Supplementary Addendum of Cap Ii 1 PDF

COURSE: CAP II
SUPPLEMENTARY STUDY PAPER - 2016
[Covers amendments made by the New syllabus]

(Relevant for students appearing for Examination held on June 2016 and onward)
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF

NEPAL
This supplementary study paper has been prepared by the Institute of Chartered Accountants
of Nepal. Permission of the Council of the Institute is essential for reproduction of any
portion of this paper.
All rights reserved. No part of this publication may be reproduced, stored in a retrieval
system, or transmitted, in any form, or by any means, electronic, mechanical, photocopying,
recording, or otherwise, without prior permission, in writing, from the publisher.
The Institute of Chartered Accountants of Nepal
Supplementary Study Material
Forward
It is always the endeavor of the institute to provide contemporary education and training to the
students. As the distinctive characteristic of the course i.e., distance education, has emphasized the
need for bridging the gap between the current market requirement to provide quality professional
education in consonance with international norm and practice, the institute hasbeen providing a variety of
educational inputs for the students for their updates.
In this respect, the institute of Chartered Accountants of Nepal has modified the syllabus of various
subject of the CAP II course wherein various topic has been added in the syllabus. In this regards, The
Institute of Chartered Accountants of Nepal has come up with this Supplementary Study Material
which has been prepared for the students of Chartered Accountancy Professional [CAP] II Level by
incorporating the additional chapters which has been introduced in new syllabus of 2015. This topic
will be applicable to the student appearing in the CAP II examination from June 2016 onwards.
This Supplementary Study Material contains a discussion of the amendments made in the syllabus of the
CAP II course. They are very important to the students for updating their knowledge regarding the latest
developments in the respective areas mentioned above. We believe this Supplementary Study material
will be of immense help to students appearing exams and to gain working level knowledge. However,
students are advised not to rely solely on the material. They should update themselves with latest
developments and pronouncements in auditing and assurance profession along with other reference
books recommended by Institute of Chartered Accountants of Nepal (ICAN).
TABLE OF CONTENT
S.No
Content
Page No
Advanced Accounting
Audit And Assurance
38
Corporate Law
151
Financial Management
161
Cost And Management Accounting
187
6A
Business Communication
247
6B
Marketing
254
Income Tax And Vat
274
PAPER 1: ADVANCED ACCOUNTING
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NEPAL
CHAPTER IX : FINANCIAL STATEMENTS OF NOT FOR PROFIT

ORGANIZATION (NPOS)
LEARNING OBJECTIVES
Understand the meaning of Receipts and Payments account and Income and Expenditure
Account and see the distinction between the two accounts.
Learn the techniques of preparing Receipts and payments Accounts
Identify main sources of Income and learn the technique of preparing income and
expenditure account from Receipts and Payments Account.
Learn the technique of preparing Balance sheet.
1. INTRODUCTION
Nonprofit making organizations (NPOs) such as public hospitals, public educational institutes,
social clubs, sports clubs, libraries etc. conventionally prepare receipts and payments account
and income and expenditure account to show periodic performance and Balance Sheet to show
financial position at the end of the period. In this unit, we shall discuss the technique of
preparing receipts and payments account, income and expenditure account and Balance Sheet of
nonprofit making (non-trading) organizations. Also we shall discuss and illustrate the technique
of preparing receipts and payments account, income and expenditure account. It may be
mentioned that income and expenditure account is just like profit and loss account prepared for
the profit making organization. In case of income and expenditure account, the excess of
expenditure over income is treated as surplus. In nonprofit making organizations, total cash
receipts and total cash payments are highlighted through receipts and payments account.
2. NATURE OF RECEIPTS AND PAYMENTS ACCOUNT
Receipts and payments account is an elementary form of account commonly adopted by
nonprofit making organizations such as hospitals, clubs, societies etc. for presenting periodically
the result of there working. It consists of a classified summary of cash receipts and payments
over a certain period together with the cash balance at the beginning and closing of the period.
The receipts are entered on the left hand side and payments are on the right hand side i.e. same
sides as those on which they appear in cash account. Charitable institutions may not necessarily
maintain proper accounting. But still they will be maintaining a cash-book where all receipts and
payments are recorded in chronological order.
For convenience of preparation of the account, the cash-book is usually provided with a
sufficient number of analysis columns on each side to record separately the principal items of
income and expenditure. A sundry column is also provided for extraordinary items, which are
analyzed at the end of the year.
Receipt & Payment Account (format)

Receipts
To Opening balance
- Cash
- Bank
Revenue Receipts
To Subscription
To Membership fees
To Entrance Fee
To Service Fees
To Donation
To Grant and Legacies
To Interest Income
To Rent Income
To Other Incomes/Receipts
Capital Receipts
To Special Fund/Donation
To Sale of Fixed Assets
To Sale of Investments
To Loan Taken
By closing balance
- Bank (overdraft)
Amount
Payments
By Opening balance
- Bank (overdraft)
Revenue Payments
By Salaries and Wages
By Rent and Taxes
By Insurance
By Entertainment Expenses
By Printing and Stationery
By Bank Charges and Interest
By Water and Electricity
By Repair and Maintenance
By Other/sundry Expenses
Capital Payments
By Purchase of Fixed Assets
By Purchase of Investments
By Repayment of Loans
By closing balance
- Cash
- Bank
Amount
Illustration
The receipts and payments of the Small Club, Dharan for the year ended Ashad 31, 2072 were:
Entrance fees Rs. 30,000; Membership fees Rs. 300,000; Donation for parking shed Rs. 100,000,
Exhibition sales Rs. 1,200,000, Exhibition expenses Rs. 980,000, Salaries and Wages Rs. 92,000,
Construction of parking shed Rs. 125,000; General expenses Rs. 6,000; Rent and taxes Rs,
4,000, Bank charges Rs. 800, Rental income for ground Rs. 30,000.
Cash balance Shrawan 1, 2071 Rs. 12,500 and Ashad 31, 2072 Rs. 8,400
Bank balance Shrawan 1, 2071 Rs, 225,580
Prepare the Receipts and Payments Account for the year ended Ashad 31, 2072.
Solution
Small Club, Dharan
Receipts and Payments Account
For the year ended Ashad 31, 2072
Receipts
To, Cash Balance b/d
To, Bank Balance b/d
To, Entrance Fees
To, Membership Fees
Rs.
12,500
225,580
30,000
300,000
Payments
By, Exhibition Expenses
By, Salaries and Wages
By, Construction of Parking Shed
By, General Expenses
Rs.
980,000
92,000
125,000
6,000
To, Donation for Parking Shed

To, Exhibition Sales
To, Rental Income
100,000 By, Rent and Taxes

1,200,000 By, Bank Charges
30,000 By, Balance c/d
Cash Balance
Bank Balance
1,898,080
4,000
800
8,400
681,880
1,898,080
Limitation of Receipts and Payments Account

From study of the above account, it will be apparent that the increase in the cash and bank
balances at the end of the year, as compared to those in beginning, does not truly represent the
surplus for the year since it does not take into account the cost of construction of the parking
shed, which is in excess of the donation received, the outstanding subscription or those which
were collected in advance, etc. Ordinarily one should ascertain whether for a year current income
is sufficient to meet the current expenses. Since the Receipts and Payments Account includes
items relating to all periods or of all types, it does not serve the purpose mentioned above.
3. SOURCES OF INCOME IN NPOS
Main sources of income are annual fee, grant, subscription, contribution, service charges; rental
incomes on the property (like building) let out and so on. The institutions maintain these
accounting heads as per the nature of their activities. In case of any investments made,
accounting treatment for interest income is not different from that of business enterprises.
a. Subscription
Subscription is a main source of income of non-profit making organization. It means the regular
fee or charge to be collected from the members of the organization. Total subscription income of
the particular period should be charged to income and expenditure account as income which
should be found out by followings;
Subscription given in Receipt & Payment account
Add: Outstanding for current year
Add: Advance received in previous year
Less: Outstanding of previous year
Less: Advance received for next year
Subscription income for the year (to be shown in Income & Expenditure A/c)
XXXX
XXXX
XXXX
(XXXX)
(XXXX)
XXXX
Illustration
Subscription received during the year 2072
170,000
Subscription outstanding at the beginning of 2072
14,000
Subscription outstanding at the end of 2072
16,000
Calculate the amount of subscription to be credited to Income and Expenditure Account during
the year of 2072.
Solution:
Subscription Account
Dr.
Cr.
Particulars
To, Balance b/d
To, Income and Expenditure A/c
Total
Rs.
Particulars
14,000 By, Cash A/c
172,000 By, Balanced c/d
186,000 Total
Rs.
170,000
16,000
186,000
Illustration
Calculate the amount of subscription to be credited to Income and Expenditure Account during
the year of 2072 from the following information.
Subscription received during the year 2072
82,000
Subscription outstanding at the beginning of 2072
8.900
Subscription outstanding at the end of 2072
3,200
Subscription received in advance for 2072
2,700
Solution
Subscription Account
Dr.
Particulars
To, Balance b/d
To, Subscription received in advance
for coming year
To, Income and Expenditure A/c
Cr.
Rs.
Particulars
8,900 By, Cash A/c
By, Balanced c/d
2,700
73,600
85,200
Rs.
82,000
3,200
85,200
b. Entrance or Admission Fee

Admission fee payable by a member only once, at the time of becoming a member, should be
treated as capital receipts and credited to Capital Fund Account. Where the amount is small, just
to cover the expenses of admission, it should be treated as revenue receipts and credited to
income and Expenditure Account. When a specific direction has been given in the rules and
regulations of the organization, it should be treated accordingly.
c. Life Membership Fees
Amount received from life membership should be credited to a special fund and an amount equal
to annual subscription is transferred every rear to the Income and Expenditure Account, the
balance of this fund is carried forward till it is fully exhausted. Alternatively, the entire amount
can be credited to the Capital Fund in the year in which it is received.
Thus, while preparing the final accounts on accrual basis by the charitable institutions, especially
in respect of the annual fee and other fee received, differentiation is required to be made between
the amounts pertaining to the previous year, amount yet to be received and amount received in
advance.
Example
A club has received in total Rs. 500,000 towards annual fees. Of this amount, Rs. 10,500 pertains
to the previous year and Rs. 20,000 has been received in advance pertaining to the next year
whereas Rs. 11,500 is yet to be received in respect of the current year's fee. Accordingly, the
actual fee earned for the year out of the total amount received during to year would be as
follows;
Rs.
Total amount received
5,00,000
Less: Previous year's fee
10,500
Less: Next year's fee
20,000
30,500
Cash received for this year
469,500
Add: Amount yet to be received for this year
11,500
Total fee income for the year
481,000
The journal entries for the above adjustment are to be passed as follows: (Only such entries
which require adjustment in the fees account).
a) Adjustment entry for the amount of Rs. 10,500 received during the year in respect of the fee
pertaining to the previous year:
Fee Income Account
Dr.
To, Fee Receivable Account
10,500
10,500
(Assuming the above amount has been debited to the Fee Receivable Account in the
previous year).
b) Adjustment entry for the amount of Rs. 11,500 being this year's fee yet to be received:
Fee Receivable Account
To, Fee Income Account
Dr.
11,500
11,500
c) Adjustment entry for the amount of Rs. 20,000 being the fee received in advance pertaining
to the next year:
Fee Income Account
To, Fee Received in Advance
Dr.
20,000
20,000
(This "Fee Received in Advance" A/c will be transferred to Fee Income A/c in the subsequent
year).
After passing and posting of the above entries, the Fee Income Account would appear as
follows:
Fee Income Account
Dr.
Particular
To, Fee Receivable
To, Fee Received in Advance
To, Net fee transferred to Income &
Expenditure A/C
Amount
Particular
10,500 By Cash
20,000 By Fee Receivable
481,000
511,500
Cr.
Amount
5,00,000
11,500
511,500
The methods of accounting treatment relating to all other income and expenditure headings other
than aforesaid special type of income that would increase or decrease the capital fund and
preparation of trail balance as well as Income & Expenditure Account are similar to preparation
of the Profit & Loss Account. Accordingly, there is no difference in preparation of the Balance
Sheet as well.
d. Donation
It is amount contributed by the supporters, members and well-wishers of the organization in form
of cash or kind. The donation may be general or specific. While expending the amount of grants
for special program (asset not to be created), it should be debited to the respective program
account. The balance in the program account should be periodically transferred to the concerned
grant account. Similarly, if the closing of the books of accounts is required to be done at the
financial year end prior to completion of the special program for which a grant has been
received, the balance amount of such grant would appear in the Balance Sheet as follows;
Liabilities Side
Grant for Annual Sports
Less: Expenditure till date
Rs.
80,000
20,000
60,000
e. Legacy
It is an amount or other item of value received from a deceased person under the terms of a will.
When anything is personally given away by a will, it is treated as a gift in the legal term. The gift
which is made by a will, out of general fund of an estate it is described as 'legacy'. The amount
received as legacy may be big or small. A legacy may be 'demonstrative' when it is made out of a
particular fund or 'specific' when a particular portion of the assets assigned. If it is for a specific
purpose, then it should be capitalized in the name of the 'Fund' for that particular purpose.
Otherwise, it is directly added to capital fund.
As in the case of business enterprises, charitable institutions also do have account headings like
salary, allowances, depreciation expense, printing and stationery, telephone, profit/loss on sale of
assets and so on in respect of their expenditure. In addition to above, other expenditure may
include the expenses for the conduction of special programs.
10
4. FUND BASED ACCOUNTING

Fund accounting is a system of accounting widely used in non-business entities, such as
nonprofits, government agencies, hospitals and colleges and universities. Fund accounting differs
from traditional business accounting, which focuses on identifying how successful an entity has
been at creating profits. Since nonprofits and governments are not designed to generate profits,
an alternative accounting method gives them a more fitting approach to tracking and reporting
their finances
Sometime it so happens that many donors provide special grant for specific program or for
purchase of assets. In such a situation, it would not be appropriate to credit the amount of such
grants directly to the "Capital Fund". If it is directly credited in this manner, the basic source of
funding the special activity could not be ascertained from its financial statement. Therefore, such
amount should be accounted for under the separate heading. For example, if grant is received for
the construction of building the receipt of the fund is required to be accounted separately as
follows:
Cash Account
Dr.
To, Building Fund A/c
Cr.
Similarly, if donation or grant is received from any source towards organizing an annual sports
program Cash Account
Dr.
To, Annual Sports Program Fund A/c
Cr.
It is not necessary that the amount of grants have to be received in cash only. Donors may
provide grants in kind as well. In such situation, the account head concerning the specific group
of goods/assets received should be debited instead of debiting the cash.
While expending the cash received for any special program or purpose, the same program
operation account should be debited. This is required to maintain the record of the extent of
expenditure made under such program or purpose. For example, if building construction is being
carried out, the amount spent for such purpose would be recorded as:
Building Construction A/c
To, Cash Account
Dr.
Cr.
The above Building Construction Account being real account should be subsequently transferred
to the fixed asset. Therefore, this should come in the assets side of the Balance Sheet.
Accordingly, the extent of expenditure made out of the grant is ascertainable. The amount of
grant received would appear in the liabilities side and the amount of expenditure incurred in the
assets side. After the completion of the construction work, the purpose of the grant is considered
achieved as such it is not required to be shown as "Special Grant" in the Balance Sheet.
Therefore, in such situation, the grant amount should be transferred to the "Capital Fund" by
passing following entries:
i.
Building Account
To, Building Construction A/C
Dr.
Cr.
(For capitalization of building on completion of construction)
11
ii.
Building Fund A/C
Dr.
To, Capital Fund
Cr.
(For transfer of specific purpose fund to capital fund account on completion of

construction of building)
Technique of Maintaining Fund Accounts
Fund based accounting essentially involves preparation of financial statements fund-wise. In case
of institutions like; colleges, schools and universities separate ledgers are maintained for each
fund. Fund ledgers are self-balancing in nature. A fund may be created for purchase, acquisition
or construction of fixed assets or for any specific activities of the organizations or for both. For
example, a building fund may be created with a view to purchase, acquire or construct buildings.
All receipts in connection with the acquisition or construction of buildings are separated from the
main accounts and shown in the building fund. Any expenditure incurred for the purpose of
construction or acquisitions of building are made out of this fund. When building is ultimately
acquired or constructed, the asset is recognized in the general balance sheet and consequently
that portion of the building fund which has been utilized for the acquisition or construction of the
building should be transferred to general fund. Depreciation can be charged on such assets only
after its completion or acquisition.
In the same way, separate funds may be created for equipment, major repairs to fixed assets and
for other development activities.
Illustration
Jhapa School maintains separate building fund. As on 31.3.2071, balance of building fund was
Rs. 1,000,000 and it was represented by fixed deposit (8% per annum) of Rs. 600,000 and
current account balance of Rs. 400,000. During the year 2071/72, the school collected as
donations towards the building fund Rs. 560,000 and transferred 40% of developmental fee
collected Rs. 2,256,500 to building fund. Capital work progress as on 31st Ashadh 2071 was Rs.
825,000 for which contractors bill upto 75% was paid on 14.4.2071. The extension of building
was finished on 31.12.2071 costing Rs. 725,000 for which contractors bill was fully met. It was
decided to transfer the cost of completed building (Rs. 1,550,000) to the corresponding asset
account.
You are required to pass journal entries to incorporate the above transactions in the books of
Jhapa School for the year 2071/72 and show the trial balance of building fund ledger.
Solution
a. Bank A/c Dr.
To Building Fund A/c
(on collection of donations)
b. Bank A/c Dr.
(40% of the development fees directly)
560,000
560,000
902,600
902,000
12
c. Fixed Deposit a/c Dr.

To Interest A/c
(on accrual of interest)
48,000
48,000
d. Interest A/c Dr.

48,000
(Interest accrued on fixed deposit transferred)
48,000
e. Capital work in progress a/c Dr.

725,000
To Contractors a/c
(Work completed and certified during the year)
725,000
f. Contractors a/c Dr.

To Bank A/c
(Payments made during the year)
1,343,750
1,343,750
g. Building a/c Dr.

1,550,000
To Capital Work in progress A/c
(transfer to completed building to asset a/c)
h. Building Fund a/c
To General Fund A/c
(corresponding building fund transferred)
1,550,000
1,550,000
1,550,000
Trial Balance of Building Fund as on 31st Ashadh 2072

Dr.
5.
Building Fund
Contractors A/c
Fixed Deposit A/c
Current a/c
648,000
560,850
Total
1,208,850
Cr.
1,002,600
206,250
1,208,850
INCOME AND EXPENDITURE ACCOUNT
An Income and Expenditure Account is same as the Profit and Loss Account of the business
enterprises. Both accounts are the nominal accounts and prepared on the basis of accrual
principle of accounting. Income and Expenditure Account is prepared by matching the revenues
against the expenses for a specific period, usually a year. It is an account which is widely
adopted by non-profit making concerns to the period of account is included therein. Since nonprofit making organization do not earn profit (or incur loss) they do not prepare Profit and Loss
Account but for evaluate the financial performance of the concern prepare Income and
Expenditure Account at the year end. This will show surplus or deficit of income over
expenditure.
The method and technique of the preparation of an Income and Expenditure Account is similar to
13
that which is followed in the preparation of a Profit and Loss Account of a profit-seeking
organization. All the income irrespective of whether received or not are shown on the right hand
side (income side) and all expenditures irrespective of whether paid or not are shown in the lefthand side (expenditure side). No capital expenditure or receipt is taken in the Income and
Expenditure Account. The difference of total of income side and expenditure side will be taken
as surplus or deficit.
Income and Expenditure Account and Receipt & Payment Account are not complimentary to
each other. The Income and Expenditure Account is a statement to shown the difference between
the Income and Expenses (considering accounts) whereas Receipt and Payment Statement shows
only the receipt of cash and payments made. The differences existing between the Income &
Expenditure Account and the Receipt & Payments Account are as follows:
Income and Expenditure Account
i.
It is a summarized and classified version of

both cash and bank transactions. It starts
with the opening cash or bank balance and is
debited with all sums received and credited
with amounts paid out whether or not such
receipts and payments relate to the period.
It is drawn up in the same from as the

Profit & Loss Account. Expenditure of
revenue nature only is shown on the debit
side, and income and gains of revenue
natures are shown on the credit side.
ii.
The balance of the accounts at the end of

year represents the difference between the
amount of cash received and paid out. It is
always in debit since it is made up of cash in
hand and at bank.
It does not start with opening balances.

The closing balance represents the amounts
by which the income exceeds the
expenditure only or vice versa.
iii.
All the receipts and payments whether of a It contains all the items of income and
revenue or capital nature are included in this expenditure relevant to the period of
account.
account, whether received or paid out as
well as that which have fallen due for
recovery or paid out as well as that which
have fallen due for payment or have
accrued for recovery. Capital receipts and
expenditures are not taken into account.
Prepaid expenses and pre-payments of
income are excluded.
Income and Expenditure Account (format)

Expenditures
Amount
Incomes
To Salaries and Wages
By Subscription
To Rent and Taxes
By Membership fees
To Insurance
By Entrance Fee
To Entertainment Expenses
By Service Fees
To Printing and Stationery
By General Donation
To Bank Charges and Interest
By Grant and Legacies
To Water and Electricity
By Interest Income
Amount
14
To Repair and Maintenance

To Other/Sundry Expenses
To Consumption of Materials
To Loss on Sale of Fixed Assets
To Loss on Sale of Investments
To Loss from any event
To Depreciation
To Amortization
To Surplus (excess of income over
expenditure)
By Rent Income
By Other Incomes/Receipts
By Gain on sale of Fixed Assets
By Gain on sale of Investments
By Profit from any event
By
Deficit
(excess
of
expenditures over incomes)
Illustration
Gokarna Golf Club provided you the following Receipts and Payments Account along with
additional information for the year ended 31.12.2014. You are required to prepare Income and
Expenditure Account for that period.
Gokarna Golf Club
For the year ended December 31, 2014
Receipts
To, Bank Balances b/d
To, Subscriptions:
2011
2,000
2012
18,500
2013
900
To, Entrance fees
To, Interest on investment
Rs.
3,800
21,400
800
1,500
27,500
Payments
By, Sports Equipment Purchased
(on 1.9.2014)
By, Salaries and Wages
By, Tournament Expenses
By, Electricity
By, Printing
By, Expenses for exhibition
By, Balance c/d
Rs.
10,000
3,400
4,000
500
300
2,100
7,200
27,500
Additional information: (i) Fixed Assets of the club on 1.1.2014 includes the following: Sports
Equipments Rs. 15,500; Club Ground Rs. 62,000; Furniture Rs. 2,000 (ii) Subscription for
2014 collected in 2013 Rs. 500, (iii) Unpaid subscription for 2014 Rs. 300 (iv) Depreciation
to be provided @ 20% p.a. sport equipment and @ 5% p.a. on furniture.
Prepare an Income and Expenditure Account for the year ended on 31.12.2014.
Solution
Gokarna Golf Club
For the year ended 31.12.2014
Dr.
Expenditure
To, Salaries and Wages
To, Tournament Expenses
Cr.
Rs.
Income
3,400 By, Subscriptions
4,000
Add: Received in 2013
Rs.
18,500
500
15
To, Electricity
To, Printing
To, Expenses for exhibition
To, Depreciation on:
Sport Equipments (Note 1)
Furniture
To, Excess of income over
expenditure
500
300
Add: Subscription in arrear
2,100 By, Interest on Investment
800
3,767
100
19,000
300
19,300
1,500
6,633
20,800
20,800
Working Note: Depreciation on sports Equipments 20% on Rs. 15,500 for 1 year + 20% on Rs.
10,000 for 4 months = Rs. 3,100 + Rs. 3,767.
6. BALANCE SHEET
The Balance Sheet of non-profit making concern is prepared on the same manner as the Balance
Sheet of a profit-seeking business. It may be prepared either in the order of liquidity or in the
order of permanence. It is classified summary of the ledger balances left over after account of all
the revenue items have been closed off by transfer to the Income and Expenditure Account. The
Balance Sheet includes fixed and floating assets, liabilities and the Capital Fund or the
Accumulated Fund. The Capital Fund represents the amount contributed by members. If,
however, members have not contributed any amount, the name should be Accumulated Fund.
The surplus or deficit, if any, on the year's working as disclosed by the Income and Expenditure
Account is shown either as an addition to or deduction from the Capital Fund brought forward
from the previous period.
Capital Fund
It is an item of Balance Sheet of a non-profit organization representing the net investment if the
organization of its contributing members. It is the main resources of these institutions. After its
initial setting up from grant, this would either increase or decrease on the basis of excess of
income over expenditure or vice versa (known as net profit or net loss in the business parlance)
arising from its activities. As capital grants may also be received separately this will also result
in increasing this fund.
Preparation of Balance Sheet
(a) Assets appearing in previous balance sheet should be adjusted for (i) addition, (ii) sale, and
(iii) depreciation during the year.
(b) New assets acquired (for which payment must have been entered on the credit side of the
receipts and payments account) will be entered in the Balance Sheet. This also applies to the
new liabilities incurred e.g. loans taken. The debit side of receipts and payments account
will show this.
(c) Outstanding and prepaid expenses, subscriptions, etc. will be shown in the Balance Sheet.
This also applies to income received in advance.
16
(d) The closing balance of cash in hand and at Bank (as shown in the Receipts and Payments
Account) will be shown in the Balance Sheet.
(e) Previous year's liabilities should be adjusted for payments made.
(f) Special capital receipts (as shown by receipts and payments account) will be shown in the
Balance Sheet.
Illustration
The following was the Receipts and payments Account of International Club for the year ended
December 31, 2014.
Receipts
Cash in Hand
Bank Balance:
Deposit Account
Current Account
Bank Interest
Donation for forthcoming Tournaments
Donation and Subscriptions
Receipts from Teas
Contribution to Fares
Sale of Equipment
Proceeds from Events
Rs.
1,000
22,300
6,000
300
10,000
26,000
3,000
1,000
800
7,800
Payments
Grounds man's Fees
Mowing Machine
Rent of Ground
Cost of Teas
Fares Expenses
Printing and Office Expenses
Repairs to Equipment
Honoraria to Secretary for 2013
Bank Balance:
Deposit Account
Current Account
Cash in Hand
Rs.
7,500
15,000
2,500
2,500
4,000
2,800
4,000
4,000
30,900
1,500
3,500
78,200
78,200
You are given the following additional information:
Jan 1
Dec 31
Rs.
Rs.
Subscriptions due
1,500
1,000
Amount due for printings etc.
1,000
800
Cheques unpresented being payment for repairs
3,000
2,600
Interest not yet entered in the Pass Book
200
Bonus to Groundsman
3,000
Machinery & Equipment
8,000
17,500
For the year ended Dec. 31, 2014, the honoraria to the secretary are to be increased by a total of
Rs. 2,000.
Prepare the Income and Expenditure Account for 2014 and the relevant Balance Sheet.
Solution
Income and Expenditure Account of International Club
For the year ending 31.12.2014
Expenditures
Rs.
Income
To, Groundsman's fee
7,500
By, Donation and Subscriptions
To, Rent of Ground
2,500
By, Receipts from teas less expenses
To, Fare Expenses
4,000
By, Proceeds from Events
Rs.
25,500
500
7,800
17
Less: Contribution
To, Printing and Office Exp.
To, Dep. on Machinery:
Opening and Purchase
Less: Closing Balance
1,000
Less: Sales
To, Honoraria to Secretary
To, Bonus to Groundsman
To, Repairs to Equipment
To, Excess of income over Exp.
3,000
2,600
23,000
17,500
5,500
800
By, Interest
500
4,700
6,000
3,000
4,000
1,000
34,300
34,300
Balance Sheet of International Club as on 31.12.2014

Liabilities
Outstanding Expenses:
Groudman's Bonus
Printing
Honoraria
Tournament Fund (Donation)
Capital Fund
Opening
Add: Surplus for the year
Rs.
3,000
800
6,000
10,000
33,800
1,000
Assets
Cash in Hand
Balance in Deposit Account
Current Account
Interest Due
Machinery and Equipment
Subscription Due
Rs.
3,500
30,900
1,500
200
17,500
1,000
34,800
54,600
54,600
Opening Balance Sheet

Liabilities
Outstanding Expenses &
Honoraria
Capital Fund (Balancing figure)
Rs.
1,000
4,000
33,800
Assets
Rs.
Cash in Hand
Balance in Deposit Account
Cash in Current Account
Subscription Due
Machinery & Equipment
1,000
22,300
6,000
1,500
8,000
38,800
35,800
7. RECEIPT AND EXPENDITURE ACCOUNT
This account also can be taken as part of Financial Statements. Some non-profit making
organization like professional firms, educational institutes etc. prefers to prepare Receipts and
Expenditure account instead of Income and Expenditure account as part of Financial Statements.
Such an account includes all expenses on accrual basis but incomes are recorded on cash basis.
In other words, to find out the result, all outstanding expenses are taken into account but the
incomes that are outstanding are not considered. The main reason behind this kind of practice is
that professionals consider it imprudent and risky to recognize the outstanding incomes.
18
Illustration
Bishalbazar Club has 500 members with annual fee of Rs. 1,000 per member. At the end of the
financial year, accountant noticed that 40 members have not paid annual fee and 70 members had
paid fee in advance for next year as well. Help the accountant to compute cash receipts of annual
fee for the year.
Solution:
Statement of computation of cash receipts of annual fee for the year
Particulars
Amount
Total fee receivable during the year (500 x Rs. 1,000)
500,000
Less: Fee not received (40 x Rs. 1,000)
(40,000)
Add: Fee received in advance (70 x Rs. 1,000)

Cash received during the year towards annual fee
70,000
530,000
Illustration
The Income and Expenditure Account of Womens Creation Club for the year 2071 is as follows.
Expenditures
To, Salaries
To, Printing and Stationery
To, Postage
To, Telephone
To, General Expenses
To, Interest and Bank Charges
To, Audit fees
To, Annual Dinner Exp.
To, Depreciation
To, Surplus
Rs.
Income
120,000
By, Subscriptions
6,000
By, Entrance Fees
500
By, Contribution for dinner
1,500
12,000
5,500
2,500
25,000
7,000
30,000
210,000
The account has been prepared after the following adjustments:
Rs.
170,000
4,000
36,000
210,000
31.12.2070
31.12.2071
Subscription outstanding
16,000
18,000
Subscription received in advance
13,000
8,400
Salaries outstanding
6,000
8,000
Sport Equipment
52,000
The club owned a building since 2069
190,000
At the end of the year after depreciation of Rs. 7,000 equipments amounted to 63,000
In 2069 the club had raised a bank loan which is still unpaid 30,000
Cash in hand on 31.12.2071 Rs. 28,500
Audit fees for 2069 paid during 2070 Rs. 2,000 and Audit fees for 2071 not paid Rs. 2,500
Prepare the Receipts and Payments Account of the Club for 2071 and Balance Sheet as on
31.12.2071. All workings should be part of your answers.
19
Solution
Womens Creation Club
Receipts and Loss Accounts
Receipts
Rs.
Payments
To, Balance b/d (balancing figure)
13,600
By, Salaries (Note 3)
To, Subscriptions (Note 2)
163,400
By, Printing & Stationery
To, Entrance Fees
4,000
By, Postage
To, Contribution for dinner
36,000
By, Telephone
By, Audit Fees
By, Annual Dinner expenses
By, Interest and Bank charges
By, Sports Equipment (Note 4)
By, Balance c/d
217,000
Rs.
118,000
6,000
500
1,500
12,000
2,000
25,000
5,500
18,000
28,500
217,000
Balance Sheet of Womens Creation Club as on 31.12.2071

Liabilities
Capital Fund
Opening balance
Add: Surplus
Bank Loan
Current Liabilities
Creditors for Expenses
Salaries
Audit fees
Subscription received in
advance
Rs.
220,600
30,000
8,000
2,500
Rs.
Assets
Fixed Assets
Building
250,600 Sports Equipments:
30,000
Opening balance
Addition
Rs.
Rs.
190,000
52,000
18,000
70,000
7,000
Less: Depreciation
10,500 Current Assets
Cash in Hand
8,400 Subscription Due
299,500
63,000
28,500
18,000
299,500
Working Notes:
1. Opening Balance Sheet
Liabilities
Bank Loan
Creditor for Expenses:
Salaries
Audit Fees
2.Subscription:
As per Income and Expenditure A/c
Add: Subscription outstanding 2071
Rs.
30,000
6,000
2,000
13,000
220,600
271,600
Assets
Building
Sports Equipment
Cash in Hand
Subscription due
Rs.
190,000
52,000
13,600
16,000
271,600
170,000
16,000
20
186,000
8,400
194,400
Add: Subscription received in advance for 2070

Less: Subscription received in advance on 2071
13,000
181,400
18,000
163,400
Less: Subscription outstanding for 2070

3.Salaries
Add: Outstanding of 2072
120,000
6,000
126,000
8,000
118,000
Less: Outstanding of 2070
4.Sports Equipment
Closing balance
Add: Depreciation for the year
63,000
7,000
70,000
52,000
18,000
Less: Opening balance

Purchases during the year
Illustration
The Income and Expenditure Account of the Famous Club, Bhaktapur for the year 2014 is as
follows:
Expenditures
Rs.
Income
Rs.
To, Salaries
To, Printing and Stationery
To, Secretary's Honorarium
To, General Expenses
To, Interest and Bank Charges
To, Audit fees
To, Annual Dinner Exp.
To, Depreciation
To, Surplus
4,750
450
1,000
500
150
250
1,500
300
600
9,500
By, Subscriptions
By, Entrance Fees
By, Contribution for dinner
7,500
250
1,000
9,500
The accounts had been prepared after the following adjustments:
Rs.
Subscription outstanding on 31.12.2013
600
Subscription received in advance on 31.12.2013
450
Subscription received in advance on 31.12.2014
270
Subscription outstanding on 31.12.2014
750
Salaries outstanding at the beginning and the end of 2014 were respectively Rs, 400 and Rs. 450.
General expenses include insurance prepaid to the extent of Rs. 60. Audit fee for 2014 is as yet
21
unpaid. During the 2014 audit fees for 2013 paid amounting to Rs. 200.
The club owned a freehold lease of ground valued at Rs. 10,000. The Club had sport equipments
on 1st January 2014 valued at Rs. 2,600. At the end of the year, after depreciation, this equipment
amounted Rs, 2,700. In 2013, the club has raised a bank loan of Rs. 2,000. This was outstanding
throughout 2014, On 31st December 2014 cash in hand amounted to Rs. 1,600. Prepare the
Receipts and Payments Account for 2014 and Balance Sheet end of the year.
Solution
The Famous Club, Bhaktapur
Receipts and Payments Accounts
for the year ending 2014 December
Receipts
Rs.
Payments
To, Balance b/d (balancing figure)
1,390
By, Salaries (Note 3)
To, Subscriptions (Note 2)
7,170
By, Printing & Stationery
To, Entrance Fees
250
By, Secy. Honorarium
To, Contribution for dinner
1,000
By, Sports Equipment (Note 4)
To, Profit on Sport meet:
500
Receipt less Expenses
750
Add: Paid for 2013
60
By, Audit Fees (2013)
By, Annual Dinner expenses
By, Interest and Bank charges
By, Balance c/d
10,560
Rs.
4,700
450
1,000
400
560
200
1,500
150
1,600
10,560
Balance Sheet of the Famous Club, Bhaktapur as on 31.12.2014

Liabilities
Capital Fund
Opening balance
Add: Surplus
Bank Loan
Current Liabilities
Creditors for Expenses
Salaries
Audit fees
Rs.
11,540
600
450
250
Rs.
Assets
Fixed Assets
Freehold ground
12,140 Sports Equipments:
2,000
Opening balance
Addition
Less: Depreciation
Current Assets
Cash in hand
270
Subscription Due
Insurance Prepaid
15,110
Rs.
Rs.
10,000
2,600
400
3,000
300
2,700
700
1,600
750
60
15,110
Working Notes
1. Opening Balance Sheet
Liabilities
Bank Loan
Rs.
2,000
Assets
Freehold Ground
Rs.
10,000
22
Creditor for Expenses:

Salaries
Audit Fees
400
200
450
11,540
14,590
2.Subscription:
Add: Subscription outstanding 2014
2,600
1,390
600
14,590
7,500
600
8,100
270
8,370
Add: Subscription received in advance for 2013

Less: Subscription received in advance on 2014
Sports Equipment
Cash in Hand
Subscriptions due
450
7,920
750
7,170
Less: Subscription outstanding for 2013

3.Salaries
Add: Outstanding of 2014
4,750
400
5,150
450
4,700
Less: Outstanding of 2013
4.Sports Equipment
Closing balance
Add: Depreciation for the year
2,700
300
3,000
2,600
400
Less: Opening balance

Purchases during the year
Illustration
Prepare Income & Expenditure Account for the year ended and Balance Sheet as at December
31, 2014 from the below mentioned information:
Receipt
January, Opening Balance
- Bank
- Cash
Subscriptions
(including Rs. 2,000 for 2013)
Interest on Investment
(Investment Rs. 300,000)
Sale of Vehicle
Amount
40,450
5,050
300,000
10,500
30,250
Payments
Amount
Salary
House Rent
Printing & Stationery
Postage
Furniture Purchase
Construction of Tennis Court
Cash Balance
Bank Balance
80,600
60,600
10,145
205
20,095
208,200
3,012
4,403
23
Interest on Bank Deposit
1,010
387,260
387,260
Additional Information
1. The amount of subscription includes Rs. 1,200 pertaining to 2015
2. Rs. 30,000 is yet to be received in respect of the subscription for the year 2014.
3. House rent Rs. 5,050 for the month of December 2014 is outstanding. House rent paid also
includes Rs. 5,050 being towards last year's outstanding.
4. Stationary expense of Rs. 500 is still to be paid.
5. The book value of the Vehicle was Rs. 20,500
Solution
Income & Expenditure Account
Dr.
To, Salary
To House Rent
Add: For Dec. 2014
Less: Paid for last year
To, Printing & Stationery
Add: Outstanding
To, Postage
To Excess of Income over
Expenditure
Cr.
60,600
5,050
65,650
5,050
10,145
500
Rs.
80,600 By Subscriptions
Add : Receivable
60,600 Less: Last Year's Receipt

Less: Advance for 2015
10,645 By Interest on Investment
20,095 By Interest on Deposit
By, Gain on sale of Vehicle
196,010
348,060
Rs.
300,000
30,000
330,000
(2,000)
(1,200)
326,800
10,500
1,010
9,750
348,060
Balance Sheet as at December 31, 2014

Liabilities
Capital Fund
Creditors (Stationery)
Outstanding House Rent
Advance Subscription 2015
Rs.
558,960
500
5,050
1,200
Assets
Furniture
Investment
Tennis Court
Subscription Receivable
Bank Balance
Cash Balance
565,710
Rs.
20,095
300,000
208,200
30,000
4,403
3,012
565,710
Working Notes:
Liabilities
Capital Fund
(Balancing Figure)
House Rent Outstanding
Opening Balance Sheet (1.1.2014)

Amount
Asset
362,950 Vehicle
Investments
5,050 Subscription Receivable
Cash at Bank
Cash in Hand
Amount
20,500
300,000
2,000
40,450
5050
24
369,800
369,800
Capital Fund Account

Dr.
Liabilities
31.12.2014 To Balance c/d
Amount
Asset
558,960 1.1.2014 By Balance b/d
31.12.2014 By Income & Expenditure
A/c
558,960
Cr.
Amount
362,950
196,010
558,960
SELF-EXAMINATION QUESTIONS
1.
The Balance sheet as on January 1, 2014 and Receipts and Payments account for the year
ended December 31, 2014 of the Himal Club, Gwarko are as under:
Liabilities
Capital Fund
Outstanding Expenses
Printing
Salaries
Total
Balance Sheet on January 1, 2014

Rs.
Assets
128,000 Fixed Assets
Subscription due
1,000 Entrance Fees due
800 Bank Balance
129,800
Total
Receipts & Payment Account

Receipts
Rs.
Payments
Opening Balance Bank
35,200 Football Tournaments
Football Tournaments
30,000 Printing
Bank interest
2,000 Salaries
Entrance Fees
10,000 Repairs
Subscriptions
40,000 Insurance
Investments
Closing Balance- Bank
Total
117,200
Total
Adjustments:
Expenses unpaid Repairs Rs. 120, Tournaments Rs. 400
Subscription outstanding for 2014 Rs. 1,400
Subscription received for 2015 Rs. 1,000
Depreciation on Fixed Assets is to be provided 15% p.a.
You are asked to prepare Income & Expenditure Account and Balance Sheet for
ended 31st December 2014
2.
Rs.
92,000
2,000
600
35,200
129,800
Rs.
31,000
1,400
4,400
1,600
1,000
33,000
44,800
117,200
the year
From the following Receipts and Payments Account of Puspanjali Recreation Club for the
year ended 31.3.2015 and additional information given, prepare an Income and Expenditure
25
Account for the year ended 31.3.2015 and Balance Sheet as on 31.3.2015:
Receipts
Rs.
Payments
Opening Balance-Cash/Bank
3,180 Secretary's Salary
Subscription
18,000 Charities
Sale of old Newspapers
2,500 Salaries to Staff
Legacies
4,000 Printing and Stationery
Interest on Investments
2,000 Postage Expenses
Endowment Fund Receipts
20,000 Rates and Taxes
Proceeds of Sport and Concerts
4,020 Upkeep of the Land
Advertisement in the year book
5,000 Purchase of Sports Materials
Telephone Expenses
Closing Balance Cash/Bank
Total
58,700 Total
Rs.
12,000
1,000
25,000
600
120
1,500
2,000
10,000
3,480
3,000
58,700
Assets and Liabilities as on 31.3.2014 and 31.3.2015 were as follows

31.3.2014
31.3.2015
Subscription in arrears
2,0001,000
500400
Furniture
2,0001,800
Land
10,00010,000
Depreciation shall be charged at 10% p.a. under the diminishing value method. Legacies
received shall be capitalized. Investments were made in securities, the rate of interest being
12% p.a., the date of investment was 1.6.2013 and the amount of investment was Rs. 20,000.
Due date of interest is 31st March every year.
3. The following information is obtained from the books of Bhaktapur Club as on 31.3.2072, at
the end of the first year of the Club. You are required to prepare Receipts and Payments
Account, Income and Expenditure Account for the year ended 31.3.2072 and a Balance Sheet
as at 31.3.2072 on mercantile basis:
(i) Donations received for Building and Library Room Rs. 2,00,000
(ii) Donation received from Bhaktapur Municipality as Capital Fund Rs. 250,000
(iii) Other revenue income and actual receipts:
Revenue Income
Actual Receipts
Entrance Fees
17,000
17,000
Subscription
20,000
19,000
Locker Rents
600
600
Sundry Income
1,600
1,060
Refreshment Account
16,000
(iv) Other revenue expenditure and actual payments:
Revenue Expenditure Actual Payments
Land (Cost Rs. 100,000)
100,000
Furniture (Cost Rs. 146,000)
130,000
Salaries
5,000
4,800
Maintenance of Playgrounds
2,000
1,000
Rent
8,000
8,000
26
Refreshment Account
9,000
Donations to the extent of Rs. 25,000 were utilized for the purchase of Library Books and
balance was still unutilized. In order to keep it safe, 9% Government Bond of Rs. 160,000
were purchased on 31.3.2065. Remaining amount was put in the Bank on 31.3.2072 under
the Fixed Deposit. Depreciation at 10% p.a. was to be provided for the whole year on
Furniture and Library Books.
4. The accountant of Popular Club furnishes you the following Receipts and Payments account
for the year ending 30th September 2015:
Receipts
Amount
Payments
Amount
Opening Cash and Bank
16,760
Honoraria to Secretary
9,600
Subscriptions
21,420
Misc. Expenses
3,060
Sale of old Newspapers
4,800
Rates and Taxes
2,520
Entertainment Fees
8,540
Ground mans wages
1,680
Bank Interest
460
Printing and Stationery
940
Bar Receipts
14,900
Payment for Bar purchases
11,540
Repairs
640
New Cycle (Less proceeds of old cycle 5,000)
25,200
Closing Cash and Bank
11,700
66,880
66,880
Additional information:
1.10.2014
30.9.2015
Subscription due (not received)
2,400
1,960
Cheques issued but not presented for payment of printing
180
60
Club Premises at cost
58,000
Depreciation on Club Premises provided so far
37,600
Cycle at cost
24,380
Depreciation on Cycle
20,580
Value of Bar Stock
1,420
1,740
Amount Payable to Bar Supplier
1,180
860
Deprecation is to be provided @5% p.a. on the written down value of the club premises and
@15%p.a. on car for the whole year.
You are required to prepare an Income and Expenditure Account of Popular Club for the year
ending 30th September 2015 and Balance Sheet as on that date.
5. Shrestha & Associates is a sole proprietorship legal consultancy firm of Mr. Awatar. You are
required to prepare Receipt and Expenditure account and Balance sheet for the year ended
31st Asahd 2072 from the followings;
To Balance Cash at Bank

- Cash in Hand
To Consultancy Fee
To Noting Fee
Receipt and Payment Account

For the year ended 31.3.2072
23,000
By Office Rent
2,500
By Stationary Expenses
270,000
By Telephone Charges
28,000
By Furniture purchased
36,000
11,200
7,350
48,000
27
To Translation Fee
To Sale of scrap
To Interest on Fixed Deposit
To Miscellaneous income
To Additional Capital
44,500
1,800
10,500
17,900
50,000
By Office Expenses
By Water & Electricity Charge
By Share Investment (Nepal Bank)
By Salaries & Facilities
By Balance c/d Cash in Hand
Cash at Bank
23,700
9,370
50,500
192,000
2,300
67,780
448,200
448,200
Consultancy Fee Outstanding
10% Fixed Deposits
Office Furniture
Outstanding Salaries
Motorcycle
Translation Fee received in advance
1.4.2071
19,000
140,000
62,000
6,800
45,000
1,500
31.3.2072
23,000
140,000
?
5,500
?
-
Provide depreciation on Furniture at 25% and on vehicle at 20% p.a. Additional furniture was
purchased at the end of Falgun 2071. The market value of the shares of Nepal Bank at the end
of the year is Rs. 48,300. Audit fee Rs. 10,000 of current year is outstanding.
6. Gorkhali Library, Gorkha showed the following position on 31.3.2072:
Balance Sheet as on 31st Ashadh 2071
Liabilities
Capital Fund
Expenses Payable - Salary
Rs.
793,000
7,000
800,000
Assets
Electrical Fittings
Furniture
Books
Investments in Securities
Cash at Bank
Cash in Hand
Rs.
150,000
50,000
400,000
150,000
25,000
25,000
800,000
The receipts and Payments Account for the year ended on 31st Ashadh 2072 is given below:
To Balance Cash at Bank
25,000
By Electricity Charges
- Cash in Hand
25,000
By Postage and Stationary
To Entrance Fees
30,000
By Telephone Charges
To Membership Subscription
200,000
By Books purchased
To Sale proceeds of Old papers
1,500
By Maintenance Expenses
To Hire of Lecture Hall
20,000
By Rent Expense
To Interest on Securities
8,000
By Investment in Securities
By Salaries
By Balance c/d Cash in Hand
Cash at Bank
309,500
You are required to prepare an Income and Expenditure Account for the year ended 31st
Ashadh 2072 and a Balance Sheet as at 31st Ashadh 2072 after making the following
28
7,200
5,000
5,000
60,000
7,000
88,000
40,000
66,000
11,300
20,000
309,500
adjustments:
(i) Membership Subscription included Rs. 10,000 received in advance.
(ii) Provide for outstanding rent Rs. 4,000 and Salaries Rs. 9,000.
(iii) Books to be depreciated @ 10% including additions. Electrical Fittings and Furniture
are also to be depreciated at the same rate.
(iv) 75% of the Entrance Fees is to be capitalized.
(v) Interest on securities is to be calculated @ 5% p.a. including purchases made on
1.10.2071 for Rs. 40,000.
7. The receipts and payments account and the income and expenditure account of a Club for the
year ended 31st December 2014 were as follows:
Receipt and Payment Account
Receipts
Amount
Payments
To Balance b/d
2,500 By Books purchased
To Subscription:
By Printing and Stationery
2013
600
By Salary
2014
4,300
4,900 By Advertisement
To Interest
500 By Electricity charges
To Donation for Special Fund
300 By Balance c/d
To Rent
2013
150
2014
300
450
To Govt. Grants
2,000
Total
10,650
Total
Amount
Incomes
To Salary
2,800 By Interest
To Tent hire
200 By Subscription
To Electricity Charges
400 By Rent
To Dep. On Building
750 By Govt. Grant
To Printing and Stationery
200
To Advertisement
150
To Surplus
5,000
Total
9,500
Total
Expenditures
Amount
1,000
200
1,500
200
400
7,350
10,650
Amount
400
4,800
2,300
2,000
9,500
The Club's assets as on 1st January 2014 were:

Building Rs. 15,000; Books Rs. 10,000
Furniture Rs. 4,000; Investments Rs. 10,000
Liabilities as on that date were Rs. 50 for advertisement and Rs. 100 for salary.
You are required to prepare the Balance sheet of the club for the year ended 31st December
2013 and 31st December 2014.
8. Mr. Thapa is a Chartered Accountant. He closes his account on Ashad End every year. The
29
following was his Balance sheet as at 31st Ashad 2072

Liabilities
Amount
Assets
Amount
Capital Account
50,000 Furniture
10,000
Audit Fees- collected in advance
5,000 Office Machinery
7,000
Liability for Salary
4,000 Library Books
4,000
Provision against outstanding Audit
23,000 Vehicles
30,000
Fees
Outstanding Audit Fees
23,000
Cash in Hand
7,000
Cash at Bank
1,000
Total
82,000
Total
82,000
The following is the Receipt and Payments Account of Mr. Thapa for the year ended 31st
Ashad 2072:
Receipts
Rs.
Opening Cash in hand
7,000
- Cash at Bank
1,000
Audit Fees
214,000
Fees for other Services
45,000
Miscellaneous Income
2,000
269,000
Payments
Salary Charges
Vehicle Expenses
Traveling Expenses
Postage expenses
Telephone charges
Library Books
Membership fees
Drawing
Cash in Hand
Cash at Bank
Rs.
110,000
17,000
11,000
9,000
1,000
8,000
6,000
1,000
60,000
22,000
24,000
269,000
The following further information is available:

a. Audit fees receivable Rs. 40,000
b. Audit fees collected in advance Rs. 10,000
c. Outstanding salary Rs. 10,000
d. Depreciation to be provided on:
Furniture 25%, Office Machinery 15%, Library Books 15% and Vehicles 20%
e. 80% of Audit fees and 40% of fees for other services should be transferred to Income and
Expenditure Account.
Prepare Income and Expenditure Account for the year ended 31st Ashad 2072 and Balance
Sheet as on that date.
9. The following is the Receipts and Payments Account of Muskan Club, Shantinagar for the
year ended 31st Ashadh 2072:
30
Receipts
Opening Balances:
Cash
Bank
Subscription Received
Entrance Donation
Interest Received
Sale of assets
Miscellaneous Income
Receipts at:
Coffee Room
Wines and Spirits
Swimming Pool
Tennis Court
Total
Amount
10,000
3,850
202,750
100,000
58,000
8,000
9,000
1,070,000
510,000
80,000
102,000
2,153,600
Payments
Salaries
Creditors
Postage
Telephone and telex
Repairs and Maintenance
Glass and Table Linen
Crockery and Cutlery
Garden Upkeep
Membership Fees
Insurance
Electricity
Closing Balance:
Cash
Bank
Total
Amount
120,000
1,520,000
70,000
40,000
52,000
48,000
12,000
14,000
8,000
4,000
5,000
28,000
8,000
224,600
2,153,600
The assets and liabilities as on 1.4.2071 were as follows:

Fixed Assets (net): Rs. 500,000; stock Rs. 380,000; Investments in 12% Government
securities Rs. 500,000; Outstanding subscription Rs. 12,000; prepaid insurance Rs. 1,000;
Sundry Creditors Rs. 112,000; Subscription received in advance Rs. 15,000; Entrance
Donation received pending membership Rs. 100,000; Gratuity Fund Rs. 150,000.
The following adjustments are to be made while drawing up the accounts
(a) Subscription received in advance as on 31st Ashadh 2072 was Rs. 18,000
(b) Outstanding subscription as on 31st Ashadh 2072 was Rs. 7,000
(c) Outstanding expenses are: salaries Rs. 8,000 and electricity Rs. 15,000
(d) 50% of the entrance donation was to be capitalized. There was no pending
membership as on 31st Ashadh 2072.
(e) The cost of assets sold net as on 1.4.2071 was Rs. 10,000
(f) Depreciation is to be provided at the rate of 10% on assets.
(g) A sum of Rs. 20,000 received in Magh 2071 as entrance donation from an applicant
was to be refunded as he had not fulfilled the requisite membership qualifications. The
refund was made on 3.6.2072.
(h) Purchases made during the year amounted to Rs. 1,500,000.
(i) The value of closing stock was Rs. 210,000.
(j) The club as a matter of policy charges off to income and expenditure account all
purchases made on account of crockery, cutlery, glass and linen in the year of
purchase.
You are required to prepare an income and expenditure account for the year ended on 31st
Ashadh 2072 and the balance sheet as on 31st Ashadh 2072 along with necessary workings.
10. The RB Yadav Memorial Trust runs a charitable hospital and a dispensary. The following
information is available for the year ended 31st Ashadh 2072 from the books of accounts:
31
Receipts
Dr.
Cr.
900,000
600,000
275,000
300,000
140,000
Capital Fund
Donations received during the year
Recovery of the rent
Fee Received from patients
Recovery of food supplies
Surgical equipment
455,000
Building and Operation theatres
320,000
Consumption in the hospital of:
Medicines
120,000
Foodstuff
90,000
Chemicals
30,000
Closing stock of hospital
Medicines
20,000
Foodstuff
4,000
Chemicals
1,000
Sale of medicines (dispensary)
310,000
Opening stock of medicines (dispensary)
55,000
Purchase of medicines (dispensary)
300,000
Salaries:
Administrative Staff
30,000
Doctors/Nurses
150,000
Assistant at the dispensary
15,000
Electricity and Power charges:
Hospital
105,000
Dispensary
2,000
Furniture and Equipment
80,000
Ambulance
30,000
Postage & Telephone expenses less recovery
26,000
Subscription to medical journals
21,000
Ambulance maintenance charges less recovery
800
Consumption of bed sheets
90,000
Fixed deposits made on 1.4.2071 for 3 years @ 11% p.a.
500,000
Cash and Bank balances
41,300
Sundry Debtors (dispensary)
60,500
Sundry Creditors (dispensary)
41,000
Remuneration to trustees, trust office expenses etc.
21,000
(a) The dispensary supplied medicines to the hospital worth Rs. 60,000, for which no
adjustment was made in the books.
(b) The closing stock of the medicines was Rs. 40,000 at the dispensary.
(c) The stock of medicines on 31st Ashadh 2072 at the hospital included Rs. 4,000 worth
of medicines belonging to the patients, which has not been considered while arriving
at the figure of consumption of medicines.
(d) The donations were received towards corpus of the trust.
32
On 15th Mangsir 2071, surgical equipment were donated having market value of Rs.
40,000.
(f) The hospital is to receive the grant of 25% of the amount spent on treatment of the
poor patients from the Red Cross Society. Such expenditure was Rs. 50,000.
(g) Out of the fee recovered from the patients, 10% is to be given to the specialist retained
by the hospital.
(h) Depreciation on the assets on the closing balances; surgical equipments @ 20%,
building @ 5%, furniture & Equipments @ 10%, Ambulance @ 30%.
You are required to prepare:
(i)
Income and Expenditure account of the Hospital, Dispensary and Trust
(ii) Statement of Affairs of the trust for the year ended 31st Ashadh, 2072.
(e)
33
CHAPTER X - PUBLIC FINANCIAL MANAGEMENT

1. CONCEPTS
Public Financial Management (PFM) in general incorporates the management of government
revenue, budget, expenditure, deposit, debt, reimbursement, procurement and other important
aspects of financial management such as accounting, recording and reporting. It also includes
internal control, final auditing and external scrutiny of the financial transactions. Hence,
strengthening Treasury System, Financial Monitoring and Capacity Building for PFM are most
critical elements of a sound public financial management practices. The overarching goal of a
PFM system is to improve efficiency of fiscal operations and enhance government accountability
and transparency as well as to improve expenditure control and monitoring. The PFM system
contributes to reduce fiduciary risk of the government expenditure. A sound and predictable
PFM system not only attracts foreign resources from development partners but also ensures
effective utilization of such resources and establishes transparency and accountability of public
funds. Similarly, an effective PFM system also contributes to channelize all resources and funds
through the national system.
Strengthening Public Financial Management (PFM) is a key element of the Government of
Nepals strategy for strengthening governance, optimizing outputs from public resources and for
ensuring inclusive and broad- based development. The increasing indiscipline in budget
execution, ineffective expenditure control and lack of transparency mainly in procurement pose
significant fiduciary risks to development projects. The GoNs intention of establishing a sound
PFM system that ensures the transparent, efficient, economical and accountable use of budgetary
resources and donor funds has resulted in several initiatives to strengthen PFM in Nepal.
2. PUBLIC FINANCIAL MANAGEMENT SYSTEM
The PFM and budgetary policies of the Nepal Government during the Nineties were directed
towards economic liberalization, privatization, poverty reduction and decentralization. Policies
and programs of the budget were mainly concerned with agriculture, modernization, employment
promotion, womens empowerment, financial sector reform, government expenditure
management, tax reform, good governance, social service and the development of basic and
physical infrastructure. PFM system of Nepal, like most developing countries, continued to be
dominated by the traditional objectives of control and accountability rather than a concern for
allocating limited public sector resources to well defined programs and projects that were
intended to serve a set of national objectives.
The extension of the budget coverage involved a combination of formal and informal
incorporation of expenditure activities. The other formal extension involved the incorporation of
foreign assistance programs, which were previously outside the budget. Planning the allocation
of scarce resources was not given due priority. The pattern of government expenditure followed
more or less the uniform course till the 1990s. Public expenditure and revenue both increased;
but the expenditure increase trend was greater than the revenue. The inadequate mobilization of
domestic resources through government revenue resulted in a serious problem of widening
resource gap in Nepal. Foreign aid was the main source of development financing and deficit
financing continued to increase. Planning, budgeting, and implementation had inherent problems
such as lack of capacity, co-ordination and monitoring. In spite of a number of initiatives taken,
34
one of the main problems of Nepal has been the lack of proper domestic resource mobilization.
Several factors have contributed in varying degrees to the lack of effectiveness of public
spending in Nepal. The institutional factors played major role in the over-programming (having
too many programs in scarce resources) of the budget, its lack of focus and prioritization and
implementation problems. The lacks of ownership of projects/ programs at various levels and the
absence of accountability, also undermined the quality and effectiveness of public spending.
Managing the national budget became increasingly difficult for Nepal Government to further
their objectives of poverty alleviation.
3. PUBLIC EXPENDITURE AND FINANCIAL ACCOUNTABILITY (PEFA)
Public expenditure and financial accountability (PEFA) is basically a framework for
strengthening public expenditure system of a country. It pays high priority to transparency and
accountability in utilizing and managing public funds. The core objective of PEFA is to enhance
expenditure management of the public funds and to reduce associated fiduciary risk. The PEFA
initiative has developed a robust tool for measuring (PFM) performances and providing sound
assessment of the quality of PFM for countries of all income levels. Nepal has assessed PEFA
indictors and adopted action plan that serve as the national policy for the overall improvement in
PFM system, process and institutions. Effective implementation of Action Plan contributes to
improve PFM performances that eventually help to achieve better service delivery and bringing
efficiency in public expenditure management.
4. STRENGTHENING PFM SYSTEM IN NEPAL
Public Expenditure Management is one of the key activities of any government in the world.
There is a growing concern to make PFM system predictable, transparent and accountable
anywhere in the world. PFM in general incorporates a credible planning system, management of
government revenues, budget execution, expenditure management, debt management,
reimbursement, procurement and other important aspects of financial management such as
accounting, recording, financial reporting and auditing and external scrutiny of the financial
transactions. Improving governance and enhancing accountability are considered as the critical
agenda of the Government of Nepal (GoN) in the endeavor of institutionalizing good governance
practices in the country. Hence, strengthening Public Financial Management has been accepted
as one of the key elements of the GoNs strategy for improving the overall governance,
optimizing outputs from public resources and ensuring inclusive and broad-based development.
Poor planning, ever increasing indiscipline in budget execution, ineffective expenditure control
and lack of transparency mainly in public procurement pose significant fiduciary risks to almost
all development projects both at center and local level. The GoNs recent initiatives such as
Financial Administration Reform Program, Strengthening PFM Project, Government Financial
Statistics (GFS) based new codes and classification of revenues and expenditures,
implementation of Treasury Single Account (TSA) system, strategy to implement International
Accounting and Reporting Standards (NAPSAS), Public Expenditure and Financial
Accountability (PEFA) initiative and other capacity building programs for PFM have resulted
some positive impacts in strengthening PFM system in general and financial good governance in
particular in Nepal.
The overarching goal of any PFM system is to improve efficiency of fiscal operations and
35
enhance government accountability and transparency as well as to improve control over public
expenditures. A sound PFM system directly contributes to reducing fiduciary risk associated to
the financial transactions. Similarly, an efficient and predictable PFM system not only mobilizes
external resources from development partners but also ensures effective utilization of such
resources by establishing proper transparency and accountability mechanisms. Similarly, an
effective PFM system also contributes to channelize all resources and funds through the national
system.
5. THE PFM REFORM INITIATIVES
GoN is developing various measures to enhancing governance particularly in the areas of service
delivery, responsiveness, transparency and accountability through various administrative and
financial reform initiatives. A number of governance reform programs are currently underway to
improve overall governance system in the country. Some of these initiatives include improving
planning and budgeting, expenditure management, accounting and financial reporting, auditing
and internal control, Medium Term Expenditure Framework (MTEF), Financial Management
Information System (FIMS), implementation of new procurement laws, and PFM reform
initiatives such as Single Treasury System, Nepal Public Sector Accounting Standards, PEFA
and government Financial Statistics based new codes and classification of the budget are the
testimony of those efforts towards good financial governance system. Below are the brief
highlights of some of the key reform initiatives:
a. Government Financial Statistics (GFS)

Government of Nepal has classified government expenditures and incomes into new codes and
successfully implemented the same. These codes and classifications are based on the
Government Financial Statistics of the IMF. All revenues, expenditures and financial
management codes have been changed accordingly. The classification as well as interpretation
has been based on the international standards. Hence, from their implementation Nepal's
accounting, recording and reporting system would be at par of the international standards. It
helps to make Nepal's financial statistics comparable and compatible with other countries of the
world.
b. Treasury Single Account (TSA)
As per recommendation of World bank and IMF to accept international best practices, GoN has
adopted a TSA system for Government Payments and Receipts processing in 2009. Under the
TSA regime the basic role of the District Treasury Control Offices (DTCOs) change from expost consolidation of expenditure/ receipt transactions to ex- antes control. For full functionality
of TSA, the DTCOs need to have access to information and be equipped with the necessary
technological infra-structure to operate the system. This system is intended basically, to provide
support for implementation of a Treasury Single Account (TSA) that enables real time budget
checks across all DTCOs in the country and at the center in the FCGO, and further enhances the
modified Financial Management Information System (FMIS) to include elements of the core
TSA functionality requirements (including commitment accounting).
The TSA system in Nepal has been piloted in two districts Bhaktapur DTCO (16 November
2009) and Lalitpur DTCO (17 January 2010) and has since then been gradually extended all over
36
the country. The TSA regime was first implemented for expenditure transactions only. It has now
been extended to revenues as well as deposits. Its core functionality include:
Budget appropriations recording,

Budget maintenance (recording of budget transfers/supplementary budgets),
Budget execution and treasury management, including;Budget release and warrant
control,
Reporting of committed and actual expenditure against revised and released budgets,
Bank account and cash management,
Procurement, including commitments of purchase orders and maintenance of a central
supplier register,
Accounting for payments and receipts,
General ledger,
Financial reporting,
Monitoring the daily and periodic treasury position,
Cash forecasting, cash and debt management of the GoN,
Integrated Financial Management Information System (IFMIS)
Hence, the overall goal of the TSA is to support the Governments efforts in improving the
efficiency of fiscal operations, improve expenditure control, cash management, cash forecasting,
working on the borrowing schedules, and monitoring as well as enhancing transparency and
accountability of financial transactions.
c. Strengthening Accounting and Financial Reporting
This initiative undertaken by FCGO to strengthen financial accounting and reporting of the
budgetary entities, State Owned Enterprises (SOEs) and private sector financial institutions by
converging Nepal Accounting Standards with International Financial Reporting Standards. The
current accounting procedures for government ministries, departments and other agencies do not
include capturing and reporting information on commitments. It is, therefore not possible to
determine what portion of the unspent budget, if any, remains available to be spent under any
budget head, or indeed, if the budget is already over-committed. This activity should devise the
new procedures and forms required to capture commitment accounting in the TSA system, and
provide training to spending units in implementing the new procedures. This will enhance exante fiscal control and provide a basis for managerial decision making by the line ministries and
the departments. This activity also supports FCGO in compiling consolidated financial
statements.
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Paper 2: AUDIT AND ASSURANCE
38
1. GENERAL CONCEPTS
a. AUDITING AND ASSURANCE
ORIGIN AND HISTORY OF AUDIT - NEPALESE PERSPECTIVE
In Nepal, the system of auditing and accounting is believed to have existed in our country long back
during the Lichhavi and Malla period. Since financial transactions were very few in numbers, and audit
on those days was simply a comparison of the records of the cash receipts and payments with vouchers
thereof. Looking back at the history of auditing in Nepal, the work of auditing started after the
establishment of the office named Kumari Chowk Adda in Baisakh 6, 1826 BS by late king Prithvi
Narayan Shah. It was assigned the duty of examining the revenue and expenditure of the country. Thus it
can be said that Auditing began in Nepal in form of examining governmental revenue and expenditure
through Kumari Chowk Adda.
After the beginning of the Rana Regime in 1903 BS, Prime Minister Jung Bdr Rana made a provision that
every Office (Then called as Adda) has to submit the income and expenditure accounts to Kumari
Chowk Adda and take clearance from it. Further Prime Minister Chandra Shamsher introduced a
predetermined format and prescribed the time for Office (Adda) to submit Accounts to Kumari Chowk
Adda. Kumari Chowk Adda used to examine whether the expenditure were made as per the provision
and rules. Further it was sanctioned to submit the list of the dues along with the account report to Prime
Minister.
After the political change in 2007 BS, Budget system was implemented in 2008 BS. For successful
implementation of budget system, the need for proper accounting and auditing was realized. Hence,
Accountant Generals Office was established in 2013 BS for maintaining booksof accountants in
government offices. However, the work of auditing o accounts remained with Kumari Chowk Adda.
Constitution of Kingdom of Nepal 2015 BS made the provision of Auditor General as a constitutional
body for auditing the books of Accounts of government offices and Kumari Chowk Adda was assigned
the duty of protecting old documents and disposing records.
After the political change in 217 BS, Auditing Act 2018 was enacted which provide Auditor General
(AG) an authority to register the auditors and to appoint auditor for fully owned stated enterprises and to
recommend auditors in case of partly owned government enterprises. It states that the provision that AG
to submit the result of annual audit to King. Further new accounting system based on double entry system
was implemented in Nepal from FY 2020/21.
In the meantime after the adoption of liberalization policy in 2037 BS the country saw substantive
movement in area of Accounts and auditing as joint stock companies and joint venture companies came
into existence. Though significant improvement in Government and public sector auditing was noticed
after People Movement 2046 BS; Constitution of Nepal 2047 and Audit Act 2048 BS was enacted.
Further companies Act 2053 made compulsory audit of all companies and Audit report to be presented in
Annual General Meeting and submit the copy of same to Office of Company Registrar.
In 1984 AD, a group of Chartered Accountants gathered and formed an association called The
Association of Chartered Accountants of Nepal and a joint association with Office of Auditor General
(OAGN), Government of Nepal (GON) enacted Nepal Chartered Accountants Act 1997 AD as an apex
professional accounting body of Nepal. And now, Nepal Chartered Accountants institute governs all the
auditors (Chartered Accountants and Registered) and all other audit related activities.
39
LATEST DEVELOPMENT IN AUDITING PROFESSION

Audit Expectation gap
Auditing expectation gap or simply expectation gap is the term used to signify the difference in
expectations of users of financial statements and auditors expectation concerning audited financial
statements. Difference in expectation can arise on the performance i.e. the level of performance what
users expect from auditor and how auditor actually performed.
Expectation gap can also be explained as the difference between the effectiveness of audit engagement
what users believe and what auditor believes. Expectation gap in related to audit can also be explained as
the difference between expectation of user and auditor himself on the responsibilities of the auditor. It can
also be referred as difference in understanding regarding nature of audit engagement i.e. what users
believe audit is and what audit actually is.
Auditor is required to reduce audit risk to an acceptably low level to attain reasonable assurance. But
what is reasonable?
Gap is about what auditor expects and what others expect from the auditor. For last few years this gap has
been debated number of times at different forums and stakeholders have agreed on reducing this gap as
most of the time it has been bone of contention between client, auditor and other users of financial
statements. On careful analysis of this gap one of the reasons that were critical in widening the gap is lack
of understanding of different connected factors. And this is not only a lacking on part of users of financial
statements but also the auditor sometimes. If efforts are invested in these areas then expectations can be
bridged to great extent.
One of the biggest reasons that have highlighted this gap is auditors responsibility to detect fraud. When
it comes to fraud, users require auditor to act as investigator and auditor is expected to unearth even the
most sophisticated fraud events. However, users do not agree on explanation that auditor is not
responsible to detect fraud it is management as they feel auditors role is much more than just a
confirmation of managements assertions. This area is still developing and audit as a profession is facing
great challenges in this regard.
Peer review
Peer Review means an examination and review of the systems and procedures to determine whether they
have been put in place by the practice unit for ensuring the quality of attestation services as envisaged and
implied/mandated by the Technical Standards and whether these were effective or not during the period
under review.
Per review shall focus on:
Compliance with Technical Standards.

Quality of Reporting.
Office systems and procedures with regard to compliance of attestation services systems and
procedures.
Training Programs for staff (including Articled Trainees) concerned with attestation
functions, including appropriate infrastructure.
The Statement specifies the main objectives of peer review as under:
To ensure that members while performing attestation services comply with technical
standards laid down by the Institute;
To ensure that such a member has in place proper system (including documentation system)
for maintaining the quality of attestation services performed by him;
To ensure adherence to various statutory and other regulatory requirements; and
To enhance the reliance placed by the users of financial statements for economic decision
making.
40
To conduct Peer review, ICAN has formed Peer Review Board. The establishment and appointment of
board shall be as follows:
The Peer Review Board shall be established by the Council.

The Peer Review Board shall consist of a maximum of 5 members to be appointed by the
Council.
The Council shall appoint the Chairman and members of the board amongst from the
members who are in full time practice. However this provision shall not applicable in the
case of Government Nominee.
The term of a member shall be for two year, or such period as may be prescribed by the
Council.
Casual vacancies on the Board shall be filled by the Council.
Members of the Disciplinary Committee and Code of Ethics Committee of the Institute shall
not be members of the Board.
Social audit
Social audit is a formal review of a company's endeavors in social responsibility. A social audit looks at
factors such as a company's record of charitable giving, volunteer activity, energy use, transparency, work
environment and worker pay and benefits to evaluate what kind of social and environmental impact a
company is having in the locations where it operates. Social audits are optional-companies can choose
whether to perform them and whether to release the results publicly or only use them internally.
In the era of corporate social responsibility, where corporations are often expected not just to deliver
value to consumers and shareholders but also to meet environmental and social standards deemed
desirable by some vocal members of the general public, social audits can help companies create, improve
and maintain a positive public relations image. Good public relation is key because the way a company is
perceived will usually have an impact on its bottom line.
Quality audit
Quality audit is the process of systematic examination of a quality system carried out by an internal or
external quality auditor or an audit team. It is an important part of organization's quality management
system
Quality audits are typically performed at predefined time intervals and ensure that the institution has
clearly defined internal system monitoring procedures linked to effective action. This can help determine
if the organization complies with the defined quality system processes and can involve procedural or
results-based assessment criteria.
Audits are an essential management tool to be used for verifying objective evidence of processes, to
assess how successfully processes have been implemented, for judging the effectiveness of achieving any
defined target levels, to provide evidence concerning reduction and elimination of problem areas. For the
benefit of the organization, quality auditing should not only report non-conformances and corrective
actions, but also highlight areas of good practice. In this way other departments may share information
and amend their working practices as a result, also contributing to continual improvement.
Environmental audit
Environmental audit is a general term that can reflect various types of evaluations intended to identify
environmental compliance and management system implementation gaps, along with related corrective
actions. Environmental accounting and auditing aims at measuring the impact of organizational activities
on the environment. Environmental audit can be defined as a systematic process of objectively obtaining
and evaluating the evidence relating to performance of an organization as reflected in the environmental
41
statement. There are generally two different types of environmental audits: compliance audits and
management systems audits.
Relationship between Regulator and Auditor
Augmented business volume and complexity in Nepalese financial sector, regulator like Nepal Rastra
Bank (NRB) and Insurance Boards has made concentrated rigorous and powerful supervision and
regulation on financial sector. With increased role of regulator and growing expectation of audit services,
soothing relation between Auditor and regulator is the need of todays regulatory and auditing profession.
In many respects the regulator/supervisor and the auditor have complementary concerns regarding the
same matters though the focus of their concerns may be different. Nonetheless, there are many areas
where the work of the regulator and of the auditor can be useful to each other. Management letters and
long-form audit reports submitted by auditors can provide supervisors with valuable insight into various
aspects of operations. Also auditors can obtain helpful insights from information originating from the
regulatory authority. Regulatory authorities may also develop certain informal prudential ratios or
guidelines which are made available and which can be of assistance to auditors in performing analytical
reviews.
There may be circumstances in which either the auditor or the regulator becomes aware of information
which he believes is not available to, and which needs to be communicated to, the other party. Such
circumstances may, for example arise:
Where the auditor becomes aware of facts which might endanger the existence of the entity
Where either the auditor or the regulator detects an indication of fraud at a senior level
Where the auditor intends to resign in the course of an audit
Where the auditor has an irreconcilable difference of view with management over a material
aspect of the financial statements, as a results of which he is intending to issue an audit
opinion which is not unqualified
Where the regulator has information which can materially affect the financial statements or
the auditor's report; and
Where the auditor believes a matter should be communicated to the regulator/supervisor and
management has failed to make such communication when requested to do so. Licensing
conditions have been complied with
The transactions which have come to the auditor's attention in the course of the audit are in
accordance with specified laws applicable
The systems for maintenance of accounting and other records and/or the systems of internal
control are adequate
Cooperation among the supervisory authority, the external auditors and the internal auditors as
required by Basel committee on Banking Supervision (BCBS)
Principle 13
Bank supervisors should evaluate the work of the banks internal audit department and, if satisfied, can
rely on it to identify areas of potential risk.
Principle 16
Supervisory authorities should encourage consultation between internal and external auditors in order to
make their cooperation as efficient and effective as possible.
Principle 18
Cooperation among the supervisor, the external auditor and the internal auditor aims to make the work of
42
all concerned parties more efficient and effective. The cooperation may be based on periodic meetings of
the supervisor, the external auditor and internal auditor.
Some example of relationship of regulator and ICAN
Joint meeting with ICAN/ASB regarding implementation of IFRS in banking sector

A committee is formed by the ICAN to make fully convergent to the directive no 4 where;
NRB senior representative is also a member. This committee is formed on request of NRB.
An interaction program on branch audit concept was jointly organized with ICAN and NRB
inviting Bankers at the premises of NRB.
Organizing informal meeting with the auditors regarding the accounting issues.
Enron and Sarbanes-Oxley Act

The Sarbanes-Oxley Act 2002 is aimed primarily at public accounting firms who participate in audits of
corporations. It was passed in response to a number of corporate accounting scandals that occurred
between 2000 /2002. This act set new standards for public accounting firms, corporate management, and
corporate boards of directors. The intent of the SOX Act was to protect investors, and really all
stakeholders in a business firm, by improving the accuracy and reliability of corporate disclosures, such
as earnings reports, pursuant to securities laws and regulations.
Purpose of Sarbanes-Oxley Act
The SOX Act holds company CEO's and CFO's responsible for the information presented by their
company in financial statements. Sarbanes-Oxley provides for increased corporate governance and
corporate accountability.
Financial crisis and the silence of the auditors
External audit is promoted as a trust engendering technology to persuade the public that capitalist
corporations and management are not corrupt and those companies and their directors are made
accountable. However lets take an example of Lehman Brothers received an unqualified audit opinion on
its annual accounts on 28 January 2008, followed by a clean bill of health on its quarterly accounts on 10
July 2008. However, by early August it was experiencing severe financial problems and filed for
bankruptcy on 14 September 2008. Bankruptcy of the bank led to the global financial crisis. In this
regards, the silence of the internal and external auditors was widely questioned. Also in numbers of
banks, within certain days of receiving unqualified audit opinions they were found seeking financial
support from the state.
This financial crisis raises some old and new questions about auditing practices. It shows that either
auditors are reluctant to qualify bank accounts for fear of creating panic or jeopardizing their liability
position or unable to meet the standards as required. This financial crisis has require the auditor to rethink
about the services they have been offering
43
TYPES OF AUDIT
Tax Audit
Tax audit is the process of review the entitys income tax returns and other information supplied to
regulatory agencies i.e. Inland Revenue Department (IRD).Tax Audit is the areas of the modern day
auditing in which Auditor is appointed for ascertaining the sales, purchase, profit and other figure
submitted by the enterprises to Tax Office.
Usually, management has an interest in pursuing inappropriate means to minimize reported earnings for
tax-motivated reasons. Thus, tax audit involves selective verification of financial figures presented on
entitys tax return reports. Basically tax audit involves compliance of the Income Tax Act 2058 which
emphasize on providing the error free Tax return to tax authorities by assessing the correct income of the
assesses.
In Nepal, though there is no any legal provision for appointing tax auditor for the Tax audit. However, in
practice, statutory auditor has been assigned with that responsibility. Generally Tax Audit review of
following transaction:
Gross Sales and Purchase

Vat Reconciliation
Allowable and disallowable expenses
Donations expenses
Treatment of Repair and maintenance, Research and Development, Pollution control cost,
depreciation as per Income Tax act 2058
Applicable fines and penalties to entity as a result of no submission, delayed submission and
short submission of tax amount and other tax return (including installment Tax)
Review the entitys income tax returns and other information supplied to regulatory agencies
Significant bank accounts or subsidiary or branch operations in tax-haven jurisdictions for
which there appears to be no clear business justification.
Unusual transactions with companies registered in tax havens.
Even though there is no such provision for appointing tax auditor in Income Tax act 2058, tax return
submitted by the entity contains the signature of the Auditor which evidence that the return has been
audited.
PUNISHMENT TO AIDING AND ABETTING FALSE TAX RETURN
If an auditor intentionally helps, advises or instigates any other person to commit any offense under
Income Tax Act shall punished with half of the punishment due to the offender. [Section 127 of the
Income Tax Act 2058]
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DIFFERENCE BETWEEN AUDITING AND ACCOUNTING

Particulars
Auditing
Accounting
An independent examination of financial Accounting is the art of recording,
information of any entity when such an classifying and summarizing financial
Meaning
examination is conducted with a view of information, transaction and events and
expressing an opinion thereon
preparation of reports thereon.
Verification of underlying vouchers and Recording of the transaction from
records and obtaining evidence on the underlying vouchers and preparation of
Objective
true and fair view presented by financial financial statement.
statement
Auditor is appointed by the owners of the It the responsibility of the management to
entity. The responsibility is to be maintain and implement an effective
Responsibility
reviewed the accounting and other control accounting system.
and express the opinion
Independent examination of the financial Measurement and communication of
information prepared by the management information to shareholders and others
Deals with
of the entity
user of the financial statement
Aspects
of Auditing review the efficacy of recording Accounting involves recording aspects of
financial information
the financial information
transaction
DIFFERENCE BETWEEN AUDITING AND MANAGEMENT

Particulars
Auditing
Management
An independent examination of Person entrusted with responsibility of
financial information of any entity overall functioning of the entity Like, day to
when such an examination is conducted day operation, managing human resources
Meaning
with a view of expressing an opinion and other resources, tactical and strategic
thereon
planning etc.
Propriety aspect is not considered
Propriety and efficiency is considered as a
Propriety
quality of management
Verification of underlying vouchers and Covers all aspects of the organization like
records and obtaining evidence on the objectives, policies, procedures, structure,
Objective
true and fair view presented by control, system, resources and results.
financial statement
Auditor is appointed by the owners of Generally Senior management team is
the entity. The responsibility is to be responsible. This includes, CEO, General
Responsibility
reviewed the accounting and other Manager, Managing director etc..
control and express the opinion
Independent examination of the Overall functioning and performance of the
financial information prepared by the organization
Deals with
management of the entity
45
b. ETHICS
BASIC CASES OF VERDICT ON DISCIPLINARY CASES
PROVISION OF CODE OF ETHICS ON ICAN ACT 1997,
As mentioned on section 34 of ICAN Act 1997, Members of ICAN should Observe the following code of
Conduct:
-
Members and members holding Certificate of Practice shall fully abide this Act and the Regulations
framed under this Act.
Auditing, either in partnership or in collusion in any manner with a person who has not obtained the
Certificate of Practice of one's class, is prohibited.
One shall not share or distribute as profit the auditing fees or remuneration with any person other than
a member of the Institute; and shall not pay any commission, brokerage etc. out of the professional
fees earned to any person or member.
One shall not, directly or indirectly, influence any person by way of fear, threat, terror or enticement
in order to secure any professional business.
One shall not disclose or divulge any information and explanations acquired in the course of
professional service to any person other than the employer employing him and the person whom he is
compiled by the law to do so.
Members holding Certificate of Practice shall not certify any financial statement or give report of any
type until they or their partner or employee checks and verifies it.
Member holding Certificate of Practice shall, while certifying financial statements or making report
thereon of any corporate body in which he or his partner has interest, clearly mention the extent of his
or his partner's interest therein.
Provided that being merely a shareholder in a company shall not be deemed to have interest therein.
Member holding Certificate of Practice shall, in order to truly present the financial statement certified
by him, clearly indicate all the material facts or any false statements or explanations known to him or
to the best of his knowledge.
Members holding Certificate of Practice shall discharge their duties with due care in the course of
their profession and shall draw attention of all concerned to all material facts which are or have taken
place contrary to the prevailing law and do not comply with generally accepted principles of auditing.
Members holding Certificate of Practice shall not base their remuneration as a percentage on the
profit or on any other uncertain results.
One shall not knowingly or recklessly mention any false matter in a notice, explanation or statement
required under the prevailing law to be provided to any office, department of His Majesty's
Government or any organization.
One shall not perform audit of accounts of any organization where he has served until the elapse of at
least three years of his leaving the service.
A member holding Certificate of Practice shall not accept his appointment as an auditor of an
organization without ascertaining that all required procedures for appointment as the auditor under the
prevailing law has been duly fulfilled.
One should have obtained sufficient information prior to give audit opinion.
Other matters concerning the conduct to be observed by the members and members holding
Certificate of Practice shall be as prescribed
46
Process of filing complaints against member and members holding certificated of practice:
The concerned person may lodge complaint to the Institute of Chartered Accountants of Nepal against
any member or member holding Certificate of Practice for not upholding the conduct mentioned in this
Act or the Regulations framed under this Act or for violation of this Act or Regulations framed under this
Act.The person can give application showing all the available evidence and paying a fee of Rs. 100.
However no fee is required if the complainant is any Government agencies or other entity where council
has waived such fee. The Executive Director shall, if he finds convincing information that proves any
member or member holding Certificate of Practice is not observing the conduct, submit the proposal
along with the related factsto the Council for further action against such member or member holding
Certificate of Practice.
The council if finds the complaints convincing, the complaint is placed in the disciplinary committee for
further discoveries and recommendation.
DISCIPLINARY COMMITTEE
Pursuant to section 14 of ICAN Act, a Disciplinary Committee, comprising of following members, shall
be constituted to recommend the Council to take necessary actions after investigation upon complaints
lodged against any action, contrary to the Chartered Accountants Act or Regulations or code of conduct
framed under this Act, rendered by any member, or the Institute receives any information of such kind.
A FCA member designated by council from amongst elected CA council members Chairman
Three persons nominated by the Council from amongst the Council members - Member
Two persons nominated by the Council amongst the members - Member
One person nominated by the Auditor General - Member
The chairman or members shall not be allowed to attend any meeting that hears complaint against the
Chairman or member of the Disciplinary Committee for their actions contrary to this Act or the
Regulations, Byelaws or code of conduct framed under this Act. The Procedures of the meeting of the
Disciplinary Committee and the term of office of the chairman and members of the committee shall be as
prescribed.
The Disciplinary committee shall have the authority, similar to a judicial court, in respect of summoning
concerned person and investigating evidences and witnesses.
The Disciplinary committee shall recommend to the Council, along with its opinion and finding, for
necessary action against a member, if found guilty, and the council may, considering such a
recommendation, impose any of the following punishment according to the degree of offence:
a. Reprimanding,
b. Removing from the membership for a period up to five years,
c. Prohibiting from carrying on the accounting profession for any particular period,
d. Cancellation of the Certificate of Practice (COP) or membership.
Any Council member against whom the Disciplinary Committee, after investing upon the complaint of
his action contrary to the Act or Regulations, Bye laws or code of conduct framed under the Act, has
decided to recommend the Council to take necessary action, shall not be allowed to attend and to vote at
the Council meeting where the Council is hearing at such recommendation.
Before imposing any punishment, the Council shall provide reasonable opportunity to the concerned
47
members to submit their clarification. The concerned member may, if he is not satisfied with the decision
file an appeal in the Appellate Court.
CODE OF ETHICS FOR THE MEMBERS OF THE INSTITUTE OF CHARTERED

ACCOUNTANTS OF NEPAL, 2060
The Council of the Institute of Chartered Accountants of Nepal (ICAN) has determined that this Code
should be adopted mandatorily by all members of Institute of Chartered Accountants of Nepal to observe
in respect of the performance of professional services in Nepal after January 15, 2004 [Magh 1, 2060]
PART A APPLICABLE TO ALL PROFESSIONAL ACCOUNTANTS
Integrity and Objectivity

Integrity implies not merely honesty but fair dealing and truthfulness. The principle of
objectivity imposes the obligation on all professional accountants to be fair, intellectually
honest and free of conflicts of interest.
Professional accountants serve in many different capacities and should demonstrate their
objectivity in varying circumstances. Professional accountants in public practice undertake
reporting assignments, and render tax and other management advisory services. Other
professional accountants prepare financial statements as a subordinate of others, perform
internal auditing services, and serve in financial management capacities in the private sector,
the public sector or education or non-government organization. They also educate and train
those who aspire to admission into the profession. Regardless of service or capacity,
professional accountants should protect the integrity of their professional services, and
maintain objectivity in their judgment.
In selecting the situations and practices to be specifically dealt within ethics requirements
relating to objectivity, adequate consideration should be given to the following factors:
- Professional accountants are exposed to situations which involve the possibility of pressures
being exerted on them. These pressures may impair their objectivity.
- It is impracticable to define and prescribe all such situations where these possible pressures
exist. Reasonableness should prevail in establishing standards for identifying relationships
that are likely to, or appear to, impair a professional accountants objectivity.
- Relationships should be avoided which allow prejudice, bias or influences of others to
override objectivity. Professional accountants have an obligation to ensure that personnel
engaged on professional services adhere to the principle of objectivity.
- Professional accountants should neither accept nor offer gifts or entertainment which might
reasonably be believed to have a significant and improper influence on their professional
judgment or those with whom they deal. Professional accountants should avoid
circumstances which would bring their professional standing into disrepute.
- Professional accountants should not act in contrary to the interest of ICAN in the delivery of
education and training.
Resolution of Ethical Conflicts
From time to time professional accountants encounter situations which give rise to
conflicts of interest. Such conflicts may arise in a wide variety of ways, ranging from the
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relatively trivial dilemma to the extreme case of fraud and similar illegal activities. It is
not possible to attempt to itemize a comprehensive checklist of potential cases where
conflicts of interest might occur. The professional accountant should be constantly
conscious of and be alert to factors which give rise to conflicts of interest. It should be
noted that an honest difference of opinion between a professional accountant and another
party is not in itself an ethical issue. However, the facts and circumstances of each case
need investigation by the parties concerned.
It is recognized, however, that there can be particular factors which occur when the
responsibilities of a professional accountant may conflict with internal or external
demands of one type or another. Hence, there may be the danger of pressure from an
overbearing supervisor, manager, director or partner; or when there are family or personal
relationships which can give rise to the possibility of pressures being exerted upon them.
Indeed, relationships or interests which could adversely influence, impair or threaten a
professional accountants integrity should be discouraged.
A professional accountant may be asked to act contrary to technical and/or professional
standards.
A question of divided loyalty as between the professional accountants superior and the
required professional standards of conduct could occur. Conflict could arise when
misleading information is published which may be to the advantage of the employer or
client and which may or may not benefit the professional accountant as a result of such
publication.
In applying standards of ethical conduct professional accountants may encounter
problems in identifying unethical behavior or in resolving an ethical conflict. When faced
with significant ethical issues, professional accountants should follow the established
policies of the employing organization to seek a resolution of such conflict. If those
policies do not resolve the ethical conflict, the following should be considered:
Review the conflict problem with the immediate superior. If the problem is not resolved
with the immediate superior and the professional accountant determines to go to the next
higher managerial level, the immediate superior should be notified of the decision. If it
appears that the superior is involved in the conflict problem, the professional accountant
should raise the issue with the next higher level of management. When the immediate
superior is the Chief Executive Officer (or equivalent) the next higher reviewing level
may be the Executive Committee, Board of Directors, Non-Executive Directors, Trustees,
Partners Management Committee or Shareholders.
Seek counseling and advice on a confidential basis with ICAN to obtain an understanding
of possible courses of action.
If the ethical conflict still exists after fully exhausting all levels of internal review, the
professional accountant as a last resort may have no other recourse on significant matters
(e.g., fraud) than to resign and to submit an information memorandum to an appropriate
representative of that organization or of an external body as required under prevalent
laws and regulations in Nepal.
Any professional accountant in a senior position should endeavor to ensure that policies
are established within his or her employing organization to seek resolution of conflicts.
49
Professional Competence
Professional accountants should not portray themselves as having expertise or experience
they do not possess.
Professional competence may be divided into two separate phases:
Attainment of professional competence
The attainment of professional competence requires initially a standard of general education

followed by specific education, training and examination in professionally relevant subjects,
and a period of work experience, as are set out to be requisite minimum qualification to
obtain membership of ICAN.
Maintenance of professional competence
The maintenance of professional competence requires a continuing awareness of

developments in the accountancy profession including relevant national pronouncements on
accounting, auditing and other relevant regulations and statutory requirements.
A professional accountant should adopt a program designed to ensure quality control in the
performance of professional services consistent with appropriate national pronouncements.
Confidentiality
Confidentiality should always be observed by a professional accountant unless specific
authority has been given to disclose information or there is a legal or professional duty to
disclose. The duty of confidentiality continues even after the end of the relationship between
the professional accountant and the client or employer.
Professional accountants have an obligation to ensure that staff under their control and
persons from whom advice and assistance is obtained respect the principle of confidentiality.
Confidentiality is not only a matter of disclosure of information. It also requires that a professional
accountant acquiring information in the course of performing professional services does neither use
nor appear to use that information for personal advantage or for the advantage of a third party.
A professional accountant has access to much confidential information about a clients or

employers affairs not otherwise disclosed to the public. Therefore, the professional
accountant should be relied upon not to make unauthorized disclosures to other persons. This
does not apply to disclosure of such information in order properly to discharge the
professional accountants responsibility according to the professions standards.
Tax Practice
A professional accountant rendering professional tax services is entitled to put forward the
best position in favor of a client, or an employer, provided the service is rendered with
professional competence, does not in any way impair integrity and objectivity, and is in the
opinion of the professional accountant consistent with the law.
A professional accountant should not hold out to a client or an employer the assurance that
the tax return prepared and the tax advice offered are beyond challenge. Instead, the
professional accountant should ensure that the client or the employer are aware of the
limitations attaching to tax advice and services so that they do not misinterpret an expression
of opinion as an assertion of fact.
50
A professional accountant who undertakes or assists in the preparation of a tax return should
advise the client or the employer that the responsibility for the content of the return rests
primarily with the client or employer. The professional accountant should take the necessary
steps to ensure that the tax return is properly prepared on the basis of the information
received
Tax advice or opinions of material consequence given to a client or an employer should be
recorded, either in the form of a letter or in a memorandum for the files.
A professional accountant should not be associated with any return or communication in
which there is reason to believe that it:
- Contains a false or misleading statement;
- Contains statements or information furnished recklessly or without any real
knowledge of whether they are true or false; or
- Omits or obscures information required to be submitted and such omission or
obscurity would mislead the revenue authorities.
A professional accountant may prepare tax returns involving the use of estimates if such use
is generally acceptable or if it is impractical under the circumstances to obtain exact data.
When estimates are used, they should be presented as such in a manner so as to avoid the
implication of greater accuracy than exists. The professional accountant should be satisfied
that estimated amounts are reasonable under the circumstances.
In preparing a tax return, a professional accountant ordinarily may rely on information
furnished by the client or employer provided that the information appears reasonable.
Although the examination or review of documents or other evidence in support of the
information is not required, the professional accountant should encourage, when appropriate,
such supporting data to be provided.
In addition, the professional accountant
should make use of the clients returns for prior years whenever feasible
is required to make reasonable inquiries when the information presented appears to be
incorrect or incomplete; and
Is encouraged to make reference to the books and records of the business operations,
as applicable.
When a professional accountant learns of a material error or omission in a tax return of a

prior year (with which the professional accountant may or may not have been associated), or
of the failure to file a required tax return, the professional accountant has a responsibility to:
Promptly advise the client or employer of the error or omission and recommend that
disclosure be made to the revenue authorities. The professional accountant is not
obligated to inform the revenue authorities.
If the client or the employer does not correct the error the professional accountant:
- Should inform the client or the employer that it is not possible to act for them
in connection with that return or other related information submitted to the
authorities; and,
51
Should consider whether continued association with the client or employer in

any capacity is consistent with professional responsibilities.
If the professional accountant concludes that a professional relationship with the
client or employer can be continued, all reasonable steps should be taken to ensure
that the error is not repeated in subsequent tax returns.
Cross Border Activities

When considering the application of ethical requirements in cross border activities a number
of situations may arise. Whether a professional accountant is a member of the profession in
Nepal only or is also a member of the profession in the country where the services are
performed should not materially affect the manner of dealing with each situation.
A professional accountant qualifying in Nepal may reside in another country or may be
temporarily visiting that country to perform professional services. In all circumstances, the
professional accountant should carry out professional services in accordance with the
relevant technical standards and ethical requirements.
When a professional accountant performs services in a country other than Nepal and
differences on specific matters exist between ethical requirements of the two countries the
following provisions should be applied:
When the ethical requirements of the country in which the services are being
performed are less strict than the ICAN Code of Ethics, then the ICAN Code of
Ethics should be applied.
When the ethical requirements of the country in which services are being performed
are stricter than the ICAN Code of Ethics, then the ethical requirements in the country
where services are being performed should be applied.
When the ethical requirements of Nepal are mandatory for services performed outside
that country and are stricter than set as outabove, then the ethical requirements of
Nepal should be applied.
Publicity
In the marketing and promotion of themselves and their work, professional accountants
should:
not use means which brings the profession into disrepute
not make exaggerated claims for the services they are able to offer, the qualifications
they possess, or experience they have gained; and
not denigrate the work of other accountants.
52
PART B APPLICABLE TO PROFESSIONAL ACCOUNTANTS IN PUBLIC PRACTICE
Independence
Professional accountants in public practice should be and appear:
to be free of any interest which might be regarded,
as being incompatible with integrity, objectivity and independence.
The following situations indicate grounds for reasonable observer for doubting the
independence of a professional accountant in public practice:
By direct financial interest in a client.
By indirect material financial interest in a client, e.g., by being a trustee of any trust
or executor or administrator of any estate if such trust or estate has a financial interest
in a client company
By loans to or from the client or any officer, director or principal shareholder of a
client company.
By holding a financial interest in a joint venture with a client or employee(s) of a
client.
By having a financial interest in a non-client that has an investor or investee
relationship with the client.
Appointments in Companies
When professional accountants in public practice are or were, within the period under current
review or immediately preceding an assignment:
a member of the board, an officer or employee of a company; or
a partner of, or in the employment of, a member of the board or an officer or
employee of a company;
They would be regarded as having an interest which could detract from independence when
reporting on that company
Commentary
It is suggested that the period immediately preceding the assignment should be no less than
two years or as required by appropriate legislation.
Provision of Other Services to Audit Clients
When a professional accountant in public practice, in addition to carrying out an audit or
other reporting function, provides other services to a client, care should be taken not to
perform management functions or make management decisions, responsibility for which
remains with the board of directors and management.
Commentary
The preparation of accounting records is a service which is frequently requested of a
professional accountant in public practice, particularly by smaller clients, whose businesses
are not sufficiently large to employ an adequate internal accounting staff. It is unlikely that
larger clients need this service other than in exceptional circumstances. In all cases in which
independence is required and in which a professional accountant in public practice is
concerned in the preparation of accounting records for a client, the following requirements
53
should be observed:
The professional accountant in public practice should not have any relationship or
combination of relationships with the client or any conflict of interest which would
impair integrity or independence.
The client should accept responsibility for the statements.
The professional accountant in public practice should not assume the role of
employee or of management conducting the operations of an enterprise.
Staff assigned to the preparation of accounting records ideally should not participate
in the examination of such records.
The fact that the professional accountant in public practice has processed or
maintained certain records does not eliminate the need to make sufficient audit tests.
Personal and Family Relationships
Personal and family relationships can affect independence. There is a particular need to
ensure that an independent approach to any assignment is not endangered as a consequence
of any personal or family relationship.
Commentary
Family relationships which always pose an unacceptable threat to independence are those in
which a sole practitioner or a partner in a practice, or an employee engaged on the
assignment relating to the client, is the spouse, dependent child, the parent or grandparent, or
relative living in a common household, of the client
Fees
When the receipt of recurring fees from a client or group of connected clients, represents a
large proportion of the total gross fees of a professional accountant in public practice or of
the practice as a whole, the dependence on that client or group of clients should inevitably
come under scrutiny and could raise doubts as to independence.
Commentary
If fees are the only or the substantial part of the gross income, the professional accountant in
public practice should carefully consider whether independence has been impaired.
Contingency Fees
Fee will be charged unless a specified finding or result is obtained or when the fee is
otherwise contingent upon the findings or results of such services.
Commentary
Fees should not be regarded as being contingent if fixed by a court or other public
authority.
Fees charged on a percentage or similar basis should be regarded as contingent fees.
Goods and Services
Acceptance of goods and services from a client may be a threat to independence. Acceptance
of undue hospitality poses a similar threat.
54
Commentary
Goods and services should not be accepted by professional accountants in public practice,
their spouses or dependent children except on business terms no more favorable than those
generally available to others. Hospitality and gifts on a scale which is not commensurate with
the normal courtesies of social life should not be accepted.
Actual or Threatened Litigation
Litigation involving the professional accountant in public practice and a client may cause
concern that the normal relationship with the client is affected to the extent that the
professional accountants independence and objectivity may be impaired
Commentary
The professional accountant in public practice should have regard to circumstances when
litigation might be perceived by the public as likely to affect the accountants independence
Long Association of Senior Personnel with Audit Clients
The use of the same senior personnel on an audit engagement over a prolonged period of
time may pose a threat to independence. The professional accountant in public practice
should take steps to ensure that objectivity and independence are maintained on the
engagement.
Commentary
There is a concern that a long involvement by a single individual with an audit client could
lead to the formation of a close relationship which could be perceived to be a threat to
objectivity and independence. The professional accountant in public practice should take
steps to provide for an orderly rotation of senior personnel serving on the engagement.
Professional Competence and Responsibilities Regarding the Use of Non-Accountants
Professional accountants in public practice should refrain from agreeing to perform
professional services which they are not competent to carry out unless competent advice and
assistance is obtained so as to enable them to satisfactorily perform such services. If a
professional accountant does not have the competence to perform a specific part of the
professional service, technical advice may be sought from experts such as other professional
accountants, lawyers, actuaries, engineers, geologists, valuers.
In such situations, although the professional accountant is relying on the technical
competence of the expert, the professional accountant must take steps to see that such experts
are aware of ethical requirements. Primary attention should be paid to the fundamental
principles provided in code of ethics.
The degree of supervision and the amount of guidance that will be needed will depend upon
the individuals involved and the nature of the engagement:
-
Asking individuals to read the appropriate ethical codes

Requiring written confirmation of understanding of the ethical requirements, and
Providing consultation when potential conflicts arise.
55
The professional accountant should also be alert to specific independence requirements or

other risks unique to the engagement. Such situations will require special attention and
guidance/supervision to see that ethical requirements are met.
If at any time the professional accountant is not satisfied that proper ethical behavior can be
respected or assured, the engagement should not be accepted; or, if the engagement has
commenced, it should be terminated.
Fees and Commissions
Professional fees should be a fair reflection of the value of the professional services
performed for the client, taking into account:
- The skill and knowledge required for the type of professional services involved.
- The level of training and experience of the persons necessarily engaged in performing the
professional services.
- The time necessarily occupied by each person engaged in performing the professional
services.
- The degree of responsibility that performing those services entails.
Professional fees should normally be computed on the basis of appropriate rates per hour or
per day for the time of each person engaged in performing professional services.
A professional accountant in public practice should not make a representation that specific
professional services in current or future periods will be performed for either a stated fee,
estimated fee, or fee range if it is likely at the time of the representation that such fees will be
substantially increased and the prospective client is not advised of that likelihood.
When performing professional services for a client it may be necessary or expedient to
charge a pre-arranged fee, estimated as per the basis for estimation of fees as outlined
above
It is not improper for a professional accountant in public practice to charge a client a lower
fee than has previously been charged for similar services, provided the fee has been
calculated in accordance with the factors referred above.
Commissions
A professional accountant in public practice should not pay a commission to obtain a client nor
should a commission be accepted for referral of a client to a third party. A professional
accountant in public practice should not accept a commission for the referral of the products or
services of others.
However, payment and receipt of commissions are permitted only for such engagements for
which independence is not required and the professional accountant in public practice should
nonetheless disclose the facts to the client.
Activities Incompatible with the Practice of Public Accountancy
A professional accountant in public practice should not concurrently engage in any business,
occupation or activity which impairs or might impair integrity, objectivity or independence,
or the good reputation of the profession and therefore would be incompatible with the
rendering of professional services.
The rendering of two or more types of professional services concurrently does not by itself
impair integrity, objectivity or independence.
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Clients Monies
The professional accountant in public practice should not hold clients monies if there is
reason to believe that they were obtained from, or are to be used for, illegal activities.
A professional accountant in public practice entrusted with monies belonging to others
should:
- keep such monies separately from personal or firm monies
- use such monies only for the purpose for which they are intended; and
- at all times, be ready to account for those monies to any persons entitled to such accounting.
A professional accountant in public practice should maintain one or more bank accounts for
clients monies
Clients monies received by a professional accountant in public practice should be deposited
without delay to the credit of a client account,
Monies may only be drawn from the client account on the instructions of the client.
Fees due from a client may be drawn from clients monies provided the client, after being
notified of the amount of such fees, has agreed to such withdrawal.
Payments from a client account shall not exceed the balance standing to the credit of the
client.
When it seems likely that the clients monies remain on client account for a significant period
of time, the professional accountant in public practice should, with the concurrence of the
client, place such monies in an interest bearing account within a reasonable time. All interest
earned on clients monies should be credited to the client account.
A statement of account should be provided to the client at least once a year
Relations with Other Professional Accountants in Public Practice
Accepting New Assignments
The extension of the operations of a business undertaking frequently results in the formation
of branches or subsidiary companies at locations where an existing accountant does not
practice. In these circumstances, the client or the existing accountant in consultation with the
client may request a receiving accountant practicing at those locations to perform such
professional services as necessary to complete the assignment.
Referral of business may also arise in the area of special services or special tasks as it is
impracticable for any one professional accountant in public practice to acquire special
expertise or experience in all fields of accountancy.
Professional accountants in public practice should only undertake such services which they
can expect to complete with professional competence. Professional accountants in public
practice are encouraged to obtain advice when appropriate from those who are competent to
provide it.
The wishes of the client should be paramount in the choice of professional advisers, whether
or not special skills are involved. Accordingly, a professional accountant in public practice
should not attempt to restrict in any way the clients freedom of choice in obtaining special
advice, and when appropriate should encourage a client to do so.
The services or advice of a professional accountant in public practice having special skills
may be sought in one or other of the following ways:
- by the client
after prior discussion and consultation with the existing accountant;
on the specific request or recommendation of the existing accountant; and
57
without reference to the existing accountant; or

by the existing accountant with due observance of the duty of confidentiality.
Superseding another Professional Accountant in Public Practice

The proprietors of a business have an indisputable right to choose their professional advisers
and to change to others should they so desire. While it is essential that the legitimate interests
of the proprietors are protected, it is also important that a professional accountant in public
practice who is asked to replace another professional accountant in public practice has the
opportunity to ascertain if there are any professional reasons why the appointment should not
be accepted. This cannot effectively be done without direct communication with the existing
accountant. In the absence of a specific request, the existing accountant should not volunteer
information about the clients affairs
Communication helps to preserve the harmonious relationships which should exist between
all professional accountants in public practice on whom clients rely for professional advice
and assistance.
The extent to which an existing accountant can discuss the affairs of the client with the
proposed professional accountant in public practice depend on:
- whether the clients permission to do so has been obtained; and/or
- the legal or ethical requirements relating to such disclosure, if any.
The proposed professional accountant in public practice should treat in the strictest
confidence and give due weight to any information provided by the existing accountant
Before accepting an appointment involving recurring professional services hitherto carried
out by another professional accountant in public practice, the proposed professional
accountant in public practice should:
- Ascertain if the prospective client has advised the existing accountant of the proposed
change and has given permission, preferably in writing, to discuss the clients affairs fully
and freely with the proposed professional accountant in public practice,
- request permission to communicate with the existing accountant. If such permission is
refused or the permission referred to in above is not given, the proposed professional
accountant in public practice should, in the absence of exceptional circumstances of which
there is full knowledge, and unless there is satisfaction as to necessary facts by other
means, decline the appointment.
- On receipt of permission, ask the existing accountant, preferably in writing:
to provide information on any professional reasons which should be known before
deciding whether or not to accept the appointment and, if there are such matters; and
to provide all the necessary details to be able to come to a decision
The existing accountant, on receipt of the communication referred above should forthwith:
- Reply, preferably in writing, advising whether there are any professional reasons why
the proposed professional accountant in public practice should not accept the
appointment.
- If there are any such reasons or other matters which should be disclosed, ensure that the
client has given permission to give details of this information to the proposed
professional accountant in public practice. If permission is not granted, the existing
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accountant should report that fact to the proposed professional accountant in public
practice.
On receipt of permission from the client, disclose all information needed by the
proposed professional accountant in public practice to be able to decide whether or not
to accept the appointment, and discuss freely with the proposed professional accountant
in public practice all matters relevant to the appointment of which the latter should be
aware
If the proposed professional accountant in public practice does not receive, within a
reasonable time, a reply from the existing accountant and there is no reason to believe that
there are any exceptional circumstances surrounding the proposed change, the proposed
professional accountant in public practice should endeavor to communicate with the existing
accountant by some other means. If unable to obtain a satisfactory outcome in this way, the
proposed professional accountant in public practice should send a further letter, stating that
there is an assumption that there is no professional reason why the appointment should not be
accepted and that there is an intention to do so.
The fact that there may be fees owing to the existing accountant is not a professional reason
why another professional accountant in public practice should not accept the appointment.
The existing accountant should promptly transfer to the new professional accountant in
public practice all books and papers of the client which are or may be held after the change in
appointment has been effected and should advise the client accordingly, unless the
professional accountant in public practice has a legal right to withhold them
In reply to a public advertisement or an unsolicited request to make a submission or submit a
tender, a professional accountant in public practice should, if the appointment may result in
the replacement of another professional accountant in public practice, state in the submission
or tender that before acceptance the opportunity to contact the other professional accountant
in public practice is required so that inquiries may be made as to whether there are any
professional reasons why the appointment should not be accepted. If the submission or tender
is successful, the existing accountant should then be contacted.
Advertising and Solicitation
Publicity by individual professional accountants in public practice is acceptable provided:
- The objective is to notify the public or such sectors of the public as are concerned, of matters
of fact in a manner that is not false, misleading or deceptive;
- it is in good taste;
- it is professionally dignified; and
- it avoids frequent repetition of, and any undue prominence being given to the name of the
professional accountant in public practice.
The examples which follow are illustrative of circumstances in which publicity is acceptable
and the matters to be considered in connection therewith:
Appointments and Awards
It is in the interests of the public and the accountancy profession that any appointment or other
activity of a professional accountant in a matter of national or local importance, or the award of
any distinction to a professional accountant, should receive publicity and that membership of the
professional body should be mentioned. However, the professional accountant should not make
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use of any of the aforementioned appointments or activities for personal professional advantage.
Professional Accountants Seeking Employment or Professional Business

The professional accountant should not, however, publicize for subcontract work in a manner
which could be interpreted as seeking to procure professional business. Publicity seeking
subcontract work may be acceptable if placed only in the professional press and provided that
neither the professional accountants name, address or telephone number appears in the publicity.
A professional accountant may write a letter or make a direct approach to another professional
accountant when seeking employment or professional business.
Directories
A professional accountant may be listed in a directory provided neither the directory itself nor
the entry could reasonably be regarded as a promotional advertisement for those listed therein.
Entries should be limited to name, address, and telephone number, professional description and
any other information necessary to enable the user of the directory to make contact with the
person or organization to which the entry relates.
Books, Articles, Interviews, Lectures, Radio and Television Appearances
Professional accountants who author books or articles on professional subjects may state their
name and professional qualifications and give the name of their organization but shall not give
any information as to the services that firm provides.
Similar provisions are applicable to participation by a professional accountant in a lecture,
interview or a radio or television program on a professional subject. What professional
accountants write or say, however, should not be promotional of themselves or their firm but
should be an objective professional view of the topic under consideration. Professional
accountants are responsible for using their best endeavors to ensure that what ultimately goes
before the public complies with these requirements.
Training Courses, Seminars, etc.
A professional accountant may invite clients, staff or other professional accountants to attend
training courses or seminars conducted for the assistance of staff. Other persons should not be
invited to attend such training courses or seminars except in response to an unsolicited request.
The requirement should in no way prevent professional accountants from providing training
services to other professional bodies, associations or educational institutions which run courses
for their members or the public. However, undue prominence should not be given to the name of
a professional accountant in any booklets or documents issued in connection therewith.
Booklets and Documents Containing Technical Information
Booklets and other documents bearing the name of a professional accountant and giving
technical information for the assistance of staff or clients may be issued to such persons or to
other professional accountants. Other persons should not be issued with such booklets or
documents except in response to an unsolicited request
Staff Recruitment
Genuine vacancies for staff may be communicated to the public through any medium in which
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comparable staff vacancies normally appear. The fact that a job specification necessarily gives
some detail as to one or more of the services provided to clients by the professional accountant in
public practice is acceptable but it should not contain any promotional element. There should not
be any suggestion that the services offered are superior to those offered by other professional
accountants in public practice as a consequence of size, associations, or for any other reason.
Publicity on Behalf of Clients
The professional accountant in public practice should ensure that the emphasis in the publicity is
directed towards the objectives to be achieved for the client.
Brochures and Firm Directories
A professional accountant in public practice may issue to clients or, in response to an unsolicited
request, to a non-client:
- a factual and objectively worded account of the services provided;
- a directory setting out names of partners, office addresses and names and addresses of
associated firms and correspondents.
Stationery and Nameplates
Stationery of professional accountants in public practice should be of an acceptable professional
standard and comply with the requirements of the law and of ICAN as to names of partners,
principals and others who participate in the practice, use of professional descriptions and
designatory letters, cities or countries where the practice is represented, logotypes, etc. The
designation of any services provided by the practice as being of specialist nature should not be
permitted. Similar provisions, where applicable, should apply to nameplates.
Newspaper Announcements
Appropriate newspapers or magazines may be used to inform the public of the establishment of a
new practice, of changes in the composition of a partnership of professional accountants in
public practice, or of any alteration in the address of a practice. Such announcements should be
limited to a bare statement of facts and consideration given to the appropriateness of the area of
distribution of the newspaper or magazine and number of insertions.
Inclusion of the Name of a Professional Accountant in Public Practice in a Document Issued
by a Client
When a client proposes to publish a report by a professional accountant in public practice dealing
with the clients existing business affairs or in connection with the establishment of a new
business venture, the professional accountant in public practice should take steps to ensure that
the context in which the report is published is not such as might result in the public being misled
as to the nature and meaning of the report. In these circumstances, the professional accountant in
public practice should advise the client that permission should first be obtained before
publication of the document.
Similar consideration should be given to other documents proposed to be issued by a client
containing the name of a professional accountant in public practice acting in an independent
professional capacity. This does not preclude the inclusion of the name of a professional
accountant in public practice in the annual report of a client. When professional accountants in
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their private capacity are associated with, or hold office in, an organization, the organization may
use their name and professional status on stationery and other documents. The professional
accountant in public practice should ensure that this information is not used in such a way as
might lead the public to believe that there is a connection with the organization in an independent
professional capacity.
PART C APPLICABLE TO EMPLOYED PROFESSIONAL ACCOUNTANTS
Conflict of Loyalties
Employed professional accountants owe a duty of loyalty to their employer as well as to their
profession and there may be times when the two are in conflict. An employees normal
priority should be to support his or her organizations legitimate and ethical objectives and
the rules and procedures drawn up in support of them. However, an employee cannot
legitimately be required to:
- break the law;
- breach the rules and standards of their profession;
- lie to or mislead (including misleading by keeping silent) those acting as auditors to the
employer; or
- put their name to or otherwise be associated with a statement which materially misrepresents
the facts.
Differences in view about the correct judgment on accounting or ethical matters should
normally be raised and resolved within the employees organization, initially with the
employees immediate superior and possibly thereafter, where disagreement about a
significant ethical issue remains, with higher levels of management or non-executive
directors.
If employed accountants cannot resolve any material issue involving a conflict between their
employers and their professional requirements they may, after exhausting all other relevant
possibilities, have no other recourse but to consider resignation. Employees should state their
reasons for doing so to the employer but their duty of confidentiality normally precludes
them from communicating the issue to others (unless legally or professionally required to do
so).
Support for Professional Colleagues
A professional accountant, particularly one having authority over others, should give due
weight for the need for them to develop and hold their own judgment in accounting matters
and should deal with differences of opinion in a professional way
Professional Competence
A professional accountant employed in private sector, public sector or education or nongovernment organization may be asked to undertake significant tasks for which he or she has
not had sufficient specific training or experience. When undertaking such work the
professional accountant should not mislead the employer as to the degree of expertise or
experience he or she possesses, and where appropriate expert advice and assistance should be
sought.
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Presentation of Information
A professional accountant is expected to present financial information fully, honestly and
professionally and so that it will be understood in its context.
Financial and non-financial information should be maintained in a manner that describes
clearly the true nature of business transactions, assets or liabilities and classifies and records
entries in a timely and proper manner, and professional accountants should do everything that
is within their powers to ensure that this is the case.
OTHER CIRCULARS ISSUED BY ICAN

Notwithstanding anything contained herein before at different places, sections or points of code
of ethics of IESAB, the provisions of above mentioned laws, rules, regulations, directives, and
pronouncement of ICAN shall override the respective conflicting provisions of code of ethics of
IESAB which has been adopted by ICAN.
Cases or points for explanation:
Regarding the Internal audit, the ICAN earlier decision prohibits the statutory auditor to
undertake such assignments.
Likewise non-assurance engagements/assignments relating to provide other accounting or
professional services assuming the responsibility of the management shall be prohibited.
While offering services members are prohibited to participate in any tendering or quoting
lower fee for that professions/services than the fees/remuneration of their previous auditor
/professional accountants in public practice, without assigning and communicating
reasonable grounds for such reduction to those charged with governance.
Regarding the rotation of audit, the provisions of company act 2063 is applicable whereby
auditors are not allowed to undertake any audit / assurance assignment of the public limited
company for more than 3 years.
Ceiling over the number of audit (Mandatory from 2067.04.01)

A member holding COP can audit the books of accounts of a maximum 100 clients only, in a
financial year. Out of these 100 clients, number of Public Companies shall not exceed 15. The
above limit is applicable for each member of a partnership firm. Provided, organizations whose
annual turnover is less than NRs. 2 lakhs, such as small Cooperatives, Religious organizations,
Social Organizations, Consumer Group, Different Committees, Trade Unions, Professional
Associations and other entities of similar nature are not included while calculating the above
limit.
Engagement as employee
The following provision is recommendatory from Shrawan 1, 2068.
To maintain the status and dignity of Chartered Accountants, all the Chartered Accountant
members of the Institute are advised not to accept appointment in a position lower than as
mentioned below:
Government Entity and Corporations Officer (2nd Class)
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However, where any person has entered into an agreement with an entity for an agreed period to
pursue his Chartered Accountancy Course, then this provision is not applicable to him for the
agreed period.
Branch Audit (Recommendatory from financial year 2067/68)
Branch audit of Banks shall be conducted for the year beginning from financial year 2067/68.
Branch having 2% or more Deposit and/ or Credit of the bank should be audited every year and
other branch should be audited at least once in every three years. The audit committee of the
concerned bank may be entrusted to appoint independent branch auditors and fix their
remuneration.
About Designation of members (Effective from 2067.01.29)
All the members of the Institute shall use the word CA or RA as the case may be before their
name in their professional documents. They may also use such designation before their name in
other documents.
Accounting profession by foreign citizen
Any foreign national who wants to do accounting professional and who has had all the required
qualification as mentioned in ICAN Act/rules may do so by entering in a partnership with a
Nepali citizen. The nature and extent and limit of the accounting profession for such accounting
firm shall be as decided by the Council.
Special Provision regarding Partnership
Every partner of the firm must hold COP
One firm can have a maximum 20 partners
A member having his own proprietorship firm can be a partner in not more than two
accounting firms at a time. But he has to get approval of every partner to run his
proprietorship firm.
Partnership of foreign accounting firm is not counted for this purpose
Remaining partner must inform ICAN if there is any change in the composition of the
partner, within 35 days of such change.
The member can use the word partner if he is one of the partners of the firm
Name Plate and Sign Board
The professional accountant shall not use sign board/ hoarding board of a size greater than (2 feet
X 3.5 feet). They shall not mention any words or symbols other than their name, certificate
number. Address, contact number and designation.
The professional accountant may keep a name plate disclosing his name and the professional
qualification in his residence. But sign board can be kept only at the office.
Professional accountant shall not use logo with special symbols on their own. They can use name
of the firm only, no additional symbol may be used. They may use logo/symbol approved by the
council.
Special provision regarding Anti Money Laundering (AML) issued by Nepal Rastra Bank
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Financial Information Unit (NRB-FIU)

Professional Accountant should conduct a Customer Due Diligence (CDD) as required by
Financial Action Task Force (FATF) in following situations:
Professional accountants when they prepare for or carry out transactions for their client
concerning the following activities:
- buying and selling of real estate;
- managing of client money, securities or other assets;
- management of bank, savings or securities account;
- organization of contributions for the creation, operation or management of companies;
- Creation, operation or management of legal persons or arrangements, and buying and selling
of business entities.
Customer Due Diligence (CDD) includes following:
- Keeping and verifying identification document of the key persons (Directors/ owners/ senior
management personnel)
- The address of the registered office, and, if different, a principal place of business
- Appointing a contact person in firm and communicating the details of the contact person to
Financial Information Unit (FIU) of NRB
- Make a suspicious transaction report (STR) to the financial intelligence unit (FIU)
However, accountants acting as independent legal professionals, are not required to report
suspicious transactions if the relevant information was obtained in circumstances where they are
subject to professional secrecy or legal professional privilege.
Some Disciplinary Cases

Given below are examples of some of the Disciplinary cases, where the council has decided to
take action against its members on recommendation of the Disciplinary Committee. Only facts of
the cases and decisions taken by the Council are given in brief.
1. The respondent, a registered auditor issued audit report without being legally
appointed as auditor and without verifying the books of accounts, knowing that the
company has another legally appointed statutory auditor. He pleaded that he issued the
audit report on request for Visa processing and that the report had not harmed
anybody, and that it was his mistake and that he will not repeat such mistakes in
future.
The respondent was found compromising the provisions of Sec. 34(6) of the Nepal
Chartered Accountants Act,2053 which requires that members holding Certificate of
Practice shall not certify any financial statement or give report of any type until they or
their partner or employee check and verify it. He was also found compromising the
provisions of Sec. 34 (9) of Nepal Chartered Accountants Act which requires that
members holding Certificate of Practice shall discharge their duties with due care in the
course of their profession and shall draw attention of all concerned to all material facts
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which are or have taken place contrary to the prevailing law and do not comply with
generally accepted principles of auditing. Further he was found compromising the code
of ethics.
On these grounds the Registered Auditor was held guilty of professional misconduct.
2. The respondent, a registered auditor issued three audit reports for same financial year
on three different dates and the figures in the financial statements are also different.
One of the audit reports was issued even before the date mentioned in the balance
sheet.
The auditor was found compromising seriously the code of ethics and the generally
accepted auditing principles and thus held guilty of professional misconduct.
3. The respondent, a Chartered Accountant issued audit report of a bank without any
qualification where, the bank while accepting the nonbanking assets,
a. did not charge the difference amount to the Income Statement as loss even though
the market value of the collateral was found lower than the principal amount, and
b. Charged the difference amount to the Income Statement as income where the
market value of the collateral was found higher than the total of loan and interest
amount, though the assets were not actually sold.
The auditor was found compromising the provisions of Sec.34(9) of the Nepal Chartered
Accountants Act 2053 which requires that members holding Certificate of Practice shall
discharge their duties with due care in the course of their profession and shall draw
attention of all concerned to all material facts which are or have taken place contrary to
the prevailing law and do not comply with generally accepted principles of auditing. The
auditor was also found compromising the provisions of clause 12 of the Code of Ethics
2060. Further, the auditor was found not complying the Accounting Policy on Nonbanking assets given in the Clause 2.5 of Part B Principle Accounting Policies of the
NRB directives on the Accounting Policies and Format of Financial Statements.
Thus, the Chartered Accountant was held guilty of professional misconduct by the
Council.
4. The respondent, a Chartered Accountant issued audit report of a bank without any
qualification where, the bank has not set aside 20% of its net profit to the General
Reserve as required by the then Banking and Financial Institution Ordinance. The
respondent pleaded that the profit was very negligible and immaterial amount, so the
transfer was not made.
The auditor was found compromising the provisions of Sec. 34(9) of the Nepal Chartered
Accountants Act 2053 which require that members holding Certificate of Practice shall
the prevailing law and do not comply with generally accepted principles of auditing.
He was found violating the mandatory provisions of Sec 44 of the then Banking Financial
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Institutions Ordinance which required the transfer of 20% of the net profit to the General
Reserve every year unless the balance in the General Reserve becomes double than
thepaid up capital.
On these grounds, the Chartered Accountant was held guilty of professional misconduct.
5. The respondent, a Registered Auditor after completing the statutory audit of two
consecutive years, issued audit report for further two years though he was not
appointed as auditor for those last two years. He signed the audit report of those last
two years mentioning himself as the representative of the statutory auditor.
The auditor was found violating the provisions of Sec. 34(13) of the Nepal Chartered
Accountants Act 2053 which requires that a member holding Certificate of Practice shall
not accept his appointment as an auditor of an organization without ascertaining that all
required procedures for appointment as the auditor under the prevailing law has been
duly fulfilled.
Thus the Registered Auditor was held guilty of professional misconduct by the Council.
6. The respondent, a Chartered Accountant issued audit reports for those financial years
for which audit was already completed by other auditors and Tax Returns were already
filed based on those reports. The figures in the two sets of reports were different. The
respondent was also given responsibility of preparing the Financial Statements for
those financial years. The respondent pleaded that the previous auditors gave false
reports and board has not approved those financial statements, his appointment as
auditor was declared lawful by Company Law Board, communication to previous
auditors tried but not successful, he has not prepared the financial statements, there
was mistake in the appointment letter which includes preparation of financial
statements also and he informed to client about this.
The auditor was found compromising the provisions of Sec. 34 (13) of the Nepal
Chartered Accountants Act, 2053 which requires that a member holding Certificate of
Practice shall not accept his appointment as an auditor of an organization without
ascertaining that all required procedures for appointment as the auditor under the
prevailing law has been duly fulfilled. The auditor was also found compromising the
provisions of section 34 (9) of the Act which requires that members holding Certificate of
Practice shall discharge their duties with due care in the course of their profession and
shall draw attention of all concerned to all material facts which are or have taken place
contrary to the prevailing law and do not comply with generally accepted principles of
auditing. Further, he was found not complying the clause 13(23) of the Code of Ethics
2060. On these grounds, the Chartered Accountant was held guilty of professional
misconduct by the Council.
7. The respondent, a Registered Auditor conducted the audit of a school for F/Y 2061/62,
and issued report, but in the Receipt and Payment account of the School for financial
2061/62, the receivable amount of2060/61 was shown as receipt and the receivable
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amount of 2061/62 was shown as payment, and thus the cash balance was understated.
The auditor when informed about this rejected to make any correction.
The auditor was found compromising the provisions of section 34 (9) of the Nepal
Chartered Accountants Act which requires that members holding Certificate of Practice
shall discharge their duties with due care in the course of their profession and shall draw
Thus the Registered auditor was held guilty of professional misconduct.
8. The respondent, a registered auditor issued report on the financial statements of a
school where the financial statements were not approved by the management. He has
not informed to the Board about the audit. Also, he has not maintained proper
documentation of his audit work as required by the auditing standards.
The auditor was held guilty of professional misconduct.
9. The respondent, a registered auditor issued two different audit reports for same
financial year of a client for continuous three years.
The auditor was held guilty of professional misconduct.
10. A registered auditor member gave all the necessary documents together with the
required fee to renew his membership and COP to another registered auditor member.
The other registered auditor member did not renew his membership and COP in ICAN,
but gave him false renewal certificates.
The other registered auditor member was found cheating another member and thus held
guilty of professional misconduct.
11. The respondent, a Chartered Accountant issued audit report of a company for
financial year 2065/066 but he failed to comment on the compliance/noncompliance of
the applicable Nepal Accounting Standards. Also the Chartered Accountant could not
show his working papers and supporting documents sufficient to prove that he had
carried out the audit in accordance with Nepal Standards on Auditing.
The auditor was found compromising the provisions of Sec. 34 (9) of the Nepal Chartered
Similarly the auditor was found compromising the provisions of clause 12 of the ICAN
Code of Ethics 2060, which requires that a Professional Accountant should carry out
professional services in accordance with the technical and professional standards and
that Professional accountants have a duty to carry out with care and skill the instructions
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of the client in so far as they are compatible with the requirements of integrity,
objectivity, and independence and that they should confirm with the technical and
professional standards promulgated by the Nepal Accounting Standards Board, Nepal
Standards on Auditing Board, ICAN or other regulatory body, and relevant legislation.
On these grounds the auditor was held guilty of professional misconduct.
12. The respondent, a Registered Auditor issued audit report of a company for financial
year 64-65. But he failed to comment on the compliance/noncompliance of the
applicable Nepal Accounting Standards. Also the Auditor could not show his working
papers and supporting documents sufficient to prove that he had carried out the audit
in accordance with Nepal Standards on Auditing.
The auditor was found compromising the provisions of Se. 34(9) of the Nepal Chartered
Similarly the auditor was found compromising the provisions of clause 12 of the ICAN
Code of Ethics 2060, which requires that a Professional Accountant should carry out
professional services in accordance with the technical and professional standards and
that Professional accountants have a duty to carry out with care and skill the instructions
of the client in so far as they are compatible with the requirements of integrity,
objectivity, and independence and that they should confirm with the technical and
professional standards promulgated by the Nepal Accounting Standards Board, Nepal
Standards on Auditing Board, ICAN or other regulatory body, and relevant legislation.
On these grounds the auditor was held guilty of professional misconduct.
13. The Respondent, a Registered Auditor issued three audit reports of a Higher Secondary
School for same financial year on three different dates and the figures in the financial
statements were also different and, none of the previous audit reports were cancelled
before issuing new reports.
The auditor was found compromising the code of ethics and the generally accepted
auditing principles and thus held guilty of professional misconduct.
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2. PLANNING AND ENGAGEMENT

b. Audit planning memorandum
Audit Planning Memorandum
It is a document prepared by the auditor setting out those information obtained during the audit
planning process and those decision taken as a result of the audit planning efforts, which are
required by those audit staff who will be engaged on the audit assignment.
It is a written document, which set out the information obtained and decision reached as a result
of audit planning effort
The nature of information contained in an audit-planning memorandum will vary from one audit
to the other, but generally may include:
A summary of the terms of engagement to lay out the nature and scope of the work;
Job timetable giving the provisional dates of the timing of the audit e.g. date of planned
commencement of the audit.
Record of any changes in the client since the last audit e.g. changes in the nature of the
clients business, change in management structure;
Details of the planning decisions such as areas identified as having weak internal controls
requiring more detailed audit work, areas where the advice of an expert is needed etc
Extent of reliance expected on internal audit;
Generally Planning Memorandum includes following areas:
The audit program will contain the following material:
Audit Objectives
Audit Scope
Details information of client, its key personnel
Information about nature of business, operation, accounting and IT control
Audit Methodology (including a sampling plan if some type of audit sampling is proposed)
Detailed audit plan
Audit Time budget
Milestone dates for completion of key elements of the audit program and preparation of the
discussion draft
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d. Internal control system and control environment, fraud and error

Knowledge of Committee on sponsoring Organization (COSO)
Background
In 1992 the Committee of Sponsoring Organizations (COSO) released its Internal Control
Integrated Framework (the original framework). The original framework has gained broad
acceptance and is widely used around the world. It is recognized as a leading framework for
designing, implementing, and conducting internal control and assessing the effectiveness of
internal control. In the twenty years since the inception of the original framework, business and
operating environments have changed dramatically, becoming increasingly complex,
technologically driven, and global. At the same time, stakeholders are more engaged, seeking
greater transparency and accountability for the integrity of systems of internal control that
support business decisions and governance of the organization. COSO is pleased to present the
updated Internal ControlIntegrated Framework (Framework). COSO believes the Framework
will enable organizations to effectively and efficiently develop and maintain systems of internal
control that can enhance the likelihood of achieving the entitys objectives and adapt to changes
in the business and operating environments.
The purpose of this Internal ControlIntegrated Framework (Framework) is to help
management better control the organization and to provide a board of directors1 with an added
ability to oversee internal control. A system of internal control allows management to stay
focused on the organizations pursuit of its operations and financial performance goals, while
operating within the confines of relevant laws and minimizing surprises along the way. Internal
control enables an organization to deal more effectively with changing economic and
competitive environments, leadership, priorities, and evolving business models.
Understanding Internal Control

Internal control is defined as follows:
Internal control is a process, effected by an entitys board of directors, management, and other
personnel, designed to provide reasonable assurance regarding the achievement of objectives
relating to operations, reporting, and compliance.
This definition emphasizes that internal control is:
Geared to the achievement of objectives in one or more separate but overlapping categories
A process consisting of ongoing tasks and activitiesit is a means to an end, not an end in
itself
Effected by peopleit is not merely about policy and procedure manuals, systems, and
forms, but about people and the actions they take at every level of an organization to effect
internal control
Able to provide reasonable assurance, not absolute assurance, to an entitys senior
management and board of directors
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Adaptable to the entity structureflexible in application for the entire entity or for a
particular subsidiary, division, operating unit, or business process
This definition of internal control is intentionally broad for two reasons. First, it captures
important concepts that are fundamental to how organizations design, implement, and conduct
internal control and assess effectiveness of their system of internal control, providing a basis for
application across various types of organizations, industries, and geographic regions. Second, the
definition accommodates subsets of internal control.
Internal control is not one event or circumstance, but a dynamic and iterative process action that
permeate an entitys activities and that are inherent in the way management runs the entity.
Embedded within this process are controls consisting of policies and procedures. These policies
reflect management or board statements of what should be done to effect internal control. Such
statements may be documented, explicitly stated in other management communications, or
implied through management actions and decisions.
Objectives, Components, and Principles
An organization adopts a mission and vision, sets strategies, establishes objectives it wants to
achieve, and formulates plans for achieving them. Objectives may be set for an entity as a whole,
or be targeted to specific activities within the entity. Though many objectives are specific to a
particular entity, some are widely shared. For example, objectives common to most entities are
sustaining organizational success, reporting to stakeholders, recruiting and retaining motivated
and competent employees, achieving and maintaining a positive reputation, and complying with
laws and regulations.
Supporting the organization in its efforts to achieve objectives are five components of internal
control:
Control Environment
Risk Assessment
Control Activities
Information and Communication
Monitoring Activities
Relationship of Objectives, Components, and the Entity
A direct relationship exists between objectives, which are what an entity strives to achieve,
components, which represent what is required to achieve the objectives, and entity structure (the
operating units, legal entities, and other structures). The relationship can be depicted in the form
of a cube:
The three categories of objectives are represented by the columns.
The five components are represented by the rows.
The entity structure, which represents the overall entity, divisions, subsidiaries, operating
units, or functions, including business processes such as sales, purchasing, production, and
marketing and to which internal control relates, are depicted by the third dimension of the
cube.
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Objectives
Management, with board oversight, sets entity-level objectives that align with the entitys
mission, vision, and strategies. These high-level objectives reflect choices made by management
and board of directors about how the organization seeks to create, preserve, and realize value for
its stakeholders. Such objectives may focus on the entitys unique operations needs, or align with
laws, rules, regulations, and standards imposed by legislators, regulators, and standard setters, or
some combination of the two.
Setting objectives is a prerequisite to internal control and a key part of the management process
relating to strategic planning. Individuals who are part of the system of internal control need to
understand the overall strategies and objectives set by the organization. As part of internal
control, management specifies suitable objectives so that risks to the achievement of such
objectives can be identified and assessed. Specifying objectives relates to the articulation of
specific, measurable or observable, attainable, relevant, and time-bound objectives.
Categories of Objectives
The Framework groups entity objectives into the three categories of operations, reporting, and
compliance.
Operations Objectives
Operations objectives relate to the achievement of an entitys basic mission and vision- the
fundamental reason for its existence. These objectives vary based on managements choices
relating to the management operating model, industry considerations, and performance. Entitylevel objectives cascade into related sub-objectives for operations within divisions, subsidiaries,
operating units, and functions, directed at enhancing effectiveness and efficiency in moving the
entity toward its ultimate goal.
Reporting Objectives
Reporting objectives pertain to the preparation of reports for use by organizations and
stakeholders. Reporting objectives may relate to financial or non-financial reporting and to
internal or external reporting. Internal reporting objectives are driven by internal requirements in
response to a variety of potential needs such as the entitys strategic directions, operating plans,
and performance metrics at various levels. External reporting objectives are driven primarily by
regulations and/or standards established by regulators, and standard-setting bodies.
Compliance Objectives
Entities must conduct activities, and often take specific actions, in accordance with applicable
laws and regulations. As part of specifying compliance objectives, the organization needs to
understand which laws and regulations apply across the entity. Many laws and regulations are
generally well known, such as those relating to taxation and environmental compliance, but
others may be more obscure, such as those that apply to an entity conducting operations in a
remote foreign territory.
Five components of internal control:
Control environment
The control environment is the set of standards, processes, and structures that provide the basis
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for carrying out internal control across the organization. The board of directors and senior
management establish the tone at the top regarding the importance of internal control including
expected standards of conduct. Management reinforces expectations at the various levels of the
organization. The control environment comprises the integrity and ethical values of the
organization; the parameters enabling the board of directors to carry out its oversight
responsibilities; the organizational structure and assignment of authority and responsibility; the
process for attracting, developing, and retaining competent individuals; and the rigor around
performance measures, incentives, and rewards to drive accountability for performance. The
resulting control environment has a pervasive impact on the overall system of internal control.
Principles relating to the Control Environment component
The organization demonstrates a commitment to integrity and ethical values.
The board of directors demonstrates independence from management and exercises oversight
of the development and performance of internal control.
Management establishes, with board oversight, structures, reporting lines, and appropriate
authorities and responsibilities in the pursuit of objectives.
The organization demonstrates a commitment to attract, develop, and retain competent
individuals in alignment with objectives.
The organization holds individuals accountable for their internal control responsibilities in
the pursuit of objectives.
Risk Assessment
Every entity faces a variety of risks from external and internal sources. Risk Assessment is
defined as the possibility that an event will occur and adversely affect the achievement of
objectives. Risk assessment involves a dynamic and iterative process for identifying and
assessing risks to the achievement of objectives. Risks to the achievement of these objectives
from across the entity are considered relative to established risk tolerances. Thus, risk assessment
forms the basis for determining how risks will be managed. A precondition to risk assessment is
the establishment of objectives, linked at different levels of the entity. Management specifies
objectives within categories relating to operations, reporting, and compliance with sufficient
clarity to be able to identify and analyze risks to those objectives. Management also considers the
suitability of the objectives for the entity. Risk assessment also requires management to consider
the impact of possible changes in the external environment and within its own business model
that may render internal control ineffective.
Principles relating to the Risk Assessment component
The organization specifies objectives with sufficient clarity to enable the identification and
assessment of risks relating to objectives.
The organization identifies risks to the achievement of its objectives across the entity and
analyzes risks as a basis for determining how the risks should be managed.
The organization considers the potential for fraud in assessing risks to the achievement of
objectives.
The organization identifies and assesses changes that could significantly impact the system of
internal control.
Control activities
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Control activities are the actions established through policies and procedures that help ensure
that managements directives to mitigate risks to the achievement of objectives are carried out.
Control activities are performed at all levels of the entity, at various stages within business
processes, and over the technology environment. They may be preventive or detective in nature
and may encompass a range of manual and automated activities such as authorizations and
approvals, verifications, reconciliations, and business performance reviews. Segregation of
duties is typically built into the selection and development of control activities. Where
segregation of duties is not practical, management selects and develops alternative control
activities.
Principles relating to the Control Activities component
The organization selects and develops control activities that contribute to the mitigation of
risks to the achievement of objectives to acceptable levels.
The organization selects and develops general control activities over technology to support
the achievement of objectives.
The organization deploys control activities through policies that establish what is expected
and in procedures that put policies into action.
Information and Communication
Information is necessary for the entity to carry out internal control responsibilities to support the
achievement of its objectives. Management obtains or generates and uses relevant and quality
information from both internal and external sources to support the functioning of other
components of internal control. Communication is the continual, iterative process of providing,
sharing, and obtaining necessary information. Internal communication is the means by which
information is disseminated throughout the organization, flowing up, down, and across the entity.
It enables personnel to receive a clear message from senior management that control
responsibilities must be taken seriously. External communication is twofold: it enables inbound
communication of relevant external information and provides information to external parties in
response to requirements and expectations.
Principles relating to the Information and Communication component
The organization obtains or generates and uses relevant, quality information to support the
functioning of other components of internal control.
The organization internally communicates information, including objectives and
responsibilities for internal control, necessary to support the functioning of other components
of internal control.
The organization communicates with external parties regarding matters affecting the
functioning of other components of internal control.
Monitoring Activities
Ongoing evaluations, separate evaluations, or some combination of the two are used to ascertain
whether each of the five components of internal control, including controls to affect the
principles within each component, is present and functioning. Ongoing evaluations, built into
business processes at different levels of the entity, provide timely information.
Separate evaluations, conducted periodically, will vary in scope and frequency depending on
assessment of risks, effectiveness of ongoing evaluations, and other management considerations.
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Findings are evaluated against criteria established by regulators, standard-setting bodies, or

management and board of directors, and deficiencies are communicated to management and the
board of directors as appropriate.
Principles relating to the Monitoring Activities component
The organization selects, develops, and performs ongoing and/or separate evaluations to
ascertain whether the components of internal control are present and functioning.
The organization evaluates and communicates internal control deficiencies in a timely
manner to those parties responsible for taking corrective action, including senior
management and the board of directors, as appropriate.
Limitations of Internal Control
Internal control, no matter how well designed, implemented and conducted, can provide only
reasonable assurance to management and the board of directors of the achievement of an entitys
objectives. The likelihood of achievement is affected by limitations inherent in all systems of
internal control. These include the realities that human judgment in decision making can be
faulty and that breakdowns can occur because of human failures such as making errors.
Additionally, controls can be circumvented by two or more people colluding, and because
management can override the internal control system.
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a. Application of Analytical Procedure

Analytical Procedures
The auditor shall design and perform audit procedures that are appropriate in the circumstances
for the purpose of obtaining sufficient appropriate audit evidence.
To obtain audit evidence, the auditor performs one or a combination of the following
procedures:
inspection
observation
external confirmation
inquiry
reperformance
recalculation
Analytical procedures.
Analytical procedures are also commonly used in non-audit and assurance engagements, such as
reviews of prospective financial information, and non-audit reviews of historical financial
information.
Analytical procedures consist of evaluations of financial information through analysis of
plausible relationships among both financial and non-financial data. They also encompass such
investigation as is necessary of identified fluctuations or relationships that are inconsistent with
other relevant information or that differ from expected values by a significant amount
Purposes of Analytical Procedures
Analytical procedures are used throughout the audit process and are conducted for three primary
purposes:
Preliminary analytical review risk assessment
Preliminary analytical reviews are performed to obtain an understanding of the business and its
environment (e.g. financial performance relative to prior years and relevant industry and
comparison groups), to help assess the risk of material misstatement in order to determine the
nature, timing and extent of audit procedures, i.e. to help the auditor develop the audit strategy
and program.
Substantive analytical procedures
Analytical procedures are used as substantive procedures when the auditor considers that the use
of analytical procedures can be more effective or efficient than tests of details in reducing the
risk of material misstatements at the assertion level to an acceptably low level.
Final analytical review
Analytical procedures are performed as an overall review of the financial statements at the end of
the audit to assess whether they are consistent with the auditors understanding of the entity.
Final analytical procedures are not conducted to obtain additional substantive assurance. If
irregularities are found, risk assessment should be performed again to consider any additional
audit procedures are necessary.
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Use of Substantive Analytical Procedures for gathering audit evidence

One of the objectives of ISA 520 is that relevant and reliable audit evidence is obtained when
using substantive analytical procedures. The primary purpose of substantive analytical
procedures is to obtain assurance, in combination with other audit testing (such as tests of
controls and substantive tests of details), with respect to financial statement assertions for one\ or
more audit areas. Substantive analytical procedures are generally more applicable to large
volumes of transactions that tend to be more predictable over time.
There are four elements that comprise\ distinct steps that are inherent in the process to using
substantial analytical procedures:
Develop an independent expectation
The development of an appropriately precise, objective expectation is the most important step in
effectively using substantive analytical procedures. An expectation is a prediction of a recorded
amount or ratio. The prediction can be a specific number, a percentage, a direction or an
approximation, depending on the desired precision.
Define a significant difference
While designing and performing substantive analytical procedures the auditor should consider
the amount of difference from the expectation that can be accepted without further investigation
The maximum acceptable difference is commonly called the threshold. Thresholds may be
defined either as numerical values or as percentages of the items being tested. Establishing an
appropriate threshold is particularly critical to the effective use of substantive analytical
procedures.
Compute difference
The third step is the comparison of the expected value with the recorded amounts and the
identification of significant differences, if any. This should be simply a mechanical calculation.
It is important to note that the computation of differences should be done after the consideration
of an expectation and threshold. In applying substantive analytical procedures, it is not
appropriate to first compute differences from prior period balances and then let the results
influence the expected difference and the acceptable threshold.
Investigate significant differences and draw conclusions
The fourth step is the investigation of significant differences and formation of conclusions.
Differences indicate an increased likelihood of misstatements; the greater the degree of
precision, the greater the likelihood that the difference is a misstatement.
Explanations should be sought for the full amount of the difference, not just the part that exceeds
the threshold.
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b. Evaluation of going concern assessment at planning stage and use of standard related to
going concern in planning an audit engagement
The auditors evaluation of whether there is a substantial doubt about the entitys ability to
continue as a going concern for a reasonable period of time (not to exceed one year beyond the
balance sheet date) is based on his or her knowledge of relevant conditions and events that exist
at, or occurred before, completion of fieldwork. It is not necessary for the auditor to design audit
procedures specifically to identify conditions and events that indicate a going concern problem.
Regular auditing procedures are sufficient.
Regular Auditing Procedures That May Identify Going Concern Problem
Regular auditing procedures that may identify conditions and events that indicate a going
concern problem include the following:
1. Analytical procedures Analytical procedures used as a substantive test or used in the
planning and overall review stages of the audit may indicate: a) Negative trends; b) Slowmoving inventory; c) Receivable collectability problems; d) Liquidity and solvency
problems.
2. Review of subsequent events Subsequent events, such as the bankruptcy of a major
customer, confirm adverse conditions that existed at the balance sheet date. Other subsequent
events that indicate a possible going concern problem include: (a) collapse of the market
price of the entitys inventory; (b) withdrawal of line of credit by bank; and (c) expropriation
of entitys assets.
3. Review of compliance with the terms of debt and loan agreements Violation of debt
covenants results in debt default.
4. Reading of minutes Minutes of meetings of stockholders, board of directors, and board
committees may indicate (a) potentially expensive litigation; (b) loss of lines of credit; (c)
loss of a major supplier; and (d) changes in the operation of the business that could result in
significant losses.
5. Inquiry of legal counsel Responses to inquiries of the entitys legal counsel about
litigation, claims, and assessments could indicate possible significant losses because of
product liability claims, copyright or patent infringement, contract violations, and illegal acts.
6. Confirmations concerning financial support Confirmation with related parties and third
parties of the details of arrangements to provide or maintain financial support may indicate
loss of bank lines of credit or loss of third-party guarantees of entity indebtedness.
Getting Know the Indications of Going Concern Problems
Regular audit procedures such as those described above may reveal conditions and events that
indicate there could be substantial doubt about the entitys ability to continue as a going concern
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for a reasonable period of time. Examples of these conditions and events (going concern warning
signs or red flags) are as follows:
1. Negative trends: (a) declining sales; (b) increasing costs; (c) recurring operating losses; (d)
working capital deficiencies; (e) negative cash flows from operations; and (f) adverse key
financial ratios.
2. Internal matters: (a) chaotic and inefficient accounting system; (b) loss of key management
or operations personnel; (c) work stoppages or other labor difficulties; (d) substantial dependence
on the success of a particular project; (e) uneconomic long-term commitments; and (f) need to
significantly revise operations.
3. External events that have occurred: (a) legal proceedings; (b) legislation or similar matters
that might jeopardize operating ability; (c) loss of a key franchise, license, or patent; (d) loss of a
principal customer or supplier; (e) uninsured catastrophes such as drought, earthquake, or flood.
4. Other indications of possible financial difficulties are: (a) default on loan or similar
agreements; (b) arrearages in dividends; (c) denial of usual trade credit from suppliers; (d)
noncompliance with statutory capital requirements; (e) seeking new sources or methods of
financing.
Including Consideration of Managements Plans
If, after considering the conditions and events described above, the auditor believes there is
substantial doubt about the entitys ability to continue as a going-concern for a reasonable
period of time, he or she should consider managements plans for addressing these conditions
and events. Managements plans may be classified as follows:
a.
b.
c.
d.
Plans to dispose of assets.

Plans to borrow money or restructure debt.
Plans to reduce or delay expenditures.
Plans to increase ownership equity.
Financial Statement Effects

Finally, substantial doubt may or may not exist on the entity financial statements:
1. Substantial Doubt Exists If the auditor concludes after considering managements plans,
that there is substantial doubt about the entitys ability to continue as a going concern for a
reasonable period of time, he or she should consider possible effects on the financial statements
and the adequacy of the related disclosure. Disclosure might include the following:
Conditions and events creating the doubt, such as recurring operating losses, negative cash
flows, working capital deficiency, and violation of debt covenants.
Possible effect of conditions and events, such as a cutback in operations, a layoff of
employees, or a bankruptcy filing.
Managements evaluation of the significance of the conditions and events and any mitigating
factors.
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Whether operations may need to be discontinued.

Managements plans, including relevant prospective financial information (Note: It is not
intended that the prospective financial information should meet the minimum presentation
guidelines of Statement on Standards for Accountants Services on Prospective Financial
Information, Financial Forecasts and Projections. Also, the inclusion of prospective
financial information does not require procedures beyond those required by generally
accepted auditing standards)
Information about recoverability or classification of recorded asset amounts or the amounts
or classification of liabilities.
2. Substantial Doubt Does Not Exist After considering managements plans, the auditor may
conclude that substantial doubt about the entitys ability to continue as a going concern for a
reasonable period of time does not exist. In these circumstances, the auditor should nonetheless
consider the need to disclose the conditions and events responsible for the initial doubt and any
mitigating factors, including managements plans.
NSA 570: GOING CONCERN
Purpose
To establish standards and provide guidance on the auditors responsibility in the audit of
financial statements with respect to the going concern assumption used in the preparation of the
financial statements, including considering managements assessment of the entitys ability to
continue as a going concern.
Managements Responsibility
The going concern assumption is a fundamental principle in the preparation of financial
statements. Under the going concern assumption, an entity is ordinarily viewed as continuing in
business for the foreseeable future with neither the intention nor the necessity of liquidation.
Accordingly, assets and liabilities are recorded on the basis that the entity will be able to realise
its assets and discharge its liabilities in the normal course of business.
Nepal Accounting Standard (NAS) 01, Presentation of Financial Statements also requires
management to make an assessment of an enterprises ability to continue as a going concern.
Since the going concern assumption is a fundamental principle in the preparation of the financial
statements, management has a responsibility to assess the entitys ability to continue as a going
concern even if the financial reporting framework does not include an explicit responsibility to
do so.
When there is a history of profitable operations and a ready access to financial resources,
management may make its assessment without detailed analysis.
Managements assessment of the going concern assumption involves making a judgement, at a
particular point in time, about the future outcome of events or conditions which are inherently
uncertain. The following factors are relevant:
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1. In general terms, the degree of uncertainty associated with the outcome of an event or
condition increases significantly the further into the future a judgment is being made about
the outcome of an event or condition. For that reason, most financial reporting frameworks
that require an explicit management assessment specify the period for which management is
required to take into account all available information;
2. Any judgment about the future is based on information available at the time at which the
judgments is made. Subsequent events can contradict a judgment which was reasonable at the
time it was made; and
3. The size and complexity of the entity, the nature and condition of its business and the degree
to which it is affected by external factors all affect the judgments regarding the outcome of
events or conditions.
Indicators of Going Concern
These are the events or conditions which may cast significant doubt about the going concern
assumption. These may be of the following types:a) Financial
Net liability or net current liability position.
Fixed-term borrowings approaching maturity without realistic prospects of renewal or

repayment; or excessive reliance on short-term borrowings to finance long-term assets.
Indications of withdrawal of financial support by debtors and other creditors.
Negative operating cash flows indicated by historical or prospective financial statements.
Adverse key financial ratios.
Substantial operating losses or significant deterioration in the value of assets used to

generate cash flows.
Arrears or discontinuance of dividends.
Inability to pay creditors on due dates.
Inability to comply with the terms of loan agreements.
Change from credit to cash-on-delivery transactions with suppliers.
Inability to obtain financing for essential new product development or other essential
investments.
b) Operating
Loss of key management without replacement.
Loss of a major market, franchise, license, or principal supplier.
Labor difficulties or shortages of important supplies.
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c) Other
Non-compliance with capital or other statutory requirements.
Pending legal or regulatory proceedings against the entity that may, if successful, result
in claims that are unlikely to be satisfied.
Changes in legislation or government policy expected to adversely affect the entity.
Auditors Responsibility
The auditors responsibility is to consider the appropriateness of managements use of the going
concern assumption in the preparation of the financial statements, and consider whether there are
material uncertainties about the entitys ability to continue as a going concern that need to be
disclosed in the financial statements.
The auditor cannot predict future events or conditions that may cause an entity to cease to
continue as a going concern. Accordingly, the absence of any reference to going concern
uncertainty in an auditors report cannot be viewed as a guarantee as to the entitys ability to
Planning Considerations
Auditor should consider whether there are events or conditions which may cast significant
doubt on the entitys ability to continue as a going concern.
Auditor should remain alert for evidence of events or conditions which may cast significant
doubt on the entitys ability to continue as a going concern throughout the audit. If such
events or conditions are identified, the auditor should perform the additional procedures
and consider whether they affect the auditors assessments of the components of audit risk.
Evaluating Managements Assessment
The auditor should evaluate managements assessment of the entitys ability to continue as
a going concern.
The auditor should consider the same period as that used by management in making its
assessment under the financial reporting framework. If managements assessment of the
entitys ability to continue as a going concern covers less than twelve months from the
balance sheet date, the auditor should ask management to extend its assessment period to
twelve months from the balance sheet date.
Period beyond Managements Assessment

The auditor should inquire of management as to its knowledge of events or conditions beyond
the period of assessment used by management that may cast significant doubt on the entitys
ability to continue as a going concern.
Additional Audit Procedures When Events or Conditions are identified
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When events or conditions have been identified which may cast significant doubt on the entitys
ability to continue as a going concern, the auditor should:
a) Review managements plans for future actions based on its going concern assessment;
b) Gather sufficient appropriate audit evidence to confirm or dispel whether or not a material
uncertainty exists through carrying out procedures considered necessary, including
considering the effect of any plans of management and other mitigating factors; and
c) Seek written representations from management regarding its plans for future action.
Audit Conclusions and Reporting
Based on the audit evidence obtained, the auditor should determine if, in the auditors
judgement, a material uncertainty exists related to events or conditions that alone or in aggregate,
may cast significant doubt on the entitys ability to continue as a going concern.
A material uncertainty exists when the magnitude of its potential impact is such that, in the
auditors judgement, clear disclosure of the nature and implications of the uncertainty is
necessary for the presentation of the financial statements not to be misleading.
Going Concern Assumption Appropriate but a Material Uncertainty Exists
If the use of the going concern assumption is appropriate but a material uncertainty exists, the
auditor considers whether the financial statements:
a) adequately describe the principal events or conditions that give rise to the significant doubt
on the entitys ability to continue in operation and managements plans to deal with these
events or conditions; and
b) state clearly that there is a material uncertainty related to events or conditions which may cast
significant doubt on the entitys ability to continue as a going concern and, therefore, that it
may be unable to realise its assets and discharge its liabilities in the normal course of
business.
If adequate disclosure is made in the financial statements, the auditor should express an
unqualified opinion but modify the auditors report by adding an emphasis of matter paragraph
that highlights the existence of a material uncertainty relating to the event or condition that may
cast significant doubt on the entitys ability to continue as a going concern and draws attention to
the note in the financial statements that discloses the matters.
The following is an example of such a paragraph when the auditor is satisfied as to the adequacy
of the note disclosure:
Without qualifying our opinion, we draw attention to Note X in the financial statements which
indicates that the Company incurred a net loss of Rs. ... during the year ended Asadh 3X, 20XX
and, as of that date, the Companys current liabilities exceeded its total assets by Rs. ... These
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conditions, along with other matters as set forth in Note X, indicate the existence of a material
uncertainty which may cast significant doubt about the Companys ability to continue as a going
concern.
If adequate disclosure is not made in the financial statements, the auditor should express a
qualified or adverse opinion, as appropriate (NSA 08: The Auditors Report on Financial
Statements, paragraphs 47-48). The report should include specific reference to the fact that
there is a material uncertainty that may cast significant doubt about the entitys ability to
The following is an example of the relevant paragraphs when a qualified opinion is to be
expressed:
The Companys financing arrangements expire and amounts outstanding are payable on ...
(specify date). The Company has been unable to re-negotiate or obtain replacement financing.
This situation indicates the existence of a material uncertainty which may cast significant doubt
on the Companys ability to continue as a going concern and therefore it may be unable to realise
its assets and discharge its liabilities in the normal course of business. The financial statements
(and notes thereto) do not disclose this fact. In our opinion, except for the omission of the
information included in the preceding paragraph, the financial statements give a true and fair
view of (or are presented fairly, in all material respects,) the financial position of the Company at
Asadh 3X, 20XX and the results of its operations and its cash flows for the year then ended in
accordance with Nepal Accounting Standards or relevant practices and comply with (Quote the
relevant statue or law)... (For example: Company Act, 2053/ Commercial Bank Act, 2031 etc.)
The following is an example of the relevant paragraphs when an adverse opinion is to be
expressed:
The Companys financing arrangements expired and the amount outstanding was payable on ...
(specify date). The Company has been unable to re-negotiate or obtain replacement financing
and is considering filing for liquidation. These events indicate a material uncertainty which may
cast significant doubt on the Companys ability to continue as a going concern and therefore it
may be unable to realise its assets and discharge its liabilities in the normal course of business.
The financial statements (and notes thereto) do not disclose this fact. In our opinion, because of
the omission of the information mentioned in the preceding paragraph, the financial statements
do not give a true and fair view of (or do not present fairly) the financial position of the
Company as at Ashad 3X, 20XX, and of its results of operations and its cash flows for the year
then ended in accordance with Nepal Accounting Standards or relevant practices ..... (and do not
comply with .....)......
Going Concern Assumption Inappropriate
If, in the auditors judgement, the entity will not be able to continue as a going concern, the
auditor should express an adverse opinion if the financial statements have been prepared on a
going concern basis.
If, on the basis of the additional procedures carried out and the information obtained, including
the effect of managements plans, the auditors judgement is that the entity will not be able to
continue as a going concern, the auditor concludes, regardless of whether or not disclosure has
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been made, that the going concern assumption used in the preparation of the financial statements
is inappropriate and expresses an adverse opinion. 39. When the entitys management has
concluded that the going concern assumption used in the preparation of the financial statements
is not appropriate, the financial statements need to be prepared on an alternative authoritative
basis. If on the basis of the additional procedures carried out and the information obtained the
auditor determines the alternative basis is appropriate, the auditor can issue an unqualified
opinion if there is adequate disclosure but may require an emphasis of matter in the auditors
report to draw the users attention to that basis.
Management Unwilling to Make or Extend its Assessment
If management is unwilling to make or extend its assessment when requested to do so by the
auditor, the auditor should consider the need to modify the auditors report as a result of the
limitation on the scope of the auditors work.
When the auditor believes that it is necessary to ask management to make or extend its
assessment. If management is unwilling to do so, it is not the auditors responsibility to rectify
the lack of analysis by management, and a modified report may be appropriate because it may
not be possible for the auditor to obtain sufficient appropriate evidence regarding the use of the
going concern assumption in the preparation of the financial statements.
Significant Delay in the Signature or Approval of Financial Statements
When there is significant delay in the signature or approval of the financial statements by
management after the balance sheet date, the auditor considers the reasons for the delay. When
the delay could be related to events or conditions relating to the going concern assessment, the
auditor considers the need to perform additional audit procedures as well as the effect on the
auditors conclusion regarding the existence of a material uncertainty.
Public Sector Perspective
The appropriateness of the use of the going concern assumption in the
preparation of the financial statements is generally not in question when
auditing either the government or those public sector entities having
funding arrangements backed by the government. However, where such
arrangements do not exist, or where government funding of the entity may
be withdrawn and the existence of the entity may be at risk, this NSA will
provide useful guidance. As government corporatize and privatize
government entities, going concern issues will become increasingly
relevant to the public sector.
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u. Communication Of Audit Matters With Those Charged With Governance

Auditor is required to make frequent communication with those charged governance. NSA 260 is
to establish standards and provide guidance on communication of audit matters arising from the
audit of financial statements between the auditor and those charged with governance of an entity.
The auditor should communicate audit matters of governance interest arising from the audit of
financial statements with those charged with governance of an entity.
Governance
It is the term used to describe the role of persons entrusted with the supervision, control and
direction of an entity.
Those charged with governance ordinarily are accountable for ensuring that the entity achieves
its objectives, financial reporting, and reporting to interested parties. Those charged with
governance include management only when it performs such functions.
Audit matters of governance interest
These are those that arise from the audit of financial statements and, in the opinion of the auditor,
are both important and relevant to those charged with governance in overseeing the financial
reporting and disclosure process. Audit matters of governance interest include only those matters
that have come to the attention of the auditor as a result of the performance of the audit.
Relevant Persons
The auditor should determine the relevant persons who are charged with governance and with
whom audit matters of governance interest are communicated. The structures of governance vary
from entity to entity reflecting different legal backgrounds. When the entitys governance
structure is not well defined, or those charged with governance are not clearly identified by the
circumstances of the engagement, or by legislation, the auditor comes to an agreement with the
entity about with whom audit matters of governance interest are to be communicated.
To avoid misunderstandings, an audit engagement letter may explain that the auditor will
communicate only those matters of governance interest that come to attention as a result of the
performance of an audit and that the auditor is not required to design procedures for the specific
purpose of identifying matters of governance interest.
The engagement letter may also:
describe the form in which any communications on audit matters of governance interest will
be made;
identify the relevant persons with whom such communications will be made;
Identify any specific audit matters of governance interest which it has been agreed are to be
communicated.
Audit Matters of Governance Interest to be communicated
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The auditor should consider audit matters of governance interest that arise from the audit of the
financial statements and communicate them with those charged with governance.
Ordinarily such matters include:
the general approach and overall scope of the audit, including any expected limitations
thereon, or any additional requirements;
the selection of, or changes in, significant accounting policies and practices that have, or
could have, a material effect on the entitys financial statements;
the potential effect on the financial statements of any significant risks and exposures, such as
pending litigation, that are required to be disclosed in the financial statements;
audit adjustments, whether or not recorded by the entity that have, or could have, a
significant effect on the entitys financial statements;
material uncertainties related to events and conditions that may cast significant doubt on the
entitys ability to continue as a going concern;
Disagreements with management about matters that, individually or in aggregate, could be
significant to the entitys financial statements or the auditors report. These communications
include consideration of whether the matter has, or has not, been resolved and the
significance of the matter;
expected modifications to the auditors report;
other matters warranting attention by those charged with governance, such as material
weaknesses in internal control, questions regarding management integrity, and fraud
involving management;
Any other matters agreed upon in the terms of the audit engagement.
As part of the auditors communications, those charged with governance are informed that:
the auditors communications of matters include only those audit matters of governance
interest that have come to the attention of the auditor as a result of the performance of the
audit;
An audit of financial statements is not designed to identify all matters that may be relevant to
those charged with governance. Accordingly, the audit does not ordinarily identify all such
matters.
Timing of Communications
The auditor should communicate audit matters of governance interest on a timely basis. This
enables those charged with governance to take appropriate action.
Forms of Communications
The auditors communications with those charged with governance may be made orally or in
writing. The auditors decision whether to communicate orally or in writing is affected by
factors such as:
the size, operating structure, legal structure, and communications processes of the entity
being audited;
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the nature, sensitivity and significance of the audit matters of governance interest to be
communicated;
the arrangements made with respect to periodic meetings or reporting of audit matters of
governance interest;
The amount of on-going contact and dialogue the auditor has with those charged with
governance.
Other Matters
If the auditor considers that a modification of the auditors report on the financial statements is
required, as per NSA 700 on The Auditors Report on Financial Statements, communications
between the auditor and those charged with governance cannot be regarded as a substitute.
The auditor considers whether audit matters of governance interest previously communicated
may have an effect on the current years financial statements. The auditor considers whether the
point continues to be a matter of governance interest and whether to communicate the matter
again with those charged with governance.
Confidentiality
The requirements of ICAN, legislation or regulation may impose obligations of confidentiality
that restrict the auditors communications of audit matters of governance interest. The auditor
refers to such requirements, laws and regulations before communicating with those charged with
governance. In some circumstances, the potential conflicts with the auditors ethical and legal
obligations of confidentiality and reporting may be complex. In these cases, the auditor may wish
to consult with legal counsel.
Laws and Regulations
The requirements of ICAN, legislation or regulation may impose obligations on the auditor to
make communications on governance related matters. These additional communications
requirements are not covered by this NSA; however, they may affect the content, form and
timing of communications with those charged with governance.
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3. Gathering evidence during an audit engagement

Assertions in the Audit of Financial Statements
Definition
Audit Assertions are the implicit or explicit claims and representations made by the management
responsible for the preparation of financial statements regarding the appropriateness of the
various elements of financial statements and disclosures.
Audit Assertions are also known as Management Assertions and Financial Statement Assertions.
Explanation
In preparing financial statements, management is making implicit or explicit claims (i.e.
assertions) regarding the recognition, measurement and presentation of assets, liabilities, equity,
income, expenses and disclosures in accordance with the applicable financial reporting
framework (e.g. IFRS).
For example, if a balance sheet of an entity shows buildings with carrying amount of $10
million, the auditor shall assume that the management has claimed that:
The buildings recognized in the balance sheet exist at the period end;
The entity owns or controls those buildings;
The buildings are valued accurately in accordance with the measurement basis;
All buildings owned and controlled by the entity are included within the carrying amount of
$10 million.
Types & Examples
Assertions may be classified into the following types:
Audit Assertions are also known as Management Assertions and Financial Statement Assertions.
Assertions relating to classes of transactions
Assertions
Explanation
Examples: Salaries & Wages Cost
Occurrence
Transactions
Salaries & wages expense has been incurred during the
recognized in the
period in respect of the personnel employed by the entity.
financial
Salaries and wages expense does not include the payroll
statements have
cost of any unauthorized personnel.
occurred and
relate to the entity.
Completenes All transactions
Salaries and wages cost in respect of all personnel have
s
that were
been fully accounted for.
supposed to be
recorded have
been recognized in
the financial
statements.
Accuracy
Transactions have Salaries and wages cost has been calculated accurately.
been recorded
Any adjustments such as tax deduction at source have been
accurately at their correctly reconciled and accounted for.
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appropriate
amounts.
Cut-off
Transactions have
been recognized in
the correct
accounting
periods.
Classification Transactions have
been classified
and presented
fairly in the
financial
statements.
Salaries and wages cost recognized during the period

relates to the current accounting period. Any accrued and
prepaid expenses have been accounted for correctly in the
financial statements.
Salaries and wages cost has been fairly allocated between:
-Operating expenses incurred in production activities;
-General and administrative expenses; and
-Cost of personnel relating to any self-constructed assets
other than inventory.
Assertions relating to assets, liabilities and equity balances at the period end
Assertions
Explanation
Examples: Inventory balance
Existence
Assets, liabilities and equity
Inventory recognized in the balance
balances exist at the period end.
sheet exists at the period end.
Completeness
All assets, liabilities and equity
All inventory units that should have
balances that were supposed to be
been recorded have been recognized
recorded have been recognized in
in the financial statements. Any
the financial statements.
inventory held by a third party on
behalf of the audit entity has been
included in the inventory balance.
Rights &
Entity has the right to ownership or Audit entity owns or controls the
Obligations
use of the recognized assets, and
inventory recognized in the financial
the liabilities recognized in the
statements. Any inventory held by the
financial statements represent the
audit entity on account of another
obligations of the entity.
entity has not been recognized as part
of inventory of the audit entity.
Valuation
Assets, liabilities and equity
Inventory has been recognized at the
balances have been valued
lower of cost and net realizable value
appropriately.
in accordance with IAS 2 Inventories.
Any costs that could not be reasonably
allocated to the cost of production
(e.g. general and administrative costs)
and any abnormal wastage has been
excluded from the cost of inventory.
An acceptable valuation basis has
been used to value inventory cost at
the period end (e.g. FIFO, AVCO,
etc.)
Assertions
Assertions relating to presentation and disclosures

Explanation
Examples: Related Party
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Occurrence
Transactions and events disclosed in

the financial statements have
occurred and relate to the entity.
Completeness
All transactions, balances, events

and other matters that should have
been disclosed have been disclosed
in the financial statements.
Classification &
Understandability
Disclosed events, transactions,

balances and other financial matters
have been classified appropriately
and presented clearly in a manner
that promotes the understandability
of information contained in the
Accuracy &
Valuation
Transactions, events, balances and

other financial matters have been
disclosed accurately at their
appropriate amounts.
Disclosures
Transactions with related parties
disclosed in the notes of financial
statements have occurred during the
period and relate to the audit entity.
All related parties, related party
transactions and balances that should
have been disclosed have been
disclosed in the notes of financial
statements.
The nature of related party
transactions, balances and events has
been clearly disclosed in the notes of
financial statements. Users of the
financial statements can clearly
determine the financial statement
captions affected by the related party
transactions and balances and can
easily ascertain their financial effect.
Related party transactions, balances
and events have been disclosed
accurately at their appropriate
amounts.
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Use and Application

Auditors are required to obtain sufficient & appropriate audit evidence in respect of all material
financial statement assertions. The use of assertions therefore forms a critical element in the
various stages of a financial statement audit as described below.
Stage of
Audit
Application of Assertions
As part of the risk assessment procedures, auditors are required to understand the
Planning
entity and its environment including the assessment of the risk of material
misstatement (ROMM) due to fraud and error at the financial statement and
assertion level.
The assessment of ROMM at the financial statement and assertion level provides
the basis for determining the nature, timing and extent of audit procedures that
are necessary to obtain sufficient and appropriate audit evidence in response to
those assessed risks.
Substantive tests are performed to identify material misstatements at the
Testing
assertion level. In case of assertions whose ROMM has been assessed as
significant and no tests of control are planned to be performed, the substantive
procedures should include tests of detail (i.e. substantive analytical procedures
alone cannot be considered as sufficient and appropriate audit evidence for
assertions with a significant risk of material misstatement.
Tests of control (TOCs) are performed to assess the operating effectiveness of
controls at the financial statement and assertion level. TOCs are necessary to
validate the auditor's expectation of the operating effectiveness of controls (as
acquired from the risk assessment procedures performed at the planning stage)
and also in case where the performance of substantive procedures alone cannot
provide sufficient and appropriate audit evidence in respect of a specific
assertion.
Completion Auditor shall conclude whether sufficient and appropriate audit evidence has
been obtained for all material financial statement assertions taking into account
any revisions in the assessment of ROMM at the assertion level.
Where an auditor is unable to obtain sufficient and appropriate audit evidence in
respect of a material financial statement assertion, he is required to modify the
audit report accordingly.
Purpose & Importance
Assertions assist auditors in considering a wide range of issues that are relevant to the
authenticity of financial statements. The consideration of management assertions during the
various stages of audit helps to reduce the audit risk.
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Concept, sufficient appropriate audit evidence
Sufficiency and Appropriateness of Evidence

Sufficiency is the measure of the quantity of evidence. Appropriateness is the measure of the
quality of evidence; that is, its relevance and its reliability. The quantity of evidence needed is
affected by the risk of the subject matter information being materially misstated (the greater the
risk, the more evidence is likely to be required) and also by the quality of such evidence (the
higher the quality, the less may be required).
Accordingly, the sufficiency and appropriateness of evidence are interrelated. However, merely
obtaining more evidence may not compensate for its poor quality.
The reliability of evidence is influenced by its source and by its nature, and is dependent on the
individual circumstances under which it is obtained. Generalizations about the reliability of
various kinds of evidence can be made; however, such generalizations are subject to important
exceptions. Even when evidence is obtained from sources external to the entity, circumstances
may exist that could affect the reliability of the information obtained. For example, evidence
obtained from an independent external source may not be reliable if the source is not
knowledgeable. While recognizing that exceptions may exist, the following generalizations about
the reliability of evidence may be useful:
Evidence is more reliable when it is obtained from independent sources outside the entity.
Evidence that is generated internally is more reliable when the related controls are effective.
Evidence obtained directly by the practitioner (for example, observation of the application of
a control) is more reliable than evidence obtained indirectly or by inference (for example,
enquiry about the application of a control).
Evidence is more reliable when it exists in documentary form, whether paper, electronic, or
other media.
Evidence provided by original documents is more reliable than evidence provided by
photocopies or facsimiles.
The practitioner ordinarily obtains more assurance from consistent evidence obtained from
different sources or of a different nature than from items of evidence considered individually. In
addition, obtaining evidence from different sources or of a different nature may indicate that an
individual item of evidence is not reliable. For example, corroborating information obtained from
a source independent of the entity may increase the assurance the practitioner obtains from a
representation from the responsible party. Conversely, when evidence obtained from one source
is inconsistent with that obtained from another, the practitioner determines what additional
evidence-gathering procedures are necessary to resolve the inconsistency.
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Written confirmation of representation from management (management representation

concept, case when management representation cannot be an audit evidence, use of
management representation as audit evidence)
Management representation is the written representations obtained by the auditor from
management on matters material to the financial statements when other sufficient appropriate
audit evidence cannot reasonably be expected to exist. It is governed by NSA 580.
Management Representation
1. The auditor should obtain appropriate representations from management.
2. The auditor should obtain evidence that management acknowledges its responsibility for the
fair presentation of the financial statements in accordance with the relevant financial
reporting framework, and has approved the financial statements.
3. The auditor should obtain written representations from management on matters material to
the financial statements when other sufficient appropriate audit evidence cannot reasonably
be expected to exist.
Representations by Management as Audit Evidence
The auditor should obtain written representations from management on matters material to the
financial statements when other sufficient appropriate audit evidence cannot reasonably be
expected to exist. The possibility of misunderstandings between the auditor and management is
reduced when oral representations are confirmed by management in writing.
Written representations requested from management may be limited to matters that are
considered either individually or collectively material to the financial statements. Regarding
certain items it may be necessary to inform management of the auditors understanding of
materiality.
During the course of an audit, management makes many representations to the auditor, either
unsolicited or in response to specific inquiries. When such representations relate to matters
which are material to the financial statements, the auditor will need to:
Seek corroborative audit evidence from sources inside or outside the entity;
Evaluate whether the representations made by management appear reasonable and consistent
with other audit evidence obtained, including other representations; and
Consider whether the individuals making the representations can be expected to be well
informed on the particular matters.
Substitute as Audit Evidence in Normal Scenario

Representations by management cannot be a substitute for other audit evidence that the auditor
could reasonably expect to be available. For example, a representation by management as to the
cost of an asset is not a substitute for the audit evidence of such cost that an auditor would
ordinarily expect to obtain.
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If a representation by management is contradicted by other audit evidence, the auditor should

investigate the circumstances and, when necessary, reconsider the reliability of other
representations made by management.
Documentation of Representations by Management
The auditor would ordinarily include in audit working papers evidence of managements
representations in the form of a summary of oral discussions with management or written
representations from management.
A written representation is better audit evidence than an oral representation and can take the
form of:
A representation letter from management;
A letter from the auditor outlining the auditors understanding of managements

representations, duly acknowledged and confirmed by management; or
Relevant minutes of meetings of the board of directors or similar body or a signed copy of
the financial statements.
Basic Elements of a Management Representation Letter

a) When requesting a management representation letter, the auditor would request that it be
addressed to the auditor, contain specified information and be appropriately dated and signed.
b) A management representation letter would ordinarily be dated the same date as the auditors
report. However, in certain circumstances, a separate representation letter regarding specific
transactions or other events may also be obtained during the course of the audit or at a date
after the date of the auditors report, for example, on the date of a public offering.
c) A management representation letter would ordinarily be signed by the members of
management who have primary responsibility for the entity and its financial aspects
(ordinarily the senior executive officer and the senior financial officer)
Action if Management Refuses to Provide Representations
If management refuses to provide a representation that the auditor considers necessary, this
constitutes a scope limitation and the auditor should express a qualified opinion or a disclaimer
of opinion.
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Initial Audit engagement consideration from the incoming auditor regarding the
correctness of opening balances
INITIAL ENGAGEMENTSOPENING BALANCES
For any auditor, opening balance of any financial statement is crucial for current year audit. And
it is of great importance when the financial statements are audited for the first time or when the
financial statements for the prior period were audited by another auditor. NSA 510 provides
standards and provides guidance regarding opening balances.
Sufficient appropriate audit evidence
For initial audit engagements, the auditor should obtain sufficient appropriate audit evidence
that:
a. The opening balances do not contain misstatements that materially affect the current periods
financial statements;
b. The prior periods closing balances have been correctly brought forward to the current period
or, when appropriate, have been restated; and
c. Appropriate accounting policies are consistently applied or changes in accounting policies
have been properly accounted for and adequately disclosed.
Opening balances
It means those account balances which exist at the beginning of the period. Opening balances are
based upon the closing balances of the prior period and reflect the effects of:
a. Transactions of prior periods; and
b. Accounting policies applied in the prior period.
In an initial audit engagement, the auditor will not have previously obtained audit evidence
supporting such opening balances.
Audit Procedures
The sufficiency and appropriateness of the audit evidence the auditor will need to obtain
regarding opening balances depends on such matters as:
the accounting policies followed by the entity,

whether the prior periods financial statements were audited, and if so whether the auditors
report was modified,
the nature of the accounts and the risk of misstatement in the current periods FS, and
The materiality of the opening balances relative to the current periods financial statements.
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When the prior periods financial statements were audited by another auditor, the current auditor
may be able to obtain sufficient appropriate audit evidence regarding opening balances by
reviewing the predecessor auditors working papers. In these circumstances, the current auditor
would also consider the professional competence and independence of the predecessor auditor. If
the prior periods auditors report was modified, the auditor would pay particular attention in the
current period to the matter which resulted in the modification
Prior to communicating with the predecessor auditor, the current auditor will need to consider
the Code of Ethics for Professional Accountants issued by The Institute of Chartered
Accountants of Nepal.
For current assets and liabilities some audit evidence can ordinarily be obtained as part of the
current periods audit procedures.
Audit Conclusions and Reporting
If, after performing procedures including those set out above, the auditor is unable to obtain
sufficient appropriate audit evidence concerning opening balances, the auditors report should
include:
(a) a qualified opinion,
We did not observe the counting of the physical inventory stated at Rs... as at Ashad 3X,
20XX, since that date was prior to our appointment as auditors. We were unable to satisfy
ourselves as to the inventory quantities at that date by other audit procedures.
In our opinion, except for the effects of such adjustments, if any, as might have been
determined to be necessary had we been able to observe the counting of physical inventory
and satisfy ourselves as to the opening balance of inventory, the financial statements give a
true and fair view of (are presented fairly, in all material respects,) the financial position of
ABC Company as at Ashad 3X, 20XX and the results of its operations and its cash flows for
the year then ended in accordance with Nepal Accounting Standards or relevant practices and
comply with (Quote the relevant statute or law)... (For example: Company Act, 2063 /
Commercial Bank Act, 2031 etc.)
(b) a disclaimer of opinion; or
(c) in those jurisdictions where it is permitted, an opinion which is qualified or disclaimed
regarding the results of operations and unqualified regarding financial position,
However, if a modification regarding the prior periods financial statements remains relevant and
material to the current periods financial statements, the auditor should modify the current
auditors report accordingly.
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If the current periods accounting policies have not been consistently applied in relation to
opening balances and if the change has not been properly accounted for and adequately
disclosed, the auditor should express a qualified opinion or an adverse opinion as appropriate.
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4. Using the work of others

Auditor alone cannot wholly and completely perform all the auditing activities. They must rely
and get there work done by some other auditor, experts, valuators and others professional.
Further with the concept of branch audit is under discussion, the frequency of using the work of
other personnel is indispensable. Also mandatory use of actuarial valuation in insurance
companies has extended the use of work of other person.
When the auditor delegates work to assistants or uses work performed by other auditors and
experts, he will continue to be responsible for forming and expressing his opinion on the
financial information. However, he will be entitled to rely on work performed by others,
provided he exercises adequate skill and care and is not aware of any reason to believe that he
should not have so relied.
In this regards, professional accountant in public practice can use/consider the work of other in
following ways:
Using the work of another auditor
Considering the work of internal auditor
Using the work of an expert
Using the work of Another Auditor [Nepal Auditing Standards on Auditing 600]
Introduction
The purpose of this Auditing Standard is to establish standards to be applied in situations where
an auditor (referred to herein as the principal auditor), reporting on the financial information of
an entity, uses the work of another auditor (referred to herein as the other auditor) with respect
to the financial information of one or more components included in the financial information of
the entity. This Statement also discusses the principal auditors responsibility in relation to his
use of the work of the other auditor.
Non applicability of this Standard
This Standard does not deal with those instances where two or more auditors are appointed as
joint auditors12 nor does it deal with the auditors relationship with a predecessor auditor.
Definition
"Principal auditor" means the auditor with responsibility for reporting on the financial
information of an entity when that financial information includes the financial information of one
or more components audited by another auditor.
"Other auditor" means an auditor, other than the principal auditor, with responsibility for
reporting on the financial information of a component which is included in the financial
information audited by the principal auditor
"Component" means a division, branch, subsidiary, joint venture, associated enterprises or other
entity whose financial information is included in the financial information audited by the
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principal auditor.
Consideration of work of another auditor
When the principal auditor uses the work of another auditor, the principal auditor should
determine how the work of the other auditor will affect the audit.
Acceptance as Principal Auditor
The auditor should consider whether the auditors own participation is sufficient to be able to act
as the principal auditor.
For this purpose the auditor would consider:
- the materiality of the portion of the financial information which the principal auditor audits;
- the principal auditors degree of knowledge regarding the business of the components;
- the risk of material misstatements in the financial information of the components audited by
the other auditor; and
- the performance of additional procedures as set out in this SA regarding the components
audited by other auditor resulting in the principal auditor having significant participation in
such audit.
Audit Procedure to be adopted t Principal Auditor
When planning to use the work of another auditor, the principal auditor should consider the
professional competence of the other auditor in the context of specific assignment if the other
auditor is not a member of the Institute of Chartered Accountants of Nepal.
The principal auditor should perform procedures to obtain sufficient appropriate audit evidence,
that the work of the other auditor is adequate for the principal auditors purposes, in the context
of the specific assignment. When using the work of another auditor, the principal auditor should
ordinarily perform the following procedures:
- advise the other auditor of the use that is to be made of the other auditors work and report
and make sufficient arrangements for co-ordination of their efforts at the planning stage of
the audit. The principal auditor would inform the other auditor of matters such as areas
requiring special consideration, procedures for the identification of inter-component
transactions that may require disclosure and the time-table for completion of audit; and
- advise the other auditor of the significant accounting, auditing and reporting requirements
and obtain representation as to compliance with them.
The principal auditor might discuss with the other auditor the audit procedures applied or review
a written summary of the other auditors procedures and findings which may be in the form of a
completed questionnaire or check-list. The principal auditor may also wish to visit the other
auditor. The nature, timing and extent of procedures will depend on the circumstances of the
engagement and the principal auditors knowledge of the professional competence of the other
auditor.
After considering above audit procedure, the principal auditor should consider the significant
findings of the other auditor. The principal auditor may consider it appropriate to discuss with
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the other auditor and the management of the component, the audit findings or other matters
affecting the financial information of the components. He may also decide that supplemental
tests of the records or the financial statements of the component are necessary. Such tests may,
depending upon the circumstances, be performed by the principal auditor or the other auditor.
Documentation
The principal auditor should document in his working papers the components whose financial
information was audited by other auditors; their significance to the financial information of the
entity as a whole; the names of the other auditors; and any conclusions reached that individual
components are not material. The principal auditor should also document the procedures
performed and the conclusions reached.
Co-ordination between Auditors
There should be sufficient liaison between the principal auditor and the other auditor. For this
purpose, the principal auditor may find it necessary to issue written communication(s) to the
other auditor. The other auditor, knowing the context in which his work is to be used by the
principal auditor, should co-ordinate with the principal auditor. The principal auditor may require
the other auditor to answer a detailed questionnaire regarding matters on which the principal
auditor requires information for discharging his duties. The other auditor should respond to such
questionnaire on a timely basis.
Reporting Considerations
When the principal auditor concludes, based on his procedures, that the work of the other auditor
cannot be used and the principal auditor has not been able to perform sufficient additional
procedures regarding the financial information of the component audited by the other auditor, the
principal auditor should express a qualified opinion or disclaimer of opinion because there is a
limitation on the scope of audit. If the other auditor issues, or intends to issue, a modified
auditors report, the principal auditor should consider whether the subject of the modification is
of such nature and significance, in relation to the financial information of the entity on which the
principal auditor is reporting that it requires a modification of the principal auditors report.
Division of Responsibility
The principal auditor would not be responsible in respect of the work entrusted to the other
auditors, except in circumstances which should have aroused his suspicion about the reliability of
the work performed by the other auditor. When the principal auditor has to base his opinion on
the financial information of the entity as a whole relying upon the statements and reports of the
other auditors, his report should state clearly the division of responsibility for the financial
information of the entity by indicating the extent to which the financial information of
components audited by the other auditors have been included in the financial information of the
entity, e.g., the number of divisions/branches/subsidiaries or other components audited by other
auditors.
Considering the work of the internal Auditor [Nepal Auditing Standards on Auditing 610]
Introduction
Though external auditor has sole responsibility for his report and for the determination of the
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nature, timing and extent of the auditing procedures, however, much of the work of the internal
auditor may also be used to in his examination of the financial information. When external
auditor determines to use the work of internal auditor, he should assess the work of the internal
auditor and put reliance upon that work.
Scope and Objectives of the Internal Audit Function
The scope and objectives of internal audit vary widely and are dependent upon the size and
structure of the entity and the requirements of its management.
Normally, however, internal audit operates in one or more of the following areas:
a) Review of accounting system and related internal controls: The establishment of an
adequate accounting system and the related controls is the responsibility of management
which demands proper attention on a continuous basis. The internal audit function is often
assigned specific responsibility by management for reviewing the accounting system and
related internal controls, monitoring their operation and recommending improvements
thereto.
b) Examination for management of financial and operating information: This may include
review of the means used to identify measure, classify and report such information and
specific inquiry into individual items including detailed testing of transactions, balances and
procedures.
c) Examination of the economy, efficiency and effectiveness of operations including nonfinancial controls of an organization: Generally, the external auditor is interested in the
results of such audit work only when it has an important bearing on the reliability of the
financial records.
d) Physical examination and verification: This would generally include examination and
verification of physical existence and condition of the tangible assets of the entity.
Relationship between Internal and External Auditors
The role of the internal audit function within an entity is determined by management and its
prime objective differs from that of the external auditor who is appointed to report independently
on financial information. However, some of the means of achieving their respective objectives
are often similar and, thus, much of the work of the internal auditor may be useful to the external
auditor in determining the nature, timing and extent of his procedures. The external auditor
should evaluate the internal audit function to the extent he considers that it will be relevant in
determining the nature, timing and extent of his compliance and substantive procedures.
Depending upon such evaluation, the external auditor may be able to adopt less extensive
procedures than would otherwise be required. By its very nature, the internal audit function
cannot be expected to have the same degree of independence as is essential when the external
auditor expresses his opinion on the financial information. The report of the external auditor is
his sole responsibility, and that responsibility is not by any means reduced because of the
reliance he places on the internal auditors work.
General Evaluation of Internal Audit Function
The external auditors general evaluation of the internal audit function will assist him in
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determining the extent to which he can place reliance upon the work of the internal auditor. The
external auditor should document his evaluation and conclusions in this respect. The important
aspects to be considered in this context are:
a) Organizational Status: Whether internal audit is undertaken by an outside agency or by an
internal audit department within the entity itself, the internal auditor reports to the
management. In an ideal situation, he reports to the highest level of management and is free
of any other operating responsibility. Any constraints or restrictions placed upon his work by
management should be carefully evaluated. In particular, the internal auditor should be free
to communicate fully with the external auditor.
b) Scope of Function: The external auditor should ascertain the nature and depth of coverage of
the assignment which the internal auditor discharges for management. He should also
ascertain to what extent the management considers, and where appropriate, acts upon internal
audit recommendations.
c) Technical Competence: The external auditor should ascertain that internal audit work is
performed by persons having adequate technical training and proficiency. This may be
accomplished by reviewing the experience and professional qualifications of the persons
undertaking the internal audit work.
d) Due Professional Care: The external auditor should ascertain whether internal audit work
appears to be properly planned, supervised, reviewed and documented. An example of the
exercise of due professional care by the internal auditor is the existence of adequate audit
manuals, audit program, and working papers.
Coordination
Having decided in principle that he intends to rely upon the work of the internal auditor, it is
desirable that the external auditor ascertains the internal auditors tentative plan for the year
and discusses it with him at as early a stage as possible to determine areas where he considers
that he could rely upon the internal auditors work. Where internal audit work is to be a
factor in determining the nature, timing and extent of the external auditors procedures, it is
desirable to plan in advance the timing of such work, the extent of audit coverage, test levels
and proposed methods of sample selection, documentation of the work performed, and
review and reporting procedures.
Coordination with the internal auditor is usually more effective when meetings are held at
appropriate intervals during the year. It is desirable that the external auditor is advised of, and
has access to, relevant internal audit reports and in addition is kept informed, along with
management, of any significant matter that comes to the internal auditors attention and
which he believes may affect the work of the external auditor. Similarly, the external auditor
should ordinarily inform the internal auditor of any significant matters which may affect his
work.
Evaluating Specific Internal Audit Work
Where, following the general evaluation described in paragraph 10, the external auditor intends
to rely upon specific internal audit work as a basis for modifying the nature, timing and extent of
his procedures, he should review the internal auditors work, taking into account the following
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factors:
a) The scope of work and related audit program are adequate for the external auditors purpose.
b) The work was properly planned and the work of assistants was properly supervised,
reviewed, and documented.
c) Sufficient appropriate evidence was obtained to afford a reasonable basis for the conclusions
reached.
d) Conclusions reached are appropriate in the circumstances and any reports prepared are
consistent with the results of the work performed.
e) Any exceptions or unusual matters disclosed by the internal auditors procedures have been
properly resolved.
Conclusion
The external auditor should document his conclusions in respect of the specific work which he
has reviewed. The external auditor should also test the work of the internal auditor on which he
intends to rely. The nature, timing and extent of the external auditors tests will depend upon his
judgment as to the materiality of the area concerned to the financial statements taken as a whole
and the results of his evaluation of the internal audit function and of the specific internal audit
work. His tests may include examination of items already examined by the internal auditor,
examination of other similar items, and observation of the internal auditors procedures.
Using the work of an expert [Nepal Auditing Standards on Auditing 620]

Introduction
The auditors education and experience enable him to be knowledgeable about business matters
in general, but he is not expected to have the expertise of a person trained for, or qualified to
engage in, the practice of another profession or occupation, such as an actuary or engineer.
An expert (or a specialist), for the purpose of this Statement, is a person, firm or other
association of persons possessing special skill, knowledge and experience in a particular field
other than accounting and auditing. An expert may be:
- engaged by the client,
- engaged by the auditor,
- employed by the client, or
- employed by the auditor.
When the auditor uses the work of an expert employed by him, he is using that work in the
employees capacity as an expert rather than delegating the work to an assistant on the audit.
Accordingly, in such circumstances, he should apply relevant procedures described in this
Statement in satisfying himself as to his employees work and findings.
Determining the Need to Use the Work of an Expert
During the audit, the auditor may seek to obtain, in conjunction with the client or independently,
audit evidence in the form of reports, opinions, valuations and statements of an expert. Examples
are:
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Valuations of certain types of assets, for example, land and buildings, plant and machinery,
works of art, and precious stones.
Determination of quantities or physical condition of assets, for example, minerals stored in
stockpiles, mineral and petroleum reserves, and the remaining useful life of plant and
machinery.
Determination of amounts using specialized techniques or methods, for example, an actuarial
valuation.
The measurement of work completed and to be completed on contracts in progress for the
purpose of revenue recognition.
Legal opinions concerning interpretations of agreements, statutes, regulations, notifications,
circulars, etc.
When determining whether to use the work of an expert or not, the auditor should consider:
- the materiality of the item being examined in relation to the financial information as a whole,
- the nature and complexity of the item including the risk of error therein, and
- the other audit evidence available with respect to the item.
Skills and Competence of the Expert
When the auditor plans to use the experts work as audit evidence, he should satisfy himself as to
the experts skills and competence by considering the experts:
- professional qualifications, license or membership in an appropriate professional body, and
- experience and reputation in the field in which the evidence is sought.
However, when the auditor uses the work of an expert employed by him, he will not need to
inquire into his skills and competence.
Objectivity of the Expert
The auditor should also consider the objectivity of the expert. The risk that an experts
objectivity will be impaired increases when the expert is:
- employed by the client, or
- related in some other manner to the client.
In these circumstances, the auditor should consider performing more extensive procedures than
would otherwise have been planned, or he might consider engaging another expert.
Evaluating the Work of an Expert
When the auditor intends to use the work of an expert, he should examine evidence to gain
knowledge regarding the terms of the experts engagement and such other matters as:
- the objectives and scope of the experts work,
- a general outline as to the specific items in the experts report,
- confidentiality of the experts work, including the possibility of its communication to third
parties,
- the experts relationship with the client, if any;
- confidentiality of the clients information used by the expert.
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The auditor should seek reasonable assurance that the experts work constitutes appropriate audit
evidence in support of the financial information, by considering:
- the source data used,
- the assumptions and methods used and, if appropriate, their consistency with the prior
period, and
- the results of the experts work in the light of the auditors overall knowledge of the
business and of the results of his audit procedures.
The auditor should also satisfy himself that the substance of the experts findings is properly
reflected in the financial information.
The auditor should consider whether the expert has used source data which are appropriate in the
circumstances. The procedures to be applied by the auditor should include:
- making inquiries of the expert to determine how he has satisfied himself that the source data
are sufficient, relevant and reliable, and
- conducting audit procedures on the data provided by the client to the expert to obtain
reasonable assurance that the data are appropriate
Usually, after completion of above procedures auditor gains reasonable assurance that he has
obtained appropriate audit evidence in support of the financial information. In exceptional cases
where the work of an expert does not support the related representations in the financial
information, the auditor should attempt to resolve the inconsistency by discussions with the
client and the expert. Applying additional procedures, including possibly engaging another
expert, may also assist the auditor in resolving the inconsistency.
If, after performing these procedures, the auditor concludes that:
- the work of the expert is inconsistent with the information in the financial statements, or that
- the work of the expert does not constitute sufficient appropriate audit evidence (e.g., where
the work of the expert involves highly technical matters or where, on grounds of
confidentiality, the expert refuses to make available to the auditor the source data used by
him),
he should express a qualified opinion, a disclaimer of opinion or an adverse opinion, as may be
appropriate.
Reference to an Expert in the Auditors Report
When expressing an unqualified opinion, the auditor should not refer to the work of an expert in
his report. If, as a result of the work of an expert, the auditor decides to express other than an
unqualified opinion, it may in some circumstances benefit the reader of his report if the auditor,
in explaining the nature of his reservation, refers to or describes the work of the expert. Where,
in doing so, the auditor considers it appropriate to disclose the identity of the expert, he should
obtain prior consent of the expert for such disclosure if such consent has not already been
obtained.
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5. INTERNAL AUDIT AD CORPORATE GOVERNANCE

Internal Audit and Corporate Governance
As defined on Nepal Standard on Auditing 610, considering the work of Internal Audit, Internal
Auditing means the appraisal activity established within an entity as a service to the entity. Its
functions include, amongst other things, monitoring internal control.
To elaborate, internal auditing is an independent, objective assurance and consulting activity
designed to add value and improve an organization's operations. It helps an organization
accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve
the effectiveness of risk management, control, and governance processes. Internal auditing is a
catalyst for improving an organization's governance, risk management and management controls
by providing insight and recommendations based on analyses and assessments of data and
business processes. With commitment to integrity and accountability, internal auditing provides
value to governing bodies and senior management as an objective source of independent advice.
Internal auditors provide an independent and objective assessment of the effectiveness and
efficiency of a companys operations, specifically its internal control structure. The internal audit
function helps an organization accomplish its objectives by bringing a systematic, disciplined
approach to evaluate and improve the effectiveness of risk management, control, and governance
processes. The scope of internal auditing is broad and may involve the efficiency of operations,
IT controls, the reliability of financial reporting, deterring and detecting fraud, and compliance
with laws and regulations. Internal Auditors may also conduct compliance and operational
audits, offering solutions for weaknesses in internal controls and verifying that all laws and
regulations are upheld.
Internal Audit Services as per IFAC code of ethics
As specified on section 290.195 to 290.200, the scope and objectives of internal audit activities
vary widely and depend on the size and structure of the entity and the requirements of
management and those charged with governance. Internal audit activities may include:
Monitoring of internal control
Examination of financial and operating function
Review of economy, efficiency and effectiveness of operations including non-financial
controls of the entity
Review of compliance with laws, regulation and other external requirements and with
management policies and directives and other internal requirements
There is always a risk that the firms personnel assume a management responsibility when
providing internal audit services to an audit client and the threat created would be so significant
that no safeguards could reduce the threat to an acceptable level. So, a firms personnel shall not
assume a management responsibility when providing internal audit services to an audit client.
Examples of internal audit services that involve assuming management responsibilities include:
- Setting internal audit policies or the strategic direction of internal audit activities;
- Directing and taking responsibility for the actions of the entitys internal audit employees;
- Deciding which recommendations resulting from internal audit activities shall be
implemented;
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Reporting the results of the internal audit activities to those charged with governance on
behalf of management;
Performing procedures that form part of the internal control, such as reviewing and
approving changes to employee data access privileges;
Taking responsibility for designing, implementing and maintaining internal control; and
Performing outsourced internal audit services, comprising all or a substantial portion of the
internal audit function, where the firm is responsible for determining the scope of the internal
audit work and may have responsibility for one or more of the matters noted stated above.
Following are the General Provision governing ethics of the internal auditor:
Condition/Circumstances
A firms personnel providing internal audit services to an audit client.
Threats
Self-review threat
Safeguards/Measures to be taken
The threat would be so significant that no safeguards could reduce it to an acceptable level. The
firm shall provide internal audit services to an audit client only if it can avoid assuming
management responsibility, and it is satisfied that:
- The client designates an appropriate and competent resource, preferably within senior
management, to be responsible at all times for internal audit activities and to acknowledge
responsibility for designing, implementing, and maintaining internal control;
- The clients management or those charged with governance reviews, assesses and approves
the scope, risk and frequency of the internal audit services;
- The clients management evaluates the adequacy of the internal audit services and the
findings resulting from their performance;
- The clients management evaluates and determines which recommendations resulting from
internal audit services to implement and manages the implementation process; and
- The clients management reports to those charged with governance the significant findings
and recommendations resulting from the internal audit services.
A firm accepts an engagement to provide internal audit services to an audit client, and the
results of those services will be used in conducting the external audit.
Threat
Self-review threat.
Safeguards/Measures to be taken
The significance of threat shall be evaluated and safeguards applied when necessary to eliminate
the threat or reduce it to an acceptable level. The safeguards may be: professionals who are not
members of the audit team shall be used to perform the internal audit service.
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In case of Audit clients that are public interest entities: Providing internal audit service.
Threat
Self-review threat
The firm shall not provide internal audit services that relate to:
- A significant part of the internal controls over financial reporting;
- Financial accounting systems that generate information that is, separately or in the aggregate,
significant to the clients accounting records or financial statements on which the firm will
express an opinion; or
- Amounts or disclosures that are, separately or in the aggregate, material to the financial
statements on which the firm will express an opinion.
Scope of Internal Audit function

The scope of internal auditing within an organization is broad and may involve topics such as an
organization's governance, risk management and management controls over:
efficiency/effectiveness of operations (including safeguarding of assets), the reliability of
financial and management reporting, and compliance with laws and regulations. Internal auditing
may also involve conducting proactive fraud audits to identify potentially fraudulent acts;
participating in fraud investigations under the direction of fraud investigation professionals, and
conducting post investigation fraud audits to identify control breakdowns and establish financial
loss. Internal auditors are not responsible for the execution of company activities; they advise
management and the Board of Directors (or similar oversight body) regarding how to better
execute their responsibilities.
Difference between Internal Audit and External Audit Services
Particulars
Appointing
authority
Scope
Approach
Independence
Reporting
responsibility
Conducted by
Coverage
Responsibility
Internal Audit
Management of the entity
External Audit
Owner of the entity
Defined by the appointing authority

To ensure adherence to management,
safeguard of assets, completeness and
accuracy of accounting records
Defined by the law

To collect sufficient and
reliable audit evidence as to
express, true and fair view
on financial statement
Complete independent
To shareholder of the owner
Less independent
To management or to Audit committee
Employee or outsourced consultancy
firm
All categories of risk, their management,
including reporting on them
for Improvement is fundamental to the
Member holding Certificate of

practice
Financial reports, financial
reporting risks.
None, however there is a duty
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improvement
purpose of internal auditing. But it is to report problems

done by advising, coaching and
facilitating in order to not undermine the
responsibility of management.
Internal audit reports

Internal auditors typically issue reports at the end of each audit that summarize their findings,
recommendations, and any responses or action plans from management. An audit report may
have an executive summary; a body that includes the specific issues or findings identified and
related recommendations or action plans; and appendix information such as detailed graphs and
charts or process information. Each audit finding within the body of the report may contain five
elements, sometimes called the "5 C's":
1. Condition: What is the particular problem identified?
2. Criteria: What is the standard that was not met? The standard may be a company policy or
other benchmark.
3. Cause: Why did the problem occur?
4. Consequence: What is the risk/negative outcome (or opportunity foregone) because of the
finding?
5. Corrective action: What should management do about the finding? What have they agreed to
do and by when?
The recommendations in an internal audit report are designed to help the organization achieve
effective and efficient governance, risk and control processes associated with operations
objectives, financial and management reporting objectives; and legal/regulatory compliance
objectives.
Audit findings and recommendations may also relate to particular assertions about transactions,
such as whether the transactions audited were valid or authorized, completely processed,
accurately valued, processed in the correct time period, and properly disclosed in financial or
operational reporting, among other elements.
Under the Institute of Internal Auditor standards, a critical component of the audit process is the
preparation of a balanced report that provides executives and the board with the opportunity to
evaluate and weigh the issues being reported in the proper context and perspective. In providing
perspective, analysis and workable recommendations for business improvements in critical areas,
auditors help the organization meet its objectives.
Quality of Internal Audit Report
Objectivity - The comments and opinions expressed in the Report should be objective and
unbiased.
Clarity - The language used should be simple and straightforward.
Accuracy - The information contained in the report should be accurate.
Brevity - The report should be concise.
Timeliness - The report should be released promptly immediately after the audit is
concluded, within a month.
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Concept of Corporate governance

Corporate governance broadly refers to the mechanisms, processes and relations by which
corporations are controlled and directed. A governance structure identify the distribution of
rights and responsibilities among different participants in the corporation (such as the board of
directors, managers, shareholders, creditors, auditors, regulators, and other stakeholders) and
includes the rules and procedures for making decisions in corporate affairs. Corporate
governance includes the processes through which corporations' objectives are set and pursued in
the context of the social, regulatory and market environment. Governance mechanisms include
monitoring the actions, policies and decisions of corporations and their agents.
Corporate governance became a pressing issue following the 2002 introduction of the SarbanesOxley Act in the U.S., which was ushered in to restore public confidence in companies and
markets after accounting fraud bankrupted high-profile companies such as Enron and
WorldCom. Both companies strive to have a high level of corporate governance. However, these
days, it is not enough for a company to merely be profitable; it also needs to demonstrate good
corporate citizenship through environmental awareness, ethical behavior and sound corporate
governance practices
Principles of Corporate governance
Rights and equitable treatment of shareholders: Organizations should respect the rights of
shareholders and help shareholders to exercise those rights. They can help shareholders
exercise their rights by openly and effectively communicating information and by
encouraging shareholders to participate in general meetings.
Interests of other stakeholders: Organizations should recognize that they have legal,
contractual, social, and market driven obligations to non-shareholder stakeholders, including
employees, investors, creditors, suppliers, local communities, customers, and policy makers.
Role and responsibilities of the board: The board needs sufficient relevant skills and
understanding to review and challenge management performance. It also needs adequate size
and appropriate levels of independence and commitment.
Integrity and ethical behavior: Integrity should be a fundamental requirement in choosing
corporate officers and board members. Organizations should develop a code of conduct for
their directors and executives that promotes ethical and responsible decision making.
Disclosure and transparency: Organizations should clarify and make publicly known the
roles and responsibilities of board and management to provide stakeholders with a level of
accountability. They should also implement procedures to independently verify and
safeguard the integrity of the company's financial reporting. Disclosure of material matters
concerning the organization should be timely and balanced to ensure that all investors have
access to clear, factual information
Role of internal audit in corporate governance
Internal auditing activity as it relates to corporate governance has in the past been generally
informal, accomplished primarily through participation in meetings and discussions with
members of the Board of Directors. Corporate governance is the policies, processes and
structures used by the organizations leadership to direct activities, achieve objectives, and
protect the interests of diverse stakeholder groups in a manner consistent with ethical standards.
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The internal auditor is often considered one of the "four pillars" of corporate governance, the
other pillars being the Board of Directors, management, and the external auditor.
A primary focus area of internal auditing as it relates to corporate governance is helping the
Audit Committee of the Board of Directors (or equivalent) perform its responsibilities
effectively. This may include reporting critical management control issues, suggesting questions
or topics for the Audit Committee's meeting agendas, and coordinating with the external auditor
and management to ensure the Committee receives effective information. In recent years, the
advocacy for assigning internal auditor for formal evaluation of corporate governance,
particularly in the areas of board oversight of enterprise risk, corporate ethics, and fraud.
For managing inherent operational risk of bank and financial institution, NRB has made
mandatory provision for internal auditor to comment on the policies and operational procedure
adopted by bank and financial institution. [Unified NRB directive 5]
Function and extent of internal audit in entities
A typical internal audit assignment involves the following steps:
- Establish and communicate the scope and objectives for the audit to appropriate
management.
- Develop an understanding of the business area under review. This includes objectives,
measurements, and key transaction types. This involves review of documents and interviews.
Flowcharts and narratives may be created if necessary.
- Describe the key risks facing the business activities within the scope of the audit.
- Identify management practices in the five components of control used to ensure each key risk
is properly controlled and monitored. Internal Audit Checklist can be a helpful tool to
identify common risks and desired controls in the specific process or industry being audited.\
- Develop and execute a risk-based sampling and testing approach to determine whether the
most important management controls are operating as intended.
- Report issues and challenges identified and negotiate action plans with management to
address the problems.
- Follow-up on reported findings at appropriate intervals. Internal audit departments maintain a
follow-up database for this purpose.
According to the institute of Internal auditors, internal audit establish and functions as follows:
1. Formulating internal Audit charter and get approved by audit committee
2. Understand industry specific benchmarking needs
3. Hiring appropriate staff (internal or outsource)
4. Review Policies and Procedures of the entity
5. Discuss and assess control issues
6. Develop the "Audit Universe" (list of all auditable unit)
7. Develop Risk Assessment of each unit
8. Develop internal audit checklist
9. Assign audit team member for the each audit unit with appropriate working days considering
risk assessed as above.
10. Prepare the audit report on the observations/recommendation
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11. Obtain the management response

12. Issue audit report
13. Present the audit report to Audit committee
14. Follow up on audit findings
General Evaluation of Internal Audit Function
The external auditors general evaluation of the internal audit function will assist him in
determining the extent to which he can place reliance upon the work of the internal auditor. The
external auditor should document his evaluation and conclusions in this respect. The important
aspects to be considered in this context are:
-
Organizational Status: Whether internal audit is undertaken by an outside agency or by an

internal audit department within the entity itself, the internal auditor reports to the
management. In an ideal situation he reports to the highest level of management and is free
of any other operating responsibility. Any constraints or restrictions placed upon his work by
management should be carefully evaluated. In particular, the internal auditor should be free
to communicate fully with the external auditor.
Scope of Function: The external auditor should ascertain the nature and depth of coverage of
the assignment which the internal auditor discharges for management. He should also
ascertain to what extent the management considers, and where appropriate, acts upon internal
audit recommendations.
Technical Competence: The external auditor should ascertain that internal audit work is
performed by persons having adequate technical training and proficiency. This may be
accomplished by reviewing the experience and professional qualifications of the persons
undertaking the internal audit work.
Due Professional Care: The external auditor should ascertain whether internal audit work
appears to be properly planned, supervised, reviewed and documented. An example of the
exercise of due professional care by the internal auditor is the existence of adequate audit
manuals, audit program, and working papers.
Outsourcing in Internal Audit

While there is a clear need for internal audit, enmity need to can create own internal audit
function or use the services of an external consultancy. The use of the external consultancy firm
for managing internal services is called outsourcing of internal audit.
For typical small and medium-sized enterprise there are clear benefits to outsourcing.
Can focus attention on core business activities the activities that make you money.
Easier way to buy in the services of an expert than it is to recruit and employ an expert.
Specialist consultancy firms can provide range of skills that may be costly on hiring staff.
Employing a specialist create a reliance on that person. However when that person leaves,
entiyyt suffer disruption to business while replacing the expertise. This is not an issue when
outsourcing function is in place.
Employing someone with the experience and qualifications to perform an internal audit role
is expensive. Recruiting cheaply will get poorly qualified person; this may cost you in the
future. There is a clear cost-benefit argument for outsourcing.
Outsource ensure independence and objectivity.
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Monitoring of outsourced firm can be easily done with relationship through confidentiality
and service-level agreements
For regulating outsourced internal audit of the Nepalese bank and financial institution, Nepal
Rastra Bank (NRB) has certain stipulated provision through NRB directive no 6, which states as
follows:
- Bank and financial institution should assign one employee as liaison officer to communicate
with outsourced internal auditor
- At least quarterly, internal audit report should be placed on meeting of Audit committee
- The audit report should include the details of manpower involved and working man days
involved on carrying out audit
Audit committee and relevant legal provision for requirement of audit committee
AUDIT COMMITTEE
Requirement of Audit Committee:
Section 164 (1) provides that a Listed Company with paid up capital of thirty million rupees [3
crore] or more or a company which is fully or partly owned by the Government of Nepal shall
form an audit committee under the Chairpersonship of a director who is not involved in the dayto day operations of the company and consisting of a least three members.
Formation
At least one member of the audit committee shall be an experienced person having obtained
professional certificate on accounting or a person having gained experience in accounting and
financial field after having obtained at least bachelors degree in accounts, commerce,
management, finance or economics [Section 164 (3)].
A person who is a close relative of the chief executive of a company shall not be eligible to be a
member of the audit committee formed pursuant to Sub-section (1) [Section 164 (2)].
The report of board of directors required to be prepared by a company shall set out a short
description of the activities of the audit committee, working policies adopted by the board of
directors to implement the suggestions, if any, given by the audit committee, the allowances or
facilities, if any, received by the members or the audit committee and the names of the members
of audit committeeSection [164 (4)].
Power of Committee to call for meeting
The audit committee may, for inquiring into any matter, notify the managing director of the
company, chief executive or the company or other director, auditor, internal auditor and accounts
chief involved in the day-to-day operations of the company to attend its meeting; and it shall be
their duty to be present in the meeting of that committee if they are so notified [Section 164(5)].
Board to implement the suggestions given by the committee
Sub section (6) provides that the board of directors shall implement the suggestions given by the
audit committee in respect of the accounts and financial management the company; and where
any suggestion cannot be implemented, the board of directors shall also mention the reasons for
the same in its report.
Procedure of the committee
Sub section (7) provides that a company shall arrange for such means and resources as may be
adequate for the fulfillment of responsibilities of the audit committee; and the audit committee
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may fix its internal rules of procedures on its own.

Quorum and Frequency of Meeting
The chairperson of the audit committee shall be present in the annual general meeting of
the company [164(8)].
The audit committee shall meet as per necessity [164(9)].
The functions, duties and powers of the audit committee

Functions, duties and powers of audit committeeas given in Section 165 shall be as follows:
(a) To review the accounts and financial statements of the company and ascertain the truth of the
facts mentioned in such statements;
(b) To review the internal financial control system and the risk management system of the
company;
(c) To supervise and review the internal auditing activity or the company;
(d) To recommend the names of potential auditors for the appointment of the auditor of the
company, fix the remuneration and terms and conditions of appointment of the auditor and
present the same in the general meeting for the ratification thereof;
(e) To review and supervise as to whether the auditor of the company has observed such conduct,
standards and directives determined by the competent body pursuant to the prevailing law as
required to be observed in the course of doing auditing work;
(f) Based on the conduct, standard and directives determined by the competent body pursuant to
the prevailing law, to formulate the polices required to be observed by the company in respect of
the appointment and selection of the auditor;
(g) To prepare the accounts related policy of the company and enforce, or cause to be enforced,
the same;
(h) Where any regulator body has provided for the long term audit report to be set out in the
audit report o f the company, to comply with the terms required to prepare such report;
(i) To perform such other terms as prescribed by the board of directors in respect of the accounts,
financial management and audit of the company.
6. Audit conclusion and reporting
c. Concept of hot review and cold review
Hot review and cold review
As per Nepal Standard on Quality Control, it is the objective of the firm to establish and maintain
a system of quality control to provide it with reasonable assurance that:
- The firm and its personnel comply with professional standards and applicable legal and
regulatory requirements; and
- Reports issued by the firm or engagement partners are appropriate in the circumstances.
Beside NSQC there can be local quality control standards as well by the bodies regulating the
auditors work in specific jurisdiction with almost similar objectives to be achieved.
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Although there are many elements and aspects of audit firm and auditors work get included but
the foremost is the auditors report. To ensure whether objectives of the audit have been achieved
or not there is a techniques called hot file review (also known as hot review) and cold file review
(also known as cold review).
Hot file review
Hot file review or hot review is conducted usually conducted during the audit and/or audit work
is completed but before the auditors report is issued. This in nature is a detailed review that is
conducted with an aim to find out if there s any weakness in application of audit procedures or if
the results have been misinterpreted. Hot reviews are usually carried out usually by the senior the
audit team or someone with the same authority who is not connected with the engagement. Such
reviews mostly include meetings with audit team personnel and their individual work so that
both work and the skills of members are improved by pointing out discrepancies and providing
recommendations.
The purpose of a hot review is to identify any key areas that need to be addressed prior to signing
the report. The categories for review which may be undertaken can be described as follows:
Comfort reviews
Number of firms, for their largest clients (not necessarily high risk clients), feel a little
exposed and want someone else to review the work before the job is complete.
High risk reviews
One off reviews may be required on files in circumstances where, for example, the company
is being sold and the firm feels that having a review undertaken by an independent party will
help to decrease their risk.
Training reviews
Where key audit staff have left, a manager-style review on files may be undertaken in order
to train a new manager or partner.
Independence reviews
Some sole practitioners require an outside review to ensure that it is reasonable for them to
maintain an audit assignment when independence might be called into question. This is
particularly the case where individuals have been an audit partner for more than seven years.
NSQC reviews
The ISQC1: Quality control for firms that perform audits and reviews of historical financial
information, and other assurance and related services engagements, requires an independent
hot review for all listed work and certain other high profile or high risk work.
To summarize, hot review is conducted during the audit work is conducted but before the
auditors report is issued with a prime objective to ensure compliance with relevant auditing
standards and achieving engagements objectives
Cold file review:
Cold file review or cold review is an objective evaluation on the date of auditors report and is
performed by the auditor i.e. partner himself when all the audit work has been concluded and the
required sufficient appropriate audit evidence has been obtained and conclusions drawn and
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reported. This review usually takes place when the auditors report is signed off. The purpose of
this review is to ensure compliance with relevant auditing standards and to analyze weaknesses
in the way whole audit work is conducted and how it can be improved for next similar
assignments by updating firms quality control standards, training the staff etc.
Normally the cold file review would aim to:
Identify whether the disclosure requirements had been properly met - incorrect disclosures
are the largest subject of complaints to the Institute.
Identify whether the Auditing Standards and Regulations have been properly complied with each audit would be "scored" using a comprehensive file review checklist.
Assess the effectiveness of any independent manager review and the partner review, looking
for any points that should have been picked up by a manager but had not been, and likewise
with the partner.
To summarize, cold review is conducted with a view to check for the weaknesses in the firms
quality control procedures and system, proficiency of audit team members and how they can be
improved to make later audit assignment more effective and efficient.
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i. Concluding and reporting on engagements

Consideration subsequent events
During the course of audit, many events may be identified and known even after completion of
audit. Such events those that are identified after the audit (whether existed at balance sheet date
or not) are called subsequent events.
NSA 560 establishes the standards and provide guidance on the auditors responsibility regarding
subsequent events.
Auditor and subsequent events
The auditor should consider the effect of subsequent events on the financial statements and on
the auditors report. IAS 10 on Contingencies and Events Occurring after the Balance Sheet Date
deals with the treatment in financial statements of events, favorable and unfavorable, occurring
after period end and identifies two types of events:
(a) Those that provide further evidence of conditions that existed at period end; and
(b) Those that is indicative of conditions that arose subsequent to period end.
Events Occurring up to the Date of the Auditors Report
The auditor should perform procedures designed to obtain sufficient appropriate audit evidence
that all events up to the date of the auditors report that may require adjustment of, or disclosure
in, the financial statements have been identified.
The procedures to identify events that may require adjustment of, or disclosure in, the financial
statements would be performed as near as practicable to the date of the auditors report and
ordinarily include the following:
reviewing procedures management has established to ensure that subsequent events are
identified,
reading minutes of the meetings of shareholders, the board of directors and audit and
executive committees held after period end and inquiring about matters discussed at meetings
for which minutes are not yet available,
reading the entitys latest available interim financial statements and, as considered necessary
and appropriate, budgets, cash flow forecasts and other related management reports,
inquiring, or extending previous oral or written inquiries, of the entitys lawyers concerning
litigation and claims
inquiring of management as to whether any subsequent events have occurred which might
affect the financial statements.
When the auditor becomes aware of events which materially affect the financial statements, the
auditor should consider whether such events are properly accounted for and adequately disclosed
in the financial statements.
Facts discovered after the Date of the Auditors Report but Before the Financial Statements are
issued
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The auditor does not have any responsibility to perform procedures or make any inquiry
regarding the financial statements after the date of the auditors report. During the period from
the date of the auditors report to the date the financial statements are issued, the responsibility to
inform the auditor of facts which may affect the financial statements rests with management.
When, after the date of the auditors report but before the financial statements are issued, the
auditor becomes aware of a fact which may materially affect the financial statements, the auditor
should consider whether the financial statements need amendment, should discuss the matter
with management, and should take the action appropriate in the circumstances.
When management amends the financial statements, the auditor would carry out the procedures
necessary in the circumstances and would provide management with a new report on the
amended financial statements. The new auditors report would be dated not earlier than the date
the amended financial statements are signed or approved.
When management does not amend the financial statements in circumstances where the auditor
believes they need to be amended and the auditors report has not been released to the entity, the
auditor should express a qualified opinion or an adverse opinion.
When the auditors report has been released to the entity, the auditor would notify those persons
ultimately responsible for the overall direction of the entity not to issue financial statements and
the auditors report thereon to third parties. If the financial statements are subsequently released,
the auditor needs to take action to prevent reliance on the auditors report. The action taken will
depend on the auditors legal rights and obligations and the recommendations of the auditors
lawyer.
Facts Discovered After the Financial Statements Have Been Issued
After the financial statements have been issued, the auditor has no obligation to make any
inquiry regarding such financial statements.
When, after the financial statements have been issued, the auditor becomes aware of a fact which
existed at the date of the auditors report and which, if known at that date, may have caused the
auditor to modify the auditors report, the auditor should consider whether the financial
statements need revision, should discuss the matter with management, and should take the action
appropriate in the circumstances.
When management revises the financial statements, the auditor would carry out the audit
procedures necessary in the circumstances, would review the steps taken by management to
ensure that anyone in receipt of the previously issued financial statements together with the
auditors report thereon is informed of the situation, and would issue a new report on the revised
The new auditors report should include an emphasis of a matter paragraph referring to a note to
the financial statements that more extensively discusses the reason for the revision of the
previously issued financial statements and to the earlier report issued by the auditor.
The new auditors report would be dated not earlier than the date the revised financial statements
are approved.
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Offering of Securities to the Public

In cases involving the offering of securities to the public, the auditor should consider any legal
and related requirements applicable to the auditor in all jurisdictions in which the securities are
being offered.
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Comparatives
NSA 710 provides guidance and establish standard on Corresponding figures and Comparative
financial statements which is defined as follows:
Corresponding figures where amounts and other disclosures for the preceding period are
included as part of the current period financial statements, and are intended to be read in relation
to the amounts and other disclosures relating to the current period (referred to as current period
figures for the purpose of this NSA). These corresponding figures are not presented as complete
financial statements capable of standing alone, but are an integral part of the current period
financial statements intended to be read only in relationship to the current period figures. For
corresponding figures, the auditors report only refers to the financial statements of the current
period;
The Auditors Responsibilities on Corresponding figures
The auditor should obtain sufficient appropriate audit evidence that the corresponding figures
meet the requirements of the relevant financial reporting framework. The extent of audit
procedures performed on the corresponding figures is significantly less than for the audit of the
current period figures and is ordinarily limited to ensuring that the corresponding figures have
been correctly reported and are appropriately classified. This involves the auditor assessing
whether:
Accounting policies used for the corresponding figures are consistent with those of the
current period or whether appropriate adjustments and/or disclosures have been made; and
Corresponding figures agree with the amounts and other disclosures presented in the prior
period or whether appropriate adjustments and/or disclosures have been made.
Comparative financial statements where amounts and other disclosures for the preceding period
are included for comparison with the financial statements of the current period, but do not form
part of the current period financial statements. For comparative financial statements, the
auditors report refers to each period that financial statements are presented.
The Auditors Responsibilities on Comparative financial statements
The auditor should obtain sufficient appropriate audit evidence that the comparative financial
statements meet the requirements of the relevant financial reporting framework. This involves
the auditor assessing whether:
Accounting policies of the prior period are consistent with those of the current period or
whether appropriate adjustments and/or disclosures have been made; and
Prior period figures presented agree with the amounts and other disclosures presented in the
prior period or whether appropriate adjustments and disclosures have been made.
Prior Period Financial Statements Not Audited
When the prior period financial statements are not audited, the incoming auditor should state in
the auditors report that the comparative financial statements are unaudited. Such a statement
does not, however, relieve the auditor of the requirement to carry out appropriate procedures
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regarding opening balances of the current period. Clear disclosure in the financial statements that
the comparative financial statements are unaudited is encouraged. In situations where the
incoming auditor identifies that the prior year unaudited figures are materially misstated, the
auditor should request management to revise the prior years figures or if management refuses to
do so, appropriately modify the report.
Other Information in Documents Containing Audited Financial Statements

An entity ordinarily issues on annual basis a document which includes its audited financial
statements together with the auditors reports thereon. Such document is called annual report.
In issuing such document entity may also include, either by law or by custom, other financial and
non-financial information.
Auditor responsibility
An audit conducted in accordance with NSAs or relevant practices is designed to provide
reasonable assurance that the financial statements taken as a whole are free from material
misstatement, whether caused by fraud or error. The fact that an audit is carried out may act as a
deterrent so the auditor is not and cannot be held responsible for the prevention of fraud and
error. Thus auditor has no specific responsibility to determine that other information is properly
stated.
Material inconsistencies
On reading the other information, the auditor identifies a material inconsistencies, the auditor
should determine whether the audited financial statement or other information needs to be
amended.
If an amendment is necessary in the audited financial statement and the entity refuses to make
the amendment, the auditor should express a qualified or adverse opinion.
If an amendment is necessary in the other information and the entity refuses to make the
amendment, the auditor should consider including in the auditors report an emphasis of mater
paragraph describing the material inconsistency or taking other actions.
Material misstatement of the fact
If the auditor becomes aware that the information appears to include a material misstatement of
fact, auditor should discuss the matter with entitys management. When the auditor still
considers that there is an apparent misstatement of fact, the auditor should request management
to consult with a qualified third party, such as the entity legal counsel and should consider the
advice received.
If the auditor concludes that there is a material misstatement of the fact in other information
which management refuses to correct, the auditor should consider taking further appropriate
actions
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ii. Related services

The concept of audit and other assurance engagements
ASSURANCE ENGAGEMENT
Assurance engagement means an engagement in which a practitioner expresses a conclusion
designed to enhance the degree of confidence of the intended users other than the responsible
party about the outcome of the evaluation or measurement of a subject matter against criteria.
Types of assurance engagement
Reasonable assurance engagement
Limited assurance engagement
There are two types of assurance engagement a practitioner is permitted to perform: a reasonable
assurance engagement and a limited assurance engagement. The objective of a reasonable
assurance engagement is a reduction in assurance engagement risk to an acceptably low level in
the circumstances of the engagement 5 as the basis for a positive form of expression of the
practitioners conclusion. The objective of a limited assurance engagement is a reduction in
assurance engagement risk to a level that is acceptable in the circumstances of the engagement,
but where that risk is greater than for a reasonable assurance engagement, as the basis for a
negative form of expression of the practitioners conclusion.
Elements of an Assurance Engagement
The following elements of an assurance engagement are discussed in this section:
A three party relationship involving a practitioner, a responsible party, and intended users;
An appropriate subject matter;
Suitable criteria;
Sufficient appropriate evidence; and
A written assurance report in the form appropriate to a reasonable assurance engagement or a
limited assurance engagement.
Three Party Relationships
Assurance engagements involve three separate parties: a practitioner, a responsible party and
intended users.
Subject Matter
The subject matter, and subject matter information, of an assurance engagement can take many
forms, such as:
Financial performance or conditions (for example, historical or prospective financial

position, financial performance and cash flows) for which the subject matter information may
be the recognition, measurement, presentation and disclosure represented in financial
statements.
Non-financial performance or conditions (for example, performance of an entity) for which
the subject matter information may be key indicators of efficiency and effectiveness.
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Physical characteristics (for example, capacity of a facility) for which the subject matter
information may be a specifications document.
Systems and processes (for example, an entitys internal control or IT system) for which the
subject matter information may be an assertion about effectiveness.
Behavior (for example, corporate governance, compliance with regulation, human resource
practices) for which the subject matter information may be a statement of compliance or a
statement of effectiveness.
Criteria
Criteria are the benchmarks used to evaluate or measure the subject matter including, where
relevant, benchmarks for presentation and disclosure. Criteria can be formal, for example in the
preparation of financial statements, the criteria may be Nepal Accounting Standards; when
reporting on internal control, the criteria may be an established internal control framework or
individual control objectives specifically designed for the engagement; and when reporting on
compliance, the criteria may be the applicable law, regulation or contract.
Evidence
The practitioner plans and performs an assurance engagement with an attitude of professional
skepticism to obtain sufficient appropriate evidence about whether the subject matter information
is free of material misstatement. The practitioner considers materiality, assurance engagement
risk, and the quantity and quality of available evidence when planning and performing the
engagement, in particular when determining the nature, timing and extent of evidence-gathering
procedures.
Assurance Report
The practitioner provides a written report containing a conclusion that conveys the assurance
obtained about the subject matter information
ENGAGEMENTS TO PERFORM AGREED-UPON PROCEDURES REGARDING

FINANCIAL INFORMATION
Introduction
The purpose of this Nepal Standards on Auditing (NSA) is to establish standards and provide
guidance on the auditors professional responsibilities when an engagement to perform agreedupon procedures regarding financial information is undertaken and on the form and content of
the report that the auditor issues in connection with such an engagement.
Objective of an Agreed-upon Procedures Engagement
The objective of an agreed-upon procedures engagement is for the auditor to carry out
procedures of an audit nature to which the auditor and the entity and any appropriate third parties
have agreed and to report on factual findings.
As the auditor simply provides a report of the factual findings of agreed-upon procedures, no
assurance is expressed. Instead, users of the report assess for themselves the procedures and
findings reported by the auditor and draw their own conclusions from the auditors work.
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General Principles of an Agreed-upon Procedures Engagement

The auditor should comply with the Code of Ethics for Professional Accountants issued by the
Institute of Chartered Accountants of Nepal (ICAN). SERVICES Ethical principles governing
the auditors professional responsibilities for this type of engagement are:
a) Integrity
b) Objectivity;
c) professional competence and due care;
d) confidentiality;
e) professional behavior; and
f) Technical standards.
The auditor should conduct an agreed-upon procedures engagement in accordance with this NSA
and the terms of the engagement.
Defining the Terms of the Engagement
The auditor should ensure with representatives of the entity and, ordinarily, other specified
parties who will receive copies of the report of factual findings, that there is a clear
understanding regarding the agreed procedures and the conditions of the engagement. Matters to
be agreed include the following:
nature of the engagement including the fact that the procedures performed will not constitute
an audit or a review and that accordingly no assurance will be expressed,
stated purpose for the engagement,
identification of the financial information to which the agreed-upon procedures will be
applied,
nature, timing and extent of the specific procedures to be applied,
anticipated form of the report of factual findings, and
Limitations on distribution of the report of factual findings. When such limitation would be
in conflict with the legal requirements, if any, the auditor would not accept the engagement.
Planning
The auditor should plan the work so that an effective engagement will be performed.
Documentation
The auditor should document matters which are important in providing evidence to support the
report of factual findings, and evidence that the engagement was carried out in accordance with
this NSA and the terms of the engagement.
Procedures and Evidence
The auditor should carry out the procedures agreed upon and use the evidence obtained as the
basis for the report of factual findings.
The procedures applied in an engagement to perform agreed-upon procedures may include the
following:
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inquiry and analysis,

Re-computation,
comparison and other clerical accuracy checks,
observation,
inspection,
Obtaining confirmations.
Reporting
The report of factual findings should contain:
a) title;
b) addressee (ordinarily the client who engaged the auditor to perform the agreed-upon
procedures);
c) identification of specific financial or non-financial information to which the agreed-upon
procedures have been applied;
d) a statement that the procedures performed were those agreed upon with the recipient;
e) a statement that the engagement was performed in accordance with this NSA applicable to
agreed-upon procedures engagements, or with relevant national standards or practices;
f) when relevant a statement that the auditor is not independent of the entity;
g) identification of the purpose for which the agreed-upon procedures were performed;
h) a listing of the specific procedures performed;
i) a description of the auditors factual findings including sufficient details of errors and
exceptions found; statement that the procedures performed do not constitute either an audit or
a review and, as such, no assurance is expressed;
j) a statement that had the auditor performed additional procedures, an audit or a review, other
matters might have come to light that would have been reported;
k) a statement that the report is restricted to those parties that have agreed to the procedures to
be performed;
l) a statement (when applicable) that the report relates only to the elements, accounts, items or
financial and non-financial information specified and that it does not extend to the entitys
financial statements taken as a whole;
m) date of the report;
n) auditors address;
o) Auditors signature.
ENGAGEMENTS TO COMPILE FINANCIAL STATEMENTS
Introduction
The purpose of this Nepal Standard on Auditing (NSA) is to establish standards and provide
guidance on the accountants professional responsibilities when an engagement to compile
financial information is undertaken and the form and content of the report the accountant issues
in connection with such a compilation.
Objective of a Compilation Engagement
The objective of a compilation engagement is for the accountant to use accounting expertise, as
opposed to auditing expertise, to collect, classify and summarise financial information. This
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ordinarily entails reducing detailed data to a manageable and understandable form without a
requirement to test the assertions underlying that information. The procedures employed are not
designed and do not enable the accountant to express any assurance on the financial information.
However, users of the compiled financial information derive some benefit as a result of the
accountants involvement because the service has been performed with professional competence
and due care.
General Principles of an Agreed-upon Procedures Engagement
The auditor should comply with the Code of Ethics for Professional Accountants issued by the
Institute of Chartered Accountants of Nepal (ICAN). SERVICES Ethical principles governing
the auditors professional responsibilities for this type of engagement are:
a) Integrity
b) Objectivity;
c) professional competence and due care;
d) confidentiality;
e) professional behavior; and
f) Technical standards.
Defining the Terms of the Engagement
The accountant should ensure that there is a clear understanding between the client and the
accountant regarding the terms of the engagement. Matters to be considered include the
following:
Nature of the engagement including the fact that neither an audit nor a review will be carried
out and that accordingly no assurance will be expressed.
Fact that the engagement cannot be relied upon to disclose errors, illegal acts or other
irregularities, for example, fraud or defalcations that may exist.
Nature of the information to be supplied by the client.
Fact that management is responsible for the accuracy and completeness of the information
supplied to the accountant for the completeness and accuracy of the compiled financial
information.
Basis of accounting on which the financial information is to be compiled and the fact that it,
and any known departures there from, will be disclosed.
Intended use and distribution of the information, once compiled.
Form of report to be rendered regarding the financial information compiled, when the
accountants name is to be associated therewith.
Planning
The accountant should plan the work so that an effective engagement will be performed.
Documentation
The accountant should document matters which are important in providing evidence that the
engagement was carried out in accordance with this NSA and the terms of the engagement.
Procedures
The accountant should obtain a general knowledge of the business and operations of the entity
and should be familiar with the accounting principles and practices of the industry in which the
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entity operates and with the form and content of the financial information that is appropriate in
the circumstances.
If the accountant becomes aware that information supplied by management is incorrect,
incomplete, or otherwise unsatisfactory, the accountant should consider performing the above
procedures and request management to provide additional information. If management refuses to
provide additional information, the accountant should withdraw from the engagement, informing
the entity of the reasons for the withdrawal.
The accountant should read the compiled information and consider whether it appears to be
appropriate in form and free from obvious material misstatements. In this sense, misstatements
include the following:
Mistakes in the application of the identified financial reporting framework.
Non-disclosure of the financial reporting framework and any known departures there from.
Non-disclosure of any other significant matters of which the accountant has become aware.
Responsibility of Management
The accountant should obtain an acknowledgement from management of its responsibility for the
appropriate presentation of the financial information and of its approval of the financial
information. Such acknowledgement may be provided by representations from management
which cover the accuracy and completeness of the underlying accounting data and the complete
disclosure of all material and relevant information to the accountant.
Reporting on a Compilation Engagement
Reports on compilation engagements should contain the following:
Title
Addressee
A statement that the engagement was performed in accordance with the Nepal Standard on
Auditing or relevant practices applicable to compilation engagements
When relevant, a statement that the accountant is not independent of the entity
Identification of the financial information noting that it is based on information provided by
management
A statement that management is responsible for the financial information compiled by the
accountant
A statement that neither an audit nor a review has been carried out and that accordingly no
assurance is expressed on the financial information;
A paragraph, when considered necessary, drawing attention to the disclosure of material
departures from the identified financial reporting framework
Date of the report;
Accountants address;
Accountants signature.
The financial information compiled by the accountant should contain a reference such as
Unaudited, Compiled without Audit or Review or Refer to Compilation Report on each
page of the financial information or on the front of the complete set of financial statements.
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7. Government Audit
International Standard of Supreme Audit Institution (Issai)
Introduction
The International Standards of Supreme Audit Institutions (ISSAIs) developed by the
International Organization of Supreme Audit Institutions (INTOSAI) aim to promote
independent and effective auditing by supreme audit institutions (SAIs). The ISSAIs encompass
public-sector auditing requirements at the organizational (SAI) level, while on the level of
individual audits they aim to support the members of INTOSAI in the development of their own
professional approach in accordance with their mandates and with national laws and regulations.
INTOSAIs Framework of Professional Standards has four levels:
Level 1 contains the frameworks founding principles.
Level 2 sets out prerequisites for the proper functioning and professional conduct of SAIs in
terms of organizational considerations that include independence, transparency and
accountability, ethics and quality control, which are relevant for all SAI audits.
Levels 3 elaborate on Level 1 and Level 2 and provide an authoritative international frame of
reference defining public-sector auditing
Level 4 translates the Fundamental Auditing Principles into more specific and detailed
guidelines.
Purpose and Authority of ISSAI
ISSAI 100 establishes fundamental principles which are applicable to all public-sector audit
engagements, irrespective of their form or context. ISSAIs 200, 300 and 400 build on and further
develop the principles to be applied in the context of financial, performance and compliance
auditing respectively. They should be applied in conjunction with the principles set out in ISSAI
100. The principles in no way override national laws, regulations or mandates or prevent SAIs
from carrying out investigations, reviews or other engagements which are not specifically
covered by the existing ISSAIs.
The fundamental Principles form the core of the General Auditing Guidelines at Level 4 of
ISSAI framework. The principle can be used to establish authoritative standard in three ways:
As a basis on which SAIs can develop standard
As a basis for the adoption of consistent national standard
As a basis for adoption of General Auditing Guidelines as standard
SAIs should declare which standard they apply when conducting audits and such should be
accessible to the user either as a part of audit reports or any other general form of
communication.
An SAI may declare that the standards it has developed or adopted are based on or are consistent
with the Fundamental Auditing Principles only if the standards fully comply with all relevant
principles. Such reference may be made by stating in audit report:
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We conducted our audit in accordance with [standards], which are based on [or consistent
with] the Fundamental Auditing Principles (ISSAIs 100-999) of the International Standards of
Supreme Audit Institutions.
SAIs may choose to adopt the General Auditing Guidelines as their authoritative standards. In
such cases the auditor must comply with all ISSAIs relevant to the audit. Reference to the
ISSAIs applied may be made by stating:
We conducted our audit[s] in accordance with the International Standards of Supreme Audit
Institutions.
In order to enhance transparency, the statement may further specify which ISSAI or range of
ISSAIs the auditor has considered relevant and applied. This may be done by adding the
following phrase:
The audit[s] was [were] based on ISSAI[s] xxx [number and name of the ISSAI or range of
ISSAIs].
An SAI will exercise its public-sector audit function within a specific constitutional arrangement
and by virtue of its office and mandate, which ensure sufficient independence and power of
discretion in performing its duties. The mandate of an SAI may define its general responsibilities
in the field of public-sector auditing and provide further prescriptions concerning the audits and
other engagements to be performed.
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PUBLIC-SECTOR AUDITING AND ITS OBJECTIVES

The public-sector audit environment is that in which governments and other public-sector entities
exercise responsibility for the use of resources derived from taxation and other sources in the
delivery of services to citizens and other recipients. These entities are accountable for their
management and performance, and for the use of resources, both to those that provide the
resources and to those, including citizens, who depend on the services delivered using those
resources. Public-sector auditing helps to create suitable conditions and reinforce the expectation
that public-sector entities and public servants will perform their functions effectively, efficiently,
ethically and in accordance with the applicable laws and regulations.
Public sector auditing can be described as a systematic process of objectively obtaining and
evaluating evidence to determine whether information or actual conditions conform to the
established criteria. It is essential in that it provides legislative and oversight bodies, those
charged with governance and the general public with information and independent and objective
assessments concerning the stewardship and performance of government policies, programmes
or operations.
All public-sector audits start from objectives, which may differ depending on the type of audit
being conducted. However, all public-sector auditing contributes to good governance by:
Providing an independent, objective and reliable information, conclusion or opinions based

on sufficient and appropriate evidence relating to public entities;
Enhancing the accountability and transparency, encouraging continuous improvement and
sustained confidence in the appropriate use of public funds and assets and the performance of
public administration;
reinforcing the effectiveness of those bodies within the constitutional arrangement that
exercise general monitoring and corrective functions over government, and those responsible
for the management of publicly-funded activities;
Creating incentives for change by providing knowledge, comprehensive analysis and wellfounded recommendations for improvement.
PROVISION OF AUDIT ACT 2048

Section 6, Audit of corporate body fully owned by Government of Nepal:
a) The audit of the corporate bodies wholly owned by Government of Nepal shall be audited by
the Auditor General.
b) If the Auditor General is constrained by time and resources to audit the corporate bodies
wholly owned by Government of Nepal pursuant to Sub-section (1) he/she may appoint
license holder auditors under the prevailing laws an assistant. While appointing auditor as
such, he/she shall give priority to the Nepali citizen.
c) The auditor appointed pursuant to Sub-section (2) shall act under the direction, supervision
and control of the Auditor General.
d) The powers, functions, duties and responsibilities of the auditors appointed pursuant to Subsection (2) and the procedures to be followed by them in course audit and provisions relating
to their report shall be as prescribed by the Auditor General.
e) The remuneration to be paid by the concerned organization to the auditors appointed
pursuant to Sub-section (2) shall be fixed by the Auditor General keeping in view the volume
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of financial transactions, status of accounts, number of branches and sub-branches, work load
and work progress of the concerned organization.
Section 7, Audit of corporate body substantially owned by Government of Nepal:
a) The audit of corporate body partially owned by Government of Nepal shall be done
accordance with the prevailing laws relating to such bodies.
b) The Auditor General shall be consulted while appointing an auditor for such corporate
bodies.
c) The procedures to be followed while consulting the Auditor General for appointing auditors
pursuant to Sub-section (2) and on matters to principles of audit to be followed by the
auditors during their audit shall be as prescribed by the Auditor General.
d) The concerned organization shall deliver at the Office of the Auditor General a copy of the
report submitted by the auditor appointed in consultation with the Auditor General pursuant
to Sub-section (2).
e) The Auditor General may issue directives to the concerned organization in respect of the
irregularities observed in the report received pursuant to Sub-section (4) and it shall be the
duty of concerned organization to abide by such directives.
Types of Public-Sector Audit
In general, public-sector audits can be categorized into one or more of three main types:
Audits of financial statements;
Audits of compliance with authorities and
Performance audits.
FINANCIAL AUDIT
Financial audit focuses on determining whether an entitys financial information is presented in
accordance with the applicable financial reporting and regulatory framework. This is
accomplished by obtaining sufficient and appropriate audit evidence to enable the auditor to
express an opinion as to whether the financial information is free from material misstatement due
to fraud or error.
ISSAI 200 provides the fundamental principles for an audit of financial statements prepared in
accordance with a financial reporting framework. The principles also apply when an SAI is
engaged or has responsibility to audit single financial statements and specific elements, accounts
or items of a financial statement, or financial statements prepared in accordance with specialpurpose financial frameworks, or summary financial statements. Where reference is made in
ISSAI 200 to audits of financial statements, this includes responsibilities of this nature.
The subject matter of a financial audit is financial position, performance, cash flow or other
elements which are recognized, measured and presented in financial statements. The subject
matter information is the financial statement. A complete set of financial statements for a publicsector entity, when prepared in accordance with a financial reporting framework for the public
sector, normally consists of:
a statement of financial position;
a statement of financial performance;
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a statement of changes in net assets/equity;

a cash flow statement;
a comparison of budget and actual amounts either as a separate additional financial
statement or as a reconciliation;
notes, comprising a summary of significant accounting policies and other explanatory
information.
In certain environments a complete set of financial statements may also include other
reports, such as reports on performance and appropriation reports.
Preconditions For An Audit Of Financial Statements In Accordance With The Issais

A financial audit conducted in accordance with the ISSAIs is premised on the following
conditions:
The financial reporting framework used for preparation of the financial statements is deemed
to be acceptable by the auditor.
The management of the entity acknowledges and understands its responsibility:
o For preparation of the financial statements in accordance with the applicable financial
reporting framework, including, where relevant, their fair presentation;
o For such internal control that management deems necessary for the preparation of
financial statements that are free from material misstatement, whether due to fraud or
error; and
o To provide the auditor with unrestricted access to all information of which it is aware
and that is relevant to the preparation of the financial statements.
The auditor should access whether the preconditions for an audit of financial statement have
been met.
Frameworks prescribed by law or regulation will often be deemed acceptable by the auditor.
However, even if deemed unacceptable, such a framework may be allowable if:
the management agrees to provide the necessary additional disclosures in the financial
statements to avoid their being misleading; and
the auditors report on the financial statements includes an Emphasis of Matter paragraph
drawing users attention to such additional disclosures.
Acceptable financial reporting framework normally exhibits certain attributes which ensures that
the information provided in the financial statement is of value to intended users:
Relevance
Completeness
Reliability
Neutrality and objectivity
Understandability
In some public-sector audit environments, financial audits are referred to as budget execution
audits, which often include the examination of transactions against the budget for compliance
and regularity issues. Such audits may be undertaken on a risk basis or with the aim of covering
all transactions. In such audit environments there is often no acceptable financial reporting
framework. The results of financial transactions may be presented as a comparison between
expenditure amounts and budgetary amounts. In environments where such audits are undertaken
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and there are no financial statements presented in accordance with an acceptable financial
reporting framework, the auditor may conclude that the preconditions for an audit established by
the ISSAIs on financial audit are not in place. Auditors may thus consider developing standards
using the Fundamental Principles of Financial Auditing as guidance to suit their specific needs.
Where the audit mandate refers to financial audit but does not link this to financial statements
prepared in accordance with a financial reporting framework, it is proposed that the ISSAIs be
considered best available practice and the spirit of the ISSAIs be implemented through standards
devised for the specific environment. Where the audit mandate refers to audits of single financial
statements and specific elements, accounts or items of a financial statement, ISSAI 1805 may be
relevant.
AUDITS OF FINANCIAL STATEMENTS PREPARED IN ACCORDANCE WITH
SPECIAL-PURPOSE FRAMEWORKS
The principles of ISSAI 200 are applicable to audits of financial statements prepared in
accordance with both general-purpose and special-purpose frameworks. Financial statements
prepared for a special purpose are not appropriate for the general public. Auditors should,
therefore, carefully examine whether the financial reporting framework is designed to meet the
financial information needs of a wide range of users (general-purpose framework) or of specific
users, or the requirements of a standard-setting body.
Special-purpose frameworks relevant to the public sector may include:
the cash receipts and disbursements basis of accounting for cash flow information that an
entity may be required to prepare for a governing body;
the financial reporting provisions established by an international funding organization or
mechanism;
the financial reporting provisions established by a governing body, the legislature or other
parties that perform an oversight function to meet the requirements of that body; or
the financial reporting provisions of a contract, such as a project grant.
AUDITS OF SINGLE FINANCIAL STATEMENTS AND SPECIFIC ELEMENTS,
ACCOUNTS OR ITEMS OF A FINANCIAL STATEMENT
The principles of ISSAI 200 are also applicable to audits of public-sector entities that prepare
financial information, including single financial statements or specific elements, accounts or
items of a financial statement, for other parties (such as governing bodies, the legislature or other
parties with an oversight function). Such information may come under the audit mandate of the
SAI. Auditors may also be engaged to audit single financial statements, or specific elements,
accounts or items such as projects financed by the government although they are not engaged
to audit the complete set of financial statements of the entity concerned.
SAIs may also find it useful to consider the requirements and guidance in ISSAI 1805 when
developing or adopting standards based on the principles in ISSAI 200. ISSAI 1805 deals with
special considerations in the application of the requirements of the ISAs to an audit of a single
financial statement or of a specific element, account or item of a financial statement. The single
financial statement or the specific element, account or item of a financial statement may be
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prepared in accordance with a general-purpose or special-purpose framework.
COMPLIANCE AUDIT
ISSAI 400 Fundamental Principles of Compliance Auditing builds on and further develops the
fundamental principles of ISSAI 100 to suit the specific context of compliance auditing.
Compliance auditing is the independent assessment of whether a given subject matter is in
compliance with applicable authorities identified as criteria. Compliance audits are carried out by
assessing whether activities, financial transactions and information comply, in all material
respects, with the authorities which govern the audited entity. These authorities may include
rules, laws and regulations, budgetary resolutions, policy, established codes, agreed terms or the
general principles governing sound public-sector financial management and the conduct of
public officials.
The subject matter in the compliance audit is defined by the scope of the audit. It may be
activities, financial transactions or information. For attestation engagements on compliance it is
more relevant to focus on the subject matter information, which may be a statement of
compliance in accordance with an established and standardized reporting framework?
Compliance auditing is often an integral part of an SAIs mandate for the audit of public-sector
entities. This is because legislation and other authorities are the primary means by which
legislatures exercise control of income and expenditure, management and the rights of citizens to
due process in their relations with the public sector. Public-sector entities are entrusted with the
sound management of public funds. It is the responsibility of public-sector bodies and their
appointed officials to be transparent about their actions and accountable to citizens for the funds
with which they are entrusted, and to exercise good governance over those funds.
Compliance auditing promotes transparency by providing reliable reports as to whether funds
have been administered, management exercised and citizens rights to due process honored as
required by the applicable authorities. It promotes accountability by reporting deviations from
and violations of authorities, so that corrective action may be taken and those accountable may
be held responsible for their actions. It promotes good governance both by identifying
weaknesses and deviations from laws and regulations and by assessing propriety where there are
insufficient or inadequate laws and regulations. Fraud and corruption are, by their very nature,
elements which counteract transparency, accountability and good stewardship. Compliance
auditing therefore promotes good governance in the public sector by considering the risk of fraud
in relation to compliance.
The different perspectives of compliance auditing
Compliance audit can be part of a combined audit that may also include other aspects.
Compliance audit is generally conducted either in relation with financial audit or in combination
with performance audit. When compliance auditing is part of a performance audit, compliance is
seen as one of the aspects of economy, efficiency and effectiveness. Non-compliance may be the
cause of, an explanation for, or a consequence of, the state of the activities that are the subject of
the performance audit.
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Compliance audit may also be planned performed and reported on separately from the audit of
financial statements and from performance audits. ISSAI 4100 provides guidance in this regard.
Compliance audits may be conducted separately on a regular or an ad hoc basis, as distinct and
clearly-defined audits each related to a specific subject matter.
PERFORMANCE AUDIT
ISSAI 300 - Fundamental Principles of Performance Auditing builds on and further develops the
fundamental principles of ISSAI 100 to suit the specific context of performance auditing.
Performance auditing is an independent, objective and reliable examination of whether
government undertakings, systems, operations, programmes, activities or organizations are
operating in accordance with the principles of economy, efficiency and effectiveness and
whether there is room for improvement.
Performance auditing seeks to provide new information, analysis or insights and, where
appropriate, recommendations for improvement. Performance audits deliver new information,
knowledge or value by:
providing new analytical insights (broader or deeper analysis or new perspectives);
making existing information more accessible to various stakeholders;
providing an independent and authoritative view or conclusion based on audit evidence;
providing recommendations based on an analysis of audit findings.
The subject matter of a financial audit is defined by the audit objective and audit questions. The
subject matter may be specific programmes, entities or funds or certain activities (with their
output, impact and outcomes), existing situation (including causes and consequences) as well as
financial and non-financial information about any of these elements. The auditor measures and
evaluates the subject matter to access the extent to which the established criteria have or have not
been met.
Economy, efficiency and effectiveness
The principles of economy, efficiency and effectiveness can be defined as follows:
The principle of economy means minimizing the costs of resources. The resources used
should be available in due time, in and of appropriate quantity and quality and at the best
price.
The principle of efficiency means getting the most from the available resources. It is
concerned with the relationship between resources employed and outputs delivered in terms
of quantity, quality and timing.
The principle of effectiveness concerns meeting the objectives set and achieving the intended
results.
Performance audits often include an analysis of the conditions that are necessary to ensure that
the principles of economy, efficiency and effectiveness can be upheld. These conditions may
include good management practices and procedures to ensure the correct and timely delivery of
services. Where appropriate, the impact of the regulatory or institutional framework on the
performance of the audited entity should also be taken into account.
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Performance auditing promotes accountability by assisting those with governance and oversight
responsibilities to improve performance. It does this by examining whether decisions by the
legislature or the executive are efficiently and effectively prepared and implemented, and
whether taxpayers or citizens have received value for money. It also promotes transparency by
affording parliament, taxpayers and other sources of finance, those targeted by government
policies and the media an insight into the management and outcomes of different government
activities
PROVISION OF AUDIT ACT 2048
Section 3, Method of audit:

a) The Auditor General may conduct final audit of the financial activities and other
activities relating thereto of the offices, bodies or organizations under its jurisdiction,
either in detail or sporadically or a random basis and present the facts obtained therefrom,
make critical comments thereon and submit its reports.
b) The Auditor General may. if it deems necessary in course of audit exercise the following
powers:
i.
To check at any time the status of the program and project being operated under
the grants obtained by Government of Nepal and examine documents relating to
accounts;
ii.
To require contractors of government contracts to produce relevant documents or
other evidence relating to the contract, which are supposed to be in his/her
possession;
iii. To hire services of any expert on the task of audit and, if necessary, engage
someone under contract with reasonable remuneration.
Section 4, Matters to Be Audited:
The Auditor General, with due regard to the regularity, economy, efficiency, effectiveness and propriety,
shall audit following matters to ascertain whether:
a) the amount appropriated in the concerned heads and subheads by the Appropriation Act for
respective services and activities have been expended for the specified purposes of
designated services or activities within the approved limit;
b) the financial transactions comply with the existing laws and the evidence relating to items of
income and expenditure are sufficient;
c) the accounts have been maintained in the prescribed forms and such accounts fairly represent
the position of the transactions;
d) the inventory of government assets is accurate and up to date and the arrangement for
protection and management of governmental property is adequate;
e) the arrangements for internal audit and internal control of cash, kind and other governmental
property against any loss, damage and abuse are adequate and if so, are they pursued;
f) the accounts of revenue, all other incomes and deposits are correct and the rules relating to
evaluation, realization and methods of book keeping are adequate and if so, are they
followed;
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g) the accounts relating to public debts, security, deposit, debt relief fund and the amounts set
aside for debt services and repayment of debts are accurate;
h) The accounts of income and expenditure of industrial and business services, and their balance
of cash and kind, and the arrangements and rules relating to their financial transactions are
adequate and if so, are they observed;
i) The organization, management and job allocation of the office are sufficient and proper and
are that operating accordingly;
j) Any function is being unnecessarily performed in duplication by any employee or agency or
any essential function is being omitted;
k) The available resources, means and assets are properly utilized and the maintenance and
perspiration thereof against any loss or damage has been properly arranged;
l) The progress has been achieved within scheduled time and the quality and quantity of the
work is satisfactory;
m) The objective and policy of the Office is explicit and the program is delineated conforming to
the specified objective and policy;
n) The program is being implemented within the limits of approved cost estimate and the
proceeds received in comparison to the cost is reasonable;
o) The arrangements for maintaining data relating to target, progress and cost are adequate and
reliable;
Section 5, Matters to be audited in view of propriety:
I.
The Auditor General shall audit following matters considering the propriety thereofa) On the propriety of any expenditure and its authorization, if in the opinion of the Auditor
General such expenditure is a reckless one or is an abuse of national property, whether
movable or immovable, despite that the expenditure confirms to the authorization, and
b) On the propriety of all authorizations issued in respect of any grant of national property
whether movable or immovable, fixed or current, or underwriting of any revenue, or any
contract, license or permits relating to mining, forest, water resources, etc. and any other
act of abandoning movable or immovable, assets of the nation.
II.
The Auditor General may not include in the report minor items of discrepancy and other
items deemed as insignificant in view of their property which were observed during the audit
of income and expenditure.
ELEMENTS OF PUBLIC SECTOR AUDITING

All public-sector audits have the same basic elements: the auditor, the responsible party,
intended users (the three parties to the audit), criteria for assessing the subject matter and the
resulting subject matter information. They can be categorized as two different types of audit
engagement: attestation engagements and direct reporting engagements.
I) THE THREE PARTIES
Public sector audit includes at least three separate parties: the auditor, a responsible party and
intended user.
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The auditor: In public sector auditing the role of the auditor is fulfilled by the Head of the
SAI and the persons to whom the task of conducting the audits is delegated. The overall
responsibility of public sector auditing remains as defined by SAIs mandate.
The responsible party: In public sector auditing the relevant responsibility are determined
by constitutional and legislative arrangement. The responsible party is responsible for the
subject matter information, for managing the subject matter or for addressing
recommendations, and may be individuals or organizations.
Intended users: The individuals, organizations or classes thereof for whom the auditor
prepares the audit report. The intended user may be the legislative or oversight bodies,
those charged with governance or the general public.
II) SUBJECT MATTER, CRITERIA AND SUBJECT MATTER INFORMATION

Subject matter refers to the information, condition or activity that is measured or evaluated
against certain criteria. It can take many forms and have different characteristics depending on
the audit objective. An appropriate subject matter is identifiable and capable of consistent
evaluation or measurement against the criteria, such that it can be subjected to procedures for
gathering sufficient and appropriate audit evidence to support the audit opinion or conclusion.
The criteria are the benchmarks used to evaluate the subject matter. Each audit should have
criteria suitable to the circumstances of that audit. In determining the suitability of criteria the
auditor considers their relevance and understandability for the intended users, as well as their
completeness, reliability and objectivity (neutrality, general acceptance and comparability with
the criteria used in similar audits). They should be made available to the intended users to enable
them to understand how the subject matter has been evaluated or measured.
Subject matter information refers to the outcome of evaluating or measuring the subject matter
against the criteria. It can take many forms and have different characteristics depending on the
audit objective and audit scope.
III) TYPES OF ENGAGEMENT
There are two types of engagement:
In attestation engagements the responsible party measures the subject matter against the
criteria and presents the subject matter information, on which the auditor then gathers
sufficient and appropriate audit evidence to provide a reasonable basis for expressing a
conclusion.
In direct reporting engagements it is the auditor who measures or evaluates the subject
matter against the criteria. The auditor selects the subject matter and criteria, taking into
consideration risk and materiality. The outcome of measuring the subject matter against
the criteria is presented in the audit report in the form of findings, conclusions,
recommendations or an opinion. The audit of the subject matter may also provide new
information, analyses or insights.
Financial audits are always attestation engagements, as they are based on financial information
presented by the responsible party. Performance audits are normally direct reporting
engagements. Compliance audits may be attestation or direct reporting engagements, or both at
once.
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Confidence and Assurance In Public-Sector Auditing

The intended users will wish to be confident about the reliability and relevance of the
information which they use as the basis for taking decisions. Audits provide information based
on sufficient and appropriate evidence, and auditors should perform procedures to reduce or
manage the risk of reaching inappropriate conclusions. The level of assurance that can be
provided to the intended user should be communicated in a transparent way. Due to inherent
limitations, however, audits can never provide absolute assurance.
Depending on the audit and the users needs, assurance can be communicated in two ways:
Through opinions and conclusions which explicitly convey the level of assurance. This
applies to all attestation engagements and certain direct reporting engagements.
In other forms. In some direct reporting engagements the auditor does not give an explicit
statement of assurance on the subject matter. In such cases the auditor provides the users with
the necessary degree of confidence by explicitly explaining how findings, criteria and
conclusions were developed in a balanced and reasoned manner, and why the combinations
of findings and criteria result in a certain overall conclusion or recommendation.
Assurance can be either reasonable or limited.
Reasonable assurance is high but not absolute. The audit conclusion is expressed positively,
conveying that, in the auditor's opinion, the subject matter is or is not compliant in all material
respects, or, where relevant, that the subject matter information provides a true and fair view, in
accordance with the applicable criteria.
When providing limited assurance, the audit conclusion states that, based on the procedures
performed, nothing has come to the auditors attention to cause the auditor to believe that the
subject matter is not in compliance with the applicable criteria. The procedures performed in a
limited assurance audit are limited compared with what is necessary to obtain reasonable
assurance, but the level of assurance is expected, in the auditor's professional judgement, to be
meaningful to the intended users. A limited assurance report conveys the limited nature of the
assurance provided.
PRINCIPLES OF PUBLIC SECTOR AUDITING

Auditing is a cumulative and iterative process. However, for the purposes of presentation the
fundamental principles are grouped by principles related to the SAIs organizational
requirements, general principles that the auditor should consider prior to commencement and at
more than one point during the audit and principles related to specific steps in the audit process.
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Ethics And Independence

Auditors should comply with the relevant ethical requirements and be independent. The SAIs
should have policies addressing ethical requirements and emphasizing the need for compliance
by each auditor. Auditors should remain independent so that their reports will be impartial and be
seen as such by the intended users. Guidance on the key ethical principles of integrity,
objectivity, professional competence and due care, confidentiality and professional behavior are
defined in ISSAI 30 Code of Ethics.
Professional Judgement, Due Care And Skepticism
Auditors should maintain appropriate professional behavior by applying professional skepticism,
professional judgment and due care throughout the audit The auditors attitude should be
characterized by professional skepticism and professional judgement, which are to be applied
when forming decisions about the appropriate course of action. Auditors should exercise due
care to ensure that their professional behavior is appropriate.
Professional skepticism means maintaining professional distance and an alert and questioning
attitude when assessing the sufficiency and appropriateness of evidence obtained throughout the
audit. It also entails remaining open-minded and receptive to all views and arguments.
Professional judgement implies the application of collective knowledge, skills and experience to
the audit process. Due care means that the auditor should plan and conduct audits in a diligent
manner. Auditors should avoid any conduct that might discredit their work.
Quality Control
Auditors should perform the audit in accordance with professional standards on quality control.
An SAIs quality control policies and procedures should comply with professional standards, the
aim being to ensure that audits are conducted at a consistently high level. Quality control
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procedures should cover matters such as the direction, review and supervision of the audit
process and the need for consultation in order to reach decisions on difficult or contentious
matters. Auditors can find additional guidance in ISSAI 40 Quality Control for SAIs.
Audit Team Management And Skills
The individuals in the audit team should collectively possess the knowledge, skills and expertise
necessary to successfully complete the audit. This includes an understanding and practical
experience of the type of audit being conducted, familiarity with the applicable standards and
legislation, an understanding of the entitys operations and the ability and experience to exercise
professional judgement. Common to all audits is the need to recruit personnel with suitable
qualifications, offer staff development and training, prepare manuals and other written guidance
and instructions concerning the conduct of audits, and assign sufficient audit resources. Auditors
should maintain their professional competence through ongoing professional development.
Some SAIs use the work of other auditors at state, provincial, regional, district or local level, or
of public accounting firms that have completed audit work related to the audit objective.
Arrangements should be made to ensure that any such work was carried out in accordance with
public-sector auditing standards.
Audits may require specialized techniques, methods or skills from disciplines not available
within the SAI. In such cases experts may be used to provide knowledge or carry out specific
tasks or for other purposes.
Audit Risk
Auditors should manage the risks of providing a report that is inappropriate in the circumstances
of the audit. The auditor performs procedures to reduce or manage the risk of reaching
inappropriate conclusions, recognizing that the limitations inherent to all audits mean that an
audit can never provide absolute certainty of the condition of the subject matter.
When the objective is to provide reasonable assurance, the auditor should reduce audit risk to an
acceptably low level given the circumstances of the audit. The audit may also aim to provide
limited assurance, in which case the acceptable risk that criteria are not complied with is greater
than in a reasonable assurance audit. A limited assurance audit provides a level of assurance that,
in the auditors professional judgment, will be meaningful to the intended users.
Materiality
Auditors should consider materiality throughout the audit process. A matter can be judged
material if knowledge of it would be likely to influence the decisions of the intended users.
Determining materiality is a matter of professional judgement and depends on the auditors
interpretation of the users needs. This judgement may relate to an individual item or to a group
of items taken together. Materiality is often considered in terms of value, but it also has other
quantitative as well as qualitative aspects. The inherent characteristics of an item or group of
items may render a matter material by its very nature. A matter may also be material because of
the context in which it occurs.
Materiality considerations affect decisions concerning the nature, timing and extent of audit
procedures and the evaluation of audit results. Considerations may include stakeholder concerns,
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public interest, regulatory requirements and consequences for society.

Documentation
Auditors should prepare audit documentation that is sufficiently detailed to provide a clear
understanding of the work performed, evidence obtained and conclusions reached
Audit documentation should include an audit strategy and audit plan. It should record the
procedures performed and evidence obtained and support the communicated results of the audit.
Documentation should be sufficiently detailed to enable an experienced auditor, with no prior
knowledge of the audit, to understand the nature, timing, scope and results of the procedures
performed, the evidence obtained in support of the audit conclusions and recommendations, the
reasoning behind all significant matters that required the exercise of professional judgement, and
the related conclusions.
Communication
Auditors should establish effective communication throughout the audit process. It is essential
that the audited entity be kept informed of all matters relating to the audit. This is key to
developing a constructive working relationship. Communication should include obtaining
information relevant to the audit and providing management and those charged with governance
with timely observations and findings throughout the engagement. The auditor may also have a
responsibility to communicate audit-related matters to other stakeholders, such as legislative and
oversight bodies.
PRINCIPLES RELATED TO THE AUDIT PROCESS
PLANNING AN AUDIT
Auditors should ensure that the terms of the audit have been clearly established. Audits
may be required by statute, requested by a legislative or oversight body, initiated by the SAI or
carried out by simple agreement with the audited entity. In all cases the auditor, the audited
entitys management, those charged with governance and others as applicable should reach a
common formal understanding of the terms of the audit and their respective roles and
responsibilities.
Auditors should obtain an understanding of the nature of the entity/programme to be
audited. This includes understanding the relevant objectives, operations, regulatory
environment, internal controls, financial and other systems and business processes, and
researching the potential sources of audit evidence. Knowledge can be obtained from regular
interaction with management, those charged with governance and other relevant stakeholders.
This may mean consulting experts and examining documents (including earlier studies and other
sources) in order to gain a broad understanding of the subject matter to be audited and its
context.
Auditors should conduct a risk assessment or problem analysis and revise this as necessary
in response to the audit findings. The auditor should consider and assess the risk of different
types of deficiencies, deviations or misstatements that may occur in relation to the subject matter.
Both general and specific risks should be considered. This can be achieved through procedures
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that serve to obtain an understanding of the entity or programme and its environment, including
the relevant internal controls. The auditor should assess the managements response to identified
risks, including its implementation and design of internal controls to address them. In a problem
analysis the auditor should consider actual indications of problems or deviations from what
should be or is expected. This process involves examining various problem indicators in order to
define the audit objectives. The identification of risks and their impact on the audit should be
considered throughout the audit process.
Auditors should identify and assess the risks of fraud relevant to the audit objectives.
Auditors should make enquiries and perform procedures to identify and respond to the risks of
fraud relevant to the audit objectives. They should maintain an attitude of professional
skepticism and be alert to the possibility of fraud throughout the audit process.
Auditors should plan their work to ensure that the audit is conducted in an effective and
efficient manner. Planning for a specific audit includes strategic and operational aspects.
Strategically, planning should define the audit scope, objectives and approach. The objectives
refer to what the audit is intended to accomplish. The scope relates to the subject matter and the
criteria which the auditors will use to assess and report on the subject matter, and is directly
related to the objectives. The approach will describe the nature and extent of the procedures to be
used for gathering audit evidence. The audit should be planned to reduce audit risk to an
acceptably low level.
Operationally, planning entails setting a timetable for the audit and defining the nature, timing
and extent of the audit procedures. During planning, auditors should assign the members of their
team as appropriate and identify other resources that may be required, such as subject experts.
Audit planning should be responsive to significant changes in circumstances and conditions. It is
an iterative process that takes place throughout the audit.
CONDUCTING AN AUDIT
Auditors should perform audit procedures that provide sufficient appropriate audit
evidence to support the audit report. The auditors decisions on the nature, timing and extent
of audit procedures will impact on the evidence to be obtained. The choice of procedures will
depend on the risk assessment or problem analysis. Evidence should be both sufficient (quantity)
to persuade a knowledgeable person that the findings are reasonable, and appropriate (quality)
i.e. relevant, valid and reliable. The auditors assessment of the evidence should be objective, fair
and balanced. Preliminary findings should be communicated to and discussed with the audited
entity to confirm their validity.
Auditors should evaluate the audit evidence and draw conclusions. After completing the
audit procedures, the auditor will review the audit documentation in order to determine whether
the subject matter has been sufficiently and appropriately audited. Before drawing conclusions,
the auditor reconsiders the initial assessment of risk and materiality in the light of the evidence
collected and determines whether additional audit procedures need to be performed.
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Based on the findings, the auditor should exercise professional judgement to reach a conclusion
on the subject matter or subject matter information.
REPORTING AND FOLLOW-UP
Auditors should prepare a report based on the conclusions reached. The audit process
involves preparing a report to communicate the results of the audit to stakeholders, others
responsible for governance and the general public. The purpose is also to facilitate follow-up and
corrective action. In some SAIs, such as courts of audit with jurisdictional authority, this may
include issuing legally binding reports or judicial decisions.
The form and content of a report will depend on the nature of the audit, the intended users, the
applicable standards and legal requirements. The SAIs mandate and other relevant laws or
regulations may specify the layout or wording of reports, which can appear in short form or long
form.
Long-form reports generally describe in detail the audit scope, audit findings and conclusions,
including potential consequences and constructive recommendations to enable remedial action.
Short-form reports are more condensed and generally in a more standardized format.
Attestation engagements
In attestation engagements the audit report may express an opinion as to whether the subject
matter information is, in all material respects, free from misstatement and/or whether the subject
matter complies, in all material respects, with the established criteria. In an attestation
engagement the report is generally referred to as the Auditors Report.
Direct engagements
In direct engagements the audit report needs to state the audit objectives and describe how they
were addressed in the audit. It includes findings and conclusions on the subject matter and may
also include recommendations. Additional information about criteria, methodology and sources
of data may also be given, and any limitations to the audit scope should be described.
The audit report should explain how the evidence obtained was used and why the resulting
conclusions were drawn. This will enable it to provide the intended users with the necessary
degree of confidence.
Opinion
When an audit opinion is used to convey the level of assurance, the opinion should be in a
standardized format. The opinion may be unmodified or modified. An unmodified opinion is
used when either limited or reasonable assurance has been obtained. A modified opinion may be:
Qualified (except for) where the auditor disagrees with, or is unable to obtain sufficient and
appropriate audit evidence about, certain items in the subject matter which are, or could be,
material but not pervasive;
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Adverse where the auditor, having obtained sufficient and appropriate audit evidence,
concludes that deviations or misstatements, whether individually or in the aggregate, are both
material and pervasive;
Disclaimed where the auditor is unable to obtain sufficient and appropriate audit evidence
due to an uncertainty or scope limitation which is both material and pervasive.
Where the opinion is modified the reasons should be put in perspective by clearly explaining,
with reference to the applicable criteria, the nature and extent of the modification. Depending on
the type of audit, recommendations for corrective action and any contributing internal control
deficiencies may also be included in the report.
FOLLOW-UP
SAIs has a role in monitoring action taken by the responsible party in response to the matters
raised in an audit report. Follow-up focuses on whether the audited entity has adequately
addressed the matters raised, including any wider implications. Insufficient or unsatisfactory
action by the audited entity may call for a further report by the SAI.
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CHAPTER 8- AUDIT OF SPECIAL SECTOR

COOPERATIVES SOCIETIES
Cooperatives are formed and in operation based on the mutual support and cooperativeness for
the economic and social development of the general pubic consumers by the farmers,
craftsperson (Kaligadh), class of people with low capital and low income, labors, landless and
unemployed people or social workers of the country. The various provisions contained with
respect to accounts and audits are as under:
Cooperatives Act
Section 17 of the Cooperatives Act provides that Accounts committee shall be formed and
following duties shall be performed:
(1) The general meeting of every association may elect and form one accounts committee
consisting of three members including one coordinator.
(2) The accounts committee may perform the internal audit of the association in a regular basis
and give suggestions to the board.
(3) The accounts committee has to submit its accounts related report to the general meeting.
Further, Section 33 provides that every association or society has to maintain records of accounts
of all transactions carried on by it and other necessary prescribed records.
Audit of accounts:
37 (1) provides that every association or society has to get its accounts of every fiscal year
examined by any registered auditor recognized by the Registrar or official designated by him/her
within three months after the expiration of that fiscal year.
(2) Notwithstanding anything contained in Sub-section (1), the general meeting of the concerned
association or society may, with the approval of the Registrar, appoint a registered auditor and
cause the accounts of that association or society to be examined by such auditor.
(3) In appointing an auditor pursuant to Sub-section (2), the same person or ompany may not be
appointed for more than three consecutive times.
(4) A report on examination of accounts has to be submitted to the general meeting and got
endorsed.
(5) If the general meeting does not endorse the report on examination of accounts submitted to
the general meeting pursuant to Sub-section (4), the general meeting may appoint another auditor
and have an inquiry held or accounts reexamined.
(6) The remuneration and facilities of auditor shall be as determined by the
General Meeting.
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JOINT VENTURE
Joint Venture audits review operator activities, procedures and costs over a defined scope period. Nonoperating partners schedule and fund a review of detail transactions and related supporting documentation
to ensure their individual ownership interests are productive and are being protected.
Why conduct a Joint Venture Audit?
1. Confirm that all transactions and billed charges are in compliance agreement
2. Ensure unrelated costs have not been billed incorrectly to the Joint Account
3. Perform a vendor audit review to confirm credits for deposits, refunds and returns have been
appropriately reflected
4. Provide valuable insight about the Operator transactions to the Non-Operator investors
5. Increase profitability by disqualifying and recovering any overcharges
Overview of Joint Venture audits
Objectives of typical Joint Venture audits
Ensure billed charges are in compliance with the operating agreement and supported by adequate
documentation
Ensure unrelated costs have not been charged to the project
Determine whether all vendor credits for deposits, refunds and returns have been appropriately
reflected in net project costs
Ensure the Operator activities are in compliance with the agreement, including maintaining adequate
insurance coverage and timely regulatory reporting
Ensure goods, services and applicable taxes are paid in a timely manner
Ensure project assets and costs are adequately managed, controlled and reported
Analyze the cash call process and ensure funding adequately matches the operation needs without
material surplus
Audit Planning and Execution
Joint Venture audits are traditionally conducted in the following manner:
1. Preliminary work, including notification to operator, data acquisition and transaction request
2. On site testing at Operator location
3. Development and Communication of Findings
4. Summarization of Findings and Audit Close meeting
5. Preparation and Presentation of the Final Report
6. Operator Response to Final Report
7. Resolution and Settlement of Audit Issues
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PAPER 3: CORPORATE LAW
151
INSURANCE ACT 2049

State the procedures, how the Insurance Board formed under the Insurance Act 2049 and
also discuss the nature of the Board.
Answer:
Formation and of the Insurance Board has been prescribed by the Section 3 of the Insurance Act
2049. According to it
(1) An Insurance Board shall be formed to systematize, regularize, develop and regulate the
Insurance Business.
(2) The Board as said above shall consists of the following Members:
(a) A person nominated or designated by the Nepal Government Chairperson
(b) Representative, Ministry of Law, Justice and Parliamentary Affairs Member
(c) Representative, Ministry of Finance Member
(d) A person nominated by the Nepal Government from among the persons having the
special knowledge in the Insurance Business Member
(e) A person nominated by the Nepal Government from among the Insured Member
(3) An employee designated by the Board shall perform the duty as a Secretary of the
Board.
(4) The Nepal Government may make alteration of the Members of the Board by
publishing a notification in the Nepal Gazette, if it deems necessary.
(5) If it is deemed necessary, the Board may invite any national or
foreign experts in the meeting of the Board as an observer.
(6) The tenure of the nominated Members of the Board shall be four
years. They may be re-nominated up to twice after the expiry of their tenure.
(7) The Head office of the Board shall be located in kathmandu .
According to Section 4 of the Act (1) The Board shall be an autonomous and corporate body
having perpetual succession.
(2) The Board shall have a separate seal for its business.
(3) The Board may deal as a person to acquire, possess, dispose or otherwise manage the
movable and immovable property.
(4) The Board may sue as a person by its own name and the Board also may be sued in its name.
Chapter 3 Section 8 of the Insurance Act 2049 prescribes the provision regarding the
Functions, Duties and Powers of the Board as follows:
(a) to provide necessary suggestions to the Nepal Government to frame the Policy
regarding to systematize, regularize, develop and regulate the Insurance Business.
(b) To frame a policy for the investment of the amount received from the insurance and to
prescribe the priority sectors.
(c) To register and renew the *Insurer, Insurance Agent, Surveyor or Broker and to cancel
or cause to cancel such registration.
(d) To arbitrate in the dispute which arises between the Insurer and the Insured.
(d1) To make decision on the complaints filed by the Insured against the Insurer regarding
to the settlement of liability of the Insurance.
(d2) To issue necessary directives to the Insurer from time to time regarding to the
Insurance Business.
(e) To formulate necessary basis for the protection of interests of the Insured, and
(f) To do or cause to do other necessary functions regarding to the Insurance business.
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Under Section 9 of the Act, Sub-Committee may be Constituted by the Board may constitute
subcommittee as per necessary to conduct its functions smoothly. The functions, duties and
powers of the Sub-Committee and the procedures regarding to the meeting shall be as prescribed
by the Board.
State how the Insurer is registered under the Insurance Act 2049. Can the Board refuse to
register the insurer? State in what conditions the it may not be registered? Whether the
insurer business can be cancelled when it is registered?
Answer:
Chapter-4 Section 10 of the Insurance Act, 2049 has prescribes the provision regarding
Registration and Cancellation of the Insurer. According to the section 10 the registration
procedures has been prescribed as follows:
(1) No Person shall operate or cause to operate the Insurance Business without obtaining a
certificate pursuant to this Act.
(2) Any national or foreign corporate body desirous to operate an Insurance Business shall
submit an application to the office of the Board in the prescribed form along with the following
documents and prescribed fees for the registration of its name as an Insurer :
(a) Memorandum and articles of association of the corporate body,
(b) Insurance Business to be operated and its policies and terms and conditions,
(c) If life Insurance Business to be operated, documents displaying calculations of the
premiums to be received in operating such business and liability,
(d) The documents regarding the methods of utilizing the amounts to be received from
the Insurance, and
(e) Other necessary documents as prescribed by the Board.
(3) The Board shall make necessary investigation upon the application received pursuant to Subsection (2) and shall make an inquiry with the applicant, if necessary, and shall register the name
of such applicant in the prescribed register-book by mentioning the types of the Insurance
Business to be operated by the applicant and shall provide the registration certificate of Insurer to
the applicant in the form as prescribed. In case there is any reasonable ground for not registering
the name, the Board shall inform the concerned applicant
accordingly.
(4) Notwithstanding anything contained elsewhere in this Section, in the case of the Life
Insurance, the Board shall, with the approval of the Nepal Government, issue a certificate to
operate the Business, based on the fulfillment of the criteria which it has fixed, from time to
time, in respect of the operation of the Insurance Business.
Section 12 of the Act prescribes the provision regarding the refusal to be registered the insurance
company in the following conditions:
Notwithstanding anything contained in Section 10, no national or foreign corporate body shall be
registered as an Insurer in the following circumstances :
(a) If the name of an Insurer to be registered is identical to the name of another Insurer which has
been already registered in the office of the Board, and
(a1) If any Insurer wants to be registered for operating Life Insurance and Non-Life Insurance
Business,
Provided that, the registered Insurer who is operating the Life Insurance and Non-Life Insurance
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Business before the commencement of this Act, shall operate the business through a separate
organization for Life and Non-Life Insurance Business as prescribed from the date specified by
the Board.
(b) If the paid-up capital does not amount to at least two hundred fifty million rupees for the Life
Insurance Business and to at least one hundred million rupees for the Non-life Insurance
Business.
(c) In the event that the Board has made a decision to ban to register to additional corporate
body as an Insurer to operate Insurance Business on the basis of the report, regarding to the
study, research and evaluation of the Insurance Business market.
According to Section 13 of the Insurance Act 2049 Registration of an Insurer may be Canceled
as follows:
(1) The Board may cancel the registration of an Insurer by providing a written notice with effect
from the date prescribed in the same notice in the following circumstances:
(a) If the Insurance Business is not started within six months from the date of obtaining the
certificate,
(b) If it is felt that the liability of the Insurer exceeds its assets within Nepal,
(c) If the Insurer could not fulfill the liability pursuant to the decision within three months from
the date of final decision of the court in the case filed under the Insurance Policy issued
within Nepal,
(d) If the head office of the Insurance Business of any foreign Insurer is situated out side Nepal
and in case it is felt that Nepalese Insurer has not obtained equal facilities there which are
enjoyed by the foreign Insurer pursuant to the prevailing law of such country,
(e) If the Insurer does not open its office inside Nepal,
(f) If the Insurer does not perform the functions to be performed or has performed any functions
which is not to be performed pursuant to this Act or the Rules made under this Act.
(2) Before canceling the registration of an Insurer pursuant to Subsection
(1), the Board shall provide a reasonable time-limit to submit clarification to the concerned
Insurer, stating the reasons for canceling its registration.
(3) If the concerned Insurer does not submit its clarification within the
time period mentioned in Sub-section (2) or in case the clarification submitted by it is found not
to be satisfactory, the Board shall cancel the registration of such Insurer pursuant to Sub-section
(1), and shall publish a notice in two major newspapers to be published Nepal for the information
public in general.
(4) Mere cancellation of the registration of an Insurer pursuant to this Section shall not make any
effect to the rights and liabilities of the concerned Insurer regarding to any action taken or
functions performed before the cancellation.
When the registration of insurer is cancelled the arrangement of payment of insurance claims
after the cancellation of the Insurer is to be made under Section 16 of the Act as follows:
The Insurer, dissolved by the cause of the cancellation of its registration pursuant to Section 13,
shall refund the amount received by it for Insurance to the person, organization or the Board,
within the period and method specified by the Board. It shall refund the principal amount along
with bonus as specified by the Board in the case of Life Insurance and it shall refund the
principal amount as specified by the Board on a proportional basis in the case of Non-Life
Insurance.
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Discuss the legal provision regarding the renewal of registration of the insurer according
to the Insurance Act 2049. In what conditions the registration of the insurer can be
refused to be renewed?
Answer:
Section 11 prescribes the provision regarding the renewal of registration of the insurer.
According to it the insurer has to follow the procedure as follows:
(1) The Insurer shall have to submit an application to the office of the Board in the prescribed
form along with the prescribed fees up to the last day of Chaitra of each year for the renewal of
the certificate of registration.
(2) Upon the receipt of the application pursuant to Sub-section (1), the Board shall have to
renew the *certificate of registration.
(3) In case any Insurer submits an application to the Board within thirty days from the date of
expiry of the time-limit pursuant to Sub-section (1), mentioning the reason for its failure to
submit an application for the renewal of the certificate of registration within the aforesaid timelimit, the Board may, if it considers the reasons to be appropriate, renew the certificate of
registration of such Insurer.
According to Section 11A. Certificate of Registration of the Insurer Cannot be Renewed in the
following Circumstance :
(1) Notwithstanding anything contained in Section 11, the Board shall not renew the certificate
of registration of the Insurer in any of the following circumstances :
(a) If the balance-sheet has not submitted pursuant,
(b) If the statement of income has not submitted,
(c) If the audit report has not submitted,
(d) If the report of Actuary has not submitted,
(e) If the service-charge has not paid pursuant to Section 40,
(f) If it has been prohibited to operate the Insurance Business as prescribed.
(2) If a circumstance has been created for not renewing the certificate of registration of an
Insurer due to any of the circumstance mentioned in subsection (1), the Board shall notify the
Insurer within fifteen days from the emergence of such circumstances.
(3) If the Insurer has submitted an application to the Board within fifteen days from the date of
receiving the notice pursuant to Sub-section (2), stating reasonable grounds for not performing
the liabilities to be performed pursuant to Section 23, 24, 25, 26 and 40, the Board may, if it
considers the reasons to be appropriate, provide an additional time-limit of up to one month to
perform such liabilities.
Discuss the punishment which has been prescribed by the Insurance Act 2049, where there
is violation of the Act or the Rules made under the Insurance or directives issued or
perform the functions as to be performed under the Act?
Section 36 of the Insurance Act prescribes the provision regarding the Punishment of
concerned responsible persons as follows :
(1) If any Insurer or the Director of the Insurer, employee or Surveyor, Broker or Insurance
Agent knowingly violates this Act or the Rules made under this Act or order or directives or does
not perform any function to be performed or does any act not to be done, the Board may punish
to such Insurer or the Director, employee or Surveyor, Broker or Insurance Agent with a fine
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ranging from three thousand rupees to ten thousand rupees. If such offense has
been made frequently, he will be fined at the rate of extra five hundred rupees for
each subsequent offense.
(2) If any Insurer or Insurance Agent or Broker has made any Insurance Business without
following the procedures to be followed pursuant to this Act, the Board may fine him up to ten
thousand rupees.
(3) If the accounts, records, register, details, information or any other documents to be
maintained, prepared, formed or submitted pursuant to this Act or the Rules made under this Act
has not maintained, prepared, formed or submitted in time by knowingly or with malafied
intention or has maintained or submitted the false details or documents by any-body, he may be
punished with a fine up to thirty thousand rupees or imprisonment up to two years or with both.
Any person or corporate body dissatisfied with the decision made by the Board pursuant to this
Act, may make an appeal in the concerned Appellate Court within thirty five days from the date
of such decision under Section 37 of the Act.
SOCIAL WELFARE ACT, 2049
What do you understand by Social Welfare Programme as per Social Welfare Act 2049?
What programmes are considered as special programme relating to social welfare? What
functions, duties and power is exercised by the Council in respect of implementing the
social welfare programme?
Answer:
According to Section 3 of the Social Welfare Act , 2049 Social Welfare Programme refers the
acts that, Government of Nepal, by means of different activities relating to the social welfare
work, to support the overall development of the country may operate the social welfare
programme through the concerned Ministry and Social organizations and institutions.
Section 4 of the Act prescribes the Special Programme relating to social welfare as follows:
Government of Nepal may operate special Programmes, relating to the social welfare activity
and social service, in the following matters:
(a) To serve interest and render welfare to the children, oldage, helpless or
disabled people.
(b) To foster participation in development and to promote and protect the welfare, rights and
interest of the women.
(c) To rehabilitate and help to lead a life of dignity to the victims of social mischief's and also to
juvenile delinquency, drug addicts and similar people involved in other kind of addictions.
(d) To help to lead a life with dignity to the jobless, poor and illiterate people.
(e) To manage religious places and the activities of the trust Guthi institutions.
(f) To take effective management and actions for the welfare of the backward
communities and classes.
Section 9 of the Act prescribes the functions, duties and powers of the Council as follows:
(a) To run or cause to run the social welfare activities smoothly and effectively, to extend help to
the social organizations and institutions and to develop co-ordinations among them and to
supervise, follow up and carry out evaluations of their activities.
(b) To extend or cause to extend help and support to establish social organizations and
156
institutions, their development, strengthening and extensions.

(c) To work or cause to work as co-coordinator between Government of Nepal and social
organizations and institutions.
(d) To provide consultancies to Government of Nepal in order to formulate policies and
programmes directly related to social welfare activit ies and other social services
(e) To establish and conduct or cause to establish and conduct a fund, for the social welfare
activities.
(f) To work or cause to work as a center for dissemination of information and documentation to
the affiliated service oriented organizations and institutions with Council.
(g) To conduct or cause to conduct trainings, studies and research programmes in the areas with
social welfare.
(h) To carry out or cause to carry out the physical supervisions of the properties of those social
institutions and organizations affiliated with the Council.
(i) To carry out or cause to carry out the necessary functions to implement the objectives of this
Act.
(j) To make or cause to make contract or agreement with the local, foreign or international
organizations and foreign countries.
(k) To collect grant from the national and international agency and to manage the received grant.
Discuss the objective behind the enactment of Social Welfare Act, 2049. How terms of
Social Werlfare Activity, Social Service and Social Organization and Institution has been
defined by the Act? Discuss the provision relating to the affiliation of social institutions
with the Council and provision to provide economic assistance.
As to the title of the Act, it is an Act enacted to provide for the Social Welfare in the nation.
Preamble of the Act clearly prescribes the objective of the Act. It states that it is made with an
expedient to the all around development of Nepalese people and Nepalese society, in order to
relate social welfare activities and various social welfare oriented activities to tie up with
reconstruction activities, in order to provide humanistic livelihood to the weak and helpless
individual, class and community and make them enable; in order to provide status and respect to
the welfare oriented institutions and individuals and in order to develop a co-ordination between
social welfare oriented institutions and organizations.
The Act also prescribes the term Social welfare activity as the welfare activity oriented
towards the economic and social upliftment and self-reliance to the weak, helpless and
disable individuals. Accordingly it also prescribes the term Social service as the social welfare
activity done, personally or collectively without the purpose of profit.
(c) "Social Organization and Institution" means an organization and institution
established under the prevailing Laws in order to carry out various social welfare activities and
social welfare oriented non-governmental organization or institution.
Section 13 of the Act prescribes the provision regarding affiliation of social institution with the
council. According to it social organizations and institution can be affiliated with the Council by
adopting the following process:
(1) Social organizations and institutions interested to keep affiliation with the Council shoul have
to submit an application as prescribed in the form.
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(2) The organizations and institutions applying pursuant to Sub-section (1) should submit and
mention its Constitution, name of executive committee members, their occupations and
addresses and the office where the organization or institution has been registered and the date of
the registration along with the application.
(3) After receiving the application pursuant to Sub-section (1) if it deems to be affiliated such
institutions or organization with the Council, the Council shall issue the certificate as prescribed
form taking the fees as prescribed.
(4) The organization or institutions affiliated with the Council may keep out its affiliation as
prescribed.
Section 14 prescribes the Provisions related to Constitution: The constitution of the
organizations and institutions intended to affiliate with the Council, shall mention the related
matters as prescribed in addition to the matters mentioned in prevailing laws.
Section 16. of the Act prescribes provision relating to economic assistance as follows:
(1) Social organizations and institutions willing to get material, technical, economic or any other
kind of assistance either from Government of Nepal or foreign countries, international social
organizations and institutions or missions or individuals shall submit a project proposal and
application along with other details to the Council as prescribed.
Provided that, yearly assistance up to Two Hundred Thousand Rupees for
the project that to be finished immediately may be taken only giving prior notice
to the Council and after the completion of said work, a report should be submitted
to the Council, within the period of three months.
(2) After receiving an application pursuant to Sub-section (1) the Council will provide
permission coordinating with the concerned ministry or agency within the period of forty-five
days.
Provided that, no permission may be given to the work or project which is against the national
interest.
(3) To cooperate and coordinate with local agency while implementing the
approved project.
(4) Notwithstanding anything stated in Sub-section (1) no pre-permission will be required to
those international institutions established under international Agreements in which .
Provided that, notice shall be given to the Council after receiving such assistance.
(5) While providing economic assistance to the approved projects by the foreign organizations,
assistance shall be channelized through the commercial banks operating within Nepal
WTO AND NEPALESE LAWS:

Discuss the concept of World Trade Organization (WTO) along with the position of
membership in the WTO. What are the main principles of the WTO?
Answer:
The World Trade Organization (WTO) is an international body dealing with the rules of trade
between nations. It has started functioning from January 1, 1995. On April 23, 2004, Nepal also
got its membership. Many countries are currently negotiating for their accession. These inclue a
number o developing countries. The membership of WTO currently stands at 161 Countries,
representing more than 97 percent of the worlds population, and 23 (including 8 Least
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developed countries) countries as an observers, most seeking membership.

Main principles of the WTO, as an international institution is to regulate trade and investment
with following fundamental principles:
1. Fair competition and Non-discrimination
2. Transparency
3. Treatment for Least Developed Countries
4. Most Favoured Treatment
5. Free Trade Principle
6. Rule-based Trading System
7. Competitive principle
8. Environment Protection.
membership in the WTO. List out the functions of WTO as fixed by it.
Answers:
developed countries) countries as an observers, most seeking membership.
Functions of WTO
The major functions of the WTO as envisaged in its Charter are as follows:
Administer and implement the trade agreements
Act as a forum for multilateral trade negotiations
Seek to resolve trade disputes
Oversee national trade policies
Cooperate with other international institutions involved in global economice policy
making
Maintain trade related database. Members are required to notify in detail various trade
measures and statistics
Act as watchdog of international trade, constantly examining the trade regimes of
individual members
Act as a management consultant for world trade
Provide technical assistance and training for developing countries
Trade liberalization has thus been the main focus of the WTO. It has given due attention to
investments and issues of broader economic cooperation making it a global platform for
integration. It is envisaged that elimination of barriers in trade and investment would integrate
the world economy. This mechanism will ultimately generate growth and encourage competitive
activities benefiting the mankind across the world.
The WTO provisions have reduced the scope for bilateral preferential arrangements. However,
159
such arrangements can be maintained at regional level. Hence, within the scope of WTO, the
importance and relevance of regional groupings have been accepted and recognized.
membership of Nepal in the WTO. Examine the legislative standards maintained by Nepal
as per the commitment made towards WTO.
Answers:
developed countries) countries as an observers, most seeking membership. Nepal became
member of the WTO on April 23rd 2004. Nepal had applied for the membership of GATT in
1989.This application of membership was made in view of trade and transit problems with India
at that time. While seeking the membership of WTO the countries have to go through a series of
negotiations and have to commit and determine conditions.
Legislative Process of Nepal
The laws of Nepal need to comply as to the standards of WTO agreements, as per the
commitment made by Nepal. The compliance requires upgrading of standards of laws,
regulations, policies, agreements and improving institutions. So far the report published by the
Government of Nepal, fifty five percent policies, laws and regulation etc. have been completed,
forty five percent are on the way to compliance i.e they are in the final stage.
S.No.
Table of law making compliance

Particulars
Total
Completed
1.
Law
27(9 new 18
amended)
2.
Regulation
6(3new
3
amended)
3.
Convention/Agreements 4
4.
Policies
2
5.
Inquiry Points
42
On the committed policy, law, regulation, adoption of
establishment of inquiry point about one fourth are new and
amendment.
14
Need to be
completed
13
3
1
2
0
24
18
international instruments and
remaining are just updated by
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PAPER 4: FINANCIAL MANAGEMENT
161
CHAPTER 8: INVESTMENT OPPORTUNITIES IN NEPALESE CAPITAL MARKET

STOCK MARKET/ SECONDARY MARKET
Although common, the term stock market is somehow abstract for the mechanism that
enables the trading of company stocks. It is also used to describe the totality of all stocks,
especially within a country, for example in the phrase the stock market was up today, or in
the term stock market bubble.
Stock market is different from a stock exchange, which is an entity (a corporation or
mutual organization) in the business of bringing buyers and sellers of stock together. For
example, the stock market in the United States includes the trading of stocks listed on the
NYSE, NASDAQ and Amex and also on the OTCBB and pink sheets. In Nepal stocks are listed
in the Nepal Stock Exchange (Referred to as NEPSE).
HISTORY OF STOCK EXCHANGE
th
In 12
century France, the courratier de change was concerned with managing and
regulating the debts of agricultural communities on behalf of the banks. Because these men
also traded with debts, they could be called the first brokers.
th
In early 13 century Bruges commodity traders gathered inside the house of a man called
Van der Beurse, and in 1309 they institutionalized this, but Until then informal meeting
and become the Brugse Beurse. The idea quickly spread around Flanders and neighboring
counties and Beurzen and soon opened in Ghent and Amsterdam.
th
In the middle of the 13 century, Venetian bankers began to trade in government securities.
In 1351, the Venetian government outlawed spreading rumors intended to lower the price
of government funds. Bankers in Pisa, Verona, Genoa and Florence also began trading in
th
government securities during the 14 century. This was only possible because these were
independent city/states not ruled by a duke but a council of influential citizens.
The Dutch later started joint stock companies, which let shareholders invest in business
ventures and get a share of their profits or losses. In 1602, the Dutch East India Company
issued the first shares on the Amsterdam stock exchange. It was the first company to issue
stocks and bonds.
th
The first stock exchange to trade continuously was the Amsterdam Beurs, in the early 17
century. The Dutch pioneered short selling, option trading, debt-equity swaps, merchant
banking, unit trusts and other speculative instruments, much as we know them.
Now, there are stock markets in virtually every developed country and most developing
countries, with the worlds biggest markets in the United States, UK, Germany, France and
Japan.
STOCK MARKET PARTICIPANTS AND TRADING
Many years ago, worldwide, buyers and sellers were individual investors such as wealthy
businessmen, with long family histories (and emotional ties) to particular corporations (think
Ford). Over time, markets have become more institutionalized with buyers and sellers largely
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institutions e.g pension funds, insurance companies, mutual funds, hedge funds, investor groups
and banks. The rise of institutional investor has brought with it some improvements in stock
market operations, but not necessarily in the interest of the small investors or even of the nave
institutions, of which there are many.
Now, participants in the stock market range from small individual stock investors to large
hedge fund traders, who can be based anywhere. Their orders usually end up with a
professional at a stock exchange, who executes the order.
Most stocks are traded on exchanges e.g NYSE, which are places where buyers and sellers
meet and decide on a price. Some exchanges are physical locations where transactions are
carried out on a trading floor, by a method known as open outcry. The other type of
exchange is a virtual kind e.g Nasdaq, composed of a network of computers where trades are
made electronically via traders at computer terminals.
The purpose of a stock exchange is to facilitate the exchange of securities between buyers and
sellers, thus providing a marketplace (virtual or real). Really, a stock exchange is nothing more
than a super-sophisticated farmers market providing a meeting place for buyers and sellers.
IMPORTANCE OF STOCK MARKETS
Just as it is important that networks of transportation, electricity and telecommunications
function properly, so is it essential that payments can be transacted, capital can be saved and
channeled to the most profitable investment projects and that both households and firms get
help in handling financial uncertainty and risk as well as possibilities of spreading consumption
over time. Financial markets constitute an important part of the total infrastructure for every
society that has passed the stage of largely domestic economies. Stock market which is part of
the financial markets, perform the following functions in an economy:
I. Raising Capital for Businesses: The stock exchange provides companies with the
facility to raise capital for expansion through selling shares to the investing public
II. Mobilizing Savings for Investment: When people draw their savings and invest in
shares, it leads to a more rational allocation of resources because funds, which could
have been consumed or kept in idle deposits with banks, are mobilized and redirected to
promote business activity with the benefits for several economic sectors such as
agriculture, commerce and industry, resulting in a stronger economic growth and higher
productivity levels.
III. Facilitate Company Growth: Companies view acquisitions as opportunity to expand
product lines, increase distribution channels, hedge against volatility, increase its market
share or acquire other necessary business assets. A takeover bid or merger agreement
through the stock market is the simplest and most common way to the growth of
companies by acquisition or fusion.
IV. Redistribution of Wealth: By giving a wide spectrum of people a chance to
buy
shares and therefore become part owners (shareholders) of profitable enterprises,
the stock market helps to reduce large income inequalities. Both casual and
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professional stock investors through stock price rise and dividends get a chance to share in
the profits of promising business that were set up by other people.
V. Corporate Governance: By having a wide and varied scope of owners, companies
generally tend to improve on their management standards and efficiency in order to satisfy
the demands of these shareholders and the more stringent rules for public corporations
by public stock exchange and the government. Consequently, it is believed that public
companies (companies that are owned by shareholders who are members of the general
public and trade shares on public exchanges) tend to have better management records
than privatively held companies (those companies where shares are not publicly traded,
often owned by the company founders and/or their families and heirs or otherwise by a
small group of investors). However, some well-documented cases are known where it is
alleged that there has been considerable slippage in corporate governance on the part of
some public companies (e.g Enron Corporation, MCI WorldCom, Pets.com, Webvan or
Parmalat).
VI. Creates Investment Opportunities for Small Investors: As opposed to other
businesses that require huge capital outlay, investing in shares is open to both the large
and small stock investors because a person buys the number of shares they can afford.
Therefore the stock exchange provides an extra source of income for small savers.
VII. Government Raise Capital for Development Projects: The Government and even
local municipalities may decide to borrow money in order to finance huge infrastructure
projects such as sewerage and water treatment works or housing estates by selling another
category of securities known as bonds. These bonds can be raised through the stock
exchange whereby members of the public can buy them. When the government or
municipal council gets this alternative source of funds, it no longer has the need to overtax
the people in order to finance these development projects.
VIII. Barometer of the Economy: At the stock exchange, share prices rise and fall
depending, largely on the market. Share prices tend to rise or remain stable when
companies or the economy in general show signs of stability. Therefore the movement
of share prices can be an indicator of the general trend in the economy.
RELATION OF STOCK MARKET TO MODERN FINANCIAL SYSTEM

The financial system in most western countries has undergone a remarkable transformation.
One feature of this development is disintermediation. A portion of the funds involved in
saving and financing flows directly to the financial markets instead of being routed via
banks traditional lending and deposit operations. The general publics heightened
interest in investing in the stock market, either directly or through mutual funds, has
been an important component of this process.
Statistics show that in recent decades shares have made up an increasingly large
proportion of households financial assets in many countries. In the 1970s, in Sweden, deposit
accounts and other very liquid assets with little risk made up almost 60 percent of households
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financial wealth, as against less than 20 percent in the 2000s. The major part of this
adjustment in financial portfolios has gone directly to shares but a good deal now takes the
form of various kinds of institutional investment for groups of individuals, e.g pension funds,
mutual funds, hedge funds, insurance investment of premiums, etc. The trend towards
forms of saving with a higher risk has been accentuated by new rules for most funds and
insurance, permitting a higher proportion of shares to bonds. Similar tendencies are to be found
in other industrial countries.
In all developed economic systems, such as the European Union, the United States, Japan and
other developed world countries, the trend has been the same; saving has moved away from
traditional (government insured) bank deposits to more risky securities of one sort or another.
But in developing countries, it is exactly the opposite that is happening with households
savings.
THE BEHAVIOR OF THE STOCK MARKET
From past experience, it is known that investors may temporarily pull financial prices away
from their long term trend level. Over-reactions may occur so that excessive optimism
(euphoria) may drive prices unduly high or excessive pessimism may drive prices unduly low.
New theoretical and empirical arguments have been put forward against the notion that
financial markets are efficient.
According to the efficient market hypothesis (EMH), only changes in fundamental factors,
such as profits or dividends, ought to affect the share prices. But this largely theoretical
academic viewpoint also predicts that little or no trading should take place contrary to fact
since prices are already at or near equilibrium, having priced in all public knowledge.
However, the efficient market hypothesis is sorely tested by such events as stock market
crash in 1987, when the Dow Jones index plummeted 22.6 percent the largest ever one
day fall in the United States. This was part of the world wide crash of stock markets which
did not originate in the United States. The event demonstrated that share prices can fall
dramatically even though, to this day, it is impossible to fix a definite cause. A thorough
search failed to detect any specific or unexpected development that might account for the
crash. It also seems to be the case more generally that many price movements are not
occasioned by new information; a study of the fifty largest one day share price movements in
the United States in the post war period confirmed this (Source: Cutler, D. Poterba, J. &
Summers, L. (1991), Speculative dynamics, Review of Economic Studies 58, pp. 520546). Moreover, while the EMH predicts that all price movement, in the absence of change
in the fundamental information, is random (e.g non-trending), many studies have shown a
marked tendency for the stock market to trend over time for periods of weeks or longer.
Various explanations for large price movements have been promulgated. For instance, some
research have shown that changes in estimated risk, and the use of certain strategies, such
as stop-loss limits and VaR limits, theoretically could cause financial markets to
overreact.
Other research has shown that psychological factors may result in exaggerated stock price
movements. Psychological research has demonstrated that people are predisposed to 'seeing'
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patterns, and often will perceive a pattern in what is, in fact, just noise. (Something like
seeing familiar shapes in clouds or ink blots.) In the present context this means that a
succession of good news items about a company may lead investors to overreact positively
(unjustifiably driving the price up). A period of good returns also boosts the investor's
self-confidence,
reducing
his (psychological) risk threshold. (Source: Tversky, A. &
Kahneman, D. (1974), Judgement under uncertainty: heuristics and biases, Science 185, pp.
1124-1131)
Another phenomenon also from psychology that works against an objective assessment is
group thinking. As social animals, it is not easy to stick to an opinion that differs markedly
from that of a majority of the group. An example with which you may be familiar is the
reluctance to enter a restaurant that is empty; people generally prefer to have their opinion
validated by those of others in the group.
In one paper the authors draw an analogy with gambling. (Source: Stephen Morris and Hyun
Song Shin, Oxford Review of Economic Policy, vol. 15, no 3, 1999) In normal times the
market behaves like a game of roulette; the probabilities are known and largely independent
of the investment decisions of the different players. In times of market stress, however, the
game becomes more like poker (herding behavior takes over). The players now must give
heavy weight to the psychology of other investors and how they are likely to react
psychologically.
We are also liable to succumb to biased thinking. An example is when supporters of a national
football team (or a favorite stock), for instance, are overconfident about the chances of
winning (or the stock moving up).
The stock market, as any other business, is quite unforgiving of amateurs. Inexperienced
investors rarely get the assistance and support they need. In the period running up to the
recent Nasdaq crash, less than 1 per cent of the analyst's recommendations had been to sell
(and even during the 2000 - 2002 crash, the average did not rise above 5%). The media
amplified the general euphoria, with reports of rapidly rising share prices and the notion that
large sums of money could be quickly earned in the so-called new economy stock market.
This later magnified the gloom which descended during the 2000 2002 crash, so that by summer of 2002, predictions of a DOW average below 5000
were quite common.
To end this section on the behavior of the stock markets, it will be worthwhile to
share a famous quote from the preface to a published biography about a well-known and long
term value oriented stock investor, Warren Buffet. Buffet began his career with only 100 U.S.
dollars and has over the years built himself a multibillion-dollar fortune. The quote illustrates
th
something of what has been going on in the stock market during the end of the 20 century
st
and the beginning of the 21 Century
With each passing year, the noise level in the stock market rises. Television commentators,
financial writers, analysts, and market strategists are all over talking each other to get
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investors' attention. At the same time, individual investors, immersed in chat rooms and
message boards, are exchanging questionable and often misleading tips. Yet, despite all this
available information, investors find it increasingly difficult to profit. Stock prices skyrocket with
little reason, then plummet just as quickly, and people who have turned to investing for their
children's education and their own retirement become frightened. Sometimes there appears to
be no rhyme or reason to the market, only folly (Hagstrom, R.G. (2001), The Essential Buffet,
John Wiley & Sons, Inc. New York).
HISTORY OF NEPALESE STOCK MARKET

The history of the capital market in Nepal dates back to 1936, when, shares of Biratnagar Jute
Mills, Ltd. were floated. In 1937, Tejarath was set up to facilitate loans to the government
employees and was later converted into Nepal Bank Ltd. In 1974, the Nepalese government
announced its Industrial Policy, under which the Securities Marketing Center (SMC) was
established to deal in government securities-development bonds and national savings bonds, and
in corporate securities for a few companies. The government has had a virtual monopoly power
over the securities market.
Then, Securities Exchange Center (SEC) was established in 1976 for the purpose of facilitating
and promoting the growth of the capital market. It was the only capital market institution in
Nepal. The SEC has operated under the Securities Exchange Act since it came into force in 1984.
The interim government (1990-1991) initiated a financial reform program and two indirect
investment vehicles, the Citizen`s Investment Fund and NIDC Capital Markets Ltd.. were
established with the collective investment schemes in the corporate sector. Then, due to the
worldwide privatization and economic liberalization, it was felt that the operation of the SEC
needed to change so that it would be compatible with the changing economic system. Thus, in
1993, the government initiated changes in the structure of the SEC by dividing it at the policy
level into two distinct entities : the Securities Board, Nepal (SEBO/N) and the Nepal Stock
Exchange, Ltd. (NEPSE). Since that time they have been operating as the main constituents of
the securities market in Nepal.
SEBO/N was established on June 7, 1993 with the mission to facilitate the orderly development
of a dynamic and competitive capital market and maintain its credibility, fairness, efficiency,
transparency and responsiveness under the Securities Exchange Act. It registers the securities
and approves the public issues. Moreover, the SEBO/N frames the policies and programs
required to monitor the securities market, provide licenses to operate stock exchange businesses
and work as a stock broker and supervise and monitor the stock exchange operations and
securities businesspersons. NEPSE, Ltd. is a non-profit organization that operates under the
Securities Act, 2063. The basic objective of NEPSE is to impart free marketability and liquidity
to the government and corporate securities by facilitating transactions on its trading floor through
market intermediaries such as brokers and market makers, etc.
Nepal Stock Exchange Ltd. (NEPSE) opened its trading floor on January 13, 1994 through its
newly appointed licensed members and has adopted an open out-cry system for transactions
involving securities with trading hours from 12pm to 2pm. NEPSE currently has 227 listed
companies in 8 sectors ; there are 23 broker firms and 9 issues managers. The market
capitalization is Rs. 301.86 billion at mid-January of 2008, and trading hours have been extended
to 3pm. On August 24, 2007, NEPSE adopted an Automated Trading System through a Wide
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Area Network (WAN).

Despite these measures, the Nepalese stock market is not still taking its height. There is
desperate need for the profound improvement of this market.
GLIMPSE OF OF NEPALESE STOCK MARKET

In the last two decades, the number of listed companies at NEPSE has increased from 79 in
1995 to 237 in 2014/15. During the same period, market capitalization has increased from 5.9
percent to 54.8 percent of GDP.
The growth in the listed companies mostly comprises the financial institutions that were opened
following the liberal licensing policy of the NRB in the post-liberalization period. Existing
regulations require bank and financial institution to publicly float at least 30 percent of shares
and get listed in the stock exchange within a specific period of time. However there is no such a
mandatory requirement for companies in the real sector. As such very few real sector companies
have been listed in the stock market. The Nepalese stock market, thus, has been dominated by
the banking sector and financial institutions. This domination is reflected in major stock market
indicators, such as the amount of share traded, number of share traded and market capitalization.
As of July 2015, there were 182 (76 %) financial institutions out of 237 listed companies in
NEPSE. Similarly, banks and financial institutions comprised 64.3 percent of the total market
capitalization followed by insurance (13.3 percent) and hydropower (8.7 percent).
As per the securities listing regulation 2053, rule 14(2), Nepal Stock Exchange classifies
companies that fulfill the following conditions under A category:
1. Paid up capital of at least 2 crores
2. Minimum of 1000 general shareholders (Excluding promoters)
3. Continuously in profit for past 3 years
4. Book value of shares not less than par value
5. Submitted the audited financial statements of the last completed fiscal year within 6
months of the end of the fiscal year
Since the start of classifying listed companies from the fiscal year 2053/54, the number of A
class listed companies have increased from 7 (in 2053/54) to 114 (in 2071/72).
Fiscal Year
2053/54
2054/55
2055/56
2056/57
2057/58
2058/59
2059/60
Table : No. of A class listed companies in Nepal

Number of Fiscal Year Number of Fiscal
Companies
Companies Year
2060/61
43
2067/68
7
2061/62
48
2068/69
15
18
2062/63
56
2069/70
23
2063/64
66
2070/71
26
2064/65
71
2071/72
31
2065/66
78
36
2066/67
94
Number of
Companies
117
133
120
130
114
The 114 out of 237 listed companies includes 25 companies in the Commercial bank group, 1 in
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others group, 3 from the Hudropower group, 1 from Hotel Group, 15 Insurance Companies, 23
Finance Companies & 46 Development Banks.
Nepalese financial system is characterized by small but a growing capital market. During the
past 14 years of its operation, securities market has witnessed three market phases of ups and
downs. The latest upswing started from the fiscal year 2002/03 and is continuing. During this
phase, Nepse index, the market indicator climbed from 205 to 621 (July 10, 2007). The market
capitalization of the listed stocks climbed from Rs. 35.24 billion to Rs. 169.05 billion during the
same period. During the past five years, capital mobilized through public issue and rights
offerings has been in the tune of Rs. 8.4 billion from 109 issues. In the fiscal year 2006/2007
alone, capital worth of Rs. 2.8 billion has been mobilized from 34 issues.
In spite of expansion in size, the securities market is yet to make quality transformation gaining
depth and maturity. The market lacks sectoral diversification of performing listed companies,
access to secondary trading services is limited , transparency and efficiency of the issuer and
market is not sufficient, capacity of the regulator, exchange and the players is limited, the market
is featured by active individual investors and the institutional investors are conspicuously absent.
The market infrastructures supporting the trading, clearing and settlement are not sufficient. Thus
the effort to build a dynamic market is going to be an ardent task requiring a lot of commitment
and efforts of the government, regulator, market place, maker players and the investors. The
vision for a new Nepal has to have an important place for a dynamic capital market. It should be
a market where issuers have choice to tap the funds at lower cost while people have choice to
invest in the securities with different risk and return. In essence, securities market is a
mechanism that delivers public access to ownership and share benefit from the investment. The
fund requirement to finance the establishment and expansion of corporate sector can
conveniently come from capital market as these entities venture to tap the opportunities in the
economy.
The vision of a vibrant capital market assumes that a country has respectable level of and visible
progress in countrys governance. Some aspects of governance like rule of law, effective tax
administration, and political stability to ensure consistency and continuity of economic policies,
directly impact the confidence of domestic and foreign investors in the market. The governance
parameter, particularly the market related ones, should be improved so as to make a meaningful
breakthrough in the capital market sector.
It is well understood that large number of intermediaries, institutions and professionals are the
players and advisors active in capital market. Regulations and laws governing the capital market
are diverse, numerous and complex too. At this point of time, Nepalese capital market is
focusing on reforming the laws, regulations and policies, building institutional capacity, above
all visualizing a dynamic capital market in order to tap the inherent potential and managing the
cross border issue and trading of securities.
MEASUREMENT OF MARKET CAPITALISATION IN NEPAL
Market capitalization of an individual company is the total assets of that individual company
available in the market. It is calculated multiplying the number of outstanding shares of a
company by its market per share price.
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In Nepal, the market capitalization is calculated by multiplying closing price with respective
outstanding number of shares of the company. The number of outstanding shares is sometimes
termed as the number of listed shares. Whenever, the term number of listed shares appears, we
should mean it as the number of outstanding shares.
The market capitalization is considered as an important secondary market indicator as it is
compared with the indicator of the economy. In terms of the mathematics the market
capitalization is expressed as
Market Capitalization = Number of Outstanding Shares * Closing Prices of Stock
If we add the market capitalization of all the companies listed in the stock exchange, we will get
the total market capitalization.
MEASURES OF DETERMINATION OF INDEX IN NEPAL
a. NEPSE Index
The Nepal Stock Exchange Index is a value weighted index of all shares listed at the Nepal Stock
Exchange and calculated on a daily basis (for the days the market remain open) at the closing
price. It is available on a daily basis from January 23, 1995 only, although Nepal Stock
Exchange (NEPSE) opened its trading floor through licensed member on January 13, 1994.
Beginning on August 29, 1999, Sunday trading sessions were eliminated.
The calculation of the NEPSE index is based on the concept of the market capitalization (sum of
the market capitalization of all the company listed in the Nepal Stock Exchange). If the ratio of
current period market capitalization to the base period market capitalization is multiplied by the
multiplier 100, we get the NEPSE index. This method of index calculation is called value
weighted method. This concept can be illustrated with a hypothetical example, considering 0 as
the base period and 1 as the current period as follows:
Companies Outstanding
Closing price
M. C.
M. C.
shares
At 0
At 1
At 0
At 1
time
time
time
time
A
1000
40
45
B
1200
35
50
C
1500
50
55
Total Market Capitalization (Total market value)
40,000
42,000
75,000
157,000
45,000
60,000
28,500
187,500
M.C. means Market Capitalization.

O. S. means outstanding shares
NEPSE Index =
NEPSE Index
*100
* 100
NEPSE Index for the time period 1 is 119.43 with reference to the base period 0.
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However in reality, the number of the listed companies keeps on changing, and the number of the
outstanding shares also keeps on changing as the company issues right shares or bonus shares or
common shares at the time of capital needs. How is the base period adjusted in such a dynamic
real world? The actual practice to adjust the base period is as follows:
Adjusted Base Period =(New Market Capitalization including new listing/ New Market
Capitalization excluding new listing )* Base Years Market Capitalization
This concept is illustrated by the following hypothetical example. First of all imagine that the
initial conditions of the outstanding shares and its prices are as follows:
Companies Outstanding shares
Closing
M. C. At 0 time
Prices
A
1000
40
40000
B
1200
35
42000
C
1500
50
75000
157000
M.C. means Market Capitalization.
Now suppose that the number of outstanding shares and the prices of the stocks at period 1
changed as presented below (company A issued 50 bonus shares and prices of the stocks
altered).
Companies
O.S.
O.S
Closing
New M. C.
New M. C.
At 0
At 1
Prices
excluding
including
Period
Period
At 1 period new listing
new listing
A
1000
1050
45
45000
47250
B
1200
1200
40
48000
48000
C
1500
1500
55
82500
82500
175500
177750
M.C. means Market Capitalization
O.S. means outstanding shares
Following the above adjustment formula,
Adjusted base year = 177750/175500 * 157000 = 159012.82
Now the NEPSE Index for period 1 is, (177750/159012.82) *100 = 111.78.
b. Float Index
NEPSE float index calculates index that is in concern to the general public. This index does not
include the promoter shareholder's shares and employee owned share which cannot be sold for
certain period of time.
As discussed earlier, majority of the Nepalese stock market is comprised of shares relating to
financial institutions. Out of these shares, most are owned by promoters that are rarely sold in the
stock market. Hence the NEPSE index computation taking all of the shares that are listed may
not be relevant to general public. Therefore this concept of calculation of float index to measure
the share transaction in the secondary market is useful one. NEPSE has taken the transaction of
August 24, 2008 as the base to calculate this index.
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c. Sensitive Index:
Sensitive index is the index calculated from the market capitalization of companies classified
under group A.
Sensitive Index = (Current MV of all shares listed in NEPSE under Group A/ MV of shares in
Base year )*100
(Base year is 11th September 2008)
d. Sensitive Float Index
Sensitive float index represents the market capitalization of securities of companies listed under
group A which are floated to public.
Sensitive Float Index = (Current MV of shares listed in NEPSE under Group A floated to
public/ MV of shares in Base year)*100
DETERMINANTS OF STOCK INDEX IN NEPAL
The NEPSE has strong positive relationship with inflation and growth of money supply, and
negative association with interest rate. It shows that people have been gradually taking stock
market as a hedge against inflation when there is ample liquidity available at a low interest rate.
More importantly, the NEPSE index has been found to be influenced by political and NRBs
policy.
The positive outlook for political stability has positive impact on stock index (Take Instance of
Constitution being drafted by the Constitution Assembly). Similarly change in NRBs monetary
& fiscal policy & policy on lending against collateral of share has significant impact on the
movement of stock index.
Hence, a positive political development with stability can promote share market further which
can play a vital role for financial intermediation and resource mobilization.
NRBs policy on lending, especially against share collateral has been effective in influencing
share market. This indicates the significant role of NRB in share market. As our share market is
also influenced by rumors, news and speculations, transparency should be increased in share
market by making easily accessible of information related to companies. Concerned authorities
should be proactive to clarify the gossips and rumors emerged in the market.
THE NEPSE OPERATION

Trading System
NEPSE operates on the NEPSE Automated Trading System (NATS), a fully screen based
automated trading system, which adopts the principle of an order driven market. Purchase & Sell
of Physical as well as dematerialized securities is done through NATS. The licenses share
brokers perform transactions on behalf of the customer.
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Market Timings
Trading on equities takes place on all days of week (except Saturdays and holidays declared by
exchange in advance). On Friday only odd lot trading is done.
The market timings of the equities are:- Market Open: - 12:00 PM Market Close: - 15:00 PM
Odd Lot Trading is done on Fridays. For Odd Lot Trading Market Timings are Market Open: 12:00 PM Market Close: - 13:00 PM
The exchange may however close the market on days other than schedule holidays or may open
the market on days originally declared as holidays. The exchange may also extend, advance or
reduce trading hours when it deems fit necessary.
Index-based Circuit Breakers
The index-based circuit breaker system applies at 3 stages of the NEPSE index movement of 3%,
4% and 5%.These circuit breakers when triggered bring about a trading halt in all securities.
In case of 3% movement either way, there would be a market halt for 15 minutes if the
movement takes place during first hour of trading i.e. 13:00 PM. In case this movement takes
after 13:00 PM there will be no trading halt at this level and market shall continue trading.
In case of 4% movement either way, there would be a market halt for half an hour if the
movement takes place before 14:00 PM. In case this movement takes after 14:00 PM there will
be no trading halt at this level and market shall continue trading.
In case of 5% movement in either way, trading shall be halted for the remainder of the day.
CENTRAL DEPOSITORY SYSTEM (CDS)

The depository is an organization where the securities of a shareholder are held in the form of
electronic accounts. The depository holds electronic custody of securities and also arranges for
transfer of ownership of securities through the modern system of effecting transfer of ownership
of securities by means of book entry on the ledgers of the depositary without the physical
movement of scrip's on the settlement dates. This system is known as scripless trading system.
The new system, thus, eliminates paper work. CDS is purely a settlement vehicle and will not
affect the trading in any manner whatsoever. Automatic facilities and transparent trading in
scrip's shortens the settlement period and ultimately contributes to the liquidity of investment in
securities. The principal function of a Central Depository System is to immobilize or dematerialize securities, assuring that the bulk of securities transactions are processed in bookentry form. CDS may also have the capability for trade clearance, safe custody and
settlement/post settlement processing of securities and information.
Players in the Central depository System
In general there are five players in the CDS; they are
i) Beneficial Owner-BO: - "Beneficial Owner" means the person who have opened their
Beneficial Owner Account with Central Depository Company for depositing their securities or
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instruments and who have held the securities and instruments which are capable of being
deposited in de-mat form.
ii) Depository:- A Depository is a service provider which takes custody of the listed securities
from the concerned securities owners and performing the jobs of maintaining their securities
account, performing clearing and settlement of the securities transaction including transfer of
securities and other similar jobs. Example: Central Depository System and Clearing Limited.
iii) Depository Participants/Member- DP/DM: - "Depository Participant" means securities
business person or the body corporate having membership of Central Depository Company. A
Depository Participants (DP) is an agent of the depository (CDS) who is authorized to offer
depository services to investors. According to CDS Service Regulation Rule-20, a Depository
Members (DM) shall be a Bank or Financial Institution, Stock Broker, Registrar and Transfer
Agent, custodian or such other entity as from time to time.
iv) Register and Transfer Agents-RTA: - "Registrar and Transfer Agent (RTA)" means any
person / body corporate, who on behalf of anybody corporate, maintains the records of holders of
securities issued by such body corporate and deals with all matters connected with the transfer
and redemption of its securities.
v) Stock Brokers: - A share broker is a regulated professional individual, who plays the role of
bridge between buyers and sellers of the shares and other securities in the stock exchange.
DEMATERIALIZATION OF SECURITIES
Dematerialisation is the process of converting physical shares into electronic format. An investor
who wants to dematerialise his shares needs to open a demat account with Depository
Participant. Investor surrenders his physical shares and in turn gets electronic shares in his demat
account. Depository Participant (DP) is the market intermediary through which investors can
avail the depository services. Depository Participant provides financial services and includes
organizations like banks, brokers, custodians and financial institutions.
Advantages of Demat
Dealing in demat format is beneficial for investors, brokers and companies alike. It reduces the
risk of holding shares in physical format from investors perspective. Its beneficial for brokers
as it reduces the risk of delayed settlement and enhances profit because of increased
participation.
From share issuing companys perspective, issuance in demat format reduces the cost of new
issue as papers are not involved. Efficiency and timeliness of the issue is also maintained while
companies deal in demat format.
There are a lot of other benefits, but lets focus on benefits with respect to common investor and
the same are listed below.
Demat format reduces the risk of bad deliveries
Time and money is saved as investors are not dealing in paper now. Investors need not
go to the notary, broker for taking delivery or submitting the share certificate
Liquidity is very high in case of demat format as whole process in automated.
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All the benefits of corporate action like bonus, stock split, rights etc are managed through
the depository leading to elimination of transit losses
Interest on loan against demat shares are less as compared to physical shares
Investors save stamp duty while transferring shares in demat format.
One needs to pay less brokerage in case of demat shares
Despite these advances, system failure is a major risk in case of demat securities.
PRESENT SITUATION OF CDS IN NEPAL
Nepali capital market has now moved on to the CDS system as physical trading of securities is
not allowed. From the establishment of CDS and Clearing Limited under the Companies Act
2063 in 2063 (promoted by Nepal Stock Exchange Limited) the Nepalese capital market has
moved to the paperless technology. Following is the status of CDSC ltd. As of mid-September
2015:
Registered Companies:
Full Demat Companies:
Registered Clearing Members:
Licensed Depository Participants:
Beneficial Owners' Demat Account:
No. of Shares in Demat Form:
Companies in Pipeline for Admission of
Securities:
DPs in Pipeline:
112
106
50
45
94,455
123,389,218
34
6
IPO & SECONDARY MARKET

a. Initial public offering (IPO)/Primary Market
An initial public offering, or IPO, is the first sale of stock by a company to the public. A
company can raise money by issuing either debt or equity.
It usually isn't possible to buy shares in a private company. You can approach the owners about
investing, but they're not obligated to sell you anything. Public companies, on the other hand,
have sold at least a portion of themselves to the public and trade on a stock exchange. This is
why doing an IPO is also referred to as "going public."
In an IPO, the proceeds from issue (and the cost of issue of Shares) goes to the issuing company.
In Nepal, IPOs are considered a less risky investment as we can see investors queued up for
application for purchasing these securities. However IPO is a risky investment for the individual
investor as it is difficult to predict what the stock will do on its initial day of trading or in the
future because there is often little historical performance data with which to analyze the
company. Also, many IPOs are issued by companies going through a transitory growth period
and are subject to additional uncertainty about their future values.
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An investor should read the prospectus (document that has to be published for information of
public in case of IPO as per the provisions of Securities Act, 2063 & Companies Act, 2063)
In 1999, near the peak of the crazed Dot.com bubble a prospectus was issued by a US company
called NetJ.com. It stated that: "The company is not currently engaged in any substantial activity
and has no plans to engage in such activities in the foreseeable future."
However, the $110 million capital raising was oversubscribed as profit crazed investors dived in.
NetJ's share price climbed 18 fold within months. But those who still held their NetJ shares in
the wake of the Dot.com bust lost their shirts. NetJ, not surprisingly, went belly up.
Process of issuance of securities in the IPO
a. Credit Rating
Where a credit rating is required by Rule 3 of Credit Rating Rules 2068, securities shall be
rated by a credit rating agency prior to their issuance. The rating shall have to specified in the
prospectus or other documents publicly issued for subscription of those securities.
b. Listing of securities
In Nepal, the company willing to sell its securities to the general public shall have to get
listed with Nepal Stock Exchange. Documents needed and points to be explained to apply for
listing are company objectives, ownership structure, memorandum of association, articles of
association and audited balance sheets and profit and loss accounts and annual reports for the
last three consecutive years to the Nepal Stock Exchange. Some documents like audited
financial statements and annual reports are mandatory to furnish to Nepal Stock Exchange at
the end of each year in order to renew the listed company. Listing of securities is governed
by the Securities Act 2063 in Nepal.
c. Issuance of Prospectus
Public issuer of securities shall have to prepare a prospectus, & publish the prospectus having
approved it by the Securities Board & getting the approved prospectus registered with the
Office of Company Registrar. The prospectus shall contain, amongst others, information
relating to capital of the issuer, major activities of the issuer, information pertaining to legal
action, financial position, general management & administration of the issuer & details of
expert preparing the prospectus. The directors signing the prospectus & the expert preparing
it shall be personally responsible for any false matters specified therein.
d. Receipt of application
The prospectus published shall specify the last date of submission of application. In
publishing prospectus for receipt of application for shares, more than 50% of the par value
should not be called on application (sec 27 of the Companies Act, 2063) except where
provided by law (BAFIA for example that requires 100% to be called on application) or
where the issuer is a company which have been in operation for at least three years which has
published its FS for last three years while publishing prospectus for collecting capital.
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e. Allotment of securities
Allotment of securities shall be done in line with the security allotment regulation, 2068. As
per that regulation at least 40% of the securities issued shall be allocated for small investors.
The allotment shall be done on a pro rata basis for investors on a group basis. In making such
a allotment, the proportion of each investor shall be rounded up.
b. Secondary market
Secondary market refers the capital market at which the securities are traded once a company
goes for IPO. After the IPO, the listed security is traded by general public in this market hence
this is referred as a secondary market. The major difference of this market is that no matter what
the trading price of security, no receipt of any amount goes to the issuer company. In Nepal,
secondary market is observed by the Nepal Stock Exchange Ltd., a public company established
under Securities Act 2063 under the oversight of SEBO/N.
PRIMARY MARKETS VS SECONDARY MARKETS

The securities / capital market is divided into two parts, namely, primary, and secondary stock
market. The relationship between these parts of the markets provides an insight into its
organization.
Differences between Primary and Secondary Markets
Nature of Securities: The primary markets deals with new securities, that is, securities, which
were not previously available and are, therefore, offered to the investing public for the first time.
The market, therefore, derives its name from the fact that it makes available a new book of
securities for public subscription. The secondary market, on the other hand, is a market for old
securities, which may be defined as securities, which have been issued already and granted stock
exchange quotation. The stock exchanges, therefore, provide a regular and continuous market for
buying and selling of securities.
Nature of Financing: Another aspect related to the separate functions of these two parts of the
securities market is the nature of their contribution to industrial financing. Since the primary
market is the concerned with new securities, it provides additional funds to the issuing
companies either for starting a new enterprise or for the expansion or diversification of the
existing one and, therefore, its contribution to company financing is direct. In contrast, the
secondary markets can in on circumstance supply additional funds since the company is not
involved in the transaction. This, however, does not mean that the stock markets does not have
relevance In the process of transfer of resources from savers to investors. Their role regarding the
supply of capital is indirect. The usual course in the development of industrial enterprise seem to
be that those who bear the initial burden of financing a new enterprise pass it on to others when
the enterprise becomes well established. The existence of secondary markets which provide
institutional facilities for the continuously purchase and sale of securities and, to that extent, lend
liquidity and marketability which play an important part in process.
Organizational Differences: The stock exchange have, physical existence and are located in a
particular geographical area. The primary market is not rooted in any particular spot and has no
geographical existence. The primary market has neither any tangible form i.e any administrative
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organizational setup like that of stock exchanges, nor is it subjected to any centralized control
and administration for the consummation of its business. It is recognized only by the services
that it renders to the lenders and borrowers of capital funds at the time of any particular
operation.
Similarities between Primary and Secondary Markets:
Nevertheless, in spite of organizational and functional differences, the primary market and the
stock exchanges are inseparably connected.
Listing: One aspect of this inseparable connection between them is listing of the share. The
securities issued in the primary market are invariably listed on a recognized stock exchange for
dealings in them. The practice of listing of new issues on the stock market is of immense utility
to the potential investors who can be sure that should they receive an allotment of new issues,
they will subsequently be able to dispose them off any time.
Control: The stock exchanges exercise considerable control over the organization new issues. In
terms of regulatory framework related to dealings in securities, the new issues of securities
which seek stock quotation/listing have to comply with statutory rules as well as regulations
framed by the stock exchanges with the object of ensuring fair dealings in them. If the new issues
do not conform to the prescribed stipulations, the stock exchanges would refuse listing facilities
to them. This requirement obviously enables the stock exchange to exercise considerable control
over the new issues market and is indicative of close relationship between the two.
Mutual Interdeendance: The markets for new and old securities are, economically, an integral
part of a single market the capital market. Their mutual interdependence from the economic
point of view has two dimensions. One, the behavior of the stock exchanges has a significant
bearing on the level of activity in the primary market and, therefore, its responses to capital
issues: Activity in the new issues market and the movement in the prices of stock exchange
securities are broadly related: new issues increase when share values are rising and vice versa.
The second dimension of the mutual interdependence of the two parts of the market is that the
prices of new issues are influenced by the price movement on the stock market. The securities
market represents an important case where the stock-demand-and-supply curves, as distinguished
from flow-demand-and-supply curves, exert a dominant influence on price determination. The
quantitative predominance of old securities in the market usually ensures that it is these, which
set the tone of the market as a whole and govern the prices and acceptability of the new issues.
Thus, the flow of new savings into new securities is profoundly influenced by the conditions
prevailing in the old securities market the stock exchange.
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MUTUAL FUND
Mutual fund is a pool money, collected from investor, and is invested according to certain
investment objectives.
An investment company that pools money from shareholders and invests in a variety of
securities, including stocks, bonds, and money market securities . A mutual fund ordinarily
stands ready to buy back (redeem ) its shares at their current net asset value, which depends on
the market value of the funds portfolio of securities at the time. Mutual funds generally
continuously offer new shares to investors.
Mutual fund is created when investors put their money together. It is therefore a pool of the
investors funds. The most important characteristic of a mutual fund is that the contributors and
the beneficiaries of the fund are the same class of people, namely the investors. The term mutual
means that investors contribute to the pool, and also benefit from the pool. There are no other
claimants to the funds. The pool of funds held mutually by investors is the mutual fund.
Mutual funds business is to invest the funds thus collected according to the wishes of the
investors who created the pool. In many markets these wishes are articulated as investment
mandates. Usually, the investors appoint professional investment managers, to manage their
funds. The same objective is achieved when professional investment managers create a
product and offer it for investment to the investor. This product represents a share in the pool,
and pre-states investment objectives. For example, a mutual fund, which sell a money market
mutual fund, is actually seeking investors willing to invest in a pool that would invest
predominantly in money market instruments.
Advantages of Mutual Funds
Investment in stocks, bonds and other financial instruments requires considerable expertise and
constant supervision, to enable an investor to take informed decisions. Small investors usually do
not have the necessary expertise and the time to undertake any study that can facilitate informed
decisions. While this is the predominant reason for the popularity of mutual funds, there are
many other benefits that can accrue to small investors. Some of the advantages are listed below:
a. Diversification benefits: Diversified investment improves risk-return profile of the portfolio.
Small investors may not have the amount of capital that would allow optimal diversification.
Since the corpus of a mutual fund is substantially big as compared to individual investments,
optimal diversification becomes possible. As the individual investors capital gets pooled into a
mutual fund, all of them are able to derive the benefits of diversification.
b. Low transaction costs: The transactions of a mutual fund are generally very large. These
large volumes attract lower brokerage commissions (as a percentage of the value of the
transaction ) and other costs, as compared to the smaller volumes of the transactions entered into
by individual investors. The brokers quote a lower rate of commission due to two reasons. The
first is competition for the institutional investors business. The second reason is that the
overhead costs for executing a trade does not differ much for large and small orders. Hence for a
large order, these costs spread over a larger volume, enabling the broker to quote a lower
commission rate.
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c. Availability of various schemes: Mutual fund generally offer a number of schemes to suit the
requirements of the investors. Thus the investors can choose between regular income schemes
and growth schemes, between schemes that invest in the money market and those that invest in
the stock market, etc. Some schemes provide some added advantages. For example, automatic
reinvestment schemes reinvest the distributed income automatically, thus making the
management of funds easier. In case direct investment in securities, the reinvestment of income
in the same proportion as the assets held, is very difficult, and something impossible. Funds that
invest in overseas markets offer the additional advantage of international diversification, which
may otherwise not be feasible to the investor.
d. Professional management : Management of a portfolio involves continuous monitoring of
various securities and the innumerable economic and non-economic variables that may affect the
portfolios performance. This requires a lot of time and effort on the part of the investor, along
with in-depth knowledge of the functioning of the financial markets. Mutual funds are generally
managed by knowledgeable, experienced professionals whose time is solely devoted to tracking
and updating the portfolio. Thus, investment in a mutual fund not only saves time and efforts for
the investor, it is also likely to produce results.
e. Liquidity: Liquidating a portfolio is not always easy. There may not be a liquid market for all
the securities held. In case only a part of the portfolio is required to sell then all the securities
forming part of the portfolio should be sold in the same proportion as they are represented in the
portfolio. These problems can be solved by investing in a mutual fund. A mutual fund generally
stands ready to buy and sell its units on a regular basis. Thus, it is easier to liquidate holdings in a
mutual fund as compared to direct investment in securities.
Disadvantages of Mutual Funds
Investment in mutual funds has its disadvantages as well. For one, the investors cannot choose
the securities they want to invest in, or the securities they want to sell . secondly, the investors
face the risk of the fund manager not performing well. Also, if the fund managers compensation
is linked to the funds performance, he may be tempted to show good results in the short-term
without paying attention to the expected long-term performance, of the fund. This would harm
the long-term interests of the investors. Another disadvantage of investing in mutual funds is the
management fees charged by the fund. It reduces the returns available to the investors. Lastly,
while investors in securities can decide the amount of earnings they want to withdraw in a
particular period, investors in a mutual fund have no such discretion as the amount to earnings
that are to be received to the investors in a particulars year .
PRECAUTIONS WHILE INVESTING IN MUTUAL FUNDS

The following are usual precautions investors should take:
a. Always keep a photocopy of the application form. This can be filed to know the manner in
which application was made (single, joint ownership and order of ownership). Investors will
also be able to see how they have signed the forms (many investors change their signatures
over time; some investors use both Nepali and English signatures; some investors have
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b.
c.
d.
e.
f.
different signatures for banking and investment transactions). Investors will also know the
choice they have exercised (dividend and redemption options).
Preserve the counterfoil /acknowledgement issued by the collecting agency. The
acknowledgement provided by collecting agency usually has the application number. If
account statement or certificate is not received, the acknowledgement is the proof of
purchase, with which investors can approach the registrar agent.
It is preferable to have joint ownership. While making the investment, joint ownership is
preferable so that investments will pass on to the joint owner in the event of death of the first
holder.
It is important to fill up nomination details in the application. This will enable legal
heirs to claim the holdings without procedural delays. Nominations that do not indicate the
guardian of a minor are not valid. Guardian indicated will have to be a person other than the
holders of the investment.
Cheques should be crossed and application number and name should be written on the
back of the cheque. Most of the mutual funds do not accept post dated cheques (with the
exception of specific investment plans ) or postal orders.
Existing investment can quote their unique account or folio numbers so that their
holdings will be consolidated. This is helpful in tax matters and in keeping investment
information in a consolidated manner.
How do mutual funds help the financial planning objectives of investors?

Though the categories of products offered can be classified under about a dozen generic heads,
investors in the mutual fund industry have a choice of different product . It is also possible for
investors to decide the manner in which their returns would be distributed, and choose from
daily, monthly, quarterly or annual payouts; or re-investment of dividends into the mutual fund
product itself; or a growth option that would seek growth in investment over distribution of
income. The most important benefit of product choice is that it enables investors to choose
options that suit their requirement and risk appetite. Investors can combine the options to arrive
at their own mutual fund portfolios that fit with their financial planning objectives.
How does a mutual fund reduce risks for the investor?

Mutual funds invest in a portfolio of securities. This means that all funds are invested in the
diversified investment avenue. It is well known that risk and returns of various investment
options do not move uniformly or in sympathy with one another. If a manufacturing company
share is going down, then an oil companys shares could be moving up; if the equity market is
moving down, the debt markets may be moving up. Therefore holding a portfolio that is
diversified across investment avenues is a wise way to manage risk. When such a portfolio is
liquid and marked to market, it enables investors to continuously evaluate the portfolio and
manage their risks more efficiently.
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What does the professional management of a mutual fund mean, to the investor?
a. Mutual funds are managed by investment managers (asset management companies or
AMCs) who are appointed by trustees and bound by the investment management
agreement, specifying the duties and responsibility on investment management
functions.
b. AMCs are also required to be adequately, and are closely regulated by SEBL. AMCs
competing for funds under management therefore bring in significant professional
expertise and are bound by regulatory and trustee supervision.
c. AMCs are prohibited by regulation to indulge in any other business.
d. Regulations also ensure that trustees are able to monitor the performance of AMCs, and
there are a number of safeguards and prudential regulations in the interest of investors.
e. Investment managers are also bound by the AMFI code of ethics, which foster
professional standards in the industry.
What information does the mutual fund usually provide to the investor?
Mutual funds inform investors periodically, about the performance of the fund. They disclose the
NAVs daily and in most cases this information is available on phone and on the internet. The
complete portfolio of the fund, and commentaries of the fund managers on how they are
managing the fund, are also available to investors.
Many mutual funds also provide additional information on the maturity portfolio of their
investments, credit quality of their portfolios, and the behavior of NAV over the period, since
inception of the fund. Investors can make informed decisions about their mutual fund
investments, from these disclosures made by funds.
EVALUATING PERFORMANCE OF MUTUAL FUNDS
(1) Net Asset Value (NAV)
This is the value per unit of a scheme on a particular day, called the valuation day. It is the value
of net assets of the fund. The investors subscription is treated as the capital in the balance sheet
of the fund and the investments on their behalf are treated as their assets. Using the formula
given below, we calculate the NAV of a mutual fund unit.
NAV=
Since investments are marked to market , the value of the investments for computing NAV will
be at market value. NAV of MF are published daily in the newspapers and electronic media and
play an important role in investors decision to buy or sell their units. Analysts use NAV to find
yield on the schemes.
Net Asset value or NAV of a mutual fund is the value of one unit of investment in the fund, in
net asset terms. It is computed by dividing the net assets of the fund by the number of units that
are outstanding in the books of the fund.
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Example 1: Consider a mutual fund that collects NRS 10 crore by issuing units of NRS 10 each.
Therefore when the mutual fund begins operations, it would have 1,00,00,000 units of NRS 10
each. Let us assume that the portfolio in which these funds are invested is as follows.
NRS
Equity shares
4,50,00,000
Government bonds
3,00,00,000
Corporate bonds
1,50,00,000
Money market instruments
1,00,00,000
Total assets
10,00,00,000
After 30 days, the fund is scheduled to open for fresh sales as repurchases. The investors who
come into the fund, will buy new units at a price that represents the value of the underlying
portfolio. Similarly, investors who redeem their units will do so at a price that reflects the current
value of the portfolio in which they originally invested.
Before making the investment, current portfolio will have to be valued again, to ascertain what
its current value is. In the firm, the mutual fund would have incurred expenses, earned incomes,
which also will have to be reflected to the price per unit. We call these charges as accrued
income and accrued expenses. Mutual funds have annual accounting policies that enable the
computation of these accruals. Let us assume that the status of investments at the end of the 30
days is as follows.
NRS
Equity shares
6,50,00,000
Government bonds
2,80,00,000
Corporate bonds
1,20,00,000
Money market instruments
1,00,00,000
Total assets
11,50,00,000
The value of the investments has changed with the increase in value of asset by using market
prices, as marking to marking. Let us assume that the accrued income and expenses are NRS
10000 and NRS 1,35,000 respectively. Let us also assume that the level of current assets and
current liabilities were NRS 4,00,000 and NRS 300000 respectively.
The net assets of the fund can be computed as follows:
Market value of the investments
Current assets
Current income
Current liabilities
Accrued expenses
Net asset of the fund
11,50,00,000
4,00,000
1,00,000
3,00,000
1,35,000
11,55,00,000
11,50,65,000
11,50,65,000
Since the number of units is 1,00,00,000 the net asset value on this date will be NRS
11,50,65,000. The price at which new investors can buy the units, and existing investors can
redeem their units will be based on this number.
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Factors that affect the NAV of a fund

The major factors affecting the NAV of a fund are:
Sale and purchase of securities
Sale and repurchase of units
Valuation of assets
Accrual of income and expenses
The NAV of a fund is primarily affected by the market value of the investment portfolio. The
number of units outstanding, the accrual of expenses and income , are other factors that impact
the NAV of fund.
Costs incurred by Mutual fund
Cost when high reduce the returns of an investor. High costs are the cause of below par
performance of some mutual funds. Costs carry two components:
(1) Initial expenses attributable to establishing a scheme under a fund and
(2) Ongoing recurring expenses (Management Expense Ratio) which is made up of
(a) cost of employing technically sound investment analysts
(b) Administrative costs
(c) Administrative costs involving promotion and maintenance of scheme funds.
The Management Expense Ratio is measured as a % of average value of assets during the
relevant period.
If Expense are expressed in per unit, then

Expense Ratio
The Expense Ratio relates to the extents of assets used to run the mutual fund. It is inclusive of
travel cost, management consultancy and advisory fees. It however excludes brokerage expenses
for trading as purchase is recorded with brokerage while sales are recorded without brokerage.
COMPUTATIONS OF RETURNS
Investors derive three types of income from owning mutual fund units
1. Cash Dividend
2. Capital Gains Disbursements
3. Changes in the funds NAV per units
For an investor who holds a mutual fund for one year, the one-year holding period return is given
by
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Where
D1= Dividend,
CG1= Realised Capital Gains,
NAV1-NAV0= Unrealised Capital Gains,
NAV0 = Base Net Asset Value.
Holding Period Return (HPR)
A simple but effective measure of performance is to describe mutual fund return in terms of the
following three major sources.
(a) Dividend Earned
(b) Capital Gain Distribution /Earned
(c) Change in price of NAV.
In case investment is held for a period less than one year, then pay offs can be easily converted
converted into returns by using Holding period Return (HPR) formula, which, which is as
follows:
)
Net Asset Value Of A Mutual Fund

This is the value per unit of a scheme on a particular day, called the valuation day. It is the value
of net assets of the fund. The investors subscription is treated as the capital in the balance sheet
of the fund and the investments on their behalf are treated as assets. The NAV is calculated for
every scheme of the MF individually. The Net Asset Value (NAV) is : (Net assets of the scheme
)/ Number of units outstanding Net asset of the scheme will normally be:
Market value of investment+ Receivables + Accrued Income + other Assets Accrued Expenses
Payables Other liabilities.
The Net Asset Value (NAV) is also calculated as follows:
The value of portfolio is the aggregate value of different investments. The securities and
Exchange Board of India (SEBI) has notified certain valuation norms calculating net asset value
of Mutual fund schemes separately for traded and non- traded schemes. Since investments by
Mutual fund are marked to market, the value of the investments for computing NAV will be at
market value.
NAV of a MF Scheme are published on a daily basis in the newspaper and electronic media and
play an important role in investors decision to enter or to exit. Analysts use the NAV to
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determine the yield on the schemes.

Example: Shri Abhay Charaji invested NRS 1,000 in a close ended MF; the NAV at the time of
investment was NRS 15 and it was being traded in the stock Exchange at a premium of 1%.
During the year the fund paid a dividend of NRA 2 per unit. The investor sold the investment in
the stock exchange after receiving the dividend. His return is NRS 2 per unit. The Assume that at
the time of sale in the stock exchange i.e. six months after the date of investment, the units were
being traded in the market at 2%discount. What was the NAV at the time of sale?
Solution :
No. of units purchased
=66.0066
Total investment =1000

Return of 20%
The wealth at the end of 6 months period
Dividend in cash
=2 *66.0066
Sale proceeds of 66.0066 units = 1100 -132
= NRS 1,100
= 132
= NRS 968
Sale proceeds per unit
= NRS 14.67
Let NAV =X
X-0.02X = NRS 14.67
X= NRS 14.96
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PAPER 5: COST AND MANAGEMENT ACCOUNTING
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CHAPTER 1: COST CONCEPTS AND COSTING METHODS

1.9 COST, EXPENSES AND LOSS
Cost
Cost is the amount of expenditure, actual (incurred) or notional (attributable), relating to a
specific thing or activity. The specific thing or activity may be a product, job, service, process or
any other activity.
Cost is the amount of resources given up in exchange for some goods or services. The resources
given up are generally in terms of money or, if not in terms of money, they are always expressed
in monetary terms. The term cost itself is without any significant meaning and, therefore, it is
always advisable to use it with an adjective or phrase that will convey the meaning intended,
such as prime, direct, indirect, fixed, variable, controllable, opportunity, imputed, sunk,
differential, marginal, replacement and the like. Each such adjective or description implies a
certain attribute or characteristic which is important in computing, measuring and analyzing the
cost.
Basically, when a cost is incurred, it could be in the form of deferred cost (asset) or expired cost
(expense). Deferred costs are unexpired cost, capitalized costs, which provide benefits in the
future periods and known as assets and hence appear on the balance sheet. Examples of deferred
or unexpired costs are plant, equipment, building, inventory, prepaid rent and insurance. When
these deferred costs (assets) are used up, to the extent used, they become expenses and appear on
the income statement and are deducted from revenues. Expired costs are costs which have been
used up totally in generating revenue. They are not capitalized but only shown as expenses on
income statement.
Expenses
Expenses are expired costs, incurred and totally used up in generating of revenue. Examples of
expired costs are costs of goods sold expense, selling administrative expenses. Expenses need
not necessarily have to be paid in cash immediately, even a promise to pay could be made for the
benefits obtained. The manufacturing costs are capitalized in the form of finished goods
inventory and when a sale is made, they expire (becoming expenses). The cost of unsold
inventory which was an asset earlier, now becomes expenses (cost of goods sold) as it has
contributed to the generation of revenue.
Factory (or manufacturing) overhead is treated as cost (an asset) because this is included in the
cost of finished goods inventory which is an asset unless sale is made. Selling and administrative
expenses, when not included in the cost of finished goods inventory, are treated only as expense
and not cost (asset). Factory overheads are assets because they are supposed to add utility to the
goods manufactured. For example, depreciation of a factory machine increases the utility of the
goods manufactured which are therefore, included in work-in-progress and finished goods
inventory. But selling and distribution overheads do not add to the utility of goods manufactured
and are treated merely as expenses and are deducted from revenues whenever incurred.
Similarly, depreciation of a factory building is a cost, but depreciation of an office building is an
expense.
Loss
Loss is lost cost. The term loss is used to describe mainly two accounting events. In traditional
188
financial accounting it is used to denote a situation where expenses exceed revenues for an
accounting period. That is the opposite of net income (earnings) for the accounting period.
Secondly, a loss arises due to the cost of an asset being more than the sale proceeds when the
asset is sold. This unfavorable event does not arise from a normal business activity but from nonoperating transactions or events. This definition of loss is used to identify the opposite of a gain.
That is if no benefit is received from the cost incurred or it becomes definite that no benefit will
accrue, the cost becomes a lost cost, that is, loss.
Loss is unrelated to revenue generation and is only offset against revenue of the period in which
the loss occurred. Examples of loss are, loss on sale of fixed asset, loss of a stock due to fire.
1.10 RELATIONSHIP BETWEEN COST ACCOUNTING, FINANCIAL

ACCOUNTING, MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT
Cost Accounting is a branch of accounting, which has been developed because of the limitations
of Financial Accounting from the point of view of management control and internal reporting.
Financial accounting performs admirably, the function of portraying a true and fair overall
picture of the results of activities carried on by an enterprise during a period and its financial
position at the end of the year. Also, on the basis of financial accounting, effective control can be
exercised on the property and assets of the enterprise to ensure that they are not misused or
misappropriated. To that extent financial accounting helps to assess the overall progress of a
concern, its strength and weaknesses by providing the figures relating to several previous years.
Data provided by Cost and Financial Accounting is further used for the management of all
processes associated with the efficient acquisition and deployment of short, medium and long
term financial resources. Such a process of management is known as financial management. The
objective of financial management is to maximize the wealth of shareholders by taking effective
investment, financing and dividend decisions. Investment decisions relate to the effective
deployment of scarce resources in terms of funds while the financing decisions are concerned
with acquiring optimum finance for attaining financial objectives. The last and very important
Dividend decision related to the determination of the amount and frequency of cash which can
be paid out of profits to shareholders.
Management Accounting refers to managerial processes and technologies that are focused on
adding value to organizations by attaining the effective use of resources, in dynamic and
competitive contexts. Hence, Management Accounting is distinctive form of resource
management which facilitates managements decision making by producing information for
managers within an organization.
1.11 CLASSIFICATION OF COSTS, COST CENTERS AND COST UNIT
1.11.2 COST UNIT AND COST CENTER
The technique of costing involves the following:
Collection and classification of expenditure according to cost elements
Allocation and apportionment of the expenditure to the cost centers or cost units or both
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Cost Unit
While preparing cost accounts, it becomes necessary to select a unit with which expenditure
may be identified. The quantity upon which cost can be conveniently allocated is known as a
unit of cost or cost unit. The Chartered Institute of Management Accountants, London
defines a unit of cost as a unit of quantity of product, service or time in relation to which
costs may be ascertained or expressed.
Unit selected should be unambiguous, simple and commonly used. Following are the
examples of units of cost:
(i) Brick works
per 1000 bricks made
(ii) Collieries
per ton of coal raised
(iii) Textile mills
per yard or per lb. of cloth manufactured or yarn spun
(iv) Electrical companies
per unit of electricity generated
(v) Transport companies
per passenger km.
(vi) Steel mills
per ton of steel made
Cost Center
According to the Chartered Institute of Management Accountants, London, cost center means
a location, person or item of equipment (or group of these) for which costs may be
ascertained and used for the purpose of cost control. Thus, cost center refers to one of the
convenient units into which the whole factory or an organization has been appropriately
divided for costing purposes. Each such unit consists of a department, a sub-department or an
item or equipment or machinery and a person or a group of persons. Sometimes, closely
associated departments are combined together and considered as one unit for costing
purposes. For example, in a laundry, activities such as collecting, sorting, marking and
washing of clothes are performed. Each activity may be considered as a separate cost center
and all costs relating to a particular cost center may be found out separately.
Cost centers may be classified as follows:
Productive, unproductive and mixed cost centers
Personal and impersonal cost centers
Operation and process cost centers
Productive cost centers are those which are actually engaged in making products. Service or
unproductive cost centers do not make the products but act as the essential aids for the
productive centers. The examples of such service centers are as follows:
Administration department
Repairs and maintenance department
Stores and drawing office department
Mixed costs centers are those which are engaged sometimes on productive and other times on
service works. For example, a tool shop serves as a productive cost center when it
manufactures dies and jigs to be charged to specific jobs or orders but serves as servicing
cost center when it does repairs for the factory.
Impersonal cost center is one which consists of a department, a plant or an item of equipment
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whereas a personal cost center consists of a person or a group of persons. In case a cost
center consists of those machines or persons which carry out the same operation, it is termed
as operation cost center. If a cost center consists of a continuous sequence of operations, it is
called process cost center.
In case of an operation cost center, cost is analyzed and related to a series of operations in
sequence such as in chemical industries, oil refineries and other process industries. The
objective of such an analysis is to ascertain the cost of each operation irrespective of its
location inside the factory.
CHAPTER 2: MATERIAL CONTROL
2.8.2 Treatment of normal loss and abnormal loss materials
Whichever method may be adopted for pricing materials, certain difference between the book
balance and the value of physical stock are bound to occur. These differences which may be a
gain or loss should be transferred to Inventory Adjustment Account pending investigation. If
upon investigation, they are regarded as normal, they should be transferred to overhead control
Account; if abnormal, they should be written off to the Costing Profit and Loss Account.
In the case of normal losses, an alternative method used to price per unit of material so at to
cover the normal loss can be understood with the help of the example considered. Suppose 1,000
meters of gunny cloth are purchased at Rs. 2 per meter. It is expected that 1% would be the
normal loss due to issues being made in small lots. The inflated price would be Rs. 2.02.i.e., (Rs.
2,000 for 990 meters). The rate of Rs. 2.02 per meter of gunny cloth covers the cost of normal
loss as well.
2.8.3 Accounting of waste, scrap, spoilage and defectives
Waste
It represents the portion of basic raw materials lost in processing having no recoverable value.
Waste may be visible remains of basic raw materials or invisible, e.g. disappearance of basic
raw materials through evaporation, smoke etc. Shrinkage of material due to natural causes may
also be a form of a material wastage.
Normal waste is absorbed in the cost of net output, whereas abnormal waste is transferred to the
Costing Profit and Loss Account.
For effective control of waste, normal allowances for yield and waste should be made from past
experience, technical factors and special features of the material process and product. Actual
yield and waste should be compared with anticipated figures and appropriate actions should be
taken where necessary. Responsibility should be fixed on purchasing, storage, maintenance,
production and inspection staff to maintain standards. A systematic procedure for feedback of
achievement against laid down standards should be established.
Scrap
It has been defined as incidental residue from certain types of manufacture usually of small
amount and low value, recoverable without further processing. Scrap may be treated in cost
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accounts in the following ways:(i)

Where the value of scrap is negligible, it may be excluded from costs. In other words, the
cost of scrap is borne by good units and income of scrap is treated as other income.
(ii)
The sale value of scrap net of selling and distribution cost, is deducted from overhead to
reduce the overhead rate. A variation of this method is to deduct the net releasable value
from material cost. This method is followed when scrap cannot be aggregated job or
process-wise.
(iii) When scrap is identifiable with a particular job or process and its value is significant, the
scrap account should be charged with full cost. The credit is given to the job or process
concerned. The profit or loss in the scrap account, on realization, will be transferred to
the Costing Profit and Loss Account.
Control of scrap means the maximum effective utilization of raw material. Scrap control does
not, therefore, start in the production department; it starts from the stage of product designing.
Thus the most suitable type of materials, the right type of equipment and personnel would help in
getting maximum quantity of finished product from a given raw material.
A standard allowance for scrap should be fixed and actual scrap should be collected, recorded
and reported indicating the cost center responsibility for it. A periodical scrap report would serve
the purpose where two or more departments or cost centers are responsible for the scrap; the
report should be routed through the departments concerned.
Spoilage
It is the term used for materials which are badly damaged in manufacturing operations and they
cannot be rectified economically and hence taken out of process to be disposed of in some
manner without further processing. Spoilage may be either normal or abnormal.
Normal spoilage (i.e., which is inherent in the operation) costs are included in costs either
charging the loss due to spoilage to the production order or by charging it as production overhead
so that it is spread over all products. Any value realized from spoilage is credited to production
order or production overhead account, as the case may be.
The cost of abnormal spoilage (i.e., arising out of causes not inherent in manufacturing process)
is charged to the Costing Profit and Loss Account. When spoiled work is the result of rigid
specification, the cost of spoiled work is absorbed by good production while the cost of disposal
is charged to production overhead.
To control spoilage, allowance for normal spoilage should be fixed and actual spoilage should be
compared with standard set. A systematic procedure of reporting would help control over
spoilage. A spoilage report should highlight the normal and abnormal spoilage, the department
responsible, the causes of spoilage and the corrective action taken, if any.
Defectives
It signifies those units or portions of production which can be rectified and turned out as good
units by the application of additional material, labor or other service. For example, some
mudguards produced in a bicycle factory may have dents; or there may be duplication of pages
or omission of some pages in a book. Defective arises due to sub-standard materials, badsupervision, bad-planning, poor workmanship, inadequate-equipment and careless inspection. To
some extent, defective may be unavoidable but usually, with proper care it should be possible to
avoid defect in the goods produced.
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Reclamation of loss from defective units

In the case of articles that have been spoiled, it is necessary to take steps to reclaim as much of
the loss as possible. For this purpose:
(i) All defective units should be sent to a place fixed for the purpose;
(ii) These should be dismantled;
(iii) Goods and serviceable parts should be separated and taken into stock;
(iv) Parts which cannot be made serviceable should be collected in one place for being melted
or sold.
Printed forms should be used to record quantities for all purposes aforementioned.
Control on the defective work
When defectives are found, the Inspector will make out the Defective Work Report, giving
particulars of the department, process or job, defective units, normal and abnormal defectives ,
cost of rectification etc. On receipt of the defective Work Report, it may be decided to rectify the
defective work; all costs of rectification are collected against the rectification work order,
precaution will be taken to see that number of defectives is within normal limits.
Treatments of Defectives
Defectives are generally treated in two ways: either they are brought up to the standard by
incurring further costs on additional material and labor or where possible, they are sold as
inferior products (seconds) at lower prices. The following illustration is given to explain the
accounting procedure followed in either case.
Total expenses of manufacture
Rs. 5,000
Output
good: 450 units
Defective: 50 units
Cost of rectifying defectives
Rs. 50
Cost per unit of production = (Rs.5,000+ Rs.50)/500 = Rs. 10.10 per unit
If defectives are not rectified but sold as seconds say, @ Rs. 8 each then cost of goods
produced will be = (Rs.5,000 - Rs.400)/450 = Rs. 10.22 per unit
Distinction between spoilage and defectives:
The difference between spoilage and defectives is that while spoilage cannot be repaired or
reconditioned, defectives can be rectified and transferred, either back to standard production or
to seconds.
Treatment of spoilage and defectives in Cost Accounting Under cost accounts, normal spoilage costs i.e. (which is inherent in the operation) are included
in cost either by charging the loss due to spoilage to the production order or charging it to
production overhead so that it is spread overall products. Any value realized from the sale of
spoilage is credited to production order or production overhead account, as the case may be. The
cost of abnormal spoilage (i.e., arising out of causes not inherent in manufacturing process) is
charged to the Costing Profit and Loss Account. When spoiled work is the result of rigid
specifications the cost of spoiled work is absorbed by good production while the cost of disposal
is charged to production overheads.
The problem of accounting for defective work is the problem of accounting of the costs of
rectification or rework.
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The possible ways for the treatment of defectives work are as below:
(i) Defectives that are considered inherent in the process and are identified as normal can be
recovered by using the following methods:
a. Charged to good products The loss is absorbed by good units. This method is used
when seconds have a normal value and defective rectified into seconds or first are
normal;
b. Charged to general overheads When the defective caused in one department are
reflected only on further processing, the rework costs are charged to general overheads;
c. Charged to Department overheads if the department responsible for defectives can be
identified then the rectification costs should be charged to that department.
d. Charged to Costing Profit and Loss Account If defectives are abnormal and are due
to causes beyond the control of organization, the rework cost should be charged to
Costing Profit and Loss Accounts
(ii) Where defectives are easily identifiable with specific jobs, the work costs are debited to the
job.
Procedure for the control of Spoilage and Defectives
To control spoilage, allowance for a normal spoilage should be fixed up and actual spoilage
should be compared with standard set. A systematic procedure of reporting would help control
over spoilage. A spoilage report (as below) would highlight the normal and abnormal spoilage,
the department responsible, the causes of spoilage and the corrective action taken if any.
Control of defectives may cover the following two areas:

Control over defective produced
Control over reworking costs
For exercising effective control over defectives produced and the cost of reworking, standards
for normal percentage of defectives and reworking costs should be established.
Actual performance should be compared with the standards set. Defective Work Report (as
shown on below page should be fed back to the respective Centers of control).
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Losses due to obsolete stores

Obsolescence are defined as the loss in the intrinsic value of an asset due to its supersession.
Materials may become obsolete under any of the following circumstances:
(i) Where it is a spare part or a component of a machinery used in manufacture and that
machinery becomes obsolete;
(ii) Where it is used in manufacture of a product which has become obsolete;
(iii) Where the material itself is replaced by another material due to either improved quality
or fall in price.
In all three cases, the value of the obsolete material held in stock is a total loss and immediate
steps should be taken to dispose it off at the best available price. The loss arising out of obsolete
materials on abnormal loss does not form part of the cost of manufacture. Losses due to
obsolescence can be minimized through careful forethought and reduced stocking of spares, etc.
Stores records should be continuously through-to-see whether any item is likely to become
obsolete. There will be such likelihood if an item has not been used for a long time. (This does
not apply to spare parts of machines still in use).
2.9 JUST IN TIME (JIT)
Just in time (JIT) is a purchasing and inventory control method in which materials are obtained
just in time for production to provide finished goods just in time for sale. There are two aspects
of JIT: (i) JIT Production, and (ii) JIT Purchasing. JIT with regard to production means
producing only what is needed, when it is needed, in the quantity just needed. A JIT
manufacturing system requires making goods or services only when the customer, internal or
external, requires it. According to CIMA official Terminology:
JIT is a technique for the organization of work flows, to allow rapid, high quality, flexible
production whilst minimizing manufacturing waste and stock level. Further, CIMA defines JIT
production as a system which is driven by demand for finished products, whereby each
component on a production line is produced only when needed for the next stage.
JIT purchasing requires better coordination with suppliers so that materials arrive immediately
prior to their use. Firms using JIT purchasing enter long term contracts with them to enable
vendors to plan their annual production. Under JIT purchasing, EOQ is much lower as compared
to EOQ under conventional purchasing. JIT purchasing provides significant savings in cost.
JIT aims to achieve the following objectives:
(i) Zero inventory
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(ii) Zero breakdown

(iii)100% on time delivery service
(iv) Elimination of non-value added activities
(v) Zero defects
JIT is a demand-pull system. Demand for customer output (not plans for using input resources)
triggers production. Production activities are pulled not pushed into action. The major
differences between JIT manufacturing and traditional manufacturing are as follows:
JIT
1 Pull system
2. Insignificant or Zero inventories
3. manufacturing cells (work centers)
4. multifunction labor
5. Total quality management (TQM)
6. Simple cost accounting
Traditional
1. Push system
2. Significant inventories
3. Process structure
4. Specialized labor
5. Acceptable quality level(AQL)
6. complex cost accounting
JIT production and JIT purchasing reduces or eliminates inventory and the costs associated with
carrying the inventory. JIT emphasizes that workers immediately correct the system making
defective units because they have no inventory. With no inventory to draw from for delivery to
customers, JIT relies on high quality materials and production. It is required that the companies
that use just-in-time manufacturing must eliminate all the sources of failure in the system.
Production people must be better trained so that they can carry out their works without errors.
Suppliers must be able to produce and deliver defect free materials or components just when they
are required, and equipment must be maintained so that machine failures are eliminated.
JIT applies to raw materials inventory as well as to work-in-progress inventory. The goals are
that both raw materials and work in-progress are held to absolute minimums. JIT is used to
complement other materials planning and control tools, such as EOQ and safety stock levels. In
JIT system, production of an item does not commence until the organization receives an order.
When an order is received for a finished product, productions people give orders for raw
materials. As soon as production is complete to fill the order, production ends. In theory, there is
no need for inventory in JIT because no production takes place until the organization knows that
it will sell them. In practice, however, companies using JIT inventory generally, have a backlog
of orders of stable demand for their products to assure continued production.
The fundamental objective of JIT is to produce and deliver what is needed, when it is needed, at
all stages of the production process.- JIT to be fabricated, sub-assembled, assembled and
dispatched to the customer. Although, in practice there are no such perfect plans, JIT is an ideal
and therefore a worthy goal. The benefits are low inventory, high manufacturing cycle rates, high
output per employee, minimum floor space requirements, minimum indirect labor, and perfect
in-process control. An associated requirement of a successful JIT operation is the pursuit of
perfect quality in order to reduce, to an absolute minimum, delays caused by defective product
units.
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2.10 MATERIAL REQUIREMENT PLANNING (MRP)

Traditionally material requirements were determined by continuously reviewing stock levels
whenever stock level fell below a pre-specific level (the reorder point) a pre-determined quantity
was ordered each time. This approach assumes that the replenishment of any one stock item can
be planned independently of all other. However, the demand for a particular stock item is a
function of assemblies and sub-assemblies of which they are part. Material Requirement
Planning (MRP) originated in the early 1960s as a computerized approach for coordinating the
planning acquisition and production of materials.
Definition
MRP is a computerized production scheduling system which takes the forward schedule of final
product requirements (the master production schedule) and translates it progressively into the
numbers of sub-assemblies, components and raw materials required at each stage of
manufacturing cycle. It is a management information system providing a basis for production
decisions when what is manufactured has a composite structure and when lead items are
important features. Obviously, the ability of the system to deliver what is required in the correct
place at the correct time will be dependent on the quality of information which is put into the
computer model.
Aims of Material Requirement Planning:
The aims of MRP to make use of computers in order to:
1. Determine for final products namely, what should be produced and at what time.
2. Ascertaining the required units of production of sub-assemblies.
3. Determining the requirement for materials based on an up-to-date bill of materials file
(BOM)
4. Computing inventories, work-in-progress, batch sizes and manufacturing and packaging
lead times.
5. Controlling inventory by ordering bought-in components and raw materials in relation to the
orders received or forecast rather than the more usual practice of ordering from stock-level
indicators.
Benefits:
The benefits of MRP are that a detailed forecast of the inventory position is highlighted period
by period. It is usually used to plan a future time period (i.e. forward planning system) of a
manufacturing operation like a month, quarter or even a year into the future.
Purpose of MRP
1. The purpose of MRP is to determine the requirement and to schedule for the manufacturing
and purchasing of items in order to accomplish the needs set out in the master production
schedule.
2. The MRP system ensure that materials and components are available in required quantities at
the requested time to make it possible to manufacture the end items as given by the master
production schedule.
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3. The output of MRP is in the form of action notices, which are inputs to the manufacturing
execution function of shop floor control.
Data requirement to operate MRP system
The core data requirements for operating a MRP include the following:
1. The master Production schedule: This schedule specify the quantity of each finished unit of
products to be produced and the time at which each unit will be required.
2. The Bill of Material file: The bill of material file specifies the sub-assemblies, components
and materials required for each finished good.
3. The inventory file: This file maintains details of items in hand for each sub-assemblies
components and materials required for each finished goods.
4. The routing file: This file specifies the sequence of operations required to manufacture
components, sub-assemblies and finished goods.
5. The master parts file: This file contains information on the production time of subassemblies and components produced internally and lead times for externally acquired items.
Method of operation of MRP system
A MRP system is a computer based inventory information system which is used to plan and
control raw materials and component parts inventories.
Like all computer based information systems, MRP system can be divided into following:
(i) Pre-requisite information,
(ii) System input,
(iii)System processing,
(iv) System output
Pre-requisite information and system input:
(i) The master production schedule (MPS) file states the production goal, generally for a week
time, in terms of desired units of production. MRP system first focused on the forecasted
units of production and timing of finished goods demand and then determines the demand for
materials, components and sub-assemblies at each stages of production. This makes MRP a
push system in which once the schedule production starts, the output of each department is
pushed through the system to the next department for processing or into inventory to be
retrieved later.
(ii) The bill of materials (BOM) file contains information about how the production of the
finished goods is undertaken. A bill of materials structure is used:
a. To assess all the raw materials and components parts required to complete a product and
b. To describe the multiple levels of assembly or manufacturing necessary to complete a
unit of finished product.
In a figure given below a typical BOM structure file is presented for three end products FG1,
FG2 and FG3. The MRP system breaks the requirements for each product by working into its
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primary sub-components (SC)/ sub-assemblies (SA), and these in turn are further separated
into second, third and so on levels of sub-components, until at the lower level in the
hierarchy, only purchased items ( i.e., backward each end products direct materials DM)
exist. It is apparent form the figure below that four direct materials (DM1, DM2, DM3 and
DM4) are purchased for finished goods. For both FG1 and FG2 the materials are used to
manufacture the components that are assembled into the end product. For FG3 no
intermediary components are produced.
FG1
SC3
FG2
FG3
SC2
SC1
SC1
DM1
DM2
DM2
DM3
DM1
DM4
DM4
FG = Finished Goods
SC = Sub Components
DM = Direct Materials
(iii) The inventory records file of the MRP system defined current levels of finished goods,
raw materials, and component parts inventory at the beginning of some planning period.
During the planning period, the organization may receive units of raw materials,
component parts, sub-assemblies, and even finished goods inventory from suppliers,
vendors, and subcontractors. These planned inventory receipts and delivery lead times are
included in the inventory records file so that their addition can be appropriately
considered in the time bucket of their arrival.
System processing and system output:
Once the MRP system knows what it is expected to produce (via the MPS file), how it should
produce it (via the BOM file), and with what it has to produce it (via the inventory record
file), the system arithmetically combines the information to determine when the production
should take place in the future planning period. To accomplish this, a process called
requirements explosion is conducted.
The program starts with the finished goods demand (from the MPS) and explodes the
demand requirements backward in time to schedule the desired production of the finished
goods from raw materials and component parts with time-phased adjustments for lead time
requirements.
The information provided by system processing includes the following:
1. Gross requirements i.e. the demand for the components or assembly as computed
from firm customers orders and forecasts.
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2. Determine the net requirement after taking into account scheduled receipts, projected
stock levels and items already allocated from the current inventory.
3. Conversion of the net requirements to a planned order quantity using an appropriate
lot size.
4. Planning orders in appropriate periods by backward scheduling from the required
usage date by the appropriate lead time required to fulfil orders.
Example; The BOM file provides the following information for product A.
Product A
B (4 units)
D (2 units)
E ( 1 unit)
C (2 units)
D (3units)
F (2 units)
The lead time for the finished product, sub-assemblies, components and raw materials and their
demand are as follows:
Product
A
B
C
D
E
F
Lead Time
Day
1
2
1
3
4
1
Day
10
8
6
Demand
Product
50A
20B (spares)
15D (spares)
The statement showing schedule of order placement for satisfying the demand Day
1 2
3
4
5
6
7
8
9
Required
Order
50
Placement
Required
20
200
Order
20
200
Placement
Required
100
Order
100
Placement
Required
40+15
400
300
Order
55
400
300
Placement
Required
20
200
10
50
200
Order
Placement
Required
Order
Placement
20
200
200
200
The above procedure helps the managers to see how well the desired MPS file objectives of
finished goods will be achieved in the future planning period.
Further to assist the management to comply with the MRP plan, the MRP system also provides
detailed inventory planning and control reports on inventory status.
Pre-requisites for successful operation of MRP
(i) Strict adherence to the schedule: The successful operation of MRP system requires a strict
adherence to the latest production and purchasing schedules. Workers must be educated to
understand the importance of schedule adherence, and controls should be in place to ensure this
adherence.
(ii) Accurate data base: Data accuracy is vital to the system. If a plan is based on inaccurate data
it may be impossible to adherence to the schedule. For example, if the bill of materials file is not
updated to reflect any changes in product composition it will be impossible to adhere to the
schedule.
SELF- EXAMINATION QUESTION

1. Define Material requirement planning (MRP). What are its purposes?
2. Explain briefly the data requirements to operate material Requirement Planning system.
3. Explain briefly the method of operation of Material requirement planning system.
4. What are pre-requisites for the successful operation of MRP?
CHAPTER 3- LABOR CONTROL
3.9
JOB EVALUATION AND MERIT RATING
a. Job Evaluation
Job evaluation is a systematic and orderly process of determining the worth of a job in relation to
other jobs. Every job has its own characteristics. Depending upon these characteristics job
demand is of varying degrees , qualifications, skill, experience etc., on the part of operators
performing the jobs. For example, some jobs require physical ability, others may need a high
degree of mental ability, while a third category may need skill, experience and high education.
job evaluation is the process of review, analysis and systematic classification of a job in
accordance with its characteristics i.e., varying factors it demands from the employees. In other
words job evaluation grades all jobs with reference to their main characteristics so that the
relative merit of each job in terms of work value may be determined. Proper job evaluation helps
in devising a wage structure which is acceptable to the workers as well as the organization.
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Purposes: Job evaluation helps following purposes:

1. It helps in devising an acceptable wage.
2. It helps to proper placement of workers in job.
3. It helps the personnel department to recruit the right person for a job since requirement of
each job are clearly indicated.
4. It helps in formulating the internal training plan.
5. It helps to avoid wage and other discrimination for similar jobs in same organization or a
group of organization under the same management.
Advantages to the Employer:
1. By bringing uniformity in wage rates, it brings about simplification of wage
administration.
2. Wage rate can be reviewed easily if a job evaluation machinery exists in the organization.
3. Disputes and grievances regarding wage rates are settled which result in uninterrupted
ongoing of work.
4. By job evaluation proper and rational wage structure can be formulated and implemented.
With the result, better workers join the firm more willingly.
5. Supervisors are treated in the essential function of judging, controlling and helping the
workers.
Advantages to the Employee:
1. Workers are rewarded on the basis of their performances. It provides effective motivation
to workers.
2. By job evaluation, right worker is put in the right place, with the result there is reduction
in the labor turnover.
Limitations of Job Evaluation
There are certain limitations. It cannot be applied easily to scientific and research pursuits. It is
seen that workers are not available at the wage suggested by the job evaluation.
Steps of Job Evaluation:
In job evaluation there are some major steps to be carried out in sequence: (1) Invention and
construction (2) Job Standardization (3) Job review and analysis, comprising determination of
relative values of jobs and grouping of jobs into classes for which minimum and maximum
remuneration are established.
Invention and construction involve the timely development, design and production of the right
type of jigs, tolls, gauge and auxiliaries required for performing the jobs. Job standardization is
the development and standardization of the most suitable arrangements, motions and times for
production based on time and motion study. Job Review and Analysis includes job review, job
analysis and job classification. Job review is to identify person needed to fill the job and
conditions which affect the rate of pay of the person needed to fill it. Job analysis is analysis and
synthesis of the data obtained by job review in order to determine degree of duties, skills,
exertion, responsibilities, conditions etc. needed in relation to the job. Job classification is the
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procedure of sorting the standard job-description specifications into a small number of groups.
Methods of Job Evaluation
There are mainly three method of Job classification: (1) Ranking Methods, (2) Grading Method
(3) The Point System and (4) The Factor Comparison Method.
(1) Ranking Method: Under this system different jobs are graded from the highest to the lowest
ranks on some basis. The hierarchy for each job group is thus outlined and pay scales are
determined. Its greatest merit is simplicity, which is also its great limitation that is the
measurement is quite crude. Besides, there is no pre-determined scale of value for the rates to be
used. This method is useful in a small unit where jobs are a few and are known to raters.
(2) Grading or Job Classification Method: In this method individual jobs are classified into a
number of grades or classes, for example: skilled, semi-skilled, unskilled, assistant, foreman,
foreman executives and work manager etc. For each class or grade a general specification is
prepared, indicating the types of responsibility and work that may be included. Salary or wage
ranges are thereafter fixed for each class or sub-class. Each job is reviewed to place the job in its
appropriate grade. The chief merit of the method is its simplicity but this is useful only in small
units, since in large organization job-specifications are quite complicated.
(3) The Point-rating Method: Under this method of evaluation jobs are analyzed into its various
characteristics or factors and then evaluated in terms of points. Points are allocated to each of the
factor or characteristics. The factors may be (i) Education or mental application, (ii) Physical
application of effort, (iii) Experience, expertise or skill, (iv) Responsibility for achievement and
failures etc. (v) Job-hazards or complex nature of job and (vi) Working conditions. These factors
are outlined in a manual which also prescribes the weightage to be applied to each such factor.
Wages scales or ranges are fixed for each of these grades.
(4) The Factor Comparison Method: Under this method, certain key jobs are selected and each
selected job is further analyzed into (i) Mental application (ii) Physical application (ii) Skill
required (iv) Responsibility and (v) Working condition. (These are also factors in point rating
method). Each factor is, thereafter, valued and aggregate values are compared to determine
relative worth of each job.
It is to be noted that first two methods are simple and suitable for application in small factories.
The last two methods are analytical in approach. But jobs involving high degree of mental
applications or hazards cannot be accurately evaluated in fixed factor points.
b. Merit Rating (Performance Appraisal)
Merit rating or performance appraisal is a device for evaluating work performance in a
systematic manner. It is a tool for appraising the relative qualities of the employees or workers.
Merit rating can be defined as all the formal procedures used in working organizations to
evaluate the personalities and contributions and potential of group members.
It is different to job-evaluation. While job evaluation is the process of analysis and classification
of jobs according to their characteristics, Merit Rating refers to the evaluation of the merits of
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persons and their classification into groups of that basis. The method of merit ratings lies,
broadly, in keeping an individuals records of performance and assessing these performances
through some norms or standards. The intention is to suitably reward an employee on the basis of
his merit. Merit rating provides a system of incentive without applying the detailed procedure of
work study and is particularly useful for remember rating, on relative merits, indirect workers
whose performance is difficult to measure.
In rating the merit i.e., qualities of the individual employee concerned, certain factors are taken
into consideration. Following are the examples of factors in common use.
(1) Quality of work done
(2) Quantity of work done
(3) Sense of responsibility
(4) initiative
(5) Reliability and integrity
(6) Knowledge, skill, experience and aptitude of work
(7) Cooperation and discapture
(8) Sense of judgment
(9) Attendance and punctuality
(10) Extra-ordinary personal characteristics
Each factor is assigned a point value or point rating and each employee is rated according to the
extent or degree of factors he possesses.
Advantages of Merit Rating
Merit rating develops better undertaking or work and men. Followings are main objectives and
merits of Merit Rating or Performance Appraisal.
1. It increases better productivity of workers, as the very fact that merit rating is in
existence, encourages workers to more exertion.
2. It encourages employee in his growth and development by appraising all phases of his
performance and then by following constructive discussion and guidance.
3. It uncovers special abilities of the employees.
4. It promotes the employees job satisfaction and morale by letting him know that his
supervisors are interested in his progress and development.
5. Merit rating eliminates guesswork and prejudice in evaluating relative qualities of the
employees.
6. It serves as systematic guide to the supervisors in planning the employees further
training.
7. It helps in planning personal moves and placement that will utilize capability of each
employee.
8. It provides employees an opportunity to talk to supervisor about job problem, interest,
future etc.
9. It helps in fixation of fair and equitable pay rates.
10. It cultivates a spirit of competition among workers and these results in better
performance.
Thus merit rating improves labor relations, reduces labor turnover and stimulates competition
among the workers resulting in increased production.
Shortcomings and Limitations of Merit Rating

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(1) Merit rating is mostly based on opinions; it may tend to be erroneous, which may lead to
dissatisfaction and unrest.
(2) Labor-incentive offered on the basis of merit rating may not be regarded enough.
(3) It is quite possible that some irrelevant factors may be given importance or there may be
biased rating by supervisors.
(4) Raters may depend upon past rating record which may influence present rating
3.10 EFFICIENCY RATING PROCEDURES

Efficiency is usually related with performance and may be computed by comparing the time
taken with the standard time allotted to perform the given job/task. If the time taken by a worker
on a job equals or less than the standard time, then he is rated efficient. In case he takes more
time, then the standard time he is rated as inefficient. It may be computed as follows:
Efficiency in % = Time allowed as per standard x 100)/Time taken
For efficiency rating of employees the following procedures may be followed:
1. Determining standard time/performance standards: The first step is to determine the
standard time taken by a worker for performing a particular job task. The standard time
can be determined by using Time & Motion study or work study techniques. While
determining the standard time for a job/task a heterogeneous group of workers is taken
and contingency allowances are added for determining standard time.
2. Measuring actual performance of workers: For computing efficiency rating it is
necessary to develop a procedure for recording the actual performance of workers. The
system developed should record the output of each worker along with the time taken by
him.
3. Computation of efficiency rating: The efficiency rating of each worker can be computed
by using the above mentioned formula.
Need for efficiency rating:
1. As discussed earlier when a firm follows a system of payment by results, the payment has
a direct relationship with the output given by a worker. The firm for making payment to
worker is required to ascertain his efficiency level. For instance, under Taylors
differential piece work system the lower rate i.e. 83% of piece rate is given to a worker
when his efficiency rating is less than 100% and higher rate viz., 125% of piece rate is
offered at efficiency level of either 100% or more. Similarly under Emersion efficiency
plans bonus is paid at rising scale at various level of efficiency, ranging from 66.67% to
150%.
2. The efficiency rating also helps the management in preparing labor requirement budget or
for preparing manpower requirements. For example, let P Ltd. manufactures two products
by using one grade of labor. The following estimates are available:
205
Budgeted production (units)

Standard hours allowed per product
Product A
3,480
5
Product B
4,000
4
It is further worked out that the efficiency rating (efficiency ratio) for productive hours worked
by direct workers in actually manufacturing the production is 80% then the exact standard labor
requirement can be worked out as follows:
Product A
Product B
Total
Budgeted production (in
3,480
4,000
units)
Standard hours allowed for
budgeted production
(3,480 units x 5 hours) (4,000 units x 4 hours)
33,400
Since efficiency ratio is given as 80% therefore standard labor hours required for 100%
efficiency level are (33,400 x 100)/80 = 41,750 hours.
Labor productivity: Productivity is generally determined by the input/output ratio. In the case of
labor it is calculated as below:
(Standard time for doing actual amount of work) / (Actual time taken to do work)
Labor productivity is an important measure for measuring the efficiency of individual workers. It
is an index of efficiency and a sign of effectiveness in the utilization of resources-men, materials,
capital, power, and all kinds of services and facilities. It is measured by the output in relation to
input. Productivity can be improved by reducing the input for a certain quantity or value of
output or by increasing the output from the same given quantity or value of input.
Factors for increasing labor productivity:
The important factors which must be taken into consideration for increasing labor productivity
are as follows:
1. Employing only those workers who possess the right type of skill.
2. Placing a right type of man on the right job.
3. Training young and old workers by providing them the right types of opportunities.
4. Taking appropriate measures to avoid the situation of excess or shortage of labor at the
shop floor.
5. Carrying out work study for the fixation of wage rate and for the simplification and
standardization of work.
CHAPTER 4- OVERHEAD CONTROL
4.9 ACTUAL OVERHEAD RATE VS. PREDETERMINED OVERHEAD RATE
Actual overhead rate
When the absorption is based on actual overhead, it is known as actual absorption rate. This can
be calculated only after the end of the accounting period when all cost and production figures
have been collected. This method has the following disadvantages:
206
1. Product cannot be determined until some considerable time after the end of the
accounting period. This may not help in controlling cost and in fixing selling prices.
2. There are likely to be variations in the overhead incurred because of the seasonal nature
of some overhead costs, change in volume of production and efficiency of the factory for
different periods.
3. Some overhead costs are of fixed nature, such as depreciation, supervision, property
taxes, etc. These overhead costs being constant give a different per unit cost when
divided by differing production volumes. Also, some overheads like fire insurance
premium are paid in advance but this should be charged to all work done/products
manufactured during the year. How should the absorption be done? It creates an
inequitable situation.
Predetermined overhead rate or Standard rate
Because of the limitations of the actual overhead rate stated above, a predetermined or standard
overhead rate is generally used by companies. This is a rate calculated in advance of the period
in which it is to be used by dividing the estimated period overhead to be absorbed by the
estimated period production. Production may be measured on any of the absorption bases, such
as prime cost, labor hours, etc.
The primary objective of predetermined overhead rate is to provide a reasonably constant unit
cost and to avoid unit cost fluctuation caused by seasonal overhead cost fluctuations, changes in
volume, or accounting methods.
Secondly, predetermined overhead rates also make possible the immediate costing of job or
products completed during the month. When a job is finished, the absorption rate is multiplied by
the absorption base to find out the total amount to be charged to the product or job. Under, a
process costing system predetermined overhead rate is used to charge overhead to the output of
the process in question.
Thirdly, predetermined rates contribute effectively to standard costing and budgetary control
programs as these programs use estimated costs and standard cost to measure production
activities.
4.10 BLANKET OVERHEAD RATE VS DEPARTMENTAL OVERHEAD RATESupplementary overhead rate
Supplementary overhead rate is one of the methods of disposal of under or over-absorption of
overheads. If the amount of under or over-absorption is considerable; the cost of job or process is
adjusted by means of supplementary levy of the overhead. Supplementary rate is calculated by
dividing the amount of under or over absorption by the actual base. Under-absorption is set right
by a plus rate while over-absorption is adjusted by minus rate. The Supplementary rate may also
be calculated as a percentage of the amount absorbed.
Under this method, the balance of over and under-absorbed overheads may be charged to cost of
work-in-progress and finished stock and cost of sales proportionately. This is done with the help
of Supplementary rate of overhead. If there has been a mistake in either working out the proper
207
rate or selecting the proper method, it should be permissible to amend the cost and arrive at new
(but correct) figures of cost. To the extent the goods have already been sold, the difference in the
two figures of cost (as already arrived at and the new correct one) should be debited or credited
to the Cost of Sales Account or even to the Costing Profit and Loss Account. The goods
remaining unsold should be costed at the correct rate. The corrective rate should be applied also
to work-in-progress.
4.11 CONCEPT RELATED TO CAPACITY
i. Rated Capacity: It refers to the capacity of a machine or a plant as indicated by its
manufacturer. In fact this capacity is the maximum possible productive capacity of a plant.
It is also known as installed capacity of a plant. Due to the loss of operating time of a plant
it is difficult to achieve this rated capacity. In other words, it is only a theoretical capacity
and is therefore, seldom achieved.
ii.
Practical Capacity: It is defined as actually utilized capacity of a plant. It is also known as

operating capacity. This capacity takes into account loss of time due to repairs,
maintenance, minor breakdown, idle time, set up time, normal delays, Sundays and
holiday, stock taking etc. Generally, practical capacity is taken between 80 to 90% of the
rated capacity. It is also used as a base for determining overhead rates. Practical capacity
is also called net capacity or available capacity.
iii.
Normal Capacity: It is the capacity of a plant which is expected to be utilized over a long
period based on sales expectancy. The determination of this capacity considers the average
utilization of plant capacity during one full business cycle which may extend over 2 to 3
years. It is also known as average capacity and is used to compute overhead recovery rate.
iv.
Capacity based on sales expectancy: it is the capacity of a plant utilized based on sales
expectancy.
v.
Actual Capacity: It is the capacity actually achieved during a given period. This capacity
may lie between practical capacity and capacity based on sales expectancy.
vi.
Idle Capacity; It is that part of the capacity of a plant, machine or equipment which cannot
be effectively utilized in production. In order words, it is the difference between the
practical or normal capacity and capacity utilization based on expected sales. For example,
if the practical capacity of production of a machine is to the tune of 10,000 units in a
month, but is used only to produce 8,000 units because of market demand of the product,
then in such a case 2,000 units will be treated as idle capacity of the machine.
The idle capacity may arise due to lack of product demand, non-available of raw material
shortage of skilled labor, absenteeism, shortage of power fuel or supplies, seasonal nature
of product etc.
208
Idle capacity cost: Costs associated with idle capacity are mostly fixed in nature. These include
depreciation, repairs and maintenance charges, insurance premium, rent, rates, management and
supervisory costs. These costs remain unabsorbed or unrecovered due to under-utilization of
plant and service capacity. Idle capacity cost can be calculated as follows:
Idle capacity cost = (aggregate overhead related to plant x Idle capacity) / normal plant
capacity
Treatment of idle capacity costs:
Idle capacity costs can be treated in product costing in the following ways:
i. If the idle capacity cost is due to unavoidable reasons such as repairs, maintenance,
change over the job etc. A supplementary overhead rate may be used to recover the idle
capacity cost. In this case, the costs are charged to the production capacity utilized.
ii. If the idle capacity cost is due to avoidable reasons such as faulty planning, power failure
etc.; the cost should be charged to profit and loss account.
iii. If the idle capacity cost is due to seasonal factors, then, the cost should be charged to the
cost of production by inflation overhead rates.
Idle facility:
The term facility has a wider connotation which may also include prediction capacity. Facilities
may be provided by fixed assets such as building space, plants equipment capacity, etc. or by
various service functions such as material services, production services, personal services etc. If
a firm fails to make full use of the facilities of its disposal, the firm may be said to have idle
facilities. Thus the idle facilities refer to that part of total facilities which remains unutilized due
to any reason such as non-availability of raw material, power, lack of demand etc. In Cost
Accounting idle facilities are treated in the same way as those of idle capacity.
4.12 COMPREHENSIVE MACHINE HOUR
If the wages of the machine operators are also included, it will be the comprehensive amount
which it costs to use that machine including the worker. The usual practice is, however, not to
include the wages of the machine operator if the wages are direct. But if the operator attends a
number of machines at the same time, then his wages cannot be direct and a proportion of his
wages will have to be included in the expenses of the machine.
5
UNIT COSTING (SINGLE OR OUTPUT COSTING)
Unit costing is a simple method of ascertaining cost per unit where there is one or uniform
product. In other words, single or output cost system is used in the business where a standard
product is turned out and it is desired to find out the cost of basic unit of production It is
applied where the manufacturing process is a simple one and the product also is generally single
(may be a few but of same kind not varying in grades or quality). The industries where this
method of costing is used are collieries, quarries, brick-making, breweries, etc. The unit of cost is
the unit in which ultimate production is measured e.g. per ton of coal, per 100 bricks or per
article of the single product.
209
For calculating cost per unit, a statement of cost is prepared. The technique of preparing this
statement has been explained in the first chapter. This statement shows prime cost, works cost,
cost of production, cost of goods sold and cost of sales. Profit may be ascertained if selling price
is known or estimated. It is a periodical statement which is prepared weekly, fortnightly,
monthly, quarterly or annually.
Various components of cost are arranged to ascertain above costs. The total of Direct Material,
direct wages and other Direct Expenses is called Prime Cost. When Factory expense or
overheads are added to prime Cost, the total becomes Factory Cost. Thereafter Office and
Administrative overheads are added to Factory Cost. The total at this level is known as Cost of
Production or Office Cost. Selling and Distribution overheads are added to office cost, the total
becomes Total Cost or Final Cost. The difference between Total Cost and Sales is Profit. In
order to calculate profit, the opening and closing stocks of finished goods are adjusted so that
cost of goods sold may be arrived at. The statement of profit will be as below:
Cost of Production or Office Cost

Add: Opening stock of finished goods
Less: Closing stock of finished goods
Cost of goods sold
Add: Selling and distribution overheads
Cost of Sales
-------------(------)
---------------------
Profit
-------Sales
-------5.1 COST SHEET
It is similar to Statement of Cost, but it includes and shows certain other information relating to
cost. It shows cost per unit of each item of cost and also their percentage to total cost.
According to CIMA London, Cost Sheet is A statement which provides for the assembly of the
detailed cost of a center or cost unit It is also a periodical statement.
The expenditure which has been incurred upon product for a period is extracted from the
financial books and the store records and set out in a memorandum statement. If this statement is
confined to the disclosure of the costs of unit produced dividing the period, it is termed as Cost
Sheet, but where the statement records total cost, profit and sales, it is usually known as
Statement of Cost or Production Account.
If information derived from the books is set out usually in the form of a statement, it is cost
sheet. But where it is set out in the form of an account recording the cost incurred, there being
separate accounts to show also sales and profit, it would be known as Production or
Manufacturing Account.
210
It is desirable that besides total expenditure incurred, cost per unit of output in case of each
element of cost should be calculated and also the percentage contribution of each item to the cost
of production should be indicated. Further, the cost sheet should give cost per unit in the
previous period also, if available for the purpose of comparison. Opening and closing block of
finished goods may be put in a subsidiary statement, which together with the total cost of
production and sales will reveal profit. The opening stock, purchases and closing stock of raw
material should not be shown separately, but suitably adjusted to give one figure of raw materials
consumed or used. Financial items like interest, discount etc. should be ignored.
Element of Cost: Although elements of cost have been discussed in detail in previous chapters,
these are again briefed for convenience and recapitulation.
(1) Direct Materials: Since there will be only one product and process of manufacture is also
simple, the raw material if any is directly charged to the production of the period in total.
Material consumed:
Opening stock of Raw Materials
Add: Purchases
Add: Carriage inward and other incidental charges
Less: Closing stock of direct material
Less: Scrap of raw material (abnormal)
Less: Materials returned or transferred to other departments.
(2) Direct Labor: The labor costs are collected periodically through pay rolls which are
prepared separately for each section of work. The cost of abnormal idle time should be deducted.
(3) Other Direct and Chargeable Expenses: Expenses other than direct material and direct
labor is chargeable expenses e.g. excise duty, royalty, expenses on designs pattern and models
etc.
(4) Prime Cost: The total of Direct Materials Consumed, Direct Labor and Other Direct or
Chargeable Expenses is known as Prime Cost.
(5) Works Expenses or Overheads: Factory expenses or manufacturing expenses have been
discussed in detail in a separate chapter. In unit costing, these expenses related to the product are
added to Prime Cost. These are (i) Indirect materials like oil, dusters, lubricants etc., (ii) Indirect
labor like wages to foreman, storekeeper, watchman, factory clerks etc., (iii) Steam, fuel or
electric power, (iv) Lighting, heating and water in the factory, (v) Rent, insurance and rates of
factory, (vi) Repairs and depreciation of machines plant, factory building and lose tools, (vii)
Factory stationery, (viii) Factory research expenses, (ix) Expenses related to factory
establishment (x) Drawing office salary, (xi) Welfare expenses and workmans compensation,
insurance, etc.
(6) Scrap or Wastage: In the production of anything some wastage or scrap materials is
obtained. Sometimes some of the units produced may be defective and such units or scrap or
wastage is sold. The amount thus obtained should be deducted from factory expenses or from
211
works cost. If however, the materials (when about to be used) are found to be defective and then
sold, the value of materials used should be reduced by the cost of such materials. The loss on sale
of such defective materials should be debited to the Costing Profit and Loss Account.
(7) Work-in-Progress: In any factory or workshop there are always some units which are not
yet complete, but on which some work has been done. Such work is known as work-in-progress
or work-in-process. The valuation of such work-in-progress is made on the basis of the value of
material already used, the amount of wages paid for the work concerned and a proper share of
factory expenses. Since various units will be at different stages of production, the value of workin-progress will have to be estimated for each stage separately.
The work-in-progress in the beginning is to be added to the current costs of production and that
at the end of the period has to be deducted from the manufacturing cost. This may be done when
factory expenses have been added to the prime cost. It may look as follows:
Particular
Prime Cost
Factory Expenses (works Overheads)
Gross Works Cost
Add: Work-in-progress in the beginning
Less: Work-in-progress at the end
Works Cost
Rs.
120,000
80,000
200,000
15,000
215,000
20,000
195,000
After this office expenses will be added as usual and the total cost of production of the finished
units is ascertained.
There is an alternate method also. This will be if the analysis of the value of work-in-progress is
known. Suppose the figures are available as under:
Work-in-progress Work-in-progress
in the beginning
at the end
(Rs.)
(Rs.)
Materials
3,000
4,000
Labor
2,000
2,500
Factory Expenses
1,500
2,000
Total
6,500
8,500
In this case when we ascertain the value of materials used, we add Rs.3,000 for materials
included in work-in-progress in the beginning and deduct Rs. 4,000 for materials included in
work-in-progress (WIP) at the end. This will give cost of materials used on finished units
produced. The figure for materials used may then be as follows (figures assumed):
Rs.
Opening Stock
25,000
Materials in WIP in the beginning
3,000
Add: Purchases
120,000
148,000
Less: Closing stock of materials
28,000
Materials included in WIP at the end
4,000
32,000
212
Materials used
116,000
Similar treatment will be given to labor and factory expenses, that is to say, in each case the
amount included in WIP in the beginning will be added and that included in WIP at the end
deducted. Needless to say there will be no necessity then to do anything further about WIP.
8. Office and Administrative Expenses: Works cost or manufacturing cost is increased by
office and administrative expenses. These are for example, (i) Staff and Management salaries,
(ii) Directors Fees, (iii) Stationery, Printing, Postage, Telephone, Fax and miscellaneous office
expenses, (iv) Office rent, tax, insurance, light and water etc., (v) Counting house or computer
and accounting expenses (vi) Repairs, depreciation and insurance of office building, furniture
and equipment.
9. Cost of Production or Office Cost: When office and administration overheads are added to
works cost, the total shows cost of production.
10. Cost of Goods Sold: If all goods produced are not sold, the cost of goods sold should be
ascertained:
Cost of production
--Add: Opening stock of finished goods
--Less: Closing stock of finished goods
--Cost of Goods Sold
11. Selling and Distribution Expense: These are added to Cost of Goods sold. The total is
known as Cost of Sales.
12. Profit: Profit is difference between sales and cost of sales.
Cost of Goods Sold
--Add: Selling and Distribution Expenses
--Cost of Sales
--Profit
--Sales
Treatment of Defective or Rejected Production: The defective production are those

production that is not as perfect as the saleable product but is capable of being rectified and
brought to required degree of perfection provided some additional expenditure overheads. The
cost of rectification is treated to be additional works overheads. On the other hand, the
production that has been totally rejected and cannot be rectified, the amount so realized by sale
of these goods is used to reduce the cost of factory cost.
213
214
Specimen 3: Cost Sheet (detailed)

Particulars
Cost per ton
(Rs.)
Total cost
(Rs.)
Material Consumed
Raw materials on 1st April (opening)
Add: Purchases during the period
Add: Carriage Inward
Less: Raw Materials on 31st March (closing )
Direct Wages
Direct or Chargeable Expenses
(A) Prime Cost
Works or Factory on cost:
Indirect wages
Depreciation on Machinery etc.
Depreciation on Factory Building etc.
Fuel, Electric Power etc.
(B) Gross Works cost
Add: Opening WIP
Less: Closing WIP
Less: Sale of Scrap etc.
(C) Works or Factory cost
Office on cost:
Office salaries
Office rent
Depreciation of office building and furniture etc.
Repairs to Office Building, furniture etc.
General Expenses etc.
(D) Total Cost of Production
Add: Opening stock of Finished Goods
Less: Closing stock of Finished Goods
(E) Cost of Goods Sold
Selling and distribution expenses
(F) Cost of Sales
Profit
Selling Price
Illustration 1: From the following particulars prepare a Cost Sheet showing the cost per item and
total cost per ton for the period ended 31st Asadh 2072
Rs.
Rs.
Raw Materials
33,000 Rent and Taxes- Office
500
Productive Wages
35,000 Water Supply
1,200
Unproductive Wages
10,500 Factory Insurance
1,100
Factory Rent and Taxes
7,500 Office Insurance
500
Factory Lighting
2,200 Legal Expenses
400
Factory Heating
1,500 Direct Expenses
3,000
215
Motor Power
Haulage
Directors Fees Works
Directors Fees Office
Factory Cleaning
Sundry Office Expenses
Factory Stationery
Office Stationery
Loose Tools Written off
4,400
3,000
1,000
2,000
500
200
750
900
600
Rent of Warehouse
Depreciation of Plant and Machinery
Depreciation of Office Building
Depreciation of Delivery Vans
Bad Debts
Advertising
Sales Department Salary
Upkeep of Delivery Van
Bank Charges
Commission on Sales
300
2,000
1,000
200
100
300
1,500
700
50
1,500
Note: The total output for the period has been 15,000 tons
Solution:
Cost Sheet for the period ended 31st Asadh 2072
(Output 15,000 tons)
Cost per ton (Rs.)
Cost per ton (Rs.)
Raw Materials
2.200
33,000
Productive Wages
2.333
35,000
Direct Expenses
0.200
3,000
4.733
71,000
Prime Cost
Works Expenses:
Unproductive Wages
0.700
10,500
Factory Rent and Taxes
0.500
7,500
Factory Lighting
0.147
2,200
Factory Heating
0.100
1,500
Motor Power
0.294
4,400
Haulage
0.200
3,000
Directors Fees Works
0.067
1,000
Factory Cleaning
0.033
500
Factory Stationery
0.050
750
Loose Tools Written off
0.040
600
Water Supply
0.080
1,200
Factory Insurance
0.073
1,100
Depreciation of Plant and Machinery
0.133
2.417
2,000
36,250
Work Cost
Office Expenses:
Directors Fees Office
Sundry Expenses
Office Stationery
Rent and Taxes
Office Insurance
Legal Expenses
Bank Charges
Depreciation of Office building
7,150
0.133
0.013
0.060
0.033
0.033
0.027
0.004
0.067
0.370
107,250
2,000
200
900
500
500
400
50
1,000
5,550
216
Cost of Production
Selling and Distribution Expenses
Rent of Warehouse
Depreciation of Delivery Vans
Bad Debts
Advertising
Sales Department Salaries
Upkeep of Delivery Van
Commission on Sales
Total Cost
7.520
0.020
0.013
0.007
0.020
0.100
0.047
0.100
0.100
7.827
112,800
300
200
100
300
1,500
700
1,500
4,600
117,400
Illustration 2: Prepare a Cost Sheet showing cost per cabinet and profit per cabinet from the
following particulars. The cabinets manufactured are classed No.1 and No.2. There is no
opening or closing stock of cabinets.
No.1
No.2
Materials Rs.
12,400
13,232
Labor Rs.
22,540
25,358
No. Sold
520
780
Selling Price (per unit) Rs.
150
110
Works Overhead comes to 100 per cent on labor and Office Overheads to 25 per cent on Works
Cost. What is the total profit for the year as per above particulars?
Solution:
Cost Sheet
Rs.
Particulars
Cabinet No.1
Cabinet No.2
(Output 520)
(Output 780)
Total Cost Cost per
Total
Cost per
of No.1
Cabinet
Cost of
Cabinet
No.1
No.2
No 2
Materials
12,400
23.85
13,232
16.96
Labor
22,540
43.35
25,358
32.51
34,940
67.20
28,590
49.47
Prime Cost
Works on Cost (100% on labor)
22,540
43.35
25,358
32.51
57,480
110.55
63,948
81.98
Works Cost
Office On Cost (25% on Works Cost)
14,370
27.63
15,987
20.50
71,850
138.18
79,935
102.48
Cost of Production
Profit
6,150
11.82
5,865
7.52
78,000
150.00
85,800
110.00
Sales
5.2 PRODUCTION STATEMENT

The production or output statement shows sales, stocks, and profit besides the cost in a statement
format. The difference between a cost sheet and production statement is that a cost sheet merely
records the costs incurred during the period, whereas a production statement records sales,
stocks, and profit in addition to the costs incurred.
217
5.3 PRODUCTION ACCOUNT

Production Account is a statement of cost or cost sheet in a ledger account form, showing during
a given period, total cost and per unit cost incurred during the period and their components, as
also the profit or loss for that period.
According to Glover and Williams, The term Production Account is used to denote a particular
form of Manufacturing Account, prepared in conjunction with the financial account in order to
show the actual cost of producing the goods manufactured during the period under review. These
accounts may be drawn up at short intervals e.g. monthly.
It should be noted that Production Account is prepared in the form in which Trading Account is
prepared. It has normally two parts. The first part gives total cost as well as cost per unit. The
second part gives the cost of goods sold and sales.
Specimen 2
Production or Manufacturing and Profit & Loss Account for the
year ending 31 Asadh 20.
Particulars
Rs.
Particulars
To opening Stock of Raw Materials
By Prime Cost c/d
To Purchases of Raw Materials
To Carriage on Purchases
Less: Closing Stock of Raw Materials
= Cost of Materials consumed
To Direct Wages
To Prime Cost b/d
Rs.
By Works Cost c/d

218
To Indirect Wages
To Manufacturing Expenses
To Rent, Rates and Insurance
To Light & Power
To Repairs to Premises
To Repairs to Plant & Machinery
To Depreciation of Plant & Machinery
To Work-in-Progress at beginning
Less: Work-in-Progress at end
To Works Cost b/d
To Salaries
To Rent, Rates and Insurance (Office)
To Light & Power (Office)
To Repairs to Premises (Office)
To Office Expenses
By Cost of Production c/d
To Opening Stock of Finished Goods

To Cost of Production b/d
Less: Closing Stock of Finished Goods
By Cost of Goods Sold c/d
To Cost of Goods Sold b/d

To Carriage on Sales
To Profit c/d
By Sales of Finished Goods
Illustration 3: From the following particulars make out a monthly cost sheet or production
account of the Coke and By-Products Company showing cost per ton and percentage of cost used
in each item of output.
January, 2015
Tons
Rate per ton (Rs)
Amount (Rs.)
Coal used
5,000
12.50
Coke produced
3,500
25.00
Tar produced
210
50.00
Sulphate of Ammonia produced
49
150.00
Benzol produced
48
65.00
Raw Materials used
8,750
Wages paid
3,585
Repairs and Renewals
2,815
General Charges
4,050
Solution:
Cost Sheet or Production Account of Coke and By-Products Company
(For the month ended 31st January 2015)
219
Particulars
To Coal used
To Raw materials
To Wages
To Repairs &
Renewals
To General
Charges
Total Cost
To P & L A/c
(Profit
Transferred)
Cost
Qty Amt Rs.
per
Tons
ton
Rs.
12.50 5,000 62,500
8,750
3,585
2,815
4,050
81,700
26,770
- 5,000 108,470
% to
Coal
used
Particulars
100 By Coke
Produced
By Tar Produced
By Sulphate of
Ammonia
produced
BY Benzol
produced
By Loss in
Weight
100
Cost Qty
per Tons
ton
Rs.
25 3,500
50
210
Amt Rs.
% to
Coal
used
87,500
10,500
70.0
4.2
150
49
7,350
0.98
65
48
3,120
0.96
- 1,193
- 5,000
108,470
23.8
6
100
Illustration 4: From the following balances of a manufacturing company, you are required to
prepare Production Account; number of articles produced is 4,000.
Rs.
35,000
4,900
52,500
95,000
17,500
10,000
Nil
35,000
189,000
Stock of Materials at beginning

Stock of Materials at end
Purchase of Material
Factory Wages
Factory Expenses
Establishment Expenses
Completed Stock at start
Completed Stock at end
Sales
Solution
Particulars
To Material
consumed
Opening Stock
of RM
Add: Purchases
35,000
52,500
87,500
4,900
Production Account
(Output 4,000 articles)
Cost per
Total Rs.
Particulars
article
Rs.
By Cost of
Production
c/d
20,650
23,750
Cost per
article
Rs.
51.275
Total Rs.
205,100
82,600
95,000
Less: Stock at
end
220
To Factory
Wages
Prime Cost
To Factory
Expenses
Factory Cost
To
Establishment
Expenses
To Cost of
Production b/d
To Profit
44,000
4,375
177,600
17,500
48,775
195,100
2,500
10,000
51.275
205,100
51.275
By Closing
205,100 Stock of
18,900 Finished
articles
224,000
51.275
205,100
35,000
189,000
224,000
Illustration 5: Given below is the Cloth and Yarn Manufacturing Accounts of Arvind Mills for
the year ended 31st Asadh 2072
Particular
Rs.
Particular
Rs.
To opening stock
By sales of 224,000 kg of waste,
Yarn 44,800 kg
33,600 being that portion of 1,153,600 kg
Cloth 88,200 kg
88,200 of cotton as per contra which
121,800 could not be utilized in yarn
To Cotton consumed 1,153,600 kg
901,250 manufacture
28,000
To spinning wages
57,050 By Yarn Sales 168,000 kg
189,000
To Weaving wages
91,700 By Cloth Sales 756,000 kg
897,750
To Stores consumed in spinning
which increased yarn by 5,600 kg
By Closing Stock:
in weight
41,300 Yarn 140,000 kg
148,750
To Stores and sizing materials
Cloth 190,400 kg
214,200
consumed in weaving which
increased cloth by 186,200 kg in
weight
148,400
To Spinning fuel
36,050
To Weaving fuel
22,400
To Gross Profit
57,750
1,477,700
1,477,700
In the above Manufacturing Account (where the closing stock of yarn and cloth is taken at actual
cost), it is contended by the Income Tax Authorities that the closing stock is valued below cost
price, in order to suppress the gross profit actually made.
For the satisfaction of the authorities you are required to prepare from the above Manufacturing
Account a separate Yarn Production Account and separate Cloth Production Account showing
the following details:
a) Gross Profit of the Department.
b) Total Quantity produced (including the Opening Balance)
c) Total cost of Production (including the value of Opening Stock which was at cost)
221
d) Cost of production per kg (including the quantity of the opening stock in total quantity,
and the cost of opening stock in the total cost).
In manufacturing cloth 672,000 kg of Yarn was consumed which to be adjusted at the actual cost
is arrived at in the manner.
Solution
Yarn Production Account
Particulars
Qty (kg)
Amount
Particulars
Qty (kg)
Amount
(Rs.)
(Rs.)
To Opening Stock
44,800
33,600 By sales
224,000
28,000
To Cotton consumed
1,153,600
901,250 By Cost of Production
To Stores consumed in
including opening
spinning
5,600
41,300 stock (Rs. 1.0625 per
980,000 1,041,250
To Spinning wages
57,050 kg)
To Spinning fuel
36,050
1,204,000 1,069,250
1,204,000 1,069,250
To Cost of Production
By Sales of Yarn
168,000
189,000
including opening
By Cloth A/c (at cost
stock (Rs. 1.0625 per
@ 1.0625)
672,000
714,000
kg)
980,000 1,041,250 By Closing stock on
To Gross Profit
10,500 31 Asadh at Cost
140,000
148,750
980,000 1,051,750
980,000 1,051,750
Particulars
To Opening Stock
To Cotton consumed
To Stores consumed
To Weaving wages
To Weaving fuel
To Cost of Production
To Gross Profit
Cloth Production Account

Amount
Particulars
(Rs.)
88,200
88,200 By Cost of Production
672,000
714,000 including opening
186,200
148,400 stock (Rs. 1.1250 per
91,700 kg)
22,400
946,400 1,064,700
946,400 1,064,700 By Sales
47,250 By Closing stock on
31 Asadh at Cost
Qty (kg)
946,400 1,111,950
Qty (kg)
Amount
(Rs.)
946,400 1,064,700
946,400 1,064,700
756,000
897,750
190,400
214,200
946,400 1,111,950
(a) Gross profit

Yarn
Rs. 10,500
Cloth
Rs.47,250
(b) Total quantity produced including opening stock
Yarn
Rs. 980,000 kg
Cloth
Rs.946,400 kg
(c) Total cost of production including opening stock
Yarn
Rs. 1,041,250
222
Cloth
Rs.1,064,700
(d) Cost per kg including opening stock
Yarn
Rs. 1.0625
Cloth
Rs.1.1250
CHAPTER 6: METHODS OF COSTING

6.1.2 ADVANTAGES AND LIMITATIONS OF JOB ORDER COSTING
Advantages
i. Profitability of each job can be individually determined.
ii. It provides a basis for estimating the cost of similar jobs which are to be taken in future.
iii. It provides the detailed analysis of the cost of material, labor and overheads for each job
as and when required.
iv.
Plant efficiency can be controlled by confining attention to costs relating to individual
jobs.
v. Spoilage and defective work can be identified with a specific job and responsibility for
the same may be fixed on individuals.
vi.
By adopting pre-determined overhead rates in job costing, all the advantages of
budgetary control can be obtained
vii.
Job costing is essential for cost-plus contract where contract price is determined directly
on the basis of cost.
Limitations
i. It is expensive to operate as it requires considerable detailed clerical work.
ii. With the increase in the clerical work the chances of errors are increased.
iii. Job order costing cannot be efficiently operated without highly developed production
control system. The job costing required intricate factory organization system.
iv.
The costs as ascertained are historical as they are compiled after incidence and therefore
do not provide control of cost unless it is used with standard costing system.
6.2 JOB TICKET
Job Ticket is a slip or card accompanying a job order and used for giving instructions or for
recording time spent on the work. A "job ticket" may also be a synonym for a work order, which
is also known as a job order, job ticket, work ticket or service ticket is a document received by an
organization from an external customer, or another department internal to that organization,
describing work to be completed and/or products to be purchased or manufactured. A work order
is sometimes used as an invoice when working with external customers.
DISTINCTION BETWEEN JOB COSTING SYSTEM AND CONTRACT
COSTING SYSTEM
It is considered that contract costing is comparatively simpler in operation than job costing
6.3.7
223
system. The accumulation, analysis, apportionment, allocation and control of cost are simplified
in contract costing. Most of the expenses are chargeable direct to Contract Account but direct
allocation to such an extent is not possible in Job Costing. Normally the number of jobs in hand
at any time in a concern may be large, only a few contracts may be undertaken at a time. As
contracts may run for long periods, there arises the problem of assessment and crediting of
profits on incomplete contracts at the end of accounting period.
A contract differs from a job only in size. We generally reserve the word contract for those
jobs which require all the attention or most of it to be devoted to it. Work is done for a customer
who agrees to pay a fixed sum of money at the completion of the work. Usually, however, the
contractee pays a portion of the work done progressively. A contract may be for the construction
of a building, a road, a ship or a complicated piece of machinery, etc. Since the number of
contracts in hand is never likely to be large, it is not necessary to maintain separate books of
account for costing purposes. Financial books are sufficient but they will have to be remodeled to
give the required information. For example, if two contracts are being undertaken
simultaneously, wages or materials will have to be separately recorded for each; otherwise it will
be difficult to know the total cost of completing a particular contract. It will even be better if, in
the account opened to record the cost of a contract, columns are provided to classify the
expenditure.
PROGRESS PAYMENT, RETENTION MONEY, ESCALATION AND DEESCALATION CLAUSE, BALANCE SHEET ENTRIES
Progress payment and balance sheet entries
It is usual for the contractee to pay a certain percentage (say 80% or 90%) of the value of a
definite stage of work completed. The payment is made after the contractee is satisfied that such
stage has been completed. Surveyors or architects issue certificates for this purpose. Suppose the
architect certifies that work of the value of Rs. 200,000 (out of the total contract price of Rs.
500,000) has been completed. Then if the contractee has agreed to pay 90%, he will pay Rs.
180,000. The balance of Rs. 20,000, known as Retention Money, will be paid when the whole
contract is complete. Retention is a sort of guarantee that the contractor will not run away in the
middle of the job, as he might have the temptation to do if he sees nothing but loss in the
completion of the contract.
Payment received can be dealt with in two ways. The value of the work done can be debited to
the Contractees account and credited to the Contract Account. Cash received will, of course,
stand to the credit of the Contractees Account. Thus in the above example the following entries
may be passed.
.
Rs.
Rs.
Contractees Account
Dr.
200,000
To Contract Account
200,000
(Being the value of work certified as per architects certificate)
Bank Account
Dr.
180,000
To Contractees Account
180,000
(Being cash received 90% of value of work certified by
retaining 10% as retention money)
6.3.7
224
In the Balance Sheet the contractees Account will be shown at Rs. 20,000 on the asset side. Care
will have to be exercised to see that in the following year the value of work certified for the
purpose of passing entries does not include Rs, 200,000 in respect of which entry has already
been passed.
The second and more popular method to deal with the payment received is to credit the amount
to the account of the contractee. The value of the work completed is debited to the Work-inprogress Account and credited to Contract Account. Or it may be carried down as a balance in
the Contract Account itself. In the Balance Sheet, the credit to the contractee is deducted from
the value of work completed, the balance being shown as an asset. In the following year, the
Work-in-progress Account will be transferred to the debit of the Contract Account and the
entries to be passed in respect of work done at the end of the next year will be for the amount of
total work done, including the amount already certified at the end of the previous year.
When Work-in-progress (WIP) is not complete at the end of the accounting period, this account
is opened. WIP Account shows value of work certified and cost of work uncertified. The entry
will be:
WIP Account
Dr.
[(i) Value of work certified and (ii) Value of work uncertified]
To Contract Account
For profit not transferred to P/L Account (Reserved profit)
Contract Account
Dr.
To WIP Account
Work-in-progress Account
To Contract Account
By Contract Account (Reserved Profit)
Value of Work Certified
By Balance c/d
Value of Work Uncertified
Work-in Progress is shown in the asset side of the Balance Sheet. Cash received from the
contractee is deducted therefrom. Plant at site and materials at site will also appear as assets in
the Balance Sheet.
Balance Sheet
Liabilities
Amount
Assets
Amount
Work-in-Progress
Less: Cash received
Plant at site
Materials at site
WIP along with materials and plant at site are carried to the next years Contract Account as
opening balance.
The contractor opens a personal account of the contractee and credits cash received from him.
Cash/Bank Account
Dr.
To Contractee Account
Contractee Account
To Balance c/d
By Cash/Bank
225
Escalation and de-escalation clause:

Escalation clause is often provided in a long-term contracts under which the settled contract price
is subject to enhancement on any likely increase in price or utilization of materials and labor etc.
Following are circumstances when this safeguard is provided to the contractor that the contract
price would be suitably enhanced:
i. When the market price of materials used for the contract work are anticipated higher
beyond a limit in the future.
ii. When quantity of materials used for the contract is anticipated more than estimated
quantity due to the nature of the contract, the correct estimate was not possible unless the
work has been sufficiently progressed. It may also be due to availability of inferior grades
of raw materials resulting in more scraps and spoilage.
iii. When labor rates are anticipated to increase or where labor usages cannot be correctly
estimated on account of the nature of the contract.
Thus an escalation clause is meant to safeguard the interest of the contractor against unforeseen
rise in cost. There may be a De-escalation clause or Reserve Clause to provide for any future
decrease in price etc., so that benefit may be passed on to the contractee.
6.4.6 DIFFERENCE BETWEEN JOB COSTING AND PROCESS COSTING
Job Costing
Process Costing
1. Production is carried on by specific
Production is a continuous flow and the
order.
products are homogeneous.
2. Costs are determined by jobs or batches
Costs are compiled on time basis i.e.
of products
for production for a given accounting
3. Various jobs are separate and
period for each process
independent.
Processes are related to each other
4. Unit cost of a job is calculated by
products also lose their individual
dividing the total cost by units
entity.
produced in the lot or batch.
The unit cost of a process, which is
5. Costs are calculated when a job is
computed by dividing the total cost for
completed.
the period into the output of the process
6. There may not be opening or closing
during that period, is an average cost
WIP in an accounting period.
(after adjusting opening and closing
7. There is normally no transfer from one
WIP) for the period.
job to another. It will be only when
Costs are calculated at the end of the
there is surplus or excess production.
period under each process.
8. Each product unit is different and
Production in process costing is
therefore more managerial attention is
continuous and therefore there is
needed for proper control.
normally WIP at beginning and closing.
Transfer from one process to another is
a usual feature.
Production is standardized and stable
the control is, therefore easier.
226
CHAPTER 7- COST CONCEPTS FOR DECISION MAKING

a. MARGINAL COST EQUATION
The contribution theory explains the relationship between the variable cost and selling price. It
tells us that selling price minus variable cost of the units sold is the contribution towards fixed
expenses and profit. If the contribution is equal to fixed expenses, there will be no profit or loss
and if it is less than fixed expenses, loss is incurred. Since the variable cost varies in direct
proportion to output, therefore if the firm does not produce any unit, the loss will be there to the
extent of fixed expenses. These points can be described with the help of following marginal cost
equation: S x U V = F + P
Where,
S = Selling price per unit
V = Variable cost per unit
U = Units
F = Fixed Expenses
P = Profit
If three out of the above four factors of the equation viz., sales revenue; total variable cost, fixed
cost and profit are given, the fourth can be computed.
Illustration:
A firm produces 500 units. The selling price is Rs. 4/- and variable cost is Rs. 2 per unit. Fixed
expenses amount to Rs. 800. Find the profit.
Solution:
Marginal cost equation is S x U V x U = F + P. Since S, V and F are given, the profit can be
calculated as below:
500 units (S-V)-F = P
500 units (Rs. 4- Rs. 2) Rs. 800 = P
Rs. 1,000 Rs. 800 = P or P = Rs. 200
C. SALES MIX
Sales mix is the relative proportion of each product line to the total sales of various products sold
by an enterprise. If there are no constraints or limitations management should try to maximize
the sales of the products with higher P/V ratio. However, a sales mix results because there are
limits to the quantities of any given product that can be produced and there may also be certain
market limitations on how much can be sold.
When different products have their own different production facilities, selling prices, variables
costs and fixed costs separately, cost-volume-profit analysis can be done for each product
separately. But, in many situations, this is not found and different products share common
facilities and have common fixed costs. In such a situation CVP analysis is performed by
averaging the data using the sales mix as weights. The break-even point is computed for a
specified sales mix and break-even chart and P/V graph are constructed for any specified sales
mix. But any one break-even chart or P/V graph will show a constant sales mix for the total sales
of different products, covering the cost and revue lines as well. The sales necessary to achieve
desired or target level of operating profit can be computed on the basis of specified sales mix. If
the sales mix changes, CVP analysis, break-even point, desired sales for target, costs and revenue
227
lines will also change accordingly.

To illustrate the computation of break-even point in a sales mix situation, an example is given
here. Assume, for a company, the fixed costs are Rs. 675,000. Further, assume that the units
sales volume, units selling prices, unit variable costs, unit contribution margins for products A, B
and C are as follows:
Products
Sales volume
Unit Selling Unit Variable Contribution
Margin %
(Units)
Price (Rs.)
Cost (Rs.)
per unit (Rs.)
(P/V Ratio)
(Rs.)
A
20,000
50
20
30
60
B
10,000
50
30
20
40
C
10,000
50
40
10
20
40,000
Break-even points (in units) will be computed using a weighted average contribution margin as
follows:
Products
Sales Mix (%)
Contribution Margin Weighted contribution
per unit (Rs.)
margin (Rs.)
A
50% x
30
15
B
25% x
20
5
C
25% x
10
2.5
Total weighted contribution margin
22.50
BEP (Units) = Fixed cost / Weighted Contribution Margin = Rs. 675,000/Rs. 22.50
=30,000 units
The detail composition of sales and contribution margins at this level (30,000 units) are as
follows:
Products
Sales Mix (%)
Total units
Units of
Contribution
Total
Products
per unit (Rs.)
contribution
(Rs.)
A
50% x
30,000
15,000
30
450,000
B
25% x
30,000
7,500
20
150,000
C
25% x
30,000
7,500
10
75,000
Contribution margin
675,000
BEP (sales in Rupees) can also be calculated. For this, first, total P/V ratio is required and then
divides the fixed costs by total P/V ratio. Using the above information, calculation is shown
below:
Products
Sales (units)
Selling price (Rs.) per unit
Sales (Rs.)
Less: Variable costs (Rs.)
Contribution Margin
A
20,000
B
10,000
C
10,000
Total
40,000
50
1,000,000
400,00
50
500,000
300,000
50
500,000
400,000
2,000,000
1,100,000
228
Contribution Margin (Rs.)

Less: Fixed cost
Profit before tax
600,000
200,000
100,000
900,000
675,000
225,000
Total P/V Ratio = Total contribution/total sales = Rs.900,000/Rs.2,000,000 = 45%

Break-even sales (Rs.) = Fixed cost/Total P/V Ratio = 675,000/45% = Rs. 1,500,000
Rs 1,500,000 as break-even sales can be verified by computing break-even sales of individual
products as follows:
Products
Break-even Units
Selling Price (Rs.)
Break-even sales (Rs.)
A
15,000
50
750,000
B
7,500
50
375,000
C
7,500
50
375,000
Total Break-even sales
1,500,000
If there is any change in the above sales mix, the break-even point, P/V ratio, amount of profit
before tax may change. For instance, assume that the quantities sold of products A, B and C is
5,000 units, 20,000 units and 15,000 units respectively. Further, assume there are no changes
with regard to fixed costs, variable cost per unit and selling price per unit. The change in the
sales-mix will influence the factors of CVP analysis as shown below.
Products
Sales Volume Sales Mix %
Contribution
Total
Sales Revenue
(Units)
per unit (Rs.)
contribution
(Rs.)
(Rs.)
A
5,000
12.5%
30
150,000
250,000
B
20,000
50%
20
400,000
1,000,000
C
15,000
37.5%
10
150,000
750,000
Contribution margin
700,000
Less: Fixed Cost
675,000
Profit before tax
25,000
Total P/V Ratio = Total contribution/total sales = Rs.700,000/Rs.2,000,000 = 35%
Break-even sales (Rs.) = Fixed cost/Total P/V Ratio =Rs. 675,000/35% = Rs. 1,928,571
Break-even point in units will be computed using a weighted average contribution-margin, as
stated earlier.
Products
Sales Mix (%)
Contribution Margin Weighted contribution
per unit (Rs.)
margin (Rs.)
A
12.5%
30
3.75
B
50%
20
10.00
C
37.5%
10
3.75
Total weighted contribution margin
17.50
BEP (Units) = Fixed cost / Weighted Contribution Margin = Rs. 675,000/Rs. 17.50
=38,571 units
It can be observed that due to change in sales mix profit before tax is considerably lower (Rs.
229
25,000) although the amount of sales revenue is the same. The total contribution is less than the
earlier ones. P/V ratio has decreased (35%0 and break-even point in units has increased to
38,571 units. These differences are due to changes in sales mix. On the need of promoting
products having different P/V ratios, Anderson and Sollenberger advise:
One way to encourage the sales force to sell more of the high contribution margin lines is to compute sales
commissions on the contribution margin and not on sales revenue. If sales commissions are based on sales revenue,
a sales force may have a high volume of sales of less profitable product lines and still earn a satisfactory
commission. But if sales commission is related to contribution margin, the sales force is encouraged to strive for
greater sales of more profitable products, and, in doing so will help to improve total company profits.
7.9
ADVANTAGES OF MARGINAL COSTING

1. The marginal cost remains constant per unit of output whereas the fixed cost remains
constant in total. Since marginal cost per unit is constant from period to period within a
short span of time, firm decision on pricing policy can be taken. If fixed cost is included,
the unit cost will change from day to day depending upon the volume of output. This will
make decision making task difficult.
2. Overheads are recovered in costing on the basis of pre-determined rates. If fixed
overheads are included on the basis of pre-determined rates, there will be under-recovery
of overheads if production is less or if overheads are more. There will be over-recovery
of overheads if production is more than the budget or actual expenses are less than the
estimate. This creates the problem of treatment of such under or over-recovery of
overheads. Marginal costing avoids such under or over recovery of overheads.
3. Advocates of marginal costing argues that under the marginal costing technique, the
stock of finished goods and work-in-progress are carried on marginal cost basis and the
fixed expenses are written off to profit and loss account as period cost. This shows the
true profit of the period.
4. Marginal costing helps in the preparation of break-even analysis which shows the effect
of increasing or decreasing production activity on the profitability of the company.
5. Segregation of expenses as fixed and variable helps the management to exercise control
over expenditure. The management can compare the actual variable expenses with the
budgeted variable expenses and take corrective action through analysis of variances.
6. Marginal costing helps the management in taking a number of business decisions like
make or buy, discontinuance of a particular product, replacement of machine, etc.
7.10 LIMITATIONS OF MARGINAL COSTING

1) It is difficult to classify exactly the expenses into fixed and variable category. Most of the
expenses are neither totally variable nor wholly fixed. For example, various amenities
provided to workers may have no relation either to volume of production or time factor.
2) Contribution of a product itself is not a guide for optimum profitability unless it tis linked
with the key factor.
3) Sales staff may mistake marginal cost for total cost and sell at a price; which will result in
loss or low profits. Hence, sales staff should be cautioned while giving marginal cost.
230
4) Overheads of fixed nature cannot altogether be excluded particularly in large contracts,

while valuing the work-in-progress. In order to show the correct position fixed overheads
have to be included in work-in-progress.
5) Some of the assumptions regarding the behavior of various costs are not necessarily true
in a realistic situation. For example, the assumption that fixed cost will remain static
throughout is not correct. Fixed cost may change from one period to another. For
example, salaries bill may go up because of annual increments or due to change in pay
rate etc. The variable costs do not remain constant per unit of output. There may be
changes in the prices of raw materials, wage rates etc. after a certain level of output has
been reached due to shortage of material, shortage of skilled labor, concessions of bulk
purchases.
6) Marginal costing ignores time factor and investment. For example, the marginal cost of
two jobs may be the same but the time taken for their completion and the cost of
machines used may differ. The true cost of a job which takes longer time and uses
costlier machine would be higher. This fact is not disclosed by marginal costing.
231
CHAPTER 9 : STANDARD COSTING

STANDARD COSTING
Planning and control inter alia are the functions of top management. Planning involves
determination of objectives of a business and it also refers to the manner in which these
objectives are to be achieved. Thus it refers to both problems solving (identification of
alternatives) and decision making (selection from alternatives). Plans can be value only if they
are achieved. The control function comes into play to measure the extent to which the plans are
achieved so that the actual results do not fully confirm to the plans; efforts can be made to
correct adverse tendencies. Control implies a system which provides for establishment of plan,
operation of the plan, automatic feedback from the system and automatic regulatory action so
that any deviation is corrected. Standard costing can be of immense use to the management in
achieving the two aforesaid important spheres of functions. In the planning stage, standard
costing can assist the managers with much of the necessary data. At the control stage, it can be
used to find the extent and place where such inefficient exist, and also to suggest ways for
combating them by bringing them to the attention of those who have authority to control them.
Definition of Standard Cost
Standard cost is defined as a pre-determined cost which is calculated from managements
standards of efficient operation and the relevant necessary expenditure. It may be used as a basis
for price fixing and for cost control through variance analysis.
Standard cost is pre-determined operating cost. It refers to quantities of materials and labor
expected to be used, prices expected to be paid for materials and labor during the coming year
and factory expense applicable to production based on good performance and practical capacity
operation of the factory.
The standard cost of a product has been defined by Blocker and Weltmer as a pre-determined
cost based upon engineering specification and representing highly efficient production for
quantity standards and forecasts of future market trends for price standards with a fixed amount
expressed in dollars for material, labor and overhead for an estimated quantity of production. It
may be seen from this definition that engineering specifications are the basis for quantity
standards for materials and time standards for labor while budgets are of importance in
determining material price standards, labor rate standards and overhead standards.
Standard costing is defined by the ICMA, London, as the presentation and use of standard costs,
their comparison with actual costs and the analysis of variances to their causes and points of
incidence.
Standard costing, thus, is a system of costing which can be used in conjunction with any method
of costing, like job costing, process costing etc. Standard costs are pre-determined by using a
careful analysis of production methods, physical conditions and price factors. They represent
achievable targets and help to build up budgets gauge performance and obtain product costs. The
actual costs will vary from month to month or even from day to day.
The basic objective, therefore, of standard costing system is to assist the departmental head by
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identifying and describing the variances over which he has control. Thus, a set of standard
developed under the standard costing system outlines how a task must be compared with
standard cost to determine the variances. The variances, thus arrived at, are analyzed further with
a view to discovering better ways of adhering to standards or of altering the standards so as to
accomplish the objectives. Under this system, the cost is pre-determined for each element,
namely, material, labor and overhead and for each line of product manufactured or service
rendered. It, therefore, involves:
a) The setting of standards,
b) Ascertainment of actual costs,
c) Comparison of actual and standard costs to determine the variance, and
Investigation of variance and taking appropriate action thereon wherever necessary
Need for Standard Costs:

Since standard costs are pre-determined costs computed before the production takes place, they
are preferable to actual costs. Moreover, certain conditions resulting from mass production make
standard costs necessary and strongly advisable. Some of such conditions are:
a) Historical costs may be too expensive to compute. For example, in a manufacturing concern
producing about 100,000 parts, divided into various lots, imagine the time and clerical labor
involved in arriving at the actual cost lot by lot then averaging it to determine the cost per
unit.
b) The unit costs computed on historical data may vary from day to day and they are of no use
to the sales department in setting selling prices. For example, if the historical costs per unit of
product is a week are Rs. 1.05, 0.99, 1.27, 1.18, 1.42, 1.56, the selling price cannot be varied
from day to day to match the costs.
c) Historical costs are not known until after the completion of the month or even a longer
period. But in many cases, to take a decision, the cost of a product has to be calculated even
before the production begins.
d) Historical costs may not be adequate for the measurement of efficiency. Standard costs are
well suited for measuring operating efficiency because they represent what the costs should
be. The management, consequently, knows immediately whether the performance is
satisfactory.
Uses of Standard Cost
a) Use of standard costs is an effective way for planning and controlling costs.
b) Pricing decisions and decisions involving submission of quotations, answering tenders
etc., are also facilitated by the use of standard costs.
c) Identification and measurement of variances from standards has been made possible with
the use of standard cost, with a view to improve performance or to correct loose
standards, if any.
d) Facilitates management by exception.
Preliminaries of establishing a system of Standard Costing:
The following preliminary steps should be considered before a system of standard costing can be
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set into operation in an organization:

a) The establishment of cost centers with clearly defined areas of responsibility.
b) Classification and coding of accounts for collection and comparison actual costs with
standard costs.
c) Selectin of s suitable type of standard for operation.
Advantages of Standard Costing
1. Exact degree of efficiency in various operations can be ascertained through comparison of
actual and standard cost. The variances between actual and standard costs reveal the
weaknesses and inefficiencies. This enables management to remove causes of inefficiency.
2. Management by exception is possible, since it is possible to separate the efficient from
inefficient operation. Variance analysis helps management to concentrate on those areas
where corrective measures are to be taken in time. They do not go to the masses of details.
They are attracted towards faults which should not be overlooked.
3. Efficiency is consolidated and if necessary, the standards are revised after identifying exact
causes of deviations of actual costs from standard costs.
4. There can be effective delegation of authority since the people concerned are told what they
have to achieve and by what they will be judged. Control itself becomes effective.
5. The effect of idle capacity or fluctuations in output or sales is also highlighted. Variances
due to idle capacity and fluctuation in sales are ascertained in the standard costing system
which provides very useful information to the management.
6. Standard costing is immense benefit for cost audit since if variances are satisfactorily
explained, the accuracy of costing can be safety assumed.
7. The cost accounting itself is reduced since all rates are fixed and do not have to be
calculated again and again. Also, automatically the effect of efficiency or inefficiency is
revealed.
8. Standard costing can be used in formulating production and price policies in advance.
Standard costs are the best basis for establishing policies in as much as such standards
which usually eliminate the effect of fluctuating volume and again avoid any cost-increase
due to waste or inefficiency.
9. Standard costs provide basis of incentive schemes to workers and supervisors. The system
determines standard labor costs of a product and with help of these, incentive schemes are
formulated.
10. Standard costing simplifies the cost control procedure as the figures for control purposes are
easily and directly obtained. Thus there is saving in the accounting computation. Moreover,
the standard cost of materials and rates of labor and overheads are available which make
accounting calculation easier.
11. Standard costing helps in business planning, budgeting and marginal costing. Standard
costing are pre-determined costs and are therefore very useful in planning and budgeting.
Standard costing can be very easily and suitably used for budgetary planning. These help in
estimating the effect in cost-price-volume relationship.
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12. Standard costs are used for inventory valuation. Once the standards have been set, it is the
standard costs, not the actual or historical costs, which are entered in the accounts for the
purpose of valuing material-stock, work-in-progress and finished goods consequently the
cost of goods sold in the trading account, because the standard cost and the gross profit is at
standard.
Limitations of Standard Costing
Standard costing may not prove a success in certain organization due to difficulty in fixing up
reliable and workable standards. If standards are not correctly established, the cost control and
variance analysis will not be effective. Conclusions drawn on such variances will be doubtful
and it will be detrimental to the system and will be worse than having no standards at all.
Thus the basic limitation is that fixation of standard cost is somewhat difficult in practice.
Moreover, the standards fixed may become rigid in course of time or even in short period.
Standards cannot be revised at every frequent change in the manufacturing condition
Some worth mentioning points of limitations of standard costing are narrated below:
1. It is expensive technique because it requires technically skilled staff. Small concern may not
find standards easy to establish due to their limited resources. But, it must be noted that once
the standard are established, the advantages achieved will be far more cost involved in the
beginning.
2. Business conditions are rapidly changing and therefore standard costs once fixed may not
be reliable even for a short period. Standards are to be revised frequently so as to make these
comparable with actuals. But the revision will create the problem of inventory adjustment.
3. In small concerns, where production is not carefully scheduled standard costing may not be
suitable. The system is also not very useful in industries dealing with non-standardized
products. For example, it cannot be successfully used in repairs jobs, which are carried on
according to customers requirement. In those contracts and jobs also, standard costing is
not suitable, where the work is carried on for more than one accounting year.
DISTINCTION BETWEEN BUDGETARY CONTROL AND STANDARD
COSTING
Budgeting is for entire activity. Budgetary control means laying down in monetary and
quantitative terms what exactly has to be done and how exactly it has to be done over a coming
period and then to ensure that actual results do not diverge from the planned course more than
necessary.
9.1
Standard costing is a system which seeks to control the cost of each unit or batch through
determination beforehand of what should be the cost and then its comparison with actual cost.
Thus standard cost is pre-determined or budgeted cost of a unit of a product or job.
In both systems there are some common basic principles:
i. In both systems the performance target or standard is predetermined.
ii. The actual performance is ascertained and both have appraisal of the actual performance.
235
iii.
iv.
In both systems there is comparison of actual performance and costs against budget or
standard. There is computation and analysis of variances between the actual cost and
budgeted or standard cost.
Both need revision of standard or budget whenever necessary in the light of attainment.
Yet both have some specific differences as narrated below:

1. Budgetary control deals with the operation of a department or the business as a whole in
the terms of revenue and expenditure. Standard costing is used in manufacturing or
producing of a product or in rendering a service. Hence budgetary control is more
extensive because it is concerned with entire organization while standard costing is
related to product and its cost, and therefore more intensive.
2. Budgetary control seeks to keep in focus the total amount involved and total activity to be
carried on. Standard costing provides control to be exercised in the cost of production.
3. Budgets prepared under Budgetary control system are for specific periods and are based
on totals of amounts while in standard costing , the standard costs are worked out
generally per unit of production or service.
4. Basically a budget under budgetary control is projection of financial accounts while
standard cost is merely a projection of cost accounts.
5. Budgetary control is generally applicable to all business establishments, while standard
costing can be usefully applied in manufacturing concerns producing standard products
and services.
6. Budgetary control is an effective tool in control of all types of expenses while standard
costing is very effective tool in the matter of control of elements of costs like direct costs
(direct material, direct labor, etc.) and overheads
7. Budgetary control is an effective tool to plan and exercise control over capital
expenditure, finance and cash forecast etc., whereas standard costing can offer no help.
8. Budgets provide ceiling or limits of expenses beyond which the actual expenditure should
be normally go up otherwise the planned profit will be reduced. On the other hand
standard costs are usually minimum targets which are to be achieved by the actual
performance. Thus the former puts more emphasis on revenue and expenditure not
crossing the budget, while the standard costing lays importance to costs approaching the
standard costs.
9. Budgets are prepared for all the activities and the functions of an establishment such as
purchasing, production, research and development, capital and financing, selling and
distribution etc., whereas standard costing relates only to production and its
manufacturing cost.
10. .Variance analysis is more intensive and searching in case of standard costing in
comparison to budgetary system. In standard costing, even if standards are achieved,
further analysis is carried on to achieve efficiency. If expenditure exceed the budget it
simply shows that situation is unsatisfactory but if actual cost of production exceeds
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standard cost, the variances are analyzed in detail to search out the possible
improvements.
Considering the basic principles and approach, standard costing and budgetary control are
somewhat inter-related, but basically these two are independent. A system of budgetary control
may be efficiently and effectively operated even if there is no standard costing system in use in a
concern. Standard costing may also be operated without budgetary control, but introduction of
standard costing will more facilitated if budgetary system is in operation. Budgetary control will
provide basic framework required in the fixation of realistic standards. If both techniques are
adopted simultaneously, there will be very effective cost control machinery. Thus budgetary
control and standard costing are essentially complementary to each other. Both provide cost
control and improve efficiency.
9.2
TYPES OF STANDARDS
The value of standards costing system depends upon the reliability of the standards set up. To
complete the standards we must know what degree of accuracy is necessary. There are four
different bases or standard which should be considered. These standards have been discussed
below.
Basic or Bogey standards:
These standards are used only when they are likely to remain constant or unaltered over a long
period. According to this standard, a base year is chosen for comparison purposes in the same
way as statisticians use price indices. Since basic standard do not represent what should be
attained in the present period, current standards should also be prepared if basic standards are
used. Basic standards are, however, well suited to business having a small range of products and
long production runs. Basic standards are set, on a long-term basis and are seldom revised. When
basic standards are in use, variances are not calculated as the difference between standard and
actual cost. Instead the actual cost is expressed as a percentage of basic cost. The current cost is
also similarly expressed and the two percentages are compared to find out how much the actual
cost has deviated from the current standard. The percentages are next compared with those of the
previous periods to establish the trend of actual and current standard from basic cost.
Ideal standards:
These represent the level of performance attainable when prices for material and labor are most
favorable, when the highest output is achieved with the best equipment and layout and when the
maximum efficiency in utilization of resources results in maximum output with minimum cost.
These types of standards are criticized on three grounds:
i.
Since such standards would be unattainable, no one would take them seriously.
ii.
The variances disclosed would be variances from the ideal standards, These
would not therefore, indicate the extent to which they could have been reasonably
and practically avoided.
iii. There would be no logical method of disposing of these variances.
Normal standards:
These are standards that may be achieved under normal operating conditions. The normal
activity has been defined as the number of standard hours which will produce at normal
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efficiency sufficient goods to meet the average sales demand over a term of years. These
standards are, however, difficult to set because they require a degree of forecasting. The
variances thrown out under this system are deviations from normal efficiency, normal sales
volume, or normal productive volume. If the actual performance is found to be abnormal, large
variances may result and necessitate revision of standards.
Current standards:
These standards reflect the managements anticipation of what actual costs will be for the current
period. These are the costs which the business will incur if the anticipated prices are paid for the
goods and services and the usage corresponds to that believed to be necessary to produce the
planned output. The variances arising form expected standards represent the degree of efficiency
in usage of the factors of production, valiance in prices paid for materials and services and
difference in the volume of production.
9.3
SETTING STANDARDS
In a big establishment, generally a standard cost committee is set-up which is entrusted the work
of setting up standard costs. This committee is normally consists of production manager,
Purchase manager, sales manager and cost accountants etc. out of these executives, the function
of the Cost Accountant is of great importance because he alone can provide all necessary data
relating to cost and he has to coordinate the activities of the standard cost committee.
Standard cost is divided into three main heads: 1. Direct Materials, 2. Direct labor, 3. Direct and
indirect overhead expenditure. Standard for each of these elements of cost are set.
1. Direct material cost standard: This standard consist of two basic elements. Standard
material quantity or usage and standard material price
a) Material quantity or usage standard: The standard quantities of direct materials, which
are required to manufacture a product, are normally decided or fixed by production
manager and engineers. For this purpose material specification, standard ratio of their
mix (when more than one direct material is needed), product design and quality should be
kept in consideration. Moreover, normal wastage or scrap should also be kept in a view
while deciding quantity or usage of direct material.
b) Material price standard: For determining material standard consumed, the cost
accountant will have to decide standard price in consultation with the purchase manager.
The standard price may be based on past average prices of raw material or on current
prices or on expected future prices. It is desirable that prevailing current prices should be
adjusted to suit future price-variations. While determining expected prices following
points should be taken into consideration.
i.
Prices of opening stock in hand
ii.
Prices for which contracts have been undertaken to obtain material
iii. Expected price-changes
iv.
Price-rebate and discounts which can be availed.
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2. Direct labor cost standards: There are two elements of standards direct labor (a) Standard
labor time, and (b) Standard labor rate
(a) Standard labor time: Standard labor time is to be set for each grade of labor and also foe
each operation involved in the production. It is set with the help and advice of the workstudy engineers. With the technique of motion and time study, the standard time for
performance of labor is fixed. Due allowance should be made for fatigue, tool setting and
other normal delays.
(b) Standard labor rate: Rate of wages to be paid to workers should be very properly
decided. Wages paid to efficient and skilled workers having technical knowledge may be
higher than those for unskilled and non-technical workers. There may be workers under a
contract, then rate approved by the contract may usually become the standard.
The standard labor hours multiplied by standard labor rate become standard labor cost.
3. Overhead cost standards: Overheads may be classified into indirect material, indirect labor,
fixed overheads and other variable overheads. Indirect material cost is determined per
machine or production hour. Indirect labor cost is determined per machine or production hour
or percentage of direct labor. Fixed expenses are total amount for the period of budgeted
production hours. Variable overhead cost is determined on the basis of cost per unit of output
or cost per production hour.
The total fixed overhead cost remains fixed and remain unchanged by changes in the volume
of production. For this purpose, it is necessary to ascertain budgeted fixed overheads for the
period and the budgeted units or standard hours for the period.
Standard cost for variable overheads, once calculated, remains the same per unit or per hour
irrespective of volume of production because standard for variable cost tends to vary directly
with the volume of production, while calculating its standard unit cost, due consideration
should be given to past records and future trend of prices.
It is to be noted that standards fixed should be comprehensive and realistic. They should be
related to the specific period and to the stipulated working conditions. The standard need not
be ideal but should be easily attainable. The attainable standard is a normal standard fixed
on the basis of average efficiency of men, machine and material. It provides reasonable
allowances for wastage of material and idle time. On the other hand an ideal standard is
based on minimum prices of material and maximum efficiency of men and machinery. It may
be said that an ideal standard is most favorable but can rarely be achieved in practice.
It is necessary that the standard cost should be related to a common measurement unit. This
common unit is normally a time unit and is called standard hour. It is the quantity of
production units which can be completed in one hour. After fixing standards hour for each
product, the standard for the different items of cost of production are related to standard hour.
Thus the standard hour may be defined as a hypothetical hour representing the amount of
work which should be performed on an hour under standard conditions.
9.4 COMPUTATION OF VARIANCES:
Let us now proceed to study with illustration the method of computation of major variances. In
239
all the problems illustrated in the following pages, F means favorable variance and A means
adverse variance.
DIRECT MATERIAL COST VARIANCE
The total direct material cost variance for actual output can basically be divided into two types,
namely (a) price variance and (b) usage variance. The method of calculating these variances is as
under:
Total material cost variance = Standard cost Actual cost
Price variance
= Actual quantity (Standard price Actual price)
Usage variance
= Standard price (Standard quantity - Actual quantity)
Illustration
The standard and actual figures of product Z are as under:
Standard
Material quantity
50 unis
Material price per unit
Re.1.00
Calculate material cost variances.
Actual
45 units
Re.0.80
Solution
The variances may be calculated as under:
a) Standard cost = std qty x std price = 50 units x Re. 1.00 = Rs. 50
b) Actual cost = Actual qty x Actual price = 45 units x Rs. 0.80 = Rs. 36
Variances
i. Price variance = Actual qty (std. price Actual price)
= 45 units (Re 1.00 Re. 0.80) = Rs. 9 (F)
ii. Usage variance = Std. price (Std.qty Actual qty)
= Re. 1 ( 50 units 45 units) = Rs. 5 (F)
iii. Material cost variance (Total variance) =Standard cost Actual cost
= Rs. 50 Rs. 36 = Rs. 14 (F)
* Mix variance: If two or more materials are mixed in a process, an optimum or standard
mixture is decided upon by the production planning department. If the actual mix is different
from the standard mix, a variance arises. This part of the usage variance attributable to the
change in mix is called the mix variance. The procedure and formula for calculating the mix
variance is as under:
i.
Calculate the standard cost per unit of the standard mix.
ii. Calculate the standard cost per unit of the actual mix.
iii. Multiply the difference between (a) and (b) with the total actual quantity.
Thus, Mix variance
= Total actual qty. (Std. cost per unit of std. mix Std. cost per unit of actual mix)
* Yield variance: In some industries the finished product can be related to the raw material input
in terms of units. Weight, volume, etc. and consequently the standard loss of material can be
readily computed. This relationship is known as the yield. When the standard yield is given and
the actual consumption deviates from standard consumption, the difference is known as yield as
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yield variance as yield variance. Yield variance is just another way at the sub-usage variance.
Illustration
The standard quantity of material required is 4 kgs Per unit of actual output. The relevant figures
are as under:
Material
A
B
C
D
Standard mix %
30%
40%
20%
10%
Price per kg (Rs.)
1.25
1.50
3.50
3.00
Actual qty. used (Kg)
1,180
1,580
830
440
Actual price per kg (Rs.)
1.30
1.80
3.40
3.00
Actual output 1,000 units
Calculate price variance, mix variance, sub-usage variance and total material cost variance.
Solution
i. Since the actual output is 1,000 untis, the standard quantity of materials required for the
actual output is 1,000 units x 4 kgs = 4,000 kgs.
ii. Statement showing computation of standard cost, standard cost of actual quantity and
actual cost.
Material Std. cost
Actual
Std. qty in Actual qty Std. cost
Std cost
Actual
per kg
cost per
kg. Rs.
in kg. Rs. (Std. qty x of actual cost
Rs.
kg
price)
qty
(actual
Rs.
Rs.
(actual
qty x
qty x std. actual
price) Rs. price) Rs.
a
b
c
d
e=axc
f=axd
g =b x d
A
1.25
1.30
1,200
1,180
1.500
1,475
1,534
B
1.50
1.80
1,600
1,580
2,400
2,370
2,844
C
3.50
3.40
800
830
2,800
2,905
2,822
D
3.00
3.00
400
440
1,200
1,320
1,320
4,000
4,030
7,900
8.070
8,520
iii.
iv.
Standard cost per unit of the standard mix = Rs. 7,900/ 4,000 kgs = Rs. 1,975
Standard cost per unit of the actual mix = Rs. 8,070/ 4,030 kgs = Rs. 2,002
Variances:
i.
Price variance
ii.
iii.
iv.
= Actual qty. (Std. price actual price)

= Rs. 8,070 Rs. 8,520 = Rs. 450 (A)
Mix variance
= Total actual qty. (Std. cost per unit of std. mix Std. cost per
unit of actual mix)
= 4,030 Kgs (Rs.1.975 Rs.2.002) = Rs. 110 (A)
Sub usage variance = Std. price per unit of std.mix (Total std. qty. Total actual
qty.)
= Rs. 1,975 (4,000 = 4,030) = Rs.60 (A)
Total material cost variance = Std. cost Actual cost = Rs. 7,900 Rs. 8,520
= Rs. 620 (A)
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Proof:
Price variance + Mix variance + sub-usage variance = Total variance

Rs. 450 (A) + Rs. 110 (A) + Rs. 60 (A) = Rs. 620 (A)
Note: Mix variance and sub usage variance are sub-part of total usage variance which may
be calculated as below:
v.
Usage variance = Std. price (Std. qty Actual qty.)
= Std. cost standard cost of actual qty.
= Rs. 7,900 Rs. 8,070 = Rs. 170 (A)
Illustration
The standard set for a chemical mixture of a firm is as under;
Material
Standard mix %
Standard price per kg (Rs.)
A
40
60
B
60
30
The standard loss in production is 10%. During a period, the actual consumption and price paid
for a good output lf 182 kg. are as under:
Material
Quantity in kg.
Actual price per kg (Rs.)
A
90
18
B
110
34
Calculate the variance.
Solution
Take the good output of 182 kgs. The standard quantity of material required for 182 kg of output
is =182/90 x 100 = 202.22 Kgs.
Standard showing the standard and actual costs and standard cost of actual mix
Standard cost
Actual cost
Std. cost of actual
quantity
Qty. Kg. Rate
Amt.
Qty.
Rate
Amt.
Qty. Rate
Amt.
Rs.
Rs.
Kg.
Rs.
Rs.
Kg. Rs.
Rs.
A (40%
of
202.22
kg)
80.89
20
1,617.80
90
18
1,620
90
20 1,800
B(60%
of
202.22
kg)
Total
input
121.33
202.22
30
26
20.22
--
3,639.90
5,257.70
110
200
34
26.40
18
--
3,740
5,360
110
200
30
25.50
3,300
5,100
--
--
--
(-) Loss
Total
output
182.00
28.89
5,257.70
182.
29.45
5,360
Standard yield in actual input is 90% of 200 kg i.e. 180 kg.
Variances:
i.
Price variance
= Actual qty. (Std. price actual price)
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= Rs.5,100 Rs. 5,360 = Rs. 260 (A)

ii.
Mix variance
= Total actual qty. of input (Std. cost per unit of std. mix Std.
cost per unit of actual mix)
= 200 Kgs (Rs.26 Rs.25.50) = Rs. 100 (F)
iii.
Total usage variance = Std. price (Std. qty. Actual qty.)
= Standard cost Standard cost of actual quantity
= Rs. 5,257.70 - Rs. 5,100 = Rs.157.70 (F)
iv.
Yield variance
= Standard price of yield. (Actual yield Std. yield)
= Rs.28.89 (182 -180) = Rs. 57.70 (F)
v.
Total variance
= Std. cost Actual cost = Rs. 5,257.70 Rs.5,360
= Rs. 102.30 (A)
Note: (iii) and (iv) above are sub parts of total usage variance
Proof:
Price variance + Mix variance + Yield variance = Total variance
Rs. 260 (A) + Rs. 100 (F) + Rs. 57.70 (F) = Rs. 102.30 (A)
LABOR COST VARIANCE ANALYSIS

The two basic variances that can be calculated in respect of direct labor are (a) rate variance and
(b) efficiency variance.
The formulas for calculating labor variances are as under:
Total labor cost variance
= Std. labor cost Actual labor cost
Rate variance
= Actual time (Std. rate Actual rate)
Efficiency variance
= Std. rate (Std. time Actual time)
Illustration
The standard and actual figures of a firm are as under:
Standard time for the job
Standard rate per hour
Actual time taken
Actual wage paid
1,000 hours
Re. 0.50
900 hours
Rs. 360
Compute the variances

Solution
(i) Std. labor cost (1,000 hours x Re.0.50)
(ii) Actual wages paid
(iii) Actual rate per hour: Rs. 360 900 hours =
Rs. 500
Rs. 360
Re. 0.40
Variances:
i.
Rate variance
ii.
iii.
= Actual time. (Std. rate actual rate)

= 900 hours ( Re. 0.50 Re. 0.40) = Rs. 90 (F)
Efficiency variance= Std. rate per hour (Std. time Actual time)
= Re. 0.50 (1,000 hours 900 hours) = Rs. 50 (F)
Total labor cost variance = Std. labor cost Actual labor cost
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= Standard cost Standard cost of actual quantity

= Rs. 500 - Rs. 360 = Rs.140 (F)
Gang composition variance or Labor mix variance: A change in the standard gang
composition may also result in a variance which can be measured as shown in the
following illustration.
Illustration
Given the following data, compute the variances.
Skilled
Semi-skilled
Unskilled
Number of workers in standard gang

Standard rate per hour
Actual number of workers in the gang
Actual rate of pay per hour (Rs.)
In a 40- hour week, the gang as a whole produced 900 standard hours
Solution
In a 40 hour week, the standard gang should have produced 1,000 std. hours as shown below:
Skilled
16 No. of worker x 40 hours = 640
Semi-skilled 6 No. of workers x 40 hours = 240
Unskilled
3 No. of workers x 40 hours = 120
1,000 hours
However, the actual output is 900 standard hours. Hence to find out the total labor cost varianc,
the standard cost (or cost charged to production) is to be computed with reference to 900
standard hours. This is done in the following statement:
Statement showing the standard cost, actual cost and standard cost of actual time for
actual output, i.e. 900 Standard hours
Gang
Standard cost
Actual cost
Standard cost of actual
time
Hours
Rate Amount
Hours
Rate Amount
Hours
Rate Amount
Rs.
Rs.
Rs.
Rs.
Rs.
Rs.
Skilled {(640*900)/1,000}
3
1,728
14*40
4
2,240
560
3
1,680
= 576
=560
{(240*900)/1,000}
2
432
9*40
3
1,080
360
2
720
= 216
=360
{(120*900)/1,000}
1
108
2*40 =80
2
160
80
1
80
= 108
900
2.52 2,268
1,000
3.48 3,480
1,000
2.48
2,480
Variances:
i.
Rate variance
= Actual time (Std. rate actual rate)

= (Standard cost of actual time actual cost)
= Rs. 2,480 Rs. 3,480 = Rs. 1,000 (A)
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= Total actual time (Std. rate of std. gang Std. rate of actual
gang)
= 1,000 (Rs.2.52 Rs.2.48) = Rs. 40 (F)
iii.
Sub-efficiency variance = Std. rate (Total std. time. Total actual time)
= Rs. 2.52 (900 hours -1,000 hours) = Rs.252 (A)
iv.
Total labor cost variance = Std. labor cost Actual labor cost
= Rs. 2,268 Rs. 3,480 = Rs. 1,212 (A)
The gang composition variance may also be known as labor mix variance and is part of
efficiency variance which may be computed as under:
v.
Efficiency variance
= Std. rate (Std. time Actual time)
= Std. cost standard cost of actual time.
= Rs. 2,268 Rs. 2,480 = Rs. 212 (A)
ii.
Gang variance
Labor idle time variance: This variance arises due to the difference between actual labor hours
worked and the actual labor hours paid (idle time hours). This is computed by multiplying the
difference between hours worked and paid by the standard labor rate. It may be written as
follows:
Standard labor rate (actual hours worked actual labor hour paid)
OR
Standard labor hour rate x idle time hours
Illustration
A firm gives you the following data:
Standard time per unit
2.5 hours
Actual hours worked
2,000 hours
Standard rate of pay
Rs. 2 per hour
25% of the actual hours has been lost as idle time.
Actual output
1,000 units
Actual wages
Rs. 4,500
Calculate the idle time variance.
Solution
Standard cost charged to production = (1,000 units x 2.5 hours x Rs. 2) = Rs. 5,000
Actual wages paid
Rs. 4,500
Actual wages rate per hour (Rs. 4,500 2,000 hours)
Rs. 2.25
Std. wage rate per hour
Rs. 2.00
Abnormal idle time (25% of 2,000 hours) =
500 hours
i.
Wage rate variance
ii.
Efficiency variance
iii.
Idle time variance
iv.
Total variance
= Actual time (Std. rate actual rate)

= 2,000 hours (Rs. 2 - Rs. 2.25) = 500 (A)
= Std. rate (Std. time Actual time*)
= Rs. 2 (2,500 hrs. 1,500 hrs.) = Rs. 2,000 (F)
= Idle time x Std. rate
= 500 hours x Rs. 2 = Rs. 1,000 (A)
= Std. labor cost Actual labor cost
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= Rs. 5,000 Rs. 4,500 = Rs. 500 (F)

* Actual time less idle time.
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PAPER 6A: BUSINESS COMMUNICATION
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CHAPTER -1 : COMMUNICATING AT WORK

BUSINESS COMMUNICATION
Business communication is the process of communication that is oriented to fulfilling the
business goals, missions and tasks of an organization. It can be both internal and external in
nature. It involves oral, written and non-verbal tools with interaction, disseminations,
presentations being sensitive to given context and culture. Memos, letters, notice, press release,
advertisements, interviews, etc. are different instances of business communications. Thus, the
explicit purpose of business communication can be interpreted (i) communication to inform, (ii)
communication to promote business, and (iii) communication is also concerned with
socialization, motivation, instructions, feedback, conflict resolution, etc. different principles of
business communication are identified. Some importance ones are:
Clarity
Completeness
Conciseness
Concreteness
Correctness
Courtesy and so on.

OVERCOMING INTERPERSONAL COMMUNICATION BARRIERS
Communication that takes place between different people in or outside the organization is an
inter-personal communication. Different obstacles can be seen during the course of interaction or
communication between people. These are termed as communication barriers. The barriers in the
communication process affect its outcome. Inadequate language forms. Fluency paralinguistic
features, noise, schema, etc. are the major communication barriers. In the channel of
communication the receiver needs to achieve the actual intention of the sender; otherwise
misunderstanding may take place. Communication barriers are most responsible for creating
misunderstanding.
COMMUNICATING IN ORGANISATIONS
Organization communication skills are important for day to day professional activities and
transaction. Professional and executives have to accomplish their jobs in both internal and
external channels through some very specific skills and knowledge. Clients and agencies should
be dealt with properly. For this, the following types of organization skills are supposed to be
significant:
Initiating discussions and interactions
Organization meetings and workshops
Creating information networks
Training about business skills, and so on.
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D. ENVIRONMENT AND ECOLOGICAL RESPONSIBILITIES

Business organization should be responsible for the conservation of natural heritage of the world
where we live. Business ethics is always concerned with environmental and ecological
responsibilities. For example, while making packages of goods, the materials used in them
should be properly thought of. The materials which do not harm the environment should be used.
Environment friendly raw materials helps us protect our home, i.e. earth. In our context, recently
plastic bags are forbidden in the markets of Nepal. This helps to keep our surrounding relatively
clean. The business persons must co-operate for this kind of national campaign, not as a rule but
as a part of business ethics. It is one of the factors of corporate society responsibility. The society
feels being served through this kind of consecration campaigns when the business sectors
becomes irresponsible to the nature and environment, the existence of human society may also
be in question. Business is one of the most important sectors of our societies. So, the business
personas must be responsible to the societies where they have to survive and carry out business.
SELF- ASSESSMENT DEVICES
1. How is business communication an autonomous discipline? Discuss in brief its function and
principles by linking them with succeeding in the workplace.
2. Who are the major actors of business communication? Specify their roles in the organization
communication process.
3. What do you mean by communication barriers? How can they be overcome? Discuss in brief
with examples.
4. How are internal communication skills different from the external ones? Discuss with
examples.
5. What is ethics in business communication? Discuss in brief economic, legal and
philosophical perspectives of business ethics.
6. What are the potential consequences of unethical business dealings? How can you repair
them?
7. Meaning is the outcome of mind, language and context. Do you agree this statement?
Explain.
8. Write short notes on:
a) Encoding and Decoding
b) Courtesy in business communication
c) Business ethics
d) Frame of reference
e) Organizational communication skills
f) Feedback in business communication
CHAPTER 2 WORKING IN GROUPS
1. LISTING SKILLS
Listening and speaking skills are regarded as the primary skills of language, while reading and
writing are the secondary ones. Similarly, listing and reading are the receptive skills, while
speaking and writing are productive ones. A listener receives the message and interprets it
according to the context. In business communication listening has a special position. To get the
intended meaning of the speaker, the listener should decode the meaning appropriately. Listening
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involves different sub-skills such as predicting, extracting general meaning, making specific
meaning, interpreting and analyzing meaning.
SELF-ASSESSMENT
1. As the member secretary of a company write a notice to deliver to the board members
about the Broad Meeting to be held on a given date next week.
2. What are the major consideration to be taken into account while writing minutes? Discuss
with examples.
3. What roles can an individual member play in a group to accomplish the business goals?
Explain
4. Think of a situation where workers are in conflict, and present convincing ways of
overcoming such conflict.
5. Elaborate the importance of listing in business communication. Also discuss Dos and Donts
of good listening.
6. Define feedback and explain how feedback should be given and received in groups.
7. Can you point out some drawbacks of team work in a business and present organization?
Think of and present a case where team work has failed due to misunderstanding.
8. Write short notes on:
a) Group dynamics
b) Position of agenda and minutes
c) Follow-up letters
d) Qualities of good minute
e) Conflict resolution strategies
CHAPTER 3- COMMUNICATING ACROSS CULTURES

5. WRITING TO AN INTERNATIONAL AUDIENCE
Primary concerns of writing to an international audience include: intercultural sensitivity, polite
language with no imposition at all, you-attitude in presentation, international conventional and
trends, choice of proper code, etc. International language should be used as the medium of
business transaction. Business letters, reports, proposal etc. in the formal style can be useful
device for international communication. Proper use of non-verbal communication has also been
significant for international exchanges. Non-verbal tools of communication are mostly universal.
Particular in multinational companies, exchanges are of international levels. Executives should
be given trainings about business communication. Writing strategies, presentation skills, and
non-verbal cues should be properly exposed to the workers of such multinational companies. The
most important thing in the international communication is the way the receivers culture
interprets the message and style of expression. The words discourse patterns, format of writing,
etc. Should be chosen in a way the receiver would be persuaded. Persuasiveness is an important
quality of international communication.
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SELF- ASSESSMENT TOOLS

1. Illustrate a case where there is workplace diversity. Explain how diversity can be properly
managed in an organization?
2. What are the major problems of workplace diversity? How can they be settled within an
organization?
3. How do people develop multicultural sensitivity and intercultural competence in business
multicultural sensitivity and intercultural competence in business communication? Explain
4. What are the major consideration that people need to take into account while carrying out
international communication?
5. Discuss the role of graphics in oral presentation of business papers.
6. What do you mean by globalization of culture? Discuss in brief in relation to business
communication
7. Why is international business communication important? Discuss in brief.
CHAPTER 4- EMPLOYMENT COMMUNICATION
1.
2.
3.
4.
5.
SELF-ASSESSMENT TOOLS
Ramesh Chand, a graduate in Business Management is looking for suitable job. What do you
think Mr. Chand has to be prepared in when he visits business houses for job?
What do you mean by a persuasive resume? Discuss the major considerations to be made
while writing a persuasive resume.
Write a professional resume to submit to an employer.
Write a follow-up letter about the application you had submitted to an organization for the
post of sales manager as required by organization.
Write a set of questions that are possibly asked to an interviewer for the post of branch
manager of a commercial bank.
CHAPTER 5 ANALYZING INFORMATION AND WRITING REPORTS AND

PROPOSALS
3. COLLECTING AND CHOOSING INFORMATION FOR REPORTS
Different tools such as interview, observation, questionnaire, etc. are used to elicit information
required for a report. Reports are based as facts and events. The information on facts and events
are presented systematically as data. The data are analyzed using tables, graphics, mean, median,
standard deviation, pie charts, etc.
Reports are written primarily when some actions are carried out. Proposal are written before
carrying out the actions. These are similar to work plan. Specific strategies are mentioned in the
proposal so that the proposed actions can be successful. The strategies and result of action are
narrated in the reports. According to the type of report, the language style and format are
different. Reports are described and narrative in nature, while proposal are more persuasive and
motivating ones. Basically, the parts such as introduction objectives, Methodology, Analysis,
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Results discussion, conclusion, and recommendation are common in reports. Reports are written
in the past tense, but proposal use the future tense. Time table should be presented for both
reports and proposal, and proper information should be chosen for the reports as required.
USE OF STATISTICAL TOOLS IN ANALYSIS AND INTERPRETATIONS
Commonly mean, median, percentage, range, etc. are used in business reports.
Stages of reports writing
1.
Pre-writing stage:
Gathering of information and data
Classification of data
Tabulation of data
2.
Drafting stage
Note making
Screening and scanning
Analysis and observation
3.
Editing and presentations stage

Style of report presentation
Concept editing
Language and grammar
Conceptual Framework of Reports Types

1. Components of information report:
Background/ Information
Objectives
Details/ Feasibility/Discussion
Executive summary
2.
Components of Investigation Reports

Introduction/ Background
Statement of problem
Objectives
Methodology
Result and Discussion
Interpretation/ finding
Bibliography
SELF-ASSESSMENT TOOLS
1. Write an operation reports representing XYZ electronics by analyzing about annual
operation events for the fiscal year 20-4-15. Kindly incorporate major activities, budget
allocation along with program highlights and its benefits.
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2. ACE development bank has nominated you to participate in the annual SAARC
conference about the challenges of financial market. Prepare a situation reports to submit
the managing director by describing about your participation and the importance of
events.
3. How are data analyzed in a business report? Illustrate.
4. After conducting a detail survey of an education institution write an investigation reports
including finding and recommendations.
5. How is a report different from a proposal? Distinguish between them in terms of
purposes, presentation styles and their types.
6. Discuss in brief the usefulness of proposals and reports in the success of business
organization.
7. How is information presented effectively in a report? Discuss.
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PAPER 6B: MARKETING
254
CHAPTER 1:
MEANING OF MARKETING AND MARKETING MIX
1.4 EMERGING MARKETING CHALLENGES

The following are the emerging marketing challenges:
1. Technology :
The digital revolution is creating a new information society. Electronic network will be
important for marketing. Technology challenges will be rapid
The twenty first century promises many opportunities. Technological advances in solar
energy, online computer networks, cable and satellite television genetic engineering and
telecommunications promise to challenge the world as we know it. Organization that is
able to innovate new solution and values are the most like to succeed.
2. Globalization:
It is making the world one single market. Competition will be everywhere. Nepalese product
will face tough competition from foreign products. Companies will think globally and act
locally.
3. Customer Empowerment:
Customer will become more empowered. They will expect higher quality and better service.
Their brand loyalty will be low. They will be able to shop intelligently online. Customization
of product will increase.
4. Marketing think:
Everyone in the organization will think marketing .emphasis will be placed on creating
customer value and satisfaction. Every employee will do the marketing job.
5. Outsourcing:
More companies will choose to own brands rather than physical assets. They will restore to
greater outsourcing in their activities. Strategic alliances will increase. Global brands will
become popular.
6. Target Market :
Companies will serve well defined target market. New market positioning will become
important. Cross cultural changes will create global life styles.
7. Relationship:
Relations will be developed with customer for lifetime. Loyalty emphasis will be given on
retaining existing customer. Stakeholders will be given importance together with shareholder.
Lifetime customers will be created.
8. Customer Share:
Companies will force on gaining customer share by offering large variety of product to
existing customer. Market share will lose importance.
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9. Organization:
Marketing organization will be based on customer segments rather than product units.
Product divisions are likely to disappear.
10. Holistic Approach:
Marketing will embrace holistic approach. It will emphasize integrated marketing,
relationship marketing internal marketing and social responsibility to achieve goals
effectively. The concern for ethical marketing will increase.
CHAPTER 2:
EVOLUTION OF MARKETING CONCEPTS
2.1 INTRODUCTION
Various concepts of marketing that have evolved over the year are:
1. Production Concept
2. Product Concept
3. Selling Concept
4. Marketing Concept
5. Customer Concept
6. Societal Concept
7. Holistic Concept
2.8 HOLISTIC CONCEPT OF MARKETING
The focus of this concept is all matters related to marketing. It integrates the new marketing
concept with the societal marketing concept. Integrated marketing is used to meet customer need.
Relationship marketing is used to make all members of the organization customer oriented.
Social responsibility is practiced to promote consumer and societal welfare.
Starting point
Focus
Target
Market
All market matters
Means
Integrated marketing
Relationship marketing
Internal marketing
Social responsibility
Ends
Goals is
achievement
through
marketing think
Figure: Holistic Concept of Marketing

The holistic concept has the following features:
a) The starting point is the target market.
b) Focus is given to all matters related to market. Any one aspect of marketing is not given too
much attention.
c) The means for marketing are:
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Integrated marketing to efficiently and effectively utilize marketing resources. All

marketing matters are put under the marketing department.
Relationship marketing is practiced to develop long term relationship with customer oriented. Customer think is promoted organization wide.
Internal marketing is practiced to make all managers and employees customer -oriented.
They are given training to become customer-oriented. Customer thing is promoted
organization wide.
Socially responsible marketing is practiced to enhance customer and social welfare.
d) The goals of the organization ate effectively achieved through marketing think
Holistic concept is the latest thinking about marketing. Its four pillars are:
Figure: Four Pillars of Holistic Concept of Marketing
CHAPTER 3: ENVIRONMENT CONTEXT OF MARKETING

3.4 IMPACT OF ENVIRONMENT ON NEPALESE MARKETING
Environment impact on marketing occurs mainly from changing forces in the environment. Such
changes result from increasing uncertainty, competition political instability and technological
developments. They prevent opportunities and threats.
Environment has both positive and negative impact on Nepalese market.
1. Positive impact:
Environment impacts Nepalese market positively in the following ways:
a) Opportunities :
Environment provides opportunities to Nepalese marketing. Changes and developments in
the environment can be monitored to locate future opportunities. This helps marketing to
expand and grow.
b) Adaption :
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Marketing detects trends and create scenarios through environmental analysis. This facilitates
environmental adaptation. Marketing can maintain its dynamism through environmental
adaptation.
c) Goals achievement:
Environment helps marketing to achieve its goals efficiently and effectively knowledge of
environmental changes can be used to improve performance. Competition can be effectively
managed. This positively helps in goals achievement.
d) Demand Management:
The tracking of environmental changes helps to identify changing customer preferences.
Customer demand can be stimulated and managed. Customer needs can be effectively.
Satisfied through appropriate marketing mixes.
e) Stability:
Marketing can foresee the impact of environmental changes on its stability. It can develop
action plans to cope with such changes to maintain stability. This helps reduce uncertainty.
2. Negative impact:
Environment poses threats and negative impacts Nepalese marketing in the following ways:
a) Political-legal forces:
Uncertainties in political forces in Nepal are having adverse impact on marketing. Similarly,
too many changes in legal framework are having adverse impact on marketing. They have
restrained marketing.
b) Economics forces:
Nepals taxation policies keep on changing. Tax laws are too complicated. Value Added Tax
has created problems for marketing. Globalization has brought competition everywhere.
Inflation has increased costs has adversely impacted marketing.
c) Socio-cultural forces:
Mass migration from hill to terai region has created shifts in market cultural forces are
changing food habits. Consumers have developed taste for fast food in urban areas.
d) Technological Forces :
Inability to adopt to changes in technology have adverse affected Nepalese industries. Most
industries are sick. Job designs are changing. Marketing has been slow in adopting
information communication technology.
CHAPTER 4:
MARKET SEGMENT AND TARGETING
4.5 MARKET TARGETING:

Organization should carefully select the segment to be served. The selected segments constitute
the target market. Segment select strategies can be.
1. Single segment coverage:
An organization selects one segment and offers one marketing mix
The organization gains reputation through specialization in the selected segment. It can match
marketing mix to customer needs with limited resources.
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2. Multi- Segment Coverage of Marketing:

An organization selects two or more market segments and offers separate marketing mixes for
each segment.
This strategies diversifies the risk. It results in greater sales volume.
3. Product Specialization Strategies:

An organization concentrates on one segment but serves many product to that segment. This
strategy helps organization to build reputation but they remain over- dependent on one segment.
4. Market Specialization Strategy:
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An organization concentrates on one segment but serves many product to that segment. This
strategy helps organization to build reputation but they remain over-dependent on one segment.
5. Full Market Coverage:
An organization serves all market segment with all the products they need. Various product
items in one product line are offered. Coca Cola is using this strategy by offering a variety of soft
drinks to all segment of the market.
4.6 MARKETING SEGMENTATION IN NEPAL
The supplier driven Nepalese market generally practiced mass marketing approach with product
variations in the past. The socio-economic changes and development in transport and
communication system have made Nepalese marketers conscious of marketing segmentation.
The marketing strategies of global organization like coca cola, Pepsi. Nepal Lever and Standard
Chartered Bank have reinforced this consciousness.
The following points describe the practices of marketing segmentation in Nepal:
1. Non-Systematic: Segmentation is generally not based on systematic market research. Past
experiences, hunches of management, and competitors strategy have influenced
segmentation.
2. Variables for Segmentation: The variable mostly used for consumer market segment are:
i. Geographic: Nepalese organization generally segment market on area basis
Development regions, zones, district, etc. Population density is also used for some
products. Geographic variable are most popular for market segmentation.
ii. Demographics: Gender, age, and income are widely used as variables for segmentation.
Family life cycle is not much used. Religion and ethnicity also influence market
segmentation in Nepal. The importance of demographic variable is gradually increasing
for market segmentation.
iii. Psychographic: life style and personality variable are not much used for market
segmentation. Some high priced products like cigarettes and liquors use personality
variables.
iv. Behavioral: Benefits, usage rate, and loyalty, have been neglected for segmentation in
Nepal.
3. Lack of Information: Nepalese marketers lack comprehensive information about consumer
characteristics. They regard marketing research as a wasteful cost. This has constrained the
effective evaluation of market segment in terms of their attractiveness and appropriateness.
Risk are not properly assessed.
4. Government Policies: Government policies in Nepal are not very supportive of marketing.
They do not regard businessmen as partners for development. Restrictions and control have
discouraged market segmentation.
5. Lack of Ethical Considerations: Environmental and welfare considerations are generally
disregarded for market segmentation in Nepal.
The concept of marketing segment is at an initial stage in Nepal. However, the importance of
marketing segmentation is likely to increase in the years to come.
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CHAPTER 5: MARKETING INFORMATION SYSTEM

5.5 PROBLEMS OF MARKETING INFORMATION SYSTEM IN NEPAL
1. The Nepalese market has traditionally been a sellers market characterized by control.
Shortages and scarcities. Most of the organization lack effective marketing information
system. Marketing decision are largely based on hunches and intuition where personal
knowledge and experience play an important role.
2. Since 1980, Nepal has adopted the policy of liberalization and privatization. Globalization of
the economy has been increasing. The growing competition has led to the emergence of a
buyers market. Computerization is increasing in business enterprises. This has led to
growing awareness about the importance of marketing information system for decision
making.
3. The following points characterize the problems of marketing information in Nepal:
a) The marketing information needs are not carefully assessed. Ad-hoc managerial decisions
generally determine such needs.
b) The internal records constitute the most important components of marketing information
system. They are used to make sales analysis, customer demand and marketing analysis.
There is a growing trend toward computerization of internal records but its pace is slow.
c) Marketing intelligence is also used by Nepalese companies in a limited way. They subscribe
to newspapers and magazines. They also use press cutting services which provided cutting
of newspaper that are of interest to the company. Sales forces and middlemen also provide
intelligence but they are not properly trained and motivated.
d) Decisions support system has not made much headway in Nepal. Some global companies use
quantitative tools to interpret data. Private sector banks use MKIS for their operation.
e) Marketing research is at an early stage of development. But it is not getting attention from
marketing managers. Some organization have set up their own market research department.
Consulting firms in the private sector have mushroomed to provide market research services.
Professional marketing research firms have started operations in Nepal. Marketing research
in Nepal is dominated by advertising and product related problems. Customer
characteristics have been little researched.
f) Nepal has been fast introducing new information technology. It is expected that the growth of
market information technology will be rapid in 21st century. The demand for market research
is growing marketing is getting on-line.
CHAPTER 6: BUYER BEHAVIOR ANALYSIS

6.6 CONSUMER BUYING BEHAVIOR IN NEPAL:
Consumer buying behavior has generally remained a dark area of marketing in Nepal. Marketers
have given very little attention to who, what, why, when, where, and how of consumer behavior,
very little marketing research has been on this aspect. The following factors characterize
consumer buying behaviors in Nepal marketing:
1. Consumer buying behavior has not been properly taken into account while creating and
offering market mixes.
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2. Nepalese marketers lack knowledge of consumer buying behavior.

3. Marketers know very little about the consumer behavior at every stage of the consumer
buying process. The post-purchase stage is hardly considered to build lifelong customers.
The disposal aspect is neglected which has created serious environment problems.
4. Marketers have not given proper attention to the psychological and social factors that
influence consumer buying behavior Economic, demographic and cultural factors have been
dominant in the design of the marketing mixes and market positioning.
5. The marketing resources have not been efficiently utilized.
6. In recent years, the advent of global enterprises and e-commerce has brought some
consciousness about the need for better understanding of customer buying behavior the
emergences of marketing research organization is likely to promote marketing research about
consumer buying behavior in Nepal.
CHAPTER 7: PRODUCT DECISIONS

7.3.1. REASONS FOR NEW PRODUCT FAILURE
New product have high failure rate. The reasons for the product failure are:
1. Development Costs: New product require high costs in terms of research and development.
The level of sales may not be sufficient to recover high development costs.
2. Product Design: New products may not be well-designed. They may not satisfy the needs of
the customers.
3. Market Size: The size of market may be small to generate sales. Fragmented markets can
result in product failure. Wrong segment may be selected as target market. This leads to
product failure.
4. Competition: Competitors can launch a better new product. They can be first in launching
the new product. The product can be imitated by competitors.
5. Positioning: The new product may be incorrectly positioned in the market. Consumers may
not perceive the product as different from competing products.
6. Price: The price may be overpriced or underpriced. Customers may perceive poor value in
the product.
7. Distribution: The channels and logistics for the product may not be well designed. It may
not be available or accessible to consumers.
8. Promotion: the product may lack effective promotion. The promotion mix may not be
appropriate.
9. Government Regulation: The product may not meet environmental standard, quality
regulations or consumer welfare provisions. Its marketing may not be allowed.
10. Favored Idea: the product may be a favored idea of an executive. It may have no relevance
to customer needs.
11. Organization arrangements: They can be ineffective for management of new products.
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CHAPTER 8: PRICE DECISION

8.2.5 FACTORS AFFECTING PRICE DETERMINATION
Several factors affecting price determination. They can ne internal factors and external factors.
1.
a)
b)
c)
d)
2.
a)
b)
c)
d)
e)
Internal factors are:

Price objectives
Cost
Other elements of marketing mix: Product, Place, Promotion.
Organizational structure.
External factors are:
Market demand
Competition
Market intermediaries
Government
Pressure groups
Figure: Factors Affecting Price Determination
Internal Factors
Internal factors affect price determination. They are controllable by the organization. They are:
a) Pricing Objectives: Pricing objectives guide price determination. They can be profit, sales,
status quo, and quality. Profits volume can be target return or satisfactory return. Sales can be
in terms of volume or market share. Status quo can be in terms of price stability, competition,
or survival. Quality can be in terms of leadership or imitation.
b) Costs: Cost must be covered by price. Cost can be production cost for raw materials, labor
and production expenses. They can be indirect costs for transport, promotion, and office
expenses. Costs vary for different levels of output. Costs set the lower limit for price. Total
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costs of a product can be classified into various and fixed. Variable costs directly vary with
the level of production. Fixed costs do not vary with production levels. Price should cover
variable costs and fixed costs.
c) Other elements of marketing mix: product, place and promotion affect price determination.
i. Product: New innovative product provides pricing freedom. Imitation product is sold at
competitive prices. Differentiated products can be sold at different prices. Price changes are
necessary over the product life cycle, for example high price at introduction stage and low
price at maturity stage.
ii. Place: Long channels increase commissions costs. Price differs according to type of
channel. Transportation mode also affects price. Air transport is expensive than road
transport.
iii. Promotion: Product promotion affects price. Aggressive advertising and sales promotion
add to costs. Locally promoted products are less expensive than nationally promoted
products.
d) Organization structure: pricing responsibility in the organization structure affects price.
Finance department is concerned about realizing costs and making profits. Marketing
department uses price to promote brand image and consumer satisfaction.
External Factors
External factors affect price determination. They are not controlled by the organization. They
are:
a) Market Demand: The demand for the product affects price. Elasticity of demand is also
important. It is the amount of quality demanded when price changes. Demand can be elastic
and inelastic. The market demand sets the upper limit for the price. Elastic demand changes
with price. Inelastic demand is not affected by price.
b) Competition: Competitors affect price. If the product is similar, the price also has to be
similar. Higher price can be charged for superior products. Competitors reaction to the price
change is also important. Competition at the brand level can encourage brand switching.
o The type of competition pure, oligopoly, monopolistic-also affect price.
When RARA chau chau was launched Magee noodles was already established in
the Nepalese market. RARA set the same price as that of Magee.
c) Market Intermediaries: They are suppliers, middlemen, transport, and financial institute. If
intermediaries change prices, the product price is affected. Price hike by suppliers, transport
and banks increase costs. Higher commission to middlemen leads to higher prices.
d) Government: Government policies and regulation affect price. Price can be controlled by
the government. New taxes or change in taxes affect price. Government subsidies reduce
price. Government can increase or decrease supply to influence price. Legal compliance is a
must for pricing.
e) Pressure Group: Pressure group is motivated by special concerns and interests.
Environment concerns lead to added costs for controlling pollution. Consumer interest group
264
pressurize to reduce Nepal, such group are emerging. But they are poorly organized,
politically motivated and weak in action.
CHAPTER 9: PLACE DECISIONS ( DISTRIBUTION)

9-2 MARKETING MIDDLEMEN
Marketing middlemen make the flow of goods smooth between manufacturer and customer.
They can be:
1. Wholesalers: They deal with retailers.
2. Retailers: They deal with customers
3. Agents: They represent buyer or seller but do not take title to goods.
4. Facilitators: They assist in distribution.
1. Wholesaler
Wholesalers are merchant middlemen. They take title to the goods. They deal with retailers.
They do not deal with the ultimate consumers. They buy for reselling. Their transaction are large
in volume. They cover large trade areas. They serve as an important link between the
manufacturers and the retailers. They are of many types.
According to Philip Kotler:

Wholesaling includes all the activities involved in selling goods or services to those who
buy for resale or business use.
Role of Wholesaler in Distribution system

Wholesalers are important not only to manufacturers but also to retailers.
Figure: Role of wholesaler in distribution system
265
Role of Wholesaler for Manufactures:

a) Distribution Efficiency: Wholesalers perform wholesaling function more efficiently than
manufacturers. Transaction costs decrease due to decrease in the number of transaction
between manufacturers and customers. Distribution efficiency increases.
b) Bulk Buying: Wholesalers buy product in large volume (bulk buying). They sell them in
smaller lots (bulk buying). Their activities match product with customer needs. They
maintain storage facilities. This reduces selling costs.
c) Financing: Wholesalers carry large inventories in warehouses. They finance manufacturers
by timely payment of bills. They also make advance payment to manufacturers.
d) Risk Bearing: Wholesalers take title to the product. They bear all the risk of price changes,
damage, spoilage, and obsolescence related to goods. They hold inventory.
e) Market Coverage: Wholesalers operate through a network of retailers. This facilitates
intensive distribution of products. Manufacturers can realize economies of scale through high
volume. They can cover multi-segments of market.
f) Promotion: Wholesalers push products to retailers. They undertake cooperative advertising
with manufacturers and retailers. They help to implements sales promotion schemes.
g) Market Information: Wholesalers are near to marketplace. They provide information to
manufacturers about customers needs, competitors activities, price changes, new product,
and environmental changes.
Role of Wholesalers for Retailers:
a) Efficiency: Wholesalers make speedy delivery of goods to retailers. This results in cost
savings. Efficiency of retailers increases.
b) Assortment of Goods: Wholesalers buy various products from various manufacturers. They
provide an assortment of goods to meet the needs of retailers. This help retailers to carry
small inventories. Their inventory cost decrease.
c) Financing: Wholesalers provide credit facilities to retailers. This helps retailers to manage
their cash flow pressures.
d) Technical support: Wholesalers provide technical support to retailers for window display,
point-of-purchase display, training of salespersons and installations of information
technology. They also provide after sales services.
e) Promotion: Wholesalers provide promotional materials to retailers. They also participate in
promotional campaigns launched by retailers at local level by cost sharing. They also help to
implement sales promotion schemes.
266
Wholesalers are of many types

1. Merchant Wholesalers: They are independently owned. They take title to goods. Also known
as Distributor. They can be:
a) Full-service Wholesaler: Provide a full line of services. They can be
Wholesale merchants: sell to retailers.
Industry Distributer: sell to manufacturers.
b) Limited Service Wholesalers: Provide fewer services. They can be:
Truck wholesaler: Pick goods from producer and deliver to retailers.
Cash and carry: Sell to retailers on cash basis; no delivery.
Drop shippers: Arrange for the product to deliver goods to retailers.
Producer cooperatives.
2. Brokers: Bring buyer and sellers together and assist in negotiation. They earn commission. They
do not take title to goods.
3. Agents: Represent buyer or seller. They do not take title to goods. They can be:
a) Manufacturer Agent: Represent manufacturers.
b) Selling Agent: Have authority to enter into contract.
c) Purchasing Agent: Purchase for buyers.
2 Retailers
Retailers are merchant middlemen. They deal with customers. They link manufacturers with
ultimate consumers. Their transactions are small in volume. They take title to the goods. They
buy from reselling. This location, display, atmosphere, and interpersonal skills are important
factors in retailing. Retailers are of many types.
According to Philip Kotler:
Retailing includes all the activities involved in selling goods or services directly to final
consumers for their personal, non-business use.
Retailer is any business enterprise whose sales volume comes primarily from retailing. The
product can be sold in person, by internet, telephone, mail, or vending machine. It can be sold in
a store, street, or at home. Cyber stores are appearing fast.
Role of the Retailer in Distribution System
Retailers serve as sales specialist for wholesalers. They serve as purchasing agent for the
consumer. They play important roles for wholesalers and customers.
267
Figure: Role of retailer in distribution system
Role of Retailer for Wholesalers:

a) Distribution Efficiency: Retailers perform retailing functions more efficiently than the
wholesalers. Transaction costs decrease due to decrease in the number of transaction between
wholesalers and ultimate consumers. The delivery cost are low. These activities save
distribution costs.
b) Financing: Retailers carry and store inventories in small lots. They convert products into
cash through the selling function. They financing wholesaler by timely payment, of bills.
They bear the risk by taking title to the goods.
c) Market Coverage: Retail outlets exist in every nook and corner of the country. They make
shopping convenient to customers. Economist of sale can be realized through intensive
distribution.
d) Promotion: Retailers promote product to ultimate consumers. They undertake store display
and point-of-purchase display. They carry out local advertising. They participate in
cooperative advertising with wholesalers. They implement sales promotion schemes.
e) Information: Retailers are nearest to the marketplace. They build long term relationship
with the consumers. They provide information about consumer needs, behavior, and
preference. They also provide information about competitors activities relating to product,
price, and promotion. They also assist in market surveys.
Role of Retailer for Consumers
a) Product Assortment: Retailers provide product assortments to consumers. This facilitates
exchange. Consumers can match products with need and purchasing power. They get choice
in terms if features, advantage, and benefits of products.
b) Credit: Retailers provide credit facilities to consumers. They sell feeds on hire-purchase and
arrange financing from financial institution.
In Nepal, consumers purchase of cars and motorcycles financed by banks and financial
companies is popular.
268
c) Information: Retailers provide information to consumers about new product, changing

fashion price fluctuations, and sales promotion schemes. Such information is useful for
making buying decisions. Consumers get free advice from retailers.
d) Service: Retailers offer a variety of service consisting of delivery, installation, repair,
maintenance, and supply of spare parts. They serve as authorized Service Centers. Large
retail establishment include restaurants, health clubs, beauty parlors, and childrens play
corner in their product assortment, they provide advice to consumers.
CHAPTER 11. EMERGING CONCEPTS IN MARKETING

11.4 GREEN MARKETING
Green marketing is a form of marketing in which marketing managers consider the impact of
marketing in the natural environment. It is environmental-friendly marketing. It considers
environmental consequences of marketing activities. It promotes environmental protection
through marketing efforts. It develops a sense of green responsibility in marketing. It does not
contribute to global warming. It contributes to environmental sustainability.
The beginning of the concept of green marketing can be traced to the Earth Summit Conference
held in 1992 at Rio de Janeiro. It emphasized the importance of protecting the environment by
raising environmental awareness among consumers and business people. Many countries if the
world have strong green movements. They build public options for green marketing. They
advocate legislation favoring environmental-friendly marketing. They have imposed restrictions
on marketing of products that are not environment-friendly.
Main points in the concept of Green Marketing
1. It is environmental-friendly marketing. It does not increase pollution.
2. It considers environmental consequences if marketing.
3. It develops sense of green responsibility in marketing.
4. It promotes consciousness among consumers and business people to protect environment.
5. It advocates legislation for environment-friendly marketing
.
11.4.1 Requirement for Green Marketing
Green marketing requires:
1. Commitment: Green marketing requires commitment from top management and marketing
managers for environmental protection. It is regarded as everybodys responsibility in the
organization. Environmental officer is appointed to promote green marketing.
2. Pollution Control: Green marketing requires avoidance of marketing decisions that cause:
Pollution of air, water, noise.
Erosion of bio-diversity and land degradation.
Deforestation, desertification, drought.
Industrial waste.
Depletion of non-renewable natural resources through wasteful uses.
Release of toxins into the atmosphere.
269
3. New Technology: Green marketing requires new technology that prevents pollution.
Environmental-friendly clean technology is used. Digitalization, robotics, and
nanotechnology is used for clean manufacturing. Production processes are also
environmental-friendly.
4. Use of Recyclable Materials: Green marketing requires the use of materials that can be
recycled. Consumer acceptance is promoted for recycled products. Generally, packaging
materials are recyclable. Recycling of waste provides viable business opportunity. Excess
packaging is avoided. Biodegradable materials are used.
5. Legal Framework: Green marketing requires legal framework that promotes environment
protection. It provides incentives for environment protection and punishment for
environment pollution.
6. Use of Eco labels: Environment friendly products carry Eco-labels. Germany has ecolabeling programme to identify eco-friendly products through Blue Angel logo. European
commission has issued guideline for eco-labeling.
7. Consumer Consciousness: Green marketing requires arousal of environmental
consciousness among consumer, Education, training, and publicity campaigns and launched
and information dissemination is done to arouse consumer consciousness. Consumer demand
environment-friendly products. They prefer durable rather than disposable products. They
willingly accept recycled products. They reject products with excessive packaging.
Consumers Think Green.
Green Marketing in Nepal
Waste paper is recycled to produce handicraft and egg-trays.
Bio-waste is converted into fertilizer.
Plastic bags are recycled into pipes.
Waste materials are converted into bio-briquettes.
11.4.2 Tools for Green Marketing

The tools of green marketing are:
270
1.
Legal Framework:
Environmental-friendly legal framework is put in place. Facilities and incentives are
provided for environmental protection. Penalties and fines are imposed for environmental
degradation. Environmental impact assessment is made compulsory for industries,
development projects and other activates detrimental to environment.
2. Environmental Friendly Technology:
Environmental friendly machineries and equipment are made compulsory for industries that
pollute environment. Pollution control technology is also used. Pollution tax is imposed on
all pollution activities.
3. Biodegradable Materials:
Polluting materials, especially, plastic, are banned for packaging purpose. Tax incentives are
given for use biodegradable materials and recycling of such materials. Plastic bags are
banned.
4. Think Green:
Everybody in the organization from chief executive officers to peons think green. Marketing
activities are guided by this philosophy. Campaigns are launched to arouse consciousness
for green marketing.
ETHICS:
Ethics involves moral issue, standards and choices that guide behavior. It is an individuals
Personal beliefs regarding right and wrong or good or bad. They are code of conduct for people.
Ethics behavior conforms to generally accept social norms. It is doing the right thing. It is a
measure of integrity. It is concern for doing the right thing.
Ethics are acceptable standards of behavior that guide professional service marketing. They
involve moral issues. They involve respecting the interest of stakeholders. They define values,
moral duties and obligation at workplace.
11.1 Factors that influence ethics is professional service marketing
271
a) Ethical Standard of managers: They are the source of individual ethics. A managers
values and moral contribute to ethical standards. They shape his personal code of ethics.
They influences employer-employee relation. Greed and fear encourage unethical acts.
b) Action of Peers and Top, Managers: They are the source of professional ethics. Actions of
peers and top management influence professional service marketing. High ethical standard by
top management contribution to ethical standard of individual managers. Pressures to
perform can lead to unethical acts.
c) Organization Culture: Organization culture can contribute to ethical standard of managers.
Code of ethics lay down moral rules for decision making. They prohibit bribes and
corruption. Which promotes ethical standard in professional service marketing practices. It
prohibits unethical practices. It integrated ethical behavior in performance criteria.
d) Organizational environment: Organization wide consciousness regarding ethical standards
contributes to ethical behavior of managers. Policies and practices also influence ethics.
Ethical behavior should be appreciated and promoted.
e) Societal Forces: They are the source if society ethics. They consist of values, standards and
embodied in societys affect management ethics. Violation of human rights is unethical. So is
sexual harassment at work.
11.2 Significance Of Service Marketing Ethics In Professional

Ethics affect marketing action and practice in following ways:
a) Promotion of Social Responsibility: ethical behavior promotes sense of social
responsibilities in marketing managers give careful consideration to the social goods in their
decisions and actions. Image of organization improves.
b) Treatment of Employees by Organization: Ethical standards affect hiring, firing, wages
and working conditions. Promises made to employees are kept. Transparency is maintained.
Team work is facilitated. Harassment at work place is avoided.
c) Treatment of Organization by Employees: Ethical standards affect employee treatment of
organization in terms of:
Conflict of interest: No individual gains at the detriment of organization. Accepting
bribe is regarded unethical.
Secrecy: No leaking of organization secrets. Keeping confidentiality norms.
Honesty: integrity is promoted
d) Treatment of other Economic Agent by organization:
Ethical standards encourage managers to:
Maintain business ethics in customer relations.
Maintain fair business practices towards competitors.
Maintain honesty with stakeholders.
Maintain fairness in dealing with labor unions.
Protect interest of society.
Ethic serves as a guide for good behavior. It applies ethical norms to professional service
marketing.
272
11.3 Ethics is Professional Service Marketing:

Service is identifiable, intangible and perishable activity designed to provide want satisfaction to
clients. It does not result in the ownership of anything.
Professional service is people-based. They are provided through personal skills. They satisfy
client needs clients are generally organization who legally or voluntarily requires such services.
Chartered accountants are engaged in providing professional services.
Professional services are provided by professionally trained people. Training and motivation of
service providers is important for professional service marketing. The institute of chartered
accountant of Nepal is legally authorized to produce theoretical and practical training to charter
accountants in Nepal.
11.4 Code of Ethics for Professional Accountants prescribed by ICAN, Nepal

1. Integrity:
Professional Accountants should be straight forward and honest in all professional and
business relationships with fair dealings and truthfulness.
2. Objectivity:
Professional should not compromise their professional or business judgment because of
bias, conflict of interest or the undue influence of others.
3. Professional Competence and Due Care:
Professional Accountants should maintain professional knowledge and skill to ensure that
clients or employers receipt competent professional services by acting diligently in
accordance with applicable technical and professional standards.
4. Confidentiality:
All professional accountants should maintain confidentiality of information acquired as a
result of professional or business relationship.
5. Professional Behavior:
All professional accountants have an obligation to comply with relevant laws and
regulations.
273
PAPER 7: INCOME TAX AND VAT
274
CHAPTER-I BASIC CONCEPTS

Concept and History of Tax
Government is the single body to levy tax under constitutional frameworks. The government
may be central, regional or local bodies. According to the Constitution of Nepal, no taxes shall
be levied without framing laws and currently various laws are in force to implement various
taxes like: Income Tax Act, VAT Act, Customs Act, Excise Act and etc.
So the term tax shall be clearly understood as: The revenue being collected as per the provisions
of various fiscal laws of the government and the amount collected from the different sources
directly goes to the different assigned code of the Nepal Government.
Taxes are levied on annual basis and on event wise. The rate procedures, collection system,
coverage and other related matters are fixed by Finance Acts enacted annually. Finance Act is
prepared and presented by Finance ministry in consultation with other line ministries and finally
approved by the parliament, once it is approved by the parliament that becomes the law.
RESIDENTIAL STATUS OF ENTITY
Person having taxable income: Taxable income is the major concept in tax law and tax is also
determined by applying the rates on taxable income. Chapter 2 and other chapters describe the
procedure of determining the tax liability of the person having taxable income within the income
year.
CALCULATION OF TAX AND RATE OF TAX

Non-resident natural person
Non-resident natural person is taxed at the rate given under Sec. 1 of Schedule 1. Tax Rate,
according to Schedule 1 of Income Tax Act, 2058 is flat 25% on the gross income.
Resident natural person
Tax Rate, according to Sec. 1 of Schedule 1 of Income Tax Act, 2058, for income year 2072/73
is as follows. These rates are subject to changes made by finance act every year:
In case of resident natural person, effective tax rate are as follows:
Zero Rated Tax: There are 6 types of facilities given for a natural person taxing at zero rates.
1. Remote Area
If a person earning income in the region as remote
Allowance
for tax purpose, then Rs. 50,000 to Rs.10,000,
2. Investment
Insurance
Premium
stepped down by Rs. 10,000 each is taxed at zero rate

for remote regions A to E. Location wise category
has been separately given.
If natural person is contributing for investment
insurance then the premium up to Rs. 20,000 is taxed
at zero rates.
3. Pension
Income holders
In case of taxable income also includes pension

income then following part is taxed at zero rate:
In case of couple opted: Additional income of Rs.
275
75,000 (i.e. 25% additional of the basic exemption

limit)In case of single : Additional income of Rs
62,500 (i.e. 25% additional of the basic limit)
4. Incapacitated
person
In case of taxable income is earned by any

incapacitated person then following part is taxed at
zero rate:
In case of couple opted: Additional income of Rs
1,50,000 (i.e. 50% additional of the basic exemption
limit)
In case of single : Additional income of Rs 1,25,000
(i.e. 50% additional of the basic exemption limit)
5. Foreign
Allowance
In case of income includes foreign allowance given

by GON being working in any foreign diplomatic
mission of Nepal, then 75% of allowance is taxed at
zero rate (i.e. only 25% of the allowance received
will be taxed).
6. Health
Insurance
Premium
If natural person is contributing for health insurance,

then the premium up to Rs. 20,000 is taxed at zero
rate.
Remaining part of taxable income, if any is taxed at following rates:

Note that pension income is exempted from the 1% tax.
Employment Non-Business
only
Chargeable
Assets only
First Rs. 2,50,000 for single and Rs. 3,00,000
for couple1
1%
Remaining NBCA income

Next Rs. 100,000
0%
Common
to all
1%
Not exceeding
10%
15%
15%
Remaining
In case of export
15%
In case of special industry
20%
In other cases
25%
25%
ILLUSTRATIVE PROBLEM
IP-1
Couples Filing Jointly- Mrs. Homagain is administrator of incapacitated husband Mr.

Homagain. A firm had registered in the name of Mr. Homagain before his incapacitation
Vide Income Tax Manual, 2068 this limit of a proprietor firm is taxed at zero rate for business income holders
276
and taxable income of Rs. 500,000.00 from export of merchandise. Mrs. Homagain has
not any special income.
Hint: In case of Mr. and Mrs. Homagain, it would be beneficial for opting couple. So,
assuming Mrs. Homagain opting couple:
Taxable income
Particulars
Tax Rate
Tax Amount
1,50,000 Incapacitated
0%
0.00
3,00,000 Couple
0%
0.00
15%
7,500
50,000
500,000.00
7,500
Taxable income
Rs. 500,000.00
Tax to be paid
Rs. 7,500
Net retained
Rs. 4,92,500
Investment Income Tax- Mrs. Chaulagain has taxable income from investments of Rs.
2,51,000 and treated as single.
Hint: In case of Mrs. Chaulagain:
IP-2
Taxable income
Particulars
Tax Rate
Tax Amount
2,50,000
1%
2,500
1,000
15%
150.00
251,000
2,650
Taxable income
Rs. 2,51,000
Tax to be paid
Rs. 2,650
Employment Tax- Mr. Majgain from Nagarkot has employment income of Rs. 1,00,000
(including PF contribution of employer) per month before deducting the contribution to
approved retirement fund which is 40%. He is widower with a child. FY 2072/73
Hint: In case of Mr. Majagain, it is beneficial to be opted as widower with dependent.
IP-3
Income from Employment
12,00,000.00
Income from Business
0.00
Assessable income
12,00,000.00
Reduce: Contribution to Approved

Retirement Fund: Minimum of
a. Maximum limit of Rs. 300,000,
277
b. One third of assessable

1200,000/3=Rs. 400,000 and
income
c. Actual contribution Rs. 480,000
300,000.00
Taxable income
900,000.00
Taxable income
Particulars
Tax Rate
Tax Amount
3,00,000
1%
3,000
100,000.00
15%
15,000.00
5,00,000
25%
1,25,000
900,000.00
1,43,000
Before tax retained (1200,000-480,000)
Rs. 720,000.00
Tax to be paid
Rs. 1,43,000
Net retained
Rs. 5,77,000
Non Business Chargeable Asset- Calculate amount of tax for Income Year 2072/73 of a
natural person from following information:
S.N Particulars
Taxable
income Net
gain
for
[Rs.]
Sec.36
a.
Resident Individual
200,000.00
20,000.00
b.
Resident Individual
120,000.00
15,000.00
c.
Non-Resident Individual
120,000.00
60,000.00
d.
Resident couple
1,200,000.00
60,000.00
e.
Resident proprietary firm
95,000.00
60,000.00
f.
Mrs. Shahi, resident in Kathmandu as
1,500,000.00
900,000.00
local
Hint: Tax on Non business chargeable assets is computed as per Sub-section (3) and (4) of
section 1 of schedule 1. According to said provision, tax is computed as follows:
IP-4
(4) Tax shall be imposed as follows on following persons subject to Sub-Section (3) of this
Schedule:
(a) Tax shall be imposed at rate mentioned in Sub-Section (1) or (2) of this Schedule on
whichever is higher of following amounts by treating concerned natural person or couple as
having only such taxable income:
(1) The amount left after deducting amount of gain from total taxable income of
natural person or couple, or
(2) Zero rated amount,
(b) Tax shall be imposed at rate of 10 percent on balance of that taxable income.
Step 1: Compute Taxable Income [including the net gain from disposal from Non business
chargeable asset.]
Step 2: Subtract the net gain on disposal of Non- business chargeable asset from Taxable
278
income.[A= Taxable Income Net Gain from Non business chargeable asset]
Step 3: Write down zero rated amounts and 1% taxed amount.
Step 4: Take higher of A and B. [C= max (A, B)].
Step 5: If C=B in Step 4, tax on Non business chargeable asset is 10% (in case of land and
building disposed after 5 years of owned rate of tax is 5%) of taxable income less zero
rated items.
If C=A in Step 4, tax on Non business chargeable asset is 10% net gain included in
taxable income. The normal income is taxed as per rates so applicable. For the purpose to
describe the method example in a tabular form is given here.
a.
b.
c.
d.
e.
f.
Taxable Income
2,00,000 1,20,000 1,20,000
12,00,000
95,000
95,000
Net gain included in TI
20,000
15,000
60,000
60,000
60,000
95,000
A= TI other than net
gain
1,80,000 1,05,000
60,000
11,40,000
35,000
0
B= 0% amount
0
0
0
0
0
0
B= 1% amount
2,50,000 2,50,000
0
3,00,000 2,50,000 2,50,000
B= Total of 0% and
1%
2,50,000 2,50,000
0
3,00,000 2,50,000 2,50,000
C=Max(A,B)
2,50,000 2,50,000
0
11,40,000 2,50,000 2,50,000
Taxable NBCA
0
0
0
60,000
0
0
Tax @ 10%
2,000
0
0
6,000
0
0
Amounts at Normal
rate
1,80,000 1,20,000 1,20,000
10,40,000
95,000
95,000
Tax @ 1%
1800
1,200
0
3,000
950
950
Tax @ 15%
0
0
15,000
0
0
Tax @ 25%
0
30,000
1,60,000
Total
3800
1,200
30,000
1,84,000
950
950
ENTITY HAVING TAXABLE INCOME
Normally, entity is taxed on corporate tax rates. Tax Rate, according to Sec. 2 of Schedule 1 of
Income Tax Act, 2058, for income year 2072/73 is as follows:
1. Default rate
25%
Subsidized Rates
2. Special industry operated whole income year
20%
3. Construction and operation of roads, tunnel, rope-way, skybridge

4. Operation of Trolley Bus or Tram
20%
5. Cooperative Society or Unions
20%
6. Export income
20%
7. Built, Own, Operate and Transferred to GON
20%
20%
279
8. Power-house construction, generation and transmission
20%
Negative Externalities double dividend and High profit

9. Tobacco or liquor related business
30%
10. Banking, general insurance and petroleum production business
30%
FIXED TAX: PRESUMPTIVE TAX

There are some incomes relating to natural person which are taxed at fixed amount of tax,
irrespective of amount of income earned by tax payers. There are two types of presumptive
taxes:
Small Resident Vendors: Resident natural person having income from business only in Nepal
with turnover not more than Rs. 2 million and profit not more than Rs. 200,000 may opt for
being presumptive tax payer and need to pay following fixed amount of income tax on annual
basis. Tax rates applicable for FY 2072/73 are:
o In case of business set up in Metropolitan City or Sub-metropolitan City- Fixed amount of
Rs. 5,000.
o In case of business set up in Municipality - Fixed amount of Rs. 2,500.
o In case of business set up in other places - Fixed amount of Rs. 1,500.
Transaction Based Tax

Finance Act, 2072 has added new Sub-section (4Ka) under Section 4 making anew provision of
transaction based income tax. Which mentions that notwithstanding Sub-section (2), the tax to be
deposited on the basis of transaction in an income year by a resident natural person under Clause
(Ka) of Section 3 and fulfilled any of the following conditions, shall be as per the prescribed rate
in Schedule 1 Section 1(17):
(Ka) The income of the person in the income year includes only from the business with the
source in Nepal,
(Kha) Not claimed for medical tax credit under Section 51,
(Ga) Not claimed for tax withheld amount under Section 93,
(Gha) The volume of the transaction crossed Rs. 20 lakh and less than Rs. 50 lakh,
(Nga) Not registered in value added tax, and
(Cha) Not included the income against consulting and expert service of natural persons
including the medical practitioner, engineer, auditor, legal professional, sportsperson,
artist, consultant etc.
Public Transport Carriers: Natural person holding public transport carriers has to pay
presumptive tax on annual basis irrespective of the income earned by them. Amount of
presumptive tax shall be the following:
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Carrier Name
Tax per carrier
Bus, Mini-bus, Truck, Mini-truck
Rs. 3,000.00
Car, jeep, van, micro-bus
Rs. 2,400.00
Three wheelers, Auto-rickshaw, tempo
Rs. 1,550.00
Tractor, power-tiller
Rs. 1,000.00
Tax on Repatriation of income

In case any foreign permanent establishment repatriates its income to its head office or home
office or similar unit, then the repatriated income is to be taxed at 5% as tax on distribution by a
resident company.
Illustration: C Bank is registered in the United States and operating its liaison office in
Kathmandu. During the year it has following summarized transactions:
Income recognized:
Rs. 5,000,000,000.00
Expenses recognized:
Rs. 4,000,000,000.00 except income tax
The liaison office has policy to repatriate all the remaining profits to its corporate office. As
being prospective Chartered Accountant from Nepal, the manager is seeking your help on how
much amount can be repatriated.
Solution: Here the office is taxed on two bases viz: resident person having taxable income @
30% of taxable income and 5% on repatriated amount. So,
Taxable income
Tax @ 30%
= Rs. 5,000,000,000.00-4,000,000,000.00
= Rs. 1,000,000,000.00
= Rs. 300,000,000.00[a]
Remaining profit
= Rs. 700,000,000.00
Tax on repatriated amount = Rs. 700,000,000.00* 5/100
=Rs. 35,000,000.00 .[b]
Total of tax payable
= Rs. 335,000,000.00
Amount that can be repatriated = Rs. 700,000,000-35,000,000.00
= Rs. 665,000,000.00
Tax on repatriated income is reverse charge taxing system income. Here the payer is paid for
income tax and income repatriated itself is not taxed. In all cases of repatriation of income the PE
is taxed in two stages: normal and repatriated.
EXEMPTIONS, CONCESSIONS, REDUCTION, DEDUCTION, OFF-SET

Expense: Deductions
Allowable expenses incurred by the tax payer during income year for earning taxable
281
income are allowed as deduction for tax purpose. All the expenses if not disallowed by Sec.
21 and allowed by Sec. 13 can be deducted from taxable income while computing tax
liabilities.
Loss: Deductions/Off-set
Loss from business or from investment can be off-set with profits/gains from another
source is called deduction/off-set of loss in taxation.
Expense: Reduction
Expenses for earning taxable income are allowed but there are some expenses which do not
contribute to earn taxable income but are required to be incurred for social reasons. These
are also allowed by taxation laws as reduction. Donation and contribution to sports
development and protection of heritage falls under these categories, however the income
tax law has imposed certain limit on reduction of these expenses.
CONCESSION, WAIVES AND PRIVILEGES
o Special Industry, Agro-industry and Tourism Industry: 70% of the tax to levied in the
income year for special industry, agro industry and tourism industry directly employing
only the Nepalese citizen for the whole year. Provided that industry getting such
concession should have employed at least 100 person. Again, 100% of the dividend tax to
levied in the distribution of dividend in case the special industry, agro industry and tourism
industry capitalize their accumulated profit for expansion of capacity of the industry.
Concession by way of credits
o Special Industry operated in Very-undeveloped, undeveloped and underdeveloped gets tax
credits of 90%, 80% and 70% for the first 10 years of operation.
o IT Park IT industry 50% credits
IP-5
Remote industry - Assume Indu Mills, in Error! Reference source not found. is in
Ramechhap, since last 7 years, the tax impact shall be as follows:
Taxable Income
Rs. 2,00,00,000
Tax @ 20%
Rs. 40,00,000
Less: Large employment credit 10%
Rs. 4,00,000
OR, Highly undeveloped tax credit of 90% Rs. 36,00,000
Rs. 36,00,000
Tax Payable
Rs. 4,00,000
In this case, the industry has two alternative benefits available. more beneficial option is Highly-undeveloped tax credit of 90%. If year for operation is more than 10 years, answer
in Error! Reference source not found. will be same.
Expenditure Incurred on Heritage Conservation and Sports Development:

A company can claim reduction in an income year in calculating the taxable income the
lower amount of Rs. one million or 10% of assessable income out of the expenditure
282
incurred with prior approval from the Department for conservation and promotion of
ancient, religious, and cultural heritage situated within Nepal and for construction of public
physical infrastructure of sports.
Contribution in the Prime Minister's Relief Fund and in the Reconstruction Fund
established by the Government of Nepal
Reduction shall be allowed in calculating the taxable income for an income year for the
amount Contribution in the Prime Minister's Relief Fund and in the Reconstruction Fund
established by the Government of Nepal.
ILLUSTRATIVE PROBLEM (DO YOUR-SELF)
IP-6
Loss Off-set, Vertical- What shall be the impact of income tax return in above case if gain
from business was Rs. 287,097 for 2071.72?
IP-7
Loss Off-set, Vertical- In 2072.73 in the example above, there is income of Rs. 15,00,000
from business, Rs. 200,000 from investments. Out of income of business Rs. 500,000 was
scrutinized as source having in United Kingdom.
CHARACTERIZATION, ALLOCATION & QUANTIFICATION

Special Quantifications
Income tax accounting is mainly and mostly based on accounting standards. The
transactions recognized in accounting shall be quantified at same amount in taxation (and
hence no deferred income tax in most cases). But there are varieties of cases, where due to
deemed disposal or due to being taxation concept only, characterized items need valuation
for quantification (deferred income tax exists there). If principles of recognition differs in
taxation as compared to the accounting in that case valuation has to be performed and it
can be done by the following ways:
CHAPTER-II COMPUTAION OF TAXABLE INCOME

COMPONENT OF INCOME FROM BUSINESS
Income from business is computed based on format equivalent to income tax profit or loss
account. Income part in taxation is called profit or gain and expense part is called deduction (of
expense and of loss), hence
Profit or Gain (Sec. 7(2)
Rs. ...( ~ Chapter Error! Reference source
not found.)
Deduction of expense (Sec. 13-19)
Rs. .. (~ Chapter Error! Reference source
not found.)
Deduction of loss (Sec. 20)
Rs. ( ~ Chapter Error! Reference source
not found.)
Income from business
Rs. ..
Any Income Derived is of a Nature of Income From Investment if it Directly Relates with
the Business of the Person
283
Income from investment earned in relation to business of a person, will be income from business
for income tax purpose, not the income from investment. Thus, it needs to be clear that an entity
cannot have income from investment for income tax purpose.
For example, interest accrued on fixed deposit of a company will not be the companys income
from investment but would be of business source.
Income which do not part of Income from Business
According to Sec. 7(3), following 4 types of incomes are not part of profit or gain on computing
income from business:
o Any business income covered by Sec. 10 Any income in the form of dividend distributed
from entity other than a resident company and a resident partnership firm is beyond the scope
of taxation according to Sec. 54.
o Dividend received from controlled foreign entity, under Sec. 69, if taxed under head of
income from business; is not part of profit or gain in income from business.
o Any income which is covered by Sec. 92 as final withholding income is not part of profit or
gain in income from business.
Test of basis of accounting under Sec. 22 to 24 (1st Test)
If basis of tax accounting of a person is cash, then expenses paid out during the period of
income year shall be considered as expenses except capital expenditures. No accruals and
provisions are allowed under this basis.
Similarly, if tax accounting of a person in accrual basis of accounting, then any provision
expense (except covered by Sec. 59(1A) and Sec. 60) are allowed. If expenditures /liabilities
to make the payment is established within the income year in that case even if the amount is
not paid out expenses will be allowed to be charged in that particular income year.
Even any of basis of tax accounting, person need to fulfill the requirements of other sections
of the Act. Based on the basis of tax accounting, if any expense is allowed, then the expense
need to tested under Sec. 21 to confirm whether that expenses is included under the list of
disallowed cost or not.
DISALLOWABLE EXPENSE
Following expense are expressively disallowed in taxation according to Sec. 21:
Expenses of Domestic or Personal Nature ~Sec. 21(1)(a)
Expenses of domestic nature or personal nature incurred by the person are not allowed for
deduction. The clarification under Sec. 21 explains the expenses as of domestic and personal
nature are as follows:
Interest incurred on an amount borrowed to the extent to which it is used for personal purpose
(interest on siphoned out loan). If an entity has taken a loan from a bank and allowed a certain
amount to be used by a partner without any interest, such an amount is a better example of
personal expenses.
284
Expenses of personal nature incurred for an individual in providing residence, meals,

refreshment, entertainment, or other leisure activities.
Expenses incurred by an individual on commuting from residence to office and office to
residence, if it is not allowed by the policy. .
Expenses incurred for an individuals clothing which is also suitable to wear outside of work
if not provided to all staffs and not included in the policy.
Expenses incurred on education and training. But the expenses incurred on such training, that
directly relates to the business are allowed for deduction, but that does not lead to a degree or
diploma.
Any expenses incurred to make a payment to a natural person or the expenses incurred for a
third person, except in and to the extent of the following conditions:
o The payment is included in calculating the income of the individual- such as house rent,
driver facility, gardener, servant, telephone in residence, or etc provided to an employee. If
the expenses are included in the taxable income of the individual, the expenses are
allowed for deduction to the person.
o The individual makes a return payment of an equal market value to the person as a
consideration for the payment.
o Small amount incurred in this respect for which keeping an individual account is
impracticable, for tea, stationery, awards, emergency medical facility or any other
expenses up to Rs.500 at a time.
Penalty on breach of law ~Sec. 21(1)(b)
Penalties or fines of similar nature payable to any Government or its local bodies for breach of
any Act or Rules or Regulations framed under the Acts are allowed as deduction. But, all
additional charges may not constitute to be disallowed expenses. For example, additional
charges for late payment of electricity charges are deductible but a penalty levied for
unauthorized use of electricity (i.e by stealing) is not allowed for deduction.
Payment in Cash for More Than Rs.50,000~Sec. 21(1)(d)
Any payment of expenses by a person having an annual turnover of more than Rs.20 lakh in an
income year, in cash for more than Rs.50 thousand at a time is not allowed for deduction, so
the person shall make all the payments above Rs 50,000 through banking channel.
Cash payment means a payment not made through any bank or financial institution in the shape
of a letter of credit, cheque, draft, money order, telegraphic transfer, money transfer and any
other kind of transfer between banks and finance institutions.
But under these circumstances, the expenditure for more than Rs.50,000 at a time in cash, if
paid, is allowed:
Payment made to GON, Constitutional bodies, corporate having ownership of
GON, Banks, and Financial institutions.
285
Payment to a farmer or a producer for primarily agro products even in the case
where the farmer himself primarily processes the product.
Payment of a retirement contribution or a retirement payment.
Payment made in such areas where banking services are not available. An area
not having banking services means the area where there are no banking facilities
within the surrounding of ten kilometers.
Payment made on the day when banking services are closed.
Payment made under circumstances, where it is most necessary to be made in
cash.
Payment is made in the bank account of the payee.
Accelerated Depreciation
According to Sec. 3(2) of Schedule 2, depreciation rate shall be increased by 1/3rd in the
following entity for Pool A, B, C and D:
Special Industry as defined in Sec. 11
Construction of Road, Bridge, Tunnel, Rope-way, Sky Bridge
Operation of Trolley Bus and Tram
Cooperative
Power house construction, generation and transmission of power
Built, Own, Operate and Transfer (BOOT) Business
The concept to this additional depreciation is for tax favor economic regime. This will reduce
the tax burden in earlier time and hence low pay back period of the investments. This
depreciation is called accelerated depreciation in tax world. Accelerated depreciation is
allowed for entity only. The acceleration is given in rate not on amount.
In spite of above regular accelerated depreciation there would be special accelerated
depreciation too, e.g. whole of cost of fiscal printer and cash machine purchased are fully
depreciated in the income year. Again, if a manufacturing industry generates energy for its
use, 50% of the cost of capitalized assets would be allowed as depreciation in the year of
incurrence.
Pool of Intangible Assets:
Intangible assets fall in Block E and each purchase is individual pool. So, Block E may have
more than 1 pool like pool E1, E2, E3 and so on. Absorbed addition of intangible assets is
similar as tangible assets, i.e. if purchased within Push fully absorbed, if purchased during Magh
- Chaitra 2/3rd absorbed and after that till Ashad end 1/3rd .
In case of any additional payment is made in case of any pool of intangible assets, these amount
is to be added based on time frame but if similar intangible asset purchases with individual
capacity and independently than already holding, later should be treated as separate pool of
assets.
In case of disposal of pool, the behavior of same as other pool.
Special Deduction by Finance Act, 2072
286
If the tax payer wants the ceiling of repair and maintenance expenses shall not be effective till
financial year 2073/74 for such expenses incurred for damaged assets in earthquake affected
districts as prescribed by the government of Nepal.
Specific Types related Income from Business
There are certain business whose taxation treatment is different than other entity or business
sectors. Mainly, those businesses are bank and financial institutions, life insurance, general
insurance, long term contract, retirement fund etc. The study of taxation of bank and financial
institutions, life insurance, and general insurance are arranged for CAP III level. So, the taxation
of long term contract and retirement fund is dealt at this level.
Long-Term Contract
Income recognition and deduction quantification in case of a long-term contract is quantified
separately for separate contracts.
A long-term contract is a contract for production, installation, construction, or the services
related to the production, installation or construction, which runs for more than twelve months
and the consideration is payable interim payment or running bills system. Whole the
consideration shall be paid at final bill with adjustments of earlier interim payments/ running
bills.
To establish a long-term contract under this Section, there should, on one hand, be a deferred
return as a condition of the contract, and on the other, the contract should not be an excluded
contract.
The term Deferred Return is defined, as the return that is received later in separate parts after
an item has been sold. But according to Rule 10 of Income Tax Regulation, 2059, a contract is
not called a deferred return contract, if any party to a contract declares the information related to
the estimated profit and estimated loss for the period of every six months starting from the
commencement of the contract, as required by IRD2.
The Section further says that an excluded contract is not taken as a long-term contract. Excluded
contracts are those contracts which are expressively excluded from cumulative procedure of
income recognition. Rule 11 of the Income Tax Regulation, 2059 has enlisted the exclusion list
of excluded contracts as:
- Any contract that is executed solely because the parties to the contract have an inherent
interest in the entity (securities contract).
-
Any contract that is executed solely because one of the parties to the contract has had
the membership of a retirement fund (retirement fund beneficiary).
Any contract for investment insurance (Life insurance contracts).
Hence all the contracts relating to production, installation or construction having
period more than 12 months being deferred return but not excluded contracts are
long-term contracts.
Conceptually, the returns are of two type- defined rerun and deferred return. In defined return contract,
anyone can reliably estimate the quantum of return during any future period; e.g. 8% 10 years bond earns Rs.
th
8 in 4 year. Here, the return is defined. Other returns, on which return for particular period cannot be
estimated (for tax every six months) are deferred return contracts.
287
According to the Section, the gain from a long-term contract during a particular income year
should be calculated on the basis of cumulative procedure based on percentage of completion of
the contract. For this method following parameters need to be analyzed:
Contract price
say Rs. 12 million
Contractors Estimated cost for completion
say Rs. 10 million
Cumulative expense (direct cost) on year 1
say Rs. 1 million
Cumulative expense (direct cost) on year 2
say Rs. 3 million
In this case percentage of completion is computed as:

Percentage of completion=Cumulative expense/ Contractors Estimated cost
Percentage of Completion- Inclusion and deduction in the above case for the income year 1 and
2 shall be computed as follows:
Year
1
2
% of completion
10% (=1/10)
30% (3/10)
Cumulative Revenue 1.2 m (10% of Rs. 3.6 million (30% of Rs. 10m)
12m)
Cumulative
1.0
3.0
Deduction
Cumulative Profit
0.2 million
0.6 million
Previous profit
0
0.2 million
This year gain
0.2 million
1.4 million
BENEFITS OF MEMBER OF APPROVED RETRIEMENT FUND
There are certain benefits awarded in case of members as:
At the time of contribution: Minimum of following amount is allowed as reduction to compute
taxable income for the income year of contribution:
Rs. 300,000
One third of assessable income
Actual contribution
At the time of being member: Interest accrued and crediting into the accounts of member is
not tax on the year of depositing or crediting in the respective accounts.
At the time of payments: There is a token tax on retirement payments received from ARF as
follows:
In case of lump sum retirement payments up to Rs. 500,000 no tax.
In case of lump sum retirement payments from Rs. 500,001 to Rs. 1,000,000; first
Rs. 500,000 has no tax, remaining amount is taxed at 5% as final withholding tax.
288
In case of lump sum retirement payments more than Rs. 1,000,000; first Rs. 50%
has no tax, remaining amount is taxed at 5% as final withholding tax.
i, e we can say that at the time of payment out of retirement fund, allowable deduction is actual
amount received or 50% of actual amount received or Rs 5,00,000 whichever is higher and in the
remaining 5% final withholding tax will be applicable.
INCOME FROM EMPLOYMENT

AMOUNT RECEIVED IN COMPENSATION OR TERMINATION OF
EMPLOYMENT:
Any amount received in compensation of accepting any limitation with regard to the terms
of employment is also included in computing taxable income from employment.
Any amount received for redundancy or a loss or termination of the employment is
considered as part of taxable income.
Employers Contribution to the Retirement Fund and Retirement Payments:
Any contribution to the retirement fund of an employee by an employer is included in
computing income from employment.
Any Other Payment by the Employer:
Any other payment made in connection with the employment is also included in computing
income from employment.
Interest Less than Market Rate ~Sec. 27(1)(d):
In cases where the rate of interest on loans or advances paid by an employee to the
employer during an income year is lower than the prevailing market rate of interest, the
amount, to the extent it is lower, shall be included in the income from employment. Here,
practical problem regarding the market rate of interest has not addressed by IRD.
INCOME FROM INVESTMENT

1.1 Female Remuneration Tax Credit
If a female resident natural person has remuneration income only, she is allowed a Female
Remuneration Tax credit of 10% on tax liability. If she has other income or clubbing
income (as couple or widow with dependent) this tax credit is not availed to her.
IP-8
Tax Credit- Mrs. Latika is working with a local bank branch, draws remuneration of Rs.
400,000. Her income tax shall be as follows for F/Y 2072/73:
Income from Employment (Assessable Income)
Rs. 400,000
Tax Computation:
1%
Rs. 250,000
Re. 2,500
289
15%
25%
Tax
Less:
Rs. 100,000
Rs. 50,000
Medical Tax Credit

Female Remuneration Tax Credit
Tax Payables
Re. 0
Rs. 4,200
Rs. 15,000
Rs. 12,500
Rs. 30,000
Rs. 3,000
Rs. 27,000
FOREIGN TAX CREDIT

If a person has foreign income, it would be taxed in that foreign country too. Resident person
need to pay tax on global income basis. Sec. 71 allows the person to off-set this foreign tax on
Nepal tax.
Any amount paid on foreign country having taxable income included by the resident is qualified
for foreign tax credit. The income included in taxable income of the person may be of same
country to get foreign tax credit facility. In Error! Reference source not found. to Error!
Reference source not found. has examples for qualifying tax credit available in the cases given.
According to Sec. 71 (1) a tax credit may be available to a resident person whose income has a
source in a foreign country is included in taxable income of the person in Nepal to the extent of
the amount of income tax paid in that country on that income.
In case a person has a source of income in more than one foreign countries, the amount of
assessable foreign income situated in each country should be calculated separately.
The maximum amount of tax credit allowed for the year shall not exceed the average rate of
Nepal income tax for the person for the year applied to the persons assessable income from each
foreign country.
The average rate of tax applicable in Nepal for the person during the year is calculated on the
basis of the following formula:
Average Tax Rate = Total tax calculated before tax credit for foreign income tax paid*100
Taxable income of the person including assessable foreign income.
The remaining amount of tax credit not absorbed during the year can be carried forward for offset from the income during subsequent years from the same country.
Foreign Tax Credit- Prabhat has a source of income in Nepal and also in more than one foreign
country. During the income year, income and tax paid in each foreign country is given below:
Name of the country
Income Rs.
Tax paid Rs.
USA
200,000
60,000
Australia
150,000
30,000
UAE
100,000
5,000
Nepal
250,000
He is a resident natural person and selected for the couple as taxpayers during the year.
Here, for income year 2072/73:
Total assessable income from all the sources:
Net income from Nepal
Rs.250,000
Net income from the USA
Rs.200,000
Net income from Australia
Rs.150,000
290
Net income from the UAE

Rs.100,000
Total taxable income
Rs.700,000
Tax calculation
First Rs. 300,000
3,000
Next Rs. 100,000
15,000
Remaining Rs. 300,000
75,000
Total Tax
93,000
Average Tax Rate
13.28%
Tax credit for the year shall be available for:
Country
Income
Tax paid
Tax
Tax credit Unabsorbed tax
Rs.
Rs.
calculated
available
credit to be
at average for the year carried forward
rate Rs.
Rs.
Rs.
USA
200,000
60,000
26,571
26,571
33,429
Australia
150,000
30,000
19,929
19,929
10,071
UAE
100,000
5,000
13,286
5,000
0
Total
450,000
95,000
59,786
51,500
43,500
The tax payable during the year comes to Rs.93,000 Rs.51,500 = Rs.41,500.00.
Expense Method: In case a person elects to relinquish the tax credit facility of the tax paid in a
foreign country during any income year, it can claim the tax paid in the foreign country as
expenses for the income having a source in that country. In the above example, person may elect
to relinquish the tax credit facility of the income tax paid in foreign countries, in that case the net
income from the foreign sources of Rs.355,000 (Rs.450,000 Rs.95,000) shall be included in the
taxable income. In that case person is neither able to claim the tax credit during the year, nor able
to carry forward for subsequent years.
Mixed Case- Mr. Amar is working with local school and earned following incomes during the
year:
Salary on pay scale of Rs. 15000-10(1000-25000. Salary excludes festival allowance which
is 2 months salary at gross. Medical allowance of one month salary is received at year-end.
He got one grade as prize and reached the maximum scale of salary. School reimbursed Rs.
15000 for medical treatment, but Mr. Amar is not willing to take medical credit benefit,
because the bills were seemed not genuine.
School has policy that provident fund contribution of 20% is to be deposited into
Karmachari Sanchaya Kosh at equal proportion by both. School allowed a loan of Rs.
100,000 at 3% during the year. Mr. Amar paid Rs. 2,000 as interest during the year. On 25th
of Ashadh Mr. Amar married with Mrs. Amar; she had a job, but resigned after marriage.
Before married she got Rs. 200,000 from that job.
Mr. Amar had bank deposit which were spent on marriage, but bank give Rs. 20,000
interest thereto on net. Nepal Bank Ltd. Share, fortunately gave some dividend but still not
collected. Mrs. Amar got some interest from bank on her personal account, but she forgot
how much that was.
Amar has an industry producing verginia tobacco products has following income status.
Income Statement
For the year ended 31st Ashadh
291
Expense
Rs.
Opening stock
300,000
Wages
400,000
Purchase
500,000
Depreciation factory
100,000
Gross Profit
900,000
2,200,000
Income
Sales revenue
Export revenue
Closing Stock
Export expense
Interest @ 10%
Prior year expense
Depreciation office
Staff cost
Office cost
Profit before tax
Gross Profit
Interest income
Other income
Prior Year income
Dividend income
10,000
100,000
100,000
100,000
100,000
100,000
610,000
1,120,000
Rs.
1200,000
800,000
200,000
2,200,000
900,000
10,000
100,000
100,000
10,000
1,120,000
Tax base of depreciable assets is 110% of carrying amount for the purpose of NAS 09 Income
Tax. Wages Rs. 50,000 is for repair works, not relating to production.
He got Rs. 20,000 for setting question in the school and Rs. 25,000 for the same from the District
Education Office.
Being first month of marriage, both of Mr. and Mrs. Amar are appreciative and wants to filed
jointly, can they do this? If or if not so, how much tax to be paid by them. Please calculate based
on the tas rates applicable for FY 2072/73
FTC and ARF- In the example, say Parbat has contribution to an approved retirement fund of
Rs. 100,000 and eligible medical cost of Rs. 30,000. Foreign tax credit and tax to be paid shall be
as follows:
Assessable income
Rs. 700,000
Reduce: Contribution to ARF
Rs. 100,000
Total taxable income
Rs.600,000
Tax calculation
First Rs. 300,000
1%
3,000
Next Rs. 100,000
15%
15,000
Remaining Rs. 200,000
25%
50,000
Total Tax
68,000
Less: Medical Tax Credit
750
Tax to be paid
67,250
Average Tax Rate
67,250/600000 11.21%
Tax credit for the year shall be available for:
Country
Income
Tax paid
Tax
Tax credit
Unabsorbed tax
Rs.
Rs.
calculated
available
credit to be
at average for the year
carried forward
rate Rs.
Rs.
Rs.
USA
200,000
60,000
22,417
22,417
37,583
292
Australia
UAE
Total
150,000
100,000
450,000
30,000
5,000
95,000
16,813
11,208
50,438
16,813
5,000
44,229
13,188
0
50,771
The tax payable during the year comes to Rs.68,000 Rs. 750 - Rs.44,229 = Rs.23,021.00.
CHAPTER-IV PAYMENT OF TAX AND TAX RETURN
FORM, PLACE AND TIME FOR PAYMENT OF TAX

Income tax is paid to Inland Revenue Department by three ways: withholding tax on
accrual/payment, advance tax by way of installment and payment of remaining tax with income
tax return.
In case of failure to pay tax liability to tax authority, they may collect in various ways like
seizing and selling the assets owned by defaulted taxpayer.
Forms for payment of tax
There are varieties of modes/ways/forms for payment of tax to tax authorities which are
explained as below:.
Tax Return Form: Self-assessment return has to be filed by each tax payer within three months
from the elapse of income year i.e end of Ashwin (may be extended till poush with an
application to the concerned IRO) and the remaining amount than the advance payment in
installment has to be paid along with the self assessment tax return.
Further sometimes tax authority may ask to deposit tax liability by jeopardy assessment
and amended assessment within the Income year (i.e before completion of FY).
Mode of payment of tax: Income tax can be paid in cash (if allowed by IRO) or by way of bank
deposit in prescribed bank account. In none case, payment in form of kind is not possible.
Place for payment of tax
There are 21 Inland Revenue Offices and one Large Tax Payers Office to pay income tax for
any person requiredto deposit income tax in revenue accounts. Inland Revenue Office has
territorial jurisdiction but Large Tax Payers Office has turnover jurisdiction. In the district,
where Inland Revenue Office is not situated, District Treasury and Comptrollers Office has been
assigned with the authority to collect tax liability of that district.
293
WITHHOLDING TAX
Concept of withholding tax
Withholding tax is payment of tax at the point of taxable transaction and TDS amount is
calculated on gross amount without deducting any expenditures. This type of tax is based on
PAYE concept (Pay As You Earn). This reduces payment burden to the payer, easy to collect
with minimum cost for collection and regular revenue generation source for the government.
According to Income Tax Act, 2058, only resident payer paying any payments covered by Sec.
87 to 89 having source in Nepal need to withhold income tax at the point of payment. Hence, to
deduct withholding tax:
o Payer must be resident.
o Source of income should be in Nepal.
o Payments should be covered by either Sec. 87 to 89.
If all three criteria meet on payments as mentioned in Sections 87, 88, 88Ka and 89, the payer
MUST withhold tax. Withholding tax is of two categories one is adjustable and the next is final
withholding. Amount received after final withholding need not to be included in taxable income.
Withholding by Employer
Sec 87. Tax Deductions by Employer
Resident employer
While paying any taxable amount in the relationship of employer and employee.
Source in Nepal.
Received by any employee or worker from employment.
Must deduct tax calculated at the rates mentioned as per Schedule 1 on estimated
income.
Donation cannot be reduced on computing withholding tax. Likewise.medical tax credit
and retirement contribution can be taken only for the amount related with the employer.
If the employee wants to enjoy the facility of reduction of the medical tax credit and
the retirement contribution except related to the employer and of the a donation, he/she
has to file annual tax return to the concerned IRO.
If all the cases above are fulfilled, then:

Step 1: Compute yearly tax based on estimated income at the time of first payment i.e first month
of salary payment.
Step 2: Divide the tax computed in step 1 by the no. Of remaining months of the income year and
deduct on monthly basis from the salary.
Simple case of withholding tax: In Error! Reference source not found. (page Error!
Bookmark not defined.) income from employment is Rs. 220,360 including provident fund
contribution of Rs. 14,400. Assuming the contribution was single side and was approved. Then
294
tax to be:
Income from employment/Assessable income
Rs. 220,360
Reduce: Contribution to ARF
Rs. 14,400
Taxable income
Rs. 205,960
As per the Finance Act 2072/73 exemption limit has been increased and annual income up to Rs
2,50,000 is exempt i.e only 1% tax will be levied in case of single opted hence in the above case
taxable income is Rs 205,960 and 1% tax will be Rs 2,059.60. So monthly withholding will be
Rs 171.62 (2,059.60/12)
Estimation Changed- During Falgun on 0 above, employer has raised salary in lumpsum of Rs.
100,000 for the remaining months for each of employee working on that date. Then withholding
tax shall be deducted as follows:
Revised Taxable income
Rs. 305,960
Tax to be paid @ 1%
2,50,000
2,500
Tax to be paid @ 15%
55,960
8,394
Tax to be paid
Less: already deducted
Remaining deduction
Monthly Tax (Falgun to Ashadh)
3,05,960
Rs. 171.62*7
10,894
1,201.34
9,692.66
Rs. 9,692.66/5 Rs. 1,938.53
Pay Scale based- Mrs. Alibadan is working in a private company since IY 2060.04.01. Find the
tax to be deducted per month for 2072/73under pay scale of Rs. 15,000- 1000(15)- 30,000.
Sanchaya kosh contribution is 10% by both.
Computation of income from employment and tax at source
Basic salary
(Rs. 15000*12)
180,000
Grade
11,000*12
1,32,000
Employers contribution to Fund
300000*10%
31,200
Income from
employment/assessable income
343,200
Reduction: Contribution to ARF
Minimum (Rs. 300,000 or 114,400
or Rs. 62,400)
62,400
Taxable income
2,80,800
Tax to be paid
1% of Rs 2,80,800
2,808
Monthly withholding tax
2,808/12
Rs. 243
Note: Female rebate has not been given as couple has been opted and Rs
3,00,000 has been used as exemption limit as availed by Finance Act,
2072/73.
Withholding from Contract Payment
In case of contract awarded to non-resident, the rate of withholding tax shall be as follows (Sec.
89(3):
o In case of aircraft repair and other contract- 5%
o Other cases, as notified by IRD.
295
Withholding tax: Administrative Procedures

According to Section 90 (3) a withholding agent is obliged by the Act to deduct withholding tax
at source. But if does not do so, in that case it will be supposed that the withholding has been
done according to the provision at the same time when it should have been deducted.
Sec. 103 provides that the withholding amount shall be collected for GON in any case, it shall
not be part of liquidation and have over priority in case of bankruptcy.
Withholding agent should file a monthly withholding return showing amount withheld and paid
during the month.
Notwithstanding Sub-section (4) of Section 90, the tax on house rent income of a natural person not
related to business shall be deposited within Ashadh-end of the running year and the tax withheld under
Chapter 17 by the person paying tax on the basis of transaction under Sub-section (4Ka) of Section 4 shall
be deposited within the time of depositing instalment tax.
Advance Taxation
Sec. 95 Ka is relating to the advance taxation on profit from commodity futures market and gain
from disposal of non-business chargeable assets.
Gain from Dealing in Commodity Futures Market
Advance tax is withheld at 10% on the gain amount. The withholding id made by the regulator of
the market.
Gain on disposal of non-business chargeable assets
In case of disposal of shares and securities: Withholding tax on gain on disposal at 10% for
natural person and 15% for other in case of non-listed and 5% for natural person and 10% for
others in case of listed. This withholding (exactly paying tax by person disposing it- not a
withholding tax itself) is to be done by stock market for the listed shares and person responsible
to transfer (dakhil-kharij) in other case.
In case of disposal of land or building having disposal value over Rs. 5 million, withholding tax
(exactly paying tax by person disposing it- not a withholding tax itself) is to be paid to Land
Office at following rates:
o If ownership is less than 5 years 5%
o If ownership is more than 5 years 2.5%.
INSTALMENT PAYMENT OF TAX

Concept of Instalment tax
Similar to withholding tax, annual tax is required to pay upon Pay As You Earn (PAYE) basis.
Peron having annual tax of Rs. 5,000 or higher from income from business or income from
investments need to pay installment tax according to Sec. 94 and 95.
Estimated income tax return
296
Within Push-end of income year, person need to file an estimated tax return showing estimated
income and expense, so estimated tax payable within the income year. Based on estimated tax
return, tax payer need to pay installment tax as follows:
Up to Push-end during income year
40% of estimated tax
Up to Chaitra-end during income year
70% of estimated tax
Up to Ashadh-end during income year
100% of estimated tax.
Inclusion: Advance tax in form of installment tax shall include the following payments:
i.
Previous installment paid,
ii. Withholding tax deducted on receiving of payments.

iii. Withholding tax not deducted on receiving payment but deposited u/s 90(3).
iv. Medical tax credit, if applicable.
Arbitrary estimation: Advance tax, according to Sec. 94, shall be within abovementioned limit
of estimated tax; but in case of arbitrary estimation or estimation not filed, there are two
measures to control this:
i.
Reassessment of estimated tax return u/s 95(7),
ii. Charging of interest under Sec. 118.

Interest in case installment tax is insufficient
In case a person need to file its estimated tax return and installment of income tax. Payment of
inadequate tax (below than estimation error of 20% of real tax) is subject of interest at 15% p.a.
for month and part of month basis, under the provision of Sec. 118. Let take example. Relaxation
of 20% goes till Ashoj of next year.
Simple example: N estimated Rs. 1000,000 as estimated tax and paid Rs. 400,000, Rs. 300,000
and Rs. 300,000 at Push, Chaitra and Ashadh. Actual tax assessed under Sec. 99 found Rs.
1300,000 settled on Kartik-end with filing income tax return. Interest under Sections 118 and
119 shall be:
Due on
Installment due Rs.
Paid Rs.
Deficit
Period
Interest@15%
Rs.
P
T
I=PTR
Push I
1300000*40%*90%= 400,000
68,000
3/12
2550
Rs. 468000
Chaitra-II
1300000*70%*90%= 700,000
119,000
3/12
4462.50
Rs. 819,000
Ashadh 1300000*100%*90%= 1000,000
170000
3/12
6375
III
Rs. 1040,000
Interest u/s 118
13387.50
Interest to be paid for deficit since Kartik for all due amounts at 15% according to Sec.
119, so, interest u/s 119 is Rs. 3,750 [ (1,300,000-1,000,000)*1/12*15%].
Paid amount includes of previous installments, advance withholding tax deducted by
others on behalf of tax payer and withholding tax not deducted but deposited by
payer.
297
Installment on Transaction Based Tax

Person paying tax on the basis of transaction shall deposit in two instalments as follows:
Date
to
be Amount to be Deposited
Deposited
By the end of Tax under the prescribed rate based upon the transaction
Poush
upto Poush 20.
By the end of Tax amount derived after reducing the deposited tax
Ashadh
within Poush end, out of the tax amount calculated on
the basis of the prescribed rate by estimating the
transaction upto Ashadh-end with the basis of the actual
transaction upto Ashadh 20.
INCOME TAX RETURNS

Return Filing not Required (Sec. 97)
(1) Unless requested by the Department by notice in writing served on the person or by public
notification, no return of income for an income year shall be required under Section 96
from following persons:(Ka) a person who has no tax payable for the year under Section 3(Ka);
(Kha) a person referred to in Section 3 (Ga) for the year;
(Ga) a resident natural person to whom Section 4 (3) applies for the year; or
(Gha) a natural person who is an owner of vehicle and is liable to pay tax under Section 1
(13) of Schedule 1.
(2) Notwithstanding Sub-section (1), a natural person with income over Rs. 40 lakh in an
income year shall file return under Section 96 of the Act.
(3) In addition to the income included by the person filing return under Sub-section (2), the
incomes under Clause (Gha) of Section 5, Sub-section (3) of Section 7, Clause (Ka) of
Sub-section (3) of Section 8, Clause (Ka) of Sub-section (3) of Section 9, and the income
under business exemptions and concessions under Section 11 shall also be included.
(4) The income under Clause (Ga) of Section 3 and tax exempted income under Section 11
shall be reduced from the income derived under Sub-section (3).
Provided that the meeting allowance and the interest income need not be reduced.
(5) The format for return statement to be furnished under Sub-section (2) shall be as prescribed
by the Inland Revenue Department.
PART II
VALUE ADDED TAX ACT, 2052

298
CHAPTER-I BASIC CONCEPTS

___________________________________________________________
Definition of Terms
Electronic device, as per Sec. 2 (ta1) is apparatus of transmission including computer, fax, Email, internet, electronic cash machine and fiscal printer as prescribed and approved by IRD used
for the purpose of transferring information, official correspondence and etc.
Conditions for Zero Rate of Tax

8. Value added tax paid on raw materials used for manufacturing sculptures, paintings, bastukala
and similar other handicrafts that are exported through Export Trading House of Nepal
will be refunded on completion of prescribed procedure of the Department.
1. The VAT paid on import or local purchase of scooter by a handicapped person shall be
refunded as prescribed by the Inland Revenue Department on recommendation from the
Ministry of Women, Children and Social Welfare or from the Chief District Officer of
the concerned district in case the scooter is registered in his/her name in the Transport
Management Office. The VAT thus refunded shall be recovered if (the scooter) is sold
to person other than a handicapped.
IP-9
Group Company- Sunakheti Ltd., Bhimkheti Ltd., Jamarkheti Ltd. and Karkheti Ltd. are
four company owned by Mr. Uperkheti. The head office for all companies is same place,
but there are four accountants one for each. Mr. Uperkheti is worried about monthly VAT
return for each company. Being the key person, he wants to file a single return. Is it
possible?
Does the answer is different in case, Karkheti Ltd. is filing trimester basis?
Hint: In VAT, group company or group entity is for inter-company transaction at market value
and not for consolidated VAT return. There is not any concept of consolidated VAT
accounting or consolidated VAT return in VAT. Even, surplus money of one unit of group
company cannot be off-set with another company. As all the companies are incorporated
separately and they have their own identity hence Mr. Uperkheti has to file VAT return of
each company individually irrespective of the monthly, bimonthly and trimester basis of
return filing.
CHAPTER-II REGISTRATION AND DEREGISTRATION
Mandatory Registration
Permanent Account Number (PAN) is provided to each taxpayer for income tax purpose. But a
taxpayer who is registered for VAT purpose also, it is mentioned on the PAN certificate that the
tax payer also has been registered in VAT with effect from such date. A PAN holder is supposed
to be registered with Inland Revenue Office for Income Tax purpose only unless it is specifically
mentioned on the PAN certificate that the taxpayer is registered in VAT.
According to Sec. 10 (1), every person desiring to engage in a VAT attractive transaction shall
299
apply to a tax office in the prescribed form (as per Annex 1 to 3 of VAT Regulation, 2053) for
registration, before beginning to engage in such a transaction.
Registration not required for
Small Vendors: According to Sec. 9, notwithstanding anything contained in other provisions of
the Act, an exemption may be provided to a small vendor, having transaction below than the
prescribed threshold, from the requirement of registration.
Rule 6 prescribed this taxable threshold is fixed for transaction of Rs. 5 million during a period
of previous 12 months. For this purpose, transaction means either purchase or sale which crossed
Rs. 5 million during last 12 months.
Provided that except the presumptive tax-payer filing returns under Section 4(4) of the Income
Tax Act, 2058 and dealing in VAT-able transaction, a small entrepreneur may register the
transaction by completing the process of Section 10 upon desiring to be registered.
Temporary registration
As per Section 10Kha, a special provision regarding registration of a Joint Venture Firm is
introduced. According to which:
(1) Two or more persons establishing a joint venture to carry out an assignment for a
certain period should temporarily be registered in VAT.
(2) The joint ventures registered under Sub-section (1) should deregister after the period
mentioned in the agreement of the joint venture elapses.
CHAPTER-III TAXABLE VALUE, COLLECTION, OFFSET AND REFUND

Square Off
Schedule 1 is the list of VAT exempted goods and services. But, in later years, some of the items
imposing VAT to buyers and getting refund by way of square off are also mentioned in this
schedule.
Collection of VAT on sale of goods or service need to deposit and gets refund is square
off arrangements. There are many items tested and imposed VAT under square off
arrangement. For the year 2072_73 followings are square off refund: 25 % of the residual
payable tax amount after offsetting the paid tax from the collected tax upon selling own
products by flour industry will be refunded to the industry as prescribed by the
Department.
50 % of the paid value added tax out of value added tax collected by selling own product
to VAT registered person shall be refunded under the prescribed procedure by Inland
Revenue Department to domestic industries manufacturing mustard oil and to industry
domestically manufacturing the vegetable ghee and other edible oils.
300
But packaging industries selling processed oil by importing and refilling in consumer
package in bulk quantity will not get such facility.
50 % of the collected value added tax upon selling own taxable product shall be refunded
as prescribed by the Inland Revenue to the domestic dairy industry dealing in dairy
products.
60 % of the paid value added tax shall be refunded to domestic industry manufacturing
cellular mobile phone-set and to the importer of cellular mobile phone-set on the raw
materials and the finished goods as prescribed by the Inland Revenue Department upon
submission of evidence of selling the goods to VAT registered person.
70 % of the collected value added tax shall be refunded as prescribed by the Inland
Revenue to the domestic industry manufacturing sugar upon selling own product to VAT
registered persons.
301

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COURSE: CAP II

SUPPLEMENTARY STUDY PAPER - 2016

[Covers amendments made by the New syllabus]

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

Audit And Assurance

Cost And Management Accounting

Income Tax And Vat

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

PAPER 1: ADVANCED ACCOUNTING

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NEPAL

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

CHAPTER IX : FINANCIAL STATEMENTS OF NOT FOR PROFIT

Learn the techniques of preparing Receipts and payments Accounts

Learn the technique of preparing Balance sheet.

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

Receipt & Payment Account (format)

The Institute of Chartered Accountants of Nepal

To, Donation for Parking Shed

Supplementary Study Material

100,000 By, Rent and Taxes

Limitation of Receipts and Payments Account

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

b. Entrance or Admission Fee

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

4. FUND BASED ACCOUNTING

(For capitalization of building on completion of construction)

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

Building Fund A/C

To, Capital Fund

(For transfer of specific purpose fund to capital fund account on completion of

The Institute of Chartered Accountants of Nepal

c. Fixed Deposit a/c Dr.

Supplementary Study Material

d. Interest A/c Dr.

e. Capital work in progress a/c Dr.

f. Contractors a/c Dr.

g. Building a/c Dr.

Trial Balance of Building Fund as on 31st Ashadh 2072

INCOME AND EXPENDITURE ACCOUNT

The Institute of Chartered Accountants of Nepal

Supplementary Study Material

Income and Expenditure Account

It is a summarized and classified version of

It is drawn up in the same from as the

The balance of the accounts at the end of

It does not start with opening balances.

Income and Expenditure Account (format)

The Institute of Chartered Accountants of Nepal

Supplementary Study Material