SUGGESTED ANSWERS TO

THE QUESTIONS SET AT

CHARTERED ACCOUNTANCY PROFESSIONAL (CAP)-III LEVEL (Group-I)

DECEMEBER 2020 EXAMINATIONS

The Institute of Chartered Accountants of Nepal (ICAN)

Satdobato, Lalitpur
© The Institute of Chartered Accountants of Nepal
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Year and month of Publication: 2021 March

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 Table of Contents
Paper-1: Advanced Financial Reporting..........................................................................................4
Paper-2: Advanced Financial Management...................................................................................21
Paper-3: Advance Audit and Assurance........................................................................................39
Paper-4: Corporate Laws...............................................................................................................51
Paper-1: Advanced Financial Reporting

Attempt all questions. Working notes should form part of the answers.
Use separate answer book for each question.

1. The statements of financial position of Jagat Co. and its investee companies, Phagat Co. and
Sangat Co. at 31 Ashadh, 2077 are as below:
Statements of Financial Position as at 31 Ashadh, 2077
Jagat Co. Phagat Co. Sangat Co.
Assets (Rs.’000) (Rs.’000) (Rs.’000)
Non- current assets
Freehold property 1,950 1,250 500
Plant and machinery 795 375 285
Investments 1,500 - -
4,245 1,625 785
Current assets
Inventory 575 300 265
Trade receivables 330 290 370
Cash 50 120 20
955 710 655
Total assets 5,200 2,335 1,440
Equity and liabilities
Equity
Share capital of Re.1/share 2,000 1,000 750
Retained earnings 1,460 885 390
3,460 1,885 1,140
Non-current liabilities
12% loan stock 500 100 -
Current liabilities
Trade payables 680 350 300
Bank overdraft 560 - -
1,240 350 300
Total equity and liabilities 5,200 2,335 1,440
Additional information:
i) Jagat Co., acquired 600,000 ordinary shares in Phagat Co., on 01 Shrawan, 2071 for Rs.
1,000,000 when the retained earnings of Phagat Co., were Rs. 200,000.
ii) At the date of acquisition of Phagat Co., the fair value of its freehold property was
considered to be Rs. 400,000 greater than its value in Phagat Co.’s statement of financial
position. Phagat Co., had acquired the property in Shrawan, 2071 and the buildings
element (comprising 50% of the total value) is depreciated on cost over 40 years.
iii) Jagat Co., acquired 225,000 ordinary shares in Sangat Co. on 01 Shrawan, 2075 for Rs.
500,000 when the retained earnings of Sangat Co. were Rs.150,000.
iv) Phagat Co., manufactures a component used by both Jagat Co., and Sangat Co.
Transfers are made by Phagat Co., at cost plus 25%. Jagat Co. held Rs. 100,000
inventory of these components at 31 Ashadh, 2077. In the same period Jagat Co., sold
 goods to Sangat Co., of which Sangat Co., had Rs. 80,000 in inventory at 31 Ashadh,
2077. Jagat Co., had marked these goods up by 25%.
v) The goodwill in Phagat Co. is impaired and should be fully written off. An impairment
loss of Rs. 92,000 is to be recognised on the investment in Sangat Co.
vi) Non-controlling interest is valued at full fair value. Phagat Co. shares were trading at
Rs. 1.60 just prior to the acquisition by Jagat Co.
Required: 20 marks
Prepare, in a format suitable for inclusion in the annual report of the Jagat Co. Group, the
consolidated statement of financial position at 31 Ashadh, 2077.
Answer:
Jagat Co. Group
Consolidated statement of financial position
As at 31 Ashadh, 2077
Assets (Rs.in ’000)
Non-current assets
Freehold property (W.N.2) 3,570.00
Plant and machinery (795+375) 1,170.00
Investment in associate (W.N.7) 475.20
5,215.20
Current assets
Inventory (W.N.3) 855.00
Receivables (330 + 290) 620.00
Cash (50 +120) 170.00
1,645.00
Total assets 6,860.20

Equity and liabilities

Equity
Share capital 2,000.00
Retained earnings (W.N.8) 1,792.20
3,792.20
Non-controlling interest (W.N.9) 878.00
4,670.20
Non-current liabilities
12% loan stock (500+100) 600.00
Current liabilities (680 +560+350) 1,590.00
Total equity and liabilities 6,860.20
Working Notes:
(1) Group structure
1.4.2071 (6 years ago)
Jagat Co. acquires 60% of Phagat Co.
1.4.2075 (2 years ago)
Jagat Co. acquires 30% of Sangat Co.
(2) Freehold Property

Rs. in’000
 Jagat Co. 1950
Phagat Co. 1250
Fair value adjustment 400
Additional depreciation [(400×50%)÷40]×6 years (2071 Shrawan - (30)
2077 Ashadh)
3570
(3) Inventory
Rs. in’000
Jagat Co. 575
Phagat Co. 300
Unrealized Profit (100× 25/125) (W.N.4) (20)
855
(4) Unrealized Profit
Rs. in ’000
On sales by Phagat Co. to Jagat Co. (Parent Co) 100×25/125 20.0
On sales by Jagat Co. to Sangat Co. (Associate) 80×25/125×30% 4.8
(5) Fair Value adjustment
Difference at Difference
acquisition now
Rs. in’000 Rs. in’000
Property 400 400
Additional depreciation: 200 × 6/40 - (30)
400 370
Therefore charge Rs. 30,000 to retained earnings
(6) Goodwill
Rs. in’000 Rs. in’000
Phagat Co.
Consideration transferred 1,000
Non-Controlling interest (400 × Rs. 1.60) 640
Net assets acquired
Share capital 1,000
Retained earnings 200
Fair value adjustment 400
(1,600)
Goodwill at acquisition 40
Impairment loss (40)
0
(7) Investment in Associates
Rs. in ’000
Cost of investment 500.00
Share of post-acquisition profit (390 – 150) × 30% 72.00
Less: Unrealized Profit (80×25/125)×30% (4.80)
Less: impairment loss (92.00)
475.20
(8) Retained earnings
Jagat Co. Phagat Co. Sangat Co.
Rs. in ’000 Rs. in ’000 Rs. in’000
Retained earnings given 1,460.0 885.0 390.0
 Adjustments
Unrealised profit (W.N.4) (4.8) (20.0)
Fair value adjustments (W.N.5) (30.0)
(Depn.)
Impairment loss (Phagat Co) (40.0)
795.0 390.0
Less pre –acquisition reserves (200.0) (150.0)
1,455.20 595.0 240.0
Phagat Co.: 60% ×595 357.00
Sangat Co.: 30% × 240 72.00
Impairment loss (Sangat Co) (92.00)
1,792.20
(9) Non – controlling interest at reporting date
Rs. in ’000
NCI at acquisition (W.N.6) 640.00
Share of post –acquisition retained earnings (595 × 40%) 238.00
878.00
2.
a) KK Ltd. runs a departmental store which awards 10 points for every purchase of Rs. 500
which can be discounted by the customers for further shopping with the same company.
Each point is redeemable on any future purchases of KK Ltd.’s products within 3 years.
Value of each point is Rs. 0.50. During the accounting year 2076/77, KK Ltd. awarded
10,000,000 points to various customers of which 1,800,000 points remained undiscounted
(to be redeemed till 31 Ashadh, 2079). The management expects only 80% of the
remaining will be discounted in future.
KK Ltd. has approached you with the following queries and has asked to state the
accounting treatment (Journal Entries) under the applicable NAS for these award points:
(i) How should the recognition be done for the sale of goods worth Rs. 1,000,000 on
a particular day?
(ii) How should the redemption transaction be recorded in the year 2076/77? The
company has requested you to present the sale of goods and redemption as
independent transaction. Total sales of the company is Rs. 500,000,000.
(iii) How much of the revenue for undiscounted points should be deferred at the year-
end (2076/77) because of the estimation that only 80% of the outstanding points
will be redeemed?
(iv) In the next year 2077/78, 60% of the outstanding points were discounted Balance
40% of the outstanding points of 2076/77 still remained outstanding. How much
of the deferred revenue should the company recognize in the year 2077/78 and
what will be the amount of balance deferred revenue?
(v) How much revenue will the company recognize in the year 2078/79, if 300,000
points are redeemed in the year 2078/79?
Required: Give answer to the queries of KK Ltd. with proper workings. 10 marks
b) R Co. is in the process of preparing its financial statements for the year ended 31 Ashadh
2077. The following matters are pending relating to deferred taxation. R’s current
income tax rate is 25%. However, this rate will be changed to 20%, with effect from 1
Shrawan 2077, as enacted by the new tax legislation.
i) Investment property acquired on 1 Shrawan 2075 for Rs. 26 million has been valued
for Rs. 32 million on 31 Ashadh 2077. The valuation does not affect the taxable profit.
R measures investment properties at fair value. R depreciates this property over 15
 years for tax purposes. If the investment property is sold, a tax rate of 10% would
apply on the sale proceeds in excess of the cost. However, reversal of tax
depreciation already claimed, will be taxed at the normal income tax rate. R expects
to sell this property in the 5th year of its useful life
ii) R has motor vehicles amounting to Rs. 50 million. R cannot deduct depreciation
allowance on these vehicles for tax purposes, and disposal gains are not taxable.
iii) R has recognised a provision for product warranty cost, amounting to Rs. 6 million.
These costs will not be taxable, until the claims are paid.
Required: 10 marks
Advise on the financial reporting treatment based on the requirements of NAS 12, Income
Taxes for the year ended 31 Ashadh 2077.
Answer:
a)
i) Points earned on Rs. 1,000,000 @ 10 points on every Rs. 500
= [(1,000,000/500) x 10]= 20,000 points.
Value of points = 20,000 points x Rs. 0.5 each point = Rs. 10,000
Revenue recognized for sale of goods Rs. 990,099 [1,000,000 x
(1,000,000/1,010,000)]
Revenue for points deferred Rs. 9,901 [1,000,000 x
(10,000/1,010,000)]
Journal Entry
Rs. Rs.

Bank A/c Dr. 1,000,000

To Sales A/c 990,099

To Liability under Customer Loyalty programme 9,901

ii) Points earned on Rs. 500,000,000 @ 10 points on every Rs. 500

= [(500,000,000/500 ) x 10] = 10,000,000 points.
Value of points = 10,000,000 points x Rs. 0.5 each point = Rs. 5,000,000
Revenue recognized for sale of goods
= Rs. 495,049,505 [500,000,000 x (500,000,000 / 505,000,000)]
Revenue for points = Rs. 4,950,495
[500,000,000 x (5,000,000 / 505,000,000)]
Journal Entries in the year 2076-77
Rs. Rs.

Bank A/c Dr. 500,000,000

To Sales A/c 495,049,505

To Liability under Customer 4,950,495
Loyalty programme
(On sale of Goods)
 Liability under Customer Loyalty 4,211,002
programme Dr.
To Sales A/c 4,211,002
(On redemption of (100 lakhs -18
lakhs) points)
Revenue for points to be recognized
Undiscounted points estimated to be recognized next year
= 1,800,000 x 80%= 1,440,000 points
Total expected points to be redeemed in 2076/2077 and 2077/78
= [(10,000,000 – 1,800,000) + 1,440,000] = 9,640,000
Revenue to be recognized with respect to discounted point in 2076/77
= Rs. 4,950,495 x (8,200,000/9,640,000) = Rs. 4,211,002
iii) Revenue to be deferred with respect to undiscounted point in 2076/77
= 4,950,495 – 4,211,002 = Rs. 739,493.
iv) In 2077/2078, KK Ltd. would recognize revenue for discounting of 60% of
outstanding points as follows:
Outstanding points = 1,800,000 x 60% = 1,080,000 points
Total points discounted till date = 8,200,000 + 1,080,000 = 9,280,000 points
Revenue to be recognized in the year 2077/78
= [{4,950,495 x (9,280,000 / 9,640,000)} – 4,211,002]
= Rs. 554,620.
Journal Entry in the year 2077/78

Rs. Rs.

Liability under Customer Loyalty programme Dr. 554,620

To Sales A/c Rs. 554,620

(On redemption of further 1,080,000 points)

The Liability under Customer Loyalty programme at the end of the year 2077/78
will be Rs. 739,493 – 554,620 = Rs. 184,873.
v) In the year 2078/79, the company will recognize the balance revenue of Rs. 184,873
irrespective of the points redeemed as this is the last year for redeeming the points.
Journal entry will be as follows:
Journal Entry in the year 2078/79
Liability under Customer Loyalty programme Dr. Rs. 184,873

To Sales A/c Rs. 184,873

(On redemption of remaining points)

b)
i) Because the investment property is measured at fair value, there is a rebuttable
 presumption that the company will recover the carrying amount of investment
property entirely through a sale. If that presumption is not rebutted, the deferred tax
reflects the tax consequences of recovering the carrying amount entirely through sale.
This presumption is rebutted if the investment property is depreciable and is held
within a business model whose objective is to consume substantially all the economic
benefits over time, rather than through sale.
Since R Co. does not expect to use the property for more than 5 years, it will not
consume substantially all the economic benefits derived from the asset and therefore
the presumption is not rebutted.
Therefore, if the property is sold, the carrying value as at the year-end (31 Ashadh
2077) is Rs. 32 million and the tax base is (Rs. 26m/15*13) Rs. 22.5 m. This results
in a taxable temporary difference of Rs. 9.5 m (i.e. Rs. 32 million – Rs. 22.50 million)
R needs to recognize deferred tax using the enacted rate applicable for a future period
of 20%.
The deferred tax impact would be as follows:
Rs. 6 m (Rs. 32 m – Rs. 26m) * 10% = Rs. 0.6m
Rs.3.5m (Rs. 26m – Rs. 22.5m) *20%= Rs. 0.7m
ii) A temporary difference may arise on initial recognition of an asset or liability, for
example, a part or all of the cost of an asset will not be deductible for tax purposes.
Since there is no tax impact at the initial recognition of these motor vehicles, deferred
tax is not recognized.
iii) The entire carrying amount will be deductible for tax purposes in the future periods.
The warranty provision has a tax base of nil (carrying amount less the amount
deductible for tax purposes in the future). The deference between the carrying amount
and its tax base is Rs. 6 millions. This is a deductible temporary difference. This will
result in a deferred tax asset of Rs. 1.2 millions.
Impact from change in the tax rate from 25% to 20% should be recorded in profit or
loss. In this case there are no amounts affecting OCI.
The change in the tax rate is an estimate change which requires prospective
adjustments in the financial statement.
3.
a) XYZ Ltd. has three cash generating units – X, Y and Z, the carrying amounts of which
as on 31 Ashadh, 2077 are as follows:
Cash Generating Units Carrying Amount Remaining useful life
(CGU) (Rs. in millions) (In years)
X 800 20
Y 1,000 10
Z 1,200 20
XYZ Ltd. also has corporate assets having a remaining useful life of 20 years as below:
Corporate Assets Carrying amount Remarks
(Rs. in millions)
AU 800 This amount can be allocated on a
reasonable basis to the individual cash
generating units.
BU 400 This amount cannot be allocated on a
reasonable basis to the individual cash
 generating units.
Recoverable amounts as on 31 Ashadh, 2077 are as follows:
Cash Generating Units Recoverable amount (Rs. in millions)
X 1,000
Y 1,200
Z 1,400
XYZ Ltd. 3,900
Required: (3+7=10 marks)
i) Allocate corporate assets to CGU and determine carrying amount.
ii) Calculate the impairment loss, if, any of XYZ Ltd.
b) Y Ltd. acquired a filling station from S Ltd. under a five - year lease agreement
commencing on 1 Shrawan 2076. The filling station was leased by S Ltd. immediately
after its completion. This was because the company decided to abandon its plans to
venture into oil marketing business. The agreement costs Y Ltd. Rs. 150,000 in legal
fees and other arrangement related costs. The lease agreement provides for annual
lease rentals of Rs. 3,000,000 for four years and Rs. 5,000,000 in year five. Further, the
agreement states that the asset will be transferred to Y Ltd. at the end of the lease
period. The lease agreement does not contain an implicit interest rate. However, Y Ltd.
has a weighted average cost of capital of 12%. In addition, review of the risk
associated with investing in Y Ltd. established that the company is now able to borrow
at an annual interest rate of 10% which was 8% previously.

The filling station has an economic useful life of ten years after which, Y Ltd. will be
required to dismantle it and restore the site to its original state. This will cost Y Ltd.
approximately Rs. 750,000. (Any provisions must be discounted at 12%).
Required: 10 marks
Advise Y Ltd. on how it should account for the lease agreement in their financial
statements for the year to 31 Ashadh 2077.
Answer:
a)
i) Allocation of corporate assets to Cash Generating Unit (CGU)
The carrying amount of AU is allocated to the carrying amount of each individual cash
generating unit. A weighted allocation basis is used because the estimated remaining
useful life of Y CGU is 10 years, whereas the estimated remaining useful lives of X and
Z CGUs are 20 years.
(Rs. in
millions)
Particular X Y Z Total
(a) Carrying amount 800 1,000 1,200 3,000
(b) Useful life 20 years 10 years 20 years
(c) Weight based on useful life 2 1 2
(d) Carrying amount (a x c) 1,600 1,000 2,400 5,000
(e) Pro-rata allocation of AU 32% 20% 48% 100%
(1,600/5,000) (1,000/5,000) (2,400/5,000)
(f) Allocation of carrying amount 256 160 384 800
of AU (32:20:48)
 (g) Carrying amount (after 1,056 1,160 1,584 3,800
allocation of AU) (a+f)

ii) Calculation of impairment loss

(a) Impairment loss of each CGU
(Rs. in millions)
Particulars X Y Z
Carrying amount (after 1,056 1,160 1,584
allocation of AU)
Recoverable amount 1,000 1,200 1,400
Impairment loss 56 Nil 184
(b) Allocation of the impairment loss
(Rs. in millions)
Allocation to X Z
AU 14 (56x256/1,056) 45 (184x384/1,584)
Other assets in CGU 42 (56x800/1,056) 139 (184x1,200/1,584)
Impairment Loss 56 184
(c) Impairment loss for the larger CGU, i.e. XYZ Ltd. as a whole
(Rs. in millions)
Particulars X Y Z AU BU XYZ Ltd.
Carrying amount 800 1,000 1,200 800 400 4,200
Impairment Loss (42) - (139) (14+45=59) - (240)
Carrying amount 758 1,000 1,061 741 400 3,960
Recoverable amount - - - - - 3,900
Impairment loss 60
b)
i) Under NAS 17, upon commencement of the lease, Y Ltd. should recognise a right-
of-use asset and a lease liability. The right-of-use asset is initially measured at the
amount of the lease liability plus any initial direct costs incurred and site restoration
obligations. This amounts to Rs. 13,003,500 (W.N. 3).
The lease liability is initially measured at the present value of the lease payments
payable over the lease term, discounted at the rate implicit in the lease if that can be
readily determined. The incremental borrowing rate of Y Ltd. of 10% will be used
as a discount rate in calculating lease liability as no implicit rate is provided in the
lease agreement.
The NAS requires recognised asset to be subject to depreciation and impairment
review and carried in the statement of financial position after taking into account
accumulated depreciation and accumulated impairment loss. The standard further
requires cost of asset to be spread over the useful life of asset as opposed to lease
period if the lessee will obtain ownership of asset at the end of lease period. This is
applicable to Y Ltd. as ownership of the filling station will be transferred to the
company after the expiry of a – five (5) year lease period. The filling station should
therefore be depreciated over the economic useful life of ten (10) years. This will
result in depreciation charge of Rs. 1,300,350 (W.N.3) which will be charged to the
statement of profit loss for the year ending 31 Ashadh 2077. The filling station will
be recognised under non-current assets in statement of financial position as at 31
Ashadh 2077 at a value of Rs. 11,703,150 (W.N.3).
ii) The lease liability will be re-measured at 31 Ashadh 2077 by taking into account
lease interest and lease payment for the year. This gives a total liability of Rs.
 10,873,200 (W.N.4) which has to be split between current and non-current
liabilities. Rs. 8,960,520 (W.N.4) should be shown under non-current liabilities
while Rs. 1,912,680 (W.N.4) under current liabilities in the statement of financial
position as at 31 Ashadh 2077. Lease interest of Rs. 1,261,200 (W.N.4) has to be
expensed to the statement of profit or loss for the year ending 31 Ashadh 2077.
iii) The cost of dismantling and site restoration of Rs. 750,000 should be recognised as
a liability in the financial statements of Y Ltd. This is because it has met the
recognition criteria of NAS 37 Provisions, contingent liabilities and contingent
assets’. The ownership of the filling station will be transferred to Y Ltd. and there is
a legal requirement to dismantle it and restore the site to its original state. Being a
future cost, the amount should be discounted using cost of capital of 12% to reflect
the time value of money. This gives Rs. 241,500 (W.N.2). This should be adjusted
for an amount representing unwinding of discount to arrive at an amount of Rs.
270,480 (W.N.5) to be shown under non-current liabilities in the statement of
financial position of Y Ltd. as at 31 Ashadh 2077. The unwound interest amount of
Rs. 28,980 (W.N.5) should be expensed to the statement of profit or loss for the
year ended 31 Ashadh 2077.
Working Notes:
1 Calculation PV of lease liability
Yr. CF (Rs.) DF @ 10% PV (Rs.)
1 to 4 3,000,000 3.169 9,507,000
5 5,000,000 0.621 3,105,000
12,612,000
2 Calculation of PV of Restoration cost
Yr. CF DF @ 12% PV
1 750,000 0.322 241,500
3 Carrying value of Filling station
Rs.
PV (W.N.1) 12,612,000
PV of restoration cost (W.N.2) 241,500
Legal cost 150,000
Total Cost (for initial
recognition) 13,003,500
Depreciation over 10yrs (yearly) 1,300,350
Value at 31 Ashadh 2077 11,703,150
Lease Liability as at 31 Ashadh
4 2077
Rs.
PV (W.N.1) (1 Shrawan 2076) 12,612,000
Interest @ 10% 1,261,200
Lease payment -3,000,000
31 Ashadh 2077 10,873,200
Interest @ 10% 1,087,320
Lease payment -3,000,000
Non - current 8,960,520
Current (3,000,000 - 1,087,320) 1,912,680
5 Restoration cost provision
 Rs.
PV
(W.N.2) 241,500
Unwinding of discount @ 12% 28,980
270,480
4. Write short notes on the following: (5×3=15 marks)
a) Treatment of the cost of internally generated software.
b) Matters to be included in annual reports in cases of material environmental impacts by
actions/operations of a company.
c) Embedded derivatives
d) Economic entity principle of accounting
e) During the year ended 31 Ashadh, 2077, Dorjee provided consultancy service to a
customer regarding the installation of a new production system. The system has caused
the customer considerable problems, so the customer has taken legal action against
Dorjee for the loss of profits that has arisen as a result of the problems with the system.
There is a 25% chance that the claim can be successfully defended, but a 75% chance
that Dorjee will be required to pay damage of Rs. 1.6 millions. Dorjee is covered by
insurance against this type of loss and a claim will be made as soon as the outcome of the
case is confirmed. No accounting has taken place because the claim is expected to
exactly offset against the damages payable. Advise Dorjee about accounting treatment.

Answer:
a) Internally generated software should be treated according to provisions of NAS 38,
Intangible Assets. As per NAS 38, Intangible Assets an Intangible asset shall be
recognized if, and only if,
 It is probable that the expected future economic benefit that are attributable to the
asset will flow to the entity; and
 The cost of the asset can be measured reliably
To assess whether as internally generated intangible asset meets the recognition criteria,
an entity classifies the generation of asset into a research phase and a development phase.
Intangible asset arising from research shall not be recognized and the expenditure on
research phase shall be recognized as an expenses when it is incurred.
An intangible asset arising from development shall be recognized if, and only if, an entity
can demonstrate all of the following:
 The technical feasibility of completing the intangible asset so that it will be available
for use or sale;
 Its intention to complete the intangible asset and use or sell it;
 Its ability to use of sale the intangible asset;
 How the intangible asset will generate probable future economic benefits. Among
other things, the entity can demonstrate the existence of a market for the output of the
intangible asset or, if it is to be sued internally, the usefulness of such asset;
 The availability of adequate technical, financial and other resources to complete the
development and to use or sale the software;
  Its ability to measure reliably the expenditure attributable to the software during its
development.
If the entity cannot distinguish the research phase from the development phase of an
internal project to create an intangible asset, or is not able to demonstrate the occurrence
of development phase, the entity charges the expenditure incurred on software to the
statement of income.
b) In cases where there are material environmental impacts, they will normally expect to see
a statement of corporate commitment, policies and strategy, showing the importance
attached to such issues. There could well be a competitive advantage to be gained from
being seen as a leader in responsible environmental practices. The statement would
usually deal with the overall control over such issues, whether through a committee of the
board or a senior manager with practical experience of environmental issues in a
corporate context.
Most users, particularly investors and lenders, will also be concerned to know whether
there are any material financial impacts, actual or potential, arising from environmental
issues. Where this is the case, discussion of environmental risks and uncertainties in the
annual report, together with the related action taken, may therefore be appropriate as well
as information about environmental performance. Depending on the nature of the entity,
there could be a call for information about matters such as site remediation, disposal of
waste, resource recycling or supply chain performance. In identifying the environmental
matters likely to be of particular concern to report users, some form of stakeholder
engagement is beneficial.
In reviewing a company’s annual report, the environmental matters attracting attention
will tend to vary according to its nature, size and geographical location but, where
environmental matters are significant, will generally fall within the following main areas:
 Commitments, policies and strategies.
 Environmental management
 Principal environmental impacts.
 Environmental performance – absolute and relative.
 Fines, penalties or awards.
In appropriate cases, it is often helpful to users if reference is made to compliance with
environment laws, or The Natural Step, or certification to a particular standard or Project
Acorn. This would normally help to demonstrate the adoption of desirable environmental
policies.
c) An embedded derivative is a component of a hybrid (combined) instrument that also
includes a non-derivative host contract with the effect that some of the cash flows of the
combined instrument vary in a way similar to a standalone derivative. An embedded
derivative causes some or all of the cash flows that otherwise would be required by the
contract to be modified according to a specified interest rate, financial instrument price,
commodity price, foreign exchange rate, index of prices or rates, credit rating or credit
index, or other variable, provided in the case of a nonfinancial variable that the variable is
not specific to a party to the contract. A derivative that is attached to a financial
instrument but is contractually transferable independently of that instrument, or has a
different counterparty form that instrument, is not an embedded derivative, but a separate
financial instrument.
 An embedded derivative should be separated from the host contract and accounted for as
derivative if, and only if;
(i) The economic characteristics and risks of the embedded derivative are not closely
related to the economic characteristics and risks of the host contract.
(ii) A separate instrument with the same terms as the embedded derivative would meet
the definition of a derivative; and
(iii) The hybrid instrument is not measured at fair value with changes in fair value
recognized in the statement of profit and loss (i.e. a derivative that is embedded in a
financial asset or financial liability at fair value though profit or loss is not
separated).
d) The economic entity principle states that the recorded activities of a business entity
should be kept separate from the recorded activities of its owner(s) and any other
business entities. This means that you must maintain separate accounting records and
bank accounts for each entity, and not intermix with them the assets and liabilities of its
owners or business partners. Also, you must associate every business transaction with an
entity.
A business entity can take a variety of forms, such as a sole proprietorship, partnership,
corporation, or government agency. The business entity that experiences the most trouble
with the economic entity principle is the sole proprietorship, since the owner routinely
mixes business transactions with his own personal transactions.
It is customary to consider a commonly-owned group of business entities to be a single
entity for the purposes of creating consolidated financial statements for the group, so the
principle could be considered to apply to the entire group as though it were a single unit.
The economic entity principle is a particular concern when businesses are just being
started, for that is when the owners are most likely to commingle their funds with those
of the business. A typical outcome is that a trained accountant must be brought in after a
business begins to grow, in order to sort through earlier transactions and remove those
that should be more appropriately linked to the owners.
e) It is necessary to consider the two parts of this issue separately
The claim made by the customer needs to be recognised as a liability in the financial
statements for the year ended 31 Ashad, 2077.
NAS 37, Provisions, Contingent liabilities and Contingent Assets states that a provision
should be made when, at the reporting date:
i) An entity has a present obligation arising out of past event
ii) There is a probable outflow of economic benefits.
iii) A reasonable estimate can be made of the outflow.
All three of those conditions are satisfied here, and so a provision is appropriate.
The provision should be measured as the amount the entity would rationally pay to settle
the obligation of the reporting date.
Where there is a range of possible outcomes, the individual most likely outcome is often
the most appropriate measure to use.
In this case a provision of Rs. 1.6 millions seems appropriate, with corresponding charge
to profit or loss
The insurance claim against Dorjee’s supplier is a contingent asset.
 NAS 37 states that contingent assets should not be recognised until their realization is
virtually certain, but should be disclosed where their realization is probable. This appears
to be the situation here.
Therefore the contingent asset would be disclosed in the financial statement. Any credit
to profit or loss arises when the claim is settled.
5.
a) Define Public Financial Management (PFM) system. Explain the problems of the PFM
and budgetary policies of Nineties in Nepal and state some initiatives taken by the
Government of Nepal to improve overall financial system of the government. 7 marks
b) Himgiri Ltd. grants 250 stock options to each of its 800 employees on 1 Shrawan, 2075,
conditional upon the employee remaining in the company for 2 years. The fair value of
the option is Rs. 22 on the grant date and the exercise price is Rs. 70 per share. The
number of employees expected to satisfy service condition are 720 in the first year and
670 in the second year. 30 employees left the company in the first year of service and 700
employees have actually completed second year vesting period. The profit of the company
before amortization of the compensation cost on account of employees stock option
(ESOP) is Rs. 5,865,000 for FY 2075/76 and Rs. 7,645,000 for FY 2076/77. The fair
value of shares for these years were Rs. 90 and Rs. 100 respectively. The company has
500,000 shares of Rs. 10 each outstanding at the end of both years.
Required: 8 marks
Calculate basic and diluted EPS for both the years. Ignore taxation impacts.
Answer:
a) Public Financial Management (PFM) in general incorporates the management of
government revenue, budget, expenditure, deposit, debt, reimbursement, procurement and
other important aspects of financial management such as accounting, recording and
reporting. It also includes internal control, final auditing and external scrutiny of the
financial transactions. Hence, strengthening Treasury System, Financial Monitoring and
Capacity Building are most critical elements of a sound public financial management
practices. The overarching goal of a PFM system is to improve efficiency of fiscal
operations and enhance government accountability and transparency as well as to
improve expenditure control and monitoring. The PFM system contributes to reduce
fiduciary risk of the government expenditure. A sound and predictable PFM system not
only attracts foreign resources from development partners but also ensures effective
utilization of such resources and establishes transparency and accountability of public
funds. Similarly, an effective PFM system also contributes to channelize all resources and
funds through the national system.
The PFM and budgetary policies of the Nepal Government during the Nineties were
directed towards economic liberalization, privatization, poverty reduction and
decentralization. Policies and programs of the budget were mainly concerned with
agriculture modernization, employment promotion, women’s empowerment, financial
sector reform, government expenditure management, tax reform, good governance, social
service and the development of basic and physical infrastructure. PFM system of Nepal,
like most developing countries, continued to be dominated by the traditional objectives of
control and accountability rather than a concern for allocating limited public sector
resources to well defined programs and projects that were intended to serve a set of
national objectives.
The extension of the budget coverage involved a combination of formal and informal
incorporation of expenditure activities. The other formal extension involved the
 incorporation of foreign assistance programs, which were previously outside the budget.
Planning the allocation of scarce resources was not given due priority. The pattern of
government expenditure followed more or less the uniform course till the 1990’s. Public
expenditure and revenue both increased; but the expenditure increase trend was greater
than the revenue. The inadequate mobilization of domestic resources through government
revenue resulted in a serious problem of widening resource gap in Nepal. Foreign aid was
the main source of development financing and deficit financing continued to increase.
Planning, budgeting, and implementation had inherent problems such as lack of capacity,
co-ordination and monitoring. In spite of a number of initiatives taken, one of the main
problems of Nepal has been the lack of proper domestic resource mobilization.
Several factors have contributed in varying degrees to the lack of effectiveness of public
spending in Nepal. The institutional factors played major role in the over-programming
(having too many programs in scarce resources) of the budget, its lack of focus and
prioritization and implementation problems. The lacks of ownership of projects/
programs at various levels and the absence of accountability, also undermined the quality
and effectiveness of public spending. Managing the national budget became increasingly
difficult for Nepal Government to further their objectives of poverty alleviation.
Public Expenditure Management is one of the key activities of any government in the
world. There is a growing concern to make PFM system predictable, transparent and
accountable anywhere in the world. PFM in general incorporates a credible planning
system, management of government revenues, budget execution, expenditure
management, debt management, reimbursement, procurement and other important
aspects of financial management such as accounting, recording, financial reporting and
auditing and external scrutiny of the financial transactions. Improving governance and
enhancing accountability are considered as the critical agenda of the Government of
Nepal (GoN) in the endeavor of institutionalizing good governance practices in the
country. Hence, strengthening Public Financial Management has been accepted as one of
the key elements of the GoN’s strategy for improving the overall governance, optimizing
outputs from public resources and ensuring inclusive and broad-based development. Poor
planning, ever increasing indiscipline in budget execution, ineffective expenditure control
and lack of transparency mainly in public procurement pose significant fiduciary risks to
almost all development projects both at center and local level. The GoN’s recent
initiatives such as Financial Administration Reform Program, Strengthening PFM
Project, Government Financial Statistics (GFS) based new codes and classification of
revenues and expenditures, implementation of Treasury Single Account (TSA) system,
strategy to implement International Accounting and Reporting Standards (NAPSAS),
Public Expenditure and Financial Accountability (PEFA) initiative and other capacity
building programs for PFM have resulted some positive impacts in strengthening PFM
system in general and financial good governance in particular in Nepal.
b) Calculation of Basic and Diluted EPS
Particulars 2075/76 (Rs.) 2076/77 (Rs.)
Profit before amortization of ESOP cost 5,865,000 7,645,000
Less: ESOP cost amortized (w.n.2) (1,980,000) (1,870,000)
Net profit for shareholders 3,885,000 5,775,000
No. of share outstanding (A) 500,000 500,000
Basic EPS 7.77 11.55
Potential equity (WN 1) (B) 19,250 52,500
Total Number of equity shares (A + B) 519,250 552,500
Diluted EPS 7.48 10.45
Working note – 1 – Calculation of potential Equity
 2075/76 2076/77
a Actual Number of employees 770 700
b Options granted per employee 250 250
c No. of options outstanding (a x b) 192,500 175,000
d Unamortized ESOP cost per option (Rs.) (22-22/2) =11 0
e Exercise price (Rs.) 70 70
f Expected exercise price to be received (c x e) (Rs.) 13,475,000 12,250,000
g Unamortized ESOP cost (cXd) (Rs.). 2,117,500 -
h Total Proceeds (f+g) 15,592,500 12,250,000
i Fair value per share 90 100
j No. of shares issued for consideration (h/i) 173,250 122,500
k Potential Equity (c-j) 19,250 52,500
Working note – 2 – Calculation of ESOP cost to be amortized
2075/76 2076/77
Fair value of options per share Rs. 22 22
No. of options expected to/ actually to vest (720x250) (700x250)
under the scheme 180,000 175,000
Fair value of options 3,960,000 3,850,000
Value of options recognized as expenses (3,960,000/2) (3,850,000 -
1,980,000 1,980,000)
1,870,000
6.
a) Saptari Ltd. holds 35% of total equity shares of Mustang Ltd., an associate company.
The value of investments in Mustang Ltd. on 31 Asadh, 2076 is Rs. 30 millions in the
consolidated financial statements of Saptari Ltd.
Saptari Ltd. sold goods worth Rs. 350,000 to Mustang Ltd. The cost of goods sold is Rs.
300,000. Out of these, goods costing Rs. 100,000 to Mustang Ltd. were in its closing
stock.
During the year ended 31 Asadh, 2077 the profit and loss statement of Mustang Ltd.
showed a loss of Rs. 10 millions.
Required: 5 marks
i) What is the value of investment in Mustang Ltd. as on 31 Asadh, 2077 in the
consolidated financial statements of Saptari Ltd., if equity method is adopted for
valuing the investments in associates?
ii) Will your answer be different if Mustang Ltd. had earned a profit of Rs. 15 millions
and declared a dividend of Rs. 7.5 millions to the equity shareholders of the
company?
b) On Shrawan 2076 the fair value of the assets of a defined benefit plan were valued at Rs.
1,100,000 and the present value of the defined benefit obligation was Rs. 1,250,000. On
31 Ashadh, 2077, the plan received contributions of Rs. 490,000 from the employer and
paid out benefits of Rs. 190,000.
The current service cost for the year was Rs. 360, 000 and a discount rate of 6% is to be
applied to the net liability/(asset).
After these transactions, the fair value of the plan asset as at 31 Ashadh, 2077 was Rs.
1,500,000. The present value of the defined benefit obligation was Rs. 1,553,600.
Required: 5 marks
 Calculate the gain or loss on re-measurement through OCI and the return on plan asset,
and illustrate how this plan will be treated in the statement of profit or loss and other
comprehensive income and statement of financial position for the year ended 31 Ashadh,
2077.
Answer:
a)
i) Value of investment in Mustang Limited as on 31 Asadh, 2077 as per equity method
in the consolidated financial statements of Saptari Ltd.
Rs. in millions
Cost of Investment 30.00
Less: Share in Post-acquisition Loss (10 m x 35%) (3.50)
Less: Unrealized gain on inventory left unsold with Mustang Limited
[{(50,000/3,00,000) x 1,00,000} x 35%] (0.006)
Carrying value as per equity method 26.494
\

ii) Value of investment in Mustang Limited as on 31 Asadh, 2077 as per equity

method in the consolidated financial statements of Saptari Ltd. (Profit Rs. 15 m and
dividend Rs. 7.5 m)
Cost of Investment 30.00
Add: Share in Post-Acquisition Profit (15 m x 35%) 5.25
Less: Unrealized gain on inventory left unsold with Mustang Limited
[{(50,000/3,00,000) x 1,00,000} x 35%] (0.006)
Less: Dividend (7.5 m x 35%) (2.625)
Carrying value as per equity method 32.619
b)
Particulars Asset Obligation
Fair value/present value at 1 Shrawan, 2076 1,100,000 1,250,000
Interest (1,100,000×6%)/ (1,250,000×6%) 66,000 75,000
Current service cost 360,000
Contributions received 490,000
Benefits paid (190,000) (190,000)
Return on plan assets excluding amounts in net 34,000 -
interest (balancing figure) (OCI) (re-measurement)
Loss of re-measurement (balancing figure) (OCI) - 58,600
Fair value/present value at 31 Ashadh, 2077 1,500,000 1,553,600
The following accounting treatment is required.
a. In the statement of profit or loss and other comprehensive income, the following
amounts will be recognized
In Profit or Loss
Current service cost 360,000
Net Interest on net defined benefit liability (75,000-66,000) 9,000
In other comprehensive income (34,000-58,600) 24,600

b. In the statement of financial position, the net defined benefit liability of Rs. 53,600
(1,553,600-1,500,000) will be recognized.
 Paper-2: Advanced Financial Management

Attempt all questions.

Working notes should form part of the answers. Make assumptions wherever necessary.
Use separate answer book for each question.

1. Hetauda Industries Ltd. (HI Ltd.) is an indigenous company that manufactures

components used in air conditioners. The company now wants to manufacture air
conditioners for sale in Nepal. Though the manufacture of air conditioners will be a
completely new business, directors of HI Ltd. plan to integrate it into the company’s core
business.
HI Ltd. has premises it considers suitable for the project. This premises was acquired two
years ago at the cost of Rs. 50,000. HI Ltd. will acquire and install the needed machinery
immediately, so production and sales can commence during the first year. The directors of
HI Ltd. intends to develop the project for five years and then sell it to a suitable investor for
an after-tax consideration of Rs. 20 million.
The following data are available for the project:
1. The cost of acquiring and installing plant and machinery needed for the project will be
Rs. 5 million at the start of the first year. Tax-allowable depreciation is available on the
plant and machinery at the rate of 30% on reducing balance basis.
2. Working capital requirement for each year is equal to 10% of the year’s anticipated
sales. HI Ltd. has to make working capital available at the beginning of the respective
year. It is expected that 40% of working capital will be redeployed to other projects at
the end of the fifth year when the project is sold.
3. It is expected that 2,000 units will be manufactured and sold in the first year. Unit sales
will grow by 5% each year thereafter.
4. Unit sales price is estimated at Rs. 2,200 in the first year. Thereafter, the unit sales price
is expected to be increased by 10% each year.
5. Unit variable cost will be Rs. 1,100 per unit in the first year. Unit variable cost is
expected to increase by 8% each year after the first year.
6. Fixed overhead costs are estimated at Rs. 1·5 million in total in each year of
production/sale. One-half of the total fixed overhead costs are head office allocated
overheads. After the first year of production/sales, fixed overhead costs are expected to
increase by 5% per year.
HI Ltd.’s pays tax at 25% on taxable profits. Tax is payable in the same year the profit is
earned. HI Ltd uses 25% as its discount rate for new projects but the directors feels that this
rate may not be appropriate for this new venture.
Currently, HI Ltd. can borrow at 500 basis points above the five-year Treasury note yield
rate. Nepal government is enthused by the venture and has offered HI Ltd. a subsidised loan
of up to 60% of the investment funds required at an interest rate of 200 basis points above
the five-year Treasury note yield rate. HI Ltd. plans to use debt capital to finance the project
by taking advantage of the government’s subsidised loan and raising the balance through a
fresh issue of 5-year debentures. Issues costs, which can be assumed to be tax-deductible
expenses, will be 5% of the gross proceeds from the debenture offer. The financing strategy
for the project is not expected to affect the company’s borrowing capacity in any way.
 HI Ltd. will be the first indigenous Nepalese company to manufacture air conditioners in
Nepal. However, it will be competing with Jack Ltd, a listed company with majority shares
held by foreign investors. The cost of equity of Jack Ltd. is estimated to be 20% and it pays
tax at 22%.
Jack Ltd has 10 million shares in issue that are trading at Rs. 5.5 each, and bonds with total
market value of Rs40 million.
The five-year Treasury note yield rate is currently 10% and the return on the market
portfolio is 18%.
Required:
Evaluate, on financial grounds, whether HI Ltd. should implement the project or not. 20 marks
Answer:
Financial appraisal of HI Ltd.’s proposed air conditioner manufacturing project. The project
presents different business risk (as it involves a new business venture) and increases financial
risk (as its financing method will increase the company’s gearing). In addition, there are
associated financing side effects that need to be factored into the financial appraisal.
Adjusted present value (APV) will be a more efficient appraisal method than the traditional
NPV approach.
Step 1: Compute the base case NPV
End of year
Growth 0 1 2 3 4 5
Annual Output 5% 2,000 2,100 2,205 2,315 2,431
Unit Sale Price(Rs) 10% 2,200 2,420 2,662 2,928 3,221
Unit Variable cost(Rs) 8% 1,100 1,188 1,283 1,386 1,497
in Thousand
Sales revenue 4,400 5,082 5,870 6,780 7,830
Variable costs 2,200 2,495 2,829 3,208 3,638
Relevant fixed costs 5% 750 788 827 868 912
Tax-allowable depreciation 1,500 1,050 735 515 360
Taxable net operating income -50 750 1,479 2,189 2,920
Taxation 25% 12.5 187 370 547 730
Net operating income after tax -37.5 562 1,109 1,641 2,190
Add back depreciation 1,500 1,050 735 514.5 360.15
Net operating cash flows 1,463 1,612 1,844 2,156 2,550
Capital investment /sale -5,000 20000
Working capital -440 68 79 91 105 313
Net cash flows -5,440 1,394 1,534 1,753 2,051 22,864
Discount factor @ 16.4% 1 0.859 0.738 0.634 0.545 0.468
PV of NCF -5,440 1,198 1,132 1,112 1,117 10,700
Base case NPV 9,818
Workings:
1 Tax allowable depreciation: ('000)
End of Year Tax-allowable depreciation (30%) Allowable depreciation
0 0 5,000
1 1,500 3,500
2 1,050 2,450
3 735 1,715
4 515 1,201
5 360 840

2. Cost of equity as if company is ungeared:

As the new project is a completely new business, an appropriate cost of equity is one that
reflects the level of business risk associated with the new business. This can be derived
from that of the competitor, Jack Ltd as under:
Using MM Proposition II with tax:
(𝑔) = (𝑢) + (𝑘(𝑢) - 𝑘𝑑) (𝑉𝑑(𝑉𝑒 1 - 𝑡))
Jack Ltd’s cost of equity, ke(g) = 20%
Market value of Jack’s equity = 10m x Rs 5.5 = Rs 55m
Market value of Jack’s debt = Rs 40m
Jack’s tax rate, t = 22%
Cost of debt, kd = 10% (taken to be the treasury note rate)
0.2 = (𝑢) + ((𝑢) - 0.1) (40 / (55 (1 -0.22))
0.2 = (𝑢) + 0.5673(𝑢) - 0.0567
0.2 = 1.5673(𝑢) - 0.05673
ke(u)=(.20+.0567)/1.567
ke(u)=0.1638 or 16.40%
Alternatively, obtain asset beta of Jack Ltd and put that into the capital asset pricing
model to obtain ungeared cost of equity as under:
Equity beta of Jack Ltd is 1.25:
0.2 = 0.1 + (0.18 - 0.1)
Be=Be=0.10.08
Be=Be=1.25
Asset beta of Jack Ltd is 0.7976:
𝛽𝑎 =Ba=(55/(55+40(1-.22))*1.25
Ba=Ba=0.797563805
Asset beta of Jack Ltd is 0.7976:0.797563805
According to CAPM, the ungeared cost of equity is 16.38%
ke(u)=.1+.7976(0.18-.1)0.163808 0.164
Note: The ungeared cost of equity may be assumed 16% so as to read present value
interest factors from the interest factor tables.
Step 2: Calculate PV of financing side effects
Financing side effects that apply in this case are:
* the issue cost and its associated tax shield
 * annual interest payments on debt financing
* benefits from subsidized loan from the government
Necessary adjustments for the financing side effects follow
Rs. 000
Issue costs 5/95*.4*Rs5,440 -114.53
Tax shield from issue cost 114.53*.25*.909 26.03
discounted @ risk free rate
Tax shield from interest payment ((5440*0.6*0.12*0.25)+ 680.56
discounted @ risk free rate (5440*0.4*0.15*0.25))*3.7
91
After-tax benefit from loan subsidy ((5440*0.6*0.03*(1- 278.41
discounted at risk free rate .25)*3.791
Total benefit from financing side effects 870.47

Notes:
* The issue costs may be included in funds borrowed instead.
* The calculation above assumed that the entire issue costs will be expensed in the first
year. One may choose to amortize it over the 5 year forecast period and discount the
annual tax shields accordingly.
* PV of tax shield and subsidy benefit are based on the 5 year government debt yield
rate. It may be discounted at the company's cost of debt, 15% (5 year yield rate plus
500 basis points) on the ground that the benefits will accrue to the company only
when it is able to discharge its financial obligation and 15% reflects the credit risk of
the company.
Step 3: Compute APV by adjusting base case NPV for financing side effects
Rs. 000
Base Case NPV 9818.39
PV of benefits from financing side effects 870.47
Adjusted Present value 10688.86
Conclusion: As the APV is positive, the value of HI Ltd will increase if the proposed project
is implemented.
2.
a) Consider the following information about three stocks:
State of Probability of state Rate of return if state occurs
economy of economy (%) Stock A (%) Stock B (%) Stock C (%)
Boom 35 20 35 60
Normal 40 15 12 5
Bust 25 1 -25 -50
Required: (4+1+5=10 marks)
i) If the portfolio is invested 40% each in A and B and 20% in C, what is the portfolio
expected return and the standard deviation?
ii) If the expected T-bill rate is 3.80%, what is the expected risk premium on the
portfolio?
 iii) If the expected inflation rate is 3.50%, what are the approximate and exact expected
real returns on the portfolio? What are the approximate and exact expected real risk
premiums on the portfolio? Use the Fisher equation, if needed.
b) ABC Limited is a company operating in the software industry. It is considering the
acquisition of XYZ Limited which is also into software industry. The following
information are available for the companies:
Particulars ABC Limited XYZ Limited
Earnings after taxes (Rs.) 900,000 240,000
Number of equity shares outstanding 150,000 60,000
P/E ratio (times) 14 10
ABC Limited is planning to offer a premium of 25 percent over the market price of XYZ
Limited.
Required: (2+1+3+1+3=10 marks)
i) What is the swap ratio based on current market price?
ii) Find the number of shares to be issued by ABC Limited to the shareholders of XYZ
Limited.
iii) Compute the new EPS of ABC Limited after merger and comment on the impact of
merger.
iv) Determine the market price of the shares when P/E ratio remains unchanged.
v) Compute the market price when P/E ratio declines to 12 and comment on the results.
Figures are to be rounded off to 2 decimal points.
Answer:
a)
i) First, find the return of the portfolio in each state of the economy. To do this, multiply the
return of each asset by its portfolio weight and then sum the products to get the portfolio
return in each state of the economy.
Portfolio return in Boom (rpboom) = WA × rA + WB × rB + WC × rC
= 0.40 × 0.20 + 0.40 × 0.35 + 0.20 × 0.60
= 0.08 + 0.14 + 0.12 = 0.34 = 34%
Portfolio return in Normal (rpnorm) = 0.40 × 0.15 + 0.40 × 0.12 + 0.20 × 0.05
= 0.06 + 0.048 + 0.01 = 0.118 = 11.8%
Portfolio return in Bust (rpbust) = 0.40 × 0.01 + 0.40 × -0.25 + 0.20 × -0.50
= 0.004 - 0.10 - 0.10 = -0.196 = -19.6%
Now, expected return of the portfolio, E (rp)
= Pboom × rpboom + Pnorm × rpnorm + Pbust × rpbust
= 0.35 × 0.34 + 0.40 × 0.118 + 0.25 × -0.196
= 0.119 + 0.0472 – 0.049 = 0.1172 =11.72%

To calculate the standard deviation, first calculate the variance by multiplying each
probability with each squared deviations of each return from the expected return. Then, add
all of these up. The result is the variance. The square root of the variance is standard
deviation of the portfolio. Now,

σp = √ 0.35 (0.34 – 0.1172)2 + 0.40 (0.118 – 0.1172)2 + 0.25 (– 0.196 – 0.1172)2

= √ 0.35 × 0.04963984 + 0.40 × 0.00000064 + 0.25 × 0.09809424

= √ 0.017373944 + 0.000000256+ 0.02452356

= √ 0.04189776

= 0.2047 = 20.47%

ii) Expected risk premium on the portfolio (RPi) = E(rp) –

rf RPi = 0.1172 – 0.038
= 0.0792 = 7.92%
iii) The approximate expected real return is the expected nominal return minus the inflation
rate, so:
Approximate expected real return = 0.1172 – 0.035
= .0822 = 8.22%
To find the exact real return, e(ri), we will use the Fisher equation. Doing so, we get:
1 + E(Rp) = (1 + h)[1 + e(ri)]
or, 1 + 0.1172 = (1 + 0.035)[1 + e(ri)]
or, e(ri) = (1.1172 / 1.035) – 1
or, e(ri) = 0.0794 = 7.94%
Approximate expected real risk-free rate, E(rf) = 0.038 – 0.035
= 0.003 = 0.30%
And, using the Fisher effect for the exact real risk-free rate, e(rf), we find:
1 + rf = (1 + h)[1 + e(rf)]
or, 1.038 = (1.035)[1 + e(rf)]
or, e(rf) = (1.038 / 1.035) – 1
or, e(rf) = 0.0029 = 0.29%
The approximate real risk premium is the approximate expected real return minus
approximate expected real risk-free rate, so:
Approximate expected real risk premium = 0.0822 – 0.003
= 0.0792 = 7.92%
The exact real risk premium is the exact real return minus the exact real risk-free rate, so:
Exact expected real risk premium = 0.0794 – 0.0029
= 0.0765 = 7.65%
b)
i) Swap ratio based on current market price:
Computation of market price of the shares
Particulars ABC Limited XYZ Limited
Earnings after taxes (Rs.) 900,000 240,000
Number of equity shares 150,000 60,000
EPS (Rs.) 6.00 4.00
P/E ratio (times) 14.00 10.00
MPS (Rs.) 84.00 40.00

Swap ratio = 40 × 1.25 : 84

= 50 : 84
That is 50 shares of ABC Limited for every 84 shares of XYZ Limited.
ii) Number of shares to be issued:
50
Ratio   0.5952
84
i.e. 0.60 shares of ABC Limited for 1 shares of XYZ Limited.
Number of shares to be issued = 60,000 × 0.60 = 36,000 shares

iii) Computation EPS and impact after merger:

(Amount in Rs.)
Total earnings after merger 1,140,000
Post-merger number of shares (150,000 + 36,000) 186,000
EPS 6.13
Impact on EPS

For shareholders of ABC Limited: Rs.

EPS before merger 6.00
EPS after merger 6.13
Increase in EPS 0.13
For shareholders of XYZ Limited:
EPS before merger 4.00
Equivalent EPS after merger (0.6 × 6.13) 3.68
Decrease in EPS 0.32
Thus, with the proposed merger EPS for shareholders of ABC Limited will improve and
EPS for shareholders of XYZ Limited will decrease.
iv) Market price of share after merger, if P/E ratio remains unchanged:

EPS after merger Rs. 6.13

P/E ratio 14.00
 New market price of shares Rs. 85.82
v) Market price of share after merger, if P/E ratio declines to 12:

EPS after merger Rs. 6.13

P/E ratio 12.00
New market price of shares Rs. 73.56

Gain/loss from merger to shareholders of ABC Limited: Rs.

Market price of shares after merger 73.56
Market price of shares before merger 84.00
Loss per share from the merger 10.44
Gain/loss from merger to shareholders of XYZ Limited:
Equivalent market price of shares after merger (0.60 × 73.56) 44.14
Market price of shares before merger 40.00
Gain per share from the merger 4.14
Comment: With the proposed merger there is a decrease in the market price of shares for
the shareholders of ABC Limited and a gain for shareholders of XYZ Limited.
3.
a) SPL Pharmaceuticals had the following financial statements for F/Y 2075/76 and F/Y
2076/77. 10 marks
Assets 2075/76 (Rs.) 2076/77 (Rs.)
Cash and Cash Equivalents 53,000 31,000
Marketable Securities 87,000 0
Accounts receivable 346,000 528,000
Inventories 432,000 683000
Current Assets 918,000 1,242,000
Net Fixed Assets 1,113,000 1,398,000
TOTAL 2,031,000 2,640,000

Liabilities and Equity 2075/76 (Rs.) 2076/77 (Rs.)

Accounts Payable 413,000 627,000
Accrued expenses 226,000 314,000
Bank Borrowings 100,000 235,000
Current Liabilities 739,000 1,176,000
Share Capital 100,000 100,000
Retained Earnings 1,192,000 1,364,000
TOTAL 2,031,000 2,640,000
i) Prepare sources and uses of funds statements and evaluate your findings considering
Rs. 189,000 as depreciation charged for the year 2076/77.
ii) Using the information provided and uses of funds statement from Part (i) above
prepare the statement of Cash Flows using the indirect method and evaluate your
findings. Explain whether the analysis based on the cash flow statement is much
different from that based on the funds flow statement.
b) CNP Corporation Limited in UK will need to make a payment of $ 250,000 in six months'
time. It is currently 1st July. The company is considering the various choices it has, in order
to hedge its transaction exposure.
In this front following market information is available:
Exchange rates: Country Money market rates (%)
£ spot rate $ 1.5617 – 1.5773 Borrowing Deposit
Six months £ forward rate $ 1.5455 – 1.5609 US 6.00 4.50
UK 7.00 5.50
Foreign currency option prices are:
Exercise price= $ 1.70
Call option (December) = $ 0.037
Put option (December) = $ 0.096
Contract size 1 unit is £ 12,500
Evaluate the following hedging alternatives with necessary calculations and decide
which of the same is the most attractive to CNP Corporation Limited. 10 marks
i) Forward market hedge;
ii) Money market hedge; and
iii) Currency options hedge.

Answer:
a)
i) Sources and uses of funds Statement:

Sources of Fund Rs. Application of Fund Rs.

Bank Borrowing 135,000 Purchase of Fixed Assets 474,000
Funds from Operation 252,000
Sale of Marketable Securities 87,000
Funds from Operation 474,000 474,000

Working Note 1:
Funds from Operation
Particulars Rs.
Increase in retained earning 172,000
Depreciation 189,000
Increase in Accounts Payable 214,000
Increase in accrued Expenses 88,000
Increase in accounts receivable -182,000
Increase in inventory -251,000
Decrease in cash balance 22,000
Total Funds from operation 252,000

Working Note 2:
 Purchase of Assets
Particulars Rs.
Year 2076-77 Fixed Assets 1,398,000
Less: Last Year balance of net fixed Assets -1,113,000
Depreciation 189,000
Assets Purchase in year 2076-77 474,000

SPL Pharmaceuticals generated cash flow from operation, borrowed money and even dispose
investment in marketable securities to acquire fixed assets. This firms is planning for
expansion with investment in fixed assets.

ii) Statement of Cash Flows of SPL Pharmaceuticals:

Cash flows from Operating activities Rs.

Net Income 172,000
Depreciation 189,000
Cash provided by current assets and operating-related
current liabilities
- Increase in Accounts payable 214,000
- Increase in Accrued expenses 88,000
- Increase in Accounts receivable (182,000)
- Increase in Inventories (251,000)
Net Cash provided (used) by operating activities 2,30,000
Cash Flows from Investing Activities
Additions to fixed assets (4,74,000)
Decrease in marketable securities 87,000
Net Cash provided (used) by investing activities (387,000)
Cash Flows from Financing Activities
Increase in short term bank borrowings 135,000
Net Cash provided (used) by financing activities 135,000
Increase in Cash and Cash Equivalents (22,000)
Cash and Cash Equivalents (F/Y 2075/76) 53,000
Cash and Cash Equivalents (F/Y 2076/77) 31,000
Supplementary Cash Flow Disclosure
- Interest paid 21,000
- Taxes paid 114,000

Analysis: In addition to the same points raised by an analysis of the sources and uses
of funds statement, we see that all of the company's cash flow from operating activities
(and then some) went towards additions to fixed assets. By and large, the cash flow
statement prepared using indirect method gives us much the same information
gathered from an analysis of the sources and uses of funds statement.

b) Total exposure is $ 250,000

i) Forward market hedge:
UK Company has a US $ liability. To meet this $ commitment, the company needs to buy
$. So, buy six months forward contract @ $ 1.5455 per £, amount payable after six months
will be:
 250,000
£ 161,759.95
1.5455
Total cost under forward market hedging = £ 161,759.95

ii) Money market hedge:

Borrow in UK, deposit in US and repay after six months. To get $ 250,000 in six months,
amount in $ required to be deposited now will be:
$ 250,000 $ 250,000
 $ 244,498.78
0.045 1.0225
1 12 6

To get $ 244,498.78 now, amount to be borrowed in £ will be:

$ 244,498.78
 £156,559.38
1.5617
Loan repayable in £ after six month will be:

£156,559.38 6 
  £ 162,038.96
  7
 100 12 
1 
Total cost under money market hedging = £ 162,038.96

iii) Currency options hedge:

Since UK Company is importing, it needs to pay dollars. It has to buy USD and sell £.
Therefore the company should purchase £ put option.
Now, value of each contract = 12,500 × 1.70 = $ 21,250
Maximum number of contract that can be purchased = 250,000 ÷ 21,250 = 12 (Approx)
Therefore, exposure covered = 12,500 × 12 = £ 150,000
Premium to be paid for the exposure = 150,000 × $ 0.096 = $ 14,400
Cost of put option in £ = $14,400 ÷ 1.5617 = £ 9,220.72
Total cost of put option hedge:
Exposure covered through put option £150,000.00
Premium as above £ 9,220.72
Total £159,220.72
Less: Excess $ covered:
$ for 12 contracts (12 × 21,250) $ 255,000.00
Liability to be met $ 250,000.00
Excess cover $ 5,000.00
Equivalent in £ at forward rate of 1.5455 £ 3,235.20
Net cost £ 155,985.52
Total cost under currency options hedging = £ 155,982.52
 Decision: Since total outflow under currency options hedge is minimum, BNP Corporation
should hedge its transaction exposure through currency option alternative.
4. Answer the following: (5 × 3=15 marks)
a) Write short note on Dividend Signalling Hypothesis.
b) Warrant Premium
c) Interest rate cap and floor
d) Purchasing power parity
e) Random Walk Theory
Answer:
a) Write short note on Dividend Signaling Hypothesis.
According to dividend signaling hypothesis, dividend changes provide an effective way of
allowing the management to convey believable information to the market about the firm's
expected future cash flows. By conveying the favorable information in a believable way, the
dividend decision is used to show effect on the value of a firm. Firms are careful in announcing
their dividend decisions. Most of the firms follow stable dividends or gradually increasing
dividends. Many investors consider dividends as a part of regular income to meet their expenses.
Hence, they prefer a predictable pattern of dividends rather than a fluctuating one. A fall in the
dividend income may lead to sale of some shares, on the other hand when the dividend income
increases, an investor may invest some of the proceeds as reinvestment in shares, and thus the
share price tends to increase. Moreover, the dividend policy of a firm conveys a lot to the
investors. Increasing dividends signal better prospects of the company. On the contrary,
decreasing dividends signals bad earnings expectations. In addition, stable dividends are signs of
stable earnings of the company. On the other hand, varying dividends lead to uncertainty in the
minds of the investors.
b) Warrant Premium
A warrant premium is the difference between the current traded price of a warrant and its
minimum value. A warrant's minimum value is the difference between its exercise price and the
current traded price of its underlying stock.
Alternatively, a warrant premium is the percentage difference between the cost of purchasing
shares by exercising the warrant and buying them in the open market at the current price.
Warrants have both a price and a premium. Typically, the premium will decrease as the price of
the warrant rises coupled with the decrease in the time to expiration. A warrant is in-the-
money when the exercise price is less than the current share price. The more in-the-money the
warrant is, the lower the warrant premium. High volatility may also cause the warrant premium
to be higher.
As with call options, the premium can increase or decrease depending on supply and demand
factors. For the simple definition, the premium is the amount above the intrinsic, or minimum
value.
Premium = current price of the warrant - minimum value
Minimum value = exercise price - current price of the underlying stock
c) Interest rate cap and floor
An interest rate cap is a type of interest rate derivative in which the buyer receives payments at
the end of each period in which the interest rate exceeds the agreed strike price. An example of a
cap would be an agreement to receive a payment for each month the LIBOR rate exceeds 2.5%.
They are most frequently taken out for periods of between 2 and 5 years, although this can vary
considerably. Since the strike price reflects the maximum interest rate payable by the purchaser
 of the cap, it is frequently a whole number integer, for example 5% or 7%. By comparison, the
underlying index for a cap is frequently a LIBOR rate, or a national interest rate. The extent of
the cap is known as its notional profile and can change over the lifetime of a cap, for example, to
reflect amounts borrowed under an amortizing loan.
The purchase price of a cap is a one-off cost and is known as the premium. The purchaser of a
cap will continue to benefit from any rise in interest rates above the strike price, which makes the
cap a popular means of hedging a floating rate loan for an issuer.
An interest rate floor is an agreed-upon rate in the lower range of rates associated with a floating
rate loan product. It is a derivative contract in which the buyer receives payments at the end of
each period in which the interest rate is below the agreed strike price. Interest rate floors are
utilized in derivative contracts and loan agreements. This is in contrast to an interest
rate ceiling (or cap).
An interest rate floor is a series of European put options or floor-lets on a specified reference
rate, usually LIBOR. The buyer of the floor receives money if on the maturity of any of the
floor-lets, the reference rate is below the agreed strike price of the floor.
Interest rate floors and interest rate caps are levels used by varying market participants
to hedge risks associated with floating rate loan products. In both products, the buyer of the
contract seeks to obtain a payout based on a negotiated rate. For example, a borrower who is
paying the LIBOR rate on a loan can protect himself against a rise in rates by buying a cap at
2.5%. If the interest rate exceeds 2.5% in a given period the payment received from the
derivative can be used to help make the interest payment for that period, thus the interest
payments are effectively "capped" at 2.5% from the borrowers' point of view. In the case of an
interest rate floor, the buyer of an interest rate floor contract seeks compensation when the
floating rate falls below the contract’s floor. This buyer is buying protection from lost interest
income paid by the borrower when the floating rate falls.
Interest rate floor contracts and interest rate cap contracts are derivative products typically
bought on market exchanges similar to put and call options.
d) Purchasing power parity
If there are no barriers or costs to trade across borders (including costs to move the goods or
services), the price of a given product will be the same regardless of where it is sold. This is
referred to as the law of one price. Applied to a situation in which there are different currencies
on either side of the borders, this means that after adjusting for the difference in currencies, the
price of a good or service is the same across borders. In the case of different currencies, the law
of one price is known as purchasing power parity (PPP). So, in the ideal, a computer in New
York and in Hong Kong should have the same price. If its price is US$ 500 in New York and the
same computer costs HK$ 2000 in Hong Kong, PPP theory says the exchange rate should be 4
HK$ for every 1 US$.
If purchasing power parity holds, we can evaluate the exchange rate of two currencies by looking
at the price of a good or service in the two different countries. Any mispricing in terms of current
exchange rates is interpreted as a sign of future changes in currency valuations. In most
situations, there are barriers (e.g., import or export quotas) and costs (e.g., tariffs) associated with
moving goods across borders. Therefore, purchasing power parity does not likely hold precisely.
PPP is the one popular macroeconomic analysis metric to compare economic productivity and
standards of living between countries. PPP is an economic theory that compares different
countries' currencies through a "basket of goods" approach. According to this concept, two
currencies are in equilibrium, known as the currencies being at par, when a basket of goods is
priced the same in both countries, taking into account the exchange rates.
 The relative version of PPP is calculated with the following formula:
S= P1÷P2
where:
S= Exchange rate of currency 1 to currency 2
P1= Cost of goods X in currency 1
P2= Cost of goods X in currency 2
The name "purchasing power parity" comes from the idea that, with the right exchange rate,
consumers in every location will have the same purchasing power.
The PPP exchange rate may not match the market exchange rate. The market rate is
more volatile because it reacts to changes in demand at each location. Also, tariffs and difference
in the price of labour can contribute to longer term differences between the two rates.
One use of PPP is to predict longer term exchange rates. Because PPP exchange rates are more
stable and are less affected by tariffs, they are used for many international comparisons, such as
comparing countries' GDPs or other national income statistics. These numbers often come with
the label "PPP-adjusted".
e) Random Walk Theory
There is a belief among many investment managers and stock market analysts that stock market
prices can never be predicted because they are not a result of any underlying factors, but are
mere statistical ups and downs. The random walk hypothesis (RWH) states that the behavior of
stock market prices is unpredictable and that there is no relationship between the present price of
a share and its future price. The term random walk is used to refer to successive price changes
which are independent of each other. M.G. Kendell found that changes in security prices behave
nearly as if they are generated by a suitably designed roulette wheel for which each outcome is
statistically independent of the past history. Successive peaks and troughs in prices are
unconnected. In the layman’s language, it may be said that prices on the stock exchange behave
exactly the way a drunk would behave while walking in a blind lane i.e up and down, with an
unsteady way going in any direction he likes, bending on the side once and on the other side the
second time. Random walk proponents does not attempt to explain the value functionally related
to company specific factors such as its earnings, dividends, assets structure, management
efficiency, competitive position etc to industry specific factors and to other environmental
factors such as government policies towards the industry. These factors only change over period.
It concerns itself with the transitory component representing the various phychological forces –
bearish or bullish tendencies that are constantly at work in the markets.
5.
a) You are evaluating a proposed expansion of an existing subsidiary located in Dubai. The
cost of the expansion would be AED 25 million. The cash flows from the project would be
AED 6.9 million per year for the next five years. The NPR required return is 13 percent
per year, and the current exchange rate is NPR 33 per AED. The going rate on NPR is 8
percent per year. It is 6 percent per year on AED.
Required: (1+4+3=8 marks)
i) What will happen to exchange rates over the coming years?
ii) Based on your answer in (i), will you carry out the project in Dubai?
iii) What is the required return on AED flows? Calculate the NPV in AED and then
convert to NPR.
 b) Sun Pharma has Rs 10 million invested in long term bonds. This bond portfolio’s
expected annual rate of return is 9%, and the annual standard deviation is 10%. Tiwariji,
their financial advisor, recommends that Pharma consider investing in an index fund
which closely tracks Nepse Index. The index has an expected return of 14% and its
standard deviation is 16%. (4+3=7 marks)
i) Suppose Pharma puts all his money in a combination of the index fund and treasury
bills, can Pharma improve the expected rate of return without changing the risk of the
portfolio? The Treasury bill yield is 6%.
ii) Could Pharma do even better by investing equal amounts in the corporate bond
portfolio and the index fund? The correlation between the bond portfolio and the
index fund is +0.10.
Answer:
a)
i) Implicitly, it is assumed that interest rates won't change over the life of the project.
Therefore, the exchange rate in coming years is projected to decline (i.e., NPR per AED
increases) because the AED interest rate is lower than the NPR interest rate.
ii) We can use relative purchasing power parity to calculate the NPR cash flows at each
time. First, we need to forecast the future spot rate for each of the next five years. From
interest rate and purchasing power parity, the expected exchange rate is:
Ft = S0 [(1+Rd)/(1+Rf)]t
Where,
Ft = Forward exchange rate of year t
S0 = Spot exchange rate
Rd = Domestic interest rate
Rf = Foreign interest rate
Now,
F1 = 33 [(1+0.08)/ (1+0.06)]1 = 33 × 1.0189 = NPR 33.62/ AED
F2 = 33 [(1+0.08)/ (1+0.06)]2 = 33 × 1.0381 = NPR 34.26/ AED
F3 = 33 [(1+0.08)/ (1+0.06)]3 = 33 × 1.0577 = NPR 34.90/ AED
F4 = 33 [(1+0.08)/ (1+0.06)]4 = 33 × 1.0777 = NPR 35.56/ AED
F5 = 33 [(1+0.08)/ (1+0.06)]5 = 33 × 1.0981 = NPR 36.24/ AED
So, the cash flows each year in NPR (in million) and NPV will be:
Year CF in AED Exch. rate CF in NPR DF @ 13% PV in NPR
0 –25.00 33.00 – 825.00 1.000 – 825.00
1 6.90 33.62 231.98 0.885 205.30
2 6.90 34.26 236.39 0.783 185.09
3 6.90 34.90 240.81 0.693 166.88
4 6.90 35.56 245.36 0.613 150.41
5 6.90 36.24 250.06 0.543 135.78
NPV 18.46
Since NPV of this project is positive, we should carry out the Dubai project.
 iii) Rearranging the relative purchasing power parity equation to find the required return in
AED, we get:
kf = (1 + kd) × [(1 + Rf) ÷ (1 + Rd)] – 1
Where,
kf = required rate of return in other country
kd = required rate of return in home country
Rf & Rd = As in (ii) above
Now,
kf = (1 + 0.13) × [1.06 ÷ 1.08)] – 1
= (1.13 × 0.9815) – 1
= 0.1091 = 10.91%
So, the NPV in AED is:
NPV (in million) = –AED 25.00 + AED 6.90 × (PVIFA10.91%,5yrs)
= –AED 25.00 + AED 6.90 × 3.704
= –AED 25.00 + AED 25.56
= AED 0.56
Converting the NPV in AED to NPR at the spot rate, we get the NPV in NPR as:
NPV = AED 0.56 × NPR 33
NPV = NPR 18.48 million
b)
i) Sun Pharma’s current portfolio provides an expected return of 9 % with an annual
standard deviation of 10%. First, we find the portfolio weights for a combination of
Treasury bills (security 1: standard deviation=0%) and the index fund (security 2:
standard deviation =16%) such that portfolio standard deviation is 10%.
In general, for a two security portfolio:
σp²=x1² σ1²+2 x1 x2 σ1 σ2p12+x2² σ2²
0.10²=0+0+x2²(0.16) ²
0.10²=0+0+x2²(0.16) ²
0.01=x2²*.0256
X2²=.01/.0256=.391
X2= 0.625 Hence x1=.375
So, rp=x1r1+x2r2=.375*.06+.625*.14=11%
Therefore, Pharma can improve expected rate of return without changing the risk of his
portfolio.
ii) With equal amount in the corporate bond portfolio (security 1) and the index fund
(security 2), the expected return is:
Rp=x1r1+x2r2=.5*.09+.5*.14=.115=11.5%
σp²=(.5) ²(.10)²+2(.5)*.(5)(.1)(.16)(.1)+ (.5) ²(.16)²=0.0097
σp=.985=9.85%
 Therefore, Pharma can do even better by investing equal amounts in the corporate bond
portfolio and the index fund. Expected fund increases to 11.5% and the standard
deviation portfolio decreased to 9.85%.
6.
a) A company is considering to engage a factor; the following information is available:
i) The current average collection period for the company’s debtors is 75 days and ½%
of debtors default. The factor has agreed to pay money due after 55 days and will
take the responsibility of any loss on account of bad debts.
ii) The annual charge for the factoring is 2% of turnover payable annually in arrears.
Administration cost saving is likely to be Rs 1 lakh per annum.
iii) Annual sales, all on credit are Rs 1 crore. Variable cost is 80% of sales price.
The company’s cost of borrowing is 15% per annum. Assume the year is consisting of
365 days.
Should the company enter into a factoring agreement? 5 marks
b) Anil owns a security which pays him Rs. 10,000 today and Rs. 10,000 in one year,
without any risk. The risk-free interest rate is 10%.
Required: (2+3=5 marks)
i) What is the no-arbitrage price of the security today (before the first Rs. 10,000 is
paid)?
ii) If the security is trading for Rs. 19,500, what arbitrage opportunity is available?
Answer:
a)
Savings Amount (Rs)
Administration cost saved 100,000
Add: Interest saving @15% p.a. on Rs 438,356 65,753
Add: Bad debts saved @1/2% of Rs 10,000,000 50,000
Total 215,753
Less: Annual factoring costs @2% of Rs 10,000,000 200,000
Net annual benefits of factoring 15,753
Conclusion: Factoring agreement is worthwhile and should be undertaken.

Working Note:
Existing average debtors Amount(Rs.)
10,000,000/365*75 2,054,795
Average new debtors
10,000,000/365*55 1,506,849
Reduction in debtors 547,945
Cost thereof @ 80% 438,356

b)
i) No-arbitrage price of the security today (before the first Rs. 10,000 is paid)
We need to compute the present value of the security’s cash flows.
In this case there are two cash flows:
Rs. 10,000 today, which is already in present value terms, and Rs. 10,000 in one year.
 The present value of the second cash flow is:
Rs. 10,000 in one year ÷ (1.10 in one year/ Re. today) = Rs. 9,090.91
Therefore, the total present value of the cash flows is:
Rs. 10,000 + Rs. 9,090.91 = Rs. 19,090.91
This is the no-arbitrage price of the security today.
i) Arbitrage opportunity available
Current trading price of the security is Rs. 19,500 which is more than the present value of
the security.
Anil can exploit its overpricing by selling it for Rs. 19,500.
Then, he can use Rs. 10,000 of the sale proceeds to replace the Rs. 10,000 which he
would have received from the security today and invest Rs. 9,090.91 of the sale proceeds
at 10% interest rate to replace the Rs. 10,000 he would have received in one year (i.e., Rs.
9090.91 × 1.10 = Rs. 10,000).
The remaining amount from the sale proceeds = Rs. 19,500 – (Rs. 10,000 + Rs. 9,090.91)
= Rs. 409.09
This Rs. 409.09 is an arbitrage profit.
 Paper-3: Advance Audit and Assurance
Attempt all questions.
Use separate answer book for each question.

1. Comment and give your view with reasons on each of the following cases, giving
consideration to respective Standards, Laws and Code of Ethics:
a)
i. Prizma Private Limited is tendering for an important contract to supply Om Shree
Private Limited. Both the companies are the audit client of OT Associates, Chartered
Accountants. Prizma Private Limited’s management has requested OT Associates to
provide advice on the tender it is preparing. What matters should OT Associates consider
in deciding whether to provide advice to Prizma Private Limited on the tender? 5 marks
ii. PCS Private Limited year end was on Ashad end and the draft financial statement shows
a profit before tax Rs. 2,999,211 revenue of Rs. 15,000,090 and inventory of Rs.
749,400. The fieldwork stage for the audit has been completed. The statutory auditors,
BD & Co were unable to attend the inventory count due to this current pandemic
situation. The inventory count at warehouse was undertaken on Ashad 31, 2077 and was
overseen by the company’s factory manager. Detailed inventory records were
maintained but it was not possible to undertake another full inventory count subsequent
to year end. Analyze the issue and describe its procedures to be followed by the audit
team to resolve this issue and its impact on the audit report if it remains unresolved.
5 marks
b)

i. RNS Associates, Chartered Accountants is a medium sized Kathmandu based sole

proprietorship. The firm is in the process for bidding the statutory audit of a
multinational company. One of the eligibility criteria for bidding was that the audit firm
should have at least two partners. So the proprietor of RNS Associates decided to enter
into partnership with another Chartered Accountant firm for bidding this particular
assignment as well as for other assignment which mandates such criteria. He also
wishes to continue his proprietorship firm for carrying the already bagged assignment
as well as for new assignment which he will get in future. As per the code of ethics can
he do so? 5 marks
ii.Mr. Neer Singh is the shareholder of B & B Private Limited holding 1% of paid up share
capital of the company since Ashad 31, 2075. The company wants to appoint Piya &
Associates as the auditor for the FY 2077/78. Piya & Associates is the sole
proprietorship firm of Mr. Neer Singh’s son in law, Mr. Beer Piya. As per Companies
Act whether he can do so ? 5 marks
Answer
a i) A potential conflict between the interest of two audit client arises from OT Associates
offering advice to Prizma Private Limited on the tender being presented to Om Shree Private
Limited. A conflict of interest may create potential threats to objectivity, confidentiality or
other threats to compliance with the fundamental ethical principles.
In this scenario, OT Associates faces the problem of potentially giving advice to one audit
client in relation to another audit client, which threatens objectivity. There may also be
 problem to do with confidentiality of information, as either party could benefit from
information obtained from the audit firm about the other party.
In dealing with conflicts of interest, the significance of any threats should be evaluated and
safeguards must be applied when necessary to eliminate the threats or reduce them to an
acceptable level. The most important safeguard is disclosure by OT Associates. The audit
firm should notify both Prizma Private Limited and Om Shree Private Limited of the
potential conflict of interest and obtain their consent to act.
Other possible safeguards include:
 The use of separate engagement teams
 Procedure to prevent access to information (for example, strict physical separation of
such teams, confidential and secure data filing).
 Clear guidelines for members of the engagement team on issues of security and
confidentiality.
 The use of confidentiality agreement signed by employees and partners of the firm and
 Regular review of the application of safeguards by a senior individual not involved
with the relevant client engagements.
 OT Associates may decide having evaluated the threats and available safeguards, that
the threats can’t be reduced to an acceptable level, in which case the firm should
decline from giving advice to Prizma Private Limited regarding tender service.
ii) BD & Co. couldn’t attend the inventory count due to this current pandemic situation.
Therefore they have not been able to gather sufficient and appropriate evidence with regard
to the completeness and existence of inventory.
Inventory is a material amount as it represents 24.98% (749,400/2,999,211) of profit before
tax and 5% (749,400/15,000,090) of revenue, hence this is a material issue.
A procedure to adopt includes:
Review the reports of the inventory count to identify the level of adjustments to the records
to assess the reasonableness of relying on the inventory records. Auditor should carry out
the audit procedures in live with NSA 501, Audit evidence - Specific Consideration for
Selected Items. The auditor shall perform alternative audit procedures to obtain sufficient
appropriate audit evidence regarding the existence and condition of inventory. If it is not
possible to do so, the auditor shall modify the opinion (in this case qualification of opinion)
in the auditor's report in accordance with NSA 705 (revised).
Undertake a sample check of inventory in the warehouse and compare to the inventory
records and then from inventory records to the warehouse, to assess the reasonableness of
the inventory records maintained by PCS Private Limited.
The BD & Co will need to modify the audit report as they are unable to obtain sufficient
appropriate evidence in relation to inventory which is a material but not pervasive balance.
Therefore a qualified opinion will be required. The opinion paragraph will be qualified
‘except for’. A basis for qualified opinion paragraph will be required to explain the
limitation in relation to the lack of evidence over inventory.
b i) As per Rule 62 of Nepal Chartered Accountant Regulation, 2061, member having
proprietorship firm but willing to be a partner in partnership audit firm has to apply to
ICAN to make the proprietorship firm inactive. After the proprietorship firm is inactive he
can be partner in the partnership firm. However even in the situation of proprietorship
being inactive, it shall not be deemed to prohibit the execution of the assignment bagged
 earlier. However, the new assignment needs to be taken only from the partnership. Thus the
chartered accountant in practice can’t run the proprietorship and partnership firm
simultaneously.
ii) Section 112 of the Companies Act states the disqualifications of an auditor. Provision
regarding appointing shareholder as auditor as per Section 112 (1) (e) of Companies Act
states that: persons or the firms or companies who is substantial shareholder of the
company or a shareholder holding one percent or more of the paid-up capital of the
company or his close relative cannot be appointed as auditor.
As per Section 2(Z9) of Companies Act, “Close relative” means a partition shareholder in
joint family or husband, wife, father, mother, mother-in -law, father-in- law, elder brother,
younger brother, elder sister, younger sister, sister in–law (elder or younger brother’s wife),
brother-in–law, sister–in–law, brother-in- law (husband of elder sister), uncle, aunt,
maternal uncle, maternal aunt, son, daughter, daughter-in-law ,grand-son, grand-daughter,
grand-daughter-in- law or son-in–law.
As per the above definition Mr. Beer Piya is the close relative of Mr. Neer Singh who holds
1% paid up share capital of the company. Hence, Piya & Associates can’t be appointed as
auditor of B & B Private Limited.
2. Comment and give views with reason on each of the following cases:
a) How are the auditor’s responsibilities in relation to obtaining sufficient appropriate
audit evidence about subsequent events impacted by the COVID-19 pandemic? 10 marks
b) Bakery Pvt. Ltd. manufactures Biscuits and Cookies and has four factories, five
warehouses and five distribution depots spread across Nepal. The audit for the year
ended 31 Ashadh 2076 is almost complete and the financial statements and audit report
are due to be signed shortly. Profit before taxation is Rs 150 lakh . The following events
have occurred subsequent to the year end and no amendments or disclosures have been
made in the financial statements.
i. On 2076.05.15, a fire occurred at the largest of the distribution depots. The fire resulted
in extensive damage to the company’s vehicles used for dispatching goods to customers;
however, there have been no significant delays to customer deliveries. The company
estimates the level of damage to the vehicles to be in excess of Rs. 12 Lakh. Only a
minimal level of inventory, approximately Rs. 50,000 was damaged. The insurance
company has started to investigate the fire to assess the likelihood and level of payment,
however, there are concerns the fire was started deliberately, and if true, would
invalidate any insurance cover. 5 marks
ii. On 2076.05.20, it was discovered that a large batch of Vitamin fortified Energy Biscuits
held in inventory at the year end was defective, as some ingredients used for that batch
was below required standard. To date no sales of this new biscuits have been made. The
cost of the defective batch of inventory is Rs. 18 lakh and the defects cannot be
corrected. However, the scrapped biscuits can be utilised as a raw material for making
animal food at a value of Rs. 100,000. 5 marks
Required:
For each of the two events described above: (i) Based on the information provided,
explain whether the financial statements require amendment; and (ii) Describe audit
procedures which should now be performed in order to form a conclusion on any required
amendment.
Answer
a) NSA 700(Revised), Forming an Opinion and Reporting on Financial Statements stipulates
that the date of the auditor’s report informs the user of the auditor’s report that the auditor
has considered the effects of events and transactions of which the auditor becomes aware and
that occurred up to that date. Therefore, it is important for the auditor to obtain an
understanding of subsequent events and how these have been dealt with in the financial
statements. Auditors are required to perform procedures designed to obtain sufficient
appropriate audit evidence that all events requiring adjustment of, or disclosure in, the
financial statements, occurring between the date of the financial statements and the date of
the auditor’s report, have been identified and appropriately reflected in the financial
statements in accordance with the applicable financial reporting.
In undertaking work to be responsive to the auditor’s risk assessment pertaining to
subsequent events, including reasons related to the impact of the COVID-19 pandemic, the
auditor considers management’s adjustments or disclosures, including the timelines used to
distinguish between adjusting and non-adjusting events. In addition, this includes the impact
of the changes in the environment on the recognition and measurement of account balances
and transactions in the financial statements (if adjusting), or other specific disclosures (if
non-adjusting).
It is important to consider COVID-19 as a factor in an entity’s analysis of estimates required
in the financial statements, including, but not limited to, estimates related to expected credit
loss, inventory obsolescence, impairment analyses, variable and contingent compensation
etc. Therefore, judgment needs to be applied to determine whether the conditions existed at
the date of the financial statements or not.
Examples of Events and Conditions that May be Relevant in the Current Environment
The following are examples of events or conditions that may be affected by, or exist as a
result of, the COVID-19 pandemic, and which may be relevant for the auditor in determining
whether subsequent events have occurred and, if applicable, have been appropriately
reflected in the financial statements.
1. New commitments, borrowings or guarantees that have been entered into as a result
of the pandemic.
2. Invocation of force majeure clause after the year-end by any party (e.g., supplier,
customer etc.) thereby impacting the supply chain / availability of customers for the
entity’s products.
3. Recent or planned sales or acquisitions of assets as a result of the pandemic.
4. Increases in capital or issuance of debt instruments, such as the issue of new shares or
debentures, or an agreement to merge or liquidate that has been made or is planned.
5. Expected credit loss provisioning – where there are customers in COVID-19
impacted countries and where they have filed for liquidation post the entity’s year-
end will impact the collectability of the trade receivables.
6. Probability of meeting performance vesting conditions under share-based payment
arrangements and the appropriate accounting for modifications or settlements of such
arrangements.
7. Relief or economic stimulus payments provided by the government in the form of
loans or grants. It is important to understand the nature of the stimulus, conditions to
be complied by entities, etc. Many of the concessions have dates attached and entities
need to be cognizant of those as they determine impact on the financial statements.
8. Any developments regarding contingencies (for example, new contingent liabilities or
circumstances affecting the evaluation of existing contingent liabilities, the ability to
meet agreed-on performance targets for contingent consideration in business
combination arrangements, etc.).
9. Any unusual accounting adjustments that have been made or are contemplated, such
as additional or revised closing entries.
10. Any events that will bring into question the appropriateness of accounting policies
and assumptions used in the financial statements (e.g. events call into question the
validity of the going concern assumption, expected credit loss model, inventory
obsolescence, useful lives of PPE etc.).
11. Impact on realizable values of inventory of a short-term nature in case of inability to
sell the products during the period of lockdown.
12. Indications of impairment in the value of investments in companies whose
businesses have been severely affected by the pandemic.
13. Any other significant events which would raise doubts over the entity’s ability to
continue as a going concern in accordance with NSA 570 (Revised), Going Concern.
The Exercise of Professional Skepticism
Management’s identification, determination and treatment of adjusting or non-adjusting
events, as applicable, are likely to be more challenging due to the impact of COVID-19.
Consequently, there may be a need for the auditor to design and perform enhanced or
additional procedures. The uncertainties and challenges associated with COVID-19, taking
into account the facts and circumstances of the entity, are more likely to result in significant
management judgments, requiring significant auditor judgments, which requires the auditor
to exercise professional skepticism in undertaking work on subsequent events. Applying
professional skepticism in this regard means questioning and considering the sufficiency and
appropriateness of audit evidence that all material subsequent events (i.e., those requiring
adjustment of, or disclosure in the financial statements) have been identified and are
appropriately reflected in the financial statements in the light of the circumstances.
Written Representations
The auditor is required by paragraph 9 of NSA 580 to request a written representation that all
events occurring subsequent to the date of the financial statements, and for which the
applicable financial reporting framework requires adjustment or disclosure, have been
adjusted or disclosed. As per paragraph 13 of NSA 580, Written Representations, written
representations are required to be dated as near as practicable to the date of the auditor’s
report, but not after that date.
The Importance of Communication with Those Charged with Governance
The COVID-19 pandemic has resulted in various challenging and complex areas related to
financial reporting. Those charged with governance are likely to have increasingly important
responsibilities in the entity’s financial reporting and other governance processes. For
example, they may need to ensure that the entity adapts its design and maintenance of
appropriate controls with regard to the reliability of financial reporting, effectiveness and
efficiency of operations and compliance with applicable laws and regulations. The auditor’s
ongoing and regular communication with those charged with governance, particularly in the
period past the date of the financial statements, may assist with the auditor’s understanding
of the changes being made to respond to the evolving environment and may help the auditor
in assessing what procedures they need to undertake to gather sufficient appropriate audit
evidence.
b i) A fire has occurred at the largest of the company’s distribution depots and property, plant
and equipment in excess of NPR 12 lakh has been damaged as well as inventory of 50,000.
The company has contacted its insurance company and they have begun to investigate the
likelihood and level of any payment. This event occurred after the reporting period and is
not an event which provides evidence of a condition at the year end and hence this is a non-
adjusting event.
Normally as the company is insured, only uninsured losses suffered by the company would
need to be accounted for, which in the normal course of events would be an immaterial
amount.
However, the insurance company is investigating, as there is a possibility the fire was
started deliberately, and this would invalidate the insurance policy. If this is the case, the
total damaged assets of 12,50,000 (12,00,000 + 50,000) would be material as they represent
8·33% (12.5/150) of profit before tax. Therefore as a material non-adjusting event, the
assets should not be written down to their scrap value in the current year financial
statements; however, the directors should include a disclosure note detailing the fire and the
total value of assets which may be impacted due to the possibility of a lack of an insurance
settlement.
The following audit procedures should be applied to form a conclusion on any amendment:
 Obtain a schedule showing the damaged property, plant and equipment and agree the net
book value to the non-current assets register to confirm the total value of affected assets.
 Obtain a breakdown of the inventory stored at the distribution centre on 2076.05.15 and
compare to earlier records or dispatch documents to ascertain the likely level of inventory
at the time of the fire.
 Review any correspondence from the insurance company confirming the amount of the
claim, and the current status of their investigation into the fire and any likely payments to
assess the extent of any uninsured amounts.
 Discuss with the directors whether they will disclose the effect of the fire, as a non-
adjusting event, in the year-end financial statements.
b ii) The company has identified that inventory at the year end with a cost of NPR 18 lakh is
defective, due to use of substandard raw material; the scrap value of this inventory is NPR
100,000. This information was obtained after the year end but provides further evidence of
the net realisable value of inventory at the year end and hence is an adjusting event.
NAS 2, Inventories requires that inventory is valued at the lower of cost and net realisable
value. The inventory of 18 lakh must be written down to its net realisable value of
100,000. The write down of 17 lakh (18 – 1) is material as it represents 11·33% (17/150)
of profit before tax. Hence, the directors should amend the financial statements by writing
down the inventory to 100,000.
The following audit procedures should be applied to form a conclusion on the adjustment:
 Discuss the matter with the directors and enquire if they are prepared to write down
the cost of the inventory to net realisable value.
 Review the board minutes to assess whether this event was the only case of defective
inventory as there could potentially be other inventory which requires writing down.
 Obtain a schedule showing the defective inventory and agree to supporting
production documentation that it was produced prior to 31 Ashadh 2076, as otherwise
it would not require a write down at the year end.
  Discuss with management how they have assessed the scrap value of 100,000 and
agree this amount to any supporting documentation to confirm the value.
3. Answer the following:
a) You are the audit manager of a listed company having five subsidiaries. Three of them
are audited by other audit firms. You are required to state the key matters / instructions
which you would communicate to the component auditors. 8 marks
b) Define Key Audit Matters and its purposes. How would you determine the Key Audit
Matters for a listed company? (3 +4=7 marks)
Answer
a) The following matters may be communicated to the auditor of the subsidiaries (component
auditor):
 Work to be performed, the use to be made of that work, and the form and content of the
component auditor’s communication with the group engagement team
 A request for confirmation from the component auditors that they would cooperate with
group engagement team.
 The ethical requirements that are relevant to the group audit and, in particular, the
independence requirements.
 Component materiality and the amount lower than the materiality level for particular
classes of transactions, account balances or disclosures, if applicable and the threshold
above which misstatements cannot be regarded as clearly trivial to the group financial
statements.
 Already identified significant risks of material misstatements in the group financial
statements, due to fraud or error that are relevant to the work of the component auditor.
 Request to the component auditor to communicate on a timely basis any other significant
risks of material misstatement of the group financial statements, due to fraud or error, in
the component, and the component auditor’s responses to such risks.
 A list of related parties prepared by group management, and any other related parties of
which the group engagement team is aware. Request the component auditor to
communicate on a timely basis related parties not previously identified by group
management or the group engagement team.
 Request the component auditor to communicate mattes relevant to the group engagement
team’s conclusion with regard to the group audit.
 Reporting deadlines by which the component auditor is required to comply.
b) Key Audit Matters are those matters that, in the auditor’s professional judgment, were of
most significance in the audit of the financial statements of the current period. The auditor is
required to communicate such matters to those charged with governance and include in
audit report in the Key Audit Matters Section. The purpose of communicating key audit
matters is to enhance the communicative value of auditor's report by providing greater
transparency about the audit that was performed. Communicating key audit matters provides
additional information to intended users of the financial statements to assist them in
understanding those matters which are of most significance in the audit of the financial
statements.
 The auditor shall determine, from the matters communicated with those charged with
governance, those matters that required significant auditor attention in performing the audit.
In making this determination, the auditor shall take into account the following
i. Areas of higher assessed risk of material misstatement, or significant risks identified in
accordance with NSA 315 (Revised), Identifying and Assessing the Risk of Material
Misstatement through Understanding the Entity and Its Environment.
ii. Significant auditor judgments relating to areas in the financial statements that involved
significant management judgment, including accounting estimates that have been
identified as having high estimation uncertainty.
iii. The effect on the audit of significant events or transactions that occurred during the
period.
The auditor shall determine which of the matters determined in accordance with above
paragraph were of most significant in the audit of the financial statements of the current
period and therefore are the key audit matters.
4. Comments on the following with reference to the Chartered Accountants Act, 1997 and
schedules thereto.
a) M/s AP & Associates, auditors of Welfare Dalit Organization, a recognized nonprofit
organization feels that the standard on auditing need not to be applied as Welfare Dalit
Organization is a non-profit making organization. 8 marks
b) "Code of Ethics is designed to uphold the conduct of the professional accountants".
Discuss. Should the auditor of merchant banking company, which is a wholly owned
subsidiary of commercial bank disclose the client information to the inspection team of
Securities Exchange Board of Nepal. 7 marks
Answer
a) The preface to Standards on Auditing gives the scope of the Standards on Auditing. As per
the preface, the NSAs will apply whenever an independent audit is carried out; that is, in the
independent examination of financial statements/information of any entity; whether profit
oriented or not and irrespective of its size, or legal form (unless specified otherwise) when
such an examination is conducted with a view to expressing an opinion thereon. As per NSA
200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Nepal Standards on Auditing stipulates that NSAs are written in the
context of an audit of the financial statement by an auditor. They are to be adopted as
necessary in the circumstances when applied to auditor of other historical financial
information.
Also while discharging their attest function; it is the duty of the Chartered Accountant to
ensure that NSAs are followed in the audit of financial information covered by their audit
reports.
In the given case, even though the client is a non-profit oriented entity the NSAs shall apply
and the auditor shall be guilty of professional misconduct for failing to discharge his duty in
case of non-compliance with NSAs. NSAs are to be applied in the audit of historical
financial information.
b) Code of ethics is the set of detailed rules, guidelines, standards of conduct on which the
ethical requirements for professional accountants in Nepal is founded. It is issued by the the
Institute of Chartered Accountants of Nepal and is mandatory for all its members to
observe in respect of the performance of professional services in Nepal.
 The Code of ethics recognizes that the objectives of the accountancy profession are to work
to the highest standards of professionalism, to attain the highest levels of performance and
generally to meet the public interest requirement. While the conducts of professionals are
within the framework of applicable professional standards, laws, regulations, these
however, do not govern all types of behavioral issues of the members. As thus, the ethics
requires the members to comply with a number of prerequisites in order to achieve the
objectives of the profession. Such prerequisites include the compliance with the
fundamental principles of integrity, objectivity, independence, confidentiality, professional
behavior, professional competence and due care and technical standards. The code also
prescribes specific issues and illustrative cases upon which the professional accountants
should act so as to remain within the boundary of their fundamental principle. For instance,
there are directives that suggests various provisions regarding publicity and advertisements
by the members; Soliciting Business, Accepting New Engagement, Fees and Commission.
Similarly, there are many different provisions that are there for compliance by the
professional accountants and that has an objective to guide towards maintenance of higher
professional values and ethics.
Hence, because of all the above reasons it can be said that the Code of Ethics is designed to
uphold the conduct of the professional accountants.
The principle of confidentially imposes an obligation on all professional accountants to
maintain confidentiality of information acquired as a result of profession or business
relationship. However, there are certain circumstances where same can be disclosed.
As per Section 140.7(c) of Code of Ethics of ICAN provides that the confidential
information can be disclosed when there is a professional duty or right to disclose, when
not prohibited by law
i. To comply with the quality review of a member body or professional body
ii. To respond to an inquiry or investigation by a member body of regulatory body
iii. To protect the professional interests of a professional accountant in legal
proceedings or
iv. To comply with technical standards and ethics requirements.
v. In view of the above requirement of Section 140.7 (c) (ii) auditor can assist
respond to an inquiry or investigation by regulatory body.
5. Answer the following:
a) Computer Assisted Audit Technique’s may be used in performing the various auditing
procedure. List any four of the audit procedures in which it can be used along with
examples. Also, state the points the auditor should keep in mind in using Computer-
Assisted Audit Techniques for audit in small business computer environments. 8 marks
b) Bhumi Associates, Chartered Accountants was appointed to review the financial
projection of Babal Bank Limited prepared for the purpose of issuance of right shares on
the basis of assumptions obtained from 5 years strategic plan and annual budget. Draft
an unmodified report giving reference to appropriate Nepal Standard Audit Engagement.
7 marks
Answer
a) CAAT’s may be used in performing the various auditing procedures including the
following
  Test of Details of transactions and balances, for example, the use of audit software for
recalculating interest or the extracting of invoices over a certain value from computer
records.
 Analytical Procedures, for example, identifying inconsistencies or significant
fluctuations.
 Test of General Controls, for example testing the set up or configuration of the
operating system or access procedures to the program libraries or using code
comparison software to check that the version of the program in use is the version
approved by the management.
 Sampling programs to extract data for audit testing
 Testing of Application Controls, for example, testing the functioning of a
programmed control
 Reperforming calculations performed by the entity accounting system.
The general principle in the application of CAAT’s does not change with small business
computer environments but some limitations have to be faced. However, the following points
should be kept in mind and given special consideration in these environments by the auditor:
 The level of general ED controls may be such that it will be difficult to place adequate
reliance on the system of internal control. This will result in:
o Greater emphasis on tests of details of transactions and balances and analytical
review procedures, which may increase the effectiveness of certain CAAT’s
particularly audit software.
o The application of audit procedures is to ensure the proper functioning of the CAAT
and validity of the entity’s data.
 In case where smaller volumes of data are processed, manual methods may be more cost
effective and economic.
 Adequate technical assistance may not be available from the entity, thus making the use
of CAATs impracticable.
 Certain audit package programs may not operate on small computers, thus restricting the
choice of CAATs. However, the entity’s data files may be copied and processed on
another suitable computer. 4
5 b)
Report on Financial Projection to Issue Right Shares
To Babal Bank Limited
We have examined the accompanying financial projections of M/s Babal Bank Limited for a
period of 5 consecutive financial years namely 2077/78 to 2081/82 in accordance with the
Nepal Standard on Assurance Engagement 3400 applicable to the examination of prospective
financial information.
Management is responsible for the preparation and fair presentation of these financial
projections in accordance with Nepal Financial Reporting Standards including the
assumptions on which it is based. These financial projections have been prepared for the
purpose of issuance of right shares. The projections have been prepared using a set of
assumptions that include hypothetical assumptions about future events and management’s
actions that are not necessarily expected to occur. Consequently, readers are cautioned that
this projection may not be appropriate for purposes other than that described above,
 Based on our examination of the evidence supporting the assumptions namely annual budget
and strategic plan, nothing has come to our attention which causes us to believe that these
assumptions do not provide a reasonable basis for projection. Further, in our opinion the
projection is properly prepared on the basis of the assumptions and is presented in accordance
with Nepal Financial Reporting Standards in consonance with financial reporting
requirements of Nepal Rastra Bank.
Even if the events anticipated under the hypothetical assumptions described above occur,
actual results are likely to be different from the projection since other anticipated events
frequently do not occur as expected and the variation may be material.
Signature
Name of the signatory
Name of the organization
Place:
Date:
6. Write short notes on the following: (5×3=15 marks)
a) Removal of name from membership register
b) Formation of Audit Committee under Companies Act
c) Objective of audit planning
d) Audit note book
e) Substantive procedures for existence or occurrence assertions about derivatives and
securities
Answer
a) The council may issue an order to remove the name of any member from the membership
register on any of the following circumstances.
i) If he/she is convicted by a court in a criminal offense involving moral turpitude and
punished there for,
ii) If he fails to pay any fees required to be paid to the Institute,
iii) If he fails to abide by the professional conduct referred to in this Act and the Rules
framed under this Act,
iv) If he becomes of unsound mind, or
v) If he is dead.
b) Section 164 of the Companies Act provides that a listed company with paid up capital of
thirty million rupees or more or a company which is fully or partly owned by the Nepal
Government shall form an audit committee under the chairmanship of a director who is
not involved in the day to day operations of the company and consisting of at least three
members.
At least one member of the audit committee shall be an experienced person having
obtained professional certificate on accounting or a person having gained experience in
accounting and financial field after having obtained at least bachelor's degree in accounts,
commerce, management, finance or economics.
A person who is a close relative of the chief executive of a company shall not be eligible
to be a member of the audit committee.
c) The objective of the auditor is to plan the audit so that it will be performed in an
effective manner. NSA 300 provides that following are the objectives of audit planning.
 To ensure that appropriate attention is devoted to important areas of the audit,
 To ensure that potential problem are identified,
 To ensure that the work is completed expeditiously,
 To ensure the proper assignment of work to assistants,
 To ensure the proper coordination of work done by other auditors and experts.
d) An audit note book is a book in which a large variety of matters observed during the
course of audit are recorded. It is thus a part of the permanent record of the auditor
available for reference later on, if required. The audit note book also provides a valuable
help to the auditor in picking up the links of work when the concerned assistant is away
or the work is stopped temporarily. The matters normally recorded in an audit note book
includes:
 Audit queries not cleared immediately,
 The mistakes or irregularities observed during the course of audit,
 Unsatisfactory book-keeping arrangements, costing method, internal or financial
administration or organization,
 Important information about the company which is not apparent from the accounts,
 Special points requiring consideration at the time of verification of final accounts,
 Important matters for future reference.
The audit notes constitute important evidence of matters considered by the auditor during
the course of the audit. It can be an important defense for the auditor in the event of an
action for negligence in the discharge of his duties being subsequently brought against
him.
e) Existence assertions address whether the derivatives and securities reported in the
financial statements through recognition or disclosure exist at the date of the statement of
financial position whereas occurrence assertions address whether derivatives and
securities transactions reported in the financial statements, as a part of earnings, other
comprehensive income, or cash flows or through disclosure occur during the period.
Examples of substantive procedures for existence or occurrence assertions about
derivatives and securities include:
 Confirmation with the issuer of the security,
 Confirmation with the holder of the security, including securities in electronic form,
or with the counterparty to the derivative,
 Confirmation of settled transactions with the broker-dealer or counterparty,
 Confirmation of unsettled transactions with the broker-dealer or counterparty,
 Physical inspection of the security or derivative contract,
 Reading executed partnership or similar agreements.
Paper-4: Corporate Laws

Attempt all questions.

Use separate answer book for each question.

1. Answer the following questions:

a) Mr. A is one of the shareholders of a company XYZ. He wants to sell and pledge his shares and
debentures. He doesn't know the process and legal provision regarding selling, pledging and
transmitting the title of shares and debentures and hence, consulted you on this matter. Advise
him on the following issues as per Companies Act, 2063:
i) How shares or debentures of a company can be sold or pledged on the basis of Companies
Act, 2063? 5 marks
ii) How the title of shares or debentures are transferred to new buyer? 5 marks
b) Certain numbers of students, who have passed MBA are interested to carry out a specific
business. For this they are planning to incorporate a company but they are not aware of the
process of incorporation of a company. If they approach in this respect, how will you advise them
with the legal provisions of the registration of the company as per the Companies Act, 2063 for
the below question. (3+3+4=10 marks)
i) Who can register the company and state the required conditions to register a private and
public company?
ii) State the process to be adopted for the registration of a company?
iii) State the conditions when the Company Registrar can refuse to register the company?
Answer
a)

i) Following are the provisions regarding selling or pledging of shares or debentures as

mentioned in section 42 of Companies Act, 2063:
a) The share or debenture of a company may be sold or pledged as good as movable
property, subject to this Act, the memorandum of association and articles of
association.
b) Notwithstanding anything contained in Sub-section (1), the promoter of a
company, other than a private company which has not borrowed loan from any
other company, shall not be entitled to sell or pledge any share held by him/her
until the first general meeting of that company is held and a call on the share
issued in his/her name is fully paid up.
c) where a share or debenture is pledged pursuant to Sub-section(a), the pledge shall
make an application, in such format and along with such fees as may be
prescribed, to the registered office of the company to have the matter recorded in
the register. The applicant shall also submit the deed on pledge as well as the
share or debenture certificate, along with the application to be so made.
d) Where an application is made pursuant to Sub-section (c), the company shall
record in the register the execution of such pledge and on receipt of information
on the redemption of the share or debenture so pledged, the records of such
pledge shall be crossed off the register.
 ii) Transferring of title of shares or debentures to new buyer is mentioned in section 43
of the Companies Act which is as follows:
a) If any share or debenture is sold, subject to Sub-sections(a) and (b) of Section 42,
the buyer thereof shall make an application to the registered office of the
company , in such format and along with such fees as may be prescribed, to have
such debenture or share transmitted to his/her name. The applicant shall also
submit, along with such application, a copy of the deed relating to the sale and
purchase of share or debenture certificate.
b) If an application is made under Sub-section (a), the company shall cross off the
name of transferor shareholder or debenture holder and enter the name of the
transferee shareholder in the register within fifteen days after the making of such
application.
c) Notwithstanding anything contained in Sub-section (a), if the prevailing law on
securities transactions provides that no deed of transfer is required to transfer the
title to the share or debenture of a company such deed shall not be required to be
produced along with an application to be so made.
d) If a person who transfers any securities makes an application, also accompanied
by a deed of transfer of share, signed by the purchaser to get the transfer of any
share or debenture recorded, the company shall register the name of share or
debenture transferee in the shareholder register or debenture holder register as if
such application was made by the transferee him/herself.
e) If any person acquires the title to any share or debenture by operation of any other
provision contained in the prevailing law the provision contained in Sub-section (a), shall
not be deemed to prevent the company from registering such person as a shareholder or
debenture-holder
b)
i) Any person desirous of undertaking any enterprise with profit motive may, either
singly or jointly with others, incorporate a company for the attainment of one or
more objectives set forth in the memorandum of association as per Section 3 of
the Company act 2063.
The required conditions for the registration of a private or public company can be
listed as follows:
a. Minimum number or maximum number of shareholders
According to Section 9 of the Companies Act, 2063 the number of
shareholders of a private company should not exceed one hundred one and in
case of public company the member of shareholders of a public company
should be at least seven and maximum may be unlimited. However any
employee who has purchased a share of a company under scheme of selling
shares to employees will not be counted as a shareholder
b. Minimum paid-up capital
According to Section 11 of the Companies Act, 2063 the paid-up capital of a
public company should be of ten million rupees except as otherwise provided
in the prevailing law and in case of private company there is no such
restriction.
c. The word Pvt. Ltd and Ltd at the end of the name
 A private company should add the words “private limited’’ to its name as the
last words and a public company should add the word “limited” to its name as
the last word pursuant to section 10 (Kha) of this Act. Pursuant to section 10
(Ka) of this Act the company shall carry on all of its activities and transactions
by this name.
d. Some specific business as public company only
Section 12 states that to be incorporated as public company, it needs to carry
on some specific transactions. Any company carrying on the business of
banking, financial transactions, insurance business related transactions, stock
exchange business, pension fund or mutual fund or a company carrying on
such other business or transactions as may be prescribed should be
incorporated as a public company. A private company is not allowed to carry
such substantial public concern business.
ii) It is mandatory to register a company to carry out business transaction under a
name of a company. Incorporation of a company means establishment or
registration of the company or a corporate body as a legal person or legal entity.
According to Sec. 5(5) of the Companies Act, 2063 a person cannot use the name
of company to carry any kind of transaction by the name of any institution or
firm. Thus registration of a company is compulsory to carry any business under its
name.
The process regarding registration of a company has been prescribed in Sec. 3, 4
and 5 of the Companies Act. The first amendment made in 2074.1.19 allows
incorporation of a company via electronic transmission with digital recording.
Prior to registration, it is necessary to submit an application as per Section 4 of the
Act. Any person desirous of incorporating a company pursuant to Section 3
should make an application to the Company Registrar's (Office), via electronic
transmission with digital recording proposing the name of a company. Where the
company Registrar is satisfied with the name of the proposed company it grants
approval to it.
On obtaining the approval to the proposed name it should make an application to
the Company Registrar's Office, in a prescribed format and accompanied by such
fees as prescribed, and along with the required documents as prescribed.
Where an application is made for the incorporation of a company pursuant to
Section 4, Section 5 of Company Act, 2063 states that the Office should, after
making necessary inquiries and found compliance of all the required legal
formalities for the registration of the company, give the decision as to the
registration company of this Act and require to register such company within
seven days as per the first amendment of the 2017 after the date of making of the
application and grant the company registration certificate to the applicant, in the
format as prescribed.
After a company has been registered, the company shall be deemed incorporated.
The office shall maintain a company register in the format as prescribed. After the
incorporation of a company under this Section, subject to this Act, the matters
contained in the memorandum of association and the articles of association shall
be binding on the company and its shareholders as if the provisions contained in
separate agreements between the company and every shareholder and amongst its
shareholders. Further it has also been mentioned that without registering a
 company under this Act, no person shall use the name company and carry on any
kind of transaction by the name of any firm or institution.
iii) The Office has the power to refuse to register a company under Section 6 of this
Act. Accordingly, the Office may refuse to register a company in any of the
following circumstances:
(a) If the name of the proposed company is identical with the name of a company in
existence or trademark name in existence or mislead the existing company
which has been previously registered or so resembles the name of that company
as it might cause misleading,
(b) If the name or objective of the proposed company is contrary to the prevailing
law or appears to be improper or undesirable in view of public interest,
morality, decency, etiquette etc. or reflects criminal motive,
(c) If the name of the proposed company is identical with the name of a company of
which registration has been cancelled pursuant to this Act or that of a company
which has been insolvent under the prevailing law or so resembles such name as
it might cause misleading and a period of five years has not expired five years
after such cancellation of registration or insolvency,
(d) If the requirements for the incorporation of a company under this Act are not
fulfilled.
If the office refuses to register company in any of the circumstances as referred to in
Sub-section (1) it should give a notice there of, accompanied by the reasons
therefore, to the applicant no later than 15 days after the date of application made
for the incorporation of company pursuant to Section 4.
If the office refuses to register any company pursuant to Subsection (1) or fails to
give a notice pursuant to Sub-section (2), a person who is not satisfied may file a
complaint in the commercial branch of the concerned high court within fifteen days.
2. Answer the following questions:
a) Office of the Auditor General is the Supreme Audit Institution of Nepal. It has specified
certain objectives and policies performing its task along with the Audit Act, 2075. Answer
the following question in line with the above statement. (2+5=7 marks)
i) What are the objectives under the Act?
ii) State the certain matters to be audited by the Office of the Auditor General as per the
Audit Act, 2075.
b) How does Nepal Rastra Bank mobilize Foreign Exchange Reserve pursuant to the Nepal
Rastra Bank Act, 2058? 6 marks
c) A family has intention to incorporate a company with an objective to produce petroleum
and atomic energy. They have decided to take consultancy from you. Can they produce
the energy as intended? Do they require approval and registration of the industry from
the prescribed authority? Examine the given issues as per the provisions of the Industrial
Enterprise Act, 2076. 7 marks
Answer
a)
i) The Office of the Auditor General (OAG) has following objectives under the Act:
 To promote public accountability and transparency;
  To bring forth economy in the mobilization of public resources and enhance
efficiency;
 To enhance effectiveness of public entities;
 To improve and assure clean practices in the working system of administrative,
financial and managerial system;
 To assist in compliance of the existing laws;
 To encourage abandonment of the discretionary work-style;
 To recommend practical suggestions for improvement by identifying weaknesses
and lacunae in the existing approaches, processes, practices and legal provisions;
and
 To encourage the practice of taking actions against delinquents and rewarding the
excellent performers.
ii) According to Section 8 of the Audit Act, 2075 the Auditor General, with due regard
to the regularity, economy, efficiency, effectiveness and propriety, should audit
following matters to ascertain whether:
(a) the amount appropriated in the concerned heads and sub- heads by the
Appropriation Act for respective services and activities have been expended or
not for the specified purposes of designated services or activities within the
approved limit,
(b) the financial transactions comply or not with the existing laws and the evidence
relating to items of income and expenditure are sufficient,
(c) The constitutional bodies, Ministries, Department and similar central offices,
subordinate offices, State ministries and other State offices have maintained the
accounts in the prescribed forms or not and such accounts fairly represent the
position of the transactions; showing the transaction with clear picture or not,
(d) Federal Reserve fund, State Reserve fund, Local Reserve fund, Federal
Emergency fund, State Emergency fund and other government funds have been
maintained properly or not,
(e) Concerned governmental authorities have released the budget in time or not,
(f) the financial statement has mentioned the real and clear picture of the financial
transactions of the period mentioned thereof or not,
(g) sufficient evidence pertaining to the accounts of revenue, all other incomes are
income and expenditure are correct or not,
(h) the arrangements for internal audit and internal control of cash, kind and other
governmental property against any loss, damage and abuse are adequate and if
so, are they pursued;
(i) the accounts of revenue, all other incomes and deposits are correct and the rules
relating to evaluation, realization and methods of book keeping are adequate
and if so, are they followed;
(j) the accounts relating to public debts, security, deposit, debt relief fund and the
amounts set aside for debt services and repayment of debts are accurate;
(k) progress report is there as per the audit report Actual approval of the authority
to dispose the budget
(l) Timely payment and fulfillment of the liability raised thereof
 (m) The available resources, means and assets are properly utilized and the
maintenance
(n) Maintenance and recording of the government property have been as per the
existing law or not,
(o) Protection and preservation of the government property preventing them from
loss and damage or not,
(p) Proper and adequate maintenance of the books of account relating to the
government loan and investment and the money received in terms of capital,
interest and dividend of the same have been made or not,
(r) There is availability or not of the adequate controlling legal mechanism to
prevent misappropriation of the expenditure and their proper implementation
and follow up of the same
(s) There is availability or not of the effective policy of internal controlling system
and follow up of the same,
(t) There is performance of internal auditing satisfactorily or not, and if the report
has been implemented effectively or not,
(u) There is timely recovery and deposition of the government revenue in the
government fund or not, and effort has been made for controlling leakage of the
revenue or not,
(v) There is adequacy of the legal provision relating to the deposit or not and their
proper implementation have been made or not,
(w) The organization, management and job allocation of the office are sufficient and
proper or not, and are that operating accordingly or not,
(x) Any function is being unnecessarily performed in duplication by any employee
or agency or any essential function is being omitted or not,
(y) The progress has been achieved within scheduled time and the quality and
quantity of the work is satisfactory or not,
(z) The objective and policy of the Office is explicit and the program is delineated
conforming to the specified objective and policy or not.
b) In pursuance to section 66 of Nepal Rastra Bank Act, 2058, NRB shall mobilize Foreign
Exchange Reserve in the following manner:
(1) NRB shall mobilize the foreign exchanges reserve. Such reserve shall be denominated
in the respective foreign exchange and such reserve shall consist of the following
asset:
(a) Gold and other precious metals held by or for the account of NRB;
(b) Foreign currencies held by or for the account of NRB;
(c) Foreign currencies held in the accounts of NRB on the books of a foreign central
bank or other foreign banks;
(d) Special drawing rights (SDR) held by NRB at the International Monetary Fund;
(e) Bill of exchange, promissory note, certificate of deposit, bonds, and other debt
instrument payable in convertible foreign currencies issued by any debtor or
liability holder and held by NRB;
 (f) Any forward purchase or repurchase agreements of NRB concluded with or
guaranteed by foreign central banks or public international financial institutions,
and any futures and option contracts of NRB providing for payment in freely
convertible foreign currency.
(2) While selecting the assets referred to in Sub-section (1), due consideration should be
given to NRB's capital and liquidity to maximize earnings.
(3) NRB shall maintain international reserve at a level, which shall be adequate for the
execution of monitory and exchange rate policies and for the prompt settlement of the
international transaction.
(4) If international reserves have declined or, in the opinion of Bank, are in danger of
declining to such an extent as to jeopardize the execution of the monetary or
exchange rate policies in the prompt settlement of the country's international
transactions, NRB shall submit to Government of Nepal a report on the international
reserves position and the causes which have led or may lead to such a decline,
together with such recommendations as it considers necessary to remedy the
situation.
(5) Until such time as, the situation referred in Sub-section (4) has been rectified, NRB
shall make further such report and recommendations to Government of Nepal.
(6) NRB shall hold the foreign exchange reserve referred to in sub-section (1) in its
balance sheet.
c) Legal Provision and validity of production of petroleum and atomic energy:
Section 8 (1) and Annex-1 of the Industrial Enterprises Act, 2076 have provided the
petroleum products excavation industry could be established after taking approval from
the Industry and Investment Promotion Board.
Similarly, Annex-3 has provided about the industries that produce energy from water,
wind, solar power, coal, natural oil and fuel or gas, biomass or other resources and
industries which manufactures machines/equipment that is used to produce such energy.
However, there is no any express provision about the atomic energy. It may be subject
matter of interpretation from authorized institution. It could be inserted in the provision
mentioned the word 'other resources'.
Sub section 4 of Section 4 of this Act has imposed restriction to establish the atomic
energy by any of the person(s) except by of the Nepal Government. It provides that
notwithstanding anything contained in sub-section (1) and (2) of section 4, the industries
that produce atomic energy, radioactive materials, industries concerning atomic energy
and industries based on Uranium shall only be established and operated by Government
of Nepal only. Therefore, the family can incorporate a company having its objectives of
petroleum products excavation only but not to produce atomic energy.
Industries requiring prior approval before registration:
Annex-1 of the Industrial Enterprise Act, 2076 has been provided the list of the industries
that requires approval before registration. The industries are as follows:
1. Industries producing arms, ammunitions, gunpowder or explosives.
2. Security printing, bank notes and coin industries,
3. Cigarette, bidi, khaini, cigar, chewing tobacco and industries producing other goods
of a similar nature utilizing tobacco as the basic raw material and industry producing
electric cigarettes,
 4. Microbrewery, beer, Alcohol or substances beer producing industries, 5. Stone,
ballast, sand excavation and processing industry,
6. Industries producing radio communication equipment,
7. Industries like mining of precious minerals and petroleum products excavation,
8. Liquefied petroleum gas (L.P.G) refilling industries,
9. All kinds of industries that produce drone products or provide services through drone,
10. Other industries that need to take permission as prescribed by the prevalent laws.
In accordance with the provision as provided in Section 8(1) and of the above Act the
annex-1 the petroleum products industries are also required to obtain approval from the
Industry and Investment Promotion Board. However, company cannot be established and
operated to produce atomic energy by the public except Government of Nepal.
3. Answer the following questions:
a) Mr B is one of the nominees of Government of Nepal to the Council of the Institute of
Chartered Accountants of Nepal. As he assumes the post, he wants to get acquainted with
functions, duties and power of council. Suggest him the major functions, duties and
power of Council under the Nepal Chartered Accountants Act, 2053? 8 marks
b) A group of non-residential Nepalese intended to carry insurance business in Nepal. They
have no knowledge about the legal provisions of Nepal in this respect. So they
approached you as an expert for the registration of an insurance company as an insurer.
How would you advise them regarding following: 7 marks
i. Registration process of an insurance business.
ii. Cancellation of Registration of an Insurer.
c) What is international financial transaction? State Bank of Gujarat (SBG) is willing to
carryout international financial transactions. Give your advice as to the authority that
grants a license to SBG and also state the formation of the authority granting license for
the international financial transaction under the International Financial Transaction Act,
2054. 5 marks
Answer
a) Section 11 of Nepal Chartered Accountants Act, 2053 mentions about the functions,
duties and power of Council which are as follows:
(a) To conduct examinations of candidates who join the accountancy.
(b) To determine the procedures in relation to the membership of the Institute and
registration of name as a member having obtained professional certificate.
(c) To provide a person who holds the required qualification with an appropriate type
of membership of the Council pursuant to Section 16 of this Act.
(d) To make coordinative development of the accountancy by having maximum
utilization of the available means and resources.
(e) To determine the qualification required for efficient human resources for the
development of the accountancy.
(f) To determine the type of curriculum and practical training required to pursue the
qualification necessary for obtaining the membership.
(g) To carry out different teaching and training programs in cooperation with any
university or other educational institute or by the Institute itself.
(h) To grant the professional certificate to the members for carrying on the
accountancy.
(i) To enhance the capacity of members by providing them with career development
opportunities.
(j) To monitor as to whether or not the members or members having obtained the
professional certificate have acted in conformity with the professional code of
conduct prescribed for the members or members having obtained the professional
certificate.
(k) In accordance with the recommendation of the disciplinary committee, to take
necessary action against any members and members having obtained the
professional certificate for their acts and actions in contravention of the
professional code of conduct.
(l) To give theoretical or practical directions and guidelines in various aspects of the
accountancy and auditing and carry out other functions as may be necessary for
the professional development.
(m) To observe, or cause to be observed, accounting standards and standards on
auditing provided or recommended by the Accounting Standards Board and
Standards on Auditing Board, and to regulate whether such standards have been
observed or not.
(n) To safeguard and promote the rights, interests and reputation of the members.
(o) To render advice and suggestion to Government of Nepal for the improvement of
the various laws in force in the fields related with industry, commerce, finance,
revenue and accountancy.
(p) To accept membership of the International Federation of Accountants, and
regional and sub-regional federations, and establish contact with the accountant
institutes of other countries.
(q) To recommend appropriate educational standards for accounting education in
coordination with universities and other educational institutes.
(r) To conduct necessary trainings, symposia and seminars in order to enhance
professional efficiency of the registered auditors.
(s) To conduct short term or long term trainings, symposia etc. for the benefit of
accountancy human resources in service.
(t) To publish materials relating to the accountancy.
(u) To operate a library relating to the accountancy.
(v) To determine the procedures to be followed by the committees to be formed by
the Council.
(w) To approve the budget of the Institute and manage the funds.
(x) To appoint such employees as may be required for the Institute and prescribe their
remuneration and other facilities.
(x1) To provide on-going professional education for members.
(x2) To develop educational system in order to prepare account technicians and do
necessary acts pertaining thereto.
 (y) To carry out such other functions as are prescribed by this Act or the Rules and
Bye-laws framed under this Act.
(z) To carry out such other functions as may be necessary for the attainment of the
objectives of this Act.
b)
i) Section 10 of the Insurance Act, 2049 prescribes the provision regarding the
Registration of the Insurer as follows:
(1) No Person shall operate or cause to operate the Insurance Business without
obtaining a certificate pursuant to this Act.
(2) Any national or foreign corporate body desirous to operate an Insurance
Business shall submit an application to the office of the Board in the prescribed
form along with the following documents and prescribed fees for the
registration of its name as an Insurer:
(a) Memorandum and articles of association of the corporate body,
(b) Insurance Business to be operated and its policies and terms and conditions,
(c) If life Insurance Business to be operated, documents displaying calculations
of the premiums to be received in operating such business and liability,
(d) The documents regarding the methods of utilizing the amounts to be
received from the Insurance, and
(e) Other necessary documents as prescribed by the Board.
(3) The Board shall make necessary investigation upon the application received
pursuant to Sub-section (2) and shall make an inquiry with the applicant, if
necessary, and shall register the name of such applicant in the prescribed
register-book by mentioning the types of the Insurance Business to be operated
by the applicant and shall provide the registration certificate of Insurer to the
applicant in the form as prescribed. In case there is any reasonable ground for
not registering the name, the Board shall inform the concerned applicant
accordingly.
(4) Notwithstanding anything contained elsewhere in this Section, in the case of the
Life Insurance, the Board shall, with the approval of the Nepal Government,
issue a certificate to operate the Business, based on the fulfillment of the criteria
which it has fixed, from time to time, in respect of the operation of the
Insurance Business.
ii) Section 13 of the Insurance Act, 2049 prescribes the provision regarding the
cancellation of the insurer. According to it the Board may cancel the registration of an
Insurer by providing a written notice with effect from the date prescribed in the same
notice in the following circumstances:
(a) If the Insurance Business is not started within six months from the date of
obtaining the certificate,
(b) If it is felt that the liability of the Insurer exceeds its assets within Nepal,
(c) If the Insurer could not fulfill the liability pursuant to the decision within three
months from the date of final decision of the court in the case filed under the
Insurance Policy issued within Nepal,
 (d) If the head office of the Insurance Business of any foreign Insurer is situated
outside Nepal and in case it is felt that Nepalese Insurer has not obtained equal
facilities there which are enjoyed by the foreign Insurer pursuant to the prevailing
law of such country,
(e) If the Insurer does not open its office inside Nepal,
(f) If the Insurer does not perform the functions to be performed or has performed
any functions which is not to be performed pursuant to this Act or the Rules made
under this Act.
However, before canceling the registration of an Insurer pursuant to Subsection (1),
the Board shall provide a reasonable time-limit to submit clarification to the
concerned Insurer, stating the reasons for canceling its registration.
If the concerned Insurer does not submit its clarification within the time period
mentioned in Sub-section (2) or in case the clarification submitted by it is found not
to be satisfactory, the Board shall cancel the registration of such Insurer pursuant to
Sub-section (1), and shall publish a notice in two major newspapers to be published
Nepal for the information public in general.
Mere cancellation of the registration of an Insurer pursuant to this Section shall not
make any effect to the rights and liabilities of the concerned Insurer regarding to any
action taken or functions performed before the cancellation.
c) Section 2(a) of International Financial Transaction Act, 2054 (IFTA) has defined the term
"International Financial Transaction" as any financial transaction carried out by any
license holder entity under this Act.
In accordance with section 3 of the IFTA the Accreditation Committee grant a license
and to regulate to an international financial entity interested to carryout international
financial transactions.
The formation of Accreditation Committee as mentioned in the section 11 of the Act is as
follows:
(a) Governor, Nepal Rastra Bank - Chairperson
(b) Secretary, Ministry of Finance - Member
(c) Secretary, Ministry of Law and Justice - Member
(d) One person nominated by Government of Nepal from among Chartered Accountants
- Member
(e) One person nominated by Government of Nepal from among Economists - Member
The Accreditation committee may invite national or foreign experts or advisors involved
in international financial transactions to participate at its meetings as observers.
An officer-level employee of Nepal Rastra Bank as designated by the Accreditation
Committee with the consent of the Nepal Rastra Bank shall act as Secretary of the
Accreditation Committee.
4. Answer the following questions:
a) Mr A, B and C having 6% of total share capital of XYZ Ltd, would like to commence a
process of liquidation. They aren’t aware on the process of liquidation and consulted you
regarding this issue. Suggest them how liquidation process can be commenced? Who can
apply for the commencement of liquidation process? Provide your answer on the basis of
Insolvency Act, 2063. 7 marks
 b) Mr. B. B. Karki is master degree holder and having more than seven years of experience
in corporate and other laws. He has been nominated for the member of Nepal Securities
Board. He holds other qualifications for being a member of the Board. However, other
member has allegation that he has been suffering from lack of competence. So, there is a
demand of his removal. State the qualifications, disqualifications and grounds of removal
of the member of Nepal Securities Board and justify the logic of his removal quoting the
provisions of the Securities Act, 2063. 8 marks
Answer
a) Liquidation of a company means a situation where the registration of a company is
cancelled by fulfilling the procedures mentioned in the insolvency Act. Section 4 of the
Insolvency Act, 2063 mentions about the process of commencing liquidation process
which is as follows:
(1) Where it is required to institute liquidation proceedings against any company, any
of the following persons may make an application to the Commercial Bench of the
concerned High Court in the prescribed form for the commencement of such
proceedings:
(a) A company itself which has become insolvent;
(b) Out of the total creditors of a company which has become insolvent, at least ten
percent creditor or creditors who has or have lent money;
(c) Shareholder or shareholder/s that has or have subscribed at least five percent of
shares, out of the total shareholders of a company;
(d) Debenture-holder or debenture-holders that has or have subscribed at least five
percent of debentures, out of the total debenture-holders of a company;
(e) A liquidator who has been appointed to liquidate the company; or
(f) In the case of a company that carries on any specific type of business set forth in
Section 8 of this Act, a body authorized to administer and regulate such
business.
(2) In order for an application to be made pursuant to Sub-section (1), a period of thirty
five days shall have been expired after a notice issued to pay the debt referred to in
Section 5 of this Act has been duly served on the concerned company.
(3) Every application to be made pursuant to Sub-section (1) above shall be
accompanied by the reason for making the application, short description of the
financial condition of the company and the evidence supporting the fact that the
company has become insolvent and the following details, as well:
(a) Where the company itself which has become insolvent makes such application:
(i) A document certified by the board of directors of the company,
mentioning that the company has become insolvent;
(ii) A special resolution adopted by the board of directors of the company to
institute the insolvency proceedings pursuant to this Act;
(iii) Certified copies of the balance sheet and audit report of the company
available at the time of making application for the institution of insolvency
proceedings.
(b) Where the creditor of a company which has become insolvent makes such
application:
 (i) A statement of the principal and interest of the debt which the creditor
claims to be due and payable by the company;
(ii) The date on which the company borrowed the debt claimed by the creditor
and the reason why the debt was borrowed;
(iii) Description that the amount referred to in Clause (1) is due and such
amount is payable immediately;
(iv) That the debtor believes or the reason and ground the debtor has to believe
that the company in respect of which demand is made for insolvency
proceedings has become insolvent.
(c) Where the liquidator makes such application:
(i) Evidence that the company in respect of which application is made for
insolvency proceedings has appointed the liquidator for the purposes of
liquidation of the company; and
(ii) The opinion expressed by the liquidator on the matter that the company in
respect of which application is made for insolvency proceedings has
become insolvent, and the ground for such opinion.
(4) Notwithstanding anything contained elsewhere in this Section, any shareholder or
debenture-holder of a company shall obtain permission of the Court to make an
application for insolvency proceedings pursuant to Clause (c) or (d) of Sub-section
(1), and the shareholder or debenture-holder may, if so permitted, make an
application on such terms and conditions as may be specified by the Court.
(5) The Court shall not give permission referred to in Sub-section (4) in above unless
and until sufficient evidence proving that the company has become insolvent is
produced.
b) Section 10 of the Securities Act, 2063 has prescribed the qualifications of a Chairperson
or a member of the Nepal Securities Board as follows:
(a) One who is a citizen of Nepal,
(b) One who has maintained high moral character,
(c) One who has gained at least seven years of professional Experience in the field of
stock exchange, management, capital market development, economics, finance,
commerce, management or law, and
(d) One who is not disqualified under Section 11 of this Act.
Any of the following person shall not be eligible to be appointed to the office of
Chairperson or member, as the case may be:-
(a) One who is an officer-bearer of a political party,
(b) A person involved in securities business,
(c) One who is adjudicated as an insolvent,
(d) One who is insane,
(e) One who has been convicted by the court of an offense involving moral turpitude.
Section 12 (1) has provided the circumstances on which a Chairperson and a member
may be removed from office: Where there occurs a circumstance for removal of the
Chairperson or the member referred to in sub section (2), the Government of Nepal shall
remove the Chairperson and member, as the case may be. Provided that prior to making
 such a removal, the Government of Nepal shall not deprive the concerned person of a
reasonable opportunity to defend him/herself.
The Chairperson and the member, as the case may be, shall be removed from the office in
any of the following circumstances pursuant to section 12 (2) of this Act:-
(a) If one is disqualified to be a Chairperson and a member, as the case may be, pursuant
to Section 11 above,
(b) If one commits any act contrary to the interest of investors in securities or any act
that may cause loss or damage to the development of capital market,
(c) If one suffers from lack of competence to implement, or cause to be implemented,
such functions required to be performed by the Board to attain the objectives of the
Board pursuant to this Act or the Rules framed under this Act,
(d) If one has been held disqualified to carry on any occupation or business by the
reason of misconduct and his or her certificate has been revoked or he or she has
thus been restricted to carry on a business,
(e) If one remains absent from three consecutive meetings of the Board without giving a
notice.
Mr BB Karki has been alleged that he has lack of competency and claimed to be removed
from the office. There is a ground of removal on the circumstances of lack of
competence. However, he has to be given reasonable opportunity to defend himself. It
should be proved no doubt that he is suffering from incompetence. If he is suffering from
such circumstances then he could be removed from the office of the member of Board.
5. Answer the following questions: (3×5=15 marks)
a) Mention the circumstances where international bidding can be published in order to
procure the goods and services as per the Public Procurement Act, 2063.
b) Describe the procedure for the receipt of payments of the exported goods as per the
Foreign Exchange (Regulation) Act, 2019.
c) Explicitly mention the objectives and functions of Cooperative Organization or
Association formed and operated under the Cooperative Act, 2074.
Answer
a) Section 15(1) of Public Procurement Act, 2063 has mentioned various circumstances
(criteria) where public entity shall make an international bidding. These circumstances
are as follows:
(a) If the goods or construction works as requisitioned by a public entity are not available
at the competitive price from more than one construction entrepreneur or supplier
within the State of Nepal,
(b) If no bid has been submitted in response to an invitation to national bidding for the
procurement of goods, construction works or other services, and the same has to be
procured from abroad,
(c) If foreign goods or construction works have to be procured through the foreign
assistance source pursuant to the agreement entered into with a donor party,
(d) If it is certified by the public entity that the goods or construction works, being of
complex and special nature, have to be procured through international bidding.
 A notice on invitation to international bidding referred to in this Section shall be
published in the English language, and all bidding or prequalification documents shall be
made available in the English language.
The notice referred to in sub-section (2) above of this Act shall be posted in the website
referred to in sub-section (2) of Section 14.
b) Section 9A of Foreign Exchange (Regulations) Act, 2019 has explained the procedures to
receive payment of value of exported goods as follows:
1) An exporter shall fill up the particulars mentioned in the declaration form prescribed
by the bank and declare before the customs officer that he will be bring payment in a
foreign exchange approved by the bank of the amount mentioned in such declaration
form within the prescribed time limit
2) In circumstances in which the amount to be received as payment for exported goods
is higher or lower than the amount mentioned in the declaration form before receiving
payment for the exported goods, he exporter shall submit an application to the bank
along with evidence thereof, and in case the matter is proved, the bank may grant
approval for receiving such higher or lower amount.
3) In case the exporter failed to obtain payments for the exported goods within the time
limit prescribed under sub-section (1) above, he shall be deemed to have violated this
act.
4) Notwithstanding anything contained in sub-section (3) above, in case the exporter
submits an application to the bank clearly mentioning legitimate reasons for his
failure to obtain payments for the exported goods within the time limit prescribed
under sub-section (1), and in case the bank is satisfied with such reason, it may order
the exporter after prescribing another time limit as in the following:
a) If the goods have already been sold, to bring payments therefore;
b) If the goods have not yet been sold, to sell them and bring the payments, or to
bring the goods back to Nepal
Provided that in case any exporter submits an application to the bank citing any
appropriate reason for his failure to bringing payments for goods exported by him due
to circumstances beyond his control, the bank shall conduct necessary investigations
and permit him to bring the goods back or exempt him from bringing in payments
either fully or partially.
5) In case the bank wishes to authenticate that the amount mentioned in the declaration
form will be paid in the prescribed manner within the prescribed time limit, it may
ask the exporter to submit the agreement concluded by the exporter with the foreign
buyer in that connection, as well as other evidence.
6) For the purpose of ensuring the full receipt of payments for exported goods, the bank
may issue orders in regard to all or any specific type of goods, or all or any specific
exporter, making it obligatory to act as follows:
a) Except in circumstances when Nepal Government has prescribed otherwise, to
receive payments for exported goods either through letters of credit or through
other means prescribed by the bank
b) or the purpose of certifying that the price mentioned in the declaration form under
sub-section (1) above is the actual export price, to submit such declaration form to
the authority or institution prescribed by the bank
 7) However, the provisions concerning the export of know-how and information-
oriented technologies and the procedure of receiving payments therefore shall be as
prescribed by the bank through the publication and broadcast of public notification.
c) Section 24 of the Cooperatives Act, 2017 provides the objectives of the Cooperative
Organization or Association. The main objective of a Cooperative Organization or
Association shall be to attain economic, social and cultural prosperity based on working
areas and on being concentrated on its members.
Section 25 of this Act deals with the functions of Cooperative Organization or
Association as under:
a) To comply with or cause to be complied with the values, norms and principles of
cooperatives;
b) To promote interests of members and its own and to carry out or cause to be carried
out their marketing;
c) To provide education, training and information to members and to promote or cause
to be promoted good governance in Organization or Association;
d) To promote or cause to be promoted mutual cooperation between Organization and
Association;
e) To determine standards of the products and services of the Organization or
Association and to carry out functions as to quality reform, economic stability and
risks management;
f) To submit internal control system;
g) To operate activities relating to commercial promotion and development of
Organization or Association;
h) To comply with the directives of the Ministry, Registrar, Province, local level or
office;
i) To carry out functions referred to in the Byelaws.
6. Answer the following questions:
a) What is an arbitration award? Explain. 3 marks
b) What are the objective of the "Act Relating to Institutions as Financial Intermediary,
2055" Also highlight the provisions of accounts and audit as prescribed. 4 marks
c) Mention various actions (NRB) may take for failure to abide by the order or directive
issued pursuant to the Foreign Exchange (Regulation) Act, 2019. 3 marks
Answer
a) Arbitration award is a decision given by the Arbitration Tribunal. Section 26 of the
Arbitration Act, 2055 has made the provision regarding the final award of the Tribunal. If
the arbitrators are three or more than three majority decision is the decision of arbitration
tribunal.
In case of different opinion among the arbitrators, the opinion of the chief arbitrator is the
decision of arbitration tribunal.
All the arbitrators need to make the signature in the award. In case of descending opinion
the concerned arbitrator need to make the decision in his opinion.
b) Preamble of the Act Relating to Institutions Acting as Financial Intermediary, 2055
highlights the following objectives as under;
 This Act aims to provide for the institutions, which act as financial intermediaries, to
collect micro-savings and provide microcredit for bringing about improvement in the
economic condition of the persons who reside in various parts of the country and have
low income by having them participate in the micro-business.
Provisions related to accounts and audit of Financial Intermediary institution have been
provided under section 26 of this Act, as under:
(1) The institution shall maintain separate accounts of the activities relating to financial
intermediation, and prepare a balance sheet for each financial year, and get the same
audited by any recognized auditor appointed by the general meeting of the institution
within six months after the expiration of the financial year.
(2) In appointing an auditor pursuant to Sub-section (1) above, the same person or firm
shall not be appointed for more than three consecutive times.
(3) The remuneration of auditor shall be as specified by the general meeting of the
institution.
(4) If Nepal Rastra Bank so wishes, it may at any time examine or cause to be examined
the accounts of the institution.
c) Pursuant to section 3A(1) of the Foreign Exchange Regulation Act, 2019, Nepal Rastra
Bank (the Bank) may take action against a licensee who fails to abide by the order or
directive issued by the Bank pursuant to this Act, the Bank may take any or all of the
following actions against such a licensee:
(a) To admonish,
(b) To impose restriction on any or all of the foreign exchange transaction,
(c) To forfeit the cash deposit in the Bank or make recovery from the guarantee,
(d) To suspend or cancel the license.
In taking action against the licensee pursuant to Sub-section (1) above, the licensee shall
be provided with a reasonable opportunity to defend himself or herself.