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Past papers/ Taxation/ May 2012
Paper 7 Qs
Question Paper · May 2012

CA Inter Taxation

This page contains all 7 questions from the CA Inter Taxation Question Paper for the May 2012 attempt cycle, sourced from VSI Jaipur.

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Q.1 20 marks very hard ⚡ Try this Q →
Multiple case scenarios requiring financial analysis and calculations
CTTP

Worked Solution

✓ Verified

(a) AK Limited — Production Budget and Break-Even

(i) Quarterly Production Budget:

Total annual sales = 18,000 + 22,000 + 35,000 + 27,000 = 1,02,000 units
Total production required = 1,02,000 + 8,000 (closing) − 6,000 (opening) = 1,04,000 units

Production formula: 70% of current quarter sales + 30% of next quarter sales.

QuarterCurrent Qtr Sales70%Next Qtr Sales30%Production (units)
I18,00012,60022,0006,60019,200
II22,00015,40035,00010,50025,900
III35,00024,50027,0008,10032,600
IV————26,300 (balancing)
Total1,04,000

Closing inventory verification: Q1: 6,000+19,200−18,000=7,200 → Q2: 11,100 → Q3: 8,700 → Q4: 8,000 ✓

(ii) Break-Even Point in Q1:

Note: The question states raw material at 20 units @ ₹40 = ₹800, which exceeds the selling price of ₹40; this appears to be a data error. Assuming variable (raw material) cost = ₹20 per unit.

Selling price = ₹40 | Variable cost = ₹20 | Contribution per unit = ₹20
P/V Ratio = ₹20/₹40 = 50%
Fixed overhead per quarter = (17,000 hours × ₹2) ÷ 4 = ₹8,500
BEP (units) = ₹8,500 ÷ ₹20 = 425 units
BEP (₹ sales) = 425 × ₹40 = ₹17,000

Since Q1 sales budget is 18,000 units (well above BEP of 425 units), the company is expected to comfortably achieve and surpass break-even in Q1.

---

(b) Machine Hour Rate

Note: Scrap value stated as ₹90 lacs for a machine costing ₹10 lacs is clearly a data error; assumed scrap value = ₹90,000.

Annual Cost Statement for New Machine:

ItemCalculationAmount (₹)
Depreciation (SLM)(10,00,000 − 90,000) ÷ 1091,000
Repairs & MaintenanceGiven5,000
Power4,200 hrs × 5 units × ₹3.2568,250
Rent₹2,400 × 12 × 1/102,880
Total Annual Cost1,67,130

Effective (productive) hours = 4,200 − 200 = 4,000 hours

Machine Hour Rate = ₹1,67,130 ÷ 4,000 = ₹41.78 per hour

---

(c) RES Ltd. — M&M Model with Taxes

Given: V_U = ₹25,00,000; k_e(U) = 16%; Debt (D) = ₹25,00,000 at k_d = 15%; Tax rate (T) = 30%

Levered firm value (M&M with taxes):
V_L = V_U + T×D = 25,00,000 + (0.30 × 25,00,000) = ₹32,50,000
Equity value (S) = 32,50,000 − 25,00,000 = ₹7,50,000

EBIT = V_U × k_e(U) = 25,00,000 × 16% = ₹4,00,000

(i) EPS (Earnings available to equity shareholders):
EBIT: ₹4,00,000
Less: Interest (25,00,000 × 15%): ₹3,75,000
EBT: ₹25,000
Less: Tax @ 30%: ₹7,500
EAT (Earnings to equity) = ₹17,500

(ii) Cost of Equity (k_e_L) — M&M Proposition II with Taxes:
k_e_L = k_e_U + (k_e_U − k_d)(1−T)(D/S)
= 16% + (16%−15%)(1−0.30)(25,00,000/7,50,000)
= 16% + 1% × 0.70 × 3.333
= 16% + 2.33% = 18.33%

(iii) Weighted Average Cost of Capital:
WACC = k_d(1−T)(D/V_L) + k_e_L(S/V_L)
= 15%(0.70)(25,00,000/32,50,000) + 18.33%(7,50,000/32,50,000)
= 10.5% × 0.7692 + 18.33% × 0.2308
= 8.08% + 4.23% = 12.31%

Comment: WACC declines from 16% (unlevered) to 12.31% (levered). In the M&M framework with corporate taxes, the tax shield on debt (₹7,50,000) increases firm value. WACC continuously falls as debt increases, implying the optimal capital structure under M&M with taxes is maximum debt (100% debt financing).

---

(d) Credit Terms Evaluation — RES Ltd.

Should the company liberalise credit terms from 1/10 n/45 to 2/10 n/45?

Incremental Analysis:

ParticularsExistingProposedIncrement
Credit Sales (₹)12,00,00036,00,00024,00,000
Contribution @50% (₹)6,00,00018,00,000+12,00,000
Bad Debts12L×1.5%=18,00036L×2%=72,000(54,000)
Cash Discount12L×50%×1%=6,00036L×40%×2%=28,800(22,800)

Investment in Debtors:
Current = (12,00,000 × 50% ÷ 360) × 30 = ₹50,000
Proposed = (36,00,000 × 50% ÷ 360) × 20 = ₹1,00,000
Incremental investment = ₹50,000
Opportunity cost = ₹50,000 × 15% = (₹7,500)

Net Benefit Statement:

Particulars₹
Incremental Contribution12,00,000
Less: Incremental Bad Debts(54,000)
Less: Incremental Cash Discount(22,800)
Less: Opportunity Cost on incremental debtors(7,500)
Net Benefit (Pre-Tax)11,15,700
Less: Tax @ 30%(3,34,710)
Net Benefit (After Tax)₹7,80,990

Decision: The company SHOULD change its credit terms. The liberalisation generates a positive net after-tax benefit of ₹7,80,990, primarily driven by a 3x increase in sales, despite higher bad debts and discount costs.

PLAN

Write it like this

Time target 36 min

1The skeleton

- Split your 40 minutes by marks before writing a single number — 4 parts × ~5 marks each means ~9 minutes per part; if you blow 15 minutes on production budget you're gifting the examiner easy marks in (c) and (d) for free.
- Open every sub-part with the formula/approach line — write 'Production = 70% of current quarter sales + 30% of next quarter sales' BEFORE the table, because examiners award method marks even if your arithmetic slips.
- Present all calculations in a structured tabular format — for Machine Hour Rate, your cost statement must be a two-column table (Item | Amount ₹); a paragraph of numbers scores zero for presentation marks.
- In M&M, write the full formula first, then substitute — 'k_e_L = k_e_U + (k_e_U − k_d)(1−T)(D/S)' on its own line before numbers, so the examiner sees you know the formula even if you make an arithmetic error downstream.
- End every decision question with a boxed/bold one-line verdict — for credit terms, write 'Decision: The company should liberalise credit terms as the net after-tax benefit is ₹7,80,990' as the last line; examiners are trained to look for this and tick it as a separate mark.
- Flag data anomalies with a one-line assumption, then move on — don't waste time debating; write 'Assuming scrap value = ₹90,000 (₹90 lacs appears to be a data error)' and proceed, because showing logical assumption-handling itself fetches marks.

2Examiner-rewarded phrases

“Incremental contribution less incremental costs — net benefit/(loss) from proposed credit policy”“Machine Hour Rate = Total Machine Cost (excluding idle time) / Effective (Productive) Machine Hours”“As per M&M Proposition II with corporate taxes, V_L = V_U + T×D, and the tax shield increases firm value”

3Common trap

Don't fall for this

The deadliest trap here is mixing up 'total hours' vs 'effective hours' in Machine Hour Rate — most students divide by 4,200 hours instead of 4,000, losing the mark entirely even though every rupee in the numerator is correct. Same energy in (d): students forget to apply the P/V ratio to incremental sales and instead use full sales as incremental contribution — your incremental contribution is only 50% of ₹24,00,000, not the full ₹24 lakhs.

Q.2(a) 08 marks hard Contract Costing ⚡ Try this Q →
A contractor commenced a contract on 1-7-2011. The costing records concerning the said contract reveal the following information as on 31-3-2012: Material sent to site: ₹ 7,74,300 Labour paid: ₹ 10,70,000 Labour outstanding as on 31-3-2012: ₹ 1,02,500 Salary to Engineer: ₹ 20,500 per month Salary to Supervisor: ₹ 7,71,000 Salary to Supervisor: ₹ 9,000 per month (3/4 time devoted to contract) Administration & other expenses: ₹ 4,60,600 Prepaid Administration expenses: ₹ 10,000 Material in hand at site on 31-3-2012: ₹ 7,34,400 Plant used for the contract has an estimated life of 7 years with residual value at the end of life of ₹ 50,000. Some of material costing ₹ 1,50,000 was found unissued on 31-3-2012. Two third of the contract was completed on 31-3-2012. Certificate amount so far issued and contractor has been paid ₹ 20,00,000 on account. Depreciation on plant if charged using half year basis.
CTTP

Worked Solution

✓ Verified

Contract Account for the period 1st July 2011 to 31st March 2012 (9 months)

Note on data: The entry 'Salary to Supervisor: ₹7,71,000' is treated as Plant at Cost: ₹7,71,000 (evidently a labelling error in the question, since plant life and residual value are given, requiring a plant cost figure; a supervisor salary of ₹7,71,000 for 9 months would be implausible relative to other costs).

Contract Account (Dr)

Particulars₹
To Materials sent to site7,74,300
To Labour paid10,70,000
To Labour outstanding1,02,500
To Engineer's salary (₹20,500 × 9)1,84,500
To Plant at cost7,71,000
To Supervisor's salary (₹9,000 × 9 × 3/4)60,750
To Administration expenses (₹4,60,600 – ₹10,000)4,50,600
To Notional Profit c/d40,250
Total34,53,900

Contract Account (Cr)

Particulars₹
By Material at site (closing)7,34,400
By Plant WDV (₹7,71,000 – ₹51,500)7,19,500
By Work Certified20,00,000
Total34,53,900

Notional Profit = ₹40,250

Profit transferred to Profit & Loss Account:
Since 2/3 of the contract is complete (exceeds 1/2), profit is recognized using the standard formula:

P&L Profit = 2/3 × Notional Profit × (Cash Received ÷ Work Certified)
= 2/3 × ₹40,250 × (₹20,00,000 ÷ ₹20,00,000)
= ₹26,833 (transferred to P&L)

Reserve (Profit retained in WIP) = ₹40,250 – ₹26,833 = ₹13,417

Balance Sheet Extracts as at 31st March 2012:

Fixed Assets: Plant WDV = ₹7,19,500

Current Assets:
- Material at site = ₹7,34,400
- Unissued material (Stores) = ₹1,50,000
- Prepaid administration expenses = ₹10,000
- WIP: Cost ₹19,59,750 + Profit recognized ₹26,833 – Amount received ₹20,00,000 = (₹13,417) → shown as liability

Current Liabilities:
- Labour outstanding = ₹1,02,500
- Advance from Contractee (excess of receipts over WIP value) = ₹13,417

Final Answer: Notional Profit = ₹40,250; Profit to P&L = ₹26,833; Reserve = ₹13,417

PLAN

Write it like this

Time target 14 min 24 sec

1The skeleton

- Label the Contract Account with the exact period ('1st July 2011 to 31st March 2012 — 9 months') — examiners scan the heading first; a missing period signals you don't understand the time-bound nature of contract costing.
- Show your depreciation working as a separate note before the account — write '(7,71,000 – 50,000) ÷ 7 × ½ = ₹51,500' explicitly, because 'half-year basis' is the deliberate trap in this question and step marks are only awarded if your working is visible.
- Explicitly state your assumption about Plant at Cost = ₹7,71,000 — one line like 'Note: Supervisor salary of ₹7,71,000 treated as Plant at Cost since plant life/residual value are given' protects every downstream mark from being cut.
- Before applying the profit formula, write the completion test: '2/3 > 1/2, therefore profit is recognised' — this single line of reasoning is what separates a 6/8 from an 8/8; the formula alone without the justification loses a presentation mark.
- Apply the exact formula in fraction form: 2/3 × NP × (Cash Received ÷ Work Certified) — write each component separately so the examiner can award partial credit even if your Notional Profit figure is slightly off.
- Close with Balance Sheet extracts showing WIP as a Current Liability when receipts exceed WIP value — most students skip this or show it as an asset; getting the sign right here is the final differentiator for full marks.

2Examiner-rewarded phrases

“Since the degree of completion exceeds one-half, profit transferred to Profit & Loss Account = 2/3 × Notional Profit × (Cash Received / Work Certified)”“Depreciation on plant is charged on half-year basis: (Cost – Residual Value) ÷ Estimated Life × 1/2”“Work-in-Progress = Cost of work certified + Profit recognised – Amount received from contractee”

3Common trap

Don't fall for this

The killer mistake here is using 9/12 for depreciation instead of 1/2 — 'half-year basis' means charge exactly half a year's depreciation regardless of how many months the plant was actually used, so the answer is (7,71,000 – 50,000) ÷ 7 × ½, NOT × 9/12. If you get this wrong, your Notional Profit, your P&L transfer, and your Balance Sheet WIP all cascade incorrectly — potentially losing 4–5 marks from one wrong assumption.

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Q.2(b) 08 marks hard Cash Flow Statement ⚡ Try this Q →
The Balance Sheet of X Ltd as on 31-1-2011 and 31-3-2012 are as under: Equity Share capital (at ₹ 10 each): 20,50,000 (2011); 22,00,000 (2012) General Reserve: 7,50,000 (2011); 6,00,000 (2012) Security premium: 50,000 (2011); 45,000 (2012) Profit & Loss A/c: 8,50,000 (2011); 3,10,000 (2012) 7% Debentures: 3,00,000 (2011); 2,00,000 (2012) Creditors: 1,50,000 (2011); 2,15,000 (2012) Provision for tax: 1,45,000 (2011); 1,65,000 (2012) Assets - Fixed Assets (including machinery): 20,50,000 (2011); 18,75,000 (2012) Stock: 7,10,000 (2011); 8,95,000 (2012) Debtors: 7,25,000 (2011); 9,80,000 (2012) Cash Balance: 1,25,000 (2011); 1,80,000 (2012) Preliminary Expenses: 35,000 (2011); 25,000 (2012) Additional Information: (i) Depreciation charge on fixed assets during the year was ₹ 2,05,000. An old machine costing ₹ 2,00,000 (WDV ₹ 80,000) was sold for ₹ 65,000 during the year. (ii) Provisions for tax made during the year for ₹ 1,78,000. (iii) On 1-4-2011 company redeemed debenture of ₹ 1,00,000 at a premium of 5%. (iv) Company has issued fully paid bonus shares of ₹ 2,00,000 by capitalization of profit. Prepare Cash Flow Statement.
CTTP

Worked Solution

✓ Verified

The Cash Flow Statement is prepared using the Indirect Method as per AS 3 (Revised) — Cash Flow Statements.

Net Loss Before Tax is derived from combined reserves analysis: Opening (P&L ₹8,50,000 + GR ₹7,50,000 + Sec. Premium ₹50,000) = ₹16,50,000; Closing = ₹9,55,000; Decrease = ₹6,95,000. Decrease explained by: Bonus capitalized ₹2,00,000 + Debenture redemption premium charged to Sec. Premium ₹5,000 + Provision for tax ₹1,78,000 + Net Loss = ₹3,12,000 (balancing figure).

Loss on Sale of Machinery: WDV ₹80,000 − Proceeds ₹65,000 = ₹15,000 loss (non-cash, added back).

Preliminary Expenses written off: ₹35,000 − ₹25,000 = ₹10,000 (non-cash, added back).

Fixed Asset Purchases: Opening WDV ₹20,50,000 + Purchases − Cost of disposed machine ₹2,00,000 − Depreciation ₹2,05,000 = Closing ₹18,75,000 → Purchases = ₹2,30,000.

Tax Paid: Opening provision ₹1,45,000 + Made during year ₹1,78,000 − Closing ₹1,65,000 = ₹1,58,000 paid.

Debenture Redemption: ₹1,00,000 at 5% premium = ₹1,05,000 cash outflow. The ₹5,000 premium charged to Securities Premium explains its fall from ₹50,000 to ₹45,000.

Bonus Shares of ₹2,00,000 issued by capitalization are a non-cash financing transaction under AS 3 para 32 — excluded from the statement body and disclosed as a note.

---

CASH FLOW STATEMENT OF X LTD (Indirect Method)

A. Cash Flow from Operating Activities
Net Loss before Tax: (3,12,000)
Add: Depreciation: 2,05,000
Add: Loss on sale of machinery: 15,000
Add: Preliminary expenses written off: 10,000
Operating Loss before Working Capital Changes: (82,000)
Increase in Stock: (1,85,000)
Increase in Debtors: (2,55,000)
Increase in Creditors: 65,000
Cash Used in Operations: (4,57,000)
Less: Income Tax Paid: (1,58,000)
Net Cash Used in Operating Activities (A): (6,15,000)

B. Cash Flow from Investing Activities
Purchase of Fixed Assets: (2,30,000)
Proceeds from Sale of Machinery: 65,000
Net Cash Used in Investing Activities (B): (1,65,000)

C. Cash Flow from Financing Activities
Redemption of 7% Debentures — Principal: (1,00,000)
Premium on Redemption (5% on ₹1,00,000): (5,000)
Net Cash Used in Financing Activities (C): (1,05,000)

Net Decrease in Cash (A+B+C): (8,85,000)
Opening Cash Balance: 1,25,000
Closing Cash Balance (per Balance Sheet): 1,80,000

Note 1 — Non-cash transaction: Bonus shares of ₹2,00,000 issued by capitalization of reserves is a non-cash financing activity disclosed separately per AS 3.
Note 2 — The given balance sheets do not balance in either year (2011: liabilities exceed listed assets by ₹6,50,000; 2012: assets exceed listed liabilities by ₹2,20,000), indicating missing items (possibly investments/bank borrowings). Accordingly, the cash flow statement does not reconcile to the stated closing balance of ₹1,80,000. All cash flows from the disclosed data are correctly captured above.

AS 3 (Revised) — Cash Flow Statements, ICAI
PLAN

Write it like this

Time target 14 min 24 sec

1The skeleton

- Start with a labelled Working Note: 'Net Profit/Loss before Tax' — derive it by combining all reserves into one pool (P&L + GR + Sec. Premium), then peel off bonus, redemption premium, and tax provision; the balancing figure IS the net loss. Examiners allocate 1-2 marks just for this working note existing at the top.
- Run a Fixed Assets T-account as a separate working note — plug in opening WDV, deduct cost of disposed asset and depreciation, set equal to closing WDV, and solve for purchases. Write it out explicitly; don't do it in your head or the examiner can't follow your ₹2,30,000.
- In Operating Activities, sequence matters: non-cash items first, then working capital changes, then tax paid — if you dump tax in the middle of adjustments you'll confuse the examiner and risk losing the sub-total mark for 'Cash Generated from Operations'.
- Flag Bonus Shares as a non-cash financing transaction in a Note, NOT inside Section C — one clean sentence citing AS 3 para 32 earns the disclosure mark without cluttering your financing section.
- Reconcile opening-to-closing cash in the last 2 lines — Net Change + Opening = Closing. This is the only self-checking mechanism available to you in the exam; if it doesn't tie, the examiner sees your error immediately. Write it even if it doesn't reconcile, and add a brief note explaining the discrepancy.

2Examiner-rewarded phrases

“as per AS 3 (Revised), cash flows are classified into operating, investing, and financing activities”“being a non-cash transaction, bonus shares issued by capitalisation of reserves are disclosed separately and excluded from the Cash Flow Statement”“tax paid during the year = opening provision + provision made during the year − closing provision”

3Common trap

Don't fall for this

The single biggest mark-killer here is treating the ₹2,00,000 bonus issue as a cash outflow in financing activities — nearly everyone does this. Bonus shares involve zero cash movement; put it only in a Note citing AS 3. Also watch out: the provision for tax figure given (₹1,78,000) is what was MADE, not what was PAID — use the T-account formula or you'll carry the wrong number into operating activities.

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Q.3(a) 08 marks hard Labour Costing - Incentive Schemes ⚡ Try this Q →
The management of a company wants to formulate an incentive plan for the workers with a view to increase productivity. The following particulars have been extracted from the books of company. Piece Wage rate: ₹ 10 Weekly working hours: 40 Hourly wages rate: ₹ 40 (guaranteed) Standard/normal time taken per unit: 15 minutes Actual work done in a week: Worker A - 176 pieces; Worker B - 140 pieces Differential piece rate: 80% of piece rate when output below normal and 120% of piece rate when output above normal. Under Haley scheme, worker gets a bonus equal to 50% of Wages of time saved. Calculate: (i) Earning of workers under Haley's and Rowan's premium scheme. (ii) Earning of workers under Taylor's differential piece rate system and Emerson's efficiency plan.
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Q.3b 08 marks hard Working Capital Management ⚡ Try this Q →
STN Ltd. is a ready-made garment manufacturing company. Its production cycle indicates that materials are introduced at the beginning of the production phase; wages and overhead accrue evenly throughout the period of cycle. The following figures for the 12 months ending 31st December 2011 are given: Production of shirts 54,000 units, Closing stock per unit ₹ 20, Duration of the production cycle 1 month, Raw material consumption 2 months, Finished goods stock held for 1 month, Credit allowed to debtors is 1.5 months and credit allowed by creditors is 1 month, Wages are paid in the next month following the month of accrual. In the work-in-progress 30% of wage and overheads are supposed to be conversion costs. The ratio of cost to sales price are - raw materials 60%, direct wages 10% and safety margin of 15% will be maintained. Calculate annual working capital required for the company on a cash cost basis.
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Q.6(b) 08 marks hard Financial Leverage and Capital Structure Analysis ⚡ Try this Q →
The capital structure of XYZ Ltd. is as follows: - Equity share capital of ₹10 each: 6,00,000 - 8% Preference share capital of ₹10 each: 6,25,000 - 10% Debenture of ₹100 each: 40,000 Additional Information: - Profit after tax (tax rate 30%): ₹ 1,82,000 - Operating expenses (excluding depreciation ₹ 90,000): being 1.50 times of EBIT - Equity share dividend paid: 15% - Market price per equity share: ₹ 20 Required to calculate: (i) Operating and financial leverage (ii) Cover the preference and equity share dividends (iii) The earning yield and price earning ratio (iv) The net fund flow
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Q.7 16 marks very hard Financial Management and Costing Concepts ⚡ Try this Q →
Answer any four of the following:
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