before the date fixed for the meeting.

The company must furnish to every creditor or member entitled to attend the meeting, free of charge and within 24 hours of a requisition being made for the same, a copy of the proposed compromise or arrangement together with a copy of the statement, required to be furnished under sec.393, unless the same had been already furnished.

4. Chairman’s Affidavit as to notice:

The chairman appointed for the meeting or the company or any other person, who is directed by the court to send notice of the meeting and issue advertisement must file an affidavit regarding compliance with the court’s directions regarding individual and public notices. This affidavit has to be filed within seven days before the date fixed for the meeting.

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5. Proceedings of meetings:

It is the responsibility of the petitioners to see that the class meetings are properly constituted, and if they fail the court has no jurisdiction to sanction the scheme. These meetings are to be held as per the court’s directions under the chairmanship of a person nominated by the court. The court may appoint the chairman of the company as the chairman of the meeting convened by the court.

6. Scheme to be approved by special majority:

The scheme must be approved by a resolution passed with the special majority stipulated in Sec.391(2), namely a majority in number representing three-fourths in value of the creditors, or class of creditors, or members, or class of members, as the case may be, present and voting either in person or by proxy.

7. Chairman’s report:

The chairman of the meeting must file in the court a report of proceedings of the meeting within seven days of the meeting or such other time as fixed by the court. The report must state accurately:

- The number of creditors or class of creditors or the number of members or class of members, as the case may be, who were present at the meeting

- The number of creditors or class of creditors or the number of members or class of members, as the case may be, who voted at the meeting either in person or by proxy

- Their individual values and

- The way they voted.

8. Requirements under Listing Agreement:

In the case of a listed company, the following requirements under Listing agreement must be complied with in respect of all stock exchanges on which the company’s shares are listed:

a) Intimation of the Board’s decision approving the scheme of compromise or arrangement will be given to the stock exchange immediately after the Board meeting on the same day

b) Intimation of the resolution passed at the general meeting approving the scheme of compromise or arrangement will be given to the stock exchange immediately after the Board on the same day

c) Copies of notices, circulars, etc. issued/advertised concerning amalgamation will be forwarded to the stock exchange.

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11. Specific requirements regarding Inter-Corporate guarantees and securities under Section 372A of the Companies Act, 1956?

Section 372A stipulates the following requirements regarding inter-corporate guarantees and securities, i.e., guarantees provided and securities given by a company in connection with a loan given

(a) By any person to any body corporate or

(b) By any body corporate to any person

The section would not apply unless either:

(a) The borrower of money on whose behalf a guarantee or security is given is a body corporate or

(b) The lender of money is a body corporate regardless of whether the borrower on whose behalf a guarantee or security is given is a body corporate or not.

In other words, a guarantee or security given by a company on behalf of or in favour of any party which is not a body corporate would not attract this section.

In order for a transaction to fall under sec.372A, the guarantee or security must be in connection with a loan. This section would not apply unless the guarantee or security is in connection with a loan. For example, the following types of guarantee or security will attract this section:

a) A guarantee given in respect of an inter corporate loan or deposit

b) A counter guarantees in respect of loans obtained by any body corporate

c) A guarantee given by the company to any body corporate in connection with a loan given by it to the company’s employee.

Any guarantee or security, which does not involve the transaction of lending and borrowing of money between a body corporate and a third party would not attract the provisions of this section. For example, the following types of guarantees will not come under the purview of this section:

a) Performance guarantees given to third parties on behalf of other companies

b) Guarantees against advance received in respect of a contract for supply of goods or a project

c) Guarantees on behalf of or in favour of a person not being a body guarantee

d) Bank guarantees given in connection with business transactions which do not involve lending of money but some other obligation.

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The requirements under sec.372A need not be complied with unless the security provided by the company is in connection with a loan. In its ordinary meaning the term ‘security’ means something given or deposited as surety for the fulfilment of a promise or an obligation, the payment of a debt, etc. It is an asset or assets to which a lender can have recourse if the borrower defaults on his loan repayment. In the case of loans by banks and other money lenders, the security is sometimes referred to as collateral. The term security is usually applied to an obligation, pledge, mortgage, deposit, lien, etc, given by a debtor in order to assure the payment or performance of his debt, by furnishing the creditor with recourse to be used in case of failure in the principal obligation.

Only those securities which are in connection with loans given by or to bodies corporate, i.e., securities which guarantee repayment of loans given by or to bodies corporate come within the purview of this section.