Suggested Answer CAP III June 2018 PDF

CAP III Paper 1: Advanced Financial Reporting
CHARTERED ACCOUNTANCY PROFESSIONAL III

(CAP-III)
Suggested Answer
June 2018
The Institute of Chartered Accountants of Nepal
The Institute of Chartered Accountants of Nepal 1

Suggested Answer - June 2018
Paper 1: Advanced Financial Reporting

Maximum Marks - 100
Total No. of Questions - 6 Total No. of Printed Pages - 17
Time Allowed - 3 Hours Marks

Attempt all questions. Working notes should form part of the answers.
1. On 1st Magh, 2073 Motte Pvt. Ltd. a retailer company, acquired 75% share of Patale Pvt.
Ltd., another retailer company. The consideration for business combination was Rs.
3,765,000 in cash and Rs. 30,000 of cost directly attributable to the business
combination. At the date of acquisition, the statement of financial position of Motte Pvt.
Ltd. and Patale Pvt. Ltd. and the fair value of assets and liabilities recognized in Patale
Pvt. Ltd.'s statement of financial position, were as follows:
Motte Pvt. Ltd. Patale Pvt. Ltd.

Carrying Carrying Fair
Particulars Amount (Rs. ) Amount (Rs.) Value (Rs.)
Assets
Non-current Assets:
Land 4,000,000 1,800,000 2,500,000
Equipment 2,000,000 500,000 550,000
Investment in Patale Pvt. Ltd. 3,795,000 - -
Total Non-current assets 9,795,000 2,300,000
Current Assets:
Inventory 500,000 300,000 400,000
Cash 700,000 100,000 100,000
Total Current Assets 1,200,000 400,000
Total Assets 10,995,000 2,700,000
Liabilities and Equity

Equity:
Share Capital 5,000,000 1,500,000
Retained Earnings 4,195,000 600,000
Total Equity 9,195,000 2,100,000
Non-current Liabilities:
Provisions (Long term) 800,000 200,000 210,000
Total Non-current liabilities 800,000 200,000
Current Liabilities:
Payables 600,000 180,000 180,000
Provisions (Short-term) 400,000 220,000 220,000
Total Current Liabilities 1,000,000 400,000
Total Liabilities 1,800,000 600,000
Total Liabilities & Equity 10,995,000 2,700,000

At the date of acquisition, Patale Pvt. Ltd. had an unrecorded patent with a fair value of
Rs. 2,000,000.
Tax records to be reflected using the following assumptions:
i) The applicable income tax rate is 20 per cent.
ii) The tax basis of the assets and liabilities recognized by Patale Pvt. Ltd. in its
individual accounting records is equal to their respective carrying amounts.
iii) The amortization of goodwill is not tax deductible in determining taxable profit.
Required: (6+8+6=20)
a) Calculate the goodwill, if any, to be recognized.
b) Prepare the consolidated financial statement of Motte Pvt. Ltd. as at 1st Magh,
2073.
c) Prepare the disclosures necessary to be presented relating to the business
combination that would be included in Motte Pvt. Ltd.'s consolidated financial
statements for the fiscal year 2073/74.
Answer:
a) Calculation of goodwill
Motte Pvt. Ltd. recognizes goodwill of Rs. 381,000 (i.e. the cost of business
combination Rs. Rs. 3,765,000 less 75% of net identifiable assets acquired Rs.
33,84,000 (0.75*Rs. 45,12,000).
Fair value of net identifiable assets of Patale Pvt. Ltd. acquired:
Particulars Fair Value (Rs.)
Intangible Assets (Patent) 2,000,000
Land 2,500,000
Equipment 550,000
Inventory 400,000
Cash 100,000
Total Assets 5,550,000
Less: Liabilities
Provisions (long-term) 210,000
Payables 180,000
Provision (short-term) 220,000
Deferred tax liability (WN 1) 428,000 10,38,000
Net identifiable Assets acquired 4,512,000
b) Motte Pvt. Ltd.‟s consolidated statement of Financial Position at Magh 01, 2073
Particulars Rs. Rs. Rs.

Assets

Non-Current Assets
Goodwill 381,000
Patent 2,000,000
Land 6,500,000
Equipment 2,550,000
Total non-current assets 11,431,000
Current Assets
Inventory 900,000
Cash 800,000
1,700,000
Liabilities & Equity

Equity attributable to owner of Motte
Pvt. Ltd.
Share Capital 5,000,000
RetainedEarning(4195,000-30,000) 4,165,000
9,165,000
Non-controlling interest (25% of 1,128,000
Rs.4,512,000)
Total Equity 10,293,000
Liabilities
Non-current liabilities
Provision (Long-term) 1,010,000
Deferred tax liability (WN 1) 428,000
1,438,000
Current Liabilities
Payables 780,000
1,400,000
Total Liabilities 2,838,000
Total Liabilities & Equity 13,131,000
c) Disclosure related to business combination in the financial statement of Motte

Pvt. Ltd. for the fiscal year 2073/74
i) Acquisition
On 1st Magh, 2073, Motte Pvt. Ltd. acquired 75% share capital and control of Patale
Pvt. Ltd. in a cash transaction. The acquisition has been accounted for under Purchase
Method and has been included in the consolidated financial statement from the date
of acquisition. Both the company are involved in retail business.
The amount recognized at fair value as a result of business combination at
the acquisition date are as follows:
Particulars Fair Value (Rs.)

Intangible Assets (Patent) 2,000,000

Land 2,500,000
Equipment 550,000
Inventory 400,000
Cash 100,000
Less: Liabilities
Provisions (long-term) 210,000
Payables 180,000
Deferred tax liability (WN 1) 428,000 1,038,000
Net identifiable Assets acquired 4,512,000
Less: Non-controlling interest(25% share) 11,28,000
33,84,000
Add: Goodwill 381,000
Cost of business combination 3,765,000
ii) Goodwill
Accumulated Carrying
Cost amortization & Amount
Particulars (Rs) Impairment (Rs.) (Rs.)
Shrawan 01, 2073 - - -
Acquired in business combination 428,000 - 428,000
Annual amortization (WN 2) - (19,050) (19,050)
Ashad end 2074 428,000 ( 19,050) 408,950
Working Note 1: Calculation of Deferred tax Assets/Liabilities on business combination
Particulars Patale Pvt. Group acquisition Difference Deferred
Ltd. carrying carrying amount tax @20%
amount (Rs.) (fair value)
Intangible assets - 2,000,000 2,000,000 (400,000)
(patent)
Land 1,800,000 2,500,000 700,000 (No)
Equipment 500,000 550,000 50,000 (10,000)
Inventory 300,000 400,000 100,000 (20,000)
Cash 100,000 100,000 - -
Provisions (long-term) (200,000) (210,000) (10,000) 2,000

Payables (180,000) (180,000) - -

Provision (short term) (220,000) (220,000) - -

Total 2,100,000 4,940,000 2,840,000 (428,000)
Notes:
(1) Negative figure (figure in bracket) indicates liability whereas positive figure indicates
assets
(2) Although the group carrying amount of goodwill i.e. Rs. 381,000 exceeds the tax base i.e.
zero, no deferred taxation arises from this temporary difference because it is exempt from
deferred tax.
Working Note 2: Amortization of goodwill

A 10 year life of goodwill is assumed and the acquisition is six months before the end of the
fiscal year
Amortization = (381,000/10)*6/12 = Rs. 19,050
Any assumptions of life of goodwill will be valid since nothing is specified in questions.
Cost of Business acquisitions should be charged to Profit and loss account as per NFRS-
3 hence deducted from group reserve at the time of consolidations.
2.
a) M Ltd. acquired following share holdings in H Ltd.:-
Fair value of net Purchase

Date of acquisition Holdings acquired assets consideration
(Rs. in million ) (Rs. in million)
1st Magh, 2072 25% 120 40
1st Magh, 2073 45% 220 100
M Ltd. accounts for the investment in H Ltd. at fair value. The share price of H Ltd.
at Ashadh end 2073, is Rs. 10 million; at Ashadh end 2074, it is Rs. 12 million. H
Ltd. has no contingent liabilities at the above dates. The following balance sheets
relate to M Ltd. and H Ltd. as at Ashadh end 2074:
M Ltd. H Ltd.
(Rs. in million) (Rs. in million)
Property, plant and equipment 340 160

Investment in H Ltd. 150
Current assets 110 80
600 240
Issued equity shares of Re. 1 each 240 40

Retained earnings 340 160
Current liabilities 20 40
600 240

There had been no new share capital issued since the acquisition of H Ltd. by M Ltd.,
The excess of the fair value over the carrying value of H Ltd.'s net assets is due to
non-depreciable land (Rs. 12 milllion at 1st Magh, 2072, Rs. 20 million at Ashadh end
2074). M Ltd. did not exercise significant influence over H Ltd. when only holding a
25% share of the equity. M Ltd. feels that the total recoverable value of goodwill
relating to H Ltd. at Ashadh end 2074 is Rs. 16 million.
Required: (1+9=10)
i) Show the accounting for the initial investment in H Ltd. by M Ltd. before
obtaining control.
ii) Prepare consolidated balance sheet for the business combination as at Ashadh end
2074.
b) The books of Mr. Z showed the following information as on:

Particulars 2073/4/1 (Rs.) 2074/3/31 (Rs.)
Bank balance - 50,000
Debtors - 87,500
Creditors - 46,000
Stock 50,000 62,500
Fixed assets 7,500 9,000
The following are the details of the bank transactions during the
fiscal year 2073/74:
Particulars Amount in Rs.
Receipt from customers 340,000
Payments to creditors 280,000
Capital brought in 5,000
Sale of fixed assets 1,750
Expenses paid 49,250
Drawings 25,000
Purchase of fixed assets 5,000
Other information:
(i) Cost of goods sold 260,000
(ii) Gross profit 25% on cost of goods sold
(iii)Book value of assets sold 2,500
Required: 10
Prepare Trading, Profit and Loss account of Mr. Z for the fiscal
year 2073/74 and the Balance Sheet as at Ashadh end 2074.

Answer: 2(a) Q.N 2(a).

i) Initial Accounting for Investment in H Ltd.
Cost 40 Million
Add: Post acquisition profit ( 220-120)×25% 25 Million
Equity method 65 Million
However As per investment value is given in Balance sheet is increased by 10 million which
need to be corrected after being subsidiary by passing the following entry.
Group Retained earning Dr. 10 Million
To Investment 10 Million
ii) Calculation of Net Assets
On Acquisition (2nd)
S/C 40 40
R/E 160 160
FV Adj. 20 20
220 220
Calculation of Goodwill
Fair Value of Consideration 1st 40 million
Fair Value of Consideration 2nd 100 million
Fair Value of NCI ( 220×30%) 66 million
206
Less: Net Assets on Acquisition 220
Gain on Bargain purchase 14 million
Calculation of Non Controlling Interest

Fair.Value of NCI (220×30%) 66 million
Add: Post profit Nil
66 Million
Calculation of Group Reserve

Retained Earning (M) 340
Add: Gain on B purchase 14
Less: Investment value correction (10)
344
Consolidated Balance Sheet at Ashad end 2074

M Ltd.
Property, plant, and equipment (340 + 160 + 20) 520
Current assets (110 + 80) 190
710
Equity share capital 240
Group Retained Earnings 344
Non-Controlling Interest 66
Current Liabilities (20+40) 60
710

The Share price of H Ltd given in the questions has been misprinted and
has been ignored in the calculations.
Alternatively students can assume the fair value of 1st purchase 50 million
in such cases gain on bargain purchase will be 4 million.
Answer: 2(b)
Trading and Profit & Loss Account of Mr. Z
for the fiscal year 2073/74
Dr. Cr.
Rs. Rs.
To Opening stock 50,000 By Sales (W.N.3) 325,000
To Purchases (W.N.1) 272,500 By Closing stock 62,500
To Gross profit (W.N.2) 65,000 _______
387,500 387,500
To Expenses 49,250 By Gross profit 65,000
To Loss on sale of fixed asset 750
To Depreciation on fixed assets 1,000
(WN7)
To Net Profit 14,000 ______
65,000 65,000
Balance Sheet as at Ashadh end 2074

Liabilities Rs. Rs. Assets Rs.
Capital as on 2073/4/1(WN8) 169,000 Fixed Assets 9,000
Add: Net profit 14,000 Debtors 87,500
Additional capital 5,000 Stock 62,500
188,000 Bank 50,000
Less: Drawings 25,000 163,000
Creditors 46,000 _______
209,000 209,000
Working Notes:
1. Cost of goods sold = Opening stock + Purchases – Closing stock
Rs. 260,000 = Rs. 50,000 + Purchases - Rs. 62,500
Purchases = Rs. 272,500.
2. Gross Profit = Rs. 260,000 x 25% = Rs. 65,000.
3. Sales = Cost of goods sold + gross profit
= Rs. 260,000 + Rs. 65,000
= Rs. 325,000.
4. Creditors account
Dr. Cr.

Rs. Rs.
To Bank 280,000 By Balance b/d (Bal. Fig.) 53,500
To Balance c/d 46,000 By Purchases (WN 1) 272,500
326,000 326,000
5. Debtors account
Dr. Cr.
Rs. Rs.
To Balance b/d (Bal. Fig.) 102,500 By Bank 340,000
To Sales (W.N. 2) 325,000 By Balance c/d 87,500
427,500 427,500
6. Bank account
Dr. Cr.
Rs. Rs.
To Balance b/d (Bal. Fig.) 62,500 By Creditors 280,000
To Debtors 340,000 By Expenses 49,250
To Capital 5,000 By Drawings 25,000
To Fixed Assets 1,750 By Fixed Assets (purchased) 5,000
______ By Balance c/d 50,000
409,250 409,250
7. Fixed Assets account
Dr. Cr.
Rs. Rs.
To Balance b/d 7,500 By Bank (Sale) 1,750
To Bank 5,000 By Profit and Loss A/c (loss on sale) 750
By Depreciation (Bal. Fig.) 1,000
______ By Balance c/d 9,000
12,500 12,500
8. Balance Sheet as at 01.04.2073

Liabilities Rs. Assets Rs.
Capital (Bal. Fig.) 169,000 Fixed Assets 7,500
Creditors 53,500 Debtors (W.N. 4) 102,500
Stock 50,000
_______ Bank Balance (WN 6) 62,500
222,500 222,500
Students are encouraged to prepare the profit and loss account and other comprehensive
income
by following the NFRS format.
3.
a)

Rs. '000
Financial Liabilities:-
10% Bonds 500
Financial Assets:-
Investment in shares 60
Loan to group company 50
Following information are relevant:

i) Date of transition to NFRS 2074/4/1
ii) 10% Bonds were issued on 2072/4/1 Bonds shall be redeemed at the end of 10th
year i.e. on 2082/3/31. Annual interest becomes due on Ashadh end every year.
Par value of bond is Rs. 100 and issue price was Rs. 99. The bond issue expense
was Rs. 5000. Discount and issue expenses are amortized on straight line basis.
The present value of future cash flows of bonds as on 2074/4/1 at implicit rate of
10.33% is Rs. 491,300.
iii) As per previous GAAP, investments were measured at cost. The entity intends to
hold some investment for more than 12 months. As on 2074/4/1, cost of such
investment was Rs. 30,000 and market price was Rs. 35,000.
iv) The entity intends to hold some investment for less than 12 months. As on
2074/4/1, cost of such investment was Rs. 30,000 and market price was Rs.
28,000.
v) Interest free loan to group company was granted on 2070/4/1 for 10 years.
Benchmark interest cost for 10 years' loan applicable to the borrower as on
2070/4/1 was 12% and as on 2074/4/1 was 11.5%. The present value of future
cash flows on reference date discounted at 12% is Rs. 25,330 and at 11.5% is Rs.
26,020.
Required: 10
How would these financial liabilities and financial assets be designated for the
purpose NFRS adoption? What would be the measurement basis? How should the
measurement be carried out?
b) Following information relating to Joseph Ltd. is extracted from the

draft financial statements as of 2074/3/31:-
i) Total comprehensive income for the year 2073/74:-
Rs. '000
Profit from Continuing Operation- net of tax 200,000
Profit from Discontinued Operation- net of tax 10,000
Fair value gain on Available for Sales investment- net of tax 16,000
Total comprehensive income 226,000
ii) Other relevant information extracted from notes are:
 Capital structure as on 2073/4/1 was:-
- 8,000,000 ordinary shares of Rs. 10 each

- 500,000 Convertible preference shares of Rs. 100 each entitled to a cumulative

dividend at 12%. Each share is convertible into two ordinary shares and the
dividend is paid on Bhadra end, every year.
- 20% bonus shares being the final dividend for the year ended 2073/3/31 were
issued on 2073/6/30.
- On 2073/7/30, holders of 80% convertible preference shares converted their
shares into ordinary shares. On 2073/10/1, Joseph Ltd. issued 20% right shares
to its ordinary shareholders at Rs. 70 per share.
- The market price prevailing on the exercise date was Rs. 80 per share.
 On 2072/11/1, Joseph Ltd. granted 2,500 share options to each of its twenty
technical managers. The managers would become eligible to exercise these
options on completion of further five years of service with Joseph Ltd. By
2074/3/31, two managers had already left and it is expected that a further six
managers would leave Joseph Ltd. before five years. As of 2074/3/31,
estimated fair value of each share option was Rs. 40.
Required: 10
Calculate Basic Earning Per Share and Diluted Earning Per Share for inclusion in
financial statements of Joseph Ltd. for the year ended 2074/3/31.
Answer:3(a)
(Rs
.'000)
Carryi
Carryi
Designation ng
Date of ng
on Measureme amount
Particulars designati amoun
NFRS nt as per
on t as
adoption basis previo
per
us
NFRS
GAAP
Financial
Liabilities
Financial
Amortised
10% Bonds Liability at 2074/4/1 500 WN 1
cost 491.30
amortised cost
Unammortised
Discount & 0 8 WN 1
Issue Expenses
Financial Assets

Financial
Assets as at
Investments in
fair value 2074/4/1 Fair value 28 30 WN2
shares
through profit
or loss
Financial
Investments in Assets as at
2074/4/1 Fair value 35 30 WN2
shares fair value
through OCI
Financial
Assets as at
Loan to group Amortised
fair value 2074/4/1 25.33 50 WN 4
Company cost
through profit
or loss
WN 1 10% Bonds
Bonds shall be measured at amortised cost retrospectively from that
inception. Amortised cost is present value of future cash flows
discounted at implicit interest rate of 10.33% i.e. Rs. 491,300 .
Valuation of Bond
Implicit rate 10.33%

PV of future cash flows (Rs.) 491,300
Carrying amt as per GAAP (Rs.) 500,000
Adjustment to retained earnings (Rs.) 8,700
Another related issue is discount and issue expense of Rs. 10,000. Given that the
entity amortises discount and issue expense on straight line basis i.e. unamortised
balance as on 2073/4/1 was Rs. 8,000 which shall be eliminated by adjusting to
retained earnings. So net effect on retained earnings is Rs. 700.
Investments
WN 2: FVTPL Investments : Investments having expected holding period of 12 months or less are
classified as fair value through profit or loss ( FVTPL). The change in fair value is accounted for in
the Statement of Comprehensive Income. Difference is adjusted against retained earnings.
WN 3: Available for sale investments : Investments having expected holding period of more than 12
months are classified as fair value through other comprehensive income. The change in fair value is
accounted for in the Statement of Other Comprehensive Income. Difference is adjusted against Fair
Value Reserve.

WN 4: Loan to Group company: It is classified as financial assets at amortised cost. Amortised cost
is determined as present value of future cash flows discounted at relevant benchmark interest rate at
the inception of the loan i.e. Rs. 25,330. The difference is adjusted against retained earnings.
Answer:3(b)
Computation of Basic & Diluted EPS

Rs.' 000 Rs.' 000
From
Description Continuing Operation Discontinued Total
Operation
Profit after tax 200,000 10,000
Dividend on convertible preference share (1,200)
['500000 * 100*12%*20%]
Profit attributable to ordinary shareholders 198,800 10,000
Weighted avg. no of shares 1,12,83,931 1,12,83,931 WN 1

Basic EPS 17.62 0.89 18.51
Diluted EPS
Profit after tax 200,000 10,000
Weighted avg No of ordinary shares 1,12,83,931 1,12,83,931

Conversion of Pref Share 466,667 466,667 WN 3
Employee Options 30,000 30,000
[(20-2-6)*2500]/1000
Total shares 11,780,598 11,780,598
Diluted EPS 16.98 0.85 17.83
W. N. 1 Calculation of Weighted Average no. of Equity share

Opening balance 80,00,000
Bonus Share 16,00,000
Converted Preference . Share (8,00,000 x 8/12 month) 5,33,333
Bonus Element 2,21,197
Paid Element ( 18,58,802 x 6/12 Month) 9,29,401
1,12,83,931
WN 2
Description Price per share (Rs.) No. of shares Amt (Rs.)
Shares prior to right issue on
exercise date 80 10,400,000 832,000,000
20% right share issue 70 2,080,000 145,600,000
Theoretical ex right value 78.33 12,480,000 977,600,000

Paid Element 14,56,00,000/78.33 = 18,58,803

Bonus = 20,80,000 – 18,58,803 = 2,21,197
WN 3 Assumed Conversion of Pref Share

Date No. of shares Period Weighted
Converted 2073/7/30 800000 4/12 266,666.67
Remaining 200000 1 200,000.00
Total 466,666.67
4. Write short notes on the following: (5×3=15)

a) Explicit statement of compliance with NFRS
b) Interest in another entity.
c) Stress testing for banks
d) Debt securitisation
e) Operating segment
Answer:
a) Explicit Statement of Compliance with NFRS
An entity whose financial statements comply with NFRSs shall make an explicit and
unreserved statement of such compliance in the notes. An entity shall not describe financial
statements as complying with NFRSs unless they comply with all the requirements of
NFRSs.
The financial statements with such disclosure are accepted as financial statements prepared
in compliance with NFRS. An entity cannot rectify inappropriate accounting policies either
by disclosure of the accounting policies used or by notes or explanatory material.
b) Interest in another entity.
Nepal Financial Reporting Standard(NFRS) 12 on „Disclosure of Interest in Other Entities‟

describe this as a contractual and non-contractual involvement of an entity in another entity
that exposes an entity to variability of returns from the performance of the other entity. An
interest in another entity can be evidence by, but is not limited to, the holding of equity or
debt instruments as well as other forms of involvement such as the provision of funding,
liquidity support, credit enhancement and guarantees. It includes the means by which an
entity has control or joint control of, or significant influence over, another entity.
c) Stress testing for banks

An analysis conducted under unfavorable economic scenarios which is designed to
determine whether a bank has enough capital to withstand the impact of adverse
developments. Stress tests can either be carried out internally by banks as part of their own
risk management, or by supervisory authorities as part of their regulatory oversight of the

banking sector. These tests are meant to detect weak spots in the banking system at an early
stage, so that preventive action can be taken by the banks and regulators.
Stress testing should be designed to provide information on the kinds of conditions under
which strategies or positions would be most vulnerable, and thus may be tailored to the risk
characteristics of the bank. Possible stress scenarios might include:
• abrupt changes in the general level of market rates;

• changes in the relationships among key market rates (i.e. basis risk);
• changes in the slope and the shape of the yield curve (i.e. yield curve risk);
• changes in the liquidity of key financial markets or changes in the volatility of market
rates; or
• conditions under which key business assumptions and parameters break down
d) Debt Securitisation
Debt securitisation is a method of recycling of funds. It is especially beneficial to financial
intermediaries to support the lending volumes. Assets generating steady cash flows are
packaged together and against this assets pool market securities can be issued. The process
can be classified in the following three functions.
1. The origination function: A borrower seeks a loan from finance company, bank or
housing company. On the basis of credit worthiness repayment schedule is structured
over the life of the loan.
2. The pooling function: Similar loans or receivables are clubbed together to create an
underlying pool of assets. This pool is transferred in favour of a SPV (Special Purpose
Vehicle), which acts as a trustee for the investor. Once, the assets are transferred they
are held in the organizers portfolios.
3. The securitisation function: It is the SPV‟s job to structure and issue the securities on the
basis of asset pool. The securities carry coupon and an expected maturity, which can be
asset based or mortgage based. These are generally sold to investors through merchant
bankers. The investors interested in this type of securities are generally institutional
investors like mutual fund, insurance companies etc. The originator usually keeps the
spread.
Generally, the process of securitisation is without recourse i.e. the investor bears the credit
risk of default and the issuer is under an obligation to pay to investors only if the cash flows
are received by issuer from the collateral.
e) Operating Segment
As per Nepal Financial Reporting Standard 8 „Operation Segments‟, an operating
segment is a component of an entity

 that engages in business activities from which it may earn revenues and
incur expenses (including revenues and expenses relating to transactions
with other components of the same entity),
 whose operating results are regularly reviewed by the entity‟s chief
operating decision maker to make decisions about resources to be allocated
to the segment and assess its performance, and
 for which discrete financial information is available.
5.
a) Explain the objectives of public financial management. Discuss NPSAS in context of
government accounting. 8
b) An entity constructs a new head office building commencing on Falgun 2073.
Directly attributable expenditure at the beginning of the month on this asset are Rs.
100,000 in Poush 2073 and Rs. 250,000 in each of the months of Magh to Falgun
2073.
The entity has not taken any specific borrowings to finance the construction of the
asset, but has incurred finance costs on its general borrowings during the construction
period. During the year, the entity had issued 10% debentures with a total face value
of Rs. 2 million and had an overdraft of Rs. 500,000, which increased to Rs. 750,000
in Falgun 2073. Interest was paid on the overdraft at 15% until 1st Magh 2073, then
the rate was increased to 16%.
Required:
Calculate the capitalization rate for computation of borrowing cost in accordance with
NAS 23 „Borrowing Costs‟. 7
Answer:5(a)
a) In order to assess a PFM system, we first need to define its objectives – the final
outcomes, by which performance can be measured. It is generally accepted that a
PFM system should achieve three objectives, to which we here add a fourth ‒ the
promotion of accountability and transparency. This is increasingly seen as an
objective in itself, because of its close relationship to the notion of inclusive
institutions.
 The maintenance of aggregate fiscal discipline is the first objective of a PFM

system: it should ensure that aggregate levels of tax collection and public
spending are consistent with targets for the fiscal deficit, and do not generate
unsustainable levels of public borrowing.
 Secondly, a PFM system should ensure that public resources are allocated to
agreed strategic priorities ‒ in other words, that allocative efficiency is achieved.
 Thirdly, the PFM system should ensure that operational efficiency is achieved, in
the sense of achieving maximum value for money in the delivery of services.
 Finally, the PFM system should follow due process and should be seen to do so,
by being transparent, with information publicly accessible, and by applying
democratic checks and balances to ensure accountability.

NEPAL PUBLIC SECTOR ACCOUNTING STANDARDS (NPSAS) in context of

government accounting.
The Accounting Standards Board – Public Sector Committee (the committee)
develops accounting standards for public sector entities referred to Nepal Public
Sector Accounting
Standards (NPSAS) in Nepal. Nepal Public Sector Accounting Standards (NPSAS)
have been developed in line with International Public Sector Accounting Standards
(IPSAS). Such Standards establishes guidelines and standardize the financial
reporting of Public Sector Entities in Nepal, resulting into the improvement of both
quality and Comparability of the financial reporting. The Accounting Standards
Board- Public Sector Committee has developed and issued Nepal Public Sector
Accounting Standard: Financial reporting under the cash basis of accounting which
becomes effective for annual financial statements covering period beginning on or
after 1 January 2009.The standard comprise two parts:
Part 1 is mandatory: It sets out the requirements which are applicable to all entities
preparing general purpose financial statements under the cash basis of accounting. It
defines the cash basis of accounting, establishes requirements for the disclosure of
information in the financial statements and supporting notes, and deals with a number
of specific reporting issues. The requirements in this part of the standard must be
complied with by entities which claim to be reporting in accordance with the Nepal
Public Sector Accounting Standard Financial Reporting under the Cash Basis of
Accounting.
Part 2 is non-mandatory: It defines additional accounting policies and disclosures
that an entity is encouraged to adopt to enhance its financial accountability and the
transparency of its financial statements. It includes explanations of alternative method
for presenting certain information.
Answer:5(b)
Since the entity has only general borrowing hence first step will be to compute the
capitalisation rate. The capitalisation rate of the general borrowings of the entity
during the period of construction is calculated as follows:
Amount Average Month Interest Period Rate Interest for the Year
Debenture 20,00,000 20,00,000 12 10% 2,00,000
Overdraft 5,00,000 2,50,000 6 15 37,500
Overdraft 5,00,000 41,667 1 16% 6,667
Overdraft 7,50,000 3,12,500 5 16% 50,000
26,04,167 2,94,167
Average borrowing Rate = 11.30%

Interest to be Capitalized
1,00,000 x 11.30% x 7 Month 6592
2,50,000 x 11.30% x 6 Month 14,125

2,50,000 x 11.30 % 5 Month 11,771

Calculations of Qualifying Assets 32,488
1 Lakh x 7 Month = 58,333
250 x 6 Month = 1,25,000
250 x 5 Month = 1,04,167
2,87,500
So Capitalizations of Borrowing rate is 32,488/2,87,500= 11.30 % . Fiscal year
ending date is Ashad end.
6.
a) An entity purchases equipment from a foreign supplier for €6 million on 31st March,
20X6, when the exchange rate was €2 = $1. The entity also sells goods to a foreign
customer for €3.5 million on 30th April, 20X6, when the exchange rate was €1.75 = $1.
At the entity‟s year-end of 31st May, 20X6, the amounts have not been paid. The closing
exchange rate was €1.5 = $1. The entity‟s functional currency is the dollar.
Required: 5
Calculate the exchange differences that would be recorded in the profit or loss for the
year ending 31st May, 20X6. Also state how these exchange difference would be
presented in the statement of profit or loss.
b) The carrying amount of a cash generating unit (CGU) is comprised of the followings:
Particulars: Rs.
Machinery 400,000
Other plant 600,000
Land 1,000,000
Goodwill 400,000
Total 2,400,000
It is determined that the recoverable value of the CGU is Rs. 1,800,000. It is not possible
to estimate the recoverable amounts of the individual assets within the CGU.
Required: 5
Calculate the carrying amount of the assets after accounting for the impairment loss.
Explain the related provisions of relevant NAS.
Answer:6(a)
Calculation of exchange differences to be recorded in the profit or loss for the year
ending 31st May, 20X6
In purchase of equipment: Date $ in million
Cost of the equipment (€6/€2) 31/3/20X6 3
(to be recorded as assets with equal
amount of liability)
Re-valuation amount (€6/€1.5) 31/5/20X6 (4)
Exchange loss (1)
In Sell of goods: Date $ in million

Value of goods (€3.5/€1.75) 30/4/20X6 2

(to be recorded as sales with equal
amount of receivable)
Re-valuation amount (€3.5/€1.5) (2.33)
Exchange gain 0.33
Total exchange loss (1-0.33) (0.67)
IAS 21 does not specify where exchange gains and losses should be shown in the
income statement.
Answer:6(b)
The provision of para 104 of NAS 36 states “An impairment loss shall be recognized for a
cash-generating unit (the smallest group of cash-generating units to which goodwill or a
corporate asset has been allocated), if, and only if, the recoverable amount of the unit (group
of units) is less than the carrying amount of the unit (group of units). The impairment loss
shall be allocated to reduce the carrying amount of the assets of the unit (group of units) in
the following order:
(i) First, to reduce the carrying amount of any goodwill allocated to the cash-generating
unit (group of units); and
(ii) Then, to the other assets of the unit (group of units) pro rata on the basis of the carrying
amount of each asset in the unit (group of units).
These reductions in carrying amounts shall be treated as impairment losses on individual
assets and recognized accordingly.
In the given case, the book value of the CGU is Rs. 2,400,000 and the recoverable value is
Rs. 1,800,000 thereby resulting into impairment loss of Rs. 600,000. In light with the above
provision of NAS, the impairment loss should first be applied to the value of goodwill. The
impairment loss of the carrying amount of assets other than goodwill amounting to Rs.
200,000 (2,000,000-1,800,000) should be accounted on pro rata basis of their carrying
amount as follows:
Machinery = 200,000 *400,000/2,000,000 40,000
Other Plant = 200,000 * 600,000/2,000,000 60,000
Land = 200,000 * 1,000,000/2,000,000 100,000
Total impairment loss 200,000
Carrying amount of the assets after impairment loss:
Particulars Rs.
Machinery (400,000 - 40,000) 360,000
Other plant (600,000 - 60,000) 540,000
Land (1,000,000 - 100,000) 900,000
Goodwill (400,000 - 400,000) 0

1,800,000

Specific Comments on the performance of the students

Batch: -June 2018
Level: -CAP-III
Paper 1: Advanced Financial Reporting
1. Lack of deep knowledge. Sub-part of the question not answers properly i.e. as
required.
2.
a) Most of the students are unable to calculate non controlling interest and gain
on bargain purchase on step acquisition.
b) Most of the students are unable to understand the question. They feel nil
balance at (-) value and solve however some students are unable to calculate
missing figure.
3.
a) Provision related to designation of Financial Liability i.e. 10% Bond and,
Financial Asset i.e. Loan to group company for the purpose of NFRS adoption
is not clearly answered by almost all students.
b) Students have performed very poorly.
Failed to compute:
- Dividend on convertible pref. share.
- Profit attributable to ordinary shareholders.
- Weighted Average No. of Equity share.
- None of the student has computed the Basic EPS and Diluted EPS
correctly.
- Most of the student failed to compute the bonus and paid element.
Overall performance of this question is very poor.

4. Some students have lack of conceptual knowledge.
5.
a) Most of the student attempted the question.
b) Many students don't know the calculation.
6.
a) Overall performance of candidate is fair and good.
b) Generally lack of expert knowledge of accounting standard.

Paper 2:
Advanced Financial Management

CAP II Paper 2: Advanced Financial Management
Roll No……………. Maximum Marks – 100

Total No. of Questions - 6 Total No. of Printed Pages – 18
Time Allowed - 3 Hours
Marks
Attempt all questions.
Working notes should form part of the answers. Make assumptions wherever necessary.
Use separate answer book for each question.
1. SLT Engineering Ltd. is a stock market listed company that manufactures panels for
vans. The business is profitable and demand has been increasing. The machine at the
company is outdated and the company is evaluating whether to replace it. The new
machine would cost Rs. 7,500,000 to purchase plus Rs. 900,000 in installation and
shipping costs. The machine would have a useful life of six years and would be
depreciated down to zero on a straight line basis. As a result of the new machine,
revenues will increase by Rs. 1,850,000 per annum over its six year life, and the
machine will also produce cost savings of Rs. 950,000 per annum.
There will be extra inventory needed for the new machine; this is expected to be Rs.
600,000. Accounts payable will increase as a result of the new machine as will accounts
receivable, by Rs. 400,000 and Rs. 500,000 respectively. These figures are expected to
remain constant until the end of the project.
The new machine will require the use of an extra depot for storage; the depot is being
rented out at the moment for Rs. 500,000 a year, but would become used by the project
if the project was adopted. The machine will require a full overhaul at the end of three
years; this is expected to cost Rs. 500,000. A mechanic that already works for the
company will be assigned to maintain the new machine; his salary is Rs. 300,000 a
year. The company will have to fill his previous position.
The old machine, which has a book value of Rs. 1,500,000 and three years of life left,
will be sold if the project is accepted for Rs. 1,000,000. It is expected that the new
machine will be sold at the end of the project for Rs. 600,000.
The project is a routine replacement project for the company; it is small in size in
relation to the company. The company is currently 25% financed by debt; there is a
bond (Face value: Rs. 100) outstanding with six years to redemption and it is priced at
Rs. 93.37 in the market. The coupon is 8%, and the risk free rate of interest is 5%. The
company‟s equity has a beta of 0.91. The company faces a tax rate of 30% in both
capital and revenue profit. The stock market risk premium is 6%.
Required: (8+4+5+3=20)
a) Lay out the relevant cash flows to the project and explain why you are including or
excluding certain items.

b) Calculate the cost of capital to be used as discount rate and the net present value
(NPV) of the project. Would you accept or reject the project?
c) Assume that the cash flows are in real rupees, the rate of return you calculated in
(ii) above, is also in real term and the inflation rate is 5%; re-calculate the NPV
and suggest whether to go for expansion.
d) Discuss the impact of inflation on a project's cash flows and how this should be
handled in the analysis.
Solution 1:
(a) Calculation of the relevant cash flows
(Rs. '000)
Cash flows Y0 Y1 Y2 Y3 Y4 Y5 Y6
Cost of New Machinery (7,500)
Installation and shipping cost (900)
Net proceeds from sale of old 1,150
machine (WN1)
Increase in Working Capital (700)
(WN2)
Revenues (a) 1,850 1,850 1,850 1,850 1,850 1,850
Cost savings (b) 950 950 950 950 950 950
Opportunity cost of rent of (500) (500) (500) (500) (500) (500)
depot (c)
Overhauling cost (d) (500)
Mechanic's salary (e) (300) (300) (300) (300) (300) (300)
Tax (WN3) (330) (330) (180) (180) (180) (180)
Terminal cash flow (WN4) 1,120
Cash flows (7,950) 1,670 1,670 1,320 1,820 1,820 2,940
WN1) Net proceeds from sale of old machine Rs.'000
Current book value 1,500
Sales value (1,000)
Capital loss 500
Tax savings on capital loss @30% 150
Net proceeds (sales value + tax savings) (1,000+150) 1,150
WN2) Calculation of Working Capital Rs.'000
Additional investment in inventory 600
Accounts receivable 500
Less: Accounts payable (400)
Increase in working capital 700

WN3) Calculation of tax on operating income (Rs.'000)

For Y1-Y2 For Y3 For Y4-Y6
Income – Expenses (a+b-c-d-e) 2,000 1,500 2,000
(as shown in table above)
Less: Incremental depreciation (900) (900) (1,400)
Profit after Tax (PBT) 1,100 600 600
Tax @ 30% (330) (180) (180)
WN4) Calculation of Terminal cash flow Rs.'000
Sales value of new machine 600
Less: Book value (0)
Gain on sales 600
Tax on gain @30% 180
i) Net proceeds (sales value-tax) (600-180) 420
ii) Working capital released 700
Total terminal cash flow (i+ii) 1,120
Explanation for items considered:

The opportunity costs of the depot and the mechanic needs to be included, as
does the differential depreciation in the first three years since, at the time of
selling the old machine the depreciation allowances that go with it cannot be
claimed.
(b) Calculation of the cost of capital to be used as discount rate and the NPV of
the project:
i) Cost of capital: WA Cost of debt + WA Cost of equity
Cost of debt (rd) = Yield to maturity of debt = {C+(F-P)/n}/ {(F+P)/2}
= {8+(100-93.37)/6}/{(100+93.37)/2}
= {8+1.105}/96.685
= 0.0942 = 9.42%
Cost of equity (re) = = rf+ (rm – rf) βe
= 0.05+0.06x0.91
= 0.1046 = 10.46%
WACC = {We × re }+ {Wd ×rd (1-t)}
= {0.75×10.46 + 0.25× 9.42 × 0.70}
= 7.845 + 1.6485
= 9.4935% 9.5%
ii) NPV of the project
Year 0 1 2 3 4 5 6

Cash flows (7,950) 1,670 1,670 1,320 1,820 1,820 2,940

after tax (Rs.
'000)
PVIF @ 9.5% 1 0.913 0.834 0.762 0.696 0.635 0.580
PV (7,950) 1,524.7 1,392.8 1,005.8 1,266.7 1,155.7 1,705.2
NPV (Rs. '000) 100.9
Since NPV is positive, the project should be accepted.
(c) Nominal discount rate will be calculated as below:
Nominal discount rate = (1+Real discount rate) × (1+Inflation rate) – 1
= (1+0.095) × (1+0.05) – 1
= 1.14975 – 1
= 0.14975 = 15% (Approx.)
With inflation, we adjust each year‟s cash flow for the inflation rate to get nominal
cash flows and then discount each cash flow separately using the nominal discount
rate.
Calculation of NPV
Year Real CFAT Cumulative Nominal PVIF PV (Rs.)
(Rs.'000) Inflation CFAT @14.975%
Rate (1+IR)n (Rs.'000)
0 (7,950) 1.000 (7,950) 1.000 (7,950)
1 1,670 1.05 1,753.5 0.870 1,525.6
2 1,670 1.1025 1,841.2 0.756 1,391.9
3 1,320 1.1576 1,528.0 0.658 1,005.4
4 1,820 1.2155 2,212.2 0.572 1,265.4
5 1,820 1.2763 2,322.9 0.498 1,156.8
6 2,940 1.3401 3,939.9 0.433 1,706.0
NPV 101.1*
* It is to be noted that „real‟ cash flows discounted at the „real‟ discount rate yield an
identical amount of NPV that is obtained by discounting „nominal‟ cash flows by
„nominal‟ discount rate. The difference in NPV of Rs. 0.2 thousand (101.1 – 100.9)
between the two discount rates is on account of rounding off the values.
Decision:
Both the inflation adjusted and unadjusted NPV are positive. Based on financial
considerations alone, the company should go for expansion.
(d) In capital budgeting, inflation must be treated consistently. Either real cash flows have to
be discounted with a real discount rate, or nominal cash flows are discounted with a

nominal discount rate. If nominal cash flows were discounted with a real rate, there is a
danger that a poor project would be selected; you would be discounting with too low a
discount rate.
There is a danger in companies that the cash flow forecasts supplied by departments are
real cash flows (in today‟s money) while the company‟s cost of capital will be used to
discount them and that would usually be a nominal discount rate. The company may
reject good projects.
The preferred method is to use nominal figures. Nominal discount rates are what the
company is familiar with; the cash flows should also be estimated with inflation included
in them. The calculation to adjust inflation is:
(1 + nominal rate) = (1 + real rate) × (1 + inflation rate)
Given any two of the three rates, the other can be calculated.
2.
a) BRS Inc. deals in computer and IT hardware‟s and peripherals. The expected revenue for
the next 8 years is as follows:
Year Sales Revenue ($ Million)
1 8
2 10
3 15
4 22
5 30
6 26
7 23
8 20
Summarized financial position on 31 March 2012 was as follows:

Liabilities Amount Assets Amount
Equity Stocks 12 Fixed Assets (Net) 17
12% Bonds 8 Current Assets 3
20 20
Additional Information:
a) Its variable expenses is 40% of sales revenue and fixed operating
expenses (cash) are estimated to be as follows:
Period Amount ($ Million)
1 – 4 Years 1.6
5 – 8 Years 2

b) An additional and sales promotion campaign shall be launched

requiring expenditure as per following details:
1 Year 0.50
2 – 3 Years 1.50
4 – 6 Years 3.00
7 – 8 Years 1.00
c) Fixed Assets are subject to depreciation at 15% as per written down value (WDV)
method
d) The company has planned additional capital expenditures (in the beginning of
each year) for the coming 8 years as follows:
1 0.50
2 0.80
3 2.00
4 2.50
5 3.50
6 2.50
7 1.50
8 1.00
e) Investment in working capital is estimated to be 20% of revenue

f) Applicable tax rate for the company is 30%
g) Cost of equity is estimated to be 16%
h) The free cash flow of the firm is expected to grow at 5% per annum after 8 years.
With the above information, you are required to determine the: (5.5+5.5=11)
i) Value of firm
ii) Value of equity
b) A study by Mutual Fund has revealed the following data in respect of three securities:
Securities σ (%) Correlation with index
A 20 0.60
B 18 0.95
C 12 0.75
The standard deviation of market portfolio is observed to be 15%.
Required: (1+1.5+3.5+1+2=9)
i) What is the sensitivity of returns of each stock with respect to the
market?

ii) What are the co-variances among the various stocks?

iii) What would be the risk portfolio consisting of all the three stocks
equally?
iv) What is the beta of the portfolio consisting of equal investment in
each stock?
v) What is the total systematic and unsystematic risk of the portfolio
in (iv)?
Solution: 2 (a)
Working Notes
(i) Determination of Weighted Average Cost of Capital
Sources of Funds Cost (%) Proportions Weights Weighted Cost
Equity Stock 16 12/20 0.60 9.60
12% Bonds 12% (1-0.30) = 8.40 8/20 0.40 3.36
12.96, say 13
(ii) Schedule of Depreciation
$ Million
Year Opening Addition during Total Depreciation
Balances of the Year @ 15%
Fixed Assets
1 17.00 0.50 17.50 2.63
2 14.87 0.80 15.67 2.35
3 13.32 2.00 15.32 2.30
4 13.02 2.50 15.52 2.33
5 13.19 3.50 16.69 2.50
6 14.19 2.50 16.69 2.50
7 14.19 1.50 15.69 2.35
8 13.34 1.00 14.34 2.15
(iii) Determination of Investment

$ Million
Year Investment Required Existing Additional
For Capital CA (20% of Total Investment Investment
Expenditure revenue) in CA required
1 0.50 1.60 2.10 3.00 0.00
*
2 0.80 2.00 2.80 2.50 0.30
**
3 2.00 3.00 5.00 2.00 3.00
4 2.50 4.40 6.90 3.00 3.90
5 3.50 6.00 9.50 4.40 5.10
6 2.50 5.20 7.70 6.00 1.70

7 1.50 4.60 6.10 5.20 0.90

8 1.00 4.00 5.00 4.60 0.40
* Balance of CA in Year 1 ($3 Million) – Capital Expenditure in Year 1 ($ 0.50 Million)
** Similarly balance of CA in Year 2 ($2.80) – Capital Expenditure in Year 2 ($0.80 Million)
(iv) Determination of Present Value of Cash Inflows
$ Million
Years
Particulars
1 2 3 4 5 6 7 8
Revenue (A) 8.00 10.00 15.00 22.00 30.00 26.00 23.00 20.00
Less: Expenses
Variable Costs 3.20 4.00 6.00 8.80 12.00 10.40 9.20 8.00
Fixed cash operating 1.60 1.60 1.60 1.60 2.00 2.00 2.00 2.00
Cost
Advertisement Cost 0.50 1.50 1.50 3.00 3.00 3.00 1.00 1.00
Depreciation 2.63 2.35 2.30 2.33 2.50 2.50 2.35 2.15
Total Expenses (B) 7.93 9.45 11.40 15.73 19.50 17.90 14.55 13.15
EBIT (C) = (A) – (B) 0.07 0.55 3.60 6.27 10.50 8.10 8.45 6.85
Less: Taxes @ 30% (D) 0.02 0.16 1.08 1.88 3.15 2.43 2.53 2.06
NOPAT (E) = (C) – (D) 0.05 0.39 2.52 4.39 7.35 5.67 5.92 4.79
Gross Cash Flow (F) =
(E) + Dep 2.68 2.74 4.82 6.72 9.85 8.17 8.27 6.94
Less: Investment in
Capital Assets plus
current Assets (G) 0 0.30 3.00 3.90 5.10 1.70 0.90 0.40
Free Cash Flow (H) =
(F) – (G) 2.68 2.44 1.82 2.82 4.75 6.47 7.37 6.54
PVF @ 13% (I) 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376
PV (H)(I) 2.371 1.911 1.261 1.729 2.579 3.106 3.132 2.459
Total Present Value = $ 18.549 million
(v) Determination of Present Value of Continuing Value (CV)
CV = = = = $ 85.8375 million
Present Value of Continuing Value (CV) = $85.8376 million × PVF13%,8 = $85.96875 million
×0.376 = $32.2749 million.
(a) Value of Firm $ Million

Present Value of cash flow during explicit period 18.5490

Present Value of Continuing Value 32.2749
Total Value 50.8239
(b) Value of Equity $ Million
Total Value of Firm 50.8239
Less: Value of Debt 8.0000
Value of Equity 42.8239
Solution: 2 (b)
(i) Sensitivity of security with market i.e, (Betasecurity)
= Correlation security with market × SDsecurity
SDmarket
Security A = 0.60 × = 0.80
Security B = 0.95 × = 1.14
Security C = 0.75 × = 0.60
(ii) Covariance of two securities = Beta (Security 1)× Beta (Security2)×Variance mkt.
(The unsystematic risk of security is peculiar to that security. It is
independent from that of other security and hence the correlation of
unsystematic risk between two securities is zero.)
Covariance AB = 0.80×1.14×(15)2 = 205.20
Covariance BC = 1.14×0.60×(15)2 = 153.90
Covariance AC = 0.60×0.80×(15)2 = 108
(iii) Correlation AB = CovarianceAB
SDA×SDB
Covariance AB = CorrelationAB×SDA×SDB
Overall Portfolio SD
=
√
We replace the [Correlation between (two securities AB)×SA×SB] with Covariance AB

and so on then
=√
=√( ) ( ) ( )

= (1/9×400) + (1/9×324) + (1/9×144) + (2/9×205.20) + (2/9×153.90) + (2/9×108)
= 1802.20/9 = 200.244
(iv) Overall Beta portfolio = Sum of (weight × Beta security)
= 1/3×0.80 + 1/3×1.14 + 1/3×0.60 = 2.54/3 = 0.847
(v) Portfolio systematic risk = (Beta portfolio)2×Variancemarket
= (0.847)2×(15)2 = 161.417
Portfolio unsystematic risk = Total variance portfolio – systematic risk
= 200.244 – 161.417 = 38.827
3.
a) Rolex International Limited has to make payment of US $ 200,000 in three months‟
time. The required amount in US dollars is available with the company. The
management of the company decides to invest them for three months and following
information is also available.
- The US $ interest rate is 9% per annum.
- The sterling pound deposit rate is 11% per annum.
- The spot rate is US $ 1.82/sterling pound.
- The three-month forward rate is US $ 1.80/ per sterling pound.
You are required to answer the following questions: (3+3+2+3=11)
(i) Where should the company invest for better returns?
(ii) Assuming that the interest rate and the spot exchange rate remain as above,
what is the equilibrium US $ forward rate?
(iii) Assuming that the US interest rate and the spot exchange rate remain as above,
where will you invest if interest rate is 15% per annum in UK?
(iv) With the originally stated spot and forward rates and the same US $ deposit
rate, what is the equilibrium sterling pound deposit rate?
b) ABC Bank was established in 2000 and doing banking business. The bank is facing
very critical situation. There are problems of gross non-performing assets (NPA) at
40 percent and capital adequacy ratio (CAR) just at 2 percent. The net worth of the
bank is not good. Shares are not traded regularly. Last week, it was traded at Rs. 4
per share.
The central bank on-site inspection report suggested that bank should either be
liquidated or merged with other bank.

PQR Bank is professionally managed bank with low gross NPA of 5 percent. It has
net NPA as 0 percent and CAR at 16 percent. Its share is quoted in the market at Rs.
64 per share. The board of directors of PQR Bank have submitted a proposal to the
central bank for the takeover of ABC Bank on the basis of share exchange ratio.
The balance sheet details of both the banks are as follows:
(Amount in crores)
Particulars ABC Bank PQR Bank
Rs. Rs.
Paid up share capital (Rs. 10 each) 140 500
Reserve and surplus 70 5,500
Deposits 4,000 40,000
Other liabilities 890 2,500
5,100 48,500
Cash in hand and with central bank 400 2,500
Balance with other banks - 2,000
Investments 1,100 15,000
Loans and advances 3,500 27,000
Other assets 100 2,000
5,100 48,500
It was decided to issue shares at book value of PQR Bank to the
shareholders of ABC Bank. All assets and liabilities are to be taken at
book value.
For the swap ratio, weights assigned to different parameters are as follows:
Gross NPA 40% CAR 10%
Market price 40% Book value 10%
You are required to: (3.5+1.5+4=9)
i) Calculate swap ratio based on above parameters;
ii) Calculate number of shares to be issued; and
iii) Prepare balance sheet after merger.
Solution: 3 (a)
(i) Investment for Better Returns:
Option I: Invest in US $ deposit @ 9% per annum for 3 months
Income = 200,000 x 9/100 x 3 /12 = US $ 4,500
Option II: Available US Dollars may be converted into Pounds at spot rate. Cover forward
position and invest @ 11% per annum for three months
Spot exchange rate: US $ 1.82/£

Therefore, US $ 200,000 = £ 200,000 / 1.82 = £ 109,890.11

Interest earning on £ 109,890.11 @ 11% per annum = £ 109,890.11 x 11 /100 x 3 /12
= £ 3,021.98
Amount £ 109,890.11
Interest £ 3,021.98
£ 112,912.09
Sterling Pound converted to US $ at 1.80 /£ = 112,912.09 x 1.80 = US $ 203,241.76
Therefore, gain under Option II = US $ 203,241.76 – US $ 2,000,000 = US $ 3,241.76
Since the gain under option I (US $ 4,500) is more than gain under option II (US $ 3,241.76)
by US $ 1,258.24, Rolex International Ltd. must invest the money under option I in US $ at
9% per annum.
(ii) Computation of Equilibrium US $ Forward Rate under given interest rate and spot
exchange rate:
In order than an equilibrium situation happens, amount at the end from both the streams
should be equal. Thus, amount invested in sterling covered by forward rate will be:
US $ 200,000 + US $ 4,500 = US $ 204,500
Let forward rate be $ x /£. Therefore, at equilibrium £ 112,912.09 equals 112,912.09 x = US
$ 204,500.
Thus, x = 204,500 /112,912.09 = 1.811
Therefore, forward rate = US $ 1.811 /£
(iii) Interest earned in £ given same spot and forward rate:

Interest earned = £ 109,890.11 x 15 /100 x 3 /12 = £ 4,120.88
Therefore, total £ = 109,890.11 + 4,120.88 = 114,010.99
Total US $ = 114,010.99 x 1.80 = US $ 205,219.78
Gain = US $ 205,219.78 – US $ 2,000,000 = US $ 5,219.78
Earlier gain = US $ 4,500
Additional gain = US $ 5,219.78 - US $ 4,500 = US $ 719.78
Thus, when interest rate is 15% per annum in UK, it would fetch an additional gain of US $
719.78 and should be chosen for investment.
(iv) Computation of Equilibrium Sterling Pound Deposit Rate:
For equilibrium sterling deposit rate, amount invested in sterling equals US $ 2,045,000 after
3 months.
Now, US $ 204,500 converted to £ at forward rate = US $ 204,500 /1.80
= £ 113,611.11.

Let the sterling pound deposit rate be x% per annum. Then,

109,890.11 x x /100 x 3 /12 + 109,890.11 = 113,611.11
Or, 274.725275 x + 109,890.11 = 113,611.11
Or, 274.725275 x = 113,611.11 - 109,890.11 = 3721
Or, x = 3,721 / 274.725275 = 13.54% per annum.
Solution: 3 (b)
(i) Calculation of swap ratio
Parameters Ratio Product

Gross NPA 5:40 5/40 × 40% = 0.0500
CAR 2:16 2/16 × 10% = 0.0125
Market price 4:64 4/64 × 40% = 0.0250
Book value 15:120 15/120 × 10% = 0.0125
0.1000
Thus, from the above calculations, it is evident that for every share of ABC
Bank 0.10 shares of PQR Bank should be issued.
Working note:
Book value of shares of both the banks
(Amount in
Rs)
Particulars ABC Bank PQR Bank
Total assets (in crores) 5,100 48,500
Less: Deposits (in crores) (4,000) (40,000)
Less: Other liabilities (in crores) (890) (2,500)
Net assets (in crores) 210 6,000
Number of shares (in crores) 14 50
Book value per share 15.00 120.00
(ii) Calculation of number of shares to be issued

Rs.140 crores
Number of shares  0.1
Rs.10
1.4 Crore Shares
(iii) Balance Sheet of PQR Bank as at date after merger
Capital & Liabilities Rs. in crores Assets Rs. in crores

Capital 514.00 Cash in hand & with CB 2,900.00

Reserve & surplus 5,500.00 Balance with banks 2,000.00
Capital reserve 196.00 Investments 16,100.00
Deposits 44,000.00 Loan & advances 30,500.00
Other liabilities 3,390.00 Other assets 2,100.00
53,600.00 53,600.00
Working note:
Calculation of capital reserve
Book value of shares = Rs. 210.00 crores
Value of shares issued = Rs. 14.00 crores
Capital reserve = Rs. 196.00 crores
4. Answer the following questions: (5×3=15)

a) Distinguish between cross hedging and currency diversification.
b) Write a brief note on „credit default swap‟.
c) What do you understand by „viability gap funding‟? Explain.
d) What are the signals that indicate that it is time for an investor to exit a mutual
fund scheme? Elaborate.
e) Distinguish between restricted and unrestricted American depository receipts.
Answer: Question 4
a) Distinguish between cross hedging and currency diversification
Cross hedging and currency diversification are methods of reducing transaction risk of
foreign currency.
Cross-hedging is a common method of reducing transaction exposure when the currency
cannot be hedged. This type of hedge is sometimes referred to as a proxy hedge because
the hedged position is in a currency that serves as a proxy for the currency in which the
multi-national company (MNC) is exposed. The effectiveness of this strategy depends on
the degree to which these two currencies are positively correlated. The stronger the
positive correlation, the more effective will be the cross-hedging strategy.
Currency diversification can limit the potential effect of any single currency‟s movements
on the value of an MNC. MNC should check the correlation of the currency of the
investing county with the home country. Lower correlation can reduce the variability of
the value of home currency and vice versa.
b) Credit default swap:

A credit default swap (CDS) is a specific type of counterparty agreement which allows
the transfer of third-party credit risk from one party to the other.
CDS act in a similar way to insurance policy. When two parties enter into a CDS, the
buyer agrees to pay a fixed spread (like insurance premium) to the seller. In return the
seller agrees to purchase a specified financial instrument from the buyer at the
instrument‟s par value in the event of default.
c) Viability gap funding
The viability gap funding scheme is aimed at providing upfront capital grant to public
private partnership (PPP) projects to enable financing of commercially unviable projects.
The level of grant is the net present value of the gap between the project cost and
estimated revenue generation over the concession period based on a user fee that was to
be levied in a pre-determined manner. Such funding arrangement is required in large
infrastructure projects such as Metro rail, Speed Highway etc.
d) What are the signals that indicate that is time for an investor to exit a mutual fund
scheme?
The signals that indicate that it‟s the time for an investor to exit a mutual fund scheme are
as follows:
1. When the mutual fund consistently under performs the broad based index, it is high
time that one should get out of the scheme.
2. When the mutual fund consistently under performs its peer group instead of it being
at the top. In such a case, one would have to get out of the scheme and then invest in
the winning schemes.
3. When the mutual fund changes its objectives e.g. instead of providing a regular
income to the investor, the composition of the portfolio has changed to a growth fund
mode which is not in tune with the investor‟s risk preferences.
4. When the investor changes his objective of investing in a mutual fund and the mutual
fund no longer is beneficial to him.
5. When the fund manager, handling the mutual fund schemes, has been replaced by a
new entrant whose image is not known.
e) Distinction between restricted and unrestricted American depository receipts:
Depository receipts issued by a company in the United States of America (USA) are
known as American Depository Receipts (ADRs). The issue of ADRs is subject to the
stringent provisions stipulated by the Securities and Exchange Commission (SEC) of
USA.

Restricted ADRs are allowed to be placed only among selected accredited investors and
face restriction on their resale. Since these ADRs are not issued to the public, there is no
need of its registration with SEC and are exempt from its reporting requirements.
Unrestricted ADRs are issued to and traded by the general investing public in United
States capital markets. There are three classes of unrestricted ADR and terms of reporting
requirements to SEC in each one of these classes is more exhaustive and stringent.
5.
a) There are two mutual funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. each
having close ended equity schemes. Net assets value (NAV) as on 31-12-
2017 of equity schemes of D Mutual Fund Ltd. is Rs. 70.71 (consisting 99% equity
and remaining cash balance) and that of K Mutual Fund Ltd. is Rs. 62.50 (consisting
96% equity and balance in cash).
Followings are the other information:
Equity Schemes
Particular
D Mutual Fund Ltd. K Mutual Fund Ltd.
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Standard Deviation 11.25 5
There is no change in portfolios during the next month and annual average cost is Rs.
3 per unit for the schemes of both the mutual funds.
If share market goes down by 5% within a month, calculate expected NAV after a
month for the schemes of both the mutual funds. 8
(For calculation, consider 12 months in a year and ignore number of days for
particular month.)
b) Lhamer Ltd. is considering a new plant in the Netherlands. The plant will cost 52.50
million Guilders. Incremental cash flows are expected to be 6 million Guilders per
year for the first 3 years, 8 million Guilders the for the next three, 10 million Guilders
in year 7 through 9 and 12 million Guilders in year 10 through 19, after which the
project will terminate with no salvage value. The current exchange rate is 1.90
Guilders per $. The required rate of return on repatriated $ is 16%.
You are required to find out: (3.5+3.5 =7)
i) Net present value (NPV) of the project if the exchange rate stays at 1.90 Guilders
per $.
ii) What happens to the NPV if the guilder appreciates to 1.84 for
years 1 – 3, to 1.78 for years 4 – 6, to 1.72 for years 7 – 9, and to
1.65 for years 10 – 19 per $.

Solution: 5 (a)
Working Notes
(i) Decomposition of Funds in Equity and Cash Component

NAV on 31.12.17 Rs. 70.71 Rs. 62.50
% of Equity 99% 96%
Equity element in NAV Rs. 70 Rs. 60
Cash element in NAV Rs. 0.71 Rs. 2.50
(ii) Calculation of Beta

(a) D Mutual Fund
Sharpe Ratio = 2 = =
E(R) – Rf = 22.50
Treynor Ratio = 15 = =
βD = 22.50/15 = 1.50
(b) K Mutual Fund Ltd.
Sharpe Ratio = 2 = =
E(R) – Rf = 16.50
Treynor Ratio = 15 = =
Βk= 16.50/15 = 1.10
(iii) Decrease in the Value of Equity
Market goes down by 5.00% 5.00%
Beta 1.50 1.10
Equity Component goes down 7.50% 5.50%
(iv) Balance of Cash after 1 month

Cash in Hand on 31.12.17 Rs. 0.71 Rs. 2.50

Less: Exp. Per month Rs. 0.25 Rs. 0.25

Balance after 1 month Rs. 0.46 Rs. 2.25
NAV after 1 month

Value of Equity after 1 month
70 × (1 – 0.075) Rs. 64.75 -
60 × (1 – 0.055) - Rs. 56.70
Cash Balance 0.46 2.25
65.21 58.95
Solution: 5 (b)
Year→ 0 1–3 4–6 7–9 10 – 19

Cash Flows (in million Guilders) (-) 52.5 6.0 8.0 10.0 12.0
Guilder/$ Exchange Rate 1.90 1.90 1.90 1.90 1.90
Cash Flows (in $) (-) 27.63158 3.158 4.211 5.263 6.316
PVF @ 16% 1 2.246 1.438 0.922 1.27
Present Value (-) 27.63158 7.09287 6.05542 4.85249 8.02132
Therefore, NPV at 16% = (-) 27.63158 + 7.09287 + 6.05542 + 4.85249 + 8.02132 = (-) $
1.60948 million.
Since the NPV is negative, the project is not acceptable.
Note: The PVF has been derived in the following manner:
Year PV Factor
0 1.000
1–3 0.862 + 0.743 + 0.641 = 2.246
4–6 0.552 + 0.476 + 0.410 = 1.438
7–9 0.364 + 0.306 + 0.263 = 0.922
10 – 19 0.227 + 0.195 + 0.168 + 0.146 + 0.125 + 0.108 + 0.093 + 0.080
+ 0.069 + 0.60 = 1.27
Year→ 0 1–3 4–6 7–9 10 – 19
Cash Flows (in million Guilders) (-) 52.50 6.0 8.0 10.0 12.0
Guilder/$ Exchange Rate 1.90 1.84 1.78 1.72 1.65
Cash Flows (in$) (-)27.63158 3.26087 4.49438 5.81395 7.27273
PVF @ 16% 1 2.246 1.438 0.922 1.27

Present Value (-)27.63158 7.32391 6.46292 5.36046 9.23637
Therefore, NPV at 16% = (-) 27.63158 + 7.32391 + 6.46292 + 5.36046 + 9.23637 =

$ 0.75208 million.
With the Guilders appreciating relative to the $, cash flows are greater. The project is now
acceptable as NPV has become positive, but not by a wide margin.
6.
a) Define financial system and explain its components. 5
b) The stock of Excel Ltd. is currently trading at Rs. 1,340 and call option exercisable
in three months‟ time has a strike price of Rs. 1,300. The standard deviation of
continuously compounded stock price change for Excel Ltd. is estimated to be 60%
per year. The annualized Treasury Bill rate corresponding to this option life is 8%.
You are required to compute the value of a three month call option on the stock
of Excel Ltd. using Black Scholes model, 5
Note:
Extracted from the tables:
(1) Natural logarithm: Ln (0.9701) = -0.0303
Ln (1.0308) = 0.0303
(2) Value of e-x: e-0.02 = 0.9802, e-0.016 = 0.9841
(3) For N (X) where X ≥ 0: N (0.3177) = 0.6246
N (0.0177) = 0.5071
where X ≤ 0: N (- 0.3177) = 0.3754
N (- 0.0177) = 0.4929
Answer: 6 (a)
Financial system is an institutional framework existing in a country to enable financial
transaction. It is a set of arrangement consisting of lending and borrowing of funds by non-
financial economic units and intermediation of this function by financial intermediaries in
order to facilitate the transfer of funds, to create additional money when required and to
create market in debt and equity instrument and their derivatives so that the price and
allocation of funds are determined efficiently.
Financial system helps in formation of capital and meeting the needs of the short term and
long term capital of the households, corporate houses, government and foreigners. Its
responsibility is to mobilize the savings in the form of money and invest them in the
productive manner.
Thus we can find the following six essential components in the financial system:
1. Lenders and borrowers; i.e. the non-financial economic units that undertake the lending
and borrowing process.

2. The financial intermediaries that intermediate the lending and borrowing process.
3. The financial instruments that are created to satisfy the needs of the participants in
lending and borrowing process.
4. The creation of money when required.
5. The financial market, i.e. the institutional arrangements that exist for the issue and trading
of the financial instruments.
6. The price discovery; i.e. the determination of the price of equity and debt.
There are some allied participants in the system without which the system will not work
efficiently. They are: i) brokers and dealers, ii) portfolio managers, iii) financial exchanges
that facilitate the transactions and settlement, iv) credit rating agencies, and v) the regulators
that regulate and supervise all players in the financial system.
Solution: 6 (b)
(i) Value of Call option (using Black Scholes model)
Value of Call option (using Black Scholes model)
Vco = Vs N (d1) – E e-rt – N (d2), where
Vs = Current price of stock = Rs. 1,340
E = Exercise price = Rs. 1,300,
r = Risk-free rate = 0.08
t = 0.25 year
Now d1 = ln (Vs /E) + [R + 0.5σ2] x t = ln (1,340 /1,300) + [0.08 + (0.5 x 0.62)] x
0.25
σ√t 0.6 √0.25
= ln (1.0308) + 0.065 = 0.0303 + 0.065 = 0.0953 = 0.3177
0.3 0.3 0.3
d2 = d1 - σ√t = 0.3,177 – 0.30 = 0.0177
N (d1) = N (0.3177) = 0.6246, N (d2) = = N (0.0177)
Thus, value of Call option (Vco) = Vs N (d1) – E e-rt N (d2)
x 0.25
Where e-rt = e- 0.02 = 0.9802
Thus, Vco = (1,340 x 0.6246) – (1300 x 0.98020 x 0.5071) = 836.96 – 646.18 = Rs.
190.78


Batch: -June 2018
Level: -CAP-III
Paper 2: Advanced Financial Management
1. Performance of the candidates in this question was found to be very poor. It was clearly
observed that majority of the candidates did not understand the very fundamental
principles of finance. They depicted their poor knowledge on the concept of incremental
and relevant costs/revenues for the decision-making. The answers given by candidates
were not properly structured in the way required by the question even though individual
components calculated in a scattered way were correct to some extent. In general,
following mistakes were committed:
a) Excepting few, candidates were not able to follow the concept of incremental
depreciation for the first three years of the project period.
b) Surprisingly few candidates calculated depreciation on total net cash outflows.
c) While preparing cash flows statement, large number of candidates included cash
flows relating to increment in working capital in all the years of project life instead of
injecting it in year 0 and recovering in year 6.
d) Though the question was very much clear about the requirement of an additional
mechanic through fulfillment of vacant position, large number of candidates simply
thought it as an irrelevant cost and excluded from the cash flows calculations. This
ultimately led to remaining solutions and conclusion being wrong.
e) Few candidates wrongly understood the question as revenues from the project to
increase by given amount (Rs. 1,850,000) each year and kept on adding the given
amount to find out the revenues for the following years.
f) Instead of preparing cash flows table covering entire project life (6 years), large
number of candidates simply put it in paragraphs citing particular cost/revenue as
being relevant or irrelevant with an remark added to them.
g) Majority of the candidates could not calculate cost of debt correctly thereby leading to
wrong calculation of WACC, NPV and the nominal rate of return though nearly
almost candidates correctly calculated cost of equity.
h) Many candidates failed to calculate nominal cash flows by adjusting inflation to the
real cash flows. Instead, many of them simply discounted real cash flows with the
nominal discount rate. Majority of the candidates were not aware of the fact that
discounting real cash flows with real discount rate and discounting nominal cash
flows with nominal discount rate will produce the same result.
i) Majority of the candidates could not point out the impact of inflation on a project's
cash flows and the ways to handle them properly. From the answers given by
candidates, it is observed that much attention is not being paid for the theoretical part
of the syllabus while preparing for the examination.
2. Around 32% of total students secured pass marks i.e 8 or more. Very few students have
correctly attempted part (a) of this question compare to part (b).
3. Around 30% only up to mark below 40%.
4. Majority of the candidates did not have knowledge on cross heading. Credit default swap,
(d) was answered by most of the candidates properly. Conceptual knowledge is lagging in
students which to be thoroughly improved.

5. Most of the students have tried to solve both sub-questions and fairly answered.
6.
a) Most of the students describe financial management for Financial System in
part.
b) Students who had done the answer, secured good marks/calculation of L1 is
wrong, who had not secured the marks.

CAP II Paper 3: Advanced Audit and Assurances
Paper 3:
Advanced Audit and Assurance

Roll No……………. Maximum Marks - 100
Total No. of Questions - 6 Total No. of Printed Pages -12

Marks
1. Comment and give your views with reasons on each of the following cases, giving
consideration to respective Standards, Laws and Code of Ethics:
a) Ram is a Chartered Accountant and a member of ICAN. He is employed as an
Finance Manager of a public listed company and is responsible for the financial
reporting of the company. He is also well remunerated by the company and is paid
an annual bonus determined based on the profit before tax earned during the year.
During the current year, it came to Ram‟s attention that a machine with a net book
value of Rs. 2 Crore is idling and cannot be used for the activities of the company.
Also this asset cannot be sold to a third party. Therefore, the company is required to
make adjustments in the value of the asset for impairment. However, in addition to
an increase in expenses during the year, this adjustment will also adversely affect the
profits of the company. As a result, the annual bonus payment of Ram will be
affected.
Required:
i) Explain three reasons why ethical behavior is important to Ram as a Finance
manager who is involved in financial reporting of the company. 3
ii) Explain the types of threat that will affect the professional ethical behavior of
Ram in this situation. 3
iii) State the safeguard available to Ram against the threat identified above. 2
iv) State two fundamental ethical principles as per the Code of ethics for
professional Accountants that Ram will violate if he decides not to recognize
impairment in the value of asset during the year. 2
b)
i) A company is engaged in telecom business. The company is listed with Nepal
stock exchange and management of the company is provided handsome
incentives based on revenue growth. The management explains to the auditor
that the revenue recognition is fully automated and there have been no auditor‟s
remark on revenue recognition for last several years and accordingly the auditor
is convinced and instructs the audit team for not focusing on revenue audit
because there is no risk of fraud on revenue recognition. 5

ii) A machinery was purchased at Rs 1 crore on 1 Shrawan 2071 by a Company.

The company's policy was to charge depreciation @ 20% on reducing balance
method. The company management is of the view that straight line method of
depreciation will reflect the pattern in which economic benefits from the asset is
consumed and decides to change the policy of charging depreciation on straight
line basis from 2073/74 and financial statement of 2073/74 is yet to be signed.
The chief finance officer intends to give retrospective effect by adjusting
depreciation expenses of comparative year 2072/73 and retained earning for the
difference amount of 2072/73 and 2071/72 5
Answer:
1 a)
i. Ethical behavior is important to all the members of the ICAN. Ram is in the
profession of accountancy and member of ICAN and he is supposed to adhere to the
professional code of ethics. Since he is in financial reporting function, there are users
of those reporting who will rely on those and make decisions. Especially Ram is
working for a public listed company and as a result there is wider coverage of users of
financial statement. Therefore, it is Ram‟s responsibility to prepare those financial
statements accurately. The financial statements to be prepared honestly as the tax
payments also depend on these. Therefore Ram‟s ethical behavior serves to protect
public interest.
ii. Ram‟s annual bonus is determined based on the profits earned by the company. He
knows if the impairment charge is recognized there is a deterioration of profits which
will affect the bonus payment. He needs to make the correct decision but he may be
tempted due to his financial interests. It is called “self-interest”. Due to his financial
benefit he can decide not to go ahead with impairment charge recognition.
iii. Protection available for Ram:
Ram has to be committed to the ethical behavior in this regard. He has to forget about
his financial interest and discharge his duties.
iv. If Ram decides not to recognize the value of asset write down during the year, he will
violate the following fundamental ethical principles as per the code of ethics for
professional Accountants.
– Integrity
– Objectivity
– Professional behavior
b)
i) Fraud Risk in Revenue Recognition:
As per NSA 240: Auditors‟ responsibility relating to fraud in an audit of financial statements,
when identifying and assessing the risks of material misstatement due to fraud, the auditor
shall, based on a presumption that there are risks of fraud in revenue recognition, evaluate

which types of revenue, revenue transactions or assertions give rise to such risks. Where the
auditor concludes that the presumption is not applicable in the circumstances of the
engagement and, accordingly, has not identified revenue recognition as a risk of material
misstatement due to fraud, appropriate documentation should be made.
In the given case, since the management of the company is provided incentive based on
revenue growth, the risk of fraud in overstating revenue seems high. So, the auditor should not
accept the management‟s explanation of less risk in revenue recognition and the presumption
of high fraud risk in this case seems un-rebuttable despite the fact that there was no history of
misstatements in revenue recognition. Students may refer following provisions while
answering this question, so consider about awarding marks.
The Nepal Chartered Accountants Act 1997 Section 34 (6) mentions that members holding
Certificate of Practice shall not certify any financial statement or give report of any type until
they or their partner or employee checks and verifies it.
NSA 330 para 18 irrespective of assessed risks of material misstatement, the auditor
shall design and perform substantive procedures for each material class of transaction,
account balance and disclosures.
b)ii) Change in method of depreciation:
NAS 8 defines change in accounting estimate as “an adjustment of the carrying amount of
an asset or a liability, or the amount of the periodic consumption of an asset, that results
from the assessment of the present status of, and expected future benefits and obligations
associated with, assets and liabilities”. Changes in accounting estimates result from new
information or new developments and accordingly, are not corrections of errors.
So, the change in method of depreciation in the given case from reducing balance method
to straight line method is the change in accounting estimate and not the change in
accounting policy because it results into adjustment of the amount of periodic consumption
of an asset.
Further, as per the said NAS, the effect of a change in an accounting estimate shall be
recognized prospectively by including it in profit or loss in:
(a) the period of the change, if the change affects that period only; or
(b) the period of the change and future periods, if the change affects both.
So, the amount of depreciation in year 2073/74 and onwards will be charged as per the new
method of depreciation (i.e. Straight line method) over the useful life of machinery and there
is no need to make retrospective adjustment (as intended by Chief Finance Officer) in the
value of machinery and depreciation expenses and retained earnings.
2. Answer the following:

a) Everest Construction Ltd. carries out construction activities in Nepal. At the beginning
of the year 2072, the internal audit plan was agreed by the board of directors of the
company. Purchasing of construction materials is an area specified in the internal
auditor‟s plan, for internal control testing. The internal auditor has carried out his
testing and submitted a draft report to the board of directors of the company.

Required:
i) Identify two risks the company may have over its process of purchasing
construction material. 2.5
ii) Explain the role of internal controls within an entity in reducing the risks of its
purchasing process. 2.5
iii) Identify the responsibilities of the internal auditor for the internal controls of the
company. 2.5
iv) Identify the responsibilities of the board of directors of the company for the
internal controls of the company. 2.5
b) You are appointed as an auditor of a life insurance company for year 2070/71. Your
audit team raised the following major concerns in this audit.
Item Total NPR Value Remarks

value in the selected in
financial the sample
statement
Insurance 10 Arab 10 crore Premium of 1 crore could be verified
premium (100 files) and other files were not made
available. The verified files indicates
overstatement of premium by 25 lakh
Insurance 3 Arab 1 Arab (50 Claim of 20 crore could be verified
claim files) and other files were not made
available. The verified file revealed
understatement of claim by Rs 2
cores.
Investment 50 Arab 5 Arab Evidence of only 1 Arab were
produced indicating no discrepancies.
Premium and claim represents 80% and 30% of total income and expenses
respectively. Similarly investment accounts for 80% of total assets of the company.
The team is under dilemma on how to frame audit opinion. Please guide your team as
the engagement partner with extract from audit report. 10
Answer:
2 a)
i. The internal control of an organization reduces the risks at the level of business
processes and operations. The purchasing process has many risks. Some of them are;
a. Selection of wrong supplier
b. Placing orders for items not required
c. Making payments for materials which are not in good condition.
d. Making purchases at higher prices

ii. If sound internal controls are established around the purchasing process of the
company, these will help to reduce the risks, and will provide reasonable assurance
regarding the achievement of the objectives in areas such as:
a. Effectiveness and efficiency of purchasing-the purchases can be made at the right
time at the right price
b. Reliability of financial information-the financial statements may be accurate and free
of errors
c. Compliance with rules and regulations related to purchases
iii.The internal auditor provides management with information and recommendations
about internal controls. He does not have a direct responsibility for internal controls.
The internal auditor‟s responsibility is to investigate control system of Everest
Construction Ltd as per the annual internal audit plan given, and report the findings to
the board/audit committee, with the recommendations.
iv. The board of directors has the final responsibility for the effectiveness of the internal
control system of the company.
The board is responsible for ensuring that the company has an effective control
system. The board should review the design and effectiveness of the system of internal
controls.
For this the board can get the help of internal auditors. The board is ultimately
responsible to the shareholders.
b)
Audit Opinion on financial statements of life insurance company:
Premium income and claim expenses of life insurance company are major items of
income and expenditures as mentioned in the given case also (premium represents
80% of total income and claim represents 30% of total expenses). Further investment
is the major asset item of a life insurance company. It seems from the case that auditor
could not obtain sufficient evidence for audit of these major items as summarized
below:
 Premium: out of sample selected, only 10% could be verified and in verified items
misstatement by 25% was noted.
 Claims: out of sample selected, only 20% could be verified and in verified sample
misstatement by 10% was noted.
 Investment: out of sample selected, only 20% could be verified and no
misstatements were found in verified cases.
So, major portion of income, expenditures and assets of the financial
statements could not be verified by the auditor in the absence of evidence. Further the
verified evidences indicate misstatements in income and expenditure whereas no
misstatements were noted in investment (i.e. assets) based on verification. Hence the
possible effect on the financial statements of misstatements that are undetected due to
inability to obtain sufficient evidence could be material and pervasive. So, it appears
that the auditor should disclaim his opinion in this situation.
Extract from audit report applicable in this situation is:

Report on the Financial Statements

We were engaged to audit the accompanying financial statements of ..., which
comprise the statement of ........
Auditor‟s Responsibility
Our responsibility is to express an opinion on these financial statements based on
conducting the audit in accordance with Nepal Standards on Auditing. Because of the
matter described in the Basis for Disclaimer of Opinion paragraph, however, we were
not able to obtain sufficient appropriate audit evidence to provide a basis for an audit
opinion.
Basis for Disclaimer of Opinion

Premium income and claim expenses are stated as NPR 10 arab and 3 arab
respectively. We have selected sample representing 1% and 33.33% of these for
verification but the company could not provide any evidence for verification of 90%
and 80% of selected samples for premium and claims respectively. Further in the
limited verification of premium and claims we noted understatement of premium
income by 25 lakh and overstatement of claim expenses by 2 crores. So, the possible
effect in the financial statements of misstatements on premium and claims that was not
verified could be material and pervasive.
Further, investment is stated at NPR 50 arab. We selected samples to verify 10% of

investment but could not verify 80% of selected samples in want of evidences. There
could be misstatements in unverified investments and the possible effect could be
material and pervasive.
As a result, we were unable to determine whether any adjustments were necessary in

respect of premium, claim, investment and other items of financial statements.
Disclaimer of Opinion
Because of the significance of the matter described in the Basis for Disclaimer of
Opinion paragraph, we have not been able to obtain sufficient appropriate audit
evidence to provide a basis for an audit opinion. Accordingly, we do not express an
opinion on the financial statements.
3. Comment and give your views with reasons on each of the following cases:
a) In the course of audit of Alibaba Ltd., its auditor Mr. Jacob observed that there was a
special audit conducted at the instance of the management on a possible suspicion of a
fraud and requested for a copy of the report to enable him to report on the fraud
aspects. Despite many reminders it was not provided. In absence of the special audit
report, Mr. Jacob insisted that he be provided with at least a written representation in
respect of fraud on/by the company. For this request also, the management remained
silent. Please guide Mr. Jacob as per the relevant provisions of Nepal Standards on
Auditing. 7

b) Amul Ltd., dealing in manufacturing and trading of milk butter, has a benchmark in its
product for so many years. DTC Ltd., a rival company to Amul Ltd., has introduced its
new product, peanut butter. Due to being health conscious, the consumers have shifted
from milk butter to peanut butter within few months. This has resulted into massive
loss during the year to Amul Ltd. due to non-selling of perishable milk products. The
company has also started having negative net worth. It's production head, finance head
and marketing head have also left the company. The company has no sound action
plan to mitigate these situations. Kindly guide the auditor of Amul Ltd., how he should
deal with the situation. 8
Answer:
3 a) Auditor‟s Responsibilities Relating to Fraud: As per NSA 240 on “The Auditor‟s

Responsibilities Relating to Fraud in an Audit of Financial Statements”, the auditor is
responsible for obtaining reasonable assurance that the financial statements, taken as a
whole, are free from material misstatement, whether caused by fraud or error. As per
NSA 580 “Written Representations”, if management modifies or does not provide the
requested written representations, it may alert the auditor to the possibility that one or
more significant issues may exist.
In the instant case, the auditor observed that there was a special audit conducted at the
instance of the management on a possible suspicion of fraud. Therefore, the auditor
requested for special audit report which was not provided by the management despite
of many reminders. The auditor also insisted for written representation in respect of
fraud on/by the company. For this request also management remained silent. It may be
noted that, if management does not provide one or more of the requested written
representations, the auditor shall discuss the matter with management; re - evaluate the
integrity of management and evaluate the effect that this may have on the reliability of
representations (oral or written) and audit evidence in general; and take appropriate
actions, including determining the possible effect on the opinion in the auditor‟s
report.
If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor
encounters exceptional circumstances that bring into question the auditor‟s ability to
continue performing the audit, the auditor shall:
1. Determine the professional and legal responsibilities applicable in the
circumstances, including whether there is a requirement for the auditor to report
to the person or persons who made the audit appointment or, in some cases, to
regulatory authorities;
2. Consider whether it is appropriate to withdraw from the engagement, where
withdrawal from the engagement is legally permitted; and
3. If the auditor withdraws:
a. Discuss with the appropriate level of management and those charged with
governance, the auditor‟s withdrawal from the engagement and the reasons for
the withdrawal; and
b. Determine whether there is a professional or legal requirement to report to the
person or persons who made the audit appointment or, in some cases, to

regulatory authorities, the auditor‟s withdrawal from the engagement and the
reasons for the withdrawal.
b)
i) Inability to Continue as a Going Concern:
As per NSA 570 on “Going Concern”, it is the responsibility of the Auditor to obtain
sufficient appropriate audit evidence about the appropriateness of management‟s use
of the going concern assumption in the preparation and presentation of the financial
statements and to conclude whether there is a material uncertainty about the entity‟s
ability to continue as a going concern.
The auditor shall evaluate management‟s assessment of the entity‟s ability to
continue as a going concern. In evaluating management‟s assessment, the auditor
shall consider whether management‟s assessment includes all relevant information
of which the auditor is aware as a result of the audit.
In the instant case, Amul Ltd. has suffered massive loss due to introduction of a
substitute of its product by its rival company, DTC Ltd., and having negative net
worth also. Besides this, its production head, finance head and marketing head have
also left the company. The company, in addition, has no action plan to mitigate these
situations. Thus there are clear indications that there is danger to entity‟s ability to
continue in future. Considering the fact that there is no sound plan of action from the
management to mitigate these factors and to put the company back on the recovery,
the going concern assumption does not hold appropriate.
Therefore, the auditor should ask the management for its adequate disclosure in the
financial statement and include the same in his report. However, if the management
fails to make adequate disclosure, the auditor should express a qualified or adverse
opinion. If the result of the inappropriate assumption used in the preparation of
financial statements is so material and pervasive as to make the financial statements
misleading, the auditor should express an adverse opinion.

a) ABC Limited has applied to a bank for loan facilities. The bank on studying the
financial statements of the company notices that you are the auditor and requested you
to call at the bank for a discussion. In the course of discussion, the bank asked for the
opinion regarding the company and also asked for detail information regarding a few
items in the financial statements. The information is available in your working file.
Should you share the requested information with the bank? 7
b) What are the professional behavior impose by „the Code of Ethics‟ for Professional
Accountants issued by The Institute of Chartered Accountants of Nepal (ICAN) while
providing “Second Opinion”. 8
Answer:

4 a) Sharing the information of an audit client with the banker of the client:
Related provisions and requirements on maintaining confidentiality of client‟s
information and the need to share information from working file is presented below:
 Section 34(5) of Nepal Chartered Accountants Act, 1997 states ―a member of
ICAN shall not disclose or divulge any information and explanations acquired in the
course of professional service to any person other than the employer employing him
and the person whom he is compelled by law to do so. A member in practice shall
deemed to be guilty of professional misconduct if he disclosed information acquired
in the course of his professional engagement to any person other than his client,
without the consent of the client or otherwise than required by law for the time being
in force.
 Further one of the fundamental principle of ICAN Code of Ethics is “to respect the
confidentiality of information acquired as a result of professional and business
relationships and, therefore, not disclose any such information to third parties
without proper and specific authority, unless there is a legal or professional right or
duty to disclose, nor use the information for the personal advantage of the
professional accountant or third parties”.
 NSA 230 on ― Audit Documentation states ―working papers are the property of
the auditor. The auditor may at his discretion, make portions of or extract from his
working papers available to his clients.
In the instant case, the bank has asked the auditor for detailed information regarding a
few items in the financial statements available in his working papers. Having regard to
the position stated earlier, the auditor cannot disclose the information in his possession
without specific permission of the client as far as working paper are concerned.
Further, there is no requirement compelling the auditor to divulge information
obtained in the course of audit and included in the working papers to any outside
agency except as when required by any law.
So, I would not share the confidential information of the client with the bank (unless
permission is granted by the client) and explain my professional duty to the banker to
comply with CA Act and code of conduct issued by ICAN.
b) As per Sec 230 of “The Code of Ethics for Professional Accountants" Situations where a
professional accountant in public practice is asked to provide a second opinion on the
application of accounting, auditing, reporting or other standards or principles to specific
circumstances or transactions by or on behalf of a company or an entity that is not an
existing client may create threats to compliance with the fundamental principles. For
example, there may be a threat to professional competence and due care in
circumstances where the second opinion is not based on the same set off acts that were
made available to the existing accountant or is based on inadequate evidence. The
existence and significance of any threat will depend on the circumstances of the request
and all the other available facts and assumptions relevant to the expression of a
professional judgment.

When asked to provide such an opinion, a professional accountant in public practice

shall evaluate the significance of any threats and apply safeguards when necessary to
eliminate them or reduce them to an acceptable level. Examples of such safeguards
include seeking client permission to contact the existing accountant, describing the
limitations surrounding any opinion in communications with the client and providing the
existing accountant with a copy of the opinion.
If the company or entity seeking the opinion will not permit communication with the
existing accountant, a professional accountant in public practice shall determine
whether, taking all the circumstances into account, it is appropriate to provide the
opinion sought.

a) What do you mean by forecast and prospective financial information? Explain the
statement that “An auditor generally provides negative assurance while reporting on
forecast”. Whether an auditor can provide reasonable assurance on forecast? (2+4+2=8)
b) You are the audit manager in charge of the audit of “Everest Nepal Limited”, which is
a newly formed company engaged in the production of Iron Rods. The company‟s
main shareholder is the managing director who is also in charge of production. The
company employs around 250 employees at present. There is an accountant who is
semi-qualified and there are five other staffs assigned to maintain the books of
accounts.
As the Managing Director is very busy with operations, you have had various
discussions with the accountant about the scope and timetable for the audit. You have
sent the draft letter of engagement to the managing director for acceptance but you
have not yet received a response to it.
Explain the purpose of a letter of engagement and why it is sent before any new audit
appointment is accepted. State four (4) main contents of a letter of engagement.
Discuss actions you would take in response to the non-reply by the management to
your draft letter of engagement. 7
Answer:
5 a) Forecast: A “forecast” means prospective financial information prepared on the basis

of assumptions as to future events which management expects to take place and the
actions management expects to take as of the date the information is prepared (best-
estimate assumptions).
Prospective financial information” means financial information based on assumptions
about events that may occur in the future and possible actions by an entity. It is highly
subjective in nature and its preparation requires the exercise of considerable judgment.
Prospective financial information can be in the form of a forecast, a projection or a
combination of both, for example, a one year forecast plus a five year projection.

Assurance on Forecast: Forecast relates to events and actions that have not yet
occurred and may not occur. While evidence may be available to support the
assumptions on which the forecast is based, such evidence is itself generally future
oriented and, therefore, speculative in nature, as distinct from the evidence ordinarily
available in the audit of historical financial information. The auditor is, therefore, not
in a position to express an opinion as to whether the results shown in the forecast will
be achieved.
Further, given the types of evidence available in assessing the assumptions on which
the forecast is based, it may be difficult for the auditor to obtain a level of satisfaction
sufficient to provide a positive expression of opinion that the assumptions are free of
material misstatement. Consequently, when reporting on the reasonableness of
management‟s assumptions the auditor provides only a moderate level of assurance;
i.e. negative form of assurance.
However, when in the auditor‟s judgment an appropriate level of satisfaction has been
obtained, the auditor is not precluded by the standard from expressing positive
assurance regarding the assumptions. That is, an auditor can provide reasonable
assurance (in the form of positive assurance) based on his level of satisfaction.
b) The purpose of a letter of engagement is to clearly define the extent of the

auditor‟s/management responsibilities and to minimize the possibility of any
misunderstanding between the auditor and the client. If a letter of engagement is not
sent to clients both new and existing, there is scope for argument and
misunderstandings about the precise extent of the respective obligations of the clients
and its auditor and directors.
The main contents of a letter of engagement are
i. The objective and scope of the audit
ii. The auditor‟s responsibilities
iii. Management‟s responsibilities
iv. Identification of the applicable financial reporting framework for the preparation of
the financial statements
v. Reference to the expected form and content of any reports to be issued by the
auditor and a statement that there may be circumstances in which a report may
differ from its expected form and content.
The auditor should make an appointment to meet the MD and clearly explain the pre-
conditions of the audit to him and ensure that the letter is signed before the
commencement of the audit. The auditor shall not accept the audit engagement or not
commence any audit work until the engagement letter is signed.

a) Reserved Capital& Capital Reserve
b) Environmental audit
c) Walk Through Tests

d) Application Control in Information Technology

e) Cut-off Procedures
Answer:
6 a) Reserve Capital
A limited company may, by a Special Resolution determine a portion of its share
capital not being called-up, is to be kept reserved and shall be called-up, in the event
and for the purpose of being wound-up.
Capital Reserve
Certain capital profit is transferred to Capital Reserve, which is not a free-reserve. It
is not available to distribute as dividend to shareholders. It is generally utilized to
write-off capital losses. For example, Profit on re-issue of forfeited shares
b) Environmental Audit
Environmental audits are reviews of a company‟s operations and processing for the
purpose of assessing compliance with environmental rules and regulations. It is the
critical analysis of the following aspects that relates to the environment.
 Policies
 Principles
 System and procedures
 Practices
c) A walk through is a procedure in which an auditor traces a transaction from its
initiation through the company‟s information systems to the point when it is reflected
in the financial reports. The auditor should perform one walk through, at a minimum,
for each major class of transactions. A walk through provides evidence to confirm
that the auditor understands:
1. The process flow of transactions,
2. The design of identified controls for internal control components, including
those related to preventing and detecting fraud, and
3. Whether all points in the process have been identified at which misstatements
related to relevant financial statement assertion could occur.
Walk through also provides evidences to evaluate the effectiveness of the controls
design and confirm that the controls have been placed in operation.
d) Application controls in information technology— Manual or automated procedures

that typically operate at a business process level. Application controls can be
preventative or detective in nature and are designed to ensure the integrity of the
accounting records. Accordingly, application controls relate to procedures used to
initiate, record, process and report transactions or other financial data.
e) Cut-off procedures mean procedures employed to ensure the separation of

transactions at the end of the year from those in the commencement of the next year.
Usually, the problem of overlapping is found in inventory accounting since quite

often goods are sold but passed on to the buyer only after the year is over or goods are
bought but received only after the close of the year. This situation may create
considerable problem for the proper stock taking of inventory. Therefore, the
principal areas of application of cut-off procedures involve sales, purchases and
stock. The auditor should satisfy himself by examination and test check that
procedures adequately ensure that:
(i) Goods purchased for which property has been passed to the client have in fact
been included in inventories and that the liability if any, has been provided
for.
(ii) Goods sold have been excluded from the inventories and credit has been taken
to the sales.
The auditor may examine a sample of documents evidencing the movement of stocks
into and out of stores, including documents pertaining to period shortly before and
shortly after the cut-off date, and check whether the stocks represented by those
documents were included or excluded, as appropriate, during the stock taking.


Batch: -June 2018
Level: -CAP-III
Paper 3: Advanced Audit and Assurance

1.
a) Overall understanding of the students was good.
b) Students could not answer the question with the relevant NSA/NAS
provisions. Very general answer.
2.
a) Average student could not identify the risks. Above 95% student could not
write BoD responsibility to shareholders and irrelevance.
b) Answer in majorities of cases is lengthy only about 20% of the students solve
the problem properly.
3. Lack of conceptual knowledge VIS-a-VIS practice.

4. Basic concepts missing and poor presentation.
5. Average performance.
6. Lack of conceptual knowledge on theory paper and very little preparations.

Paper 4:
Corporate Laws

CAP II Paper 4: Corporate Laws

Marks

1. Answer the following questions:

a. Nepal Micro Hydro Private Limited is extending its business by increasing its paid-up
capital out of which more than fifty percent of the share of the company has been
subscribed by a public company. The shareholders of the company have come up to one
hundred in the course of extending its business. The board of directors of the company is
in confusion if it is required to be converted it into a public company where the members
and the paid up capital have been extended. The board then appointed you a consultant
of the company to provide the suggestions to the board on the following questions
considering the various provisions of Company Act, 2063. 10
i. What were the mandatory requirements for conversion of a private company into a
public company as per the Company Act, 2063 (Prior to the amendment in 2073)?
ii. How would you suggest the Company as per the request of the board with reference to
the Company Act, 2063 (amendment in 2073) pertaining to the private company?
b. State the circumstances in which Nepal Rastra Bank will advise the financial institution
to compulsorily wind up under the Banks and Financial Institutions Act, 2073. 10
Answer:
1 a i) Prior to the First amendment, under Section 13(1)(b) and (c) of the Companies Act,
2063 a private company is required to be converted into a public company in
following conditions
(i) If 25% or more shares of such company are held by one or more public companies,
(ii) If such private company acquires 25% or more shares of a public company.
This mandatory conversion provision had forced a private company to comply with all
the requirements applicable to the public companies, For instance
a. Minimum paid up capital of 10 million or more,
b. Minimum number of shareholders to be raised to seven,
Minimum number of directors to be three with a requirement to appoint at least one
independent director
1 a ii) As per the First Amendment of the Companies Act 2073 pertaining to the provisions
of the private company it can be suggested as follows:
Change in the Section 9 of the existing Act:
Before the Amendment the number of shareholders of a private company should not exceed
fifty. The First Amendment has extended this limitation to one hundred one.

It is traditional now to define the companies as public companies or private companies in

terms of the minimum or maximum number of promoters or shareholders. The Amendment
has provided some flexibility to the private companies in terms of the maximum number of
the shareholders. The threshold of maximum number of the shareholders does not count in
case of the employee shareholders.
a. Change in the Section 13 of the existing Act:
The first Amendment has deleted Section 13(1) (b), (c), (4), (5), (6) and (7) thereby allowing
a public company to hold hundred percent shares of private company and vice versa without
the requirement of mandatory conversion.
b. Maximum number of directors
The flexibility allowed to a private company regarding the appointment of directors in
desired number under Section 86(1) has been removed by the Amendment. Under the Clause
21 of the First Amendment, a private company can now only have a maximum of eleven (11)
numbers of directors. As the private companies generally have small board of directors, this
provision should not have any adverse impact to the company.
c. Change in the Section 76 of the existing Act:
The First Amendment in the Section 76 has now provided the requirement of convening of
Annual General Meeting and other compliances thereto in case of private company as well.
The statutory timeline, as mentioned under Section 76, for concluding the annual general
meeting is also now applicable to private company as well.
This will provide right and recourse to the shareholders of a private company to ask such
company to conduct annual general meeting by taking assistance from the OCR and court.
1b
Liquidation or winding up of a banks and financial institution may be either voluntary or
compulsory. Here the question is related to the compulsory winding up or liquidation of a
Banks and Financial Institution under the advice of the Nepal Rastra Bank it is discussed
accordingly below here.
Chapter 12 of the BAFIA 2073 prescribes the provision regarding Compulsory winding up or
liquidation of the Banks and Financial Institutions. Under Section 78 of the BAFIA,
application can be filed into court for the initiation of the compulsory winding up of a bank
or financial institution by Nepal Rastra Bank by fulfilling following procedures:
1. While making application by NRB as said above, it is to be notified by publishing
the action initiated in the national daily newspaper in this respect.
2. To initiate such action of compulsory winding up of bank or financial institution
under sub-section (1) the Section 78 Nepal Rastra Bank should submit various
documents as to show the grounds and reasons thereof as per the Section 79 of the
Act.
Under Section 79 of the Act, it prescribes the binding circumstances of the

compulsory winding up of a bank and financial institution in the following
circumstances:
i. Where failed to fulfill liability or due there regarding matured fixed deposit or
failed to make immediate payment as required including other financial
liabilities within given time.
ii. Where the capital fund of a bank or financial institution is under debt.

iii. Where the inspector of the banks or financial institution in its report has
recommended for its compulsory winding up by the NRB.
iv. Where the substantial shareholders or the authorities of the banks or financial
institution has initiated any act and activities contrary to the interest of the
depositors and creating hurdles in the financial development system thereof.
v. Where failed or ignored to comply repeatedly the directives issued by the
NRB.
vi. Where there arises any other situation of compulsory winding up of a bank or
financial institution under the policy fixed by the NRB.
3. Besides above conditions it is required to submit financial statement of banks or
financial institution along with the application under Section 78(2) (b).
Notwithstanding in Sub section (1) of the Section 78 any of the persons representing
more than 25% of deposit amount when payment is requested which is not paid even
if it is payable deposit or collective request of more than one percent depositors or as
per the capability of the applying for compulsory winding up as per the prevailing law
of insolvency Act, 2063 may submit application to the court for compulsory winding
up. However it requires the prior approval of the NRB to make an application for the
compulsory winding up other than by NRB.

a. State the matters to be mentioned in the notice on invitation to bid or prequalification
proposal under the Public Procurement Act, 2063. 7
b. Under what conditions, Nepal Rastra Bank can process the work of resolution by
taking up any commercial bank or financial institution under its control? Explain. 7
c. Mr. Gopal K. Sharma, a practicing auditor and a member of ICAN, published a
compilation of all the existing audit principles of various sectors. While publishing the
compilation he gave his personal resumes and detail as one of the leading auditor in
respect of his professional experience of an auditor and his present association as a
partner with M & Associates. Answer the following questions in the given issues: 6
i) Examine whether the details given by Mr. Gopal K. Sharma is a violation of the
code of conduct as prescribed by the Nepal Chartered Accountant Act, 2053?
ii) If there is violation of code of conduct to what extent Mr. Gopal K. Sharma can be
penalized?
Answer:
2a
It is essential as per the Section 14 (1) of the Act that a notice for invitation to bids or
prequalification proposals shall have to be published in a daily newspaper of national
circulation and, in the case of an international bid; it may also be published in any
international communication media as well.
Section 14(2) also provided on such matters about the publication of bid notice. Such
notice shall be published in the website of such entity and Public Procurement

Monitoring Office (PPMO) if such notice is concerned to the Central level Public
Entity. Further, such notice, concerning the District level Public entity, shall be
published in the website of such entity or Public Procurement Monitoring Office
(PPMO)
Pursuant to Sub-section (3) of Section 14, the notice on invitation to bid or

prequalification proposal shall contain the following matters:-
a. The name and address of the Public Entity inviting bid,
b. The nature of and time limit for procurement work and the place of delivery of
the goods to be supplied, the services to be delivered and the construction work
to be performed,
c. If bid security is required, the amount and validity period thereof.
d. Where bid security is required, the validity period of the bid.
e. The place, manner of obtaining the bidding documents or prequalification
documents and the fees charged therefor.
f. The place, manner, the deadline for the submission or forwarding of the
bidding documents or prequalification proposal.
g. The place, date and time for the opening of bids or prequalification proposals
and matter that the bidders or their authorized agents shall be invited to attend
the opening of bid.
h. Other matters as prescribed.
2b
Section 88A of Nepal Rastra Bank Act, 2058 with latest amendment has explained the
power to resolution. On any of the following conditions, Nepal Rastra Bank can
further the work of resolution by taking up any commercial bank or financial
institution under its control:
(a) If its liability of payment cannot be made fully or partially,

(b) If there is condition of not being able to fulfill the liabilities to be paid, on the
ground of supervisory analysis, within ninety days form the date of the completion
of the work relating to such analysis,
(c) If liability exceeds the net assets,
(d) If sustained loss that cannot be covered up even by all kinds of capital funds
prescribed by the Bank.
(e) If the bank makes decision to take to the process of resolution as per section 86G.
Only Nepal Rastra Bank shall have the power to carry out, or get the resolution carried
out, of the claim of the depositor and secured creditor remained upon any commercial
bank or financial institution.
Total expenses incurred while carrying out work relating to resolution of the
commercial bank or financial institution shall have to be borne out of the amount
received after selling out the properties of the commercial bank or financial institution
concerned.

2 c i) Mr. Gopal K. Sharma as a member of ICAN one has to be fully abided by the NCA
Act and the Regulations of it. As profession of auditor it has been prescribed as
mandatory duties of an auditor. In the given context publishing a compilation
regarding the existing audit principles of various sectors is an act for promoting
professional job and is not a violation of the code as prescribed by the Act. However,
publishing the personal detail regarding the professional experience of an auditor is a
kind of violation of code of conduct of the Act. Chapter VIII of Nepal Chartered
Accountants Act, 1997 has prescribed the provision regarding conducts that are to be
fully observed by Members of it. One of the conducts prescribed by the Act under
subsection (5) of section 34, is that members should not disclose or divulge any
information and explanations acquired in the course of professional service to any
person other than the employer employing him and the person whom he is compiled
by the law to do so. The Act further prescribes in its subsection (4) of the same
section that members should not directly or indirectly influence any person by way of
enticement in order to secure any professional business. Finally it is the duty of a
member to be abided by all other matter concerning the conduct in the course of his
profession. In the given issue it is clear that the publishing the personal details as one
of the leading auditor and his professional experience of an auditor is a violation of
code prescribed by the Act and liable for it.
2 c ii) One of the prime functions of NCA Council is to monitor as to whether or not the
members and members holding certificate or practice have acted in conformity with
the prescribed professional code of conduct. In the given issue it is clear that Mr.
Gopal K. Sharma has violated code of conduct prescribed by the NCA Act 1997 by
giving his personal detail regarding professional experience of an auditor and his
present association as a partner with an audit firm. Section subsection 4 of section 41
has provided the penalty provision in such case. Pursuant this subsection, if a member
lodge a complaint to the Institute against such member in respect of not upholding the
conduct mentioned in the Act, an action can be taken against such member by NCA
and the member so violated will liable to be punished for committing an act contrary
to the provision of NCA Act or Regulation framed there on with a suspension for a
maximum period of five years and will be liable of punishment with a maximum
penalty of two thousand rupees or imprisonment for a maximum period of three
months or both.

a) The Industrial Enterprises Act, 2073 has provided various facilities to the industries
established under this act. State the income tax facilities to the following group of
industries: 7
i) Production oriented industry in general,
ii) Infrastructure industries,
iii) Industries established in areas as described in schedule -10,
iv) Exports by production oriented industries,
v) Industries who expend big amount for the long term benefit to workers and
employees,
vi) Expenditure incurred on machinery and instruments to increase the productivity of
energy.

b) Securities business person after making a contract of purchase or sale or exchange of

securities has to keep a record of the contract by making a contract note as per Section
77 of the Securities Act, 2063. State the particulars to be mentioned in the contract
note and distribution of the same. 7
c) Government of Nepal has enacted Money Laundering Prevention Act, 2064 for the
prevention of laundering of money (assets) earned through criminal proceeds. What
activities are considered as money laundering offence under the Money Laundering
Prevention Act, 2064? 6
Answer:
3a
Chapter 5 of the Industrial Enterprises has explained various facilities that are to be
provided to the various types of industries established in Nepal. Section 22 of the act
has specified the income tax exemption in the net profit of these industries as follows:
(i) The production oriented industries will get 20% rebate on the leviable income
tax;
(ii) Infrastructure industries like road, bridge, tunnel, train, tram, trolley bus,
airport, industrial infrastructure will get rebate 40% on the income tax leviable;
(iii) All production industries except industries producing brandy, cider, and wine
based on the fruits will get 90%, 80% & 70% rebate in applicable income tax
for 10 years from the date of commercial production if these industries were
established in least developed areas, developing and less developing areas as
mentioned in the schedule -10 of the act.
(iv) The income from exports of production oriented industries will be eligible for a
rebate of 25% on the leviable income tax;
(v) Expenses on long term benefits to workers will be fully allowed while arriving
at the income;
(vi) Expenses incurred on machinery and instruments to increase the efficiency of
energy production and economize the consumption of energy will be allowed
in full while arriving at the income.
3b
Section 77 of Security Act, 2063 explained the contract note as follows:
(1) Provisions relating to obtaining the identification of the concerned investor,

opening a customer account, making transaction of money and concluding an
agreement relating to transactions by any securities business person prior to carrying
on the securities business shall be as prescribed. :
(2) Any securities business person shall, upon making a contract on the purchase, sale
or exchange of securities, make a contract note before the closing of market on the
following day, and where the securities business person has made such a contract as an
agent, the original copy of the contract note shall be delivered to the concerned
customer and where such person has made such a contract for himself, such a person
shall mention that matter in the contract note and retain the note with him. :
(3) The contract note referred to in Sub-section (2) shall contain, inter alia, the
following matters:- :

(a) Type of securities business and place where such business is operated,
(b) Where the securities business person him/herself has acted as the principal, details
thereof,
(c) Name and address of the person to whom the contract note is given,
(d) Date of the contract and date on which the contract note is prepared,
(e) Description and quantity of securities,
(f) Per unit value of securities,
(g) Description relating to consideration payable under the contract,
(h) Amount or rate of commission payable under the contract,
(i) If any fee is chargeable, the rate of such fee and description pertaining thereto,
(j) Day on which account is settled or cleared
(k) Such other matters as prescribed
3c
Principally an offence refers to an act done against the state. In other words it refers to
do an act which has been forbidden by law or prohibited by the prevailing law of the
nation. In this context Government of Nepal has enacted an Act to prevent Laundering
of criminally earned money (assets).
The Money Laundering Act 2063 has prescribed money laundering as an offence.
According to Section 3 of the Act, no person should commit or cause to commit in any
of the following acts:-
(a) Converting and transferring property by any means knowing or having
reasonable grounds to believe that it is proceeds of crime for the purpose of
concealing or disguising the illicit origin of property, or assisting any person
involved in the offence for evading legal consequences of offender.
(b) Concealing or disguising or changing the true nature, source, location,
disposition, movement or ownership of property or rights with respect to such
property knowing or having reasonable grounds to believe that it is proceeds of
crimes.
(c) Acquiring, using, possessing property knowing or having reasonable grounds
to believe that it is the proceeds of crime.
The Act further clarifies that no person should conspire to commit, aid, abet, facilitate,
counsel, attempt, associate with or participate in the commission of the acts mentioned
above.
Where any person who commits any act mentioned as above amounts to commitment
of the offence of money laundering.

a) ABC group are interested to establish a non-life public limited insurance company in
Nepal. The group has appointed you a consultant to provide the detail information

regarding the minimum paid up capital, its composition among the promoters and
others if: 8
i) It is a newly established company with in-country promoters.
ii) It is a newly established company with foreign investment.
iii) It is an existing company.
b) When a company can be deemed to have become insolvent under the Insolvency Act,
2063? Explain the cases when insolvency proceedings can proceed, in respect of
certain companies although there is no application for the insolvency proceedings. 7
Answer:
4a
The paid up capital of a newly established insurance company will be two billion
rupees if it a life insurance company and one billion rupees if it is a non life insurance
company. The composition of the proposed insurance company will be as follows:
(i) Insurance with Nepalese Promoters:

(a) Promoters group should have minimum 51 percent.
(b) For general public at least 30 percent as an initial public offering.
The proposed insurance company should allocate at least 5% of the total paid up
capital to their staff.
The promoters of the proposed insurance company has no any authority to invest
in the proposed insurance company by taking loan from any bank, financial
institution and any other areas whatsoever.
(ii) Insurance with foreign investor:

(a) Foreign investor who are interested to establishment a insurance company
along with the Nepalese Promoter should have invest maximum 80% of the paid
up equity capital.
(b) If the foreign investment is less than 50% then 30% of the total paid up capital
should be allocate for general public for the initial public offering.
However if the foreign investor is interested to invest more than 50% in equity
capital, then the public offering should be at least 15% of the total paid up capital.
(c) As mentioned above the proposed insurance should allocate at least 5% of the
total share to the staff whether they have allocated 30% to general public or 15%
as per the first proviso of the previous section.
(iii) In case of existing insurance company:

(a) Those insurance companies who are under operating at the time when this
guideline was implemented, then these companies should have their paid up capital
as mentioned in the section 4 of this guidelines within Ashad 2075.

(b) These companies should submit their capital plan within three months after
implementing this guideline to make the paid up capital to the level as mentioned
in section 4 of the guideline.
(c) The existing insurance company who has submitted the capital plan to increase
capital as prescribed if could not manage to fulfill the proposed capital plan by
increasing the paid up capital, the company should apply to Beema Samiti to
increase the duration with genuine reasons. The Samittee if satisfied with the
reasons may grant 3 more months to the existing such insurance company to
increase the capital as prescribed in this guideline.
Beema Samittee will provide such type chances to the existing insurance company
maximum two times. .
(d) If any existing insurance company could not fulfill to make the paid up capital
as prescribed in the guideline after providing maximum time as above, the
Samittee will direct such company to merge with the other existing insurance
company.
4b
According to Sec. 7 of the insolvency Act 2063, a company will be deemed to have
become insolvent on the following condition:
(a) Where the general meeting of shareholders adopts a resolution that the company
has become insolvent or a meeting of the board of directors of the company
makes such decision; or
(b) where the Court issues an order requiring the company to pay the debt and the
debt is not paid up within thirty five days from the date of receipt by the company
of such order; or
(c) Where the company fails to pay the debt within thirty five days after the service by
the creditor on the company a notice for the payment of the debt or fails to make
an application to the Court within the said period to void such notice.
(2) Nothing contained in this Section shall prevent the establishing of the fact that a
company has become insolvent where it is proved from any other matter that the
liability of the company exceed the value of the assets of the company or the
company itself admits that it has become insolvent.
According to Section 4 of the Insolvency Act 2063 an Application is to be made to the

court for insolvency proceedings
Where it is required to institute insolvency proceedings against any company, any of

the concern person like shareholder, creditor or debenture holder having the
qualification as prescribed may make an application to the Court in the prescribed
format for the institution of such proceedings.

Section 8 of the Act prescribes that an insolvency proceedings may be initiated in case
of certain companies although there is no application from the concern persons. In
pursuant to Section 8 of the Act, no application may be made to the Court for
insolvency proceedings in relation to the following company without obtaining prior
approval of the following authority:
(a) In the case of a bank or financial institution carrying on banking and financial
business, the Nepal Rastra Bank, or
(b) In the case of an insurance company carrying on insurance business, the Insurance
Board formed pursuant to the Insurance Act, 2049, or
(c) In the case of a company which cannot undergo voluntary liquidation without
approval of the competent body or authority, except that mentioned in Clause (a)
or (b), such authority.
(2) Every application to be made for insolvency proceedings in relation to a company
as mentioned above should be accompanied by a copy of the approval given by
the authority set forth in that Sub-section for that purpose.
5. Answer the following questions: (3×5=15)

a) Discuss the various exemptions and facilities which are granted to the co-operative
societies under the Co-operative Act, 2074.
b) Define the process of formation of Collective Bargaining Committee. Also explain
the matters which could not be included in the collective demand.
c) Promoters of a limited company had signed an agreement for the purchase of certain
assets for the company and payment was to be made to the suppliers by the company
after its incorporation. Shortly, after incorporation the company went into liquidation
and the debt for the purchase of assets could not be paid by the company. As a result
suppliers sued the promoters of the company for recovery of the dues. Examine this
issue with reference to the provisions of the company Act, 2063 explaining whether
promoters can be held liable for payment.
Answer:
5a
Section 78 of the Cooperative Act, 2074 grants the following exemptions and
facilities to a cooperative society:
(1) Notwithstanding anything contained in the prevailing law, the cooperative society
will be entitled to the various exemptions and facilities under the Section 78(1) of
the Act as follows:
(a) The cooperative society will not be required to have registration passed of any
instrument relating to its transaction, other than an instrument relating to
immovable property.
(b) No revenue stamp fee or registration fee will be charged on a document or any
kind of instrument related with the purchase and sale of an immovable property
as carried out for the construction of its office building in the course of
providing service by the cooperative society.

However, revenue stamp fee or registration fee will be charged on a document

or any kind of instrument related with the purchase of land and other immovable
properties for the purpose its business.
And also that, where the land and immoveable properties purchased with
exemption of revenue stamp fee or registration fee as per the exemption
facilities, is sold without being used by it, the exemption charges of registration
fee enjoyed by it, is required to be returned.
(c) No charges will be levied on its loan investment or in the registration of pledged
land which is received as guarantee.
(2) Notwithstanding anything contained in the prevailing law, no income tax will be
levied on the sum allotted for the reserve fund as per Sec. 68(2)(a), the amount
allotted as protection fund under Section 69(2) and amount allotted as
cooperative promotion fund as per Sec. 70(2)Provided that, it will be levied tax
pursuant to the prevailing law where an amount is received by the member from
the protection fund,.
(3) Government of Nepal may, by a notification in the Nepal Gazette and pursuant to
the prevailing law, exempt fully or partly from chargeable customs tariff or sales
tax or VAT on such machineries, industrial and agro-machines, equipment, spare
parts, raw materials, office equipment and means of transport as are imported by a
cooperative society for its use.
(4) Government of Nepal may, by a notification in Nepal Gazette and pursuant to the
prevailing law, exempt fully or partly from chargeable excise duty or sales tax on
the goods produced by a cooperative society.
(5) Government of Nepal may, by a notification in Nepal Gazette and pursuant to the
prevailing law, exempt fully or partly from export duty or sales tax on the goods
produced by a cooperative society and provided export cash benefit as given to
other industries.
(6) A cooperative society doing industrial business will also be provided such other
exemptions, facilities and protection as the industries are entitled pursuant to the
law, in addition to the exemptions mentioned as above.
(7).Government of Nepal or Provincial government or local bodies may, exempt fully
or partly from any tax in the industry, or cooperative agriculture carried by
marginalized group or dalit or by the backward class on the basis of their skill or
labour under the self-employment promotion scheme.
(8) Government of Nepal may provide seedling grant or loan by fixing at low interest
rate facilities for transfer of ownership of sick public industries or to handle such
industries by the labours themselves under the cooperative scheme or exempt tax
as an encouragement for transfer of ownership in a reasonable way for helping
them.
(9) Government of Nepal may, by a notification in Nepal Gazette provide fully or
partly exemption facilities in the land acquisition charges or payment of the same
or VAT and other taxes, in cases of industries intended to operate in the specific
industrial cooperative village with market place policies under the participation of
shares scheme.
(10) While providing the exemption and facilities under this provision, it is required to
follow the procedures as prescribed thereof.

5b
Any enterprise employing 10 or more than 10 workers shall have a collective
bargaining committee comprising three to eleven representatives as mentioned in the
sub section (1) of Section 116 of Labour Act, 2074. The committee will be formed as
follows:
a) a team of representatives appointed for negotiation on behalf of the elected
authorized trade union of the enterprise, or
b) where an election for the authorised trade union pursuant to sub-section (a) could
not be held or the term of the elected authorised trade union has expired, a team of
representatives nominated through a mutual agreement of all the unions in the
enterprise;
c) where an authorised trade union pursuant to sub-section (a) or a team of
representatives pursuant to sub-section (b) could not be formed, a team of
representatives supported with the signatures of more than 60% of the workers
working in the enterprise.
Collective bargaining committee, on issues relating to the interest of workers, may
submit collective claims or demands in writing to the employer. However the
committee could not authorized to the following matters in their collective demands:
a. Matters which is contrary to the Constitution of Nepal;
b. Which may adversely affect the interest of any other person because it is based on
groundless allegation without any proof;
c. Any matter which may affect the personal behavior of any employer or worker;
d. Matter which is not related to the enterprise;
e. Where a collective agreement has been made and the period specified in the act
for such agreement has not expired yet;
f. Relating to contribution rate and benefits specified for social security schemes;
5c
The solution on this question is explained in Section 17 of the Company Act, 2063.
It is a case of pre-incorporation contract. A pre-incorporation contract is one which is

made by a person on behalf of or purporting to be the company at a date prior to that
on the company‟s certificate of incorporation. Under common law pre-incorporation
contract cannot bind the company and cannot ratify a contract to which it could not
have been a party when the contract was made. In such case it cannot sue company
for recovery of price. According to English Company Act 2006 contracts entered into
before a company is formed the person acting for the company shall be personally
liable.
Section 17 of the Companies Act 2063 prescribes provision regarding pre-

incorporation contract. Section 17(1) prescribes that a contract made prior to the

incorporation of a company shall be a proposed contract only, and such contract shall
not be binding on the company. Section 17(2) makes personal liable for any contract
related with transaction so carried on, if a person carries on any transaction or
borrows money on behalf of the company prior to the incorporation of a company.
However, Section 17(3) prescribes provision regarding the nonliability for any
transaction if within the time mentioned in any transaction or within the reasonable
time after incorporation of a company, the company through its act, action or conduct,
accept any act, action or borrowing done or made prior to the date of authorization to
commence its transaction or endorses such act or action that transaction shall be
binding on the company and the other contracting party, and the person carrying out
such act or action shall be released from the personal liability to be borne.
In case of Private Company the liability against the promoter will be governed by
consensus agreement among them before incorporation (Section 145 of the
Companies Act).

a) Mention the grounds which disqualify a person to become an arbitrator
under Arbitration Act, 2055. 4
b) Mention the objectives of enactment of Banking Offence and Punishment
Act, 2064. 3
c) Explain the provision on reward to be provided to the informant under
Foreign Exchange (Regulation) Act, 2019. 3
Answer:
6a
Section 10 of the Arbitration Act, 2055 mentions few grounds for disqualification to
become arbitration in Nepal. These grounds are:
1) Person disqualified to become a party to the contract under the prevailing laws
of Nepal cannot be an arbitrator.
2) Person punished by a court on criminal charges involving moral turpitude.
3) Person becomes insolvent or been declared bankrupt.
4) Person having any interest on the issues to be settled through arbitration.
5) Person not having any specific qualification to become an arbitrator
mentioned in the agreement.
6b
Objective of enactment of banking offence and punishment Act has been mentioned
in the preamble of that Act. According to the preamble it is enacted to provide legal
provisions on banking offences and punishments with a view to promoting trust
towards banking and financial system thereby mitigating the consequences and the

risks that the banking and financial system may suffer on account of the offences may
be occurred in course of transactions of bank and financial institution.
6c
Section 20 of the foreign exchange regulation Act, 2019 has mentioned the provision
on reward to the informant.
According to this provision if any person provides Nepal Government or the authority
authorized by the Government of Nepal information that any person has done any act
in contravention of this Act or Rules, Bye-laws, orders notices or directions or license
framed or issued under this Act and the foreign exchange is seized and the offence
proved on the basis of the information so given, twenty percent of the amount in
question set by converting such seized foreign exchange into the Nepalese currency
shall be given as a reward to such informant. The amount of reward to be given shall
be given from the amount to be set by converting such seized foreign exchange into
the Nepalese currency after the finality of the case.


Batch: -June 2018
Level: -CAP-III
Paper 4: Corporate Laws

1. Being 1st question very few students have not attempt 2nd part i.e. (b) questions.
Students should give emphasis in clear legal provisions as question is related to
the clear legal provision.
2.
a) Students have submitted the answer with the requirements of matters that is
mentioned in the questions. However, the requirements of publication of
notice in newspaper, website are not mentioned almost students. Matters
included in the sub section 3 of subsection 14 have mentioned with
segregation thereof.
b) Questions requirement is as per the section 88 A. Therefore, students should
present as per the requirement and legal provision. Some students has
submitted as per the requirements of the question. Rest of the students
submitted minimum of its requirements. However, the presentation of
minimum requirements is not sufficient for such type of examination.
c) Sub section 4, 5 of section 34 concerns violation of code of conduct and sub
section 4 of section 41. Question has required the code of conduct and
punishment in the violation there under. Almost half of the students appearing
in the examination has submitted as requirements of the question and rest is
vice-versa.
3. General points of Sec. 77 of the Securities Act, 2063 have been stated but the
students most of them have not clear of the provisions of Industrial Enterprises
Act, 2073 and money Laundering Act, 2063.
4. Some are good and some others seem to be negligent in studying the course.
5. Satisfactory, whenever very common answer for part (a).
6. Students should answer the question by understanding the question properly and
should explain provision while answering the question.

Paper 5:
Management Information and Control System

CAP II Paper 5: Management Information and Control System
Total No. of Questions - 6 Total No. of Printed Pages -12

Marks
1. Assume that you are working as a system analyst in a software development

company. Your company assigned you in a project to develop information system
for XYZ Company. Based on this scenario, answer the following questions.
a) Discuss data and process modeling tools you use during system analysis phase
of the information systems development. 10
b) Why do we need information systems audit? Discuss the phases of
information systems audit in detail for the system you develop for XYZ
Company. (4+6=10)
Answer:
a) During analysis phase, a systems analyst uses entity relationship diagram (E-R diagram) as a
data modeling tool. A data model is a detailed model that captures the overall structure of
organizational data while being independent of any database management system or other
implementation consideration. The E-R diagram is a graphical representation that has three
basic concepts: entities, attributes, and relationships.
Entity: An entity is a person, place, object, event, or concept in the user environment about
which the organization wishes to capture and store data. An entity set is a collection of
entities that share common properties or characteristics. For example STUDENT is an entity
set. An entity set in E-R diagram is drawn using rectangle.
Attribute: Each entity type has a set of attributes associated with it. An attribute is a
property or characteristic of an entity that is of interest to the organization. For example,
STUDENT entity set can have Student_ID, Student_Name, Home_Address,
Phone_Number, and Major as its attributes. An attribute in E-R diagram is drawn using an
ellipse.
Every entity type must have an attribute or set of attributes that distinguishes one instance
from other instances of the same type. A candidate key is an attribute or combination of
attributes that uniquely identifies each instance of an entity type. Some entity type may have
more than one candidate key. In such a case, we must choose one of the candidate keys as
the identifier. An identifier (or primary key) is a candidate key that has been selected to be
used as the unique characteristic for an entity type.
A multi-valued attribute may take more than one value for each entity instance. We use a
double-lined ellipse to represent multi-valued attribute. An attribute that has meaningful
component parts is called composite attribute. An attribute whose value can be computed
from related attribute values is called derived attribute. We use dashed ellipse to denote
derived attribute.

Relationships: A relationship is an association between the instances of one or more entity

types that is of interest to the organization. We use diamond to denote relationships.
Relationships are labeled with verb phrases. The cardinality of a relationship is the number
of instances of one entity type that can (or must) be associated with each instance of another
entity type. The cardinality of a relationship can be in one of the following four forms: one-
to-one, one-to-many, many-to-one, and many-to-many.
E-R Diagram
Name ID Address Type Function Price
Qualification
Developer Develops Software
Customer Buys
Company
Name ID Address
Process modeling involves graphically representing the functions or processes that capture,
manipulate, store, and distribute data between a system and its environment and between
components within a system. A common form of a process modeling tool is a data flow
diagram (DFD). A data flow diagram (DFD) is a tool that depicts the flow of data through a
system and the work or processing performed by that system. It is also called bubble chart,
transformation graph, or process model. There are two different sets of data flow diagram
symbols, but each set consists of four symbols that represent the same things: data flows,
data stores, processes, and sources/sinks (or external entities).
Process is the work or actions performed on data so that they are transformed, stored or
distributed. Data store is the data at rest (inside the system) that may take the form of many
different physical representations. External entity (source/sink) is the origin and/or
destination of data. Data flow represents data in motion, moving from one place in a system
to another.

Team Info
ID 1.0 Project Team 2.0
D2
Developer Team Member Database
Form Dev Info Develop
Team Project
Enrollment
Team Info
Receipt
3.0
Sales Record
Product Details
Product
Client Sell Product D1
Database
Request Sales Update
Payment
b) First Part: An information technology audit, or information systems audit, is an

examination of the management controls within an Information
technology (IT) infrastructure. The evaluation of obtained evidence determines if the
information systems are safeguarding assets, maintaining data integrity, and operating
effectively to achieve the organization's goals or objectives. These reviews may be
performed in conjunction with a financial statement audit, internal audit, or other form of
attestation engagement. IT audits are also known as "automated data processing (ADP)
audits" and "computer audits". They were formerly called "electronic data processing (EDP)
audits".
The purposes of an IT audit are to evaluate the system's internal control design and
effectiveness. This includes, but is not limited to, efficiency and security protocols,
development processes, and IT governance or oversight. Installing controls are necessary but
not sufficient to provide adequate security. People responsible for security must consider if
the controls are installed as intended, if they are effective, or if any breach in security has
occurred and if so, what actions can be done to prevent future breaches.
The primary functions of an IT audit are to evaluate the systems that are in place to guard an
organization's information. Specifically, information technology audits are used to evaluate
the organization's ability to protect its information assets and to properly dispense
information to authorized parties. The IT audit aims to evaluate the following:
 Will the organization's computer systems be available for the business at all times when
required? (known as availability)
 Will the information in the systems be disclosed only to authorized users? (known as
security and confidentiality)
 Will the information provided by the system always be accurate, reliable, and timely?
(measures the integrity)
Many organisations are spending large amounts of money on IT because they recognise the
tremendous benefits that IT can bring to their operations and services. However, they need
to ensure that their IT systems are reliable, secure and not vulnerable to computer attacks.

IT audit is important because it gives assurance that the IT systems are adequately protected,
provide reliable information to users and properly managed to achieve their intended
benefits. Many users rely on IT without knowing how the computers work. A computer error
could be repeated indefinitely, causing more extensive damage than a human mistake. IT
audit could also help to reduce risks of data tampering, data loss or leakage, service
disruption, and poor management of IT systems.
Second Part: There are four phases in information systems audit: audit planning, risk
assessment and business process analysis, performance of audit work, and reporting.
The same shall be used to audit the system developed for xyz company.
 Audit Planning - In this phase we plan the information system coverage to comply with
the audit objectives specified by the Client and ensure compliance to all Laws and
Professional Standards. The first thing is to obtain an Audit Charter from the Client
detailing the purpose of the audit, the management responsibility, authority and
accountability of the Information Systems Audit function as follows:
1. Responsibility: The Audit Charter should define the mission, aims, goals and
objectives of the Information System Audit. At this stage we also define the Key
Performance Indicators and an Audit Evaluation process;
2. Authority: The Audit Charter should clearly specify the Authority assigned to the
Information Systems Auditors with relation to the Risk Assessment work that will be
carried out, right to access the Client‟s information, the scope and/or limitations to the
scope, the Client‟s functions to be audited and the auditee expectations; and
3. Accountability: The Audit Charter should clearly define reporting lines, appraisals,
assessment of compliance and agreed actions.
The Audit Charter should be approved and agreed upon by an appropriate level within the
Client‟s Organization.
In addition to the Audit Charter, we should be able to obtain a written representation

(“Letter of Representation”) from the Client‟s Management acknowledging:
1. Their responsibility for the design and implementation of the Internal Control
Systems affecting the IT Systems and processes
2. Their willingness to disclose to the Information Systems Auditor their knowledge of
irregularities and/or illegal acts affecting their organization pertaining to management
and employees with significant roles within the internal audit department.
3. Their willingness to disclose to the IS Auditor the results of any risk assessment that a
material misstatement may have occurred
 Risk Assessment and Business Process Analysis:Risk is the possibility of an act or
event occurring that would have an adverse effect on the organisation and its
information systems. Risk can also be the potential that a given threat will exploit
vulnerabilities of an asset or group of assets to cause loss of, or damage to, the assets. It
is ordinarily measured by a combination of effect and likelihood of occurrence.
More and more organizations are moving to a risk-based audit approach that can be
adapted to develop and improve the continuous audit process. This approach is used to

assess risk and to assist an IS auditor‟s decision to do either compliance testing or

substantive testing. In a risk based audit approach, IS auditors are not just relying on
risk. They are also relying on internal and operational controls as well as knowledge of
the organisation. This type of risk assessment decision can help relate the cost/benefit
analysis of the control to the known risk, allowing practical choices.
The process of quantifying risk is called Risk Assessment. Risk Assessment is useful in
making decisions such as:
1. The area/business function to be audited
2. The nature, extent and timing of audit procedures
3. The amount of resources to be allocated to an audit
 Performance of Audit Work: In the performance of Audit Work the Information

Systems Audit Standards require us t o provide supervision, gather audit evidence and
document our audit work. We achieve this objective through:
1. Establishing an Internal Review Process where the work of one person is reviewed by
another, preferably a more senior person.
2. We obtain sufficient, reliable and relevant evidence to be obtained through Inspection,
Observation, Inquiry, Confirmation and recomputation of calculations
3. We document our work by describing audit work done and audit evidence gathered to
support the auditors‟ findings.
Based on our risk assessment and upon the identification of the risky areas, we move
ahead to develop an Audit Plan and Audit Program. The Audit Plan will detail the nature,
objectives, timing and the extent of the resources required in the audit.
Based on the compliance testing carried out in the prior phase, we develop an audit
program detailing the nature, timing and extent of the audit procedures. In the Audit Plan
various Control Tests and Reviews can be done. They are sub-divided into:
1. General/ Pervasive Controls

2. Specific Controls
 Reporting: Upon the performance of the audit test, the Information Systems Auditor is
required to produce and appropriate report communicating the results of the IS Audit.
An IS Audit report should:
1. Identify an organization, intended recipients and any restrictions on circulation
2. State the scope, objectives, period of coverage, nature, timing and the extend of the
audit work
3. State findings, conclusions, recommendations and any reservations, qualifications and
limitations
4. Provide audit evidence
2. Assume you are working as IT officer for a reputed college. You have been
assigned to prepare detailed project plan including acquisition, implementation
and maintenance of an automated student management system. Answer the
following questions in this context.

a) Present a strong case to college management to move from current traditional

system to the new system by highlighting major aspects of cost-benefit
analysis. 7
b) What are the major external systems that your new system needs to interact to
enable electronic payment for the students‟ dues to the college? 7
c) Present your detailed plan to ensure high availability and disaster recovery of
the new system. 6
Answer:
a) A reputed college needs to manage a lot of students and their transactions with the
college. A manual or traditional paper-based system poses a lot of challenges in
efficient handling of the student activities, academic transactions, admissions etc. As
the number of students rises, the challenge level also increases accordingly. The
following are the major points that make the transition to computer-based system
necessary:
 College education depends upon the attraction of students towards the college
facilities and services. That include the efficient processing of the student data,
student services and transactions. To make those transactions and student
management efficient, computer based system is mandatory.
 Computer based system is also good for college management as the system can
generate real-time reports, performance statistics, information about the student
activities, financial transactions etc.
 The transactions become more transparent and easier to control with computer
based system.
 Since the computer based system is more efficient, the same task can be managed
by much less number of dedicated staff.
 Because of the increase in efficiency, transparency and cost saving in terms of
reduced manpower and operational cost, the benefits of the computer-based
student management system far outweigh the cost.
b) To enable electronic payment for the students‟ dues to college, the student
management system shall have to interact with the following external
systems:
 The public website of the college to push notices, fees, payment modes etc. This is
not directly related to financial management but is related to the flow of
information related to the financial transactions.
 The online payment system of a bank or similar financial service provider that can
carry out financial transactions (such as taking in payment from students) for the
college.
 The clearing house (if there is such in the market) to clear payment cheques issued
by colleges for students services such as scholarships and other payments. This is
also needed to make payment for different student activities, events and programs
organized by the college.

 Communication medium such as SMS, email systems to send notifications to

students or guardians about the transactions, dues etc.
c) My detailed plan for ensuring high availability and disaster recovery of the
system include the following activities and arrangements:
 Use of two servers for the purpose, one in active operation and one with identical
configuration acting as standby.
 An external system component (load balancer or switch) to automatically transfer
regular load to standby machine if the active machine is in problem.
 Regular backup of data and configurations in online (hard disks or storage
devices) and offline (tape drives or CDs) mode to recover data in case of data
corruption or problem in both servers.
 Network redundancy for public access. Internet connectivity shall be taken from at
least two different service providers.
 One replica of the student management system shall also be maintained in the
local or international cloud based datacenters. Such backup shall keep regular
operational data and application without long time archiving to conserve space
and same operational cost.
 Dedicated system administration staff for 24 hours. For this, 3 shifts of work shall
be arranged with additional shifts for morning and night time in addition to the
regular working hours.
 A detailed and step-by-step data and service recovery plan shall be prepared and
approved by college administration. This plan shall be tested with regular drill
activities so that when actual disaster happens, the team has proper understanding
and experience of the activities to be done and processes to be followed.
3.
a) Illustrate the importance of good knowledge of the business process to
develop an effective IT system for the business organization. Also give an
example. (5+3=8)
b) What is the significance of artificial intelligence in expert support system?
What are the effects of change in technology on business IT environment? (4+3=7)
Answer:
a) An effective IT system for a business organization is supposed to help carry out the
business processes in efficient and effective manner. A system becomes effective for
a business organization if it is designed and developed with the specific requirements
of the organization in mind. A custom-build system is always better than a general
purpose off-the-shelf system. However, to make such custom-built systems effective,
the design and development process should be based on good understanding of the
nature of the business and the activities, processes and transactions involved in the
business activities. Proper tailoring of the system for the business process

requirement needs a thorough understanding of the business processes being

automated.
For example, if the need is to design a IT system for an accounting consultancy firm,
the development process should be taking input from the actual users of the system
and the persons that carry out the daily business activities. A system designed for a
marketing agency or an advertisement company shall not be a perfect match for the
accounting consultancy firm whose business activities and processes are significantly
different from the other two.
b) Artificial intelligence is a sophisticated computer based cognitive system that uses

complex and human-like intelligent logic to process data and draw structured and
unstructured conclusions. Modern systems such as self-driving vehicles, computer-
based cognitive games such as chess, intelligent package routing in warehouses and
delivery channels etc use artificial intelligence. These systems try to mimic the
logical reasoning and judgement processes to process complex data sets such as
marketing, consumer data, weather data, scientific research data etc. Expert support
systems are designed to support decision makers make structured and unstructured
decisions based on data and information from internal and external sources. Since
such information is not only based on pre-defined processing of specific data but also
expert reasoning and analysis based on the data as well as other factors such as the
context, environment and other processes, artificial intelligence has a significant
scope in processing the information and arriving at logical conclusions or
recommendations.
The effect of change in technology on business IT environment can be outlined as
follows:
 Need to change the system to be up to date with new technology.
 Changes in business processes to adopt and adapt to the new technologies.
 For example, a traditional HR management system may need change to handle
new, biometric based attendance system or a financial accounting system may
need to be customized to support electronic payment mechanism.
 Change in technology also creates need for HR management challenges such as
re-training, recruitment, support contracts etc.
4.
a) Discuss supply chain management system in detail. Why do businesses need
this system? (5+3=8)
b) What is digital signature? Discuss its working mechanism along with
benefits. (2+5=7)
Answer:
a) Supply chain management is the close linkage and coordination of activities in buying,
making, and moving a product. It integrates supplier, manufacturer, distributor, and
customer logistics processes to reduce time, redundant effort, and inventory cost. The
supply chain is a network of organizations and business processes for procuring

materials, transforming raw materials into intermediate and finished products, and
distributing the finished products to customers. It links suppliers, manufacturing plants,
distribution centers, conveyances, retail outlets, people and information through
processes such as procurement, inventory control, distribution, and delivery to supply
goods and services from source through consumption. Supply chain also includes
reverse logistics in which returned items flow in the reverse direction from buyer back to
the seller.
The manufacturer also manages internal supply chain process for transforming the
materials, components, and services furnished by suppliers into finished goods and for
merging materials and inventory.
Information systems make supply chain management more efficient by helping
companies coordinate, schedule, and control procurement, production, inventory
management, and delivery of products and services. Supply chain management systems
can be operated using intranets, extranets, and special supply chain management
software.
Inaccurate or untimely information in the supply chain causes inefficiencies such as
parts shortages, underutilized plant capacity, excessive finished goods inventory, or
runaway transportation costs. One recurring problem in supply chain management is the
bullwhip effect, in which information about the demand for a product gets distorted as it
passes from one entity to next across the supply chain.Supply chain management uses
systems for supply chain planning (SCP) and supply chain execution (SCE). Supply
chain planning systems enable the firm to generate demand forecasts for a product and
to develop sourcing and manufacturing plans for that product. Supply chain execution
systems manage the flow of products through distribution centers and warehouses to
ensure that products are delivered to the right locations in the most efficient manner.
Second Part: Information systems for supply chain management can help participants
in the supply chain in the following activities:
 Decide when and what to produce, store, and move
 Rapidly communicate orders
 Track the status of orders
 Check inventory availability and monitor inventory levels
 Reduce inventory, transportation, and warehousing costs
 Track shipments
 Plan production based on actual customer demand
 Rapidly communicate changes in product design
b)
First Part: A digital signature is a mathematical technique used to validate the
authenticity and integrity of a message, software or digital document.
The digital equivalent of a handwritten signature or stamped seal, but offering far more
inherent security, a digital signature is intended to solve the problem of tampering and
impersonation in digital communications. Digital signatures can provide the added
assurances of evidence to origin, identity and status of an electronic document,
transaction or message, as well as acknowledging informed consent by the signer. In

many countries, digital signatures have the same legal significance as the more
traditional forms of signed documents.
Second Part: Digital signatures are based on public key cryptography, also known
as asymmetric cryptography. Using a public key algorithm such as RSA, one can
generate two keys that are mathematically linked: one private and one public. To create a
digital signature, signing software (such as an email program) creates a one-way hash of
the electronic data to be signed. The private key is then used to encrypt the hash. The
encrypted hash along with other information, such as the hashing algorithm is the digital
signature. The reason for encrypting the hash instead of the entire message or document
is that a hash function can convert an arbitrary input into a fixed length value, which is
usually much shorter. This saves time since hashing is much faster than signing.
The value of the hash is unique to the hashed data. Any change in the data, even
changing or deleting a single character, results in a different value. This attribute
enables others to validate the integrity of the data by using the signer's public key to
decrypt the hash. If the decrypted hash matches a second computed hash of the same
data, it proves that the data hasn't changed since it was signed. If the two hashes don't
match, the data has either been tampered with in some way (integrity) or the signature
was created with a private key that doesn't correspond to the public key presented by
the signer (authentication).
A digital signature can be used with any kind of message whether it is encrypted or
not simply so the receiver can be sure of the sender's identity and that the message
arrived intact. Digital signatures make it difficult for the signer to deny having signed
something (non-repudiation) assuming their private key has not been compromised as
the digital signature is unique to both the document and the signer, and it binds them
together.

Digital signatures are also used extensively to provide proof of authenticity, data
integrity and non-repudiation of communications and transactions conducted over the
Internet.
5.
a) Explain the characteristics and advantages of SAAS model of cloud
computing. (4+4=8)
b) Explain Intrusion detection system and Intrusion prevention system. (3.5+3.5=7)
Answer:
a) The SAAS characteristics are as follows:
 Network-based access to, and management of, commercially available software.

 Activities managed from central locations rather than at each customer's site,
enabling customers to access applications remotely via the Web.
 Application delivery typically closer to a one-to-many model (single instance,
multi-tenant architecture) than to a one-to-one model, including architecture,
pricing, partnering, and management characteristics.
 Centralized feature updating, which obviates the need for end-users to download
patches and upgrades.
Advantages of SaaS are as follows:
 Pay per use

 Anytime, anywhere accessibility
 Pay as you go
 Instant scalability
 Security
 Reliability
 APIs.
b)
An intrusion detection system (IDS) is a type of security software designed to
automatically alert administrators when someone or something is trying to
compromise information system through malicious activities or through security
policy violations.
An IDS works by monitoring system activity through examining vulnerabilities in the

system, the integrity of files and conducting an analysis of patterns based on already
known attacks. It also automatically monitors the Internet to search for any of the
latest threats which could result in a future attack.
Intrusion prevention is a preemptive approach to network security used to identify

potential threats and respond to them swiftly. Like an intrusion detection system
(IDS), an intrusion prevention system (IPS) monitors network traffic. However,
because an exploit may be carried out very quickly after the attacker gains access,
intrusion prevention systems also have the ability to take immediate action, based on

a set of rules established by the network administrator. For example, an IPS might
drop a packet that it determines to be malicious and block all further traffic from that
IP address or port. Legitimate traffic, meanwhile, should be forwarded to the recipient
with no apparent disruption or delay of service.
6. Write short notes on: (53=15)

a) Mobile Computing
b) Internet Vulnerability
c) Virtual Organization
d) Mirroring
e) Artificial Neural Network
Answer:
a) Mobile Computing
Mobile Computing is a technology that allows transmission of data, voice and video
via a computer or any other wireless enabled device without having to be connected to
a fixed physical link.
Mobile may also refer to access in a fixed location via equipment that users can
relocate as required, but is stationary while in operation. This mode of operation is
often called nomadic computing.
The applications of mobile computing today have become ubiquitous and pervasive in
business, consumer, industrial, entertainment and many specialized vertical-market
activities. Desktop, or nonmobile, computers allow for a higher degree of hardware
configurability or higher computational performance, but a mobile computing device
is the vehicle of choice for almost every end user today. The key advantage of mobile
computing is convenience, allowing users anytime, anywhere access to information
and computational resources.
b) Internet Vulnerability.
Large public networks such as the Internet are more vulnerable than internal networks
because they are virtually open to anyone. The Internet is so huge that when abuses do
occur, they can have an enormously widespread impact. When the Internet becomes part
of the corporate network, the organization‟s information systems are even more
vulnerable to actions from the outsiders. Computers that are constantly connected to the
Internet by cable modems or Digital Subscriber Line (DSL) are more open to penetration
by outsiders because they use fixed Internet addresses where they can be easily identified.
(With dial-up service, a temporary Internet address is assigned for each session.) A fixed
Internet address creates a fixed target for hackers.

Telephone service based on Internet technology can be more vulnerable than the switched
voice network if it does not run over a secure private network. Most Voice over IP (VoIP)
traffic over the public Internet is not encrypted, so anyone linked to a network can listen
in on conversations. Hackers can intercept conversations to obtain credit card and other
confidential personal information or shut down voice service by flooding servers
supporting VoIP with bogus traffic.
Vulnerability has also increased from widespread use of e-mail and instant messaging
(IM). E-mail can contain attachments that serve as springboards for malicious software or
unauthorized access to internal corporate systems. Employees may use e-mail messages
to transmit valuable trade secrets, financial data, or confidential customer information to
unauthorized recipients. Popular instant messaging applications for consumers do not use
a secure layer for text messages, so they can be intercepted and read by outsiders during
transmission over the public Internet.
a) Virtual Organization
A virtual organization is that entity or business firm whose employees / resource person
are geographically located at different parts of the world and are connected by means of
tools of information technology (emails, social media, networks, groupware) to connect to
each other but they seem to be a single unified organization from a single location. Thus
the organization set-up of virtual organization is slightly different the traditional one.
These organizations can be formed for long-term objective to do the commercial activities
or they can be formed for a certain period of time to achieve a particular goal.
It is the IT that coordinates the activities, combines the workers‟ skills and resources with
an objective to achieve the common goal set by a virtual organization. Managers in these
organizations coordinate and control external relations with the help of computer network
links. The virtual form of organization is increasing globally. The main advantages of the
virtual organization are the flexibility: flexi-time, part-time work, job sharing, home
based work etc.
b) Mirroring
In data storage, disk mirroring or RAID1 is the replication of logical disk volumes onto
separate physical hard disks in real time to ensure continuous availability. A mirrored
volume is a complete logical representation of separate volume copies. In a Disaster
Recovery context, mirroring data over long distance is referred to as storage replication.
Depending on the technologies used, replication can be performed synchronously,
asynchronously, semi-synchronously, or point-in-time. Replication is enabled via
microcode on the disk array controller or via serversoftware. It is typically a proprietary
solution, not compatible between various storage vendors. Mirroring is typically only
synchronous. Synchronous writing typically achieves a Recovery Point Objective (RPO)
of zero lost data. Asynchronous replication can achieve an RPO of just a few seconds
while the other methodologies provide an RPO of a few minutes to perhaps several hours.
In addition to providing an additional copy of the data for the purpose of redundancy in
case of hardware failure, disk mirroring can allow each disk to be accessed separately for

reading purposes. Under certain circumstances, this can significantly improve

performance as the system can choose for each read which disk can reach most quickly to
the required data. This is especially significant where there are several tasks competing
for data on the same disk, and thrashing (where the switching between tasks takes up
more time than the task itself) can be reduced. This is an important consideration in
hardware configurations that frequently access the data on the disk.
c) Artificial Neural Network
Artificial neural networks are one of the main tools used in machine learning. As the
“neural” part of their name suggests, they are brain-inspired systems which are intended
to replicate the way that we humans learn. Neural networks consist of input and output
layers, as well as (in most cases) a hidden layer consisting of units that transform the
input into something that the output layer can use. They are excellent tools for finding
patterns which are far too complex or numerous for a human programmer to extract and
teach the machine to recognize.
While neural networks (also called “perceptrons”) have been around since the 1940s, it is
only in the last several decades that they have become a major part of artificial
intelligence. This is due to the arrival of a technique called “backpropagation,” which
allows networks to adjust their hidden layers of neurons in situations where the outcome
doesn‟t match what the creator is hoping for – likea network designed to recognize dogs,
which misidentifies a cat, for example.
Another important advance has been the arrival of deep learning neural networks, in
which different layers of a multilayer network extract different features until it can
recognize what it is looking for.


Batch: -June 2018
Level: -CAP-III
Paper 5: Management Information and Control System
1. General type of answer not specific.
2.
a) Most of the students have given correct answer.
b) They do not have conceptual knowledge.
c) Most students have given correct answer.
3. Most of the student confused on Artificial Intelligence to part (b).
4. Both parts have satisfactory answers.

5. Students are answering very general points on (a) and (b) questions. The specific
answers are expected in the questions however only surfacial points are explained.
6. Most of the students have no basic concept of (a) and (b).

Paper 6:
Advanced Taxation

CAP II Paper 6: Advanced Taxation
Roll No……………. Maximum Marks

- 100
Total No. of Questions - 6 Total No. of Printed
Pages - 18
Marks
Attempt all questions. Working notes should form part of the answer.
1. You are given following information of Samrat Cements Pvt. Ltd. pertaining to income
year 2073/74.
Particulars Amount (Rs.)
Sales 500,000,000
Profit Before Tax as Per Financial Book 4,500,000
a) Samrat Cements Pvt. Ltd. is a Special Industry as per the provision of Income Tax
Act, 2058.
b) Property, plant and equipment as per Financial Books are as follows:
Block Opening WDV (Rs.)
A 260,000
B 1,400,000
C 300,000
D 450,000
Depreciation on the same is calculated as per the rates prescribed by Income Tax Act,
2058. However, for tax purpose, property, plant and equipment are as follows:
Opening WDV including Unabsorbed Repair &

Block
Maintenance Expenses of previous year (Rs.)
A 300,000
B 1,600,000
C 400,000
D 500,000
Company has received tax assessment order from IRD for income year 2072/73 and
the company did not file any appeal to concerned authority. As per the assessment
order, following depreciation relating to income year 2072/73 is not allowed as
deductible expenses due to unsupported purchase capitalized on 2072.04.02.
Company has claimed depreciation on such capitalization as per the rates so provided
by Income Tax Act, 2058.
Particulars Disallowed Depreciation (Rs.)
Block A 10,000
Block B 25,000
Block C 30,000

No purchase and sales of depreciable assets is done during the year. The company
desires to claim additional depreciation as per Income Tax Act from this year
onwards, which is available to a special industry. This claim is only for tax purpose.
Besides that the assessment order also recalculated the carry forward losses and
assessed the same as Rs. 335,000.
c) Expenses include the following:
i) Other expenses include expenses of Rs. 100,000 not related to business.
ii) Office expenses include expenses worth Rs. 250,000 for which neither supporting
documents nor justification could be provided by the management.
iii) Donation has been paid amounting Rs. 200,000 to the Prime Minister Relief Fund
and Rs. 150,000 to Futsal Football Club.
d) Samrat Cements Pvt. Ltd. had sold a land at a profit of Rs. 1.5 Lakh, the land was
acquired in the year 2073. Gain is included in the net profit for the year 2073/74.
e) The entity had filed return under self-assessment on Mangsir 19, 2074. But time
extension for filing of return was not taken.
f) The entity employs 348 Nepalese citizens during the year.
g) Advance Tax details for the year 2073/74 is as follows:

Upto Poush, 2073 250,000
Additional Upto Chaitra 2073 200,000
Additional Upto Ashad 2074 150,000
Additional Upto Mangsir 2074 350,000
Total 950,000
h) Carry forward loss details of Samrat Cements Pvt. Ltd. are as follows:
2065|66 40,000
2066|67 50,000
2067|68 55,000
2068|69 65,000
2069|70 75,000
2070|71 45,000
2071|72 65,000
2072|73 80,000
Total 475,000
i) Samrat Cements Pvt. Ltd. did not file estimated Income Tax Return for the Income
Year 2073/74.
Required: 20
Based on the information provided above, calculate the following:
i) Taxable Income,

ii) Income Tax Liability, and

iii) Interest Chargeable, if any, for the income year 2073/74.
Answer:
In lack of details of expenses, the taxable income can be calculated only
on the basis of Net profit.
1)
i. Computation of Taxable Income:
Particulars Reference Amount (Rs.)
Net Profit As Per Financial Books 4,500,000.00
(+) Expenses Disallowed As Per Income Tax Act W.N. 1 350,000.00
(+) Donation W.N. 2 150,000.00
(+) Depreciation As Per Financial Books W.N. 3 490,500.00
(-) Depreciation As Per Income Tax Return W.N. 3 (690,333.33)
Gross Total Income 4,800,166.67
(-) Carried Forward Loss (As Per Assessment Order) W.N. 4 (335,000.00)
(-) Unadjusted Loss of Previous Years W.N. 5 (40,000.00)
Total Taxable Income 4,425,166.67

ii. & iii. Computation of Income tax liability along with Fine & Interest.
a. Tax Computation:
Amount Tax Rate Tax Amount

Particulars
(Rs.) (W. N. 6) (Rs.)
Business Income 4,425,166.67 18.00% 619,523.00
b. Additional Charges for Delay in filling Annual Return: [(Sec. 117(ga)]
SN. Particulars Amount (Rs.)

A. 0.1 % of Turnover
Turnover 500,150,000.00
0.1 % of the same 500,150.00
For 2 months (Kartik - Mangsir) 83,358.33
B. Rs. 100 Per Month
For 2 months (Kartik - Mangsir) 200.00
Fine is Higher of A & B 83,358.33
c. Additional Charges for failure to file estimated Income Tax Return.

As per Section 117(ka), additional charges for non-filing of estimated tax
return is 2,000 per return. So, Rs.2,000.00 shall be charged.

d. Interest for short payment of advance tax as per Sec:118

As per Section 118, where an installment of tax paid by a person is less than
90% of stipulated amount of tax payable, the person shall be liable to pay
interest of each month and part of month from the date of first installment on
the amount to the excess of installment that would have to be paid over the
installment paid. So, interest to Samrat Cements Pvt. Ltd. would be:
1st 2nd 3rd

Particulars Installment Installment Installment
40% 70% 100%
Installment Amount (A)
318,612.00 557,571.00 796,530.00
Minimum Installment To Be Paid (90%) (B)
286,751.00 501,814.00 716,877.00
Instalment Paid (C)
250,000.00 450,000.00 600,000.00
Amount Subject to Interest (B-C) 36,751.00 51,814.00 116,877.00
Interest Applicable Month
3.00 3.00 3.00
Interest Rate 15% 15% 15%
Interest Amount
Total Interest As Per Sec 118
1,378.16 1,943.02 4,382.89
e. Interest for delay in Payment of Final tax as per Sec: 119
Amount Payable Till Ashoj, 2074

796,530.00
Amount Deposited Till Ashoj, 2074
600,000.00
Amount Remaining To Be Deposited
196,530.00
19th
Balance Amount Deposited In
Mangsir, 74
Delay of Months Post Ashoj (Kartik &
Mangsir) 2.00
Applicable Interest Rate 15%
Total Interest As Per Sec 119
4,913.25
Net Tax Liability (Including Fine & Interest)

SN Amount
Particulars
. (Rs.)
a Tax Liability 786,530.00
b Additional Charges for Delay in filling Annual Return 83,358.33
c Interest for delay in Payment of advance tax (Sec: 118) 7,704.06
Additional Charges for failure to file estimated Income Tax Return
d 2,000.00
(Sec: 117)
e Interest for delay in Payment of Final Tax (Sec: 119) 4913.25
Total 886,801.58
Less: Advance Tax Paid 600,000.00
Net Tax Liability (Including Additional Charges & Interest) 286,801.58
Working Notes:
1. Expenses Disallowed as Per Income Tax Act
Amount
Particulars
(Rs)
Other Expenses (Expenses not related to business) 100,000.00
Office Expenses (No documentation available – So disallowed as per Sec:
250,000.00
13)
350,000.00
2. Donation paid to Prime Minister Relief Fund amounting Rs.200,000.00 is

allowed as deduction. Whereas the Futsal Football Club should fulfill some
criteria and procedure to get the tax exemption status, in lack of information
of the same, the Footsal Club shall not be taken as a TEO and cannot be
allowed the donation for reduction.
3. Calculation of Allowable Depreciation.
Depreciation
Opening Disallowance Allowable Additional
Particulars WDV in Op WDV Op. WDV Rates Normal 1/3rd Total
As Per Tax (W.N. 3.1) As Per Tax
Block A 300,000.00 190,000.00 110,000.00 5.00% 5,500.00 1,833.33 7,333.33
Block B 1,600,000.00 75,000.00 1,525,000.00 25.00% 381,250.00 127,083.33 508,333.33
Block C 400,000.00 120,000.00 280,000.00 20.00% 56,000.00 18,666.67 74,666.67
Block D 500,000.00 0.00 500,000.00 15.00% 75,000.00 25,000.00 100,000.00
517,750.00 172,583.33 690,333.33
3.1. Non - Allowable Depreciation Basis.
Particulars Disallowed Rates (B) Capitalized Disallowance

Depreciation (A) Amount (C = A/B) (C - A)

Block A 10,000.00 5.00% 200,000.00 190,000.00
Block B 25,000.00 25.00% 100,000.00 75,000.00
Block C 30,000.00 20.00% 150,000.00 120,000.00
Block D - 15.00% 0.00 0.00
Since the Company did not claim additional depreciation in previous year, only
depreciation as per the rates provided by Act is used for backward calculation of
capitalized amount.
3.2. As the company did not file any appeal in assessment order of IRD, it is established
that the company admits the disallowed depreciation and capitalization of concerned
fixed Assets.
3.3. As per Schedule 2 of Income Tax Act, Special Industry can claim additional 1/3rd
depreciation on depreciable blocks of assets.
3.4. Depreciation Computation as Per Financial Books
Opening
Block Rates Depreciatio
WDV
n
A 260,000.00 5.00% 13,000.00
1,400,000.0 25.00
B 350,000.00
0 %
20.00
C 300,000.00 60,000.00
%
15.00
D 450,000.00 67,500.00
%
490,500.00
4. Carry forward loss calculation.

As Per Section 20 (1 b) of the Income Tax Act 2058, any unrelieved loss of the
previous seven income years incurred by the person from any business can be
deducted while calculating income from business or investment in an income year but
in this case this clause will not be applicable as we have accepted the Tax Assessment
Order for income year 2072/73 and along with that the carry forward loss of 335,000
is also accepted and will be used for Taxable Income Calculation.
5. Unadjusted Loss of IY 2065/66

According to Section 36, the gain from disposal of business assets can be deducted
from any loss from business for any previous years. So, the gain Rs. 150,000.00 from
disposal of land is deducted with the unadjusted loss Rs. 40,000.00 of IY 2065/66.
6. Applicable Income Tax Rate

The tax rate applicable to the entity is 90% of the applicable tax rate. (As per Section
11(3), any Special Industry & Information Technology Industry providing direct
employment throughout the year for 300 or more Nepali Citizens shall be levied tax @
90% of applicable tax).
Note: If the question had clearly mentioned that there were only Nepalese citizen
working in the special industry, the tax rate would be 70% under Section 11 (3) (Ka).
It is assumed that working 348 Nepalese citizen does not mean that there are only
Nepalese citizen.
If a student solves the question with clear assumption that all employees in the
industry are Nepalese citizens and has applied 70% tax rate, it is assumed as correct
answer.
2.
a) Orange Technology Private Limited has profit of Rs. 15,000,000 for the Income Year
2073-74, subject to below adjustments, if any, earned exclusively from export of
services. It has work force of 50 employees only.
a. Orange Technology Private Limited has paid a secret consultancy fee of Rs.
1,700,000 after deducting TDS @ 15% for which there is no supporting available
except invoice of the Party of Rs. 2,000,000. Party is also not registered under
VAT.
b. Interest Expenses of Rs. 1,000,000 has been charged as expenses against a loan
taken for purchase of a Server. The loan has been taken on 20th Shrawan 2073, and
the assets was put to use on 1st Bhadra 2074.
c. Company has paid advance tax of Rs. 500,000 for first installment, Rs. 2,500,000
for second installment and Rs. 1,000,000 for third installment.
You are required to compute the total tax liability of Orange Technology Private
Limited for the Income Year 2073-74 including fee and interest, if any, by providing
appropriate justification as per the provisions of the Income Tax Act, 2058 and Rules
2059 for treatment of above adjustments. The Company has taken time extension for
filing of the tax return till Poush end 2074 and intends to pay the balance amount of
tax on Poush end. 7
b) Mr. Ferguson, a European resident wanted to do business in Nepal and accordingly he
brought foreign currency amounting to US$ 50,000 and promoted a one man
company and purchased agricultural land in the name of the Company equivalent to
US$ 50,000 at that time. The total amount invested in the Company was Rs.
2,500,000 at the exchange rate prevailing at that time. But due to various reasons he
could not start his operation for more than 5 years and so he lost interest in the project
and wanted to sell the Company at an agreed price of Rs. 7,500,000 and get the
money remitted back to his country. Discuss the tax implication of the above
transaction in view of the provisions of the Income Tax Act, 2058. Also state how
much Mr. Ferguson can remit back to his country? 7

c) Mr. Captain America, an American citizen is an employee in a Nepali Company who

went to Qatar on 7th Shrawan, 2072 to work in a project for 1 year. The project was
obtained by the Nepali Company in a global tender. Mr. Captain America earned US
$ 5,000 per month in Qatar. He then returned to Nepal on 1st Falgun 2073 and joined
the same company in Nepal from that date and was entitled to a salary of Rs. 500,000
per month, i.e. equivalent to amount he was receiving in Qatar (Ex. Rate $ 1 = Rs.
100). Calculate the tax liability of Mr. Captain America for the income year 2072/73
and 2073/74 in Nepal as per Income Tax Act, 2058. Note: Books of Accounts of
Qatar project is maintained and tax return is accordingly submitted in Qatar itself. 6
Answer:
2 a)
Computation of Tax Liability of Orange Technology Private Limited
Particulars Amount Remarks
Income from Business 15,000,000
Disallowances:
Add: Secret consultancy fee 2,000,000 As per section 13 of the Income Tax Act,
paid 2058, expenses made for business of the
Company is only allowable as expenses.
Expenses made without any valid reason is
not allowed even though TDS is deducted.
Add: Interest Expenses against 1,000,000 As per section 14(1) of the Income Tax
a loan taken for purchase of Act, 2058, interest expenses incurred for
Server assets which has been used for business
purpose in the Income Year is only
allowable. If the asset is not used during
the income year, then the same should be
capitalized.
Net Income from Business 18,000,000
Income Tax @ 20% 3,600,000 Applicable Tax Rate for export income by
Orange Technology Private Limited is
20% [Schedule 1(2) of Income Tax Act,
2058]
Total Tax Liability 3,600,000
Additional Charge u/s 117 0
Interest u/s118 29,850 See calculations below.
Interest u/s 119 Nil Total Tax = 3,600,000 Less Total Advance
Tax Paid 4,000,000,
Total Tax Liability including 3,629,850
fee and interest.
Calculation of Interest for Advance Tax :
Tax 90% of Tax Advance Tax Shortfall Interest u/s 118
Amount Amount Paid (Rs.) (Rs.) for 3 months
(Rs.) (Rs.) @ 15% pa
First Installment – 1,440,000 1,296,000 500,000 796,000 29,850.00

40% of total Tax

Liability
Second Installment – 2,520,000 2,268,000 3,000,000 - -
70% of total Tax
Liability
Third Installment – 3,600,000 3,240,000 4,000,000 - -
100% of total Tax
Liability
29,850.00
2 b)
(1) In this case, when he sells his company, in which his investment was Rs.25 lakhs for
Rs.75 lakhs, there is gain of Rs. 50 lakhs on which the new management of
company, has to collect 15% tax at source on the gain i.e. Rs.750,000 and deposit it
with the Tax Department.[Sec. 95 ka(2)(kha)]
(2) When he first invested in the Company, he should have taken permission from the
Department of Industries. Now also he should take permission of Department of
Industries by filing the original copy of the documents of transfer of shares.
(3) The same should be intimated to the office of the Company Registrar also with the
prescribed fees along with the share transfer document and the permission from the
Department of Industries. The change of shareholder should be registered in
Company Registrar's Office.
(4) Then he shall apply to Nepal Rastra Bank with all the documents for remitting the
money.
(5) For giving permission, Nepal Rastra Bank will require evidence of earlier receipt of
US$ 50,000.
(6) Since he is non-resident / individual, he will have to pay tax at 25% in the whole
amount without any basic exemption.
His total tax liability will be as follows:
Since he is a non-resident, the tax on Rs.5,000,000 will be Rs.1,250,000. Apart from
his paying Rs.750,000 as tax in advance, he has to pay a further tax of Rs.500,000
and get tax clearance certificate from the Tax Department.
(7) Nepal Rastra Bank, after being satisfied with his inward remittance of US$50,000
and tax clearance, will give permission for the remittance of Rs.3,750,000
(Rs.5,000,000-1,250,000) to his home country.
2 c)
Following provisions of Income Tax Act shall be considered.
1) As per the provisions of Section 2 (Ka Nga)(1)(Kha), to be a resident for an income

year, a person shall reside in Nepal for a period of minimum 183 days out of the past
continuous 365 days period. As Mr. Captain America was not in Nepal for 183 days in

income year 2072/73 as well as in income year 2073/74, he is a non-resident in both the
years.
(Note: If a student has assumed that he was in Nepal even before departing to Qatar, the
residential status and tax implications shall be different and upon disclosing the logic,
the answer shall be taken as correct.)
2) Sec 67(6)(Jha-1): As per this section- irrespective of the place of payment, in case of
the activities the service for which is provided in Nepal , the source of payment is
considered in Nepal. Thus, while Mr. Captain America was in Qatar, the place of
rendering of service not being in Nepal, his salary is not taxable in Nepal. But when he
returned to Nepal, inspite of being a non-resident as above in point no. 1, his salary is
taxable in Nepal, as the source of payment is in Nepal.
3) As per Section - 8 of Schedule-1 of Income Tax Act 2058, tax rate on the taxable
income of a non-resident is 25%.
Calculation of Tax Liability of Mr. Captain America
i) Income Year 2072/73:

Taxable Salary: NIL (As Source of Payment Not in Nepal)
Tax Liability: NIL
ii) Income Year 2073/74:

Taxable Status: Non-Resident
Taxable Salary: Rs.500,000 P.M.

No. of months (Falgun To Ashad) = 5
Total Salary: Rs.2,500,000
Tax @ 25% = Rs.625,000
3.
a) Double & Associates, statutory auditor of a limited company, is also appointed to
provide taxation services. Explain about the conflict of interest situations that may
arise and the remedy for the same. 5
b) The audit firm is charged for abetting in tax avoidance of a company while claiming
bad debt in excess of supporting evidences. Explain about the legal provisions and
additional charges and penalties that the audit firm may be liable. 5
Answer:
3 a)
Taxation services comprise a broad range of services, including:
Tax return preparation;
Tax calculations for the purpose of preparing the accounting entries;
Tax planning and other tax advisory services; and
Assistance in the resolution of tax disputes.

While taxation services are provided by a firm to an audit client, they are addressed
separately under each of these broad headings; in practice, these activities are often
interrelated. Performing certain tax services creates self-review and advocacy threats.
The significance of any threat shall be evaluated and safeguards shall be applied
when necessary to eliminate the threat or reduce it to an acceptable level. The
safeguards may include:
• Using professionals who are not members of the audit team to perform the service;
• Having a tax professional, who was not involved in providing the tax service, advise
the audit team on the service and review the financial statement treatment;
• Obtaining advice on the service from an external tax professional; or
• Obtaining pre-clearance or advice from the tax authorities.
Professional accountants engaged in the audit of the financial statements and the tax
returns to an audit client shall not provide any services falling under the
responsibilities and obligations of the management of the client for example making
accounting entries, posting into the ledgers, giving advice or consultancy services in
regard to tax matters, tax planning, assisting in the resolution of tax disputes,
representing clients to tax authorities etc.
b)
The legal provisions and additional charges and penalties that the audit firm may be
liable in charge of abetting in tax evasion are:
Section 96 (3)/(4) has stipulated that if a tax advisor has supported in taxation service
of a tax payer, the tax advisor should clearly mention in its report to the tax payer
about any non-compliance to the tax laws.
If the tax advisor is found guilty in abetting in the tax evasion, then, as per Section
121 of Income Tax Act, 2058 s/he is liable for equivalent additional charges that are
levied to the tax payer. In addition, the tax advisor may be penalized up to 50% of the
penalties imposed on the tax payer as per Section 127 of the Income Tax Act, 2058.
4.
a) Shri Ram Hospital Private Limited runs a 200 bed hospital at Pokhara. During the
income year 2073-74, it has done various construction works at its hospital site. The
details of various construction works done by the hospital is as below:
(a) Construction of Parking Lot:
Parking lot was constructed through a local contractor who is not registered under
VAT. The total cost paid to the contractor was Rs. 1,500,000 net. Apart from the
above cost, hospital has incurred Rs. 100,000 for clearance of the site which was
paid to the employees of the hospital as overtime.
(b) Construction of Canteen:
Hospital constructed canteen itself for which hospital has paid below amount:

i. For Construction Material from VAT registered party – Rs. 565,000

(including VAT)
ii. For Labour and Engineering services from individuals not registered under
VAT – Rs. 100,000
iii. For Design of Canteen by individual not registered under VAT – Rs. 100,000
iv. Various Expenses for approval of building design – Rs. 100,000 (paid to
individual not registered under VAT)
(c) Repair of a Private Ward:
i. Hospital has given contract to a VAT registered party for repair of Private
Ward at Rs. 10,000,000 plus VAT.
ii. Hospital has taken loan of Rs. 1,500,000 from a bank for repair of the Private
Ward. It has paid interest of Rs. 100,000 till the date of completion of repair
work.
Shri Ram Hospital Private Limited has duly submitted its VAT return showing
VATable and non-VATable transactions on due date. Assessing Officer during Audit
of the VAT raised issue that the Hospital has not paid VAT on construction as
required by the law, and should be assessed for the same. Management of the
Hospital is surprised to know that it has to pay VAT on construction of various
facilities for which there is no VAT bill. Citing relevant provisions of the Value
Added Tax Act, 2052 and Rules 2053, advise the management of the Hospital on the
above matter, and compute the amount of VAT payable, if any. 10
b) Avengers Pvt. Ltd. has entered into a contract for the purchase of following
equipments under following terms and conditions from Stark Enterprises. The
equipments were imported by Stark Enterprises under Bank Guarantee facility. The
import details are as follows:
Name of Equipment Original Cost (In Euro) Import Date
Excavator (2 Pcs) 500,000.00 01-04-68
Lorry (1 Pc) 100,000.00 01-04-72
Terms and Conditions:
i) Total Purchase Price of Both Equipments shall be Euro 150,000.00
ii) Custom Duty shall be paid by Avengers Pvt. Ltd.
Ignore Excise Duty, CSF and other taxes. Custom Duty rate is 10% for both
equipments.
Required: 10
Calculate Custom Duty and VAT to be paid by Avengers Pvt. Ltd., if custom
clearance is done on 2074.04.01 (Exchange Rate: Euro 1 = Rs. 120).
Answer:
4 a)

Section 8(3) of Value Added Tax Act, 2052 provides that if any construction work of
more than Rs 50 Lakh has been carried out for business purpose from non VAT
registered party, then VAT on such construction work should be deposited as if the
said construction work has been done from VAT registered Party. If the VAT is not
deposited for such construction works, then VAT can be assessed and recovered from
owner of such property.
Further, Value Added Tax Act Directives, 2069 provides that for ascertaining the
ceiling of Rs 50 Lakh, all the construction works carried out in a particular location
should be considered even though various construction works has been undertaken
from various different parties. However, while paying VAT on construction, interest
cost should not be considered. Further, if VAT has already been paid on certain
expenses, then such VAT amount should be adjusted from final VAT payment.
Hence, contention of the Tax Officer is correct if total expenses incurred for
construction is more than 50 Lakh.
Computation of VAT Payable on Construction by Shri Ram Hospital Private Limited
Particulars Expenses VAT Balance Remarks
(Rs.) Paid(Rs.) VAT(Rs.)
(a) Construction of Parking
Lot:
Paid to Local Vendor 1,500,000 195,000
Site Clearance Expenses 100,000 13,000
(b) Construction of Canteen:
Purchase of Construction 500,000 65,000 0 VAT already Paid
Material
Labour and Engineering service 100,000 13,000
Design of Canteen 100,000 13,000
Expenses for approval of 100,000 13,000
building design
(c) Repair of Private Ward:

Contract Value 10,000,000 1,300,000 0 VAT already Paid
Interest 0 0 Interest should not be
included in
Construction cost
Total Construction Value 12,400,000 1,365,000 247,000
4 b)
Notes:
- Excavator is a construction equipment and falls under HS Code Group 84.29 so no
VAT shall be payable on that.
- Rate of Depreciation has been taken as provided by Custom Act, 2064 i.e. 10% to the
Maximum of 5 Years (As Per Custom Act, Schedule – I, Section: 9(1)).
Particulars Rate Amount Particulars Rate Amount

Excavator (In Euro) 500,000 Lorry (In Euro) 100,000

(-) Depreciation 1 10% (50,000) (-) Depreciation 1 10% (10,000)
WDV 450,000 WDV 90,000
(-) Depreciation 2 10% (45,000) (-) Depreciation 2 10% (9,000)
WDV 405,000 WDV 81,000
(-) Depreciation 3 10% (40,500)
WDV 364,500
(-) Depreciation 4 10% (36,450)
WDV 328,050
(-) Depreciation 5 10% (32,805)
WDV 295,245
Excavator WDV (Euro) 295,245 Lorry WDV (Euro) 81,000

Excavator WDV (NPR) 120 35,429,400 Lorry WDV (NPR) 120 9,720,000
(+) Custom Duty 10% 3,542,940 (+) Custom Duty 10% 972,000
(-) Rebate (More Than (-) No Rebate (5 Year
60% (2,125,764) 0% -
5 Yrs of Import) Not Crossed)
Custom Duty To Be
1,417,176 Custom Duty To Be paid 972,000
paid
WDV + Custom Duty 36,846,576 WDV + Custom Duty 10,692,000

VAT To Be Paid Exempt - VAT To Be Paid 13% 1,389,960
5.
a) General Households Pvt. Ltd. provides you the following information:
Particulars Period Amount (Rs.)
Total Sales 2074 Baishakh to Chaitra 4,054,000
2074 Chaitra 360,000
Export 2074 Baishakh to Chaitra 2,400,000
2074 Chaitra 200,000
The company seeks your opinion based on Value Added Tax Act, 2052 and wants to
know: 7
1. Does the Company get bank guarantee facility for importing finished goods?
2. Does the Company get bank guarantee facility for importing raw materials?
3. Does the Company get tax refund facility in the month of return submission?
b) You have been appointed as an Auditor of Parimal and Sons, a sole proprietorship
firm established on 5th Asoj 2073 without being registered under VAT, for the
Income Year 2073-74. It deals in trading of various vatable goods. During the audit,
you came across below facts:

Particulars Days in a Sales Purchase with Closing Stock

Month (Rs.) VAT (Rs.) with VAT (Rs.)
Asoj 2073 30 500,000 1,000,000 700,000
Kartik 2073 30 700,000 500,000 800,000
Mangsir 2073 30 1,000,000 600,000 600,000
Poush 2073 29 800,000 500,000 500,000
Magh 2073 29 1,000,000 500,000 200,000
Falgun 2073 30 1,000,000 1,000,000 300,000
Chaitra 2073 31 1,695,000 1,130,000 300,000
Baishakh 2074 31 1,130,000 1,695,000 900,000
Jestha 2074 31 1,130,000 452,000 400,000
Ashad 2074 31 2,260,000 1,808,000 100,000
On Bhadra 2074, you advised the owner of Parimal and Sons that the firm needs to
get registered under VAT and pay applicable VAT since it has turnover over the
threshold limit for not registering under VAT. Owner agreed for the same, and asks
you for computing the total amount of VAT along with fine, interest and penalty, if
any, he needs to pay if he intends to clear his VAT liability on 25 Bhadra 2074. Also
explain in brief the provisions for registration under VAT. No. of Days in Shrawan
2074 is 32.
7
c) Royal Stag Distillery has been manufacturing 65 UP Alcohol using Molasses as
prime raw material. The input output ratio is 20 litre per quintal of molasses. During
the month Bhadra 2074, it has purchased 200 quintal Molasses on which the excise
duty is Rs. 50 per quintal. The excise duty payable on 65 UP Alcohol is Rs. 90 per
liter. It is assumed that all the production has been sold, out of which 70% is sold to a
duty-free shop under recommendation from Inland Revenue Office. Calculate the net
Excise Duty payable for the month? 6
Answer:
5 a)
Section 8Ka of the VAT Act, 2052 allows bank guarantee facility for import of
necessary raw materials by industry exporting more than 40% of its total sales in the
latest 12 months from the date of industry operation and import of goods for duty free
shop through bonded warehouse can be made by submitting bank guarantee to the
related customs office for the tax to be levied.
Provided that, in order to avail such facility, 10 % value addition from the raw material
should have been made at the time of exporting the finished goods by the exporter
except by the duty free shop importing through bonded warehouse.
The liquor and cigarettes imported under the privilege should be sold only to the
diplomatic or duty privileged person or entity recommended by the Ministry of
Foreign Affairs of the GON. The liquor and cigarettes in stock in Tribhuvan
International Airport at the time of introduction of this Section can be transferred to
approved own bonded warehouse or can be sold after paying due taxes. The bank
guarantee maintained shall be released from the respective customs office as per the

prescribed procedure by the Department. The facility under Sub-section (4) of Section
24 shall not be available to persons availing facility under this Section.
As per Section 24(4), notwithstanding anything contained in Sub-sections (2) and (3)
any registered person whose export sales for a month are 40 percent or more of his
total sales for that month, and files a claim following the procedures underlined in this
Section for the refund of the amount pertaining to Section 17 shall be entitled to a
refund of the remaining excess after setting off any outstanding amount.
Taking into consideration of the above provisions:
1. Bank guarantee facility is not available as the import is related to finished goods.
2. The export is more than 40% (2,400,000/4,054,000*100=59%) of total sales in the
just previous 12 months, so, bank guarantee facility is available in import of raw
materials.
3. The export sales is greater than 40% (200,000/360,000*100 = 55%) of the month‟s
total sales, the Company gets tax refund facility in the month of return submission.
5 b)
A person needs to be registered under VAT if his annual transaction is more than Rs.
50 Lakh. If any person has not registered under VAT assuming its transaction will not
cross threshold of Rs. 50 Lakh per annum, but it has crossed, then such person should
get registered under VAT within 30 days of crossing of the threshold of Rs 50 Lakh.
If, a person does not get registered under VAT within such period, then such person is
liable for fine, interest as per VAT Act.
Date on which turnover of the Firm crossed Rs 50 Lakh

On Falgun 2073, the turnover of the firm crossed Rs 50 Lakh. Hence, Parimal and
Sons should have been registered under VAT within 30 days of Falgun 2073. Since, it
has not been registered under VAT, it has to pay VAT on the sales made from Chaitra
2073 assuming the sales amount is inclusive of VAT.
Computation of VAT Liability of Parimal and Sons
Particulars Chaitra Baishak Jestha Ashadh Total

Liability
(Rs.)
Opening VAT – VAT A 34,513 (30,487) 34,513 (43,487)
on closing stock on
Falgun 2073
Purchase VAT B 130,000 195,000 52,000 208,000
Sales VAT C 195,000 130,000 130,000 260,000
Closing VAT Liability D (30,487) 34,513 (43,487) (95,487) 95,487
(A+B-C)
Total No. of overdue 31 31 31 32
days
Additional Tax u/s 19 @ E 258.93 0 369.34 837.15 1,465.42
10% pa

Interest u/s 26 @ 15% F 388.40 0 544.01 1,255.72 2,188.13

pa
Penalty u/s 29(1)(ka) G 10,000 10,000 10,000 10,000 40,000
Penalty u/s 29(2) 100% H 0 0 0 95,487 95,487
of VAT Liability as per
D
Total Amount Payable 234,627.55
5 c) Calculation of Excise Duty Payable is as follows:
Excise Payable on Production

Particular UOM Rate Quantity Amount(Rs.) Remarks
Use of Molasses as Raw
Quintal 200
Material
Excise Duty on Molasses
Quintal 50 200 10,000
purchased
Alcohol Production & Sales Liters 4,000 Ratio is 20:1
Excise Duty on Alcohol Sold Liters 90 4,000 360,000
Backed by Cash &
Exicse Duty Not Payable on
70% 252,000 Bank Guarantee
Sale to Duty Free Shops
Net Excise Duty Payable on
108,000
Balance Sales
(-) Excise Duty Paid on
(10,000)
Molasses Purchased
Final Excise Duty Payable to
98,000
Government
6.
a) What is the concept of Arm‟s Length Principle as per OECD Model Tax Convention?
Explain significance of Arm‟s Length Principle. 5
b) Himalayan Expeditions (P) Ltd., Bangalore provided travel service in India to a group
of employees of Surya Tobacco (P) Ltd., Nepal. Explain about the tax withholdings
and income tax liability of Himalayan Expeditions (P) Ltd. on the service fee it
received from Surya Tobacco, giving consideration to Double Taxation Avoidance
Agreement between Nepal and India. 5
Answer:
6 a)
The Arm‟s Length Price (ALP) of a transaction between two associated enterprises is
the price that would be paid if the transaction had taken place between two
comparable independent and unrelated parties, where the consideration is only
commercial. The OECD transfer pricing guidelines provides guidance on the
application of the arm‟s length principle in order to arrive at the proper transfer

pricing range between associated enterprises. Market forces determine business

relations between independent parties. The Arm‟s length principle seeks to adjust the
profits between two associated enterprises by comparing the same as if the transaction
is carried out between two independent enterprises. It treats each enterprise as a
separate independent entity rather than as inseparable parts of a single unified
business.
Significance of Arm’s Length Principle

(1) Parity of Tax Treatment
ALP provides broad parity of tax treatment for MNCs and independent enterprises.
Since the ALP puts associated and independent enterprises on a more equal footing
for tax purposes, it avoids the creation of tax advantages and disadvantages that
would otherwise distort the relative competitive positions of these entities. The
ALP, thus promotes the growth of international trade and investment by removing
these tax considerations from economic decisions.
(2) Determines Real Taxable Profits

The transfer price adopted by a multinational has a direct bearing on the
proportional profit it derives in each country in which it operates. If inadequate or
excessive consideration is paid for the transfer of goods, services or intangible
property between the members of an MNC group, the income calculated for each
of these members will be inconsistent with their relative economic contribution.
An arm‟s length price is needed to determine taxable profits earned in each
country.
(3) Reduction of Artificial Price Distortion

If the ALP is not followed, an MNC will sell goods/provide services to a
controlled entity in a high tax regime at a high price (which exceeds the market
price) and to an entity in a low tax regime or a tax heaven at a low price (which is
lower than the market price). This would result in extreme price distortion of
goods and services in the international market. Thus following the principle of
ALP leads to reduction of such artificial price distortion.
(4) Minimization of Double Taxation

The ALP is an international concept and it represents the international practice.
The potential for double taxation thus is minimized, since in international transfer
pricing, adjustment to the transfer price in one tax jurisdiction requires a
corresponding adjustment in the other tax jurisdiction.
(5) ALP ensures proper amount of income being attributed to where it is earned.
The ALP provides accurate measurement of the fair market value of the economic
contribution units of a MNC. The focus of the ALP is to ensure that the proper
amount of income is attributed to where it is earned. This results in each unit of the
MNC earning a return commensurate with its economic contribution and risk
assumed.

6 b)
Article 7 of the Double Taxation Avoidance Agreement between Nepal and India
stipulates that the income from business of an enterprise is taxed only in the country of
the enterprise except for the portion of its businesses carried through its permanent
establishment in the other country.
In the given case, Himalayan Expeditions (P) Ltd, Bangalore has provided travel
service without a permanent establishment in Nepal and the service is also provided in
India to a group of employees of Nepal, so, there is no provision of taxing the income
in Nepal. Since, the income is not taxed in Nepal, no question of tax withholding and
any other income tax liability arises in Nepal to the Indian Company.


Batch: -June 2018
Level: -CAP-III
Paper 6: Advanced Taxation

1. Performance was very poor. Question was also confusing a little.
2. Lack of conceptual knowledge. The answer should be specific and students should
mention section.
3.
a) Candidates who have appeared part (a) only have answered properly.
b) Students are confused between Sec. 120 (a), (b) and Sec. 121, 127 in most of
the case.
4.
a) Though Provision is correctly written, most failed to apply and interpret
correctly.
b) None of the student correctly stated the 'rebate part'. Most were not aware of
the appreciable Depreciation.
5.
a) Most of candidates attempted this question satisfactory performance. Could
not address the bonded warehouse part.
b) Poor performance. Almost all the candidates failed to attempt this question.
c) Excellent performance.
6.
a) Average performance.
b) Poor performance.

CAP II Paper 7: Advanced Cost and Management Accounting
Paper 7:
Advanced Cost and Management Accounting


Marks
Attempt all questions. Working notes should form part of the answer.
Make assumptions whenever necessary.
1. Lumbini Rubber Industries Ltd. produces two types of tyres; namely, Special and
Premium from one of its factory located at Butwal. The company is very keen to adopt
new technology in accounting, and is currently following the activity based costing
system. The following estimated production, revenue and cost information from the
company's activity based costing system of Butwal factory is available for next financial
year:
a. The factory will produce and sell 4,000 units of Special tyre and 5,000 units of
Premium tyre. The selling price will be Rs. 12,500 per unit and Rs. 20,000 per unit
for Special tyre and Premium tyre respectively.
b. The direct materials and direct manufacturing labour costs will be Rs. 7,500 per unit
and Rs. 10,500 per unit for Special tyre and Premium tyre respectively.
c. The factory has separate plant for production of each product line. The total book
value of the plants will be Rs. 10,000,000 at the beginning of the next financial year
with a one-year useful life and zero disposal value. Any plant not used will remain
idle. The plants can be distinguished between the product lines in the proportion of
42:58.
d. The factory incurs both fixed and variable type of marketing and distribution costs.
The fixed cost portion is Rs. 10,000,000 and can be allocated between the product
lines in the ratio of 40:60. This fixed cost of a product line can be avoided if the line
is discontinued. Besides, the variable part is based on number of shipment of each
type of tyres at the rate of Rs. 75,000 per shipment. It is estimated that the product
will be distributed in 40 shipments and 100 shipments respectively for Special tyre
and Premium tyre.
e. Fixed general administration cost of Rs. 33,000,000 and Corporate office cost of Rs.
15,000,000 are allocated to the product lines on the basis of their respective revenue.
These costs will not change if sales of individual product lines are increased or
decreased or if product lines are added or dropped.
Required: (5×4=20)
i) Prepare an Income Statement of Butwal factory of the company showing operating
income or loss of each product line separately and in total.
ii) If, from the statement in (a) above, any product line shows higher loss, should Butwal
factory discontinue the product line for the year, assuming the released facilities
remain idle? Show your calculations based on financial consideration alone and
explain the relevant or irrelevant items.

iii) Calculate, with explanation of costs, the effect on the factory's operating income
considering that it will sell 4,000 more "Special tyre"? Assume that, to sell the
additional quantity, the factory would have to acquire additional equipment costing Rs.
4,200,000 with a one-year useful life and zero terminal disposal value. Assume further
that the fixed marketing and distribution costs would not change but that the number
of shipments would double.
iv) Given the expected performance of Butwal factory, should the company shut it down
for the year? Assume that shutting down the factory will have no effect on corporate
office costs but will lead to savings of all general administration costs of the factory.
Support your recommendation with proper calculations.
v) Suppose the company has the opportunity to open another factory at Dang, whose
revenues and costs are expected to be identical to Butwal factory's revenues and costs
(including a cost of Rs. 10,000,000 to acquire equipment with a one-year useful life
and zero terminal disposal value). Opening the new factory will have no effect on
corporate office costs. Should the company open factory at Dang? Show your
calculations.
Answers:
i)
Estimated Income Statement of Butwal Factory for next financial year
Particulars Special Premium Total (Rs.)
Tyres (Rs.) Tyres (Rs.)
Revenue 50,000,000 100,000,000 150,000,000
{(Rs. 12,500×4,000); (Rs. 20,000×5,000)}
Costs:
Variable direct material and labour cost 30,000,000 52,500,000 82,500,000
{(Rs. 7,500×4,000); (Rs. 10,500×5,000)}
Depreciation (WN 1) 4,200,000 5,800,000 10,000,000
Marketing and distribution cost (Rs.)
Fixed 4,000,000 6,000,000 10,000,000
Variable {(Rs. 75,000×40); (Rs. 75,000×100)} 3,000,000 7,500,000 10,500,000
Fixed general administration costs (allocated on
the basis of revenue) 11,000,000 22,000,000 33,000,000
Corporate office costs (allocated on the basis
of revenue) 5,000,000 10,000,000 15,000,000
Total costs 57,200,000 103,800,000 161,000,000
Operating income (loss) (7,200,000) (3,800,000) (11,000,000)
WN 1) Calculation of depreciation
Since the plants have a one-year useful life and zero disposal value, their book value
of Rs. 10,000,000 at the beginning of the financial year shall be fully depreciated. The
depreciation shall be allocated to the product line on the proportion of their respective
book value; i.e. 42:58.
ii) Decision on discontinuation of the product line with higher
loss

As seen in (a) above, the product line "Special Tyre" will have higher loss than
"Premium Tyre". The decision on discontinuation can be taken by comparing the loss
in revenue with saving in costs as below:
Incremental Revenue lost (Rs.) (50,000,000)
Incremental saving in costs:
Variable direct material and labour costs 30,000,000
Marketing and distribution costs (all avoidable) 7,000,000
Total incremental saving in costs 37,000,000
Incremental operating income/ (loss) (13,000,000)
Explanation on relevant and irrelevant items:
By dropping the "Special Tyre" product line, Butwal Factory will save none of the
depreciation on equipment, general administration costs, and corporate office costs,
but it will save variable manufacturing costs and all marketing and distribution costs.
Analysis and decision:
Dropping the "Special Tyre" product line will result in revenue losses of Rs.
50,000,000 and cost savings of Rs. 37,000,000. Hence, Butwal Factory's operating
income will be Rs. 13,000,000 lower, if it drops this product line. Therefore, Butwal
Factory should not discontinue the "Special Tyre" product line.
iii) Effect on the factory's operating income considering that it will sell
4,000 more "Special tyre"
Incremental Revenue (Rs. 12,500×4,000) 50,000,000
Incremental Costs:
Variable direct material and labour cost (Rs. 30,000,000
7,500×4,000)
Writing off the cost of additional equipment 4,200,000
Marketing and distribution cost (for additional shipment)
Variable (Rs. 75,000×40) 3,000,000
Total incremental costs 37,200,000
Incremental operating income 12,800,000
Explanation on relevant and irrelevant items:
The additional costs of equipment written off as depreciation are relevant future costs
for selling more "Special Tyre" decision, because they represent incremental future
costs that differ between the alternatives of selling and not selling additional "Special
Tyre".
General administration and corporate office costs will be unaffected if Butwal Factory
decides to sell more "Special Tyre". Hence, these costs are irrelevant for the decision.
Selling 4000 more "Special Tyre" will result in incremental operating income of Rs.
12,800,000. Therefore, Butwal Factory should try to sell additional "Special Tyre"
product.
iv) Decision on shutting down Butwal Factory
Statement showing relevant costs and relevant revenue of shutting down the Factory

Particulars Total (Rs.)

Incremental Revenue loss (As in (a) above) (150,000,000)
Incremental savings in costs:
Variable direct material and labour cost (As in (a) above) 82,500,000
Depreciation 0
Marketing and distribution cost (As in (a) above) 20,500,000
Fixed general administration costs 33,000,000
Corporate office costs 0
Total incremental saving in costs 136,000,000
Operating income/ (loss) (14,000,000)
The company will save variable manufacturing costs, marketing and distribution
costs, and factory general administration costs by closing the Butwal Factory but
equipment-related depreciation and corporate office allocations are irrelevant to the
decision. Equipment-related costs are irrelevant because they are past costs (and the
equipment has zero disposal price). Corporate office costs are irrelevant because the
company will not save any actual corporate office costs by closing the factory. The
corporate office costs that used to be allocated to the factory will be allocated to other
factory.
As the above calculations show, the company's operating income would decrease by
Rs. 14,000,000 if it shuts down the Butwal Factory. Therefore, it is not recommended
to shut down the Butwal Factory.
v) Decision on opening Dang Factory
Statement showing relevant costs and relevant revenue of opening the Factory
Particulars Total (Rs.)
Incremental Revenue (As in (a) above) 150,000,000
Incremental costs:
Variable direct material and labour cost (As in (a) above) (82,500,000)
Depreciation (equipment used for this factory written off) (10,000,000)
Marketing and distribution cost (As in (a) above) (20,500,000)
Fixed general administration costs (33,000,000)
Corporate office costs 0
Total incremental costs (146,000,000)
Operating income/ (loss) 4,000,000
The relevant costs include direct materials, direct manufacturing labor, marketing and
distribution, equipment, and division general administration costs but not corporate
office costs. The cost of equipment written off as depreciation is relevant because it is
an expected future cost that the company will incur only if it opens the Dang Factory.
Corporate office costs are irrelevant because actual corporate office costs will not
change if the company opens the new factory. The company will allocate some
corporate office costs to the factory but this allocation represents corporate office
costs that are currently being allocated to some other factory.
The company should open the Dang Factory because it would increase operating
income by Rs. 4,000,000.

2.
a) Vistas Electronics Ltd. provides you with the following actual data of cost, prices and
output relating to four varieties of electronic calculators manufactured by them during
the year 2017
Products
Particulars A B C D
Rs. per unit
Output (units) 16,000 10,000 8,000 12,000
Selling Price 600 1,200 1,500 1,000
Direct Materials 120 280 320 120
Direct Wages 100 160 300 120
Variable Overhead 200 320 600 240
Fixed Overhead 200 320 600 240
In preparing the budget for the year 2018, the company anticipated the following
increases in costs and prices:
a. The market will absorb an increase of 5% in the prices of each of the four
products, if the volume of sales in quantities is maintained at the same level as in
the year 2017.
b. The unit cost increases are expected to be:
Direct Materials 5%
Direct Wages 10%
Variable Overheads 10%
c. Fixed Overhead will go up by Rs. 320,000.
In order to combat inflation, the Marketing Director puts forth the following
proposals in respect of each of the products manufactured:
Product A: The price of product A will be further increased by 10% (making in all a
total increase of 15%) resulting thereby in a reduction in the volume of sales by 5%.
Product B: Substitution on direct materials of product B by cheaper materials will
bring about a reduction in direct material cost by Rs. 60 per unit. This will reduce the
sales volume in units by 5%.
Product C: An allowance of special sales commission of 2% on the increased price on
all quantities sold will increase the sales volume by 10%.
Product D: A reduction of selling price by 5% on the price of 2017 will yield an
increase in sales volume by 15%.
The direct labour rate in 2017 is Rs. 8 per hour and the number of direct labour hours
cannot be increased in the year 2018.
You are required to: (1.5+2.5+6=10)
i) Present a statement showing profitability for the year 2017

ii) Prepare a budget for the year 2018 after taking into consideration the effects of
inflation in costs and prices only, and
iii) Evaluate the proposals put forth by the Marketing Director and set an optimum
product mix after taking into consideration the inflation in costs and prices but
subject to the constraint of available labour hours.
b) A company engaged in the manufacture of various types of equipment nearly
completed a job relating to the production of a specialized equipment when it
suddenly discovered that the customer who had ordered it became bankrupt and no
longer capable to honour the earlier agreement. At this stage, the position of the job
was as under:
Rs.
Original cost estimate: 584,000
Costs incurred so far: 495,000
Costs to be incurred: 99,000
Progress payment received from original customer: 330,000
After continuous efforts and searches, the company found a new customer for the
equipment. The new customer has agreed to buy the equipment, if certain
modifications are carried out. The customer, however, wanted the equipment in its
original condition, but without its control device and with certain other modifications.
The cost for these additions and modifications are estimated as under:
Direct materials (at cost) Rs.3,500
Direct Wages:
Department A 15 man-days
Department B 25 man-days
Variable overheads 25% of direct wages in each department
Delivery costs Rs. 4,500
Fixed overheads will be absorbed at 50% of direct wages in each department.
The following additional information is also available:
a. The direct materials required for the modification are in stock and if not used for
the modification of this order, they will be used in another job in place of
materials that will now cost Rs. 7,500.
b. Department A is working normally and therefore any engagement of labour will
have to be paid at the direct wage rate of Rs. 400 per man-day.
c. Department B is extremely busy. Its direct wages rate is Rs. 340 per man-day and
it is currently yielding a contribution of Rs. 10.70 per rupee of direct wages.
d. Supervisory overtime payable for the modification is Rs. 3,500.
e. The cost of control device that the new customer does not require is Rs. 45,000. If
it is taken out, it can be used in another job in place of a different mechanism. The
latter mechanism has otherwise to be bought for Rs. 35,000. The dismantling and
removal of the control mechanism will take 1 man-day in department A.
f. If the conversion is not carried out, some of the materials in the original
equipment can be used in another contract in place of materials that would have
cost Rs. 40,000. It would have taken 2 man-days of work in department A to
make them suitable for this purpose. The remaining materials will realize Rs.

38,000 as scrap. The drawings, which are included as part of the job can be sold
for Rs. 5,000.
You are required to calculate the minimum price, which the company can afford to
quote for the new customer stated above. 10
Answers:
a)
(i) Statement showing profitability of 2017:
A B C D Total
Sales units 16,000 10,000 8,000 12,000
Rs. in million
Sales value 9.60 12.00 12.00 12.00 45.60
Direct materials 1.92 2.80 2.56 1.44 8.72
Direct wages 1.60 1.60 2.40 1.44 7.04
Variable 3.20 4.80 2.88 14.08

overheads 3.20
Total variable 6.72 7.60 9.76 5.76 29.84
costs
Contribution 4.40 2.24 6.24 15.76
2.88
Fixed overhead 3.20 3.20 4.80 2.88 14.08
Profit 1.20 (2.56) 3.36 1.68
(0.32)
(ii) Budget for 2018 taking into account inflation in cost and prices:
A B C D Total
Sales units 16,000 10,000 8,000 12,000
Rs. in million
Sales value 10.08 12.60 12.60 12.60 47.88
Direct wages 1.76 1.76 2.64 1.58 7.74
Variable overheads 3.52 3.52 5.28 3.17 15.49
Total variable costs 7.30 8.22 10.61 6.26 32.39
Contribution 2.78 4.38 1.99 6.34 15.49
Fixed overhead 14.40
Profit 1.09

Direct labour hours

200,000 200,000 300,000 180,000 880,000
(Based on labour
hour rate in 2017):
(Direct wages of
2017 Labour rate
per hour)
Contribution per 13.90 21.90 6.63 35.22
labour hour
(iii) Statement showing profitability position in 2018, if the proposals of Marketing
Director are implemented:
A B C D Total
Sales units 15,200 9,500 8,800 13,800
Selling price per unit 690 1,260 1,543.50* 950**
Rs. in million
Sales value 10.49 13.58 13.11 49.15
11.97
Direct wages 1.67 1.67 2.90 1.82 8.06
Variable overheads 3.34 5.81 3.64 16.13
3.34
Total variable costs 6.93 7.23 11.67 7.20 33.03
Contribution 3.56 4.74 1.91 5.91 16.12
Profit 1.72
Labour hours 190,000 330,000 207,000
190,000
Contribution per 18.74 5.79 28.55
labour hour 24.95
* 1,500 x 105 x 98 = 1,543.50 ** 1,000 x 95 = 950
100 100 100
It is seen from the above table that the contribution per labour hour gets reduced in
the case of products C and D when changes suggested by the marketing manager are
implemented. Therefore, it is recommended that these changes should be
implemented in the case of products A and B only. The revised position when the
changes are applied in the case of products A and B will be as shown below.
A B C D Total
Sales units 15,200 9,500 8,000 12,000
Selling price per 690 1,260 1,575.00 1,050.00
unit
Rs. in million

Sales value 10.49 11.97 12.60 12.60 47.66

Direct wages 1.67 1.67 2.64 1.58 7.56
Variable 3.34 3.34 5.28 3.17 15.13
overheads
Total variable 6.93 7.23 10.61 6.26 31.03
costs
Contribution 3.56 4.74 1.99 6.34 16.63
Profit 2.23
Labour hours 190,000 190,000 300,000 180,000
Contribution per 18.74 24.95 6.63 35.22
labour hour
b)
Working Notes:
1. Cost of control device to be used in another job: Rs.
Cost of control device 35,000
Less: Dismantling and removal cost of control mechanism (-) 400
(1 man day x Rs. 400)
Less: Variable cost (25% of Rs. 400) (-) 100
Balance cost of control device: 34,500
2. Net loss on material cost saving of equipment:
Loss on material cost saving of equipment 40,000
Less: Conversion cost (-) 800
(2 man-days x Rs. 400)
Less: Variable overhead (25% x Rs. 800) (-) 200
Net loss on material cost saving of equipment: 39,000
Statement of Minimum Price which the
Company can afford to quote for the New Customer
Rs.
Cost to be incurred to bring the equipment in its original condition: 99,000
Opportunity cost of the direct material: 7,500
Direct wages:
Department A (15 man days x Rs. 400) 6,000
Department B (25 man days x Rs. 340) 8,500
Opportunity cost of contribution
lost by Department B (Rs. 8,500 x 10.70) 90,950
Variable overhead 25% x (6,000 + 8,500) 3,625
Delivery cost 4,500
Supervisory overtime payable for modification 3,500

Control device to be used in another job (Refer to working note 1) (-) 34,500
Net loss on material cost savings, in the original equipment 39,000
(Refer to working note 2)
Opportunity cost of remaining materials which can be sold as scrap 38,000
Opportunity cost of sale of drawings 5,000
Total Minimum Price which may be Quoted to New Customer: 271,075
3.
a) Auto Engines assembles two small engines, S1 and B1, at its
Bharatpur plant. It can sell as many engines as it produces. The
following data are available:
S1 (Rs.) B1 (Rs.)
Selling price 80,000 100,000
Variable cost per unit 56,000 62,500
Contribution margin per unit 24,000 37,500
Contribution margin percentage 30% 37.5%
Assume that only 600 machine-hours are available daily for assembling engines. It
takes 2 hours to produce one S1 engine and 5 hours to produce one B1 engine. Both
the engines must be tested on a very expensive machine before they are shipped to
customers. The available machine-hours for testing are 120 testing-hours. It takes 1
hour to test one S1 engine and 0.5 hours to produce one B1 engine. Additional
capacity cannot be obtained in the short run for assembly and testing. In addition, as a
result of material shortages for B1 engines, Auto cannot produce more than 110 B1
engines per day.
Required: 10
How many engines of each type should Auto Engines produce and sell daily to
maximize operating income? Formulate the LP Model and use revised simplex
method to solve the problem.
b) Global Enterprise manufactures telecom antenna. It has just completed the
manufacture of its first newly designed antenna system, A-11. Manufacturing data for
the A-11 are as follows:
Direct material costs per unit of A-11 (Rs.) 160,000
Direct manufacturing labour time for first unit (hours) 6,000
Learning curve for manufacturing labour time per antenna system 85%
(cumulative average time)
Direct manufacturing labour cost per direct manufacturing labour 30
hour (Rs.)
Variable manufacturing overhead cost per direct manufacturing 20
labour hour (Rs.)
Required: (7+3=10)
i) Calculate the total variable costs of producing 2, 4, and 8 units of
A-11.
ii) Define learning curve. Outline two models that can be used when
incorporating learning into the estimation of cost functions.
Answers:

a)
i) Formulation of LP Model
Suppose X1 unit of S1 engine and X2 unit of B1 engine should be produced
daily.
Objective function of operating income maximization: Max. Z = 24,000X1 +
37,500X2
Assembly hour constraint: 2X1 + 5X2 ≤ 600
Testing hour constraint: 1X1 + 0.5X2 ≤ 120
Material constraint: X2 ≤ 110
Non-negative constraint: X1, X2 ≥ 0
Now, LP Model is:
Max. Z = 24,000X1 + 37,500X2
Subject to,
2X1 + 5X2 ≤ 600
1X1 + 0.5X2 ≤ 120
X2 ≤ 110, and
X1, X2 ≥ 0
ii) Determining the unit of S1 and B1 to be produced to maximize the operating
income using revised simplex method:
Introducing slack variables S1, S2 and S3 for ≤ situations and re-writing the
problem:
Max. Z = 24,000X1 + 37,500X2+ 0S1 + 0S2 + 0S3
Subject to
2X1 + 5X2 + 1S1 + 0S2 + 0S3 = 600
1X1 + 0.5X2 + 0S1 + 1S2 + 0S3 = 120
0X1 + 1X2+ 0S1 + 0S2 + 1S3 = 110
Where, X1, X2, S1, S2, S3 ≥ 0
Converting into standard LPP:
Row 0: Z - 24,000X1 - 37,500X2 - 0S1 - 0S2 - 0S3= 0
Row 1: 0Z + 2X1 + 5X2 + 1S1 + 0S2 + 0S3 = 600
Row 2: 0Z + 1X1 + 0.5X2 + 0S1 + 1S2 + 0S3 = 120
Row 3: 0Z + 0X1 + 1X2+ 0S1 + 0S2 + 1S3 = 110
Simplex Table I:
Table I Z X1 X2 S1 S2 S3 Constant Ratio
R0 1 -24000 -37500 0 0 0 0 -
R1 0 2 5 1 0 0 600 120
R2 0 1 0.5 0 1 0 120 240
R3 0 0 1 0 0 1 110 110
Key column is X2 with highest negative value (-37500) in R0.
Ratio for each row is derived by dividing the constant of each row with the
value of key column, except for R0.
Key row is R3 with minimum ratio of 110.
Key element is 1; i.e. the value at the intersection of key column and
key row.

Replacing value for key row (R3) is to be calculated by dividing the

value of key row for Table I by key element:
New R3: 0/1, 0/1, 1/1, 0/1, 0/1, 1/1, 110/1 : 0, 0, 1, 0, 0, 1, 110
Replacing value for other remaining row is calculated using the
following formula:
Replacing value = Element of old row – (intersecting element of old
row with key column x corresponding element of replacing row)
Now,
Replacing value for R0
Old R0 1 -24000 -37500 0 0 0 0
Intersecting element -37500 -37500 -37500 -37500 -37500 -37500 -37500
Element of replacing 0 0 1 0 0 1 110
row
New R0 1 -24000 0 0 0 37500 4125000
Old R1 0 2 5 1 0 0 600
Intersecting element 5 5 5 5 5 5 5
row
New R1 0 2 0 1 0 -5 50
Old R2 0 1 0.5 0 1 0 120
Intersecting element 0.5 0.5 0.5 0.5 0.5 0.5 0.5
row
New R2 0 1 0 0 1 -0.5 65
Simplex Table II:
Table II Z X1 X2 S1 S2 S3 Constant Ratio
R0 1 -24000 0 0 0 37500 4125000 -
R1 0 2 0 1 0 -5 50 25
R2 0 1 0 0 1 -0.5 65 65
R3 0 0 1 0 0 1 110 i
Key row = R1; Key element = 2
Replacing value for key row (R1) is to be calculated by dividing the value of
key row for Table II by key element:
New R1: 0, 1, 0, 0.5, 0, -2.5, 25
Now,
Old R0 1 -24000 0 0 0 37500 4125000
Element of replacing 0 1 0 0.5 0 -2.5 25
row
New R0 1 0 0 12000 0 -22500 4725000

Old R2 0 1 0 0 1 -0.5 65
row
New R2 0 0 0 -0.5 1 2 40
Old R3 0 0 1 0 0 1 110
row
New R3 0 0 1 0 0 1 110
Simplex Table III:
Ta Z X1 X2 S1 S2 S3 Constant Ratio
ble
III
R0 1 0 0 12000 0 -22500 4725000 -
R1 0 1 0 0.5 0 -2.5 25 -10
R2 0 0 0 -0.5 1 2 40 20
R3 0 0 1 0 0 1 110 110
Note: Do not consider negative value in ratio column to determine the
minimum ratio.
Key row = R2; Key element = 2
Replacing value for key row (R2) is to be calculated by dividing the
value of key row for Table III by key element:
New R2: 0, 0, 0, -0.25, 0.5, 1, 20
Now,
Old R0 1 0 0 12000 0 -22500 4725000
Element of replacing 0 0 0 -0.25 0.5 1 20
row
New R0 1 0 0 6375 11250 0 5175000
Old R1 0 1 0 0.5 0 -2.5 25
Intersecting element -2.5 -2.5 -2.5 -2.5 -2.5 -2.5 -2.5
row
New R1 0 1 0 -0.125 1.25 0 75
Old R3 0 0 1 0 0 1 110
row
New R3 0 0 1 0.25 -0.5 0 90

Simplex Table IV:

Table Z X1 X2 S1 S2 S3 Constant
IV
R0 1 0 0 6375 11250 0 5175000
R1 0 1 0 -0.125 1.25 0 75
R2 0 0 0 -0.25 0.5 1 20
R3 0 0 1 0.25 -0.5 0 90
Since all the values of R0 is, now, ≥ 0, the optimal solution is reached.
Basic solution:
1 0 0 0 Z 5,175,000
0 1 0 0 X1 = 75
0 0 0 1 S3 20
0 0 1 0 X2 90
Therefore, required unit, to maximize operating income, of S1 engine is
75 units and B1 is 90 units. It will give a total operating income of Rs.
5,175,000.
Slack unit is not considered.
b)
i) Given the assumption of a cumulative average-time learning curve of
85%, the direct manufacturing labor-hours (DMLH) required to produce
the first 2, 4, and 8 units is as follows:
Cumulative Cumulative Cumulative
Number Average Time Total Time:
of Units per Unit: Labor Hours Labor-Hours
(1) (2) (3) = (1)×(2)
1 6,000 6,000
2 5,100 (6,000×0.85) 10,200
4 4,335 (5,100×0.85) 17,340
8 3,685 (4,335×0.85) 29,480
Variable Costs of Producing:
2 Units (Rs.) 4 Units (Rs.) 8 Units
(Rs.)
Direct materials 320,000 640,000 1,280,000
(Rs. 160,000×2; 4; 8)
Direct manufacturing labour 306,000 520,200 884,400
(Rs. 30×10,200; 17,340; 29,480)

Variable manufacturing overhead 204,000 346,800 589,600
(Rs. 20×10,200; 17,340; 29,480)
Total variable costs 830,000 1,507,000 2,754,000

ii) A learning curve is a function that measures how labor-hours per unit decline as
units of production increase because workers are learning and becoming better at
their jobs.
Two models used to capture different forms of learning are:
1. Cumulative average-time learning model. The cumulative average time per
unit declines by a constant percentage each time the cumulative quantity of
units produced doubles.
2. Incremental unit-time learning model. The incremental time needed to
produce the last unit declines by a constant percentage each time the
cumulative quantity of units produced doubles.
4.
a) Anamol Company makes two models of an antitheft device. The portable model is
relatively small and is primarily for use in automobiles. The standard model is much
larger and is designed for houses and buildings. The Fabricating Department cuts,
bends, and welds sheet metal to produce the external box of the device. The box is
also painted in this department. The Assembly Department uses purchased parts to
produce the internal workings and fits them into the prepared metal boxes.
Company has conducted a special study to determine if an activity-based costing
system would be beneficial in determining the costs of the two products. The
Fabricating Department is a more complex department than the Assembly
Department and has been chosen for a pilot test of an ABC system. The following
activities have been identified, along with their associated costs:
Rs.
Depreciation ....................................... 250,000
Factory lease ...................................... 125,000
Inspection ........................................... 75,000
Factory maintenance .......................... 150,000
Materials handling ............................. 100,000
Power ................................................. 50,000
Product engineering changes ............. 25,000
Setups ................................................. 125,000
Department manager salaries ............. 60,000
The analysts have identified the following potential activity drivers and the capacity
of each:
Portable Standard
Direct labor (Rs.10 per hour) ............ Rs.75,000 Rs.90,000
Machine hours .................................... 4,000 6,000
Materials ............................................ Rs.450,000 Rs.650,000
Number of moves ............................... 1,500 1,500
Number of products ........................... 1 1
Number of setups ............................... 150 350
Units produced ................................... 15,000 17,500
Required: (4×2=8)
i) Classify each activity according to activity level and identify an appropriate
driver for each.

ii) Create identical cost pools and calculate pool rates using the number of setups as
the activity driver for both inspection and setups costs. Machine hours as the
activity driver for depreciation, factory lease, factory maintenance, and
department manager salaries.
iii) Use the pool rates to compute per unit overhead costs for the two products.
iv) Explain main three purpose of cost allocation under ABC costing.
b) A public health center runs an Medical Care Unit. For this purpose, it has hired a
building at a rent of Rs. 50,000 per month with the understanding that it would bear
the repairs and maintenance charges also.The Unit consists of 25 beds and 5 more beds
can be comfortably accommodated when the occasion demands. The permanent staff
attached to the unit are as follows:
One Supervisor, each at a salary of Rs. 2,000 per month
Two Nurses, each at a salary of Rs. 1,200 per month
Two Ward boys, each at a salary of Rs. 300 per month
Though, the unit is open for patients all the 365 days in a year scrutiny of accounts in
2017 reveals that only for 120 days in the year, the unit bed the full capacity of 25
patients per day and for another 80 days, it had on an average 20 beds occupied per
day. But there were occasion when the beds were full, extra beds were hired at a
charge of Rs. 50 per day and this did not come to more than 5 beds extra above the
normal capacity on any one day. The total hire charges for extra beds incurred for the
whole year accounted to Rs. 20,000.
The unit engaged expert doctors from outside to attend the patients and the fees were
paid on the basis of the number of patients attended and time spent by them which on
an average worked out to Rs. 50,000 per month in 2017.
The other expenses for the year as under:
Rs.
Repairs and maintenance 25,000
Food supplied to patients 88,000
Janitor and other service for patients 25,000
Laundry charges for bed linen 56,000
Medicines supplied 70,000
Cost of Oxygen, X-ray etc. other than
Directly borne for treatment of patients 2,08,000
General administrative charges allocated to the unit 98,000
Required: (5+2=7)
i) Calculate profit per patient day made by the unit in 2017,If the
unit recovered an overall amount of Rs.500 per day on an average
from each patient?
ii) The unit wants to work on a budget for 2018 but the number of
patients requiring intensive medical care is a very uncertain factor.
Assuming that the same revenue and expenses prevail in 2018,
work out the number of patient days required by the unit to break-
even.
Answers:
a)

i) Activities Level Driver

Depreciation Facility Machine hours
Factory lease Facility Machine hours
Inspection Batch Number of setups
Factory maintenance Facility Machine hours
Materials handling Batch Number of moves
Power Unit Machine hours
Product engineering changes Product Number of products
Setups Batch Number of setups
Department manager salaries Facility Machine hours
ii) Pool Activities Costs Driver Quantity Rate

1 Inspection Rs. 75,000
Setups 125,000
Rs.200,000 Number of setups 500 Rs.400.00
2 Materials handling Rs.100,000 Number of moves 3,000 Rs.33.33
3 Product engineering changesRs. 25,000Number of products 2 Rs.12,500.00
4 Depreciation Rs.250,000
Factory lease 125,000
Factory maintenance 150,000
Power 50,000
Department manager salaries 60,000
Rs.635,000 Machine hours 10,000 Rs.63.50
iii) Pool Portable Standard
Setups ...................Rs. 60,000 (150 × Rs.400) Rs.140,000 (350 × Rs.400)
Moves ................... 50,000* (1,500 × Rs.33.33) 50,000* (1,500 × Rs.33.33)
Products ................ 12,500 (1 × Rs.12,500) 12,500 (1 × Rs.12,500)
Machine hours ...... 254,000 (4,000 × Rs.63.50) 381,000 (6,000 × Rs.63.50)
Total ......................Rs.376,500 Rs.583,500
Divided by units ... ÷ 15,000 ÷ 17,500
Per unit..................Rs. 25.10 Rs. 33.34
*rounded
iv) Costs are allocated for three main purposes:
a. To obtain desired motivation: Cost allocations are sometimes made to influence
management behavior and thus promote goal congruence and managerial effort.
Consequently, in some organizations there is no cost allocation for legal or internal
auditing services or internal management consulting services because top
management wants to encourage their use. In other organizations there is a cost
allocation for such items to spur managers to make sure the benefits of the specified
services exceed the costs.
b. To compute income and asset valuations: Costs are allocated to products and projects
to measure inventory costs and cost of goods sold. These allocations frequently
service financial accounting purposes. However, the resulting costs are also often
used by managers in planning, performance evaluation, and to motivate managers, as
described above.
c. To justify costs or obtain reimbursement: Sometimes prices are based directly on
costs, or it may be necessary to justify an accepted bid. For example, government
contracts often specify a price that includes reimbursement for costs plus some profit

margin. In these instances, cost allocations become substitutes for the usual working
of the marketplace in setting prices
b) Number of
Patient days in
2017:
25 beds x 120 days 3,000
20 beds x 80 days 1,600
Extra bed days 400
5,000 Patient days
(Total hire charges of extra beds/charges per bed per day = Rs. 20,000/Rs.
50).
We have presumed in the solution that the cost of janitor and other services
are variable as they are related to number of patient days. Cost of oxygen, X-
ray has been taken as a fixed cost since it has been stated that this cost is
other than costs directly borne for treatment of patients.
i. Statement of Cost and Profit in year 2017
Rs. Rs.
Income received (Rs. 500 x 5000 patient days) 25,00,000
Variable costs:
Food 88,000
Janitor services 25,000
Laundry 56,000
Medicines 70,000
Doctors‟ fee (50,000 x 12) 6,00,000
Hire charges for extra beds 20,000 8,59,000
Contribution 16,41,000
Fixed Costs:
Salaries (1 x 2,000 + 2 x 1,200 + 2 x 300) x 12 60,000
Rent (50,000 x 12) 6,00,000
Repairs and maintenance 25,000
General administration 98,000
Cost of Oxygen, X-ray etc. 2,08,000 9,91,000
Profit 6,50,000
Profit per patient day = Rs. 6,50,000/5,000 = Rs. 130
ii. Break even point for year 2018
Break-even Point = Total Fixed Cost/ Total Contribution *Gross Income
= 9,91,000/16,41,000 *25,00,000
= Rs. 15,09,750
=Rs.15,09,750/500
=Rs. 3,020 Patient day
5. Write short notes: (5×3=15)
a) State the features of partial plan of standard cost accounting
procedure.
b) Write a brief note on incremental and marginal costs.
c) Explain the main characteristics of service sector costing.

d) Will the initial solution for a minimization problem obtained under Vogel‟s
approximation method and least cost method be the same? Why?
e) Describe „project crashing‟ and „resource smoothening‟ as used in program
evaluation and review technique.
Answers:
a) Standard cost operations can be recorded in the books of accounts by using partial
plan as well. The features of partial plan of standard cost procedure are described
below.
 The partial plan of standard costing uses current standards in which the inventory
will be valued at current standard cost figure.
 Under this method, work in process account is charged at the actual cost of
production for the month and is credited with the standard cost the month‟s
production of finished product.
 The closing balance of work in process is also known at standard cost. The
balance after making the credit entries represent the variance from standard for
the month.
 In partial plan, the analysis of variance is done after the end of the month.
b) Incremental costs and revenues are the difference between costs and revenues for the
corresponding items under each alternative being considered. For example, the
incremental costs of increasing output from 1,000 to 1,200 units per day are the
additional costs of producing an extra 200 units per day.
Incremental costs may or may not include fixed costs. If fixed costs change as a result
of a decision, the increase in costs considered as incremental cost. If fixed cost does
not change as a result of decision, there will be no incremental cost on account of
fixed cost.
Incremental costs are similar in principle to the concept of marginal cost used by the
economists. The only difference is that the marginal cost represents the additional
cost of one extra unit of output whereas incremental cost represents the additional
cost resulting from a group of additional units of output.
c) The main characteristics of service sector are as follows:
(i) Activities are labour intensive: The activities of service sector are generally
labour intensive and therefore the direct material cost is either small or non-
existent.
(ii) Difficult to define cost unit: The selection of cost unit for service sector is
difficult to ascertain as compared to the selection of cost unit for manufacturing
sector. Examples of some cost units for service sector are:
Hospital – patient per day, room per day
Transport – passenger kilometer, quintal kilometer
Machine maintenance – maintenance hour provided to the user department
Computer department – computer time provided to user department
Accounting firm – charged out client hours

(iii) Costing methods used: In the service sector, costing method used is job costing
method, process costing method or hybrid method which is combination of job
costing and process costing.
In the job costing, the cost of a particular service is obtained by assigning costs to a
distinct identifiable service. On the other hand, the process costing used in service
sector determines cost by assigning costs to masses of similar unit and then
computing cost per unit on an average basis.
d) The initial solution for a minimization problem obtained under Vogel‟s
approximation method and least cost method need not be the same.
It is because Vogel‟s method uses the difference between the minimum and the next
minimum costs for each row and column. This is the penalty or opportunity cost of
not utilizing the next alternative. The highest penalty is given the first preference for
allocation. This need not be the lowest cost. On the other hand, the least cost method
gives preference to the lowest cost cell irrespective of the next cost.
Due to the penalty mechanism, Vogel‟s approximation method will result in a more
optimal solution than the least cost. The solution under the both the method will be
the same only when the maximum penalty and the minimum cost coincide.
e) Project crashing means reduction in the duration of the project. Additional resources
in the form of additional costs will be involved depending upon the length of a
project. It is because additional indirect cost will be required for each day of project
duration. In the project crashing, activities that can be crashed are identified by
comparing the activity cost slope with indirect cost per day in order to arrive at
project duration at optimum cost.
Resource smoothening is used in program evaluation and review technique to
smoothen the peak resource requirement during different periods of project duration.
It is a time scaled diagram of various activities and their float along with resource
requirement. Float gives the option of balancing the resources over longer period so
that resource requirement is smoothened without affecting the project duration very
much.
6.
a) Nepal Music Company produces music player (MP) that can download thousands of
songs. The company forecasts that demand in FY 2075-76 will be 48,000 of such MP.
The variable production cost of each MP is Rs. 5,400. Due to the large Rs. 1,000,000
cost per setup, the company plans to produce MP once a month in batches of 4,000
each. The carrying cost of a unit in inventory is Rs. 1,700 per year.
Required: (2.5+2.5=5)
i) Using an MRP system, what is the annual cost of producing and carrying MP in
inventory? (Assume that, on average, half of the units produced in a month are in
inventory.)
ii) Nepal Music is also considering switching from an MRP system to a JIT system.
This will result in producing MP in batch sizes of 600 MPs and will reduce
obsolescence, improve quality, and result in a higher selling price. The frequency
of production batches will force the company to reduce setup time and will result
in a reduction in setup cost. The new setup cost will be Rs. 50,000 per setup.
What is the annual cost of producing and carrying MP in inventory under the JIT
system?

b) Road Star manufactures and sells a model of motorcycle, SR5.0. In

FY 2073-74, it reported the following:
Units produced and sold 1,500
Investment (Rs.) 84,000,000
Markup percentage on full cost 9%
Rate of return on investment 18%
Variable cost per unit 84,500
Required: (3+2=5)
i) What was Road Star's operating income on SR5.0 in FY 2073-74? What was the
full cost per unit? What was the selling price? What was the percentage mark-up
on variable cost?
ii) Road Star is considering increasing the annual spending on advertising for the
SR5.0 by Rs. 5,000,000. The company believes that the investment will translate
into a 10% increase in unit sales. Should the investment be made? Show your
calculations
Answers:
a)
i) Under a MRP system:
Annual cost of producing and carrying MPs in inventory
= Variable production cost + Setup cost + Carrying cost
= Rs. 5,400 × 48,000 + (Rs. 1,000,000 × 12 months) + [Rs. 1,700 × (4,000 ÷
2)]
= Rs. 259,200,000 + Rs. 12,000,000 + Rs. 3,400,000
= Rs. 274,600,000
ii) Under a JIT system:

Annual cost of producing and carrying MPs in inventory
= Variable production cost + Setup cost + Carrying cost
= Rs. 5,400 × 48,000 + (Rs. 50,000 × 80*) + [Rs. 1,700 × (600 ÷ 2)]
= Rs. 259,200,000 + Rs. 4,000,000 + Rs. 510,000
= Rs. 263,710,000
* Production of 48,000 per year divided by a batch size of 600 would
imply 80 setups per year.
Theoretically there will be no inventory under JIT. The student who has
assumed that there will be no inventory under JIT system will be awarded
marks.
b)
i) Investment (Rs.) 84,000,000
Return on investment 18%
Operating income (18% × Rs. 84,000,000) (Rs.) 15,120,000

Operating income per unit of SR5.0 (Rs. 15,120,000÷1,500) (Rs.) 10,080
Full cost per unit of SR5.0 (Rs. 10,080 ÷ 9%) (Rs.) 112,000
Selling price (Rs. 112,000 + Rs. 10,080) (Rs.) 122,080
Mark-up percentage on variable cost (Rs. 10,080÷ Rs. 84,500) 11.93%
ii) Contribution margin per unit (Rs.) = 122,080 – 84,500 = 37,580

Increase in sales = 10%×1,500 units = 150 units
Increase in contribution margin (Rs.) = 37,580×150 units =
5,637,000
Less: Advertising costs (Rs.) =
(5,000,000)
Increase in operating income (Rs.) = 637,000
Decision:
Road Star should spend Rs. 5,000,000 in advertising because it increases
operating income by Rs. 637,000.


Batch: -June 2018
Level: -CAP-III
Paper 7: Advanced Cost and Management Accounting

1. Did not read question properly and did not answer sub parts.
2.
a) Part (c) of the question was lengthy. Apart from 2 students none has solved the
part (c) correctly. Though the question was easy.
b) Concept of majority of students regarding relevant cost was found ok.
3. Part (a) was not attempted in full. Some candidates had final answer but did not
explain how?
4.
a) The question was asking to identify for cost drivers and question itself explain
such cost drivers but students try to write answer without reading full setup
question so made mistake in many cases. Question asked to create cost pool,
find pool rate and determine the cost but students applied Activities Based
Costing methods without creating pool and without finding pool rate.
b) Student performance was not up to mark. Many students could not classify
cost into fixed cost and variable cost. Some students failed to find out total
patient days from the beginning so cost per patient and break even calculation
was wrongly calculated. While calculating BEP students considered total cost
plus revenue as well in formula. Only fixed cost needed to be considered to
find out BEP in the given scenario.
5.
a) Most of the students did not attempt this part. Those attempted were with less
preparations leading to unnecessary an irrelevant explanations.
b) Few students even could not distinguish incremental cost of managerial cost.
Besides, instead of describing cost, they are describing costing.
c) Students are mentioning importance and lists of service costing. While the
question requires characteristics.
d) Most of the students performed well.
e) Most of the students performed well.
6. The question was comparatively easy. The performance was not satisfactory due
to lack of conceptual knowledge as well as practical solution.

CAP II Paper 8: Strategic Management and Decision Making Analysis
Paper 8:
Strategic Management and Decision Making

Analysis


Marks
7. Read the following and answer the questions accordingly:
Mr. Bhagawat Malhotra, chairman of Nepal‟s largest business group, decided to
restructure and streamline the company by focusing on a few key industries and selling
off business that do not logically fit into those industries. He made the decision suddenly
after the blockade in December 2015.
He had started his business fifty years back. In 1965 he opened Bhagawat grocery shop
near Basantapur. After one year he added there a tea corner with comfortable chairs
decorating the wall by Nepalese Thanka paintings. The tea stall became a unique place
for foreign tourists visiting Nepal. He did not miss the opportunity of flourishing tourist
business in Nepal. Next year he moved to Basantapur Durbar square area near to
immigration office and fully decorated the shop with traditional cultural reflection with
additional background music of Nepalese folk songs.
While enjoying the growing success of the Teashop for five years, he identified another
sector of business mostly related to previous one. He wishes to lead market of teashop
with unique flavor and taste of tea grown in hill region of Nepal and serve variety of tea
to the customers in typical Nepalese village with view of natural tea garden. He presented
his proposal to the government and it had been immediately accepted, as the government
policy was to support the tourism industry in the nation. So he got full support of central
and local government as well financial to land acquisition. His business was expanded to
all fourteen zones.
He assessed the need for transportation service to operate the business through out the
nation. The government granted the permission of importing cars and buses and custom
duties are exempted. As all the time he analyzed the economic and political situation, he
found the opportunities of forming new establishments and adding new product lines.
After the people's movement of 1991 his decision was so fast and compatible to situation
that he could make the money from every business unit. Now he owns Bhagawat group
of twenty-two diverse companies that manufacture a wide range of merchandise from tea
to steel.
In one side the weak monetary and fiscal policy, instable government and labour unions
created threat to those steel and cement manufacturing industries. On the other side the
market of organic tea is expanding globally and globalization is making space for
competency promoting multi-country operations. Mr. Bhagawat Malhotra‟s vision is to
become a regional leader in organic tea and coffee. To implement this vision, Bhagawat
group already have formed joint partnerships and strategic alliances with a number of
well known Tea-Coffee companies of South East Asian Nations.

a) Explain the ability of Mr. Bhagawat Malhotra in making decision to assess the impact
of external environment? 10
b) Discuss the above case from a strategic viewpoint. 10
Answers:
a) An organization‟s ability to cope with its external environment is probably the major
factor for its success or failure. Changes in customer needs, economic and political
conditions not only affect the business company but can make or break an entire
industry. Bhagawat group has learned to interact profitably with its environment.
Generally the managers have a tendency to focus on the working of the organization,
that is, its internal environment. They usually underestimate the effect of the external
environment on their business. It is important to take in consideration the external
environmental forces during management decision-making. The prioritizing of these
external factors needs considerable conceptual ability in the context of specific
situation.
In above case, Mr. Bhagawat Malhotra has been successful to do this. He has ability
to analyze each of the external environmental forces and structure its impact on his
business with clear picture of opportunities and threats. Opportunities provide
potential for market growth and he pursued the growth strategy. New product, new
markets and new functions are added in Bhagawat group business. He followed
growth strategy through diversification. It facilitated growth in size and large scale of
operations provides strategic advantage to his business.
The major factors in the external environment are political, economic, socio-cultural
and technological. Keeping an eye on political and sociological factors, Mr. Malhotra
had been able to identify opportunities that he could expand the grocery shop to
multiline big business company. Tourism industry was flourishing at time of his new
venture in business. Government policy was to support the tourism industry and
Bhagawat group grasped the opportunity. He went on adding new product line in his
business as environment favors.
Environmental analysis results in a mass of information related to forces offering
opportunities and challenging with threats. As per the information provided in above
case, recently he visualized the threat of weak governance system and weak political
institutions. As all the time he analyzes the economic and political situation, he
became aware of the threatening alarm by the impact of weak monetary and fiscal
policy. The opportunity prevailing in the environmental element of global context is
very positive in present situation. So he chooses the strategy of joint development and
strategic alliances method.
b) Strategy is something that is critical and provides long term future direction. It is not a
quick fix. The modality of business followed by Bhagawat group for sure is not like a
quick fix. It has vision of long-term future direction. From the very start of its

business fifty years back, it is heading towards growth and expansion. It is clear about
its way to get success and survive for long run.
As a grocery shop it protected its market share and new product teashop was
developed for existing market. Market development strategy adapted with new
territories and new competencies. With diversification it exploited its core
competencies of uniqueness in new business too. So in above case, the business
owner is very sharp in directions for strategy development.
Its central focus is on continuity of the business. Alternative strategies are considered
and right method for strategy development is followed. As the political and economic
environment of the country is getting complex and threatening, Bhagawat group has
formed joint development and strategic alliances. This alliances help to exploit current
resources and competencies. In future, learning from partners can develop new
competencies. Mr. Malhotra as a strategist of Bhagawat group of business is critical
enough in thinking and making the decision right.
Just from above information, it cannot say that it is strictly following the strategic
management process or not. But the company is creating competitive advantages as
strategic management does. It is leading successfully through all changes in the
environment. Strategic management includes understanding the strategic position of
the company, strategic choices for the future, and turning strategies into actions. In
above case, it seems to have gone this process and done well.
8.
a) Discuss the different directions of strategy development. 10
b) Explain the Porter‟s alternative business strategies and their
implications. 10
Answers:
a) Directions for strategy development are the strategic options available to an
organization in terms of product and market coverage. They are developed
considering the strategic capability of the organization and stakeholders‟ expectations.
However, these directions are not mutually exclusive. For example, development into
new markets usually requires some product changes too. The following are the
directions for strategy development.
a. Protect and Build on Current Position
These strategies are concerned with protecting and building on the current position of
an organization. There are a number of strategic options under this category which are
mentioned below.
Consolidation
Consolidation is concerned with protecting and strengthening the organization‟s
position in existing market with existing product. Consolidation does not mean
rigidness since market situation is likely to be changing. Hence, the organizations

adopt and develop their resources and competencies to maintain their competitive
position.
It requires attention to the extent to which the organization‟s resources and
competencies continue to fit the market needs and how they should be developed to
maintain the competitive position of the organization.
Market Penetration
Market penetration refers to increasing the market share of existing product in
existing markets to protect and build market position. It is possible through aggressive
marketing tactics like trade allowances, advertising, price reduction, and package
improvements. It is also possible through sustaining or improving quality and
innovation.
b. Product Development
An organization can achieve growth through product development strategy. It
includes delivery of modified or new products to the existing market. The new
product can be brought about by:
 Innovation: Product new to the world
 Modification: Product new to the market
 Imitation: Product new to the organization
It involves development of products with new and different characteristics to improve
performance. It requires core competences and research and development efforts.
Therefore, product development can be risky and unprofitable. However, it is the
essence of survivable and growth for an organization.
c. Market Development
An organization can increase sales of its existing product by market development
strategy. Market development implies a firms‟ entry into new market with existing
product. This is required when there are no further opportunities in existing markets
and/or organization has excess production capacity. Using a market development
strategy, a company can capture a larger share of the existing market for current
products through market penetration or it can develop new uses and/or markets for
current products.
This strategy can be adopted by the following ways:
 Extending into new market segments, which are not currently served
 Opening up additional geographical markets
 Resorting to new channels of distribution
 Developing new uses of existing products
d. Diversification

It is a decision to enter into the new business. This strategy is pursued if growth has
plateaued and opportunities for growth in the original business have been depleted.
Unless the competitors are able to expand internationally into less mature markets,
they may have no choice but to diversify into different industries if they want to
continue growing. The two basic diversification strategies are concentric and
conglomerate.
1. Concentric (related) diversification: It is diversifying into an industry related to the
current one. It may be an appropriate strategy when a firm has a strong competitive
position but industry attractiveness is low. It may be achieved through two ways.
a. Vertical integration: Under this, a firm operates in multiple locations on an
industry‟s value chain from extracting raw materials to retailing. More specifically,
assuming a function previously provided by a supplier is called backward integration
(going backward on an industry‟s value chain). Assuming a function previously
provided by a distributor is labeled forward integration (going forward on an
industry‟s value chain).
b. Horizontal integration: It is the degree to which a firm operates in multiple
geographic locations at the same point on an industry‟s value chain. Horizontal
integration can be achieved through internal development or externally through
acquisitions and strategic alliances with other firms in the same industry.
2. Conglomerate (Unrelated) diversification: It is diversifying into an industry
unrelated to its current one. It is pursued if the current industry is unattractive and that
the firm lacks outstanding abilities or skills that it could easily transfer to related
products or services in other industries.
b) There are 4 alternative business strategies as devised by M.E. Porter‟s.
Competitive Advantage
Lower Cost Differentiation
(1) Cost (2) Differentiation

Broad target
Leadership Strategy
Competitive
(3) Cost (4) Differentiation
Scope
Focus Strategy Focus Strategy
Narrow target
Exhibit 4.2: Porter’s Generic Strategies
Exhibit 4.2: Porter‟s Generic Strategies
Broad Target
-When the business strategy does not segment market but adopts mass marketing Under
this approach, there are 2 sub strategies: cost leadership strategy and differentiation
strategy.
1) Cost leadership strategy

Hence, cost leadership strategy aims at broad mass market sets out to become the low (i.e.
lowest) cost producer in the industry.
 So the SBU must exploit all resources optimally and has to have all sources of cost
advantage, reap scale of economy, efficient scale facilities, cost reduction from
experience.
 Such SBU typically sells a standard quality product.
 The SBU has to drive down cost throughout the value chain.
 This strategy allows profit even during heavy competition.
 For example: Wal-Mart, Almo Rent- A- Car, Southwest Airlines, Timex, Gateway
2000 have been found to have followed cost leadership strategy time and again.
2) Differentiation Strategy
Differentiation strategy aims at broad mass market sets out to become the unique or
different in the industry. The SUB‟s products are assumed as different in the whole
industry. This is the mass marketing approach as there is no market segmentation in this
strategy.
 It seeks to be unique in the industry on some dimensions & attributes that are widely
valued by buyers, i.e. providing unique & superior value to the buyer in terms of
product quality, special features or after sale service. Broad scope differentiator bases
its strategy on “widely valued attributes” E.g., Walt Disney productions, Maytag
Appliance, Nike athletic shoes, Apple computer, Mercedes Benz automobiles, IBM
all have adopted this strategy.
 Differentiation based strategy is rewarded for its uniqueness with a premium price
compared with that of competitors.
A Focus Strategy
Contrary to broad target strategy, in focus strategy, a particular segment is selected to be
served. There are 2 sub strategies: cost focus strategy and differentiation focus strategy.
(3) Cost Focus Strategy
Cost focus strategy focuses on a particular segment or niche, i.e. buyer group or
geographical market, and in this segment, the SBU is the lowest cost producer, i.e. not in
the whole industry. The firm seeks cost advantage in its target segment and becomes the
lowest cost producer in the particular segment. For example Fadal Engineering (that deals
in machine tools to small manufacturers). This strategy is more possible alternative as
compared to cost leadership, i.e. in one industry there may be as many cost focusers as
there are segments.
(4) Differentiation Focus
The SBU seeks differentiation action in its target segment, i.e. the SBU differentiates to
meet the particular requirements of the segment in a way that allows the firm to charge
premium price. In contrast to broad scope differentiator, focus differentiator looks for
segments with special needs and meets them better. For example, Apple computers‟
customized computers, Casey‟s General Stores, Morgan Stores, and Inner City

Entertainment: (the company that builds hi quality movie theaters in inner-city locations
for Afro American esp. South side of Chicago).
9.
a) Explain the project selection with its criteria and models. 10
b) Draw and describe the project organization structure. Also explain the
relationship between line and project authorities. (4+6=10)
Answers:
a) Project selection is the process that evaluates proposed projects or group of projects
and chooses some set of them to implement for the purpose of achieving the
objectives of the parent organization. Its same systematic process applied to any area
of the organization‟s businesses in which choices are made between competing
alternatives. Each project will have different costs, benefits, and risks. The selection
of one project out of a set is a difficult task, as theses are rarely known with certainty.
It is important to the success of the project management that project manager fully
understands the parent organization‟s objectives. It is better to involve project
manager in the process by which projects are selected. It is important to know by the
project manager why this project was selected for investment. The proper choice of
investment projects is crucial to the long-run survival of every organization.
In fact project selection is only one of many decisions associated with project
management. But it is concerned with many issues and problems. What we need is
use models that abstract the relevant issues about a problem from the mass of detail in
which the problem is embedded. The models allow stripping away almost all the
reality from a problem, leaving only the relevant aspects of the real situation to deal
with. The following criteria are the most important when an organization chooses a
project selection model.
 Realism: The model should reflect the reality of the organization‟s decision
situation bearing in mind that without a common measurement system, direct
comparison of different projects is impossible. It should take into account the
realities of organization‟s limitations on facilities, capital and personnel.
 Capability: The model should be sophisticated enough to deal with the relevant
factors like multiple time periods and all types of situations.
 Flexibility: The model should be easy to modify in response to changes in the
environment that can give valid result.
 Ease of use: The model should be reasonably convenient, easy to use and
understand. It should not require special interpretation, excessive personnel or
unavailable equipment.
 Cost: Including the costs of data management the modeling costs should be low
relative to the cost of the project and less than the potential benefits of the project.

 Easy computerization: It should be easy and convenient to gather and store the
information in a computer database, and to manipulate data in the model through
use of widely available standard computer package.
Model assists in making decision of project selection. There are two basic types of
project selection models, numeric and nonnumeric. Nonnumeric models are old and
simple with some subtypes like the sacred cow, the operating necessity, the
competitive necessity, the product line extension and comparative benefit model.
Most uses profitability as main measure for numeric model. Real options, scoring,
window of opportunity analysis and discovery driven planning are some numeric type
model. Selecting the type of model to aid project selection process depends on the
philosophy and wish of management.
b) Project-based organization structure (single project)
President
Finance Production Marketing HR
Finance group production group marketing group HR group

Project
Manager
-only one project exists across the functional departmentation

-Here the president has line authority and finance manager, production manager,
marketing manager, and HR manager have line authority in their own respective
specialized departments.
-Project manager directly reports to the president.
-Project manager procures finance staff, production staff, marketing staff, HR staff for
the project either through outsourcing or insourcing from the respective functional
departments by requesting directly to the president.
Matrix organization structure (multiple projects)
“Is a combination of structures which could take the form of product and geographical
divisions, or functional and divisional structure operating in tandem”
Features
-combination of project management and functional departmentation
-Project manager (middle managers) report directly to president.
-Project groups are temporary & scrapped when the project is completed. The employees in
the project then return to their original departments.
-In matrix structure, several projects may be simultaneously undertaken.

This organization structure

-suitable for firms whose products change frequently and are short lived, e.g. defense firms
-Permits maximum use of limited pool of functional specialists
-direct contact replaces bureaucracy (project managers & CE)
-Increases managerial motivation
-Development of managers through increased involvement in decisions
But in matrix organization structure there
-May create power struggle/conflict between project managers and functional area heads (I.
e, VPs) due to Joint responsibility
-may be delayed decisions than in conventional structure due to the conflict of line and staff
-Unclear job & task responsibilities between the staff
-Unclear cost & profit responsibilities due to the sharing of resources between the groups
-Not suitable if managers are incapable to collaborate & are fiercely competitive (internally)
& who cannot cope with ambiguity
-Frequent referral to the CEO by managers in conflict will not allow CEO to devote on
strategic issues
President
V. P. V. P. V. P. V. P.
Finance Production Marketing HR
Project Finance Production Marketing HR

Manager A Group Group Group Group

Manager B Group Group Group Group

Manager C Group Group Group Group
Line authority Project authority
10.
a) Discuss the role of organizational structure in strategy implementation. 7

b) Describe various types of strategy evaluation after explaining its

concept. 8
Answers:
a) Organizational structure specifies the work to be done and how to do it in regard to
the strategy or strategies. It influences how managers work and the decisions resulting
from that work. Organizational structure determines the processes used to complete
organizational tasks to support the implementation of strategies. When the strategy is
modified, it demands changes in organizational structure.
Strategy and structure are closely related to each other. This relationship shows
interconnectedness between strategy formulation and strategy implementation. More
precisely, changes to the firm‟s strategy demand changes in structure. Similarly, the
existing structure may require a particular strategy to be pursued. However, strategy
has a much more important influence on structure than the reverse. It is important that
matching each strategy with a structure enables the use of current competitive
advantages as well as provides flexibility required to develop future advantages. The
following points show how and why strategy demands structure.
a. New strategy is formulated
b. New administrative problem emerges
c. Organizational performance decreases
d. Organizational performance improves
e. A new organizational structure is established.
b) Strategy evaluation continually assesses the changing environment to uncover events
that significantly affect the course of the strategy. Top management exercises strategy
evaluation. It is long term oriented. It focuses on external environment. It is proactive
and provides early warning about the performance of the strategy. Strategy evaluation
involves reexamination of assumptions, measuring performance and appropriate
corrective measures. Assumptions made while formulating a strategy may no longer
be valid and relevant as the environment is dynamic. So the strategy evaluation takes
into account the changing assumptions. Strategy evaluation continually evaluates the
implementation performance of a strategy and gaps are identified. Appropriate
measures are taken to adjust the strategy with due consideration to changing
assumptions and implementation gaps. Strategy evaluation can be strategic and
operational.
Strategic evaluation can be of four types: premise evaluation, implementation
evaluation, strategic surveillance evaluation and special alert evaluation. Premise
evaluation involves reexamination of the validity of premises to make necessary
changes at the right time. It is concerned with keeping track of changes in premises
and assessing their impact on strategy implementation. Implementation evaluation

evaluates whether the plans, program, projects and budget are guiding the
organization towards objective achievement. It involves strategic rethinking. Strategic
surveillance monitors a broad range of events inside and outside the organization,
which threaten the course of action. It can be selective surveillance or organizational
surveillance. Special alert control is triggered by detection of a crisis. It provides rapid
response through immediate reassessment of strategy during crisis situation.
Operating evaluation controls the allocation and use of resources through performance
evaluation of strategic business units. It is a cyclical process of four steps: setting
standards of performance, measure actual performance, evaluate performance and
taking corrective actions. Standards in the form of planned or budgeted performance
are set for implementation. Then actual performance is measured and compared
against performance standards. Corrective actions are taken to bring performance in
line with the standards.

a) Internal analysis
b) Strategic change
c) Red ocean strategy
d) Levels of strategy
e) ETOP
Answers:
a) Internal analysis also called internal appraisal. It systematically evaluates
organizational capability in terms of strengths and weaknesses in various functional
areas. Capability is what an organization does well. Internal analysis is based on the
scanning of internal environment. It is done to find out strengths in order to exploit
opportunities in the external environment. It is also done to find out weaknesses in
order to face threats in the external environment. It analyses resources and
competencies. It identifies unique resources and core competencies of the
organization. The internal appraisal must be done within the scope of mission, goals,
objectives and strategies.
Internal analysis locates strategic advantage. Strategic advantage is gaining advantage
over competitors. Thus internal analysis helps to outperform competitors and create
new opportunities.
b) The environment should be reviewed constantly to address the dynamism. Strategic
change involves changes in the content of a firm's strategy as defined by its scope,
resource deployments and, competitive advantages. Strategic drift demands change in
strategy. It occurs when the current strategy loses relevancy in terms of addressing the
environmental issues. Strategic change should be managed properly. Change
management involves diagnosing the change situation in the organization. It further
involves the determination of styles and roles in managing change. Finally, it also

deals with levers for managing change. In simple form, strategic change is a way of
changing the objectives and vision of the company in order to obtain greater success.
c) If the various firms are operating similar business within same market for limited
consumer then the level of competition scales high. In such situation, the market is
defined, competitors are also defined but the potential business is small. So,
competing firms need typical way to run their business. They compete at cut-throat
level as the sharks fight for each other for a single prey and the color of the sea
becomes red. As the symbol of the shark's fight is resulted with bloody red color, the
competition is termed as Red Ocean. All the strategies formulated by rival
competitors in defined market, defined competitor and limited business opportunities
are called red ocean strategies.
a. Focus on current customers : Firms focus on the customers currently purchasing
the goods and services from it rather than attracting new customers.
b. Compete in existing markets : Under this strategy, any one or very few
competing firms try to win the battle with eroding the other firms. For this, any
sort of strategies like cut-throat pricing strategy, introducing special benefit
packages, etc.
c. Exploiting existing demand : Firms do not try to attract new customers so they
formulate the strategies to exploit the existing demand.
d. Choose cost-value trade off : Firms try to maintain the best value at possibly low
cost.
e. Align the organization with differentiation or low cost: Organization should
choose the differentiation or low cost strategy.
d)
(i) Corporate level strategy
Corporate strategy involves decisions about the organization as a whole. Corporate
level strategy has top level involvement (i.e. CE), and it has a long horizon. It is a key
basis of other strategic decisions. It is organization wide strategy involving decisions
about overall purpose, mission, objectives, goals, scope; allocation of resources among
SBU/divisions. Corporate strategy involves what business areas of operation should an
organization be in?
(ii) Business level strategy
Also known as generic strategy, business strategy is related to a single strategic
business unit (SBU), or division within the corporation. Business strategy is used by
multidivisional companies, i.e. diversified company. It is formulated in order to
achieve objectives of the SBU or division. It involves deciding how to compete in a
particular product-market. Business strategy has to be formulated in line with
corporate strategy.
Generic strategies are: (i) cost leadership strategy (ii) cost focus strategy (iii)
differentiation strategy (iv) Differentiation focus strategy.
(iii) Functional level strategy

Also known as operational strategy, functional strategy is the strategy & policy of a
particular functional department of the business or enterprise, like marketing, finance,
production, human resource. It is formulated in order to achieve annual objectives &
short term strategies of individual department. It involves decisions regarding
allocation of resources among different operations within the functional area.
e)
 ETOP stands for environmental threat and opportunity profile. It is a technique of
diagnosing external environment in terms of relevant changes there in. ETOP
analysis can be demonstrated by the example of a hypothetical company, XYZ
Company, as tabulated in exhibit 1.
 It is a convenient means of drawing attention of top management on most critical
factors & their potential impact on firm‟s strategy, i.e. threats and opportunities.
 Unlike PESTEL, ETOP analysis picks up relevant variables in task environment
and macro environment, i.e. suppliers, intermediaries, customers, competitors,
political, socio-cultural, legal, economic, etc.
 ETOP should be matched with SAP (i.e. strategic advantages profile to develop
SWOT analysis (i.e. strengths-weaknesses-opportunities-threats). Such matching
generates alternative strategies.
Exhibit 1: ETOP Analysis (for XYZ Company: An example)
Environmental sector Impact of each sector:
+ Opportunity - threat
Socio-economic + Some Increased foreign markets & high export potential
- Slow economic growth
-Perception of public about XYZ Company
Technological + High growth envisaged in technological up-gradation
+ Device for reducing pollution by the use of our product
Government + Liberalization of technology import policy
- Regulation on pollution
- Work environment safety rules that increase costs
Supplier - Hostile labor union
-Scarce capital
-Scarce source of technology due to formation of technology
cartel
Competitive - Competitors are much shrewd.
-Top 3 competitors holding 90 percent of market share

12.
a) Present a scenario of external environment analysis practice in Nepal 5
b) State some planning and decision making practices common in
Nepalese organizations. 5
Answers:
a) Organization in any country operates in a unique environment and so is the case in
Nepal too. Environmental forces greatly influence the development, performance and
outcomes of Nepalese organizations. Business environment in Nepal is characterized
by rapid change, growing uncertainty and emerging globalization.
Environment can be external and internal. Political, economical, socio-cultural and
technological forces are external environment. The situation is that the political
uncertainties are increasing. The economic growth rate is very low. Foreign direct
investment is being attracted. Modernization coupled with cross-cultural influences
and high rate of migration are vital forces changing socio-culture. The role of
information technology is increasing. But Nepalese managers do not carry out
systematic auditing of environmental influences for strategic consideration. Scenario
analysis is little emphasized. There is no effective competitor analysis. The state of
competitive position is not very clear to the managers of Nepalese organizations. Very
little emphasis is given to environmental scanning to identify opportunities.
The scenario of external environment is challenging to Nepal. It is creating threat but
institutions in general are not in position to handle it properly. They are weak to grasp
in time the available opportunities.
b) Most of management practices in Nepal are largely classical. Managers are reluctant
for changing their way of making decision with prudent management practices.
Though Nepal started way of industrialization but management practices have not
become fully advanced and competitive. Here are some common planning and
decision making practices in Nepalese organizations :
Planning practices
 Basically 'Top down' approach of planning is in practice in Nepalese organization.
Managers plan and give instructions to the lower level staffs to implement.
 Nepalese managers tend to dislike pre-determined courses of action. They wish to
implement ad-hoc plans at their own will. The choice of the course of action is
based on their experience and interest.
 In Nepal most of organizations prepare short term strategic plan.
 Managers do not like to participate their subordinates in planning process.
Decision making practices

 Decision making is highly centralized in both public enterprises and private
enterprises.

 Decisions making process lacks the employee participation and is based on

experiential learning of the managers.
 Decision making tools are rarely used and the decision alternatives are not
prepared. Basically intuitive decision making practice in common.
 Nepalese managers usually postpone the decision for tomorrow.
 Decisions in Nepalese organization are not effectively implemented effectively
implemented. Implementation process lacks effective monitoring, evaluation and
follow-up. Feedback system is not used properly.


Batch: -June 2018
Level: -CAP-III
Paper 8: Strategic Management and Decision Making Analysis

1. It's satisfactory but need to be more creative.
2. Students need to be coached by excellent expert with due example. They need to
be thorough in concept. Handwriting should be legible. As far as applicable,
diagram or graphical representation is appreciated. Unit in points not in paragraph.
Explain the points elaborately.
3. Students were not prepared for the question. They lack the subjective clarity too.
4. They have concept. However, they found it difficult to link the concept with the
requirement of question.
5. Lack of preparation and expert Knowledge.
6. Student attempted answer well. Above average and satisfactory.
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CAP III Paper 1: Advanced Financial Reporting

CHARTERED ACCOUNTANCY PROFESSIONAL III

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal 1

Paper 1: Advanced Financial Reporting

The Institute of Chartered Accountants of Nepal 2

Maximum Marks - 100

Total No. of Questions - 6 Total No. of Printed Pages - 17

Time Allowed - 3 Hours Marks

Motte Pvt. Ltd. Patale Pvt. Ltd.

Liabilities and Equity

The Institute of Chartered Accountants of Nepal 3

Particulars Rs. Rs. Rs.

The Institute of Chartered Accountants of Nepal 4

Liabilities & Equity

c) Disclosure related to business combination in the financial statement of Motte

The Institute of Chartered Accountants of Nepal 5

Intangible Assets (Patent) 2,000,000

Provisions (long-term) (200,000) (210,000) (10,000) 2,000

The Institute of Chartered Accountants of Nepal 6

Provision (short term) (220,000) (220,000) - -

Working Note 2: Amortization of goodwill

Fair value of net Purchase

Property, plant and equipment 340 160

Issued equity shares of Re. 1 each 240 40

The Institute of Chartered Accountants of Nepal 7

b) The books of Mr. Z showed the following information as on:

The Institute of Chartered Accountants of Nepal 8

Answer: 2(a) Q.N 2(a).

ii) Calculation of Net Assets

Calculation of Non Controlling Interest

Calculation of Group Reserve

Consolidated Balance Sheet at Ashad end 2074

The Institute of Chartered Accountants of Nepal 9

Balance Sheet as at Ashadh end 2074

The Institute of Chartered Accountants of Nepal 10

8. Balance Sheet as at 01.04.2073

The Institute of Chartered Accountants of Nepal 11

Following information are relevant:

b) Following information relating to Joseph Ltd. is extracted from the

The Institute of Chartered Accountants of Nepal 12

- 500,000 Convertible preference shares of Rs. 100 each entitled to a cumulative

The Institute of Chartered Accountants of Nepal 13

Implicit rate 10.33%

The Institute of Chartered Accountants of Nepal 14

Computation of Basic & Diluted EPS

Weighted avg. no of shares 1,12,83,931 1,12,83,931 WN 1

Weighted avg No of ordinary shares 1,12,83,931 1,12,83,931

W. N. 1 Calculation of Weighted Average no. of Equity share

The Institute of Chartered Accountants of Nepal 15

Paid Element 14,56,00,000/78.33 = 18,58,803

WN 3 Assumed Conversion of Pref Share

4. Write short notes on the following: (5×3=15)

b) Interest in another entity.

Nepal Financial Reporting Standard(NFRS) 12 on „Disclosure of Interest in Other Entities‟

c) Stress testing for banks

The Institute of Chartered Accountants of Nepal 16

• abrupt changes in the general level of market rates;

The Institute of Chartered Accountants of Nepal 17