Unit 2 Accounting and Auditing PYQ’s 27th June 2025

The correct answer is – Ind AS 110

Key Points

• Ind AS 110
  • Ind AS 110 specifically addresses the principles for the presentation and preparation of consolidated financial statements.
  • The standard applies when an entity controls one or more other entities (subsidiaries) and is required to prepare consolidated financial statements.
  • It establishes the definition of control as the basis for consolidation, which requires:
    • Power over the investee.
    • Exposure or rights to variable returns from involvement with the investee.
    • Ability to use power to affect the amount of returns.
  • Ind AS 110 replaces the previous concept of consolidation under Ind AS 27.

Additional Information

• Ind AS 29
  • This standard deals with financial reporting in hyperinflationary economies.
  • It is not related to consolidated financial statements and is applicable in specific economic conditions.
• Ind AS 101
  • Focuses on first-time adoption of Indian Accounting Standards.
  • It provides transition guidance for entities moving to Ind AS for the first time.
• Ind AS 41
  • Relates to agriculture, including biological assets and agricultural produce.
  • It is not relevant to the preparation of consolidated financial statements.

The correct answer is – A, C, and E Only

Key Points

• Conservatism principle
  • This accounting principle requires that potential losses be recognized as soon as they are probable, but gains should only be recorded when they are realized.
  • It ensures that financial statements provide a realistic picture of the financial position, avoiding overstatement of assets or income.
• Application in the question
  • Valuation of stock in trade at the lower of cost or market value (A)
    • This application ensures that the value of inventory is not overstated in case market value falls below cost.
  • Making provision for bad and doubtful debts (C)
    • Recognizing potential losses from customers’ inability to pay ensures realistic representation of accounts receivable.
  • Creation of investment fluctuation fund (E)
    • This safeguards against potential losses arising from fluctuations in investment values.

Additional Information

• Other examples of the conservatism principle
  • Provision for contingent liabilities:
    • Contingent liabilities, such as lawsuits or warranties, are recorded if they are probable and can be reasonably estimated.
  • Amortization of intangible assets:
    • Gradual reduction in the value of intangible assets is applied to avoid overstatement in the financial statements.
• Common misconceptions:
  • Conservatism principle does not allow deliberate understatement of income or assets; it only ensures that potential risks are accounted for reasonably.

The correct answer is – A, C, and D Only

Key Points

• Modified Audit Reports
  • As per SA 705, modified audit reports refer to reports that differ from the standard “Unmodified Opinion” due to specific circumstances.
  • Types of modified audit reports include:
    • Qualified Opinion: Issued when there are material misstatements or scope limitations but not pervasive.
    • Disclaimer of Opinion: Issued when the auditor is unable to obtain sufficient evidence and the issue is both material and pervasive.
    • Adverse Opinion: Issued when the financial statements contain material misstatements that are pervasive.
• Emphasis of Matter Paragraph
  • An “Emphasis of Matter” paragraph does not modify the audit opinion; it is used to highlight significant matters.
  • It is included in an Unmodified Opinion report and does not fall under the category of modified audit reports.

Additional Information

• Qualified Opinion
  • Used when there are material misstatements or scope limitations that are significant but not pervasive.
  • The auditor provides a clear explanation of the reasons for qualification in the report.
• Disclaimer of Opinion
  • Issued when the auditor is unable to obtain sufficient evidence to form an opinion.
  • This occurs in situations where the scope limitations are material and pervasive.
• Adverse Opinion
  • Issued when the financial statements contain material misstatements that are pervasive and affect the reliability of the financial statements.
  • Indicates that the financial statements do not provide a true and fair view.
• SA 705
  • SA 705 establishes guidelines for auditors on when to issue a modified opinion.
  • It clearly differentiates between the types of modified opinions and their implications.

The correct answer is – ₹8,85,000

Key Points

• Net Cash from Operating Activities
  • To calculate Net Cash from Operating Activities, adjustments are made to the Net Profit Before Tax to account for non-cash items and changes in working capital.
  • Non-cash items like Depreciation are added back to the profit because they do not involve actual cash outflow.
  • Changes in working capital include adjustments for Decrease in Current Assets (added) and Decrease in Current Liabilities (subtracted).
  • Tax Paid is subtracted because it represents actual cash outflow.
• Calculation:
  • Net Profit Before Tax = ₹5,90,000
  • Depreciation = ₹4,30,000
  • Decrease in Current Assets = ₹30,000
  • Decrease in Current Liabilities = ₹85,000
  • Tax Paid = ₹80,000
  • Net Cash from Operating Activities = ₹5,90,000 + ₹4,30,000 + ₹30,000 – ₹85,000 – ₹80,000 = ₹8,85,000

Additional Information

• Operating Activities
  • Operating activities refer to the primary revenue-generating activities of a business, such as selling goods or providing services.
  • The cash flow from operating activities is a key indicator of a company’s ability to generate cash from its normal operations.
• Non-Cash Adjustments
  • Non-cash items like Depreciation and Amortization are added back because they reduce accounting profit but do not involve cash outflow.
  • These adjustments ensure the cash flow statement accurately reflects actual cash movements.
• Working Capital Adjustments
  • Decrease in Current Assets (e.g., inventory or accounts receivable) increases cash flow because it implies cash inflow or reduced cash usage.
  • Decrease in Current Liabilities (e.g., accounts payable) reduces cash flow because it implies a cash outflow to settle liabilities.
• Tax Paid
  • Tax paid is subtracted because it represents an actual cash outflow.
  • This adjustment ensures the operating cash flow reflects all cash movements related to taxes.

The correct answer is – B, C and E Only

Key Points

• Amalgamation in the nature of merger
  • Amalgamation in the nature of merger involves the transfer of all assets and liabilities from the transferor company to the transferee company.
  • Under this method, shareholders holding not less than 90% of the face value of the equity shares of the transferor company must become equity shareholders of the transferee company.
  • Payment of purchase consideration cannot be made in cash. It should be made through the issue of equity shares of the transferee company.
  • The journal entries for recording such mergers are passed using the pooling of interest method, as opposed to the purchase method.
  • The business of the transferor company is intended to be continued by the transferee company after the merger.
• The statements B, C, and E are incorrect as they deviate from the required conditions for amalgamation in the nature of merger:
  • B: The correct threshold for equity shareholders is 90%, not 95%.
  • C: Payment of consideration in cash is not allowed in a merger.
  • E: The business of the transferor company must be continued, not discontinued.

Additional Information

• Pooling of Interest Method
  • Used to account for amalgamation in the nature of merger.
  • Under this method, the assets, liabilities, and reserves of the transferor company are recorded at their book values in the transferee company’s books.
  • No new goodwill or capital reserve is created due to the merger.
  • The financial statements of both companies are combined as if they were a single entity from the beginning.
• Purchase Method
  • Used to account for amalgamation in the nature of purchase.
  • The assets and liabilities of the transferor company are recorded at their fair values in the transferee company’s books.
  • Goodwill or capital reserve may arise depending on the difference between the purchase consideration and the net assets acquired.
• Key Distinction Between Merger and Purchase
  • In a merger, the identity of the transferor company is absorbed entirely into the transferee company, and the business is continued.
  • In a purchase, the transferee company may or may not continue the business of the transferor company.

The correct answer is – A-III, B-I, C-IV, D-II

Key Points

• Matching Ind AS Standards
  • Ind AS 2 refers to Inventories, which deals with the accounting treatment for inventories including their valuation and recognition.
  • Ind AS 16 pertains to Property, Plant, and Equipment, addressing the accounting for tangible fixed assets.
  • Ind AS 103 is related to Business Combinations, covering accounting for mergers and acquisitions.
  • Ind AS 113 deals with Fair Value Measurement, providing a framework for fair value determination.
• The correct matching is as follows:
  • A – III (Ind AS 2: Inventories)
  • B – I (Ind AS 16: Property, Plant, and Equipment)
  • C – IV (Ind AS 103: Business Combinations)
  • D – II (Ind AS 113: Fair Value Measurement)

Additional Information

• Ind AS 2: Inventories
  • Ind AS 2 defines inventories as assets held for sale in the ordinary course of business, in the process of production, or as materials consumed in production.
  • It prescribes the cost formula and the methods for valuing inventories, such as FIFO and weighted average cost.
• Ind AS 16: Property, Plant, and Equipment
  • This standard applies to tangible fixed assets used in production, supply of goods or services, and administrative purposes, with a useful life of more than one year.
  • It includes provisions for depreciation, revaluation, and disposal of assets.
• Ind AS 103: Business Combinations
  • Ind AS 103 provides guidance on accounting for business combinations, focusing on the acquisition method.
  • It includes the recognition of goodwill or bargain purchase gain, measurement of non-controlling interest, and acquisition-related costs.
• Ind AS 113: Fair Value Measurement
  • This standard establishes a single framework for fair value measurement under other Ind AS standards.
  • It defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
  • It specifies the valuation approaches: market approach, cost approach, and income approach.

The correct answer is – Management audit is a statutory requirement.

Key Points

• Incorrect nature of the statement:
  • Management audit is not a statutory requirement, meaning it is not mandated by law.
  • It is a voluntary process undertaken by organizations to evaluate the efficiency and effectiveness of their management practices.
  • Statutory audits, such as financial audits, are legally required, whereas management audits are conducted as per the discretion of the organization.
• Purpose of management audit:
  • It provides a critical evaluation of management policies, processes, and practices.
  • The focus is on improving organizational efficiency and identifying areas for development.

Additional Information

• Scope of management audit:
  • It covers all aspects of management, including planning, organizing, staffing, directing, and controlling.
  • It is a comprehensive review and can span multiple financial years for assessing long-term trends.
• Appointment of management auditor:
  • The management auditor is typically appointed by the shareholders or the board of directors of the organization.
  • The appointment is made based on the organization’s specific needs for performance evaluation.
• Key differences from statutory audit:
  • A statutory audit focuses solely on financial compliance, while a management audit evaluates overall management practices.
  • Statutory audits are mandatory by law, whereas management audits are voluntary.

The correct answer is – Inventories

Key Points

• Non-Monetary Items
  • Non-monetary items refer to those assets or liabilities whose value is not fixed in monetary terms.
  • Examples include inventories, property, plant, and equipment, as their value can fluctuate based on market conditions.
  • In the context of current purchasing power accounting, these items are adjusted for changes in the purchasing power of money.
• Inventories
  • Inventories are classified as non-monetary items because their value is subject to market price changes.
  • They are measured at cost or net realizable value, which is not fixed in monetary terms.
• Monetary Items vs. Non-Monetary Items
  • Monetary items have a fixed nominal value, such as cash, debtors, and debentures.
  • Non-monetary items, like inventories, do not have a fixed monetary value and are influenced by external factors such as inflation and market conditions.

Additional Information

• Monetary Items
  • Monetary items include assets and liabilities that have a fixed value in terms of currency.
  • Examples include:
    • Cash: Always has a fixed nominal value.
    • Debtors: Represent amounts receivable in fixed monetary terms.
    • Debentures: Represent fixed obligations payable in monetary terms.
  • These items are not affected by inflation adjustments in current purchasing power accounting.
• Current Purchasing Power (CPP) Accounting
  • CPP accounting adjusts the financial statements for changes in the purchasing power of money due to inflation or deflation.
  • Monetary items remain unadjusted, while non-monetary items are restated to reflect their current value in real terms.
  • This method ensures that the financial statements provide a more accurate picture of an entity’s financial position in times of changing inflation rates.

The correct answer is – Option 3: C, A, D, B

Key Points

• Correct Order for Asset Application in Partnership Firm Dissolution
  • Step C: Paying the debts of the firm to third parties is the first priority, as the external liabilities must be cleared before internal obligations.
  • Step A: Paying to each partner rateably what is due to them from the firm for advances (as distinguished from capital) comes next. These represent loans or temporary funding provided by partners.
  • Step D: Settling the partners’ capital accounts is the third step. This ensures that partners are reimbursed for their invested capital.
  • Step B: Distributing any remaining residues among the partners in the proportion in which they were entitled to share profits is the final step in the process.
• This prioritization aligns with the legal requirements for the orderly settlement of obligations during the dissolution of a partnership firm.

Additional Information

• Legal Provisions:
  • The order of application of assets is governed by Section 48 of the Indian Partnership Act, 1932.
  • This ensures fair and equitable distribution of the firm’s assets among creditors, partners, and other stakeholders.
• Explanation of Key Terms:
  • Debts to third parties: These include liabilities to banks, suppliers, and other external creditors.
  • Advances: Temporary loans or additional contributions made by partners, which are different from their fixed capital contributions.
  • Capital: The amount invested by partners in the firm, which is reimbursed after settling external obligations.
  • Residues: Any remaining assets distributed among partners as per the profit-sharing ratio.
• Practical Application:
  • Correctly following this order protects the interests of creditors and ensures transparency and fairness during the dissolution process.
  • Understanding the order is crucial for accountants, lawyers, and partners involved in a partnership firm.

The correct answer is – 120 days

Key Points

• Working Capital Cycle
  • The working capital cycle is the time taken by a company to convert its net current assets and current liabilities into cash.
  • It includes raw material holding, production, finished goods holding, and credit terms with both suppliers and debtors.
• Calculation Breakdown
  • Raw material holding period: 60 days
  • Production process: 15 days
  • Finished goods holding period: 30 days
  • Debtors’ credit period: 30 days
  • Supplier credit period: Subtract 15 days
  • Total working capital cycle = (60 + 15 + 30 + 30) – 15 = 120 days
• Correct Answer: Based on the calculation, the total working capital cycle is 120 days.

Additional Information

• Importance of Working Capital Cycle
  • The working capital cycle helps businesses understand their liquidity and operational efficiency.
  • Shorter cycles generally indicate better cash flow management and quicker turnover of assets.
• Components of Working Capital Cycle
  • Raw Material Holding Period: Time for which raw materials are stored before production begins.
  • Production Period: Time taken for raw materials to be converted into finished goods.
  • Finished Goods Holding Period: Time for which finished goods are stored before being sold.
  • Debtors’ Credit Period: Time given to customers to pay for purchased goods.
  • Supplier Credit Period: Time allowed by suppliers before payment is due; this reduces the cycle length.
• Objective Exam Tips
  • Understand formula-based calculations for the working capital cycle.
  • Pay attention to subtracting the supplier credit period from the overall cycle.
  • Practice similar questions to improve speed and accuracy for exams.

The correct answer is – 1600 buckets

Key Points

• Break-even Analysis Formula
  • To calculate the number of buckets required to achieve a specific profit, use the formula:
    Sales Quantity = (Fixed Cost + Desired Profit) / (Selling Price – Variable Cost)
• Given Data
  • Fixed Cost = ₹1,50,000
  • Desired Profit = ₹90,000
  • Selling Price per Bucket = ₹210
  • Variable Cost per Bucket = ₹60
• Step-by-Step Calculation
  • Contribution per Bucket = Selling Price – Variable Cost = ₹210 – ₹60 = ₹150
  • Total Amount Needed = Fixed Cost + Desired Profit = ₹1,50,000 + ₹90,000 = ₹2,40,000
  • Sales Quantity = Total Amount Needed / Contribution per Bucket = ₹2,40,000 / ₹150 = 1600 buckets

Additional Information

• Concept of Contribution Margin
  • The contribution margin is the difference between the selling price per unit and the variable cost per unit.
  • It represents the portion of sales revenue that contributes to covering the fixed costs and generating profit.
• Break-even Point
  • The break-even point is the level of sales at which total revenue equals total costs (fixed and variable).
  • At this point, the business makes neither a profit nor a loss.
• Profit Calculation
  • Once the break-even point is surpassed, the contribution margin from additional units sold contributes to profit.
  • Profit = (Sales Quantity × Contribution Margin) – Fixed Costs