CHARTERED ACCOUNTANCY PROFESSIONAL III

(CAP-III)

Revision Test Paper

Dec 2019

Education Department
The Institute of Chartered Accountants of Nepal

The Revision Test Papers are prepared by the institute with a view to assist the students in their study.
The suggested answers given here are indicative and not exhaustive. Students are expected to apply their
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Paper 1: Advanced Financial Reporting
CAP III Paper 1: Advanced Financial Reporting-Question

Revision Questions:
1. Investment Property (Numerical) - Financial Reporting Standards
Delta is an entity which is engaged in the construction industry and prepares financial statements
to 30 September each year. The financial statements for the year ended 30 September 2015 are
shortly to be authorized for issue. The following events are relevant to these financial statements:

a) On 1 October 2000, Delta purchased a large property for $20 million and immediately began
to lease the property to Epsilon on an operating lease. Annual rentals were $2 million.
b) On 30 September 2014, the fair value of the property was $26 million. Under the terms of the
lease, Epsilon was able to cancel the lease by giving six months’ notice in writing to Delta.
c) Epsilon gave this notice on 30 September 2014 and vacated the property on 31 March 2015.
On 31 March 2015, the fair value of the property was $29 million.
d) On 1 April 2015, Delta immediately began to convert the property into ten separate flats of
equal size which Delta intended to sell in the ordinary course of its business.
e) Delta spent a total of $6 million on this conversion project between 31 March 2015 and 30
September 2015.
f) The project was incomplete at 30 September 2015 and the directors of Delta estimate that
they need to spend a further $4 million to complete the project, after which each flat could be
sold for $5 million.
g) Delta uses the fair value model to measure property whenever permitted by International
Financial Reporting Standards.

Required

Explain and show how the events would be reported in the financial statements of Delta for the
year ended 30 September 2015.

2. Earnings Per Share (Simple)- Financial Reporting Standards

The profit after tax earned by AAZ Limited during the year ended December 31, 2016 amounted
to Rs. 127.83 million. The weighted average number of shares outstanding during the year were
85.22 million.

Details of potential ordinary shares as at December 31, 2016 are as follows:

a) The company had issued debentures which are convertible into 3 million ordinary shares. The
debenture holders can exercise the option on December 31, 2018. If the debentures are not
converted into ordinary shares they shall be redeemed on December 31, 2018. The interest on
debentures for the year 2016 amounted to Rs. 7.5 million.
b) Preference shares issued in 2013 are convertible into 4 million ordinary shares at the option of
the preference shareholders. The conversion option is exercisable on December 31, 2020. The
dividend paid on preference shares during the year 2016 amounted to Rs. 2.45 million.
c) The company has issued options carrying the right to acquire 1.5 million ordinary shares of
the company on or after December 31, 2016 at a strike price of Rs. 9.90 per share. During the
year 2016, the average market price of the shares was Rs. 11 per share.
d) The company is subject to income tax at the rate of 30%.

Required
(a) Compute basic and diluted earnings per share.
(b) Prepare a note for inclusion in the company’s financial statements for the year ended
December 31, 2016 in accordance with the requirements of International Accounting
Standards.

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CAP III Paper 1: Advanced Financial Reporting-Question

3. Earnings Per Share (Complex)- Financial Reporting Standards

The following information pertains to ABC Limited, in respect of year ended March 31, 2016.
Rs. in ‘000
Consolidated profit for the year (including non-controlling interest) 15,000
Profit attributable to non-controlling interest 2,000
Dividend paid during the year to ordinary shareholders 4,000
Dividend paid on 10% Cumulative preference shares for the year 2015 2,000
Dividend paid on 10% Cumulative preference shares for the year 2016 2,000
Dividend declared on 12% Non-cumulative preference shares for the year 2016 2,400

(i) The company had 10 million ordinary shares at March 31, 2015.
(ii) The cumulative preference shares were issued at the time of inception of the company.
(iii) The 12% non-cumulative preference shares are convertible into ordinary shares, on or
before December 31, 2017 at a premium of Rs. 2 per share. The conversion rights are not
adjusted for subsequent bonus issues.
(iv) 0.50 million non-cumulative preference shares were converted into ordinary shares on
July 1, 2015.
(v) The dividend declared on the non-cumulative preference shares, as referred above, was
paid in April 2016.
(vi) 1.20 million right shares of Rs. 10 each were issued at a premium of Rs. 1.50 per share on
October 1, 2015. The market price on the date of issue was Rs. 12.50 per share.
(vii) 20% bonus shares were issued on January 1, 2016.
(viii) Due to insufficient profit no dividend was declared during the year ended March 31,
2015.
(ix) The average market price for the year ended March 31, 2016 was Rs. 15 per share.

Required
Compute the basic and diluted earnings per share and prepare a note for inclusion in the consolidated
financial statements for the year ended March 31, 2016.

4. Share Based Payment (Logical)- Financial Reporting Standards

NFRS 2 requires an entity to recognise share-based payment transactions in its financial
statements. These include transactions with the employees or other parties where they are to be
settled in cash, other assets or equity instruments of the entity. The NFRS identifies three types of
share-based payment transaction and sets out the measurement principles and specific
requirements for each.

Required
(i) Suggest why there was a need for a standard in this area.
(ii) Identify and briefly explain the three types of share based payments recognised by NFRS 2.

5. Intangible Assets, Provisions, PPE (Comprehensive Logic) - Financial Reporting Standards

Brooklyn is a bio-technology company performing research for pharmaceutical companies. The

finance director has contacted your financial consulting company to arrange a meeting to discuss
issues relevant to the preparation of the financial statements for the year to 30th June 2016. Your
initial telephone conversation has provided the necessary background information.

a. On 1st August 2015 Brooklyn began investigating a new bio-process. On 1st September 2016,
the new process was widely supported by the scientific community and the feasibility project
was approved. A grant was then obtained relating to future work. Several pharmaceutical
companies have expressed an interest in buying the ‘know how’ when the project completes

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CAP III Paper 1: Advanced Financial Reporting-Question

in June 2017. The nominal ledger account set up for the project shows that the expenditure
incurred between 1st August 2015 and 30th June 2016 was Rs. 300,000 per month.

b. In August 2016, an employee lodged a legal claim against the company for damage to his
health as a result of working for the company for the two years through to 31st March 2015
when he had to retire due to ill health. He has argued that his health deteriorated as a result of
the stress from his position in the organisation. Brooklyn has denied the claim and has
appointed an employment lawyer to assist with contesting the case. The lawyer has advised
that there is a 25% chance that the claim will be rejected, 50% chance that the damages will
be Rs. 600,000 and 25% chance of Rs. 1 million. The company has an insurance policy that
will pay 10% of any damages to the company. The lawyer has said that the case could take
until 30th June 2019 to resolve. The present value of the estimated damages discounted at 8%
is Rs. 476,280 and Rs. 793,800 respectively.

c. Brooklyn owns several buildings, which include an administrative office in the centre of
London. The company has revalued these on a regular basis every five years and the next
valuation is due on 30th June 2018. Property prices have increased since the last review and
particularly for the London premises. The cost of engaging a professionally qualified valuer is
very expensive and so to reduce costs the finance director is proposing that the property
manager, who is a professionally qualified valuer, should value the London property and that
the increase in value should be included in the financial statements. The finance director is of
the opinion that the property prices may fall next year.

Required
Prepare notes for your meeting with the finance director which explain and justify the
accounting treatment of these issues, preparing calculations where appropriate and identifying
matters on which your require further information.

6. Consolidation, First Time Adoption and share based payment (Comprehensive Logic) -
Financial Reporting Standards

You are the financial controller of Omega, a listed entity which prepares consolidated financial
statements in accordance with International Financial Reporting Standards (IFRS). One of your
assistants, a trainee accountant, is involved in the preparation of the consolidated financial
statements for the year ended 31 March 2017. She is also involved in the preparation of the
individual financial statements for the entities in the group. She has sent you an email with the
following queries:

Dear Sir / Madam,

While preparing financial statements of the companies I am working in, I have face the following
issues. Please suggest me the way forward.

Query One
On 1 April 2016 we acquired a new subsidiary. This subsidiary has always prepared its financial
statements in $ but has used IFRS for the first time this year. Previously, they have used local
standards. This means that the comparative figures (they present comparatives for one year only),
taken from last year’s financial statements, will be based on local standards not IFRS. How do I
make sure we are comparing like with like in the current year individual financial statements of
the subsidiary? Please just give me the general procedure, rather than dealing with any specialised
exemptions.

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CAP III Paper 1: Advanced Financial Reporting-Question

Query Two
I notice that on 1 April 2016 we lent $50 million to a key supplier. The loan has an annual rate of
interest of 5%, with interest of $2·5 million payable on 31 March each year in arrears. The loan is
repayable on 31 March 2026 but I believe that if interest rates change, we might consider
assigning the loan to a third party. As it turns out, interest rates have fallen since 1 April 2016 and
the fair value of the loan asset at 31 March 2017 was $52 million. I have been told that this loan
asset should be measured at ‘fair value through other comprehensive income’. Why is this? I
thought loan assets were measured at amortised cost. If the loan asset is measured at fair value
through other comprehensive income, does the interest income get recorded in other
comprehensive income rather than profit or loss?

Query Three
I’m not sure whether we need to make any entries in respect of the equity settled share-based
payment scheme we started on 1 April 2016. I believe we granted options to 1,000 employees to
purchase 100 shares in Omega for a fixed price. The options vest on 31 March 2021 subject to
two conditions. The first vesting condition is that the employees remain employed by Omega
throughout the five-year period up to the date of vesting. Best estimates are that 900 of the 1,000
will stay for that period – only 25 left in the year ended 31 March 2017. The other condition is
that the Omega share price on 31 March 2021 should be at least $10. The share price on 31 March
2017 was only $8·50 so it doesn’t look like this condition is satisfied yet. I’ve also noticed that
the fair value of one share option was $1 on 1 April 2016, rising to $1·05 on 31 March 2017. Do
we need any accounting entries and, if so, what should they be?

Required: Provide answers to the three queries raised by the trainee accountant. Your answers
should refer to relevant provisions of International Financial Reporting Standards.

Sincerely,
Dipesh Lama
Account Trainee

7. Lease, Going Concern, Joint Arrangement (Comprehensive Logic with Numerical) -

Financial Reporting Standards

Delta is an entity which prepares financial statements to 31 March each year. Each year, the
financial statements are authorised for issue on 25 May. The following events have occurred
which are relevant to the year ended 31 March 2017:

Event (a)
On 1 April 2016, Delta purchased an asset for $771,000 and immediately leased this asset to
entity X. The lease term was for five years and the lease rental, receivable annually in arrears on
31 March, was $200,000. Delta incurred direct costs of $20,000 in arranging this lease. The
annual rate of interest implicit in this lease was 10%. Under the terms of the lease, entity X is
responsible for insuring the asset and for carrying out any necessary repairs and maintenance of
the asset. At a discount rate of 10% per annum the present value of $1 receivable annually in
arrears for five years is $3·80.

Event (b)
On 1 April 2016, Delta entered into a joint arrangement with entity Y to jointly operate a delivery
depot. Entity Y is located, and has major customers in, the same geographical region as Delta.
Delta and entity Y each made the following payments in respect of the arrangement on 1 April
2016:
• $25 million each to purchase a joint 25-year leasehold interest in a depot which was close to
both Delta and entity Y’s business premises. This depot was to act as headquarters for the
delivery vehicles (see below).

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CAP III Paper 1: Advanced Financial Reporting-Question

• $7·5 million each to purchase a fleet of delivery vehicles. The vehicles have an expected
useful life of five years, with no expected residual value.

Delta and entity Y agreed to jointly use the delivery vehicles to deliver products to their
customers, and to share the operating costs of the depot equally. Any delivery charges to
customers were levied by Delta and entity Y directly at the discretion of the individual entities.
During the year ended 31 March 2017, the total cash cost of operating the depot was $8 million.
This was paid equally by Delta and entity Y. In the year ended 31 March 2017, Delta charged its
customers a total of $2 million in delivery charges.

Event (c)
On 31 March 2017, Delta was owed $10m by entity Z. The amount was due for payment by 30
April 2017. Entity Z has been a customer for many years and has an excellent payment record. At
31 March 2017, there was no reason to suppose that entity Z would fail to pay the $10m owed to
Delta by 30 April 2017. By 20 April 2017, entity Z’s going concern status was in considerable
doubt.

Required:
Explain and state (where possible by quantifying amounts) how the three events would be
reported in the financial statements of Delta for the year ended 31 March 2017.

8. Income Taxes (Tax expenses and Deferred Tax – Simple Numerical) - Financial Reporting
Standards

Given below is the statement of profit or loss and other comprehensive income of Shakir
Industries for the year ended December 31, 2016:
FY 2016
Rs. m
Sales 143.00
Cost of goods sold (96.60)
Gross profit 46.40
Operating expenses (28.70)
Operating profit 17.70
Other income 3.40
Profit before interest and tax 21.10
Financial charges (5.30)
Profit before tax 15.80

Following information is available:

(i) Operating expenses include an amount of Rs.0.7 million paid as penalty to SECP on
noncompliance of certain requirements of the Companies Act, 2017.
(ii) During the year, the company made a provision of Rs. 2.4 million for gratuity. The actual
payment on account of gratuity to outgoing members was Rs. 1.6 million.
(iii) Lease payments made during the year amounted to Rs.0.65 million which include
financial charges of Rs.0.15 million. As at December 31, 2016, obligations against assets
subject to finance lease stood at Rs. 1.2 million. The movement in assets held under
finance lease is as follows:
Rs. m
Opening balance – 01/01/2016 2.50
Depreciation for the year (0.7)
Closing balance – 31/12/2016 1.80

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CAP III Paper 1: Advanced Financial Reporting-Question

(iv) The details of owned fixed assets are as follows:

Accounting Tax
Rs. m Rs. m
Opening balance – 01/01/2016 12.50 10.20
Purchased during the year 5.3 5.3
Depreciation for the year (1.10) (1.65)
Closing balance – 31/12/2016 16.70 13.85

(v) Capital work-in-progress as on December 31, 2016 include financial charges of Rs. 2.3
million which have been capitalised in accordance with NAS-23 Borrowing Costs.
However, the entire financial charges are admissible, under the Income Tax Act.
(vi) Deferred tax liability and provision for gratuity as at January 1, 2016 was Rs.0.55 million
and Rs.0.7 million respectively.
(vii) Applicable income tax rate is 35%.
Required: Based on the available information, compute the current and deferred tax expenses for
the year ended December 31, 2016.

9. Income Taxes (Tax expenses and Deferred Tax – Simple Numerical) - Financial Reporting
Standards

The following statement of financial position relates to Model Town Group, a public limited
company at 30 June 2016:
Rs.000
Assets:
Non-current assets:
Property, plant, and equipment 10,000
Goodwill 6,000
Other intangible assets 5,000
Financial assets (cost) 9,000
a. Total 30,000
Trade receivables 7,000
Other receivables 4,600
Cash and cash equivalents 6,700
b. Total 18,300
c. Total (a+b) 48,300

Equity and liabilities

Share capital 9,000
Other reserves 4,500
Retained earnings 9,130
a. Total equity 22,630

Non-current liabilities
Long term borrowings 10,000
Deferred tax liability 3,600
Employee benefit liability 4,000
b. Total non-current liabilities 17,600
Current tax liability 3,070
Trade and other payables 5,000
c. Total current liabilities 8,070
Total liabilities (b+c) 25,670
Total equity and liabilities (a+b+c) 48,300

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CAP III Paper 1: Advanced Financial Reporting-Question

The following information is relevant to the above statement of financial position:

(i) The financial assets are investments in equity. Model Town has made an irrevocable
election to recognise gains and losses on these assets in other comprehensive income.
However, they are shown in the above statement of financial position at their cost on
1 July 2015. The market value of the assets is Rs. 10.5 million on 30 June 2016.
Taxation is payable on the sale of the assets.

(ii) The stated interest rate for the long term borrowing is 8 per cent. The loan of Rs. 10
million represents a convertible bond which has a liability component of Rs. 9.6
million and an equity component of Rs.0.4 million. The bond was issued on 30 June
2016.

(iii) The tax bases of the assets and liabilities are the same as their carrying amounts in the
statement of financial position at 30 June 2016 except for the following:
(a)
Rs.000
Property, plant, and equipment 2,400
Trade receivables 7,500
Other receivables 5,000
Employee benefits 5,000
(b) Other intangible assets were development costs which were all allowed for tax
purposes when the cost was incurred in 2015.

(c) Trade and other payables include an accrual for compensation to be paid to
employees. This amounts to Rs. 1 million and is allowed for taxation when paid.

(iv) Goodwill is not allowable for tax purposes in this jurisdiction.

(v) Assume taxation is payable at 30%.

Required
Calculate the provision for deferred tax at 30 June 2016 after any necessary adjustments to the
financial statements showing how the provision for deferred taxation would be dealt with in the
financial statements. (Assume that any adjustments do not affect current tax. You should briefly
discuss the adjustments required to calculate the provision for deferred tax).

10. Write down the differences between a Principles Based System and a Rules Based System of
developing accounting standards?

11. Share Based payments (Numerical) - Financial Reporting Standards

a. Kappa prepares financial statements to 31 March each year. The following share-based
payment arrangements were in force during the year ended 31 March 2015:
(i) On 1 April 2013, Kappa granted options to 500 employees to subscribe for 400 shares
each in Kappa on 31 March 2017, providing the employees still worked for Kappa at
that time. On 1 April 2013, the fair value of each option was $1·50. In the year ended
31 March 2014, ten of these employees left Kappa and at 31 March 2014, Kappa
expected that 20 more would leave in the three-year period from 1 April 2014 to 31
March 2017.
Kappa’s results for the year ended 31 March 2014 were below expectations and at 31
March 2014 the fair value of each option had fallen to 25 cents. Therefore, on 1 April

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CAP III Paper 1: Advanced Financial Reporting-Question

2014 Kappa amended the exercise price of the original options. This amendment
caused the fair value of these options to rise from 25 cents to $1·45.

During the year ended 31 March 2015, five of the employees left and at 31 March
2015, Kappa expected that ten more would leave in the two-year period from 1 April
2015 to 31 March 2017. The results of Kappa for the year ended 31 March 2015 were
much improved and at 31 March 2015, the fair value of a re-priced option was $1·60.

(ii) On 1 April 2013, Kappa granted share appreciation rights to 50 senior employees.
The number of rights to which each employee becomes entitled depends on the
cumulative profit of Kappa for the three years ended 31 March 2016:
 1,000 rights per employee are awarded if the cumulative profit for the three-year
period is below $500,000.
 1,500 rights per employee are awarded if the cumulative profit for the three-year
period is between $500,000 and $1 million.
 2,000 rights per employee are awarded if the cumulative profit for the three-year
period exceeds $1 million.

On 1 April 2013, Kappa expected that the cumulative profits for the three-year period would be
$800,000. After the disappointing financial results for the year ended 31 March 2014, this
estimate was revised at that time to $450,000. However, given the improvement in results for the
year ended 31 March 2015, the estimate was revised again at 31 March 2015 to $1,100,000.

On 1 April 2013, the fair value of one share appreciation right was $1·10. This estimate was
revised to $0·90 at 31 March 2014 and to $1·20 at 31 March 2015. All the senior employees are
expected to remain employed by Kappa for the relevant three-year period. The rights are
exercisable on 30 June 2016.

Show how and where transactions would be reported in the financial statements of Kappa for the
year ended 31 March 2015.

12. Calculation of Distributable Profit – Banking Industry

BBL Bank Limited has earned profit of Rs. 150 Million. The profit earned has been calculated
using NFRS. The profit includes Rs. 10 million foreign exchange revaluation amount. The Bank
has also issued Rs. 50 million Debenture 3 years back to be redeemed in next 2 years. The bank
has booked Rs.316 million as Interest Income out of which Rs. 300 was received in cash. The
bank also has Rs. 25 million of Non-Banking Assets, Deferred tax assets of Rs. 15 million and
Actuarial Losses of Rs. 5 Million.
You are required to prepare statement of distributable profit as per NRB Directive.

13. Foreign Exchange (Numerical) - Financial Reporting Standards

DND Limited is a listed company, having its operations within Pakistan. During the year ended
December 31, 2016, the company contracted to purchase plants and machineries from a US
Company. The terms and conditions thereof, are given below:
(i) Total cost of contract = US$ 100,000.
(ii) Payment to be made in accordance with the following schedule:
Payment dates Amount Payable
on Signing contract July 01, 2016 USD 20,000
on shipment* Sep 30, 2016 USD 50,000
After Instalation & Test Jan 31, 2017 USD 30,000
*(risk and rewards of ownership are transferred on shipment)

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CAP III Paper 1: Advanced Financial Reporting-Question

The contract went through in accordance with the schedule and the company made all the
payments on time. The following exchange rates are available:

July 01, 2016 US 1 = Rs. 60.50

Sep 30, 2016 US 1 = Rs. 61.00
Dec 31, 2016 US 1 = Rs. 61.20
Jan 31, 2017 US 1 = Rs. 61.50
Required
Prepare journals to show how the above contract should be accounted for under NAS 21.

14. Concept of Various entities for applying NFRS

Ram has invested in several companies ranging from Small retail to big listed companies. He as a
investor, has received varieties of financial statements. Some state of being compiled with NFRS
some doesn't. You as a CA finalist clarify Mr. Ram about varieties of organizations and
applicability of NFRS.

15. Financial Instruments (Concept) - Financial Reporting Standards

On 1 July 2016, Passila Ltd, issued 20,000 8% debentures at Rs. 97.50. The security is
redeemable in five years’ time. The interest on the debentures is payable bi-annually on 30 June
and 31 December.

On 31 December 2016, the Company’s year-end date, the debentures were quoted on the Karachi
Stock Exchange for Rs. 96.00. The company accountant has suggested each of the following as
possible valuation basis for reporting the debentures liability on the statement of financial position
as at 31 December 2016:

(i) Face value of the debentures.

(ii) Face value of the debenture plus interest payment for five years.
(iii) Market value on the statement of financial position as at the year end.

Required
a) Determine the face value of the debentures and the proceeds accruing to the company.
b) Determine the amount and explain the nature of the differences between the face value and
the market value of the debentures on 1 July, 2016.
c) Distinguish between nominal and effective rate of interest.
d) Determine the nominal interest payable on the debentures for the year ended 31 December
2016.
e) State arguments for or against each of the suggested alternatives for reporting the debentures
liability on the statement of financial position as at 31 December 2016.

16. Related Party (Concept) - Financial Reporting Standards

Discuss whether the following events would require disclosure in the financial statements of the
RP Group, a public limited company, under NAS 24 Related party disclosures. The RP Group,
merchant bankers, has a number of subsidiaries, associates and joint ventures in its group
structure. During the financial year to 31 October 20X9 the following events occurred.

(a) The company agreed to finance a management buyout of a group company, AB, a limited
company. In addition to providing loan finance, the company has retained a 25% equity holding
in the company and has a main board director on the board of AB. RP received management fees,
interest payments and dividends from AB.

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CAP III Paper 1: Advanced Financial Reporting-Question

(b) On 1 July 20X9, RP sold a wholly owned subsidiary, X, a limited company, to Z, a public
limited company. During the year RP supplied X with secondhand office equipment and X leased
its factory from RP. The transactions were all contracted for at market rates.

(c) The retirement benefit scheme of the group is managed by another merchant bank. An
investment manager of the group retirement benefit scheme is also a non-executive director of the
RP Group and received an annual fee for his services of $25,000 which is not material in the
group context. The company pays $16m per annum into the scheme and occasionally transfers
assets into the scheme. In 20X9, property, plant and equipment of $10m were transferred into the
scheme and a recharge of administrative costs of $3m was made.

17. Change in Estimates, Policies and Error (Concept) - Financial Reporting Standards
Duncan Company has previously written off any expenditure on borrowing costs in the
period in which it was incurred.
The company has appointed new auditors this year. They have expressed the view that the
previous recognition of borrowing costs in the statement of profit or loss was in error. The
company has decided to correct the error retrospectively in accordance with NAS 8.
The financial statements for 2015 and the 2016 draft financial statements, both reflecting
the old policy, show the following:

Statements of changes in Equity (extract) ('000)

2015 2016
Retained Earnings Retained Earnings
Opening Balance 222,500 23,950
Profit after tax for the period 3200 4712
Dividends Paid (1750) (2500)
Closing Balance 23950 26162

Borrowing costs written off were Rs. 500,000 in 2015 and Rs. 600,000 in 2016. The
directors have calculated that borrowing costs, net of depreciation which should have
been included in property, plant and equipment had the correct policy been applied, are as
follows.
Rs.000
At 30 December 2014 400
At 31 December 2015 450
At 31 December 2016 180
Had the correct policy been in force depreciation of Rs. 450,000 would have been
charged in 2015 and Rs. 870,000 in 2016.
Required
Show how the change in accounting policy must be reflected in the statement of changes
in equity for the year ended 31 December 2016. Work to the nearest Rs.000.

18. Change in Estimates, Policies and Error (Concept) - Financial Reporting Standards

a. X Ltd is considering acquiring a machine. It has two options; cash purchase at a cost of Rs.
11,420,000 or a lease. The terms of the lease are as follows:
I. The lease period is for four years from 1 January 2016 with an annual rental of Rs.
4,000,000 payable on 31 December each year.

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CAP III Paper 1: Advanced Financial Reporting-Question

II. The lessee is required to pay all repairs, maintenance and other incidental costs. (iii)
The interest rate implicit in the lease is 15% p.a.

Note: Estimated useful economic life span of the machine is four years.

Required
(a) Prepare a schedule of the allocation of the finance charges in the books of X Limited for
the entire lease period.
(b) Prepare an extract of the Statement of Financial Position of X Limited for the year ended
31 December 2016.

19. Financial Instruments (Concept and Numerical) - Financial Reporting Standards

Waters Ltd acquired the following financial assets and liabilities in 2016.
1. On 1 September, Waters acquired 2,000 Rs. 100 nominal units of 7% treasury stock 2022 for Rs.
104.10 per unit. The gross redemption yield at the date of purchase was 6.30%. Waters does not
intend to hold the treasury stock until maturity, as the cash may be required in the meantime.
Interest is paid annually in arrears.
2. Waters buys and sells goods in Constantia, a country whose currency is the Prif (PR). On 3
December Waters enters into a futures contract to sell PR500,000 on 30 April 2017 at an agreed
price of PR1.98/Rs. 1. This contract is not part of a designated hedge. The cost of entering into the
contract was Rs. 750.
3. On 5 February Waters acquired 250,000 ordinary shares in Gilmour Ltd at Rs. 4.85 per share
incurring Rs. 35,000 attributable transaction costs.
4. On 1 July Waters sells goods to Mason for Rs. 500,000 on interest free credit payable 30 June
2017. The imputed rate of interest is 11%.
5. On 30 April Waters acquired 1,000 Rs. 100 nominal units of 8.5% treasury stock 2018 at Rs.
107.10 per unit. The gross redemption yield is 5.9%. Waters intends to hold the investment to
maturity. Interest is paid annually in arrears.
6. On 26 December Waters purchased Rs. 25,000 of quoted company loan notes. This asset has been
designated as being held for short-term trading purposes.
7. On 24 December Waters sold 10,000 shares 'short' in Wright Ltd for Rs. 3.60 each, hoping that
the share price would fall so that it could clear its position by buying the shares in January 2017 at
a lower price.

On 31 December 2016, the values are as follows:

1. Rs. 100 nominal units of 7% treasury stock 2022 are trading at Rs. 98.07 per unit at 31
December 2016. The gross redemption yield at that date is 7.3%.
2. The futures rate for a Prif contract with a delivery date of 30 April 2017 is PR1.99/Rs. 1.
3. The shares in Gilmour are now trading at Rs. 5.20 – Rs. 5.25 per share, having an average of
Rs. 5.05 during the year. Disposal costs would be 2% of the sale proceeds.
4. Amounts receivable from Mason remain outstanding at the reporting date. The imputed
interest rate for current sales is 12%.
5. The 8.5% treasury stock 2018 is now trading at Rs. 101.50 per unit and the gross redemption
yield is currently quoted at 7.48%.
6. The loan notes are now worth Rs. 25,500 due to the market being more confident that the
interest will be paid in full and on time.
7. Shares in Wright Ltd are now trading at Rs. 3.30 each.

Required Explain and calculate the impact of the above transactions on the financial statements of
Waters Ltd for the year ended 31 December 2016.

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CAP III Paper 1: Advanced Financial Reporting-Question

20. General Purpose Financial (Framework) - Financial Reporting Standards

The IFRS are generally accepted as accounting standards in the preparation of general purpose
financial statements in many countries of the world.

Required
a. Briefly explain the meaning of general purpose financial statements in accordance with IAS 1
(Presentation of Financial Statements)
b. Explain briefly any FOUR possible reasons for the prevalence of IFRS in many countries of the
world.
c. Explain the arguments in support and against financial reporting standards.

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Suggested Answers/Hints:

1. Investment Property - Financial Reporting Standards

From 1 October 2000, the property would be regarded as an investment property since it is being
held for its investment potential rather than being owner occupied or developed for sale.

The property would be measured under the fair value model. This means it will be measured at its
fair value each year end, with any gains or losses on remeasurement recognised in profit or loss.

On 31 March 2015, the property ceases to be an investment property because Delta begins to
develop it for sale as flats.

The increase in the fair value of the property from 30 September 2014 to 31 March 2015 of $3
million ($29 million – $26 million) would be recognised in P/L for the year ended 30 September
2015. Since the lease of the property is an operating lease, rental income of $1 million (($2
million x 6/12) would be recognised in P/L for the year ended 30 September 2015.

When the property ceases to be an investment property, it is transferred into inventory at its then
fair value of $29 million. This becomes the initial ‘cost’ of the inventory.

The additional costs of $6 million for developing the flats which were incurred up to and
including 30 September 2015 would be added to the ‘cost’ of inventory to give a closing cost of
$35 million.

The total selling price of the flats is expected to be $50 million (10 x $5 million). Since the further
costs to develop the flats total $4 million, their net realisable value is $46 million ($50 million –
$4 million), so the flats will be measured at a cost of $35 million. The flats will be shown in
inventory as a current asset.

2. Earnings Per Share (Simple)- Financial Reporting Standards

Working notes for identifying Dilutive or Antidilutive

Earnings
Impact on per
Impact on Earning Increase in No. incremental Dilutive
Particulars Earning (after Tax) of Shares shares /Antidilutive
Ordinary Number 125,380,000 125,380,000 85,220,000 1.47 Basic EPS
Convertible Debentures 7,500,000 5,250,000 3,000,000 1.75 Antidilutive
Convertible Preference Dilutive
Shares 2,450,000 2,450,000 4,000,000 0.6125
150,000 Dilutive
Options - - 1.5m (11-9.9)/11 -

Notes to the financial statements for the year ended December 31, 2016

EARNINGS PER SHARE 2016

Basic attributable to ordinary shareholders Profit (Rupees) 125,383,000

Rs. 127,830,000 – Rs. 2,450,000 = Rs. 125,380,000

Weighted average number of ordinary shares outstanding during the year 85,220,000

Earnings per share - basic (Rupees) 1.47

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Diluted profit after taxation (Rupees) 127,833,000

Weighted average number of ordinary shares, options and convertible

preference shares outstanding during the year 89,370,000
(85,220,000+4,000,000+150,000)

Earnings per share - diluted (Rupees) 1.430

3. Earnings Per Share (Complex)- Financial Reporting Standards

Extract from notes of ABC Limited

Notes to consolidated financial statements for the year ended March 31, 2016
Rs. in '000
Earnings per share basic
Profit after tax and non-controlling interest (15,000-2,000) 13,000
Dividend paid during the year to ordinary shareholders (Rs. 4,000) -
10% Cumulative preference dividend for 2015 (Rs. 2,000) -
10% Cumulative preference dividend for 2016 (2,000)
Dividend declared on 12% non-cumulative preference shares for 2016 (2,400)
Profit available for distribution to ordinary share holders 8,600

Diluted earnings per share

Profit available for distribution to ordinary share holders 8,600
Effect of dividend declared on 12% non-cumulative preference shares
Convertible into ordinary shares on or before December 31, 2017 2,400
11,000

April July Oct Jan Mar

3m 3m 3m 3m

No of shares
10,000,000 416,667 1,200,000 2,323,333 13,940,000

Right factor
Outstanding shares before the exercise of
rights at fair value 10,416,667 12.50 130,208,337.50
Rights issued at a premium of Rs. 1.5 1,200,000 11.50 13,800,000.00
11,616,667 144,008,337.50

Theoretical ex-right value per share 1,44,008,337.5 / 11,616,667 12.40

Right Factor 12.50/12.40 1.00833

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Bonus Factor
Bonus issued on January 01, 2016 (20%) Adjusting factor (6 shares for 5 shares) = 1.2
Time Right
Month No of Shares Factor Factor Bonus Factor Total
Apr - June 10,000,000 3/12 1.00833 6/5 3,024,998.55
Jul - Sep 10,416,667 3/12 1.00833 6/5 3,151,040.26
Oct - Dec 11,616,667 3/12 - 6/5 3,485,000.10
Jan - Mar 13,940,000 3/12 - - 3,485,000.00
13,146,038.91
Total 13,146 ('000)

Basic Earnings per Shares = 8600 / 13146 = Rs. 0.65 per shares

Diluted EPS

April July Oct Jan Mar

3 months 9 months

No of Non-cumulative Pref. shares

2,500,000 500,000 (given) 2,000,000
(b/f) Total

Weighted no of convertible Pref Shares

= 2,500,000 * 3/12 * 10/ 12 + 2,000,000 * 9/12 * 10/ 12
= 1,770,833.33
= 1,770 ('000)

Diluted Earnings per Shares = (8600 +2400) / (13146 +1,770) = Rs. 0.74 per shares
The non-cumulative preference shares are anti-dilutive

4. Share Based Payment (Logical)- Financial Reporting Standards

i. The need for accounting standard regulation Share options are often granted to employees at an
exercise price that is higher than the market price of the shares.
Therefore, the options have no intrinsic value to the company and, prior to the issue of IFRS 2,
these transactions were not generally recognised until such time as the shares were issued. This
approach could be seen as resulting in a distortion of reported results between accounting
periods and leaving liabilities unrecorded.
In addition, the subject of accounting for share-based payments contains a number of other
contentious issues, notably relating to the measurement principles to be applied in recognising
the transactions. If employees agree to stay until their options vest, the organisation must
recognise the service they will provide in return, but how should this be valued? IFRS 2 was
therefore issued in February 2004 to provide comprehensive guidance on these matters.

ii.The three types of share based payments

These can be summarised as follows:
Equity-settled share-based payment transactions
The entity pays for goods or services by issuing equity instruments in the form of shares or
share options.

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Cash-settled share-based payment transactions

The entity incurs a liability for goods or services and the settlement amount is based on the
price (or value) of the entity’s shares or other equity instruments.

Share based payments with cash alternatives

Transactions where an entity acquires goods or receives services and either the entity or the
supplier can choose payment to be a cash amount based on the price (or value) of the entity’s
shares or other equity instruments, or equity instruments of the entity.

5. Intangible Assets (Comprehensive) - Financial Reporting Standards

i. Development expenditure
NAS 38 on intangibles requires that research and development be considered separately:
Research – which must be expensed as incurred
Development – which must be capitalised where certain criteria are met.
It must first be clarified how much of the Rs. 3 million incurred to date (10 months at Rs.
300,000) is simply research and how much is development. The development element will only
be capitalised where the NAS 38 criteria are met. The criteria are listed below together with the
extent to which they appear to be met.

 The project must be believed to be technically feasible. This appears to be so as the feasibility
has been acknowledged.
 There must be an intention to complete and use/sell the intangible. Completion is scheduled
for June 2017
 The entity must be able to use or sell the intangible. Interest has been expressed in purchasing
the knowhow on completion
 It must be considered that the asset will generate probable future benefits. Confirmation is
required from Brooklyn as to the extent of interest shown by the pharmaceutical companies
and whether this is of a sufficient level to generate orders and to cover the deferred costs.
 Availability of adequate financial and technical resources must exist to complete the project.
The financial position of Brooklyn must be investigated. A grant is being obtained to fund
further work and the terms of the grant, together with any conditions, must be discussed
further.
 Able to identify and measure the expenditure incurred. A separate nominal ledger account has
been set up to track the expenditure.

If all of the above criteria are met, then the development element of the Rs. 3m incurred to date
must be capitalised as an intangible asset. Amortisation will not begin until commercial
production commences.

ii. Provision
Although the claim was made after the reporting period, NAS 10 considers this to be an adjusting
event after the reporting period. The employment of the individual dates back to 20X2 and so the
lawsuit constitutes a current obligation for the payment of damages as a result of this past event
(the employment).
The amount and the timing are not precisely known but the likelihood of payment of damages by
Brooklyn is probable and so a provision should be made for the estimated amount of the liability,
as advised by the lawyer. Disclosure, rather than provision, would only be appropriate if the
expected settlement was possible or remote, and the lawyer’s view is that a payment is more
likely than not.

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It is not appropriate to calculate an expected value where there is only one event, instead a
provision should be made for the most likely outcome. The lawyer has various views on the
possible, but the most likely payout is Rs. 500,000 as this has a 50% probability. As settlement of
the provision is not anticipated until 2019, the provision should be discounted back at 8% to give
a liability of Rs. 476,280.
Provided that the payment from the insurance company is virtually certain, this should be shown
as an asset, also at its discounted value of Rs. 47,628, being 10% of the provision.

In both cases the discounting should be unwound over the coming three years through profit or
loss.

iii. Revaluation
NAS 16 on Property, Plant and Equipment does not impose a frequency for updating revaluations.
It simply requires a revaluation where it is believed that the fair value of the asset has materially
changed. Hence, if in the past there have been material differences between the carrying amount
and fair value at the 5 yearly review then Brooklyn should consider having more frequent
valuations following on from this year’s valuation.

Revaluations should be regular and not timed simply when property prices are at a peak. It is not
acceptable for Brooklyn to defer its next revaluation while values are low. If property prices do
fall in 2017, then it may be necessary to perform an impairment test in accordance with NAS 36
Impairment of assets.
If it is believed that an asset value has moved materially, then all assets in that class must be
revalued. Hence it is not sufficient for Brooklyn to just revalue the London property. NAS 16
does not require the valuation to be performed by an external party, and so the use of the property
manager to conduct the valuations is acceptable.

Notes to the financial statements will disclose that he is not independent of the company.

6. Consolidation, First Time Adoption and share based payment (Comprehensive Logic) -
Financial Reporting Standards

Dear Dipesh,

I am pleased to write you back addressing your queries.

Query One
When an entity adopts International Financial Reporting Standards (IFRSs) for the first time, the
entity needs to prepare an opening IFRS statement of financial position at the date of transition to
IFRS. This is a requirement of IFRS 1 First Time Adoption of International Financial Reporting
Standards. The date of transition to IFRS is the beginning of the earliest period for which the
entity provides comparative information. In our case, this date is 1 April 2015.

The opening IFRS statement of financial position should be prepared in accordance with IFRSs
which are in force for the current reporting period – in this case, the year ended 31 March 2017.

The statement of profit or loss and other comprehensive income, and the statement of changes in
equity, which are presented as comparative figures in the financial statements for the year ended
31 March 2017, shall also be prepared in accordance with IFRSs which are in force for the year
ended 31 March 2017.

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In the first set of financial statements we will need a reconciliation of those amounts which were
previously reported under local standards in the previous year’s financial statements.

The reconciliation will be between the amounts reported in previous periods under local standards
and the equivalent amounts reported as comparatives in the current period under IFRSs. For us,
this will mean reconciling equity at 1 April 2015 and 31 March 2016, plus total comprehensive
income for the year ended 31 March 2016

Query Two
The measurement basis for financial assets is set out in IFRS 9 Financial Instruments. The
measurement basis depends on the business model for managing the financial asset and the
contractual cash flow characteristics of the financial asset.

In order for the financial asset to be measured at amortised cost, the contractual terms should give
rise to cash flows on specified dates which are solely payments of principal and interest on the
amounts outstanding. This condition is satisfied in the case of the loan you are querying.

There is, however, another condition to be satisfied. The asset should be held under a business
model whose objective is to hold the financial asset in order to collect the contractual cash flows.
This condition is not satisfied, given the possibility of assigning the loan should interest rates rise.

A financial asset is measured at fair value through other comprehensive income where the
‘contractual cash flow test’ is passed and the asset is held under a business model whose objective
is achieved both by collecting the contractual cash flows and by selling the financial asset. This
appears to be the case here, so classification as fair value through other comprehensive income
seems appropriate.
Where a financial asset is measured at fair value through other comprehensive income, the
interest income which is included in profit or loss is the same amount as would be recorded were
the asset to be measured at amortised cost. Therefore interest income of $2·5 million will be
recorded in profit or loss.
The increase in fair value of $2 million ($52 million – $50 million) will be recorded in other
comprehensive income.

Query Three
Under the provisions of IFRS 2 Share-based Payment, this arrangement is an equity settled share-
based payment.

IFRS 2 regulates the treatment of vesting conditions based on whether they are market based or
non-market based. A market based vesting condition is taken into account by reflecting it in the
measurement of the fair value of the option. It does not need to be considered subsequently as to
do so would result in double-counting. Therefore the condition relating to the share price can be
ignored after the fair value of $1 is determined. A non-market condition is taken into account by
reflecting it in the calculation of the number of options ultimately expected to vest. In this case,
that number would be 90,000 (900 x 100). The cost of the arrangement is recognised over the
vesting period, based on the fair value of the option at the grant date.

The amount recognised for the year ended 31 March 2017 would be $18,000 (90,000 x $1 x 1/5).
This amount is recognised as an employment cost (probably in profit or loss) and a corresponding
credit to equity.

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CAP III Paper 1: Advanced Financial Reporting- Solution

I hope I have cleared out your queries. Please feel to reach for further information.

Yours,
Bigreko Senior

7. Lease, Going Concern, Joint Arrangement (Comprehensive Logic with Numerical) -

Financial Reporting Standards

Event a
It would appear that the lease of the asset to entity X is a finance lease. This is because entity X is
responsible for repairs, maintenance and insurance of the asset and because the present value of
the minimum lease payments by entity X is $760,000 (200,000 x $3·80). This is 98·6% of the fair
value of the asset at the inception of the lease ($771,000). Because the lease is a finance lease,
Delta will show a lease receivable – net investment in finance leases under non-current assets.

The carrying amount of the lease receivable on 1 April 2016 will be $791,000 ($771,000 +
$20,000). During the year ended 31 March 2017, Delta will recognise income from finance leases
in the statement of profit or loss. The amount recognised will be $79,100 ($791,000 x 10%).

Following recognition of the lease income and the rental payment from Delta on 31 March 2017,
the net investment in finance leases in the statement of financial position of Delta at 31 March
2017 will be $670,100 ($791,000 + $79,100 – $200,000).

Event b
The joint arrangement with entity Y is a joint operation because Delta and entity Y have equal
rights to the assets and joint obligations for the liabilities relating to the arrangement. In a joint
operation, the operators include their share of any jointly held assets.
Therefore the property, plant and equipment of Delta at 31 March 2017 will include:
– Leasehold property of $25m x 24/25 = $24m
– Plant and equipment of $7·5m x 4/5 = $6m

In a joint operation, the operators include their share of jointly incurred costs. Therefore the
statement of profit or loss of Delta for the year ended 31 March 2017 will include the following
costs:
– Amortisation of lease premium $1m.
– Depreciation of plant and equipment $1·5m
–Cash cost of operating the depot $4m.

Delta will also include its own discretionary delivery charges of $2m as a reduction in its
operating costs.

Event c
Doubts regarding the going concern status of a customer would normally be regarded as prima
facie evidence that any trade receivable had suffered impairment. In such circumstances an
impairment allowance equal to the expected losses would normally be appropriate. However,
IFRS 9 Financial Instruments requires the impairment assessment to be made at the reporting
date.
At the reporting date, the going concern status of Z was not in doubt, so in this case no allowance
is necessary. However, the information about the decline in the going concern status of Z after the
reporting date is a non-adjusting event after the reporting date.

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Therefore whilst no impairment allowance is necessary, it will be necessary to disclose details of

the 20 April event at Z’s business premises and its impact on the collectability of Delta’s trade
receivable.

8. Income Taxes (Comprehensive Numerical) - Financial Reporting Standards

COMPUTATION OF TAX EXPENSE FOR THE YEAR ENDED DECEMBER 31, 2016

Rs.in million
Profit before tax 15.80
Add: Inadmissible expenses
Accounting depreciation (Rs. 1.1 million + Rs.0.7 million) 1.80
Financial charges on finance lease (Allowable in Nepal 0.15
Penalty paid 0.70
Provision for gratuity 2.40
20.85

Less: Admissible expenses

Tax depreciation 1.65
Lease payments 0.65
Payment of gratuity 1.60
Borrowing cost capitalised 2.30

Taxable profit for the year 14.50

Current tax expense @ 35% 5.075

Items Carrying amount Tax base Temp difference

Fixed Assets 16.70 13.85 2.85
CWIP 2.30 - 2.30
Gratuity Provision 1.50 - (1.50)
Total 3.65
Deferred tax expense @ 35% 1.28

Deferred tax liability (Opening) 0.55

Deferred tax expenses for the year 0.73
Deferred tax liability (Closing) 1.28

9. Income Taxes (Tax expenses and Deferred Tax – Simple Numerical) - Financial Reporting
Standards

Assets: Carrying amount Tax base Temp difference

Property, plant, and
10,000
equipment 2,400 (7,600)
Goodwill 6,000 6,000 -
Other intangible assets 5,000 - (5,000)
Financial assets (cost) 10,500 9,000 (1,500)
Trade receivables 7,000 7,500 500
Other receivables 4,600 5,000 400
Cash and cash equivalents 6,700 -

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6,700
Sub Total (13,200)
Liabilities
Long term borrowings 9,600 10,000 (400)
Employee benefit liability 4,000 5,000 (1,000)
Current tax liability 3,070 3,070 -
Trade and other payables 5,000 4,000 1,000
Sub Total (400)
Total (13,600)
Deferred tax expense @ 30% (4,080.00)
Less existing liability (3600)
Charged to P & L (480.00)

10. Difference Between Principles Based System and a Rules Based System of developing
accounting standards.

A rules-based system requires preparers to understand and apply detailed rules to report specific
transactions.
A principles-based system requires preparers to use judgment in order to develop accounting
policies to report specific types of transactions and events.

Consider accounting for tangible non-current assets. An extreme rules-based approach would set
out precise requirements for each type of asset, for example:
'Plant and equipment should be depreciated on the straight line basis over a period not
exceeding four years.'

A principles-based approach would contain more general requirements, for example:

'The depreciable amount of an asset shall be allocated on a systematic basis over its useful
life…The depreciation method used shall reflect the pattern in which the asset's future economic
benefits are expected to be consumed by the entity.

Rules-based accounting standards often need to contain complex definitions and scope
exceptions. For example, if plant and equipment must be depreciated over four years, while other
classes of asset are depreciable over a longer period, the standard must define what is meant by
plant and equipment. Standards often contain further material that explains and interprets the rules
and this in turn may be supplemented by guidance and regulations relating to particular industries
or types of transaction. As a result, accounting standards and guidance can be voluminous.

A purely rules-based system has the following advantages:

 in theory, it results in financial statements being comparable between entities (or between
entities in the same industry);
 it may reduce the volume of explanation necessary in financial statements (as in theory there
is only one allowed accounting treatment for each type of transaction or event);
 it is suitable for large, complex economies; and
 it provides the 'answers' in almost all situations; preparers do not have to make judgments and
risk the consequences (e.g. litigation or reputational damage if a user makes a wrong decision
based on information in the financial statements).

A purely or mainly principles-based system has the following advantages:

 in theory, it is more likely than a rigid-rules based system to result in financial statements that
show a true and fair view/give a fair presentation;
 it encourages the use of professional judgment;
 it is less open to 'creative accounting' abuses as principles are harder to evade than rules; and

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 arguably it is more flexible than a system of rules and can therefore cope better with a rapidly
changing business and economic environment.

11. Share Based payments (Numerical)- Financial Reporting Standards

Solution to Part a
The expected total cost of the arrangement at 31 March 2014 is

400 X $1·50 X (500 – 10 – 20) = $282,000.

Therefore $70,500 ($282,000 X ¼) would be credited to equity and debited to profit or loss for
the year ended 31 March 2014.

For the year ended 31 March 2015, the expected total cost of the originally granted options would
be
400 X $1·50 X (500 – 10 – 5 – 10) = $285,000.

The cumulative amount taken to profit or loss and recognised in equity at 31 March 2015 is
$142,500.

The additional cost of the repriced options must also be recognised over the three-year period to
31 March 2017. The total additional cost is

400 X ($1·45 – $0·25) X 475 = $228,000.

Therefore the amount recognised in the year ended 31 March 2015 is $76,000 ($228,000 X 1/3).

Therefore the total recognised in equity at 31 March 2015 is $218,500 ($142,500 + $76,000).

The amount recognised in equity would be shown as ‘other components of equity’. And the
charge to profit or loss for the year ended 31 March 2015 is $148,000 ($142,500 + $76,000 –
$70,500).

The amount recognised in profit or loss would be shown as an employment expense.

Solution to Part b

For the year ended 31 March 2014, the expected total cost will be

50 X 1,000 X $0·90 = $45,000.

The amount taken to profit or loss in the prior period, and recognised as a liability, will be

$15,000 ($45,000 X 1/3).

At 31 March 2015, the liability will be 50 X 2,000 X $1·20 X 2/3 = $80,000

Since the rights are exercisable on 30 June 2016, the liability will be non-current. The charge to
profit or loss for the year ended 31 March 2015 will be $65,000 ($80,000 – $15,000). This will be
included in employment expenses.

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12. Calculation of Distributable Profit – Banking Industry

Amount in Million
Statement of Distributable Profit
Particulars Current Year
Net Profit/(loss) as per Statement of Profit or Loss 150.00
Appropriation
a. General Reserve (30.00)
b. Foreign Exchange Fluctuation fund (10*25%) (2.50)
c. Capital redemption reserve (50 / 5 yrs) (10.00)
d. Corporate social responsibility fund (1.50)
e. Employees training fund -
f. Other -
Profit/(loss) before regulatory adjustment 106.00
Regulatory Adjustments:
a. Interest Receivable (-)/previous accrued interest received(+) (316-300) (16.00)
b. Short loan loss provision in accounts(-)/reversal(+) -
c. Short provision for possible losses on investment(-)/reversal(+) -
d. Short provision for possible losses on Non-Banking Assets (-)/reversal(+) (25.00)
e. Deferred Tax Assets recognized(-)/reveral(+) (15.00)
f. Goodwill recognized (-)/Impairment of Goodwill(+) -
g. Bargain purchase gain recognized (-)/reversal(+) -
h. Actuarial Loss recognized (-)/reversal(+) (5.00)
i. Other (+/-) -
Profit or (Loss) after Regulatory Adjustments 45.00

13. Foreign Exchange (Numerical) - Financial Reporting Standards

Date Particulars Dr Cr
1-Jul-16 Advance to suppliers 1,210,000
Cash 1,210,000
(Amount paid on signing the contract. Exchange rate was Rs. 60.5/US$)

30-Sep-16 Advance to suppliers 3,050,000

Cash 3,050,000
(Amount paid on delivery. Exchange rate was Rs. 61/US$)

30-Sep-16 PPE in transit/ CWIP 6,090,000

Advance to suppliers 4,260,000
Payable to suppliers 1,830,000
(Recording of asset on the delivery date as risk and rewards are transferred to the company)

31-Dec-16 Exchange loss 6,000

Payable to suppliers 6,000
(Adjustment of exchange rate as of reporting date. Exchange rate was Rs. 60.5/US$)

31-Jan-17 Property, plant and Equipment 6,090,000

PPE (In transit/ in progress) 6,090,000
(Transfer the new plants and machineries to Property, Plant and Equipment)

31-Jan-17 Payable to suppliers 1,836,000

Exchange loss (Bal.) 9,000
Cash 1,845,000
(Final payment to supplier. Exchange rate was Rs. 61.5/US$1)

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14. Concept of Various entities for applying NFRS

Any entity that publishes general purpose financial statements for external users and does not
have public accountability can use the NFRS for SMEs. An entity has ‘public accountability’ if it
files or is in the process of filing its financial statements with a securities commission or other
regulatory organization for the purpose of issuing any class of instrument in a public market or if,
as a main part of its business, it holds assets in a fiduciary capacity for a broad group of third
parties. Banks, insurance entities, securities brokers, and dealers and pension funds are examples
of entities that hold assets in a fiduciary capacity for a broad group of third parties. Note that size
is not the determining factor as to which entitles can use the NFRS for SMEs – the applicability is
based entirely on whether the entity has public accountability or not.

NFRS for SMEs is formulated and issued for application on the basis of IFRS for SMEs 2015
issued by IASB. The term small and medium-sized entities around the world have developed
their own definitions of SMEs for a broad range of purposes including prescribing financial
reporting obligations. Definitions include quantified criteria based on revenue, assets, employees
or other factors. Frequently, the term SMEs is used to mean or to include very small entities
without regard to whether they publish general purpose financial statements for external users.
SMEs often produce financial statements only for the use of owner-managers or only for the use
of tax authorities or other governmental authorities.

The NFRS for SMEs is intended for use by small and medium-sized entities (SMEs). Small and
medium-sized entities are entities that:
a) Do not have public accountability; and
b) Publish general purpose financial statements for external users.

For financial reporting purpose the entities can be classified as:

- Those having public accountability: NFRS shall be applicable.
- Those not having public accountability: NFRS for SME shall be applicable.
- Those not having public accountability other than SMEs: Micro Entities are required to
prepare financial statements in accordance with the Accounting Guidelines for Micro
Entities on consistent basis.

Definition of Public Accountability

Entities having economic significance are:
- Borrowings from banks or financial institutions or public funds or from entities holding
assets in fiduciary capacity of NRs 500 million or more;
- Balance Sheet total (without off-setting current liabilities with current assets) of NRs
1,000 million or more;
- Employing more than 300 employees including workers in an average;
- Annual Turnover of NRs 1,000 million or more;
- Holding assets in fiduciary capacity in excess of NRs 500 million (includes security
brokers handling demat account, micro finance and cooperatives)

What are the Micro Entities?

Micro entities are those entities with the following thresholds (all):
- Annual Turnover of NRs 100 million or less
- Borrowings from banks or financial institutions or public funds or from entities holding
assets in fiduciary capacity of NRs 50 million or less
- Balance Sheet Total of NRs 100 million (without off-setting current liabilities in current
assets) or less
- Holding assets in fiduciary capacity of NRs 50 million or less (includes security brokers
handling demat account, micro finance and cooperatives.

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CAP III Paper 1: Advanced Financial Reporting- Solution

- An entity must meet all of the above thresholds in 2 consecutive years to qualify as a
micro-entity and once qualified, must exceed at least 1 of the above thresholds for 2
consecutive years to cease to qualify.

15. Financial Instruments (Concept) - Financial Reporting Standards

a) The face value of the debentures
Rs. 100 X 20,000 = Rs. 2,000,000
The amount accrued to the company as proceeds = Rs. 97.5 X 20,000 = Rs. 1,950,000

b) The difference between the face value and the market value of the debentures is Rs. 50,000.
This is as a result of discount allowed on the issue on the debentures. Discount on debentures
attracts investors.
c) Nominal interest rate is the rate based specifically on the face value of the loan capital. In
case of Passila Ltd., the nominal interest rate on the debentures is 8% per annum on Rs.
2,000,000. The effective interest is the rate based on the market value.
This is the actual value collected on issue which can be at par, discount or premium. For
Passila Ltd., the effective interest rate will be 8% of Rs. 1,950,000

d) The nominal interest payable Rs. 2,000,000 X 8% X 6 months ÷ 12 months = Rs. 80,000

e) (i) The face value of Rs. 2,000,000 will be the most appropriate valuation to be disclosed in
the Statement of financial position. The management may be interested in the quoted market
value or the proceeds, but for the sake of outside investors who would only be interested in
the company having good reputations devoid of trading losses, it is advisable that the face
value be adopted.

(ii) Disclosing the debentures’ liability at face value plus interest payment for five years may
seem proper in the eyes of external investors and credit institutions, but principally, it would
be wrong to credit debentures’ account with both the face value and the interest payments.
An interest payment on debentures is a revenue item which is debited to the Profit and Loss
Account.

(iii)Disclosing debentures’ liability at market value on the Statement of financial position

will amount to disclosure at replacement value. The market value should be disclosed.

16. Related Party (Concept) - Financial Reporting Standards

a. NAS 24 does not require disclosure of transactions between companies and providers of
finance in the ordinary course of business. As RP is a merchant bank, no disclosure is needed
between RP and AB. However, RP owns 25% of the equity of AB and it would seem
significant influence exists (NAS 28, greater than 20% existing holding means significant
influence is presumed) and therefore AB could be an associate of RP.NAS 24 regards
associates as related parties. The decision as to associate status depends upon the ability of RP
to exercise significant influence especially as the other 75% of votes are owned by the
management of AB. Merchant banks tend to regard companies which would qualify for
associate status as trade investments since the relationship is designed to provide finance.
NAS 28 presumes that a party owning or able to exercise control over 20% of voting rights is
a related party. So an investor with a 25% holding and a director on the board would be
expected to have significant influence over operating and financial policies in such a way as
to inhibit the pursuit of separate interests. If it can be shown that this is not the case, there
is no related party relationship. If it is decided that there is a related party situation then
all

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CAP III Paper 1: Advanced Financial Reporting- Solution

material transactions should be disclosed including management fees, interest, dividends and
the terms of the loan.

b. NAS 24 does not require intragroup transactions and balances eliminated on consolidation to
be disclosed. NAS 24 does not deal with the situation where an undertaking becomes, or
ceases to be, a subsidiary during the year. Best practice indicates that related party
transactions should be disclosed for the period when X was not part of the group.

Transactions between RP and X should be disclosed between 1 July 20X9 an 31 October

20X9 but transactions prior to 1 July will have been eliminated on consolidation. There is no
related party relationship between RP and Z since it is a normal business transaction unless
either parties interests have been influenced or controlled in some way by the other party.

c. Employee retirement benefit schemes of the reporting entity are included in the NAS 24
definition of related parties. The contributions paid, the non current asset transfer ($10m) and
the charge of administrative costs ($3m) must be disclosed.

The pension investment manager would not normally be considered a related party. However,
the manager is key management personnel by virtue of his non-executive directorship.
Directors are deemed to be related parties by NAS 24, and the manager receives a $25,000
fee.

NAS 24 requires the disclosure of compensation paid to key management personnel and the
fee falls within the definition of compensation. Therefore, it must be disclosed.

17. Change in Estimates, Policies and Error (Concept) - Financial Reporting Standards

Statement of changes in equity (extract) for the year ended December 31, 2016
Retained earnings Retained earnings
2016 2015
Rs.000 Rs.000
Opening balance as reported 23,950 22,500
Change in accounting policy (W2) 450 400
––––––– –––––––
Re-stated balance 24,400 22,900
Profit after tax for the period (W1) 4,442 3,250
Dividends paid (2,500) (1,750)
––––––– –––––––
Closing balance 26,342 24–,400

Workings
(1) Revised profit
2016 2015
Rs.000 Rs.000
Per question 4,712 3,200
Add back: Expenditure for the year 600 500
Minus: Depreciation (870) (450)
–––––– ––––––
Revised profit 4,442 3,250
–––––– ––––––

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CAP III Paper 1: Advanced Financial Reporting- Solution

(2) Prior period adjustment

The prior period adjustment is the reinstatement of the Rs. 400,000 asset on 1 January 2015
and the Rs. 450,000 asset at 1 January 2016. On 31 December 2016 the closing balance above
of Rs. 26,342,000 can be reconciled as the original Rs. 26,162,000 plus the reinstatement of
the remaining asset of Rs. 180,000.

18. Change in Estimates, Policies and Error (Concept) - Financial Reporting Standards

Year Opening Balance Finance Charge at 15% Rentals Closing Balance

2016 11,420 1,713 4,000 9,133
2017 9,133 1,370 4,000 6,503
2018 6,503 975 4,000 3,478
2019 3,478 522 4,000 -
Total 4,580 16,000

Statement of Financial Position (Extract) as at 31 December 2016

Rs.’000

Non-Current assets (Rs.11,420,000 – Rs.2,855,00) 8,565

Non-Current Liabilities (Obligation under lease) 6,503

Current Liabilities Obligation under lease

(Rs.9,133,000 – Rs.6,503,000) 2,630

Note: Annual Depreciation = 11,420,000 / 4 = 2,855,000

19. Financial Instruments (Concept and Numerical) - Financial Reporting Standards

Investment in 7% treasury stock 2022

As there is not an intention to hold the investment to maturity, the investment should be classified
as at fair value (with gains and losses recognised in profit or loss).

At initial recognition it will be measured at fair value which is the consideration given of Rs.
208,200. There is no interest received up to year end (first payment will be received on 31
October 2017)

The market value of the stocks at the reporting date is Rs. 196,140 and the revaluation loss of Rs.
12,060 will be recognised in profit or loss.

Futures Prif contract

The derivative will be classified as at fair value through profit or loss. Initial transaction costs
cannot be included as part of the carrying amount and therefore the fee of Rs. 750 will be
immediately charged to profit or loss. At the reporting date the contract is valued at the fair value
of PR1.99/Rs. 1 so the loss is Rs. 1,269 to be included in profit or loss and as a liability on the
statement of financial position

Investment in Gilmour Ltd

This would normally be classified as at fair value (with gains and losses recognised in profit or
loss).

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CAP III Paper 1: Advanced Financial Reporting- Solution

On initial recognition it would be valued at fair value which would be the cost of Rs. 1,212,500.
The directly attributable transaction costs (Rs. 35,000) would be expensed to profit or loss.

At the reporting date the shares will be valued at fair value (Rs. 5.20 per share) ignoring selling
costs = Rs. 1,300,000. The revaluation gain of Rs. 87,500 will be recognised in profit or loss.

Amount receivable from Mason

On recording the sale, the revenue needs to be discounted at the imputed rate of interest of 11%.
Revenue recognised on 1 July is therefore Rs. 450,450 (500,000 * 1.11).
The receivable on the statement of financial position will include the accrued interest element of
Rs. 24,775 (Rs. 450,450 x 0.11 x 6/12) and so will be Rs. 475,225 (Rs. 450,450 + Rs. 24,775) in
total.
The accrued interest of Rs. 24,775 will be recognised as finance income. The receivable would
not be adjusted for any change in interest rates.

Investment in 8.5% treasury stock 2018

This would be classified as to be subsequently measured at amortised cost. On initial recognition,
it will be recorded at fair value, the cost of Rs. 107,100. Finance income will be credited to profit
or loss using the gross redemption yield of 5.9%.

Interest recognised in profit or loss will be Rs. 4,213 (Rs. 107,100 * 5.9% * 8/12).

The investment in the statement of financial position at 31 December 2016 will be at Rs. 107,100
plus Rs. 4,213 = Rs. 111,313. (No interest will have been received to date as it is paid annually in
arrears).

The market value is not reflected in the statement of financial position at 31 December 2016 but it
would be disclosed in accordance with IFRS 7.

Investment in loan notes

The investment has been classified as held for trading so it is accounted for as a financial asset at
fair value through profit or loss. On acquisition it will be recorded at its cost of Rs. 25,000. At the
reporting date the notes will be revalued to their fair value of Rs. 25,500 with the Rs. 500 uplift
being recognised in profit or loss

Selling shares short

On initial recognition, the journal would be:
Rs. Rs.
Dr Cash (10,000 *Rs. 3.60) 36,000
Cr Financial liability 36,000

At the reporting date the financial liability must be revalued to its fair value of Rs. 33,000:
Rs. Rs.
Dr Financial liability 3,000
Cr Statement of profit or loss 3,000

20. General Purpose Financial (Framework) - Financial Reporting Standards

a. A general purpose financial statement is a statement that is intended to meet the needs of users
who are not in a position to demand information that are tailored to their needs. Such information
is useful to existing and potential investors.

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CAP III Paper 1: Advanced Financial Reporting- Solution

b. Reasons for the prevalence of IFRS in many countries

(i) Production of high quality financial statements It involves the preparation of financial
statements that have qualitative features, that is, faithful representation, error free,
neutrality, understandability etc.
(ii) Preparation of user-friendly financial statements Production of financial statements that
contains necessary information that will assist users of financial statements to make
crucial economic decisions.
(iii) Uniformity of financial statements prepared Financial accounting is a language of
business. This language must not be different across countries of the world for it to assist
international investors.
(iv) Access to international finances With a General Purpose Financial Statements, it would
be easier for multi-national entities to have more access internationally.
(v) Enhancement of major economic decisions High quality financial statements will assist
users of the statements to make informed and important financial decisions.
(vi) Comparability of financial statements General purpose financial statements enhance
comparability of financial information among similar industries.
(vii) Globalisation and integration With IFRS, Chartered Accountants become more mobile,
since the standards are the same across the countries.
(viii) Job Creation Jobs are created across countries and a Chartered Accountant in Nepal can
practice in other countries with convenience.

c. Arguments for and against financial reporting standards

Arguments for:
(i) They guide preparers and users of financial statements
(ii) Their use enhances objectivity and comparability of financial statement which would in
turn engender reliability
(iii) Their use helps to curtail or significantly narrow the divergence in the principles adopted
by preparers of financial statements.
(iv) Standards improve the uniformity of treatment of transactions in the financial statements
among companies thereby increasing the credibility and comparability of financial
statement.
(v) Standards compel organisations to disclose information which they may not want to
disclose had the standards not been in existence.
(vi) Standards reduce the number of choices in the methods used to prepare financial
statement thereby reducing the risk of creative accounting.
(vii) Foreign companies which are targets for takeovers or mergers can be more easily
evaluated.

Arguments against:
(i) The cost of setting up and maintaining a standard-setting apparatus is quite significant
and not all countries can afford it.
(ii) The standards cannot address all issues or transactions. There are some which are unique
and so rare/unusual that global standards are not and cannot be available for them.
(iii) Low level of details or explanations.

© The Institute of Chartered Accountants of Nepal 17

CAP III Paper 2: Advanced Financial Management-Question

Paper 2: Advanced Financial Management

© The Institute of Chartered Accountants of Nepal 1

CAP III Paper 2: Advanced Financial Management-Question

Revision Questions:

CHAPTER: FINANCIAL INTERMEDIARIES

Question No. 1
Explain about Credit Rating and functions of Credit Rating Agencies? What are the advantages
of Credit Rating?
Question No. 2
Write short notes on:
a. Pension Funds and their importance
b. Mutual Funds and their importance

CHAPTER: THE FINANCIAL SYSTEM

Question No. 3
Discuss about regulation of Nepalese Financial Market.
Question No. 4
Difference between Investment Banks and Commercial Banks

CHAPTER: CAPITAL MARKET

Question No. 5
Write about meaning and reasons for Reverse Stock Split up
Question No. 6
Surya Nepal Textile Division has taken floating interest rate loan of Rs. 40,00,000 on 1st April,
2012. The rate of interest at the inception of loan is 8.5% p.a. interest is to be paid every year on
31st March, and the duration of loan is four years. In the month of October 2012, the Central
bank of Nepal releases following projections about the interest rates likely to prevail in future.

(i) On 31st March, 2013, at 8.75%; on 31st March, 2014 at 10% on 31st March, 2015 at
10.5% and on 31st March, 2016 at 7.75%. Show how this borrowing can hedge the risk
arising out of expected rise in the rate of interest when he wants to peg his interest cost
at 8.50% p.a.
(ii) Assume that the premium negotiated by both the parties is 0.75% to be paid on 1st
October, 2012 and the actual rate of interest on the respective due dates happens to be
as: on 31st March, 2013 at 10.2%; on 31st March, 2014 at 11.5%; on 31st March, 2015
at 9.25%; on 31st March, 2016 at 9.0% and 8.25%. Show how the settlement will be
executed on the perspective interest due dates.

© The Institute of Chartered Accountants of Nepal 2

CAP III Paper 2: Advanced Financial Management-Question

Question No. 7
Manchester Inc. issues a £ 10 million floating rate loan on July 1, 2013 with resetting of coupon
rate every 6 months equal to LIBOR + 50 bp. Manchester is interested in a collar strategy by
selling a Floor and buying a Cap. XYZ buys the 3 years Cap and sell 3 years Floor as per the
following details
Notional Principal Amount $ 10 million on July 1, 2013:
Reference Rate 6 months LIBOR
Strike Rate 4% for Floor and 7% for Cap
Premium 0* *

Since Premium paid for Cap = Premium received for Floor

Using the following data you are required to determine:

i. Effective interest paid out at each reset date

ii. The average overall effective rate of interest p.a.

Reset Date LIBOR (%)

31-12-2013 6.00
30-06-2014 7.50
31-12-2014 5.00
30-06-2015 4.00
31-12-2015 3.75
30-06-2016 4.25

Question No. 8
Anup Ltd. and Barun Ltd. intend to borrow $200,000 and $200,000 in ¥ respectively for a time
horizon of one year. The prevalent interest rates are as follows:
Company ¥ Loan $ Loan
Anup Ltd. 5% 9%
Barun Ltd. 8% 10%
The prevalent exchange rate is $1 = ¥120.

They entered in a currency swap under which it is agreed that Barun Ltd. will pay Anup Ltd @
1% over the ¥ Loan interest rate which the later will have to pay as a result of the agreed
currency swap whereas Anup Ltd. will reimburse interest to Barun Ltd. only to the extent of 9%.

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CAP III Paper 2: Advanced Financial Management-Question

Keeping the exchange rate invariant, quantify the opportunity gain or loss component of the
ultimate outcome, resulting from the designed currency swap.

CHAPTER: VALUATION OF ASSETS, SHARES AND COMPANIES

Question No. 9
Himalayan Distillery Pvt. Ltd has the following information. Calculate the value of shares from
the given information.
Profit after tax of the company 290 crores
Equity capital of company 1,300 crores
Par value of share 40 each
Debt ratio of company (Debt/ Debt + Equity) 27%
Long run growth rate of the company 8%
Beta 0.1; risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share 47
Depreciation per share 39
Change in Working capital 3.45 per share

Question No. 10
Angel Ltd. and Demon Ltd. both the companies operate in the same industry. The
Financial statements of both the companies for the current financial year are as follows:
Balance Sheet

Particulars Angel Ltd. Demon Ltd.

Current Assets 14,00,000 10,00,000
Fixed Assets (Net) 10,00,000 5,00,000
Total (`) 24,00,000 15,00,000
Equity capital (`10 each) 10,00,000 8,00,000
Retained earnings 2,00,000 --
14% long-term debt 5,00,000 3,00,00
Current liabilities 7,00,000 4,00,000
Total (`) 24,00,000 15,00,000

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CAP III Paper 2: Advanced Financial Management-Question

Income Statement

Particulars Angel Ltd. Demon Ltd.

Net Sales 34,50,000 17,00,000
Cost of Goods sold 27,60,000 13,60,000
Gross profit 6,90,000 3,40,000
Operating expenses 2,00,000 1,00,000
Interest 70,000 42,000
Earnings before taxes 4,20,000 1,98,00
Taxes @ 50% 2,10,000 99,000
Earnings after taxes
(EAT) 2,10,000 99,000
Additional Information :
No. of Equity shares 1,00,000 80,000
Dividend payment ratio 40% 60%
(D/P)
Market price per share 40 15

Assume that both companies are in the process of negotiating a merger through an
exchange of equity shares. You have been asked to assist in establishing equitable
exchange terms and are required to:
(i) Decompose the share price of both the companies into EPS and P/E components; and
also segregate their EPS figures into Return on Equity (ROE) and book
value/intrinsic value per share components.
(ii) Estimate future EPS growth rates for each company.
(iii) Based on expected operating synergies Angel Ltd. estimates that the intrinsic value
of Demon’s equity share would be Rs. 20 per share on its acquisition. You are
required to develop a range of justifiable equity share exchange ratios that can be
offered by Angel Ltd. to the shareholders of Demon Ltd. Based on your analysis in
part (i) and (ii), would you expect the negotiated terms to be closer to the upper, or
the lower exchange ratio limits and why?
(iv) Calculate the post-merger EPS based on an exchange ratio of 0.4: 1 being offered by
Angel Ltd. and indicate the immediate EPS accretion or dilution, if any that will
occur for each group of shareholders.
(v) Based on a 0.4: 1 exchange ratio and assuming that Angel Ltd.’s pre-merger P/E ratio
will continue after the merger, estimate the post-merger market price. Also show the
resulting accretion or dilution in pre-merger market prices.

© The Institute of Chartered Accountants of Nepal 5

CAP III Paper 2: Advanced Financial Management-Question

Question No.11
Wafer Division of Sujal Foods Ltd., a food item manufacturing company has started facing
financial difficulties for the last 2 to 3 years. The management of the division headed by Mr.
Shrestha is interested in a buyout on 31st Ashad 2075. However, to make this buy-out
successful there is an urgent need to attract substantial funds from venture capitalists.
Dolma Impact Fund, a European venture capitalist firm has shown its interest to finance the
proposed buy- out. Sujal Foods Ltd. is interested to sell the division for Rs. 180 crore and
Mr. Shrestha is of opinion that an additional amount of Rs. 85 crore shall be required to make
this division viable. The expected financing pattern shall be as follows:

Source Mode Amount (Rs. Crore)

Management Equity Shares of Rs. 10 each 60.00
Dolma Impact Fund Equity Shares of Rs. 10 each 22.50
9% Debentures with attached warrant of Rs. 100 each 22.50
8% Loan 160.00
Total 265.00
The warrants can be exercised any time after 4 years from now for 10 equity shares @ Rs. 120
per share.
The loan is repayable in one go at the end of 8th year. The debentures are repayable in equal
annual installment consisting of both principal and interest amount over a period of 6 years.
Mr. Shrestha is of view that the proposed dividend shall not be kept more than 12.5% of
distributable profit for the first 4 years. The forecasted EBIT after the proposed buyout is as
follows:
Year 2013-14 2014-15 2015-16 2016-17
EBIT (Rs. crore) 48 57 68 82

Applicable tax rate is 35% and it is expected that it shall remain unchanged at least for 5 -6
years. In order to attract Dolma Impact Fund, Mr. Shrestha stated that book value of equity shall
increase by 20% during above 4 years. Although, Dolma Impact Fund has shown their interest in
investment but are doubtful about the projections of growth in the value as per projections of
Mr. Shrestha. Further Dolma Impact Fund also demanded that warrants should be
convertible in 18 shares instead of 10 as proposed by Mr. Shrestha.
You are required to determine whether or not the book value of equity is expected to grow
by 20% per year. Further if you have been appointed by Mr. Shrestha as advisor then whether
you would suggest to accept the demand of Dolma Impact Fund of 18 shares instead of 10 or
not.

© The Institute of Chartered Accountants of Nepal 6

CAP III Paper 2: Advanced Financial Management-Question

CHAPTER: INVESTMENT DECISIONS AND STRATEGIES

Question No. 12
JME Group Ltd. In Nepal is planning on adding additional plant in one of its
manufacturing sites in Birgunj. Following are the estimates of the net cash flows and
probability of a new project of JME Group Ltd.:

Particulars Year P=0.3 P=0.5 P=0.2

Initial investment 0 4,00,000 4,00,000 4,00,000
Estimated net after tax cash inflows per 1 to 5 1,00,000 1,10,000 1,20,000
year
Estimated salvage value (after tax) 5 20,000 50,000 60,000
Required rate of return from the project is 10%. Find:
(i) The expected NPV of the project.
(ii) The best case and the worst case NPVs of the project.
(iii) The probability of occurrence of the worst case if the cash flows are perfectly dependent
overtime and independent overtime.
(iv) Standard deviation and coefficient of variation assuming that there are only three
streams of cash flow, which are represented by each column of the table with the given
probabilities.
(v) Coefficient of variation of JME Group Ltd. on its average project which is in the range of
0.95 to 1.0. If the coefficient of variation of the project is found to be less risky than
average, 100 basis points are deducted from the cost of Capital.
Should the project be accepted by JME Group Ltd?

Question No. 13
Nepal Electricity Authority (NEA) has a diesel plant which produces electricity in Rural
Electrification Project in Jumla. The plant must be replaced at least every four years considering
environmental and other factors. Following is the detail of costs incurred to run the plan
according to its age:

Age of the Machine (years)

Particulars 0 1 2 3 4
Purchase price 60,000
Maintenance 16,000 18,000 20,000 20,000
Repair 0 4,000 8,000 16,000
Scrap Value 32,000 24,000 16,000 8,000

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CAP III Paper 2: Advanced Financial Management-Question

Future replacement will be with identical plant with the same cost. Revenue is unaffected by the
age of the machine. Ignoring inflation and tax, determine the optimum replacement cycle of the
plant for NEA.

Question No. 14
Nepal Tongshi Cement Ltd. is a listed company which plans to meet increased demand for its
products by buying new machinery costing Rs. 5 million. The machinery would last for four
years, at the end of which it would be replaced. The scrap value of the machinery is expected to
be 5% of the initial cost. Capital allowances would be available on the cost of the machinery on a
25% reducing balance basis, with a balancing allowance or charge claimed in the final year of
operation.
This investment will increase production capacity by 9,000 units of cement per year and all of
these units are expected to be sold as they are produced. Relevant financial information in
current price terms is as follows:

Particulars Value Forecast Inflation

Selling price Rs. 650 per unit 4·0% per year
Variable cost Rs. 250 per unit 5·5% per year
Incremental fixed costs Rs. 250,000 per year 5·0% per year

In addition to the initial cost of the new machinery, initial investment in working capital of Rs.
500,000 will be required. Investment in working capital will be subject to the general rate of
inflation, which is expected to be 4·7% per year.
The company pays tax on profits at the rate of 20% per year, one year in arrears. The company
has a nominal (money terms) after-tax cost of capital of 12% per year.
Required:
(a) Calculate the net present value of the planned purchase of the new machinery using a
nominal (money terms) approach and comment on its financial acceptability.
(b) Discuss the difference between a nominal (money terms) approach and a real terms
approach to calculating net present value. Illustrate your answer with figures give
above.
(c) Identify financial objectives companies such as Nepal Tongsi Cement and discuss how
each of these financial objectives is supported by the planned investment in new
machinery.

© The Institute of Chartered Accountants of Nepal 8

CAP III Paper 2: Advanced Financial Management-Question

CHAPTER: INTERNATIONAL FINANCIAL MANAGEMENT

Question 15
Hulas Brothers, a famous Nepali business house is planning to make an investment through a
wholly owned subsidiary in a manufacturing project in China with a shelf life of two years
initially. The inflation in China is estimated as 8 percent. Operating cash flows are received at
the year end.
For the project an initial investment of Chinese Yuan (CN¥) 30,00,000 will be in land. The land
will be sold after the completion of project at estimated value of CN¥ 35,00,000. The project also
requires an office complex at cost of CN¥ 15,00,000 payable at the beginning of project. The
complex will be depreciated on straight-line basis over two years to a zero salvage value. This
complex is expected to fetch CN¥ 5,00,000 at the end of project.
The company is planning to raise the required funds through Depository Receipt (DRs) issue in
Mauritius. Each DR will have 5 common equity shares of the company as underlying security
which are currently trading at Rs. 200 per share (Face Value = Rs 10) in the domestic market.
The company has currently paid the dividend of 25% which is expected to grow at 10% p.a. The
total issue cost is estimated to be 1 percent of issue size.
The annual sales is expected to be 10,000 units at the rate of CN¥ 500 per unit. The price of unit
is expected to rise at the rate of inflation. Variable operating costs are 40 percent of sales. Fixed
operating costs will be CN¥ 22,00,000 per year and expected to rise at the rate of inflation.
The tax rate applicable in China for income and capital gain is 25 percent and as per GON Policy
no further tax shall be payable in Nepal. The current spot rate of CN¥ 1 is Rs. 9.50. The nominal
interest rate in Nepal and China is 12% and 10% respectively and the international parity
conditions hold.
You are required to
a. Identify expected future cash flows in China and determine NPV of the project in CN¥.
b. Determine whether Hulas Brothers should go for the project or not assuming that there
neither there is restriction on the transfer of funds from China to Nepal nor any charges/taxes
payable on the transfer of funds.

CHAPTER: PORTFOLIO THEORY AND ASSETS PRICING

Question No. 16
Chhaya Investment Pvt. Ltd, invested on 1.4.2016 in certain equity shares as below:

Name of Co. No. of shares Cost (Rs.)

KIBL Ltd. 1,000 (Rs. 100 each) 2,00,000
HIBL Ltd. 500 (Rs. 10 each) 1,50,000

© The Institute of Chartered Accountants of Nepal 9

CAP III Paper 2: Advanced Financial Management-Question

In September, 2016, 10% dividend was paid out by KIBL Ltd. and in October, 2016, 30%
dividend paid out by HIBL Ltd. On 31.3.2017 market quotations showed a value of Rs. 220 and
Rs. 290 per share for KIBL Ltd. and HIBL Ltd. respectively.
On 1.4.2017, investment advisors indicate (a) that the dividends from KIBL Ltd. And HIBL
Ltd. for the year ending 31.3.2018 are likely to be 20% and 35%, respectively and (b) that the
probabilities of market quotations on 31.3.2018 are as below:

Probability Price/share of Price/share of

factor KIBL Ltd. HIBL Ltd.
0.2 220 290
0.5 250 310
0.3 280 330
You are required to:
(i) Calculate the average return from the portfolio for the year ended 31.3.2017;
(ii) Calculate the expected average return from the portfolio for the year 2017-18; and
(iii) Advise Chhaya Investment Pvt. Ltd.., of the comparative risk in the two investments by
calculating the standard deviation in each case.

Question No. 17
Chaudhary Holdings Ltd. which is in the manufacturing and real estate business is planning to
set up an software development company. The project will have a D/E ratio of 0.27. The
company has identified following four pureplay firms in the line of software business.
Pureplay firm βL D/E
One Ltd. 1.1 0.3
Two Ltd. 0.9 0.25
Three Ltd. 0.95 0.35
Four Ltd. 1.0 0.3
Assuming tax rate applicable to XYZ Ltd. as 35 per cent, Rf as 12%, Kd as 14% and RM as
18%, you are required to compute the WACC to be used to compute NPV of the project using
Pureplay Technique.
Also describe about Pureplay Technique.

CHAPTER: FOREIGN EXCHANGE MANAGEMENT

Question No. 18
CG Electronics Ltd. exports air conditioners to Germany by importing all the components
from Singapore. The company is exporting 2,400 units at a price of Euro 500 per unit. The
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CAP III Paper 2: Advanced Financial Management-Question

cost of imported components is S$ 800 per unit. The fixed cost and other variables cost per
unit are Rs. 1,000 and Rs. 1,500 respectively. The cash flows in foreign currencies are due in
six months. The current exchange rates are as follows:

Rs./Euro 51.50/55
Rs./S$ 27.20/25
After six months the exchange rates turn out as follows:

Rs./Euro 52.00/05
Rs./S$ 27.70/75
(1) You are required to calculate loss/gain due to transaction exposure.
(2) Based on the following additional information calculate the loss/gain due to transaction
and operating exposure if the contracted price of air conditioners is Rs. 25,000 :
(i) the current exchange rate changes to
Rs./Euro 51.75/80
Rs./S$ 27.10/15

Price elasticity of demand is estimated to be 1.5

(ii)
Payments and receipts are to be settled at the end of six months.

Question No. 19
The following market data is available:Spot USD/JPY 116.00

Deposit rates p.a. USD JPY

3 months 4.50% 0.25
%
6 months 5.00% 0.25
%
Forward Rate Agreement (FRA) for Yen is Nil.
1. What should be 3 months FRA rate at 3 months forward?
2. The 6 & 12 months LIBORS are 5% & 6.5% respectively. A bank is quoting 6/12 USD
FRA at 6.50 – 6.75%. Is any arbitrage opportunity available?
Calculate profit in such case.

Question No. 20
General Electrical Co is a company based in the USA, supplying medical equipment to the USA
and Europe. It is 30 November 20X8. General Electrical’s treasury department is currently
dealing with a sale to a Swiss customer of CHF12.3 million which has just been agreed, where

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CAP III Paper 2: Advanced Financial Management-Question

the customer will pay for the equipment on 31 May 20X9. The treasury department intends to
hedge the foreign exchange risk on this transaction using traded futures or options as far as
possible. Any amount not hedged by a futures or option contract will be hedged on the forward
market.
Exchange rates (quoted as US$/CHF 1)
Spot 1·0292–1·0309
Three months forward 1·0327–1·0347
Six months forward 1·0358–1·0380

Currency futures (contract size CHF125,000 futures price quoted as US$ per CHF1)
Futures price
December 1·0318
March 1·0345
June 1·0369
Currency options (contract size CHF125,000, exercise price quotation US$ per CHF1, premium:
US cents per CHF1)

Calls Puts
Exercise price
December March June December March June
1·0375 0·47 0·50 0·53 0·74 0·79 0·86

Futures and options contracts mature at the month end.

The contract specification for the CHF futures contract states that an initial margin of US$1,450
per contract will be required and a maintenance margin of US$1,360 per contract will also be
required.
You are required to evaluate which of the exchange-traded derivatives would give General
Electrical the higher receipt, considering scenarios when the options are and are not exercised.

CHAPTER: EMERGING CONCEPT OF FINANCING

Question No. 21
Write short note on Foreign Currency Convertible Bonds (FCCBs).

CHAPTER: FOREIGN DIRECT INVESTMENT

Question No. 22
Write about Foreign Direct Investment (FDI) and its importance.

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CAP III Paper 2: Advanced Financial Management-Solution

Suggested Answers/Hints:

CHAPTER: FINANCIAL INTERMEDIARIES

Question No. 1 Answer
Credit rating is an analysis of the credit risks associated with a financial instrument or a financial
entity. It is a quantified assessment of the creditworthiness of a borrower in general terms or with
respect to a particular debt or financial obligation. A credit rating can be assigned to any entity
that seeks to borrow money — an individual, corporation, state or provincial authority, or
sovereign government.
A credit rating not only determines whether or not a borrower will be approved for a loan or debt
issue but also determines the interest rate at which the loan will need to be repaid.
Credit ratings for borrowers are based on substantial due diligence conducted by the rating
agencies. While a borrowing entity will strive to have the highest possible credit rating since it
has a major impact on interest rates charged by lenders, the rating agencies must take a balanced
and objective view of the borrower’s financial situation and capacity to service/repay the debt.
Credit ratings are an important tool for borrowers to gain access to loans and credit cards. Good
credit ratings allow people to easily borrow money from financial institutions or public debt
markets. At the consumer level, banks will usually base the terms of a loan as a function of your
credit rating; this typically means that the better your credit rating, the better the terms of the
loan. If your credit rating is poor, the bank may even reject you for a loan.
At the corporate level, it is usually in the best interest of a company to look for a credit rating
agency to rate its debt. Investors often times base part of their decision to buy a corporation's
bonds, or even the stock, on the credit rating of the company's debt. Major credit agencies, such
as Moody's or Standard and Poor's, perform this rating service for a fee. Usually, investors will
look at the credit rating given by these international agencies as well as ratings given by
domestic rating agencies before deciding to invest.
Credit ratings are also important at the country level. Many countries rely on foreign investors to
purchase their debt, and these investors rely heavily on the credit ratings given by the credit
rating agencies. The benefits for a country of a good credit rating include being able to access
funds from outside their country, and the possession of a good rating can attract other forms
of financing to a country, such as foreign direct investment. For instance, a company looking to
open a factory in a particular country may first look at the country's credit rating to assess its
stability before deciding to invest.

Question No. 2 Answer

a. Pension Funds and their importance

Pension funds are investment pools that pay for employee retirement commitments. Funds are
paid for by either employees, employers, or both. This collected funds are pooled by pension

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CAP III Paper 2: Advanced Financial Management-Solution

funds and invested to generate returns. Pension funds act as financial intermediaries in financial
system because they collect funds from those who have excess funds to those who are in need of
funds. They collect funds from contributories and provide funds to borrowers like banks, various
projects, etc.
Importance of Pension Funds:
i. They encourage savings from contributories.
ii. They provide large amount of investible funds for borrowers which are in need of funds.
iii. They provide tax benefits to contributories.

b. Mutual Funds and their importance

A mutual fund is a type of financial vehicle made up of a pool of money collected from many
investors to invest in securities such as stocks, bonds, money market instruments, and other
assets. Mutual funds are operated by professional money managers, who allocate the fund's
assets and attempt to produce capital gains or income for the fund's investors. A mutual fund's
portfolio is structured and maintained to match the investment objectives stated in its prospectus.
Mutual funds pool money from the investing public and use that money to buy other securities,
usually stocks and bonds. The value of the mutual fund company depends on the performance of
the securities it decides to buy. So, when you buy a unit or share of a mutual fund, you are
buying the performance of its portfolio or more precisely, a part of the portfolio's value.
Investing in a share of a mutual fund is different from investing in shares of stock. Unlike stock,
mutual fund shares do not give its holders any voting rights. A share of a mutual fund represents
investments in many different stocks (or other securities) instead of just one holding. That's why
the price of a mutual fund share is referred to as the net asset value (NAV) per share. A fund's
NAV is derived by dividing the total value of the securities in the portfolio by the total amount of
shares outstanding.
Generally, there are two types of mutual funds, Closed End Mutual Funds and Open End Mutual
Funds. Closed end mutual funds are those in which units are issued for one time and further issue
and buy back of units is not done. Whereas, in case of Open end mutual fund once units are
issued, further issuance of units and buy back can also be done.
Following are some of the importance of mutual funds:
i. Mutual funds act as financial intermediaries which pool funds from people having
excess funds to people having deficit funds.
ii. They provide small investors opportunities to participate in professionally managed
funds.
iii. They provide risk diversification through investment in variety of securities.
iv. Lower transaction and other costs
v. Operation and management of funds is regulated by regulators.

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CHAPTER: THE FINANCIAL SYSTEM

Question No. 3 Answer

Financial system refers to the system of economy which transfers funds from units having excess
funds to units having deficit of funds. Many units in economy may have excess funds and many
other units may be requiring additional funds. This gap in an economy is bridged by financial
system. Financial intermediaries like banks and financial markets like stock and bond markets
are major parts of financial system.
As financial system is an essential part of economy, regulation of financial system is also
important issue. Irregularities that can incur in financial system can cause major damage in an
economy that is why financial system should be regulated by government bodies. In Nepal also
financial system is regulated by various government authorities. Banks and Financial Institutions
are closely regulated and monitored by Nepal Rastra Bank (NRB). NRB regulates entire
financial intermediaries of the country. Similarly, Insurance Companies are regulated by
Insurance Board. Financial markets and securities trading in country are regulated by Securites
Board of Nepal (SEBON). SEBON regulates primary as well as secondary security markets and
security market participants like merchant banks, mutual funds, brokers, market makers, etc.
Similarly, policy level regulation of financial system like formulation of broader policies,
frameworks and planning is done by government through ministry of finance. Government is
shall be the ultimate responsible person for regulation of financial market.

Question No. 4 Answer

The fundamental differences between an investment bank and a commercial bank can be
outlined as follows:
Investment Banks Commercial Banks
Investment Banks help their clients in raising Commercial Banks are engaged in the
capital by acting as an intermediary between business of accepting deposits from
the buyers and the sellers of securities (stocks customers and lending money to
or bonds) individuals and corporate
Investment Banks do not take deposits from Commercial banks can legally take deposits
customers from customers.
The Investment Banks do not own the Commercial Banks own the loans granted to
securities and only act as an intermediary for their customers.

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CAP III Paper 2: Advanced Financial Management-Solution

smooth transaction of buying and selling

securities.
Investment Banks earn underwriting Commercial banks earn interest on loans
commission granted to their customers.

CHAPTER: CAPITAL MARKET

Question No. 5 Answer

A ‘Reverse Stock Split’ is a process whereby a company decreases the number of shares
outstanding by combining current shares into fewer or lesser number of shares. For example, in a
5 : 1 reverse split, a company would take back 5 shares and will replace them with one share.

Although, reverse stock split does not result in change in Market value or Market
Capitalization of the company, but it results in increase in price per share.

Considering above mentioned ratio, if company has 100 million shares outstanding having
Market Capitalisation of Rs. 500 crore before split up, the number of shares would be equal to 20
million after the reverse split up and market price of one share shall increase from Rs. 50 to Rs.
250.

Reasons for Reverse Split Up

Although Reverse Split up is not so popular especially in India but company carries out reverse
split up due to following reasons:
(i) Avoiding delisting from stock exchange: Sometimes as per the stock exchange regulations
if the price of shares of a company goes below a certain limit it can be delisted. To avoid
such delisting company may resort to reverse stock split up.
(ii) Avoiding removal from constituents of Index: If company’s share is one of the
constituents of the market index then to avoid their removal of scrip from this list due to
persistent fall in the prices of share, the company may take reverse split up route.
(iii) To avoid the tag of “Penny Stock”: If the price of shares of a company goes below a limit
it may be called “Penny Stock”. In order to improve the image of the company and
avoiding this stage, the company may go for Reverse Stock Split.
(iv) To attract Institutional Investors and Mutual Funds: It might be possible that institutional
investors may be shying away from acquiring low value shares and hence to attract these
investors the company may adopt the route of Reverse Stock Split up to increase the
price per share.

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CAP III Paper 2: Advanced Financial Management-Solution

Question No. 6 Answer

As borrower does not want to pay more than 8.5% p.a., on this loan where the rate of interest is
likely to rise beyond this, hence, the borrower to has hedge the risk by entering into an
agreement to buy interest rate caps with the following parameters:
• National Principal : Rs. 40,00,000/-
• Strike rate: 8.5% p.a.
• Reference rate : the rate of interest applicable to this loan
• Calculation and settlement date : 31st March every year
• Duration of the caps : till 31st March 2016
• Premium for caps : negotiable between both the parties
To purchase the caps this borrower is required to pay the premium upfront at the time of buying
caps. The payment of such premium will entitle him with right to receive the compensation from
the seller of the caps as soon as the rate of interest on this loan rises above 8.5%. The
compensation will be at the rate of the difference between the rate of none of the cases the cost
of this loan will rise above 8.5% calculated on Rs. 40,00,000/-. This implies that in none of the
cases the cost of this loan will rise above 8.5%. This hedging benefit is received at the respective
interest due dates at the cost of premium to be paid only once.

The premium to be paid on 1st October 2012 is 30,000/- (Rs. 40,00,000 x 0.75/100). The
payment of this premium will entitle the buyer of the caps to receive the compensation from the
seller of the caps whereas the buyer will not have obligation. The compensation received by the
buyer of caps will be as follows:

On 31st March 2013

The buyer of the caps will receive the compensation at the rate of 1.70% (10.20 - 8.50) to be
calculated on Rs. 40,00,000, the amount of compensation will be Rs. 68000/- (40,00,000 x
1.70/100)

On 31st March 2014

The buyer of the caps will receive the compensation at the rate of 3.00% (11.50 – 8.50) to be
calculated on Rs. 40,00,000/-, the amount of compensation will be Rs. 120000/- (40,00,000 x
3.00/100).

On 31st March 2015

The buyer of the caps will receive the compensation at the rate of 0.75% (9.25 – 8.50) to be
calculated on Rs. 40,00,000/-, the amount of compensation will be Rs. 30,000 (40,00,000 x
0.75/100).

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On 31st March 2016

The buyer of the caps will not receive the compensation as the actual rate of interest is 8.25%
whereas strike rate of caps is 8.5%. Hence, his interest liability shall not exceed 8.50%.

Thus, by paying the premium upfront buyer of the caps gets the compensation on the respective
interest due dates without any obligations.

Question No. 7 Answer

i. The pay-off of each leg shall be computed as follows:
Cap Receipt
Max {0, [Notional principal x (LIBOR on Reset date – Cap Strike Rate) x
Number of days in the settlement period}
365
Floor Pay-off

Max {0, [Notional principal x (Floor Strike Rate – LIBOR on Reset date) x
Number of days in the settlement period}
365
Statement showing effective interest on each re-set date

Interest Cap
LIBOR Payment ($) Floor Effective
Reset Date Days Receipts Pay-off
(%) LIBOR+0.50 ($) Interest
($)
%
31-12-2013 6.00 184 3,27,671 0 0 3,27,671

30-06-2014 7.50 181 3,96,712 24,795 0 3,71,917

31-12-2014 5.00 184 2,77,260 0 0 2,77,260
30-06-2015 4.00 181 1,98,356 0 0 1,98,356
31-12-2015 3.75 184 1,89,041 0 12,603 2,01,644
30-06-2016 4.25 182 2,36,849 0 0 2,36,849
Total 1096 16,26,094
ii. Average Annual Effective Interest Rate shall be computed as follows:
16,26,094 / 1,00,00,000 X (365 / 1096) X 100 = 5.42%

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CAP III Paper 2: Advanced Financial Management-Solution

Question No. 8 Answer

Opportunity gain of Anup Ltd. under currency swap Receipt Payment Net

Interest to be remitted to Barun Ltd. in

$ 2,00,000х9%=$18,000
¥21,60,000
Converted into ($18,000х¥120)
Interest to be received from Barun Ltd. in $ converted
¥14,40,000 -
into Y (6%х$2,00,000 х ¥120)
Interest payable on Y loan - ¥12,00,000
¥14,40,000 ¥33,60,000
Net Payment ¥19,20,000 -

¥33,60,000 ¥33,60,000
$ equivalent paid ¥19,20,000 х(1/¥120) $16,000
Interest payable without swap in $ $18,000
Opportunity gain in $ $ 2,000

Opportunity gain of Barun Ltd. under currency swap Receipt Payment Net
Interest to be remitted to Anup Ltd. in ($ 2,00,000 х 6%) $12,000
Interest to be received from Anup Ltd in Y converted into
$18,000
$ =¥21,60,000/¥120
Interest payable on $ loan@10% - $20,000
$18,000 $32,000

$14,000 -
Net Payment
$32,000 $32,000

Y equivalent paid $14,000 X ¥120 ¥16,80,000

Interest payable without swap in ¥ ($2,00,000X¥120X8%) ¥19,20,000

Opportunity gain in Y ¥ 2,40,000

Alternative Solution
Cash Flows of Anup Ltd.

(i) At the time of exchange of principal amount

Transactions Cash Flows

Borrowings + ¥240,00,000
$2,00,000 x ¥120
Swap - ¥240,00,000

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CAP III Paper 2: Advanced Financial Management-Solution

Swap +$2,00,000
Net Amount +$2,00,000

(ii) At the time of exchange of principal amount

Transactions Cash Flows

Interest to the lender ¥240,00,000X5% ¥12,00,000
Interest Receipt from Barun Ltd. ¥2,00,000X120X6% ¥14,40,000
Net Saving (in $) ¥2,40,000/¥120 $2,000
Interest to Barun Ltd. $2,00,000X9% -$18,000
Net Interest Cost -$16,000

Anup Ltd used $2,00,000 at the net cost of borrowing of $16,000 i.e. 8%. If it had not opted
for swap agreement the borrowing cost would have been 9%. Thus there is saving of 1%.
Cash Flows of Barun Ltd.

(i) At the time of exchange of principal amount

Transactions Cash Flows
Borrowings + $2,00,000
Swap - $2,00,000
Swap +¥240,00,000
$2,00,000X¥120
Net Amount +¥240,00,000

(ii) At the time of exchange of principal amount

Transactions Cash Flows

Interest to the lender - $20,000
$2,00,000X10%
Interest Receipt from Anup Ltd. +$18,000
Net Saving (in ¥) -$2,000X¥120 - ¥2,40,000
Interest to Anup Ltd. - ¥14,40,000
$2,00,000X6%X¥120
Net Interest Cost - ¥16,80,000

Barun Ltd. used ¥240,00,000 at the net cost of borrowing of ¥16,80,000 i.e. 7%. If it had not
opted for swap agreement the borrowing cost would have been 8%. Thus there is saving of 1%.

CHAPTER: VALUATION OF ASSETS, SHARES AND COMPANIES

Question No. 9 Answer

No. of Shares = 1,300 crores / 40
= 32.5 Crore

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EPS = Profit after Tax/No. of Shares

= 290 Crore/32.5 Crore
=8.923

FCFE = Net income – [(1-b) (capex – dep) + (1-b) ( ΔWC )]

FCFE = 8.923 – [(1-0.27) (47-39) + (1-0.27) (3.45)]

= 8.923 – [5.84 + 2.5185] = 0.5645

Cost of Equity = Rf + ß (Rm – Rf)

= 8.7 + 0.1 (10.3 – 8.7) = 8.86%

Price of share (P) = [FCFE ( 1+g)]/[Ke – g]

= 0.5645(1.08)/(0.0886 – 0.08)

= 0.60966/0.0086

= 8.7 + 0.1 (10.3 – 8.7) = 8.86%

Question No. 10 Answer

Market price per share (MPS) = EPS X P/E ratio or P/E ratio = MPS/EPS
(i) Determination of EPS, P/E ratio, ROE and BVPS of Angel Ltd. and Demon Ltd.
Particulars Angel Ltd. Demon Ltd.
Earnings After Tax (EAT) 2,10,000 99,000
No. of Shares (N) 100000 80000
EPS (EAT/N) 2.10 1.2375
Market price per share (MPS) 40 15
P/E Ratio (MPS/EPS) 19.05 12.12
Equity Funds (EF) 12,00,000 8,00,000
BVPS (EF/N) 12 10
ROE (EAT/EF) × 100 17.50% 12.37%

(ii) Estimation of growth rates in EPS for Angel Ltd. and Demon Ltd.

Retention Ratio (1-D/P ratio) 0.6 0.4

Growth Rate (ROE × Retention Ratio) 10.50% 4.95%

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(iii) Justifiable equity shares exchange ratio

(a) Intrinsic value

= 20 /40 = 0.5:1 (upper limit)
based
=
(b) Market price
MPSDA/MPS = 15 /40 =0.375:1(lower limit)
based
BA
Since, Angel Ltd. has a higher EPS, ROE, P/E ratio and even higher EPS growth
expectations, the negotiable terms would be expected to be closer to the lower limit,
based on the existing share prices.

(iv) Calculation of Post-merger EPS and its effects

Particulars Angel Ltd. Demon Ltd. Combined

EAT (i) 2,10,000 99,000 3,09,000
Share outstanding (ii) 100000 80000 132000*
EPS (i) / (ii) 2.1 1.2375 2.341
EPS Accretion (Dilution)
0.241 (0.301***)
(Re.)

(v) Estimation of Post-merger Market price and other effects

Particulars Angel Ltd. Demon Ltd. Combined

EPS (i) 2.1 1.2375 2.341
P/E Ratio (ii) 19.05 12.12 19.05
MPS (i) / (ii) 40 15 44.6
MPS Accretion 4.6 2.84***

* Shares outstanding (combined) = 100000 shares + (.40 × 80000) = 132000 shares

** EPS claim per old share = 2.34 × 0.4 0.936

EPS dilution = 1.2375 – 0.936 0.3015
***S claim per old share (44.60 × 0.4) 17.84
Less: MPS per old share 15.00
2.84

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Question No.11 Answer

Working Notes
Calculation of Interest Payment on 9% Debentures

PVAF (9%,6) = 4.486

Annual Installment = Rs. 22.5/4.486 = Rs. 5.0156

Year Balance Interest (Rs. Installment Principal Balance (Rs.

Outstanding Crore) (Rs. Crore) Repayment Crore)
(Rs. Crore) (Rs. Crore)
1 22.5000 2.025 5.0156 2.9906 19.5094
2 19.5094 1.756 5.0156 3.2596 16.2498
3 16.2498 1.462 5.0156 3.5536 12.6962
4 12.6962 1.143 5.0156 3.8726 8.8236
Statement showing Value of Equity

2013-14 2014-15 2015-16 2016-17

Particulars
(Rs. Crore) (Rs. Crore) (Rs. Crore) (Rs. Crore)
EBIT 48.0000 57.0000 68.0000 82.0000
Interest on 9% Debentures 2.0250 1.7560 1.4620 1.1430
Interest on 8% Loan 12.8000 12.8000 12.8000 12.8000
EBT 33.1750 42.4440 53.7380 68.0570
Tax* @35% 11.6110 14.8550 18.8080 23.8200
EAT 21.5640 27.5890 34.9300 44.2370
Dividend @12.5% of EAT* 2.6955 3.4490 4.3660 5.5300
18.8685 24.1400 30.5640 38.7070
Balance b/f Nil 18.8685 43.0085 73.5725
Balance c/f 18.8685 43.0085 73.5725 112.2795
Share Capital 82.5000 82.5000 82.5000 82.5000
101.3685 125.5085 156.0725 194.7795
*Figures have been rounded off.
In the beginning of 2013-14 equity was Rs. 82.5000 crore which has been grown to Rs.
194.7795 over a period of 4 years. In such case the compounded growth rate shall be as
follows:
(194.7795/82.5000)¼ - 1 = 23.96%
This growth rate is slightly higher than 20% as projected by Mr. Shrestha.
If the condition of Dolma Impact Fund for 18 shares is accepted the expected shareholding
after 4 years shall be as follows:

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No. of shares held by Management 6.00 crore

No. of shares held by Dolma Impact Fund at the starting 2.25 crore
stage
No. of shares held by Dolma Impact Fund after 4 years 4.05 crore

Total holding 6.30 crore

Thus, it is likely that Mr. Shrestha may not accept this condition of Dolma Impact Fund as this
may result in losing their majority ownership and control. Mr. Shrestha may accept their
condition if management has further opportunity to increase their ownership through other
forms.

CHAPTER: INVESTMENT DECISIONS AND STRATEGIES

Question No. 12 Answer

i. Expected NPV:-

Year Net cash flows P.V. PV. @ 10%

0 (4,00,000 x 1) = (-)4,00,000 1.000 (-)4,00,000
(1,00,000x0.3+1,10,000x0.5
1 to 4 = 1,09,000 3.170 3,45,530
+ 1,20,000 x 0.2)

5 = 1,52,000 0.621 94,392

[1,09,000 + (20,000 x 0.3 +
50,000 x 0.5 + 60,000 x 0.2)]
NPV= 39,922

ii.
ENPV of the worst case
1,00,000 x 3.790 = 3,79,000 (Students may have 3.791 also the values will change accordingly)
20,000 x 0.621 = 12,420
ENPV = (-) 4,00,000 + 3,79,000 + 12,420 = (-) 8,580

ENPV of the best case

ENPV = (-) 4,00,000 + 1,20,000 x 3.790 + 60,000 x 0.621 = 92,060.

iii. a. Required probability = 0.3

b. Required probability = (0.3)5 = 0.00243

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iv. The base case NPV = (-) 4,00,000 + (1,10,000 x 3.79) + (50,000 x 0.621)
= 47,950
ENPV = 0.30 x (-) 8580 + 0.5 x 47950 + 92060 x 0.20 = 39,813

√ [0.3(-8580 -39,813)2 + 0.5(47950 -39813)2 + 0.2(92,060 -39,813) 2 ]

= 35,800
Therefore, CV = 35,800/39,813 = 0.90

v. Risk adjusted out of cost of capital of JME Group Ltd. = 10% - 1% = 9%.
NPV Calculation

Year Expected net cash flow PV @ 9% Present Value

0 (-) 4,00,000 1.000 (-)4,00,000

1 to 4 1,09,000 3.240 3,53,160
5 1,52,000 0.650 98,800
ENPV = 51,960

Since NPV after adjustment of risk factor in cost of capital (i.e. NPV @ 9%) is positive, the
project should be accepted by JME Group Ltd on financial terms. Technical and other aspects of
the projects should be analyzed separately.

Question No. 13 Answer

Working Notes
First of all we shall calculate cash flows for each replacement cycle as follows:

One Year Replacement Cycle `

Year Replacement Maintenance & Residual Net cash
Cost Repair Value Flow
0 (60,000) - - (60,000)
1 - (16,000) 32,000 16,000

Two Years Replacement Cycle `

Year Replacement Maintenance & Residual Net cash
Cost Repair Value Flow
0 (60,000) - - (60,000)
1 - (16,000) - (16,000)
2 - (22,000) 24,000 2,000

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CAP III Paper 2: Advanced Financial Management-Solution

Three Years Replacement Cycle `

Year Replacement Maintenance & Residual Net cash
Cost Repair Value Flow
0 (60,000) - - (60,000)
1 - (16,000) - (16,000)
2 - (22,000) - (22,000)
3 - (28,000) 16,000 (12,000)

Four Years Replacement Cycle `

Year Replacement Maintenance & Residual Net cash
Cost Repair Value Flow
0 (60,000) - - (60,000)
1 - (16,000) - (16,000)
2 - (22,000) - (22,000)
3 - (28,000) - (28,000)
4 - (36,000) 8,000 (28,000)

Now we shall calculate NPV for each replacement cycles

1 Year 2 Years 3 Years 4 Years

Year PVF@ Cash PV Cash PV Cash PV Cash PV

15% Flows Flows Flows Flows

0 1 -60,000 -60,000 -60,000 -60,000 -60,000 -60,000 -60,000 -60,000

1 0.8696 16,000 13,914 -16,000 -13,914 -16,000 -13,914 -16,000 -13,914

2 0.7561 - - 2,000 1,512 -22,000 -16,634 -22,000 -16,634

3 0.6575 - - - 0 -12,000 -7,890 -28,000 -18,410

4 0.5718 - - - 0 0 -28,000 -16,010

-46,086 -72,402 -98,438 -1,24,968

Replacement Cycles Equivalent Annual Cost

(EAC) (Rs.)
46,086
1 Year 52,997
0.8696
72,402
2 Years 44,536
1.6257
98,438
3 Years 43,114
2.2832

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CAP III Paper 2: Advanced Financial Management-Solution

1,24,968
4 Years 43,772
2.855

Since Equivalent Annual Cost is the least in case of replacement cycle of 3 years and hence NEA
shall replace the plant in cycle of every three years.

Question No. 14 Answer

a.

Net present value of investment in new machinery

Year 1 2 3 4 5
Sales Income 6,084 6,327 6,580 6,844
Variable cost -2,374 -2,504 -2,642 -2,787
Contribution 3,710 3,823 3,938 4,057
Fixed costs -263 -276 -289 -304
Cash flow 3,447 3,547 3,649 3,753
Taxation @ 20% (One Year
-689 -709 -730 -751
After)
CA tax benefits 0 250 188 141 372
After-tax cash flow 3,447 3,108 3,128 3,164 -379
Working capital -24 -25 -26 -27
Scrap value 0 0 0 250 0
Net cash flow 3,423 3,083 3,102 3,387 -379
Discount at 12% 0.893 0·797 0·712 0·636 0·567
Present values 3,057 2,457 2,209 2,154 -215

PV of future Cash flows 9,662

Initial investment -5,000
Working capital -500
NPV 4,162

As the net present value of Rs. 4,161 million is positive, the expansion can be recommended as
financially acceptable.

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CAP III Paper 2: Advanced Financial Management-Solution

Workings

Year 1 2 3 4
Selling price /unit 676·00 703·04 731·16 760·41
Sales (units/year) 9,000 9,000 9,000 9,000
Sales income (Rs.000) 6,084 6,327 6,580 6,844
Year 1 2 3 4
Variable cost (Rs./unit) 263·75 278·26 293·56 309·71
Sales (units/year) 9,000 9,000 9,000 9,000
Variable cost (Rs.000) 2,374 2,504 2,642 2,787
Year 1 2 3 4
Rs.000 Rs.000 Rs.000 Rs.000
Capital allowance 1,250·0 937·5 703·1 1,859·4
Tax benefit 250 188 141 372
Year 1 2 3 4
Working capital 523·50 548·11 573·87 600·84
Incremental Working Capital 24 25 26 27

b. A nominal (money terms) approach to investment appraisal discounts nominal cash flows
with a nominal cost of capital. Nominal cash flows are found by inflating forecast values
from current price estimates, for example, using specific inflation. Applying specific inflation
means that different project cash flows are inflated by different inflation rates in order to
generate nominal project cash flows.

A real terms approach to investment appraisal discounts real cash flows with a real cost of
capital. Real cash flows are found by deflating nominal cash flows by the general rate of
inflation. The real cost of capital is found by deflating the nominal cost of capital by the
general rate of inflation. For this we can use the Fisher equation:
(1 + real discount rate) x (1 + inflation rate) = (1 + nominal discount rate)

The net present value for an investment project does not depend on whether a nominal terms
approach or a real terms approach is adopted, since nominal cash flows and the nominal
discount rate are both discounted by the general rate of inflation to give real cash flows and
the real discount rate, respectively. Both approaches give the same net present value.

Illustration

The real after-tax cost of capital for Nepal Tongshi Cement can be found as follows:
1·12/1·047 = 1·07, i.e. the real after-tax cost of capital is 7%.

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CAP III Paper 2: Advanced Financial Management-Solution

The following illustration deflates nominal net cash flows (NCF) by the general rate of
inflation (4·7%) to give real NCF, which are then discounted by the real cost of capital (7%).

Year 1 2 3 4 5
Nominal NCF 3,423 3,083 3,102 3,387 -379
Real NCF 3,269 2,812 2,703 2,819 -301
Discount at 7% 0·935 0·873 0·816 0·763 0·713
Present values 3,057 2,455 2,206 2,151 -215

Allowing for rounding, the illustration shows that the present values of the real cash flows
are the same as the present values of the nominal cash flows, and that the real terms approach
NPV of Rs. 4,154 million is the same as the nominal terms approach NPV of Rs. 4,161
million. The two approaches produce identical NPVs and offer the same investment advice.

c. A listed company such as Nepal Tongshi Cement is likely to have a range of financial
objectives. Maximization of shareholder wealth is often suggested to be the primary financial
objective, and this can be substituted by the objective of maximizing the company’s share
price. Other financial objectives that might be used by Tonghsi could relate to earnings per
share (for example, a target EPS value for a given period), operating profit (for example, a
target level of profit before tax or PBIT), revenue (for example, a desired increase in revenue
or sales) and so on. These examples of financial objectives can all be quantified, so that
progress towards meeting them can be measured over time.
The investment in the new machine will enable Tongshi to meet increased demand for its
products and the company expects to be able to sell all of the increased production at a profit.
This will lead to increased revenue and operating profit (profit before interest and tax), so
financial objectives relating to these accounting figures will be supported.
Whether a financial objective relating to increasing earnings per share (EPS) will be
supported will depend on how the investment is financed. For example, raising equity
finance by issuing new shares will dilute (decrease) EPS, while raising debt finance will
increase interest payments, which will also dilute EPS.
The investment in the new machine has a positive net present value (NPV), so the market
value of the company is expected to increase by the amount of the NPV. This increases the
wealth of shareholders irrespective of how the investment is financed, since financing costs
were accounted for by the discount rate (whether nominal or real). The investment in the new
machine will therefore support the objective of shareholder wealth maximization.

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CHAPTER: INTERNATIONAL FINANCIAL MANAGEMENT

Question No. 15 Answer:

Working Notes:
1. Calculation of Cost of Capital (DRs)

Current Dividend (D0) 2.50

Expected Dividend (D1) 2.75
Net Proceeds 198.00
Growth Rate 10.00%
Ke= 2.75 / 198 + 0.10 = 0.1139 i.e. 11.39%

2. Calculation of Expected Exchange Rate as per Interest Rate Parity

Year Expected Rate

1 9.50 X (1.12 / 1.10) = 9.67
2 9.50 X [(1.12)2 / (1.10)] = 9.85

3. Realization on the disposal of Land net of Tax

Particulars CN¥
Sale value at the end of project 3500000.00
Cost of Land 3000000.00
Capital Gain 500000.00
Tax paid 125000.00
Amount realized net of tax 3375000.00

4. Realization on the disposal of Office Complex

Particulars (CN¥)
Sale value at the end of project 500000.00

WDV 0.00

Capital Gain 500000.00

Tax paid 125000.00

Amount realized net of tax 375000.00

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CAP III Paper 2: Advanced Financial Management-Solution

5. Computation of Annual Cash Inflows

Year 1 2
Annual Units 10000 10000
Price per bottle (CN¥) 540.00 583.20
Annual Revenue (CN¥) 5400000.00 5832000.00
Less: Expenses
Variable operating cost (CN¥) 2160000.00 2332800.00
Depreciation (CN¥) 750000.00 750000.00
Fixed Cost per annum (CN¥) 2376000.00 2566080.00
PBT (CN¥) 114000.00 183120.00
Tax on Profit (CN¥) 28500.00 45780.00
Net Profit (CN¥) 85500.00 137340.00
Add: Depreciation (CN¥) 750000.00 750000.00
Cash Flow 835500.00 887340.00

(a) Computation of NPV of the project in CN¥

(CN¥)
Year 0 1 2
Initial Investment -4500000
Annual Cash Inflows 835500.00 887340.00
Realization on the disposal of Land net of
Tax 3375000.00
Realization on the disposal of Office
Complex 375000.00
Total -4500000.00 835500.00 4637340.00
PVF @11.39% 1.000 0.898 0.806
PV of Cash Flows -4500000.00 750279.00 3737696.00
NPV -12,025

(b) Evaluation of Project from Hulas Brothers Point of View

(i) Assuming that inflow funds are transferred in the year in which same are generated i.e.
first year and second year.

Year 0 1 2

Cash Flows (CN¥) -4500000.00 835500.00 4637340.00

Exchange Rate (Rs. / CN¥) 9.50 9.67 9.85

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CAP III Paper 2: Advanced Financial Management-Solution

Cash Flows (Rs.) -42750000.00 8079285.00 45677799.00

PVF 1.00 0.893 0.797

-42750000.00 7214802.00 36405206.00

NPV 870008.00

(ii) Assuming that inflow funds are transferred at the end of the project i.e. second year.

Year 0 2
Cash Flows (CN¥) -4500000.00 5472840.00
Exchange Rate (Rs./ CN¥) 9.50 9.85
Cash Flows (Rs.) -42750000.00 53907474.00
PVF 1.00 0.797
-42750000.00 42964257.00
NPV 214257.00

Though in terms of CN¥ the NPV of the project is negative but in Rs. it has positive NPV due to
weakening of Rs. in comparison of CN¥. Thus Hulas Brothers can accept the project based on
financial assumptions. There may be other various non-financial considerations that Hulas
Brothers needs to analyze.

CHAPTER: PORTFOLIO THEORY AND ASSETS PRICING

Question No. 16 Answer

(i)
(Calculation in Rs. / Share)
Calculation of return on portfolio for 2016-17
KIBL Ltd. HIBL Ltd.
Dividend received during the year 10 3
Market value by 31.03.10 220 290
Cost of investment 200 300
Capital Gain/loss 20 (-)10
Yield (Dividend + Capital Gain/Loss) 30 (-)7
Cost 200 300
% return 15% -2.33%
Weight in the portfolio 0.57 0.43
Weighted average return 7.55%

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(ii)

(Calculation in Rs. / Share)

Calculation of estimated return for 2017-18
KIBL Ltd. HIBL Ltd.
Expected dividend 20 3.5
Capital gain by 31.03.2018
(220x0.2)+ (250x0.5)+(280x0.3) – 220=(253-220) 33 -
(290x0.2)+(310x0.5)+(330x0.3) – 290= (312 – 290) - 22
Yield (Dividend + Capital Gain/Loss) 53 25.5
*Market Value 01.04.17 220 290
% return 24.09% 8.79%
*Weight in portfolio (1,000x220): (500x290) 0.603 0.397
Weighted average (Expected) return 18.02%
(*The market value on 31.03.17 is used as the base for calculating yield for 10-18)
(iii) Calculation of Standard Deviation
KIBL Ltd.
Exp. Exp Prob. Square
Exp. Exp. (1) X
market Yield Factor Deviation of dev. (2) X (3)
Gain div. (2)
value (1) (2) (3)
220 0 20 20 0.2 4 20-53 = -33 1089 217.80
250 30 20 50 0.5 25 50-53 = -3 9 4.50
280 60 20 80 0.3 24 80-53 = 27 729 218.70
53 2
σ = 441.00

Standard Deviation (σM) = 21

HIBL Ltd.
Exp. Exp. Exp. Exp Prob. (1) X (2) Deviation Square of (2) X (3)
market gain div. Yield Factor dev.
value (1) (2) (3)
290 0 3.5 3.5 0.2 0.7 3.5-25.5 = -22 484 96.80
310 20 3.5 23.5 0.5 11.75 23.5-25.5 = -2 4 2.00
330 40 3.5 43.5 0.3 13.05 43.5-25.5 = 18 324 97.20
25.5 2
σ = 196.00

Standard Deviation (σM) = 14

Share of company KIBL Ltd. is more risky as the S.D. of shares of KIBL Ltd. is more than that
of company HIBL Ltd.

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CAP III Paper 2: Advanced Financial Management-Solution

Question No. 17 Answer

First of all we shall unlever the beta of the pureplay firms as follows:
β = β L / [ 1 + (1-T)D/E]
U

Companies Unlevered Beta

One Ltd 1.1/(1+0.65x0.3) 0.921
Two Ltd 0.9/(1+0.65x0.25) 0.774
Three Ltd 0.95/(1+0.65x0.35) 0.774
Four Ltd 1/(1+0.65x0.3) 0.837
Average βU = (0.921+0.774+0.774+0.837) / 4
= 0.827
This can be taken as proxy for unlevered beta of the project. Next, we shall lever
the beta for the project as follows:
β L = β U [1+ (1 – T) D / E]
= 0.827 [1 + (0.65) (0.27)] = 0.97
Since R f = 12% and R M = 18% Cost of equity for the project will be:
= R F + β L [E (RM) – RF]
= 12% + 0.97 [18% – 12%] = 17.82%
The project’s Weighted Average Cost of Capital (WACC) or (Ko) will be:
Ko = D X [K d (1-T)] / V + E X K e /V
= 0.27 X 0.14 (1-0.35) / 1.27 + 1 X 0.1782 / 1.27
= 0.1597
The project’s WACC (Ko) i.e. 15.97% can be used to calculate to discount the project.

Pureplay Technique:
To compute the Beta of project the technique known as ‘Pure Play’ can be used. As it is difficult
to compute the beta for the project in the marketplace, a proxy beta derived from a publicly-
traded firm whose operations are as similar as possible to the project in question can be used as
the measure of the project’s systematic risk. This technique attempts to identify firms with
publicly-traded securities, which are engaged solely in the same line of business as the division
or project. These comparable firms are called ‘pureplay’ firm and should have the following

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CAP III Paper 2: Advanced Financial Management-Solution

characteristics.
1. The firm should have only one business line and no miscellaneous revenues.
2. The pureplay should be in the same industry or business line as the division in question.
3. The revenues of the pureplay should be approximately the same as those of the division
under consideration.
4. When more than one firm could be identified as potential pureplay, the firm with the
median beta could be chosen as the pureplay. Otherwise mean of beta of these firms can
also be used.
Once the proxy betas are obtained, next step involves the estimation of the unlevered betas for
each of these firms. The basic purpose of this exercise is to remove the effect of capital structure
on beta as unlevered beta reflects only the operating risk.
The relationship between levered and unlevered beta is as follows:

β = β L / [ 1 + (1-T)D/E]
U

The next step shall involve the re-levering the project beta reflecting the project’s financing
mix using above formula
β L = β U [1+ (1 – T) D / E]

CHAPTER: FOREIGN EXCHANGE MANAGEMENT

Question No. 18 Answer

i. Profit at current exchange rates
2400 [€ 500 × Rs. 51.50 – (S$ 800 × Rs. 27.25 + Rs. 1,000 + Rs. 1,500)]
2400 [Rs. 25,750 - Rs. 24,300] = Rs. 34,80,000
Profit after change in exchange rates
2400[€500× Rs. 52 – (S$ 800 × Rs. 27.75 + Rs. 1000 + Rs. 1500)]
2400[Rs. 26,000 - Rs. 24,700] = Rs. 31,20,000

LOSS DUE TO TRANSACTION EXPOSURE

Rs. 34,80,000 – Rs. 31,20,000 = Rs. 3,60,000

ii. Profit based on new exchange rates

2400[Rs. 25,000 - (800 × Rs. 27.15 + Rs. 1,000 + Rs. 1,500)]

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CAP III Paper 2: Advanced Financial Management-Solution

2400[Rs. 25,000 - Rs. 24,220] = Rs. 18,72,000

Profit after change in exchange rates at the end of six months
2400 [Rs. 25,000 - (800 × Rs. 27.75 + Rs. 1,000 + Rs. 1,500)]
2400 [Rs.. 25,000 - Rs. 24,700] = Rs. 7,20,000
Decline in profit due to transaction exposure
Rs. 18,72,000 - Rs. 7,20,000 = Rs. 11,52,00
Current price of each unit in € = 25,000/51.50 = € 485.44
Price after change in Exch. Rate = 25,000/51.75 = € 483.09
Change in Price due to change in Exch. Rate
€ 485.44 - € 483.09 = € 2.35 or (-) 0.48%
Price elasticity of demand = 1.5
Increase in demand due to fall in price 0.48 × 1.5 = 0.72% Size of
increased order = 2400 ×1.0072 = 2417 units
Profit = 2417 [ 25,000 – (800 × 27.75 + 1,000 + 1,500)] = 2417 [ 25,000 - 24,700] = 7,25,100
Therefore, decrease in profit due to operating exposure 18,72,000 – 7,25,100 = 11,46,900
Alternatively, if it is assumed that Fixed Cost shall not be changed with change in units then
answer will be as follows:
Fixed Cost = 2400[Rs. 1,000] = Rs. 24,00,000
Profit = 2417 [ 25,000 – (800 × 27.75 + Rs. 1,500)] – Rs. 24,00,000
= 2417 ( 1,300) – Rs. 24,00,000 = ` 7,42,100
Therefore, decrease in profit due to operating exposure 18,72,000 – 7,42,100 = 11,29,900

Question No. 19 Answer

6 Months Interest rate is 5% p.a. & 12 Month interest rate is 6.5% p.a.
Future value 12 month from now is a product of Future value 6 Months from now and 6
Months Future value from after 6 Months.
(1+0.065) = (1+0.05*6/12) x (1+i6,6 *6/12)
i6,6 = [(1+0.065/1.025) – 1] *12/6
6 Months forward 6 month rate is 7.80% p.a.
The Bank is quoting 6/12 USD FRA at 6.50 – 6.75%
Therefore, there is an arbitrage Opportunity of earning interest at the rate of 7.80% p.a. &
paying interest at 6.75%

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CAP III Paper 2: Advanced Financial Management-Solution

Borrow for 6 months, buy an FRA & invest for 12 months

To get $ 1.065 at the end of 12 months for $ 1 invested today
To pay $ 1.060# at the end of 12 months for every $ 1 Borrowed today
Net gain $ 0.005 i.e. risk less profit for every $ borrowed

# (1+0.05/2) (1+.0675/2) = (1.05959) say 1.060

Question No. 20 Answer

General Electrical will have a Swiss Franc receipt in six months’ time and needs to hedge against
the dollar strengthening.
Alternative 1: Futures Contract
Sell Swiss futures and use June futures contracts.
No. of contracts = CHF12,300,000/125,000 = 98·4, say 98, hedging CHF12,250,000
Remainder to be hedged on the forward market is CHF12,300,000 – CHF12,250,000 = CHF
50,000
Receipt = CHF50,000 x 1·0358= $51,790
Calculation of futures price
Assume that basis reduces to zero at contract maturity in a linear fashion.
Estimate from March and June futures contract rates.
Predicted futures rate at the end of May = 1·0345 + ([1·0369 – 1·0345] x 2/3) = 1·0361
Expected receipt = CHF12,250,000 x 1·0361 = $12,692,225
Outcome
$
Futures 12,692,225
Remainder on forward
51,790
market
12,744,015
Or
Calculation of futures price
Alternatively, use spot rate = 1·0292
Predicted futures rate at the end of May = 1·0292 + (6/7 x (1·0369 – 1·0292)) = 1·0358 (when
the June futures contract is closed out in May)

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CAP III Paper 2: Advanced Financial Management-Solution

Expected receipt = CHF12,250,000 x 1·0358 = $12,688,550

Outcome
$
Futures 12,688,550
Remainder on forward market 51,790
12,740,340
Alternative 2 : Options contract
General Electrical would purchase CHF June put options.
Number of contracts 98, as before.
Amount not hedged, hedged by forward contract CHF translated as $51,790 as before.
Assuming the options are exercised:
$
Receipt (W1) 12,709,375
Premium (W2) -105,350
Forward contract 51,790
12,655,815
Workings
1. Receipt
CHF125,000 x 98 x 1·0375 = $12,709,375
2. Premium
1·0375 options = 98 x 125,000 x 0·0086 = $105,350
The options would give the higher receipt if they were not exercised and the spot rate moved
sufficiently in General Electrician’s favor. If General Electrical allowed the option to lapse, it
would obtain the same receipt as under the futures if the US$/CHF spot rate was x, such that:
12,692,225 = 12,250,000x – 105,350
12,250,000x = 12,692,225 + 105,350
so that x is US$1·0447 = CHF1.
Or
12,688,550 = 12,250,000x – 105,350
12,250,000x = 12,688,550 + 105,350
so that x is US$1·0444 = CHF1.
Comments
If the options are exercised, the futures would give the higher receipt. The options give a lower
receipt because of the premium which General Electrical has to pay.

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CAP III Paper 2: Advanced Financial Management-Solution

The futures will be subject to the risk that basis (the difference between the futures price and the
spot price) may not decrease linearly as the futures approach maturity as assumed in the above
calculations.
This will mean that the hedge of the CHF 12,250,000 is imperfect, and the receipt may be
unpredictable despite a futures hedge being taken out.
The options can also be allowed to lapse if for some reason the contract is not completed. If this
happens, General Electrical will only have to settle the forward contract.

CHAPTER: EMERGING CONCEPT OF FINANCING

Question No. 21
Answer
A type of convertible bond issued in a currency different than the issuer's domestic currency. In
other words, the money being raised by the issuing company is in the form of a foreign currency.
A convertible bond is a mix between a debt and equity instrument. It acts like a bond by making
regular coupon and principal payments, but these bonds also give the bondholder the option to
convert the bond into stock.
These types of bonds are attractive to both investors and issuers. The investors receive the safety
of guaranteed payments on the bond and are also able to take advantage of any large price
appreciation in the company's stock. (Bondholders take advantage of this appreciation by means
of warrants attached to the bonds, which are activated when the price of the stock reaches a
certain point.) Due to the equity side of the bond, which adds value, the coupon payments on the
bond are lower for the company, thereby reducing its debt-financing costs.
Advantages of FCCBs
(i) The convertible bond gives the investor the flexibility to convert the bond into
equity at a price or redeem the bond at the end of a specified period, normally
three years if the price of the share has not met his expectations.
(ii) Companies prefer bonds as it leads to delayed dilution of equity and allows
company to avoid any current dilution in earnings per share that a further
issuance of equity would cause.
(iii) FCCBs are easily marketable as investors enjoys option of conversion into
equity if resulting to capital appreciation. Further investor is assured of a
minimum fixed interest earnings.
Disadvantages of FCCBs
(i) Exchange risk is more in FCCBs as interest on bonds would be payable in

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CAP III Paper 2: Advanced Financial Management-Solution

foreign currency. Thus companies with low debt equity ratios, large forex
earnings potential only opt for FCCBs.
(ii) FCCBs mean creation of more debt and a forex outgo in terms of interest which
is in foreign exchange.
In the case of convertible bonds, the interest rate is low, say around 3 –4% but there is
exchange risk on the interest payment as well as re-payment if the bonds are not converted into
equity shares.

CHAPTER: FOREIGN DIRECT INVESTMENT

Question No. 22
Answer:
Foreign Direct Investment (FDI) is the investment of funds by an organisation from one country
into another, with the intent of establishing ’lasting interest’. According to OECD (Organisation
for Economic Co-operation and Development), lasting interest is determined when the
organisation acquires a minimum of 10% of voting power in another organisation.

Reinvestment of profits from overseas operations, as well as intra - organisational loans and
borrowings to overseas subsidiaries are also categorised as FDI. The meaning of FDI is not
restricted only to international movement of capital. Its definition also encompasses the
international movement of elements that are complementary to capital - such as skills, processes,
management, technology etc.

There is a difference between FDI and FPI (Foreign Portfolio Investments), wherein the investor
purchases equity of foreign companies. FPI means only equity infusion, and does not imply the
establishment of a lasting interest.
There are many ways in which FDI benefits the recipient nation:
1. Increased Employment and Economic Growth
2. Human Resource Development
3. Development of Backward Areas
4. Access to Finance & Technology
5. Increase in Exports
6. Improved Capital Flow
7. Creation of a Competitive Market

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Paper 3: Advanced Auditing

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Revision Questions:

ICAN ACT/CIRCULARS/NOTICES/CODE OF ETHICS ISSUED BY ICAN

Question No. 1
Answer the following with reference to ICAN Act, Rules, circulars/notices and code of ethics
issued by ICAN.
a) Mr. Kumar, a practicing chartered accountant was appointed as external auditor by
Sahara Ltd. Mr. Kumar quoted his audit fees as 1% of turnover of the company for that
fiscal year. Comment

b) Mr. Rahish, practicing chartered accountant was appointed as auditor of Sea Zone Ltd.
He mentioned his remuneration as Rs. 3 lakhs in engagement letter whereas the audit
fee of previous year was Rs. 3.5 lakhs. Comment

c) PQR Associates is the new firm in the market. Suggest provisions of the sign board to
be followed by the firm? Further the firm has also obtained affiliation with renowned
auditing firm of India and desires to mention the same in the sign board. Does the firm
need approval of ICAN?

d) ABC and Associates has been appointed as external auditor by XYZ Industries Pvt. Ltd
for Fiscal Year 2075/76. The client has demand loan of limit Rs. 30 crore at Piggy
Bank which is in process of renew. The bank asked company to submit the certified
statement of net working capital of the company. The company requested ABC and
Associates to certify his current assets and current liabilities as the auditor is already at
his place for audit. ABC and associates duly accepted his request. Comment.

OECD PRINCIPLES ON CORPORATE GOVERNANCE

Question No. 2
Describe Disclosure and transparency principle as per OECD Principles on corporate
governance.

ENGAGEMENT PROCEDURE
Question No. 3
a) Ms. Sita has been appointed statutory auditor of Sahara Trading Pvt. Ltd. Her brother in
law Mr. Poudel holds 5% share of the company. She did not know about the
shareholding of his brother in law at the time of acceptance and only got to know during
her audit. Comment on above.
b) Insurance Ltd. for FY 2074/75 in which CA Shiva Rimal was engagement team leader.
Mr. Rimal left the audit firm and started his own Chartered Accountants in practice in the
name of Shiva and associates. Om Insurance Ltd. appointed him as the statutory audit for

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FY 2076/77 on the basis of previous relationship and Mr. Rimal accepted the audit
engagement. Comment

Question No. 4
Reliable Spinning Mills Pvt. Ltd. is a small sized company engaged in business of production
of threads. The company has production plant in Sunsari and corporate office in Kathmandu.
The company appointed a chartered accountants audit firm as their statutory auditor. The
statutory auditor before commencement of audit wants to enter engagement letter with the
management and shared a format of engagement letter to the management. The management
are not aware of the engagement letter and denies to sign the letter contending that the AGM
has already appointed the auditor as mandated by Company Act and no agreement need to be
signed again. Convince the management regarding the need of agreeing the terms of audit
engagement and form and content of audit engagement letter.

PLANNING AND RISK ASSESSMENT

Question No. 5
What is audit strategy? Narrate the steps involved in formulation of audit strategy.

Question No. 6
Mr. Neupane has been appointed as the auditor of M/S Cool Summer Ltd. for first time.
While planning his audit, he intends to apply the concept of materiality for the financial
statements as a whole. He is confused regarding determination of appropriate materiality
level and wants to know factors that may affect the identification of benchmark for this
purpose. Guide him as per NSA 320.

Question No. 7
The primary responsibility for the prevention and detection of fraud rests with both those
charged with governance of the entity and management. An auditor conducting an audit in
accordance with NSAs 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. The auditor shall identify and assess the risks of material misstatement due to fraud at
the financial statement level, and at the assertion level for classes of transactions, account
balances and disclosure. Provide examples of possible audit procedures to address the
assessed risks at assertion level.

AUDIT TEST
Question No. 8
a) Auditor of SUN Ltd. desires to use confirmation request as audit evidence during the
course of audit. Does he need approval from the company for issuing confirmation
request? What factors should be considered by the auditor while designing confirmation
request? State the methods of confirmation?

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b) Mr. Surya Bhatta was appointed as the auditor of BHK Ltd. for the first time. He plans
his audit in the way to satisfy the sufficiency and appropriateness of the current financial
figures only. He thinks that the correctness of opening balances need not be verified as it
has been audited by previous year’s auditor. Is his notion correct? Comment.

Question No. 9
a) Analytical procedures are one of the important financial audit processes. Explain when to
use the substantive analytical procedure in audit with reference to NSA 520. What are the
key factors affecting the precision of analytical procedures.

b) CA Smart, auditor of AXE Limited identified some non-compliance with laws and
regulations applicable to the company that may have a material effect on the financial
statements. He seeks your guidance for auditor’s responsibility in communicating and
reporting identified or suspected non-compliance.

Question No. 10
a) Mr. Shankar is appointed as external auditor of Nirantar Ltd. Nirantar Ltd. has internal
audit department where Mr. Sahas is the head internal auditor. Mr. Shankar thought that
Mr. Sahas has detail knowledge about the entity and has worked with management for
long time, so he asked Mr. Sahas to provide him direct assistance regarding evaluating the
appropriateness of management’s use of the going concern assumption and evaluating
significant accounting estimates used by management. Discuss whether the external
auditor can ask direct assistance from internal auditor as stated above. Give your answer
in reference to auditing standards.
b) As an auditor of group financial statements, state the communication requirements with
the component auditor with reference to applicable standards.

Question No. 11
ABC Carpets Pvt. Ltd. is newly incorporated company engaged in manufacturing of various
carpets and furnishing products. The managing director of the company appointed his brother
in law as in charge of procurement and inventory department, which is responsible of
purchases of raw materials and maintaining the inventory records. The managing director is
confident that the internal control system is strong. According to you comment on the above
system of control.

AUDIT REPORTING
Question No. 12
As an auditor give your advice to incorporate the same in audit report and frame the relevant
audit opinion part in following cases.
a) You are auditor of a Penguine Company for the FY 2075/76. The financial statements are
prepared for a general purpose by management of the entity in accordance with NFRSs.
The terms of the audit engagement reflect the description of management’s responsibility
for the financial statements. Based on the audit evidence obtained, the auditor has

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concluded that a material uncertainty does not exist related to events or conditions that
may cast doubt on the entity’s ability to continue as a going concern. The inventories are
stated in financial statements at Rs. 3.5 crore which are valued in cost. The net realizable
value of the inventories would come Rs. 3.45 crore based the market value and average
selling costs. The management contented that the decrease in price of inventory is
temporary as it always fluctuates up-down and hence cost method of valuation of
inventory is to be followed. If the inventories are valued at net realisable value, cost of
sales would have been increased by Rs. 5 lakh, and income tax, net income and
shareholders’ equity would have been reduced by Rs. 1 lakh, Rs. 4 lakh and Rs. 3.5 lakh,
respectively.

b) You are auditor of a PQR Ltd. for the FY 2075/76. The financial statements are prepared
for a general purpose by management of the entity in accordance with NFRSs. The terms
of the audit engagement reflect the description of management’s responsibility for the
financial statements. You have concluded an unmodified (i.e., “clean”) opinion is
appropriate based on the audit evidence obtained. On Bhadra 01, 2076, there was massive
fire in the entity’s factory and half of the inventories shown in balance sheet date was
completely destroyed and two of the major plants were destructed resulting production
halt for next two months. The company is in process of insurance claim.

Question No. 13
a) Write short note on Key audit matters and circumstances in which a matter determined
to be a key Audit Matters is not communicated in Auditor’s Report.

b) What do you understand by Other Information. What is the responsibility of auditor in

case material inconsistencies are identified in other information obtained subsequent to
the Date of the Auditor’s Report?

c) Differentiate between Reporting to Shareholders Vs. Those charged with governance

AUDIT OF SPECIALIZED ENTERPRISES

Question No. 14
Explain different types of audit other than financial audit which the auditor general can carry
out in government offices as provided in Audit Act, 2075.

Question No. 15
a) You have been appointed as an auditor of National Bank Ltd. which has been dealing
nostro accounts. Enumerate the verification process of Nostro accounts.
b) Mention the provisions of Audit committee in bank and financial institutions.

Question No. 16
As an auditor, mention special points or areas to be covered for the audit of mutual funds
companies.

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ASSURANCE AND RELATED SERVICES

Question No. 17
a) State the circumstances when the practitioner shall not accept the review engagement
with reference to Standard on Review Engagement 2400.

b) Shikhar Hydropower Ltd. is in process of further public issue of shares. For this, it has
prepared the prospectus to provide potential investors with the information about future
expectations of the company. Mr. Bishal, FCA has been appointed by the company as an
expert to examine the projected financial statements and give report thereon. Explain
what should be considered and what evidence should be obtained for reporting on
projected financial statements.

OTHER SERVICES
Question No. 18
a) Write short note on Compliance Audit
b) Explain forensic audit procedures.
c) Differentiate between Financial audit and management audit

FRAUD AND AUDITOR’S LIABILITY

Question No. 19
a) Describe the functions and duties of statutory auditor and offenses and punishment that
can be charged to auditor as per the Companies Act.

b) AB Associates was external auditor of Surya Ltd. for FY 2074/75. During the tax
assessment by tax officer for the same fiscal year, it was brought to light that there has
been fraud of Rs. 10 lakh in procurement of heavy equipment in which procurement
officer and managing director was involved. The tax officer alleged external auditor for
non identification of such report during audit. Is allegation of tax officer correct?

AUDIT OF FAIR VALUES

Question No. 20
Briefly explain the valuation Techniques of measuring fair values.

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Suggested Answers/Hints:
Answer No. 1
a) As per section 34(10) of ICAN Act, 1997, members holding Certificate of Practice shall
not base their remuneration as a percentage on the profit or on any other uncertain results.
Similarly according to code of ethics, contingent fees might create threats to compliance
with the fundamental principles, particularly a self-interest threat to compliance with the
principle of objectivity, in certain circumstances. Though safeguards to address such a
self-interest threat such as having an appropriate reviewer who was not involved in
performing the non-assurance service review the work performed by the professional
accountant and obtaining an advance written agreement with the client on the basis of
remuneration might be followed.

In the given case, the auditor has fixed his remuneration as a percentage on the turnover
of the company for that fiscal year. Thus this is professional misconduct.

b) As per hand book of code of ethics, 2018, the level of fees quoted might impact a
professional accountant’s ability to perform professional services in accordance with
professional standards. A professional accountant might quote whatever fee is considered
appropriate. Quoting a fee, which is lower than another auditor, is not itself unethical.
However, the level of fees quoted creates a self-interest threat to compliance with the
principle of professional competence and due care if the fee quoted is so low that it might
be difficult to perform the engagement in accordance with applicable technical and
professional standards. Factors that are relevant in evaluating the level of such a threat
include:
• Whether the client is aware of the terms of the engagement and, in particular,
the basis on which fees are charged and which professional services the quoted
fee covers.
• Whether the level of the fee is set by an independent third party such as a
regulatory body.
Examples of actions that might be safeguards to address such a self-interest threat
include:
• adjusting the level of fees or the scope of the engagement
• having an appropriate reviewer review the work performed.

Thus, in the given case if the remuneration fixed by the auditor is based on the scope of
audit as mentioned in engagement letter and accordingly the auditor can comply the
principle of professional competence and get audit review from appropriate reviewer, the
quotation of fee is not unethical.

c) A Professional Accountant in Public Practice can put up sign board for his/her office. The
sign board can be of any size as per their own discretion and good taste. Use of glow
signs or lights on large-sized boards as is used by traders or shop-keepers are not allowed.
The sign board should contain name of the office and address but it is not permitted to

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mention types of service provided by the firm and any other information that is in the
nature of advertisement of professional services. The use of logo/monogram of any
kind/form/style/design/color etc. whatsoever on any display material or media e.g. paper
stationery, documents, visiting cards, magnetic devices, internet, signboard by the
Professional Accountant in Public Practice, firm of the Professional Accountant in Public
Practice is not permitted. Use/printing of member/firm name in any other manner
tantamount to logo/monogram is also not permitted. However, the use of a common CA/
RA logo, if prescribed by ICAN, shall be allowed to the members, provided it is used in
the correct manner. As per rule 45 (4) of ICAN Rule, the sign board of the firm shall not
mention as member of ICAN or any other foreign professional body.
As per rule 45(7) of ICAN rule, if Professional Accountants in public practice (firm or
individual) holding valid Certificate of Practice (COP) from the ICAN has carried out
auditing practice through agreement with foreign auditing firm or obtaining approval for
the same, such auditor or firm may use words or sentence disclosing such affiliation only
after obtaining prior approval of council. Professional Accountants in public practice
(firm or individual) holding valid COP from the ICAN shall have to submit authenticated
documentary evidence such as signed contract or agreement with the network firm
together with the stipulated amount of fees for registration with ICAN in form. After the
registration of the network firm, the ICAN approves the local network form to use the
words such as: “affiliate to ……………(name of the international network firm. In no
condition the local network firm shall further add any words excepting “affiliate to
…………….(name of the international network firm).

d) As per NRB Directive No. 2 clause 35 (2), the loanee shall submit current assets and
current liabilities statement certified by chartered accountants while approval of new loan
or renew of existing working capital loan. In this regards, ICAN through its council
decision dated 2075.09.08 has made provision that COP holding chartered accountant
except following can certify the working capital statement:
a) Incumbent external auditor, internal auditor and financial advisor of the loan taking
company
b) Incumbent external auditor and internal auditor of the concerned bank
In given case, ABC and associates is incumbent external auditor of XYZ Industries Pvt.
Ltd. Hence he cannot certify the current assets and current liabilities of the company.

OECD PRINCIPLES ON CORPORATE GOVERNANCE

Answer No. 2
The corporate governance framework should ensure that timely and accurate disclosure is
made on all material matters regarding the corporation, including the financial situation,
performance, ownership, and governance of the company. The Principles support timely
disclosure of all material developments that arise between regular reports. They also support
simultaneous reporting of material or required information to all shareholders in order to
ensure their equitable treatment. In maintaining close relations with investors and market
participants, companies must be careful not to violate this fundamental principle of equitable

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treatment. Disclosure requirements are not expected to place unreasonable administrative or

cost burdens on enterprises. Nor are companies expected to disclose information that may
endanger their competitive position unless disclosure is necessary to fully inform the
investment decision and to avoid misleading the investor. In order to determine what
information should be disclosed at a minimum, many countries apply the concept of
materiality. Material information can be defined as information whose omission or
misstatement could influence the economic decisions taken by users of information. Material
information can also be defined as information that a reasonable investor would consider
important in making an investment or voting decision. A strong disclosure regime that
promotes real transparency is a pivotal feature of market-based monitoring of companies and
is central to shareholders’ ability to exercise their shareholder rights on an informed basis.
Experience shows that disclosure can also be a powerful tool for influencing the behaviour of
companies and for protecting investors. A strong disclosure regime can help to attract capital
and maintain confidence in the capital markets. By contrast, weak disclosure and non-
transparent practices can contribute to unethical behaviour and to a loss of market integrity at
great cost, not just to the company and its shareholders but also to the economy as a whole.
Shareholders and potential investors require access to regular, reliable and comparable
information in sufficient detail for them to assess the stewardship of management, and make
informed decisions about the valuation, ownership and voting of shares. Insufficient or
unclear information may hamper the ability of the markets to function, increase the cost of
capital and result in a poor allocation of resources. Disclosure also helps improve public
understanding of the structure and activities of enterprises, corporate policies and
performance with respect to environmental and ethical standards, and companies’
relationships with the communities in which they operate. The OECD Guidelines for
Multinational Enterprises may, in many jurisdictions be relevant for multinational enterprises.
A. Disclosure should include, but not be limited to, material information on:
1. The financial and operating results of the company.
2. Company objectives and non-financial information.
3. Major share ownership, including beneficial owners, and voting rights.
4. Remuneration of members of the board and key executives.
5. Information about board members, including their qualifications, the selection process,
other company directorships and whether they are regarded as independent by the
board.
6. Related party transactions.
7. Foreseeable risk factors.
8. Issues regarding employees and other stakeholders.
9. Governance structures and policies, including the content of any corporate governance
code or policy and the process by which it is implemented.

B. Information should be prepared and disclosed in accordance with high quality standards
of accounting and financial and non-financial reporting.
C. An annual audit should be conducted by an independent, competent and qualified,
auditor in accordance with high-quality auditing standards in order to provide an
external and objective assurance to the board and shareholders that the financial

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statements fairly represent the financial position and performance of the company in all
material respects.
D. External auditors should be accountable to the shareholders and owe a duty to the
company to exercise due professional care in the conduct of the audit.
E. Channels for disseminating information should provide for equal, timely and cost-
efficient access to relevant information by users.

ENGAGEMENT PROCEDURE
Answer No. 3
a) As per section 112 of Company Act, 2063, substantial shareholder of the company or a
shareholder holding one percent or more of the paid up capital of the company or his
close relative shall not qualified for appointment as auditor, despite appointment, shall not
continue to hold office.
In given case, Mr. Poudel being brother in law is close relative of of Ms. Sita. Mr. Poudel
holds 5% share of the company which is above 1% of the total shareholding also he is
substantial shareholder of the company. Thus, she is not qualified for the appointment as
auditor and should immediately withdraw from the audit.

b) As per section 111 of Companies Act, 2063, no auditor or his/her partner or ex-partner
or employee or ex-employee shall be appointed as auditor for more than three
consecutive terms to perform the audit of a public company. Provided, however, that this
restriction shall not apply to any partner who ended partnership or any employee who
left the service of such auditor three years before.
In the given case, Mr. Rimal is ex-employee of Bishnu Associates, auditor of Om
Insurance Ltd. for FY 2074/75. Here, three years has not completed since he left the audit
firm. So, Shiva and associates cannot be appointed as the auditor for FY 2075/76. Further,
Mr. Rimal was engagement team leader in the statutory audit for FY 2074/75 and thus
familiarity threat exists and this threat cannot be minimized since the audit engagement
was offered to him on the basis of relationship with management. Hence, he should not
accept the audit engagement.

Answer No. 4
As per NSA 210 “Agreeing the Terms of the Audit Engagement”, the auditor shall agree the
terms of the audit engagement with management or those charged with governance, as
appropriate. It is in the interests of both the entity and the auditor that the auditor sends an
audit engagement letter before the commencement of the audit to help avoid
misunderstandings with respect to the audit. In the agreed terms of the audit engagement shall
be recorded in an audit engagement letter or other suitable form of written agreement and
shall include:
(a) The objective and scope of the audit of the financial statements;
(b) The responsibilities of the auditor;
(c) The responsibilities of management;

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(d) Identification of the applicable financial reporting framework for the preparation of the
financial statements; and
(e) 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.
In addition to including the matters required as above, an audit engagement letter may make
reference to, for example:
• Elaboration of the scope of the audit, including reference to applicable legislation,
regulations, NSAs, and ethical and other pronouncements of professional bodies to
which the auditor adheres.
• The form of any other communication of results of the audit engagement.
• The fact that because of the inherent limitations of an audit, together with the inherent
limitations of internal control, there is an unavoidable risk that some material
misstatements may not be detected, even though the audit is properly planned and
performed in accordance with NSAs.
• Arrangements regarding the planning and performance of the audit, including the
composition of the audit team.
• The expectation that management will provide written representations
• The agreement of management to make available to the auditor draft financial
statements and any accompanying other information in time to allow the auditor to
complete the audit in accordance with the proposed timetable.
• The agreement of management to inform the auditor of facts that may affect the
financial statements, of which management may become aware during the period
from the date of the auditor’s report to the date the financial statements are issued.
• The basis on which fees are computed and any billing arrangements.
• A request for management to acknowledge receipt of the audit engagement letter and
to agree to the terms of the engagement outlined therein.
When relevant, the following points could also be made in the audit engagement letter:
• Arrangements concerning the involvement of other auditors and experts in some
aspects of the audit.
• Arrangements concerning the involvement of internal auditors and other staff of the
entity.
• Arrangements to be made with the predecessor auditor, if any, in the case of an initial
audit.
• Any restriction of the auditor’s liability when such possibility exists.
• A reference to any further agreements between the auditor and the entity.
• Any obligations to provide audit working papers to other parties.

PLANNING AND RISK ASSESSMENT

Answer No. 5
An audit strategy sets the direction, timing, and scope of an audit. Audit strategy is
concerned with designing optimised audit approaches that seeks to achieve the necessary

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audit assurance at lowest cost within the constraints of the information available. The
strategy is then used as a guideline when developing an audit plan to achieve the audit
objectives in most efficient and effective manner. The strategy document usually
includes a statement of the key decisions needed to properly plan the audit. The audit
strategy is based on the following considerations:

• The characteristics of the engagement

• Reporting objectives
• Timing of the audit
• Nature of communications
• Significant factors in directing engagement team efforts
• The results of preliminary engagement activities
• The knowledge gained on other engagements
• The nature, timing, and extent of resources available for the engagement

The audit strategy could be relatively short for the audit of a smaller entity, perhaps in
the form of a brief memo. If there are unexpected changes in conditions or the outcome
of audit procedures, it may be necessary to alter the audit strategy. If there is an
alteration, the reasons for the alteration should be stated in the accompanying
documentation.

Audit strategy generally involves following steps:

i) Obtaining knowledge of business:
In performing audit of financial statements, the auditor should obtain sufficient
knowledge of the business to enable auditor to identify and understand the events,
transactions and practices that, in the auditor’s judgement may have significant effect
on the financial statements or on the examination or audit report. Knowledge of
business is a frame of reference within which the auditor in exercises professional
judgement. Understanding the business and using this information appropriately
assists the auditor in assessing risks and identifying problems, planning and
performing the audit effectively and efficiently. It also ensures that the audit staff
assigned to an audit engagement obtains sufficient knowledge of the business to
enable that they understand the need to be alert for additional information and need to
share that information with the auditor and the other audit staff.
ii) Performing analytical procedures
The analytical procedures at planning stage is attention directing and requires the
extensive use of accounting and business knowledge and experience to assess the
potential for material misstatement in the financial statements as a whole. The
key aspect of this task is to identify the relevant risk indicators and to interpret
them properly.
iii) Evaluating inherent risk
The auditor uses professional judgement to evaluate numerous factors such as
quality of accounting system, unusual pressure on management, etc. Having

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regards to his experience of the entity from previous audit engagements of the
entity, any controls established by management to compensate for a high level of
inherent risk and his knowledge of any significant changes which, might have
taken place since his last assessment.
iv) Evaluating internal control
The auditor’s assessment of the control environment is crucial to the decision on
whether to make an extended assessment of controls. This is because a good
control environment is conductive to the maintenance of a reliable system of
accounting and control procedures. For strategy purposes, the auditor should
obtain a sufficient understanding of the control environment. The auditor needs
an understanding of the accounting system, regardless of whether the audit
strategy will involve an extended assessment of internal accounting controls. This
is done by considering the results of gathering or updating information about the
client and making preliminary judgements about materiality, inherent risk and
control effectiveness. These will include identification of the system of the
auditor proposes to subject to an extended assessment of controls.

Thus the audit strategy is evolved after considering the engagement objectives, the results of
the business review, preliminary judgements as to materiality and identified inherent risks.
Audit strategy also considers main points relating to planning and controlling the audit or
comments on adequacy of the existing arrangements. Thus the overall audit plan involving
determination of timing, manpower, coordination and the directors in which the audit work
has to proceed is dependent upon the audit strategy formulated by the audit firm.

Answer No. 6
NSA 320 ‘Materiality in Planning and Performing an Audit’ deals with the auditor’s
responsibility to apply the concept of materiality in planning and performing an audit of
financial statements. The concept of materiality is applied by the auditor both in planning and
performing the audit, and in evaluating the effect of identified misstatements on the audit and
of uncorrected misstatements, if any, on the financial statements and in forming the opinion
in the auditor’s report. The auditor’s determination of materiality is a matter of professional
judgment, and is affected by the auditor’s perception of the financial information needs of
users of the financial statements. When establishing the overall audit strategy, the auditor
shall determine materiality for the financial statements as a whole. If, in the specific
circumstances of the entity, there is one or more particular classes of transactions, account
balances or disclosures for which misstatements of lesser amounts than materiality for the
financial statements as a whole could reasonably be expected to influence the economic
decisions of users taken on the basis of the financial statements, the auditor shall also
determine the materiality level or levels to be applied to those particular classes of
transactions, account balances or disclosures. In planning the audit, the auditor makes
judgments about the size of misstatements that will be considered material. These judgments
provide a basis for:
(a) Determining the nature, timing and extent of risk assessment procedures;

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(b) Identifying and assessing the risks of material misstatement; and

(c) Determining the nature, timing and extent of further audit procedures.

The materiality determined when planning the audit does not necessarily establish an amount
below which uncorrected misstatements, individually or in the aggregate, will always be
evaluated as immaterial. The circumstances related to some misstatements may cause the
auditor to evaluate them as material even if they are below materiality. Although it is not
practicable to design audit procedures to detect misstatements that could be material solely
because of their nature, the auditor considers not only the size but also the nature of
uncorrected misstatements, and the particular circumstances of their occurrence, when
evaluating their effect on the financial statements.
Determining materiality involves the exercise of professional judgment. A percentage is often
applied to a chosen benchmark as a starting point in determining materiality for the financial
statements as a whole. Factors that may affect the identification of an appropriate benchmark
include the following:
• The elements of the financial statements (for example, assets, liabilities, equity,
revenue, expenses);
• Whether there are items on which the attention of the users of the particular entity’s
financial statements tends to be focused (for example, for the purpose of evaluating
financial performance users may tend to focus on profit, revenue or net assets);
• The nature of the entity, where the entity is in its life cycle, and the industry and
economic environment in which the entity operates;
• The entity’s ownership structure and the way it is financed (for example, if an entity is
financed solely by debt rather than equity, users may put more emphasis on assets,
and claims on them, than on the entity’s earnings); and

Examples of benchmarks that may be appropriate, depending on the circumstances of the

entity, include categories of reported income such as profit before tax, total revenue, gross
profit and total expenses, total equity or net asset value. Profit before tax from continuing
operations is often used for profit-oriented entities. When profit before tax from continuing
operations is volatile, other benchmarks may be more appropriate, such as gross profit or total
revenues.

Answer No. 7
The auditor shall identify and assess the risks of material misstatement due to fraud at the
financial statement level, and at the assertion level for classes of transactions, account
balances and disclosure. The following are specific examples of responses to address the
assessed risks at assertion level:
• Visiting locations or performing certain tests on a surprise or unannounced basis. For
example, observing inventory at locations where auditor attendance has not been
previously announced or counting cash at a particular date on a surprise basis.
• Requesting that inventories be counted at the end of the reporting period or on a date
closer to period end to minimize the risk of manipulation of balances in the period
between the date of completion of the count and the end of the reporting period.

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• Altering the audit approach in the current year. For example, contacting major customers
and suppliers orally in addition to sending written confirmation, sending confirmation
requests to a specific party within an organization, or seeking more or different
information.
• Performing a detailed review of the entity’s quarter-end or year-end adjusting entries and
investigating any that appear unusual as to nature or amount.
• For significant and unusual transactions, particularly those occurring at or near year-end,
investigating the possibility of related parties and the sources of financial resources
supporting the transactions.
• Performing substantive analytical procedures using disaggregated data. For example,
comparing sales and cost of sales by location, line of business or month to expectations
developed by the auditor.
• Conducting interviews of personnel involved in areas where a risk of material
misstatement due to fraud has been identified, to obtain their insights about the risk and
whether, or how, controls address the risk.
• When other independent auditors are auditing the financial statements of one or more
subsidiaries, divisions or branches, discussing with them the extent of work necessary to
be performed to address the assessed risk of material misstatement due to fraud resulting
from transactions and activities among these components.
• If the work of an expert becomes particularly significant with respect to a financial
statement item for which the assessed risk of misstatement due to fraud is high,
performing additional procedures relating to some or all of the expert’s assumptions,
methods or findings to determine that the findings are not unreasonable, or engaging
another expert for that purpose.
• Performing audit procedures to analyze selected opening balance sheet accounts of
previously audited financial statements to assess how certain issues involving accounting
estimates and judgments, for example, an allowance for sales returns, were resolved with
the benefit of hindsight.
• Performing procedures on account or other reconciliations prepared by the entity,
including considering reconciliations performed at interim periods.
• Performing computer-assisted techniques, such as data mining to test for anomalies in a
population.
• Testing the integrity of computer-produced records and transactions.
• Seeking additional audit evidence from sources outside of the entity being audited.

Answer No. 8
a) External confirmation is the process of obtaining and evaluating audit evidence through a
direct communication from a third party in response to a request for information about a
particular item affecting assertions made by management in the financial statements. The
auditor does not specifically need approval of management of company for issuing
confirmation request but the consent of management can increase the response from the
confirming party. However, sometimes management may request the auditor not to seek
external confirmation and that time the auditor should consider whether there are valid
grounds for such a request and obtain evidence to support the validity of management’s

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requests. If the auditor agrees to management’s request not to seek external confirmation
regarding a particular matter, the auditor should apply alternative procedures to obtain
sufficient appropriate evidence regarding that matter. If the auditor does not accept the
validity of management’s request and is prevented from carrying out the confirmations,
there has been a limitation on the scope of the auditor’s work and the auditor should
consider the possible impact on the auditor’s report.
As per NSA 505 “External Confirmation” factors to be considered when designing
confirmation requests are:
(i) the assertions being addressed
(ii) Specific identified risks of material misstatement including fraud risks
(iii) The layout and presentation of confirmation request
(iv) Prior experience on audit or similar engagements
(v) The method of communication (in form of paper or electronic form)
(vi) Management’s interaction authorization or encouragement to the confirming
parties to respond to auditor. Confirming parties may only be willing to respond to
confirmation request containing management’s authorisation.
(vii) The ability of the intended confirming party to confirm or provide the requested
information.
There are two types of confirmation request: positive confirmation request and negative
confirmation request. The auditor may use positive or negative external confirmation
requests or a combination of both. A positive external confirmation request asks the
respondent to reply to the auditor in all cases either by indicating the respondent’s
agreement with the given information, or by asking the respondent to fill in information.
A response to a positive confirmation request is ordinarily expected to provide reliable
audit evidence. There is a risk, however, that a respondent may reply to the confirmation
request without verifying that the information is correct. The auditor is not ordinarily able
to detect whether this has occurred. The auditor may reduce this risk, however, by using
positive confirmation requests that do not state the amount (or other information) on the
confirmation request, but ask the respondent to fill in the amount or furnish other
information. On the other hand, use of this type of “blank” confirmation request may
result in lower response rates because additional effort is required of the respondents.

A negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request. However, when no response
has been received to a negative confirmation request, the auditor remains aware that there
will be no explicit evidence that intended third parties have received the confirmation
requests and verified that the information contained therein is correct. Accordingly, the
use of negative confirmation requests ordinarily provides less reliable evidence than the
use of positive confirmation requests, and the auditor considers performing other
substantive procedures to supplement the use of negative confirmations. Negative
confirmation requests may be used to reduce audit risk to an acceptable level when: (a)
the assessed level of inherent and control risk is low; (b) a large number of small balances
is involved; (c) a substantial number of errors is not expected; and (d) the auditor has no
reason to believe that respondents will disregard these requests.

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b) No the auditor is not correct. The auditor shall read the previous year’s financial
statements and the predecessor auditor’s report thereon for information relevant to
opening balances, including disclosures. As per NSA 510 ‘Initial Audit Engagement
Opening Balance’, the auditor shall obtain sufficient appropriate audit evidence about
whether the opening balances contain misstatements that materially affect the current
period’s financial statements by:
(a) Determining whether the prior period’s closing balances have been correctly brought
forward to the current period or, when appropriate, have been restated;
(b) Determining whether the opening balances reflect the application of appropriate
accounting policies; and
(c) Performing one or more of the following:
(i) Where the prior year financial statements were audited, reviewing the predecessor
auditor’s working papers to obtain evidence regarding the opening balances;
(ii) Evaluating whether audit procedures performed in the current period provide
evidence relevant to the opening balances; or
(iii) Performing specific audit procedures to obtain evidence regarding the opening
balances.

If the auditor obtains audit evidence that the opening balances contain misstatements that
could materially affect the current period’s financial statements, the auditor shall perform
such additional audit procedures as are appropriate in the circumstances to determine the
effect on the current period’s financial statements. If the auditor concludes that such
misstatements exist in the current period’s financial statements, the auditor shall
communicate the misstatements with the appropriate level of management and those
charged with governance.

Answer No. 9
a) Analytical procedures mean evaluations of financial information made by a study of
plausible relationships among both financial and non-financial data. Analytical
procedures also encompass the investigation of identified fluctuations and relationships
that are inconsistent with other relevant information or that differ from expected values
by a significant amount. Analytical procedures are very important audit process during
financial audit. It can be used during planning stage to assess the potential for material
misstatement in the financial statements as whole, used as substantive procedures in
response to assessed risk and can be used to analyse the evidences in arriving at the
overall conclusion as to whether the financial statements as a whole are consistent with
the auditor’s understanding of the entity.

According to NSA 520, the application of analytical procedures is based on the

expectation that relationships among data exist and continue in the absence of known
conditions to the contrary. The presence of these relationships provides audit evidence as
to the completeness, accuracy and occurrence of transactions captured in the information

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produced by the entity’s information system relevant to financial reporting. However, the
suitability of a particular analytical procedure will depend upon the auditor’s assessment
of how effective it will be in detecting a misstatement that, when aggregated with other
misstatements, may cause the financial statements to be materially misstated.

The determination of the suitability of analytical procedures as substantive procedures is

influenced by the nature of the assertion and the auditor’s assessment of the risk of
material misstatement. For example, if controls over sales order processing are weak, the
auditor may place more reliance on tests of details rather than analytical procedures for
assertions related to receivables; or if inventory balances are material, the auditor may
decide not to rely only on analytical procedures when performing audit procedures on the
existence assertion. Analytical procedures as substantive procedures may also be
considered appropriate when tests of details are performed on the same assertion. For
example, when obtaining audit evidence regarding the valuation assertion for accounts
receivable balances, the auditor may apply analytical procedures to an aging of
customers’ accounts in addition to performing tests of details on subsequent cash receipts
to determine the collectability of the receivables.

In deciding to use, and when designing and performing, analytical procedures, either
alone or in combination with tests of details, as substantive procedures in accordance with
NSA 330, the auditor shall:
i. Determine the suitability of using substantive analytical procedures given the
assertions, taking account of the assessed risks of material misstatement and tests of
details, if any, directed towards the same assertion;
ii. Develop an expectation of recorded amounts or ratios;
iii. Evaluate the reliability of data, whether internal or external, from which the auditor’s
expectation of recorded amounts or ratios is developed, taking account of source,
comparability, and nature and relevance of information available, and controls over
preparation;
iv. Evaluate whether the expectation is sufficiently precise to identify a misstatement
that, when aggregated with other misstatements, may cause the financial statements
to be materially misstated; and
v. Determine the amount of any difference of recorded amounts from expected values
that is acceptable without further investigation.

Factors affecting the precision of analytical procedures are:

a) Availability and Reliability of the Data: The more reliable the data is, the more
precise the expectation. The data used to form an expectation in an analytical
procedure may consist of external industry and economic data gathered through
independent research. The reliability of data is influenced by its source and by its
nature and is dependent on the circumstances under which it is obtained Internal data
produced from systems and records that are covered by the audit, or that are not
subject to manipulation by persons in a position to influence accounting activities,
are generally considered more reliable. Accordingly, the following are relevant when

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determining whether data is reliable for purposes of designing analytical procedures

as substantive procedures:
(a) Source of the information available. For example, information may be more
reliable when it is obtained from independent sources outside the entity;
(b) Comparability of the information available. For example, broad industry data may
need to be supplemented to be comparable to that of an entity that produces and sells
specialized products;
(c) Nature and relevance of the information available. For example, whether budgets
have been established as results to be expected rather than as goals to be achieved;
and
(d) Controls over the preparation of the information that are designed to ensure its
completeness, accuracy and validity. For example, controls over the preparation,
review and maintenance of budgets.
b) Disaggregation: The degree to which information can be disaggregated affect the
precision of analytical procedures. .The more detailed the level at which analytical
procedures are performed, the greater the potential precision of the procedures.
Analytical procedures performed at a high level may mask significant, but offsetting,
differences that are more likely to come to the auditor’s attention when procedures
are performed on disaggregated data. For example, analytical procedures may be
more effective when applied to financial information on individual sections of an
operation or to financial statements of components of a diversified entity, than when
applied to the financial statements of the entity as a whole.
c) Predictability: There is a direct correlation between the predictability of the data
and the quality of the expectation derived from the data. Generally, the more precise
an expectation is for an analytical procedure, the greater will be the potential
reliability of that procedure. The use of non-financial data (eg number of employees,
occupancy rates, units produced) in developing an expectation may increase the
auditor’s ability to predict account relationships. However, the information is subject
to data reliability considerations mentioned above.
d) Type of analytical procedures: There are several types of analytical procedures
commonly used as substantive procedures and will influence the precision of the
expectation. The auditor chooses among these procedures based on his objectives for
the procedures (ie purpose of the test, desired level of assurance). 1. Trend analysis –
the analysis of changes in an account over time. 2. Ratio analysis – the comparison,
across time or to a benchmark, of relationships between financial statement accounts
and between an account and non-financial data. 3. Reasonableness testing – the
analysis of accounts, or changes in accounts between accounting periods, that
involves the development of a model to form an expectation based on financial data,
non - financial data, or both.

b) NSA 250 ‘Consideration of Laws And Regulations in An Audit of Financial Statements’

guides auditor regarding consideration of compliance with laws and regulations, audit
procedures when non- compliance is identified or suspected and communicating and
reporting identified or suspected non-compliance. Accordingly, if the auditor becomes

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aware of information concerning an instance of non-compliance or suspected non-

compliance with laws and regulations, the auditor shall obtain:
(a) An understanding of the nature of the act and the circumstances in which it has
occurred; and
(b) Further information to evaluate the possible effect on the financial statements.
If the auditor suspects there may be non-compliance, the auditor shall discuss the matter,
unless prohibited by law or regulation, with the appropriate level of management and,
where appropriate, those charged with governance. If, in the auditor’s judgment, the non-
compliance is believed to be intentional and material, the auditor shall communicate the
matter with to those charged with governance as soon as practicable. If management or,
as appropriate, those charged with governance do not provide sufficient information that
supports that the entity is in compliance with laws and regulations and, in the auditor’s
judgment, the effect of the suspected non-compliance may be material to the financial
statements, the auditor shall consider the need to obtain legal advice. If the auditor
suspects that management or those charged with governance are involved in
noncompliance, the auditor shall communicate the matter to the next higher level of
authority at the entity, if it exists, such as an audit committee or supervisory board. Where
no higher authority exists, or if the auditor believes that the communication may not be
acted upon or is unsure as to the person to whom to report, the auditor shall consider the
need to obtain legal advice.

If sufficient information about suspected non-compliance cannot be obtained, the auditor

shall evaluate the effect of the lack of sufficient appropriate audit evidence on the
auditor’s opinion. If the auditor concludes that the identified or suspected non-compliance
has a material effect on the financial statements, and has not been adequately reflected in
the financial statements, the auditor shall, express a qualified opinion or an adverse
opinion on the financial statements. If the auditor is precluded by management or those
charged with governance from obtaining sufficient appropriate audit evidence to evaluate
whether non-compliance that may be material to the financial statements has, or is likely
to have, occurred, the auditor shall express a qualified opinion or disclaim an opinion on
the financial statements on the basis of a limitation on the scope of the audit.

In addition, the auditor shall determine whether law, regulation or relevant ethical
requirements require the auditor to report to an appropriate authority outside the entity
and establish responsibilities under which reporting to an appropriate authority outside
the entity may be appropriate in the circumstances.

Answer No. 10
a) As per NSA 610 ‘Using the work of internal auditor’, the external auditor may be
prohibited by law or regulation from obtaining direct assistance from internal auditors.
Even if the external auditor is not prohibited to do so, he shall not use internal auditors to
provide direct assistance to perform procedures that involve making significant judgments
in the audit. Since the external auditor has sole responsibility for the audit opinion

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expressed, the external auditor needs to make the significant judgments in the audit
engagement. Significant judgments include the following:
• Assessing the risks of material misstatement;
• Evaluating the sufficiency of tests performed;
• Evaluating the appropriateness of management’s use of the going concern
assumption;
• Evaluating significant accounting estimates; and
• Evaluating the adequacy of disclosures in the financial statements, and other matters
affecting the auditor’s report.
Hence, in reference to above provision of NSA 610, the external auditor Mr. Shankar
cannot ask direct assistance from internal auditor Mr. Sahas regarding evaluating the
appropriateness of management’s use of the going concern assumption and evaluating
significant accounting estimates used by management

b) NSA 600 ‘Special considerations-Audit of Group Financial statements (including the

work of component Auditors’ deals with the communication requirements with the
component auditor. Accordingly, the group engagement team shall communicate its
requirements to the component auditor on a timely basis. This communication shall set
out the work to be performed, the use to be made of that work, and the form and content
of the component auditor’s communication with the group engagement team. It shall also
include the following:
i. A request that the component auditor, knowing the context in which the group
engagement team will use the work of the component auditor, confirms that the
component auditor will cooperate with the group engagement team.
ii. The ethical requirements that are relevant to the group audit and, in particular, the
independence requirements.
iii. In the case of an audit or review of the financial information of the component,
component materiality (and, if applicable, the materiality level or levels for particular
classes of transactions, account balances or disclosures) and the threshold above
which misstatements cannot be regarded as clearly trivial to the group financial
statements.
iv. Identified significant risks of material misstatement of the group financial statements,
due to fraud or error that are relevant to the work of the component auditor. The group
engagement team shall request the component auditor to communicate on a timely
basis any other identified significant risks of material misstatement of the group
financial statements, due to fraud or error, in the component, and the component
auditor’s responses to such risks.
v. A list of related parties prepared by group management, and any other related parties
of which the group engagement team is aware. The group engagement team shall
request the component auditor to communicate on a timely basis related parties not
previously identified by group management or the group engagement team. The group
engagement team shall determine whether to identify such additional related parties to
other component auditors.

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The group engagement team shall request the component auditor to communicate matters
relevant to the group engagement team’s conclusion with regard to the group audit. Such
communication shall include:
i. Whether the component auditor has complied with ethical requirements that are
relevant to the group audit, including independence and professional competence;
ii. Whether the component auditor has complied with the group engagement team’s
requirements;
iii. Identification of the financial information of the component on which the component
auditor is reporting;
iv. Information on instances of non-compliance with laws or regulations that could give
rise to a material misstatement of the group financial statements;
v. A list of uncorrected misstatements of the financial information of the component (the
list need not include misstatements that are below the threshold for clearly trivial
misstatements communicated by the group engagement team
vi. Indicators of possible management bias;
vii. Description of any identified significant deficiencies in internal control at the
component level;
viii. Other significant matters that the component auditor communicated or expects to
communicate to those charged with governance of the component, including fraud or
suspected fraud involving component management, employees who have significant
roles in internal control at the component level or others where the fraud resulted in a
material misstatement of the financial information of the component;
ix. Any other matters that may be relevant to the group audit, or that the component
auditor wishes to draw to the attention of the group engagement team, including
exceptions noted in the written representations that the component auditor requested
from component management; and
x. The component auditor’s overall findings, conclusions or opinion.

Answer No. 11
Internal check system is important part of internal control system. Internal check system
implies organization of the overall system of book-keeping and arrangement of staff duties in
such a way that no one person can carry through a transaction and record every aspect thereof
with the objective to minimize or avoid the possibility of commission of errors or frauds and
misappropriation or embezzlement of cash and falsification of accounts by any staff and
detect such error and fraud. The system provides existence of checks on day to day
transactions which operate continuously as part of the routine system whereby the work of
each person is either proved independently or is made complimentary to the work of another.
The effectiveness of system depends on clarity of responsibility, division of work,
standardization and appraisal. The general conditions pertaining to internal check system can
be highlighted as below:
i) No single person should have complete control over any important aspect of the
business operation. Every employee’s action should come under the review of
another.

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ii) Staff duties should be rotated from time to time so that the members do not
perform the same function for a considerable length of time.
iii) Every member should be encouraged to go on leave at least once a year.
iv) Persons having physical custody of assets must not be permitted to have access to
the books of accounts.
v) There should exist an accounting control in respect of each class of assets, in
addition, there should be periodical inspection so as to establish their physical
condition.
vi) Mechanical devices should be should be used, where ever practicable to prevent
loss or misapplication of cash.
vii) Budgetary control should be exercised and wide deviations observed should be
reconciled.
viii) For inventory taking, at the close of the year, trading activities should, if possible
suspended and it should be done by staff belonging to several sections of the
organization.
In the given case, the single person is in charge of procurement and inventory department,
which is responsible of purchases of raw materials and maintaining the inventory records.
Hence, internal check system which is one of the basic constituent of internal control system
has been violated here. In detail, the segregation of duties and check and balance where the
transaction processing is allocated to different persons in such a manner that no one person
carry through the completion of transaction from start to finish has not been followed here
because the procurement of raw materials and inventory maintenance is different work.
Single person carrying out the purchase of inventory and making in and out in inventory
records may raise possibility of misappropriation or embezzlement of cash and inventory by
the staff.

Answer No. 12
a) As per NAS 02 inventories shall be measured at the lower of cost and net realisable value.
Here the net realisable value of inventories is lower that the cost, but the inventories are
stated at cost by management. The inventories are misstated and the misstatement is
deemed to be material but not pervasive to the financial statements. Thus the auditor may
express qualified opinion is appropriate. The audit opinion part is given below:

Qualified Opinion
We have audited the financial statements of Penguine Company (the Company), which
comprise the statement of financial position as at Ashad 31, 2076, and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for
the year then ended, and notes to the financial statements, including a summary of
significant accounting policies.
In our opinion, except for the effects of the matter described in the Basis for Qualified
Opinion section of our report, the accompanying financial statements present fairly, in
all material respects, (or give a true and fair view of) the financial position of the

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Company as at Ashad 31, 2076, and (of) its financial performance and its cash flows for
the year then ended in accordance with Nepal Financial Reporting Standards (NFRSs).

Basis for Qualified Opinion

The Company’s inventories are carried in the statement of financial position at Rs. 3.5
crore. Management has not stated the inventories at the lower of cost and net realizable
value but has stated them solely at cost, which constitutes a departure from NFRSs. The
Company’s records indicate that, had management stated the inventories at the lower of
cost and net realizable value, an amount of Rs.5 lakh would have been required to write
the inventories down to their net realizable value. Accordingly, cost of sales would have
been increased by Rs. 5 lakh, and income tax, net income and shareholders’ equity
would have been reduced by Rs. 1 lakh, Rs. 4 lakh and Rs. 3.5 lakh, respectively.
We conducted our audit in accordance with Nepal Standards on Auditing (NSAs). Our
responsibilities under those standards are further described in the Auditor’s
Responsibilities for the Audit of the Financial Statements section of our report. We are
independent of the Company in accordance with the ethical requirements that are
relevant to our audit of the financial statements and have fulfilled our other ethical
responsibilities in accordance with these requirements. We believe that the audit
evidence we have obtained is sufficient and appropriate to provide a basis for our
qualified opinion.

b) The destruction of major production plant by a fire after the reporting period is non-
adjusting events requiring disclosure in financial statements. As an auditor, in my
judgment, the matter is of such importance that it is fundamental to users’ understanding
of the financial statements. The matter does not require significant auditor attention in the
audit of the financial statements in the current period. The destruction of production plant
and inventory by fire on Bhadra 01, 2076 is subsequent event and need disclosure in the
financial statements and also the auditor should inlcude emphasis of matter paragraph in
the audit report. The opinion part is given below:

Opinion
We have audited the financial statements of PQR Ltd. (the Company), which comprise
the statement of financial position as at Ashad 31, 20, and the statement of
comprehensive income, statement of changes in equity and statement of cash flows for
the year then ended, and notes to the financial statements, including a summary of
significant accounting policies.
In our opinion, the accompanying financial statements present fairly, in all material
respects, (or give a true and fair view of) the financial position of the Company as at
Ashad 31, 20X1, and (of) its financial performance and its cash flows for the year then
ended in accordance with Nepal Financial Reporting Standards (NFRSs).

Basis for Opinion

We conducted our audit in accordance with Nepal Standards on Auditing (NSAs). Our
responsibilities under those standards are further described in the Auditor’s

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Responsibilities for the Audit of the Financial Statements section of our report. We are
independent of the Company in accordance with the ethical requirements that are
relevant to our audit of the financial statements and we have fulfilled our other ethical
responsibilities in accordance with these requirements. We believe that the audit
evidence we have obtained is sufficient and appropriate to provide a basis for our
opinion.

Emphasis of Matter- effects of fire

We draw attention to Note X of the financial statements, which describes the effects of a
fire in the Company’s production facilities. Our opinion is not modified in respect of this
matter.

Answer No. 13
a) As per NSA 701, “Communicating Key Audit Matters in the independent Auditor’s
Report”, those matters that in the auditor’s professional judgment, were of most
significance in the audit of the financial statements of the current period. Key audit
maters are selected from matters communicated with charged with governance.

Circumstances in Which Matter Determined to Be a Key Audit Matter is not communicated

in Auditor’s report:
The auditor shall describe each key audit matter in the auditor’s report unless:
i. Law or regulation precludes public disclosure about the matter; or
ii. In extremely rare circumstances, the auditor determines that the matter should not
be communicated in the auditor’s report because the adverse consequences of
doing so would reasonably be expected to outweigh the public interest benefits of
such communication. This shall not apply if the entity has publicly disclosed
information about the matter.

b) Other information refers to financial and non-financial information (other than the
financial statements and the auditor’s report thereon) which is included, either by law,
regulation or custom, in a document containing audited financial statements and the
auditor’s report thereon. Other information may comprise, for example:
• A report by management or those charged with governance on operations.
• Financial summaries or highlights.
• Employment data.
• Planned capital expenditures.
• Financial ratios.
• Names of officers and directors.
• Selected quarterly data.

As per NSA 720 ‘The auditor’s responsibilities relating to other information in documents
containing audited financial statements’ in case material inconsistencies are identified in
other information obtained subsequent to the Date of the Auditor’s Report, the auditor shall

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determine whether the audited financial statements or the other information needs to be
revised following shall be responsibility of auditor:

If revision of the audited financial statements is necessary and management refuses to make
the revision, the auditor shall modify the opinion in the auditor’s report.

If revision of the other information is necessary and management refuses to make the
revision, the auditor shall communicate this matter to those charged with governance, unless
all of those charged with governance are involved in managing the entity; and
(a) Include in the auditor’s report an Other Matter paragraph describing the material
inconsistency
(b) Withhold the auditor’s report; or
(c) Withdraw from the engagement, where withdrawal is possible under applicable law or
regulation.

c)
Reporting to Shareholders Reporting to those charged with
governance

It is statutory audit report which is It is reporting to those charged with

addressed to the shareholders of company governance according to NSA 260.
as per company act and NSA 700.
Statutory audit report is on true and fair It is reporting on matters to those charged
view and as per prescribed format. with governance like scope of audit, audit
procedures, audit modifications, lapses in
internal control system etc.
Statutory audit reports are in public Reporting to those charged with
domain. governance is an internal document i.e.
private report.
It is presented to annual general meeting. It is presented to board of directors.

AUDIT OF SPECIALIZED ENTERPRISES

Answer No. 14
As per Section 5 of Audit Act 2075 the Auditor General may carry out the audit of others
subjects other than financial audit like Information Technology, performance, gender,
methodology science, environment of the offices, bodies or organizations under its
jurisdiction on the basis of sampling. The methods, procedures, scope, period, examination
and reporting of audit of various subjects as mentioned above shall be as prescribed by
Auditor General.
Section 6 of Audit Act 2075 has made provision of periodic Audit. Accordingly the Auditor
General may conduct periodic audit of the offices, bodies or organizations under its
jurisdiction before the end of fiscal year or after completion of transactions. The methods,

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procedures, scope, period, examination and reporting of periodic audit shall be as prescribed
by Auditor General. The report of periodic audit shall be made public by delivering to
concerned offices.
According to Section 7 of Audit Act 2075, the Auditor General may audit the any grants,
assistance received or provided by Nepal government, State government and Local Level as
per federal laws. The methods, procedures, scope, period, examination and reporting of such
audit shall be as prescribed by Auditor General.

Answer No. 15
a) A nostro account refers to an account that a bank holds in a foreign currency in another
bank. Following procedures shall be followed for the verification of nostro accounts:
• Obtain a list of all Nostro Accounts for the purpose of verification.
• Verify whether the Nostro Accounts are being regularly operated. If not give the list
of Nostro Accounts with balances outstanding, which are not operated regularly, the
date of last transaction, etc.
• Verify whether the balance confirmation from all concerned overseas branches/
correspondents have been obtained on a periodic basis.
• Confirm whether reconciliation of Nostro Accounts with the respective mirror
account is being done on periodic basis. The amount in the Nostro account is stock of
foreign currency in the form of bank accounts with the overseas branches and
correspondents. Unreconciled Nostro Accounts, on an examination, may reveal
unauthorised payments from the foreign currency account, unauthorised withdrawals,
and unauthorised debit to mirror account.
• Evaluate the internal control with regard to inward/outward messages. The
inward/outward messages should be properly authenticated and discrepancies noticed
should be properly dealt with in the books of accounts. In case balance confirmation
certificate have been received but the same have not been reconciled, report, in
respect of each bank, the balances as per books maintained by the branch and the
balance as per the relevant balances confirmation certificate, stating in either case
whether the balance is debit or credit.

b) As provided in section 60 of BAFIA 2073, the Board of Directors of a bank or financial

institution shall form an audit committee under the coordination of non-executive director
and consisting of three members. The chairman of bank or financial institution,
coordinator of sub-committee and executive chief shall not work in an audit committee.
The member of audit committee shall not be involved in accepting deposit, supplying
credit, making investment in securities, taking decision by spending approved budget
including day-to-day transactions. The meeting of audit committee shall be held, except
in the situation where the meeting is called by the Board of Directors, at least once in
every three months. The working procedure regarding the meetings of audit committee
shall be as determined by the same committee.
The functions, duties and powers of audit committee as mentioned in section 61 of the
BAFIA 2073 shall be as follows:-

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i. To monitor and supervise whether or not the account, budget and internal
audit procedure, internal control system of bank or financial institution is
appropriate and if it is appropriate than whether or not it is implemented.
ii. To conduct internal audit of account and books of bank and financial
institution and to confirm whether or not such documents are prepared
accurately as per prevailing laws, regulation and directives of the Rastra Bank.
iii. To examine or caused to be examine the management and functioning of
regular management and work performance of bank or financial institution so
as get assured that the prevailing laws has been fully implemented in bank or
financial institution.
iv. To monitor whether or not the functions and activities carried on by bank or
financial institution is as per this Act or rules formed under this Act, bye-laws,
rules or given directives and submit a report to the Board of Directors on this
matter.
v. To recommend the names of three auditors for appointment of external
auditor.
vi. To suggest on matters as asked by the Board of Directors

Answer No. 16
The special points or areas to be covered by auditor during the audit of mutual funds
companies are as follows:
i. Verify all the securities (shares or debentures) held by the company either in physical
form or dematerialized form. In respect of securities held through depository, obtain
confirmation from the depository regarding shares/securities held on behalf of the
company.
ii. Examine the ceiling on investment in the shares by mutual funds in a single entity or
group of entities where the ceiling of investment has been fixed. For example; the
shares in bank or financial institution. Verify that the investment made is within
prescribed limit.
iii. Verify that the company has not advanced any loans against the security of its own
shares.
iv. Verify that the dividend income wherever declared by an entity has been duly
received and booked and or interest income wherever due has been duly accounted as
per NFRS.
v. Verify the bonus shares, right shares or any other rights or benefits are duly received
and treatment of such in books of accounts.
vi. Check the contract notes received from brokers with reference to prices vis-a vis the
stock market quotations on respective dates.
vii. Examine the board minutes for purchase and sale of investments. Verify the profit or
loss on sale of investment has been duly accounted for as per NAS/NFRS.
viii. Verify the brokerage charges and TDS deducted on the purchase and sale of
investments.

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ix. Check whether the investments have been valued in accordance with NFRS/NAS and
the provision for fall in market value of securities have been made as required.
x. Verify the calculation of net assets value.
xi. Check the dividend distributed to participants of mutual funds and verify the proper
application of tax thereon.

ASSURANCE AND RELATED SERVICES

Answer No. 17
a) According to NSRE 2400, unless required by law or regulation, the practitioner shall not
accept a review engagement if:
(a) The practitioner is not satisfied:
(i) That there is a rational purpose for the engagement; or
(ii) That a review engagement would be appropriate in the circumstances;
(b) The practitioner has reason to believe that relevant ethical requirements, including
independence, will not be satisfied;
(c) The practitioner’s preliminary understanding of the engagement circumstances
indicates that information needed to perform the review engagement is likely to be
unavailable or unreliable;
(d) The practitioner has cause to doubt management’s integrity such that it is likely to
affect proper performance of the review; or
(e) Management or those charged with governance impose a limitation on the scope of the
practitioner’s work in the terms of a proposed review engagement such that the
practitioner believes the limitation will result in the practitioner disclaiming a conclusion
on the financial statements.

b) The projected financial statements are form of prospective financial information which
are 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. As per NSAE 3400 ‘The Examination of Prospective Financial
Information’, the auditor should obtain a sufficient level of knowledge of the business to
be able to evaluate whether all significant assumptions by considering the internal
controls over the system used to prepare prospective financial information and the
expertise and experience of those persons preparing the prospective financial information,
the nature of the documentation prepared by the entity supporting management’s
assumptions, the extent to which statistical, mathematical and computer-assisted
techniques are used and the methods used to develop and apply assumptions. Further the
auditor requires knowledge of the entity’s historical financial information to assess
whether the prospective financial information has been prepared on a basis consistent
with the historical financial information and to provide a historical yardstick for
considering management’s assumptions. The auditor will need to establish, for example,
whether relevant historical information was audited or reviewed and whether acceptable
accounting principles were used in its preparation. Similarly, the auditor should consider
the period of time covered by the prospective financial information.

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In an engagement to examine prospective financial information, the auditor should obtain

sufficient appropriate evidence as to whether:
o Management’s best-estimate assumptions on which the prospective financial
information is based are not unreasonable and, in the case of hypothetical
assumptions, such assumptions are consistent with the purpose of the information;
o The prospective financial information is properly prepared on the basis of the
assumptions; for example, making clerical checks such as re-computation and
reviewing internal consistency.
o The prospective financial information is properly presented and all material
assumptions are adequately disclosed, including a clear indication as to whether
they are best-estimate assumptions or hypothetical assumptions; and
o The prospective financial information is prepared on a consistent basis with
historical financial statements, using appropriate accounting principles.
The auditor needs to assess the source and reliability of the evidence supporting
management’s best-estimate assumptions. Sufficient appropriate evidence supporting
such assumptions would be obtained from internal and external sources including
consideration of the assumptions in the light of historical information and an evaluation
of whether they are based on plans that are within the entity’s capacity. The auditor would
consider whether, when hypothetical assumptions are used, all significant implications of
such assumptions have been taken into consideration. For example, if sales are assumed
to grow beyond the entity’s current plant capacity, the prospective financial information
will need to include the necessary investment in the additional plant capacity or the costs
of alternative means of meeting the anticipated sales, such as subcontracting production.
The auditor should obtain written representations from management regarding the
intended use of the prospective financial information, the completeness of significant
management assumptions and management’s acceptance of its responsibility for the
prospective financial information.

OTHER SERVICES
Answer No. 18
a) Compliance audit is the independent assessment of whether a given subject matter is in
compliance with the applicable authorities identified as criteria. This audit is carried out
by assessing whether activities, financial transactions and information comply in all
material respects, with the regulatory and other authorities which govern the audited
entity. Compliance audit is concerned with:
i. Regulatory- adherence of the subject matter to the formal criteria emanating from
relevant laws, regulations and agreements applicable to the entity.
ii. Propriety-observance of the general principles governing sound financial
management and the ethical conduct of public officials.
While regularity is emphasized in compliance auditing, propriety is equally pertinent in
the public-sector context, in which there are certain expectations concerning financial
management and the conduct of officials.

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Compliance audit is generally conducted either in relation with the audit of financial
statements, or separately as individual compliance audits, or in combination with
performance audit.

b) A forensic audit is an examination and evaluation of a firm's or individual's financial

records to derive evidence that can be used in a court of law or legal proceeding. Forensic
audits cover a wide range of investigative activities. A forensic audit may be conducted to
prosecute a party for fraud, embezzlement, or other financial crimes or even situations
that do not involve financial fraud, such as disputes related to bankruptcy filings, business
closures, and divorces. Forensic auditing is a specialization within the field of accounting
and requires the expertise of accounting and auditing procedures as well as expert
knowledge about the legal framework of such an audit. Forensic auditing process
involves an initial investigation, information reporting, and a final litigation.
i. Investigation
Forensic audit involves initially planning the investigation to achieve its objectives of
discovering about fraud and then collect evidence when fraud suspicions already
exist. The forensic auditors may interview staff at an organization to gain more
information and attempt to find the individual behind the fraud. Using the gathered
information they begin to form a hypothesis as to what happened and create follow-up
plans to continue to assess the business. Once this step reaches completion, the
forensic accountant determines the next necessary action and relays this information
to the company. The evidence collected should be adequate enough to prove the
identity of the fraudster(s) in court, reveal the details of the fraud scheme, and
document the financial loss suffered and the parties affected by the fraud. A logical
flow of evidence will help the court in understanding the fraud and the evidence
presented.

ii. Reporting
A forensic audit requires a written report about the fraud to be presented to the client
so that they can proceed to file a legal case if they so desire. At a minimum, the report
should include the findings of the investigation, a summary of the evidence collected,
an explanation of how the fraud was perpetrated and suggestions for preventing
similar frauds in the future—such as improving internal controls.

iii. litigation
The final step of a forensic accountant's process involves participation as an expert
witness in the incident's court case. The professional presents their findings as
evidence in court and testifies against the offenders. He or she should simplify any
complex accounting issues and explain the case in a layperson’s language so that
people who have no understanding of legal or accounting terms can understand the
fraud clearly.

c) Differences are:

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Financial audit Management audit

Financial audit is concerned with Management audit is a systematic
expressing opinion whether the financial evaluation of capabilities of the
statements are prepared, in all material company’s management with regard to
respects, in accordance with the effectiveness in achieving the strategic
applicable financial reporting framework. objectives of the company and quality of
decision making.
It is quantitative in nature, the attention It is qualitative in nature, the attention is
more on figures. more on process, performance and
stewardship.
It is statutory requirement. It is voluntary.

It is conducted on annual basis. It is conducted as per specific

requirement.
It is conducted by statutory auditor, It is conducted by an employee or
professional accountant in practice. independent consultant.

FRAUD AND AUDITOR’S LIABILITY

Answer No. 19
a) As per section 115 and section 116 of Companies Act, 2063, have provisions regarding
functions and duties of statutory auditor appointed by the company. Accordingly, the
auditor shall submit his/her report to the company, addressing to the shareholders or the
appointing authority, certifying the Statement of Financial Position, Statement of Profit or
Loss and cash flow statement based on the books of account, records and accounts
audited by him/her.
The audit report shall be prepared in accordance with the prevailing law or in consonance
with the audit standards prescribed by the competent body; and such report shall disclose
the matters to be set out prescribed under the companies act. The audit report shall also
indicate the following matters, inter alia:
(a) Whether such information and explanations have been made available as required for
the completion of audit;
(b) Whether the books of account as required by this Act have been properly maintained
by the company in a manner to reflect the real affairs of its business;
(c) Whether the Statement of Financial Position, Statement of Profit or Loss and cash
flow statements received have been prepared in compliance with the accounting
standards prescribed under the prevailing law and whether such statements are in
agreement with the books of account maintained by the company;
(d) Whether, in the opinion of the auditor based on the explanations and information
made available in the course of auditing, the present balance sheet properly reflects

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the financial situation of the company, and the Statement of Profit or Loss and cash
flow statement for the year ended on the same date properly reflect the profit and
loss, cash flow of the company, respectively;
(e) Whether the board of directors or any representative or any employee has acted
contrary to law or misappropriated any property of the company or caused any loss
or damage to the company or not;
(f) Whether any accounting fraud has been committed in the company
(g) Suggestion, if any.
The audit report, prepared by the auditor shall be signed and dated by the auditor
him/herself.
Section 160 and section 161 of Companies Act, have mentioned provisions relating to
offenses and punishment that can be charged to auditor. Under these provisions, auditor if
commits the following offense shall be punished with a fine from twenty thousand rupees
to fifty thousand rupees or with imprisonment for a term not exceeding two years or with
both punishments:
i. where the auditor of a company states a false matter in his/her report in the course
of carrying out his/her duty or omits necessary comments while making audit, with
mala fide intention or malicious recklessness, such auditor;
ii. An auditor who knowingly carries out auditing of the concerned company even after
that he/she is not qualified to carry out auditing of any company;
Similarly, auditor if commits the following offense shall be punished with a fine not
exceeding fifty thousand rupees:
i. An auditor who does not present a report as specified in the Act;
ii. An company, director, auditor, officer and employee who violate the provision
contained in Chapter-18 Audit Committee or who fail to fulfil the duty and
obligations specified in that Chapter.

b) As per NSA 240, ‘The Auditor’s Responsibilities Relating to Fraud in An Audit Of

Financial Statements’, the primary responsibility for the prevention and detection of fraud
rests with both those charged with governance of the entity and management. It is
important that management, with the oversight of those charged with governance, place a
strong emphasis on fraud prevention, which may reduce opportunities for fraud to take
place, and fraud deterrence, which could persuade individuals not to commit fraud
because of the likelihood of detection and punishment. An auditor conducting an audit in
accordance with NSAs 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. Owing to the inherent limitations of an audit, there is an unavoidable risk that
some material misstatements of the financial statements may not be detected, even though
the audit is properly planned and performed in accordance with the NSAs. This is because
fraud may involve sophisticated and carefully organized schemes designed to conceal it,
such as forgery, deliberate failure to record transactions, or intentional misrepresentations

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being made to the auditor. Such attempts at concealment may be even more difficult to
detect when accompanied by collusion. Collusion may cause the auditor to believe that
audit evidence is persuasive when it is, in fact, false. The auditor’s ability to detect a
fraud depends on factors such as the skilfulness of the perpetrator, the frequency and
extent of manipulation, the degree of collusion involved, the relative size of individual
amounts manipulated, and the seniority of those individuals involved. Furthermore, the
risk of the auditor not detecting a material misstatement resulting from management fraud
is greater than for employee fraud, because management is frequently in a position to
directly or indirectly manipulate accounting records, present fraudulent financial
information or override control procedures designed to prevent similar frauds by other
employees. However, when obtaining reasonable assurance, the auditor is responsible for
maintaining professional skepticism throughout the audit, recognizing the possibility that
a material misstatement due to fraud could exist. The auditor shall identify and assess the
risks of material misstatement due to fraud at the financial statement level, and at the
assertion level for classes of transactions, account balances and disclosures. The auditor
shall evaluate whether the information obtained from the risk assessment procedures and
related activities performed indicates that one or more fraud risk factors are present. The
auditor shall determine overall responses to address the assessed risks of material
misstatement due to fraud at the financial statement level.

The subsequent discovery of material misstatement of financial information resulting

from fraud or error existing during the period covered by auditor’s report does not, in
itself, indicate that whether the auditor has adhered to the basic principles of governing an
audit. The question of whether the auditor has adhered to the basic principles of
governing an audit such as performance of audit with professional competence and due
care, details of audit plan, nature, timing and extent of compliance and substantive audit
procedures, documentation of significant matters is determined by the adequacy of the
procedures undertaken in the circumstances and the suitability of the auditor’s report
based on the results of those procedures. The liability of auditor for failure to detect fraud
exists only when such failure is clearly due to not exercising reasonable care and skill.

Here in the given case, if the auditor can prove from his working papers that he has
conducted the audit in accordance with NSAs and has assessed the risks of material
misstatement due to fraud and conducted the extended audit procedures as response to
those addressed risks maintaining professional skepticism in audit, then the auditor cannot
be alleged for non detection of fraud.

Answer No. 20
The objective of a fair value measurement is to estimate the price at which an orderly
transaction to sell the asset or to transfer the liability would take place between market
participants at the measurement date under current market conditions. The NFRS 13 notes
that there are three widely used valuation techniques; the market approach, the cost approach
and the income approach.

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i) The market approach: The market approach uses prices and other relevant
information generated by market transactions involving identical or comparable
(i.e. similar) assets, liabilities or a group of assets and liabilities, such as a
business. For example, valuation techniques consistent with the market approach
often use market multiples derived from a set of comparables. Multiples might be
in ranges with a different multiple for each comparable. The selection of the
appropriate multiple within the range requires judgement, considering qualitative
and quantitative factors specific to the measurement.Valuation techniques
consistent with the market approach include matrix pricing. Matrix pricing is a
mathematical technique used principally to value some types of financial
instruments, such as debt securities, without relying exclusively on quoted prices
for the specific securities, but rather relying on the securities’ relationship to other
benchmark quoted securities.
ii) The cost approach: The cost approach reflects the amount that would be required
currently to replace the service capacity of an asset (often referred to as current
replacement cost). From the perspective of a market participant seller, the price
that would be received for the asset is based on the cost to a market participant
buyer to acquire or construct a substitute asset of comparable utility, adjusted for
obsolescence. That is because a market participant buyer would not pay more for
an asset than the amount for which it could replace the service capacity of that
asset. Obsolescence encompasses physical deterioration, functional
(technological) obsolescence and economic (external) obsolescence and is broader
than depreciation for financial reporting purposes (an allocation of historical cost)
or tax purposes (using specified service lives). In many cases the current
replacement cost method is used to measure the fair value of tangible assets that
are used in combination with other assets or with other assets and liabilities.
iii) The income approach: The income approach converts future amounts (eg cash
flows or income and expenses) to a single current (ie discounted) amount. When
the income approach is used, the fair value measurement reflects current market
expectations about those future amounts. Those valuation techniques include, for
example, the following:
• present value techniques;
• option pricing models, such as the Black-Scholes-Merton formula or a
binomial model (ie a lattice model), that incorporate present value
techniques and reflect both the time value and the intrinsic value of an
option; and
• the multi-period excess earnings method, which is used to measure the fair
value of some intangible assets.

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Paper 4: Corporate Laws

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Revision Questions:
NEPAL CHARTERED ACCOUNTANTS ACT, 2053 AND RULES, 2061
1. Mr. Sher Bahadur Thapa, a Nepalese national qualified as a Chartered Accountant from the Institute of
Chartered Accountants of Pakistan (ICAP) in the year 2017. He returned to Nepal in January, 2019. He is
contemplating to obtain membership of ICAN. Is it possible? Please advise him under Nepal Chartered
Accountants Act, 1997.

2. The Institute of Chartered Accountants of Nepal (ICAN) received a letter containing a complaint
against Mr. Hero, a member of ICAN that he conducts audit in partnership with Mr. Smart, a ‘B’ Class
RA member of the Institute. How and what action the Council of ICAN can take against Mr. Hero & Mr.
Smart under Nepal Chartered Accountants Act, 2053?

COMPANIES ACT, 2063

3. Dream Garden was incorporated as a private limited company on 2068/2/20. It had profitable business
from the year of its registration to the year 2071. In the year 2072 it was converted into a public limited
company. The company also changed its name as Heaven Garden Public Limited in the year 2073 as per
the provisions of the Act. The extract of Balance Sheet of the company as on 2076/3/32 is as follows:

Liabilities Amount (Rs) Assets Amount (Rs)

Capital 1,25,00,000 Fixed assets 1,30,00,000
Reserve & Surplus (1,00,00,000) Current assets 45,00,000
Loan & outsider liabilities 1,50,00,000
Total 1,75,00,000 Total 1,75,00,000

In the light of the above balance sheet, you are required to provide the legal solutions on the following
questions:
(i) Is there any responsibility on the part of the directors?
(ii) State the punishment if any imposed to the directors under the Companies Act, 2063 in case of failure
to comply the responsibility of (a)
(iii) What shall be the consequences if the above figures in the balance sheet are occurred due to malafide
(bad) intention of any director/s?

4. Globe Limited is a subsidiary company of World Limited. Global Limited sold some of its property. It
has hired you as a consultant to advice in the following matters:
(i) If Globe Limited or World Limited need to inform the Company Registrar's Office (CRO) about sold
property. When and under what conditions does a company need to inform the acquisition or sold of
property to the Office of Company Registrar?
(ii) Explain the matters to be provided to CRO in this respect.

SECURITIES ACT, 2063

5. Lali Gurans Stock Exchange Limited is a body corporate having obtained the license to operate the
stock exchange from the Securities Board of Nepal since 2072. In the year 2076 Shrawan, it became

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insolvent being unable to repay credit to creditors. In this regards you are required to advice the following
matters:
(i) Explain the circumstances/situations in which the Securities Board may revoke (cancel) license
obtained by any stock exchange or securities business.
(ii) Can the Securities Board cancel the license of Laligurans Stock Exchange Limited on the ground of
being insolvent?

BANKS AND FINANCIAL INSTITUTIONS ACT, 2073

6. Bank X and Bank Y have obtained theoretical approval of merger from Nepal Rastra Bank. Now, the
two banks are required to make arrangement on different matters as provided in the Banks and Financial
Institutions Act, 2073 and required to make agreement. Explain the matters to be included in such
agreement.

NEPAL RASTRA BANK ACT, 2058

7. Nepal Rastra Bank has declared Xina Bank Limited as a problematic institution pursuant to section
86(B) of Nepal Rastra Bank Act, 2058. State the possible actions NRB may take upon Xina Bank Limited
under NRB Act, 2058.

AUDIT ACT, 2075

8. What do you mean by Corporate Body? Explain the provisions relating to audit of Corporate Body.
Explain it pursuant to the provisions of Audit Act, 2075.

INDUSTRIAL ENTERPRISES ACT, 2073

9. Yeti industry has been in operation from 2068. The company operated in profit up to the year 2071. It
was in loss from the year 2072 to 2075 with production level of 50% during these years. Ram Lal, the
managing director of the company is contemplating that his industry be classified as sick industry and it
shall obtain facilities and exemptions accordingly. You are required to advise Mr. Ram Lal citing the
legal provisions of Industrial Enterprises Act, 2073.

FOREIGN INVESTMENT AND TECHNOLOGY TRANSFER ACT, 2075

10. Parrot Industry is an industry established under the Industrial Enterprises Act, 2073. Mr. John, a
Japanese investor has invested in 12 % of share capital of the industry. A dispute has arisen between Mr.
John and the Industry regarding foreign investment. You are hired as a consultant of the industry to
advice regarding the dispute settlement mechanisms citing the legal provisions of the Foreign Investment
& Technology Transfer Act, 2075.

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INSURANCE ACT, 2049

11. Lumbini General Insurance Company Limited has been given order to cancel the registration by
Insurance Board. The following are the liabilities of the company. However the company could only
realize Rs. 600 million from its assets on liquidation. You have been appointed as a liquidator of the
company. How do you settle the following liabilities in the priority basis?
(i) Loan amount 150 million
(ii) Amount due to the Board 120 million
(iii) Amount due to GON 30 million
(iv) Dues to the employees 35 million
(v) Insurance claim 250 million
(vi) Amount of liquidation 15 million

LABOUR ACT, 2074 AND RUES, 2075

12. Explain the provisions relation to formation of Labour Coordination Committee and its functions,
duties & powers under the Labour Laws.

INTERNATIONAL FINANCIAL TRANSACTIONS ACT, 2054

13. Explain the facilities and privileges available to International Financial Entity under the International
Financial Transactions Act, 2054.

COOPERATIVES ACT, 2074 & RULES 2075

14. Explain the provisions relating to formation and functions, duties and powers of Accounts
Supervision Committee under the Cooperatives Act, 2074.

INSOLVENCY ACT, 2063

15. Sriman was appointed as the liquidator of ABC Limited. During his working period he found that
certain transitions as carried out by the company were voidable. Considering the provisions of the Act, he
has made application to the Court to declare these transactions void. Enumerate the powers of the Court in
Relation to Voidable Transactions.

ASSET (MONEY) LAUNDERING PREVENTION ACT, 2064 & RULES 2073

16. Define Domestic Politically Exposed Person. Explain the special provisions for identification of
Politically Exposed Person (PEP) as provided in Asset (Money) Laundering Prevention Act, 2064.

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PUBLIC PROCUREMENT ACT, 2063 AND RULES 2064

17. Public Procurement Rules, 2064 (Rule, 32) provides that if a Public Entity is to invite a bid by
determining pre-qualification, it shall have to prepare prequalification documents before inviting a bid.
State the matters to be included in such pre-qualification documents.

ARBITRATION ACT, 2055

18. Explain the powers of the Arbitrators exercised in the arbitration process as provided in Arbitration
Act, 2055.

BANKING OFFENSE AND PUNISHMENT ACT, 2064

19. Define ‘Dhukuti Transactions’ and state the punishments relating to offense of ‘Dhukuti transactions’
pursuant to Banking Offenses and Punishment Act, 2064.

ACT RELATING TO INSTITUTIONS ACTING AS FINANCIAL INTERMEDIARY, 2055

20. Explain the provisions relating to merger of a financial intermediary institution under Financial
Intermediary Act, 2055?

FOREIGN EXCHANGE (REGULATION) ACT, 2019 (1962)

21. Green Apparels Limited, a garment exporter makes arrangements to receive the payments from the
White Company Limited, a Japan based company for the garments exported after a month than that of the
prescribed time limit. There has been a very cordial business relationship between these two companies
since a decade. Will action of Green Apparels limited justified?

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Suggested Answers/Hints:
NEPAL CHARTERED ACCOUNTANTS ACT, 2053 AND RULES, 2061
Answer to Question no 1
Section 26 of the Nepal Chartered Accountants Act, 1997 provides that a person who has passed the
chartered accountancy or examination equivalent thereto and taken training from any foreign
accountancy practitioner institute shall make an application, as prescribed, to the Institute for the
recognition of such examination and training. If an application is so made for recognition, the Council
shall make decision to or not to recognize such examination and training.
If the Council holds that any term has to be fulfilled by the applicant prior to recognizing such
examination and training such term shall also be specified. If any term to be fulfilled is so specified, an
application may be made for the membership of the Institute under this Act only after the fulfillment of
such term.
Further section 27 of the Act provides that the Council may, with the prior approval of Government of
Nepal, recognize any foreign accountancy practitioner institutes and the examinations and trainings held
and provided by such institutes. The Council shall maintain a list of Institutes recognized as such and
it shall not be necessary to fulfill the procedures set forth in Section 26 in relation to any examinations
held and trainings provided by such Institutes.
Conclusion:
In the given case Mr. Sher Bahadur Thapa has passed Chartered Accountancy Examinations from the
Institute of Chartered Accountants of Pakistan. ICAP is not recognized Institute by the Council of ICAN.
Thus, Mr. Thapa shall be required to proceed pursuant to section 26 of the Act. Hence, he may make an
application, as prescribed, to the ICAN for the recognition of such examination and training. If an
application is so made for recognition, the Council shall make decision to or not to recognize such
examination and training.

Answer to Question no 2
Pursuant to section 35 of Nepal Chartered Accountants Act, 1997 where a member having obtained the
professional certificate does not observe the conduct set forth in this Act or the Rules framed under this
Act or such member violates this Act or the Rules framed under this Act, the concerned person may make
a complaint to ICAN Council against such members under this provision.
Where there is a reason to believe that the members having obtained the professional certificate have not
observed the conduct required to be observed, the Secretary of ICAN, shall submit a motion, accompanied
by the available fact, to the Council of ICAN for taking action against him.
The Council of ICAN thereupon refers this case to the Disciplinary Committee of ICAN for investigation
under sections 11(k) and 14 of this Act. The Disciplinary Committee shall exercise its authority similar to
a judicial court while investigating evidences and witnesses under section 14(4) of this Act.
The Disciplinary committee shall make recommendation, along with its opinion and finding, to the
Council for taking necessary action against them if found guilty from its investigation, and the Council
may, in view of such recommendation, impose any of the following penalties on Mr. Hero & Mr. Smart,
according to the gravity of the offence committed under section 14(5) of this Act:
(a) Reprimanding;

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(b) Removing from the membership for a period not exceeding Five years;
(c) Prohibiting from carrying on the accounting profession for any specific period;
(d) Canceling the professional certificate or membership.
Before imposing a punishment as said above the Council should provide a reasonable opportunity to the
concerned members to submit their clarification as an opportunity of being heard.

COMPANIES ACT, 2063

Answer to Question no 3

(i) The Net worth of Heaven Garden Public Limited is Rs. 1,75,00,000 -1,50,00,000 = Rs. 25,00,000.
Section 60(1) of the Companies Act, 2063 provides that if the net worth of a public company is reduced to
half of the paid up capital or less than that, the directors shall prepare an appropriate strategy for the
interest of the company and shareholders as well, within 35 days of the knowledge of this matter, and
present a separate resolution thereon at the general meeting to be held immediately after the knowledge of
such matter. Provided, however, that where approval of the general meeting is required to implement such
strategy, the extra-ordinary general meeting shall be called promptly. Thus, the directors of Heaven
Garden Limited shall prepare an appropriate strategy for the interest of the company and shareholders
within 35 days of the knowledge of the matter and present a separate resolution at the general meeting to
be held immediately after the knowledge of such matter.

(ii) Section 60(2) of the Act provides that the directors of company who fails to prepare strategy or to
present a resolution at the general meeting pursuant to sub-section (1) or who knowingly permit the
existence of the situation where such meeting is not called shall be liable to punishment under this Act.
Further, section 160(1) of the Act provides that a director who fails to do any act required to be done
pursuant to Section 60, shall be punished with a fine ranging from Rs. 20,000 to Rs. 50,000 or with
imprisonment for a term not exceeding 2 years or with both punishments:

(iii) Section 60(3) of the Act provides that if it is held that the net worth of company has been reduced as
mentioned in sub-section (1) as a result of malafide (bad) intention or malicious (wicked) recklessness
(carelessness) of any director, the director who commits such act shall also be liable to pay compensation
for the same.

Answer to Question no 4

(i) Section 141(1) of the Companies Act, 2063 provides that a public company or its subsidiary company
shall, if the purchase or sale of any property by it results in the following situation, give information
thereof to the Company Registrar Office (CRO).
(a) If the purchase of any property results in an increase in the value of its property or the value of
consolidated property mentioned in the audited latest annual financial statement, by more than 15
%,
(b) If the income to be earned from the property sold or intended to be sold exceeds by more than 15 %
of the consolidated income before making payment for tax as mentioned in the audited latest books
of account of the company.

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Thus, by inferring the provisions of the Act, simply sales of property by Globe Limited is not required to
be informed to the CRO. However, reporting for sale of property shall be required to be made if the
income to be earned from the property sold or intended to be sold exceeds by more than 15 % of the
consolidated income before making payment for tax as mentioned in the audited latest books of account
of the company.

(ii) Section 141(2) of the Companies Act, 2063 provides that any information to be given to the CRO
pursuant to sub-section (1) shall set out the following matters:
(a) Date of, and parties involved in, the transaction,
(b) Details about the nature of property, and if that property includes, wholly or partly, any shares
issued by any other company, the name of company issuing such shares and the nature of business
to be carried on by that company,
(c) Value of the transaction , and other terms and conditions of the transaction,
(d) The ground pursued for the valuation of property, while buying or selling any property,
(e) In the event of sale of any property, matter whether the proceeds of such sale is more or less than
the book value of such property as shown in the records thereof.

SECURITIES ACT, 2063

Answer to Question no 5
(i) Section 89 of the Securities Act, 2063 provides that the Securities Board may revoke a license obtained
by any stock exchange or securities business person to operate the stock exchange or securities business
under this Act on any of the following circumstances:
(a) If one stops operating the stock exchange or securities business,
(b) If one operate the stock exchange or securities business in contrary to the interest of investors,
(c) If one violates the terms set forth in the license,
(d) If one violates this Act or the Rules and Bye -laws framed under this Act,
(e) If one fails to observe any order or direction issued by the Board,
(f) If one becomes insolvent being unable to repay credit to creditors,
(g) If the company or body having obtained a license to operate the stock exchange or securities
business is wound up,
(h) If the stock exchange or securities business person having obtained a license to operate the stock
exchange or securities business makes an application for the revocation of a license,
(i) If the securities business person who has removed an agent appointed by it does not appoint another
agent in lieu of such an agent,
(j) If one fails to submit such financial and transaction related statements as required to be submitted to
the Board,
(k) If one fails to pay such fees as required to be paid pursuant to Section 50 to the Board within the
time limit specified by such a Section.

(ii) Thus, by inferring clause (f) the Board may cancel the license of Luligurans Stock Exchange Limited
on the ground of becoming insolvent being unable to repay credit to creditors.

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BANKS AND FINANCIAL INSTITUTIONS ACT, 2073

Answer to Question no 6
Section 72 of the Banks and Financial Institutions Act, 2073 provides that unless otherwise ordered by
Nepal Rastra Bank under this Act, the banks or financial institutions having obtained theoretical approval
of merger shall have to enter into an agreement having stated the following matters:
(a) Provisions concerning protection of interests of depositors, creditors and shareholders,
(b) Provisions concerning valuation system and matching of assets and liabilities of bank or financial
institutions,
(c) Provisions concerning management of investment and transaction, inter-agency ownership and
inter-agency give and take, guarantee and assurance, management of non-banking transaction,
assets and liabilities,
(d) Merger, merging and acquisition processes, the time to be taken and costs to be incurred,
(e) Operation and management structure and name list of Directors,
(f) Matching of levels of employees of both institutions, or of the principal institution and of the target
institution/s getting theoretical approval for merger or acquisition and matching of terms and
conditions of services,
(g) Details of the shareholders with substantial ownership and of other shareholders,
(h) If the bank or financial institutions to be merged or acquired as a new bank or financial institution,
the name, Memorandum of Association and Articles of Association, capital structure, restructuring
and class,
(i) In case of foreign bank or financial institution, the letter of approval from the concerned regulating
agency,
(j) In case of foreign bank or financial institution, matters as to whether or not acquire the business of
bank or financial institutions in Nepal or sell entire business of such bank or financial institutions in
Nepal,
(k) Grievance handling system of stakeholders,
(l) The prevailing laws and process for its compliance,
(m) Other necessary details required by the Rastra Bank.

NEPAL RASTRA BANK ACT, 2058

Answer to Question no 7
Xina Bank Limited has been declared as a problematic institution by Nepal Rastra Bank. Sub-section (1)
of section 86(C) of Nepal Rastra Bank Act, 2058 provides that notwithstanding anything contained in the
Companies Act or other prevailing law, NRB can take any or all of the following actions by taking up
management of such commercial bank or financial institution under its control or against the Board of
Directors of the commercial bank or financial institution concerned which is declared problematic:
(a) To increase the paid up capital by issuing new shares or by receiving due amount of issued capital,
(b) To suspend the right to vote or other rights of shareholder,
(c) To stop payment of dividend or any other amount to the shareholders to increase the capital,
(d) To determine limitation to the amount of bonus, salary, compensation and other expenses for the
director and other high level management officials,

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(e) To make necessary arrangement for the corporate governance, internal control and risk management
of commercial bank or financial institution,
(f) To prohibit or make limitation in collection of deposit, credit supply or investment,
(g) To maintain sufficient capital and high proportion of liquidity or prohibit business transaction or
determination of other necessary terms,
(h) To limit transaction of the commercial bank or financial institution or prohibit sale of property or
expansion of branch office or close any domestic or international branch,
(i) To maintain necessary arrangement for reduction of risk of the properties which are materially
doubtful or securities without proper evaluation or other properties,
(j) To prohibit any action carried out illegally by breaching the prevailing law and regulation of the
bank that is against the interest of commercial bank or financial institution,
(k) To prohibit from doing some specific business among the businesses allowed to commercial bank
or financial institution for specific time,
(l) To receive prior approval of the bank for major capital expenditure, substantial commitments
having major liabilities or for the expenditure of contingent liabilities,
(m) To issue order to remove from the post to single or more director or manager or employee as per the
necessity,
(n) Bank can remove the director or manager or employee in case of not discharge of the order made
under Clause (m) by respective commercial bank or financial institution,
(o) To suspend board of director of the commercial bank or financial institution and takeover the
management of such commercial bank or financial institution in self-control or operate the
management and transaction of such commercial bank or financial institution by appointed official,
Clarification: “Appointed Officer” means any person, firm, company or organization appointed by
the bank for the management and operation of transaction of the commercial bank or financial
institution which is in the control of bank under the provision of this Clause.
(p) To order commercial bank or financial institution, which is listed in Stock Exchange for the
application of de-listing,
(q) To prohibit payment of interest and principal for time bond auxiliary loan without having securities
of commercial bank or financial institution,
(r) To take any other action as bank feels necessity and proper.

AUDIT ACT, 2075

Answer to Question no 8
According to section 2(f) of Audit Act, 2075 "Corporate body” means a corporate body whose more than
50 % shares or assets are owned by Nepal Government, Provincial Government or local level and this
expression shall also include a corporate body whose more than 50 % shares are owned by the corporate
body.

Section 11 of the Act provides provisions relating to audit of Corporate Body. The laid down provision is
as follows:
- Corporate bodies shall appoint auditors and conduct audit in accordance with the principles
prescribed by Auditor General.

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- The Corporate bodies shall consult Auditor General while appointing an auditor pursuant to this
section
- The concerned organization shall deliver at the Office of the Auditor General a copy of the report
submitted by the appointed auditor.
- The Auditor General may issue directives to the concerned organization and the auditor in respect
of the irregularities observed in the audit report.
- It shall be the duty of concerned organization and the auditor to abide by such directives.
- The concerned corporate body shall submit to the Auditor General the implementation progress
report of the directives within the period prescribed by Auditor General.

INDUSTRIAL ENTERPRISES ACT, 2073

Answer to Question no 9
Background of the Case:
Yeti industry is suffering from the losses from the year 2072 to 2075. Managing director of the company
is thinking that the industry falls into sick industry and it shall obtain facilities and exemptions. This case
is related to the sick industries as per Industrial Enterprises Act, 2073.
Relevant Provision of the Act:
Section 37(1) of the Industrial Enterprises Act, 2073 states that if any Industry is being operated for a
consecutive period of five years and its production level is thirty percent or less than thirty percent of the
total production capacity in the last three years without any default or weakness on the part of the
management and operating in loss for a consecutive period of such 3 years, Government of Nepal may, if
it deems necessary, declare it a sick industry by notification published in the Nepal Gazette.

Conclusion:
In the given case Yeti Industry is operating in loss since 4 years with production level of 50%. To be
classified as sick industries, the industry should be required to be operated with production level of 30%
or less than 30 %. Hence, Yeti Industry cannot be classified as sick industry. As the industry cannot be
classified as sick industry, there is no question of availing facilities and exemptions.

FOREIGN INVESTMENT AND TECHNOLOGY TRANSFER ACT, 2075

Answer to Question no 10
Section 40 of the Foreign Investment & Technology Transfer Act, 2075 provides legal provisions on
settlement of dispute between the foreign investor and Nepalese investor. If any dispute arises between
foreign investor and Nepalese investor in relation to foreign investment, the dispute shall be resolved in
the following manner:
- Firstly, through mutual discussion or negotiation. The Department may provide necessary
facilitation.
- Secondly, if dispute could not be resolved by mutual discussion or negotiation within 45 days of
arising of dispute, the dispute shall be resolved as per joint investment agreement or dispute

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resolution agreement if any. The Department of Industries or the Investment Board should be
informed about dispute resolution within 15 days of resolving such dispute.
- In the absence of any such agreement or if the parties feel such agreement is inadequate to resolve
the dispute, the parties can enter into an agreement to resolve such dispute even after the occurrence
of dispute. The parties shall inform about such agreement to the Department of Industries or
Investment Board of Nepal.
- Failing to resolve the dispute even after taking the above measures, the dispute shall be resolved
according to the prevailing arbitration laws of Nepal.
- Except as agreed otherwise between the disputed parties, the arbitration shall be done in accordance
with the prevailing laws on United Nations Commission on International Trade Law (UNCITRAL).
- The arbitration shall be held in Nepal and the substantive laws of Nepal shall be applicable.

INSURANCE ACT, 2049

Answer to Question no 11

Section 41B of the Insurance Act, 2049 has made provision regarding the cancellation of the registration
and settlement of the liabilities on priority basis of the Insurance Company. If any Insurer is dissolved due
to the cancellation of its registration pursuant to Section 13, the liabilities shall be settled in the following
order of priority :
(a) The expenses incurred for the dissolution,
(b) The amount to be paid against the insurance claims to the Insured pursuant to Section 16,
(c) The remuneration and other outstanding amounts to be obtained by the employees of the Insurer,
(d) Loan amounts,
(e) The amount to be paid to the Board,
(f) The amount to be paid to the Government of Nepal.

In the given question Gandaki General insurance Company has been given ordered to cancel the
registration by Insurance Board. Being appointed as a liquidator of the company I have to follow up the
procedure and provision stated in section 41B for the settlement of the liabilities. As given in the question
the realization of the amount from the liquidation of the assets Rs 600 million, the priority has to make as
under:
(a) The expenses incurred for the dissolution: 15 million
(b) Insurance claim: 250 million
(c) Due to employees for remuneration: 35 million
(d) Loan Amount: 150 million
(e) Amount to be paid the Board: 120 million
(f) Amount to be paid to the Government of Nepal: 30 million

LABOUR ACT, 2074 AND RUES, 2075

Answer to Question no 12
Rule 79 of Labour Rules, 2075 states that the Labour Coordination Committee shall be formed under the
chairmanship of the Director General of the Department of Labour and the membership of Representative
of Trade Union Federation & Representatives of Employers Association.

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Rule 80 has prescribed the function, duties and powers of the Committee shall be as follows:
- To discuss with the concerned party and provide necessary suggestions for the settlement of
industrial dispute of any enterprise.
- To make necessary arrangement and coordination with the concerned for the settlement of any
dispute between the employer and the employee.

INTERNATIONAL FINANCIAL TRANSACTIONS ACT, 2054

Answer to Question no 13
International Financial Transactions Act, 2054 has provided the following facilities and privileges to the
International Financial Entity:
(a) No restrictions on bringing in foreign currencies (Section 6):
- No restriction of any kind shall be imposed on a license holder entity to bring in foreign
currencies as may be required for international financial transactions.
- No restriction of any kind imposed by the existing laws relating to foreign exchange shall apply
in relation to a license holder entity.

(b) Repatriation of Fund (Section 7): A license holder entity may repatriate outside the Nepal the foreign
currencies earned by it by carrying out international financial transactions and the foreign currencies
brought in by such entity for the purpose of carrying out international financial transactions. Provided that
no property or capital accrued from any illicit or illegal act shall be allowed to be repatriated.

(c) Nationalization not to be done (Section 8): The capital or the property of any International Financial
Entity shall not be subjected to nationalization.

COOPERATIVES ACT, 2074 & RULES 2075

Answer to Question no 14
Section 48 of the Cooperatives Act, 2074 states that Accounts Supervision Committee shall be composed
of one coordinator and two members possessing prescribed qualification formed by the general meeting
through election. More than one individual of the same family shall not be the coordinator or member of
accounts supervision committee during the same period.

Section 49 of the Act states the functions, duties and powers of the accounts supervision committee shall
be as follows:
(a) To perform or cause to perform the internal audit quarterly.
(b) To comply or cause to comply fundamental principles of audit during the internal audit.
(c) To inspect and evaluate commercial and financial transaction of the institution.
(d) To supervise functions and activities of the committee on a regular basis and advice accordingly.
(e) To monitor as to whether the decision, direction of general meeting and decision of committee has
been implemented or not.
(f) To present annual reports as to matters related to Accounts and Functions and activities of
committee.

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(g) Where negative effect to cooperatives interest, misappropriation or irregularity in the cash or other
physical assets, or possibility of serious financial difficulties due to non- implementation of its
frequent advice has occurred, it shall recommend the committee to call EGM by clarifying the
reasons.
(h) To recommend the name of 3 persons for the appointment of internal auditor to the board of
directors if deemed necessary.
(i) The coordinator or member of the accounts supervision committee shall not be involved in the daily
financial or administrative functions of the institution.

INSOLVENCY ACT, 2063

Answer to Question no 15
Section 61 of the Insolvency Act, 2063 states that where the Court is satisfied that any transaction is
voidable, the Court may issue orders as follows:
(a) To order the concerned person to pay to the liquidator some or all of the amounts paid by the
company in connection with such transaction;
(b) To order the concerned person to hand over to the liquidator the asset so transacted or an amount
equivalent thereto;
(c) To order that the debt obtained by the company through such transaction, or the collateral or
guarantee furnished by the company for that debt be fully or partly remitted or released;
(d) To order that any remission or assignment made or agreement entered into between the company
and any other person in consequence of the voidable transaction be void, inoperative or
unenforceable.
The Court may also issue any such other additional order as may be required to enforce such order.

ASSET (MONEY) LAUNDERING PREVENTION ACT, 2064 & RULES 2073

Answer to Question no 16
Section 2 of Money Laundering Prevention Act, 2064 defines “Domestic politically exposed person”
means President, Vice-president, Prime Minister, Chief Justice, Speaker of Federal Parliament, Chairman
of National Assembly, Head of State, Ministers of Nepal Government, Chief Minister of State
Government, Member of Federal Parliament, Office bearer of Constitutional body, Speaker of State
Assembly, Ministers of State Government, Special class or equivalent class or higher than this class
officer of Nepal Government, justice of High Court and above, Deputy Speaker of State Assembly,
Member of State Assembly, central member of national political party, Chief and Deputy Chief of District
Coordination Committee, Chief and Deputy Chief of Municipality, Chairman and vice-chairman of
Village Council, senior executives or person with such responsibility of any institution fully or partially
owned by Nepal Government.
Section 7B of Money Laundering Prevention Act, 2064 has provided the provisions on identification of
Politically Exposed Person. The Act provides that Reporting entity shall establish a risk management
system to identify whether a customer, person seeking to be customer or a beneficial owner of a customer
or transaction is politically exposed person.

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Reporting entity, while evaluating as such, shall adopt the following additional measures in establishing
business relationship or transactions if it finds the customer or beneficial owner is either a foreign
politically exposed person or a domestically exposed person or international politically exposed persons
evaluated to be of high risk:
(a) To obtain approval from senior management official while establishing a business relationship,
(b) To acquire approval from senior management official to continue the business relation with an
existing customer if he is identified as a politically-exposed person,
(c) To take all reasonable measures to identify the source of amount, fund and property of such
customer or beneficial owner,
(d) To provide ongoing monitoring of such customer and the business relationship,
(e) To apply Enhanced Customer Due Diligence (CDD) measures.
Above provisions shall be applicable to the family members and associated persons of foreign politically
exposed person, or international politically exposed person or domestic politically exposed person
identified as high risk.

PUBLIC PROCUREMENT ACT, 2063 AND RULES 2064

Answer to Question no 17
The matters to be included in the prequalification documents as provided in Rule 32 of Public
Procurement Rules, 2064 are as follows:
(a) Qualification required for the proposed work and in the case of a joint venture, the qualification of
the partners,
(b) Documents and information to be submitted by a bidder to prove his/her qualifications and
eligibility,
(c) If procurement requires to be made by making separate lot or package of goods or construction
work, such lot or package,
(d) Method of preparing proposal,
(e) Process of evaluating pre-qualification proposal,
(f) Major conditions of procurement contract,
(g) Such matters specified from time to time by the Public Procurement Monitoring Office as required
to be included into the pre-qualification documents, and
(h) Method, place, deadline for submitting pre-qualification proposal.

ARBITRATION ACT, 2055

Answer to Question no 18
Section 21 of the Arbitration Act, 2055 provides that except when otherwise provided for in the
agreement, the powers of the arbitrator shall be as follows:
(a) To direct the concerned parties to appear before him/her to submit documents, and record their
statements as required.
(b) To record statements of the witness.
(c) To appoint expert and seek their opinion or cause examination on any specific issue.

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(d) In case party is a foreign national so that the decision pronounced by the arbitrator is not likely to be
implemented for that reason, to obtain a bank guarantee or any other appropriate guarantee as
determined by the arbitrator.
(e) To inspect the concerned place, object, product, structure, production process or any other related
matter which are connected with the dispute on the request of the parties or on his/her own initiative
if he/she so deems appropriate, and in case there is any material or object which is likely to be
destroyed or damaged, to sell them in consultation with the parties, and keep the sale proceeds as a
deposit.
(f) To exercise any specific power conferred by the parties.
(g) To issue preliminary orders, or interim or inter locating orders in respect to any matter connected
with the dispute on the request of any party, or take a conditional decision.
(h) To issue certified copy of document.
(i) To exercise the other power conferred by this Act.

BANKING OFFENSE AND PUNISHMENT ACT, 2064

Answer to Question no 19
Section 2(g) of Banking Offense and Punishment Act, 2064 defines ‘Dhukuti Transaction’ means
transaction of raising fund from each other and taking or providing loan on rotation basis on the basis of
agreement. Section 14A of the Act provides that no one shall carry or caused to be carried out ‘Dhukuti
transactions’.

If anyone commits any offense of ‘Dhukuti Transactions’ he/she shall be punished with fine and
imprisonment as stipulated on the basis of the claimed amount, after recovering the claimed amount, if
any and depending upon the degree of the offense committed:
Claim Amount Imprisonment Fine Compensation
Upto 50 lakhs Up to 1-3 year As per claim Amount As per claim amount
50 -500 lakhs 3- 5 years As per claim Amount As per claim amount
5 -50 crore 5-7 years As per claim Amount As per claim amount
Above 50 crore 7-9 years As per claim Amount As per claim amount

ACT RELATING TO INSTITUTIONS ACTING AS FINANCIAL INTERMEDIARY, 2055

Answer to Question no 20

Section 33A of Act Relating to Institutions Acting as Financial Intermediary, 2055 has laid down the
following provisions relating to merger of financial intermediary institution:
- Notwithstanding anything contained in the Associations Registration Act, 2034 (1977), if two-
thirds members of the number of members present at the general meeting of the institution
carrying out the act of financial intermediation pursuant to this Act support a proposal to merge
another institution to it or be merged to another institution, the proposal shall be deemed to have
been passed by the general meeting. Provided that, no proposal may be passed in a manner to
merge or be merged to any institution that has not carried out the act of financial intermediation.

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- The proposal passed above shall be submitted to the office registering the institution to be merged
and come into force only when separate approval is received from that office and the Bank.
- After the receipt of such approval, the legal identity of such an institution shall be deemed to have
ipso facto lapsed.
- The properties of the institution to be merged above shall be transferred to the merging institution,
and the merging institution shall bear all liabilities of that institution.

FOREIGN EXCHANGE (REGULATION) ACT, 2019 (1962)

Answer to Question no 21

Section 9B of Foreign Exchange (Regulation) Act, 2019 states the activities not to be carried out by the
exporter. Likewise, the Act prohibits the following activities:
(a) To receive payment for the exported goods through other mode except as prescribed,
(b) To arrange the payment for the exported goods delayed than the period as prescribed,
(c) To do any act in order not to receive payment for total value of the exported goods,
(d) To do any act defying real invoicing or any other act pertaining to such an act.

Thus, by inferring the above provisions, making arrangements by Green Apparels Limited to receive the
payments from White Company Limited for the garments exported after a month than that of the
prescribed time limit is not justified. It shall be liable for punishment under the Act.

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Paper 5: Management Information and Control System

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Revision Questions:

Organizational Management and Information System

Question No 1
A small grocery store chain owner in the Satdobato area is having difficulties getting certain products
into the market while other products seem to be sitting on the shelves. In addition, he has had
discrepancies in meat prices changing day-to-day without receiving updates. You are hire as a
consultant advised on the information system for the effective decision making process. Describe the
main prerequisite of effective management information system with makes it an effective tool.

Types of Information System

Question No 2:
Define the term “Information”. Discuss the various important characteristic that are required for useful
and effective information.

Question No 3
What do you mean decision support systems (DSS)? What are the commonly used mathematical and
statistical models of decision support systems?

Question No 4
Explain the characteristics of strategic information needed to make decisions for strategic planning and
tactical information needed to make decisions at an operational level of a business organization.

System Development Life Cycle- Acquisition, Development, Implementation, Maintenance and

support
Question No 5
Joint Application Development and Rapid Application Development are two application development
methodologies. Briefly explain the phases of the two methodologies.

Question No 6
An information system is being developed to automate all the student records, their marks, results
processing and administration details of an institute which has over 2000 students at any given moment.
The system has just been develop and has not been tested for its objective. Briefly describe the types of
System Testing that can be applied for the newly developed information system.

Question No 7
What is Software Development Life Cycle and explain the different phases of software development life
cycle.

E-Commerce and Inter organizational Systems

Question No 8
M-commerce is a term that is used to refer to the growing practice of conducting financial and
promotional activities with the use of a wireless handheld device.What do you mean by e- commerce?
State its various features. Explain the application of e-commerce in supply chain management and
customer relationship management.

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Question No 9
Explain Enterprise Resource Planning? Briefly describe its benefits and limitation

Question No 10
AB and Limited want to implement SAP in the organization while it has been using another ERP
presently. What are the consideration which AB limited needs to keep in consideration while switchover
to SAP?

Question No 11
There is an increased tendency for companies to adopt e-commerce to carry out business. A company
cannot simply succeed in its business by adopting e-commerce, unless an effective strategy for e-
commerce is established. List and explain briefly the key areas/steps that need to be considered for an e-
commerce strategy.

Question No 12
Outsourcing has been practiced by many business organizations today as they want to focus on their core
business. Outsourcing is the contracting out of specified operations or services to an external party.
Discuss briefly the benefits and drawbacks of outsourcing

Protection of Information Assets

Question No 13
Adequate controls should be built into Computerized Processing. These controls can be classified as (i)
Data Security Controls (ii) Integrity Controls, and (iii) Contingency Controls.
Briefly explain the Data Security Controls and List and explain the Data Security Controls relating to
Input, output and processing functions.

Question No 14
Most household personal computers are now connected to the Internet and to local area networks
facilitating on-line ordering and payments for goods and services. In addition to the private sector, the
government too has embarked on many projects popularizing on-line government services / payments
such as eTDS, eVAT, ePayment. Success of these projects will also depend on the protection available to
the users from computer viruses, other malware, abuses, misuses, crimes and frauds.
In this context explain briefly with example
• Impact of Virus attacks; and
• Briefly explain how a computer system can be protected against virus infection.

Disaster Recovery and Business Continuity Planning

Question No 15
One of the main concerns of the top management is to have a proper disaster recovery plan when
organization goes online in the future. In the recent history, many organizations have faced natural
disasters and man-made disasters. Therefore, the top management is very concerned about having a
proper disaster recovery plan in place. Briefly explain the types of disaster recovery plan

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Auditing and Information System

Question No 16
You have been appointed as the IS Auditor of a Company. Can you please explain the different
steps involved in the conduct of your Information System Audit.

Question No 17
What are the ways in which remote and distributed data processing applications can be controlled in
relation to issues and revelations related to logical access?

Question No 18
As an IS Auditor, what are the key areas you would verify during review of BCM
arrangement of an Enterprise?

Question No 19
You are appointed as a information system auditor of the construction company. Which aspects of
environmental controls should be physically inspected by an information system auditor, while
auditing environmental controls of construction company.

Question No 20
Define the Information Systems Auditing and its objective of auditing information system

Question No 21
Explain the scope of Information System Audit

Electronic Transactions Act, 2063

Question No 22
Discuss the Offence Relating To Computer under section 44 of Electronic Transaction Act 2063

Question No 23
Describe the Powers of the Controller in respect of section 5 of Electronic Transaction Act 2063

Question No 24

Explain the Functions, Duties and Rights of Subscriber as per Electronic Transaction Act 2063

Question No 25
Write short notes on the following:
a. Benefits of Expert System
b. Inherent limitations of IS Audit
c. Role of IS Auditor in Physical Access Control
d. Encryption
e. Call Back Devices
f. Recording of Transaction Log

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Suggested Answers/Hints:

Answer No 1
The following are the main pre-requisites of an effective MIS, which make it an effective tool:
• Qualified System and Management Staff: MIS should be handled by qualified officers.
These officers who are experts in the field should understand clearly the views of their fellow
officers. The organizational management base should comprise of two categories of officers
(i) System and Computer experts and
(ii) Management experts.
Management experts who should also understand quite-clearly the concepts and operations of a
computer should be placed for the design of information system. This basic knowledge of computer
will place them in a comfortable position, while working with systems, technicians in designing or
otherwise, of the information system. Their whole hearted support and cooperation helps in
making MIS an effective tool.

• Support of Top Management: An MIS becomes effective only if it receives the full support of
top management. To gain the support of top management, the officer should place all the
supporting facts before them and state clearly the benefits, which will accrue from it to the
concern. This step certainly enlightens the management and changes their attitude towards MIS.

• Control and Maintenance of MIS: Control of the MIS means the operation of the system as it
was designed to operate. Sometimes, users develop their own procedures or shortcut methods to
use the system, which reduces its effectiveness.
• To check such habits of users, the management at each level in the organization
should device checks for the information system control.
• Maintenance is closely related to control. There are times when the need for
improvement to the system will be discovered. Formal methods for changing and
documenting changes must be provided.

• Evaluation of MIS: An effective MIS should be capable of meeting the information

requirements of its executives in future as well. The capability can be maintained by evaluating
the MIS and taking appropriate timely action. The evaluation of MIS should take into account
the following points:
• Examining the flexibility to cope with future requirements;
• Ascertaining the view of the users and designers about the capabilities and
deficiencies of the system ; and
• Guiding the appropriate authority about the steps to be taken to maintain
effectiveness of MIS.

• Common Database : It is an integrated collection of data and information which is utilized by

several information subsystems of an organization. A common database may be defined as a super
file which consolidates and integrates data records formerly stored in a separate data file. Such a
database can be organized as an integrated collection of data records into a single super file or it can
be organized as an integrated collection of several data file.

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Answer No 2
In MIS, information has a precise meaning and it is different from data. The information has a value in
decision making while data does not have. Information brings clarity and creates an intelligent human
response in the mind. In MIS a clear distinction is made between data and information. Data is like raw
materials while the information is equivalent to the finished goods produced after processing the raw
material. Information has certain characteristics.

These are: Information

♣ Improves representation of an entity
♣ Updates the level of knowledge.
♣ Has a surprise value.
♣ Reduces uncertainty.
♣ Aids in decision making.

The quality of information could be called good or bad depending on the mix of these characteristics.
Devis and Olson defines “Information as a data that has been processed into a form that is meaningful to
the recipient and is of real or perceived value in the current or the prospective actions or decisions of the
recipient”.

Data is defined as groups of non-random symbols in the form of text, images or voice representing
quantities, actions and objects. Whether an entity is a data or information, it must be transferred through
communication from the source to the destination without loss of content. The data may be collected in
the best possible manner and processed analytically, bringing lot of value in the information; however, if
it is not presented properly, it may fail to communicate anything of value to the receiver. The degree of
communication is affected by the methods of transmission, the manner of information handling and the
limitations and constraints of a receiver as the information processor and the organization as the
information user.

The methods used for improving communication of information are summarization and message routing.
The concept of summarization is used to provide information which is needed in the form and content.
The principle behind summarization is that too much information causes noises and distortions, i.e.,
confusion, misunderstanding and missing the purpose. The summarization suppresses the noise and the
distortions.

Another method of improving the degree of communication is through message routing. The principle
here is to distribute information to all those who are accountable for the subsequent actions or decisions in
any manner. That is if the information is generated with a certain purpose for a primary user, then such
information may have secondary purposes to some other users in the organization. This is achieved by
sending the copies of the reports or documents to all the concerned people or users. The principle of the
message routing achieves the spread of information to the appropriate quarters

The parameters of a good quality are difficult to determine, however, the information can be termed as of
a good quality if it meets the norms of impartiality, validity, reliability, consistency and age. The quality
of information has another dimension of utility from the user.s point of view. The users being many, this
is difficult to control. Therefore, if one can develop information with due regards to these parameters, one

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can easily control the outgoing quality of the information with the probable exception of the satisfaction
at the users end. Following are the essential characteristic features :

(i) Timeliness : Timeliness means that information must reach the recipients within the prescribed
timeframes. For effective decision-making, information must reach the decision-maker at the
right time, i.e. recipients must get information when they need it. Delays destroys the value of
information. The characteristic of timeliness, to be effective, should also include up-to-date, i.e.
current information.

(ii) Accuracy : Information should be accurate. It means that information should be free from
mistakes, errors &, clear Accuracy also means that the information is free from bias. Wrong
information given to management would result in wrong decisions. As managers decisions are
based on the information supplied in MIS reports, all managers need accurate information.

(iii) Relevance : Information is said to be relevant if it answers especially for the recipient what, why,
where, when, who and why? In other words, the MIS should serve reports to managers which is
useful and the information helps them to make decisions..

(iv) Adequacy : Adequacy means information must be sufficient in quantity, i.e. MIS must provide
reports containing information which is required in the deciding processes of decision-making.
The report should not give inadequate or for that matter, more than adequate information, which
may create a difficult situation for the decision-maker. Whereas inadequacy of information leads
to crises, information overload results in chaos.

(v) Completeness : The information which is given to a manager must be complete and should meet
all his needs. Incomplete information may result in wrong decisions and thus may prove costly to
the organization.

(vi) Explicitness : A report is said to be of good quality if it does not require further analysis by the
recipients for decision making.

(vii) Impartiality: Impartial information contains no bias and has been collected without any distorted
view of the situation. The partiality creeps in, if the data is collected with a preconceived view, a
prejudice, and a pre-determined objective or a certain motive.

(viii) Validity: The validity of the information relates to the purpose of the information. In other
words, it is the answer to the question-dose the information meet the purpose of decision making
for which it is being collected? The validity also depends on how the information is used. Since
the information and the purpose need not have one to one correspondence, the tendency to use it
in a particular situation may make the information invalid. For example, if the quality of the
manufactured product is deteriorating and it is decided to select the causes of poor quality, then

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one must collect all the possible causes which may affect the quality. Quality is a function of the
raw material, the process of manufacture, the tools applied, the measures of the quality
assessment, the attitude of the people towards the control of quality. However, if the information
collected talks only about raw materials and the process of manufacture, then this information is
not sufficient and hence it is not valid for all the decisions which are required to control the
quality.

(ix) Reliability: It is connected to the representation and the accuracy of what is being described. For
example, if the organization collects the information on the product acceptance in the selected
market segment, the size of the sample and the method of selection of the sample will decide the
reliability. If the sample is small, the information may not give the correct and a complete picture
and hence it is not reliable. The reliability is also affected from the right source.

(x) Consistency: The information is termed as inconsistent if it is derived form a data which dose not
have a consistent pattern of period. Somewhere, the information must relate to a consistent base
or a pattern. For example, you have collected the information on the quantity of production for
the last twelve months to fix the production norms. If in this twelve months period, the factory
has worked with variable shift production, the production statistics of the twelve months for
comparison is inconsistent due to per shift production. The consistency can be brought in by
rationalizing the data to per shift production per month. The regularity in providing the
information also helps in assessing the consistency in the information.

(xi) Age: If the information is old, it is not useful today. The currency of the information makes all
the difference to the users. If the information is old then it does not meet any characteristics of
the information viz., the update of knowledge, the element of surprise and the reduction of
uncertainty, and the representation. Maintaining these parameters at a high degree always poses a
number of problems. These problems are in the management of the operations, the sources, the
data processing and the systems in the organization. A failure to maintain the parameters to a
high degree affects the value of the information to the decision maker

Answer No 3
The term DSS refers to a class of systems, which supports the process of making decisions. The Emphasis
is on “support” rather than on automation of decision. DSS allow the decision maker to retrieve data and
test alternative solutions during the process of problem solving.
According to Scott Morton, “DSS as interactive computer based systems, which help decision makers
utilize data and model to solve unstructured problems”.

Decision support systems are created to help people make decisions by providing access to information
and analysis tools, it’s a way to model data and make quality decisions based upon it. Decision support
systems constitute a class of computer-based information systems including knowledge based systems
that support decision making activities. Making the right decision in business is usually based on the data
quality and the ability to sift through and analyze the data to find trends that can create solutions and
strategies. DSS are interactive computer based systems and subsystems intended to help decision makers

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use communications technologies, data, documents, knowledge and models to complete decision process
tasks. A decision support system may present information graphically and may include an expert system
or artificial intelligence. Typical information that a decision support application might gather and present
would be: accessing all information assets, including legacy and relational data sources, comparative data
figures, projected figures based on new data or assumptions, consequences of different decision
alternatives, given past experience in a specific context.

While most companies have actually integrated this system into their day to day operating activities.
Many companies constantly download and analyze sales data, budget sheets and forecasts and they update
their strategy once they analyze and evaluate the current results. The solution to decision support systems
is to gather data, analyze and shape the data that is collected and then try to make sound decisions or
construct strategies from analysis. Decision support applications that just collect data and organize it
effectively are usually called passive models, they do not suggest a specific decision and they only reveal
data. On the other hand, an active decision support system actually processes data and explicitly shows
solutions based upon that data. A cooperative decision support system is when data is collected, analyzed
and then is provided to a human component which can help the system revise or refine it. It means that
both a human component and computer component work together to come up with the best solution.

Some of the commonly used mathematical and statistical models are as follows:-
• Statistical Models: They contain a wide range of statistical functions, such as mean, median, mode,
deviations etc. These models are used to establish, relationships between the occurrences of an event and
various factors related to that event. It can, for example, relate sale of product to differences in area,
income, season, or other factors. In addition to statistical functions, they contain software that can analyze
series of data to project future outcomes.

• Sensitivity Analysis Models: These are used to provide answers to what-if situations occurring
frequently in an organization. During the analysis, the value of one variable is changed repeatedly and
resulting changes on other variables are observed. The sale of product, for example, is affected by
different factors such as price, expenses on advertisements, number of sales staff, productions etc. Using a
sensitivity model, price of the product can be changed (increased or decreased) repeatedly to ascertain the
sensitivity of different factors and their effect on sales volume. Excel spreadsheets and Lotus 1-2-3 are
often used for making such analysis.

• Optimization Analysis Models: They are used to find optimum value for a target variable under given
circumstances. They are widely used for making decisions related to optimum utilization of resources in
an organization. During optimization analysis, the values for one or more variables are changed
repeatedly keeping in mind the specific constraints, until the best values for target variable are found.
They can, for example, determine the highest level of production that can be achieved by varying job
assignments to workers, keeping in mind that some workers are skilled and their job assignment cannot be
changed. Linear programming techniques and Solver tool in Microsoft excel are mostly used for making
such analysis.
• Forecasting Models: They use various forecasting tools and techniques, including the regression
models, time series analysis, and market research methods etc., to make statements about the future or to
predict something in advance. They provide information that helps in analyzing the business conditions
and making future plans. These systems are widely used for forecasting sales.

• Backward Analysis Sensitivity Models: Also known as goal seeking analysis, the technique followed in
these models is just opposite to the technique applied in sensitivity analysis models. In place of changing
the value of variable repeatedly to see how it affects other variables, goal seeking analysis sets a target
value for a variable and then repeatedly changes other variables until the target value is achieved. To

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increase the production level by 40 percent using the backward sensitivity analysis, for example, first, the
target value for the production level can be set and then the required changes to made in other factors,
such as the amount of raw material, machinery and tools, number of production staff, etc., to achieve the
target production level.

Answer No 4
Characteristics of Information required for Strategic Planning
(i) Ad hoc Basis: The information may be produced either regularly or periodically. For example,
top management uses periodic accounting system reports such as the income statement, balance
sheet, statement of sources and uses of funds, and capital statements in its planning functions.
However, strategic planning information is more often produced when it is needed, on an ad hoc
basis.

(ii) Unexpected Information: The information produced by the system may not be the same that was
anticipated. For example, economic forecast information may be requested for the economy as a
whole and for the industry in particular. The result of the economic forecast may be a surprise to
the organization planners.

(iii) Predicted nature: The information produced is usually predictive of the future events rather than
descriptive of past events. Long range planners try to set a course for an organization through an
uncharted future. Theirprimary task is to choose a route that will improve the organization’s level
of success.

(iv) Summary Form: The information produced is usually not detailed but in summary form. Long
range planners are not usually interested in detailed information; they are concerned with more
global data. For example strategic planners may not be interested in the customer invoices but
overall buying trends for their product vis-à-vis the product of the competitors.

(v) External Data: A large part of data used for input to the system is acquired from the external
sources. To mention, rate of borrowed capital, investment opportunities, demographic
characteristics of a market group, and economic conditions etc. and the example of this type of
information.
(vi) Unstructured format: The data used for input to the system may contain data that are
unstructured in format.For example: forecasts of future stock market trends may be using the
opinions of stock buyers, sales people,or market analysts obtained in casual conversations.

(vii) Subjectivity: The input to the system may be highly subjective in nature.

Characteristics of Information required for Tactical Planning

1. Predictive Nature: The information from a tactical system is sometimes produced periodically.
For example,a branch credit manager for an organization may receive a weekly report showing
the total dollar amount of accounts that are more than 60 days overdue, 90 days overdue, and in
hands of a collection agency. The report might compare the three amounts with the same data
from other branches of the organization. The same data can be compared for different time

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periods may be this year and last two years to see the trends. Based on this information, credit
manager can decide whether the overdue account totals are within the normal range for the
branch or whether the difference between the amounts warrants special managerial action or
decisions. Thus, this information system provides the means by which the credit manager can
quickly identify problems and bring them under control. On the other hand, tactical information
systems can produce information when it is needed on ad hoc basis.

2. Unexpected Findings: The information provided by a tactical information system may not be the
information that was expected to be produced. For example: querying an accounting system
database, a manger can find the characteristics of major customer related to credit difficulty. It
may have relation with customer position and type of employer. Investigation may reveal that
overdue problem is with those customers whose employer had a cut in its workforce. The
unemployment of these customers is creating an overdue problem. As a credit agency, it has to
analyze the purchasing of these customers as a fresh.

3. Comparative Nature: The information produced is usually comparative in nature rather than
merely descriptive. They provide managers with information that alerts them to major variation
from the accepted standards. These types of information systems are similar to the control
process systems that monitor output of the system continuously and provide feedback when
output parameters are at variance with accepted standards.

4. Summary Form: The information produced is not detailed but is in summary form, however, in
comparison to the strategic planning systems, it may be more elaborate. For example: a credit
manager is not interested in a detailed listing of each customer account and its balance. In large
organizations, there would be an enormous quantity of data and would not, therefore, be
information to the manager. The manager needs information relating to credit performance or
balances of accounts that are overdue or in collection.

5. Both External and Internal Sources: The data used, as input to the system may not always
confine to sources internal to the organization. It may be from external sources also. For example:
the credit manager may compare the information pertaining to problems to other branches, to
other periods from the same organization, or to a goal set up by top management. The credit
manager may like to compare sometimes it with the experience of the whole industry.

Answer No 5
Joint application development (JAD) is a process originally meant for the development of computer
systems, but it can be applicable to other types of development also. It is an approach of ensuring
accuracy between project scope definition and delivery through continuous collaboration with the
stakeholders. These interactions between stakeholders form the core of Joint application development
process and lifecycle. It is a modern means of collecting and analysing software requirements that are
discussed on series of meetings and workshops between business and the technical teams.
Joint application development is more prevalent in agile delivery environments in which software
products are developed in short cycles based on agreements between the commercial and technical
stakeholders on minimum viable product. In other words, anytime there is a need for business

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representatives and the technology teams to deliberate and develop synergy on issues around product
development or testing requirements, Joint application development session becomes necessary.
Joint application development approach is to allow project executives and the representatives of the
customer to identify and appoint a trained facilitator whose role is to support project delivery. While the
facilitator helps in driving the projects, key decisions have to be taken by the executive sponsors. Other
key stakeholders include the subject matter expert who are responsible for turning customer's
requirements into technology-powered solution, and the documentation expert whose role is to clarify
the points of discussions and to document them effectively during the Joint application development
sessions. The facilitator serve as the central link between different stakeholders for the purpose of
initializing and driving the Joint application development workshops and sessions.
Planning/Definition
Planning and Definition can be combined if the scope of the project is small. The deliverables from the
Definition stage can be completed by conducting a JAD session with high level managers. It is possible to
have a Finalization phase after Planning and Definition that sells the business and leads to the Planning
stage of the actual project.

To complete the Planning stage, following tasks need to be perform:

• Designate the executive sponsor.
• Establish the need for the system.
• Select team members for the definition component.
• Define the scope of the session.

The starting point for any Joint application development process is the designation of an executive
sponsor. During the Planning phase, the facilitator should be working closely with this sponsor to provide
an orientation to the Joint application development process and Joint application development
environment. The executive sponsor's full commitment to the project is critical to its success.

After an executive sponsor is identified, the next task is to establish the need for the system by asking the
following questions:
• What are the expected benefits?
• What opportunities does it address?
• What problems would it resolve?
• What are the risks?
• How does it fit in with the strategic direction of the organization?
If it is determined that the project should be undertaken, the executive sponsor and facilitator select the
team members who will participate in the Definition phase.

Preparation
To complete the preparation stage, following tasks need to be perform:
• ·Schedule design sessions.
• ·Conduct orientation and training for design session participants.
• ·Prepare the materials, room, and software aids.
• ·Customize the design session agenda.
• ·Conduct the kickoff meeting.
After the scope is set, the design sessions are scheduled and the participating team members are
informed. In most cases, a particular technique or methodology will be followed in the JAD sessions. To
ensure participation, the customer must be educated in the terminology that will be used and the
deliverables that will be created in the JAD sessions. Other preparation tasks include preparing the room
with the proper equipment (PC, workstation, overhead projector, flip charts, markers, white boards, and

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so forth), obtaining any software aids, and preparing the reference materials and definition documentation
that will be referenced throughout the design sessions. An agenda is also prepared so that the objectives
for each design session are clearly stated and the participants can stay focused on the work to be done.

The final Preparation step is the final meeting, at which the executive sponsor addresses the team
members and shows support for the JAD effort. This meeting is a key component of JAD. In
organizations using JAD for the first time, the meeting will minimize resistance within the customer's
organization and kindle a spirit of teamwork. A high level explanation of the JAD process is given,
preferably by the executive sponsor. If the sponsor is uncomfortable doing this, the facilitator can present
the orientation. The goals of the project are stated and everyone is made to feel a part of the process.
Initial concerns are expressed, and the executive sponsor works to ease any fears. The executive sponsor
also gives a personal statement of support for the facilitator.

A successful orientation is key to starting off the JAD process on a good footing. Everyone should leave
with a sense of pride in what is going to happen and with confidence that they will be performing a highly
valued service for the company.

Design Sessions
To complete the Design Session component of JAD, the following tasks need to be perform:
• Review the project scope, objectives, and definition document.
• Identify data, process, and system requirements.
• Identify system interfaces.
• Develop a prototype.
• ·Document decisions, issues, assumptions, and definitions of terms.
• ·Assign someone to resolve all issues.

The session objectives determine which techniques are used in the design session and what deliverables
are created. A good starting point, however, is to review the definition document that was prepared during
the definition phase. This document outlines the project's scope, expected benefits, and high?level
requirements.

The facilitator should frequently review the session goals and objectives, and report on how the session's
progress relates to the overall project. The facilitator should also designate a person who will be
responsible for resolving each issue or concern documented during the session. A resolution date must
also be assigned. Subsequent design sessions can then begin with a discussion of any issues that have
been resolved

Finalization
To complete the Finalization component, the following tasks need to be perform
• Complete the design documents.
• Sign off on the design documents.
• Make a presentation to the executive sponsor.
• Demonstrate the prototype.
• Obtain the executive sponsor's approval to proceed.
• Evaluate the JAD process.

The first goal of the Finalization component is to obtain closure on the deliverables by reaching a team
consensus that all necessary elements have been incorporated to fit the project's scope. The second goal is
to produce a high quality presentation that includes a prototype demonstration (if appropriate). The third
goal is to prepare a document that includes all of the deliverables that will be referenced in the future

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development effort. The presentation and prototype demonstration should be given to the executive
sponsor, as well as to other leaders. The goal is to get approval to proceed to the next stage of
development. The team members, executive sponsor, and facilitator should also take some time to
evaluate the effectiveness of the JAD process and to discuss ways to improve that process for future use.

The Rapid Application Development model is based on prototyping and iterative development with no
specific planning involved. The process of writing the software itself involves the planning required for
developing the product. Rapid Application Development focuses on gathering customer requirements
through workshops or focus groups, early testing of the prototypes by the customer using iterative
concept, reuse of the existing prototypes (components), continuous integration and rapid delivery.
Rapid application development is a software development methodology that uses minimal planning in
favor of rapid prototyping. A prototype is a working model that is functionally equivalent to a
component of the product.
In the Rapid Application Development model, the functional modules are developed in parallel as
prototypes and are integrated to make the complete product for faster product delivery. Since there is no
detailed preplanning, it makes it easier to incorporate the changes within the development process.
Rapid Application Development projects follow iterative and incremental model and have small teams
comprising of developers, domain experts, customer representatives and other IT resources working
progressively on their component or prototype.
The most important aspect for this model to be successful is to make sure that the prototypes developed
are reusable. Following are the various phases of the Rapid Application Development Model
Business Modeling
The business model for the product under development is designed in terms of flow of information and
the distribution of information between various business channels. A complete business analysis is
performed to find the vital information for business, how it can be obtained, how and when is the
information processed and what are the factors driving successful flow of information.

Data Modeling
The information gathered in the Business Modeling phase is reviewed and analyzed to form sets of data
objects vital for the business. The attributes of all data sets is identified and defined. The relation
between these data objects are established and defined in detail in relevance to the business model.
Process Modeling
The data object sets defined in the Data Modeling phase are converted to establish the business
information flow needed to achieve specific business objectives as per the business model. The process
model for any changes or enhancements to the data object sets is defined in this phase. Process
descriptions for adding, deleting, retrieving or modifying a data object are given.
Application Generation
The actual system is built and coding is done by using automation tools to convert process and data
models into actual prototypes.

Testing and Turnover

The overall testing time is reduced in the RAD model as the prototypes are independently tested during
every iteration. However, the data flow and the interfaces between all the components need to be
thoroughly tested with complete test coverage. Since most of the programming components have already
been tested, it reduces the risk of any major issues.

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Answer No 6
Software testing is the main activity of evaluating and executing software with a view to find out errors. It
is the process where the system requirements and system components are exercised and evaluated
manually or by using automation tools to find out whether the system is satisfying the specified
requirements and the differences between expected and actual results are determined
Different types of System Testing are as follows:
• Recovery Testing:
This is the activity of testing ‘how well the application is able to recover from crashes, hardware
failures and other similar problems’. Recovery testing is the forced failure of the software in a
variety of ways to verify that recovery is liable to be properly performed, in actual failures.
• Security Testing:
This is the process to determine that an Information System protects data and maintains
functionality as intended or not. The six basic security concepts that need to be covered by security
testing are – Confidentiality, Integrity, Availability, Authentication, Authorization and Non-
repudiation. This testing technique also ensures the existence and proper execution of access
controls in the new system.
As per the current scenarios timing and buffer overflow attacks are most common. In object
oriented systems, design level problems include error , sharing and trust issues, unprotected data
channels, incorrect or missing access control mechanisms, lack of auditing, incorrect logging and
timings and ordering errors also lead to security risks. The software is required to test for the
security features like strong authentication, cryptography and access control and some other
security mechanisms. Vulnerability is an error that an attacker can exploit. Security testing of
software is important as to protect the information, services, skills and resources of adversaries and
the cost of potential assurance remedies
Security testing basically follows two types of approaches:
a. Testing software regarding software’s functional mechanisms
b. Performing risk based approach according to attackers mindset.
Penetration Testing is a security testing in which evaluators attempt to circumvent the security
features of a system based on their understanding of the system design and implementation. Also a
other type which is Fuzz Testing was given by Barton Miller, university of Wisconsin in 1988. It is
software testing technique in which automatically invalid, random and unexpected data to the
software is given to find out the reaction of software. It is good for testing that software where
inputs have no control over the predefined data. This testing technique is only used to find only the
simple features of the software but not the complex software code.

• Performance Testing:

In the computer industry, software performance testing is used to determine the speed or effectiveness of
a computer, network, software program or device. This testing technique compares the new system's
performance with that of similar systems using well defined benchmarks. This is one of a non-functional
testing types which test performance of software under all favorable and nonfavorable conditions.
Performance Testing is defined as a type of software testing to ensure software applications will perform
well under their expected workload. Features and functionality supported by a software system is not the
only concern. A software application's performance like its response time, reliability, resource usage and
scalability do matter. The goal of Performance Testing is not to find bugs but to eliminate performance
bottlenecks. The focus of Performance Testing is checking a software program's

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• Speed - Determines whether the application responds quickly

• Scalability - Determines maximum user load the software application can handle.
• Stability - Determines if the application is stable under varying loads

Performance Testing is done to provide stakeholders with information about their application regarding
speed, stability, and scalability. More importantly, Performance Testing uncovers what needs to be
improved before the product goes to market. Without Performance Testing, software is likely to suffer
from issues such as: running slow while several users use it simultaneously, inconsistencies across
different operating systems and poor usability.

Performance testing will determine whether their software meets speed, scalability and stability
requirements under expected workloads. Applications sent to market with poor performance metrics due
to nonexistent or poor performance testing are likely to gain a bad reputation and fail to meet expected
sales goals.

Also, mission-critical applications like space launch programs or life-saving medical equipment should be
performance tested to ensure that they run for a long period without deviations.

Types of Performance Testing

• Load testing - checks the application's ability to perform under anticipated user loads. The
objective is to identify performance bottlenecks before the software application goes live.
Load testing is a kind of Performance Testing which determines a system's performance
under real-life load conditions. This testing helps determine how the application behaves
when multiple users access it simultaneously. This testing usually identifies -
o The maximum operating capacity of an application
o Determine whether the current infrastructure is sufficient to run the application
o Sustainability of application with respect to peak user load
o Number of concurrent users that an application can support, and scalability to allow more
users to access it.
It is a type of non-functional testing. In Software Engineering, Load testing is commonly
used for the Client/Server, Web-based applications - both Intranet and Internet. Loading
testing identifies the following problems before moving the application to market or
Production
• Response time for each transaction
• Performance of System components under various loads
• Performance of Database components under different loads
• Network delay between the client and the server
• Software design issues
• Server configuration issues like a Web server, application server, database server etc.
• Hardware limitation issues like CPU maximization, memory limitations, network bottleneck,
etc.

Load testing will determine whether the system needs to be fine-tuned or modification of
hardware and software is required to improve performance.

• Stress testing - involves testing an application under extreme workloads to see how it
handles high traffic or data processing. The objective is to identify the breaking point of an
application. Stress or Volume Testing: Stress testing is a form of testing that is used to

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determine the stability of a given system or entity. It involves testing beyond normal
operational capacity, often to a breaking point, in order to observe the results. Stress testing
may be performed by testing the application with large quantity of data during peak hours to
test its performance. Stress testing is performed to find and understand the upper limits of
capacity within the system. Extreme load is given to the application to determine the
robustness of the system.

• Endurance testing - is done to make sure the software can handle the expected load over a
long period of time. Soak testing is also performed which is called as endurance testing. This
testing is done to determine if the system can sustain the continuous expected load. Potential
leaks are detected by monitoring the memory utilization. Soak testing ensures that the
throughput and response time after some long period of sustained activity are as good as or
better than at the beginning of the test. The main goal of performing soak test is to discover
the system behavior under its sustained use. Mean Time To Repair (MTTR) and Mean Time
Between Failures (MTBF) are calculated for the system efficiency and robustness.

• Spike testing - tests the software's reaction to sudden large spikes in the load generated by
users. Spike testing is done by suddenly increasing the number of users or load generated by
users by a very large amount and observing the behavior of the system. Mainly tools are
used to test performance of software, as it is very difficult to test the load manually. There
are lots of freeware tools like Soap UI and Jmeter used to test performance of software. The
most popular tool used to test performance of software is Load runner tool and there are
various IBM tools also available to test the performance of software . Most of the recent
failure occurred in software industry are due to lack of performance testing

• Volume testing - Under Volume Testing large no. of. Data is populated in a database and
the overall software system's behavior is monitored. The objective is to check software
application's performance under varying database volumes.

• Scalability testing - The objective of scalability testing is to determine the software

application's effectiveness in "scaling up" to support an increase in user load. It helps plan
capacity addition to your software system.

Most performance problems revolve around speed, response time, load time and poor scalability. Speed is
often one of the most important attributes of an application. A slow running application will lose potential
users. Performance testing is done to make sure an app runs fast enough to keep a user's attention and
interest. Take a look at the following list of common performance problems and notice how speed is a
common factor in many of them:

• Long Load time - Load time is normally the initial time it takes an application to start. This
should generally be kept to a minimum. While some applications are impossible to make load in
under a minute, Load time should be kept under a few seconds if possible.
• Poor response time - Response time is the time it takes from when a user inputs data into the
application until the application outputs a response to that input. Generally, this should be very
quick. Again if a user has to wait too long, they lose interest.
• Poor scalability - A software product suffers from poor scalability when it cannot handle the
expected number of users or when it does not accommodate a wide enough range of users. Load
Testing should be done to be certain the application can handle the anticipated number of users.

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• Bottlenecking - Bottlenecks are obstructions in a system which degrade overall system

performance. Bottlenecking is when either coding errors or hardware issues cause a decrease of
throughput under certain loads. Bottlenecking is often caused by one faulty section of code. The
key to fixing a bottlenecking issue is to find the section of code that is causing the slowdown and
try to fix it there. Bottlenecking is generally fixed by either fixing poor running processes or
adding additional Hardware. Some common performance bottlenecks are
o CPU utilization
o Memory utilization
o Network utilization
o Operating System limitations
o Disk usage

Answer No 7
The Software Development Lifecycle is a systematic process for building software that ensures the
quality and correctness of the software built. SDLC process aims to produce high-quality software which
meets customer expectations. The software development should be complete in the pre-defined time
frame and cost.

SDLC consists of a detailed plan which explains how to plan, build, and maintain specific software.
Every phase of the SDLC lifecycle has its own process and deliverables that feed into the next phase.

• It offers a basis for project planning, scheduling, and estimating

• Provides a framework for a standard set of activities and deliverables
• It is a mechanism for project tracking and control
• Increases visibility of project planning to all involved stakeholders of the development process
• Increased and enhance development speed
• Improved client relations
• Helps you to decrease project risk and project management plan overhead

The entire SDLC process divided into the following stages:

• Phase 1: Requirement collection and analysis

• Phase 2: Feasibility study:
• Phase 3: Design:
• Phase 4: Coding:
• Phase 5: Testing:
• Phase 6: Installation/Deployment:
• Phase 7: Maintenance:

In this tutorial, I have explained all these phases

Phase 1: Requirement collection and analysis:

The requirement is the first stage in the SDLC process. It is conducted by the senior team members with
inputs from all the stakeholders and domain experts in the industry. Planning for the quality assurance
requirements and recognization of the risks involved is also done at this stage.

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This stage gives a clearer picture of the scope of the entire project and the anticipated issues,
opportunities, and directives which triggered the project.

Requirements Gathering stage need teams to get detailed and precise requirements. This helps companies
to finalize the necessary timeline to finish the work of that system.

Phase 2: Feasibility study:

Once the requirement analysis phase is completed the next step is to define and document software needs.
This process conducted with the help of 'Software Requirement Specification' document also known as
'SRS' document. It includes everything which should be designed and developed during the project life
cycle.

There are mainly five types of feasibilities checks:

• Economic: Can we complete the project within the budget or not?
• Legal: Can we handle this project as cyber law and other regulatory framework/compliances.
• Operation feasibility: Can we create operations which is expected by the client?
• Technical: Need to check whether the current computer system can support the software
• Schedule: Decide that the project can be completed within the given schedule or not.

Phase 3: Design:
In this third phase, the system and software design documents are prepared as per the requirement
specification document. This helps define overall system architecture. This design phase serves as input
for the next phase of the model.

There are two kinds of design documents developed in this phase:

High-Level Design (HLD)
• Brief description and name of each module
• An outline about the functionality of every module
• Interface relationship and dependencies between modules
• Database tables identified along with their key elements
• Complete architecture diagrams along with technology details

Low-Level Design (LLD)

• Functional logic of the modules
• Database tables, which include type and size
• Complete detail of the interface
• Addresses all types of dependency issues
• Listing of error messages
• Complete input and outputs for every module

Phase 4: Coding:

Once the system design phase is over, the next phase is coding. In this phase, developers start build the
entire system by writing code using the chosen programming language. In the coding phase, tasks are
divided into units or modules and assigned to the various developers. It is the longest phase of the
Software Development Life Cycle process.

In this phase, Developer needs to follow certain predefined coding guidelines. They also need to use
programming tools like compiler, interpreters, debugger to generate and implement the code.

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Phase 5: Testing:

Once the software is complete, and it is deployed in the testing environment. The testing team starts
testing the functionality of the entire system. This is done to verify that the entire application works
according to the customer requirement.

During this phase, QA and testing team may find some bugs/defects which they communicate to
developers. The development team fixes the bug and send back to QA for a re-test. This process continues
until the software is bug-free, stable, and working according to the business needs of that system.

Phase 6: Installation/Deployment:

Once the software testing phase is over and no bugs or errors left in the system then the final deployment
process starts. Based on the feedback given by the project manager, the final software is released and
checked for deployment issues if any.

Phase 7: Maintenance:

Once the system is deployed, and customers start using the developed system, following 3 activities occur

• Bug fixing - bugs are reported because of some scenarios which are not tested at all
• Upgrade - Upgrading the application to the newer versions of the Software
• Enhancement - Adding some new features into the existing software

The main focus of this SDLC phase is to ensure that needs continue to be met and that the system
continues to perform as per the specification mentioned in the first phase.

Answer No 8
M-commerce is a term that is used to refer to the growing practice of conducting financial and
promotional activities with the use of a wireless handheld device. The term m-commerce is short for
mobile commerce, and recognizes that the transactions may be conducted using cell phones, personal
digital assistants and other hand held devices that have operate with Internet access. While still in its
infancy, the concept of m-commerce has been refined in recent years and is beginning to become more
popular.

It is quite different from traditional e-Commerce. Mobile phones impose very different constraints than
desktop computers. But they also open the door to a slew of new applications and services.

They follow you wherever you go, making it possible to look for a nearby restaurant, stay in touch with
colleagues, or pay for items at a store.

Key Components of M-commerce Applications

• Mobile storefront modules are an integral part of m-commerce apps, where all commodities and
services are categorized and compiled in catalogues for customers to easily browse through the items
on sale and get essential information about the products.

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• Mobile ticketing module is an m-commerce app component that is closely linked to promotional side
of commercial business and enables vendors to attract customers by distributing vouchers, coupons
and tickets.
• Mobile advertising and marketing module empowers merchants to leverage m-commerce channels in
order to manage its direct marketing campaigns, which are reported to be very effective especially
when targeted at younger representatives of digital information consumers.
• Mobile customer support and information module is a point of reference for information about a
particular retailer, its offerings and deals. The news about the company, current discounts, shop
locations and other information is either pushed to users’ m-commerce apps or can be found in m-
commerce app itself.
• Mobile banking is inextricably linked to selling process via m-commerce apps, because no purchase
can be finalized without a payment. There are various options for executing mobile payments, among
which are direct mobile billing, payments via sms, credit card payments through a familiar mobile
web interface, and payments at physical POS terminals with NFC technology.

Characteristics of Mobile Commerce

1. Fast Processing: One important characteristic of mobile commerce is that it allows the user to process
a transaction fast. Not only does the customer receive his item almost instantly via download, e-mail or
another form of electronic delivery, the business owner receives payment for his product or service more
quickly compared to traditional methods. The customer must set up a payment option, such as a credit
card or an agreement to pay using a specified account, to process the payment immediately before
downloading the item. Of course, the speed of delivery is dependent on the reliability of the Internet and
network services.

2. Reduced Business Costs: Mobile commerce also helps reduce costs for the seller. She rarely needs to
pay for a separate office space, overhead costs or employees. In some cases a small business owner who
sets up a mobilecommerce operation doesn't need an office at all. The seller can monitor sales online or
by receiving statements froma processing service. The main expense for this type of business owner is
advertising to disseminate information onhow users can access the product or service. The lowered cost
allows the business owner to take advantage of ahigher per-sale profit. He also can offer the product at a
lower price compared to delivery in other formats.

3. Little Need for Maintenance: Another characteristic of mobile commerce is that it requires very little
maintenance from the seller. The owner sets the product up for mobile delivery one time and then
receives payment for sales automatically. From time to time, he may need to perform a few maintenance
duties, such as correcting a technology error or updating the product, but overall it is a selling format that
requires very little management compared with other selling strategies.

Future of M-commerce
The most prominent m-commerce trend is its own growth. According to Forrester,annual m-commerce
sales are predicted to quadruple to $31 billion in the next five years. In 2012, some ecommerce sites (like
Amazon) saw remarkable growth, while most businesses experienced only limited m-commerce success.
However, one thing they all have in common is that they now universally recognize m-commerce as an
important way to enhance their brand, increase their sales and keep up with competitors. In short, the
future of m-commerce is bright, and looks like it’s getting even brighter.

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Another trend in m-commerce is that customers desire more information on mobile websites. Studies
show that 80% of smart phone users want more product information when shopping on their mobile
devices. A large part of m-commerce’s appeal may be convenience, but if that convenience comes at the
sacrifice of information, customers will be sure to look elsewhere. The larger trend here is that ultimately,
businesses are in uncharted waters when it comes to their mobile offerings, they’re still finding out what
works and what doesn’t.

Answer No 9
Enterprise Resource Planning (ERP) involves the organization of computing systems, business processes
and procedures under one umbrella designed to improve business efficiency. Originally designed for
manufacturing organizations, ERP is now available for a wide range of industries, including financial
services companies and companies focused on customer service. In the past, ERP systems were designed
for very large organizations. However, many suppliers now offer products for small and medium-sized
businesses.
ERP systems are being implemented by most of the organisation for innumerable benefits. Some of them
are as given:

1. Integrated Information

The key benefit of implementing ERP is integration. ERP helps in reducing operational costs by
coordinating various departments of the organization. The major idea behind ERP is to control accuracy
as well as redundancy of data and data entry. This centralized working system is able to replace multiple,
disconnected databases with a single system, incorporate different applications and data sources. It also
aims to lowers help desk support and marketing cost. In addition, this real time application has the
capabilities of interfacing internal and external entities. Moreover, ERP is an ideal application to improve
the cooperation between departments and employees as well as communication with prospects and
customers.

2. Standardization of processes

A manufacturing company that has grown through acquisitions is likely to find that different units use
different methods to build the same product. Standardizing processes and using an integrated computer
system can save time, increase productivity, and reduce head count. It may also enable collaborating and
scheduling production across different units and sites.

3. Standardization of human resource information

This is especially useful in a multi-site company. A unified method for tracking employee time and
communicating benefits is extremely beneficial, because it promotes a sense of fairness among the
workforce as well as streamlines the company as a whole.

4. Effective Management of Repeatable Processes

One of the fundamental objectives of ERP systems are repeatable processes. By creating repeatable
processes, management is able to ensure that tasks are done using organization-wide best practices.
Employees are able to improve quality by performing tasks the same way each time.

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Repeatable processes also reduce the risk of a key employee leaving with his or her knowledge of how a
job is done. These types of processes are also easier to change. Because a large number of people are
performing the same set of tasks, finding improvements can be easier. Rolling out those changes
organization-wide can also be easier.

5. Lower Training Costs

Standardizing these processes also results in lower training costs. Because the processes are the same
throughout an organization, training programs that are standardized, reduce overall development costs.
By standardizing processes, training can be patterned and optimized to reduce the time spent in training.
Reduced time spent in training means less non-productive time.

6. Reduced Inventory Costs

Many ERP systems, especially systems designed for manufacturing industries, are customizable for lean
manufacturing or other parts-control management systems. By linking repeatable processes with
inventory usage, a manufacturer can maintain lower parts inventories. This is possible because of the
integration between processes and ordering. Each time a procedure is executed; inventory levels can be
updated in real time. Once a pre-defined level of parts inventory is reached, replacements can be
automatically ordered from the supplier.

7. Improved Business Visibility

Depending on how a system is implemented, one objective of an ERP system might focus on business
performance and operations visibility. By creating reports based on actual manufacturing tasks, the
overall performance of the organization can be more easily analyzed and optimized.Things that might
require tracking include time it takes to complete tasks, production levels, and production units per units
of time and almost any measurable that could help an organization analyze performance.

8. Increased Profits

By optimizing production through process visibility, the cost per production unit can be reduced.
Reducing training costs can, again, add to the bottom line. By reducing inventory levels, less money is
tied up in non-liquid business resources which increase available cash to allow a company to make faster
business decisions.

9. Enhanced and Efficient Technology

This software enhances day to day management activities. It also supports strategic planning that defines
objectives for the business. Since it has better data accessibility, top management can also use this tool to
make better and more effective decisions. In addition, ERP system has a capability of eliminating manual
activities and streamlining critical business processes for many departments of an organization. The
following are somemore benefits that improve the efficiency of an ERP system:

10. Easy Reporting

An ERP system improves and customizes reporting. It provides easy technique of generating reports.
With better access to data you can generate and manipulate reports anytime you want to.

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11. User Friendliness

This robust and user-friendly application easily eliminates problems without over- grown data tables.
Moreover, non-technical people can easily access data or information using ERP applications. This
handy application also allows you to deal with high volumes because of its real time capability and future
based orientation.

12. Easy Data Accessibility

An ERP system enables you to access real time data and increase self-service of critical information.
Many ERP vendors are providing mobile functionalities so that you can always remain connected and
well-informed in regards your business processes and performance.

13. Increased Security

ERP system not only improves data integrity and security but also enhances the data restrictions, allowing
you to keep your customer information and company data safe and secure.

14. Providing Business and Financial Solution

ERP offers the best business and financial solutions for almost every type of organization. By permitting
flow of resources and finances into different and vital business activities it enables enterprises to
increased efficiencies in its daily operations.

15. Accuracy & Consistency

An ERP enables companies to maintain consistent and accurate data throughout all the departments
enabling the complete flow of information to be viewed through a single system. The department heads
can see the timing of employees and total work completed. It provides better visibility and helps in
improving the performance of the organization.

16. Better Resource Management

This centralized application provides the tools and reporting capabilities to allow management to better
allocate valuable resources. This allows decision makers to monitor and take action during crucial times
and prevent delays.

For any productive business organization ERP can play a vital role. A successfully implemented
centralized ERP system will help in improving alignment of strategies and operations, productivity and
insight, financial management and corporate governance. ERP system also enables in reducing costs
through increased flexibility and overall risk. Before implementing ERP system be assured in terms of
where and how the organisation will benefit, discussion with the potential suppliers of ERP in this regards
plays a vital role.

Limitations of the Enterprise Resource Planning are as follows:

Each good system is having some limitations and for these limitations, sometime people become reluctant
to implement good system. ERP is also not different and it has also got some limitations. The limitations
which are associated with an ERP system are discussed herein:

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1. Difficult to implement in running businesses

Implementing an ERP system in a new business can be very ffective. Implementing the same system in an
older business can be very difficult. All employees must be trained, and there will be significant down
time as the business switches all applications over to the new system. Some businesses cannot afford the
profit loss this downtime would require. ERP systems also tend to have industry standards for specific
types of businesses, and the strict moulds may lower creativity or competitive advantage.

2. Customization is problematic

Every business has its own requirement and there is no ERP which may be suited for all business’s
requirement so to implement an ERP system in an organisation, first the detailed study about the
different processes of a business is done and then various customizations is done to make the ERP
suitable for a particular organization requirement. The customization process involves lot of money and
resources which works as a limitation to the implementation of an ERP system in an organisation.

3. Policy Limitations

ERP systems do not fit the business plans of every enterprise. Often, ERP systems must be customized to
allow for specific tasks. Not all ERP systems allow this—depending on the system or company the
business uses, it may be against policy to make such drastic changes to the application.

4. Ongoing Support

Support for ERP systems often can be difficult to depend on. technical response can be adept at dealing
with minor problems, but major complications with the ERP systems can be beyond the limited customer
service available to businesses.

5. Lack of user participation in ERP implementation

The participation of users is very important for successful implementation of ERP projects – So,
exhaustive user training and simple user interface might be critical. Moreover involvement of key

users at the pre implementation stage and implementation stage is very important and lack of their
involvement acts as a limitation for ERP system.

6. Problem of Harmonization of ERP processes with the business processes

Harmonization of ERP systems can be a mammoth task (especially for big companies) and requires a lot
of time, planning, and money.

7. Resistance to change

Implementing ERP system in an organisation requires lot of process changes, starting new process etc. In
this process, certain people’s profile gets redundant and they need to transfer to other processes.
Moreover implementing ERP requires people to new the new processes and technologies. All this become
a reason of resistance by people which works as a big limitation for ERP implementation.

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8. High Annual Charges

Most of the ERP vendors charge large sum of money for annual license renewal that is unrelated to the
size of the company using the ERP or its profitability. This acts as a big limitation for an ERP
implementation.

9. Cutting Expenses on Training

Success depends on the skill and experience of the workforce, including training about how to make the
system work correctly. Many companies cut costs by cutting training budgets. Privately owned small
enterprises are often undercapitalized, meaning their ERP system is often operated by personnel with
inadequate education in ERP in general. This acts as a big limitation.

10. Dependency on one Vendor/High switching cost

Once an ERP system is implemented it becomes a single vendor lock-in for further upgrades,
customizations etc. Moreover once a system is established, switching costs are very high for any one of
the partners (reducing flexibility and strategic control at the corporate level).

Answer No 10
The selection of the right Enterprise Resource Planning system can integrate key business functions and
boost the bottom line while the wrong ERP application can drain the IT budget. The following five
criteria should be considered when evaluating ERP vendors.

1. Functional Specifications.
The application should accommodate the needs of the business efficiently and effectively. Functional
compatibility depends on a complex analysis of the company’s unique business needs and the ERP
industry’s varied solutions.

2. Define and prioritize company processes.

Identify core corporate functions, and develop a comprehensive picture based on input from all
stakeholders.

3. Identify “showstoppers.”
A showstopper is the “missing feature or unsupported business process that transforms an otherwise great
fit into a complete mismatch.” Often these problems lurk beneath the radar, surfacing upon
implementation. The software that can count widgets but can’t track the problem like the application that
won’t assign dual currency prices to export items depending on the enterprise can fail the whole system.

Functional incompatibility can be avoided by determining that the ERP system is designed for:
– Discrete or process manufacturing
– Work orders or repetitive manufacturing
– Distributor or manufacturer process management
– Multi-plant or a warehouse environment
– Multilanguage and/or multicurrency needs

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4. Evaluate the options:

Not all ERPs are created equal. A clue to a product’s relative strengths is its origin. Some ERP vendors
began by developing manufacturing software; others entered the field via a robust human resources
package, or a data warehouse solution. The program like Oracle Accelerate program leverages the
company’s abroad spectrum of world-class business applications to deliver a comprehensive, modular
ERP package.

5. Business Model

Functional compatibility is absolutely crucial—but it’s also important to consider structural fit. The
companies have to examine more subtle issues such as company’s corporate culture and management
style. An ERP package may look great on paper, but will it mesh with the model of doing business. For
example, hands-on managers may want to drill down to the details; Oracle’s ERP application excels in
aggregating data into expansive transaction reports. Other applications favor a more granular approach.

6. Flexibility:
The application should be modified and should be scale to accommodate evolving needs of the
organizations. Enterprise Resource Planning is a long-range investment. A flexible system will grow with
the company, accommodating new specifications as they emerge. Flexibility is also crucial in the
implementation phase, to ensure that the program can align with existing business needs and achieve
integration. Organisation should look for an ERP solution that will accommodate new operating
protocols, future business growth, market expansion, and any other initiatives that might arise.
To evaluate ERP flexibility, organisation needs to consider:
– System parameters and default settings
– Custom screen and menu options
– Tools for modifying standard forms
– Data access options and custom reporting
– Modular format

7. Time to Implement:

Implementation can be a scary prospect when company-wide integration is taken. Organisation needs to
check the ERP provider’s implementation track record and methodology. An efficient rollout minimizes
the costs and disruption associated with conversion. A speedy, vendor-supported implementation process
also promotes user buy-in and a faster time to ROI.

8. Industry Expertise:

The ERP solution which was selected should come with a pedigree of successful installations in the
organisations. There are very few companies that don’t have specialized processes dictated by their
industry. A proven track record means that the vendor is already well attuned to the particular business
requirements of this market sector. “For manufacturers,” for example, “the right system is one that, from
its beginning, has been based on a strong process engineering foundation.” Some ERP integration
specialists even recommend an on-site visit to an ERP customer in the same industry, if possible. Many
ERP providers offer applications customized to a particular industry. The program like Oracle Accelerate

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program includes applications for 32 industries, ranging from aerospace to defense to wholesale
distribution.

The formula for finding the perfect ERP match is fairly straightforward, provided the team performs the
due diligence research, functional and structural compatibility, flexibility, solid vendor support, and a
proven track record add up to an ERP solution that works.

Answer No 11
E-commerce strategy was treated as an integral part of the competitive profile while system stability,
system security and system speed were considered as just facilitators to implement e-commerce
operations.
• Commitment.
Many studies identified owner’s commitment to grow his business and capabilities as a very important
determinant of e-commerce success. The growth motivation of business owners can be observed from
their readiness to adapt to market changes and reinvent their business strategies continuously. They must
be open and flexible to new ideas, technologies and business opportunities. When necessary, the owners
are prepared to seek strategic partners and venture capitalists to provide the appropriate technology,
funding, management expertise and contacts to grow their businesses rapidly.

• Content.
The website serves as a focal point for gathering and disseminating information related to the marketing,
sales and other functions of the organisation . Web content must be accurate, informative, updated, easy-
to-understand and relevant to users’ need. In addition, online retailers must offer a suitable range of
products, provide accurate and relevant product information and make it easier for customers to compare
prices with other competitors with the help of other service providers when necessary.

• Convenience.
Convenience factor, synonymous with usability, refers to the development of user-friendly interfaces and
designs on websites. E-merchants can deploy navigation tools such as menu, directory, site map and
search engines, multimedia capabilities such as audio/video clips, animation and games, and
customization capabilities such as zoom capabilities, product configuration tools and item comparison
engines to demonstrate a product or service, improve communication and enhance the shopping
experience. However, web designers must strike a balance between an attractive design and fast loading
time because “system response time was inversely related to user satisfaction”.

• Interaction.
Consumers expect high quality interaction with online retailers, particularly in the areas of prompt and
responsive customer services, round-the-clock help line and real-time chat, in-house mailing lists and
loyalty programmes, high ethical standards in enforcing customer privacy, security measures and refund
policy, and an effective system to make every step of the order fulfillment process transparent to the
customers. Performing well on these activities has proven to be very effective in earning consumers’ trust
and loyalty.

• Control.
Control factor evaluates the systems that the online retailer has put in place to track and respond to
customers’ queries, handle complaints, feedback and product returns, control the entire order fulfillment
process, update Web content, process online transactions and control credit risks. Online retailers must

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conduct operational audits regularly to measure and correct any lapses in customers’ expectation and
perception of service quality for key business processes and services provided by third-party vendors.

• Community.
The community factor emphasizes the interactions among like-minded people and organizations in online
communities that allow participants to exchange relevant information, products and services with one
another through applications such as forums, blogs, peer-to-peer auctions and independent product
reviews. A vibrant online community offers many opportunities for the e-merchant to increase sales and
profitability. The online activities can also be extended to the real world where e-merchants organise
recreational activities for their customers in collaboration with other like-minded organizations.

• Price sensitivity.
Customers tend to expect lower prices on the web. After factoring in the shipping and handling charges,
the same product cannot sell for significantly higher prices than traditional stores, especially in a
physically concentrated and competitive market environment. A shop.org study showed that the
competitive environment had forced e-merchants to accept free or discounted shipping as a cost of doing
business online, yet most merchants experienced an improvement in overall profit margins. To compete
effectively, online retailers may consider charging premiums on specialized services or selling products
that are not widely available locally

• Brand image.
The customer base is bounded only by the language used on-site and the geographical regions where
orders can be shipped economically. Building a distinctive brand name is essential for an e-merchant to
compete effectively with other online sellers. The success hinges on how well a business define its
‘mental position’ in terms of perceived benefits that fulfill the consumers’ needs better than its
competitors. Economists have found that customers were prepared to pay more to retailers with a high
reputation or favourable brand image.

• Partnership.
Partnership is particularly important to small businesses because resource scarcity compels them to work
closely with customers, suppliers and business partners to leverage brand awareness, improve marketing
effectiveness, launch customized products, take advantage of new market opportunities and streamline
their operations. It may be worthwhile for small businesses to consider joining a business community
because the membership may lead to new business and potential partnerships.

• Process improvement.
Business Process Re-engineering (BPR) uses information technology to change and automate
organizational processes in order to achieve greater operational efficiency and e-commerce readiness to
cope with rapid growth in transaction volume. This approach is widely practiced in large enterprises.
Among SMEs, financial constraints restrict “re-engineering work to a lower level and narrower scope”
although studies showed that SMEs could benefit equally from BPR because “business processes are at
the heart of e-commerce”. Content management and integration of cross-channel operations are typical
processes that offer great scopes for re-engineering.

• Integration.
Integrated Electronic Data Interchange (EDI) systems could deliver the ultimate service quality,
performance and productivity capable of supporting high volume business .Many small enterprises do not
have the necessary technical expertise and resources to seek full enterprise integration unless they have
support from technologically advanced partners . A three-staged model is proposed for small businesses,

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in which “integration starts with inter-organisational systems, followed by selected local integration and,
finally, full integration” of external and internal systems

Answer No 12

With the globalization, many companies do not have to produce every things on their own. Outsourcing is
one of the best ideas that allow many companies to focus on what they do best and outsourcing what
others can do better, faster, cheaper, and higher quality. Outsourcing is one of the successful business
concept becomes an increasingly popular organization management strategy. Outsourcing is a modern
management adopted in responding business units’ requirement of enhancing competitiveness and many
experts agreed that it is the most powerful manpower management. Outsourcing is nowadays the most
popular business concept applied in many companies and many industries around the world. However,
there still is a lack of confident in value perception in many industries of developing countries towards
this type of business concept. The concept is increasingly important that outsourcing has been applied in
many countries under the concept of economic integration, with a belief that economic integration will
facilitate organisation to enhance an even higher competitive advantages over other competitor, to attract
more intra-regional investments and trading, and to have high ability to sharing the expertise in various
types of industries in creating more quality products and services. Outsourcing is known to be a reduction
of costs of raw materials and labor, resulting in reduced production costs. Moreover, by integrated the
system of outsourcing mobility in productions of goods and services between countries, it can increase the
level of competitive for all nations.

The large trading partner countries such as U.S.A and Japan have adopted outsourcing policy in many
business units of their industries with vital signs that outsourcing is a significant mechanism in increasing
their level of competitive, improve business core competency and reducing production costs, whereas
protecting businesses from seasonal uncertainties which can lead to a less stability of production quantity.
Even though outsourcing economically benefits to businesses in many ways, there still are many
arguments that outsourcing causes some setbacks such as issues concerning quality of finished goods, late
delivery of goods, and skills of labors. In other words, there are advantages and disadvantages of
outsourcing. Nowadays, outsourcing concepts has been accepted as part of business partnership
development with evident business cooperation all over the world

Advantages of Outsourcing

(1) Expertise and fast delivery:

Most of the times tasks or projects are outsourced to others who specialize in the particular field. The
outsourced vendors must have specific equipment and technical expertise, most of the times better than
the ones at the outsourcing organization. This means the tasks should be completed faster and with better
quality and prompt delivery.

(2) The ability to concentrate on core process rather than the supporting ones:

Outsourcing the supporting processes allows the organization more time to focus on company’s core
business process or job assignment.

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(3) Risk-sharing:
This is the most crucial factors determining the outcome of a campaign is risk-analysis. Outsourcing
certain components of many company’s business process that helps the organization to shift certain
responsibilities to the outsourced vendor. The outsourced must have ability to plan the risk-mitigating
factors better

(4) Reduced cost such as Set up cost, Operational and Recruitment costs:

Outsourcing reduces the need to hire individuals in-house; hence recruitment and operational costs can be
minimized to a great extent. Therefore, the time and many costs can be safe and focus on something else.

Disadvantages of Outsourcing

(1) Risk of exposing confidential data and technology:

Whenever an organization outsources HR, Payroll and Recruitment services, it involves a risk if exposing
confidential company information as well as technology to a third-party. For example, if organisation
allow outsourcing, soon there is going to be imitation products.

(2) Synchronizing the deliverables:

If you choose a wrong partner for outsourcing, some of the common problem areas include stretched
delivery time frames, substandard quality output, defects, and inappropriate categorization of
responsibilities. At times it is easier to mitigate these factors inside an organization rather than with an
outsourced partner.

(3) Many Hidden costs:

In general, the concept of outsourcing is cost-effective but at times the hidden costs involved in signing a
contract while signing a contract across international boundaries may pose a serious threat.

(4) Lack of customer focus:

An outsourced vendor may have to serve many companies and multiple organizations at a time.
Therefore, they may lack a complete focus on your organization’s tasks and job assignment

Answer No 13
Protection of information resources requires a well-designed set of controls. Computer systems are
controlled by a combination of general controls and application controls. General controls govern the
design, security, and use of computer programs and the security of data files in general throughout the
organization’s information technology infrastructure. On the whole, general controls apply to all
computerized applications and consist of a combination of hardware, software, and manual procedures
that create an overall control environment. Application controls are specific controls unique to each
computerized application, such as payroll or order processing. They consist of controls applied from the
business functional area of a particular system and from programmed procedures.

Data security controls ensure that valuable business data files are not subject to unauthorized access,
change, or destruction. Such controls are required for data files when they are in use and when they are

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being held for storage. It is easier to control data files in batch systems, since access is limited to
operators who run the batch jobs. However, on-line and real-time systems are vulnerable at several points.
They can be accessed through terminals as well as by operators during production runs. When data can be
input online through a terminal, entry of unauthorized input must be prevented. For example, a credit note
could be altered to match a sales invoice on file. In such situations, security can be developed on several
levels:

• Terminals can be physically restricted so that they are available only to authorized individuals.

• System software can include the use of passwords assigned only to authorized individuals. No one can
log on to the system without a valid password.

• Additional sets of passwords and security restrictions can be developed for specific systems and
applications. For example, data security software can limit access to specific files, such as the files for the
accounts receivable system. It can restrict the type of access so that only individuals authorized to update
these specific files will have the ability to do so. All others will only be able to read the files or will be
denied access altogether. Systems that allow online inquiry and reporting must have data files secured.

Example the security allowed for two sets of users of an online personnel database with sensitive
information such as employees' salaries, benefits, and medical histories. One set of users consists of all
employees who perform clerical functions such as inputting employee data into the system. All
individuals with this type of profile can input the data in the system but can neither read nor update
sensitive fields such as salary, medical history, or earnings data. Another profile applies to a divisional
manager, who cannot input the system but can read all employee data fields for his or her division,
including medical history and salary. These profiles would be established and maintained by a data
security system. A multilayered data security system is essential for ensuring that this information can be
accessed only by authorized persons. The data security system should provide very fine grained security
restrictions, such as allowing authorized personnel users to inquire about all employee information except
in confidential fields such as salary or medical history. Although the security risk of files maintained
offline is smaller, such data files on disk or tape can he removed for unauthorized purposes. 'These can he
secured in lockable storage areas, with tight procedures so that they are released only for authorized
processing. Usage logs and library records can be maintained for each removable storage device if it is
labeled and assigned a unique identity number.

Answer No 14
A computer virus is program code which 'hides' in other files and can either cause irreparable damage to
the computer or more likely steal passwords, bank/credit card details, and email addresses. Computer
viruses spread easily between computers through shared files, from the internet and through attachments
in email messages.A virus signature is a program code which detects and cleans infected files. New
viruses are continually being produced by virus writers. When this happens, the suppliers of virus
protection software have to understand how each new virus spreads, and what it is trying to do, in order to
develop, test and send out new anti-virus updates to deal with it. Because of this, it is necessary to update
and deploy new virus signatures as soon as they are released. Viruses are often picked up by pen drives
from home or public computers that do not have up-to-date virus protection. To protect the system
environment, user should always ensure that the computer has the most up to date virus protection

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software. A reputable anti-virus program should install updates regularly, and should never be more than
one year.

The computers contain a wealth of personal information about the user which may include banking and
other financial records, and medical information – information that user want to protect. If the computer is
not protected, identity thieves and other fraudsters may be able to get access and steal those sensitive and
personal information. Spammers could use the computer as a “zombie drone” to send spam that looks like
it came from genuine user. Malicious viruses or spyware could be deposited on the computer, slowing it
down or destroying files. By using safety measures and good practices to protect your home computer,
user can protect the sensitive information of organization and user.

a. Install a Firewall

A firewall is a software program or piece of hardware that blocks hackers from entering and using the
computer system. Hackers search the Internet the way some telemarketers automatically dial random
phone numbers. They send out pings (calls) to thousands of computers and wait for responses. Firewalls
prevent the computer from responding to these random calls. A firewall blocks communications to and
from sources that are not permitted. This is especially important if a system have a high-speed Internet
connection, like DSL or cable. Some operating systems have built-in firewalls that may be shipped in the
“off” mode.so it should be turned on. To be effective, the firewall must be set up properly and updated
regularly.

b. Use Anti-virus Software

Anti-virus software protects the computer from viruses that can destroy the data, slow down or crash the
computer, or allow spammers to send email through the personal account. Anti-virus protection scans the
computer and all the incoming email for viruses, and then deletes them. User of computer system must
keep the anti-virus software updated to cope with the latest “bugs” circulating the Internet. Most anti-
virus software includes a feature to download updates automatically when the systems are online. In
addition, it is required to make sure that the software is continually running and checking the system for
viruses, especially if files are downloading from the Web or checking the email. Set the anti-virus
software to check for viruses when user first turn on the computer. System should be given a thorough
scan at least twice a month.

c. Use Anti-spyware Software

Spyware is software installed without the user’s knowledge or consent that can monitor the online
activities and collect personal information while user surf the Web. Some kinds of spyware, called key
loggers, record everything user key in – including the passwords and financial information. Signs that the
computer may be infected with spyware include a sudden flurry of pop-up ads, being taken to Web sites
,user don’t want to go to, and generally slowed performance. Spyware protection is included in some
antivirus software programs. Antivirus software documentation needs to be checked for instructions on
how to activate the spyware protection features. User can buy separate anti-spyware software programs
and keep the anti-spyware software updated and make it run regularly. To avoid spyware in the first
place, download software only from sites that are known and trust. Piggybacking spyware can be an

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unseen cost of many “free” programs. User should be aware that they don’t click on links in pop-up
windows or in spam email.

d. Manage the System and Browser to Protect Your Privacy

Hackers are constantly trying to find flaws or holes in operating systems and browsers. To protect the
computer and the information on it, put the security settings in the system and browser at medium or
higher. Check the “Tool” or “Options” menus for how to use the computer system. User needs to update
the system and browser regularly, taking advantage of automatic updating when it’s available. Windows
Update is a service offered by Microsoft. It will download and install software updates to the Microsoft
Windows Operating System, Internet Explorer, Outlook Express, and will also deliver security updates .
Patching can also be run automatically for other systems, such as Macintosh Operating System.

e. Use a Strong Password

Protect the computer from intruders by choosing passwords that are hard to guess. Use strong passwords
with at least eight characters, a combination of letters, numbers and special characters. Don’t use a word
that can easily be found in a dictionary. Some hackers use programs that can try every word in the
dictionary. Try using a phrase to help user remember their password, using the first letter of each word in
the phrase. For example, HmWc@wC2 – How much wood could a woodchuck chuck.

f. Secure Your Wireless Network.

If user uses a wireless network in the organization, be sure to take precautions to secure it against
hackers. Encrypting wireless communications is the first step. Choose a wireless router with an
encryption feature and turn it on. WPA encryption is considered stronger than WEP. The computer,
router, and other equipment must use the same encryption. If the router enables identifier broadcasting, it
needs to be disabled. Hackers know the pre-set passwords of this kind of equipment. Change the default
identifier on the router and the pre-set administrative password. Need to Turn off the wireless network
when it is not in use. Administrator needs to remember that public “hot spots” may not be secure. It’s
safest to avoid accessing or sending sensitive personal information over a public wireless network. User
may also consider buying a mobile broadband card that will allow to connect to the Internet without
relying on Wi-Fi hot spots. A mobile broadband card is a device that plugs into the computer, laptop,
PDA, or cell phone and uses a cell phone signal to provide high-speed Internet access which are sold by
cell phone companies and require a monthly service plan.

g. Conscious while Sharing the Files

Many consumers enjoy sharing digital files, such as music, movies, photos, and software. File sharing
software that connects the computer to a network of computers is often available for free. File-sharing can
pose several risks. When connected to a file-sharing network, it may allow others to copy files that didn’t
intend to share. It might download a virus or bit of spyware that makes the computer vulnerable to
hackers. It might also break the law by downloading material that is copyright protected.

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h. Shop Safely Online

When shopping online, check out the Web site before entering the credit card number or other personal
information. Read the privacy policy and look for opportunities to opt out of information sharing. Learn
how to tell when a Web site is secure. Look for “https” in the address bar or an unbroken padlock icon at
the bottom of the browser window. These are signs that the information will be encrypted or scrambled,
protecting it from hackers as it moves across the Internet.

Answer No 15
There are various kinds of plans that need to be designed. They include the following:
• Emergency Plan :
The emergency plan specifies the actions to be undertaken immediately when a disaster occurs.
Management must identify those situations that require the plan to be invoked for example, major fire,
major structural damage, and terrorist attack. The actions to be initiated can vary depending on the nature
of the disaster that occurs. If an organisation undertakes a comprehensive security review program, the
threat identification and exposure analysis phases involve identifying those situations that require the
emergency plan to be invoked.
When the situations that evoke the plan have been identified, four aspects of the emergency plan must be
articulated. First, the plan must show who is to be notified immediately when the disaster occurs -
management, police, fire department, medicos, and so on. Second, the plan must show actions to be
undertaken, such as shutdown of equipment, removal of files, and termination of power. Third, any
evacuation procedures required must be specified. Fourth, return procedures (e.g., conditions that must
be met before the site is considered safe) must be designated. In all cases, the personnel responsible for
the actions must be identified, and the protocols to be followed must be specified clearly.

• Back-up Plan :

The backup plan specifies the type of backup to be kept, frequency with which backup is to be
undertaken, procedures for making backup, location of backup resources, site where these resources can
be assembled and operations restarted, personnel who are responsible for gathering backup resources and
restarting operations, priorities to be assigned to recovering the various systems, and a time frame for
recovery of each system.

For some resources, the procedures specified in the backup plan might be straightforward. For example,
microcomputer users might be admonished to make backup copies of critical files and store them off site.
In other cases, the procedures specified in the backup plan could be complex and somewhat uncertain.
For example, it might be difficult to specify; exactly how an organisation’s mainframe facility will be
recovered in the event of a fire. The backup plan needs continuous updating as changes occur. For
example, as personnel with key responsibilities in executing the plan leave the organisation, the plan
must be modified accordingly. Indeed, it is prudent to have more than one person knowledgeable in a
backup task in case someone is injured when a disaster occurs. Similarly, lists of hardware and software
must be updated to reflect acquisitions and disposals. Perhaps the most difficult part in preparing a
backup plan is to ensure that all critical resources are backed up. The following resources must be
considered;

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(i) Personnel : Training and rotation of duties among information system staff so enable them to replace
others when required. Arrangements with another company forprovision of staff.
(ii) Hardware : Arrangements with another company for provision of hardware.
(iii) Facilities : Arrangements with another company for provision of facilities.
(iv) Documentation : Inventory of documentation stored securely on-site and off-site.
(v) Supplies : Inventory of critical supplies stored securely on-site and off-site with a list of
vendors who provide all supplies.
(vi) Data / information : Inventory of files stored securely on site and off site.
(vii) Applications software : Inventory of application software stored on site and off site.
(viii) System software : Inventory of system software stored securely on site and off site.

• Recovery Plan :

The backup plan is intended to restore operations quickly so the information system function can
continue to service an organisation, whereas, recovery plans set out procedures to restore full information
system capabilities. Recovery plans should identify a recovery committee that will be responsible for
working out the specifics of the recovery to be undertaken. The plan should specify the responsibilities of
the committee and provide guidelines on priorities to be followed. The plan might also indicate which
applications are to be recovered first. Members of a recovery committee must understand their
responsibilities. Again, the problem is that they will be required to undertake unfamiliar tasks.

Periodically, they must review and practice executing their responsibilities so they are prepared should a
disaster occur. If committee members leave the organisation, new members must be appointed
immediately and briefed about their responsibilities.

Answer No 16
The different steps involved in the conduct of Information Systems Audit are as follows:
(i) Scoping and pre-audit survey: Auditors determine the main area/s of focus and any areas that
are explicitly out-of-scope, based on the scope-definitions agreed with management.
Information sources at this stage include background reading and web browsing, previous audit
reports, pre-audit interview, observations and, sometimes, subjective impressions that simply
deserve further investigation.
(ii) Planning and preparation: During which the scope is broken down into greater levels of
detail, usually involving the generation of an audit work plan or risk-control- matrix.
(iii) Fieldwork: This step involves gathering of evidence by interviewing staff and managers,
reviewing documents, and observing processes etc.
(iv) Analysis: This step involves desperately sorting out, reviewing and trying to make sense of
all that evidence gathered earlier. SWOT (Strengths, Weaknesses, Opportunities, and
Threats) or PEST (Political, Economic, Social, and Technological) techniques can be used for
analysis.
(v) Reporting: Reporting to the management is done after analysis of evidence is gathered and
analysed. Analysis and reporting may involve the use of automated data analysis tools such as

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ACL, IDEA, Excel, Access and hand-crafted SQL queries.

(vi) Closure: Closure involves preparing notes for future audits and follow up with management to
complete the actions they promised after previous audits.

Answer No 17
The ways in which remote and distributed data processing applications can be controlled in relation
to issues and revelations related to logical access are as follows:
• Remote access to computer and data files through the network should be implemented.
• Having a terminal lock can assure physical security to some extent.
• Applications that can be remotely accessed via modems and other devices should be controlled
appropriately.
• Terminal and computer operations at remote locations should be monitored carefully and
frequently for violations.
• To prevent the unauthorized user’s access to the system, there should be proper control
mechanisms over system documentation and manuals.
• Data transmission over remote locations should be controlled. The location which sends data
should attach needed control information that helps the receiving location to verify the
genuineness and integrity.
• When replicated copies of files exist at multiple locations, it must be ensured that all are
identical copies contain the same information and checks are also done to ensure that duplicate
data does not exist.

Answer No 18
As an Information Systems (IS) Auditor, the key areas that would be verified during review of BCM
arrangement of an enterprise are as follows:
• All key products and services and their supporting critical activities and resources
have been identified and included in the enterprise’s BCM strategy;
• The enterprise’s BCM policy, strategies, framework and plans accurately reflect its
priorities and requirements (the enterprise’s objectives);
• The enterprise’ BCM competence and its BCM capability are effective and fit -for- purpose
and will permit management, command, control and coordination of an incident;
• The enterprise’s BCM solutions are effective, up-to-date and fit-for-purpose and appropriate
to the level of risk faced by the enterprise;
• The enterprise’s BCM maintenance and exercising programs have been effectively
implemented;
• BCM strategies and plans incorporate improvements identified during incidents and exercises
and in the maintenance program;
• The enterprise has an ongoing program for BCM training and awareness;
• BCM procedures have been effectively communicated to relevant staff and that those staff
understand their roles and responsibilities; and Change control processes are in place and
operate effectively.

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Answer No 19
Following aspects of environmental controls should be physically inspected by an Information
System Auditor, while auditing environmental controls: The Auditor should verify:
• The IPF (Infrastructure Planning and Facilities) and the construction about the type of materials
used for construction;
• The presence of water and smoke detectors, power supply arrangements to such devices, and testing
logs;
• The location of fire extinguishers, firefighting equipment and refilling date of fire
extinguishers;
• Emergency procedures, evacuation plans and marking of fire exists. There should be half-yearly
Fire drill to test the preparedness;
• Documents for compliance with legal and regulatory requirements with regards to fire safety
equipment, external inspection certificate and shortcomings pointed out by other
inspectors/auditors;
• Power sources and conduct tests to assure the quality of power, effectiveness of the power
conditioning equipment and generators. Also, the power supply interruptions must be checked
to test the effectiveness of the back-up power;
• Environmental control equipment such as air-conditioning, dehumidifiers, heaters, ionizers
etc.;
• Compliant logs and maintenance logs to assess if MTBF (Mean Time Between Failures) and
MTTR (Mean Time To Repair) are within acceptable levels; and
• Identify undesired activities such as smoking, consumption of eatables etc.

Answer No 20
Information systems auditing or systems audit is the process of collecting and evaluating evidence to
determine whether a computer system safeguards assets, maintains data integrity, allows organizational
goals to be achieved effectively, and uses resources efficiently. Thus, information systems auditing
supports traditional audit objectives; attest objectives (those of the external auditor) that focus on asset
safeguarding and data integrity, and management objectives (those of the internal auditor) that
encompass not only attest objectives but also effectiveness and efficiency objectives.

Sometimes information systems auditing has another objective-namely, ensuring that an organization
complies with some regulation, rule or condition. For example, a bank might have to comply with a
government regulation about how much it can lend;

• Asset Safeguarding Objectives

The information system assets of an organization include hardware, software, facilities, people
(knowledge), data files, system documentation, and supplies. Like all assets, they must be protected by a
system of internal control. Hardware can be damaged maliciously. Proprietary software and the contents
of data files can be stolen or destroyed. Supplies of negotiable forms can be used for unauthorized
purposes.

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These assets are often concentrated in one or a small number of locations, such as a single disk. As a
result, asset safeguarding becomes an especially important objective for many organizations to achieve.

• Data Integrity Objectives

Data integrity is a fundamental concept in information systems auditing. It is a state implying data has
certain attributes: completeness, soundness, purity, and veracity. If data integrity is not maintained, an
organization no longer has a true representation of itself or of events. Moreover, if the integrity of an
organization’s data is low, it could suffer from a loss of competitive advantage. Nonetheless, maintaining
data integrity can be achieved only at a cost. The benefits obtained should exceed the costs of the control
procedures needed.

• System Effectiveness Objectives

An effective information system accomplishes its objectives. Evaluating effectiveness implies knowledge
of user needs. To evaluate whether a system reports information in a way that facilitates decision making
by its users, auditors must know the characteristics of users and the decision-making environment.
Effectiveness auditing often occurs after a system has been running for some time. Management requests
a post audit to determine whether the system is achieving its stated objectives. The evaluation provides
input to the decision on whether to scrap the system, continue running it, or modify it in some way.
Effectiveness auditing also can be carried out during the design stages of a system. Users often have
difficulty identifying or agreeing on their needs. Moreover, substantial communication problems often
occur between system designers and users. If a system is complex and costly to implement, management
might want auditors to perform an independent evaluation of whether the design is likely to fulfill user
needs.

• System Efficiency Objectives

An efficient information system uses minimum resources to achieve its required objectives. Information
systems consume various resources: machine time, peripherals, system software, and labor. These
resources are scarce, and different application systems usually compete for their use. The question of
whether an information system is efficient often has no clear-cut answer. The efficiency of any particular
system cannot be considered in isolation from other systems. Problems of sub-optimization occur if one
system is “optimized” at the expense of other system. For example, minimizing an application system’s
execution time might require dedication of some hardware resource (e.g., a printer) to that system. The
system might not use the hardware fully, however, while it undertakes its work. The slack resource will
not be available to other application system if it is dedicated to one system. System efficiency becomes
especially important when a computer no longer has excess capacity. The performance of individual
application systems degrades (e.g., slower response times occur), and users can become increasingly
frustrated Management must then decide whether efficiency can be improved or extra resources must be
purchased. Because extra hardware and software is a cost issue, management needs to know whether
available capacity has been exhausted because individual application systems are inefficient or because
existing allocations of computer resources are causing bottlenecks. Because auditors are perceived to be
independent, management might ask them to assist with or even perform this evaluation.

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CAP III Paper 5: Management Information and Control System-Solution

Answer No 21

The scope of systems audit covers the entire IS management process. The scope includes review of the
entire design & development process, the review of technology choice, the processes employed to assess
risks and losses that could accrue to the system, the possibility of computer frauds, the care taken in
managing changes to the system, extent of testing and reliability of the system. It also cover Senior
management involvement, review applicable minutes Network, workstation, Internet, disaster recovery,
and other IT security policies, Overall security procedures, Segregation of IT duties, Internal quality and
integrity controls, Data communication security,

User identification authorization, User level of accessibility, Restricted transactions, Activity and
exception reports, Backup procedures, Other operational security controls, Insurance coverage, Network
security including the internet, Internal auditing procedures, Contingency planning and disaster recovery,
Internet security procedures, Vendor due diligence etc.

IS Audit is an evaluation of adequacy of controls. In a computerized environment, controls can be

classified as under, which are verified by the IS Auditor:
A. Management Controls
1. Security Policy and Standards
2. Constitution of Steering Committee
3. Business Continuity Planning
4. Systems Development Methodology

B. Operational Controls
1. Monitoring physical assets
2. Ensuring adequate environmental controls such as Air-conditioning (dust, temperature &
humidity controls), Power Conditioning (Online UPS functioning all the time with backups,
proper earthing)

C. Organizational Controls
1. Defining roles, responsibilities and duties of User Departments and IT Department
2. Defining roles, responsibilities and duties within IT Department – such as developers,
operators and Administrators

D. Application Controls
1. Each of the Computer Systems and subsystems must have its own set of controls for Inputs,
Processing & Outputs. Processing controls should also ensure checks for legal compliance.
2. While performing the audit, each of the controls needs to be studied for its existence and
adequacy.

E. Environment Control
While performing the audit, adequate control over the physical item should be monitored like
i) Online UPS not used; either line-interactive UPS or Offline UPS used,
ii) Electrical cabling loose / points having loose contact.
iii) No separate earth pit for the Computing equipment.

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CAP III Paper 5: Management Information and Control System-Solution

iv) Switches/Hubs/Routers not fed UPS power.

v) Server room door kept open.
vi) AC not functioning properly, especially in summer.
vii) In winter AC set at 29 Deg C instead of 22 Deg C.
viii) No pest control measures taken.
ix) Eatables taken into server room/ Smoking in the server room.
x) Heavy duty printer kept inside server room: scope for dust.
xi) UPS, AC, other electricals not under regular AMC.
xii) No genset backup in case City power supply fails for long hours.
xiii) No smoke detectors/fire alarms in server room area.
xiv) Fire extinguishers not kept filled and ready.
xv) No fire drill carried out to make people aware of dos and don’ts

Answer No 22
Various offence relating to the computer under Electronic Transaction Act 2063 are as follow

Pirate, Destroy or Alter computer source code:

When computer source code is required to be kept as it is position for the time being the prevailing law, if
any person, knowingly or with malafide intention, pirates, destroys, alters computer sources code to be
used for any computer, computer programme, computer system or computer network or cause, other to do
so, he/she shall be liable to the punishment with imprisonment not exceeding three years or with a fine
not exceeding two hundred thousand Rupees or with both. Explanation: For the purpose of this section
"computer source code" means the listing of programmes, computer command, computer design and
layout and programme analysis of the computer resource in any form.

Unauthorized Access in Computer Materials:

If any person with an intention to have access in any programme, information or data of any computer,
uses such a computer without authorization of the owner of or the person responsible for such a computer
or even in the case of authorization, performs any act with an intention to have access in any programme,
information or data contrary to from such authorization, such a person shall be liable to the punishment
with the fine not exceeding Two Hundred Thousand Rupees or with imprisonment not exceeding three
years or with both depending on the seriousness of the offence.

Damage to any Computer and Information System:

If any person knowingly and with a mala fide intention to cause wrongful loss or damage to any
institution destroys, damages, deletes, alters, disrupts any information of any computer source by any
means or diminishes value and utility of such information or affects it injuriously or causes any person to
carry out such an act, such a person shall be liable to the punishment with the fine not exceeding two
thousand Rupees and with imprisonment not exceeding three years or with both.

Publication of illegal materials in electronic form:

If any person publishes or displays any material in the electronic media including computer, internet
which are prohibited to publish or display by the prevailing law or which may be contrary to the public
morality or decent behavior or any types of materials which may spread hate or jealousy against anyone
or which may jeopardize the harmonious relations subsisting among the peoples of various castes, tribes

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CAP III Paper 5: Management Information and Control System-Solution

and communities shall be liable to the punishment with the fine not exceeding One Hundred Thousand
Rupees or with the imprisonment not exceeding five years or with both.

If any person commit an offence referred above time to time he/she shall be liable to the punishment for
each time with one and one half percent of the punishment of the previous punishment.

Confidentiality to Divulge:
Save otherwise provided for in this Act or Rules framed hereunder or for in the prevailing law, if any
person who has an access in any record, book, register, correspondence, information, documents or any
other material under the authority conferred under this Act or Rules framed hereunder divulges or causes
to divulge confidentiality of such record, books, registers, correspondence, information, documents or
materials to any unauthorized person, he/she shall be liable to the punishment with a fine not exceeding
Ten Thousands Rupees or with imprisonment not exceeding two years or with both, depending on the
degree of the offence.

Inform false statement:

If any person with an intention to obtain a license from Certifying Authority under this Act or with any
other intention either to Controller or with an intention to obtain Digital Signature Certificate or with any
other intention conceals statement knowingly or lies any statement to be submitted to the Certifying
Authority any false statements shall be liable to the punishment with a fine not exceeding One Hundred
Thousands rupees or with an imprisonment not exceeding two years or with both.

Submission or Display of False License or Certificates:

If any person who works as a Certifying Authority without a license issued by the Controller under this
Act, shall be liable to the punishment with a fine not exceeding one hundred thousand Rupees or with an
imprisonment not exceeding two years or with both, depending on seriousness of the offence.

Any person without obtaining a license from the Certifying Authority publishes a fake license or false
statement in regard to license or provides to any person by any other means, shall be liable to the
punishment not exceeding one hundred thousand Rupees in the case where the act referred above has not
been accomplished by such a person.

If any person publishes or otherwise makes available a certificate to any other person by any means
knowingly that a certificate is not issued by the Certifying Authority referred to in such a certificate or the
subscriber listed in such certificate has not accepted the certificate or such a certificate is already
suspended or revoked, shall be liable to the punishment with a fine not exceeding one hundred thousand
Rupees or with an imprisonment not exceeding two years or with both. Provided that, if such a certificate
suspended or revoked is published or provided for the purpose of verification of the Digital Signature
before it was suspended or revoked, it shall not be deemed to have been committed an offence under this
Sub-section.

Non-submission of Prescribed Statements or Documents:

If any person responsible to submit any statement, document or report to the Controller or Certifying
Authority under this Act or Rules framed hereunder, fails to submit such statement, document, or report
within the specified time limit, such a person shall be liable to the punishment with a fine not exceeding
fifty thousand Rupees.

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CAP III Paper 5: Management Information and Control System-Solution

Any person who fails to maintain duly any book, register, records or account and in a secured manner to
be maintained duly and in a secured manner under this Act or Rules framed hereunder shall be liable to
the punishment with a fine not exceeding fifty thousand Rupees.

Commit computer fraud:

If any person, with an intention to commit any fraud or any other illegal act, creates, publishes or
otherwise provides digital signature certificate or acquires benefit from the payment of any bill, balance
amount of any one's account, any inventory or ATM card in connivance of or otherwise by committing
any fraud, amount of the financial benefit so acquired shall be recovered from the offender and be given
to the person concerned and such an offender shall be liable to the punishment with a fine not exceeding
one hundred thousand Rupees or with an imprisonment not exceeding two years or with both.

Abetment to commit computer related offence:

A person who abets other to commit an offence relating to computer under this Act or who attempts or is
involved in the conspiracy to commit such an offence shall be liable to the punishment with a fine not
exceeding fifty thousand Rupees or with imprisonment not exceeding six months or with both, depending
on the degree of the offence.

Answer No 23
The functions, duties and powers of the controller shall be as follows:-
(a) To issue a license to the certifying Authority,
(b) To exercise the supervision and monitoring over the activities of Certifying Authority,
(c) To fix the standards to be maintained by certifying authority in respect to the verification of digital
signature,
(d) To specify the conditions to be complied with by the certifying authority in operating his/her business,
(e) To specify the format of the certificate and contents to be included therein,
(f) To specify the procedures to be followed by the certifying authority while conducting his/her dealings
with the subscribers,
(g) To maintain a record of information disclosed by the certifying authority under this act and to make
provision of computer database accessible to public and to update such database,
(h) To perform such other functions as prescribed.

Answer No 24

Function of subscriber is to Generate Key pair:

Where any Certificate issued by the Certifying Authority and accepted by subscriber, consisting of a
public key which corresponds to the key pair and to be listed in such Certificate and if such key pair is
supposed to be generated by the subscriber only, then the subscriber shall generate such key pair by
applying the secured asymmetric crypto system.

if a Certifying Authority and the subscriber have concluded an agreement or the Certifying Authority
has accepted any specific system regarding the security system to be used to generate the key pair, then, it
shall be the duty of subscriber to apply the security system as specified in agreement or accepted by the
Certifying Authority.

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CAP III Paper 5: Management Information and Control System-Solution

Rights of subscriber is as follow

To Accept a Certificate:
(1) The certificate shall be deemed to have been accepted by the subscriber in the following conditions:

• If he publishes such a certificate or authorizes to publish to one or more persons, or

• If there exists any ground of his acceptance to such certificate which may cause to believe it.

(2) If the certificate is accepted it shall be deemed that the subscriber, by that reason, has guaranteed to all
who reasonably rely on the information contained in the certificate that-

• The subscriber holds the private key corresponding to the public key and is entitled to hold the
same,
• All representations and information made by the subscriber to the Certifying Authority in course
of issuance of the certificate are true and correct and all facts relevant to the information
contained in the certificate are true, and
• All information mentioned in the certificate is, to the best knowledge of subscriber, is true and
correct.

Duties of subscribers is as follow

i. To retain the private key in a secured manner:

• Every subscriber shall exercise reasonable care to retain control of the private key
corresponding to the public key listed in the Certificate and adopt all measures to prevent its
disclosure to a person not authorized to affix the digital signature of subscriber.
• If the private key has been disclosed or compromised by any reason whatsoever, then, the
subscriber shall communicate the same without any delay to the Certifying Authority and on
receipt of such information the Certifying Authority shall immediately suspend such a
Certificate.
• If a certificate is suspended under this Act, it shall be a duty of the subscriber to retain the
private key under this section in a safe manner throughout the duration of such suspension of
Certificate.
ii. To Deposit the Private Key to the Controller:
• If the Controller thinks, in order to protect the sovereignty or integrity of Nepal, to maintain
the friendly relations with friendly countries, to maintain the law and order, to prevent from
committing of any offence under the laws prevailing, and or in other conditions as prescribed,
necessary to issue an order to any subscriber to deposit the private key to him/her specifying
reason there for, such a subscriber shall immediately deposit the private key to the Controller.
• The controller shall not inform any unauthorized person about the private key deposited

Answer No 25

(a) The key benefits of Expert Systems are as follows:

• Expert Systems preserve knowledge that might be lost through
retirement, resignation or death of an acknowledged company expert.
• Expert Systems put information into an active-form so it can be summoned almost

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CAP III Paper 5: Management Information and Control System-Solution

as a real-life expert might be summoned.

• Expert Systems assist novices in thinking the way experienced professional do.
• Expert Systems are not subjected to such human fallings as fatigue, being too
busy, or being emotional.
• Expert Systems can be effectively used as a strategic tool in the areas of
marketing products, cutting costs and improving products.

(b) Inherent Limitations of Information Systems (IS) Audit are as follows:

• The nature of financial reporting;
• The nature of audit procedures
• The need for the audit to be conducted within a reasonable period of time and at
a reasonable cost.
• The matter of difficulty, time, or cost involved is not in itself a valid basis for the
auditor to omitan audit procedure for which there is no alternative or to be
satisfied with audit evidence that is less than persuasive.
• Fraud, particularly fraud involving senior management or collusion.
• The existence and completeness of related party relationships and transactions.
• The occurrence of non-compliance with laws and regulations.
• Future events or conditions that may cause an entity to cease to continue as a going
concern.

(c) Auditing physical access requires the auditor to review the physical access risk and
controls to form an opinion on the effectiveness of the physical access controls. This
involves the following:
• Risk Assessment: The auditor must satisfy him/herself that the risk assessment
procedure adequately covers periodic and timely assessment of all assets, physical
access threats, vulnerabilities of safeguards and exposures there from.
• Controls Assessment: The auditor based on the risk profile evaluates whether the
physical access controls are in place and adequate to protect the IS assets against the
risks.
• Review of Documents: It requires examination of relevant documentation such as
the security policy and procedures, premises plans, building plans, inventory list
and cabling diagrams.

(d) Encryption:
Encryption is the conversion of data into a secret code for storage in databases and
transmission over networks. The sender uses an encryption algorithm and the original
message called the clear text is converted into cipher text. This is decrypted at the
receiving end. The encryption algorithm uses a key. The more bits in the key, the
stronger are the encryption algorithms. Two general approaches are used for encryption
viz. private key and public key encryption.

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CAP III Paper 5: Management Information and Control System-Solution

(e) Call Back Devices:

It is based on the principle that the key to network security is to keep the intruder off
the Intranet rather than imposing security measure after the criminal has connected to
the intranet. The call- back device requires the user to enter a password and then the
system breaks the connection. If the caller is authorized, the call back device dials the
caller’s number to establish a new connection. This limits access only from authorized
terminals or telephone numbers and prevents an intruder masquerading as a legitimate
user. This also helps to avoid the call forwarding and man-in-the middle attack.

(f) Recording of Transaction Log:

An intruder may penetrate the system by trying different passwords and user ID
combinations. All incoming and outgoing requests along with attempted access should
be recorded in a transaction log. The log should record the user ID, the time of the
access and the terminal location from where the request has been originated.

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CAP III Paper 6: Advanced Taxation-Question

Paper 6: Advanced Taxation

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CAP III Paper 6: Advanced Taxation-Question

Revision Questions:
1. Question no.1
Define Resident person as per definition section of Income Tax Act, 2058. Advise the
resident status of the following cases.
Case 1: Mr. Tek Singh Permanent resident of Dadeldhura is in Dubai for three years
for foreign employment. During three years Mr. Tek is visited his home once in a year
in every three years. He is regularly sending 50% of his earning to home for his family.
Case 2: Suppose in the above case no.1 Mr. Tek Sing departure in Dubai in Bhadra 06,
2073 for foreign employment and return in Bhadra 05, 2075 in Nepal thereafter
regularly staying in Nepal than what is his residential status in Nepal for the different
financial year?
Case 3: Suppose in the above case no.1 Mr. Tek Sing working in Embassy of Dubai
Government of Nepal than what is his residential status in Nepal for the different
financial year?
Case 4: Trust Dubai is established in Dubai but control over Dubai Trust is by Nepal
resident person than what is the resident status of trust Dubai?

2. Question no.2
Define Tax as per Income Tax Act, 2058. As the tax advisor, what is the priority of
payment from the amount collected by Mr. Liquidator of Insolvent Company Limited
in the following cases?
“M/s Insolvent Company Limited become insolvent on dated 27th of Jestha 2076 having
with Limited Liability Company. On dated 15th of Ashad 2076 Company register office
has appointed Mr. Liquidator as liquidator of the Insolvent Company Limited. As on
the date of liquidation the company has NPR. 2 Million as Tax Deducted at Source
(TDS) liability and NPR. 6 Million Income Tax liability payable to Inland Revenue
Department. Inland Revenue department has served notice for payment of TDS and
Income tax liability within 15 days from the date 30 Jestha 2076. The company has
taken a loan from Ms. Puja Bank Ltd. NPR. 6 Million With fixed assets collateral
having with preferential right i.e Secured Creditors and other unsecured creditors are
NPR. 10 Million. In the process of liquidation, liquidation expenses are NPR. 0.5
Million. Mr. Liquidator has sold out all the assets of the company and collects cash of
NPR. 20.5 Million as on dated 31st Ashad 2076.”

3. Question no.3
Define payment as per income tax act 2058, identify whether the following payment is
payments or not as per the definition of Income Tax Act, 2058.

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CAP III Paper 6: Advanced Taxation-Question

a) Mr. Consultant has provided the consultancy service to M/s Service needed company
Limited of NPR. 150,000. M/s Service needed company Limited did not pay
consultancy fee but made set off of consultancy fee with receivable from Wife of Mr.
Consultant.

b) Ms. Deepa, Professional Doctor appointed as a regular doctor of M/s Service needed
company Limited for regular health checkup of all staffs of the company. The
company did not pay anything to the Doctor Ms. Deepa as his service but the company
made available of four-room space building for his office purpose and company
regularly paying NPR. 50,000 as rent.

c) Mr. Legal, legal advisor of M/s Service needed company Limited, a repair, and
maintenance Company of situated in the heart of Kathmandu. Mr. Legal did not take
anything as service fee but he regularly repair and maintenance of his office Car.

4. Question no.4
Define Employment as per Income Tax Act, 2058. What is the difference between a
contract of Service and contract for service as per Income Tax Manual 2066(update)?
As a tax advisor answer the following cases;

a) Ms. Sharada is doing the job in Everest Hotel Ltd. from the year 2064. In the year 2071,
the financial condition of M/s Everest Hotel is poor due to some business line closed
and Ms. Sharada is receiving 50% of his salary regularly only. In year 2075/76 the
financial condition of M/s Everest Hotel Ltd. is in good track and company has decided
the payment of employment salary pending from the year 2071 and Ms. Sharada has
received the pending amount in year 2075/076. What is the treatment of employment
amount received by M/s Sharada in year 2075/076?

b) Mr. Binod is working with NB Bank Ltd. in year 2074/075 huge fund of money is
needed for construction of Building and Mr. Binod has requested to the bank for the
salary of 2075/076 in year 2074/075 and bank has provided one year salary as advance.
What is treatment in these cases?

c) Mr. Shaker Adhikari, Program Coordinator of Law program of Law College of

Kathmandu, his total gross salary is NPR. 50,000 per months, total salary for the
financial year 2074/075 is NPR. 600,000 but Law college of Kathmandu did not
provide any salary to Mr. Adhikari in financial year 2074/075. In the months of
Shrawan 20, 2075 Mr. Adhikari received his salary from the Law College of
Management. What is the treatment of his salary for the purpose of Employment?

d) Mr. Govinda Ballab Joshi is Retired employee of Nepal Rastra Bank Ltd. Mr. Joshi
received pension income of financial year 2073/074 to 2074/075 in the financial year

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CAP III Paper 6: Advanced Taxation-Question

2075/076. What is the tax treatment of the amount received in financial year 2075/076
by Mr. Govinda Ballab Joshi?

5. Question no.5
Based on the following information calculate the Income Tax Liability of M/s GBJ
Sugar industries Ltd including applicable interest under section 118 and section 119 of
Income Tax Act, 2058 with reference of Finance Act, 2076.
A. General Information of the company:
M/s GBJ Sugar industries Ltd. is registered under the CRO and IRD for the financial
transaction of the company. Company have two division manufacturing and trading
unites.
B. Note to annual financial statements of the M/s GBJ Sugar Industries Ltd. for the
financial year 2075/076.
a) GBJ Sugar Industries Vat refund is related to sales of Jestha 2076.
b) GBJ Company export sales during the year to Indian counterparty.
c) Inland Revenue Department has assessed the financial transaction of the company
and the company has accepted the sale in under-invoicing as assessed by IRD i.e.
under invoiced Trading sales NPR. 900,000 and manufacturing sales NPR.4, 050,
000, as on 19.02.076. However, the assessment order is given in 05.05.2076 by IRO.
d) Salary expenses and NPR. 55,550,000 out of Production Expenses is the payment to
workers and staff of the companies. The status of the worker and staff in the
manufacturing unit for the year man are 261 and women are 159.
e) Manufacturing unites closing stock includes :
Particular
Raw Materials 1,800,000
Finished goods
Raw Materials 1,800,000
Production expenses 900,000
Repair Plant & Machinery 5,400,000
Depreciation 900,000
Interest 450,000 9,450,000
Total 11,250,000

f) Repair and maintenance Factory building is related to the Factory building.

Depreciation base for Block A is NPR. 45,000,000.
g) The company entire consumption of raw materials from Nepal production only.
h) The company has made an additional capital investment of NPR. 2 corers in this
financial year.

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CAP III Paper 6: Advanced Taxation-Question

i) Company has provided depreciation as per Income Tax Act, 2058 schedule -2 but
trading units includes of NPR. 600,000 cost of fiscal printer acquired on 19.03.2076
for issuing of bills. Depreciation base for block D is NPR. 30,000,000 before
deduction depreciation.
j) Expenses on disposal of the liability of the company include NPR. 120,000 bank
commission.
k) Income Tax Act, 2058 section 94 require to pay tax in installments but the company
did not pay any installments.
l) The company could not produce additional capital investment sources of income so
IRD includes the taxable income of the company.
m) The tax provision is provided by the companies is at the rate of 25% for the financial
year.
n) The companies have provided provisional for the bonus as per the Bonus Act, 2030.
o) Entire loan of the company borrowed from Bank is used by the chairman of the
company.
p) Other supporting to notes to financial statements:

Note-13 Manufacturing Trading Note 14 Manufacturing Trading

Cost of Goods
Sales Proceeds Sold
Sales 270,000,000 18,600,000 Opening Stocks 6,750,000 2,250,000
Raw Materials
Export sales 45,000,000 9,000,000 Purchased 30,000,000 22,500,000
Production
sales Returns - - Expenses 112,500,000 -
Raw materials
Total Sales 315,000,000 27,600,000 Returns - -
Note-18 Closing Stock (11,250,000) (11,250,000)
Administrative
expenses Manufacturing Trading Total 138,000,000 13,500,000
Salary
Allowances 9,916,667 2,125,000
Legal Fees &
Expenses 885,417 -
Business
Promotions - - Note 15 Manufacturing Trading
Miscellaneous
Donations - - Incomes
Cash Discount 3,541,667 - VAT Refund 5,833,333 -
Bank
commission 354,167 - Gift - -
Total 14,697,917 2,125,000 Total 5,833,333 -

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CAP III Paper 6: Advanced Taxation-Question

C. Extract financial statements of M/s GBJ Sugar industries Ltd.

Statement of Income for the Financial Year ended 2076
Particular Note Manufacturing Trading
NPR
Sales Proceeds 13 315,000,000 27,600,000
Less: Cost of Goods Sold 14 138,000,000 13,500,000
Gross Profit 177,000,000 14,100,000
Miscellaneous Income 15 5,833,333
Administrative expenses 18 14,697,917 2,125,000
Operating Profit 168,135,417 11,975,000
Interest Expenses 19 2,712,960
Depreciation Expenses 4 2,700,000 5,062,500
Profit Before Staffs
Bonus 162,722,457 6,912,500
Provision for Staffs Bonus 14,792,951 628,409
Profit Before Tax 12 147,929,506 6,284,091
Provision for Income Tax 36,982,377 1,571,023
Net Profit for the period 12 110,947,130 4,713,068

6. Question no.6
BBB Chartered Accountants registered sole proprietorship firm with the Institute of
Chartered Accountants of Nepal (ICAN) and Inland Revenue Department (IRD). The
firm for the purpose of the Tax accounting books of account is maintained on the Cash
basis of accounting. For the financial year 2075/076 the financial transaction of the
company are as below:
Particular Amt (NPR.)
Credit sales of Financial Year 2074/075 received in Financial Year
2075/076 100,000
Total Sales of the Financial Year 2075/076 2,000,000
Cash received from sales of Financial Year 2075/076 1,800,000
Total salary expenses of Financial Year 2075/076 400,000
Salary payment in Financial Year 2075/076 360,000
Outstanding salary of Financial Year 2075/076 paid in 2076/06/02 40,000
Cost of Goods sold and payment is made 1,200,000
Office Rent of Financial Year 2075/076 is paid in Financial Year
2074/075 180,000
Advance rent of Financial Year 2076/077 paid in Financial Year
2075/076 200,000
total interest expenses of Financial Year 2075/076 is 120,000
Outstanding interest expenses of Financial Year 2075/076 paid in
2076/05/02 20,000

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CAP III Paper 6: Advanced Taxation-Question

What shall be inclusion and deduction of BBB Chartered Accountants under cash basis
of accounting for the financial year 2075/076? Suppose, BBB Chartered Accountants
has applied to Inland Revenue Department (IRD) for change in accounting from cash
basis to accrual basis and IRD has approved which is in line with accounting standards
with effective from Financial Year 2075/076 than what is the procedures and what shall
be inclusion and deduction for tax accounting for the financial year 2075/076, advice to
BBB Chartered Accountants as tax advisor.

7. Question no.7
Airways Toothpaste Pvt. Ltd is registered with the Company Registered Office (CRO)
and the Inland Revenue Department (IRD). The transaction of the company is related to
the production and sales of toothpaste all over the world. On date 2075/02/30 the
company has an export of toothiest and issues bill of sales amount of US $ 100,000 to
M/s Thomas Incorporation Germany. The company has recognized sales amount NPR.
10,999,000 in the books of account with Nepal Rastra Bank (NRB) published exchange
rate of 1US $ 111.99. Airways Toothpaste received actual sales amount NPR.
10,999,000 on date 2075.08.03 with an Exchange rate of 1 US $ 109.99.

Similarly, the company has purchase Raw materials of Toothpaste from Thomas and
Thomas Incorporation by opening the Usance LC of 180 days Value of US $ 100,0000.
The raw material according to the specification of LC is imported from Birjung Custom
Office in 2075/03/15 with a clearance of goods with paying applicable Government of
Nepal Tax and recognized purchase cost of materials etc. is NPR. 11,199,000 in the
books of the accounts. The company has made payment of raw materials to the Thomas
and Thomas Incorporation on dated 2075/08/03 of NPR. 10,999,000.
Ms. Rana, CFO of the company is arguing that amount receivable and payable is
revalued as the yearend exchange rate for recognition in the financial statement as per
accounting standards foreign exchange. As tax advisor of the company advice about the
inclusion and deduction of foreign exchange gain and loss as per Income Tax Act, 2058
relevant provisions and CFO argument.

8. Question no.8
Following are the information related to Ms. Principal for the financial year 2076/077.
a) Ms. Principal is Principal of Excellence MBA College in Dadeldhura
b) Basic salary is NPR. 550,000 per month.
c) Excellence MBA College provides a contribution to the Social Security fund
established under the contribution-based Social Security Fund Act, 2074.
d) As per the letter of Board, Ms. Principal will receive Dashain allowance equal
to one month’s basic salary.
e) Ms. Principal will receive 15% as performance bonus each month of basic
salary and Gift from employer of value NPR. 250,000.

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CAP III Paper 6: Advanced Taxation-Question

f) College is providing residence facility allowance of NPR.50,000 per months

and medical allowance 5% of his salary per month.
g) Meeting allowance is per meeting of NPR. 15,000 per meeting and the total
number of meeting attained is 10 during the meeting session.
h) Educational allowance of his children 15,000 per months.
i) The college has taken a life insurance policy for Ms. Principal and with a
premium of NPR. 45,000.
j) College is providing care facility to Ms. Principal.
k) Ms. Principal donate NPR. 100,000 to tax-exempted entity.
l) Ms. Principal is received women excellence award from Women principals of
worlds group.
Required:
Calculate total tax liability of Ms. Principal with considering relevant provisions of
the Income Tax act, 2058(update if any by finance act 2076) for the financial year
2076/077.

9. Question no.9
Based on the following information, calculate the loan loss provision allowed for
deduction as section 59(1Ka) of Income Tax Act, 2058 of Bikas Bank Ltd. for the
financial year 2075/076.
Particular Amount (NPR.)
Outstanding Loan 34,321,121,782
Total Loan Loss Provision up to Ashad end 2076 1,139,240,503
Non-Banking Asset 110,262,573
Loan Written off during the year 21,099
Loan Loss provision claimed in Income Tax Return F/Y
2074-075 757,832,566

10. Question no.10

Mr. Raju koirala has 17 ropani lands in Bhaktpur, which is purchased in 2065 with the
cost of NPR.70 lac. Mr. Raju has planned to the sale of land after land planning for that
on Baikash 2075 he has developed land with accesses road, sewerage system
infrastructure and land are converted in 4/4 ana plots. The market value of the land on
that day is NPR. 2 corer.
At the time of land development, Mr. Koirala has spent NPR. 50 lac for an access road
and sewerage systems development is NPR. 30 lac. After completion of the land
development, all land has been sold at NPR. 3.5 corer by MR. Raju. What is the tax
treatment of the above transaction as per the provisions of Income Tax Act, 2058 and
capital gain directive 2072?

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11. Question no.11

Mr. Saroj Bhandari CA, resident in Texas of USA required 2 Ropani of land in capital
city Kathmandu. For the entire process of land purchase, he has appointed BBB
consultancy company Ltd. BBB Consultancy Company has published notice of 2
Ropani lands required in National newspaper. According to notice Mr. Rosahan and
Mr. Khagendra come to contact and wants to sell their land to Mr. Saroj through BBB
consultancy Ltd, which is as per the needs of Mr. Saroj but the land is two plots one
Ropani each in different areas. Mr. Roshan has priced his one ropani land of Nrs. 1.4
corer and Mr. Khagendra has priced his one Ropani land at NPR. 2 corers. The
consultancy company has charged NPR. 10 lac for his service fee, NPR.10 lac for
advertisement expenses, for NPR. 10 lac for legal documents and NPR. 10 lac for land
measurement. As tax advisor of BBB Consultancy Company how the cost of land
acquisition for Mr. Saroj is apportionment between two land plots and your advice must
be based on the relevant provision apportionment of outgoing and income of assets and
liabilities of Income Tax provisions 2058.
What happens if Mr. Saraoj sales plot of Mr. Roshan NPR. 2 corers after the purchase
of land?

12. Question no.12

You received mail from Mr. Chairman of Bhageshwor Hydro Pvt.

“Dear Chartered Accountant sir,

Namaste
I hope everything going good.

Respect sir,
We Bhageshwor Hydro Pvt. Ltd. has obtained a license of 30 megawatts hydro project
under BOT/BOOT concepts. We need to transfer the project to the government of
Nepal after 30 years of operation of the project as per term and conditions of
BOT/BOOT. We have lots of assets as per the definition of assets of the Income Tax
Act 2058 and we are providing deprecation accordingly. We have also purchased land
of NPR. 1.80 corer in the project is for the purpose of the project. Dear sir, please
suggest us regarding the treatment of land purchased by us and our CFO arguing that
deprecation on land is not allowed as per the Income Tax Act, 2058.”
Please, advise to Mr. Chairman of Bhageshwor Hydro Pvt. for the treatment of land
depreciation in Income Tax Act, 2058 and considering the relevant provision income
Tax manual.

13. Question no.13

Define receiver and Tax Debtor as per Income Tax Act, 2058. State the provisions of
Recovery of Tax from Receiver and liability of the officer of Entities as per relevant
provisions of Income Tax Act 2058.

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14. Question no.14

Bikash Housing Company Pvt. Ltd is registered with the Company register office
(CRO) Kathmandu and Inland Revenue Department (IRD). The main objective of the
company is related to build the residential building and corporate housing for the
individual as well as corporate house and after establishment, the company sales
residential building at cost plus profit but the company is not registered in VAT.
On Ashad end 2075, the company has built three and half-floor building with a cost of
NPR. 2.64 corer. The company has included the following payments;
Particular Amount(NPR)
Purchase of 6 Anna land for construction of Building 7,500,000
Development expenses of land 150,000
Consultancy fee for drawing of Building 150,000
Electricity development expenses paid to engineer 150,000
Consultancy fee paid for drawing of the design to engineer 150,000
Licenses for construction of Building map approval expenses 150,000
Building construction materials Bricks road, cements sand etc. 7,500,000
Wages for construction of Building 3,000,000
Cost of Electrification and sanitary 1,500,000
Wages of Electrification and sanitary 750,000
Salary of engineer for the supervision of building construction, Electrification,
and sanitations 900,000
Windows, main gate and wooden furniture and fixture expenses 2,250,000
Other overhead expenses 750,000
Electricity, water telephone line related expenses 150,000
Painting, furniture, fixture and flooring expenses 1,350,000
As a tax expert suggest management of Bikash Housing Company Pvt. Ltd for the
attraction of Vat on its transaction of construction of the commercial building. What
happens if not comply with the VAT Act 2052?

15. Question no.15

After the success of Visit Nepal Year 1998 and Nepal Tourism Year 2011, the Tourism
Board of Nepal introduced Visit Nepal Campaign 2020. The Campaign was announced
in 2015 to be held in 2018 but was later postponed to 2020. The mainstream media
publicized Nepal as utterly devastated by the earthquake in 2015 and failed to show that
Kathmandu with other major cities was almost intact. The earthquake significantly
affected the inflow of tourists in 2016 as the number of tourists halved compared with
the previous year. Currently, the country sees nearly one million tourist visitors yearly
and expect to double this number promoting Visit Nepal Campaign aggressively. M/s
Khagendra Distilleries manufacturer of all kinds of Alcohol products including Beer
Whiskey rum etc. International Brands in Nepal registered with company registered
office of Government of Nepal and Inland Revenue Department.

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Chief Operating Officer and Chief Finance Officer (CFO) of M/s Khagendra
Distilleries have planning to introduce the following scheme for targeting and
promotion of Tourist in 2020.

Particular Budget Remarks

Kathmandu –Pokhara (two ways) USD 212 2 Person
Kathmandu-Bhairahawa (two ways) USD 200 2 Person
KTM –Bharatpur(two ways) USD 190 2 Person
Five Star hotel Accommodation in all USD 100 Per night and the average
places stay for 2 night
All Alcohol Beer and whiskey other Free No limits for dinks

COO and CFO have planned some schemes for retailer wholesaler some free cartons of
alcohol to growth sales during the tourist year 2020. CFO has planned to book the
expenses incurred during this scheme under sales promotion expenses heading. Mr. Chief
Executive Officer of the M/s Khagendra distilleries seek your advice whether COO and
CFO proposed scheme is benefited to the company from a legal perspective.

16. Question no.16

a) Tax office of Department of Excise has wanted to issue show causes notice to delta Ltd.
because M/s Delta Ltd. had clearance goods without payment of excise duty. However,
M/s Delta Ltd has got information from reliable sources for show causes notice and
deposit excise duty with interest before issuing of actual notice. Mr. Ram and Ms. Sita
both the tax officer issue cause notice to M/s Delta Ltd. stating that why the M/s Delta
Ltd. should not be subject to a mandatory penalty equal to the excise duty sought to be
evaded under Excise Act, 2058. As a tax expert, state the conditions for levy of penalty
under excise Act 2058 and state whether there is any discretion to reduce Excise
penalty.

b) M/s Delta Ltd has filled VAT return of Months Baikash 2076 on 5th Ashad
2076. Actual liability of the Vat for the months of Baikash 2075 of M/s Delta Ltd. is
NPR, 2 million. As a tax advisor, you are required to compute the total amount payable
by M/s Delta Ltd. under Vat act 2052. Your answer must be based on the relevant
provision of VAT Act 2058.

c) M/s Delta Ltd has worked in dadeldhura district and registered with CRO and IRD for
power-related products in Nepal. Financial transaction of the company for the end of
Ashad 2076 is as under. Finding the vat implication on its transaction as per the Vat
Act 2052 and rules thereunder.

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Particular Amount (NPR.)

Consultancy fee paid to Germany 2,500,000
Computer equipment purchased 2,000,000
Office expenses 200,000
Telephone expenses 280,000
Purchase of car of CEO use in Office 3,000,000
Total Sales for the year 7,000,000
Export sales 4,000,000

17. Question no.17

A partial government-owned entity awarded contract M/s Nabarj Construction Pvt. Ltd.
of Bhairawa Airport in the months of Aahad end 2076. The total contract price is NPR.
500 Million Including Vat. According to the agreement Awarded party M/s Nabarj
Construction Pvt. Ltd. has submitted the first bill of NPRs. 50 Million excluding Vat.
Accordingly, government-owned entitles paid the amount after deduction of TDS and
other applicable tax. As tax advisor of M/s Nabaraj Construction how VAT payment is
treated under Vat Act, 2052 and Vat Rules, 2053. Your answer must be according to
the recent change provisions of the Vat Rules 2053.

18. Question no.18

Letter from Inland Revenue department
“Dear Chairman of M/s Production Ltd, the transaction between related-party
companies is unreasonable. As per section 3kha (3) of Excise Act, 2058, as Excise
Officer the company needs to pay excise duty as per difference between consumer price
and factory price. Due to unreasonable difference per unit’s transaction price to
consumer and wholesaler (related parties) you need to pay additional excise duty as
per the Excise Act 2058. We are considering imposing additional excise on the
company on the ground that factory price is not derived properly as prescribed by the
Excise Act, 2058.
Details of difference calculation is as under
Particular Amount
Consumer price 111
Normal commission to wholesalers 29
Transport expenses 17
Estimated selling cost 46
Modified consumer price 65
Factory price to wholesaler 42
Difference 23

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In addition to the above, Chairman Inland Revenue Department what to buy Stock
of the company at the price valued by your company due to under-invoicing.
Mr. Chintamani
Tax Officer (IRD) 05, Bhadra 2076”
General Information and Financial Transaction Production Ltd
M/s Production Ltd. is registered with VAT, Excise (IRD) and CRO in Nepal for
production of high-quality packing materials. It has another company for distribution of
packing materials named Distribution Ltd holding 100% share in it.
Other information:
 The standard input and output ration of the raw materials and its finished product is 1:92,
i.e there is a production losses in the process.
 Customs duty is paid @33% of the landed cost is not included in the above data.
 The rate of excise duty on the product is 7% of the value.
 Margin is 24.5% of Factory price
 Distribution Ltd. sales its products at NPR. 111 and normal commission to distributors
for such product paid by other considering best standard practice is NPR 29 per Kg and
other transport expenses are NPR. 17 per Kg.
 Details of the financial transaction on Bhadra end 2076 are:

Particular Amount(NPR)
Import of plastic Raw materials-600 tons 8,625,000
Clearing and forwarding expenses at customs 1,293,750
Carriage Inward incurred 741,750
Factory Wages 2,113,125
Other production costs 1,322,500
Raw Material Stock Bhadra end 2076 300 ton
Finished product Stock Bhadra end 2076 90 ton
The company purchased Scoter Price of these vehicles is
inclusive of VAT 1,271,250
Based on the above issues answer the following questions.
a) Is a letter issued by excise officer is as per the Excise Act, 2058?

b) Vat payable and receivable for the months of Bhadra end 2076.

c) Comments about under-invoicing and IRD consent to bur of the stock of the
company and IRD have assessed additional VAT of finished goods sold on the
ground that the product was heavily under invoiced than the prevailing market
price. State the relevant provision of Value Added Act, 2052.

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d) M/s Production Ltd, raw materials are destroyed by the electricity short on
Bhandra end 2076. What are the obligation consequences and time limit to the
company as per the Vat Act 2052, Custom Act 2064 and Excises Act 2058?

19. Question no.19

Write a short note in the following topics based on the recent change in Financial
Act 2076
a) Special provision for startup Business.
b) Tax payment more than NPR. 10 Lac
c) Vat Refund
d) Amount deposit for administrative review
e) Infrastructure tax rebate

20. Question no.20

What do you understand by NII-Equipment’s? Explain types of NII- equipment’s,
benefits and Constrains to NII.

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Suggested Answers/Hints:
1. Answer to Question no.1
According to section 2(Ka Na) of Income Tax Act, 2058, Resident person with respect
to an income-year means-
1) In the case of an individual, an individual-
whose normal place of abode is in Nepal and who is present in Nepal for 183 days or
more in the 365 consecutive days, or who is an employee or an official of Government
posted abroad at any time during the income year;
(2) Any partnership;
(3) In the case of a trust, a trust that-
• is established in Nepal;
• has a trustee that is a resident person for the income-year; or
• is controlled directly or through one or more interposed entities by a person or
persons one of whom is a resident person for the income-year;

(4) in the case of a company, a company that-

• is incorporated or formed under the laws of Nepal; or
• has its effective management in Nepal during the income year;

(41)Government of Nepal or province government

(5) a Rural municipality, municipality or district coordination committee;
(6) in case of a foreign government or a political subdivision of the foreign government,
such an entity-
• if it is established under the laws of Nepal; or
• has its effective management in Nepal during the income year; and

(7) any institution or entity established under the treaty; and

(8) a foreign permanent establishment of a non-resident person situated in Nepal.

Case 1: According to income Tax manual Habitual place of abode means where
economic activities taken place and being permanent address is in Nepal doesn’t
indicate Habitual place of abode is in Nepal. In the given cases the permanent address
of Mr. Tek sing is at Dadeldhura but economic activities are taken place in Dubai, so
habitual place of abode is not in Nepal.
Case 2: In the given cases, Mr. Tek Sing is in the first 365 continuous days i.e 6th
Bhadra, 2073 to 5th Bhadra, 2074 his stay in Nepal is less than 183 days so for financial

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year 2073/074 is residential status is non-residence person. Similarly, in the continuous

period of 6th Bhadra, 2074 to 5th Bhadra 2075, he is in Dubai so for financial year
2074/075 his residential status is also non-residence. Finally, for financial year
2075/076 is not resident up to 5th Bhadra 2075 and thereafter he is residential in Nepal
so his residential status is resident for financial year 2075/076.
Case 3: In the case of the government of Nepal has deputed any person in any of its
offices outside Nepal than his residential status is resident. So in these case, the
residential status of Mr. Tek Sing is Resident in Nepal.
Case 4: In the given case, Trust Dubai is controlled directly or through one or more
interposed entities by a person or persons one of whom is a resident person for the
income-year so the residential status of the Trust Dubai is Resident.

2. Answer to Question no.2

As per section 2(Dha) of Income Tax Act, 2058, Tax means income tax imposed under
this act and includes the following payments: -
(1) Expenses incurred in the process of creating a charge and performing auction of the
property of tax creditor by the department as mentioned in section 104 (8) (a);
(2) the amount payable by a withholding agent or withholdee under section 90, or
amount payable by an installment payer under section 94, amount payable by
Withholding agent tax deducted at sources as per section 95 Ka and amount payable on
assessment under sections 99, 100, and 101;
(3) the amount payable to the Department in respect of tax liability of a third party
under section 107(2), 108(3) or (4), 109(1), and 110(1);
(4) The amount payable by way of interest and penalties under Chapter 22 of the
Income Tax Act 2058; and
(5) The amount payable by way of fines in order of the department as per section 129.

Payment priority of M/s Insolvent Company Limited by Mr. Liquidator as on

dated 31st Ashad 2076.

S.No. Particular Amount Remarks

1 Amount collection 20,500,000
2 Less: Expenses of liquidation (500,000) Note 1
3 Less: Tax Deducted At Source (TDS) liability (2,000,000) Note 2
4 Less: Secured Creditors (preferential Right) (6,000,000) Note 3
5 Less : Income Tax payable (6,000,000) Note 4
Remaining amount 6,000,000 Note 5

Note 1: as per section 104(8ka) of the Income Tax Act 2058, expenses of liquidation
i.e notice of liquidation, legal expenses incurred during the process of the auction are
allowed for deduction. Therefore NPR. 500,000 has first right over the payments. ( as

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per section 2 Dha(1) of Income Tax Act 2058 and as per section 105(5) of Income Tax
Act 2058)
Note 2: and as per section 105(5) of Income Tax Act 2058 and as per section 2 Dha(2)
of Income Tax Act 2058, NPR. 2 Million TDS liability need to pay to IRD as a second
priority by the Liquidator.
Section 105(5) of Income Tax Act 2058 has following provision for auction of charged
assets “The proceeds of an auction under subsection (4) of Section 105 shall be used to
pay the costs of charge and auction of the assets sold, then to pay the tax payable and
interest accrued with respect to that tax under section 119, and any remainder shall be
paid to the tax debtor” and income tax manual 2066(Updated) also clarify secured
creditors with preferential right over the other tax payment while making payment by
liquidator.
Note 3: after payment of tax Mr. Liquidator has to pay NPR. 6 Million Secured
Creditors (preferential Right) (Section 105(5) of Income Tax Act 2058 and Income tax
manual 2066(Updated))
Note 4: after payment of Secured creditors Mr. Liquidator need to pay Income tax
Liability of NPR. 6 Million, as per section (Section 105(5) of Income Tax Act 2058 and
Income tax manual 2066(Updated))
Note 5: amount remaining after above payment NPR. 6 million shall be distributed over
the unsecured creditors on a proportionate basis.

3. Answer to question no.3

According to section 2(Ha) of Income Tax Act, 2058, Payment means,
(1) The transfer by one person of money or an asset to another person or the transfer
by another person of a liability to the one person;
(2) The creation by one person of an asset that on creation is owned by another
person or the decrease by one person of a liability owed by another person;
(3) The provision by one person of services to another person; and
(4) The use, or availability for use, of an asset owned by one person to another
person.
a) According to section 2 ha(1) of the Income Tax Act, 2058, the transfer by one
person of money or an asset to another person or the transfer by another person of a
liability to the one person is defined as payment in this cases consultancy fee set off
by M/s Service needed company Limited of NPR. 25,000 is considered a payment.
b) According to section 2ha (3) and 4 of the Income Tax Act, 2058, the provision by
one person of services to another person; and the use, or availability for use, of an
asset owned by one person to another person is considered as payment in this case
M/s Service needed company Limited assets (lease right) has provided to Doctor so
NPR. 50,000 is considered a payment received by Doctor Ms. Deepa.

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c) According to section 2ha (3) and 4 of the Income Tax Act, 2058, the provision by
one person of services to another person; and the use, or availability for use, of an
asset owned by one person to another person is considered as payment in this case,
M/s Service needed company Limited is providing repair and maintained service to
Mr. Legal advisor for his legal fee in this case, this transaction is also considered as
payment under Income Tax Act 2058.

4. Answer to question no.4

As per section 2(Gya) of Income Tax Act 2058, employment includes past, present or
prospective employment. Contract of service indicates the employment and contract for
service mean consultant service. As per section 22(2) of Income Tax Act, 2058 income
from employment and investment of natural person is accounting as per the cash basis
of accounting. According to income received of the present, a past or prospective
employer is income included in the year of actual received.

a) In this case, the company has allowed to accounting expenses as accrual basis in the
financial year in which this is accrued but in the case of Ms. Sharada, this is taxable in
year 2075/076 financial year at the time of cash received.

b) Even Mr. Binod has received a salary in year 2074/075 but NB bank needs to included
employment income of Mr. Binod in the financial year 2075/076 and tax shall be
deducted as per income tax provisions.

c) As per section 22(2) of Income Tax Act, 2058, the income of a natural person from
employment and investment income is accounting on the cash basis of account and this
is more clarify by Income Tax Manual 2066(updated) that income is taxable in the year
of cash received. In the given cases income of financial year, 2074/075 is received in
year 2075/076 by Mr. Adhikari so Income is taxable in the year 2075/076 as actual cash
received.

d) According to section 3 of Income-tax, Act 2058, Income Tax is imposed on a yearly

basis of income. Supreme Court on the issue of past employees of Nepal Rastra Bank
vide case no.2677, decided on 2064/04/23 that Income Tax on pension income should
calculate on a yearly basis. As per this decision, Mr. Govinda Ballab Joshi retirement
income (pension income) is taxable on a yearly basis of income.

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5. Answer to question no.5

Calculation of Tax Liability of M/s GBJ Sugar industries Ltd. for the financial year
2075/076
Calculation of Taxable Income Manufacturing Trading
Sales(WN#1) 319,050,000 28,500,000
VAT Refund(WN#5) - -
Total inclusion 319,050,000 28,500,000
Dedication:
General deduction u/s 13 29,490,867 2,753,409
Interest Expenses u/s 14 - -
Cost of Goods Sold u/s 15 145,650,000 13,500,000
Repair and Maintenance u/s 16 4,050,000 -
Depreciation expenses u/s 19 3,600,000 5,062,500
Total Deduction 182,790,867 21,315,909
Adjusted Taxable income 136,259,133 7,184,091
Less:
Research and Development expenses u/s 18 -
Donation u/s 12 -
Taxable Income 136,259,133 7,184,091

Calculation of Tax Liability Manufacturing Trading

Taxable Income 136,259,133 7,184,091
Local sales portions 117,040,637 -
Export sales 19,218,495 -
Manufacturing applicable rate (Local) 18% -
Manufacturing applicable rate (Export) 15% -
Manufacturing applicable tax(Local) 21,067,315 -
Manufacturing applicable Tax (Export) 2,882,774 -
Tax Manufacturing tax liability 23,950,089 -
Taxable income of trading units 7,184,091
Trading unit -export income portion of
taxable income 2,268,660.29
Trading unit -local income portion of
taxable income 4,915,431
Trading income export is 19% 425,374
other income is 25% 1,228,857.66
Total tax liability trading 1,654,231
Total liability 25,604,320
Interest u/s 118 2,016,340
Interest u/s 119 -
Total tax liability including fine and
penalty 27,620,661

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WN#1
Sales Proceeds Manufacturing Trading
Sales 270,000,000 18,600,000
Add: additional sales 4,050,000 900,000
Export sales 45,000,000 9,000,000
Total Sales 319,050,000 28,500,000

Assessment done by IRD is related to this financial year and accepted by the company
which is included in the taxable income.

WN#2
Cost of Goods Sold
Opening Stocks 6,750,000 2,250,000
Add: -
Raw Materials Purchased 30,000,000 22,500,000
Production Expenses(WN#5) 112,500,000 -
Less:
Raw materials Returns -
Closing Stock (WN# 3) (3,600,000) (11,250,000)
Total 145,650,000 13,500,000

WN# 3
Closing Stock 11,250,000 11,250,000
Less: Repair and Maintenance u/s 15(8) included
in production expenses (900,000)
Less: Repair and Maintenance u/s 15(8) (5,400,000) -
Less Depreciation expenses u/s 19 (900,000) -
Less interest expenses u/s 14 (450,000) -
Total 3,600,000 11,250,000

Note: As per section 15(8), Repair and Maintenance, depreciation shall not be included
in Valuation of Closing stock and again as per the circular of department dated
2066.02.27, interest shall not be included in the calculation of closings stock.

WN#4
Production expenses include in closing stock repair and maintenance is separately
claimed u/s 16 and this is not part of closing stock.

WN#5
Under section 17 of the Vat Act, 2052, Vat can be offset, so Vat refunded is not part of
taxable income.

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WN#6 Calculation of Repair and Maintenance u/s 16

WN#6
Calculation of allowable Repair and Maintenance u/s 16.
Depreciable Base of Block D 40,000,000
Allowable repair @ 7% 2,800,000
2,800,000
Actual Repair of Plant and machinery
included in production expense 900,000
Minimum of above 900,000
Depreciable Base of Block B 45,000,000
Allowable repair @ 7% 3,150,000
Actual expenses 5,400,000
allowed repair and maintenance for Building 3,150,000
Total Repair and maintenance u/s 16 4,050,000

WN#7 Calculation of Depreciation

As per section 3(4) of schedule 2 of Income Tax Act, 2058, any person may
deduct the expenditure incurred on the fiscal printer and cash machine as
depreciation expenses, if the person issues bill through it. Expenses incurred for
the fiscal printer is allowed as whole depreciation.
Total Depreciation Manufacturing Trading
As Per statement of income 2,700,000 5,062,500
depreciation included in closing stock 900,000 -
Total allowed depreciation 3,600,000 5,062,500

WN#8
Commission paid for discharging liability is deductible expenses as per Income
Tax Act.

WN#9 Interest Expenses u/s 14

Interest expenses NPR. 2,712,960 and addition to closing stock NPR. 450,000 is
not allowed u/s section 14 of Income Tax Act, 2058 as a deduction, it is used by
Chairman of the company for the personal purpose.

WN#10 General Deduction:

Salary Allowances 9,916,667 2,125,000
Legal Fees & Expenses 885,417 -
Cash Discount 3,541,667 -
Bank commission 354,167 -
Bonus expenses 14,792,951 628,409
Total 29,490,867 2,753,409

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WN# 11 Applicable tax rate

a) Schedule 1 section (2)1, rate of tax on the trading business of entity is 25%.
b) as per section11 (2) (Kha) (Amended as per Finance Act, 2076); tax rebate of
20% provided for applicable tax and additional other benefits can be taken as per
this section(11) of Income Tax Act, 2058.
c) as per section11 (3) (ka) (Amended as per Finance Act, 2076); if direct
employment in the industry throughout the year is for 300 or more Nepali citizens
the effective tax rate shall be 80% of the prevailing rate, Additional as per same
section additional 10% tax rebate shall provide if 33% or more women are
employed throughout the year. Same the company are providing the
same.
d) As per Section 11(3na) Kha if an industry exports goods that it has manufactured,
tax rebate shall be granted by twenty percent on the rate of tax applicable on
income earned therefrom. And an additional 25% rebate shall be provided after-
tax applicable after this rebate for manufacturing industries.
e) As per Section (4) of section 11 of Income Tax Act 2058, a person who is entitled
to a concession under this section shall calculate the income referred to in those
subsections as though the income was the only income derived by a separate
person.
f) 11(5) where a person qualifies for more than one concession under subsections
with respect to the same income, the person shall only be entitled to one
concession with respect to that income but shall be entitled to select which
concession applies.
Applicable Tax Rate manufacturing Trading
Local
Local sales Export sales sales Export sales
Actual Tax Rate (a) 25% 25% 25% 25%
as per point above (b) 20% 20% 25% 25%
applicable tax rate as
considering above point (c) 18% 18% 25% 25%
Additional 113na kha(d) 18% 15% 25% 19%
Accordingly, the rate of manufacturing units local sales is 18% and export sales
are 15% and the rate for trading units local sales is 25% and trading units export
sales are 19%.

WN# 12 As per section 11kha of income Tax act 2058

As per section 11kha of Income Tax Act 2058, “Concession on National
Importance Infrastructure Development Project” Arrangement has been made not
to look into the income source of manufacturing industries IRO cannot include
additional capital investment amount in taxable income. This provision is
canceled by financial act 2076 from financial year 2076/077 this amount is
taxable as per the latest amendments.

WN# 13 Total Interest u/s 118

The interest is calculated up to the time that the return is to be filed as per Sec.118
(2),i.e. up to Aswin end.

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Fine
Installment Required Required Deposited Fine period
First installment required
40% 10,241,728 - 384,065 3 months
Second installment required
70% 17,923,024 - 672,113 3 months

Final installment 25,604,320 - 960,162 3 months

Total Interest u/s 118 25,604,320 - 2,016,340

Interest under 119 - - - 3 months

WN# 14 Calculation of Interest u/s 119 (Interest for failure to pay tax)
Interest for failure to pay tax shall be charged @ 15% p.a. for the period from Kartik,
2076 to date of return filing on a monthly basis. We assumed that return is submitted in
the months of Ashwin end 2076 so no more interest as per section 119 shall be
chargeable. However, under the provision of Sec. 119 'Ka' changes for noncompliance
will be levied as set form in Sec. 128. If the return is not filed before Aswin, the
company will be liable for fees under sec.117 (1)Kha.

6. Answer to question no. 6

According to section 22(2), Method of Accounting of Income Tax Act, 2058, an
individual shall account for tax purposes on a cash basis in calculating the individual's
income from an employment or investment”.
Similarly According to section 23(a) of Income Tax Act 2058, in related to cash basis
of accounting person’s income from an employment, business or investment shall treat
an amount as is derived and include in that calculation only when payment is received
or made available to the person and similarly section 23(b) of income tax act 2058,
incur an expenses to be deducted in that calculation only when payment is made

Under the cash basis of accounting amount inclusion and Deduction in financial
year 2075/076
Particular Amount (NPR.)
Inclusion
Credit sales of Financial year 2074/075 received in Financial year
2075/076 100,000
Cash received from sales of financial year 2075/076 1,800,000
Total Inclusion in financial year 2075/076 1,900,000
Deduction:
salary payment in financial year 2075/076 360,000
Cost of Goods sold (U/s 15) 1,200,000
Office Rent of Financial year 2075/076 is paid in financial year 2074/075 -

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advance rent of financial year 2076/077 paid in financial year 2075/076 200,000
Interest expenses payment made in financial year 2075/076 100,000
Total Deduction 1,860,000
Accordingly BBB Chartered Accountants firm shall be the inclusion of income NRs
1,900,000 in income and Deduction of Expenses of NPR. 1860,000

Under the section 22(5) of Income Tax Act, 2058, a person may apply in writing for a
change in the person’s basis of accounting for tax purposes and the Department may, by
notice in writing and if satisfied that the change is necessary to clearly reflect the
person’s income, approve the application. In this case, IRD has approved for a change in
method of accounting.

According to section 24(2) of Income Tax Act, 2058, for purpose of Accrual basis of
accounting, For the purpose of deduction in calculating a person's income as mentioned
in subsection (1), the following expenses shall be treated as incurred-
(a) in the case where the payment constituting the expense is to be made in return for a
payment or payments received from another person, the expense shall be treated as
incurred in the following conditions- (1) when the person is obliged to make the payment;
(2) the value of the obligation can be determined with reasonable accuracy; and(3) the
other payment has been received; or
(b) in any other case, except as provided in paragraph (a), the expense shall be treated as
incurred when the payment is made.

Under Accrual Basis of Accounting BBB Chartered Accountants amount inclusion

and deduction for financial year 2075/076
Particular Amt (NPR.)
Inclusion
Credit sales of Financial year 2074/075 received in Financial year
2075/076 -
Total Sales of the financial year 2075/076 2,000,000
Total Inclusion in financial year 2075/076 2,000,000
Deduction:
Salary expenses 400,000
Cost of Goods sold (U/s 15) 1,200,000
Office Rent of Financial year 2075/076 is paid in financial year
2074/075 180,000
advance rent of financial year 2076/077 paid in financial year
2075/076(Advance) -
Interest expenses 120,000
Total Deduction 1,900,000

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Accordingly BBB Chartered Accountants firm shall be the inclusion of income NRs
2000, 0000 in income and Deduction of Expenses of NPR. 1,900,000.

7. Answer to question no. 7

According to section 24(4) of the Income Tax Act. 2058 In case where a person
includes a payment to which the person is entitled or deducts a payment that the person
is obliged to make in calculating the person's income from a business or investment on
an accrual basis, and the actual payment received or made by the person comes to be
different including by reason of a change in currency valuations that took place
afterward, an appropriate adjustment should be made at the time the payment is
received or made so as to account for the inaccuracy.
According to the above provisions, Airways Toothpaste Pvt. Ltd, Exchange Gain/Loss
for the financial year 2075/076.

In the case of Sales

Particular US $ US $ rate (NRB) NPR.
Sales 1000000 111.99 111,990,000
Sales Amount Received 1000000 109.99 109,990,000
Exchange Loss 2,000,000
In case of Purchase
Particular US $ US $ rate (NRB) NPR.
Purchase 1000000 111.99 111,990,000
Actual payment made 1000000 109.99 109,990,000
Exchange Gain 2,000,000

Accordingly, in the financial year 2075/076, the company can take a deduction of NPR.
2000,000 exchange loss and inclusion in income of Exchange gain in the financial of
financial year 2075/076.
As per section 28(2) of Income Tax Act, 2058, Where an amount to be included or
deducted in calculating a person's income for an income-year is quantified in a currency
other than Rupees, he amount shall be converted at the standard exchange rate
applying between the currency and the Rupee at the time the amount is derived,
incurred, made, received, or otherwise taken into account for tax purposes.
The argument of Ms. Rana CFO is not according to the provision of Income Tax Act,
2058 but in line with the accounting standards. Accordingly for the last day of financial
year 2074/075, whatever the exchange rate than the date of 2075.02.30 increase or
decrease at that day the company is not allowed booked exchange gain or loss due to
unrealized amount in case of sales and payment not made in case of payment for the
purpose of inclusion and deduction of exchange gain or loss i.e at the time the amount
is derived, incurred, made, received, or otherwise taken into account for tax purposes.

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8. Answer to question no. 8

Calculation of Taxable Income of Ms. Principal for the financial year 2076/077

Particulars Amount Unit Amount (NPR.)

Basic Salary - Sec.8(2) (Ka) 550,000 12 6,600,000
Contribution to Social Security Fund
(20% of basic salary contributed by
employer) 110,000 12 1,320,000
Dasain Bonus - Sec.8(2) (Ka) 550,000 1 550,000
Performance Allowance (15% of basic
salary each month) 82,500 12 990,000
Gift from employer 250,000 1 250,000
Residential Allowance 50,000 12 600,000
Medical Allowance (5% of basic salary) 27,500 12 330,000
Meeting Allowance (Final Withholding,
not included in assessable income) - -
Cost of education of children paid by
employer 15,000 12 180,000
Cost of life policy reimbursement by
employer 45,000 1 45,000
Quantification of Vehicle Facility (0.5%
of basic salary) 33,000 1 33,000
Assessable income 10,898,000
Reduction
Donation (Min of below three conditions)

5% of AI (5% of 10,898,000) 544,900

NPR. 100,000 100,000 100,000
Actual payment 100,000
Life Policy (Minimum of below two
conditions) 25,000
NPR. 25,000 25,000 25,000
Actual payment 45,000
Approved Retirement Fund (Minimum of below three
conditions) (Social Security Fund is ARF as per Finance
Act of 2076.77)
300,000
NPR. 300,000 300,000 300,000
1/3rd of AI 3,632,667
Actual payment (NPR. 550,000*31%*12) 2,046,000
Taxable income 10,473,000
No Social Security tax for 450,000 -
10% for Next 100,000 10,000

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20% for Next 200,000 40,000

30% for Next 1250,000 375,000
above 2000,000 @36% 3,050,280
Total Tax 3,475,280

Note: As per requirement of Contributed Social Salary Act, 20% of basic salary
contributed by the employer and 11% deducted from her salary and total of 31%
deposited to Social Security Fund (as per the requirements of Contribution to social
security fund act 2074). 1% social security tax also not applicable.

9. Answer to question no. 9

As per Income Tax Act 2058, section 59 (1)ka of Income Tax Act 2058, Provision
made by a person running banking business to cover the risk for outstanding loan will
be deductible up to a limit of 5 percent of total outstanding loan and Non-Banking
assets under the norms and standards prescribed by the Nepal Rastra Bank maintained
in risk bearing fund.
Allowable Loan loss provision for the FY 2075-76 shall be as following:
a. O/S loan as on year end 34,321,121,782
b. Loans written off during the year 21,099
c. Provision for Non-Banking Assets 110,262,573
Total (a+b+c) 34,431,405,454
d. 5% provision of the loan 1,721,570,273
e. Loan Loss claim in Tax up to Previous Year 757,832,566
f. LLP provision up to 2075/76 1,139,240,503
Allowable LLP: Minimum of
(f)-(e) 381,407,937
(d)-(f) 963,737,707
g. Allowable Loan loss Provision For FY 2075/76 381,407,937

10. Answer to question no. 10

As per sub-section 3(d) of section 40 of Income Tax Act, 2058 in the case of an asset
that is a business asset, non-business chargeable asset, depreciable asset, or trading
stock, immediately before the person begins to use the asset in such a way that it ceases
to be an asset of the type it was immediately prior to that use is deemed disposal.
Similarly as per section 41 of Income Tax Act, 2058, “Disposal with Retention of Asset
or Liability” In the case where a person disposes of an asset or liability in any of the
manners described in section 40(3)(c), (d), (e) and (f), the following provisions shall be
applied:-
(a) in the case of an asset-
(1) the person shall be treated as deriving an amount in respect of the disposal equal to
the market value of the asset at the time of the disposal; and

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(2) for the purpose of the subsequent disposal of the asset, the net outgoings for the
asset to the time of the disposal under this Section shall be treated as equal to the
amounts derived.
(b) in the case of a liability-
(1) the person shall be treated as incurring expenses for the disposal in an amount equal
to the market value of the liability at the time of disposal; and
(2) for the purpose of the subsequent disposal of the liability, the net incomings for the
liability to the time as per Sub-clause (1) shall be treated as equal to the number of
outgoings.

As per provision of the Income Tax Act 2058, on date 2075 Baikash Mr. Raju has
changed the structure of the land originally it was which is deemed disposal of land and
disposal with retention. On this date following capital gain on disposal of land arise.
On date 2075 Baikash 2075.
Incoming from land (Market Value) NPR. 2 corer
Outgoing of land (Outgoing of land) NPR. 70 lac
Capital gain is NPR. 1.30 Corer
In this case, capital gain of Mr. Raju on disposal of Non-business Chargeable assets is
NPR. 1.3 corer on the date of development of land.

In the case of actual disposal of land the nature of the assets change from Non-
Business chargeable assets to business assets the actual gain on the date of disposal is:
Incoming from land (Market Value) NPR. 3.5corer
Outgoing of land (Outgoing of land);
Outgoing of land: Marker value in the change of assets plus the cost of the access road
and sewerage systems development (2 corers +50lac +30 lac) (on the person shall be
treated as incurring expenses for the disposal in an amount equal to the market value of
the liability at the time of disposal
Outgoing of land: NPR. 2.8 corer
Capital gain is NPR. 70 lac and in which tax is applicable as business tax rate rather
than non-business chargeable assets.

11. Answer to question no. 11

Apportionment of joint cost of land purchased between two plots of land as per
Section 49 of Income Tax Act, 2058
Price of Land -Mr. Roshan 14,000,000
Price of Land -Mr. Khagendra 20,000,000
Total cost of land 34,000,000
Percentage of Land cost of Mr. Roshan in the total cost 41.18%
Percentage of Land cost of Mr. Roshan in the total cost 58.82%
Capitalize expenses details
the consultancy fee of BBB Company Ltd. 1,000,000
Advertisement Expenses 1,000,000

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Legal Documents Expenses 1,000,000

cost of land measurement 1,000,000
Total cost to be capitalized 4,000,000

cost to be capitalized in the land of Mr. Rosha 1,647,059

cost to be capitalized in the land of Mr. Rosha 2,352,941

The total cost of Mr. Roshan 15,647,059

Total cost of MR.Khagendra 22,352,941
The total cost of two ropani of Mr. Saroj 38,000,000
Note: 1:
As per section 49 of Income Tax Act, 2058 apportionment of outgoing and incomings are
determined with the following provisions
1) In the following circumstances, a person shall be required to apportion the costs
incurred or the amounts derived by the person in acquiring, incurring, or disposing of
each asset or liability between the assets and liabilities according to their market values at
the time of acquisition, incursion, or disposal, as the case requires:
(a) in case the person acquires one or more assets or incurs one or more liabilities at the
same time; or
(b) in case the person disposes of one or more assets or liabilities at the same time,
In the case of sales of land by Mr. Saroj
Net gain or loss on sales of land by Mr. Saroj(land of Mr. Roshan)

Total Incoming (sales price of land) 20,000,000

Total outgoing (cost of land) 15,647,059
Gain on sales of land(Note-2) 4,352,941
Note: 2
According to section49 (2) of the Income Tax Act, 2058, Where a person who owns an
asset or liability disposes of part of the asset or the liability, then the net outgoings or net
incomings of the asset or liability immediately before the disposal shall be apportioned
between the part of the asset or liability disposed of and the part retained according to
their market values immediately after the disposal. Accordingly, the total incoming of
land is NPR. 2 corer, total outgoing of land (cost of land) is NPR. 15,647,059 and gain on
sale of land are NPR. 4,352,941.

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12. Answer to question no. 12

Thank you, Chairman Sir, for seeking my opinion and my opinion is as under:
According to section 19(2) of Income Tax Act 2058, whatever mention in section 19(1)
the following provision shall be applied in respect of the depreciation of the machines,
equipment and other machinery installed in the electricity projects that are involving in
building power station, generating and transmitting electricity and in the projects
conducted by any entity so as to build public infrastructure, own, operate and transfer to
the Government.
(a) in case where the old machines, equipment, and other machinery that are already
installed require replacement in any income year as they are out of order due to being
too old, the balancing value of the old machines, equipment, and other machinery
remained after subtracting the depreciation up to the year from their cost shall be
allowed as expenses for the year.
(b) at the time of transfer of other assets to the Government except the old assets
replaced in accordance with paragraph (a), the balancing value, if remained, after
subtracting the depreciation up to the year of the transfer from their cost shall be
allowed as expenses.
According to above provision the Bhageshwor Hydro Pvt. has obtained a license of 30
years from operation of hydropower. The estimated life of the project is 30years. The
land purchased by the company NPR. 1.8 corer deductible every year over a period of
30 years. In this case, NPR. 600,000 per is allowed as a deduction under the Income
Tax Act, 2058. (the same provision is mention in Income Tax Manual 2066( 2nd
amendments 2073).

13. Answer to question no. 13

As per clarification point of Section 108(a) of Income Tax Act 2058, Receiver means any
of the following persons:-
 a liquidator;
 a receiver appointed out of court or by a court in respect of an asset or entity;
 a mortgagee in possession;
 an executor, administrator, or direct heir of a deceased individual's estate; or
 Any person conducting the affairs of an incapacitated individual.
Same section clarification point of section 108((b) of Income Tax Act, 2058, Tax debtor
means the person whose assets come into the possession of a receiver.

As per section 108 of Income Tax Act 2058, “Recovery of Tax from Receiver” has the
following provisions;

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(1) A receiver shall be required to notify the Department in writing within 15 days of
being appointed to the position of receiver or of taking possession of an asset situated in
Nepal, whichever occurs first.
(2) The Department shall be required to serve on a receiver a notice in writing of the
amount that is payable by the tax debtor.
(3) After receiving a notice under subsection (2), a receiver shall be required to do as
follows:-
(a) Sell sufficient of the assets that come into the receiver's possession and set aside,
subject to section 103(2)(c), after payment of any debts having priority over the tax
referred to in subsection (2), the amount notified by the Department under that
subsection; and (b) be liable to pay to the Department on account of the tax debtor's tax
liability the amount set aside.
(4) To the extent that a receiver fails to set aside an amount as required by subsection (3),
the receiver shall personally be liable to pay an equal amount to the Department on
account of the tax debtor's tax liability. Provided that the receiver may recover any
amount paid from the tax debtor.
Provisions related to section 107 of Income Tax act 2058, Liability of the Officers of
Entities
(1) Where an entity does not comply with the laws, every person who is an officer of the
entity at that time shall be liable for that.
(2) Where an entity fails to pay tax on or before the date on which the tax is payable,
every person who is an officer of the entity at that time or was such an officer within the
previous six months shall be jointly and severally Liable every other such othersuch such
for payment of the tax.
(3) Notwithstanding subsections (1) and (2), those subsections shall not apply in the
following cases-
(a) where the offence is committed by the entity without that person’s knowledge or
consent; and
(b) where the person has exercised the degree of care, diligence, and skill that a
reasonably prudent person would have exercised in comparable circumstances to prevent
the commission of the offence.
(4) Where a person pays tax under subsection (2)-
(a) the person may recover the payment from the entity;
(b) for the purposes of paragraph (a), the person may retain out of any assets including
money of the entity in or coming into the possession of the person an amount not
exceeding the payment; and

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(5) No claim may be made against the person by the entity or any other person with
respect to the retention referred to in subsection (4)(b).
Clarification:- For the purpose of this section, officer of an entity means a manager of the
entity or a person purporting to act in that capacity.

14. Answer to question no. 14

According to section 8(3) of Value Added Tax (VAT) Act 2052, Building, Apartment
or shopping complex of more than 50 lakh rupees constructed for the commercial
purpose or other similar infrastructure of such type prescribed by the department,
through being constructed through an unregistered person, the tax shall be deposited as
if such construction is done through a registered person. In case no such deposit is
made, the tax shall be assessed and recovered from the person having ownership on
such infrastructure.
Explanation: for the purpose of this sub-section “Commercial purpose” means the act
of selling after constructing a building, apartment, shopping complex or other similar
infrastructure as prescribed by the department and act of using for the generation of
income by recording such infrastructure as current or fixed assets.

Accordingly building construction by M/s Bikash Housing Company Pvt. Ltd is under
the preview of Section 8(3) of VAT Act 2052. According Vat shall be calculated as
follows;
For the purpose of section 8(3) of VAT Act 2052

Nontaxable Taxable
Particular
Value Value
Purchase of 6 Anna land for construction of Building 7,500,000
development expenses of land 150,000
Consultancy fee for drawing of Building 150,000
Electricity development expenses paid to engineer 150,000
Consultancy fee paid for drawing of the design to
engineer 150,000
Licenses for construction of Building map approval
expenses 150,000
Building construction materials Bricks road, cements
sand, etc. 7,500,000
Wages for construction of Building 3,000,000
Cost of Electrification and sanitary 1,500,000
wages of Electrification and sanitary 750,000
Salary of engineer for the supervision of building
construction, Electrification and sanitations 900,000

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Windows, main gate and wooden furniture and fixture

expenses 2,250,000
Other overhead expenses 750,000
Electricity, water telephone line related expenses 150,000
Painting, furniture, fixture and flooring expenses 1,350,000
Total 18,750,000
Vat amount 13% 2,437,500

As per the provision of Section 8(3) of the Vat Act 2052, the total taxable value is NPR.
18,750,000 and applicable tax @ 13%, NPR. 2,437,500 shall be deposited as VAT by
M/s Bikash Housing Company Pvt. Ltd.
In case of noncompliance with section 8(3) of Value Added Tax(VAT), 2052 tax
officer while assessing tax under section 20 of Value Added Tax Act 2052, must fine
as per section 29(1ka) 25% of the actual amount of tax.

15. Answer to question no. 15

In Nepal, excisable goods are governed by the Excise Act, 2058. As per section 4NA of
Excise Act, 2058 if any liquor, beer or cigarette manufacturing industries offering any
schemes shall be deemed to violate the condition of license. In the present context,
Dolma Distilleries, who intends to offer the promotional scheme, is not in line with the
provision of the Excise Act, 2058. Therefore, it is advised to the Company not to
implement any free scheme and lucky draw scheme without paying excise duty.

The company will liable to pay excise duty as per the Excise Act, 2058 and Vat as per
Value Added Tax Act, 2052.

In Nepal excisable goods are governed by Excise Act 2058, according to section 4na of
excise Act 2058 Prize and cash discount, if any liquor, beer or cigarette manufacturing
industries offering any schemes shall be deemed to violate the condition of license and
liquor, beer or cigarette manufacturing industries cannot provide discount on sale of its
products other than VAT registered party. In the Give cases, COO and CFO are
planning to implement some promotional schemes including free air tickets, hotel
accommodations, and free consumption of alcohol products and same schemes to its
retailer and wholesaler is not in line with section 4 Na of Excise act 2058 and
conditions of license. There for it is advice to Mr. Chief Executive Office not to
implement any kinds of schemes against Excise Act 2058. In case of implementation of
schemes planned by COO and CFO the M/s Khagendra Distillery will liable to pay
excise duty as per excise act 2058 and VAT as per Value Added Tax act 2052. If the
company has paid applicable excise duty and VAT as applicable business promotion
expenses are allowed under section 13 of the Income Tax act 2058.

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16. Answer to question no. 16

a) Even in case of payment of any excise duty by M/s Delta Ltd. Penalty provision
would attract by reasons of fraud, collusion or any willful misstatement or
suppression of facts, or contravention of any of the provision of the Excise Act
2058 or Rules made thereunder with intent to evade payment of Excise duty.
Hence, it drew the inference that the penalty provision would come into play only
if the notice under excise Act 2058 states that the escaped duty was the result of
any conscious and deliberate wrongdoing and order passed under excise Act, 2058
there is legally tenable finding to that effect. The payment of the differential duty,
whether before/after the show cause notice is issued, cannot alter the liability for
penalty of M/s Delta Ltd. therefore as per decision and notice of Tax Officer Mr.
Ram and Ms. Sita, M/s Delta Ltd. is liable to pay mandatory penalty under Excise
Act, 2058 even if he has paid differential dues before issue of show cause notice
but the amount paid before date of show causes notice by M/s Delta Ltd. shall be
taken as advance.

b) As per section 19, Tax payment of Value Added Tax act 2052, A taxpayer shall
have to pay the tax for each month within twenty-five days of the close of the
month(section 19(1) and as per section 19(2) of Vat act 2052 , If a taxpayer does
not pay the tax within the time limit specified under sub-section (1), an extra
charge of ten percent shall be imposed on the tax due until the end of the close of
the first full month from the date the tax first becomes due. Accordingly the last
due date for the months of Baikash 2075 is 25th Jestha 2076.
Delay in payment is: from 26th Jestha 2076 to 5th Ashad 2076 equal to 12 days
The extra charge under section 19(2) of Vat Act 2052
is (NPR. 2 Million *10%*12/365days) NPR. 6,575
Again as per section 26(1) of Vat act 2052, if any taxpayer does not pay the tax within
the time limit specified under section 19(1), the interest of 15% per annum shall be
charged on the tax due.
Thus the interest under section 26(1) shall be under
is (NPR. 2 Million *15%*12/365 days) NPR. 9,863.

As per section 18 of section Vat act 2052, every taxpayer shall self-assess the amount of
tax and he is required to pay every month and shall submit, as prescribed, a tax return to a
tax officer within 25 days after the close of that month. According to as per section
29(1)(h), if a person commits infringement of the provisions of Section 18, A tax officer
may impose the fine @ 0.05% per day or Rs.1,000 per return period whichever is higher.
Fine under section 29(1)(h) is ( NPR. 2 million * 0.05%*12 days) NPR. 12,000

Total amount payable by M/s Delta Ltd. is: NPR

Vat of Months of Baikash 2075 is : NPR. 2000,000
An additional charge under section 19(2) is: NPR. 6,575
Interest under section 26(1) is : NPR. 9863
Fine under section 29(1)(h) is : NPR. 12,000
Therefore M/s Delta Ltd. total amount due is NPR. 2,028,438.

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CAP III Paper 6: Advanced Taxation-Solution

c) In these cases, the entire items are attractive of Vat as per Vat Act 2052 according
to Vat payable/ receivable of M/s Delta Ltd for the month of Ashad end 2076 is:

Calculation of Vat payable or Taxable Vat

receivable amount amount
Total Sales for the year 7,000,000
Export sales 4,000,000 - -
Local Sales 3,000,000 3,000,000 390,000
Total output Tax (A) 390,000
Input tax:
Consultancy fee paid to
Germany 2,500,000 2,500,000 325,000
computer equipment purchased 2,000,000 2,000,000 260,000
Telephone expenses 280,000 280,000 36,400
Purchase of car of CEO use in
Office 3,000,000 1,200,000 156,000
Total Input Tax (B) 7,780,000 5,980,000 777,400
Vat Credit Refunded (B-A) 387,400

Notes:
1) M/s. Delta ltd that all the goods and services were purchased from VAT registered
person and the amounts given in the question is before VAT.
2) According to section 8(2) of Vat Act, 2052, the recipient of services in Nepal from
a person who is not registered and is outside the Kingdom of Nepal shall have to assess
and collect tax at the taxable value in accordance with this Act and Rules thereunder.
According to the payment of service fee to Germany party is fall under the preview of
section 8(2) of Vat Act 2052 and consultancy fee paid to Germany NPR. 325,000 first
deposit required by M/s Delta ltd to IRO and thereafter the company could be set off the
amount.
3) As per rules 41(2) of Vat 2053, vat set off is 40% of vat paid on Automobiles shall
be allowed for deduction.

17. Answer to question no. 17

As per provision of rules, 6Ga of Vat rules 2053(updated by Financial Act 2076),
Special provision relating to the payment of tax under contract and supply of goods and
services” following provision is made:
Rules 6GA (1), While making payment to concerned contractor or suppliers in respect
of supply of goods services or both under any agreement or contract the government
entities, institution or organization fully or partly owned by the government of Nepal
shall deposit fifty percent of tax amount to be paid to him into concerned heading of
revenue in his name and only remaining amount in respect of ta shall be paid to him.
Again Rules 6GA (2), an entity making payment pursuant to sub-rule (1) shall give
information about the deposit in revenue heading to the concerned contractor.

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CAP III Paper 6: Advanced Taxation-Solution

The concerned contractor or suppliers may offset the amount deposited pursuant to sub-
rules (1).
According to these rules, government entities shall deduct 50% of Vat while making
payment:
Particular Amount
Bill Amount 5,000,000
Vat 13% 650,000
Total 5,650,000
TDS 1.5% 75,000
VAT 50% to be deposited by Government entities 325,000
Net payment 5,250,000

According to the above calculation, government entities shall be deposit 50% of Vat
Amount, NPR. 325,000 in the name of M/s Nabaraj Contraction and M/s Nabaraj
Contraction can set off this amount in his VAT return.

18. Answer to question no. 18

Answer based on letter and other issues raised by Tax/Excise officer:

a) As per section 3kha (3) of Excise Act, 2058, confers power to Excise Officer to
collect excise if the difference between consumer price and factory price is not
reasonable. In this cases excise officer may assess and collect excise duty after
considering consumer price, commission to wholesaler or retailer, transport
expenses and taxes in the nearest market. It seems excise officer is not satisfied
due to the difference in consumer price and factory price. Therefore, such
difference should be calculated before opposing the excise officer's view.
Consumer price 111
Normal commission to
wholesalers 29
Transport expenses 17
Estimated selling cost 46
Modified consumer price 65
Factory price to wholesaler 47.48
Difference 17.52
As per our calculation, the difference is unreasonable, excise officer’s view is not
contrary to the legal provisions. Therefore, Excise Officer may order rightly to pay
additional excise duty to the company and company need to pay as per letter issued
by tax officer but the actual calculation is 17.52 per units.

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CAP III Paper 6: Advanced Taxation-Solution

b) Vat payable and Receivable for the months of Bhadra 2076.

Particulars NPR NPR

Cost of Plastic Polypropylene 8,625,000
Clearing and forwarding expenses 1,293,750
Carriage inward 741,750
Landed cost 10,660,500
Custom Duty @ 33% 33% 3,517,965
Sub Total 14,178,465
VAT paid @ 13% 1,843,200
Cost of raw material consumed(14178465*300/600) 7,089,232.50 7,089,233
Factory wages 2,113,125
Other production cost 1,322,500
Factory Cost 10,524,858
Factory cost per kg finished product 10524858/(276*1000) 38.13
Margin @ 24.5% of factory cost 24.50% 9.34
Factory price to whole seller 47.48
Excise duty @ 7% 7% 3.32
Sub Total 50.80
VAT per kg @ 13% 13% 6.60
Total VAT collected 1,228,334.27 1,228,334
Less VAT paid
Paid at customs 1,843,200
Paid in purchase of Scotter 146,250
Total credit to be claimed 1,989,450 1,989,450
Net credit to be claimed 761,116

 Stock of raw material is 600 tonne, so used is 300 tonne.

 Input to out to ratio is 10: 0.92, 300 tonne materials used so the output is 276 tonne,
sold unit of finished goods is 186 tonne and stock of finished goods are 90 tonne.

c) Under section 23ga (1) of VAT Act, 2052, VAT authorities have the power to
buy the stock of goods considered to be under invoice. VAT authorities may
choose to buy the stock at the value sold by the company without the consent of
the company and pay amount calculated at the rate invoiced by the company. As
per this provision, the tax office can buy under invoiced goods.
As per section 20(1(e)) of Vat Act, 2052 Tax Officer is empowered to assess tax
if he has reasonable ground to believe that the product is sold by under-invoicing.
Since in this case, it seems to be under invoiced compared to similar products, the
VAT Officer may rightly assess additional tax.

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CAP III Paper 6: Advanced Taxation-Solution

d) The obligation under Vat Regulations 2053

As per rule 39ka Vat Regulations, 2053 requires such an event to be informed
within 30 days of such incidents along with the evidence of writing off the goods
from stock due to fire. The Company will not be able to write off the loss under
Vat Act 2053. Further under Rule 40 of VAT regulations, tax officer may
assume the stock as sold on physical verification and may order to pay VAT.
The obligation under the Excise Act and Regulations, 2058
Similarly, in rule 17 of Excise Regulations, 2058 requires such an event to be
informed as soon as possible. Similarly, the company may be required to pay loss
of excise suffered by Nepal Government under rule 17 of the Excise Regulations,
2058.
The obligation under Customs Act, 2064.
There is no obligation under the Customs Act, 2064. Therefore, the company
should inform the authorities within the stipulated time to enable it to write off the
loss. If these authorities are not informed the company will have to follow the
consequences.

19. Answer to question no. 19

a) As per section 20 of Financial Act 2076, new innovative technology, skills and
enterprises established with use of technology-related business done by individual
or entities who are not registered in Tax if registered within Poush end 2076 by
taking PAN number along with VAT than financial return, tax fine and penalties
before the financial year 2075/076 are not need to submit to IRD.

b) As per section 19(7ka) of VAT Act 2052, tax more than NPR. 10 lac need to pay
through cheque, draft or any electronic means of transfer. (Updated by Financial
Act 2076).

c) VAT credit remains continuous for more than 4 months a registered person can
apply for a refund as procedures prescribed. Section 24(3) of Vat Act 2052,
updated by financial act 2076.

d) Application for administrative review to Director General (DG) of Inland

Revenue Department 1/4th of disputed tax amount needs to deposit by the
taxpayer. As per section 31 Ka(6) of Vat Act 2052 and as per section 115(6) of
the Income Tax Act 2058. ( updated by financial act 2076)

e) As per section 11(3Tha) of Income Tax Act, 2058 wherein the any income year,
any entities carries on project such as to build, operate any public infrastructure
project and transfer it to government of Nepal and builds powerhouse, generates
and transmits electricity tax shall be exempted by 20% on tax imposable on
income of such entity. (Updated by financial act 2076).

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CAP III Paper 6: Advanced Taxation-Solution

20. Answer to question no. 20

NII-equipment’s stand for Non-intrusive inspection Equipment’s. It is Customs inspection

method without opening the package of cargos. No sampling or destruction of sample good is
required. In the airport, customs do the x-ray scanning of passenger baggage without our notice.
Sometimes customs officer take a swab from our hand luggage and dog may smell the luggage,
actually, they are doing NII to control of drugs and food, etc. Customs has the duty to control the
illegal chemical, harmful substances, waste and high duty goods hidden behind the ordinary
cargo. In this regard NII equipment’s help customs and make the job easy. In a manual way, it's
not possible to inspect each and every cargo thoroughly only can inspect randomly as we do
these days (Red channel). When NII deputed in customs can check or inspect in a very short time
and real red channel cargo will reduce. Customs officer can inspect cargo timely, without delay
and most of the time consignee don’t know their cargo has been inspected thoroughly. This will
help to achieve trade facilitation goal of customs. World Customs Organization (WCO) has
pointed out the use of non-Intrusive inspections equipment are very important for customs
administration to address some of the challenges like Smuggling control, control of illegal trade
of chemicals and control goods. Non-Intrusive inspection equipment permits customs officer to
inspect the cargos or goods being importing or exporting without opening the packages.

Types of NII-Equipment’s
• Living animals: Inspection by trained dog etc.
• Man-made Instrument: These are of two types based on mobility
1. Fixed: Equipment fixed at one place like fixed baggage x-ray, container scanners (larger).
2. Mobile: Not fixed like a mobile van with x-ray, mobile laboratory, small equipment’s.

Based on the scientific principle and application man-made NII can be divided into three types
1. Radiation based Imaging equipment’s, e.g., X-ray, neutron ray
2. Molecular/ Atomic-level analysis equipment’s (Spectroscopy etc.)
3. Thermal detection devices, thermal camera, etc.

Benefits of using NII

Smart inspection; without touching and opening the package. Save the time of Customs
officer and inspectors and enhance efficiency. Trade facilitation by timely inspection and
faceless inspection. Fewer hazard to the Customs Inspector. Makes the officers confident on
what they cleared.
Constrains to NII
 Need budgetary investment.
 Require the technical capacity/training
Complex Procurement and Maintenance

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

Paper 7: Advanced Cost and Management Accounting

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

Revision Questions:
Learning curve theory
Question No.1.
In your company, production manager has observed that learning curve theory is very much
applicable in the newly procured machine @ 90%. A batch of production is of 50 units. The
average labour cost for the first batch is Rs.100. Material cost and overheads are Rs.150 and 50
per unit respectively. If profit margin is 25% on cost, estimate the price per unit if the order size
is for (a) 400 units and (b) 800 units (c) 1000 unit.

Simulation
Question No. 2.
A car manufacturing company manufactures 40 cars per day. The sale of cars depends upon
demand, which has the following distributions.
SALES OF CARS PROBABILITY
37 0.10
38 0.15
39 0.20
40 0.35
41 0.15
42 0.05
The production cost and sale price of each car are Rs.4 lakhs and Rs.5 lakhs respectively. Any
unsold car is to be disposed off at a loss of Rs.2 lakhs per car. There is a penalty of Rs. 1 lakh per
car, if the demand is not met. Using the following random numbers, estimates total profit/loss for
the next ten days.
9, 98, 64, 98, 94, 01, 78, 10, 15, 19
If the company decides to produce 39 cars per day, what will be its impact on its profitability?

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

PERT/CPM
Question No.3.
The following network gives the duration in days for each activity:

2 8
2 5 5

1 3
6

4 1 6

i. You are required to list the critical paths.

ii. Given that each activity can be crashed by a maximum of one day, choose to crash any
four activities so that the project duration is reduced by 2 days.

Assignment problem
Question No.4.
Imagine yourself to be the Executive Director of a 5-Star Hotel which has four banquet halls that
can be used for all functions including weddings. The halls were all about the same size and the
facilities in each hall differed. During a heavy marriage season, 4 parties approached you to
reserve a hall for the marriage to be celebrated on the same day. These marriage parties were told
that the first choice among these 4 halls would cost Rs. 25,000 for the day. They were also
required to indicate the second, third and fourth preferences and the price that they would be
willing to pay. Marriage party A & D indicated that they won’t be interested in Halls 3 & 4.
Other particulars are given in the following table-
Revenue/Hall (Rs.)
Marriage party Hall 1 Hall 2 Hall 3 Hall 4
A 25,000 22,500 X X
B 20,000 25,000 20,000 12,500
C 17,500 25,000 15,000 20,000
D 25,000 20,000 X X

Where X indicates that the party does not want that hall. Decide on an allocation that will
maximize the revenue to your hotel.

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

Transportation
Question No.5.
A fertilizer company has the following production in its four plants with following production
capacity:
Plant A B C D
Demand (Tons) 10,000 18,000 22,000 24,000

The company has three distributions centers located at places P, Q and R. The capacity of
warehouses at these places and the cost of transportation from different plants to these
warehouses are indicated given below:
Ports Demand (Tons) A B C D
P 20,000 50 60 100 50
Q 38,000 80 40 70 50
R 16,000 90 70 30 50

Devise distribution plan to optimize transportation cost.

Linear programming
Question No.6.
An investor is interested in investing Rs.15,00,000 in a portfolio of investments. The investment
choices and expected rates of return on each one of them are:
Investment Projected Rate of Return
Mutual Fund ‘AB’ 15%
Mutual Fund ‘CD’ 9%
Money Market Fund 8%
Government Bonds 8.75%
Shares ‘E’ 17%
Shares ‘F’ 18%

The investor wants at least 40% of his investment in Government Bonds. Because of the higher
perceived risk of the two shares, he has specified that the combined investment in these two
shares not to exceed Rs. 2,60,000. The investor has also specified that at least 25% of the
investment should be in the money market fund and that the amount of money invested in shares
should not exceed the amount invested in Mutual Funds. His final investment condition is that
the amount invested in mutual fund ‘AB’ should be no more than the amount invested in mutual
fund ’CD’. The problem is to decide the amount of money to invest in each alternative so as to
obtain the highest annual total return.

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

Costing of service sector

Question No.7.
Norvic, a day care health center covered under insurance plan receives payment from the
insurance company each time any patient attends the center for consultation as under:
Consultation involving Payment from insurance company (Rs.)
Bandaging 80
Plastering 300
Rehabilitation 600
In addition, the adult patients will have to make co-payment for Plastering and Rehabilitation
which is at the same rate of payment by insurance company for respective category of treatment
made. Senior citizens are required to make co-payment for Rehabilitation only to the extent of
50% of the payment by insurance company for that category.
The health Centre will remain open for 6 days a week for 52 weeks in a year. Each physician
treated 10 patients per day.
The health center received a fixed income of, Rs.6,05,200 per annum for promotion of health
products from the manufacturers.
The annual expenditure of the health center is estimated as under:
Rs.
Materials and consumables (100% variable) 7,64,000
Staff salaries per annum per employee (Fixed):
Physician 4,00,000
Assistant 1,50,000
Administrative staff 90,000
Establishment and other operating cost (Fixed) 6,00,000
The non-financial information is as under:
(1) Staff:
Physician 5
Assistant 6
Administrative staff 2
(2) patient mix:
Adult 50%
Children 30%
Senior citizens 20%
(3) Mix of patient Appointment (%)
Bandaging 60%
Plastering 30%
Rehabilitation 10%
I. Calculate the net income of Norvic (the day care health center) for the next year.
II. Determine the number of patients to break-even.
Show the amount to the nearest rupee.

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 CAP III Paper 7: Advanced Cost and Management Accounting-Question

Activity Based Costing

Question No.8.
Afno Pariwar Limited is engaged in production of three types of baby suits: Baby; Babu and
Superman. During the year ended 31st march, 2018 the company produced and sold 80,000 Baby
suits, 48,000 Babu Suits and 36,000 Superman suits. The cost details are as follows:
i. Per unit Material and Labour Costs:
Baby (Rs.) Babu (Rs.) Superman (Rs.)
Material 120 180 260
Labour @ RS. 60 per hour 150 195 270

ii. Overheads:
Activity cost pool Associated cost (Rs.)
Purchasing section 20,30,200
Machine Setup 39,65,000
Delivery Section 31,50,000
Labour amenities & welfare 77,70,000
Customer Support 38,04,800
You are required to calculate total cost per suit for each type of suits by using:
i. Traditional Costing System if the overheads are charged on Direct Labour Hour Rate
basis
ii. Activity Basis Costing System if the additional information under this system is as given
below:

Activity cost pool Cost driver Activity utilized

Baby Babu Superman
Suits Suits Suits
Purchasing section No. of purchase orders 400 250 350
Machine setup Production runs 1,100 750 1,200
Delivery section No. of deliveries 700 440 960
Labour amenities & welfare Direct Labour Hours - - -
Customer Support Sales units - - -

Transfer pricing
Question No.9.
Division of X of KL Industries Limited is a profit centre and its entire production is utilized
internally by other divisions.
The information regarding Divisions X is as follows:

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

Annual production 25,000 units

Rs
Material cost per unit 115
Labour cost per unit 90
Manufacturing overhead per unit (40% fixed) 35
Administrative overhead per unit (fixed) 9
Apportioned amount of Investment of Division X 75,00,000
Corporate tax rate 30%

You are required to determine the transfer price under each of the following strategies:
i. 15% After tax profit on transfer price
ii. 20% Return on Investment (After Tax)
iii. 15% After tax profit on list sale price, when actual sales (transfer) is made at a discount
of 25% on list price.
iv. 30% Mark up on marginal cost is added to total cost.

Standard costing & variance Analysis

Question No.10.
The standard cost of a certain chemical mixture is as under:
40% of Material P @ Rs. 30 per kg
60% of Material Q @ Rs. 40 per kg
A standard loss of 10% of input is expected in production. The following actual cost data is
given for the period.
350kg Material -P at a cost of Rs. 25
400kg Material -Q at a cost of Rs. 45
Actual weight produced is 630kg
Required
Calculate the following variances raw material wise and indicate whether they are favorable (F)
or adverse (A):
i. Cost variance
ii. Price variance
iii. Mix variance
iv. Yield variance

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

Budget & Budgetary control

Question No.11.
DEMA Corporation manufactures and sells two products RB and RD. Three types of materials
A, B and C are required for producing these products. Projected information for 2018-19 is given
below:
Product Projected sales for 2018-19 Inventory (in units) Direct
Labour
Requirement
Units On 1-4-2028 On 31-3-2019 Hours/unit
RB 75,000 25,000 31,250 4
RD 50,000 10,000 11,250 6

Raw material stock usage are as follows:

Direct Requirement per unit Inventory on 1-4-2018 Inventory on 31-3-2019
Material
RB RD
A 5.00 kg 5.00 kg 40,000 kg 45,000 kg
B 2.50 kg 3.00 kg 36,250 kg 40,000 kg
C 0 1.00 kg 7,500 kg 8,750 kg

Required
Prepare the following for 2018-19:
i. Production budget (in units)
ii. Direct material purchase budget in quantities for A, B and C.
iii. After (i) and (ii), you are told that only 6,00,000 labour hours will be available for
production. If there is no requirement to hold the stated level of finished goods closing
inventory, what would be the principal budget factor? Substantiate your view with
appropriate figures.

Target Costing
Question No.12.
A company has sales of 1,00,000 units at a price of Rs. 150 per unit and profit of Rs. 30 lakhs in
the current year. Due to stiff competition, the company has to reduce its price of product next
year by 8% to achieve same volume of sales as in the current year. The cost structure and profit
for the current year is given below:
Particulars (Rs. Lakhs)
Direct Material 50

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

Direct Wages 30
Variable factory overhead 15
Fixed overheads including sales & Admin. Expenses 25
Total cost 120
To achieve the target cost to maintain the same profit, the company is evaluating the proposal to
reduce the labour cist and fixed factory overhead. A vendor supplying the machine suitable for
the company’s operations has offered an advanced technology semi-automatic machine of Rs. 10
lakhs as replacement of old machine worth Rs. 3 lakhs. The vendor is agreeable to take back the
old machine at Rs 2.25 lakhs only. The company’s policy is to charge depreciation at 10% on
WDV. The maintenance charge of the existing machine is Rs. 0.80 lakhs per annum whereas
there will be warranty of services free of cost for the new machine for first two years. There are 9
supervisors whose salary is Rs.1.20 lakhs each per annum. The new machine having conveyor
belt is expected to help in cost cutting measures in the following ways:
1. Improve productivity of workers by 25%.
2. Cut down material wastage by 1%.
3. Elimination of services of supervisors because of automatic facilities of the machine.
4. Saving of packaging cost by RS.1.35 lakhs.
Assuming cost of capital to be 12%, calculate how many supervisors should be removed from
the production activities to achieve the target cost.

Decisions making problems (Shutdown/continue decision)

Question No.13.
PRS Limited is normally manufacturing 50,000 units of its product ‘Sewda Beauty’ in a year.
The cost structure at this level is as follows:
Rs (in Lakhs)
Materials 45
Labour 35
Manufacturing overheads 20 (75% variable)
Administrative overheads 10 (80% fixed)
Selling & Distributions overheads 06 (50% fixed)
Total 116

Due to adverse trade conditions, the company expected that only 10,000 units of ‘Sewda Beauty’
can be sold at a price of Rs. 250/- per unit, during the next year. The board of Directors plans to
shut down the plant. In this situation the fixed costs for next year is expected to be reduced by
60% and additional costs of shut down are expected at Rs. 2,00,000. Should the plant be shut
down? What is the shutdown point?
Show amount to the nearest rupee.

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

Marginal costing Vs Standard Costing

Question No.14.
W & T is a leading consumer goods firm. The budgeted and actual data of W & T for the year
2017-18 are as follows; -
Particulars Budget Actual Variance
Sales / production (units) 2,00,000 1,65,000 (35,000)
Sales (Rs.) 21,00,000 16,92,900 (4,07,100)
Less: variable costs (Rs.) 12,66,000 10,74,150 1,91,850
Less: fixed cost (Rs.) 3,15,000 3,30,000 (15,000)
Profit 5,19,000 2,88,750 (2,30,250)

The budgeted data shown in the table is based on the assumption that total market size would be
4,00,000 units but it turned out to be 3,75,000 units.
Required
Prepare a statement showing reconciliation of budget profit to actual profit through marginal
costing approach for the year 2017-18 in as much detail as possible.

Marginal Costing & Decision-Making Problems

Question No.15.
If DBC Ltd. is producing a component called ‘DBC’. Estimated costs are:
Fixed cost per year Variable cost per ‘DBC’
(Rs.’000) (Rs.)
Production 32,000 3,600
Distribution 2,000 200

Direct labour cost are 40% of the variable production costs. In the production department
machining and assembling of ‘DBC’, 90 men work 8 hours per day for 300 days in a year. Each
worker can machine and assemble 1 ‘DBC’ per uninterrupted 180 minutes time frame. In each 8
hours working day, 20 minutes are allowed for coffee-break, 30 minutes on an average for
training and 22 minutes for supervisory instructions. Besides 10% of each day is booked as idle
time to cover checking in and checking out changing operations, getting materials and other
miscellaneous matters.
DBC Ltd. has been facing industrial relations problem as the workers of company have a very
strong union. Company is faced with the possibility of a strike by direct production workers
engaged on the assembly of ‘DBC’. The trade union is demanding an increase of 15%, back-
dated from the beginning of financial year, but the company expects that if a strike does take

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

place, it will last 25 Days after which the union will settle for an increase of 10% similarly back-
dated. The only product of the company is being sold at Rs.6,000.
If the strike takes place, Sales of 1,300 ‘DBC’ would be lost. The balance that would ordinarily
have been produced during the strike period could, however be sold, but these ‘DBC’ would
have to be made up in overtime working which would be at an efficiency rate of 90% of normal.
This would entail additional fixed cost of Rs.1,00,000 and wage payments at time and one-half.
Required
Give necessary advice to the management to allow the strike to go ahead or to accept the union’s
demand.

Just in time approach

Question No.16.
Revolution Ltd. has entered into a contract to supply a component to a company which
manufactures electronic equipment’s.
Expected demand for the component will be 70,000 units totally for all the periods.
Expected sales and production cost will be.
Period 1 2 3 4
Sales (units) 9,500 17,000 18,500 25,000
Variable cost per unit 30 30 32.50 35

Total fixed overheads are expected to be Rs.14 lakhs for all the periods.
The production manager has to decide about the production plan.
The choices are:
Plan 1: produce at a constant rate of 17,500 units per period. Inventory holding costs will be Rs.
6.50 per unit of average inventory per period.
Plan 2: use a just-in- Time (JIT) system
Maximum capacity per period normally 18,000 units
It can produce further up to 10,000 units per period in overtime.
Each unit produced in overtime would incur additional cost equal to 30% of the expected
variable cost per unit of that period.
Assume zero opening inventory.
Required

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

(i) CALCULATE the incremental production cost and the savings in inventory holding cost by
JIT production system.
(ii) ADVISE the company on the choice of plan.

Marginal costing
Question No.17.
The details of the output presently available from a manufacturing department of Hitech
Industries Ltd. are as follows.
Average output per week 48,000 units from 160 employees
Saleable value of output Rs. 600,000
Contribution made by the output towards fixed expenses and profit Rs. 2,40,000
The Board of Directors plans to introduce more automation in the department of capital cost of
Rs. 1,60,000. The effect of this will be to reduce the number of employees to 120, but to increase
the output per individual employee by 60%. To provide the necessary incentive to achieve the
increased output the Board intends to offer a 1% increase in the piecework rate of one rupee per
article for every 2% increase in average individual output achieved. To sell the increased output,
it will be necessary to decrease the selling price by 4%.
Required:
Calculate the extra weekly contribution resulting from the proposed change and evaluate, for the
Board’s information, the worth of the project.

Marginal Costing & Decision-Making Problems

Question No.18.
A farmer owns an orchard, which has an area of 350 acres on which he grows apples, apricots,
cherries and plums. Of the total areas, 250 acres of land are unsuitable for growing apples &
plums and are suitable only for apricots and cherries. On the remaining 100 acres of land, any of
the four fruits can be grown.
The marketing policy requires that in each season all the four types of fruits must be produced
and quantity of any one type should not be less than 12,000 boxes. It is also essential that the
area devoted to anyone should be in terms of complete acres and not in fraction of an acre. There
are no physical or marketing limitations and there is an adequate supply of all types of labour.
The details regarding the selling price, production and costs are given below:

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CAP III Paper 7: Advanced Cost and Management Accounting-Question

Apples Apricots Cherries Plums

Selling price per box (in Rs.) 10 10 20 30
Seasons yield per acre (in boxes) 500 150 100 200
Weight per box (kgs.) 30 30 40 20
Material per acre. (Rs.) 180 70 60 100
Labour growing per acre. (Rs.) 200 150 100 130
Harvesting and packing per box (Rs.) 1 1 2 3
Transport per box (Rs.) 2 2 1 3

Fixed overhead each season:

Cultivation and growing Rs. 58,000, Harvesting Rs. 68,000, Transport Rs. 5,000,
Administration Rs. 42,000, Land Revenue Rs. 9,000.
Required:
Advise the farmer on the area to be allotted to each item in order to earn the maximum total
profit and what is the total profit?

Question No.19.
Write short notes on:
a. Elaborate the steps in decision making process
b. Profit Planning
c. Meaning and features of Enterprise Resource Planning (ERP)
d. Unbalanced assignment Problems
e. Project crashing

Question No.20.
What are the differences between :
a. Transportation & Assignment Problems
b. Standard Cost & Actual Cost
c. Target Cost- & Cost-plus Pricing

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Suggested Answers/Hints:
Learning curve theory
Answer No. 1:
Average labour cost for first 50 units = Rs.100.00
Average labour cost for first 100 units = 0.90 × 100 = Rs.90
Average labour cost for first 200 units = 0.90 × 90 = Rs.81
Average labour cost for first 400 units = 0.90 × 81 =Rs.72.90
Average labour cost for first 800 units = 0.90 × 72.90 =Rs.65.61
We know that learning curve equation: Y=axb
Where y = average time for producing x units
a = time spent on first unit/batch
b = co-efficient of learning curve
b = -log (1-% decrease)
log 2
= log (1-0.10)
Log 2
= -0.0458
0.3010
= -0.15206
Thus, for 1000 units, batch = 1000 =20
50
Y = 100 x 20-0.15206
Thus y = antilog (1.802172) = 63.41
Thus, average labour cost for 1000 units = Rs.63.41
Thus, price to be quoted for:
First 400 units (Rs.) First 800 units (Rs.) First 1000 unit (Rs.)
Material @ RS.150 60,000 1,20,000 1,50,000
Labour cost 29,160 52,488 63,410
Overheads 20,000 40,000 50,000
Total cost 1,09,160 2,12,488 2,63,410

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Profit 27,290 53,122 65,852

Price to be quoted 1,36,450 2,65,610 3,29,262

Simulation
Answer No. 2:
First of all, random numbers 00-99 are allocated in proportion to the probabilities with the sales
of cars as given below:
Sales of car Probability Cumulative Probability Range of random number
37 0.10 0.10 00-09
38 0.15 0.25 10-24
39 0.20 0.45 25-44
40 0.35 0.80 45-79
41 0.15 0.95 80-94
42 0.05 1.00 95-99

Based on the given numbers, we simulate the estimated sales and calculate the profit/loss on the
basis of specified units of production.
Day Random Estimated Profit (production) 40 Profit (production) 39
numbers sales cars/day (Rs. Lakhs) cars/day
1 9 37 37 × 1 – 3 × 2= 31 37 × 1 -2 × 2 =33
2 98 42 40 × 1 – 2 × 1= 38 39 × 1 -3 × 1 =36
3 64 40 40 × 1 =40 39 × 1 -1 × 1 =38
4 98 42 40 × 1 – 2 ×1 = 38 39 × 1 -3 × 1 =36
5 94 41 40 × 1 – 1 ×1 = 39 39 × 1 -2 × 1 =37
6 01 37 37 × 1 – 3 × 2 = 31 37 × 1 -2 × 2 =33
7 78 40 40 × 1 =40 39 × 1 -1 × 1 =38
8 10 38 38 × 1 – 2 ×2 = 34 38 × 1 -1 × 2 =36
9 15 38 38 × 1 – 2 ×2 = 34 38 × 1 -1 × 2 =36

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

10 19 38 38 × 1 – 2 ×2 = 34 38 × 1 -1 × 2 =36
Total = 359 Total = 359

There is no additional profit or loss if the company decides to reduce production to 39 cars per
day.

PERT / CPM
Answer No. 3:
Critical paths:
All are critical paths:
i. 1-2-5-6 2+8+5 = 15
ii. 1-3-5-6 3+7+5 = 15
iii. 1-4-5-6 4+6+5 = 15
iv. 1-3-4-5-6 3+1+6+5 =15
a)
Choose 5 – 6, common path; crash by 1 day
b)
Choose: 1 – 2, 1 - 3, 1 – 4
Or
c) Choose: 1 – 2, 3 – 5, 4 – 5
Or
d) Choose: 2 – 5, 3 – 5, 4 – 5
Or
e) Choose: 1 – 3, 1 – 4, 2 – 5

Assignment problem
Answer No. 4:
The objective of the given problem is to identify the preferences of marriage parties about halls
so that hotel management could maximize its profit.
To solve this problem first convert it to a minimization problem by subtracting all the elements
of the given matrix from its highest element. The matrix so obtained which is known as loss
matrix is given below-
Loss Matrix/Hall
Marriage party 1 2 3 4
A 0 2,500 X X

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

B 5,000 0 5,000 12,500

C 7,500 0 10,000 5,000
D 0 5,000 X X
Now we can apply the assignment algorithm to find optimal solution. Subtracting the minimum
element of each column from all elements of that column-
Loss Matrix/Hall
Marriage party 1 2 3 4
A 00 2,500 X X
B 5,000 0 0 7,500
C 7,500 0 5,000 0
D 0 5,000 X X
The minimum number of lines to cover all zeros is 3 which is less than the order of the square
matrix (i.e.4), the above matrix will not give the optimal solution.
Subtracting the minimum uncovered element (2,500) from all uncovered elements and add it to
the elements lying on the intersection of two lines, we get the following matrix-
Loss Matrix/Hall
Marriage party 1 2 3 4
A 0 0 X X
B 7,500 0 0 7,500
C 10,000 0 5,000 0
D 0 25,00 X X
Since the minimum number of lines to cover all zeros is 4 which is equal to the order of the
matrix, the below matrix will give the optimal solution which is given below-
Loss Matrix/Hall
Marriage party 1 2 3 4
A 0 0 X X
B 7,500 0 0
7,500
C 10,000 0 5,000 0
D 0 2,500 X X

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Optimal schedule is-

Marriage party Hall Revenue (RS.)
A 2 22,500
B 3 20,000
C 4 20,000
D 1 25,000
Total 87,500

Transportation
Answer No. 5:
Following Vogel’s Approximation Method (VAM), an initial feasible solution is:
From A B C D Demand ui

P 10000 50
60 100 10000 50 20000 u 1 =0
Q 80 18000 40 6000 70 15000 50 38000 u 2=0
R 90 70 16000 30 50 16000 u 3= - 40
Supply 10000 18000 22000 24000 74000
vj V 1 =50 V 2 =40 V 3 =70 V 4 =50

Since, there are 6 allocation i.e. (4 + 3 – 1) and all the opportunity cost are negative, the optimum
solution has been reached. Transportation cost = Rs. (10,000 × 50 + 18,000 × 40 + 6,000 × 70 +
14,000 × 50 + 16,000 × 30) = RS. 3,32, 000

Linear programming
Answer No. 6:
Let
U = Investment in “Mutual Fund ‘AB’”
V = Investment in “Mutual Fund ‘CD’”
W =Investment in “Money Market Fund”

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

X =Investment in “Government Bond”

Y =Investment in “Share ‘E’”
Z =Investment in “Share ‘F’”
Objective function:
Maximize
Z = 0.15u + 0.09v + 0.08w + 0.0875x + 0.17y + 0.18z
Condition-1:
Rs. 15,00,000 to be invested-
u + v + w + x + y + z ≤ 15,00,000
Condition-2:
At least 40% of investment in Government Bonds-
X ≥ (u + v + w + x + y + z) × 0.40
Or
2u + 2v + 2w - 3x +2y + 2z ≤ 0
Condition-3:
Combined investment in two shares not to be exceed Rs. 2,60,000-
y + z ≤ 2,60,000
Condition-4:
At least 25% of the investment in the money market fund-
W ≥ (u + v + w + x + y + z) × 0.25
u + v – 3w + x + y + z ≤ 0
Or
Condition-5:
Amount of money invested in shares should not exceed the amount invested in mutual funds-
y+z≤u+v
-u – v + y + z ≤ 0
Or
Condition-6:

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Amount invested in mutual fund ‘AB’ should not be more than the amount invested in mutual
fund ‘CD’-
u≤v
Or u–v ≤0
This problem can be solved with the assumption of Investment Exactly Rs. 15,00,000.

Costing of service sector

Answer No. 7:
(i)
Statement showing Net Income of Norvic
(Rs.) (Rs.)
Payment from Insurance companies 30,88,800
Co-payment from senior Citizens 93,600
Co-payment from Adult Patients 11,70,000 43,52,400
Other Income (Fixed) 6,05,200
Total Income (A) 49,57,600
Less: variable Expenses
Material and consumables 7,64,000
Less: Fixed Expenses:
Physician Salary (5 × 4,00,000) 20,00,000
Assistant Salary (6 × 1,50,000) 9,00,000
Administrative Staff’s Salary (2 × 90,000) 1,80,000
Establishment and other operating costs 6,00,000 36,80,000
Total expenditure (B) 44,44,000
Net Income (A – B) 5,13,600
Workings
(i) Total Number of Patients Attended
Number of Patients Attended per Day by a physician 10

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Number of physicians Employed 5

Number of Days in Week 6
Number of weeks in a year 52
Total number of patients Attended (10 × 5 × 6 × 52) 15,600

(ii) Patient Mix

Adults (50%) [15,600 × 50/100] 7,800
Children (30%) [15,600 × 30/100] 4,680
Senior Citizens (20%) [15,600 × 20/100] 3,120
Total 15,600

(iii) Patients Appointments

Bandaging (60%) [15,600 × 60/100] 9,360
Plastering (30%) [15,600 × 30/100] 4,680
Rehabilitation (10%) [15,600 × 10/100] 1,560
Total 15,600

(iv) Income from Insurance Companies

Number of Patients (Rs.) (Rs.)
(A) (B) (A × B)
Bandaging (60%) 9,360 80 7,48,800
Plastering (30%) 4,680 300 14,04,000
Rehabilitation (10%) 1,560 600 9,36,000
Total 30,88,800

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

(v) Co- payments for Adult Patients

Total Number of Adult patients = 7,800
Number of patients Payment Total Payment (Rs.)
(Rs.)
Bandaging (60%) 4,680 - -
Plastering (30%0 2,340 300 7,02,000
Rehabilitation (10%) 780 600 4,68,000
Total 11,70,000

Total number of senior Citizens = 3,120

Number of patients Payment Total Payment (Rs.)
(Rs.)
Bandaging (60%) 1,872 - -
Plastering (30%) 936 - -
Rehabilitation (10%) 312 300 93,600
Total 93,600

(ii) Number of Patients for Break-even

(RS.)
Fixed costs 36,80,000
Less: Fixed Income 6,05,200
Net Fixed costs 30,74,800
Break even patients Rs.30,74,800 13,367
Rs.230.03

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Workings
Statement showing contribution Analysis
(Rs.)
Total fees from Insurance Companies, Adult Patients & Sr. Citizens 43,52,400
Less: variable cost 7,64,000
Contribution 35,88,400
Average contribution per patient Rs.35,88,400 230.03
15,600 patients

Activity Based Costing

Answer No. 8:
(i)
Statement showing “computation of cost of product”
(Based on the Traditional Costing System- Direct Labour Hour Rate)
Baby suits (Rs. /U) Babu suits (Rs. /U) Superman suits (Rs. /U)
Materials Cost 120 180 260
Labour Cost 150 195 270
(2.50 hrs. × Rs.60) (3.25 hrs. × Rs.60) (4.50 hrs. × Rs.60)
Overheads 100 130 180
(Refer to W.N.1) (2.50 hrs. × Rs.40) (3.25 hrs. × Rs.40) (4.50 hrs. × Rs.40)
Total Cost 370 505 710

W.N.1
Overhead Rate per Labour Hour
= Total Overhead incurred
Total Direct Labour Hours
= Rs.20,30,200 +Rs. 39,65,000+Rs.31,50,000+Rs.77,70,000+Rs.38,04,800

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

(2.50 hrs.×80,000) + (3.25hrs.×48,000) +(4.50hrs. ×36,000)

=RS.40.00 per labour hour
(ii)
Statement showing “computation of Cost of Product”
(Based on the Activity Based Costing System)
Baby suits (Rs. /U) Babu suits (Rs. /U) Superman suits (Rs. /U)
Materials Cost 120 180 260
Labour Cost 150 195 270
(2.50 hrs. × RS.60) (3.25 hrs. × RS.60) (4.50 hrs. × RS.60)
Overheads 101.85 116.59 193.77
(Refer to W.N.1)
Total Cost 371.85 491.59 723.77

W.N.2
Overhead Cost per unit under Activity Based Costing
Activity cost Baby Suits Babu Suits Superman Suits
pool
Purchase 8,12,080 5,07,550 7,10,570
section
[ 400
1000
×Rs.20,30,200 ] [ 250
1,000
×Rs.20,30,200 ] [ 350
1000
×Rs.20,30,200 ]

Machine Setup 14,30,000 9,75,000 15,60,000

[ 1,100
3,050
×Rs.39,65,000 ] [ 750
3,050
×Rs.39,65,000 ] [ 1,200
3,050
×Rs.39,65,000 ]

Delivery 10,50,000 6,60,000 14,40,000

Section
[ 700
2,100
×Rs.31,50,000 ] [ 440
2,100
×Rs.31,50,000 ] [ 960
2,100
×Rs.31,50,000 ]

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Labour 30,00,000 23,40,000 24,30,000

Amenities &
Welfare [ 2,00,000
5,18,000
×Rs.77,70,000] [ 1,56,000
5,18,000
×Rs.77,70,000 ] [ 1,62,000
5,18,000
×Rs.77,70,000]

Customer 18,56,000 11,13,600 8,35,200

Support
[ 80,000
1,64,000
×Rs.38,04,800] [ 48,000
1,64,000
×Rs.38,04,800 ] [ 36,000
1,64,000
×Rs.38,04,800]

Total overheads 81,48,080 55,96,150 69,75,770

cost
Units 80,000 48,000 36,000
Overhead Cost 101.85 116.59 193.77
per unit

Transfer pricing
Answer No. 9:
i. Total cost = Rs.115 + Rs.90+Rs.35 + Rs.9 = RS.249
Let ‘T’ be the Transfer Price
{Transfer price – (Total Cost)} (1-Tax Rate) = 015T
{T – 249} (1 – 0.30) = 0.15T
{T – 249} ( 0.70) = 0.15T
0.70T – 174.30 = 0.15T
0.70T – 0.15T =174.30
T =Rs.316.91
ii. {Transfer Price – (Total Cost)} (1 – Tax Rate) = 20% of ROI

{T – 249} (1 – 0.30) = 0.20 × [ Rs.75,00,000

25,000𝑢𝑛𝑖𝑡𝑠
]
{T – 249} (0.70) = 60

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

0.70T – 174.30 = 60
0.70T = 234.30
T = Rs.334.71
iii. {Transfer Price – (Total Cost)} (1 – Tax Rate) = 15% of List sales price

{T – 249} (1-0.30) = 0.15× [ ]

T
0.75

{T – 249} (0.70) = 0.20T

0.70T – 174.30 = 0.20T
0.70T – 0.20T = 174.30
T = Rs.348.60

iv. Transfer price = Total cost + 30% of Marginal Cost

= 249 + 0.30 × (115 + 90 + 35 × 0.60)
= RS.316.80

Standard costing & variance Analysis

Answer No. 10:
Actual output produced is 630 kg. The standard quantity of material required for 630 kg. of
output is 700 kg. (630kg/90*100)
Statement showing computation of standard cost/actual cost /revised actual quantity
Material Standard Cost Actual Revised Actual Quantity [RAQ]
Cost (Kg.)
Quantity [SQ] Price Amount Quantity Price Amount
(Kg.) [SP] [SQ× [AQ] [AP] [AQ×AP]
(Rs.) SP] (Kg.) (Rs.) (Rs.)
(Rs.)
p 280 30 8,400 350 25 8,750 300
(40% of 700 Kg.) (40% of
750 kg.)
Q 420 40 16,800 400 45 18,000 450
(60% of 700 Kg.) (60% of

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750 kg.)
Total 700 25,200 750 26,750 750

COMPUTATION OF VARIANCES
Material cost variance = SQ × SP – AQ × AP
P = 280 Kg. × Rs.30 – 350 kg. × Rs.25
= Rs.350 (A)
Q = 420 Kg. × Rs.40 – 400 kg. Rs.45
= Rs.1,200 (A)
Total = Rs. 350 (A) + Rs.1,200 (A)
= Rs.1,550 (A)
Material price variance = AQ x (AP – AP)
P = 350 Kg. × (Rs.30 – Rs.25)
= Rs.1,750 (F)
Q = 400kg. (Rs.40 – Rs.45)
= Rs. 2,000 (A)
Total = Rs. 1,750 (F) + Rs. 2,000 (A)
= Rs.250 (A)
Material mix variance = SP x (RAQ – AQ)
P = Rs.30 x (300 kg – 350 kg)
= Rs. 1,500 (A)
Q = Rs.40 x (450 kg. – 400 kg)
= Rs. 2,000 (F)
Total = Rs. 1,500 (A) + Rs. 2,000 (F)
= Rs.500 (F)
Material yield variance = SP x (SQ – RAQ)
P = Rs.30 x (280 kg. – 300 kg)
= Rs. 600 (A)

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Q = Rs.40 x (420 kg. – 450kg)

= Rs. 1,200 (A)
Total = Rs. 1,800 (A)

Budget & Budgetary control

Answer No. 11:
(I)
Statement showing “production Budget”
Particulars ‘RB’ ‘RD’
(units) (units)
Inventory (at the end of the year) 31,250 11,250
Add: projected Sales 75,000 50,000
Total Requirements 1,06,250 61,250
Less: Beginning inventory 25,000 10,000
Production 81,250 51,250

(ii) Statement showing “Direct Material Purchase Budget”

Particulars Material Material Material
‘A’ (kg.) ‘B’ (kg.) ‘C’ (kg.)
Requirement for production 4,06,250 2,03,125 -
‘RB’
(81,250 units x 5 kg.) (81,250 units x 2.50kg)
Requirement for production 2,56,250 1,53,750 51,250
‘RD’
(51,250 units x 5 kg.) (51,250 units x 3 kg) (51,250 units x 1
kg)

Total Requirement 6,62,500 3,56,875 51,250

Add: Closing inventory 45,000 40,000 8,750

Less: Beginning inventory 40,000 36,250 7,500

Purchase 6,67,500 3,60,625 52,500

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(iii) Statement showing “Direct Labour Hours Required vs Available”

Particulars ‘RB’ units ‘RD’ units Total
Maximum sales 75,000 50,000
Less: From stock 25,000 10,000
Required Goods for pdn. 50,000 40,000
Direct Labour Requirement 2,00,000 2,40,000 4,40,000 hrs.
(50,000 units x 4 hrs.) (40,000 units x 6 hrs.)
Direct labour Available 6,00,000 hrs.

Since Direct Labour Hrs. (Requirement) is < Direct Labour Hrs. (Availability), Sales (units) is
the principal budget factor.

Target Costing
Answer No. 12:
For the same quantity, sales value will reduce by 8% of (1,00,000 units x Rs. 150) = Rs. 12
lakhs. For maintaining the same amount of profit, cost also has to be reduced by Rs. 12 lakhs,
which can be achieved as under-
Particulars Rs. In lakhs
Savings: Reduction in wages 6.00
(Due to higher labour productivity, wages will be 30/1.25 = Rs.24.00 lakhs)
Elimination of wastage of Materials = 1% of Rs.50 lakhs 0.50
Savings in packaging Cost (given) 1.35
Savings in Maintenance Cost (given) 0.80
Sub- Total Savings ...(A) 8.65
Loss in Disposal of old Machine (Rs.3 lakhs – Rs.2.25 lakhs) 0.75
Difference in Depreciation (Rs.10 lakhs – Rs.3lakhs) x 10% 0.70
Cost of capital Investment (Rs.10 lakhs x 12%) 1.20

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Sub-Total Costs …(B) 2.65

Effective cost Reduction before considering removal of supervisors …(A) – (B) 6.00
Additional reduction required for meeting Target Cost, by removing supervisors 6.00
(Rs.12 lakhs – Rs.6 lakhs)
Hence,
Number of Supervisors to be Removed = Rs.6lakhs/Rs.1.20 lakhs = 5 supervisors

Decision Making Problems (Shutdown/continue decision)

Answer No. 13:
Contribution per unit
Particulars (Rs.)
Selling price 250
Variable cost (Rs.90+Rs.70+Rs.30+Rs.4+Rs.6) 200
Contribution per unit 50
Savings/ (Loss) if the Plant is Shut Down
Particulars (Rs.)
Savings in Fixed Cost (Rs.16,00,000 x 60%) 9,60,000
Loss of contribution (Rs.50 x 10,000 units) (5,00,000)
Additional cost of Shut Down (200,000)
Total 2,60,000*
(#) Rs.20Lx 25%+Rs.10Lx80%+Rs.6Lx50%= Rs.16L
Considering the above analysis*, we can conclude that the decision of discountinuing plant will
be beneficial for the company.
Shut Down point = Rs.9,60,000 – Rs.2,00,000
Rs.50
= 15,200 units

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Marginal costing Vs Standard Costing

Answer No. 14:
Statement of reconciliation- Budgeted Vs Actual Profit
Particulars Rs.
Budgeted profit 5,19,000
Less: Sales volume Contribution planning variance (Adverse) 52,125
Less: Sales volume Contribution Operational variance (Adverse) 93,825
Less: Sales price variance (Adverse) 39,600
Less: variable cost variance (Adverse) 29,700
Less: fixed Cost variance (Adverse) 15,000
Actual profit 2,88,750

Workings
Basic workings
Budgeted Market Share (in %) = 2,00,000 units = 50%
4,00,000 units
Actual Market Share (in %) = 1,65,000 units = 44%
3,75,000 units
Budgeted contribution = Rs.21,00,000 – Rs.12,66,000
= Rs.8,34,000
Average Budgeted Contribution (per unit) = Rs.8,34,000 = Rs.4.17
Rs.200,000
Budgeted Sales Price per unit = Rs.21,00,000 =Rs.10.50
RS.2,00,000
Actual Sales Price per unit = Rs.16,92,900 = Rs.10.26
Rs.1,65,000
Standard variable Cost per unit = Rs.12,66,000 =Rs.6.33
Rs.2,00,000
Actual Variable cost per unit = Rs.10,74,150 = RS.6.51
Rs.1,65,000
Calculations of variances
Sales variances:

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Volume contribution Planning* = Budgeted Market Share % x (Actual industry Sales Quantity
in units – Budgeted Industry Sales Quantity
in units) x (Average Budgeted contribution per unit)
= 50% x (3,75,000 units – 4,00,000 units) x Rs.4.17
= Rs. 52,125 (A)
(*) Market Size variance
Volume contribution operational** = (Actual Market Share % - Budgeted Market Share %) x
(Actual Industry Sales Quantity in units) x (Average
Budgeted Contribution per unit)
= (44% - 50%) x 3,75,000 units x 4.17
= Rs. 93,825 (A)
(**) Market share variance
Price = Actual sales – Standard sales
= Actual sales Quantity x (Actual Price – Budgeted Price)
= 1,65,000 units x (Rs.10.26 – Rs.10.50)
= Rs.39,600 (A)
Variable Cost Variances
Cost = Standard Cost for Production – Actual Cost
= Actual production x (Standard Cost per unit – Actual cost per
Per unit)
= 1,65,000 units x (Rs. 6.33 – Rs. 6.51)
= Rs. 29,700 (A)
Fixed Cost variances
Expenditure = Budgeted Fixed Cost – Actual Fixed Cost
= Rs. 3,15,000 – Rs.3,30,000
= Rs. 15,000 (A)
Note: Fixed Overhead Volume Variance does not arise in a Marginal Costing system.
Marginal costing & Decision-making Problems

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Answer No. 15:

Alternative- 1 with No Strike: (Refer W.N.-2,3)
Cost of settlement is 15% increase i.e. Rs. 216 per unit
Annual cost of settlement
= 54,000 units x Rs.216

= Rs.1,16,64,000
Alternative 2 i.e. if Strike Goes Ahead: (Refer W.N.-1,2,3)
Extra cost (Rs.)
Annual Incremental Labour Cost (Ex. Strike Days Production) 71,28,000
[{54,000 units – (25 Days x 180 units per Day)} x Rs.144.00]
Loss of contribution due to loss of sales [1,300 units x Rs. 2,200] 28,60,000
Incremental Labour Cost for Balance 3,200 units 4,60,800
[(25 Days x 180 units per Day) – 1300 units} x Rs.144.00]
Overtime premium [3,200 units x 1,584 x 0.5] 25,34,400
Payment for Efficiency [3,200 units x 1/9 x 1,584 x 1.5] 8,44,800
Additional Fixed Cost 1,00,000
1,39,28,000

If there is no strike, it will yield financial benefit of RS. 22,64,000 (Rs.1,39,28,000 –

Rs.1,16,64,000). Management should accept union’s demand.
Working Note
(1) Statement Showing Contribution per unit of ‘DBC’
(Rs.)
Selling price 6,000
Less: variable Costs:
Labour Cost 1,440
Production Ex. Wages (Rs.3,600 – RS.1,440) 2,160

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Distribution 200
Contribution 2,200

(2) Calculation of Labour Cost

Direct Labour (40% of production costs of Rs. 3,600) = Rs.1,440 per unit
With 15% Increase, Revised Labour Cost (Rs.1,440 + Rs.216) = Rs.1,656
With 10% Increase, Revised Labour cost (Rs.1,440 + Rs.144) = Rs.1,584
(3) Statement Showing Budgeted Production
Total Time in a Day: (8hrs. x 60 minutes) = 480 minutes
Less: Idle time = 48 minutes
Coffee Break = 20 minutes
Instructions = 22 minutes
Training = 30 minutes
Productive Time per day = 360 minutes
Therefore, ‘DBC’ to be produced per man per day. (360/180 x 1)
= 2 units
Since ‘DBC’ are produced at the rate of 2 ‘DBC’ per man day, so total yearly production will be
54,000 units (2 units x 90 men x 300 days) of ‘DBC’.

Just in time approach

Answer No. 16:
(I) workings
Statement Showing ‘Inventory Holding Cost’ under plan 1
Particulars Pd. 1 Pd. 2 Pd. 3 Pd. 4
Opening Inventory (A) --- 8,000 8,500 7,500
Add: Production 17,500 17,500 17,500 17,500
Less: Demand/ Sales 9,500 17,000 18,500 2,5000
Closing Inventory (B) 8,000 8,500 7,500 ---

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Average Inventory ( )
A+B
2
4,000 8,250 8,000 3,750

Inventory Holding cost @ RS.6.50 26,000 53,625 52,000 24,375

Inventory Holding cost for the four periods = Rs,1,56,000
(Rs.26,000 +Rs.53,625+Rs.52,000+Rs.24,375)
Statement showing ‘Additional Cost-overtime’ under Plan 2 (JIT system)
Particulars Pd.1 Pd.2 Pd.3 Pd.4
Demand/Sale 9,500 17,000 18,500 25,000
Production in Normal Time 9,500 17,000 18,000 18,000
Production in Over Time (A) --- --- 500 7,000
Variable Cost Per Unit 30 30 32.50 35.00
Additional Cost – Overtime Per Unit (B) 9 9 9.75 10.50
(@) 30% of variable Cost)
Additional Cost – Overtime (A)X(B) --- --- 4,875 73,500
Total Additional payment (overtime) = Rs.78,375
(Rs.4,875 + Rs.73,500)
Statement Showing ‘Additional Variable Cost’ under Plan 2 (JIT System)
Particulars Pd.1 Pd.2 Pd.3 Pd.4 Total
Production (plan 1) 17,500 17,500 17,500 17,500 70,000
Variable Cost …(A) 5,25,000 5,25,000 5,68,750 6,12,500 22,31,250
Production (Plan 2, JIT) 9,500 17,000 18,500 25,000 70,000
Variable Cost (B) 2,85,000 5,10,000 6,01,250 8,75,000 22,71,250
Total (B) – (A) 40,000
*excluding overtime cost
Incremental Production Cost in JIT System = Rs.78,375 + Rs.40,000
= Rs.1,18,375
Therefore, Saving in JIT System (Net) = Rs.1,56,000 – Rs.1,18,375
= Rs.37,625

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

(ii) Advice
Though Revolution Ltd is saving Rs. 37,625 by changing its production system to Just-in-time
but it has to consider other factors as well before taking any final call which are as follows: -
- Revolution Ltd has to ensure that it receives materials from its suppliers on the exact date
and at the exact time when they are needed. Credentials and reliability of supplier must
be thoroughly checked.

- To remove any quality issues, the engineering staff must visit supplier’s sites and
examine their processes, not only to see if they can reliably ship high-quality parts but
also to provide them with engineering assistance to bring them up to a higher standard of
product.

- Revolution Ltd. should also aim to improve quality at its process and design levels with
the purpose of achieving ‘Zero Defects” in the production process.

- Revolution Ltd. should also keep in mind the efficiency of its work force. Revolution
Ltd. must ensure that labour’s learning curve has reached at steady rate so that they are
capable of performing a variety of operations at effective and efficient manner. The
workforce must be completely retrained and focussed on a wide range of activities.

Marginal Costing
Answer No. 17:
Statement of extra weekly contribution resulting from the proposed change of automation
to evaluate the worth of the project for the Board’s information
Sales (units) 57,600
A. Sales value: [57,600 units x Rs. 12] Rs. 6,91,200
B. Marginal costs (excluding wages) [57,600 units x Rs.6.50) Rs.374,400
C. Wages [57,600 units x Rs.1.30] Rs.74,880
Total marginal cost: Rs.4,49,280
D. Marginal contribution: [A-B-C] Rs.2,41,920
E. Less: present contribution Rs.2,40,000
F. Increase in contribution (per week) Rs.1,920
Payback period for recovering the capital cost (Rs.1,60,000/Rs.1,920) =83.33
weeks

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Evaluation: The project is recommended assuming that the increase in fixed overhead if any, is
less than, the increase in contribution
Working Notes:
(i) present output per employee = Total present output
Total number of present employees

= 48,000 units
160 employees
= 300 units
(ii) Total future expected output = Total number of future employees [present output per
employees + 60% present output per employee]
=120X(300 units+60%X300 units)=57,600 units
(iii) Present piece work rate = Rs. 1 per unit
(iv) Proposed piece work rate = Present piece work rate + 30% x Rs.1 = Rs.1.30 per unit
(v) Present sale price per unit = Rs.12.50 (Rs.6,00,000/48,000 units)
(vi) Proposed sale price per unit = (Rs. 12.50 - 4% x Rs.12.50) = Rs. 12
(vii) Present marginal cost (excluding wages) per unit.
= present sales value – contribution towards fixed expenses & profit – present wages
Present output (units)
= Rs.6,00,000 – Rs.2,40,000 -Rs.48,000
48,000 units
= Rs.6.50 per unit

Marginal costing & Decision-making Problems

Answer No. 18:
I. Statement showing the contribution and Ranking of the product
Particulars Apples Apricots Cherries Plums

A. No. of Boxes per Acre 500 150 100 200

B. Selling Price per Box. (Rs.) 10 10 20 30
C. Selling Price per Acre (Rs.) [A x B] 5,000 1,500 2,000 6,000

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

D. Less: Marginal Cost (Rs.)

(a) Material Cost per acre 180 70 60 100
(b) Labour cost per acre
(i) Growing 200 150 100 130
(ii) Harvesting & Packing 500 150 200 600
(iii) Transport 1000 300 100 600
Total Marginal Cost per acre 1,880 670 460 1,430
E. contribution per acre (RS.) [C – D] 3,120 830 1,540 4,570
F. Priority as per contribution per acre II IV III I

II. Statement showing the Allocation of Area Suitable for Apricots and Cherrie only
A. Total such area 250
B. less: Area for Min. Qty of Apricots (i.e. the product having lesser contribution) 80
[12,000/150]
C. Balance to be used for product having greater contribution i.e. cherries [A – B] 170

III. Statement showing the Allocation of Area Suitable for Every Fruit
Total such Area 100
Less: Min. Qty of Apples (i.e. the product having lesser contribution) [12,000/500] 24
C. Balance to be used for product having greater contribution [A – B] 76

IV. Statement showing the Maximum Total profits at suggested product Mix
Apples Apricots Cherries Plums Total
A. Area in Acres 24 80 170 76
B. contribution/Acre (Rs.) 3,120 830 1,540 4,570
C. Total Contribution (A x B) 74,880 66,400 2,61,800 3,47,320 7,50,400
D. Less: Fixed costs 1,82,000
E. profit [C – D] 5,68,400

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

Write short notes on

Answer No. 19:
a) Ans: Managers take decisions on a daily basis, addressing everything from day-to-day
operational issues to long-range strategic planning. The decision-making process of a manager
can be broken down into six distinct steps. Although each step can be examined at length,
managers often run through all of the steps quickly when making decisions. Understanding the
process of managerial decision-making can improve your decision-making effectiveness.
(i) Identify Problems
The first step in the process is to recognize that there is a decision to be made. Decisions are not
made arbitrarily; they result from an attempt to address a specific problem, need or opportunity.
(ii) Seek Information
Managers seek out a range of information to clarify their options once they have identified an
issue that requires a decision. Managers may seek to determine potential causes of a problem, the
people and processes involved in the issue and any constraints placed on the decision-making
process.
(iii) Possible solutions
Having a more complete understanding of the issue at hand, managers move on to make a list of
potential solutions. This step can involve anything from a few seconds of thought to a few
months or more of formal collaborative planning, depending on the nature of the decision.
(iv) Choose an alternate
Managers weigh the pros and cons of each potential solution, seek additional information if
needed and select the option they feel has the best chance of success at the least cost. Consider
seeking outside advice if you have gone through all the previous steps on your own; asking for a
second opinion can provide a new perspective on the problem and your potential solutions.
(v) Implement the Plan
There is no time to second-guess yourself when you put your decision into action. Once you
have committed to putting a specific solution in place, get all of your employees on board and
put the decision into action with conviction. That is not to say that a managerial decision cannot
change after it has been enacted; savvy managers put monitoring systems in place to evaluate the
outcomes of their decisions.
(vi) Evaluate outcomes
Even the most experienced business owners can learn from their mistakes. Always monitor the
results of strategic decisions you make as a small business owner; be ready to adapt your plan as
necessary, or to switch to another potential solution if your chosen solutiondoes not work out the
way you expected.

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

(b) Ans: A firm’s performance is measured by the profit it makes. Profits of a firm depend upon
a large number of factors. But, the most important factors are costs of manufacture, volume of
sales and selling price of the products.
The analytical technique employed to study the inter-relationship of cost, volume and price and
its impact on the behavior of profit is known as ‘Cost-Volume Profit (CVP) Analysis’.
In the short-run, profit planning can be made with the use of CVP analysis. It helps the
management to achieve an ideal combination of costs and volume. This becomes possible with
the understanding of the implications of variable cost, fixed costs and volume. CVP analysis
helps the management in deciding the quantum of sales required to be made to avoid losses, as
well as reaching a particular level of sales to achieve the targeted amount of profit.
Utility of CVP Analysis: CVP analysis studies the relationship of cost-volume-profit at different
levels of output. This analysis is an important tool for profit planning. The three factors of CVP
analysis — costs, volume and profit — are interconnected and dependent on one another.
(c) Ans: ERP refers to software, which integrates all departments and functions across a
company into a single computer system that can serve all the needs of different departments.
It combines all computerized departments together with the help of a single integrated software
program that uses a single database so that various departments can more easily share
information and communicate with each other.
The major features of Enterprise Resource Planning (ERP) are:
(i) Integrated: ERP facilitates company-wide information integration covering all functional
areas like manufacturing, selling & distribution, payables, receivables, inventory,
accounts, human resources etc. ERP provides complete integration of systems not only
across departments but also across companies under the same management.

(ii) Customer Service: ERP Performs core activities and increases customer service, thereby
augmenting the corporate image.

(iii) Information sharing: ERP bridges the information gap across organizations.

(iv) Project management: ERP is the solution for better project management.

(v) E-com Facilities: ERP allows automatic introduction of technologies like Electronic Fund
transfer (EFT), Electronic data interchange (EDI), Internet, Intranet, Video Conferencing,
and E-Commerce.

(vi) Business Decision making solutions: ERP provides business intelligence tools like
Decision Support System (DSS), Executive Information System (EIS), Reporting, Data
mining and Early warning system (Robots) for enabling people to make better decisions.
It eliminates most business problems like material shortages, productivity enhancements,
customer service, cash management, inventory problems, quality problems, prompt
delivery etc.

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

(vii) Futuristic: ERP not only addresses the current requirements of the company but also
provides the opportunity of continually improving and refining business processes.
(d) Ans: Unbalanced assignment problems
Unbalanced Assignment problem is an assignment problem where the number of facilities is not
equal to the number of jobs. To make unbalanced assignment problem, a balanced one, a dummy
facility(s) or a dummy job(s) (as the case may be) is introduced with zero cost or time.
The Assignment problem can be Balanced or Unbalanced problem. A Balanced problem means
the no. of rows and no. of columns in the problem are equal. E.g. if the problem contains 4
workers and 4 jobs, then it is balanced.
Sometimes, it is possible to cross out all the zeros in the reduced matrix in two or more ways. If
we can choose a zero cell arbitrarily, then there will be multiple optimal solutions with the same
total pay-off for assignments made.
(e) Ans: Project crashing is the name given to schedule compression techniques that are used
when a person wants to shorten the duration of a project without changing the scope. There are
basically two techniques that can be used to shorten project duration while maintaining project
scope. These techniques are fast tracking and crashing. Cost and schedule trade-offs are analyzed
to determine how to obtain the greatest amount of compression for the least incremental cost.
Crashing analyzes and categorizes activities based on the lowest crash cost per unit time.
Crashing only works for critical path activities where it is possible to shorten schedules. The
project crashing results in a high direct cost to the project, but also gives clear identification for
optimal time cost. In project management, direct cost is the basis for crashed cost calculation.
Project crashing serves the purpose of effective time management.

Answer No. 20:

(a) Transportation & Assignment Problems

Transportation Problem Assignment Problem

Number of sources and number of Since assignment is done one basis, the
destinations need not be equal. Hence, the number of sources and number of
cost matrix is not necessarily the square destinations are equal. Hence, the cost
matrix. matrix must be a square matrix.

The Problem is unbalanced if the total The problem is unbalanced if the cost
supply and total demand are not equal. matrix is not a square matrix.

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CAP III Paper 7: Advanced Cost and Management Accounting-Solution

(b) Standard Cost & Actual Cost

Standard cost Actual Cost

Standard cost refers to estimated cost of a Actual cost is the realized cost and is
product pertaining to material, labour and not based on the estimates of the same.
other overhead costs.
It cannot be included in the Financial It is shown as expenses in the financial
statements of the Company. statement.
In case of any errors in data capture, the The errors in data capture would lead to
inventory valuation does not change but distorted costs and actual inventory
shown as variance. valuation.
These costs are recorded at the beginning These costs are recorded and realized
of the year when the budget is planned. during the entire year and recorded in
the same manner.
Method of costing using standard costing In the method of costing using actual
provides better visibility and chances to costs, certain issues can be hidden by
improve the performance, as the variances capitalizing them with the costs of the
can be useful to identify the issues in the inventory.
production and manufacturing process.

(c) Target Cost and Cost plus Pricing

Target Cost Cost Plus Pricing
Business starts by determining how much Business adds up the total cost of
it wants to charge for a product. It then producing an item, adds on a markup
subtracts its desired profit from that price for its profit, and the result is the selling
to arrive at the maximum cost it can price
afford to pay to produce that product.
Target costing recognizes that a business It is simple and predictable. It is other
does not have total control over pricing; way around to target costing.
price is limited by what the market will
pay.
Target costing often requires a business A key disadvantage is that it sets a price
to design its entire production process without taking into consideration how
around meeting the cost. Here, the price that price will affect demand. The price
of the product is set considering the it sets could be either too low or too
demand and supply. high.

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