CA Inter Audit & Ethics — Question Paper — May 2012

(i) Embezzlement discovered in April 2012 — before approval of financial statements:

As per AS 4 — Contingencies and Events Occurring after the Balance Sheet Date (issued by ICAI), events occurring after the balance sheet date are classified as either adjusting events or non-adjusting events.

Adjusting events are those that provide additional evidence of conditions that existed at the balance sheet date. Such events require adjustment of assets and liabilities in the financial statements.

In the present case, the embezzlement of ₹ 6,00,000 actually occurred during March 2012, i.e., before the balance sheet date of 31st March, 2012. The fact that it came to the notice of management only in April 2012 does not alter the underlying condition — the cash was already missing as on 31st March, 2012.

Since the financial statements have not yet been approved by the Board of Directors, the company is still in a position to incorporate the adjustment. Therefore, the embezzlement should be adjusted in the books of accounts for the year ended 31st March, 2012. The loss of ₹ 6,00,000 should be recognised and the cash/asset balance should be reduced accordingly.

(ii) Embezzlement discovered only after approval of financial statements:

If the embezzlement of ₹ 6,00,000 comes to the notice of management only after the Board of Directors has approved the financial statements, then it is no longer possible to adjust the financial statements for the year ended 31st March, 2012, as those statements stand finalised.

In such a situation, the loss arising from the embezzlement will have to be recorded in the books of accounts of the subsequent accounting year (i.e., the year ending 31st March, 2013) when it is discovered and quantified.

However, if the amount is material, appropriate disclosure may be made so that users of financial statements are aware of the event. AS 4 requires that events of such importance that they could influence decisions of users should be disclosed even if adjustment is not possible.

Conclusion: The key distinction lies in the timing of discovery relative to the approval of financial statements. Since the embezzlement originated before the balance sheet date, it is an adjusting event if discovered before approval, and must be accounted for in the year ended 31st March, 2012. If discovered after approval, it must be accounted for in the next year.

Topic: Replacement of Mains — Electricity Company (Fixed Assets)

The transactions involve (i) laying an Auxiliary Main alongside one-fourth of the old Main, and (ii) replacing the old Main. The key principle is: the original cost of the replaced portion is estimated by deflating the current replacement cost using the price-rise index; the difference between new cost and old cost (net of salvage) is charged to Revenue Account.

Working Notes (see working_notes for step-by-step):

— Original cost of replaced portion = ₹40,00,000
— Old materials recovered = ₹3,50,000
— Balance of old Mains written off = ₹36,50,000
— Total cost of Auxiliary Main = ₹16,50,000
— Total cost of New Main (replacement) = ₹46,00,000

Journal Entries in the books of M/s Mary Electricity Company:

Entry 1 — Cash expenditure on Auxiliary Main:
Auxiliary Main A/c Dr. ₹15,00,000
To Bank A/c ₹15,00,000
*(Being cash paid for laying auxiliary main)*

Entry 2 — Old materials used in Auxiliary Main:
Auxiliary Main A/c Dr. ₹1,50,000
To Old Materials A/c ₹1,50,000
*(Being old materials of ₹1,50,000 utilised in construction of auxiliary main)*

Entry 3 — Recovery of old materials from dismantled portion of old Main:
Old Materials A/c Dr. ₹3,50,000
To Old Mains A/c ₹3,50,000
*(Being old materials recovered: sold ₹1,00,000 + used in auxiliary ₹1,50,000 + used in replacement ₹1,00,000 = ₹3,50,000)*

Entry 4 — Sale of old materials:
Bank A/c Dr. ₹1,00,000
To Old Materials A/c ₹1,00,000
*(Being old materials sold for cash)*

Entry 5 — Writing off balance of old Mains (net of materials recovered):
Revenue A/c Dr. ₹36,50,000
To Old Mains A/c ₹36,50,000
*(Being original cost of replaced portion ₹40,00,000 less materials recovered ₹3,50,000 written off to Revenue)*

Entry 6 — Cash expenditure on replacement (new Main):
New Mains A/c Dr. ₹45,00,000
To Bank A/c ₹45,00,000
*(Being cash paid for replacement work)*

Entry 7 — Old materials used in replacement:
New Mains A/c Dr. ₹1,00,000
To Old Materials A/c ₹1,00,000
*(Being old materials of ₹1,00,000 used in replacement work)*

Entry 8 — Capitalising Auxiliary Main:
Mains A/c Dr. ₹16,50,000
To Auxiliary Main A/c ₹16,50,000
*(Being auxiliary main capitalised upon completion)*

Entry 9 — Capitalising New Main (replacement):
Mains A/c Dr. ₹46,00,000
To New Mains A/c ₹46,00,000
*(Being replacement main capitalised upon completion)*

Verification — Old Materials A/c: Dr ₹3,50,000 (Entry 3); Cr ₹1,50,000 (Entry 2) + ₹1,00,000 (Entry 4) + ₹1,00,000 (Entry 7) = ₹3,50,000 ✓
Verification — Old Mains A/c: Original Dr ₹40,00,000; Cr ₹3,50,000 (Entry 3) + ₹36,50,000 (Entry 5) = ₹40,00,000 ✓

Net result: Old Mains (₹40,00,000) removed; New Mains (₹46,00,000) + Auxiliary Main (₹16,50,000) = ₹62,50,000 added to asset base. Revenue charged ₹36,50,000.

Part (a): Amortization of Deferred Development Cost

Development costs should be capitalized and amortized systematically over the period during which benefits are expected to accrue. Per AS 26 (Intangible Assets), the amortization method should reflect the pattern of economic benefits expected from the asset.

Given the expected sales for the four years total ₹3,000 Lakhs, the development cost of ₹450 Lakhs should be amortized in proportion to expected sales in each year:

Year 1: (1,200/3,000) × 450 = ₹180 Lakhs
Year 2: (900/3,000) × 450 = ₹135 Lakhs
Year 3: (600/3,000) × 450 = ₹90 Lakhs
Year 4: (300/3,000) × 450 = ₹45 Lakhs

Unamortized Expenditure at End of Year 3: If it is discovered at the end of Year 3 that no further benefit will accrue in Year 4, the remaining unamortized amount of ₹45 Lakhs (allocated to Year 4) should be written off entirely in Year 3 itself as an exceptional charge to the Profit and Loss Account. The assets must not be carried at a value beyond what is expected to generate economic benefits. The total charge to P&L in Year 3 would therefore be ₹135 Lakhs (₹90 Lakhs amortization + ₹45 Lakhs write-off).

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Part (b): Journal Entries for Asset Purchase with Government Grant (Year 1)

Machinery cost: ₹25,00,000; Useful life: 10 years; Salvage value: ₹5,00,000; Grant received: ₹5,00,000 (deferred income method)

Annual depreciation: (25,00,000 − 5,00,000) / 10 = ₹2,00,000

Entry 1 - Purchase of Machinery:
Dr. Machinery (Fixed Asset) A/c ₹25,00,000
Cr. Bank/Creditors A/c ₹25,00,000
(Being machinery purchased)

Entry 2 - Receipt of Government Grant:
Dr. Bank A/c ₹5,00,000
Cr. Deferred Government Grant A/c ₹5,00,000
(Being government grant received as deferred income)

Entry 3 - Recording Depreciation:
Dr. Depreciation Expense A/c ₹2,00,000
Cr. Accumulated Depreciation A/c ₹2,00,000
(Being depreciation on machinery for Year 1)

Entry 4 - Recognition of Grant in P&L:
Dr. Deferred Government Grant A/c ₹50,000
(₹5,00,000 ÷ 10 years)
Cr. P&L A/c / Grant Recognition A/c ₹50,000
(Being proportionate recognition of government grant in P&L)

The grant is recognized over 10 years to match the useful life of the asset.

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Part (c): Bank Provisions Calculation (Year ending 31-03-2012)

Applicable RBI Provisioning Norms per Master Circular on Prudential Norms:

1. Standard Advances: ₹7,000 Lakhs × 0.40% = ₹28 Lakhs

2. Sub-standard Advances: ₹3,500 Lakhs × 10% = ₹350 Lakhs

3. Doubtful Advances - Unsecured Portion:
₹1,500 Lakhs × 100% = ₹1,500 Lakhs

4. Doubtful Advances - Secured Portion:
• Up to 1 year: ₹500 Lakhs × 20% = ₹100 Lakhs
• More than 1 year and up to 3 years: ₹600 Lakhs × 30% = ₹180 Lakhs
• More than 3 years: ₹300 Lakhs × 100% = ₹300 Lakhs
Subtotal secured doubtful = ₹580 Lakhs

5. Loss Advances: ₹200 Lakhs × 100% = ₹200 Lakhs

Total Provision for the Year:
₹28 + ₹350 + ₹1,500 + ₹580 + ₹200 = ₹2,658 Lakhs

This amount should be credited to the Profit and Loss Account as provision for doubtful debts/advances and shown as a deduction from advances in the Balance Sheet.

Concept of Weighted Average Number of Equity Shares Outstanding

As per AS-20 (Earnings Per Share), issued by ICAI, the weighted average number of equity shares outstanding during the period is the number of equity shares outstanding at the beginning of the period, adjusted by shares bought back or issued during the period, multiplied by a time-weighting factor. The time-weighting factor is the number of days or months the specific shares are outstanding as a proportion of the total number of days or months in the period.

The rationale is that the capital available to generate earnings changes each time shares are issued or bought back. Weighting adjusts for this so that EPS reflects the actual capital employed throughout the year.

Key rules under AS-20:
- Shares issued for cash are weighted from the date cash is receivable (generally the issue date).
- Shares bought back are weighted only up to the date of buyback; they are excluded thereafter.
- Shares issued as bonus shares are treated as if they were always outstanding (no time-weighting; prior periods also restated).

Computation of Weighted Average Number of Equity Shares (Year: 1 April 2011 to 31 March 2012)

The accounting year is 12 months. Based on the movements given:

- 1 April 2011: Opening balance = 4,80,000 shares
- 31 August 2011: Issue for cash = +3,60,000 → Balance becomes 8,40,000
- 1 February 2012: Buyback = −1,80,000 → Balance becomes 6,60,000

Three periods are identified:

| Period | Dates | Months | Shares Outstanding |
|---|---|---|---|
| 1 | 1 Apr 2011 – 30 Aug 2011 | 5 | 4,80,000 |
| 2 | 31 Aug 2011 – 31 Jan 2012 | 5 | 8,40,000 |
| 3 | 1 Feb 2012 – 31 Mar 2012 | 2 | 6,60,000 |

Weighted Average Number of Equity Shares = 6,60,000

*Note: The closing balance stated in the question as 6,00,000 appears to contain a typographical error — the arithmetically correct closing balance based on the given movements (4,80,000 + 3,60,000 − 1,80,000) is 6,60,000.*

Applicable Standard: AS 20 — Earnings Per Share

As per AS 20, when bonus shares are issued, the weighted average number of equity shares outstanding during all periods presented must be adjusted retrospectively, as if the bonus issue had occurred at the beginning of the earliest period reported. This is because bonus shares are issued without any consideration and do not represent a real economic event in the current period.

Bonus Factor: 1 additional share for every 1 existing share → Bonus factor = 2 (shares are doubled)

Basic EPS for 2011-12:

The bonus issue on 1st January 2012 falls within the financial year 2011-12. Per AS 20, the weighted average shares for 2011-12 are computed treating the bonus as if issued at the start of the year:

Weighted Average Shares = 5,00,000 × 2 = 10,00,000 shares

Basic EPS (2011-12) = ₹22,50,000 ÷ 10,00,000 = ₹2.25 per share

Adjusted EPS for 2010-11 (Restated):

The previously reported EPS for 2010-11 must be restated to reflect the bonus issue, for comparability:

Adjusted EPS (2010-11) = ₹11,40,000 ÷ 10,00,000 = ₹1.14 per share

(The originally reported EPS for 2010-11, before adjustment, would have been ₹11,40,000 ÷ 5,00,000 = ₹2.28 per share.)

Summary:
- Basic EPS (2011-12): ₹2.25 per share
- Adjusted EPS (2010-11): ₹1.14 per share

Ajay Enterprise – Partnership Dissolution

Step 1: Identify Claims and Assets

External Liabilities (to be paid first):
- Sundry Creditors: ₹16,500
- B's Loan Account (B is a creditor): ₹4,500
- Total External Liabilities: ₹21,000

Partners' Capital Accounts:
- A: ₹15,000 | B: ₹7,500 | C: ₹15,000 | Total: ₹37,500

Profit & Loss Ratio: A:B:C = 4:3:3 (Total = 10 parts)

Assets (at book value, since revaluation postponed):
- Factory Building: ₹24,160
- Plant & Machinery: ₹16,275
- Debtors: ₹5,400
- Stock: ₹nil
- Cash at Bank: ₹275
- Total Assets: ₹46,110

*Note: Balance sheet shows asset total as ₹58,500, but individual items sum to ₹46,110. Proceeding with individual figures as stated, which indicates an implied loss of ₹12,390.*

Step 2: Calculate Implied Loss on Dissolution

Assets realized (at book value): ₹46,110
Less: External Liabilities: (₹21,000)
Net Available for Partners: ₹25,110

Total Capital Accounts: ₹37,500
Implied Loss (shortfall): ₹12,390

This loss is borne by partners in P&L ratio 4:3:3:
- A's share of loss: ₹12,390 × 4/10 = ₹4,956
- B's share of loss: ₹12,390 × 3/10 = ₹3,717
- C's share of loss: ₹12,390 × 3/10 = ₹3,717

Step 3: Adjusted Capital Accounts

- A: ₹15,000 – ₹4,956 = ₹10,044
- B: ₹7,500 – ₹3,717 = ₹3,783
- C: ₹15,000 – ₹3,717 = ₹11,283
- Total: ₹25,110 ✓

Step 4: Apply C's Liquidation Commission (10%)

C is appointed as liquidating agent and receives 10% of the amount distributed:

C's Commission = ₹25,110 × 10% = ₹2,511

Amount available for distribution in P&L ratio = ₹25,110 – ₹2,511 = ₹22,599

Distribution to partners (in ratio 4:3:3):
- A: ₹22,599 × 4/10 = ₹9,040
- B: ₹22,599 × 3/10 = ₹6,780
- C: ₹22,599 × 3/10 = ₹6,780

Step 5: Final Settlement of Accounts

Payments (in priority order):
1. Sundry Creditors: ₹16,500
2. B's Loan Account (to B): ₹4,500
3. A (Capital share): ₹9,040
4. B (Capital share): ₹6,780
5. C (Capital share + Commission): ₹6,780 + ₹2,511 = ₹9,291

Total Cash Distributed: ₹46,111 (rounding difference of ₹1)

Summary of Final Amounts Received by Each Partner:
- A receives: ₹9,040
- B receives: ₹4,500 (loan settlement) + ₹6,780 (capital) = ₹11,280
- C receives: ₹6,780 (capital) + ₹2,511 (commission) = ₹9,291
- Creditors receive: ₹16,500

Balance Sheet Analysis of M/s Competent Limited as on 31st March, 2012

(a) Shareholders' Funds (Net Worth)

Shareholders' Funds represent the owners' stake in the company. It is computed by aggregating share capital and reserves, after adjusting for any loss provisions:
- Equity Share Capital: ₹12,50,000
- Revenue Reserve: ₹14,00,000
- Securities Premium: ₹2,50,000
- Less: Provision for Loss Account: (₹1,25,000)
- Shareholders' Funds = ₹27,75,000

The number of equity shares = ₹12,50,000 ÷ ₹10 = 1,25,000 shares

The book value per share = ₹27,75,000 ÷ 1,25,000 = ₹22.20 per share, indicating the shares are trading at a premium to face value on a net asset basis.

(b) Long-Term Borrowings and Capital Employed

Long-term Debt:
- 13% Debentures (Secured): ₹18,75,000
- Unsecured Loans: ₹10,00,000
- Total Long-term Debt = ₹28,75,000

Capital Employed = Shareholders' Funds + Long-term Borrowings
= ₹27,75,000 + ₹28,75,000 = ₹56,50,000

This can be cross-verified from the assets side: Fixed Assets + Net Working Capital = ₹46,50,000 + ₹13,50,000 = ₹60,00,000. The difference arises due to the treatment of Provision for Loss Account; the asset-side figure includes it as a separate liability.

(c) Key Financial Ratios

Current Ratio = Current Assets ÷ Current Liabilities = ₹30,00,000 ÷ ₹16,50,000 = 1.82:1
This is below the ideal benchmark of 2:1, suggesting the company's short-term liquidity position is slightly weak.

Debt-Equity Ratio = Long-term Debt ÷ Shareholders' Funds = ₹28,75,000 ÷ ₹27,75,000 = 1.04:1
This indicates that for every ₹1 of owners' capital, the company has borrowed approximately ₹1.04, reflecting a moderately leveraged but near-balanced capital structure.

Proprietary Ratio = Shareholders' Funds ÷ Total Assets = ₹27,75,000 ÷ ₹76,50,000 = 0.363 (36.3%)
A low proprietary ratio implies significant reliance on external funds.

Fixed Assets to Net Worth = ₹46,50,000 ÷ ₹27,75,000 = 1.68:1
This ratio exceeding 1 suggests that fixed assets exceed shareholders' funds, meaning a portion of fixed assets is financed by long-term borrowings — acceptable for capital-intensive industries but a risk signal in others.

Annual Interest on 13% Debentures = 13% × ₹18,75,000 = ₹2,43,750

Summary: The company has a moderately leveraged capital structure with long-term debt slightly exceeding shareholders' funds. Liquidity is below the standard benchmark. The heavy investment in fixed assets (₹46,50,000 out of ₹76,50,000 total assets) indicates a capital-intensive business. The presence of a Provision for Loss Account of ₹1,25,000 signals potential exposure to future losses and should be monitored.

Note: The actual balance sheet figures of Vasudha Ltd and Vaishali Ltd were not included in the question as stated ('Given below balance sheet…'). The solution below demonstrates the complete methodology with all given adjustment figures applied, and shows the framework every CA student must follow. Where source balance sheet line items are absent, placeholder references (denoted [BS]) are used.

Nature of Amalgamation

This is an Absorption, where Vasudha Ltd (Transferee/Purchasing Company) takes over the entire business of Vaishali Ltd (Transferor/Vendor Company). Since Vaishali Ltd is not liquidated but continues to exist (the question specifies 'without liquidating latter'), this is treated as an Amalgamation in the Nature of Purchase under AS 14 – Accounting for Amalgamations (issued by ICAI). The Purchase Method is applied.

Step 1 – Revaluation / Adjusted Net Assets of Vaishali Ltd (Transferor)

Before calculating intrinsic value, assets and liabilities of both companies must be restated to fair value:

(a) Goodwill is to be recognised at ₹50,000 for Vaishali Ltd (given). If goodwill was absent or at a different figure in the books, the difference is adjusted.

(b) Fixed Assets (Land/Property) of Vaishali Ltd: book value stated as ₹1,24,000 (given). This is the fair value to be used.

(c) Stock Adjustment for Vaishali Ltd: Stock is shown at 10% above cost in the books. Therefore:
- If book value of stock = S, then S = Cost × 1.10
- Overvaluation = S – S/1.10 = S × (10/110)
- This overvaluation must be deducted from stock and from net assets before computing intrinsic value.

(d) Fixed Assets (Land/Property) of Vasudha Ltd: ₹1,75,000 (given) – used for Vasudha's intrinsic value calculation.

(e) Goodwill of Vasudha Ltd: ₹75,000 (given) – added to Vasudha's net assets.

Step 2 – Intrinsic Value of Shares

Intrinsic Value per Share = Adjusted Net Assets ÷ Number of Equity Shares

For Vasudha Ltd:
Adjusted Net Assets = Paid-up Share Capital + Reserves & Surplus + Revaluation Surplus (Goodwill ₹75,000 added; Land restated to ₹1,75,000) – External Liabilities

For Vaishali Ltd:
Adjusted Net Assets = Paid-up Share Capital + Reserves & Surplus + Revaluation Surplus (Goodwill ₹50,000 added; Land at ₹1,24,000; Stock reduced by 10/110 of book value) – External Liabilities

Step 3 – Purchase Consideration

Since payment is by issue of shares at intrinsic value:

Purchase Consideration = Adjusted Net Assets of Vaishali Ltd (as computed above)

Number of Shares to be issued by Vasudha Ltd = Purchase Consideration ÷ Intrinsic Value per share of Vasudha Ltd

Step 4 – Journal Entries in Books of Vaishali Ltd (Transferor)

1. Revaluation entries: Dr./Cr. individual assets and liabilities to fair value; difference to Revaluation Reserve / P&L.
2. Realisation Account: Dr. all assets at revised values; Cr. all liabilities; balance = profit/loss on realisation.
3. Vasudha Ltd Account Dr. (Purchase Consideration) → To Realisation Account
4. Equity Share Capital / Reserves Dr. → To Shareholders' Account
5. Shareholders' Account Dr. → To Vasudha Ltd Account (shares received distributed to shareholders)

Step 5 – Journal Entries in Books of Vasudha Ltd (Transferee)

1. Dr. individual assets of Vaishali Ltd at agreed values (including goodwill ₹50,000, land ₹1,24,000, stock at cost)
2. Cr. liabilities of Vaishali Ltd at agreed values
3. Cr. Business Purchase Account (Purchase Consideration)
4. Dr. Business Purchase Account → Cr. Equity Share Capital + Securities Premium (if any) for shares issued at intrinsic value
5. Any excess of Purchase Consideration over net assets → Goodwill; deficiency → Capital Reserve

Step 6 – Balance Sheet of Vasudha Ltd after Amalgamation

Post-amalgamation balance sheet is prepared by combining:
- Vasudha Ltd's own restated balance sheet
- Assets and liabilities taken over from Vaishali Ltd at agreed values
- New share capital issued as Purchase Consideration
- Cancellation of intercompany balances if any

Key line items will include: Goodwill (own ₹75,000 + any arising on amalgamation), Land (₹1,75,000 + ₹1,24,000 = ₹2,99,000), Stock of Vaishali at cost, all other combined assets and liabilities.

The final Balance Sheet is presented in the prescribed format under Schedule III to the Companies Act 2013, showing Sources of Funds (Share Capital including newly issued shares, Reserves) and Application of Funds (combined Fixed Assets, Current Assets net of liabilities).

Conclusion: For a complete numerical solution, the balance sheet figures (share capital, reserves, liabilities, individual asset values) of both companies as at 31st March 2012 are required. The above framework, with the specific adjustments for goodwill (₹75,000 / ₹50,000), land values (₹1,75,000 / ₹1,24,000), and stock overvaluation (10/110 reduction on Vaishali's stock), must be applied to derive the final intrinsic values and post-amalgamation balance sheet.

Buyback of Shares — Analysis under Section 77A of the Companies Act, 1956

Conditions to be satisfied for Buyback of Shares (Section 77A, Companies Act, 1956):

For a buyback to be valid, the following conditions must be met:

(i) It must be authorised by the Articles of Association.
(ii) A Special Resolution must have been passed in the General Meeting (Board Resolution suffices only if buyback ≤ 10% of total paid-up capital and free reserves).
(iii) Buyback must be made only out of: (a) free reserves, (b) securities premium account, or (c) proceeds of any fresh issue of shares or other specified securities — NOT from proceeds of debentures.
(iv) Buyback in any financial year shall not exceed 25% of total paid-up equity capital and free reserves.
(v) Post-buyback debt-equity ratio shall not exceed 2:1.
(vi) All shares proposed to be bought back must be fully paid up.
(vii) Company should not have defaulted in repayment of deposits, redemption of debentures/preference shares, payment of dividend, or repayment of term loans.

Comment on Whether the Proposed Buyback is Valid:

| Condition | Status |
|---|---|
| Authorised by Articles | Satisfied ✓ |
| Necessary resolution passed | Satisfied ✓ |
| Source of funds — from Debentures | NOT Satisfied ✗ |

The company proposes to fund the buyback from proceeds of Debentures. Under Section 77A, debentures are not a permitted source for buyback. Only free reserves, securities premium, or proceeds of a fresh issue of shares/specified securities are allowed.

Conclusion: The proposed buyback is NOT within the provisions of Section 77A of the Companies Act, 1956, because the source of payment (debenture proceeds/bank balance raised via debentures) is not a permitted source.

Journal Entries for Buyback (Assuming Buyback is done from Free Reserves as mandated):

Total buyback consideration = 25,000 shares × ₹20 = ₹5,00,000
Nominal value of shares cancelled = 25,000 × ₹10 = ₹2,50,000
Premium on buyback = ₹5,00,000 − ₹2,50,000 = ₹2,50,000

Entry 1 — On Buyback of Shares:

Equity Share Capital A/c — Dr. ₹2,50,000
General Reserve A/c — Dr. ₹2,50,000
  To Bank A/c — Cr. ₹5,00,000
*(Being 25,000 equity shares of ₹10 each bought back at ₹20 per share; premium on buyback charged to General Reserve)*

Entry 2 — Transfer to Capital Redemption Reserve (Section 77AA):

General Reserve A/c — Dr. ₹2,50,000
  To Capital Redemption Reserve A/c — Cr. ₹2,50,000
*(Being transfer to Capital Redemption Reserve equivalent to the nominal value of shares bought back, out of free reserves, as required by Section 77AA)*

Note on Capital Redemption Reserve (Section 77AA): When shares are bought back out of free reserves, a sum equal to the nominal value of shares so purchased must be transferred to the Capital Redemption Reserve Account. This reserve can be used only for the purpose of issuing fully paid bonus shares.

Note on Balance Sheet: Since no opening Balance Sheet has been provided in the question, a post-buyback Balance Sheet cannot be constructed. In exam practice, if the opening Balance Sheet is given, the post-buyback Balance Sheet will reflect: (a) reduction in Equity Share Capital by ₹2,50,000; (b) reduction in General Reserve by ₹5,00,000 (₹2,50,000 premium + ₹2,50,000 transferred to CRR); (c) creation of Capital Redemption Reserve of ₹2,50,000; (d) reduction in Bank balance by ₹5,00,000.

Capital Adequacy Ratio (CAR) — Classification of Capital Funds and Computation

Under RBI guidelines (based on Basel II / Basel III norms), a bank's capital is classified into Tier-I (Core Capital) and Tier-II (Supplementary Capital).

Tier-I Capital consists of elements that are permanent, fully paid-up, and freely available to absorb losses. These include: Paid-up Equity Share Capital, Statutory Reserves, Share Premium, and Capital Reserves arising from actual sale proceeds (not revaluation).

Tier-II Capital consists of elements of a less permanent nature. Revaluation Reserves are included in Tier-II but are subject to a discount of 55% (i.e., only 45% of revaluation reserves are eligible), since such reserves are contingent and may be unrealised.

Classification of the given Capital Funds:

Tier-I Capital:
- Paid-up Equity Share Capital: ₹760 Crore
- Statutory Reserve: ₹150 Crore
- Share Premium: ₹150 Crore
- Capital Reserve from sale of assets (₹90 Cr − ₹40 Cr revaluation): ₹50 Crore
- Total Tier-I Capital: ₹1,110 Crore

Tier-II Capital:
- Revaluation Reserve portion of Capital Reserve: ₹40 Crore
Eligible amount @ 45% (discount of 55%): ₹40 × 45% = ₹18 Crore
- Total Tier-II Capital: ₹18 Crore

Total Capital Funds (Tier-I + Tier-II): ₹1,128 Crore

Note: Tier-II Capital cannot exceed 100% of Tier-I Capital. Here, ₹18 Crore < ₹1,110 Crore, so the condition is satisfied.

Capital Adequacy Ratio (CAR):

CAR = (Tier-I Capital + Tier-II Capital) / Risk-Weighted Assets × 100

The Risk-Weighted Assets (RWA) are computed by assigning prescribed risk weights (0%, 20%, 50%, 100%, etc.) to different categories of assets as per RBI norms. The specific asset data required to compute RWA and the final CAR ratio has not been provided in the question. If asset details were given, each asset would be multiplied by its applicable risk weight, totalled to get RWA, and then CAR = ₹1,128 Crore / RWA × 100. As per RBI guidelines, banks in India must maintain a minimum CAR of 9% (higher than the Basel minimum of 8%).

Summary:
- Tier-I Capital: ₹1,110 Crore
- Tier-II Capital: ₹18 Crore
- Total Capital: ₹1,128 Crore
- CAR = ₹1,128 Crore / RWA × 100 (RWA data required to complete)

Preliminary Computations before preparing accounts:

Interest on Sinking Fund Investment: Face value of 10% Govt. bonds = ₹6,50,000. Interest = 10% × ₹6,50,000 = ₹65,000.

Sale proceeds of investment: Sold at 90% of face value = 90% × ₹6,50,000 = ₹5,85,000. Book value = ₹6,00,000. Loss on sale = ₹15,000 (charged to Sinking Fund A/c).

Redemption of debentures: Face value = ₹7,50,000 + 10% premium = ₹75,000. Total payable to debenture holders = ₹8,25,000. The premium is charged to Sinking Fund A/c.

Annual debenture interest: 12% × ₹7,50,000 = ₹90,000.

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(1) 12% Debentures Account

| Dr | ₹ | Cr | ₹ |
|---|---|---|---|
| Debenture Holders A/c | 7,50,000 | Balance b/d (1-4-2011) | 7,50,000 |
| Total | 7,50,000 | Total | 7,50,000 |

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(2) Sinking Fund Account

| Dr | ₹ | Cr | ₹ |
|---|---|---|---|
| Sinking Fund Investment A/c (Loss on sale) | 15,000 | Balance b/d (1-4-2011) | 6,00,000 |
| Debenture Holders A/c (Premium on redemption) | 75,000 | P&L / Appropriation A/c (Annual contribution) | 1,20,000 |
| General Reserve A/c (Transfer) | 6,95,000 | Sinking Fund Investment A/c (Interest on Govt. bonds) | 65,000 |
| Total | 7,85,000 | Total | 7,85,000 |

*Note: On redemption, the balance in Sinking Fund is transferred to General Reserve as the debentures have been fully redeemed.*

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(3) Sinking Fund Investment Account

| Dr | ₹ | Cr | ₹ |
|---|---|---|---|
| Balance b/d (1-4-2011) | 6,00,000 | Bank A/c (Interest received) | 65,000 |
| Sinking Fund A/c (Interest accrued on Govt. bonds) | 65,000 | Bank A/c (Sale proceeds: 90% × ₹6,50,000) | 5,85,000 |
| | | Sinking Fund A/c (Loss on sale — balancing figure) | 15,000 |
| Total | 6,65,000 | Total | 6,65,000 |

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(4) Bank Account

| Dr | ₹ | Cr | ₹ |
|---|---|---|---|
| Balance b/d (31-3-2012, before interest) | 3,00,000 | Debenture Holders A/c (Redemption) | 8,25,000 |
| Sinking Fund Investment A/c (Interest on Govt. bonds) | 65,000 | Debenture Interest A/c (12% on ₹7,50,000) | 90,000 |
| Sinking Fund Investment A/c (Sale of investment) | 5,85,000 | Balance c/d | 35,000 |
| Total | 9,50,000 | Total | 9,50,000 |

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(5) Debenture Holders Account

| Dr | ₹ | Cr | ₹ |
|---|---|---|---|
| Bank A/c (Payment: ₹7,50,000 + ₹75,000 premium) | 8,25,000 | 12% Debentures A/c (Face value) | 7,50,000 |
| | | Sinking Fund A/c (Premium @ 10%) | 75,000 |
| Total | 8,25,000 | Total | 8,25,000 |

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Closing Bank balance = ₹35,000 after redemption and payment of debenture interest.

CRITICAL ISSUE: The question as presented is incomplete. The problem provides adjustment items (1) through (7) but does not include the base Trial Balance of the Foreign Branch that these adjustments should be applied to. Without opening balances for Sales, Purchases, Expenses, Fixed Assets, Stock, Receivables, and Liabilities, a complete trial balance and financial statements cannot be prepared.

What the question requires (if trial balance were provided):

(a) Trial Balance with Adjustments (Converting $ to ₹):
The approach would be:
1. Convert all foreign currency items to rupees at appropriate rates:
- Fixed assets purchased on 1.4.2010: Use rate ₹45 per $
- Opening balances on 1.4.2011: Use closing rate of previous year (₹47 per $)
- Current year transactions: Use average rate ₹45 per $ for P&L items
- Closing balances on 31.3.2012: Use closing rate ₹50 per $ (for balance sheet items like receivables/payables)
2. Apply adjustments:
- Salaries outstanding: ₹400
- Depreciation on office equipment and Furniture & Fixtures @ 10% p.a. on WDV
- Goods from HO to Branch: ₹15,80,000 (affects stock and inter-company transaction)
- HO's claim: ₹20,50,000 (inter-company account)
- Closing stock: ₹21,500
3. Exchange gain/loss on retranslation of opening balances and monetary items must be computed and shown separately.

(b) Trading, P&L Account and Balance Sheet:
With complete trial balance data, the financial statements would show:
- Trading Account: Opening stock + Purchases - Closing stock = Cost of Goods Sold; Gross Profit derived
- P&L Account: Gross Profit - Operating Expenses (including accrued salaries, depreciation) ± Exchange gains/losses = Net Profit
- Balance Sheet: Fixed assets (net of depreciation at ₹50 per $ closing rate), Current assets (receivables, stock at ₹50 rate), Current liabilities (payables, salaries payable), and Inter-company accounts clearly segregated as per HO records

The answer cannot be completed without the original Trial Balance data from the question paper.

This is an equity-settled share-based payment transaction governed by Ind AS 102 - Share-based Payments. The employees receive shares at a price below fair value, and the difference represents employee compensation that should be expensed over the vesting period.

Calculation of Shares Issued:
Total employees who accepted the offer = 400 × 50% = 200 employees
Shares per employee = 100
Total shares issued = 200 × 100 = 20,000 shares

Analysis of Fair Value and Employee Benefit:
Fair value at grant date = ₹28 per share
Cash paid by employees = ₹25 per share
Benefit granted per share = ₹28 − ₹25 = ₹3 per share
Total employee benefit/compensation = ₹3 × 20,000 = ₹60,000

This benefit arises because employees acquire shares at ₹25 while the fair value (reflecting post-vesting transfer restrictions) is ₹28. The difference represents the value of the employee share plan benefit.

Share Capital and Premium Computation:
Cash received from employees = 20,000 shares × ₹25 = ₹5,00,000
Share Capital (at nominal value) = 20,000 shares × ₹10 = ₹2,00,000
Share Premium = Cash received − Share Capital = ₹5,00,000 − ₹2,00,000 = ₹3,00,000

Journal Entry (30th April 2012):
Dr. Cash/Bank Account ₹5,00,000
Dr. Employee Share Plan Expense/Reserve ₹60,000
Cr. Share Capital (Nominal) ₹2,00,000
Cr. Share Premium ₹3,00,000

Accounting Treatment and Subsequent Recognition:
The Employee Share Plan Reserve of ₹60,000 represents the benefit granted to employees and should be recognized as an expense over the 3-year vesting period (1st April 2012 to 1st April 2015) through monthly or periodic amortization at ₹60,000 ÷ 36 months = ₹1,666.67 per month. Alternatively, it may be recognized annually based on the reporting periods. The corresponding credit entry would be to Employee Share Plan Reserve (within equity) or directly to Profit & Loss if expensed immediately in the accounting period. The post-vesting transfer restriction is already reflected in the fair value measurement of ₹28 per share, so no separate adjustment is required for the lock-in period.

Answer: No separate disclosure of arrear wages as a prior period adjustment is required under AS 3 for the financial statements ending 31.03.2012.

Reasoning: AS 3 'Net Profit or Loss for the Period, Prior Period Adjustments' defines prior period items as income or expenses which arise in the current period as a result of errors or omissions in the preparation of financial statements of one or more prior periods. The key requirement is that a prior period item must involve a correction of an error or omission from prior period records.

In this case, the arrear wages do NOT constitute a prior period item because:

1. No Error or Omission Existed: During the periods 2008-2011, wages were correctly recorded and paid at the rates applicable under the employment agreement existing at that time. There was no error or omission in the prior period financial statements.

2. New Event in Current Period: The wage revision agreement was signed on 01.07.2011, which is in the current financial year 2011-12. This is a new contractual event that crystallized in the current period, not a correction of a prior period error.

3. Retrospective Impact: Although the agreement has retrospective effect from 01.04.2008, this does not make it a prior period adjustment. It is a settlement of a new liability arising from a current period agreement.

Accounting Treatment: The arrear wages of ₹3,50,000 should be recognized in the Statement of Profit and Loss for 2011-12 as a wage expense (or accrued in the Balance Sheet as wages payable if not yet settled). It should be treated as a normal transaction of the current period.

Disclosure Note: While not required as a prior period adjustment under AS 3, the arrear wages may warrant disclosure as a material unusual item in the notes to the financial statements based on materiality and for transparency, but this is not a requirement of AS 3.

Applicability of AS 29:

AS 29 (Provisions, Contingent Liabilities and Contingent Assets) requires that a provision must be recognized when three conditions are simultaneously satisfied: (1) an entity has a present obligation (legal or constructive) as a result of a past event; (2) it is probable that an outflow of resources will be required to settle the obligation; and (3) a reliable estimate can be made of the obligation's amount.

Analysis of Pacific Airlines' Situation:

Applying AS 29 to the aircraft overhaul requirement, all three conditions are clearly met. First, the airline has a present legal obligation imposed by law to overhaul aircraft once every five years—this is not a conditional or future obligation but an existing legal requirement. Second, the past event that creates this obligation is the operation and use of the aircraft itself; as aircraft are operated, the obligation to perform periodic overhaul crystallizes. Third, it is highly probable (virtually certain) that economic resources will be required to satisfy the legal mandate—there is no conditionality or uncertainty about whether the overhaul will be required. Fourth, a reliable estimate of the overhaul cost can be made using manufacturer specifications, technical standards, historical maintenance records, and industry practices.

Measurement Under AS 29:

The provision should be measured at the best estimate of the expected expenditure required to settle the obligation. Where the time value of money is material (and with a 5-year settlement period, it typically is), the provision must be discounted to present value.

Conclusion:

Pacific Airlines' failure to recognize a provision violates AS 29 and results in overstating assets, understating liabilities, and overstating profit. The airline must recognize the provision with appropriate disclosure in the notes to financial statements showing the nature, amount, and expected timing of settlement.

Accounting Treatment of Sale-Leaseback Transactions under Ind AS 116

The accounting treatment of sale-leaseback transactions involving an operating lease leaseback is governed by Ind AS 116 (Leases), paragraphs 89-91. The core principles are:

Principle 1: If Fair Value < Carrying Amount (WDV), recognize the loss immediately.
Principle 2: If Sale Price < Fair Value, defer the loss over the lease term.
Principle 3: If Sale Price > Fair Value, defer the gain over the lease term.

Analysis of Each Scenario:

(i) Sale Price ₹60 Lakhs = Fair Value ₹60 Lakhs; WDV ₹50 Lakhs

Since the sale price equals fair value, the transaction is at arm's length with no financing element. Fair Value exceeds WDV, so no immediate loss recognition is required. The entire gain of ₹10 Lakhs (₹60 - ₹50) should be recognized immediately in the profit and loss statement. No deferral is needed as the sale price matches fair value exactly.

(ii) Fair Value ₹50 Lakhs; Sale Price ₹45 Lakhs; WDV ₹50 Lakhs

Fair value equals carrying amount, so no loss must be recognized at the fair value level. However, the sale price (₹45 Lakhs) is below fair value (₹50 Lakhs), indicating a sub-fair-value transaction. The loss of ₹5 Lakhs (FV ₹50 - SP ₹45) should be deferred and recognized over the lease term. No gain or loss is recognized in the current period; the ₹5 Lakhs loss is amortized as an expense over the leaseback period.

(iii) Fair Value ₹55 Lakhs; Sale Price ₹62 Lakhs; WDV ₹50 Lakhs

Fair value exceeds WDV, so no immediate loss is required. The sale price (₹62 Lakhs) exceeds fair value (₹55 Lakhs) by ₹7 Lakhs, indicating a above-fair-value transaction. The gain attributable to fair value (₹55 - ₹50 = ₹5 Lakhs) should be recognized immediately. The excess of sale price over fair value (₹7 Lakhs) is a financing component and must be deferred and recognized as income over the lease term. Net effect: Gain of ₹5 Lakhs recognized immediately; ₹7 Lakhs deferred.

(iv) Fair Value ₹45 Lakhs; Sale Price ₹48 Lakhs; WDV ₹50 Lakhs

Fair value (₹45 Lakhs) is below WDV (₹50 Lakhs), so an immediate loss of ₹5 Lakhs (WDV ₹50 - FV ₹45) must be recognized immediately as an economic loss. However, the sale price (₹48 Lakhs) exceeds fair value (₹45 Lakhs) by ₹3 Lakhs. This excess constitutes a financing benefit to the seller-lessee and should be deferred and recognized as income over the lease term. Net effect: Loss of ₹5 Lakhs recognized immediately; ₹3 Lakhs deferred as deferred income.