CA Inter Audit & Ethics — Question Paper — May 2018

Part (a): Computation of Basic EPS as per AS 20

Under AS 20 'Earnings Per Share', the Basic EPS is computed by dividing earnings attributable to equity shareholders by the weighted average number of equity shares outstanding during the period. Partly paid-up shares are treated as a fraction of an equity share to the extent they participate in dividends relative to a fully paid-up share.

The net profit of ₹21,96,000 is stated after considering preference dividend of ₹3,40,000. Hence, earnings attributable to equity shareholders = ₹21,96,000.

For the weighted average number of shares: From 1 April 2019 to 31 August 2019 (5 months), all 6,00,000 shares were ₹5 paid-up (half of ₹10), so each counts as 0.5 share → 3,00,000 equivalent shares. From 1 September 2019 to 31 March 2020 (7 months), 5,40,000 shares became fully paid; 60,000 shares (held by the defaulting shareholder) remained ₹5 paid → 30,000 equivalent shares. Total equivalent shares in this period = 5,70,000.

Weighted average = (3,00,000 × 5/12) + (5,70,000 × 7/12) = 1,25,000 + 3,32,500 = 4,57,500 shares.

Basic EPS = ₹21,96,000 ÷ 4,57,500 = ₹4.80 per share.

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Part (b): Events After Reporting Date — AS 4

Under AS 4 'Contingencies and Events Occurring After the Balance Sheet Date', events are classified as adjusting (conditions existing at balance sheet date) or non-adjusting (conditions arising after balance sheet date). Financial statements are approved on 30 June 2020.

(i) Decline in inventory prices: The company was already expecting a decline as on 31 March 2020. The subsequent sale at ₹4,000 per machine in April 2020 provides evidence of the Net Realisable Value (NRV) at the balance sheet date. This is an adjusting event. Under AS 2, inventories must be valued at cost or NRV, whichever is lower. The inventories (50 machines) should be written down from ₹5,500 to ₹4,000 per machine, recognising a write-down of ₹75,000 (₹1,500 × 50) in the financial statements for 2019-20.

(ii) Fire on 15 April 2020: The fire occurred after the balance sheet date; no condition existed on 31 March 2020. This is a non-adjusting event. No adjustment is required in the financial statements. However, since the amount is material (₹25 lakhs gross loss; net loss ₹6.25 lakhs after 75% insurance recovery), it must be disclosed by way of a note — nature of event, estimated gross loss of ₹25 lakhs, and expected insurance recovery of ₹18.75 lakhs.

(iii) Sale agreement dated 30 March 2020: Under AS 9, revenue from sale of property is recognised only when significant risks and rewards of ownership are transferred. The transfer of possession and execution of conveyance deed occurred in May 2020. Hence, as at 31 March 2020, the sale is not complete and no revenue or profit (₹2,00,000) should be recognised. The property continues to be shown at its carrying value of ₹5,50,000. The existence of the sale agreement should be disclosed as a post-balance-sheet commitment.

(iv) Notice for refund of government grant (15 June 2020): The violation of grant conditions occurred during 2019-2020 (the year under report), and the notice was received before the financial statements were approved (30 June 2020). The underlying condition thus existed at the balance sheet date. This is an adjusting event. Under AS 12, the grant repayment of ₹15 lakhs must be recorded in the financial statements for the year ended 31 March 2020 — by reversing the deferred income or increasing the asset's carrying amount as applicable, and creating a liability for the refund payable.

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Part (c): Sale and Leaseback (Operating Lease) — AS 19

Under AS 19 'Leases', when a sale and leaseback results in an operating lease, the accounting treatment depends on the relationship between sale price, fair value (FV), and book value (WDV = ₹400 lakhs).

(i) Sale price ₹500 lakhs = Fair Value ₹500 lakhs: The transaction is at fair value. Profit = ₹500 – ₹400 = ₹100 lakhs is recognised immediately in the Statement of Profit & Loss. No deferral is required.

(ii) Fair Value ₹450 lakhs, Sale Price ₹380 lakhs (below FV): Sale price is below both WDV and FV. Loss = ₹400 – ₹380 = ₹20 lakhs. This loss should be recognised immediately, unless future lease rentals are at below-market rates (which would compensate the seller). Since no such indication is given, the ₹20 lakhs loss is recognised in P&L immediately.

(iii) Fair Value ₹400 lakhs, Sale Price ₹500 lakhs (above FV): Sale price exceeds fair value. The excess over FV = ₹500 – ₹400 = ₹100 lakhs is not a real gain — it represents future lease rentals pre-paid in advance. This excess of ₹100 lakhs must be deferred and amortised over the lease term. Profit based on FV vs WDV = ₹400 – ₹400 = Nil — no immediate profit recognition.

(iv) Fair Value ₹460 lakhs, Sale Price ₹500 lakhs (above FV): Sale price exceeds FV by ₹500 – ₹460 = ₹40 lakhs → deferred and amortised over lease term. Profit up to FV = ₹460 – ₹400 = ₹60 lakhs → recognised immediately in P&L.

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Part (d): Provisions and Contingent Liabilities — AS 29

Under AS 29 'Provisions, Contingent Liabilities and Contingent Assets', a provision is recognised when: (a) a present obligation exists, (b) outflow of resources is probable (more likely than not), and (c) a reliable estimate can be made.

(i) Consumer court case — penalty of ₹20 lakhs: There is only a 25% probability of the penalty being levied (75% chance it will not be levied). Since this is not probable, no provision is required for the ₹20 lakhs penalty. It should be disclosed as a contingent liability in the notes. Regarding legal fees: the ₹2 lakhs is a definite contractual obligation — ₹1 lakh already paid should be charged as an expense; the remaining ₹1 lakh (50% balance payable on conclusion) should be accrued as a provision since the obligation is certain and can be reliably estimated.

(ii) Consignment accident and dealer's compensation claim: Three accounting treatments arise:

- Loss on goods destroyed: Goods worth ₹30 lakhs lost in accident. Insurance covers 90% = ₹27 lakhs (confirmed as collectible per surveyor's report). The ₹27 lakhs insurance receivable should be recognised as an asset. The ₹3 lakhs (unrecoverable 10%) should be charged to P&L as a loss.

- Compensation to dealer: The contract provides for 15% compensation on delayed/lost consignment. On ₹30 lakhs: 15% = ₹4.5 lakhs. Since the dealer has already claimed this amount and the obligation is certain and reliably estimable, a provision of ₹4.5 lakhs must be created before closing the books.

- The remaining consignment of ₹70 lakhs is unaffected.

SOLUTION TO PARTNERSHIP DISSOLUTION AND CONVERSION

PART (I): CALCULATION OF SHARES TO BE ISSUED

To preserve the partners' rights regarding interest on capital and profit-sharing rights, shares must be issued in two classes:

Class A: Preference Shares (10% cumulative dividend)

These preserve the interest on capital rights based on opening capital balances:
- M: ₹1,36,000 ÷ ₹10 = 13,600 Preference Shares
- N: ₹90,000 ÷ ₹10 = 9,000 Preference Shares
- O: ₹46,000 ÷ ₹10 = 4,600 Preference Shares

Total Preference Shares: 27,200 (₹2,72,000)

Class B: Equity Shares (dividend in profit-sharing ratio 5:3:2)

These preserve profit-sharing rights:
- Total capital to be invested: ₹3,32,000
- Less: Preference Share Capital: ₹2,72,000
- Equity Share Capital: ₹60,000

Distribution in ratio 5:3:2:
- M: ₹60,000 × 5/10 = ₹30,000 = 3,000 Equity Shares
- N: ₹60,000 × 3/10 = ₹18,000 = 1,800 Equity Shares
- O: ₹60,000 × 2/10 = ₹12,000 = 1,200 Equity Shares

Summary of Share Allotment:
| Partner | Preference Shares | Equity Shares | Total Shares | Value (₹) |
|---------|-------------------|---------------|--------------|----------|
| M | 13,600 | 3,000 | 16,600 | 1,66,000 |
| N | 9,000 | 1,800 | 10,800 | 1,08,000 |
| O | 4,600 | 1,200 | 5,800 | 58,000 |
| Total | 27,200 | 6,000 | 33,200 | 3,32,000 |

PART (II): CAPITAL ACCOUNTS SHOWING ALL ADJUSTMENTS

| Particulars | M (₹) | N (₹) | O (₹) |
|------------|-------|-------|-------|
| Opening Capital | 1,36,000 | 90,000 | 46,000 |
| Less: Drawings during year | (50,000) | (46,000) | (34,000) |
| Balance | 86,000 | 44,000 | 12,000 |
| Add: Interest on Capital (10% on opening capital) | 13,600 | 9,000 | 4,600 |
| Add: Profit after interest ₹2,21,400* in ratio 5:3:2 | 1,10,700 | 66,420 | 44,280 |
| Add: Gain on Machinery ₹20,000 in ratio 5:3:2 | 10,000 | 6,000 | 4,000 |
| Sub-total | 2,20,300 | 1,25,420 | 64,880 |
| Less: Final drawings from profit for bank reduction* | (39,300) | (23,580) | (15,720) |
| Closing Capital (for share issue) | 1,81,000 | 1,01,840 | 49,160 |

*Profit earned (₹2,48,600) less Interest on Capital (₹27,200) = ₹2,21,400
Machinery transferred at ₹1,40,000, less book value ₹1,20,000 = gain ₹20,000
*Bank balance reduction: ₹1,78,600 - ₹1,00,000 = ₹78,600 distributed in ratio 5:3:2

PART (III): BALANCE SHEET OF MNO PRIVATE LIMITED COMPANY
As on 31st March 2020 (immediately after acquisition and share issue)

ASSETS
| Particulars | (₹) |
|------------|-----|
| Non-Current Assets | |
| Property, Plant & Equipment: Machinery | 1,40,000 |
| Current Assets | |
| Inventory | 1,37,400 |
| Trade Receivables | 1,24,000 |
| Cash at Bank | 1,00,000 |
| Total Assets | 5,01,400 |

LIABILITIES & SHAREHOLDERS' EQUITY
| Particulars | (₹) |
|------------|-----|
| Current Liabilities | |
| Trade Payables | 1,69,400 |
| Shareholders' Equity | |
| Authorized Share Capital: 2,00,000 shares @ ₹10 each | 20,00,000 |
| Issued & Subscribed Capital: | |
| Preference Shares (Class A): 27,200 @ ₹10 | 2,72,000 |
| Equity Shares (Class B): 6,000 @ ₹10 | 60,000 |
| Total Issued Capital | 3,32,000 |
| Total Liabilities & Equity | 5,01,400 |

Verification: Assets ₹5,01,400 = Liabilities ₹1,69,400 + Equity ₹3,32,000 ✓

Sub-part (1): Computation of Debentures and Shares to be Issued

Step A — Capital Employed after Revaluation (for Debentures)

Capital Employed = Revalued Fixed Assets + Revalued Current Assets − Current Liabilities

Sun: ₹7,10,000 + ₹2,99,500 − ₹5,97,000 = ₹4,12,500

Neptune: ₹3,90,000 + ₹1,57,750 − ₹1,80,250 = ₹3,67,500

Step B — 15% Debentures to provide 8% return on Capital Employed

Income required = 8% × Capital Employed; Debentures = Income required ÷ 15%

Sun: 8% × ₹4,12,500 = ₹33,000 → Debentures = ₹33,000 ÷ 15% = ₹2,20,000

Neptune: 8% × ₹3,67,500 = ₹29,400 → Debentures = ₹29,400 ÷ 15% = ₹1,96,000

Total 15% Debentures issued = ₹4,16,000

Step C — Average Net Profit (for allocation of 60,000 Equity Shares)

Sun: (₹4,49,576 − ₹2,500 + ₹3,77,924) ÷ 3 = ₹8,25,000 ÷ 3 = ₹2,75,000

Neptune: (₹2,73,900 + ₹3,42,100 + ₹3,59,000) ÷ 3 = ₹9,75,000 ÷ 3 = ₹3,25,000

Ratio = 2,75,000 : 3,25,000 = 11 : 13

Sun: 60,000 × 11/24 = 27,500 shares → Value = 27,500 × ₹5 = ₹1,37,500

Neptune: 60,000 × 13/24 = 32,500 shares → Value = 32,500 × ₹5 = ₹1,62,500

Summary of Purchase Consideration:

| | Sun (₹) | Neptune (₹) | Total (₹) |
|---|---|---|---|
| Equity Shares (₹5 each) | 1,37,500 | 1,62,500 | 3,00,000 |
| 15% Debentures | 2,20,000 | 1,96,000 | 4,16,000 |
| Total P.C. | 3,57,500 | 3,58,500 | 7,16,000 |

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Sub-part (2): Balance Sheet of Jupiter Ltd. (as at 31st March 2021)

Capital Reserve arises since Purchase Consideration < Net Assets taken over:

Sun: ₹4,12,500 − ₹3,57,500 = ₹55,000 (Capital Reserve)
Neptune: ₹3,67,500 − ₹3,58,500 = ₹9,000 (Capital Reserve)
Total Capital Reserve = ₹64,000

Inter-company balance of ₹43,350 (Sun owed to Neptune) is eliminated: deducted from Current Liabilities (Sun's creditors) and Current Assets (Neptune's debtors).

Balance Sheet of Jupiter Ltd. as at 31st March 2021

Equity & Liabilities:

| Particulars | ₹ |
|---|---|
| Share Capital | |
| Authorised: 80,000 Equity Shares of ₹5 each | 4,00,000 |
| Issued & Paid-up: 60,000 Equity Shares of ₹5 each | 3,00,000 |
| Reserves & Surplus | |
| Capital Reserve | 64,000 |
| Non-Current Liabilities | |
| 15% Debentures | 4,16,000 |
| Current Liabilities | |
| (5,97,000 + 1,80,250 − 43,350) | 7,33,900 |
| Total | 15,13,900 |

Assets:

| Particulars | ₹ |
|---|---|
| Fixed Assets (7,10,000 + 3,90,000) | 11,00,000 |
| Current Assets (2,99,500 + 1,57,750 − 43,350) | 4,13,900 |
| Total | 15,13,900 |

The Balance Sheet tallies at ₹15,13,900.

(Note: All five parts are solved below. Attempt any four in the examination.)

(a) Refund of Government Grant – AS 12

As per AS 12 (Accounting Standard 12 – Government Grants), when a grant related to a specific fixed asset (credited to cost) becomes refundable: (i) the book value of the asset is increased by the amount refundable, and (ii) the cumulative additional depreciation that would have been recognised in the absence of the grant is recognised immediately as an extraordinary expense.

Original treatment: Grant ₹100 L netted against cost → Net cost recorded = ₹500 – ₹100 = ₹400 lakhs.

WDV as per books (on ₹400 L): FY17-18: dep ₹80 L, WDV ₹320 L → FY18-19: dep ₹64 L, WDV ₹256 L → FY19-20: dep ₹51.2 L, WDV ₹204.8 L

WDV as if no grant (on ₹500 L): FY17-18: dep ₹100 L, WDV ₹400 L → FY18-19: dep ₹80 L, WDV ₹320 L → FY19-20: dep ₹64 L, WDV ₹256 L

Cumulative additional depreciation = ₹244 L – ₹195.2 L = ₹48.8 lakhs

Journal Entries on 2nd April, 2020:

Entry 1 – Restoration of asset book value:
Machinery A/c Dr. ₹1,00,00,000
To Bank / Govt. A/c ₹1,00,00,000
*(Grant refunded; book value of machinery enhanced by ₹100 lakhs as per AS 12)*

Entry 2 – Cumulative additional depreciation (extraordinary item):
Profit & Loss A/c (Extraordinary Item) Dr. ₹48,80,000
To Accumulated Depreciation A/c ₹48,80,000
*(Cumulative additional depreciation recognised immediately as required by AS 12)*

Revised WDV = ₹204.8 + ₹100 – ₹48.8 = ₹256 lakhs (= WDV as if grant never received). Future depreciation charged on ₹256 lakhs.

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(b) Nature of LLP and Designated Partner

Nature of LLP: A Limited Liability Partnership is a body corporate incorporated under the Limited Liability Partnership Act, 2008, with the following features:

Separate Legal Entity: An LLP is distinct from its partners — it can own property, enter contracts, and sue or be sued in its own name. Perpetual Succession: The LLP continues regardless of changes in partners. Limited Liability: Each partner's liability is limited to their agreed contribution; no partner is personally liable for the wrongful acts or negligence of another partner (unlike the Indian Partnership Act, 1932). Flexible Structure: Rights and duties of partners are governed by the LLP Agreement. No Maximum Partners: No ceiling on number of partners. No Minimum Capital Requirement. An LLP cannot raise capital from the public.

Designated Partner [Section 7, LLP Act 2008]: Every LLP must have at least two designated partners, of whom at least one must be a resident in India (stayed ≥182 days in preceding calendar year).

Who can be a designated partner: Only an individual can be a designated partner (not a body corporate directly; if a body corporate is a partner, it must nominate an individual). The individual must: (i) obtain a Designated Partner Identification Number (DPIN); (ii) file written consent with the Registrar; and (iii) not be an undischarged insolvent, of unsound mind, or convicted of an offence involving moral turpitude. Designated partners are personally responsible for statutory compliance under the LLP Act — filing annual returns, accounts — and are liable for penalties for non-compliance.

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(c) Income Recognition – Performing and Non-Performing Assets

As per RBI Guidelines on Income Recognition and Asset Classification: interest on Performing Assets is recognised on accrual basis (interest earned); interest on Non-Performing Assets (NPAs) is recognised only on cash basis (interest actually received).

Income to be recognised (₹ in lakhs):

Performing Assets (interest earned): Cash credits & overdrafts ₹1,800 + Term Loans ₹480 + Bills purchased & discounted ₹700 = ₹2,980 lakhs

Non-Performing Assets (interest received only): Cash credits & overdrafts ₹70 + Term Loans ₹40 + Bills purchased & discounted ₹36 = ₹146 lakhs

Total Income Recognised = ₹2,980 + ₹146 = ₹3,126 lakhs

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(d) ESOP – Journal Entries in books of A Limited

ESOP discount per share = Market price – Exercise price = ₹130 – ₹70 = ₹60 per share
Total ESOP compensation = 25,000 × ₹60 = ₹15,00,000
Options lapsed = 25,000 – 18,000 = 7,000 options

Entry 1 – Recognising ESOP compensation expense:
Employee Compensation Expense A/c Dr. ₹15,00,000
To Employee Stock Options Outstanding A/c ₹15,00,000
*(Being ESOP compensation expense for 25,000 options at ₹60 discount recognised for FY 2020-21)*

Entry 2 – On exercise of 18,000 options:
Bank A/c Dr. ₹12,60,000 (18,000 × ₹70)
Employee Stock Options Outstanding A/c Dr. ₹10,80,000 (18,000 × ₹60)
To Share Capital A/c ₹1,80,000 (18,000 × ₹10)
To Securities Premium A/c ₹21,60,000 (18,000 × ₹120)
*(Being 18,000 options exercised; shares of ₹10 face value issued at ₹70 exercise price; securities premium = exercise price – face value + ESOP discount = ₹70 – ₹10 + ₹60 = ₹120 per share)*

Entry 3 – On lapse of 7,000 unexercised options:
Employee Stock Options Outstanding A/c Dr. ₹4,20,000 (7,000 × ₹60)
To General Reserve A/c ₹4,20,000
*(Being lapsed options transferred to General Reserve; ESOP Outstanding account closes to nil: ₹15,00,000 – ₹10,80,000 – ₹4,20,000 = ₹0)*

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(e) Software Cost Recognition – AS 26

Under AS 26 (Intangible Assets), costs incurred before establishment of technical feasibility are in the research phase → expense to P&L. Costs incurred after technical feasibility → capitalise as intangible asset. Costs for production of units → inventory. Technical feasibility was established after completion of Phase 2.

Phase 1 – Detailed program & design (₹50,000): Pre-feasibility → Charged to P&L (research phase)
Phase 2 – Coding & Testing (₹40,000): Pre-feasibility → Charged to P&L (research phase)
Phase 3 & 4 – Other coding costs (₹63,000): Post-feasibility → Capitalise as Intangible Asset
Phase 3 & 4 – Testing costs (₹18,000): Post-feasibility → Capitalise as Intangible Asset
Phase 5 – Product masters for training materials (₹19,500): Post-feasibility → Capitalise as Intangible Asset
Phase 6 – Packing 1,500 units (₹16,500): Production cost → Treated as Inventory (@ ₹11 per unit)

Summary: Expensed to P&L: ₹90,000 | Capitalised (Intangible Asset): ₹1,00,500 | Inventory: ₹16,500 | Total: ₹2,07,000