PAPER – 5: ADVANCED ACCOUNTING

PART – I: ANNOUNCEMENTS STATING APPLICABILITY & NON-APPLICABILITY

FOR NOVEMBER, 2019 EXAMINATION

A. Applicable for November, 2019 Examination

I. Amendments in Schedule III (Division I) to the Companies Act, 2013
In exercise of the powers conferred by sub-section (1) of section 467 of the
Companies Act, 2013), the Central Government made the following amendments in
Division I of the Schedule III with effect from the date of publication of this notification
in the Official Gazette:
(A) under the heading “II Assets”, under sub-heading “Non-current assets”, for the
words “Fixed assets”, the words “Property, Plant and Equipment” shall be substituted;
(B) in the “Notes”, under the heading “General Instructions for preparation of Balance
Sheet”, in paragraph 6,-
(I) under the heading “B. Reserves and Surplus”, in item (i), in sub- item (c), the word
“Reserve” shall be omitted;
(II) in clause W., for the words “fixed assets”, the words “Property, Plant and
Equipment” shall be substituted.
II. Maintenance of Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR)
Statutory Liquidity Ratio (SLR)
In exercise of the powers conferred by sub-section (2A) of Section 24 read with
Section 51 and Section 56 of the Banking Regulation Act, 1949 (10 of 1949) and in
supersession of the notifications [Link].14/12.02.001/2016 -17 dated
October 13, 2016 [Link].91/12.02.001/2017-18 dated October 04,
2017, the Reserve Bank hereby specifies that with effect from the dates given below,
every Scheduled Commercial Bank (including RRBs), Local Area Bank, Small
Finance Bank, Payments Bank, Primary (urban) co-operative bank and State and
central co-operative banks shall continue to maintain in India assets (referred to as
‘SLR assets’) the value of which shall not, at the close of business on any day, be
less than:
(i) 19.25 per cent from January 5, 2019
(ii) 19.00 per cent from April 13, 2019
(iii) 18.75 per cent from July 6, 2019
(iv) 18.50 per cent from October 12, 2019
(v) 18.25 per cent from January 4, 2020
2 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(vi) 18.00 per cent from April 11, 2020

of their total net demand and time liabilities in India as on the last Friday of the second
preceding fortnight, valued in accordance with the method of valuation specified by
the Reserve Bank from time to time.
Cash Reserve Ratio (CRR)
The current Cash Reserve Ratio (CRR) is 4% of their Net Demand and Time Liabilities
(NDTL) with effect from the fortnight beginning February 09, 2013 vide circular
[Link].76 /12.01.001/2012-13 dated January 29, 2013. The Local Area
Banks shall also maintain CRR at 4.00 per cent of its net demand and time liabilities
from the fortnight beginning from February 09, 2013.
III. Merging three categories of NBFCs viz. Asset Finance Companies (AFC), Loan
Companies (LCs) and Investment Companies (ICs) into a new category called
Investment and Credit Company (NBFC-ICC)
As per circular RBI/2018-19/130 DNBR (PD) [Link].097/03.10.001/2018-19 dated
February 22, 2019, in order to provide NBFCs with greater operational flexibility, it
has been decided that harmonisation of different categories of NBFCs into fewer ones
shall be carried out based on the principle of regulation by activity rather than
regulation by entity. Accordingly, it has been decided to merge the three categories
of NBFCs viz. Asset Finance Companies (AFC), Loan Companies (LCs) and
Investment Companies (ICs) into a new category called NBFC - Investment and Credit
Company (NBFC-ICC). Investment and Credit Company (NBFC-ICC) means any
company which is a financial institution carrying on as its principal business - asset
finance, the providing of finance whether by making loans or advances or otherwise
for any activity other than its own and the acquisition of securities; and is not any
other category of NBFC as defined by the RBI in any of its Master Directions. (Circular
[Link].25/21.06.001/2018 -19 dated 22 February 2019)
Differential regulations relating to bank’s exposure to the three categories of NBFCs
viz., AFCs, LCs and ICs stand harmonised vide Bank’s circular
[Link].25/21.06.001/2018 -19 dated February 22, 2019. Further, a deposit
taking NBFC-ICC shall invest in unquoted shares of another company which is not a
subsidiary company or a company in the same group of the NBFC, an amount not
exceeding twenty per cent of its owned fund. All related Master Directions (Non-
Banking Financial Company – Non-Systemically Important Non-Deposit taking
Company (Reserve Bank) Directions, 2016, Non-Banking Financial Company -
Systemically Important Non-Deposit taking Company and Deposit taking Company
(Reserve Bank) Directions, 2016, Non-Banking Financial Companies Acceptance of
Public Deposits (Reserve Bank) Directions, 2016, Standalone Primary Dealers
(Reserve Bank) Directions, 2016 and Residuary Non-Banking Companies (Reserve
Bank) Directions, 2016) have also been updated accordingly.
 PAPER – 5 : ADVANCED ACCOUNTING 3

NOTE: Chapters No. 2, 12, 13 and 14 have been revised and the revised chapters
have been web hosted at the BoS Knowledge Portal. It is advised to refer the revised
chapters.
B. Not applicable for November, 2019 examination
I. Non-Applicability of Ind AS for November, 2019 Examination
The Ministry of Corporate Affairs has notified Companies (Indian Accounting
Standards) Rules, 2015 on 16 th February, 2015, for compliance by certain class of
companies. T hese Ind AS are not applicable for November, 2019 Examination.
II The Guidance Note on ‘Accounting for Depreciation in Co mpanies in context of
schedule II to the Companies Act, 2013’ is not applicable for November, 2019
Examination.

PART – II : QUESTIONS AND ANSWERS

QUESTIONS

Employee Stock Option Plans

1. The following particulars in respect of stock options granted by a company are available:
Grant date April 1, 2016
Number of employees covered 50
Number of options granted per employee 1,000
Fair value of option per share on grant date (`) 9
The options will vest to employees serving continuously for 3 years from vesting date,
provided the share price is ` 65 or above at the end of 2018-19.
The estimates of number of employees satisfying the condition of continuous employment
were 48 on 31/03/17, 47 on 31/03/18. The number of employees actually satisfying the
condition of continuous employment was 45.
The share price at the end of 2018-19 was ` 68.
You are required to compute expenses to be recognised in each year in the books of the
company.
Buy Back of Securities
2. Umesh Ltd. resolves to buy back 4 lakhs of its fully paid equity shares of ` 10 each at
` 22 per share. This buyback is in compliance with the provisions of the Companies Act
and does not exceed 25% of Company’s paid up capital in the financial year. For the
purpose, it issues 1 lakh 11 % preference shares of ` 10 each at par, the entire amount
being payable with applications. The company uses ` 16 lakhs of its balance in Securities
4 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Premium Account apart from its adequate balance in General Reserve to fulfill the legal
requirements regarding buy-back. Give necessary journal entries to record the above
transactions.
Equity Shares with Differential Rights
3. (a) What is meant by “equity shares with differential rights”. Can preference shares be
also issued with differential rights?
(b) L, M, N and O hold Equity capital in the proportion of 30:30:20:20 in AB Ltd. X, Y, Z
and K hold preference share capital in the proportion of 40:30:20:10.
You are required to identify the voting rights of shareholders in case of resolution of
winding up of the company if the paid-up capital of the company is ` 80 Lakh and
Preference share capital is ` 40 Lakh.
Underwriting of Shares
4. A company made a public issue of 2,00,000 equity shares of ` 10 each at a premium of
` 2 per share. The entire issue was underwritten by the underwriters L, M, N and O in the
ratio of 4:3:2:1 respectively with the provision of firm underwriting of 5,000, 4,000, 2,000
and 2,000 shares respectively.
The company received application for 1,50,000 shares (excluding firm underwriting) from
public, out of which applications for 55,000, 40,000, 42,000 and 8,000 shares were marked
in favour of L, M, N and O respectively.
Calculate the liability of each underwriter as regards the number of shares to be taken up
assuming that the benefit of underwriting is not given to the individual underwriter.
Amalgamation of Companies
5. The following is the summarized Balance Sheet of A Ltd. as at 31 st March, 2019:
Liabilities ` Assets `
8,000 Equity shares of ` 100 each 8,00,000 Building 3,40,000
10% Debentures 4,00,000 Machinery 6,40,000
Loans 1,60,000 Inventory 2,20,000
Trade payables 3,20,000 Trade receivables 2,60,000
General Reserve 80,000 Bank 1,36,000
Patent 1,30,000
Share issue Expenses 34,000
17,60,000 17,60,000
B Ltd. agreed to absorb A Ltd. on the following terms and conditions:
(1) B Ltd. would take over all assets, except bank balance and Patent at their book values
less 10%. Goodwill is to be valued at 4 year’s purchase of super profits, assuming
 PAPER – 5 : ADVANCED ACCOUNTING 5

that the normal rate of return be 8% on the combined amount of share capital and
general reserve.
(2) B Ltd. is to take over trade payables at book value.
(3) The purchase consideration is to be paid in cash to the extent of ` 6,00,000 and the
balance in fully paid equity shares of ` 100 each at ` 125 per share.
The average profit is ` 1,24,400. The liquidation expenses amounted to ` 16,000. B Ltd.
sold prior to 31st March, 2018 goods costing ` 1,20,000 to A Ltd. for ` 1,60,000.
` 1,00,000 worth of goods are still in Inventory of A Ltd. on 31 st March, 2018. Trade
payables of A Ltd. include ` 40,000 still due to B Ltd.
Show the necessary Ledger Accounts to close the books of A Ltd. and prepare the Balance
Sheet of B Ltd. as at 1 st April, 2019 after the takeover.
Internal Reconstruction of a Company
6. Platinum Limited has decided to reconstruct the Balance Sheet since it has accumulated
huge losses. The following is the draft Balance Sheet of the company as on
31st March, 2019 before reconstruction:
Liabilities Amount (`) Assets Amount (`)
Share Capital
50,000 shares of ` 50 Goodwill 22,00,000
each fully paid up 25,00,000 Land & Building 42,70,000
1,00,000 shares of ` 50 Machinery 8,50,000
each ` 40 paid up 40,00,000 Computers 5,20,000
Capital Reserve 5,00,000 Inventories 3,20,000
8% Debentures of ` 100 each 4,00,000 Trade receivables 10,90,000
12% Debentures of ` 100 each 6,00,000 Cash at Bank 2,68,000
Trade payables 12,40,000 Profit & Loss Account 7,82,000
Outstanding Expenses 10,60,000
Total 1,03,00,000 Total 1,03,00,000
Following is the interest of Mr. Shiv and Mr. Ganesh in Platinum Limited:
Mr. Shiv Mr. Ganesh
8% Debentures 3,00,000 1,00,000
12% Debentures 4,00,000 2,00,000
Total 7,00,000 3,00,000
6 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

The following scheme of internal reconstruction was framed and implemented, as approved
by the court and concerned parties:
(1) Uncalled capital is to be called up in full and then all the shares to be converted into
Equity Shares of ` 40 each.
(2) The existing shareholders agree to subscribe in cash, fully paid up equity shares of
40 each for ` 12,50,000.
(3) Trade payables are given option of either to accept fully paid equity shares of ` 40
each for the amount due to them or to accept 70% of the amount due to them in cash
in full settlement of their claim. Trade payables for ` 7,50,000 accept equity shares
and rest of them opted for cash towards full and final settlement of their claim.
(4) Mr. Shiv agrees to cancel debentures amounting to ` 2,00,000 out of total debentures
due to him and agree to accept 15% Debentures for the balance amount due. He also
agrees to subscribe further 15% Debentures in cash amounting to ` 1,00,000.
(5) Mr. Ganesh agrees to cancel debentures amounting to ` 50,000 out of total
debentures due to him and agree to accept 15% Debentures for the balance amount
due.
(6) Land & Building to be revalued at ` 51,84,000, Machinery at ` 7,20,000, Computers
at ` 4,00,000, Inventories at ` 3,50,000 and Trade receivables at 10% less to as they
are appearing in Balance Sheet as above.
(7) Outstanding Expenses are fully paid in cash.
(8) Goodwill and Profit & Loss A/c will be written off and balance, if any, of Capital
Reduction A/c will be adjusted against Capital Reserve.
You are required to pass necessary Journal Entries for all the above transactions and draft
the company's Balance Sheet immediately after the reconstruction.
Liquidation of a Company
7. Given below is the Balance Sheet of OM Limited as on 31.3.2019:
Liabilities ` Assets `
Share Capital: Fixed Assets:
14%, 1,60,000 cumulative preference Land 1,60,000
shares of `100 each fully paid up 16,00,000 Buildings 6,40,000
32,000 equity shares of `100 each, Plant and Machinery 21,60,000
` 60 per share paid up 19,20,000 Patents 1,60,000
Reserves and Surplus NIL Investments NIL
Secured Loans: Current Assets:
14% debentures 9,20,000 Inventory at cost 4,00,000
 PAPER – 5 : ADVANCED ACCOUNTING 7

(Having a floating charge on all assets) Trade receivables 9,20,000

Interest accrued on above Cash at bank 2,40,000
debentures 1,28,800 Profit and Loss A/c 9,60,000
(Also having a floating charge as
above)
Loan on mortgage of land and building 6,00,000
Unsecured Loan NIL
Current liabilities
Trade payables 4,71,200
56,40,000 56,40,000
On 31.3.2019 the company went into voluntary liquidation. The dividend on 14%
preference shares was in arrears for one year. Trade payables include preferential
creditors amounting to `1,20,000.
The assets realized the following sums:
Land ` 3,20,000; Buildings ` 8,00,000; Plant and machinery ` 20,00,000; Patent
` 2,00,000; Inventory ` 6,40,000; Trade receivables ` 8,00,000.
The expenses of liquidation amounted to ` 1,17,736. The liquidator is entitled to a
commission of 2% on all assets realized (except cash at bank) and 2% on amounts among
unsecured creditors other than preferential creditors. All payments were made on
30th June, 2019. Interest on mortgage loan shall be ignored at the time of payment.
Prepare the liquidator’s final statement of account.
Financial Statements of Insurance Companies
8. From the following information as on 31 st March, 2019 of Xeta Insurance Co. Ltd. engaged
in fire insurance business, prepare the Revenue Account, reserving 50% of the net
premiums for unexpired risks and an additional reserve of ` 7,00,000:
Particulars Amount
`
Reserve for unexpired risk on 31st March, 2018 15,00,000
Additional reserve on 31st March, 2018 3,00,000
Claims paid 19,20,000
Estimated liability in respect of outstanding claims on 31st March, 2018 1,95,000
Estimated liability in respect of outstanding claims on 31st March, 2019 2,70,000
Expenses of management (including ` 90,000 in connection with claims) 8,40,000
Re-insurance premium paid 2,25,000
8 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Re-insurance recoveries 60,000

Premiums 33,60,000
Interest and dividend (gross before TDS) 1,50,000
Profit on sale of investments 30,000
Commission 3,50,000
Financial Statements of Banking Companies
9. The following is an extract from the Trial Balance of Jeevan Bank Ltd. as at 31 st March,
2019:
Rebate on bills discounted as on 1-4- 2018 1,36,518 (Cr.)
Discount received 3,40,312 (Cr.)
Analysis of the bills discounted reveals as follows:
Amount (` ) Due date
5,60,000 June 1, 2019
17,44,000 June 8,2019
11,28,000 June 21, 2019
16,24,000 July 1, 2019
12,00,000 July 5, 2019
You are required to find out the amount of discount to be credited to Profit and Loss account
for the year ending 31 st March, 2019 and pass Journal Entries. The rate of discount may
be taken at 10% per annum.
NBFCs
10. While closing its books of account on 31 st March, 2018 a Non-Banking Finance Company
has its advances classified as follows:
` in lakhs
Standard assets 13,400
Sub-standard assets 670
Secured portions of doubtful debts:
 Up to one year 160
 one year to three years 45
 more than three years 20
Unsecured portions of doubtful debts 48
Loss assets 24
 PAPER – 5 : ADVANCED ACCOUNTING 9

You are required to Calculate the amount of provision, which must be made against the
Advances as per the Non-Banking Financial Company –Systemically Important Non-
Deposit taking Company (Reserve Bank) Directions, 2016.
Mutual Funds
11. Surakshit Mutual Fund is registered with SEBI and is in the process of finalizing the annual
statement of accounts of one of its open ended mutual fund schemes. From the information
furnished below, you are required to prepare a statement showing the movement of uni t
holders’ funds for the financial year ended 31 st March, 2018.
` ’000
Opening Balance of net assets 54,00,000
Net Income for the year (Audited) 3,82,500
38,25,900 units issued during 2017-2018 4,34,250
33,85,350 units redeemed during 2017-2018 3,20,940
The par value per unit is ` 100
Valuation of Goodwill
12. The following is the summarized Balance Sheet of Mansa Ltd. as at 31 st March, 2019:
Liabilities (` in lakhs) Assets (` in lakhs)
Share Capital: Fixed Assets:
Equity shares of ` 10 each 1,200.00 Land and buildings 600.00
9% Preference share fully paid up 240.00 Plant and machinery 1,926.00
Reserve and Surplus: Furniture and fixture 132.00
General reserve 288.00 Vehicles 120.00
Profit and Loss 729.60 Investments 240.00
Secured loans: Inventory 162.00
10% Debentures 120.00 Trade Receivables 117.60
12% Term loan 432.00 Cash and bank 249.60
Trade Payables 384.00
Provision for taxation 153.60
3547.20 3547.20
Non-trade investments were 15% of the total investments.
Balances as on 1.4.2018 to the following accounts were as: Profit and Loss account
` 259.20 lakhs, General reserve ` 276 lakhs. The company requires you to calculate the
value of average capital employed.
10 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Consolidated Financial Statements

13. The following summarised Balance Sheets of H Ltd. and its subsidiary S Ltd. were prepared
as on 31st March, 2019:
H Ltd. (`) S Ltd. (`)
Equity and Liabilities
Shareholders' Funds
Equity Share Capital (fully paid up shares of ` 10 each) 12,00,000 2,00,000
Reserves and Surplus
General Reserve 4,35,000 1,55,000
Profit and Loss Account 2,80,000 65,000
Current Liabilities
Trade Payables 3,25,000 1,25,000
Total 22,40,000 5,45,000
H Ltd. (`) S Ltd. (`)
Assets
Non-Current Assets
Property, Plant and Equipment
Machinery 6,40,000 1,80,000
Furniture 3,75,000 34,000
Non-Current Investments
Shares in S Ltd. - 16,000 shares @ ` 20 each 3,20,000 -
Current Assets
Inventories 2,68,000 62,000
Trade Receivables 4,73,000 2,37,000
Cash and Bank 1,64,000 32,000
Total 22,40,000 5,45,000
H Ltd. acquired the 80% shares of S Ltd. on 1 st April, 2018. On the date of acquisition, General
Reserve and Profit Loss Account of S Ltd. stood at ` 50,000 and ` 30,000 respectively.
Machinery (book value ` 2,00,000) and Furniture (book value ` 40,000) of S Ltd. were
revalued at ` 3,00,000 and ` 30,000 respectively on 1 st April,2018 for the purpose of fixing
the price of its shares (rates of depreciation computed on the basis of useful lives:
Machinery 10% and Furniture 15%). Trade Payables of H Ltd. include ` 40,000 due to S
Ltd. for goods supplied since the acquisition of the shares. These goods are charged at
 PAPER – 5 : ADVANCED ACCOUNTING 11

10% above cost. The inventories of H Ltd. includes goods costing ` 55,000 (cost to H Ltd.)
purchased from S Ltd.
You are required to prepare the Consolidated Balance Sheet of H Ltd. with its subsidiary
S Ltd. as at 31st March, 2019.
Guidance Notes
14. (i) How will a company classify its investment in preference shares, which are
convertible into equity shares within one year from the balance sheet date? Will it
classify the investment as a current asset or a non-current asset? Explain.
Accounting Standards
AS 7 Construction Contracts
(ii) On 1st December, 2018, “Sampath” Construction Company Limited undertook a
contract to construct a building for ` 108 lakhs. On 31st March, 2019 the company
found that it had already spent ` 83.99 lakhs on the construction. A prudent estimate
of additional cost for completion was ` 36.01 lakhs.
You are required to compute the amount of provision for foreseeable loss, which must
be made in the Final Accounts for the year ended 31 st March, 2019 based on AS 7
“Accounting for Construction Contracts.”
AS 9 Revenue Recognition
15. The Board of Directors decided on 31.3.2019 to increase the sale price of certain items
retrospectively from 1st January, 2019. In view of this price revision with effec t from 1st
January 2019, the company has to receive ` 15 lakhs from its customers in respect of
sales made from 1st January, 2019 to 31st March, 2019. Accountant cannot make up his
mind whether to include ` 15 lakhs in the sales for 2018-2019. Advise.
AS 18 Related Party Transactions
16. SP hotels Limited enters into an agreement with Mr. A for running its hotel for a fixed return
payable to the later every year. The contract involves the day-to-day management of the
hotel, while all financial and operating policy decisions are taken by the Board of Directors
of the company. Mr. A does not own any voting power in SP Hotels Limited. Would he be
considered as a related party of SP Hotels Limited”?
AS 19 Leases
17. Sun Limited wishes to obtain a machine costing ` 30 lakhs by way of lease. The effective
life of the machine is 14 years, but the company requires it only for the first 3 years. It
enters into an agreement with Star Ltd., for a lease rental for ` 3 lakhs p.a. payable in
arrears and the implicit rate of interest is 15%. The chief accountant of Suraj Limited is not
sure about the treatment of these lease rentals and seeks your advice. (use annuity factor
at @ 15% for 3 years as 3.36)
12 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

AS 20 Earnings Per Share

18. T he following information relates to M/s. XYZ Limited for the year ended 31 st March, 2019:
Net Profit for the year after tax: ` 37,50,000
Number of Equity Shares of ` 10 each outstanding: ` 5,00,000
Convertible Debentures Issued by the Company (at the beginning of the year)
Particulars Nos.
8% Convertible Debentures of ` 100 each 50,000
Equity Shares to be issued on conversion 55,000
The Rate of Income Tax: 30%.
You are required to calculate Basic and Diluted Earnings Per Share (EPS).
AS 26 Intangible Assets
19. K Ltd. launched a project for producing product X in October, 2018. The Company incurred
` 40 lakhs towards Research and Development expenses upto 31 st March, 2019. Due to
prevailing market conditions, the Management came to conclusion that the product cannot
be manufactured and sold in the market for the next 10 years. The Management hence
wants to defer the expenditure write off to future years.
Advise the Company as per the applicable Accounting Standard.
AS 29 Provisions, Contingent Liabilities and Contingent Assets
20. XYZ Ltd. has not made provision for warrantee in respect of certain goods due to the fact
that the company can claim the warranty cost from the original supplier. Hence the
accountant of the company says that the company is not having any liability for warrantees
on a particular date as the amount gets reimbursed. You are required to comment on the
accounting treatment done by the XYZ Ltd. in line with the provisions of AS 29.

SUGGESTED ANSWERS/HINTS

1. The vesting of options is subject to satisfaction of two conditions viz. service condition of
continuous employment for 3 years and market condition that the share price at the end of
2018-19 is not less than ` 65. The company should recognise value of option over 3-year
vesting period from 2016-17 to 2018-19.
Year 2016-17
Fair value of option per share = ` 9
Number of shares expected to vest under the scheme = 48 × 1,000 = 48,000
Fair value = 48,000 × ` 9 = ` 4,32,000
 PAPER – 5 : ADVANCED ACCOUNTING 13

Expected vesting period = 3 years

Value of option recognised as expense in 2016-17 = ` 4,32,000 /3 = ` 1,44,000
Year 2017-18
Fair value of option per share = ` 9
Number of shares expected to vest under the scheme = 47 × 1,000 = 47,000
Fair value = 47,000 × ` 9 = ` 4,23,000
Expected vesting period = 3 years
Cumulative value of option to recognise as expense in 2016-17 and 2017-18
= (` 4,23,000/ 3) × 2 = ` 2,82,000
Value of option recognised as expense in 2016-17 = ` 1,44,000
Value of option recognised as expense in 2017-18
= ` 2,82,000 – ` 1,44,000 = ` 1,38,000
Year 2018-19
Fair value of option per share = ` 9
Number of shares actually vested under the scheme = 45 × 1,000 = 45,000
Fair value = 45,000 × ` 9 = ` 4,05,000
Vesting period = 3 years
Cumulative value of option to recognise as expense in 2016-17, 2017-18 and 2018-19 =
` 4,05,000
Value of option recognised as expense in 2016-17 and 2017-18 = ` 2,82,000
Value of option recognised as expense in 2018-19 = ` 4,05,000 – ` 2,82,000 =
` 1,23,000
2. Journal Entries in the books of Umesh Ltd.
` `
1. Bank A/c Dr. 10,00,000
To 11% Preference share application
& allotment A/c 10,00,000
(Being receipt of application money on
preference shares)
2. 11% Preference share application & allotment
A/c Dr. 10,00,000
To 11% Preference share capital A/c 10,00,000
14 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(Being allotment of 1 lakh preference shares)

3. General reserve A/c Dr. 30,00,000
To Capital redemption reserve A/c 30,00,000
(Being creation of capital redemption reserve for
buy back of shares)
4. Equity share capital A/c Dr. 40,00,000
Premium payable on buyback A/c Dr. 48,00,000
To Equity shareholders/Equity shares
buy back A/c 88,00,000
(Amount payable to equity shareholder on buy
back)
5. Equity shareholders/ Equity shares buy back A/c Dr. 88,00,000
To Bank A/c 88,00,000
(Being payment made for buy back of shares)
6. Securities Premium A/c Dr. 16,00,000
General reserve A/c 32,00,000
To Premium payable on buyback A/c 48,00,000
(Being premium on buyback charged from
securities premium and general reserve)
Working Notes:
1. Calculation of amount used from General Reserve Account
`
Amount paid for buy back of shares (4,00,000 shares x ` 22) 88,00,000
Less: Proceeds from issue of Preference Shares (10,00,000)
(1,00,000 shares x `10)
Less: Utilization of Securities Premium Account (16,00,000)
Balance used from General Reserve Account 62,00,000
* Used under Section 68 for buy back 32,00,000
Used under Section 69 for transfer to CRR (W.N 2) 30,00,000
62,00,000
2. Amount to be transferred to Capital Redemption Reserve account
`
Nominal value of shares bought back 40,00,000
(4,00,000 shares x `10)
 PAPER – 5 : ADVANCED ACCOUNTING 15

Less: Nominal value of Preference Shares issued for such buy

back (1,00,000 shares x `10) (10,00,000)
Amount transferred to Capital Redemption Reserve Account 30,00,000
3. (a) Equity shares with Differential Rights means the share with dissimilar rights as to
dividend, voting or otherwise. Preference shares cannot be issued with differential
rights. It is only the equity shares, which are issued.
(b) L, M, N and O hold Equity capital is held by in the proportion of 30:30:20:20 and X,
Y, Z and K hold preference share capital in the proportion of 40:30:20:10. As the paid-
up equity share capital of the company is ` 80 Lakhs and Preference share capital is
` 40 Lakh (2:1), then relative weights in the voting right of equity shareholders and
preference shareholders will be 2/3 and 1/3. The respective voting right of various
shareholders will be
L = 2/3X30/100 = 3/15
M = 2/3X30/100 = 3/15
N = 2/3X20/100 = 2/15
O = 2/3X20/100 = 2/15
X = 1/3X40/100 = 2/15
Y = 1/3X30/100 = 1/10
Z = 1/3X20/100 = 1/15
K = 1/3X10/100 = 1/30
4. Calculation of liability of each underwriter assuming that the benefit of firm
underwriting is not given to individual underwriter
No. of shares
Particulars
L M N O Total
Gross liability 80,000 60,000 40,000 20,000 2,00,000
Less: Marked Applications (55,000) (40,000) (42,000) (8,000) (1,45,000)
(excluding firm underwriting)
Balance 25,000 20,000 (2,000) 12,000 55,000
Less: Surplus of N allotted to L, (1,000) (750) 2,000 (250) -
M & O in the ratio of 4:3:1
Balance 24,000 19,250 - 11,750 55,000
Less: Unmarked application
including firm underwriting
(WN) (7,200) (5,400) (3,600) (1,800) (18,000)
16 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Net Liability 16,800 13,850 (3,600) 9,950 37,000

Less: Surplus of N allotted to L,
M & O in the ratio of 4:3:1 (1,800) (1,350) 3,600 (450) -
Balance 15,000 12,500 - 9,500 37,000
Add: Firm Underwriting 5,000 4,000 2,000 2,000 13,000
Total Liability 20,000 16,500 2,000 11,500 50,000
Working Note:
Particulars No. of shares
Applications received from public 1,50,000
Add: Firm underwriting 13,000
Total Applications 1,63,000
Less: Marked application (1,45,000)
Unmarked application including firm underwriting 18,000
5. Books of A Limited
Realization Account
` `
To Building 3,40,000 By Trade payables 3,20,000
To Machinery 6,40,000 By B Ltd. 12,10,000
To Inventory 2,20,000 By Equity Shareholders (Loss) 76,000
To Trade receivables 2,60,000
To Patent 1,30,000
To Bank (Exp.) 16,000
16,06,000 16,06,000
Bank Account
To Balance b/d 1,36,000 By Realization (Exp.) 16,000
To B Ltd. 6,00,000 By 10% Debentures 4,00,000
By Loan 1,60,000
By Equity shareholders 1,60,000
7,36,000 7,36,000
10% Debentures Account
To Bank 4,00,000 By Balance b/d 4,00,000
4,00,000 4,00,000
 PAPER – 5 : ADVANCED ACCOUNTING 17

Loan Account
To Bank 1,60,000 By Balance b/d 1,60,000
1,60,000 1,60,000
Share Issue Expenses Account
To Balance b/d 34,000 By Equity shareholders 34,000
34,000 34,000
General Reserve Account
To Equity shareholders 80,000 By Balance b/d 80,000
80,000 80,000
B Ltd. Account
To Realisation A/c 12,10,000 By Bank 6,00,000
By Equity share in B Ltd. (4,880
shares at ` 125 each) 6,10,000
12,10,000 12,10,000
Equity Shares in B Ltd. Account
To B Ltd. 6,10,000 By Equity shareholders 6,10,000
6,10,000 6,10,000
Equity Share Holders Account
To Realization Account 76,000 By Equity share capital 8,00,000
To Share issue Expenses 34,000 By General reserve 80,000
To Equity shares in B Ltd. 6,10,000
To Bank 1,60,000
8,80,000 8,80,000
B Ltd
Balance Sheet as on 1 st April, 2019 (An extract)

Particulars Notes `
Equity and Liabilities
1 Shareholders' funds
a Share capital 1 4,88,000
b Reserves and Surplus 2 1,07,000
2 Current liabilities
a Trade Payables 3 2,80,000

 Inthe absence of the particulars of assets and liabilities (other than those of A Ltd.), the complete Balance Sheet
of B Ltd. after takeover cannot be prepared.
18 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

b Bank overdraft 6,00,000

Total 14,75,000
Assets
1 Non-current assets
a Property, Plant and Equipment
Tangible assets 4 8,82,000
Intangible assets 5 2,16,000
2 Current assets
a Inventories 6 1,83,000
b Trade receivables 7 1,94,000
14,75,000
Notes to Accounts
`
1 Share Capital
Equity share capital
4,880 Equity shares of ` 100 each (Shares have
been issued for consideration other than cash) 4,88,000
Total 4,88,000
2 Reserves and Surplus (an extract)
Securities Premium 1,22,000
Profit and loss account …..
Less: Unrealized profit (15,000) (15,000)
Total 1,07,000
3 Trade payables
Opening balance 3,20,000
Less: Inter-company transaction cancelled upon
amalgamation (40,000) 2,80,000
4 Tangible assets
Buildings 3,06,000
Machinery 5,76,000
Total 8,82,000
5 Intangible assets
Goodwill 2,16,000
 PAPER – 5 : ADVANCED ACCOUNTING 19

6 Inventories
Opening balance 1,98,000
Less: Cancellation of profit upon amalgamation (15,000) 1,83,000
7 Trade receivables
Opening balance 2,34,000
Less: Intercompany transaction cancelled upon (40,000) 1,94,000
amalgamation

Working Notes:
1. Valuation of Goodwill `
Average profit 1,24,400
Less: 8% of ` 8,80,000 (70,400)
Super profit 54,000
Value of Goodwill = 54,000 x 4 2,16,000
2. Net Assets for purchase consideration
Goodwill as valued in W.N.1 2,16,000
Building 3,06,000
Machinery 5,76,000
Inventory 1,98,000
Trade receivables (2,60,000-26,000) 2,34,000
Total Assets 15,30,000
Less: Trade payables (3,20,000)
Net Assets 12,10,000
Out of this ` 6,00,000 is to be paid in cash and remaining i.e., (12,10,000 – 6,00,000)
` 6,10,000 in shares of ` 125. Thus, the number of shares to be allotted 6,10,000/125 =
4,880 shares.
3. Unrealized Profit on Inventory `
The Inventory of A Ltd. includes goods worth ` 1,00,000 which was sold
by B Ltd. on profit. Unrealized profit on this Inventory will be
40,000 25,000
1,00,000
1,60,000
As B Ltd purchased assets of A Ltd. at a price 10% less than the book
value, 10% need to be adjusted from the Inventory i.e., 10% of (10,000)
` 1,00,000.
Amount of unrealized profit 15,000
20 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

6. Journal Entries in the books of Platinum Ltd.

` `
Bank A/c (1,00,000 x ` 10) Dr. 10,00,000
To Equity share capital A/c 10,00,000
(Being money on final call received)
Equity share capital (` 50) A/c Dr. 75,00,000
To Equity share capital (` 40) A/c 60,00,000
To Capital Reduction A/c 15,00,000
(Being conversion of equity share capital of ` 50 each
into ` 40 each as per reconstruction scheme)
Bank A/c Dr. 12,50,000
To Equity Share Capital A/c 12,50,000
(Being new shares allotted at ` 40 each)
Trade payables A/c Dr. 12,40,000
To Equity share capital A/c 7,50,000
To Bank A/c (4,90,000 x 70%) 3,43,000
To Capital Reduction A/c 1,47,000
(Being payment made to trade payables in shares or
cash to the extent of 70% as per reconstruction
scheme)
8% Debentures A/c Dr. 3,00,000
12% Debentures A/c Dr. 4,00,000
To Shiv A/c 7,00,000
(Being cancellation of 8% and 12% debentures of Shiv)
Bank A/c Dr. 1,00,000
To Shiv A/c 1,00,000
(Being new debentures subscribed by Shiv)
Shiv A/c Dr. 8,00,000
To 15% Debentures A/c 6,00,000
To Capital Reduction A/c 2,00,000
(Being issuance of new 15% debentures and balance
transferred to capital reduction account as per
reconstruction scheme)
8% Debentures A/c Dr. 1,00,000
12% Debentures A/c Dr. 2,00,000
To Ganesh A/c 3,00,000
(Being cancellation of 8% and 12% debentures of
Ganesh)
 PAPER – 5 : ADVANCED ACCOUNTING 21

Ganesh A/c Dr. 3,00,000

To 15% Debentures A/c 2,50,000
To Capital Reduction A/c 50,000
(Being issuance of new 15% debentures and balance
transferred to capital reduction account as per
reconstruction scheme)
Land and Building Dr. 9,14,000
(51,84,000 – 42,70,000)
Inventories Dr. 30,000
To Capital Reduction A/c 9,44,000
(Being value of assets appreciated)
Outstanding expenses A/c Dr. 10,60,000
To Bank A/c 10,60,000
(Being outstanding expenses paid in cash)
Capital Reduction A/c Dr. 33,41,000
To Machinery A/c 1,30,000
To Computers A/c 1,20,000
To Trade receivables A/c 1,09,000
To Goodwill A/c 22,00,000
To Profit and Loss A/c 7,82,000
(Being amount of Capital Reduction utilized in writing
off P & L A/c (Dr.) balance, goodwill and downfall in
value of other assets)
Capital Reserve A/c Dr. 5,00,000
To Capital Reduction A/c 5,00,000
(Being debit balance of capital reduction account
adjusted against capital reserve)
Balance Sheet (as reduced) as on 31.3.2019
Particulars Notes `
Equity and Liabilities
1 Shareholders' funds
a Share capital 1 80,00,000
2 Non-current liabilities
a Long-term borrowings 2 8,50,000
Total 88,50,000
22 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Assets
1 Non-current assets
a Property, Plant and Equipment
Tangible assets 3 63,04,000
2 Current assets
a Inventories 3,50,000
b Trade receivables 9,81,000
c Cash and cash equivalents 12,15,000
Total 88,50,000
Notes to accounts
`
1. Share Capital
2,00,000 Equity shares of ` 40 80,00,000
2. Long-term borrowings
Secured
15% Debentures (assumed to be secured) 8,50,000
3. Tangible assets
Land & Building 51,84,000
Machinery 7,20,000
Computers 4,00,000 63,04,000
Working Notes:
1. Cash at Bank Account
Particulars ` Particulars `
To Balance b/d 2,68,000 By Trade Creditors A/c 3,43,000
To Equity Share capital 10,00,000 By Outstanding expenses 10,60,000
A/c A/c
To Equity Share Capital 12,50,000 By Balance c/d (bal. fig.) 12,15,000
A/c
To Shiv A/c 1,00,000
26,18,000 26,18,000
 PAPER – 5 : ADVANCED ACCOUNTING 23

2. Capital Reduction Account

Particulars ` Particulars `
To Machinery A/c 1,30,000 By Equity Share Capital A/c 15,00,000
To Computers A/c 1,20,000 By Trade Creditors A/c 1,47,000
To Trade receivables A/c 1,09,000 By Shiv A/c 2,00,000
To Goodwill A/c 22,00,000 By Ganesh A/c 50,000
To Profit and Loss A/c 7,82,000 By Land & Building 9,14,000
By Inventories 30,000
By Capital Reserve A/c 5,00,000
33,41,000 33,41,000

7. OM Ltd.
Liquidator’s Final Statement of Account
Receipts Value Payments Payments`
Realised `
Assets Realised:
Cash at Bank 2,40,000 Liquidator’s Remuneratio n 1,02,224
(W.N. 1)
Trade receivables 8,00,000 Liquidation Expenses 1,17,736
Inventory 6,40,000 Debentureholders:
Plant and Machinery 20,00,000 14% Debentures 9,20,000
Patent 2,00,000 Interest Accrued (W.N. 2) 1,61,000 10,81,000
Surplus from Securities Creditors:
(W.N. 3) 5,20,000 Preferential 1,20,000
Unsecured 3,51,200 4,71,200
Preference Shareholders:
Preference Share Capital 16,00,000
Arrears of Dividend 2,24,000 18,24,000
Equity Shareholder s
(W.N.4)
` 25.12 per share on 32,000
shares 8,03,840
44,00,000 44,00,000
24 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Working Notes:
`
1 Liquidator’s remuneration:
2% on assets realised (2% of `47,60,000) 95,200
2% on payments to unsecured creditors (2% on `3,51,200) 7,024
1,02,224
2 Interest accrued on 14% Debentures:
Interest accrued as on 31.3.2019 1,28,800
Interest accrued upto the date of payment i.e. 30.6.2019 32,200
1,61,000
3 Surplus from Securities:
Amount realised from Land and Buildings 11,20,000
(`3,20,000 + `8,00,000)
Less: Mortgage Loan (6,00,000)
5,20,000
4 Amount payable to Equity Shareholders:
Equity share capital (paid up) 19,20,000
Less: Amount available for equity shareholders (8,03,840)
Loss to be borne by equity shareholders 11,16,160
Loss per equity share (`11,16,160/32,000) 34.88
Amount payable to equity shareholders for each equity share 25.12
(60-34.88)

8. FORM B– RA
Name of the Insurer: Xeta Insurance Company Limited
Registration No. and Date of registration with IRDA: ……………………..
Revenue Account for the year ended 31 st March, 2019
Particulars Schedule Amount (` )
Premium earned (net) 1 26,67,500
Profit on sale of investment 30,000
Others –
Interest and dividend (gross) 1,50,000
 PAPER – 5 : ADVANCED ACCOUNTING 25

Total (A) 28,47,500

Claims incurred (Net) 2 20,25,000
Commission 3 3,50,000
Operating expenses related to insurance 4 7,50,000
Total (B) 31,25,000
Operating loss from insurance business (A) – (B) 2,77,500
Schedule –1 Premium earned (net)
`
Premium received 33,60,000
Less: Premium on reinsurance ceded (2,25,000)
Net Premium 31,35,000
Less: Adjustment for change in Reserve for Unexpired risk (as per W.N.) (4,67,500)
Total premium earned 26,67,500
Schedule -2 Claims incurred (net)
`
Claims paid 19,20,000
Add: Expenses regarding claims 90,000
20,10,000
Less: Re-insurance recoveries (60,000)
19,50,000
Add: Claims outstanding as on 31 March, 2019
st 2,70,000
22,20,000
Less: Claims outstanding as on 31 March, 2018
st (1,95,000)
20,25,000
Schedule -3 Commission
`
Commission paid 3,50,000
Schedule-4 Operating expenses related to Insurance Business
`
Expenses of management (8,40,000 - 90,000) 7,50,000
26 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Working Note:
Calculation for change in Reserve for Unexpired risk:
`
Reserve for Unexpired Risk as on 31 March, 2019 (50% of 15,67,500
st

31,35,000)
Additional Reserve as on 31 st March, 2019 7,00,000 22,67,500
Less: Reserve for Unexpired Risk as on 31 st March, 2018 15,00,000
Additional Reserve as on 31 st March, 2018 3,00,000 (18,00,000)
4,67,500
9. The amount of rebate on bills discounted as on 31 st March, 2019 the period which has not
been expired upto that day will be calculated as follows:
Discount on `5,60,000 for 62 days @ 10% 9,512
Discount on `17,44,000 for 69 days @ 10% 32,969
Discount on `11,28,000 for 82 days @ 10% 25,341
Discount on `16,24,000 for 92 days @ 10% 40,934
Discount on `12,00,000 for 96 days @ 10% 31,562
Total 1,40,318

Note: The due date of the bills discounted is included in the number of days above.
The amount of discount to be credited to the profit and loss account will be:
`
Transfer from rebate on bills discounted as on 31.03. 2018 1,36,518
Add: Discount received during the year 3,40,312
4,76,830
Less: Rebate on bills discounted as on 31.03. 2019 (as above) (1,40,318)
3,36,512
Journal Entries
` `
Rebate on bills discounted A/c Dr. 1,36,518
To Discount on bills A/c 1,36,518
(Transfer of opening unexpired discount on 31.03. 2018)
Discount on bills A/c Dr. 1,40,318
To Rebate on bills discounted A/c 1,40,318
(Unexpired discount on 31.03. 2019 taken into account)
 PAPER – 5 : ADVANCED ACCOUNTING 27

Discount on Bills A/c Dr. 3,36,512

To P & L A/c 3,36,512
(Discount earned in the year, transferred to P&L A/c)
10. Calculation of provision required on advances as on 31 st March, 2018:
Amount Percentage of Provision
` in lakhs provision ` in lakhs
Standard assets 13,400 .40 53.60
Sub-standard assets 670 10 670
Secured portions of doubtful debts
up to one year 160 20 32
one year to three years 45 30 13.5
more than three years 20 50 10
Unsecured portions of doubtful debts 48 100 48
Loss assets 24 100 24
851.10
11. Statement showing the Movement of Unit Holders’ Funds
for the year ended 31 st March, 2018
(` ’000)
Opening balance of net assets 54,00,000
Add: Par value of units issued (38,25,900 × ` 100) 3,82,590
Net Income for the year 3,82,500
Transfer from Reserve/Equalisation fund (Refer working note) 69,255
62,34,345
Less: Par value of units redeemed (33,85,350 × ` 100) (3,38,535)
Closing balance of net assets (as on 31 st March, 2018) 58,95,810
Working Note:
Particulars Issued Redeemed
Units 38,25,900 33,85,350
` 000 ` 000
Par value 3,82,590 3,38,535
Sale proceeds / Redemption value 4,34,250 3,20,940
 28 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Profit transferred to Reserve / Equalization Fund 51,660 17,595

Balance in Reserve / Equalization Fund (Issued & 69,255
Redeemed)
12. Computation of Average Capital employed
(` in lakhs)
Total Assets as per Balance Sheet 3,547.20
Less: Non-trade investments (15% of ` 240 lakhs) (36.00)
3,511.20
Less: Outside Liabilities:
10% Debentures 120.00
12% Term Loan 432.00
Trade Payables 384.00
Provision for Taxation 153.60 (1,089.60)
Capital Employed as on 31.03.2019 2,421.60
Less: ½ of profit earned during the year:
Increase in General Reserve balance 12.00
Increase in Profit & Loss A/c 470.40
482.40 241.20
Average capita Average capital employed 2,180.40
13 Consolidated Balance Sheet of H Ltd. and its Subsidiary S Ltd.
as at 31st March, 2019
Particulars Note No. (` )
I. Equity and Liabilities
(1) Shareholder's Funds
(a) Share Capital 12,00,000
(1,20,000 equity shares of ` 10 each)
(b) Reserves and Surplus 1 8,16,200
(2) Minority Interest (W.N.4) 99,300
(3) Current Liabilities
(a) Trade Payables 2 4,10,000
Total 25,25,500
 PAPER – 5 : ADVANCED ACCOUNTING 29

II. Assets
(1) Non-current assets
(a) Property, Plant and Equipment
(i) Tangible assets 3 13,10,500
(ii) Intangible assets 4 24,000
(b) Current assets
(i) Inventories 5 3,25,000
(ii) Trade Receivables 6 6,70,000
(iii) Cash at Bank 7 1,96,000
Total 25,25,500
Notes to Accounts
`
1. Reserves and Surplus
General Reserves 4,35,000
Add: 80% share of S Ltd.’s post-
acquisition reserves (W.N.3) 84,000 5,19,000
Profit and Loss Account 2,80,000
Add: 80% share of S Ltd.’s post- 21,200
acquisition profits (W.N.3)
Less: Unrealised gain (4,000) 17,200 2,97,200
8,16,200
2. Trade Payables
H Ltd. 3,25,000
S Ltd. 1,25,000
Less: Mutual transaction (40,000) 4,10,000
3. Tangible Assets
Machinery
H Ltd. 6,40,000
S Ltd. 2,00,000
Add: Appreciation 1,00,000
3,00,000
Less: Depreciation (30,000) 2,70,000 9,10,000
Furniture
H. Ltd. 3,75,000
S Ltd. 40,000
30 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Less: Decrease in value (10,000)

30,000
Less: Depreciation (4,500) 25,500 4,00,500
13,10,500
4. Intangible assets
Goodwill [WN 5] 24,000
5. Inventories
H Ltd. 2,68,000
S Ltd. 62,000 3,30,000
Less: Inventory reserve (5,000)
3,25,000
6. Trade Receivables
H Ltd. 4,73,000
S Ltd. 2,37,000
7,10,000
Less: Mutual transaction (40,000)
6,70,000
7. Cash and Bank
H Ltd. 1,64,000
S Ltd. 32,000 1,96,000

Working Notes:
1. Profit or loss on revaluation of assets in the books of S Ltd. and their book
values as on 1.4.2018
`
Machinery
Revaluation as on 1.4.2018 3,00,000
Less: Book value as on 1.4.2018 (2,00,000)
Profit on revaluation 1,00,000
Furniture
Revaluation as on 1.4.2018 30,000
Less: Book value as on 1.4.2018 (40,000)
Loss on revaluation (10,000)
2. Calculation of short/excess depreciation
Machinery Furniture
Upward/ (Downward) Revaluation (W.N. 4) 1,00,000 (10,000)
 PAPER – 5 : ADVANCED ACCOUNTING 31

Rate of depreciation 10% p.a. 15% p.a.

Difference [(short)/excess] (10,000) 1,500
3. Analysis of reserves and profits of S Ltd. as on 31.03.2019
Pre-acquisition Post-acquisition profits
profit upto (1.4.2018 – 31.3.2019)
1.4.2018
(Capital profits) General Profit and
Reserve loss account
General reserve as on 31.3.2019 50,000 1,05,000
Profit and loss account as on 30,000 35,000
31.3.2019
Upward Revaluation of machinery 1,00,000
as on 1.4.2018
Downward Revaluation of Furniture (10,000)
as on 1.4.2018
Short depreciation on machinery (10,000)
(W.N. 5)
Excess depreciation on furniture 1,500
(W.N. 5)
Total 1,70,000 1,05,000 26,500
4. Minority Interest
`
Paid-up value of (2,00,000 x 20%) 40,000
Add: 20% share of pre-acquisition profits and reserves
[(20% of (50,000 + 30,000)] 16,000
20% share of profit on revaluation 18,000
20% share of post-acquisition reserves 21,000
20% share of post-acquisition profit 5,300
1,00,300
Less: Unrealised Profit on Inventory
(55,000 x 10/110) x 20% (1,000)
99,300
5. Cost of Control or Goodwill
Cost of Investment 3,20,000
Less: Paid-up value of 80% shares 1,60,000
80% share of pre-acquisition profits and reserves
32 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(` 64,000 + `72,000) 1,36,000 (2,96,000)

Cost of control or Goodwill 24,000
14. (i) In accordance with the Schedule III, an investment realizable within 12 months from
the reporting date is classified as a current asset. Such realization should be in the
form of cash or cash equivalents, rather than through conversion of one asset into
another non-current asset. Hence, company must classify such an investment as a
non-current asset, unless it expects to sell the preference shares or the equity shares
on conversion and realise cash within 12 months.
(ii) Calculation of foreseeable loss for the year ended 31 st March, 2019
(as per AS 7 “Construction Contracts”)
(` in lakhs)
Cost incurred till 31 March, 2019
st 83.99
Prudent estimate of additional cost for completion 36.01
Total cost of construction 120.00
Less: Contract price (108.00)
Foreseeable loss 12.00
According to para 35 of AS 7 (Revised 2002) “Construction Contracts”, when it is
probable that total contract costs will exceed total contract revenue; the expected loss
should be recognized as an expense immediately. Therefore, amount of `12 lakhs is
required to be provided for in the books of Sampath Construction Company for the
year ended 31st March, 2019.
15. Price revision was effected during the current accounting period 2018-2019. As a result,
the company stands to receive ` 15 lakhs from its customers in respect of sales made from
1st January, 2019 to 31st March, 2019. If the company is able to assess the ultimate
collection with reasonable certainty, then additional revenue arising out of the said price
revision may be recognised in 2018-2019 vide para 10 of AS 9.
16. Mr. A will not be considered as a related party of SP Hotels Limited in view of paragraph
3(c) of AS 18 which states, “individuals owning, directly or indirectly, an interest in the
voting power of the reporting enterprise that gives them control or significant influence over
the enterprise, and relatives of any such individual”. In the given case, in the absence of
share ownership, Mr. A would not be considered to exercise significant influence on SP
Hotels Limited, even though there is an agreement giving him the power to manage the
company. Further, the fact that Mr. A does not have the ability to direct or instruct the board
of directors does not qualify him as a key management personnel.
 PAPER – 5 : ADVANCED ACCOUNTING 33

17. As per AS 19 ‘leases’, a lease will be classified as finance lease if at the inception of the
lease, the present value of minimum lease payment• amounts to at least substantially all
of the fair value of leased asset. In the given case, the implicit rate of interest is given at
15%. The present value of minimum lease payments at 15% using PV- Annuity Factor can
be computed as:
Annuity Factor (Year 1 to Year 3) 3.36
Present Value of minimum lease payments ` 10.08 lakhs (approx.)
(` 3 lakhs each year)
Thus present value of minimum lease payments is `10.08 lakhs and the fair value of the
machine is ` 30 lakhs. In a finance lease, lease term should be for the major part of the
economic life of the asset even if title is not transferred. However, in the given case, the
effective useful life of the machine is 14 years while the lease is only for three years.
Therefore, lease agreement is an operating lease. Lease payments under an operating
lease should be recognized as an expense in the statement of profit and loss on a straight
line basis over the lease term unless another systematic basis is more representative of
the time pattern of the user’s benefit.
18. Computation of basic earnings per share
Net profit for the current year / Weighted average number of equity shares outstanding
during the year
` 37,50,000 / 5,00,000 = ` 7.50 per share
Adjusted net profit for the current year
Computation of diluted earnings per share
Weighted average number of equity shares
Adjusted net profit for the current year
`
Net profit for the current year 37,50,000
Add: Interest expense for the current year 4,00,000
Less: Tax relating to interest expense (30% of ` 4,00,000) (1,20,000)
Adjusted net profit for the current year 40,30,000
Number of equity shares resulting from conversion of debentures
= 55,000 Equity shares (given in the question)

• In calculating the present value of the of minimum lease payments, the discount rate is the interest rate
implicit in the lease.
34 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Weighted average number of equity shares used to compute diluted earnings per
share
= 5,55,000 shares (5,00,000 + 55,000)
Diluted earnings per share
= 40,30,000/ 5,55,000 = ` 7.26 per share
Note: Conversion of convertible debentures into Equity Share will be dilutive potential
equity shares. Hence, to compute the adjusted profit the interest paid on such debentures
will be added back as the same would not be payable in case these are converted into
equity shares.
19. As per para 41 of AS 26 “Intangible Assets”, expenditure on research should be recognized
as an expense when it is incurred. An intangible asset arising from development (or from
the development phase of an internal project) should be recognized if, and only if, an
enterprise can demonstrate all of the conditions specified in para 44 of the standard. An
intangible asset (arising from development) should be derecognised when no future
economic benefits are expected from its use according to para 87 of the standard. Thus,
the manager cannot defer the expenditure write off to future years in the given case.
Hence, the expenses amounting ` 40 lakhs incurred on the research and development
project has to be written off in the current year ending 31st March, 2019.
20. As per para 46 of AS 29 "Provisions, Contingent Liabilities and Contingent Assets", where
some or all of the expenditure required to settle a provision is expected to be reimbursed
by another party, the reimbursement should be recognised when, and only when, it is
virtually certain that reimbursement will be received if the enterprise settles the obligation.
The reimbursement should be treated as a separate asset. The amount recognised for the
reimbursement should not exceed the amount of the provision.
It is apparent from the question that the company had not made provision for warranty in
respect of certain goods considering that the company can claim the warranty cost from
the original supplier. However, the provision for warranty should have been made as per
AS 29 and the amount claimable as reimbursement should be treated as a separate asset
in the financial statements of the company rather than omitting the disclosure of such
liability. Accordingly, it is viewed that the accounting treatment adopted by the company
with respect to warranty is not correct.
 PAPER – 6: AUDITING AND ASSURANCE

PART – I : ACADEMIC UPDATE

(Legislative Amendments / Notifications / Circulars / Rules / Guidelines issued by
Regulating Authority)

Chapter 10-Company Audit

(1) Casual Vacancy by Resignation: As per section 140(2) of the Act, the auditor
who has resigned from the company shall file within a period of 30 days from the date of
resignation, a statement in the prescribed Form ADT–3 (as per Rule 8 of CAAR) with the
company and the Registrar.
In case of the companies referred to in section 139(5) i.e. Government company, the auditor
shall also file such statement with the CAG along with the company and the Registrar.
The auditor shall indicate the reasons and other facts as may be relevant with regard to his
resignation.
In case of failure, the auditor shall be liable to a penalty of fifty thousand rupees or the
remuneration of the auditor, whichever is less, and in case of continuing failure, with further
penalty of five hundred rupees for each day after the first during which such failure continues,
subject to a maximum of five lakh rupees as per section 140(3) of Companies (Amendment)
Second Ordinance 2019.
{Note: Amendment in section 140(3) of (Companies (Amendment) Second Ordinance
2019 dated 21 February 2019 has been inserted above in Bold and italic part. The
Relevant page no 10.12 of the Company Audit Chapter under the heading no 2.3.1}
(2) Submission of Cost Audit Report to the Central Government- The company shall
within 30 days from the date of receipt of a copy of the cost audit report prepared (in pursuance
of a direction issued by Central Government) furnish the Central Government with such report
along with full information and explanation on every reservation or qualification contained
therein in Form CRA-4 in Extensible Business Reporting Language (XBRL) format in the manner
as specified in the Companies (Filing of Documents and Forms in Extensible Business Reporting
language) Rules, 2015 along with fees specified in the Companies (Registration Offices and
Fees) Rules, 2014.
Provided that the companies which have got extension of time of holding Annual General
Meeting under section 96 (1) of the Companies Act, 2013, may file form CRA-4 within
resultant extended period of filing financial statements under section 137 of the
Companies Act, 2013.
36 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

If, after considering the cost audit report and the, information and explanation furnished by the
company as above, the Central Government is of the opinion, that any further information or
explanation is necessary, it may call for such further information and explanation and the
company shall furnish the same within such time as may be specified by that Government.
{Note: As per MCA notification dated 3 December 2018 vide Companies (cost records
and audit) Amendment Rules, 2018, a Proviso has been inserted above in Bold and itali c
Relevant page no 10.44 of the Company Audit Chapter under the heading no 14
sub heading namely Submission of Cost Audit Report}

PART – II: QUESTIONS AND ANSWERS

QUESTIONS

PART – II A: Multiple Choice Questions

1. Judging the significance of a matter requires _____of the facts and circumstances.
(a) objective analysis
(b) subjective analysis
(c) Both subjective and objective analysis
(d) qualitative analysis
2. An important factor in determining the form, content and extent of audit documentation of
significant matters is the extent of _________exercised in performing the work and
evaluating the results.
(a) professional skepticism
(b) professional integrity
(c) professional judgment
(d) Professional sincerity
3. Audit evidence is necessary to support the auditor’s opinion and report. It is_____in nature
and is primarily obtained from audit procedures performed during the course of the audit.
(a) cumulative
(b) regressive
(c) selective
(d) objective
 PAPER – 6: AUDITING AND ASSURANCE 37

4. ______refer to the audit procedures performed to obtain an understanding of the entity

and its environment, including the entity’s internal control, to identify and assess the risks
of material misstatement, whether due to fraud or error, at the financial statement and
assertion levels.
(a) Audit assessment procedures
(b) substantive procedures
(c) test of control
(d) Risk assessment procedures
5. When more persuasive audit evidence is needed regarding the effectiveness of a control,
(a) it may be appropriate to increase the extent of testing of the control and reduce the
extent of the degree of reliance on controls.
(b) it may be appropriate to decrease the extent of testing of the control as well as the
degree of reliance on controls.
(c) it may be appropriate to decrease the extent of testing of the control and increase the
extent of the degree of reliance on controls.
(d) it may be appropriate to increase the extent of testing of the control as well as the
degree of reliance on controls.
6. When deviations from controls upon which the auditor intends to rely are detected,
(a) the auditor shall not make any inquiries to understand these matters and their
potential consequences
(b) the auditor shall make specific inquiries to understand these matters and their
potential consequences
(c) the auditor shall make general inquiries to understand these matters and their
potential consequences
(d) the auditor shall make both general as well as specific inquiries to understand these
matters and their potential consequences
7. Which of the following statement is correct :
(a) Substantive analytical procedures are generally more applicable to large volumes of
transactions that tend to be predictable over time
(b) Substantive analytical procedures are generally less applicable to large volumes of
transactions that tend to be predictable over time
(c) Substantive analytical procedures are generally more applicable to small volumes of
transactions that tend to be predictable over time
(d) None of the above
38 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

8. If the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening
balances, the auditor shall express:
(a) a disclaimer opinion
(b) a qualified opinion
(c) a qualified opinion or a disclaimer of opinion, as appropriate, in accordance with
SA 705.
(d) unmodified opinion
9. A failure of the confirming party to respond, or fully respond, to a positive confirmation
request, or a confirmation request returned undelivered is called-
(a) Negative confirmation request
(b) Non-response
(c) Exception
(d) Positive confirmation request
10. In case of a company that is required to constitute an Audit Committee under section 177,
the committee, and, in cases where such a committee is not required to be constituted,
__________, shall take into consideration the qualifications and experience of the
individual or the firm proposed to be considered for appointment as auditor and whether
such qualifications and experience are commensurate with the size and requirements of
the company.
(a) the board
(b) any director
(c) Managing Director
(d) Whole time director
PART II B – DESCRIPTIVE QUESTIONS
1. State with reason (in short) whether the following statements are true or false:
(i) As per Section 139(6), the first auditor of a company, including a Government
company, shall be appointed by the Board of Directors within 60 days from the date
of registration of the company.
(ii) As per section 140(2) of the Act, the auditor who has resigned from the company
need not inform the Registrar of Companies.
(iii) Preconditions for an audit have not been defined in SA 210 “Agreeing the Terms of
Audit Engagements.”
(iv) The auditor need not discuss elements of planning with the entity’s management in any
case.
 PAPER – 6: AUDITING AND ASSURANCE 39

(v) Planning is a discrete phase of an audit.

(vi) Subjective examination connotes critical examination and scrutiny of the accounting
statements.
(vii) Inquiry alone provides sufficient audit evidence of the absence of a material
misstatement at the assertion level and of the operating effectiveness of controls.
(viii) The assessment of risks is a matter capable of precise measurement.
(ix) According to Section 53 of the Companies Act, 2013, a company can issue shares at
a discount.
(x) An intangible asset is an identifiable monetary asset.
Chapter 1- Nature, Objective and Scope of Audit
2. (a) An auditor who, before the completion of the engagement, is requested to change the
engagement to one which provides a lower level of assurance, should consider the
appropriateness of doing so. Explain stating the factors based on which client can
request the auditor to change the engagement.
(b) The firm should establish policies and procedures designed to provide it with
reasonable assurance that the policies and procedures relating to the system of quality
control are relevant, adequate, operating effectively and complied with in practice.
Such policies and procedures should include an ongoing consideration and evaluation
of the firm’s system of quality control, including a periodic inspection of a selection of
completed engagements. Explain in the above context the purpose of monitoring
compliance with quality control policies and procedures.
3. (a) The Chartered Accountant has a responsibility to remain independent by taking into
account the context in which they practice, the threats to independence and the
safeguards available to eliminate the threats.
In the above context, explain the guiding principles.
(b) Write a note on “Self-review threats”
Chapter 2- Audit Strategy, Audit Planning and Audit Programme
4. (a) Plans should be made to cover acquiring knowledge of the client’s accounting
systems, policies and internal control procedures. Explain.
(b) As a result of unexpected events, changes in conditions, or the audit evidence
obtained from the results of audit procedures, the auditor may need to modify the
overall audit strategy and audit plan. Explain.
5. (a) Engagement partner of Audit Firm MKC AND COMPANY thinks that Planning an audit
would involve establishing the overall audit strategy for the engagement and
developing an audit plan. Also, Adequate planning would benefit the audit of financial
statements in several ways. Analyse explaining the benefits of adequate planning.
40 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(b) Planning is not a discrete phase of an audit, but rather a continual and iterative process
that often begins shortly after the completion of the previous audit and continues until
the completion of the current audit engagement. Analyse and Explain.
Chapter 3- Audit Documentation and Audit Evidence
6. (a) Auditing is a logical process. An auditor is called upon to assess the actualities of the
situation, review the statements of account and give an expert opinion about the truth
and fairness of such accounts. This he cannot do unless he has examined the
financial statements objectively. He needs evidence to obtain information for arriving
at his judgment. Discuss explaining clearly the detailed meaning of audit evidence.
(b) Audit evidence is necessary to support the auditor’s opinion and report. It is
cumulative in nature and is primarily obtained from audit procedures performed during
the course of the audit. Most of the auditor’s work in forming the auditor’s opinion
consists of obtaining and evaluating audit evidence. Explain
7. (a) SQC 1 requires firms to establish policies and procedures for the timely completion
of the assembly of audit files. Explain
(b) When the use of the going concern basis of accounting is appropriate, assets and
liabilities are recorded on the basis that the entity will be able to realize its assets and
discharge its liabilities in the normal course of business. Explain stating also the
objective of the auditor regarding going concern.
8. (a) Discuss the meaning and nature of Audit Documentation.
(b) Explain clearly objective of the auditor regarding written representation.
Chapter 4- Risk Assessment and Internal Control
9. (a) Based on the results of the tests of control, the auditor should evaluate whether the
internal controls are designed and operating as contemplated in the preliminary
assessment of control risk. Analyse and Explain.
(b) The extent and the nature of the audit programme is substantially influenced by the
internal control system in operation. Analyse and explain.
10. (a) The SAs do not ordinarily refer to inherent risk and control risk separately, but rather to
a combined assessment of the “risks of material misstatement”. Explain.
(b) The auditor of FAST CARS Ltd obtains an understanding of the control environment.
As part of obtaining this understanding, the auditor evaluates whether management
has created and maintained a culture of honesty and ethical behaviour and the
strengths in the control environment elements collectively provide an appropriate
foundation for the other components of internal control.
Advise what is included in control environment. Also explain the elements of control
environment.
 PAPER – 6: AUDITING AND ASSURANCE 41

Chapter 5- Fraud and Responsibilities of the Auditor in this Regard.

11. The scope of auditor’s inquiry under clause (x) of paragraph 3 of Companies (Auditor’s
Report) Order, 2016 is restricted to frauds ‘noticed or reported’ during the year. Explain.
12. Detection of manipulation of accounts with a view to presenting a false state of affairs is a
task requiring great tact and intelligence. Explain stating clearly how this type of fraud is
generally committed.
Chapter 6- Audit in an Automated Environment
13. Give some of the points that an auditor should consider to obtain an understanding of the
company’s automated environment:
14. Having obtained an understanding of the IT systems and the automated environment of a
company, the auditor should understand the risks that arise from the use of IT systems.
Explain those risks.
Chapter 7- Audit Sampling
15. There is a growing realisation that the traditional approach to audit is economically wasteful
because all efforts are directed to check all transactions without exception. Explain
16. The extent of the checking to be undertaken is primarily a matter of judgment of the auditor.
It is in the interest of the auditor that if he decides to form his opinion on the basis of a part
checking, he should adopt standards and techniques which are widely followed Explain
Chapter 8 - Analytical Procedures
17. Routine checks cannot be depended upon to disclose all the mistakes or manipulation that
may exist in accounts, certain other procedures also have to be applied like trend and ratio
analysis. Analyse and Explain stating clearly the meaning of analytical procedures.
18. Give examples of Analytical Procedures having consideration of comparisons of the
entity’s financial information
Chapter 9 - Audit of Items of Financial Statements
19. The auditor A of ABC & Co.- firm of auditors is conducting the audit of XYZ Ltd and while
performing testing of additions wanted to verify that all PPE (Property Plant and
Equipment) purchase invoices are in the name of the entity he is auditing. For all additions
to land, building in particular, the auditor desires to have conc rete evidence about
ownership. The auditor is worried about whether the entity has valid legal ownership rights
over the PPE claimed to be held by the entity and recorded in the financial statements.
Advise the auditor.
20. Explain with examples the audit procedure to establish the existence of intangible fixed
assets as at the period- end.
42 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Chapter 10 - The Company Audit

21. The practice of appointing Chartered Accountants as joint auditors is quite widespread in
big companies and corporations. Explain stating the advantages of the joint audit.
22. According to Companies Act, 2013, the person appointed as an auditor of the company
shall sign the auditor's report in accordance with the relevant provisions of the Act. Explain
clearly the relevant provisions relating to signing of report.
23. The auditor shall make a report to the members of the company on the accounts examined
by him. Explain with reference to relevant provisions of the Companies Act, 2013.
Chapter 11 - Audit Report
24. Communicating Key Audit Matter is not a substitute for disclosure in the Financial
Statements rather Communicating key audit matters in the auditor’s report is in the context
of the Auditor having formed an opinion on the financial statements as a whole. Analyse.
25. The auditor’s report shall include a section, directly following the Opinion section, with the
heading “Basis for Opinion”. Explain what is included in this “Basis for Opinion” section.
Chapter 12- Bank Audit
26. (a) Advances generally constitute the major part of the assets of the bank. There are
large number of borrowers to whom variety of advances are granted. The audit of
advances requires the major attention from the auditors. In carrying out audit of
advances, the auditor is primarily concerned with obtaining evidence about, among
other points, the amounts included in balance sheet in respect of advances are
outstanding at the date of the balance sheet. Explain
(b) The auditor can obtain sufficient appropriate audit evidence about advances by study
and evaluation of internal controls relating to advances. Explain in the context of Audit
of Banks.
Chapter 13- Audit of Different Types of Entities
27. (a) Audit of government expenditure is one of the major components of government audit
conducted by the office of C&AG. The basic standards set for audit of expenditure
are to ensure that there is provision of funds authorised by competent authority fixing
the limits within which expenditure can be incurred. Explain those standards.
(b) Explain in detail the duties of Comptroller and Auditor General of India.
28. What are the special steps involved in conducting the audit of an Educational Institution?
 PAPER – 6: AUDITING AND ASSURANCE 43

SUGGESTED ANSWERS / HINTS

ANSWERS - MULTIPLE CHOICE QUESTIONS

1. (a)
2. (c)
3. (a)
4. (d)
5. (d)
6. (b)
7. (a)
8. (c)
9. (b)
10. (a)
DESCRIPTIVE ANSWERS
1. (i) Incorrect: As per Section 139(6), the first auditor of a company, other than a
Government company, shall be appointed by the Board of Directors within 30 days
from the date of registration of the company.
(ii) Incorrect: As per section 140(2) of the Act, the auditor who has resigned from the
company shall file within a period of 30 days from the date of resignation, a statement
in the prescribed Form ADT –3 (as per Rule 8 of CAAR) with the company and the
Registrar.
(iii) Incorrect: As per SA 210 “Agreeing the Terms of Audit Engagements”, preconditions
for an audit may be defined as the use by management of an acceptable financial
reporting framework in the preparation of the financial statements and the agreement
of management and, where appropriate, those charged with governance to the
premise on which an audit is conducted.
(iv) Incorrect: The auditor may decide to discuss elements of planning with the entity’s
management to facilitate the conduct and management of the audit engagement.
(v) Incorrect: According to SA-300, “Planning an Audit of Financial Statements” ,
planning is not a discrete phase of an audit, but rather a continual and iterative
process that often begins shortly after (or in connection with) the completion of the
previous audit and continues until the completion of the current audit engagement.
The auditor shall establish an overall audit strategy that sets the scope, timing and
direction of the audit, and that guides the development of the audit plan.
44 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(vi) Incorrect: Objective examination connotes critical examination and scrutiny of the
accounting statements of the undertaking with a view to assessing how far the
statements present the actual state of affairs in the correct context and whether they
give a true and fair view about the financial results and state of affairs.
(vii) Incorrect: Although inquiry may provide important audit evidence, and may even
produce evidence of a misstatement, inquiry alone ordinarily does not provide
sufficient audit evidence of the absence of a material misstatement at the assertion
level, nor of the operating effectiveness of controls.
(viii) Incorrect: The assessment of risks is based on audit procedures to obtain
information necessary for that purpose and evidence obtained throughout the audit.
The assessment of risks is a matter of professional judgment, rather than a matter
capable of precise measurement.
(ix) Incorrect: According to Section 53 of the Companies Act, 2013, a company shall not
issue shares at a discount, except in the case of an issue of sweat equity shares
given under Section 54 of the Companies Act, 2013.
(x) Incorrect: An intangible asset is an identifiable non-monetary asset, without physical
substance, held for use in the production or supply of goods or services, for rental to
others, or for administrative purposes.
2. (a) An auditor who, before the completion of the engagement, is requested to change the
engagement to one which provides a lower level of assurance, should consider the
appropriateness of doing so.
A request from the client for the auditor to change the engagement may result from -
1. a change in circumstances affecting the need for the service,
2. a misunderstanding as to the nature of an audit or related service originally
requested.
3. a restriction on the scope of the engagement, whether imposed by management
or caused by circumstances.
(b) The firm should establish policies and procedures designed to provide it with
reasonable assurance that the policies and procedures relating to the system of quality
control are relevant, adequate, operating effectively and complied with in practice.
Such policies and procedures should include an ongoing consideration and evaluation
of the firm’s system of quality control, including a periodic inspection of a selection of
completed engagements.
The purpose of monitoring compliance with quality control policies and procedures is
to provide an evaluation of:
(a) Adherence to professional standards and regulatory and legal requirements;
(b) Whether the quality control system has been appropriately designed and
 PAPER – 6: AUDITING AND ASSURANCE 45

effectively implemented; and

(c) Whether the firm’s quality control policies and procedures have been appropriately
applied, so that reports that are issued by the firm or engagement partners are
appropriate in the circumstances.
Follow-up by appropriate firm personnel so that necessary modifications are promptly
made to the quality control policies and procedures.
3. (a) The Chartered Accountant has a responsibility to remain independent by taking into
account the context in which they practice, the threats to independence and the
safeguards available to eliminate the threats.
The following are the guiding principles in this regard: -
1. For the public to have confidence in the quality of audit, it is essential that auditors
should always be and appears to be independent of the entities that they are
auditing.
2. In the case of audit, the key fundamental principles are integrity, objectivity and
professional skepticism, which necessarily require the auditor to be independent.
3. Before taking on any work, an auditor must conscientiously consider whether it
involves threats to his independence.
4. When such threats exist, the auditor should either desist from the task or put in
place safeguards that eliminate them.
5. If the auditor is unable to fully implement credible and adequate safeguards, then
he must not accept the work.
(b) Self-review threats, which occur when during a review of any judgement or
conclusion reached in a previous audit or non-audit engagement (Non audit services
include any professional services provided to an entity by an auditor, other than audit
or review of the financial statements. These include management services, internal
audit, investment advisory service, design and implementation of information
technology systems etc.), or when a member of the audit team was previously a
director or senior employee of the client. Instances where such threats come into play
are (i) when an auditor having recently been a director or senior officer of the
company, and (ii) when auditors perform services that are themselves subject matters
of audit.
4. (a) The auditor should plan his work to enable him to conduct an effective audit in
an efficient and timely manner. Plans should be based on knowledge of the client’s
business.
Plans should be made to cover, among other things:
(a) acquiring knowledge of the client’s accounting systems, policies and internal
control procedures;
46 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(b) establishing the expected degree of reliance to be placed on internal control;

(c) determining and programming the nature, timing, and extent of the audit
procedures to be performed; and
(d) coordinating the work to be performed.
From the above, it is clear that statement given in the question is partly correct.
(b) The auditor shall update and change the overall audit strategy and the audit plan
as necessary during the course of the audit. As a result of unexpected events,
changes in conditions, or the audit evidence obtained from the results of audit
procedures, the auditor may need to modify the overall audit strategy and audit plan
and thereby the resulting planned nature, timing and extent of further audit
procedures, based on the revised consideration of assessed risks. This may be the
case when information comes to the auditor’s attention that differs significantly from
the information available when the auditor planned the audit procedures. For
example, audit evidence obtained through the performance of substantive
procedures may contradict the audit evidence obtained through tests of controls.
5. (a) Planning an audit involves establishing the overall audit strategy for the engagem ent
and developing an audit plan. Adequate planning benefits the audit of financial
statements in several ways, including the following:
1. Helping the auditor to devote appropriate attention to important areas of the
audit.
2. Helping the auditor identify and resolve potential problems on a timely basis.
3. Helping the auditor properly organize and manage the audit engagement so that
it is performed in an effective and efficient manner.
4. Assisting in the selection of engagement team members with appropriate levels
of capabilities and competence to respond to anticipated risks, and the proper
assignment of work to them.
5. Facilitating the direction and supervision of engagement team members and the
review of their work.
6. Assisting, where applicable, in coordination of work done by auditors of
components and experts.
(b) Planning is not a discrete phase of an audit, but rather a continual and iterative process
that often begins shortly after (or in connection with) the completion of the previous
audit and continues until the completion of the current audit engagement. Planning,
however, includes consideration of the timing of certain activities and audit procedures
that need to be completed prior to the performance of further audit procedures. For
example, planning includes the need to consider, prior to the auditor’s identification
and assessment of the risks of material misstatement, such matters as:
 PAPER – 6: AUDITING AND ASSURANCE 47

1. The analytical procedures to be applied as risk assessment procedures.

2. Obtaining a general understanding of the legal and regulatory framework
applicable to the entity and how the entity is complying with that framework.
3. The determination of materiality.
4. The involvement of experts.
5. The performance of other risk assessment procedures.
6. (a) Auditing is a logical process. An auditor is called upon to assess the actualities of the
situation, review the statements of account and give an expert opinion about the truth
and fairness of such accounts. This he cannot do unless he has examined the
financial statements objectively.
Objective examination connotes critical examination and scrutiny of the accounting
statements of the undertaking with a view to assessing how far the statements present
the actual state of affairs in the correct context and whether they give a true and fair
view about the financial results and state of affairs. An opinion founded on a rather
reckless and negligent examination and evaluation may expose the auditor to legal
action with consequential loss of professional standing and prestige.
He needs evidence to obtain information for arriving at his judgment.
Audit evidence may be defined as the information used by the auditor in arriving at
the conclusions on which the auditor’s opinion is based. Audit evidence includes both
information contained in the accounting records underlying the financial statements
and other information.
Explaining this further, audit evidence includes:-
(1) Information contained in the accounting records: Accounting records include
the records of initial accounting entries and supporting records, such as checks
and records of electronic fund transfers; invoices; contracts; the general and
subsidiary ledgers, journal entries and other adjustments to the financial
statements that are not reflected in journal entries; and records such as work
sheets and spreadsheets supporting cost allocations, computations,
reconciliations and disclosures.
(2) Other information that authenticates the accounting records and also
supports the auditor’s rationale behind the true and fair presentation of the
financial statements: Other information which the auditor may use as audit
evidence includes, for example minutes of the meetings, written confirmations
from trade receivables and trade payables, manuals containing details of
internal control etc. A combination of tests of accounting records and other
information is generally used by the auditor to support his opinion on the
financial statements.
48 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(b) Audit evidence is necessary to support the auditor’s opinion and report. It is
cumulative in nature and is primarily obtained from audit procedures performed during
the course of the audit. It may, however, also include information obtained from other
sources such as previous audits. In addition to other sources inside and outside the
entity, the entity’s accounting records are an important source of audit evidence. Also,
information that may be used as audit evidence may have been prepared using the
work of a management’s expert. Audit evidence comprises both information that
supports and corroborates management’s assertions, and any information that
contradicts such assertions. In addition, in some cases the absence of information
(for example, management’s refusal to provide a requested representation) is used
by the auditor, and therefore, also constitutes audit evidence.
Most of the auditor’s work in forming the auditor’s opinion consists of obtaining and
evaluating audit evidence. Audit procedures to obtain audit evidence can include
inspection, observation, confirmation, recalculation, re-performance and analytical
procedures, often in some combination, in addition to inquiry. Although inquiry may
provide important audit evidence, and may even produce evidence of a misstatement,
inquiry alone ordinarily does not provide sufficient audit evidence of the absence of a
material misstatement at the assertion level, nor of the operating effectiveness of
controls.
As explained in SA 200, “Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Standards on Auditing”, reasonable
assurance is obtained when the auditor has obtained sufficient appropriate audit
evidence to reduce audit risk (i.e., the risk that the auditor expresses an inappropriate
opinion when the financial statements are materially misstated) to an acceptably low
level. The sufficiency and appropriateness of audit evidence are interrelated.
7. (a) The auditor shall assemble the audit documentation in an audit file and complete
the administrative process of assembling the final audit file on a timely basis after the
date of the auditor’s report.
SQC 1 “Quality Control for Firms that perform Audits and Review of Historical
Financial Information, and other Assurance and related services”, requires firms to
establish policies and procedures for the timely completion of the assembly of audit
files. An appropriate time limit within which to complete the assembly of the final audit
file is ordinarily not more than 60 days after the date of the auditor’s report.
The completion of the assembly of the final audit file after the date of the auditor’s
report is an administrative process that does not involve the performance of new audit
procedures or the drawing of new conclusions. Changes may, however, be made to
the audit documentation during the final assembly process, if they are administrative
in nature.
 PAPER – 6: AUDITING AND ASSURANCE 49

Examples of such changes include:

 Deleting or discarding superseded documentation.
 Sorting, collating and cross referencing working papers.
 Signing off on completion checklists relating to the file assembly process.
 Documenting audit evidence that the auditor has obtained, discussed and
agreed with the relevant members of the engagement team before the date of
the auditor’s report.
After the assembly of the final audit file has been completed, the auditor shall not
delete or discard audit documentation of any nature before the end of its retention
period.
SQC 1 requires firms to establish policies and procedures for the retention of
engagement documentation. The retention period for audit engagements ordinarily is
no shorter than seven years from the date of the auditor’s report, or, if later, the date
of the group auditor’s report.
(b) Under the going concern basis of accounting, the financial statements are prepared
on the assumption that the entity is a going concern and will continue its operations
for the foreseeable future. When the use of the going concern basis of accounting is
appropriate, assets and liabilities are recorded on the basis that the entity will be able
to realize its assets and discharge its liabilities in the normal course of business.
Objectives of the auditor regarding going concern
The objectives of the auditor are:
(a) To obtain written representations from management and, where appropriate,
those charged with governance that they believe that they have fulfilled their
responsibility for the preparation of the financial statements and for the
completeness of the information provided to the auditor;
(b) To support other audit evidence relevant to the financial statements or specific
assertions in the financial statements by means of written representations, if
determined necessary by the auditor or required by other SAs; and
(c) To respond appropriately to written representations provided by management
and, where appropriate, those charged with governance, or if management or,
where appropriate, those charged with governance do not provide the written
representations requested by the auditor.
8. (a) Audit documentation: SA 230 on “Audit Documentation”, audit documentation refers
to the record of audit procedures performed, relevant audit evidence obtained, and
conclusions the auditor reached. (terms such as “working papers” or “work papers” are
also sometimes used.)
50 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Nature of Audit Documentation

Audit documentation provides:
(a) evidence of the auditor’s basis for a conclusion about the achievement of the
overall objectives of the auditor; and
(b) evidence that the audit was planned and performed in accordance with SAs and
applicable legal and regulatory requirements.
(b) The objectives of the auditor regarding written representation
The objectives of the auditor are:
(a) To obtain written representations
To obtain written representations from management. Also that management
believes that it has fulfilled its responsibility for the preparation of the financial
statements and for the completeness of the information provided to the auditor;
(b) To support other evidence
To support other audit evidence relevant to the financial statements or specific
assertions in the financial statements by means of written representations; and
(c) To respond appropriately
To respond appropriately to written representations provided by management or
if management does not provide the written representations requested by the
auditor.
9. (a) While obtaining audit evidence about the effective operation of internal
controls, the auditor considers how they were applied, the consistency with which
they were applied during the period and by whom they were applied. The concept of
effective operation recognises that some deviations may have occurred. Deviations
from prescribed controls may be caused by such factors as changes in key personnel,
significant seasonal fluctuations in volume of transactions and human error. When
deviations are detected the auditor makes specific inquiries regarding these matters,
particularly, the timing of staff changes in key internal control functions. The auditor
then ensures that the tests of control appropriately cover such a period of change or
fluctuation.
Based on the results of the tests of control, the auditor should evaluate whether the
internal controls are designed and operating as contemplated in the preliminary
assessment of control risk. The evaluation of deviations may result in the auditor
concluding that the assessed level of control risk needs to be revised. In such cases,
the auditor would modify the nature, timing and extent of planned substantive
procedures.
Before the conclusion of the audit, based on the results of substantive procedures
and other audit evidence obtained by the auditor, the auditor should consider whether
 PAPER – 6: AUDITING AND ASSURANCE 51

the assessment of control risk is confirmed. In case of deviations from the prescribed
accounting and internal control systems, the auditor would make specific inquiries to
consider their implications. Where, on the basis of such inquiries, the auditor
concludes that the deviations are such that the preliminary assessment of control risk
is not supported, he would amend the same unless the audit evidence obtained from
other tests of control supports that assessment. Where the auditor concludes that the
assessed level of control risk needs to be revised, he would modify the nature, timing
and extent of his planned substantive procedures.
It has been suggested that actual operation of the internal control should be tested
by the application of procedural tests and examination in depth. Procedural tests
simply mean testing of the compliance with the procedures laid down by the
management in respect of initiation, authorisation, recording and documentation of
transaction at each stage through which it flows.
(b) The auditor can formulate his entire audit programme only after he has had a
satisfactory understanding of the internal control systems and their actual operation.
If he does not care to study this aspect, it is very likely that his audit program me may
become unwieldy and unnecessarily heavy and the object of the audit may be
altogether lost in the mass of entries and vouchers. It is also important for him to know
whether the system is actually in operation. Often, after installation of a system, no
proper follow up is there by the management to ensure compliance. The auditor, in
such circumstances, may be led to believe that a system is in operation which in
reality may not be altogether in operation or may at best operate only partially. This
state of affairs is probably the worst that an auditor may come across and he would
be in the midst of confusion, if he does not take care.
It would be better if the auditor can undertake the review of the internal control system
of client. This will give him enough time to assimilate the controls and implications
and will enable him to be more objective in the framing of the audit programme. He
will also be in a position to bring to the notice of the management the weaknesses of
the system and to suggest measures for improvement. At a further interim date or in
the course of the audit, he may ascertain how far the weaknesses have been
removed.
From the foregoing, it can be concluded that the extent and the nature of the audit
programme is substantially influenced by the internal control system in operation. In
deciding upon a plan of test checking, the existence and operation of internal control
system is of great significance.
A proper understanding of the internal control system in its content and working also
enables an auditor to decide upon the appropriate audit procedure to be applied in
different areas to be covered in the audit programme.
In a situation where the internal controls are considered weak in some areas, the
auditor might choose an auditing procedure or test that otherwise might not be
52 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

required; he might extend certain tests to cover a large number of transactions or

other items than he otherwise would examine and at times he may perform additional
tests to bring him the necessary satisfaction.
10. (a) The SAs do not ordinarily refer to inherent risk and control risk separately, but rather to
a combined assessment of the “risks of material misstatement”. However, the auditor
may make separate or combined assessments of inherent and control risk depending
on preferred audit techniques or methodologies and practical considerations. The
assessment of the risks of material misstatement may be expressed in quantitative
terms, such as in percentages, or in non-quantitative terms. In any case, the need for
the auditor to make appropriate risk assessments is more important than the different
approaches by which they may be made.
It can be concluded from the above that-
Risk of Material Misstatement= Inherent Risk x Control Risk
(b) Control Environment – Component of Internal Control: The auditor shall obtain
an understanding of the control environment. As part of obtaining this understanding,
the auditor shall evaluate whether:
(i) Management has created and maintained a culture of honesty and ethical
behavior; and
(ii) The strengths in the control environment elements collectively provide an
appropriate foundation for the other components of internal control.
What is included in Control Environment?
The control environment includes:
(i) the governance and management functions and
(ii) the attitudes, awareness, and actions of those charged with governance and
management.
(iii) The control environment sets the tone of an organization, influencing the control
consciousness of its people.
Elements of the Control Environment: Elements of the control environment that
may be relevant when obtaining an understanding of the control environment include
the following:
(a) Communication and enforcement of integrity and ethical values – These
are essential elements that influence the effectiveness of the design,
administration and monitoring of controls.
(b) Commitment to competence – Matters such as management’s consideration
of the competence levels for particular jobs and how those levels translate into
requisite skills and knowledge.
 PAPER – 6: AUDITING AND ASSURANCE 53

(c) Participation by those charged with governance – Attributes of those

charged with governance such as:
 Their independence from management.
 Their experience and stature.
 The extent of their involvement and the information they receive, and the
scrutiny of activities.
 The appropriateness of their actions, including the degree to which difficult
questions are raised and pursued with management, and their interaction
with internal and external auditors.
(d) Management’s philosophy and operating style – Characteristics such as
management’s:
 Approach to taking and managing business risks.
 Attitudes and actions toward financial reporting.
 Attitudes toward information processing and accounting functions and
personnel.
(e) Organisational structure – The framework within which an entity’s activities for
achieving its objectives are planned, executed, controlled, and reviewed.
(f) Assignment of authority and responsibility - Matters such as how authority
and responsibility for operating activities are assigned and how reporting
relationships and authorisation hierarchies are established.
(g) Human resource policies and practices – Policies and practices that relate
to, for example, recruitment, orientation, training, evaluation, counselling,
promotion, compensation, and remedial actions.
11. Reporting under Companies (Auditor’s Report) Order, 2016 [CARO, 2016]: The auditor
is also required to report under clause (x) of paragraph 3 of Companies (Auditor’s Report)
Order, 2016, whether any fraud by the company or any fraud on the Company by its officers
or employees has been noticed or reported during the year. If yes, the nature and the
amount involved is to be indicated.
The scope of auditor’s inquiry under clause (x) of paragraph 3 of Companies (Auditor’s
Report) Order, 2016 is restricted to frauds ‘noticed or reported’ during the year. It may be
noted that this clause of the Order, by requiring the auditor to report whether any fraud by
the company or on the company by its Officer or employees has been noticed or reported,
does not relieve the auditor from his responsibility to consider fraud and error in an audit
of financial statements. In other words, irrespective of the auditor’s comments under this
clause, the auditor is also required to comply with the requirements of SA 240, “The
Auditor’s Responsibility Relating to Fraud in an Audit of Financial Statements”.
54 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Audit Procedures and Reporting under CARO:

(1) While planning the audit, the auditor should discuss with other members of the audit
team, the susceptibility of the company to material misstatements in the financial
statements resulting from fraud. While planning, the auditor should also make
inquiries of management to determine whether management is aware of any known
fraud or suspected fraud that the company is investigating.
(2) The auditor should examine the reports of the internal auditor with a view to ascertain
whether any fraud has been reported or noticed by the management. The auditor
should examine the minutes of the audit committee, if available, to ascertain whether
any instance of fraud pertaining to the company has been reported and actions taken
thereon.
The auditor should enquire from the management about any frauds on the company
that it has noticed or that have been reported to it. The auditor should also discuss
the matter with other employees including officers of the company. The auditor should
also examine the minute book of the board meeting of the company in this regard.
(3) The auditor should obtain written representations from management that:
(i) it acknowledges its responsibility for the implementation and operation of
accounting and internal control systems that are designed to prevent and detect
fraud and error;
(ii) it believes the effects of those uncorrected misstatements in financial
statements, aggregated by the auditor during the audit are immaterial, both
individually and in the aggregate, to the financial statements taken as a whole.
A summary of such items should be included in or attached to the written
representation;
(iii) it has
(a) disclosed to the auditor all significant facts relating to any frauds or
suspected frauds known to management that may have affected the entity;
and
(b) disclosed to the auditor the results of its assessment of the risk that the
financial statements may be materially misstated as a result of fraud.
(4) Because management is responsible for adjusting the financial statements to correct
material misstatements, it is important that the auditor obtains written representation
from management that any uncorrected misstatements resulting from fraud are, in
management's opinion, immaterial, both individually and in the aggregate. Such
representations are not a substitute for obtaining sufficient appropriate audit
evidence. In some circumstances, management may not believe that certain of the
uncorrected financial statement misstatements aggregated by the auditor during the
audit are misstatements. For that reason, management may want to add to their
 PAPER – 6: AUDITING AND ASSURANCE 55

written representation words such as, "We do not agree that items constitute
misstatements because [description of reasons]."
The auditor should consider if any fraud has been reported by them during the year
under section 143(12) of the Act and if so whether that same would be reported under
this Clause. It may be mentioned here that section 143(12) of the Act requires the
auditor has reasons to believe that a fraud is being committed or has been committed
by an employee or officer. In such a case the auditor needs to report to the Central
Government or the Audit Committee. However, this Clause will include only the
reported frauds and not suspected fraud.
(5) Where the auditor notices that any fraud by the company or on the company by its
officers or employees has been noticed by or reported during the year, the auditor
should, apart from reporting the existence of fraud, also required to report, the nature
of fraud and amount involved. For reporting under this clause, the auditor may
consider the following:
(i) This clause requires all frauds noticed or reported during the year shall be
reported indicating the nature and amount involved. As specified the fraud by
the company or on the company by its officers or employees are only covered.
(ii) Of the frauds covered under section 143(12) of the Act, only noticed frauds shall
be included here and not the suspected frauds.
(iii) While reporting under this clause with regard to the nature and the amount
involved of the frauds noticed or reported, the auditor may also consider the
principles of materiality outlined in Standards on Auditing.
12. Manipulation of Accounts: Detection of manipulation of accounts with a view to
presenting a false state of affairs is a task requiring great tact and intelligence because
generally management personnel in higher management cadre are associated with this
type of fraud and this is perpetrated in methodical way. This type of fraud is generally
committed:
(a) to avoid incidence of income-tax or other taxes;
(b) for declaring a dividend when there are insufficient profits;
(c) to withhold declaration of dividend even when there is adequate profit (this is often
done to manipulate the value of shares in stock market to make it possible for selected
persons to acquire shares at a lower cost); and
(d) for receiving higher remuneration where managerial remuneration is payable by
reference to profits.
56 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

13. Given below are some of the points that an auditor should consider to obtain a n
understanding of the company’s automated environment:
 Information systems being used (one or m ore application systems and what they
are).
 T heir purpose (financial and non-financial).
 Loc ation of IT systems - local vs global.
 Arc hitecture (desktop based, client-server, web application, cloud based).
 Version (functions and risks could vary in different versions of same application).
 Interfaces within systems (in case multiple systems exist).
 In-house vs Packaged.
 Outsourced activities (IT m aintenance and support).
 Key persons (CIO, CISO, Administrators).
14. Having obtained an understanding of the IT systems and the automated environment of a
company, the auditor should now understand the risks that arise from the use of IT
systems.
Given below are some such risks that should be considered:
 Inaccurate processing of data, processing inaccurate data, or both.
 Unauthorized access to data.
 Direct data changes (backend changes).
 Exc essive access / Privileged access (super users).
 Lac k of adequate segregation of duties.
 Unauthorized changes to systems or programs.
 Failure to m ake necessary c hanges to systems or programs.
 Loss of data.
15. No conscious effort in human society is divested of economic considerations and auditing
is no exception. There is a growing realisation that the traditional approach to audit is
economically wasteful because all efforts are directed to check all transactions without
exception. This invariably leads to more emphasis on routine checking, which often is not
necessary in view of the time and the cost involved. With the shift in favour of formal
internal controls in the management of affairs of organisations, the possibilities of routine
errors and frauds have greatly diminished and auditors often find extensive routine
checking as nothing more than a ritual because it seldom reveals anything material. Now
the approach to audit and the extent of checking are undergoing a progressive change in
favour of more attention towards the questions of principles and controls with a curtailment
 PAPER – 6: AUDITING AND ASSURANCE 57

of non-consequential routine checking. By routine checking we traditionally think of

extensive checking and vouching of all entries.
16. The extent of the checking to be undertaken is primarily a matter of judgment of the auditor,
there is nothing statutorily stated anywhere which specifies what work is to be done, how it
is to be done and to what extent. It is also not obligatory that the auditor must adopt the
sampling technique. What he is to do is to express his opinion and become bound by that.
To ensure good and reasonable standard of work, he should adopt standards and
techniques that can lead him to an informed professional opinion. On a consideration of this
fact, it can be said that it is in the interest of the auditor that if he decides to form his opinion
on the basis of a part checking, he should adopt standards and techniques which are widely
followed and which have a recognised basis. Since statistical theory of sampling is based
on a scientific law, it can be relied upon to a greater extent than any arbitrary technique
which lacks in basis and acceptability.
17. Since routine checks cannot be depended upon to disclose all
the mistakes or manipulation that may exist in accounts, certain
other procedures also have to be applied like trend and ratio
analysis in addition to reasonable tests. These collectively are
known as overall tests. With the passage of tests, analytical
procedures have acquired lot of significance as substantive
audit procedure. SA-520 on Analytical Procedures discusses
the application of analytical procedures during an audit.
Meaning of Analytical Procedures. As per the Standard on
Auditing (SA) 520 “Analytical Procedures”, the term “analytical procedures” means
evaluations of financial information through analysis of plausible relationships among both
financial and non-financial data. Analytical procedures also encompass such investigation
as is necessary of identified fluctuations or relationships that are inconsistent with other
relevant information or that differ from expected values by a significant amount.
18. Examples of Analytical Procedures having consideration of comparisons of the
entity’s financial information with are:
 Com parable information for prior periods.
 Antic ipated results of the entity, such as budgets or forecasts, or expectations of
the auditor, such as an estimation of depreciation.
 Sim ilar industry information, such as a c omparison of the entity’s ratio of sales to
ac counts receivable with industry averages or with other entities of comparable
size in the same industry
19. In addition to the procedures undertaken for verifying completeness of additions to PPE
during the period under audit, the auditor while performing testing of additions should also
verify that all PPE purchase invoices are in the name of the entity that entitles legal title of
ownership to the respective entity. For all additions to land, building in particular, the
58 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

auditor should obtain copies of conveyance deed/ sale deed to establish whether the entity
is mentioned to be the legal and valid owner.
The auditor should insist and verify the original title deeds for all immoveable properties
held as at the balance sheet date. In case the entity has given such immoveable property
as security for any borrowings and the original title deeds are not available with the entity,
the auditor should request the entity’s management for obtaining a confirmation from the
respective lenders that they are holding the original title deeds of immoveable property as
security. In addition, the auditor should also verify the register of charges, available with
the entity to assess the PPE that has been given as security to any third parties
20. Since an Intangible Asset is an identifiable non-monetary asset, without physical
substance, for establishing the existence of such assets, the auditor should verify whether
such intangible asset is in active use in the production or supply of goods or services, for
rental to others, or for administrative purposes.
Example- for verifying the existence of software, the auditor should verify whether such
software is in active use by the entity and for the purpose, the auditor should verify the
sale of related services/ goods during the period under audit, in which such software has
been used.
Example- For verifying the existence of design/ drawings, the auditor should verify the
production data to establish if such products for which the design/ drawings were
purchased, are being produced and sold by the entity.
In case any intangible asset is not in active use, deletion should have been recorded in the
books of account post approvals by the entity’s management and amortization charge
should have ceased to be charged beyond the date of deletion Chapter 10 - The Company
Audit
21. Joint Audit: The practice of appointing Chartered Accountants as joint auditors is quite
widespread in big companies and corporations. Joint audit basically implies pooling
together the resources and expertise of more than one firm of auditors to render an expert
job in a given time period which may be difficult to accomplish acting individually. It
essentially involves sharing of the total work. This is by itself a great advantage.
In specific terms the advantages that flow may be the following:
(i) Sharing of expertise.
(ii) Advantage of mutual consultation.
(iii) Lower workload.
(iv) Better quality of performance.
(v) Improved service to the client.
(vi) Displacement of the auditor of the company taken over in a takeover often obviated.
 PAPER – 6: AUDITING AND ASSURANCE 59

(vii) In respect of multi-national companies, the work can be spread using the expertise of
the local firms which are in a better position to deal with detailed work and the local
laws and regulations.
(viii) Lower staff development costs.
(ix) Lower costs to carry out the work.
(x) A sense of healthy competition towards a better performance
22. Duty to Sign the Audit Report: As per section 145 of the Companies Act, 2013, the
person appointed as an auditor of the company shall sign the auditor's report or sign or
certify any other document of the company, in accordance with the provisions of section
141(2).
Section 141(2) of the Companies Act, 2013 states that where a firm including a limited
liability partnership is appointed as an auditor of a company, only the partners who are
chartered accountants shall be authorised to act and sign on behalf of the firm.
The qualifications, observations or comments on financial transactions or matters, which
have any adverse effect on the functioning of the company mentioned in the auditor's report
shall be read before the company in general meeting.
23. Right to report to the members of the company on the accounts examined by him –
The auditor shall make a report to the members of the company on the accounts examined
by him and on every financial statements which are required by or under this Act to be laid
before the company in general meeting and the report shall after taking into account the
provisions of this Act, the accounting and auditing standards and matters which are
required to be included in the audit report under the provisions of this Act or any rules
made there under or under any order made under this section and to the best of his
information and knowledge, the said accounts, financial statements give a true and fair
view of the state of the company’ s affairs as at the end of its financial year and profit or
loss and cash flow for the year and such other matters as may be prescribed.
24. Communicating key audit matters in the auditor’s report is not:
(i) A substitute for disclosures in the financial statements that the applicable
Financial reporting framework requires management to make, or that are otherwise
necessary to achieve fair presentation;
(ii) A substitute for the auditor expressing a modified opinion when required by the
circumstances of a specific audit engagement in accordance with SA 705 (Revised);
(iii) A substitute for reporting in accordance with SA 570 when a material uncertainty
exists relating to events or conditions that may cast significant doubt on an entity’s
ability to continue as a going concern; or
(iv) A separate opinion on individual matters
60 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

25. Basis for Opinion: The auditor’s report shall include a section, directly following the
Opinion section, with the heading “Basis for Opinion”, that:
(a) States that the audit was conducted in accordance with Standards on Auditing;
(b) Refers to the section of the auditor’s report that describes the auditor’s responsibilities
under the SAs;
(c) Includes a statement that the auditor is independent of the entity in accordance with
the relevant ethical requirements relating to the audit and has fulfilled the auditor’s
other ethical responsibilities in accordance with these requirements.
(d) States whether the auditor believes that the audit evidence the auditor has obtained
is sufficient and appropriate to provide a basis for the auditor’s opinion.
26. (a) Audit of Advances: Advances generally constitute the major part of the assets of the
bank. There are large number of borrowers to whom variety of advances are granted.
The audit of advances requires the major attention from the auditors.
In carrying out audit of advances, the auditor is primarily concerned with obtaining
evidence about the following:
(a) Amounts included in balance sheet in respect of advances are outstanding at
the date of the balance sheet.
(b) Advances represent amount due to the bank.
(c) Amounts due to the bank are appropriately supported by Loan documents and
other documents as applicable to the nature of advances.
(d) There are no unrecorded advances.
(e) The stated basis of valuation of advances is appropriate and properly applied,
and that the recoverability of advances is recognised in their valuation.
(f) The advances are disclosed, classified and described in accordance with
recognised accounting policies and practices and relevant statutory and
regulatory requirements.
(g) Appropriate provisions towards advances have been made as per the RBI
norms, Accounting Standards and generally accepted accounting practices.
(b) The auditor can obtain sufficient appropriate audit evidence about advances by study
and evaluation of internal controls relating to advances, and by:
 examining the validity of the recorded amounts;
 examining loan documentation;
 reviewing the operation of the accounts;
 examining the existence, enforceability and valuation of the security;
 PAPER – 6: AUDITING AND ASSURANCE 61

 checking compliance with RBI norms including appropriate classification and

provisioning; and
 carrying out appropriate analytical procedures.
In carrying out his substantive procedures, the auditor should examine all large
advances while other advances may be examined on a sampling basis. The accounts
identified to be problem accounts however need to be examined in detail unless the
amount involved is insignificant.
Advances which are sanctioned during the year or which are adversely commented
by RBI inspection team, concurrent auditors, bank’s internal inspection, etc. should
generally be included in the auditor’s review.
27 (a) Government Expenditure Audit: Audit of government expenditure is one of the
major components of government audit conducted by the office of C&AG. The basic
standards set for audit of expenditure are to ensure that there is provision of funds
authorised by competent authority fixing the limits within which expenditure can be
incurred. Briefly, these standards are explained below:
(i) Audit against Rules & Orders: The auditor has to see that the expenditure
incurred conforms to the relevant provisions of the statutory enactment and is in
accordance with the financial rules and regulations framed by the competent
authority.
(ii) Audit of Sanctions: The auditor has to ensure that each item of expenditure is
covered by a sanction, either general or special, accorded by the competent
authority, authorising such expenditure.
(iii) Audit against Provision of Funds: It contemplates that there is a provision of
funds out of which expenditure can be incurred and the amount of such
expenditure does not exceed the appropriations made.
(iv) Propriety Audit: It is required to be seen that the expenditure is incurred with due
regard to broad and general principles of financial propriety. The auditor aims to
bring out cases of improper, avoidable, or in fructuous expenditure even though
the expenditure has been incurred in conformity with the existing rules and
regulations. Audit aims to secure a reasonably high standard of public financial
morality by looking into the wisdom, faithfulness and economy of transactions.
(v) Performance Audit: This involves that the various programmes, schemes and
projects where large financial expenditure has been incurred are being run
economically and are yielding results expected of them. Efficiency-cum-
performance audit, wherever used, is an objective examination of the financial
and operational performance of an organisation, programme, authority or
function and is oriented towards identifying opportunities for greater economy,
and effectiveness.
62 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(b) Duties of C&AG: The Comptroller & Auditor General’s (Duties, Powers and
Conditions of Service) Act, 1971 lays down duties of the C&AG as under-
(i) Compile and submit Accounts of Union and States - The C&AG shall be
responsible for compiling the accounts of the Union and of each State from the
initial and subsidiary accounts rendered to the audit and accounts offices under
his control by treasuries, offices or departments responsible for the keeping of
such account.
(ii) General Provisions Relating to Audit - It shall be the duty of the C&AG –
(a) to audit and report on all expenditure from the Consolidated Fund of India
and of each State and of each Union Territory having a Legislative
Assembly and to ascertain whether the moneys shown in the accounts as
having been disbursed were legally available for and applicable to the
service or purpose to which they have been applied or charged and
whether the expenditure conforms to the authority which governs it;
(b) to audit and report all transactions of the Union and of the States relating
to Contingency Funds and Public Accounts;
(c) to audit and report on all trading, manufacturing profit and loss accounts
and balance-sheets and other subsidiary accounts kept in any department
of the Union or of a State.
(iii) Audit of Receipts and Expenditure - Where any body or authority is
substantially financed by grants or loans from the Consolidated Fund of India or
of any State or of any Union Territory having a Legislative Assembly, the
Comptroller and Auditor General shall, subject to the provisions of any law for
the time being in force applicable to the body or authority, as the case may be,
audit all receipts and expenditure of that body or authority and to report on the
receipts and expenditure audited by him.
(iv) Audit of Grants or Loans - Where any grant or loan is given for any specific
purpose from the Consolidated Fund of India or of any State or of any Union
Territory having a Legislative Assembly to any authority or body, not being a
foreign State or international organisation, the Comptroller and Auditor General
shall scrutinise the procedures by which the sanctioning authority satisfies itself
as to the fulfillment of the conditions subject to which such grants or loans were
given and shall for this purpose have right of access, after giving reasonable
previous notice, to the books and accounts of that authority or body.
(v) Audit of Receipts of Union or States - It shall be the duty of the Comptroller
and Auditor General to audit all receipts which are payable into the Consolidated
 PAPER – 6: AUDITING AND ASSURANCE 63

Fund of India and of each State and of each Union Territory having a Legislative
Assembly and to satisfy himself that the rules and procedures in that behalf are
designed to secure an effective check on the assessment, collection and proper
allocation of revenue and are being duly observed and to make this purpose
such examination of the accounts as he thinks fit and report thereon.
(vi) Audit of Accounts of Stores and Inventory - The Comptroller and Auditor
General shall have authority to audit and report on the accounts of stores and
inventory kept in any office or department of the Union or of a State.
(vii) Audit of Government Companies and Corporations - The duties and powers
of the Comptroller and Auditor General in relation to the audit of the accounts of
government companies shall be performed and exercised by him in accordance
with the provisions of the Companies Act, 2013. The comptroller and Auditor -
General of India shall appoint the auditor under sub-section (5) or sub-section
(7) of section 139 (i.e. appointment of First Auditor or Subsequent Auditor) and
direct such auditor the manner in which the accounts of the Government
company are required to be audited and thereupon the auditor so appointed
shall submit a copy of the audit report to the Comptroller and Auditor-General of
India which, among other things, include the directions, if any, issued by the
Comptroller and Auditor-General of India, the action taken thereon and its
impact on the accounts and financial statement of the company.
28. The Special Steps Involved in the Audit of an Educational Institution are the
following:
(i) Examine the Trust Deed, or Regulations in the case of school or college and note all
the provisions affecting accounts. In the case of a university, refer to the Act of
Legislature and the Regulations framed thereunder.
(ii) Read through the minutes of the meetings of the Managing Committee or Governing
Body, noting resolutions affecting accounts to see that these have been duly complied
with, specially the decisions as regards the operation of bank accounts and
sanctioning of expenditure.
(iii) Check names entered in the Students’ Fee Register for each month or term, with the
respective class registers, showing names of students on rolls and test amount of
fees charged; and verify that there operates a system of internal check which ensures
that demands against the students are properly raised.
(iv) Check fees received by comparing counterfoils of receipts granted with entries in the
cash book and tracing the collections in the Fee Register to confirm that the revenue
from this source has been duly accounted for.
64 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(v) Total up the various columns of the Fees Register for each month or term to ascertain
that fees paid in advance have been carried forward and the arrears that are
irrecoverable have been written off under the sanction of an appropriate authority.
(vi) Check admission fees with admission slips signed by the head of the institution and
confirm that the amount had been credited to a Capital Fund, unless the Managing
Committee has taken a decision to the contrary.
(vii) See that free studentship and concessions have been granted by a person authorised
to do so, having regard to the prescribed Rules.
(viii) Confirm that fines for late payment or absence, etc., have either been collected or
remitted under proper authority.
(ix) Confirm that hostel dues were recovered before students’ accounts were closed and
their deposits of caution money refunded.
(x) Verify rental income from landed property with the rent rolls, etc.
(xi) Vouch income from endowments and legacies, as well as interest and dividends from
investment; also inspect the securities in respect of investments held.
(xii) Verify any Government or local authority grant with the relevant papers of grant. If
any expense has been disallowed for purposes of grant, ascertain the reasons and
compliance thereof.
(xiii) Report any old heavy arrears on account of fees, dormitory rents, etc, to the Managing
Committee.
(xiv) Confirm that caution money and other deposits paid by students on admission have
been shown as liability in the balance sheet and not transferred to revenue.
(xv) See that the investments representing endowment funds for prizes are kept separate
and any income in excess of the prizes has been accumulated and invested along
with the corpus.
(xvi) Verify that the Provident Fund money of the staff has been invested in appropriate
securities.
(xvii) Vouch donations, if any, with the list published with the annual report. If some
donations were meant for any specific purpose, see that the money was utilised for
the purpose.
(xviii)Vouch all capital expenditure in the usual way and verify the same with the sanction
for the Committee as contained in the minute book.
 PAPER – 6: AUDITING AND ASSURANCE 65

(xix) Vouch in the usual manner all establishment expenses and enquire into any unduly
heavy expenditure under any head.
(xx) See that increase in the salaries of the staff have been sanctioned and minuted by
the Committee.
(xxi) Ascertain that the system ordering inspection on receipt and issue of provisions,
foodstuffs, clothing and other equipment is efficient and all bills are duly authorised
and passed before payment.
(xxii) Verify the inventories of furniture, stationery, clothing, provision and all equipment,
etc. These should be checked by reference to Inventory Register and values applied
to various items should be test checked.
(xxiii)Confirm that the refund of taxes deducted from the income from investment (interest
on securities, etc.) has been claimed and recovered since the institutions are
generally exempted from the payment of income-tax.
(xxiv)Verify the annual statements of accounts and while doing so see that separate
statements of account have been prepared as regards Poor Boys Fund, Games Fund,
Hostel and Provident Fund of Staff, etc.
 PAPER – 7: ENTERPRISE INFORMATION SYSTEMS AND STRATEGIC
MANAGEMENT
SECTION – A: ENTERPRISE INFORMATION SYSTEMS
QUESTIONS

Multiple Choice Questions

1. In an organization, there are certain risks that would prevent an organization from
accomplishing its objectives and meeting its goals. These are referred as ___________
risks.
(a) Operational
(b) Strategic
(c) Financial
(d) Reputational
2. Mr. A visited an e-commerce website and placed an order for a pair of shoes. He made
his payment of ` 2,000 through credit card and received a confirmation mail on his
registered email-id. With respect to e-commerce architecture, which layer of the software
is he working on?
(a) Database Layer
(b) Application Layer
(c) Presentation Layer
(d) Client Layer
3. Which of the following statement is incorrect?
(a) A Proxy Server is a computer that offers a computer network service to allow clients
to make indirect network connections to other network services.
(b) The term Information Security refers to ensure Confidentiality, Integrity and
Availability of information.
(c) Any Application Software has primarily four gateways through which enterprise can
control functioning, access and use the various menus and functions of the software
- Configuration, Masters, Transactions and Reports.
(d) Section 66-C of Information Technology Act, 2000 provides for the punishment for
cheating by personation by using computer resource.
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 67

4. An amount of `100/- is to be written off as same is not recovered from customer since
last three years. Which voucher is best suited for the transaction?
(a) Journal
(b) Sales
(c) Purchase
(d) Contra
5. While doing a concurrent audit in a bank, Mr. X noticed that some changes have been
made to advance master data files of the database. He uses an audit technique to
identify such suspicious transactions. This technique shall be defined as ___________.
(a) Continuous and Intermittent Simulation (CIS)
(b) System Control Audit Review File (SCARF)
(c) Audit Hook
(d) Integrated Test Facility (ITF)
Descriptive Questions
Chapter 1: Automated Business Processes
1. A book publisher offered discount to customers based on their mode of purchase and the
number of copies ordered as shown below:
Mode of Purchase Number of copies ordered Discount %
Online More than 5 20
Less than or equal to 5 15
Offline More than 10 10
Less than or equal to 10 5
If Customer name, Customer type, Date of order placed, Number of copies ordered and
unit price are input; draw a flowchart to calculate the net amount of the bill and date of
purchase for each customer and print it. The above is to be carried out for 50 customers.
2. Discuss all the stages of Human Resource (HR) Life Cycle.
Chapter 2: Financial and Accounting Systems
3. Sales and Distribution Process that is used by organizations to support sales and
distribution activities of products and services, starting from enquiry to order and then
ending with delivery is one of the most important module in ERP. Determine the various
activities that are involved in Sales and Distribution Process.
68 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

4. Describe the term “Business Reporting” and why do you think there is a need of it in
today’s world?
Chapter 3: Information Systems and Its Components
5. Many organizations now recognize that data is a critical resource that must be managed
properly and therefore, accordingly, centralized planning and control are implemented.
Identify the various control activities involved in maintaining the integrity of the database.
6. An Internet connection exposes an organization to the harmful elements of the outside
world. Prepare a list of various Network Access Controls by means of which the
protection can be achieved against these harmful elements.
Chapter 4: E- Commerce, M-Commerce and Emerging Technologies
7. Discuss various Commercial Laws that govern e-Commerce/m-Commerce transactions in
India.
8. The Prime Minister Office of a country X plans to establish specific infrastructure setup
with its access shared amongst members of the group constituting of some selected
high-profiled dignitaries and officers from different ministries. The objective of the group
is to carry out certain assignments related to nation’s security and integrity. Which is the
most suitable choice of the cloud under Cloud Computing? Discuss its advantages and
limitations as well.
Chapter 5: Core Banking Systems
9. “The deployment and implementation of Core Banking Systems (CBS) should be
controlled at various stages to ensure that the banks automation objectives are
achieved”. Analyse the statement.
10. Differentiate between Internet Banking Channel Server (IBCS) and Internet Banking
Application Server (IBAS) used in Core Banking Systems (CBS).

SUGGESTED ANSWERS/HINTS

Multiple Choice Answers

1. (b) Strategic
2. (b) Application Layer
3. (d) Section 66-C of Information Technology Act, 2000 provides for the punishment for
cheating by personation by using computer resource.
4. (a) Journal
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 69

5. (c) Audit Hook

Descriptive Answers
1. The required flowchart is given below:

Start

Clear all Working Locations

NOC = 1

Read CNAME, CTYPE, NO_CP, UNT_PR, DOP

If CTYPE= ‘OFF_Ln’
Yes
No
If NO_CP > 10
If NO_CP > 5

Yes No Yes
No
DISC = 0.05 DISC = 0.10
DISC = 0.15 DISC = 0.20

AMT = NO_CP * UNT_PR

NAMT = AMT – AMT*DISC

Print CNAME, NAMT, DOP

NOC = NOC + 1

Yes No
If NOC <= 50 Stop
70 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Abbreviations used in the flowchart are as follows:

DOP - Date of order placed CNAME - Customer Name
NO_CP - Number of Copies UNT_PR - Unit Price
DISC - Discount AMT - Total Amount
NAMT - Net Amount NOC - Number of Customers
CTYPE - Type of the Customer (Can either be Online or Offline[OFF_LN])
2. The Human Resources (HR) Life Cycle refers to human resources management and
covers all the stages of an employee’s time within a specific enterprise and the role the
human resources department plays at each stage. Typical stage of HR cyc le includes the
following:
(a) Recruiting and On-boarding: Recruiting is the process of hiring a new employee.
The role of the human resources department in this stage is to assist in hiring. This
might include placing the job ads, selecting candidates whose resumes look
promising, conducting employment interviews and administering assessments such
as personality profiles to choose the best applicant for the position. On boarding is
the process of getting the successful applicant set up in the system as a new
employee.
(b) Orientation and Career Planning: Orientation is the process by which the
employee becomes a member of the company’s work force through learning her
new job duties, establishing relationships with co-workers and supervisors and
developing a niche. Career planning is the stage at which the employee and her
supervisors work out her long-term career goals with the company. The human
resources department may make additional use of personality profile testing at this
stage to help the employee determine her best career options with the company.
(c) Career Development: Career development opportunities are essential to keep an
employee engaged with the company over time. After an employee, has established
himself at the company and determined his long-term career objectives, the human
resources department should try to help him meet his goals, if they’re realistic. This
can include professional growth and training to prepare the employee for more
responsible positions with the company. The company also assesses the
employee’s work history and performance at this stage to determine whether he has
been a successful hire.
(d) Termination or Transition: Some employees will leave a company through
retirement after a long and successful career. Others will choose to move on to
other opportunities or be laid off. Whatever the reason, all employees will eventually
leave the company. The role of HR in this process is to manage the transition by
ensuring that all policies and procedures are followed, carrying out an exit interview
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 71

if that is company policy and removing the employee from the system. These stages
can be handled internally or with the help of enterprises that provide services to
manage the employee life cycle.
3. The various activities that are involved in a Sales and Distribution Process are as follows:
• Pre-Sales Activities: This include prospecting of customers, identifying prospective
customers, gathering data, contacting them and fixing appointments, showing
demo, discussion, submission of quotations, etc.
• Sales Order: Sales order is recorded in our books after getting a confirmed
purchased order from our customer. Sales order shall contain details just like
purchase order. E.g. Stock Item Details, Quantity, Rate, Due Date of Delivery, Place
of Delivery, etc.
• Inventory Sourcing: It includes making arrangements before delivery of goods,
ensuring goods are ready and available for delivery.
• Material Delivery: Material is delivered to the customer as per sales order. All
inventory details are copied from Sales Order to Material Delivery for saving user’s
time and efforts. This transaction shall have a linking with Sales Order. Stock
balance shall be reduced on recording of this transaction.
• Billing: This is a transaction of raising an invoice against the delivery of material to
customer. This transaction shall have a linking with Material Delivery and all the
details shall be copied from it. Stock balance shall not affect again.
• Receipt from Customer: This is a transaction of receiving amount from customer
against sales invoice and shall have a linking with sales invoice.
4. Business Reporting is defined as the public reporting of operating and financial data by
a business enterprise, or the regular provision of information to decision-makers within
an organization to support them in their work. This reporting process involves querying
data sources with different logical models to produce a human readable report - for
example, a computer user must query the Human Resources databases and the Capital
Improvements databases to show how efficiently space is being used across an entire
corporation.
Through reporting, organizations communicate with their stakeholders about:
• mission, vision, objectives, and strategy;
• governance arrangements and risk management;
• trade-offs between the shorter- and longer-term strategies; and
• financial, social, and environmental performance (how they have fared against their
objectives in practice).
72 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

The need of Business Reporting is for following reasons:

• Effective and transparent business reporting allows organizations to present a
cohesive explanation of their business and helps them engage with internal and
external stakeholders, including customers, employees, shareholders, creditors, and
regulators.
• High-quality business reporting is at the heart of strong and sustainable
organizations, financial markets, and economies, as this information is crucial for
stakeholders to assess organizational performance and make informed decisions
with respect to an organization’s capacity to create and preserve value.
• Many organizations are increasingly complex, and have larger economic,
environmental, and social footprints. Thus, various stakeholder groups require ESG
(Environmental, Social and Governance) information, as well as greater insight into
how these factors affect financial performance and valuations.
• High-quality reports also promote better internal decision-making. High-quality
information is integral to the successful management of the business, and is one of
the major drivers of sustainable organizational success.
5. Many organizations now recognize that data is a critical resource that must be managed
properly and therefore, accordingly, centralized planning and control are implemented.
For data to be managed better; users must be able to share data, data must be available
to users when it is needed, in the location where it is needed, and in the form in which it
is needed. Careful control should be exercised over the roles by appointing senior,
trustworthy persons, separating duties to the extent possible and maintaining and
monitoring logs of the data administrator’s and database administrator’s activities.
The control activities involved in maintaining the integrity of the database is as under:
(a) Definition Controls: These controls are placed to ensure that the database always
corresponds and comply with its definition standards.
(b) Existence/Backup Controls: These ensure the existence of the database by
establishing backup and recovery procedures. Backup refers to making copies of
the data so that these additional copies may be used to restore the original data
after a data loss. Backup controls ensure the availability of system in the event of
data loss due to unauthorized access, equipment failure or physical disaster; the
organization can retrieve its files and databases. Various backup strategies like dual
recording of data; periodic dumping of data; logging input transactions and changes
to the data are used.
(c) Access Controls: Access controls are designed to prevent unauthorized individual
from viewing, retrieving, computing or destroying the entity’s data. These controls
are User Access Controls through passwords, tokens and biometric Controls; and
Data Encryption controls that keep the data in database in encrypted form.
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 73

(d) Update Controls: These controls restrict update of the database to authorized
users by either permitting only addition of data to the database or allowing users to
change or delete existing data.
(e) Concurrency Controls: These controls provide solutions, agreed-upon schedules
and strategies to overcome the data integrity problems that may arise when two
update processes access the same data item at the same time.
(f) Quality Controls: These controls ensure the accuracy, completeness, and
consistency of data maintained in the database. This may include traditional
measures such as program validation of input data and batch controls over data in
transit through the organization.
6. Various Network Access Controls by means of which the protection can be achieved
against harmful elements in an organization are as follows:
• Policy on use of network services: An enterprise wide policy applicable to
internet service requirements aligned with the business need for using the Internet
services is the first step. Selection of appropriate services and approval to access
them should be part of this policy.
• Enforced path: Based on risk assessment, it is necessary to specify the exact path
or route connecting the networks; e.g., internet access by employees will be routed
through a firewall and proxy.
• Segregation of networks: Based on the sensitive information handling function;
say a Virtual Private Network (VPN) connection between a branch office and the
head-office, this network is to be isolated from the internet usage service
• Network connection and routing control: The traffic between networks should be
restricted, based on identification of source and authentication access policies
implemented across the enterprise network facility.
• Security of network services: The techniques of authentication and authorization
policy should be implemented across the organization’s network.
• Firewall: A Firewall is a system that enforces access control between two networks.
To accomplish this, all traffic between the external network and the organization’s
Intranet must pass through the firewall that will allow only authorized traffic between
the organization and the outside to pass through it. The firewall must be immune to
penetrate from both outside and inside the organization.
• Encryption: Encryption is the conversion of data into a secret code for storage in
databases and transmission over networks. The sender uses an encryption
algorithm with a key to convert the original message called the Clear text into
Cipher text. This is decrypted at the receiving end.
• Call Back Devices: It is based on the principle that the key to network security is to
keep the intruder off the Intranet rather than imposing security measure after the
74 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

criminal has connected to the intranet. The call- back device requires the user to
enter a password and then the system breaks the connection. If the caller is
authorized, the call back device dials the caller’s number to establish a new
connection. This limits access only from authorized terminals or telephone numbers
and prevents an intruder masquerading as a legitimate user.
7. Following commercial laws are applicable to e-commerce and m-commerce transactions
in India.
• Income Tax Act, 1961: Income Tax Act, has detailed provisions regarding taxation
of income in India. In respect of e-commerce / m-commerce transactions; the issue
of deciding place of origin transaction for tax purpose is critical.
• Companies Act, 2013: Companies Act, 2013, regulates the corporate sector. The
law defines all regulatory aspects for companies in India. Most of the merchants in
e-commerce / m-commerce business are companies, both private and public.
• Foreign Trade (Development and Regulation) Act, 1992: This is an act to provide
for the development and regulation of foreign trade by facilitating imports into,
augmenting exports from India and for matters connected therewith or incidental
thereto.
• The Factories Act, 1948: This is an act to regulate working conditions of workers
and extends to the place of storage as well as transportation. Most of the merchants
in e-commerce/m-commerce business need to comply with provisions of the act.
• The Custom Act, 1962: This act defines import/export of goods/services from India
and provides for levy of appropriate customs duty.
• The Goods and Services Tax Act, 2017 (GST): This Act requires each applicable
business, including e-commerce/m-commerce, to upload each sales and purchase
invoice on one central IT infrastructure, mandating reconciliations of transactions
between business, triggering of tax credits on payments of GST, facilitating filling of
e-return s, etc.
• Indian Contract Act, 1872: This act defines constituents of a valid contract. In case
of e-commerce/m-commerce business, it becomes important to define these
constituents.
• The Competition Act, 2002: This is a law to regulate practices that may have
adverse effect on competition in India. Competition Commission have been vigilant
to ensure that e-commerce/m-commerce merchants do not engage in predatory
practices.
• Foreign Exchange Management Act (FEMA 1999): This law regulates foreign
direct investments, flow of foreign exchange in India and has important implications
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 75

for e-commerce/m-commerce business.

• Consumer Protection Act, 1986: The law to protect consumer rights has been
source of most of litigations for transaction done through e-commerce and m-
commerce.
All laws above have same nature of applicability as in a normal commercial transaction.
The fact that transactions are done electronically gives rise to issues which are unique in
nature. Few of issues have been put to rest by court decisions but new issues crop up
every day.
8. The most suitable choice is Community Cloud which is the cloud infrastructure
provisioned for exclusive use by a specific community of consumers from organizations
that have shared concerns (eg. mission security requirements, policy, and compliance
considerations). It may be owned, managed, and operated by one or more of the
organizations in the community, a third party or some combination of them, and it may
exist on or off premises. In this, a private cloud is shared between several organizations.
This model is suitable for organizations that cannot afford a private cloud and cannot rely
on the public cloud either.
Advantages of Community Cloud are as follows:
• It allows establishing a low-cost private cloud.
• It allows collaborative work on the cloud.
• It allows sharing of responsibilities among the organizations.
• It has better security than the public cloud.
The limitation of the Community Cloud is that the autonomy of the organization is lost
and some of the security features are not as good as the private cloud. It is not suitable
in the cases where there is no collaboration.
9. The deployment and implementation of Core Banking Systems (CBS) should be
controlled at various stages to ensure that banks automation objectives are achieved:
• Planning: Planning for implementing the CBS should be done as per strategic and
business objectives of bank.
• Approval: The decision to implement CBS requires high investment and recurring
costs and will impact how banking services are provided by the bank. Hence, the
decision must be approved by the Board of directors.
• Selection: Although there are multiple vendors of CBS, each solution has key
differentiators. Hence, bank should select the right solution considering various
parameters as defined by the bank to meet their specific requirements and business
objectives.
• Design and develop or procured: CBS solutions used to be earlier developed in-
house by the bank. Currently, most of the CBS deployment are procured. There
76 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

should be appropriate controls covering the design or development or procurement

of CBS for the bank.
• Testing: Extensive testing must be done before the CBS is live. The testing is to be
done at different phases at procurement stage to test suitability to data migration to
ensure all existing data is correctly migrated and testing to confirm processing of
various types of transactions of all modules produces the correct results.
• Implementation: CBS must be implemented as per pre-defined and agreed plan
with specific project milestones to ensure successful implementation.
• Maintenance: CBS must be maintained as required. E.g. program bugs fixed,
version changes implemented, etc.
• Support: CBS must be supported to ensure that it is working effectively.
• Updation: CBS modules must be updated based on requirements of business
processes, technology updates and regulatory requirements.;
• Audit: Audit of CBS must be done internally and externally as required to ensure
that controls are working as envisaged.
Fundamentally, in a CBS, all the bank’s branches access applications from centralized
data-centers. All transactions are routed through core systems, which are available 24x7
and accessible from anywhere, anytime and through multiple devices such as desktops,
laptops, ATM, Internet, mobile phone, tablets, etc.
10. Internet Banking Channel Server (IBCS): IBCS (Internet Banking Channel Server)
software stores the name and password of the entire internet banking c ustomers. IBCS
server also contains the details about the branch to which the customer belongs. The
Internet Banking customer would first have to log into the bank’s website with the user
name and password.
Internet Banking Application Server (IBAS): The Internet Banking Software which is
stored in the IBAS (Internet Banking Application Server) authenticates the customer with
the login details stored in the IBCS. Authentication process is the method by which the
details provided by the customer are compared with the data already stored in the data
server to make sure that the customer is genuine and has been provided with internet
banking facilities.
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 77

SECTION – B: STRATEGIC MANAGEMENT

Multiple Choice Questions
1. In the questions given below select the best answer out of options (A), (B), (C), or (D):
(a) Which of the following statements correctly explain strategic management?
(i) Strategic management provides framework for major decisions.
(ii) Strategic management helps to enhance the longevity of the business.
(iii) Strategic management is an inexpensive process.
(iv) Strategic management helps organisation to be more reactive than proactive.
(A) (i) and (ii)
(B) (i), (ii) and (iii)
(C) (i), (ii) and (iv)
(D) (i), (iii) and (iv)
(b) Which of the following is not true for core competency:
A. It distinguishes a company competitively.
B. It is a source of competitive advantage.
C. It is an individual skill and separate technique.
D. It is often visible in the form of organizational functions.
(c) Statement that is typically focused on present business scope and broadly describes
an organizations present capabilities, customer focus, activities, and business
makeup is:
A. Vision
B. Mission
C. Strategy
D. Goals
(d) Arrange divestment, liquidation, stability and turnaround strategies in order of
preference for adoption by a typical organisation.
A. Turnaround, stability, liquidation and divestment.
B. Divestment, liquidation, stability and turnaround.
C. Stability, turnaround, liquidation and divestment.
D. Stability, turnaround, divestment and liquidation.
(e) Best-cost provider strategy is related to providing customers more value for money
by:
A. Highlighting low cost and low quality difference.
78 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

B. Emphasizing low cost and better quality difference.

C. Producing high cost and low quality difference.
D. Managing high cost and low quality difference.
(f) Supply chain refers to the linkages between:
A. Suppliers
B. Logistics
C. Customers
D. All the above
(g) Which of the following is not true for SBUs
A. It is relevant for multi-product, multi-business enterprises.
B. It provides for more control at enterprise level with centralised strategic planning.
C. A SBU has its own set of competitors.
D. SBUs can be created for units at distant geographical locations.
(h) Strategy evaluation is difficult on account of following trends, except:
A. There is dramatic increase in the environment’s complexity.
B. It is difficult to predict future.
C. Firms have unlimited resources.
D. Obsolescence is rapid.
(i) Acquisition of another organisation that was using your product in their manufacturing
is:
A. Horizontal integrated diversification
B. Forward integrated diversification
C. Backward integrated diversification
D. conglomerate diversification
(j) Porter’ cost leadership is a ____________ strategy
A. Functional level
B. Business level
C. Corporate level
D. Implementation
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 79

Descriptive answers
Chapter 1-Introduction to Strategic Management
2. Ramesh Sharma has fifteen stores selling consumer durables in Delhi Region. Four of
these stores were opened in last three years. He believes in managing strategically and
enjoyed significant sales of refrigerator, televisions, washing machines, air conditioners
and like till four years back. With shift to the purchases to online strores, the sales of his
stores came down to about seventy per cent in last four years.
Analyse the position of Ramesh Sharma in light of limitations of strategic management.
3. Strategic management helps an organization to work through changes in environment to
gain competitive advantage. In light of statement discuss its benefits.
Chapter 2-Dynamics of Competitive Strategy
4. Shridhar who is running a medium size cloth manufacturing business in Panipat wishes to
understand the driving forces that trigger change. He has sought advice from you and
wishes to know common driving forces.
5. Major core competencies are identified in three areas - competitor differentiation, customer
value and application to other markets. Discuss.
Chapter 3-Strategic Management Process
6. Mr Raj has been hired as a CEO by XYZ ltd a FMCG company that has diversified into
affordable cosmetics. The company intends to launch Feelgood brand of cosmetics. XYZ
wishes to enrich the lives of people with its products that are good for skin and are produced
in ecologically beneficial manner using herbal ingredients. Draft vision and mission
statement that may be formulated by Raj.
7. With the help of a model explain strategic management process.
Chapter 4-Corporate Level Strategies
8. Pizza Galleria was India's first pizza delivery chain enjoying monopoly for several years.
However, after entry of Modino and Uncle Jack it is struggling to compete. Both Modino and
Uncle Jack have opened several eateries and priced the product aggressively. In last four
years the chain has suffered significant losses. The chain wishes to know whether they
should go for turnaround strategy. List out components of action plan for turnaround strategy.
9. What is stability strategy? What are the reasons to pursue stability strategy?
Chapter 5-Business Level Strategies
10. A century-old footwear company “Mota Shoes” had an image of being the footwear choice
for formal occasions. In an attempt to reinvent its brand, it tied up with a foreign footwear
giant “Buffrine” to manufacture and sell its Hideseek brand in the country. Putting its best foot
forward, it launched extra soft, casual and relaxed footwear for young. Aiming at a brand and
image makeover the “Mota Shoes” decided to price the Hide Seek products at premium.
What kind of Michael Porter business level strategy is being used by “Mota Shoe
company”? State its advantages.
80 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

11. Buyers can exert considerable pressure on business. Do you agree? Discuss.
Chapter 6-Functional Level Strategies
12. A web company initially started as an online marketplace for books. From “biggest E -
Bookstore,” its owners wants to expand into an e commerce platform selling electronic
goods. Implementation of this needs additional funds.
What are the different sources of raising funds and their impact on the financial strategy
which you as a financial manager will consider?
13. Implementing supply chain management in a business organization has several steps. Discuss.
Chapter 7-Organisation and Strategic Leadership
14. Jupiter Electronics Ltd. is known for its ability to come out with path-breaking products.
Though the work environment at Jupiters is relaxed and casual, yet, there is a very strong
commitment to deadlines. The employees believe in "work hard play hard" ethic. The
organisation has moved away from formal and hierarchical set up to a more results -driven
approach. Employees are committed to strategies and work towards achieving th em. They
guard innovations, maintain confidentiality and secrecy in their working. They are closely
related to values, practices, and norms of organisations
What aspects of an organization that are being discussed? Explain.
15. Discuss the concept of Hourglass Structure
Chapter 8-Strategy Implementation and Control
16. India's luxurious domestic airline Indijet in an attempt to retain its leadership in aviation
sector has hired J S Dutta as its Chief Executive. Mr Dutta wishes to reorient company to
make it a domestic discount carrier. He desires to introduce no frills business model by
offering extremely low fares and improve margins by cutting down traditional amenities
such as reclining seats and complimentary meals. At the same time setting the stage for a
new air revolution, he wishes to brand itself as on-time airlines having proper systems in
place and removing additional and wasteful activities and processes.
What steps will you advise to Mr Dutta?
17. What is implementation control? Discuss its basic forms.

SUGGESTED ANSWERS/HINTS

1.
(a) A (b) C (c) B (d) D (e) B
(f) D (g) B (h) C (i) B (j) B
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 81

2. Ramesh Sharma is facing declining sales on account of large scale shift of customers to
online stores. While he is using the tools of strategic management, they cannot counter all
hindrances and always achieve success. There are limitations attached to strategic
management as follows:
 Environment under which strategies are made is highly complex and turbulent. Entry
of online stores, a new kind of competitor brought a different dimension to selling
consumer durables. Online stores with their size power could control the market and
offer stiff competition to traditional stores.
 Another limitation of strategic management is that it is difficult to predict how things
will shape-up in future. Ramesh Sharma, although managing strategically failed to
see how online stores will impact the sales.
 Although, strategic management is a time-consuming process, he should continue to
manage strategically. The challenging times require more efforts on his part.
 Strategic management is costly. Ramesh Sharma may consider engaging experts to
find out preferences of the customers and attune his strategies to better serve them
in a customized manner. Such customized offerings may be difficult to match by the
online stores.
 The stores owned by Ramesh Sharma are much smaller than online stores. It is very
difficult for him to visualize how online stores will be moving strategically.
3. Strategic management involves developing the company’s vision, environmental scanning,
strategy formulation, implementation, evaluation and control. It emphasises the monitoring
and evaluation of external opportunities and threats in the light of a company’s strengths
and weaknesses and designing strategies for the survival and growth. It helps in creation
of competitive advantage to outperform the competitors and also guide the company
successfully through all changes in the environment.
The major benefits of strategic management are:
 Strategic management gives a direction to the company to move ahead. It defines the
goals and mission.
 It helps organisations to be proactive instead of reactive in shaping its future.
 It provides framework for all major decisions of an enterprise such as decisions on
businesses, products, markets, manufacturing facilities, investments and organisational
structure. It provides better guidance to entire organisation on the crucial point - what it
is trying to do.
 It helps organisations to identify the available opportunities and identify ways and
means to achieve them.
 It serves as a corporate defence mechanism against mistakes and pitfalls.
82 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

 It helps to enhance the longevity of the business.

 It helps the organisation to develop certain core competencies and competitive
advantages that would facilitate survival and growth.
4. Industry and competitive conditions of organisation change as environmental forces are in
motion. The most dominant forces are called driving forces because they have the biggest
influence on what kinds of changes will take place in the industry's structure and
competitive environment. Analyzing driving forces has two steps: identifying what the
driving forces are and assessing the impact they will have on the industry.
Many events can affect an industry powerfully enough to qualify as driving forces. Some
are unique and specific to a particular industry situation, but many drivers of change fall
into general category affecting different industries simultaneously. Some of the
categories/examples of drivers are:
 The internet and the new e-commerce opportunities and threats it breeds in the
industry.
 Increasing globalization.
 Changes in the long-term industry growth rate.
 Product innovation.
 Marketing innovation.
 Entry or exit of major forms.
 Diffusion of technical know-how across more companies and more countries.
 Changes in cost and efficiency.
5. According to C.K. Prahalad and Gary Hamel, major core competencies are identified in
three areas - competitor differentiation, customer value, and application to other markets.
 Competitor differentiation: The company can consider having a core competence if
the competence is unique and it is difficult for competitors to imitate. This can provide
a company an edge compared to competitors. It allows the company to provide better
products or services to market with no fear that competitors can copy it.
 Customer value: When purchasing a product or service it has to deliver a
fundamental benefit for the end customer in order to be a core competence. It will
include all the skills needed to provide fundamental benefits. The service or the
product has to have real impact on the customer as the reason to choose to purchase
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 83

them. If customer has chosen the company without this impact, then competence is
not a core competence.
 Application of competencies to other markets: Core competence must be
applicable to the whole organization; it cannot be only one particular skill or specified
area of expertise. Therefore, although some special capability would be essential or
crucial for the success of business activity, it will not be considered as core
competence, if it is not fundamental from the whole organization’s point of view. Thus,
a core competence is a unique set of skills and expertise, which will be used through
out the organisation to open up potential markets to be exploited.
6. Feelgood brand of cosmetics may have following vision and mission:
Vision: Vision implies the blueprint of the company’s future position. It describes where
the organisation wants to land. Mr Raj should aim to position “Feelgood cosmetics” as
India’s beauty care company. It may have vision to be India’ largest beauty care company
that improves looks, give extraordinary feeling and bring happiness to people.
Mission: Mission delineates the firm’s business, its goals and ways to reach the goals. It
explains the reason for the existence of the firm in the society. It is designed to help
potential shareholders and investors understand the purpose of the company:
Mr Raj may identify mission in the following lines:
 To be in the business of cosmetics to enhance the lives of people, give them
confidence to lead.
 To protect skin from harmful elements in environment and sun rays.
 To produce herbal cosmetics using natural ingredients.
7. The strategic management process can best be studied and applied using a model.
Identifying an organization’s vision, mission, goals and objectives, is the starting point for
strategic management process. The strategic management process is dynamic and
continuous. A change in any one of the major components in the model can necessitate a
change in any or all of the other components. Therefore, strategy formulation,
implementation, and evaluation activities should be performed on a continual basis, not
just at the end of the year or semi-annually.
Formulating, implementing, and evaluating strategies are the major components of the
strategic management that are represented in the following model:
84 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Environmental
Analysis

Develop Vision, Generate, Analyse Implement Strategic

Mission and and select Strategies Strategies Evaluation and
Objectives Control

Organisation
Appraisal

Analysis Implementation Evaluation

Figure: Strategic Management Model

The strategic management process is not as cleanly divided and neatly performed in
practice. Strategists do not go through the process in lockstep fashion. Generally, there is
give-and-take among hierarchical levels of an organization. Many organizations conduct
formal meetings semi-annually to discuss and update the firm’s vision/mission,
opportunities/threats, strengths/weaknesses, strategies, objectives, policies, and
performance. Creativity from participants is encouraged in meeting. Good communication
and feedback are needed throughout the strategic management process.
8. Pizza Chain may choose to have turnaround strategy if there are:
 Persistent negative cash flow from business.
 Uncompetitive products or services.
 Declining market share.
 Deterioration in physical facilities.
 Over-staffing, high turnover of employees, and low morale.
 Mismanagement.
For turnaround strategies to be successful, it is imperative to focus on the short and long-
term financing needs as well as on strategic issues. The chain may attempt to leverage the
potential Indian market by engaging a new logistics partner. It may bring innovation in food
items, as well as quality and improvements in the overall dine-in and delivery experience.
During the turnaround, the “product mix” may be changed, requiring the organization to do
some repositioning.
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 85

A workable action plan for turnaround would involve:

Stage One – Assessment of current problems: The first step is to assess the current
problems and get to the root causes and the extent of damage the problem has caused.
Stage Two – Analyze the situation and develop a strategic plan: Before making any
major changes; determine the chances of the business’s survival. Identify appropriate
strategies and develop a preliminary action plan.
Stage Three – Implementing an emergency action plan: If the organization is in a critical
stage, an appropriate action plan must be developed to stop the bleeding an d enable the
organization to survive. A positive operating cash flow must be established as quickly as
possible and enough funds to implement the turnaround strategies must be raised.
Stage Four – Restructuring the business: The financial state of the organization’s core
business is particularly important. If the core business is irreparably damaged, then the
outlook for the entire organization may be bleak. Efforts to be made to position the
organization for rapid improvement.
Stage Five – Returning to normal: In the final stage of turnaround strategy process, the
organization should begin to show signs of profitability, return on investments and
enhancing economic value-added. Emphasis is placed on a number of strategic efforts
such as carefully adding new products and improving customer service, creating alliances
with other organizations, increasing the market share, etc.
9. One of the important goals of a business enterprise is stability - to safeguard its existing
interests and strengths, to pursue well established and tested objectives, to continue in the
chosen business path, to maintain operational efficiency on a sustained basis, to
consolidate the commanding position already reached, and to optimise returns on the
resources committed in the business. A stability strategy is pursued by a firm when:
 It continues to serve in the same or similar markets and deals in same or similar
products and services.
 The strategic decisions focus on incremental improvement of functional performance.
Major reasons for stability strategy are as follows:
 A product has reached the maturity stage of the product life cycle.
 It is less risky as it involves less changes and the staff feels comfortable with things
as they are.
 The environment faced is relatively stable.
 Expansion may be perceived as being threatening.
 Consolidation is sought through stabilizing after a period of rapid expansion.
10. Mota shoes is trying to use differentiation. This strategy is aimed at broad mass market
and involves the creation of a product or service that is perceived by the customers as
unique. The uniqueness can be associated with product design, brand image, features,
86 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

technology, dealer network or customer service. Because of differentiation, the business

can charge a premium for its product.
A differentiation strategy has definite advantages as it may help to remain profitable even
with rivalry, new entrants, suppliers’ power, substitute products, and buyers’ power.
i. Rivalry: Brand loyalty acts as a safeguard against competitors. It means that
customers will be less sensitive to price increases, as long as the firm can satisfy the
needs of its customers.
ii. Buyers: They do not negotiate for price as they get special features and also they
have fewer options in the market.
iii. Suppliers: Because differentiators charge a premium price, they can afford to absorb
higher costs of supplies and customers are willing to pay extra too.
iv. New entrants: Innovative features are expensive to copy. So, new entrants generally
avoid these features because it is tough for them to provide the same product with
special features at a comparable price.
v. Substitutes: Substitute products can’t replace differentiated products which have
high brand value and enjoy customer loyalty.
11. Buyers of an industry’s products or services can exert considerable pressure on existing
firms to secure lower prices or better services. This is evident in situations where buyers
enjoy superior position than the seller of product. This leverage is particularly evident when:
(i) Buyers have full knowledge of the sources of products and their substitutes.
(ii) They spend a lot of money on the industry’s products, i.e., they are big buyers.
(iii) The industry’s product is not perceived as critical to the buyer’s needs and buyers
are more concentrated than firms supplying the product. They can easily switch to
the substitutes available.
12. Successful strategy implementation often requires additional capital. Besides net profit
from operations and the sale of assets, two basic sources of capital for an organization are
debt and equity. Being a financial manager to determine an appropriate mix of debt and
equity in a firm’s capital structure can be vital to successful strategy implementation. Fixed
debt obligations generally must be met, regardless of circumstances. This does not mean
that stock issuances are always better than debt for raising capital. If ordinary stock is
issued to finance strategy implementation; ownership and control of the enterprise are
diluted. This can be a serious concern in today’s business environment of hostile takeovers,
mergers, and acquisitions.
The major factors regarding which strategies have to be made by a financial manager are:
capital structure; procurement of capital and working capital borrowings; reserves and
surplus as sources of funds; and relationship with lenders, banks and financial institutions.
Strategies related to the sources of funds are important since they determine how financial
resources will be made available for the implementation of strategies. Organizations have
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 87

a range of alternatives regarding the sources of funds. While one company may rely on
external borrowings, another may follow a policy of internal financing.
13. Successful implementing supply management systems requires a change from managing
individual functions to integrating activities into key supply chain processes. It involves
collaborative work between buyers and suppliers, joint product development, common
systems and shared information. A key requirement for successfully implement ing supply
chain will be network of information sharing and management. Implementing and
successfully running supply chain management system will involve:
(i) Product development: Customers and suppliers must work together in the product
development process. Right from the start the partners will have knowledge of all.
Involving all partners will help in shortening the life cycles.
(ii) Procurement: Procurement requires careful resource planning, quality issues,
identifying sources, negotiation, order placement, inbound transportation and storage.
Organizations have to coordinate with suppliers in scheduling without interruptions.
(iii) Manufacturing: Flexible manufacturing processes must be in place to respond to
market changes. They should be adaptive to accommodate customization and
changes in the taste and preferences.
(iv) Physical distribution: Delivery of final products to customers is the last position in a
marketing channel. Availability of the products at the right place at right time is
important for each channel participant.
(v) Outsourcing: Outsourcing is not limited to the procurement of materials and
components, but also include outsourcing of services so that the company is able to
focus on those activities where it has competency.
(vi) Customer services: Organizations, through interfaces with the company’s production
and distribution operations, develop customer relationships so as to satisfy them.
(vii) Performance measurement: Supplier capabilities and customer relationships can be
correlated with a firm performance. Performance is measured in different parameters
such as costs, customer service, productivity and quality.
14. The scenario being referred to is culture in Jupiter Electronics. Strong culture promotes
good strategy execution when there’s fit and impels execution when there’s negligible fit.
A culture grounded in values, practices, and behavioral norms that match what is needed
for good strategy execution helps energize people throughout the organization to do their
jobs in a strategy-supportive manner. A culture built around such business principles as
listening to customers, encouraging employees to take pride in their work, and giving
employees a high degree of decision-making responsibility. This is very conducive to
successful execution of a strategy of delivering superior customer service.
A strong strategy-supportive culture makes employees feel genuinely better about their
jobs and work environment and the merits of what the company is trying to accomplish.
Employees are stimulated to take on the challenge of realizing the organizational vision,
do their jobs competently and with enthusiasm, and collaborate with others.
88 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

15. Information technology and communications have significantly altered the functioning of
organizations. The role played by middle management is diminishing as the tasks
performed by them are increasingly being replaced by the technological tools. Hourglass
organization structure consists of three layers with constricted middle layer. The struc ture
has a short and narrow middle-management level. Information technology links the top and
bottom levels in the organization taking away many tasks that are performed by the middle
level managers. A shrunken middle layer coordinates diverse lower level activities.
Contrary to traditional middle level managers who are often specialist, the managers in the
hourglass structure are generalists and perform wide variety of tasks. They would be
handling cross-functional issues emanating such as those from marketing, finance or
production.

Hourglass structure has obvious benefit of reduced costs. It also helps in enhancing
responsiveness by simplifying decision making. Decision making authority is shifted close
to the source of information so that it is faster.
16. Mr Dutta should adopt business process reengineering (BPR). It is an approach to unusual
improvement in operating effectiveness through the redesigning of critical business
processes and supporting business systems. It is revolutionary redesign of key business
processes that involves examination of the basic process itself. BPR refers to the analy sis
and redesign of workflows and processes both within the organization and between the
organization and the external entities like suppliers, distributors, and service providers.
The orientation of redesigning efforts involves total deconstruction and r ethinking of
business process BPR involves the following steps:
i. Determining objectives: Objectives are the desired end results of the redesign
process. They will provide the required focus, direction, and motivation for the
redesign process and help in building a comprehensive foundation for the
reengineering process.
ii. Identify customers and determine their needs: The process designers have to
understand customers. The purpose is to redesign business process that clearly
provides value addition to the customer.
iii. Study the existing processes: The study of existing processes will provide an
important base for the process designers. The purpose is to gain an understanding of
the ‘what’, and ‘why’ of the targeted process.
PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 89

iv. Formulate a redesign process plan: Formulation of redesign plan is the real crux of
the reengineering efforts. Customer focussed redesign concepts are identified and
formulated. In this step alternative processes are considered and the best is selected.
v. Implement the redesigned process: It is easier to formulate new process than to
implement them. Implementation of the redesigned process and application of other
knowledge gained from the previous steps is key to achieve dramatic improvements.
17. Managers implement strategy by converting major plans into concrete, sequential actions
that form incremental steps. Implementation control is directed towards assessing the need
for changes in the overall strategy in light of unfolding events and results associated with
incremental steps and actions.
Strategic implementation control is not a replacement to operational control. Strategic
implementation control, unlike operational controls continuously monitors the basic
direction of the strategy. The two basic forms of implementation control are:
(i) Monitoring strategic thrusts: Monitoring strategic thrusts help managers to
determine whether the overall strategy is progressing as desired or whether there is
need for readjustments.
(ii) Milestone Reviews. All key activities necessary to implement strategy are
segregated in terms of time, events or major resource allocation. It normally involves
a complete reassessment of the strategy. It also assesses the need to continue or
refocus the direction of an organization.
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE
SECTION A: FINANCIAL MANAGEMENT
QUESTIONS

Ratio Analysis
1. The following is the Profit and loss account and Balance sheet of KLM LLP.
Trading and Profit & Loss Account
Particulars Amount (` ) Particulars Amount (` )
To Opening stock 12,46,000 By Sales 1,96,56,000
To Purchases 1,56,20,000 By Closing stock 14,28,000
To Gross profit c/d 42,18,000
2,10,84,000 2,10,84,000
By Gross profit b/d 42,18,000
To Administrative expenses 18,40,000 By Interest on investment 24,600
To Selling & distribution 7,56,000 By Dividend received 22,000
expenses
To Interest on loan 2,60,000
To Net profit 14,08,600
42,64,600 42,64,600
Balance Sheet as on……….
Capital & Liabilities Amount (` ) Assets Amount (` )
Capital 20,00,000 Plant & machinery 24,00,000
Retained earnings 42,00,000 Building 42,00,000
General reserve 12,00,000 Furniture 12,00,000
Term loan from bank 26,00,000 Sundry receivables 13,50,000
Sundry Payables 7,20,000 Inventory 14,28,000
Other liabilities 2,80,000 Cash & Bank balance 4,22,000
1,10,00,000 1,10,00,000
You are required to COMPUTE:
(i) Gross profit ratio (ii) Net profit ratio (iii) Operating cost ratio
(iv) Operating profit ratio (v) Inventory turnover ratio (vi) Current ratio
(vii) Quick ratio (viii) Interest coverage ratio (ix) Return on capital employed
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 91

(x) Debt to assets ratio.

Cost of Capital
2. KM Ltd. has the following capital structure on September 30, 2019:
Sources of capital (` )
Equity Share Capital (40,00,000 Shares of ` 10 each) 4,00,00,000
Reserves & Surplus 4,00,00,000
12% Preference Shares 2,00,00,000
9% Debentures 6,00,00,000
16,00,00,000
The market price of equity share is `60. It is expected that the company will pay next year
a dividend of `6 per share, which will grow at 10% forever. Assume 40% income tax rate.
You are required to COMPUTE weighted average cost of capital using market value
weights.
Capital Structure
3. The management of RT Ltd. wants to raise its funds from market to meet out the financial
demands of its long-term projects. The company has various combinations of proposals
to raise its funds. You are given the following proposals of the company:
Proposal Equity shares (%) Debts (%) Preference shares (%)
P 100 - -
Q 50 50 -
R 50 - 50
(i) Cost of debt and preference shares is 12% each.
(ii) Tax rate –40%
(iii) Equity shares of the face value of `10 each will be issued at a premium of `10 per
share.
(iv) Total investment to be raised `8,00,00,000.
(v) Expected earnings before interest and tax `3,60,00,000.
From the above proposals the management wants to take advice from you for appropriate
plan after computing the following:
• Earnings per share
• Financial break-even-point
COMPUTE the EBIT range among the plans for indifference.
92 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Leverage
4. The following summarises the percentage changes in operating income, percentage
changes in revenues, and betas for four listed firms.
Firm Change in Change in operating income Beta
revenue
A Ltd. 35% 22% 1.00
B Ltd. 24% 35% 1.65
C Ltd. 29% 26% 1.15
D Ltd. 32% 30% 1.20
Required:
(i) CALCULATE the degree of operating leverage for each of these firms. Comment
also.
(ii) Use the operating leverage to EXPLAIN why these firms have different beta.
Capital Budgeting
5. MTR Limited is considering buying a new machine which would have a useful economic life of
five years, at a cost of `25,00,000 and a scrap value of `3,00,000, with 80 per cent of the cost
being payable at the start of the project and 20 per cent at the end of the first year. The machine
would produce 75,000 units per annum of a new product with an estimated selling price of `300
per unit. Direct costs would be `285 per unit and annual fixed costs, including depreciation
calculated on a straight- line basis, would be `8,40,000 per annum.
In the first year and the second year, special sales promotion expenditure, not included in the
above costs, would be incurred, amounting to `1,00,000 and `1,50,000 respectively.
EVALUATE the project using the NPV method of investment appraisal, assuming the
company’s cost of capital to be 15 percent.
Risk Analysis in Capital Budgeting
6. SL Ltd. has invested `1,000 lakhs in a project. The risk-free rate of return is 5%. Risk
premium expected by the Management is 10%. The life of the project is 5 years. Following
are the cash flows that are estimated over the life of the project.
Year Cash flows (` in lakhs)
1 125
2 300
3 375
4 400
5 325
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 93

CALCULATE Net Present Value of the project based on Risk free rate and also on the
basis of Risks adjusted discount rate.
Dividend Decision
7. The following information pertains to SD Ltd.
Earnings of the Company ` 50,00,000
Dividend Payout ratio 60%
No. of shares outstanding 10,00,000
Equity capitalization rate 12%
Rate of return on investment 15%
(i) COMPUTE the market value per share as per Walter’s model?
(ii) COMPUTE the optimum dividend payout ratio according to Walter’s model and the
market value of Company’s share at that payout ratio?
Management of Working Capital
8. Following are cost information of KG Ltd., which has commenced a new project for an
annual production of 24,000 units which is the full capacity:
Costs per unit (`)
Materials 80.00
Direct labour and variable expenses 40.00
Fixed manufacturing expenses 12.00
Depreciation 20.00
Fixed administration expenses 8.00
160.00
The selling price per unit is expected to be `192 and the selling expenses `10 per unit,
80% of which is variable.
In the first two years of operations, production and sales are expected to be as follows:
Year Production (No. of units) Sales (No. of units)
1 12,000 10,000
2 18,000 17,000
To assess the working capital requirements, the following additional information is
available:
(a) Stock of materials 2 months’ average consumption
94 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(b) Work-in-process Nil

(c) Debtors 2 month’s average sales.
(d) Cash balance ` 1,00,000
(e) Creditors for supply of 1 month’s average purchase during the year.
materials
(f) Creditors for expenses 1 month’s average of all expenses during the year.
PREPARE, for the two years:
(i) A projected statement of Profit/Loss (Ignoring taxation); and
(ii) A projected statement of working capital requirements
Management of Working Capital
9. A regular customer of your company has approached to you for extension of credit facility
for purchasing of goods. On analysis of past performance and on the basis of information
supplied, the following pattern of payment schedule emerges:
Pattern of Payment Schedule
At the end of 30 days 20% of the bill
At the end of 60 days 30% of the bill.
At the end of 90 days 30% of the bill.
At the end of 100 days 18% of the bill.
Non-recovery 2% of the bill.
The customer wants to enter into a firm commitment for purchase of goods of `30 lakhs in
2019, deliveries to be made in equal quantities on the first day of each quarter in the
calendar year. The price per unit of commodity is `300 on which a profit of `10 per unit is
expected to be made. It is anticipated that taking up of this contract would mean an extra
recurring expenditure of `10,000 per annum. If the opportunity cost is 18% per annum,
would you as the finance manager of the company RECOMMEND the grant of credit to the
customer? Assume 1 year = 360 days.
Miscellaneous
10. Write short notes on the following:
(a) STATE the meaning of Payback Reciprocal.
(b) STATE the functions of treasury department.
(c) DESCRIBE the Inter relationship between investment, financing and dividend
decisions.
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 95

SUGGESTED HINTS/ANSWERS

Grossprofit ` 42,18,000
1. (i) Gross profit ratio =  100 =  100 = 21.46%
Sales `1,96,56,000

Net profit `14,08,600

(ii) Net profit ratio =  100 =  100 = 7.17%
Sales `1,96,56,000

Operatingcos t
(iii) Operating ratio =  100
Sales
Operating cost = Cost of goods sold + Operating expenses
Cost of goods sold = Sales – Gross profit
= 1,96,56,000 - 42,18,000 = 1,54,38,000
Operating expenses = Administrative expenses + Selling & distribution expenses
= 18,40,000 + 7,56,000 = 25,96,000
1,54,38,000  25,96,000
Therefore, Operating ratio =  100
1,96,56,000

1,80,34,000
=  100 = 91.75%
1,96,56,000

(iv) Operating profit ratio = 100 – Operating cost ratio

= 100 – 91.75% = 8.25%
Cost of goods sold
(v) Inventory turnover ratio =
Average stock
1,54,38,000
=
(14,28,000  12,46,000) / 2
1,54,38,000
= = 11.55 times
13,37,000

Current assets
(vi) Current ratio =
Current liablities

Current assets = Sundry receivables + Inventory + Cash & Bank balance

= 13,50,000 + 14,28,000 + 4,22,000 = 32,00,000
96 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Current liabilities = Sundry Payables + Other liabilities

= 7,20,000 + 2,80,000 = 10,00,000
32,00,000
Current ratio = = 3.2 times
10,00,000
Current assets  Inventories
(vii) Quick Ratio =
Current liablities
32,00,000  14,28,000
= =1.77 times
10,00,000

EBIDT Net profit  Interest

(viii) Interest coverage ratio = =
Interest Interest
14,08,600  2,60,000
= = 6.42 times
2,60,000
EBIT
(ix) Return on capital employed (ROCE) = 100
Capitalemployed
Capital employed = Capital + Retained earnings + General reserve + Term loan
= 20,00,000 + 42,00,000 + 12,00,000 + 26,00,000
= 1,00,00,000
16,68,600
Therefore, ROCE =  100 = 16.69%
1,00,00,000
Debts 26,00,000
(x) Debt to assets ratio = 100 =  100 =23.64%
Totalassets 1,10,00,000

2. Workings:
D1 `6
(i) Cost of Equity (Ke) = g = + 0.10 = 0.20 = 20%
P0 ` 60

(ii) Cost of Debentures (Kd) = I (1 - t) = 0.09 (1 - 0.4) = 0.054 or 5.4%

Computation of Weighted Average Cost of Capital (WACC using market value
weights)
Source of capital Market Value Weight Cost of WACC
of capital (`) capital (%) (%)
9% Debentures 6,00,00,000 0.1875 5.40 1.01
12% Preference Shares 2,00,00,000 0.0625 12.00 0.75
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 97

Equity Share Capital 24,00,00,000 0.7500 20.00 15.00

(`60 × 40,00,000 shares)
Total 32,00,00,000 1.00 16.76
3. (i) Computation of Earnings per Share (EPS)
Plans P (` ) Q (`) R (` )
Earnings before interest & tax (EBIT) 3,60,00,000 3,60,00,000 3,60,00,000
Less: Interest charges -- (48,00,000) --
Earnings before tax (EBT) 3,60,00,000 3,12,00,000 3,60,00,000
Less : Tax @ 40% (1,44,00,000) (1,24,80,000) (1,44,00,000)
Earnings after tax (EAT) 2,16,00,000 1,87,20,000 2,16,00,000
Less : Preference share dividend -- -- (48,00,000)
Earnings available for equity 2,16,00,000 1,87,20,000 1,68,00,000
shareholders
No. of equity shares 40,00,000 20,00,000 20,00,000
E.P.S 5.40 9.36 8.40
(ii) Computation of Financial Break-even Points
Proposal ‘P’ =0
Proposal ‘Q’ = `48,00,000 (Interest charges)
Proposal ‘R’ = Earnings required for payment of preference share dividend
i.e. `48,00,000  0.6 = `80,00,000
(iii) Computation of Indifference Point between the Proposals
Combination of Proposals
(a) Indifference point where EBIT of proposal “P” and proposal ‘Q’ is equal
EBIT(1- 0.4) (EBIT - `48,00,000)(1- 0.4)
=
40,00,000shares 20,00,000shares
0.6 EBIT = 1.2 EBIT – `57,60,000
EBIT = `96,00,000
(b) Indifference point where EBIT of proposal ‘P’ and proposal ‘R’ is equal:
EBIT(1- 0.40) EBIT(1- 0.40) `48,00,000
=
40,00,000shares 20,00,000shares
98 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

0.6EBIT 0.6EBIT - `48,00,000

=
40,00,000shares 20,00,000shares
0.30 EBIT = 0.6 EBIT – `48,00,000
` 48,00,000
EBIT = =`1,60,00,000
0.30
(c) Indifference point where EBIT of proposal ‘Q’ and proposal ‘R’ are equal
(EBIT - `48,00,000)(1- 0.4) EBIT(1- 0.4) - `48,00,000
=
20,00,000shares 20,00,000shares
There is no indifference point between proposal ‘Q’ and proposal ‘R’
% Change in Operating income
4. (i) Degree of operating leverage =
% Change in Revenues

A Ltd. = 0.22 / 0.35 = 0.63

B Ltd. = 0.35 / 0.24 = 1.46
C Ltd. = 0.26 / 0.29 = 0.90
D Ltd. = 0.30 / 0.32 = 0.94
It is level specific.
(ii) High operating leverage leads to high beta. So when operating leverage is lowest i.e.
0.63, Beta is minimum (1) and when operating leverage is maximum i.e. 1.46, beta is
highest i.e. 1.65
5. Calculation of Net Cash flows
Contribution = (300 – 285)  75,000 = `11,25,000
Fixed costs = 8,40,000 – [(25,00,000 – 3,00,000)/5] = `4,00,000
Year Capital (` ) Contribution Fixed costs Adverts Net cash
(` ) (`) (`) flow (`)
0 (20,00,000) (20,00,000)
1 (5,00,000) 11,25,000 (4,00,000) (1,00,000) 1,25,000
2 11,25,000 (4,00,000) (1,50,000) 5,75,000
3 11,25,000 (4,00,000) 7,25,000
4 11,25,000 (4,00,000) 7,25,000
5 3,00,000 11,25,000 (4,00,000) 10,25,000
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 99

Calculation of Net Present Value

Year Net cash flow (` ) 12% discount factor Present value
(`)
0 (20,00,000) 1.000 (20,00,000)
1 1,25,000 0.892 1,11,500
2 5,75,000 0.797 4,58,275
3 7,25,000 0.711 5,15,475
4 7,25,000 0.635 4,60,375
5 10,25,000 0.567 5,81,175
1,26,800
The net present value of the project is `1,26,800.
6. The Present Value of the Cash Flows for all the years by discounting the cash flow at 5% is
calculated as below:
Year Cash flows Discounting Factor Present value of Cash
` in lakhs @5% Flows ` In Lakhs
1 125 0.952 119.00
2 300 0.907 272.10
3 375 0.863 323.62
4 400 0.822 328.80
5 325 0.783 254.47
Total of present value of Cash flow 1,297.99
Less: Initial investment 1,000.00
Net Present Value (NPV) 297.99
Now when the risk-free rate is 5% and the risk premium expected by the Management is
10%. So the risk adjusted discount rate is 5% + 10% =15%.
Discounting the above cash flows using the Risk Adjusted Discount Rate would be as
below:
Year Cash flows Discounting Present Value of Cash
` in Lakhs Factor@15% Flows
`in lakhs
1 125 0.869 108.62
2 300 0.756 226.80
100 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

3 375 0.657 246.37

4 400 0.571 228.40
5 325 0.497 161.52
Total of present value of Cash flow 971.71
Initial investment 1,000.00
Net present value (NPV) (28.29)
7. (i) Walter’s model is given by
r
D+ (E - D)
P = Ke
Ke
Where
P = Market price per share.
E = Earnings per share = ` 5
D = Dividend per share = ` 3
R = Return earned on investment = 15%
Ke = Cost of equity capital = 12%
0.15
3+ (5 - 3)
P = 0.12 = ` 45.83
0.12
(ii) According to Walter’s model when the return on investment is more than the cost of
equity capital, the price per share increases as the dividend pay-out ratio decreases.
Hence, the optimum dividend pay-out ratio in this case is nil.
So, at a pay-out ratio of zero, the market value of the company’s share will be:
0.15
0+ (5 - 0)
P = 0.12 = `52.08
0.12
8. (i) Projected Statement of Profit / Loss
(Ignoring Taxation)
Year 1 Year 2
Production (Units) 12,000 18,000
Sales (Units) 10,000 17,000
PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 101

(`) (`)
Sales revenue (A) 19,20,000 32,64,000
(Sales unit × `192)
Cost of production:
Materials cost 9,60,000 14,40,000
(Units produced × `80)
Direct labour and variable expenses 4,80,000 7,20,000
(Units produced × `40)
Fixed manufacturing expenses 2,88,000 2,88,000
(Production Capacity: 24,000 units × `12)
Depreciation 4,80,000 4,80,000
(Production Capacity : 24,000 units × `20)
Fixed administration expenses 1,92,000 1,92,000
(Production Capacity : 24,000 units × `8)
Total Costs of Production 24,00,000 31,20,000
Add: Opening stock of finished goods --- 4,00,000
(Year 1 : Nil; Year 2 : 2,000 units)
Cost of Goods available for sale 24,00,000 35,20,000
(Year 1: 12,000 units; Year 2: 20,000 units)
Less: Closing stock of finished goods at average (4,00,000) (5,28,000)
cost (year 1: 2000 units, year 2 : 3000 units)
(Cost of Production × Closing stock/ units
produced)
Cost of Goods Sold 20,00,000 29,92,000
Add: Selling expenses – Variable (Sales unit × 80,000 1,36,000
`8)
Add: Selling expenses -Fixed (24,000 units × `2) 48,000 48,000
Cost of Sales : (B) 21,28,000 31,76,000
Profit (+) / Loss (-): (A - B) (-) 2,08,000 (+) 88,000
Working Notes:
1. Calculation of creditors for supply of materials:
Year 1 Year 2
(` ) (`)
Materials consumed during the year 9,60,000 14,40,000
102 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

Add: Closing stock (2 month’s average consumption) 1,60,000 2,40,000

11,20,000 16,80,000
Less: Opening Stock --- 1,60,000
Purchases during the year 11,20,000 15,20,000
Average purchases per month (Creditors) 93,333 1,26,667
2. Creditors for expenses:
Year 1 (`) Year 2 (` )
Direct labour and variable expenses 4,80,000 7,20,000
Fixed manufacturing expenses 2,88,000 2,88,000
Fixed administration expenses 1,92,000 1,92,000
Selling expenses (variable + fixed) 1,28,000 1,84,000
Total 10,88,000 13,84,000
Average per month 90,667 1,15,333
(ii) Projected Statement of Working Capital requirements
Year 1 (` ) Year 2 (`)
Current Assets:
Inventories:
- Stock of materials 1,60,000 2,40,000
(2 month’s average consumption)
- Finished goods 4,00,000 5,28,000
Debtors (2 month’s average sales) (including profit) 3,20,000 5,44,000
Cash 1,00,000 1,00,000
Total Current Assets/ Gross working capital (A) 9,80,000 14,12,000
Current Liabilities:
Creditors for supply of materials 93,333 1,26,667
(Refer to working note 1)
Creditors for expenses 90,667 1,15,333
(Refer to working note 2)
Total Current Liabilities: (B) 1,84,000
2,42,000
Estimated Working Capital Requirements: (A-B) 7,96,000 11,70,000
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 103

9. Statement showing the Evaluation of credit Policies

Particulars Proposed Policy `
A. Expected Profit:
(a) Credit Sales 30,00,000
(b) Total Cost
(i) Variable Costs 29,00,000
(ii) Recurring Costs 10,000
29,10,000
(c) Bad Debts 60,000
(d) Expected Profit [(a) – (b) – (c)] 30,000
B. Opportunity Cost of Investments in Receivables 1,00,395
C. Net Benefits (A – B) (70,395)
Recommendation: The Proposed Policy should not be adopted since the net benefits under
this policy are negative
Working Note: Calculation of Opportunity Cost of Average Investments
Collection period Rate of Return
Opportunity Cost = Total Cost × 
360 100
Particulars 20% 30% 30% 18% Total
A. Total Cost 5,82,000 8,73,000 8,73,000 5,23,800 28,51,800
B. Collection period 30/360 60/360 90/360 100/360
C. Required Rate of Return 18% 18% 18% 18%
D. Opportunity Cost 8,730 26,190 39,285 26,190 1,00,395
(A × B × C)
10. (a) As the name indicates it is the reciprocal of payback period. A major drawback of the
payback period method of capital budgeting is that it does not indicate any cut off
period for the purpose of investment decision. It is, however, argued that the
reciprocal of the payback would be a close approximation of the Internal Rate of
Return (later discussed in detail) if the life of the project is at least twice the payback
period and the project generates equal amount of the annual cash inflows. In
practice, the payback reciprocal is a helpful tool for quick estimation of rate of return
of a project provided its life is at least twice the payback period.
104 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

The payback reciprocal can be calculated as follows:

Average annual cash in flow
Payback Reciprocal =
Initial investment
(b) 1. Cash Management: It involves efficient cash collection process and managing
payment of cash both inside the organisation and to third parties.
There may be complete centralization within a group treasury or the treasury
may simply advise subsidiaries and divisions on policy matter viz.,
collection/payment periods, discounts, etc.
Treasury will also manage surplus funds in an investment portfolio. Investment
policy will consider future needs for liquid funds and acceptable levels of risk as
determined by company policy.
2. Currency Management: The treasury department manages the foreign
currency risk exposure of the company. In a large multinational company (MNC)
the first step will usually be to set off intra-group indebtedness. The use of
matching receipts and payments in the same currency will save transaction
costs. Treasury might advise on the currency to be used when invoicing
overseas sales.
The treasury will manage any net exchange exposures in accordance with
company policy. If risks are to be minimized then forward contracts can be used
either to buy or sell currency forward.
3. Fund Management: Treasury department is responsible for planning and
sourcing the company’s short, medium and long-term cash needs. Treasury
department will also participate in the decision on capital structure and forecast
future interest and foreign currency rates.
4. Banking: It is important that a company maintains a good relationship with its
bankers. Treasury department carry out negotiations with bankers and act as
the initial point of contact with them. Short-term finance can come in the form
of bank loans or through the sale of commercial paper in the money market.
5. Corporate Finance: Treasury department is involved with both acquisition and
divestment activities within the group. In addition, it will often have responsibility
for investor relations. The latter activity has assumed increased importance in
markets where share-price performance is regarded as crucial and may affect
the company’s ability to undertake acquisition activity or, if the price falls
drastically, render it vulnerable to a hostile bid.
(c) Inter-relationship between Investment, Financing and Dividend Decisions: The
finance functions are divided into three major decisions, viz., investment, financing
and dividend decisions. It is correct to say that these decisions are inter-related
because the underlying objective of these three decisions is the same, i.e.
maximisation of shareholders’ wealth. Since investment, financing and dividend
decisions are all interrelated, one has to consider the joint impact of these decisions
PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 105

on the market price of the company’s shares and these decisions should also be
solved jointly. The decision to invest in a new project needs the finance for the
investment. The financing decision, in turn, is influenced by and influences dividend
decision because retained earnings used in internal financing deprive shareholders
of their dividends. An efficient financial management can ensure optimal joint
decisions. This is possible by evaluating each decision in relation to its effect on the
shareholders’ wealth.
The above three decisions are briefly examined below in the light of their inter-
relationship and to see how they can help in maximising the shareholders’ wealth i.e.
market price of the company’s shares.
Investment decision: The investment of long term funds is made after a careful
assessment of the various projects through capital budgeting and uncertainty
analysis. However, only that investment proposal is to be accepted which is expected
to yield at least so much return as is adequate to meet its cost of financing. This have
an influence on the profitability of the company and ultimately on its wealth.
Financing decision: Funds can be raised from various sources. Each source of
funds involves different issues. The finance manager has to maintain a proper
balance between long-term and short-term funds. With the total volume of long-term
funds, he has to ensure a proper mix of loan funds and owner’s funds. The optimum
financing mix will increase return to equity shareholders and thus maximise their
wealth.
Dividend decision: The finance manager is also concerned with the decision to pay
or declare dividend. He assists the top management in deciding as to what portion of
the profit should be paid to the shareholders by way of dividends and what portion
should be retained in the business. An optimal dividend pay-out ratio maximises
shareholders’ wealth.
The above discussion makes it clear that investment, financing and dividend
decisions are interrelated and are to be taken jointly keeping in view their joint effect
on the shareholders’ wealth
106 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE

SECTION: B: ECONOMICS FOR FINANCE
QUESTIONS
1. (a) Explain few important points which one needs to bear in mind while calculating
National Income.
(b) Calculate Net Domestic Product at Factor Cost from the following data:
Particulars In Crore
Wages 7142
Mixed income 450
Rent 541
Salaries 8912
Interest 1013
Profit 714
(c) Calculate Personal Income from the following data:
Particulars In Crore
Undistributed profits of corporation 50
Net domestic product accruing to private sector 700
Corporation tax 65
Net factor income from abroad 10
Net current transfer from rest of the world 20
Net current transfer from the government 25
Interest on national debt 40

2. (a) Explain the concept of circular flow in two sector economy model?
(b) i. Find out the MPC, when in an economy total income increases by ` 7500 crore
due to increase in investment by ` 2500 crore?
ii Assume that the consumption function in an economy is specified by the
equation C = 200 + 0.9Y
With the help of an example show that in this economy as income increases MPC
remains constant.
3. How can the government influence the resource allocation in an economy?
4. When price of certain essential goods rises excessively, how does the government
intervene to control the price? Explain with the help of an example and with suitable
diagram.
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 107

5. (a) Is cable television an example of impure public good? Verify your answer.
(b) Is production of steel a demerit good? Give reason.
6. (a) Explain the classical version of quantity theory of demand for money.
(b) Why empirical analysis of money supply is important?
7. (a) Calculate the narrow money from the following information.
Components in Million (`)
Currency with the public 15473.2
Demand deposits of banks 6943.1
Saving deposits with post office saving banks 978.1
Other deposits of the RBI 501.2
(b) What is high powered money? Calculate it from the following data:
Components in Million (`)
Net RBI Credit to the Government 41561.2
RBI credit to the Commercial sector 18459.3
RBI’s net non-monetary liabilities 24981.2
RBI’s claims on banks 31456.2
RBI’s Net foreign assets 10456.1
Government’s currency liabilities to the public 21417.1
8. (a) The table below shows the output of Wheat and Rice by using one hour of labour time
in country A and country B -
Goods Country A Country B
Wheat (Quintal /hour) 10 5
Rice (Quintal/hour) 5 10
Which country has an absolute advantage over other country in production of wheat
and rice and which good they obtain through international trade?
(b) Define custom duties? What are their main goals?
9. (a) Is prohibition of import of poultry from countries affected by avian flu, m eat and poultry
processing standards to reduce pathogens, residue limits for pesticides in foods etc.
an example of Sanitary and Phytosanitary (SPS) measure? How?
(b) Food Laws, Quality Standards and Industrial Standards are examples of which type
of non-tariff measures? Give Comments.
10. (a) Distinguish between horizontal and vertical Foreign Direct Investment.
108 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

(b) Assume that ` 70 is needed to buy one US dollar in foreign exchange market (i.e. the
nominal exchange rate is ` 70/ US $). Suppose that a price index of standardized
basket of goods and services is ` 200 in India and US $ 100 in United States, find
out the real exchange rate? (Treat India as a domestic country and United States as
a foreign country)

SUGGESTIONS ANSWERS/ HINTS

1. (a) Few important points which one needs to bear in mind while calculating National
Income are -
(i) The value of only final goods and services or only the value added by the
production process would be included in GDP. By ‘value added’ we mean the
difference between value of output and purchase of intermediate goods.
(ii) Intermediate consumption consists of the value of the goods and services
consumed as inputs by a process of production, excluding fixed assets whose
consumption is recorded as consumption of fixed capital. Intermediate goods
used to produce other goods rather than being sold to final purchasers are not
counted as it would involve double counting.
(iii) Gross Domestic Product (GDP) is a measure of production activity which covers
all production activities recognized by SNA called the ‘production boundary’.
(iv) Economic activities include all human activities which create goods and services
that are exchanged in a market and valued at market price. On the other hand,
Non-economic activities are those which produce goods and services, but since
these are not exchanged in a market transaction they do not command any
market value; for e.g. hobbies, housekeeping and child rearing services of home
makers and services of family members that are done out of love and affection.
(v) National income is a ‘flow’ measure of output per time period—for example, per
year—and includes only those goods and services produced in the current
period i.e. produced during the time interval under consideration. The value of
market transactions such as exchange of goods which already exist or are
previously produced, do not enter into the calculation of national income.
Therefore, the value of assets such as stocks and bonds which are exchanged
during the pertinent period are not included in national income as these do not
directly involve current production of goods and services.
(vi) Two types of goods used in the production process are counted in GDP namely,
capital goods (business plant and equipment purchases) and inventory
investment—the net change in inventories of final goods awaiting sale or of
materials used in the production which may be positive or negative.
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 109

(b) Net Domestic Product at Factor Cost = Compensation of Employees (wages and
salaries) + operating surplus (rent, interest and profit) + mixed income
= 7142+8912+541+1013+714+450
= 18772 crores.
(c) Personal Income = Net domestic product accruing to private sector + Net factor
income from abroad + Net current transfers from government + Net current transfers
from rest of the world + interest on National debt – Corporation tax – Undistributed
profits of corporations
= 700+10+25+20+40-65-50
= 680 Crores
2. (a) The two sector economy model assumes that there are only two sectors in the
economy viz., households and firms, with only consumption and investment outlays.
Households own all factors of production and they sell their factor services to earn
factor incomes which are entirely spent to consume all final goods and services
produced by business firms. The business firms are assumed to hire factors of
production from the households; they produce and sell goods and services to the
households and they do not save. There are no corporations, corporate savings or
retained earnings. The total income produced, Y, accrues to the households and
equals their disposable personal income Yd i.e., Y = Yd. All prices (including factor
prices), supply of capital and technology remain constant. The government sector
does not exist and therefore, there are no taxes, government expenditure or transfer
payments. The economy is a closed economy, i.e., foreign trade does not exist; there
are no exports and imports and external inflows and outflows. All investment outlay
is autonomous (not determined either by the level of income or the rate of interest);
all investment is net and, therefore, national income equals the net national product.
The circular flow of income and expenditure which presents the working of the two-
sector economy should be illustrated diagrammatically. There are no injections into
or leakages from the system. Since the whole of household income is spent on goods
and services produced by firms, household expenditures equal the total receipts of
firms which equal value of output.
(b) i. Given,
Increase in income= 7500 crore
Increase in investment= 2500 crore
Therefore,
Investment multiplier (k)= ∆Y/∆I or
∆Y/∆I=1/1-mpc
7500/2500=1/1-mpc
110 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

mpc= 0.66
ii. Suppose assume that income is 1000, 2000 and 3000
Then consumption is C= 200+0.9(1000) =1100
C= 200+0.9(2000) = 2000
C= 200+0.9(3000) = 2900
Thus:
Y C MPC (∆C/∆Y)
1000 1100 -
2000 2000 900/1000=0.9
3000 2900 900/1000=0.9
So we see as income increases from ` 1000 to ` 2000 and from ` 2000 to
` 3000, marginal propensity to consume remains constant i.e., 0.9.
3. A variety of allocation instruments are available by which governments can influence
resource allocation in the economy. They are -
i. government may directly produce the economic good (for example, electricity and
public transportation services)
ii. government may influence private allocation through incentives and disincentives (for
example, tax concessions and subsidies may be given for the production of goods
that promote social welfare and higher taxes may be imposed on goods such as
cigarettes and alcohol)
iii. government may influence allocation through its competition policies, merger policies
etc. which will affect the structure of industry and commerce (for example, the
Competition Act in India promotes competition and prevents anti-competitive
activities).
iv. governments’ regulatory activities such as licensing, controls, minimum wages, and
directives on location of industry influence resource allocation.
v. government sets legal and administrative frameworks, and
vi. any of a mixture of intermediate techniques may be adopted by governments.
4. When prices of certain essential commodities rise excessively, government may resort to
control in the form of price ceilings (also called maximum price) for making a resource or
commodity available to all at reasonable prices. For example: maximum prices of food
grains and essential items are set by government during times of scarcity. A price ceiling
which is set below the prevailing market clearing price will generate excess demand over
supply. (The students should draw the diagram in support of their answers)
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 111

With the objective of ensuring stability in prices and distribution, governments often
intervene in grain markets through building and maintenance of buffer stocks. It involves
purchases from the market during good harvest and releasing stocks during periods when
production is below average.
5. (a) Yes, cable television is an example of impure public good. Impure public goods only
partially satisfy two characteristics of public goods namely, non-rivalry in consumption
and non-excludability.
Cable television is non-rivalrous because the use of cable television by other
individuals will in no way reduce your enjoyment of it. The good is excludable since
the cable TV service providers can refuse connection if you do not pay for set top
box and recharge it regularly.
(b) Demerits goods are those goods which are believed to be socially undesirable. The
consumption of these goods imposes significant negative externalities on the society
as a whole.
No. The production of steel is not essentially a demerit good. Though it causes
pollution and have negative externalities, it is not a socially undesirable good.
6. (a) According to Fisher, quantity theory of money demonstrate that there is strong
relationship between money and price level and the quantity of money is the main
determinant of the price level or the value of money. In other words, changes in the
general level of commodity prices or changes in the value or purchasing power of
money are determined first and foremost by changes in the quantity of money in
circulation. Fisher’s version, also termed as ‘equation of exchange’ or ‘transaction
approach’ is formally stated as follows:
MV = PT
Where, M= the total amount of money in circulation (on an average) in an economy
V = transactions velocity of circulation i.e. the average number of times across all
transactions a unit of money (say Rupee) is spent in purchasing goods and services
P = average price level (P= MV/T) T = the total number of transactions.
Later, Fisher extended the equation of exchange to include demand (bank) deposits
(M’) and their velocity (V’) in the total supply of money. Thus, the expanded form of
the equation of exchange becomes:
MV + M'V' = PT
Where M’ = the total quantity of credit money V' = velocity of circulation of credit
money The total supply of money in the community consists of the quantity of actual
money (M) and its velocity of circulation (V). Velocity of money in circulation (V) and
the velocity of credit money (V') remain constant. T is a function of national income.
Since full employment prevails, the volume of transactions T is fixed in the short run.
Briefly put, the total volume of transactions (T) multiplied by the price level (P)
112 INTERMEDIATE (NEW) EXAMINATION: NOVEMBER, 2019

represents the demand for money. The demand for money (PT) is equal to the supply
of money (MV + M'V)'. In any given period, the total value of transactions made is
equal to PT and the value of money flow is equal to MV+ M'V'.
Fisher did not specifically mention anything about the demand for money; but the
same is embedded in his theory as dependent on the total value of transactions
undertaken in the economy. Thus, there is an aggregate demand for money for
transactions purpose and more the number of transactions people want, greater will
be the demand for money. T he total volume of transactions multiplied by the price
level (PT) represents the demand for money.
(b) Empirical analysis of money supply is important for two reasons:
1. It facilitates analysis of monetary developments in order to provide a deeper
understanding of the causes of money growth.
2. It is essential from a monetary policy perspective as it provides a framework to
evaluate whether the stock of money in the economy is consistent with the
standards for price stability and to understand the nature of deviations from this
standard. The central banks all over the world adopt monetary policy to stabilise
price level and GDP growth by directly controlling the supply of money. This is
achieved mainly by managing the quantity of monetary base. The succ ess of
monetary policy depends to a large extent on the controllability of money supply
and the monetary base.
7. (a) M 1= Currency with the public+ demand deposits of banks+ other deposits of the RBI
= 15473.2 + 6943.1+ 501.2 = 22917.5 million
(b) High powered money is also known as reserve money which determines the level of
liquidity and price level in the economy.
Reserve Money = Net RBI Credit to the Government + RBI credit to the Commercial
sector+ RBI’s claims on banks+ RBI’s Net foreign assets+ Government’s currency
liabilities to the public- RBI’s net non-monetary liabilities
= 41561.2 + 18459.3 + 31456.2 + 10456.1 + 21417.1 - 24981.2 = 98368.7 million
8. (a) As can be seen from the table, one hour of labour time produces 10 quintal and 5
quintal of wheat respectively in country A and country B. On the other hand, one hour
of labour time produces 5 quintal of rice in country A and 10 quintal of rice in country
B. Country A is more efficient than country B, or has an absolute advantage over
country B in production of wheat. Similarly, country B is more efficient than country
A, or has an absolute advantage over country A in the production of rice. If both
nations can engage in trade with each other, each nation will specialize in the
production of the good it has an absolute advantage in and obtain the other
commodity through international trade. Therefore, country A would specialise
completely in production of wheat and country B in rice.
 PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 113

(b) Customs duties are basically taxes or duties imposed on goods and services which
are imported or exported. It is defined as a financial charge in the form of a tax,
imposed at the border on goods going from one customs territory to another. They
are the most visible and universally used trade measures that determine market
access for goods. Import duties being pervasive than export duties, custom duties
are often identified with import duties. Custom duties are aimed at altering the relative
prices of goods and services imported, so as to c ontract the domestic demand and
thus regulate the volume of their imports. Custom duties leave the world market price
of the goods unaffected; while raising their prices in the domestic market. The main
goals of custom duties are to raise revenue for the government, and more importantly
to protect the domestic import-competing industries.
9. (a) Yes, prohibition of import of poultry from countries affected by avian flu, meat and
poultry processing standards to reduce pathogens, residue limits for pesticides in
foods etc. are the examples of Sanitary and Phytosanitary (SPS) measures. These
measures are applied to protect human, animal or plant life from risks arising from
additives, pests, contaminants, toxins or disease-causing organisms and to protect
biodiversity. These include ban or prohibition of import of certain goods, all measures
governing quality and hygienic requirements, production processes, and associated
compliance assessments.
(b) Food laws, quality standards, industrial standards are some of the examples of
Technical Barriers to Trade (TBT), which cover both food and non-food traded products.
Technical Barriers to Trade refer to mandatory ‘Standards and Technical Regulations’
that define the specific characteristics that a product should have, such as its size,
shape, design, labelling/marking/packaging, functionality or performance and
production methods, excluding measures covered by the SPS Agreement.
10. (a) A horizontal direct investment is one under which the investor establishes the same type
of business operation in a foreign country as it operates in its home country, for example,
a cell phone service provider based in the United States moving to India to provide the
same service. On the other hand, vertical investment is one under which the investor
establishes or acquires a business activity in a foreign country which is different from the
investor’s main business activity yet in some way supplements its major activity. For
example; an automobile manufacturing company may acquire an interest in a foreign
company that supplies parts or raw materials required for the company.
(b) Real Exchange Rate = Nominal exchange rate*Domestic price index/ Foreign price
index
= 70*200/100
=140