CA Inter Audit & Ethics — Question Paper — November 2011

Garner vs Murray Rule (applied in partnership dissolution when a partner is insolvent): The deficiency of the insolvent partner is borne by the remaining solvent partners in their capital ratio (not profit-sharing ratio). Partners R and S have overdrawn capital accounts (shown as assets in the Balance Sheet). Since R is declared insolvent and nothing is recoverable from his estate, R's net deficiency is written off and shared by P and Q (the only solvent partners with positive capital balances on the Balance Sheet) in their capital ratio of ₹1,68,000 : ₹1,08,000 = 14 : 9. S, though solvent, had a negative (overdrawn) capital balance and is therefore excluded from the Garner vs Murray ratio; S must bring in cash to clear her own deficit.

Realisation Account

Dr side — Assets at book value: Land & Building ₹2,46,000; Furniture & Fixtures ₹65,000; Stock ₹1,00,000; Debtors ₹72,500 = ₹4,83,500. Cash payments: Sundry Creditors ₹36,000; Mortgage Loan ₹1,10,000; Further Creditors ₹18,000; Dissolution Expenses ₹7,800 = ₹1,71,800. Total Dr = ₹6,55,300.

Cr side — Liabilities transferred: Sundry Creditors ₹36,000; Mortgage Loan ₹1,10,000 = ₹1,46,000. Proceeds received: Land & Building ₹2,30,000; Furniture ₹42,000; Stock ₹72,000; Debtors ₹65,000 = ₹4,09,000. Loss on Realisation = ₹1,00,300 transferred to partners in 4:3:2:1 — P ₹40,120; Q ₹30,090; R ₹20,060; S ₹10,030.

Partners' Capital Accounts

Reserves (General ₹95,000 + Capital ₹25,000 = ₹1,20,000) credited in 4:3:2:1: P ₹48,000; Q ₹36,000; R ₹24,000; S ₹12,000.

After reserves and loss on realisation: P = ₹1,75,880 (Cr); Q = ₹1,13,910 (Cr); R = ₹21,060 (Dr — deficiency, insolvent); S = ₹16,030 (Dr — deficiency, solvent, must pay cash).

Applying Garner vs Murray: R's deficiency ₹21,060 shared by P and Q in capital ratio 14:9 — P bears ₹12,819; Q bears ₹8,241.

Final settlement: P receives ₹1,63,061; Q receives ₹1,05,669; S pays ₹16,030 to bank.

Cash Account

Total receipts: Opening cash ₹15,500 + Realisation proceeds ₹4,09,000 + Cash from S ₹16,030 = ₹4,40,530. Total payments: Creditors & expenses ₹1,71,800 + P ₹1,63,061 + Q ₹1,05,669 = ₹4,40,530 ✓.

(i) Purchase Consideration (PC) and Shares to be Issued by Z Ltd.

Z Ltd. Issue Price per share = ₹10 (face value) + ₹6 (premium) = ₹16 per share

For X Ltd. Shareholders:
Number of X Ltd. shares = ₹30,00,000 ÷ ₹10 = 3,00,000 shares
PC = 3,00,000 × ₹18 = ₹54,00,000
Z Ltd. shares to be issued = ₹54,00,000 ÷ ₹16 = 3,37,500 shares

For Y Ltd. Shareholders:
Number of Y Ltd. shares = ₹18,00,000 ÷ ₹10 = 1,80,000 shares
PC = 1,80,000 × ₹20 = ₹36,00,000
Z Ltd. shares to be issued = ₹36,00,000 ÷ ₹16 = 2,25,000 shares

Total Z Ltd. shares issued = 3,37,500 + 2,25,000 = 5,62,500 shares

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(ii) Realisation Account and Equity Shareholders' Account

Realisation Account — X Ltd.

| Dr. Particulars | ₹ | Cr. Particulars | ₹ |
|---|---|---|---|
| Land & Building | 27,00,000 | 10% Debentures (Z Ltd.) | 15,00,000 |
| Plant & Machinery | 15,00,000 | Sundry Creditors (Z Ltd.) | 7,80,000 |
| Investments in Y Ltd. | 2,40,000 | Contingent Liability (Z Ltd.) | 1,80,000 |
| Stock | 15,60,000 | Z Ltd. – Purchase Consideration | 54,00,000 |
| Debtors | 12,30,000 | | |
| Cash at Bank | 90,000 | | |
| Contingent Liability (now actual) | 1,80,000 | | |
| Profit on Realisation (to Shareholders) | 3,60,000 | | |
| Total | 78,60,000 | Total | 78,60,000 |

*Note: The contingent liability of ₹1,80,000 appears on both sides — debited when recognised as actual, and credited when Z Ltd. assumes it. The net effect on profit is nil.*

Equity Shareholders' Account — X Ltd.

| Dr. Particulars | ₹ | Cr. Particulars | ₹ |
|---|---|---|---|
| Shares in Z Ltd. | 54,00,000 | Equity Share Capital | 30,00,000 |
| | | Securities Premium | 6,00,000 |
| | | General Reserve | 9,00,000 |
| | | Profit & Loss A/c | 5,40,000 |
| | | Profit on Realisation | 3,60,000 |
| Total | 54,00,000 | Total | 54,00,000 |

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Realisation Account — Y Ltd.

| Dr. Particulars | ₹ | Cr. Particulars | ₹ |
|---|---|---|---|
| Land & Building | 13,50,000 | Secured Loan (Z Ltd.) | 9,00,000 |
| Plant & Machinery | 11,40,000 | Sundry Creditors (Z Ltd.) | 5,10,000 |
| Stock | 10,50,000 | Z Ltd. – Purchase Consideration | 36,00,000 |
| Debtors | 7,80,000 | | |
| Cash at Bank | 1,20,000 | | |
| Profit on Realisation (to Shareholders) | 5,70,000 | | |
| Total | 50,10,000 | Total | 50,10,000 |

Equity Shareholders' Account — Y Ltd.

| Dr. Particulars | ₹ | Cr. Particulars | ₹ |
|---|---|---|---|
| Shares in Z Ltd. | 36,00,000 | Equity Share Capital | 18,00,000 |
| | | General Reserve | 7,50,000 |
| | | Profit & Loss A/c | 4,80,000 |
| | | Profit on Realisation | 5,70,000 |
| Total | 36,00,000 | Total | 36,00,000 |

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(iii) Balance Sheet of Z Ltd. as on 1-4-2011

The 15,000 shares of Y Ltd. held by X Ltd. (₹2,40,000) are transferred to Z Ltd. as an asset. Since Y Ltd. ceases to exist (merged into Z Ltd.), this investment is eliminated. Under AS 14 (Accounting for Amalgamations) — Purchase Method, the excess of Purchase Consideration over the net assets acquired is treated as Goodwill.

Net Assets acquired:
Total assets (X Ltd. + Y Ltd.) = ₹73,20,000 + ₹44,40,000 = ₹1,17,60,000
Less: Investment in Y Ltd. (eliminated) = ₹2,40,000
Net real assets = ₹1,15,20,000
Less: Total liabilities assumed = ₹38,70,000
Net Assets = ₹76,50,000

Goodwill = Total PC − Net Assets = ₹90,00,000 − ₹76,50,000 = ₹13,50,000

Balance Sheet of Z Ltd. as on 1-4-2011

| Liabilities | ₹ | Assets | ₹ |
|---|---|---|---|
| Share Capital | | Goodwill | 13,50,000 |
| 5,62,500 shares of ₹10 each | 56,25,000 | Land & Building | 40,50,000 |
| Securities Premium | 33,75,000 | Plant & Machinery | 26,40,000 |
| 10% Debentures | 15,00,000 | Stock | 26,10,000 |
| Secured Loan | 9,00,000 | Debtors | 20,10,000 |
| Sundry Creditors | 12,90,000 | Cash at Bank | 2,10,000 |
| Contingent Liability (now actual) | 1,80,000 | | |
| Total | 1,28,70,000 | Total | 1,28,70,000 |

Legal Framework: Under the Sixth Schedule of the Electricity (Supply) Act, 1948, a licensed electricity company's clear profit must be appropriated in a prescribed order after computing the Capital Base and Reasonable Return.

Step 1 — Preliminary Calculations from Available Data

The debenture principal is back-calculated: ₹2,40,000 ÷ 12% = ₹20,00,000. Income on Contingencies Reserve Investments = ₹24,00,000 × 10% = ₹2,40,000 p.a.

Note: The question as presented is missing amounts for (i) Share Capital, (ii) Fixed Assets, (iii) Depreciation Reserve on Fixed Assets, (iv) Loan from Electricity Board, and (v) Reserve Fund Investments. The complete methodology is shown below; wherever specific amounts are absent, the rule and treatment are stated.

Step 2 — Capital Base (per Sixth Schedule)

Capital Base = Net Fixed Assets (Fixed Assets at cost LESS Depreciation Reserve) [data not provided] + Intangible Assets ₹7,60,000 + Working Capital (monthly average Current Assets ₹34,60,000, including ₹7,00,000 due from consumers, LESS monthly average Current Liabilities [not provided]) LESS the following exclusions: Consumer's contribution to fixed assets ₹3,40,000; Security deposits of consumers ₹10,00,000; Tariff and Dividends Control Reserve ₹16,00,000; Development Reserve ₹12,00,000; Contingencies Reserve (funded separately) ₹24,00,000; Loan from Electricity Board [excluded entirely per Sixth Schedule]. Debentures of ₹20,00,000 are not deducted — they form part of the capital base (they are licencee's own long-term loan capital).

Total known deductions = ₹65,40,000. Capital Base = (Net Fixed Assets − Electricity Board Loan) + ₹7,60,000 + ₹34,60,000 − ₹65,40,000.

Step 3 — Reasonable Return

Reasonable Return = Capital Base × Bank Rate = Capital Base × 10% (given).

Step 4 — Clear Profit

Clear Profit = Net profit after tax as given = ₹75,00,000 (debenture interest of ₹2,40,000 has already been charged; it does not get added back for Clear Profit under the standard Sixth Schedule framework taught at CA Intermediate level).

Step 5 — Appropriation of Clear Profit under the Sixth Schedule

The Sixth Schedule mandates the following order of appropriation:

(a) Reasonable Return available as Dividend: The amount of clear profit not exceeding the Reasonable Return is available for dividend. In the event the Reasonable Return computed from the (complete) Capital Base is less than ₹75,00,000, the excess must be dealt with as in (b) and (c) below.

(b) Transfer to Reserve Fund: In any year in which a dividend is paid, the licensee must transfer to the Reserve Fund not less than one-fourth (25%) of the dividend paid. The Reserve Fund is required to be invested in Government securities (here at 8% Govt. securities per the question). The existing Reserve Fund balance (invested at 8%) is available; the annual transfer tops it up to the required level.

(c) Excess Profit (Clear Profit > Reasonable Return): Any amount by which the Clear Profit exceeds the Reasonable Return must be disposed of as follows: one-third of the excess shall be applied to reduce the tariffs charged to consumers or, if the State Government so directs, placed in the Tariff and Dividends Control Reserve; two-thirds of the excess shall be transferred to the Tariff and Dividends Control Reserve (existing balance ₹16,00,000; this reserve can be drawn upon to maintain tariffs or dividends in lean years).

(d) Contingencies Reserve: The licensee must maintain a Contingencies Reserve (existing: ₹24,00,000 invested at 10%). If the balance falls below the prescribed minimum, a further transfer is required from profits before the Tariff & Dividends Control Reserve appropriation.

(e) Development Reserve: Amounts may be transferred to the Development Reserve (existing ₹12,00,000) for replacement and expansion of assets, as determined by the State Electricity Board.

Summary — Format of Profit Appropriation Account (skeleton)

Clear Profit = ₹75,00,000. Less: Transfer to Reserve Fund (1/4 of dividend) = ₹A. Less: Contingencies Reserve (if required) = ₹B. Dividend (≤ Reasonable Return) = ₹C. Less: Excess over Reasonable Return — 1/3 reduces tariffs/goes to Reserve Fund = ₹D; 2/3 to Tariff & Dividends Control Reserve = ₹E. Total = ₹75,00,000.

Once the full Capital Base is computed with the missing balance sheet data (Net Fixed Assets and Loan from Electricity Board), the exact monetary split across A, B, C, D, E can be determined. All other steps and treatment of items (deductions, inclusions, income from investments) are as shown above.