CAP-III RTPs June2023 Group-I
CAP-III RTPs June2023 Group-I
CAP-III RTPs June2023 Group-I
(CAP-III)
June 2023
The Revision Test Papers are prepared by the institute with a view to assist the students in their study.
The suggested answers given here are indicative and not exhaustive. Students are expected to apply their
knowledge and write the answer in the examinations taking the suggested answers as guide. Due care
has been taken to prepare the revision test paper. In case students need any clarification, creative
feedbacks or suggestions for the further improvement on the material, or any error or omission on the
material, they may report to the email of the Institute.
Contents
Paper 1 - Advanced Financial Reporting ................................................................................ 3
Paper 2 - Advanced Financial Management ......................................................................... 39
Paper 3 - Advanced Audit & Assurance ............................................................................... 71
Paper 4 - Corporate Laws ...................................................................................................... 92
2
Paper-1
Advanced Financial Reporting
3
Q. No. 1 Consolidated Financial Statements
Kanchenjunga Ltd. has investment in Koshi Ltd., Mechi Ltd. and Api Ltd. The Statements of
financial position of Kanchenjunga, Koshi and Mechi as at 32 Ashadh 2079 are as under:
Rs.
000"
Assets Kanchenjunga Koshi Mechi
Non-Current Assets
Property, Plant and Equipment 53,100 60,500 63,250
Investment in Subsidiaries
Koshi 57,000
Mechi 46,400
Investment in Api 3,400
Financial assets 9,500 - -
169,400 60,500 63,250
Current Assets 44,250 39,100 11,200
4
On 1 Shrawan 2078, Kanchenjunga took control of Mechi Ltd., by further acquiring 45%
interest for cash consideration of Rs. 25,000,000 and included this amount in carrying amount
of investment in Mechi Ltd.
On 1 Shrawan 2078, the retained earnings and other components of equity of Mechi Ltd. were
Rs. 14,650,000 and 2,950,000 respectively and the fair value of identifiable net assets was Rs.
53,100,000. The difference between the carrying amounts and the fair values was in relation
to plant with a remaining useful life of 5 years.
The share prices of Kanchenjunga and Mechi were Rs. 500 and Rs. 160 per share respectively
on 1 Shrawan 2078. The fair value of original 40% holding and the fair value of non-
controlling interest should both be estimated using the market value of shares.
c. Kanchenjunga has been holding 25% equity shares in Api Ltd. since couple of years. Api Ltd.
made profits during the FY 2078/79 of Rs. 1,000,000, which can be assumed to have accrued
evenly. Api does not have any other comprehensive income. On Poush end 2078,
Kanchenjunga sold 10% equity interest for cash of Rs. 2,100,000. Kanchenjunga was unsure
about accounting of this disposal and so has deducted the proceeds from the carrying amount
of the investment at 1 Shrawan 2078 which was Rs. 5,500,000.
The fair value of the remaining 15% shareholding was estimated to be Rs. 3,250,000 at Poush
end, 2078 and Rs. 3,350,000 at 32 Ashadh, 2079. Kanchenjunga no longer exercises
significant influences and has designated the remaining shareholding as fair value through
other comprehensive income.
d. There has been no impairment of goodwill.
e. Kanchenjunga operates a defined benefit pension scheme. On 32 Ashadh, 2079, the company
announced that it was to close down a business division and agreed to pay each of its 150
staffs a cash payment of Rs. 2,500 to compensate them for loss of pension arising from wage
inflation. It is estimated that the closure will reduce the present value of the pension obligation
by Rs. 290,000. Kanchenjunga is unsure of how to deal with such settlement and curtailment
and has not yet recorded anything in its financial statements.
Required:
Prepare the consolidated statement of financial position of Kanchenjunga Group as at 32 Ashadh,
2079 in accordance with Nepal Financial Reporting Standards.
5
Following information are also relevant:
31 Dec, 2018 31 Dec, 2019 31 Dec, 2020
Number of employees Left 50 45 30
Estimated No. of employees
expected to leave in next year(s) 80 35 0
On 31st December 2021, 650 employees exercised the option.
Required:
Compute the amount of expenses to be recognized by the company for the year 2018, 2019 and
2020 and also give extract of ESOP outstanding Account as appeared in in the books of account
of Info Developers ltd. in the year 2021.
Q. No. 3 NFRS 5 Non-Current Assets Held for Sale and Discontinued Operations
Rohit Ltd and Kohli Ltd are engaged in similar nature of business. Due to this, on 01.01.2022,
both of them mutually agreed that it would be in the best interest of both of them that Kohli Ltd
be acquired by Rohit Ltd. 1 Jan 2022. The acquired entity, Kohli Ltd, however is itself
a holding entity with two wholly owned subsidiaries, Rahul and Dhawan.
Dhawan is however, acquired exclusively with a view to resale and meets the criteria for
classification as held for sale. Rohit Ltd.’s year end is 32 Dec 2022.
On 1 Jan 2022 the following information is relevant:
❖ The identifiable liabilities of Dhawan have a fair value of Rs.10 Lakhs
❖ The acquired assets of Dhawan have a fair value of Rs.20 Lakhs
❖ The expected costs of selling Dhawan are 1 Lakh
❖ On 32 Dec 2022, the assets of Dhawan have a fair value of Rs. 15 Lakhs.
❖ The liabilities have a fair value of Rs. 6 Lakhs and the selling costs still remain at 1 Lakh.
Discuss how Dhawan Ltd will be treated in the Rohit Group financial statements on acquisition
and at 32 Dec 2022.
6
The management wants to know according to NFRS 8, which segments need to be reported?
7
of Rs. 100,000. If the investor did not convert to shares they would have been redeemed at par.
At maturity all of the bonds were converted into 2.5 million ordinary shares of $1 of Pawan.
No bonds could be converted before that date. The directors are uncertain how the bonds should
have been accounted for up to the date of the conversion on 31 Dec 20X8 and have been told
that the impact of the issue costs is to increase the effective interest rate to 9.38%.
8
Q. No. 10 NAS 2 Inventories
Bhandari Retail Shop Pvt. Ltd. is engaged in retail business of consumable goods. The company
has obtained VAT registration to carry out its retail business. As on Ashadh end 2079, the company
holds 1,000 kg goods as inventories. The following expenditure was incurred by the company in
relation to the inventories of goods:
Particulars Rs. Per kg
Cost of per kg of Goods 500
Less: Trade discount received 10
Add: VAT paid 63.7
Billing price by the vendor 553.7
Transportation cost per kg 20
You are asked to calculate the cost of per kg of goods to the company and its valuation when the
net realizable value is Rs. 580.
9
Compounding happens half-yearly. The normal interest rate for 6 months period is 10% per
annum, while the effective interest rate for 12 months period is based on the following data:
At 1 Shrawan, 2078, the company made the following estimates based on market prices at that
date:
Particulars %
Interest and Dividend Income after tax payable by the fund 9.25
Add: Realized and Unrealized Gains on Plan Assets (after tax) 2.00
Less: Administration Cost (1.00)
Expected Rate of Return 10.25
Determine actual return and expected return on plan asset. Also compute amount to be recognized
in ‘Other Comprehensive Income’ in this case.
10
Discuss the correct treatment of the above transaction in France Ltd.'s financial statements for
the year ended 30 June 2022.
b. At the end of FY 2078/79, there are three shareholders in FinTax Ltd. The finance director has
60%, and the operation director has 30% stake in the company. The third owner is a passive
investor who does not participate in the management and operation of the company. All
ordinary shares carry equal voting rights. Further, the spouse of the finance director is serving
as the sales director of the company and their son also works there as an intern and receives a
salary of Rs. 700,000 p.a. which is normal compensation package prevailing in the industry.
The finance director and his wife have set up an investment company, InvoMax Ltd. They
jointly own InvoMax and their shares in InvoMax will eventually be transferred to their son
when he has finished the internship with FinTax.
Further, on 1 Chaitra 2078, FinTax obtained a loan of Rs. 20 Lakhs from a local bank, by
keeping the private property of finance director as a collateral.
Required:
Advise FinTax Ltd. for the identification and disclosure of the company’s related parties in
preparing its separate financial statements for the FY 2078/79.
Rs. in Lakhs
Pre-tax Cash Post-tax Cash
Financial Year flows flows
FY 2079/80 16 10
FY 2080/81 14 10
FY 2081/82 10 6
FY 2082/83 6 3
FY 2083/84 26 20
The pre-tax discount rate for the SBU is 12% and the post-tax discount rate is 9%. Grow Ltd. has
no plans to expand the capacity of the SBU and believes that a reorganization would bring cost
savings but, as yet, no plan has been approved.
Give advice to the CFO whether the SBU’s value is impaired and suggest how it should be
reflected in the financial statements for the year ended on 32 Ashadh, 2079 in accordance with
relevant Nepal Financial Reporting Standards.
b. NB Ltd has two machineries in its books. The carrying value of first machinery after 2 years of
use is Rs. 30 lakhs with remaining life of 3 years. The machinery if sold now would generate Rs.
25 lakhs cash flows net of all the selling costs. However, due to accidents that occur in the factory
in the same day, the company now expects the machinery to generate less cash flow than
anticipated for the rest of its useful life. The estimated cash flow for the next year would be Rs. 5
lakhs with an estimated growth rate of 3% pa thereafter for the remaining term.
The expected growth rate for the following years is estimated to be 3% pa with the discount rate
of 10%.
The second machinery was acquired as on 01.04.2075 for 18 lakhs which had estimated useful life
of 5 years. On 01.04.2078, the carrying value of the machinery was reassessed to Rs. 12.4 lakhs
and the gain arising out of revaluation was credited to revaluation reserve. However, during the
year 2078.79, due to the change in the market conditions, the recoverable amount was ascertained
to be only Rs. 2.6 lakhs as on Ashadh end 2079. NB Ltd had followed the policy of writing down
the revaluation gain by the increased charges of depreciation resulting from revaluation.
Both the fixed assets are subjected to Straight line depreciation (SLM) with nil residual value each.
14
Answers:
Q. No. 1 Consolidated Financial Statements
Kanchenjunga Group
Statement of Financial Position
As at 32 Ashadh 2079
Rs. '000
Assets Amount
Non-Current Assets
Goodwill 3,950
Property, Plant and Equipment 179,050
[53,100+60,500+63,250+1,800+500-100]
Financial assets 12,850
[9,500+3,350]
195,850
Current Assets 94,550
Total 290,400
Equity and Liabilities
Equity Fund
Equity Share Capital (Rs. 100 per share) 82,500
Retained Earnings 66,072.50
Other Components of Equity 7,115
155,687.50
Non-Controlling Interest 34,877.50
Non-Current Liabilities
Term Loan 71,950
Defined Benefit Obligation 2,960
Current Liabilities 24,925
Total 290,400
15
\Working Notes:
Associates (25%)
Associates (40%)
Koshi Ltd. Poush end, 2078
1 Shrawan, 2078
Mechi Ltd.
000"
Particulars At Acquisition Date At Reporting Date
Equity Share capital 35,000 35,000
Retained Earnings 14,650 18,200
Other Components of Equity 2,950 2,950
Fair Value adjustment-Plant (Bal. Fig.) 500 500
Additional Depreciation on Plant (500/5) (100)
Total 53,100 56,550
Increase in Net assets 3,450
16
Working Note 3: Goodwill Calculation
000"
Koshi Ltd. Mechi Ltd.
Cash consideration 57,000 25,000
Fair value of Existing Holding* 22,400
Fair Value of Non-controlling Interest** 24,250 8,400
Working Note 4: Gain (loss) on existing holding (40%) at Mechi while acquiring control
000"
Amount
Cost of investment 21,000
Share in increase in Net Assets 400
(14650+2950+35000-51600)*0.4
Carrying amount as on 2078.04.01 21,400
Fair Value of Existing Holding 22,400
Gain 1,000
This amount of gain should be debited to investment in Mechi Ltd and credited to Profit or loss
account at the time of acquiring control over Mechi Ltd.
17
Working Note 6: Non-controlling Interest
000"
Koshi Ltd. Mechi Ltd.
Fair Value of NCI at Acquisition date 24,250 8,400
Share in Post-acquisition increment in net assets 1,710 517.50
[5700*30%]
[3450*15%]
25,960 8,917.50
Total NCI 34,877.50
18
Gain on Fair value of Investment in Api 100
Total 7,115.00
Year 2019
Under Original Arrangement [(750-45-35)*130*30*2/3] 1,742,000 871,000
Modification [(750-45-35)*130*(28-24)*1/2] 174,200 174,200
Total 1,916,200 1,045,200
Year 2020
Under Original Arrangement [(705-30)*130*30*3/3] 2,632,500 890,500
Modification [(705-30)*130*4*2/2] 351,000 176,800
Total 2,983,500 1,067,300
19
Q. No. 3 NFRS 5 Non-Current Assets Held for Sale and Discontinued Operations
On acquisition, the assets and liabilities of Dhawan are measured at fair value less costs to sell in
accordance with IFRS 5:
Particulars Rs. In Lakhs
Assets 20
less: Selling Cost (1)
19
Liabilities (10)
Net Fair Value less cost to sell 9
At the reporting date, the assets and liabilities of Dhawan are remeasured to update the fair value
less cost to sell.
Particulars Rs. In Lakhs
Assets 15
less: Selling Cost (1)
14
Liabilities (6)
Net Fair Value less cost to sell 8
The fair value less cost to sell has decreased from Rs. 9 Lakhs on 1 Jan to 8 Lakhs on 32 Dec. This
1 lakh reduction in the fair value must be presented in the consolidated statement of profit or loss
as a part of the single line item entitled “Discontinued operations”. Also included in this line is the
post-tax profit or loss earned/incurred by Dhawan in the Jan-Dec 2022 period.
The assets and liabilities of Dhawan must be disclosed separately on the face of the statement of
financial position. Dhawan’s assets will appear below the subtotal for the Rohit group’s current
assets:
Non-current assets classified as held for sale Rs. 14 Lakhs.
Dhawan’s liabilities will appear below the subtotal for the Rohit group’s current liabilities:
Liabilities directly associated with non-current assets classified as held for sale Rs. 6 Lakhs.
No Other disclosure is required.
20
Pradesh 5 No No No No
Pradesh 6 No No No No
Pradesh 7 No No No No
** From Working Notes below
Based on the 10% tests, Pradesh 1, 3 and 4 are reportable. However, we must check whether they
comprise at least 75% of the company's external revenue.
Step 2: The 75% Test: ‘000
External
Segments revenue
Pradesh 1 250
Pradesh 3 200
Pradesh 4 270
Total 720
The external revenue of reportable segments is 83.14% (720/866) of total external revenue. The
75% test is met and no other segments need to be reported.
Hence, the reportable segments are Pradesh 1, 3 and 4.
Working Notes (All figures in ‘000)
W. No. 1 10% of total Sales
10% of 15,35,000 153.5
Hence, all the segments having total sales above 153.50 thousand are reportable
W. No. 2 10% of result
10% of profit-making segments
10% of (100+50+130+15+10) 30.5
10% of profit-making segments
10% of (30+20) 5
Therefore, all the segments making profit or loss greater than 30.5 thousand are
reportable.
W. No. 3 10% of Total Assets
10% of 10.6 million 1,060
22
substance of the contractual arrangement and the definitions of a financial liability and an equity
instrument.
One of the most common types of compound instrument, as here, is convertible debt. This creates
a primary financial liability of the issuer and grants an option to the holder of the instrument to
convert it into an equity instrument (usually ordinary shares) of the issuer. This is the economic
equivalent of the issue of conventional debt plus a warrant to acquire shares in the future.
Although in theory there are several possible ways of calculating the split, the following method
is recommended:
(1) Calculate the value for the liability component.
(2) Deduct this from the instrument as a whole to leave a residual value for the equity component.
The reasoning behind this approach is that an entity's equity is its residual interest in its assets
amount after deducting all its liabilities.
The sum of the carrying amounts assigned to liability and equity will always be equal to the
carrying amount that would be ascribed to the instrument as a whole.
The equity component is not re-measured. However, the liability component is measured at
amortized cost using an effective interest rate (here 9.38%).
It is important to note that the issue costs (here $m) are allocated in proportion to the value of the
liability and equity components when the initial split is calculated.
Step 1: Calculate Liability Element
* A 9% discount rate is used, which is the market rate for similar bonds without the conversion
rights:
Present value of interest at end of: Rs'000
Year 1 (31 Dec 20X6) (Rs.10m × 6%) × 0.9174 550
Year 2 (31 Dec 20X7) (Rs.10m × 6%) × 0.8417 505
Year 3 (31 Dec 20X8) (Rs.10m × (Rs.10m × 6%)) × 0.7722 8,185
Total liability component 9,241
Total equity element 759
Proceeds of issue 10,000
23
Cr. Liability - 9,241
Cr. Equity - 759
Rs'000 Rs'000
Dr. Liability 92 -
Dr. Equity 8 -
Cr. Cash - 100
25
Q. No. 9 NFRS 16 Leases
When the payments are made at the end of the year:
At the commencement date, a lessee shall measure the lease liability at the present value of the
lease payments that are not paid at that date. The lease payments shall be discounted using the
interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily
determined, the lessee shall use the lessee’s incremental borrowing rate. (Para 26 of NFRS 16:
Leases) Hence, Lumbini Ltd should discount the cash flows associated with the lease with the
incremental borrowing rate i.e. 8.5%.
The carrying amount of the right-of-use-asset at the commencement date would be Rs.
13,42,269.61 (Working note 1) (Rs. 13,12,269.61 + Rs.30,000 initial direct costs) and
consequently the annual depreciation charge will be Rs. 13,42,26.96 (Rs. 13,42,269.61 x 1/10).
The lease liability will be measured using amortized cost principles.
Working Note 1.
Year Cash flows PVIF @8.5% PV
1 200,000.00 0.9217 184,331.80
2 200,000.00 0.8495 169,891.06
3 200,000.00 0.7829 156,581.62
4 200,000.00 0.7216 144,314.86
5 200,000.00 0.6650 133,009.08
6 200,000.00 0.6129 122,589.02
7 200,000.00 0.5649 112,985.27
8 200,000.00 0.5207 104,133.89
9 200,000.00 0.4799 95,975.94
10 200,000.00 0.4423 88,457.08
Present value 1,312,269.61
Working Note 2:
Year Balance b/fwd Finance cost (8.5%) Payment Balance c/fwd
1 13,42,269.61 114,092.92 (200,000) 12,56,362.53
2 12,56,362.53 106,790.81 (200,000) 11,63,153.34
At the end of year one, the carrying amount of the right-of-use-asset will be 12,08,042.65 (Rs.
13,42,269.61 less Rs. 13,42,26.96 depreciation).
The interest cost of Rs. 114,092.92 will be taken to the statement of profit or loss as a finance cost.
The total lease liability at the end of year one will be Rs. 12,56,362.53. As the lease is being paid
off over 10 years, some of this liability will be paid off within a year and should therefore be
classed as a current liability.
Hence Non-Current liability will be Rs. 11,63,153.34 and Current Liability will be Rs. 93,209.19
(Rs. 12,56,362.53 – Rs. 11,63,153.34)
26
Where payment are made in advance:
Where payment are made in advance, the carrying amount of the right-of-use-asset at the
commencement date would be Rs. 1,453,812.53 (Working note 3) (Rs. 1,423,812.53 + Rs.30,000
initial direct costs) and consequently the annual depreciation charge will be Rs. 1,453,81.25 (Rs.
1,453,812.53 x 1/10). At the end of year one, the carrying amount of the right-of-use-asset will be
Rs.13,08,431.28 (Rs. 1,453,812.53 less Rs. 1,453,81.25 depreciation).
The initial lease payment of Rs. 200,000 would actually be included as part of the cost of the right-
of-use asset rather than the lease liability. This is because the cost of the right-of-use asset should
include the initial measurement of the lease liability plus any lease payments made at or before the
commencement date.
The total lease liability at the end of year one will be Rs. 13,27,836.59.(Working note 4) Where
payments are made in advance, the non-current liability would be Rs. 12,23,702.70 and current
liability would be Rs. 104,133.89 (Rs. 13,27,836.59 - 12,23,702.70)
Working Note 3.
Year Cash flows PVIF @8.5% PV
1 200,000.00 1.0000 200,000.00
2 200,000.00 0.9217 184,331.80
3 200,000.00 0.8495 169,891.06
4 200,000.00 0.7829 156,581.62
5 200,000.00 0.7216 144,314.86
6 200,000.00 0.6650 133,009.08
7 200,000.00 0.6129 122,589.02
8 200,000.00 0.5649 112,985.27
9 200,000.00 0.5207 104,133.89
10 200,000.00 0.4799 95,975.94
Present value 1,423,812.53
Working Note 4.
Year Balance b/fwd Payment Subtotal Finance cost (8.5%) Balance c/fwd
1 1,423,812.53 (200,000) 12,23,812.53 104,024.06 13,27,836.59
2 13,27,836.59 (200,000) 11,27,836.59 95,866.11 12,23,702.70
27
Computation table for cost per kg of goods purchased:
Particulars Rs. Per kg
Normal price per kg of goods 500
Less: Trade discount (10)
Cost to the Company 490
Add: Transportation cost to the Company 20
Cost of purchase per kg** 510
** As the company is registered with VAT, the amount of VAT paid at the time of purchase will
be netted off against the VAT amount that will be collected from the buyer and hence the VAT
paid will not form part of cost of goods.
Hence, the inventory of goods should be valued at cost i.e. Rs. 510 per kg.
28
Less: Contribution received during the year (490,000)
Add: Benefits paid during the year 190,000
Actual Return on Plan Assets 200,000
4. Total amount to be capitalized for building and total cost of the buildings:
Cost of building (20000+157000+275000+76000) = Rs. 528,000.00
Amount of interest = Rs. 35,727.27
Total cost of both buildings = Rs. 563,727.27
29
Q. No. 14 NAS 24 Related Party Disclosure
a. A finance lease is a lease where the risks and rewards of ownership are transferred from lessor
to lessee. This lease between France Ltd and Brazil Ltd is only for a fraction of the asset’s
remaining useful life and the lease payments are insignificant. The lease is therefore an operating
lease. France Ltd should recognize lease income on a straight line basis over the lease term.
Therefore, Rs. 12,500 (Rs. 25,000 × 6/12) should be recognized in the current year’s statement of
profit or loss, as well as a corresponding entry to accrued income on the statement of financial
position.
A related party transaction is defined by NAS 24 as a transfer of resources, services or obligations
between a reporting entity and a related party. An entity is related to the reporting entity if they
are under joint control. An entity must disclose if it has entered into any transactions with a related
party.
France Ltd and Brazil Ltd are under joint control of Argentina Ltd, so this means that they are
related parties. Disclosure is required of all transactions between France Ltd and Brazil Ltd during
the financial period.
France Ltd must disclose details of the leasing transaction and the income of Rs. 12,500 from
Brazil Ltd during the year. Disclosures that related party transactions were made on terms
equivalent to an arm’s length transaction can only be made if they can be substantiated. The lease
rentals are only 10% of normal market rate meaning that this disclosure cannot be made.
b. NAS 24 Related Party Disclosures requires an entity to identify and disclose facts related to
existence of related parties and transactions and outstanding balances with them in its financial
statements in order to draw the attention of users of financial statements on the possible impact
that may have on the financial performance and position of the entity due to such relationship.
The standard further states that a person or a close family member of such person is related to a
reporting entity if that person:
➢ has control or joint control over the reporting entity;
➢ has significant influence over the reporting entity; or
➢ is a member of the key management personnel of the reporting entity or of a parent of
the reporting entity.
In case of FinTax, the finance director is a related party, as he owns more than half of the voting
power (60%). In the absence of evidence to the contrary, he controls FinTax and is a member of
the key management personnel.
The sales director is also a related party of FinTax as she is a member of the key management
personnel and a close family member (spouse) of a finance director. Their son being a close family
member also meets the criteria for being a related party of the company.
The operation director is also a related party as he owns more than 20% of the voting right in the
company. In the absence of evidence to the contrary, the operation director has significant
influence over FinTax and is a member of key management personnel.
Further, an entity is related to a reporting entity if the entity is controlled or jointly controlled by a
person identified as a related party. Considering this criterion, it can be concluded that InvoMax
Ltd. is a related party of FinTax.
30
In the absence of evidence to the contrary, the third owner of the company is not a related party.
The person is a passive investor who does not appear to exert significant influence over the FinTax.
The loan from the bank, which has been secured through the private property of finance director,
shall be disclosed in the Financial Statements of FinTax, by detailing the facts in Notes that the
loan has been obtained by keeping the personal property of finance director as a collateral.
Working Notes
1. Computation of theoretical ex-rights fair value per share
31
Q. No. 16 NAS 36 Impairment of Assets
a. NAS 36 Impairment of Assets requires that assets be carried at no more than their recoverable
amount. Therefore, entities should test all assets within the scope of the standard if there is
potential impairment when indicators of impairment exist. If fair value less cost to sell or value
in use is more than carrying amount, the asset is not impaired. It further says that in measuring
value in use, the discount rate used should be the pre-tax rate which reflects current market
assessments of the time value of money and the risks specific to the asset. The discount rate
should not reflect risks which future cash flows have been adjusted and should equal the rate of
return which investors would require if they were to choose an investment which would
generate cash flows equivalent to those expected from the asset. Therefore, pre-tax cash flows
and pre-tax discount rates should be used to calculate value in use. Discounting post-tax cash
flows with a post-tax discount rate could give the same result in any entity were it not for any
temporary difference and/or tax losses which might exist.
Rs. in Lakhs
Financial Year Pre-tax Cash flows DF@12% Discounted cash flows
FY 2079/80 16 0.8929 14.29
FY 2080/81 14 0.7972 11.16
FY 2081/82 10 0.7118 7.12
FY 2082/83 6 0.6355 3.81
FY 2083/84 26 0.5674 14.75
Value in Use 51.13
The SBU is impaired by the amount by which its carrying amount exceeds its recoverable
amount which is the higher of an asset’s fair value less cost to sell and its value in use. The fair
value less cost to sell of the SBU is:
Rs. in Lakhs
Assets Fair Value Cost to sell FV less Cost to sell
Property, Plant and Equipment 20 2 18
Other Assets 34 6 28
SBU's Fair value less cost to sell 46
Therefore, recoverable amount of the SBU is Rs. 51.13 Lakhs.
Impairment loss of SBU = Carrying amount – Recoverable amount
= 64 – 51.13
= Rs. 12.87 lakhs
Now, Grow Ltd. has to allocate this amount, first to the goodwill and then to other remaining
assets on pro rata basis based on their carrying amount provided that their individual value
should not be less than fair value less cost to sell.
Allocation of Impairment loss:
Rs. in Lakhs
Allocation of Value after
Assets Carrying Amount Impairment Loss Impairment
Goodwill 6 6 0.00
Property, Plant and Equipment 20 2.37 17.63
Other Assets 38 4.50 33.50
32
Total 64 12.87 51.13
Since carrying amount of an asset cannot be reduced below its fair value less cost to sell,
allocation of impairment loss as shown in above table shall be adjusted for property, plant and
equipment and other assets by Rs. 0.37 lakhs (Rs. 18 lakhs – Rs. 17.63 Lakhs). So, impairment
loss on property, plant and equipment should be reduced by Rs. 0.37 lakhs and that of other
assets should be increased by such amount. Hence, final allocation of impairment loss and
carrying amount of assets shall be as under:
Rs. in Lakhs
Allocation of Value after
Assets Carrying Amount Impairment Loss Impairment
Goodwill 6 6 0.00
Property, Plant and Equipment 20 2.00 18.00
Other Assets 38 4.87 33.13
Total 64 12.87 51.13
The amount of impairment loss Rs. 12.87 lakhs shall be shown under Statement of Profit or loss
of the Grow Ltd.
b. NAS 36 prescribes the procedures that an entity should apply to ensure that its assets are carried
at no more than their recoverable amount. An asset is carried at more than its recoverable amount
if its carrying amount exceeds the amount to be recovered through use or sale of the asset. If this
is the case, the asset is described as impaired and the Standard requires the entity to recognize an
impairment loss. The Standard also specifies when an entity should reverse an impairment loss
and prescribes disclosures.
To ascertain whether the asset is impaired, the company should firstly calculate the value in use of
the asset in order to determine the higher amount among the value in use and fair value less cost
to sell.
Calculation of value in use of the first machinery:
Amount in Lakhs
Year Future cash flows PV @ 10% Discounted Cash flows
1 9.00 0.9091 8.18
2 9.27 0.8264 7.66
3 9.54 0.7513 7.17
Total 23.02
The impairment loss would be calculated by comparing the carrying value (Rs. 30 lakhs) with the
higher of value in use (Rs. 23.02 lakhs) and net selling price (Rs. 25 Lakhs)
Thus the impairment loss would be (Rs. 30 Lakhs - Rs. 25 Lakhs = Rs. 5 lakhs) and the new
carrying value would be Rs. 25 Lakhs.
For the second machinery:
Amount in Lakhs
Amount
Particulars (Rs.)
Cost of the machine as on 01.04.2075 18
33
Depreciation for 3 years i.e. up to 01.04.2078 (18/5)*3 Years 10.8
Carrying amount as on 01.04.2078 7.2
Add: Upward revaluation (Credited to revaluation reserve) (12.5-7.2) 5.3
Revaluated amount as on 01.04.2078 12.5
Less: Depreciation for 1 year (12.5/2)*1 6.25
Carrying amount as on Ashadh End 2079 6.25
Less: Recoverable amount 2.6
Impairment loss 3.65
Less: Balance in revaluation reserve as on Ashadh End 2079
Balance in revaluation reserve as on 01.04.2078 less amount equal to
additional depreciation transferred from revaluation reserve for 2078.79 i.e. -2.65
[5.3 - (5.3/2)*1] 2.65
Impairment loss to be debited to profit and loss account 1
34
Working Notes:
Cost of trademark (Rs.) 5,000,000
Expected useful life (Years) 10
Amortization Expenses per year (Rs.) 500,000
Rs. '000
Year 2017 2018 2019 2020 2021
Employee Cost 975 1,140 1,260 1,476 1,680
Value Added 2,280 2,700 3,150 3,600 4,200
Percentage 42.76% 42.22% 40.00% 41.00% 40.00%
Target Index = 40%
Value Added Statement for 2022
Rs. "000
Particulars Amount Amount
Sales 10,950
Less: Cost of bought in goods and
services
Cost of Materials 3,750
Production Expenses 1,050
Administrative Expenses 450
Sales Expenses 300 (5,550)
Value Added 5,400
35
Employee Cost
Wages 1,050
Production staff salaries 300
Administrative salaries 450
Sales Department's Salaries 90
Total Employee Cost 1,890
Bonus Calculation:
Employee cost as per target index 2,160
[5400*40%]
Actual Cost 1,890
Saving in employee cost 270
Employee Share 180
[270*2/3]
i.e. Rs. 180,000.00
36
Several factors have contributed in varying degrees to the lack of effectiveness of public spending
in Nepal. The institutional factors played major role in the over-programming (having too many
programs in scarce resources) of the budget, its lack of focus and prioritization and implementation
problems. The lacks of ownership of projects/ programs at various levels and the absence of
accountability, also undermined the quality and effectiveness of public spending. Managing the
national budget became increasingly difficult for Government of Nepal to further their objectives
of poverty alleviation.
Public Expenditure Management is one of the key activities of any government in the world. There
is a growing concern to make PFM system predictable, transparent and accountable anywhere in
the world. PFM in general incorporates a credible planning system, management of government
revenues, budget execution, expenditure management, debt management, reimbursement,
procurement and other important aspects of financial management such as accounting, recording,
financial reporting and auditing and external scrutiny of the financial transactions. Improving
governance and enhancing accountability are considered as the critical agenda of the Government
of Nepal in the endeavour of institutionalizing good governance practices in the country. Hence,
strengthening Public Financial Management has been accepted as one of the key elements of the
GoN’s strategy for improving the overall governance, optimizing outputs from public resources
and ensuring inclusive and broad-based development.
Poor planning, ever increasing indiscipline in budget execution, ineffective expenditure control
and lack of transparency mainly in public procurement pose significant fiduciary risks to almost
all development projects both at centre and local level. The GoN’s recent initiatives such as
Financial Administration Reform Program, Strengthening PFM Project, Government Financial
Statistics (GFS) based new codes and classification of revenues and expenditures, implementation
of Treasury Single Account (TSA) system, strategy to implement International Accounting and
Reporting Standards (NAPSAS), Public Expenditure and Financial Accountability (PEFA)
initiative and other capacity building programs for PFM have resulted some positive impacts in
strengthening PFM system in general and financial good governance in particular in Nepal.
38
Paper-2
Advanced Financial Management
39
The Financial System
Question No. 1
Describe basic functions of financial system.
Financial Intermediaries
Question No. 2
Explain economic functions of secondary markets.
Question No. 3
What are rigidities in Nepalese Money Market?
Question No. 4
Sagarmatha International Limited (SIL) currently has Rs. 2,000 million of corporate bonds. The
average maturity of SIL's corporate bonds is 18 years. SIL currently has 'AA' credit rating.
Following information regarding quoted credit spread for corporates in the concerned sector are
as follows:
Rating 1 year 2 years 3 years 5 years 7 years 10 years 30 years
AAA 18 24 28 33 43 57 79
AA 28 37 43 55 63 75 103
A 53 71 77 91 96 103 137
BBB 67 113 133 153 161 169 207
BB 243 278 290 313 320 337 384
Note: The table above is quoted in basis points where 1% = 100 basis points
The current yield on government bonds is 3.75% for all bond maturities. The current market return
on the equity market portfolio is 6.85% and the corporate tax rate is expected to be 29% for the
foreseeable future.
Required:
Estimate the cost of cost of debt using credit rating tables.
Capital Markets
Question No. 5
Neptune Chemicals is a paint manufacturing company listed on the Stock Exchange, whose
earnings and capital structures are given below:
No. of shares issued 10 million
Current share price (Rs.) 75
Corporate debentures (Rs. million ) 3,000
Debenture interest rate 12%
Corporate tax rate 15%
40
The CEO of Neptune Chemicals has sold the company's controlling stake (51%) to a high net
worth businessman at Rs. 75 per share. He continues to hold 15% of the equity and enters into a
contract to be its CEO for the next 3 years. In an attempt to improve financial performance, recently
the company made a successful rights issue of 4:5 at Rs. 50 per share to infuse funds, and the entire
proceeds had been used to retire the debt. The company offered a redundancy package to some of
its workforce and 1,000 workers accepted the compensation package of 6 months’ salary (average
worker salary is Rs. 35,000 per month). The company reduces its working capital by going for a
sub-contractor model; thereby the company would increase its operating profit to Rs. 1.5 billion
(before the compensation costs). Post rights shares are trading at Rs. 65 per share and Neptune
Chemicals declares a 60% dividend.
Required:
(i) Determine the new capital structure of Neptune Chemicals immediately after the rights issue.
(ii) What would be the dividend yield of the high net worth investor?
(iii) Assuming the dividend growth is 5%, and the cost of equity is 20%, calculate the share price
of Neptune Chemicals using Gordon's dividend growth model.
Question No. 6
The following data relate to Beta Ltd.'s share price:
Current price per share Rs. 1,900
6 months’ future's price per share Rs. 2,050
Assuming it is possible to borrow money in the market for transactions in securities at 10% per
annum, you are required followings:
(a) Advise the justified theoretical price of a 6-months forward purchase; and
(b) Evaluate any arbitrage opportunity, if available.
Question No. 7
Swap Bank entered into a plain vanilla swap through on Overnight Index Swap on a principal of
Rs.100 million and agreed to receive LIBOR overnight floating rate for a fixed payment on the
principal. The swap was entered into on Sunday, 5th January, 2023 and was to commence on 6th
January, 2023 and run for a period of 7 days.
Respective LIBOR rates for Monday to Sunday were:
8.15%, 8.12%, 7.95%, 7.75%, 8.15%, 7.98%
Calculate fixed rate and interest under both legs if Swap Bank received Rs. 423 net on settlement.
Notes:
Saturday is Holiday. Consider 365 days a year and ignore other holidays if any.
41
Question No. 8
On 1 September 2022, Kanchenjunga Securities Limited (KSL) bought three-month share options
which can be exercised at any time up to its maturity date i.e. 30 November 2022. While approving
the investment in options, KSL's Board advised the management as follows:
• Exercise 60% of the options when any options yield 10% at any time.
• Exercise further 40% of the options if any options yield 20% at any time.
• For all remaining options at 30 November 2022, exercise options if they are 'in the money'.
Following information in respect of options are available:
Stock Symbol
LPA SPB BDC NMD
Type of share options purchased Call Call Put Put
No. of share options purchased 250,000 1,000,000 500,000 300,000
Rs. per Share
Exercise price 240.00 16.00 158.60 285.50
Options premium 7.00 1.00 4.50 8.00
3 months High 304.60 19.00 165.20 295.00
3 months Low 235.30 15.50 150.00 255.00
Spot price as on 30 November 2022 292.00 17.80 155.00 290.00
Now you shall assume today is 30 November 2022 and ascertain the net profit/(loss) for KSL, if
advice of the Board has been adopted.
Question No. 9
Mr. Ram is holding 10,000 shares of face value of 100 each of Apex Ltd. He wants to hold these
shares for long term and have no intention to sell. On 1 January 2020, Xerox Ltd. has made short
sales of Apex Ltd.'s shares and approached Mr. Ram to lend his shares under certain arrangement
with following terms:
a) Shares to be borrowed for 3 months from 01-01-2020 to 31-03-2020,
b) Lending Charges/Fees of 1% to be paid every month on the closing price of the stock
quoted in Stock Exchange and
c) Bank Guarantee will be provided as collateral for the value as on 01-01-2020.
Other Information:
a) Cost of Bank Guarantee is 8% per annum,
b) On 29-02-2020 Apex Ltd., declared dividend of 25%,
c) Closing price of Apex Ltd.'s share quoted in Stock Exchange on various dates are as
follows.
Scenario -1 Scenario-2
Date
Closing Price (Rs.) Closing Price (Rs.)
01-01-2020 1000 1000
31-01-2020 1020 980
29-02-2020 1040 960
31-03-2020 1050 940
42
Required:
a) Earning of Mr. Ram through the arrangement in both the scenarios.
b) Total Earnings of Mr. Ram during 01-01-2020 to 31-03-2020 in both the scenarios.
c) What is the Profit or loss to Xerox Ltd. by shorting the shares using through the
arrangement in both the scenarios?
Question No. 11
XYZ Bank enters into a Repo for 21 days with ABC Bank in 8% Government Bonds 2023 @
6.10% for Rs. 50 million. Assuming that clean price is Rs. 97.30 and initial margin is 1.50% and
days of accrued interest are 240 days (assuming 360 days in a year).
You are required to compute: (i) the dirty price and (ii) the repayment at maturity.
44
The production manager has forecasted that Rs. 25 million of additional fixed costs of maintenance
and product quality control will be incurred in the first year of production of the Celica and will
continue to be incurred for each year of production. An additional production manager would need
to be recruited to manage the manufacture of the new product. The new FeelFresh production
manager will be paid a salary of Rs. 2.5 million per annum in the first year of production,
increasing by annual inflation each year thereafter.
Working capital to support production of the FeelFresh will be required at a rate of 15% on net
revenue of FeelFresh (i.e. revenue from FeelFresh less revenue forgone of FRZ100) for each year.
Working capital is assumed to be in place at the beginning of each respective year. The directors
have assumed all working capital will be released after five years of production and sales.
Additionally, all cash flows are assumed to occur on the last day of each year, unless stated
otherwise.
The company's current weighted average cost of capital is 8%, which the directors have determined
should be used to evaluate the launch of the FeelFresh. All revenues and costs are subject to annual
inflation which is expected to remain stable at 3% per annum over the next five years. All revenues
and costs are stated at current values, unless stated otherwise.
Required:
Recommend if the directors should proceed to launch the FeelFresh production based on the
assumptions provided by the directors of Celica Limited.
Question No. 13
Saurya Energy is a large producer of energy in Nepal which has a strategy of increasing its
proportion of energy generation and supply from sustainable sources. Saurya's marketing
department has recently completed extensive research in the energy market at a cost of Rs. 2
million. Based on the findings of this research, Chief Marketing Officer (CMO) has recommended
to the board of directors that the retail division could significantly increase its consumer market
share by adopting wireless energy monitoring technology and installing this in consumers' homes.
The technology allows consumers to monitor their energy usage through an energy monitor that
links to an app via the consumer's home Wi-Fi. The CMO believes introducing this technology
will attract significant new consumers by providing information that can help to reduce energy
consumption. The CMO has asked the Chief Finance Officer to determine if contribution from
forecast new retail energy consumers is sufficient to outweigh the cost of implementation of new
energy monitor in consumers' homes. The project timeframe is expected to be five years and the
CMO has requested that the finance and planning department apply the following assumptions in
their analysis:
(i) Initial energy monitoring infrastructure costs of Rs. 125 million will be paid at the beginning
of the project, of which Rs. 100 million is expected to be eligible to claim capital allowances. Due
to their nature, the entire infrastructure costs are not expected to have any residual value at the end
of the project.
(ii) Existing electricity revenue is Rs. 500 million. Revenue from new consumers is expected to
grow over the life of the project as follows:
Years 1 2 3 4 5
Percentage to be applied on existing 20% 40% 60% 80% 100%
Additionally, price inflation of 4% per annum is expected to apply to revenue in the first year and
each year of the project thereafter.
45
(iii) New consumers are expected to generate a contribution of 35% each year over the life of the
project.
(iv) For the new consumers, incremental fixed costs of Rs. 20 million are expected to be incurred
in the first year of the project and each year thereafter. Cost inflation of 5% per annum is expected
to apply each year.
(v) The project is expected to require additional working capital of 10% of the incremental project
sales revenue for a given year, to be in place at the beginning of each year. Working capital is
expected to be released at the end of the project.
(vi) Saurya pays tax on profits at the rate of 28%. Eligible capital expenditure is subject to initial
and normal depreciation of 25% and 10% respectively under reducing balance method. Saurya
earns sufficient profits to adjust the claim arising from depreciation. Assume tax is payable in the
same year in which it arises.
(vii) Saurya is currently ungeared and has a cost of equity of 13%. The directors plan to finance
the project through the sale of other subsidiary assets.
(viii) All project revenue and cost cash flows occur annually at the end of the year in which they
arise except otherwise specified.
Required:
Evaluate the proposed energy monitor implementation project by calculating the net present value
of the new project and its modified internal rate of rate return.
Question No. 15
Escape Suppliers is consumer electronics wholesaler. The business of the firm is highly seasonal
in nature. In 6 months of a year, firm has a huge cash deposits and especially near Festival time
and other 6 months firm cash crunch, leading to borrowing of money to cover up its exposures for
running the business.
It is expected that firm shall borrow a sum of £25 million for the entire period of slack season in
about 3 months.
The banker of the firm has given the following quotations for Forward Rate Agreement (FRA):
Spot 5.50% - 5.75%
3x6 FRA 5.59% - 5.82%
3x9 FRA 5.64% - 5.94%
3-month £50,000 future contract maturing in a period of 3 months is quoted at 94.15.
You shall ignore the time value of money in settlement amount for future contract.
Required:
(a) Advise the position to be taken in Future Market by the firm to hedge its interest rate risk and
demonstrate how 3 months Future contract shall be useful for the firm, if later interest rate turns
out to be (i) 4.5% and (ii) 6.5%
(b) Evaluate whether the interest cost to the firm shall be less had it adopted the route of FRA
instead of Future Contract.
48
Foreign Exchange Management
Question No. 17
Country Metals Limited (CML) is a company located in the province of Bagmati, Nepal. CML is
in the iron mining industry and currently has two mines in operation. Iron metal ore is the primary
deposit, though the company has also been successful in retrieving gold, silver and sulphur
deposits from these mines.
The price of iron fluctuates depending on market demand and supply for the metal, along with the
availability of iron substitute metals.
CML is in the final stages of negotiations with Alzer Bukri (AB) Limited, a company based in
Dubai. AB requires 300,000 pounds of iron in six months' time on 31 December 2022. AB wants
that the contract price is set at the prevailing market rate when delivery takes place at the end of
December.
CML's CFO is proposing that CML should hedge against a likely fall in the value of iron. He has
obtained relevant financial information included below and would like your help in evaluating if
a futures contract hedge on the price of iron is worthwhile.
Iron prices are quoted in the global commodity market as US dollars (USD) per pound.
Relevant financial information for iron hedge
Financial information Estimated December
June 2022
2022
USD/pound USD/pound
Spot price 4.3525 4.2835
Futures contracts (December dated) 4.3675 4.2845
Contract size 25,000 pounds
Tick size 0.0005 USD/pound
Required:
Recommend, with supporting calculations and explanations, if CML should proceed and hedge
the sale of iron in six months' time. In doing so, compare a hedging strategy with the expected no
hedge position and state your answers in USD.
Question No. 18
Jack sparrow Ltd. (JL) is located in South Korea. You have recently been appointed Finance
Manager of the company and you have collected the following information: It is now, 1 January
and the prevailing money market rates are as follows:
Borrowing Deposit
3 Months SKW 9.60 7.20
3 Months JPY 12.30 9.00
3 Months PHP 7.00 6.50
Other relevant information
Spot rate (CNY to SKW) 2.1610 +/- 0.0050
Spot rate (PHP to SKW) 2.2504 +/- 0.0060
49
Spot rate (JPY to SKW) 7.5585 +/- 0.00195
Three-month forward rate (CNY to SKW) 2.2145 +/- 0.0075
Where:
SKW = South Korean Won
PHP = Philippine Peso
JPY = Japanese Yen
CNY = Chinese Yuan
JL imports parts, assembles and re-brands them and then sells the assembled items. One of its most
popular products is disposable Camping Huts which are manufactured by a third party in China.
These are sold by JL in its domestic market as well as exported overseas. JL has recently taken
delivery of a container full of disposable Camping Huts. The contracted price for the Camping
Huts is 4,000,000 Chinese Yuan. Half of this has already been settled; the balance is payable on 1
April.
Required:
(a) Compare the cost to JL if it buys Yuan at the spot rate as against entering into a forward
agreement. Briefly comment on your answer and discuss the advantages/disadvantages of using
forward rate agreements.
(b) JL also imports DVDs from Japan. JL owes a Japanese supplier JPY 1,400,000 payable in
three months' time. What will be the cost in South Korean Won (SKW) with a money market hedge
and what effective forward rate would this represent?
(c) A major export market for JL for both Camping Huts and other products is Philippines. JL is
owed PHP 2.5 million in three months' time by a Philippine company. What will be the receipt in
South Korean Won (SKW) with a money market hedge and what effective forward rate would this
represent?
51
Answers
The Financial System
Answer No. 1
Basic functions of financial system are as follows:
1. The Savings Function:
Public savings find their way into the hands of those in production through the financial
system. Financial claims are issued in the money and capital markets, which promise future
income flows. The funds are in the hands of the producers, resulting in better goods and
services and an increase in society's living standards. When savings flow declines, however,
the growth of investment and living standards begins to fall.
2. Liquidity Function:
Money in the form of deposits offers the least risk of all financial instruments. But its value is
mainly eroded by inflation. That is why one always prefers to store funds in financial
instruments like stocks, bonds, debentures, etc. However, in such investments, (i) a greater
level of risk is involved, (ii) and the degree of liquidity (i.e., conversion of the claims into
money) is; moreover, the financial markets provide the investor with the opportunity to
liquidate their investments.
3. Payment Function:
The financial systems offer a very convenient mode of payment for goods and services. The
check system, credit card systems, etc. are the easiest methods of charge in the economy; they
also drastically reduce the cost and time of transactions.
4. Risk Function:
The financial markets provide protection against life, health, and income risks. These are
accomplished through the sale of life, health, and property insurance policies. Overall, they
provide immense opportunities for the investor to hedge himself/herself against or reduce the
possible risk involved in various instruments.
5. Policy Function:
Most governments intervene in the financial system to influence macroeconomic variables like
interest rates or inflation. So, for example, the central bank indulges in several cuts in CRR
and tries to decrease the interest rates and increase the availability of credit at cheaper rates to
the corporates.
Financial Intermediaries
Answer No. 2
The economic functions of secondary markets are as follows:
Price discovery
Price discovery is one of the central functions of secondary markets. It is the route through which
securities markets arrive at prices for the securities traded. Price discovery is important because it
provides information that influences economic decisions, for example whether a company will
expand production and finance this with long-term borrowing or the issue of new shares (rights
52
offer). Price discovery also provides clues as to the prices that need to be offered on new issues of
securities.
Liquidity
Liquidity refers to the ability to trade a security with ease, i.e. without impacting significantly on
its price. It will be apparent that in liquid markets, prices will not be adversely affected by large
orders, whereas in thin markets prices may be shifted markedly by small orders. It may be said
that a liquid market is more likely to create a state of equilibrium in the market. By this is meant
that if the buyers and sellers are equally matched in terms of orders, the price will not be affected
adversely (up or down), i.e. the price is a market-clearing price. As indicated, in a thin market, the
market may clear at a vastly different price, depending on whether buyer orders outweigh sell
orders (higher price), or vice versa (lower price). Equilibrium is disturbed in thin markets.
Liquidity enables investors to rapidly adjust their portfolios in terms of size, risk, return, liquidity
and maturity. This in turn has a major influence of the liquidity premium investors place on liquid
securities. This of course means that the issuer is able to borrow at a lower cost than in the absence
of liquidity. It is for this reason that many issuers of bonds attempt to create their own markets by
acting as market makers (quoting buying and selling prices simultaneously) in their own securities,
or by outsourcing this function to an investment / merchant bank/s. An important question is how
to enhance liquidity. The answer is, firstly, the active participation of the role-players in the
financial markets, secondly, the existence of market makers, and thirdly the existence of
arbitrageurs and speculators
Support of primary market
The secondary market plays an important role in terms of supporting the primary market. We noted
above that price discovery in the secondary market assists the primary markets in terms of
providing clues as to the pricing of new issues. In addition to this important function, the secondary
market provides clues as to the receptiveness of market for new issues. Clearly, a liquid market
improves the ability of issuers to place securities, and lowers the price.
Implementation of monetary policy
An active secondary market enables the central bank to buy and sell securities in order to influence
the liquidity of the banking system, with a view the ultimately influencing interest rates. This is
termed open market operations, which means that the central bank buys and sells securities in the
open market.
Answer No. 3
The most important rigidities in the Nepalese money market are:
(i) Markets are not integrated: Money market in Nepal is not well integrated. There is a more
developed secondary capital market in Nepal, which does not exist in money market.
(ii) Players restricted: Only Government, banks and financial institutions are involved in the
money market. Retail investors are rarely interested in the money market.
(iii) Supply based-sources influence uses: Banks and financial institutions are generally the main
sources of fund in the money market. Commercial Banks are main supplier of funds in money
market instruments especially NRB which issues Treasury Bills on behalf of the Government of
Nepal.
53
(iv) Not many instruments: Unlike European Market, only few money market instruments are
available in Nepal i.e. Treasury bill, Citizen Saving Bonds, Government Bonds, deposit collection
in Nepal.
(v) Reserve requirements: There are fixed reserve requirements in case of Cash Reserve Ratio
(CRR) and Statutory Liquidity Ratio (SLR) which banks and financial institutions have to maintain
at all times. CRR is the reserve which banks have to keep with NRB whereas SLR is the reserve
which banks have to keep with themselves, thus, restricting the flow of money market instruments.
(vi) Lack of transparency: There is lack of transparency in money market because the secondary
market is not very well developed. Since, the transactions are mostly done Over the Counter, there
may be lack of transparency and public information.
Answer No. 4
Calculation of the after-tax cost of debt using credit rate tables:
SIL has Rs. 2,000 million of 'AA' rated corporate bonds with an average 18 years to maturity
Rating 10 years 30 years
AA 75 103
The expected yield of the bond = risk free bond rate + credit risk premium.
Expected yield on government bond, which equates to risk free rate, is 3.75%.
Calculation of credit risk premium:
Using interpolation to determine 18-year maturity premium between 10 years and 30 years.
Credit risk premium on a 10-year AA rated bond is 75 basis points.
Credit risk premium on a 30-year AA rated bond is 103 basis points.
Credit risk premium for 18 years = 10 years + additional 8 years bond maturity.
Additional risk premium per year = (103-75) / (20 years) = 1.4 basis point per year.
Additional eight years of risk premium = 8years x 1.4 = 11.2 basis points.
Credit risk premium for 18 years = 10-year credit risk premium + additional 8 years bond maturity.
Credit premium for 18 years = 75 + 11.2= 86.2 basis points
The expected yield on AA 18-year bond = 3.75% + (86.2/100) = 4.61%
The estimated cost of debt = 4.61% x (1-0.29) = 3.27%
Capital Markets
Answer No. 5
(i) Number of rights issue= 10,000,000 x 4/5 = 8,000,000 shares
Rights issue = 8,000,000 x 50 = Rs. 400 million
Capital Structure after right issue
Capital Structure Rs. Million
Equity 18 million shares @ Rs. 65 1,170
Debt (3,000 - 400) 2,600
3,770
54
(ii)
Rs in million
Operating profit 1,500
Less: Redundancy costs (35,000 x 6 x 1,000) (210)
Finance cost (Rs. 2,600 @ 12%) (312)
Profit before tax 978
Tax @ 15% (146.7)
Profit after tax 831.3
Dividend (60%) = 831.3 x 60% 498.78
High net worth individual dividend = 498.78 x 51% 254.37
High net worth individual investment
= (51% x 10 million shares x Rs. 75 per shares) + (Rs. 400 million x 51%)
= 382.5 million + 204 million = Rs. 586.5 million
Dividend yield = Rs. 254.37 million /586.5 million = 43.37%
(iii) Dividend per share = Rs. 498.78 million/18 million shares = Rs. 27.71
Here,
P = Do (1+ g) / (Ke – g) = 27.71 x 1.05 /(0.20 - 0.05)
Per share price = Rs. 193.97
Answer No. 6
(a) The justified theoretical price of a 6 months’ forward contract as per Cost to Carry Model is as
follows:
Theoretical minimum price = Rs. 1,900 + (Rs. 1,900 x 10/100 x 6/12) = Rs.1,995
(b) Arbitrage Opportunity:
Since current future price is Rs. 2050, yes there is an opportunity for carrying arbitrage profit. The
arbitrageur can borrow money @ 10% for 6 months and buy the shares at Rs. 1,900. At the same
time, he can sell the shares in the futures market at Rs. 2,050. On the expiry date 6 months later,
he could deliver the share and collect Rs. 2,050 pay off Rs. 1,995 and record a risk-less profit of
Rs. 55 (Rs. 2,050 – Rs. 1,995).
Answer No. 7
Day Principal Rs. LIBOR % Interest Rs.
Monday 100,000,000 8.15% 22,329
Tuesday 100,022,329 8.12% 22,252
Wednesday 100,044,580 7.95% 21,791
Thursday 100,066,371 7.75% 21,247
Friday 100,087,618 8.15% 22,348
Saturday and Sunday* 100,109,966 7.89% 43,280
Total interest @ Floating 153,247
Less : Net received 423
55
Day Principal Rs. LIBOR % Interest Rs.
Expected interest @ fixed 152,824
Fixed interest rate 7.97%
* Interest for two days
Answer No. 8
Stock Symbol LPA SPB BDC NMD Total
Type of options Call Call Put Put
Exercise price A. 240 16 158.6 285.5
Profit 10% [A x 110% & 90%] B. 264.00 17.60 142.74 256.95
Profit @ 20% [A x 120% & 80%] C. 288.00 19.20 126.88 228.40
90 days high for Call D. 304.6 19
90 days low for Put E. 150 255
Spot price F. 292 17.8 155 290
No. of options G. 250,000 1,000,000 500,000 300,000
Options premium H. 7 1 4.5 8
Rs. In thousand
Exercise of 60% call option if D>B
3,600.00 960.00 4,560.00
Gx60%x(B-A)
Exercise of 60% put option if E<B
5,139.00 5,139.00
Gx60%x(A-B)
Exercise of 40% call option if D>C
4,800.00 4,800.00
GX40%x(C-A)
Exercise of 40% put option if E<C -
Gain realized at spot price if on 30
Nov:
720.00 1,800.00 2,520.00
the spot price> A in case of call
and the spot price < A in case of put
Total cost of option (G x H) (1,750.00) (1,000.00) (2,250.00) (2,400.00) (7,400.00)
Option wise profit or loss 6,650.00 680.00 (450.00) 2,739.00 9,619.00
Answer No. 9
a) Earning of Mr. Ram through the arrangement in both the scenarios
Date Particulars Scenario 1 Scenario 2
31/01/2020 1020*1 % and 980 *1% 10.2 9.8
29/02/2020 1040*1 % and 960 *1% 10.4 9.6
31/03/2020 1050*1 % and 940 *1% 10.5 9.4
Earnings from Lending per share(a) 31.1 28.8
No. of shares 10,000 10,000
Total earning from lending 311,000 288,000
b) Total Earnings of Mr. Ram during 01-01-2020 to 31-03-2020 in both the scenarios.
56
Particulars Scenario 1 Scenario 2
Dividend income per share (b) 25 25
Total earnings per share (a + b) 56.1 53.8
No. of shares 10,000 10,000
Total earnings 561,000 538,000
c) Profit or loss to Xerox Ltd. by shorting the shares using through the arrangement in both
the scenarios
Particulars Scenario 1 Scenario 2
Gain on shorting of shares
(50) 60
(1000-1050) and (1000-940)
Lending fees paid (31) (29)
Bank Guarantee Charges @8% for 3 months (20) (20)
Gain per share (101.1) 11.2
No. of shares 10,000 10,000
Total Gain on shorting of shares (1,011,000) 112,000
57
Answer No. 11
(i)Dirty Price
= Clean price + Interest Accrued
=97.30+ 100 *8%* 240/360
=97.30+ 5.33
=Rs. 102.63
(ii) First leg (Start Proceed)
= Nominal value * Dirty Price/ 100 * (100-Initial Margin)/ 100
=Rs. 50,000,000 * 102.63/100 * (100-1.5)/100
= Rs. 50,545,275
Second leg (Repayment at Maturity)
= Start proceed * [1+ (Repo rate * No. of days/360)]
= Rs. 50,545,275 * [1+ (6.10%* 21/360)]
= Rs. 50,725,132
58
Year Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Net present value (NPV) 586.51
Based on the positive NPV of Rs. 586.51 million, the launch of the FeelFresh refrigerator should
proceed subject to risk assessment and analysis of non-financial factors, such as resource
constraints, production planning and logistics.
Working Notes:
WN-1: Expected sales volume
Year 1 Year 1Year 2 Year 2 Year 2 Year 2
If 2,000 If 2,000 If 2,500 in If 2,500
in Yr.1 in Yr.1 Yr. 1 in Yr. 1
Year 1 probability 60% 40% 60% 60% 40% 40%
Year 2 probability, given
70% 30% 65% 35%
Year 1
Probability (year 1 x year
42% 18% 26% 14%
2)
Predicted sales volume 2000 2500 2250 2500 2750 3000
Probability x Predicted
1200 1000 945 450 715 420
sales volume
Expected sales volume 2200 2530
WN-2: Lost contribution
Year 1 Year 2 Year 3 Year 4 Year 5
In units
FeelFresh volumes A. 2,200 2,530 2,783 2,922 3,068
FeelFresh units in replacement of FRZ100 ( A-
600 930 1,183 1,322 1,468
1600#) B.
Decrease in production of FRZ100 (B*5/8) 375 581 739 826 918
Rs. In million
Lost contribution 245@ * decrease in productions
94.63 151.01 197.84 227.77 260.73
*1.03^year
@
900-375-160-120
In hours
Spare Capacity (1000* 8 hours per unit) 8000
FeelFresh production units using spare capacity (8000/ 5 hours per unit) 1600#
WN-3: Tax saved on capital allowances
Year 1 Year 2 Year 3
Year 4 Year 5
Rs. In million
Capital expenditure / Tax written down value b/f 250.00 168.75 151.88 136.69 123.02
Initial capital allowance (250*25%) 62.50
Normal Tax depreciation at 10% 18.75 16.88 15.19 13.67 12.30
Tax-allowable depreciation 81.25 16.88 15.19 13.67 12.30
Loss on disposal of machine (123.02×0.9)-24 86.72
Total tax allowances 81.25 16.88 15.19 13.67 99.02
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Year 1 Year 2 Year 3 Year 4 Year 5
Tax written down value c/f 168.75 151.88 136.69 123.02 24.00
Tax saving at 29% 23.56 4.89 4.40 3.96 28.72
Answer No. 13
Rs. In million
Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Incremental sales revenue (WN1) 104.00 216.32 337.46 467.94 608.33
Contribution 35% 36.40 75.71 118.11 163.78 212.91
Incremental fixed costs (20.00) (21.00) (22.05) (23.15) (24.31)
Profit before tax 16.40 54.71 96.06 140.63 188.60
Tax @ 28% (4.59) (15.32) (26.90) (39.38) (52.81)
Tax saving at capital allowance
9.10 1.89 1.70 1.53 13.78
(WN2)
Working capital (WN3) (10.40) (11.23) (12.11) (13.05) (14.04) 60.83
Infrastructure costs (125.00)
Net cash flows (135.40) 9.68 29.17 57.82 88.74 210.41
13% discount factor 1 0.88 0.78 0.69 0.61 0.54
Present value (135.40) 8.56 22.84 40.07 54.43 114.20
Present value (135.40) 240.10
NPV 104.70
Working Notes:
WN1:
Incremental revenue
Rs. In million
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Existing retail revenue 500
Incremental increase in revenue
20% 40% 60% 80% 100%
each year
60
Total incremental revenue 100 200 300 400 500
Price Inflation at 4% p.a. 1.04 1.08 1.12 1.17 1.22
Incremental revenue 104.00 216.32 337.46 467.94 608.33
WN2:
Tax saving on capital allowance
Rs. In million
Year 1 Year 2 Year 3 Year 4 Year 5
Assets value eligible for allowance 100.00 67.50 60.75 54.68 49.21
Sales proceeds
Balancing allowance 49.21
Initial Capital Allowance at 25% 25.00
Normal Capital Allowance at 10% 7.50 6.75 6.08 5.47 -
Tax-allowable allowance 32.50 6.75 6.08 5.47 49.21
Balance 67.50 60.75 54.68 49.21 -
Tax saving at 28% 9.10 1.89 1.70 1.53 13.78
WN3:
Working Capital
Rs. In million
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Working capital (10% of 10.40 21.63 33.75 46.79 60.83
incremental sales revenue)
Working capital (required)/
(10.40) (11.23) (12.11) (13.05) (14.04) 60.83
released
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Subject: Evaluation of proposed investment in Country Y
(a) Net present value of the investment
The financial evaluation of the Country Y Project is based on estimates of the future nominal cash
flows of the investment, in both Country X and Y. All foreign cash-flows are converted to CX and
total is discounted at a shareholders' required rate i.e. 22% per annum. The theory of purchasing
power parity has been used to estimate future currency exchange rates. This predicts that if
currencies are allowed to float freely on the market, they will adjust in the long run to compensate
for differences in countries' inflation rates. The results show that the investment has an expected
net present value of approximately CX 81.19 million, which indicates that it is worthwhile and
should add to shareholder value.
Calculations:
Growth Inflation Years
0 1 2 3
Exchange rate (PY *1.2/1.07) 45 50.47 56.60 63.48
Amount in million
Cash flows in Country X 5% 7% (7.00) (0.54) (0.60) (0.68)
Cash flows in Country Y (in CY) 20% 800.00 204.00 360.00 501.12
Cash flows in Country Y (in CX) (17.78) 4.04 6.36 7.89
Total nominal cash flows (in CX) (24.78) 3.51 5.76 7.22
Working Notes:
1. Growth rate for Country X from year 4 to perpetuity [(1.07x1.05)-1] =12.35%
Perpetuity value = - {(0.68* 1.1235) / (0.3054-0.1235} * 0.45 = (1.89)
2. Growth rate for Country Y from year 4 to perpetuity [(1.20x1.05)-1] = 26%
Perpetuity value = {(7.89* 1.26) / (0.3054-0.26)}*0.45 = 98.54
(b) Risks and uncertainties
(i) Large margins of potential error in the exchange rate prediction
(ii) A slow payback: in present value terms the project will probably not break even until
Year 8 or 4.
(iii) The economic uncertainties in Country Y which may affect adversely on rate of inflation.
(iv) Inappropriate projection of future cash flows specially the cash flows to be generated in
Country Y and cash flows expectation to perpetuity.
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(c) Management Strategies
To counter the increase in local taxes
(i) Negotiate tax concessions in advance
(ii) Use transfer price strategies including royalties and management, to minimize the impact
of variation in Country Y taxable profits and dividends
Answer No. 15
(a) Since firm is a borrower it will like to off-set interest cost by profit on Future Contract.
Accordingly, if interest rate rises it will gain hence it should sell interest rate futures.
No. of Contracts = (Amount of Borrowing/ Contract Size) X (Duration of Loan/3 months)
= (£25,000,000/£50,000) x (6/3)
=1000 Contracts
The final outcome in the given two scenarios shall be as follows:
If the interest rate turns out to If the interest rate turns out to
be 4.5% be 6.5%
Future Course Action:
Sell to open 94.15 94.15
Buy to close 95.50 (100-4.5) 93.50 (100-6.5)
Loss/ (Gain) 1.35% (0.65)%
Cash Payment (Receipt) for £50,000x1000x1.35% x 3/12 £50,000x1000x0.65% x 3/12
Future Settlement = £168,750 =(£81,250)
Interest for 6 months at actual £25 million x 4.5% x 1/2 £ 25 million x 6.5% x 1/2
rates =£562,500 =£812,500
£ 731,250 £ 731,250
Thus, the firm locked itself in interest rate:
£731,250/£25,000,000 x 100 x 12/6 = 5.85%
(b) No, the interest cost shall not be less for Escape Suppliers had it taken the route of FRA, as the
3x9 FRA contract are available at 5.64% -5.94% i.e. borrowing rate of 5.94%. Hence, the
interest cost under this option shall be nearby by 5.94% which is more than interest rate under
Future contract rate of 5.85%.
64
(d) βA= (Ve x βe) / [((1-T)*Vd)+E]
=(48×1.25)/((1-0.29)×14.8+48
=1.0255
Overall ẞA for company going forward is weighted average
Market Value βA Weight
Manufacturing and cold logistics 48 1.0255 49.22
Retail outlets 20 2.2300 44.60
68 93.82
Overall βA= 93.82/68 = 1.380
New overall βe for company going forward
Assume that no change in the market values of equity and original debt
1.380 = (48 x βe )/[ (1-0.29) 34.8+48]
βe = 2.09
Ke = Rf + βe (Rm-Rf) = 4% +2.090 × 6% =16.54%
(e) The market value of CL's corporate bonds will fall if the credit rating reduces.
A fall in the credit rating suggests that the debt will no longer be considered risk free for the
investor.
This will increase the required return by the debt investor.
Revised gross yield on CL's corporate bond using CAPM at A credit rating:
Kd gross yield = Rf+ Bd (Rm-Rf)
= 4%+0.25 x 6% = 5.5%
Revised market value of original debt
65
Foreign Exchange Management
Answer No. 17
Outcome if no hedge:
If CML does not hedge and use the spot rates in six months' time, the net receipt will be:
Sell Iron at December 2022 spot (4.2835x300,000) = USD 1,285,050
Outcome if hedge using Futures contract:
If CML takes out a future contract to hedge against the fall in the value of iron, then the expected
receipt in USD will be:
Iron futures
Sell Iron for Dec 22 spot price (4.2835×300,000) = USD 1,285,050
Gain on Iron futures hedge (WN-1) = USD 24,900
Total receipts = USD 1,309,950
Conclusion:
Iron future is beneficial for Country Metals Limited as compared to no hedge.
WN-1:
Movement per pound (4.3675-4.2845) USD 0.0830
Number of ticks (0.0830/0.0005) 166
Tick size per contract (25,000 x 0.0005) USD 12.5
Gain on one contract (166 x USD 12.50) USD 2,075
Number of contracts (300,000/25,000) 12
Gain on futures contracts hedge (12x USD 2,075) USD 24,900
Answer No. 18
a. Note: Rates expressed are “annualized rates”. Therefore, before solving the problems it is
important to express the given rates as rates for a period of three months.
3 months annualized rates converted for a period of three month rates
Borrowing Deposit
3 Months SKW 2.4% 1.8%
3 Months JPY 3.075% 2.25%
3 Months PHP 1.75% 1.625%
The balance to be settled = CNY 4,000,000/2 = CNY 2,000,000
Spot rate (CNY to SKW) = 2.1610 +/- 0.0050
As JL buying CNY, they have to buy at the bank’s selling rate which is = 2.1610 + 0.0050
= 2.166
Cost at the spot rate = CNY 2,000,000 x 2.166 = SKW 4,332,000
Three month’s forward rate (CNY to SKW) = 2.2145 + 0.0075
Under forward rate JL has to buy at the rate of = 2.2145 + 0.0075 = 2.2220
66
(bank forward selling rate)
Cost at the forward rate = CNY 2,000,000 x 2.222 = SKW = 4,444,000
At a glance it seems the cost is more if the company goes for a forward contract in terms
of SKW by 4,444,000 – 4,332,000 = 112,000
Advantages of using forward agreement:
A firm can fix the exchange rate today (at the current rate) for a transaction which will take place
at a future date. Then the firm is sure of exactly how much it is going to receive or pay in terms of
local currency. Therefore, it does not face a risk in terms of future exchange rate changes. Finally,
a large fluctuation of firm's cost/revenue and profits due to exchange rate changes can be
controlled.
Disadvantages of using forward contracts:
The exchange rate could change favourably. There is a possibility that the value of the paying
foreign currency to go down against the local currency and to pay less in terms of the local
currency. Such favourable changes cannot be expected when the rate is fixed in advance under a
forward agreement. There may be occasions where you may have to cancel the transaction due to
various reasons.
(b) JL has to borrow SKW and buy JPY in advance and invest in JPY for three months till the payment
date.
The amount of JPY needed at the end of three months = JPY 1,400,000
The amount, JL has to invest now to get JPY 1,400,000 in 3 months
= JPY1,400,000/1.0225 = JPY 1,369,193
*Note that the JPY deposit Rate is 2.25% or 0. 0225 for a period of three months
Amount of SKW needed to buy JPY 1,369,193 = JPY 1,369,193 x 7.56045 =SKW 10,351,715
* Recognize that JL has to buy at Bankers selling rate (7.5585 +0.00195 = 7.56045)
As JL is going to borrow SKW 10,351,715, it has to pay in 3 months with interest
= SKW 10,351,715* (1.024)
= SKW 10,600,156
SKW 10,600,156 is the real cost South Korean Won.
*Recognize that they have to borrow at the rate of 2.4% = .024
The effective forward rate of the firm:
At the end of three months, JL settles JPY 1,400,000 to the Japanese party with the money available
in JPY deposit. For the borrowed money they will have to pay to the bank SKW 10,600,156.
So effective forward rate is = SKW10,600,156/ JPY1,400,000 = 7.571
(c) JL borrows Philippine Peso (PHP) in 3 months’ advance and invest in SKW.
Amount JL has to collect from Philippine in three months’ time = PHP 2,500,000. JL has to
borrow PHP against the amount receivable in 3 months
= PHP 2,500,000 / 1.0175 = PHP 2,457,002 (That is the present value of future receivables)
*Note that PHP borrowing rate is 1.75% = 0.0175
67
Convert PHP 2,457,002 to SKW = PHP 2,457,002 x 2.2444 = SKW 5,514,495
(Note that they have to sell at the bank buying rate = 2.2504 - 0.0060 = 2.2444)
The company then will invest SKW 5,514,495 for three months at the rate of 1.8%
= SKW 5,514,495 * (1.0180)
Amount with the interest = SKW 5,613,755
Therefore, the receipt in South Korean Won (SKW) with a money market hedge is = SKW
5,613,755
The company will settle the PHP borrowing with PHP 2.5 million receipt. The effective forward
exchange rate in this case is = 2.245 approximately (SKW 5,613,755/ PHP2,500,000)
Note: Exchange rates given in the question do not necessarily reflect the real parity rates.
68
11 13.31 0.650 8.65
12 13.31 0.625 8.31
Total 112.78
Conclusion: Imark’s option is better as it gives lower overall cost in present value terms.
Working Notes:
WN-1: Finding the rate offered by MAN
PV of inflow = Present value of outflows (annuity) = R × Annuity Factor (AF)
Hence, 80 − 10 = 7.46 × AF
AF = 70 ÷ 7.46 = 9.3834
IRR is approx. 4% per quarter i.e. the figure corresponding to annuity factor of 9.385 (of 9.3834)
and 12 periods, on the annuity table.
70
Paper-3
Advanced Audit & Assurance
71
Nepal Standards on Auditing
1. Explain analytical procedure. Further explain the points to be considered while designing and
performing substantive analytical procedure.
2. You are the auditor of Car Spare Parts Pvt. Ltd. for the year 2079-80. The inventory as at the
end of the year was Rs.8.5 cr. Due to some circumstances, you were not able to be present at
the time of annual physical verification.
Under the above circumstances how would you ensure that the physical verification conducted
by the management was in order?
3. During the course of audit of Federal Limited the auditor received confirmation of the balances
of trade payables outstanding in the balance sheet by negative confirmation request.
In the list of trade payables, there are number of trade payables of small balances except one,
old outstanding of Rs.3.8 cr, of whom, no confirmation on the credit balance has been received.
Comment with respect to Nepal Standard of Auditing.
4. Gelal Associates, Chartered Accountants, conducting the audit of Plant Ltd., a listed Company
for the fiscal year 2078/79 is concerned with the auditor's responsibilities relating to other
information, both financial and non-financial, included in the Company’s annual report. While
reading other information, Gelal Associates considers whether there is a material inconsistency
between other information and the financial statements. As a basis for the consideration the
auditor shall evaluate their consistency, compare selected amounts or other items in the other
information with such amounts or other items in the financial statements. Guide Gelal
Associates with examples of "Amounts" or "other items" that may be included in the "other
information" with reference to NSA 720.
73
Teti Airlines employs ten full-time cabin crew attendants who are trained in air-stewardship
including passenger safety in the event of accident and illness. Flight personnel (the captain
and co-pilots) are provided under a contract with the international airline from which the
aircraft is leased. At the end of each flight the captain completes a timesheet detailing the crew
and actual flight time.
Ticket sales are made by Teti Airlines and travel agents in Nepal and India. On a number of
occasions Economy seating has been over-booked. Customers who have been affected by this
have been accommodated in Business Class as there is much less demand for this, and even
less for First Class. Ticket prices for each class depend on many factors, for example, whether
the tickets are refundable/non-refundable, exchangeable/non-exchangeable, single or return,
mid-week or weekend, and the time of booking.
Teti Airlines' insurance cover includes passenger liability, freight/baggage and compensation
insurance. Premiums for passenger liability insurance are determined on the basis of passenger
miles flown.
Required
Identify and explain the business risks facing Teti Airlines Ltd.
Audit Reports
14. CA Shaquile O’Niel is the statutory auditor of PQR Ltd. for the FY 2078-79. During the course
of audit CA Shaquile O’Niel noticed the following:
1. With respect to the debtors amounting to Rs. 150 crores, balance confirmation was not
obtained. Further, there has been defaults on the payment deadline by debtors on the due
dates during the year under audit. The Company has created a provision for bad debts to
the tune of Rs.25 Cr. during the year under audit. The Company has stated that the
provision is based on receivables which are older than 36 months, which according to the
audit team is inadequate and team is unable to ascertain the carrying value of trade
receivables.
2. Further, in respect of Inventories (40% of the total assets of the company), during the
reporting period, the management has not done physical verification at periodic intervals.
Also, the Company has not maintained adequate inventory records at the factory. The audit
team was unable to undertake the physical inventory count as such the value of inventory
could not be ascertained.
Under the above circumstances what kind of opinion should CA Shaquile O’Niel give?
74
year ended 31/03/2079 show revenue of Rs.67.0 million (2078 – Rs.62.3 million), profit before
taxation of Rs. 11.9 million (2078 – Rs. 14.2 million) and total assets of Rs.48.0 million (2078
– Rs.36.4 million).
The following issues arising during the final audit have been noted on a schedule of points for
your attention.
(a) In early 2079 a chemical leakage from refrigeration units owned by Galley Cold Store
caused contamination of some of its property. Galley Cold Store has incurred Rs.0.3 million
in clean-up costs, Rs.0.6 million in modernization of the units to prevent future leakage and
Rs.30, 000 fine to a regulatory agency. Apart from the fine, which has been expensed, these
costs have been capitalized as improvements.
(b) While the refrigeration units were undergoing modernization Galley Cold Store outsourced
all its cold storage requirements to Masu Warehousing Services. At 31/03/2079 it was not
possible to physically inspect Galley Cold Store's inventory held by Masu due to health and
safety requirements preventing unauthorized access to cold storage areas. Galley Cold Store's
management has provided written representation that inventory held at 31/03/2079 was Rs.10.1
million (2078 – Rs.6.7 million). This amount has been agreed to a costing of Masu's monthly
return of quantities held at 32/03/2079.
(c) Galley Cold Store owns a residential apartment above its head office. Until 31 Chaitra 2078
it was let for Rs.3,000 a month. Since 1 Baishakh 2079 it has been occupied rent-free by the
senior sales executive.
Required
In undertaking your review of the audit working papers and financial statements of Galley Cold
Store Co for the year ended 32/03/2079, for each of the above issues:
(i) Comment on the matters that you should consider; and
(ii) State the audit evidence that you should expect to find
Short Notes
18. Define parallel simulation and illustrate the overall process with the help of a diagram
19. Write a short note on general objectives of an operational audit.
20. Write a short note on the contents of an audit plan.
75
Answers
1. Evaluation of financial information through analysis of plausible relationships among both
financial and non-financial data. Analytical procedures also encompass such investigation as
is necessary of identified fluctuations or relationships that are inconsistent with other relevant
information or that differ from expected values by a significant amount.
While designing and performing substantive analytical procedure, either alone or in
combination with tests of details, as substantive procedures in accordance with NSA 330, the
auditor shall:
a) Determine the suitability of particular substantive analytical procedure for given assertions,
taking account of the assessed risks of material misstatement and tests of details, if any, for
these assertions.
b) Evaluate the reliability of data from which the auditor’s expectations of recorded amounts
or ratios is developed, taking account of source comparability, and nature and relevance of
information available, and controls over preparation.
c) Develop an expectation of recorded amounts or ratios and evaluate the expectation is
sufficiently precise to identify a misstatements that, individually or when aggregated with
other misstatements, may cause the financial statements to be materially misstated and,
d) Determine the amount of any difference of recorded amounts from expected values that is
acceptable without further investigation.
2. As per NSA 501 Audit Evidence – Specific Considerations for Selected Items, the auditor
should perform audit procedures, designed to obtain sufficient appropriate audit evidence
during his attendance at physical inventory counting. NSA 501 is additional guidance to that
contained in NSA 500, Audit Evidence, with respect to certain specific financial statement
amounts and other disclosures. If the auditor is unable to be present at the physical inventory
count on the date planned due to unforeseen circumstances, the auditor should take or observe
some physical counts on an alternative date and where necessary, perform alternative audit
procedures to assess whether the changes in inventory between the date of physical count and
the period end date are correctly recorded. The auditor would also verify the procedure
adopted, treatment given for the discrepancies noticed during the physical count. The auditor
would also ensure that appropriate cut off procedures were followed by the management. He
should also get management’s written representation on
a) The completeness of information provided regarding the inventory, and
b) Assurance with regard to adherence to laid down procedures for physical inventory count.
By following the above procedure it will be ensured that the physical verification conducted
by the management was in order.
3. As per NSA 505, External Confirmation, negative confirmation is a request that the confirming
party respond directly to the auditor only if the confirming party disagrees with the information
provided in the request. Negative confirmations provide less persuasive audit evidence than
positive confirmations. The failure to receive a response to a negative confirmation request
does not explicitly indicate receipt by the intended confirming party of the confirmation request
or verification of the accuracy of the information contained in the request. Accordingly, a
failure of a confirming party to respond to a negative confirmation request provides
76
significantly less persuasive audit evidence than does a response to a positive confirmation
request.
Confirming parties also may be more likely to respond indicating their disagreement with a
confirmation request when the information in the request is not in their favour, and less likely
to respond otherwise. In the instant case, the auditor sent the negative confirmation requesting
the trade payables having outstanding balances in the balance sheet while doing audit of
Federal Limited. One of the old outstanding of Rs.3.8 cr has not sent the confirmation on the
credit balance. In case of nonresponse, the auditor may examine subsequent cash
disbursements or correspondence from third parties, and other records, such as goods received
notes.
Further non response for negative confirmation request does not means that there is some
misstatement as negative confirmation request itself is to respond to the auditor only if the
confirming party disagrees with the information provided in the request.
But, if the auditor identifies factors that give rise to doubts about the reliability of the response
to the confirmation request, he shall obtain further audit evidence to resolve those doubts.
4. As per NSA 720 the Auditor’s Responsibility in Relation to Other Information in Documents
Containing Audited Financial Statements, the following are examples of amounts and other
items that may be included in other information. This list is not intended to be exhaustive.
Amounts
i. Items in a summary of key financial results, such as net income, earnings per share,
dividends, sales and other operating revenues, and purchases and operating expenses.
ii. Selected operating data, such as income from continuing operations by major operating
area, or sales by geographical segment or product line.
iii. Special items, such as asset dispositions, litigation provisions, asset impairments, tax
adjustments, environmental remediation provisions, and restructuring and
reorganization expenses.
iv. Liquidity and capital resource information, such as cash, cash equivalents and
marketable securities; dividends; and debt, lease and minority interest obligations.
v. Capital expenditures by segment or division.
vi. Amounts involved in, and related financial effects of, off-balance sheet arrangements.
vii. Amounts involved in guarantees, contractual obligations, legal or environmental
claims, and other contingencies.
viii. Financial measures or ratios, such as gross margin, return on average capital employed,
return on average shareholders’ equity, current ratio, interest coverage ratio and debt
ratio. Some of these may be directly reconcilable to the financial statements.
Other Items
i. Explanations of critical accounting estimates and related assumptions.
ii. Identification of related parties and descriptions of transactions with them.
iii. Articulation of the entity’s policies or approach to manage commodity, foreign
exchange or interest rate risks, such as through the use of forward contracts, interest
rate swaps, or other financial instruments.
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iv. Descriptions of the nature of off-balance sheet arrangements.
v. Descriptions of guarantees, indemnifications, contractual obligations, litigation or
environmental liability cases, and other contingencies, including management’s
qualitative assessments of the entity’s related exposures.
vi. Descriptions of changes in legal or regulatory requirements, such as new tax or
environmental regulations, that have materially impacted the entity’s operations or
fiscal position, or will have a material impact on the entity’s future financial prospects.
vii. Management’s qualitative assessments of the impacts of new financial reporting
standards that have come into effect during the period, or will come into effect in the
following period, on the entity’s financial results, financial position and cash flows.
viii. General descriptions of the business environment and outlook.
ix. Overview of strategy.
x. Descriptions of trends in market prices of key commodities or raw materials.
xi. Contrasts of supply, demand and regulatory circumstances between geographic
regions.
xii. Explanations of specific factors influencing the entity’s profitability in specific
segments.
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viii. Verify the system of payment of salaries and other benefits to the employees and ensure
that statutory requirements are complied with.
ix. Verify the payments effected in respect of the maintenance of the building and ensure
the same is in order.
x. Verify the insurance premium paid and ensure it covers the entire assets.
8. As per NSA 265, Communicating Deficiencies in Internal Control to Those who charged with
Governance and Management, the auditor shall include in the written communication of
significant deficiencies in internal control -
I. A description of the deficiencies and an explanation of their potential effects; and
II. Sufficient information to enable those charged with governance and management to
understand the context of the communication. In other words, the auditor should
communicate material weaknesses to the management or the audit committee, if any, on a
timely basis.
This communication should be, preferably, in writing through a letter of weakness or
management letter.
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Important points with regard to such a letter are as follows-
a) The letter lists down the area of weaknesses in the system and offers suggestions for
improvement.
b) It should clearly indicate that it discusses only weaknesses which have come to the
attention of the auditor as a result of his audit and that his examination has not been
designed to determine the adequacy of internal control for management.
c) This letter serves as a valuable reference document for management for the purpose of
revising the system and insisting on its strict implementation.
d) The letter may also serve to minimize legal liability in the event of a major defalcation
or other loss resulting from a weakness in internal control.
9. 'Due Diligence' is a term that is often heard in the corporate world these days in relation to
corporate restructuring. The purpose of due diligence is to assist the purchaser or the investor
in finding out all he can, reasonably about the business he is acquiring or investing in prior to
completion of the transaction including its critical success factors as well as its strength and
weaknesses.
Due diligence is an all pervasive exercise to review all important aspects like financial, legal,
commercial, etc. before taking any final decision in the matter. As far as any hidden liabilities
or overvalued assets are concerned, this shall form part of such a review of Financial
Statements.
Normally, cases of hidden liabilities and overvalued assets are not apparent from books of
accounts and financial statements. Review of financial statements does not involve
examination from the view point of extraordinary items, analysis of significant deviations, etc.
However, in order to investigate hidden liabilities, the auditor should pay his attention to the
following areas:
• The company may not show any show cause notices which have not matured into demands,
as contingent liabilities. These may be material and important.
• The Company may have sold some subsidiaries/businesses and may have agreed to take
over and indemnify all liabilities and contingent liabilities of the same prior to the date of
transfer. These may not be reflected in the books of accounts of the company.
• Product and other liability claims; warranty liabilities; product returns/discounts;
liquidated damages for late deliveries etc. and all litigation.
• Tax liabilities under direct and indirect taxes.
• Long pending sales tax assessments.
• Pending final assessments of customs duty where provisional assessment only has been
completed.
• Agreement to buy back shares sold at a stated price.
• Future lease liabilities.
• Environmental problems/claims/third party claims.
• Unfunded gratuity/superannuation/leave salary liabilities; incorrect gratuity valuations.
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• Huge labour claims under negotiation when labour wage agreement has already expired.
• Contingent liabilities not shown in books.
Regularly Overvalued Assets:
The auditor shall have to specifically examine the following areas:
• Uncollected/uncollectable receivables.
• Obsolete, slow non-moving inventories or inventories valued above NRV; huge
inventories of packing materials etc. with name of company.
• Underused or obsolete Plant and Machinery and their spares; asset values which have been
impaired due to sudden fall in market value etc.
• Assets carried at much more than current market value due to capitalization of
expenditure/foreign exchange fluctuation, or capitalization of expenditure mainly in the
nature of revenue.
• Litigated assets and property.
• Investments carried at cost though realizable value is much lower.
• Investments carrying a very low rate of income / return.
• Infructuous project expenditure/deferred revenue expenditure etc.
• Group Company balances under reconciliation etc.
• Intangibles of no value.
10. Data Mining Techniques: It is a set of assisted techniques designed to automatically mine large
volumes of data for new, hidden or unexpected information or patterns.
Data mining techniques are categorized in three ways:
• Discovery,
• Predictive modelling and
• Deviation and Link analysis
It discovers the usual knowledge or patterns in data, without a predefined idea or hypothesis
about what the pattern may be, i.e. without any prior knowledge of fraud. It explains various
affinities, association, trends and variations in the form of conditional logic.
11. Following are the certain illustrative points, Auditors are required to follow during The Audit
of Accounting of Premiums:
Collection of Premium:
• Check whether there is daily reconciliation process to reconcile the amounts collected,
entered into the system and deposited into the bank.
• Check that there is appropriate mechanism to ensure all the collections are deposited
into the Bank on timely basis.
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Calculation of Premium:
• Check that Accounting system, employed by the Company, calculates premium
amounts and its respective due dates correctly.
• Check that system employed as such is equipped to calculate all types of premium
modes correctly.
Recognition of Income:
• Check that premium is recognized only on the basis of ‘Issued Policies’ and not on
underwriting dates.
• Check that there is inbuilt mechanism the system all the premium collected are
correctly allocated all various components of the Policies.
• Check that there is appropriate mechanism in place to conduct reconciliation on daily
basis and reconciling items, if any, are rectified/ followed up.
Accounting of Advance Premium:
• Check, whether system has capability to identify regular and advance premium.
• Check whether there is a process of applying advance premium to a contract when
premium is due.
Reporting of Premium figures to Nepal Insurance Authority:
• Check the methodology for generation of MIS from the system and there is no manual
intervention.
• Check the procedure for Maker/ Checker before finalizing the MIS.
• Check whether there is a reconciliation process between premiums Income as per
financials and as reported.
Other Areas:
• Check whether there are appropriate SOPs developed by the Companies and are strictly
followed by all the departments/ branches of the Company.
• Ensure duly approved Delegation of Authority parameters matrix already in place for
authorization limits.
• Premium recognition and refund of premium are independent processes with adequate
segregation of duties amongst the personnel.
• Check that the Company conducts premium reconciliation on daily basis.
• Check the robustness of interface between administration and accounting system.
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(viii) Pricing. There is a complex system of pricing and a large number of sales agents, and
Teti Airlines is at risk of operating at a sales value less than required to cover costs (for
example, if too many of the cheapest tickets are sold).
(ix) Safety. The airline industry has stringent safety conditions and Teti Airlines may face
customer boycott or difficulty in recruiting staff if safety requirements are not met.
(x) Fuel. The aircraft cannot fly without fuel, which can be a scarce or high-cost resource. If
fuel prices escalate due to world conditions, the company might not be able to meet the costs
of operating.
14. In the present case, CA Shaquile O’Niel is unable to obtain sufficient and appropriate audit
evidence with respect to the following:
• The balance confirmation with respect to debtors amounting to Rs. 150 crores is not
available. Further there has been default in payment by the debtors and the provision so
made is not adequate. The audit team is also unable ascertain the carrying value of trade
receivables.
• With respect to 40% of the company’s inventory, neither the physical verification has been
done by the management nor are adequate inventory records maintained. The audit team is
also unable to undertake the physical inventory count as such the value of inventory could
not be verified.
In the above two circumstances the auditor is unable to obtain sufficient appropriate audit
evidence on which to base the opinion, and the possible effects on the financial statements of
undetected misstatements, if any, could be both material and pervasive. Thus, CA Shaquile
O’Niel should give a Disclaimer of Opinion.
The relevant extract of the Disclaimer of Opinion Paragraph and Basis for Disclaimer of
Opinion paragraph is as under:
Disclaimer of Opinion
We do not express an opinion on the accompanying financial statements of PQR Ltd. Because
of the significance of the matters described in the Basis for Disclaimer of Opinion section of
our report, we have not been able to obtain sufficient appropriate audit evidence to provide a
basis for an audit opinion on these financial statements.
Basis for Disclaimer of Opinion
We are unable to obtain balance confirmation with respect to the debtors amounting to Rs.
150 crores. Further, there have been defaults on the payment obligations by debtors on the
due dates during the year under audit. The Company has created a provision for doubtful debts
to the tune of Rs. 25 Cr. during the year under audit which is inadequate in the circumstances
of the company. The carrying value of trade receivables could not be ascertained.
Further, in respect of Inventories (which constitutes 40% of the total assets of the company),
during the reporting period, the management has not undertaken physical verification of
inventories at periodic intervals. Also, the Company has not maintained adequate inventory
records at the factory. We were unable to undertake the physical inventory count and as such
the value of inventory could not be verified.
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15. Self Interest Threat: Self-interest threats, which may occur as a result of the financial or other
interests of a professional accountant or of a relative.
Circumstances that may create self-interest threats
• A financial interest in a client or jointly holding a financial interest with a client.
• Undue dependence on total fees from a client.
• Having a close business relationship with a client.
• Concern about the possibility of losing a client.
• Potential employment with a client.
• Contingent fees relating to an assurance engagement.
Self-Review Threat: Self-review threats, which may occur when a previous judgment needs
to be re- evaluated by the professional accountant responsible for that judgment;
Circumstances that may create self-review threats
• The discovery of a significant error during a re-evaluation of the work of the
professional accountant in public practice.
• Reporting on the operation of financial systems after being involved in their design or
implementation.
• Having prepared the original data used to generate records that are the subject matter
of the engagement.
• A member of the assurance team being, or having recently been, a director or officer
of that client.
• A member of the assurance team being, or having recently been, employed by the
client in a position to exert direct and significant influence over the subject matter of
the engagement.
• Performing a service for a client that directly affects the subject matter of the assurance
engagement.
16. The concept of an expectations gap between auditors and the public is a key lens through which
assertions such as this one can be viewed. The first part of the statement would appear to assert
that the auditor is in some way responsible for the failure of a company. This is not the case:
those charged with governance are responsible for risk assessment and risk management. It is
not the role of the auditor to become involved with the entity's risk management processes –
indeed, this could be deemed to constitute a management role, which would compromise the
auditor's independence.
However, it is true that the auditor should gain an understanding of the client's business; this
is a crucial requirement of NSAs. Amongst other things, it is necessary for an auditor to audit
management's assessment of the appropriateness of the going concern assumption, for which
a good understanding of the business risks faced by the client is necessary. The auditor must
judge whether the going concern assumption used is appropriate. However, this is never a
matter of cut-and-dried logic: it is a judgment, based on an assessment of risk. It is in the nature
of risk for there to be uncertainties, and it is in the nature of judgment to contain elements of
doubt.
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It is therefore to be expected that there will be cases where the auditor has judged the going
concern assumption to be appropriate, and yet the company fails within the year. The question
is not whether the assumption was proved correct by subsequent events, but whether the
auditor's assessment was reasonable and in line with auditing standards.
There is more scope for discussion on the question of whether auditors should do more to
highlight problems. This may be the responsibility of management; it would be possible for
regulators and setters of accounting standards to require increased disclosure on going concern.
For example, financial statements could be required to provide more narrative detail regarding
the risks faced by an entity.
At present, auditors should disclose the presence of material uncertainties over going concern
by way of an emphasis of matter paragraph in the auditor's report, and if they deem the
assumption to be inappropriate then the opinion would be modified. It may be possible for
these disclosures to be made clearer than they are, or for auditors to use their report to draw
users' attention to any parts of the financial statements that are significant to the assessment of
going concern.
In conclusion, it is unfair to require auditors to accept the blame for company failures which
are the proper responsibility of management, although it may be argued that more could be
done by auditors to highlight going concern problems where they exist.
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Inventory held by Masu Warehousing
Matters to consider
• Inventory is material to the statement of financial position, comprising 21% of total
assets, therefore the auditors need to obtain sufficient, appropriate audit evidence of its
valuation as at the year end.
• Inventory has increased from the year before by 51% which is very high – the reason
for this increase needs to be investigated further.
• A written representation from management on the value of inventory held at the year-
end is not sufficient audit evidence as there should be other more reliable audit evidence
available to confirm the Rs.10.1 million figure.
• If the inventory figure cannot be adequately verified, this may result in a limitation on
the scope of the audit, and a modification of the auditor's opinion on the grounds of an
inability to obtain sufficient appropriate audit evidence.
• Although the quantity of inventory held by Masu Warehousing can be provided, this
does not provide evidence of its valuation as at the year-end date. Given that inventory
comprises fish, it may be that some of the inventory might be damaged and therefore
its value would be less. Inventory may therefore be overstated in the financial
statements.
Audit evidence
• Written representation from management referring to the value of year-end inventory
• Correspondence between Galley Cold Store and Masu Warehousing regarding the
inventory held by Masu Warehousing on behalf of Galley Cold Store
• Masu's monthly returns of quantities held
• Correspondence relating to the health and safety issues preventing access to cold
storage areas
• Analytical procedures on inventory, such as month by month comparisons to the
previous year, to try to ascertain why the value of inventory has increased so much this
year
Residential apartment
Matters to consider
• The senior sales executive is a related party in accordance with related party disclosures
as he would be a member of key management.
• A related party transaction has therefore occurred by virtue of the senior sales executive
using the residential apartment of the company even though no money has exchanged
hands –a related party transaction is 'a transfer of resources, services or obligations
between a reporting entity and a related party, regardless of whether a price is charged'.
• NAS 24 requires related party transactions to be disclosed in the financial statements
as they are material by their nature. The standard details what is required for disclosure,
but it includes the names of the related parties, the relationships, the amounts involved
and a description of the transactions.
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Audit evidence
• Rental agreement to confirm charge of Rs.3,000 per month and identification of the
other party
• Deeds to confirm ownership of the apartment by Galley Cold Store
• Physical inspection of the apartment to confirm its existence and that it is being
occupied
• A written representation from the directors of Galley Cold Store to confirm all related
party transactions and that there are no others that need to be disclosed
• A written representation from the senior sales executive stating that he is occupying the
apartment rent-free
18. With parallel simulation, the auditor processes real client data on an audit program similar to
some aspect of the client’s program. The auditor compares the results of this processing with
the results of the processing done by the client’s program.
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19. General objectives of operational audit: It includes-
i) Appraisal of Controls.
ii) Evaluation of performance.
iii) Appraisal of objectives and plans and
iv) Appraisal of organizational structure.
i) Appraisal of controls: Operations and the results in which management is interested are
largely a matter of control. If controls are effective in design and are faithfully adhered to
the result that can be attained then they will be subject to the other limiting constraints in
the organization.
ii) Evaluation of performance: In the task of performance evaluation, an operational auditor
is heavily dependent upon availability of acceptable standards. The operational auditor
cannot be expected to possess technical background in so many diverse technical fields
obtaining even in one enterprise. Even when examining or appraising performance or
reports of performance the operational auditor’s mind is invariably fixed on control aspects.
iii) Appraisal of objectives and plans: In performance appraisal, the operational auditor is
basically concerned not so much with how well technically the operations are going on,
but with accumulating information and evidence to measure the effectiveness, efficiency
and economy with which the operations are being carried on.
iv) Appraisal of organizational structure: Organizational structure provides the line of
relationships and delegation of authority and tasks. This is an important element of the
internal control design. In evaluating organizational structure, the operational auditor
should consider whether the structure is in conformity with the management objectives and
it is drawn up on the basis of matching of responsibility and authority. He should also
analyse whether line of responsibility has been fixed, whether delegation of responsibility
or authority is clear and there is no overlapping area.
20. Contents of an Audit Plan: The auditor shall develop an audit plan that shall include a
description of-
• The nature, timing and extent of planned risk assessment procedures, as determined under
NSA 315 Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and Its Environment.
• The nature, timing and extent of planned further audit procedures at the assertion level, as
determined under NSA 330, The Auditor’s Responses to Assessed Risks.
• Other planned audit procedures that are required to be carried out so that the engagement
complies with NSAs.
The audit plan is more detailed than the overall audit strategy that includes the nature, timing
and extent of audit procedures to be performed by engagement team members. Planning for
these audit procedures takes place over the course of the audit as the audit plan for the
engagement develops. For example, planning of the auditor's risk assessment procedures
occurs early in the audit process. However, planning the nature, timing and extent of specific
further audit procedures depends on the outcome of those risk assessment procedures. In
addition, the auditor may begin the execution of further audit procedures for some classes of
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transactions, account balances and disclosures before planning all remaining further audit
procedures.
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Paper-4
Corporate Laws
92
Nepal Chartered Accountants Act, 2053 & Regulation, 2061
Question No. 1
CA. Innovative is a new member of the Institute of Chartered Accountants of Nepal (ICAN). He
argues that alike registered auditors, the council shall categorize CA members as well into 3 classes
and limit in audit as per their categorization.
Give your opinion upon the validity of his argument pursuant to Nepal Chartered Accountants Act,
2053 & Rules, 2061.
Question No. 3
Birtamode Construction Company Pvt Ltd is a single shareholder private company. Unfortunately,
its shareholder Mr. X died in a plane crash with his wife at Pokhara. The shareholder had a son
Mr. Y and 2 daughters Ms A & Ms. B who were living jointly with their parents. Now, their
relatives are suggesting Mr. Y to get transfer the entire shares of his father Mr. X into his name on
the ground that being the single shareholder company, no any additional person can become its
shareholder and further he is the only son of their parents.
Give your opinion on the validity of the suggestion of the relatives in accordance with the
Companies Act, 2063.
Question No. 4
Kanyam Learning Ground is a company not distributing profit. Due to inconvenience in operation,
members of the company are planning to liquidate the company and donate the remaining assets
to a social organization operating the senior citizen shelter.
Give your opinion regarding the validity of the members’ plan for donating remaining assets to a
social organization in accordance with the Companies Act, 2063.
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Labour Act, 2074
Question No. 10
Ms. Active had been working properly at an enterprise for last 3 years. Suddenly, the general
manager of the enterprise handed over her an employment termination letter with a notice that she
need not continue her employment with effect from the next day. She argues that how her
employment can be terminated so easily providing just 1 day prior notice.
Now, give your opinion, if the argument of Ms. Active is valid in accordance with the Labour Act,
2074. Will your answer be different if Ms. Active had stolen a diamond statue of the enterprise?
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Insolvency Act, 2063
Question No. 14
The Court has appointed Ms. Positive as a liquidator of ABC Industry Ltd for conducting its
liquidation proceedings. After 3 months of her appointment, she is planning to make an application
to the Court to implement the restructuring program instead of liquidation. However, a shareholder
of the company objects her plan on the ground the decision of the court to liquidate the company
cannot be challenged.
Now, give your opinion upon the legal validity of the objection made by the shareholder in
accordance with the Insolvency Act, 2063.
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Arbitration Act, 2055
Question No. 18
At request of a disputing party Ms. A, their arbitrator made an interim order against Ms. B
prohibiting in meantime for selling her goats which are connected with the dispute. Ms. B being
dissatisfied with such decision claims the arbitrator is not entitled to make any such interim
decision.
Now, give your opinion regarding the validity of the arbitrator’s interim order pursuant to
Arbitration Act, 2055.
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Answers:
Nepal Chartered Accountants Act, 2053 & Regulation, 2061
Answer to Question No. 1
Legal provision:
As per section 30 of the Nepal Chartered Accountants Act 2053, notwithstanding anything
mentioned elsewhere in this Act, the Council, subject to this Act, Regulations and bye-regulations
framed under this Act, shall categorize the Registered Auditors existed at the commencement of
this section and shall issue Certificate of Practice to carry out audit service as per the provisions
of this Act. Provided that such Registered Auditors shall not be deprived of the privileges provided
under the Auditors' Act, 1974.
Further, as per section 30A of the NCA Act, the limit of audit, entitled to a Registered Auditor
member holding a Certificate of Practice categorized pursuant to Section 30, shall be as prescribed
by the council taking approval of the Government of Nepal.
Case:
In the given case, CA. Innovative is a new member of the Institute of Chartered Accountants of
Nepal (ICAN). He argues that alike registered auditors, the council shall categorize CA members
as well into 3 classes and limit in audit as per their categorization.
Analysis:
Section 30 of the NCA Act has mandated the council to categorize only the Registered Auditors
existed at the commencement of this section and issue Certificate of Practice (COP) to carry out
audit service as per the provisions of this Act, not chartered accountant members. In addition,
section 30A of idem Act has entitled the council, taking approval of the Government of Nepal, to
limit audit for Registered Auditor members holding COP categorized pursuant to Section 30, not
chartered accountant members.
Conclusion:
Hence, the argument of CA. Innovative for categorizing CA members as well into 3 classes and
limiting their audit as per their categorization alike registered auditors is not valid in accordance
with section 30 & 30A of the Nepal Chartered Accountants Act, 2053.
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where the other heirs transfer the title to only one heir, and the memorandum of association
and articles of association of the company shall be amended on that basis.
Provided, however, that where there arises a question of entitlement, such matter shall be
governed by a judgment of the competent court.
In the given case, Birtamode Construction Company Pvt Ltd is a single shareholder private
company. Its shareholder Mr. X died in a plane crash with his wife. He had a son Mr. Y and 2
daughters Ms. A & Ms. B who were living jointly with their parents. Now, their relatives are
suggesting Mr. Y to get transfer the entire shares of his father Mr. X into his name on the ground
that being the single shareholder company, no any additional person can become its shareholder
and further he is the only son of their parents.
While analysing the given case pursuant to section 153 of the Act:
(1) As per section 153(1) of idem Act, in the event of death of the shareholder Mr. X, his son and
2 daughters Ms. A & Ms. B living jointly being heirs of equal position pursuant to National
Civil Code, 2074 are equally entitled to acquire the right of shareholder. Hence, in addition to
his son Mr. Y, his 2 daughters are also entitled to acquire the share of Birtamode Construction
Company Pvt Ltd equally.
(2) As per section 153(4) of idem Act, though Birtamode Construction Company Pvt Ltd is a
single shareholder company, except where the other 2 heirs viz. Ms A & Ms. B transfer the
title on shares to their brother Mr. Y only, all 3 heirs of Mr. X shall be considered to be the
directors of company for the time being. Then, they have to amend the memorandum of
association and articles of association of the company for converting the single shareholder
company into multiple shareholder company.
Hence, the suggestion of the relatives that only the son of the deceased shareholder is entitled to
acquire his share and the company with single shareholder cannot have more than 1 shareholder
at all is not in accordance with section 153 of the Companies Act, 2063.
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(e) The company shall obtain prior approval of the Office to change objectives.
(f) Any company not distributing profits shall not be merged with any company distributing
profits.
(g) The members of a company incorporated under this Chapter shall elect the directors from
amongst themselves in such number as fixed in the articles of association, on the basis of one
member one vote.
(h) The meeting allowance, salary, facility receivable by the officers of a company incorporated
under this Chapter and the incorporation and operational expenses of the company shall not
exceed the amount as specified by the Office; and in so specifying expenses, the Office shall
have regard to the capital situation and profits of such company.
Provided, however, that administrative expenses shall not be more than twenty five percent of
total expenses.
(i) In the event of liquidation or cancellation of registration of a company incorporated under this
Chapter, the assets of the company, if any, remaining after the settlement of the debts and
liabilities of the company shall be dealt with as per the provision, if any, contained in its articles
of association, and failing such provision, such assets shall devolve on the Government of
Nepal.
Provided that such assets shall, in no way, devolve on any institution or company where a
promoter or member of such company or his/her close relative or close relative of such relative
is a promoter or member.
In the given case, Kanyam Learning Ground is a company not distributing profit. Due to
inconvenience in operation, members of the company are planning to liquidate the company and
donate the remaining assets to a social organization which is operating the senior citizen shelter.
As per clause (i) of section 167(1) of the idem Act, in the event of liquidation of Kanyam Learning
Ground, the assets of the company, if any, remaining after the settlement of the debts and liabilities
of the company shall be dealt with as per the provision, if any, contained in its articles of
association, and failing such provision, such assets shall devolve on the Government of Nepal.
Provided, however, that the social organization should not have a member or promoter who is a
promoter or member of Kanyam Learning Ground or his/her close relative or close relative of such
close relative.
Hence, as per section 167(1) of idem Act, the plan of members of Kanyam Learning Ground to
donate the remaining assets after its liquidation is valid on the condition:
(1) Its AOA has clearly mentioned about such provision and
(2) The recipient social organization should not have a member or promoter who is already a
promoter or member of liquidating Kanyam Learning Ground or his/her close relative or close
relative of such close relative.
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(a) To make or publish any statements or projection related statements with knowledge that such
a statement is false, misleading or fake,
(b) To hide any fact or information with mala fide intention,
(c) To make or publish a false or misleading statement, promise or projection with mala fide
intention.
Further, section 102 of idem Act prescribes about the following provision regarding the
investigation and filing of a case:
(1) If a complaint is made by any one that any one has committed the offense referred to in Sections
91, 94, 95, 96, 97, 98, 99 and 100 or the Board receives in any manner an information relating
to such an offense or the Board believes that any one has committed such an offense, the Board
may designate any officer as an investigating authority to conduct investigations of the case
relating to such an offense.
(2) The investigating authority designated pursuant to Sub-section (1) shall conduct investigations
as prescribed in relation to such an offense and file a case in the concerned District Court within
35 days after the date of completion of investigations.
(3) The investigating authority designated pursuant to Sub-section (1) may, in the course of
conducting investigation, make necessary inquiry with, take depositions of, any person or body
related with the offense or demand necessary documents, statements and records from such
person or body.
(4) The designated investigating authority shall, in conducting investigation of and filing a case
pursuant to this Section, shall obtain advice of the government attorney.
In the given case, Mr. Expert is an active Facebook user. He wants to buy shares of a listed
company XYZ Ltd. However, its market price is very high in the stock exchange. So, he wrote a
misleading statement in his Facebook page stating that “Market price of XYZ Ltd is going to be
decreased drastically due to internal conflict of management. Hence, in order to preclude loss, it
would be better if its shareholders sell shares as soon as possible”. On the ground of such statement,
the Securities Board of Nepal is planning to conduct an investigation and file case to punish him.
As per section 97 of idem Act, publishing a misleading statement about XYZ Ltd by Mr. Expert
with an intention to incite others to sell its securities shall be deemed to have committed an offense
of misleading. In such case, the Board may designate any officer as an investigating authority to
conduct investigations of the case relating to such an offense and file case to the District Court
under section 102 of the Act.
Hence, in my opinion, the plan of SEBON to conduct an investigation against the misleading
information of Mr. Expert and file case to punish him is valid in accordance with section 97 and
102 of the Securities Act, 2063.
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for general reserve fund pursuant to Section 44 and until complete sale of shares to be allotted to
the general public.
In the given case, Tinjure Micro Finance Financial Institution Ltd, a newly licensed financial
institution, has earned a huge amount of surplus in F/Y 2078/79. So, its Board of Directors
proposed the Nepal Rastra Bank for granting approval to declare 20% dividend to its promoter
shareholders. However, NRB refused to grant the approval on the ground it has not allotted shares
to general public yet.
As per section 47 of idem Act, the Nepal Rastra Bank is entitled to disallow Tinjure Micro Finance
Financial Institution to declare or distribute dividends to its shareholders until it completes the sale
of shares to be allotted to the general public.
Hence, the action of Nepal Rastra Bank disallowing Tinjure Micro Finance Financial Institution
to declare and distribute dividend until it allots its shares to the general public completely is valid
pursuant to section 47 of the Banks & Financial Institution Act 2073.
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be as approved by GoN and the pictures invisible at note, internal security arrangements, the
materials for printing banknotes and other materials shall be as decided by the Board of NRB.
In the given case, an agenda for printing bank notes with denomination of NPR 2,000 was proposed
at recent Board meeting of NRB. Favouring the necessity of such high denominated bank notes,
the agenda was passed unanimously.
As per section 52 of idem Act, NRB has power to issue bank notes and coins in Nepal. However,
while issuing banknotes, the denomination shall be as approved by the Government of Nepal.
Decision of the Board of Directors of Nepal Rastra Bank is not enough to print bank notes with
new denomination.
Hence, the decision made by the Board of Directors of NRB for printing bank note of new
denomination NPR 2,000 is invalid in accordance with section 52 of Nepal Rastra Bank Act, 2058
and hence void ab initio.
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Labour Act, 2074
Answer to Question No. 10
Section 144 of the Labour Act, 2074 prescribes following provisions regarding the period of notice
to be given prior to the termination of the contract:
(1) Prior to terminating the employment relation in any circumstance except when employment
is terminated upon action taken for misconduct, the employer or labour shall give a notice
as follows to each other:
(a)Prior to at least 1 day, in the case of employment for a maximumof 4 weeks,
(b) Prior to at least 7 days, in the case of employment for a periodof 4 weeks to one year,
and
(c)Prior to at least 30 days, in the case of employment for a period of more than 1 year.
(2) Where the employer terminates employment without giving the notice referred to in sub-
section (1), the employer shall pay the amount equal tothe remuneration for the period
requiring the notice to be given to the concerned labour.
(3) Where the labour terminates employment without giving a notice to the employer pursuant
to sub-section (1), the employer may deduct the amount equal to the remuneration for the
period requiring the notice to be so given from the remuneration payable to the concerned
labour.
Further, as per section 131(4) of idem Act, a labour may be dismissed from the service on the
ground of misconduct if he or she steals anyone’s property in the workplace. However, as per
section 135 of idem Act, prior to imposing such punishment on any labour for misconduct, the
authority imposing punishment shall provide such a labour with a notice giving opportunity to
submit clarification within a period of seven days, and such a notice shall clearly state also the
facts of commission of the misconduct and possible punishment imposable if it is proved.
In the given case, Ms. Active had been working properly at an enterprise for last 3 years. Suddenly,
the general manager of the enterprise handed over her an employment termination letter with a
notice that she need not continue her employment with effect from the next day. She argues that
how her employment can be terminated so easily providing just 1 day prior notice.
As per section 144(1) of the Labour Act 2074, in the case of employment for a period of more
than 1 year, prior to terminating the employment relation in any circumstance except when
employment is terminated upon action taken for misconduct, the employer or labour shall give
a 30 days prior notice to counter party. However, if the employer terminates employment without
giving the notice referred to in sub-section (1), the employer shall pay the amount equal to
the remuneration for the period requiring the notice to be given (i.e. 30 days remuneration in the
given case) to the concerned labour.
In addition, as per section 131(4) of idem Act, stealing a diamond statue of the enterprise is a
misconduct attracting dismissal punishment. However, as per section 135 of idem Act, prior to
imposing such dismissal punishment on Ms. Active, the general manger shall provide a notice
giving opportunity to submit clarification within a period of 7 days, clearly stating the facts of
commission of the misconduct and possible punishment imposable if it is proved.
Further, as per section 135 of the idem Act, prior to imposing punishment on any labour for
misconduct, the authority imposing punishment shall provide such a labour with a notice giving
opportunity to submit clarification within a period of seven days, and such a notice shall clearly
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state also the facts of commission of the misconduct and possible punishment imposable if it
is proved.
Hence, being the employment period of Ms. Active more than 1 year, prior notice of at least 30
days would have been provided by the general manager to her. Hence, her argument is valid as
providing 1 day prior notice for the termination of contract even while working properly is not
consistent with section 144 of idem Act. In such event, Ms. Active is entitled to claim
compensation equivalent to salary of 30 days.
In addition, if Ms. Active had stolen a diamond statue of the enterprise, the general manager could
have authority to dismiss her from the employment by allowing at least 7 days period for presenting
clarification. Hence, even if she had done the misconduct, giving one day prior notice of
employment termination without providing opportunity to defend would be invalid pursuant to
section 135 of idem Act.
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So, the chief of the Department is complaining against the investigation officer that she cannot
arrest anyone without furnishing its prior information to him. The chief is accusing that the
investigation officer is doing what she likes disobeying the law.
As per proviso clause under section 17(6) of idem Act, Ms. Prana is entitled to arrest Ms Shun if
requires even without furnishing prior information to the chief of the department. However,
immediately after arresting her, she shall provide its information to the chief of the department as
soon as possible.
Hence, complain of the chief of the department is not valid at all times in accordance with section
17(6) of the Money Laundering Prevention Act, 2064.
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(p) Circumstances in which the procurement contract may beterminated,
(q) Provision whether sub-contracting can be made or not,
(r) Mechanism for the settlement of disputes,
(s) The governing law, and
(t) Other matters as prescribed.
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Arbitration Act, 2055
Answer to Question No. 18
Section 21 of the Arbitration Act, 2055 prescribes about the powers of arbitrator which are as
follows:
(1) The powers of the arbitrator shall be as follows, except when otherwise provided for in the
agreement:
(a) To direct the concerned parties to appear before him/her to submit documents, and record
their statements as required.
(b) To record statements of the witness.
(c) To appoint expert and seek their opinion or cause examination on any specific issue.
(d) In case party is a foreign national so that the decision pronounced by the arbitrator is not
likely to be implemented for that reason, to obtain a bank guarantee or any other
appropriate guarantee as determined by the arbitrator.
(e) To inspect the concerned place, object, product, structure, production process or any other
related matter which are connected with the dispute on the request of the parties or on
his/her own initiative if he/she so deems appropriate, and in case there is any material or
object which is likely to be destroyed or damaged, to sell them in consultation with the
parties, and keep the sale proceeds as a deposit.
(f) To exercise any specific power conferred by the parties.
(g) To issue preliminary orders or interim or inter locating orders in respect to any matter
connected with the dispute on the request of any party, or take a conditional decision.
(h) To issue certified copy of document.
(i) To exercise the other power conferred by this Act.
(2) Any party which is not satisfied with the order issued by the arbitrator pursuant to Clause (g)
of Sub-section (1) may submit an application to the high court within 15 days, and the decision
made by the High Court shall be final.
In the given case, at request of a disputing party Ms. A, the arbitrator made an interim order against
Ms. B prohibiting in meantime for selling her goats which are connected with the dispute. Ms. B
being dissatisfied with such decision claims the arbitrator is not entitled to make any such interim
order.
As per section 21 of the Act, the arbitrator has power to issue an interim order prohibiting Ms. B,
in meantime, to sell her goats which are connected with the dispute on the request of disputing
party Ms. A.
Hence, in my opinion, the interim order of Arbitrator against Ms. B is valid pursuant to section
21(1) of the Arbitration Act, 2055. If she is dissatisfied with such decision, she may submit
an application to the high court within 15 days pursuant to section 21(2) of the Act.
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failed to renew its registration certificate at the concerned District Administration Office on time.
So, suddenly it got a notice from the Nepal Rastra Bank that its license has been cancelled.
As per section 19(1) of the Act, Nepal Rastra Bank is entitled to cancel the license of financial
intermediary on the ground Makalu Rural Financial Society did not renew its registration
certificate at District Administration Office on time. However, as per section 19(3) of the Act, the
NRB should have given an opportunity to Makalu Rural Financial Society for submitting its
explanation.
Hence, in my opinion, Nepal Rastra Bank has power to cancel the financial intermediary license
after providing opportunity to defend pursuant to section 19 of the Act relating to Institutions
acting as Financial Intermediary, 2055.
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