The Institute of Chartered Accountants of Nepal

Suggested Answers of Advanced Accounting

CAP II Examination June 2010

1. The following list of account balances relates to Virat as at 31st Ashadh, 2067:

Rs'000 Rs'000
Sales revenue 473,300
Purchases 310,500
Operating expenses 18,400
Loan stock interest 5,000
Dividends paid 15,500
Leasehold building at cost (note (ii)) 200,000
Plant and equipment at cost (note (ii)) 124,800
Deferred development expenditure (note (iii)) 75,000
Joint venture (note (iv)) 62,000
Depreciation at 1st Shrawan, 2066 – leasehold 56,000
– plant and equipment 48,800
– development expenditure 15,000
Trade receivables 49,200
st
Inventory – 1 Shrawan, 2066 27,500
Bank 12,100
Trade payables 82,200
Ordinary shares of Rs 100 each 100,000
10% Convertible Loan stock – issued 2065 100,000
Deferred tax at 1st Shrawan, 2066 (note (v)) 11,400
Profit and loss reserve at 1st Shrawan, 2066 13,300
9,00,000 9,00,000

The following notes are relevant:

(i) The cost of the inventory at 31st Ashadh, 2067 was Rs.37.7 million (excluding joint venture
inventory – see note (iv)).

(ii) Non-current assets:

On 1st Shrawan, 2066, Virat‘s leasehold building was revalued at Rs.270 million by an
independent surveyor. The lease was for a 25-year period when Virat acquired it. The directors
wish to incorporate the revalued amount in Virat‘s financial statements. The revaluation reserve
will be deemed to be realised in line with the remaining life of the lease.

Plant is depreciated at 20% per annum on the reducing balance basis.

All depreciation is charged to cost of sales.

(iii) The deferred development expenditure relates to a new product. The project was successfully
completed on 1st Shrawan, 2065 and sales of the new product commenced on that date. The
development costs are being depreciated on a straight-line basis over the expected product life of
five years. Early in the current year, a review of the sales figures for the new product showed that
they were disappointing. In view of this, Virat has estimated that the present value of the expected
net future cash flows from sales of the new product is Rs.30 million; however, Virat has been
approached by a rival company with an offer of Rs.40 million for the rights to the product. At this
stage, Virat intends to continue to market and sell the product.
 Suggested Answers of Advanced Accounting
CAP II Examination – June 2010

(iv) On 1st Shrawan, 2066, Virat entered into a joint venture with two other companies. Each venturer
contributes its own assets and pays its own expenses. The agreement stipulates that the joint
venture will be terminated on 31st Ashadh, 2070. Virat is entitled to 30% of the joint venture‘s total
revenues. The joint venture is not a separate entity. Details of Virat‘s joint venture transactions are:
Rs'000
Plant and equipment at cost 70,000
Share of joint venture sales revenues (30% of total sales revenues) (18,000)
Related cost of sales excluding depreciation 8,000
Inventory 31st Ashadh, 2067 2,500
Accounts receivable 31st Ashadh, 2067 3,500
Accounts payable 31st Ashadh, 2067 (4,000)
Net balance included in the above list of balances 62,000
Plant should be depreciated on a straight-line basis. It is not expected to have any residual value at
the end of the joint venture.
(v) The directors have estimated the required provision for income tax for the year to 31st Ashadh,
2067 is Rs.15 million. The deferred tax provision at 31st Ashadh, 2067 is to be adjusted to reflect
the tax base of the company‘s assets being Rs.70 million less than their carrying values. Rs.28·8
million of this Rs. 70 million is attributable to the revaluation of the leasehold. Virat‘s rate of
income tax is 25%.
(vi) The directors have proposed a final ordinary dividend of Rs.24 per share. Virat discloses proposed
dividends as part of shareholders‘ funds.
Required:

Prepare for Virat, in accordance with International Accounting Standards as far as the information
permits:
a) the Income Statement;
b) the Statement of Changes in Equity for the year to 31st Ashadh, 2067; and
c) a Balance Sheet as at 31st Ashadh, 2067.
Notes to the financial statements are not required. (7+4+9=20)
Answer:
a) Virat – Income Statement - for the year to 31st Ashadh, 2067

Rs '000
Sales revenue (473,300 + 18,000 (w (i)) 491,300
Cost of sales (w (ii)) (366,000)
Gross profit 125,300
Operating expenses (18,400)
Impairment of non-current asset (60,000 – 40,000) (w (iv)) (20,000)
Profit on the ordinary activities before interest 86,900
Loan interest (5,000 + 5,000) (10,000)
Profit before tax 76,900
Taxation (w (iii)) (13,900)
Profit for the period 63,000
_______

b) Virat – Statement of Changes in Equity – for the Year to 31st Ashadh, 2067

Ordinary Revaluation Accumulated Total

Shares reserve profits
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Rs '000 Rs '000 Rs '000 Rs '000

Balance at 1st Shrawan, 2066 100,000 nil 13,300 113,300

Surplus on revaluation of leasehold (w (iv)) - 126,000 - 126,000
Transfer to deferred tax (w (iii)) - (7,200) - (7,200)
Transfer to realised profits re leasehold
(126,000 – 7,200 deferred tax)/18 years) - (6,600) 6,600 -
Net profit for the period (63,000 – 24,000) - - 39,000 39,000
Dividends paid - - (15,500) (15,500)
Amount attributable to proposed dividends
(1000×Rs.24) - - 24,000 24,000

Balance at 31st Ashadh, 2067 100,000 112,200 67,400 279,600

c) Virat – Balance Sheet as at 31st Ahsadh 2067

Non-current assets Rs '000 Rs '000

Development expenditure (w (iv)) 30,000
Property, plant and equipment (w (iv)) 368,300
_______
398,300
Current Assets
Inventory (37,700 + 2,500) 40,200
Trade receivables (49,200 + 3,500) 52,700
Bank 12,100
105,000
Total assets 503,300
_______
Equity and liabilities
Ordinary shares Rs. 100 each 100,000
Reserves:
Accumulated profits (see (b) above) 67,400
Revaluation reserve (see (b) above) 112,200 179,600
______ _______
279,600
Non-current liabilities
10% Convertible loan stock 100,000
Deferred tax (70,000 × 25%) 17,500 117,500
______
Current liabilities (w (v)) 106,200
Total equity and liabilities 503,300

Working Notes
(i) IAS 31 ―Financial Reporting of Interests in Joint Ventures‖ requires each venturer in jointly
controlled operations to account for the assets that it controls and the liabilities that it incurs in its
balance sheet and the expenses that it incurs and the revenues that it receives in its income statement.
As this is not a separate entity the above should be included in the appropriate ―line‖ items in the
financial statements e.g. Virat‘s share of the sales of the joint venture should be added to its own sales
figure. A similar procedure should be applied to all other elements of the joint venture.

(ii) Cost of sales: Rs.‘000

Opening inventory 27,500
Purchases 310,500
Joint venture cost of sales 8,000
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Depreciation (w (iv)) – leasehold 15,000

– Plant (15,200 + 17,500) 32,700
– Development expenditure 10,000
Closing inventory (37,700)
_______
366,000
_______

(iii) Taxation Rs. ‗000

Current tax provision for year 15,000
Deferred tax (see below) (1,100)
_______
13,900
_______
The difference between the tax base of the assets and their carrying value of Rs.70 million would
require a balance sheet provision for deferred tax of Rs.17·5 million (at 25%). Of this Rs.7·2
million (Rs.28·8 million × 25%) is taken to the revaluation reserve leaving a balance of Rs.10·3
million. The opening provision was Rs.11·4 million, thus Rs.1·1 million (Rs.11·4 million –
Rs.10·3 million) is released to the income statement.

(iv) Non-current assets/depreciation/revaluation:

Development expenditure:

The capitalised development expenditure has suffered impairment due to falling sales of the related
product. Therefore, it should be written down to its recoverable amount, which is the higher of its
value in use (Rs.30 million) or its realisable value (Rs.40 million). Thus it should be written down
to Rs.40 million.

Impairment loss on development expenditure Rs.'000

Carrying amount (Rs.70 – 15) million 60,000

Less : Higher of realizable value and value in use (i,e. realizable value) 40,000
20,000

Depn. on development expenditure

Amortisation for the current year will be based on the revised carrying value of Rs.40 million and
its remaining life of 4 years.
Depn. on development expenditure = Rs 40/4 = Rs 10 million

a) Leasehold Building Rs. '000

Cost 200,000
Depreciation at 1 Shrawan 2066 (of 7yrs@8milion each year) (56,000)
Net book value prior to revaluation 144,000
(difference on revalued amount and net book value)
Valuation 1 Shrawan 2066 270,000
Revaluation surplus 126,000

Depreciation year to 31 Ashadh 2067 (270,000/18 (i.e. 25 – 7) years) (15,000)

Net book value at 31 Asad 2067=Rs. (270-15) million= 255,000

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_______
b) Plant: Rs. '000
Cost – non joint venture 124,800
– joint venture 70,000
_______
194,800
Depreciation for year
– non joint venture (124,800 – 48,800) × 20% 15,200
– joint venture (70,000/4 years) 17,500
_______
32,700
Net book value (194,800 – (48,800 + 32,700)) 113,300
_______

Net book value of property, plant and equipment (b+c)

(255,000 + 113,300) 368,300
_______

(v) Current liabilities Rs. '000

Per trial balance 82,200
Joint venture 4,000
Accrued loan interest ((10% × 100,000) – 5,000) 5,000
Taxation 15,000
_______
106,200

2.
a) As a bad luck in the very beginning of new year, a fire occurred on 1st Baisakh, 2066 in the
premises of Kanchanjungha Ltd. and business was partially affected up to 30th Bhadra, 2066. The
Company was insured under a loss of profits policy for Rs. 150,000 with a six months period of
indemnity. Following further information are available:
Rs.
st th
Actual turnover from 1 Baisakh, 2066 to 30 Bhadra 2066 100,000
Turnover from 1st Baisakh, 2065 to 30th Bhadra, 2065 200,000
st st
Turnover from 1 Baisakh, to 31 Chaitra, 2065 450,000
Net profit for last financial year 86,000
Insured standing charges for last financial year 43,000
Turnover for the last financial year 430,000

It has been agreed that an adjustment of 20% be made in respect of the upward trend in turnover.
Required:
Computation of the amount of claim under the loss of profit policy. 10

b) On 31st Ashadh, 2065, A Ltd's Balance Sheet showed 10,000, 12 % debentures of Rs. 100 each
outstanding. Interest on debenture is payable on 30th Poush and 31st Ashadh every year. On 1st
Mangsir, 2065, the company purchased 500 of its own debentures as investment at Rs. 97 ex-
interest.
Required:
Journal entries supposing:
i) The company cancels all its own debentures on 1st Ashadh, 2066.
ii) The company resells all its own debentures at Rs. 105 cum- interest on 1st Ashadh, 2066.
(7+3=10)

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Answer:
a) Computation of the amount of claim for the loss of profit
Reduction in turnover Rs.
Turnover from 1st Baisakh, 2065 to 30th Bhadra, 2065 200,000
Add: 20% expected increase 40,000
240,000
Less: Actual Turnover from 2066 to 30th Bhadra, 2066 100,000
Short Sales (Reduction in turnover) 140,000
Gross profit on reduction in turnover @ 30% on Rs.140000 42,000
(see working note 1 for gross profit)
Application of Average Clause:
Amount of Policy x Reduction in GP
GP on Annual Turnover
38,888.88
=(150000/162000) x 42000

Amount of claim under the policy = Rs. 38,888.88

Working notes
(i) Rate of Gross profit for last financial Year:
Gross profit: Rs.
Net Profit 86,000
Add: Insured Standing Charge 43,000
129,000
Turnover for the last financial year 430,000
Rate of Gross Profit = (129,000 / 430,000 ) x 100%

(ii) Annual Turnover and Gross Profit there on:

Turnover from 1st Baisakh 2065 to 31st Chaitra 2065 450,000
Add: 20% expected increase 90,000
540,000
Gross profit on Rs. 5,40,000 @ 30% 162,000

b) Journal Entries
Cr. Dr.

Rs. Rs.
2065 Own debenture Account 48,500
Mansir 1 Debentures Interest Account 2,000
To bank 50,500
(Purchase of 500 of own Debentures of Rs. 100 each
at Rs. 97 ex- interest. Amount of interest paid being
Rs. 12/100 * 4/12 * 50 =Rs. 2,000)
Poush 30 Debenture Interest Account 58,000
2065 To bank 57,000
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To Interest on Own debenture Account 1,000

(Payment of half yearly interest on 9500 debenture
and credit of 2 months interest)
2066 12% Debenture a/c 50,000
Ashadh 1 To Own Debenture A/C 48,500
To Profit on cancelation of own Debenture A/C 1,500
(Cancellation of 500 own debenture purchased earlier
at 97 ex- interest)
2066 Profit on cancelation of own Debenture A/C 1,500
Ashadh 1 To capital Reserve A/c 1,500
(Transfer of profit on cancelation of own debenture
A/c to capital reserve a/C)
2066 Debenture Interest A/C 2,500
Ashadh 1 To interest on own debenture A/c 2,500
(Interest accrued on 500 own debenture from the last
date of payment of interest ( 30th Poush 2065) to the
date of cancelation of debenture ( 1st Ashad 2066)

Ashadh Debenture Interest A/C 57,000

31, 2066 To bank A/c 57,000
(Payment of half yearly interest on 9500 debenture
in cash)
Profit & Loss A/c 119,500
To Debenture Interest A/c 119,500
(Transfer of debenture interest a/c/to p. & L. A/C)
Interest on Own debenture Account 2,500
To Profit & Loss A/c 3,500
(Transfer of interest on debenture a/c/to p. & L. A/C)
2nd option
2066 Bank 52,500
Ashad 1st To Own debenture a/c 50,000
To Interest on own debenture a/c 2,500
(Resale of 500 own debenture at rs. 105 cum-
interest, ex- interest price being credited to own
debenture a/c/and 5 months interest to interest on
own debenture a/c)
Own Debenture a/c 1,500
To profit on resale of Own debenture a/c 1,500
(Profit on resale of own debenture being excess of ex
interest sale price over ex interest purchase
pricetransfered from own debenture a/c to profit on
resale of Own debenture a/c)
Ashad Interest on Own debenture A/C 3,500
31,2066 Profit on resale of Own debenture a/c 1,500
To Profit & Loss A/C 4,000
(Transfer of interest on own debenture and profit on
resale Own Debenture a/c to P/L a/c)

3.
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 Suggested Answers of Advanced Accounting
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a)
i) Butwal Electricity Ltd. decides to replace one of its old plant with a modern one with large
capacity. The plant, when installed in 2050 B.S., cost the company Rs. 2,400,000, the
components of material, labour and overhead being in the ratio of 5:3:2. It is ascertained that
the cost of material and labour have gone up by 40% and 80% respectively. The proportion of
overhead to total cost is expected to remain the same as before.

The cost of the new plant as per improved design is Rs. 6,000,000 and, in addition, material
recovered from the old plant of a value of Rs. 240,000 has been used in the construction of the
new plant. The old plant was scrapped and sold for Rs. 750,000.

The accounts of the company are maintained under Double Account System.

Required:
Indicate how much would be capitalized, and the amount that would be charged to revenue by
preparing relevant ledger accounts. 7

ii) Discuss about the treatment of capital losses under Double Account System of electricity
companies. 3

b)
i) Pashupati asked you to prepare his Balance Sheet from the particulars furnished hereunder:
Gross Profit margin: 10%
Stock velocity: 12
Capital turnover ratio: 2
Fixed assets turnover ratio: 5
Debt collection period: 1 month
Creditor‘s payment period: 73 days
Gross profit: Rs. 100,000
Excess of closing stock over opening stock: Rs. 30,000
Make suitable assumptions wherever necessary. 7

ii) Explain the concept of Capital Maintenance. 3

Answer:
a) i)
Plant Account
Rs. Rs.
To balance B/F 2,400,000 By Balance C/d 4,920,000
To Bank A/C 2,280,000
( cost of new plant- capitalized)
To replacement A/c ( old parts) 240,000
4,920,000 4,920,000

Replacement Account
Rs. Rs.
To Bank a/c 3,720,000 By Bank a/c 750,000
(current cost of replacement) ( sale of scrap)
By Plant A/C
(old material used) 240,000
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By revenue A/C
( transfer) 2,730,000
3,720,000 3,720,000
Working notes

Cost to be incurred for replacement of present plant:

Cost of existing plant increase Current cost

Rs. % Rs
Materials 1,200,000 40 1,680,000
Labour 720,000 80 1,296,000
2,976,000
Overheads ( ¼ of above or 1/5 of total) 744,000
Current replacement cost 3,720,000
Current replacement cost 3,720,000
Total cash cost (a) 6,000,000
Amount capitalized excluding old material used 2,280,000

ii) Treatment of Capital Losses under double account system of electricity companies.
If the assets are abandoned or their normal life is exhausted it is not necessary to write off losses in
capital accounts. As a result assets which are not in use or which are of no value to the entity are
carried on the capital accounts at their original cost.
For practical reason and to account for the losses in Profit and Loss Account, suitable alternatives can
made be and adopted by charging the amount against profits and creating certain provisions.

b) i) Balance Sheet of Mr. Pashupati

Liabilities Rs. Assets Rs.

Capital 500,000 Fixed Assets 200,000
Creditors 1,86,000 Stock 90,000
Debtors 83,333
*Bank balance 312,667
686,000 686,000

*taken to be balancing figure

Working Note
(i) Gross profit= Rs. 100,000
Gross profit margin= 10%
Hence, Sales= Rs. 100,000 x 100/10= Rs. 1,000,000
Cost of goods sold = Sales – Gross profit
= Rs.( 1000,000-100,000)
= Rs. 900,000
Purchase = Cost of goods sold + Increase in stock
= Rs. ( 900,000+30,000) = Rs. 930,000

Average stock= Cost of goods sold/stock velocity

= Rs. 900,000/12=75000

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(ii) Capital:
Capital turnover ratio = 2
Sales/Capital=2
Hence, Capital= Rs. 1,000,000/2 = Rs. 500,000

(iii)Creditors:
Creditors payment period = 73 days
Hence, Creditors= Purchases x 73/365 =Rs. 930,000 x 1/5 = Rs. 186,000

(iv) Fixed assets:

Fixed assets turnover ratio = 5
Hence, Fixed Assets = Sales/5= Rs. 1,000,000/5= Rs. 200,000

(v) Closing stock:

Closing stock is Rs. 30,000 more than opening stock; it is Rs. 15000 more than average stock.
Hence, closing stock= Average stock + Rs. 15000
= Rs. 75,000+Rs.15,000= Rs. 90,000

(vi) Debtors:
Debt collection period = 1 month
Hence, debtors= Sales x 1/12 = Rs. 1,000,000 x 1/12 = Rs. 83,333.33
It is assumed that there is no change in capital during the period.

Note: Alternate solutions are possible.

ii) Capital Maintenance

Broadly, there are two major concept of capital maintenance:
First one is the concept of physical capital maintenance where profit means increase in operating
or production capacity of an enterprise at the end of a period compared to that at the beginning of
the period.
In second concept, profit is only earned if the monetary value of the net assets at the end of a
period exceeds the monetary value at the beginning of the period.
Both the concepts exclude any contributions from and distributions to the owners during the
period.
Underlying principle of capital maintenance is that profit should be only recognized, after ensuring
that capital is intact as compared to the beginning of the period and its not eroded as compared to
the starting point of the period under consideration.

4.
a) Sima, Rima and Hima are running a Beauty Parlor in the form of a partnership firm. They share
profits and losses in the proportion of 1:4:5. Sima received an offer for foreign employment, and
retires from the partnership. However, existing partners are not able to pay her share of capital at
the time of retirement. Adjusted capital at the time of retirement of Sima was as follows:

Sima: Rs. 100,000

Rima: Rs. 250,000
Hima: Rs. 300,000

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Remaining two partners continued to carry on the business of partnership and they are in a position
to settle Sima‘s share of capital after 6 months. During the period the Parlor made a net profit of
Rs. 36,000. Sima borrowed loan of Rs. 120,000 from a bank at an interest rate of 10% at the time
of going for foreign employment.

There was a dispute among the partners regarding sharing of profits after separation of Sima.
However, existing partners agreed either to pay bank interest on borrowed fund or to share profits
according to Capital share at the time of separation.

Required:
Suggest Sima of the option that is more beneficial for her. 5

b) Following figures represent expected production of a machinery taken on 5 years operating lease:

Years Lease Amount(Rs) Production(MT)

1 15,000 13,000
2 35,000 21,000
3 50,000 34,000
4 47,000 32,500
5 44,500 30,000
191,500 130,500

Required:
Pass necessary journal entries in the books of lessee for initial two years. 5

c) Briefly explain about the preferential creditors and their order of payment in the case of a company
under liquidation. 5

Answer:
a) As Sima is already retired, she is entitled a profit share in proportion to her capital investment and
previous profit sharing ratio is irrelevant in this situation.

Total profit for 6 month‘s period = Rs 36,000

Sima‘s Share = 100,000/(100,000+250,000+300,000) X 36,000= Rs.5,538.46

Interest on unpaid Capital=100,000 X10%X6/12=Rs.5,000

Since share of profit will be more beneficial to Sima, she has to opt for the option of sharing
profits in the proportion of capital at the time of separation.

b) Lease rental to be recognized as expense in proportionate to units of production.

Here, Total lease rental for 5 years= Rs.191,500

Total Production for 5 years=130,500

Hence, Lease rental to be charged in 1st year=Rs. 13,000/130,500 X 191,500= Rs.19,077

Lease rental to be charged in 2nd year=Rs. 21,000/130,500 X 191,500=Rs.30,816

Journal Entries in the books of lessee for first and second year:
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First Year
a) Lease Rent Dr 15,000
To Bank Cr. 15,000
(Being Lease rent for the first year of lease paid)

b) Lease Rent Dr 4,077

To Lease Rent Adjustment Ac Cr 4,077
(Being adjustment of lease rent for the year)

c) P&L Ac Dr 19,077
To lease Rent Cr 19,077
(Being recognition of lease rent as expense for the year)

Second Year

a) Lease Rent Dr. 35,000

To Bank Cr. 35,000

(Being Payment of Lease rent for the year)

b) Lease Rent Adjustment Dr. 4,184

P& L Ac Dr . 30,816
To Lease Rent Cr. 35,000
(Being recognition of lease rent as expense for the year)

c) Preferential creditors in case of liquidation of a company are those creditors who get priority in
payment over others though they are unsecured creditors by virtue of provisions of insolvency
(Damasahi) Act 2063.

According to insolvency Act, expenses relating to liquidation, wages and remuneration payable
and gratuity, provident fund, leave encashment gets priority over other creditors. The amount
available with liquidator from the disposal of assets of the company needs to pay in the following
priority:
a) Payment of liquidation expenses and liquidator‘s remuneration.
b) Payment of wages and remuneration to workers and employees outstanding at the time of start
of liquidation process or at the time of order of restructure of the company, however, directors
engaged in the capacity of employee are not entitled to get payment under this priority.
c) Payment of accumulated sick leave, home leave, gratuity and provident fund to workers and
employee outstanding at the time order of liquidation or at the time of restructure of the
company.
d) Payment to other creditors whose claims are accepted by liquidator.

Furthermore, The Insurance Act, 2049 and Bank and financial institution Act, 2063 have separate
priority order in respect of payment in case of liquidation of company engaged in the business of
Insurance and Banking respectively and provision of Insolvency Act regarding priority in payment
would not apply to above mentioned companies.

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5.
a) NAS 18 "Impairment of Assets" requires an entity to write down the value of its assets, or group of
assets, whenever the recoverable amount of an asset is less than its carrying value.
Required:
Define ―recoverable amount‖ and state why an asset should be written down to this value if it is
below its carrying value. 5

b) Brindawan Ltd. has an item of plant that is carried in the balance sheet at a revalued amount of Rs.
16,200,000. The plant manufactures a product which, until recently, was the only product of its
type in the market place. A competitor is now manufacturing a similar product, and Brindawan
Ltd.‘s market share has consequently fallen. Brindawan Ltd. has re-assessed the expected cash
flows, to be generated from using the plant over the remaining four years of its life, to be as
follows:
Rs.
2067/68 7,000,000
2068/69 4,000,000
2069/70 3,500,000
2070/71 2,000,000

Brindawan Ltd. has been offered Rs. 15,000,000 for the plant by an overseas company.
Brindawan Ltd. would be responsible for any shipping and conversion costs that are estimated to
be Rs. 1,000,000.
The depreciated historic cost of the asset is Rs 15,200,000.
Brindawan Ltd.‘s cost of capital is 8%. The present value of Re 1 receivable at the end of each
year, based on discount rates of 8% can be taken as:

End of year 1 0·93

2 0·86
3 0·80
4 0·74
Required:

Calculate the impairment loss in respect of the plant and state how the loss should be accounted for
in Brindawan Ltd.‘s financial statements for the year ended 31st Ashadh, 2067. 6

c) NAS 9 ―Income Taxes‖ uses the concept of temporary differences. Temporary differences are the
difference between the carrying value of an asset and its tax base. The standard distinguishes
between ―taxable temporary differences‖ and ―deductible temporary differences‖.
Required:
Explain the distinction between taxable and deductible temporary differences. 4
Answer:
a)
NAS 18 ―Impairment of Assets‖ defines recoverable amount as the higher of an asset‘s fair value less
costs to sell and its value in use.

It further defines the fair value less costs to sell as the amount obtainable from the sale of an asset (in
an arm‘s length transaction between knowledgeable, willing parties) less costs of disposal.

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Also, it defines the value in use as the present value of the future cash flows expected to be derived
from an asset (or cash-generating unit).

The recoverable amount of an asset represents the amount of economic benefits that the asset will
generate for an entity. If the carrying value of an asset exceeds its recoverable amount this means that
the asset will not generate sufficient economic benefits to meet its carrying value, the asset should
therefore be written down to the value that is recoverable by either continuing to use the asset or by
selling it.

b) Calculation of impairment loss

Fair value less costs to sell
Rs
Selling price 15,000,000
Shipping
_ and conversion costs (1,000,000)
Net proceeds 1,4000,000
_______

Value in use
Year Cash flow DF Rs
2067/68 70,00000 0.93 6,510,000
2068/69 40,00000 0.86 3,440,000
2069/70 35,00000 0.80 2,800,000
2070/71 20,00000 0.74 1,480,000
14,230,000

Impairment Loss ( Rs) = Carrying Amount – Value in Use

= 16,200,000 – 14,230,000 = Rs. 1,970,000
_______

The recoverable amount of the asset is the greater amount, i.e. its value in use of Rs 1,4230,000. The
asset is carried at a revalued amount in the balance sheet of Rs 16,200,000, this means that an
impairment loss of Rs 1,970,000 has occurred and must be written off the carrying value of the asset.

As the asset is carried at a revalued amount and the depreciated historic cost of the asset is Rs
15,200,000 there will be a revaluation surplus of Rs 970,000 (Rs.15,2500,000 – Rs.14,230,000) in
respect of the asset, this surplus would initially be utilised for the write down.

The remaining impairment loss of Rs. 1,000,000 will be charged to the profit and loss account for the
period.
c) Distinction between taxable and deductible temporary differences

Temporary differences are differences between the carrying amount of an asset or liability in the
balance sheet and its tax base. The tax base of an asset or liability is the amount attributed to that asset
or liability for tax purposes.

Temporary differences may be either taxable temporary differences or deductible temporary

differences. Taxable temporary differences are temporary differences that will result in taxable
amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the
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asset or liability is recovered or settled. For instance if a tax authority taxes interest income on a cash
basis then any income accrued at the balance sheet date will not be included in the current tax charge
but will be taxed in the future when the cash is received.

Deductible temporary differences are the temporary differences that will result in amounts that are
deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the
asset or liability is recovered or settled. For instance, if a tax authority taxes interest expense on a cash
basis then any expense accrued at the balance sheet date will not be included in the current tax charge
but will be deductible in the future when it is paid.

6. Write Short notes on (ANY FOUR): (4×2.5=10)

a) Super profits in partnership firms
b) Contract revenue
c) Floating Policy
d) Events after Balance Sheet date
e) Consequences of insolvency of a partnership firms

Answer:

a) Super profits in partnership firms

Among various basis of determining the sharing and paying for joining or sacrificing the profits of a
firm one basis is super profit method. Under this method, it is assumed that any partner can get normal
profits by joining any average firm in the market. However, focus should be given on super profits of
the firm. Such super profit implies that the profit can be earned by a firm over and above all ordinary
firms in the industry/market. This is the excess amount of profit earned by a firm over the past years
and expected to continue the same in the future.
If and only if the average profit of the firm is more than the normal profit in the market there comes
into existence the super profit or goodwill.
b) Contract revenue
Contract revenue can be:
A fixed price or cost plus basis prices
Compensation for variations in contract work
Claims
Incentives and
Other possible inflows by way of sale of residue assets otherwise not fit for use at the end of
contract period.
c) Floating Policy
It is some sense which resembles blanket policy of insurance. It is a policy which covers several types
of goods for one lump sum premium. The goods may be lying at different locations and may be
exposed to different level of risk.
The premium, normally charged under this policy, should nearly resemble the sum of premium
charged under specific policy.
The benefit of this policy is that insured need not take many specific policies for goods lying in
different locations and for different types thereon.

d) Events after balance sheet date

All financial events up to the balance sheet date should be taken in to consideration in preparation of
financial statement or for an accounting period. Certain important events may occur after balance
sheet date, the knowledge of which is important for making an assessment of performance and
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making projection for the future. Nepal Accounting Standard defines the events after balance sheet
data as:

Events after the balance sheet date are those events, favorable and unfavorable, that occur between
the balance sheet date and the date when the financial statements are authorized for issue. There are
two types of events.

e) Consequences of insolvency of a partner

Following consequences arise when a partner is insolvent:
-The partner ceases to be a partner
-The firm is dissolved unless there is a contrary contract not to do so.
-The firm and existing partner can not be held liable after the date of declaration of insolvency.
Similarly, the estate of insolvent partner can not be made liable for any subsequent act of the firm or
partners thereon.

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1. G
ive your opinions with reason on the following cases: (45=20)
a) M/s Joshi & Joshi is a practicing Chartered Accountants firm. One of the senior partners of the
firm is also associated with import/export trade and he is the sole proprietor of that business.
Mr. Joshi has also taken huge amount of loan from various banks and he is found visiting more
to government offices than in his own firm or to his clients. Comment on given case with
reference to ‗Code of Ethics‘.
b) Metro Developers Pvt. Ltd is Bharatpur based Real Estate Company. It has invested heavily on
the apartments and commercial complexes on and around Narayangarh. Recently, audit of the
transaction for rental receipts was hastily completed by taking monthly average figure and
multiplying it by 12. You are required to suggest appropriate way of conducting of audit for the
above said transaction of rental receipts.

c) Association for Backward Communities (ABC) is one of the NGOs working in the Midwest
part of the country. There seems to be confusion regarding total receipt of the NGO as what
could be the probable revenue sources and how they should be vouched. The chief of the NGO
is mostly on the foreign tour and the accountant of the NGO simply says ‗boss knows
everything and he is just clerk‘. What documents you will insist to check to deal with the
situation?

d) Torstar‘s Heaven is star level hotel situated at Nagarkot. During the initial discussion it is
noticed that the hotel management is aware of pilferage issues, however due attention is not
paid to address the situation. You are required to express your statement underlying the
importance of internal control on the pilferage issues and the probable consequences of it, if
not addressed properly.

Answers:
1.a.) A professional accountant in public practice should not concurrently engage in any business,
occupation or activity which impairs or might impair integrity, objectivity or independence, or the
good reputation of the profession and therefore would be incompatible with the rendering of
professional services. The simultaneous engagement in other business, occupation or activity
unrelated to professional services, which have the effect of not allowing the professional
accountant in public practice properly to conduct a professional practice in accordance with the
fundamental ethical principles of the accountancy profession should be regarded as inconsistent
with the practice of public accountancy.

b.) To vouch for rental receipts, various documents need to be seen. To start with, copies of bills
issued to tenants should be test checked by reference to copies of tenancy agreements and bills of
charges paid by the landlord on behalf of the tenants e.g., house tax, water tax etc. The amounts
collected from tenants on account of rent should be checked by reference to receipts issued by
them. The entries in the Rental Register in respect of rents accrued afterwards should be verified.
The register should also be scrutinized for finding out the rent amount, which have not been
recovered and are considered bad or irrecoverable, for deciding whether these should be written off
or provision against the same should be made.

c.) The receipt of income of NGO may be checked on the following lines:
i) Contribution and grants for projects and programmes: Check agreements with donors
and grants letters to ensure that funds received have been accounted for. Check that all
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CAP II Examination – June 2010

foreign contributions receipts are deposited into bank accounts and proper disclosure is
made.
ii) Receipts from fund raising programmes: Verify in detail the internal control system and
ascertain who are the persons responsible for collection of funds and mode of receipt.
iii) Interest and dividends: Check the interest and dividends received and receivable with
investments held during the year.
iv) Miscellaneous receipts: Check sale of scrap, rental receipts etc, if any.

d.) Pilfering is one of the greatest problems in any hotel and the importance of internal control
cannot be over stressed. It is the responsibility of the management to introduce controls, which will
minimize the leakage as far as possible. If the internal control in the hotel is weak, then a very
serious problem exists for the auditor. Preparing accounts at regular interval for each of the cost/
revenue centers and investigating the deviation if any could be helpful in this regard. If necessary,
scope of audit tests will have to be increased and in the event of material margin discrepancy
being unexplained, the auditor may consider qualifying his report.

2. A
nswer the following:
a) T
he auditor may encounter circumstances that, individually or in combination, indicate the
possibility that the financial statements may contain a material misstatement resulting from
fraud or error. List down some of those (at least 8) circumstances that indicate a possible
misstatement. 8
b) S
o far as the auditor is concerned, the examination and evaluation of the internal control system
is an indispensable part of the overall audit programme. What are the key areas that auditor
will enable to know after reviewing internal controls. 7

Answers:
2.a.)
Some of the circumstances that, individually or in combination, indicate the possibility that the
financial statements may contain the material misstatement:
i) Unrealistic time deadlines for audit completion imposed by management.
ii) Reluctance by management to engage in frank communication with appropriate third
parties, such as regulators or bankers.
iii) Limitation of audit scope imposed by management.
iv) Identification of important matters not previously disclosed by management.
v) Significant difficult-to-audit figures in the accounts.
vi) Aggressive application of accounting principles.
vii) Conflicting or unsatisfactory evidence provided by management or employees.
viii) Unusual documentary evidence such as handwritten alterations to documentations
ix) Information provided unwillingly or after unreasonable delay.
x) Seriously incomplete or inadequate accounting records.

b.) The review of internal controls will enable the auditor to know:
i) Whether errors and frauds are likely to be located in the ordinary course of operations
of the business.
ii) Whether an adequate internal control system is in use and operating as planned by the
management.
iii) Whether an effective internal auditing department is operating.
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iv) Whether the controls adequately safeguards the assets.

v) How far and the how adequately the management is discharging its function in so far as
correct recording of transactions is concerned.
vi) How reliable the reports, records and the certificates to the management can be.
vii) The extent and the depth of the examination that he needs to carry out in the different
areas of auditing.
viii) What would be appropriate audit technique and audit procedure in the given
circumstances.
ix) What are the areas where control is weak and where it is excessive.
x) Whether some worthwhile suggestions can be given to improve the control system.

3. G
ive your comments on the following: (35=15)
a) G
iant Ltd. is newly established cement industry and yet to start commercial production. Various
payments, large and small, are being regularly made. You are required to prepare internal
control questionnaire regarding ‗procedure for authorization‘ for payments.
b) During the course of audit, M/s Guess and Guess Associates, an audit firm, has checked 20
percent of the postings from Cashbook to General Ledger. Some serious questions could be
raised about the representative nature of the sample and about the validity of sample results.
What could those serious concerns be?
c) Forward Looking Co Ltd is dealing with various transactions that could be well termed as
contingent liability. As an auditor, suggest some of the procedures for verifying contingent
liabilities?

Answers:
3.a)
The internal control questionnaire for ‗procedure for authorization‘ may be drawn as below:
i) Does the enterprise have a formal document showing the various authorities, which can
sanction payments along with the nature of the relevant payments and the limit on sanctioning
powers?
ii) Does the system provide for authorization for certain payments by the top
management or the governing body?
iii) Are the financial powers of various sanctioning/disbursing authorities reasonable?
iv) Have the financial powers of various authorities been intimated to various
departments of the enterprise?
v) Is there a system of post facto authorization of payments in exceptional cases where
prior sanction could not be obtained?

b. Some of the serious concerns about the representative nature of the sample and about the
validity of sample results could be:
i) Why select, say 20 percent of the posting? Why can it not be 15 or 25 percent? Why check
only 2 months?
ii) Can we just state the percentage size of the sample without reference to the total number of
transactions? Are we taking the same amount of risk if we check 2 out of a total of 10
transactions or 200 out of 2000 transactions?
iii) How can we draw conclusions about the transactions of the whole year by merely checking the
transactions of a few specified months, especially as the level of activity may vary from month
to month?
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iv) By not stating the manner in which the 20 percent of the transactions have to be selected,
would not the audit assistants consciously or unconsciously select only those transactions,
which are simpler and easier to audit?

c.
The auditor may carryout the following procedures for verifying the contingent liabilities:
i) Review the minutes of the meetings of board of directors/ committees.
ii) Review the relevant contracts, agreements and arrangements.
iii) Review the list of pending legal cases, correspondence relating to taxes, duties etc.
iv) Review the records maintained by the entity regarding contingent liabilities.
v) Make enquiries of and hold discussion with the entity‘s management.
vi) Obtain representations from the management.

4. A
nswer the following: (35=15)
a) W
hat are the assertions with which an auditor is concerned with while obtaining audit evidence
from substantive procedures?
b) Mention briefly the conditions or events, which increase the risk of fraud or error leading to
material misstatement in Financial Statements.
c) What is agreed upon procedures?

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

(b) In planning and performing his examination, the auditor should take into consideration the
risk of material misstatements of the financial information caused by fraud or error.
Weaknesses in the design of the internal control system and non-compliance with
identified control procedures amongst other conditions or events which increase the risk of
fraud or error are:
(i) Weaknesses in the design of internal control system and non-compliance with the laid
down control procedures, e.g., a single person is responsible for the receipt of all d ak and
marking it to the relevant sections or two persons are responsible for receipt of dak but the
same is not followed in actual practice, etc.
(ii) Doubts about the integrity or competence of the management, e.g., domination by one
person, high turnover rate of employees, frequent change of legal counsels or auditors,
significant and prolonged understaffing of the accounts department, etc.
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(iii)Unusual pressures within the entity, for example, industry is doing well but the company is
not performing all right, heavy dependence on a single line of product, inadequate working
capital, entity needs raising share prices to support the market price in the wake of public
offer, etc.
(iv)Unusual transactions such as transactions with related parties, excessive payment for
certain services to lawyers, etc.
(v) Problems in obtaining sufficient and appropriate audit evidence, e.g., inadequate
documentation, significant differences between the figures as per the accounting records
and confirmation received from third parties, etc.

(c)
According to the NSA 4400, ―Engagement Agreed upon Procedures Regarding Financial
Information‖ the objective of an agreed-upon procedures engagement is for the auditor to carry out
procedures of an audit nature to which the auditor and the entity and any appropriate third parties
have agreed and to report on factual findings.
As the auditor simply provides a report of the factual findings of agreed-upon procedures, no
assurance is expressed by him in his report. Instead, users of the report assess for themselves the
procedures and the findings reported by the auditor and draw their own conclusions from the work
done by the auditor.
The report is restricted to those parties that have agreed to the procedures to be performed since
others, unaware of the reasons for the procedures, may misinterpret the results. However, it is
possible in certain circumstances that the report of the engagement may not be restricted only to
those parties that have agreed to the procedures to be performed, but made available to a wider
range of entities or individuals, e.g., in case of Government organisations.
The auditor should conduct an agreed-upon procedure engagement in accordance with this NSA
and the terms of the engagement. The auditor should ensure with representatives of the entity and,
ordinarily, other specified parties who will receive copies of the report of factual findings, that
there is a clear understanding regarding the agreed procedures and the conditions of the agreement.

Matters to be agreed include the following:

- Nature of the engagement including the fact that the procedures performed will not constitute
an audit or a review and that accordingly no assurance will be expressed.
- Stated purpose for the engagement.
- Identification of the financial information to which the agreed-upon procedures will be applied.
- Nature, timing and extent of the specific procedures to be applied.
- Limitations on distribution of the report of factual findings. When such limitation would be in
conflict with the legal requirements, if any, the auditor would not accept the engagement.

In certain circumstances, for example, when the procedures have been agreed to between the
regulator, industry representatives and representatives of the accounting profession, the auditor
may not be able to discuss the procedures with all the parties who will receive the report. In such
cases, the auditor may consider, for example, discussing the procedures to be applied with
appropriate representatives of the parties involved, reviewing relevant correspondence from such
parties.

Matters that would be included in the engagement letter include:

- A listing of the procedures to be performed as agreed-upon between the parties.
- A statement that the distribution of the report of factual findings would be restricted to the
specified parties who have agreed to the procedures to be performed.

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5. C
omment on the following: (35=15)

a) W
hat is clean audit report? Explain how it is different from qualified report?

b) H
ow the work of an expert should be evaluated before accepting the same as Audit
evidence?

c) C
are Limited purchased machinery on 1.4.2065 from a foreign country at a price of $ 200
thousands upon terms of credit that the price should be settled within six months from the date
of purchase. The company capitalised the asset and created liability for the capital goods
converting the foreign currency liability to Nepalese Rupees at a rate of exchange prevailing as
on 1.4.2065. When the company settled the liability on 30 Poush 2065, it had to incur an
additional amount of Rs. 5,00,000 due to change in foreign exchange rate on the date of
settlement. It added this additional amount of exchange variation in the capital cost of the asset
and charged depreciation upon the enhanced amount of asset value from 1 Magh 2065. Give
your opinion.

Answers:
a) A clean audit report is a report issued by an auditor in case he does not have any reservation in
respect of matters contained in the financial statements. In such a case, the audit report may
state that the financial statements give a true and fair view of the state of affairs and of profit
and loss account during the period. A clean report may be without any modifications or with
modifications which are just for matter of emphasis. Under the following circumstances an
auditor is justified in issuing a clean report:
(i) the financial information has been prepared using acceptable accounting policies, which have
been consistently applied;
(ii) the financial information complies with relevant regulations and statutory requirements; and
(iii) there is adequate disclosure of all material matters relevant to the proper presentation of the
financial information, subject to statutory requirements, where applicable.
Qualified audit report, on the other hand, is one when auditor does not give a clean chit about the
truthfulness and fairness of the financial statements but makes certain reservations. A qualified
report is a modified report as to the auditor‘s opinion. A qualified report is issued when there is
limitation on the scope of audit or disagreement with management, regarding the acceptability of
accounting policies selected or the method of application or the adequacy of financial statement
disclosure.
The auditor uses the word to indicate his qualification or reservation by placing the word ―subject
to‖ or ―except to‖. The qualifications should indicate impact on profits and account balances and
should be specific, clear and self explanatory. The auditor should also give reasons for
qualification. In case of companies, there is also a legal requirement of the CompanyAct which
provides that where the auditor answers any of the statutory affirmations in negative or with
qualification, his report shall state the reasons for such answer.
Thus, it is clear from the above that in case of a clean report, the auditor has no reservation in
respect of various matters contained in the financial statements but a qualified report may involve
certain matters involving difference of opinion between the auditor and the management.

b) Using the work of an expert: As per the NSA 620, when the auditor intends to use the work
of an expert he should evaluate the following before accepting the same as audit evidence:
(i) Professional qualification of the expert;
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(ii) Experience and reputation of expert in related field;

(iii)Independence and objectivity of the expert;
(iv) The objectives and scope of the expert‘s work;
(v) Expert‘s relationship with the client, if any;
(vi) The source data used;
(vii)Assumptions and method used;
(viii) The results of the expert‘s work in the light of auditor‘s overall knowledge of the business
and of the result of his audit procedures.

c) Effects of Changes in Foreign Exchange rates: According to NAS 11-Para 24, the foreign
currency transactions should be initially recognized at the exchange rate prevailing on the date
of transaction. Accordingly, the asset and liability should be accounted at exchange rate
prevailing on the date of purchase. The monetary items should be reported at the exchange rate
prevailing on the close of the accounting period. The liability for capital goods purchased is a
monetary item.
If during the accounting period, if a monetary liability is settled at a rate different from the rate
at which it was initially recognized the exchange difference should be charged to P&L account
in the year of settlement.
According to NAS 11, hence, it is necessary to write off Rs, 500 thousands being exchange
differences at the date of settlement. It cannot be added to the cost of the capital. Hence, the
company is wrong in capitalizing foreign exchange differences between the amounts of initial
recognition and settlement and computing depreciation on the wrongly capitalized portion of
the asset. This needs correction by the company. Else, the auditor may qualify his report upon
relevant considerations.

6. W
rite short notes on the following (ANY TWO): (25=10)

a) Change in Accounting Policies

b) Management representation as an audit evidence
c) External Confirmation Process to obtain audit evidence at the assertion level
Answers:
a) Change in accounting policies:
- The consistency is also an accounting assumption. Therefore the accounting policies should
consistently be applied and followed from years to years.
- Change in accounting policy is permitted only if such change is to bring accounts in line with
accounting standards, provisions of law or for better presentation of financial statements.
- When change in accounting policies or method is effected, the fact of such change and its
impact on accounts must be disclosed.
- If change is made in the accounting policies which has no material effect on the financial
statements for the current period but which is reasonably expected to have a material effect in
later periods, the fact of such change should be appropriately disclosed in the period in which
the change is adopted.

b) The management representation as an audit evidence:

- During the course of an audit, management makes many representations to the auditor, either
unsolicited or in response to some specific enquiries.
- The auditor also should obtain representation from management, where considered appropriate
and necessary.

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- The management representation is taken to corroborate audit evidence, but representations by

management can not be a substitute for other audit evidences that the auditor could reasonably
expect to be reasonably available.
- In certain cases, where knowledge of facts is confined to management, a representation by
management may be the only audit evidence, which can reasonably be expected to be
available.
- If a management representation is contradicted by an available other audit evidence, the auditor
should examine the circumstances and, when necessary, reconsider the reliability of other
representations made by management.

c) External Confirmation Process:

Para 30 of NSA 505: When confirming confirmation procedures, the auditor should maintain
control over the process of selecting those to whom a request will be sent, the preparation and
sending of confirmation requests and the responses to those requests. Control is maintained
over communications between the intended recipients and the auditor to minimise the
possibility that the results of the confirmation process will be biased because of the
interception and alteration of confirmation requests or responses. The auditor ensures that it is
the auditor who sends out the confirmation requests, that the requests are properly addressed,
and that it is requested that all replies are sent directly to the auditor. The auditor considers
whether replies have come from the purported senders.

7. H
ow will you vouch and verify the followings (ANY TWO): (25=10)
a) Provision for income tax
b) Bank Borrowings
c) Premium paid for insurance of a Motor car.

Answers:
a) Provision for income tax
(i) Obtain the computation of income prepared by the auditee and verify whether it is as per the
Income-tax Act, 1961 and Rules made there under.
(ii) Review adjustments, expenses, disallowed special rebates, etc. with particular reference to the
last available completed assessment.
(iii) Examine relevant records and documents pertaining to advance tax, self assessment tax and
other demands.
(iv) Compute tax payable as per the latest applicable rates in the Finance Act.
(v) Ensure that overall provisions on the date of the balance sheet is adequate having regard to
current year provision, advance tax paid, assessment orders, etc.

b) Bank Borrowings
Borrowings from the banks may be either in the form of overdraft limit or fixed loans.
In each case, borrowings should be verified as follows:
1. Reconcile the balances in the overdraft or loan account with that shown in the pass books and
confirm the last mentioned balance by obtaining balance confirmation certificate from the
bank.
2. Obtain certificate from the bank showing particulars of securities deposited with the bank as
security for the loans or of the charge created on an asset / assets of the concern and confirm
the same has been correctly disclosed and duly registered with the Registrar of Companies and
recorded in the Register of Charges.

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3. Verify the authority under which the loan or overdraft has been raised. In case of the company,
only the Board of Directors is authorised to raise a loan or borrow from a bank.
4. In case of company, confirm restraint of Company Act regarding the maximum amount of loan
that the company can raise has not been contravened.
5. Ascertain the purpose for which the loan has been raised and the manner in which it has been
utilized and that this has not prejudicially affected the concern.

c) Premium paid on Insurance of a Motor Car

(i) Check insurance cover note issued by Insurance Company. Verify car no., period of Insurance
etc.
(ii) See that ―No claim Bonus‖ is given, where entitled, by the Insurance Company.
(iii) Ensure that proper adjustment is made for pre-paid insurance premium.

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CAP II Examination June 2010

Part: 'A'
1.
a) Answer the following questions with reference to Companies Act, 1956.
i) What is the procedure to be followed, when a Board meeting is adjourned for want of
quorum? 5
ii) What do you understand by passing of a resolution by circulation? 5
b) EZEE Company Ltd. is in the process of winding up and the liquidator could only recover
Rs. 1 million from sale of securities of a secured creditor of the company. The total amount
of workmen's dues is Rs. 1 million and the amount of debts due from the company to its
secured creditors is Rs. 3 million. Both the workmen and the secured creditors are claiming
preferential rights on the amount recovered. Provide your advice stating the relevant
provisions of the Companies Act, 1956? 5
c) What is the meaning of ‗Maturity of negotiable instrument‘? When such instruments
become mature under the Negotiable Instrument Act, 1881. 5
d) State the effects of an irregular allotment as provided in the Companies Act, 1956? 5

Answer

a)
i) Section 288 of the Companies Act, 1956 provides that if a Board Meeting could not be held for
want of quorum then, unless the articles otherwise provide, the meeting shall be automatically
stand adjourned till the same day in the next week at the same time and place, or if that day is a
public holiday, till the next succeeding day which is not a public holiday, at the same time and
place. It is also provided that section 285 (i.e frequency of Board meetings) shall not be deemed
to have been contravened merely by reason of the fact that a meeting of the Board which had
been called in compliance with the terms of that provision, could not be held for want of
quorum.

ii) Section 289 of the Companies Act, 1956 provides for passing a resolution by circulation. No
such resolution shall be deemed to have been duly passed by the Board or Committee thereof of
a Company, unless the following conditions are complied with, viz:
a) the draft resolution, together with supporting papers has been circulated, to all the directors,
or members of the Committee of the quorum for a Board meeting.
b) to all directors of the Board or member of the Committee who are not in India, at their usual
address in India, and
c) the same has been approved by such of the directors, then in India, or by a majority of them,
who are entitled to vote on the resolution.

b) Section 529A. Overriding preferential payments.

(1)Notwithstanding anything contained in any other provision of this Act or any other law for the
time being in force, in the winding up of a company-
(a) workmen's dues; and
(b) debts due to secured creditors to the extent such debts rank under clause
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(c) of the proviso to sub-section (1) of section 529 pari passu with such dues,
shall be paid in priority to all other debts.
(2) The debts payable under clause (a) and clause (b) of sub-section (1) shall be paid in full unless
the assets are insufficient to meet them, in which case they shall abate in equal proportions.
Considering the above mentioned provisions, the aggregate of the amount of workmen's dues
and of the amounts of debts due to secured creditors is Rs. 4.00 lac. The workmen's portion of
the security is, therefore, one-fourth of the value of the security, that is Rs. 25,000 only and the
balance Rs. 75,000 belongs to the secured creditors.

c) Maturity means the date on which payment of an negotiable instrument falls due. A
cheque is become mature immediately after its execution . However, section 22 of Negotiable
Instrument Act,1881 states that every promissory note or bill of exchange expressed to be payable
on a specified day, or at a certain period after date or after sight or at a certain period after the
happening of an event which is certain to happen is at maturity on the third day after the day on
which it is expressed to be payable

d) Effects of an irregular allotment as provided by Section 71 of the Companies Act 1956 are
as follows:
Section 71
(1) An allotment made by a company to an applicant in contravention of the provisions of
section 69 or 70 shall be voidable at the instance of the applicant –
(a) within two months after the holding of the statutory meeting of the company, and not later,
or
(b) in any case where the company is not required to hold a statutory meeting or where the
allotment is made after the holding of the statutory meeting, within two months after the date of
the allotment, and not later.
(2) The allotment shall be voidable as aforesaid, notwithstanding that the company is in course
of being wound up.
(3) If any director of a company knowingly contravenes, or willfully authorizes or permits the
contravention of, any of the provisions of section 69 or 70 with respect to allotment, he shall be
liable to compensate the company and the allottee respectively for any loss, damages or costs
which the company or the allottee may have sustained or incurred thereby:
Provided that proceedings to recover any such loss, damages or costs shall not be commenced
after the expiration of two years from the date of allotment.

Part: 'B'
2.
a) G. Upadhaya & Co. the auditor of XYZ Company in course of its audit comes through mass
irregularities in the accounts of the company but due to certain reasons it is unable to provide an
adverse opinion. The auditors feel that the shareholders need to know about the matter hence
requested the Board of the Company to convene an Extraordinary General Meeting (EGM). The
Board refuses to convene the meeting on the ground that the auditor can present its observations in
the audit report which shall be placed at the AGM. Provide your opinion whether the audit firm can
convene an EGM, clearly stating the circumstances for conducting an EGM as provided in the
Companies Act, 2063. 9

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b) Mr. Jack, an American National desirous to make investment in water rafting business in
Kaligandaki River. He comes before you to take a consultancy regarding registration of such
business and visa for carrying out research with the objective of making investment. What do you
suggest? 6

Answer
a) The circumstances in which and EGM can be convened as specified in the Companies Act 2063
are as follows:
Extra-ordinary General Meeting (Section 82):
(1) The board of directors of a company may convene an extra-ordinary general meeting if it deems
necessary.
(2) If, in the course of examining the accounts of a company, it is deemed necessary to call an
extraordinary general meeting for any reason, the auditor may request the board of directors to
call such meeting; and if the board of directors fails to call the meeting accordingly, the auditor
may make an application, setting out the matter, to the Office; and if an application is so made,
the Office may call the extra-ordinary general meeting of the company.
(3) If the shareholders holding at least ten per cent shares of the paid-up capital of a company or at
least twenty five per cent shareholders of the total number of shareholders make an application,
setting out the reasons thereof, to the registered office of the company for calling an
extraordinary general meeting, the board of directors shall call the extra-ordinary general
meeting of the company.
(4) If the board of directors does not call the extraordinary general meeting within thirty days from
the date on which an application is made pursuant to sub-section (3), the concerned
shareholders may make a petition to the office setting out the matter; and if such petition is
made, the Office may cause to call such meeting.
(5) If the Office deems necessary to call an extraordinary general meeting in view of the findings of
any inspection or investigation or for any other reason, it may itself call or cause the board of
directors to call such meeting.
Considering the provisions of Section 82 (2) as mentioned above the auditor can approach the
Office of the Company Registrar for convening the EGM to report the irregularities to the
shareholders.

b) Under section 3 of the Foreign Investment and Technology Transfer Act, 2049.
Permission to be Obtained:
(1) Permission of the Department shall be required to be obtained for foreign investment or
technology transfer.
(2) A person desiring to avail the foreign investment or technology transfer shall be required
to make an application to the Department in the prescribed form along with the prescribed
particulars for obtaining permission in that behalf.
(3) If an application is made pursuant to Sub-section (2) the Department shall, in the case of
an industry with fixed assists up to five hundred million rupees, itself, and in the case of an
industry with fixed assets in excess thereof, in accordance with the decision of the Board,
grant permission within thirty days from the date of application. The Department shall
communicate the decision made in regard to such permission to the applicant.
(4) Notwithstanding anything contained in Sub-section (1) and (2) no permission shall be
granted for making foreign investment in the industries set forth in the Annex.

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Under Annex of the Act, Water Rafting Industries shall not be granted permission for making
foreign investment.
Under section 6(1) A foreign national visiting Nepal in connection with undertaking any study
or carrying out any research with the objective of making investment in Nepal shall be provided
a non tourist visa for up to six months.
But Mr. Jack is desirous to make investment which is prohibited under the act. He shall not be
allowed visa for carrying out such research.

3.
a) Enumerate the circumstances under which the Securities Board of Nepal may revoke a license
issued under the Securities Act, 2063. 5
b) Who are directors? Discuss the provision of Companies Act, 2063 relating to voting on election
of director. 5

Answer
a) Revocation of License by the Nepal Securities Board (Section 89):
(1) The Board may, on any of the following circumstances, revoke a license obtained by any
stock exchange or securities business (the licensee) to operate the stock exchange or
securities business under this Act:-
(i) If the licensee stops operating the stock exchange or securities business,
(ii) If the licensee operates the stock exchange or securities business in contrary to the interest
of investors,
(iii) If the licensee violates the terms set forth in the license,
(iv) If the licensee violates any provision of this Act or the rules and bye-laws framed under this
Act,
(v) If the licensee fails to comply with any order or direction issued by the Board,
(vi) If the licensee becomes insolvent being unable to repay its dues to its creditors,
(vii) If the company or body having obtained a license to operate the stock exchange or
securities business is wound up,
(viii) If the licensee having obtained a license to operate the stock exchange or securities
business makes an application for the revocation of the license,
(ix) If the securities business having removed the agent appointed by it does not appoint another
agent in lieu of such an agent,
(x) If the licensee fails to submit such financial and transaction related statements as required to
be submitted to the Board,
(xi) If the licensee fails to pay such fees as required to be paid pursuant to Section 50 to the
Board within the specified time limit.

(2) No revocation of a license made pursuant to subsection (1) shall have any effect on any
liabilities arising from any activities done by such a stock exchange or securities business
person prior to the cancellation of license.

b) Though a company is legal entity in the eye of the law, it cannot, act in its own person. It
must act through human agency. Persons through whom it acts and does its business would be its
agents. Such persons are usually called directors. They are appointed by shareholders. Under

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Section 2(y) of Companies Act, 2063 ―Director‖ means any director of a company and this term
includes any alternate director.
Section 72 of the Companies Act, 2063 (Provision on voting in election of director):
(1) Except as otherwise provided in the articles of association, on a poll in election of directors,
every shareholder shall be entitled to cast such number of votes as may be set after multiplying the
number of shares held by him/her by the number of directors to be appointed; and the director who
casts such votes may cast all his/her votes for a single candidate or may cast votes in a manner that
his/her votes are divided for more than one candidate as indicated by him.

(2) A corporate body entitled to appoint a director pursuant to this Act or articles of association may
appoint directors in proportion to its share holding and in such a case, it shall but be entitled to cast
vote in the election.
Provided, however, that a corporate body which is not able to appoint even a single director in
proportion to the number of shares and the total number of directors or which fails to appoint a
director in exercise of the power conferred by this Sub-section may, like other shareholder, take part
in the election of directors representing shareholders, cast vote or file candidacy up to the number of
directors that can be elected in proportion to the shares held by that body in such election.

4.
a) What do you understand by the term Government office? What are the matters to be audited in
view of propriety? Explain with reference to Audit Act, 2048. 5
b) The board of directors of M/s XYZ Ltd. having net worth of Rs. 125 million (paid up capital Rs.
100 million plus free reserves Rs. 25 million) intend to provide a loan of Rs. 100 million to BC
Ltd. Mr. Y one of the shareholders of XYZ Ltd., upon coming to know that M/s BC Ltd. is not
financially stable, had reported to the board of M/s XYZ Ltd. however they took no attention to
his complaint. Provide your opinion to Mr. Y regarding the validity of transaction between
companies as per the provisions of the Companies Act, 2063. 5
Answer
a) The term "Government Office" means all government office and courts, including the Supreme
Court, parliament, Commission for investigation of Abuse of Authority, Auditor General,
Public Service Commission and offices of other Constitutional bodies and Nepal Army and
Nepal Police.

The Auditor General shall audit following maters considering the propriety
thereof:
i) On the propriety of any expenditure and authorizations, if the opinion of the Auditor
General such expenditure is a reckless one or is an abuse of national property whether
movable or immovable, despite that the expenditure confirms to the authorization and
ii) On the propriety of all authorizations issued in respect of any grant of national property
whether movable or immovable, fixed or current or underwriting of any revenue, or any
contract, license or permits relating to mining, forest, water resources etc and any other act
of abandoning movable or immovable assets of the nation.
iii) The Auditor General may not include in the report minor items of discrepancy and other
items deemed as insignificant in view of their property which were observed during the
audit of income and expenditure.
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b)Restriction on transaction between companies (Section 176 of Companies Act, 2063):

(1) No company shall, whether directly or indirectly, lend money to another company in excess of
an amount that is sixty per cent of its paid-up capital and free reserves or an amount to be set by
hundred per cent of its free reserves, whichever is higher, or give guarantee for a loan borrowed
by another company or make investment in the securities of another company in excess of the
said amount.
(2) Provided, however, that this provision shall not apply to a company carrying on banking or
financial transaction, insurance company, company with main object to buy and sell securities,
private company which has not borrowed any loan from a bank or financial institution, company
with object to provide infrastructure facility, and investment made by the holding company in its
fully owned subsidiary company, moneys lent by such holding company to such subsidiary and
guarantee given by such holding company for a loan borrowed by such subsidiary and
investment made in the right shares issued under this Act.
(3) Subject to sub-section (1), a company shall maintain the details, as prescribed, on the moneys
lent by it to another company, investment made by it in such company or guarantee given by it
for a loan borrowed by such other company.
Considering the above mentioned provisions of Section 176 Mr. Y can lodge a complaint to the
Office of the Company Registrar regarding violations of the Act and upon making an inquiry
into the matter the Office can give necessary directive under Section 178 to the company,
directors, officer or employees to refrain from doing acts in contravention of the Companies
Act.

5.
a) State the Objectives, Functions, Duties and Powers of the Nepal Rastra Bank as provided in the
Nepal Rastra Bank Act, 2058. 9
b) Sagarmatha Enterprises, an industry established in the year 2060 being operated in loss till date.
Mr. Luckless, promoter of the industry thinks that if the industry is declared sick industry and
more facilities would be obtained and the industry would be exempted tax on the raw material
to be imported from India. 6
i) Can such industry be declared as sick industry?
ii) Who has the right to declare the industry as sick industry?
iii) Whether the contention of Mr. Luckless regarding exemption of tax is tenable?

Answer
a)
Objectives of the Bank (Section 4):
(1) The objectives of the Bank shall be as follows:-
(a) To formulate necessary monetary and foreign exchange policies in order to maintain the stability
of price and balance of payment for sustainable development of economy, and manage it;
(b) To promote stability and liquidity required in banking and financial sector;
(c) To develop a secure, healthy and efficient system of payment;
(d) To regulate, inspect, supervise and monitor the banking and financial system; and
(e) To promote entire banking and financial system of Nepal and to enhance its public credibility.

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(2) The Bank shall, without any prejudice to the objectives referred to in subsection (1), extend co-
operation in the implementation of the economic policies of the Government of Nepal.

Functions, Duties and Powers of the Bank (Section 5):

(1) In order to achieve the objectives referred to in section 4, the functions, duties and powers of the
Bank shall be as follows:
(a) To issue bank notes and coins;
(b) To formulate necessary monetary policies in order to maintain price stability and to implement
or cause to implement them;
(c) To formulate foreign exchange policies and to implement or cause to implement them;
(d) To determine the system of foreign exchange rate;
(e) To manage and operate foreign exchange reserve;
(f) To issue license to commercial banks and financial institutions to carry on banking and financial
business and to regulate, inspect, supervise and monitor such transactions;
(g) To act as a banker, advisor and financial agent of Government of Nepal;
(h) To act as the banker of commercial banks and financial institutions and to function as the lender
of the last resort;
(i) To establish and promote the system of payment, clearing and settlement and to regulate these
activities; and
(j) To implement or cause to implement any other necessary functions which the Bank has to carry
out in order to achieve the objectives of the Bank under this Act;

(2) While exercising the powers conferred by this Act or any other prevailing law, the Bank shall
have the power to carry out other functions and take actions, which are incidental thereto.

(3) No one shall violate powers conferred on the Bank under this Act.

b) Section 25a of the Industrial Enterprise Act, 2049 (Provisions relating to Sick Industries):
(1) If any industry is being operated in loss for a consecutive period of five years and its production
level is twenty percent or less than twenty percent of the total production capacity, Government of
Nepal may, if it deems necessary, declare it a sick industry by notification published in the Nepal
Gazette.
(2) No duty, fee and tax of any kind shall be levied on the machinery imported by any industry as
referred to in Sub-section (1) for the extension and diversification of such industry.
On the basis of above provision the answer can be given as follows.
i) No, as per above provision If any industry is being operated in loss for a consecutive period of
five years and its production level is twenty percent or less than twenty percent of the total
production capacity can only be declared as sick industry.
ii) Government
iii) No, because exemption shall be obtained only in case of import of machinery.

6.
a) How the council of the Institute of Chartered Accountants of Nepal (ICAN) takes a decision for
the report received from Disciplinary Committee? 5
b) Under what circumstances, the registration certificate of insurers cannot be renewed. Explain in
light of relevant provisions of Insurance Act, 2049. 5

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Answer
a) Rule 84 of the Nepal Chartered Accountants Rules, 2061 (Report to be submitted):
(1) The disciplinary committee shall have to submit a report in the council on the proceedings of
the investigation carried on the complaint filed against a member or an accounting firm in
accordance with rule 81 with its recommendations.

2) After being reported according to sub-rule (1), the council shall make a decision on the
complaint following the procedures written below:
i) The council shall inform the complainer and order to replete the complaint if recommended to
so by the disciplinary committee.
ii) The council sending the alleged member or accounting firm a copy of the report shall, once
again grant an opportunity according to sub section (7) of section 14 of the Act to defend of his
own or by appointing a legal advisor if the disciplinary committee in its report has
recommended an action. After receiving a reply from the alleged member or accounting firm in
this connection the council can direct the disciplinary committee for re-reporting performing
more investigation on the subject if it feels essential.
iii) After the completion of the procedure according to sub rule (ii) if a member or an accounting
firm is found guilty the council shall order punishment in accordance with sub-section (5) of the
section 14 of the Act.

b)
(1) Notwithstanding anything contained in section 11 of the Insurance Act, 2049, the Board shall
not renew the Certificate of Registration of an insurer in any of the following circumstances:
i) In case it does not submit the balance sheet according to section 23.
ii) In case it does not submit the statement of income according to section 24.
iii) In case it does not submit the Auditor's report according to section 25.
iv) In case it does not submit the Actuary's report according to section 26.
v) In case it does not pay the insurance service fee according to section 40.
vi) In case it has been prohibited from engaging in the insurance business according to section 12A.

(2) In case the certificate of registration of an insurer cannot be renewed because of any of the
circumstances mentioned in the above, the Board shall notify the insurer accordingly within 15 days
from the date of emergence of such circumstances.

(3) In case the insurer submits an application to the Board within 15 days from the date of receipt of
a notice under section (2) by explicitly mentioning appropriate reason for its inability to fulfill the
obligations to be fulfilled by it under section 23, 24, 25, 26 and 40, the Board may it considers the
reasons to be appropriate, provide an additional time limit of not more than one month to fulfill
those obligations.

7. Write short notes on the followings: (3×5=15)

a) "Standard Form of Contract"
b) Welfare Fund under Labour Rules, 2049
c) Privileges of a "holder in due course"

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Answer
a) Where the term and condition of agreement has already been fixed in a standard form and the
other party of the agreement has to accept those term and condition such types of contract is
called 'Standard Form of Contract'. In the modern age some persons, institutions or
establishments such as the Railway, insurance companies, Bank, Manufacturers of various
goods, etc. may have to enter into a very large numbers of contracts with thousands of persons,
they cannot possibly negotiate individually with the persons with whom the contracts are to be
made. Contracts with pre-drafted matters are generally prepared by one party, which the other
has to agree to it or leave it.

b) The provisions relating to welfare funds under Labour Rules are as follows:

i) The establishment must establish a welfare fund under section 37 of the Labour Act, 2048 in
order to carry out activities for the benefit and welfare of workers or employees.
ii) Seventy percent of the balance left after distributing bonus from the amount allocated for the
purpose under section 5 of the Bonus Act, 2030 shall be carried to the fund established under
above (i).
iii) The amount credited to the Fund established under sub-Rule (i) shall be deposited in an
account opened in any commercial bank.
iv)The welfare fund shall be operated in the manner prescribed by the Labour Relations
Committee under its direct control and direction. The accounts of the Fund shall be operated
through the joint signatures of the two members of the Labour Relations Committee
designated by itself.

c) The privileges of a holder in due course are as follows:

i) A person signing and delivering to another a stamped but otherwise inchoate instrument is
debarred from asserting, as against a holder in due course, that the instrument has not been
filled in accordance with the authority given by him, the stamp being sufficient to cover the
amount.
ii)In case a bill of exchange is drawn payable to the drawer's order in a fictitious name and is
endorsed by the same hand as the drawer's signature, it is not permissible for acceptor to
allege as against the holder in due course that such name is fictitious.
iii) In case a bill or note is negotiated to a holder in due course, the other parties to the bill or
note cannot avoid liability on the ground that the delivery of the instrument was conditional
or for a special purpose only.
iv)The person liable in a negotiable instrument cannot set up against the holder in due course
the defenses that the instrument had been lost or obtained from the former by means of an
offence or fraud or for an unlawful consideration.
No maker of a promissory note, and no drawer of a bill or cheque and no acceptor of a bill
for the honour of the drawer shall, in a suit thereon by a holder in due course be permitted to
deny the validity of the instrument as originally made or drawn.
No maker of a promissory note and no acceptor of a bill payable to order shall, in a suit thereon
by a holder in due course, be permitted to deny the payee's capacity, at the rate of the note or
bill, to endorse the same. In short, a holder in due course gets good title to the bill.

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1. HB Ltd. is a small manufacturing company which produces a range of three special cashmere
sweaters under the brand-names of Alpine, Border and Island.
For the month of Shrawan, the management accountant has prepared the following forecast
of trading results:
Alpine Border Island Total
Rs. Rs. Rs. Rs.
Sales 1,000,000 960,000 320,000 2,280,000
Variable costs
Direct materials 350,000 300,000 100,000 750,000
Direct labour 50,000 80,000 30,000 160,000
Works overhead 200,000 180,000 110,000 490,000
Fixed overhead 300,000 270,000 100,000 670,000
(Apportioned)
Net profit/ (Loss) 100,000 130,000 (20,000) 210,000
The following information is also available:
 A
lthough there are other materials which are required for the manufacture of sweaters, the
major material is cashmere, purchased directly from China. Unfortunately, due to delays
in shipment from China, production for the month of Shrawan will be limited by the
availability of cashmere supplies. The purchasing manager believes that he will be able to
increase the current stockholding of 61,000 kg by a delivery of 31,000 kg in mid-
Shrawan. There are no substitute suppliers in the short term.
 T
he production manager advises that the different products absorb different quantities of
cashmere: Alpine- 8 kg per unit, Border- 4 kg per unit and Island- 1 kg per unit.
 T
he sales manager confirms that the current unit prices of the products are: Alpine- Rs.100,
Border- Rs.120 and Island- Rs.80. He is convinced that sales of the Border product could
be substantially increased beyond the current forecast, although he is unable to quantify
the effect. Extra advertising of Rs. 80,000 would be required to achieve this increase,
together with a 10% reduction in the price of the Alpine product. The current forecast of
trading results does not include the view.
 T
he managing director has reviewed the forecast for Shrawan and believes that results can
be improved immediately through stopping the manufacture of the Island product.
Neither the sales manager nor the production manager agrees with his view, but they are
not certain why they disagree.
 F
ixed overhead is apportioned over the product lines on the basis of an allocation by space
occupied on the factory floor.

The managing director is confused by the different proposals being put forward and he
seeks your services as the company‘s external financial consultant to assist him in
drawing up a sensible plan of action.

You are required to do the following: (3+9+5+3=20)

 Suggested Answers of Cost Accounting
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a) Assuming that the full sales forecast for Shrawan can be achieved, assess the impact of
the managing director‘s proposal to drop the entire Island range and advise on its
desirability.
b) In view of the shortage of cashmere, assist the company by preparing an optimal
production plan and a revised forecast of trading results for Shrawan.
c) In light of (b) above, assess the viability and effects of the sales manager‘s plans to
increase sales of the Border range through extra advertising expenditure.
d) What other points of commercial interest would you wish to draw to the attention of the
managing director?

Solution to the Question No. 1

(a) The managing director believes that the act of dropping the Island range of products will
increase profits by Rs.20,000; since it seems that the loss forecast would be avoided.
Unfortunately, it is necessary to appraise him (as tactfully as possible) that his thinking is
being unduly influenced by the arbitrary allocation of Rs.100,000 of fixed overheads to
the Island range. If the Island range was stopped, then Rs.100,000 of fixed overhead
would not be saved, but merely reallocated to the other two lines.
The correct approach is to assess the contribution to fixed overheads arising from the
Island product, as follows:

Statement of contribution of Island

Particulars Rs. Rs.
Sales 320,000
Less: Variable Costs
Direct materials 100,000
Direct labour 30,000
Works overhead 110,000 240,000
Contribution 80,000

In fact, therefore, if this proposal had been adopted, the forecast trading profit of
Rs.210,000 would have fallen to Rs.130,000 (i.e. Rs.210,000-Rs.80,000) due to above
lost contribution. Hence, this proposal should be soundly rejected.

(b) Since the shortage of cashmere constitutes a limiting factor on Shrawan‘s output, it is
necessary to deploy the available cashmere over the three products in a manner which
will optimize overall profit. In the first instance, it is necessary to identify the ranking of
the products, in terms of the contribution they generate from use of per kg of cashmere:

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Statement of contribution per kg of cashmere used

Particulars Alpine Border Island
Rs. Rs. Rs. Rs. Rs. Rs.
Sales 1,000,000 960,000 320,000
Less: Variable Costs
Direct materials 350,000 300,000 100,000
Direct labour 50,000 80,000 30,000
Works overhead 200,000 600,000 180,000 560,000 110,000 240,000
Contribution 400,000 400,000 80,000
Unit Selling Price (Rs.) 100 120 80
Therefore, no. of units 10,000 8,000 4,000
Contribution per unit (Rs.) 40 50 20
Cashmere Used per unit (kg) 8 4 1
Contribution per kg of 5 12.50 20
cashmere (Rs.)
Ranking III II I

The ranking exercise indicates that the Island product (contrary to the managing director‘
belief) is the best product in the current situation of limited supplies of cashmere.
As a result, the optimal production plan is:

Statement showing Revised optimal production plan for Shrawan

Product as Maximum Cashmere Cashmere Remaining Revised Contribution Total
per ranking forcasted required to to be used quantity of optimal per unit (Rs.)
sales unit meet (kgs) from cashmere production (Rs.)
maximum 92000 kgs (kgs) and sales
forcasted available unit
sales unit
(kgs)
Island 4000 4000 4000 88000 4000 20 80000
Border 8000 32000 32000 56000 8000 50 400000
Alpine 10000 80000 56000 0 7000 40 280000
Total revised contribution 760000
Total Fixed costs 670000
Total revised profit 90000

Note: As the third-ranked product, Alpine received only the residual balance of the
available cashmere, i.e.56,000 kgs. This means that only 7,000 units can be
manufactured, leaving an unsatisfied demand for 3000 units in Shrawan.

(c) Assessment of the effect of Sales Manager's Plan

The sales manager is not clear about the extent to which the sales of Border could be increased.
In any case, production/sales of Border can be increased at the expense of Alpine which has the
lowest contribution per kg. of cashmere of Rs. 5 keeping the sales units of Island intact at the
level of revised production plan as found out under (b) above. As per the conditions given, the
sales unit of Border will have to be accompanied by a 10% reduction in the price of Alpine, the
contribution per unit of Alpine will be reduced to Rs. 30 per unit.

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Considering the additional advertisement cost of Rs. 80,000 to increase the sales of Border, a
total contribution of at least Rs. 840,000 (Contribution as per revised plan of Rs. 760,000 +
Advertisement cost of Rs. 80,000) is needed to make the sales manager's plan financially
justifiable.
Let x be the increase in the sales units of Border from the units of revised optimum level derived
in (b). Based on this, the total contribution generated by the respective products is computed in
the table given below.
Cashmere Contribution
Product Sales Units
Required (kg.) Per Unit (Rs.) Total (Rs.)
Island 4,000 4,000 20 80,000
Border 8,000 + x 32,000 + 4x 50 400,000 + 50 x
Alpine 7,000 – ½ x** 56,000 – 4 x* 30 210,000 – 15 x
Total: 43,000 + ½ x 92,000 690,000 + 35 x

In order to ensure that the sales manager's plan is financially viable, the contribution derived in
the above table should be greater than Rs. 840,000.
Therefore, Rs. 690,000 + 35 x > 840,000, Or, 35 x > 840,000 – 690,000
Or, x > 150,000/35 Or, x > 4,285.71, say, 4,286 units.

Thus, the sales units of Border should be 12,286 (8,000 + 4,286) or 53.575% more than sales
units derived under option (b) for the sales manager's plan to yield at least the same level of
profit as obtained under that option. Any increase in the sales units of Border in excess of that
level by reducing the sales units of Alpine will make the sales manager's proposal financially
better as compared to the revised optimum production/sales plan.

(d) Other possible points of commercial interest are:

 What can be done to increase the sales of the Island range since it is the best performing
product?
 Is it possible to increase the selling prices of all the products as a means to restrict demand
to attainable levels?
 Is there any impact on sales caused by the restricted availability of any one range of
product?
 Would any customers be prepared to wait for deliveries until cashmere is in greater supply?

2.
a) Jagger Products Ltd. manufactures toy dolls in a moulding process. The management
accountant has been taken ill and you have been requested to assist in identifying the
usual monthly adjustments to measure output and cost of output.
Opening work-in-progress amounted to 8000 dolls, with costs attached of materials Rs.
398,400 and labour/conversion of Rs. 384,000. Materials are added at the beginning of
the moulding process. Opening work-in-progress is 50% complete in terms of
labour/conversion costs.
During the month, a further 40000 dolls have been input to the process, incurring material
costs of Rs. 2,400,000 and labour/conversion costs of Rs. 3,993,600. Completed dolls

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totaled 42000 in the month, leaving 6000 in work-in-progress, 60% complete in terms of
labour/conversion costs.
The company operates a FIFO approach to accounting for stock movements.
You are required to compute/prepare: (4+2+2+2=10)
i) Equivalent unit statement and cost per equivalent unit;
ii) Costs attached to closing work-in-progress;
iii) Costs attached to units started and completed;
iv) Costs attached to completion of opening work-in-progress.

b) Component CT is made entirely in a machine shop. Material cost is Rs. 15 per

component. Each component requires 4 minutes to produce and the machine operator is
paid Rs. 90 per hour. Machine hour rate is Rs. 360 per hour.
It takes 2 hours for the operator to set up the machine before the production of
components can take place.
You are required to prepare cost sheet showing the setting up costs and production costs,
both in total for the batch and per component, assuming a batch size of 500 components. 5

c) Nepal Travels runs 20 buses in various routes of Kathmandu and Dhulikhel which are 25
kilometer apart. Seating capacity of each bus is 40 passengers. The expenses for the
month of Chaitra 2066 were as follows:
Salaries of the drivers and conductors : Rs. 2,60,000
Salaries of mechanical staff : Rs. 30,000
Diesel oil and lubricants : Rs. 4,80,000
Taxes and Insurance : Rs. 28,000
Repairs and Maintenance : Rs. 1,04,000
Depreciation : Rs. 4,18,000
Seating capacity utilized was 60%. All the buses ran 25 days of the month. Each bus
made four round-trips.
You are required to find:
Cost per passenger kilometer and cost per round trip per passenger. 5

Solution to the Question No. 2 a)

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Equivalent unit statement

Particulars Materials Labour/ Remarks
Conversion
Units Units
Opening work-in-progress 0 4000 (8000 units 50% complete in
terms of labour/ conversion)
Units started and completed 34000 34000 (40000 units less closing WIP of
6000 units on FIFO basis)
Closing work-in-progress 6000 3600 (6000 units 60% complete in
terms of labour/ conversion)
Equivalent units 40000 41600
Rs. Rs. Total (Rs.)
Costs to be accounted for 2,400,000 3,993,600 6,393,600
incurred in the month
Costs per equivalent unit 60 96 156

(ii)
Costs attached to closing work-in-progress
Particulars of costs Equivalent Rate per Total costs (Rs.)
Unit Unit (Rs.)
Materials 6000 60 360,000
Labour/ conversion 3600 96 345,600
Total 705,600

(iii)
Costs attached to unit started and completed
Particulars of costs Equivalent Rate per Total costs (Rs.)
Unit Unit (Rs.)
Total costs 34000 156 5,304,000

(iv)
Costs attached to completion of opening work-in-progress
Particulars of costs Equivalent Rate per Total costs (Rs.)
Unit Unit (Rs.)
Materials (already complete) 0
Labour/ conversion 4000 96 384,000
Total 384,000
Note:
In completing opening work-in-progress, costs incurred last month and brought forward
(Materials Rs.398,400 and Labour/ conversion Rs.384,000) will also be transferred to finished
goods.

Solution to the Question No. 2 b)

A. Setting up cost: Total Batch Cost per
Cost Component
Wages (2 hours @ Rs. 90) Rs. 180

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Machine Expenses (2 hours @ Rs. 360 per hour) 720

Total Setting up cost: 900 1.80
B. Production cost
Material (500 X Rs. 15) 7,500
Wages (500 X 4 minutes X Rs. 90/60) 3,000
Machine Expenses (500 X 4 minutes X 360/60) 12000
Total Production Cost 22,500 45.00
Total Setting up and Production Cost 23,400 46.80

Solution to the Question No. 2 c)

Calculation of Cost per Passenger Km. & Cost per round trip
Since the two destinations are 25 kms. apart, a round trip will cover 50 kms.
Four round trips are made for 25 days
Total running in a month = 50 kms. X 4 trips X 25 days X 20 buses = 100,000 Kms
Seating Capacity utilized = 60% or 24 passengers
Therefore, passenger kilometer run = 24 X 100,000 = 2,400,000
Total cost per month = Rs. (260,000 + 30,000 + 480,000 + 28,000 + 104,000 +
418,000)
= Rs. 1,320,000
Cost per passenger kilometer = Rs. 1,320,000/Rs. 2,400,000 = Rs. 0.55
Cost per round trip per passenger = 50 X Rs. 0.55 = Rs. 27.50

3.
a) S
V Limited which has established its product K furnishes the following forecast of sales in
units for 2009.
I Quarter II Quarter III Quarter IV Quarter
Units 12,000 15,000 13,500 9,000
The opening stock on 1.1.2009 is expected to be 10,000 units and the company proposes to
maintain a closing stock of 4,500 units on 31.12.2009. The rejection in the process of
manufacture of product K is 12% and the production will be spread out uniformly throughout the
year.
Two raw materials C and D are used for the manufacture of product K. At present the company
orders inventory of the two raw materials in quantities equivalent to 13 weeks‘ consumption. The
management of the company has been advised that considerable economies in provisioning of
raw materials can be effected by changing over to the ordering system based on economic order
quantities. The Materials Manager has complied the following data:
C D
Raw material quantity required per unit of output of K (kg) 2.4 4.2
Raw material usage rate/week (kg) 2,300 4,000
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Price per kg (Rs.) 2.00 4.00

Lead time to obtain deliveries (weeks) 5 3
Order costs per order (Rs.) 10.00 10.00
Carrying Costs 20% 25%
You are required to: (4+4+4+3=15)
i) Prepare a Production and Raw Material Requirement Budget for the year 2009.
ii) Calculate the Economic Order Quantity for raw materials C & D using Tabular
Method assuming order sizes of 1,200, 1,800, 2,400 and 3,000.
iii) The company feels that a safety stock should be built up to cover a lead time of 8
weeks and 5 weeks respectively for C and D and increase in the usage of raw
materials up to 3,000 kg and 5,000 kg respectively for C and D per week. Calculate
the ordering level to meet the above requirement.
iv) Based on the ordering level calculate at (iii) above, find the saving arising from
switching over to the new ordering system.

b) What is integral accounting? Briefly describe its main features. 5

Solution to the Question No. 3 a)

i (a) Annual Production budget (quantitative)
Units
Total annual sales (12,000 +15,000 + 13,000 + 9,000) 49,500
Add: desired closing Stock 4,500
54,000
Less: Expected Opening Stock 10,000
Production of good units 44,000
Rejection 12%
Units to be produced 44,000 x (100/88) 50,000

(b) Material Budget (Quantitative)

C D
Quantity per unit 2.4 kg 4.2 kg
Material requirement per annum (kg) 120,000 210,000

ii) Computation of Economic Order Quantity (EOQ)

EOQ for C
Lot Size No of Average Ordering Inventory Total
Orders Inventory Costs Carrying Costs
Rs. Cost Rs.
Rs.
1,200 100 600 1,000 240 1,240
1,800 67 900 670 360 1,030
2,400 50 1,200 500 480 980
3,000 40 1,500 400 600 1,000
EOQ for D
1,200 175 600 1,750 600 2,350
1,800 117 900 1,170 900 2,070
2,400 88 1,200 880 1,200 2,080

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3,000 70 1,500 700 1,500 2,200

Thus, EOQ for Material C is 2,400 units while for Material D it is 1,800 units.

iii) Computation of Revised Ordering Level

C D
Kg kg
Normal Ordering Level = Lead Time x Inventory Usage (2,300 x 5) (4,000 x 3)
= 11,500 = 12,000
Usage over increased lead time
C : 2,300 x 3 6,900
D : 4,000 x 2 8,000
Usage increase per week
C : (3,000 – 2,300) x 8 5,600
D : (5,000 – 4,000) x 5 5,000
Revised ordering level 24,000 25,000

iv) Computation of Savings due to change in system

Rs. Rs.
(a) Present : No. of orders p.a. 4 4
Average Inventory (once in 13 weeks) (120,000/4 x ½) (210,000/4 x ½)
= 15,000 = 26,250
Ordering cost 40 40
Carrying cost (15,000 x 2 x 20%) (26,250 x 4 x 25%)
= 6,000 = 26,250
Total cost 6,040 26,290
(b) Proposed : Total cost (See (ii) 980 2,070
above)
(c) Saving : (a) – (b) 5,060 24,220

Solution to the Question No. 3 b)

Under integral accounting, financial and costing transactions are recorded in one self contained
ledger called integral ledger. When integral accounting is used, there will be no need for
reconciliation of costing and financial results.
Features of Integral Accounting
The principal features of integral accounting are as follows:
i) R
ecords are maintained to undertake complete analysis of cost and sales.
ii) C
omplete details regarding all receipts and payments are kept.
iii) R
ecords to show all the details of assets and liabilities are kept. This system does not use a
notional account to represent all impersonal accounts.
In non-integral system, a cost control account or general ledger adjustment account is used in
cost ledger. In integral accounting system, this adjustment account is not used. Instead, detailed
accounts for assets and liabilities are maintained.
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In integral system, all accounts necessary for the classification of cost is used. The use of
following accounts replaces the general ledger adjustment account as used in non-integral
accounting system:
(i) B
ank account
(ii) D
ebtors account
(iii) C
reditors account
(iv) P
rovision for depreciation account
(v) D
iscount account
(vi) F
ixed assets account
(vii) Share Capital account, etc.

4.
a) A
company is producing three types of products, A,B,C. The sales territory of the company is
divided into three areas X,Y and Z. The estimated sales for the year are as under:
Territories
X Y Z
Product Rs. Rs. Rs.
A 50,000 20,000
B 30,000 - 80,000
C - 70,000 40,000

Budgeted advertising cost is as under:

Territories
X Y Z Total
Rs. Rs. Rs.
Local cost 3,200 4,500 4,200 11,900
General - - - 5,800
You are required to find the advertising cost per cent on sales for each product and territory
showing how you will present the statement to management. 10

b) Calculate the earnings of workers A and B from the following particulars for a month and
allocate the labour cost to each job X, Y and Z: 10
A B
(i) Basic Wages (Rs.) 100 160
(ii) Dearness Allowance 50% 50%
(iii) Contribution to Provident Fund (on basic wages) 8% 8%
(iv) Contribution to Employees‘ Life Insurance (on basic wages) 2% 2%
(v) Overtime Hours 10 -

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The Normal working hours for the month are 200. Overtime is paid at double the total of normal
wages and dearness allowance. Employer‘s contribution to life Insurance and Provident Fund are
made at the rates equal to employees‘ contributions. The two workers were employed on jobs X,
Y and Z in the following proportions:

Jobs
X Y Z
Workers A 40% 30% 30%
Worker B 50% 20% 30%
Overtime was done on job Y.

Solution to the Question No. 4 a)

General advertising cost of Rs. 5,800 is allocated to territories on the basis of sales value, as
follows:
Sales Value General advertising cost

Territory X: Product A 50,000 1,000

Product B 30,000 80,000 600 1,600
Territory Y: Product A 20,000 400
Product C 70,000 90,000 1,400 1,800
Territory Z: Product B 80,000 1,600
Product C 40,000 120,000 800 2,400
Total : 5,800
Local costs allocated to territories are apportioned to products on the basis of sales value:
Territory X: Product A 50,000 2,000
Product B 30,000 80,000 1,200 3,200
Territory Y: Product A 20,000 1,000
Product C 70,000 90,000 3,500 4,500
Territory Z: Product B 80,000 2,800
Product C 40,000 120,000 1,400 4,200
Total: 11,900

Presentation of advertisement cost to the management will be made in the following statement:
Territories
X Y Z Total % on Sales
Product A 3,000 1,400 - 4,400 6.28
Product B 1,800 - 4,400 6,200 5.64
Product C - 4,900 2,200 7,100 6.45
Total 4,800 6,300 6,600 17,700 6.10
% on Sales 6.00 7.00 5.50 6.10

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Solution to the Question No. 4 b)

Statement Showing Earnings of Workers A and B

Workers: A B
Rs. Rs.
Basic Wages 100 160
Dearness Allowance (50% of Basic Wages) 50 80
Overtime Wages (Refer to Working Note 1) 15 -
Gross Wages earned 165 240
Less: - Provident Fund – 8% of Basic wages and ELI – 10 16
2% of Basic wages
Net Wages paid 155 224
Statement of Labour Cost: Rs. Rs.
Gross Wages (excluding overtime) 150 240
Employer‘s Contribution to P.F. and E.L.I. 10 16
Ordinary wages 160 256
Labour Rate per hour 0.80 1.28
(Rs. 160/200) (Rs. 256/200)

Statement showing allocation of Wages to Jobs

Jobs
Total Wages: X Y Z
Rs. Rs. Rs. Rs.
Worker A:
Ordinary Wages: (4 : 3 :3) 160 64 48 48
Overtime 15 - 15 -
Workers B:
Ordinary Wages: (5: 2 : 3) 256 128 51.20 76.8
431 192 114.2 124.8

Working Notes:
Normal Wages are considered as basic wages
Overtime = 2 x (Basic wage + D.A.)
200
= 2 × (Rs. 150/200) × 10 hours = Rs. 15/-.

5. D
istinguish between: (4×2.5=10)
a) Product costs and period costs
b) Cost control and cost reduction
c) Shift Premium and Overtime Premium
d) Treatment of spoilage and defectives

Solution to the Question No. 5 a)

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Product costs are costs which can be identified with goods produced for resale. They vary with
production because these costs are directly affected by the production volume. If there is no
production, these costs will not be incurred. Raw materials and direct labour costs are the
examples of product costs.
Period costs are costs which are matched against the revenue of the current period. These costs
vary with the passage of time and not with the volume of production. Therefore, even if there is
no production, these costs have to be incurred. Rent, insurance, salary etc are the examples of
period costs.

Solution to the Question No. 5 b)

Cost control process involves setting standards, ascertaining actual performance, comparing
actual with standards, investigating variances, and taking corrective actions finally resulting to
cost reduction. Cost control aims at achieving standards where as cost reduction aims at
improving the standards. Cost reduction assumes existence of concealed potential savings in the
standards. It is dynamic and always looks for measures of reducing cost.
Cost control is preventive. It attempts to optimize costs before they are incurred. Cost reduction
is corrective and attempts to find scope of reducing incurred costs under controlled conditions.
Cost control requires existence of standards and management guidelines; but cost reduction is
applicable to every activity of the business. It does not require standard and provides guidelines
to management.

Solution to the Question No. 5 c)

Shift premium/differential refers to the payment of higher hourly rates for working in less
desirable shifts of job, such as evening or night shift. It is charged to factory overhead control
rather than work-in-process, and spread over all units produced because they are not caused by
specific units. For example, if day time rate per hour is Rs.50 and night time rate is Rs.60 per
hour, the shift premium per hour is Rs. 10 only, which is charged to factory overhead.
Overtime work is caused due to random scheduling of jobs, requirement of a specific job and
poor workmanship or negligence. It may be paid at the regular rate or higher rate as required. If
higher rate is paid for the overtime hours, the differential is termed as overtime premium. If it is
caused by random scheduling of jobs, it is treated as shift premium; if it is caused by requirement
of specific job, it is charged to that specific job; and if it is caused by poor workmanship or
negligence, it is charged to profit and loss account.

Solution to the Question No. 5 d)

Spoilage occurs when materials are so damaged in manufacturing operations that they are taken
out of the process and disposed off without further work.
Normal spoilage is included in cost either by charging the loss to the production order or
charging it to production overhead. The cost of abnormal spoilage is charged to costing profit
and loss account.
Defectives represent unit of output which fail to comply with a set quality standard. These can be
subsequently rectified, sold as 'seconds' or disposed off as scrap.

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Normal defectives can be recovered; charged to good production: charged to general overhead;
or charged to department. If defectives are abnormal and are due to causes beyond the control of
organization, they should be charged to profit and loss account.

6. A
nswer the following questions: (5×2=10)
a) State the appropriate ‗cost unit‘ for the following industries:
i) Steel
ii) Bricks making
iii) Sugar
iv) Power
b) What are the assumptions involved in the definition of cost reduction?
c) Briefly explain the benefits of cost audit to the management.
d) Describe what do you understand by engineered costs?
e) What items are generally included in good uniform costing manual?

Solution to the Question No. 6 a)

Industry Cost Unit
i) Steel : Per ton
ii) Bricks making : Per 1000 bricks
iii) Sugar : Per quintal or 100 kg.
iv) Power : Kilo-watt hour

Solution to the Question No. 6 b)

The threefold assumption involved in the definition of cost reduction may be
summarized as under:
(i) There is a saving in unit cost.
(ii) Such saving is of permanent nature.
(iii) The utility and quality of goods and services remain unaffected, if not
improved.

Solution to the Question No. 6 c)

Benefits of Cost Audit to the management
i) Cost audit assists in the detection of errors and frauds. Continuous cost audit prevents
manipulation and frauds.
ii) Cost data becomes more reliable. Inventory valuation certified by the cost auditor ensures
the correctness and integrity.
iii) Cost audit facilitates improved cost accounting methods and better internal control.

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iv) Disclosures made in the cost audit reports create cost consciousness in the management.
v) Cost audit helps to improve the effectiveness of cost control and cost presentation. This is
achieved when the cost auditor points out avoidable wasteful routines and procedures and
recommends the introduction of cost efficient routines and procedures.
vi) Cost audit assists the management to take action for economic and efficient use of labour
material and other resources. This will contribute towards achieving higher productivity
and higher utilization of capacity.
vii) Cost audited data could be helpful in comparing inter-firm performance.
viii) Cost audit could be instrumental in identifying the symptoms of sickness in a unit. This
will help the management to initiate timely remedial actions to prevent the sickness.

Solution to the Question No. 6 d)

Engineered costs are built into the product or output and an organization cannot avoid incurring
them. For example, direct material, direct labor and directly related overhead are designed into
the product and simply must be incurred if output is to be achieved.

Engineered costs should be contrasted with discretionary costs, the level of which is determined
solely by management. For example, the level of R & D, marketing and selling, and maintenance
expenditures are determined by management and are not necessarily related to the level of
productive output.

Solution to the Question No. 6 e)

Uniform costing manual includes essential information and instructions to implement accounting
procedures.
(i) Introduction: It includes objects and scope of the planning.
(ii) Accounting procedure and planning includes rules, and general principle to be followed.
(iii) Cost accounting planning includes methods of costing, relation between cost and financial
accounts and methods of integration.

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Suggested Answers of Financial Management

CAP II Examination June 2010

1. Growmore Ltd. is considering two projects, A and B, to undertake. The projects are
mutually exclusive and the firm can choose any one these two. There is a controversy at the
top management level of Growmore regarding the capital budgeting technique to be
employed as the basis for selection of the investment projects.
The finance director is of the view that the project with higher net present value (NPV)
should be chosen whereas the managing director strongly feels that the one with higher
internal rate of return (IRR) should be undertaken especially when the mutually exclusive
projects have the same initial outlay and length of life.
The company anticipates a cost of capital of 10% and the net after tax cash flow of the
projects (in ‗000 rupees) are as given below:

Projects _
Year A B
0 (-) 800 (-) 800
1 140 872
2 320 40
3 360 40
4 300 16
5 80 12

You are required to: (6+3+5+6=20)

a) Calculate the NPV and IRR of each project;
b) Recommend, with reasons, which project should be undertaken (if either);
c) Explain the inconsistency in ranking of the two projects in the light of the remarks of the
directors; and
d) Identify the cost of capital at which your recommendation made in part (b) would be
reversed.
Following discount factors may be adopted:
Discount Year
Factor 0 1 2 3 4 5
At 10% 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209
At 15% 1.0000 0.8696 0.7561 0.6575 0.5718 0.4972
At 20% 1.0000 0.8333 0.6944 0.5787 0.4823 0.4019
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Answer

(a) Computation of NPV and IRR:

Project A:

Discount Factors Cash Flow NPV at

Year 10% 15% 20%
10% 15% 20%

0 1.0000 1.0000 1.0000 – 800 – 800.00 – 800.00 – 800.00

1 0.9091 0.8696 0.8333 140 27.27 121.74 116.66
2 0.8264 0.7561 0.6944 320 264.45 241.95 222.21
3 0.7513 0.6575 0.5787 360 270.47 236.70 208.33
4 0.6830 0.5718 0.4823 300 204.90 171.54 144.69
5 0.6209 0.4972 0.4010 80 49.67 39.78 32.15
Total: 116.76 11.71 -75.96

Project B:

Discount Factors Cash Flow NPV at

Year 10% 15% 20%
10% 15% 20%

0 1.0000 1.0000 1.0000 – 800 – 800.00 – 800.00 – 800.00

1 0.9091 0.8696 0.8333 872 792.74 758.29 726.63
2 0.8264 0.7561 0.6944 40 33.06 30.24 27.76
3 0.7513 0.6575 0.5787 40 30.05 26.30 23.15
4 0.6830 0.5718 0.4823 16 10.93 9.15 7.72
5 0.6209 0.4972 0.4010 12 7.45 5.97 4.82
Total: 74.23 29.95 -9.82

From the above table, at 10% discount rate:

Formula: IRR=

NPV of Project A = Rs. 116,760

NPV of Project B = Rs. 74,230
Using interpolation method, IRR of individual projects are computed as follows:
Project A = 15% + [11.71/ 11.71 – (-75.96)] X 5%
= 15% + [11.71/ (11.71+ 75.96)] X 5%
= 15% + (11.71/ 87.67) X 5% = 15% + 0.67% = 15.67%
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Project B = 15% + [(29.95/(29.95 + 9.82) X 5%]

= 15% + [(29.95/(39.77 + 9.82) X 5%]
= 15% + 29.95/ 39.77 X 5% = 15% + 3.77 % = 18.77%

Note: Using the rate of 10% and 20% rate for discounting, IRR derived for project A and B will
be 16.06% and 18.83% respectively.

(b) Recommendation on the Selection of Project:

Under NPV technique, project A has higher NPV (Rs. 116,760) as compared to project B which
has a NPV of Rs. 74,230. On the contrary, IRR of project B (18.77%) is much higher than that
of Project A which has an IRR of 15.67%.
The projects are mutually exclusive and conflicting rankings have occurred. In this situation,
NPV method will indicate the correct rankings due to certain limitation of IRR method as
explained under point (c). It is therefore recommended that project A should be selected for
implementation since it yields the higher NPV at a discount rate of 10%.
(c) Reasons for Inconsistency in the ranking of two Projects:
Such an inconsistency in the rankings generally occurs when the cash inflow in the project with
lower NPV is heavily loaded in the earlier years. That is exactly what has happened in the case
of Project B in the present case. Exactly, 88% of the cash inflow occurred in the first year in this
project whose NPV is lower as computed under point (a) above.
The superiority of NPV technique over the IRR method in such instances can be explained in
terms of the following factors:
(i) Percentage Returns: IRR expresses the results in percentage rather than in absolute or
monetary terms. Comparison of percentage can be misleading. For instance, an investment
of Rs. 500,000 that generates a return of 15 per cent is better than an investment of Rs.
200,000 which yields a return of 30 per cent. If the two projects are mutually exclusive, the
first investment will yield Rs. 75,000 but the second will only contribute Rs. 60,000
towards the profit pool of the firm. Therefore, if the objective is to maximize the
shareholders wealth, NPV is the correct measure.
(ii) Reinvestment assumptions: When NPV method is adopted, the implicit assumption is that
the cash flows generated from an investment will be reinvested at the cost of capital.
However, the IRR method assumes that all the proceeds from a project can be reinvested
to earn a return equal to the IRR of the original project. The underlying assumption of
NPV method is therefore more realistic as compared to the assumption made in IRR
method.

(d) Cost of Capital at which the Recommendation would be Reversed:

The cost of capital at which Project A would be preferred to Project B can be ascertained by
calculating the IRR on incremental investment, A – B.

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Total

Particulars
(Rs. in ‘000)
Project A : Cash Flow – 800 140 320 360 300 80
Project B : Cash Flow – 800 872 40 40 16 12
Project (A – B) 0 –732 280 320 284 68

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Discount Factor 10% 1.0000 0.9091 0.8264 0.7513 0.683 0.6209

NPV @ 10% 0 –665.46 231.39 240.42 193.97 42.22 42.54
Discount Factor 15% 1.0000 0.8696 0.7561 0.6575 0.5718 0.4972
NPV @ 15% 0 –636.55 211.71 210.40 162.39 33.81 –18.54

Using interpolation method, IRR on incremental investment

= [10% + 42.54/(42.54 + 18.24) X 5%] = 10% + 42.54/ 60.78 X 5%
= 10% + 3.5% = 13.5%
Thus, the IRR on incremental investment (A – B) is 13.5 per cent. This implies that the decision
recommended in (b) above would be reversed if the cost of capital were in excess of 13.5 per
cent assuming that of the projects has a positive NPV.

2. a) Describe Walter's approach to dividend policy along with his formulation. 5

b) X
YZ Ltd. is foreseeing a growth rate of 12% per annum in the next 2 years. The growth
rate is likely to fall to 10% for the third year and fourth year. After that the growth rate is
expected to stabilise at 8% per annum. If the last dividend paid was Rs. 1.50 per share
and the investors' required rate of return is 16%, find out the intrinsic value per share of
Z Ltd. as of date. You may use the following table: 10

Years 0 1 2 3 4 5
Discounting factor at 16% 1 0.86 0.74 0.64 0.55 0.48

Answer

a) The formula given by Prof. James. E. Walter shows how the dividend policy can be used to
maximise the wealth position of the equity holders. He argues that in the long run, the share
prices reflect only the present value of the expected dividends. Retentions influence share prices
only through their effect on further dividends. The relationship between dividend and share price
can be shown on the basis of the following formula:

Vc = D + Ra/Rc (E - D)
Rc
where,
Vc = Market value of the ordinary shares of the company
Ra = Return on internal retention i.e. the rate company earns on retained profits.
Rc = Capitalisation rate
E = Earnings per share
D = Dividend per share

Professor Walter emphasizes two factors which influence the market price of a share. The first is
the dividend per share and the second is the relationship between internal return on retained
earnings and the market expectation from that company as reflected in the capitalisation rate. In
other words, if the internal return on retained earnings is higher than the market capitalisation
rate, the value of the ordinary shares would be high even if the dividends are low. However, if
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the internal return within the business is lower than what the market expects, the value of the
share would be low. In such a case, the share holders would prefer that a higher dividend is
declared so that they can utilise the funds in more profitable opportunities elsewhere.

b) Present value of dividend stream for first 2 years:

Rs. 1.50 (1.12) x 0.86 + 1.50 (1.12)2 x 0.74
Rs. 1.68 x 0.86 + 1.88 x 0.74
Rs. 1.45 + 1.39 = 2.84 (A)

Present value of dividend stream for next 2 years:

Rs. 1.88 (1.1) x 0.64 + 1.88 (1.1)2 x 0.55
Rs. 2.07 x 0.64 + 2.28 x 0.55
Rs. 1.33 + 1.25 = 2.58 (B)

Market value of equity share at the end of 4th year computed by using the constant dividend
growth model would be:
P4 = D5
Ks - gn
Where D5 is dividend in the fifth year, gn is the growth rate and Ks is required rate of return.
Now, D5 = D4 (1 + gn)
D5 = Rs. 2.28 ( 1 + 0.08)
= Rs. 2.46
P4 = Rs. 2.46
0.16 - 0.08
= Rs. 30.75

Present market value of P4 = 30.75 x 0.55 = Rs. 16.91 (C)

Hence the intrinsic value per share of Z Ltd. would be
A + B + C i.e. Rs. 2.84 + 2.58 + 16.91 = Rs. 22.33

3 M
/s X. Ltd. has three divisions, each of approximately the same size. Its Finance Department
has estimated the rates of return for different states of nature as given. 15
State Probability Rm Rate of Rate of Rate of
Return of Return of Return of
Division 1 Division 2 Division 3
Great 0.25 0.35 0.40 0.6 0.20
Good 0.25 0.20 0.36 0.3 0.12
Average 0.25 0.13 0.24 0.16 0.08
Horrible 0.25 -0.08 0 -0.26 -0. 02

a) If the risk free rate is 9 %, what rate of return does the market require for each division?
b) What is the beta of the entire company?
c) If the company has 30 percent of its funds provided by riskless debt and the remainder
by equity what is the equity beta for the company?
d) Which of the divisions should be kept? Which should be spun off?
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e) What will the company's beta be if the actions in part (d) are undertaken?

Answer to Question 3
Calculation of the expected return of market, division1, division 2, division 3.

State Prob. Rm R1 R2 R3 pjRm pjR1 PjR2 PjR3

Great 0.25 0.35 0.40 0.6 0.20 0.0875 0.10 0.15 0.05
Good 0.25 0.20 0.36 0.3 0.12 0.05 0.09 0.075 0.03
Average 0.25 0.13 0.24 0.16 0.08 0.0325 0.06 0.04 0.02
Horrible 0.25 -0.08 0 -0.26 -0. 02 -0.02 0 -0.065 -0.005
Total 0.15 0.25 0.20 0.095

Expected Return from market E(Rm) = ∑ pjRm= 0.15 =15%

Expected Return from division 1 E(R1) = ∑ pjR1= 0.25 =25%
Expected Return from division 2 E(R2) = ∑ pjR2= 0.20 =20%
Expected Return from division 3 E(R3) = ∑ pjR3= 0.095 =9.5%
Calculation of the market variance ( cov1m, cov2m,cov3m)

State [Rm-E(Rm)]2 *Pj [R1-E(R1)][Rm- [R2-E(R2)][Rm- [R3-E(R3)][Rm-

E(Rm)] * Pj E(Rm)] * Pj E(Rm)] * Pj
Great 0.01 0.0075 0.02 0.00525
Good 0.000625 0.001375 0.00125 0.0003125
Average 0.0001 0.00005 0.0002 0.000075
Horrible 0.0132 0.014375 0.02645 0.0066125
Total 0.02395 0.023300 0.0495 0.01225

Market Variance σm2 = ∑[Rm-E(Rm)]2 * Pj = 0.02395

Covariance between division 1 and market cov1m = ∑ [R1-E(R1)][Rm-E(Rm)] * Pj =0.023300
Covariance between division 2 and market cov2m = ∑[R2-E(R2)][Rm-E(Rm)] * Pj = 0.0495
Covariance between division 3 and market cov3m = ∑[R3-E(R3)][Rm-E(Rm)] * Pj = 0.01225
Calculation of Betas
Beta of division 1 β1 = cov1m/ σm2= 0.023300/0.02395 = 0.97287
Beta of division 2 β 2= cov2m/ σm2= 0.0495/0.02395 = 2.067
Beta of division 3 β3 = cov3m/ σm2= 0.01225/0.02395 = 0.5115

a. Required Rate of return for each division

E(Rj) = Rf + [E(Rm) – Rf] βj
E(Rj) = 9% + [15% – 9%] βj

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E(R1) = 9% + [15% – 9%] 0.97287 = 14.8%

E(R2) = 9% + [15% – 9%] 2.067 = 21.4%
E(R3) = 9% + [15% – 9%] 0.5115 = 12.1%

b. The Beta of the entire company

Average beta (β) = 0.97287 + 2.067 + 0.5115/3 = 1.18614

c. The equity beta for the company

Proportion of riskless debt (Wd) = 0.3
Beta of the riskless debt (βd) =0
Proportion of equity( Ws) = 0.70
We have,
β = βdWd + βsWs
1.18614 = 0*3.3 + 0.7 * βs
βs = 1.18614/0.7 = 1.6945

d. Division 1 should be kept. Division 2 and division 3 spun off.

e. If the action in part(d) taken, the company's beta will be equal to division 1. So the
company's beta will be 0.97287.

4.
a) Zee Limited, manufacturer of Colour TV sets, are considering the liaberalisation of
existing credit terms to three of their large customers A, B and C. The credit period and
likely quantity of TV sets that will be lifted by the customers are as follows:
(Quantity lifted) (No. of TV Sets)
Credit Period (Days) A B C
0 1,000 1,000 -
30 1,000 1,500 -
60 1,000 2,000 1,000
90 1,000 2,500 1,500
The selling price per TV set is Rs. 9,000. The expected contribution is 20% of the selling
price. The cost of carrying debtors averages 20% per annum.

You are required to determine the credit period to be allowed to each customer.
(Assume 360 days in a year for calculation purposes). 8

b) Explain briefly two basic principles of effective portfolio management. 7

Answer
a) In case of customer A; there is no increase in sales as far as the credit period is
concerned. Apparently A enjoys good liquidity and the demand for TV sets in his area is
limited. Hence there is no point in allowing credit to 'A'. In case of customers 'B' and 'C'
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the credit period can be determined by trading off between profitability of additional
sales and the cost of carrying additional debtors as a result of relaxation of credit period.

Profitability of additional sales on account of relaxing credit period

Customer 'B Customer 'C'
Credit period 0 30 60 90 0 30 60 90

(days) 1000 1,500 2,000 2,500 - - 1,000 1,500

Rs. lakhs Rs. lakhs

Sales 90 135 180 225 - - 90 135
Contribution at 20% 18 27 36 45 - - 18 27
Incremental
Contribution (A) - 9 9 9 - - 18 9

Debtors:
Credit period X sales - 11.25 30 56.25 - - 15 33.75
360

Incremental Debtors - 11.25 18.75 26.25 - - 15 18.75

Cost of incremental
debtors at 80% - 9 15 21 - - 12 15
Cost of carrying incremental
debtors at 20% (B) - 1.8 3 4.2 - - 2.4 3

Excess incremental contribution

over cost of carrying incremental
debtors (A - B) 7.2 6 4.8 - - 15.6 6

It is seen from the above computations that incremental contribution exceeds incremental cost of
carrying additional debtors at each credit period. Therefore, credit period to B and C should be
90 days.

b) The two basic principles of effective portfolio management are:

i. Effective investment planning for the investment in securities by considering the
following factors.
a. Fiscal, financial and monetary policies of the Government and Central Bank.
b. Industrial and economic environment and its impact on industry prospects in terms
of prospective technological changes, competition in the market, capacity
utilisation with industry and demand prospects etc.
ii. Constant review of investment: Portfolio managers are required to review their
investment in securities on a continuous basis to indentify more profitable avenues for
selling and purchasing their investment. For this purpose, they will have to carry out
the following analysis:
a. Assessment of quality of management of the companies in which investment has
already been made or is proposed to be made.

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b. Financial and trend analysis of companies' balance sheets / profit and loss accounts
to identify sound companies with optimum capital structure and better performance
and to disinvest the holding of those companies whose performance is found to be
slackening.
c. The analysis of securities market and its trend is to be done on a continuous basis.

5. a) The clients of an accounting firm wherein you are employed are concerned about the fall
in dividend from a company whose shares they hold as investment. The abridged profit
and loss account and balance sheet of the company for two years are given as follows:
Abridged P & L A/C (year ended Ashadh 31) (Rs. in lakh)

Particulars Current year Previous year

Income:
Sales and other income 19,200 15,500
Expenditure:
Operating and other expenses 15,600 11,900
Depreciation 700 650
Interest 1,850 1,750
18,150 14,300
Profit for the year 1,050 1,200
Taxes 500 200
Profit after taxes 550 1,000
Proposed dividend 200 400

Abridged Balance Sheet as on Ashadh 31 (Rs. in lakh)

Particulars Current year Previous year
Sources of funds:
Share capital (of Rs. 10 each) 4,200 2,600
Reserves and surplus 7,550 1,200
Convertible portion of
12.5% Debentures -- 500
Loan funds:
Secured loans (16%) 10,100 8,700
Unsecured loans (15%) 1,000 3,300
Total 22,850 16,300

Application of funds:
Fixed Assets:
Cost 14,800 11,200
Less: Depreciation 2,700 2,000
12,100 9,20
Advances on capital A/C
& work in progress 1,000 200
13,100 9,400

Current Assets, Loans and Advances

Inventories 8,600 7,100
Sundry debtors 1,400 550
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Cash and bank balances 850 680

Loans and advances 3,000 1,600
13,850 9,930
Less: Current liabilities 4,100 3,030
9,750 6,900
Total 22,850 16,300

Compute the following: interest cover, return on net worth, earnings per
share, dividend cover. 10

b.)What is stock repurchase and why company repurchases its own stock. 5

Answer:
(a)
Abridged P & L A/C (year ended Ashadh 31) (Rs. in lakh)

Particulars Current year Previous year

Sales and other income 19,200 15,500

Less: Operating and other expenses 15,600 11,900
Depreciation 700 650
Earnings before interest and taxes (EBIT) 2,900 2,950
Less: Interest 1,850 1,750
1,050 1,200
Earnings before taxes 1,050 1,200
Less: Taxes 500 200
Earnings after taxes (EAT) 550 1,000
Proposed dividend (Dp) 200 400
Interest coverage ratio (EBIT/Interest) 1.57 1.69
Return on Net worth (EAT/Net worth)* 0.047 0.263
Earnings per share (EAT/no. of shares)** 1.31 3.85
Dividend cover (EAT/ Dp) 2.75 2.50

* Net worth: previous year = Rs. 3,800 (Rs. 2,600 + 1,200); current year = Rs. 11,750 (Rs.
4,200 + 7,550)
**No. of shares: previous year = 260 lakh; current year = 420 lakh.

(b) Stock repurchase is a method, in which a firm buys back shares of its own stock, thereby
decreasing shares outstanding, increasing EPS and often increasing the price of the stock. Stock
repurchases are an alternative to dividends for transmitting cash to stockholders.
Stock repurchased by the issuing firm is called Treasury Stock.
Stock price for repurchase or the equilibrium price is calculated from the following equation.
Repurchase price = S*Pc/S-n
Where,
S=Total number of shares outstanding
Pc= Current market price per share
n= Number of shares to be repurchased

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Alternatively,
Repurchase price= Market price before stock repurchase/1-stock repurchase in fraction.
Reason for purchasing its own stock - If a firm has excess cash, it may repurchase its own
stock leaving fewer shares outstanding and increasing the earnings per share. Stock repurchase
may be alternative to paying cash dividends. The benefits to the shareholder are the same under
a cash dividend policy and stock repurchase. Firms also repurchase their stock if the stock price
is low. The market often sees the stock repurchases as a signal to future prosperity. Stock
repurchases may be used for employee stock options. Stock repurchases reduces the possibility
of being taken over by another firm. Stock repurchases can be made in open market or on tender
offer or on negotiation basis.

Question 6: Write short notes on: (42.5=10)

a) Working Capital Cycle
b) Tools of Financial forecasting
c) Tax consideration influencing the dividend policy of the firm
d) Bridge Finance
Answers
(a) Working Capital Cycle
Every business undertaking requires funds for two purposes - investment in fixed assets and
investment in current assets. Funds required to invest in stock, debtors and other current assets
keep on changing shape and volume. For example, a company has some cash in the beginning.
This cash may be paid to the suppliers of raw materials, to meet labour costs and other
overheads. These three combined would generate work-in-progress which will be converted into
finished goods on the completion of the production process. On sale, these finished goods get
converted into debtors and, when debtors pay, the firm will again have cash. The cash will again
be used for financing raw materials, work-in-progress etc. Thus there is a complete cycle when
cash gets converted into raw materials, work-in-progress, finished goods, debtors and finally
again cash. This time period is known as the working capital cycle of the firm.

(b) Tools of Financial forecasting

i. Days' sales method is a traditional method under which an attempt is made to calculate the
number of days sales and tie it up with the balance sheet items. As different components of
the balance sheet are forecasted in terms of days' dale, this method measures the resources
that are to be financed.

ii. Percentage of sales method is another tool of financial forecasting in which the balance sheet
items are expressed as percentage of sales. This will clearly (to some extent) show the
financial needs caused by increase in sales.
iii. In simple regression method, with sales forecast as starting point and based on past
relationship between sales and assets items, it is possible to construct a line of best fit or the
regression line for them. This method is used for long term forecasting.
iv. In multiple regression method, it is assumed that sales are a function of several variables,
while in simple regression method only one variable is considered.

(c) Tax consideration influencing the dividend policy of the firm

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The firm's dividend policy is directed by the provisions of income-tax law. If a firm has a large
number of owners, in high tax bracket, its dividend policy may be to have higher retention. As
against this if the majority of shareholders are in lower tax bracket requiring regular income the
firm may resort to higher dividend payout, because they need current income and the greater
certainty associated with receiving the dividend now, instead of the less certain prospect of
capital gains later.

(d) Bridge Finance

Bridge Finance refers, normally, to loans taken by a business, usually from commercial banks
for a short period, pending disbursement of term loans by financial institutions. Normally, it
takes time for the financial institution to finalise procedures of creation of security, tie-up
participation with other institutions etc., even though a positive appraisal of the project has been
made. However, once the loans are approved in principle, firms, in order not to lose further time
in starting their projects, arrange for bridge finance. Such temporary loan is normally repaid out
of the proceeds of the principal term loans. Generally the rate of interest on bridge finance is 1%
or 2% higher than on normal term loans.

7. Distinguish between: (42.5=10)

a) Operating Leverage and Financial Leverage.
b) Floatation cost and Transaction Costs
c) Retention policy and Pay Out policy
d) Investing Activities and Financing Activities

Answers to Question 7
(a) Operating Leverage and Financial Leverage.
Operating leverage results from the existence in the firm's income stream. The operating
leverage may be defined as the firm's ability to use fixed operating costs to magnify the effects
of changes in sales on its earnings before interest and taxes. Operating leverage occurs any time
a firm has fixed costs that must be met regardless of volume.

Financial Leverage results from the presence of fixed financial charges in the firm's income
stream. Financial Leverage is concerned with the effects of changes in EBIT on the earnings
available to equity holders. It is defined as the ability of a firm to use fixed financial charges to
magnify the effects of changes in EBIT on the earnings per share.

(b) Floatation cost and Transaction Costs

Floatation cost refers to the cost involved in raising capital from the market, for instance,
underwriting, commission, brokerage and other expenses. The presence of floatation costs
affects the balancing nature of internal (retained earnings) and external (dividend payments)
financing. The introduction of floatation costs implies that the net proceeds from the sale of new
shares would be less than the face value of the shares, depending upon their size.

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Transaction costs refer to costs associated with the sale of securities by the shareholder
investors. In the Modigliani Miller Hypothesis, it is assumed that if dividends are not paid (or
earnings are retained), the investors desirous of current income to meet consumption need can
sell a part of their holdings without incurring any cost, like brokerage and so on. This is
obviously an unrealistic assumption. Since the sale of securities involves cost, to get current
income equivalent to the dividend, if paid, the investors would have to sell securities in excess
of income that they will receive.

(c) Retention policy and Pay Out policy

The firms resort to different dividend policies according to the situations. The firms deciding to
retain the internal accruals and deciding not to pay dividends are called retention policy.
Whereas the firms deciding to pay the dividends are called pay out policy.

The Higher retention policy will lead to lower pay out policy and vice-versa.

(d) Investing Activities and Financing Activities

The investing activities relate to the acquisition and disposal of long-term assets and other
investments not included in cash-equivalents. Their separate disclosure in Cash flow statement is
important as they represent the extent to which expenditures have been made for resources
intended to generate future income and cash flows.
The financing activities report the changes in the size and composition of the share/owner's
capital and debt of the enterprise. Their separate disclosure is useful in predicting claims on
future cash flow by providers of funds (both capital and borrowings) to the enterprise.

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Suggested Answers of Business Communication and Marketing

CAP II Examination June 2010

Section –―Business Communication‖

8. As per the vacancy announcement appeared in an English daily by the Bank of Asia, you had submitted
your covering letter and a resume for the post of an Accountant. However, you have not heard from them
till date. Now, write a sample follow up letter to the bank. 10
Answer:
Kathmandu-14,
Kalimati
11 April 2010

Dear Sir/Madam,

I submitted a letter of application and a resume earlier this month for the position of an accountant
advertised in The Himalayan Times dated 12 January 2010. Till date, I have not heard from your office. I
would, therefore, like to confirm receipt of my application and reiterate my interest in the job.

I am very interested in working at your bank and I believe that my experience and skills would be an ideal
match for this position.

If necessary, I would be glad to resend my application materials or to provide with any further information
you might need regarding my candidacy. I can be reached at 977-01-4765897 or mail2dinesh@gmail.com.
I look forward to hearing from you.

Thanking you,

Yours sincerely,

Dinesh Wagle

9. What are the barriers to effective interpersonal communication? Suggest some of the ways to overcome
them (5+5=10)
Answer:

Communication plays a major role in employer-employee relationships on farms. It also affects the
relationships among family members on the management team. Although effective communication does
not guarantee success of a farm business, its absence usually assures problems. A communication problem
may soon become a crisis or it may linger on for years.

Problems with any one of the components of the communication model can become a barrier to effective
communication. Here are some of the barriers to effective interpersonal communication. The barriers can
be treated with some means of solution. Each of these barriers are discussed below with their solutions.
 Suggested Answers of BC and Marketing
CAP II Examination – June 2010
1. Muddled messages
Muddled messages are a barrier to communication because the sender leaves the receiver unclear about the
intent of the sender. Muddled messages have many causes. The sender may be confused in his or her
thinking. The message may be little more than a vague idea. The problem may be semantic, e.g., note this
muddled newspaper ad: "Dog for sale. Will eat anything. Especially likes children. Call 888-3599 for more
information."
Feedback from the receiver is the best way for a sender to be sure that the message is clear rather than
muddled. Clarifying muddled messages is the responsibility of the sender. The sender hoping the receiver
will figure out the message does little to remove this barrier to communication.

2. Stereotyping

Stereotyping causes us to typify a person, a group, an event or a thing on oversimplified conceptions,

beliefs, or opinions. Thus, basketball players can be stereotyped as tall, green equipment as better than red
equipment, football linemen as dumb, Ford as better than Chevrolet, Vikings as handsome, and people
raised on dairy farms as interested in animals. Stereotyping can substitute for thinking, analysis and open
mindedness to a new situation.
Stereotyping is a barrier to communication when it causes people to act as if they already know the
message that is coming from the sender or worse, as if no message is necessary because "everybody
already knows." Both senders and listeners should continuously look for and address thinking, conclusions
and actions based on stereotypes.

10. Wrong channel

"Good morning." An oral channel for this message is highly appropriate. Writing "GOOD MORNING!"
on a chalkboard, in the machine shed is less effective than a warm oral greeting. On the other hand, a
detailed request to a contractor for construction of a farrowing house should be in writing, i.e., non-oral. A
long conversation between a pork producer and a contractor about the farrowing house construction, with
neither taking notes, surely will result in confusion and misunderstanding. These simple examples illustrate
how the wrong channel can be barrier to communication. Variation of channels helps the receiver
understand the nature and importance of a message.
Simple rules for selection of a channel cause more problems than they solve. In choice of a channel, the
sender needs to be sensitive to such things as the complexity of the message (good morning versus a
construction contract); the consequences of a misunderstanding (medication for a sick animal versus a
guess about tomorrow's weather); knowledge, skills and abilities of the receiver (a new employee versus a
partner in the business); and immediacy of action to be taken from the message (instructions for this
morning's work versus a plan of work for 1994).

4. Language

Words are not reality. Words as the sender understands them are combined with the perceptions of those
words by the receiver. Language represents only part of the whole. We fill in the rest with perceptions.
Trying to understand a foreign language easily demonstrates words not being reality. Being "foreign" is not
limited to the language of another country. It can be the language of another farm. The Gerken house may
be where the Browns now live. The green goose may be a trailer painted red long after it was given the
name green goose. A brassy day may say much about temperature and little about color.
Each new employee needs to be taught the language of the farm. unless the farm's language is learned, it
can be as much a barrier to communication as a foreign language.
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5. Lack of feedback

Feedback is the mirror of communication. Feedback mirrors what the sender has sent. Feedback is the
receiver sending back to the sender the message as perceived. Without feedback, communication is one-
way.
Feedback happens in a variety of ways. Asking a person to repeat what has been said, e.g., repeat
instructions, is a very direct way of getting feedback. Feedback may be as subtle as a stare, a puzzled look,
a nod, or failure to ask any questions after complicated instructions have been given. Both sender and
receiver can play an active role in using feedback to make communication truly two-way.
Feedback should be helpful rather than hurtful. Prompt feedback is more effective than the feedback saved
up until the "right" moment. Feedback should deal in specifics rather than generalities. Approach feedback
is a problem in perception rather than a problem of discovering the facts.

6. Poor listening skills

Listening is difficult. A typical speaker says about 125 words per minute. The typical listener can receive
400-600 words per minute. Thus, about 75 percent of listening time is free time. The free time often
sidetracks the listener. The solution is to be an active rather than passive listener.
One important listening skill is to be prepared to listen. Tune out thoughts about other people and other
problems. Search for meaning in what the person is saying. A mental outline or summary of key thoughts
can be very helpful. Avoid interrupting the speaker. "Shut up" is a useful listening guideline. "Shut up
some more" is a useful extension of this guideline. Withhold evaluation and judgment until the other
person has finished with the message. A listener's premature frown, shaking of the head, or bored look can
easily convince the other person there is no reason to elaborate or try again to communicate his or her
excellent idea.
Providing feedback is the most important active listening skill. Ask questions. Nod in agreement. Look the
person straight in the eye. Lean forward. Be an animated listener. Focus on what the other person is saying.
Repeat key points.

7. Interruptions

A farm is a lively place. Few days are routine. Long periods of calm and quiet rarely interrupt the usual
hectic pace. In this environment, conversations, meetings, instructions and even casual talk about last
night's game are likely to be interrupted. The interruptions may be due to something more pressing,
rudeness, lack of privacy for discussion, a drop-in visitor, an emergency, or even the curiosity of someone
else wanting to know what two other people are saying.
Regardless of the cause, interruptions are a barrier to communication. In the extreme, there is a reluctance
of employees and family members even to attempt discussion with a manager because of the near certainty
that the conversation will be interrupted. Less extreme but serious is the problem of incomplete instructions
because someone came by with a pressing question.

3. Need for communication across cultures: As business and very many things concerned with human
development are getting globalized, communicating across cultures has become indispensable for people
intending to achieve development goals. Besides, cross-cultural aspects of human communication have
greatly impacted national and international trade and commerce.
Justify the above statements with concrete examples. 10

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Need for communication across cultures: In the remote past, when people lived in a closed society,
communication was understood in a narrow sense. Things that were once considered taboos are talked
about freely now. With things changing with the times, it has been strongly felt that no country can survive
without linkage, communication and association with other nations. Korean Peninsula, for example, split
into two countries after World War I- the South and the North – one making the best of its resources-
human, material and technical for material prosperity and global dignity and the other depleting its
resources for gaining military strength. In spite of their long standing enemity, the latter during the time of
food crisis sought assistance (supply of food grains) from the former.

To survive in a world of cross-cultural communication, it is necessary to understand and interpret culture in

a broader dimension. Culture is a way of life through which people understand and interpret the world in a
broad dimension. As cultural diversity is a matter of complexities, culture is wrongly assumed to be the
cause of misconception. This problem can be overcome by trying to understand cultural differences and
differences in the ways of life of people of different parts of the world. Cultural differences make people of
different places behave differently – in eating, in sitting, in walking, in speaking, and in looking into things
and interpreting them in their own ways. These differences might look complicated for people of different
people but in an age of cross-cultural communication, people have to compromise in the process of
globalization of communication. This requires us to consider the following so as to promote cross-cultural
communication.

 People should be culturally intelligent to understand other people‘s ways of life.

 Be mindful of the differences of others‘ cultures
 Be aware of various factors of human relationship between cultural differences.
 Respect others‘ cultural norms and values
 Understand the impact of cultural differences on people‘s non-verbal communication.
 Understand others‘ attitudes and behavior in relation to time, place,etc.

Though the world of business communication is also affected by cross-cultural traits the cultural gap
bridges in money mattes. It is rightly said that when there is the question of money, everyone is of the
same culture.
To conclude, with things changing much faster in a situation of globalization and sophistication, many
cultures have lost their values. Old traditions and customs are dying out. In the process of modernization,
bigger cultures are dominating the smaller ones. But cross-cultural traits will survive against all odds.

11. Identify the characteristics of successful teams (or groups) and explain them briefly. 10
Answer:

The use of teams has been called the ―solution‖ to many ills in the current work place. Someone even
observed that as an acronym TEAM means ―Together, Everyone Achieves More.‖ Yet, many teams do not
work well together. In fact, some teams can actually increase frustration, lower productivity, and create
employee dissatisfaction. Experts who have studied team workings and decisions have discovered that
effective teams share some or all of the following characteristics.

Small Size, Diverse Makeup. For most functions the best teams range from 2 to 25 members, although 4 or
5 is optimum for many projects. Larger groups have trouble interacting constructively, much less agreeing
on actions. For the most creative decisions, teams generally have male and female members who differ in
age, social background, training, and experience. Members should bring complementary skills to a team.

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Paul Fireman, founder of sports shoe manufacturer Reebok, wisely remarked, "If you put five centers on
the basketball court, you‘re going to lose the game. You need, we all need, people of different
backgrounds. Diverse teams can produce innovative solutions with broader applications than homogeneous
teams can".

Agreement on Purpose. An effective team begins with a purpose. Xerox scientists who invented personal
computing developed their team purpose after the chairman of Xerox called for an ―architecture of
information.‖ A team at Sealed Air Corporation developed its purpose when management instructed it to
cut waste and reduce downtime. Working from a general purpose to specific goals typically requires a huge
investment of time and effort. Meaningful discussions, however, motivate team members to ―buy into‖ the
project.

Agreement on Procedures. The best teams develop procedures to guide them. They set up intermediate
goals with deadlines. They assign roles and tasks, requiring all members to contribute equivalent amounts
of team work. They decide how they will reach decisions using one of the strategies shown in the
accompanying Career Coach box. Procedures are continually evaluated to ensure movement toward
attainment of the team‘s goals.

Ability to Confront Conflict. Poorly functioning teams avoid conflict, preferring sulking, gossip, or
backstabbing. A better plan is to acknowledge conflict and address the root of the problem openly.
Although it may feel emotionally risky, direct confrontation saves time and enhances team commitment in
the long run. To be constructive, however, confrontation must be task oriented, not person oriented. An
open airing of differences, in which all team members have a chance to speak their minds, should center on
strengths and weaknesses of the different positions and ideas—not on personalities. After hearing all sides,
team members must negotiate a fair settlement, no matter how long it takes. The best decisions are based
on consensus: all members agree.

Use of Good Communication Techniques. The best teams exchange information and contribute ideas freely
in an informal environment. Team members speak clearly and concisely, avoiding generalities. They
encourage feedback. Listeners become actively involved, read body language, and ask clarifying questions
before responding. Tactful, constructive disagreement is encouraged. Although a team‘s task is taken
seriously, successful teams are able to inject humor into their interactions.

Ability to Collaborate Rather than Compete. Effective team members are genuinely interested in achieving
team goals instead of receiving individual recognition. They contribute ideas and feedback unselfishly.
They monitor team progress, including what‘s going right, what‘s going wrong, and what to do about it.
They celebrate individual and team accomplishments.

Shared Leadership. Effective teams often have no formal leader. Instead, leadership rotates to those with
the appropriate expertise as the team evolves and moves from one phase to another. Many teams operate
under a democratic approach. This approach can achieve buy-in to team decisions, boost morale, and create
fewer hurt feelings and less resentment. But in times of crisis, a strong team member may need to step up
as leader.

12. Write short notes on the followings (Any Two): (2×5=10)

a) Organizing information in reports
b) Effective presentation of information
c) Difference between formal and informal communication

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Answers:
a) Organizing information in reports

A report may be defined as formal and factual statement describing a state of affairs on what happened and
how it happened. In other words, a report is a detailed description of a problem or a situation, findings of
investigation with conclusions and recommendations. A report is produced after a study or a research work
- be it or large or small scale - has been carried out. A report should be well formed to become cohesive
and coherent. This is to say, writing a report entails organizing information in a systematic way. It includes:

i) an orderly presentation of facts

ii) close observation of facts with an investigative approach
iii) collection of information supported by evidences
iv) verifying reliability of information
v) drawing on conclusion,
vi) suggesting recommendations

b) Effective presentation of information

Every piece of communication dessiminates some kind of information – formal or informal, complete or
incomplete. The way and style of presentation of information varies with the receiver - individual, group or
public. Matter (contents) and manner (way and style) count much in an effective presentation. The
presentation of information needs to consider the following points:
i) the contents of the message (information)
ii) clear objective of presentation of the message
iii) the identification of the recipient of the information- the audience
iv) choice of appropriate channel of communication for the presentation
v) the relationship between the presenter and the audience, the level of understanding of the two, geo-
physical conditions in which the information is presented
vi) language and style of presentation: using short, simple and understandable language using simple
and impressive style
vii) application of appropriate presentation skills.

c) Difference between formal and informal communication

Formal communication, also called mainline operational communication takes place in a transparent
manner. It is hierarchical and structured and functions under certain organizational rules and regulations.
Much of the organizational communication is formal.
Official correspondence, policy plans, manuals, employee bulletins, newsletters, directive, memos, letters,
reports, proposals, etc. are examples of formal communication.

Informal communication is defined as the channel of communication which does not follow any prescribed
codes of conduct or the rules and regulations. To simplify, an informal communication could be a
discussion or simple talk between two different organizational heads, two senior managers of an
organization. Such talks and communication cannot affect the existing rules and regulations.
Both forms of communication have their advantages as well as disadvantages.

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Section –“MARKETING”

6. Read the following case carefully and answer the questions that follows: (4×2.5=10)
Bimala Giri, migrated from Dhading District, has enough knowledge about cooking varieties of
pastries, Momo and Chowmin. She survives with two small children. So she decided to open a small
pastry and tea shop in the periphery of Global College and KCMIT, Baneswor, hoping that a large
number of students may come to the shop for varieties of pastry, coffee and tea. She bought the
necessary equipments for kitchen and shop with a cash outlay of Rs. 50,000. She managed for
furniture and furnishings. She decided to name her shop as ―Hazur Ko Khaja Ghar‖. She maintained
neat and clean in the shop to satisfy the consumers. Beside it, her behaviour with the consumers was
also impressive.

The business has been operating for the last ten months. Both sales volume and value increased
satisfactorily. The major consumers are college students, who drop in for varieties of pastry, tea and
coffee. Occasionally, professors come by with their friends for pastry and a cup of tea. With the passes
of time, a large number of pedestrians also started coming to the shop for tea, coffee and pastries.
Local households and shop-keepers also come to purchase pastries over the counter. Consumers are
satisfied with her services and treatment. But many students, pedestrians and shopkeepers frequently
asked for keeping Momo and Chowmin dishes in the shop. During the vacation period, Bimala noticed
considerable drop in the sales. Though she has knowledge about cooking Momo and Chowmin, she
needs to make additional investment of about Rs. 25,000 for managing Momo and Chowmin in the
shop, for which she has to take loan from others. This money is necessary not only to purchase
necessary equipments and furniture but also needs to hire more space in the rented house.

Actually, Bimala hesitates to keep additional items like Momo and Chowmin dishes, because of
limited managerial and financial capacity. She was, to some extent, satisfied with the existing business
flow and profit margin. But if the demanded items could be added, she is confident that she would be
able to earn more money. On the other, if she avoids keeping the demanded items and insists only in
the current items, it may become difficult for her to retain the current customers and expand volume
and value of business in future.

Bimala is now in a big problem, because she does not know about the modern marketing concept and
marketing techniques; so she is searching for persons who can provide her an expert advice in
marketing field. As a marketing student, you are asked to give answers to the following questions for
the improvement of her business.

Questions:
a) Identify the target market of Bimala‘s business with reason.
b) Who are the customers of Bimala‘s shop and why?
c) What are the various needs of the customers?
d) Should Bimala keep the additional dishes in her shop as per demand of the students, pedestrians,
and shop-keepers? Or, continue the existing tea, coffee, and pastry items only? Why? Give answer
with justifiable reasons from marketing point of view.

Answers:
(Given below are the hints to the above questions. Students are expected to elaborate the hints to
arrive at a full solution)

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a) Students of Global College and KCMIT are the target market, because Bimala started her business
focusing on them.
b) Students, pedestrians, Professors, shopkeepers, local households, offices of the location are the
customers of Bimala‘s business, because they drop to the shop for the purchase and consumption of
tea, coffee, and pastries.
c) The various needs of the customers are tea, coffee, and varieties of pastries.
d) As a marketer I should suggest Bimala to add the demanded items – momo and chowmin. This is
because; marketing is a customer-oriented philosophy of business. She should address the demand of
the customers and should try to satisfy them by offering as per their demand.

7.
a) Summarize the economic and demographic environments in Nepal. 5
b) Point out the components of marketing information system and explain briefly the Marketing
Decision Support System. (2+3=5)

Answers:
a) The following Para explains the economic and demographic environments in Nepal-
Economic Environment:
Nepal is an agrarian country. Contribution of agriculture sector to the country‘s real GDP and
employment is high. Farming is still highly labour-intensive.
Recently, marketing opportunities for services sectors like computer software, insurance, banking,
education, hospitals and nursing homes have been fostering rapidly with bright future. Economically,
Nepal hopes from the SAFTA & WTO regimes.

Demographic Environment:
According to Population Census 2001, Nepal has 23.2 million people and is increasing at the rate of
2.05% annually. Both male and female occupy equal status in size. About 90% of the total population
lives in rural area. Though the Nepalese market is characterized by rural market, the marketing
activities are heavily concentrated in urban area due to the difficult topography of the country.
The demographic character of Nepal shows that the market structure of the country is diverse in
nature.

b) The components of marketing information system includes –

i. Internal Records System;
ii. Marketing Intelligence System;
iii. Marketing Information Processing System; and
iv. Marketing Information Analysis System or Marketing Decision Support System (MDSS)/

The following Para explains about MDSS:

Analytical system is a set of statistical or mathematical tools and decision models that help the
marketing managers in analyzing data gathered or supplied through the sub-systems of the MIS and
making rational decision. Analytical system helps marketers to make decisions on the problems by
telling the truth about the situations. In other words, analytical systems allow a firm to ask, "Why did
that happen?" and "What will happen if……..?" Mathematical and/or statistical tools and decision
models are used to solve several marketing problems such as media selection problems to evaluate
new product acceptance o weigh sales and pricing alternatives, and so forth. Therefore, analytical
systems are also called as "marketing decision support systems". Ultimately, the MDSS serves as a
―Data Bank‖.
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8.
a) Give the meaning of a product and explain the feature of industrial products. (2+3=5)
b) How is marketing mix controllable and tactical in nature? 5

Answers:
a) A product is both what a seller has to sell and buyer has to buy as a most important part of
marketing mix of a company. Products are the physical goods, services, events, persons, places, ideas,
information, organizations, etc. A product is anything that can be offered to a market to satisfy a need
or want. Tangible or intangible, durable or nondurable, consumer or industrial type and features
differentiate the products.
Product is the first and most important element of the marketing mix. A good product mix, brands
packaging and labeling all are very important. Products can be classified in several ways. In terms of
use products can be broadly classified in two groups namely: Consumer goods and industrial goods.
As demanded by the question only the features of industrial products of industrial products are
mentioned here:
Products that are destined to be sold primarily to use in producing other goods or rendering services or
operating a business institution are industrial products. Material and parts, capital items or suppliers
and business services related products comes under this category.
Features of industrial products are:
- Large scale purchase but fewer buyers
- Systematic and routine purchase
- Role of professional purchase procedure is important
- Customer supplier long fear relations
- Marketing is geographically concentrated
- Some are expensive, capital expenditures
- Durability, brand, direct purchase differs to product types
The above points are to be briefly explained by the students.

b) Controllable
Marketing mix is a set of product, price, place and promotion, which are used to pursue the firm‘s
marketing objectives in the target market. Marketing tools, techniques, strategies, activities, etc. are
decided by the management. So, these are controllable in spite of being flexible in nature as per the
flexibility that occurs in the marketing environment. Marketing mix consists of four components that
can separately be named as product mix, price mix, place mix and promotion mix.
Product mix Price mix Place mix Promotion mix
 Product attributes  Discounts,  Channels  Advertising
 Product variety with allowance  Channel  Sales
quality  Pricing structures promotion
 Product lines and objectives  Channel  Personal
components  Pricing policies dynamics selling
 Product mix and  Pricing methods  Channel conflict  Publicity
innovation  Pricing management  Public
 Product branding, strategies  Physical relations
packaging, labeling  Pricing terms distribution and  strategies
 Service product and conditions logistics
strategies

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The four Ps of marketing mix are tactical in nature of their uses. That means, the firm needs to use its
own techniques while implementing them for objective achievement. The decided mix is used as per
the situation of competition being tricky.
o Normal
o Intensive (national, global)
o Throat-cut

9.
a) State and explain the methods of cost-based pricing. 5
b) Draw channel levels structure for consumer market and explain them in that structure. 5

Answer:
a) Methods o f cost-based pricing
This pricing method includes mark-up pricing, target return pricing and BEP pricing.

Mark up pricing method

Mark-up price is that selling price which any manufacturer/marketer decides by expecting a certain
percentage of on sales of each item. It does so to recover costs and expected profit as soon as possible.
o MUP = Unit cost / (1 – desired profit percent)

Target return pricing method

When the firm determines price that would yield its target rate of return on investment, it is known as
target return pricing. This can be determined by
o TRP = Unit cost +(Desired profit % X Investment)/Assumed total sales

Breakeven pricing method

According to this method price in determined at that point where revenue equals total cost. This point
is called Break Even Point or BEP. The BEP can be computed in two ways i.e. In terms of units and in
terms of money value.
o BEP in units= Total fixed cost / (TRP – Variable cost per unit)
o BEP in Rs. = BEP in units X TRP

b) Channel levels structure for consumer market

Manufacturer

Agent
Retailer Whole-
saler
Whole-saler

Retailer Retailer

Consumer

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The major channel participants or components of channel structure of consumer market are
producers/manufacturers, agents, wholesalers and retailers. There are four channel levels structure
alternatives for the distribution of goods to consumer markets, ranging from a zero level to three
levels. Under zero level structure, the manufacturer may distribute the merchandise directly to
consumers by passing all marketing intermediaries. Under one level structure, the manufacturer may
use retailers to reach consumers. In two levels structure, the product may reach consumers through
wholesalers and retailers. Similarly, in three levels structure, the manufacturer may use the agents to
contact and execute the sales transaction to different categories of buyers.

10. Briefly explain any five of the followings (5×2=10)

a) Promotion objectives
b) Post purchase behavior
c) Psychological discount pricing strategy
d) Types of labels
e) High involvement purchase.
f) E-marketing
g) Importance of physical distribution system.

Answers:
a) Promotion objectives:
Promotion seeks to stimulate dormant needs of target markets. Promotion performs the major role of
communicating to the target markets. Promotional efforts within a firm include advertising, personal
selling, sales promotion, publicity and public relations. The major objectives of promotion are to
inform, persuade, remind and reassure the market about the organization and its products.
 Informing: The primary task of promotion is to inform the buyers about the product/brand, it‘s
price, availability, utilities and benefits.
 Persuading: Promotion seeks to persuade buyers to make at least one purchase decision in favor of
organization‘s product.
 Reminding: Most promotions seek to constantly remind the buyers about the brand and company
names.
 Reassuring: Promotion also plays the role of reassuring the buyers‘ on the quality and benefits of
the product. It helps in reducing buyers‘ anxiety resulting from cognitive dissonance.

b) Post purchase behavior:

A consumer has to pass through six stages to complete the buying process. Post purchase behavior is
also one major stage of the buying process. After having purchased the product, it may be possible that
the buyer may experience some restlessness in his mind. The marketer‘s job does not end when the
product is brought. After purchasing the product, the consumer will be satisfied or dissatisfied and will
engage in post purchase behavior of interest to the marketer. In this stage, consumer will compare their
expectations before purchasing the product and the product‘s perceived performance. If the product
falls short of expectations, the consumer is disappointed, if it meets expectations, the consumer is
satisfied, if it exceeds expectations, and the consumer is delighted.

c) Psychological discount pricing strategy:

Psychological discount pricing encourage purchases on emotional responses. A superficial discounting
price is charged by showing heavy discount for consumers. Making buyers feel that they are getting
high priced things at very low price. In fact, they are deceived.
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d) Types of labels: There are mainly three types of labels i.e.

Brand label: It is the simplest form of label in which only the brand name appears on it. For example,
Nike, Levi‘s, brand names are either stamped or tagged to the product.
Descriptive label: This type of label provides information on the quality or grade of the product along
with the brand name. They are mostly used in perishable and semi-perishable products such as fruits
Grade label: This is more elaborate than brand and grade labels. It contains full description of the
products and their ingredients including their uses, operation methods, precautions etc.

e) High Involvement Purchase:

The complexity of the buying process is affected by whether the product to be bought is of high
involvement or low involvement. In high involvement purchase, the consumer is prepared to invest
more time, resources and efforts. In this situation, the consumer lacks full information about the
product, the amount of money involved is large, the product has high social importance and the
product is perceived to give long-run benefits. Normally, the purchase of a car or a house is high
involvement.

f) E-Marketing: E-marketing is the newest channels for direct marketing based upon electronic
devices. E-business describes a wide variety of electronic platforms, such as the sending of purpose
orders to suppliers via electronic data interchange or extranets, the use of fax & emails to conduct
transactions, the use of ATM and smart Cards to facilitate payment and the use of Interest and online
services all these can be termed as business in a ― market space‖.
The internet today functions as an information source, an entertainment source, a communication
channel, a transaction channel, and every a distribution channel. The way telemarketing has become a
major direct marketing tool. Under direct marketing as an interactive method, especially electronic
marketing is becoming very popular and is showing explosive growth.

g) Importance of physical distribution system:

The importance of physical distribution system – Physical distribution refers to the management of
physical movement of goods from production point to consumption points for final consumption of
goods and services. The contribution of physical distribution include: -
i. It performs several distribution-related services like arrangement of transportation, storing and
warehousing, order processing, materials handling, etc; so it helps maximizing services to the
customers to supply right product at right time;
ii. It helps distributing goods more safely by adopting appropriate materials handling techniques;
iii. It attempts to use appropriate channel of distribution so it helps minimizes the distribution time and
cost; and
iv. It helps supplying necessary goods to the right market place.

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Suggested Answers of Income Tax and Value Added Tax

CAP II Examination June 2010

13. Answer the following questions with reference to Indian Income Tax Act, 1961.
a) Define the ‗Income‘. Distinguish between ‗Gross Total Income‘ and ‗Total Income‘ 3
b) Discuss the income which are exempt in the case of a political party. Are there any
conditions for claiming such exemptions? 4
c) A Ltd. is an Indian company. It carries business in Mumbai and London. The entire control
and management of A Ltd. is situated outside India. 80% of the total income of the company
is from the business in London. What is the residential status of A Ltd.? 3

Answers:
a) Generally speaking, the word ‗Income‘ covers receipts in the shape of money or money‘s
worth which arise with certain regularity or expected regularity from a definite source. As per
Section 2 (24), income includes the profits and gains, dividend, perquisites etc. which shall be
included while calculating income under the following five heads:
i. Salaries,
ii. Income from house property,
iii. Profits and Gains from Business or Profession.
iv. Capital Gains,
v. Income from other sources.

The aggregate of the incomes computed under the above five heads, after applying the clubbing
provisions and making adjustments of set off and carry forward of losses, is known as Gross
Total Income.

The total income of an assessee is computed by deducting from the gross total income, all
deductions permissible under chapter VIA of the Income Tax Act, i.e. deductions under sections
80C to 80U.

b) Section 13A of the Income Tax Act prescribes the conditions for the exemption of incomes of a
political party. The following incomes derived by a political party are not included in computing
its total income:
i. Income which is chargeable under the head ‗Income from house property‘.
ii. Income which is chargeable under the head ‗Income from other sources‘.
iii. Any income by way of voluntary contribution from any person.
iv. Any income by way of capital gains.

The exemption of the above income shall be available only when the following conditions are
satisfied:
i. The political party keeps and maintains such books of accounts and other documents as will
enable the Assessing Officer to properly deduce its income therefrom.
ii. Where the voluntary contributions from a person exceed Rs. 20,000, it keeps and maintains
a record of such contribution and the name and address of the person who has made such
contribution.
iii. The accounts of the political party are audited by a Chartered Accountant.
 Suggested Answers of IT and VAT
CAP II Examination – June 2010

iv. The treasurer of such political party or any person authorized by the political party in this
behalf must submit a report under section 29C(3) of the Representation of People Act, 1951
for the relevant financial year.

Political party for the purpose of this section means a political party registered under section 29a
of the Representation of People Act, 1951.

c) As per section 6(3), a company is said to be a resident in India in any previous year if:
i. It is and Indian company, or
ii. During the relevant previous year, the control and management of its affairs is situated in
India.

Since A Ltd. is an Indian Company, in is resident in India.

14.
a) Mr. Clinton is working in an embassy representing USA and come to Nepal on 1st Ashwin,
2065. His salary and other emoluments are paid by the country he represents. He declared
the following sources of income during the year 2065/66.
i) Salary of Rs. 2,80,000 per month.
ii) Dearness allowance Rs. 1,50,000 per month.
iii) Foreign allowance Rs. 80,000 per month.
iv) He runs a handicraft business in Nepal and earned a net profit of Rs.
1,75,000 in the income year 2065/66.
v) He was a member of Royal Golf Club of Nepal. He won a prize of Rs.
1,50,000 from the game.
However he claimed the following expenses:
i) Renewal of membership and subscription Rs. 50,000
ii) Golf Expenses Rs. 32,000
iii) Donation to a school of remote district Rs. 50,000
(School is the organization recognized as tax exempted by IRD)
iv) Tax deducted at source in Nepal Rs. 2,000

You are required to find Mr. Clinton‘s residential status and taxable income for the income
year 2065/66. 10

b) KMC Pvt. Ltd. had these depreciated balances in ‗Block B‘ of assets as on Ashadh 31,
2066:
Amount (Rs.)
Furniture and Fixtures 50,000
Computers 25,000
Other office Equipments 10,000
Total of Block B 85,000

The company on Shrawan 10, 2066 disposed of the computer for the following
considerations:
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Condition I: Sales consideration received was Rs. 100,000.

Condition II: Sales consideration received was Rs. 30,000.
Calculate the taxable gain from the disposal of Computer and balances in the Block for the
purpose of depreciation for the year 2066-67 in each of the above conditions. 5

c) Mr. Ramseh has sold a building with one ropani land at a consideration of Rs. 15,000,000 on
Chaitra 31, 2066. This building was purchased by him on Falgun 20, 2061 at a consideration of
Rs. 5,000,000 and also incurred an expenditure of Rs. 1,000,000 for extension of building.
Calculate the amount of tax to be deducted at the time of the sale of land.
Will your answer be different if Mr. Ramesh had purchased that building on Falgun 20, 2055?
5
Answers:
a)
i. Residential status of Mr. Clinton:
Mr. Clinton has lived in Nepal from 1st Ashwin 2065 to last of Ashadh, 2066 i.e 300 days
approximately (10 months x 30 days) which is more than 183 days, thus he is resident for the
income year 2065-66.

ii. Income from Employment:

Remuneration received by a foreign diplomat (representative of foreign countries) is non taxable
in Nepal but other than remuneration income earned in Nepal are taxable.

iii. Computation of Taxable income of Mr. Clinton:

Computation of Taxable income of Mr. Clinton for the Income Year 2065-66

Particulars (Rs.) (Rs.)

Income from Business:
Income from handicraft business 175,000
Assessable income from Business 175,000
Less: Allowable Deduction:
Donation to a school 8,750
Taxable Income 166,250

Taxable income of Mr. Clinton for the Income Year 2065-66 is Rs. 166,250.

Working Notes:
1. Calculation of donation allowable for deduction
Lower of the following amount:
i. Actual donation Rs. 50,000.
ii. 5% of adjustable taxable income (i.e. Rs. 175,000) Rs. 8,750.
iii. Maximum amount Rs. 100,000.
Therefore, donation allowable for deduction is Rs. 8,750.

2. It is assumed that total number of days in a month is 30.

3. TDS @ 25% will be deducted in the prize income and it will be the final withholding.

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Note: 2 marks each for Residential status and income from employment and 6 marks for
working notes and solution.

b) Calculation of Taxable Income under Condition I:

Sale proceeds 100,000

Less: Depreciated balance of the Block B 85,000
Taxable gain from the sale of computer 15,000

Balances in the Block for the purpose of depreciation for the year 2066-67:
In this case the value of assets in Block B after the disposal is treated as nil as the sales proceed is
more than the depreciated value of the Block.

Note: It is assumed that there is no absorbed addition during the year.

Calculation of Taxable Income under Condition II:

Sale proceeds 30,000

Less: Depreciated balance of the Block B 85,000
Taxable gain from the sale of computer Nil

Since the sale proceed of the Block B is lower than the depreciable balance, the taxable balance
from the disposal is nil during the year.

Balance in the Block B for the purpose of depreciation for the year 2066-67:
Balance of Block B at the beginning of the year Rs. 85,000
Less: Sale proceeds of Computer Rs. 30,000
Balance of Block for the year 2066-67 Rs. 55,000

Note: It is assumed that there is no absorbed addition during the year.

c) Calculation of Tax to be deducted at the time of Sale of Building (Section 89 Kha)

Sale proceed 15,000,000

Less: Purchase price 5,000,000
Building Extension expenses 1,000,000 6,000,000
Taxable profit 9,000,000

Tax to be deducted @ 5% of Rs. 9,000,000 Rs. 450,000

As the building was in the ownership of Mr. Ramesh for more than 5 years therefore 5% tax to be
deducted by Malpot Office at the time of sale (section 89 Kha).

If that building was purchased by Mr. Ramesh on Falgun 20, 2055 than tax shall not be deducted in
this transaction as the building was in the ownership of Mr. Ramesh for more than 10 years. In this

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case, this building will not be the non-business chargeable asset as per the definition of section 2
(da).
[ Answer should be elaborated with all the provisions. ]

15.
a) What do you mean by Income Splitting? Mention the right available to Inland Revenue
Department to prevent any reduction in tax payable as a result of the splitting of income. 5
b) From the following Income Statement of an exempt controlled resident entity, compute the
taxable income for the financial year 2066/67. 5

Income
Sales Rs. 7,50,000
Interest Income Rs. 5,000
Total Income Rs. 7,55,000

Expenditure
Cost of sales Rs. 5,00,000
Administrative Expenses Rs. 1,20,000
Interest expenses to controlling (exempt) entity Rs. 75,000
Depreciation expenses Rs. 20,000
Rs. 7,15,000
Net Profit Rs. 40,000

c) Mr. X held 500 shares of ABC Ltd., a Listed Company, of Rs. 100 each. He acquired those
shares through a stockbroker by paying Rs. 700 each, and incurred Rs. 2,800 towards broker
commission. He sold all those shares through the broker for Rs. 3,500 each with the
brokerage commission of Rs. 8,750. Assuming that Mr. X is a non-resident, compute the
gain amount and withholding tax amount. 5
d) What are the conditions that enable Inland Revenue Officer to levy interest on failure to pay
tax on due date and to comply with Act under sec. 119 and 119(ka) respectively? 5
Answers:
a) Income splitting is also a kind of Transfer Pricing. Generally income splitting technique is
indulged where the "Progressive Rates of Taxation" is in existence. Income splitting helps to
cause tax reduction where a tax payer attempts to split income with another tax payer.
- Where a taxpayer attempts to split income with another tax payer and this income
splitting is likely to cause a tax reduction, the Inland Revenue Department (IRD) is
given the right to adjust amounts to be included or deducted in calculating the income of
each persons. The duty of IRD is to prevent any reduction in tax payable as a result of
splitting of income. Sec [34(1)].

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- If a taxpayer attempts income splitting by a way of transfer of following with an intent to

reduce the total tax payable by the person either directly or indirectly:
- amounts to be derived or costs to be incurred OR
- an amount received by the transferee of an asset that is derived from the asset; or an amount
paid in owning the asset.
In deciding as aforesaid whether a person is seeking to split income, the IRD has power to consider
the market value of any payment made for transfer.

b) Computation of Taxable Income of Exempt Controlled Resident Entity for the financial year
2066/67.

Income
Sales Rs. 7,50,000
Interest Income Rs. 5,000
Total Income Rs. 755,000

Expenditure
Cost of sales Rs. 5,00,000
Administrative Expenses Rs. 1,20,000
Interest Expenses (see working note) Rs. 60,000
Depreciation Expenses Rs. 20,000 Rs. 7,00,000
Taxable Income Rs. 55,000

Working note:
Computation of allowable Interest Expenses under sec. [14(b)]
Interest Income Rs. 5,000
Profit exclusive of Interest Income/Expenses
Net Profit Rs. 40,000
Less Interest Income Rs. 5,000
Rs. 35,000
Plus Interest Expenditure Rs. 75,000
Total Profit Rs. 1,10,000
Total allowable Interest
50% of the above profit Rs. 55,000
Total allowable Interest Expenses Rs. 60,000

Excess of allowable interest expenses over actual interest expenses to controlling entity to be
carried forward to the subsequent year (Rs. 75,000- Rs. 60,000)= Rs. 15,000

c) Computation of gain on the sales of shares of ABC Ltd.

Sales (500 shares of Rs. 3,500 each) (a) Rs. 17,50,000
Less: Outgoings
500 shares at Rs. 700 each Rs. 3.50,000
Brokerage commission:
Acquisition of shares Rs. 2,800
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Sales Rs. 8,750

Total outgoing (b) Rs. 3,61,550
Gain on sale of shares (a-b) Rs. 13,88,450

Amount of withholding tax by Stock Exchange Ltd. on total gain amount is:
15 % on Rs. 13,88,450 = Rs. 2,08,267
Note: Withholding Tax @ 15 % on gain is applicable to the non resident
person.
d) In case no tax is paid on due date, the tax payer is liable to pay interest for each month and
part of a month at the standard interest rate (10% p.a) on the tax amount outstanding.
For the purpose of calculating interest payable as above, any time extension granted (u/s 98)
will be ignored.
Also, a withholding agent may not recover from a withholdee interest payable by the agent in
respect of a failure to deposit at Inland Revenue Office, the withheld amount on behalf of
withholdee (u/s 90(4)).
Except as stated otherwise, any person who fails to comply with any provisions of the
Income Tax Act 2058 and Rules made there under will be liable to a interest of not less than
Rs. 5000 and not more than Rs. 30,000 [u/s 119(ka)]

16. Answer the following questions quoting the relevant provisions of Income Tax
Act, 2058.
a) Explain briefly the tax provisions relating to loan loss provisions available to
the banks and financial institutions. 5
b) What are the matters that should be included in the assessment notice issued
by Inland Revenue Department? 5
Answers:
a) Section 59 of the Income Tax Act, 2058 deals about the special provisions applicable to the
Banking Business. A person running a banking business along with other businesses, it has to
treat the banking business as being run by a separate person. It means the accounts, activities,
transactions etc. related to the banking business should be kept separate from the same of other
business.

A banking business is allowed a deduction of a loss of loan provided by it according to the

regulation of Nepal Rastra Bank, subject to a maximum ceiling of 5% of the outstanding loan as
on the last day of the income year.

Actual expenses for a loan loss, if incurred, should be deducted from the provision outstanding
on that date. If deducted as an expense, it is not allowed for tax purpose. In case the amount of
loan loss provision is capitalized or utilized for distribution, or for payment of dividend in any
income year, up to that amount, it should be included in the taxable income of the income year.

Section 24 (3) has given an authority to IRD to accept the accounting procedures followed by
banking businesses as per the instructions given by NRB.
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b) As per the section 102 of Income Tax Act, 2058, IRO has to give notice of the assessment
under section 100(2) or section 101 to the assessee which shall include the following
information:
a. The tax payable by the tax payer for the year of assessment and the tax due to him.
b. The method of calculation of the tax liability.
c. The reason for making the amended assessment by the IRO.
d. The period within which the tax due is payable and
e. Where, when and how to appeal against the order if the taxpayer is not satisfied with
the amended assessment.

A period of 15 days should be given to the tax payer to explain and produce evidence against the
IRO‘s contention.

17.
a) ABC Export House has a credit of Rs. 200,000 in the first month representing 30% of its
total sales during that month. However, it has a credit of Rs. 600,000 representing 60% of its
total sales in the following month.
How does ABC Export House claim refund if it does not always have exports over 50% of
total sales? 5

b) A company dealing with computer parts sold the goods worth Rs. 25 lacs in the month of
Baisakh 2067. It has imported the computer parts on which input VAT has been paid as per
the cost fixed/determined by Custom Offices on CIF basis with details below:
Cost declared by importer Rs. 200,000
Revised cost fixed by Custom Officer Rs. 250,000
(based on prevailing international price)
Transportation Rs. 25,000
Insurance Rs. 5,000
Import Duty @ 6%
Besides, the credit balance up to Chaitra 2066 is Rs. 20,500. In addition, it has omitted to
adjust input tax credit on the purchase of Rs. 30,000 pertaining to the month of Chaitra
2066.
Compute the Input and Output VAT. 10

c) What are the types of accounts and records to be kept by a taxpayer under VAT Act, 2052?
What are their contents? 5

Answers:
a) In the case of given question, the exporter will not be entitled to a refund as the sales
reported in first month did not amount to 50% of its total sales. The credit of Rs. 2,00,000
will be carried forward in the following month for refund.
Since its credit amount represents 60% of the total sales in the following month, ABC
Export House is entitled to claim the full refund of Rs. 6 lac plus Rs. 2 lac from the
preceding months. [U/s 39(5) of VAT Rule]

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b) Computation of Net VAT Payable.

Credit balance up to Chaitra '066 Rs. 20,500
Input Tax (working note) Rs. 38,584
Adjustment for omitted Input tax credit Rs. 3,900
Total Input Tax to be credited (A) Rs. 62,984
Total sales in Baisakh '067 Rs. 25,00,000
Output VAT on sales of Rs. 25 lac (B) Rs. 3,25,000
Tax payable (Net output VAT) (A-B) Rs. 2,62,016
Working note:
Computation of Input VAT amount on import of computer parts.
Cost of computers Rs. 2,50,000
Transportations Rs. 25,000
Insurance Rs, 5,000
Total Rs. 2,80,000
Import duty @ 6% Rs. 16,800
Total cost for VAT purpose Rs. 2,96,800
Input VAT amount = 13% on Rs. 2,96,800
= Rs. 38,584

c) A taxpayer must keep the following accounts and records:

1. a purchase book
2. a sales book, and
3. a VAT account.
Purchase and sales books include:
1. the invoice number
2. the invoice date
3. the supplier's name and PAN/VAT in the purchase book
4. the customer's name and PAN/VAT in the sales book
5. the taxable value, and
6. the amount of VAT.
Businesses which sell both taxable and exempt goods will need to complete additional columns of
information to separate exempt sales and the purchases related to them.

18. Answer the following questions with reference to the Value Added Tax Act,
2052. (4×5=20)
a) What are the conditions for compulsory registration on VAT? Explain.
b) What are the conditions for refund of VAT to the foreign tourist? Answer
citing the provisions of the Act.
c) Mention the provisions regarding collection of tax by custom authorities.
d) Elaborate the provisions relating the market value and its determination.
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Answers:
a) As per the Section 10 (2) of the Value Added Tax Act, if any person who is dealing in the
product which is taxable as per the Act, or any person doing business with in metropolitan,
sub-metropolitan, municipality or such other area specified by the Department in hardware,
sanitary, furniture, fixture, furnishing, automobiles, motor parts, electronics, marble and color
lab operation shall apply for registration with in 30 days of starting the business.

Above provision requires person who deals in the taxable goods and does business of a
particular nature in a particular area shall have to compulsorily get registered. There is
exception to this mandatory provision in Sec 9 which provides that up to a specified threshold
of taxable transaction by a small scale business, the registration requirement is waived. Such
threshold is 20 lakh currently. Such small scale business, however can get registered
voluntarily.

b) Section 25 Ka provides for the refund of VAT to the foreign tourists. Following are the
conditions:

1. The tourist should have purchased at least 15 thousand worth of goods which are
taxable,
2. The tourist should be returning from the air route.
3. Three percent of such refund shall be deducted as service charge.

c) Section 28 of the Act has prescribed the authorities of the custom officer as per the Act to
collect the tax. Following are the provisions:

1) Unless otherwise prescribed by the Ministry of Finance, Government of Nepal, Custom

Officer will collect the tax on imports as per the Value Added Tax Act.

1 Ka) When goods produced or prepared in Nepal, after completing the customs procedures
for export or after reaching the foreign land, rejected by the party or due to any other
reason such goods are re-imported to the country with the aim to export again within 3
months, then value added tax payable at the time of returning the goods may be allowed to
be paid as deposit and when the goods is exported such deposit can be refunded. Custom
office should be providing the details to the Inland Revenue Department.

2) In case of goods being imported the custom officer can exercise the authority from this and
the prevailing Customs Act for collection of tax.

d) Section 13 reading along with the Rule 22 will clarify the provision relating the market
value and its determination.

The market value of goods or services shall be determined as the consideration in money
which the supply of these goods or services would generally be agreed on if the transaction
were made under similar circumstances between persons who are unrelated and the supply
freely offered.
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While determining the market value as per above provision, the tax officer shall determine
the market value by studying the transactions and value of other vendors registered in regard
to the transaction of the same nature.

In cases where the market value of any goods or services cannot be determined as set forth as
prescribed in the Act, the Director General shall determine the value on the basis also of the
information received in that regard by him from the registered persons of the same nature.

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