Accountant

Vol # 38 Issue # 3 May - June 2005

EDITORIAL OFFICE 3 Editorial

Abdul Rahim Suriya, FCA
The Pakistan Accountant
Chartered Accountants Avenue Clifton Karachi (Pakistan) 4 President’s Page
Zafar Iqbal Sobani, FCA
UAN: 111-000-422 Fax: (92-21) 9251626
E-mail: asad.shahzad@icap.org.pk Mutual Funds
Website: www.icap.org.pk 5 Mutual Funds - Some Unique Issues
Nasim Beg, FCA
P U B L I C ATIONS COMMITTEE
7 Investing in Mutual Funds
Chairman Altaf Noor Ali, ACA
Abdul Rahim Suriya, FCA
11 Mutual Fund
Vice-Chairman Nadeem Butt, ACA
Ahmad Saeed, FCA
15 Investing in Mutual Funds
Members
Sophia Ahmed, ACA Rizwan Razzak, ACA
Murtaza Ahmed Ali, FCA
Muhammad Murtaza Ali, ACA
Hedging Instruments
Faisal Imran Hussain, ACA Hedging Instruments in the Petroleum Industry:
Asif Jamal, FCA 20 A Brief Survey
Fazal Mahmood, FCA Herald A. Osel
Muhammad Mahmood Marfatia, ACA
Adnan Ahmad Mufti, ACA Hedge Funds
Ahmed Akhter Qazi, FCA 25 Challenging Conventional Investment Management
Shakil Akhtar Qureshi, FCA
Mohammad Shoaib Jan Memon, ACA
Abdul Rab, ACA
M. Arshad Siddiqui, FCA
Zeeshan Tayyeb, ACA
Banking
Operational Risk Management in a Bank:
Advisors
Bilal Masood
27 Easier said than done!
Danish Ahmed Siddiqui, ACA
Fariya Zaeem
Federal Budget 2005-06
THE COUNCIL 33 Distortions in an Investor Friendly Budget?
Adnan A. Mufti, ACA
Council and Office Bearers
Proposal to bring more services into GST Net
President 37 Abbas, FCA
Zafar Iqbal Sobani, FCA

Vice Presidents
Information Technology
Hidayat Ali, FCA Flowcharting and Accountants
Asad Ali Shah, FCA 39 Noor-ul-Huda Ashraf, FCA
Members Human Resource Management
Imran Afzal, FCA Attributes of a Successful Manager
Syed Ahmad, FCA 48 Amirali Kassim Merchant, FCA
Muhammad Shoaib Ansari
A. Husain A. Basrai, FCA Institute News
Mujahid Eshai, FCA Obituary
Nasimuddin Hyder, FCA 50 Sk. Hashmat Ali
Dr. Tariq Hassan
Khaliq-Ur-Rahman, FCA SAFA Conference
Dr. Faizullah Khilji SAFA Conference
Fazal Mahmood, FCA 51 Tasneem Yusuf, ACA
Masud Muzaffar
Abdul Rahim Suriya, FCA IFAC News
Syed Mohammad Shabbar Zaidi, FCA 56 IFAC eNews
Executive Director: Health News
Moiz Ahmad, FCA Constipation: Prevention and Treatment
Secretary:
58 Dr. S. M. Wasim Jafri
F. H. Saifee, FCA Students’ Section
Publications Coordinator: The Brilliant Scholar - Irfan Ghani
Asad Shahzad 61 Interviewed by Shakil Akhtar Qureshi, FCA

Pakistan Accountant can be downloaded from Institute’s website at www.icap.org.pk

The views expressed here do not necessarily represent the official policy of the Institute.
Editorial
Mutual Funds
Never in their wildest of dreams had the three Boston Privatization and the entry of the private sector have
securities executives who pooled their money together rejuvenated the mutual fund industry in Pakistan. Not
to create the first official mutual fund in 1924 imagined only the number of funds has substantially increased
how popular these would become for channelizing but also a number of new products have been
savings. Today, not only in the developed world where introduced, and the net assets value of the funds is
trillions of dollars are invested in these Funds, but also estimated to have increased by five times in just three
in developing countries like Pakistan mutual funds are years.
growing at a galloping pace and have become an
important vehicle for investing one’s savings. The regulators too have been active, and have enacted
rules and regulations to provide all the players a level
People with small savings or those preparing for their playing field. However, Mr.Nasim Beg, FCA has
retirements are particularly attracted towards these highlighted in his article published in this journal a
funds. It is not difficult to understand why mutual funds number of anomalies in these rules and regulations that
are so popular in these classes of investors. Empirical need to be redressed.
evidence indicates that these groups of investors are
Industry analysts are predicting a very bright future for
generally bad at picking stocks. Mutual Funds provide
these funds, and the interest of the general public is
them with an easy way out. One is not required to be
expected to increase manifold in them. It is therefore
an expert on the hundreds of thousands of stocks that
essential to strengthen the regulatory framework
these funds own. Furthermore, they are easy to use,
governing these funds and make it more effective. On
could be liquidated quickly in times of need, and have
its part the industry should not only follow religiously
unique diversification capabilities that help in keeping
the code of corporate governance in Pakistan, but also
the returns up and the risks down.
voluntarily adopt the international best practices. This
would boost the confidence of the investor in mutual
In Pakistan, the Government of Pakistan (GOP)
funds, and in the capital markets of the country.
ventured into this industry in 1960s by establishing the
National Investment Trust (NIT) and the Investment
Corporation of Pakistan (ICP). However, in 2002 the
GOP decided to privatize the two funds. ICP is now
operating in the private sector, and the privatization of
NIT is slated for 2005. A number of private sector Abdul Rahim Suriya, FCA
companies have also entered into this industry. Chief Editor

The Pakistan Accountant May - June 2005 03

President’s Page
Pakistan Accountant has been regularly bringing its issues on
very interesting topic and the current issue on Mutual Funds
in Pakistan perspective is a very important theme.
Mutual Funds are a vital component of the financial market
for mobilization of savings Their incredible popularity in
advanced countries is recognized, Mutual Funds have also
progressed significantly in emerging economies and our
neighboring country India is excellent example reflecting the
gigantic growth in the regime of Mutual Funds in last few
years. In Pakistan Mutual Funds have evolved at a cautious
pace, however for the last three years the fund management
industry has progressed at a very fast pace with the
participation of private sector in this industry which was run
exclusively in the public sector and was unfortunately
working with lot of red tapism generally associated in the
public sector.
Now the focus of the industry is tilting towards open end
funds from closed end funds, several new products have
been introduced and others are in the process of being rolled
out. These Mutual Funds are now developing the quality
man power resources who are working with them and this
will result in the Mutual Fund industry poised for significant
growth in the next few years. We have, on several occasions,
witnessed the crisis in the Stock Exchanges and bleeding of
the common investor who opted to enter in the highly
bullish market for making some quick money. Mutual Fund
industry development at fast pace will go in long way to
facilitate these investors and they can use this vehicle to
channelise their savings for achieving steady return. One
important thing which should be borne in mind is the role of
regulators and their efforts to evolve the Code of Corporate
Governance and best practices for the mutual industry and it
is heartening to note that at present all the players in the
field are, by and large, playing proactive role which will
add great value to mutual fund industry, it is also heartening
that a few members of ICAP are associated with the mutual
industry in key position and are contributing exceedingly
well.
ICAP elections process which started in February was
successfully completed in June with nail biting finish, the
election also witnessed high turnout of members on electoral
day which has been the hall mark of our last few elections
and it reflects close attachments our members have with
ICAP., the new Council will be meeting in due course as we
have received the name of government nominees after
which the two regional committees in South and North will
The Pakistan Accountant
start their business. I congratulate the newly elected
members and wish them great success. The current four
years term of the council was a very challenging one as a
result of the global events which brought accounting
profession in the focus, these events have benefited the
accounting profession in a big way as International
Federations of Accountants took a lead in revisiting the
issues relating to the profession and other accounting bodies
followed it and this process is still going on. The
accountancy profession in Pakistan under the lead of ICAP
has also taken number of initiatives in this regard which are
shared with our members through our publication and web
site and I am thankful for the whole hearted support we have
got from all of you .Our coordination with the front line
regulators is excellent and has resulted in bridging the gap
of trust to quite an extent. ICAP’s resources have been
strengthened specially in the human resource area, the
members are feeling this change and I am confident, in
future, the results of the improvements which are taking
place will be more visible to all the stakeholders, however
this is not the end of story as the reform process will need to
carry on to face the challenging of complexities in
businesses. I will like to share, in this regard, that in last
council meetings we have taken a few bold decisions in the
area of education in order to attract the good entrants in the
profession which will enable in increasing the size of
membership which currently is not in line with the demand
of our professionals in the country and outside Pakistan
specially developed countries. The council has also recently
allowed the professional firms engaged in auditing practice
the use of foreign names in combination with their local
name, these reforms will strengthen us to face the global
challenges.
In the end, I would like to place on record admirable support
from all the council members specially the Vice Presidents
from South and North and the Regional Committees
members. I would also like to thank the ICAP management
team for their admirable support to me and I am very
confident that this new team under the leadership of
Executive Director will be able to cope with the challenges
of future.
Zafar Iqbal Sobani, FCA
May - June 2005 04
Mutual Funds
Mutual Funds
Some Unique Issues
Most readers of this journal are reasonably well informed about the
advantages of investing through mutual funds. However, there are
some issues unique to mutual funds that should be of special
interest for professional accountants.
Income Tax
Most professional accountants will know that mutual funds are not
taxed provided they distribute 90% of their income. However, what
is generally not realised is that this is not an ‘exemption” but simply
a mechanism for avoidance of double taxation. A person investing
directly in the market would pay tax on dividends received. If,
however, the person went through a mutual fund and the fund
suffered tax on the dividend received by it and in turn the investor
also were to suffer tax on the income distributed by the fund, it
would amount double taxation of the same income. The tax law is
designed to avoid this anomaly.
Net Asset Based Accounting
The Net Asset Value (NAV) is an important aspect of mutual funds.
An investor buying or selling a share (unit or certificate) of a closed-
end mutual fund through the stock exchange needs to know the
underlying true market value of the share so as to make an informed
decision. In the case of open-end funds, the units are issued and
redeemed on NAV based prices.
The NAV is the market value of the portfolio of assets/securities less
any liabilities; and the NAV per unit is the NAV of the fund divided
by the number of its units in issue. The point to note is that the
assets of a mutual fund are valued at market and not at “cost or
market whichever is lower”, which is what is considered prudent
for most other situations. The reason for using market value is that
anyone buying into or exiting from a mutual fund must be treated
fairly with respect to the true value of the portfolio. The significance
of this is illustrated by the example in the following paragraph.
If we assume a fund was set up a few years ago and it continues to
hold the shares bought by it then and that the market value of the
shares today is three times the original cost. If we also assume that
the original size of the fund was Rs. 1,000,000,000 and it had
issued 100,000,000 units at Rs. 10 each, the market value of the
portfolio today will be Rs. 3,000,000,000 and the NAV Rs. 30 per
unit. In the event we valued the portfolio at historic cost and
consequently the price of Rs. 10 per unit, a person joining the fund
today with say Rs. 1,000,000 would get 100,000 units instead of
33,333 units (if market value was applied). In other words, this new
investor would get an undue benefit by paying a lower price and
becoming a 1.0% owner of the portfolio instead of 0.33% owner at
The Pakistan Accountant
Nasim Beg, FCA
the market value. This would be at the cost of the rest of the
investors in the fund as their interest will be diluted. A similar logic
will apply for someone leaving the fund, where the person must be
paid fair market value rather than historic cost.
Daily Financial statements: The NAV based accounting makes it a
must to draw up daily financial statements with full accruals so as
to ensure determination of accurate NAV. Some mutual funds
subject themselves to a continuous audit throughout the year so as
to ensure accuracy, as errors cannot be undone once units have
been issued or redeemed.
Element of Profit or Gains included in NAV
Having addressed the matter of the importance of issuing and
redeeming units of an open-end fund on the basis of an accurate
marked-to-market NAV, another interesting aspect from the
accounting view point is of the treatment of certain elements
included in the NAV.
Each time new units are issued one could simply take the entire
proceeds of the issue to the capital account of the fund as this
would be new capital coming into the fund. However, this would
pose a problem as, at any point in time, a fund will have some
realised and unrealised income and gains (or losses), thus the
distributable amount of income per unit (if any) at that point in time,
will be diluted by the new units that are issued (albeit at NAV and
therefore not impacting the overall worth per unit).
The way to manage this is to work out the break-down of the net
assets. Assuming that some new units are being issued at this point
in time but there has been no issue or redemption since the
beginning of the financial year prior to this, then the net assets at
this point in time will comprise of the capital at the beginning of the
financial period, some amount in the Income Statement (profit or
loss resulting from realised gains or losses, income such as
dividends etc., less expenses) and an unrealised surplus or deficit
on the valuation of the assets (being marked to market). The NAV
per unit applicable to the new entrant will be apportioned between
the Income Statement and the Capital Account in proportion to
their relative weight in the net assets.
Thus if an investor comes into an open-end fund on the last
day of the financial year, the person will buy into
the income (or the loss) accrued for the financial year
and will be entitled to get some portion of this back by
way of dividend that may be declared after the close of the year.
May - June 2005 05
Mutual Funds
This new entrant will be entitled to the
dividend distribution for the year (at par
with other unit holders) and the Income
Statement will have the capacity to
accommodate this new entrant’s
entitlement as it would have been credited
with the element of income this person has
bought while coming into the fund. Once
the dividend is paid out, the NAV will drop
to the extent of the dividend. Thus a person
remains indifferent as to when he or she
enters or exits an open-end fund (expect to
the extent of tax impact, if any, on
dividend). On the other hand, the dividend
distribution capacity of the fund is not
impacted by dilution.
Element of income at redemption stage:
Similar to the principle applied at the entry
stage, a person exiting the fund gets full
NAV and takes the accrued earnings with
him or her. This means that the dividend
distributable out of the Income Statement is
reduced in proportion to the number of
units redeemed, thus the amount
distributable per unit remains undisturbed.
Timing of NAV based prices
The NAV based prices are designed to
ensure that all unit holders of a fund are
treated fairly at the time of any investor
joining or leaving the fund. Since the NAV
based price reflects the marked-to-market
valuation of the portfolio of the fund, one
expects that the by using this price we will
achieve the objective. However, in view of
the price volatility of the underlying assets,
by the time we act in the market after an
investor comes in, the prices in the market
may have moved up, thus the fund would
pay more than it has recovered from the
new investor. This would be at the cost of
the rest of the unit holders. The best way
would be to charge the new entrant the
exact purchase cost and not the historic
NAV, however this is not practical, thus the
next best way is to charge the NAV based
price next fixed after the person joins the
fund. In this manner the new entrant
cannot deliberately attempt arbitrage
against the fund by trying to buy units at a
historic price when the market may have
moved up. Similarly, a person exiting the
fund is best paid off at the price determined
after the application to redeem has been
The Pakistan Accountant
lodged so as to avoid deliberate arbitrage
by exiting at the historic price when the
market may have fallen. Mutual funds can
favour some clients by bending the rules in
this regard, something we must guard
against.
Transaction Costs
Having dealt with various issues in trying to
ensure that we have a fair (to everyone)
system for allowing entry into and exit
from a mutual fund, there still remains one
important issue which is not widely
recognized. This relates to the transaction
costs of buying or selling securities in the
market such as brokerage and custodian’s
movement charges etc. When some new
entrant comes into the fund on an NAV
based price, it is assumed that the fund will
be able to buy more securities out of the
new entrant’s money by buying these at the
prices used for working out the NAV. Even
if the fund is able to, (we assume that some
times it will pay more and at times less,
thus averaging out over time), it will still
have to suffer transaction costs that would
not have been included in the NAV, as the
NAV reflects market prices without
brokerage etc. These transaction costs
should be ideally be recovered from the
new entrant. Funds following best industry
practices estimate these transaction costs as
a percentage of the NAV and add these on
to the NAV for determining the issue price
of the units. The transaction costs are
separate to any sales load a fund may
charge for paying towards distribution
costs. The sales load recovered in the issue
price is retained by the management
company and paid out in form of selling
commissions etc. However, the transaction
costs that are recovered are paid to the fund
enabling it to offset the costs it will suffer.
Based on this rationale the transaction costs
should also be recovered from exiting unit
holders so that the fund does not suffer
these costs while selling securities to pay
off the exiting unit holder. This would be
achieved by deducting the estimated costs
from the NAV. However, if a fund is at a
growing stage, i.e., it has net inflows, it is
not likely to be selling securities to pay off
exiting unit holders, thus it need not
recover this cost. In fact it may have some
surplus left over from the transaction costs
recovered from new entrants as there will
be some redemptions and therefore
somewhat lesser amount of securities to be
purchased as a result of the net cash
received from the proceeds of issues less
redemptions.
Valuation of Debt Securities
As has been elaborated earlier, it is
extremely important that all securities in
the portfolio of a mutual fund are valued at
market. However, the NBFC Rules, which
govern mutual funds, have their origin in a
set of earlier rules which were structured
with listed shares in mind. The Rules
require listed securities to be valued at the
price at the stock exchange and unlisted
securities at cost or break-up value.
Corporate bonds (TFCs) are listed but rarely
traded at the exchanges. Thus the last price
recorded at the exchange can be quite
outdated and at times does not even
account for in part redemption of the TFC.
These prices are therefore not
representative of true market value at
which these are traded at between financial
institutions outside the exchange.
Government bonds are not listed and it
would be totally inappropriate to value
these at historic cost. Most mutual funds
value these at true market but in violation
of the Rules, thus the audit reports of such
funds get qualified by their auditors. On the
other hand some funds are known to have
treated government bonds as “Held to
maturity” under IAS 39, thus totally flouting
the NAV principle and yet their accounts
do not get qualified – Perhaps the
accountant community needs to be a bit
more alive to the matter and propose some
remedial measures for having the Rules and
the IAS brought in line with ground
realities.
About the Author:
Mr. Nasim Beg is a Fellow Member of
the Institute of Chartered Accountants of
Pakistan. He is the Founder and Chief
Executive Officer of Arif Habib
Investments. Readers are welcome to
contact him at:
nasimbeg@arifhabib.com.pk
May - June 2005 06
Mutual Funds
Investing in Mutual Funds
Think of a group of people who collectively decide to
contribute funds with an intention of making a return by
investing the pool prudently in financial securities - primarily
in shares of companies listed on stock exchange.
The above is a practical illustration of what ‘mutual funds’
are all about. In a slightly sophisticated way, it is simply a
legal arrangement where by a group of investors contribute
funds with the specific objective of investing it in securities.
You may be wondering why should one be bothering about
‘mutual funds’ when you can just about walk in any bank
and deposit almost immediately your entire funds there in
any of the so-called ‘attractive’schemes such as certificate of
investments etc. Alternatively, you may also invest in
National Saving Schemes, which offers Khas Deposit
Certificates, or Defence Saving Certificates. The advantage of
doing so is that you can go for whoever is offering you the
best ‘rate’ and lock your funds. It is easy and relatively risk-
free. Isn’t it?
Panel -1
Net Asset Value:
To compute NAV of a close-end mutual fund, we simply take
the total of ‘shareholders’equity’and divide it by the number
of shares.
For example, the total of shareholders’ equity of Al-Meezan
Mutual Fund at 30 June 2004 was Rs. 1,127,312,058 (the
same as net assets). On that date, there were 77,500,000
shares outstanding (Note 12).
This means on that date its NAV was 1,127,312,058 divided
by 77,500,000 = Rs. 14.54 per share.
True. However, you need to see what happens after you lock
your funds. Whoever has promised you to pay a certain
‘rate’, whether it is an established bank or a government
saving institution, they would not sit on your money. They
need to invest funds where it earns a return not only to keep
Johnnies like us happy but also to make something above it
to keep making all those high-rise buildings and immaculate
offices. And where do you think they invest? They either loan
it out to businesses who promise to pay them even higher, or
invest it in capital market. And its in the capital markets (of
which stock exchange is an example), where you find ‘close-
end’and ‘open-end’ mutual funds in which these institutions
invest heavily, hoping that at the end of the day they will pay
The Pakistan Accountant
Altaf Noor Ali, ACA
peanuts to depositors like us and keep the cake for
themselves.
You do not have to believe me. We will discuss only one
representative example. Just pick up the Annual Report 2004
of Al-Meezan Mutual Fund Limited, a close-end mutual fund
listed on the Karachi Stock Exchange, and go to ‘Categories
of Shareholders as of 30 June 2004’ on page 33.
You will find that on 30-6-04, the general public held 21%
only of its shares, whereas banks, development finance
institutions, insurance companies and other institutions held
79%. Specifically, these included names like Meezan Bank
Limited (2%); Meezan Islamic Fund (12%); Al-Meezan
Investment Management Ltd. (14%); NIT & ICP (4%); Pak
Kuwait Investment Company (Pvt) Ltd. (19%); State Life
Insurance Corporation of Pakistan (3%); and 10% held by
Union Bank Ltd, Faysal Bank Ltd., Muslim Commercial Bank
Ltd., Prime Commercial Bank Ltd., PICIC Commercial Bank
Ltd., and Dawood Leasing Company Ltd. The last 15% was
held by provident funds, corporate bodies etc.
The bottom line here is that if you are a little ambitious than
a conservative deposit holder, to start with, you may as well
consider investing a part of your funds in a mutual fund in
your quest for finding better ‘returns’ than a bank deposit.
As time goes by, with an experience of couple of accounting
cycles, you are likely to grow in confidence. Investing in
Mutual Funds may sound a bit risky to a new comer as there
is no promise of a pre-determined ‘rate’, but you can be sure
that the level of risk you are accepting is no different then
that of the banks who invest in them.
Assuming that you feel confident enough to explore this
topic further, remembering the difference between ‘close-
end’ and ‘open-end’ mutual funds can be helpful.
As a rule, you will find a ‘close-end’ mutual fund only to be
listed on stock exchanges in Pakistan, primarily because the
holders of its shares or certificates can buy and sell it without
any reference to the company (except for registering change
in ownership), just like any other security traded on the stock
exchange. For example, if you wish to buy 1000 shares of Al-
Meezan Mutual Fund Limited, only a holder who has already
got it can sell it to you. The funds involved in the transaction
would not go to the Fund directly. Does it mean that all
mutual funds listed on Stock Exchanges in Pakistan are close-
end Funds? Certainly!
May - June 2005 07
Mutual Funds
On the other hand, for open-end mutual fund, no buying or
selling in its securities can take place without direct
reference to the Fund. For example, National Investment
Trust is an open-end mutual fund. If you wish to buy its 1,000
certificates, you may do so only by going to one of its
designated branches or dealers; whatever agreed price you
pay would go directly to NIT on whose behalf a certificate of
ownership will be issued to you. This is also true for the rest
of open-end mutual funds like Al-Meezan Islamic Fund, for
which you need to contact the Fund or its authorised dealer
directly.
You may be longing to figure out: which type of Fund would
be suitable for you? Well, I personally like ‘close-ends’ and
the reason is that most of them are available at a discount to
their Net Asset Value (see panel-1) whereas open-ended
mutual funds are normally quoted at their NAV or at a slight
premium. So, if I can buy a close-end at a discount of almost
20 to 35%, what is the need of going for an open-end fund,
each with its own way of working, especially when the
returns are also quite competitive?
Secondly, you can invest relatively smaller amounts in close-
ends. For example, on 24 August 2005, Abamco Composite
Fund Limited, another close-end fund, was traded between
Rs. 6.45 and Rs.6.85 per certificate. Buying 500 or 50,000 of
The Pakistan Accountant
Facts about Close-end Mutual Funds:
Market capitalisation = Number of shares x Closing price.
Example: PICIC Investment Fund had 284.125 million shares
and its closing price on 24-8-05 was Rs. 13.95. Therefore, its
market capitalisation was = 284.125 x 13.95 = Rs. 3.963
billion.
Similarly, the market capitalisation of close-end mutual fund
as a whole on 24-8-05 was Rs. 31.4 billion.
its certificates can be as easy as calling my stockbroker and
within ‘seconds’ he can confirm the purchase transaction to
me. I need less than Rs. 3,500/= to buy its 500 certificates.
On the other hand, I would only get less than 7 units of Atlas
Income Fund, an open-ended fund whose offer price that
day was Rs. 516.54 plus a time consuming trip to its offices
and filling out some forms.
Let us now try to gain some idea about the close-end mutual
funds listed on the Karachi Stock Exchange. You will find
stock quotes in almost all newspapers and you will have no
difficulty in finding the headline ‘close-end mutual funds’
under which all such funds are listed. On 24-8-05, there
were around 22 Funds listed there. Panel-2 shows the
close-end mutual funds listed on Karachi Stock Exchange
on 24-8-05.
May - June 2005 08
 Mutual Funds

Panel 2: Additional Notes

1. Price behaviour of last 52 weeks. We take PICIC Growth
Fund (PGF) as an example and see that during last 52 weeks,
its price oscillated between Rs. 37.50 and Rs. 79.95 – a
fluctuation of 2.13 times from its lows (during this time PGF
declared an interim stock bonus of 25%; it may have touched
Rs. 79.95 with 25% stock dividend included in that price).

The lesson here is that market gives an opportunity to invest

at a reasonable price to a patient long-term investor. Buying
it ex-bonus ex-interim around Rs. 45 would give you a gain
of Rs. 5 per certificate at 24-8-05 closing and gross final
dividend of Rs. 3.50. Total gain=Rs.8.50 or 17.8% of Rs. 45.
Not bad!

2. What is EPS? Earning per Share is computed by taking the

profit after tax for the year and dividing it by the number of
outstanding shares. Example: Meezan Balanced Fund MBF
earned Rs. 146.636 m for the year ended 30 June 2005. On
that date, it had 120 m shares. Its EPS 2005 was = 146.636
divided by 120 = Rs. 1.22.
What are the 2005 yields?
3. What is P/E? Price Earning ratio is computed by taking the The close-end mutual funds yield is an important matter for
closing price and dividing it by EPS. The P/E for MBF on 24- an investor. Panel-4 shows how they fared for the fiscal year
8-05 = 8.80 divided by 1.22 = 7.25 times. It can be said that 2005.
its present price equals its current earnings of 7.25 years.
Buying good stocks at lowest P/Es is a goal of every sensible It is a valid question to find out if the close-end funds will
continue to perform similarly in 2006. For this, the investors
investor.
need to understand the direct relationship between the close-
end mutual funds and the stock market. When market
Where is the NAV?
performs better, so do most mutual funds. The reverse is also
Earlier, I said that most close-end mutual funds are available true. The market goes down and the returns are anaemic.
at a discount to its NAVs. Let us validate this point and have
a look at Panel-2 to see if you can spot the NAVs?
Panel 3: Additional Notes
You may be thinking of a misprint, since the column for NAV 1. NAV = Net Asset Value = Total of Shareholders Equity. This
information of each Fund is missing in the Panel. The truth is
is actually NAV per share. To find it you take Shareholders
that there is no misprint. Simply put, the NAV of close-end
Equity and divide it by number of outstanding shares.
mutual funds is not a part of the daily stock quote. Infact,
NAV of each Fund is notified by the management of the Fund
2. Discount. The closing price of Abamco Composite on 24-
to the Stock Exchange on a weekly basis but you may not
8-05 was Rs. 6.45. On that date, its NAV was Rs. 10.54. The
find such information readily available in the newspapers
[The daily NAV of Abamco and Al-Meezan related close-end NAV was higher than Market Value by Rs. 4.09. This means
(and open-end) funds can be found from their websites it was selling at a discount = 4.09/10.54 = 0.388 or 38.8%.
www.abamco.com and www.almeezangroup.com Buying at scrip at a discount from NAV is ‘safe’ for the
respectively. ‘The News’daily, also prints NAV of some funds investor.
in its business section].
However, investor should be alert about too steep discount.
I could not access the latest NAV of all the Funds, of those In this case, no final dividend for 2005. It paid 12.5% as
with me follows. Panel-3 shows that most of close-end interim dividend, reasonable given its price.
mutual funds are available at a discount.

The Pakistan Accountant May - June 2005 09

Mutual Funds

Panel 4: Additional Notes Conclusion:

1. Distributions = Cash Dividends, Stock Bonus, or Right
shares issued during last three years. Example: In 2004, In this article, we have explored values of close-end mutual
Pakistan Premier Fund announced a 12.5% Cash Dividend, funds through NAV and Yield approaches. Feel free to use
25% Stock Bonus, and 50% Rights (an option to subscribe an
the format here to update position.
additional share for every two shares held).

2. Net Dividend = For individuals there is a 10% at source
deduction hence the difference between dividend and net
dividend. Example: Pakistan Strategic Fund declared a cash
dividend of Rs. 1 but an individual investor would only get
Rs. 0.90.
As a courtesy to my readers, I must also disclose that I own
some of the close-end funds mentioned in this article and
that I carry out investment research for my clients.

3. Average = The average of high and low prices during last About the Author:
52 weeks. Example: Abamco Growth Fund = high + low
divided by 2 = Rs. 31+ Rs. 19 divided by 2 = Rs. 25. Mr. Altaf Noor Ali is Chartered Accountant practicing in
his own name.
4. Yield = Net Dividend divided by Average Price. Example:
Readers are welcome to contact him at:
Golden Arrow = 1.80 divided by 6.65 = 0.2707 or 27.07%.
altafnoorali@yahoo.com

The Pakistan Accountant May - June 2005 10

Mutual Funds
A fund operated by an investment company that pools /
raises money from shareholders and invests in a variety of
securities, including stocks, options, bonds and money
market instruments.
A mutual fund stands ready to buy back (redeem) its shares
at their current net asset value, which depends on the total
market value of the fund's investment portfolio at the time of
redemption. The US name for mutual fund is “Unit
Trust”.(refer table attached)
The two principal types are closed-end and open-end mutual
funds.
Shares in closed-end mutual funds, some of which are listed
on stock exchanges, are readily transferable on the open
market and are bought and sold like other shares. Open-end
funds sell their own new shares to investors, stand ready to
buy back their old shares, and are not listed.
Closed-End Fund - A type of investment company that has a
fixed number of shares that are publicly traded. The price of
a closed-end fund share fluctuates based on investor supply
and demand. Closed-end funds are not required to redeem
shares and have managed portfolios.
As open-end investments, most mutual funds continuously
offer new shares to investors. These funds offer investors the
advantages of diversification and professional management
and enables its shareholders to pool their funds for
professional management as a single investment account.
A mutual fund, or an open-end fund, sells as many shares as
investor demand requires. As money flows in, the fund
grows. If money flows out of the fund the number of the
fund’s outstanding shares drops. Open-end funds are
sometimes closed to new investors, but existing investors can
still continue to invest money in the fund. In order to sell
shares an investor usually sells the shares back to the fund. If
an investor wishes to buy additional shares in a mutual fund,
the investor must buy newly issued shares directly from the
fund. Mutual Funds have a low minimum investment
amount, can be bought or sold any business day.
The Pakistan Accountant
MUTUAL FUND Nadeem Butt, ACA
Each shareholder ’s investment is priced at a net asset value
representing that share’s portion of the collective investments
of the fund and at which price shares may be purchased or
redeemed (sold).
Professional portfolio investment managers, usually called
the AMC ( Asset Management Company), decide to buy, sell
or hold securities in an attempt to take advantage of current
and future market conditions. Investors profit through
increases in the fund's share price (appreciation) and through
the distribution of dividends. All owners in the fund share in
the gains or losses of the fund.
How the fund invests is determined by the fund's objectives.
The mutual fund's prospectus details this type of information
plus information on any fees, the management company and
other relevant data.
They offer investors a variety of goals, depending on the fund
and its investment charter. Some funds, for example, seek to
generate income on a regular basis. Others seek to preserve
an investor's money. Still others seek to invest in companies
that are growing at a rapid pace.
Funds can impose a sales charge, or load, on investors when
they buy or sell shares. Many funds these days are no load
and impose no sales charge.
If you wish to invest in a mutual fund you should get answers
of the following:
1. What area or instruments does the fund invest in?
2. What has been the long-term rate of return?
3. How much return has been varied in the past?
4. How does the fund’s performance compare with that of
the underlying market?
5. Is the fund seeking income or capital growth?
*Past performance is not indicative of future results.
And before selecting a fund to invest in you should learn:
1. How to read a fund prospectus
2. How to assess a fund manager's investment style and its
impact on your returns
3. How to evaluate fees and expenses
4. How to evaluate risks
5. How to calculate return on investments
May - June 2005 11
Mutual Funds
1.HOW TO READ A
FUND PROSPECTUS
Key Elements of a Mutual Fund
Prospectus are:
Date of issue—First, verify that you
have received an up-to-date edition of
the prospectus. A prospectus must be
updated at least annually.
Minimum investments—Mutual funds
differ both in the minimum initial
investment required, and the minimum
for subsequent investments.
Investment objectives — The goal of
each fund should be clearly defined —
such as income with preservation of
principal or long-term capital
appreciation. Be sure the fund’s
objective matches your objective.
Investment policies — A prospectus
will outline the general strategies the
fund managers will implement. You’ll
learn what types of investments will be
included, such as government bonds
or common stock. The prospectus may
also include information on minimum
bond ratings and types of companies
considered appropriate for a fund. Be
sure to consider whether the fund
offers adequate diversification.
Risk factors—Every investment involves
some level of risk. In a prospectus
you’ll find descriptions of the risks
associated with investments in the
fund. Refer to your own objectives and
decide if the risk associated with the
fund’s investments matches your own
risk tolerance.
Performance data—You’ll find selected
per-share data including net asset
value (NAV) and total return for
different time periods since the fund’s
inception. Remember that past results
do not guarantee future performance.
When evaluating performance, look at
the track record of a fund over a time
period that matches your own
investment goals.
The Pakistan Accountant
Fees and expenses — Sales and
management fees associated with a
mutual fund must be clearly listed. The
prospectus will also display the impact
these fees and expenses would have on
a hypothetical investment over time.
Tax information — A prospectus will
include information on the tax status
and implications of a fund’s
distributions, and whether they will be
treated as dividend income or capital
gains.
Investor services — Shareholders may
have access to certain services, such as
automatic reinvestment of dividends
and systematic withdrawal plans.
Be sure to read the prospectus and ask
questions about items that you are not
sure about before investing.
2. HOW TO ASSESS A
FUND MANAGER’S
INVESTMENT STYLE AND
ITS MPACT ON
RETURNS:
Some fund managers follow an
investing "style" to try and maximize
fund performance while meeting the
investment objectives of the fund.
Fund styles usually fall with in the
following three categories.
Fund Styles:
w Value: The manager invests in
stocks believed to be currently
undervalued by the market.
w Growth: The manager selects
stocks they believe have a strong
potential for beating the market.
w Blend: The manager looks for a
combination of both growth and
value stocks.
To determine the style of a mutual
fund, consult the prospectus as well as
other sources that review mutual funds.
Don't be surprised if the information
conflicts. Although a prospectus may
state a specific fund style, the style may
change. Value stocks held in the
portfolio over a period of time may
become growth stocks and vice versa.
Other research may give a more
current and accurate account of the
style of the fund.
3. HOW TO EVALUATE
FEES AND EXPENSES:
Mutual funds charge some amount for
their services. Of course, these charges
will affect the amount of money you’ll
have someday. The secret is to
evaluate the full potential of an
investment—the amount you keep
after paying the fees. Here’s a simple
strategy to help you get started:
1.Understand fees and expenses.
2.Compare charges that apply to
mutual funds.
3.Consider redemption fees or rates
(difference of buying selling)
Shareholder Fees
These fees are paid directly from the
share-holder's account and may
include:
Sales Charge
This fee, also called a "load," is paid to
the shareholder's investment
professional as compensation for
acting as the intermediary between the
fund company and the investor.
Front-end Load
This load is imposed at the time of the
purchase. It is shown as a percentage
of the fund's offering price (the fund's
price per share, which includes the
front-end sales charge).
Exchange Fee
This fee is levied to help defray the
administrative costs associated with
exchanging from one fund to another
within the same family, within the
same class of shares. Often, a fund will
allow a certain number of free
exchanges before imposing this fee.
May - June 2005 12
Mutual Funds
Redemption Fee
In an attempt to discourage frequent
trading in and out of a fund, a
redemption fee may be imposed. This
fee may be eliminated after the shares
are held within a fund for a certain
amount of time, such as 30 or 60 days.
This fee can apply to redemptions as
well as exchanges out of a fund.
Account Fee
This may be applied to help cover the
administrative costs of maintaining an
account. For example, some funds may
charge an annual fee.
Annual Fund Operating Expenses
These expenses are deducted from the
fund's assets and typically cover
ongoing costs associated with running
the fund itself. These may include the
following:
Management Fee
This is often the largest operating
expense and it covers the costs
associated with the professional
management of a fund's portfolio.
Other Expenses
These include miscellaneous custodial,
legal, accounting, and other
administrative expenses associated
with operating a mutual fund.
Adding it up — Total Annual Fund
Operating Expenses
Now that you know what your fund is
paying for and how you're being
charged, you need a way to evaluate
and compare these costs. The tool for
this job is the expense ratio and it
generally appears in the "Total
Operating Expenses" line at the bottom
of the Annual Fund Operating
Expenses table in the prospectus.
Simply defined, the expense ratio is the
percentage of a fund's average net
assets (assets minus liabilities), which
is spent on operating expenses during a
fiscal year. For instance, if a fund has
assets of Rs.500 million and annual
operating expenses of Rs.10 million,
the expense ratio in this case would be
2%.
The Pakistan Accountant
The expense ratio excludes
shareholder fees and some other
charges such as portfolio trading costs.
Because portfolio transaction costs are
not always paid separately from the
cost of buying or selling securities, they
do not appear in the fund's expense
ratio.
Anything that affects operating costs
can have a bearing on the expense
ratio. When you're examining expense
ratios among funds, be sure you're
comparing apples-to-apples — that country to decline.
because the average costs of managing
different types of investments can vary
dramatically. And, while expense
ratios make it easy to evaluate the costs
of similar funds, don't forget to
compare a figure that's even more
important in your investment decision:
total return.
"No Load" Doesn't Mean "No Fees"
Although mutual funds labeled as "no
load" don't have an up front sales
charge that does not mean they are free
of other charges. No-load funds may
carry purchase fees, redemption fees,
exchange fees, and account fees. And,
of course, shareholders of almost all
funds are subject to the indirect costs
associated with annual operating
expenses.
4. HOW TO EVALUATE
RISKS
Different mutual funds have inherently
different risk characteristics and should
not be compared side by side. A bond
fund with below-average risk, for
example, should not be compared to a
stock fund with below average risk.
Even though both funds have low risk
for their respective categories, stock
funds overall have a higher risk/return
potential than bond funds.
Mutual funds face risks based on the
investments they hold.
Following is a glossary of some risks to
consider when investing in mutual
funds.
Call Risk. The possibility that falling
interest rates will cause a bond issuer
to redeem—or call—its high-yielding
bond before the bond's maturity date.
Country Risk. The possibility that
political events (a war, national
elections), financial problems (rising
inflation, government default), or
natural disasters (an earthquake, a poor
harvest) will weaken a country's
economy and cause investments in
Credit Risk. The possibility that a bond
issuer will fail to repay interest and
principal in a timely manner. Also
called default risk.
Currency Risk. The possibility that
returns could be reduced because of a
rise in the value of the currency against
foreign currencies. Also called
exchange-rate risk.
Income Risk. The possibility that a
fixed-income fund's dividends will
decline as a result of falling overall
interest rates.
Industry Risk. The possibility that a
group of stocks in a single industry will
decline in price due to developments
in that industry.
Inflation Risk. The possibility that
increases in the cost of living will
reduce or eliminate a fund's real
inflation-adjusted returns.
Interest Rate Risk. The possibility that
a bond fund will decline in value
because of an increase in interest rates.
Manager Risk. The possibility that an
actively managed mutual fund's
investment adviser will fail to execute
the fund's investment strategy
effectively resulting in the failure of
stated objectives.
May - June 2005 13
Mutual Funds
Market Risk. The possibility that stock
fund or bond fund prices overall will
decline over short or even extended
periods. Stock and bond markets tend
to move in cycles, with periods when
prices rise and other periods when
prices fall.
Principal Risk. The possibility that an
investment will go down in value, or
"lose money," from the original or
invested amount.
5. HOW TO CALCULATE
RETURN ON
INVESTMENTS
You make money from mutual fund
investment when:
w The fund earns income on its
investments, and distributes it to you
in the form of dividends.
The key difference between the two lies in the legal structure:
Form of establishment
Beneficiary
Governing law
Legal document in which the rules
are laid down
Who protect investor interests
Who owns or holds the fund assets
Who is liable
The Pakistan Accountant
w The fund produces capital gains by
selling securities at a profit, and
distributes those gains to you.
w You sell your shares of the fund at a
higher price than you paid for them
The average annual return for a mutual
fund is stated after expenses. The
expenses include fund management
fees. Average annual returns are also
factored for any reinvested dividend
and capital gain distributions. To
compute this number, the annual
returns for a fixed number of years
(e.g., 3, 5, life of fund) are added and
divided by the number of years, hence
the name "average" annual return. This
specifically means that the average
annual return is not a compounded
rate of return. In addition to this
appreciation in the sale price of the
fund share / unit over that period is
also part of the profit.
Unit Trusts
Trust
Unit holder
Trust law
Trust deed
Trustee
Trustee holds the
assets for the
benefit of the
investors
Trustee
ARE UNIT TRUSTS
DIFFERENT FROM
MUTUAL FUNDS?
From an investment perspective, there
are no major differences between unit
trusts and mutual funds. Both are
professionally managed portfolios
which invest in a wide variety of
financial instruments.
About the Author:
Mr. Nadeem Butt, ACA qualified
from Gardezi & Co., Lahore in
2001. Presently he is working as
Head of Internal Audit & Budget
Depts. at TAQ Logistics. Readers
are welcome to contact him at:
nadeem.butt@tlpk.com
Mutual Funds
Limited liability company
Shareholder
Company law
Company's articles/ bye laws &
custodian agreement
Custodian (but according to the custodian
agreement and articles / bye laws).
The mutual fund company
owns the assets and
Investors are shareholders
of the company.
The company has limited
liability; directors can be liable.
May - June 2005 14
Mutual Funds
Investing in Mutual Funds
Looking for income and some growth from your
investments?
Who isn’t?
The big problem: You typically can’t have your cake and eat
it too. The higher the return on an investment, the greater
the risk. Mutual Funds are the tools to diversify risk and
earn decent returns.
Thanks to the break of the bear spell over the stock market
that catalyzed the rebirth of mutual funds in Pakistan. It now
promises to be one of the fastest growing industries in the
financial sector. The economic overturn of the country after
9/11 has played significant role in the boost of this sector.
Once reluctant corporate giants are now the leading
investors in the mutual funds. The concept of mutual fund is
very simple. It replicates a prudent single individual by
pooling the resources to exploit the underlying asset class
more efficiently and effectively.
Securities and Exchange Commission of Pakistan introduced
Investment Companies and Investment Advisers Rules, 1971
and Asset Management Companies Rules, 1995 to regulate
open and close end funds. Although not comprehensive,
however these were the initial steps in regularising the fund
management industry in Pakistan.
Later in 2003 The Non-Banking Finance Companies
(Establishment and Regulation) Rules, 2003 were introduced
that not only combined scattered regulations governing non-
banking financial sector but also tried to be more
comprehensive then the predecessors individual laws. This
shows progression and commitment of the regulators for the
sector. However still the issues of benchmarks for fund
return, addressing accounting and reporting issues and
standardised risk control measures for investment in other
than stock sectors are few of the concerns that need proper
attention.
In Pakistan, at present 14 open end and 20 close end funds
are under operation. Many more are in pipeline and several
are in conceptual phase. Most of them are plain vanilla funds
investing purely in capital markets or money markets and a
The Pakistan Accountant
Rizwan Razzak, ACA
few of them calling them as balanced fund. However, as the
market grows we may witness products with complex and
sophisticated investment strategies and overlapping asset
classes.
We appreciate regulators recognition of the sensitivity of the
industry. In accordance with the NBFC Rules, a fund
manager cannot advertise in any form unless the proof of
advertisement is approved by the regulators. However, there
is still a lack of awareness about the concept of mutual funds
among the masses that needs to be taken up by the regulators
and the industry players.
Scaring from the past experience of investment companies
scams, most of us still conceive mutual funds as the new
version of such companies. Mutual Funds are different from
our nightmare investment companies in terms of their
regulations, supervision and professional management.
Nevertheless, the investments in mutual funds are not free
from risk. Before you invest in any mutual funds, be it stocks
or bonds, it is important understand all the risks. The greater
the risk, the greater the potential return. Unfortunately, there
are quite a few types of risks to consider.
Market risk is the risk that your individual stock, bond or
mutual fund will decline if the stock or bond market
declines.
There is the risk that bad news about a single company will
tumble its stock price. Similar there may be a situation
wherein a rumour or the social or political issues nosedives
the market. In such a situation the fund manager would not
be able to prevent the loss however; if the asset class of a
fund is adequately diversified you may witness reduction of
loss in comparison with its benchmarks and peers.
On the bond side, you face interest rate risk. Bond prices
move in opposite directions to interest rates. So when rates
rise, bond prices fall.
There also is inflation risk. The income you get from your
bonds through the years, may not keep pace with rising
costs.
Credit risk is the danger that the issuer of a money market
instrument could go bankrupt.
May - June 2005 15
Mutual Funds
Due to influx of new and giant
corporate and financial sector players
in the market, there is a sign of good
healthy competition in the industry.
However, on the other hand this would
also be a test of investors’ preference.
Although the fund’s return would top
the investors’ choice however, it is not
as simple as it appears; there are a few
things that require deeper digging
especially in our nascent market:
WHAT DOES THE FUND
INVEST IN?
Does the fund invest in stocks or
bonds? Does it invest in large,
medium-size or small companies?
Does that fund invest in growth stocks
or undervalued stocks? Does the fund
invest in bonds for income? These all
questions have relevance to your
investment goals and risk preferences.
Stock funds tend to involve more risk
then the bond funds and trading stock
funds riskier then the stock funds
having strategy to invest in
undervalued and growth stocks.
WHAT ARE THE FEES?
The level and method of charging load
may also have impact on your choice.
Do you have a choice of a front-end or
back-end load, or is there an ongoing
level load? A load is a commission.
The higher the load the longer it would
take to make your absolute returns in
line with the fund returns.
PRICING METHODOLOGY:
Is the fund has forward pricing
mechanism or it announces the offer
and redemption prices in advance?
Generally, stock funds or the funds
having significant equity asset class
follow forward pricing mechanism to
avoid arbitrage against the fund.
On the other hand, bond funds may
advance pricing mechanism as the
underlying market is not volatile and
any expected move in the interest rates
may already being digested over in the
The Pakistan Accountant
market before its official
announcement. The fund having
pricing policy protecting the interest of
the unit holder is the preferred choice.
FUND RETURNS:
The past performance of the fund
reflects the fund manager’s capability
of rowing the boat. Stable returns over
a longer period is more important then
peaks of a short period followed by
trough.
The asset class of the fund may
perform well due to some alien
conditions and in turn the fund may
perform well. However, as soon as the
triggering conditions are no longer in
the field the fund’s return may show
nosedive effects. Take an example of
from our markets, if a fund having asset
concentration in PSO Stock, its returns
shoot up as soon as we hear the
announcement of its privatisation due
to market expectations of having its
pricing over its fair value. However, as
soon as the government put off the
decision of its privatisation or the
company is sold off below the
expected market price, the market
would dilute its price to its fair level.
Although quiet riskier, this also give
rise to an opportunity to earn good
returns by playing with the market.
Nevertheless, focusing too much on a
mutual fund's past performance is also
not advisable. While it's easy to get
swept up in the latest investment trend,
relying solely on past results rarely
leads to success. Instead, ask yourself,
"Is this a good investment right now?"
There may be situations where bond
funds may be outperforming the stock
returns.
The advisable thing is to review a
fund's return against the return of its
stated benchmark and its peer group
over the most recent three- year
period. Then consider how the asset
class as a whole has fared during this
period. If the asset class has performed
well recently, consider whether now is
the right time to invest.
Harvesting the field in the favourable
conditions is not a big task. Anyone
can reap the benefits in bull markets.
You may be looking for one who can
sail your boat during tumbling times.
One should also take into account the
fund’s performance during down
markets. How much the fund asset
shrinks during such period? Do the
funds NAV falls in line with the market
index or its peers or it falls more
rapidly then the market index or its
peers? Naturally, the one who can
provide you decent returns in all
weathers would be the preferred
choice.
PAYING TOO MUCH IN
EXPENSES
Costs matter. Fund expenses - the costs
of running a fund, measured by its
expense ratio - come directly out of the
fund's income and can significantly
dampen your return. Over time, a
seemingly small difference in expenses
can have a big effect on your nest egg.
Managers of high-cost funds have to
earn higher returns in light of expenses
just to outperform their low-cost peers.
Mind it there might be some expenses
whose dilution effect to the fund’s
earnings could not be picked from the
naked eyes, you might require to go
deep into the waters to see such
effects. All else being equal, it is
recommended to avoiding funds with
high expenses.
ACCOUNTING
TREATMENT FOR THE
INCOME AND EXPENSE
ITEMS:
Being new and specialised industry,
lack of standardised accounting
treatments / pronouncements may
have significant impact on the fund
returns. Book returns may not
correspond to the implicit returns and
may result in enronimism.
May - June 2005 16
Mutual Funds
Mutual funds being specialised
industry require standardisation of
accounting procedures for its major
class of transactions. In certain cases,
generally accepted accounting
principals may provide flexibility for
presentation however, from mutual
fund's perspective it may not be the
case. Like a fund may not defer the
valuation of its securities for the year
end as it has to announce the net asset
value of the underlying asset frequently
or it may not adopt a certain IAS in toto
to avoid distortion in the net asset
values of the underlying assets.
In such a scenario, the fund that adopts
the accounting policy that fairly
reflects the net asset value of the assets
would be the preferred choice in
comparison with the book return.
Further, the matter should not be left in
abeyance. We should not wait for the
eruption of accounting scam. Being the
involvement of people hard earned
money, issues should be taken up by
the SECP and ICAP more proactively.
FUND SIZE
Every fund category has a range of
assets under management where, all
other factors being equal, fund
managers have their best chance to
compete against their peers. In general,
it's best to avoid funds with really
small asset bases. And, it's generally
best to avoid small cap funds with
large amounts of assets under
management. Selecting the right-size
fund is no guarantee of success, but it
can enhance your prospects for a
better return.
PUTTING TOO MUCH IN
FOCUSED FUNDS
Focused funds concept is new to our
environment due to limited market
size. However, as the size of the
market grows we would witness
emergence of focused funds. Focused
funds are limited to a single sector or
The Pakistan Accountant
even in the case of very large market
cap companies limited to a single
company.
Investing too much in the focused fund
is exposing you to volatile returns.
Focused funds are subject to greater
volatility than diversified funds
because they fail to completely
diversify security and sector risk.
RISK CONTROLS
Risk controls are policies such as limits
on stock or sector weights. Although,
NBFC Rules address this issue to a
basic extent however, it is really an
internal risk control policy and its
effective implementation that provides
security and disciplined returns to the
investors. They set the playing field for
a fund and ensure that the portfolio
manager seeks to generate returns in
an efficient manner.
Being the investor in the fund you have
the fullest right to learn about what
types of risk controls portfolio
managers use while exercising options
to buy or sell specific securities. The
more risky or volatile the investment
category, the more important it is to
have these controls in place.
NOT KNOWING WHO IS
MANAGING YOUR
MONEY
How long has the fund manager been
running the fund? If the fund manager
is new, you might want to go with a
manager with a longer-term track
record. After all, your hard earned
savings should be in the safe hand. A
loss of profit is bearable as against the
loss of capital.
A fund's prospectus should clearly
identify who makes the investment
decisions. Be wary of investing in a
fund with a novice manager or a
faceless team whose compensation
might not be aligned with the
performance of your fund. In some
scenarios, committees manage some
funds. So if one of the co-managers
leaves, it‘s not that big a deal.
OVERLOOKING
EXCESSIVE DEMANDS ON
YOUR MANAGER'S TIME
The next issue is that a successful fund
manager could be promoted to run
multiple funds or chair multiple
committees, or become chief
investment officer for the firm. It's
important to revaluate whether the
manager is going to be focused enough
on your fund. Start by reviewing how
many funds your manager is
managing, and in what roles. The
better money management firms give
their best managers ample support so
they can devote sufficient time to
managing your money.
THE BOTTOM LINE:
No doubt mutual funds are the best
tool for earning decent return with risk
diversification. Entrance of new fund
managers and growth of the sector
would witness a number of
opportunities knocking your door.
With a number of mutual funds to
choose from, the selection process can
be overwhelming. Being aware of
these issues, should help narrow the
field.
About the Author:
Mr. Rizwan Razzak is an Associate
Member of Chartered Institute of
Management Accountants, UK and
the Institute of Chartered
Accountants of Pakistan. He is
presently serving as Chief Financial
Officer of RUSD Investment Bank
Inc, Labuan, Malaysia.
Readers are welcome to contact him
at: rizwan@rusdbank.com
May - June 2005 17
Hedging Instruments
Hedging Instruments in the
Petroleum Industry: A Brief Sur vey
A basic building block for economic success of every
company is the management of the risks inherent to its
business activities. Risk is closely associated with uncertainty
and the extent to which probabilities could be attributed to
the occurrence of future developments FN1. With respect to
prices the magnitude of risk could be expressed in terms of
price volatility.
The prices of primary importance to each economic
enterprise are the interest rate in the capital market, prices for
goods and services sold and received, exchange rates, as
well as the market value of the company (e.g. expressed in
terms of the market capitalization of the company’s shares).
Techniques to manage the risk associated with the
fluctuations of these prices have further been developed,
which resulted in the creation of a variety of hedging
instruments.
Hedging
A hedge basically aims at initiating a market transaction in
order to dispose of the risks of price volatility. The company’s
philosophy and attitude towards risk management, trading
and hedging is typically reflected in its Risk Management
Policies and Procedures FN2. An integrated oil company for
example with the entire upstream production of crude being
processed in the refinery experiences two offsetting price
risks – i.e. a natural hedge - and might opt not to use
additional hedging instruments. Alternatively the oil
company might run its up- and downstream divisions as
completely independent profit centers, which are requested
to hedge its relevant price risk. The oil company might go for
an alternative scenario and hedge only a fraction of the total
production but not 100%, which could again form part of the
Risk Management Policies and Procedures.
A competitive spot market for the underlying commodity as
well as an associated market for derivative securities forms
the basis for applying hedging technology.
Markets for hedging instruments could be highly organized
such as in an exchange for stocks and commodities or
otherwise be governed by individual over-the-counter (OTC)
transactions.
The basic concept of hedging is to hedge risks originating
from a present transaction in the physical market by
simultaneously initiating an equal and opposite position for
a future transaction in the futures market.
The Pakistan Accountant
Harald A. Osel
In case price fluctuations of the hedged position (e.g. oil)
could be fully offset via price fluctuations of the hedging
instrument (futures, options and others) a perfect hedge
would have been achieved. In reality a perfect hedge often
represents only a theoretical possibility. One reason for this
being that the price of the hedged position respectively
underlying commodity and the price of the hedging
instrument do not move in tandem. That difference between
the price in the physical, cash market and the price of the
hedging instrument is called the basis and the risk associated
with it is known as the basis risk.
Crude oil, refined products and natural gas represent the
underlying commodities in the Petroleum Industry for which
hedging instrument could be used.
Futures, options and swaps, as well as forward contracts
represent the standard hedging instruments.
(1) Forward Contracts
Forward contracts represent over-the-counter transactions
with a varying degree of standardization. Forward contracts
essentially represent an agreement to buy or sell a
commodity such as oil at a specific future date. Physical
delivery of the oil traded is required upon agreed terms as
stipulated in the contract. Forward contracts could be further
indorsed and traded on to other market participants, which
could result in a large number of transactions known as
Strings and Daisy Chains. As forward contracts are traded
over-the-counter the risk of non-fulfillment of the contract
remains. In case of a hedging instrument that trades on an
exchange a clearinghouse would guarantee fulfillment,
which provides additional liquidity for that hedging
instrument.
(2) Futures
Futures are standardized contracts, offered to the general
public while being traded over an exchange. Buyers and
sellers are connected at this exchange via a clearinghouse,
which matches the longs (buyers) and the shorts
(sellers).The clearinghouse charges a margin for its services
but guarantees the fulfillment of the futures contract, which
makes futures a much easier negotiable asset. Companies
interested in trading futures contracts often interact with the
clearinghouse via a clearing broker. Conversations between
the client and broker are regularly recorded.
May - June 2005 20
Hedging Instruments
The futures contracts traded in the
petroleum industry are for crude oil, oil
products such as heating oil or
unleaded gasoline, as well as natural
gas futures. Other energy futures are
also available for electricity.
The principle energy futures exchanges
worldwide are the NYMEX (New York
Mercantile Exchange or the “Merc”)
and the IPE (International Petroleum
Exchange) in London. Futures contracts
are further traded on other exchanges
such as the SIMEX (Singapore
International Monetary Exchange).
Most energy futures traded on the
NYMEX require upon expiry the
physical delivery of the underlying
commodity at a predefined delivery
point. The paper barrels originally
purchased with the futures contract
consequently turn into wet barrels
upon the expiry date of the future.
With the IPE alternative delivery
methods - especially cash settlement
upon expiry of the contract as it was
the case for a financial futures – are
more common.
For a futures contract requiring
physical delivery (e.g. at NYMEX) the
purchaser of that contract is
consequently not responsible for
storage of the petroleum, i.e. the costs
of carrying, up to the future point of
delivery FN3. The same could be valid
when purchasing commodities on the
basis of a forward contract.
Prices of contracts on a forward basis
plotted against time represent on a
graphical basis the forward curve. The
forward curve, nevertheless, not only
includes costs of carrying but also the
price expectations of the market
participants.
If futures prices for closer month are
higher than for later month – e.g. May
35 $/bbl, June 30 $/bbl - the market is
said to be inverted. Even though costs
of carrying would point towards rising
prices the overall price decline is what
causes an inverted market, which is
The Pakistan Accountant
also known as trading in
backwardation. Inverted futures
markets are linked to the expectations
of market participants for prices in the
cash market for the underlying
commodity to fall. Otherwise if later
month trade at a premium over closer
month the market is referred to as
trading in contango, which is linked to
the expectation of rising prices in the
cash market.
The link of the futures to the physical
market provides the confidence that
prices on both markets tend to move in
tandem, which is a prerequisite for a
futures contract to serve as at hedging
instrument for the physical commodity.
Hedging Example – Futures
An oil company sells crude oil today,
Sep. 15, for physical delivery on
Dec.1, at prices prevailing at the date
of delivery. The company is concerned
about falling prices and wants to lock
in the price offered by a futures
contract today for deliveries in three
month, i.e. Dec. 15, which is 39 $/bbl.
The company consequently sells 3-
month futures on NYMEX on Sep. 15.
Going short in futures (i.e. selling
futures) thereby constitutes a contract
that gives the right to sell in future at
today’s price of the futures contract.
On Dec.1 the physical transaction
takes place at a price of 39.5 $/bbl.
The company subsequently has to
close its futures position and buys
futures at Dec.1-prices of 39.5 $/bbl as
well. Futures for same underlying,
contract quantity are first sold and then
The following table should visualize this concept:
Today: Sep.15
Delivery: Dec.1
Hedging Costs
Net Sales Price
bought, i.e. offsetting positions are
traded back-to-back. A standard
NYMEX futures contract requires
physical delivery at the end of its term.
In case the originally sold futures
contract would not be offset and
bought back the physical delivery of
oil would be required on the basis of
the futures contract and the company
would have to sell oil twice, once in
the physical and once in the futures
market. (See Table)
In this example the hedger has sold oil,
-which in the language of traders is
usually referred to as going short of oil
– and ultimately bought futures, i.e. he
goes long of futures. This type of
transaction is also known as a short
hedge. The basic aim of the short
hedge is to protect companies such as
oil producers from falling prices in the
physical, cash market by originally
selling futures and locking in the prices
for future sales.
A hedge where oil should be
purchased at a future date and futures
would first be bought and then sold
would be a long hedge. A long hedge
aims at protecting the buyer of oil from
rising acquisition costs for oil. The
buyer intending to purchase oil in
future consequently buys futures now
in order to try to fix the price of oil at
the future delivery date. At that future
date and the then prevailing prices the
oil buyer would, nevertheless, have to
ultimately sell futures in order to avoid
physical purchase upon expire of the
futures contract.
Physical Hedging
Cash Market Futures Market
Credit/(Debit) Credit/(Debit)
Sell at 39 $/bbl
sell at 39.5 (buy at 39.5
$/bbl $/bbl)
(0.5 $/bbl)
39 $/bbl
May - June 2005 21
Hedging Instruments
ADP & EFP
The buyer and the seller of the futures
contract could agree upon an
Alternative Delivery Procedure (ADP),
which deviates from the standardized
futures contract in which case the
clearinghouse would not generally
guarantee for fulfillment of the
contract.
In case the exchange of an equal and
opposite position is directly achieved
between buyer and seller during the
trading period of the future the
associated transaction is known as
Exchange of Futures for Physicals
(EFP). The EFP contract trades futures
for physicals under conditions other
than what is defined with respect to the
delivery point of the exchange traded
future. An EFP agreement shows some
similarity with an Alternative Delivery
Procedure (ADP), which is a provision
in the futures contract that allows for
delivery conditions in alternation to
the futures contract. Whereas with an
EFP a transfer of title, nevertheless,
takes place such transfer is not part of
an ADP.
The IPE has successfully developed a
Brent crude oil future, which requires
physical delivery based on an EFP with
an option for a cash settlement. The
Brent futures contract with a combined
cash settlement plus EFP mechanism
for deliveries is meanwhile traded on
the SIMEX, as well as on the Merc
(NYMEX).
Hedgers, Speculators &
Arbitrageurs
The basic concept of hedging is to
offset a position in the physical market
with an equal and opposite transaction
in the futures market.
To otherwise buy oil in the physical
and the futures market or to sell vice
versa is sometimes humorously
referred to as a Texas hedge. Rising or
falling prices consequently result in
this scenario in gaining or loosing
twice, as there are no equal and
opposite positions involved. The Texas
The Pakistan Accountant
hedge ultimately represents a highly
risky form of speculation but not a
hedge.
In contrast to a hedger a speculator
enters into open position trading. The
speculator for example sells at 39 $/bbl
in the futures market and speculates on
buying back later at a lower price, e.g.
38 $/bbl leaving him with a profit
margin of 1 $/bbl. Position trading
consequently aims at taking advantage
of changes in absolute prices of a
futures contract.
Spread trading of futures represents
another trading activity for a
speculator, which aims at profiting
from changes in relative prices of
futures contracts. Unlike with position
trading - where the speculator goes
either short or long in futures - in case
of spread trading a short and a long
position is acquired. These positions
are held in different futures contracts
relating to same or similar underlying
commodities. The spread consequently
comprises of two opposite and equal
positions in the futures market. The
speculator could gain or loose once
the relative prices of the futures
contract change FN4.
The market participants in the futures
market that are required for a company
to finalize its hedging transaction are
usually not the speculators but hedgers
searching for an opposite coverage.
A third group of market participants
could be the arbitrageurs, searching to
profit from price differences for same
products in different markets. Arbitrage
is an inconsistency that should not
exist in perfect markets. However, in
case of less than perfect markets
arbitrage provides a riskless (risikolos)
profit opportunity thereby pushing
prices towards perfect market
conditions.
Costs of Trading Futures
The costs of trading futures for the
hedger on an exchange such as the
NYMEX basically comprise of a
deposit, a variation margin and the
broker’s commission. An initial or
original margin respectively a deposit
is a payment the clearinghouse could
request from its customers in order to
prove and provide financial security. If
not required the deposit would be
returned (including interest) at the
close out of the futures contract.
During the trading of the futures a
difference between the original cost of
the contract and the daily closing or
settlement price arises. That difference
is known as the variation margin. A
negative margin represents a loss a
positive margin a profit. The hedger
holding the futures contract has to pay
the negative margin on a daily basis. In
case payment was not received funds
provided by the deposit would be
utilized. The clearinghouse receives all
negative margins and distributes it to
the holders of the positive margins on a
daily basis. The daily balance for the
clearinghouse is consequently always
zero.
All positions in the futures markets are
consequently valued daily on the basis
of market clearing prices, i.e. they are
marked-to-market.
Contracts such as futures and options
are known as derivative securities or
derivatives as they derive their value
from an underlying asset or commodity
such as for example crude oil.
(3) Options
Options are standardized contracts
that could be traded via an exchange
or as an over-the-counter (OTC) traded
option. Options on physical assets are
sometimes referred to as real options.
Exchange traded energy options are
generally options on an underlying
futures contract. On the NYMEX
options on all energy futures contracts
are available. The IPE offers options on
Brent crude and gas oil futures. A non-
standardized OTC option could
otherwise be based on any energy
market.
Options are short-term contracts with a
maturity of for example up to half a
year. For crude oil and oil products
futures and options are usually traded
at the same exchange.
May - June 2005 22
Hedging Instruments
Types of Options
Different types of options could be
distinguished further such as American
or European options. An American
option could be exercised during each
day of the validity of the option at
prices of the day, whereas a European
option could be exercised only at the
due date. Asian options further provide
the right to execute the option during
every day of its term but at an average
price with reference to a stated period.
The main difference between options
and futures is that options provide the
right but no obligation to buy or sell.
For that right an option premium has to
be paid.
The purchaser of an option is thereby
called taker whereas the seller is called
granter or writer. An option could
further constitute the right to sell,
which is a put option or to buy in case
of a call option. The combinations of
buy/call, buy/put, sell/call and sell/put
are the four basic positions of option
trading. Straddles, strangles and
spreads further represent combinations
of call and put options - or just calls
respectively just puts - with varying
contract terms. Complexly structured
options, - which do not represent a
usual or standardized option contract –
are also referred to as exotic options. In
trading terminology the converse of an
exotic contract would be a vanilla or
plain vanilla position.
Option Value
The option premium – describing the
total value of an option – consists of an
intrinsic value and a time value also
referred to as extrinsic value.
The intrinsic value describes the value
of an option in case it could be
immediately exercised. When prices
for Brent crude oil in the physical
market were for example USD 35 bbl
and the strike price of a call option was
USD 34 bbl – respectively USD 36 bbl
for a put option - the intrinsic value of
the option was USD 1 bbl. These
options are further described as in-the-
money due to their positive intrinsic
value. Otherwise – in case an option –
has no intrinsic value it is known as
The Pakistan Accountant
out-of-the-money unless the value in
the physical market coincides with the
strike price (here USD 35 bbl), which
refers to an option trading at-the-
money.
During the period between issuance
and expiry of the option a time period
during which a potential for favorable
movements of oil prices in the physical
market – or prices of the underlying
commodity in general - exists. The
value associated with this potential is
the extrinsic value of the option. Once
an option has expired that extrinsic
value is zero and only the intrinsic
value of the option remains.
Option pricing models have further
been developed in context with the
Black-Scholes Model originally
designed for financial, stock markets
FN5. Black further adapted this model
– known as the Black ’76 Model - so as
to evaluate options on forward
positions such as in the commodity
markets. The purpose of option pricing
is to calculate a theoretical, fair value
that provides in the long run for a
break even between traders FN6.
Hedging Examples –
Options
(I) An oil producer intends to sell oil –
i.e. he goes short in oil - at a future date
and wants to lock in a price of 35 $/bbl
in order to be protected against falling
prices in future. Consequently the
producer goes long in options and
buys a put during the current period
with a strike price of 35 $/bbl. In case
prices rise above the strike price of the
option he could let the put expire and
sell at the higher price in the physical
market. That short hedge – going long
in the current period in the futures
market but short in the physical market
for future deliveries - otherwise
provides the producer with the
opportunity to fully participate in any
upside potential by paying an option
premium in return. (II) An alternative
strategy for the producer intending to
sell oil in future in the physical market
could be to sell a call at 35 $/bbl for
which he could receive a call
premium. A pay out for the producer
would only occur when prices in the
physical market are higher than the
strike price of the call and the buyer of
the option requests fulfillment of the
contract. By selling the call the
producer consequently receives a call
premium but has given up the upside
potential beyond the strike price of the
option. (III) Assuming now a consumer
who wants to buy oil at a future date
and intends to lock in prices. The
typical long hedge for the consumer in
this case would be to buy calls in order
to be protected against rising prices.
(IV) Alternatively the consumer -
intending to purchase oil in the
physical market at a future date - could
sell puts and receive an option
premium for assuming a granter’s
position. In case of rising prices the
taker of the option would further not
execute his option rights. Only in case
of falling prices the put would have
to be fulfilled. When selling puts the
consumer consequently limits his
possibility to fully participate in the
downside potential associated with
falling oil prices.
(4) Oil Price Swap
An oil price swap is an instrument that
is designed to provide protection
against fluctuating prices.
Swaps are no classical hedging
instruments in the sense of establishing
equal and opposite transactions in the
cash and futures market but could
provide the price stability required for
hedging.
Price swaps represent an agreement
between two parties to interchange a
predetermined series of payments.
Plain Vanilla Swap
The exchange of payments between
seller and buyer of an oil price swap
consists of a fixed amount, Af, and a
variable amount, Av. The balance of
the two amounts determines the actual
payout, which is settled in certain
intervals such as every month or
quarter.
May - June 2005 23
Hedging Instruments
The seller of the price swap – usually a
trading company or bank – agrees to
pay a fixed amount, Af, to the buyer of
the swap - an oil company - for which
the seller receives a premium.
That fixed amount, Af, is the product of
an agreed locked-in price, P, and a
notional quantity of oil, i.e.: Af = P * Qn.
The variable amount, Av, is paid by the
oil company to the trader and is the
product of an indexed price, Pi, and
same notional quantity of oil, i.e.: Av =
Pi * Qn.
The daily average of WTI (West Texas
Intermediate) futures contracts on the
NYMEX during a stipulated period
could serve as an example of such an
indexed price.
The type of oil price swap described
above is also referred to as a plain
vanilla swap FN7.
Terms and Types of Swaps
The buyer and the seller of an oil price
swap could be individual companies
in the petroleum industry. An oil
company as buyer of the swap and a
trading company respectively bank as
the seller provides an alternative
combination. Oil Company and trader
swapping fixed and floating liabilities,
nevertheless, represent the standard
scenario.
Oil price swaps usually are non
standardized, over-the-counter
transactions while futures and options
are exchange traded. Other types of
swaps are occasionally exchange
traded in the futures market. Options
on swaps – known as swaptions – are
sometimes issued further.
For swaps, which are not exchange
traded no clearinghouse guarantees for
the fulfillment of the contract. A high
rating and financial standing of the
companies involved consequently
represent a prerequisite for trading
price swaps.
The Pakistan Accountant
While over-the-counter transactions
such as forward contracts are linked to
the fulfillment of the contract in kind
an oil or gas price swap otherwise does
not demand physical deliveries.
Price swaps are usually long term
agreements with a typical duration in
the order of one to ten years.
Price swaps consequently protect the
oil company on a long-term basis from
prices falling below the locked-in price
– e.g. 30 $/bbl –, as the trader of the
swap has to compensate the company
for the loss occurred. When prices
move otherwise above the lock in
price the oil company generates the
full sales value in the physical market
but has to pay to the trader the surplus
price generated with reference to the
agreed upon, notional quantity of oil.
Swap Agreements could further be
varied and designed so as to express a
floor or collar agreement. An oil price
floor represents an agreement whereby
the oil company ensures a minimum
oil price by concluding a contract with
a trader who in return for that
guarantee receives an upfront
premium. In case the company wants
to be protected against market prices
falling below a floor price but also
intends to save on that upfront
premium the oil company could enter
into a collar contract with the trading
company. This type of agreement
provides for a floor price as well as a
ceiling price above that the company
passes on all upside to the trader.
A type of swap that is of further
importance to the downstream
petroleum industry is the refining
margin swap. This sort of swap aims at
simultaneously hedging the price of
the refinery output products as well as
the price of input crude. Consequently
crude is purchased and products are
sold for an equivalent forward period,
which contributes to locking-in the
refinery margin.
Literature / Footnotes:
FN1: For a more detailed discussion on
uncertainty (i.e. knowing the
possibility of a future outcome but not
the probabilities) and risk (i.e. knowing
the probabilities) and the associated
management strategies see e.g.
M.Hamberg, “Strategic Financial
Decisions”, Liber AB, Malmo, 2001, p.
91-118.
FN2: A description of the concept of
Risk Management Policies and
Procedures is provided in J. Wengler,
“Managing Energy Risk: a
nontechnical guide to markets and
trading”, Penn Well, Tulsa, 2001, p.
47- 69.
FN3: A brief, quantitative description
of commodity futures and the
associated costs of carry is provided by
Y.-D. Lyuu, “Financial Engineering and
Computation. Principles, Mathematics,
Algorithms”, Cambridge University
Press, Cambridge/UK et al., 2002, p.
166-67.
FN4: For an overview on speculation
and spread trading see: S. Errera, S. L.
Brown, “Fundamentals of Trading
Energy Futures & Options”, 2nd ed.,
Penn Well, Tulsa, 2002, p. 53-74.
FN5: An introduction to calculating a
risk premium on the basis of the
Capital Asset Pricing Model, as well as
to the valuation of options in the
financial market is provided by e.g. R.
Pike, B. Neale, “Corporate Finance
and Investment Decisions and
Strategies”, 4th ed., Prentice Hall /
Pearson Education Ltd., Harlow et al.,
2003, p. 331-366 and 398-425.
FN6: For a brief introduction to option
pricing in context with commodities in
the energy markets see e.g.: M. Lynch,
“Options Strategies” in J.E.Treat (ed.),
“Energy Futures Trading Opportunities”,
3rd ed., Penn Well, Tulsa, 2000, p.
178-194.
FN7: For an overview of other types of
swap agreements in the energy market
see C. Mason, S. Jones, “Swaps”, in:
“Managing Energy Price Risk”, Risk
Publications, London, 1995, p.81-96.
May - June 2005 24
Hedging Instruments
Challenging Conventional Investment Management
The hedge fund industry has experienced enormous growth
in the last several years growing by some estimates from as
few as 300 funds in 1990 to more than 8,700 funds today.
They have become highly visible in the global markets and
the financial press, and are stated to command up to $950
billion in capital. The article briefly describes a hedge fund,
investment strategies and performance analysis supporting
the importance gained by hedge funds in global financial
markets.
Description
An investing glossary defines hedge funds as follows:
“A fund, usually used by wealthy individuals and institutions,
which is allowed to use aggressive strategies that are
unavailable to mutual funds, including selling short,
leverage, program trading, swaps, arbitrage, and derivatives.
They are restricted by law to a maximum number of investors
per fund, and as a result most hedge funds set extremely high
minimum investment amounts. As with traditional mutual
funds, investors in hedge funds pay a management fee;
however, hedge funds also collect a large percentage of the
profits (usually 20%).”
Hedge funds, therefore like other established alternative
investments including real estate, commodities, venture
capital and private equity are thought to provide access to
returns that are uncorrelated with traditional investments and
superior risk-adjusted returns.
Difference between mutual funds and
hedge funds
The essential difference between the two asset classes is
what can be called as "investment freedom." Essentially,
hedge funds can invest in anything they want. On the other
hand, mutual funds are highly regulated and have very
specific investment guidelines. Typically, with mutual funds,
the investor knows exactly what he is getting into and
therefore are one dimensional. However, the same can't be
said of hedge funds. The fact that they can invest in many
different strategies, ideas, or assets allows hedge funds to
produce positive returns in any investment climate.
However, this freedom also makes it that much harder for the
average investor to understand hedge funds.
The Pakistan Accountant
Hedge Funds
Mohammad Shoaib Jan Memon, ACA, ACCA
Hedge funds strategies
Hedge funds employ variety of investment strategies, some
of which use leveraging and derivatives while others are
more conservative and employ little or no leverage. Many
hedge fund strategies seek to reduce market risk specifically
by shorting the equities or derivatives. Their returns over a
sustained period of time have outperformed standard equity
and bond indexes with less volatility and risk of loss than
equities carry.
Some of the common hedge funds strategies adopted
include:
Aggressive Growth:
Invest in equities expected to experience acceleration in
growth of earnings per share. Generally high P/E ratios, low
or no dividends; often smaller and micro cap stocks which
are expected to experience rapid growth. Includes sector
specialist funds such as technology, banking or
biotechnology.
Distressed Securities:
Buy equities, debt or trade claims at deep discounts of those
companies which are in or facing bankruptcy or
reorganization. Profit from the market’s lack of
understanding of the true value of the deeply discounted
securities and inability of those institutional investors which
cannot own below investment grade securities. Results are
therefore generally not dependent on the direction of the
markets.
Emerging Markets:
Invest in securities issued by businesses and/or governments
of countries with less developed economies that have the
potential for significant future growth.
Macro:
Aim to profit from changes in global economies, typically
brought about by shifts in government policy which impact
interest rates, in turn affecting currency, stock, and bond
markets.
Market Neutral - Arbitrage:
Attempt to hedge out most market risk by taking offsetting
positions, often in different securities of the same issuer.
Focus on obtaining returns with low or no correlation to both
the equity and bond markets.
May - June 2005 25
Hedging Instruments
Opportunistic:
Investment theme changes from strategy to strategy as
opportunities arise to profit from events such as IPOs,
sudden price changes often caused by an interim earnings
disappointment, hostile bids, and other event-driven
opportunities.
Special Situations:
Invest in event-driven situations such as mergers, hostile
takeovers, reorganizations, or leveraged buy outs. May
involve simultaneous purchase of stock in companies being
acquired, and the sale of stock in its acquirer, hoping to
profit from the spread between the current market price and
the ultimate purchase price of the company.
Value:
Invest in securities perceived to be selling at deep discounts
to their intrinsic or potential worth. Such securities may be
out of favour or undervalued / not followed by analysts
otherwise.
Fund of Funds:
Invest in other hedge funds rather than directly investing in
securities such as stocks, bonds, etc. These underlying hedge
funds may follow a variety of investment strategies or may
all employ similar approaches. Because investors’ capital is
diversified among a number of different hedge fund
managers, fund of funds generally exhibit lower risk than do
single-manager hedge funds exhibit.
Broadly speaking hedge funds can be considered to be less
regulated investment pools, generally with a limited number
of investors that may invest in any class as well as derivative
securities and use long and short positions, as well as
leverage. A distinguishing feature of hedge funds has been
the routine use of long or short positions to offset market risks
and isolate arbitrage opportunities, although these
opportunities are not without their own specific risks. Hedge
funds are therefore considered on an overall basis to be more
nimble and dynamic in their trading strategies than
traditional mutual funds.
Hedge funds performance analysis
In aggregate, hedge funds have provided superior returns
and lower statistical risk than the S&P or mutual funds in
most multi-year periods. An analysis against significant
world indices is as follows:
Global Hedge Fund Net Returns
1 January 1998 - 31 December 2004
Style/Strategy Net Compound Standard Sharpe
Annual Return Deviation Ratio
Van Global 16% 8.8%
Hedge Fund Index
MSCI World Equity 6.6% 16.1%
S&P 500 12.4% 15.2%
Average Equity
Mutual Funds 10% 15.7%
Lehman Brothers
Aggregate Bond index 8.1% 4.4%
Soure: Van Hedge Fund Advisors International LLC.
The Pakistan Accountant
The average US hedge fund has also outperformed the
average US mutual fund for the past five years. The highest
returning US hedge funds significantly outperformed the
highest returning US mutual funds, and the worst performing
US hedge funds fared better than the worst performing US
mutual funds. This can be noted as follows:
Comparison of Best and Worst Performing US Hedge
Funds and Mutual Funds
5-Yr Net Compound Annual Returns, 3rd Quarter
99 to 2nd Quarter 04
Hedge Funds Mutual Funds
Top 10 39.9% 28.8%
Top 10% 28.6% 13.4%
Top 25% 21.3% 9.4%
Bottom 25% -0.6% -4.0%
Bottom 10% -5.9% -7.2%
Bottom 10 -14.0% -28.1%
Source: Van Hedge Fund Advisors International LLC.
The level of excess returns produced by hedge fund
portfolios reflects the average success of their investment
strategies. The key to success of hedge funds lies in their
ability to exploit structural inefficiencies in the markets. They
also enjoy an edge in transforming market inefficiencies into
returns largely because hedge fund managers are focused,
and generally avoid risks outside of their areas of expertise.
The typical performance based fee structures for a hedge
fund attracts the industry’s best talent and provides
significant incentive to identify and focus on winning
strategies. Moreover, managers often have a proportion of
their own money invested in the fund. It is also the case that
the typical fund operates in a much less constrained
environment than large institutional funds and the decision
making tends to be more streamlined and less committee
oriented, contributing to an overall nimbleness.
Conclusion
Hedge funds portfolios have therefore produced risk
adjusted returns and excess returns that are superior to
traditional investments with low correlation to fundamental
asset classes. The structure of hedge fund industry and
growth in supply of market inefficiencies, suggest that
advantages of hedge fund investments are not likely to
diminish soon. Hedge funds are therefore expected to grow
in significance and increasingly challenge conventional
investment management in the years to come.
This memorandum is based on information available to
1.5
public. No representation is made that it is accurate and
complete and does not provide any investment advice.
0.3 Specific credit is given to Dion Frediland and Magnum
Funds for use of certain information.
0.7
About the author:
0.6 Mr. Shoaib is an associate member of the Institute of Chartered
Accountants of Pakistan. Currently he is working in Banking and
1.3 Capital Markets Group in Ernst & Young London Office. He can
be contacted at: mmemon@uk.ey.com.
May - June 2005 26
Banking

Operational Risk Management in a Bank:

Easier said than done!
Danish Ahmed Siddiqui, ACA

Operational risk management is not a new concept. and Supervision of Operational Risk" issued in December
However, it was not until the turn of the century that the 2001. The framework analyses the risk management, which
stakeholders especially the regulators started to pay close is generally seen as a continuous process, into the following
attention to the operational risk management practices identifiable steps:
adopted by the banks. Especially the 9/11 acted as a catalyst
in generating interest in the operational risk management.
The dreadful incidence of 9/11 unearthed the reality that in
general the firms had adopted a somewhat laid back
approach to operational risk management; many did not
have a comprehensive disaster recovery plan, some did not
have enough geographical space between their offices, some
lacked redundant technology and others (including New
York Stock Exchange) did not have the physical back up
infrastructure.

In this backdrop the Basel Committee on Banking

Supervision ("the Committee") issued a document titled
"International Convergence of Capital Measurement and
Capital Standards" more commonly known as the revised
Basel Capital Accord II in June 2004 and for the first time
introduced the requirements for the adopting banks to
measure the operational risk and allocate capital for it!1
Implications of allocating capital for operational risk forced
the managers to reconsider their risk management practices
and take action in order to minimize the capital allocated to
operational risk thus optimize the return on capital.
Definition of Operational Risk
The Committee defines the operational risk as:
"the risk of loss resulting from inadequate or failed internal
processes, people and systems or from external events".
This definition includes legal risk, but specifically excludes
strategic and reputational risk.
Definition of risk is important as it enables the management
to draw boundaries and separately identify the operational
risk from other business risks - thus ensuring capital allocated
for the risk reflects the correct level of operational risk - and
to take practical decisions in implementing an operational
risk management framework.
Operational Risk Management
The Framework
The Committee suggested an operatoinal risk management
framework in its paper "Sound Practices for the Management
Diagram 1: Risk management framework
Identify the operational risk
Identification of operational risk is critical as it forms the
basis for implementing the next blocks of the framework. If
management fails to identify a risk, it is not likely to establish
measurement, monitoring and controlling mechanisms for
such risk!
Identifying the risk involves a detailed review of the
management practices with a view to identify potential for
losses without considering the related controls and
mitigating factors such as insurance. A bank may choose to
identify risks based on the "loss events" and for a bank with
more than a single business line it might be more useful to
identify the loss events for each business line. A typical
example would be "loss due to regulatory action in corporate
finance" or"damage to physical assets in retail banking" etc.
By identifying the risk consistent with their internal
accounting definition of loss into various loss categories,
bank can trace the loss data, clearly segregate the
operational risk from credit or market risk and develop
models to analyze the risk thus implement a measurement,
monitoring and control mechanism.

The Pakistan Accountant May - June 2005 27

Banking

Operational Risk Type Frequency Severity

Clients, products and business practices Low to Medium Medium to High

Internal fraud Low High
External fraud Medium to High Low to Medium
Damage to physical assets Low Low
Execution delivery and process management High Low
Business disruptions and systems failure Low Low
Employment practices and workplace safety Low Low

Source: Basel Committee on Banking Supervision, 2001a, Operational Risk, Consultative Paper 2 January.

The risk identification process must be ongoing and open to
review based on new risks posed by a changing environment
or changing aspects of the products and services. Best
practice is to have the Board of Directors' approval for all the
new products and services and a periodic review of the
existing practices by internal and external audit, moreover,
increasing number of banks have established dedicated risk
management units which have a direct reporting line to the
Board of Directors.
In a consultative paper on Operational Risk issued by the
Committee in 2001 the operational risk has been categorized
into the above seven categories with indication of their
frequency and severity based on the data collected.
The above table classifies risk into broad categories and
definition of low medium and high frequency across
different risk types may not be consistent (i.e. "low"
frequency for internal fraud is not equal to a "low" frequency
of damage to physical assets!), however, a bank may use the
above table as a starting point for identification the potential
risk in its business or each business line. Frequency and
severity data given here may assist the management in
focusing on specific risks and assessing the likely impact of
these risks on their bottom line, however, in all such analyses
the peculiarities of individual businesses should be given
due considerations. The Committee emphasized that low
frequency high severity events should be given due
significance in identification process - bear in mind that
Barrings went down because of an internal fraud and various
problems were identified in business practices adopted by
Enron during the bankruptcy proceedings! Although, in these
cases actual loss was driven by the market or credit risk
exposures, taking on such risk could have been avoided in a
low operational risk environment.
Tools that banks use to identify the operational risk include:
w Self or risk assessment;
a bank assesses its operations and activities against a
menu of operational risk events. This process is
internally driven and often incorporates checklists and/or
workshops to identify the strengths and weaknesses of
the operational risk environment.
w Risk mapping;
in this process, various business units, organisational
functions or process flows are mapped by risk type. This
exercise can reveal areas of weakness and help prioritise
subsequent management action.
w Key risk indicators;
risk indicators are statistics and/or metrics, often
financial, which can provide insight into a bank’s risk
position.These indicators should be reviewed on a
periodic basis (often monthly or quarterly) to alert banks
to changes that may be indicative of risk concerns.Such
indicators may include for example the number of failed
trades,staff turnover rates the frequency and/or severity
of errors and omissions.
w Threshold/limits; and
typically tied to risk indicators, threshold levels (or
changes) in key risk indicators, when exceeded, alert
management to areas of potential problems.
w Scorecards
these provide a means of translating qualitative
assessments into quantitative metrics that can be used to
allocate economic capital to business lines in relation to
performance in managing and controlling various
aspects of operational risk.

The Pakistan Accountant May - June 2005 28

Banking
Measure the
operational risk
Some bank managers argue that due to
the lack of consistent and reliable data
and suitable statistical models, it is a
futile exercise to attempt to measure
the operational risk. They believe that
the focus should be on managing the
risk based on the qualitative
assessments rather than attempting to
measure or quantify it statistically or
through proxy measures. Others are of
the opinion that measurement of
operational risk should be the part of
overall risk management framework
and attempts should be made to
measure the risk in order to facilitate
communication of risk to investors and
regulators and to provide meaningful
information to the stakeholders
allowing them to compare the risk
profile of the bank with its peers and
over different periods.
The Basel Capital Accord II requires
the banks to quantify their exposure to
operational risk and presents three
methods to calculate operational risk
capital charge (i.e. quantify the
operational risk). Banks have the
option to choose any of the following
methods considering their individual
sophistication and risk sensitivity and
subject to their respective regulator's
approval:2
w Basic Indicator Approach
w Standardised Approach (and
Alternative Standardised Approach)
w Advanced Measurement Approach
Basic Indicator Approach
Under this methodology the capital
charge is equal to the average over the
previous three years of a fixed
percentage (denoted alpha) of positive
annual gross income. Figures for any
year in which annual gross income is
negative or zero should be excluded
from both the numerator and
denominator when calculating the
average. The charge may be expressed
as follows:
KBIA = [(GI1…n xa)]/n
Where
KBIA = the capital charge under the
Basic Indicator Approach
The Pakistan Accountant
GI = annual gross income, where
positive, over the previous three years
n = number of the previous three years
for which gross income is positive
a = 15%, which is set by the
Committee, relating the industry wide
level of required capital to the industry
wide level of the indicator.
Gross income is defined as net interest
income plus net non-interest income. It
is intended that this measure should:
(i) be gross of any provisions (e.g. for
unpaid interest);
(ii) be gross of operating expenses,
including fees paid to outsourcing
service providers;
(iii) exclude realized profits/losses from
the sale of securities in the banking
book; and
(iv) exclude extraordinary or irregular
items as well as income derived
from insurance.
This methodology is the most simple of
the three methodologies presented and
there are no prerequisite conditions for
a bank to use it. This is based on the
premises that the level of revenues of a
bank can be used as a proxy to assess
the complexity of its operations and
thus can be used to estimate its
operational risk. Insurance revenues
have been specifically excluded from
the computation recognizing the fact
that the operational risk of insurance
business is very different from that of
banking business.
w Standardized Approach (and
Alternative Standardized Approach)
In the Standardised Approach, banks'
activities are divided into eight
business lines:
w Corporate finance
w Trading & sales
w Retail banking
w Commercial banking
w Payment & settlement
w Agency services
w Asset management
w Retail brokerage
Within each business line, gross
income is a broad indicator that serves
as a proxy for the scale of business
operations and thus the likely scale of
operational risk exposure within each
of these business lines. The capital
charge for each business line is
calculated by multiplying gross
income by a factor (denoted beta)
assigned to that business line. Beta
serves as a proxy for the industry-wide
relationship between the operational
risk loss experience for a given
business line and the aggregate level of
gross income for that business line. It
should be noted that in the
Standardised Approach gross income is
measured for each business line, not
the whole institution, i.e. in corporate
finance, the indicator is the gross
income generated in the corporate
finance business line.
The total capital charge is calculated as
the three-year average of the simple
summation of the regulatory capital
charges across each of the business
lines in each year. In any given year,
negative capital charges (resulting from
negative gross income) in any business
line may offset positive capital charges
in other business lines without limit.
However, where the aggregate capital
charge across all business lines within a
given year is negative, then the input to
the numerator for that year will be zero.
Those banks that are unable to
disaggregate their gross income into the
other six business lines can aggregate
the total gross income for these six
business lines using a beta of 18%.
The total capital charge may be
expressed as:
KTSA={∑years 1-3 max[∑(GI1-8 x ß1-8),0]}/3
Where:
KTSA = the capital charge under the
Standardised Approach
GI1-8 = annual gross income in a given
year, as defined above in the Basic
indicator Approach, for each of the eight
business lines
ß1-8 = a fixed percentage, set by the
Committee, relating the level of required
capital to the level of the gross income for
each of the eight business lines. The values
of the betas are detailed below.
May - June 2005 29
Banking

Business Lines Beta Factors
Corporate finance (ß1) 18%
Trading and sales (ß2) 18%
Retail banking (ß3) 12%
Commercial banking (ß4) 15%
Payment and settlement (ß5) 18%
Agency services (ß6) 15%
Asset management (ß7) 12%
Retail brokerage (ß8) 12%
The Alternative Standardised
Approach ("ASA")
A bank may be permitted by its supervisor to use the ASA if
it can satisfy its supervisor that this alternative approach
provides an improved basis by, for example, avoiding double
counting of risks. However, once a bank has been allowed to
use the ASA, it will not be allowed to revert to use of the
Standardised Approach without the permission of its
supervisor. The Committee does not envisage that large
diversified banks in major markets would use the ASA.
Under the ASA, the operational risk capital
charge/methodology is the same as for the Standardised
Approach except for two business lines - retail banking and
commercial banking. For these business lines, loans and
advances - multiplied by a fixed factor 'm' - replaces gross
income as the exposure indicator. The betas for retail and
commercial banking are unchanged from the Standardised
Approach. The ASA operational risk capital charge for retail
banking (with the same basic formula for commercial
banking) can be expressed as:
KRB = ßRB x m x LA RB
Where
KRB is the capital charge for the retail banking business line
ßRB is the beta for the retail banking business line
LARB is total outstanding retail loans and advances (non-risk
weighted and gross of provisions), averaged over the past
three years
m is 0.035
For the purposes of the ASA, total loans and advances in the
retail banking business line consists of the total drawn
amounts in the following credit portfolios: retail, Smal and
Medium Entrprises (SMEs) treated as retail, and purchased
retail receivables. For commercial banking, total loans and
advances consists of the drawn amounts in the following
credit portfolios: corporate, sovereign, bank, specialised
lending, SMEs treated as corporate and purchased corporate
receivables. The book value of securities held in the banking
book should also be included.
Under the ASA, banks may aggregate retail and commercial
banking (if they wish to) using a beta of 15%. As under the
Standardised Approach, the total capital charge for the ASA
is calculated as the simple summation of the regulatory
capital charges across each of the eight business lines.
Advanced Measurement Approaches (AMA)
Under the AMA, the regulatory capital requirement will
equal the risk measure generated by the bank's internal
operational risk measurement system using the quantitative
and qualitative criteria. Use of the AMA is subject to
supervisory approval. Diversification benefits might be
factored in under certain circumstances and allocation of risk
to subsidiaries also needs to be supported by empirical
evidence and approved by the relevant supervisors.
The appropriateness of the allocation methodology will be
reviewed with consideration given to the stage of
development of risk-sensitive allocation techniques and the
extent to which it reflects the level of operational risk in the
legal entities and across the banking group. Supervisors
expect that AMA banking groups will continue efforts to
develop increasingly risk-sensitive operational risk allocation
techniques, notwithstanding initial approval of techniques
based on gross income or other proxies for operational risk.
This approach provides maximum facility to the banks that
have enough resources to implement sophisticated systems
to gather and process operational risk data and demonstrate
that they have the capability to reasonably estimate the
operational risk based on actual risk factors rather than
proxies. Robustness of statistical techniques currently used to
model the operational risk is questionable as these suffer
mainly from a lack of sufficient real life data against which a
model can be tested. A bank may benefit (or is most likely to
benefit) from implementation of such statistical models as it
can achieve a lower capital charge for operational risk,
however, due to the resource requirements it is beyond the
reach of most of the smaller to medium sized banks and thus
puts them in a disadvantaged position compared to other
giant players in the market.
Monitoring the Operational Risk
Monitoring the risk involves regular reports to the adequate
level of management e.g. daily reports of processing errors to
line managers, weekly/monthly summary of operational
effectiveness and efficiency to department heads,
monthly/quarterly assessment of actual and potential losses
due to operational errors (including internal audit reports)
and external/regulatory reports should also be circulated to
senior management and board of directors. Board should
also review all the related reports submitted to bank's
supervisors.

The Pakistan Accountant May - June 2005 30

Banking
Reports can be quantitative or
qualitative in nature e.g. sensitivity
analysis, results of self assessment
surveys, internal audit assessments or
quantitative data on errors trends etc
and should clearly communicate the
risk levels to the management and
board. With additional requirements of
more disclosure to the investing public
it is increasingly important to have
adequate monitoring systems in place
that can generate reliable timely
information for internal and external
use.
Controlling the
Operational Risk
As the risk cannot be eliminated,
management attempts to reduce it to
an acceptable level. It can accomplish
this by either insuring it internally or
transferring it to an external party (in
which case it exchanges its own
operational risk with a third party risk)
in the form of an outsourced operation
or buying insurance on employee
infidelity. Opting to handle risk
internally or externally is a management of operational risk as it
management decision based on the
specific circumstances of the business
and management style. For example
most banks run large internal control
departments while fund managers
outsource almost all data processing to
external service providers.
However, most of the operational risks
have to be managed internally thus
management invests significant time
and resources to internally ensure that
the operational risk is within
acceptable levels. This requires a
system of regular compliance review
and sufficient documentation of
approval and authorization to ensure
accountability. Control activities
should be considered as part of the
operating/business processes of the
bank and should involve all level of
personnel. Management should ensure
adequate segregation of duties and pay
due attention to operational
disruptions such as information system
failures etc. If the management uses a
The Pakistan Accountant
service provider for any part of its
operations it should have policies and
procedures to ensure it is not exposed
to significant risks of the service
provider. Such policies may include
service provider selection criteria, due
diligence procedures before selection
and ongoing monitoring of the
activities of the service provider,
regular performance reviews and
clearly documented service levels
agreements etc.
Committee of Sponsoring Organizations
of the Treadway commission ("COSO")
has developed a framework for internal
control which can provide a good
reference point for establishing
adequate system of internal control.
However, internal controls should be
highly tailored to suit the business
needs and operational facts of
individual bank.
Issues and Implications of
the Basel II
Basel II marks a significant milestone in
forces quantitative measurement of the
risk. However, it has been criticized for
its simplistic approach to a
significantly complex problem. Use of
gross revenues as an indicator of
operational risk (as suggested by basic
and standard approaches) is not quite
acceptable to many risk managers and
the use of standard beta factors to
measure risk tends to ignore the
differences of quality of earnings
among different banks. Alternative
Standardized approach does allow
banks to use gross advances as a proxy
for risk in their retail and corporate
business lines but even this does not
quite resolve the problem for banks
that see themselves at a disadvantaged
position compared to ones that can use
advanced measurement approach and
use their own indicators and measures
of risk.
Furthermore, the risk measures of
various business lines are simply
added together to arrive at the overall
risk measure of the bank in
standardized approach which implies
that the diversification of the revenue
streams has no impact on operational
risk of the bank; an assumption that
might not be considered theoretically
sound by many.
Basel II envisions a more active role of
the local bank supervisors in
operational risk management and
banks are required to obtain approvals
of their supervisors for adopting any of
the suggested measurement
approaches. Supervisors are also
required to monitor the banks to
ensure they are correctly applying the
selected approach. However, most of
the regulators, especially those in the
developing countries, do not have the
capability and resources to carry out
the task which may lead to divergent
practices within a marketplace and
make it an uneven playing field.
More practical implications of the
Basel II involve the real business
impact on small banks especially those
in underdeveloped countries. Large
sophisticated banks with resources to
implement the advanced measurement
approach will be able to measure the
operational risk with increased
precision using better indicators of risk
than revenue or advances portfolio.
These banks will be in a position to
keep their operational risk at a low
level notwithstanding their revenues or
portfolio while for smaller banks
increase in revenue or advances
portfolio will mean an automatic
increase in operational risk! This
would put the smaller banks in a
disadvantaged position and restrict
their ability to lend money and
generate revenues for per unit of
capital compared with their larger
counterparts. Some see this as a force
that would catalyze the merger and
acquisition activity in the banking
sector over the next few years and may
harm local institutions.
May - June 2005 31
Banking
Basel II is a product of a committee that
has no representation from the
developing world and thus it is not
surprising that the document tilts the
tables in favor of large sophisticated
banks that mainly operate in
developed world and does not
consider implications for the smaller
banks operating in underdeveloped
countries. As these banks will have
higher operational risk they would
need more capital to support their
activities which will reduce return on
equity and make it difficult for these
banks to raise funds thus forcing them
to merge with the larger banks. Smaller
local banks serve various local needs
which might not be seen important by
the larger banks e.g. funding small
business activities in local countries.
Larger banks have access to
international markets and may not see
the local risky projects as worthy
options. Thus merger and acquisition
activity may lead to a lack of much
needed funding in the developing
countries as this money is more likely
to be diverted to the "less risky"
projects in the same country or another
country. This dearth of funding is likely
to have adverse implications for the
economic prosperity of the developing
countries.
These issues are being actively debated
by the banks and supervisors alike.
Even in USA the SEC has notified that it
expects only its top seven largest banks
to implement the new accord. China
has decided to only selectively adopt
the new accord; an approach termed
as Basel 1.5! Quantitative impact
studies are being conducted to assess
the potential impact of implementing
the new accord on the financial system
and banks are working closely with the
supervisors to be able to implement the
accord on due date, however, there is
still uncertainty in the market as to the
utility of measurement of operational
risk and adequacy of the measurement
approaches suggested by the accord.
The Pakistan Accountant
Reference:
1. The Basel Committee on Banking
Conclusion
Operational risk management Supervision is a committee of
has recently come to focus and banking supervisory authorities that
was established by the central bank
practices have only recently
been started to be actively governors of the Group of Ten
debated. Basel Committee has countries in 1975. It consists of
made great efforts in improving senior representatives of bank
the operational risk supervisory authorities and central
management and the revised banks from Belgium, Canada,
Basel Capital Accord II marks a France, Germany, Italy, Japan,
significant step towards Luxembourg, the Netherlands,
measurement of certain risks Spain, Sweden, Switzerland, the
faced by banks and it has United Kingdom and the United
successfully focused States. It usually meets at the Bank
management attention on the for International Settlements in
operational risk. Although
Basel, where its permanent
measuring operational risk Secretariat is located.
remains a complicated problem
surrounded by various issues, a 2. Description of the approaches has
better focus on the topic is likely
been taken from the Basel Capital
to lead to some solutions in the
Accord II. Please refer to the Basel
future.
Capital Accord II for full description
and detailed guidance on all the
Implications of the accord for
approaches.
the banking system are
significant as the risk charge for
operational risk would have a About the Author:
direct impact on competitive
Mr. Danish is an associate member
advantage of smaller banks.
Supervisors in under developed of the Institute of Chartered
countries have a great Accountants of Pakistan. Currently
responsibility of ensuring that he is an Executive in Global
the interests of local banks and Capital Markets Group in
local financial systems are not PricewaterhouseCoopers London.
jeopardized by the
implementation of the accord Danish also worked in Karachi and
which has been drafted by G-10
Bahrain offices of Ernst & Young.
countries to mainly suite their
financial systems and economic Readers are welcome to contact him
interests. at: daniche_siddiqui@hotmail.com
May - June 2005 32
Federal Budget 2005-06
DISTORTIONS IN AN INVESTOR
FRIENDLY BUDGET ?
It is rare that the business community in Pakistan happens to
be a key advocate of the Government and more particularly
of Central Board of Revenue (the Board). It is but, happening
today. The other day when I was attending a Post Budget
Seminar jointly hosted by the Federation of Pakistan
Chamber of Commerce & Industry (FPCCI) and Karachi Sales
Tax Bar Association, I was amazed to hear a key business
leader of the apex trade body carrying compliments for the
Board and saying; “I was wrong in my early perception. CBR
is an angle”.
Undoubtedly, the businessmen have reasons to be jubilant
over the taxations measures announced in the Finance Bill
2005. With the textile and leather industries getting the much
desired breathing space which was now perhaps overdue in
the post WTO regime – the zero rating of sales tax on the
entire chain of products, the much talked about relief has
been provided by the Government.
Besides zero rating of 5 major products, other major
announcements of the Finance Bill 2005 were extension of
time limit for adjustment of input tax from 3 months to 12
months, reduction in time limit for maintenance of records to
3 years, fixation of time limit of 90 days for the Collectors to
dispose refund applications filed under section 66 and
admissibility of payments made through credit cards for the
purposes of section 73 of the Sales Tax Act, 1990 (the Act).
Despite the aforementioned incentives announced in the
Finance Minister’s Speech, the climax cannot be called as
over until we actually come across the Budget Documents
and the relevant notifications. As soon as I saw the
underlying data, I was confirmed that on the contrary, the
taxation amendments would make the implementation even
more difficult and perplexed. That exactly happened later
on. Immediately few days after the Budget was announced
amid thumping applause form the business community, the
Budget which was initially termed as “Investor Friendly
Budget” started receiving severe criticism from taxpayers,
who ascertained the actual substance after settling the dust.
In the ensuing paragraphs, we shall look upon various
aspects of, what we reckon as, major distortions of this
Investor Friendly Budget:
Extension of 12 more items
under 3rd Schedule
The Third Schedule to the Act specifies items which are
charged to tax at the retail price fixed by the manufactures
The Pakistan Accountant
Tax Amendments in Finance Act 2005
Adnan A. Mufti, ACA
for such products. For sometime this provision was made
applicable to importers but this time, it has again restricted
only to manufacturers.
The ‘retail price’ vehicle under section 2(27) of the Act read
with 3rd Schedule thereof is a distortion of Value Added Tax
(VAT) concept. The idea is to recover the entire tax leviable
on a particular product from the manufacturer instead of
following the VAT machinery and recovering the said tax
from all sectors of the supply chain and thus documenting
the economy till retail level.
Now, induction of consumer items like Toilet & laundry
soap, Detergents, Shampoo, Toothpaste, Shaving cream,
Perfumery and Cosmetics, Biscuits, Confectionery, Tea,
Powder drinks, Milky drinks, Footwear confirms that the
Government has miserably failed to extend the tax net to the
intermediaries namely, distributors, wholesalers and retailers
and therefore decided to make the manufacturer the single
escape goat. This manifests we are moving again in the
reverse gear.
Input Tax Carried Forward
As a, probably, biggest uncomprehending move, the benefit
of carry forward of input tax has been withdrawn and now
the taxpayers would need to seek for refunds for so much
input tax as it left after adjustment of output tax for a tax
period. This reflects that there remains a hidden hand in the
policy corridors of the Revenue Authorities which desires the
taxpayers to continue fighting the tax machinery and do not
focus on business and trade.
The biggest drawback of the amendment, besides the hide
and seek game usually involved in refund processing, lies
where the excess input tax on purchases / imports is not
refunded to the taxpayer on time and he also makes the sales
of relevant goods on credit. At this point of time, the taxpayer
would surely suffer double taxation – a concept never
entertained by the modern VAT theories. As another
ambiguity, the Refund Rules do not suggest procedures
which would be followed for processing and sanctioning
applications for excess input tax. In the wake of the potential
problems including the time limit within which the relevant
refunds would be paid to the registered persons, it is highly
suspected taxpayers would resort to ‘tax planning’ for
avoidance of excess input tax.
May - June 2005 33
Federal Budget 2005-06
Conviction by Special
Judge
By virtue of the newly amended
section 33(5) of the Act, non payment
of tax due in 60 days from the date of
issuance of related notice by the
Assistant Collector shall render the
accused convicted by a Special Judge
and could also be liable to
imprisonment of 3 years and with fine.
Perhaps the revenue forgot that such
harsh provisions, as are already
incorporated under section 37-40B of
the Act, have miserably failed to ‘deter’
the taxpayers to remain compliant with
the tax laws. Strictly speaking, apart
from tax fraud, non payment of alleged
tax could be due to multiple reasons. It
is, therefore, suspected that this
provision could be misused by the
revenue officers for harassment of
taxpayers.
Penalty for non compliance
with Section 73
The provision of section 33(1)(16)
suggests a penalty of higher of Rs.
5,000 or 3% of the tax involved in case
payment is not made in the manner
prescribed under section 73 of the Act.
At the very outset, the penalty is quite
harsh especially in the backdrop when
non compliance of section 73 makes
the entire claim of input tax
inadmissible in the hands of registered
buyer. In short, in the presence of the
existing provision, there was no need
to introduce another penal section in
the statute.
It may be noted that in the past the
Board had held that section 73 only
applies to transactions between
registered persons. Simultaneously, it is
high time for a clarification from CBR
regarding non invocation of the
aforesaid penal provision in case of
transactions between registered and
non registered persons since in the
absence of any such notification, this
provision is likely to be misused by the
department.
The Pakistan Accountant
Default Surcharge
In a highly unexpected and
unwarranted move, the term
‘additional tax’ has been substituted
with that of ‘default surcharge’.
Surprisingly, a plain reading of the
newly drafted provision projects the
following areas of concern:
a) The change of name from
‘additional tax’ to ‘default
surcharge’ could be intended to
make the numerous case laws non
applicable in fresh disputes. Since
the superior courts have discussed
the situations / application of
additional tax in most of the cases,
the underlying idea of the policy
makers in the Revenue Division
could well be to change the name
of the levy thereby making those
judgments non applicable and
anfractuous on technical grounds.
b) The section provides levy of
default surcharge if the registered
person does not pay the tax due or
any part thereof, whether wilfully
or otherwise. These wordings of
the substituted provision suggests
as if the intention of the legislature
is to surpass and negate the ruling
of the recent Honourable
Supreme Court of Pakistan
regarding non applicability of
additional tax, if the revenue fails
to prove any malafide, mens rea
or willful on the part of the
taxpayer.
c) The previous section contained an
explanation at the end whereby
‘tax due’, for the purpose of
computation of additional tax,
would exclude the amount of
penalty. The newly replaced
version of section 34 does not
contain any such explanation
which could mean that from now
onward, the departmental
demand of default surcharge
could be a composite of principal
tax and penalty. If this is allowed,
perhaps it would result in extreme
imbalance in the statute and the
miseries of the taxpayers would
be doubled.
Scrapping of Adjudication
Collectorate
The scheme of keeping Executive
Collectorate separate from that of
Judicial was indeed a positive step,
though it did not result in desired relief
to the taxpayer. A good plan practically
became ill founded when the officers
sitting under the Revenue Division
kept interchanged / transferred from
Executive to Judicial Collectorates and
vice versa. This resulted in harassment
and denial of justice of the taxpayers.
According to CBR’s own sources, since
the ultimate purpose of separate
Collectorates did not succeed, there
was no justification of maintaining it
further.
On our part, we would rather say that
a fine scheme has been dismantled just
due to wrong doings of few officers
and the corrupt bureaucracy. The basis
of taxation laws lies in equity and fair
play. We should not delegate the
powers of a Judge to a Station House
Officer (SHO). With the detecting
agency now empowered to decide
cases as well, one can only dream of
justice being done in his case. Hence,
there is a need for immediate
restoration of the said scheme with
specific stream of officers holding the
charge of Judicial Collectorate.
Time Limit for opening
assessments
Previously, the time limitation for
opening of cases in terms of sections
45A and 36 was five years. This time
limit was in consonance with the
requirement of maintenance of books
and records as mentioned in the Act.
The Finance Act 2005 has reduced the
time period for maintaining records
from five to three years. However, a
corresponding amendment has not
been incorporated in section 45A and
36 of the Act. In the wake of this
inconsistency, a taxpayer (especially
corporate entities) would invariably be
required to maintain sales tax records
for five years instead of three years.
May - June 2005 34
Federal Budget 2005-06
Disposal of Cases by
Collector (Appeals)
By virtue of fresh amendment, the
Collector (Appeals) has been bound to
pass orders within 90 days from the
date of filing of appeal or equally
extended period. In our view, this
amendment can only become effective
and fruitful if the aforesaid time limit is
made as a directory provision instead
of mandatory. To facilitate this process,
reference could be made to various
judgments of Customs, Excise & Sales
Tax Appellate Tribunal whereby the
Appellate Tribunal has taken
cognizance of late decisions by the
officers of CBR and held that revenue
officers were bound to dispose of the
case within the prescribed time.
Mandatory Payment of
15% tax
As a clear deviation of what is claimed
to be taxpayers’ friendly policies, the
Office of Collector (Adjudication) has
been dismantled thereby making the
Office of Collector (Appeals) as the
forum where first stage appeals would
lie. To make the things more complex
and cumbersome, the taxpayers would
be required to make a mandatory
payment of 15% of the impugned
principal tax before preferring such
appeal to Collector (Appeals). It would
not be out of context to mention that in
few case relating to Income Tax, the
superior courts have held that first
stage appeal cannot be burdened with
any fees.
It is worthwhile to note that the
mandatory payment of 15% of alleged
liability before preferring appeals was
done away with in Income Tax
Ordinance 2001 vide Finance Act
2004. However, the corresponding
provision, as contained in section
45B(4) of the Act, is still very much
intact and applicable and has now
made a significant place in the statute.
It is imperative that, in order to
streamline fiscal laws and to provide
cheap and speedy justice, condition of
The Pakistan Accountant
mandatory payment of 15% in section
45B should be withdrawn forthwith.
Tax Refunds
The Finance Act 2005 has prescribed a
maximum time limit of finalisation of
refund applications under section 66
as 90 days from the date of filing the
relevant claim. It is imperative that a
corresponding explicit provision is
added to the statute whereby delayed
refunds may carry 6% interest to the
taxpayer if his claim filed under section
10 or 66 are not finalized within 90
days. These unambiguous wordings of
section 67 are intended to bring
desired relief to the taxpayers.
Secondly, a significant inconsistency
and disparity between section 34 and
section 67 of the Act. In accordance
with section 34, a registered person is
penalized for additional tax @12% or
18% p.a if he fails to pay off the tax
liability on time. On the other hand,
failure of the department to pay off the
due tax refunds would only cost it 6%
p.a. It is proposed that the interest rate
on delayed refund be enhanced to
atleast 12%.
Tax Return for Retailers
Since the year 2004, the Retail Tax is
collected in terms of the Special
Procedures Rules which require a
minimum value addition of 10% on
purchases a retailer makes in a
particular tax period. No inputs are
allowed anymore to such retailer, as
the tax paid becomes the final
discharge of his liability. However, a
perusal of the tax return prescribed for
retailer would reveal that a specific
Column No. 11 for refund has been
prescribed, which is complicating the
stream. It is, therefore, imminent that
the tax return be modified to bring it in
harmony with the Special Procedure.
Service Tax
The government is making all possible
efforts to bring the services in the tax
net. In the original draft of the Finance
Bill 2005, the financial services
rendered by banks and financial sector
were proposed to attract Central Excise
Duty, adjustable under VAT mode.
However, with the reported late
minute intervention of Governor State
Bank of Pakistan, the move was
deferred till a ‘reasonable time’.
Services contribute a sizable portion of
our GDP. Hence, there is a need for a
proper and thoughtful study before
they are brought under the Service Tax
Regime. The facts, however, depicts a
very bleak picture on the contrary.
In the year 2000, eleven services were
brought under the Sales Tax Regime
through Provincial Ordinances
promulgated by respective provinces.
Till the year 2004, there was a total
chaos with respect to taxability of
subject services, adjustment of relevant
inputs against output tax of Federal
Legislature, value of services, etc. The
only hope emerged in the year 2004
when Special Procedure Rules 2004
were enacted and specific definitions
of taxable services, value of service,
time of service, levy and other allied
matters were notified.
Inspite of such promulgation, various
provisions of Service Tax are self
contradictory. For example, the
definition of the term ‘value of service’
has been defined to mean “Gross
amount charged or the consideration
in money received by the service
provider from the clients or customers
or members for providing or rendering
taxable services”.
A plain reading of the definition would
deduce the apparent conflict hidden in
the definition. Gross amount charged
to customers could, at times, be
different than what the service provider
receives from them. For instance, a
service provider could bill his
customer for Rs. 10,000 (excluding
sales tax). However, he might end up
in recovering Rs. 8,000 (excluding
sales tax) from his client. What would
be the value of taxable services
keeping in view the aforesaid situation
in consideration?
May - June 2005 35
Federal Budget 2005-06
Secondly, a proviso of the term ‘value
of service’ asserts that in case the
consideration for providing taxable
service is in kind, it would be the open
market value of the service that would
be taken for sales tax purposes.
Evidently, one could not easily
determine market value of the service
rendered. Therefore, there is a need to
modify such conditions before they are
misused by the departmental auditors
for harassment of taxpayers.
Tax Payment on Advances
through ‘Advance Payment
Receipt’
A perusal of the rules read in
conjunction with the definition of ‘time
of supply’ in terms of section 2(44) of
the Act, instigates the following key
question / anomalies:
a) The preamble of the rules (Rule
107), suggests that the rules ‘shall
apply to all the registered persons
receiving advances against their
taxable supplies’. On the contrary,
Rule 110 of the rules prescribe
that ‘a registered person at the
time of receipt of advances may
issue a serially numbered
“Advance Payment Receipt” in
the format as prescribed in
Annexure- A to this Chapter. The
sales tax invoice…………….may
be issued at the time of actual
delivery of goods.” It appears
that the preamble is not in
harmony with the remaining rules
as the latter provide an option /
discretion to the taxpayer to
either issue advance payment
receipt or not?
Keeping in view the provision of
section 23 read with section 2(44)
of the Act, one might construe as
if the aforesaid option applies to
only those taxpayers who do not
wish to issue a ‘tax invoice’at the
time of supply. However, there is
a need to clarify the issue for
better understanding of the
taxpayers and the tax
practitioners.
The Pakistan Accountant
b) The last sentence of Rule 110
prescribe that “no tax shall be
payable at the time of issuance of
tax invoice in pursuance of
advance payment receipt issued
by the registered person on which
tax has already been paid at the
time of receipt of advances.”
A study of the above in the light
of section 2(44) of the Act would
mean that a registered person
receiving payments would not be
liable to pay anything further in
respect of future supplies since all
the tax must have been paid at
the time of supply (receipt of
advance). In other words, we
understand that in case of
advance receipts, the supplier
(recipient of advance) is liable to
offer all the advance receipts for
tax purposes and no exception is
permissible under the statute in
this respect. In this respect, we
are also enlightened by Sales Tax
General Order (Part – 1) wherein
it has been held that:
“…sales tax is chargeable if
the amount is received in
advance. Although this
concept is clear, problems
arise when full payment is not
received and only some
percentage of the actual
amount is received in
advance.……… It is,
therefore, clarified that sales
tax for a tax period should be
charged only on that portion
of money which is received ….”
Inspite of the above, the format of
the ‘Advance Payment Receipt’
prescribes the following
additional 2 columns besides the
column of “Amount of Sales Tax
Involved”:
w Amount of Sales Tax received
in Advance
w Balance amount of Sales Tax
Payable (if any)
Based on our understanding of
law as aforesaid, we understand
that the ‘Amount of Sales Tax
Involved’ would invariably
remain equivalent to ‘Amount of
Sales Tax received in Advance’.
Accordingly, in the absence of
any relaxation in payment of
output tax on advances, there
would be no “Balance Amount
of Sales Tax” since the recipient
of money would have already
discharged all his liability to the
extent of advances. However, the
last 2 columns in the format of
the Advance Payment Receipt, as
prescribed in the rules,
contradict the last sentence of
Rule 110 of the rules, section
2(44) of the Act and the Sales Tax
General Order (Part – 1).
c) In most of the cases, the recipient
of advance does not know the
ultimate goods which would be
adjusted against such receipts.
This uncertainty hold on the
ground till the supplier receives a
confirm Purchase Order with
complete specification and
quantity of goods to be bought.
In that scenario, the prospective
supplier would not be able to
define ‘description & quantity’ of
the future goods on the face of
Advance Payment Receipt at the
time of receipt of advance.
Hence, there is a need to either
modify the said Format or to
allow the registered person not
to fill in the unwarranted
columns for lack of information.
About the Author:
Mr. Adnan Mufti is a Partner in
Shekha & Mufti, Chartered
Accountants.
He is a member of Publication
Committee of ICAP and Chairman
of Technical & Research
Committee of Karachi Sales Tax
Bar Association (KSTBA).
Readers are welcome to contact
him at: shekhamufti@cyber.net.pk
May - June 2005 36
Federal Budget 2005-06
Proposal to bring more
s e rvices into GSTNet
The Central Board of Revenue (CBR) proposes to bring more
services into the general sales tax (GST) net subjecting these
services to the Central Excise Duty in GST Mode. Before any
final decision is taken in this regard, I would urge, in the best
interest of our country to analyze the existing revenue
collection from the service providers and to make objective
cost-benefit analysis of the proposal [net revenue collection
vs. additional expenses (Registration, maintenance of
records filed, audits, litigation etc.) on net collection) of the
proposed levy of GST on more services. Each proposed
service to be taxed is to be analysed individually. As we are
all aware that if adequate net revenue cannot be generated
out of a particular service, it will be an exercise in futility
resulting not only in a net loss to the country's exchequer
but also reduced concentration on the tax collection from
the existing registered persons. For all this consequence, the
one responsible, for the final decision should owe an
explanation for the foreseeable waste of the scarce resources
since the decisions cannot be left to the caprice of the
regulators or outside agencies neither having insight of the
VAT mode in the context of our peculiar economy nor the
conditions and business practices (ability of the indirect tax
payer of passing of the indirect tax burden to the final
consumers) prevalent in the country. The problems being
faced with the existing registered persons are manifold and
in a number of cases are pending with adjudication and at
appellate forums.
The last year's reasonably low collection from the following
services (as reported in the daily, Business Recorder dated
February 17,2004) from all the four provinces reflected the
error of judgment to bring these services to the tax net in the
past.
Services Tax Collection During 2002-03
Luxurious clubs 00.58 million
Laundries & dry cleaners 02.44 million
Marriage halls, lawn 07.63 million
Beauty parlours, clinics,
slimming centers 14.45 million
The following services have, however, on the face of it
shows considerable revenue.
Hotels, restaurants,
fast food & caterers 717.00 million
Courier services 416.70 million
Advertisement on television 214.15 million
Custom agents 241.79 million
The Pakistan Accountant
Abbas, FCA
But except for the Custom agents, all of the above services
were already subjected to un-adjustable excise duty and
provincial duties wherever applicable. All such direct and
unadjustable revenues were replaced by VAT mode of Sales
Tax which allowed input tax adjustment, particularly on
electricity which form substantial part of Hotel, Restaurant
and fast food Industry. If the above tabled contribution is net
collection then reasonable otherwise the CBR need to wok
out the figures of net collection, i.e., output tax charged by
the above services less the same if claimed as input tax by
the recipients of the services in making their taxable
supplies. This net collection then be compared with what the
government was already earning on the excise duty and
provincial taxes (wherever applicable) on such services so as
to arrive at the incremental revenue.
As regards contribution from Custom agents are concerned,
the entire payments of sales tax by custom agent is the input
tax of importers which is adjustable against the supplies by
such commercial importers and in case of importers of raw
materials against the supplies of finished goods by the
manufacturers. So the ultimate (net) contribution from
custom agents seems to be ZERO. However, the state has
incurred expenses on the registration of custom agents,
maintaining voluminous record of their monthly returns
filed, maintaining their files/profile, and expenses on audit
and matters arising out to be dealt with by the
adjudication/collectorate etc.
This shows that the CBR has to give serious thought before
bringing in those services against which the buyers of these
services will have the undeniable rights under VAT mode to
adjust against their output tax due. The appropriate cost
benefit analysis should, therefore, be conducted. Further
documentation of the economy should be done only if the
desired results can be foreseen with substantial accuracy. The
economy of Pakistan has already been burdened with the
futile exercise of Survey in the name of documentation. The
failure of the government to document the retail sector is a
ground reality. The cost-benefit analysis, therefore, prevail
over the mere documentation of economy. A gradual, steady
and careful fiscal approach is the dire need to boost the
economy.
The professional firms of accountants, consultants and
lawyers, particularly large and medium sized firms provide
services mostly to the large and medium sized companies
that are already registered under the Sales Tax Act (except few
service providers) 1990. If sales tax is charged by these
professional firms to the buyer of the services, they may argue
to claim this payment as input tax (the CBR may finally, under
the logical pressure from concerned quarters, allow such
adjustments and the cost of such adjustmentsmay go unnoticed).
May - June 2005 37
Federal Budget 2005-06
The admissibility of input tax paid on
services is, however, disputed. Section 7
read with section 8 may be interpreted in
favour of the registered person and input
tax paid for the purpose of making
taxable supplies will have to be allowed.
The root cause of any taxable supply is
the carrying on of that business which
makes the taxable supply. If there is no
business there is no supply at all. All
activities of a business-whether
manufacturing, selling, finance or
administration or for that matter any
other relevant activities, must be put
together to generate taxable or non-
taxable supplies. It transpires that any
activity whether consultancy, audit,
taxation, legal services etc. are acquired
for the business then it is for the purpose
of making supplies. Any input tax paid in
acquiring such services will have to be
allowed. This is the gist of VAT mode, in
my opinion. This finally may mean
ZERO net revenue from such service
providers (the tax paid on services does
not, generally, result in the
proportionate increase in the value of
supply made by the recipient of services)
plus cost of registration, maintenance of
the records and profile of such service
providers, cost of audit, cost on
adjudication and appellate officers etc.
This fact need to be explained to those
pressure group urging that such services
be brought under tax net. The CBR is
already short of sufficient staff to cater to
the need of audit and other matter
pertaining to the existing registered
persons. The experience has shown that
adding an army of auditor is not likely to
result in increasing the revenue.
However, it is likely that the auditors,
taking the advantages of various vague
provisions of the law, may generate more
personal revenues. It has been tried at
various forums to convince the
government to simplify the law and
make them clear. The back-door, purely
budget oriented and hurriedly
introduced legislation is not only causing
problems to the honest tax-payers but
also creating problems for the CBR in the
form of unwanted disputes. It is,
therefore, more important to build an
effective system of taxation incorporating
simplified and duly legislated tax laws.
The audit being important component of
The Pakistan Accountant
any system of control is effective only if
introduced as a moral check and future
guide to improve rather than a punitive
tool in the hands of auditors allowing
them to detect irregularities to the extent
necessary to serve their purpose only.
The purely punitive tool may only teach
the registered persons to accumulate
means and commit acts to meet such
punishment on a net profit basis.
So far as the small sized firms are
concerned, they also provide the services
to the already registered persons and
impact of bringing them into net would
be almost the same as with the large and
medium sized firms. If by all means, the
CBR is forced to bring in more services
into GST net, it should atleast go for a
gradual implementation with a justified
policy for both- the suppliers of goods
and the providers of services. A good
number of the firms' gross revenue is not
over Rs.1.0 million. Since the
government has already exempted
retailers having turnover of not over
Rs.1.0million such small sized firms
need also be exempted on the basis of
their gross fee. Furthermore, turnover tax
scheme may be extended to the service
providers whose annual revenue is
Rs.1.0million and over but do not exceed
a certain sum. The definition of whole-
seller need be amended to
accommodate their exemption or to
qualify for turnover tax as the case may
be since in most of the cases their
receipts are subject to at source income
tax deduction. The above step will
enable the CBR to generate more
revenue by making least efforts and with
minimum expenditure.
Furthermore, the government needs
additional/modified enactments to
exempt the service providers from a
number of provisions of sales tax act
1990 since they are not practical. By
traditions and under the Income Tax
Ordinance 2001 such professional firms
are allowed to account for their revenue
on receipts basis due to inherent risk in
the receipts of such profession.
Therefore, the supply, time of supply and
a number of other provisions may not
practically be applied in case of such
firms. The revenue is not frequent and
not on daily basis. The requirements of
section 22 and 23 of the Sales Tax Act
may not be practically followed.
As regards indenting services, such firms
whose commission is received from the
foreign principal will have to be
exempted. By zero-rating their supply
the CBR may lose as the input tax paid
need to be refunded plus cost of
registering them and maintaining their
records/profiles etc.
It is interesting to note that the Sales Tax
Act 1990 still has its firm roots in the
repealed Sales Tax Act 1951 which
primarily dealt with sales tax on
manufacturers in Pakistan. The
categories such as importer, wholesaler,
distributor and retailer of goods were
also brought under sales tax net under
the Sales Tax Act 1990, which were all
exempt under the repealed act. The
Sales Tax Act 1990 was, however, not
modified to cater to the requirements of
taxing these further categories. Issues
relating to invoices, maintenance of
records etc. cropped up. The present
sales tax rate of 15% would be
exorbitant to the services providers. The
service providers would hardly benefit
from the GST mode, as they would
hardly have any input tax to adjust rather
they would suffer as a result of
competition since they would not be
abl;e to pass on the burden which is the
fundamental of GST Mode. It is,
therefore, important to bring in a distinct
legislation on services before bringing
more service to sales tax net.
About the Author:
Mr. Abbas is a fellow member of
the Institute of Chartered
Accountants of Pakistan. He is in
practice under the name and style
of Abbas & Co., Chartered
Accountants since September
1994. He has specialized in the
Sales Tax Laws and Systems
Consultancy. He is a member of
Technical Advisory and Quality
Control Review Committees.
May - June 2005 38
Information Technology

Flowcharting and Accountants

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(Advertising Executive 1921) who said it was a Chinese Proverb.
Noor-ul-Huda Ashraf, FCA

Definition charts provide a comprehensive system description and,

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Flowcharting is a tool originally developed in the computer w defining areas of responsibility;

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Flowcharting is probably the oldest method of w identifying key accounting controls; and
diagrammatically representing system processes (or
sequence of activities). A flow chart is a pictorial description w evaluating the efficiency of system procedures.
of how accounting transactions flow through a system.
Flowcharts clearly and graphically convey work processes, The auditors’primary purpose for preparing a flow chart is to
process controls, decision flows, time flows and paper flows. understand the system in order to identify the key control
A flowchart is a diagram made up of boxes, diamonds and attributes--those attributes that achieve control objectives. As
other shapes, connected by arrows - each shape represents a
an audit tool, the flow chart is an excellent tool that helps
step in the process, and the arrows show the order in which
internal auditors perform the study and evaluation of the
they occur. They are frequently used to visually document
organization’s systems of internal accounting control. This
how a job is being done and compare it to how it should be
can efficiently point out cases of under/over control and
done. Because there is no better way to illustrate a process,
processing redundancy. A flowchart can visually
flowcharts are no longer the domain of engineers and
communicate procedures, controls and the sequence in
auditors. Flowcharts are to managers and business owners
which they occur.
what spreadsheets are to accountants.

The advantages of using a flowchart to document a system

Overview of Flowcharting
are as follows:
A flowchart is a method for documenting and understanding
the flow of a system. A flowchart is a pictorial description of
w Flowcharts are easier and less time consuming to
how transactions flow through a system. Flow charting help
understand than a narrative.
to ensure documentation of important aspects of the
accounting system and recognition of system control points.
Flow charts conveniently describe complex relationships w Flowcharts make it easier to represent flow of transactions
because they reduce narrative explanations to a picture of using standardized symbols.
the system. They visually communicate attributes and
procedures, and the sequence in which they occur. Flow w Flowcharts are easier to update.

The Pakistan Accountant May - June 2005 39

Information Technology

Flowcharting Symbols & Their Uses

There are dozens of different symbols used in flowcharting which are confusing for the users of flowcharts. Following table
contains suggested symbols for use in the Internal Audit Department at Beaconhouse Group:

S. No. Title Symbol Description

1. Process Use it to represent an event which occurs or is controlled.

Typically this will be a step or action which is taken. In
most flowcharts this will be the most frequently used symbol.

2. Decision Use it to represent a decision point in the process.

Typically, the diamond contains a question that will require
a ‘yes’ or ‘no’ response and branch to different parts of the
flowchart accordingly.

3. Data Input / Output Use a skewed rectangle to represent a point in the

process where data is entered or retrieved.

4. Manual Input Indicates manual input of data into the system under review.

5. Manual Process Indicates a manual procedure which should be described

on the flowchart and referenced to an operation.

6. Automatic / Pre-defined Process Use to represent when an automatic event takes place.
This usually occurs as a result of external influence and
will trigger some action or process to occur.

7. Disk Storage Use to represent a database stored on a computer system.

8. Document Use to represent a report or document produced

from the computer system.

9. Multipart Document Use to represent a document with multiple pages.

10. Display Indicates a computer display screen (CRT or PC) used for
input, output, or inquiry purposes.

11. Connector Use it to represent a point at which the flowchart connects

with another process on the same page. The name or reference
for the other process should appear within the symbol.

12. Terminator Use to represent the beginning and end of a flowchart. It

can also be used to highlight an interruption point in the
flow when an external influence might be present.

The Pakistan Accountant May - June 2005 40

Information Technology
S No. Title
13. Permanent File
14. Temporary File
15. Flow Line
16. Information Line
17. Off-Page Connector
Types of Flowcharts
A flowchart is essentially a picture of a
process. Auditors have been using
flowcharts for decades as a tool to detail
management processes in order to
evaluate internal controls. The
following types of flowcharts may be
used by auditors:
Basic flowcharts quickly identify all the
major steps in a process. They are used
to orient a team with the major steps by
just giving a broad overview of the
process.
Systems flowchart - Depicts overall or
broad flow of operations (minimal
detail). They may show the flow of data
or the sequence of operations of a
system. Sometimes they include all
steps to process data into information.
Procedures flowchart - presents the
steps in a process.
The Pakistan Accountant
Symbol Description
A triangle is used to denote a permanent file. Typically the
basis for filing or order of the files is shown within the
triangle.
An inverted triangle is used to highlight a temporary file
where documents may reside in a particular order or
location for a short time only. Typically the basis for the
filing is shown as text within the symbol.
Show the connection between steps and the direction of
the process flow.
Alternate relationship between two or more symbols /
information flow.
Use when a flowchart is spread over pages. It is used to
show how and where the pages are connected with the
linking label/number shown in the symbol.
Document flowchart - depicts the flow 15 paragraphs of text that describe the
of documents through specific same thing.
processing steps.
Process flowcharts examine the process
Program flowchart - A more detailed in great detail. They provide a
comprehensive listing of all the major
flowchart that illustrates specific steps in
and sub-steps in a process.
a computer run.
Deployment Flowchart - A Deployment
Network Diagram - A network diagram
chart is used to show a process or
can show the layout of anything from a
procedure as it flows through different
small network to a world-wide network.
departments or uses different resources.
You can use hyperlinks between charts
to show the overview (organized by
Deployment flowcharts are similar to
region, department, or office) and then
Process flowcharts in that they are very
the finer details to show the actual
detailed but also indicate the people
hardware and connections.
who are involved in the process. This
could be very useful when the process
Process Flowchart - A process flowchart
is the most common type of business involves cooperation between
functional areas.
diagram, and it is used to communicate
any idea that consists of a series of
Opportunity flowcharts highlight
steps. These types of diagrams truly
demonstrate that a picture is worth a decision step and check point. They are
thousand words. It is so much easier to used for very complicated processes
learn a new task by following a process because they highlight specific
flowchart than it is to understand 10 or opportunities for improvement.
May - June 2005 41
Information Technology
Flowcharting Benefits and
Limitations
Benefits
w Portrays the logical "flow" between
tasks
w Visually successful in communicating
the sequence of tasks
w Easy to know the sequential impact
of changes
w Easy to spot redundant operations
& other inefficiencies
w Training tool for new employees
w Spot internal control weaknesses
w Helps the auditor see the “whole
picture”
w Better Communication
w Effective analysis
w Effective synthesis
w Proper program Documentation
w Effective coding
w Systematic debugging
w Systematic testing
Limitations
w Task start and finish dates are not
known.
w The duration of tasks are not
known.
w Resources needed are not known.
w Lacks the incorporation of resource
constraints.
w Physical locations of tasks are not
known.
w Difficult to distinguish importance
of tasks.
w Different levels of detail can easily
become confused.
The Pakistan Accountant
w As flowcharts become more
complex they can resemble
‘spaghetti’.
w No obvious mechanism for
proceeding from one level to the
next.
w What is done can easily get lost in
the detail of how it is done.
Flowcharting for Auditors
For decades, accountants and auditors
have used flowcharting as an audit tool
to understand and evaluate systems for
their clients.
Following is process overview for
building flowcharts:
w Auditors interview employees,
write-up narratives of the
interviews and then flowchart the
process.
w Subsequent interviews and follow-
ups result in adjustments to the
original flow chart.
w Eventually, a revised detailed
flowchart of the process is
produced as explained by
employees and confirmed by
management.
w Then management’s signatures are
obtained attesting to the accuracy
of the flow chart and the process
under review.
w From that flowchart, auditors
identify where the controls were
weak and the processes required
changes.
w The flowchart analysis of controls
helps to design an audit work
program that would test those
controls to ensure that they were
operating as designed.
w As a by-product of the evaluation of
internal control, management
usually requested a copy of the
flowchart for use in orientation
training for new employees.
In the 1980’s new flowcharting tools
were introduced which made the
standard flowcharting template a
dinosaur. The software was easy to use
and made modifications as easy as the
click of the mouse. While the software
made it easier, it is clear that
management is finding that
flowcharting was not only a science
but a combination of science and art.
Flowcharting Guidelines
and Standards
Clarity and simplicity in presentation
are essential. Mistaken use of extreme
detail may tend to conceal rather than
expose key points. However, narrative
explanations should be kept brief. In
most cases, the combination of the
flow chart and a narrative description
tends to be far superior to either
document alone.
Drawing a Flowchart
• Decide what activities are to be
shown and the purpose of
drawing the flowchart.
• Obtain the information needed
to draw the flowchart.
• A flowchart proceeds from top to
bottom and from left to right.
• Use arrow heads to show the
direction of flow and improve
clarity.
• A flowchart may be of any size
but keep dimensions and be as
neat and tidy as possible.
• Put a title on each chart
identifying the process that it
illustrates. (For example: "Order
Entry Process").
• Put the author's name and the
date on each chart.
May - June 2005 42
Information Technology
Only transactions/documents with
control significance should be shown
(i.e., control over authorization,
recording, safeguarding, reconciliation,
and valuation). This can generally be
accomplished by including only those
activities within an application where
data is initialized, changed, or
transferred to other departments. For a
process to be flow charted, it must be
broken down into its component parts,
namely actions and decisions. Also,
the name(s) and position(s) of the
people performing the transactions
should be indicated for each action.
The names of each document should
also be included within the document
symbols.
The auditor usually obtains
information necessary for preparing or
updating flow charts by interviewing
personnel at each site about
procedures followed, and by reviewing
procedure manuals, existing flow
charts and other system
documentation. Sample documents
are collected and each department
involved is questioned about its
specific duties. Inquiries can be made
concurrently with the performance of
transaction reviews, particularly when
flow charts are being updated. If
possible, the auditor should observe
the process.
Documentation
Techniques
The first step in flowcharting involves
obtaining an understanding of the
system. This involves documenting
how transactions are processed and
assets are safeguarded. The
documentation process involves
understanding how the system works
and the nature of the transactions
processed. Typically, auditors prepare
an overview which may come from the
following sources:
w Narrative descriptions of the system
w Interviews with employees
responsible for the system
The Pakistan Accountant
w Accounting and administrative
policy and procedure manuals,
charts of accounts
w Policies
w Laws and regulations
w Prior audit working papers
Interviewing Employees
Interviewing responsible personnel is a
productive way to obtain information
about how the system or process
operates. Strong interviewing
techniques are important.
It is important to select the right
employees to interview. If an employee
is responsible for an entire function,
questions should be directed
exclusively to him.
Cradle to Grave Approach
It is best to document the system from
the beginning of the process. It is much
easier if employees begin at the
beginning. The interviewer should
clearly explain the objectives of the
interview before asking any questions.
It is important that the interviewer
control the interview and not allow the
employee to wander “off track.”
Use the following guide for obtaining
the necessary information:
w Ask each employee:
q What procedures are
performed?
q What records they maintain,
including unofficial records
q What documents are processed
and what documents are
prepared?
q From whom are the documents
received?
q What information is recorded
on the documents, and what is
the source of the information?
q To whom are the documents
sent?
q What error detection methods
are used?
q What is done when errors are
found?
q When was an error last found
and describe the type of error?
w Follow one procedure at a time to a
logical conclusion.
w Ask to see documents described by
the employee, and relate them to
information received. This may
help to identify inaccuracies or
incomplete answers.
w Ask about the impact of changes in
routine during slack or busy
periods, vacations or sickness.
w Be careful not to oversimplify or
over-elaborate.
Avoiding the Common
Pitfalls of Detailed
Flowcharting
w Develop a detailed flowchart only
when it is required.
w Complicated detailed flowcharts
cannot be drawn accurately on a
first attempt. Rough out an initial
draft. Eliminate all irrelevant,
confusing information.
w Too little detail may not provide a
meaningful analysis. Clearly
understand how the flowchart will
be used before preparing.
w Large complex systems cannot be
presented in a single flowchart.
Prepare separate flowcharts tied
together by an overview flowchart.
w Provide an overview flowchart for
complex detailed flowcharts. This
provides the reader an opportunity
to understand the overall process
before attempting to understand the
detailed process and flow.
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Information Technology
Tips for Preparing
Flowcharts
w Create a flow chart beginning at a
high level on the first draft. As you
look at each of the operations or
processes, fill in the detail. Do not
be concerned about getting all the
detail on the first draft (this is an
iterative process).
w Refrain from trying to analyze and
fix a process until it is completely
flow charted.
w Review your chart. Does it show
the proper flow of information or
operations? Does it reflect
sequential and simultaneous
events? Does it accurately capture
what really happens? Are all major
decisions reflected?
w When the operations and decisions
are charted as they actually
happen, analyze the process to
determine possible improvements.
You should concentrate on
eliminating unnecessary or
Sample Process Flowchart
The Pakistan Accountant
inefficient steps or highlight major
control weaknesses such as lack of
segregation of incompatible duties,
no approval of key events, lack of
accountability.
w Involve all people actually involved
in the process in order to get
accurate perceptions.
w Have a manager or supervisor of
the actual operations review and
attest to the accuracy of the
completed flow chart.
w Clearly indicate the starting and
ending points of the process, using
the standard terminator symbols.
w Keep the direction of flow
consistent. Avoid confusion by
keeping your flow lines moving
from top to bottom and left to right.
w Number your steps.
w Break the steps down to a
consistent level of detail. Don't
include trivial sub-steps of one task
while treating another equivalent
task as a whole. If one-step or task
needs to be analyzed in detail,
make a separate chart illustrating
that sub-process.
w Avoid crossing flow lines. In a well-
designed chart, flow lines will not
cross each other. If two lines must
cross, use a "bridge" (also known as
a "line hop") to show that the lines
do not intersect.
w Make sure there are at least two
outcomes from every decision
diamond.
w Label your flowchart components.
Use active verbs to label activity
steps and questions to label
decisions. Clearly label the
outcomes from a decision diamond
in terms that answer the question.
w Know your symbols
w Create charts that flow form the top
to the bottom of the page
w Try to fit flowcharts on as few pages
as possible
About the Author:
Mr. Noor-ul-Huda Ashraf has been
working as consultant to various
companies after qualifying in 1991
from Fords Rhodes Robson
Morrow, Chartered Accountants.
His specialization is in Business
Process Reengineering and
Information Systems Management.
Currently he is working as General
Manager Energy at Beaconhouse
Group.
May - June 2005 44
Human Resource Management
ATTRIBUTES OF A SUCCESSFUL MANAGER
It may be stated at the very outset that the word MANAGER
as used in this write-up means "any person who manages"
and that he may be of any RANK / DESIGNATION / STATUS.
Man by nature is imperfect, in the real sense of the word, as
the Creator Himself has retained the divine power of
perfection with Him.
In a product manufacturing industry following is the
generally acceptable HIERARCHY of the MANAGERS who
contribute most significantly, through their respective
disciplines, in the material progress thereof.
1. Procurement Manager (both for local as well as imported
raw materials / supplies).
2. Production Manager (also called Plant/Works/Factory
Manager)
3. Sales Manager
4. Marketing Manager
5. Personnel Manager
6. Human Resources Development Manager
7. Public Relations Manager
8. Finance Manager
9. Manager – CISA (Certified Information Systems Auditor)
10. Manager – Internal Audit -Risk Assessment and
Evaluation
If a significant number of the below stated ingredients are
found in a manager, these would be construed as a Manager,
with virtues and as such he, in my humble opinion, is a
successful Manager.
I. CONTEMPORARINESS IN THE FIELD OF
DEVELOPMENT, IN HIS PROFESSION
We are today in the world of innovations which in turn have
emerged with new things coming up in operations. A
successful manager, to my mind and as the expression of an
independent opinion, is one who keeps a timely pace with
the development in his profession.
II. EXPANSION OF HORIZONS
With rapid changes taking place in the social /mercantile
/industrial and other environments, as of today it has now
become imperative to have a broadened outlook, grooming-
up, and a wide exposure to the multiple facets, within a
given discipline.
The Pakistan Accountant
Amirali Kassim Merchant, FCA
III. A WELL CONCEIVED 'TIME PLANNER’ &
THE RELATED CYCLE
Of the ladders leading towards the success of a Manager, the
above stated ingredient in my opinion, emerges to be of
pioneer / torch bearing / and one which is crowned with
famous dictum 'if time is lost, everything is lost". In other
words, Time Management in an. ideal manner, itself speaks
of the degree of success of a Manager. What it means in a
practical sense is the ensuring of an equilibrium in his
multifarious engagements of the day, week, quarter, bi-
annual and annual events taking place, of his regular
professional package of the work to be executed/ handled
most efficiently. In short, he as the Head of a given
department must be able to apply his time to the required
cycle.
IV. MANAGERIAL DECISIONS: IN THE CONTEXT
OF TIME, SOUNDNESS & EFFECTIVENESS
Gone are the days, when people used to ponder over a
long/abnormal period, by way of an interval between a.
proposal having been presented and a decision either to
implement or give-up used to take place. Although the
phenomenon as described above may be witnessed in
common among the Departments of any Government
organization, in a developing country, such a negation has
no place in the functions of a successful Manager of today.
It would not be out of place to mention here that among the
important duties which have been delegated to a manager,
his ability to take, timely, sound and effective decisions, is
the CORE of it.
The simplest, among the list of so many examples to
substantiate our contents of this para is: his ability to take a
timely and sound decision as to "whether to make, or buy,
whether to borrow or raise additional share capital".
V. APPLICATION OF LAW IN ‘SPIRIT, RATHER
THAN IN LETTERS'
A Manager of today, if he wants to be successful, in relation
to his subordinates, must exercise his managerial authority,
in the absolute context of what could be the best beneficial
judgement in the larger /supreme administration/ reigning of
May - June 2005 48
Human Resource Management
his team (which may be small, medium
or large). What it means is that he must
exercise a restraint against the use /
application of his prerogative, resulting
into an embarrassment inconvenience
/ harm, to any of his team members. If
he is wise and farsighted, then be must
remember that "a slave of today may
be the king of tomorrow”.
VI.DELEGATE AND TRUST
To manage the Departmental affairs
most successfully, it is necessary that
the authority conferred upon a
Manager be delegated in a suitable
manner among his team members.
Too-much concentration of authority
or its retention in a significant manner
by a manger himself may not result
into a smooth running of his
Departmental affairs. A time may come
when he is completely bogged down
in routine affairs or matters of an
insignificant nature, directly leading to
the application of an unproductive
time and result. Such a situation is
undesirable for a Manager both in
terms of the rank he is holding as well
as the duties he has been entrusted
with.
Another factor in relation to the
delegation is that of trust. The fact that
a Manger has delegated a part of his
authority among his team members,
equally implies on his part that. the
requisite degree of trust has been
reposed in them. Trust is the reflection
of the degree of confidence, which a
manager has in his team and that the
same is built up in the due course of
time. In short it is hereby emphasized
that a successful Manager never works
in a unilateral manner as well as in an
environment of SINGLENESS. The
more the smoothness on his part of
delegating trustworthiness among his
team, the more the prospects, .for his
departmental success.
The Pakistan Accountant
VII.LISTENING TO THE TEAM
GRIEVANCES
A successful Manager is one who never
considers himself as the SOLE
MONARCH of his kingdom, under a
belief of "MY SHIP, MY ORDER" and
such an attitude is undoubtedly to
result, sooner of later, in his downfall.
It is therefore necessary that he must
listen, very carefully, patiently,
sympathetically and impartially to all
the GENUINE COMPLAINTS being
brought to his notice by his team either
individually or collectively.
VIII. WINDOW DRESSING
/MATERIAL CONCEALMENT
A Manager is viewed in the context of
his duties, as the man reporting to
higher authority, and. there is an
absolute FIDUCIARY relationship
between him and his higher authority
Window Dressing" is the concept of a.
material concealment. A Manager must
exercise complete care that there is no
material concealment while presenting
true picture to the Management.
IX.ACCEPTANCE OF CRITICISM -
A KEY TOWARDS FUTURE
CORRECTION
It is not necessary as a matter of
prudence, that whatever a Manager
does is free from : incorrectness, fault
or mistakes. To err is human and that
an error free work is very rare.
Negative / faulty outcome of a
delegated job is bound to arouse
criticism from the Management. This
must not cause any pessimism or
disappointment to a Manager.
Successful Manager must gladly accept
the criticism, which in my opinion is a
source of strength in rectifying faults, if
any as of today, as a better destination
of tomorrow.
X. HANDS ON COMPUTER
Computer literacy has become
indispensable these days, hence each
Manager must be fully conversant with
atleast the following:
a) MS Word
b) MS Excel
c) MS Power Point
d) MS Access
e) Outlook Express
f) Use of Internet
In addition to what has been
elaborated in the preceding paragraphs
following being in an ABRIDGED
manner supplementary ingredients to
augment or provide a fillip to the
contents of this write-up.
1. Requisite degree of an acumen in
visualizing the impact of his
planned strategies.
2. An ever-readiness for an
ALTERNATIVE line of action/stand-
by under any EVENTUALITY, or
where deviation is expected to
accrue from a defined path of any
contemplated action.
3. Ability to read ACCURATELY (and
if not accurately then much nearer
thereto) the MIND of the
Management.
4. Unshattered CONFIDENCE in his
own talents, skills and dexterity.
5. RESULT-ORIENTATION being the
sole supreme goal to be chosen by
him.
6. Ability to positively ASSERT of all
his CONVICTIONS.
7. He is a problem SOLVER and not
its CREATOR.
8. He is responsible for FUTURE
LEADERSHIP. He identifies and
nurtures future Leader, as his
timely REPLACEMENT.
May - June 2005 49
Human Resource Management
9. He is a very strong
NEGOTIATOR.
10 .He defines/EXPLAINS the tasks.
His team FOLLOWS the path
drawn by him, for the
accomplishment thereof.
11. He never SURRENDERS to the
pressure.
12. He is responsible for
EFFECTIVENESS. What it means
is that efficiency is doing a
RIGHT THING whereas
effectiveness means doing the
thing in a rightful manner.
ETHICAL ATTRIBUTES
Each Manager, in addition to being a
TECHNOCRAT, which undoubtedly
his job demands, is equally, expected
to posses some ETHICAL ATTRIBUTES
in order to soften/ease the burden of
his onerous/cumbersome duties. These
ethical attributes have been stated as
under:-
Institute News
Mr. Sk. Hashmat Ali
born on 07 September
1939, Benaras in the
Province of U.P.
British India, arrived
in the former East
Pakistan (now
Bangladesh) in 1947.
He passed matriculation Examination
from the then East Bengal Secondary
Education Board, Dacca in April 1954
and graduated in Commerce from the
Dacca University in 1958 and secured
First Position. He obtained SEATO
Scholarship and did his Masters in Arts
in 1961 from the University of the
Philipplines and then proceeded to U.K.
to join M/S PricewaterHouse in London.
The Pakistan Accountant
1. Duties are his DESTINY. In other
words, he never grumbles for any
of his rights, of which he may have
been DEPRIVED of.
2. He always SERVES and that he
never RULES.
3. He ADHERES to all the
COMMITMENTS made by him.
4. NO FICKLE MINDEDNESS in the
decisions taken by him and
absolutely no COMPROMISE
there against.
5. An ever-readiness to ACCEPT
responsibility in the event of
FAILURE, if any.
6. Achievement of success is just like
an ILLUSION to him, whereas
failure, if any, (in his tasks) is an
EYE-OPENER.
7. NEUTRALITY is the only justice,
which he administers.
On having passed C.A. Final
Examinations of ICA (Eng. & Wales) in
1966 he was admitted to membership
of that Institute in October 1966.
Mr. Sk. Hashmat Ali was admitted as an
Associate Member in April 1967 of the
Institute and was admitted to Fellowship
on 23 July 1977.
He was a very senior member of the
Institute. He had joined the EPIDC in
February 1967 and subsequently joined
James Finlay & Co., Ltd., Chittagong in
April 1967 as Chief Accountant. In
1971 he came over to West Pakistan
and proceeded to Zambia to join M/s
Timber Merchants of Zambia where he
served for around 3 years. In December
8. He has an abnormal degree of
PATIENCE and BROAD
MINDEDNESS.
9. He never INFLICTS pain, he
always BEARS the pain.
10. He leaves behind himself
ASSETS/LEGACY and not any
LIABILITY.
CONCLUSION
Having discussed the above stated
"ATTRIBUTES11 of a successful
Manager. I am of the opinion that he
has to develop these not simply by
being a part of the Management, but
also by an -equal application of;
(a) Tact,
(b) Exposure,
(c) Groom,
(d) Systematized application of mental
faculties, and
(e) Humbleness / Submissiveness in
approach
OBITUARY
1975 he joined the IBRD (now World
Bank) Oil Palm Project of the Ministry
of Agriculture and Natural Resources,
E.C.S., Nigeria where he served for few
years. He returned to Paksitan in
December 1978 and than he joined M/s
Pakistan Gum & Chemicals Ltd. where
he worked upto 1980. He again joined
M/s James Finlay plc. in 1981 where he
served until 2001.
Mr. Sk. Hashmat Ali expired on 23 April
2005 due to post surgical complications
which resulted in coma and eventual
death.
He left behind a widow and two
daughters.
May - June 2005 50
SAFA Conference
The South Asian Federation of Accountants (SAFA)
conference jointly hosted by Institute of Chartered
Accountants of Pakistan (ICAP) and Institute of Cost and
Management Accountants of Pakistan (ICMAP) was held at
Karachi on May 6 and 7 2005. The theme chosen for the
conference was “Transformation of Accounting Profession”.
About 1,000 local and 45 foreign delegates attended the
conference.
The inaugural session took place at Sheraton on the evening
of May 6, 2005. Dr. Ishrat Hussain, Governor of State Bank
of Pakistan, graced the conference by being the chief guest.
Chairman of the conference organizing committee,
Mr. Khaliq-ur-Rahman presented the welcome address.
The SBP governor kept his tradition of closely interacting
with the professional accounting bodies of Pakistan and the
large gathering of professional accountants, bankers,
businessmen and regulators both from within the country
and from India, Bangladesh, Sri Lanka and Nepal were
fortunate enough to listen to his highly thought provoking
and lively address to the participants.
The chief guest dwelt at length on the macro and micro
economic issues with which the developing countries
particularly in the SAARC region are faced. He emphasized
that with the removal of quota restrictions, the European
Union countries need to take structural reforms and remove
rigidities with regard to goods and labour markets. In the
SAARC region, the governments and the exporters need to
take measures to capture the increasing market share by
enhancing productivity, improving quality and cutting costs.
The SBP governor identified 3 key risks to the global
economy, namely (1) further sharp increase in oil prices, (2)
continued fiscal and current account imbalances in USA and
(3) sluggish demand in Japan and the European Union.
The keynote speaker on the occasion was Mr. Abbas Ali
Mirza, partner of Deloitte and Touche (M.E). The participants
were fortunate that the Pakistan Consulate in Dubai, after
great persuasion and phone calls, granted him the visa to
The Pakistan Accountant
SAFA CONFERENCE Tasneem Yusuf, ACA
visit Pakistan. He presented his views on International
Accounting Standards (IAS) and International Financial
Reporting Standards (IFRS). His first slide which stated that
the suicide rate among ICAEW members was higher than the
national average caught everybody’s attention and from that
moment onwards his unique presentation kept the
participants fully involved and attentive. There was a lot of
food for thought in his presentation for all the participants.
The learned key note speaker, in view of his vast knowledge
and involvement with several Task Force and Committees,
had complete command over the subject and he very ably
discussed the problems being faced in the implementation of
several IASs, the changes in the IFRSs that he saw
forthcoming in the future and the challenges being faced by
the professional accountants the world over.
Mr. Mirza gave a practical demonstration to the relevancy of
the theme of the conference “Transformation of Accounting
Profession” by transforming himself from a highly competent
and technically sound accounting professional into a high-
class singer as after the inaugural session, he thrilled and
amazed the participants with his songs. His performance was
contrary to the popular belief that ‘we accountants can only
deal with numbers!” He had complete command on the
traditional “key notes” as well. For me it was difficult to
judge whether Mr. Abbas Ali Mirza excelled as a keynote
speaker or as a singer.
Others who spoke on the occasion were the SAFA President,
Mr. Muhammad Nurul Hassan of Bangladesh; SAFA Vice
President, Mr. Sunil Goyal of India; SAFA Advisor, Mr.
Badruddin Fakhri of Pakistan; ICAP President, Mr. Zafar Iqbal
Sobani and ICMAP President, Mr. Muhammad Rafi.
The technical sessions were held on the 2nd day of the
conference. Unlike in the past, the technical sessions were
divided into 2 groups and the participants were given the
choice to attend any 3 sessions either at Sheraton or at Pearl
Continental (PC). Full credit goes to the organizers for giving
choice to the participants. The last session was held at
Sheraton and all the participants were required to attend the
same.
May - June 2005 51
SAFA Conference
Technical sessions
The following subjects were covered in
the technical sessions held at PC.
1) Opportunities for Accountants in
the post - WTO Regime
Mr. Mohammad Hanif of Pakistan
presented this paper. The thrust of his
paper was about the changes under the
WTO regime that on the one hand
offered good opportunity to expand
and grow, while on the other hand
posed serious threats and challenges to
the developing economies. With
globalization in many aspects of life,
the financial reporting system across
the globe is governed by the IASs and
IFRSs and now the trade and industry
would be governed by the WTO rules
and regulations. He was of the view
that the accountants of Pakistan were
yet to gear up to the challenges of
WTO.
2) Role of Accountants in Poverty
Alleviation through Capacity Building
Professor Dr. Muhammad Habibur
Rahman of Bangladesh presented his
paper on “Accountants Role in Poverty
Alleviation through Capacity Building”.
He highlighted the role of NGOs,
particularly of BRAC and Grameen
Bank to address the problem of poverty
alleviation in Bangladesh. These and
other NGOs have greatly contributed
in helping the poorest of the poor to
become self-reliant through
community cooperation, training, skill
enhancement etc.
The learned speaker suggested that
accountants through cost and waste
controls and by introducing effective
accounting systems can help in
enhancing the productivity and
profitability to reduce poverty. He
suggested that the accountants could
identify small groups of entrepreneurs
for designing human resour ce
development programs to address their
The Pakistan Accountant
problems. The accountants can
identity the capabilities of individual
men and women who are the real
assets of an enterprise and the nation.
By utilizing these talents, resources cab
be put to optimum use to reduce
poverty.
3) Recent Developments in Professional
Reporting Standards and their
Implications
Mr. Reyaz Mihular of Sri Lanka
presented the paper. Mr. Reyaz is a
renowned accounting professional and
is frequently seen at numerous
international accounting seminars and
conferences where he has presented
his papers. His presentation was in the
most practical manner punctuated with
humorous comments. He discussed the
inadequacies and inconsistencies of
the IASs, the emerging trends including
the convergence of US GAAP and
moving off balance sheet items onto
balance sheet items like intangibles,
customer lists and brands. In light of
the changing scenario, the session
chairman was of the view that we need
to “unlearn, learn and re-learn” to keep
ourselves abreast of the constant
changes that are taking place in the
reporting and auditing regulations.
Sessions held at Karachi
Sheraton Hotel and Towers
covered the following topics
1) Diverse Roles of Professional
Accountants
Mr. Nadeem Mustafa Khan of Pakistan,
another eminent speaker, presented
this paper. His paper covered (i)
background – change, (ii) diverse roles,
(iii) skills, (iv) meeting the challenge
and his concluding remarks. The
learned speaker very ably and
interestingly covered the entire
spectrum of the diverse role of
professional accountants. The main
emphasis of his paper was that one has
to look to the future, be adaptive to the
changing world and provide the
infrastructure that is most supportive to
the people. Accountants are new
getting out of their traditional role of
book keeping and finance and getting
more involved in business decisions
like marketing and sales, customer
service, R&D and HRD etc. In order to
meet the new challenges, accountants
must continue to strive to enhance
their skills to be successful in the future.
2) Education, Training and Research
Mr. Kashi Prasad Khandelwal of India
presented the paper on this subject.
The learned speaker emphasized the
need to structure the education and
training of the future accountants in
such a way as to meet the demands of
standardization and globalization of
the auditing and accounting reporting
standards, corporate governance,
information technology etc. He very
ably dealt upon the present education
and training system in India and the
plans to re-design the system to cater to
the future needs of the profession,
business and industry.
3) Professional Ethics and Social
Responsibilities
Dr. Jamaluddin Ahmed of Bangladesh
was the speaker at the 6th technical
session on the subject “Professional
Ethics and Social Responsibilities”. Dr.
Jamaluddin discussed the background
of ethical issues facing the profession,
the need for ethics, common
misconceptions, the reasons why
people tend to act unethically and the
fundamental principles of professional
conduct. He emphasized the need for
professional independence and
adequate fee structure to enhance the
level of compliance to the code of
professional ethics. The speaker
distinguished the difference between
auditors and other professionals and
why it is more important for an auditor
to conduct himself at a high
professional level as the statements
certified by auditor are used and relied
upon by various stakeholders such as
the shareholders, bankers, creditors,
credit rating agencies and customers.
May - June 2005 52
SAFA Conference

After each technical paper, two
panelists very briefly commented on
the paper, which was followed by
questions and answers and concluding
remarks by the session chairmen.
The eminent scholar and Chairman of
SEC of Sri Lanka, Dr. Dayanath
Jayasuriya and Mr. Asad Ali Shah of
Pakistan jointly addressed the 7th and
last session on “Auditors in Changing
Regulatory Environment”.
Dr. Jayasuriya discussed the corporate
responsibilities and the role of the
regulatory bodies to have in place
systems that would alert them to
emerging problems and to take
corrective measures before it is too
late.
Mr. Asad Ali Shah in his address
underlined the need for auditors to
keep themselves abreast of the
challenges faced by them on account
of significant changes in the new and
revised International Standards on
Auditing (ISAs). The changes would
apply to all financial statement audits
and all audit firms. The changes
anticipate more emphasis on
inspections by the regulators. He
stressed the need for the auditors to
enhance their learning requirements
and make greater use of specialists.
The changes lay greater emphasis on
detection of frauds and errors put in
place effective risk and quality control
standards and which would involve
more independence, professional
ethics and quality learning. Changes
will continue and an auditor has to
increase his level of competence to
keep pace with the changing world.
The event concluded with remarks and
vote of thanks by Mr. Abdul Rahim
Suriya, Vice Chairman of the
conference organizing committee. This
was followed, on popular demand, by
another round of songs by the keynote
speaker and singer Mr. Abbas Ali Mirza.
The conference included trips for the
foreign dignitaries to places of
historical and cultural importance,
fishing off the coast of Kaemari and
shopping trips around the city. It was a
great sense of pride for me when all the
foreign delegates praised the
hospitality shown towards them by the
host Institutes and all its members.
About the Author:
Ms. Tasneem Yusuf is an associate
member of the Institute of Chartered
Accountants of Pakistan. She is also
a member of the Association of
Chartered Certified Accountants.
She can be contacted at:
tasneem.yusuf@yahoo.com

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The Pakistan Accountant May - June 2005 53

IFAC eNews
1. Education Committee Extends Comment
Period for Auditor Competence ED
IFAC's Education Committee has extended the comment
period on its exposure draft (ED), Competence Requirements
for Audit Professionals, until August 15, 2005. The proposed
International Education Standard is designed to ensure that
audit professionals have the necessary knowledge, skills,
values, ethics, and attitudes to perform competently and
carry out their public interest responsibilities. The proposed
standard will apply to all professional accountants, not just
the audit engagement partner, who have a substantial
involvement in the audit assignment and who are
responsible for making significant judgment decisions
contributing to the overall audit opinion.
2. IFAC Strengthens Code of Ethics for
Professional Accountants
The IFAC Ethics Committee has issued a newly revised Code
of Ethics for Professional Accountants, which establishes a
conceptual framework for all professional accountants to
ensure compliance with the five fundamental principles of
professional ethics - integrity, objectivity, professional
competence and due care, confidentiality, and professional
behavior. Under the framework, all professional accountants
are required to identify threats to these fundamental
principles and, if there are threats, to apply safeguards to
ensure that the principles are not compromised. The
framework applies to all professional accountants, whether
in public practice, business, industry or government. The
Code is effective from June 30, 2006, and early adoption is
encouraged.
3. Ethics Committee Invites Comments on
ED on Network Firms
The Ethics Committee has issued an exposure draft (ED)
proposing revisions to the definition of a network firm in the
IFAC Code of Ethics for Professional Accountants. Network
firms are required to be independent of an audit client of a
firm within the network. The ED, Proposed Revised Section
290, Independence - Assurance Engagements, proposes
changes that would classify a firm as a network firm of
another firm if the two share a common brand name or if
they share significant professional resources or revenues,
profits, costs or expenses.
The Pakistan Accountant
IFAC eNews
Comments on the ED are requested by September 30, 2005.
To download the ED, please visit http://www.ifac.org/EDs.
4. IAASB Issues New Standard on Review
of Interim Financial Information
To further enhance consistency in auditor performance and
reporting, the International Auditing and Assurance
Standards Board (IAASB) has issued a new standard:
International Standard on Review Engagements (ISRE) 2410,
Review of Interim Financial Information Performed by the
Independent Auditor of the Entity. The new ISRE contains
standards and guidance on the inquiries and analytical and
other review procedures that the auditor performs to
conclude on such interim financial information. The
standard is effective beginning December 15, 2006.
5. IAASB Invites Comments on Proposed
Standards on Auditor Reporting
The IAASB is seeking comments on exposure drafts of two
proposed International Standards on Auditing (ISAs)
designed to further enhance the quality of auditor reporting.
Proposed ISA 701, The Independent Auditor's Report on
Other Historical Financial Information, addresses auditors'
reports for a wide variety of engagements, including
reporting on a single financial statement or a specific
element of a financial statement. Proposed ISA 800, The
Independent Auditor's Report on Summary Audited Financial
Statements, provides new standards and guidance on the
criteria to be used and the procedures to be performed in an
engagement to report on summary financial statements.
Comments on the exposure drafts, which can be
downloaded at http://www.ifac.org/EDs, are requested by
October 31, 2005.
6. 2004 IFAC Annual Report Available
Online
IFAC has issued its 2004 Annual Report . The report
highlights IFAC activities to develop the global profession.
These include initiatives to strengthen standard setting, to
identify and address the needs of small and medium
practices and professional accountants in business, to reach
out to developing nations, and to encourage quality
performance by all accountants.
May - June 2005 56
IFAC eNews
7. IFAC Expands Support
for Developing Nations
IFAC's Developing Nations Permanent
Task Force is continuing its work to
build the capacity of the accountancy
profession throughout the world. To
assist in the establishment and
development of professional
accountancy bodies, the task force is
developing a tool kit that will provide
guidance on the essential elements
necessary for a successful accountancy
organization, including guidance on
relations with government,
membership requirements, education
and training, and regulation and
standard setting. The task force is also
providing comments on a number of
key projects by IFAC's standard-setting
boards and committees and other
international standard setters to ensure
they give due consideration to issues
relevant to developing nations.
For more information on these and
other initiatives, please visit the
Developing Nations Permanent Task
Force's home page.
8. IFAC Comments on IASB
Project on Accounting
Standards for SMEs
IFAC has responded to the
International Accounting Standards
Board's (IASB) staff questionnaire on
possible modifications of the
recognition and measurement
principles in International Financial
Reporting Standards (IFRSs) for use in
IASB standards for small and medium-
sized entities (SMEs). The
questionnaire was published for public
comment in early April 2005.
IFAC's preferred outcome for the SME
project, as explained in the response, is
a "substantial simplification of IFRSs for
SMEs, both in terms of disclosure and
presentation as well as recognition and
measurement." The response sets out a
package of simplifications that IFAC
The Pakistan Accountant
believes will "both serve the public
interest as well as respond to the
circumstances of SMEs and those
external users interested in their
general purpose financial statements."
IFAC's response may be downloaded
from the IFAC website. The IASB
questionnaire and other responses to it
are available on the IASB's website at
http://www.iasb.org.
9. Information on National
Regulatory Frameworks
Available as Part of IFAC
Compliance Program
As a result of Part 1 of the IFAC
Member Body Compliance Program,
Assessment of the Regulatory and
Standard-Setting Framework, IFAC's
compliance team has collected
information from more than 145
member bodies on the roles of IFAC
member bodies and other
organizations (including government,
regulatory or other appointed
authorities) with respect to:
a. Setting auditing, accounting,
ethics, public sector and
education standards; and
b. Regulating the accountancy
profession.
Over 50 responses to Part 1 have now
been posted to IFAC's website and
additional responses will be posted in
the next month. The responses provide
insight into the differences in the
regulatory and standard-setting
frameworks in place in member body
countries. Click here to view the
responses.
Part 2 of the Compliance Program, the
member body self-assessment of
compliance with IFAC's Statements of
Membership Obligations, will be
launched later this year.
10. Keynote Speeches on
International Accountancy
Issues Available on IFAC's
Website
Visitors to IFAC's website
(http://www.ifac.org) may view more
than a dozen speeches presented over
the last few months by IFAC President
Graham Ward, IFAC Chief Executive
Ian Ball and other IFAC leaders to IFAC
member bodies, regional accountancy
organizations, governmental bodies,
and investor groups on a range of
topics including the profession's role in
serving the public interest, building an
investment climate of trust, and
promoting strong corporate
governance. The speeches are
available in the Media Center
(http://www.ifac.org/MediaCenter) as
well in the Articles and Speech Library
(http://www.ifac.org/Library).
For more information about any of the
items mentioned above or for other
information about IFAC, please contact
pr@ifac.org.
About IFAC
IFAC is the worldwide organization
for the accountancy profession
dedicated to serving the public
interest by strengthening the
profession and contributing to the
development of strong international
economies. Its current membership
consists of over 160 professional
accountancy bodies in 119
countries, representing more than
2.5 million accountants in public
practice, education, government
service, industry and commerce.
The organization sets international
standards of ethics, auditing and
assurance, education and public
sector accounting and issues
guidance to encourage high quality
performance by professional
accountants in business.
May - June 2005 57
Health News
Constipation:
Prevention and Treatment
Constipation is a very common symptom at all ages,
especially in the elderly. However, at any age if it develops
as a change of bowel habit, it needs thorough evaluation by
a physician who would then seek a gastroenterologist's
opinion for further tests like sigmoidoscopy / colonoscopy
(passage of a flexible tube through rectum for examination of
rectum, sigmoid and other parts of large intestine to diagnose
or rule out problems like carcinoma, stricture, etc). Blood in
stools almost always necessitates through examination by a
gastroenterologist. The following discussion regarding
constipation is in the absence of any serious cause and is
referred to the habitual constipation or as a result of dietary
modification.
Constipation
Constipation is a symptom, not a disease. It is frequently
caused by a disturbance of how the colon (large intestine)
works. The normal functions of the colon are to:
w Remove water from the waste material that passes from the
small intestine into the colon;
w Serve as a storage area for waste material, and;
w Help move and expel stool from the body.
Constipation may occur because:
w Too much water s removed by the colon, causing dry or
hard stools;
w Stool moves too slowly through the colon, or;
w The patient is unable to expel stools.
Normal bowel habits among healthy people vary greatly
from three times a day to three times a week. In some
individuals, constipation may refer to infrequent bowel
movements (less than three in a week). While troublesome,
constipation is usually not serious. It should be treated and
corrected to reduce abdominal discomfort and other related
symptoms and to prevent the development of complications.
Untreated chronic constipation may lead to or aggravate
more serious problems such as haemorrhoids (Piles) or fecal
impaction (partial blockage due to hard stool).
Measures to Treat Constipation
The goal of treatment is to re-establish normal bowel habits
without the use of laxatives (tablets or syrups used to treat
The Pakistan Accountant
Dr. S. M. Wasim Jafri
constipation) or enemas (medicine in liquid form or water
given through anal orifice or back passage to help passing
stools). The treatment measures listed below are explained in
more detail in the following paragraphs:
w Eat a diet high in roughage (fibre);
w Eat regular meals; it is especially important to have
breakfast;
w Take bulking agent with meals and follow with a full glass
of water. Begin with:
l 1-2 tablespoons miller bran three times a day or;
l 1-2 heaping teaspoons Metamucil (Ispaghula husk) three
times a day;
w Do not take harsh (stimulant) laxatives except as directed;
w Establish regular daily bowel habits; DO NOT ignore the
urge to have a bowel movement;
w Allow 15 minutes after breakfast to sit on the toilet - do not
strain;
w If there has been no bowel movement after 48 hours, take
1or 2 tablespoons Milk of Magnesia at bedtime. If
unsuccessful, the dose may be increased the next evening;
w If now bowel movement occurs after three days, use a
glycerin suppository or, if necessary, you may take a small
tap water enema;
w Exercise daily;
w Whenever possible, avoid medications that contribute to
constipation. DO NOT stop taking any prescribed
medications unless approved to do so by your physician.
Proper Diet
The first treatment for constipation is to eat a high fibre diet
to provide natural bulk in your daily food intake. Dietary
fibre, often called roughage, is a portion of food that passes
through the intestine and colon almost unchanged.
Undigested fibre holds water to keep the stool soft and adds
bulk which helps move stool to the rectum. Most eat a lot of
roughage and this is often a major factor in frequent bowel
movement. An increase in dietary fibre generally results in a
softer and bulkier stool which can be passed more easily. For
details, consult your physician.
May - June 2005 58
Health News
Bulk Agents
Bulk agents are very useful in addition
to dietary fibre to restore and maintain
regularity. These include bran and
psyllium (Ispaghula husk).
Bran
Unprocessed bran, known as "millers
bran," can be purchased at a health
food store as an inexpensive source of
fibre. Bran is the outer coating or shell
on grain which is removed during
processing white flour. It has very little
taste. Wheat, oats and brown rice are
common source of fibre. This may be
used to supplement to fibre content of
bread.
Start with one or two tablespoons of
bran in a glass of juice or water and
gradually increase to three times a day
with meals. Start slowly to allow your
digestive system a chance to get used
to increased fibre. Bran tablets are also
available - one tablet equals
approximately two grammes dietary
fibre. Drink a full 8-oz glass of water
with the tablets. You will find both fine
bran and coarse bran available.
Purchase the coarse bran because it
holds water better.
With an increase in dietary fibre of the
addition of bran to your diet, you may
notice a temporary increase in
bloating, fullness, abdominal cramps
and gas. DO NOT STOP USING THE
BRAN! Symptoms will lessen the
bowel habits improve and usually
disappear within 2-3 weeks. If
discomfort is significant, it may be
necessary to temporarily reduce your
amount of fibre intake, then again
gradually increase it as your body
usually adjusts to the additional fibre.
Do not give up if success is not
achieved immediately.
Bran will not have any effect on stool
already in the colon. It must mix with
food in order to absorb water and
increase stool volume. Depending on
how long you have had constipation,
improvement may take a few days to
several months. Sometimes it is helpful
to empty the bowel with a laxative
before starting the high fibre and bran
diet.
The Pakistan Accountant
Commercial Bulk Agents
Commercial bulk products provide
natural or synthetic fibre which softens
the stools, increases the bulk and
makes the stool easier to pass.
Psyllium is a natural dietary fibre made
from ground husks of psyllium seed,
which has the ability to hold water and
form bulk. Psyllium holds water better
than bran, so smaller amounts are
needed to be effective. Metamucil,
Fybogel, Ispaghula husk, Isogel of
psyllium.
Synthetic or man-made bulk forming
products, such as Citrucel Tablets are
similar to psyllium. They work the
same way and may cause lass gas.
Many pharmacies sell generic brands of
bulk agents which are less costly.
Begin by taking one or two rounded
teaspoonfuls of powder one or two
times a day with meals. These agents
are very safe and if you are not getting
the desired results, you should increase
the daily dose. Mix rapidly with water
or juice and drink immediately,
followed by drinking a large glass of
fluid. Again, it may be a few days to
several months before the desired
effects are seen.
It is important to be aware that harsh
stimulant laxatives are sometimes
added to bulking agents. These are
harmful to take regularly and should be
avoided. You must ask your physician if
you are not sure a harsh laxative is
included in the product you are using.
Some individuals experience increased
difficulty with gas and bloating when
they use these products. This becomes
less of a problem when bowel habits
improve. So as with natural fibre, do
not give up if success does not occur
immediately. Once the need for bulk
agents has been established, use should
continue indefinitely unless bulking
agents are replaced by equal amounts
of natural fibre in the daily diet.
Adequate Fluid Intake
It is especially important to drink fluids
with any bulking agents, either bran or
the psyllium products. Drink at least
eight (eight ounces) glasses every day,
including one glass with each meal.
However, fluids alone will not promote
normal bowel function because the
small intestine can absorb all of this
fluid. A high fluid intake without a high
dietary fibre and bulk intake will only
result in increased urination.
Use of Suppositories and
Enemas
Avoid all harsh (stimulant) laxatives
that contain cascara, senna and castor
oil. Some of these products include
Dulcolax, Skilax. Prolonged daily use
of these agents can be habit-forming
and may damage your bowel.
A glycerin suppository may be used
during the retraining period to
stimulate the urge to have a bowel
movement. Glycerin suppositories
inserted into the rectum provide a mild
irritant to help pass the stool. You
should gradually decrease this practice
until you no longer need it.
Sometimes the above measures alone
are not effective and a laxative may be
required. If a laxative is necessary, it is
best to use one such as Milk of
Magnesia. Other magnesium products
may be recommended by your
physician. These are effective,
inexpensive and safe. They may be
taken as needed or even regularly
without fear of becoming dependent
on a laxative. When using Milk of
Magnesia, start with two tablespoons
(30 ml) by mouth in the evening.
Results from the laxative are likely to
occur the following morning. It is very
important to measure the dose
carefully. Too little may not work, too
much may cause watery diarrhoea.
You will need to experiment to find the
right dose. For example, if two
tablespoons do not work, increase the
dose to three. If three tablespoons
cause diarrhoea, try two tablespoons. It
takes time and patience to find the
right dose. By trial and error one can
find the right amount to take, but it
may take several weeks.
May - June 2005 59
Health News

If you do not have a bowel movement
for three days after beginning the
retraining programme, you may use a
single 250 cc (one cup) enema. If an
enema is necessary, use tap water. I
would recommend that you consult a
physician before the use of enemas.
Medications
Some medications slow the
movements of the colon and may
cause constipation or make it worse.
Medicines that you can buy in the
drugstore without a prescription and
which should be avoided include:
antacids containing aluminum
hydroxide (for example Aludrox) or
bismuth (for example, Pepto Bismol),
antihistamines (for example, Benadryl)
and iron. When buying medicine off
the shelf in the drugstore, ask your
pharmacist for help in choosing a drug
that does not make constipation worse.
It is important to discuss your
medications with your physicians as
there are a number of prescription
drugs that may cause constipation. Do
not stop taking any prescribed
medications without approval from
your physicians.
Habits
It is extremely important to have
regular habits to re-establish normal
bowel function. Establish a regular
routine based on your own schedule.
Try to have a bowel movement at the
same time every day. The activity of
the colon increases after waking up in
the morning and after eating, so the
urge to have a bowel movement is
usually greatest after breakfast. Get up
early enough in the morning to eat
breakfast, exercise, and sit on the
toilet. This should become a daily
routine.
Promptly obey all urges to have a
bowel movement - do not delay or
postpone a visit to the bathroom as the
urge will disappear. Repeated ignoring
of an urge will change your normal
sensation in the rectum and can lead to
constipation.
Avoid over stressing. If you feel stool in
the rectum but cannot expel it, you
may find it helpful to apply external
pressure by pushing with your hand
placed in front of the rectum or just
behind the rectum.
Whenever possible, plan in advance
for changes in your daily routine.
Constipation often occurs during
travel, vacation or stressful situations.
Take bulk agents and glycerin
suppositories with you in case you
need them.
Regular Exercise
Exercise increases muscle movements
of the colon and promotes normal
bowel habits.
About the Author:
Dr. S. M. Wasim Jafri,
FRCP, FRCPE, FRCPG, FACP, FACG
Ibn-e-Sina Professor,
Chief of Gastroenterology
Chairman, Department of Medicine
The Aga Khan University Hospital,
Karachi.

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The Pakistan Accountant May - June 2005 60

Students’ Section
The Brilliant Scholar
Mr. Irfan Ghani, a vanquisher of FOUR GOLD MEDALS in
final exam of Chartered Accountancy held in December
2004, says, "January 31, 2005 was one of the most special
days in my life. It was WONDERFUL, MARVELLOUS, AND
AWESOME. I never expected such a grand finale. Only
passing the exam within my training period would have been
quite satisfying but having done it with four Gold Ones was
a real blessing of Allah. I have secured gold medals before
but to secure four of them in the final exam of Chartered
Accountancy is something very special, a pleasure not
describable".
Education:
w September 98 – June 2005 : Chartered Accountancy from
Institute of Chartered Accountants of Pakistan
w June 98 – June 2000 : Graduation – Economics, English
Literature and Statistics (Optional), from Punjab
University, Lahore.
w June 96 – June 98 : Intermediate from Government
College, Lahore
Awards:
Chartered Accountancy
w Gold medal in Management Accounting – Final
Examination
w Gold medal in Advanced Taxation – Final Examination
w Gold medal for overall performance in Module F – Final
Examination
w Gold medal for overall performance in Module E & F –
Final Examination
w Gold medal for overall performance in Foundation
Examination
Graduation
w Gold medal for highest marks in English Literature
Intermediate
Silver medal for 2nd position in Lahore Board
I conscious keeps on nagging him and weighing him down
nterests and activities:
w English Literature – Classical and contemporary, snooker
etc.
Training:
w July 2000 to-date : A. F. Ferguson & Company, Chartered
Accountants
E-mail address: ig_ghani@yahoo.com
The Pakistan Accountant
Mr. Irfan Ghani
Interviewed by Shakil Akhtar Qureshi, FCA
After the announcement of exam results on January 31,
2005, he was invited to share coverts of his effulgent
accomplishment in professional examination of Chartered
Accountancy. He stated, "Chartered Accountancy is not
easy with one’s articles going along with one’s studies.
Passing the exams in straight attempts is blend of many
factors mainly honesty with your studies and work, prayers
of parents and friends and most importantly Graces of Allah
Almighty". His explicit riposte to assorted questions put to
him is replicated vide infra for the readers of Pakistan
Accountant in general and enlightenment of Chartered
Accountancy students in particular.
Q. Why did you choose Chartered Accountancy profession?
A. When I did my matriculation I had a faint idea that I do
not have the making of a scientist. With my schooling and
family background I knew nothing about the profession of
Chartered Accountancy. What I liked was English Literature.
In the free period before joining Government College I asked
my teacher of Literature "What is Chartered Accountancy?"
to which he replied "I do not know much about it but have
heard that it is something very professional, difficult and
adventurous." I knew my teacher to be very selective about
the use of words and these three adjectives appealed to me
so much that I decided to join the ‘elite force’.
Q. How did you plan your studies at school / university /
RAET institution and final level examination of Chartered
Accountancy?
A. I have never been a truant when it comes to studies. The
studies did not require much planning during the school,
college or RAET days. The only requirement for full time
studies is to revise daily whatever has been taught in class.
The planning is crucial when a CA student enters a CA firm.
His life is split apart in many a segment. The fight between
his conscious and sub conscious begins, whenever he is
loyally performing his duties as a trainee student his sub
about his studies. It is time for him to realize that his studies
require conscious planning. I made it my habit to study
regularly planning for the month of Ramadan which was
coinciding with my study leaves before exams of Module F.
I made a promise to myself that I will study eight hours a
week during the period from the announcement of the result
of Module E to my study leaves for Module F –
approximately 14 months. I took classes for Management
May - June 2005 61
Students’ Section
Accounting and Business Finance
Decisions quickly after my passing
Module E so that I had sufficient time to
revise the syllabus and understand the
concepts. The most important thing
which I understood very late in Module
E is the fact that good performance in
one subject and poor performance in
other subjects undermines one’s
chances of passing the final exam. All
the subjects are equally important and
hence after recognizing this fact I tried
to give equal time to every subject –
every subject is tested for 100 marks
and D grade in Auditing or Taxation is
as detrimental as it is in Financial
Reporting or Business Finance
Decisions.
Q. To whom do you owe this enviable
achievement i.e. your own hard work,
your schooling / university / RAET /
audit training background, your
parents or sheer luck?
A. Luck and blessing of parents are the
things that are indispensable in every
wake of life. I used to thank Allah a few
days before exams that I was lucky
enough that I was able to prepare for the
exams as I intended to without any
untoward incident. After every paper I
used to thank Allah that I was able to
perform in the examination hall and
negotiate with uncontrollable variables
outside the hall, variables like weather,
traffic, etc. Allah is so beneficent that
He does not let us feel our insecurity in
this world against the factors which we
cannot control, if we study hard and do
our part (the factor which we can
control) our luck would shine on us.
A man is thankfully not alone in this
world. I was supported well by my
mother, my family and friends. I would
like to name two Chartered
Accountants, Hammad Ali Ahmad and
Khawar Meer, colleagues of mine, who
inspired in me self belief that I could
strike gold. I owe this success to their
believing in me and making me prepare
for this coveted award.
The Pakistan Accountant
Q. Did you aim for distinct position /
GOLD MEDAL in final level
examination of Chartered Accountancy
well before exam?
A. Although my colleagues asked me to
plan for gold medal but the only thing I
could do to aim for it was try to cover
the whole syllabus diligently. You do
not know whom you are competing
against. I tried to understand what I was
studying and enjoyed it thoroughly. The
same amount of effort is required for
passing the final exams, the ‘over and
aboves’ are very welcome.
Q. Did you expect securing GOLD
MEDAL after final exam?
A. I could not tell how my papers would
have looked through the eyes of the
examiner. I received medal when I did
not expect it in Intermediate, CA
Foundation and Graduation but did not
get it when I expected to get one in
Financial Reporting in Module E. Hence
I decided not to expect anything golden
this time although at heart I believed all
my papers especially that of
Management Accounting went very
well.
Q. What is your advice to other
students of Chartered Accountancy to
excel in exam?
A. Well I am not in a position to advise
anyone because every student is
different and peculiar in many respects.
However, if I narrate my own strategy it
was very simple; study honestly and
seriously because my career depended
on it, take my work as trainee student
seriously as I have a commitment with
the firm, ask my mother to pray for me
and take good eight hours sleep before
every paper. Many things I have
mentioned may not seem related to
success in CA but I have said before,
Allah is the One who compensates and
rewards for things He likes – honesty,
commitment and dedication.
Q. Are you satisfied with education and
training scheme of ICAP? If not, what
are your suggestions?
A. ICAP education and training scheme
has been recognized world over by
different professional bodies of
accountants which in itself is good
evidence that the scheme is
worthwhile. But my main grievance is
with the examination system when an
unsuccessful candidate cannot get
personal appraisal of his paper even if
he is willing to pay for it. Many students
make the same mistakes in the
examination hall time and time again
but never know the cause of their failure
and as a result lose their self-
confidence. Many students with
extraordinary track record leave
Chartered Accountancy despondently
after repeated failures not because they
failed but because they did not know
why they were failed.
Q. What do you want to do for the
country in general and chartered
accountancy profession in particular?
A. My dream is to see Pakistan as a true
Islamic State and as a stepping stone I
intend to find an economically viable
solution to the problem of "riba" and
insurance - apart from changing their
name instead of substance. I believe
that there is a solution as Islamic
community thrived more in the olden
times of Khulafa than it does now, what
we lack is belief in Allah. As for
chartered accountancy profession I
would really like to play my part to
bring it at par with the standards of
accountancy profession in the
developed countries.
About the Author:
Mr. Shakil Akhtar Qureshi is a fellow
member of ICAP and member of
Publications Committee, Accounting
and Auditing Standards Committee
and Educational Research Faculty of
ICAP.
Readers are welcome to contact him
at: accountancyupdate@yahoo.com
May - June 2005 64