Revisionary Test Paper_Intermediate_Syllabus 2012_June2014

Paper 12 – Company Accounts and Audit

Section A – Generally Accepted Accounting Principles (GAAP)

(1) (A) Give a brief note on the component of Financial Statement.

Answer:

Financial Statement Source / Type of Companies

Components

Profit and Loss Account Under section 210(1) of the companies Act in accordance
Schedule and Notes Forming with the provisions of the Companies Act and the Indian
Part thereto GAAP, to be prepared by all the companies.
As per section 211(3B) all applicable accounting standards
should be followed. Otherwise reasons of departure from
accounting standards and financial effect should be
disclosed.
Compliance with accounting standards without any
deviation is mandatory for the listed companies as per
clause 50 of the Listing Agreement vide SEBI Circulars SMRP/
Policy/ Cir-44/01, Aug 31,2001

Cash Flow Statement As per clause 32 of the Listing Agreement vide SEBI circular
SMD-II/Policy/cir-80/2000 February 4, 2000. Cash Flow
Statement should be prepared in accordance with the
requirements of AS- 3 issued by the ICAI.
To be prepared by listed companies.

Consolidated Financial Applicable to listed companies as per the SEBI circular

Statements SMRP/policy/cir-44/01, Aug.31,2001
Companies Listed in a recognized stock exchange shall be
mandatorily required to publish Consolidated Financial
Statements in the annual report in addition to the individual
financial Statements shall be mandatory.
To be prepared in accordance with AS-21 and AS-23.
Section 217 (2AA) requires that board’s Report shall include
a Director’s Responsibility Statement in which it is to be
indicated that in the preparation of annual accounts, the
applicable accounting standards are followed.

(B) What are the Accounting assumptions in preparation and presentation of a Financial
Statement?
Answer:
Accounting Assumption
Underlying assumptions for the preparation and presentation of financial statements are accrual
and going concern. Under accrual assumption, the effects of transactions and other events are
recognised when they occur (and not as cash or its equivalent is received or paid) and they are

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recorded in the books of account and reported in the financial statements of the periods to
which they relate. It helps in performance measurement in a better manner and identifying the
financial position appropriately.
Under going concern assumption, the financial statements are normally prepared on the
assumption that an entity is a going concern and will continue in operation for the foreseeable
future. Therefore, it is assumed that the entity has neither the intention nor the need to liquidate
or curtail materially the scale of its operations; if such an intention or need exists, the financial
statements may have to be prepared on a different basis. In case going concern basis could
not be used, the entity shall disclose the basis used as well.

2. (A) UPC Ltd. purchased fixed assets for US $ 50 lakhs costing ` 1825 lakhs on 1.4.2011 and the
same was fully financed by the foreign currency loan [i.e.US Dollars] repayment in five equal
instalments annually. [Exchange rate at the time of purchase was 1 US Dollar = ` 36.50]. As on
31.3.2012 the first installment was paid when 1 US Dollar fetched `41.50. The entire loss on
exchange was included in cost of goods sold etc. UPC Ltd. normally provides depreciation on
fixed assets at 20% on WDV basis.
Solution:
In this case AS-11 (pre-revised 1994) shall be applicable on Accounting for effects of changes in
Foreign Exchange Rates, as the transaction in foreign currency has been entered into by the
reporting enterprises before 1.4.2012. Exchange differences arising on repayment of liabilities
incurred for the purpose of acquiring fixed assets, should be adjusted in the carrying amount of
the respective fixed assets. The carrying amount of such fixed assets to the extent not already so
adjusted or otherwise accounted for , also to be adjusted to account for any increase or
decrease in the liability of enterprise, as expressed in the reporting currency by applying the
closing rate, for making payments towards the whole or a part of the cost of the assets of for
repayment of the whole or a part of the monies borrowed by the enterprise from any person
directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets.
Thus the entire exchange loss due to variation of ` 50 lakhs on 31-3-2012 on payment of US $ 10
lakhs should be added to the carrying amount of fixed assets and not to the cost of goods sold.
Further, depreciation on the unamortized depreciable amount should also be provided, in
accordance with AS-6 on Depreciation Accounting.
Calculation Exchange loss:
1825 lakh
Foreign currency loan = = 50 lakhs US Doller
36.50 lakh
Exchange loss on outstanding loan on 31-3-2012 = 40 lakhs US $ X (41.50-36.50) = ` 200 lakhs
should also be added to cost of fixed asset with corresponding credit to outstanding loan.
Calculation of additional depreciation on account of increase in the depreciable amount of
fixed assets = 20% of ` 250 lakhs = `50 lakhs

(B) AD Softex (India) Ltd. entered into purchase of forward contract as under:
Amt. of foreign currency US $ 100000

Date of entering in forward cover 28-2-2014

Exchange rate of this date ` 47.10 per US $

Forward Rate ` 48

Period of forward cover 3 months (31-5-2014)

Spot Rate on reporting date (31-3-2014) ` 47.85

Forward Rate available at the reporting date `47.50

For the remaining maturity of the contract

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Forward cover has been entered into for sole purchase of managing risk associated with change
of exchange rate for payment to supplier against purchase.
Required:
a) Calculate the forward premium/discount
b) Accounting for such forward premium/discount.
c) Calculate the exchange difference on 31-3-2014 (reporting date)
d) If the forward contract entered into is for speculation, what is the profit/loss for the period?

Answer:
(a) As per AS-11 forward premium is to be calculated as under:
(Forward contract rate less spot rate on the date of entering forward contract)
= (48.00 - 47.10) = 0.90 X 1, 00,000 = ` 90,000 is premium paid for forward contract.
(b) This premium should be amortized as expense over the life of the contract in absence of
clear cut method of amortization in AS-11, it is better to amortize on straight-line method
over three months. One month for the reporting period 31-3-2014 = 90,000/3 = ` 30,000
Two months for the next accounting period (April and May 2014) = 90,000/3 X 2 = 60,000
(c) Exchange difference on reporting date 31-3-2014
Rate at the inception of forward contract `47.10 per US$
Rate on the reporting date `47.75 per US $
Difference (47.85-47.10) = 0.75 X 100,000 = ` 75,000 credited to Profit and Loss A/c as exchange
gain on forward contract.
(d) If the forward contract is for speculation -
The forward contract value should be marked to market on the reporting date
Rate of forward contract `48.00 per US$
Forward contract available for remaining period of maturity on the reporting date = `47.50 per
US $ (Current market value)
If forward contract is marked to market there will be a loss of ` 50,000 as under:
Difference (48.00-47.50) X 1,00,000 = `50,000 (loss)
This loss should be debited to profit and loss account for the period ended 31-3-2014.

(C) Shyam Management Institute furnishes you the following information in respect of
Development Fund in the year 2013-14:

Particulars (` in crores)

Govt. grant received for construction of Building 50

Private grants for acquisition of Land 25

Transfer from unrestricted fund for purchase of furniture 1

Income from fixed deposit (Fixed deposit for one year ` 25 crores) 2

Cost of Land 30

Advance payment made for acquisition of further land 5

Furniture purchased 1

Payment made to contractors for construction of Building 8

Prepare a Statement of changes in balance of Development Fund for the year 2013-14 and
Balance Sheet for the Development Fund as on 31.03.2014.

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Solution:
(a) Statement of changes in Balance of Development Fund.

Particulars (` in crores)

Government grant 50

Private grant 25

Transfer from unrestricted fund 1

Income from fixed deposit 2

Less: Payments: 78
Cost of Land 30
Furniture Purchased 1 31

47

(b) Balance Sheet for the Development Fund as at 31.03.2014

Liabilities Amount Assets Amount

` crores ` crores

Development Fund Advance Payment of Land 5

Balance 47 Fixed Deposits 25
Construction of Building 8
Cash at Bank 9*

47 47

**Balance of Cash and Bank Receipts

Particulars (` in lakhs)

Government grant 50

Private grant 25

Transfer from unrestricted fund 1

Income from fixed deposit 2

78
Less: Payments:
Land 30
Advance for Land 5
Fixed Deposit 25
Furniture 1 69
Contractors 8

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3. (A) A limited company has set up its business in a designated backward area which entitles it
to receive, as per a public scheme, announced by the Govt. of India, a subsidy of 25% of the
cost of investment. Having fulfilled all the conditions laid down under the scheme, the company,
on its investment of ` 300 lakhs in capital assets during its accounting year ended 31.3.2014,
received a subsidy of ` 75 lakhs in January 2014 from the Govt. of India. The accountant of the
company would like to record the receipt as an item of revenue and to reduce the losses on the
Profit and Loss Account for the year ended 31.3.2014.
Is his action justified? Discuss.
Solution:
As per para 8.4, AS 12, grants related to depreciable assets are treated as deferred income
which is recognised in the profit and loss statement on a systematic and rational basis over the
useful life of the asset. Such allocation of income is usually made over the periods and in the
proportion in which depreciation on related assets is charged.
Thus, in the present case, the subsidy amounting to ` 75 lakhs which had been received for the
acquisition of capital asset is a depreciable in character. As per above provisions the above
subsidy should not be credited to Profit and Loss Account for the period ended 31.3.2014; rather,
the said amount of subsidy should be credited to Profit and Loss Account as a recognised one in
proportion to depreciation charges.
(B) Based on the following information, calculate the actual return on pension plan assets:

Particulars Amount ( `) Amount (`)

Benefit payments 2,50,000

Contribution 2,90,000

Fair market value of plan assets

End of year 7,90,000

Beginning of year 7,20,000

Solution: The actual return on pension plan assets follows:

Particulars Amount (`) Amount (`)

Change in fair market value of plan assets (7,90,000 – 7,20,000) 70,000

Adjustments:

Employer Contribution 2,90,000

Less: Benefit payments 2,50,000 40,000

Actual return on plan assets 30,000

(C) A company reports the following information regarding pension plan assets. Calculate the
fair value of plan assets at the end of the year.

Particulars Amount (`)

Fair market value of plan assets (beginning of year) 6,30,000

Employer Contribution 1,70,000

Actual return on plan assets 90,000

Benefit payments to retirees 3,40,000

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Solution:
The actual return on pension plan assets follows:

Particulars Amount (`)

Fair market value of plan assets (beginning of year) 6,30,000

Employer Contribution 1,70,000

Actual return 90,000

Benefit payments (3,40,000)

Fair market value of plan assets (end of year) 5,50,000

4. (A) R Ltd. (the lessee) acquired machinery on lease from S Ltd. (the Lessor) on January1,2010.
The lease term covers the entire economic life of the machinery i.e. 3 years. The fair value of the
machinery on January 1, 2010 is `3,50,000. The lease agreement requires the lessee to pay an
amount of `1,50,000 per year beginning on December 31,2010. The lessee has guaranteed a
residual value of `11,400 on December 31, 2012 to the lessor. The lessor however estimates that
the machinery will have a salvage value of only `10,000 on December 31, 2012. The implicit rate
of interest is 15% p.a. Compute the value of machinery to be recognized by the lessee and also
the finance charges every year on the basis of AS-19. PV Factor of 15% in three years is 2.283.
Solution:
As per para 11 of AS-19, at the inception of a finance lease, the lessee should recognize the
lease as an asset and a liability. Such recognition should be at an amount equal to the fair value
of the leased asset at the inception of lease. However, if the fair value of leased asset exceeds
the present value of minimum lease payments from the standpoint of the lessee, the amount
recorded, as an asset and liability should be the present value of minimum lease payments from
the standpoint of the lessee. In this case fair value of the machinery is `3,50,000 and the net
present value of minimum lease payment from the minimum lease payment is not less than the
fair value, then the machinery will be recognized by the lessee at `3,50,000.
Present value of minimum lease payment:
Annual lease rental X P.V Factor + Present value of Guaranteed residual value
= `1,50,000 X (0.8695 +0.7561 +0.6575) +11,400 X 0.6575
=`(3,42,465 +7,496) = Payment `3,49,961. Rounded off to `3,50,000

Year Finance Payment Reduction in Outstanding Outstanding

Charges ` Liability Liability
` ` `

Year 1(January 1) - - - 3,50,000

(Dec.31) 52,500 1,50,000 97,500 2,52,500

Year 2 (Dec.31) 37,875 1,50,000 1,12,125 1,40,375

Year 3(Dec.31) 21,056 1,50,000 1,28,944 11,431

(B) An Equipment is leased for 3 years and its useful life is 5 years. Both the cost and the fair
market value of the equipment are `3,00,000. The amount will be paid in 3 instalments and at the
termination of lease lessor will get back the equipment. The unguaranteed residual value at the
end of 3 years is `40,000. The (internal rate of return) IRR of the investment is 10%. The present
value of annuity factor of `1 due at the end of 3rd year at 10% IRR is 2.4868. The present value of
`1 due at the end of 3rd year at 10% rate of interest is 0.7513.

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(i) State with reason whether the lease constitute finance lease
(ii) Calculate unearned finance income.

Solution:
As per the question, IRR of the investment is 10%
Investment in lease is ` 3,00,000
If IRR is 10% that means P.V. of minimum lease payment (MLP) from lessor point of view plus
unguaranteed residual value is equal to ` 3,00,000.
P.V. of unguaranteed residual value - (40,000 X 0.7513) = ` 30,052
P.V. of M.L.P. should be `(3,00,000 -30,052) = ` 2,69,948
As at the beginning of lease period the P.V. of M.L.P cover substantially the initial fair value i.e.,
2,69,948/3,00,000 = 90% approx.
Moreover lease period covers major part of the lease of the asset
Hence, it is a finance lease.
Calculation of annual lease payment to the lessor = 2,69,948/2.4868 = `1,08,552
Gross investment in lease – 1,08,552 X 3 = ` 3,25,657
Unguaranteed residual value - ` 40,000
` 3,65,657
Less: P.V. of Gross investment in lease ` 3,00,000
Unearned finance income ` 65,657

(C) Briefly discuss how do you calculate diluted earning per share as per AS 20.

Answer:
As per paras 26, 27, and 30 of AS 20:
For the purpose of calculating diluted earnings per share, the net profit or loss for the period
attributable to equity shareholders and the weighted average number of shares outstanding
during the period should be adjusted for the effects of all dilutive potential equity shares.
In calculating diluted earnings per share, effect is given to all dilutive potential equity shares that
were outstanding during the period.
The amount of net profit or loss should be adjusted by the following after taking into account
any attributable change in tax expense for the period:
(a) any dividends on dilutive potential equity shares which have been deducted in arriving at
the net profit attributable to equity shareholders as calculated in accordance with
paragraph 11;
(b) interest recognised in the period for the dilutive potential equity shares; and
(c) any other changes in expenses or income that would result from the conversion of the
dilutive potential equity shares.
After the potential equity shares are converted into equity shares the dividends, interest and
other expenses or income associated with those potential equity shares will no longer be
incurred (or earned). Instead, the new equity shares will be entitled to participate in the net
profit attributable to equity shareholders.

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5. (A) M Ltd. presented the following particulars for the period ended 31st March 2012, from which
you are requested to calculate the diluted earnings per share:

Particulars Amount

Net Profit earned for the year 2011-12 (`) 20,00,000

No of equity shares outstanding at the end of the period 10,00,000
No. of 12% Convertible Debentures of ` 100 each to be convertible into 10 equity
shares 25,000
Income Tax Rate 30%

Answer:
Interest to be paid to 12% Convertibles Debenture holders

Particulars Amount
`

No. of Debentures x Value per Debenture = 25,000 x ` 100 25,00,000


12 3,00,000
 Interest = ` 25,00,000 x
100
90,000
Tax on the said interest = ` 3,00,000 x 30%

Adjusted Net Profit

Particulars Amount
`

Net Profit 20,00,000

Add: Debenture Interest 3,00,000
23,00,000
Less: Tax on Debenture Interest @30% 90,000
Adjusted Net Profit 22,10,000
Net Profit 20,00,000
Ordinary Earning per Share = = = ` 2.00
No. of Equity Shares 10,00,000
Diluted Earnings per Share =
No. of additional equity shares for conversion of debentures will be 25,000 x 10 = 2,50,000 Shares.
Diluted Earnings per Share =
Adjusted Net Profit 22,10,000
=
(No. of Equity Shares + Convertible EquityShares) (10,00,000 + 2,50,000)

= ` 1.768
(B) Prava Ltd., in the past three years, spent ` 75,00,000 to develop a drug to treat cancer, which
is charged to Profit and Loss A/c since they did not meet AS 8 criteria for capitalisation. In the
current year, approval of the concerned Govt. Authority, has been received. The company
wishes to capitalise ` 75,00,000 and disclose it as a prior period item. Is it correct? Give reasons
for your answer.
Answer:
As per paras 58 and 59 of AS 26, expenditure on an intangible item that was initially recognised
as an expense by a reporting enterprise in previous annual financial statements or interim

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financial reports should not be recognised as part of the cost of an intangible asset at a later
date.
Similarly, subsequent expenditure on an intangible asset, after its purchase or its completion,
should be recognised as an expense when it is incurred unless:
(a) it is probable that the expenditure will enable the asset to generate future economic
benefits in excess of its originally assessed standard of performance; and
(b) the expenditure can be measured and attributed to the asset reliably.
Thus, from the above, it becomes clear that AS 26 prohibits reinstating the expenditure as
recognised expenses. So, the company cannot capitalised the amount of ` 75,00,000 as it has
already been adjusted against Profit and Loss Account in the previous accounting periods.

(C) An intangible asset appears in Balance Sheet of C Ltd. at ` 16 lakhs as on 31.3.2004. The
asset was acquired for ` 40 lakhs in April 1991. The company has been amortising the asset
value on Straight Line Basis. The policy is to amortise it for 20 years.
Do you advise the company to amortize the entire asset value in the books of the company as
on 31.3.2004?

Answer:
We know that AS 26 came into effect on or after 1.4.2003 and was mandatory in nature.
As per para 67 of AS 26, if there may be persuasive evidence that the useful life of an
intangible asset will be a specific period longer than 10 years then, in the circumstances, no
adjustment is needed as on 1.4.2003.
Para 63 states that the depreciable amount of an intangible asset should be allocated on a
systematic basis over the best estimate of the useful life. There is a rebuttable presumption that
the useful life of an intangible asset will not exceed ten years from the date when the asset is
available for use. Amortisation should commence when that asset is available for use.
As such, in the present case, as the amortisation period has already been expired on 1.4.2003,
as per para 63, ` 16 lakhs should be eliminated along with an adjustment to be made with the
opening balance of revenue reserve as on that date.

6. (A) What will be the treatment of the following in the final statement of accounts for the year
ended 31.3.2012, of a limited company?
In 2010-11, the company has spent and carried forward in the books a total of ` 5,00,000 on
developing a cure for cancer. During the current year, i.e., 2011-12, it is decided to terminate this
product, as test results in the current year have proved adverse.
Answer:
As per para 87 of AS 26, an intangible asset should be derecognised on disposal or when no
future economic benefits are expected from its use and subsequent disposal. As per para 88 of
AS 26, gains or losses arising from the retirement or disposal of an intangible asset should be
recognised as income or expense in the Statement of Profit and Loss.
In this case, however, the company decided ultimately to discontinue the product due to
adverse test result. As such, the entire amount of ` 5 lakhs should be treated as an expense
which should be adjusted against current year’s P&L A/c.

(B) Ravan Ltd. Was involved in wage negotiation with trade unions of their organization as on 31 st
March 2013. Wage revision proposals could be finalized only after obtaining the final approval
from the Head Office of the Company located at Chennai. The final approval was granted on

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15th April 2013 w.e.f. 1st April 2011. The settlement covered period from 01.04.2011 to 31.03.2013.
the liability upto 31st March 2013 was disclosed on account of the above settlement in the notes
forming part of the Accounts. As an Auditor, you may advise whether such disclosure is proper.
Answer:
As per AS-29, a provision should be recognized if the following conditions are satisfied –
(i) Present obligation as a result of past event – Wage revision is for the period covered by
Financial Statements, i.e. 2012-2013, and consists of the Company’s present obligation.
(ii) Outflow of resources to settle the obligation is probable – Post Balance Sheet date events
(i.e. sanction from H.O.) that the payment of revised wages is probable, i.e. more likely than
not.
(iii) Reliable estimate of the amount – Though not quantified in the question, wage payable on
the revised scale can be estimated reliable.
Since all the conditions for recognition of a provision are satisfied, the Provision should be
recognized for the year ending 31st March 2013. Also, under AS-5, when items of Income and
Expenses within Profit & Loss from ordinary activities are of such size, nature or incidence, that
their disclosure is relevant to explain the performance of the Enterprise for the period, they
should be disclosed separately. Since the company has only disclosed the fact and not created
any provision, the treatment given by the company is not correct.
(C) Paras Ltd is in the process of finalizing its Accounts for the year ended 31 st March 2013. The
company seeks your advice on the following:
(i) The Company’s Sales Tax Assessment for the A.Y. 2010-2011 has been completed on 10th
February 2013 with a demand of ` 2 crores. The company paid the entire due under protest
without prejudice to its right of appeal. The company files its appeal before the Appellate
Authority wherein the grounds of appeal cover Tax on additions made in the Assessment
Order for a Sum of ` 1.75 crore.
(ii) The company has entered into a Wage Agreement in April 2013 whereby Labour Union has
accepted a revision in wage from July 2012. The agreement provided that the hike till April
2013 will not be paid to the employees but will be settled to them at the time of retirement.
The company agrees to deposit the arrears in Government Bonds by September 2013.

Answer:
Since the company is not appealing against the addition of ` 0.25 crores, the same should be
provided for in its Accounts for the year ended on 31 st March 2013. The amount paid under
protest can be kept under the head “Loans and Advances” and disclosed along with the
contingent liability of ` 1.75 crores.
The arrears for the period from July 2012 to March 2013 are required to be provided for in the
Accounts of Company for the year ended on 31st March 2013.

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Section B – Accounts of Joint Stock Companies

7. (A) A limited Company was registered with a capital of ` 5,00,000 in share of ` 100 each and
issued 2,000 such shares at a premium of ` 20 per share, payable as ` 20 per share on
application (including ` 10 as premium), ` 50 per share on allotment (including balance of
premium) and ` 20 per share on first call made three months later. All the money payable on
application, and allotment were duly received but when the first call was made, one
shareholder paid the entire balance on his holding of 30 shares, and another shareholder
holding 100 shares failed to pay the first call money. Subsequently, those 100 shares were
forfeited and reissued at ` 95 each, ` 100 fully called up and paid up.
Required:
Give Journal entries to record the above transactions.
Answer:
Journal

Particulars L.F. Dr. Amount Cr. Amount

` `

Bank A/c Dr 40,000

To Share Application A/c 40,000
[Being the issue of 2,000 shares and application money received
@ ` 20 per share]

Share Application A/c Dr 40,000

To Share Capital A/c 20,000
To Securities Premium A/c 20,000
[Being the transfer of application money on 2,000
shares @ ` 10 per share to Share Capital A/c and `10 to Securities
Premium)

Share Allotment A/c Dr 1,00,000

To Share Capital A/c (2,000 x 40) 80,000
To Securities Premium A/c (2,000 x 10) 20,000
(Being the allotment money on 2,000 shares @ ` 50 including
balance premium of ` 10 made due)

Bank A/c Dr 1,00,000

To Share Allotment A/c 1,00,000
(Being the allotment money on 2,000 shares
@ ` 50 per share received)

Share First Call A/c Dr 40,000

To Share Capital A/c 40,000
(Being the first call money on 2,000
shares @ ` 20 per share made due)

Bank A/c Dr 38,900

Calls-in-Arrear A/c (100 x 20) Dr 2,000
To Share First Call A/c 40,000
To Call-paid-in-advance A/c 900
(Being the first call money on 1,900 shares @ ` 20
per share and share Second call money on 30 shares @ ` 30 per
share received in advance)

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Particulars L.F. Dr. Amount Cr. Amount

` `

Share Capital A/c [100 ( 10+40+20)] Dr 7,000

Note: Share Capital is debited upto the amount of capital called
up
To Calls-in-Arrear A/c (amount not paid on 1st call) 2,000
To Share Forfeiture A/c (amount paid towards capital on 5,000
application and allotment) [ 100 (10+40)]

Note: Since the shareholder has paid the amount due on

application and allotment, there is no adjustment made towards
Securities Premium, since the amount is already realized.

Bank A/c Dr (100 x 95) ( No. of shares reissued x reissue price) 9,500
Share Forfeiture A/c Dr (100 x 5) (No. of shares reissued x discount 500
on reissue) 10,000
To Share Capital A/c ( 100 x 100) (No. of shares reissued x paid up
capital per share)

(B) Alpha Co. Ltd. has a paid up equity share capital of ` 20,00,000 in 2,00,000 shares of ` 10
each. It resolved to buy-back 50,000 equity shares at ` 15 per share. For this purpose it issued
20,000 12% preference shares of ` 10 each, at par, payable along with application. The
company has to its credit ` 2,50,000 in securities premium account and ` 10,00,000 in the
general reserve account. Pass the necessary journal entries.
Answer:
In the Books of Alpha Co. Ltd
Journal Entries

Date Particulars Debit Credit

` `

Bank A/c Dr. 2,00,000

To 12% Preference Share Application A/c 2,00,000
(Application money on 20,000 preference shares at
` 10 each)

12% Preference Share Application A/c Dr 2,00,000

To 12% Preference Share Capital A/c 2,00,000
(Transfer of application money to preference
share capital account on shares being allotted)

Equity Share Capital A/c Dr. 5,00,000

Securities Premium A/c Dr. 2,50,000
To Equity Shareholders A/c 7,50,000
(Amount due to equity shareholders consequent
upon buy-back of 50,000 Shares at ` 15)

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Equity Shareholders A/c Dr 7,50,000

To Bank A/c
7,50,000
(Payment to equity shareholders for amount due to
them on buy-back of shares)

General Reserve A/c Dr. 3,00,000

To Capital Redemption Reserve A/c 3,00,000
(Transfer of the amount equal to net nominal value
of shares bought back.) In this case, the equity
shares were bought back both from fresh issue of
preference shares as well as from reserves.
As per rule, the amount which is utilized from
reserves, shall only be considered for transferring it
from General Reserve to Capital Redemption
Reserve.
In this case, Equity Share Capital was Rs.5,00,000
and from issue of 12% Preference Shares, Rs.2,00,000
was collected. Hence, from reserves/ profits, the
balance is to be taken. [= 5,00,000 (-) 2,00,000]

8. (A) The following was the Balance Sheet of Diamond Ltd. as at 31st March, 2014.

Liabilities ` in lakhs
10% Redeemable Preference Shares of ` 10 each, fully paid up 2,500
Equity Shares of ` 10 each fully paid up 8,000
Capital Redemption Reserve 1,000
Securities Premium 800
General Reserve 6,000
Profit and Loss Account 300
9% Debentures 5,000
Trade Payables 2,300
Sundry Provisions 1,000
26,900

Assets ` in lakhs
Non-Current Assets (including investments Rs.3,000) 17,000
Cash at Bank 1,650
Other Current assets 8,250
26,900
On 1st April, 2014 the company redeemed all of its preference shares at a premium of 10% and
bought back 25% of its equity shares @ ` 20 per share. In order to make cash available, the
company sold all the investments for ` 2,850 lakh and raised a bank loan amounting to ` 2,000
lakhs on the security of the company’s plant.
Pass journal entries for all the above mentioned transactions including cash transactions and
prepare the company’s balance sheet immediately thereafter. The amount of securities
premium has been utilized to the maximum extent allowed by law.

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Answer:
Journal Entries

Particulars Debit Credit

` `

1. Bank A/c Dr. 2,850

Profit and Loss A/c Dr. 150
To Investment A/c
3,000
(Being sale of investments at a loss)

2. Bank A/c Dr. 2,000

To Bank Loan A/c
(Being loan taken from bank) 2,000

3. 10% Redeemable preference Share capital A/c Dr. 2,500

Premium on redemption of preference
shareholder A/c Dr. 200
To Preference shareholder A/c 2,750
(Being redemption of preference shares)

4 Preference shareholders A/c Dr. 2,750

To Bank A/c 2,750

(Being payment of amount due to preference
shareholders)

5. Securities premium A/c Dr. 250

To Premium on redemption of preference share
A/c 250
(Being use of securities premium to provide
premium on redemption of preference shares)

6. Equity Share capital A/c Dr. 2,000

Securities premium A/c [800 - 250] Dr. 550

General reserves A/c Dr. 1,450

[(200×20) - 2000 - 550]

To Equity shareholders A/c 4,000

(being buy back of equity shares)

Note : Balance of General Reserve

[6000 - 1450] = ` 4550.

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Particulars Debit Credit

` `

7. General Reserves A/ c Dr. 4,500

To Capital redemption reserve A/c (2000 + 2500) 4,500

(Being creation of capital redemption reserve to

the extent of the face value of preference share
redeemed and equity shares bought back).

Note: Balance in General reserve as on

01.04.2012 (4550 - 4500) = ` 50.

8. Equity shareholders A/c Dr. 4,000

To Bank A/c 4,000

(Being payment of amount due to equity

shareholders).

Note : Cash at Bank [1650+2,850+2000-2750-4000] = (`

250). This is an Overdraft Balance.

Balance Sheet of Diamond Ltd., as on 01.04.2014 (relevant extracts)

Balance Sheet as at: 01.04.2014 (` in lakhs)

Ref Particulars Note No. Current Year Previous Year

No. Reporting Period Reporting Period

` `

1 EQUITY AND LIABILITIES

(a) Share capital 1 6,000

(b) Reserves and surplus 2 5,750

( c) Money received against share warrants

2 Share application money pending allotment

3 Non-current liabilities

(a) Long-term borrowings 3 7,000

(b)Deferred tax liabilities (Net)

(c ) Other Long term liabilities

(d) Long-term provisions

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4 Current Liabilities

(a) Short-term borrowings

(b) Trade payables 2,300

(c )Other current liabilities - Bank Overdraft 250

(d) Short-term provisions 4 1,000

Total(1+2+3+4) 22,050

1 ASSETS

Non-current assets

(a) Fixed assets

(i) Tangible assets 5 14,000

(ii) Intangible assets

(iii) Capital work-in-progress

(iv) Intangible assets under development

(b) Non-current investments (Market value of

Investment)

( c)Deferred tax assets (Net)

(d) Long-term loans and advances

(e) Other non-current assets

2 Current assets

(a)Current investments

(b) inventories

(c ) trade receivables

(d) Cash and cash equivalents 50

(e)Short-term loans and advances

(f) Other current assets 8,250

Total(1+2) 22,300

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Notes to the Accounts

(` in crores)

Note 1. Share Capital Current Year Previous Year

Reporting Period Reporting
(`) Period(`)

Issued Capital , Subscribed and Paid Up capital

Equity Shares of ` 10 each 6,000

Total 6,000

Note 2. Reserve and Surplus Current Year Previous Year

Reporting Period Reporting Period

Capital Redemption Reserve (1,000+4,500) 5,500

General Reserve 50

Profit and Loss(300-150) 150

Total 5,750

Note 3. Long Term borrowings Current Year Previous Year

Reporting Period Reporting Period

9% Debenture 5,000

Bank Loan 2,000

Total 7,000

Note 4. Short Term Provisions Current Year Previous Year

Reporting Period Reporting Period

Sunday Provision 1,000

Total 1,000

Note 4. Tangible Assets Current Year Previous Year

Reporting Period Reporting Period

Fixed Assets 14,000

Total 14,000

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(B) On 01.04.08, P Ltd. issued 1,000, 15% Debentures of ` 100 each at a discount of 10%
redeemable at par.
Required: Show the ‘Discount on Issue of Debentures A/c if (a) such debentures are redeemable
after 4 years, and (b) such debentures are redeemable by equal annual drawings in 4 years. A
Ltd. follows financial year as its accounting year.

Answer:
(a) When such debentures are redeemable after 4 years:
A. Total discount allowed (` 1,00,000 × 10/100) = ` 10,000
B. Period for which debentures are held = 4 Years
C. Amount of discount to be written off to P & L A/c every year (A/B) = ` 2,500

Dr. Discount on Issue of Debentures Account Cr.

Date Particulars ` Date Particulars `

01.04.08 To 15% Debentures A/c 10,000 31.03.09 By P & L A/c 2,500

By Balance c/d 7,500

10,000 10,000

01.04.09 To Balance b/d 7,500 31.03.10 By P & L A/c 2,500

By Balance c/d 5,000

7,500 7,500

01.04.10 To Balance b/d 5,000 31.03.11 By P & L A/c 2,500

By Balance c/d 2,500

5,000 5,000

01.04.11 To Balance b/d 2,500 31.03.12 By P & L A/c 2,500

2,500 2,500

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(b) When such debentures are redeemable by equal annual drawings in 4 years:
Statement Showing the Debentures Discount to be Written Off Each Year

Year Face Value of Period of Use Product Ratio Amount of Discount to

ended on Deb. used (Month) D = B×C be w/o 10,000×E/10
A B C D E

31.03.09 1,00,000 12 months 12,00,000 4 4,000

31.03.10 75,000 12 months 9,00,000 3 3,000

31.03.11 50,000 12 months 6,00,000 2 2,000

31.03.12 25,000 12 months 3,00,000 1 1,000

Dr. Discount on Issue of Debentures Account Cr.

Date Particulars ` Date Particulars `

01.04.08 To 15% Debentures 10,000 31.03.09 By P & L A/c 4,000

A/c

By Balance c/d 6,000

10,000 10,000

01.04.09 To Balance b/d 6,000 31.03.10 By P & L A/c 3,000

By Balance c/d 3,000

6,000 6,000

01.04.10 To Balance b/d 3,000 31.03.11 By P & L A/c 2,000

By Balance c/d 1,000

3,000 3,000

01.04.11 To Balance b/d 1,000 31.03.12 By P & L A/c 1,000

1,000 1,000

9. (A) On 01.01.2009 E Ltd. issued 500, 10% Debentures of ` 100 each, at a discount of 10%
redeemable at a premium of 10%.
Required: Show the ‘Loss on Issue of Debentures A/c’, if (i) such debentures are redeemable
after 4 years, and (ii) such debentures are redeemable by equal annual drawings in 4 years. E
Ltd. follows calendar year as it accounting year.

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Answer:
Loss on Issue at Discount = 10%; Loss on Redemption at premium = 10%
Total Loss = 20%
(i) When such debentures are redeemable after 4 years:
A. Total Loss (` 50,000 × 20/100) = ` 10,000
B. Period for which debentures are held = 4 Years
C. Amount of discount to be written off to P & L A/c every year (A/B) = ` 2,500
Dr. Loss on Issue of Debentures Account Cr.

Date Particulars ` Date Particulars `

01.01.09 To 10% Debentures A/c 5,000 31.12.09 By P & L A/c 2,500

To Premium on 5,000 By Balance c/d 7,500

redemption

10,000 10,000

01.01.10 To Balance b/d 7,500 31.12.10 By P & L A/c 2,500

By Balance c/d 5,000

7,500 7,500

01.01.11 To Balance b/d 5,000 31.12.11 By P & L A/c 2,500

By Balance c/d 2,500

5,000 5,000

01.01.12 To Balance b/d 2,500 31.12.12 By P & L A/c 2,500

2,500 2,500

(ii) When such debentures are redeemable by equal annual drawings in 4 years:
Statement Showing the Debentures Discount to be Written Off Each Year

Year Face Value of Period of Use Product Ratio Amount of Discount to

ended on Deb. used (Month) D = B×C be w/o 10,000×E/10
A B C D E

31.03.09 1,00,000 12 months 6,00,000 4 4,000

31.03.10 75,000 12 months 4,50,000 3 3,000

31.03.11 50,000 12 months 3,00,000 2 2,000

31.03.12 25,000 12 months 1,50,000 1 1,000

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Dr. Discount on Issue of Debentures Account Cr.

Date Particulars ` Date Particulars `

01.01.09 To 10% Debentures A/c 5,000 31.12.09 By P & L A/c 4,000

To Premium on redemption 5,000 By Balance c/d 6,000

10,000 10,000

01.01.10 To Balance b/d 6,000 31.12.10 By P & L A/c 3,000

By Balance c/d 3,000

6,000 6,000

01.01.11 To Balance b/d 3,000 31.12.11 By P & L A/c 2,000

By Balance c/d 1,000

3,000 3,000

01.01.12 To Balance b/d 1,000 31.12.12 By P & L A/c 1,000

1,000 1,000

(B) On 1st April 2008. H Ltd. issued 442, 10% Debentures of ` 1000 each at a discount of 10%
redeemable at a premium of 5% after 4 years. It was decided to create a Sinking Fund for the
purposes of accumulating sufficient funds to redeem the Debentures and to invest in some radily
convertible securities yielding 10% interest p.a. Reference to the table shows that ` 1.00 p.a. at
10% compound interest amounts to ` 4.641 in 4 years. Investments are to be made in the Bonds
of ` 1000 each available at par.
On 31st March 2012, the investments realised ` 3,40,000 and debentures were redeemed. The
bank balance as on that date was ` 50,000.
Required: Prepare Debenture Redemption Fund Account and Debenture Redemption Fund
Investments Account for 4 years.
Answer:
DRF = Debenture Redemption Fund, DRFI = Debenture Redemption Fund Investment
Discount on Issue of Debentures Account
Dr. Cr.

Date Particulars ` Date Particulars `

31.03.09 To Balance c/d 1,00,000 31.03.09 By P & L App. A/c 1,00,000

31.03.10 To Balance c/d 2,10,000 01.04.09 By Balance b/d 1,00,000

31.03.10 By Interest on DRFI A/c 10,000

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By P & L App. A/c 1,00,000

2,10,000 2,10,000

31.03.11 To Balance c/d 3,31,000 01.04.10 By Balance b/d 2,10,000

31.03.11 By Interest on DRFI A/c 21,000

By P & L App. A/c 1,00,000

3,31,000 3,31,000

31.03.12 To Loss on issue of 01.04.11 By Balance b/d 3,31,000

Debentures By Interest on DRFI A/c 33,100

(premium) 22,100 By P & L App. A/c 91,000

To Debenture By Debenture Red.

Redemption Fund Investment A/c

Reserve A/c 4,52,000 (profit) 19,000

4,74,100 4,74,100

Debentures Redemption Fund Investment (DRFI) Account

Dr. Cr.

Date Particulars ` Date Particulars `

31.03.09 To Bank A/c 1,00,000 31.03.09 By Balance c/d 1,00,000

01.04.09 To Balance b/d 1,00,000 31.03.10 By Balance c/d 2,10,000

31.03.10 To Bank A/c 1,10,000

2,10,000 2,10,000

01.04.10 To Balance b/d 2,10,000 31.03.11 By Balance c/d 3,31,000

31.03.11 To Bank A/c 1,21,000

3,31,000 3,31,000

01.04.11 To Balance b/d 3,31,000 31.03.12 By Bank A/c 3,50,000

31.03.12 To Debenture (Sales)

Redemption

Fund A/c (Profit) 9,000

3,50,000 3,50,000

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Working Note:
(i) Calculation of the amount of profit set aside
`
a. Face Value of Debentures 4,42,000
b. Premium Premium Payable on Redemption 22,100
c. Depreciable Cost (A + B) 4,64,100
d. Value of annuity per Re 1 4,641
e. Annual amount to be charged (C/D) 1,00,000
(ii) Calculation of the amount of investments and interest

Year Opening Balance Interest Saving Investments Closing Balance

a b c = b×10/100 d e=c+d f=b+e

2008-09 — — 1,00,000 1,00,000 1,00,000

2009-10 1,00,000 10,000 1,00,000 1,10,000 2,10,000

2010-11 2,10,000 21,000 1,00,000 1,21,000 3,31,000

2011-12 3,31,000 33,100 1,00,000 — —

10. (A) On 01.01.2011, Hudco Ltd. issued 1,000, 15% Convertible Debentures of ` 200 each at a
discount of 5% redeemable at par after 4 years by coverting their holdings into equity shares of `
100 each at a premium of 25%. As per terms of issue, the holders of these Debentures also have
an option to convert their holdings as aforesaid at any time after 6 months but within 3 years. On
31.12.2011, a holder of 250 Debentures notified his intention to exercise the option.
Requirements: (a) Give Journal entries as on 01.01.2011, 31.12.2011 and on 31.12.2012 (ignoring
interest), and (b) Prepare the Balance Sheet as on 31.12.2012 (showing related items only).

Answer:
Journal

Date Particulars L.F. Dr. (` ) Cr. (` )

01.01.07 Bank A/c Dr. 1,90,000

Discount on Issue of Debentures A/c Dr. 10,000

To 15% Debenture A/c 2,00,000
(Being the issue of 1,000 debentures at a discount
of 5%)

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Date Particulars L.F. Dr. (` ) Cr. (` )

31.12.11 15% Debentures A/c Dr. 50,000

To Discount on Issue Debentures A/c 2,500
To Equity Shares Capital A/c 38,000
To Securities Premium A/c 9,500
(Being the issue of 380 shares at 25% premium to a
holder of 500 Debentures as per Board Resolution
dated....)

31.12.12 15% Debentures A/c Dr. 1,50,000

To Equity Share Capital A/c 1,20,000
To Securities Premium A/c 30,000
(Being the issue of 1,200 share @ 25% premium to
the holders of 1,500 Debentures as per Board’s
Resolution dated...)

An Extract of Balance Sheet as at 31st December 2012

Liabilities ` Assets `

Share Capital: Miscellaneous Expenditure:

Equity Shares of ` 100 each fully Discount on Issue of Debentures 7,500

paid up
38,000

Reserves & Surplus:

Securities Premium 9,500

Secured Loans:

750, 15% Debentures of ` 200 each 1,50,000

Working Notes:
(i) It has been assumed that no portion of Discount on Issue of Debentures has yet been
written off.
(ii) Calculation of No. of Shares to be issued on 31.12.2012.
a. Normal Value of Debentures to be converted (250 × 200) ` 50,000
b. Less: Reversal of Discount @ 5% ` 2,500
c. Amount actually received (a – b) ` 47,500
d. Issued price of an Equity Share (` 100 + 25%) ` 125
e. No. of Shares to be issued (c/d) 380

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New Shares have been issued exactly equal to be amount actually received (i.e., Net of
discount) at the time of issue of Debentures, otherwise it would amount to an issue of shares
at discount indirectly without complying with the provision of Sec. 79 of the Companies Act,
1956.
(iii) Calculation of No. of Shares to be issued on 31.12.2010.
a. Nominal Value of Debentures to be converted ` 1,50,000
b. Issue Price of an Equity Share (` 100 + 25%) ` 125
c. No. of Equity Shares to be issued (a/b) 1,200
Since the debentures are due for redemption and the conversion of debentures into
shares is on the basis of terms and conditions mutually agreed upon at the time of issue for
redemption, even the debentures originally issued at a discount can be converted into
shares.
(B) On 01.01.2007 S Ltd. had 2,000, 12% Debentures of ` 100 each. On 01.05.2007 the company
purchased 400 own Debentures at ` 97 cum-interest in the open market. Interest on debenture is
payable on 30the June and 31st Dec. each year.
Required: Give the necessary journal entires assuming (a) that the own Debentures purchased
were cancelled immediately and (b) the the own Debentures purchased were retained as
investments till 31.12.2012 on which date they were cancelled.

Answer:
(a) If own Debentures were cancelled immediately on date of purchase
Journal

Date Particulars L.F. Dr. (` ) Cr. (` )

2007 12% Debentures A/c Dr. 40,000

May 01 Debentures Interest A/c Dr. 1,600
To Bank A/c 38,800
To Capital Reserve A/c 2,800
(Being 400 debentures cancelled by
purchase @ ` 97 cum-interest)
June 30 Debentures Interest A/c Dr. 9,600
To Bank A/c 9,600
(Being the interest paid on ` 1,60,000 @ 12%
p.a. for 6 months)

Dec. 31 Debenture Interest A/c Dr. 9,600

To Bank A/c 9,600
(Being the interest paid on ` 1,60,000 @ 12%
p.a. for 6 months)
Dec. 31 Profit & Loss A/c Dr. 20,800
To Debenture Interest A/c 20,800
(Being the transfer of debenture interest to P
& L A/c)
Dec. 31 Profit & Loss Appropriation A/c Dr. 37,200
To Debenture Redemption Reserve A/c 37,200
(Being the transfer of an amount equivalent to
the cash sum applied (towards principal) in
redeeming the debentures to DRR out of
profits)

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(b) If own debentures were cancelled on 31.12.2012.

Journal entries in the books of X Ltd

Date Particulars L.F. Dr. (` ) Cr. (` )

May 01 Own Debentures A/c Dr. 37,200

Debentures Interest A/c 1,600
To Bank A/c 38,800
(Being the purchase of 400 debentures @ `
97 cum-interest)

June 30 Debentures Interest A/c Dr. 10,400

To Interest on Own Debentures A/c 800
To Bank A/c 9,600
(Being the Interest paid/credited on `
1,60,000 debentures held by outsiders for 6
months & on ` 40,000 own debentures for 2
months)

Dec. 31 Debenture Interest A/c Dr. 12,000

To Bank A/c 9,600
To Interest on Own Debentures A/c 2,400
(Being the interest paid/credited on `
1,60,000 debentures held by outsiders and `
40,000 own debentures for 6 months)

Dec. 31 Profit & Loss A/c Dr. 24,000

To Debenture Interest A/c 24,000
(Being the transfer of debenture interest to P
& L A/c)

Dec. 31 Interest on Own Debentures A/c Dr. 3,200

To Profit & Loss A/c 3,200
(Being the transfer of interest on own
debentures to P & L A/c)

Dec. 31 12% Debentures A/c Dr. 40,000

To Own Debentures A/c 37,200
To Capital Reserve A/c 2,800
(Being the cancellation of 200 own
debentures)

Dec. 31 Profit & Loss Appropriation A/c Dr. 37,200 37,200

To Debenture Redemption Reserve A/c
(Being the transfer of an amount equivalent
to the cash sum applied in redeeming the
debentures)

11. (A) At the beginning of year 1, an enterprise grants 300 options to each of its 1,000
employees. The contractual life (comprising the vesting period and the exercise period) of
options granted is 6 years. The other relevant terms of the grant are as below:

Vesting Period 3 years

Exercise Period 3 years

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Expected Life 5 years

Exercise Price ` 50

Market Price ` 50

Expected forfeitures per year 3%

The fair value of options, calculated using an option-pricing model, is ` 15 per option. Actual
forfeitures, during the year 1, are 5% and at the end of year 1, the enterprise still expects that
actual forfeitures would average 3% per year over the 3 year vesting period. During the year 2,
however, the management decides that the rate of forfeitures is likely to continue to increase,
and the expected forfeiture rate for the entire award is changed to 6% per year. It is also
assumed that 840 employees have actually completed 3 years vesting period. Suggest
Accounting Treatment.

Answer:
Year 1
1. At the grant date, the enterprise estimates the fair value of the options expected to vest at
the end of the vesting period as below
Number of options expected to vest
=300×1,000×0.97×0.97×0.97=2,73,802 options
Fair value of options expected to vest
=2,73,802 options × ` 15 = ` 41,07,030
2. At the balance sheet date, since the enterprise still expects actual for forfeitures to average
3% per year over the 3 year vesting period, no change is required in the estimates made at
the grant date. The enterprise, therefore, recognize one-third of the amount estimated at
(1) above (i.e. ` 41,07,030/3) towards the employee services received by passing the
following entry:

Employee Compensation Expenses A/c Dr. ` 13,69,010

To Stock Options Outstanding A/c ` 13,69,010
(Being compensation expenses recognized in respect of the ESOP)

3. Credit balance in the ‘Stock Option Outstanding A/c’ may be disclosed in the balance
sheet under a separate heading, between ‘Share Capital’ and ‘Reserve and Surplus’.

Year 2
1. At the end of the financial year, management has changed its estimate of expected
forfeiture rate from 3% to 6% per year. The revised number of options expected to vest is
2,49,175 (3,00,000×.94×.94×.94). Accordingly the fair value of revised options expected to
vest is ` 37,37,625 (2,49,175 × `15). Consequent to the change in the expected forfeitures,
the expenses to be recognized during the year are determined as below:

Revised total fair value ` 37,37,625

Revised cumulative expenses at the end of the year 2= (`

37,37,625×2/3) ` 24,91,750

Expenses already recognized in year 1 ` 13,69,010

Expenses to be recognized in year 2 ` 11,22,740

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2. The enterprise recognizes the amount determined at (1) above (i.e. ` 11,22,740) towards the
employee services received by passing the following entry:
3. Credit balance in the ‘Stock Option Outstanding A/c’ may be disclosed in the balance
sheet under separate heading between ‘Share Capital’ and ‘Reserve and Surplus’.

Year 3
1. At the end of financial year, the enterprise would examine its actual forfeitures and make
necessary adjustment, if any, to reflect expenses for the number of options that actually
vested. Considering that 840 employees have completed three years vesting period, the
expenses to be recognized during the year is determined as below:
Number of options actually vested =840×300= 2,52,000

Fair value of options actually vested (` 2,52,000×`15) `37,80,000

Expenses already recognized ` 24,91,750

Expenses to be recognized in year 3 ` 12,88,250

2. The enterprise recognized the amount determined at (1) above towards the employee
service received by passing the following entry:

Employee compensation expenses A/c Dr. ` 12,88,250

To Stock Options Outstanding A/c ` 12,88,250
(Being compensation expenses recognized in respect of the ESOP)

3. Credit balance in the ‘Stock Option Outstanding A/c’ may be disclosed in the balance
sheet under separate heading between ‘Share Capital’ and ‘Reserve and Surplus’.

(B) What are the disclosure requirements under Director’s Report for Employees Stock Option
Scheme?
Answer:
Disclosure in the Director’s Report – The Board of Directors shall inter alia, disclosure either in the
Director’s Report or in the annexure to the Director’s Report, the following details of the ESOS:
a. Options granted;
b. The pricing formula;
c. Options vested;
d. Options exercised;
e. The total number of shares arising as a result of exercise of option;
f. Options lapsed;
g. Variation of terms of options;
h. Money realized by exercise of options;
i. Total number of options in force;
j. Employee-wise details of options granted to:
(i) Senior managerial personnel;

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(ii) Any other employee who receives a grant in any one year of option amounting to
5% or more of option granted during that year;
(iii) Identified employees who were granted option, during any one year, equal to or
exceeding 1% of the issued capital (excluding outstanding warrants and conversions)
of the company at the time of grant;
k. ‘diluted earnings per share’ pursuant to issue of shares on exercise of option calculated
in accordance with IAS-33.

12. (A) ABCL grants 1,250 options on 1st May 2009 at ` 80 when the market price is ` 200 and the
face value of ` 10. The vesting period is 3 years. The maximum exercise period is one year. 450
unvested options lapse on 1st June 2011, 800 options are exercised on 30th Sept. 2012. Pass
necessary journal entries to record the above transactions and also show Deferred Employee
Compensation Expense Account and Employee Stock Options Outstanding Account and state
how these accounts will be shown in the Balance Sheet.
Answer:
Value of options = 1,250 x ` (200 – 80) = ` 1,50,000
Amount to be amortised = ` 1,50,000 /3 = ` 50,000 each year.
In the books of ABC Ltd
Journal

Date Particulars L.F. ` `

01.06.09 Deferred Employee Compensation Expenses A/c. Dr. 1,50,000

To, Employee Stock Options Outstanding A/c. 1,50,000
(being the grant of 1,250 options at a discount of ` 80 each)

31.3.10 Employee Compensation Expense A/c. Dr. 50,000

To, Deferred Employee Compensation Expense A/c. 50,000
(being the amortization of the deferred compensation over
three years on straight line basis)

31.3.11 Employee Compensation Expense A/c. Dr. 50,000

To, Deferred Employee Compensation Expense A/c. 50,000
(being the amortization of the deferred compensation over
two years on straight line basis)

01.06.11 Employee Stock Options Outstanding A/c. (Note 1) Dr. 54,000

To, Deferred Employee Compensation Expense A/c.(Note 2) 18,000
To, Employee Compensation Expense A/c. (Note 3) 36,000
(being the reversal of compensation accounting on lapse of
450 options)

31.3.12 Employee Compensation Expense A/c Dr. 32,000

To, Deferred Employee Compensation Expense A/c. 32,000
(being the amortization of the balance deferred
compensation)

30.09.12 Bank A/c. (800 x ` 80) Dr. 64,000

Employee Stock Options Outstanding A/c Dr. 96,000 8,000
To Equity Share Capital A/c. 1,52,000
To Securities Premium A/c
(being the exercise of 800 options)

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Deferred Employee Compensation Expense Account

Dr. Cr.

Date Particulars Amount Date Particulars Amount

` `

01.06.09 To, Employee Stock 31.1.10 By, Employee Compensation 50,000

Options Outstanding A/c 1,50,000 Expense A/c
By, Balance c/d 1,00,000

1,50,000 1,50,000

01.04.10 To Balance b/d 1,00,000 31.3.11 By, Deferred Employee 50,000

Compensation Expense A/c 50,000

1,00,000 1,00,000

01.04.11 To Balance b/d 50,000 31.3.12 By, Employee Compensation 18,000

Expense A/c 32,000
By, Balance c/d

50,000 50,000

Employee Stock Options Outstanding Account

Dr. Cr.

Date Particulars Amount Date Particulars Amount

` `

31.3.10 To, Balance c/d 01.04.09 By, Deferred Employee 1,50,000

1,50,000 Compensation Expense
A/c.

1,50,000 1,50,000

31.3.11 To Balance c/d 1,50,000 01.04.10 By, Balance b/d 1,50,000

1,50,000 1,50,000

31.3.12 To Deferred Employee 18,000 01.04.11 By, Balance b/d 1,50,000

30.9.12 Compensation Expense A/c. 36,000
To, Employee Compensation 4,800
Expense A/c. 91,200
To, Equity Share Capital A/c
To Securities Premium A/c

1,50,000 1,50,000

Disclosure in the Balance Sheet:

(i) Employee Stock Options Outstanding will appear in the Balance Sheet as part of net worth
or shareholders’ equity.
(ii) Deferred employee compensation expense will appear as a negative item as part of net
worth or shareholders’ equity.

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Working notes:
Total Value of Compensation 1,50,000
(i) x Number of Options not excercise = x 450 = ` 54,000
Total Number of Options 1,250

Not yet Amortised Value of Compensation 50,000

(ii) x Number of Options not excercise = x 450
Total Number of Options 1,250
= ` 18,000
Amortised Value of Compensation 1,00,000
(iii) x Number of Options not excercise = x 450
Total Number of Options 1,250
= ` 36,000
Total Value of Compensation 1,50,000
(iv) x Number of Options not excercise = x 800
Total Number of Options 1,250
= ` 96,000

(B) Virat Company made a public issue of 1,25,000 Equity Shares of ` 100 each, ` 50 payable on
application. The entire issue was underwritten by four parties - Amal, Badal, Chapal and Dhabal
in the proportion of 30%, 25%, 25% and 20% respectively. The Underwriting Commission was 5%.
Amal, Badal, Chapal and Dhabal had also agreed on “Firm” Underwriting of 4,000, 6,000, NIL and
15,000 Shares respectively.
The total subscriptions, excluding Firm Underwriting, including Marked Applications were for
90,000 Shares. Marked Applications received were as under: Amal - 24,000 Shares; Badal -20,000
Shares; Chapal - 12,000 Shares; and Dhabal - 24,000 Shares.
Ascertain the liability of the Individual Underwriters and also show the Journal Entries that you
would make in the books of the Company. All workings should form part of your answer.
Solution:

The Underwriters’ Liability can be determined under two possible assumptions-

 When Benefit of Firm Underwriting is GIVEN to Underwriters - Assumption 1

 When Benefit of Firm Underwriting is NOT GIVEN to Underwriters - Assumption 2

1. Underwriters Liability under Assumption 1 (Figures in No. of Shares)

If Benefit of Firm Underwriting is GIVEN to Underwriters

Particulars Amal Badal Chapal Dhabal Total

Ratio of Gross Liability 30% 25% 25% 20% 100%
Gross Liability 37,500 31,250 31,250 25,000 1,25,000
Less: Unmarked forms in ratio of Gross (3,000) (2,500) (2,500) (2,000) (10,000)
Liability
[90,000-(24,000+20,000+12,000+24,000)]
34,500 28,750 28,750 23,000 1,15,000

Less: Marked Applications (24,000) (20,000) (12,000) (24,000) (80,000)

10,500 8,750 16,750 (1,000) 35,000

Less: Firm Underwriting (4,000) (6,000) NIL (15,000) (25,000)

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Particulars Amal Badal Chapal Dhabal Total

Balance to be taken under Contract 6,500 2,750 16,750 (16,000) 10,000
Adjust: Dhabal’s surplus transferred to (6,000) (5,000) (5,000) 16,000 -
Amal, Badal and Chapal in Gross Liability
Ratio [30:25:25]
Balance 500 (2,250) 11,750 - 10,000
Adjust: Badal’s surplus transferred to (1,127) 2,250 (1,023) - -
Amal and Chapal Gross Liability Ratio
[30:25]
Balance (727) - 10,727 - 10,000
Adjust: Amal’s surplus transferred to 727 - (727) - -
Chapal
Net Liability - - 10,000 - 10,000
Add: Firm Underwriting 4,000 6,000 NIL 15,000 25,000
Total Liability 4,000 6,000 10,000 15,000 35,000

2. Calculation of Amount due from Underwriters under Assumption 1

Particulars Amal Badal Chapal Dhabal Total

Total Liability 4,000 6,000 10,000 15,000 35,000

Amount Payable at ` 50 for Net Liability (`) 2,00,000 3,00,000 5,00,000 7,50,000 17,50,000

Less: Underwriting Commission at 2% (`) (75,000) (62,500) (62,500) (50,000) 2,50,000

Amount Receivable / Payable (`) 1,25,000 2,37,500 4,37,500 7,00,000 15,00,000

3. Journal Entries in the books of Company under Assumption 1

S. Particulars Dr. Cr.

No. ` `

1. Bank A/c Dr. 45,00,000

To, Equity Share Application A/c 45,00,000
[Being amount received at `50 per share from public on
90,000 shares)

2. Amal A/c Dr. 2,00,000

Badal A/c Dr. 3,00,000
Chapal A/c Dr. 5,00,000
Dhabal A/c Dr. 7,50,000
Equity Share Application A/c Dr. 45,00,000
To, Equity Share Application A/c 62,50,000
(Being amount transferred to Share Capital due in respect
of Total Liability of Underwriters and amount received from
public)

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3. Underwriting Commission A/c Dr. 2,50,000

To, Amal A/c 75,000
To, BadalA/c 62,500
To, Chapal A/c 62,500
To, Dhabal A/c 50,000
(Being underwriting commission due 2%)

4. Bank A/c Dr. 2,50,000

To, Amal A/c 1,25,000
To, Badal A/c 2,37,500
To, Chapal A/c 4,37,500
To, Dhabal A/c 7,00,000
(Being amount received from underwriters in final
settlement)

4. Underwriters Liability under Assumption 2 (Figures in No. of Shares)

If Benefit of Firm Under writing is NOT given to underwriters
(Under this assumption “Firm Underwriting” is also treated as “Unmarked Applications”. Hence,
“Unmarked Applications + Firm Underwriting Applications” are first apportioned in Gross Liability
ratio)

Particulars Amal Badal Chapal Dhabal Total

Gross Liability 37,500 31,250 31,250 25,000 1,25,000
Less: Unmarked Application and (10,500) (8,750) (8,750) (7,000) (36,000)
Firm Underwriting (10,000+25,000)
27,000 22,750 22,750 18,000 90,000

Less: Marked Applications (24,000) (20,000) (12,000) (24,000) (80,000)

3,000 2,500 10,500 (6,000) 10,000

Adjust: Dhabal’s surplus transferred (2,250) (1,875) (1,875) 6,000 -

to Amal, Badal and Chapal in Gross
Liability Ratio[30:25:25]
750 625 8,625 - 10,000

Adjust: Firm Underwriting 4,000 6,000 NIL 15,000 25,000

Total Liability 4.750 6.625 8.625 15,000 35,000

5. Calculation of Amount due from Underwriters under Assumption 2

Particulars Amal Badal Chapal Dhabal Total

Total Liability 4.750 6.625 8.625 15,000 35,000

Amount Payable at `50 for (`) 2,37,500 3,31,250 4,31,250 7,50,000 17,50,000

Less: Underwriting Commission at 2% (`) (75,000) (62,500) (62,500) (50,000) 2,50,000

Amount Receivable / Payable (`) 1,62,500 2,68,750 3,68,750 7,00,000 15,00,000

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6. Journal Entries in the books of Company under Assumption 2

S. Particulars Dr. Cr.

No. ` `

1. Bank A/c Dr. 45,00,000

To, Equity Share Application A/c 45,00,000
(Being amount received at `50 per share from public and
90,000 Shares)

2. Amal A/c Dr. 2,37,500

Badal A/c Dr. 3,31,250
Chapal A/c Dr. 4,31,250
Dhabal A/c Dr. 7,50,000
Equity Share Application A/c Dr. 45,00,000
To, Equity Share Application A/c(1,25,000 Shares × `50) 62,50,000
(Being amount transferred to Share Capital due in respect of
Total Liability of Underwriters and amount received from public)

3. Underwriting Commission A/c Dr. 2,50,000

To, Amal A/c 75,000
To, Badal A/c 62,500
To, Chapal A/c 62,500
To, Dhabal A/c 50,000
(Being underwriting commission due 2%)

4. Bank A/c Dr. 2,50,000

To, Amal A/c 1,62,500
To, Badal A/c 2,68,750
To, Chapal A/c 3,68,750
To, Dhabal A/c 7,00,000
(Being amount received from underwriters in final settlement)

13. (A) Explain the disclosure requirement of Money received against Share Warrant & Share
Application Money pending allotment under revised schedule VI.
Answer:

Money Received Against Share Warrants

Sch. VI Disclosure Requirement Points

To be shown as a separate line  In case of Listed Companies, Share warrants are issued to
item on the face of Balance Promoters & others in terms of the Guidelines for Preferential
Sheet Issues viz. SEBI (Issue of Capital and Disclosure Requirements),
Guidelines, 2009.
  Effectively, Share Warrants are amounts which would
ultimately form part of the Shareholder’s Funds. Since Shares
are yet to be allotted against the same, these are not
reflected as part of Share Capital, but as a separate line –
item.

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Share Application Money Pending Allotment

Sch. VI Disclosure Requirement Points

To be shown as a separate line  Share Application Money not exceeding the Issued
item on the face of Balance Capital and to the extent not refundable, is to be disclosed as
Sheet a separate line item after “Share Holders Funds” and before
“Non-Current Liabilities”.
 If the Company’s Issued Capital is more than the
Authorized Capital, and approval of increase in Authorized
Capital is pending, the amount of Share Application Money
received over and above the Authorized Capital should be
shown under the head “Other Current Liabilities”.
 The amount shown as ‘Share Application Money Pending
Allotment’ will not include Share Application Money to the
extent refundable. For example, the amount in excess of
Issued Capital, or where Minimum Subscription requirement is
not met. Such amount will have to be shown separately under
‘Other Current Liabilities’.
 Calls Paid in Advance are to be shown under “Other
Current Liabilities”. The amount of interest which may accrue
on such advance should also is to be reflected as a Liability.

(B) Explain the disclosure requirement of Current Investment & Inventories under Revised
Schedule VI.
Answer:
Current Investments

Schedule VI Disclosure Requirement Points

Current Investments shall be classified as – Principles given for Non-current
(a) Investments in Equity Instruments, Investments will apply here, to the
extent relevant. However, Trade vs.
(b) Investment in Preference Shares,
Non-Trade Classification, is not
(c) Investments in Government or Trust Securities, required for Current Investments.
(d) Investments in Debentures or Bonds,
(e) Investments in Mutual Funds,
(f) Investments in Partnership Firms,
(g) Other Investments (specify nature).
Notes:
1. Under each classification, details shall be given of
Names of Bodies Corporate [indicating separately
whether such Bodies are – (i) Subsidiaries, (ii)
Associates, (iii) Joint Ventures, or (iv) Controlled
Special Purpose Entities] in whom Investments
have been made and the nature and extent of
the Investment so made in each such Body
Corporate (Showing Separately Investments which
are party-paid). In regard to Investments in the
Capital of Partnership Firms, the names of the Firms
(with the names of all their Partners, Total Capital
and the Shares of each Partner) shall be given.

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2. The following shall also be disclosed:

(a) Basis of Valuation of individual Investments,
(b) Aggregate Amount of Quoted Investments
and Market Value thereof,
(c) Aggregate Amount of Unquoted Investments,
(d) Aggregate Provision made for Diminution in
Value of Investments.

Inventories

Schedule VI Disclosure Requirement Points

Inventories shall be classified as –  Goods in Transit should be included

(a) Raw materials, under relevant heads with suitable
disclosure.
(b) Work In Progress,
 The heading “Finished Goods”
(c) Finished Goods,
should comprise of all Finished
(d) Stock-in-Trade (in respect of goods acquired for Goods other than those acquired
Trading), for trading purposes. Those
(e) Stores and Spares, acquired for trading purposes are
(f) Loose Tools, to be shown under “Stock in
(g) Others (specify nature) Trade”.

Note: Goods-in-Transit shall be disclosed under the

relevant sub-head of Inventories. Mode of Valuation
shall be stated.
14. (A) The following balances are extracted from the books of Supreme Ltd., a real estate
company, on 31st March, 2013:

(` ’000)

Dr. Cr.

Sales 13,800

Purchases of materials 6,090

Share capital fully paid 500

Land purchased in the year as stock 365

Leasehold premises 210

Creditors 2,315

Debtors 3,675

Directors’ salaries 195

Wages 555

Work in progress on 01.04.2013 1,050

Sub-contractors’ cost 4,470

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Equipment, Fixtures and Fittings at cost on 01.04.2013 1,320

Stock on 01.04.2013 295

Profit and Loss Account, Credit Balance on 01.04.2013 640

Secured Loan 560

Bank Overdraft 525

Interest on Loan and Overdraft 110

Depreciation on Equipment on 01.04.2013 820

Administration Expenses 735

Office Salaries 90

19,160 19,160

You also obtain the following information:

(a) On 31st March, 2014, stock on hand including the land acquired during the year, is valued
at ` 7,10,000. Work in progress at that date is valued at `7,00,000.
(b) On 1st October, 2013 the company moved to new premises. The premises are on a 12
years lease and the lease premium paid amounted to `2,10,000. The company used sub-
contract labour of `2,00,000 and materials at cost of `1,90,000 in the refurbishment of the
premises. These are to be considered as part of the cost of leasehold premises.
(c) A review of the debtors reveals specific doubtful debts of `1,75,000 and the directors wish to
provide for these together with a general provision based on 2% of the balance.
(d) Depreciation on equipment, fixtures and fittings is provided at 15% on the written down
value.
(e) Supreme Ltd. sued Shallow Ltd. for supplying defective materials which has been written off
as valueless. The Directors are confident that Shallow Ltd. will agree for a settlement of
`2,50,000.
(f) The directors propose a dividend of 25%.
(g) `1,00,000 is to be provided as audit fee.
(h) The company will provide 10% of the pre-tax profit as bonus to employees in the accounts
before charging the bonus.
(i) Income tax to be provided at 50% of the profits.
You are required:
(i) to prepare the company’s financial statements for the year ended 31st March, 2014 as near
as possible to proper form of company final accounts; and
(ii) to prepare a set of Notes to accounts including significant accounting policies.
Notes: Workings should form part of your answer.
Previous year figures can be ignored.
Figures are to be rounded off to nearest thousands.

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Solution:
Name of the Company: Supreme Ltd.
Balance Sheet as at: 31st March, 2014 (` in ‘000)

Ref No. Particulars Note As at 31st As at 31st

No. March, 2014 March, 2013

1 EQUITY AND LIABILITIES

(a) Share capital 1 500

(b) Reserves and surplus 2 945

(c) Money received against share warrants

2 Share application money pending allotment

3 Non-current liabilities

(a) Long-term borrowings 3 560

(b) Deferred tax liabilities (Net)

(c) Other Long term liabilities

(d) Long-term provisions

4 Current Liabilities

(a) Short-term borrowings 4 525

(b) Trade payables 5 2,315

(c) Other current liabilities 6 100

(d) Short-term provisions 7 895

Total (1+2+3+4) 5840

II ASSETS

1 Non-current assets

(a) Fixed assets

(i) Tangible assets 7 1,000

(ii) Intangible assets

(iii) Capital work-in-progress

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Ref No. Particulars Note As at 31st As at 31st

No. March, 2014 March, 2013

(iv) Intangible assets under development

(b) Non-current investments

(c) Deferred tax assets (Net)

(d) Long-term loans and advances

(e) Other non-current assets

2 Current assets

(a) Current investments

(b) inventories 8 1,410

(c) trade receivables 9 3,430

(d) Cash and cash equivalents

(e) Short-term loans and advances

(f) Other current assets

Total (1+2) 5840

Name of the Company: Supreme Ltd.

Profit and Loss Statement for the year ended: 31st March, 2012 (` in ‘000)

Ref. Particulars Note As at 31st As at 31st

No. No. March, 2014 March, 2013

I REVENUE FROM OPERATIONS 11 13,800

Less: Excise duty Nil

13,800

II OTHER INCOME Nil

III TOTAL REVENUE(I+II) 13,800

IV EXPENSES:

(a) Cost of material consumed 12 11,025

(b) Purchase of products for sale

(c) changes in inventories of finished goods,

work-in-progress and products for sale

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Ref. Particulars Note As at 31st As at 31st

No. No. March, 2014 March, 2013

(d) Employees cost/ benefits expenses 13 405

(e) Finance cost 110

(f) Depreciation and amortization expenses 100

(g) Other expenses 14 1,080

TOTAL EXPENSES 12,720

V PROFIT BEFORE EXCEPTIONAL AND 1,080

EXTRAORDINARY ITEMS AND TAX ( III-IV)

VI EXCEPTIONAL ITEMS

VII PROFIT BEFORE EXTRAORDINARY ITEMS AND 1,080

TAX (V-VI)

VIII EXTRAORDINARY ITEMS

IX PROFIT BEFORE TAX FRON CONTINUING 1,080

OPERATIONS (VII-VIII)

X Tax expenses:

(1) Current Tax 650

(2) deferred tax

XI PROFIT AFTER TAX FOR THE YEAR FROM 430

CONTINUING OPERATION(IX-X)

XII Profit (loss) from discontinuing operations

XIII Tax expenses from discontinuing operations

XIV Profit(loss) from discontinuing operations

(after tax)(XII-XIII)

XV PROFIT (LOSS) FOR THE PERIOD (XI+XIV) 430

Balance brought forward from previous year 640

Profit available for appropriation 1,070

Appropriation:

Proposed dividend 125

Transfer to General Reserve 45 170

Balance carried forward 900

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Ref. Particulars Note As at 31st As at 31st

No. No. March, 2014 March, 2013

XVI Earning per equity share:

(1) Basic

(2) Diluted

(` In ‘000)

Note 1. Share Capital As at 31st As at 31st

March, 2014 March, 2013
Authorized, Issued, Subscribed and paid-up Share capital:

50,000 Equity share of ` 10 each 500

Total 500

RECONCILIATION OF SHARE CAPITAL

FOR EQUITY SHARE As at 31st March, 2014 As at 31st March, 2013

Nos. Amount (`) Nos. Amount (`)

Opening Balance as on 01.04.11 (Figure in ‘000) 50 500

Add: Fresh Issue (Including Bonus shares, right

shares, split shares, share issued other than cash)
50 500

Less: Buy Back of share

Total 50 500

Note 2. Reserve & Surplus As at 31st As at 31st

March, 2014 March, 2013
General Reserve 45

Profit and loss A/c 900

Total 945

Note 3. Long term borrowings As at 31st As at 31st

March, 2014 March, 2013
Secured Loan 560

Total 560

Note 4. Short-term borrowings As at 31st As at 31st

March, 2014 March, 2013
Bank Overdraft 525

Total 525

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Note 5. Trade Payables As at 31st As at 31st

March, 2014 March, 2013
Sundry Creditors 2,315

Total 2,315

Note 6. Other Current Liabilities As at 31st As at 31st

March, 2014 March, 2013
Audit fees 100

Total 100

Note 7. Short- term provisions As at 31st As at 31st

March, 2014 March, 2013
Proposed dividend 125

Provision for Taxation 650

Provision for bonus 120

Total 895

Note 8. Tangible Assets As at 31st As at 31st

March, 2014 March, 2013
Equipment, Fixtures & Fittings at cost- Opening 1,320

Less: Depriciation 895 425

Leasehold premises (210+200+190) 600

Less: Witten off 25 575

Total 1,000

Note 9. Inventories As at 31st As at 31st

March, 2014 March, 2013
Stock – Finished stock 710

Work in progress 700

Total 1410

Note 10.Trade Receivables As at 31st As at 31st

March, 2014 March, 2013
Trade Debtors (more than six months ) 3,675

Less: Provision for doubtful debts 245

Total 3,430

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Note 11. Revenue from operation As at 31st As at 31st

March, 2014 March, 2013
Sales ( net of Excise Duty) 13,800

Total 13,800

Note 12. Cost of materials Consumed As at 31st As at 31st

March, 2014 March, 2013
Manufacturing expenses- Opening Stock (FG) 295

Opening WIP 1,050 1,345

Purchase of materials (6,090-190) 5,900

Purchase of land as stock 365

Wages 555

Sub-contract Cost (4,470-200) 4,270

Less: Closing Stock- Finished goods 710

Work in progress 700 (1,410)

Total 11,025

Note 13. Employees benefit expenses As at 31st As at 31st

March, 2014 March, 2013
Salary- office staff (90+195) 285

Bonus 120

Total 405

Note 14. Other Expenses As at 31st As at 31st

March, 2014 March, 2013
Administrative Expenses 735
Provision for doubtful debts 245
Auditors remuneration 100
Total 1,080

NOTES ON ACCOUNTS FOR THE YEAR ENDED 31ST MARCH, 2014

Significant Accounting Policies:
(a) Basis for preparation of financial statements: The financial statements have been prepared
under the historical cost convention, in accordance with the generally accepted
accounting principles and the provisions of the companies Act, 1956 as adopted
consistently by the company.
(b) Fixed Assets: Fixed assets are shown at cost less depreciation. Cost comprises the purchase
price and other attributable expenses.
(c) Depreciation: Depreciation on fixed assets is provided using the written down method.
Lease-hold premises/improvements are being amortised over the lease period.
(d) Inventories: Inventories are valued at the lower of historical cost or the net realizable value.

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1. Other Matters:
(a) The cost of leasehold premises includes the cost of refurbishment to the extent of ` 3,90,000
(Materials ` 1,90,000 + Labour ` 2,00,000).
(b) Shallow Ltd. has been sued for supplying defective materials. Settlement of ` 2,50,000 is
hopeful however it has not been recognized in the accounts as it represents contingent
gain.

(1a) Administration Expenses 735

Directors’ Salaries 195

Provision for Doubtful Debts [175 + 2% of (3675 – 175)] 245

Audit Fees 100

Other expenses 1,275

b) Employee Benefits:
Office salaries 90
120

Bonus 210

(2) Bonus Calculation

Sales 13,800

Less: Manufacturing Expenses 11,025

Other Exp. (excluding bonus) 1,365

Depreciation 100

Interest 110 12,600

Pre-tax Profit 1,200

Bonus (10%) 120

(3) Fixed Asset:

Tangible Asset

(a) Gross block

Furniture and Fixture 1,320

Leasehold Premises (210 + 200 + 190) 600

1,920

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(b) Depreciation

Furniture and fixture(1.4.2011) 820 820

For the year [15% on (1,320– 820)] 75 895

Cost of Leasehold Premises written off

[(210 + 200 + 190) X 1/12 X 1/2] 25

920

(4) Provision for Taxation

Profit as per Profit and Loss Account 1,080

Add back: Provision for doubtful debts 245

Cost of Leasehold premises written off 25

Depreciation on equipment, fixtures and fittings 75 345

1,425

Less: Depreciation under Income-tax Act 125

1,300

Provision for Tax (@ 50%) 650

(It has been assumed that depreciation calculated under

Income-tax Act amounts to ` 1,25,000)
(B) The following is the Profit and Loss Account (as per Schedule VI) of ABC Ltd., for the year
ended 31st March, 2014:
Dr. Cr.
Particulars Amount (`) Particulars Amount (`)

Administrative, Selling and distribution Balance b/d 5,72,350

expenses 8,22,542 Balance form Trading A/c 40,25,365
Donation to Charitable Funds 25,500 Subsidies received from Govt. 2,32,560
Directors Fees 66,750 Interest on Investments 15,643
Interest on debentures 31,240 Transfer fees 722
Compensation for breach of contracts Profit on sale of machinery:
Managerial remuneration 42,530 Amount realized 55,000
Depreciation on fixed assets 2,85,350 Written down value 30,000 25,000
Provision for taxation 5,22,543
General reserve 11,42,500
Investment Revaluation Reserves 5,00,000
Balance c/d 12,500
14,20,185
48,71,640
48,71,640
Additional Information:
(i) Original cost of the machinery sold was `40,000.
(ii) Depreciation on fixed assets as per Schedule XIV of the Companies Act,1956 was `5,75,345.
You are required to comment on the managerial remuneration in the following situations:
(a) There is only one whole time director;
(b) There are two whole time director;
(c) There are two whole time directors, a part time director, and a manager.

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Solution:
Calculation of Profits u/s 349 of the Companies Act,1956
Particulars Amount (`)

Net Profit ( bal c/d) 14,20,185

(+) Managers remuneration 2,85,350
(+) Depreciation charged 5,22,543
(+) Provision for taxation 11,42,500
(+) General Reserve 5,00,000
(+) Investment Revaluation Reserve 12,500
(-) Opening Profit 5,72,350
(-) Profit on machinery — Capital Profit (`55,000-`40,000) 15,000
(-) Depreciation as per Schedule XIV 5,75,345
Book Profit 27,20,383
(a) 5% of `27,20,383 = `1,36,019
(b) 10% of `27,20,383 = `2,72,038
(c) 11% of `27,20,383 = `2,99,242

15. (A) Why Cash Flow Statement is Prepared?

Answer:
Cash Flow Statement is considered to be a summarized statement showing sources of Cash
Inflows and application of cash outflows of an enterprise during a particular period of time. It is
prepared on the basis of the published data as disclosed by the Financial Statement of two
different financial periods. It is an essential tool for managerial decision-making. Cash Flow
reports the management Net Cash Flow (i.e. cash inflow less cash outflow or vice versa) from
each activity of the enterprise as well as of the overall business of the enterprise. The
management of the enterprise gets a picture of movement of cash resources from the Cash
Flow Statement and can assess the stronger and weaker area of movement of cash for different
activities of the business for drawing up the future planning.

(B) Explain the Importance of Cash flows.

Answer:
Cash flows are crucial to business decisions. Cash is invested in the business and the rationality of
such investment is evaluated taking into account the future cash flows it is expected to
generate. Economic value of an asset is derived on the basis of its ability to generate future cash
flows. Economic value of an asset is given by the present value of future cash flows expected to
be derived from the asset.
Profit is an accounting concept. Profit is derived on accrual assumption. Profit and cash flows
from operational activities are not the same. Dividend decision is taken on the basis of profit,
although it is to be paid in cash. Similarly, debt servicing capacity of a company is determined
on the basis of cash flows from operations before interest. Plugging back of profit is a much
talked about source of financing modernisation, expansion and diversification. Unless retained
profit is supported by cash, plugging back is not possible. Thus cash flows analysis is an important
basis for making several management decisions.

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(C) Given below is Profit and Loss Account of ABC Ltd. and relevant Balance Sheet information:
Profit and Loss Statement for the year ended 31st March, 2014 (` in lakhs)
Particulars Note As at 31st As at 31st
No. March,2014 March,2013

I REVENUE FROM OPERATION 4,150

II OTHER INCOME 100

III TOTAL REVENUE(I+II) 4,250

IV EXPENSES:

(a) Cost of material consumed

(b) Purchase of products for sale 2,400

(C) changes in inventories of finished goods, work-in- (20)

progress and products for sale

(d) Employees cost/ benefits expenses 800

(e) Finance cost 60

(f) Depreciation and amortization expenses 100

(g) Product development expenses/Engineering

expenses

(h) Other expenses 200

(i) Expenditure transfer to capital and other account

TOTAL EXPENSES 3,540

V PROFIT BEFORE EXCEPTIONAL AND EXTRAORDINARY ITEMS 710

AND TAX ( III-IV)

VI EXCEPTIONAL ITEMS -

VII PROFIT BEFORE EXTRAORDINARY ITEMS AND TAX (V-VI) 710

VIII EXTRAORDINARY ITEMS -

IX PROFIT BEFORE TAX FROM CONTINUING OPERATIONS (VII- 710

VIII)

X Tax expenses:

(1) Current Tax 200

(2) deferred tax -

XI PROFIT AFTER TAX FOR THE YEAR FROM CONTINUING 510

OPERATION(IX-X)

XII Profit (loss) from discontinuing operations

XIII Tax expenses from discontinuing operations

XIV Profit(loss) from discontinuing operations (after tax)(XII-

XIII)

XV PROFIT (LOSS) FOR THE PERIOD (XI+XIV)

Balance brought forward from previous year 50

Profit available for appropriation 560

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Particulars Note As at 31st As at 31st

No. March,2014 March,2013

Appropriation:

Proposed dividend 300

Transfer to General Reserve 200

Distribution Tax 30

Total 530

Balance carried forward 30

XVI Earning per equity share:

(1) Basic

(2) Diluted

Notes on Accounts
1. Revenue from operation As at 31st As at 31st
March,2014 March,2013

Sales ( net of Excise Duty) 4,150

Total 4,150

2. Other Income As at 31st As at 31st

March,2014 March,2013

Interest and Dividend 100

Total 100

3. Employees Cost/ Benefits Expenses As at 31st As at 31st

March,2014 March,2013

Wages and Salaries 800

Total 800

4. Finance Expenses As at 31st As at 31st

March,2014 March,2013

Interest 60

Total 60

Relevant Balance Sheet information 31-03-2014 31-03-2013

` in lakhs ` in lakhs

Debtors 400 250

Inventories 200 180

Creditors 250 230

Outstanding wages 50 40

Outstanding expenses 20 10

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Advance tax 195 180

Tax provision 200 180

Assessed tax liability 180

Compute cash flow from operating Activities under Direct & Indirect method.

Answer:
Computation of cash flow from Operating Activities
Under Direct Method

Cash Receipts (a) ` in lakhs

Cash sales & Collection from debtors

Sales + Opening Debtors - Closing Debtors (4,150+250-400) 4000

Cash Payments (b)

Cash purchases & Payment to creditors

Purchases+ Opening Creditors - Closing creditors (2,400+230-250) 2380

Wages & salaries paid (800+40-50) 790

Cash Expenses (200+10-20) 190

Taxes paid - Advance tax 195

3555

Cash Flow from Operating Activities (a-b) 445

Under Indirect Method

Profit before tax 710

Add : Non-cash items : Depreciation 100

Add : Interest : Financing cash outflow 60

Less : Interest and Dividend : Investment 100

Cash inflow 770

Less : Tax paid 195

Working Capital Adjustments 575

Debtors 250-400 150

Inventories 180-200 -20

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Creditors 250-230 20

Outstanding wages 50-40 10

Outstanding expenses 20-10 10

Cash Flow from Operating Activities 445

(D) The following is the Income statement XYZ Company for the year 2013-14:
(`)

Sales 1,62,700

Add: Equity In ABC Company’s earning 6,000

1,68,700

Expenses (`)

Cost of goods sold 89,300

Salaries 34,400

Depreciation 7,450

Insurance 500

Research and development 1,250

Patent amortisation 900

Interest 10,650

Bad debts 2,050

Income tax :

Current 6,600

Deferred 1,550 8,150

Total expenses 1,54,650

Net income 14,050

Additional information are:

(i) 70% of gross revenue from sales were on credit.
(ii) Merchandise purchases amounting to ` 92,000 were on credit.
(iii) Salaries payable totaled ` 1,600 at the end of the year.
(iv) Amortisation of premium on bonds payable was ` 1,350.
(v) No dividends were received from the other company.
(vi) XYZ Company declared cash dividend of ` 4,000.
(vii) Changes in Current Assets and Current Liabilities were as follows:

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Increase/
(Decrease)
`

Cash 500

Marketable securities 1,600

Accounts receivable (7,150)

Allowance for bad debt (1,900)

Inventory 2,700

Prepaid insurance 700

Accounts payable (for merchandise) 5,650

Salaries payable (2,050)

Dividends payable (3,000)

Prepare a statement showing the amount of cash flow from operations.

Answer:

Statement showing cash flow from Operations

` `
Cash flow from operations
Cash sales (30% 1,62,700) 48,810
Collection from debtors 1,20,890
Total cash from operations 1,69,700
Uses of cash from operations
Payment to suppliers 86,350
Salaries expense 36,450
Payment for insurance 1,200
Research and development 1,250
Interest payment 12,000
Income tax payment 6,600
Total operating cash payment 1,43,850
Net cash flow from operations 25,850

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Notes:
(1) Collection from debtors `
Credit sales (70%× 1,62,700) 1,13,890
Less : Bad debts (2,050 less 1,900) 150
1,13,740
Add : decrease in accounts receivables 7,150
Collection from debtors on credit sales 1,20,890
(2) Dividends earned ` 6,000 on equity of ABC Company
has not been considered as it has not been received in cash.
`
(3) Payment to suppliers
Cost of goods sold 89,300
Add: Increase in inventory 2,700
Purchases 92,000
Less: increase in accounts payable 5,650
Payment to suppliers 86,350
(4) Calculation of salaries payment
Salary expense 34,400
Add : decrease in salary payable 2,050
Payment of salaries 36,450
(5) Insurance payments
Insurance 500
Add : increase in prepaid insurance 700
Payment for insurance 1,200
(6) Interest payment
Interest expenses 10,650
Add : Amortisation of bond premium 1,350
Interest payments 12,000

(7) Income tax payments `

Income tax expense 8,150
Less: Deferred tax 1,550
6,600
Changes in current tax payable Nil
Income tax payments 6,600

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(E) From the following information prepare cash flow statement:

Name of the Company: XYZ Ltd.
Balance Sheet as at 31-12-2012 and 31-12-2013

(` in ‘000)

Ref Particulars Note 31.12.2013 31.12.2012

No. No.

I EQUITY AND LIABILITIES

1 Shareholders’ fund

(a) Share capital 1,500 1,250

(b) Reserves and surplus 3,410 1,380

( c) Money received against share warrants

2 Share application money pending allotment

3 Non-current liabilities

(a) Long-term borrowings 1,110 1,040

(b)Deferred tax liabilities (Net)

(c )Other Long term liabilities

(d) Long-term provisions

4 Current Liabilities

(a) Short-term borrowings

(b) Trade payables 150 1,890

(c )Other current liabilities 230 100

(d) Short-term provisions 400 1,000

Total 6,800 6,660

II ASSETS

1 Non-current assets

(a) Fixed assets

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(` in ‘000)

Ref Particulars Note 31.12.2013 31.12.2012

No. No.

(i) Tangible assets 730 850

(ii) Intangible assets

(iii) Capital work-in-progress

(iv) Intangible assets under development

(b) Non-current investments 2,500 2,500

( c)Deferred tax assets (Net)

(d) Long-term loans and advances

(e) Other non-current assets

2 Current assets

(a)Current investments 670 135

(b) Inventories 900 1,950

(c ) Trade receivables 1,700 1,200

(d) Cash and cash equivalents 200 25

(e)Short-term loans and advances

(f) Other current assets

Total 6,800 6,660

Notes on Accounts (` in ‘000)

1. Other Current Liabilities 31.12.2013 31.12.2012

Interest Payable 230 100
Total 230 100

2.Short Term Provision 31.12.2013 31.12.2012

Income Tax Payable 400 1,000
Total 400 1,000

3. Fixed Assets 31.12.2013 31.12.2012

Fixed Assets at cost 2,180 1,910
Less: Accumulated Depreciation 1,450 1,060
Total 730 850

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4. Other Current Assets 31.12.2013 31.12.2012

Interest Receivable 100 -
Total 100 -

Statement of Profit and Loss for the year ended 31-12-2013 (` in ‘000)
Sales 30,650

Cost of sales (26,000)

Gross profit 4,650

Depreciation (450)

Administration and selling expenses (910)

Interest expenses (400)

Interest income 300

Dividend income 200

Foreign exchange loss (40)

Net profit before taxation and extraordinary item 3,350

Extraordinary item - Insurance proceeds from earthquake disaster settlement 180

Net profit after extraordinary item 3,530

Income-tax (300)

Net profit 3,230

Additional information (` in thousands):
(a) An amount of `250 was raised from the issue of share capital and a further ` 250 was raised
from long-term borrowings.
(b) Interest expense was ` 400 of which `170 was paid during the period. ` 100 relating to
interest expenses of the prior period was also paid during the period.
(c) Dividends paid were ` 1,200.
(d) Tax deducted at source on dividends received (included in the tax expenses of ` 300 for the
year) amounted to ` 40
(e) During the period, the enterprise acquired fixed assets for ` 350. The payment was made in
cash.
(f) Plant with original cost of ` 80 and accumulated depreciation of ` 60 was sold for ` 20.
(g) Foreign exchange loss of ` 40 represents reduction in the carrying amount of a short-term
investment in foreign currency designated bonds arising out of a change in exchange rate
between the date of acquisition of the investments and the balance sheet date.
(h) Sundry debtors and sundry creditors include amounts relating to credit sales and credit
purchases only.

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Answer:
Cash Flow Statement (Direct Method) (` in ‘000)
Cash Flows from Operating Activities:

Cash receipts from customers 30,150

Cash paid to suppliers and employees (27,600)

Cash generated from operations 2,550

Income taxes paid (860)

Cash flow before extraordinary item : 1,690

Proceeds from earthquake disaster settlement 180

Net cash from operating activities (a) 1,870

Cash Flows from Investing Activities:

Purchase of fixed assets (350)

Proceeds from sale of equipment 20

Interest received 200

Dividend received 160

Net cash from investing activities (b) 30

Cash Flows from Financing Activities:

Proceeds from issuance of share capital 250

Proceeds from long-term borrowing 250

Repayments of long-term borrowings (180)

Interest paid (270)

Dividend paid (1,200)

Net cash used in financing activities (c) (1,150)

Net increase in cash and cash equivalents 750

Add: Cash and cash equivalents at beginning of period 160

Cash and cash equivalents at end of period 910

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Cash Flow Statement (Indirect Method)

Cash flows from Operating Activities

Net profit before taxation, and extraordinary item 3,350

Adjustments for:

Depreciation 450

Foreign exchange loss 40

Interest income (300)

Dividend income (200)

Interest expenses 400

Operating profit before working capital changes 3,740

Increase in sundry debtors (500)

Decrease in inventories 1,050

Decrease in sundry creditors (1,740)

Cash generated from operations 2,550

Income taxes paid (860)

Cash flow before extraordinary item : 1,690

Proceeds from earthquake disaster settlement 180

Net cash from operating activities 1,870

Cash Flows from Investing Activities

Purchase of fixed assets (350)

Proceeds from sale of equipment 20

Interest received 200

Dividend received 160

Net cash from investing activities 30

Cash Flows from Financing Activities:

Proceeds from issuance of share capital 250

Proceeds from long-term borrowings 250

Repayment of long-term borrowings (180)

Interest paid (270)

Dividends paid (1,200)

Net cash used in financing activities (1,150)

Net increase in cash and cash equivalents 750

Cash and cash equivalents at beginning of period 160

Cash and cash equivalents at end of period 910

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Working Notes:
1. Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand and balance with banks, and investments in
money-market instruments. Cash and cash equivalents included in the cash flow statement comprise
the following balance sheet amounts:
Particulars 2013 2012
Cash on hand and balances with banks 200 25
Short-term investments 670 135
Cash and cash equivalents 870 160
Effect of exchange rate changes 40
Cash and cash equivalents as restated 910 160
Cash and cash equivalents at the end of the period include deposits with banks of 100 held by a
branch which are not freely remissible to the company because of currency exchange restrictions.
The company has undrawn borrowing facilities of 2,000 of which 700 may be used only for future
expansion.
2. Total tax paid during the year (including tax deducted at source on dividends received) amounted to
900.
3. Cash receipts from customers

Sales 30,650
Add : Sundry debtors at the beginning of the year 1,200
31,850
Less : Sundry debtors at the end of the year 1,700
30,150

4. Cash paid to suppliers and employees

Cost of sales 26,000

Administrative & selling expenses 910

26,910

Add : Sundry creditors at the beginning of the year 1,890

Inventories at the end of the year 900 2,790

29,700

Less : Sundry creditors at the end of the year 150

Inventories at the beginning of the year 1,950 2,100

27,600

5. Income taxes paid (including tax deducted at source from dividends received)
Income tax expenses for the year (including tax)
deducted at source from dividends received) 300
Add : Income tax liability at the beginning of the year 1,000
1,300
Less : Income tax liability at the end of the year 400
900

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Out of 900, tax deducted at source on dividends received (amounting to 40) is included in cash flows from
investing activities and the balance of 860 is included in cash flows from operating activities.
6. Repayment of long-term borrowing
Long-term debt at the beginning of the year 1,040
Add : Long-term borrowings made during the year 250
1,290
Less : Long-term borrowings at the end of the year 1,110
180
7. Interest Paid
Interest expenses for the year 400
Add : Interest payable at the beginning of the year 100
500
Less : Interest payable at the end of the year 230
270

16. (A) Explain the concept & disclosure requirement of reportable segments under Accounting
Standard 17 on “Segment Reporting”.

Answer:
Reportable Segments -
A business segment or geographical segment should be identified as a reportable segment if:
(a) its revenue from sales to external customers and from transactions with other segments is 10
per cent or more of the total revenue, external and internal, of all segments; or
(b) its segment result, whether profit or loss, is 10 per cent or more of -
(i) the combined result of all segments in profit, or
(ii) the combined result of all segments in loss,
whichever is greater in absolute amount; or
(c) its segment assets are 10 per cent or more of the total assets of all segments.
A business segment or a geographical segment which is not a reportable segment, may be
designated as a reportable segment despite its size at the discretion of the management of the
enterprise. If that segment is not designated as a reportable segment, it should be included as an
unallocated reconciling item.
If total external revenue attributable to reportable segments constitutes less than 75 per cent of
the total enterprise revenue, additional segments should be identified as reportable segments,
even if they do not meet the 10 per cent, until at least 75 per cent of total enterprise revenue is
included in reportable segments.
Disclosure Requirements -
An enterprise should disclose the following for each reportable segment:
(a) segment revenue, classified into segment revenue from sales to external customers and
segment revenue from transactions with other segments;
(b) segment result;
(c) total carrying amount of segment assets;
(d) total amount of segment liabilities;
(e) total cost incurred during the period to acquire segment assets that are expected to be
used during more than one period (tangible and intangible fixed assets);

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(f) total amount of expense included in the segment result for depreciation and amortisation in
respect of segment assets for the period; and
(g) total amount of significant non-cash expenses, other than depreciation and amortisation in
respect of segment assets, that were included in segment expense and, therefore,
deducted in measuring segment result.

(B) Define Business Segment and Geographical Segment as per AS 17.

Answer:
Business segment -
A business segment is a distinguishable component of an enterprise that is engaged in providing
an individual product or service or a group of related products or services and that is subject to
risks and returns that are different from those of other business segments. Factors that should be
considered in determining whether products or services are related include:
(a) the nature of the products or services;
(b) the nature of the production processes;
(c) the type or class of customers for the products or services;
(d) the methods used to distribute the products or provide the services; and
(e) if applicable, the nature of the regulatory environment, for example, banking, insurance, or
public utilities.
Geographical segment -
A geographical segment is a distinguishable component of an enterprise that is engaged in
providing products or services within a particular economic environment and that is subject to
risks and returns that are different from those of components operating in other economic
environments. Factors that should be considered in identifying geographical segments include:
(a) similarity of economic and political conditions;
(b) relationships between operations in different geographical areas;
(c) proximity of operations;
(d) special risks associated with operations in a particular area;
(e) exchange control regulations; and
(f) the underlying currency risks.

(C) From the following information of a company having two primary segments, prepare a
statement classifying the same under appropriate heads.
(` in lakh)
Segment Revenue A 27,050
Segment Revenue B 3,280
Inter Segment Revenue A 50
Segment Profit A 4,640
B
Segment Profit Loss 197
Dividend Income 285
Interest Expense 35
Tax Provision 1,675
Capital Expenditure A 1,300

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Capital Expenditure B 16
Non Cash Expenses
(excluding depreciation)
Segment A 114
Segment B 16
Liabilities A 3,430
Liabilities B 770
Other Liabilities 2,200
Assets A 19,450
Assets B 2,700
Other Assets 6,550
Depreciation A 110
Depreciation B 15

Answer:
Particulars Segment Segment Others Eliminations Total
A B
I Revenue:
a) External Revenue 27,050 3,280 30,330
b) Inter segment Revenue 50 -50
Total 27,100 3,280 -50 30,330

II Result: 4,640 -197 4,443

a) Income from Investment 285
b) Interest Expenses -35
c) Tax provision -1,675
d) Net profit 3,018

III Assets:
a) Segment assets (directly attributable & 19,450 2,700 22,150
allocated)
b) Unallocated assets 6,550

IV Liabilities
a) Segment assets (directly 3,440 770 4,200
attributable & allocated)
b) Unallocated liabilities 2,200

V Others:
a) Depreciation 110 15 125
b) Non cash expenses 114 16 130
c) Capital Expenditure 1,300 16 1,316

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(D) Information relating to five segments of V Ltd. is as under: (` in lakhs)

Segments A B C D E Total

Segment Revenue 100 300 200 100 300 1,000

Segment Result 40 (60) 90 10 (30) 50

Segment Assets 45 55 140 20 40 300

As a cost accountant of this company management wishes to know from you which company
need to be reported.

Answer: (` in lakh)

Particulars A B C D E Total
1. Segment Revenue 100 300 200 100 300 1,000
2. % of Segment
Revenue 10% 30% 20% 10% 30%
3. Segment Result:
Profit 40 90 10 140
Loss (60) (30) (90)

4. % of segment Result,
absolute amount of 28.57% 42.88% 64.29% 7.14% 21.43%
profit/ whichever is
higher, i.e. as a % of
140
5. Segment Assets 45 55 140 20 40 300
6. % of Segment Assets 15% 18.33% 46.67% 6.66% 13.33%

Reportable Yes Yes Yes Yes Yes

Segment
Criteria satisfied Revenue Revenue Revenue, Revenue Revenue,
, Result & Result & Result & Result &
Assets Assets Assets Assets

17. (A) The Balance Sheet (in Conventional Format) of MM Ltd. on 31st March, 2014 is as under:

Liabilities ` Assets `

Authorised, issued equity share capital Goodwill 5,00,000

50,000 shares of ` 100 each 50,00,000 Plant and machinery 45,00,000

25,000 preference shares (7%) of Stock 7,50,000

` 100 each 25,00,000
Debtors 18,75,000

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Sundry creditors 17,50,000 Preliminary expenses 2,50,000

Bank overdraft 7,50,000 Cash 3,75,000

Profit and loss account (Dr.) 17,50,000

1,00,00,000 1,00,00,000

Two years’ preference dividends are in arrears. The company had bad time during the last two
years and hopes for better business in future, earning profit and paying dividend provided the
capital base is reduced.
An internal reconstruction scheme as follows was agreed to by all concerned:
(i) Creditors agreed to forego 50% of the claim.
(ii) Preference shareholders withdrew arrear dividend claim. They also agreed to lower their
capital claim by 20% by reducing nominal value in consideration of 9% dividend effective
after reorganization in case equity shareholders’ loss exceed 50% on the application of the
scheme.
(iii) Bank agreed to convert overdraft into term loan to the extent required for making current
ratio equal to 2: 1.
(iv) Revalued figure for plant and machinery was accepted as `37,50,000.
(v) Debtors to the extent of `10,00,000 were considered good.
(vi) Equity shares shall be exchanged for the same number of equity shares at a revised
denomination as required after the reorganisation.
Show:
(a) Total loss to be borne by the equity and preference shareholders for the reorganization;
(b) Share of loss to the individual classes of shareholders;
(c) New structure of share capital after reorganization;
(d) Working capital of the reorganized Company; and
(e) A proforma balance sheet after reorganization.

Answer:
(a) Loss to be borne by Equity and Preference Shareholders

Profit and loss account (debit balance) 17,50,000

Preliminary expenses 2,50,000

Goodwill 5,00,000

Plant and machinery (` 45,00,000 – ` 37,50,000) 7,50,000

Debtors (` 18,75,000 – ` 10,00,000) 8,75,000

Amount to be written off 41,25,000

Less: 50% of sundry creditors 8,75,000

Total loss to be borne by the equity and preference shareholders 32,50,000

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(b) Share of loss to preference shareholders and equity shareholders

Total loss of ` 32,50,000 being more than 50% of equity share capital i.e. ` 25,00,000.
Preference shareholders’ share of loss = 20% of ` 25,00,000 = ` 5,00,000
Equity shareholders’ share of loss (` 32,50,000 – ` 5,00,000) = ` 27,50,000
Total loss ` 32,50,000
(c) New structure of share capital after reorganisation

Equity shares: `

50,000 equity shares of ` 45 each, fully paid up (` 50,00,000 – ` 27,50,000) 22,50,000

Preference shares:

25,000, 9% preference shares of ` 80 each, fully paid up (` 25,00,000 – ` 20,00,000

5,00,000)

42,50,000

(d) Working capital of the reorganized company

Current Assets: ` `

Stock 7,50,000

Debtors 10,00,000

Cash 3,75,000

21,25,000

Less: Current liabilities:

Creditors 8,75,000

Bank overdraft 1,87,500 10,62,500

Working capital 10,62,500

Note:
Current ratio shall be 2: 1, i.e. total current liabilities shall be 50% of ` 21,25,000 (i.e. ` 7,50,000
+
10,00,000 + 3,75,000) = ` 10,62,500. Therefore, Bank overdraft = ` 1,87,500 (` 10,62,500 less creditors
` 8,75,000).

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(e)

Name of the Company: MM Ltd.

Balance Sheet of (and reduced) as at 31st March, 2014

(`)
Ref Particulars Note As at 31st As at 31st
No. No. March, 2014 March, 2013
1 EQUITY AND LIABILITIES

(a) Share capital 1 42,50,000

(b) Reserves and surplus

(c) Money received against share warrants

2 Share application money pending allotment

3 Non-current liabilities

(a) Long-term borrowings 2 5,62,500

(b)Deferred tax liabilities (Net)

(c ) Other Long term liabilities

(d) Long-term provisions

4 Current Liabilities

(a) Short-term borrowings 3 1,87,500

(b) Trade payables 4 8,75,000

(c)Other current liabilities

(d) Short-term provisions

Total (1+2+3+4) 58,75,000

II ASSETS

1 Non-current assets

(a) Fixed assets

(i) Tangible assets 5 37,50,000

(ii) Intangible assets

(iii) Capital work-in-progress

(iv) Intangible assets under development

(b) Non-current investments

(c)Deferred tax assets (Net)

(d) Long-term loans and advances

(e) Other non-current assets

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(`)
Ref Particulars Note As at 31st As at 31st
No. No. March, 2014 March, 2013
2 Current assets

(a)Current investments

(b) inventories 6 7,50,000

(c ) trade receivables 7 10,00,000

(d) Cash and cash equivalents 8 3,75,000

(e)Short-term loans and advances

(f) Other current assets

Total (1+2) 58,75,000

(`)
Note 1. Share Capital As at 31st As at 31st
March, 2014 March, 2013
Authorized share capital

50,000 equity share of ` 100 each 50,00,000

25,000 7% Preference share of ` 100 each 25,00,000

Issued, Subscribed and paid-up share capital

50,000 Equity share of ` 45 each 22,50,000

25,000 7% Preference share of ` 80 each 20,00,000

Total 42,50,000

Reconciliation of Share Capital

FOR EQUITY SHARE As at 31st March, 2014 As at 31st March, 2013
Nos. Amount (`) Nos. Amount (`)

Opening Balance as on 01.04.11 50,000 22,50,000

Add: Fresh Issue (Including Bonus shares, right

shares, split shares, share issued other than cash)
50,000 22,50,000

Less: Buy Back of share

Total 50,000 22,50,000

FOR 7% PREFERENCE SHARE As at 31st March, 2014 As at 31st March, 2013

Nos. Amount (`) Nos. Amount (`)

Opening Balance as on 01.04.11 25,000 20,00,000

Add: Fresh Issue (Including share issued other Nil Nil

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than cash)
25,000 20,00,000

Less: Redemption of Preference shares Nil Nil

Total 25,000 20,00,000

Note 2. Long-term borrowings As at 31st As at 31st

March, 2014 March, 2013
Term Loan - Unsecured 5,62,500

Total 5,62,500

Note 3. Short-term borrowings As at 31st As at 31st

March, 2014 March, 2013
Bank Overdraft 1,87,500

Total 1,87,500

Note 4. Trade Payables As at 31st As at 31st

March, 2014 March, 2013
Sundry Creditors 8,75,000

Total 8,75,000

Note 5. Tangible Assets As at 31st As at 31st

March, 2014 March, 2013
Plant and machinery 37,50,000

Total 37,50,000

Note 6. Inventories As at 31st As at 31st

March, 2014 March, 2013
Stock 7,50,000

Total 7,50,000

Note 7.Trade receivables As at 31st As at 31st

March, 2014 March, 2013
Sundry Debtors 10,00,000

Total 10,00,000

Note 8.Cash and cash equivalent As at 31st As at 31st

March, 2014 March, 2013
Cash 3,75,000

Total 3,75,000

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(B) Jay Ltd., and Krishna Ltd., had the following financial position as at 31st March, 2014.
Jay Krishna Jay Krishna
Ltd. Ltd. Ltd. Ltd.
Share capital : 24,00,000 18,00,000 Goodwill 15,00,000 3,00,000
Equity shares of Fixed assets 12,00,000 21,00,000
` 100 each fully paid Investment at cost 9,00,000 6,00,000
General Reserve 9,00,000 6,00,000 Current assets 9,00,000 7,50,000
Investment Allowance
Reserve — 9,00,000
Liabilities 12,00,000 4,50,000
45,00,000 37,50,000 45,00,000 37,50,000

It was decided that Jay Ltd. will take over the business of Krishna Ltd., on that date, on the basis
of the respective share values adjusting, wherever necessary, the book values of assets and
liabilities on the strength of information given below:
1) Investment of Krishna Ltd., included 3,000 shares in Jay Ltd., acquired at a cost of ` 150 per
share. The other investments of Krishna Ltd., have a market value of ` 75,000;
2) Investment Allowance Reserve was in respect of additions made to Fixed assets by Krishna
Ltd., in the years 2009-2012 on which Income Tax relief has been obtained. In terms of the
Income Tax Act, the company has to carry forward till 2013, reserve of ` 4,50,000 for
utilisation;
3) Goodwill of Jay Ltd., and Krishna Ltd., are to be taken at ` 12,00,000 and ` 6,00,000
respectively;
4) The market value of investments of Jay Ltd., was ` 6,00,000;
5) Current assets of Jay Ltd., included `24,00,000 of stock in trade obtained from Krishna Ltd.
which company sold at a profit of 25% over cost ;
6) Fixed assets of Jay Ltd., and Krishna Ltd., are valued at `15,00,000 and `22,50,000
respectively.
Suggest the scheme of absorption and show the journal entries necessary in the books of Jay
Ltd. Also prepare the Balance Sheet of that company after takeover of the business of Krishna
Ltd.

Answer:
Part I: Purchase Consideration
WN # 1: Intrinsic Value of Shares
Particulars Jay Ltd. Krishna Ltd.
` `
Goodwill 12,00,000 6,00,000
Fixed assets 15,00,000 22,50,000
Investments - Outside 6,00,000 75,000
- Inter Co. [13,000 shares @ ` 125 each] — 3,75,000
Current assets 9,00,000 7,50,000
Liabilities (12,00,000) (4,50,000)
Net assets 30,00,000 36,00,000
No. of shares outstanding 24,000 18,000
Intrinsic value per share (30,00,000/24,000); (36,00,000/18,000) 125 200

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WN # 2: Purchase Consideration
Particulars Krishna Ltd.
`
Total no. of shares outstanding in Krishna Ltd. 18,000
Value of shares @ ` 200/- each 36,00,000
No. of shares issuable on the basis of Intrinsic value of share 28,800
(36,00,0000 ÷ 125)
Less : Shares already held (3,000)
No. of shares to be issued 25,800
Shares price 125
Purchase Consideration (25,800 × 125) 32,25,000
Part II: In the Books of Jay Ltd.
 Nature of Amalgamation - Purchase
 Method of Accounting - Purchase
Particulars Debit Credit
` `
1. For Purchase Consideration Due
Business Purchase A/c Dr. 32,25,000
To Liquidator of Krishna Ltd A/c 32,25,000
2. For Assets and Liabilities taken over:
Goodwill A/c Dr. 6,00,000
Fixed Assets A/c Dr. 22,50,000
Investments A/c Dr. 75,000
Current Assets A/c Dr. 7,50,000
To Liabilities A/c 4,50,000
To Business Purchase A/c 32,25,000
3. For Discharge of Purchase consideration
Liquidator of Krishna Ltd A/c Dr. 32,25,000
To Equity Share Capital A/c 25,80,000
To Securities Premium A/c 6,45,000
4. Contra entry for statutory reserve
Amalgamation adjustment A/c Dr. 4,50,000
To Investment allowance A/c 4,50,000
5. For adjustment of stock reserve
Goodwill A/c Dr. 48,000
To Stock Reserve A/c 48,000

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Name of the Company: Jay Ltd.

Balance Sheet as at 31.03.2014
Ref Note After Before
Particulars
No. No. absorption absorption
` `

I. Equity and Liabilities

1 Shareholders’ funds

(a) Share capital 1 49,80,000

(b) Reserves and surplus 2 19,95,000

( c) Money received against share warrants

2 Share application money pending allotment

3 Non-current liabilities

(a) Long-term borrowings

(b)Deferred tax liabilities (Net)

(c ) Other Long term liabilities

(d) Long-term provisions

4 Current Liabilities

(a) Short-term borrowings

(b) Trade payables

(c )Other current liabilities 3 16,50,000

(d) Short-term provisions

Total(1+2+3) 86,25,000

II. Assets

1 Non-current assets

(a) Fixed assets

(i) Tangible assets 4 34,50,000

(ii) Intangible assets 5 21,48,000

(iii) Capital work-in-progress

(iv) Intangible assets under development

(b) Non-current investments 6 9,75,000

( c)Deferred tax assets (Net)

(d) Long-term loans and advances

(e) Other non-current assets 7 4,50,000

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2 Current assets

(a)Current investments

(b) Inventories

(c ) Trade receivables

(d) Cash and cash equivalents

(e) Short-term loans and advances

(f) Other current assets 8 16,02,000

Total(1+2) 86,25,000

(`)
After Before
Note 1. Share Capital
absorption absorption
Authorised, Issued, Subscribed and paid up:- 49,80,000
49,800 Equity Shares of ` 1000 (of which 25,800 shares of ` 1,000
each issued for consideration other than cash)
Total 49,80,000

Reconciliation of Share Capital

For equity share:- After absorption Before absorption
Nos. Amount (`) Nos. Amount (`)
Opening Balance as on 01.04.13 24,000 24,00,000 NIL NIL
Add: Fresh Issue (Incld Bonus shares, Right shares, NIL NIL
split shares, shares issued other than cash) 25,800 25,80,000
49,800 49,80,000 NIL NIL

Less: Buy Back of shares - - - -

Closing Balance as on 31.03.14 49,800 49,80,000 NIL NIL

After Before
Note 2. Reserves and Surplus
absorption absorption
Securities Premium 6,45,000
Investment allowance Reserve 4,50,000
General Reserve 9,00,000
Total 19,95,000

After Before
Note 3. Other Current Liabilities
absorption absorption
Current Liabilities 16,50,000
Total 16,50,000

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After Before
Note 4. Tangible assets
absorption absorption
Fixed Assets 34,50,000
Total 34,50,000

After Before
Note 5. Intangible assets
absorption absorption
Goodwill 21,48,000
Total 21,48,000

After Before
Note 6. Non Current Investments
absorption absorption
Investment at cost 9,75,000
Total 9,75,000

After Before
Note 7. Other Non Current Assets
absorption absorption
Amalgamation Adjustment Accounts 4,50,000
Total 4,50,000

After Before
Note 8. Other Current Assets
absorption absorption
Current Assets 16,02,000
Total 16,02,000

(C) The following is the summarized Balance Sheet of XY Ltd. as on 31.3.2014:

Liabilities ` Assets `

Authorized and Issued Capital: Goodwill 1,20,000

30,000,6% Pref. Shares of `10 each 3,00,000 Land and Buildings 2,67,000
6,00,000 Equity Shares of `1 each 6,00,000 Plant 2,55,000
Shares – in- Subsidiary Ltd. 75,000
(at cost)

8% Debentures
(Secured on Land & Building) 1,20,000 Stock 2,25,000
Accrued Interest 6,000 1,26,000 Debtors 2,70,000
Profit and Loss A/c 2,64,000
Bank Overdraft (Secured on Stock) 1,65,000
Directors’ Loan 75,000 Deferred Expenditure:
Creditors 2,70,000 Advertisement 60,000
15,36,000 15,36,000

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Notes:

(a) There is a contingent liability for damages of `30,000.

(b) Preference shares are cumulative and dividends are in arrears for three years. A Capital
Reduction Scheme settling the following terms was duly approved;
(i) The preference shares to be reduced to `8 per share and the Equity shares to 25 paise each
and to be consolidated as shares of `10 each and `1each, fully paid, respectively. The
Preference shareholders waive 2/3 rd of the dividend arrear and receive Equity shares for
the balance. The authorized Capital to be restored to: 30,000 Preference shares of `10 each
and 6,00,000 Equity Shares of `1 each.
(ii) The Share-in-Subsidiary Ltd. are sold to an outside interest for `1,50,000.
(iii) All intangible assets are to be eliminated and bad debts of `12,000 and obsolete Stock of
`30,000 to be written –off.
(iv) The debenture holders to take over one of the company’s property (Book Value `54,000) at
a price of `60,000 in part satisfaction of the Debentures and to provide further cash of
`45,000 on a floating charge. The arrears of interest are paid.
(v) The contingent liability materialized in the sum stated but the company recovered `15,000
of these damages in action against one of its Directors. This was debited to his Loan
Account of `24,000, the balance of which was paid in cash on his resignation.
(vi) The remaining Directors agreed to take Equity Shares in satisfaction of their loans.
You are required to:

1. Give the necessary journal entries, including cash transactions;

2. Set-out the revised Balance Sheet after giving effect to the foregoing entries.
Solution:

In the Books of XY Ltd.

Journal Entries

Date Particulars L.F. Debit Credit

(`) (`)

2014 6% Pref. Share Capital (`10)A/c Dr. 3,00,000

Mar.31 To 6% Pref. Share Capital (`8) A/c 2,40,000
“ Capital Reduction A/c 60,000
(Reduction in value of Pref. Shares from `10 to `8
each as per scheme of capital reduction)

6% Pref. Share Capital (`8) A/c Dr 2.40,000

To 6% Pref. Share Capital (`10) A/c 2,40,000
(Consideration of 30,000 shares of `8 each to 24,000
shares of `10 each)

Equity Share Capital (`1) A/c Dr 6,00,000

To Equity Share Capital (`0.25) A/c 1,50,000
To Capital Reduction A/c 4,50,000
(Reduction in value of equity shares from `1 to `0.25
each as per scheme of capital reduction)

Equity Share Capital A/c (`0.25) Dr 1,50,000

To Equity Share Capital (`1) A/c 1,50,000
(Consolidation of 6,00,000 equity shares of `0.25 to
1,50,000 equity shares of `1 each)

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Capital Reduction A/c Dr 18,000

To Equity Share Capital A/c 18,000
(Discharge arrear pref. dividend by the issue of
equity shares of `1 each)

Bank A/c Dr 1,50,000

To Shares – in- Subs. Co. A/c 75,000
To Capital Reduction A/c 75,000
(Share-in-Subs. Sold at a profit, profit being
transferred to Capital Reduction Account)

8% Debenture A/c Dr 60,000

To Debenture holders A/c 60,000
(Amount of debenture transferred to Debenture
holders Account)

Debenture holders A/c Dr 60,000

To Properties A/c 54,000
To Capital Reduction A/c 6,000
(Profit on discharge of debenture holders transferred
to Capital Reduction Account)

Bank A/c Dr 45,000

To 8% Debenture A/c 45,000
(Amount received by the issue of 8% Debentures)

Accrued Interest A/c Dr 6,000

To Bank A/c 6,000
(Accrued Interest paid)

Directors’ Loan A/c Dr 15,000

Capital Reduction A/c Dr 15,000
To Bank A/c 30,000
(Damages adjusted against Directors’ loan and loss
being debited to Capital Reduction Account)

Directors’ Loan (24,000 -15,000) A/c Dr 9,000

To Bank A/c 9,000
( Balance due to said Directors’ loan paid)

Directors’ Loan A/c (75,000-24,000) Dr 51,000

To Equity Share Capital A/c 51,000
(Equity shares were issued in satisfaction of the
balance of Directors’ loan)

Capital Reduction A/c Dr 5,58,000

To Profit and Loss A/c 2,64,000
To Advertisement A/c 60,000
To Goodwill A/c 1,20,000
To Bad Debt A/c 12,000
To Stock A/c 30,000
To Capital Reserve (bal. fig.) A/c 72,000
(Various fictitious assets are eliminated and the
balance transferred to Capital Reserve Account)

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Name of the Company: XY Ltd.

Balance Sheet as at 31st March, 2014 ( and reduced)
(`)

Ref Particulars Note As at 31st As at 31st

No. No. March, 2014 March, 2013

1 EQUITY AND LIABILITIES

(a) Share capital 1 4,59,000

(b) Reserves and surplus 2 72,000

(c) Money received against share warrants

2 Share application money pending allotment

3 Non-current liabilities

(a) Long-term borrowings 3 1,05,000

(b)Deferred tax liabilities (Net)

(c) Other Long term liabilities

(d) Long-term provisions

4 Current Liabilities

(a) Short-term borrowings 4 1,65,000

(b) Trade payables 5 2,70,000

(c)Other current liabilities

(d) Short-term provisions

Total (1+2+3+4) 10,71,000

II ASSETS

1 Non-current assets

(a) Fixed assets

(i) Tangible assets 6 4,68,000

(ii) Intangible assets

(iii) Capital work-in-progress

(iv) Intangible assets under development

(b) Non-current investments

(c)Deferred tax assets (Net)

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(d) Long-term loans and advances

(e) Other non-current assets

2 Current assets

(a)Current investments

(b) inventories 7 1,95,000

(c) trade receivables 8 2,58,000

(d) Cash and cash equivalents 9 1,50,000

(e)Short-term loans and advances

(f) Other current assets

Total (1+2) 10,71,000

(`)

Note 1. Share Capital As at 31st As at 31st

March, 2014 March, 2013
Authorized share capital
6,00,000 Equity shares of ` 1 each 6,00,000
30,000 ,6 % Pref. shares of ` 10 each 3,00,000
9,00,000
Issued, Subscribed and paid-up share capital
2,19,000 Equity share of ` 1 each fully paid 2,19,000
24,000 6 % Pref. shares of ` 10 each fully paid 2,40,000
Total 4,59,000

RECONCILIATION OF SHARE CAPITAL

FOR EQUITY SHARE As at 31st March, 2014 As at 31st March, 2013
Nos. Amount (`) Nos. Amount (`)

Opening Balance as on 01.04.11 2,19,000 2,19,000

Add: Fresh Issue (Including Bonus shares, right

shares, split shares, share issued other than cash)
2,19,000 2,19,000

Less: Buy Back of share

Total 2,19,000 2,19,000

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For Preference Share As at 31st March, 2014 As at 31st March, 2013

Nos. Amount (`) Nos. Amount (`)

Opening Balance as on 01.04.11 24,000 2,40,000

Add: Fresh Issue

Total 24,000 2,40,000

Note 2. Reserve & Surplus As at 31st As at 31st

March, 2014 March, 2013
Capital Reserve 72,000

Total 72,000

Note 3. Long-term borrowings As at 31st As at 31st

March, 2014 March, 2013
8% Debenture- secured 1,05,000

Total 1,05,000

Note 4. Short-term borrowings As at 31st As at 31st

March, 2014 March, 2013
Bank overdraft - unsecured 1,65,000

Total 1,65,000

Note 5. Trade Payables As at 31st As at 31st

March, 2014 March, 2013
Sundry Creditors 2,70,000

Total 2,70,000

Note 6. Tangible Assets As at 31st As at 31st

March, 2014 March, 2013
Land and buildings ( 2,67,000 – 54,000) 2,13,000

Plant 2,55,000

Total 4,68,000

Note 7. Inventories As at 31st As at 31st

March, 2014 March, 2013
Stock ( 2,25,000 – 30.000) 1,95,000

Total 1,95,000

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Note 8.Trade receivables As at 31st As at 31st

March, 2014 March, 2013
Sundry Debtors (2,70,000 - 12,000) 2,58,000

Total 2,58,000

Note 9.Cash and Cash equivalents As at 31st As at 31st

March, 2014 March, 2013
Bank ( 1,50,000 + 45,000 -6,000 -30,000 - 9,000) 1,50,000

Total 1,50,000

(D) Following is the Balance Sheet as at 31st March 2014:

Liabilities Max Mini Assets Max Mini

` ` ` `
Share Capital Goodwill 20 -----
Equity Shares of `100 1,500 1,000 Other Fixed Assets 1,500 760
each Debtors 651 440
9% Pref. Shares of `100 500 400 Stock 393 680
each Cash at Bank 26 130
General Reserve 180 170 Own Debentures
Profit & Loss A/c ----- 15 (Nominal value 192
12% Debentures (`100 600 200 `2,00,000)
each) Discount on Issue of 2
Sundry Creditors 415 225 Debentures
Profit & Loss A/c 411

3,195 2,010 3,195 2,010

On 1.4.2014 Max Ltd. adopted the following scheme of reconstruction:

(i) Each equity share shall be sub-divided in to 10equity shares of `10 each fully paid-up . 50%
of the equity share capital would be surrendered to the company.
(ii) Preference dividends are in arrear for 3 years. Preference shareholders agreed to waive
90% of the dividend claim and accept payment for the balance.
(iii) Own debentures of `80,000 were sold at `98 cum-interest and remaining own debentures
were cancelled.
(iv) Debenture holders of `2,80,000 agreed to accept one machinery of book value of `3,00,000
in full settlement.
(v) Creditors, Debtors and Stocks were valued at `3,50,000, `5,90,000 and `3,60,000
respectively. The Goodwill, Discount on Issue of Debentures and Profit and Loss Account (Dr)
are to be written-off.
(vi) The company paid `15,000 as penalty to avoid Capital commitments of `3,00,000.
On 2.4.2014, scheme of absorption was adopted. Max Ltd. would take over Mini Ltd. The
purchase consideration was fixed as:

(a) Equity shareholders of Mini Ltd. will be given 50 equity shares of `10each, fully paid, in
exchange for 5 shares had in Mini Ltd.

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(b) Issue of 9% Pref. shares of `100 each in the ratio of 4 Pref. shares of Max Ltd. for every 5 Pref.
shares of Mini Ltd.
(c) Issue of one 12% debentures of `100 each of Max Ltd. for every 12% Debentures in Mini Ltd.
You are required to give Journal Entries in the books of Max Ltd.

Answer:

In the Books of Max Ltd.

Journal
Date Particulars L.F Debit Credit
(`) (`)
2014 Equity Share Capital A/c(`100) Dr 15,00,000
Apr.1 To Equity Share Capital A/c (`10) 15,00,000
(Subdivision of one share of `100 each into 10 shares of `10
each)
Equity Share Capital A/c (`10) Dr 7,50,000
To Capital Reduction A/c 7,50,000
(50% of the Equity Share Capital to be surrendered as per
scheme of capital reduction)
Capital Reduction A/c Dr 13,500
To Bank A/c 13,500
(10% of the arrear Pref. dividend paid i.e., `45,000 X 3 =
`1,35,000 X 10%)
Bank A/c (`80,000 X `98) Dr 78,400
To Own Debenture A/c 76,800
To Capital Reduction A/c 1,600
(Own debenture sold at `98- Cum. Interest)
12% Debentures A/c Dr 1,20,000
To Own Debentures A/c 1,15,200
(`1,92,000-`76,800)
To Capital Reduction A/c 4,800
(Profit on cancellation of own debentures transferred)
12% Debentures A/c Dr 2,80,000
Capital Reduction A/c Dr 20,000
To Machinery A/c 3,00,000
(Machinery taken over by the debenture holders)
Creditors A/c Dr 65,000
To Capital Reduction A/c 65,000
(Creditors are reduced)
Capital Reduction A/c Dr 7,72,900
To Profit and Loss A/c 4,11,000
To Goodwill A/c 20,000
To Discount on Debenture A/c 2,000
To Debtors A/c 61,000
To Stock A/c 33,000
To Capital Reserve A/c (bal.fig) 2,45,900
(Various assets are written – off and Sundry Asset written-down
as per scheme of Capital Reduction)

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Capital reduction A/c Dr 15,000

To Bank A/c 15,000
(Penalty paid for Capital commitment)
Fixed Assets A/c Dr 7,60,000
Stock A/c Dr 6,80,000
Debtors A/c Dr 4,40,000
Cash and Bank A/c Dr 1,30,000
To Sundry Creditors A/c 2,25,000
To Liabilities for 12% Debentures of Mini Ltd A/c 2,00,000
To Liquidator of Mini Ltd A/c 13,20,000
To Capital Reserve A/c (bal.fig) 2,65,000
(Various assets and liabilities taken over and purchase
consideration payable)
Liquidation of Mini Ltd A/c Dr 13,20,000
To Equity Share Capital A/c 10,00,000
To 9% Pref. Share Capital A/c 3,20,000
(Payment of Purchase Consideration made)
Liabilities for 12%Debentures of Mini Ltd A/c Dr 2,00,000
To 12% Debenture A/c 2,00,000
(Liabilities for debenture discharged)

Workings

Calculation of Purchase Consideration

` From
1. Payment to Equity Shareholders----- 10,000 Equity
Share ÷ 5= 2,000 X 50 X `10 = Equity Shares
Payment to Pref. Shareholders --- 10,00,000
4,000 Pref. Share ÷ 5 = 800 x4 x `100 = 3,20,000 9% Pref. Shares

13,20,000

(E) On 1st June, 2012 Amit Patel and Co. sold their business to Asha Private Ltd. as of 1 st April,
2012 for a total consideration of ` 1,00,000 – for Goodwill – ` 30,000; Building – ` 30,000;
Machinery – ` 15,000 and stock – ` 25,000.
Asha Private Ltd was incorporated on 1st June,2012 and the purchase consideration was met by
Issue of shares. The business was carried on by the Vendors on behalf of the Company from 1 st
April,2012 and the same set of account books was maintained till 30 th June,2012 when the
following Trial Balance was prepared -

Particulars Debit Credit

Capital Account - Amit - 36,000

Capital Account - Patel - 30,000

Sundry Creditors (including for June purchases of `5,000) - 10,000

Sales - 1,00,000

Salaries and Wages (including `1,000 being Sitting Fees to Directors) 12,000 -

Rent 1,500 -

Purchases 36,000 -

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AB Private Ltd. 10,000 -

Expenses 5,000 -

Bank 3,500 -

Goodwill 25,000 -

Building 20,000 -

Machinery (purchases after 1st April were `1 0,000) 25,000 -

Stocks on 1st April 25,000 -

Sundry Debtors (including Sales of `8,000 in June) 13,000

Total 1,76,000 1,76,000

Stocks on Hand on 30th June,2012 were `18,000.

On 30th June,2012 Amit Patel & Co. paid `10,000 for additional shares and out of this amount, the
Company incurred Preliminary Expenses of `6,000 and purchased a typewriter for `3,000.
Debtors and Creditors prior to 1st June were to be taken over by Amit Patel & Co.
Prepare the Profit and Loss Account of Asha Private Ltd. for the 3 months ended 30th June 2012
and a Balance Sheet as at that date. All workings are to form part of your answer.
Answer:
Dr. 1. Profit & Loss of Asha Pvt. Ltd for the period from 1st April to 30th June 2012 Cr.

Particulars ` Particulars `

To Opening Stock 25,000 By Sales 1,00,000

To Purchases 36,000 By Closing Stock 18,000

To Salaries and Wages (excl. Dir. Fees) 11,000

To Rent 1,500

To Expenses 5,000

To Net Profit c/d 39,500

Total 1,18,000 1,18,000

2.
Particulars April-May June Particulars April-May June
Pre Incorp Post Incorp Pre Incorp Post Incorp
To Director Fees - 1,000 By Net Profit ( in 26,333 13,167 [39500x1/3]
the time ratio [39500x2/3]
of 2:1)

To Capital Reserve- Pre- 26,333 -

Incorporation Profit
To profit and Loss- Post - 12,167
Incorporation Profit
26,333 13,167 26,333 13,167

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3. Journal Entries in books of Asha private Ltd

Sl. No Particulars Dr Cr
1. Goodwill A/c Dr 5,000
Building A/c Dr 10,000
To Asha Private Ltd(Vendor ) A/c 15,000
(Being Goodwill and Building revalued as agreed upon and gain
transferred to Asha Private Ltd a/c as such revaluation gain
belongs Amit Patel & Co.)
2. Amit’s Capital A/c Dr 36,000
Patel’s Capital A/c Dr 30,000
Trade Creditors A/c [10,000 – 5,000] Dr 5,000
To Asha Private Ltd (Vendor ) A/c 71,000
(Being Liabilities not taken over by Asha Private Ltd transferred to
Amit Patel & Co.)
3. Amit Patel & Co. ( Vendor ) A/c Dr. 18,500
To Asha Private ltd A/c 10,000
To Trade Debtors A/c [13,000-8,000] 5,000
To Bank A/c 3,500
(Being Assets not taken over by Asha Private Ltd transferred to
Amit Patel & Co. A/c)
4 Amit Patel & Co.(Vendor) A/c Dr 1,00,000
To Equity Share Capital A/c 1,00,000
(Being issue of 10,000 Equity Shares of Rs.10 as fully paid, in
discharge of purchase Consideration due to Amit Patel & Co.)
5 Bank A/c Dr. 10,000
To Equity Share Capital A/c 10,000
(Being additional 1,000 Equity Shares at `10 each subscribed by
and allotted to Amit Patel & Co.)
6 Preliminary Expenses A/c Dr. 6,000
Typewriter A/c Dr. 3,000
To Bank A/c 9,000
(Being preliminary expenses incurred and typewriter purchased
out of amount received on subscription to additional share
capital)

Dr 4. Asha Pvt Ltd’s Bank Account Cr.

Receipts ` Payments `

To Equity Share Capital – additional 10,000 By Preliminary Expenses 6,000

Shares subscribed by Amit Patel & Co. By Typewriter 3,000
By balance c/d-balancing figure 1,000

Total 10,000 Total 10,000

Note: Amit Patel & Co. Firm’s Bank A/c is retained by the Firm only, not taken over by the Company.

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Dr 5. Amit Patel & Co.( Vendor ) Account Cr.

Particulars ` Particulars `
To Assets not taken over by Asha Private By Liabilities not taken over by Asha pvt.
Ltd. Ltd.
- Balance in Asha Pvt Ltd A/c 10,000 -Balance in Capital Account of Amit 36,000
-Trade Debtors [13,000-8,000] 5,000 -Balance in Capital Account of Patel 30,000
-Bank 3,500 -Trade Creditors [10,000-5,000] 5,000
To Equity Share Capital- Settlement of 1,00,000 By gain on Revaluation of :
Purchase Consideration - Goodwill[30,000-25,000] 5,000
-Buildings [30,000-20,000] 10,000
By balance c/d [balancing figure] 32,500
Total 1,18,500 Total 1,18,500

6. Balance Sheet of Asha Private Ltd as at 30th June 2012

Name of the Company: Asha Private Ltd.
Balance Sheet as at : 30.06.12
Ref Particulars Note No. As at 30.06.12
No. (`)

I EQUITY AND LIABILITIES

1 Shareholders’ fund
(a) Share capital 1 1,10,000
(b) Reserves and surplus- 2 12,167
( c) Money received against share warrants
2 Share application money pending allotment
3 Non-current liabilities
(a) Long-term borrowings
(b)Deferred tax liabilities (Net)
(c )Other Long term liabilities
(d) Long-term provisions
4 Current Liabilities
(a) Short-term borrowings
(b) Trade payables 3 5,000
(c )Other current liabilities
(d) Short-term provisions
Total 1,27,167
II ASSETS
1 Non-current assets
(a) Fixed assets
(i) Tangible assets 4 58,000
(ii) Intangible assets 5 3,667
(iii) Capital work-in-progress
(iv) Intangible assets under development
(b) Non-current investments

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( c)Deferred tax assets (Net)

(d) Long-term loans and advances
(e) Other non-current assets
2 Current assets
(a)Current investments
(b) Inventories 6 18,000
(c ) Trade receivables 7 40,500
(d) Cash and cash equivalents 8 1,000
(e)Short-term loans and advances
(f) Other current assets 9 6,000
Total 1,27,167

Workings:
1. Authorized Capital As at 30.06.12
11,000 Equity Share capital fully paid @ ` 10 each 1,10,000
Issued and paid up capital
11,000 Equity shares @ ` 10 each fully paid 1,10,000
(out of the above 10,000 shares were issued pursuant to a contract, without payment
being received in cash)
Total 1,10,000

2. Reserve and Surplus As at 30.06.12

Profit & Loss A/c 12,167
Total 12,167

3. Trade Payable As at 30.06.12

Sundry Creditors 5,000
Total 5,000

4. Tangible Assets As at 30.06.12

Building (At Cost) 30,000
Plant and Machinery (At Cost) 25,000
Typewriter (At Cost) 3,000
Total 58,000

5.Intangible Assets As at 30.06.12

Goodwill 30,000
Less: Pre Incorporation Profit 26,333
Total 3,667

6. Inventories As at 30.06.12
Stock 18,000
Total 18,000

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7. Trade Receivable As at 30.06.12

Sundry Debtors 8,000
Due from vendor Company 32,500
Total 40,500

8. Cash & Cash Equivalent As at 30.06.12

Bank 1,000
Total 1,000

9. Other Current Assets As at 30.06.12

Preliminary Expenses 6,000
Total 6,000

(F) Pele, and Maradona, who have been carrying on a partnership business, agreed on
conversion of the Firm into a Private Limited Company with effect from 1st April 2012. The
agreement among other things includes the following -
(i) Since the Bank desires that the Term Loan should be liquidated, the Partners bring in the
required amount in proportion to their Capitals.
(ii) Goodwill of the Firm is to be revalued at ` 1,20,000.
(iii) Certain Assets are to be revalued at their Current Realizable Values as indicated below: (a)
Furniture - ` 40,000; (b) Car - ` 13,000; and (c) Plant and Equipment - ` 4,00,000.
(iv) Partners agree that revaluation be carried out before dissolution and surplus be adjusted in
their Current A/c.
(v) The New Company to be called WC Ltd shall issue shares of `10 each to the Partners in
consideration of take-over of the business.
(vi) The New Company shall not assume the Debtors and Creditors but shall assist the Vendor
Firm in realization and settlement.
The Balance Sheet of Pele and Maradona on 31st March immediately before the agreement
reads as below:

Liabilities ` Assets `
Sundry Creditors 1,60,000 Cash and Bank 50,000
Cash Credit from Bank 1,52,000 Sundry Debtors 60,000
Term Loan from Bank 1,60,000 Stock and Stores 2,00,000
Partners’ Capitals: Furniture 50,000
- Pele 1,60,000 Motor Car 12,000
- Maradona 80,000 Plant and Machinery 3,00,000
Partner’s Current Accounts
- Pele 15,000
- Maradona 25,000
7,12,000 7,12,000
Calculate the number of shares to be allotted by the New Company way of purchase
consideration and suggest the equitable distribution thereof between the Partners

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Solution:
Calculation of Purchase consideration

Particulars ` `

Assets taken over :

Goodwill 1,20,000
Furniture 40,000
Car 13,000
plant & Machinery 4,00,000
Stock & Stores 2,00,000 7,73,000
Less : Cash Credits (1,52,000)
Net assets taken over = Purchase Consideration 6,21,000

Distribution of Purchase consideration

Particulars No. of `
shares
Distribution based on balance in Capital a/c. : In the ratio of
2:1 (See note)
Pele - ` 6,21,000 x 2/3 41,400 4,14,000
Maradona - ` 6,21,000 x 1/3 20,700 2,07,000
Total 62,100 6,21,000

Note : The Purchase Consideration may also be distributed on the following alternative bases :
Based on the profit sharing ratio (this is not given in the question, hence to be presumed as
equal shares)
Based on the ratio of capital (after adjusting for Current account Balances and settling Term
Loan from Bank) prior to dissolution. However, this will require the profit sharing ratio since the
gain on creation of goodwill/ realization of assets should be distributed to the partners based on
the profit sharing ratio.
Verification for Vendor’s Suspense Account
The net amount in Vendor’s Suspense will be ` 1,00,000 credit, which is equal to the total of the
debit balance of the Partner’s Accounts in the dissolved firm, determined as under :
a. Revaluation Account
Dr. Cr.

Particulars ` Particulars `

To, Furniture – downward revaluation 10,000 By, Motor Car – upward 1,000
revaluation

To, Capital A/c. – Gain transferred 2:1 By, Plant & machinery – upward 1,00,000
revaluation
Pele (2/3 x 91,000) = 60,667

Maradona (1/3 x 91,000) = 30,333 91,000

1,01,000 1,01,000

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b. Partner’s Capital Account

Dr. Cr.

Particulars Pele Maradona Particulars Pele Maradona

` ` ` `
To, Current a/c. – transfer 15,000 25,000 By, balance c/d 1,60,000 80,000
To, Equity shares in Ltd. 4,14,000 2,07,000 By, Goodwill (1,20,000 as 80,000 40,000
2:1)
By, Revaluation A/c. 60,667 30,333
(profit as 2:1)
By, Bank – Term Loan 73,333 36,667
settled (2:1)
By, Balance c/d – 55,000 45,000
balancing figure
4,29,000 2,32,000 4,29,000 2,32,000

Note: Amount required to settle the Bank Term Loan = ` 1,60,000 Less Present Bank Balance as
given in the Balance sheet ` 50,000 = ` 1,10,000. This amount will be brought in by the Partners in
the ratio 2:1. Hence, Balance in Partner’s Capital Accounts before adjusting debtors and
creditors = ` 1,00,000 Dr.
Journal entries in the books of the Company (for clarification purpose only)

S. Particulars Dr. Cr.

No.
1 Business Purchase A/c. Dr. 6,21,000
To, Vendor Firm A/c. 6,21,000
(being purchase of Pele & Maradona Firm’s business vide agreement
dated ………)
2 Goodwill A/c. Dr. 1,20,000
Furniture A/c. Dr. 40,000
Motor Car A/c. Dr. 13,000
Plant and Machinery A/c. Dr. 4,00,000
Stocks A/c. Dr. 2,00,000
To, Bank Cash Credit A/c. 1,52,000
To, Business Purchase A/c. 6,21,000
(being the recording of various assets and liabilities taken over from
Firm)
3 Vendor Firm A/c. Dr. 6,21,000
To, Equity Share Capital A/c. 6,21,000
(being the discharge of purchase consideration by allotment of 62,100
equity shares of ` 10 each at par)
4 Vendors Debtors A/c. Dr. 60,000
To, Equity Share Capital A/c. 60,000
(being recording of Vendors Debtors not taken over, to be realized and
settled)
5 Vendors Creditors suspense A/c. Dr. 1,60,000
To, Vendors Creditors A/c. 1,60,000
(being recording of Vendors Creditors not taken over, to be settled by
vendors)

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18. (A) What are the Procedure in Creditors’ Voluntary Winding up?

Answer:
Procedure in Creditors’ Voluntary Winding up:
(i) Meeting of creditors: The Company calls a meeting of its creditors. The board of directors
lay before the meeting a full statement of the position of the company’s affairs and a list of
the creditors of the company and the estimated amount of their claim. A copy of the
resolution passed at the creditors’ meeting is filed with the Registrar of Companies.
(ii) Appointment of liquidator: Appointment of liquidator is made by nomination both by the
members and creditors at their respective meetings. If they nominate different persons,
ordinarily, the creditors’ nominee shall be the liquidator. But any director, member or
creditor may apply to the Tribunal for an order that the company’s nominee or the official
liquidator or some other person should be appointed. If no person is nominated by the
creditors, the members’ nominee shall be the liquidator. Likewise, if no nomination is made
by the members, the creditors’ nominee shall be the liquidator.
(iii) Inspection committee: (a) The creditors of the company may appoint a committee of
inspection consisting of five persons; (b) Company can also in its general meeting appoint 5
members to work as members of inspection committee.
(iv) Meeting of members and creditors: If the winding up process continues for more than a
year, the liquidator shall call a general meeting of members and creditors at the end of
each year within three months from the expiry of such year. In the meeting, he will present
an account of his acts and dealings and the progress of the winding up during the year.
(v) Final meeting: When the affairs of the company are fully wound up, an account of the
winding up is prepared to show how the winding up has been conducted and the property
of the company has been disposed off. The account is presented before the final meeting
of members. Besides, a copy of the account along with a report is sent to the National
Company Law Tribunal and the Registrar within one week of the meeting. The company is
deemed to have been dissolved from the date of submission of the report.

(B) Liquidation of YZ Ltd. commenced on 2nd April, 2012. Certain creditors could not receive
payments out of the realisation of assets and out of the contributions from A list contributories.
The following are the details of certain transfers which took place in 2011 and 2012:

Shareholders No. of Shares Date of Ceasing to be a member Creditors remaining unpaid

transferred and outstanding on the date
of such transfer
A 2,000 1st March, 2011 ` 5,000
P 1,500 1st May, 2011 ` 3,300
Q 1,000 1st October, 2011 ` 4,300
R 500 1st November, 2011 ` 4,600
S 300 1st February, 2012 ` 6,000
All the shares were of ` 10 each, ` 8 per share paid up. Show the amount to be realised from the
various persons listed above ignoring expenses and remuneration to liquidator etc.

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Answer:
Statement of liabilities of B list contributories

Shareholders No. of Maximum Division of Liability as on

shares liability
1.5.2011 1.10.2011 1.11.2011 1.2.2012 Total
transferred (upto ` 2
per share)
` ` ` ` ` `

P 1,500 3,000 1,500 − − − 1,500

Q 1,000 2,000 1,000 555 − − 1,555
R 500 1,000 500 278 188 − 966
S 300 600 300 167 112 21 600
3,300 6,600 3,300 1,000 300 21 4,621

Working Note:

Date Cumulative liability Increase in liability Ratio of no. of shares

held by the members
1.5.2011 3,300 − 30 : 20 : 10 : 6
1.10.2011 4,300 1,000 20 : 10 : 6
1.11.2011 4,600 300 10 : 6
1.2.2012 6,000 1,400 Only S

Liability of S has been restricted to the maximum allowable limit of ` 600, therefore amount
payable by S is restricted to ` 21 only, on 1.2.2012.
Notes:
1. A will not be liable to pay to the outstanding creditors since he transferred his shares prior to
one year preceding the date of winding up.
2. P will not be responsible for further debts incurred after 1st May, 2003 (from the date when
he ceases to be member). Similarly, Q and R will not be responsible for the debts incurred
after the date of their transfer of shares.

(C) Following is the Balance Sheet of “Forum Ltd”. as on 30.09.2012: (Amount in `)

Liabilities ` Assets `

Share Capital: Land and Building 1,20,000

11% Preference Shares of ` 10 each 1,00,000 Sundry Current Assets 3,95,000
10,000 Equity Shares of `10 each, fully paid 1,00,000 Profit & Loss Account 38,500
5,000 Equity Shares of ` 10 each, ` 7.50 paid 37,500 Debenture Issue expenses not 2,000
written off
13% Debentures 1,50,000
Mortgage Loan 80,000
Bank Overdraft 30,000
Creditors for Trade 32,000
Arrears of Income tax (Assessments

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Liabilities ` Assets `
concluded in July 2004)
Assessment Year 2010-2011 - 21,000
Assessment Year 2011-2012 - 5,000 26,000
Total 5,55,500 Total 5,55,500

Other Information
• Mortgage Loan was secured against Land and Buildings. Debentures were secured by a Floating
Charge on all the other assets.
• The Company was unable to meet the payments and therefore the Debenture holders appointed a
Receiver and this was followed by a resolution for Members Voluntary Winding Up.
• The Receiver for the Debenture holders brought the Land and Buildings to auction and realized
` 1,50,000. He also took charge of Sundry Assets of the value of ` 2,40,000 and realized ` 2,00,000.
• The Liquidator realized ` 1,00,000 on the sale of the balance of Sundry Current Assets.
• The Bank Overdraft was secured by a personal guarantee of two of the Directors of the Company and
on the Bank raising a demand, the Directors paid off the dues from their personal resources.
• Costs incurred by the Receiver were ` 2,000 and by the Liquidator ` 2,800.
• The Receiver was not entitled to any remuneration but the Liquidator was to receive 3% Fee on the
value of assets realized by him.
• Preference Shareholders had not been paid dividend for the period after 30.9.2010 and interest for the
last half-year was due to Debenture holders.
From the above information, prepare the Liquidator's Receipts and Payments Account.

Answer:
Determination of Surplus received by Liquidator from Receiver
Receipts ` Payments `

Land and Buildings 1,50,000 Debenture Interest (1,50,000 x 13% x 6/12) 9,750
Sundry Current Assets 2,00,000 Income Tax Arrears (21,000 + 5,000) 26,000
Expenses of Receiver Given 2,000
Mortgage Loan Given 80,000
Debenture holders Principal Amount 1,50,000
Balance Surplus handed over to Liquidator 82,250
(b/f)

Total 3,50,000 3,50,000

Liquidator’s Receipts & Payments Account

Receipts ` Payments `

Surplus received from Receiver 82,250 Remuneration to Liquidator (1,00,000 x 3%) 3,000
(WN 1) Liquidation Expenses 2,800
Sundry Assets realized 1,00,000 Unsecured Creditors:
Calls on Contributories: Trade Creditors 32,000
From 5,000 Partly Paid Shares at ` 10,850 Directors (for Bank Overdraft paid) 30,000 62,000
2.17 per share (See WN 3 below)
Preference Shareholders:
Share Capital 1,00,000
Arrears of Dividend (2 yrs) 22,000 1,22,000
Equity Shareholders’ Final Payment:
Return of money to holders of 10,000 Fully
Paid Shares at ` 0.33 each 3,300

Total 1,93,100 Total 1,93,100

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Calls from Holders of Partly Paid Shares

Particulars `

a. Total of Receipts before considering Call Money (82,250 + 1,00,000) 1,82,250

b.
Total Payments before final payment to Equity Shares (2,800 + 3,000 + 62,000 + 1,22,000) 1,89,800
c. Deficit from above from Calls made on Equity Shares (a-b) (7,550)
d. Notional Call on 5,000 Partly Paid Shares at ` 2.50 each 12,500
e. Surplus Cash Balance after Notional Call (comparing c and d) 4,950
f. Number of Shares deemed fully paid (10,000 + 5,000) 15,000
g. Hence, Refund on Fully Paid Shares ` 4,950 / 15,000 Shares (e ÷ f) 33paise
h. Therefore, Required Call on Partly Paid Shares (2.50 – 0.33) ` 2.17

(D) The following is the Balance Sheet of “Moon” Ltd. as at 31.3.2011:

Liabilities ` Assets `

Share Capital : Fixed Assets:

2,000 Equity Shares of ` 100, ` 75 paid up 1,50,000 Land & Buildings 4,00,000

6,000 Equity Shares of ` 100, ` 60 paid up 3,60,000 Plant & Machineries 3,80,000

2,000 10% Pref. Share of ` 100, fully paid up 2,00,000 Current Assets:

10% Debentures (floating Charge on all assets) 2,00,000 Stock at Cost 1,10,000

Int. accrued on Deb. (also secured as above) 10,000 Sundry Debtors 2,20,000

Sundry Creditors 4,90,000 Cash at Bank 60,000

Profit and Loss A/c 2,40,000

Total 14,10,000 Total 14,10,000

On that date, the Company went into Voluntary Liquidation. The dividends on Preference Shares were in
arrears for the last two years. Sundry Creditors include a loan of ` 90,000 on Mortgage of Land and
Buildings. The assets realized were as under: (a) Land & Buildings ` 3,40,000; (b) Plant & Machinery `
3,60,000; (c) Stock ` 1,20,000;and (d) Sundry Debtors ` 1,60,000. Interest accrued on Loan on Mortgage of
Buildings upto the date of payment amounted to ` 10,000. The expenses of Liquidation amounted to ` 4,600.
The Liquidator is entitled to a remuneration of 3% on all the assets realized (except cash at bank) and 2%
on the amounts distributed among Equity Shareholders. Preferential Creditors included in Sundry Creditors
amount ` 30,000. All payments were made on 30.06.2011. Prepare the Liquidator’s Final Statement of
Account.
Answer:
Liquidator’s Final Statement of Account
Receipts Amount Amount Receipts Amount
Assets realized: Liquidator’s Remn.[3% on(6,40,000 +
Cash at Bank 60,000 3,40,000)] 29,400
Sundry Debtors 1,60,000 [2% as computed in WN 4] 1,000
Stock 1,20,000 Liquidation Expenses (given) 4,600
Plant & Machinery 3,60,000 6,40,000 Debentureholders
10% Debentures 2,00,000
Surplus from Securities Interest accrued as per B/S 10,000
Land & Buildings 3,40,000 Further Interest (WN 2) 5,000 2,15,000
Less: Mortgage Loan (90,000) Preferential Creditors (given ) 30,000
Less Interest upon date of A/c (10,000) 2,40,000 Unsecured Creditors (WN 3) 3,70,000
Preference Shareholders
Preference Share Capital 2,00,000
Divd Arrears at 10% for 2 yrs 40,000 2,40,000
Equity Share Holders (WN 4)
On 6,000 Shares at ` 2.50 per share 15,000
On 2,000 Shares at `17.50 per share 35,000

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Total 9,40,000 Total 9,40,000

2. Interest on Debentures: As the Company is solvent, Interest on Debentures should be paid up to

the date of final settlement i.e., for the period 01.04.2011 to 30.06.2011 i.e. ` 2,00,000 x 10% x 3/12 =
5,000.
3. Balance Unsecured Creditors=Creditors as per B/s – Mortgage Loan – Preferential Creditors
= (4,90,000 – 90,000 – 30,000) = 3,70,000
4. Payment to Equity Shareholders and Liquidators’ Remuneration:
Particulars `

a. Total of Receipts before considering Call Money (from the above account) 9,40,000
b. Total Payments before final payment to Equity Shares & Liquidators’ Remn. at 2%
thereon (29,400 + 4,600 + 2,15,000 + 30,000 + 3,70,000 + 2,40,000) 8,89,000
c. Surplus from above before Liquidators’ Remuneration & Calls made on Equity Shares
(a-b) 51,000
d. Liquidators’ Remuneration on payment to Equity Share = 2% of amount paid = 2/102
x 51,000 1,000
e. Surplus from above before Calls made on Equity Shares (c-d) 50,000
f. Notional Call on 6,000 Partly Paid Shares at ` 15 each (to make all shares ` 75 paid 90,000
up) 1,40,000
g. Surplus Cash balance after Notional Call (comparing e and f) 8,000
h. Number of Shares deemed paid at ` 75 per share (2,000 + 6,000) ` 17.50
i. Hence, Refund on every ` 75 paid up Share (g ÷ h) ` 57.50
j. Loss per ` 75 paid up Equity Share = Paid Up Value ` 75 – Refund as above ` 17.50
The final settlement is made in any of the following ways –
(a) Calling ` 15 on 6,000 Shares presently ` 60 paid up, so as to make all Shares ` 75 paid up,
and then refunding ` 17.50 per share for all 8,000 Shares.
(b) Refunding ` 17.50 per Share (` 75 – ` 57.50 Loss) for 2,000 Shares; and Refunding ` 2.50 per
Share
(` 60 – ` 57.50 Loss) for the balance 6,000 Shares, without calling the further money from
those Shares.
Alternative (b) is adopted in the above presentation.

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Section C - Auditing

19. Comment on the following statements based on legal provisions:

(A) According to Sec 227(1) of the Companies Act, 1956, the auditor can call for any
explanations or information from the officers and employees of the company.
Answer:
The statement is false. According to the Companies Act, 1956 the auditor can call for
explanations or information which he thinks is relevant for the purpose of audit and proper
discharge of his duties.

(B) The scope of verification is much wider than that of vouching.

Answer:

The statement is true. Vouching enables the auditor to know whether the transactions are
genuine and valid to enable the auditor to report on the financial statements with reference to
relevant documentary evidence. Vouching is the substantive testing/examination of transaction
at their point of origin. On other hand, verification process encompasses the inquiry into the
ownership/ title, existence, valuation, completeness and presentation of assets and liabilities in
the balance sheet. Verification usually deals with the final balance in the Final Accounts viz the
balance sheet and profit and loss account.

(C) Auditor is entitled to rely on work performed by others.

Answer:
SA 200 (AAS 1) on, “Basic Principles Governing an Audit” envisages manifold circumstances
when an auditor would have to depend upon the work performed by others. Such other parties
may be experts, other auditors including branch auditors or his own assistants.
SA 200 while laying down “Work Performed by Others” as one of the basic principle governing
an audit makes it clear that in cases where the auditor is required to delegate a part of his work
to his assistants or use the work performed by other auditors/experts, he continues to remain
responsible for expressing his opinion on the financial statements. Thus, he can rely on work
performed by others provided he exercises reasonable skill and care and he has no reason to
believe that he should not have so relied.
The auditor should carefully direct, supervise and review work delegated to assistants. The
auditor should obtain reasonable assurance that work performed by other auditors or experts is
adequate for his purpose.
In case of statutory assignments, like relying on audit report of branches conducted by other
auditors, he should expressly state the fact of such reliance.

(D) The Cost Auditor of a company cannot function as an internal auditor of the same company.
Answer:
The statement is true. The Cost Auditor is required to comment on the scope and performance
of the internal audit as per the provisions of the Cost Audit (Report) Rules, 2011. If the Cost
Auditor also functions as internal auditor, he will not be able to discharge his duties in proper and
dispassionate manner.

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(E) Reclassification of long term investment as short term investment is made at cost as on
the date of classification.
Answer:
The statement is false. As per AS-13 , ‘Accounting for Investments’ the transfer should be at
lower of cost and carrying amount of the investment at the date of reclassification of long
term as short term investment.

(F) Where the accounts of the company do not present a ‘true and fair ‘ view, the auditor of
the company can give a qualified opinion.
Answer:
The statement is false. An adverse opinion is appropriate where the reservations or the
objections are so substantial that the auditor feels, that the accounts do not give a ‘True
and Fair’ view. Qualified opinion would imply that the financial statement project a ‘True
and Fair’ view subject to certain reservations.

(G) For calculating minority interest there is a need to distinguish between capital and
revenue profits of the subsidiary.
Answer:
The statement is false. Minorities are concerned with their stakes in the holding company.
Their right consists of capital and reserves & surplus. To ascertain minority interests, neither
capital profit nor revenue profit is necessary.

(H) Internal check is part and parcel of internal control.

Answer:
The statement is true. Internal control is a plan of organisation and covers all methods and
procedures adopted by management to assist its objectives of ensuring the orderly and
efficient conduct of business. It includes financial and physical control and covers internal
check and internal audit also. Hence internal check is part of internal control.

(I) Audit is concerned with ethics of business.

Answer:
The statement is false. Audit is not concerned with ethics of business unless the business itself
is illegal or unlawful.
(J) A company can refuse to provide access to its books of accounts to the company’s
auditor outside normal working hours of the company , as it will inconvenience the accounts
staff.
Answer:
The statement is false. Section 227(1) of the Companies Act, 1956, provides that every
auditor of a company shall have a right of access to books , accounts and vouchers of the
company at all times and shall be entitled to require from the officers of the company such
information and explanations as he may think necessary for proper performance of his
duties. The auditor thus has the right of access to the records kept by the company at all
times and may therefore, inspect them in the course of performance of his duties as auditor.
As per law, the company cannot refuse to provide such access after regular office hours.

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(K) The appointment of Mr. A as statutory auditor was held to be void ab initio. So the
company holds another annual general meeting and appoints Mr. B , through a special
resolution.
Answer:
Where the appointment of an auditor is void ab initio, it is as if no auditor has been
appointed at all. Section 224(3) of the Companies Act, 1956 will come into play. As per this
subsection, where at an annual general meeting, no auditors are appointed or reappointed,
the Central Government shall appoint a person to fill the vacancy. Hence, in the given
situation, the vacancy cannot be filled up by the company, but only by the Central
Government. Accordingly, the appointment of Mr. B as new auditor at subsequent meeting
will not be valid.
(L) Operational audit is merely an extension of Internal Audit.
Answer:
The statement is true. In operational audit function, the internal auditor goes beyond
financial controls and looks into operational areas also. Operational auditing having scope
and objectives similar to that of Internal Audit is therefore an extent ion of Internal Audit.

(M) Audit Committee has a two-fold relationship and has therefore, to react only with
management and Internal Auditor.
Answer:
The statement is false. The audit committee has a fourfold responsibility and therefore has to
interact with management, internal auditor, statutory auditor and the public.

(N) Shareholders, by a majority vote, have authorized the Board of Directors to keep the books
of accounts of the company in its Administrative Office, as against the earlier practice of
keeping them in the Registered Office. The ROC was not informed about this change. Company
intends that this practice is in order.
Answer:
The statement is false. As per Section 209 of the Companies Act, 1956 , the books of accounts
can be kept in a place other than its registered office also, but the Board of Directors should
within seven days , file a written notice to the Registrar of Companies , the full address of the
new place. Here the company has not complied with this mandatory requirement.

(O) There is no need to design better internal controls in an EDP or computerized system.
Answer:
The statement is false. Computerisation, automatically implies a constant review of the system to
increase the efficiency in producing reliable data. As a result, the internal controls are normally
better designed under computerized systems. Automatic checks are instituted and the
responsibilities of various people are clearly stated.

20. (A) What is an “Audit Evidence”?

(B) What are the assertions with which an auditor is concerned with while obtaining audit
evidence from substantive procedures?
(C) Discuss the principles, which are useful in assessing the reliability of audit evidence.

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Answer:
(A) Audit evidence refers to any information, verbal or written, obtained by the auditor on
which he bases his opinion on financial statements.
The audit evidence may be of varied nature and can assume various forms. For example, a
signature on the voucher of a designated official, the payee’s receipt, etc. Even the
information obtained by the auditor by discussing with the officials of the company also
constitutes audit evidence
AAS 1 (SA 200) on “Basic Principles Governing and Audit”, mention audit evidence as one of the
basic principles and requires that the auditor should obtain sufficient appropriate audit
evidence through the performance of compliance and substantive procedures to enable him
to draw reasonable conclusions therefrom on which to base his opinion on the financial
information.
According to AAS 5 (SA 500) on Audit Evidence, sufficiency and appropriateness are inter-
related and apply to evidence obtained from both compliance and substantive procedures.

(B) An auditor is concerned with following assertions:-

(i) Existence: That an asset or liability exists at a given date.
(ii) Rights and obligations: That an asset is a right of the concern and a liability is an
obligation at a given date.
(iii) Occurrence: That a transaction or event which took place pertains to the entity during
the relevant period.
(iv) Completeness: That there are no unrecorded assets, liabilities or transaction.
(v) Valuation: That an asset or liability is recorded at an appropriate carrying value.
(vi) Measurement: That a transaction is recorded in the proper amount and revenue or
expense is allocated to the proper period.
(vii) Presentation and disclosure hat an item is disclosed classified and described in
accordance with recognized accounting policies and practices and relevant statutory
requirements.

(C) The reliability of audit evidence depends on its source-internal or external, and on its
nature-visual, documentary, or oral. While the reliability of audit evidence is dependent on
the circumstances under which it is obtained, the following generalisations may be useful in
assessing the reliability of audit evidence:
(i) External evidence (e.g. confirmation received from third party) is usually more reliable
than internal evidence.
(ii) Internal evidence is more reliable when related internal control is satisfactory.
(iii) Evidence in the form of documents and written representations is usually more reliable
than oral representations.
(iv) Evidence obtained by the auditor himself is more reliable than that obtained through
the entity.

21. (A) Auditors of M/s FBG (P) Ltd. were changed for the accounting year 2012-13. The closing
stock of the company as on 31.3.2012 amounting to ` 350 lacs continued as it is and became
closing stock as on 31.3.2013. The auditors of the company propose to exclude from their audit
programme the audit of closing stock of ` 350 lacs on the understanding that it pertains to the
preceding year which was audited by another auditor. Give your comments.

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Answer:
According to SA 510 “Initial Engagements – Opening Balances”, requires that for initial audit
engagements, the auditor should obtain sufficient appropriate audit evidence that:
(a) the closing balances of the preceding period have been correctly brought forward to
the current period;
(b) the opening balances do not contain misstatements that materially affect the financial
statements for the current period; and
(c) appropriate accounting policies are consistently applied.
When the financial statements for the preceding period were audited by another auditor,
the current auditor may be able to obtain sufficient appropriate audit evidence regarding
opening balances by perusing the copies of the audited financial statements. Ordinarily, the
current auditor can place reliance on the closing balances contained in the financial
statements for the preceding period, except when during the performance of audit
procedures for the current period the possibility of misstatements in opening balances is
indicated.
General principles governing verification of assets require that the auditor should confirm
that assets have been correctly valued as on the balance sheet date. The contention of the
management that the stock has not undergone any change cannot be accepted, it forms
part of normal duties of auditor to ensure that the figures on which he is expressing opinion
are correct and properly valued. Moreover, it is also quite likely that the stock lying as it is
might have deteriorated and the same need to be examined. The auditor is advised not to
exclude from his audit programme the audit of closing stock.

(B) No depreciation has been charged for the year ended 31st March 2013, in respect of a spare
Car purchased during the year and kept ready by the company for use as a stand-by on the
ground that it was not used during the year. State your views as an auditor.
Answer:
As per AS 6 on "Depreciation Accounting", depreciation is a measure of the wearing out,
consumption or other loss of value of a depreciable asset arising from use, effluxion of time
or obsolescence through technology and market changes. Thus, depreciation has to be
charged even in case of these assets which are not used at all during the year but by mere
effluxion of time provided such assets qualify as depreciable assets. When the spare car was
kept ready for use as stand-by, it means it was intended to be used for the purpose of
business. Depreciation in respect of this bus ought to have been provided in the accounts
for the year ended 31 st March, 2013. If there is an intention to use an asset, though it may not
have actually been used, it is a 'constructive' or 'passive' use and eligible for claim of
depreciation.

(C) Fixed assets have been revalued by HIG Ltd. and the resulting surplus has been adjusted
against the brought forward losses. What is your opinion as an auditor?

Answer:

The revaluation of fixed assets is a normally accepted practice which involves writing up the
book value of fixed assets. AS 10 on ‘Accounting for Fixed Assets’ requires that “an increase in
net book value arising on revaluation of fixed assets is normally credited directly to owner’s
interests under the heading of revaluation reserves and is regarded as not available for
distribution”. Thus, creation of revaluation reserves does not result into any cash inflows and
represents unrealised gains. However, brought forward losses are in the nature of revenue losses.
As a matter of prudence, revenue losses can be adjusted against revenue reserves only and not

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the capital reserves. Therefore, the accounting treatment followed by the entity is not correct
and the auditor should qualify the audit report by mentioning the above fact.

22. (A) Draft the audit programme for audit of receipt of participation fees from delegates to the
National Cost Convention.

Answer:
The organization of three-day National Cost Convention is a one-time event. Normally, in view of
mega-size of the event, a special cell is made in the organization to handle the entire event.
Since few people would be handling the event, the internal controls may not be that strong
and, thus, more emphasis is required to be given on substantive procedure. Audit of receipt of
participation fees should be under the following areas:
(I) Internal Control System
(i) Examine the organization structure of special cell created for the National Cost
Convention, if any, and division of responsibilities amongst persons and
control/custody over receipt books.
(ii) Verify the internal control system for restricting the participation of unregistered
delegates.
(II) Rate of Participation Fees
(i) Verify with reference to resolution passed by the Organizing Committee
(ii) Also verify the rate from the literature/registration form circulated for
promotion of conference.
(III) Receipts of Participation Fees
(i) Verify counter foil of the receipts issued for individual registration.
(ii) Ensure that receipts are issued for all the registration received in cash.
(iii) Trace the receipts in Bank Statement or Cash Book – as the case may be.
(iv) Verify Bank Reconciliation Statement and list out dishonored cheques.
(v) Verify subsequent recovery in respect of dishonored cheques.
(IV) Overall Checking
(i) Verify the total receipts of participation fees shown in the financial statements
with reference to total number of receipts issued to participants.
(ii) Cross check the total number of delegates with reference to the following:
(a) Kits distributed to participants.
(b) Bill of caterer for providing meals during conference.
(c) Capacity of the Hall.
(d) Participation Certificate if any issued.
(V) Foreign Delegates: In case of foreign delegates – if registration fees are higher – ensure
that they are registered at higher fees.
(VI) Special Issues
(i) Take out list of absentees and in case of nil absentees, probe the issue further.
(ii) If certain participants are exempted from payment of fees – obtain the list along
with proper authorization in this regard.

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(B) The HIJ College, an institution managed by WB Trust, has received a grant of ` 5 crore
from Government nodal agencies for funding a project of research on rural health systems in
India. Draft an audit programme for auditing this fund in the accounts of the college.
Answer:
Audit of grant fund of a college:
(i) The auditor should obtain the basic documents about the constitution of the college,
objectives of the trust, rules of college etc.
(ii) The government policy on grant should be checked with the relevant application,
brochure, and sanction advices.
(iii) The conditions stipulated in award of grant should be studied.
(iv) The receipt of grant should be vouched with bank statement.
(v) The budgeted heads of expenses for the project and actual utilization of the fund
should be checked.
(vi) The purchase of capital items covered within the project should be correctly
capitalized. The same should be properly and distinctly shown in the balance sheet of
the college. The cost of the asset should be adjusted for the grant amount.
(vii) The expenses of revenue nature incurred from and out of grant in the form of salaries to
field staff, materials purchased, traveling, survey and field work expenses and analysis
and preparation of reports etc should be vouched with the relevant vouchers.
(viii) The expenses should be accounted as withdrawal of amounts from the fund. It is to be
checked that these expenses are not accounted in income and expenditure of the
college.
(ix) In balance sheet, the fund account should be shown as a liability with a separate
schedule indicating the receipts, payments and balance as on the date of closing of
accounts.
(x) The fund balance should be cross checked with the periodical statements of accounts
submitted to the nodal agencies.
(xi) The physical verification of assets pertaining to the project should be done by the
management of the college.
(xii) The progress of the project may be ascertained from the minutes, committee meeting
extracts and reports. This must be done to ensure that the project fund is genuinely
utilized for the purposes it intended for.

(23) As an auditor, how will you vouch and/or verify the following?

(A) Work-in-progress

(B) Receipt of special backward area subsidy from Government:

(C) Recovery of Bad Debts written off.
(D) Borrowing from Banks
(E) Machinery acquired under Hire-purchase system.

Answer:

(A) Work-in-progress:

The audit procedures regarding work-in-progress are similar to those used for raw materials
and finished goods. However, the auditor has to carefully assess the stage of completion of
the work-in-progress for assessing the appropriateness of its valuation. For this purpose, the

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auditor may examine the production/costing records (i.e., cost sheets), hold discussions with
the personnel concerned, and obtain expert opinion, where necessary. The auditor may
advise his client that where possible the work-in-progress should be reduced to the minimum
before the closing date. Cost sheets of work-in-progress should be verified as follows:
(i) Ascertain that the cost sheets are duly attested by the works engineer and works
manager.
(ii) Test the correctness of the cost as disclosed by the cost records by verification of
quantities and cost of materials, wages and other charges included in the cost sheets
by reference to the records maintained in respect thereof.
(iii) Compare the unit cost or job cost as shown by the cost sheet with the standard cost or
the estimated cost expected.
(iv) Ensure that the allocation of overhead expenses had been made on a rational basis.
Compare the cost sheet in detail with that of the previous year. If they vary materially,
investigate the cause thereof.

(B) Receipt of special backward area subsidy from Government:

i. The claim for backward area subsidy submitted to the authorities should be studied.
ii. It should be ascertained whether the grant is of a capital nature for funding assets
or of a revenue nature. Mere computation formula of quantum of grant with
reference to the cost of project of itself will not make the grant a capital nature is to
facto.
iii. The accounting of grant should be in accordance with AS 12 “Accounting for
Government Grants”. The revenue grant can be taken to income statement, with
appropriate disclosure.
iv. The capital grant may be adjusted against cost of asset or may be kept in a capital
reserve to be transferred to profit and loss account each year in proportion to
depreciation of that asset charged in profit and loss account.
v. The receipt of the grant should be checked with bank statement, remittance
challan etc.
vi. The conditions attached to grant should be fulfilled by the company. The auditor
should check whether any liability or refund of grant for breach of conditions could
arise.

(C) Recovery of Bad Debts written off:

(i) Ascertain the total amount of bad debts.
(ii) Ensure that all recoveries of bad debts have been properly recorded in the books of
account.
(iii) Examine notification from the Court or from bankruptcy trustee, letters from coll ecting
agencies or from debtors should also be seen.
(iv) Check Credit Manager’s file for the amount received and see that the said amount
has been deposited into the bank promptly.

(D) Borrowing from Banks:

Borrowing from banks may be either in the form of overdraft limits or term loans. In each
case, the borrowings should be verified as follows:
(i) Reconcile the balances in the overdraft or loan account with that shown in the pass

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book(s) and confirm the last mentioned balance by obtaining a certificate from the
bank showing the balance in the accounts as at the end of the year.
(ii) Obtain a certificate from the bank showing particulars of securities deposited with the
bank as security for the loans or of the charge created on an asset or assets of the
concern and confirm that the same has been correctly disclosed and duly registered
with Registrar of Companies and recorded in the Register of charges.
(iii) Verify the authority under which the loan or draft has been raised. In the case of a
company, only the Board of Directors is authorised to raise a loan or borrow from a
bank.
(iv) Confirm, in the case of a company, that the restraint contained in Section 293 of the
Companies Act, 1956 as regards the maximum amount of loan that the company can
raise has not been contravened.
Ascertain the purpose for which loan has been raised and the manner in which it has been
utilised and that this has not prejudicially affected the entity

(E) Machinery acquired under Hire-purchase system.

(i) Examine the Board’s Minute Book approving the purchase on hire-purchase terms.
(ii) Examine the hire-purchase agreement carefully and note the description of the
machinery, cost of the machinery, hire purchase charges, terms of payment and rate
of purchase.
(iii) Ascertain that the machinery has been included in the related assets account at its
cash value. Also instalments due have been paid and the hire-purchase charges
applicable to the period from the commencement of the agreement to the end of the
financial year have been charged against current profits.
(iv) Ensure that machinery acquired on hire purchase basis has been included at its cash
value in the balance sheet and depreciation has been calculated on the cash value
from the date of the purchase. The amount due to the hire purchase company in
respect of the capital outstanding has either been shown as a deduction from the
machinery account or as a separate amount under current liabilities.

24. As an auditor, comment on the following situations:

(A) One of the debtors of PQR Ltd. From whom `7 lacs is recoverable for credit sales gives a
motor car in full settlement of dues. The directors estimate that the market value of the car
transferred is `7.50 lacs. As on date of Balance Sheet, the car has not been registered in the
name of PQR Ltd.
Answer:
According to AS-10, Accounting for Fixed Assets, when fixed asset is acquired in exchange or
in part exchange for another asset, the cost of asset acquired should be recorded either at
fair market value or net book value of the asset given up. In present case book value is more
evident than fair value of car estimated by the directors. Hence, Debtor’ A/c should be
credited with `7 lacs and motor car recorded at the same amount.
Taking principle of substance over form into consideration as laid down in AS 1, the auditor
should ensure that the car’s acquisition is recorded in the present year though the car is not
registered in the name of the auditee.

(B) M/s XYZ Ltd. has taken a Group Gratuity Policy from an Insurance Company. During
accounting year 2012-13 it received a communication from an Insurance Company
informing that premium amount for the accounting year 2011-12 was less charged by `95

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lacs on account of arithmetical error on the part of Insurance Company. M/s XYZ Ltd. paid
the said sum of `95 lacs during the accounting year 2012-13 by debiting the same to prior
period expenses.
Answer:
AS-5 has defined prior period expenses as those which arise in current period as a result of
error or omission in the preparation of financial statement of one or more prior periods. The
nature and amount of prior period items should be separately disclosed in the Profit & Loss
A/c in a manner that their impact on current profit or loss can be prescribed.
In the given case-
i) Arithmetical mistake of `95 lacs in computing the amount of premium is not a prior
period expense as per AS 5.
ii) The error was on part of insurance company.
iii) The accounting treatment by M/s XYZ Ltd. is thus incorrect.
iv) The auditor should ensure that the disclosure of `95 lacs is an ordinary item in current
year’s Profit & Loss A/c. This may be disclosed in Notes to Accounts.

25. As an auditor, what would you do in the following situations?

(A) The company has sent semi-finished goods to third parties for further processing, which is
lying with them at the end of the year.

Answer:
Semi-finished goods being composite part of the inventories, normally, constitute significant
item in case of any entity. It is the duty of the auditor to ensure that entire inventories which
are owned by the enterprise exist on that date and valuation thereof is also proper. Since
the semi-finished goods belong to the company, it is necessary to ensure that the same have
been included for in valuation of inventories. The auditor should also obtain direct
confirmation about the quantity of inventories lying with the processors at the end of the
year. Also, the auditor should see that the valuation has been made properly with reference
to the stage of completion in respect of work-in-process inclusive of expenses incurred in
sending the goods for processing. In case, the amount happens to be material, such stock
may be disclosed separately as stocks with processors.

(B) The management has obtained a certificate from an actuary regarding provision of gratuity
payable to employees.
Answer:
The computation of gratuity liability payable to employees is dependent upon several
factors such as age of the employee, expected span of service in the orga nisation, life
expectancy of the employee, prevailing economic environment, etc. Thus, it gives rise to
uncertainty in the determination of provisions of liabilities. Under such circumstances, the
management is required to make an assessment and estimate the amount of provision. In
view of this, the management may engage an expert in the field to assist them in arriving at
fair estimation of the liability. Therefore, it is an accepted auditing practice to use the work
of an expert.
SA 620(AAS 9) on “Using the Work of an Expert” also states that an expert may be
engaged/employed by the client. It further requires the auditor to assess skill, competence
and objectivity of the expert amongst other factors and evaluate the work of an expert
independently to conclude whether or not to rely upon such a certificate obtained by the
management from the actuary. Therefore, the auditor must follow the requirements of SA

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620(AAS 9) before relying upon the certificate obtained by the management from the
actuary.

26. Comment on the following situations:

(A) At an Annual General Meeting, Mr. B a retiring auditor claims that he has been reappointed
automatically, as the intended resolution of which a notice had been given to appoint Mr. A,
could not be proceeded with, due to Mr. A's death.
Answer:
Section 224(2) of the Companies Act, 1956 dealing with reappointment of auditors specifies
that subject to the provisions of sub-section (1B) and section 224A, at any Annual General
Meeting a retiring auditor, by whatsoever authority appointed, shall be re -appointed unless,
inter alia:
"Where notice has been given of an intended resolution to appoint some person or persons
in the place of a retiring auditor, and by reason of the death, incapacity or dis-qualification
of that person or of all those persons, as the case may be, the resolution cannot be
proceeded with."
However, it should be noted that even for the re-appointment of a retiring auditor, the
passing of a resolution is essential. Section 224 of the Companies Act, 1956, requires that a
resolution has to be passed by the company every year. In the absence of a resolution, the
retiring auditor is not re-appointed automatically.
Thus, the claim of Mr. B would not hold good.

(B) One of the directors of XYZ Ltd. is attracted by the disqualification under Section
274(1)(g).
Answer:
Section 227(3)(f) as inserted by the Companies (Amendment) Act, 2000 imposes a specific
duty on the auditor to report whether any director is disqualified from being appointed as
directors under Section 274(1)(g) of the Companies Act, 1956. To this end, the auditor has to
ensure that written representation have been obtained by the Board from each director that
one is not hit by Section 274(1)(g).
Since in this case, one of the directors is attracted by disqualification u/s 274(g) of the Act,
the auditor shall state in his report u/s 227 about the disqualification of the particular
director.

(C) PQR Limited with its registered office at Bangalore has two branch offices located at
Mumbai and Kolkata. The accounting transactions of the branches are recorded and the
accounting records are maintained in the branches themselves. Only quarterly summarized
Trial balance, Profit and Loss account and Balance Sheet are sent to Bangalore office by the
branch Accountants. Do you think that the Company is at fault of not maintaining proper
books at registered office as per the Company law provisions?

Answer:
According to Section 227 of the Companies Act, 1956, the auditor has to report whether the
company has maintained proper books of account. According to section 209 of the
Companies Act, the company has to keep at its registered office all the accounting records
specified therein.

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As regards, the records of the branch, Section 209 permits that the same may be maintained
at branches provided summarized returns of the branch are sent to registered office at such
frequent intervals not less than a quarter.
In the present case, since the branches are sending quarterly summarized returns of
accounting details, it is deemed that proper books of accounts are maintained at registered
office.
Hence, there is no statutory violation committed by the company.
It may be noted, still the company auditor has right of access (at registered office itself by
calling for records) and right to visit the branch.

(D) The members of XYZ Ltd. preferred a complaint against the auditor stating that he has
failed to send the auditor’s report to them.
Answer:
Section 227 of the Companies Act, 1956 lays down the powers and duties of auditor. As per
provisions of the law, it is no part of the auditor’s duty to send a copy of his report to
members of the company. The auditor’s duty concludes once he forwards his report to the
company. It is the responsibility of company to send the report to every member of the
company. It will be for the secretary or the director to convene a general meeting and send
the balance sheet and report to the members (or other person) entitled to receive it. Hence
in the given case, the auditor cannot be held liable for the failure to send the report to the
shareholders.

27. As a Company Auditor, how would you deal with the following situations?
(A) In the books of accounts of M/s WBS Ltd. huge differences are noticed between the
control accounts and subsidiary records. The Chief Accounts Officer informs that this is
common due to huge volume of business done by the company during the year.

Answer:
The huge differences found between control accounts and subsidiary records in the books
of M/s WBS Ltd. indicate that there may be material misstatements requiring detailed
examination by the auditor to ascertain the cause. The contention of Chief Accounts Officer
cannot be accepted simply because the company has done huge volume of business. Such
a phenomenon indicates that recording of transactions is not being done properly or the
accounting system in the company which might have several branches spread over the
country fails to capture all transactions in time. It would also be interesting to see whether it is
a recurring phenomenon or such reconciliation could not be done at a subsequent date.
Having regard to all these circumstances, it appears from the facts of the case that these
differences indicate the possibility of some kind of material misstatements.
As per SA 240(AAS 4), “The Auditor’s Responsibility to Consider Fraud and Error in an Audit of
Financial Statements” when the auditor encounters circumstances that there is material
misstatement, the auditor should perform procedures to determine whether the financial
statements are materially misstated. If as a result of such examination the auditor comes
across any material information involving fraud or gross irregularity the same shall be
reported by him appropriately.

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B) The surplus arising from a change in the basis of accounting was set off by X Ltd., against
a non-recurring loss.
Answer:
AS 5 on “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting
Policies” states that any change in an accounting policy which has a material effect should
be disclosed. The impact of, and the adjustments resulting from such change, if material,
should be shown in the financial statements of the period in which such change is made, to
reflect the effect of such change.
Transactions which are of an abnormal on non-recurring nature may also be considered
material, even though prima facie, they do not appear to be material.
Materiality is an important and relevant consideration in determining whether or not such
exclusion/non-disclosure will distort the true and fair view of the financial statements. Thus, it
would be important that users must know the quantum of non-recurring loss. In offsetting and
aggregating items, care need to be taken to ensure that material items are not offset
against each other.
Accordingly, it would not be prudent to set off the surplus emanating from a ‘change in the
basis of accounting’ against a ‘non-recurring loss’. Accordingly, it would be better to
disclose surplus on account of change in the basis of accounting and non-recurring loss
separately.

C) Interest on share capital was paid to the shareholders by GHI Ltd. as the company had a
long gestation period before it could become operational.

Answer:
Section 208 of the Companies Act, 1956 permits payment of interest to shareholders out of
capital, where there is a long gestation period. Payment of interest on capital is, however,
capitalised as part of cost of construction of the project. The auditor should ensure that following
conditions have been complied whenever such interest has been paid:
(i) Payment is authorised by the Articles or by special resolution of shareholders in general
meeting;
(ii) Payment is approved by the Central Government;
(iii) It is paid only for the period determined by the Central Government not exceeding six
months after the half-year in which the project has been completed.
(iv) The rate shall not exceed 12% p.a. or such other rate as may be prescribed by the
Government.
(v) The payment of interest shall not operate as a reduction of the amount paid -up on the
shares in respect of which it is paid.

28. Explain how following are dealt in Auditor’s Report as per CARO, 2003?
(A) No Cost Accounting records are maintained though the company is required to maintain the
same.
Answer:
Under CARO, 2003 where maintenance of cost records, where maintenance of cost records has
been prescribed by the Central Government, the auditor of the company is specifically required
to state whether such accounts and records as prescribed have been made and maintained.
Whether cost audit is ordered or not, the auditor should report on non maintenance of cost
records.

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(B) A Term Loan was obtained from a bank for ` 90 lacs for acquiring R&D equipment, out of
which `15 lacs was used to buy a car for use of the concerned director, who was
overlooking the R&D activities.

Answer:
Under CARO, 2003, an auditor is required to comment whether term loans were applied for the
purpose for which the loans were obtained.
The auditor should examine the terms and conditions of the term loan with the actual utilisation
of the loans. If the auditor finds that the fund has not been utilized for the purpose for which they
were obtained, the report should state the fact.
In the instant case, since term loan taken for the purpose of R&D equipment has been utilized for
purchase of car which has no relation with R&D equipment. Therefore, car though used for R&D
Director cannot be considered as R&D equipment. The auditor should state the fact in his report
that the out of term loan of R&D lack, `15 lacs was not utilised for the purpose of acquiring the R
& D equipment.

(C) Fixed assets comprising 1/3 rd of the total assets have been disposed off during the
year by LMN ltd.
Answer:
Under CARO, 2003, an auditor is required to state if substantial part of the fixed assets have
been disposed off during the year, whether it has affected the going concern. This clause
requires the auditor to carry out adequate audit procedures to satisfy himself that the
company shall be able to continue as going concern for the foreseeable future despite the
sale of substantial part of the fixed assets.
Accordingly, in the instant case, the auditor should satisfy himself as to whether disposal off
of 1/3rd of fixed assets during the year had any effect on the going concern assumption on
account of such sale of fixed assets.
The Auditor is required to exercise his professional judgement to determine whether disposal
off of one-third of total assets constitutes substantial part or not. Depending upon the
judgement arrived at by the auditor, he shall report whether substantial part of fixed assets
have been disposed off or not during the year and it has affected or not affected the going
concern status of the company.
Alternatively, in case the auditor is of the opinion that it constitutes substantial sale but the
going concern assumption is appropriate because of mitigating factors then he has to
ensure that the same are disclosed in the financial statements or else he shall have to modify
the auditor report. The manner of reporting shall also be modified appropriately in case the
going concern assumption is resolved or not.

29. (A) In XYZ LTD, F a junior accountant was given additional responsibility of making
recoveries from the debtors. On one occasion, when an insurance claim of `85,000 was
received, he credited the same to the account of a debtor and misappropriated the cash
which he had recovered from the said debtor. Pinpoint weaknesses in the internal control
system which led to this situation.

Answer:
Following two essential features of internal control are relevant here:
(i) Breaking the chain of the work in a manner so that no single person can handle a
transaction from the beginning to the end and
(ii) Segregation of accounting and custodial functions.

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Weakness in internal control system in the instant case:

i) The accountant is receiving cash and also passing the entries in the books. The
accountant should not have been allowed to effect recoveries.
ii) It also appears that system for issuing receipts for amount received - whether cash or
cheque is also lacking.
iii) In a small and to some extent medium size organization, the supervision of the owner
offsets the deficiencies in internal control system. But in this case, it appears, that supervision
and personal control is also lacking.
Thus, in the given case, the main weakness of the system is that it is ignoring the basic
requirements of a good internal control system.

(B) Elaborate the principles of internal check system that should be followed with regard to cash
payments.
Answer:
The principles to be followed are enumerated below:
i) Making all payments through cheques except petty cash payments.
ii) Segregating duties: The employee in charge of receipts should not be involved in making
payments.
ii) All payments should be duly authorized. Payments above `20000 should be tendered
through crossed cheque.
iv) The unused cheques should be under proper custody.
v) The vouchers supporting payments should be stamped as ‘paid’ so that they are not
presented twice.
vi) Statement of dues received from creditors should be verified with invoices and ledger
accounts before authorizing payments. Confirmation of accounts should be made with
creditors.
vii) Monthly or periodic payments should be always be made on fixed dates.
viii) Bank reconciliation statements should be made at least monthly to locate the difference
between cash and bank book if any. The statement should be prepared by an
independent person not in charge of receipts or payments.

(C) How would you audit ‘Inventory Control and Management’ as an Internal Auditor?
Answer:
The Internal Auditor should ensure the following as regards ‘Inventory Control and
Management’:
(i) Has the inventory been classified for proper control? Is A, B, C system of inventory
classification followed?

(ii) How the inventory levels – maximum, minimum, reorder, economic order quantity fixed?

(iii) Is material budget prepared in advance to regulate purchase?

(iv) Study the opening/closing stocks of the last few years.

(v) Study the procurement of materials for the last 2/3 years and see whether the same
compares favourably with production.

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(vi) Is there any regular system to assess slow-moving/non-moving stores items for early disposal
in cases considered necessary?

(vii) Who is the person to declare some material as surplus? Who authorizes its disposal?

(viii) Review whether value analysis, PERT etc. are applied for better management of stores.

(ix) Work out inventory ratios to judge the reasonableness of inventory build up

(a) working capital to store inventory

(b) Current assets to store inventory

(c) Inventory turnover.

Some General Aspects:-

(i) Sometimes used materials are returned to stores. In such cases procedure for recording would
be the same as followed in case of unused materials except that these may or may not be
priced. Usually separate stores ledger / bin cards are opened. See whether the procedure in this
regard has been observed.

(ii) Review whether any study has been made in regard to mechanization in stores receipt/issue,
store accounting.

(iii) Review whether proper numerical accounts have been kept in respect to stand by spares.

(iv) See whether there is any Material Receiving Report pending disposal – recording valuation in
stores ledger/bin card, accounting the accounts records etc.

(v) Review the mode of valuation of closing stock.

(vi) How soon the stores schedule is prepared for annual accounts purpose?

(vii) Are the stores materials adequately covered by insurance against loss from fire and other
risks?

(viii) Is there proper coordination between –

(a) Central Purchase Department

(b) Local Purchase Department

(c) Stores Department

(d) Stock – verification Department

(ix) In case there are number of factories producing same / similar products make comparative
study regarding –

(a) Surplus materials

(b) Obsolete/slow-moving materials.

(c) Finished/work-in-progress stock

(d) Opening/closing stock of raw material, etc.

Apart from the above O and M study may be carried out for standardization of forms,
modification of work flow for improvement in efficiency in various directions etc.

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30. (A) Discuss the qualities a management auditor should possess.

Answer:
The management auditor should possess the following qualities:
i) Ability to understand the nature and objectives and problems faced by the organisation.
ii) He should have general understanding of different laws and regulations like Tax Laws,
Company Laws etc.
iii) Expert knowledge of management principles such as delegation of authority,
management by exception, budgetary control, flow charts, etc.
iv) Sufficient knowledge and experience in preparing and presenting reports to different levels
of management.
v) Working knowledge of engineering, costing, statistics, management accounting, industrial
psychology etc.
vi) Dynamic, tactfulness and a pleasing personality.

(B) What are the main points involved in ‘Performance Audit’ under Government Accounting
system?

Answer:
Performance audit refers to an examination of a program, function, operation or the
management systems and procedures of a governmental or non-profit entity to assess whether
the entity is achieving economy, efficiency and effectiveness in the employment of available
resources. The examination is objective and systematic, generally using structured and
professionally adopted methodologies.
The scope of audit has been extended to cover efficient, economy and effectiveness audit or
performance audit.
Efficiency audit look into whether various schemes/projects are executed and their
operations conducts economically & see that amount spent gives expected result & projects
carried out in an economical manner.
Economy aspect looks whether government has acquired financial, human and physical
resources in an economical manner and that sanctioning and spending authority have
observed economy.
Effectiveness looks into appraisal of performance of programmes, schemes, projects with
overall targeted objectives.
Efficiency cum performance audit is examination of Financial & operational aspect of
performance.
The performance audit involves preliminary study, planning & execution of audit & reporting.

(C) In a system based audit, test checking approach provides a good base for the auditor to
form an opinion on the Financial statement. Explain your views.
Answer:
System-based audit is done by evaluating the accounting system and internal control and
ascertaining their reliability through audit tests. Depending upon the size and nature of the
business concerned, an accounting system will incorporate necessary internal control to provide
assurance that:
(i) All the transactions and information have been recorded,

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(ii) Fraud and errors, if any, in preparing the accounts will be identified,
(iii) All the assets and liabilities recorded in the books of account do exist and are shown at
correct amounts,
(iv) There is compliance with statutory regulations.
After the auditor has ascertained the client’s accounting system, he should assess it to satisfy the
above-mentioned requirements. The auditor, therefore, after evaluating internal control system,
tests the same to ascertain whether it is actually in operation. For this purpose, he assorts to
actual testing of the system in operation. This he does on a selective basis, i.e., he adopts test
checking technique. He plans this testing in such a manner that all the important areas stated
above are covered. The test checking is done by application of procedural test and/or by
auditing in depth. This approach is adopted in system based audit which is the modern audit
approach. The system-based audit approach begins by evaluating the accounting system and
internal control and then by testing them to ascertain their reliability. By this, the auditor first
establishes how reliable the system is and then decides how much detailed checking of the
transactions and verification of assets and liabilities he must undertake. If the system is found to
be good, the detailed checking could be curtailed, but if system is week, more detailed
checking would be necessary. However, checking cannot be completely eliminated; it can only
be scaled down if state of the system is satisfactory. In case the initial evaluation itself shows
weaknesses, extensive checking should invariably be undertaken.

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